Industry Update

SEC Chairman Shapiro Testifies Before Congress on SEC Agenda

On March 26, 2009, SEC Chairman Shapiro testified before the Senate Committee on Banking, Housing and Urban Affairs with regard to SEC objectives for investor protection enhancement and securities market regulation.  In her prepared statement, Shapiro outlined the SEC’s agenda for, among other things, strengthening oversight related to the safekeeping of investor assets, money market fund standards, credit rating agencies, investor access to public company proxies and short selling.

Shapiro explained that the SEC may request legislation to fill regulatory gaps relating to hedge funds, hedge fund investment advisers, municipal securities and credit default swaps.  Schapiro further indicated that the SEC may recommend legislation to eliminate the requirements for differing regulatory regimes for investment advisers and broker-dealers. Shapiro also noted that the SEC staff is developing reforms to better protect investor assets. Among these measures is a proposal to require investment advisers that have custody of client assets to undergo an annual, unannounced third-party audit to confirm that the assets are being properly safeguarded.

In addition, Shapiro expects the SEC staff to recommend a proposal requiring investment advisers to undergo third-party audits to ensure compliance with the law, and to require senior officers of broker-dealers and investment advisers with custody of client assets to attest to the adequacy of their controls.  Shapiro stated that the SEC was considering measures to “improve the credit quality, maturity, and liquidity standards” applicable to money market funds in order to ensure that such funds do not experience a drop in net asset value below one dollar per share.  Turning to SEC oversight of credit rating agencies, Shapiro emphasized the significant reforms adopted by the SEC since 2006, and stressed the importance of continued activity in this area.

Shapiro noted that she intends to make “proxy access,” which she characterized as “meaningful opportunities for a company’s owners to nominate its directors,” a key part of the SEC’s agenda.  Shapiro also indicated that the SEC will consider proposals to reinstate the uptick rule, “or something much like it,” and explained that she expects to come before Congress in the near future to seek authority to pay whistleblowers who provide the SEC with “well-documented” information on fraudulent activity.

Finally, with respect to the creation of a systemic risk regulator, Shapiro testified that she “strongly support[s] the view that there is a need for system-wide consideration of risks,” adding that “a strong and investor-focused capital markets regulator complements the role of a systemic risk regulator.”  In closing, Shapiro emphasized that the SEC has made substantial progress in reinvigorating its enforcement program since she joined the agency in January.  Shapiro stated, however, that additional measures are still required.

SEC to Seek Third-Party Confirmation of Investor Assets

On March 9, 2009, Gene Gohlke, the Associate Director of the SEC’s Office of Compliance Inspections and Examinations, sent separate letters (the “Letters”) to the Managed Funds Association and the Investment Adviser Association indicating that, going forward during the course of SEC examinations of the books and records of SEC-regulated persons and organizations, such as registered investment advisers, SEC staff may request independent confirmation of investor assets from (i) bank and broker-dealer custodians, (ii) account administrators, (iii) investors in hedge funds managed by the adviser, (iv) advised clients, (v) derivative counterparties, (vi) hedge fund administrators and/or managers in which advised clients invest, (vii) the National Securities Clearing Corp., (viii) the Depository Trust & Clearing Corp. and (ix) auditors for the advisory firm and/or investor accounts (collectively, the “Third Parties”).

The SEC staff will seek confirmation from Third Parties of cash and securities held by clients and confirmation of account transactions.  If seeking confirmation from advised clients, the SEC staff will ask the clients to confirm that the account balances reflected in the investment adviser’s records are consistent with their individual records and that they authorized the contributions and withdrawals that occurred in their accounts over a period of time.  In seeking confirmation from investors in hedge funds managed by registered investment advisers, the SEC staff will request that investors confirm that the capital account balances reflected in the hedge funds’ records are consistent with the investors’ records.

The Letters further provide that SEC communications with Third Parties are non-public, and that requests for confirmation of investor assets from Third Parties should not be considered an indication that the investment adviser has violated any law or otherwise adversely reflect upon the investment adviser or its affiliates.  The Letters state that “[t]he staff’s letter seeking such confirmation will make clear that the request should not be considered as a reflection on the adviser or that any violation of law has occurred.”

In light of the various frauds on investors that have come to light in the last few months, incorporation of third-party verification into SEC compliance exams is not surprising, although confirmation by actual clients and investors is unprecedented and may create concern for managers, e.g., that a call from the SEC could provoke unwarranted worries for a client or investor.

