Tuesday, November 30, 2010

Tokyo Stock Exchange Adopts Corporate Governance Principles for Listed Companies

The Tokyo Stock Exchange has adopted a corporate governance code for listed companies that focuses on enhanced disclosure and assuring the quality and independence of outside auditors. Under the code, listed companies must conduct timely and accurate disclosure regarding corporate activities. In the view of the TSE, such disclosure is indispensable for appropriate investor evaluation of enterprises in the market, and concurrently for the appropriate exercising of voting rights by shareholders.

For this purpose, shareholders require periodic, reliable and comparable information sufficient to evaluate the operational conditions of businesses by the management, and further timely disclosure regarding material events taking place during the intervals between periodic disclosures. Such disclosure shall be conducted simultaneously to ensure equal treatment of shareholders. Fair disclosure helps to secure the confidence of investors in the market, reasoned the exchange, and is an important means to prevent the abuse of insider information.

The corporate governance standards call for the enhanced disclosure of quantitative information on financial conditions and operating results and enhanced disclosure of qualitative information that deepens the understanding of the management conditions of companies by investors. Companies should ensure that investors have access to information equally and easily. Companies should also develop internal systems to secure the accuracy and promptness of disclosure.

The principles of corporate governance also call for the appointment of highly independent outside auditors with an in-depth knowledge of finance and accounting. Also, management and the dequivalent of the board audit committee must work together to strengthen the functions of auditors and maintain adequate resources and infrastructure to support audits carried out by the auditors.

Kansas Seeks Public Comments on Exemption for Private Fund Advisers

Pubic comments on whether the State should promulgate an exemption for private fund advisers are being sought by the Kansas Office of the Securities Commissioner ("Office"). The Office believes that having a rule in place by July 21, 2011, the date the Dodd-Frank Act requires the states to begin regulating investment advisers to private funds with assets under management of less than $150 million, would address the legitimate, value-generating business models of private funds it's current rules do not adequately cover.

People submitting comments are asked to include a description of their knowledge, expertise and experience on the private fund adviser topic, and to supply their contact information. Comments should be sent as a PDF or a Microsoft Word document and may be emailed to ksc@ksc.ks.gov (emailed content should also include the text of the comment in the body of the email) or may be mailed to the Office of the Kansas Securities Commissioner, Attn: Private Fund Adviser Comments, 109 S.W. 9th, Suite 600, Topeka, Kansas 66612. Comments should be received by the close of business December 17.

Marc Wilson, the Kansas Securities Commissioner asks people to consider the following questions and include answers to these questions in their comment submission:

1. What is the extent of private fund activity in Kansas currently, with funds of any size and both within and outside of banks, and what types of investment strategies do they typically pursue?

2. Should KSC adopt the same or different rules with regard to advisers to funds formed pursuant to Section 3(c)(1) of the Investment Company Act of 1940 (ICA) and those formed pursuant to Section 3(c)(7) of the ICA? What are the consumer protection consequences of regulating advisers to these funds in the same manner?

3. The Act exempts from SEC registration advisers to a ‘‘venture capital fund,’’ though it does require these advisers to follow SEC recordkeeping and reporting requirements. Though the SEC is yet to define ‘‘venture capital fund,’’ what policy changes, if any, should KSC consider with regard to registration or regulation of advisers to venture capital funds?

4. Should KSC adopt rules or provide exemptions with regard to advisers to funds formed pursuant to Section 3(c)(5) of the ICA?

5. Requiring advisers to private funds to provide yearly audited financial statements of the fund to investors reduces the possibility of fraud. What are the advantages and disadvantages of requiring a private fund adviser, as a condition of their registration exemption, to provide to investors the private fund’s yearly audited financial statements?

6. Should KSC apply current adviser bonding requirements to advisers to private funds?

7. What are the typical qualifications of advisers to Kansas-based private funds? Should KSC require certain minimal examinations and expertise for private fund advisers?

8. Recent changes to financial institution affiliate transaction rules prohibit banks from certain private fund transactions and management arrangements. Will banks with these types of operations spin off their advisory personnel, and if so, to what extent are the needs of these fund advisers different than that of other private fund advisers?

9. Government funds available for borrowing by Small Business Investment Companies (SBICs) are subject to unpredictable congressional appropriation and increasing regulatory scrutiny. Might some SBICs choose to forgo SBIC regulation and convert to a state-sponsored regime if one were available? If so, what characteristics of a state-sponsored regime might be attractive to an SBIC?

People should note that this is not the first and last time they will be able comment on an exemption for private fund advisers; they will have another opportunity to submit written comments between the date the rule is proposed and the date of its public hearing.

Monday, November 29, 2010

CFTC Chair Says No Going Back to Originate and Hold World of It's a Wonderful Life

Referencing the holiday movie It's A Wonderful Live, CFTC Chair Gary Gensler said that in passing the Dodd-Frank Act, Congress determined that it is incumbent upon regulators to update to the reality that we no longer live in George Bailey’s pre-derivatives originate and hold time. Rather, federal financial regulators must oversee a banking system, shadow banking system composed of mutual funds and hedge funds, a complex derivatives marketplace and a Wall Street that continue to change and pose new risks. In remarks at the Woodrow Wilson School of Public and International Affairs, he emphasized that the CFTC and SEC don’t have the luxury to turn back the clock, but rather have the responsibility to update their oversight for the financial system of the time.

Chairman Gensler joins a growing and by now overwhelmong consensus that we have ``crossed the Rubicon’’ into originate and distribute securitization and there is no turning back to originate and hold. Indeed, restarting private-label securitization markets, especially in the United States, is critical to limiting the fallout from the credit crisis and to the withdrawal of central bank and government interventions. However, no one wants policies that would take markets back to their high octane levels of 2005–07. Thus, the Dodd-Frank legislation aims to put securitization on a solid and sustainable footing and provide for transparency and accountability of the derivatives markets.

When the movie was filmed in 1946, the CFTC Chair noted, 98 percent of bank liabilities were made up of deposits. But today, there are many alternative ways for money and credit to flow through the economy other than banking. There has been explosive growth in shadow or alternative banking, including money market funds, asset backed and mortgage securitizations, government sponsored enterprises, repo and securities lending and open market paper, such as commercial paper. This has all grown to $16.4 trillion, he noted, larger than bank liabilities. That figure does not even include the $1.6 trillion with finance companies, the $1.9 trillion with securities brokers, the $1.8 trillion with hedge funds or the $1.5 trillion in private equity and venture capital, all of which might also be considered part of, up until Dodd-Frank, the largely unregulated shadow banking system that former Fed Chair Paul Volcker warned about.

The changes in how the financial system intermediates money is only part of the story, he continued, as there also have been significant changes in how it intermediates risk. Though risk is intermediated as part of the intermediation of money and credit, it also is done so with the use of derivative contracts. The CFTC Chair explained that derivatives are used by banks and by the alternative banking sector, as well as throughout the economy. Derivatives, and in particular currency swaps, interest rate swaps and credit default swaps, have come to serve important roles in the credit markets as well. Today they are intertwined with many of the client relationships and risks of a bank. Based upon figures compiled by the Office of the Comptroller of the Currency, the largest 25 bank holding companies currently have $277 trillion notional amount of over-the-counter derivatives, he observed, representing more than 20 times these bank holding companies’ combined total assets.

Sunday, November 28, 2010

ABA Asks SEC to Follow Legislative History When Adopting Securitization Conflict of Interest Regulations

In a joint comment letter to the SEC, the American Bar Association Committees on Federal Securities Regulation and Securitization ask the Commission to permit a broad range of common activities that they believe are essential to the functioning of securitization when adopting regulations dealing with conflicts of interest in securitization as commanded by Section 621 of the Dodd-Frank Act. According to the ABA, the legislative history of Section 621 indicates that the statutory intent was to address blatant conflicts of interest in which an underwriter or sponsor creates an asset-backed security that is designed to fail and then profits by betting against it, by means of short sales or otherwise.

The legislative history further provides that changes in market conditions may lead an underwriter to wish to sell the securities it holds. That is also not likely to pose a conflict. Although the legislative history indicates a focused intent, noted the ABA, the language of Section 621 is significantly broader. The ABA groups request that the SEC, in adopting rules implementing this provision, should give appropriate weight to Congressional intent while permitting a broad range of common activities essential to the functioning of the securitization markets. Ordinary course business transactions do not involve the types of material conflicts contemplated by Congress and should be permitted under the rules. Instead, the SEC regulations implementing Section 621 should focus on the asset-backed securities transactions in which the adverse performance of the pool assets would directly benefit an identified party or sponsor of the applicable securitized transaction, as well as those transactions in which a loss of principal, monetary default or early amortization event on the asset-backed security would directly benefit an identified party or sponsor.

The implied conflicts in most ordinary course transactions involving underwriters, placement agents, initial purchasers and sponsors of ABS do not have the above characteristics, said the ABA, and indeed, these transaction parties generally have a strong interest in the positive performance of the assets and the transaction. The ABA believes that the relationship between an asset-backed security sponsor and investors in such instruments is inherently conflicted. The sponsor is seeking funding and the investors in the securitization are providing that funding on negotiated terms. Pool selection also may involve conflicts, and risk retention itself may create conflicts with some classes of investors. Conflicts of this type relating to the terms and nature of the security exist in any ABS transaction, posited the ABA, and cannot be eliminated. Similarly, many potential conflicts of interest are an unavoidable byproduct of the of the securitization process or arise from transaction features that on the whole are beneficial to investors. For example, subordinate tranches act as credit enhancement for the more senior
tranches and are frequently required by the rating agencies and investors.

