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					                                                                              As of July 10, 2009


                             Filling the Regulatory Gaps -
          An Overview of the Obama Administration’s Securities Law Agenda

        The Obama Administration’s framework for financial regulatory reform includes
several elements which will, if enacted, extend the reach of the Federal securities laws
into areas largely unregulated currently.1 This document briefly describes a number of
items that are expected to be taken up by Congress and/or the SEC in the near term.

Hedge Fund and Adviser Registration

        Background. Currently, most hedge funds, private equity funds and venture
capital funds are not required to register as investment companies with the SEC because
they meet one of the available exceptions from the definition of ―investment company‖ in
the Investment Company Act of 1940.2 As currently operated, most hedge funds and
other private investment funds would find it very difficult to comply with the various
substantive restrictions that would come with registration under the Investment Company
Act, such as limitations on leverage, periodic reporting requirements, independent
director requirements, rules pertaining to the custody of fund assets, and restrictions on
transactions with affiliates. Similarly, most advisers to unregistered investment funds
avoid registration with the SEC under the so-called ―private adviser exemption‖ in the
Investment Advisers Act of 1940, which is available if, among other things, the adviser
has fewer than 15 clients.3 Although some advisers to private investment funds register
voluntarily under the Advisers Act, many would find it undesirable to comply with the

1
  The Administration’s regulatory reform framework was first outlined by Secretary Timothy
Geithner in testimony before the House Financial Services Committee on March 26, 2009, and in
an outline released by the Treasury Department the same day. Then, on June 17, 2009 the
Treasury Department released an 88-page ―white paper‖ with more detailed proposals for reform
of the financial regulatory structure. See U.S. Department of the Treasury, Financial Regulatory
Reform; A New Foundation: Rebuilding Financial Supervision and Regulation (Jun. 17, 2009).
In addition to these statements by the Treasury Department, SEC Chairman Mary Schapiro has
articulated her agenda for rulemaking by the SEC in testimony before the Senate Banking
Committee on March 26, 2009, and in a speech to the Council of Institutional Investors on April
6, 2009. She has provided further details in subsequent public statements.
2
 The two exceptions typically relied upon by such funds are Section 3(c)(1), which generally is
available to funds owned by 100 or fewer investors, and Section 3(c)(7), which generally is
available to funds owned solely by ―qualified purchasers.‖ These exceptions also permit
ownership by certain knowledgeable employees.
3
  The SEC adopted a rule in December 2004 requiring advisers to ―look through‖ their fund
clients to count the fund’s limited partners and other owners as separate clients; however, this rule
was vacated by the D.C. Circuit Court of Appeals in June 2006. Partially in response to this
decision, in July 2007 the SEC adopted Rule 206(4)-8 under the Advisers Act, which prohibits
any investment adviser to a ―pooled investment vehicle‖ from making untrue statements to, or
engaging in fraudulent practices with respect to, any investor or prospective investor in such
pooled investment vehicle. This antifraud rule applies to all investment advisers to pooled
vehicles (whether the adviser is registered with the SEC or not).


DC: 3155198-9
Advisers Act’s recordkeeping requirements, limitations on incentive-based
compensation, and other provisions.

      Treasury’s Proposal. Treasury’s proposal includes the following broad
recommendations:

           Advisers to hedge funds (and other private investment funds such as private
            equity funds and venture capital funds) with assets under management over a
            certain ―modest‖ dollar threshold would be required to register with the SEC
            under the Investment Advisers Act.4

           Registered investment advisers would be required to report information to the
            SEC regarding the funds they manage that is sufficient to enable the
            government to assess whether the fund poses a threat to financial stability.

           All funds advised by an SEC-registered investment adviser would become
            subject to a range of new requirements, including:

                 rules regarding disclosures to fund investors, creditors, and
                  counterparties;

                 recordkeeping requirements; and

                 a requirement to report to the SEC, on a confidential basis, the fund’s
                  assets under management, borrowings, off-balance sheet exposures,
                  and other information necessary to assess whether the fund or fund
                  family is so large, highly leveraged or interconnected that it poses a
                  threat to financial stability.5

           Funds advised by an SEC-registered investment adviser would be subject to
            regular, periodic examinations by the SEC to monitor compliance with the
            foregoing requirements.

           The SEC would share the reports it receives from funds (and, presumably,
            SEC-registered investment advisers) with the Federal Reserve, which would
            use such information to determine whether any fund or fund family meets the


4
  Several trade associations representing hedge funds and other private investment funds,
including the Managed Funds Association and the Alternative Investment Management
Association, have endorsed the Administration’s proposal to require advisers to private
investment funds with assets under management over a certain amount to register under the
Advisers Act.
5
  The Administration’s proposal states that it may be appropriate to tailor some of these
requirements according to the type or category of investment fund; presumably such variations
would be the subject of rulemaking by the SEC.


                                               2
           criteria for designation as a ―Tier 1 Financial Holding Company‖ (Tier 1
           FHC).

          Any fund or fund family meeting the Tier 1 FHC criteria would become
           subject to prudential supervision and regulation by the Federal Reserve. The
           prudential standards for such Tier 1 FHCs would include capital, liquidity,
           and risk management requirements and would be stricter than the
           requirements that apply to regulated banks. Tier 1 FHCs would also be
           subject to a prompt corrective action regime that would require the firm to
           take corrective actions if its regulatory capital levels decline. Further, Tier 1
           FHCs would be subject to the full range of prudential regulations, supervisory
           guidance, and limitations on nonfinancial activities applicable to bank holding
           companies.

          Funds that are Tier 1 FHCs and which experience severe difficulties could be
           subject to the new resolution authority to be vested in the Treasury, pursuant
           to which the fund could be placed into conservatorship or receivership or
           otherwise resolved.

