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Lehman Brothers (Oct. 31, 2003) (Cash Solicitation)

Lehman Brothers (Oct. 31, 2003) (Cash Solicitation)

Friday, 31 October 2003 08:00

Investment Advisers Act of 1940
Section 206(4) and Rule 206(4)-3

Lehman Brothers

October 31, 2003

RESPONSE OF THE OFFICE OF CHIEF COUNSEL IM Ref. No. 2003428856
Lehman Brothers Inc.
DIVISION OF INVESTMENT MANAGEMENT File No. 8-12324

We would not recommend enforcement action to the Commission under Section 206(4) of the Investment Advisers Act of 1940 (“Advisers Act”) and Rule 206(4)-3 thereunder if any investment adviser that is required to be registered pursuant to Section 203 of the Advisers Act pays to Lehman Brothers Inc. (“Lehman”), a registered broker-dealer and investment adviser, or any of Lehman’s associated persons, as defined in Section 202(a)(17) of the Advisers Act, a cash fee, directly or indirectly, for the solicitation of advisory clients in accordance with Rule 206(4)-3,1 notwithstanding a judgment of injunction from the United States District Court for the Southern District of New York (the “Final Judgment”) that otherwise would preclude such an investment adviser from paying Lehman a solicitation fee.2

Our position is based on the facts and representations in your incoming letter dated October 3, 2003, particularly Lehman’s representations that:

  1. it will conduct any cash solicitation arrangement entered into with any investment adviser required to be registered under Section 203 of the Advisers Act in compliance with the terms of Rule 206(4)-3 except for the investment adviser’s payment of cash solicitation fees to Lehman, which is subject to the Final Judgment;
  2. the Final Judgment does not bar or suspend Lehman or any person currently associated with Lehman from acting in any capacity under the federal securities laws;
  3. it will comply with the terms of the Final Judgment, including, but not limited to, the payment of disgorgement, pre-judgment interest, civil or administrative penalties and fines; and
  4. for ten years from the date of the entry of the Final Judgment, Lehman or any investment adviser with which it has a solicitation arrangement subject to Rule 206(4)-3 will disclose the Final Judgment in a written document that is delivered to each person whom Lehman solicits (a) not less than 48 hours before the person enters into a written or oral investment advisory contract with the investment adviser or (b) at the time the person enters into such a contract, if the person has the right to terminate such contract without penalty within 5 business days after entering into the contract.

This position applies only to the Final Judgment and any State Judgment3 and not to any other basis for disqualification under Rule 206(4)-3 that may exist or arise with respect to Lehman or any of its associated persons.

Sara P. Crovitz
Senior Counsel

 

Endnotes

1 Rule 206(4)-3 prohibits any investment adviser that is required to be registered under the Advisers Act from paying a cash fee, directly or indirectly, to any solicitor with respect to solicitation activities if, among other things, the solicitor is subject to an order, judgment or decree that is described in Section 203(e)(4) of the Advisers Act.

2 Securities and Exchange Commission v. Lehman Brothers Inc., 03 Civ 2940 (WHP) (S.D.N.Y. October 31, 2003).

3 “State Judgment” means any injunction by decree, order, or judgment of any court of competent jurisdiction in connection with a settlement agreement entered into by Lehman with a state or territorial agency that generally relates to the same facts and is based on the same conduct as alleged in the Commission complaint underlying the Final Judgment.

Incoming Letter:

October 3, 2003

Douglas J. Scheidt
Associate Director and Chief Counsel
Division of Investment Management
Securities and Exchange Commission
450 Fifth St., N.W., Mail Stop 0506
Washington, D.C. 20549

Re: Lehman Brothers Inc.

Dear Mr. Scheidt:

We submit this letter on behalf of our client, Lehman Brothers Inc. (“Lehman”), in connection with a settlement agreement (the “Settlement”) arising out of a joint investigation by the Securities and Exchange Commission (the “Commission”), the New York Stock Exchange, Inc. (the “NYSE”), NASD Regulation, Inc. (“NASDR”) and various state and territory regulatory agencies (the “States”) into research analyst conflicts of interest at Lehman and several other large investment banking firms.

Lehman, a broker-dealer registered under Section 15 of the Securities Exchange Act of 1934, as amended (the “Exchange Act”), and an investment adviser registered under Section 203 of the Investment Advisers Act of 1940, as amended (the “Advisers Act”), seeks the assurance of the staff of the Division of Investment Management (“Staff”) that it would not recommend any enforcement action to the Commission under Section 206(4) of the Advisers Act, or Rule 206(4)-3 thereunder (the “Rule”), if an investment adviser pays Lehman, or any of its associated persons, a cash payment for the solicitation of advisory clients, notwithstanding the existence of the Final Judgment (as defined below) and any related state or territory court injunction. While the Final Judgment in question does not operate to prohibit or suspend Lehman or any of its associated persons from acting as or being associated with an investment adviser and does not relate to solicitation activities on behalf of investment advisers, it may affect the ability of Lehman and its associated persons to receive such payments. The Staff in many other instances has granted no-action relief under the Rule in similar circumstances.

