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Investment Management Regulation, Fourth Edition

Investment companies have become an important part of the financial system. This case book is designed to familiarize students with the special laws governing investment companies: their creation, structure, corporate governance, operations (including the distribution of shares and the management of the portfolios), dissolution and, time permitting, taxation. The case book focuses on the Investment Company Act of 1940 and on the practice in this area before the Securities and Exchange Commission.

Chapter 1, The Financial System

Chapter 2, The Investment Advisers Act

Chapter 3, What is an Investment Company?

Chapter 4, Companies Excluded from the Definition of an Investment Company and the Investment Company Act

Chapter 5, Obligations of Financial Institutions That Do Not Fall Squarely under the 1940 Act

Chapter 6, Registration and Disclosure

Chapter 7, Fund Management: The Advisory Function, Fees and Contract Terms

Chapter 8, Corporate Governance: Fund Directors and Shareholder Voting

Chapter 9, Capital Structure

Chapter 10, The Investment Company as Investor

Chapter 11, Distribution of Investment Company Shares

Chapter 12, Protection Against Conflicts of Interests

Chapter 13, Money Market Funds

Chapter 14, Unit Investment Trusts

Chapter 15, Closed-End Investment Companies

Chapter 16, Variable Insurance Products

Chapter 17, Ethics Issues

 

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Chapter 1, The Financial System

The Nature of the Financial System and the Place of Investment Companies and Investment Advisers in the System ; The Financial System; Benefits and Disadvantages to the Economy: Liquidity and Volatility; Risks for the Financial System and the Economy; The Investment Management Profession; Glance at History; The Variety of Financial Services; Investment Theories; The On-Going Problems Managers Pose for Investors, the Markets, and the Economy; The Regulators’ Study of the 1920s Investment Management; Congressional Response: the Investment Company Act of 1940; The Responses of the Markets to the Problems Posed by Investment Companies. How did the Investment Companies Structures Reflect the Investors’ Choices? What was the Congressional Reaction?; The Pattern of Investment Management Regulation; Federal Statutes: The Investment Company Act and the Investment Advisers Act; The Substance of the Regulation; Exemptive Authority, General and Particular. Procedures Applicable to Requests for Exemptions. Sections 6(c), (e) and Sections 6(b), (d), 9(c), 10(f), 17(b), 23(c)(3); No-Action Letters. Procedures Applicable to Requests for No-Action and Interpretive Letters; Rulemaking; Enforcement Authority; Other Laws Applicable to Investment Management; State Laws; Tax; Self Regulatory Organizations (SROs)

Chapter 2, The Investment Advisers Act

History, Outline, and Definition of Advisers; History and Outline; The Basic Definition: Who is an Adviser?; The Exclusion of Publishers from the Definition of an Investment Adviser; The Publisher’s Exclusion; The Exclusion of Broker-Dealers from the Definition of an Investment Adviser; The Status of Broker-Dealers under the Advisers Act; Broker-Dealers’ Changing Practices and the Legal Developments; The Investor Protection Act of 2009; The Congressional Mandate; Who Are Fiduciaries?; The Approach of the Labor Department Regulating ERISA; The Relationship Between Federal and State Law; Dividing the Burden of Enforcement; Fiduciary Duties of Advisers under State and Federal Law; Section 206 of the Advisers Act. The Anti-Fraud Provision; Fiduciary Law Principles Relating to Sales of Investment Companies’ Shares – the “give ups”; Registration and Disclosure Requirements; The Registration Forms; Form ADV; The Information Items; Regulation of Advisers; Referrals and Advertising; Referrals; Advertising; Testimonials; Past Specific Recommendations; Automatic Selection Devices; Catch-all Category; Fees; Limitation on Performance Fees; Advisers-brokers’ Relationship. Regulation of “Soft Dollars.” Section 28(e), Securities Exchange Act of 1934; The Advisers’ Interests and Incentives; The Interests of Broker-Dealers; Family Offices; The Evolution of “Research” under Section 28(e); Principal and Agency Transactions; Duty to Supervise; The Requirement for a Code of Ethics; The Duty to a Adopt a Code of Ethics; Advisory Services to State and Local Governments. Lobbying; Political Contributions by Certain Investment Advisers;  Compliance Officers

Chapter 3, What is an Investment Company?

