February 2012
Inside this issue:
SEC Targets Alleged Pricing Violations
SEC Targets Alleged Pricing
Violations ................................... 1
The Securities and Exchange Commission’s (“SEC”) Enforcement Division
made headlines this January by targeting, in two separate actions, pricing
violations in mutual fund portfolios that occurred in 2008.
SEC Continues Crackdown
against Insider Trading .............. 2
SEC Enforcement Chief Makes
Statement on Citigroup Case..... 2
Chairman Schapiro Outlines
SEC’s Corporate Governance
Regulation Agenda; Evaluates
Recent Rulemaking ................... 3
Possible Changes from the Public
Company Accounting Oversight
Board ......................................... 4
Money Market Funds
Money Market Fund
Regulation under the
Dodd-Frank Act .................. 5
Future Regulation Uncertain
for Money Market Funds..... 6
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In the first instance, the SEC fined and censured UBS Global Asset Management
(“UBSGAM”) for allegedly not following established fair valuation
procedures in pricing certain illiquid fixed-income securities in the portfolios
of three UBSGAM mutual funds. The SEC alleged as follows. The funds’
Boards of Directors had established valuation methodologies and delegated
implementation of those methodologies to UBSGAM, who in turn appointed its
Global Valuation Committee (“Committee”) to carry out the valuation
responsibilities pursuant to certain pricing hierarchies. Under the procedures, the
Boards of Directors reviewed the Committee’s valuations and ratified or adjusted
them. Among other things, the procedures provided that if the difference
between the purchase price and the valuation from a third party pricing
source was 3% or more: (i) the purchase price was to be used for a maximum
of five business days; (ii) UBSGAM was to issue a “price challenge”
requesting justification from the third party pricing source for the price quoted,
and, if justified by the response, UBSGAM could use the pricing source price;
and (iii) the Committee was to make a fair valuation determination if no
resolution was reached by the end of five business days.
According to the SEC order, 48 of 54 purchases of non-agency mortgagebacked securities in 2008 were valued upon purchase at prices substantially
higher than the purchase prices – at least 100% higher in a majority of the
cases, and in some cases 1,000% higher – using valuations provided by
broker-dealers or third party pricing services. The SEC alleged that the
valuations provided by these pricing sources in some cases were stale and did
not seem to take into consideration the prices at which the funds had
purchased the securities. The SEC further asserted that UBSGAM did not fair
value the securities until the Committee met more than two weeks after it started
receiving “price tolerance reports” triggering the procedure for greater than 3%
discrepancies between the purchase prices and the prices provided by the third
party pricing sources. Thus, according to the SEC, the procedures were not
followed in that: (i) the securities were not valued at their purchase price,
(ii) no price challenges were issued to the third party pricing sources for a
majority of the securities on the “price tolerance reports” and, when only a
handful of responses were received, there was no follow up, and (iii) no fair
value determinations were made within the five business day deadline. Once
the Committee did meet and fair valued the securities, they decided to fair value
the securities at the midpoint between the purchase price and the pricing source
quote pending receipt of responses to price challenges, which was later ratified
by the Boards of Directors.
As a result of these actions, according to the SEC,
the NAVs of the funds were misstated between
one cent and 10 cents per share for several
days in June 2008. UBSGAM settled the charges
without admitting or denying the SEC’s findings,
and agreed to be censured and to pay a $300,000
penalty. UBSGAM also consented to a ceaseand-desist order from committing or causing the
same violations in the future.
In the second proceeding, the SEC’s Enforcement
Division alleged that the NAV of the Evergreen
Ultra Short Opportunities Fund was materially
overstated from at least March 2008 to early June
2008 due to the conduct of Lisa B. Premo, at the
time the Fund’s lead portfolio manager and
CIO of liquidity and structured solutions for
Evergreen Investment Management Co.
(“Evergreen”). Specifically, the SEC alleged
that Premo failed to convey to either the
Fund’s board or Evergreen’s valuation
committee certain material information she
possessed concerning the value of a
collateralized debt obligation owned by the
Fund that had experienced an event of default.
Thus, the SEC asserts that Premo defrauded the
Fund and breached her fiduciary duty to the
Fund as its portfolio manager. A hearing will
be scheduled to consider the allegations.
