Industry Update
Changes to New York Law Governing Powers of Attorney Effective September 1, 2009
New York has enacted significant amendments (the "Amendments") to the law governing powers of attorney ("POAs"), which became effective on September 1, 2009.[1] The Amendments may be significant in the private and registered fund context. As discussed below, POA provisions are standard in many fund operating, subscription, transfer and related documents, and the changes could implicate those POAs. Of note, the Amendments:
- impose new requirements for the creation of valid POAs, both statutory and non-statutory;
- establish that an agent acting under a POA owes a fiduciary duty to the principal and set forth an agent’s fiduciary obligations (e.g., the agent must keep a record of all receipts, disbursements and transactions entered into on behalf of the principal and make such records available upon request);
- create a new statutory short form POA to replace the two statutory short form POAs currently in use in New York (the durable and non-durable statutory short form POAs);
- prohibit financial institutions and other third parties (including partnerships and limited liability companies) from refusing to honor a properly executed statutory short form POA, unless there is reasonable cause for such refusal;
- provide for a special proceeding to compel third parties to accept a statutory short form POA and to resolve other issues relating to a POA; and
- provide that, unless additional requirements are met, the only gifts an agent acting under a POA is authorized to make on behalf of the principal are gifts which do not exceed $500 per recipient, per calendar year, and which are consistent with gifts the principal has customarily made to individuals and charities before the creation of the power of attorney relationship.
The new requirements for the creation of a valid POA apply only to POAs executed in New York by individuals on or after September 1, 2009. These requirements do not apply to POAs executed by entities. Until further guidance is available, it may be advisable to treat a POA executed by an individual granting authority to exercise powers held by that individual as a fiduciary or official of any legal, governmental or commercial entity as a POA executed by an individual. POAs executed by individuals in another state or jurisdiction in compliance with the law of that state or jurisdiction are valid in New York, regardless of whether the individual is a domiciliary of New York.
Although the Amendments do not affect the validity of a POA executed prior to September 1, 2009 if the POA was valid when executed, the execution of a new POA by an individual on or after this date automatically revokes any and all prior POAs executed by that individual unless that individual expressly provides otherwise. The New York State Legislature is considering a technical corrections bill that would reverse the default rule in the Amendments so that a subsequently executed POA would not automatically revoke all prior POAs. Until such a bill is enacted, however, it is prudent to include an explicit non-revocation provision in any new POA governed by the Amendments to avoid the unintentional revocation of a POA.
As noted above, POA provisions are standard in many fund operating, subscription, transfer and related documents. In private funds, subscription and transfer agreements often include a POA authorizing the general partner to sign the fund’s operating documents on behalf of its limited partners or make certain representations on their behalf. The fund’s operating documents also typically include a POA authorizing the fund’s general partner to take certain actions and execute certain documents and amendments on behalf of its limited partners. For example, many private equity funds permit the use of "alternative investment vehicles" when structuring investments, and general partners may be empowered to execute the operative documents of such vehicles through a POA embedded in the partnership agreement. In registered investment companies, members of the company’s senior management or board of directors may, for example, execute a POA designating one or more of its members to sign and file a registration statement.
To be valid, all POAs subject to the Amendments executed by individuals in New York on or after September 1, 2009 must (i) contain the exact wording in the "Caution to the Principal" and "Important Information for the Agent" provisions set forth in the Amendments, (ii) be typed or printed using letters that are legible or of clear type no less than 12 point in size, or if in handwriting, a reasonable equivalent thereof and (iii) be signed and dated by both the principal and the agent, and both signatures must be duly acknowledged.