       Pending Legislation. At least two bills have been introduced in Congress this
year addressing the hedge fund registration issue:

          In the Senate, the Hedge Fund Transparency Act would remove the existing
           exceptions to the definition of investment company in Sections 3(c)(1) and
           3(c)(7) of the Investment Company Act, but would exempt from most
           provisions of the Investment Company Act any fund that registers with the
           SEC on a specified form, files a publicly available report disclosing specified
           information (including the identify of its owners), maintains books and
           records to be specified by the SEC, and cooperates with any request for
           information or examination by the SEC. It appears that investment advisers to
           such funds would also be required to register with the SEC under the
           Investment Advisers Act, because they would no longer be able to avail
           themselves of the ―private adviser exemption‖ in such Act.

          In the House, the Hedge Fund Adviser Registration Act would simply delete
           Section 203(b)(3) of the Advisers Act, the so-called ―private adviser
           exemption.‖ As a result, investment advisers with even a single client would
           be required to register with the SEC (absent another available exemption).

        SEC Chairman Schapiro has stated that the SEC is considering asking Congress
for legislation to require some investment advisers who advise private investment funds
to register under the Investment Advisers Act, and/or to require some category of private
investment funds themselves to register under the Investment Company Act in some
manner. As part of such legislation, the SEC could also be given rule-making authority
to impose prudential or other requirements on certain investment funds. To our
knowledge SEC Chairman Schapiro has not commented publicly on the portions of the


                                             3
Administration’s white paper specifically addressing private investment funds and
investment advisers, so it is not clear whether the SEC is still considering asking for
legislation to require funds to register with the SEC (in addition to investment advisers).

        Key Issues. The Treasury’s proposal and pending legislative efforts to expand
SEC oversight of investment advisers and funds raise a number of significant issues for
affected firms, including the following −

          The dollar threshold that would trigger SEC registration, and whether (and
           how) the legislation will deal with the issue of aggregating individual funds
           (anti-avoidance provisions).

          The precise scope and frequency of the information that will be required to be
           provided to the SEC by registered investment advisers, and whether it exceeds
           the scope and frequency of information currently required to be reported by
           registered advisers under the Investment Advisers Act.

          The nature and content of disclosures that funds will be required to make to
           their investors, counterparties and creditors.

          How the legislation will address privacy concerns regarding the identities of
           fund investors, and, more broadly, whether confidential submissions will be
           subject to discovery through the Freedom of Information Act process.

          The precise scope and frequency of the information required to be provided to
           the SEC by investment funds regarding their assets under management,
           leverage, off-balance sheet exposures, and other information.

          Whether the disclosure and reporting requirements for funds will vary
           according to the nature of the fund’s business or the type of fund (e.g., hedge
           fund, private equity fund, venture capital fund).

          Beyond the disclosure and reporting requirements noted above, the scope of
           any other regulation by the SEC over investment funds advised by an SEC-
           registered investment adviser, including whether such funds would be subject
           to any of the substantive restrictions under the Investment Company Act such
           as limitations on leverage, periodic public reporting requirements, limitations
           on affiliate transactions, and restrictions on compensation to fund advisers.

          For funds-of-funds/secondary funds, whether the legislation will impose any
           limitations on the ability of SEC-registered funds to invest in other SEC-
           registered funds (anti-layering provisions).

          The specific factors or criteria that the Federal Reserve will consider in
           determining whether a hedge fund or other private investment fund should be



                                             4
            designated as a ―Tier 1 FHC‖ because its failure could pose a threat to
            financial stability, including:

             whether there will be any exceptions in the legislation (or adopted by
              rulemaking) pursuant to which specific categories of firms would be
              excluded from designation as a Tier 1 FHC due to the nature of their
              business or other attributes, such as, for example, the fund’s potential for
              (i) systemic risk (based on equity and/or leverage characteristics), (ii)
              trading or liquidity risk (length of period before fund permits
              redemptions),6 and/or (iii) consumer harm (fund investor suitability
              requirements);

             whether the legislation or guidance provided by the Federal Reserve will
              identify specific criteria or factors that would operate as a ―safe harbor‖
              from designation as a Tier 1 FHC;

             whether firms will be given advance notice of the Federal Reserve’s intent
              to designate the firm as a Tier 1 FHC and a meaningful opportunity to take
              corrective action;

             whether firms will be able to seek advisory opinions from the Federal
              Reserve confirming the firm’s status as a non-Tier 1 FHC;

             whether firms will have any opportunities to contest the Federal Reserve’s
              designation of the firm as a Tier 1 FHC; and

             the circumstances under which a firm previously designated as a Tier 1
              FHC could exit such status.

           For any fund designated as a Tier 1 FHC, the extent to which the Federal
            Reserve will have the power to impose individually tailored requirements in
            areas such as capital, liquidity, leverage, executive compensation, and risk-
            management, and the extent to which funds will have an opportunity to
            challenge or negotiate the scope of such requirements.

           For any fund designated as a Tier 1 FHC, how the fund will alter its business
            and operations to comply with the requirements of the Bank Holding
            Company Act, including its limitations on nonfinancial activities.

           The scope of the Fed’s authority to enforce substantive requirements it
            imposes on funds designated as Tier 1 FHCs.


6
  The SEC has previously drawn such distinctions - its 2004 rule (which was later overturned on
other bases) exempted from Advisers Act registration any adviser to a fund that did not permit its
investors to redeem for at least two years from the date of their investment.


                                                5
           How the cost of the new systemic resolution process will be assessed against
            firms subject to its reach, including whether there will be new FDIC-style
            assessments on some universe of firms and, if so, how such assessments will
            be apportioned.

           The extent to which federal regulators, in exercise of systemic risk resolution
            authority, will be allowed to resolve the claims of creditors and other
            claimants − and how.

