Category Archives: Business Issues

Simple Agreement for Future Tokens (SAFT)

SAFT Background for Cryptocurrency Funds

As we discussed in a recent post, the SEC Report on the DAO, issued in July of this year, discussed how the SEC views Initial Coin Offerings (ICOs). One key takeaway from this report was that some digital assets/ tokens fall within the definition of securities, depending on the facts and circumstances related to the nature of the particular digital asset/token. If an ICO is considered an offer and sale of a security, then that offering must comply with federal securities laws.  This means the token must either be registered as a security with the SEC or that the token qualifys for an exemption from registration requirements.

In an attempt to comply with SEC regulations and account for some of the uncertainties around regulation of these digital assets, some recent ICOs have launched using a Simple Agreement for Future Tokens (SAFT) along with an accompanying offering memorandum. The SAFT, modeled after Y Combinator’s Simple Agreement for Future Equity (SAFE), is an agreement offering future tokens to accredited investors. Instead of offering an immediately available token, these SAFTs offer the right to a token upon a triggering event. SAFTS are intended to be private offerings exempt from registration with the SEC. Notably, Protocol Labs, Inc. offered the right to purchase Filecoin tokens through a SAFT earlier this year. Since then, multiple other ICOs have launched using SAFTS, including Unikrn, StreamCoin Labs, and Kik Interactive.

Overview of SAFT documentation

As part of some ICO launches, investors are subscribing through a SAFT and accompanying offering memorandum.  The SAFT is an agreement signed by both the issuer and the purchaser of the future tokens. The general SAFT template includes various provisions which we outline below.

  • Country legends – disclaimers directed toward specific countries, including statements on registration and restrictions on transfer of the tokens.
  • Sale information – purchase amount and price, token amounts, and vesting period.
  • Background information – various events including network launch, dissolution events, and termination events are discussed. A network launch will generally trigger an issuance of tokens based on the purchase amount of each investor.
  • Purchaser and Issuer representations – various representations made by both the issuer and purchaser are included. Notably, the purchaser will represent that it has been advised that the SAFT is a security and has not been registered, and cannot be resold without the consent of the issuer. The agreement also includes the procedures for purchase of rights under the SAFT including the form of payment.
  • Miscellaneous/ transfer provisions – various miscellaneous provisions including transfer restrictions and rights under the SAFT.

SAFT Offering Memorandum

The offering memorandum is similar private placement memorandum (PPM) for a traditional hedge fund and provides the prospective investor with information on the structural and business aspects of the offering. Below is a non-exhaustive list of some of the major sections of the offering memorandum:

  • Legends and securities laws notices
  • Table of contents
  • Company overview
  • Description of the directors and management
  • Terms of the purchase rights and the SAFTS
  • Risk factors
  • Description of the use of proceeds
  • Description of the plan of distribution

Potential Issues

There are a number of potential issues, including legal and regulatory, that may arise through the use of SAFTS.

Is a SAFT a security?

The SEC has applied the Howey test to digital assets, concluding that a token may be a security based on specific facts and circumstances. To determine whether tokens are securities, the SEC has looked to whether there is an investment of money in a common enterprise with a reasonable expectation of profits to be derived from the entrepreneurial or managerial efforts of others.

The drafters of SAFTs have generally taken the position that SAFTs are securities (e.g., investment contracts). The SEC has commented in the past on SAFEs with respect to crowdfunding, mentioning that SAFEs are a type of security, warning investors to be cautious. SAFTs that are limited to accredited investors will likely elicit less concern from the SEC as they are not aimed at retail investors. It remains to be seen, however, whether the SEC will also consider SAFTs securities in a similar context with SAFEs. While any determination on whether the SAFT is a security will likely be based on the specific use of the underlying tokens, it seems likely that many SAFTs would be deemed securities because the purchasers are investing money (or other digital assets) in the rights to the future underlying token with the expectation of profits from the efforts of the issuers of the SAFT.

Restrictions on transfer

Under a SAFT, there is typically a restriction on the purchaser’s ability to transfer or make use of the tokens until the tokens are vested. Vesting takes place once the network is launched and the tokens are mined. A purchaser generally can, however, transfer its rights in a SAFT to another person or entity with the consent of the company issuing the SAFT. Below is a non-exhaustive list of some of the major provisions that should be in the transfer agreement.

