Private Investment Companies Under Section 3(c)(1) of the Investment Company Act of 1940
Thomas P. Lemke and Gerald T. Lins, 44(2): 401–38 (Feb. 1989)
This Article discusses a topic of recurring interest to securities practitioners: the ability of private investment vehicles to avoid registration and regulation under the Investment Company Act of 1940.
Regulation of Series Investment Companies Under the Investment Company Act of 1940
Joseph R. Fleming, 44(4): 1179–1205 (Aug. 1989)
This Article follows the development of SEC regulation of series investment companies, including particular disclosure practices, and identifies areas that need SEC interpretive guidance or congressional action. By focusing on the rationale underlying SEC interpretations involving series companies, the Article attempts to present an analysis that will assist in discerning how these companies mesh with the framework of the 1940 Act.
Reorganizing Insurance Company Separate Accounts Under Federal Securities Laws
Stephen E. Roth, Susan S. Krawczyk, and David S. Goldstein, 46(2): 537–621 (Feb. 1991)
Insurance company separate accounts are pooled investment vehicles used to fund variable annuity contracts and variable life insurance policies. Recently, consistent with similar developments and trends in the investment industry generally, many insurers have reorganized their separate accounts registered as investment companies under the Investment Company Act of 1940. This Article discusses the nature and structure of these separate accounts and examines the complex issues under the federal securities laws raised by separate account reorganizations.
Organization of a Mutual Fund
Victoria E. Schonfeld and Thomas M. J. Kerwin, 49(1): 107–61 (Nov. 1993)
This Article addresses some of the fundamental legal and business considerations which arise in connection with the organization of an open-end registered investment company, known as a mutual fund. The Article highlights the concerns of the fund's sponsor (usually its investment adviser or distributor) in structuring and distributing the mutual fund. It also addresses issues faced by the fund's directors and officers and the entities that provide management and other services to the fund.
Reorganizations of Investment Companies
Michael L. Sapir and James A Bernstein, 50(3): 817–77 (May 1995)
Over the past decade, the tremendous growth and maturation of the mutual fund industry has been accompanied by considerable consolidation and transactional activity. This Article provides a general overview of investment company reorganizations under federal and state laws and reviews the numerous disclosure requirements and legal and regulatory constraints to which a mutual fund reorganization is subject. The Article is designed to guide the practitioner through the regulatory labyrinth from board consideration to preparation of filing to closing the transaction.
Mutual Fund and Variable Insurance Products Performance Advertising
Clifford E. Kirsch, Wendell M. Faria, and W. Thomas Conner, 50(3): 925–93 (May 1995)
The investment company industry has grown dramatically in recent years. Investment company assets have grown at an annual rate of 23.1%–doubling every four years since 1980–and now stand at $2.4 trillion. Mutual funds, the most popular form of investment company, account for 86% of this $2.4 trillion. Variable annuities and variable life insurance policies have also grown very popular. Advertising by the issuers of these investment companies, their sponsors, and their underwriters has played a crucial role in the growth of these products. These funds face a common problem, namely, that, because they offer similar types of products and services, they must differentiate themselves in order to hold a place in the market. Many funds have attempted to achieve differentiation through performance advertising. The SEC, specifically through rule 432 of the Securities Act, has permitted investment companies to advertise performance data since 1979. Overall, rule 482 has been effective in regulating historical performance data; however, the rule has been less effective in situations when competitive pressures have caused funds to engage in structural changes. This Article presents a detailed analysis of the regulation of mutual fund and variable insurance products advertising, with an emphasis on the regulation of performance advertising.
Fund Director's Guidebook
Task Force on the Fund Director's Guidebook, 52(1): 229–82 (Nov. 1996)
The Guidebook is intended for use by directors of investment companies registered under the Investment Company Act of 1940. It should be useful to directors of both open-end investment companies (typically referred to as mutual funds) and closed-end funds. Inspired in part by the Corporate Director's Guidebook , this Guidebook summarizes or incorporates relevant information from the Corporate Director's Guidebook and supplements that information with specific guidance on matters arising under the 1940 Act and other applicable law. See Committee on Corporate Laws, Corporate Director's Guidebook , 33 BUS. LAW. 1591 (1978); Committee on Corporate Laws, Corporate Director's Guidebook–1994 Edition , 49 BUS. LAW. 1243 (1994).
