Cole-Frieman & Mallon 2016 Second Quarter Update

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 www.colefrieman.com

July 22, 2016

Clients and Friends:

We hope that this message finds you well and that you are enjoying the first months of summer. As we move into the third quarter, we would like to provide you with a brief overview of some items that we hope will help you stay on top of the business and regulatory landscape in the coming months.

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SEC Revises Qualified Client Threshold. The SEC recently published an order approving an adjustment to the definition of a “Qualified Client” under the Investment Advisers Act of 1940 (the “Advisers Act”). Specifically, the “net worth” threshold has been increased from $2,000,000 to $2,100,000 to account for inflation since the date the original definition was adopted. The Qualified Client threshold is critically important for investment advisers because in nearly all jurisdictions, including for SEC registered investment advisers, performance fees and incentive allocations can only be charged to investors who are Qualified Clients. The new definition becomes effective August 15, 2016 (the “Effective Date”), but will not be applied retroactively to contractual relationships existing as of such date. Additionally, investors who subscribed for interests in a private fund before the Effective Date may make additional subscriptions without needing to confirm the new net worth requirement.

All investment advisers should promptly update their subscription documents to ensure that new investors who agree to make investments on or after the Effective Date have provided accurate representations regarding their Qualified Client status.

Private Equity Fund Adviser Acting as an Unregistered Broker Settles SEC Charges. The SEC charged Blackstreet Capital, a private equity advisory firm, and its owner with performing in-house brokerage services without being properly registered as a broker-dealer. While the firm disclosed to investors that it would operate as a broker-dealer in exchange for a fee, it did not register as a broker-dealer with the SEC or any state securities commission. The SEC’s investigation also found that the firm engaged in several conflicted transactions and did not disclose certain fees and expenses to investors when such disclosure was warranted (such as using fund assets to make political and charitable contributions and pay for entertainment expenses). The firm and its owner have agreed to pay more than $3.1 million to the SEC in settlement of the charges. Broker-dealer activities are highly regulated, so we encourage all clients to not only confirm that any marketers they use are properly registered but also to ensure that their own marketing activities are in compliance with the applicable rules.

SEC to Require IAs to Adopt Business Continuity and Transition Plans. The SEC proposed a new rule on June 28, 2016, that would require SEC registered investment advisers to implement written business continuity and transition plans designed to mitigate the effects of significant internal or external disruptions in operations, such as natural disasters, cyber-attacks, technology failures, the departure of key personnel, and similar events. This is the SEC’s latest effort to encourage proper risk management in the asset management industry and minimize any potential client harm from material service disruptions. Under the proposed rule, the content of an SEC registered adviser’s business continuity and transition plan would be based upon risks associated with an IA’s operations and would include policies and procedures designed to address different elements of a firm’s business. Firms would be required to review the adequacy and effectiveness of their plans at least annually and to retain certain records.

No Expansion of SEC Examinations of Exempt Reporting Advisors. In our 2015 fourth quarter newsletter, we reported that the SEC intended to expand the scope of its on-going examination program to include Exempt Reporting Advisers (“ERAs”) who rely on the Private Fund Adviser Exemption or Venture Capital Fund Adviser Exemption to registration. The previous discussion was based on published reports interpreting comments made by Marc Wyatt, the Director of the SEC’s Office of Compliance Inspections and Examinations, at a conference in November 2015. Further investigation by our firm, however, has revealed that Mr. Wyatt’s comments were misreported and misinterpreted by the industry. We have received confirmation from the SEC that the agency does not intend to expand the scope of its on-going examination program to include ERAs. It should be noted, however, that the SEC does continue to conduct examinations of ERAs for cause and other misconduct.

Notwithstanding the SEC’s general stance on examinations of ERAs, the SEC has indicated that it is focusing some of its examination efforts on those who rely on the Venture Capital Fund Adviser Exemption. The SEC suspects that many ERAs who rely on this exemption are in fact not eligible to do so. With that in mind, we recommend all ERAs who rely on the Venture Capital Fund Adviser Exemption to confirm with counsel their eligibility to rely on this exemption.

SEC Signals a Focus on Cybersecurity.With a new hire to the agency’s cybersecurity division and cybersecurity charges being brought against an institutional wealth management firm, the SEC is signaling its focus on the issue to the investment management industry. In June, the SEC appointed Christopher R. Hetner, a career information security expert, to the role of Senior Advisor to the Chair for Cybersecurity Policy. Later in the month it was announced that Morgan Stanley had settled SEC charges brought against the firm for failure to protect digital customer information through failure to adopt the statutorily required written policies and procedures.  Failing to comply with cybersecurity laws didn’t just lead to a former Morgan Stanley employee accessing and transferring approximately 730,000 unique client accounts data to his personal server, which was ultimately hacked by third parties, but also led to Morgan Stanley having to pay a $1 million penalty to settle the SEC charges. Given the SEC’s recent emphasis on cybersecurity, firms should be moving forward with cybersecurity implementation and may want to discuss with counsel or other outside service providers.

Fund Administrator Settles with the SEC for Failure to Identify and Respond to Fraud by Two Investment Adviser Clients. A well-known fund administrator recently settled charges with the SEC due to its failure to identify and correct fraudulent faulty accounting perpetrated by two of its investment adviser clients. The SEC noted that fund administrators have a “gatekeeping responsibility” in relation to the investment funds which they administer and are primarily responsible for accurate reporting of fund assets to investors and other service providers. In this case, the administrator failed to uphold its gatekeeping responsibility by either missing or ignoring clear indications of fraudulent books which allowed the advisory firm’s scheme to persist until the SEC stepped in. Without admitting to the allegations, the firm agreed to pay a fine in its settlement. Managers might want to think about amending their administration agreements to include additional termination rights which could be exercised by the manager in the event their administrator suffers the same fate.

