Prohibition of Fraud by Advisers to Certain Pooled Investment Vehicles, 44756-44763 [E7-15531]
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Federal Register / Vol. 72, No. 153 / Thursday, August 9, 2007 / Rules and Regulations
if there are signs of movement or if there are
gaps under the head or collar.
(3) Do detailed inspections of the fasteners
that hold the strut to the horizontal flange of
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An Acceptable Method of Compliance With
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Authorized Representative for the Boeing
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Contact Boeing Commercial Airplanes, P.O.
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Issued in Renton, Washington, on July 31,
2007.
Ali Bahrami,
Manager, Transport Airplane Directorate,
Aircraft Certification Service.
[FR Doc. E7–15419 Filed 8–8–07; 8:45 am]
BILLING CODE 4910–13–P
SECURITIES AND EXCHANGE
COMMISSION
17 CFR Part 275
[Release No. IA–2628; File No. S7–25–06]
RIN 3235–AJ67
Prohibition of Fraud by Advisers to
Certain Pooled Investment Vehicles
Securities and Exchange
Commission.
ACTION: Final rule.
AGENCY:
SUMMARY: The Securities and Exchange
Commission is adopting a new rule that
prohibits advisers to pooled investment
vehicles from making false or
misleading statements to, or otherwise
defrauding, investors or prospective
investors in those pooled vehicles. This
rule is designed to clarify, in light of a
recent court opinion, the Commission’s
ability to bring enforcement actions
under the Investment Advisers Act of
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1940 against investment advisers who
defraud investors or prospective
investors in a hedge fund or other
pooled investment vehicle.
DATES: Effective Date: September 10,
2007.
FOR FURTHER INFORMATION CONTACT:
David W. Blass, Assistant Director,
Daniel S. Kahl, Branch Chief, or Vivien
Liu, Senior Counsel, at 202–551–6787,
Division of Investment Management,
Securities and Exchange Commission,
100 F Street, NE., Washington, DC
20549–5041.
SUPPLEMENTARY INFORMATION: The
Commission is adopting new rule
206(4)–8 under the Investment Advisers
Act of 1940 (‘‘Advisers Act’’).1
I. Introduction
On December 13, 2006, we proposed
a new rule under the Advisers Act that
would prohibit advisers to pooled
investment vehicles from defrauding
investors or prospective investors in
pooled investment vehicles they
advise.2 We proposed the rule in
response to the opinion of the Court of
Appeals for the District of Columbia
Circuit in Goldstein v. SEC, which
created some uncertainty regarding the
application of sections 206(1) and
206(2) of the Advisers Act in certain
cases where investors in a pool are
defrauded by an investment adviser to
that pool.3 In addressing the scope of
the exemption from registration in
section 203(b)(3) of the Advisers Act
and the meaning of ‘‘client’’ as used in
that section, the Court of Appeals
expressed the view that, for purposes of
sections 206(1) and (2) of the Advisers
Act, the ‘‘client’’ of an investment
1 15 U.S.C. 80b. Unless otherwise noted, when we
refer to the Advisers Act, or any paragraph of the
Advisers Act, we are referring to 15 U.S.C. 80b of
the United States Code, at which the Advisers Act
is codified.
2 Prohibition of Fraud by Advisers to Certain
Pooled Investment Vehicles; Accredited Investors in
Certain Private Investment Vehicles, Investment
Advisers Act Release No. 2576 (Dec. 27, 2006) [72
FR 400 (Jan. 4, 2007)] (the ‘‘Proposing Release’’). In
the Proposing Release, we also proposed two new
rules that would define the term ‘‘accredited natural
person’’ under Regulation D and section 4(6) of the
Securities Act of 1933 [15 U.S.C. 77d(6)]
(‘‘Securities Act’’). As proposed, these rules would
add to the existing definition of ‘‘accredited
investor’’ and apply to private offerings of certain
unregistered investment pools. On May 23, 2007,
we voted to propose more general amendments to
the definition of accredited investor. Proposed
Modernization of Smaller Company Capital-Raising
and Disclosure Requirements, Securities Act
Release No. ll (ll, 2007) [72 FR ll (ll,
2007)]. We plan to defer consideration of our
proposal to define the term accredited natural
person until we have had the opportunity to
evaluate fully the comments we received on that
proposal together with those we receive on our May
2007 proposal.
3 451 F.3d 873 (D.C. Cir. 2006) (‘‘Goldstein’’).
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adviser managing a pool is the pool
itself, not an investor in the pool. As a
result, it was unclear whether the
Commission could continue to rely on
sections 206(1) and (2) of the Advisers
Act to bring enforcement actions in
certain cases where investors in a pool
are defrauded by an investment adviser
to that pool.4
In its opinion, the Court of Appeals
distinguished sections 206(1) and (2)
from section 206(4) of the Advisers Act,
which is not limited to conduct aimed
at clients or prospective clients of
investment advisers.5 Section 206(4)
provides us with rulemaking authority
to define, and prescribe means
reasonably designed to prevent, fraud by
advisers.6 We proposed rule 206(4)–8
under this authority.
We received 45 comment letters in
response to our proposal.7 Most
commenters generally supported the
proposal. Eighteen endorsed the rule as
proposed, noting that the rule would
strengthen the antifraud provisions of
the Advisers Act or that the rule would
clarify the Commission’s enforcement
authority with respect to advisers.8
4 Prior to the issuance of the Goldstein decision,
we brought enforcement actions against advisers
alleging false and misleading statements to
investors under sections 206(1) and (2) of the
Advisers Act. See, e.g., SEC v. Kirk S. Wright,
International Management Associates, LLC,
Litigation Release No. 19581 (Feb. 28, 2006); SEC
v. Wood River Capital Management, LLC, Litigation
Release No. 19428 (Oct. 13, 2005); SEC v. Samuel
Israel III; Daniel E. Marino; Bayou Management,
LLC; Bayou Accredited Fund, LLC; Bayou Affiliates
Fund, LLC; Bayou No Leverage Fund, LLC; and
Bayou Superfund, LLC, Litigation Release No.
19406 (Sept. 29, 2005); SEC v. Beacon Hill Asset
Management LLC, Litigation Release No. 18745A
(June 16, 2004).
5 See Goldstein, supra note 3, at note 6. See also
United States v. Elliott, 62 F.3d 1304, 1311 (11th
Cir. 1995).
6 Section 206(4) of the Advisers Act makes it
unlawful for an investment adviser to ‘‘engage in
any act, practice, or course of business which is
fraudulent, deceptive, or manipulative’’ and
authorizes us ‘‘by rules and regulations [to] define,
and prescribe means reasonably designed to
prevent, such acts, practices, and courses of
business as are fraudulent, deceptive, or
manipulative.’’
7 We received over 600 comment letters that
addressed the proposed amendments to the term
‘‘accredited natural person’’ under Regulation D
and section 4(6) of the Securities Act. All of the
public comments we received are available for
inspection in our Public Reference Room at 100 F
Street, NE., Washington DC, 20549 in File No. S7–
25–06, or may be viewed at https://www.sec.gov/
comments/s7-25-06/s72506.shtml.
8 E.g., Letter of the Alternative Investments
Compliance Association (Mar. 5, 2007); Letter of the
CFA Center for Financial Market Integrity (Mar. 9,
2007) (‘‘CFA Center Letter’’); Letter of the Coalition
of Private Investment Companies (Mar. 9, 2007);
Letter of the Commonwealth of Massachusetts (Mar.
9, 2007) (‘‘Massachusetts Letter’’); Letter of the
Department of Banking of the State of Connecticut
(Mar. 8, 2007); Letter of the North America
Securities Administrators Association (Apr. 2,
2007) (‘‘NASAA Letter’’); and Letter of the U.S.
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Others, however, urged that we make
revisions that would restrict the scope
of the rule to more narrowly define the
conduct or acts it prohibits.9
Today, we are adopting new rule
206(4)–8 as proposed. The rule prohibits
advisers from (i) making false or
misleading statements to investors or
prospective investors in hedge funds
and other pooled investment vehicles
they advise, or (ii) otherwise defrauding
these investors. The rule clarifies that an
adviser’s duty to refrain from fraudulent
conduct under the federal securities
laws extends to the relationship with
ultimate investors and that the
Commission may bring enforcement
actions under the Advisers Act against
investment advisers who defraud
investors or prospective investors in
those pooled investment vehicles.
indicated, our intent is to prohibit all
fraud on investors in pools managed by
investment advisers. Congress expected
that we would use the authority
provided by section 206(4) to
‘‘promulgate general antifraud rules
capable of flexibility.’’ 11 The terms
material false statements or omissions
and ‘‘acts, practices, and courses of
business as are fraudulent, deceptive, or
manipulative’’ encompass the welldeveloped body of law under the
antifraud provisions of the federal
securities laws. The legal authorities
identifying the types of acts, practices,
and courses of business that are
fraudulent, deceptive, or manipulative
under the federal securities laws are
numerous, and we believe that the
conduct prohibited by rule 206(4)–8 is
sufficiently clear and well understood.12
II. Discussion
Rule 206(4)–8 prohibits advisers to
pooled investment vehicles from (i)
making false or misleading statements to
investors or prospective investors in
those pools or (ii) otherwise defrauding
those investors or prospective investors.
We will enforce the rule through civil
and administrative enforcement actions
against advisers who violate it.
Section 206(4) authorizes the
Commission to adopt rules and
regulations that ‘‘define, and prescribe
means reasonably designed to prevent,
such acts, practices, and courses of
business as are fraudulent, deceptive, or
manipulative.’’ In adopting rule 206(4)–
8, we intend to employ all of the broad
authority that Congress provided us in
section 206(4) and direct it at adviser
conduct affecting an investor or
potential investor in a pooled
investment vehicle.
1. Investors and Prospective Investors
Rule 206(4)–8 prohibits investment
advisers from making false or
misleading statements to, or engaging in
other fraud on, investors or prospective
investors in a pooled investment vehicle
they manage. The scope of the rule is
modeled on that of sections 206(1) and
(2) of the Advisers Act, which make
unlawful fraud by advisers against
clients or prospective clients. Rule
206(4)–8 prohibits false or misleading
statements made, for example, to
existing investors in account statements
A. Scope of Rule 206(4)–8
Some commenters questioned the
scope of the rule, arguing that the
Commission should define fraud.10 We
believe that we have done so, only more
broadly than some commenters would
have us do. As the Proposing Release
Chamber of Commerce (Mar. 9, 2007). Another
commenter observed that the proposed rules are
broadly similar to current U.K. legislation and
regulations. See Letter of Alternative Investment
Management Association (Mar. 9, 2007) (‘‘AIMA
Letter’’).
9 E.g., Letter of American Bar Association (Mar.
12, 2007) (‘‘ABA Letter’’); Letter of Davis Polk &
Wardwell (Mar. 9, 2007) (‘‘Davis Polk Letter’’);
Letter of Dechert LLP (Mar. 8, 2007) (‘‘Dechert
Letter’’); Letter of New York City Bar (Mar. 8, 2007)
(‘‘NYCB Letter’’); Letter of Schulte Roth & Zabel
LLP (Mar. 9, 2007) (‘‘Schulte Roth Letter’’); and
Letter of Sullivan & Cromwell LLP (Mar. 9, 2007)
(‘‘Sullivan & Cromwell Letter’’).
10 E.g., ABA Letter, supra note 9; Letter of
Debevoise & Plimpton LLP (Mar. 14, 2007); and
NYCB Letter, supra note 9.
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11 S. Rep. No. 1760, 86th Cong., 2d. Sess. (June
28, 1960) at 4. See rule 206(4)–1(a)(5) [17 CFR.
275.206(4)–1(a)(5)] under the Advisers Act; rule
17j–1(b) [17 CFR 270.17j–1(b)] under the
Investment Company Act of 1940 [15 U.S.C. 80a–
1] (‘‘Investment Company Act’’); and rule 13e–
3(b)(1) [17 CFR 240.13e–3(b)(1)] under the
Securities Exchange Act of 1934 [15 U.S.C. 77a]
(‘‘Exchange Act’’).
12 Loss, Seligman, & Paredes, Securities
Regulation, Chap. 9 (Fraud) (Fourth Ed. 2006);
Hazen, Treatise on The Law of Securities
Regulation, Vol. 3, Ch. 12 (Manipulation and
Fraud—Civil Liability; Implied Private Remedies;
SEC Rule 10b–5; Fraud in Connection With the
Purchase or Sale of Securities; Improper Trading on
Nonpublic Material Information) (Fifth Ed. 2005).
See, e.g., Superintendent of Insurance of New York
v. Bankers Life & Casualty Co., 404 U.S. 6, 11 n.
7 (1971) (‘‘ ‘We believe that section 10(b) and Rule
10b–5 prohibit all fraudulent schemes in
connection with the purchase or sale of securities,
whether the artifices employed involve a garden
type variety of fraud, or present a unique form of
deception. Novel or atypical methods should not
provide immunity from the securities laws.’ ’’
(quoting A. T. Brod & Co. v. Perlow, 375 F.2d 393,
397 (CA2 1967))); Santa Fe Industries, Inc. v. Green,
430 U.S. 462, 477 (1977) (‘‘No doubt Congress
meant to prohibit the full range of ingenious
devices that might be used to manipulate securities
prices.’’). Moreover, the established legal principles
are sufficiently flexible to encompass future novel
factual scenarios. United States v. Brown, 555 F.2d
336, 339–40 (2d Cir. 1977) (‘‘The fact that there is
no litigated fact pattern precisely in point may
constitute a tribute to the cupidity and ingenuity of
the malefactors involved but hardly provides an
escape from the penal sanctions of the securities
fraud provisions here involved.’’).
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as well as to prospective investors in
private placement memoranda, offering
circulars, or responses to ‘‘requests for
proposals,’’ electronic solicitations, and
personal meetings arranged through
capital introduction services.
Some commenters argued that the
rule should not prohibit fraud against
prospective investors in a pooled
investment vehicle, asserting that such
fraud does not actually harm investors
until they, in fact, make an
investment.13 We disagree. False or
misleading statements and other frauds
by advisers are no less objectionable
when made in an attempt to draw in
new investors than when made to
existing investors.14 For similar policy
reasons that we believe led Congress to
apply the protections of sections 206(1)
and (2) to prospective clients, we have
decided to apply those of rule 206(4)–
8 to prospective investors.15 We believe
that prohibiting false or misleading
statements made to, or other fraud on,
any prospective investors is a means
reasonably designed to prevent fraud.
