Crypto Fund Offering Documents Post FTX Collapse

Items to Consider for Fund Terms / Structures

We are moving into the next phase of operations after the FTX collapse – for those crypto funds that did not face issues with assets on FTX (and even for those who did and who are remaining in business), we are now examining how this disruption changes the way managers operate their business and/or how do investors look at crypto fund terms and operational structures. 

As managers deal with questions from investors, or how they will proceed with their operations post-FTX bankruptcy, they may want to be thinking about the following items:

  1. Side Pockets – some managers may have seen their investment in FTX turn from individual crypto assets into a single asset (a bankruptcy claim) that has much different liquidity parameters.  The single asset bankruptcy claim may need to be sidepocketed and if so managers should review their fund documentation to see how that works and also discuss the mechanics with their fund administrator.  Of course, when sidepocketing any asset, managers should be careful with accounting and valuation. There are a number of other issues applicable to side pockets that managers may want to think about, including maximum percentage allocable to side pockets and when assets can be so designated.
  2. Lock-ups – in general liquid crypto funds have been able to institute longer initial and ongoing lock-up periods than traditional managers.  How these periods interact with the withdrawal provisions will determine required liquidity for any withdrawal periods. 
  3. Suspension of withdrawals – most offering documents (both in the traditional and digital asset spaces) have pretty standard suspension of withdrawals discussions.  Normally to suspend withdrawals there needs to be a major disruption in the industry.  My normal talking point is that it would be a 9-11 type event.  Here, for managers who had assets on FTX, this may be a suspension type event depending on the various circumstances of the particular fund (including total liquidity and normal withdrawal provisions, which may include a gate provision).  Managers may want to take another look at this language given the recent market events.
  4. Custody – this is always one of the most important disclosures for managers.  Custody in the digital assets space, while much improved from 2017-2018, is still all over the place.  Some managers will self-custody as much assets as possible while keeping certain assets with actual qualified custodians, and some managers will keep some or most assets on-exchange.  Whatever the technical expertise the manager has, and the mix of cold/hot storages and off/on-exchange, should be reviewed to make sure that a manager’s current practice mirrors the disclosure in the offering documents.
  5. Conflicts of interests (COI) – COI is always a vitally important section in any offering documents and managers should always try to over-disclose here.  For most groups with streamlined structures (GP-Fund entities only), there are standard COIs.  For groups with multiple management level entities and different agreements between them, or for groups with multiple fund structures and outside entities (like staking, mining, other service businesses) there will need to be more robust disclosure of the activities.
  6. Discussion of investment program – the purpose of the investment program disclosure is to provide investors with some kind of an overview of how the assets will be invested.  Some managers have multiple pages of disclosures and some will have a couple of paragraphs.  Some will include a discussion of everything they could potentially do and percentages etc, and some will be purposefully vague (and then augment the discussion with more detail in a pitchbook or other marketing materials).  Managers sould review the program and make sure it accurately describes their current state of affairs as well as how the program may change in the future.
  7. Risk factors – perhaps the most important part of the documents for a crypto fund manager is the risk factor section. There are some limitations in what ultimately is disclosed because at any particular time because the industry is constantly evolving, and quickly.  For managers in the traditional investment management space, most risks for any particular investment strategy has been developed over a long period of time.  In the digital asset space, risk factors are constantly being added and also modified over time.  For our manager clients, the risks related to exchanges and counterparties, both domestic and offshore, were robust and accurately depicted the issues that the FTX bankruptcy brought to the forefront.  Many times we work hand in hand with managers to understand the risks of a particular part of the industry and we develop them together.  Our specific risk factors have been informed by our interactions with regulators.  

For each of the sections above, there are many different ways for managers to think about the issues presented. We believe that it is important to discuss and think about these items on the front end, and we also believe that investors will be giving greater weight to these items in the future (especially with respect to side pockets and liquidity) so crypto fund managers should give these items extra thought during the fund formation process. While the above items were written with the crypto space in mind, the concepts apply equally to those groups in the traditional investment management space.

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Bart Mallon is a founding partner of Cole-Frieman & Mallon LLP.  Cole-Frieman & Mallon 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.

Crypto Funds Selling FTX Bankruptcy Claims

Contracting for the Sale of a FTX Bankruptcy Claim

There are a number of digital asset focused funds that have their assets on FTX frozen pending the bankruptcy process.  These managers now have a claim against FTX and it is unclear when such claims will ultimately be settled and for how much.  For a variety of reasons then many of these groups are looking to sell their claims and move on with their operations (either to continue their investment program or to close down). 

In the event a crypto manager does decide to sell a claim, we believe the sale should be memorialized in a contact of some kind, as would be normal operating procedure. However there are not really any standardized contracts for these types of claims.  What we are seeing though is that parties are modifying existing OTC trade document to fit the particulars of this situation.  In these documents we are seeing the following as the main sections:

  1. Discussion of the parties – this is pretty clear here, but the main selling party is the fund that holds the claim.  That fund may be a standalone or may be the master fund in a master-feeder structure.
  2. Discussion of the claim – the claim will normally be identified by the name of the selling party, but there may be additional information included as well including account numbers, account activity, outstanding amount, etc.
  3. Price – obviously this is the most important part for the selling party.  We are seeing/hearing anywhere from 3 cents to 8 cents on the dollar depending on a number of factors.  Managers should speak to at least two counterparties to see what the prevailing price and other terms are for these claims. 
  4. Buyer due diligence – the contract may have a discussion about continued buyer due diligence on the claim. [Note: this seems a bit odd and kind of turns the “contract” into more of a kind of “binding term sheet”…]
  5. Reps and warranties – manager sellers should be careful of any contract here that requires reps and warranties on the managers behalf.  This is especially true if the manager will be shutting the fund down after the sale of the claim.  It is unclear how the process will play out and the manager does not want to be creating a headache for themselves in later years based on a rep made in haste while trying to sell the asset. We would recommend negotiating this section pretty aggressively. Notwithstanding the above, normal reps regarding AML/KYC, ability to contract, etc are likely to not pose any issues to manager sellers.
  6. Miscellaneous items – there are standard miscellaneous items in these contracts around jurisdiction, which is turning into an interesting issue in this bankruptcy case.

If the manager ultimately does decide to sell a bankruptcy claim, they should talk with their various service providers to make sure that all important items are addressed (legal, tax, accounting, audit). 

With respect to the auditor, the most important item is to make sure that title over the claim has fully passed to the third-party so the auditor can determine that the transfer of the asset/claim to the buyer is complete and therefore off the books of the fund. Please note again there may be jurisdictional issues (needing Bahamian counsel) or issues with respect to the bankruptcy process (which may require bankruptcy counsel). We expect that these sales will pick up as managers try to get these claims off of their books by the end of the year.

We are also recommending to clients that they draft some kind of compliance memo to file that discusses all aspects of the decision to sell and the factors around the ultimate sale price.

Please feel free to reach out if you have questions on this process and we will try to keep this post updated as we deal with more of these sales over time.

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Bart Mallon is a founding partner of Cole-Frieman & Mallon LLP.  Cole-Frieman & Mallon 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.