New Federal Law Expands Trade Secret Remedies. As the “secret sauce” for many investment managers may now take the form of a trade secret in an easily copied digital format, misappropriation of trade secrets by employees and other service providers has become an increasingly important area of concern for the investment management industry. President Obama recently signed into law the Defend Trade Secrets Act of 2016 (“DTSA”), which expands the options available to firms who suspect an employee misappropriated trade secrets. The DTSA permits a firm to sue for civil damages in federal court, considerably simplifying the litigation process. Further, the DTSA expands the scope of damages available for a successful claimant, including but not limited to royalties for the misuse of trade secrets as well as attorneys’ fees. In order for a firm to take advantage of the expanded options available under the DTSA, a firm must provide notice to its employees and other service providers of the confidentiality and whistleblower protections. Firms will likely need to amend their contracts with employees and service providers in order to provide such notice.

Cayman Islands Publishes LLC Law. On June 8, 2016, the Cayman Islands introduced the highly anticipated Cayman Islands Limited Liability Companies Law, developed in a joint effort by the Cayman Islands Government and the Cayman Islands Monetary Authority in response to requests from the investment funds industry. The law came into effect on July 8, 2016 and currently allows for the formation and operation of limited liability companies similar in structure and flexibility to that of a Delaware LLC. It is now possible to:

  • form and register a new Cayman Islands LLC;
  • migrate an entity organized in another jurisdiction (e.g., Delaware) into the Cayman Islands as an LLC;
  • convert an existing Cayman Islands exempted company into an LLC; and
  • merge an existing Cayman Islands exempted company into an LLC.

We have been in discussions with certain Cayman law firms about how managers might use such LLCs in their offshore structures in future. It seems like the best use will be for certain management company entities or as single-purpose investment vehicles under a larger fund structure. At this time we do not expect the LLC form to supercede the Ltd. form for actual fund entities in the Cayman Islands. If you are interested in how you might be able to utilize these vehicles in the futures, we recommend that you speak with your firm’s offshore counsel to discuss the entity’s advantage and disadvantages.

SEC Adopts Final Rules Implementing Business Conduct Standards for Security-Based Swap Dealers and Major Security-Based Swap Participants. On April 15, 2016, the SEC adopted new rules that would require security-based swap (“SBS”) entities to comply with a comprehensive set of business conduct standards and chief compliance officer (“CCO”) requirements. The SEC believes the new rules will enhance accountability and transparency in transactions with investors and special entities in the over-the-counter derivatives market, which, according to SEC Chair Mary Jo White, has lacked fundamental customer protections for years. Some of the provisions applicable to SBS dealers and major participants include:

  • disclosure to the counterparty of material information about the security-based swap, including material risks, characteristics, incentives, and conflicts of interest;
  • disclosure of information concerning the daily mark of the security-based swap and the ability of the counterparty to require clearing of the security-based swap;
  • communication with counterparties in a fair and balanced manner based on principles of fair dealing and good faith;
  • establishment of a supervisory and compliance infrastructure; and
  • designation of a CCO who must fulfill the described duties and prepare an annual compliance report.

Additional provisions and heightened protections apply in transactions with special entities, such as municipalities, pension plans, and endowments.

New Due Diligence Requirements for Covered Financial Institutions. In an effort to promote enhanced transparency in financial transactions and help law  enforcement entities fight illegal money laundering,  the U.S. Treasury Department’s Financial Crimes Enforcement Network (“FinCEN”) has issued new customer due diligence (“CDD”) requirements that cover financial institutions, including, banks, broker-dealers, mutual funds, futures commission merchants and introducing brokers in commodities, must comply with by May 11, 2018. Covered financial institutions will now be required to verify the identity of any natural person that is a beneficial owner of at least 25% of any legal entity applying to open a new account, develop a customer risk profile for each customer, and establish an account monitoring system to report suspicious transactions. Certain types of customers are exempted from these requirements.

Other Items

  • Accounting Firm Charged for Deficient Surprise Exams. The SEC recently charged an accounting firm and one of its partners for failing to perform adequate surprise examinations of an SEC registered investment adviser which retained the firm for such purpose. The SEC noted that on two occasions the firm filed paperwork with the SEC containing false statements – first, that the manager had complied with certain procedures when in fact they had not, and second, that the manager’s client assets were held with a qualified custodian when in fact they were not. The accounting firm, without admitting or denying fault, agreed to pay disgorgement of fees and a penalty. The accounting firm and the partner in charge were also suspended from practicing before the SEC (including performing audits of public companies). In light of this action, investment managers would be well advised to ensure that the accountants they retain for surprise examinations dutifully comply with the applicable requirements.
  • SEC Charges Investment Adviser that Schemed to Acquire Larger Incentive Fees. On May 31, 2016, the SEC charged a Tennessee firm and its owner for orchestrating a fraudulent trading scheme designed to increase the incentive fees earned by the adviser. Specifically, the scheme caused large gains to be realized at the end of any given month and large losses to be realized at the beginning of the subsequent month, thereby artificially increasing the net gains subject to the incentive fee. The SEC’s investigation uncovered that the firm made millions of dollars in unearned incentive fees and that, without the fraudulent trading scheme, the firm would have earned almost no incentive fees since October 2014. The SEC is seeking disgorgement of fraudulently obtained gains, penalties, and permanent bans from the industry.
  • Cayman Islands FATCA Compliance Deadlines Further Extended. The Cayman Islands Department of International Tax Cooperation has recently extended both the notification and reporting deadlines for U.S. FATCA to August 10, 2016. This further extends the previously extended deadlines of June 10, 2016 and July 8, 2016 for notification and reporting of U.S. FATCA, respectively. We suggest speaking with your tax advisers to determine your notification and reporting obligations with respect to FATCA and confirm compliance with the new deadlines.
  • CFTC Issues a Compliance Advisory. The CFTC Division of Swap Dealer and Intermediary Oversight issued a Staff Advisory in early July, reminding Futures Commission Merchants (“FCMs”) and Introducing Brokers (“IBs”) to report suspicious activity and to comply with the economic sanctions programs administered by the Office of Foreign Affairs Control (“OFAC”). The suspicious activity reporting regulation requires every FCM and IB to report any possible violation of law or regulation no later than 30 calendar days after the date the suspicious activity is initially detected unless no suspect is identified. The economic sanctions regulations by OFAC generally prohibit U.S. persons from engaging in transactions with individuals or entities located in countries subject to sanction programs. Accordingly, FCMs and IBs should regularly review the economic sanctions programs each time they are updated and screen all new and current customers periodically.
  • Investment Advisers Modernization Act of 2016. The House of Financial Services Committee approved a bill directing the SEC to update portions of the Advisers Act by removing duplicative and burdensome regulations that impose an unnecessary burden on small business’ access to capital. Among the rules to be amended are Rule 206(4)-1 (Advertisements), Rule 206(4)-6 (Proxy Voting), and Rule 204(b)-1 (Form PF).
  • NFA Amends Compliance Rule 2-46. Effective September 30, 2016, each Form CPO-PQR or Form CTA-PR that is filed after the due date will be subject to a fee of $200 for each business day it is late. Generally, Form CTA-PR is due within 45 days and Form CPO-PQR is due within 60 days of the relevant calendar quarter end. Please examine the compliance calendar below for the relevant due dates.