  • Transfer of the SAFT
  • Consideration
  • Consent of the company that issued the SAFT
  • Transferor representations and warranties that it owns the SAFT and is able to transfer
  • Transferee representations that it will be bound by the terms of the SAFT

Source of funds

Many of these SAFTs allow purchasers to use various forms of consideration for these contracts including US dollars, Bitcoin, and other digital assets. This may raise anti-money laundering concerns around the source of the funds used for these purchases.

How do regulators view SAFTs?

US regulators have not provided specific guidance on the use of SAFTS. As discussed previously, the SEC has stated that some tokens are securities. Additionally, earlier this year, the SEC charged a businessman with allegedly running two fraudulent ICOs and appears to be taking an increasing interest in these issues. The SEC has mentioned the crowdfunding regulations in the SEC Report on the DAO, and the SEC seemed to be highlighting an option for certain fund sponsors. Given also that the SEC has commented on SAFEs with respect to venture and crowdfunding, it is possible that regulators will draw certain parallels between SAFEs and SAFTs in its views on these instruments. Unfortunately, until regulators issue additional guidance, it is not yet clear whether the SAFT in some cases will be sufficient to satisfy the SEC or other regulators.

Looking Forward

The SAFT represents some investment managers’ response to the concerns of the SEC and may encourage more ICOs to be based in the US. We hope the SEC and other regulators comment on their view of SAFTs, although much of the discussion over whether a SAFT or token is a security will remain a facts and circumstances determination.

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For more information on this topics related to the digital asset space, please see our collection of cryptocurrency fund legal and operational posts.

Bart Mallon is a founding partner of Cole-Frieman & Mallon LLP.  Cole-Frieman & Mallon LLP has been instrumental in structuring the launches of some of the first cryptocurrency focused hedge funds. For more information on this topic, please contact Mr. Mallon directly at 415-868-5345.

Hedge Fund Bits and Pieces for March 24, 2017

Happy Friday from rainy San Francisco. As a reminder, there is one week left for investment advisers to complete the annual ADV update.

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Notes on cryptocurrency and blockchain – earlier this week Coinbase added a new margin product for leveraged trading in certain leading cryptocurrencies including Bitcoin. We believe that a product like this would be subject to CFTC jurisdiction and certain registration (or exemption) requirements. As we’ve had more discussions with groups in this space over the last couple of weeks we are seeing both the difficulties of running a fund strategy in this space (hard to find banks willing to support crypto managers; lack of audit firms able to audit these strategies) and the possibilities of blockchain technology (potentially uses for compliance in the hedge fund space).  These discussions have come in the wake of significant client interest in this are and our article on bitcoin hedge funds.

Cannabis Investment Management Conference – continuing on our earlier discussion of the rise of investment opportunities in the cannabis space, MedMen and IMN are putting on The Institutional Capital & Cannabis Conference next week in San Jose. The conference will take place on March 28-29 and will include a number of funds and allocators in the cannabis space.

Regulations and Tax – not as much news this week on the regulatory front applicable to hedge funds – we expect to begin hearing more next week (after the Health Care Bill vote) when/if the discussion of tax reform begins. If Trump keeps his word to eliminate the “carried interest loophole”, we may see more discussion of the issue like we did back in 2011 and 2009.

Other Items:

  • SEC Compliance Seminars – the SEC announced compliance seminars in a number of cities. Please see the release here.
  • Connecticut Reminder to Exempt IAs – the Connecticut Department of Banking sent out a regulatory reminder about managers who utilize the Connecticut IA registration exemption (more information in our post about the Connecticut ERA filing) in the state. The release can be found here.
  • SEC Adopts T+2 – the settlement cycle for securities transactions gets shorter by one day on September 5, 2017. We expect to hear more from the brokerage firms about this change in the next couple of months as systems become integrated with the new requirements. The announcement can be found here.

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Bart Mallon is a founding partner of Cole-Frieman & Mallon LLP and focuses his legal practice on the investment management industry. He can be reached directly at 415-868-5345.

Cole-Frieman & Mallon 2016 End of Year Update

Below is our quarterly newsletter. If you would like to be added to our distribution list, please contact us

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January 4, 2016

Clients, Friends, Associates:

While the holiday season is a cause for celebration and reflection, it is also the busiest time of the year for most investment managers.  Year-end administrative upkeep and 2017 planning are particularly important, especially for General Counsels, Chief Compliance Officers, and key operations personnel.  As we head into 2017, we have put together this checklist to help managers stay on top of the business and regulatory landscape for the coming year.