BACKGROUND

The Commission, the NYSE, NASDR and the States have engaged in settlement discussions with Lehman in connection with a joint investigation into research analyst conflicts of interest at Lehman and several other large investment banking firms. As a result of these discussions, the Commission filed a complaint (the “Complaint”) against Lehman in the United States District Court for the Southern District of New York (the “District Court”) in a civil action captioned Securities and Exchange Commission v. Lehman Brothers Inc. Lehman has executed a consent and undertaking (the “Consent”) in which Lehman neither admitted nor denied any of the allegations in the Complaint, except as to jurisdiction, but consented to the entry of a judgment against Lehman by the District Court (the “Final Judgment”). The Final Judgment will, among other things, enjoin Lehman, directly or through its officers, directors, agents and employees, from engaging in conduct violating NASD Conduct Rule 2110, NASD Conduct Rule 2210, NYSE Rule 401, NYSE Rule 472 and NYSE Rule 476, and from failing to supervise adequately its research analysts or to establish policies and procedures to ensure their proper conduct in violation of NASD Conduct Rule 3010 and NYSE Rule 342. Additionally, the Final Judgment will order Lehman to make payments aggregating $80 million in settlement of the matters addressed in the Final Judgment, and to comply with the undertakings set forth in the Final Judgment.1

EFFECT OF RULE 206(4)-3

The Rule prohibits an investment adviser from paying a cash fee to any solicitor that has been temporarily or permanently enjoined by an order, judgment or decree of a court of competent jurisdiction from engaging in or continuing any conduct or practice in connection with the purchase or sale of any security. Entry of the Final Judgment could cause Lehman to be disqualified under the Rule, and accordingly, absent no-action relief, Lehman may be unable to receive cash payments for the solicitation of advisory clients.2

DISCUSSION

In the release adopting the Rule, the Commission stated that it “would entertain, and be prepared to grant in appropriate circumstances, requests for permission to engage as a solicitor a person subject to a statutory bar.”3 We respectfully submit that the circumstances present in this case are precisely the sort that warrant a grant of no-action relief.

The Rule’s proposing and adopting releases explain the Commission’s purpose in including the disqualification provisions in the Rule. The purpose was to prevent an investment adviser from hiring as a solicitor a person whom the adviser was not permitted to hire as an employee, thus doing indirectly what the adviser could not do directly. In the proposing release, the Commission stated that:

[b]ecause it would be inappropriate for an investment adviser to be permitted to employ indirectly, as a solicitor, someone whom it might not be able to hire as an employee, the Rule prohibits payment of a referral fee to someone who . . . has engaged in any of the conduct set forth in Section 203(e) of the [Advisers] Act . . . and therefore could be the subject of a Commission order barring or suspending the right of such person to be associated with an investment adviser.4

The Final Judgment does not bar, suspend, or limit Lehman or any person currently associated with Lehman from acting in any capacity under the federal securities laws. Lehman has not been sanctioned for activities relating to its activities as an investment adviser or its solicitation of advisory clients.5 Accordingly, consistent with the Commission’s reasoning, there does not appear to be any reason to prohibit an adviser from paying Lehman or its associated persons for engaging in solicitation activities under the Rule.

The Staff previously has granted numerous requests for no-action relief from the disqualification provisions of the Rule to individuals and entities found by the Commission to have violated a wide range of federal securities laws and rules thereunder and SRO rules or permanently enjoined by courts of competent jurisdiction from engaging in or continuing any conduct or practice in connection with the purchase or sale of any security.6

UNDERTAKINGS

In connection with this request, Lehman undertakes the following:

  1. to conduct any cash solicitation arrangement entered into with any investment adviser required to be registered under Section 203 of the Advisers Act in compliance with the terms of Rule 206(4)-3 except for the investment adviser’s payment of cash solicitation fees to Lehman which is subject to the Final Judgment;
  2. to comply with the terms of the Final Judgment, including, but not limited to, the payment of disgorgement, pre-judgment interest, civil or administrative penalties and fines; and
  3. that for ten years from the date of the entry of the Final Judgment, Lehman or any investment adviser with which it has a solicitation arrangement subject to Rule 206(4)-3 will disclose the Final Judgment in a written document that is delivered to each person whom Lehman solicits (a) not less than 48 hours before the person enters into a written or oral investment advisory contract with the investment adviser or (b) at the time the person enters into such a contract, if the person has the right to terminate such contract without penalty within 5 business days after entering into the contract.