ICI Releases Recommendations for Money Market Funds

On March 17, 2009, the Investment Company Institute (the “ICI”) released the report of its Money Market Working Group that details its proposals and recommendations for reform of money market funds and the money market industry.  The reforms aim to improve the resistance of money market funds to adverse market conditions by addressing regulatory weaknesses, improving safety and oversight, and providing the government with detailed data to enhance surveillance.

The report comes in the wake of the Reserve Primary Fund having “broken-the-buck” in September 2008, a development which led investors to withdraw substantial sums from money market funds, threatened a run on the bank, triggered a collapse in the commercial paper market, and necessitated a temporary Federal Reserve guarantee of money market funds.  Since that time, Treasury Secretary Geithner has specifically charged the SEC with the task of money market fund reform and, as discussed in SEC Chairman Shapiro Testifies Before Congress on SEC Agenda above, SEC Chairman Schapiro has testified before Congress that the SEC plans to present proposals this spring aimed at strengthening money market mutual funds.  Notable recommendations included in the ICI’s report are summarized below.

Liquidity.  Five percent of the net assets of taxable money market funds should be required to be held in securities accessible within one day; 20 percent of the net assets of all money market funds should be required to be held in securities accessible within seven days.  Additionally, mandatory stress testing should be required in order to assess a portfolio’s ability to meet certain levels of shareholder redemption, credit risk and interest rate change and to evaluate whether higher levels of portfolio liquidity are required.

Portfolio Maturity.  The maximum weighted average maturity (“WAM”) of fund portfolios should be shortened from 90 days to 75 days.  Additionally, a new WAM calculation—“spread WAM”—should be adopted, which would require funds to calculate WAM using a security’s stated final maturity date or the date on which principal and interest payments may be demanded.  Spread WAM differs from traditional WAM measurements in that it does not allow funds to use interest rate reset dates of variable- and floating-rate securities as a measure of their maturity.  Spread WAM may not exceed 120 days.

Credit Analysis.  Money market funds should be required to establish “new products” committees to evaluate new investment products that may be eligible for purchase by money market funds, but which may ultimately be imprudent money market fund investments.  Moreover, funds should follow certain best practices in determining whether securities present minimal credit risks.  Finally, the SEC should retain ratings as a credit analysis starting point under Rule 2a-7 under the Investment Company Act of 1940 (the “Investment Company Act”), and money market funds should designate at least three credit rating agencies of which they will monitor the ratings in determining the eligibility of a portfolio security.

Client Risk.  In order to avoid anticipated redemption pressure, money market fund advisers should be required to adopt substantial “know your client” procedures.  In addition, money market funds should be required to provide monthly disclosure on their Websites concerning client concentration levels and resultant risks.

Possibility of a “Run”.  The SEC should permit money market fund boards of directors, including independent directors, to temporarily suspend redemptions under exigent circumstances for up to five business days in order to take corrective measures with respect to a fund that either has fallen or reasonably believes it may fall below a one dollar per share net asset value.  Fund boards should also be able to suspend redemptions permanently upon a determination to liquidate a fund, and within five business days after such a determination, approve and announce a plan of liquidation.

Investor/Market Confusion.  As many investors incorrectly believe that money market funds always return principal in full, money market funds should reassess their risk disclosures, including in advertising and marketing materials, to ensure that risks are adequately addressed.  Furthermore, funds should provide monthly portfolio disclosure on their Websites to allow analysts and commentators to compare funds and highlight notable items to the market.  Finally, the SEC should adopt a rule under the Investment Advisers Act of 1940 to help investors distinguish funds which are similar to money market funds but that are not subject to the risk limitation requirements applicable to money market funds.

Government Oversight.  Given the systemic importance of the market of taxable money market instruments in which money market funds invest, money market funds and other institutional money market investors should provide the appropriate government body with nonpublic data to facilitate oversight of the markets as a whole.  Additionally, each month, the SEC should monitor money market fund performance on a categorical basis, scrutinize funds which significantly outperform their peers—as such performance may be indicative of higher risk assumption—and monitor ten randomly selected funds.

Governmental Matters.  The Treasury Guarantee Program should be extended until September 18, 2009 (see related article on announced extension below). Additionally, a no-action letter previously issued to the ICI by the SEC in relation to money market fund valuation in exigent circumstances, which expired in January 2009, should be made available for reinstatement upon the motion of the SEC or upon industry request.  Separately, to minimize the use of government resources in processing requests by money market fund sponsors to provide certain financial support to their funds, Rule 19a-9 under the Investment Company Act, which permits such support, should be expanded, and sponsors should be required to provide nonpublic notice to the SEC of reliance on the rule.

