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The financial crisis dominated events for yet another year, although to a lesser degree than in 2008. The number of private securities litigation matters fell, as did the number of such matters filed against financial services companies—perhaps signaling a change of focus by the plaintiffs’ bar to other industries as the new decade begins.

Other key findings were that institutional investors played a key role as lead plaintiffs during 2009, the number of settlements decreased from 2008, and regulators and law enforcement agencies stepped up their enforcement and prosecution efforts during the period.

Institutional investors remained active as lead plaintiffs during 2009, although to a lesser extent than in previous years. The percentage of total 2009 filings naming an institutional investor as lead plaintiff fell to 48 percent from a high of 60 percent in 2005, and an average of 52 percent since 2002.

. . .

The number of settlements was two lower in 2009 than in 2008, though the total remained slightly higher than the average annual number of settlements recorded since the passage of the Private Securities Litigation Reform Act of 1995 (PSLRA). A total of 93 settlements were made in 2009 compared to 95 in 2008. The total value of settlements agreed in 2009 decreased when compared to 2008. Total settlement value in 2009 was $3.1 billion compared to $3.9 billion in 2008—a decrease of 21 percent. The average settlement value in 2009 was 20 percent less than in 2008, though it remained 10 percent above the average settlement value over the last ten years.

. . .

By the end of 2009, the DOJ reported that it had some 189 major corporate fraud investigations in process, 18 of which have losses over $1 billion.4 The SEC claimed to have opened 54 more investigations than in the previous year.5 The SEC continued to reach substantial settlements in matters related to auction rate securities (ARS) with companies including Deutsche Bank, Bank of America, and RBC Capital Markets, in addition to reaching settlements in other financial-crisis-related cases that included Evergreen Investment Management Company and UBS AG.

The full text of PWC’s 2009 Securities Litigation Study is available at:  http://10b5.pwc.com/PDF/NY-10-0559%20SEC%20LIT%20STUDY_V7%20PRINT.PDF

. . . Raval failed to respond appropriately to various red flags concerning [the company's CEO's] expenses and Info’s related party transactions with [the company's CEO's] other entities. Two Info internal auditors raised concerns to Raval that [the company's CEO] was submitting requests for reimbursement of personal expenses, yet Raval failed to take meaningful action to further investigate the matter and he omitted critical facts in a report to the board concerning Gupta’s expenses.

The SEC further alleged that, because Raval failed to act on “red flags” of wrongdoing, the company’s financial disclosures were wrong, and Raval failed to live up his duty as a director to ensure the accuracy and completeness of the financial disclosures in the company’s SEC filings.

In settlement, Raval agreed to pay a $50,000 penalty and consented to an order barring him from serving as an officer or director of a public company for five years. He also consented to a final judgment enjoining him from violations of Exchange Act Sections 10(b) and 14(a) and Rules 10b-5, 14a-3, and 14a-9, and from aiding and abetting Info’s violations of Exchange Act Sections 13(a), 13(b)(2)(A), and 13(b)(2)(B) and Rules 12b-20 and 13a-1.

Though it is rare for the Commission to pursue actions against independent directors of registrants, this case makes it clear that the SEC sees the role of the independent director and audit committee chair as critical to investor protection. 

The full text of the SEC’s press release on Raval is available at:  http://www.sec.gov/news/press/2010/2010-39.htm

The full text of the SEC’s complaint against Raval is available at: http://www.sec.gov/litigation/complaints/2010/comp21451-raval.pdf

Complex Securities

The Commission has made no secret of its concerns about funds’ use of derivatives, and it’s worries “that these instruments, while affording the opportunity for efficient portfolio management and risk mitigation, also can present potentially significant additional risk as well as raise issues of investor protection.”  According to Donohue, the 1940 Act body of regulation contemplated a different world of investment companies from the growing range of funds that mimic hedge fund strategies, absolute return funds, commodity return funds, alternative investment funds, long-short funds, leveraged funds, inverse index funds, etc.  In response, as we have reported earlier, the Donohue’s division has launched a comprehensive review of the way in which funds use derivatives, and how regulations should be changed to keep pace.