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2. Unregistered Investment Advisers
Rule 206(4)–8 applies to both
registered and unregistered investment
advisers.16 As we noted in the
Proposing Release, many of our
enforcement cases against advisers to
pooled investment vehicles have been
brought against advisers that are not
registered under the Advisers Act, and
we believe it is critical that we continue
to be in a position to bring actions
against unregistered advisers that
manage pools and that defraud investors
in those pools.17 The two commenters
that expressed an explicit view on this
aspect of the proposal supported our
application of the rule to advisers that
are not registered with the
Commission.18
13 Davis Polk Letter, supra note 9; Dechert Letter,
supra note 9; NYCB Letter, supra note 9; Letter of
the Securities Industry and Financial Markets
Association (Mar. 9, 2007); Sullivan & Cromwell
Letter, supra note 9.
14 See CFA Center Letter, supra note 8.
15 We have used the term ‘‘prospective investor’’
to give the term similar scope to the term
‘‘prospective client’’ in sections 206(1) and (2). See,
e.g., In the Matter of Ralph Harold Seipel, 38 S.E.C.
256, 257–58 (1958) (the solicitation of clients is part
of the activity of an investment adviser and it is
immaterial for purposes of an enforcement action
under sections 206(1) and (2) that an adviser
engaging in fraudulent solicitations was not
successful in his efforts to obtain clients).
16 A few commenters requested that we clarify
how we intend to apply rule 206(4)–8 to offshore
advisers’ interaction with non-U.S. investors. See
AIMA Letter, supra note 8; Letter of Jones Day (Mar.
9, 2007); Sullivan & Cromwell Letter, supra note 9.
Our adoption of this rule will not alter our
jurisdictional authority.
17 Proposing Release, supra note 2, at note 14.
18 Massachusetts Letter, supra note 8; NASAA
Letter, supra note 8.
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3. Pooled Investment Vehicles
The rule we are adopting today
applies to investment advisers with
respect to any ‘‘pooled investment
vehicle’’ they advise. The rule defines a
pooled investment vehicle 19 as any
investment company defined in section
3(a) of the Investment Company Act 20
and any privately offered pooled
investment vehicle that is excluded
from the definition of investment
company by reason of either section
3(c)(1) or 3(c)(7) of the Investment
Company Act.21 As a result, the rule
applies to advisers to hedge funds,
private equity funds, venture capital
funds, and other types of privately
offered pools that invest in securities, as
well as advisers to investment
companies that are registered with us.22
Several commenters supported
applying the protection of the new
antifraud rule to investors in all these
kinds of pooled investment vehicles,
noting, for example, that every investor,
not just the wealthy or sophisticated
that typically invest in private pools,
should be protected from fraud.23 Some
other commenters urged us not to apply
the rule to advisers to registered
investment companies, arguing that the
rule is unnecessary because other
provisions of the federal securities laws
prohibiting fraud are available to the
19 Rule
206(4)–8(b).
U.S.C. 80a–3(a). Unless otherwise noted,
when we refer to the Investment Company Act, or
any paragraph of the Investment Company Act, we
are referring to 15 U.S.C. 80a of the United States
Code, at which the Company Act is codified.
21 Section 3(c)(1) of the Investment Company Act
excludes from the definition of investment
company an issuer the securities (other than shortterm paper) of which are beneficially owned by not
more than 100 persons and that is not making or
proposing to make a public offering of its securities.
Section 3(c)(7) of the Investment Company Act
excludes from the definition of investment
company an issuer the outstanding securities of
which are owned exclusively by persons who, at
the time of acquisition of such securities, are
‘‘qualified purchasers’’ and that is not making or
proposing to make a public offering of its securities.
‘‘Qualified purchaser’’ is defined in section 2(a)(51)
of the Investment Company Act generally to include
a natural person (or a company owned by two or
more related natural persons) who owns not less
than $5,000,000 in investments; a person, acting for
its own account or accounts of other qualified
purchasers, who owns and invests on a
discretionary basis, not less than $25,000,000; and
a trust whose trustee, and each of its settlors, is a
qualified purchaser.
22 We have brought enforcement actions under
the Advisers Act against advisers to these types of
funds. See, e.g., In the Matter of Askin Capital
Management, L.P and David J. Askin, Investment
Advisers Act Release No. 1492 (May 23, 1995)
(hedge fund); In the Matter of Thayer Capital
Partners, Investment Advisers Act Release No. 2276
(Aug. 12, 2004) (private equity fund); SEC v.
Michael A. Liberty, Litigation Release No. 19601
(Mar. 8, 2006) (venture capital fund).
23 E.g., NASAA Letter, supra note 8.
20 15
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Commission to address these matters.24
They expressed concern that application
of another antifraud provision with
different elements would be
burdensome. These commenters
claimed that the rule would, for
example, make it necessary for advisers
to conduct extensive reviews of all
communications with clients. But the
other antifraud provisions available to
us contain different elements because
they were not specifically designed to
address frauds by investment advisers
with respect to investors in pooled
investment vehicles. In some cases, the
other antifraud provisions may not
permit us to proceed against the
adviser.25 As a result, the existing
antifraud provisions may not be
available to us in all cases. As we
discussed above, before the Goldstein
decision we had brought actions against
advisers to mutual funds under sections
206(1) and (2) for defrauding investors
in mutual funds.26 Because, before the
Goldstein decision, advisers to pooled
investment vehicles operated with the
understanding that the Advisers Act
prohibited the conduct that this rule
prohibits, we believe that advisers that
are attentive to their traditional
compliance responsibilities will not
need to alter their business practices or
take additional steps and incur new
costs as a result of this rule’s adoption.
B. Prohibition on False or Misleading
Statements
Rule 206(4)–8(a)(1) prohibits any
investment adviser to a pooled
investment vehicle from making an
untrue statement of a material fact to
any investor or prospective investor in
the pooled investment vehicle, or
omitting to state a material fact
necessary in order to make the
statements made to any investor or
24 E.g., ABA Letter, supra note 9; Letter of
Investment Adviser Association (Mar. 9, 2007);
Letter of Investment Company Institute (Mar. 9,
2007) (‘‘ICI Letter’’); Sullivan & Cromwell Letter,
supra note 9. Commenters noted in particular that
section 34(b) of the Investment Company Act
already prohibits an adviser from making
fraudulent material statements or omissions in a
fund’s registration statement or in required records.
25 This may be the case with respect to section
34(b) of the Investment Company Act, for example,
if the adviser’s fraudulent statements are not made
in a document described in that section, or with
respect to rule 10b–5 under the Exchange Act,
where the fraudulent conduct does not relate to a
misstatement or omission in connection with the
purchase or sale of any security.
26 See, e.g., In the Matter of Van Kampen
Investment Advisory Corp., Investment Advisers
Act Release No. 1819 (Sept. 8, 1999); In the Matter
of The Dreyfus Corporation, Investment Advisers
Act Release No. 1870 (May 10, 2000); In the Matter
of Federated Investment Management Company,
Investment Advisers Act Release No. 2448 (Nov. 28,
2005).
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prospective investor in the pooled
investment vehicle, in the light of the
circumstances under which they were
made, not misleading.27
The provision is very similar to those
in many of our antifraud laws and rules
that, depending upon the
circumstances, may also be applicable
to the same investor communications.28
Sections 206(1) and (2) have imposed
similar obligations on advisers since
1940 and, before Goldstein, were
commonly accepted as imposing similar
requirements on communications with
investors in a fund. For these reasons,
and because the nature of the duty to
communicate without false statements
is so well developed in current law, we
believe that commenters’ concerns
about the breadth of the prohibition or
any chilling effect the new rule might
have on investor communications are
misplaced.29 Advisers to pooled
investment vehicles attentive to their
traditional compliance responsibilities
will not need to alter their
communications with investors.
Rule 206(4)–8(a)(1) prohibits advisers
to pooled investment vehicles from
making any materially false or
misleading statements to investors in
the pool regardless of whether the pool
is offering, selling, or redeeming
securities. While the new rule differs in
this aspect from rule 10b–5 under the
Exchange Act, the conduct prohibited is
similar. The new rule prohibits, for
example, materially false or misleading
statements regarding investment
strategies the pooled investment vehicle
will pursue, the experience and
credentials of the adviser (or its
associated persons), the risks associated
with an investment in the pool, the
performance of the pool or other funds
advised by the adviser, the valuation of
the pool or investor accounts in it, and
practices the adviser follows in the
27 A fact is material if there is a substantial
likelihood that a reasonable investor in making an
investment decision would consider it as having
significantly altered the total mix of information
available. Basic, Inc. v. Levinson, 485 U.S. 224,
231–32 (1988); TSC Industries, Inc. v. Northway,
Inc., 426 U.S. 438, 449 (1976). See also In the Matter
of Van Kampen Investment Advisory Corp., supra
note 26; In the Matter of the Dreyfus Corporation,
supra note 26.
28 See, e.g., sections 12 and 17 of the Securities
Act [15 U.S.C. 77l, 77q]; section 14 of the Exchange
Act [15 U.S.C. 78n]; section 34 of the Investment
Company Act; rules 156, 159, and 610 under the
Securities Act [17 CFR 230.156, 230.159, 230.610];
rules 10b–5, 13e–3, 13e–4, and 15c1–2 under the
Exchange Act [17 CFR 240.10b–5, 240.13e–3,
240.13e–4, 240.15c1–2]; and rule 17j–1 under the
Investment Company Act [17 CFR 270.17j–1]).
29 Letter of Managed Funds Association (Mar. 9,
2007) (‘‘MFA Letter’’); NYCB Letter, supra note 9;
Davis Polk Letter, supra note 9; Dechert Letter,
supra note 9; Letter of Seward & Kissel LLP (Mar.
8, 2007) (‘‘Seward & Kissel Letter’’).
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operation of its advisory business such
as how the adviser allocates investment
opportunities.30
securities laws under which broad
prohibitions have been applied against
specific harmful activity.
C. Prohibition of Other Frauds
Rule 206(4)–8(a)(2) makes it a
fraudulent, deceptive, or manipulative
act, practice, or course of business for
any investment adviser to a pooled
investment vehicle to ‘‘otherwise engage
in any act, practice, or course of
business that is fraudulent, deceptive, or
manipulative with respect to any
investor or prospective investor in the
pooled investment vehicle.’’ 31 As we
noted in the Proposing Release, the
wording of this provision is drawn from
the first sentence of section 206(4) and
is designed to apply more broadly to
deceptive conduct that may not involve
statements.32
Some commenters asserted that
section 206(4) provides us authority
only to adopt prophylactic rules that
explicitly identify conduct that would
be fraudulent under the new rule.33 We
believe our authority is broader. We do
not believe that the commenters’
suggested approach would be consistent
with the purposes of the Advisers Act
or the protection of investors. That
approach would have us adopt the rule
prohibiting fraudulent communications
but not fraudulent conduct.34 But,
section 206(4) itself specifically
authorizes us to adopt rules defining
and prescribing ‘‘acts, practices and
courses of business,’’ (i.e., conduct), and
does not explicitly refer to
communications, which, nonetheless,
represent a form of an act, practice, or
course of business. In addition, rule
206(4)–8 as adopted would provide
greater protection to investors in pooled
investment vehicles.
Alternatively, commenters would
have us adopt a rule prohibiting
identified known fraudulent conduct or
would have us provide detailed
commentary describing specific forms of
fraudulent conduct that the rule would
prohibit.35 Either approach would fail to
prohibit fraudulent conduct we did not
identify, and could provide a roadmap
for those wishing to engage in
fraudulent conduct. This approach
would be inconsistent with our
historical application of the federal
D. Other Matters
We noted in the Proposing Release
that, unlike violations of rule 10b–5
under the Exchange Act, the
Commission would not need to
demonstrate that an adviser violating
rule 206(4)–8 acted with scienter.36
Commenters questioned whether the
rule should encompass negligent
conduct, arguing that it would ‘‘expand
the concept of fraud itself beyond its
original meaning.’’ 37 We read the
language of section 206(4) as not by its
terms limited to knowing or deliberate
conduct. For example, section 206(4)
encompasses ‘‘acts, practices, and
courses of business as are * * *
deceptive,’’ thereby reaching conduct
that is negligently deceptive as well as
conduct that is recklessly or deliberately
deceptive. In addition, the Court of
Appeals for the District of Columbia
Circuit concluded that ‘‘scienter is not
required under section 206(4).’’ 38 We
believe use of a negligence standard also
is appropriate as a method reasonably
designed to prevent fraud. As the
Supreme Court noted in U.S. v.
O’Hagan, ‘‘[a] prophylactic measure,
because its mission is to prevent,
typically encompasses more than the
core activity prohibited.’’ 39 In O’Hagan,
the Court held that under section 14(e)
‘‘the Commission may prohibit acts, not
themselves fraudulent under the
common law or § 10(b), if the
prohibition is ‘reasonably designed to
prevent * * * acts and practices [that]
are fraudulent.’ ’’ 40 Along these lines,
the prohibitions in rule 206(4)–8 are
reasonably designed to prevent fraud.
We believe that, by taking sufficient care
to avoid negligent conduct, advisers will
be more likely to avoid reckless
deception. Since the Commission
clearly is authorized to prescribe
30 We have previously brought enforcement
actions alleging these or similar types of frauds. See
Proposing Release, supra note 2, at note 29.
31 Rule 206(4)–8(a)(2).
32 See Section II.C of the Proposing Release, supra
note 2.
33 ABA Letter, supra note 9; ICI Letter, supra note
24; Schulte Roth Letter, supra note 9; Sullivan &
Cromwell Letter, supra note 9.
34 See, e.g., ABA Letter, supra note 9.
35 Id.
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36 Section II.B of the Proposing Release, supra
note 2.
37 See ABA Letter, supra note 9 at page 3.
38 SEC v. Steadman, 967 F.2d 636, at 647 (D.C.
Cir. 1992). The court in Steadman analogized
section 206(4) of the Advisers Act to section
17(a)(3) of the Securities Act, which the Supreme
Court had held did not require a finding of scienter,
id. (citing Aaron v. SEC, 446 U.S. 680 (1980)). In
discussing section 17(a)(3) and its lack of a scienter
requirement, the Steadman court observed that,
similarly, a violation of section 206(2) of the
Advisers Act could rest on a finding of simple
negligence. Id. at 643, note 5. But see Aaron at 690–
91 (citing Ernst & Ernst v. Hochfelder, 425 U.S. 185,
199 (1976)); cf. S. Rep. No. 1760, 86th Cong., 2d.
