SEC Rules and Regulations

SEC Votes to Adopt Electronic Filing of Form D and Update Form D Information Requirements

At its December 11, 2007 open meeting, the SEC voted to require the electronic filing of Form D and to update the information required to be presented in
Form D.  The July 2007 Investment Management Regulatory Update addressed the SEC release discussing the proposed rules.

Pursuant to the adopted provisions, the electronic filing of Form D will be phased in beginning on September 15, 2008.  Electronic filing of Form D will become mandatory on March 16, 2009.  The news release discussing the SEC's vote stated that the SEC would post Form D filings on its website.

The SEC also voted to require changes to the information requirements of Form D, effective as of September 15, 2008.  Key new information requirements include, but are not limited to, the following:

  • identifying all issuers in multi-issuer offerings;
  • requiring disclosure of standardized industry group information from an SEC list instead of individual business descriptions;
  • "subject to an option to decline to disclose," requiring revenue information for operating companies and net asset value disclosure for hedge funds [this will presumably be described in detail once the release becomes available];
  • noting the first date of sale of the security(ies);
  • requiring an amended Form D to correct a previously filed Form D that was initially materially incorrect or inaccurate or, due to the passage of time, has become materially incorrect or inaccurate;
  • mandating that amendments "contain current information in response to all information requests";
  • noting that any minimum investment amount applies to outside investors only;
  • eliminating broad-based expense disclosures in favor of disclosures highlighting expenses related to sales commissions and finders' fees as well as the amount of proceeds paid to "related persons";
  • eliminating the requirement to identify owners of 10% or more of a class of equity securities as related persons;
  • allowing "free writing" to add clarity to responses.

The SEC's John White, Director of the Division of Corporation Finance, expressed his hope that the newly adopted rules would allow "one-stop" filing of state and federal Form D notices and would decrease the filing burdens faced by small companies.

The full release concerning these amendments is not yet available, but it will be posted on the SEC's website "as soon as possible."


Federal District Court Grants Class Certification in 401(k) Lawsuit

In an action claiming breaches of fiduciary duty brought pursuant to Sections 502(a) and 409(a) of the Employee Retirement Income Security Act ("ERISA"), the U.S. District Court for the Western District of Missouri certified as a class certain past, present and future participants or beneficiaries of ABB, Inc.'s 401(k) plan (Ronald C. Tussey, et al., v. ABB, Inc., et al., Case No. 06-04305-CV-NKL).

ABB, Inc., a subsidiary of ABB, Ltd., a Swiss engineering conglomerate, established a 401(k) plan (the "Plan") for its employees in 1992.  ABB, Inc. served as the Plan's administrator and was designated as the Plan's fiduciary.  Starting in 1995, ABB, Inc. hired Fidelity Management Trust Company and its affiliates (together "Fidelity") to administer and manage the Plan.  According to the complaint, the Plan had over $1 billion in assets and over 12,000 participants.  Both ABB, Inc. and Fidelity were named as defendants in the lawsuit.

The complaint, initiated by several participants of the Plan, alleges numerous allegations of breaches of fiduciary duty under Sections 502(a) and 409(a) of ERISA.  In particular, the complaint alleges that ABB Inc. breached its fiduciary duty to the Plan by ceding veto power over the mixture of investment options available in the Plan to Fidelity, and Fidelity breached its fiduciary duty to the Plan by improperly excluding non-Fidelity funds from the available investment options, choosing "retail" and "actively managed" Fidelity funds with higher fees instead of private pooled investment vehicles or index funds (available to large plans such as ABB's) in order to provide additional "soft dollars" to support Fidelity's internal revenue sharing programs, and by using Fidelity-affiliated brokers and other service providers who charged unnecessarily high transaction fees.  Additionally, the complaint alleges that Fidelity and ABB, Inc. failed to properly disclose the nature of "soft dollar" arrangements to the Plan's participants.

The plaintiffs were granted class certification for their ERISA breach of fiduciary duty claims.  ERISA litigation of this sort, the court opined, "present[s] an especially appropriate instance for treatment under [the class action rules]."