MSRB to Launch Permanent Series 50 Exam in September. The Municipal Securities Rulemaking Board (“MSRB”) will make available the permanent Municipal Advisor Representative Qualification Examination (Series 50) beginning September 12, 2016. Any individual who engages in municipal advisory activities or supervises a municipal advisor representative is required to take the Series 50 to demonstrate the level of knowledge needed to perform municipal advisory activities. To facilitate the transition to the new exam requirement, the MSRB is providing a one-year grace period during which individuals will be able to take the municipal advisor representative exam while still engaging in municipal advisory activities.

Compliance Calendar.  As you plan your regulatory compliance timeline for the coming months, please keep the following dates in mind:

Deadline             Description

Deadline Filing
June 1, 2016 Limited partnerships and limited liability companies formed in Delaware were required to pay the annual tax of $300.
June 30, 2016 Deadline for filing AIFMD annual report (AIFs with a financial year ending on December 31st).
June 30, 2016 Delivery of audited financial statements to investors (private fund managers to funds of funds, including SEC, State and CFTC registrants).
June 30, 2016 Deadline for Cayman Island registered funds with a fiscal year end of December 31 to file the Fund Annual Return and audited financial statements with Cayman Islands Monetary Authority.
June 30, 2016 Review transactions and assess whether Form 13H needs to be amended.
June 30, 2016 Annual Foreign Bank and Financial Accounts Report (FBAR).
July 30, 2016 Quarterly NAV Report (CPOs claiming the 4.7 exemption).
August 10, 2016 Deadline for Reporting Financial Institutions under U.S. FATCA to file both notification and reporting with the Cayman Islands Tax Authority.
August 14, 2016 CTA-PR filing with NFA.
August 15, 2016 Form 13F filing (advisers managing $100 million in 13F Securities).
August 29, 2016 CPO-PQR filing with NFA (large CPOs).
August 29, 2016 Form PF for quarterly filers.
September 28, 2016 CPO-PQR filing with NFA (mid-size and small CPOs).
Variable Distribute copies of Schedule K-1 to fund investors.
Periodic Filings Form D and Blue Sky filings should be current.

Please contact us with any questions or for assistance with any compliance, registration or planning issues on any of the above topics.

Sincerely,

Karl Cole-Frieman, Bart Mallon & Lilly Palmer

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Cole-Frieman & Mallon LLP is a premier boutique investment management law firm, providing top-tier, responsive and cost-effective legal solutions for financial services matters. Headquartered in San Francisco, Cole-Frieman & Mallon LLP has an international practice that services both start-up investment managers as well as multi-billion dollar firms. The firm provides a full suite of legal services to the investment management community, including: hedge fund, private equity fund, and venture capital fund formation, adviser registration, counterparty documentation, SEC, CFTC, NFA and FINRA matters, seed deals, hedge fund due diligence, employment and compensation matters, and routine business matters.

Hedge Fund Events December 2015

The following are various hedge fund events happening this month.  Please email us if you would like us to add your event to this list.

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Date: December 1-3, 2015

Date: December 2, 2015

Date: December 2, 2015

Date: December 2-4, 2015

Date: December 3, 2015

Date: December 3, 2015

Date: December 3, 2015

Date: December 3, 2015

Date: December 3, 2015

Date: December 6-8, 2015

Date: December 7, 2015

Date: December 7, 2015

Date: December 7-8, 2015

Date: December 7-8, 2015

  • Sponsor: IIR
  • Event: Yield Show
  • Location: New York, NY

Date: December 7-8, 2015

Date: December 7-8, 2015

Date: December 7-9, 2015

Date: December 7-10, 2015

Date: December 8, 2015

Date: December 8, 2015

Date: December 8, 2015

Date: December 8, 2015

Date: December 8, 2015

Date: December 9, 2015

Date: December 9, 2015

Date: December 9, 2015

Date: December 9-11, 2015

Date: December 10, 2015

Date: December 10, 2015

Date: December 10, 2015

Date: December 10-11, 2015

Date: December 11, 2015

Date: December 14, 2015

Date: December 14, 2015

Date: December 15, 2015

Date: December 15, 2015

Date: December 16, 2015

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Cole-Frieman & Mallon provides legal services for hedge fund managers and other groups within the investment management industry.  Bart Mallon can be reached directly at (415) 868-5345.

Hedge Fund Events November 2015

The following are various hedge fund events happening this month.  Please email us if you would like us to add your event to this list.