Sess. (June 28, 1960) at 8 and H. R. Rep. 2179, 86th
Cong., 2d Sess. (Aug. 26, 1960) at 8 (comparing
section 206(4) to section 15(c)(2) of the Exchange
Act).
39 U.S. v. O’Hagan, 521 U.S. 642, 672–73 (1997).
40 Id. at 673.
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conduct that goes beyond fraud as a
means reasonably designed to prevent
fraud, prohibiting deceptive conduct
done negligently is a way to accomplish
this objective.
Rule 206(4)–8 does not create under
the Advisers Act a fiduciary duty to
investors or prospective investors in a
pooled investment vehicle not
otherwise imposed by law. Nor does the
rule alter any duty or obligation an
adviser has under the Advisers Act, any
other federal law or regulation, or any
state law or regulation (including state
securities laws) to investors in a pooled
investment vehicle it advises.41 The
rule, for example, will permit us to
bring an enforcement action against an
investment adviser that violates a
fiduciary duty imposed by other law if
the violation of such law or obligation
also constitutes an act, practice, or
course of business that is fraudulent,
deceptive, or manipulative within the
meaning of the rule and section
206(4).42
Finally, the rule does not create a
private right of action.43
III. Paperwork Reduction Act
The Paperwork Reduction Act of 1995
does not apply because rule 206(4)–8
does not impose a new ‘‘collection of
information’’ within the meaning of the
Paperwork Reduction Act of 1995. The
rule does not create any filing,
reporting, recordkeeping, or disclosure
requirements for investment advisers
subject to the rule. Accordingly, there is
no ‘‘collection of information’’ under
the Paperwork Reduction Act that
requires the approval of the Office of
Management and Budget under 44
U.S.C. 3501.
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IV. Cost-Benefit Analysis
The Commission is sensitive to costs
imposed by our rules and the benefits
that derive from them. In the Proposing
Release, we encouraged commenters to
discuss any potential costs and benefits
that we did not consider in our
discussion. Three commenters
addressed the issue of cost. Two of them
41 For example, under the Uniform Limited
Partnership Act, advisers who serve as general
partners owe fiduciary duties to the limited
partners. Unif. Limited Partnership Act section 408
(2001).
42 For example, if an adviser has a duty from a
source other than the rule to make a material
disclosure to an investor in a fund and negligently
or deliberately fails to make the disclosure, the rule
would apply to the failure.
43 The Supreme Court has held that ‘‘there exists
a limited private remedy under the Investment
Advisers Act of 1940 to void an investment
adviser’s contract, but that the Act confers no other
private causes of action, legal or equitable.’’
Transamerica Mortgage Advisors, Inc. v. Lewis, 444
U.S. 11 at 24 (1979) (footnote omitted).
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stated their belief that the rule would
increase advisers’ costs of compliance,
by, for example, making it necessary for
advisers to conduct extensive reviews of
all communications with clients.44 One
stated that the rule would achieve a
reasonable balance of providing
important benefits to investors at an
acceptable cost.45 None of the three
commenters, however, provided
analysis or empirical data in connection
with their statements.
The rule makes it a fraudulent,
deceptive, or manipulative act, practice,
or course of business within the
meaning of section 206(4) for any
investment adviser to a pooled
investment vehicle to make any untrue
statement of a material fact or to omit
to state a material fact necessary in
order to make the statements made, in
light of the circumstances under which
they were made, not misleading, to any
investor or prospective investor in the
pooled investment vehicle. The rule
also makes it a fraudulent, deceptive, or
manipulative act, practice, or course of
business within the meaning of section
206(4) for any investment adviser to a
pooled investment vehicle to otherwise
engage in any act, practice, or course of
business that is fraudulent, deceptive, or
manipulative with respect to any
investor or prospective investor in the
pooled investment vehicle. For the
reasons discussed, we do not believe
that the rule will require advisers to
incur new or additional costs.
Investment advisers to pooled
investment vehicles should not be
making untrue statements or omitting
material facts or otherwise be engaged
in fraud with respect to investors or
prospective investors in pooled
investment vehicles today, because
federal authorities, state authorities, and
private litigants often can, and do, seek
redress from the adviser for the untrue
statements or omissions or other frauds.
In most cases, the conduct that the rule
prohibits is already prohibited by
federal securities statutes,46 other
44 NYCB Letter, supra note 9; Seward & Kissel
Letter, supra note 29.
45 CFA Center Letter, supra note 8.
46 See, e.g., section 10(b) of the Exchange Act [15
U.S.C. 78j(b)] and section 17(a) of the Securities Act
[15 U.S.C. 77q] which would apply when the false
statements are made ‘‘in connection with the
purchase or sale of a security’’ or involve the ‘‘offer
or sale’’ of a security, and section 34(b) of the
Investment Company Act which makes it unlawful
‘‘to make any untrue statement of a material fact in
any registration statement, application, report,
account, record, or other document filed or
transmitted pursuant to [the Investment Company
Act] * * *.’’
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federal statutes (including federal wire
fraud statutes),47 as well as state law.48
We recognize that there are costs
involved in assuring that
communications to investors and
prospective investors do not contain
untrue or misleading statements and
preventing other frauds. Advisers have
incurred, and will continue to incur,
these costs due to the prohibitions and
deterrent effect of the law and rules that
apply under these circumstances. While
each of the provisions noted above may
have different limitation periods, apply
in different factual circumstances, or
require the government (or a private
litigant) to prove different states of mind
than the rule, as discussed above we
believe that the multiple prohibitions
against fraud, and the consequences
under both criminal and civil law for
fraud, should currently cause an adviser
to take the precautions it deems
necessary to refrain from such conduct.
Furthermore, prior to Goldstein,
advisers operated with the
understanding that the Advisers Act
prohibited the same conduct that would
be prohibited by the rule. Accordingly,
we do not believe that advisers to
pooled investment vehicles attentive to
their traditional compliance
responsibilities will need to take steps
or alter their business practices in such
a way that will require them to incur
new or additional costs as a result of the
adoption of the rule.
We also recognize that the rule may
cause some advisers to pay more
attention to the information they present
to better guard against making an untrue
or misleading statement to an investor
or prospective investor and to
reevaluate measures that are intended to
prevent fraud. As a consequence, some
advisers might seek guidance, legal or
otherwise, and more closely review the
47 See, e.g., 18 U.S.C. 1341 (Frauds and Swindles)
and 18 U.S.C. 1343 (Fraud by wire, radio, or
television) which make it a criminal offense to use
the mails or to communicate by means of wire,
having devised a scheme to defraud or for obtaining
money or property by means of false or fraudulent
pretenses, and 18 U.S.C. 1957 (Engaging in
monetary transactions in property derived from
specified unlawful activity) which makes it a
criminal racketeering offense to engage or attempt
to engage in a transaction in criminally derived
property of a value greater than $10,000.
48 See, e.g., Metro Communications Corp. BVI v.
Advanced Mobilecomm Technologies, 854 A.2d
121, 156 (Del. Ch. 2004) (court held that plaintiffformer member of LLC had sufficiently alleged a
common law fraud claim based on the allegation
that a series of reports by LLC’s managers contained
misleading statements; court stated that ‘‘[i]n the
usual fraud case, the speaking party who is subject
to an accusation of fraud is on the opposite side of
a commercial transaction from the plaintiff, who
alleges that but for the material misstatements or
omissions of the speaking party he would not have
contracted with the speaking party’’).
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information that they disseminate to
investors and prospective investors and
the antifraud related policies and
procedures they have implemented.
While increased concern about making
false statements or committing fraud
could be attributable to the new rule,
advisers should already be incurring
these costs to ensure truthfulness and
prevent fraud, regardless of the rule,
because of the myriad of laws or
regulations that may already apply.
The principal benefit of the rule is
that it clearly enables the Commission
to bring enforcement actions under the
Advisers Act, if an adviser to a pooled
investment vehicle disseminates false or
misleading information to investors or
prospective investors or otherwise
commits fraud with respect to any
investor or prospective investor. As
noted above, the existing antifraud
provisions may not be available to us in
all cases. Through our enforcement
actions we are able to protect fund
investor assets by stopping ongoing
frauds,49 barring persons that have
committed certain specified violations
or offenses from being associated with
an investment adviser,50 imposing
penalties,51 seeking court orders to
protect fund assets,52 and to order
disgorgement of ill-gotten gains.53
Moreover, we believe that rule 206(4)–
8 will deter advisers to pooled
investment vehicles from engaging in
fraudulent conduct with respect to
investors in those pools and will
provide investors with greater
confidence when investing in pooled
investment vehicles.
V. Regulatory Flexibility Act Analysis
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The Commission certified, pursuant
to section 605(b) of the Regulatory
Flexibility Act, that rule 206(4)–8 will
not have a significant economic impact
on a substantial number of small
entities.54 This certification was
included in the Proposing Release.55
While we encouraged written comment
regarding this certification, none of the
commenters responded to this request.
49 See section 203(k) of the Advisers Act
(Commission authority to issue cease and desist
orders).
50 See section 203(f) of the Advisers Act
(Commission authority to bar a person from being
associated with an investment adviser).
51 See section 203(i) of the Advisers Act
(Commission authority to impose civil penalties).
52 See section 209(d) of the Advisers Act
(Commission authority to seek injunctions and
restraining orders in federal court).
53 See section 203(j) of the Advisers Act
(Commission authority to order disgorgement).
54 5 U.S.C. 605(b).
55 Section VII.A of the Proposing Release, supra
note 2.
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VI. Statutory Authority
We are adopting new rule 206(4)–8
pursuant to our authority set forth in
sections 206(4) and 211(a) of the
Advisers Act (15 U.S.C. 80b–6(4) and
80b–11(a)).
List of Subjects in 17 CFR Part 275
Reporting and recordkeeping
requirements, Securities.
VII. Text of Rules
For the reasons set out in the
preamble, Title 17, Chapter II of the
Code of Federal Regulations is amended
as follows:
I
PART 275—RULES AND
REGULATIONS, INVESTMENT
ADVISERS ACT OF 1940
1. The authority citation for Part 275
continues to read in part as follows:
I
Authority: 15 U.S.C. 80b–2(a)(11)(F), 80b–
2(a)(17), 80b–3, 80b–4, 80b–4a, 80b–6(4),
80b–6a, and 80b–11, unless otherwise noted.
*
*
*
*
*
I 2. Section 275.206(4)–8 is added to
read as follows:
§ 206(4)–8
Pooled investment vehicles.
(a) Prohibition. It shall constitute a
fraudulent, deceptive, or manipulative
act, practice, or course of business
within the meaning of section 206(4) of
the Act (15 U.S.C. 80b–6(4)) for any
investment adviser to a pooled
investment vehicle to:
(1) Make any untrue statement of a
material fact or to omit to state a
material fact necessary to make the
statements made, in the light of the
circumstances under which they were
made, not misleading, to any investor or
prospective investor in the pooled
investment vehicle; or
(2) Otherwise engage in any act,
practice, or course of business that is
fraudulent, deceptive, or manipulative
with respect to any investor or
prospective investor in the pooled
investment vehicle.
(b) Definition. For purposes of this
section ‘‘pooled investment vehicle’’
means any investment company as
defined in section 3(a) of the Investment
Company Act of 1940 (15 U.S.C. 80a–
3(a)) or any company that would be an
investment company under section 3(a)
of that Act but for the exclusion
provided from that definition by either
section 3(c)(1) or section 3(c)(7) of that
Act (15 U.S.C. 80a–3(c)(1) or (7)).
Dated: August 3, 2007.
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By the Commission.
Nancy M. Morris,
Secretary.
Concurrence of Commissioner Paul S.
Atkins to the Prohibition of Fraud by
Advisers to Certain Pooled Investment
Vehicles
New Rule 206(4)–8 under the
Investment Advisers Act of 1940
(‘‘Advisers Act’’),56 which we adopt
today, prohibits advisors from (i)
making false or misleading statements to
investors or prospective investors in
hedge funds and other pooled
investment vehicles they advise, or (ii)
otherwise defrauding these investors.57
Although the SEC has other ways to
reach fraud by advisors, this new rule
will fill in gaps in the coverage of other
transaction-based, anti-fraud provisions
so that the SEC may pursue advisors of
pooled investment vehicles who have
defrauded investors and prospective
investors in the course of their acting as
fund advisors. I support the new rule,
but I am writing separately to express
my disagreement with the conclusions
in the Adopting Release 58 related to the
requisite mental state for violation of the
rule.59
In discussing the mental state
required for violation of the rule, the
Adopting Release states that ‘‘the
Commission would not need to
demonstrate that an adviser violating
rule 206(4)–8 acted with scienter.’’ 60
56 15
U.S.C. 80b.
CFR 275.206(4)–8. Paragraph (a) of the new
rule provides:
Prohibition. It shall constitute a fraudulent,
deceptive, or manipulative act, practice or course of
business within the meaning of section 206(4) of the
Act (15 U.S.C. 80b–6(4)) for any investment adviser
to a pooled investment vehicle to:
(1) Make any untrue statement of a material fact
or to omit to state a material fact necessary to make
the statements made, in the light of the
circumstances under which they were made, not
misleading, to any investor or prospective investor
in the pooled investment vehicle; or
(2) Otherwise engage in any act, practice, or
course of business that is fraudulent, deceptive, or
manipulative with respect to any investor or
prospective investor in the pooled investment
vehicle.
Paragraph (b) of the rule defines a ‘‘pooled
investment vehicle’’ to include any investment
company and any company that relies on an
exclusion from the definition of ‘‘investment
company’’ in Section (3)(c)(1) or (3)(c)(7) of the
Investment Company Act [15 U.S.C. 80a–3(c)(1) or
(7))].
58 Prohibition of Fraud by Advisers to Certain
Pooled Investment Vehicles, Advisers Act Release
No. 2628 (Aug. 3, 2007) (‘‘Adopting Release’’).
59 See Section II.D of the Adopting Release. I
agree with the Section’s conclusions with respect to
fiduciary duty (Rule 206(4)–8 does not create a
fiduciary duty) and private rights of action (Rule
206(4)–8 does not create any private rights of
action).