Finally, the court addressed the proper scope of the class.  It held that the proper scope of the class included former Plan participants whose claims were not time-barred by ERISA's six-year statute of limitations, current Plan participants and all persons "who will become participants or beneficiaries of the Plan[] in the future."

Industry Update

SEC Releases RAND Report: "Investor and Industry Perspectives on Investment Advisers and Broker-Dealers"

Concerned that the lines between different financial services professionals, particularly brokers and investment advisers, had blurred considerably in the 1990s, in 2006 the SEC commissioned the RAND Corporation ("RAND") to study the status of the brokerage and investment advisory industries. On January 3, 2008, the SEC made available to the public a prepublication version of RAND's recently completed report, entitled "Investor and Industry Perspectives on Investment Advisers and Broker-Dealers" (the "Report").

The Report was commissioned in 2006 after a suit was filed to vacate the SEC's Rule 202(a)(11)-1 (the "Rule") under the Investment Advisers Act of 1940 (the "Advisers Act"), which deemed certain broker-dealers not to be investment advisers subject to the Advisers Act.  The court ultimately vacated the Rule (Fin. Planning Ass'n v. SEC (375 U.S. App. D.C. 389, 2007)), as discussed in more detail in the April 2007 Investment Management Regulatory Update.  The Rule was one of several SEC rule-making attempts intended to address what the authors of the Report call a "general sense of uncertainty about the regulatory categorization" of various financial service providers.

The purpose of the Report is to provide the SEC with a factual overview of the current financial services landscape and inform the SEC's approach to refining and clarifying the regulatory framework encompassing broker-dealers and investment advisers.  The Report focuses on the current business practices of broker-dealers and investment advisers and assesses investors' understanding of the differences between, and relationships among, broker-dealers and investment advisers.  While the Report does not provide policy recommendations, its authors make the following observations:

  • A few, large investment advisory and brokerage firms offer a full suite of products and services and control an "overwhelming proportion" of the market, while there are a great many niche firms that offer one or two products or services and rely on affiliations with other firms to bolster their offerings.
  • RAND "found it difficult [to] disentangle the services and business relationships of firms that were dually registered or affiliated with other firms."
  • Investment advisers, broker-dealers and their clients are dissatisfied with the current disclosure regime.  Investment advisers and broker-dealers expressed their frustration toward investors whom they felt would not read any disclosures they created, no matter how finely crafted and phrased in "plain English."  Investors, for their part, expressed frustration in what they perceived as a lack of willingness of broker-dealers and investment advisers to explain disclosures to them.
  • Investors are confused as to the differences between brokers and investment advisers, including, but not limited to, their duties, titles and services.  Among the reasons cited for this confusion was the proliferation of alternative titles, such as "financial advisor" or "financial consultant," used to describe someone who might be a broker or an investment adviser.
  • Many investors were equally willing to use a broker for investment advice as an investment adviser, despite differences in the duties owed to the investor.  Upon further questioning, most investors felt that differences between suitability and fiduciary duty are ignored in practice.
  • Most investors reported being happy with their financial services provider.  The RAND study noted that investors generally cited accessibility, attentiveness and trustworthiness as being more important to them than expertise or performance.

According to a January 9, 2008 BNA update, SEC Chairman Christopher Cox has asked SEC staff in the Divisions of Investment Management and Trading and Markets to develop policy options based on the information presented in the Report.

SEC Releases RAND Report: "Investor and Industry Perspectives on Investment Advisers and Broker-Dealers"

In a recent speech at the Investment Company Institute's 2007 Securities Law Developments Conference, Andrew J. Donohue, director of the SEC's Division of Investment Management (the "Division"), provided his views on the Division's progress on its goals for 2007 and its priorities for 2008.

Mutual find disclosure.  Donohue characterized the SEC's proposed rules regarding enhanced mutual fund disclosure (as discussed in the December 2007  Investment Management Regulatory Update) as a "win-win for fund investors" and stated that allowing mutual funds to satisfy their prospectus delivery requirements by providing investors with standardized summaries, with additional information in the form of the statutory prospectus a hyperlink away, will result in better informed investors.  Additionally, Donohue noted that mutual funds would pass on cost savings resulting from the proposed rules to their investors.