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Date: November 2-4, 2015

Date: November 2-6, 2015

  • Sponsor: Power Week
  • Event: Power Week
  • Location: Singapore

Date: November 3, 2015

Date: November 3, 2015

Date: November 3, 2015

Date: November 3, 2015

Date: November 3, 2015

Date: November 3-4, 2015

Date: November 4, 2015

Date: November 4-5, 2015

Date: November 4-5, 2015

Date: November 4-5, 2015

Date: November 4-6, 2015

Date: November 5, 2015

Date: November 5, 2015

Date: November 5, 2015

Date: November 5, 2015

Date: November 5, 2015

Date: November 5, 2015

Date: November 5, 2015

Date: November 5, 2015

Date: November 5-6, 2015

Date: November 5-6, 2015

Date: November 9-10, 2015

Date: November 9-10, 2015

Date: November 9-10, 2015

Date: November 9-10, 2015

Date: November 9-11, 2015

Date: November 10, 2015

Date: November 10, 2015

Date: November 10-11, 2015

  • Sponsor: Worldwide Business Research
  • Event: FIMA
  • Location: London

Date: November 10-12, 2015

Date: November 11, 2015

Date: November 11, 2015

Date: November 11-12, 2015

Date: November 11-12, 2015

Date: November 11-13, 2015

Date: November 12, 2015

Date: November 12, 2015

Date: November 12, 2015

Date: November 12-13, 2015

Date: November 12-13, 2015

Date: November 12-13, 2015

Date: November 12-13, 2015

Date: November 15-16, 2015

Date: November 16-17, 2015

Date: November 16-17, 2015

Date: November 16-18, 2015

Date: November 16-19, 2015

Date: November 16-19, 2015

Date: November 17, 2015

Date: November 17, 2015

Date: November 17, 2015

Date: November 17, 2015

Date: November 17-18, 2015

Date: November 18, 2015

Date: November 18, 2015

Date: November 18, 2015

Date: November 18, 2015

Date: November 18, 2015

Date: November 18, 2015

Date: November 18-19, 2015

Date: November 18-19, 2015

Date: November 19, 2015

Date: November 19, 2015

Date: November 19, 2015

Date: November 19, 2015

Date: November 19-20, 2015

Date: November 23, 2015

Date: November 23-25, 2015

Date: November 23-25, 2015

Date: November 26-27, 2015

Date: November 30 – December 1, 2015

Date: November 30 – December 1, 2015

Date: November 30 – December 2, 2015

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Cole-Frieman & Mallon provides legal services for hedge fund managers and other groups within the investment management industry.  Bart Mallon can be reached directly at (415) 868-5345.

Hedge Fund Events August 2015

The following are various hedge fund events happening this month.  Please email us if you would like us to add your event to this list.

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Date: August 1, 2015

Date: August 5, 2015

Date: August 5, 2015

Date: August 10, 2015

Date: August 12, 2015

Date: August 18-20, 2015

Date: August 19, 2015

Date: August 20-21, 2015

Date: August 24-25, 2015

Date: August 24-27, 2015

Date: August 24-27, 2015

Date: August 25, 2015

Date: August 27, 2015

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Cole-Frieman & Mallon provides legal services for hedge fund managers and other groups within the investment management industry.  Bart Mallon can be reached directly at (415) 868-5345.

Hedge Fund Events July 2015

The following are various hedge fund events happening this month.  Please email us if you would like us to add your event to this list.

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Date: June 29-July 1, 2015

Date: June 29-July 2, 2015

Date: July 2, 2015

Date: July 2, 2015

Date: July 2-3, 2015

Date: July 7-10, 2015

Date: July 8, 2015

  • Sponsor: Incisive Media
  • Event: Risk Hedge
  • Location: New York, NY

Date: July 9, 2015

Date: July 9, 2015

Date: July 10-11, 2015

Date: July 13-14, 2015

Date: July 14, 2015

Date: July 14, 2015

Date: July 15, 2015

Date: July 15, 2015

Date: July 15-16, 2015

Date: July 16, 2015

Date: July 16, 2015

Date: July 20-21, 2015

Date: July 20-22, 2015

Date: July 20-22, 2015

Date: July 22-24, 2015

Date: July 23, 2015

Date: July 23-24, 2015

Date: July 26-29, 2015

Date: July 27, 2015

Date: July 29, 2015

Date: July 29, 2015

Date: July 29-30, 2015

Date: July 29-31, 2015

Date: July 30, 2015

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Cole-Frieman & Mallon provides legal services for hedge fund managers and other groups within the investment management industry.  Bart Mallon can be reached directly at (415) 868-5345.

Hedge Fund Events June 2015

The following are various hedge fund events happening this month.  Please email us if you would like us to add your event to this list.

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Date: May 31-June 2, 2015

Date: June 1, 2015

Date: June 2, 2015

Date: June 2, 2015

Date: June 2-3, 2015

Date: June 2-3, 2015

Date: June 3, 2015

Date: June 3, 2015

June 3, 2015

Date: June 3, 2015

Date: June 3-4, 2015

Date: June 3-4, 2015

Date: June 3-4, 2015

Date: June 4, 2015

Date: June 4, 2015

Date: June 4, 2015

Date: June 4, 2015

Date: June 7-9, 2015

Date: June 8-9, 2015

Date: June 8-9, 2015

Date: June 8-12, 2015

Date: June 9, 2015

Date: June 9, 2015

Date: June 9-10, 2015

  • Sponsor: Broadridge
  • Event: IDX 2015
  • Location: London, United Kingdom

Date: June 9-11, 2015

Date: June 9-11, 2015

Date: June 10, 2015

Date: June 10, 2015

Date: June 10, 2015

Date: June 10, 2015

Date: June 10-11, 2015

Date: June 10-11, 2015

Date: June 10-12, 2015

Date: June 10-12, 2015

Date: June 11, 2015

Date: June 11, 2015

Date: June 11, 2015

Date: June 11-12, 2015

Date: June 12, 2015

Date: June 15-16, 2015

Date: June 15-16, 2015

Date: June 15-19, 2015

Date: June 16-17, 2015

Date: June 17, 2015

Date: June 18, 2015

Date: June 18, 2015

Date: June 22, 2015

Date: June 22, 2015

Date: June 22-23, 2015

Date: June 23-24, 2015

Date: June 23-24, 2015

Date: June 24, 2015

  • Sponsor: MFA
  • Event: Forum 2015
  • Location: Chicago, IL

Date: June 25, 2015

Date: June 26, 2015

Date: June 29-July 2, 2015

Date: June 30, 2015

Date: June 30, 2015

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Cole-Frieman & Mallon provides legal services for hedge fund managers and other groups within the investment management industry.  Bart Mallon can be reached directly at 415-868-5345.

Cole-Frieman & Mallon LLP 2015 First Quarter Update

COLE_FRIEMAN_LOGO_large

 www.colefrieman.com

May 13, 2015

Clients and Friends:

The first quarter of 2015 was a busy period for investment managers and service providers alike and we find ourselves sending out this update very late.  As a variety of filing deadlines have passed and audit work is completed (or will be soon), we enter the second quarter with a number of new regulatory changes on the horizon, as well as many other topics worthy of discussion.  Below, we have prepared a short overview of some of these items.  Please note there are some items from the start of the second quarter which will be included in the next update.

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SEC Cybersecurity Sweep Examination Results.  The Office of Compliance Inspections and Examinations (“OCIE”) of the SEC recently released a Risk Alert in connection with its examination of over 100 broker-dealers (“BDs”) and registered investment advisers (“RIAs”) with respect to the cybersecurity preparedness and practices of such registered firms. The examinations focused on if and how the examined BDs and RIAs establish (1) cybersecurity policies, procedures, and oversight processes, (2) protect their networks and information, and (3) detect and handle unauthorized activities and other cyber-attacks.

Key findings from the examinations include:

  • More than 80% of RIAs and 90% of BDs examined have adopted written cybersecurity policies and conduct periodic firm-wide cybersecurity assessments.
  • Less than 25% of RIAs examined incorporate cybersecurity requirements into their contracts with vendors, service providers, and other business partners. However, more than 70% of BDs incorporate such provisions into their contracts.
  • More than 50% of BDs examined maintain insurance coverage for cybersecurity-related incidents, while only 21% of RIAS examined hold such policies. (Note that only one BD and one RIA reported that they had filed a claim with their insurance provider in connection with a cybersecurity incident.)

As shown in the statistics above, many RIAs and BDs could bolster their cybersecurity preparedness by including cybersecurity requirements in all of their vendor contracts and by obtaining insurance coverage for cybersecurity-related incidents. The OCIE has stated that the cybersecurity practices and preparedness of BDs and RIAs will be a focus for 2015, so we encourage our clients to contact their service providers to ensure that they are adequately protected against such cybersecurity risks.

The SEC has issued a Guidance Update in connection with the Risk Alert described above.  We will be discussing the “best practices” recommended by the SEC in a future quarterly update.

SEC 2015 Examination Priorities.  The SEC recently announced its 2015 examination priorities, which are intended to address market-wide issues, such as fraud detection/prevention and corporate governance, as well as those specific to particular business models and organizations.  In 2015, the SEC will focus on its efforts on: matters of importance for retail investors and investors saving for retirement, including whether the information, advice, products, and services being offered are consistent with applicable laws, rules and regulations; market-wide risks, such those created by clearing agencies, cybersecurity compliance and controls, and equity order routing conflicts; and, using data analytics to identify signals of potential illegal activity. Despite the SEC’s stated focus, its priorities list is not exhaustive and may be adjusted throughout the year in response to ongoing risk evaluation.

FINRA 2015 Exam Priorities.  FINRA published its 2015 Regulatory and Examinations Priorities Letter, outlining the organization’s enforcement priorities for the current year. While the priorities listed in the letter are too numerous to describe here, focus areas for 2015 will include:

  • Sale and supervision of interest-rate-sensitive and complex products, including alternative mutual funds;
  • Controls around the handling of wealth events in investors’ lives;
  • Management of cybersecurity risks;
  • Treatment of senior investors; and,
  • High-risk brokers and removing bad actors from the securities industry.

FINRA noted that they will increasingly rely on data analytics to identify potential problem areas within firms, and it encourages firms to use data analytics themselves to self-identify such problems.

Improperly Registered Investment Advisers.  Although not listed as an exam priority for 2015, investment advisers should be mindful that the SEC actively pursues improperly registered investment advisers. Several recent enforcement actions targeted SEC-registered investment advisers claiming to be Wyoming-based after investigations conducted by the SEC revealed that the investment advisers primarily directed their advising services from locations outside of Wyoming and should have been registered with the relevant state authority. We caution investment advisers against abusing the “Wyoming exception” or from exaggerating assets in order to secure SEC registration and avoid registration with state securities agencies.

Guidance Update Regarding Key Employee Trusts and Family Office Rule.  The Division of Investment Management of the SEC issued an Investment Management Guidance Update regarding whether certain key employee trusts would qualify as “Family Clients” under Rule 202(a)(11)(G)-1 of the Advisers Act (the “Family Office Rule”).  The Advisers Act defines “Family Clients” as including “any trust of which: each trustee or other person authorized to make decisions with respect to the trust is a key employee; and each settlor or other person who has contributed assets to the trust is a key employee.” The guidance update clarified that if a non-key employee makes non-investment decisions for the trust, the trust may still qualify as a Family Client so long as investment decisions are made by a key employee. “Investment decision” is not defined in the Advisers Act; however, the Division provided an illustrative list of decisions that would qualify as “investment decisions,” including preparing or filing taxes for the trust; keeping records for the trust; and distributing periodic statements or disclosures to trust beneficiaries.

Auditor Independence Violations. The SEC and Public Company Accounting Oversight Board (PCAOB) released an alert in November highlighting certain aspects the independence rules for non-issuer audit and attestation engagements. Auditors engaged to provide financial statement audit and attestation services for (i) non-issuer SEC-registered broker-dealers and (ii) SEC- and state-registered investment advisers and private funds who are subject to the SEC Custody Rule, are required to be “independent” from the clients that they audit. Under Rules 2-01(b) and (c) of Regulation S-X, an auditor is considered not to be “independent” if, at any time during the engagement, the auditor provides prohibited non-auditor services to the client, such as bookkeeping or financial statement preparation services. In December, the SEC sanctioned eight auditing firms for violating these rules when they prepared the financial statements for clients that they were hired to audit. The SEC noted that by preparing the financial statements for their clients, the auditors were effectively auditing their own work and inappropriately aligning themselves with the interests of the clients’ management teams rather than remaining neutral, independent auditors. As a result of the auditors’ non-independence, the auditors’ clients were also deemed to have violated their statutory obligation to provide independently audited financial statements. In light of these sanctions, we encourage our clients to ensure that their auditors remain independent throughout the auditing process and to engage other service providers to prepare their financial statements.