60 Adopting Release, at text accompanying note
36.
57 17
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According to the Adopting Release,
therefore, the rule covers negligent
conduct as well as intentional conduct.
My objections to this interpretation of
the rule’s scope are twofold. First, I do
not believe that a negligence standard is
consistent with the Commission’s
authority under Section 206(4). Second,
even if a negligence standard were
within our authority, for policy reasons,
we should require a finding of
scienter 61 as part of establishing a
violation under this anti-fraud rule.
The Adopting Release offers several
arguments in support of a negligence
standard. First, it argues that the
language of section 206(4) is not limited
to knowing or deliberate conduct. In
support of this argument, it cites the
decision by the United States Court of
Appeals for the District of Columbia
Circuit in SEC v. Steadman.62 Second,
the Adopting Release contends that use
of a negligence standard is an
appropriate method reasonably
designed to prevent fraud. In support of
this contention, it cites U.S. v.
O’Hagan.63 I will discuss each of these
in turn.
The language of Section 206(4) does
not reach negligent conduct. Section
206(4) makes it unlawful for an advisor
‘‘to engage in any act, practice, or course
of business which is fraudulent,
deceptive, or manipulative’’ and directs
the Commission ‘‘by rules and
regulations [to] define, and prescribe
means reasonably designed to prevent,
such acts, practices, and courses of
business as are fraudulent, deceptive, or
manipulative.’’
The Adopting Release maintains that,
because Section 206(4) ‘‘encompasses
‘acts, practices, and courses of business
as are * * * deceptive,’ ’’ it reaches
‘‘conduct that is negligently deceptive
as well as conduct that is recklessly or
deliberately deceptive.’’ 64 As the
Supreme Court has said, however, ‘‘it is
a ‘familiar principle of statutory
construction that words grouped in a
list should be given related
meaning.’ ’’ 65 Hence, it is inappropriate
to base a conclusion that negligent
conduct is reached by looking at the
term ‘‘deceptive’’ apart from its
companion terms.
61 ‘‘Scienter’’ is ‘‘a mental state embracing intent
to deceive, manipulate, or defraud.’’ Ernst & Ernst
v. Hochfelder, 425 U.S. 185, 194 (1976).
Recklessness has also been found to satisfy a
scienter standard.
62 SEC v. Steadman, 967 F.2d 636 (D.C. Cir.
1992).
63 U.S. v. O’Hagan, 521 U.S. 642, 672–73 (1997).
64 Adopting Release at Section II.D.
65 Schreiber v. Burlington Northern, Inc. 472 U.S.
1, 8 (1985) (quoting Securities Industry Assn. v.
Board of Governors, FRS, 468 U.S. 207, 218 (1984).
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In the Section 10(b) context, the
Supreme Court has accorded special
significance to the term ‘‘manipulative’’:
Use of the word ‘‘manipulative’’ is
especially significant. It is and was virtually
a term of art when used in connection with
securities markets. It connotes intentional or
willful conduct designed to deceive or
defraud investors by controlling or artificially
affecting the price of securities.66
The language of Section 206(4), like
the language of Section 10(b), would
seem then to suggest a scienter
requirement.
The Adopting Release, however, cites
for the contrary conclusion a decision
by the United States Court of Appeals
for the District of Columbia. Indeed, it
is true that in SEC v. Steadman, the
court held that ‘‘scienter is not required
under section 206(4).’’ 67 The court
reached its conclusion by comparing the
language of Section 206(4) to the
language of Section 17(a)(3) under the
Securities Act of 1933,68 which makes it
unlawful ‘‘to engage in any transaction,
practice, or course of business which
operates or would operate as a fraud or
deceit upon the purchaser.’’ 69 The
Steadman court drew a comparison
between Section 17(a)(3)’s ‘‘transaction,
practice, or course of business’’ and
Section 206(4)’s ‘‘act, practice, or course
of business.’’ The court, relying on the
Supreme Court’s decision in Aaron,
held that, in both cases, the focus was
on effect. 70 The Supreme Court in
Aaron, however, placed considerable
weight on the terms ‘‘operate’’ or
‘‘would operate,’’ neither of which
appears in Section 206(4).71 In fact,
Section 206(4) instead uses the
affirmative word ‘‘is,’’ which would
seem to de-emphasize effect.72 Further,
while Section 17(a)(3) speaks of only
66 Hochfelder, 425 U.S. at 199 (footnote to
dictionary definition omitted). Hochfelder
considered whether scienter was a necessary
component of a private action under Section 10(b).
In a subsequent case, the Court considered whether
scienter was a necessary element of an injunctive
action by the SEC and concluded that it was. Aaron
v. SEC, 446 U.S. 680, 691 (1980) (‘‘the rationale of
Hochfelder ineluctably leads to the conclusion that
scienter is an element of a violation of section 10(b)
and Rule 10b–5, regardless of the identity of the
plaintiff or the nature of the relief sought.’’).
67 Steadman, 967 F.2d at 647.
68 15 U.S.C. 77a et seq.
69 15 U.S.C. 77q(a)(3).
70 Steadman at 647.
71 Aaron, 446 U.S. at 696–97 (‘‘the language of
section 17(a)(3), under which it is unlawful for any
person to ‘engage in any transaction, practice, or
course of business which operates or would operate
as a fraud or deceit,’ quite plainly focuses upon the
effect of particular conduct * * * rather than upon
the culpability of the person responsible.’’)
(emphasis in original).
72 Section 206(4) makes it unlawful ‘‘to engage in
any act, practice, or course of business which is
fraudulent, deceptive, or manipulative.’’ (Emphasis
added.)
PO 00000
Frm 00038
Fmt 4700
Sfmt 4700
‘‘fraud’’ and ‘‘deceit,’’ Section 206(4)
also includes ‘‘manipulative.’’
It is also helpful to note that Section
206(4), which was adopted in 1960,73
was modeled on Section 15(c)(2) under
the Securities Exchange Act of 1934.74
Section 15(c)(2) makes it unlawful for
brokers and dealers to effect
transactions in or induce the purchase
or sale of securities in connection with
which they ‘‘engage[] in any fraudulent,
deceptive, or manipulative act or
practices, or make[] any fictitious
quotation.’’ 75 Hence, as the legislative
history of Section 206(4) noted, Section
206(4) ‘‘is comparable to section
15(c)(2).’’ 76 The Steadman opinion did
not address the link between Sections
206(4) and 15(c)(2).
Section 14(e) under the Exchange Act,
which relates to tender offers, also
follows the Section 15(c)(2) pattern.77
Section 14(e), like Section 206(4),
includes both a proscription against
‘‘engag[ing] in any fraudulent,
deceptive, or manipulative acts or
practices’’ and a directive that the SEC
‘‘by rules and regulations define, and
prescribe means reasonably designed to
prevent such acts and practices as are
fraudulent, deceptive, or manipulative.’’
Because of the similarities, it is useful
to look at the Supreme Court’s
interpretation of Section 14(e). In
Schreiber v. Burlington Northern, the
Supreme Court relied on Hochfelder’s
interpretation of the term
‘‘manipulative’’ in the Section 10(b)
context to interpret that term in the
Section 14(e) context.78 The Schreiber
Court noted that the addition of the
rulemaking authorization to Section
14(e) did not ‘‘suggest[] any change in
the meaning of ‘manipulative’ itself.’’ 79
In U.S. v. O’Hagan, The Supreme Court
again looked at Section 14(e). This time,
it considered whether Rule 14e–3(a),
which prohibits trading on undisclosed
information in connection with a tender
offer, exceeds the SEC’s authority under
Section 14(e) given that the prohibition
applies regardless of whether there is a
duty to disclose. The Court held that
73 S. Rep. No. 86–1760, at 4 (1960) (‘‘The proposal
has precedent in similar authority granted to the
SEC over brokers and dealers by the Securities
Exchange Act of 1934.’’).
74 15 U.S.C. 78a et seq.
75 15 U.S.C. 78o(c)(2).
76 H.R. Rep. No. 86–2179, at 8 (1960). See also S.
Rep. No. 86–1760, at 8 (1960) (‘‘almost the identical
wording of section 15(c)(2)’’).
77 15 U.S.C. 78n(e).
78 Schreiber, 472 U.S. at 12 (‘‘We hold that the
term, ‘manipulative’ as used in § 14(e) requires
misrepresentation or nondisclosure. It connotes
‘conduct designed to deceive or defraud investors
by controlling or artificially affecting the price of
securities.’’) (citing Hochfelder, 425 U.S. at 199).
79 Id. at 12 n.11.
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Federal Register / Vol. 72, No. 153 / Thursday, August 9, 2007 / Rules and Regulations
Rule 14e–3(a) was within the SEC’s
authority under Section 14(e) because
Section 14(e) allows the SEC to
‘‘prohibit acts, not themselves
fraudulent under the common law or
§ 10(b), if the prohibition is ‘reasonably
designed to prevent * * * acts and
practices [that] are fraudulent.’ ’’ 80 The
lesson from both of these cases is that
the SEC cannot effect a change in the
meaning of specific statutory terms
under its comparable Section 206(4)
rulemaking authority.
The Adopting Release asserts that,
under O’Hagan, a negligence standard is
a means reasonably designed to prevent
fraud. As the Adopting Release notes,
conduct outside of the bounds of the
statutory prohibition can be prohibited
by Commission rule under Section
206(4). The rule that we are adopting
here, however, differs markedly from
the rules at issue in O’Hagan and
Steadman.81 Both of those rules were
narrowly targeted rules that covered
clearly-defined behavior. They were
designed to prohibit conduct, that,
although outside of the ‘‘core activity
prohibited’’ by the statute, were
designed to ‘‘assure the efficacy’’ of the
statute.82
Rule 206(4)–8(a)(2), by contrast, is as
broad as the statute itself. It essentially
repeats the statutory prohibition. It does
not logically follow, therefore, that
lowering the standard of care would be
the type of ‘‘means reasonably designed
to prevent’’ within the contemplation of
the regulatory mandate within Section
206(4). Lowering the standard of care is
instead an attempt to rewrite the statute
by assigning new definitions to the
words of the statute. A potential
unfortunate consequence of the
Adopting Release’s change in mental
state is that it is now arguably contrary
to statute and therefore might interfere
with the SEC’s ability to use the rule
effectively.83 Congress included a
rulemaking directive in order to give the
SEC the necessary authority to provide
clarity in this area about the types of
practices covered by the statute’s broad
80 O’Hagan,
521 U.S. at 672–73.
dealt with Rule 14e–3(a), which
governed trading on non-public, material
information in connection with a tender offer.
Steadman dealt with Rule 206(4)–2, the investment
advisor custody rule.
82 O’Hagan, 521 U.S. at 673–74.
83 See Chevron U.S.A. Inc. v. Natural Resources
Defense Council, Inc., 467 U.S. 837, 844 (1984). The
Adopting Release states: ‘‘Since the Commission is
clearly authorized to prescribe [sic] conduct that
goes beyond fraud as a means reasonably designed
to prevent fraud, prohibiting deceptive conduct
done negligently is a way to accomplish this
objective.’’ Adopting Release at Section II.D. This
does not answer the question, however, of whether
‘‘fraudulent, deceptive, or manipulative’’ conduct
can arise from negligent acts.
jlentini on PROD1PC65 with RULES
81 O’Hagan
VerDate Aug<31>2005
17:01 Aug 08, 2007
Jkt 211001
prohibition,84 not to alter the standard
of care that Congress selected through
the language it used.85 Imposing a
negligence standard is particularly
improper given that, as the Adopting
Release notes, ‘‘Rule 206(4)–8 does not
create under the Advisers Act a
fiduciary duty to investors and
prospective investors in a pooled
investment vehicle.’’ 86
Finally, from a purely practical
perspective, I dispute the regulatory
approach underlying the contention that
‘‘by taking sufficient care to avoid
negligent conduct, advisers will be more
likely to avoid reckless deception.’’ 87
By an extension of that same logic, a
strict liability standard would evoke
even more care by advisors. Even if the
SEC is authorized to pick the standard
of care that applies broadly to all
‘‘fraudulent, deceptive, or
manipulative’’ acts and practices,
arbitrarily selecting a higher standard of
care ‘‘just to be on the safe side’’ has the
potential of misdirecting enforcement
and inspection resources and chilling
well-intentioned advisors from serving
their investors.
[FR Doc. E7–15531 Filed 8–8–07; 8:45 am]
BILLING CODE 8010–01–P
SOCIAL SECURITY ADMINISTRATION
20 CFR Parts 404 and 416
[Docket No. SSA 2007–0036]
RIN 0960–AG49
Amendment to the Attorney Advisor
Program
Social Security Administration.
Interim final rule with request
for comments.
AGENCY:
ACTION:
SUMMARY: We are announcing this
interim final rule to modify, on a
temporary basis, the prehearing
procedures we follow in claims for
Social Security disability benefits or
supplemental security income (SSI)
84 Up until now under Section 206(4), we have
done exactly this. We have adopted rules covering
advertisements [17 CFR 275.206(4)–1], custody of
client funds and securities [17 CFR 275.206(4)–2],
cash payments for client solicitations [17 CFR
275.206(4)–3], disclosure of financial and
disciplinary information [17 CFR 275.206(4)–4],
proxy voting [17 CFR 275.206(4)–6], and
compliance procedures [17 CFR 275.206(4)–7].
85 See H.R. Rep. No. 2179 at 7 (1960) (identifying
as the ‘‘problem’’ that Section 206(4) was intended
to remedy: ‘‘there has always been a question as to
the scope of the fraudulent and deceptive activities
which are prohibited and the extent to which the
Commission is limited in this area by common law
concepts of fraud and deceit.’’).
86 Adopting Release at Section II.D.
87 Adopting Release at Section II.D.
PO 00000
Frm 00039
Fmt 4700
Sfmt 4700
44763
payments based on disability or
blindness. Under the interim final rule,
we may allow certain attorney advisors,
under managerial oversight, to conduct
certain prehearing proceedings, and
where the documentary record
developed as a result of these
proceedings warrants, issue decisions
that are wholly favorable to the parties
to the hearing.
DATES: Effective date: This rule is
effective August 9, 2007. Comment date:
To be sure that your comments are
considered, we must receive them no
later than October 9, 2007.
