The Staff (the “Staff”) of the SEC’s Division of Investment Management recently wrote to the Investment Company Institute (the “ICI”) announcing that it would not recommend enforcement action if a money market fund board did not designate at least four nationally recognized statistical rating organizations (“NRSROs”) whose ratings would be used by the fund to determine the eligibility of portfolio securities for the purposes of Rule 2a-7 under the Investment Company Act of 1940.  The Staff also provided relief from related disclosure requirements for the designated NRSROs.  The compliance timeline for the February 2010 amendments to Rule 2a 7 and other rules affecting money market funds would have required a money market fund to comply with both provisions by December 31, 2010.

In its letter to the ICI, the Staff said that its no-action relief would remain in effect until the SEC determines whether to modify Rule 2a 7 and remove all references in the rule to NRSROs, as required by Section 939A of the Dodd-Frank Wall Street Reform and Consumer Protection Act (discussed in the July 28, 2010 Alert).  Until such modifications to Rule 2a 7, the Staff said that a money market fund must continue to comply with its obligations for determining and monitoring whether its securities, other than unrated asset backed securities, are or continue to be eligible securities for purposes of Rule 2a-7 as in effect before the February 2010 amendments to Rule 2a 7 took effect on May 5, 2010.  The Staff said that a money market fund may continue to acquire unrated asset-backed securities as permitted by the February 2010 amendments.  (Prior to the February 2010 amendments, a money market fund could acquire an asset-backed security only if the security was a rated security for purposes of Rule 2a-7.)

Although the staff of the SEC (the “Staff”) has not completed its review of derivatives use by registered funds, which, among other issues, is exploring the adequacy of derivatives-related disclosures (see the March 30, 2010 Alert for a more detailed discussion of the Staff’s review), the Staff provided initial observations on registration statement and shareholder report disclosures regarding derivatives use in a letter sent to the Investment Company Institute for communication to its members. [Read more →]

The Staff of the SEC’s Division of Investment Management recently wrote to the Investment Company Institute (the “ICI”) and stated that a money market fund may treat a short-term floating rate security (“STFRS”) that is subject to an unconditional demand feature as a short term variable rate security (“STVRS”) for the purpose of calculating the fund’s dollar weighted average life to maturity (“WAL”).  Rule 2a-7 under the 1940 Act, which regulates all registered investment companies that hold themselves out as money market funds or which use the term “money market” or a similar term in their names, requires among other things that each money market fund maintain a WAL of 120 days or less.  Rule 2a-7(c)(2)(iii) provides that WAL is calculated without reference to the maturity shortening provisions in Rule 2a 7(d) regarding interest rate readjustments. [Read more →]

The SEC published a joint advance notice of proposed rulemaking requesting comment from interested parties on rulemaking by the agencies to further define certain key definitions that are part of the comprehensive scheme for regulating swaps and securitybased swaps set forth in the Wall Street transparency and Accountability Act of 2010, Title VII of the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”). The SEC has requested public comment on other rulemaking and studies required by the Dodd-Frank Act, as discussed in the August 3, 2010 Alert. The key definitions at issue are the definitions of “swap,” “security-based swap,” “swap dealer,” “security-based swap dealer,” “major swap participant,” “major security-based swap participant,” “eligible contract participant,” and “security-based swap agreement.” The two agencies have also solicited comment on the regulations regarding “mixed swaps” that Title VII requires them to jointly prescribe. For further discussion of Title VII of the Dodd-Frank Act, please see the August 2, 2010 Special Edition of the Alert.

The SEC published a request for public comment to assist it in preparing a study examining the legal and regulatory standards of care for broker-dealers, investment advisers and their personnel when providing personalized investment advice and recommendations about securities to retail investors.  The study is required by the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (the “Dodd-Frank Act”).  The SEC must submit a report on the study to the Senate Committee on Banking, Housing, and Urban Affairs and the House Committee on Financial Services no later than January 21, 2011.  The Dodd-Frank Act also gives the SEC express authority to address the foregoing standards of care, but does not mandate rulemaking based on the study.  Comments must be submitted no later than 30 days after publication of the SEC request for comment in the Federal Register.

