May 7, 2013 - Quarterly Review May 07, 2013
In This Issue

SEC Settles Administrative Proceedings Against Mutual Fund Trustees and Fund Service Providers Over Advisory Contract Approval Disclosure, Related Recordkeeping, and Adviser Compliance Program Approvals

The SEC settled public administrative and cease and desist proceedings against the trustees (the “Trustees”) of certain registered open-end investment companies (the “Funds”) and the Funds’ compliance and administrative services providers (collectively with the Trustees, the “Respondents”), relating to (1) the requirement under the Investment Company Act of 1940 (the “1940 Act”) to provide disclosure in the Funds’ shareholder reports describing advisory contract approvals during the period January 2009 through December 2010 (the “Relevant Period”), (2) recordkeeping required by the 1940 Act related to advisory contract approvals and (3) the Trustees’ approval of certain Fund advisers’ compliance programs.  This article summarizes the SEC’s findings, which the Respondents neither admitted nor denied.

Background.  The order describing the settlement characterizes the Funds as being part of a “turn-key” operation in which the Trustees as a single board oversaw as many as 71 Funds, most of them managed by different, unaffiliated advisers and sub-advisers.  The company that provided chief compliance officer services to the Funds (the “CCO Services Provider”) and the company that provided administrative/transfer agency services to the Funds (the “Administrator”) were affiliates.  The only Trustee who was an interested person of the Funds within the meaning of the 1940 Act is an indirect owner of each of the service providers.

The settlement focuses in large part on disclosure that each Fund is required to provide in its shareholder reports regarding its Trustees’ initial approval and subsequent annual renewal of the Fund’s advisory and any sub-advisory contracts.  The order notes the number of advisory and sub-advisory contract approvals and renewals for the Funds during the Relevant Period, stating that the Trustees “conducted fifteen board meetings during which they considered whether to approve or renew a total of 113 advisory and 32 sub-advisory contracts in accordance with their duties under Section 15(c) of the 1940 Act.  The board meetings also covered other official business of the [Funds], and typically lasted at least a full day.  The number of advisory contracts that the Trustees considered varied with respect to each meeting as did the time for which the Trustees discussed each contract, with more time typically spent on new contracts and less on renewals.  Because of the large number of [Funds], the Trustees often had to consider several new contracts and renewals at each board meeting, and at two separate board meetings, the Trustees considered over twenty contracts.”

Advisory Contract Approval Disclosure Requirement.  The specific disclosure obligation cited by the SEC in the settlement requires shareholder report disclosure regarding advisory contract approval to address specific factors the SEC deems material to the ultimate decision to approve or renew a particular advisory contract, as follows (the “Specified Factors”):  “[A]s to the approval or renewal of an advisory contract, Funds must include a discussion in their shareholder reports concerning, at a minimum: (1) the nature, extent, and quality of the services to be provided by the investment adviser; (2) the investment performance of the fund and the investment adviser; (3) the costs of the services to be provided and profits to be realized by the investment adviser and its affiliates from the relationship with the fund; (4) the extent to which economies of scale would be realized as the fund grows; and (5) whether fee levels reflect these economies of scale for the benefit of fund investors.  See Form N-1A, Item 27(d)(6)(i).  Furthermore, Form N-1A requires that the shareholder report indicate whether the board relied upon fee comparisons with other funds or types of clients in approving the contract and, if so, describe the comparisons that were relied upon and how they assisted the board in concluding that the contract should be approved.”  Form N-1A directs that this disclosure discuss how the board evaluated each factor and cautions that conclusory statements or a list of factors will not be considered sufficient.  In enacting these disclosure requirements, the SEC stated that “boilerplate” disclosure would not be appropriate.