Marketing to Investors in Switzerland.  On March 1, 2015, new regulations came into effect that require specific steps to be taken before marketing to “unregulated qualified investors” in Switzerland. In Switzerland, a fund can be marketed to qualified investors without registering with the Swiss Financial Market Authority (“FINMA”). Qualified investors are divided into two categories: “regulated” and “unregulated.” “Regulated” qualified investors are entities that are already regulated by FINMA, such as banks, securities dealers, fund managers, and insurance companies.  The new regulations do not change the way funds are marketed to regulated qualified investors.

However, the new regulations do change the requirements for funds that wish to market to “unregulated” qualified investors, such as public institutions, pension funds, businesses, and high-net-worth individuals that (a) have made a declaration as such and (b) meet an asset and/or sophistication threshold. The new rules mandate that, before marketing to unregulated qualified investors, the fund must first: (1) appoint a licensed Swiss-representative to represent the fund to FINMA and Swiss investors, (2) appoint a Swiss bank to serve as a paying agent, (3) enter into a distribution agreement with the appointed Swiss-representative, and (4) make necessary disclosures to Swiss investors.

Nonetheless, Swiss investors do not trigger the Annex IV reporting requirements or the remuneration disclosure requirements under AIFMD and the up-front expense associated with marketing to Swiss investors is comparatively cheaper than in other jurisdictions. Funds interested in marketing to Swiss investors should consult with their offshore counsel to discuss whether marketing in Switzerland is worthy of additional attention and focus.

Cayman Islands FATCA Reporting.  The Department for International Tax Cooperation of the Cayman Islands (“DITC”) recently released guidance regarding the registration process for financial institutions with reporting requirements under the Cayman Islands FATCA framework on the Cayman Automated Exchange of Information Portal (“CAEIP”). Such reporting institutions are required to notify the DITC of the following information on or before May 21, 2015 (extended from the original deadline of March 31, 2015):

  • Name;
  • FATCA classification;
  • Global Intermediary Identification Number (aka GIIN – can be obtained on IRS website); and,
  • Point of Contact.

Following the initial informational submission on CAEIP described above, each Cayman Islands reporting institution is then required to submit their FATCA reports via the CAEIP by May 31, 2015.

Updated FATCA Guidance – British Virgin Islands.  Last June, the British Virgin Islands (“BVI”) and the United States entered an intergovernmental agreement that requires BVI financial institutions, including hedge funds, to report information about U.S. persons with offshore accounts to the BVI International Tax Authority (the “Authority”). Although BVI has not yet passed legislation or promulgated regulations under the agreement, the Authority has released a detailed guide to help affected entities comply with the new reporting requirements. The guide provides clarification about which entities must register with the IRS and report information to the Authority, due diligence requirements, and other procedural issues.

The initial reporting deadline is June 30, 2015; in subsequent years, the deadline will fall on May 31. Reports can only be filed through the BVI’s Financial Account Reporting System (“BVIFARS”). The Authority expects the website to be accessible by April 15, 2015. In the future, BVI may pass legislation and promulgate rules in accordance with the FATCA agreement. Managers should remain in touch with both U.S. and offshore fund counsel regarding the regulatory landscape and to plan any changes to the fund’s offering documents, and/or any investor communications that may become necessary.

Foreign Corporation Tax for Offshore Funds.  In January, the IRS’s Office of Chief Counsel released a memorandum explaining that an offshore fund and an offshore feeder may be taxed as a foreign corporation if the offshore fund engages in a “trade or business” within the United States. Normally an offshore fund qualifies for an exemption from taxation as a foreign corporation that covers security trading activities (the “Trading Safe Harbors”), but, as the memo clarifies, underwriting and money lending (as well as “other fact patterns”) are considered “trade and business” activities that do not fall within the Trading Safe Harbors. Offshore funds should consult with tax and legal advisors to consider whether their investment activities may fall outside the protection of the Trading Safe Harbors.

Cayman Fund Director Liability.  The Cayman Islands Court of Appeals overturned the contentious Weavering verdict on February 12, 2015.  In Weavering, the lower court found two directors of a Cayman fund “willfully negligent” for signing a quarterly report without reading its contents; the judge determined that a simple review of the quarterly report would have alerted the directors to fraudulent trading occurring within the fund. In reversing the verdict, the appellate court acknowledged that a director can be held willfully negligent for consciously choosing not to perform its duties to a fund, but signing a quarterly statement without reading the content is not in and of itself willfully negligent under Cayman law. Although the original ruling was reversed, the case highlights the importance for directors of Cayman Islands funds to not take their statutory duties lightly.

Finance Lenders Regulatory Reminder. The 2014 Annual Report for Lenders and Brokers Licensed under the California Finance Lenders Law (CFLL) was due on March 15, 2015. The form and instructions are available on the DBO’S website. In order to upload and file the report, licensees must log in to the self-service portal using their username and password. For licensees who have not registered in the DBO’s Self-Service DOCQNET Portal, registration is a three-step process: (1) licensees create an account; (2) DBO staff verify the information; and, (3) following the verification, licensees reenter the portal to complete their registration.  The registration process normally takes five days to complete. The registration portal can be found here.