These two proceedings demonstrate the
Enforcement Division’s heightened scrutiny of
mutual fund portfolio valuation and its focus on
valuation practices during the height of the
financial crisis in 2008.
SEC Continues Crackdown
against Insider Trading
In a move that signals the SEC is still on the
offensive against alleged insider trading, on
January 18th the SEC charged seven individual
hedge fund traders and analysts, and their
respective firms, for allegedly making $78 million
from trades based on nonpublic information about
Dell, Inc. (“Dell”) and the Nvidia Corporation
(“Nvidia”). The U.S. Attorney for the Southern
District of New York has also brought criminal
charges against the individual defendants. These
claims stem from the SEC’s and the Justice
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February 2012
Department’s continuing investigations into
insider trading in the wake of the high-profile
case against the Galleon Group and its
founder, Raj Rajaratnam.
In the SEC’s Dell and Nvidia case, the SEC
alleges that the traders and analysts, each of
whom worked for either Diamondback Capital
Management LLC or Level Global Investors LP:

obtained information from insiders at Dell,
regarding Dell’s quarterly earnings
performance, and at Nvidia, regarding
revenue figures and gross profit margins, in
each case in advance of the issuer’s
quarterly earnings announcements,

illegally tipped portfolio managers at their
firms, which traded on the information, and

benefited their firms with ill-gotten gains in
excess of $62.3 million on the basis of inside
information about Dell and $15.3 million on
the basis of information about Nvidia.
The SEC has charged each of the defendants with
violations of the federal anti-fraud provisions of
Section 17(a) of the Securities Act of 1933 and
Section 10(b) and Rule 10b-5 of the Securities
Exchange Act of 1934 (“the Exchange Act”) and
has charged each of the individual defendants
with aiding and abetting others’ violations of the
Exchange Act. The SEC is seeking a judgment
ordering the defendants to disgorge all of their
illicit gains, with interest and penalties, and
permanently enjoining them from future
violations of these provisions.
SEC Enforcement Chief
Makes Statement on
Citigroup Case
The SEC recently found itself on the defensive
regarding its established practice of settling
enforcement actions without requiring the
subject of the action to admit or deny
wrongdoing. In a high-profile decision, in
November 2011, Judge Rakoff of the U.S.
District Court for the Southern District of New
York refused to accept a $285 million proposed
SEC settlement with Citigroup over the sale of
Investment Management Update
toxic mortgage securities on the grounds that the
SEC’s policy, “hallowed by history, but not by
reason,” deprives a reviewing court “of even the
most minimal assurance that the substantial
injunctive relief it is being asked to impose has
any basis in fact.” In his decision, Judge Rakoff
particularly challenged the settlement for letting
Citigroup off the hook on negligence charges
only and without admitting anything, and what
he characterized as a penalty that was nothing
more than a “modest cost of doing business.”
The Director of the SEC’s Division of
Enforcement, Robert Khuzami, recently espoused
the SEC’s belief that the court committed legal
error when it announced that the SEC’s
allegations were “unsupported by any proven or
acknowledged facts” and claimed the court’s
“new and unprecedented standard . . . harms
investors by depriving them of substantial, certain
and immediate benefits.”
The SEC defends its practice of settling cases
without requiring an admission of wrongdoing
because, the SEC contends, it benefits investors
by preventing long, drawn-out trials, which carry
the risk the SEC may either lose at trial or not
recover as much as the proposed settlement
amount. According to the Director, the SEC
carefully balances those risks and benefits, and
maintains that “settling on favorable terms even
without an admission serves investors,
including investors victimized by other frauds”
because permitting such settlements allows the
SEC to more efficiently allocate its resources
towards investigating more “frauds” without
having to spend time litigating a case that could
have been resolved without a trial. While careful
to note that the SEC is “fully prepared to refuse to
settle and proceed to trial when proposed
settlements fail to achieve the right outcome for
investors,” Mr. Khuzami contended that the new
standards imposed by the district court would
force the SEC to take more cases to trial, which
would result in the SEC bringing fewer cases
overall and returning less money to investors.