Donohue stated that his key concerns about funds’ use of derivatives are:

• Leverage, and how funds may be exposing themselves to impermissible amounts of leverage through use of derivatives and the use of various structures and offshore or special purpose vehicles.

• Diversification, and how funds may become unintentionally (or intentionally) concentrated through the use of derivatives, thereby underestimating the exposure and associated risk.  In addition, Donohue points out that “utilizing derivative instruments introduces another dimension to the equation, in addition to the exposure sought from the derivative instrument, the fund frequently has now exposed the fund to the credit and other risks associated with the issuing of the derivative instrument and its issuer.”

Donohue also stated that he is worried about how funds’ use of derivatives also exposes them to systematic risks.

Thinking about how interconnected our markets can be daunting. For this reason, the Division is also looking at how funds are addressing risk in this area and asking whether funds that rely heavily on the use of derivatives, particularly those that seek leveraged returns, have appropriate expertise and maintain robust risk management systems and procedures in light of their investments. In addition, the Division is looking at how fund derivative investments are being regulated and overseen. Do existing regulations sufficiently address whether funds’ procedures for pricing and liquidity determinations of their derivatives holdings are appropriate and do the current disclosure requirements adequately address the risks created by derivatives? Has the Commission provided adequate guidance on how much leverage is permissible, how it should be measured and “covered” for purposes of the Act?

Of note to fund directors, Donohue also announced that the Commission will look into the role of directors in overseeing derivatives and their associated risks.  He also emphasized that, while the Division examines the regulatory framework for funds’ use of derivatives, board oversight is even more important.

In addition, the staff, in its review, is looking at whether boards of directors are providing sufficient oversight of the use of derivatives by funds and how the Commission might assist directors in this important area. As we are refining the appropriate regulatory framework for derivatives usage by funds, effective Board oversight in this area, in the meantime, is critically important. As funds’ use of derivatives presents concerns and risks on many levels, fund boards’ oversight of the use of these instruments by advisers also requires a multi-faceted approach, an approach that not only considers the more obvious risks these instruments present – such as market, liquidity, leverage, counterparty, legal and structure risks – but some less obvious risks as well. For example, certain derivative-based investment products, such as collateralized debt obligations, collateralized mortgage obligations and swaps are potentially difficult to price, directors should ensure that the fund’s procedures to price such securities are appropriate. Does the fund have the necessary expertise (other than the portfolio manager) to understand the impact on the fund’s portfolio of the derivatives and to properly determine their price and liquidity?

It is clear from Mr. Donohue’s remarks that the Commission expects board oversight of their fund’s use of derivatives to to keep pace with the kinds of instruments and increased sophistication of the derivatives employed.   As boards reexamine their role in oversight of their funds’ risk management function, they should bear Donohue’s remarks in mind.

To assist directors in understanding and performing their risk management oversight duties, next week, the Forum will issue practical guidance designed specifically for fund independent directors, “Risk Principles for Fund Directors.”  The document will be available at the Forum’s Policy Conference, April 15-16, and on the Forum’s website, www.mfdf.com.

Money Market Funds

Though the Commission has already amended rule 2a-7, tightening restrictions on money funds and aimed at increasing their stability and preventing the kind of sudden vulnerability they suffered last fall due to liquidity problems and market events, Donohue outlined the second phase of money market reform. Commencing “later this year,” following the release of the President’s Working Group report on money market funds, Donohue’s division will examine ways in which the risk of runs on money funds can be reduced and managed.  Donohue mentioned the idea of a private liquidity bank for money market funds to turn to should they exhaust their own liquidity; however, he criticized the idea as ineffective:

This facility would operate to augment the recent rule changes with respect to liquidity, but it would not prevent funds from breaking the dollar and thus would not fully resolve systemic risk concerns. Institutional investors would still have an incentive to run if the marked to market value of a money market fund is below a dollar.

