Month: November 2010

Proposed Rules for Implementing the Whistleblower Provisions From Dodd-Frank

The SEC has released the text of its proposed new rules for implementing the whistleblower provisions of Section 21F of the Securities Exchange Act of 1934: Release No. 34-63237.

In fashioning these proposed rules, the Commission has considered and weighed a number of potentially competing interests that are presented in implementing the statute. Among them was the potential for the monetary incentives provided to whistleblowers by Section 21F of the Exchange Act to reduce the effectiveness of a company’s existing compliance, legal, audit and similar internal processes for investigating and responding to potential violations of the federal securities laws. With this possible tension in mind, we have included provisions in the proposed rules intended not to discourage whistleblowers who work for companies that have robust compliance programs to first report the violation to appropriate company personnel, while at the same time preserving the whistleblower’s status as an original source of the information and eligibility for an award. At the same time, the proposed rules would not prohibit a whistleblower in a compliance function from reporting information to the Commission where the company did not provide the information to the Commission within a reasonable time or acted in bad faith.

At this point, it is merely a proposed rule. Comments should be submitted on or before December 17, 2010.

There will be a new Form TCR for submitting a tip, complaint or referral and a new Form WB-DEC, Declaration Concerning Original Information Provided Pursuant to §21F of the Securities Exchange Act of 1934, signed under penalty of perjury, for submission to the SEC to meet the standards of the new regulations.

Is a Fund Manager an Investment Adviser?

Yes, for private investment funds, the general partner is generally considered an investment adviser under the Investment Adviser Act.

Let’s start with the definition of an investment adviser from the Investment Advisers Act:

“any person who, for compensation, engages in the business of advising others, either directly or through publications or writings, as to the value of securities or as to the advisability of investing in, purchasing, or selling securities, or who, for compensation and as part of a regular business, issues or promulgates analyses or reports concerning securities…” [202(a)(11)]

You can parse three elements out of that definition:

  1. Compensation
  2. Advice concerning securities
  3. In the business

Compensation

The first one is the easiest. I don’t think you’re going to find a fund manager who is not getting paid. It may be a combination of management fees or carried interest, but it’s still compensation. You could look at some academic arguments about who would fall in and out of the definition, but those arguments are irrelevant to fund managers.

Advice concerning securities

If you are giving recommendations to buy or sell, then you are giving advice. In addition, if you are telling people when to switch between different investments or how to select investment advisers then you are giving advice. The fund manager is making the decision about what to buy, sell and finance so the fund manager is giving advice. [I’m writing about the “securities” side in another post.]

In the business

Lastly, you need to be “in the business” of giving advice. That’s going to rule out your shoeshine boy, but clearly fund managers are in the business of giving advice. Again, there are some academic questions that could make this prong of discussion interesting. But for a fund manager, it’s very straightforward.

Abrahamson

It’s not just me making this interpretation. The Second Circuit answered this question in 1978. [See: Abrahamson v. Fleschner, 568 F.2d 862 (2d Cir. 1977) , overruled in part on other grounds by Transamerica Mortgage Advisors, Inc. v. Lewis, 444 U.S. 11 (1979)] “These provisions reflect the fact that many investment advisers ‘advise’ their customers by exercising control over what purchases and sales are made with their clients’ funds.”

Exclusions

There are six exclusions in the definition of the “Investment Adviser” [202(a)(11)]but they are inapplicable to most fund managers:

  1. banks
  2. lawyers, accountants, teachers and engineers
  3. Certain broker/dealers
  4. publishers of bona fide newspapers and magazines in general circulation
  5. government securities advisers
  6. Nationally recognized statistical rating organization

Registration

That means fund managers are typically going to be considered to investment advisers. That also means that they may have to register with the SEC, unless there is an exemption from registration. Up until the Dodd-Frank Act, there was the 15 client exemption. That’s gone.

Voting and Compliance

The midterm elections are upon us, which means you get to vote for your next congressman and about a 1/3 of the senators are up for election and most of you get to vote for your senator. Don’t forget the state and local elections.

In many states that means employers must allow their employees to have time off to vote. In 31 states, voting takes legal precedence over work.

Make sure that you vote and that your employees have time to vote.

For each polling place here in my Commonwealth of Massachusetts:

  • They must display the national flag. [MGL c.54, §25A]
  • They can’t serve alcohol in the any portion of the building designated as a polling place. [MGL c.54, §24]
  • You also carry intoxicating liquor into the polling place. [MGL c.54, §73]
  • Voting machines have to suitably lighted so you can read the ballot. [MGL c.54, §33A]
  • You can’t smoke at the polling place. [MGL c.54, §73]

So if you’re trying to vote in Massachusetts and you just bought a drink, the lights are dim, you’re smoking a cigar and you can’t salute the flag, then your polling place is not in compliance.

Sources:

Image is from Woot! Shirts

Updated to correct my voting miscalculation.

Legal Enterprise 2.0 Success Story

Penny Edwards of Headshift shares a Legal Enterprise 2.0 Success Story.

Matthew Arnold & Baldwin LLP, a regional firm in the United Kingdom, put the firm’s intranet, “The Cube”, up for the Law Society’s Excellence in Innovation Awards. The firm came away with a Shortlisted Award.

The Cube is Matthew Arnold & Baldwin LLP’s adoption of Enterprise 2.0 principles.

Heloïse Paull, the firm’s marketing director and the project’s sponsor, witnessed that as the firm grew, “People relied heavily on email communication, which created exclusivity on certain knowledge. Information and knowledge became diluted in information silos. Accurate CRM and cross selling suffered. There was a decline in the social aspect of the firm.”

Mark Weston, the partner responsible for the project, explains that email is not necessarily a bad thing: It works just fine when clients email instructions to the firm for new matters. But when those instructions and other matter related communication is drowned out by internal conversation in a way that makes it hard to share valuable insights then there is a clear need to move that conversation to a different platform.

Investment Advisers and Business Continuity Plans

When an investment adviser is designing its policies and procedures you need to identify the risks for their firm so they address those risks. A big risk is missing an applicable requirement under the regulatory scheme. So you sit down with the regulations and tie them to your specific policies and procedures.

An easy one to miss is the requirement for having a business continuity plan. It’s in Rule 206(4)-7.

Oh, you don’t see anything about business continuity in the rule? It’s not in the rule, it’s in the Release for Rule 206(4)-7:

We believe that an adviser’s fiduciary obligation to its clients includes the obligation to take steps to protect the clients’ interests from being placed at risk as a result of the adviser’s inability to provide advisory services after, for example, a natural disaster or, in the case of some smaller firms, the death of the owner or key personnel. The clients of an adviser that is engaged in the active management of their assets would ordinarily be placed at risk if the adviser ceased operations. [SEC Release No. IA-2204]

There is not much in the release to help you understand what is required, but there are two good places to help you.

One is to look at an intragency paper published by The Federal Reserve Board, the Office of the Comptroller of the Currency and the Securities and Exchange Commission on business continuity objectives. They lay out four broad sound practices for core clearing and settlement organizations and firms that play significant roles in critical financial markets:

  1. Identify clearing and settlement activities in support of critical financial markets.
  2. Determine appropriate recovery and resumption objectives for clearing and settlement activities in support of critical markets.
  3. Maintain sufficient geographically dispersed resources to meet recovery and resumption objectives.
  4. Routinely use or test recovery and resumption arrangements.

The other source (more practical source) is the disaster recovery requirements of broker/dealers. FINRA Rule 4370 is their emergency preparedness rule. They have a template for small introducing firms to help start designing a plan.

Sources: