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Cole-Frieman & Mallon 2017 Second Quarter Update

Below is our quarterly update which went out via email today to our firm’s clients and friends.

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August 23, 2017

Clients, Friends, Associates:

We hope you are enjoying the summer. Although the second quarter is typically not as busy as the first quarter from a regulatory/compliance standpoint, we saw many regulatory developments this quarter, as well as a surge in digital asset investment activity. Below is an overview of noteworthy items, as well as what to expect as we move into the third quarter.

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SEC Matters:

Proposed SEC Amendment to Advisers Act for VC and Private Fund Advisors. On May 3, 2017, the SEC proposed a rule to amend the Investment Advisers Act of 1940, as amended (the “Investment Advisers Act”), that would amend the definition of a “venture capital fund” and the definition of “assets under management” with respect to the private fund adviser exemption. For purposes of the exemption for advisers to venture capital funds, small business investment companies (“SBIC”) would be included in the definition of a venture capital fund. This would expand exemption coverage for advisers solely relying on the SBIC adviser’s exemption. Eligible advisers would file as an “exempt reporting adviser,” reducing the extra costs and burdens of recordkeeping required of registered investment advisers. Additionally, with respect to the private fund adviser exemption, currently firms that advise solely private funds and that have less than $150 million of regulatory assets under management are exempt from registration with the SEC. The proposed rule would exclude SBIC assets from the calculation of private fund assets used to determine if the $150 million threshold has been crossed. The SEC closed requests for comment on the proposal on June 8, 2017.

SEC Seeks Input Regarding Department of Labor (“DOL”) Fiduciary Rule. SEC Chairman Jay Clayton issued a statement on June 1, 2017 welcoming public input to help the SEC formulate its assessment of the impact the DOL’s Fiduciary Rule (as discussed further below) may have on investors and entities regulated by the SEC. The statement was released in anticipation of a DOL request for information from the SEC to promote consistency and clarity with respect to implementation of the rule between the two agencies. Interested individuals can respond to SEC questions about the rule’s impact on investment advisers and broker-dealers via email or an online webform. Public submissions remain open and are currently available for review.

SEC Action Against Outsourced CCO.  On August 15, 2017, the SEC reached a settlement with an outsourced CCO and his consulting firm, which offered compliance consulting and outsourced CCO services to investment advisory firms. The outsourced CCO served as CCO for two registered investment advisers (collectively, “Registrants”). The SEC found the Registrants either filed their Form ADV annual amendments late or not at all, and the outsourced CCO relied on estimates provided by the Registrants’ CIO. It was established the AUM and number of advisory accounts reported on the Form ADV were greatly overstated, and the outsourced COO did not confirm the accuracy of the information. The SEC held the outsourced CCO violated the Investment Advisers Act by failing to amend the Form ADV annually and willfully submitting a false statement. The SEC suspended the outsourced CCO from association or affiliation with any investment advisers for one year and ordered him to pay a $30,000 civil penalty. The action indicates that outsourced compliance persons solely relying on internal estimates of AUM and number of advisory contracts, without further confirmation, are at risk of filing false reports and subject to enforcement with the SEC.

CFTC Matters:

CFTC Requests Input to Simplify and Modernize Commission Rules. In response to President Trump’s executive order to reform regulations to stimulate economic growth, the CFTC is requesting public input in an effort to simplify and modernize CFTC rules and make complex CFTC regulations more understandable for the public. Rather than rewrite or repeal existing rules, a primary goal of Project Keep it Simple Stupid (“Project KISS“) is to find simpler means of implementing existing rules. The CFTC will review rules with an ultimate goal of reducing regulatory burdens and costs for industry participants. The solicitation period for comments began on May 3, 2017 and will close on September 30, 2017. Comments can be submitted via the Project KISS portal on the CFTC’s website.

CFTC Approves Amendments to Strengthen Anti-Retaliation Whistleblower Protections. The CFTC unanimously approved new amendments to the “Whistleblower Incentives and Protection” section of the Commodity Exchange Act of 1936, as amended (the “CEA”) on May 22, 2017. The amendments provide for greater anti-retaliation measures against employers who attempt to retaliate against employees that report employer CEA violations. Further, the amendments help clarify the process of determining whistleblower awards. The amendments will become effective July 31, 2017.

CFTC Unanimously Approves Recordkeeping Amendment Requirements. On May 23, 2017, the CFTC unanimously approved amendments to Regulation 1.31 to clarify the rule and modernize the manner and form required for recordkeeping. Specifically, the amendment will allow the manner and form of recordkeeping to be technology-neutral (i.e. not requiring or endorsing any specific record retention system or technology, and not limiting retention to any format). The amendments do not expand or decrease any existing requirements pertaining to regulatory records covered by other CFTC regulations.