Rather, Mr. Donohue suggested that the second phase of money market reform would focus on ways in which the incentive for institutional investors to run on money market funds in times of market stress could be reduced, and how systematic and liquidity risks can be managed for the money market fund industry as whole.

Collective Investment Trusts

Donohue expressed concern about whether collective investment trusts, exempt from the Investment Company Act, are properly protecting investors.  He stated that, in certain cases, the exemption from the rules governing investment companies may not be appropriate, and some of these investment vehicles should be subject to the regulatory scheme applicable to mutual funds.  Donohue’s division will be looking into this area, and considering regulatory recommendations as well.

The full text of Andrew J. Donohue’s April 8, 2010 address is available at:  http://www.sec.gov/news/speech/2010/spch040810ajd.htm

The rules we are proposing stem from lessons learned during the financial crisis . . . These rules if adopted would revise the regulatory regime for asset-backed securities in order to better protect investors.

The proposals would:

• Revise the filing deadlines for offerings of asset-backed securities;

• Repeal the current credit ratings references in shelf eligibility criteria for asset-backed issuers;

• Establish new shelf eligibility criteria that would include, among other things, a requirement that the sponsor retain a portion of each tranche of the securities that are sold and a requirement that the issuer undertake to file Exchange Act reports on an ongoing basis so long as its public securities are outstanding;

• Require that, with some exceptions, prospectuses for public offerings of asset-backed securities and ongoing Exchange Act reports contain, in interactive data format, specified asset-level information about each of the assets in the pool; and

• Create new information requirements for the safe harbors for exempt offerings and resales of asset-backed securities.

The full text of the asset-backed securities proposing rule release is available at: http://www.sec.gov/rules/proposed/2010/33-9117.pdf

Fidelity filed a motion to dismiss the cases, arguing that Sarbanes-Oxley does not apply to FMR because FMR is not a public company but a privately held company.  Judge Woodlock’s ruling rejects Fidelity’s argument.  The ruling does not deal with the substance of the retaliation claims, but merely rules that Section 806 of the Sarbanes-Oxley Act, the provisions prohibiting whistleblowers from retaliation by their employees, encompasses not only employees of public companies but also employees of private companies, particularly those that act as investment advisers to public investment companies.

According to the legislative history of the Sarbanes-Oxley Act, its purpose was “to prevent and punish corporate fraud, protect the victims of such fraud, preserve evidence of such fraud and crime, and hold wrongdoers accountable for their actions.”  The legislative history clearly indicates that “Congress was concerned with failures to report instances of fraud against shareholders, failures not only on the part of public company employees, but also employees of those institutions working with the public company.”  Consequently, the judge ruled that “protecting employees of a public company’s related entities would not result in an overly broad application of the statute that would be counter to the statute’s purpose.”

Judge Woodlock then applied his reasoning to mutual funds, noting the special relationship between mutual funds and their advisers.

For the goals of [Sarbanes-Oxley] to be met, contractors and subcontractors, when performing tasks essential to insuring that no fraud is committed against shareholders, must not be permitted to retaliate against whistleblowers. These concerns are especially strong for mutual funds, which have no employees and implement the funds’ management through contractual arrangements with investment advisers. If Section 806 [whistleblower protections] only protected employees of public companies, then any reporting of fraud involving a mutual fund’s shareholders would go unprotected, for the very simple reason that no “employee” exists for this particular type of public company.

This case applies the full whistleblower protections of the Sarbanes-Oxley act to employees of mutual fund advisers, whether the adviser be public or privately held companies.  Fidelity stated that the company plans to appeal this decision.

The full text of Judge Lawson’s Memorandum and Order is available at: http://docs.justia.com/cases/federal/district-courts/massachusetts/madce/1:2008cv10466/114607/43/0.pdf

■ Overview of reforms

■ Management’s consideration of new quality, maturity, and liquidity requirements

■ New disclosure requirements: website postings, SEC reporting

■ Operational issues: processing of transactions, purchases by affiliates, and suspension of redemption

■ New duties of boards: designation of NRSROs, stress testing of portfolios, and evaluation of repurchase agreement counterparties

■ New authority of boards: suspension of redemptions

Because the Dechert lawyers will be discussing the role of boards in the new money market regulatory regime, fund directors are sure to take away from the discussion useful knowledge they can use in the board room.