Credit Default Swaps and Other OTC Derivatives

        Background. There is currently little Federal regulation of trading, settlement
and clearing of over-the-counter derivatives, including credit default swaps (CDSs).
Although market participants have voluntarily adopted protocols governing certain
trading activities, these have not always been followed and they lack the force of law.7 In
the absence of regulation, some believe that institutions trading in CDSs have not had
sufficient information about the CDSs or the downside risks involved. Further, many
contend that, in the absence of a central counterparty to clear trades, participants in the
CDS market have not been able to adequately manage the counterparty risks associated
with CDSs. Regulators have also been concerned that the absence of a central
clearinghouse shrouds the CDS market in secrecy, making it impossible for regulators to
gauge systemic and other risks posed by the market. Transparency for regulators would
be enhanced if more trades in CDSs were centrally cleared.8

        In recent months, the SEC has taken a number of steps toward the establishment
of a central counterparty for CDSs.9 In November 2008, the SEC signed a Memorandum
of Understanding with the Federal Reserve and the Commodity Futures Trading
Commission (CFTC) to establish a framework for consultation and information sharing
on issues related to CDS central counterparties. Since December 2008, the SEC has
published orders granting conditional exemptions under the Exchange Act, and issued
interim final temporary rules under the Securities Act and the Exchange Act, to facilitate

7
  The International Swaps and Derivatives Association (ISDA) recently announced the
implementation of a supplemental protocol (the so-called ―Big Bang Protocol‖) to its standard
documentation, in order to provide a binding and uniform method of determining (i) whether
credit events under credit default swaps have occurred, and (ii) the close out of such trades upon
the occurrence of a credit event.
8
  This was most evident in the market for CDSs written on asset-backed securities - as the value
of the asset-backed securities fell, some firms that wrote CDSs on such securities experienced
difficulty posting the necessary collateral to cover their obligations to pay their CDS
counterparties.
9
  In taking these actions, the SEC posits that a central counterparty will allow participants in the
CDS market to avoid credit exposure to individual counterparties. The central counterparty,
capitalized by its members and with the authority to impose margin requirements, will novate
bilateral trades by entering into separate contractual arrangements with both counterparties -
becoming buyer to one and seller to the other - thereby assuming the counterparty credit risk.


                                                  6
the establishment of central counterparties for CDSs.10 However, under current law the
SEC’s ability to regulate the CDS market is circumscribed by its lack of statutory
authority over ―swap agreements‖ (as defined in Section 206A of the Gramm-Leach-
Bliley Act). CDSs that meet the ―swap‖ definition, which is quite broad, are therefore
outside the scope of the SEC’s exemptive orders and rules other than the SEC’s antifraud
provisions. We expect this gap in oversight to be addressed by legislation.11

        Treasury Proposal. On May 13, 2009, Treasury released a statement outlining its
proposed framework for regulating OTC derivatives. This proposal was then repeated in
the Treasury white paper on regulatory reform released on June 17, 2009. The stated
objectives of the proposal are to prevent activities in the OTC derivatives markets from
posing systemic financial risks, bring greater transparency to these markets, prevent
market manipulation and fraud, and protect unsophisticated parties to whom OTC
derivatives may be marketed.

        More specifically, the Treasury proposal provides that:

           The Commodity Exchange Act and the federal securities laws would be
            amended to require that all ―standardized‖ OTC derivatives be cleared through
            regulated central counterparties (CCPs), which will be required to impose
            robust margin requirements on counterparties and other risk controls to ensure
            that customized OTC derivatives are not used solely to avoid using a CCP.12

           All OTC derivatives dealers, and all other firms whose activities create large
            exposures to counterparties, would be subject to a robust regime of prudential
            supervision and regulation, including capital requirements (more conservative
            than existing bank regulatory capital requirements for OTC derivatives),

10
   See Rel. No. 34-59165 (Dec. 24, 2008) (order granting temporary exemptions from Sections 5
and 6 of the Exchange Act); Rel. No. 34-59164 (Dec. 24, 2008) (order granting temporary
exemptions under the Exchange Act to LCH.Clearnet Ltd.); Rel. No. 33-8999 (Jan. 14, 2009)
(interim final temporary rules providing exemptions under the Securities Act, Exchange Act and
Trust Indenture Act for eligible CDS); Rel. No. 34-59527 (Mar. 6, 2009) (order granting
temporary exemptions under the Exchange Act to ICE US Trust LLC); Rel. No. 34-59578 (Mar.
13, 2009) (order granting temporary exemptions under the Exchange Act to Chicago Mercantile
Exchange Inc. and Citadel Investment Group, L.L.C.).
11
   See the discussion below of SEC Chairman Schapiro’s recent testimony outlining a proposed
allocation of jurisdiction between the SEC and CFTC for oversight of the OTC derivatives
markets.
12
   The Managed Funds Association, which represents hedge funds, has proposed that
―standardization‖ of OTC derivatives be defined as requiring (i) common product
terms/definitions (e.g., published ISDA product definitions), (ii) common specifications (e.g., T-
30 effective date, 100/500 coupon, etc.), (iii) common trading/market conventions (e.g., novation
protocol, auctions), and (iv) eligibility for clearing on an ―established‖ clearinghouse, which
would be a CCP that includes initial margin segregation, customer position portability, and direct
and indirect buy-side customer access.


                                                7
            business conduct standards, reporting requirements, and conservative margin
            requirements.

           The CFTC and/or SEC should be given authority to impose recordkeeping and
            reporting requirements on all OTC derivatives which could be satisfied by
            clearing standardized transactions through a CCP or reporting customized
            transactions to a regulated trade repository.

           To improve market efficiency and price transparency, the SEC and/or CFTC
            should require that standardized parts of the OTC derivatives markets be
            moved onto regulated exchanges and regulated transparent electronic trade
            execution systems, and that a system for the timely reporting of trades and
            prompt dissemination of prices and other trade information be developed.

           The Commodity Exchange Act and the federal securities laws should be
            amended as may be necessary to ensure that the CFTC and the SEC have clear
            authority to police and prevent fraud, market manipulation and other market
            abuses involving OTC derivatives.

           The SEC and the CFTC should make recommendations to Congress, by
            September 30, 2009, regarding changes to applicable law and regulations that
            would harmonize regulation of futures and securities, at least in the case of
            instruments that have similar characteristics or are economically equivalent
            (e.g., an option on a security and a futures contract on the same underlying
            security).