This overview includes the following:

  • Annual Compliance & Other Items
  • Annual Fund Matters
  • Annual Management Company Matters
  • Regulatory & Other Changes in 2016
  • Compliance Calendar

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Annual Compliance & Other Items:

Annual Privacy Policy Notice. On an annual basis, registered investment advisers (“RIAs”) must provide natural person clients with a copy of the firm’s privacy policy, even if there are no changes to the policy.

Annual Compliance Review. On an annual basis, the Chief Compliance Officer (“CCO”) of an RIA must conduct a review of the adviser’s compliance policies and procedures. This annual compliance review should be in writing and presented to senior management. We recommend that firms discuss the annual review with their outside counsel or compliance firm, who can provide guidance about the review process as well as a template for the assessment and documentation. Advisers 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. Advisers that are not registered may still wish to review their procedures and/or implement a compliance program as a best practice.

Form ADV Annual Amendment. RIAs or managers filing as exempt reporting advisers (“ERAs”) with the SEC or a state securities authority, must file an annual amendment to Form ADV within 90 days of the end of their fiscal year. RIAs must provide a copy of the updated Form ADV Part 2A brochure and Part 2B brochure supplement (or a summary of changes with an offer to provide the complete brochure) to each “client”. Note that for SEC-registered advisers to private investment vehicles, a “client” for purposes of this rule include the vehicle(s) managed by the adviser. State-registered advisers need to examine their state’s rules to determine who constitutes a “client”.

Switching to/from SEC Regulation.SEC Registration. Managers who no longer qualify for SEC registration as of the time of filing the annual Form ADV amendment must withdraw from SEC registration within 180 days after the end of their fiscal year by filing Form ADV-W. Such managers should consult their state securities authorities to determine whether they are required to register in the states in which they conduct business. Managers who are required to register with the SEC as of the date of their annual amendment must register with the SEC within 90 days of filing the annual amendment.Exempt Reporting Advisers. Managers who no longer meet the definition of an ERA will need to submit a final report as an ERA and apply for registration with the SEC or the relevant state securities authority, if necessary, generally within 90 days after the filing of the annual amendment.

Custody Rule Annual Audit.

SEC-Registered IA. SEC-registered advisers must comply with certain custody procedures, including (i) maintaining client funds and securities with a qualified custodian; (ii) having a reasonable basis to believe that the qualified custodian sends an account statement to each advisory client at least quarterly; and (iii) undergoing an annual surprise examination conducted by an independent public accountant.

Advisers to pooled investment vehicles may avoid both the quarterly statement and surprise examination requirements by having audited financial statements prepared for each pooled investment vehicle in accordance with generally accepted accounting principles by an independent public accountant registered with the Public Company Accounting Oversight Board (“PCAOB”). Statements must be sent to the fund or, in certain cases, investors in the fund, within 120 days after the fund’s fiscal year-end. Managers should review their custody procedures to ensure compliance with the rules.

California-Registered IA. California-registered investment advisers (“CA RIAs”) that manage pooled investment vehicles and are deemed to have custody of client assets must, among other things, (i) provide notice of such custody on the Form ADV; (ii) maintain client assets with a qualified custodian; (iii) engage an independent party to act in the best interest of investors to review fees, expenses, and withdrawals; and (iv) retain an independent certified public accountant to conduct surprise examinations of assets. CA RIAs to pooled investment vehicles may avoid the independent party and surprise examinations requirements by having audited financial statements prepared by an independent public accountant registered with the PCAOB and distributing such audited financial statements to all limited partners (or members or other beneficial owners) of the pooled investment vehicle, and to the Commissioner of the California Department of Business Oversight (“DBO”).

Advisers registered in other states should consult with legal counsel about those states’ custody requirements.

California Minimum Net Worth Requirement and Financial Reports.

RIAs with Custody. Every CA RIA that has custody of client funds or securities must maintain at all times a minimum net worth of $35,000. Notwithstanding the foregoing, the minimum net worth for a CA RIA (A) deemed to have custody solely because they act as general partner of a limited partnership, or a comparable position for another type of pooled investment vehicle; and (B) that otherwise comply with the California custody rule described above (such advisers, the “GP RIAs”), is $10,000.

RIAs with Discretion. Every CA RIA that has discretionary authority over client funds or securities but does not have custody, must maintain at all times a minimum net worth of $10,000.

Financial Reports. Every CA RIA that either has custody of, or discretionary authority over, client funds or securities must file an annual financial report with the Department of Business Oversight within 90 days after the adviser’s fiscal year end. The annual financial report must contain a balance sheet, income statement, supporting schedule, and a verification form. These financial statements must be audited by an independent certified public accountant or independent public accountant if the adviser has custody and is not a GP RIA.

Annual Re-Certification of CFTC Exemptions. Commodity pool operators (“CPOs”) and commodity trading advisers (“CTAs”) currently relying on certain exemptions from registration with the CFTC are required to re-certify their eligibility within 60 days of the calendar year-end. CPOs and CTAs currently relying on relevant exemptions will need to evaluate whether they remain eligible to rely on such exemptions.

CPO and CTA Annual Updates. Registered CPOs and CTAs must prepare and file Annual Questionnaires and Annual Registration Updates with the NFA, as well as submit payment for annual maintenance fees and NFA membership dues. Registered CPOs must also prepare and file their fourth quarter report for each commodity pool on Form CPO-PQR, while CTAs must file their fourth quarter report on Form CTA-PR. Unless eligible to claim relief under Regulation 4.7, registered CPOs and CTAs must update their disclosure documents periodically, as they may not use any document dated more than 12 months prior to the date of its intended use. Disclosure documents that are materially inaccurate or incomplete must be corrected promptly, and the corrected version must be distributed promptly to pool participants.

Trade Errors. Managers should make sure that all trade errors are properly addressed pursuant to the manager’s trade errors policies by the end of the year. Documentation of trade errors should be finalized, and if the manager is required to reimburse any of its funds or other clients, 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 from the previous year.

Schedule 13G/D and Section 16 Filings. Managers who exercise investment discretion over accounts (including funds and SMAs) that are beneficial owners of 5% or more of a registered voting equity security must report these positions on Schedule 13D or 13G. Passive investors are generally eligible to file the short form Schedule 13G, which is updated annually within 45 days of the end of the year. Schedule 13D is required when a manager is ineligible to file Schedule 13G and is due 10 days after acquisition of more than 5% beneficial ownership of a registered voting equity security. For managers who are also making Section 16 filings, this is an opportune time to review your filings to confirm compliance and anticipate needs for the first quarter.

Section 16 filings are required for “corporate insiders” (including beneficial owners of 10% or more of a registered voting equity security). An initial Form 3 is due within 10 days after becoming an “insider”; Form 4 reports ownership changes and is due by the end of the second business day after an ownership change; and Form 5 reports any transactions that should have been reported earlier on a Form 4 or were eligible for deferred reporting and is due within 45 days after the end of each fiscal year.

Form 13F. A manager must file a Form 13F if it exercises investment discretion with respect to $100 million or more in certain “Section 13F 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 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) are required to file an initial Form 13H with the SEC within 10 days of crossing the threshold. Large traders also need to amend Form 13H annually within 45 days of the end of the year. In addition, changes to the information on Form 13H will require interim amendments following the calendar quarter in which the change occurred.

Form PF. Managers to private funds that are either registered with the SEC or required to be registered with the SEC and have at least $150 million in regulatory AUM must file Form PF. Smaller private advisers (fund managers with less than $1.5 billion in regulatory AUM) must file Form PF annually within 120 days of their fiscal year-end. Larger private advisers (fund managers with $1.5 billion or more in regulatory AUM) must file Form PF within 60 days of the end of each fiscal quarter.

SEC Form D. Form D filings for most funds need to be amended on an annual basis, on or before the anniversary of the most recently filed Form D. Copies of Form D can be obtained by potential investors via the SEC’s EDGAR website.

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. Several states impose late fees or reject late filings altogether. Accordingly, it is critical to stay on top of filing deadlines for both new investors and renewals. We also recommend that managers review blue sky filing submission requirements. Many states now permit blue sky filings to be filed electronically through the Electronic Filing Depository (“EFD”) system, and certain states will now only accept filings through EFD.

IARD Annual Fees. Preliminary annual renewal fees for state-registered and SEC-registered investment advisers are due on December 16, 2016. If you have not already done so, you should submit full payment now.

