Ropes & Gray's Investment Management Update - September 2011

The following summarizes recent legal developments of note affecting the mutual fund/investment management industry:

Regulatory Matters

SEC Staff Issues No-Action Letter Concerning Recordkeeping Requirements for "Pay-to- Play" Rule

On September 12, 2011, the staff of the Securities and Exchange Commission ("SEC") issued no-action relief concerning recordkeeping requirements associated with the SEC's "pay to-play" rule. The SEC adopted Rule 206(4)-5 (the "pay-to-play rule") under the Investment Advisers Act of 1940 (the "Advisers Act") in July 2010 to prohibit an investment adviser from providing advisory services for compensation to a government client for two years after the adviser or certain of its employees or third-party solicitors make a contribution to certain candidates or elected officials. More information about the pay-to-play rule is available here. In connection with the pay-to-play rule, the SEC also amended Rule 204-2 under the Advisers Act to incorporate new recordkeeping requirements. Rule 204-2(a)(18)(i)(B) under the Advisers Act requires investment advisers to maintain a list of all government entities to which the adviser has provided advisory services, or which are or were investors in any covered investment pool to which the investment adviser provides or has provided investment advisory services in the past five years. The Investment Company Institute's incoming letter to the staff of the SEC observed that government entities may hold shares in covered investment pools through one or more omnibus accounts in such a way that a government entity is wholly unknown to the adviser, and that this lack of transparency impeded the ability of advisers to comply with this requirement. To address this concern, the staff of the SEC agreed not to bring enforcement actions against advisers who make and keep a list or other record that includes:

Each government entity that invests in a covered investment pool, where the account of such government entity can reasonably be identified as being held in the name of or for the benefit of the government entity on the records of the covered investment pool or its transfer agent; Each government entity, the account of which was identified as that of a government entity — at or around the time of the initial investment — to the adviser or one of its client servicing employees, regulated persons or covered associates; Each government entity that sponsors or establishes a 529 Plan and has selected a specific covered investment pool as an option to be offered by such 529 Plan; and Each government entity that has been solicited to invest in a covered investment pool either (i) by a covered associate or regulated person of the adviser; or (ii) by an intermediary or affiliate of the covered investment pool if a covered associate, regulated person, or client servicing employee of the adviser participated in or was involved in such solicitation, regardless of whether such government entity invested in the covered investment pool. The text of the no-action letter may be found here.

FINRA Proposes to Streamline Communications Rules

The Financial Industry Regulatory Authority, Inc. ("FINRA") has filed proposed rule changes with the SEC regarding member communications with the public. FINRA's proposal is intended to revise how written communications with the public are categorized for purposes of determining compliance with FINRA's related rules. The proposal would reduce the number of communication categories to three categories based on the intended audience as follows:

"Institutional communication" would include any written (including electronic) communication that is distributed or made available only to institutional investors. "Institutional investor" generally would have the same definition as under current NASD Rules. "Retail communication" would include any written (including electronic) communication that is distributed or made available to more than 25 retail investors within any 30 calendar-day period. "Retail investor" would include any person other than an institutional investor, regardless of whether the person has an account with the member. "Correspondence" would include any written (including electronic) communication that is distributed or made available to 25 or fewer retail investors within any 30 calendar-day period. While the proposed rules would expand filing requirements for and exemptions from certain categories, existing requirements for and exclusions from regulatory requirements for communications will remain largely unchanged following the proposed recategorization. Among other changes, the proposed rules would also expand the filing requirements to include all retail communications concerning closed-end funds, including communications distributed after the fund's initial public offering, as well as communications regarding government securities, collateralized mortgage obligations, and securities derived from or based on a single security, a basket of securities...