        SEC Chairman’s Proposal to Allocate Jurisdiction Over OTC Derivatives. In
testimony before the House Subcommittee on Securities, Insurance and Investment on
June 22, 2009, SEC Chairman Schapiro outlined an approach for allocating jurisdiction
for oversight of the OTC derivatives markets between the SEC and CFTC. Chairman
Schapiro’s proposed approach would give primary responsibility to the SEC for
regulating all ―securities-related‖ OTC derivatives (including CDSs), and the CFTC
would be primarily responsible for regulating all other OTC derivatives. An OTC
derivative would be classified as ―securities-related‖ if it references an issuer of
securities, a security itself (or a related event such as a dividend payment or default), a
group or index of securities or issuers, or related aspects of a security or index such as
price, yield, volatility, dividend payments or value. Non-securities-related OTC
derivatives would include those related to interest rates, foreign exchange, commodities,
energy, and metals.13 Chairman Schapiro’s testimony also outlined in very broad strokes
some of the elements of substantive regulation of securities-related OTC derivatives that
she is apparently considering, including recordkeeping, reporting and business conduct
standards for dealers in OTC derivatives, disclosure requirements to counterparties,

13
  In testimony at the same hearing, CFTC Chairman Gary Gensler concurred with SEC
Chairman Schapiro’s approach for allocating jurisdiction for oversight of the OTC derivatives
markets.


                                               8
beneficial ownership reporting, capital requirements for OTC derivatives dealers, and
enhanced regulation of trading markets and clearing organizations handling transactions
in OTC derivatives.

        Industry Voluntary Commitments. On June 2, 2009, a group of dealers and buy-
side institutions, together with certain trade groups including ISDA and the Managed
Funds Association, sent a letter to the Federal Reserve Bank of New York and other U.S.
and international financial regulatory bodies, outlining a framework of voluntary
commitments to strengthen the risk management and processing infrastructure of the
markets for OTC credit, interest rate, and equity derivatives markets. These
commitments would be implemented under the auspices of the ISDA Board Oversight
Committee and its constituents. Presumably the industry participants that signed the
letter would contend that these voluntary commitments obviate the need for at least some
of the new regulation being considered. This framework includes the following series of
voluntary commitments:

          Trade repositories. All trades in OTC derivatives that are not cleared through
           a CCP will be recorded in centralized trade repositories. More specifically,
           the following categories of OTC derivative trades not cleared through a CCP
           will be recorded in a centralized trade repository by the date indicated: (i) for
           trades in CDSs, by July 17, 2009; (ii) for trades in interest rate derivatives, by
           December 31, 2009; and (iii) for trades in OTC equity derivatives, by July 31,
           2010.

          Expanded use of CCPs. The range of ―standardized‖ OTC derivatives
           products that are cleared through CCPs should continue to be expanded. (In
           2009, the categories of OTC derivatives that will be added to the list of
           products cleared through CCPs includes liquid single name CDS and
           Overnight Indexed Swaps (OIS). The industry signatories will work with
           regulators to deliver a set of performance targets for products cleared through
           CCPs by August 31, 2009.

          Customer access to CDS clearing. Buy-side customers should have access to
           CCP clearing of CDSs (via either direct membership in a CCP or indirect
           access through a dealer that is a CCP member) by December 31, 2009. This
           access to CCP clearing would include customer initial margin segregation and
           portability of customer transactions. Dealer signatories who ordinarily
           provide customer clearing services will agree to provide CDS clearing
           services for their customers through CCPs that have (i) broad buy-side and
           dealer support and (ii) a commitment to develop viable direct and indirect
           buy-side clearing models.

          Enhanced collateral management. By June 30, 2009, all dealer signatories
           will be performing daily electronic portfolio reconciliation of all OTC inter-
           dealer derivative transactions that are collateralized. Signatories will also



                                             9
            work to have a market-wide solution for improved resolution of disputed
            margin calls by September 30, 2009.

           Enhanced industry governance. Industry trade groups will work to effect
            changes in the composition, rules, and procedures of relevant industry
            committees, to better incorporate the views of all market participants,
            including both buy-side and sell-side participants. The views of the buy-side
            participants will be represented by SIFMA and the Managed Funds
            Association.

           Continued operational improvements. Industry signatories will continue to
            focus on four key operational improvements: (i) working toward an end goal
            of T+0 confirmation; (ii) increased electronic processing across asset classes;
            (iii) increased standardization of confirmation documentation; and (iv)
            continued focus on aged confirmation reduction targets.

         Recent Legislative Activity. Legislation has been introduced in both houses of
Congress to address the perceived regulatory gap in oversight of the CDS market. Much
of this legislative activity has occurred in the House and Senate Agriculture committees,
which generally have jurisdiction over regulation of commodity futures trading and the
CFTC. The legislation introduced thus far reflects the respective orientation of the
sponsoring members. Legislation introduced in the Agriculture committees in Congress
generally tends to favor the CFTC as primary regulator of CDSs, whereas legislation
introduced in the House Financial Services Committee or the Senate Banking Committee
tends to give primacy to the SEC in this area.

        In the House, the Agriculture Committee passed the Derivatives Markets
Transparency and Accountability Act in February 2009. This act would generally require
OTC derivatives transactions to be settled and cleared through a CFTC-regulated
derivative clearing organization, although OTC transactions in ―excluded commodities‖
(for example, interest rates, exchange rates, currencies, securities, security indices, credit
risks, and other similar financial instruments or measures) could be settled and cleared
through a SEC-regulated clearing agency.14

        Also in the House, the American Clean Energy and Security Act (H.R. 2454)
would generally prohibit so-called ―naked‖ CDSs, i.e., CDSs in which at least one of the
contracting parties does not own a credit instrument insured by the CDS or would not
experience financial loss if an event that is the subject of the CDS occurs with respect to
the credit instrument. The act would also impose minimum capital adequacy standards
on parties transacting in CDSs.



14
  The House bill would specifically prohibit the Federal Reserve from establishing rules
regarding the clearing of OTC derivatives transactions, and would grant the CFTC authority to
suspend trading in CDSs with the concurrence of the President.


                                              10
       In the Senate, the Derivatives Trading Integrity Act takes a different approach,
and would generally treat all swap transactions, including CDSs, as futures contracts,
with the result that all such swaps would be required to be traded on a CFTC-regulated
exchange.15 Also in the Senate, the Authorizing the Regulation of Swaps Act would
remove all current exemptions in the Commodity Exchange Act and the federal securities
laws for OTC derivatives. However, this legislation leaves many unanswered questions,
such as which Federal regulatory agency would have primary authority to regulate the
OTC derivatives market.