Mutual Funds, Investment Advisers, and the National Securities Markets Improvement Act
Paul S. Stevens and Craig S. Tyle, 52(2): 419–78 (Feb. 1997)
This Article presents an overview of the recently enacted National Securities Markets Improvement Act, as it affects investment companies and investment advisers. NSMIA amended the Investment Company Act of 1940 and the Investment Advisers Act of 1940 in several important respects and, more significantly, reallocated and rationalized the regulatory responsibilities of federal and state regulators with respect to investment companies and investment advisers. The Article discusses factors that led to the enactment of the legislation, explains its various provisions, and notes interpretive questions that have arisen or are likely to arise under NSMIA.
The Financing of Mutual Fund "B Share" Arrangements
Rochelle Kauffman Plesset and Diane E. Ambler, 52(4): 1385–1429 (Aug. 1997)
This Article explores possible financing arrangements that package cash flow from rule 12b-1 plans and contingent deferred sales loads into assets available for funding front-end commission and related distribution expenses for sales of mutual fund shares.
In Search of the Perfect Mutual Fund Prospectus
Robert A. Robertson, 54(2): 461–532 (Feb. 1999)
The mutual fund prospectus has become profoundly important in the lives of everyday Americans with over one-third of U.S. households investing in funds. In light of the SEC's new rules to simplify fund prospectuses, this Article examines mandatory disclosure theory in the fund context. Then, after analyzing the real world competing forces that must come together to prepare a fund prospectus, the Article sets forth a prototype prospectus that is based upon a proposed theoretical framework and is consistent with real world dynamics.
Roundtable on the Role of Independent Investment Company Directors: Issues for Independent Directors of Bank-Related Funds, Variable Insurance Product Funds, and Closed-End Funds
Diane E. Ambler, 55(1): 205–42 (Nov. 1999)
This Article analyzes the role of independent directors of three specific types of mutual funds: bank-related funds, variable insurance product funds, and closed-end funds. It was originally prepared for presentation at a Roundtable sponsored by the SEC on the role of independent investment company directors, and considers the extent to which legal obligations of mutual fund directors differ in kind or emphasis in the context of these three specific types of funds, which have their own distinct legal and practical issues.
Internet Incubators: How to Invest in the New Economy Without Becoming an Investment Company
Meredith M. Brown, Michael P. Harrell, and William D. Regner, 56(1): 273 (Nov. 2000)
A number of firms have sought to participate in the growth of the new economy by forming "incubators"-organizations that foster startup companies and help them grow into viable businesses. Incubators, which often hold minority equity stakes in the companies they nurture, may find themselves bumping up against the restrictions of the Investment Company Act of 1940. This Article discusses possible methods of organizing and operating an incubation business in a way that avoids becoming an investment company subject to regulation under the Investment Company Act.
The Fiduciary Duties of Institutional Investors in Securities Litigation
Craig C. Martin & Matthew H. Metcalf, 56(4): 1381 (Aug. 2001)
The Private Securities Litigation Reform Act of 1995 was enacted to expand the role of institutional investors in securities litigation in the hopes that such involvement would serve to moderate what were widely perceived as abusive litigation practices in this area. However, these institutional investors must also observe their significant fiduciary obligations under the Employee Retirement Income Security Act. The Article discusses the redefined role of institutional investors in securities litigation in light of both of these pieces of legislation and examines some potential benefits and unique concerns that institutional investors must now consider when a securities fraud claim arises.