Pursuant to the Amendments, a third party may not, without reasonable cause, refuse to honor a statutory short form POA that is properly executed. The Amendments define "third party" as a financial institution or any person (including a partnership, limited liability company or any other legal or commercial entity). In addition, the Amendments (i) set forth a non-exclusive list of what constitutes "reasonable cause" to refuse to honor a properly executed statutory short form POA, (ii) state that it shall not be unreasonable for a third party to require an agent to execute an acknowledged affidavit that a POA is still in full force and effect and (iii) provide that it would be unreasonable for a third party to refuse to honor a properly executed statutory short form POA solely because: (A) the POA is not on a form prescribed by the third party; (B) there has been a lapse of time since the execution of the POA or (C) on the face of the statutory short form POA, there is a lapse of time between the date of the acknowledgment of the signature of the principal and the date of the acknowledgment of the signature of the agent.
We will continue to keep you apprised of any developments in New York law governing POAs.
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See a copy of the "Caution to the Principal" and "Important Information for the Agent" provisions |
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See a copy of the proposed technical corrections bill |
SEC, CFTC Hold Joint Meetings on Regulatory Harmonization
The SEC and the CFTC held joint meetings on September 2 and 3, 2009 at the CFTC and the SEC, respectively, to solicit public input regarding the harmonization of the two agencies' regulatory regimes. Five panels discussed the following issues: the regulation of exchanges and markets, the regulation of intermediaries, the regulation of clearance and settlement, the regulation of investment funds and enforcement.
The joint meetings were part of the agencies' response to the Obama Administration's recent White Paper on Financial Regulatory Reform (the "White Paper"), which directed the SEC and the CFTC to provide recommendations to Congress for amendments to statutes and regulations to harmonize the regulation of futures and securities. The White Paper recommended that the agencies submit to Congress, by September 30, 2009, a report detailing the existing conflicts contained in statutes and regulations regarding similar types of financial instruments and setting forth either reasons why such differences promote investor protection or proposed changes to the statutes and regulations to harmonize the differences.
SEC Chairman Mary Schapiro stated that the joint meetings would "build on the progress the CFTC and SEC have made on designing a framework to regulate OTC derivatives" and "move us further down the road of harmonizing our regulations to increase transparency, reduce regulatory arbitrage and rebuild confidence in our markets." In connection with the joint meetings, CFTC Chairman Gary Gensler said that "harmonizing [the CFTC and SEC's] regulatory policies will improve market integrity by applying consistent standards to market participants."
SEC, FINRA Issue Warning to Retail Investors About Risks of Leveraged, Inverse ETFs
In an August 18, 2009 joint release entitled Leveraged and Inverse ETFs: Specialized Products with Extra Risks for Buy-and-Hold Investors (the "Investor Alert"), the SEC and FINRA cautioned retail investors about the risks associated with investments in leveraged and inverse exchange-traded funds ("ETFs"). ETFs are funds, usually registered investment companies, whose shares constitute interests in a securities portfolio that tracks a benchmark or index, and whose shares are traded on a securities exchange. Different variations of ETFs have emerged over the years, and the Investor Alert emphasizes that leveraged and inverse ETFs are significantly different from and riskier than traditional ETFs. Leveraged ETFs aim to generate returns representing multiples of the performance of the underlying benchmark or index, while inverse ETFs target returns that are the opposite of the returns delivered by the underlying index or benchmark. Leveraged inverse ETFs seek to deliver a multiple of the opposite performance of the underlying index or benchmark.
Leveraged and inverse ETFs are typically structured to generate their performance objectives on a daily basis, and due to the effects of compounding, their performance over a prolonged period of time can diverge significantly from the performance of the underlying index or benchmark over such period. In the Investor Alert, the SEC and FINRA expressed concern that some retail investors are investing in leveraged and inverse ETFs under the incorrect "expectation that these ETFs may meet their stated daily performance objectives over the long term as well," and urged investors to consult with investment professionals before investing in such products.