CoinAlts Fund Symposium Recap

Remarks from Digital Asset Private Fund Conference

A couple of weeks ago on November 3rd our law firm sponsored and ran our digital asset fund conference called CoinAlts. While originally an open conference for all in the digital assets space, it has more recently turned into a client event centered around crypto fund managers.  The goal has always been the same though – to come together to discuss topical digital asset items and to figure out ways for our manager clients to operate their business better.  We were lucky that the conference happened just before the FTX debacle unfolded because the panels were engaged with the real day-to-day issues involved in running a crypto investment management business. 

Below I’ve published my opening remarks and my quick closing remarks.  For a list of the speakers and the panel topics, you can visit our CoinAlts website. 

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OPENINING REMARKS

By Bart Mallon

Before we get into everything, I wanted to ask this question – why are we here today?  What are we hoping to accomplish?  

Welcome everyone to CoinAlts 2022.  This is the 5th full installment of the conference series which was started in 2017 dedicated solely to digital asset fund managers and put on by four founding sponsor firms – Cole-Frieman & Mallon, MG Stover, Cohen & Co, and Harneys.  My name is Bart Mallon and I’ll be saying a few items this morning and will be with you throughout the day. 

I often ask myself what am I trying to get out of a conference before I go – many times, it is just that I want to get away and see friends and have a few drinks.  But in general, when I am going to conferences I try to look at what panels will help me with information help me be better in my business or how will it help me look at the world in a different way.    

Over the last few crytpo conferences, I’ve felt there was not much new stuff or one good idea that I could carry through back to day to day life – the narratives that I’ve heard lately at these conferences are generally “well we’re in bear market and new good things are coming because that’s how the cycles work”…

So, I guess, if that’s where we are – that it’s a bear market and we have to wait until the next cycle until there is something interesting or important, then why are we here?  Before I tell you my thoughts on that, let’s take a quick look at where we have been and what has been accomplished over these last five years since coinalts started.  

Let’s start with just the sheer amount of different crypto strategies we’ve seen during this time:

  • Long bitcoin
  • Long bitcoin and other tokens
  • Token trading
  • Long/short tokens
  • High frequency trading
  • Exchange arbitrage 
  • Blended or Multi-Strat offerings
  • Crypto VC
  • Mining focused funds and operations
  • Yield farming
  • Offshore focused exchange trading
  • Staking (and the rise of staking specific service entities)
  • Ecosystem dedicated strategies
  • Lending and DeFi strategies
  • NFTs
  • Web3, and,
  • DAO focused strategies

We all know that each of these are unique strategies, some literally having not existed even a couple of years ago.   From these strategies the founding sponsors have collectively worked with our manager clients (many of you here today) to develop “the firsts” in an industry and I’ll list off a few of these:

  • The first to really force the definition of crypto tokens as securities – we started with the question of what are crypto assets?  I am not sure we know for sure still – we know that bitcoin is not a security (at least for now), but what about ETH and Ripple?  At some point we will gain clarity, but our law firm was adamant from the very beginning that many assets would “likely be deemed to be securities” and therefore are subject to many of the traditional investment management laws.
  • The first firm to specialize in the crypto audit – how do you even audit something that is not physical and may not have a traditional custodian?  There are so many questions here that the team at Cohen had to deal with from the theoretical of “what does it mean to have the ability to control an asset?” to the mundane – “how do we see this asset on a blockchain?”
  • The first to deal with issues around Net Asset Value:
    • Traditional investment managent space markets don’t trade 24/7
    • Concept of first/last business day of a month or quarter versus the last calendar day
    • We collective saw themovement from midnight ET to UTC (which I now understand means Universal Time Coordinated – I had to look that up, perhaps Matt can confirm)
    • The first full crypto NAV process (as opposed to NAV Lite)
    • The first daily NAV crypto hedge fund
  • The first questions around Hard Forks – how do you deal with these from an accounting and tax standpoint?  How do you deal with any legal issues.  Operational items?  What to be careful with?  Same thing with Airdrops.
  • In-Kind Crypto Subscriptions and Redemptions – same thing here – this is a completely different process from the tradfi space and we helped facilitate all aspects of these transactions, from legal to tax to operations. 
  • Custody – for a few years this was one of the bigger legal and compliance issues for our managers.  How do you deal with the various issues around self-custody given the lack of qualified custodians?  It’s been a pretty constant five years of dealing with this front and center issue and there are many knowledgeable people here.
  • SEC registration – similar to the custody issue, how would digital asset managers actually register with the SEC if they were trading digital assets.
  • SEC examination – perhaps even a bigger question than registration was examination.  We didn’t know how the SEC would react to our clients – we helped our clients with both of these and found out that they did ok.
  • Many people here were some of the first people to speak with regulators of all kinds – SEC, state securities regulators, the IRS – about digital assets.  Many people here have been and currently are involved with discussions with legislators for future tax and regulatory bills.
  • Finally, the firsts for really building the basis for the industry – obviously legal and audit and tax were huge in this space, but we literally had the folks at MG Stover building APIs into exchanges.  Helped correct/fix/create APIs for various exchanges and custodians.  Build pricing sources. Standardized OTC trade confirms. Standardized custody reporting.  None of the day-to-day nuts and bolts for reporting would happen without these items…and

They even found $5mm hack of a client through their reconciliation process and the client ended up recouping all the crypto.

All of these things are the firsts that were developed hand in hand between our clients and our firms through many hours of phone calls, collaborations, research, a lot of “I thinks” and “we’ll see” and “hopefullys”…some “I don’t knows”…these are the things you go through when you are building the infrastructure of an industry…

I’ve already mentioned the four founding sponsors, but this conference also could not be put on without our Partner level sponsors Cowen Digital, Figment, Standard Custody and Trust Company; and out Supporter level sponsor Aspect Advisors, IQEQ, Silvergate, Withum, Copper, and Nova.  We also had our Women in Crypto networking event yesterday which was sponsored by Aspect, Strix Leviatian (a crypto fund manager), and StoneX that had about 75 attendees.  CalAlts, HF Alert, Help for Children were also our partner sponsors and we appreciate all their help.

For the first time our conference auctioned off an NFT 1.07ETH to a private collector in the Bay Area…the proceeds from this transaction will be donated to Help for Children, along with a match from our law firm.  Anyone else who wants to match, please see Sharon Hamilton over there.  I will spend more time thanking Sharon later today, but she is the main person who put this conference on, along with Karen Thornton, so please thank her if you see her today. 

We have six panels that will cover topics ranging from legal to custody to raising assets.  We also have two special keynotes from Mark Yusko and Punk6529, a lunch, breaks and networking reception at the end.  There is no shortage of current topical items that will probably be discussed during these times today:

  • Is crypto simply a risk-on asset that will move in lockstep with tech?
  • When is the crypto spring?
  • How do we not yet have a bitcoin ETF?
  • How will the recent OFAC rulings affect business going forward?
  • What did Terra Luna tell us about systemic risks of the industry?
  • Will the SEC and CFTC begin to regulate through rulemaking or continue with regulation by enforcement?
  • What does the successful ETH merge mean, if anything?
  • How will midterm elections affect the crypto space, if at all? 
  • Will FTX continue buying everything in sight?
  • Apple, Twitter, Google, Starbucks, Reddit…each one of them have real and interesting crypto use cases…which of these are going to emerge as real things that will be integrated into our daily lives?
  • And… funds have raised hundreds of millions of dollars, there are billion dollar funds, and even multi-billion dollar crytpo and crypto VCs fund that have been raised over the last 12 months…what will they be doing with that capital?

