The SEC alleged that the investment advisers
violated Section 205 of the Investment
Advisers Act of 1940, which generally requires
that if an investment advisory contract provides
for performance-based fees, those fees must be
calculated based upon asset levels from the same
time period upon which the performance in question
is measured. Because the advisory contracts
allegedly enabled the advisers to calculate
performance-based fees using time frames that
were different than the time frames during which
asset levels were determined, the SEC alleged that
the advisers violated Section 205.
In addition to agreeing to reimburse the funds in
question, each investment adviser was censured
by the SEC and required to “cease and desist from
committing or causing violations” of Section 205 of
the Advisers Act. The investment advisers neither
admitted nor denied the findings of the SEC’s order.
Investment Management Update
Investment Management and
financial MARKETS Group
Cameron S. Avery
312-807-4302
cavery@bellboyd.com
Alicia A. Perla
312-807-4318
aperla@bellboyd.com
Kevin R. Bettsteller
312-807-4226
kbettsteller@bellboyd.com
Andrew T. Pfau
312-807-4386
apfau@bellboyd.com
Kelly R. Bowers
202-955-7081
kbowers@bellboyd.com
Paulita A. Pike
312-781-6027
ppike@bellboyd.com
Paul H. Dykstra
312-781-6029
pdykstra@bellboyd.com
Bruce A. Rosenblum
202-955-7087
brosenblum@bellboyd.com
Jennifer C. Esquibel
312-807-4262
jesquibel@bellboyd.com
Laura E. Simpson
312-807-4219
lsimpson@bellboyd.com
Alan Goldberg
312-807-4227
agoldberg@bellboyd.com
Donald S. Weiss
312-807-4303
dweiss@bellboyd.com
Veena Jain
312-807-4287
vjain@bellboyd.com
Stacy H. Winick
202-955-7040
swinick@bellboyd.com
Anna Paglia
312-781-7163
apaglia@bellboyd.com
Deborah M. Connor • Group Coordinator • 312-578-6034
dconnor@bellboyd.com
Gwen C. Cooney • Paralegal • 312-558-7826
gcooney@bellboyd.com
A service to our clients.
February 2007
Inside This Issue
Andrew Donohue
Speaks on Brokerage
and Trade Execution page 2
SEC Sanctions Auditor
for Improper Conduct page 3
SEC Reopens
Comment Period
for Mutual Fund
Governance Rule page 3
Investment Advisers
Sanctioned for
Allegedly Calculating
Performance Fees
Improperly - page 3
ICI Weighs in on FIN 48 – SEC Clarifies and Delays Implementation
for Funds
In response to a request from the Investment Company Institute, the Securities
and Exchange Commission recently clarified the application of Financial
Accounting Standards Board Interpretation Number 48, Accounting for
Uncertainty in Income Taxes, and delayed the implementation date for funds. FIN 48
provides new standards for all companies, including investment companies, to use
when determining and assessing the value of uncertain tax positions. Effective
for fiscal years beginning after December 15, 2006, FIN 48 aims to improve
comparisons between companies by requiring more consistent recognition
thresholds and measurements. As a result of the SEC’s clarification, funds with a
December 31 fiscal year will be the first to have to comply with FIN 48 and they
will have to do so beginning on June 29.
Under FIN 48, companies will have to determine both “whether it is more likely
than not that a tax position will be sustained upon examination…by the
appropriate taxing authority,” and, for those tax positions meeting the morelikely-than-not threshold, “the amount of benefit to recognize in the financial
statements.” One trend resulting from FIN 48 is that companies have begun to
assume that every uncertain tax position will be examined, rather than taking tax
positions based on calculations that account for the likelihood that the appropriate
tax authority would review each position.
SEC Provides Relief for Funds
The ICI’s recent letter to the SEC highlighted that FIN 48 “uniquely affects the
fund industry because the price at which fund shares are purchased and sold
(the net asset value or “NAV”) is calculated each business day….” According to
the ICI:
• “funds could have significant difficulties meeting this standard in certain cases
because the general tax rules applicable to funds or their investments are
unclear or because the guidance that exists cannot be applied confidently to
specific fact patterns,”
• “unlike other corporate registrants [e.g., operating companies] that are
IN TOUCH. IN SYNC. INVOLVED.
www.bellboyd.com
© 2007 Bell, Boyd & Lloyd LLP. All rights reserved.
70 West Madison Street
Chicago, Illinois 60602
t. 312-372-1121
f. 312-827-8000
1615 L Street, N.W.
Washington, D.C. 20036
t. 202-466-6300
f. 202-463-0678
Investment Management Update is published by Bell, Boyd & Lloyd LLP for clients and friends of the firm and is for information only. It is not a substitute for legal advice or
individual analysis of a particular legal matter. Readers should not act without seeking professional legal counsel. Transmission and receipt of this publication does not create
an attorney-client relationship.
required to apply FIN 48 only to their periodic financial statements, mutual
funds must apply the interpretation on a daily basis,” and
• as a result, “fund share prices will be inaccurate whenever FIN 48 requires a
fund to recognize tax liabilities that the fund will not be required to pay.”
Investment Management Update
FASB Rejects Requests to Delay
Implementation for Operating Companies
In highlighting more of the problematic issues
particular to funds, the ICI further noted that:
Though it received over 400 unsolicited comment
letters from operating companies, many requesting
more time to prepare for implementation, the FASB
recently announced it would not delay the
effective date for operating companies. Operating
companies must implement FIN 48 for fiscal years
beginning after December 15, 2006.
• “Mistakes occasionally are made that
cause a tax liability to arise. For example,
a derivative instrument may generate more
income than the fund anticipated, thus
subjecting the fund to an excise tax for
under-distributing its income. Under FIN 48,
these types of mistakes would require an
immediate adjustment to the Fund’s NAV,
even if it were expected that another party
(e.g., the investment adviser) would pay the
tax liability on behalf of the fund. Before
the application of FIN 48, funds did not
recognize tax liabilities until the payment of
tax was both probable and estimable.”
Andrew Donohue Speaks on Brokerage
and Trade Execution
In a recent speech before the Securities Industry
Association Institutional Brokerage Conference,
the director of the SEC’s Division of Investment
Management, Andrew “Buddy” Donohue confirmed
that brokerage and trade execution remain
priorities for the SEC. Mr. Donohue expressed “a
continuing concern over whether advisers in all
cases are truly seeking best execution, or whether
in certain instances other considerations may be
influencing their decisions regarding the placement
of client trades.” He also noted that upcoming SEC
pronouncements on portfolio trading practices
will focus on “additional disclosure and related
guidance to fund boards regarding soft dollars
and brokerage practices” to help fund directors
“fulfill their responsibilities with respect to soft
dollars as well as oversight of brokerage execution
developments, policies and practices.”
• “Under the Internal Revenue Code, the
reporting standard for tax returns is one
of “substantial authority,” which is lower
than the “more-likely-than-not” standard
required by FIN 48. Funds that filed tax
returns for prior years under the substantial
authority standard will be required to reduce
their NAVs on the first business day that FIN
48 applies if those positions do not also satisfy
the more-likely-than-not standard. This is true
even though the funds’ positions likely will not
be challenged by the IRS.”
After receiving the ICI’s letter, the SEC clarified
that the scope of authority a fund could rely on
to make a determination on a tax position included
“administrative practices and precedents”
and “less formal forms of guidance from the
taxing authority.” Also, the SEC postponed the
implementation date of FIN 48 for funds by
providing that funds may delay the implementation
of FIN 48 in their daily NAV calculations. Investment
companies must implement FIN 48 beginning
with the last NAV calculation of the first financial
statement reporting period after December 15,
2006.
In the meantime, Mr. Donohue shared these thoughts
regarding trading practices:
Technological Developments
• Technological developments are making it
possible for advisers to demonstrate with
“quantifiable measures” to fund boards and
others that they are “properly meeting their
best execution obligation.” He encouraged
advisers to “make effective use of technology
and their own professional judgment to
help them consider which trades may be
2
appropriate for low-cost platforms and which
require greater human management and cost
to execute.”
statements, which “falsely represented” that the
audits and financial statements were conducted
and prepared in accordance with the applicable
professional standards. The SEC prohibited the
auditor from appearing or practicing before the
SEC as an accountant, with a right to apply for
reinstatement after three years.
Best Execution for Non-Equities
• “[A]n investment adviser’s duties with
respect to seeking best execution apply
equally to fixed income securities and other
asset classes.” He encouraged the industry
to “develop meaningful, quantifiable fixed
income execution measures and methods of
evaluation to assist them in meeting their best
execution obligations and evaluating their
execution quality for non-equity securities.”
SEC Reopens Comment Period for Mutual
Fund Governance Rule
On December 15, 2006, the SEC reopened the
comment period for proposed amendments to
their previously announced governance initiatives,
which would require mutual funds to be led by an
independent board chair and mandate that at least
75% of the independent directors on the board be
independent. The comment period was reopened to
allow for comments on two recently released papers
prepared by the SEC’s Office of Economic Analysis.
The first paper summarizes empirical studies and
their failure to statistically measure a relationship
between board independence, governance and
performance. The second study discusses a review
of academic literature on the independence of mutual
fund chairs and boards and the relationship between
board independence and performance. Comments
are due by March 2, 2007.
Use of Research
• In instances where “advisory clients may be
benefiting, through an improved investment
process, from research obtained through
commission dollars of other clients,” he
encouraged advisers to consider whether
their clients “understand these conflicts”
or whether “enhanced disclosure” may be
necessary.
SEC Sanctions Auditor for Improper
Conduct
The SEC recently sanctioned an auditor for allegedly
engaging in “improper professional conduct” in the
course of his firm’s audits of a money market fund
and a bond fund. The SEC alleged, in part, that the
auditor was aware that:
Investment Advisers Sanctioned for
Allegedly Calculating Performance Fees
Improperly
The SEC announced that five different mutual fund
investment advisers (Kensington Investment Group,
Inc., Numeric Investors LLC, Marsh & McLennan
Company’s Putnam Investment Management LLC,
Gartmore Mutual Fund Capital Trust and The Dreyfus
Corporation’s unit of Mellon Corporation) agreed to
reimburse certain funds advised by them for allegedly
charging funds excessive performance-based
fees. According to the SEC, the fees and the asset
levels upon which the fees were derived were not
based upon the same time period.
• “more than half of the securities” in the money
market fund’s portfolio were not eligible for
investment by a money market fund, and
• the bond fund was “over-accruing interest for
bonds,” and “a significant portion of the fund’s
interest receivable balance was uncollectible.”
According to the SEC, the auditor’s “reckless or at
least highly unreasonable conduct,” led his firm to
issue unqualified opinions of the funds’ financial
3
Investment Management Update
FASB Rejects Requests to Delay
Implementation for Operating Companies
In highlighting more of the problematic issues
particular to funds, the ICI further noted that:
Though it received over 400 unsolicited comment
letters from operating companies, many requesting
more time to prepare for implementation, the FASB
recently announced it would not delay the
effective date for operating companies. Operating
companies must implement FIN 48 for fiscal years
beginning after December 15, 2006.
• “Mistakes occasionally are made that
cause a tax liability to arise. For example,
a derivative instrument may generate more
income than the fund anticipated, thus
subjecting the fund to an excise tax for
under-distributing its income. Under FIN 48,
these types of mistakes would require an
immediate adjustment to the Fund’s NAV,
even if it were expected that another party
(e.g., the investment adviser) would pay the
tax liability on behalf of the fund. Before
the application of FIN 48, funds did not
recognize tax liabilities until the payment of
tax was both probable and estimable.”
Andrew Donohue Speaks on Brokerage
and Trade Execution
In a recent speech before the Securities Industry
Association Institutional Brokerage Conference,
the director of the SEC’s Division of Investment
Management, Andrew “Buddy” Donohue confirmed
that brokerage and trade execution remain
priorities for the SEC. Mr. Donohue expressed “a
continuing concern over whether advisers in all
cases are truly seeking best execution, or whether
in certain instances other considerations may be
influencing their decisions regarding the placement
of client trades.” He also noted that upcoming SEC
pronouncements on portfolio trading practices
will focus on “additional disclosure and related
guidance to fund boards regarding soft dollars
and brokerage practices” to help fund directors
“fulfill their responsibilities with respect to soft
dollars as well as oversight of brokerage execution
developments, policies and practices.”
• “Under the Internal Revenue Code, the
reporting standard for tax returns is one
of “substantial authority,” which is lower
than the “more-likely-than-not” standard
required by FIN 48. Funds that filed tax
returns for prior years under the substantial
authority standard will be required to reduce
their NAVs on the first business day that FIN
48 applies if those positions do not also satisfy
the more-likely-than-not standard. This is true
even though the funds’ positions likely will not
be challenged by the IRS.”
After receiving the ICI’s letter, the SEC clarified
that the scope of authority a fund could rely on
to make a determination on a tax position included
“administrative practices and precedents”
and “less formal forms of guidance from the
taxing authority.” Also, the SEC postponed the
implementation date of FIN 48 for funds by
providing that funds may delay the implementation
of FIN 48 in their daily NAV calculations. Investment
companies must implement FIN 48 beginning
with the last NAV calculation of the first financial
statement reporting period after December 15,
2006.
In the meantime, Mr. Donohue shared these thoughts
regarding trading practices:
Technological Developments
• Technological developments are making it
possible for advisers to demonstrate with
“quantifiable measures” to fund boards and
others that they are “properly meeting their
best execution obligation.” He encouraged
advisers to “make effective use of technology
and their own professional judgment to
help them consider which trades may be
2
appropriate for low-cost platforms and which
require greater human management and cost
to execute.”
statements, which “falsely represented” that the
audits and financial statements were conducted
and prepared in accordance with the applicable
professional standards. The SEC prohibited the
auditor from appearing or practicing before the
SEC as an accountant, with a right to apply for
reinstatement after three years.
Best Execution for Non-Equities
• “[A]n investment adviser’s duties with
respect to seeking best execution apply
equally to fixed income securities and other
asset classes.” He encouraged the industry
to “develop meaningful, quantifiable fixed
income execution measures and methods of
evaluation to assist them in meeting their best
execution obligations and evaluating their
execution quality for non-equity securities.”
SEC Reopens Comment Period for Mutual
Fund Governance Rule
On December 15, 2006, the SEC reopened the
comment period for proposed amendments to
their previously announced governance initiatives,
which would require mutual funds to be led by an
independent board chair and mandate that at least
75% of the independent directors on the board be
independent. The comment period was reopened to
allow for comments on two recently released papers
prepared by the SEC’s Office of Economic Analysis.
The first paper summarizes empirical studies and
their failure to statistically measure a relationship
between board independence, governance and
performance. The second study discusses a review
of academic literature on the independence of mutual
fund chairs and boards and the relationship between
board independence and performance. Comments
are due by March 2, 2007.
Use of Research
• In instances where “advisory clients may be
benefiting, through an improved investment
process, from research obtained through
commission dollars of other clients,” he
encouraged advisers to consider whether
their clients “understand these conflicts”
or whether “enhanced disclosure” may be
necessary.
SEC Sanctions Auditor for Improper
Conduct
The SEC recently sanctioned an auditor for allegedly
engaging in “improper professional conduct” in the
course of his firm’s audits of a money market fund
and a bond fund. The SEC alleged, in part, that the
auditor was aware that:
Investment Advisers Sanctioned for
Allegedly Calculating Performance Fees
Improperly
The SEC announced that five different mutual fund
investment advisers (Kensington Investment Group,
Inc., Numeric Investors LLC, Marsh & McLennan
Company’s Putnam Investment Management LLC,
Gartmore Mutual Fund Capital Trust and The Dreyfus
Corporation’s unit of Mellon Corporation) agreed to
reimburse certain funds advised by them for allegedly
charging funds excessive performance-based
fees. According to the SEC, the fees and the asset
levels upon which the fees were derived were not
based upon the same time period.
• “more than half of the securities” in the money
market fund’s portfolio were not eligible for
investment by a money market fund, and
• the bond fund was “over-accruing interest for
bonds,” and “a significant portion of the fund’s
interest receivable balance was uncollectible.”
According to the SEC, the auditor’s “reckless or at
least highly unreasonable conduct,” led his firm to
issue unqualified opinions of the funds’ financial
3
The SEC alleged that the investment advisers
violated Section 205 of the Investment
Advisers Act of 1940, which generally requires
that if an investment advisory contract provides
for performance-based fees, those fees must be
calculated based upon asset levels from the same
time period upon which the performance in question
is measured. Because the advisory contracts
allegedly enabled the advisers to calculate
performance-based fees using time frames that
were different than the time frames during which
asset levels were determined, the SEC alleged that
the advisers violated Section 205.
In addition to agreeing to reimburse the funds in
question, each investment adviser was censured
by the SEC and required to “cease and desist from
committing or causing violations” of Section 205 of
the Advisers Act. The investment advisers neither
admitted nor denied the findings of the SEC’s order.