The Investor Alert follows FINRA's June 2009 regulatory notice to firms (the "Notice"), in which the regulator reminded firms of their sales practice obligations with respect to leveraged and inverse ETFs, including the following:
- Suitability. Ensuring that recommendations are suitable for clients and made with a complete understanding of the recommended products. The Notice emphasizes that in many cases, inverse and leveraged ETFs are not suitable investments for retail investors intending to hold them longer than one trading session;
- Risk disclosure. Accurately disclosing in firm sales materials and oral presentations regarding leveraged and inverse ETFs the material risks associated with such products, including that they are structured to obtain their investment objectives on a daily basis and may not track the performance of their underlying benchmarks over longer periods; and
- Supervisory procedures. Establishing supervisory procedures to ensure compliance with the above sales practice obligations associated with leveraged and inverse ETFs.
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See the press release regarding the Investor Alert |
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See a copy of the Investor Alert |
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See a copy of the Notice |
SEC Grants No-Action Relief to Foreign Funds
On August 4, 2009, the SEC issued a no-action letter granting relief to Foreign Funds (as defined below) that acquire shares of a registered investment company (a "U.S. RIC") in excess of the limitations set forth in Sections 12(d)(1)(A)(ii) and (iii) of the Investment Company Act of 1940 (the "Investment Company Act"). On August 24, 2009, the SEC issued a slightly revised version of the letter, revising a footnote to the letter issued on August 4, 2009. "Foreign Funds" are investment companies organized outside the United States and not registered under the Investment Company Act.
Section 12(d)(1)(A)(ii) of the Investment Company Act prohibits an investment company and companies it controls (including unregistered funds) from investing more than five percent of its total assets in any one U.S. RIC. Section 12(d)(1)(A)(iii) prohibits an investment company from investing more than ten percent of its total assets in all other investment companies. According to the no-action letter, these restrictions are intended to address potentially duplicative fees and unnecessary complexity that could cause harm to the acquiring investment company and its shareholders. The SEC acknowledged in the no-action letter that the United States would have little regulatory interest in protecting a non-U.S. acquiring investment company with no U.S. shareholders from such risks. Accordingly, the SEC concluded that a Foreign Fund may purchase securities issued by a U.S. RIC in excess of the percentage limitations set forth in Sections 12(d)(1)(A)(ii) and (iii). In the August 24 revision of the no-action letter, the SEC clarified that foreign funds offered in the United States in reliance on Sections 3(c)(1) or 3(c)(7) of the Investment Company Act remain "subject to Section 12(d)(1) to the same extent as a U.S. 3(c)(1) or 3(c)(7) fund."
The SEC's no-action relief is based on several conditions. One condition is that a Foreign Fund must comply with Section 12(d)(1)(A)(i) and Section 12(d)(1)(B) of the Investment Company Act. Section 12(d)(1)(A)(i) prohibits an investment company and companies it controls from purchasing more than three percent of the voting shares of a U.S. RIC. Section 12(d)(1)(B) prohibits a registered open-end investment company from selling its shares if, as a result of such sale, (i) more than three percent of its outstanding voting shares would be owned by any one investment company and companies controlled by such investment company or (ii) more than ten percent of its outstanding voting shares would be owned by other investment companies and companies controlled by them. Because the restrictions in these two provisions are designed to protect a U.S. RIC from potential abuse of voting control and undue influence by an acquiring investment company, the SEC concluded that a Foreign Fund must continue to comply with these restrictions. The SEC also required a Foreign Fund to (i) refrain from offering or selling securities in the United States or to any U.S. person and (ii) conduct transactions with its shareholders consistent with the definition of "offshore transactions" in Regulation S under the Securities Act of 1933.
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See the SEC's August 24, 2009 no-action letter |
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See the application letter submitted by Dechert LLP |
IRS Extends FBAR Filing Deadline
Taxpayers have been struggling to comply with their reporting obligations for foreign financial accounts because of informal statements by IRS officials in June suggesting that the obligations were broader than previously thought. The IRS previously extended the June 30, 2009 filing deadline for the Report of Foreign Bank and Financial Accounts (the "FBAR") to September 23, 2009.