So I go back to the original question – why are we here?

I submit we might not know the reason right now but I am hoping we all find ideas, or hints of ideas, during the panels today that will help us in our day to day business and in life going forward.  I also hope that something here will spark another first we can add to our list…

With that as perhaps one reason for us to be here, we’ll move into our first item of the day, our Keynote discussion with Mark Yusko, Managing Partner of Morgan Creek Digital, talking here with Matt Stover of founding sponsor MG Stover.

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CLOSING REMARKS

Thanks to all of the speakers, panelists and moderators today – there were a number of distinct takeaways for me – from not calling NFTs NFTs (instead digital property rights), do not make misrepresentations in your offshore account paperwork, that exchanges and custody will continue to bifurcate, the importance of crypto fund service providers to work together, that defi platforms generally worked, that there is an opportunity with respect to asset prices right now because of the crypto winter, and operational due diligence for crypto funds is in a much different place than it was even a couple of years ago.

Thank you again to all of our sponsors who helped make this event possible and specific thank yous go out to Sharon Hamilton of Cole-Frieman & Mallon and Karen Thornton – I know these two spent an inordinate amount of time working to make sure this symposium would be a success and we obviously could not have done this without them.

At the beginning of the conference I had asked everyone why we were here today…I didn’t realize we would get such a forceful call to action from Punk 6529 but I think that he’s right – we have to look to ourselves to see what we have individually done to help this industry and we have to fight for it.  It is not guaranteed. 

And with that I’d like to invite you all to our cocktail reception.

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Bart Mallon is a founding partner of Cole-Frieman & Mallon LLP.  Cole-Frieman & Mallon 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.

Cole-Frieman & Mallon 2022 Q2 Update

July 21, 2022

Clients, Friends, Associates:

As we end the second quarter and enter the summer season, we would like to highlight some of the recent industry updates and occurrences we found to be interesting and impactful. While we try to keep these topics higher-level, please feel free to explore the links included and reach out to us if you have any related questions.

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CFM Items

We are pleased to announce the addition of Alex Yastremski to our firm as Partner to lead our Digital Asset Practice. We’d also like to highlight the addition of Frank J. Martin as Counsel and the promotion of Tony Wise to Partner. Additionally, we have hired Joe Burgess as Executive Director to continue our focus on operational excellence. Please join us in welcoming them all to our firm!

Our annual CoinAlts Fund Symposium is returning to San Francisco and will be held on November 3, 2022. Please mark the date on your calendar and stay tuned for further registration information. Attendance will be complimentary for clients of our firm and those of the other CoinAlts founding firms, MG Stover, Cohen & Company, and Harneys.

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SEC Matters

SEC Risk Alert on Material Non-Public Information Compliance Issues. The SEC recently released a risk alert summarizing the most common compliance deficiencies of both registered and unregistered investment advisers. Of note were (1) the lack of written policies to prevent the misuse of material non-public information (“MNPI”) and (2) the lack of compliance with the reporting requirements for “Access Persons” under the Code of Ethics Rule. All advisers should periodically revisit their written policies and procedures for the use of MNPI and registered investment advisers should review their Code of Ethics and establish reporting requirements for their Access Persons.

Enforcement Action for Misrepresenting Fees. The SEC instituted an enforcement action against a venture capital fund adviser and its CEO for misrepresenting their management fees as “industry standard 2 and 20” when they collected 10 years of management fees up front. This was misleading because it led investors to believe they would be charged an annual 2% management fee, rather than 20% of their total investment up front. The SEC also found that the adviser breached operating agreements by making inter-fund loans and cash transfers between funds. The adviser and its CEO agreed to a cease-and-desist order, returned funds, and paid penalties. In addition to confirming that the fund administrator reviews the offering documents and follows the mechanics for charging fees described therein, we recommend advisers closely review marketing materials with legal counsel or compliance consultants for any misleading or subjective statements.

OpenSea Insider Trading. A former high-ranking employee of OpenSea was recently indicted for wire fraud and money laundering in what the United States Attorney’s Office for the Southern District of New York characterized as the “first-ever digital asset insider trading scheme.” The former head of Product at OpenSea was in charge of selecting NFTs to feature on the website’s homepage and allegedly misappropriated that confidential information by purchasing those NFTs before they were promoted on OpenSea’s homepage.

While the alleged actions in the indictment are reminiscent of traditional insider trading under Section 10(b) of the Securities Exchange Act of 1934 (the “Exchange Act”), since NFTs are not yet categorized as securities under the Exchange Act, the prosecutors here wove allegations of traditional fraud and insider trading concepts into charges for wire fraud and money laundering. The prosecutorial creativity signals that despite lagging legislation, law enforcement is taking notice of the increasing fraudulent activity in the NFT space and is ready to tackle such unsavory business practices and provide greater consumer protection. While insider trading remains an unsettled area of law in the digital asset space, concepts of fraud are well established, malleable, and largely immune from claims that certain digital assets are not “securities.”

Adviser Liable for Late Audit Distribution. The SEC charged a registered investment adviser with Custody Rule and compliance violations for failing to complete an audit within 120 days of the private fund’s fiscal year end. The SEC found that the adviser failed to have required audits performed and failed to deliver audited financial statements to investors in certain funds from 2014 onward, and in certain other funds from 2018 onward. The adviser consented to a cease-and-desist order, a censure, a monetary penalty, and to provide a notice of the Order to past and current investors in the fund. This enforcement action serves as a reminder to all advisers to remain vigilant and stay on top of their auditors to complete and distribute the annual fund audit in a timely fashion.

SEC Doubles Size of Crypto Enforcement Unit. The SEC announced the allocation of 20 additional positions to a Crypto Assets and Cyber Unit (formerly the Cyber Unit) to protect investors in crypto markets from cyber-related threats. The expanded Crypto Assets and Cyber Unit will focus on investigating securities law violations related to crypto asset offerings, crypto asset exchanges, crypto asset lending and staking, decentralized finance, NFTs, and stablecoins. We think this is a step in the right direction; it is clear the SEC recognizes that the digital asset space is growing and that greater resources need to be brought to bear on the industry. 