Pay-to-Play and Lobbyist Rules. SEC rules disqualify 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 have similar rules, including California, which requires internal sales professionals who meet the definition of “placement agents” (people who act for compensation as finders, solicitors, marketers, consultants, brokers, or other intermediaries in connection with offering or selling investment advisory services to a state public retirement system in California) to register with the state as lobbyists and comply with California lobbyist reporting and regulatory requirements. Investment professionals (employees who spend at least one-third of their time managing the assets or securities of the manager) are statutorily excluded from California’s “placement agent” definition, and thus do not have to register as lobbyists. Note that managers offering or selling investment advisory services to local government entities must register as lobbyists in the applicable cities and counties.

State laws on lobbyist registration differ widely, so we recommend reviewing your reporting requirements in the states in which you operate to make sure you are in compliance with the rules.

Annual Fund Matters:

New Issue Status. On an annual basis, managers need to confirm or reconfirm the eligibility of investors that participate in initial public offerings or new issues, pursuant to both FINRA Rules 5130 and 5131. Most managers reconfirm investors’ eligibility via negative consent (i.e. investors are informed of their status on file with the manager and are asked to inform the manager of any changes). A failure to respond by any investor operates as consent to the current status.

ERISA Status. Given the significant problems that can occur from not properly tracking ERISA investors in private funds, we recommend that managers confirm or reconfirm on an annual basis the ERISA status of their investors. This is particularly important for managers that track the underlying percentage of ERISA funds for each investor.

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 Conversion. These strategies should be considered carefully to make sure they are consistent with the investment objectives of the fund.

Redemption Management. Managers with significant redemptions at the end of the year should carefully manage unwinding 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 should pay careful attention to the liquidation procedures in the fund constituent documents and the managed account agreement.

NAV Triggers and Waivers. Managers should promptly seek waivers of any applicable termination events set forth in a fund’s ISDA or other counterparty agreement that may be triggered by redemptions, performance, or a combination of both at the end of the year (NAV declines are common counterparty agreement termination events).

Fund Expenses. Managers should wrap up all fund expenses for 2016 if they have not already done so. In particular, managers should contact their outside legal counsel to obtain accurate and up to date information about legal expenses for inclusion in the NAV for year-end performance.

Electronic Schedule K-1s. The IRS authorizes partnerships and limited liability companies taxed as partnerships to issue Schedule K-1s to investors solely by electronic means, provided the partnership has received the investor’s affirmative consent. States may have different rules regarding electronic K-1s and partnerships should check with their counsel whether they may still be required to send state K-1s on paper. Partnerships must also provide each investor with specific disclosures that include a description of the hardware and software necessary to access the electronic K-1s, how long the consent is effective and the procedures for withdrawing the consent. If you would like to send K-1s to your investors electronically, you should discuss your options with your service providers.

“Bad Actor” Recertification Requirement. A security offering cannot rely on the Rule 506 safe-harbor from SEC registration if the issuer or its “covered persons” are “bad actors”. Fund managers must determine whether they are subject to the bad actor disqualification any time they are offering or selling securities in reliance on Rule 506. The SEC has advised that an issuer may reasonably rely on a covered person’s agreement to provide notice of a potential or actual bad actor triggering event pursuant to contractual covenants, bylaw requirements or undertakings in a questionnaire or certification. If an offering is continuous, delayed or long-lived, however, issuers must update their factual inquiry periodically through bring-down of representations, questionnaires and certifications, negative consent letters, periodic re-checking of public databases and other steps, depending on the circumstances. Fund managers should consult with counsel to determine how frequently such an update is required. As a matter of practice, most fund managers should perform such an update at least annually.

U.S. FATCA and UK FATCA. Funds should monitor their compliance with U.S. FATCA and UK FATCA. U.S. FATCA reports are due on March 31, 2017 or September 30, 2017, depending on where the fund is domiciled. UK FATCA reports are due May 31, 2017. As a reminder for this year, we strongly encourage managers to file the required reports and notifications, even if they already missed previous deadlines. Applicable jurisdictions may be increasing enforcement and monitoring of FATCA reporting and imposing penalties for each day late. We recommend managers contact their tax advisors to stay on top of these requirements and avoid potential penalties.

Annual Management Company Matters:

Management Company Expenses. Managers who distribute profits on an annual basis should attempt to address 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 the risk of 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.

Compensation Planning. In the fund industry, and the financial services industry in general, the end of the year is the appropriate time to make adjustments to compensation programs. 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 programs should be effective on the first of the year. Make sure that partnership agreements and operating agreements are appropriately updated to reflect such changes.