On August 7, 2009, the IRS released a draft Notice extending the filing deadline to June 30, 2010 for FBARs relating to 2008 and prior years for (i) persons who have signature authority but no financial interest in a foreign financial account and (ii) persons who have a financial interest or signature authority over commingled funds. To the extent investments in foreign hedge funds or private equity funds constitute foreign financial accounts, the new filing deadline would apply. The IRS stated in the draft Notice that it "intends to issue regulations clarifying the FBAR filing requirements pertaining to those persons with respect to these foreign financial accounts."
The IRS Notice also invites comments on a range of related issues by October 6, 2009.
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See a copy of the IRS' Notice |
SEC RULES AND REGULATIONS
SEC Proposes Alternative Uptick Rule
More than four months after announcing a set of proposals to restrict short selling, the SEC on August 17, 2009 announced an additional proposal and reopened the comment period for its existing short selling restriction proposals. As discussed in more detail in our May 4, 2009 client memorandum Short Sale Proposals: Key Questions, on April 10, 2009, the SEC published a set of proposals setting forth two approaches to restrict short selling. One approach would employ "circuit breakers" to a particular security during any sharp decline in the price of that security. The other approach would restrict short selling on a market-wide basis and could take the form of either an "Uptick Rule" or a "Modified Uptick Rule." Both the Uptick Rule and the Modified Uptick Rule would limit short selling by restricting the price at which short sales may be effected. They differ primarily in the price indicator used to limit short selling: the Uptick Rule uses the last sale price as the reference point for short sale restrictions, while the Modified Uptick Rule uses the current national best bid as the reference point.
Similar to the Modified Uptick Rule, the newly proposed alternative uptick rule (the "Alternative Uptick Rule") would also use the current national best bid as a reference point for short sale orders. However, unlike the Modified Uptick Rule, which would permit short selling at the current national best bid, the Alternative Uptick Rule would only permit short selling at an increment above the current national best bid. Because any short selling must be at an increment above the current national best bid, the Alternative Uptick Rule would prevent the immediate execution of short sales, even when the price of the listed security is on the rise. As a result, the Alternative Uptick Rule would restrict short selling to a greater extent than either the Uptick Rule or the Modified Uptick Rule.
According to the SEC, the Alternative Uptick Rule, unlike the Uptick Rule or the Modified Uptick Rule, would not require monitoring of the sequence of bids (i.e., whether the last sale price or current national best bid is above or below the previous last sale price or national best bid). Proponents of the Alternative Uptick Rule argue that as a result, it would be easier to implement than either the Uptick Rule or the Modified Uptick Rule.
In connection with the release of the proposed Alternative Uptick Rule, the SEC has extended the ending date of the comment period for the April proposals from June 19, 2009 to September 21, 2009. In its press release announcing the Alternative Uptick Rule proposal, the SEC noted that it "particularly seeks comments on the alternative uptick rule as a permanent market-wide approach, as well as whether the alternative uptick rule should be combined with a circuit breaker approach."
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See the SEC's proposing release |
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See the SEC's press release |
SEC Adopts Regulation S-AM Limiting Affiliate Marketing to Consumers
On August 4, 2009, the SEC adopted Regulation S-AM, restricting the ability of any SEC-registered investment company, investment adviser, transfer agent or non-notice-registered broker or dealer (together, the "Covered Entities") to use consumer eligibility information obtained from an affiliate to make a marketing solicitation to a consumer. The SEC adopted Regulation S-AM, initially proposed in July 2004, to fulfill its obligation under Section 624 of the Fair Credit Reporting Act (the "FCRA"), which requires the SEC and other federal agencies to issue regulations limiting entities from using certain information received from affiliates to market products or services to a consumer unless the consumer has received notice and a reasonable opportunity to opt out of the solicitation. As such, the SEC notes in its adopting release that Regulation S-AM is, to the extent possible, consistent with the regulations adopted by other federal agencies pursuant to Section 624 to the FCRA. The regulation has an effective date of September 10, 2009 and a compliance date of January 1, 2010.