Money Market Mutual Funds

        In the wake of the Lehman Brothers bankruptcy, at least one prime money market
mutual fund experienced a decline in its normally constant $1.00 net asset value. This
sparked sharp withdrawals across the money market fund industry, which resulted in
severe liquidity pressures throughout the entire financial system and led to the provision
of a temporary Federal government guarantee of money market funds.

       Treasury Proposal. Treasury’s white paper recommends that the SEC consider
new rules to:

             require money market funds to maintain substantial liquidity buffers;

             reduce the maximum weighted average maturity of money market fund assets;

             tighten credit concentration limits for money market funds;

             improve the credit risk analysis and management of money market funds; and

             permit money market funds to suspend redemptions in extraordinary
              circumstances to protect fund shareholders.


       SEC Actions. At an open meeting on June 24, 2009, the SEC voted to propose
rule amendments to strengthen the regulatory framework for money market funds.16 The
proposals include the following elements:

             Money market funds would be prohibited from purchasing illiquid securities,
              and funds would be required to have a minimum percentage of their assets in
              highly liquid securities. Specifically:
15
   The Senate bill would amend the Commodity Exchange Act to eliminate ―excluded‖ and
―exempt‖ commodities and transactions so that all commodities and transactions of the same
nature would be treated the same. The bill would also eliminate the statutory exclusion of swap
transactions and end the CFTC’s authority to exempt swap transactions from the general
requirement that futures contracts trade on a regulated exchange.
16
     Rel. No. IC-28807 (Jun. 30, 2009). Comments are due September 8, 2009.


                                               11
     For retail money market funds at least 5% of assets must be in cash, U.S.
      Treasury securities, or readily convertible into cash (collectively,
      ―liquid‖) within one day, and at least 15% must be liquid within one
      week.

     For institutional money market funds, at least 10% of assets must be
      liquid within one day, and at least 30% must be liquid within one week.

   Average maturity limits for money market funds would be shortened:

     The maximum ―weighted average life‖ maturity of a fund’s portfolio
      would be limited to 120 days (currently there is no such limit).

     The maximum weighted average maturity of a fund’s portfolio would be
      limited to 60 days (currently the limit is 90 days).

   Funds would not be permitted to invest in ―Second Tier‖ securities (currently,
    most funds are permitted to invest up to 5% of their assets in ―Second Tier‖
    securities).

   Fund managers would be required to perform periodic stress tests to examine
    the fund’s ability to maintain a stable net asset value per share in the event of
    shocks such as interest rate changes, higher redemptions, and changes in
    credit quality of the portfolio.

   Funds would be required to hold sufficiently liquid securities to meet
    foreseeable redemptions. In order to meet this requirement, it is expected that
    funds would develop procedures to identify investors whose redemption
    requests may pose risks for funds. As part of these procedures, funds would
    anticipate the likelihood of large redemptions.

   Money market funds would be required each month to post on their Web sites
    their portfolio holdings.

   Funds would be required each month to report to the SEC detailed portfolio
    schedules in a format that could be used to create an interactive database
    through which the SEC could better oversee the activities of money market
    funds. This would replace the current quarterly reporting requirement.

   All money market funds and their administrators would be required to be able
    to process purchases and redemptions electronically at a price other than $1
    per share.




                                      12
           A fund’s board of directors would be permitted to suspend redemptions if the
            fund were to break a buck and decide to liquidate. The fund would be
            required to notify the SEC when it relies on this rule.

           Affiliates of money market funds would have greater flexibility to purchase
            distressed assets from funds in order to protect a fund from losses. Currently,
            an affiliate cannot purchase securities from the fund before a ratings
            downgrade or a default of the securities – unless it receives individual
            approval. The fund would have to notify the SEC when it relies on this rule.

        In addition, the SEC voted to solicit public comment on the following:

           Whether money market funds should be required to sell and redeem shares at
            a floating share price rather than a stable share price (typically $1 per share).

           The role that ratings by credit rating agencies should have in money market
            fund regulation.

           Whether the money market fund rule should be amended with respect to
            investment in asset-backed securities and attendant risks.

Short Sale Rules

        As the credit crisis deepened and the share prices of financial institutions declined
sharply during the second half of 2008, the SEC took a number of actions to restrict short
selling in an effort to stabilize the markets and restore investor confidence.17 These
actions included:

           An emergency order in July 2008 (which expired in August 2008) prohibiting
            naked short selling (i.e., selling securities short that the seller does not borrow
            or arrange to borrow in time to make delivery to the buyer within the standard
            3-day settlement period) in respect of the stocks of 17 financial institutions.

           A further emergency order in September 2008 (which expired in October
            2008) prohibiting any short selling in the securities of 799 companies in the
            financial sector.

           Rules adopted in September 2008 to tighten the requirement to close out a
            short position by the settlement date (i.e., within three trading days of the sale
            date), or purchase or borrow securities to cover a ―fail to deliver‖ by the
            beginning of the next trading day, subject to certain exceptions.


17
   By way of background, in July 2007 the SEC had eliminated all short sale price test
restrictions then in place (i.e., Rule 10a-1 under the Exchange Act, known as the ―uptick‖ rule,
and the NASD’s bid test for certain Nasdaq-listed securities).


                                                13
             Emergency orders (since codified in an interim final temporary rule and
              extended to August 1, 2009) requiring the reporting of short sales to the SEC
              by institutional investment managers in certain circumstances.

             Rule 10b-21 adopted to prohibit fraudulent and deceitful actions by a short
              seller with respect to such seller’s ability or intent to deliver shares to close
              out a short sale.

             Amendments to Regulation SHO to eliminate the options market maker
              exception to the close-out requirements.

       At an open meeting on April 8, 2009, the SEC voted unanimously to propose for
comment two approaches to new short sale price restrictions, one of which includes the
former ―uptick‖ rule.18 The two approaches proposed by the SEC are:

          Market-Wide, Permanent Approach

             Bid Test. This rule would prohibit short sales at or below the national best
              bid. In the proposing release, the SEC indicates that it preliminarily believes
              this test would have advantages over the uptick rule described below.

