OCIE Director Speaks on Compliance Matters
10.25.2005 OCIE Director Lori Richards spoke in Washington, D.C. at the NSCP's National Membership meeting about compliance matters and the need for better communication.
She stated that it is vital to have open lines of communication between OCIE and advisers. She stated that advisers need to get information to OCIE.
She noted that OCIE has taken the following steps to improve communication:
- OCIE established an Exam Hotline to make sure advisers could always reach a senior examination attorney in Washington, D.C. The hot line has been in place for several months. The number is (202) 551-EXAM.
- Senior officials in OCIE and in the field offices have been handing out their personal phone numbers. They also have been receiving calls. Soon, the names and phone numbers of exam program managers in the SEC's field offices will be on the SEC's website. If a CCO has a problem or a question, she encouraged adivsers to call the exam program managers.
- OCIE's policy is to provide feedback at the end of examinations, both informally via an exit interview with the firm, and then in writing in either a "no further action" letter, or a deficiency letter.
- OCIE has been conducting Chief Compliance Officer Outreach programs. OCIE wants the CCOutreach Program to be a vehicle for meaningful and personal interaction between examiners and compliance professionals.
In closing, the Director spoke about forensic testing in OCIE's examination program and she urged advisers to conduct such testing. She stated that it was clear to her that an adviser or OCIE can never be certain that they are effective in their work unless it is somehow tested.
She stated that a good forensic test has three characteristics:
- It provides a real test. In other words, it does more than simply repeat things the adviser already does.
- It helps the adviser answer the question: what am are we missing? In other words, it covers new material to test and validate the material the adviser usually work with.
- It adds current value. The adviser can use it in your everyday program.
Please click
http://www.sec.gov/news/speech/spch102605lr.htm to access a copy of the speech.
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SEC Proposes Soft Dollar Guidance
10.19.2005 The SEC published for public comment an interpretive release (the “Release”) regarding the scope of brokerage and research services in light of “evolving technologies and industry practices.”
Section 28(e) of the Securities Exchange Act of 1934 provides a safe harbor that protects money managers from liability for a breach of fiduciary duty solely on the basis that they paid more than the lowest commission rate in order to receive “brokerage and research services” provided by a broker-dealer if the managers determined in good faith than the amount of the commission was reasonable in relation to the value of the brokerage and research services received.
In the Release, the SEC reiterated the statutory requirement that money managers must make a good-faith determination that commissions paid are reasonable in relation to the value of the products and services provided by broker-dealers in connection with the managers’ responsibilities to the advisory accounts for which the managers exercise investment discretion.
The Release provides a reinterpretation of the meaning of "research and brokerage services." Research services eligible for the safe harbor provided in Section 28(e) include "advice," an "analysis" or a "report" that concerns one or more of the subject matter categories described in Section 28(e)(3)(A) and (B). For example, "research" includes advice, analysis and reports regarding the value of securities, the advisability of investing in or selling securities, economic factors and trends, portfolio strategy or the performance of accounts.
Ineligible products or services include "products with inherently tangible or physical attributes" such as telephone lines and office furniture; ineligible products or services would also include operational overhead expenses, travel, entertainment and meals associated with seminars, software for managing back office functions, computer hardware and computer accessories, telecommunications lines and computer cable.
Please click http://www.sec.gov/rules/interp/34-52635.pdf. for a copy of the proposing release.
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SEC Associate Director Speaks on Risk Assessment
10.19.2005 Mary Ann Gadziala, Associate Director of OCIE, spoke before the SIA Compliance and Legal Division Regional Seminar, on risk assessment and proactive examinations.
With respect to risk assessment, she noted that OCIE has established a formal risk assessment team. OCIE now has dedicated personnel whose sole responsibility is risk assessment. She said that this team works together with the examination staff. Together, they are developing more robust risk assessment technology, collecting and organizing risk-related data, conducting trend analysis based on examination findings, sharing information, and coordinating risk assessment examination initiatives. OCIE also is continuing what have been frequently referred to as "mini sweeps". Through these initiatives, examiners identify potential compliance risks, select appropriate candidates for review, conduct focused examinations, and prepare reports for other SEC staff. These reports present a risk analysis of the combined examination findings and make recommendations for future actions. Recommendations may include additional examinations, rule changes, interpretive guidance, or the publication of reports to share with the public sound and weak practices identified during the exams.