He added that the $285 million proposed
settlement represented most of the total recovery
the SEC could have expected to seek at trial and
that an SEC settlement does not limit the ability of
injured investors from pursuing private claims.
Chairman Schapiro
Outlines SEC’s Corporate
Governance Regulation
Agenda; Evaluates Recent
Rulemaking
Undeterred by the vacating of what it believed to
be a vital tool in the advancement of corporate
governance – the so-called proxy access rule –
SEC Chairman Schapiro has indicated an intent to
continue to work to improve the manner in which
public companies communicate with their
shareholders. Providing an indication of some
things to come from the SEC in 2012, Chairman
Schapiro stated to an audience of policy-making
European and American academics and corporate
leaders that “economies broadly benefit as wellrun companies flourish and grow” and that
investors in those companies benefit in
particular from “effective engagement” and
insight into “management’s priorities.” She
continued the theme of “effective engagement”
throughout her speech, admitting that there is no
exact formula for achieving it.
According to the Chairman, the first priority of
effective engagement is the accurate disclosure
of material financial information. Here, the
Chairman acknowledged that the SEC is not short
on regulatory requirements. The second
priority, and an area in which the SEC has found
it difficult to prescribe effective improvements, is
shareholder engagement. The Chairman noted
that “shareholders should have a voice and a
straightforward and transparent process for
engaging with companies on issues that are
important to them.”
While she was careful to note that the SEC is not
in the business of “determining the
communications strategies of individual
companies,” the Chairman remarked that the SEC
is interested in “breaking down barriers that
may prevent effective engagement, impact
investor confidence and, ultimately, diminish
financial performance to the detriment of
shareholders.”
With this foundation, the Chairman began a brief
summary of the regulatory environment for
corporate governance and a recent history of steps
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the SEC has taken to improve governance,
including the ill-fated proxy access rule, which
would have given shareholders the right to
participate directly in the nomination of directors.
She also commented briefly on proxy advisory
firms and their role in the system.
The Path Ahead
Chairman Schapiro highlighted some initiatives
the SEC intends to undertake over the coming
year, namely, a review of beneficial ownership
reporting rules and a renewed focus on proxy
access, and took an opportunity to pat the SEC on
the back for what she deems the emerging success
of recent “say-on-pay” rules.
Beneficial Ownership Reporting. The Chairman
noted that the Dodd-Frank Wall Street Reform
and Consumer Protection Act (“Dodd-Frank Act”)
provided the SEC with the authority to shorten the
reporting periods with respect to beneficial
ownership and to regulate ownership reporting
based on security-based swaps, and she suggested
that 2012 is likely to be the year in which the SEC
uses some of that authority.
Proxy Access. The Chairman noted that, despite
the fact that the proxy access rule was vacated,
existing rules that allow certain shareholders to
submit proposals for inclusion in a company’s
proxy materials will still “increase shareholder
access to the proxy ballot in key circumstances.”
In addition, under various rule amendments,
shareholders will be able to submit proposals for
proxy access at their individual companies –
known as “private ordering.” The Chairman feels
that this is forward progress in the proxy process
and a positive step toward enhanced shareholder
engagement.
Say-on-Pay. The last topic the Chairman touched
on was so-called “say-on-pay,” a Dodd-Frank Act
requirement for companies to periodically give
shareholders a non-binding advisory vote on the
company’s executive compensation practices.
These votes must take place at least once every
three years, and a shareholder vote on the
frequency of say-on-pay votes must take place at
least once every six years. Even though
shareholders have no binding authority to set
compensation practices, the Chairman noted that:
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February 2012
“[i]t has given shareholders a clear
channel to communicate to the
boards their satisfaction – or lack of
satisfaction – with executive
compensation practices . . . [a]nd it is
giving boards a powerful incentive to
clarify disclosure to shareholders, and
to make a clear, coherent case for the
compensation plans they have
approved.” [emphasis added]
The Chairman sees the say-on-pay rule as
advancing shareholder engagement and corporate
governance in general. She noted that companies
are required to quickly report the results of the
votes on Form 8-K, and proxy statements for the
year following a vote will need to include an
explanation of how the company responded to the
most recent say-on-pay vote. The Chairman said
companies are already beginning to file
responsive proxy statements.
