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News December 20, 2004 Issue

2004: The Year in Review

If 2003 was the Year of the Canary, 2004 was the Year of the Canaryís Aftermath. Hereís what happened:

January . . .

The SEC starts the year off with a bang by proposing the new Advisers Act personal trading code of ethics rule, a package of fund governance reforms (including the controversial independent chair requirement), and new mutual fund point-of-sale disclosure and fund confirmation requirements (which remain outstanding).

The Senate Financial Management subcommittee holds a hearing on "hidden" mutual fund fees and fund "misgovernance." New York attorney general Eliot Spitzer testifies that his office has evidence that some advisers charge their mutual fund clients significantly more than other institutional clients for comparable advisory services.

February . . .

Massachusetts Financial Services agrees to pay $225 million (representing a $50 million penalty and $175 million in disgorgement) to settle SEC market timing and late trading charges.

Senator Peter Fitzgerald (R-IL) introduces a sweeping mutual fund reform bill that, among other things, does away with 12b-1 fees, soft dollars in the investment management industry, and side-by-side management of mutual funds and hedge funds. The bill is referred to the Senate Banking committee, where it dies.

In a marathon open meeting, the SEC adopts rules requiring mutual funds to disclose in shareholder reports the dollar cost of the fundís expenses associated with an $1,000 investment based on the fundís actual expenses and return, and also on an assumed 5 percent return. The SEC adopts rules requiring open and closed-end funds to report their portfolio holdings quarterly on new Form N-PX. The SEC proposes to require open and closed-end fund shareholder reports to discuss the basis of the board of directorsí decision to approve the fundís advisory contract. And last but not least, the SEC proposes to ban mutual funds from directing brokerage to reward brokers for distributing the funds. The SEC asks for comment on whether it should amend or rescind Rule 12b-1. One approach floated for comment: requiring funds to deduct distribution-related costs directly from shareholder accounts.

The SECís Division of Market Regulation issues a no-action letter to the Securities Industry Association, giving broker-dealers the green light to rely on advisers in connection with the brokersí customer identification program requirements.

The SEC and NASD announce a joint enforcement proceeding against fifteen brokerage firms that agree to pay a total of $21.5 million to settle charges they improperly calculated mutual fund breakpoints.

The SEC proposes Reg. NMS.

The SEC proposes a mandatory 2 percent redemption fee for mutual funds.

The Senate Banking committee holds two mutual fund oversight hearings.

March . . .

Banc of America agrees to pay $10 million for failing to timely produce e-mails and other documents over the course of a two-year SEC investigation.

The SEC proposes to require funds to disclose additional information about their portfolio managers, including other accounts they manage, their compensation structure, and ownership of securities in accounts they manage.

The Senate Banking committee holds no fewer than five mutual fund oversight hearings this month.

Based on published reports of SEC officials speaking at industry conferences, some advisers worry that they must keep all e-mails for 20 years (the short answer: no).

Massachusetts Financial Services agrees to pay $50 million to settle SEC charges that it failed to adequately disclose to the MFS fund boards and shareholders the specifics of its "shelf-space" arrangements with brokerage firms and the conflicts created by those arrangements.

April . . .

The SEC adopts rule amendments requiring enhanced disclosure of market timing, fair value pricing, and selective disclosure of portfolio holding practices.

Putnam Investment Management agrees to pay $55 million (representing a $50 million penalty and $5 million in disgorgement) to settle SEC market timing charges.

The Senate Banking committee wraps up its series of ten mutual fund oversight hearings. Committee Chairman Richard Shelby (R-AL) indicates that he is pleased with SEC Chairman William Donaldsonís response to the fund trading scandals and signals that he is not inclined to support mutual fund reform legislation.

The SEC holds a hearing on Reg. NMS.

The SEC proposes a new Advisers Act rule excepting thrifts from the definition of "investment adviser" when they provide investment advice in their traditional trust capacity.

May . . .

The SEC files civil fraud charges against PIMCO equity fundsí adviser, distributor, and two senior officers for market timing arrangements. The firms, but not the individuals, settle with the SEC in early September.

The SEC extends Reg. NMSís comment period and asks for additional comment.

Strong Capital Management and founder Richard Strong agree to pay $140 million to settle market timing charges (representing a $40 million penalty and $40 million in disgorgement for the firm, and a $30 million penalty and $30 million in disgorgement for Strong). Strong is permanently barred from the investment management and brokerage industries. The firmís CCO agrees to pay a $50,000 penalty to settle charges he aided and abetted the firmís and Strongís violations. The CCO agrees to be permanently barred from the investment management industry.

The SEC adopts rules requiring mutual funds to provide enhanced disclosure of breakpoint discounts in their prospectuses.

The SEC adopts the new Advisers Act personal trading code of ethics rule.

June . . .

Pilgrim Baxter & Associates agrees to pay $100 million to settle SEC and Spitzer market timing charges (representing a $50 million penalty, $40 million in disgorgement, and a $10 million side-deal with Spitzer to reduce management fees over a five-year period).

The SEC adopts rules requiring fund shareholder reports to discuss the basis of the board of directorsí decision to approve the fundís advisory contract.

The SEC adopts final fund governance rules. Commissioners Cynthia Glassman and Paul Atkins dissent.

Banc One Investment Advisors agrees to pay $50 million (representing a $40 million penalty and $10 million in disgorgement) to settle SEC market timing charges. The firmís former president and CEO agrees to pay a $100,000 civil penalty and consents to a two-year bar from the fund industry and a three-year prohibition on serving as an officer or director of a mutual fund or adviser.

July . . .

By a 3-2 vote, the SEC proposes to require hedge fund managers to register. Commissioners Glassman and Atkins dissent. During the SECís open meeting, Division of Investment Management director Paul Roye announces that as part of the SECís overall risk-based approach, a group of SEC officials is working on identifying factors that will be used to target high-risk advisers. The group is later given a name: the Investment Adviser Task Force.

The Senate Banking committee holds a hearing on hedge funds. SEC Chairman Donaldson tells the committee that he doesnít get "much push back from people who are operating good funds."

The Financial Planning Association sues the SEC over the fee-based brokerage rule, first proposed in 1999.

The ICAA releases its Best Practices for Investment Adviser Codes of Ethics.

The Senate Banking committee holds two days of hearings on Reg. NMS.

The Mutual Fund Directors Forum releases its Best Practices Report, urging fund directors to prohibit their fundís advisers from participating in soft dollar trades.

August . . .

Franklin Advisers agrees to pay $50 million (representing a $20 million penalty and $30 million in disgorgement) to settle market timing charges.

The SEC brings its first enforcement action against insurance companies for permitting market timing of mutual funds through variable annuities. The insurance companies (subsidiaries of Conseco and related firms) agree to pay $20 million to settle the cases.

Janus Capital Management agrees to pay $100 million (representing a $50 million penalty and $50 million in disgorgement) to settle SEC market timing charges.

The SEC reopens comment period on its proposed fee-based brokerage rule.

The SEC adopts final ban on fund brokerage for distribution. The SEC adopts final portfolio manager rules.

Van Wagoner Capital Management and Garrett Van Wagoner settle an SEC fraud action for allegedly devaluing securities in order to meet a fundís 15 percent illiquid cap.

September . . .

The U.S. Chamber of Commerce files a lawsuit challenging the SECís authority to adopt the independent chair and 75 percent independent directors requirement.

The law firm of Wilmer, Cutler, Pickering, Hale and Dorr files a comment letter on the SECís hedge fund manager proposal, raising questions about the agencyís authority to adopt the rule.

Phillip Goldstein files his no-holds-barred "Bumpty Dumpty" comment letter on the SECís hedge fund manager proposal.

Charles Schwab & Co. pays a $350,000 civil penalty to settle SEC charges it allowed certain customers to purchase mutual fund shares after market close.

PIMCO equity fundsí adviser, sub-adviser, and distributor, agrees to pay $50 million (representing a $40 million penalty and $10 million in disgorgement) to settle SEC market timing charges. Two days later, PIMCO agrees to settle SEC charges that it failed to disclose the use of its multi-manager series fundsí directed brokerage to pay for shelf space. Various PIMCO affiliates pay $4 million in penalties and $6.6 in disgorgement. PIMCO also settles related changes with California attorney general Bill Lockyer, who additionally alleges that PIMCO engaged in fraud by failing to disclose hard dollar revenue sharing payments.

Bridgeway Capital Management and president John Montgomery settle SEC charges that the firm incorrectly assessed performance fees. In addition to reimbursing fund shareholders nearly $5 million, the firm and Montgomery agree to pay penalties of $250,000 and $50,000, respectively.

TD Waterhouse and three small advisers settle charges that the brokerage firm made undisclosed cash payments to encourage the advisers to use Waterhouse for their clientsí brokerage. Waterhouse agrees to pays $2 million in penalties. Two of the advisers pay civil penalties of $100,000 and $40,000 and make disgorgement of $54,256 and $22,331, respectively. The third adviser chooses to fight the charges.

October . . .

The October 5 compliance date for the new compliance program rule goes into effect. SEC officials speaking at fall industry conferences talk of reaching out and fostering a working relationship with the newly-minted crop of CCOs, promising not to play "gotcha" during examinations.

RS Investment Management agrees to pay $25 million (representing a $13.5 million penalty and $11.5 million in disgorgement) to settle SEC market timing charges. The firmsí CEO and former CFO agree to pay civil penalties of $150,000 each.

Invesco Funds Group, AIM Advisors, and AIM Distributors agree to pay $375 million (representing $140 million in penalties and $235 million in disgorgement) to settle SEC market timing charges. The former president and CEO of one of the firms pays a $500,000 penalty and $1 in disgorgement to settle related charges (three other employees previously had settled at the end of August). 

Citigroup Global Markets agrees to pay $250,000 to settle NASD charges that it distributed inappropriate hedge fund sales literature containing targeted returns and improper hypothetical returns.

The SEC adopts the hedge fund manager rule, with Commissioners Glassman and Atkins dissenting.

November . . .

Fremont Investment Advisors agrees to pay over $4 million (representing a $2 million penalty and $2.5 million in disgorgement) to settle SEC market timing and late trading charges.

The U.K. Financial Services Authority issues a new policy statement discussing how it proposes to define "research" and "execution." The NASDís mutual fund task force issues its soft dollar report, recommending modest changes.

Harold Baxter and Gary Pilgrim agree to pay a total of $160 million (representing a $20 million penalty and $60 million in disgorgement each) to settle SEC market timing charges. Each man was permanently barred from the investment management industry.

December . . .

The ICAA formally asks the SEC for guidance on a variety of e-mail issues.

Franklin Advisers and Franklin Templeton Distributors agree to pay a total of $20 million (representing a $20 million penalty and one dollar in disgorgement) to settle SEC charges related to use of brokerage commissions to pay for shelf space.

The SEC reproposes Reg. NMS.

Lastly, hereís two predictions: The SEC will adopt the fee-based brokerage rule by year-end. And look for Form ADV Part 2 fairly early on in 2005.