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CFTC Items

Perpetual Futures and CFTC Regulation. Digital assets managers continue to inquire into the possibility of trading cryptocurrency futures contracts. With the Commodity Futures Trading Commission (“CFTC”) recognizing certain digital assets as commodities, proper registration with the CFTC is required (or an appropriate exemption from registration must be utilized) if managers plan to trade cryptocurrency futures on registered exchanges. Under the Commodity Exchange Act, many, if not all, derivatives based on digital assets must be traded on a Designated Contract Market (“DCM”). However, many managers prefer not to trade on DCMs due to the lack of volume and liquidity and instead seek to trade on offshore exchanges that offer higher volume and reduced margin requirements. We caution U.S. managers who are trading on such exchanges – there may be risks to engaging with such counterparties in foreign jurisdictions and such U.S. managers often are unable to make the representations required in the account opening paperwork or terms of service (e.g., that the trading activity will not occur in the U.S.). To our knowledge, the CFTC has yet to take any action against managers trading on such offshore exchanges; however, we believe it is only a matter of time. Managers should carefully diligence any offshore exchanges they may use and disclose any applicable risks to investors.

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Digital Asset Items

Coinbase’s Bankruptcy Disclosure. The industry was caught off guard when Coinbase filed its latest 10-Q filing in which it stated “custodially held crypto assets may be considered to be the property of a bankruptcy estate.” In essence, in the event of Coinbase’s bankruptcy, its customers’ crypto assets may not be returned, and such clients could be treated as general unsecured creditors, meaning they would not have a claim to specific crypto assets held with Coinbase and could only recover the value of their crypto assets to the extent the bankruptcy estate has assets remaining after more senior claims are satisfied. While the Coinbase founder and CEO subsequently tweeted that Coinbase’s statement was a response to SEC disclosure requirements and that “customers have strong legal protections…in a black swan event like this,” the bankruptcy risks that Coinbase disclosed remain a possibility, however remote. In addition, other crypto exchanges, as well as third party wallet providers and custodians, may be subject to similar bankruptcy risks even though they may not have an obligation to disclose such risks publicly like Coinbase. In light of Coinbase’s disclosures, managers who do not exclusively rely on self-custody or cold wallets should review their custody practices, policies, and procedures, as well as agreements with their service providers, to ensure they have taken all available steps to safeguard investor assets. Managers should also consider making additional risk disclosures in their fund offering documents or other investor communications to educate their investors on these potential bankruptcy risks.

Liability Issues for Investing in a DAO. Due to the emerging nature of, and the scarce legislation surrounding, Decentralized Autonomous Organizations (“DAOs”), operating, participating in, or investing in DAOs carries a heightened risk of liability as DAOs formed for the purpose of making a profit could be deemed general partnerships and therefore expose their participants to unlimited joint and several personal liability for the debts and obligations of such DAO. One recommendation to minimize exposure is to wrap the DAO in a liability blocker. As legislation related to, and use cases of, DAOs evolve and iterate, the need or effectiveness of liability blockers may change. Until then, managers should disclose this heightened risk to their investors and should consider only participating or investing in DAOs that are wrapped in a liability blocking entity such as a limited liability company.

Senators Introduce Bipartisan Crypto Regulatory Framework Bill. Sens. Kirsten Gillibrand (D-NY) and Cynthia Lummis (R-WY) recently introduced bipartisan legislation to regulate the cryptocurrency market. The Responsible Financial Innovation Act aims to create a clear standard for determining whether certain digital assets are commodities or securities. The bill would give the CFTC authority over digital asset spot markets, allowing the agency to regulate digital assets in the same way as more traditional commodities. The bill has been referred to the Senate Finance Committee for examination and is pending approval of the Senate and the House of Representative.

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Other Items

In-Kind Crypto Contributions / Redemptions. We are starting to see greater difficulty for managers of offshore funds to utilize in-kind crypto contributions and redemptions because of administrator and Anti Money Laundering (“AML”) officers’ unease. We expect this trend to generally continue until administrators and AML officers become more comfortable with verifying and authenticating in-kind crypto transactions, either with additional regulatory guidance or with innovative processes.

Investors with Connections to Russia. It may be simply anecdotal, but we are seeing more administrator inquiries regarding investors with ties to Russia who are flagged for potential sanctions issues. In these instances, we encourage clients to work with legal counsel and their administrator to analyze their specific facts and circumstances and determine an appropriate course of action.

NFTs. Although far removed from its headline status of 2021, the NFT ecosystem continues to evolve, and many groups are developing products for the sector that more closely mirror the traditional asset space. We anticipate continued growth in this area and the development of business, legal and regulatory norms.

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Compliance Calendar

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

July 10, 2022

  • Form 13H Quarterly Filing for Changes. Filing is for calendar quarter that ended June 30, 2022 and should be submitted within 10 days of quarter end.

July 15, 2022

  • Form PF for Large Liquidity Fund Advisers. Filing is for calendar quarter that ended June 30, 2022.

July 31, 2022

  • ERISA Schedule C of DOL Form 5500 Disclosure.

August 15, 2022

  • Form 13F Quarterly Filing. Filing is for calendar quarter that ended June 30, 2022 and should be submitted within 45 days of quarter end.
  • CTA Form PR. Filing is for calendar quarter that ended June 30, 2022 and should be submitted within 45 days of quarter end.

August 29, 2022

  • Form PF for Large Hedge Fund Advisers. Filing is for calendar quarter that ended June 30, 2022.
  • CPO-PQR Form. Filing is for calendar quarter that ended June 30, 2022 and should be submitted within 60 days of quarter end.

August 31, 2022

  • Deadline to submit Annual FINRA Entitlement Certification for 2022. If not completed, FINRA accounts will be withdrawn.

Consult our complete Compliance Calendar for all 2022 critical dates as you plan your regulatory compliance timeline for the year. 

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

Sincerely,

Karl Cole-Frieman, Bart Mallon, David Rothschild, Scott Kitchens, Alex Yastremski, & Tony Wise

Cole-Frieman & Mallon LLP is an investment management law firm known for providing innovative and collaborative legal solutions to clients with complex financial needs in both the traditional and digital asset spaces. Headquartered in San Francisco, CFM services a wide variety of groups, from start-up investment managers to multi-billion-dollar firms. The firm provides a full suite of legal services including: formation of hedge funds, private equity funds, and venture capital funds; adviser compliance and registration; counterparty documentation; equity financings and token offerings; 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 add us on LinkedIn and visit us at colefrieman.com.

Cole-Frieman & Mallon Announces Promotion of Tony Wise to Partner

San Francisco, Calif. – July 14, 2022: Investment management law firm Cole-Frieman & Mallon LLP (“CFM”) is pleased to announce that Counsel Tony Wise has been promoted to Partner. Mr. Wise joined CFM in 2016 and advises asset managers in fund formation and regulatory matters. Mr. Wise specializes in funds that invest in cryptocurrency and the broader ecosystem, and more recently has focused on digital asset counterparty documentation. Mr. Wise helped Partner Scott Kitchens open CFM’s Denver office in 2019.

“We are proud to advance Tony to the role of Partner. He has undoubtedly earned it,” said Bart Mallon, Co-Managing Partner. “Tony has gained an exceptional standing within the investment industry due to his forward-thinking ability, our clients’ results, and his commitment to helping them achieve their financial business goals.”

“Since joining our firm, Tony has worked diligently on behalf of our clients’ investment interests within the digital asset space. His commitment to the success of our firm is a true value to our team and our clients,” said Co-Managing Partner Karl Cole-Frieman.

Mr. Wise added, “I truly enjoy providing guidance to our asset manager clients and am excited to continue expanding the firm’s digital asset-related legal services.”