What Now?
In closing, the Chairman reiterated that the SEC
is taking a varied approach in several different
areas to improve company-shareholder
communication and particularly “where [it] can
increase the quality of communication and the
level of responsiveness in the board-shareholder
dialogue.” While it is probably too early to tell
how effective the SEC’s actions have been, the
Chairman believes they will bring “real benefits
to investors, companies and the larger economy.”
Possible Changes from the
Public Company
Accounting Oversight
Board
The Public Company Accounting Oversight
Board (“PCAOB”), the Congressionally
established entity in charge of overseeing public
company audits, has recently explored several
areas of interest, which, if acted upon, may
significantly affect the audit process. These
areas include: (1) possible changes to the
auditor’s reporting model; (2) the possibility of
mandatory audit firm rotation; and
Investment Management Update
(3) standards on fair valuation, particularly
when a third party is used.
Auditor Reports
On June 21, 2011, the PCAOB issued a concept
release requesting information on possible
revisions to PCAOB standards related to auditor’s
reports. The PCAOB is concerned that auditors
have significant financial information about
the companies they audit which is not covered
by the standard auditor’s report and thus does
not reach investors. The concept release
discusses several alternatives that could be
implemented to increase transparency and
relevance in the auditor’s report. These
alternatives are not mutually exclusive and
include requiring (1) a supplement to the auditor’s
report in which the auditor would provide
additional information about the audit and the
company’s financial statements, (2) the
expanded use of “emphasis paragraphs” to
highlight the most significant matters in the
financial statements, (3) reporting on information
outside the financial statements, and
(4) clarifying language to provide additional
explanations about what an audit represents and
the auditor’s responsibilities. All of the
alternatives currently considered would retain the
auditor’s “pass/fail” opinion on the financial
statements while providing additional
information.
Auditor Independence
The PCAOB issued a concept release on August
16, 2011 soliciting comments on ways to
improve auditor independence. In particular,
this concept release discusses whether the
PCAOB should implement mandatory audit firm
rotation, which would limit the number of
consecutive years a firm could audit a company’s
books and records. Similar proposals have been
considered at various times since the 1970s, most
recently in 2002 when Congress considered
including it in the Sarbanes-Oxley legislation.
Instead, Congress decided to require audit firms to
rotate the partner in charge of a particular
company’s audit every five years, even though the
audit firm could remain the same. Supporters of
mandatory audit firm rotation assert that the
practice would improve auditor independence
and objectivity. Opponents cite concerns about
the increased costs and potentially reduced
audit quality involved in getting a new audit
firm up to speed.
Fair Valuation
Fair valuation continues to be an area of focus for
the PCAOB. A Staff Audit Practice Alert issued
December 6, 2011 highlights auditing fair value
measurements as an ongoing concern. In
addition, the PCAOB has formed the “Pricing
Sources Task Force” to focus on fair valuation as
a part of the PCAOB’s Standing Advisory Group.
In particular, the Pricing Sources Task Force
will study the use of third-party pricing
sources.
Money Market Funds
Money Market Fund Regulation
under the Dodd-Frank Act
Newly-appointed SEC Commissioner
Daniel M. Gallagher recently addressed the
conservative U.S. Chamber of Commerce
regarding SEC reform after the Dodd-Frank Act.
Of particular interest are his remarks on
regulation of money market funds, which have
been the subject of debate stemming from their
possible status as so-called systemically
important non-bank financial institutions
(“SIFIs”), a responsibility of the Financial
Stability Oversight Council (“FSOC”) under the
new Dodd-Frank Act oversight structure.
With regard to FSOC oversight and regulation in
general, Commissioner Gallagher indicated that,
in his view, “the framework for regulating
SIFIs should allow for these firms to fail.”
Moreover, in connection with money market fund
regulation, he expressed his views that two key
questions should be addressed before further
regulating money market funds: first, identifying
the specific risks or problems that need
resolution and, second, having the necessary
data to regulate meaningfully and effectively.
With regard to the first point, he noted that the
goal of the SEC is to prevent fraudulent and
manipulative practices; it is not, as he put it, to
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ensure that investments are risk free. In his
words, “in light of the extensive disclosures
regarding the possibility of loss, money market
funds should not be treated by investors or by
regulators as providing the surety of federally
insured demand deposits.”
