Clients, Friends, Associates:
Although we are late in publishing this year-end planning memo, we believe it may still be helpful for managers on this last day of 2011 and into the new year. In addition to all of the administrative details involved in closing out the year, the regulatory landscape has shifted dramatically over the past year. As a result, year-end processes and 2012 planning are particularly important, especially for General Counsels, Chief Compliance Officers (CCOs) and key operational and financial personnel. We have updated our own year-end checklist to help managers stay on top of these priorities.
New Issue Status. On an annual basis, a manager needs to confirm or reconfirm the eligibility of investors that participate in initial public offerings or new issues. Most managers reconfirm this via negative consent, i.e., investors are informed of their status as on file with the manager and asked to inform the manager of any changes. No response operates as consent to the current status.
In addition, this is a good time to review your offering documents to confirm that they include FINRA’s anti-spinning rule (Rule 5131), as well as the SEC’s current thresholds for accredited investor and qualified client status, which became effective this year.
ERISA Status. Given the significant problems that can occur from not properly tracking ERISA investors, we recommend that managers also confirm or reconfirm on an annual basis the ERISA status of its investors. This is particularly important for managers that track the underlying percentage or ERISA funds for each investor. This reconfirmation can also be obtained through a negative consent. [For more information, please see our post on ERISA issues for hedge funds.]
Annual Compliance Review. On an annual basis, the CCO of a registered investment adviser must conduct an annual review of a manager’s compliance policies and procedures. This annual compliance review should be in writing and presented to senior management. We recommend that you discuss the annual review with your outside counsel, who can provide guidance about the review as well as a template for the review. Managers should be careful that sensitive conversations regarding the annual review are protected by attorney-client privilege. CCOs may also want to consider additions to the compliance program, including implementation of policies relating to use of social media, a hot topic for both managers and regulators in 2011.
Managers who are not registered may still wish to review their procedures and/or implement a compliance program as a best practice.
Trade Errors. Managers should make sure that all trade errors are addressed by the end of the year, pursuant to the manager’s polices regarding trade errors. Documentation of trade errors should be finalized, and if the manager is required to reimburse the funds, it should do so by year-end.
Soft Dollars. Managers that participate in soft dollar programs should make sure that they have addressed any commission balances by the end of the year.
Custody Rule Annual Audit. SEC-registered advisers must (i) maintain client funds and securities with a qualified custodian in a separate account for each client under that client’s name, or in an account that contains only client funds and securities with the adviser listed as agent or trustee for the clients; (ii) have a reasonable basis, formed after “due inquiry,” for believing that the qualified custodian holding client funds or securities sends an account statement to each advisory client at least quarterly; (iii) notify clients upon opening any new custodial account on behalf of the client (or changes to any such account) and include a legend in such notice urging the clients to compare custodial account statements with any statements received from the adviser (if the adviser elects to send any such statements directly); and (iv) undergo an annual surprise examination conducted by an independent public accountant.
Advisers to pooled investment vehicles may avoid both the quarterly statements and surprise examination requirements by having audited financial statements prepared in accordance with GAAP by an independent public accountant registered with the Public Company Accounting Oversight Board. Statements must be sent to the fund or, in certain cases, investors the fund within 120 days after the fund’s fiscal year end. Managers should review their custody procedures to ensure compliance with the rule. Requirements for state-registrants may differ, and we encourage you to contact us if you have any questions or concerns about your custody arrangements.
Please see our post on the SEC Custody Rule for more information.
Schedule 13G/D and Section 16 Filings. A manager whose managed funds are beneficial owners of 5% or more of a registered voting equity security must report these positions on Schedule 13G. Schedule 13G filings are updated annually within 45 days of the end of the year. For managers who are also filing Schedule 13D and/or Section 16 filings, this is an opportune time to review your filings to confirm compliance and anticipate needs for Q1.
Form 13F. A manager must also file a Form 13F if it exercises investment discretion with respect to $100 million or more in certain securities within 45 days after the end of the year in which the manager reaches the $100 million filing threshold. The SEC lists the securities subject to 13F reporting on its website.
Form 13H. Managers who meet the SEC’s new large trader thresholds (in general, managers whose transactions in exchange-listed securities equal or exceed two million shares or $20 million during any calendar day, or 20 million shares or $200 million during any calendar month) were required to file an initial Form 13H with the SEC on December 1, 2011. Large traders will need to file amended 13Hs on an annual basis. In addition, changes to the information on 13H will require interim amendments following the calendar quarter in which the change occurred.
Blue Sky Filings. On an annual basis, a manager should review its blue sky filings for each state to make sure it has met any renewal requirements. States are increasingly imposing late fees or rejecting late filings altogether. Accordingly, it is critical to stay on top of filing deadlines, for both new investors and any renewals.
SEC Form D. Form D filings for most funds need to be amended on an annual basis, on or before the anniversary of the initial SEC Form D filing. Copies of Form D can be obtained by potential investors via the SEC’s website.
IARD Annual Fees. Preliminary annual renewal fees for state registered and SEC registered investment advisors were due by December 12, 2011. In the event a manager has not submitted these fees, the manager should submit these fees immediately through the IARD system. The manager will likely be subject to additional late filing fees and these must be paid through the IARD by February 3, 2012.
Pay-to-Play Rules. In 2010, the SEC’s adopted Rule 206(4)-5, which disqualified investment advisers, their key personnel and placement agents acting on their behalf from seeking to be engaged by a governmental client if they have made political contributions. State and local governments are following suit, including California, which requires such persons to register with the state as lobbyists, and mandates lobbyist registration in California’s cities and counties as well. This is an important issue for any manager seeking investments by government pension plans.
Registered Commodity Pool Operators and Commodity Trading Advisers. Registered CPOs and CTAs must prepare and file Annual Questionnaires and Annual Registration Updates with the NFA. Registered CPOs must also prepare and file an annual report for each commodity pool. Unless its funds qualify for an exemption, registered CPOs and CTAs must update their disclosure documents periodically, as they may not use any document dated more than 9 months prior to the date of its intended use. Disclosure documents that are materially inaccurate or incomplete must be promptly corrected and the correction must be promptly distributed to pool participants.
Fund Accounting and Financial Matters:
Wash Sales. Managers should carefully manage wash sales for year end. Failure to do so could result in embarrassing book/tax differences for investors. Certain dealers can provide managers with swap strategies to manage wash sales, including Basket Total Return Swaps and Split Strike Forward Conversions. These strategies should be considered carefully to make sure they are consistent with the investment objectives of the fund.
Financial Accounting Standards Board Interpretation No. 48 (“FIN48”). Under FIN48, which became effective in 2009, managers must implement procedures to assess material tax positions, and potentially accrue liabilities. Managers should begin preparing to implement FIN48 as soon as possible, and should discuss with their auditors whether FIN48 will apply to them. Funds with exposure to certain countries, including Spain and Australia, should make sure they are aware of the implications of FIN48.
Redemption Management. Managers with significant redemptions at the end of the year should carefully manage the unwinding of positions so as to minimize transaction costs in the current year (that could impact performance), and prevent transaction costs from impacting remaining investors in the next year. When closing funds or managed accounts, managers shall pay careful attention to the liquidation procedures in the managed account agreement and the fund constituent documents. Offshore funds may involve unusual or lengthy dissolution procedures. Please contact us to help you evaluate and manage any fund dissolutions you are considering.
NAV Triggers and Waivers. If redemptions, performance or a combination of these are expected cause a termination event (NAV declines are typical inclusions in these provisions) in a fund’s ISDA or other counterparty agreement, managers should seek waivers of those events before the end of the year. We recommend starting this process early as credit officers at many banks may become unavailable during the holiday season.
Fund Expenses. Managers should make sure that all fund expenses for a particular year are paid for in that year, and do not roll over into the next year. In particular, managers should contact their outside legal counsel to obtain accurate and up to date information about legal expenses. Outside counsel and other vendors should be given a deadline so that checks do not need to be processed on New Year’s Eve.
Management Company Issues:
Management Company Expenses. Similarly, managers who distribute profits on an annual basis should attempt to pay management company expenses in the year they are incurred. If ownership or profit percentages are adjusted at the end of the year, a failure to manage expenses could significantly impact the economics of the partnership or the management company.
Employee Reviews. An effective annual review process is important to reduce employment related litigation and protect the management company in the event of such litigation. Moreover, it is an opportunity to provide context for bonuses, compensation adjustments, employee goals and other employee-facing matters at the firm. It is not too late to put an annual review process in place for 2011.
Compensation Planning. In the hedge fund industry, and the financial services industry in general, the end of the year is the appropriate time to make adjustments to the compensation program. Since much of a manager’s revenue is tied to annual income from incentive fees, any changes to the management company structure, affiliated partnerships, or any shadow equity program should begin on the first of the year.
Insurance. If a manager carries D&O Insurance or other liability insurance, the policy should be reviewed on an annual basis to make sure that the manager has provided notice to the carrier of all claims and all potential claims.
Future Regulatory Change:
Form ADV. Current registrants must file an annual amendment to Form ADV within 90 days of the end of its fiscal year. For SEC registrants, an updated Part 1A will be due on March 30, 2012, regardless of your FYE, to indicate your AUM for purposes of eligibility to remain registered with the SEC.
Annual amendments for SEC registrants will include Parts 1A and 2A (the firm brochure). For most state registrants, this will include all parts of the ADV as well as U4s for its investment adviser representatives. For managers who have not yet filed using the revised ADV Part 2 (for example, those who filed at the end of 2010, but were not approved until after January 1, 2011), you should anticipate additional time translating your old Part II and Schedule F information into the narrative format of Part 2A and B.
Additionally, on an annual basis, registered investment advisers must provide a copy of the updated Form ADV 2A brochure and Part 2B brochure supplement to clients (or a summary of changes, with an offer to provide the complete brochure).
For managers who are required to register with the SEC, the deadline to be registered is March 30, 2012. We recommend filing the ADV by at least February 14, 2012 to ensure meeting this deadline.
Managers who will no longer meet the AUM threshold to maintain registration with the SEC will have until June 28, 2012 to transition to state registration.
Form PF. Managers to private funds who are either registered with the SEC, or required to be registered with the SEC, will begin filing Form PF in 2012. Most private fund advisers will be required to begin filing Form PF following the end of their first fiscal year or fiscal quarter, as applicable, to end on or after December 15, 2012. Those with $5 billion or more in private fund assets must begin filing Form PF following the end of their first fiscal year or fiscal quarter, as applicable, to end on or after June 15, 2012.
For assistance with any compliance, registration, or planning issues with respect to any of the above topics, please contact Karl Cole-Frieman at 415-352-2300, Bart Mallon at 415-868-5345 or Aisha Hunt at 415-762-2854.
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.
Cole-Frieman & Mallon LLP
150 Spear Street, Suite 825
San Francisco, CA 94105
This Cole-Frieman & Mallon LLP Announcement is published as a source of information only for clients and friends of the firm, and should not be construed as legal advice or opinion on any specific facts or circumstances. The mailing of this publication is not intended to create, and receipt of it does not constitute, an attorney-client relationship. Circular 230 Disclosure: Pursuant to regulations governing practice before the Internal Revenue Service, any tax advice contained herein is not intended or written to be used and cannot be used by a taxpayer for the purpose of avoiding tax penalties that may be imposed on the taxpayer. Cole-Frieman & Mallon LLP is a California limited liability partnership.