ARBITRATION PANEL RULES AGAINST CIBC IN HEDGE FUND SALES CASE
2.26.2005 An arbitration panel ordered the brokerage arm of CIBC, a large Canadian bank, to pay approximately $3.6 million to 11 investors who lost $5.5 million investing in a New York-based hedge fund marketed by the firm. The investors claimed that the bank's brokerage unit
conducted virtually no research on the hedge fund that it sold its client and failed to disclose that some of the sister hedge funds were poor performers.
Arbitration panels do not publish opinions on their rulings.
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INVESTMENT COMPANY INSTITUTE RELEASES 12b-1 FEE STUDY
2.25.2005 The Investment Company Institute released the findings from a survey of mutual funds on the use of 12b-1 fees. The funds responding to the survey reported their use of 12b-1. Signficant conclusions include:
- 52% went for ongoing shareholder services;
- 40% went for compensation to financial advisers in place of, or in addition to, front-end sales loads;
- 6% was paid to fund underwriters; and
- 2% went for promotion and advertising.
The survey also found that $10.4 billion in 12b-1 fees was collected in 2004, up from zero in 1980, when 12b-1 fees were first introduced. During the same time, typical front-end sales loads decreased from 8% to 5%, reports ICI Chief Economist Brian Reid.
Please click http://www.ici.org/pdf/1fm-v14n2.pdf for a copy of the study.
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INVESTMENT ADVISER MISAPPROPRIATES CLIENT ASSETS
2.23.2005 The SEC brought charges against Roger A. Householder (Householder), a CPA and formerly a
resident of Park Ridge, Illinois. Mr. Householder was an investment adviser to a number of accounting clients. He provided investment advice
individually and through his accounting firm, Householder
Accounting Services, Inc. (Householder Accounting).
The complaint alleged that Householder recommended promissory notes and interests in several
investment funds. In offering these securities, Householder, according to the SEC, knowingly misrepresented the existence of
the entity purportedly issuing the security, the use of proceeds, and
the safety of the investment. Householder then misappropriated the
assets his clients gave him to manage and the funds his clients gave him
to purchase the securities he recommended they buy.
The SEC's complaint also
alleged that Householder defrauded the Aapex Equity Fund, a registered
investment company that Householder formed in 1998. Householder made
the Aapex Equity Fund’s investment decisions through Aapex Equity
Advisors, Inc., an investment adviser he formed and for which he was
president. The complaint alleged that on a number of occasions
between March and May of 1999, Householder conducted trading on behalf
of the Aapex Equity Fund that violated restrictions on concentration of
assets and short selling set forth in the Fund’s offering materials,
resulting in the loss of all of the Fund’s assets. The SEC further alleged that Householder formed Apex Capital Management Corporation, an investment advisory firm for which he was Director of
Operations and Accounting Director, and then sold securities in Apex
Limited Partnership through fraudulent offering documents that
misrepresented Householder’s securities industry background and failed
to advise investors of Householder’s previous disciplinary history.
Finally, the SEC alleged that Householder failed to disclose his disciplinary history in Apex Capital Management’s Form ADV filed with the SEC.
Please click http://www.sec.gov/litigation/litreleases/lr19079.htm for a copy of the administrative action.
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SEC TO HOST SARBANES-OXLEY ROUNDTABLE
2.22.2005 The SEC will host a roundtable discussion and will solicit written feedback regarding the experiences of registrants, accounting firms and others in implementing the new internal control requirements under Section 404 of the Sarbanes-Oxley Act. The roundtable will be held on Wednesday, April 13, 2005, at the SEC's headquarters in Washington, D.C., beginning at 9 a.m. The roundtable will be open to the public on a first come, first served basis. The roundtable also will available by webcast. Interested parties may submit their written feedback on the internal control implementation process.
Please click http://www.sec.gov/news/press/2005-20.htm for a copy of the press release announcing the roundtable.
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NASD FINES BROKER-DEALER IN MUTUAL FUND SHELF-SPACE CASE
2.22.2005 The NASD fined one brokerage firm $570,000, and a second brokerage firm $275,000, for directed brokerage violations. The NASD found that both firms operated “preferred partner” or “shelf space” programs, giving favorable treatment to funds offered by certain mutual fund companies in return for brokerage commissions and other payments. That special treatment included higher visibility on the firms' internal websites, increased access to the firms' sales forces, participation in “top producer” or training meetings, and promotion of their funds on a broader basis than was available for other funds. The NASD claimed that this conduct violated NASD's “Anti-Reciprocal Rule” by favoring the sale of shares of particular mutual funds on the basis of brokerage commissions.
