Forum News Feed Has Moved to www.mfdf.com

As part of the Forum’s website redesign, Forum News Feed has moved to the Forum’s main site, www.mfdf.com.  You will still be able to get the news and updates you rely on, just with a new look and new location.

If you subscribe to the Forum News Feed via RSS, nothing has changed, and new posts should arrive in your feed reader as they have before.

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If you visit http://fundforum.org, however, this site will soon redirect to the new home of Forum News Feed.

PWC’s 2009 Securities Litigation Study

Last week, PWC issued its 2009 Securities Litigation Study, the firm’s annual review of securities class action litigation.  The report finds that the number of securities class action filings in 2009 declined markedly from that of 2008 (155 in 2009 versus 210 in 2008).

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

Audit Committee Chairs in the Hot Seat

Last month, the SEC charged a former the former audit committee chair and independent director of InfoUSA, a public company based in Nebraska, for failing to properly oversee an investigation into fraud by the company’s CEO.  The SEC based its charges against the company’s former audit committee chair, Vasant H. Raval, on allegations that:

. . . 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

Donohue Outlines IM Concerns

Yesterday, in an address before the Practicing Law Institute’s Investment Management Institute in New York, IM Director, Andrew J. Donohue, outlined areas about which he and his division are concerned.  Though there were no surprises, Donohue’s remarks shed some light on the directions the Commission may potentially take in several key areas.

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

Commission Proposes Rules on Asset-Backed Securities

At yesterday’s open meeting of the SEC, the Commission approve the proposal of rules and rule amendments governing asset-backed securities.  According to SEC Chair, Mary L. Schapiro:

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

Court Extends SOX Whistleblower Protections to Fund Advisers’ Employees

In March, a ruling by U.S. District Judge Douglas Woodlock in the U.S. District Court for the District of Massachusetts applied to mutual fund companies the provisions of the Sarbanes-Oxley Act protecting whistle-blowers. The ruling covers two cases filed by former Fidelity Management and Research (FMR) employees alleging retaliation FMR.  The cases, Jackie Hosang Lawson vs. FMR LLC, FMR Corp and Fidelity Brokerage Services and Jonathan Zang vs. Fidelity Management & Research Co, FMR Co and FMR LLC were combined in U.S. District Court for the District of Massachusetts as case No. 08-10759.

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

Dechert Conference Call on the New Money Market Regulations

On April 8, 2010 from noon to 1:30PM EDT, Dechert LLP will hold a conference call, “Navigating the New Regulatory Structure Governing Money Market Funds.”  This call will feature Dechert partners, experts in the regulation of money market mutual funds, discussing the reforms recently adopted by the SEC, including:

■ 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

What Does the Jones Decision Mean?

Almost immediately after the Supreme Court issued its unanimous opinion in the Jones v. Harris Associates case, legal experts throughout the country began parsing the opinion and exploring what the decision means to funds and their directors.  Assembled below are links to publications from various law firms and academics discussing the Jones decision and its potential meaning and effect.

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.

SEC Chair Advises Congress on Swaps in Washington Post Op-Ed

In today’s Washington Post, Mary L. Schapiro, Chairman of the SEC, penned an editorial asking Congress to close the gaps on regulation of swaps.  Schapiro offers three pieces of advice to strengthen the provisions covering swaps in the Senate legislation on financial market regulatory reform. 

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

April 7 SEC Open Meeting on Asset Backed Securities Regulation

The SEC has announced that at their April 7, 2010 meeting the Commission will consider whether to amend Regulation AB governing disclosure and reporting and the offering process for asset backed securities:

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