Investment Management Commentary
September 2002
SEC Adopts Rules and Issues Additional Proposals
on Registered Investment Company Certifications
On August 27, 2002, the Securities and Exchange
Commission (“SEC”) adopted new rules to
implement the certification requirement of Section
302 of the Sarbanes-Oxley Act of 2002 (the “Act”)
with respect to registered open-end and closed-end
management investment companies (“Funds”), as
well as unit investment trusts (together with Funds,
“Investment Companies”), that file periodic reports,
on Form N-SAR, under Section 13(a) or 15(d) of the
Securities Exchange Act of 1934 (“Exchange Act”).
The new rules require each such company to certify
any Form N-SAR it files after August 29, 2002.
In addition, the SEC has proposed rules that would
require all Funds to file certified shareholder reports
on a new Form N-CSR, which would fall within
Section 302 of the Act, and require all Investment
Companies to maintain and evaluate disclosure
controls and procedures with regard to all filings
under the Exchange Act, the Securities Act of 1933
(“Securities Act”) and the Investment Company Act
of 1940 (“1940 Act”). Finally, the SEC is proposing
an amendment to Form N-SAR that would uniformly
apply the Section 302 certification of Form N-SAR
to all Investment Companies, including those that
currently do not file periodic reports on Form NSAR under Section 13(a) or 15(d) of the Exchange
Act.1 The proposed rules would become effective 30
days after publication of the final rules.
NEW RULES
Certifications to be Filed with Form N-SAR
Under the new rules, Investment Companies must file
the certification specified by Section 302 of the Act
as an exhibit to Form N-SAR.
Certification Provisions
Each principal executive officer and principal
financial officer, or persons performing similar
functions, of an Investment Company must certify
the following as to its report filed on Form N-SAR:
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the officer has reviewed the Form N-SAR
being filed;
based on the officer’s knowledge, the report
does not contain any untrue statement of a
material fact or omit to state a material fact
necessary to make the statements made, in light
of the circumstances under which such
statements were made, not misleading with
respect to the period covered by the report;
based on the officer’s knowledge, the financial
information included in the report, and the
financial statements on which the financial
information is based, fairly present in all
material respects the financial condition,
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As a technical matter, the Act and the new rules do not apply to a small class of Investment Companies that do not
make filings under the Exchange Act, on Form N-SAR. The proposed rules would encompass all Investment
Companies, other than the Form N-CSR requirement, which would apply only to Funds.
Kirkpatrick & Lockhart LLP
results of operations, changes in net assets, and
cash flows (if the financial statements are
required to include a statement of cash flows)
of the Fund as of, and for, the periods
presented in the report;2
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the officer and the Investment Company’s other
certifying officers:
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are responsible for establishing and
maintaining disclosure controls and
procedures for the Investment Company;
have designed the disclosure controls and
procedures to ensure that material
information relating to the Investment
Company is made known to them by others
within the Investment Company, particularly
during the period in which the report is
being prepared;
have evaluated the effectiveness of the
Investment Company’s disclosure controls
and procedures as of a date within 90 days
prior to the filing date of the report; and
have presented in the report their
conclusions about the effectiveness of the
disclosure controls and procedures based on
the required evaluation;
the officer and the Investment Company’s other
certifying officers have disclosed, based on
their most recent evaluation, to the Investment
Company’s auditors and its audit committee:
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all significant deficiencies in the design or
operation of internal controls which could
adversely affect the Investment Company’s
ability to record, process, summarize, and
report financial data and have identified for
the Investment Company’s auditors any
material weaknesses in internal controls;
and
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any fraud, whether or not material, that
involves management or other employees
who have a significant role in the
Investment Company’s internal controls;
and
the officer and the Investment Company’s other
certifying officers have indicated in the report
whether or not there were significant changes
in internal controls or in other factors that
could significantly affect internal controls
subsequent to the date of their evaluation,
including any corrective actions with regard to
significant deficiencies and material
weaknesses.
The certification must be in the exact form set forth
in Form N-SAR, as amended. The wording of the
certification may not be changed in any respect,
although statements relating to disclosure controls
and procedures and internal controls may be omitted
for Form N-SAR filings covering periods ending
before August 29, 2002.
Disclosure Controls and Procedures
An Investment Company must maintain “disclosure
controls and procedures” designed to ensure that
information required to be disclosed in Form N-SAR
is recorded, processed, summarized, and reported
within the time periods specified in SEC rules and
forms. The SEC indicated that “disclosure controls
and procedures” should be designed to ensure that
the required information is accumulated and
communicated to management, particularly the
principal executive officer(s) and principal financial
officer(s), as appropriate, to allow timely decisions
regarding relevant disclosure.