Participants may e-mail questions they would like addressed prior to the webinar, and participants will be able to submit questions electronically during the program.

Online registration is available via: http://www.dechert.com/eventspubs/eventspubs.jsp?pg=seminar_detail&id=11789

For additional details about this call visit:  http://www.dechert.com/emailings/fs-04-08-10/fs-04-08-10.html

Supreme Court Clarifies Standards for Judicial Review of Mutual Fund Fees, Eduardo Gallardo, Gibson, Dunn & Crutcher LLP

Court Adopts Flexible Gartenberg Standard, Connor Williams, Stanford Law School

The United States Supreme Court Upholds the Gartenberg Standard for Claims Alleging Excessive Advisory Fees, Dechert On Point

Supreme Court Upholds Gartenberg Standard in Jones v. Harris, by Cameron S. Avery, Paul H. Dykstra, Richard M. Phillips, Paulita A. Pike, John W. Rotunno, Gwendolyn A. Williamson, K&L | Gates LLP.

U.S. Supreme Court Uphelds Gartenberg Standard; Sends Message of Judicial Deference to Mutual Fund Board’s Fee Decisions, Securities Law Professor Blog

Jones v. Harris Associates: Let the First Lawsuit Bloom, Jennifer Taub, Isenberg School of Management, University of Massachusetts Amherst

Have questions of your own? The Forum will present a webinar on April 7 at 12:30PM EDT, featuring Ruth Epstein – one of the authors of the Forums amicus brief in Jones – discussing the opinion and answering your questions.  If you would like to participate in the webinar, contact the Forum via email or call 202-507-4495.

First, Schapiro argues that the Senate bill’s language would provide insufficiently clear lines of regulation between financial swaps and commodity swaps, inviting potential gaming of the regulations by market participants, as well as potential abuse.  Second, Schapiro urges more transparency to the “shadow market” in which swaps are traded by creating a trade reporting system similar to the one used for corporate debt securities.  Third, Schapiro urges the mandating the use of clearinghouses and exchanges for swaps, thereby reducing counterparty credit risk by “substituting the creditworthiness of the clearinghouse for the creditworthiness of the parties to the transaction.” 

The SEC recently announced that it was taking a hard look at use of derivatives, including swaps, by mutual funds, and also warned about the risks of leveraged and inverse ETFs, that also use swaps, and further has frozen exemptive requests permitting ETFs that would make significant investments in derivatives like swaps.  This editorial reflects the ongoing and serious concerns the SEC has with governing the risks posed by swap transactions.

The full text of Chairman Schapiro’s Washington Post Op-ed is available at:  http://www.washingtonpost.com/wp-dyn/content/article/2010/04/01/AR2010040102801.html?hpid=opinionsbox1

The Commission will consider whether to propose revisions to Regulation AB and other rules regarding the offering process, disclosure and reporting for asset-backed securities. The proposed amendments would revise the shelf offering process and eligibility criteria for asset-backed securities and require asset-backed issuers to provide enhanced disclosures including information regarding each asset in the underlying pool in a standardized, tagged format. The Commission will also consider proposed revisions to Securities Act Rule 144A and other rules for privately-placed asset-backed securities.

The April 7 meeting is open to the public on a first come first served basis, and will be webcast via a link on the SEC’s website, www.sec.gov.

The full text of the Commission’s announcement is available at: http://www.sec.gov/news/openmeetings/2010/ssamtg040710.htm

To help fund directors better understand the contours of the opinion and what the decision means for boards in the annual contract renewal process, the Forum will present  a webinar on Wednesday, April 7 at 12:30 pm EDT.  The webinar will feature Ruth Epstein, a partner at Dechert LLP and one of the authors of the Forum’s amicus brief in the case.  Ms. Epstien will address the implications of the decision on fund boards and answer questions from webinar participants.