Introduction to the Basic Definition; Who is an Issuer?; Who is a Person? What is a Company?; What is a Security?; What is an Investment Contract?; Viatical Settlements and Life Settlements; The Classification of Notes; Wrap-Around arrangements. When do Contract Relationships Turn into a Security?; The Distinction Between a Security and Advisory and Information Services; Definition of Investment Company by the Nature of Its Business and by the Nature of Its Assets. Section 3(a)(1)(A); Section 3(a)(1)(C) and Section 3(b); The Slippery Area between Operating a Business and the Service of Investment Management; When Does an Operating Company Become an Investment Company?; Excluding Operating Companies whose Assets may be Investment Securities

Chapter 4, Companies Excluded from the Definition of an Investment Company and the Investment Company Act

Introduction; Exceptions for Operating Companies; Section 3(b); Operating Companies that have Financial Assets; SEC rules; Venture Capital Companies and Business Development Companies. Sections 2(a)(48), 54-63; Private Investment Companies; Section 3(c)(1); Section 3(c)(7); Hedge Funds; Banks and Savings and Loan Associations. Section 3(c)(3); Insurance Companies. Section 3(c)(3); Financing, Factoring, and Real Estate Companies. Section 3(c)(5); Charitable Corporations. Section 3(c)(10); Pension Plans. Section 3(c)(11)

Chapter 5, Obligations of Financial Institutions That Do Not Fall Squarely under the 1940 Act

Pools That Are Used to Securitize Financial Assets; Introduction; Pooling; Highlights of Securitization; Benefits and Disadvantages, Winners and Losers; The Status of SPVs. Exclusion from the Applicability of the Investment Company Act; Offshore Funds; Commodity Pools; Exemptions from Regulation

Chapter 6, Registration and Disclosure

Registration Under the Investment Company Act; Registering the Investment Company?; Disclosure: The Prospectus and the Statement of Additional Information; The prospectus and the Statement of Additional Information; Efforts to Enhance the Effectiveness of Prospectus Disclosure; Prospectus Simplification and the Profile Prospectus; Improving Risk Disclosure Update.; Electronic Delivery of Disclosure; Prospectus Updates; Liability for a Misleading Prospectus; The Relationship Between the Prospectus and the SAI; Advertising; Background; Performance Advertising; Incoming Request to SEC Staff; A Bit of History; An Example of Wrongful Advertising; Changes in Advertising Rules and Shareholder Reports; History; Transaction Costs and Soft Dollars; Abusive Trading Practices; Privacy of Consumer Financial Information and Use of Consumer Financial Information in Marketing Solicitation;

Chapter 7, Fund Management: The Advisory Function, Fees and Contract Terms

Introduction; The Business of the Advisers to Investment Companies; Structuring Advisory Services; External and Internal Advisory Services; The Sub-Advisory Relationship; Regulatory Response to the Potential Conflicts of Interest Posed by the Determination of the Adviser’s Fees; The Advisory Contract, Section 15.

Chapter 8, Corporate Governance: Fund Directors and Shareholder Voting

Introduction; Popular Forms of Organization Under State Law; The Following is a Description of the Delaware Business Trust Act.; Investment Company Act Regulation of Corporate Structure. Sections 2(a)(19), 10, 16, 36(a); The Additional Provisions Imposed by the Investment Company Act; Relationship Between State Law and the Investment Company Act; Composition of the Board. Section 10(a); Section 10(a) of the Investment Company Act of 1940 and the SEC’s Structural Changes; The Issue of High Compensation and Directors’ Independence; The Role of the Board; Shareholder Voting; Proposals for Reform of Corporate Governance Model

Chapter 9, Capital Structure

Issuance of Stock. Redeemability Sections 2(a)(32), 22(c), 22(e). Rule 22c-1; 333; Definition of Redeemability; Pricing Redeemable Shares; Valuation; Valuation under the Investment Company Act; Establishing the Net Asset Value (NAV); SEC’s Reaction to Market Timing; Payment of Redemptions. Section 22(e);  Issuance of Senior Securities (e.g., Bonds). Section 18 of the Investment Company Act; ; Application of Section 18; Use of Borrowed Money Leverage; Structural Issues Involving Different Versions of the Same Fund; Leveraged Investments and Derivatives; Derivatives; The Study of Derivatives; Derivative’ Investments by Investment Companies; The ABA Task Force on Investment Company Use of Derivatives and Leverage.; Dealing Effectively with Derivatives

Chapter 10, The Investment Company as Investor

Introduction; Restrictions on Investments of Investment Companies. Section 12; Investments in Broker-Dealers, Underwriters, and Advisers; Section 12(d)(3); The Commission’s Staff Approach; Investments in Insurance Companies. Section 12(d)(2); Investments in Other Investment Companies. Section 12(d)(1); The Nature and Rationale of Restricting Investments in Other Investment Companies; Hub and Spoke funds of funds; The Regulation of Investment Companies as Investors in Their Own Portfolios?; Diversification; Diversification under the Investment Company Act; Diversification under the Internal Revenue Act; Investment Policies and Industry Concentration; The Role of the Investment Company in the Portfolio Company’s Board Room; The Arguments for Involvement of Investment Companies’ Advisers; Voting on Behalf of Investment Companies but Keeping the Record Secret; Custody of Investment Company Assets. Section 17(f); Regulation of Custodians; Foreign Custodians. Rule 17f-5; Bonding of Persons Having Access to Investment Company Assets; Personal Investment Activities of Investment Company Personnel. Section 17(j); Portfolio Managers’ Access to Information