Regulation S-AM prohibits a Covered Entity from using eligibility information regarding a consumer that has been received from an affiliate to make a marketing solicitation to the consumer, unless the following conditions are met:
- Clear and conspicuous notice. The consumer has received a clear and conspicuous written disclosure, or if the consumer agrees, electronic disclosure, in a concise notice stating that the Covered Entity may use eligibility information about the consumer that is obtained from an affiliate to make a marketing solicitation to the consumer;
- Reasonable opportunity and simple method to opt out. The consumer has received a "reasonable opportunity and a reasonable and simple method to opt out"; and
- Lack of opt out by consumer. The consumer has not opted out of receiving marketing solicitations from the Covered Entity.
The notice and opportunity to opt out must be issued to the consumer by either (i) an affiliate identified in the notice who has or has had a pre-existing business relationship with the consumer or (ii) two or more constituents of an affiliated group of companies, at least one of which has or has had a pre-existing business relationship with the consumer. Eligibility information covered by the regulation includes information regarding a consumer's account history and information contained in consumer reports or applications, but does not include "aggregate or blind data that does not contain personal identifiers such as account numbers, names or addresses." For purposes of Regulation S-AM, the term "marketing solicitation" means the marketing of a product or service to a specific consumer that is (a) based on eligibility information received from an affiliate and (b) designed to encourage the consumer to utilize such product or service.
Regulation S-AM sets forth certain exceptions to the notice and opt-out requirements, including for marketing solicitations made by a Covered Entity to a consumer:
- with whom that Covered Entity has a pre-existing business relationship;
- in response to a communication initiated by the consumer regarding the Covered Entity's products or services; or
- in response to a request from the consumer to receive marketing solicitations.
Regulation S-AM specifically allows the required notice and opt-out information to be provided to consumers in consolidation with other legally required disclosures, such as those mandated by Regulation S-P, which requires brokers and dealers, investment companies and SEC-registered investment advisers to provide their consumers and customers with notice of their privacy policies and prohibits the covered parties from sharing nonpublic personal information regarding a consumer to nonaffiliated third parties unless certain notice and opt-out opportunities have been provided to the consumer.
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See a copy of the adopting release |
LITIGATION
Options Traders and Broker-Dealers Settle SEC Charges of "Naked" Short Sale Rule Violations
Shortly after the SEC's adoption of Rule 204 ("Rule 204") of Regulation SHO ("Reg SHO") under the Securities Exchange Act of 1934 (the "Exchange Act"), which was intended to curtail "naked" short selling abuses, on August 5, 2009, the SEC announced its first enforcement actions relating to "naked" short selling. In two separate administrative proceedings, the SEC charged two broker-dealers, Hazan Capital Management LLC ("Hazan Capital") and TJM Proprietary Trading LLC ("TJM"), and their options traders, Steven M. Hazan and Michael R. Benson, respectively, with violations of their locate and close-out obligations pursuant to Reg SHO. The SEC also charged TJM's Chief Operating Officer, John T. Burke, for failing to reasonably supervise Benson to prevent him from willfully aiding and abetting TJM's Reg SHO violations. The broker-dealers and individuals each settled the charges without making any admissions or denials with respect to the agency's findings.
Rule 203(b)(1) of Reg SHO imposes a locate requirement on broker-dealers, requiring them to borrow or arrange to borrow a security, or reasonably believe that a security can be borrowed, before executing a short sale transaction. Rule 203(b)(2), however, provides a limited exception from the locate requirement, known as the "market-maker exception," for "a market maker in connection with bona-fide market making activities in the security for which [the] exception is claimed." Reg SHO also sets forth a close-out requirement on short-selling broker-dealers, requiring them to deliver shorted securities by a particular date. At the time of the traders' and firms' short selling violations, the close-out requirement was imposed by Rule 203(b)(3) of Reg SHO, which has since been superseded by Rule 204 as reported in the August 5, 2009 Investment Management Regulatory Update and the Davis Polk client newsflash Short Sales: SEC Adopts Final Rule 204, Allows Rule 10a-3T (Form SH) to Expire and Announces Other Short Sale Initiatives. Furthermore, under Section 15(b)(4)(E) of the Exchange Act, broker-dealers and persons associated with a broker-dealer are required to reasonably supervise persons under their supervision, "with a view to preventing violations of the [federal] securities laws."
