Category Archives: Legal Resources

Cole-Frieman & Mallon LLP 4th Quarter Newsletter

Below is our quarterly newsletter which was sent to our clients and friends last week. If you would like to receive this news letter, please contact us.


Clients and Friends:

There have been a number of new regulatory developments over the past three plus months of concern to investment managers, namely:

  • California Private Fund Adviser Exemption
  • CFTC Regulatory Changes
  • Foreign Account Tax Compliance Act (“FATCA”)
  • JOBS Act

Below we detail these developments, provide some of our thoughts on the current regulatory environment and outline some items that managers should be aware of as this year comes to a close. Please feel free to contact us with any thoughts or questions on these matters.

California Private Fund Adviser Exemption

On August 27, 2012 the California Office of Administrative Law approved the long awaited private fund adviser exemption (“Private Fund Adviser Exemption”). The immediately effective exemption is only available to advisers who provide advice solely to “qualifying private funds,” which include venture capital funds, Section 3(c)(1) funds and Section 3(c)(7) funds. The Private Fund Adviser Exemption is not available to advisers who also manage separate accounts. Advisers to qualifying private funds who qualify for the Private Fund Adviser Exemption and manage less than $100,000,000 can file as “exempt reporting advisers” and thereby avoid the registration and compliance requirements in California. Specific requirements for advisers seeking to rely on the Private Fund Adviser Exemption can be found here.

CFTC Expanded Jurisdiction Over Certain Swaps

With the issuance of new rules from the CFTC affecting swaps, investment managers that trade swaps will need to determine whether the swaps they trade will subject the manager to CFTC regulation; and if so, whether CFTC registration is required or an exemption from registration is available. As of October 12, 2012 an investment manager that trades swaps covered by the new rules may find itself subject to regulation by the CFTC, even if the adviser does not trade futures or commodity interests. Similarly, an adviser to a commodity pool that trades swaps and is currently relying on Regulation 4.13(a)(3) – the “de minimis” exemption from CFTC regulation for advisers who trade only minimal futures, commodity interests and swaps – will need to reassess whether it can still fit within this exemption after taking into account its swaps trading.

CFTC Regulatory Changes

Recent regulatory changes, which become effective on December 31, 2012, require advisers to private funds or accounts using commodity futures, commodity options and other CFTC regulated derivatives to register with the CFTC or rely on an exemption from such registration. These changes include:

  • CFTC Regulation 4.13(a)(4) Exemption Rescinded: Managers to funds offered only to “qualified eligible persons” have previously relied on this exemption from CPO registration. This exemption will no longer be available as of December 31, 2012.
  • CFTC Regulation 4.13(a)(3) De Minimus Exemption: Managers to commodity pools with a limited use of commodity interests can rely on this exemption from registration as a CPO. However, with the CFTC’s extended jurisdiction over swaps, many pools may no longer qualify and must register as a CPO with the CFTC.
  • Annual Re-Certification: CPOs and CTAs relying on exemptions from registration will be required to re-certify their qualifications annually on a calendar-year basis, beginning on December 31, 2012.
  • New Reporting Requirements: Registered CPOs and CTAs must file certain new reports and include standardized risk disclosure to describe risks of swap transactions in the disclosure documents.


Enacted by Congress as part of the HIRE Act of 2010 with the goal to combat tax evasion, FATCA will go into effect on January 1, 2013. The new regulations will require financial institutions to identify and disclose direct and indirect U.S. investors and withhold U.S. income tax on nonresident aliens and foreign corporations, or be subject to a 30% FATCA tax. Foreign financial institutions, which include hedge funds, funds of funds, commodity pools and other offshore investment vehicles, will be required to enter into an agreement with the IRS by June 30, 2013 to avoid being subject to the FATCA tax. Domestic funds will also need to determine the FATCA status of each of their investors and will be subject to new withholding and reporting requirements for any recalcitrant investors. Final regulations have not been promulgated, however, managers should discuss compliance methods with their administrators and other third party service providers.

Jumpstart Our Business Startups Act (“JOBS Act”)

The JOBS Act, signed into law in April 2012, has two big implications for the hedge fund industry:

  • The first, which was effective immediately, raised the maximum number of investors permitted in a 3(c)(7) fund from 499 to 1,999. Private funds relying on the 3(c)(1) exemption are still limited to 99 investors.
  • The second, which is still awaiting final rules by the SEC, lifts the ban on general solicitation and advertising under Rule 506 of Regulation D. The proposed amendments would allow issuers to use general solicitation and general advertising to offer securities, provided that the issuer takes reasonable steps to verify that the purchasers of the securities are accredited investors.

Managers should remember that while general solicitations may be allowable in the future, these rules are not yet final. In addition, all registered investment advisers will still be subject to applicable advertising regulations under the Investment Advisers Act. CFTC registered managers are still subject to certain CFTC regulations that prohibit marketing to the public, and managers that intend to rely on the 4.13(a)(3) “de minimus” exemption (discussed above) are also prohibited from marketing to the public.