About: Cole-Frieman & Mallon LLP is an investment management law firm known for providing innovative and collaborative legal solutions to clients with complex financial needs in both the traditional and digital asset spaces. Headquartered in San Francisco, CFM services a wide variety of groups, from start-up investment managers to multi-billion-dollar firms. The firm provides a full suite of legal services including: formation of hedge funds, private equity funds, and venture capital funds; adviser compliance and registration; counterparty documentation; equity financings and token offerings; 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 add us on LinkedIn and visit us at colefrieman.com.

Press Release

Cole-Frieman & Mallon Further Expands Cryptocurrency and Digital Asset Practice; Hires Alex Yastremski as Partner

San Francisco, June 1, 2022: Cole-Frieman & Mallon LLP (“CFM”), a boutique investment management law firm focusing on the digital asset space, has hired Alex Yastremski as a Partner to lead its Digital Asset Practice. Mr. Yastremski is a digital asset industry veteran with significant experience helping large and small companies with their go-to-market strategies. His practice is focused on start-ups through emerging growth companies, venture capital financings, equity issuances (including Web3 platforms and token launches), and other regulatory matters related to blockchain-related businesses. Prior to joining CFM, Alex served as Co-Chair of the Blockchain and Digital Currency Task Force of a large law firm and was General Counsel of DASAN Zhone Solutions and BitFury Group Ltd.

“We are obviously excited to expand the core CFM investment management practice with the addition of specific digital asset equity and financing practice,” said CFM Co-Founder and Co-Managing Partner Bart Mallon. “Alex has strong and varied experience with private companies, financial sponsors, investors, and entrepreneurs dealing with novel legal issues. His skill set is a perfect match for the needs of many CFM clients.”

Alex’s arrival comes at a time of notable growth for CFM. The CFM team includes over 35 professionals, serving over 1,500 clients and launching over 250 private funds per year, predominately in the digital asset space. The addition of Mr. Yastremski also highlights the expansion of the firm’s corporate and finance capabilities and showcases the growth of the firm.

Karl Cole-Frieman, also a CFM Co-Founder and Co-Managing Partner, added, “We could not be more delighted to have Alex join our many talented professionals. Our pioneering and best-in-class work with non-traditional asset classes, notably our work with cryptocurrency fund managers, continues to be our firm’s core strength.”

About: Cole-Frieman & Mallon LLP is an investment management law firm known for providing innovative and collaborative legal solutions to clients with complex financial needs in both the traditional and digital asset spaces. Headquartered in San Francisco, CFM services a wide variety of groups, from start-up investment managers to multi-billion-dollar firms. The firm provides a full suite of legal services including: formation of hedge funds, private equity funds, and venture capital funds; adviser compliance and registration; counterparty documentation; equity financings and token offerings; 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, focusing on legal issues that impact the hedge fund community. For more information, please add us on LinkedIn and visit us at colefrieman.com.

Press Release

Schedule to Meet with Our Legal Team During Bitcoin 2022

We are thrilled to announce that we are sponsoring the Bitcoin 2022 conference in Miami next week. The team from CFM will be attending the conference and many of the ancillary events and look forward to meeting with clients, friends, service providers, and some of the most critical minds in the digital asset space. 

Karl Cole-Frieman, Bart Mallon, Dave Rothschild, Tony Wise, Malhar Oza, and Dominic Althoff will all be there. 

We welcome you to engage with our team of industry-leading lawyers, so please get in touch with us if you want to catch up or schedule a meeting next week in Miami: https://resources.colefrieman.com/bitcoin2022

Aspect Advisors and C-F&M 2022 IA/BD Compliance Update

We wanted to take this opportunity to thank everyone who attended and participated in our 2022 compliance update hosted by Justin Schleifer, Co-Founder, President (Aspect Advisors), and Bart Mallon, Co-Managing Partner (Cole-Frieman & Mallon). Our discussion on March 3 touched on many essential topics for financial industry professionals to keep top of mind for the upcoming year. 

Some high points included:

Compliance Calendar.

  • Imminent Deadlines & Filings
    • ADV and CRS – March 31
    • Form PF – April 30 (annual filers)
  • Rule Implementation Dates
    • SEC Advertising Rule – November 2022
    • Proposed Private Fund Disclosures – Q2 2023
    • Proposed Cybersecurity Rules – Q2 2023
  • Periodic Tasks
    • Annual review of policies and procedures
    • Business continuity test/review
    • Cybersecurity test
    • Customer/account reviews
    • Employee training
    • Code of ethics surveillance

SEC Marketing Rule Implementation. The new SEC Marketing rules will replace the existing regime of no-action letters and establish clear rules for fund managers. These rules will not fundamentally change the spirit of the current regime and instead clarify specifics on today’s issues such as social media use, blog posts, testimonials, and others. The new rules are not expected to impact the investment management industry significantly. Still, fund managers will need to update policies and procedures and review current advertising materials to ensure compliance with the new rules.

Proposed Private Fund Disclosure Rules. The SEC has proposed new rules for private fund disclosures that seek to improve transparency for types of information that investors receive to aid them in making informed decisions. As it stands, the proposals could profoundly impact private fund operations and the relationship between managers and investors regarding investments. The effects would be felt by large fund managers who receive institutional investments. The institutional investor has the leverage to ask managers for preferential rights and other forms of favorable treatment. The SEC is reviewing proposals, and experts believe that some version of the rules will likely be implemented in 2023.

Proposed Cybersecurity Rules. In recent years, there has been a push from the SEC and other financial regulators to improve cybersecurity, so it comes as no surprise that the SEC has formally proposed a set of rules to govern the matter. Like other policy and procedure requirements, many of the new rules lack specifics, meaning that individual firms will need to determine what they view as necessary to include to maintain compliance.

NFTs. From the past six months, everyone’s favorite buzzword has grown in prominence within the investment management industry following the launch of NFT-exclusive private investment funds. Like other digital assets, the primary concerns for managers are custody and the general compliance of the assets. NFTs have also raised novel valuation questions as experts seek ways to appraise the assets in ways beyond their trading price.

DAOs. The emergence of DAOs as legal entities has raised two critical items to follow in 2022. First, DAOs have sought to create real-world investment products, raising questions about how private fund managers can allow a DAO to invest in the fund. Second, DOAs have inquired about launching their private investment fund products, which presents unique legal and compliance challenges that need to be tackled.

Offshore Exchanges. A popular question from fund managers in the digital asset space regards opening accounts at offshore exchanges legally. To date, there is no easy answer, and attempts to do so must be conducted carefully on a client-by-client basis. There will be instances where opening an offshore exchange account is impossible or cost-prohibitive.

BlockFi’s Settlement. The SEC succeeded in sending shockwaves through the digital asset space after it agreed to a $100 million settlement with BlockFi over BlockFi’s interest product. BlockFi has decided to work with the SEC to register the product. Still, experts are unsure of how this will be done and wonder if this settlement will affect the desire of other market participants to develop new products. Furthermore, this settlement reflects the SEC’s troubling pattern of regulating by enforcement instead of publishing new rules and guidance. It also shines a light on how the SEC views these products as securities and could be the first step in considering specific lending-focused smart contracts to be securities.

