NO IMPLIED CAUSE OF ACTION UNDER THE ANTI-PYRAMIDING SECTION

A complaint brought by closed end fund Gabelli Global Multimedia Trust, Inc. alleging violations of the anti-pyramiding provisions of the Investment Company Act was dismissed for a lack of standing. The defendants were Arthur Lipson and a group of investment companies he controlled. The Gabelli Global Multimedia Trust, Inc. v. Western Investment LLC., Civil No. RBD 10-0557 (D. Md.).

The complaint claimed that Mr. Lipson, through his controlled funds, pursued an arbitrage strategy of acquiring up to 3% of shares of closed-end funds such as plaintiff which sell at a discount to NAV. By having each entity acquire up to 3%, the defendants violated the Section 12(d)(1)(A) of the Investment Company Act, according to plaintiff.

Section 12(d)(1)(A) of the Act makes it unlawful for any registered investment company to own in the aggregate “any security issued by any other investment company . . . if the acquiring company and any company or companies controlled by it immediately after such purchase . . . own in the aggregate . . . more than 3% of the total outstanding voting stock of the acquired company.” The section does not contain an express cause of action.

The test for determining if a cause of action can be implied under a statutory section was defined by the Supreme Court in Alexander v. Sandoval, 532 U.S. 275 (2001). That case revamped the standards for implying a cause of action. There, the court held that the question is whether the statute illustrates an intent to create a private right of action and remedy. The statute must have specific “rights-creating” language. If that language is present, the court must determine whether the overall-statutory scheme demonstrates that primary responsibility for enforcement rests with the government or private parties.

Using the Sandoval approach the Second Circuit held in Olmsted v. Pruco Life Ins. Co. , 283 F.3d 429 (2nd Cir. 2002) that the section on which this case is based does not evidence an intent which would permit a court to imply a cause of action. The section does not contain the necessary rights-creating language. In addition, the fact that Congress created other specific private rights of actions in certain sections of the Act, but not the once the anti-pyramiding section, compels the result that a private right of action should not be implied here. Accordingly the complaint was dismissed.

CFTC CHAIRMAN GENSLER ON OTC DERIVATIVES

CFTC Chairman Gary Gensler has become one of the leading proponents for the regulation of OTC derivatives. In his remarks to the Council of Institutional Investors on April 13, 2010, Mr. Gensler outlined what he views as the key provisions necessary for reform in this area and commented on the existing House and Senate bills.

Recounting the history of derivatives, the Chairman noted that these instruments have been around since the civil war. From the early 1930s until 1980, all derivatives and publicly listed securities were subject to comprehensive oversight by federal regulators. In 1981, this changed with the first over-the-counter derivatives transaction. It was not on an exchange. Rather, it was transacted bilaterally and not subject to regulation.

Transactions in these instruments grew and were at the center of the 2008 financial crisis, Mr. Gensler noted. Derivatives added more leverage to the financial system backed by less capital. AIG, for example, had ineffectively regulated a $2 trillion derivatives portfolio, clearly illustrating the need for reform.

The essential elements of regulation in this area begin with comprehensive regulation of any entity that deals in derivatives. This includes Wall Street banks as well as other non-bank dealers. All standardized over-the-counter derivatives must be brought onto transparent, regulated exchanges or similar trading venues. This will lower risk and improve pricing in the market place. Finally, to further lower risk, all standardized OTC derivatives must be brought into central clearinghouses.

While in the past institutions which dealt in derivatives were regulated, they were not expressly regulated for their derivatives business. This is essential in the Chairman’s view. Regulators must be authorized to set capital and margin requirements for derivatives dealers. This authority should extend to all derivatives dealers.

Another key element of regulatory reform is adding transparency to the markets. Currently, derivatives trade out of sight. This contrasts sharply with regulated futures and securities markets. Indeed, a critical lesson of the 2008 market crisis is that transparency lowers risk in the marketplace. Trading these instruments on exchanges would implement this goal. Exchanges and swap execution facilities also lower risk. Clearing all standardized derivatives through central clearinghouses also helps lower risk.

Some derivatives are not standardized. Rather, they are tailored to the needs of a particular hedger. Those contracts should not be subject to a clearing requirement Mr. Gensler noted. New regulation should ensure that the dealer regulation and capital requirements account for the risks of these transactions. At the same time, it is critical that as many over-the-counter derivatives transactions as possible are moved into the central clearinghouses. This means that there should not be broad exemptions. To ensure fairness and competition, the clearinghouses should have open access. Those clearinghouses should not be governed by parties that might have a conflict of interest or financial stake in the transactions.

These key elements are incorporated into the Senate Banking Committee bill and the current House legislation. Moving forward, it is critical that each of these key elements be incorporated into the final legislation.