For those unable to participate in the webinar,  an archived version will be available for Forum members, and also for non-members who registered for the webinar.  In addition, the Funds Under Fire panel at the Forum’s upcoming Policy Conference (April 15 – 16 in Washington, DC) will also discuss the Jones decision as well as other recent court cases.

To register for the April 7 webinar, or any other Forum webinar, contact the Forum via email or call 202-507-4495.

In upcoming weeks, the Forum and Morningstar will hold a series of webinars, “Life After Jones,” exploring what the Supreme Court’s ruling in Jones means to fund directors.

The Supreme Court’s slip opinion in Jones v. Harris Associates is available at:  http://www.supremecourt.gov/opinions/09pdf/08-586.pdf

The full text of the the SEC’s posting and the sample letter can be found at: http://www.sec.gov/divisions/corpfin/guidance/cforepurchase0310.htm

• current market practices involving derivatives are consistent with the leverage, concentration and diversification provisions of the Investment Company Act;
• funds that rely substantially upon derivatives, particularly those that seek to provide leveraged returns, maintain and implement adequate risk; management and other procedures in light of the nature and volume of the fund’s derivatives transactions;
• fund boards of directors are providing appropriate oversight of the use of derivatives by funds;
• existing rules sufficiently address matters such as the proper procedure for a fund’s pricing and liquidity determinations regarding its derivatives holdings;
• existing prospectus disclosures adequately address the particular risks created by derivatives, and
• funds’ derivative activities should be subject to special reporting requirements.

Pending the SEC review, the Commission has announced that:

the staff has determined to defer consideration of exemptive requests under the Investment Company Act to permit ETFs that would make significant investments in derivatives. The staff’s decision will affect new and pending exemptive requests from certain actively-managed and leveraged ETFs that particularly rely on swaps and other derivative instruments to achieve their investment objectives. The deferral does not affect any existing ETFs or other types of fund applications.

The SEC did not estimate a time when the study will be completed, or when/if the deferral of ETF requests would be lifted. The full text of the Commission’s announcement is available at:  http://www.sec.gov/news/press/2010/2010-45.htm

In a recent article in Law and Technology News, Satish M. Kini and Thomas S. Wyler, provide a helpful overview of what these new privacy regulations mean to to firms.  Highlighting the FTC’s Red Flags Rule, the SEC’s Regulation S-AM and recent action In re Commonwealth Equity Services, as well as pending legislation in Congress on privacy, the article provides an excellent overview of  the movement toward stricter controls, basic safeguards, and best practices in securing customer data.

The full text of Kini and Wyler’s article is available at:  http://www.law.com/jsp/lawtechnologynews/PubArticleFriendlyLTN.jsp?id=1202446085582

• Governance. It plays a critically important role in having an effective compliance and ethics program and in ensuring that the program has the necessary independence , standing, and authority to be effective.
• Culture. Culture is a key measure of whether a program is effective or not. It is the first thing that employees tune in to — there is nothing employees notice more than when the leaders in a culture say one thing and do another. So, culture is a critical enabler of effective compliance programs.
• Incentives and rewards. These can either be key enablers of effective compliance and ethics programs or, if poorly structured, they can be leading indicators of where the risk decisions and products reside.
• Risk assessment and a risk-based approach. Just like the SEC, you have limited resources, so you must allocate your resources to their highest and best use. Thus, you must make sure that your key risks are identified and covered adequately and effectively.
• Policies and procedures. Awareness of policies and establishing basic policies are critical. However, tailoring those policies and procedures to your business model, your products, your business network, the conflicts of interest in your business model, and other key tailoring components is very important.
• Communication and training. Similar to policies and procedures, while awareness training is good, it is really training that is roles-based and that lets each critical partner in the compliance program understand their roles and responsibilities that is the most effective.
• Monitoring, testing and reporting. This collective process is critical to maintaining the health of the system, checking the health of the system, identifying possible issues, and making sure that they are addressed effectively.
• Investigations and enforcement. These help ensure that the program is firm, fair, and consistent in its application.
• Issues management process. This process is critical because issues can get ahead of us or behind us without having been adequately addressed. However, a good issues management process that helps us identify issues, escalate them quickly, analyze them critically, and action them timely is fundamental to an effective compliance program.
• On-going improvement process. This is the process that lets us make sure that our compliance program is effective and healthy, that it is keeping pace with the rapidly changing market environment , complexity environment, and product and service environment.

di Florio stressed that each of these concepts should be implemented in a manner that avoids siloing of the programs, duties and responsibilities, and be an integral part of day-to-day running of the the company and longer term strategy.