Crypto Best Practices. There are essential best practices that fund managers in the digital asset space need to be aware of, especially managers experienced in traditional asset classes:

  1. It is essential to conduct and document diligence on counterparties and vendors. Vendors in the digital asset space are often new and unproven, in contrast to the established vendors of traditional asset classes.
  2. Fund managers must have a reasonable basis for custody providers and custody solutions. Nonetheless, while the SEC views custody of digital assets as being out of the ordinary, they have primarily been receptive to new solutions.
  3. Be aware of the potential to receive MNPI.

Unlike traditional asset classes, there are fewer mechanisms for publishing company information to make it public. It is essential that employees understand the meaning of MNPI and how it impacts their business.

Big Predictions for 2022. Justin predicts that the SEC will bring another significant enforcement action that matches the BlockFi action in scale. The agency wants to further apply traditional securities law to digital assets, which means we could see another large settlement or a case fought in public court to set a precedence within the industry. Bart predicts increased activity from DAOs and potentially a significant breakthrough with DAOs in the next six months.

Regards,

Bart Mallon & Justin Schleifer

Aspect Advisors LLC

Aspect Advisors LLC is modern regulatory consultant providing customized compliance solutions to entrepreneurs. The firm has a focus on fintech companies, broker-dealers, and investment managers (hedge fund, VC, PE, RIA, etc).  We provide compliance and back-office solutions engineered to decrease worry and save time and resources. Among other items, the firm helps clients with regulatory registration, drafting compliance policies and procedures, conducting annual reviews, and other bespoke items.

Cole-Frieman & Mallon LLP

Cole-Frieman & Mallon LLP is one of the top investment management law firms in the United States, known for providing top-tier, innovative, and collaborative legal solutions for complex financial services matters. Headquartered in San Francisco, Cole-Frieman & Mallon LLP 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, venture capital fund, mutual 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 add us on LinkedIn and visit us at colefrieman.com.

Cole-Frieman & Mallon 2021 End of Year Update

Clients, Friends, Associates:

As we near the end of 2021, we have developed a checklist to help managers effectively oversee the business and regulatory landscape for the coming year. We have also highlighted some recent industry updates that we believe may impact our clients. While we strive to present an informative, albeit brief, overview of these topics, we are also available should you have any related questions.

This update includes the following:

  • Annual Compliance & Other Items
  • Annual Fund Matters
  • Annual Management Company Matters
  • Regulatory & Other Items from 2021
  • 2022 Compliance Calendar

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Annual Compliance & Other Items

Annual Privacy Policy Notice. On an annual basis, Securities and Exchange Commission (“SEC”) registered investment advisers (“SEC RIAs”) are required to provide natural person clients with a copy of the firm’s privacy policy if: (i) the SEC RIA has disclosed nonpublic personal information other than in connection with servicing consumer accounts or administering financial products; or (ii) the firm’s privacy policy has changed. The SEC has provided a model form and accompanying instructions for firm privacy policies.

Annual Compliance Review. The Chief Compliance Officer (“CCO”) of a registered investment advisor (“RIA”) must conduct a review of the adviser’s compliance policies and procedures annually. This annual compliance review should be in writing and presented to senior management. CCOs should consider additions, revisions, and updates to the compliance program as may be necessary. We recommend firms discuss the annual review with their outside counsel or compliance firm to obtain guidance about the review process and a template for the assessment. Conversations regarding the annual review may raise sensitive matters, and advisers should ensure that these discussions are protected by attorney-client privilege. 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 their Form ADV within 90 days of the end of their fiscal year. For most managers, the Form ADV amendment will be due on March 31, 2022. 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” and, if applicable, Part 3 (Form CRS: Client Relationship Summary) to each “retail investor” with which the RIA has entered into an investment advisory contract. Note that for SEC-registered advisers to private investment vehicles, a “client” for purposes of this rule refers to the vehicle(s) managed by the adviser and not the underlying investors. State-registered advisers need to examine their states’ regulations to determine who constitutes a “client.” For purposes of the Form ADV Part 3, a “retail investor” means a natural person, or the legal representative of such natural person, who seeks to receive or receives services primarily for personal, family, or household purposes.

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 (June 30, 2022, for most managers), by filing a Form ADV-W. Such managers should consult with legal counsel 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 (June 30, 2022, for most managers, assuming the annual amendment is filed on March 31, 2022).

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, as applicable, generally within 90 days after the filing of the annual amendment (June 30, 2022, for most managers, assuming the annual amendment is filed on March 31, 2022).

Custody Rule Annual Audit.

SEC RIAs. SEC RIAs must comply with specific 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.

SEC RIAs 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 (“GAAP”) by an independent public accountant registered with the Public Company Accounting Oversight Board (“PCAOB”). Audited financial statements must be sent to investors in the fund within 120 days after the fund’s fiscal year-end (or for fund-of-fund clients, within 180 days after fiscal year-end). SEC RIAs should review their internal procedures to ensure compliance with the custody rules.

California RIAs. California-registered investment advisers (“CA RIAs”) that manage pooled investment vehicles and are deemed to have custody of client assets are also subject to independent party surprise examinations. However, CA RIAs can avoid these additional requirements by engaging a PCAOB-registered auditor to prepare and distribute audited financial statements to all beneficial owners of the pooled investment vehicle, and the Commissioner of the California Department of Financial Protection and Innovation (“DFPI”). Those CA RIAs that do not engage an auditor 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.

Other State RIAs. Advisers registered in other states should consult their legal counsel about those states’ specific custody requirements.

California Minimum Net Worth Requirement and Financial Reports.

CA RIAs with Discretion. Every CA RIA (other than those also registered as broker-dealers) that has discretionary authority over client funds or securities, regardless of if they have custody, must maintain a net worth of at least $10,000 (CA RIAs with custody are subject to heightened minimum net worth requirements, discussed further below).

CA RIAs with Custody. Generally, every CA RIA (other than those also registered as broker-dealers) that has custody of client funds or securities must maintain a minimum net worth of $35,000. However, a CA RIA that: (i) is deemed to have custody solely because it acts as the general partner of a limited partnership, or a comparable position for another type of pooled investment vehicle; and (ii) otherwise complies with the California custody rule described above is exempt from the $35,000 minimum (and instead is required to maintain the $10,000 minimum).

Financial Reports. Every CA RIA subject to the above minimum net worth requirements must file certain reports with the DFPI. In addition to annual reports, CA RIAs may be required to file interim reports or reports of financial condition if they fall below certain net worth thresholds.

Annual Re-Certification of CFTC Exemptions. Commodity pool operators (“CPOs”) and commodity trading advisers (“CTAs”) currently relying on certain exemptions from registration with the Commodity Futures Trading Commission (“CFTC”) are required to re-certify their eligibility within 60 days of the calendar year-end. A common example includes the 4.13(a)(3) exemption also known as the “de minimis” exemption. CPOs and CTAs currently relying on relevant exemptions should consult with legal counsel 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 National Futures Association (“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 promptly corrected, and redistributed to pool participants.