ADDRESSES: You may give us your
comments by: Internet through the
Federal eRulemaking Portal at https://
www.regulations.gov; e-mail to
regulations@ssa.gov; telefax to (410)
966–2830; or letter to the Commissioner
of Social Security, P.O. Box 17703,
Baltimore, MD 21235–7703. You may
also deliver them to the Office of
Regulations, Social Security
Administration, 107 Altmeyer Building,
6401 Security Boulevard, Baltimore, MD
21235–6401, between 8 a.m. and 4:30
p.m. on regular business days.
Comments are posted on the Federal
eRulemaking Portal, or you may inspect
them on regular business days by
making arrangements with the contact
person shown in this preamble.
FOR FURTHER INFORMATION CONTACT:
Marilyn Hull, Social Security
Administration, 5107 Leesburg Pike,
Falls Church, VA 22041–3260, 703–
605–8500 for information about this
notice. For information on eligibility or
filing for benefits, call our national tollfree number, 1–800–772–1213 or TTY
1–800–325–0778, or visit our Internet
site, Social Security Online, at https://
www.socialsecurity.gov.
SUPPLEMENTARY INFORMATION:
Electronic Version
The electronic file of this document is
available on the date of publication in
the Federal Register at https://
www.gpoaccess.gov/fr/.
Explanation of Changes
We are dedicated to providing highquality service to the American public.
Today and for the foreseeable future, we
face significant challenges in our ability
to provide the level of service that
disability benefit claimants deserve
because of the significantly increased
number and complexity of these benefit
claims. Consequently, we are publishing
a temporary modification to the
procedures we follow in the
administrative law judge (ALJ) hearings
process in claims for Social Security
disability benefits or SSI payments
E:\FR\FM\09AUR1.SGM
09AUR1
]]>Agencies
[Federal Register Volume 72, Number 153 (Thursday, August 9, 2007)]
[Rules and Regulations]
[Pages 44756-44763]
From the Federal Register Online via the Government Printing Office [www.gpo.gov]
[FR Doc No: E7-15531]
=======================================================================
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SECURITIES AND EXCHANGE COMMISSION
17 CFR Part 275
[Release No. IA-2628; File No. S7-25-06]
RIN 3235-AJ67
Prohibition of Fraud by Advisers to Certain Pooled Investment
Vehicles
AGENCY: Securities and Exchange Commission.
ACTION: Final rule.
-----------------------------------------------------------------------
SUMMARY: The Securities and Exchange Commission is adopting a new rule
that prohibits advisers to pooled investment vehicles from making false
or misleading statements to, or otherwise defrauding, investors or
prospective investors in those pooled vehicles. This rule is designed
to clarify, in light of a recent court opinion, the Commission's
ability to bring enforcement actions under the Investment Advisers Act
of 1940 against investment advisers who defraud investors or
prospective investors in a hedge fund or other pooled investment
vehicle.
DATES: Effective Date: September 10, 2007.
FOR FURTHER INFORMATION CONTACT: David W. Blass, Assistant Director,
Daniel S. Kahl, Branch Chief, or Vivien Liu, Senior Counsel, at 202-
551-6787, Division of Investment Management, Securities and Exchange
Commission, 100 F Street, NE., Washington, DC 20549-5041.
SUPPLEMENTARY INFORMATION: The Commission is adopting new rule 206(4)-8
under the Investment Advisers Act of 1940 (``Advisers Act'').\1\
---------------------------------------------------------------------------
\1\ 15 U.S.C. 80b. Unless otherwise noted, when we refer to the
Advisers Act, or any paragraph of the Advisers Act, we are referring
to 15 U.S.C. 80b of the United States Code, at which the Advisers
Act is codified.
---------------------------------------------------------------------------
I. Introduction
On December 13, 2006, we proposed a new rule under the Advisers Act
that would prohibit advisers to pooled investment vehicles from
defrauding investors or prospective investors in pooled investment
vehicles they advise.\2\ We proposed the rule in response to the
opinion of the Court of Appeals for the District of Columbia Circuit in
Goldstein v. SEC, which created some uncertainty regarding the
application of sections 206(1) and 206(2) of the Advisers Act in
certain cases where investors in a pool are defrauded by an investment
adviser to that pool.\3\ In addressing the scope of the exemption from
registration in section 203(b)(3) of the Advisers Act and the meaning
of ``client'' as used in that section, the Court of Appeals expressed
the view that, for purposes of sections 206(1) and (2) of the Advisers
Act, the ``client'' of an investment
[[Page 44757]]
adviser managing a pool is the pool itself, not an investor in the
pool. As a result, it was unclear whether the Commission could continue
to rely on sections 206(1) and (2) of the Advisers Act to bring
enforcement actions in certain cases where investors in a pool are
defrauded by an investment adviser to that pool.\4\
---------------------------------------------------------------------------
\2\ Prohibition of Fraud by Advisers to Certain Pooled
Investment Vehicles; Accredited Investors in Certain Private
Investment Vehicles, Investment Advisers Act Release No. 2576 (Dec.
27, 2006) [72 FR 400 (Jan. 4, 2007)] (the ``Proposing Release''). In
the Proposing Release, we also proposed two new rules that would
define the term ``accredited natural person'' under Regulation D and
section 4(6) of the Securities Act of 1933 [15 U.S.C. 77d(6)]
(``Securities Act''). As proposed, these rules would add to the
existing definition of ``accredited investor'' and apply to private
offerings of certain unregistered investment pools. On May 23, 2007,
we voted to propose more general amendments to the definition of
accredited investor. Proposed Modernization of Smaller Company
Capital-Raising and Disclosure Requirements, Securities Act Release
No. ---- (----, 2007) [72 FR ---- (----, 2007)]. We plan to defer
consideration of our proposal to define the term accredited natural
person until we have had the opportunity to evaluate fully the
comments we received on that proposal together with those we receive
on our May 2007 proposal.
\3\ 451 F.3d 873 (D.C. Cir. 2006) (``Goldstein'').
\4\ Prior to the issuance of the Goldstein decision, we brought
enforcement actions against advisers alleging false and misleading
statements to investors under sections 206(1) and (2) of the
Advisers Act. See, e.g., SEC v. Kirk S. Wright, International
Management Associates, LLC, Litigation Release No. 19581 (Feb. 28,
2006); SEC v. Wood River Capital Management, LLC, Litigation Release
No. 19428 (Oct. 13, 2005); SEC v. Samuel Israel III; Daniel E.
Marino; Bayou Management, LLC; Bayou Accredited Fund, LLC; Bayou
Affiliates Fund, LLC; Bayou No Leverage Fund, LLC; and Bayou
Superfund, LLC, Litigation Release No. 19406 (Sept. 29, 2005); SEC
v. Beacon Hill Asset Management LLC, Litigation Release No. 18745A
(June 16, 2004).
---------------------------------------------------------------------------
In its opinion, the Court of Appeals distinguished sections 206(1)
and (2) from section 206(4) of the Advisers Act, which is not limited
to conduct aimed at clients or prospective clients of investment
advisers.\5\ Section 206(4) provides us with rulemaking authority to
define, and prescribe means reasonably designed to prevent, fraud by
advisers.\6\ We proposed rule 206(4)-8 under this authority.
---------------------------------------------------------------------------
\5\ See Goldstein, supra note 3, at note 6. See also United
States v. Elliott, 62 F.3d 1304, 1311 (11th Cir. 1995).
\6\ Section 206(4) of the Advisers Act makes it unlawful for an
investment adviser to ``engage in any act, practice, or course of
business which is fraudulent, deceptive, or manipulative'' and
authorizes us ``by rules and regulations [to] define, and prescribe
means reasonably designed to prevent, such acts, practices, and
courses of business as are fraudulent, deceptive, or manipulative.''
---------------------------------------------------------------------------
We received 45 comment letters in response to our proposal.\7\ Most
commenters generally supported the proposal. Eighteen endorsed the rule
as proposed, noting that the rule would strengthen the antifraud
provisions of the Advisers Act or that the rule would clarify the
Commission's enforcement authority with respect to advisers.\8\ Others,
however, urged that we make revisions that would restrict the scope of
the rule to more narrowly define the conduct or acts it prohibits.\9\
---------------------------------------------------------------------------
\7\ We received over 600 comment letters that addressed the
proposed amendments to the term ``accredited natural person'' under
Regulation D and section 4(6) of the Securities Act. All of the
public comments we received are available for inspection in our
Public Reference Room at 100 F Street, NE., Washington DC, 20549 in
File No. S7-25-06, or may be viewed at https://www.sec.gov/comments/
s7-25-06/s72506.shtml.
\8\ E.g., Letter of the Alternative Investments Compliance
Association (Mar. 5, 2007); Letter of the CFA Center for Financial
Market Integrity (Mar. 9, 2007) (``CFA Center Letter''); Letter of
the Coalition of Private Investment Companies (Mar. 9, 2007); Letter
of the Commonwealth of Massachusetts (Mar. 9, 2007) (``Massachusetts
Letter''); Letter of the Department of Banking of the State of
Connecticut (Mar. 8, 2007); Letter of the North America Securities
Administrators Association (Apr. 2, 2007) (``NASAA Letter''); and
Letter of the U.S. Chamber of Commerce (Mar. 9, 2007). Another
commenter observed that the proposed rules are broadly similar to
current U.K. legislation and regulations. See Letter of Alternative
Investment Management Association (Mar. 9, 2007) (``AIMA Letter'').
\9\ E.g., Letter of American Bar Association (Mar. 12, 2007)
(``ABA Letter''); Letter of Davis Polk & Wardwell (Mar. 9, 2007)
(``Davis Polk Letter''); Letter of Dechert LLP (Mar. 8, 2007)
(``Dechert Letter''); Letter of New York City Bar (Mar. 8, 2007)
(``NYCB Letter''); Letter of Schulte Roth & Zabel LLP (Mar. 9, 2007)
(``Schulte Roth Letter''); and Letter of Sullivan & Cromwell LLP
(Mar. 9, 2007) (``Sullivan & Cromwell Letter'').
---------------------------------------------------------------------------
Today, we are adopting new rule 206(4)-8 as proposed. The rule
prohibits advisers from (i) making false or misleading statements to
investors or prospective investors in hedge funds and other pooled
investment vehicles they advise, or (ii) otherwise defrauding these
investors. The rule clarifies that an adviser's duty to refrain from
fraudulent conduct under the federal securities laws extends to the
relationship with ultimate investors and that the Commission may bring
enforcement actions under the Advisers Act against investment advisers
who defraud investors or prospective investors in those pooled
investment vehicles.
II. Discussion
Rule 206(4)-8 prohibits advisers to pooled investment vehicles from
(i) making false or misleading statements to investors or prospective
investors in those pools or (ii) otherwise defrauding those investors
or prospective investors. We will enforce the rule through civil and
administrative enforcement actions against advisers who violate it.
Section 206(4) authorizes the Commission to adopt rules and
regulations that ``define, and prescribe means reasonably designed to
prevent, such acts, practices, and courses of business as are
fraudulent, deceptive, or manipulative.'' In adopting rule 206(4)-8, we
intend to employ all of the broad authority that Congress provided us
in section 206(4) and direct it at adviser conduct affecting an
investor or potential investor in a pooled investment vehicle.
A. Scope of Rule 206(4)-8
Some commenters questioned the scope of the rule, arguing that the
Commission should define fraud.\10\ We believe that we have done so,
only more broadly than some commenters would have us do. As the
Proposing Release indicated, our intent is to prohibit all fraud on
investors in pools managed by investment advisers. Congress expected
that we would use the authority provided by section 206(4) to
``promulgate general antifraud rules capable of flexibility.'' \11\ The
terms material false statements or omissions and ``acts, practices, and
courses of business as are fraudulent, deceptive, or manipulative''
encompass the well-developed body of law under the antifraud provisions
of the federal securities laws. The legal authorities identifying the
types of acts, practices, and courses of business that are fraudulent,
deceptive, or manipulative under the federal securities laws are
numerous, and we believe that the conduct prohibited by rule 206(4)-8
is sufficiently clear and well understood.\12\
---------------------------------------------------------------------------
\10\ E.g., ABA Letter, supra note 9; Letter of Debevoise &
Plimpton LLP (Mar. 14, 2007); and NYCB Letter, supra note 9.
\11\ S. Rep. No. 1760, 86th Cong., 2d. Sess. (June 28, 1960) at
4. See rule 206(4)-1(a)(5) [17 CFR. 275.206(4)-1(a)(5)] under the
Advisers Act; rule 17j-1(b) [17 CFR 270.17j-1(b)] under the
Investment Company Act of 1940 [15 U.S.C. 80a-1] (``Investment
Company Act''); and rule 13e-3(b)(1) [17 CFR 240.13e-3(b)(1)] under
the Securities Exchange Act of 1934 [15 U.S.C. 77a] (``Exchange
Act'').
\12\ Loss, Seligman, & Paredes, Securities Regulation, Chap. 9
(Fraud) (Fourth Ed. 2006); Hazen, Treatise on The Law of Securities
Regulation, Vol. 3, Ch. 12 (Manipulation and Fraud--Civil Liability;
Implied Private Remedies; SEC Rule 10b-5; Fraud in Connection With
the Purchase or Sale of Securities; Improper Trading on Nonpublic
Material Information) (Fifth Ed. 2005). See, e.g., Superintendent of
Insurance of New York v. Bankers Life & Casualty Co., 404 U.S. 6, 11
n. 7 (1971) (`` `We believe that section 10(b) and Rule 10b-5
prohibit all fraudulent schemes in connection with the purchase or
sale of securities, whether the artifices employed involve a garden
type variety of fraud, or present a unique form of deception. Novel
or atypical methods should not provide immunity from the securities
laws.' '' (quoting A. T. Brod & Co. v. Perlow, 375 F.2d 393, 397
(CA2 1967))); Santa Fe Industries, Inc. v. Green, 430 U.S. 462, 477
(1977) (``No doubt Congress meant to prohibit the full range of
ingenious devices that might be used to manipulate securities
prices.''). Moreover, the established legal principles are
sufficiently flexible to encompass future novel factual scenarios.
United States v. Brown, 555 F.2d 336, 339-40 (2d Cir. 1977) (``The
fact that there is no litigated fact pattern precisely in point may
constitute a tribute to the cupidity and ingenuity of the
malefactors involved but hardly provides an escape from the penal
sanctions of the securities fraud provisions here involved.'').