Saturday, November 27, 2010

UK Will Introduce Tax Transparent Funds to Take Advantage of Master-Feeder Structures under UCITS IV Directive

The UK will launch a new regulatory regime for tax transparent mutual funds to align with other EU jurisdictions taking advantage of the UCITS IV Directive, said UK Finance Minister Mark Hoban. In recent remarks, he said that the new fund vehicle the UK plans to authorize will be suitable for both the pooling of pensions, and for use within the new UCITS IV master/feeder fund structure. A tax transparent fund is one where the taxing authorities disregard the fund entity and look to the shareholders as the source of the income

UCITS IV, or more formally the tongue-twisting Undertakings for Collective Investments in Transferable Securities Directive IV, will usher in the widespread introduction of a master-feeder fund structure across the EU, noted the Minister, and its is currently unlikely that firms will establish master funds in the UK due to a lack of a suitable tax-transparent vehicle. Since other Member States in the EU already have suitable vehicles, and are well-positioned to take advantage of firms wanting to establish master funds, the UK must act or find itself left behind. The Minister also indicated that tax transparent funds are fast becoming the preferred mechanism for cross-border pooling of pension funds. Also, firms operating life insurance funds are looking for alternative options as the EU approaches final agreement on the Solvency II Directive.

According to the Investment Management Association, the UCITS IV Directive includes a number of measures designed to improve the efficiency of European funds, allowing for the first time master-feeder structures to be marketed across Europe as an alternative to merging fund ranges. Feeder funds in different domiciles will invest in the same master fund, thus allowing a single portfolio of assets to be offered in multiple jurisdictions and for different types of investors.

Welcoming the Minister's announcement, Deloitte estimated that around £20billion of additional multinational pension fund investments would be made in the UK each year as a result of the authorization of a tax transparent fund vehiclen entity, which Deloitte described as allowing beneficial double tax treaties between investors and investments to be accessed. The potential for third party investment management funds to be transferred to such vehicles will be far more significant. This is due to the ability of the tax transparent vehicle both to support a master-feeder fund structure, and allow asset managers to realise economies of scale through fund rationalization.

Senate Extenders Legislation Contains Carried Interest Provision with Impact Beyond Hedge Fund Managers

Provisions in a Senate version of tax extenders legislation would expand the taxation of carried interest far beyond hedge fund managers, said the ABA Section on Taxation in a letter to Congress, and significantly alter fundamental aspects of partnership taxation. Proposed Section 710 to the Internal Revenue Code would recharacterize income allocations of an investment service partnership from capital gain to ordinary income and defer losses allocated by such a partnership. These new provisions would apply to a partner providing investment services to the partnership. The service partner’s interest would be defined as an investment services partnership interest (“ISPI”). Proposed Section 710 also would change the taxation of distributions by the partnership on ISPIs and dispositions of ISPIs. In addition, Proposed Section 710 would further add penalties with respect to disqualified interests and impose self-employment tax with respect to ISPIs.

While the general purpose of proposed Section 710 is to tax the compensation element of a carried interest granted to fund managers as ordinary income rather than the capital gain it is currently taxed at, the ABA group believes that Section 710 goes beyond that original purpose in several ways. For example, if the intent of the legislation is to convert capital gains to ordinary income, it is unclear why proposed Section 710 provides loss deferral and mandatory gain recognition for C corporations, which are not taxed at different rates on capital gains or ordinary income.

Proposed Section 710 would also treat all partnership interests held by a partnership as “specified assets” regardless of the underlying character of the lower tier partnership’s assets. The ABA is not aware of any significant policy rationale for including all partnership interests, especially those issued by partnerships with no securities, commodities or derivatives, such as operating small grocery stores. If the intent of Congress is to prevent taxpayers from circumventing proposed Section 710 by forming partnerships to hold securities, commodities or derivatives, reasoned the taxation section, this could be addressed in a manner similar to the approach used in IRC section 731(c)(2)(B)(v) and (vi),5 which treatx partnerships holding specified assets in a manner similar to the manner in which those assets would be treated (i.e., a look-through analysis) without causing all partnership interests to be treated as the specified “bad” assets.

Senate Amendment 4386 was introduced on June 23, 2010, by Senate Majority Leader Reid for Finance Committee Chairman Baucus, to amend the American Jobs and Closing Tax Loopholes Act of 2010 to alter the taxation of certain carried interests by adding a new section 710 to the Internal Revenue Code. On July 22, 2010, H.R. 4213, Unemployment Compensation Extension Act of 2010, Pub. Law 111–205, 124 Stat. 2236, was enacted into law. As enacted, H.R. 4213 did not include any provisions affecting the taxation of carried interests. On September 16, 2010, Chairman Baucus introduced S. 3793, Job Creation and Tax Cuts Act of 2010, which includes a proposal with respect to the taxation of carried interests that appears to be identical to proposed Section 710.

Friday, November 26, 2010

Hedge Fund Industry Seeks Fair Market Valuation for Securities in Dodd-Frank Liquidation Authority

The hedge fund industry has urged regulators implementing the orderly liquidation provisions of the Dodd-Frank Act to provide for the fair market valuation of securities of failing financial firms rather than the fixed valuations proposed for government securities and contemplated for other securities. In a letter to the Managed Funds Association said that assigning fixed valuations for certain types of assets in advance, as the Proposed Rule contemplates for Treasury and other U.S. government securities, is likely to lead to valuations inconsistent with the statutory standard of fair market value. It could also lead to distortions in market activity.

In the MFA's view, the appropriate valuation of assets is a critical component of any liquidation process. Section 210(a)(3)(D)(ii)(I) of the Dodd-Frank Act treats any portion of a secured claim which exceeds the fair market value of the underlying collateral as an unsecured claim, paid in the same manner as other general unsecured creditors. But Dodd-Frank does not define the term “fair market value” for the purpose of determining the amount of secured claim that will be treated as an unsecured claim. The proposed rules contemplate adopting a regulation establishing a fixed valuation for U.S. government securities, and asks whether valuations should be fixed for other forms of collateral.

Thursday, November 25, 2010

Bachus Asks for SEC-Like Transparency in Setting Up Bureau of Consumer Financial Protection

The incoming Chair of the House Financial Services Committee wants to see more transparency and accountability in the process of establishing the new Bureau of Consumer Financial Protection mandated by the Dodd-Frank Act. In a letter to Treasury officials, Rep. Spencer Bachus said that, in sharp contrast to the approach taken by the SEC and CFTC in implementing Dodd-Frank, Treasury has provided little or no transparency in its activities implementing the Bureau for eventual hand-off to the Fed, where it will reside. For example, he noted that Treasury officials have provided little transparency on who they are meeting with and who they are soliciting input from. Rep. Bachus asks for the names of any other persons who Secretary Geithner has delegated duties to during this interim phase. The Congressman wants a response from Treasury on this and his other queries by January 10, 2011.

Rep. Bachus noted that the SEC and CFTC are publicly disclosing the names of all persons from outside government who meet with them about implementing Dodd-Frank, as well as the subject matter of such meetings. Rep. Bachus asks Treasury if the federal employees responsible for establishing the Bureau, including Professor Elizabeth Warren, complying with this protocol with regard to meetings regarding the Bureau. The incoming Chair also asks if the officials creating the Bureau have studied the organizational changes that the SEC and other federal financial regulators made in response to criticisms in the wake of the financial crisis. He believes that the Warren team has a unique opportunity to learn from the lessons of the past in crafting a the largest new federal regulator in a generation with a guaranteed annual budget of over $500 million. The Congressman wants to know the plans for the new organization, including what divisions and offices are being contemplate, as well as how public comment will be sought on this matters. The current Ranking Member said that, since the Bureau will be under scant oversight of how it spends the annual budget, Congress needs to know the internal mechanisms the Bureau will put in place to prevent fraud, waste and abuse.

UK Supreme Court Explains Fiduciary Duty Limits of De Facto Directors

The UK Supreme Court has ruled that a person who created 42 companies to service the tax and business needs of IT contractors, and also created a company to be the sole director of each of the 42 companies with himself as the director of that corporate director, was not the de facto director of each of the 42 companies. In a 3-2 opinion, the Court declined to impose fiduciary duties on the individual when all of his relevant acts were done as a director of the corporate director and could be attributed in law solely to the activities of the corporate director so long as the relevant acts were done by the individual entirely within the ambit of the discharge of the his duties as a director of the corporate director. It is to that capacity that his acts must be attributed. The individual was simply not part of the corporate governance structure of the composite companies, said the Court, and did not assume a role in those companies which imposed on him the fiduciary duties of a director.Holland v. Commissioners for Her Majesty's Revenue and Customs, UKSC 51, Nov. 24, 2010.

The 42 companies were created separately in an effort to stay below a higher corporate tax rate, a scheme that failed when UK tax authorities found that the companies were associated and imposed the higher corporate rate. The government alleged that the individual was a de facto directors of the 42 companies, which had become insolvent, and of which HMRC is the only creditor, and that he had been guilty of misfeasance and breach of duty in causing the payment of dividends to the companies’ shareholders when the companies had insufficient distributable reserves to pay their creditors.

A company is an artificial entity, said Lord Hope for the majority, a creature of statute. So it can act only through human beings. Inevitably it is human beings who must take the decisions, and give effect to them by actions, if the company is to do anything
at all. It follows that persons can be validly appointed as company directors and that persons who are not directors de jure may nevertheless be treated as directors de facto. In addition, UK law allows for a company to be the director of another company and, up until the Companies Act of 2006 which required a company to have at least one natural director, to be the sole director. It followed that the corporate set up here of a sole corporate director for the 42 composite companies was proper since these events occurred before 2006.

The Court cited a key UK precedent holding that a de facto director is a person who assumes to act as a director. He is held out as a director by the company, and claims and purports to be a director, although never actually or validly appointed as such. To establish that a person was a de facto director of a company it is necessary to plead and prove that he undertook functions in relation to the company which could properly be discharged only by a director. It is not sufficient to show that he was concerned in the management of the company’s affairs or undertook tasks in relation to its business which can properly be performed by a manager below board level.