Form PF

Managers to private funds who are registered (or required to be registered) as investment advisers with the SEC and have at least $150 million under management, will need to file Form PF with the SEC. The filings must be made either on a quarterly or annual basis, depending on the type of private fund and regulatory assets under management. For managers to hedge funds, the filings and compliance dates are as follows:

  • Greater than $5 billion regulatory AUM – The filing must be made on a quarterly basis, within 60 days of the end of each fiscal quarter, beginning on June 15, 2012.
  • At least $1.5 billion (but less than $5 billion) in regulatory AUM – The filing must be made on a quarterly basis, within 60 days of the end of each fiscal quarter, beginning on December 15, 2012.
  • At least $150 million (but less than $1.5 billion) in regulatory AUM – The filing must be made on an annual basis, within 120 days of the end of each fiscal year, beginning on December 15, 2012.

4th Quarter Items

  • January 1, 2013 Fund Launches – Managers seeking to launch a fund on the first of the year should begin the fund formation process as soon as possible in order to give themselves and service providers ample time to prepare during the busy season.
  • CFTC Regulatory Matters:
    • Managers should review the recently expanded list of CFTC regulated products to determine whether they will be subject to CFTC regulation. CPOs currently relying on CFTC Regulation 4.14(a)(4) will need to assess whether the commodity pool is eligible for the “de minimis” exemption or register with the CFTC as a CPO by December 31, 2012. CPOs currently relying on CFTC Regulation 4.13(a)(3) will need to evaluate whether the commodity pool is still eligible for the exemption.
    • CPOs and CTAs that have exemptive relief under CFTC Regulations will need to reconfirm their qualifications by December 31, 2012.
  • IARD Renewal – FINRA will be sending out notice reminders to facilitate the annual renewal of investment adviser registration. Preliminary Renewal Statements will be made available on IARD on November 12, 2012.
  • Form PF – As discussed above, managers to private funds with less than $5 billion regulatory AUM will need to make Form PF filings with the SEC beginning on December 15, 2012, on either a quarterly or annual basis, depending on the types of private funds managed and regulatory AUM.


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. The firm also publishes the prominent Hedge Fund Law Blog ( which focuses on legal issues that impact the hedge fund community. For more information please visit us at:

This newsletter 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 and this publication may be considered attorney advertising in some jurisdictions.


SEC Focusing on Marketing Misrepresentations

SEC v. Kapur Highlights Increased Focused of Examination

On November 10, 2011, the SEC filed in action in the US District Court for the Southern District of New York against Chetan Kapur (“Kapur”) and Lilaboc, LLC (“Lilaboc” or “t

he firm”). The SEC alleged that Kapur and Lilaboc overstated the performance, longevity, and assets of funds they managed as well as Kapur’s credentials as a manager and the due diligence procedures in place to safeguard investments.

The SEC’s complaint claims that Kapur and the firm made numerous misrepresentations in mailings, emails, postings on hedge fund websites, and marketing materials distributed to prospective investors.

The SEC asserted causes of action under Section 17(a) of the Securities Act (prohibiting fraudulent interstate transactions), Section 10(b) of the Exchange Act and related rules (prohibiting the use of manipulative and deceptive devices); Section 206(4) of the Advisers Act (prohibiting acts, practices or courses of business that are fraudulent, deceptive or manipulative), and for equitable relief.

The SEC’s complaint is available here: SEC v. Kapur.

Takeaways for Managers

The alleged misrepresentations included the following:

  • Overstating the performances of funds the firm managed, giving investors the false impression that the funds’ track records were consistently positive and minimally volatile;
  • Statements of the true inception dates of funds, routinely providing information about funds’ performances for years prior to the true creation of said funds;
  • Statements that certain individuals were involved as part of the

    firm’s management team, when in fact they were not affiliated with the firm in any way;

  • Statements that Kapur had an MBA from Wharton and had 15 years of experience in investing. In fact, Kapur only had an undergraduate degree from Wharton, and his claim of 15 years of experience in investing would have meant he began his career when he was 14 years old; and
  • Statements that the firm conducted high levels of due diligence, when in actuality the firm repeatedly failed to conduct due diligence resulting in investments in Ponzi schemes and other fraudulent offerings.

This action highlights several points for managers:

  • The SEC takes a broad approach to enforcing anti-fraud provisions of the securities laws, and managers should pay careful attention to the accuracy of the information provided in their marketing materials;
  • Do not lie in materials provided to prospective investors, including exaggerations about management qualifications, experience and funds’ performances;
  • Be sure to adhere to the procedures and policies you claim to follow; and
  • Maintain files of backup materials to document every factual statement made in your marketing materials.


Though Kapur encompasses a deeply troubling pattern of fraud and misrepresentation, the message from the SEC to managers is clear: managers should take care that the material they provide to prospective clients is accurate and avoid making claims that do not truly reflect the nature of their operations. We recommend that your attorney, in-house counsel or compliance consultant review all marketing materials prior to distributing them, and that you retain these materials and backup information in your files.


Bart Mallon is a partner with Cole-Frieman Mallon & Hunt LLP, an investment management law firm. Bart can be reached directly at 415-868-5345.

FINRA Announces PFRD System for Form PF

Form PF Filing System Active

As we have discussed in previous posts, many hedge fund managers are going to be required to complete Form PF on either a quarterly or annual basis. The filing will be made through a new filing system administered by FINRA called the PFRD (Private Fund Reporting Depository). Many funds will have outside groups who will be accessing the system on their behalf. Smaller funds may be able to complete the form themselves.

If you have questions on the form or accessing the PFRD, please contact us.

The PFRD announcement from FINRA is reprinted below.


To: Super Account Administrators of Investment Advisers

From: FINRA Entitlement Group

Date: June 4, 2012

Re: New Electronic Private Fund Reporting Depository (PFRD) System Entitlement

The new electronic Private Fund Reporting Depository (PFRD) System facilitates investment adviser reporting of private fund information via Form PF. Beginning today, if you are an investment adviser that is required to report private fund information, you have the ability to entitle yourself as a user to this new application; update existing accounts; and/or create new accounts with this new application. Your current user ID and password remain valid. To determine if you are required to file Form PF, refer to the criteria below.

Complete and file Form PF if:

• You are registered or required to register with the SEC as an investment adviser, or you are registered or required to register with the Commodity Futures Trading Commission (CFTC) as a commodity pool operator or commodity trading advisor and you are also registered or required to register with the SEC as an investment adviser; and

• You manage one or more private funds; and

• You and your related persons, collectively, had at least $150 million in private fund assets under management as of the last day of your most recently completed fiscal year.

For more information on the PFRD System, refer to the information on the IARD web page:

For questions concerning:

• Form PF filing requirements or policy issues, contact the SEC at (202) 551-6999 or

• Technical questions regarding the PFRD System, contact the FINRA Gateway Call Center at (240) 386-4848.

• FINRA Entitlement, contact the FINRA Entitlement Group at (240) 386-4185.


Bart Mallon is a partner with Cole-Frieman Mallon & Hunt LLP, an investment management law firm. Bart can be reached directly at 415-868-5345.

NASAA Examination of IA Compliance Deficiencies

Examination Reveals Compliance Focus Areas

NASAA, the lobbying body of the various state securities divisions, recently released a set of examination findings which describe the common compliance deficiency areas for IA firms registered with the state securities commissions.  The exams, which were completed by state administrators, showcase a number of compliance issues for both registered investment advisers and fund managers.  According to the NASAA press release:

Examinations of 825 investment advisers conducted between January 1, 2011 and June 30, 2011 uncovered 3,543 deficiencies in 13 compliance areas, compared to 1,887 deficiencies in 13 compliance areas identified in a similar 2009 coordinated examination of 458 investment advisers.

Below we have summarized the findings released in the NASAA 2011 Examinations Findings (.ppt).

Deficiency Categories

Below are the categories which were covered, along with the percentages of advisers with at least one deficiency in such category:

  • Registration (59.9%)
  • Books and Records (45%)
  • Unethical Business Practices (36.8%)
  • Supervisory/Compliance (30.2%)
  • Advertising (21.6%)
  • Privacy (21.2%)
  • Financials (19.8%)
  • Fees (19.4%)
  • Custody (12.6%)
  • Investment Activities (3.9%)
  • Solicitors
  • Pooled Investment Vehicles (Hedge Fund)
  • Performance Reporting

Discussion of Deficiencies

There are a number of slides devoted to providing more granular information on the various deficiencies.  Below are some of my thoughts when I read through these deficiencies:

  • Properly completing ADV, including proper descriptions (AUM, fees, business overview, disclosures) and making sure there are no inconsistencies; unregistered IAs were not a large part of the deficiencies.
  • Investment adviser books and records are what you would expect – a number of different items were not properly kept as required by regulations. Surprisingly, it seems that many IAs do not keep the suitability information on their clients as required.
  • Under unethical practices, it seems that many of the deficiencies were likely caused by careless drafting of contract documents. Non-contract unethical business practices revolved around advertising and conflicts of the IA.
  • One interesting note for Supervisory/Compliance is that a large number of IAs did not follow their own internal procedures. This might be worse than having inadequate procedures – if your compliance manual says you will do something, you should make sure it is being done.
  • Financials might be what you would expect – issues with respect to net worth of the IA, bond issues and inaccurate financials.
  • Advertising deficiencies focused on website issues. I would expect this to increase in the future as more IAs establish websites in the future. Additionally, social media deficiencies are likely to increase in the future as more firms use these tools to advertise their business. [Note: while the managed futures industry has different regulations, the concepts of social media regulation for the futures industry can be applied to securities compliance.]
  • Custody is probably the single most misunderstood concept for IA firms. Most people view custody to be having physical possession of a client’s cash or securities.  However, if you directly deduct a fee from a client account (even if this is done by the custodian, i.e. Schwab) then in most states the IA is deemed to have “custody” of the account and must adhere to the custody requirements of the state.
  • It is interesting to note that with respect to investment activities the following were some common deficiencies: preferential treatment (I assume, without disclosure), aggregate trades, and soft dollars.
  • Solicitors have become a more prevalent issue over the last few months as more fund managers (who are RIAs) offer separately managed account programs. [Note: we will have more articles forthcoming on this issue shortly.] For solicitor issues the big items were undisclosed solicitors and issues with disclosure. Also, the agreement between the IA and the solicitor was a common deficiency.
  • Hedge fund managers with no separately managed account business had many more deficiencies than IA only firms. Deficiencies with respect to hedge funds related to valuation, cross-trading and preferential treatment (again, we assume, without disclosure).

IA Compliance Best Practices

As a result of the report, the NASAA identified the following as best practices for IAs:

  • Review and revise Form ADV and disclosure brochure annually to reflect current and accurate information.
  • Review and update all contracts.
  • Prepare and maintain all required records, including financial records.
  • Back-up electronic data and protect records.
  • Document all forwarded checks.
  • Prepare and maintain client profiles.
  • Prepare a written compliance and supervisory procedures manual relevant to the type of business to include business continuity plan.
  • Prepare and distribute a privacy policy initially and annually.
  • Keep accurate financials. File timely with the jurisdiction.
  • Maintain surety bond if required.
  • Calculate and document fees correctly in accordance with contracts and ADV.
  • Review all advertisements, including website and performance advertising, for accuracy.
  • Implement appropriate custody safeguards, if applicable.
  • Review solicitor agreements, disclosure, and delivery procedures.