With respect to SEC exams, she noted that OCIE now has three types of broad-based proactive audit initiatives in our program: risk management and internal controls examinations, comprehensive compliance examinations, and our discussions with firms and analyses of conflicts of interests at those securities firms.
Please click http://www.sec.gov/news/speech/spch101905mag.htm for a copy of the speech.
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SEC May Repropose Part II of Form ADV in the Coming Months
10.18.2005 The SEC is expected to re-propose Part II of Form ADV, the registration form for investment advisers, in the Winter of 2005/2006. It will be a narrative document that resembles a brochure. This would be the same format as originally proposed five years ago.
Part II would be filed with the SEC in PDF format. There would be a brochure supplement, which would contain disclosure specific to the investment adviser representative. Large asset managers are expected to resist the brochure supplement, which received many critical comments when originally proposed.
Issues will exist on how hedge fund advisers will file Part II of Form ADV without engaging in a prohibited public offering. Hedge fund advisers were not required to register with the SEC when Part II was originally proposed.
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SEC Files Action Against a Hedge Fund Manager
10.13.2005 The SEC filed an action seeking a preliminary and permanent
injunction against Wood River Capital Management, LLC, Wood River
Associates, LLC, Wood River Partners, L.P., Wood River Partners Offshore,
Ltd. and John Whittier (collectively, the “Advisers”). The SEC alleged material misrepresentations regarding the oversight and
diversification of Wood River Partners, L.P. and Wood River Partners Offshore,
Ltd. (the “Hedge Funds”).
The SEC’s alleged that investors made investment decisions with
respect to the Hedge Funds based on representations that such vehicles
would be broadly diversified and subject to frequent audits. The Advisers,
however, failed to have any audits conducted and accumulated an extraordinary
position in EndWave Corporation, a small cap stock. By July
2005, EndWave stock accounted for 65% of the Hedge Funds’ $265 million
in assets under management, far exceeding the 10% cap on individual long
positions set forth in the Hedge Funds’ offering memoranda. Further, the
Advisers neither disclosed the size of their position to investors in a timely
manner nor filed reports required under the Securities Exchange Act of 1934.
The SEC’s complaint cited violations of the general antifraud
provisions of the Securities Act of 1933, antifraud and reporting provisions of the
Securities Exchange Act of 1934 and antifraud provisions of the Investment Advisers Act of 1940.
Please click http://www.sec.gov/litigation/complaints/comp19428.pdf. to access a copy of the complaint.
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Connecticut-Based Hedge Fund Manager Charged with Fraud
10.12.2005 The SEC filed charges in the U.S. District Court for the
Southern District of New York against Connecticut-based Durus Capital
Management, LLC, Durus Capital Management (N.A.), LLC, and its founder and various other principals ("Principals"). The Principals managed the Durus
Life Sciences Master Fund Ltd., a master fund, and two feeder funds, Durus
Life Sciences Fund, LLC and Durus Life Sciences International Fund, Ltd., as
well as the Artal Long Biotech Fund, LLC (collectively, the “Durus Funds”).
The complaint alleged that the Principals manipulated the price of two
biotechnology stocks (the “Biotech Stocks”) through regular and large block
purchases of both Biotech Stocks by the Durus Funds. Such trading purportedly
created the false appearance of demand and increased the Biotech Stocks’
prices. The Principals allegedly concealed such regular purchases and sales
from the market, and from the issuers of the Biotech Stocks, and failed to disclose
such activity as required under the federal securities laws. The SEC
specifically charged the Principals with the failure to make required filings
pursuant to Section 13 of the Securities Exchange Act of 1934, including the failure to
make at least 43 filings on Schedule 13D with respect to certain equity positions
in the issuers of the Biotech Stocks. The SEC also charged that the
Principals’ activities breached their fiduciary duties to the Durus Funds
because: (i) the Principals’ market manipulation artificially inflated the value
of the Durus Funds’ portfolios, thus resulting in higher management and performance
fees paid by the Durus Funds to the Principals, and (ii) the Durus
Funds were placed at risk with high concentrations in two thinly-traded stocks.
On the same day as the SEC’s complaint, Schmidt plead guilty to one count of
aiding and abetting the filing of false statements with the SEC and faces up to
20 years in prison and a fine of up to $5 million.
Please click http://www.sec.gov/litigation/litreleases/lr19426.htm. to access a copy of the administrative action.