Both firms offered a preferred partner program to a relatively small number of mutual fund families. One brokerage firm operated its preferred partner program from 1998 to 2003, and included only 12 to 15 fund complexes in the program, but sold funds offered by more than 100 fund complexes. The other brokerage firm maintained its program from 2001 to 2003 and included only 16 to 20 fund complexes, while it sold funds offered by about 300 fund complexes.
The participating mutual fund companies paid the firms extra fees in addition to regular sales fees. One firm negotiated those extra payments with mutual fund companies each year, asking for minimum payments of $100,000 to $125,000. Some fund complexes paid a flat fee; others paid amounts based on a percentage of gross fund sales and the average daily assets under management for the fund complex. The other firm charged participating fund complexes 10 basis points on the gross amount of sales and five basis points on the average daily assets under management, subject to a minimum annual payment of $75,000.
Several of the funds participating in the preferred partner programs paid part or all of the extra fees by directing the funds' brokerage business to the firms. The commissions were generated by the funds through portfolio transactions which the funds executed either through the firm, in one case, or through an affiliate or third party, in the other case.
One firm, on its own initiative, conducted an internal review of the general subject matter involved in the case and self-reported its findings to NASD staff. This self-reporting was taken into account in assessing sanctions. In settling these matters, the two firms neither admitted nor denied the charges, but consented to the entry of NASD's findings.
Please click http://www.nasd.com/web/idcplg?IdcService=SS_GET_PAGE&ssDocName=NASDW_013402&ssSourceNodeId=551 for a copy of the NASD action.
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PAUL ROYE TO STEP DOWN AS DIRECTOR OF SEC'S DIVISION OF INVESTMENT MANAGEMENT
2.18.2005 Paul F. Roye, Director of the SEC’s Division of Investment Management, announced that he will leave the SEC to pursue private sector opportunities. Mr. Roye became Director of the Division of Investment Management in 1998, and was at the forefront of the development of regulatory policy for mutual funds and other investment companies. The SEC said that Mr. Roye first considered leaving the SEC nearly a year ago, but SEC Chairman William Donaldson asked him to stay in order to assist the SEC with its mutual fund reform agenda. The SEC did not indicate who would replace him.
Please click at http://www.sec.gov/news/press/2005-18.htm for a copy of the press release announcing the resignation.
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INVESTMENT ADVISER CRIMINALLY INDICTED FOR ILLEGAL FRAUDELENT IPO SCHEME
2.17.2005 Barry J. Goodman, who resides in North
Andover, Massachusetts, was indicted by the U.S. Attorney for the
District of Massachusetts on 11 criminal counts, including 3 counts of
fraud under the Securities Exchange Act of 1934and three counts of fraud under the
Investment Advisers Act.
The indictment charges that between February and August 2000, Goodman
obtained and then misappropriated $700,000 through two fraudulent
investment schemes offered through his investment advisory business, New
England Capital Advisory Group, LLC. The first scheme involved a
fictitious “initial public offering pool” (IPO Pool). Goodman collected
$500,000 from two investors after falsely representing that he would use
their funds to obtain stock in initial public offerings underwritten by
five investment banks during a specified period. Goodman, however, did
not invest the funds in IPOs. Instead, he used the funds to engage in
day trading, to pay other clients, and to pay himself.
The second
scheme involved a false "arbitrage" opportunity in the internet company,
Lycos, Inc. (Lycos). In that scheme, Goodman falsely represented to one
of the IPO Pool investors that he had created an investment strategy in
which New England Capital would buy stock in Lycos and use options to
minimize the risk that Lycos stock would decline in value. Goodman
collected an additional $200,000 from that investor. Goodman, however,
did not invest the money as he represented. Instead, as he had done
with the IPO Pool funds, Goodman used the funds to pay other clients and
to pay himself.
Please click http://www.sec.gov/litigation/litreleases/lr19050.htm for the Morgan Stanley administrative order.
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BROKER-DEALER SETTLES CHARGES RELATED TO MUTUAL FUND SHARES LATE TRADING
2.17.2005 Brean Murray, a broker-dealer registered in New York
City, consented to an order finding that from August 2001 through September
2003, Brean Murray, on behalf of Canary Capital Partners LLC (Canary)
and at least four other hedge fund customers, accepted and executed more
than 3,500 trades in dozens of mutual funds after 4:00 p.m. Eastern
Time, the time as of which those funds calculated their respective net
asset value per share (NAV). Brean Murray received and executed through its
clearing broker the overwhelming majority of these trades after 5:00
p.m. Such “late trading” violated Rule 22c-1 under the Investment Company Act.