It is clear that NASAA is trying to be more of an influence on how the state administrators conduct examinations and the focus areas of those examinations.  While it is helpful for NASAA to release investment adviser compliance best practices, it would be more useful if they released more robust compliance materials such as sample compliance manuals/ policies and clearer guidance on state interpretations of regulations.  As Congress and the SEC determine whether to establish an investment adviser SRO, we are likely to see NASAA take a larger thought leadership role.  In any event, investment advisers and hedge fund managers should begin to start thinking about registration and implementing robust compliance policies and procedures which address all parts of state or SEC IA registration regulations.


Cole-Frieman & Mallon LLP provides legal advice to hedge fund start ups and well as established fund complexes.  Bart Mallon can be reached directly at 415-868-5345.

SEC Announces Open Meeting on Hedge Fund Regulations

SEC Considers Whether to Adopt Registration Requirement

Yesterday the SEC announced that they will conduct an Open Meeting on June 22 to determine whether to adopt the new hedge fund registration requirements and related rules. At the Open Meeting the SEC is expected to delay implementation of the regulations until next year.   While the SEC announced in a letter to NASAA that they would likely extend the registration deadline, there has been no official action on this issue.  This has left managers (and lawyers and compliance personnel) unsure of how to proceed.  We will know more after the June 22 meeting.

The notice of the Open Meeting, reprinted below in full, can be found here.  Hat tip to Doug Cornelius at Compliance Building for publishing this story earlier today.


Notice is hereby given, pursuant to the provisions of the Government in the Sunshine Act, Pub. L. 94-409, that the Securities and Exchange Commission will hold an Open Meeting on June 22, 2011 at 10:00 a.m., in the Auditorium, Room L-002.

The subject matters of the Open Meeting will be:

Item 1: The Commission will consider whether to adopt new rules and rule amendments under the Investment Advisers Act of 1940 to implement provisions of the Dodd-Frank Wall Street Reform and Consumer Protection Act. These rules and rule amendments are designed to gi

ve effect to provisions of Title IV of the Dodd-Frank Act that, among other things, increase the statutory threshold for registration of investment advisers with the Commission, require advisers to hedge funds and other private funds to register with the Commission, and address reporting by certain investment advisers that are exempt from registration.

Item 2: The Commission will consider whether to adopt rules that would implement new exemptions from the registration requirements of the Investment Advisers Act of 1940 for advisers to venture capital funds and advisers with less than $150 million in private fund assets under management in the United States. These exemptions were enacted as part of the Dodd-Frank Wall Street Reform and Consumer Protection Act. The new rules also would clarify the meaning of certain terms included in a new exemption for foreign private advisers.

Item 3: The Commission will consider whether to adopt a rule defining “family offices” that will be excluded from the definition of an

investment adviser under the Investment Advisers Act of 1940.

At times, changes in Commission priorities require alterations in the scheduling of meeting items.

For further information and to ascertain what, if any, matters have been added, deleted or postponed, please contact:

The Office of the Secretary at (202) 551-5400.

Elizabeth M. Murphy


June 8, 2011


Bart Mallon is an attorney with a practice focused on hedge funds and investment adviser registration.  He can be reached directly at 415-868-5345.


In-Kind Contributions

Hedge Fund In-Kind Contributions

Fund managers may allow investors to make “in-kind” contributions to the fund.  This means that instead of, or in addition to, a cash subscription, the manager may allow the investor to transfer securities or other assets to the fund in exchange for fund interests.  Both managers and investors should be

aware of the tax consequences that arise from such transfers.  This post will provide an overview of the general rule and other issues which managers should be aware of with respect to future transactions after an in-kind contribution.  We always recommend that managers discuss the tax consequences of any in-kind contribution with tax counsel prior to the contribution and then with respect to any future disposition of the assets which were contributed.

Please note that tax issues are often complex and depend on the facts of a situation.  This post is intentionally general and you should not rely on this post with respect to any tax issue.  Please see our disclaimer and note we are not providing tax advice.

General Rule

For hedge fund investors, the general rule with respect to in-kind contributions is:

a gain will be recognized on the transfer of stocks or securities to an “investment company” that results in “diversification” of that investor’s interests

Please note that this is a two part test: the transfer must be

  1. to an “investment company” and
  2. result in “diversification

If both parts of the test are not met then there will be no gain on the transfer.

What is an “Investment Company”?

The term “investment company” means an entity with more than 80% of the value of its assets consisting of certain properties including money, readily-marketable stocks or other equity interest, options, futures contracts, derivative financial instruments, and foreign currency.  The determination of whether an entity qualifies as an “investment company” is generally made immediately after the transfer of property.

Most hedge funds will qualify as an “investment company” using the 80% test.

What is “Diversification”?

The crucial test for investors is whether or not there is diversification with respect to a transfer.  Diversification happens if, at the time of the transfer (i.e. subscription to the fund), two or more investors transfer non-identical assets.  In most cases, the determination of whether diversification resulted is made immediately after the transfer of property.