The Court said that the mere fact of acting as a director of a corporate director will not be enough for that individual to become a de facto director of the subject company. In this case, the individual charged as de facto director wasdoing no more than discharging his duties as the director of the corporate director of the composite companies. Everything that he did was done under that umbrella. Evidence that the individual director of the body corporate was actually giving instructions in that capacity to the subject company and the subject company was accustomed to act in accordance with those directions would not be enough to prove that the individual director assumed a role in the management of the subject company which imposed responsibility on him for misuse of the subject company’s assets.

In his concurring opinion, Lord Collins noted that for almost 150 years de facto directors in English law were persons who had been appointed as directors, but whose appointment was defective, or had come to an end, but who continued to act as directors. There was a striking judicial innovation in the late 1980s by which persons who were held to be part of the corporate governance of a company, even though not directors, could be treated as directors for the purposes of statutory provisions
relating to such matters as wrongful trading by, and disqualification of, directors. To extend that line of authority so as to impose fiduciary duties on the individual in this case in relation to the composite companies, when all of his acts can be attributed solely to the activities of the corporate director of the composite companies would be an unjustifiable judicial extension of the concept of de facto director, and best left to the legislature, given that it was as recently as 2006 that it intervened to require that at least one director of a company be a natural person.

In dissent, Lord Walker feared that the Court’s decision will make it easier for risk averse individuals to use artificial corporate structures in order to insulate themselves against responsibility to an insolvent company’s unsecured creditors. While stopping short of calling it a sham, Lord Walker said that the Court's assertion that everything that the individual did was done in his capacity as a director of the corporate director of the composite companies and was within his authority as a director of that company, is the ``most arid formalism.'' The dissent believes that the individual was acting both as a de jure director of the corporate director and as a de facto director of the composite companies. A de facto director is not formally invested with office, reasoned Lord Walker. but if what he actually does amounts to taking all important decisions affecting the relevant company, and seeing that they are carried out, he is acting as a director of that company. It makes no difference that he is also acting as the only active de jure director of a corporate director of the company.

Wednesday, November 24, 2010

UK Financial Minister Hails Passage of Non-Protectionist Legislation Regulating Hedge Funds

Recently enacted non-protectionist EU hedge fund legislation is an achievement that looked doubtful six months ago, said UK Financial Services Secretary Mark Hoban, but he hailed the Alternative Funds Managers Directive as a signal success for the free cross-border movement of capital. In remarks to PricewaterhouseCoopers, the Minister said that EU authorities reached an agreement where managers of hedge funds and private equity providers will be regulated in an internationally consistent and non-discriminatory way. Rather than seeing US and other third country managers frozen out of EU markets, he added, they will be able to qualify for a passport. This is of huge significance to the UK, as a leading player in this industry, the Minister emphasized, and will introduce greater competition, open up new markets, and create new investment opportunities. Most importantly, the EU has signaled it is open for business and will not close its borders and restrict free movement of capital.

There had been great concern earlier in the year from US and UK officials that the EU was moving towards protectionist hedge fund regulation through legislation that would deny an EU passport to US and other third country hedge funds. Treasury Secretary Tim Geithner had sounded an alarm in this regard. EU Commissioner for the Internal Market Michel Barnier had assured US officials that the EU would work towards non-discriminatory hedge fund and private equity fund regulatory legislation.

Florida Adopts Discliplinary Guidelines for Dealers, Investment Advisers and Associated Persons

Disciplinary guidelines applicable to each ground for which disciplinary action may be taken against an individual or firm were adopted by the Florida Office of Financial Regulation, effective November 22, 2010. The guidelines as contained in the "Office of Financial Regulation, Division of Securities, Disciplinary Guidelines for Dealers, Investment Advisers and Associated Persons" specify a range of penalties based on the severity and repetition of specific offenses, and distinguish minor violations from violations that endanger the public health, safety or welfare, provide reasonable notice to the public of the penalties imposed for proscribed conduct and ensure that the penalties are imposed in a consistent manner, but listed mitigating or aggravating circumstances allow the Office to impose penalties other than those specified in the guidelines. Disqualification periods relate to crimes involving dealer, investment adviser, issuer, associated person or branch office applicants or registrants, or crimes involving moral turpitude or fraudulent or dishonest dealing. Disqualification periods suspending applicants from registration are based on criminal convictions or pleas of nolo contendere or guilt and include up to 5 days for a level A suspension, 6 to 30 days for level B suspension and over 30 days for a level C suspension. Fines range from $2,000 to $10,000 depending on the level of the fine from A to D. Applicants are not eligible to register until their disqualifying period expires.

Please see http://www.flofr.com/

Tuesday, November 23, 2010

Securities Industry Urges Supreme Court to Apply FRCP Rule 9(b) Standard to Materiality Element of Rule 10b-5

As the US Supreme Court considers the materiality element of Rule 10b-5 for the first time since 1988, the securities industry asks the Court to rule that materiality,like all other elements of a securities fraud, is subject to the heightened pleading standard of Federal Rule of Civil Procedure 9(b) and must pled with particularity. In a joint amicus brief filed with the Court in a private securities fraud action, SIFMA and the Chamber of Commerce contend that the Ninth Circuit incorrectly applied the “notice pleading” standard embodied by Federal Rule of Civil Procedure 8. Also, the brief said that the Ninth Circuit wrongly rejected the district court’s use of a “statistical significance” standard to evaluate whether the investors had sufficiently pled materiality. The Court has set oral argument for January 10, 2011. Matrixx Initiatives, Inc, v. Siracusano, Dkt. No. 09-1156.

While conceding that no federal circuit court of appeals has specifically addressed whether Rule 9(b) applies to the pleading of materiality, amici pointed out that a number of courts have held in general terms that Rule 9(b) applies to all elements of a federal securities fraud claim. Moreover, federal circuit courts of appeal have found that Rule 9(b) applies to analogous elements of a Section 10(b) claim, including loss causation and reliance. For example, the Fourth Circuit has observed that a strong case can be made that because loss causation is among the circumstances constituting fraud for which Rule 9(b) requires particularity, loss causation should be pleaded with particularity, see Teachers’ Ret. Sys. of La. v. Hunter, 477 F.3d 162, 185-86 (4th Cir. 2007). The same “strong case” exists for materiality, contended SIFMA and the Chamber.

The proper choice of pleading standards is important, emphasized amici, since Rule 9(b)’s heightened pleading standard serves to weed out meritless fraud claims. As to the crucial element of materiality, they noted, the complaint should include details
from which a judge could infer that the alleged misstatement or omission involved a fact that a reasonable investor would have considered important. And the securities fraud complaint should be dismissed if it does not do so. In this case, the Ninth Circuit never conducted the required Rule 9(b) particularity analysis.

FSOC Issues ANPR in Effort to Determine Which Securities Clearance and Settlement Utilities Are Systemically Important

As envisioned by the Dodd-Frank Act, the Financial Stability Oversight Council has issued an advanced notice of proposed rulemaking (ANPR) as a precursor of adopting regulations governing a determination when a financial market utility is systemically important. As defined in Section 803(6) of Dodd-Frank, a “financial market utility” is any person that operates a multilateral system for the purpose of transferring, clearing, or settling payments, securities, or other financial transactions among financial institutions or between financial institutions and that person. In Dodd-Frank, Congress recognized that the utility-like arrangements used to settle financial transactions, whether involving payments, securities, or derivatives are critical parts of the financial infrastructure and are integral to the soundness of the financial system. The importance of these arrangements has been highlighted by the recent period of market stress. Dodd-Frank authorizes the Council to designate as systemically important a financial market utility if the Council determines that the failure, or a disruption to the functioning, of a financial market utility could create or increase the risk of significant liquidity or credit problems spreading among financial institutions or markets and thereby threaten the stability of the financial system.

Financial market utilities exist in a number of markets and provide many benefits, but also concentrate risk. The payment and settlement processes of such systems are also highly interdependent, either directly through operational, contractual or affiliation linkages, or indirectly through liquidity flows or common participants. Problems in the completion of settlement at one system could spill over to other systems or financial institutions in the form of liquidity and credit disruptions.

Through the ANPR the Council is seeking to gather information as it begins to develop the specific criteria and analytical framework by which it will designate financial market utilities as systemically important under Title VIII of the Act.

Chinese Auditing Standards Board Is in Full Convergence with International Financial Auditing Standards

The Chinese Auditing Standards Board has adopted financial auditing standards that are in full convergence with the clarified international auditing standards promulgated by the IAASB. The standards will take effect for audits of financial statements for periods beginning on or after January 1, 2011. During the process of international convergence, the CASB made limited additions it considered necessary and maintained some standards dealing with matters that are not specially covered in ISAs to reflect China’s unique circumstances and business requirements, such as standards for the verification of capital contributions and communication between predecessor and successor auditors. The IAASB recognizes that such additional requirements may be necessary and are acceptable where they do not conflict with ISAs.

In recent years, the IAASB has conducted the Clarity Project to enhance the clarity of international standards on auditing, which involved the application of new drafting conventions to all ISAs and substantial revisions of a number of ISAs. On February 27, 2009, the Clarity Project reached its completion with the approval of the Public Interest Oversight Board (PIOB). Auditors worldwide now have access to 36 newly updated and clarified ISAs and a clarified International Standard on Quality Control (ISQC).

In announcing China's firm support for the efforts of the IAASB to promote international convergence of auditing standards, Dr. Wang Jun, Vice Minister of the Chinese Ministry of Finance and Chairman of the CASB noted that the fundamental principle of drafting the Chinese auditing standards is to continuously improve them, as well as achieve continuous and comprehensive convergence with international auditing standards in line with the development of the Chinese market economy and the overall trend of economic globalization and international convergence.