Trade Errors. Managers should ensure 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 separately managed accounts) 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 acquiring 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 one of the SEC’s large trader thresholds (generally, 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 a 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 who have at least $150 million in regulatory assets under management (“RAUM”) must file a Form PF. Private advisers with less than $1.5 billion in RAUM must file Form PF annually within 120 days of their fiscal year-end. Private advisers with $1.5 billion or more in RAUM must file Form PF within 60 days of the end of each fiscal quarter.

Form MA. Investment advisers that provide advice on municipal financial products are considered “municipal advisors” by the SEC and must file a Form MA annually, within 90 days of their fiscal year-end.

SEC Form D. Form D filings for most funds need to be amended annually, on or before the anniversary of the most recently filed Form D. Copies of Form D are publicly available on 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 initial and renewal filing 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 13, 2021. Failure to submit electronic payments by the deadline may result in registrations terminating due to a “failure to renew.” If you have not already done so, you should submit full payment into your Renewal Account by E-Bill, check, or wire as soon as possible.

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 certain 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. 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 significantly, so managers should carefully review reporting requirements in the states in which they operate to make sure they comply with the relevant rules.

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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 Financial Industry Regulatory Authority, Inc. (“FINRA”) Rules 5130 and 5131. Most managers reconfirm investor eligibility via negative consent (i.e., investors are informed of their status on file with the manager and are asked to notify the manager of any changes), whereby a failure to respond by any investor operates as consent to its 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, with respect to each class of interests in a pooled investment vehicle.

Wash Sales. Managers should carefully manage wash sales for year-end. Failure to do so could result in 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 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 specified in a fund’s International Swaps and Derivatives Association (“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 2021 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 Internal Revenue Service (“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 investors’ affirmative consent. States may have different rules regarding electronic K-1s, and partnerships should check with their counsel whether they may be required to send hard copy state K-1s. 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. However, if an offering is continuous, delayed or long-lived, issuers must periodically update their factual inquiry through a bring-down of representations, questionnaires, and certifications, negative consent letters, reexamination of public databases or other means, 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 these updates at least annually.

U.S. FATCA. Funds should monitor their compliance with the U.S. Foreign Account Tax Compliance Act (“FATCA”). Generally, U.S. FATCA reports are due to the IRS on March 31, 2022, or September 30, 2022, depending on where the fund is domiciled. However, reports may be required by an earlier date for jurisdictions that are parties to intergovernmental agreements (“IGAs”) with the U.S. Additionally, the U.S. may require that reports be submitted through the appropriate local tax authority in the applicable IGA jurisdiction, rather than the IRS. Given the varying U.S. FATCA requirements applicable to different jurisdictions, managers should review and confirm the specific U.S. FATCA reporting requirements that may apply. As a reminder, 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.

CRS. Funds should also monitor their compliance with the Organisation for Economic Cooperation and Development’s Common Reporting Standard (“CRS”). All “Financial Institutions” in the British Virgin Islands (“BVI”) and the Cayman Islands must register with the respective jurisdiction’s Tax Information Authority and submit various reports with the applicable regulator via the associated online portal. Managers to funds domiciled in other jurisdictions should also confirm whether any CRS reporting will be required in such jurisdictions and the procedures required to enroll and file annual reports. We recommend managers contact their tax advisors to stay on top of the U.S. FATCA and CRS requirements and avoid potential penalties.

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Annual Management Company Matters

Management Company Expenses. Managers who distribute profits annually 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 vital 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 never 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. Because 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. Partnership agreements and operating agreements should be appropriately updated to reflect any such changes.

Insurance. If a manager carries director and officer or other liability insurance, the policy should be reviewed annually 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 necessary.

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 potentially be minimized by structuring the investment manager as a limited partnership. Several steps are available to optimize 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 (“Code”); (v) making a Section 475 election under the Code; and (vi) making charitable contributions. Managers should consult legal and tax professionals to evaluate whether any of these options are appropriate.

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Regulatory & Other Items from 2021

SEC Updates.

SEC Issues Risk Alert on Investment Advisers’ Fee Calculations. The SEC’s Division of Examinations has recently completed a review of 130 SEC-RIAs and published its findings in this November 2021 Risk Alert. The review focused on three key areas: (i) the accuracy of fees charged by investment advisers; (ii) the accuracy and adequacy of investment adviser disclosures; and (iii) the effectiveness of investment advisers’ compliance programs and the accuracy of their books and records. The risk alert notes key mistakes such as the failure to maintain written billing policies and inaccurate financial statements caused by errors in accounting procedures. Though mistakes such as these are not new to the industry, this report provides a reminder to investment advisers to consistently review and improve their policies and disclosures pertaining to client fees.

SEC Proposes Revisions to Electronic Recordkeeping Requirements. The SEC has published proposed amendments to electronic recordkeeping rules applicable to broker-dealers, as well as security-based swap dealers (“SBSDs”) and major security-based swap participants (“MSBSPs”) that are not also registered as broker-dealers (collectively, “SBS Entities”). Currently, broker-dealers, are required to maintain electronic records in a “non-rewritable, non-erasable format” while SBS Entities are not subject this requirement. However, the new proposal provides for an audit trail alternative whereby records may be preserved “in a manner that permits the recreation of an original record if it is lost, over-written or erased.” Under the new rule, SBS Entities without a prudential regulator would also be required to utilize one of the two authorized recordkeeping methods. The proposed amendment, if enacted, would apply only to newly created records and not to records created prior to the amendment. Applicable entities should keep an eye out for the final rule to ensure their electronic recordkeeping policies and procedures are appropriately updated.

SEC Proposes Substantial Reporting and Disclosure of Securities Lending Information. The SEC has published and requested comment on proposed Rule 10c-1 under the Exchange Act. The proposed rule would require all lenders of securities to provide certain information and material terms related to securities lending transactions. The proposal covers loans of any “security” as defined in Section 3(a)(10) of the Exchange Act, applying to both equity and debt securities. The reporting requirements would also apply to “lending agents,” in situations where securities are lent through an intermediary, and any broker dealers acting as “reporting agents” . Certain of the information provided, including, but not limited to, the legal name and legal entity identifier of the issuer, the securities’ ticker symbol, and the date and time the loan was effected, would be made public. Questions remain regarding the scope of the information to be collected, as well as how lending of certain digital assets that are classified as “securities” may be impacted by this proposal. There are various activities that involve the lending of digital assets, such as yield farming, which could be subject to the proposed rule. The SEC has not yet commented on the effect of Rule 10c-1 on digital asset lending, but we will continue to monitor this matter for any updates or related guidance.

New Qualified Client Standard in Effect. As a reminder, the SEC revised dollar thresholds for Qualified Clients went into effect August 16, 2021. The “net worth” threshold increased from $2,100,000 to $2,200,000 and the dollar amount for the “assets-under-management” test was raised from $1,000,000 to $1,100,000. Please refer to our previous update for more information.