In the following situations, there is generally no diversification:

1.  No diversification if identical assets

Example: Individuals A and B organize New Co with 100 shares of common stock.  A and B each contribute $500 worth of the only class of corporation X stock, listed on the NYSE, in exchange for 50 shares of New Co stock each.

2.  No diversification if “insignificant amount of assets” transferred are non-identical.  According to the IRS (in Treasury Regulations and various private letter rulings*), 1% and 5% of non-identical assets were insignificant, but 11% of non-identical assets was significant and resulted in diversification.

Example: Individuals A and B organize New Co with 100 shares of common stock. A contributes $990 worth of the only class of corporation X stock, listed on the NYSE, in exchange for 99 shares of stock.  B contributes $10 of readily-marketable securities in corporation Y in exchange for 1 share of New Co stock.

3.  No diversification if all investors transfer a diversified portfolio of assets.  The term “diversified portfolio of assets” means a portfolio in which not more than 25%  of transferred assets are invested in the stock or securities of one issuer and not more than 50% is invested in the stock or securities of five or fewer issuers.   Cash transfers are not included in these calculations.  There are also restrictions on the inclusion of government securities in these calculations.  Each investor to the transaction must transfer diverse portfolios.  If one transfers a non-diverse portfolio, all will be taxed on the gains.

Example: Individuals A and B organize New Co with 100 shares of common stock.  A and B each contribute $120 worth of the only class of corporation X stock, listed on the NYSE, in exchange for 12 shares of stock; $240 worth of the readily-marketable securities in corporations Y and Z in exchange for 24 shares of stock; and $140 worth of options in exchange for 14 shares of stock.

Issues after an In-Kind Contribution

Both the manager and investor should be aware of the potential tax consequences which follow from an in-kind contribution.  The following is a non-exclusive list of tax issues which the manager and investor should consider.

Allocation of Gains and Losses When the Fund Disposes of In-Kind Contributions

If the person making an in-kind contribution does not recognize taxable gains at the time of transfer, then what happens to the gains or losses once there is a disposition of the assets at the fund level?  In general, the fund will be required to first allocate the recognized gains and losses to the contributing investor and then pro rata to the other investors.  This allocation is required to account for the variation between the fund’s adjusted tax basis resulting from the in-kind contribution and the fair market value of those securities when they were contributed.  In essence, the contributing investor will pay the tax, but gets the benefit of the deferral.

Distributing the In-Kind Contributions

If the fund distributes a contributed security (which was not taxed at the time of contribution) to an investor other than the person who made the in-kind contribution anytime within 7 years of the contribution, such person will generally recognize the unrealized gain or loss at the time of the distribution.

Two Year Rule

If the fund makes a distribution of cash to a person who made an in-kind contribution simultaneously with or after the contribution, the contribution may be treated as if such person sold the securities to the fund for fair market value–resulting in recognized gain.   In fact the Treasury Regulations has established a rebuttable presumption about such a situation–if an person who made an in-kind contribution receives a distribution within 2 years after contributing securities, the distribution will be deemed to have been part of a disguised sale.  Such person can rebut the presumption by demonstrating that when it made the contribution, it did not intend to receive a distribution of cash in exchange or that the investment is subject to the appreciation or depreciation of the fund’s assets while invested.


Cole-Frieman & Mallon LLP provides comprehensive hedge fund formation and other legal services.  Bart Mallon can be reached directly at 415-868-5345.

NFA 2011 Annual Regulatory Reminder

Earlier this year we provided a general overview of the annual compliance requirements for CPOs and CTAs.  The NFA has just released their annual reminder for all CFTC registratants (including IBs, FCMs and RFEDs).  The NFA notice, reprinted below in full, provides a good overview of what CFTC registered firms need to be focusing on during the next month or so.

CFTC registered firms are reminded that now is a good time to review and revise their compliance manuals and complete the NFA self-examination process.


Notice I-11-06
February 03, 2011

Annual Regulatory Reminder

National Futures Association has always been committed to providing our Members with the resources they need to meet their regulatory obligations as efficiently as possible. Therefore, we are providing you with an annual reminder regarding certain requirements that are not part of your day-to-day operations. This list does not capture all of your responsibilities for the upcoming year, but it should help remind you of certain non-routine requirements.

Within the next 12 months you will be required to:

  1. Complete the Annual Update process on the anniversary date of your firm’s registration. This process includes (1) completing the electronic Annual Registration Update; (2) electronically submitting the firm’s Annual Questionnaire on NFA’s website and (3) paying your annual registration fees and NFA dues.  Failure to satisfy all of the requirements in the annual update process within 30 days of your anniversary date will result in the withdrawal of your firm’s NFA registration and/or Membership. NFA’s BASIC system displays information reflecting whether or not firms are actively engaged in futures-related business activity or retail off-exchange foreign currency activities. If you commence operations, you should update your Questionnaire in order to change how your status is displayed in BASIC.
  2. Complete NFA’s Self-Examination Checklist located on NFA’s website at
  3. Send your firm’s Privacy Policy to every current customer, client and pool participant (in addition to sending it to every new customer when the customer opens an account, enters into an advisory agreement, or purchases a subscription). For guidance in preparing your policy, please consult NFA’s Privacy Policy questionnaire (Appendix D of the Self-Exam Checklist).
  4. Test your Disaster Recovery Plan and make any necessary adjustments. For guidance in preparing your plan, please consult NFA’s Business Continuity and Disaster Recovery Plan questionnaire (Appendix B of the Self-Exam Checklist).
  5. Provide Ethics Training as outlined in your firm’s written Ethics Training Procedures. For guidance in developing your procedure, please consult NFA’s Ethics Training Policy questionnaire (Appendix C of the Self-Exam Checklist).
  6. Supervise the operations of any Branch Offices, including conducting an annual onsite inspection of every Branch Office.