Fund Director's Guidebook, Second Edition
Task Force on Fund Director's Guidebook of the Committee on Federal Regulation of Securities, Section of Business Law of the American Bar Association, 59(1): 201-76 (Nov. 2003)
The New Portfolio Society, SEC Mutual Fund Disclosure, and the Public Corporation Model
Henry T. C. Hu, 60(4):1303—1367 (August 2005)
The Securities and Exchange Commission's disclosure philosophy has largely focused on a single model: the publicly held corporation. From its inception, the SEC's disclosure framework for mutual funds has been a relative backwater and based largely on the disclosure framework for publicly held corporations. This situation is untenable. The use of the public corporation model leads to fundamental flaws in the SEC's fund disclosure system. The inherent differences between a public corporation and a mutual fund and the markets for their respective shares are significant and have manifold implications for disclosure. Moreover, the stakes have changed: far more households own stock funds than own stocks. Ours has become a portfolio society, a society in which household investments will largely define retirement well—being. This Article proceeds to outline a new SEC fund disclosure framework. One element in this new framework is the adoption of investor education as a supplemental principle for guiding disclosure requirements; this departure from the disclosure philosophy found in the public corporation context in fact furthers classic SEC regulatory tenets. In addition, the new framework contemplates moving away from the fund—specific focus of the current framework, a carryover from the firm—specific focus of the public corporation model. In most situations, a fund should instead be viewed primarily as the asset class or asset classes in which it invests, coupled with a managerial overlay. The implications of such a reconceptualization are set out in respect of the three key elements that together will largely determine how a typical fund will perform over the long run: asset class returns net of deadweight costs comprehensively defined, asset class risks, and the locus of asset class decisionmaking. The longstanding SEC fund disclosure framework not only has the potential for misleading investors as to risks and returns but can result in the very absence of rational decisionmaking as to the surprisingly important matter of asset class choice. A new fund disclosure framework can play a role in helping a massively unprepared public.
Summary of Mendes Hershman Winning Article: Protecting Mutual Funds from Market Timing Profiteers: Forward Pricing International Fund Shares
David Ward, 61(2):607—608 (February 2006)
Empty Voting and Hidden (Morphable) Ownership: Taxonomy, Implications, and Reforms
Henry T. C. Hu and Bernard Black, 61(3):1011–1070 (May 2006)
Most American publicly held corporations have a one-share, one-vote structure, in which voting power is proportional to economic ownership. This structure gives shareholders economic incentives to exercise their voting power well and helps to legitimate managers' exercise of authority over property the managers do not own. Berle-Means' "separation of ownership and control" suggests that shareholders face large collective action problems in overseeing managers. Even so, mechanisms rooted in the shareholder vote, including proxy fights and takeover bids, constrain managers from straying too far from the goal of shareholder wealth maximization.
In the past few years, the derivatives revolution, hedge fund growth, and other capital market developments have come to threaten this familiar pattern throughout the world. Both outside investors and corporate insiders can now readily decouple economic ownership of shares from voting rights to those shares. This decoupling—which we call "the new vote buying"—is often hidden from public view and is largely untouched by current law and regulation. Hedge funds, sophisticated and largely unfettered by legal rules or conflicts of interest, have been especially aggressive in decoupling. Sometimes they hold more votes than economic ownership, a pattern we call "empty voting." That is, they may have substantial voting power while having limited, zero, or even negative economic ownership. In the extreme situation of negative economic ownership, the empty voter has an incentive to vote in ways that reduce the company's share price. Sometimes hedge funds hold more economic ownership than votes, though often with "morphable" voting rights—the de facto ability to acquire the votes if needed. We call this "hidden (morphable) ownership" because under current disclosure rules, the economic ownership and (de facto) voting ownership are often not disclosed. Corporate insiders, too, can use new vote buying techniques.
This article analyzes the new vote buying and its corporate governance implications. We propose a taxonomy of the new vote buying that unpacks its functional elements. We discuss the implications of decoupling for control contests and other forms of shareholder oversight, and the circumstances in which decoupling could be beneficial or harmful to corporate governance. We also propose a near-term disclosure-based response and sketch longer-term regulatory possibilities. Our disclosure proposal would simplify and partially integrate five existing, inconsistent share-ownership disclosure regimes, and is worth considering independent of its value with respect to decoupling. In the longer term, other responses may be needed; we briefly discuss possible strategies focused on voting rights, voting architecture, and supply and demand forces in the markets on which the new vote buying relies.