Insurance. If a manager carries D&O insurance or other liability insurance, the policy should be reviewed on an annual basis to ensure that the manager has provided notice to the carrier of all claims and all potential claims. Newly launched funds should also be added to the policy as appropriate.

Other Tax Considerations. Fund managers should assess their overall tax position and consider several steps to optimize tax liability. Managers should also be aware of self-employment taxes, which can be minimized by structuring the investment manager as a limited partnership. Managers can take several steps to optimize their tax liability, including: (i) changing the incentive fee to an incentive allocation; (ii) use of stock-settled stock appreciation rights; (iii) if appropriate, terminating swaps and realizing net losses; (iv) making a Section 481(a) election under the Internal Revenue Code of 1986, as amended (the “Code”); (v) making a Section 475 election under the Code; and (vi) making charitable contributions. Managers should consult legal and tax professionals to evaluate these options.

Regulatory & Other Changes in 2016:

The Supreme Court Declines to Follow Newman in Ruling on Insider Trading Case. On December 6, 2016, The Supreme Court decided Salman v. United States, unanimously upholding the Ninth Circuit’s decision to affirm Bassam Salman’s conviction of insider trading, a decision we discussed previously. Salman was a closely-watched “tipper-tippee” liability case in which Mr. Salman traded on inside information he received from his future brother-in-law, who in turn received the information from his brother, a former investment banker at Citigroup. Historically, the Supreme Court has held that “tippers” are liable if they disclose material, nonpublic information in breach of a fiduciary duty and in order to receive a “personal benefit”; and tippees are liable for trading on the tip if they know the tipper’s disclosure was in breach of a duty and to receive a personal benefit. Salman sought to rely on the Second Circuit’s holding in Newman that a tipper must receive something of a “pecuniary or similarly valuable nature” in arguing that a gift of confidential information to a friend or family member was alone insufficient to establish the “personal benefit” required for tippee liability. The Supreme Court disagreed, holding that gifting inside information to “a relative or friend” constitutes a sufficient personal benefit to the tipper. Salman does not completely overturn Newman, and key questions remain unanswered (including how close the relationship must be between tipper and tippee) but it makes clear that gifting nonpublic confidential information to a friend or relative who trades on that information can trigger insider trading liability.

SEC Updates.

SEC Revised Qualified Client Threshold. Effective August 15, 2016, the SEC increased the “net worth” threshold in the definition of “Qualified Client” under the Investment Advisers Act of 1940, as amended (the “Advisers Act”), from $2,000,000 to $2,100,000 to account for inflation. The Qualified Client threshold is critically important for investment advisers because performance fees and incentive allocations can only be charged to investors who are Qualified Clients in nearly all jurisdictions. All investment advisers should examine their subscription documents to ensure that new investors have provided accurate representations regarding their Qualified Client status.

SEC Proposes Rule Requiring RIAs to Adopt Business Continuity and Transition Plans. The SEC’s proposed rule would require SEC RIAs 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, and departure of key personnel. The content of such plans would be based upon risks associated with a RIA’s operations and would include policies and procedures designed to address different elements of a firm’s business. Firms would also be required to review the adequacy and effectiveness of their plans at least annually and retain certain records.

SEC Emphasis on Cybersecurity. Throughout 2016, cybersecurity remained an enforcement priority for the SEC. 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 that 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.  Given the SEC’s continued emphasis on cybersecurity, firms should be moving forward with cybersecurity implementation and may want to discuss with counsel or other outside service providers.

SEC Implemented Business Conduct Standards for SBS Dealers and Major SBS 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 CCO requirements. The new rules aim at enhancing 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. Additional provisions and heightened protections apply in transactions with special entities, such as municipalities, pension plans, and endowments.

SEC Amended Form ADV and Rule 204-2. On August 25, 2016, the SEC adopted rules to enhance the information reported by investment advisers on Form ADV with a goal of increasing transparency, efficiency and compliance. The rules increase reporting on Form ADV with respect to SMAs, formalize umbrella registration requirements for related investment advisers, and expand the books and records required to be kept related to performance. Advisers will need to begin complying with the amendments on October 1, 2017.

