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SEC Gives Exemptive Relief For Foreign IDs


An exemptive relief that the Securities and Exchange Commission granted last week to Rule 22c-2 is welcome news for mutual fund companies, as it will pave the way for the use of an alternate system of identifying foreign investors who are market timing mutual funds.

Late last month, the Investment Company Institute (ICI), on behalf of all registered investment companies, along with the Institute of International Bankers (IIB), a group that represents the non-U.S. community of foreign financial services intermediaries, petitioned the SEC. The two groups asked to circumvent one portion of a rule set to take effect April 16, explaining to the SEC that privacy rules in other non-U.S. regions, including the member nations of the European Union, were presenting a compliance obstacle between some mutual funds and foreign financial intermediaries.

According to the ICI, many intermediaries outside the U.S. are prohibited by law from disclosing investors' government-issued identification numbers, the equivalent of Social Security numbers in the U.S., without explicit consent from investors. In addition, requiring these foreign intermediaries to obtain "the necessary consent from each of their thousands of customers is not feasible," the ICI noted in its request letter to the SEC.

Under the March 2005 SEC-promulgated Rule 22c-2, the securities regulator requires each fund company to enter into "shareholder information agreements" with each intermediary through which it sells its shares. These agreements must be worded such that funds will be allowed, upon request, to obtain all transactional information that is linked to each shareholder's taxpayer identification number, Social Security number or alternate government-issued identification number.

Under the terms of Rule 22c-2, fund companies must either enter into shareholder information agreements with financial intermediaries, or prohibit them from purchasing fund shares for clients through street name accounts.

The rule was intended to allow mutual funds to better identify investors who are violating a fund's frequent trading policies, especially where accountholders are registered with the mutual fund company not by individual shareholder name, but in nominee name.

Many mutual fund investment accounts are directly registered in the names of individual investors who must provide their Social Security or tax ID numbers when establishing an account. But accounts are also often held in a broker/dealer's "street name," or nominee, account. Such nominee accounts may represent a single client, or can combine the investments from several different brokerage clients and usually include no identifying information that clearly reveals to the mutual fund company who the underlying shareholders are.

"The ICI heard from its members that foreign financial intermediaries had expressed concerns that they would be violating their home state privacy laws if they provided government-issued identification numbers on their customers to U.S. mutual funds without the customer's direct consent," explained Tamara Salmon, senior associate counsel at the ICI.

Consequently, the ICI and IIB initiated a request for exemptive relief from the SEC that would allow mutual funds to enter into information-sharing agreements with foreign intermediaries without causing them to violate privacy laws. The relief they sought was to allow foreign intermediaries to develop their own numerical identification system, perhaps by using a client's own brokerage account number, to uniquely identify each of their clients. That information would then be shared with the mutual fund company upon its request.

These unique numbers, although not official government-issued identification numbers, would enable fund companies to easily track excessive trading activity, the two associations said.

In addition, the financial intermediary that generated the unique identifying number would be required to use the exact same number to identify all accounts having the same beneficial owners. That thwarts attempts by unscrupulous brokers who, in the past, repeatedly assigned brand new brokerage account numbers to the same clients so as to escape detection by fund company personnel who look for frequent trading patterns.

The SEC granted exemptive relief on Feb. 1 to all mutual fund companies that solicit these agreements. While SEC exemptive reliefs aren't regulatory blessings, they do assure investment firms that engage in the specified activity that the SEC will not take enforcement action against them. However, this exemptive relief is only a temporary fix.

"The relief provided by the SEC for foreign intermediaries only applies to accounts opened by their customers prior to Jan. 1, 2008," said Salmon of the ICI. That extended deadline gives foreign financial intermediaries enough time to revise both applications and systems so that investor consent will be automatically obtained from new clients going forward.

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