Digital Asset Matters:

CoinAlts Fund Symposium.  Cole-Frieman & Mallon LLP is pleased to announce that it is hosting, along with fellow symposium sponsors Arthur Bell CPAs, MG Stover & Co., and Harneys Westwood & Riegels, the CoinAlts Fund Symposium on Thursday, September 14, 2017, in San Francisco. This one-day symposium is for managers, investors and service providers in the cryptocurrency space and discussion points will include cryptocurrency investment, as well as legal and operational issues pertaining to this new asset class. The key-note speaker will be Olaf Carlson-Wee, Founder and CEO of Polychain Capital, and the symposium will include a number of other speakers representing the perspectives of investment management, fund administration, audit and tax, custody of funds, offshore fund formation and compliance. Early bird registration for investors, manager and students ends August 31st.

California Proposes a BitLicense via the Virtual Currency Act. Following in New York’s footsteps with its implementation of a BitLicense to regulate virtual currency activity in New York, California has proposed A.B. 1123 (or the “Virtual Currency Act”), its own version of a BitLicense. If passed, any persons involved in a “virtual currency business” must register with the California Commissioner of Business Oversight (the “Commissioner”). Under the Virtual Currency Act, a “virtual currency business” is defined as maintaining full custody or control of virtual currency in California on behalf of others. The application and registration process includes an extensive review of the business by the Commissioner, maintenance of a minimum capital amount, annual auditing, and an application fee of $5,000 with a $2,500 renewal. Currently aimed at those offering exchanges or wallet services we do not believe digital asset fund managers will need to obtain this licence. More information can be found here.

SEC Grants Review of Initial Rejection of Winklevoss Bitcoin Exchange-Traded Fund. In March, the SEC rejected a proposed rule change to list and trade shares of the Winklevoss Bitcoin Trust as commodity-based trust shares on the Bats BZX Exchange. In the disapproval order, the SEC claimed that the bitcoin market was too unregulated at the time, and the BZX Exchange would therefore lack the capability of entering into necessary surveillance-sharing agreements that are required of current commodity-trust exchange traded products. Bats BZX Exchange filed a petition for review of the disapproval order. The SEC granted the petition in April and has yet to release any further comments. As digital asset trading has increased over the past few months, many are looking at the review of the petition as a potential indicator of future cryptocurrency regulation to come.

SEC Petitioned for Proposed Rules and Regulation of Digital Assets and Blockchain Technology.  A broker-dealer operating an alternative trading system (“ATS”) for unregistered securities, petitioned the SEC for rulemaking regarding guidance on digital assets. The Petitioner argued that some digital assets should be considered securities, and that current regimes in the United Kingdom and Singapore can be modeled domestically to successfully facilitate the issuance and trading of digital assets. The model currently used by those countries is known as a “regulatory sandbox,” in which companies are allowed to operate without significant regulatory interference, so long as they do so within a set of established rules. As of today, the SEC has not responded to the petition, but we expect the frequency of petitions and requests for no-action letters to increase as this space continues to grow.

Other Items:

Department of Labor (“DOL”) ‘Implements’ Fiduciary Rule. On June 9, 2017, the DOL partially implemented its amended fiduciary rule (the “Fiduciary Rule”), which expands the definition of a “fiduciary” subject to important exemptions.  On August 9, 2017 the DOL submitted proposed amendments to these exemptions thereby delaying enforcement; and extending the transition period and uncertainty over the ultimate fate of the fiduciary rule by another eighteen months to July 1, 2019. Managers with questions regarding the applicability of these exemptions should discuss with counsel.

Generally, anyone that makes a “recommendation” as to the value, disposition or management of securities or other investment property for a fee or other compensation, to an employee benefit plan or a tax-favored retirement savings account such as an individual retirement account (“IRA”) (collectively “covered account”) will be deemed to be providing investment advice and, thus, a “fiduciary,” unless an exception applies. Many fund managers and other investment advisers may unintentionally be deemed to be fiduciaries to their retirement investors under the amended rule. Fund managers with investments from covered accounts or that wish to accept contributions from covered accounts will need to consider whether their current business activities and communications with investors could constitute a recommendation, including a suggestion that such investors invest in the fund. Under certain circumstances, fund managers may be deemed fiduciaries.  Notably, the Fiduciary Rule provides an exception for activity that would otherwise violate prohibited transaction rules which is applicable to investments made by plan investors who are represented by a qualified independent fiduciary acting on the investor’s behalf in an arms’ length transaction (typically for larger plans). For clients or investors that do not have an independent fiduciary, managers must evaluate whether they are fiduciaries and what actions must be taken to comply with ERISA’s fiduciary standards or the prohibited transaction rules.  The Fiduciary Rule also contemplates a Best Interest Contract (“BIC”) Exemption, which permits investment advisers to retail retirement investors to continue their current fee practices, including receiving variable compensation, without violating prohibited transactions rules, subject to certain safeguards.