---------------------------------------------------------------------------
1. Investors and Prospective Investors
Rule 206(4)-8 prohibits investment advisers from making false or
misleading statements to, or engaging in other fraud on, investors or
prospective investors in a pooled investment vehicle they manage. The
scope of the rule is modeled on that of sections 206(1) and (2) of the
Advisers Act, which make unlawful fraud by advisers against clients or
prospective clients. Rule 206(4)-8 prohibits false or misleading
statements made, for example, to existing investors in account
statements
[[Page 44758]]
as well as to prospective investors in private placement memoranda,
offering circulars, or responses to ``requests for proposals,''
electronic solicitations, and personal meetings arranged through
capital introduction services.
Some commenters argued that the rule should not prohibit fraud
against prospective investors in a pooled investment vehicle, asserting
that such fraud does not actually harm investors until they, in fact,
make an investment.\13\ We disagree. False or misleading statements and
other frauds by advisers are no less objectionable when made in an
attempt to draw in new investors than when made to existing
investors.\14\ For similar policy reasons that we believe led Congress
to apply the protections of sections 206(1) and (2) to prospective
clients, we have decided to apply those of rule 206(4)-8 to prospective
investors.\15\ We believe that prohibiting false or misleading
statements made to, or other fraud on, any prospective investors is a
means reasonably designed to prevent fraud.
---------------------------------------------------------------------------
\13\ Davis Polk Letter, supra note 9; Dechert Letter, supra note
9; NYCB Letter, supra note 9; Letter of the Securities Industry and
Financial Markets Association (Mar. 9, 2007); Sullivan & Cromwell
Letter, supra note 9.
\14\ See CFA Center Letter, supra note 8.
\15\ We have used the term ``prospective investor'' to give the
term similar scope to the term ``prospective client'' in sections
206(1) and (2). See, e.g., In the Matter of Ralph Harold Seipel, 38
S.E.C. 256, 257-58 (1958) (the solicitation of clients is part of
the activity of an investment adviser and it is immaterial for
purposes of an enforcement action under sections 206(1) and (2) that
an adviser engaging in fraudulent solicitations was not successful
in his efforts to obtain clients).
---------------------------------------------------------------------------
2. Unregistered Investment Advisers
Rule 206(4)-8 applies to both registered and unregistered
investment advisers.\16\ As we noted in the Proposing Release, many of
our enforcement cases against advisers to pooled investment vehicles
have been brought against advisers that are not registered under the
Advisers Act, and we believe it is critical that we continue to be in a
position to bring actions against unregistered advisers that manage
pools and that defraud investors in those pools.\17\ The two commenters
that expressed an explicit view on this aspect of the proposal
supported our application of the rule to advisers that are not
registered with the Commission.\18\
---------------------------------------------------------------------------
\16\ A few commenters requested that we clarify how we intend to
apply rule 206(4)-8 to offshore advisers' interaction with non-U.S.
investors. See AIMA Letter, supra note 8; Letter of Jones Day (Mar.
9, 2007); Sullivan & Cromwell Letter, supra note 9. Our adoption of
this rule will not alter our jurisdictional authority.
\17\ Proposing Release, supra note 2, at note 14.
\18\ Massachusetts Letter, supra note 8; NASAA Letter, supra
note 8.
---------------------------------------------------------------------------
3. Pooled Investment Vehicles
The rule we are adopting today applies to investment advisers with
respect to any ``pooled investment vehicle'' they advise. The rule
defines a pooled investment vehicle \19\ as any investment company
defined in section 3(a) of the Investment Company Act \20\ and any
privately offered pooled investment vehicle that is excluded from the
definition of investment company by reason of either section 3(c)(1) or
3(c)(7) of the Investment Company Act.\21\ As a result, the rule
applies to advisers to hedge funds, private equity funds, venture
capital funds, and other types of privately offered pools that invest
in securities, as well as advisers to investment companies that are
registered with us.\22\
---------------------------------------------------------------------------
\19\ Rule 206(4)-8(b).
\20\ 15 U.S.C. 80a-3(a). Unless otherwise noted, when we refer
to the Investment Company Act, or any paragraph of the Investment
Company Act, we are referring to 15 U.S.C. 80a of the United States
Code, at which the Company Act is codified.
\21\ Section 3(c)(1) of the Investment Company Act excludes from
the definition of investment company an issuer the securities (other
than short-term paper) of which are beneficially owned by not more
than 100 persons and that is not making or proposing to make a
public offering of its securities. Section 3(c)(7) of the Investment
Company Act excludes from the definition of investment company an
issuer the outstanding securities of which are owned exclusively by
persons who, at the time of acquisition of such securities, are
``qualified purchasers'' and that is not making or proposing to make
a public offering of its securities. ``Qualified purchaser'' is
defined in section 2(a)(51) of the Investment Company Act generally
to include a natural person (or a company owned by two or more
related natural persons) who owns not less than $5,000,000 in
investments; a person, acting for its own account or accounts of
other qualified purchasers, who owns and invests on a discretionary
basis, not less than $25,000,000; and a trust whose trustee, and
each of its settlors, is a qualified purchaser.
\22\ We have brought enforcement actions under the Advisers Act
against advisers to these types of funds. See, e.g., In the Matter
of Askin Capital Management, L.P and David J. Askin, Investment
Advisers Act Release No. 1492 (May 23, 1995) (hedge fund); In the
Matter of Thayer Capital Partners, Investment Advisers Act Release
No. 2276 (Aug. 12, 2004) (private equity fund); SEC v. Michael A.
Liberty, Litigation Release No. 19601 (Mar. 8, 2006) (venture
capital fund).
---------------------------------------------------------------------------
Several commenters supported applying the protection of the new
antifraud rule to investors in all these kinds of pooled investment
vehicles, noting, for example, that every investor, not just the
wealthy or sophisticated that typically invest in private pools, should
be protected from fraud.\23\ Some other commenters urged us not to
apply the rule to advisers to registered investment companies, arguing
that the rule is unnecessary because other provisions of the federal
securities laws prohibiting fraud are available to the Commission to
address these matters.\24\ They expressed concern that application of
another antifraud provision with different elements would be
burdensome. These commenters claimed that the rule would, for example,
make it necessary for advisers to conduct extensive reviews of all
communications with clients. But the other antifraud provisions
available to us contain different elements because they were not
specifically designed to address frauds by investment advisers with
respect to investors in pooled investment vehicles. In some cases, the
other antifraud provisions may not permit us to proceed against the
adviser.\25\ As a result, the existing antifraud provisions may not be
available to us in all cases. As we discussed above, before the
Goldstein decision we had brought actions against advisers to mutual
funds under sections 206(1) and (2) for defrauding investors in mutual
funds.\26\ Because, before the Goldstein decision, advisers to pooled
investment vehicles operated with the understanding that the Advisers
Act prohibited the conduct that this rule prohibits, we believe that
advisers that are attentive to their traditional compliance
responsibilities will not need to alter their business practices or
take additional steps and incur new costs as a result of this rule's
adoption.
---------------------------------------------------------------------------
\23\ E.g., NASAA Letter, supra note 8.
\24\ E.g., ABA Letter, supra note 9; Letter of Investment
Adviser Association (Mar. 9, 2007); Letter of Investment Company
Institute (Mar. 9, 2007) (``ICI Letter''); Sullivan & Cromwell
Letter, supra note 9. Commenters noted in particular that section
34(b) of the Investment Company Act already prohibits an adviser
from making fraudulent material statements or omissions in a fund's
registration statement or in required records.
\25\ This may be the case with respect to section 34(b) of the
Investment Company Act, for example, if the adviser's fraudulent
statements are not made in a document described in that section, or
with respect to rule 10b-5 under the Exchange Act, where the
fraudulent conduct does not relate to a misstatement or omission in
connection with the purchase or sale of any security.
\26\ See, e.g., In the Matter of Van Kampen Investment Advisory
Corp., Investment Advisers Act Release No. 1819 (Sept. 8, 1999); In
the Matter of The Dreyfus Corporation, Investment Advisers Act
Release No. 1870 (May 10, 2000); In the Matter of Federated
Investment Management Company, Investment Advisers Act Release No.
2448 (Nov. 28, 2005).
---------------------------------------------------------------------------
B. Prohibition on False or Misleading Statements
Rule 206(4)-8(a)(1) prohibits any investment adviser to a pooled
investment vehicle from making an untrue statement of a material fact
to any investor or prospective investor in the pooled investment
vehicle, or omitting to state a material fact necessary in order to
make the statements made to any investor or
[[Page 44759]]
prospective investor in the pooled investment vehicle, in the light of
the circumstances under which they were made, not misleading.\27\
---------------------------------------------------------------------------
\27\ A fact is material if there is a substantial likelihood
that a reasonable investor in making an investment decision would
consider it as having significantly altered the total mix of
information available. Basic, Inc. v. Levinson, 485 U.S. 224, 231-32
(1988); TSC Industries, Inc. v. Northway, Inc., 426 U.S. 438, 449
(1976). See also In the Matter of Van Kampen Investment Advisory
Corp., supra note 26; In the Matter of the Dreyfus Corporation,
supra note 26.
---------------------------------------------------------------------------
The provision is very similar to those in many of our antifraud
laws and rules that, depending upon the circumstances, may also be
applicable to the same investor communications.\28\ Sections 206(1) and
(2) have imposed similar obligations on advisers since 1940 and, before
Goldstein, were commonly accepted as imposing similar requirements on
communications with investors in a fund. For these reasons, and because
the nature of the duty to communicate without false statements is so
well developed in current law, we believe that commenters' concerns
about the breadth of the prohibition or any chilling effect the new
rule might have on investor communications are misplaced.\29\ Advisers
to pooled investment vehicles attentive to their traditional compliance
responsibilities will not need to alter their communications with
investors.
---------------------------------------------------------------------------
\28\ See, e.g., sections 12 and 17 of the Securities Act [15
U.S.C. 77l, 77q]; section 14 of the Exchange Act [15 U.S.C. 78n];
section 34 of the Investment Company Act; rules 156, 159, and 610
under the Securities Act [17 CFR 230.156, 230.159, 230.610]; rules
10b-5, 13e-3, 13e-4, and 15c1-2 under the Exchange Act [17 CFR
240.10b-5, 240.13e-3, 240.13e-4, 240.15c1-2]; and rule 17j-1 under
the Investment Company Act [17 CFR 270.17j-1]).
\29\ Letter of Managed Funds Association (Mar. 9, 2007) (``MFA
Letter''); NYCB Letter, supra note 9; Davis Polk Letter, supra note
9; Dechert Letter, supra note 9; Letter of Seward & Kissel LLP (Mar.
8, 2007) (``Seward & Kissel Letter'').
---------------------------------------------------------------------------
Rule 206(4)-8(a)(1) prohibits advisers to pooled investment
vehicles from making any materially false or misleading statements to
investors in the pool regardless of whether the pool is offering,
selling, or redeeming securities. While the new rule differs in this
aspect from rule 10b-5 under the Exchange Act, the conduct prohibited
is similar. The new rule prohibits, for example, materially false or
misleading statements regarding investment strategies the pooled
investment vehicle will pursue, the experience and credentials of the
adviser (or its associated persons), the risks associated with an
investment in the pool, the performance of the pool or other funds
advised by the adviser, the valuation of the pool or investor accounts
in it, and practices the adviser follows in the operation of its
advisory business such as how the adviser allocates investment
opportunities.\30\
---------------------------------------------------------------------------
\30\ We have previously brought enforcement actions alleging
these or similar types of frauds. See Proposing Release, supra note
2, at note 29.
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C. Prohibition of Other Frauds
Rule 206(4)-8(a)(2) makes it a fraudulent, deceptive, or
manipulative act, practice, or course of business for any investment
adviser to a pooled investment vehicle to ``otherwise engage in any
act, practice, or course of business that is fraudulent, deceptive, or
manipulative with respect to any investor or prospective investor in
the pooled investment vehicle.'' \31\ As we noted in the Proposing
Release, the wording of this provision is drawn from the first sentence
of section 206(4) and is designed to apply more broadly to deceptive
conduct that may not involve statements.\32\
---------------------------------------------------------------------------
\31\ Rule 206(4)-8(a)(2).
\32\ See Section II.C of the Proposing Release, supra note 2.
---------------------------------------------------------------------------
Some commenters asserted that section 206(4) provides us authority
only to adopt prophylactic rules that explicitly identify conduct that
would be fraudulent under the new rule.\33\ We believe our authority is
broader. We do not believe that the commenters' suggested approach
would be consistent with the purposes of the Advisers Act or the
protection of investors. That approach would have us adopt the rule
prohibiting fraudulent communications but not fraudulent conduct.\34\
But, section 206(4) itself specifically authorizes us to adopt rules
defining and prescribing ``acts, practices and courses of business,''
(i.e., conduct), and does not explicitly refer to communications,
which, nonetheless, represent a form of an act, practice, or course of
business. In addition, rule 206(4)-8 as adopted would provide greater
protection to investors in pooled investment vehicles.
---------------------------------------------------------------------------
\33\ ABA Letter, supra note 9; ICI Letter, supra note 24;
Schulte Roth Letter, supra note 9; Sullivan & Cromwell Letter, supra
note 9.
\34\ See, e.g., ABA Letter, supra note 9.
---------------------------------------------------------------------------
Alternatively, commenters would have us adopt a rule prohibiting
identified known fraudulent conduct or would have us provide detailed
commentary describing specific forms of fraudulent conduct that the
rule would prohibit.\35\ Either approach would fail to prohibit
fraudulent conduct we did not identify, and could provide a roadmap for
those wishing to engage in fraudulent conduct. This approach would be
inconsistent with our historical application of the federal securities
laws under which broad prohibitions have been applied against specific
harmful activity.
---------------------------------------------------------------------------
\35\ Id.
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D. Other Matters
We noted in the Proposing Release that, unlike violations of rule
10b-5 under the Exchange Act, the Commission would not need to
demonstrate that an adviser violating rule 206(4)-8 acted with
scienter.\36\ Commenters questioned whether the rule should encompass
negligent conduct, arguing that it would ``expand the concept of fraud
itself beyond its original meaning.'' \37\ We read the language of
section 206(4) as not by its terms limited to knowing or deliberate
conduct. For example, section 206(4) encompasses ``acts, practices, and
courses of business as are * * * deceptive,'' thereby reaching conduct
that is negligently deceptive as well as conduct that is recklessly or
deliberately deceptive. In addition, the Court of Appeals for the
District of Columbia Circuit concluded that ``scienter is not required
under section 206(4).'' \38\ We believe use of a negligence standard
also is appropriate as a method reasonably designed to prevent fraud.
