SEC Launches Year 2000 Sweep and Proposes Investment Adviser Year 2000 Reports

August 7, 1998

SUMMARY

The Securities and Exchange Commission (the "SEC") has launched a nationwide sweep of registered investment advisers to ask about their preparations for the Year 2000 computer problem. In addition, the SEC has proposed a new rule and form under the Investment Advisers Act of 1940 that would require most registered investment advisers to file a report regarding their readiness with the SEC. The form would require the investment adviser to include the steps that the investment adviser has taken, and will take, to prepare for potential Year 2000 problems.

BACKGROUND

The SEC is undertaking a review of U.S. public companies and the U.S. securities industry to examine whether they will be prepared for the computer challenges associated with the Year 2000 problem. As part of this initiative the SEC has identified six steps of preparation that advisers and funds can take to prepare for the Year 2000 computer problem. These steps are: (i) awareness of potential Year 2000 problems; (ii) assessment of steps advisers and funds must take to avoid Year 2000 problems; (iii) implementation of the steps to avoid Year 2000 problems; (iv) internal testing of software designed to avoid Year 2000 problems; (v) point-to-point testing of software designed to avoid Year 2000 problems (i.e., testing with service providers such as broker-dealers, custodians, transfer agents and distributors); and (vi) implementation of tested software that will avoid Year 2000 problems. The SEC desires that advisers and funds address Year 2000 issues now in order to identify and solve potential problems well in advance of December 31, 1999.

SEC ACTION

The current SEC sweep, which began in New York, Boston and Los Angeles, is intended to gauge the state of Year 2000 preparedness in the investment advisory industry. Because the SEC lacks the technical capability to determine whether a company has or has not properly prepared for Year 2000 and has never adopted any specific compliance standards, the sweep is anticipated to be primarily informational in nature. The SEC is expected to conclude the sweep this year and issue a report on its findings to Congress.

Proposed new Rule 204-5 would require each investment adviser that (i) is registered with the SEC, and (ii) has at least $25 million of assets under management or is an adviser to an investment company registered under the Investment Company Act of 1940 to file new Form ADV-Y2K with SEC (by fax). The form would have to be filed no later than 30 days after the rule becomes effective, and an updated form would have to be filed no later than eight months from the date of the first filing. The second filing would reflect progress made in preparing for the Year 2000 problem up to that time.

Proposed Form ADV-Y2K would have two parts. Part I would be completed by all respondents and would contain 11 questions about the adviser¹s preparation for the Year 2000 problem with respect to all of the adviser¹s clients. Part II would consist of questions similar to those in Part I and would be completed by advisers and sub-advisers to a registered investment company or a group of registered investment companies.

The form would require each responding investment adviser to provide the SEC with information relating to the following areas: (1) the scope and status of the adviser¹s Year 2000 compliance plan; (2) the commitment by the adviser of resources and personnel (including consultants) to address Year 2000 issues; (3) the systems that may be affected by the Year 2000 problem; (4) progress on each of the six steps of preparation identified above; (5) contingency plans in the event that the adviser experiences Year 2000 difficulties after December 31, 1999; and (6) the readiness of third parties upon whom the adviser relies for critical systems. The form would be required to be signed by an authorized person that participates in managing or directing the adviser¹s affairs, but would not be required to be attested to by an independent public accountant.

The SEC recognizes that an investment adviser may use more than one computer system in its business. For example, an advisor might use a different systems for portfolio management, client services, etc. Advisers will be asked to utilize a "qualitative average" in order to present the most accurate practical picture of the adviser¹s Year 2000 preparedness. If one system is more important than another the adviser¹s qualitative average should be weighted accordingly. The SEC has solicited comments on this proposal, including alternative approaches to report on multiple system preparedness, and may ultimately adopt a different method for reporting.

To discuss other issues relating to hedge funds and their investment managers, contact Howard A. Neuman or Steven B. Katz at (212) 818-9200 .