The SEC distinguished “disclosure controls and
procedures,” which are intended to address the
quality and timeliness of disclosure, from the current
concept of “internal controls,” which apply to
controls and procedures for financial reporting
Because the Form N-SAR does not require a unit investment trust to report financial information based on its financial
statements, the new rules do not require unit investment trusts to include in the certification the statements certifying the
financial information included in Form N-SAR or the financial statements on which the Form N-SAR is based.
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Kirkpatrick & Lockhart LLP
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purposes. Under the supervision and with the
participation of its principal executive and financial
officers, an Investment Company also must conduct
an evaluation of the effectiveness of the design and
operation of its “disclosure controls and
procedures” within 90 days prior to filing its Form
N-SAR.
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PROPOSED RULES
In addition, the SEC has proposed the following
rules and rule amendments:
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Funds would be required to file certified
shareholder reports on new Form N-CSR.
These certified shareholder reports would
consist of a copy of any required
shareholder report, information regarding a
Fund’s “disclosure controls and
procedures,” and the certification required
by Section 302 of the Act. In addition,
Form N-CSR would be designated as a
report under Sections 13(a) and 15(d) of
the Exchange Act, thus bringing a Fund’s
shareholder report—including the MD&A
—within the requirements of Section 302
of the Act.
Investment Companies would be required
to maintain and regularly evaluate the
effectiveness of their “disclosure controls
and procedures” to ensure that the
information required in their disclosure
documents filed under the Exchange Act,
the Securities Act and the 1940 Act is
collected, processed, and disclosed on a
timely basis.
Form N-SAR would be amended so that all
Investment Companies (not just those
required to file periodic reports under
Section 13(a) or 15(d) of the Exchange
Act) would need to include the certification
required by Section 302 of the Act in their
Form N-SAR filings.
IMPLICATIONS
The new and proposed rules have various
implications for Investment Companies, a few of
which are briefly described as follows:
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Investment Companies must identify
appropriate persons to act as “principal
executive officer and principal financial
officer, or persons performing similar
functions” to design, establish, maintain,
review and evaluate the issuer’s “disclosure
controls and procedures” and sign the
appropriate certifications. Where unaffiliated
third party administrators or others are
employed to perform critical functions
underlying these responsibilities, the
Investment Company must develop an
appropriate process for conducting the required
review and evaluation, and possibly consider
appointing additional officers to assume these
responsibilities.
Investment Companies must consider whether
their existing procedures satisfy the
requirement for appropriate “disclosure
controls and procedures” and sufficiently
provide the basis of support for the statements
required by the Form N-SAR certification (and
the N-CSR certification for Funds under the
proposed rules). Significantly, the proposed
rules would expand the requirements of the Act
and the new rules, which apply only to
Exchange Act filings, by requiring “disclosure
controls and procedures” with respect to all
filings under the Securities Act, the Exchange
Act and the 1940 Act.
The proposed Form N-CSR, which would
require Funds to file certified shareholder
reports (signed by the Fund and its principal
executive and financial officers) with the SEC,
would subject Funds to the officer certification
requirement of Section 906 of the Act, which
imposes substantial criminal penalties.
Both the new rules and the proposed rules
imply significant new responsibilities for
Investment Company Boards of Directors or
Trustees (“Boards”). Among other things,
Boards should consider their “disclosure
controls and procedures,” including the identity
of the principal executive and principal
financial officers, and audit committees should
assure they have conducted all necessary
evaluations to support the certification.
Kirkpatrick & Lockhart LLP
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If you have any questions about the SEC rules and proposals under the Act related to
registered investment company certification requirements, please contact:
Diane E. Ambler
Catherine A. Bardsley
Kari M. Gibbs
Shirley A. Hinton
Alicia L. Lewis
202.778.9886
202.778.9289
202.778.9397
202.778.9303
202.778.9453
dambler@kl.com
cbardsley@kl.com
kgibbs@kl.com
shinton@kl.com
alewis@kl.com
Alternatively, the K&L attorney with whom you most often work can direct you to the
appropriate people within the firm for your specific needs.
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This publication/newsletter is for informational purposes and does not contain or convey legal advice. The information herein
should not be used or relied upon in regard to any particular facts or circumstances without first consulting a lawyer.
© 2002 KIRKPATRICK & LOCKHART LLP.
ALL RIGHTS RESERVED.