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Second Circuit Affirms Dismissal of Mutual Fund Class Action, Applies SEC Guidance on Industry Concentration

In a decision ratifying the mutual fund industry’s long-standing treatment of portfolio concentration, the U.S. Court of Appeals for the Second Circuit affirmed the dismissal of a putative class action against the Sequoia Fund on September 9. In Edwards v. Sequoia Fund, Inc., the shareholder-plaintiffs alleged that the Fund violated its industry concentration policy when healthcare stocks grew to comprise more than 25% of the Fund’s assets in 2015, due to strong growth in the value of its holdings in Valeant Pharmaceuticals, Inc. The Fund’s healthcare position grew to more than 25% due solely to increases in Valeant’s share price, not because of any additional share purchases. Applying SEC guidance from 1983, the Second Circuit affirmed the trial court’s holding that such “passive” increases in concentration cannot constitute a policy violation, defeating the plaintiffs’ claims. The Fund is represented by a Ropes & Gray litigation team.

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CPOs of Registered Investment Companies Granted Limited Relief from CFTC Liquidation Audit Requirements


Time to Read: 1 minutes Practices: Investment Management

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The U.S. Commodity Futures Trading Commission (the “CFTC”) Division of Swap Dealer and Intermediary Oversight (the “Division”) recently issued Letter 17-04 (the “Letter”), which grants relief from certain financial disclosure obligations to a registered commodity pool operator (“CPO”) of an investment company registered under the Investment Company Act of 1940 (“RIC”). Specifically, where not all series of a RIC are liquidating, the Letter exempts the CPO of a liquidating series from the investor waiver provisions of CFTC Rule 4.22(c)(7), such that the CPO may provide to investors and the National Futures Association (“NFA”) unaudited liquidation financial statements in accordance with CFTC Rule 4.22(c)(7).

Upon the liquidation of a commodity pool, CFTC Rule 4.22(c)(7) requires a CPO to provide to investors and the NFA audited liquidation financial statements. Pursuant to CFTC Rule 4.22(c)(7)(iii), liquidation financial statements are not required to be audited if the CPO obtains from each investor in the commodity pool a written waiver of its right to receive audited liquidation financial statements.

Notably, CFTC Rule 4.22(c)(7) was not included in the “substituted compliance” regime that was finalized by the CFTC in August 2013 that allows CPOs of RICs to comply with many CFTC disclosure, reporting and recordkeeping requirements by complying with comparable requirements of the Securities and Exchange Commission (the “SEC”). However, where there is a liquidation of the entire entity that constitutes the RIC, or all of the series of the RIC, the CFTC will accept SEC Form 8-F as substituted compliance with the CFTC’s liquidation financial statements requirement. Until Letter 17-04 was issued, because of the difficulty of obtaining written waivers from investors, a CPO had to prepare audited financial statements of a liquidating series under CFTC rules even though it was not required to do so under SEC rules.

In issuing the Letter, the Division only granted relief from the investor waiver requirement of CFTC Rule 4.22(c)(7)(iii). Consequently, the CPO of a liquidating series of a RIC must provide unaudited liquidation financial statements directly to investors or through the relevant financial intermediaries that sell the pool’s shares and to the NFA within 90 calendar days of the permanent cessation of trading.

 
Please contact Deborah Monson, Jeremy Liabo, Elizabeth Martin or the Ropes & Gray attorney who usually advises you with any questions you may have or if you would like additional information.

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