Advisory Contract Approval and Related Minutes and Shareholder Report Disclosures.  The order describes the process followed by the Trustees, the Administrator, outside counsel and others that ultimately resulted in the Funds’ shareholder report disclosure regarding advisory contract approvals.  For each contract, the Trustees requested that each adviser provide information related to the Specified Factors.  Outside counsel reviewed the information received for completeness in advance of the board meeting at which the Trustees, with counsel’s guidance, used the information in making their decision to approve or renew the advisory contract.  The SEC found that the process of creating minutes began with draft minutes created by paralegals at the Administrator using “a minutes template, which included boilerplate language concerning the material factors and conclusions which formed the basis for the Trustees’ Section 15(c) approval or renewal of the advisory contracts.”  The initial draft was reviewed and revised successively by the secretary of the particular board meeting, the Funds’ secretary and the Funds’ outside counsel before the minutes were reviewed and approved by the Trustees.  The Administrator used the Trustee-approved minutes to draft the advisory contract approval disclosures that appeared in the Funds’ shareholder reports.

Boilerplate Disclosures.  A principal finding of the order is that in certain instances the Funds provided “boilerplate disclosure” regarding certain of the Specified Factors that was materially untrue or misleading.  The order gives only three examples of “boilerplate disclosure” that the SEC found materially untrue or misleading, all of which are variations on the following conclusion: “the Fund’s advisory fees and expense ratio were acceptable in light of the quality of the services the Fund currently receives from the Adviser, and the level of fees paid by a peer group of other similarly managed mutual funds of comparable size.”  As to the Fund in one example, the SEC found that the Trustees had not received any peer group information.  In the other two examples, the SEC found that “these boilerplate statements were materially misleading since they implied that the fund was paying fees that were not materially higher than the middle of its peer group range when, in fact, the adviser’s approved fee was materially higher than all of the fees of the adviser’s selected peer group and nearly double the peer group’s mean fee.”  As noted above, the SEC also found that the paralegals at the Administrator who produced the initial draft of minutes used “boilerplate language concerning the material factors and conclusions which formed the basis for the Trustees’ Section 15(c) approval or renewal of the advisory contracts.”  The SEC also determined that the minutes of board meetings at which the Trustees approved advisory contracts “sometimes contained boilerplate language that was materially untrue or misleading.”

On the basis of the foregoing, the SEC found that the Trustees caused certain Funds to violate Section 34(b) of the 1940 Act, which prohibits any person from making any untrue statement of a material fact in any document filed with the SEC or required to be maintained by Section 31(a) of the 1940 Act, which specifies the records required to be kept by registered funds.  Specifically, the SEC found that “certain board minutes reviewed and approved by the Trustees contained boilerplate language and materially untrue or misleading statements concerning the material factors and conclusions that formed, at least in part, the basis for the Trustees’ renewal or approval of certain advisory contracts.  These minutes were then used by [the Administrator] to draft the required disclosures within the applicable series’ shareholder reports, which also included the materially untrue or misleading disclosures concerning the Trustees’ Section 15(c) evaluation process.” 

The SEC also cited Rule 31a-1(b)(4) which requires a registered fund to maintain minute books of its trustees’ meetings, and in that regard, found that “in connection with each meeting, the Trustees understood that their meeting minutes should document their consideration of the material factors considered, and conclusions reached, in deciding to approve or renew a fund’s advisory contract.  Accordingly, the Trustees also caused violations of Section 34(b) of the Investment Company Act by approving certain board minutes that were materially untrue or misleading.”

Missing Contract Approval Disclosures.  The SEC found that the Administrator, which had contractually agreed to prepare the Funds’ shareholder reports, caused certain Funds to violate 1940 Act’s disclosure requirements for shareholder reports under Section 30(e) and Rule 30e‑1 by failing in ten instances during the Relevant Period to include the required disclosures regarding advisory contract approval in the relevant Funds’ shareholder reports. 

Recordkeeping Omissions.  The SEC found that the Administrator caused certain Funds to violate Section 31(a) of the 1940 Act and Rule 31a-2(a)(6) thereunder which require a fund to maintain documents considered by fund trustees during the advisory contract approval process, an obligation that the Funds had delegated to the Administrator.  In three instances, in response to requests from advisers prompted by concerns about confidentiality, the Administrator discarded or returned written financial information the adviser had submitted as part of the contract approval process.  In four other instances, the Administrator failed to keep peer group fee comparisons submitted by advisers.  The Administrator also failed to maintain some of the written summaries prepared by outside counsel to assist the Trustees in the contract approval process.