Securities Industry Seeks Nuanced Approach to Uniform Federal Fiduciary Standard for Advisers and Brokers

While generally supporting SEC regulations implementing a uniform federal fiduciary standard for investment advisers and brokers, the securities industry asks the Commission to adopt a nuanced approach to the standard recognizing that broker-dealers play an important role in retail brokerage, which cannot be easily replicated with alternative service models. In a recent letter to the SEC, SIFMA said that access to investment products traditionally offered on a principal basis (corporate and municipal securities) is more common and more affordable through commission-based accounts, particularly for small investors. The Dodd-Frank Act mandates an SEC study on advisers and brokers as a precursor to adopting a uniform standard of care.

The legislation does not prohibit commission-based compensation or other common elements of the broker-dealer service model, noted SIFMA, and a survey bears out the relative value of commission-based accounts. If these same brokerage services had to be provided under the existing provisions of the Investment Advisers Act, emphasized SIFMA, it would negatively affect client choice and access to products, such as those now available on a principal basis. Thus, SIFMA reaffirmed its support for a uniform federal fiduciary standard for broker-dealers and investment advisers who provide personalized investment advice to retail clients, but cautioned that the new standard must be “operationalized” to reflect the many different business models currently serving investors.

Indiana Extends Deadline for Filing New Part 2 of Form ADV

The deadline for filing new Part 2 of Form ADV was extended from December 31, 2010 to February 28, 2011 by the Indiana Securities Division. Investment advisers are cautioned, however, that the date for filing Part 1 and paying the renewal fees remains at December 31, 2010.

Monday, November 22, 2010

Ohio Sets Forth Policy on IAs Filing New Part 2 of Form ADV

Investment adviser initial applicants and currently licensed investment advisers filing Form ADV may, between October 12 and December 31, 2010, use either old Part II or new Part 2 of Form ADV. Beginning January 1, 2011, investment adviser initial applicants must file new Part 2A of Form ADV electronically through the IARD, and currently licensed investment advisers must incorporate new Part 2 with their next amended filing of Form ADV. Starting April 1, 2011, all Ohio licensed investment advisers must have converted their existing Part II to new Part 2; additional time to comply will not be granted and failure to comply by April 1, 2011 will subject investment advisers to enforcement action. Investment advisers are encouraged to become familiar with the new Brochure and Brochure Supplement distribution and delivery schedules as provided in the Instructions to new Part 2. NOTE: Ohio will not charge a fee for updating or amending Part 2 of Form ADV.

Please see http://www.com.ohio.gov/secu

TEXAS Does Not Adopt But Encourages IAs to Use New Part 2 of Form ADV

New Part 2 of Form ADV is not yet adopted in Texas for use by either investment adviser applicants or registrants but the Securities Board encourages new and currently registered firms to use new Part 2. New investment adviser applicants must file Form ADV Part 1B electronically through IARD, beginning January 1, 2011, and the Securities Board encourages applicants to begin the process by importing new Part 2 instead of old Part II onto IARD. After January 1, 2011, registrants may file an annual updating amendment on new Part 2 instead of on old Part
II since an annual updating amendment is not required in Texas.

Please see http://www.ssb.state.tx.us/

Sunday, November 21, 2010

SEC Urges US Supreme Court to Reaffirm Flexible Materiality Definition under Rule 10b-5

In what will be the US Supreme Court's first pronouncement in decades on the threshold and seminal materiality element of Rule 10b-5, the SEC urges the Court to reaffirm the flexible standard hammered out in the Northway and Basic, Inc opinions that an omitted fact is ““material”” when there is a substantial likelihood that a reasonable investor would have considered it important. The SEC filed an amicus brief in a private securities fraud action posing the question of whether an investor can state a claim under Rule 10b-5 based on a pharmaceutical company’s nondisclosure of adverse event reports about a drug even though the reports are not alleged to be statistically significant. The SEC urges the Court to hold that information that a drug causes adverse effects may be material to investors even absent statistical significance. Information suggesting a causal link between use of a drug and a serious adverse effect may significantly alter the behavior of consumers and regulators, contended the SEC, even when there is no allegation of a statistically significant association. In turn, because those reactions can affect a company’’s share price reasonable investors would consider such information to be highly relevant to their investment decisions. Matrixx Initiatives Inc. v. Siracusano, Dkt. No. 09-1156.

According to the SEC, the drug company is asking the Court to depart from the settled definition of materiality refined in the 1988 Basic, Inc. v. Levinson case in favor of a categorical rule that deems information about an adverse effect associated with use of a drug immaterial unless the association is statistically significant. In the SEC's view, that rule conflicts with the standard the Supreme Court refined in Basic for two important reasons. First, evidence other than data showing a statistically significant association can suggest a causal link between use of a drug and an adverse effect. Medical researchers, courts, and FDA regularly consider multiple factors in assessing causation, especially where (as in this case) the available epidemiological data
are inconclusive. Second, a reasonable investor may consider information suggesting an adverse drug effect important even if it does not prove that the drug causes the effect. Even reports that simply suggest causation may affect the behavior of consumers, potential litigants, and FDA. Because such a reaction may affect a product’’s commercial viability, and thus the company’’s financial condition, noted the SEC, a reasonable investor often will want to know about such information.

The position urged by the company also conflicts with Supreme Court’ precedent because it establishes a rigid restriction, particularly at the pleading stage. In Basic and Northway, the Court rejected a ““bright-line”” rule both because it was too underinclusive and because the materiality inquiry requires “delicate assessments” better suited to the trier of fact.

The SEC also found unpersuasive the company's concern that indiscriminate release of adverse event reports will mislead investors The Commission pointed to statutory and regulatory requirements that drug manufacturers report those events to FDA, and FDA’’s policy of making those reports publicly available. For all drugs with an approved new drug application as well as for prescription drugs without an approved new drug application, the FDA has long required companies to report post-marketing “adverse drug experiences.”

Finally, it is the SEC's view that the company is placing a false choice before the Court of adopting a statistical significance threshold or forcing companies to disclose every report of an adverse effect to stave off liability. The choice is false, said the SEC, because application of Basic’’s materiality standard could sometimes permit a company to withhold adverse drug information. For example, a company could reasonably conclude that a single report of an adverse event from an anonymous
user, or a dozen reports of a dozen different adverse events, would not be important to a reasonable investor for a widely used drug that had undergone rigorous pre-market testing and FDA review and approval. Even if the reports of an adverse effect were more numerous or reliable, a company could reasonably conclude that they were not material if the effect was minor and transient relative to the drug’’s benefit and the drug sales did not contribute meaningfully to the company’’s revenues.

Saturday, November 20, 2010

UK Corporate Governance Regulator Updates Guidance for Audit Committees in Light of Financial Crisis

In light of the recent financial crisis and the ongoing economic climate, the UK corporate governance regulator, the Financial Reporting Council, has issued updated guidance for audit committees that focuses on accounting valuations and creating an environment in which the outside auditor can question management with professional skepticism. In that context, the audit committee should agree with the outside auditor on arrangements to ensure that the auditors can express any concerns they have about estimates, assumptions and forecasts without undue influence by management.

The audit committee must also refocus its oversight of risk management. In particular, the audit committee should discuss business and financial risks with the outside auditor and the committee should satisfy itself that the auditor has properly addressed risk in itsr audit strategy and plan. The audit committee must also be satisfied that the external auditor has allocated sufficient additional and experienced resources to address heightened risks. Another thing to watch for is whether company management has exerted undue pressure on the level of audit fees such that it creates a risk to audit work being conducted effectively.

In light of the issues of fair value accounting regarding illiquid securities in inactive markets, tghe FRC wants audit committtes to ensure that valuation processes are supported by appropriate internal controls and reasonableness checks and that key underlying assumptions are changes consistent with external events and circumstances. Last year’s valuations should be compared to actual outcomes. The audit commitee must also ensure tha models and key assumptions adequately address low probability but high impact events. The audit committee must make sure that management has considered which combination of scenarios could conspire to be the most challenging for the company.

The updated guidance also seeks to ensure that the audit committee is satisfied that appropriate sensitivity analysis has been conducted to flex assumptions to identify how robust the model outputs are in practice and that the assumptions are free from bias. Where assets are not traded, perhaps because markets are no longer active, the committee must be satisfied that appropriate additional procedures have been undertaken to estimate fair values through the selection of market‐based variables and the use of appropriate assumptions.

Further, a best practice is to determine if the assumptions that underlie valuations, including any impairment tests, are consistent with internal budgets and forecasts and with how the prospects for the business have been described in the narrative sections of the annual report and accounts. Importantly, the audit committee should ask the outside audit firm for a written summary of their views on the assumptions that underlie cash flow forecasts and other estimation techniques used to value assets and liabilities.

Friday, November 19, 2010

SEC Proposes Regulations Implementing Dodd-Frank Mandated Hedge and Private Equity Fund Reporting Regime

The SEC has proposed regulations implementing the regulatory regime for hedge funds and private equity funds mandated by the Dodd-Frank Act. Under the proposed rules, advisers to hedge funds and private funds would have to register with the SEC and provide information on the basic organizational and operational information about the funds they manage, such as information about the amount of assets held by the fund, the types of investors in the fund, and the adviser's services to the fund. The hedge fund and private funds would also have to identify five categories of "gatekeepers" that perform critical roles for advisers and the private funds they manage (i.e., auditors, prime brokers, custodians, administrators and marketers). According to the SEC, these new reporting requirements are designed to help identify practices that may harm investors, deter advisers' fraud, and facilitate earlier discovery of potential misconduct. And this information would provide for the first time a census of this important area of the asset management industry.

In addition, the Commission proposed other amendments to the adviser registration form to improve its regulatory program. These amendments would require all registered advisers to provide more information about their advisory business, including information about the types of clients they advise, their employees, and their advisory activities, as well as their business practices that may present significant conflicts of interest (such as the use of affiliated brokers, soft dollar arrangements and compensation for client referrals). The proposal also would require advisers to provide additional information about their non-advisory activities and their financial industry affiliations.

Dodd-Frank exempted from SEC registration advisers solely to venture capital funds and advisers solely to private funds with less than $150 million in assets under management in the U.S. However, Congress authorized the SEC to impose reporting requirements on these exempt advisers.

Under proposed rules, exempt reporting advisers would nonetheless be required to file, and periodically update, reports with the Commission, using the same registration form as registered advisers. Rather than completing all of items on the form, exempt reporting advisers would fill out a limited subset of items, including basic identifying information for the adviser and the identity of its owners and affiliates, information about the private funds the adviser manages and about other business activities that the adviser and its affiliates are engaged in that present conflicts of interest that may suggest significant risk to clients, and disciplinary history of the adviser and its employees that may reflect on their integrity. Exempt reporting advisers would file reports on the Commission's investment adviser electronic filing system (IARD), and these reports would be publicly available on the Commission's website.

Directed by the Dodd-Frank Act to define the term "venture capital fund," the Commission has proposed a definition designed to effect Congress' intent in enacting this exemption. Under the proposed definition, a venture capital fund is a private fund that represents itself to investors as being a venture capital fund, only invests in equity securities of private operating companies to provide primarily operating or business expansion capital (not to buy out other investors), U.S. Treasury securities with a remaining maturity of 60 days or less, or cash, is not leveraged and its portfolio companies may not borrow in connection with the fund's investment, offers to provide a significant degree of managerial assistance, or controls its portfolio companies and does not offer redemption rights to its investors. Under a proposed grandfathering provision, existing funds that make venture capital investments would generally be deemed to meet the proposed definition, as long as they have represented themselves as venture capital funds. The Commission is proposing this approach because it could be difficult or impossible for advisers to conform existing funds, which generally have terms in excess of 10 years, to the new definition.

According to SEC Chair Mary Schapiro, the proposed definition distinguishes venture capital funds from hedge funds and private equity funds by focusing on the lack of leverage of venture capital funds and the non-public, start-up nature of the companies in which they invest. The rule therefore focuses on the provision of capital for the operating and expansion of start-up businesses, rather than buying out prior investors. the SEC head described this as a challenging line-drawing exercise.

Thursday, November 18, 2010

Hedge Fund Industry Urges Flexible Volcker Regulations on Market Making and Feeder Funds

In a letter to the SEC and other federal financial regulators, the hedge fund industry said that the regulations implementing Section 619 of Dodd-Frank should not impede two important intermediary functions of banks and brokerage firms: market making and distribution platforms for customers to invest in third-party private funds. In the view of the Managed Funds Association, Congress did not intend for the Volcker Rule ban on proprietary trading and sponsoring hedge funds to include market making activity and third-party fund distribution. Hedge funds and private equity funds rely on market makers to provide the liquidity that allows trading activities. Banks and brokers must also be permitted to engage in hedging activities through a flexible application of the Volcker Rule.

The distribution platforms allowing investment in third-party funds are set up through a pooled investment vehicle established by the bank or brokerage firm that will invest substanially all of its assets in the third-party fund. This distribution platform is important to independent private funds, as well as to bank customers who can invest in a third-party fund without putting the bank's money at risk, noted the MFA, although Dodd-Frank envisions that the bank may invest a de minimis amount of money as seed capital when it sets up the feeder fund. Aside from this de minimis amount, the risks associated by this type of feeder fund are borne entirely by the investors in the feeder fund.

Wednesday, November 17, 2010

Treasury Official Outlines Role for Office of Financial Research

Mandated by Dodd-Frank to assist the Financial Stability Oversight Council in its work , the Office of Financial Research is working with regulators and industry, laying the groundwork to standardize financial reporting and develop reference data that will identify and describe financial contracts and institutions.

Data standardization will provide for more consistent and complete reporting, said Deputy Treasury Secretary Neil Wolin, making the data available to decision makers easier to obtain, digest, and utilize. The OFR is created by Title I, Subtitle B, authored by Senator Jack Reed for the logical reason that the Council will need reliable data from the SEC and other federal financial regulators to identify systemic risk in the financial system.

In remarks to the LSE, Secretary Wolin said that, over the coming weeks and months, the OFR will begin to define a set of standards for reporting of financial transaction and position data. The OFR will collaborate with the financial industry, data experts, and regulators to develop an approach to standardization that works for everyone.

He assured the industry that Treasury is mindful that the OFR must not duplicate existing government data collection efforts or impose unnecessary burdens. That is why Treasury is working with the regulators to catalogue carefully the data they already collect to ensure the OFR relies on their data whenever possible. The OFR is also exploring ways in which it could act as a central warehouse of data for the regulatory community, which could generate efficiencies and interagency cooperation.

For example, new reporting requirements in the Dodd-Frank Act, which are consistent with reforms supported by the G-20, will make possible a comprehensive cataloging of derivatives in order to track their redistribution of risk through the system. Data standards will make it easier for individual firms to assess their own risks and will improve discipline by giving market participants better information on what individual firms are doing.

Beyond establishing standards, the OFR is also required to develop and publish key reference data that will describe financial institutions and contracts. Regulators and supervisors, as well as private firms and investors, rely on such reference data to analyze risk. The OFR is beginning the effort to put all of this in place.

In his view, the the true measure of success will be in how it facilitates more robust and sophisticated analysis of the financial system, both for the government and the private sector. This is critical for the Council as well as its international counterparts.

Illinois Adopts Rules Regulating IA Advertising and Client Information

Two new rules adopted by the Illinois Securities Department on November 3, 2010:

* Investment advisers registered or required to register in Illinois are prohibited from using advertisements that contain untrue statements of material fact or that are misleading.

* Investment advisers registered or required to register in Illinois are required to have a written consumer privacy policy to protect their clients' information.

See http://www.cyberdriveillinois.com/departments/securities/home.html

Details Are Key to Landrieu-Isakson Qualified Residential Mortgage Exemption from Skin in the Game Rule

In a letter submitted today to the SEC and other joint regulators charged with implementing the section of the Dodd-Frank Act dealing with risk retention for securitized mortgage-backed securities, the American Securitization Forum (ASF) underscored its support for retention requirements which are tailored to different classes of securitized assets and spelled out a series of specific criteria that should be used to establish the definition for a Qualified Residential Mortgage (QRM). The Landrieu-Isakson Amendment to the Dodd-Frank Act carved out an exemption for qualified residential mortgages from the skin in the game requirement of securitized mortgages, but left the details to the SEC and other regulators. The ASF also proposed several different options sponsors could 0use to satisfy risk retention obligations for residential mortgage-backed securities. In developing a definition of a QRM which would exempt qualifying mortgage-backed securities from risk retention requirements. ASF members, including institutional investors and issuers, developed a series of standards, such as income and asset verification, minimum borrower equity and debt-to-income ratios, that mortgages would have to meet in order to be included in a qualifying QRM. The ASF has produced a definition that seeks to significantly strengthen mortgage pools, while, at the same time, ensures appropriate credit can resume flowing to homebuyers. The Forum said that it is essential that a balanced definition is developed for the Qualified Residential Mortgage to ensue creditworthy borrowers qualify for the lowest mortgage rate possible.

Colorado Adopts BD, Sales Rep. and IA/IAR Rule Amendments

Adding new solicitation and custody rules for investment advisers, modifying licensing exam requirements for sales and investment adviser representatives, providing a time frame for abandoning licensing applications, and changing NASD to FINRA to reflect the current name of the organization were the amendments adopted by the Colorado Securities Division, effective 11-30-2010.

For more information, please see http://www.dora.state.co.us/securities

Monday, November 15, 2010

FINRA Provides Data on Dual Registants in Aid of SEC Dodd-Frank Study

As part of its Dodd-Frank mandated inquiry into whether a uniform fiduciary duty should be imposed on investment advisers and broker, the SEC requested information from FINRA, which the SRO has provided. FINRA noted that as of mid-October, 4642 firms are registered with FINRA as a broker-dealer. Of these, 842 also are registered as an inviser with either the SEC or a state. Thus, approx. 18.4 percent of registered broker-dealers are dual registrants.

Saturday, November 13, 2010

Group Urges Securitization Exemption from Volcker Rule

In a letter to the SEC and other regulators, the American Securitization Forum urged the Commission and other financial regulators to clarify that there is a securitization exclusion from the Dodd-Frank Volcker Rule to allow banking entities and financial companies to participate in certain securitization relationships and activities without falling within the scope of the Rule and more broadly the Volcker Rule, as codified in Sec. 619 recognizes that securitization relationships and activities are not be prohibited activities under Section 13(a)(2) of the Bank Holding Company Act and that the definition of "hedge fund and private equity fund" contain appropriate limitations to implement these modifications

In defining permissible securitization relationships, the Forum said that the securitization exclusion must allow firms to engage, both directly and indirectly, through affiliates and securitization vehicles which they sponsor, in traditional and sound securitization activities.

The Volcker Rule prohibits a banking entity from acquiring or retaining any ownership interest in or sponsoring a hedge fund or a private equity fund." A "hedge fund" or "private equity fund" is defined very broadly in the Volcker Rule to be "a company or other entity that would be an investment company under the Investment Company Act but for Section 3(c)(1) or 3(c)(7) of the 1940 Act, or such similar funds as the appropriate Federal banking agencies, the SEC, and the CFTC may determine.

The Fourm feared that,taken literally, and without giving effect to the exceptions contained in the Volcker Rule, these two provisions could be read to restrict a firm from engaging in any securitization transaction with an issuer fund in which that firm has any equity interest or a sponsorship role if that fund relies on the private placement exemptions of Section 3(c)(1) or 3(c)(7). The Forum noted that many securitization issuers currently rely on one of those exemptions.