We recommend that investment advisers contact their counsel regarding making any necessary updates to the applicable documents.

MSRB Establishes Continuing Education Requirements for Municipal Advisors. Beginning January 1, 2018, the Municipal Securities Rulemaking Board (“MSRB”) will implement amendments requiring municipal advisors to have a continuing education program in place for “covered persons” and require such persons to participate in continuing education training. The amendment will require an annual analysis to evaluate training needs, develop a written training plan, and implement training in response to the needs evaluated. The amendments also provide for record-keeping of the plans and analysis to promote compliance. Municipal advisors will have until December 31, 2018 to comply with the new requirements. To further clarify the requirements, the MSRB will be hosting an education webinar for municipal advisors on Thursday October 12, 2017, from 3:00 p.m. to 4:00 p.m. EDT.

Full Implementation of MSRB Series 50 Examination. The grace period for municipal advisor representatives and municipal advisor principals that have not passed the Series 50 examination to qualify as a municipal advisor representative or principal will be ending on September 12, 2017. Thereafter, all municipal advisor professionals who either engage in municipal advisory activities or engage in the management or supervision of municipal advisory activities will be required to pass the Series 50. The MSRB has a content outline which specifies eligibility, the structure of the exam, and the regulations to be tested.

Form ADV Technical Amendment Including Wyoming for Mid-Size Advisers. On July 1, 2017, a technical amendment to Form ADV was implemented to reflect a new Wyoming law that now requires investment advisers with $25 million to $100 million in AUM and a principal place of business in Wyoming to register with the state as an investment adviser instead of the SEC. The technical amendment will also appear on Form ADV-W.

Further Updated CRS Guidance Notes. The Cayman Islands Department for International Tax Cooperation (“DITC”) and the Cayman Islands Tax Information Authority (“TIA”) issued further guidance notes on April 13, 2017 for compliance with Automatic Exchange of Information (“AEOI”) obligations. Among some of the more important notes are the following:

  • US FATCA notification and reporting deadlines will now parallel the Common Reporting Standard (“CRS”) deadlines. The notification deadline was June 30, 2017, and the reporting deadline will be July 31, 2017.
  • The deadline for correcting any FATCA report errors for 2014 and for 2015 will be July 31, 2017.
  • CRS reporting must be completed with the CRS XML v1.0 or a manual entry form on the AEOI portal.

We recommend contacting your tax advisors to discuss any potential issues regarding the above updates and deadlines.

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

Deadline – Filing

  • July 15, 2017 – Quarterly Form PF due for large liquidity fund advisers (if applicable).
  • July 30, 2017 – Collect quarterly reports from access persons for their personal securities transactions.
  • August 14, 2017 – Form 13F filing (advisers managing $100 million in 13F Securities).
  • August 29, 2017 – Quarterly Form PF due for large hedge fund advisers (if applicable).
  • September 30, 2017 – Review transactions and assess whether Form 13H needs to be amended.
  • October 2017 – Revised Form ADV 1A goes into effect for advisers filing an initial ADV or an annual updating amendment.
  • October 16, 2017 – Quarterly Form PF due for large liquidity fund advisers (if applicable).
  • November 14, 2017 – Form 13F filing (advisers managing $100 million in 13F Securities).
  • November 29, 2017 – Quarterly Form PF due for large hedge fund advisers (if applicable).
  • Ongoing – Amendment due on or before anniversary date of prior Form D filing(s), or for material changes.
  • Ongoing – Due on or before anniversary date, and promptly when material information changes


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

Sincerely,
Karl Cole-Frieman, Bart Mallon & Lilly Palmer

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

NFA Provides Guidance for CPOs on Performance Fees

Notice to Members I-11-01

As many CFTC registered entities understand, having disclosure documents approved by the NFA can be a lengthy and frustrating process.  While the NFA has done a decent job explaining to firms that disclosure documents must meet all of the requirements under the CFTC’s Part 4 Regulations, it can feel as though the NFA has a target which is constantly moving.  As we explained earlier in a post describing the NFA Changes after the CFTC audit (see also CFTC Report on NFA Registration Process, the CFTC will occasionally communicate to the NFA certain items which the CFTC would like to see emphasized or changed in the disclosure documents.

Recently, the CFTC provided guidance to the NFA with respect to incentive or performance fee arrangements in CTA and CPO  investment programs.  Essentially the CFTC asked the NFA to make sure that all disclosure documents for programs with performance fees include a discussion of the conflicts of interest involved with performance fee arrangements.  Specifically:

[The CFTC] staff’s guidance prescribes that every CPO or CTA that charges a typical incentive fee include in its Disclosure Document a discussion that the incentive fee may encourage a CPO or CTA to take excessive risks to earn an outsized incentive fee, and that such risk-taking may place the interests of the CPO and CTA in conflict with the interests of its clients. Furthermore, [CFTC staff] has indicated that the fact that Regulations 4.24(i) and 4.34(i) require the disclosure of fees and expenses (from which conflicts of interest frequently arise) does not mitigate or lessen the required discussion of conflicts of interest.