Inadequate Basis for Adviser Compliance Program Approvals.  The SEC found fault with the fact that the Trustees approved the compliance programs for certain Fund advisers based on summaries provided by the CCO Services Provider that were inadequate under the Funds’ compliance program and Rule 38a-1 under the 1940 Act relating to the approval of Fund compliance programs, which required the Trustees to receive “either: (1) copies of the advisers’ policies and procedures for the Trustees’ review; or (2) a summary of the advisers’ compliance programs prepared by [the CCO Services Provider] that familiarized the Trustees with the salient features of the compliance programs and that provided the Trustees with a good understanding of how the advisers’ compliance programs addressed particularly significant risks.”  (Consistent with the SEC’s statements regarding the basis on which a fund board could approve the compliance program of a fund service provider, the Funds’ compliance program also allowed the Trustees to rely on summaries produced by legal counsel or other persons familiar with the compliance program.)  The SEC found that in certain instances the Trustees’ approval was instead based on “a brief written statement prepared by [the CCO Services Provider] at the conclusion of its compliance review, indicating that the advisers’ compliance manuals were ‘sufficient and in use’ and also indicating that the code of ethics and proxy voting policies were ‘compliant.’  This written statement was accompanied by a verbal representation by [a representative of the CCO Services Provider] at the relevant board meeting that the adviser’s policies and procedures were adequate.”

On the basis of the foregoing, the SEC found that the CCO Services Provider and the Trustees caused certain Funds to violate Rule 38a-1 under the 1940 Act.

Sanctions.  Both the Trustees and the service providers agreed to a cease and desist order.  Each of the service providers will pay a civil money penalty of $50,000.  The Respondents undertook to engage a compliance consultant to address the problems with advisory contract and compliance program approval found by the SEC in the order.

In the Matter of Northern Lights Compliance Services, LLC, Gemini Fund Services, LLC, Michael Miola, Lester M. Bryan, Anthony J. Hertl, Gary W. Lanzen, and Mark H. Taylor, SEC Release No. ICA-30502 (May 2, 2013).

Quarterly Review

February 5, 2013

Goodwin Procter Alert - HHS Issues Long-Awaited Final HIPAA Omnibus Rule
Goodwin Procter Alert - New NYSE and NASDAQ Listing Standards Approved: Compensation Committee Independence, Compensation Adviser Engagement and Independence
The NYSE Rules will be effective on July 1, 2013, although companies are not required to comply with the NYSE Rules concerning the independence of compensation committee members until the earlier of (i) the first annual meeting held after January 15, 2014 or (ii) October 31, 2014.

The NASDAQ Rules also will be effective on July 1, 2013, although companies are not required to comply with the NASDAQ Rules concerning the independence of compensation committee members, and the requirement that companies have a formal compensation committee and written compensation committee charter, until the earlier of (i) the first annual meeting held after January 15, 2014 or (ii) October 31, 2014. In connection with these changes, NASDAQ-listed companies are required to certify to NASDAQ, no later than 30 days after the final applicable implementation deadline, that they have complied with the new compensation committee composition and charter requirements.
Goodwin Procter Alert - SEC Enforcement Division Signals Likely Increase in Private Equity Enforcement Actions

February 12, 2013

FRB Governor Duke Speaks on the Future of Community Banking
DOL Issues Advisory Opinion Clarifying ERISA Issues With Respect to Cleared Swap Transactions Involving ERISA Plans
SEC Extends Securities Law Exemptions For Security-Based Swaps
The SEC extended the expiration date to February 11, 2014.
FDIC Issues Financial Institution Letter Alerting Banking Institutions to Modifications to the Statement of Policy for Section 19 of the Federal Deposit Insurance Act

February 19, 2013

FDIC Issues Notice of Proposed Rulemaking Regarding Insured Deposits at Foreign Branches of U.S. Banks
FRB Staff Working Paper Discusses Historical Use of U.S. Reserve Requirements to Promote Bank Liquidity
FINRA Requests Comments on Proposed FINRA Rules Governing Markups, Commissions and Fees