The SEC’s Division of Corporation Finance is creating three specialized offices that will focus on (a) enhancing the Division’s existing program for reviewing periodic reports filed by large financial institutions, (b) disclosure review and interpretive and rulemaking activities for asset-backed securities and other structured products, and (c) evaluation of securities offering trends.

Formed in April 2009 in response to a request from the Director of the SEC’s Division of Investment Management, the Task Force on Investment Company Use of Derivatives and Leverage of the American Bar Association (“ABA”) submitted a report to the Division that evaluates regulation and practice relating to the use of derivatives and leverage by registered investment companies (“funds”) and makes recommendations on how the SEC and its staff can improve the regulatory framework in these areas.  The report provides an overview of different kinds of derivatives used by funds and how the SEC has historically regulated funds’ use of derivatives.  The report identifies a number of issues that funds have had to address in the absence of SEC guidance and describes common industry practices that have arisen to address these issues.  In addition to a general recommendation that regulation of derivative use by funds be principles-based, the report makes a number of specific recommendations, summarized as follows:

DIVERSIFICATION

For purposes of Section 5(b) of the Investment Company Act of 1940 (the “1940 Act”), which divides management investment companies (generally consisting of mutual funds and closed-end funds) into diversified and non-diversified funds, the report recommends that a fund classify a derivative based on its reference asset, i.e., the asset to which the derivative provides exposure, unless the reference asset is a broad-based index, or a commodity or currency. [Read more →]

The U.S. Court of Appeals for the District of Columbia Circuit (the “Court”) issued an order vacating Rule 151A under the Securities Act of 1933 (the “1933 Act”).  Rule 151A was designed to require registration under the 1933 Act of certain indexed annuity contracts.

As discussed in more detail in the July 28, 2009 Alert, the Court had previously ruled that the SEC failed to properly consider the effect of Rule 151A upon efficiency, competition and capital formation and therefore had remanded the matter to the SEC to address the shortcomings in its rulemaking.  In response to a petition for rehearing, on June 12, 2010, the Court determined to vacate the rule rather than continue the remand to the SEC.  In its order, the Court noted that the SEC has stated that it is likely to reissue the rule, but the SEC also acknowledged that it is in the midst of analyzing the effect of the rule upon the law of each state.  The Court reasoned that the SEC cannot know whether that analysis will support reissuing  Rule 151A until the analysis has been completed.  The Court also stated that the decision to vacate would not be destructive of the agency’s regulatory program because the rule has not gone into effect and, until such time as it does, the regulations supplied by state law will remain in place.

The Court did not address a related legislative development, which is the inclusion of the Harkin Amendment (Section 989G) in the conference report for the pending financial services reform legislation.  The Harkin Amendment is designed to prevent the SEC from requiring registration of indexed annuities meeting certain state law requirements.

On June 25, 2010, the U.S. District Court for the Southern District of New York ruled in favor of a high yield bond salesman and a former portfolio manager for one of the bond salesman’s hedge fund clients, dismissing the first insider trading case brought by the SCE involving credit default swaps.  (SEC v. Rorech, No. 09-4329, 2010 U.S. Dist. LEXIS 63804 (S.D.N.Y. June 24, 2010).)  The Court’s decision provides important additional definition regarding how insider trading prohibitions apply to the high yield debt markets and credit default swaps and the SEC’s jurisdiction over the credit default swaps.  A Goodwin Procter Alert prepared by the firm’s White Collar Crime & Government Investigations Practice discusses the decision in greater detail.   

A litigation team of Goodwin Procter attorneys led by Richard M. Strassberg and Roberto M. Braceras represented the high yield bond salesman charged by the SEC in the case.

The Staff of the SEC’s Division of Investment Management published responses to various questions relating to Rule 30b1-7 under the Investment Company Act of 1940, as amended (the “1940 Act”), and new Form N-MFP.  Rule 30b1-7 generally requires a money market fund to file a report of its portfolio holdings on Form N-MFP each month, with the portfolio holdings information becoming publicly available sixty days after the end of the month to which the report relates.  Rule 30b1-7 and Form N-MFP were adopted by the SEC in conjunction with the recent amendments to Rule 2a-7 under the 1940 Act and other rules relating to money market funds, which were discussed in the March 5, 2010 and June 1, 2010 Alerts.  Below is a summary of the Staff’s responses (with references to the relevant Items of Form N MFP, as applicable).  The compliance date for the requirements relating to Form N MFP is December 7, 2010.