Municipal Advisor Regulatory Update. The Municipal Securities Rulemaking Board (“MSRB”) and SEC have continued to develop municipal advisor rules in the areas of supervision and compliance, pay-to-play, standards of conduct including fiduciary duty, professional qualifications, and gifts and gratuities. The regulatory environment was discussed during a 2014 Compliance Outreach program for Municipal Advisors hosted by the MSRB, SEC and FINRA.  Notably, registered municipal advisors must be in compliance with the following MSRB Rules by April 23, 2015:

  • Rule G-44 Supervisory and Compliance Obligations of Municipal Advisors
  • Rule G-8 Books and Records
  • Rule G-9 Preservation of Record

The MSRB recently hosted a webinar on compliance with the foregoing rules.  As the municipal advisor regulatory framework is continuously changing, we recommend that registered municipal advisors regularly review the applicable MSRB Rules and register for MSRB email updates.

Electronic Blue Sky Notice Filings for Regulation D Offerings.  The North American Securities Administrators Association (“NASAA”) recently announced the launch of an online Electronic Filing Depository (“EFD”) for electronic notice filings made in connection with offerings under Rule 506 of Regulation D. The EFD will permit filers to submit the blue sky notice filings and pay the related filing fees electronically for such Regulation D offerings. Note that while some states currently accept electronic filings made through EFD, many states are expected to require such EFD-submitted filings in the near future.

Other Notes.

  • Basing Claims on Back-Tested Performance Data. Last December, the SEC issued a cease-and-desist order against an investment adviser for exaggerating the “proven track-record” of their proprietary trading technique.  The adviser advertised that their investing model, created in 2008, had been successful in managing client assets going back to 2001. The SEC determined that these claims were based on back-tested data, which snowballed into an assortment of securities law violations. The SEC prohibits substituting historic performance with back-tested data because such a claim, without disclosure, is materially misleading to investors. Investment advisers should be cognizant that back-tested data cannot be used to allege actual historic performance.
  • ESMA Guidelines and Technical Standards Overview. The European Securities and Markets Authority (“ESMA”) published an overview of guidelines and technical standards for an assortment of security-related regulations as well as compliance tables, consultation papers, and other useful information.  The overview is available on the ESMA website.
  • California Management Fee Withholding Tax. Many of you may have received a recent news bulletin that implied hedge funds with California investors will be subject to a new California state tax. The article was largely misleading, as the “new tax hit” the author identified generally reflects the status quo. California uses a “market-based” tax sourcing system: the source of revenues determines where the tax on such revenues should be paid. Most, if not all, fund managers already comply with this tax scheme. Note that there are on-going revisions to this rule and hearings scheduled for this summer, so the status quo may change. For now, this should not raise any “new” concerns for managers; however, we will be on the look-out for any updates on this front.
  • New Irish Legal Entity Designed for Hedge Funds. Ireland, long an attractive alternative to the Caribbean for offshore investment vehicles, recently passed legislation creating a new legal entity specifically tailored for hedge funds. The form of entity, named an Irish Collective Asset-Management Vehicle (“ICAV”), is designed to minimize the administrative burdens of establishing and maintaining an investment vehicle in Ireland, while at the same time permitting the vehicle to “check the box” and be taxed by the U.S. as a partnership. The latter feature allows U.S. taxable investors to circumvent certain adverse tax consequences that typically apply to U.S. investors of passive foreign investment companies.  Additionally, an ICAV will fall under Ireland’s tax regime for regulated funds, meaning that it is generally exempt from Irish income taxes at the fund level, transfer taxes for the issue, transfer, or sale of shares, and withholding taxes on distributions to non-Irish investors. The Irish Parliament hopes that ICAVs will further encourage the formation of new funds, and the re-domiciliation of existing offshore funds, in Ireland.
  • New Registration Requirement for Security-Based SDRs. The SEC has adopted new rules requiring security-based swap data repositories (“SDRs”) to register with the SEC and proposed additional rules relating to the reporting and public dissemination of security-based SDRs.  A notice about the new rule and proposed rules can be found here.
  • Alternative Trading Systems Reporting. FINRA is soliciting comments for proposed rules that would require alternative trading systems (“ATSs”) to report quotation information for corporate and agency debt securities to FINRA.  More information about the proposed rules can be found here.
  • OCR Final Rule. The CFTC issued a no-action letter extending the conditional deadline to comply with the OCR Final Rule’s expanded information reporting requirements. The new deadlines are September 30, 2015 for New Form 102A, New Form 102S and DCM threshold accounts via New Form 102B and February 13, 2017 for SEF volume threshold accounts via New Form 102B.  The deadline for reporting on New Form 40/40S and New Form 71 is February 11, 2016.  The extended deadlines are conditioned on the Reporting Parties continuing to report on Legacy Form 102, Legacy 102S Filing, Legacy Form 40, and Legacy 40S Filing.  The no-action letter can be found here.

Compliance Calendar.  As you plan your regulatory compliance timeline for the coming months, please keep the following dates in mind:

Deadline             Description

March 31, 2015  Form ADV annual updating amendment deadline.

April 15, 2015     1st Quarter 2015 Form PF filing for quarterly filers (Large Liquidity Fund Advisers).

April 30, 2015     2014 Annual Form PF filing for annual filers (Large Private Equity Fund Advisers and Smaller Private Fund Advisers).

April 30, 2015     Offer or delivery of Form ADV Part 2 to clients (most registered investment advisers); Delivery of Privacy Notice.

April 30, 2015     Delivery of audited financial statements to investors (most private fund managers, including SEC, State and CFTC registrants).

April 30, 2015     Quarterly NAV Report (registered commodity pool operators claiming the 4.7 exemption).

May 5, 2015        FATCA registration with the IRS through the online web portal found here. Enter into a foreign financial institution agreement with the IRS via the web portal, or comply with an applicable intergovernmental agreement. Meet the other due diligence, reporting and withholding requirements under FATCA, as applicable.

May 15, 2015      Form 13F filing (advisers managing $100 million in 13F Securities).

May 15, 2015      CTA-PR filing.

May 21, 2015      Deadline for Cayman Islands Financial Institutions with reporting obligations under the Cayman FATCA regulatory framework to register their status on the Cayman Islands Tax Information Authority on the Cayman Automated Exchange of INFORMATION Portal (extended from March 31, 2015).