The full text of di Florio’s January 26 address is available at:  http://www.sec.gov/news/speech/2010/spch012610cvd.htm

If the study . . . identifies any gaps or overlap in the legal or regulatory standards in the protection of retail customers relating to the standards of care for brokers, dealers, investment advisers, persons associated with brokers or dealers, and persons associated with investment advisers for providing personalized investment advice about securities to such retail customers, the Commission, not later than 2 years after the date of enactment of this Act, shall . . . commence a rulemaking, as necessary or appropriate in the public interest and for the protection of retail customers, to address such regulatory gaps and overlap that can be addressed by rule, using its authority under the Securities Exchange Act of 1934 . . . and the Investment Advisers Act of 1940 . . . and . . . consider and take into account the findings, conclusions, and recommendations of the study required under this section.

The House version of financial regulatory reform, the Wall Street Reform and Consumer Protection Act of 2009, takes a much stronger approach, eliminating the broker-dealer exclusion from the Investment Advisers Act, and require the SEC to issues rules applying the same fiduciary standard of care to both investment advisers and broker-dealers “when providing personalized investment advice about securities.”

SEC Chairman, Mary Schapiro, has been a vocal advocate of harmonizing regulation of regulation of broker-dealers and investment advisers, and investor groups have called for an end to the broker-dealer exclusion.

The video of the interview is  available at:  http://www.washingtonpost.com/wp-dyn/content/video/2010/03/18/VI2010031801885.html

According to the summary of the bill released earlier this week, the bill highlights include:

Consumer Protections with Authority and Independence: Creates a new independent watchdog, housed at the Federal Reserve, with the authority to ensure American consumers get the clear, accurate information they need to shop for mortgages, credit cards, and other financial products, and protect them from hidden fees, abusive terms, and deceptive practices.

Ends Too Big to Fail: Ends the possibility that taxpayers will be asked to write a check to bail out financial firms that threaten the economy by: creating a safe way to liquidate failed financial firms; imposing tough new capital and leverage requirements that make it undesirable to get too big; updating the Fed’s authority to allow system-wide support but no longer prop up individual firms; and establishing rigorous standards and supervision to protect the economy and American consumers, investors and businesses.

Advanced Warning System: Creates a council to identify and address systemic risks posed by large, complex companies, products, and activities before they threaten the stability of the economy.

Transparency & Accountability for Exotic Instruments: Eliminates loopholes that allow risky and abusive practices to go on unnoticed and unregulated – including loopholes for over-the-counter derivatives, asset- backed securities, hedge funds, mortgage brokers and payday lenders.

Federal Bank Supervision: Streamlines bank supervision to create clarity and accountability. Protects the dual banking system that supports community banks.

Executive Compensation and Corporate Governance: Provides shareholders with a say on pay and corporate affairs with a non-binding vote on executive compensation.

Protects Investors: Provides tough new rules for transparency and accountability for credit rating agencies to protect investors and businesses.

Enforces Regulations on the Books: Strengthens oversight and empowers regulators to aggressively pursue financial fraud, conflicts of interest and manipulation of the system that benefit special interests at the expense of American families and businesses.

The full text of the summary of the bill is available at: http://lawprofessors.typepad.com/files/financialreformsummary231510final.pdf

The full text of the bill is available at:  http://banking.senate.gov/public/_files/ChairmansMark31510AYO10306_xmlFinancialReformLegislationBill.pdf

The Commission continues to believe that a single set of high-quality globally accepted accounting standards will benefit U.S. investors and that this goal is consistent with our mission of protecting investors, maintaining fair, orderly, and efficient markets, and facilitating capital formation. As a step toward this goal, we continue to encourage the convergence of U.S. GAAP and IFRS and expect that the differences will become fewer and narrower, over time, as a result of the convergence project.