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SEC Issues No-Action Letter Regarding Status of Foreign Bank Under the 1940 Act
10.12.2005 The SEC's Division of Investment Management issued a no-action letter
with respect to Rule 3a-6 under the Investment Company Act
of 1940 (the “1940 Act”), which excludes a “foreign bank” from the definition of “investment company.” Rule 3a-6 provides that a foreign bank will not
be considered an investment company if such bank is a banking institution
incorporated or organized under the laws of a country other than the United
States that is:
- regulated as such by that country’s government;
- engaged substantially in commercial banking activities; and
- not operated for the purpose of evading the provisions of the 1940 Act.
Rule 3a-6(b)(2) further defines “engaged substantially in commercial banking activity” as “engaged regularly
in, and deriving a substantial portion of its business from, extending commercial
and other types of credit, and accepting demand and other types of
deposits, that are customary for commercial banks in the country in which the
head office of the banking institution is located.”
The foreign bank sought the ability to rely upon the Rule if were to derive
“a substantial portion of its business from” commercial banking activity if the
average of the separate percentages obtained by computing such entity’s: (i)
credit extension revenues as a percentage of such foreign bank’s revenues; (ii)
receivables from credit activities as a percentage of the foreign bank’s assets;
and (iii) aggregate deposits as a percentage of the foreign bank’s liabilities,
exceeds 10% (the “10% Test”).
The SEC staff declined to interpret “a substantial portion” based on the 10% Test. Instead, the SEC set forth certain banking activities that it would expect a foreign bank
to be engaged in to meet the “substantial” standard. The SEC staff
expects a foreign bank:
- to be authorized to accept demand and other types of deposits and to extend commercial and other types of credit;
- to hold itself out as engaging in, and to engage in, each of those activities
on a continuous basis, including actively soliciting depositors and borrowers;
- to engage in both deposit taking and credit extension at a level sufficient
to require separate identification of each in publicly disseminated reports
and regulatory filings describing the bank’s activities; and
- to engage in
either deposit taking or credit extension as one of the bank’s principal activities.
Please click http://www.sec.gov/divisions/investment/noaction/seward101205.htm. to access a copy of the SEC no-action letter.
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Court Enters Order Against Operators of a Web Site Purporting to be a Mutual Fund
10.12.2005 The United States District Court of New Hampshire, entered a judgment by default against FairPax.com,
FairPax, Inc. and the unknown owners and operators of FairPax identified
as John Does 1-20. In a complaint filed on June 21, 2004, the SEC alleged that FairPax.com was impersonating a New Hampshire
mutual fund complex and promising investors returns of 657% per year.
The court’s judgment permanently enjoins the defendants from violating
the federal securities laws.
The SEC’s complaint alleged that the FairPax website contained
descriptions of purported socially responsibly mutual funds that were
taken verbatim and without authorization from the description of the
high yield mutual fund offered for sale by a registered New
Hampshire-based mutual fund complex, Pax World Funds. FairPax also
falsely identified Pax World’s chairman and president as its own. The
SEC’s complaint further alleged that the mutual funds offered by
FairPax had not been registered with the SEC, as required.
Finally, the SEC’ s complaint alleged that the defendants
promoted their scheme with fraudulent promises of a 657% annual return.
The Court’s final judgment enjoins defendants from future violations of
Sections 5(a), 5(c), and 17(a) of the Securities Act of 1933 and Section
10(b) of the Securities Exchange Act of 1934 and Rule 10b-5 thereunder.
Please click http://www.sec.gov/litigation/litreleases/lr19431.htm to access a copy of the SEC release announcing the order.
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Certain IARD Fees Waived
10.7.2005 The SEC issued an order waiving, for one year, Investment Adviser
Registration Depository annual filing fees for advisers registered with
the SEC. The waiver will apply to IARD system fees due in
connection with annual updating amendments filed from November 1, 2005,
through October 31, 2006.
Separately, the North
American Securities Administrators Association (NASAA) announced that it is reducing by 30 percent system fees paid by state-
regulated investment advisers on an on-going basis. NASAA is waiving payment of IARD system renewal fees by state-regulated
investment advisers and all investment adviser representatives.
Currently, state-regulated investment adviser firms pay an annual system
fee of $100 and individual representatives pay an annual system fee of
$45. NASAA also announced that the system fees paid by state-regulated
investment advisers will be reduced by 30 percent to $70 on an on-going
basis.