If you are a registered Commodity Trading Advisor, you will also be required to:

  1. File any new exemption notices electronically through NFA’s Exemption System.
  2. If soliciting new clients, distribute a Disclosure Document that is no more than 9 months old and that has been reviewed and accepted by NFA. Ensure that the document includes a complete business background and discloses all potentialconflicts of interest in accordance with NFA’s recent guidance. Disclosure Documents should be filed electronically throughNFA’s Disclosure Document System.
  3. If placing bunched orders, analyze each trading program at least quarterly to ensure that the order allocation method has been fair and equitable and document this analysis.
  4. The FCM that carries your client accounts will be contacting your clients to verify that the information obtained under NFA Compliance Rule 2-30(c) remains materially accurate, and provide the client with an opportunity to correct and complete the information. If the FCM notifies you of any material changes to the information, assess whether additional risk disclosure is required to be provided to the client based on the changed information.

If you are a registered Commodity Pool Operator, you will also be required to:

  1. File any new exemption notices electronically through NFA’s Exemption System.
  2. If soliciting new pool participants, distribute a Disclosure Document that is no more than 9 months old and that has been reviewed and accepted by NFA. Ensure that the document includes a complete business background and discloses all potential conflicts of interest in accordance with NFA’s recent guidance. Disclosure Documents should be filed electronically through NFA’s Disclosure Document System.
  3. Update your CPO Questionnaire on NFA’s website for any pools that have liquidated.
  4. Submit to NFA through NFA’s EasyFile system, and distribute to current participants, a certified Annual Report for each pool as of the close of the pool’s fiscal year. CFTC Regulations require Commodity Pool Operators to follow strict deadlines and filing requirements, and failing to meet those deadlines may result in a disciplinary action against a CPO. To learn more about EasyFile, go to NFA’s website and access the seminar at Since NFA acts as the CFTC’s delegate when NFA receives and reviews Annual Reports, the reports are subject to requests under FOIA. CPOs may request confidential treatment of Annual Reports but must strictly follow the CFTC procedures contained in CFTC Regulation 145.9 for filing such requests. For information on how to request confidential treatment of Annual Reports filed with NFA, consult the information on NFA’s website at  When preparing pool Annual Reports, refer to the CFTC’s annual letter for useful tips.
  5. Within 45 days after the end of each quarter, submit to NFA through NFA’s EasyFile system, a Pool Quarterly Report for each pool that you operate. Information required to be filed includes: (a) the identity of the pool’s administrator, carrying broker(s), trading manager(s) and custodian(s); (b) a statement of changes in net asset value; (c) monthly performance for the three months comprising the quarterly reporting period; and (d) a schedule of investments identifying any investment that exceeds 10% of the pool’s net asset value at the end of the quarterly reporting period.

If you are a registered Introducing Broker, you will also be required to:

  1. Conduct Anti-Money Laundering (“AML”) training for relevant employees and complete an audit of your AML procedures and training. For guidance in developing your AML procedures, use NFA’s AML Procedures System.
  2. The FCM that carries your customer accounts will be contacting your customers to verify that the information obtained under NFA Compliance Rule 2-30(c) remains materially accurate, and provide the customer with an opportunity to correct and complete the information. If the FCM notifies you of any material changes to the information, assess whether additional risk disclosure is required to be provided to the customer based on the changed information.
  3. If you are not operating pursuant to a guarantee agreement, submit a certified annual report within 90 days after the firm’s fiscal year end. IBs that are also registered as Broker/Dealers (“BDs”) must submit the report within 60 days after the firm’s fiscal year end. IBs that are not also registered as BDs must file this certified statement via NFA’s EasyFile system.
  4. If you are not operating pursuant to a guarantee agreement, submit semi-annual 1-FR-IB filings via EasyFile within 17 business days of the date of the statement (in addition to completing and maintaining monthly net capital computations). IBs also registered as BDs may file via WinJammer and must also file with NFA all statements required by FINRA. All financial statements should be prepared using the accrual basis of accounting as required by Generally Accepted Accounting Principles.

If you are a registered Futures Commission Merchant or Retail Foreign Exchange Dealer, you will also be required to:

  1. Conduct Anti-Money Laundering (“AML”) training for relevant employees and complete an audit of your AML procedures and training. For guidance in developing your AML procedures, use NFA’s AML Procedures System.
  2. Review your Point of Contact information for USA PATRIOT Act 314(a) information requests and notify NFA of any changes (FCMs only).
  3. Supervise the operations of any GIBs, including conducting an annual onsite inspection of every GIB.
  4. Contact active customers who are individuals, at least annually, to verify that the information obtained from that customer under NFA Compliance Rule 2-30(c) remains materially accurate, and provide the customer with an opportunity to correct and complete the information. If the customer notifies you of any material changes to the information, assess whether additional risk disclosure is required to be provided to the customer based on the changed information. However, if another FCM or IB introduces the customer’s account on a fully disclosed basis or a CTA directs trading in the account, then notify that Member of the changes to the customer’s information.
  5. Submit a certified annual report within 90 days after the firm’s fiscal year end, or if your firm is also registered as a Broker/Dealer, within 60 days after the fiscal year end (in addition to submitting the firm’s monthly Focus II/I-FR-FCM with NFA via WinJammer).
  6. For firms that offer off-exchange foreign currency futures and options contracts (FOREX) to retail customers, provide written information regarding NFA’s Background Affiliation Status Information Center (BASIC), including the website address to every current customer (in addition to sending it to every new customer when the customer opens an account).
  7. For firms that offer FOREX to retail customers, review the security, capacity, credit and risk-management controls, and records provided by your electronic trading systems and certify that the requirements outlined in NFA Interpretive Notice 2-36(e) have been met. Prepare a certification, signed by a principal who is also a registered AP, and provide a hardcopy to NFA with the submission of your annual audited financial statement.