             Uptick Rule. This rule would prohibit short sales at or below the last quoted
              sale price.

          Security-Specific, Temporary Approach

             Circuit Breaker- ―Stop Trading‖ Rule. All short selling in a stock would be
              banned for the remainder of the trading day if there is a ―severe‖ decline in
              that stock’s price. In the proposing release, the SEC states that it preliminarily
              believes that a 10% decline in a security’s price as measured from the prior
              day’s closing price would be an appropriate level at which to trigger a circuit
              breaker.

             Circuit Breaker-Bid Test. If there is a ―severe‖ decline in a stock’s price, the
              bid test described above would apply to that stock for the remainder of the
              trading day.

             Circuit Breaker-Uptick Rule. If there is a ―severe‖ decline in a stock’s price,
              the uptick rule described above would apply to that stock for the remainder of
              the trading day.

Rating Agencies



18
     The SEC also held a roundtable of experts on short sale regulation on May 6, 2009.


                                                 14
        SEC Actions. In 2007, the SEC adopted forms and rules relating to the
registration of nationally recognized statistical rating organizations (NRSROs), in
accordance with the Credit Rating Agency Reform Act of 2006. In June 2008, the SEC
proposed several new rules relating to NRSROs. In January 2009, the SEC adopted a
portion of the rules originally proposed in June 2008.

        The rules adopted in January 2009 (which generally became effective in April
2009) require an NRSRO to: (i) provide enhanced disclosure of performance
measurements statistics and the procedures and methodologies used by the NRSRO in
determining credit ratings for structured finance products and other debt securities on
Form NRSRO; (ii) make, keep and preserve additional records under Rule 17g-2; (iii)
make publicly available on its web site in XBRL format a random sample of 10% of the
ratings histories of credit ratings paid for by the obligor being rated or by the issuer,
underwriter, or sponsor of the security being rated (―issuer-paid credit ratings‖) in each
class of credit ratings for which it is registered and has issued 500 or more issuer-paid
credit ratings, with each new ratings action to be reflected in such histories no later than
six months after they are taken; and (iv) furnish the SEC with an additional annual report.

          The following rule proposals remain pending at the SEC:

             A new rule that would require NRSROs to distinguish their ratings for
              structured finance products from other classes of credit ratings by publishing a
              report with the rating or using a different rating symbol.19

             A series of amendments to rules under the Exchange Act, Securities Act and
              Investment Company Act that would replace rule and form requirements that
              rely on security ratings (for example, Forms S-3 and F-3 eligibility criteria)
              with alternative requirements. The SEC also requested comment on its rules
              relating to the disclosure of security ratings.20

             Amendments to paragraphs (a) and (b) of Rule 17g-5 (addressing conflicts of
              interest) and paragraph (d) of Rule 17g-2. These amendments would require
              the public disclosure of credit rating histories for all outstanding credit ratings
              issued by an NRSRO on or after June 26, 2007 paid for by the obligor being
              rated or by the issuer, underwriter, or sponsor of the security being rated.
              Further, the amendments would prohibit an NRSRO from issuing a rating for
              a structured finance product paid for by the product’s issuer, sponsor, or
              underwriter unless the information about the product provided to the NRSRO
              to determine the rating and, thereafter, to monitor the rating is made available
              to other persons. In addition, these proposals would amend Regulation FD to
              permit the disclosure of material non-public information to NRSROs
              irrespective of whether they make their ratings publicly available.21
19
     Rel. No. 34-57967 (Jun. 16, 2008).
20
     Rel. No. 34-58071 (Jul. 1, 2008).
21
     Rel. No. 34-59343 (Feb. 2, 2009).


                                                15
       Treasury Proposal. In its June 17, 2009 white paper, Treasury recommended that
regulators reduce their use of credit ratings in regulations and supervisory practices,
where possible. In addition, Treasury urged the SEC to adopt rules requiring credit rating
agencies to:

             maintain robust policies and procedures for managing and disclosing conflicts
              of interest;

             differentiate ratings assigned to structured credit products from those assigned
              to unstructured debt; and

             provide clear public disclosures regarding credit rating performance measures
              for structured credit products, the risks that credit ratings are designed to
              assess, and methodologies used by the agencies for rating structured finance
              products

        Since at least some elements of this proposal have already been implemented by
the SEC in the form of rules adopted in January 2009, it is not clear whether the
Treasury’s proposal envisions enhancement of these rules or something new. However,
SEC Chairman Schapiro has said that the SEC might consider other rule proposals that
would require additional disclosures by rating agencies, including regarding assumptions
underlying methodologies used by the agencies, fees received from issuers, and factors
that could change the agencies’ ratings.22

NYSE Rule 452

        On July 1, 2009, the SEC approved an amendment to NYSE Rule 452 to
eliminate broker discretionary voting in elections of directors (except for registered
investment companies). Under Rule 452, NYSE member brokers holding shares as
nominees on behalf of their customers may vote on ―routine‖ proposals at shareholder
meetings if the beneficial owner of the shares, i.e., the broker’s customer, has not
instructed the broker how to vote the shares within a specified time. For purposes of
Rule 452, a routine proposal is one that is not contested and does not involve a merger or
any other matter which may substantially affect the rights or privileges of the
shareholders. The rule also sets forth a list of specific matters that are considered non-
routine. The amendment approved by the SEC adds the election of directors to this list of
non-routine matters (except for companies registered under the Investment Company Act
of 1940). As a result, in the absence of instruction from beneficial owners, brokers will
no longer be able to vote shares they hold on behalf of such beneficial owners in the
election of directors. This amendment will be applicable to proxy voting for shareholder
meetings held on or after January 1, 2010.