Reforming the Regulation of Broker-Dealers and Investment Advisers
Arthur B. Laby, 65(2): 395–440 (February 2010)
A key component of financial regulatory reform is harmonizing the law governing broker-dealers and investment advisers. Historically, brokers charged commissions and were regulated under the Securities Exchange Act of 1934. Advisers charged asset-based fees and were subject to the Investment Advisers Act of 1940, which contains a special exclusion for brokers. In recent years, brokers have changed their compensation structure and many now market themselves as advisers, raising questions about whether they should be treated as such. The Obama Administration's 2009 white paper on regulatory reform and draft legislation call for a fiduciary duty to be imposed on brokers that provide advice. This Article explores the debate over regulating brokers and advisers, and makes four key claims. First, changes in brokers' compensation and marketing methods vitiate application of the broker-dealer exclusion and should subject brokers to the Advisers Act. Second, changes in the nature of brokerage, spurred by changes in technology, make the broker-dealer exclusion unsustainable and Congress should repeal it. The third claim is that imposing fiduciary duties on brokers is incompatible with their historical roles as dealers and underwriters. To resolve this tension, this Article suggests a compromise that enhances brokers' duties but does not hobble their ability to perform their traditional functions. Finally, regulating brokers as advisers would overburden the U.S. Securities and Exchange Commission. This Article offers alternatives to alleviate the strain.
The Uniform Statutory Trust Entity Act: A Review
Thomas E. Rutledge and Ellisa O. Habbart, 65(4): 1055–1104 (August 2010)
The Uniform Statutory Trust Entity Act, the most recent product of the National Conference of Commissioners on Uniform State Laws in the area of business entity legislation, is intended to render uniform the statutory (i.e., "business") trust across the various states. Currently, business trust legislation is widely disparate across the various states, and many of the existing statutes are at best skeletal. This Act has the objective of rendering the business trust more effective as a form of organization by addressing many issues that are typically seen in other business entity laws, while at the same time seeking to minimize both unexpected and, in certain places, undesirable results otherwise dictated by applicable trust law. This Article both reviews the workings of this new uniform act and identifies issues and deficiencies therein.
How Safe Are Institutional Assets in a Custodial Bank’s Insolvency?
Edward H. Klees,68(1): 103 - 136 (November 2012)
It is a widely held belief among institutional investors that custody accounts are protected against a bank's insolvency in the United States. This assumption undergirds trillions of dollars of assets held in custody in U.S. banks. However, despite the 2008 financial crisis, little if any attention has been paid to analyzing whether this belief is, indeed, valid. This article argues that while the FDIC, as receiver of almost all failed banks in the United States, will likely protect custodied assets to the extent permitted by law, clients bear several significant legal and operational risks that could limit recovery of their custodied assets. While investors can protect against some risks, others may be outside their control. The article outlines these risks and proposes ameliorative steps for institutional investors.
Massey Prize for Research in Law, Innovation, and Capital Markets Symposium—Foreword
70(2): 319-320 (Spring 2015)
Financial Innovation and Governance Mechanisms: The Evolution of Decoupling and Transparency
Henry T. C. Hu; 70(2): 347-406 (Spring 2015)
Financial innovation has fundamental implications for the key substantive and information-based mechanisms of corporate governance. “Decoupling” undermines classic understandings of the allocation of voting rights among shareholders (via, e.g., “empty voting”), the control rights of debtholders (via, e.g., “empty crediting” and “hidden interests”/ “hidden non-interests”), and of takeover practices (via, e.g., “morphable ownership” to avoid section 13(d) disclosure and to avoid triggering certain poison pills). Stock-based compensation, the monitoring of managerial performance, the market for corporate control, and other governance mechanisms dependent on a robust informational predicate and market efficiency are undermined by the transparency challenges posed by financial innovation. The basic approach to information that the SEC has always used—the “descriptive mode,” which relies on “intermediary depictions” of objective reality—is manifestly insufficient to capture highly complex objective realities, such as the realities of major banks heavily involved with derivatives. Ironically, the primary governmental response to such transparency challenges—a new system for public disclosure that became effective in 2013, the first since the establishment of the SEC—also creates difficulties. This new parallel public disclosure system, developed by bank regulators and applicable to major financial institutions, is not directed primarily at the familiar transparency ends of investor protection and market efficiency.