If your firm or its clients trade security futures products (futures whose underlying instrument is either a single security or a narrow-based security index), consult NFA’s website for a comprehensive listing of your requirements at

We recommend that you keep this email as a reference guide to ensure that all requirements are completed on time throughout the year.

We also want to remind you again: Every firm that is required to be registered as an FCM, RFED, IB, CPO or CTA in connection with its FOREX activity must be approved by NFA as a FOREX firm. NFA Members are prohibited from engaging in retail Forex transactions with these firms unless the firm has received this designation. In addition, FOREX firms must have at least one principal who is registered as an Associated Person (AP) and is approved as a FOREX AP. All individuals who solicit retail FOREX business or who supervise that activity must have taken and passed two exams — the National Commodity Futures Examination (Series 3) and the Retail Off Exchange Forex Examination (Series 34), which is a new exam focusing exclusively on Forex-related questions. However, individuals who were registered as APs, sole proprietors or floor brokers on May 22, 2008, do not need to take the Series 34 exam unless there has been a

two year gap in their registration since that date.

As always, if you need assistance with these or any other NFA requirements, please contact NFA’s Information Center at (800) 621-3570.


Cole-Frieman & Mallon LLP provides comprehensive compliance and regulatory support for CTAs and CPOs.  Bart Mallon, Esq. can be reached directly at 415-868-5345.

New York LLC Publication Requirement

Fund sponsors who have established a limited liability company in New York to serve as the management company for their hedge fund should be aware of the New York publication requirement.  Pursuant to Section 206 of the New York Limited Liability Company Act, within 120 days after the effective date of the initial articles of organization, a LLC must publish a copy of the articles of organization or a notice related to the formation of the LLC in two newspapers.  After publication, the sponsor will need to submit additional paperwork to the New York Department of Corporations to complete the publication requirement process.  This article provides an overview of the process as well as the consequences for not fulfilling the requirement.

Publication in Newspapers

The notice required under the act must be printed in two different newspapers once each week for six successive weeks.  The sponsor does not choose the newspapers in which the notice will be published; instead, the newspapers are predetermined for the LLC.

The first newspaper will be the same for all LLCs – the New York Law Journal.  [Information on the New York Law Journal to be forthcoming.]

The second newspaper will be different for each LLC.  In order to determine the second newspaper, the fund sponsor will need to contact the county clerk of the county in which the LLC’s office is located (as stated in the articles of organization).  After the county clerk provides the sponsor with the information as to which newspaper to publish the notice, the sponsor will need to contact the newspapers for instruction on the manner in which to cialis in the united kingdom submit the materials for publication.

Submitting the Certificate of Publication

After the publication notices have run for six weeks in the two newspapers, the printer or publisher of each newspaper will provide the sponsor with an affidavit of publication.  The sponosor will then need to submit (1) a Certificate of Publication (2) the affidavits of publication of the newspapers, and (3) a filing fee of $50, to:

Department of State, Division of Corporations
One Commerce Plaza
99 Washington Avenue
Albany, NY 12231

Failure to Satisfy the Publication Requirement

According to the law, if an LLC fails to satisfy this requirement, the LLC will be “suspended” from carrying on, conducting or transacting business in the state.  However, a suspension will not invalidate any contract or act of the LLC or the limited liability of the members.  It is therefore unclear exactly what “suspended” means, as the law and the courts have failed to elaborate.  In the future, the New York legislature or courts could institute more serious repercussions, such as the inability to open bank accounts or enter into certain transactions, but presently, the law explicitly states that a suspension does not invalidate the LLC’s contracts or acts and a suspension can be lifted if the LLC substantially complies with the publication requirement.

More information about the LLC publication requirement is available here and here.


Other related articles include:

Bart Mallon, Esq. is a hedge fund attorney and provides hedge fund compliance services through Cole-Frieman & Mallon LLP. He can be reached directly at 415-868-5345.

California Adopts New Part 2 of Form ADV

At the end of July, the SEC adopted amendments to Form ADV Part 2 and the related rules.  The amended Form ADV Part 2 will be used by SEC-registered advisers to meet their disclosure obligations and generally describe the adviser’s services, fees, and strategies.

On September 1, 2010, the California Department of Corporations followed suit and announced its adoption of the new Part 2 as well, effective October 12, 2010 (see California ADV Part 2 Announcement).  This effective date corresponds with the effective date of the SEC’s rule changes.  The Department’s decision will help bring consistency between state and SEC investment adviser registration requirements.

New ADV Part 2

The amended Form ADV Part 2 consists of three parts:

  • the “Firm Brochure” (Part 2A),
  • a Wrap Fee Program Brochure (Part 2A, Appendix 1), and
  • the “Brochure Supplement (Part 2B).