Moreover, in considering what risks are presented
by money market funds that demand further
regulation, Commissioner Gallagher noted that
the SEC’s 2010 money market reforms have
yet to be tested to understand whether they
have adequately stemmed the problems that
arose during the crisis of 2008. Dismissing
those who “simply hand-wave and speak vaguely
of addressing ‘systemic risk’ or some other kind
of protean problem,” he stated that the “risks and
issues justifying a rulemaking must be
specifically and thoughtfully defined in relation
to the Commission’s mission.” Overall, he
noted his “belief that any rulemaking in this
space could be premature, and possibly
unnecessary.”
In any event, he shared his views on the “current
proposals being bandied about.” He indicated that
he is “hesitant” about any form of capital
requirement, “whether it takes the form of a
‘buffer’ or of an actual capital requirement similar
to those imposed on banks.” His reasoning was
twofold. One, he believes that the “level of
capital that would be required to legitimately
backstop the funds would effectively end the
industry.” Moreover, he expressed his concern
that a buffer “could simply create the illusion of
protection, and further obscure the welldisclosed risk of investing in money market
funds.” He noted that he feels somewhat positive
about a stand-alone redemption fee, depending
on the details. He noted that this “minimal
approach does not set up false expectations of
capital protection, externalizes the costs of
redemptions, and could be part of an orderly
process to wind down funds when necessary.”
It also, in his view, “may cause a healthy
process of self-selection among investors that
could cull out those more likely to ‘run’ in a time
of stress.” Nevertheless, he would not approve
of “grafting the [redemption] fee onto a capital
buffer regime,” which he believes “retains all the
problems of any capital solution, unless
something significant is done to manage
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February 2012
investor expectations regarding the level of
protection provided.”
With regard to a floating NAV, he believes it is
“an important option to keep on the table and
to subject to further study and consideration.”
Overall, however, Commissioner Gallagher
believes “the option of doing nothing until we
have seriously analyzed the impact of last
year’s reforms must be given serious
consideration.”
Future Regulation Uncertain for
Money Market Funds
In a November 2011 speech to the Securities
Industry and Financial Markets Association
(“SIFMA”), SEC Chairman Mary Schapiro
revealed that the SEC expects to introduce a
proposal that would overhaul regulation of the
money market fund (“MMF”) industry. Plans
for the proposal come despite recent reforms in
2010 to improve the daily and weekly liquidity of
MMFs, as the SEC has experienced increased
pressure to safeguard the industry amid the
ongoing financial crisis in Europe and increased
fears of a potential run on MMFs.
According to Chairman Schapiro, the proposal
would establish a capital buffer designed to
provide MMFs with a source of capital to
cover potential losses in an emergency,
potentially combined with redemption
restrictions to further avoid a run on MMFs. She
alternatively proposed that MMFs use floating
net asset values instead of artificially
maintaining a constant $1 price. Chairman
Schapiro indicated that the proposal, expected by
the end of the first quarter of 2012, will be
designed to prevent MMFs from “breaking the
buck” as had happened during the 2008 financial
crisis.
The proposal, however, faces staunch opposition
from the MMF industry, members of Congress
and various corporate groups, as well as
resistance from within the SEC. In a letter to
Chairman Schapiro in January 2012, twenty-three
large and well-known corporations and business
organizations expressed their view that no
additional MMF reforms are required beyond
those implemented in 2010. The letter asserted
Investment Management Update
that MMFs purchase over one-third of commercial
paper issued by U.S. companies, which provides
significant support to corporate credit markets.
The organizations fear that the changes
contemplated by the proposal would have
substantial negative consequences on the
ability of U.S. businesses to raise the capital
required to restore economic stability and
spark job creation.
Currently, the exact form that the proposal will
take is not known. The SEC may move directly
to issuing a proposed rule and seek comments
from the industry. Or it may opt for a more
deliberate approach and publish a “concept”
release to solicit the public’s views on this matter
to better evaluate the need for future rulemaking.
In the meantime, the industry and other interested
parties will have to stay tuned as these interesting
developments unfold.
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