Other.  Money market funds should be prohibited from investing in second-tier securities (i.e., securities with the second-highest short-term rating, or comparable securities), as currently allowed under Rule 2a-7.  The SEC should modernize money market fund regulation to reflect an appropriate oversight role for fund boards, with a particular emphasis on avoidance of money market fund board involvement at inappropriate levels of the investment process.

On March 18, 2009, the ICI Board of Governors endorsed the report’s recommendations and called for prompt implementation of the recommendations that do not require prior regulatory action.

Treasury Announces Extension of Temporary Guarantee Program for Money Market Funds

On March 31, 2009, the U.S. Treasury Department announced that it was extending its temporary guarantee program for money market funds (the “Program”) through September 18, 2009.  The Program had been scheduled to end on April 30, 2009.  Pursuant to the extension, Treasury will continue to guarantee the share price of eligible money market funds that have participated in the Program since inception and that apply for and pay to continue to participate in the Program.

As reported in the October 8, 2008 Investment Management Regulatory Update, money market funds originally eligible to participate in the Program included funds regulated under Rule 2a-7 under the Investment Company Act of 1940 that are publicly offered, have a policy of maintaining a stable net asset value (“NAV”) of $1.00 per share, and had a NAV on September 19, 2008 of at least $0.995.  Funds whose NAV was less than $0.995 on September 19 were not eligible to participate.

Under the extension, money market funds currently participating in the Program that meet the extension requirements of their “Guarantee Agreement” will be eligible to continue participating in the Program; funds that do not currently participate in the Program will not be eligible to participate.  Funds wishing to continue participating in the Program must submit a program extension payment, an extension notice and an updated Annex A by April 13, 2009, and a Bring-Down Notice by May 11, 2009.

Federal Identity Theft Prevention Laws Become Effective on May 1, 2009

Under a new set of rules, referred to as “Red Flag Rules” (the “Red Flag Rules”), adopted by the Federal Trade Commission pursuant to the Fair and Accurate Credit Transactions (FACT) Act of 2003, investment companies that are “financial institutions” must establish and obtain board approval of an identity theft prevention program (a “Program”) by May 1, 2009.

For purposes of the Red Flag Rules, the term “financial institution” means any person or institution that “directly or indirectly holds a transaction account belonging to a consumer.”  “Transaction account” is defined as an “account on which the depositor or account holder is permitted to make withdrawals by negotiable or transferable instrument, payment orders of withdrawal, telephone transfers, or similar items for the purpose of making payments or transfers to third persons or others.”  Therefore, only funds that permit investors to make withdrawals (or redemptions) payable to third persons by check, transferable or negotiable instruments, or similar items are subject to the Red Flag Rules.  For example, the Red Flag Rules could apply to a money market mutual fund that permits shareholders to write checks from their accounts.  In addition, because most mutual funds allow investors to direct payment to others, they may also be subject to the Red Flag Rules.

Financial institutions subject to the Red Flag Rules must establish a written Program in connection with the opening of any “covered account”[1] that (i) identifies relevant Red Flags[2] and incorporates them into the Program, (ii) detects Red Flags that have been incorporated into the Program, (iii) responds appropriately to any Red Flags that are detected and (iv) ensures the Program is updated periodically to reflect current identity theft risks to customers.  In addition, each financial institution must (i) obtain approval of its initial written Program from either its board of directors or an appropriate committee of the board of directors, (ii) involve the board of directors, an appropriate committee thereof or a designated employee at the senior management level in the development, oversight and administration of the Program, (iii) train staff, as necessary, to effectively implement the program, and (iv) exercise appropriate and effective oversight of service provider arrangements.

Appendix A to the Red Flag Rules also contains specific guidelines that a financial institution must consider in establishing and administering its Program, including guidance relating to (i) the identification of specific risk factors and common sources and categories of Red Flags, (ii) the detection of Red Flags, including the need for financial institutions to verify the identity of and authenticate covered account holders, monitor transactions and verify change of address requests, (iii) the prevention and mitigation of identity theft, including how a financial institution should respond to suspected identity theft, and (iv) ways to update, administer and effectively oversee the Program.