SEC Approved FINRA Pay-To-Play Rule. The SEC approved FINRA’s proposed Rule 2030 which applies to investment advisers who are also FINRA member firms (i.e. also broker-dealers).  Rule 2030 was modeled after Advisers Act Rule 206(4)-5 and addresses pay-to-play practices by investment advisers who are also broker-dealers. The elements and terms of FINRA’s rule are substantially similar to the SEC’s pay-to-play rule and prohibit covered members from engaging in distribution and solicitation activities for compensation with government entities on behalf of an investment adviser within two years after a contribution is made to an official of the government entity by the covered member. FINRA member firms that are not yet subject to the pay-to-play rule should familiarize themselves with its provisions.

Outgoing SEC Chair. SEC Chair Mary Jo White announced recently that she plans to step down from that role around when President Obama leaves office in January. During Ms. White’s tenure, the SEC focused on tightening rules implementing the Dodd–Frank Wall Street Reform and Consumer Protection Act and pursued record numbers of enforcement cases. President-elect Trump will appoint Ms. White’s successor, and it is not yet clear how the SEC’s focus and priorities may change under new leadership.

CFTC and NFA Updates.

NFA Proposed Amendments to Financial Reporting Rule and Amended Compliance Rule 2-46. The NFA proposed to revise forms PQR and PR to require CPOs and CTAs respectively to disclose two ratios related to their financial health that would measure the firm’s ability to pay its short-term obligations with current assets and the firm’s pricing strategy and operating efficiency. CPOs and CTAs would also be required to keep records demonstrating how the ratios were calculated. Additionally, effective September 30, 2016, each late Form CPO-PQR or CTA-PR will be subject to a $200 fee for each business day it is late. Generally, Form CTA-PR is due within 45 days and Form CPO-PQR within 60 days of the relevant calendar quarter end. Note, however, that payment and acceptance of the fees does not preclude the NFA from filing a disciplinary action for failure to comply with the deadlines imposed by NFA Compliance Rules.

CFTC Amended CPO Financial Report Requirements. On November 25, 2016, the CFTC published final rules amending certain CPO financial report requirements. Effective December 27, 2016, the amendments will permit the use of additional alternative generally accepted accounting principles, standards or practices; provide relief from the Annual Report audit requirement under certain circumstances; and clarify that an audited Annual Report must be distributed and submitted at least once during the life of a commodity pool. The amendments codify certain exemptions provided by the Commission over the years on a case-by-case basis through exemptive or no-action letters.  We recommend contacting counsel, or reviewing the Federal Register to determine eligibility for the amended regulations.

Prudential Regulators and CFTC Adopted Margin Rules for Uncleared Swaps. The prudential regulators – the Federal Deposit Insurance Corporation, the Department of the Treasury (the Office of the Comptroller of the Currency), the Board of Governors of the Federal Reserve System, the Farm Credit Administration and the Federal Housing Finance Agency – (“PRs”) adopted a joint final rule covering swap entities that are supervised by one of the PRs (such covered swap entities, “CSEs”). Shortly thereafter, the CFTC adopted its own final rule covering swap entities that are not supervised by one of the PRs, but that are registered with CFTC (“Non-Bank CSEs”). Both the PRs and the CFTC emphasized that the margin requirements are intended to reduce risk for individual CSEs and for the financial system as a whole. We recommend that you speak with your firm’s outside counsel to determine if either rule applies to you.

NFA Guidance Regarding Cybersecurity. Beginning March 1, 2016, each NFA member firm should have established a written information systems securities program (“ISSP”) discussing, among other items, the firm’s current cybersecurity risks and ongoing cybersecurity training, and creating an “incident response” plan to help manage, contain and mitigate identified security breaches. Each ISSP must be reviewed annually by an executive-level officer of the firm. NFA members should review their cybersecurity programs and promptly take appropriate steps to make sure they are in compliance with the new rule.

Municipal Advisor Rulemaking. On August 17, 2016, the Municipal Securities Rulemaking Board (“MSRB”) extended pay-to-play standards to municipal advisors. Amended Rule G-37 prohibits municipal advisors from engaging in municipal securities business for two years after making certain political contributions and from soliciting or coordinating contributions with certain municipal officials and political parties with which the municipal advisor is engaging, or seeking to engage, in business. The rule also requires quarterly disclosures of certain contributions to the MSRB. Municipal advisors should review their current policies and consider whether they adequately address the new pay-to-play rules.

Other Updates.