As the Supreme Court noted in U.S. v. O'Hagan, ``[a] prophylactic
measure, because its mission is to prevent, typically encompasses more
than the core activity prohibited.'' \39\ In O'Hagan, the Court held
that under section 14(e) ``the Commission may prohibit acts, not
themselves fraudulent under the common law or Sec. 10(b), if the
prohibition is `reasonably designed to prevent * * * acts and practices
[that] are fraudulent.' '' \40\ Along these lines, the prohibitions in
rule 206(4)-8 are reasonably designed to prevent fraud. We believe
that, by taking sufficient care to avoid negligent conduct, advisers
will be more likely to avoid reckless deception. Since the Commission
clearly is authorized to prescribe
[[Page 44760]]
conduct that goes beyond fraud as a means reasonably designed to
prevent fraud, prohibiting deceptive conduct done negligently is a way
to accomplish this objective.
---------------------------------------------------------------------------
\36\ Section II.B of the Proposing Release, supra note 2.
\37\ See ABA Letter, supra note 9 at page 3.
\38\ SEC v. Steadman, 967 F.2d 636, at 647 (D.C. Cir. 1992). The
court in Steadman analogized section 206(4) of the Advisers Act to
section 17(a)(3) of the Securities Act, which the Supreme Court had
held did not require a finding of scienter, id. (citing Aaron v.
SEC, 446 U.S. 680 (1980)). In discussing section 17(a)(3) and its
lack of a scienter requirement, the Steadman court observed that,
similarly, a violation of section 206(2) of the Advisers Act could
rest on a finding of simple negligence. Id. at 643, note 5. But see
Aaron at 690-91 (citing Ernst & Ernst v. Hochfelder, 425 U.S. 185,
199 (1976)); cf. S. Rep. No. 1760, 86th Cong., 2d. Sess. (June 28,
1960) at 8 and H. R. Rep. 2179, 86th Cong., 2d Sess. (Aug. 26, 1960)
at 8 (comparing section 206(4) to section 15(c)(2) of the Exchange
Act).
\39\ U.S. v. O'Hagan, 521 U.S. 642, 672-73 (1997).
\40\ Id. at 673.
---------------------------------------------------------------------------
Rule 206(4)-8 does not create under the Advisers Act a fiduciary
duty to investors or prospective investors in a pooled investment
vehicle not otherwise imposed by law. Nor does the rule alter any duty
or obligation an adviser has under the Advisers Act, any other federal
law or regulation, or any state law or regulation (including state
securities laws) to investors in a pooled investment vehicle it
advises.\41\ The rule, for example, will permit us to bring an
enforcement action against an investment adviser that violates a
fiduciary duty imposed by other law if the violation of such law or
obligation also constitutes an act, practice, or course of business
that is fraudulent, deceptive, or manipulative within the meaning of
the rule and section 206(4).\42\
---------------------------------------------------------------------------
\41\ For example, under the Uniform Limited Partnership Act,
advisers who serve as general partners owe fiduciary duties to the
limited partners. Unif. Limited Partnership Act section 408 (2001).
\42\ For example, if an adviser has a duty from a source other
than the rule to make a material disclosure to an investor in a fund
and negligently or deliberately fails to make the disclosure, the
rule would apply to the failure.
---------------------------------------------------------------------------
Finally, the rule does not create a private right of action.\43\
---------------------------------------------------------------------------
\43\ The Supreme Court has held that ``there exists a limited
private remedy under the Investment Advisers Act of 1940 to void an
investment adviser's contract, but that the Act confers no other
private causes of action, legal or equitable.'' Transamerica
Mortgage Advisors, Inc. v. Lewis, 444 U.S. 11 at 24 (1979) (footnote
omitted).
---------------------------------------------------------------------------
III. Paperwork Reduction Act
The Paperwork Reduction Act of 1995 does not apply because rule
206(4)-8 does not impose a new ``collection of information'' within the
meaning of the Paperwork Reduction Act of 1995. The rule does not
create any filing, reporting, recordkeeping, or disclosure requirements
for investment advisers subject to the rule. Accordingly, there is no
``collection of information'' under the Paperwork Reduction Act that
requires the approval of the Office of Management and Budget under 44
U.S.C. 3501.
IV. Cost-Benefit Analysis
The Commission is sensitive to costs imposed by our rules and the
benefits that derive from them. In the Proposing Release, we encouraged
commenters to discuss any potential costs and benefits that we did not
consider in our discussion. Three commenters addressed the issue of
cost. Two of them stated their belief that the rule would increase
advisers' costs of compliance, by, for example, making it necessary for
advisers to conduct extensive reviews of all communications with
clients.\44\ One stated that the rule would achieve a reasonable
balance of providing important benefits to investors at an acceptable
cost.\45\ None of the three commenters, however, provided analysis or
empirical data in connection with their statements.
---------------------------------------------------------------------------
\44\ NYCB Letter, supra note 9; Seward & Kissel Letter, supra
note 29.
\45\ CFA Center Letter, supra note 8.
---------------------------------------------------------------------------
The rule makes it a fraudulent, deceptive, or manipulative act,
practice, or course of business within the meaning of section 206(4)
for any investment adviser to a pooled investment vehicle to make any
untrue statement of a material fact or to omit to state a material fact
necessary in order to make the statements made, in light of the
circumstances under which they were made, not misleading, to any
investor or prospective investor in the pooled investment vehicle. The
rule also makes it a fraudulent, deceptive, or manipulative act,
practice, or course of business within the meaning of section 206(4)
for any investment adviser to a pooled investment vehicle to otherwise
engage in any act, practice, or course of business that is fraudulent,
deceptive, or manipulative with respect to any investor or prospective
investor in the pooled investment vehicle. For the reasons discussed,
we do not believe that the rule will require advisers to incur new or
additional costs.
Investment advisers to pooled investment vehicles should not be
making untrue statements or omitting material facts or otherwise be
engaged in fraud with respect to investors or prospective investors in
pooled investment vehicles today, because federal authorities, state
authorities, and private litigants often can, and do, seek redress from
the adviser for the untrue statements or omissions or other frauds. In
most cases, the conduct that the rule prohibits is already prohibited
by federal securities statutes,\46\ other federal statutes (including
federal wire fraud statutes),\47\ as well as state law.\48\
---------------------------------------------------------------------------
\46\ See, e.g., section 10(b) of the Exchange Act [15 U.S.C.
78j(b)] and section 17(a) of the Securities Act [15 U.S.C. 77q]
which would apply when the false statements are made ``in connection
with the purchase or sale of a security'' or involve the ``offer or
sale'' of a security, and section 34(b) of the Investment Company
Act which makes it unlawful ``to make any untrue statement of a
material fact in any registration statement, application, report,
account, record, or other document filed or transmitted pursuant to
[the Investment Company Act] * * *.''
\47\ See, e.g., 18 U.S.C. 1341 (Frauds and Swindles) and 18
U.S.C. 1343 (Fraud by wire, radio, or television) which make it a
criminal offense to use the mails or to communicate by means of
wire, having devised a scheme to defraud or for obtaining money or
property by means of false or fraudulent pretenses, and 18 U.S.C.
1957 (Engaging in monetary transactions in property derived from
specified unlawful activity) which makes it a criminal racketeering
offense to engage or attempt to engage in a transaction in
criminally derived property of a value greater than $10,000.
\48\ See, e.g., Metro Communications Corp. BVI v. Advanced
Mobilecomm Technologies, 854 A.2d 121, 156 (Del. Ch. 2004) (court
held that plaintiff-former member of LLC had sufficiently alleged a
common law fraud claim based on the allegation that a series of
reports by LLC's managers contained misleading statements; court
stated that ``[i]n the usual fraud case, the speaking party who is
subject to an accusation of fraud is on the opposite side of a
commercial transaction from the plaintiff, who alleges that but for
the material misstatements or omissions of the speaking party he
would not have contracted with the speaking party'').
---------------------------------------------------------------------------
We recognize that there are costs involved in assuring that
communications to investors and prospective investors do not contain
untrue or misleading statements and preventing other frauds. Advisers
have incurred, and will continue to incur, these costs due to the
prohibitions and deterrent effect of the law and rules that apply under
these circumstances. While each of the provisions noted above may have
different limitation periods, apply in different factual circumstances,
or require the government (or a private litigant) to prove different
states of mind than the rule, as discussed above we believe that the
multiple prohibitions against fraud, and the consequences under both
criminal and civil law for fraud, should currently cause an adviser to
take the precautions it deems necessary to refrain from such conduct.
Furthermore, prior to Goldstein, advisers operated with the
understanding that the Advisers Act prohibited the same conduct that
would be prohibited by the rule. Accordingly, we do not believe that
advisers to pooled investment vehicles attentive to their traditional
compliance responsibilities will need to take steps or alter their
business practices in such a way that will require them to incur new or
additional costs as a result of the adoption of the rule.
We also recognize that the rule may cause some advisers to pay more
attention to the information they present to better guard against
making an untrue or misleading statement to an investor or prospective
investor and to reevaluate measures that are intended to prevent fraud.
As a consequence, some advisers might seek guidance, legal or
otherwise, and more closely review the
[[Page 44761]]
information that they disseminate to investors and prospective
investors and the antifraud related policies and procedures they have
implemented. While increased concern about making false statements or
committing fraud could be attributable to the new rule, advisers should
already be incurring these costs to ensure truthfulness and prevent
fraud, regardless of the rule, because of the myriad of laws or
regulations that may already apply.
The principal benefit of the rule is that it clearly enables the
Commission to bring enforcement actions under the Advisers Act, if an
adviser to a pooled investment vehicle disseminates false or misleading
information to investors or prospective investors or otherwise commits
fraud with respect to any investor or prospective investor. As noted
above, the existing antifraud provisions may not be available to us in
all cases. Through our enforcement actions we are able to protect fund
investor assets by stopping ongoing frauds,\49\ barring persons that
have committed certain specified violations or offenses from being
associated with an investment adviser,\50\ imposing penalties,\51\
seeking court orders to protect fund assets,\52 \and to order
disgorgement of ill-gotten gains.\53\ Moreover, we believe that rule
206(4)-8 will deter advisers to pooled investment vehicles from
engaging in fraudulent conduct with respect to investors in those pools
and will provide investors with greater confidence when investing in
pooled investment vehicles.
---------------------------------------------------------------------------
\49\ See section 203(k) of the Advisers Act (Commission
authority to issue cease and desist orders).
\50\ See section 203(f) of the Advisers Act (Commission
authority to bar a person from being associated with an investment
adviser).
\51\ See section 203(i) of the Advisers Act (Commission
authority to impose civil penalties).
\52\ See section 209(d) of the Advisers Act (Commission
authority to seek injunctions and restraining orders in federal
court).
\53\ See section 203(j) of the Advisers Act (Commission
authority to order disgorgement).
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V. Regulatory Flexibility Act Analysis
The Commission certified, pursuant to section 605(b) of the
Regulatory Flexibility Act, that rule 206(4)-8 will not have a
significant economic impact on a substantial number of small
entities.\54\ This certification was included in the Proposing
Release.\55\ While we encouraged written comment regarding this
certification, none of the commenters responded to this request.
---------------------------------------------------------------------------
\54 \ 5 U.S.C. 605(b).
\55\ Section VII.A of the Proposing Release, supra note 2.
---------------------------------------------------------------------------
VI. Statutory Authority
We are adopting new rule 206(4)-8 pursuant to our authority set
forth in sections 206(4) and 211(a) of the Advisers Act (15 U.S.C. 80b-
6(4) and 80b-11(a)).
List of Subjects in 17 CFR Part 275
Reporting and recordkeeping requirements, Securities.
VII. Text of Rules
0
For the reasons set out in the preamble, Title 17, Chapter II of the
Code of Federal Regulations is amended as follows:
PART 275--RULES AND REGULATIONS, INVESTMENT ADVISERS ACT OF 1940
0
1. The authority citation for Part 275 continues to read in part as
follows:
Authority: 15 U.S.C. 80b-2(a)(11)(F), 80b-2(a)(17), 80b-3, 80b-
4, 80b-4a, 80b-6(4), 80b-6a, and 80b-11, unless otherwise noted.
* * * * *
0
2. Section 275.206(4)-8 is added to read as follows:
Sec. 206(4)-8 Pooled investment vehicles.
(a) Prohibition. It shall constitute a fraudulent, deceptive, or
manipulative act, practice, or course of business within the meaning of
section 206(4) of the Act (15 U.S.C. 80b-6(4)) for any investment
adviser to a pooled investment vehicle to:
(1) Make any untrue statement of a material fact or to omit to
state a material fact necessary to make the statements made, in the
light of the circumstances under which they were made, not misleading,
to any investor or prospective investor in the pooled investment
vehicle; or
(2) Otherwise engage in any act, practice, or course of business
that is fraudulent, deceptive, or manipulative with respect to any
investor or prospective investor in the pooled investment vehicle.
(b) Definition. For purposes of this section ``pooled investment
vehicle'' means any investment company as defined in section 3(a) of
the Investment Company Act of 1940 (15 U.S.C. 80a-3(a)) or any company
that would be an investment company under section 3(a) of that Act but
for the exclusion provided from that definition by either section
3(c)(1) or section 3(c)(7) of that Act (15 U.S.C. 80a-3(c)(1) or (7)).
Dated: August 3, 2007.
By the Commission.
Nancy M. Morris,
Secretary.
Concurrence of Commissioner Paul S. Atkins to the Prohibition of Fraud
by Advisers to Certain Pooled Investment Vehicles
New Rule 206(4)-8 under the Investment Advisers Act of 1940
(``Advisers Act''),\56\ which we adopt today, prohibits advisors from
(i) making false or misleading statements to investors or prospective
investors in hedge funds and other pooled investment vehicles they
advise, or (ii) otherwise defrauding these investors.\57\ Although the
SEC has other ways to reach fraud by advisors, this new rule will fill
in gaps in the coverage of other transaction-based, anti-fraud
provisions so that the SEC may pursue advisors of pooled investment
vehicles who have defrauded investors and prospective investors in the
course of their acting as fund advisors. I support the new rule, but I
am writing separately to express my disagreement with the conclusions
in the Adopting Release \58\ related to the requisite mental state for
violation of the rule.\59\
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\56\ 15 U.S.C. 80b.