CONCLUSION

We respectfully request the Staff to advise us that it will not recommend enforcement action to the Commission if an investment adviser that is required to be registered with the Commission pays Lehman, or any of its associated persons, a cash payment for the solicitation of advisory clients, notwithstanding the Final Judgment and any related state or territory injunction.

Please do not hesitate to call the undersigned at (212) 373-3309 or Audrey Woo at (212) 373-3581 regarding this request.

Sincerely,
Raphael M. Russo

 

Endnotes

1 Lehman will additionally enter into settlement agreements relating to the activities referred to in the Complaint with the relevant state and territory agencies (the “State Settlement Agreements”). To the extent that any such State Settlement Agreement may result in an injunction by a court of competent jurisdiction, Lehman intends this request to cover any resulting disqualifications under the Rule.

2 Lehman has obtained similar no-action relief in the past. See, e.g., In the Matter of Certain Municipal Bond Refundings, SEC No-Action Letter (pub. avail. Apr. 13, 2000); In the Matter of Certain Market Making Activities on Nasdaq, SEC No-Action Letter (pub. avail. Jan. 11, 1999).

3 See Requirements Governing Payments of Cash Referral Fees by Investment Advisers, Inv. Adv. Act Rel. No. 688 (July 12, 1979), 17 S.E.C. Docket (CCH) 1293, 1295, at note 10.

4 See Requirements Governing Payments of Cash Referral Fees by Investment Advisers, Inv. Adv. Act Rel. No. 615 (Feb. 2, 1978), 14 S.E.C. Docket (CCH) 89, 91.

5 Lehman additionally notes that it has not violated, or aided and abetted another person in violation of, the Rule, nor have individuals performing solicitation activities been personally disqualified under the Rule.

6 See, e.g., Prime Advisors, Inc., SEC No-Action Letter (pub. avail. Nov. 8, 2001); Legg Mason Wood Walker, Inc., SEC No-Action Letter (pub. avail. June 11, 2001); Dreyfus Corp., SEC No-Action Letter (pub. avail. March 9, 2001); Prudential Securities Inc., SEC No-Action Letter (pub. avail. Feb. 7, 2001); Tucker Anthony Inc., SEC No-Action Letter (pub. avail. Dec. 21, 2000); J.B. Hanauer & Co., SEC No-Action Letter (pub. avail. Dec. 12, 2000); Founders Asset Management LLC, SEC No-Action Letter (pub. avail. Nov. 8, 2000); Credit Suisse First Boston Corp., SEC No-Action Letter (pub. avail. Aug. 24, 2000); Janney Montgomery Scott LLC, SEC No-Action Letter (pub. avail. July 18, 2000); Aeltus Investment Management, Inc., SEC No-Action Letter (pub. avail. July 17, 2000); William R. Hough & Co., SEC No-Action Letter (pub. avail. Apr. 13, 2000); In the Matter of Certain Municipal Bond Refundings, SEC No-Action Letter (pub. avail. Apr. 13, 2000); In the Matter of Certain Market Making Activities on Nasdaq, SEC No-Action Letter (pub. avail. Jan. 11, 1999); Paine Webber, Inc., SEC No-Action Letter (pub. avail. Dec. 22, 1998); NationsBanc Investments, Inc., SEC No-Action Letter (pub. avail. May 6, 1998); Morgan Keegan & Co., Inc., SEC No-Action Letter (pub. avail. Jan. 9, 1998); Merrill Lynch, Pierce, Fenner & Smith, Inc., SEC No-Action Letter (pub. avail. Aug. 7, 1997); Gruntal & Co., SEC No-Action Letter (pub. avail. July 17, 1996); Carnegie Asset Management, SEC No-Action Letter (pub. avail. July 11, 1994); Salomon Brothers Inc., SEC No-Action Letter (pub. avail. Jan. 26, 1994); BT Securities Corporation, SEC No-Action Letter (pub. avail. Mar. 30, 1992); Kidder Peabody & Co. Inc., SEC No-Action Letter (Oct. 11, 1990); First City Capital Corp., SEC No-Action Letter (pub. avail. Feb. 9, 1990); RNC Capital Management Co., SEC No-Action Letter (pub. avail. Feb. 7, 1989); and Stein Roe & Farnham, Inc., SEC No-Action Letter (pub. avail. Aug. 25, 1988).


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