The IARD system is an Internet-based national database sponsored by
NASAA and the SEC and operated by NASD in its role as a vendor. IARD
provides a single nationwide database for the collection and
dissemination of information about individuals and firms in the
investment advisory field; and offers investment advisers and
representatives a single source for filing state and federal
registration and disclosures. IARD system fees are used for user and
system support along with periodic enhancements to the system.
Please click http://www.sec.gov/litigation/admin/ia-2435.pdf to access a copy of the administrative order.
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SEC Reimposes Sanctions on Advisory Firm That Made Improper IPO Allocations
10.4.2005 On remand from the Court of Appeals for the Seventh Circuit, the SEC reassessed the sanctions previously imposed on Monetta
Financial Services, Inc. (MFS), a registered investment adviser. The
Court affirmed the SEC's finding that MFS violated Section 206(2)
of the Investment Advisers Act of 1940 by failing to disclose to mutual fund
advisory clients its allocations of shares in initial public offerings
(IPOs) to a director and two trustees of those clients. However, the
Court remanded the matter for reconsideration of the sanctions that the
SEC had imposed.
The SEC noted that MFS had breached its fiduciary duty to its
fund clients by failing to disclose the IPO allocations. It further
noted that the breach occurred in a situation that was "fraught with the
potential for abuse." The allocations created the potential that the
director and trustees might favor MFS's interests over those of their
funds, which could have subverted the oversight of MFS and allowed it to
act in its own self-interest at the funds' expense.
Please click http://www.sec.gov/litigation/opinions/ia-2438.pdf for a copy of the administrative order.
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SEC Seeks Industry Help to Make Financial Data Filed with the SEC to be More Interactive
10.4.2005 The SEC released a Request for Information (RFI)
concerning interactive financial data. The SEC stated that interactive data holds the
promise of transforming the static, text-only documents companies file
with the SEC into dynamic financial reports that can be quickly and
easily accessed and analyzed.
The RFI seeks information from the software industry to assist the
SEC’s staff in identifying ways to receive, store, view, and
analyze interactive financial data. For the past 10 months, since
February 2005, the SEC has been testing financial data tagging
technology through a voluntary program that allows registrants to file
periodic and investment company reports using interactive data.
By using computer codes to "tag" different kinds of data in financial
reports, the information companies file with the SEC can be made
much easier to find and analyze. For example, specific items in a
financial statement, such as net income or gross sales, are given
computer-readable labels. At the same time, the task of preparing the
reports can be automated for the companies who file them.
Interactive data relies on standard definitions to "tag" various kinds
of information, turning financial reports that have previously been text-
only into documents that can be retrieved through computer searches, and
analyzed in a variety of spreadsheet programs and analytical software.
The data can also be more readily used to compare companies’ financial
performance, both for investors who are seeking attractive investment
opportunities, and for regulators looking for fraud.
Please click http://www.sec.gov/news/press/2005-141.htm to access a copy of the press release.
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New York Hedge Fund Manager Charged with Fraud
10.1.2005 The SEC brought charges against Joseph W. Daniel, former managing partner of the Critical
Infrastructure Fund (the "Fund"), a hedge fund based in New York that
invested primarily in telecommunications and internet companies.
The SEC alleged that Daniel was managing partner for the hedge fund from March 1999 to February 2002, and during that time was
responsible for valuing private placement investments held in the hedge fund’s
portfolio. The SEC further alleged that Daniel wrote up the value
of the hedge fund’s private placement investments by over 20%. Starting in at
least December 2000, however, Daniel improperly failed to write down the
value of the private placement investments when those companies
encountered financial difficulties, even when some declared bankruptcy.
As a result, Daniel made misrepresentations to investors about the value
of their investments in the hedge fund and the hedge fund’s performance, allowed
certain investors to redeem their shares at inflated values to the
detriment of the remaining investors, and inflated the management fees
paid by investors. These events caused significant losses for
investors. In addition, the complaint alleges that when new investors
invested in the hedge fund in December 2001 and January 2002, Daniel made
misrepresentations about the hedge fund’s assets, performance, and the
percentage of assets the hedge fund invested in private placements.
Please click http://www.sec.gov/litigation/litreleases/lr19427.htm to access a copy of the administrative order.
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