Municipal Securities

22
     A roundtable on possible further rulemaking was held on April 15, 2009.


                                                16
        SEC Chairman Schapiro has said that the SEC is considering whether to seek
legislation to give the SEC authority to regulate municipal securities, in order to give
investors in such securities the same type of disclosure and investor protections as are
provided to investors in other securities. Of course, the SEC already has anti-fraud
authority over municipal securities. The SEC has also re-established the Office of
Municipal Securities within the Division of Trading and Markets, and its new director,
Martha Haines, has been on the lecture circuit suggesting increased SEC activity in this
area.23

Corporate Governance and Disclosure

        Treasury Activities. On June 10, 2009, Treasury Secretary Geithner outlined a set
of principles and two legislative proposals to govern reform of executive compensation
practices. These actions are directed at all public companies, not just those in the
financial sector.

       Broad-Based Principles. The following is an overview of Secretary Geithner’s
broad-based principles to guide public companies in reviewing their executive
compensation practices:

                 Compensation plans should properly measure and award performance.
                  Performance-based compensation should effectively link the incentives of
                  executives and other employees with the company’s long-term value and
                  should be conditioned on a wide range of internal and external metrics, not
                  simply the price of the company’s stock. Compensation should take
                  account of a company’s results relative to its peers.

                 Executive compensation should be structured to account for the time
                  horizon of risks executives are taking for their companies and
                  shareholders. Compensation should be conditioned on long-term
                  performance and tightly aligned with the long-term value and soundness
                  of the company.

                 Compensation practices should be aligned with sound risk management.
                  Compensation committees should conduct and publish risk assessments of
                  individual compensation packages to ensure that the packages do not
                  encourage imprudent risk-taking.

                 Golden parachutes and supplemental retirement packages should be
                  reexamined to determine whether these compensation tools provide
                  incentives to perform or whether they reward executives even if the
                  company’s shareholders lose value.


23
     Ms. Haines testified before the House Financial Services Committee on May 21, 2009.


                                                17
               Transparency and accountability in the executive compensation process
                should be promoted (including through the specific legislative and
                rulemaking proposals summarized below).

       Legislative Proposals. To help promote the principles of transparency and
accountability, the Administration will seek legislation to allow the SEC to enact two
new requirements.

               First, the SEC would be given authority to require non-binding ―say on
                pay‖ shareholder votes for all public companies.24 The proposal appears
                to contemplate separate shareholder votes on executive compensation
                actually paid to the top five executives, and more generally on the
                company’s executive compensation packages and practices as disclosed in
                the proxy statement; however, the precise content of the proposal to be
                voted on will likely be refined through the rulemaking process.
                Shareholders would also have the right to cast a non-binding vote on any
                golden parachute compensation relating to a merger, acquisition, or other
                change of control transaction.25

               Second, the SEC would be directed to promulgate rules, applicable to
                companies listed on national securities exchanges, to (1) require
                compensation committee members to meet independence standards similar
                to audit committee members under the Sarbanes-Oxley Act of 2002,26 (2)
                give compensation committees the authority and funding to retain
                compensation consultants and legal counsel, and (3) provide independence
                standards for compensation consultants and legal counsel to compensation
                committees. It is worth noting that the independence requirement
                represents a relatively minor change from the current regulatory
                landscape, as the listing standards of the national securities exchanges
                already require that executive compensation matters be handled by
                directors deemed independent under the exchange’s independence criteria.
                However, Nasdaq’s listing standards do not mandate the existence of a
                separate compensation committee; query whether these new rules will
                have the effect of requiring all listed companies to have a compensation
                committee.


24
  The SEC is required to adopt ―say on pay‖ rules for entities receiving TARP financial
assistance by February 2010. The SEC proposed such rules on July 1, 2009.
25
  The Shareholder Bill of Rights Act of 2009, described below, includes ―say on pay‖ provisions
substantially similar to those described above.
26
  The audit committee independence rule (Rule 10A-3 under the Securities Exchange Act of
1934) requires, among other things, that audit committee members may not, other than in their
capacity as board members, (i) accept any consulting, advisory, or other compensatory fee from
the company (with very limited exceptions), or (ii) be an affiliated person of the company.


                                               18
       SEC Rulemaking Initiatives. SEC Chairman Schapiro has identified several
rulemaking initiatives in the Division of Corporation Finance. Notably absent from her
comments has been any reference to the International Financial Reporting Standards
(IFRS) roadmap issued for comment in November 2008, and related issues surrounding
convergence of accounting standards.27

             Shareholder access to the proxy. On May 20, 2009, the SEC, by a 3-2 vote,
              proposed rules to give shareholders the opportunity to nominate directors in
              their company’s proxy materials. Under the SEC’s proposal, a shareholder
              meeting specified ownership thresholds (1% for a large accelerated filer, 3%
              for an accelerated filer, 5% for all others) would be entitled to require the
              company to include its nominee(s) in the company’s proxy materials, as long
              as the shareholder has the right to nominate directors under applicable state
              law and the company’s governing documents. Such shareholders would be
              entitled to nominate the greater of one nominee or 25% of the number of
              board seats up for election.

             “Say on pay.” As noted above, on June 10, 2009 Treasury announced it
              would seek legislative authority for the SEC to adopt a rule requiring all
              public companies to allow their shareholders a nonbinding vote on executive
              compensation. As a separate matter, on July 1, 2009, the SEC proposed rules
              to implement shareholder ―say-on-pay‖ rules for institutions that are recipients
              of financial assistance under the TARP.28

             Executive compensation and related disclosure. On July 1, 2009, the SEC
              voted to propose a number of new proxy disclosure requirements regarding
              compensation and other corporate governance topics. These include:

                     The scope of the Compensation Discussion and Analysis (―CD&A‖)
                      accompanying executive compensation disclosure would be broadened
                      such that it would need to address the company’s overall policies and
                      practices for employees generally (including non-executive officers), if
                      the risks arising from such policies and practices could have a material
                      effect on the company.

                     In the Summary Compensation and Director Compensation tables, the
                      value of stock awards and option awards made in a particular year
                      would be presented based on the aggregate grant date fair value of
                      such awards, as determined in accordance with applicable accounting
                      standards, rather than the current approach of showing the


27
   However, the Treasury’s June 17, 2009 white paper does include a recommendation that
accounting standard setters make substantial progress in 2009 toward the development of a single
set of high quality global accounting standards.
28
     Rel. No. 34-60218 (Jul. 1, 2009).