Though a convergence between US financial reporting standards and IFRS has been generally supported by the Commission, this statement reinforces the SEC’s commitment to pursue the course laid out in the “Roadmap for the Potential Use of Financial Statements Prepared in Accordance with International Financial Reporting Standards by U.S. Issuers” issued in 2008.

The Commission’s recent release supporting IFRS lays out generally how the international standards are set, and how they are overseen.  It also explains how the migration to international standards maintains a focus on investors, how they are represented on the standard setting bodies, and how the Commission and other agencies and organizations will move forward in educating the investing public on the new disclosure regime presented by IFRS.

The full text of the Commission’s February 2010 release on IFRS is available at:  http://www.sec.gov/rules/other/2010/33-9109.pdf

FINRA further warns investors considering a reverse convertible, to “be prepared to ask your broker or other financial professional lots of questions about the product’s risks, features and fees and why it’s right for you.”

Reverse convertibles are debt obligations of an issuer that are “tied to the performance of an unrelated security or basket of securities.”   According to the investor alert, reverse convertibles may be appropriate for an investor:

who wants a higher stream of current income than is currently available from other bonds or bank products—and who is willing to give up any appreciation in the value of the underlying asset. But, in exchange for these higher yields, investors in these products take on significantly greater risks.

In exchange for high coupon rates or “stated” rates in times when markets are expected to be flat, and the convenience of not having to buy futures and options separately that would allow them to take advantage of certain market conditions, investors subject themselves to some downsides, including:

Exposure to asset-related risks. When you purchase a reverse convertible, you get all the risks that debt instruments ordinarily entail, plus the risks of the underlying asset. That is why it is so critical that you fully comprehend what is behind the higher coupons these products offer—and that you fully understand the product you are buying. Remember that purchasing a reverse convertible means you are either bullish on the underlying asset itself or you are betting that the asset’s volatility will be low for the term of the note.

Embedded options. When investing in a reverse convertible, you effectively buy a note fromthe issuer and sell a put option to the issuer simultaneously. If you don’t have the risk tolerance for selling put options generally, you should question whether you want to invest in a security that contains an embedded one. If you are considering reverse convertibles, be sure you fully understand the complexities of the product and have the financial means to bear the risks.

Fees. Issuers charge an up-front embedded fee to investors—typically ranging from less than 1 percent to 8 percent or more—for assembling and packaging a reverse convertible’s individual components. Prospectuses may call this fee “built-in costs” or “costs of hedging,” although the exact amount is not typically disclosed to the investor. Industry experts say that it is all but impossible for individual investors to determine the size of this embedded fee (and therefore whether the reverse convertible represents a good deal), because that would require dissecting the reverse convertible’s parts and determining what it would cost for the investor to obtain and assemble them.

FINRA’s investor alert offers some suggestions on key issues to look out for when investing in convertibles, as well as a list of ways investors can look out for themselves in the complicated world of reverse convertibles.

The full text of FINRA’s investor alert is available at:  http://www.finra.org/Investors/ProtectYourself/InvestorAlerts/Bonds/P120883

• Amended the SEC’s proxy rules to clarify and provide additional flexibility when companies and other persons are relying on the “e-proxy rules.” Those rules allow a notice to be sent to shareholders indicating that the proxy materials are online and available upon request, rather than requiring a full package of materials containing a proxy card, annual report and proxy statement be sent. The new rule amendments will, among other things, allow shareholders to be provided with additional materials explaining the e-proxy rules. The Commission issued an adopting release related to the amended rules.

• Published a new Investor Alert entitled New Shareholder Rules for the 2010 Proxy Season. The Alert provides investors with information related to the recent changes to broker voting rules and the impact of those new rules on proxy voting.