SCOPE OF RULE 30b1-7

Any fund subject to Rule 2a-7 (that is, a registered investment company that holds itself out as a money market fund) must file a Form N-MFP each month, even if the fund does not maintain a stable share price using the amortized cost method or penny rounding method. [Read more →]

The SEC published for public comment proposals by the national securities exchanges and FINRA to expand a recently adopted circuit breaker program to include all stocks in the Russell 1000 Index and certain exchange-traded products (the “ETPs”), consisting of selected (a) exchange-traded funds, which are generally designed to track securities indices, (b) exchange-traded vehicles, which are designed to track the underlying performance of an asset or index, related to futures contracts, commodities or currency, and (c) exchange traded notes, which are senior unsecured debt obligations designed to track the total return of an underlying index, benchmark or strategy.  As discussed in the June 15, 2010 Alert, the SEC has previously approved a circuit breaker pilot program in effect through December 10, 2010 that applies to stocks listed in the S&P 500 Index.  The ETPs proposed to be included in the pilot program are listed here.  The NYSE proposal is available here.  The FINRA proposal is available here.

The SEC issued proposed amendments to Rule 482 under the Securities Act of 1933, as amended (the “Securities Act”), and Rule 34b-1 under the Investment Company Act of 1940, as amended, that are designed primarily to provide additional information about target date funds to potential investors.  Because of the impact of market events in 2008 on target date funds and their increased importance as retirement savings investment vehicles, the SEC has devoted particular attention to issues raised by target date funds.  In 2009, target date funds were the subject of a joint hearing by the SEC and DOL and congressional testimony by SEC Chairman Mary L. Schapiro and Andrew J. Donohue, Director of the SEC’s Division of Investment Management (as discussed in the May 26, 2009 Alert).  In 2010, the SEC and DOL subsequently issued a joint bulletin designed to provide basic information to Directors on target date funds (as discussed in the May 18, 2010 Alert).  The major elements of the proposed amendments (the “Amendments”) are described below.  [Read more →]

The SEC issued the formal release proposing rule changes that would require additional disclosure in sales materials for target date funds, including information about a fund’s target date asset allocation and asset allocations over time.  The SEC’s proposal would also require certain cautionary disclosures in target date fund sales literature and identify types of potentially misleading statements in target date fund sales literature.

The SEC issued an order approving rule proposals by U.S. securities exchanges and an order approving a rule proposal by FINRA that would establish a pilot program under which trading in any stock in the S&P 500® Index would pause across U.S. equity markets for a five-minute period in the event that the stock experiences a 10% change in price over the preceding five minutes.  The SEC indicated in its announcement regarding the approvals that the exchanges and FINRA were expected to begin implementing the new rules as early as June 11.  The pilot will continue through December 10, 2010.  The SEC also indicated that it anticipated the exchanges and FINRA would file additional rule proposals in the near future to expand the scope of the pilot (for example, to include ETFs) within the pilot period.  At the  request of SEC Chairman Mary Schapiro, the SEC staff also will:

• consider ways to address the risks of market orders and their potential to contribute to sudden price moves.
• consider steps to deter or prohibit the use by market makers of “stub” quotes, which are not intended to indicate actual trading interest.
• study the impact of other trading protocols at the exchanges, including the use of trading pauses and self-help rules.
• continue to work with the exchanges and FINRA to improve the process for breaking erroneous trades, by assuring speed and consistency across markets.

The SEC staff will also consider whether to recalibrate the existing market wide circuit breakers for equity trading venues and futures markets, which were not triggered on May 6.

At its open meeting on June 16, 2010, the SEC is scheduled to consider whether to propose amendments to Rules 156 and 482 under the Securities Act of 1933 and Rule 34b-1 under the Investment Company Act of 1940 to address concerns about target date retirement fund names and marketing materials.