February 26, 2013

OCIE Announces 2013 SEC National Examination Program Priorities
SEC Staff Provides Guidance on Incorporation of 3.8% Tax on Net Investment Income Into Standardized Mutual Fund After-Tax Return Calculation
FRB Extends Comment Period to April 30, 2013 on its Proposed Rule to Enhance Prudential Standards for Foreign Banking Organizations and Certain Foreign Nonbank Financial Companies
GAO Issues Report on Financial Crisis Losses and Potential Impacts of the Dodd-Frank Act
Reminder: Swap End-Users Must Obtain LEIs/CICIs by April 10, 2013

March 5, 2013

SEC Exam Review Prompts Risk Alert on Advisers Act Custody Rule Compliance
SEC Staff Grants No-Action Relief to Allow Advisory Agreement Amendment Establishing Unified Fee Structure Without Shareholder Approval
FRB Issues Notice of Proposed Rulemaking Concerning Provision of Financial Services to Systemically Important Financial Market Utilities
FRB Governor Raskin Urges Banks to Take Proactive Role in Dealing with Reputational Risk
Comptroller of the Currency Curry Discusses Enforcement Practice and Philosophy of OCC and States That No Large Bank Is “Too Big to Prosecute”
Goodwin Procter Alert Describes ESMA Remuneration Guidelines Under the Alternative Investment Fund Managers Directive

March 12, 2013

Comptroller of the Currency Curry Testifies on OCC’s Supervision and Enforcement of BSA/AML Compliance and Discusses Future BSA/AML Corporate Governance Compliance Guidance to be Provided by the OCC
OCC Issues Guidance Concerning Process by Which National Banks and Thrifts Sponsoring a Short-Term Investment Fund Must Make Monthly Disclosures to the OCC
Banks managing short-term investment funds must comply with all provisions of the STIF Rule beginning July 1, 2013, with the first monthly reports due August 7, 2013.
IRS Office of Chief Counsel Makes Publicly Available Field Attorney Advice Memorandum Concerning Capitalization of Costs of Holding OREO Property
SEC Requests Information on Standards of Conduct for Broker-Dealers and Advisers When Advising Retail Customers
The submission deadline is July 5, 2013.

March 19, 2013

Goodwin Procter Attorneys to Participate in Financial Markets Association’s Securities and Compliance Seminar
SEC Settles Administrative Proceeding Over Deviation from Valuation Policy Stated in Fund Offering Materials and Investor Reports for Registered Adviser’s Fund of Private Equity Funds
SEC Staff Provides Guidance on SEC Filing Obligations for Social Media Postings Regarding Mutual Funds
OCC Issues Proposed Reporting Requirements for Annual Stress Tests of Covered Financial Institutions with Consolidated Assets of $10 Billion to $50 Billion
Comments on the Proposal are due by May 10, 2013.

March 26, 2013

Goodwin Procter Alert: Massachusetts High Court Rules that ZIP Codes Are Personal Identification Information
Goodwin Procter Alert: Aiding and Abetting Liability of Fund Manager for Use of Unregistered Broker – Recent SEC Enforcement Action
SEC Staff Provides FAQ on Rule 15a-6 and Foreign Broker-Dealers
FinCEN Issues Guidance on the Application of its Money Services Businesses Regulations to Users, Administrators and Exchangers of Virtual Currencies
FDIC, FRB and OCC Jointly Propose Revisions to Interagency Q&As Regarding Community Reinvestment; Comptroller Curry Presents Remarks Concerning Revisions to Q&As
Comments on the Proposal are due by May 17, 2013.
CFTC Issues No-Action Relief from Clearing Requirement for Multilateral Portfolio Compression Exercises and for Stub Swaps

April 2, 2013

Goodwin Procter Alert and April 17 Seminar Provide Updates for Non-European Private Fund Managers on the European Union Alternative Investment Fund Managers Directive
Effective July 22, 2013 (subject to any extensions that may be granted, e.g., the UK proposal discussed in the April 30, 2013 Financial Services Alert), the European Union Alternative Investment Fund Managers (AIFM) Directive will govern the marketing and operation of alternative investment funds within the European Economic Area.
New Goodwin Procter ERISA Litigation Update Available
ISDA Releases Second Dodd-Frank Protocol
FRB, FDIC and OCC Issue Updated Guidance Concerning Leveraged Lending
The compliance deadline for the Interagency Guidance is May 21, 2013.
Federal Agencies Issue Guidance Concerning Revisions to Flood Disaster Protection Act