In its letter to the SEC, the Forum was confident that Congress did not intend this result. Indeed, in the Volcker Rule drafters provided compelling evidence that such application was not intended by providing that the Volcker Rule is not to be construed to limit or restrict the ability of banking entities or financial companies to sell or securitize loans. Congress thus made clear that even though some securitization issuers would otherwise fall within the definition of "hedge fund and private equity fund", those issuers and their sponsors were not meant to be included in the prohibited activities, maintained the Forum.

Friday, November 12, 2010

G-20 Calls for Globally Consistent Regulation of Hedge Funds and Derivatives and Coordinated Resolution Authorities to End Too Big to Fail

In the final communiqué from their Seoul summit, the G-20 committed to take action at the national and international level to ensure that national authorities implement global financial regulatory standards developed to date in a consistent manner that ensures a race to the top and avoids fragmentation of markets, protectionism and regulatory arbitrage. In particular, the G-20 pledged to implement fully the new bank capital and liquidity standards and address too-big-to-fail problems.

Also, with the European Parliament having just passed legislation similar to Dodd-Frank to regulate hedge funds, the G-20 committed to work in an internationally consistent and non-discriminatory manner to strengthen regulation of hedge funds, OTC derivatives and credit rating agencies. They endorsed the Financial Stability Board’s recommendations for implementing OTC derivatives market reforms, designed to fully implement previous commitments in a consistent manner, recognizing the importance of a level playing field. The FSB was asked to monitor the progress regularly. They also endorsed the FSB's principles on reducing reliance on external credit ratings. Standard setters, market participants, and regulators should not rely mechanistically on external credit ratings.

The G-20 again re-emphasized the importance of achieving a single set of improved high quality global accounting standards and called on the International Accounting Standards Board and the Financial Accounting Standards Board to complete their convergence project by the end of 2011. They also encouraged the International Accounting Standards Board to further improve the involvement of stakeholders, including outreach to, and membership of, emerging market economies, in the process of setting the global standards.

The G-20 reaffirmed that no firm should be too big or too complicated to fail and that taxpayers should not bear the costs of resolution. Addressing the moral hazard risks posed by systemically important financial institutions and addressing the too-big-to-fail problem requires a multi-pronged framework combining: a resolution framework and other measures to ensure that all financial institutions can be resolved safely, quickly and without destabilizing the financial system and exposing the taxpayers to the risk of loss. This is the goal of the resolution authority created by Title II of Dodd-Frank.

Financial institutions that are globally systemic should have higher loss absorbency capacity to reflect the greater risk that the failure of these firms pose to the global financial system; more intensive oversight; robust core financial market infrastructure to reduce contagion risk from individual failures; and other supplementary prudential and other requirements as determined by the national authorities which may include, in some circumstances, liquidity surcharges, tighter large exposure restrictions, levies and structural measures. In the context of loss absorbency, the G-20 encouraged further progress on the feasibility of contingent capital and other instruments.

Concerns Voiced Over International Impact of Volcker Rule

International banks with U.S. banking operations are subject to Federal Reserve Board supervision and regulation as bank holding companies under the Bank Holding Company Act of 1956. As a result, they are “banking entities” for purposes of the Volcker Rule, and their U.S. operations are subject to the same prohibitions and empowerments under the Volcker Rule as domestic banking organizations. Consistent with the longstanding approaches of the BHC Act, Congress drew an appropriate territorial boundary regarding the scope of the Volcker Rule’s prohibitions. The Volcker Rule specifically authorizes international banks to conduct proprietary trading and fund activities solely outside the United States under Sections 4(c)(9) and 4(c)(13) of the BHC Act, subject to certain limitations.

The Japanese Bankers Association has asked the federal financial regulators formulating the Volcker Rule regulations for an explicit statement that the rule does not apply to the operations of non-US banks outside the United States. The exceptions for extra-territorial application in Section 619 refers to "the acquisition or retention of any equity, partnership, or other ownership interest in, or the sponsorship of, a hedge fund or a private equity fund by a foreign banking entity... solely outside of the United States, provided that no ownership interest in such hedge fund or private equity fund is offered for sale or sold to a resident of the United States.

The association believes that the phrase "solely outside of the United States" must be defined more precisely. In that context, the group suggested that the definition of “solely outside of the United States” consider the fund's domicile, the location at which it is managed and the location of its bookings. The group seeks an explicit statement that regulations do not apply to foreign funds, funds managed outside the United States and investments in hedge funds booked outside the United States (for example, in Tokyo for Japanese banks) because these constitute "transactions outside of the United States.”

Under the wording of regulations on investments in funds, noted the association, the Volcker Rule could apply to a non-US bank that has been licensed under the Bank Holding Company Act investing in a limited partnership ownership interest in a non-US fund if the fund's ownership interest is, or in the future will be, sold in the United States.

However, it is not always possible for investors in limited partnership interests to obtain information in advance regarding the participation of US investors in funds in which they invest, and even if such confirmation is made in advance, other investors may sell their ownership interest in the United States. An additional problem is the lack of means by which foreign financial institutions investing in funds can actively adhere to the Volcker Rule. The Japanese Bankers Association asked that these issues be fully considered when formulating detailed regulations and that the exceptions explicitly describe the differences in treatment for general partnership ownership interests and limited partnership ownership interests.

The Institute of International Bankers noted that Section 619 limited the extraterritorial reach of the Volcker Rule, which should reduce the likelihood of conflicts with international banks’ home country banking laws and regulations. In its view, implementation of the Volcker Rule’s non-U.S. activities authorization for international banks, which is based on Sections 4(c)(9) and 4(c)(13) of the BHC Act, can be adequately addressed in the rulemaking process implementing the Volcker Rule.

NYU Professor Says Federal Financial Regulators Should Adopt IRS Model in Monitoring Volcker Rule

The SEC and other regulators charged with implementing the Dodd-Frank Volcker Rule provisions should establish the same type of multi-dimensional approach that the IRS uses to identify tax evasion, said NYU Professor William Silber, including face-to-face audits where such are indicated. Beyond that, in his letter to the federal financial regulators, he urged them to arm themselves with a variety of methodologies, including one that he developed, for monitoring the Volcker Rule ban on proprietary trading by financial institutions. Professor Silber, formerly on the President’s Council of Economic Advisors, was favorably mentioned by Chairman Volcker in his letter to the regulators, in which the central banker described the professor as an expert witness in cases requiring identification of, and distinctions between, proprietary and market-making activity. Chairman Volcker asked the regulators to consider the relevant analysis provided by Professor Silber.

In his letter, Professor Silber offered his published article on how to distinguish between market-making and proprietary trading. The article was written in connection with a legal dispute concerning whether a party to a takeover was engaged in speculative trading despite their representations to the contrary. While the methodology in the article could be applied to the proprietary trading ban in Section 619 of Dodd-Frank, said the professor, it should not be viewed as a substitute for a comprehensive approach to implementing the Volcker Rule.

Thursday, November 11, 2010

European Parliament Approves Legislation Regulating Hedge Funds and Private Equity Funds

By a vote of 513 to 92, the European Parliament has approved legislation regulating hedge funds and private equity funds. In approving the Directive on Investment Funds Managers, Parliament set up a new regulatory regime designed to bring transparency and regulation in the way these funds are managed and operated. The final step is formal approval by the European Council of Ministers, which is expected soon. The Directive should come into force in early 2011. European Commissioner for the Internal Market Michel Barnier hailed the Directive for increasing transparency, reinforcing investor protection and strengthening the internal market in a responsible and non-discriminatory manner.

The legislation makes full use of the opportunities afforded by the new European securities and markets authorities to strengthen supervision and to enhance the macro-prudential oversight of hedge and private equity funds. The term alternative investment fund encompasses a wide range of investment funds that are not already regulated at a European level by the UCITS Directive, including hedge funds, private equity funds, real estate funds and a wide range of other types of institutional funds. The Directive will not apply to entities such as governments managing funds supporting social security and pension systems; supranational institutions, such as the World Bank and member organizations of the World Bank Group.

The all-encompassing approach of the European Commission’s draft proposal has been retained in the final legislation, covering all the major types of alternative investment fund managers and alternative investment funds. This will ensure a level playing field and help minimize the risks of regulatory arbitrage. Strict rules have been included on the valuation and safekeeping of assets, risk and liquidity management, the use of leverage and the acquisition of companies.

The strong single market dimension of the draft has also been preserved, introducing a single market passport for European managers and funds, as well as a third country passport, which will in due course become a single harmonized regime for third country access to investors in the EU. Specifically, once a hedge fund manager is authorized under the legislation in one Member State and complies with the rules of the Directive, the manager will be entitled upon notification to manage or market funds to professional investors throughout the EU.

There was a fierce debate over whether or not to grant the same rights to EU and non-EU hedge fund managers until a compromise was reached on the passport question that allowed the legislation to be passed. The final agreement allows US and other non-EU hedge fund managers to acquire a passport to market funds in the EU.

Following a limited transition period of two years, and subject to the conditions set out in the legislation, the passport will be extended to the marketing of US and other non-EU funds in the EU, managed both by EU fund managers and fund managers based outside the EU. In accordance with the principle of same rights, same obligations, this approach will ensure a level playing field and a consistently high level of transparency and protection of European investors.
The phased introduction of the US and other third country passports is designed to allow European regulators to ensure that the appropriate controls and cooperation arrangements necessary for the effective regulation of non-EU alternative investment fund managers are operating effectively.

Before the third country passport is introduced and for a period of three years thereafter, national regimes will remain available subject to certain harmonized safeguards. Once this period has elapsed, and on the basis of conditions set out in the legislation, a decision will be taken to eliminate the parallel national regimes. At this point, all hedge fund and private equity fund managers active in the EU will be subject to the same high standards and will enjoy the same rights.

