A Compilation of Non-Enforcement Actions

06 July 2010 Publication
Authors: Peter D. Fetzer Terry D. Nelson

Legal News: Investment Management Update

Non-Enforcement Matters

SEC Adopts Regulations to Restrict Pay-to-Play Activities by Investment Advisers
On June 30, 2010, the SEC approved a new rule that significantly curtails the pay-to-play practices by investment advisers who seek to provide investment advisory services to public pension and other government plans.

Pay-to-play practices involve the making of campaign contributions and related payments by an investment management firm or its executives or employees to elected officials for the purposes of influencing such officials to award investment management contracts to the contributor-investment management firm.

The new rule provides that an investment adviser who makes a political contribution to an elected official (or to a candidate who is running for such office) in a position to influence the selection of the adviser, will be barred for two years from providing advisory services for compensation, either directly or through a fund. The contribution prohibition covers not only the firm, but also certain of its executives and employees. A de minimis provision permits an executive or employee of the investment adviser to make contributions of up to $350 per election per candidate if the contributor is entitled to vote for the candidate and up to $150 per election per candidate if the contributor is not entitled to vote for the candidate.

The new rule also prohibits the adviser and certain of its executives and employees from asking another person or political action committee (PAC) to: (i) make a contribution to an elected official or candidate for such a position who can influence the selection of the adviser; or (ii) make a payment to a political party of the state or locality where the adviser is seeking to provide advisory services to the government.

The new rule also prohibits the adviser and certain of its executives and employees from paying a third party such as a solicitor or placement agent, to solicit a government client on behalf of the adviser unless the third party is an SEC-registered investment adviser or broker-dealer who is subject to similar pay-to-play prohibitions.

The SEC is currently conferring with the Financial Industry Regulatory Authority to come up with similar pay-to-play prohibitions for registered broker-dealers. The SEC has given the industry one year from the new rule’s effective date to comply with the ban against third-party solicitors.

Finally, the rule prohibits such parties from engaging indirectly in pay-to-play practices such as by using third parties such as spouses, lawyers, or other entities affiliated with the adviser to make payments that would be prohibited under the rule if conducted directly by the adviser or certain of its executives and employees.

Other than the postponed effective date to comply with the ban against third-party solicitors, compliance with the other provisions of the rule is required within six months of the effective date, which is 60 days after its publication in the Federal Register.

Supreme Court Rules on Application of the U.S. Securities Laws to Foreign Transactions
In a June 24, 2010 decision (Morrison v. Australia National Bank Ltd., U.S. No. 08-1191, 6/24/10), the Supreme Court affirmed the dismissal of a would-be class securities fraud charge by foreign investors against an Australian bank who offered its shares on non-U.S. trading exchanges.

The Court’s decision reflects a relatively narrow view of the extraterritorial reach of the U.S. securities laws as it determined that the anti-fraud provisions under Sec. 10(b) of the Securities Exchange Act of 1934 applies only to securities transactions that occur in the United States or securities listed on a U.S. exchange.

The defendant in the matter, a corporation incorporated and headquartered in Australia, purchased a U.S.-based company in 1998. The defendant’s financial statements were later restated due to inaccurate financial assumptions used by its U.S.-based subsidiary. The defendant’s stock price declined substantially on foreign and U.S. stock markets subsequent to the write-downs traced to the defendant’s balance sheet. The plaintiffs filed a would-be class suit on behalf of non-U.S. shareholders who bought the defendant’s stock on foreign exchanges, alleging violations of Section 10(b) under the Exchange Act.

In making its decision, the Supreme Court determined that the plaintiffs failed to state a claim for which relief could be granted. The Court stated that a fundamental principle of American law is that congressional legislation is intended to apply only within the territorial United States. In this case, although the deception occurred in the United States (i.e., the overstating of values by the U.S.-based subsidiary), the focus of Section 10(b) claims is not upon where the deception occurred but upon purchases and sales of securities in the United States. Since the case involved no U.S.-listed securities and the transactions all occurred outside of the United States, the plaintiffs failed to state a claim upon which relief could be granted.

The Court’s decision is viewed by many as the right decision that brings clarity as to the reach of the U.S. securities laws for non-U.S. issuers and their investors.

Resistance to SEC Large Traders Proposal
In April of this year, the SEC proposed a rule that would require “large traders” to identify themselves to the SEC through a filing. Those traders who trade in exchange-listed securities of two million shares or $20 million in any one day, or 20 million shares or $200 million during any calendar month would be deemed to be a large trader and required to make the filing. The proposal also requires broker-dealers to maintain and report transaction data for their customers who are large traders. In the proposal, the SEC estimated that market participants would bear a total of approximately $33 million in initial costs and ongoing costs of about $17 million on an annual basis. Many of these costs are expected to be picked up by the broker-dealers.

Comments on the proposed large trader reporting rule were due by June 22, 2010. Critics of the proposed rule made it known through their comment letters to the SEC that the rule, if approved as currently proposed, would impose substantial costs and compliance burdens on both the affected investment adviser and broker-dealer firms. In addition, as one critic noted, the rule would needlessly affect a participant who executed large volume transactions on an infrequent basis. Several of the critics pointed to the fact that the reporting system would provide the public with trading strategy information that is proprietary and should be shielded from public review.

As a compromise, one suggestion was to require institutions to maintain a record of the large trading information that could be provided to the SEC upon request.

As to further action on the proposed rule, the ball is back in the SEC’s court to consider the comments to its proposed rule, whether to make revisions to the proposal and if and when to adopt the rule.

Legal News is part of our ongoing commitment to providing legal insight to our clients and colleagues. If you have any questions about or would like to discuss these topics further, please contact your Foley attorney or any of the following individuals:


Terry D. Nelson
Madison, Wisconsin

Peter D. Fetzer
Milwaukee, Wisconsin

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