The period for comments on the proposed rules ends on February 28, 2008, and Donohue noted that the SEC is particularly interested in hearing from fund investors, especially concerning the "prototype" summary prospectus released along with the proposed rules.

Donohue applauded those mutual funds that voluntarily filed with the SEC risk/return summaries using an interactive data format developed by the Investment Company Institute (as discussed in the March 2007 and July 2007 Investment Management Regulatory Update).  He expressed optimism about the potential of interactive data filings to ease "the reporting burden on mutual funds" and to make "the information the funds do report easier to use for fund investors and regulators alike."

Review of exemptive applications.  A major goal of the Division for 2007 had been increasing the number of "substantive notices for exemption" issued under the Investment Company Act of 1940.  Donohue noted that the Division issued 81 such substantive notices in fiscal year 2007, an 84% increase over fiscal year 2006.  The number of pending applications was reduced by approximately 25%, and the median time applications remained outstanding dropped "from 16 months to 8 months over the course of the fiscal year."  Donohue outlined additional steps that the Division took in 2007 to further streamline the exemptive application process, including providing for the electronic filing of exemptive applications and the appointment of a new Associate Director, Elizabeth Osterman, who is in charge of the group overseeing the exemptive applications group.

Director outreach.  Donohue stated that he personally visited 20 boards of fund families during 2007.  He declared that he remains very interested in the role directors play on the boards of mutual funds and has asked Mark Berman, a Senior Special Counsel in the Division's Special Projects Office, to suggest rule amendments or "additional guidance."  Donohue said that his goal "is not to make fund directors' jobs easier, but to enable directors to be more effective and to more appropriately tailor their duties."

Market turmoil.  The market turmoil of 2007, Donohue noted, affected the entire mutual fund industry.  He cautioned fund managers to act in the best interest of their investors and "uphold their commitments. of liquidity and accurate valuation."  He expressed optimism that further market turmoil could be overcome by the industry so long as it upholds these fundamental principles.

After discussing his observations regarding the progress made on the Division's goals for 2007, Donohue gave an overview of two of the Division's priorities for 2008.

Rule 12b-1.  Donohue continues to believe that Rule 12b-1 is "broken, or at least not functioning as it should," and he noted his intent to reform Rule 12b-1 by considering the rule through the perspective of a "retail mutual fund investor" and not only through the perspective of a "fund insider or intermediary."  Donohue cited specifically the following concerns of the Division regarding Rule 12b-1:

  • Donohue and his staff estimate that 50% of the fees collected pursuant to Rule 12b-1 are better characterized as "asset based sales charge[s]."  Donohue said, "I want investors to better know and understand that they are paying a sales charge, whether that sales charge is paid over time and deducted from fund assets or paid in a lump sum at the time of purchase."  An investor should be informed of any and all sales charges in the fund's prospectus and trade confirmation, according to Donohue.
  • Donohue and his staff noted that some retail share classes of mutual funds bear disproportionate distribution expenses.  A better system would treat investors in each class of shares "fairly" with no one paying disproportionate distribution expenses.  According to Donohue, differences amongst share classes are often unclear to retail fund investors.
  • Donohue and his staff plan on focusing on whether investors are paying sales loads that are higher than allowed by applicable regulations.
  • Donohue noted that he and his staff are cognizant of the fact that funds often pass on additional operational expenses incurred as a result of changes in legislation to investors and would proceed with recommendations with that concern in mind.
  • Fund boards do not consider the correct Rule 12b-1 factors, according to Donohue, because they often fail to take into account the fact that Rule 12b-1 distribution fees are effectively sales charges.
  • Donohue and his staff would also like to see increased competition on sales loads, and they believe that reforms to Section 22(d) of the Investment Company Act might initiate this competition. 

Recordkeeping.  Finally, Donohue characterized the investment adviser and investment company recordkeeping regimes as very "out of date" and called for modernization of book- and recordkeeping requirements.  Technology will play a pivotal role in any modernization efforts, predicted Donohue.  The Division will focus on updating adviser books and records regulations first, using information and observations gleaned from its visits with advisory firms in 2007.