Investment Management Update
Investment Management and
financial MARKETS Group
Cameron S. Avery
312-807-4302
cavery@bellboyd.com
Alicia A. Perla
312-807-4318
aperla@bellboyd.com
Kevin R. Bettsteller
312-807-4226
kbettsteller@bellboyd.com
Andrew T. Pfau
312-807-4386
apfau@bellboyd.com
Kelly R. Bowers
202-955-7081
kbowers@bellboyd.com
Paulita A. Pike
312-781-6027
ppike@bellboyd.com
Paul H. Dykstra
312-781-6029
pdykstra@bellboyd.com
Bruce A. Rosenblum
202-955-7087
brosenblum@bellboyd.com
Jennifer C. Esquibel
312-807-4262
jesquibel@bellboyd.com
Laura E. Simpson
312-807-4219
lsimpson@bellboyd.com
Alan Goldberg
312-807-4227
agoldberg@bellboyd.com
Donald S. Weiss
312-807-4303
dweiss@bellboyd.com
Veena Jain
312-807-4287
vjain@bellboyd.com
Stacy H. Winick
202-955-7040
swinick@bellboyd.com
Anna Paglia
312-781-7163
apaglia@bellboyd.com
Deborah M. Connor • Group Coordinator • 312-578-6034
dconnor@bellboyd.com
Gwen C. Cooney • Paralegal • 312-558-7826
gcooney@bellboyd.com
A service to our clients.
February 2007
Inside This Issue
Andrew Donohue
Speaks on Brokerage
and Trade Execution page 2
SEC Sanctions Auditor
for Improper Conduct page 3
SEC Reopens
Comment Period
for Mutual Fund
Governance Rule page 3
Investment Advisers
Sanctioned for
Allegedly Calculating
Performance Fees
Improperly - page 3
ICI Weighs in on FIN 48 – SEC Clarifies and Delays Implementation
for Funds
In response to a request from the Investment Company Institute, the Securities
and Exchange Commission recently clarified the application of Financial
Accounting Standards Board Interpretation Number 48, Accounting for
Uncertainty in Income Taxes, and delayed the implementation date for funds. FIN 48
provides new standards for all companies, including investment companies, to use
when determining and assessing the value of uncertain tax positions. Effective
for fiscal years beginning after December 15, 2006, FIN 48 aims to improve
comparisons between companies by requiring more consistent recognition
thresholds and measurements. As a result of the SEC’s clarification, funds with a
December 31 fiscal year will be the first to have to comply with FIN 48 and they
will have to do so beginning on June 29.
Under FIN 48, companies will have to determine both “whether it is more likely
than not that a tax position will be sustained upon examination…by the
appropriate taxing authority,” and, for those tax positions meeting the morelikely-than-not threshold, “the amount of benefit to recognize in the financial
statements.” One trend resulting from FIN 48 is that companies have begun to
assume that every uncertain tax position will be examined, rather than taking tax
positions based on calculations that account for the likelihood that the appropriate
tax authority would review each position.
SEC Provides Relief for Funds
The ICI’s recent letter to the SEC highlighted that FIN 48 “uniquely affects the
fund industry because the price at which fund shares are purchased and sold
(the net asset value or “NAV”) is calculated each business day….” According to
the ICI:
• “funds could have significant difficulties meeting this standard in certain cases
because the general tax rules applicable to funds or their investments are
unclear or because the guidance that exists cannot be applied confidently to
specific fact patterns,”
• “unlike other corporate registrants [e.g., operating companies] that are
IN TOUCH. IN SYNC. INVOLVED.
www.bellboyd.com
© 2007 Bell, Boyd & Lloyd LLP. All rights reserved.
70 West Madison Street
Chicago, Illinois 60602
t. 312-372-1121
f. 312-827-8000
1615 L Street, N.W.
Washington, D.C. 20036
t. 202-466-6300
f. 202-463-0678
Investment Management Update is published by Bell, Boyd & Lloyd LLP for clients and friends of the firm and is for information only. It is not a substitute for legal advice or
individual analysis of a particular legal matter. Readers should not act without seeking professional legal counsel. Transmission and receipt of this publication does not create
an attorney-client relationship.
required to apply FIN 48 only to their periodic financial statements, mutual
funds must apply the interpretation on a daily basis,” and
• as a result, “fund share prices will be inaccurate whenever FIN 48 requires a
fund to recognize tax liabilities that the fund will not be required to pay.”