\57\ 17 CFR 275.206(4)-8. Paragraph (a) of the new rule
provides:
Prohibition. It shall constitute a fraudulent, deceptive, or
manipulative act, practice or course of business within the meaning
of section 206(4) of the Act (15 U.S.C. 80b-6(4)) for any investment
adviser to a pooled investment vehicle to:
(1) Make any untrue statement of a material fact or to omit to
state a material fact necessary to make the statements made, in the
light of the circumstances under which they were made, not
misleading, to any investor or prospective investor in the pooled
investment vehicle; or
(2) Otherwise engage in any act, practice, or course of business
that is fraudulent, deceptive, or manipulative with respect to any
investor or prospective investor in the pooled investment vehicle.
Paragraph (b) of the rule defines a ``pooled investment
vehicle'' to include any investment company and any company that
relies on an exclusion from the definition of ``investment company''
in Section (3)(c)(1) or (3)(c)(7) of the Investment Company Act [15
U.S.C. 80a-3(c)(1) or (7))].
\58\ Prohibition of Fraud by Advisers to Certain Pooled
Investment Vehicles, Advisers Act Release No. 2628 (Aug. 3, 2007)
(``Adopting Release'').
\59\ See Section II.D of the Adopting Release. I agree with the
Section's conclusions with respect to fiduciary duty (Rule 206(4)-8
does not create a fiduciary duty) and private rights of action (Rule
206(4)-8 does not create any private rights of action).
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In discussing the mental state required for violation of the rule,
the Adopting Release states that ``the Commission would not need to
demonstrate that an adviser violating rule 206(4)-8 acted with
scienter.'' \60\
[[Page 44762]]
According to the Adopting Release, therefore, the rule covers negligent
conduct as well as intentional conduct. My objections to this
interpretation of the rule's scope are twofold. First, I do not believe
that a negligence standard is consistent with the Commission's
authority under Section 206(4). Second, even if a negligence standard
were within our authority, for policy reasons, we should require a
finding of scienter \61\ as part of establishing a violation under this
anti-fraud rule.
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\60\ Adopting Release, at text accompanying note 36.
\61\ ``Scienter'' is ``a mental state embracing intent to
deceive, manipulate, or defraud.'' Ernst & Ernst v. Hochfelder, 425
U.S. 185, 194 (1976). Recklessness has also been found to satisfy a
scienter standard.
---------------------------------------------------------------------------
The Adopting Release offers several arguments in support of a
negligence standard. First, it argues that the language of section
206(4) is not limited to knowing or deliberate conduct. In support of
this argument, it cites the decision by the United States Court of
Appeals for the District of Columbia Circuit in SEC v. Steadman.\62\
Second, the Adopting Release contends that use of a negligence standard
is an appropriate method reasonably designed to prevent fraud. In
support of this contention, it cites U.S. v. O'Hagan.\63\ I will
discuss each of these in turn.
---------------------------------------------------------------------------
\62\ SEC v. Steadman, 967 F.2d 636 (D.C. Cir. 1992).
\63\ U.S. v. O'Hagan, 521 U.S. 642, 672-73 (1997).
---------------------------------------------------------------------------
The language of Section 206(4) does not reach negligent conduct.
Section 206(4) makes it unlawful for an advisor ``to engage in any act,
practice, or course of business which is fraudulent, deceptive, or
manipulative'' and directs the Commission ``by rules and regulations
[to] define, and prescribe means reasonably designed to prevent, such
acts, practices, and courses of business as are fraudulent, deceptive,
or manipulative.''
The Adopting Release maintains that, because Section 206(4)
``encompasses `acts, practices, and courses of business as are * * *
deceptive,' '' it reaches ``conduct that is negligently deceptive as
well as conduct that is recklessly or deliberately deceptive.'' \64\ As
the Supreme Court has said, however, ``it is a `familiar principle of
statutory construction that words grouped in a list should be given
related meaning.' '' \65\ Hence, it is inappropriate to base a
conclusion that negligent conduct is reached by looking at the term
``deceptive'' apart from its companion terms.
---------------------------------------------------------------------------
\64\ Adopting Release at Section II.D.
\65\ Schreiber v. Burlington Northern, Inc. 472 U.S. 1, 8 (1985)
(quoting Securities Industry Assn. v. Board of Governors, FRS, 468
U.S. 207, 218 (1984).
---------------------------------------------------------------------------
In the Section 10(b) context, the Supreme Court has accorded
special significance to the term ``manipulative'':
Use of the word ``manipulative'' is especially significant. It
is and was virtually a term of art when used in connection with
securities markets. It connotes intentional or willful conduct
designed to deceive or defraud investors by controlling or
artificially affecting the price of securities.\66\
---------------------------------------------------------------------------
\66\ Hochfelder, 425 U.S. at 199 (footnote to dictionary
definition omitted). Hochfelder considered whether scienter was a
necessary component of a private action under Section 10(b). In a
subsequent case, the Court considered whether scienter was a
necessary element of an injunctive action by the SEC and concluded
that it was. Aaron v. SEC, 446 U.S. 680, 691 (1980) (``the rationale
of Hochfelder ineluctably leads to the conclusion that scienter is
an element of a violation of section 10(b) and Rule 10b-5,
regardless of the identity of the plaintiff or the nature of the
relief sought.'').
The language of Section 206(4), like the language of Section 10(b),
would seem then to suggest a scienter requirement.
The Adopting Release, however, cites for the contrary conclusion a
decision by the United States Court of Appeals for the District of
Columbia. Indeed, it is true that in SEC v. Steadman, the court held
that ``scienter is not required under section 206(4).'' \67\ The court
reached its conclusion by comparing the language of Section 206(4) to
the language of Section 17(a)(3) under the Securities Act of 1933,\68\
which makes it unlawful ``to engage in any transaction, practice, or
course of business which operates or would operate as a fraud or deceit
upon the purchaser.'' \69\ The Steadman court drew a comparison between
Section 17(a)(3)'s ``transaction, practice, or course of business'' and
Section 206(4)'s ``act, practice, or course of business.'' The court,
relying on the Supreme Court's decision in Aaron, held that, in both
cases, the focus was on effect. \70\ The Supreme Court in Aaron,
however, placed considerable weight on the terms ``operate'' or ``would
operate,'' neither of which appears in Section 206(4).\71\ In fact,
Section 206(4) instead uses the affirmative word ``is,'' which would
seem to de-emphasize effect.\72\ Further, while Section 17(a)(3) speaks
of only ``fraud'' and ``deceit,'' Section 206(4) also includes
``manipulative.''
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\67\ Steadman, 967 F.2d at 647.
\68\ 15 U.S.C. 77a et seq.
\69\ 15 U.S.C. 77q(a)(3).
\70\ Steadman at 647.
\71\ Aaron, 446 U.S. at 696-97 (``the language of section
17(a)(3), under which it is unlawful for any person to `engage in
any transaction, practice, or course of business which operates or
would operate as a fraud or deceit,' quite plainly focuses upon the
effect of particular conduct * * * rather than upon the culpability
of the person responsible.'') (emphasis in original).
\72\ Section 206(4) makes it unlawful ``to engage in any act,
practice, or course of business which is fraudulent, deceptive, or
manipulative.'' (Emphasis added.)
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It is also helpful to note that Section 206(4), which was adopted
in 1960,\73\ was modeled on Section 15(c)(2) under the Securities
Exchange Act of 1934.\74\ Section 15(c)(2) makes it unlawful for
brokers and dealers to effect transactions in or induce the purchase or
sale of securities in connection with which they ``engage[] in any
fraudulent, deceptive, or manipulative act or practices, or make[] any
fictitious quotation.'' \75\ Hence, as the legislative history of
Section 206(4) noted, Section 206(4) ``is comparable to section
15(c)(2).'' \76\ The Steadman opinion did not address the link between
Sections 206(4) and 15(c)(2).
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\73\ S. Rep. No. 86-1760, at 4 (1960) (``The proposal has
precedent in similar authority granted to the SEC over brokers and
dealers by the Securities Exchange Act of 1934.'').
\74\ 15 U.S.C. 78a et seq.
\75\ 15 U.S.C. 78o(c)(2).
\76\ H.R. Rep. No. 86-2179, at 8 (1960). See also S. Rep. No.
86-1760, at 8 (1960) (``almost the identical wording of section
15(c)(2)'').
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Section 14(e) under the Exchange Act, which relates to tender
offers, also follows the Section 15(c)(2) pattern.\77\ Section 14(e),
like Section 206(4), includes both a proscription against ``engag[ing]
in any fraudulent, deceptive, or manipulative acts or practices'' and a
directive that the SEC ``by rules and regulations define, and prescribe
means reasonably designed to prevent such acts and practices as are
fraudulent, deceptive, or manipulative.'' Because of the similarities,
it is useful to look at the Supreme Court's interpretation of Section
14(e). In Schreiber v. Burlington Northern, the Supreme Court relied on
Hochfelder's interpretation of the term ``manipulative'' in the Section
10(b) context to interpret that term in the Section 14(e) context.\78\
The Schreiber Court noted that the addition of the rulemaking
authorization to Section 14(e) did not ``suggest[] any change in the
meaning of `manipulative' itself.'' \79\ In U.S. v. O'Hagan, The
Supreme Court again looked at Section 14(e). This time, it considered
whether Rule 14e-3(a), which prohibits trading on undisclosed
information in connection with a tender offer, exceeds the SEC's
authority under Section 14(e) given that the prohibition applies
regardless of whether there is a duty to disclose. The Court held that
[[Page 44763]]
Rule 14e-3(a) was within the SEC's authority under Section 14(e)
because Section 14(e) allows the SEC to ``prohibit acts, not themselves
fraudulent under the common law or Sec. 10(b), if the prohibition is
`reasonably designed to prevent * * * acts and practices [that] are
fraudulent.' '' \80\ The lesson from both of these cases is that the
SEC cannot effect a change in the meaning of specific statutory terms
under its comparable Section 206(4) rulemaking authority.
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\77\ 15 U.S.C. 78n(e).
\78\ Schreiber, 472 U.S. at 12 (``We hold that the term,
`manipulative' as used in Sec. 14(e) requires misrepresentation or
nondisclosure. It connotes `conduct designed to deceive or defraud
investors by controlling or artificially affecting the price of
securities.'') (citing Hochfelder, 425 U.S. at 199).
\79\ Id. at 12 n.11.
\80\ O'Hagan, 521 U.S. at 672-73.
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The Adopting Release asserts that, under O'Hagan, a negligence
standard is a means reasonably designed to prevent fraud. As the
Adopting Release notes, conduct outside of the bounds of the statutory
prohibition can be prohibited by Commission rule under Section 206(4).
The rule that we are adopting here, however, differs markedly from the
rules at issue in O'Hagan and Steadman.\81\ Both of those rules were
narrowly targeted rules that covered clearly-defined behavior. They
were designed to prohibit conduct, that, although outside of the ``core
activity prohibited'' by the statute, were designed to ``assure the
efficacy'' of the statute.\82\
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\81\ O'Hagan dealt with Rule 14e-3(a), which governed trading on
non-public, material information in connection with a tender offer.
Steadman dealt with Rule 206(4)-2, the investment advisor custody
rule.
\82\ O'Hagan, 521 U.S. at 673-74.
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Rule 206(4)-8(a)(2), by contrast, is as broad as the statute
itself. It essentially repeats the statutory prohibition. It does not
logically follow, therefore, that lowering the standard of care would
be the type of ``means reasonably designed to prevent'' within the
contemplation of the regulatory mandate within Section 206(4). Lowering
the standard of care is instead an attempt to rewrite the statute by
assigning new definitions to the words of the statute. A potential
unfortunate consequence of the Adopting Release's change in mental
state is that it is now arguably contrary to statute and therefore
might interfere with the SEC's ability to use the rule effectively.\83\
Congress included a rulemaking directive in order to give the SEC the
necessary authority to provide clarity in this area about the types of
practices covered by the statute's broad prohibition,\84\ not to alter
the standard of care that Congress selected through the language it
used.\85\ Imposing a negligence standard is particularly improper given
that, as the Adopting Release notes, ``Rule 206(4)-8 does not create
under the Advisers Act a fiduciary duty to investors and prospective
investors in a pooled investment vehicle.'' \86\
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\83\ See Chevron U.S.A. Inc. v. Natural Resources Defense
Council, Inc., 467 U.S. 837, 844 (1984). The Adopting Release
states: ``Since the Commission is clearly authorized to prescribe
[sic] conduct that goes beyond fraud as a means reasonably designed
to prevent fraud, prohibiting deceptive conduct done negligently is
a way to accomplish this objective.'' Adopting Release at Section
II.D. This does not answer the question, however, of whether
``fraudulent, deceptive, or manipulative'' conduct can arise from
negligent acts.
\84\ Up until now under Section 206(4), we have done exactly
this. We have adopted rules covering advertisements [17 CFR
275.206(4)-1], custody of client funds and securities [17 CFR
275.206(4)-2], cash payments for client solicitations [17 CFR
275.206(4)-3], disclosure of financial and disciplinary information
[17 CFR 275.206(4)-4], proxy voting [17 CFR 275.206(4)-6], and
compliance procedures [17 CFR 275.206(4)-7].
\85\ See H.R. Rep. No. 2179 at 7 (1960) (identifying as the
``problem'' that Section 206(4) was intended to remedy: ``there has
always been a question as to the scope of the fraudulent and
deceptive activities which are prohibited and the extent to which
the Commission is limited in this area by common law concepts of
fraud and deceit.'').
\86\ Adopting Release at Section II.D.
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Finally, from a purely practical perspective, I dispute the
regulatory approach underlying the contention that ``by taking
sufficient care to avoid negligent conduct, advisers will be more
likely to avoid reckless deception.'' \87\ By an extension of that same
logic, a strict liability standard would evoke even more care by
advisors. Even if the SEC is authorized to pick the standard of care
that applies broadly to all ``fraudulent, deceptive, or manipulative''
acts and practices, arbitrarily selecting a higher standard of care
``just to be on the safe side'' has the potential of misdirecting
enforcement and inspection resources and chilling well-intentioned
advisors from serving their investors.
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\87\ Adopting Release at Section II.D.
[FR Doc. E7-15531 Filed 8-8-07; 8:45 am]
BILLING CODE 8010-01-P
