The following are summaries of key developments in the investment management industry. More detailed coverage of these and other topics is available for review.

SEC Works on Rules To Address Risks Posed by Asset Management Industry

In September 2014, it was reported that the Securities and Exchange Commission (SEC) is weighing new rules to enhance oversight of registered funds, private funds, and investment advisers. The aim would be to provide insight into whether the asset management industry presents risks to the financial system. The new requirements would mandate that investment advisory firms provide regulators more information about portfolio holdings, and that the firms conduct stress tests. Such tests would be focused on whether funds have sufficient liquid assets to sustain large-scale redemptions if market shocks were to occur.

Though the SEC and its staff have not yet arrived at a formal proposed rule, the potential rules would likely resemble requirements imposed after the worst of the financial crisis on large financial institutions to address risks that regulators believed these institutions posed to the economy.  In particular, the practice by some mutual funds of using derivatives and other strategies employed by hedge funds is attracting the SEC’s attention.

SEC Pay-To-Play Rules

On June 20, 2014, the SEC brought its first case under the “pay-to-play” rules against a Philadelphia-area private equity firm, TL Ventures, Inc. (TL Ventures).

The SEC’s pay-to-play rules were adopted in 2010 to prohibit investment advisers from providing compensatory advisory services for two years following a campaign contribution by the firm or certain firm agents to political candidates or officials in a position to influence the selection or retention of advisers to manage public pension funds or other government client assets. In 2011, a TL Ventures executive made a $2,500 contribution to a campaign of a candidate for Mayor of Philadelphia and a $2,000 contribution to the Governor of Pennsylvania. Both are officials covered by the pay-to-play rules and therefore the contributions triggered a two-year ban on business under SEC Rule 206(4)-5 prohibiting TL Ventures' advisory services to those government entities. TL Ventures agreed to pay nearly $300,000 in disgorgement and penalty fees to settle the case.

In its press release announcing the enforcement action, the chief of the SEC’s Municipal Securities and Public Pensions Unit stated: “Public pension funds are increasingly investing in alternative investment vehicles such as hedge funds and private equity funds. When dealing with public pension fund clients, advisers to those kinds of investment vehicles should be mindful of the restrictions that can arise from political contributions.”

State Street Appeal Implicates the Supreme Court’s Janus Ruling

The recent appeal of an action by the SEC could affect the U.S. Supreme Court’s seminal decision in Janus Capital Group, Inc. v. First Derivative Traders. In Janus, the Supreme Court held that an investment adviser that was a legally separate entity from the mutual fund that filed an allegedly misleading prospectus could not be primarily liable under Rule 10b-5(b) under the Securities Exchange Act of 1934, even if the adviser had taken part in drafting the statement.

In the SEC action, two former State Street Bank and Trust Co. executives, John Flannery and James Hopkins, were alleged to have misrepresented the status of investments in one of the bank’s funds. In the case against Mr. Flannery and Mr. Hopkins, the SEC alleged each had a key role in intentionally misrepresenting the risks associated with the bank's Limited Duration Bond Fund. The Fund, which was supposed to serve as an alternative to a money market fund (generally considered a safe investment), turned out to be almost entirely invested in high-risk subprime mortgage-backed securities. In October 2011, SEC Chief Administrative Law Judge Brenda Murray dismissed fraud claims against Mr. Flannery and Mr. Hopkins because she found that the SEC’s Division of Enforcement lacked evidence to support claims against them by failing to “establish that Respondents had ultimate authority and control over such documents.”

If the SEC has any success on appeal with the claims that Mr. Flannery and Mr. Hopkins made false statements in violation of Rules 10b-5(b) and 10b-5(c), as well as under Section 17(a), the scope of the protection afforded to investment advisers by the Janus decision may be narrowed.

To learn more about these developments and other investment management news, please contact a member of the Ballard Spahr Investment Management Group or the attorney with whom you regularly work. 

Copyright © 2014 by Ballard Spahr LLP.
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This alert is a periodic publication of Ballard Spahr LLP and is intended to notify recipients of new developments in the law. It should not be construed as legal advice or legal opinion on any specific facts or circumstances. The contents are intended for general informational purposes only, and you are urged to consult your own attorney concerning your situation and specific legal questions you have.

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