President Signs Legislation Authorizing Sudan Divestment

President Bush signed into law on December 31 the Sudan Accountability and Divestment Act of 2007 (S. 2271) (the "Act"), which authorizes state and local governments to divest from companies with certain business operations in Sudan, as described in more detail below ("covered business operations").  The Act also provides a safe harbor for registered investment companies and their advisers, and ERISA fiduciaries, with respect to certain investment and divestment decisions relating to persons engaged in covered business operations.  

Safe harbor for investment advisers and ERISA fiduciaries.  The Act amends the Investment Company Act of 1940 to disallow civil, criminal or administrative actions against any registered investment company, or any employee, officer, director or investment advisers of a registered investment company, that are based solely upon the investment company divesting from or avoiding investing in securities issued by persons that conduct or have direct investments in covered business operations.

Furthermore, the Act provides a safe harbor for a fiduciary of an ERISA plan to divest plan assets from, or avoid investing plan assets in, any person that is conducting or has direct investments in covered business operations. 

The availability of the safe harbor requires the investment company or ERISA fiduciary to make its determination using "credible information that is available to the public."  In addition, in order to take advantage of the safe harbor, registered investment companies will be required to make certain disclosures pursuant to regulations that are to be promulgated by the SEC by the end of April 2008.  For ERISA fiduciaries, the divestment or avoidance of investment decision must be made in accordance with the Department of Labor's "Interpretive bulletin relating to the fiduciary standard under ERISA in considering economically targeted investments," 29 C.F.R. 2509.94-1 (June 23, 1994).

State and local government authority to divest.  Pursuant to the Act, a state or local government may adopt and enforce measures to divest assets from, or prohibit investment of assets in, a person that the state or local government determines to be conducting or to have direct investments in covered business operations. 
To meet the requirements of the Act, a state or local government enforcing a divestment measure must provide written notice and an opportunity to comment in writing to each person to whom the measure applies.  The measure cannot apply earlier than 90 days after such notice is given, and it cannot apply to a person that demonstrates that the person does not conduct or have direct investments in covered business operations.  The Act emphasizes that a state or local government should make every effort to avoid erroneously targeting persons for divestment.  But for the notice requirements described above, the Act applies retroactively to divestment measures taken prior to the Act's effectiveness.

Finally, the Act requires a government contractor entering into an agreement with an executive agency to certify that such contractor does not conduct business operations in Sudan.  The President may waive this requirement on a case-by-case basis if the President determines it to be in the national interest to do so. 

Covered business operations.  The Act defines the covered business operations as follows:

  • Power production activities, which means any business operation that involves a project commissioned by the National Electricity Corporation of Sudan or other similar entity of the Government of Sudan the purpose of which is to facilitate power generation and delivery, including establishing power-generating plants or hydroelectric dams, selling or installing components for the project, or providing service contracts related to the installation or maintenance of the project.
  • Mineral extraction activities, which means exploring, extracting, processing, transporting, or wholesale selling or trading of elemental minerals or associated metal alloys or oxides (ore), including gold, copper, chromium, chromite, diamonds, iron, iron ore, silver, tungsten, uranium, and zinc.
  • Oil-related activities, which means (i) exporting, extracting, producing, refining, processing, exploring for, transporting, selling, or trading oil; and (ii) constructing, maintaining, or operating a pipeline, refinery, or other oilfield infrastructure.  The Act excludes from the definition of "oil-related activities" the retail sale of gasoline or related consumer products in Sudan and the lease or ownership of rights to an oil block in Sudan, as long as the entity in question is not involved in any other oil-related activities as defined by the Act.
  • The production of military equipment, which means the production of (i) weapons, arms, military supplies, and equipment that readily may be used for military purposes, including radar systems or military-grade transport vehicles; or (ii) supplies or services sold or provided directly or indirectly to any force actively participating in armed conflict in Sudan.

Business operations from which the Act does not authorize divestment are those that:

  • are conducted under contract directly and exclusively with the regional government of southern Sudan;
  • are conducted under a license from the Office of Foreign Assets Control, or are expressly exempted under federal law from the requirement to be conducted under such a license;
  • consist of providing goods or services to marginalized populations of Sudan;
  • consist of providing goods or services to an internationally recognized peacekeeping force or humanitarian organization;
  • consist of providing goods or services that are used only to promote health or education; or
  • have been voluntarily suspended.