                                               19
                    compensation cost for financial statement reporting purposes during
                    the year of all outstanding awards.

                   Disclosures regarding the qualifications of directors and director
                    nominees, required by Item 401 of Regulation S-K, would be revised
                    to cover the particular experience, qualifications, attributes, or skills
                    that qualify such persons, in light of the company’s business, to serve
                    on the company’s board of directors and on any board committee that
                    such person serves on or is chosen to serve on. This item would also
                    be expanded to require disclosure of (i) other public company
                    directorships held by the director or nominee during the previous five
                    years, and (ii) disclosure of relevant legal proceedings involving the
                    director or nominee during the prior 10, versus the current five,
                    years.29

                   Item 407 of Regulation S-K would be amended to require additional
                    disclosures regarding the company’s leadership structure, including a
                    discussion of why the company’s particular leadership structure is
                    appropriate, whether (and why) the company has chosen to combine or
                    separate the chief executive officer and board chair positions, whether
                    the board of directors has a lead independent director, and the role
                    played by the board in overseeing the company’s risk management.

                   Disclosure regarding compensation consultants would be expanded
                    beyond that already required. This would include:

                        disclosures about any services provided to the company by such
                         consultants or their affiliates in addition to consulting services
                         related to executive or director compensation,

                        whether the engagement of the consultant to provide such other
                         services was recommended or made by management,

                        whether the board of directors or compensation committee
                         approved such other services, and

                        fees paid to such consultants and affiliates for compensation-
                         related services and for all such other services.




29
   The SEC is also soliciting comment on whether it should amend its rules to require disclosure
about whether diversity is a factor a nominating committee considers when selecting someone for
a board position, and whether the SEC should amend other rules to provide for additional or
different disclosures related to diversity.


                                              20
                  Companies would be required to report voting results of shareholder
                   meetings within four business days on Form 8-K.30

       Shareholder Bill of Rights Act. On May 19, 2009, Senators Schumer and
Cantwell introduced the Shareholder Bill of Rights Act of 2009. This bill contains a
laundry list of corporate governance provisions long advocated by institutional
shareholder groups. Specifically, the bill would:

          amend the Exchange Act to require an annual, non-binding shareholder vote
           on executive compensation;

          amend the Exchange Act to require detailed disclosure of golden parachutes in
           proxy statements in connection with business combinations, as well as a
           separate, non-binding shareholder vote on any such arrangements;

          require the SEC to adopt rules enabling shareholder access to the company’s
           proxy statement for the election of directors (which rules shall require, at a
           minimum, a 1% ownership stake held for at least 2 years) (note that the SEC
           proposed shareholder access rules on May 20, 2009); and

          require national securities exchanges to amend their listing standards to
           require (i) an independent chairperson of the Board (and that such chairperson
           shall not have been an executive of the issuer), (ii) annual election of all
           directors (i.e., no classified Boards), (iii) election of directors by majority vote
           (for uncontested elections), with nominees who receive less than a majority
           being required to tender their resignation, and (iv) a Board risk committee
           with oversight of the issuer’s risk management practices.31

Trading & Markets Initiatives

       SEC Actions. SEC Chairman Schapiro has identified the following initiatives in
the Trading & Markets Division:

          Establishment of a new Broker-Dealer Risk Office to focus on broker-dealers
           that are part of a holding company.

          Rulemaking to require that additional information be provided to the SEC to
           assess the risk that an affiliate’s business activities (particularly unregulated
           activities) pose to a broker-dealer.

30
  In addition, the SEC voted on July 1, 2009 to propose a number of amendments to clarify
certain aspects of the proxy solicitation rules.
31
  On June 12, 2009 Representatives Peters, Dingell and others introduced the Shareholder
Empowerment Act of 2009, which covers many of the same topics as the Shareholder Bill of
Rights Act.


                                              21
           Harmonization of broker-dealer and investment adviser obligations, which
            SEC Chairman Schapiro noted may require legislation.

        Treasury Proposal. The Treasury’s June 17, 2009 white paper endorsed the
proposal that broker-dealer and investment adviser regulation be harmonized, and stated
that the SEC should be given new tools to promote fair treatment of investors. The white
paper also recommended that broker-dealers who provide investment advice to customers
should have the same fiduciary obligations under the federal securities laws as registered
investment advisers.32

Investment Management Initiatives

        On May 14, 2009, the SEC proposed amendments to Rule 206(4)-2 under the
Investment Advisers Act to strengthen protection of consumers who have assets held by
registered broker-dealers or investment advisers. Specifically, under the proposed rules:

           all registered advisers with custody of client assets would be required to
            undergo an annual ―surprise exam‖ by an independent public accountant to
            verify those assets exist;

           investment advisers whose client assets are not held or controlled by a firm
            independent of the adviser will be required to obtain a written report —
            prepared by a PCAOB-registered and inspected accountant — that, among
            other things, describes the controls in place, tests the operating effectiveness
            of those controls, and provides the results of those tests;

           advisers would be required to (i) disclose in public filings with the SEC the
            identity of the independent public accountant that performs its ―surprise
            exam,‖ (ii) amend its filings to report if it changes accountants, and (iii) report
            the termination of its engagement with the adviser and, if applicable, any
            problems with the examination that led to the termination of its engagement,
            and if the accountants find any material discrepancies during the surprise
            examination, they would have to report them to the SEC;

           all custodians holding advisory client assets directly would be required to
            deliver custodial statements to advisory clients rather than through the
            investment adviser, and advisers opening custody accounts for clients would
            be required to instruct those clients to compare account statements they
            receive from the custodian with those received from the adviser.



32
   Currently, brokers do not have a fiduciary obligation under federal law, although they may
have some fiduciary duties under state law. Brokers must also comply with the self-regulatory
organizations’ ―suitability‖ rules, which require brokers to know their customers and to have
reasonable grounds for believing that recommended transactions are suitable for such customers.


                                              22
        In addition, it has been reported that the SEC may consider in July proposing
rules to regulate political contributions by registered investment advisers.




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