May 31, 2015      First reporting deadline for Cayman Islands Financial Institutions in respect of the Cayman FATCA regulatory framework.

June 30, 2015     Delivery of audited financial statements to investors (private fund managers to funds of funds, including SEC, State and CFTC registrants).

June 30, 2015     Deadline for filing audited financial statements for preceding financial year and Fund Annual Return with Cayman Islands Monetary Authority.

June 30, 2015     Review transactions and assess whether Form 13H needs to be amended.

Variable               Distribute copies of Schedule K-1 to fund investors.

Periodic Filings  Form D and Blue Sky filings should be current.

Please contact us with any questions or for assistance with any compliance, registration or planning issues on any of the above topics.

Sincerely,

Karl Cole-Frieman, Bart Mallon & Lilly Palmer

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Cole-Frieman & Mallon LLP is a premier boutique investment management law firm, providing top-tier, responsive and cost-effective legal solutions for financial services matters. Headquartered in San Francisco, Cole-Frieman & Mallon LLP has an international practice that services both start-up investment managers as well as multi-billion dollar firms. The firm provides a full suite of legal services to the investment management community, including: hedge fund, private equity fund, and venture capital fund formation, adviser registration, counterparty documentation, SEC, CFTC, NFA and FINRA matters, seed deals, hedge fund due diligence, employment and compensation matters, and routine business matters.

Hedge Fund Events May 2015

The following are various hedge fund events happening this month.  Please email us if you would like us to add your event to this list.

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Date: May 4, 2015

Date: May 5, 2015

Date: May 5, 2015

Date: May 5, 2015

Date: May 5-6, 2015

Date: May 5-8, 2015

  • Sponsor: SkyBridge Capital
  • Event: SALT Las Vegas
  • Location: Las Vegas, NV

Date: May 6, 2015

Date: May 6, 2015

Date: May 6, 2015

Date: May 6, 2015

Date: May 7, 2015

Date: May 10-11, 2015

Date: May 12, 2015

Date: May 12, 2015

Date: May 12-13, 2015

Date: May 13, 2015

Date: May 13, 2015

Date: May 13, 2015

Date: May 13-14, 2015

Date: May 14, 2015

Date: May 18-20, 2015

Date: May 19, 2015

Date: May 19, 2015

Date: May 20, 2015

Date: May 20, 2015

Date: May 21, 2015

Date: May 27-28, 2015

Date: May 27-29, 2015

Date: May 28, 2015

Date: May 30, 2015

Date: May 31-June 2, 2015

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Cole-Frieman & Mallon provides legal services for hedge fund managers and other groups within the investment management industry.  Bart Mallon can be reached directly at 415-868-5345.

Hedge Fund Events April 2015

The following are various hedge fund events happening this month.  Please email us if you would like us to add your event to this list.

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Date: April 1, 2015

Date: April 6, 2015

Date: April 7, 2015

Date: April 9, 2015

Date: April 12-14, 2015

Date: April 13, 2015

Date: April 13-14, 2015

Date: April 13-14 , 2015

Date: April 13-16, 2015

  • Sponsor: SIFMA
  • Event: Ops 2015
  • Location: San Diego, CA

Date: April 14-17, 2015

Date: April 15-16 , 2015

Date: April 16, 2015

Date: April 19-21, 2015

Date: April 20, 2015

Date: April 20-21, 2015

Date: April 21, 2015

Date: April 21, 2015

Date: April 22-23, 2015

  • Sponsor: FRA
  • Event: OCIO Summit
  • Location: New York, NY

Date: April 22-23, 2015

Date: April 22-24, 2015

Date: April 22-24, 2015

Date: April 23, 2015

Date: April 23, 2015

Date: April 23-24, 2015

Date: April 26-28, 2015

Date: April 26-29, 2015

Date: April 27-28, 2015

Date: April 27-28, 2015

Date: April 27-29, 2015

Date: April 28, 2015

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Cole-Frieman & Mallon LLP provides legal services for hedge  fund managers and other groups within the investment industry.  Bart Mallon can be reached directly at 415-868-5345.

Hedge Fund Events March 2015

The following are various hedge fund events happening this month.  Please email us if you would like us to add your event to this list.

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Date: March 2-3, 2015

Date: March 3, 2015

Date: March 3-4, 2015

  • Sponsor: sifma
  • Event: IRLS 2015
  • Location: New York, NY

Date: March 4, 2015

Date: March 4, 2015

Date: March 5, 2015

Date: March 5, 2015

Date: March 5, 2015

  • Sponsor: Capital Link
  • Event: MLP Forum
  • Location: New York, NY

Date: March 5, 2015

Date: March 5, 2015

  • Sponsor: CHFA
  • Event: AltsLA
  • Location: Los Angeles, CA

Date: March 5-6, 2015

Date: March 9-10, 2015

Date: March 9-11, 2015

Date: March 9-11, 2015

Date: March 10, 2015

Date: March 10, 2015

Date: March 10, 2015

Date: March 10-13, 2015

Date: March 11-12, 2015

Date: March 11-13, 2015

Date: March 12, 2015

Date: March 12, 2015

Date: March 12-13, 2015

Date: March 14, 2015

  • Sponsor: Quantopian
  • Event: QuantCon 2015
  • Location: New York, NY

Date: March 16, 2015

Date: March 18, 2015

Date: March 18-19, 2015

Date: March 19, 2015

Date: March 20, 2015

Date: March 23, 2015

Date: March 24, 2015

Date: March 24, 2015

Date: March 24, 2015

Date: March 24-25, 2015

Date: March 24-25, 2015

Date: March 25-26, 2015

Date: March 26, 2015

Date: March 26, 2015

Date: March 30-31, 2015

Date: March 30-31, 2015

Date: March 30-April 1, 2015

  • Sponsor: WBR
  • Event: FIMA 2015
  • Location: Boston, MA

Date: March 31, 2015

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Cole-Frieman & Mallon provides legal services for hedge fund managers and other groups within the investment management industry.  Bart Mallon can be reached directly at 415-868-5345.