The order further found that in August 2001, at the request of Canary,
Brean Murray began entering mutual fund trades directly into its
clearing broker’s platform as late as 5:45 p.m., but almost always after
4:00 p.m. ET. Shortly thereafter Brean Murray started entering late
trades on behalf of its other hedge fund customers.
The SEC censured Brean Murray and ordered it to cease and desist from committing or causing any
violations and any future violations of Rule 22c-1 under the Investment
Company Act, to pay a civil penalty in the amount of $150,000, as well as to
comply with certain specified undertakings.
Please click http://www.sec.gov/litigation/admin/34-51219.htm for a copy of the administrative action.
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SEC INVESTMENT MANAGEMENT SPEAKS BEFORE THE MUTUAL FUND DIRECTORS FORUM
2.17.2005 Paul F. Roye, Director of the SEC’s Division of Investment Management, spoke at the Mutual Fund Directors Forum Fifth Annual Policy Conference: Critical Issues for Investment Company Directors in Washington, D.C. Mr. Roye spoke about the Forum's Director Best Practices, Code of Ethics and the industry scandal.
The Director then spoke about the following "lessons" for mutual fund independent directors:
- Think Outside the Box
- Beware of Fund Intermediaries
- Gathering Assets at the Expense of Fiduciary Obligations
- Focus on Conflicts of Interest
- Consider Risk Assessment
Please click http://www.sec.gov/news/speech/spch021705pfr.htm for a copy of speech.
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AMERICAN FUNDS' DISTRIBUTOR CHARGED WITH VIOLATING THE NASD'S ANTI-RECIPROCAL RULE
2.16.2005 The NASD charged the distributor of the American Funds with violating the NASD’s anti-reciprocal rule, by directing $100 million in brokerage commissions over three years to 50 brokerage firms that were the top sellers of the funds it distributed. The NASD argues that its anti-reciprocal rule prohibits such quid pro quo arrangements. The rule also helps ensure that portfolio transactions by brokerage firms are guided by best execution, and not by other considerations.
The NASD complaint alleges that the distributor directed commissions to top-selling firms each year to reward them for sales. The distributor, according to the complaint, set “target commissions” for year, based on past year sales. They used 10 or 15 basis points, and directed commissions to the firms in those amounts.
The distributor admits that it took sales into consideration when two or more brokers could give best execution, but denies that it violated NASD rules. It will fight the complaint, and it has requested a hearing before an NASD panel. The American Funds are the third largest mutual fund family in the U.S., with more than $450 billion in assets, and approximately 25 million shareholder accounts.
Please click http://www.nasd.com/web/idcplg?IdcService=SS_GET_PAGE&ssDocName=NASDW_013358&ssSourceNodeId=551 for a copy of the NASD action.
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SEC FREEZES HEDGE FUND ASSETS
2.16.2005 The SEC filed an emergency enforcement action to halt fraudelent conduct by Northshore Asset Management LLC (“Northshore”) and its three principals, concerning their misappropriation of assets of two hedge funds, Ardent Research Partners, L.P. (Ardent Domestic) and Ardent Research Partners, Ltd. (Ardent Offshore). In its complaint, the SEC alleged that Northshore, through its principals, diverted approximately $37 million of the funds’ assets to their control and invested them in illiquid securities of, and made loans to, entities in which Northshore and its principals have interests.
In its emergency enforcement action, the SEC sought a temporary restraining order (i) freezing the defendants’ assets; and (ii) appointing a temporary receiver over Northshore, Ardent Domestic, Ardent Offshore, and Saldutti Capital Management, L.P. The Commission also sought orders enjoining the defendants, preliminarily and permanently, from committing future violations of the federal securities laws, and a final judgment ordering the defendants to disgorge ill-gotten gains, and assessing civil penalties.
Please click http://www.sec.gov/litigation/litreleases/lr19084.htm for a copy of the administrative action.
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J.P. MORGAN SECURITIES INC. CHARGED FOR FAILING TO PRESERVE E-MAIL
2.14.2005 The SEC settled administrative proceedings against J.P. Morgan Securities Inc.
(JPMSI), where the SEC found that during the period from 1999 to 2002, JPMSI failed to
preserve its business-related e-mail for the required three year period.