April 9, 2013

Goodwin Procter Alert - SEC Clarifies Social Media Use and Reg FD Compliance
Goodwin Procter Alert - Using the Web to Match Private Companies and Potential Investors: SEC No-Action Letters Open a Door, but Questions Remain
FDIC Releases Videos Designed to Provide Information to Bank Directors, Officers and Employees Regarding Responsibilities of Bank Directors and Risk Management Examination and Compliance Examination Processes
FRB Adopts Final Rule Defining “Predominantly Engaged in Financial Activities” and “Significant” Nonbank Financial Company and Bank Holding Company under the Dodd-Frank Act
CFTC Exempts Swaps Between Certain Affiliates from Clearing
CFTC Provides Time-Limited No-Action Relief for Commodity Pool Operators of Securitization Vehicles
The relief available to eligible securitization vehicle CPOs continues through June 30, 2013.
SEC Staff Grants No-Action Relief for Blanket Shareholder Approval of Successor Advisory Agreements Resulting from Restructuring by Fund Advisers’ Ultimate Parent
Form 13 Filers Must Use New Online Form Beginning April 29
The implementation date was subsequently postponed until at least May 20, 2013.

April 16, 2013

SEC and CFTC Adopt Rules to Address FCRA Requirements for Identity Theft Programs and Credit Card Changes of Address
The final rules become effective May 20, 2013; compliance is required beginning November 20, 2013.
Federal Court Rules That Failure to Meet Statutory 180-Day Deadline After Wells Notice Does Not Bar Filing of Enforcement Action
FRB Issues Proposed Rule Concerning Annual Assessments on Largest Banking Organizations and on Nonbank Financial Companies Designated for FRB Supervision by FSOC
Comments on the Proposed Rule are due by June 15, 2013.
OCC Deputy Chief Counsel Testifies Before Senate Subcommittee Concerning Retention by Banks of Independent Consultants in Connection with OCC Enforcement Actions
FRB Issues Final Retail Forex Rule
The Final Rule becomes effective on May 13, 2013.
CFTC Extends Reporting Requirement Compliance Date for End-Users
The letter provides extensions to as early as May 29, 2013 and as late as October 31, 2013 depending on the nature of the reporting entity and the nature of the swaps data reporting.

April 23, 2013

IRS Allows Banks to Deduct, Rather Than Capitalize, Costs Associated with Selling Foreclosure Property
SEC Investor Advisory Committee Issues Recommendations Related to Target Date Mutual Funds
FDIC Files Complaint Against Former Senior Officers of Failed Bank Who Allegedly Ignored Both FDIC Lending Regulatory Requirements and Repeated Regulatory Criticisms

April 30, 2013


The EU AIFM Directive for Private Investment Fund Managers – Breakfast Seminars in NYC (May 9) and Boston (May 10)
The EU AIFMD Directive for Private Fund Managers – UK Proposes to Postpone Compliance for Non-EU Managers Until July 22, 2014
Goodwin Procter Alert: Senior SEC Lawyer Remarks Indicate Continued Focus on Private Fund Adviser Activities and Broker-Dealer Registration Issues
Basel Committee Seeks Comments on Proposal to Require Recognition of Cost of Credit Protection
Comments on the proposal outlined in the Consultative Document are due by June 21, 2013.
OCC and FDIC Issue Proposed Guidance and FRB Issues Statement on Deposit Advance Loan Products
Comments on both the OCC’s version of the Proposed Guidance and the FDIC’s version of the Proposed Guidance are due by May 30, 2013.
SEC Settles Administrative Proceedings Against Adviser and Top Executive Over Undocumented Block Trade Allocation Practices
Rollout of New Online Form 13F Delayed Until At Least May 20