SEC Adopts Marketing Rule. As a reminder, the SEC adopted new marketing rules for investment advisers that will drastically overhaul and replace the prior cash solicitation and advertising rules applicable to investment advisers, their marketing materials, and their advertising practices to replace. The compliance period for these new marketing rules begins on November 4, 2022. Please refer to our previous update for more information.

Digital Asset Updates.

The President’s Working Group on Financial Markets Issues Risk Assessment on Stablecoins. An interagency report released on November 1, 2021 outlines the risks that stablecoins pose to the safety and efficiency of the financial market, as well as recommendations for congressional and agency action intended to address such risks. The primary concerns raised are: (i) the loss of value; (ii) payment system risks; and (iii) systemic risks, such as rapid scaling or failures by key participants. The recommendations include requiring stablecoin issuers to be insured as depository institutions, implementation of federal oversight regimes for digital wallet providers, limiting stablecoin issuers’ and digital wallet providers’ ability to affiliate with commercial entities, and limiting their use of users’ transaction data. The report further recommends that federal agencies, including the SEC, CFTC, and the Financial Crimes Enforcement Network (“FinCEN”), use their oversight power where appropriate and that the Financial Stability Oversight Council (“FSOC”) designate certain stablecoin arrangement activities as, or as likely to become, systemically important payment, clearing, and settlement (“PCS”) activities, enabling agencies to establish appropriate risk-management standards for institutions engaging in PCS activities.

The Treasury Issues Reports Addressing Threats Linked to Virtual Currency Transactions and Ransomware Payments. The U.S. Department of the Treasury’s (“Treasury”) Office of Foreign Assets Control (“OFAC”) issued guidance on October 15, 2021 regarding the application of sanctions laws to virtual currency activity and best practices for compliance with such sanctions regulations. OFAC also issued an updated advisory report discouraging private companies and individuals from making ransomware or extortion payments and highlighting risks to companies that facilitate such payments on behalf of the victim, such as the risk of directly or indirectly engaging in a prohibited transaction with individuals or entities on OFAC’s Specifically Designated Nationals and Blocked Persons List. OFAC recommends companies implement sanctions compliance programs to mitigate exposure to related violations, and notes that such programs are taken into consideration in the event of a violation.

South Korea to Introduce 20% Tax on Crypto Trading Profits. As a reminder, South Korea will implement a 20% capital gains tax on Bitcoin (BTC) and cryptocurrency profits starting January 1, 2022.

Offshore Updates.

BVI’s New Data Privacy Law in Effect. A new BVI statute, the Data Protection Act, 2021 (“DPA”) went into effect on July 9, 2021. The DPA applies to all BVI companies, limited partnerships, other entities, such as data controllers and non-BVI entities that use data processing equipment in the BVI or use the BVI for data transmission. The DPA is modeled after the European Union’s General Data Protection Regulation (“GDPR”) and requires an individual or entity’s consent prior to data processing. Additionally, the law requires that data controllers implement data protection safeguards before they transfer personal data out of the BVI. Altogether, the DPA aligns with the international movement towards stringent data privacy laws as governments seek more accountability from companies managing personal data. Managers with BVI funds should consult offshore counsel to ensure compliance with the DPA.

Other Matters.

Treasury Form SHC Due by Owners of Foreign Securities on December 31, 2021. Investment advisers, managers, administrators, and fund sponsors that are involved in master-feeder structures established both inside and outside of the U.S. should report such interests to the Treasury by filing a Form SHC no later than December 31, 2021. This includes a U.S. feeder fund, created by a U.S. investment manager / fund sponsor (“IM / FS”) entity, that holds, as a portfolio investment, interests in a foreign master fund. The portfolio investment by the U.S. feeder fund will need to be reported by the IM / FS as the representative of the U.S. feeder. Conversely, if the IM / FS is a foreign entity, the U.S. feeder fund will need to self-report the ownership interest in the foreign master fund as ownership of foreign equity on the Form SHC. The Treasury provides further directions regarding how to know if you must report ownership of such foreign securities.

European Union Announces Delay of Sustainable Finance Disclosure Regulation (“SFDR”) Rollout. As a reminder, the EU’s SFDR will now be implemented on July 1, 2022, instead of January 1, 2022. The SFDR is a series of disclosure requirements for asset managers intended to increase the transparency of a fund’s sustainability and environmental impact. Please refer to our previous update for more information.

California Lenders’ License Update. As a reminder, the DFPI announced that starting on October 1, 2021 applications under California Financing Law (“CFL”) must be submitted through the Nationwide Multistate System and Registry (“NMLS”). Existing licenses must be transitioned onto NMLS by December 31, 2021. Please refer to our previous update for more information.

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Compliance Calendar

Please note the following important dates as you plan your regulatory compliance timeline for the coming months: 

DeadlineFiling
December 13Deadline for paying annual IARD charges and state renewal fees, through IARD.
December 16Cayman Islands FATCA and CRS reporting deadlines.
December 26Last day to submit form filings via IARD prior to year-end.
December 31Review RAUM to determine 2021 Form PF filing requirement.
December 31Small and mid-sized registered CPOs must submit a pool quarterly report (CPO-PQR).
December 31Cayman funds regulated by CIMA that intend to de-register (i.e. wind down or continue as an exempted fund) should do so before this date to avoid 2022 CIMA fees.
January
11
Amended Form 13H filing due if any information on the previously filed Form 13H became inaccurate during the prior quarter.
January
15
Quarterly Form PF due for large liquidity fund advisers (if applicable).
January
31
“Annex IV” AIFMD filing.
February 16Quarterly Form 13F due.
February 16Annual Form 13H updates due.
March
1
Quarterly Form PF due for larger hedge fund advisers (if applicable).
March
1
Deadline for annual affirmation of CFTC exemptions.
March
31
Deadline to update and file Form ADV Parts 1, 2A &2B.
March
31
Cayman Islands CRS Compliance Form deadline.
PeriodicFund Managers should perform “Bad Actor” certifications annually.
PeriodicForm D and Blue Sky Filings should be current.
PeriodicCPO/CTA Annual Questionnaires must be submitted annually, and promptly upon material information changes, through NFA Annual Questionnaire system.

Please contact us with any questions or for assistance with any of the above topics.

Sincerely,

Karl Cole-Frieman, Bart Mallon, Lilly Palmer, David Rothschild, & Scott Kitchens

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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 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, venture capital fund, mutual 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 add us on LinkedIn and visit us at colefrieman.com.

2022 IARD Renewal

As of November 8, 2021, FINRA issued Preliminary Statements for the 2022 IARD Renewal Program. You should have received an email from FINRA reminding you of the annual renewal fee due in December. The IARD Renewal Program is essentially where FINRA assists with the collection and disbursement of system processing and jurisdiction-related renewal fees. Please note that the renewal fee varies by jurisdiction/registration, but the exact amount will be reflected in your Preliminary Statement in the E-bill tab.

Please note that full payment of registration renewal fees will be due on or before December 13, 2021. You are responsible for logging into your firm’s FINRA account and making this payment, and we are happy to walk you through the process if you have any questions. If the renewal fee is not paid in a timely manner, the firm’s Form ADV will be withdrawn for failure to comply with the fee requirement. If you have any questions or concerns, please feel free to contact us for assistance.