Funds should also note that the majority of states have enacted separate identity theft laws to protect their citizens.  Of particular note, Massachusetts adopted a far-reaching set of regulations called the “Standards for the Protection of Personal Information of Residents of the Commonwealth” (the “Standards”), which provides that any person who owns, licenses, stores or maintains “personal information” [3] about a resident of Massachusetts must (i) implement a comprehensive information security program and (ii) comply with specified computer system security requirements, such as encrypting all personal information stored on laptops or other portable devices.  The Standards will take effect on January 1, 2010.

SEC Encourages Culture of Compliance for Investment Advisers

On March 12, 2009, Director of the SEC Office of Compliance Inspections and Examinations (“OCIE”) Lori Richards delivered a speech to investment advisory compliance personnel at the IA Compliance Best Practices Summit.  Director Richards’ speech stressed the importance of conducting a thorough review of investment adviser compliance programs and recommended that compliance personnel take a “fresh look” at the following areas: (i) disclosure, (ii) custody, (iii) performance claims and (iv) resources supporting compliance programs.

Disclosure. Director Richards emphasized the importance of accurate and meaningful disclosure and the importance of ensuring that clients clearly understand the information being disclosed. Most fundamentally, compliance personnel should ensure that their firm is delivering required disclosure documents to clients and making proper and timely filings with the SEC.

Custody. A second area of concern is custody. Director Richards indicated that in light of recent Ponzi schemes and other frauds, OCIE staff will make custody a key focus (see related article above regarding third-party confirmation of investor assets).

Performance Claims. Director Richards stressed the importance of providing accurate performance information to clients or potential clients and stated that the most common problems that occur with respect to performance claims are (i) overstating the firm’s performance returns, assets under management or length of operation; (ii) not including the disclosures necessary to prevent the performance claims from being misleading, such as not disclosing whether results reflected dividends; and (iii) inappropriately including or excluding information or data in composites, such as advertising past specific recommendations.

Resources Supporting the Firm's Compliance Program. Director Richards emphasized the importance of devoting adequate resources to compliance programs, noting that a number of SEC staff “have cautioned against making resource reductions to compliance programs that could undercut their effectiveness.”  Director Richards stated that chief compliance officers should consider whether their compliance program has adequate resources during the annual review process.  If it is determined that a firm’s compliance program lacks sufficient resources, the chief compliance officer should document this finding in a report relating to the annual review.

SEC Rules and Regulations

SEC Staff Issues No-Action Letter to Investment Company Institute on Liquidity Protected Preferred Shares

On March 12, 2009, the SEC’s Division of Investment Management issued a no-action letter in response to a letter from the Investment Company Institute (the “ICI”) requesting no-action assurances regarding certain affiliation issues relating to liquidity protected preferred shares (“LPP”).  As discussed in the July 14, 2008 Investment Management Regulatory Update LPP is a type of auction rate or remarketed preferred stock (“ARPS”) issued by closed-end investment companies (“Funds”) to money market funds and was the subject of a no-action letter to Eaton Vance Management and its affiliates dated June 13, 2008.  LPP was designed to help restore liquidity to the ARPS market, as most ARPS auctions and remarketings (the process for resetting ARPS dividend rates and the primary means for reselling ARPS) froze in February 2008.  The common feature of LPP is a liquidity facility (“Liquidity Facility”) pursuant to which a liquidity provider (“Liquidity Provider”) agrees to purchase LPP at its liquidation preference plus accumulated but unpaid dividends in the event of remarketing failure.

The ICI’s request for no-action assurances from the SEC was triggered by concern that a Liquidity Provider could be deemed an “affiliate” of a Fund pursuant to Section 2(a)(3) of the Investment Company Act of 1940 (the “Investment Company Act”) if it acquired a substantial amount of LPP through operation of a Liquidity Facility.  If this were to occur, the Liquidity Provider would be restricted from engaging in certain transactions with the Fund and its affiliates, thus creating a disincentive for parties to serve as Liquidity Providers and potentially hindering the effectiveness of LPP in restoring liquidity to the ARPS market.