Every investment adviser must complete the Firm Brochure and the Brochure Supplement.  The Firm Brochure, which is filed electronically with the SEC on the IARD system, will include information about the adviser and its business. The Brochure Supplement, which is a brief disclosure document about certain personnel of the adviser, will be provided to clients but not filed with the SEC.

In addition, the new Part 2 will no longer be in the check-the-box format.  Instead, it will take the form of a narrative brochure written in plain English–the purpose of which is to provide clients with a more clear disclosure of the adviser’s business practices, conflicts of interest, and background.

Compliance Dates

Effective October 12, 2010,  for California registered investment advisers, the relevant compliance dates for the new ADV Part 2 are:

  • As of January 1, 2011 all new investment adviser applicants will have to file, through the IARD, the new Part 2 of Form ADV as part of their application.
  • As of January 1, 2011 all licensed investment advisers will need to incorporate the new Part 2 of Form ADV with their next filing of an amendment to Form ADV, or their annual updating amendment to Form ADV.
  • Between October 12, 2010 and January 1, 2011 applicants and current licensed investment advisers filing amendments to their Part II of Form ADV may use either the current Part II or the new Part 2.

With this change, investment advisers should review and become familiar with the new Part 2.  Advisers that are currently registered with the California Securities Regulation Division will have to incorporate the new Part 2 when they file amendments to Form ADV and also when they file the required annual update.  For most advisers with a December 31, 2010 year-end, the deadline for the annual update will be March 31, 2011.


Other related hedge fund law articles:

Bart Mallon, Esq. runs the Hedge Fund Law Blog and provides investment adviser registration and compliance services through Cole-Frieman & Mallon LLP.  He can be reached directly at 415-868-5345.

Series 66 Exam

This exam is required by certain states for an individual who wants to register as an investment adviser representative and securities agent.  Passing the Series 66 would be equivalent to passing both the Series 63 and Series 65 exams.  Additionally, individuals are required to pass the Series 7 exam as a prerequisite for taking the Series 66.  This post will provide an overview on the Series 66 exam and some thoughts on both taking and passing the exam.

The Series 66 Basics

What: The exam has a time limit of two hours and 30 minutes and a total of 110 questions, 10 of which are “pretest” questions and do not count in your final score.  The exam covers the following topics: Economic Factors and Business Information; Investment Vehicle Characteristics; Client Investment Recommendations and Strategies; and Laws, Regulations, and Guidelines, including Prohibition on Unethical Business Practices.  You must earn at least 75% to pass the exam.

Where: You can take the exam at most Pearson VUE or Prometric testing centers.

When: You should probably sign up for the exam at least a week prior to taking it, and you can choose the time and date on either the Pearson or Prometric website when you register.

Why: The exam is required for those individuals who want to become both securities agents (generally brokers) and investment adviser representatives.

How to sign up

You can register for the exam by submitting a Form U-4 or Form U-10 through the IARD system online.  Please not that, effective September 15, 2010, FINRA requires individuals to use either their CRD number or FINRA ID number in order to schedule an exam and no longer accepts social security numbers.  If you have any questions regarding registering for an exam, be sure to ask your law firm, compliance consultant, or feel free to contact us.

The cost to take the exam is $128.

How to study for the exam

It is recommended that you obtain a study guide and thoroughly read the entire guide.  NASAA (North American Securities Administration Association) provides a study guide available for download on their website.  Also, Kaplan provides a useful study guide that presents the study material in a simple and easy-to-understand way, and their practice questions are very similar to questions you are likely to see on the actual exam.

Take at least two to three practice exams prior to taking the test, possibly more.  Use memory refreshers such as note cards or other review materials.  Do not cram the morning of the test, as this will probably only make you more anxious.  In fact, it is recommended that you take the exam in the morning after a full night’s rest.

Day of exam

Arrive at the testing center at least 45 minutes prior to taking the exam to allow yourself time to review some of your notes beforehand.  The proctor will require you take off your jackets and place your belongings, including your study material, in a provided locker.  Be sure to have woken up early enough to eat breakfast beforehand and be fully alert during the test.

The exam

The exam is computer-based and will initially instruct you on how to properly answer and mark the following questions.  Note that the beginning of the exam will most likely include the easiest questions, and then the questions will get harder as you reach the middle.  Always attempt to make the most educated guess on questions you do not understand.

The length of the exam might require you to pause and use the restroom or take a break.  Allow yourself time to step away from the computer for a moment, take a drink, and gather your thoughts.  When you encounter difficult questions, you always have the option of marking the question for review.  Never spend an extended period of time on a question, as you will just waste time on answering other questions you might know better.

After you have completed the questions, you will have the option of changing any of your answers.  After completely answering everything, you will receive your score immediately.

If you don’t pass

A number of managers who take the exam do not pass or only come close to passing.  If this is the case, you will need to wait another 30 days before re-taking the exam.  If you do not pass the exam the second time, you will need to wait another 60 days before taking the exam.  If you do not pass either the third or fourth attempt, you will need to wait at least 180 days before taking the exam again.  There is no limit on the number of times allowed for taking a test.


Other related hedge fund law articles:

Bart Mallon, Esq. runs the Hedge Fund Law Blog and provides hedge fund start up and legal services through Cole-Frieman & Mallon LLP. He can be reached directly at 415-868-5345.