As starting points, this Article offers brief overviews of: (1) the analytical framework developed in 2006−2008 for “decoupling” and its calls for reform; and (2) the analytical framework developed in 2012−2014 reconceptualizing “information” in terms of three “modes” and addressing the two parallel disclosure universes.
As to decoupling, the Article proceeds to analyze some key post- 2008 developments (including the status of efforts at reform) and the road ahead. A detailed analysis is offered as to the landmark December 2012 TELUS opinion in the Supreme Court of British Columbia, involving perhaps the most complicated public example of decoupling to date. The Article discusses recent actions on the part of the Delaware judiciary and legislature, the European Union, and bankruptcy courts—and the pressing need for more action by the SEC. At the time the debt decoupling research was introduced, available evidence as to the phenomenon’s significance was limited. This Article helps address that gap.
As to information, the Article begins by outlining the calls for reform associated with the 2012−2014 analytical framework. With revolutionary advances in computer- and web-related technologies, regulators need no longer rely almost exclusively on the descriptive mode rooted in intermediary depictions. Regulators must also begin to systematically deploy the “transfer mode” rooted in “pure information” and the “hybrid mode” rooted in “moderately pure information.” The Article then shows some of the key ways that the new analytical framework can contribute to the SEC’s comprehensive and long-needed new initiative to address “disclosure effectiveness,” including in “depiction-difficult” contexts completely unrelated to financial innovation (e.g., pension disclosures and high technology companies). The Article concludes with a concise version of the analytical framework’s thesis that the new morphology of public information—consisting of two parallel regulatory universes with divergent ends and means—is unsustainable in the long run and involve certain matters that need statutory resolution. However, certain steps involving coordination among the SEC, the Federal Reserve, and others can be taken in the interim.
How Did We Get Here? Dissecting the Hedge Fund Conundrum Through an Institutional Theory Lens
Cary Martin Shelby, 74(3) 735-788 (Summer 2019)
This article dissects both the origins and resulting harms of what the author terms the “hedge fund conundrum,” in which institutional investors, such as pension plans and endowments, have consistently increased hedge fund allocations over the past decade despite pervasive evidence of excessive fees and subpar returns. It then utilizes an historical institutionalist lens to examine how lawmakers may have enabled a conundrum of this magnitude. By and large, this phenomenon is a symptom of regulatory loopholes that have permitted the private hedge fund market to increase in “publicness” through its expanding access and subsequent harm to retail investors. Such investors are now indirectly exposed to hedge funds through pension plans and endowments, without receiving the investor protection guarantees under the federal securities laws. Subsets of historical institutionalism, such as “conversion” and “drift,” provide useful rubrics in analyzing how the law has evolved in this regard. An examination of this nature provides a useful guidepost for exploring well-tailored solutions that concede the unlikelihood of subjecting hedge funds to direct regulation.
Soft Dollars, Hard Choices: Reconciling U.S. and EU Policies on Sell-Side Research
Paul G. Mahoney, 75(3): 2173-2200 (Summer 2020)
Investors use research provided by broker-dealers, also known as sell-side research, to help formulate trading ideas and strategies. Investors normally pay for sell-side research through brokerage commissions. Recent European Union regulations require some institutional investment managers to unbundle, or pay separately for, research and trade execution. Unbundling might subject a U.S. broker-dealer to regulation under the Investment Advisers Act of 1940, significantly affecting the broker’s business practices.
Business Development Companies: Venture Capital for Retail Investors
A. Joseph Warburton, 76(1): 59-108 (Winter 2020-2021)
Business development companies (“BDCs”) offer retail investors the allure of becoming venture capitalists, funding emerging enterprises with the help of professional asset managers. BDCs are investment companies that finance businesses traditionally locked out of conventional capital markets. Nearly forty years old, the BDC has remained virtually unexplored by academic researchers.