In its letter to the SEC, the ICI first argued that a Liquidity Provider would not be an affiliate under Section 2(a)(3)(A) of the Investment Company Act. [4] While a Liquidity Provider may acquire a majority of a Fund’s preferred stock, it would not be possible for a Liquidity Provider to acquire five percent of a Fund’s total outstanding voting securities because ARPS and LPP will constitute a small fraction of a Fund’s outstanding voting securities, given the capital structure of Funds.[5]

Second, the ICI argued that, in a typical case, a Liquidity Provider would not become an affiliate of a Fund pursuant to Section 2(a)(3)(C) or (D) of the Investment Company Act.[6] The ICI conceded that acquiring a substantial amount of LPP would give a Liquidity Provider the power to elect directors and a substantial economic interest in a Fund, but argued that a Liquidity Provider acting in its capacity as such would not “control” the Fund.[7] The ICI advanced a number of arguments in support of this proposition, including that actual control will remain vested in management, that a Liquidity Provider would not control the directors it elected, that directors have fiduciary duties to all shareholders and that absent a majority of directors, board representation is not sufficient to control a Fund.

The SEC stated that, based on the facts, representations and assumptions set forth by the ICI in its incoming letter, and without necessarily agreeing with the ICI’s legal analysis, it would not recommend enforcement action against a Liquidity Provider or any Fund (with respect to the Liquidity Provider) for violations of affiliation restrictions under the Investment Company Act solely due to the operation of a Liquidity Facility.

SEC Solicits Comment on NYSE Proposal Regarding Broker Voting on Director Elections and Advisory Contracts

As previously reported in the March 5, 2009 Davis Polk & Wardwell Client Newsflash, on February 26, 2009, the SEC published a NYSE proposal to amend NYSE Rule 452 (“Rule 452”) to eliminate broker discretionary voting for the election of directors (with respect to all issuers except registered investment companies) and to codify certain NYSE interpretations concerning broker voting on investment company advisory contracts.  The period for public comment on the proposal expired on March 27, 2009.

Rule 452 currently allows broker voting on “routine” proposals if the stock’s beneficial owner has not provided specific voting instructions to the broker at least ten days before a scheduled meeting.  An “uncontested” election for a company’s board of directors is among the matters currently treated as routine under Rule 452.  The release explains that the NYSE had previously filed a proposal to eliminate discretionary broker voting with respect to uncontested director elections of all issuers; however, after considering the cost and difficulties of obtaining a quorum, general problems in getting fund shareholders to vote and existing regulation applicable to investment companies under the Investment Company Act of 1940 (“Investment Company Act”), the NYSE determined that it was not advisable to make the proposal applicable to registered investment companies.

With respect to “non-routine” matters (which, according to the release, are generally those involving a contested director election or any matter which may affect substantially the rights or privileges of stockholders), NYSE rules currently prohibit discretionary broker voting.  Rule 452 lists 18 examples of such non-routine matters, including matters such as mergers or consolidations and stockholder proposals opposed by management.  Beyond these 18 examples, the NYSE has also interpreted Rule 452 to preclude discretionary broker voting on material amendments to investment advisory contracts with an investment company and proposals to obtain shareholder approval of an investment company’s investment advisory contract with a new investment adviser, which approval is required by the Investment Company Act.  The proposal seeks to codify these interpretations in Rule 452.

The amendment would generally be applicable to shareholder meetings held on or after January 1, 2010.

Recent Federal Economic Stimulus and Regulatory Initiatives

As described in several recent Davis Polk & Wardwell client communications, Treasury has recently proposed numerous measures relating to economic stimulus and legal and regulatory reform.  On March 23, 2009, Treasury Secretary Geithner announced a public-private investment program designed to remedy the illiquidity in the secondary markets for certain mortgage-backed securities and create a market for troubled loans on the balance sheets of U.S. banks and thrifts.  On March 25, 2009, Treasury proposed legislation for a unified federal resolution authority over systemically significant financial companies modeled on Sections 11 and 13 of the Federal Deposit Insurance Act, the specialized law that governs the resolution of U.S. Federal Deposit Insurance Corporation-insured banks and thrifts.  Finally, on March 26, 2009, Secretary Geithner announced his new “rules of the road,” which outline Treasury’s framework for regulatory reform, including addressing systemic risk, protecting consumers and investors, eliminating gaps in the regulatory structure and fostering international coordination.

