New 24f-2 Fee Rates for Mutual Fund Filings (MF)
2.15.2007 Pursuant to its authority under Section 6(b) of the Securities Act of 1933, the SEC set a new rate of $30.70 per $1 million of sales of securities registered with the SEC. This rate applies to 24f-2 filings. The new rate will take effect five days after enactment of House Joint Resolution 20.
No-Action Letter Issued on Hedge Clauses in Advisory Contracts (IA)
2.12.2007 The SEC staff issued a no-action letter to permitting an investment adviser to include a certain type of hedge clause and related disclosure in its advisory contract. The no-action letter was issued to Heitman Capital Management, LLC, Heitman Institutional Advisors, Heitman Endowment Advisors, L.P., Heitman Institutional Realty Advisors L.P., and Heitman Real Estate Securities LLC (each, a “Heitman Advisor”).
Sections 206(1) and 206(2) of the Investment Advisers Act of 1940 make it unlawful for any investment adviser to employ any device, scheme, or artifice to defraud, or to engage in any transaction, practice, or course of business that operates as fraud or deceit on clients or prospective clients. Those antifraud provisions may be violated by the use of a hedge clause or other exculpatory provision in an investment advisory agreement which is likely to lead an investment advisory client to believe that he or she has waived non-waivable rights of action against the adviser that are provided by federal or state law. The SEC staff has previously taken the position that hedge clauses that purport to limit an investment adviser’s liability to acts involving gross negligence or willful malfeasance are likely to mislead an unsophisticated client into believing that he or she has waived non-waivable rights, even if the hedge clause explicitly provides that rights under federal or state law cannot be relinquished.
The SEC staff stated that whether the use of a hedge by an investment adviser violates Sections 206(1) and 206(2) of the Advisers Act would depend on all of the surrounding facts and circumstances. In making this determination, the SEC staff would consider:
- the form and content of the particular hedge clause (e.g., its accuracy),
- any oral or written communications between the investment adviser and the client about the hedge clause; and
- the particular circumstances of the client.
When a hedge clause is in an investment advisory agreement with a client who is unsophisticated in the law, the SEC would consider factors including, but not limited to, whether:
- the hedge clause was written in plain English;
- the hedge clause was individually highlighted and explained during an in-person meeting with the client;
- enhanced disclosure was provided to explain the instances in which such client may still have a right of action; and
- the presence and sophistication of any intermediary assisting a client in his dealings with the investment adviser, and the nature and extent of the intermediary’s assistance to the client.
The SEC staff granted no-action relief to Heitman Advisors, whose hedge fund clause was as follows:
Client Indemnification: Client shall indemnify and hold harmless Manager [a Heitman Advisor] and its affiliates and their respective directors, managers, officers, agents and employees, from and against any and all losses, claims, demands, actions, or liability of any nature, including but not limited to attorneys’ fees, expenses and court costs, arising out of or in connection with this Agreement, except to the extent based upon, arising out of or in connection with Manager’s grossly negligent, reckless, willfully improper or illegal conduct in its performance or failure to perform under this Agreement, actions outside the scope of Manager’s authority or other material breach under this Agreement, by Manager, its directors, managers, officers, employees and agents.
The SEC staff noted that the form used by Heitman Advisors’ for such investment advisory contracts also included the following provision that stated that the client may have legal rights against the Heitman Advisor regardless of the hedge clause:
Non-Waiver of Rights: Notwithstanding the foregoing, nothing contained in this paragraph or elsewhere in this Agreement shall constitute a waiver by Client of any of its legal rights under applicable U.S. federal securities laws or any other laws whose applicability is not permitted to be contractually waived.
The SEC staff noted that the clients of Heitman Advisors are sophisticated persons that have the resources and experience to understand the investment advisory agreements with the applicable Heitman Advisor. These clients also have the bargaining power to negotiate, and in some cases even dictate, the terms of the investment advisory agreements. The no-action letter listed the types of clients:
- Registered investment companies;
- Institutional investors who are “qualified institutional buyers” as defined in Rule 144A under the Securities Act of 1933;
- Natural persons or companies who are “qualified clients” as defined in Rule 205-3 under the Advisers Act;
- Any person or entity who is a “qualified purchaser” as defined in Section 2(a)(51) of the Investment Company Act of 1940 (“Qualified Purchasers”);
- Any commingled fund entity (“CFE”), such as a multiple owner trust, partnership or limited liability company, that has a reasonable expectation (based upon indications of interests from investors) that it will meet the definition of Qualified Purchaser within 120 days of the date that the CFE acquires its first investment;
- Investors in wrap accounts (“Wrap Account Clients”) that are sponsored by registered investment advisers under the Advisers Act (“Wrap Account Sponsors”);
- Any CFE that is sponsored by an entity that is both unaffiliated with Heitman and a Qualified Purchaser (a “Qualified Sponsor”); and
- Any entity in which all of the equity owners are entities or individuals of the types described above.
The SEC staff noted that the Wrap Account Sponsors act as intermediaries (the “Intermediaries”) between the appropriate Heitman Advisor and the Wrap Account Clients and that Wrap Account Sponsors enter into investment advisory agreements with the appropriate Heitman Advisor on behalf of the Wrap Account Clients. Heitman Advisors represented that an Intermediary could evaluate, and assist a Client in interpreting, the hedge clause and the non-waiver disclosure in the unlikely event that a Heitman Advisor’s conduct gave rise to a cause of action under the investment advisory agreement.
CFTC Issues Guidance on Audit of Financial Statements of Futures Commission Merchants (HF)
2.8.2007 The CFTC issued a letter to assist futures commission merchants ("FCMs") with meeting their obligation under the Commodity Exchange Act (“Act”) to file an audited annual financial report with the CFTC and with their designated self-regulatory organizations (“DSROs”). FCMs are required to file this document with the CFTC and with their DSROs within the timeframe specified in CFTC Regulation 1.10(b)(1)(ii). Each FCM is required to supplement its audited annual financial report with a report on material inadequacies issued by the FCM’s public accountant. Depending on whether material inadequacies were found to exist, or to have existed, since the date of the previous audit, the accountant’s report will consist of either: (1) a statement that the audit did not disclose any material inadequacies; or (2) a description of any material inadequacies and the corrective action that the FCM has taken, or proposes to take, to address them.
In determining whether to report an item as a material inadequacy, the CFTC reminded auditors to test not only the financial statements, but also the following required regulatory supplementary schedules, which also must be audited:
- the Computation of Minimum Capital Requirements;
- the Statements of Segregation Requirements and Funds in Segregation for customers trading on U.S. commodity exchanges and for customers’ dealer option accounts (“segregated funds”); and
- the Statements of Secured Amounts and Funds held in Separate Accounts for foreign futures and foreign options customers (“secured funds”).
The CFTC also reminded FCMs and their auditors that the term “material inadequacy” is defined in CFTC Regulation 1.16(d)(2). The CFTC has provided additional relevant guidance in Financial and Segregation Interpretation No. 4-1, issued in 1985.
The FCM is required to file amended financial reports with the CFTC if errors in FCM financial reporting result in changes of 10% or more in the FCM’s excess net capital or its excess segregated or secured funds, or result in the FCM falling below required net capital “early warning” levels.