In the administrative proceeding against Hazan Capital, the SEC found that the firm willfully violated the Rule 203(b)(1) locate requirement in connection with its short selling activities between January 2005 and October 2007 by incorrectly relying on the market-maker exception to avoid its obligation to locate shares before executing short sales. The SEC determined that Hazan Capital should not have claimed the market-maker exception because it "was not engaged in bona fide market making activity in connection with effecting the short sale transactions." The SEC also found that Hazan Capital willfully violated the Reg SHO close-out requirement by engaging in complex "sham transactions" that gave the appearance that the firm was complying with the close-out requirement when in fact it was not. With respect to Steven Hazan, the SEC determined that the principal trader and majority owner of Hazan Capital willfully aided and abetted Hazan Capital's locate and close-out violations. Hazan Capital and Steven Hazan agreed to pay $3 million in disgorgement, the payment of which the SEC deemed satisfied by the orders of NYSE Amex, LLC ("NYSE Amex") and NYSE Arca, Inc. ("NYSE Arca") in their related actions ordering Hazan Capital and Steven Hazan to disgorge that same amount. The SEC further acknowledged Hazan Capital and Steven Hazan's commitment to pay $1 million in fines in the related NYSE Amex and NYSE Arca actions. The SEC also ordered Hazan Capital and Steven Hazan to cease and desist from causing any further violations of the Reg SHO locate and close-out requirements, censured Hazan Capital and barred Steven Hazan from associating with any broker-dealer for five years.
In the administrative proceeding against TJM, the SEC found that between January 2007 and July 2007, TJM willfully violated the Rule 203(b)(1) locate requirement in connection with its short selling activities by improperly claiming the market-maker exception because it had not engaged in bona fide market-making activities in connection with the securities it shorted. The SEC also determined that TJM willfully violated the Reg SHO close-out requirement by entering into complex arrangements that created the appearance of compliance with the requirement, without actually complying with the requirement. The SEC further found that Benson willfully aided and abetted TJM's Reg SHO violations and that Burke failed to supervise Benson as required by Section 15(b)(4)(E) of the Exchange Act with a view to preventing Benson's aiding and abetting of TJM's Reg SHO violations. TJM agreed to pay $541,000 in disgorgement, deemed by the SEC to be satisfied by an order of the Chicago Board Options Exchange Inc.'s Business Conduct Committee ("CBOE's BCC") in its related action ordering TJM to pay disgorgement in the same amount. The SEC also acknowledged TJM, Benson and Burke's commitment to pay a $250,000 fine to the CBOE's BCC in its related proceeding. The SEC further ordered TJM and Benson to cease and desist from causing any further violations of the Reg SHO locate and close-out requirements, censured TJM, suspended Benson from the industry for three months and suspended Burke from supervising anyone in connection with a broker-dealer for nine months.
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See the SEC's press release |
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See a copy of the order against Hazan Capital and Steven Hazan |
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See a copy of the order against TJM, Benson and Burke |
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
212 450 4550 | john.crowley@davispolk.com
Nora Jordan
212 450 4684 | nora.jordan@davispolk.com
Yukako Kawata
212 450 4896 | yukako.kawata@davispolk.com
Leor Landa
212 450 6160 | leor.landa@davispolk.com
Jeffrey N. Schwartz
212 450 4957 | jeffrey.schwartz@davispolk.com
Danforth Townley
212 450 4240 | danforth.townley@davispolk.com
Sophia Hudson
212 450 4762 | sophia.hudson@davispolk.com
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.
Davis Polk & Wardwell LLP