DOL Defined Fiduciary of an Employee Benefit Plan under ERISA. The United States Department of Labor (“DOL”) issued a new rule that will extend fiduciary status to all advisers offering investment advice to employee benefit plans, plan fiduciaries, and IRAs when the rule comes into effect early next year. Under the new rule, all investment advisers who provide such advice will be required to make recommendations that are in the “best interest” of their clients. Under certain exemptions, an investment adviser would be able to continue using methods of conflicted compensation as long as the adviser meets specific conditions that mitigate conflicts of interest and ensure that investment advice is in the best interest of their clients. The general fiduciary standard becomes effective on April 10, 2017. There is a fair amount of uncertainty regarding the new rule’s application to private fund advisers, but at this time we have no reason to believe it will apply to private funds that are not “plan assets” funds (i.e., funds that do not exceed the 25% ERISA threshold). Investment advisers are encouraged to review their client base and discuss with legal counsel to determine whether they are subject to this new regulation.

New Due Diligence Requirements for Covered Financial Institutions. The U.S. Treasury Department’s Financial Crimes Enforcement Network (“FinCEN”) issued new customer due diligence (“CDD”) requirements that covered financial institutions must comply with by May 11, 2018. Covered financial institutions (which include banks, broker-dealers in securities, mutual funds, futures commission merchants and introducing brokers in commodities) will 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.

New Filing Deadline for Form 1099-MISC. The IRS now requires Form 1099-MISC to be filed on or before January 31, 2017, when reporting nonemployee compensation payments. Otherwise, Form 1099-MISC may be filed by February 28, 2017, if it is filed on paper, or by March 31, 2017, if it is filed electronically. Automatic 30-day extension is available by filing Form 8809 by January 31, 2017. No signature or explanation is required for the extension.

Offshore Updates.

Cayman Islands Publishes Limited Liability Company Law. The highly-anticipated Cayman Islands Limited Liability Companies Law came into effect on July 8, 2016, and allows for the formation and operation of a limited liability company similar in structure and flexibility to that of a Delaware limited liability company (“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 supersede 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 future, we recommend that you speak with your firm’s offshore counsel to discuss the entity’s advantage and disadvantages.

ESMA Proposed Extension of Funds Passport to 12 Non-EU Countries. The European Securities and Markets Authority (“ESMA”) recommended this year that the Alternative Investment Fund Managers Directive (“AIFMD”) passport should apply to 12 non-EU countries: Australia, Bermuda, Canada, Cayman Islands, Guernsey, Hong Kong, Japan, Jersey, Isle of Man, Singapore, Switzerland, and the United States. The passport is currently available to EU entities, but according to ESMA, there are generally no significant obstacles impeding the application of AIFMD in these 12 countries. ESMA’s advice will be considered next by the European Commission, Parliament and Council. If the passport is extended, it will be easier for non-EU alternative investment fund managers and alternative investment funds to market and manage funds throughout the EU.

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

Deadline – Filing

  • December 16, 2016 – IARD Preliminary Renewal Statement payments due (submit early to ensure processing by deadline)
  • December 27, 2016 – Last day to submit form filings via IARD prior to year-end
  • December 31, 2016 – Review AUM to determine 2017 Form PF filing requirement
  • January 15, 2017 – Quarterly Form PF due for large liquidity fund advisers (if applicable)
  • January 31, 2017 – “Annex IV” AIFMD filing
  • February 14, 2017 – Form 13F due
  • February 14, 2017 – Annual Schedule 13G updates due
  • February 14, 2017 – Annual Form 13H updates due
  • March 1, 2017 – Deadline for re-certification of CFTC exemptions
  • March 1, 2017 – Quarterly Form PF due for larger hedge fund advisers (if applicable)
  • March 31, 2017 – Annual ADV amendments due
  • March 31, 2017 – Annual Financial Reports due for CA RIAs (if applicable)
  • February 14, 2017 – Annual Form 13H updates due
  • April 15, 2017 – Extended FBAR deadline for certain individuals with signature authority over, but no financial interest in, one or more foreign financial accounts
  • April 30, 2017 – Annual Form PF due for all other advisers (other than large liquidity fund advisers and large hedge fund advisers)
  • Periodic – Form D and blue sky filings should be current
  • Periodic – Fund managers should perform “Bad Actor” certifications annually.

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Bart Mallon is a founding partner of Cole-Frieman & Mallon LLP.  Mr. Mallon can be reached directly at 415-868-5345.

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.