Chapter 11, Distribution of Investment Company Shares

Regulation of Sales Loads; Different Methods of Paying for Distribution; The Forms of Payments; Financing Distribution Using Fund Assets; What “sells” Investment Company Shares?; Who Should Bear the Distribution Costs? How Should the Costs be Divided?; Sales by Fund Supermarkets; The Role of Brokers as Sellers of Fund Shares and as Executors of Fund Trading Activities. Rule 12b-1; Retail Price Maintenance; Buying Mutual Fund Shares on Margin; Exchanging Investment Company Shares

Chapter 12, Protection Against Conflicts of Interests

Introduction; The Nature of Conflicts and the Structure of Fiduciary Law; What are Conflicts of Interest and How are they Resolved?; How is Fiduciary Law Structured?; The Investment Company Act; Section 17 of the Investment Company Act of 1940; The Reach of Section 17(a); Exemptions from Section 17(a); Developments; The SEC’s Self Limitations on the Use of Exemptive Relief; Conflict of Interest in Joint Transactions. Section 17(d) and Rule 17d-1; The Reach of Section 17(e); The Evolving Exemptions; Conflict of Interest in Agency Transactions. Section 17(e);  Treatment of Brokers and Underwriters under Section 17(e); Duties and Relationships with Auditors; Conflict of Interest by Underwriters. Section 10(f); Protecting Investment Companies from “Dumping”; Exemptions under Section 10(f)(3). Rule 10f-3; Conclusion

Chapter 13, Money Market Funds

The History of Money Market Funds; Regulatory Framework. Rule 2a-7; Introduction; Money Market Fund Investments in Derivatives

Chapter 14, Unit Investment Trusts

Introduction; Organization of Unit Investment Trusts; Registration of UITs; Governance of UITs; History of UITs and Distribution of Their Units; The Main Actors; Sponsors-Depositors; Trustees; Underwriters; Evaluators; Regulation of UITs; Charges to UITs; Protection of UITs’ Assets; Orphan UITs; Substitution of UITs’ Assets; Affiliated Transactions; Minimum Size of UITs; Switching of UIT Units; Distribution of UITs’ Securities; Dividend Distributions; 1940 Act Regulation Which Does Not Apply to UITs

Chapter 15, Closed-End Investment Companies

Use and Nature of Closed-End Investment Companies; Distribution of Closed-End Fund Shares. The Puzzle of Closed-End Investment Companies: Their Shares Sell at a Discount from Their Net Asset Value; Proposed Solutions to the Discount Problem; Interval Funds; Conversion into Open End Companies; Repurchase of Closed End Fund Shares; Capital Structure of Closed-End Investment Companies; Exchange-Traded Funds—ETFs

Chapter 16, Variable Insurance Products

The History and Structure of Variable Insurance Products; The Status of Variable Financial Instruments as Securities; The Status of “Mixed” Contracts as Securities; The Status of Separate Accounts as Investment Companies; 1940 Act Regulation of Variable Financial Instruments; Variable Annuities and Section 27 of the Investment Company Act of 1940 Sales Charges of Periodic Payment Plans

Chapter 17, Ethics Issues

The Investment Management Profession; Introduction; The Altman case.; The Monson and Rasch Cases Indicating Possible Rule 102(e) Applicability.; FINRA Rule 2010: Conduct Inconsistent with Just and Equitable Principles of Trade. The Heath case.; Responsibility of Lawyers to Disclose Clients’ Misdeeds; In-House Counsel; Behavior of Lawyers Engaged in Occupations Other than Lawyering; Investment Managers’ Ethical Issues; Investment by Portfolio Managers; “Social Investing”; Relation to Two or More Clients; Issues Regarding Fund Directors; Epilogue; Table of Statutes and Regulations

Tamar Frankel

Photo of Tamar FrankelTamar Frankel is a Michaels Faculty Research Scholar, Professor of Law at Boston University, where she has been teaching for over thirty years. She has been a visiting Professor at Harvard Law School and Harvard Business School and has lectured in Japan, Oxford, UK, Switzerland, Malaysia and India. She served as an attorney fellow at the Securities and Exchange Commission and was a Visiting Scholar at the Brookings Institution, Washington D.C.

Her writings include Securitization (2d. ed. 2006), Trust and Honesty, America’s Business Culture at a Crossroad (2006), The Regulation of Money Managers (2d ed. 2001) (with Ann Taylor Schwing), and Investment Management Regulation (3rd. ed. 2005) (with Clifford E. Kirsch). She is the author of numerous articles on corporate governance, Internet governance of names and numbers, fiduciary law, and the regulation of investment companies. Her most recent book is Fiduciary Law: The Law of Different Fiduciary Relationships: Definitions, Duties, Remedies Over History and Cultures available from Oxford Press.

Prof. Frankel holds a law degree from the Jerusalem Law Classes in Israel, and an LL.M. and S.J.D. degrees from Harvard Law School.

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