Litigation

Supreme Court to Address Circuit Split on Excessive Fee Standard for Mutual Funds

On March 9, 2009, the U.S. Supreme Court granted certiorari to review Jones v. Harris Associates L.P., 527 F.3d 627 (7th Cir. 2008), an excessive fee case in which the U.S. Court of Appeals for the Seventh Circuit broke with Second Circuit precedent on the issue of how courts should analyze whether fees that an investment adviser charges registered investment companies are “excessive” under Section 36(b) of the Investment Company Act of 1940 (“Investment Company Act”).  As reported in the September 8, 2008 Investment Management Regulatory Update, Jones received particular attention when Judge Richard Posner, who was not on the panel that issued the ruling, requested a rehearing of the decision by the full Seventh Circuit and, when the request failed to gain majority support, issued an opinion strongly dissenting from the panel’s approach (as articulated in the opinion of Chief Judge Frank Easterbrook).

Section 36(b) of the Investment Company Act assigns the adviser of a registered investment company fiduciary duties with regard to its receipt of compensation from the company.  The Seventh Circuit held in Jones that it is not for a court to decide whether a fiduciary’s fees are “reasonable,” but whether they were fully and fairly disclosed.  In contrast, the U.S. Court of Appeals for the Second Circuit had previously ruled in Gartenberg v. Merrill Lynch Asset Management, Inc., 694 F.2d 923 (2d Cir. 1982), that the adviser’s fiduciary duty is violated if the fee it charges is “so disproportionately large that it bears no reasonable relationship to the service rendered and could not have been the product of arm’s-length bargaining.”

The petitioner asks the Supreme Court to decide whether the Seventh Circuit “erroneously held, in conflict with the decisions of three other circuits, that a shareholder’s claim that the fund’s investment adviser charged an excessive fee–more than twice the fee it charged to funds with which it was not affiliated–is not cognizable under § 36(b), unless the shareholder can show that the adviser misled the fund’s directors who approved the fee.”  The Supreme Court will hear the case during its next term, commencing on October 5, 2009.

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If you have any questions regarding the matters covered in this Regulatory Update, please contact any of our Investment Management Group lawyers listed below or your regular Davis Polk contact:

John Crowley, Partner
212-450-4550 | john.crowley@dpw.com

Nora Jordan, Partner
212-450-4684 | nora.jordan@dpw.com

Yukako Kawata, Partner
212-450-4896 | yukako.kawata@dpw.com

Leor Landa, Partner
212-450-6160 | leor.landa@dpw.com

Danforth Townley, Partner
212-450-4240 | danforth.townley@dpw.com

Sophia Hudson, Associate
212-450-4762 | sophia.hudson@dpw.com

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To ensure compliance with requirements imposed by the IRS, we inform you that, unless explicitly provided otherwise, any U.S. federal tax advice contained in this communication (including any attachments) is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code or (ii) promoting, marketing or recommending to another party any transaction or matter addressed herein.

1. The Red Flag Rules define the term "covered account" as "(i) an account that a financial institution or creditor offers or maintains, primarily for personal, family, or household purposes, that involves or is designed to permit multiple payments or transactions, such as a credit card account, mortgage loan, automobile loan, margin account, cell phone account, utility account, checking account, or savings account; and (ii) any other account that the financial institution or creditor offers or maintains for which there is a reasonably foreseeable risk to customers or to the safety and soundness of the financial institution from identity theft, including financial, operational, compliance, reputation, or litigation risks."

2. The Red Flag Rules define the term "Red Flag" as "a pattern, practice, or specific activity that indicates the possible existence of identity theft."

3. "Personal information" is defined as "a Massachusetts resident's first and last name, or first initial and last name, in combination with any one or more of the following data elements that relate to such resident: (1) Social security number; (2) driver's license or state identification number; and (3) financial account number or credit or debit card number; provided, however, that "Personal information" shall not include information that is lawfully obtained from publicly available information, or from federal, state or local government records lawfully made available to the general public."

4. Section 2(a)(3)(A) of the Investment Company Act defines "affiliated person" as "any person directly or indirectly owning, controlling, or holding with the power to vote, 5 per centum or more of the outstanding voting securities of such other person."

5. Section 18(a)(2) of the Investment Company Act requires investment funds to have asset coverage of at least 200 per centum for preferred stock, both immediately after issuance of the stock and upon the declaration of any dividend or distribution.

6. E.g., Section 2(a)(3)(C) of the Investment Company Act defines "affiliated person" as "any person directly or indirectly controlling, controlled by, or under common control with, such other person." Section 2(a)(3)(D) defines "affiliated person" as "any officer, director, partner, copartner, or employee of such other person."

7. "Control" is defined in Section 2(a)(9) of the Investment Company Act as "the power to exercise a controlling influence over management or policies of the company, unless such power is solely the result of an official position with such company."