The order also found that the firm lacked adequate systems or procedures
for the preservation of electronic mail communications.
The SEC ordered JPMSI to cease from violating or future violation of recordkeeping rules under the
Securities Exchange Act of 1934 and ordered the firm to comply with undertakings to establish e-mail retention procedures that comply with the record-keeping
requirements of the federal securities laws and the rules of NASD and
the New York Stock Exchange. The SEC also ordered JPMSI to pay a
penalty of $700,000.
Please click http://www.sec.gov/litigation/admin/34-51200.htm to access the administrative action.
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SEC LOSES MUTUAL FUND B-SHARES CASE
2.10.2005 The SEC lost its case before an administrative law judge (ALJ) against a broker-dealer and three registered representatives. The SEC had accused the defendants of securities fraud in selling “B” shares to customers who, according to the SEC, should have been sold “A” shares. The judge reasoned that, though A shares may often outperform B shares, they do not always do so, and some of the specific instances where B shares would be preferable actually applied to this case. Also, the subject of whether point-of-sale disclosures should be made concerning distribution-related costs was the subject of ongoing SEC rulemaking; thus, the issue was not settled as a matter of law, and could not be enforced against the defendants as if it were.
The ALJ also held, going against the SEC, that it was not fraudulent for the registered representatives to fail to disclose the higher commissions that they would receive for sales of B shares. It was not industry practice for such information to be provided, and the absence of any SEC action in the face of proposed rulemaking, again, made it difficult for the judge to invent law in the face of SEC inaction.
Please click http://www.sec.gov/litigation/aljdec/id273cff.htm for the release about the case.
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COLUMBIA MANAGEMENT ADVISORS SETTLES CHARGES RELATED TO MARKET TIMING
2.9.2005 According to the SEC, Columbia Management Advisors, Inc. and Columbia Funds
Distributor, Inc. from at least 1998 through October 2003, Columbia
Advisors and Columbia Distributor entered into arrangements allowing
certain preferred customers to engage in short-term or excessive
trading. These arrangements were contrary to the restrictions and/or representations set forth
in the Columbia Funds’ prospectuses, that benefited Columbia Advisors
and Columbia Distributor but was detrimental to the funds’ long-term
shareholders without disclosing these trading arrangements to fund
shareholders or to fund trustees. By entering into these arrangements,
Columbia Advisors breached its fiduciary duty to the funds.
Please click http://www.sec.gov/litigation/admin/33-8534.htm for a copy of the administrative action.
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SEC INVESTMENT MANAGEMENT DIRECTOR SPEAKS ON HEDGE FUND ADVISER RULE
2.9.2005 Paul F. Roye, Director of the SEC’s Division of Investment Management, spoke at the he Managed Funds Association Educational Seminar Series 2005 Guidance on the SEC's New Regulatory Framework for Hedge Fund Advisers in Key Biscayne, Florida. Notable statements made by Mr. Roye are listed below:
- Regulation "I have no doubt that the remainder of the hedge fund advisers, who will register as a result of the SEC's new rule, will find that the registration requirement will not impede their investment operations."
- Slippery Slope "I want to assure you that hedge fund adviser registration is not the SEC's first step down a slippery slope toward more comprehensive regulation of hedge fund activities."
- Part II Update "It is very likely that the Division will recommend that the Commission revise Part II prior to next February when you are required to register. Under the current proposal to revise Part II, the format of Part II would become a plain English, narrative document. The document could be formatted with charts, graphs and other illustrations, if desired. The staff is also working on recommendations to amend the IARD system so that it can accept the electronic filing of Part II-which then will be made available to the public through the SEC's website."
- Hedge Fund Adviser CCO "Depending on the size of your advisory firm and the nature of the services you offer, it may not be necessary to have a full-time chief compliance officer. Again, you know your firms best, and the rule provides you the flexibility necessary to design a chief compliance officer position that is appropriate for you."
- CFTC Registration "Commodity trading advisors who are registered with the CFTC are not required to register with the SEC if their business does not consist primarily of acting as an investment adviser."
- 2 Year Lock-Up "I encourage hedge fund investors to seriously scrutinize any hedge fund manager that is seeking to extend redemption periods in order to avoid adviser registration. I expect that a redemption period longer than two years on all initial and subsequent investments will serve as a red flag for hedge fund investors, signaling that the adviser may be structuring its operations to avoid SEC oversight. The staff will continue to monitor this issue. If it becomes necessary to recommend rule revisions to the Commission in order to enhance the effectiveness of our hedge fund adviser registration requirements, we certainly will do so."