• Launched a new Spotlight page that provides investors with information on the mechanics of proxy voting, the e-proxy rules, corporate elections and proxy matters generally.

This educational initiative is presumably being launched in response to deacred levels of voting by shareholders following the Commission’s adoption of “notice and access” e-proxy rules.   Also, with the NYSE’s recent elimination of broker “discretionary voting” (the NYSE rule that gave brokers the discretion to vote their customers’ shares in uncontested elections when the customers did not provide instructions), concerns have arisen that issuers may not have a quorum at annual meetings.

The Commission’s press release announcing the initiative is available at:  http://www.sec.gov/news/press/2010/2010-23.htm

The seminar will be held on March 23 beginning at 1 p.m. ET in the auditorium at the SEC’s headquarters (100 F Street N.E. in Washington DC).  The event also will be webcast via a link on the SECs web site.

The event is intended to answer registrants’ frequently asked questions about XBRL taxonomies  (the list of tags associated used in XBRL filings), as well as the recently announced role of the Financial Accounting Foundation in maintaining that taxonomy in conjunction with its GAAP standard-setting activities.  SEC staff will also answer questions and present guidance on other tools and information available to assist with compliance.

The event is open to the public, and seating will be provided on a first-come first-served basis.

More information about this event is available at:  http://www.sec.gov/news/press/2010/2010-25.htm

In application, the alternative uptick rule adopted by the Commission “imposes restrictions on short selling only when a stock has triggered a circuit breaker by experiencing a price decline of at least 10 percent in one day. At that point, short selling would be permitted if the price of the security is above the current national best bid.”  The rule new rule includes the following features:

• Short Sale-Related Circuit Breaker: The circuit breaker would be triggered for a security any day in which the price declines by 10 percent or more from the prior day’s closing price.

• Duration of Price Test Restriction: Once the circuit breaker has been triggered, the alternative uptick rule would apply to short sale orders in that security for the remainder of the day as well as the following day.

• Securities Covered by Price Test Restriction: The rule generally applies to all equity securities that are listed on a national securities exchange, whether traded on an exchange or in the over-the-counter market.

• Implementation: The rule requires trading centers to establish, maintain, and enforce written policies and procedures that are reasonably designed to prevent the execution or display of a prohibited short sale.

The new rule (Rule 201) will be effective 60 days from its publication in the Federal Register.

The full text of the final rule release is available at:  http://www.sec.gov/rules/final/2010/34-61595.pdf

Related articles:

• SEC Seeks Comments on New Short-Selling Price Test, August 20, 2009

• SEC Proposes Short-Selling Restrictions, April 16, 2009

The paper suggests that fund boards ask key questions about economies of scale, including:

1) from what business segments does scale originate (and thus ‘operational savings’)?

2) what is the level of savings?

3) what is the appropriate sharing of savings via scale that should be passed along to fund shareholders?

4) how impactful (sic) is corporate structure and investment philosophies on the ability to realize scale?

5) how should savings be used with regard to reinvestment or parent company dividends (if applicable)? and

6) what should a Board expect from a fund sponsor in the way of data, information, analysis and the like that brings transparency to the economies of scale issue, i.e., more concrete evidence that scale creates savings and sharing with investors is indeed occurring?

The paper also provides some suggestions for actions boards can take to better assess and analyze economy of scale issues:

Trustees should consider forming a Board philosophy on economies of scale and craft related guidelines.  While functions such as fund advisory services may generate not insignificant profits for fund management (economies), those margins may be partially or fully negated by expenditures on the sales, marketing, shareholder servicing, and information technology sides of the business Items such as waivers, expense reimbursements, expense caps, and reinvestments in a fund advisor’s business may be legitimately considered savings or revenues shared with shareholders and can be quantified.

The paper is an excellent source of guidance for fund directors, helping them assess and address economies of scale during their fund’s annual 15(c) process.

The full text of “Economies of Scale: Implications of Analyses Depth of a Fund Board’s Assessment” is available at: http://www.mfdf.com/members/documents/KeilFiduciary_EconofScale_Mar10.pdf