Thus, there will be a dual system for about three years during which US and other non-EU hedge funds and fund managers will be governed by national private placement regimes under which registration in each jurisdiction will be required, until the rules allowing them to obtain a passport take effect.

The legislation also imposes a range of transparency requirements and robust safeguards in relation to the use of leverage by hedge funds and private equity funds. Fund managers will be required to set a limit on the leverage they use and will have to comply with these limits on an ongoing basis. Fund managers will also be required to inform regulators about their use of leverage so that the authorities can assess whether the use of leverage by the manager contributes to the build-up of systemic risk in the financial system. This information will be shared with the European Systemic Risk Board.

The legislation also authorizes regulators to intervene to impose limits on leverage when deemed necessary in order to ensure the stability and integrity of the financial system. The new European Securities and Markets Authority will advise competent authorities in this regard and will coordinate their action, in order to ensure a consistent approach.
Rules on compensation practices are being introduced in all major financial services sectors and the hedge fund sector will be no exception. Specifically, the legislation requires hedge fund managers to implement compensation policies promoting sound risk management. The compensation policies cannot encourage risk-taking that is inconsistent with the risk profile and fund rules of the funds being managed.

The legislation contains a number of investor protection safeguards to ensure that investors in alternative investment funds are well-informed and adequately protected. In particular, conflicts of interest will be avoided or will have to be managed and disclosed. Hedge fund managers will be required to employ adequate risk management systems and ensure that the fund’s liquidity profile reflects the obligations towards investors. Further, valuation must be performed properly and independently and strict conditions must be met when the fund manager delegate functions to third parties.

Importantly, investment in many types of hedge funds and other alternative investment funds is limited to professional investors. Consequently, the Directive creates rights for marketing to professional investors only. At the same time, Member States are not prevented from making certain types of hedge funds and private equity funds available to retail investors. However, in this situation, regulators are authorized to apply additional safeguards to ensure that retail investors are adequately protected.

The legislation mandates that a hedge fund's assets must be kept by an independent and qualified depositary subject to a high liability standard. In the event of a loss of fund assets, the burden of proof will be on the depositary. The legislation also provides for a robust mechanism for the delegation of depositary functions and careful regulation of the circumstances under which liability can be transferred to a sub-depositary, including when the sub-depositary is located outside the EU. This requirement is intended to allow investors to benefit from investment in third countries without compromising the level of investor protection.

The Commission is currently examining the corresponding depositary rules in the UCITS Directive with a view to producing proposals for their revision in 2011. This will ensure that the standard of protection afforded to investors in mutual funds regulated under the UCITS Directive does not fall below the standard for hedge funds. The rules adopted under the hedge fund legislation will serve as a clear benchmark for this work, but the Commission will also assess whether additional safeguards are required to reinforce the protection of retail investors.

Volcker Urges SEC to Use Dodd-Frank's Anti-Evasive Authority to Thwart Attempts to Evade Ban on Proprietary Trading and Hedge Fund Sponsoring

In a letter to the SEC and other regulators comprising the Financial Stability Oversight Council, former Fed Chair Paul Volcker said that clear and concise definitions, firmly worded prohibitions, and specificity in describing permissible activities will be of prime importance as they implement the Dodd-Frank Act ban on financial institutions conducting proprietary trading and sponsoring hedge funds. He said that the plain intent of Section 619 of Dodd-Frank, codifying the Volcker Rule, is to restrict certain high risk, proprietary trading activities by financial institutions that receive government protection and support. The former Fed Chair also emphasized that hedge and private equity funds should be aligned with and support established customer-focused asset management business.

He also advised that the anti-evasion clause of Section 619 provides ample authority for regulators to detect attempts to circumvent the Volcker Rule. Dodd-Frank clearly states that regulators may look beyond the trading account into any such other accounts as the SEC and CFTC may determine. In practice, he noted, particularly active trading relative to peer institutions in the guise of “market making” should be a signal for regulatory interest, especially if further reflected in relatively wide fluctuations in trading results. He advised the SEC and other federal financial regulators that such signals of potential proprietary trading should be tested against direct visits to trading desks and specific trading records.

In his view, defining the term “market making” will be especially important since it is this function where trading presumptively in response to customers’ initiative might disguise essentially proprietary wagers on the direction of individual securities or markets. Other important terms which deal with scope, such as “trading account”, should be defined broadly so as not to limit regulatory examination of trading activities that may or may not in a particular institution be labeled as “trading account”.

In addition, insuring the proper implementation and enforcement of Section 619 requires that the de minimis exemptions and other permissible activities be defined clearly. Federal financial regulators must recognize that the thrust of Dodd-Frank is that certain of those activities be confined only to customer related activities within the firm. Rules that determine whether an action by a financial institution is in response to customers’ initiative and needs are critical, said the former Fed Chair.

In providing a de minimis provision for sponsorship and temporary seed investments in hedge funds and private equity funds, explained Chairman Volcker, Dodd-Frank endeavors to isolate the risk and to protect against conflicts of interest by prohibiting guarantees or bail-outs of such funds by the organizations and other safeguards against advertising and director or employee investment. Crucially, said Mr. Volcker, such funds should be organized only by institutions with established trust and investment management services, and should be offered only to persons that were customers of such services.

Finally, Chairman Volcker said that tone at the top will be very important in implementing Section 619. Effective compliance must start with a clear understanding at the top of the regulated institution. The first step for regulators should be the “corner office,” noted the central banker, and the CEO’s understanding and instructions to other executives and staff regarding the prohibition on proprietary trading and compliance procedures for the new rules should be carefully reviewed. The directors and the audit committee, should understand their own responsibilities to insure effective procedures for compliance with Section 619, he added, and meetings with the firm’s risk management vehicles should include surveillance with respect to compliance with the Section 619.

Wednesday, November 10, 2010

Bowles-Simpson Commission Calls for Major Overhaul of Federal Tax Code

The President’s National Commission on Fiscal Responsibility and Reform has called for a complete overhaul of the US federal tax code that would significantly affect public companies, investment companies, hedge funds and offshore funds. The overall goal of the draft proposal is to dramatically reduces rates, simplify the Code, broaden the base, and reduce the deficit. The proposal would consolidate the tax Code into three individual rates and one corporate rate, which would be reduced to 26 per cent. The draft would eliminate or modify several business tax expenditures, including the LIFO method of accounting and depreciation rules.

The draft also proposes international tax reform, including a territorial system. Many foreign corporations that trade with the United States are incorporated in countries, such as Germany, that operate under a territorial tax system. Under a territorial system, income earned by foreign subsidiaries and branch operations (e.g., a foreign owned company with a subsidiary operating in the United States) is exempt from their country’s domestic corporate income tax. Therefore, under a territorial system, profits are only taxed by the country where the income is earned. In contrast, the U.S. tax system is basically a worldwide system whereby companies registered as U.S. domestic companies are subject to taxation on all income regardless of where it is earned. See Joint Economic Committee study.

The Commission co-chairs, Erskine Bowles and Alan Simpson, call on the tax-writing committees, Senate Finance and House Ways & Means, to develop and enact comprehensive tax reform by end of 2012. It is envisioned that the new Code would put in place across-the-board “haircuts” for itemized deductions, employer health exclusion, and general business credits.

Federal Court Limits Sarbanes-Oxley Protection to PCAOB-Auditor Documents Prepared Specifically for the Board

Sarbanes-Oxley provisions protecting PCAOB-auditor documents from disclosure are expressly limited to materials that an audit firm prepared specifically for the Board, ruled a federal judge, and do not protect from discovery documents related to or concerning the Board’s inspection process. Indeed, the plain language of Section 105(b)(5)(A) makes clear that Congress did not create a blanket privilege regarding the PCAOB inspection process. Thus, in a securities fraud action alleging that a company failed to disclose the effect of significant financial transactions in violation of GAAP and SEC rules, the outside auditor was ordered to produce all documents on the accounting and disclosure of the transactions that were not prepared specifically for the PCAOB. In addition, the audit firm must give the investors a privilege log describing the nature of any documents that it has withheld pursuant to Section 105(b)(5)(A). (Silverman v. Motorola, Inc. et al., ND Ill, June 29, 2010, No. 07 C 4507).

Section 105(b)(5(A) is a clear and unambiguous provision that protects from disclosure only materials that an accounting firm prepared specifically for the Board. Since there is no ambiguity in this statutory provision, noted the court, there was no need to look any further than the text of the statue in order to resolve the discovery issue. Inclusion of the phrase "specifically for the Board" makes clear that the statute is applicable to only a portion of any information or documents that may derive from, refer to, or relate to a PCAOB inspection. The court rejected KPMG’s assertion that the statutory protection includes any documents related to or concerning the PCAOB inspection process since to accept the firm’s premise would extend interpretation of the provision beyond its plain language and render meaningless the phrase "specifically for the Board."

The court similarly rejected an assertion set forth by the Center for Audit Quality in its amicus brief that internal KPMG documents relating to the inspection process are prepared specifically for the Board because absent the inspection they would never have been created in the first place. If Congress intended the privilege to protect all materials related to a Board inspection, reasoned the court, the text of Section 105(b)(5)(A) would reflect that intention. Instead, the statute limits the protection to materials prepared specifically for the Board. Despite arguments by KPMG and CAQ regarding the legislative history of Sarbanes-Oxley, the court said that it did not need to consider legislative history because the plain language of the statute is clear and there was no need to judicially look beyond its text.

The court also rejected KPMG’s contention that documents relating to the PCAOB's inspection of the firm’s audit practice are irrelevant to this litigation because violations of accounting and auditing standards are generally insufficient to support a securities fraud claim. Because the defendants have placed their accounting at issue by contending that the company acted in conformance with GAAP, noted the court, they have necessarily placed KPMG's communications regarding the corporate transactions directly at issue. Given that the PCAOB conducted an investigation of KPMG to determine whether its audits complied with professional standards, and that the PCAOB made specific findings regarding deficiencies associated with the firm’s auditing procedures of the transactions, continued the court, these documents are directly relevant to this litigation.