Please click http://www.sec.gov/news/speech/spch021705pfr.htm for a copy of speech.
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COLORADO BRINGS FRAUD CASE AGAINST HEDGE FUND
2.3.2005 The Colorado Securities Commission sued XL Capital Partners, Inc., and it principals for defrauding investors in the sale of interests in hedge funds (Hedge Funds) sponsored by XL Capital. The Colorado Securities Commission made a number of allegations, including the following:
- Beginning in 2002, XL Capital engaged in a scheme to defraud Hedge Fund investors and prospective investors by significantly inflating investment returns for the Hedge Funds. By way of example, to induce prospective investors to invest in the Vision Fund, XL Capital represented on its website that one Hedge Fund generated a 74.6% return from December 2002 through May 2003 when in fact they knew that the actual returns for this period were substantially lower. XL Capital never corrected or updated these fraudulently inflated returns but nonetheless gave prospective investors “guest access” to the XL Capital website and induced investors to rely on these fraudulent returns in making their investment decisions.
- XL Capital fraudulently overstated investment returns in account statements sent to Hedge Fund investors. Specifically, XL Capital represented to Hedge Fund investors in these account statements that the Hedge Funds generated a total return of approximately 195% from December 2002 through November 2004. In truth, XL Capital knew that the Hedge Funds generated a total return that approached zero during this period. As a result, many investors withdrew substantial profits from the Hedge Funds that in fact did not exist. These withdrawals were detrimental to the remaining investors. Furthermore, based on these inflated returns, XL Capital withdrew incentive allocations from the Hedge Funds that grossly exceeded what they were entitled to receive. By way of example, XL Capital improperly withdrew incentive allocations for periods in which they represented that the Hedge Funds generated positive returns when in fact they suffered trading losses. Reporting positive returns for periods in which the Hedge Funds actually suffered net losses also enabled XL Capital to avoid having to offset these net losses against future net profits when calculating their incentive allocation. In addition, XL Capital withdrew incentive allocations that were grossly in excess of what they were entitled to receive by significantly overstating net profits in periods in which the Hedge Funds enjoyed positive returns.
- XL Capital misappropriated investor funds to themselves.
- The PPMs generally prohibited the use of investor funds to pay commissions in connection with sales of limited partnership interests to Hedge Fund investors. Notwithstanding these restrictions, XL Capital paid substantial referral fees to itself based on a percentage of the net profits allocated to each investor referred to the Hedge Funds. And because XL Capital fraudulently overstated investment returns, these improper fees greatly exceed the maximum 20% incentive allocation the XL Capital Defendants were entitled to withdraw from the Hedge Funds. Indeed, because net profits for the Hedge Funds approached zero between December 2002 and November 2004, XL Capital was entitled to withdraw little or no inventive allocations from the Hedge Funds during this period.
Please click http://www.dora.state.co.us/securities/pdf_forms/xlcapital.pdf for a copy of the complaint.
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CFTC PROPOSES TO EXPAND CASH INVESTMENT OPTIONS FOR FUTURES COMMISSION MERCHANTS
2.3.2005 The CFTC proposed to amend its regulations regarding investment of customer
funds and related recordkeeping requirements. The proposed rule amendments relate to standards for investing in instruments
with embedded derivatives, permitted benchmarks for adjustable rate securities, and concentration limits on reverse repos. The CFTC also is proposing proposing an amendment requested by
the FIA regarding certain transactions by FCM/BDs, an amendment to
eliminate the rating requirement for money market funds, an amendment to require
that all permitted money market funds be registered with the SEC, and an amendment establishing an auditability
standard for investment records.
Please click http://www.cftc.gov/foia/fedreg05/foi050203a.htm for a copy of the release proposing the rule.
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MUTUAL FUND INDEPENDENT DIRECTOR SELF-EVALUATION REPORT ISSUED
2.1.2005 The Independent Directors Council, an association of independent mutual fund directors, has released a Task Force Report on Board Self-Assessments: Seeking to Improve Mutual Fund Board Effectiveness (February, 2005). The report provides guidance on complying with the pending regulatory requirement for virtually all investment company boards to conduct self-assessments annually. The report acknowledges that it is premature to offer best practices for the conduct of board self-evaluations, but identifies what the Task Force regards as considerations for a board embarking on the self-assessment exercise.
Please click http://www.idc1.org/getPublicPDF.do?file=18543 for a copy of the report.
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