Also rejected was the firm’s assertion that the requests for the documents were unduly burdensome. The audit firm has already produced documents in this litigation, noted the court, and the requests at issue are limited in time and scope. In addition, the investors agreed to reimburse the firm for reasonable production and copying costs and only requested to take the depositions of two KPMG professionals.

Giving Assurances on Tax Avoidance Scheme Did Not Make Law Firm Liable for Securities Fraud Since No Attribution Meant No Reliance

A law firm that gave assurances on a tax avoidance scheme that employed digital securities options was not liable for securities fraud, ruled a Fifth Circuit panel, since without direct attribution to the firm’s role in the tax scheme, any taxpayer-investor reliance on the firm’s participation in the scheme was too indirect for liability. The panel said that a secondary actor cannot be held liable in a private securities fraud action for deceptive conduct not attributed to it before an investor decides to invest. (AFFCO Investments 2001 LLC v. Proskauer Rose LLP, CA-5, No. 09-20734, Oct. 27, 2010).

The Fifth Circuit panel distinguished its ruling that explicit attribution is required to show reliance under Rule 10b-5 from an earlier Fourth Circuit ruling that an investor can plead fraud-on-the-market reliance by alleging facts from which a court could plausibly infer that investors would have known that the defendant was responsible for the statement at the time it was made even if the statement on its face is not directly attributed to the defendant. Janus Capital Group v. First Derivatives Traders. The distinguishing factor, said the panel, is that the Fourth Circuit was dealing with fraud on the market and this tax scheme case is not that. The Fifth Circuit was concerned about whether the Fourth Circuit’s standard comports with the Supreme Court’s stated goals of certainty and predictability in securities law. This question may soon be answered because the Supreme Court has agreed to review the Fourth Circuit’s opinion in Janus, with oral argument set for December.

The scheme before the Fifth Circuit was a variation on a tax avoidance strategy that was heavily marketed and promoted by the financial planning and management industry in the late 1990s The IRS’s subsequent disallowance of these strategies resulted in a number of lawsuits against their developers and promoters.

This particular scheme involved a sophisticated income tax avoidance strategy in which taxpayers attempted to claim tax losses through a mechanism of offsetting digital options. Through a limited liability company (LLC) created solely for the purpose, a taxpayer would use a brokerage firm as a counterparty to buy and sell nearly identical options at approximately the same prices. Having thus hedged against any true losses, the taxpayer would claim a tax basis in the company that was increased by the cost of the purchased options, but not reduced by the price received for the options sold. When the company later suffered a “loss” (for example, by selling its options for their low fair-market value), taxpayers would claim a share of that “loss” calculated according to their increased tax basis. Digital options are option contracts in which the purchaser of the option wagers that the price of an underlying security will be above or below a certain “strike price” at a particular point in time.

The accounting firm solicited the law firm for participation in the tax scheme, representing the scheme to be a legitimate investment vehicle as well as a legitimate tax shelter through which taxpayers could offset some or all of their income. As part of their marketing strategy, the accounting firm promised to provide independent opinions from “several major national law firms” that had analyzed and approved the tax strategy On the strength of the accounting firm’s assurances, including the promise of opinions from unnamed law firms, investors agreed to participate in the scheme. The IRS later investigated investors for participation in an abusive tax shelter, and they were required to pay millions of dollars in back taxes, interest, and penalties.

As a threshold issue, the panel ruled that the taxpayers’ ownership interests in the LLCs constituted investments contracts and therefore were securities within the meaning of the federal securities laws. The tax avoidance scheme met the Supreme Court’s Howey test of an investment of money in a scheme functioning as a common enterprise with the expectation that profits will be derived solely from the efforts of individuals other than the investors. Tax benefits may constitute an expectation of profits under the test, said the panel. Further, while the taxpayer-investors may have had theoretical control over the situation, they did not exercise any managerial authority over the LLCs. Rather, under the terms of the investment contracts, the LLCs were to be managed by various investment consulting and brokerage entities for the purpose of implementing the tax scheme.

Absent attribution at time of investment decision making, the law firm recruited to give assurances on the tax avoidance strategy could not be liable under Rule 10b-5. While the investors’ allegations painted a clear picture of the law firm’s intimate involvement in the tax scheme, there was no assertion that they had knowledge of the firm’s role prior to their actual investment in the tax scheme. They do not allege that they ever saw or heard any of the firm’s work product before making their decision, nor do they allege that the promoters specifically identified the firm as one of the “major national law firms” that had vetted and cleared the tax scheme or that had agreed to provide opinions supporting the same.

Indeed, the law firm’s explicit involvement in the scheme, two tax opinions regarding the IRS reporting requirements, were rendered well after the purchase of the digital options and the creation of the taxpayers’ interests in the LLCs. Since the investors do not allege that they knew of the firm’s role in the tax scheme during the relevant time period when they were making their investment decisions, they failed to show reliance on the firm.

Knowing the identity of the speaker is essential to show reliance, reasoned the panel, because a word of assurance is only as good as its giver. Clients engage name-brand law firms at premium prices because of the security that comes from the general reputations of such firms for giving sound advice, or for winning trials. Specific attribution to a reputable source also induces reliance because of the ability to hold such a party responsible should things go awry.

Michigan Issues Fifth Transition Order Following Adoption of its 2009 New Securities Act

The nonprofit organization Exemption for securities, previous Act-exempt broker-dealers, Canadian broker-dealers and their agents, and senior-specific designations are the provisions covered in the fifth transition order of the Michigan Office of Financial and Insurance Regulation following adoption of the State’s new uniform securities act on October 1, 2009.

Nonprofit organization securities exemption. Nonprofit organization issuers may only claim Michigan's self-executing nonprofit organization securities exemption at 451.2201(g) of the Michigan Uniform Securities Act of 2009 if their offers or sales are part of an issue having an aggregate sales price of $500,000 or less and sold to a bona fide member of the issuing organization without payment of a commission or consulting fee. Nonprofit organization issuers not qualifying for the exemption must register the securities by qualification, by filing with the Administrator at least 20 days before the offer or sale of the security, an offering circular or prospectus stating the material terms of the proposed offer or sale, together with copies of any proposed to-be-used advertising or sales literature, and a $250 registration fee. The securities are considered approved as registered if the issuer does not receive a written notice disallowing the registration within 20 business days of the Administrator’s receipt of the filing. NOTE: Neither the self-executing exemption nor the registration requirements will apply to any offer or sale made within one year after the November 1, 2010 date of this fifth transition order in accordance with a good faith offering made before the November 1, 2010 date of this fifth transition order.

Broker-dealers exempt under the Michigan's predecessor Act. Persons who were both registered as broker-dealers and exempt from investment adviser registration under the predecessor Michigan Securities Act in effect before the Model 2002 Uniform Securities Act replaced it on October 1, 2009 may, by December 1, 2010, register as investment advisers by following the procedures in paragraph 4 of the first transition order that also requires paying the $200 investment adviser fee and submitting a list of employed/associated investment adviser representatives. Previously exempt broker-dealers timely filing an application will be exempt from investment adviser registration unless and until the Administrator approves or denies their application, and will not be subject to fines or penalties between October 1, 2010 and the date their application is approved or denied solely because of failure to be registered as investment advisers during this time period, although they remain subject to Michigan's fraud and other liability provisions.

Investment adviser representatives of previously exempt broker-dealers. Investment adviser representatives associated with or employed by a previously exempt broker-dealer that timely filed an application for investment adviser registration will, themselves, be exempt from investment adviser representative registration unless and until the Administrator: (1) approves or denies the employing exempt broker-dealer's investment adviser application and, if approved, (2) also approves or denies the investment adviser representatives' registration, provided the individuals file their investment adviser representative applications and comply with all related requirements by May 2, 2011. Individuals will not be subject to fines or penalties between October 1, 2010 and the date their application is approved or denied solely because of not being registered as investment adviser representatives during this time period, although they remain subject to Michigan’s fraud and other liability provisions. Investment adviser representatives relying on a waiver from the written examination requirement in accordance with Transition Order No. 4 must send the Administrator an Investment Adviser Representative Certification and Consent Form no later than February 1, 2011.

See Transition Order No. 1 that contains Michigan’s investment adviser and investment adviser representatives requirements, as well as Transition Order No. 3 that clarifies the requirements.

Canadian broker-dealer exemption. A Canadian-registered broker-dealer without a place of business in Michigan is exempt from registration in the State when effecting or attempting to effect securities transactions with either: (1) an individual from Canada temporarily present in Michigan and with whom the Canadian broker-dealer had a bona fide business relationship before the individual entered the United States; (2) an individual from Canada now present in Michigan whose transactions are in a self-directed tax advantage retirement plan the individual holds or contributes to in Canada; or (3) an individual present in Michigan with whom the broker-dealer customer relationship arose while the individual was temporarily or permanently residing in Canada.

Agents of Canadian broker-dealers. Agents of Canadian broker-dealers exempt from Michigan’s registration requirements may effect the same above-mentioned securities transactions permitted to their employing/associating broker-dealers.

Prohibited use of senior-specific certifications and professional designations. Michigan-registered broker-dealers, agents, investment advisers and investment adviser representatives are prohibited from using certain professional designations or certifications that state or imply specialized knowledge of the financial needs of senior investors. The use of these "senior designations" by a broker-dealer, agent, investment adviser or investment adviser representative is a fraudulent, unethical practice under Section 451.2502(3)(a) of the Michigan Uniform Securities Act of 2009. Only those professional designations attained through prescribed training offered by a nationally recognized accredited institution are approved professional designations by the Commissioner.

For more information please see http://www.michigan.gov/ofir