Many firms will have already provided this information in the disclosure documents.  For those groups who have not, this means that the disclosure document will need to be amended and reviewed by the NFA according to normal amendment procedures.

The full notice to members is reprinted below and can be found here.

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Notice I-11-01

January 05, 2011

NFA provides guidance for disclosure of conflicts of interests arising from Typical Incentive Fee Arrangements by commodity pool operators and commodity trading advisors

In 1997, the Commodity Futures Trading Commission (CFTC) delegated the review of Disclosure Documents submitted by commodity pool operators (CPO) and commodity trading advisors (CTA) to NFA. The Division levaquin cipro of Clearing and Intermediary Oversight (DCIO) performs periodic oversight of NFA’s implementation of its delegated authority. As part of these reviews, DCIO staff has recently communicated to NFA by letter dated December 2, 2010 its position as to the disclosure of conflicts of interests that arise from typical incentive fee arrangements. NFA is providing the following guidance based upon DCIO’s letter to assist members in complying with the requirements as they relate to the disclosure of conflicts of interests.

CFTC Regulations 4.24(j) and 4.34(j) require CPOs and CTAs to include in their respective Disclosure Documents a “full description of any actual or potential conflicts of interest” regarding “any aspect” of their pools or trading programs as it concerns an enumerated list of entities, including the CPOs and CTAs themselves.

DCIO staff’s guidance relates specifically to the conflicts of interests arising from the collection of incentive fees by CPOs and CTAs. The typical incentive fee collected by a CPO or CTA is usually a fixed percentage of new profits that exceed a pool’s or an account’s previous high-water mark. DCIO stated that from one perspective, the typical incentive fee can be viewed as aligning the interests of the CPOs and CTAs with the interests of their clients as the fee ensures that CPOs and CTAs are compensated in proportion to their clients’ gains, which plainly incentivizes CPOs and CTAs to pursue investment strategies that will seek to maximize returns for their clients. DCIO further states that the typical incentive fee can also be viewed as placing the interests of CPOs and CTAs in conflict with the interests of their clients. From this perspective, the incentive fee could encourage a CPO or CTA to take excessive risks in an attempt to earn an outsized incentive fee. Because the typical fee is generally paid quarterly and is not subject to clawbacks for poor long-term performance, the typical incentive fee can be viewed as an incentive for CPOs and CTAs to take greater short-term risks, which may conflict with their clients’ long-term interests.

DCIO staff’s guidance prescribes that every CPO or CTA that charges a typical incentive fee include in its Disclosure Document a discussion that the incentive fee may encourage a CPO or CTA to take excessive risks to earn an outsized incentive fee, and that such risk-taking may place the interests of the CPO and CTA in conflict with the interests of its clients. Furthermore, DCIO has indicated that the fact that Regulations 4.24(i) and 4.34(i) require the disclosure of fees and expenses (from which conflicts of interest frequently arise) does not mitigate or lessen the required discussion of conflicts of interest.

CPOs and CTAs are encouraged to review their existing Disclosure Documents in light of DCIO’s guidance and make any necessary changes prior to submitting subsequent filings of the document. If you have any questions concerning this notice or Disclosure Documents generally, please contact Mary McHenry, Senior Manager, Compliance (mmchenry@nfa.futures.org or 312-781-1420) or Susan Koprowski, Manager, Compliance (skoprowski@nfa.futures.org or 312-781-1288).

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Other related hedge fund law articles:

Cole-Frieman & Mallon LLP provides comprehensive hedge fund start up and regulatory support for commodity pool operators.  Bart Mallon, Esq. can be reached directly at 415-868-5345.

CTA Expo 2010 | November 3, 2010

Bart Mallon Speaking at Chicago CTA buy anabolic steroids Expo

This year’s Chicago CTA Expo will again be held the same week as the FIA Expo and it will be a day after the NIBA Sales and Marketing Conference.  Bart Mallon of Mallon P.C. will be a speaker at the event.  The full line up of speakers can be found below.

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CTA EXPO 2010, for the first time, had conferences in New York, April 21 and now Chicago, November 3.  CTA EXPO Chicago will continue to focus on the needs of the CTA community.

November 2, 2010

  • 4:30 – 6:00 – Joint NIBA/CTA EXPO Cocktail Party (Sponsored by Telvent DTN)

November 3, 2010

  • 8:00 – 9:00 – Continental Breakfast (Sponsored by DMAXX)
  • 8:45 – 9:00 – Welcoming Remarks (Sponsored by Barclay Hedge Ltd.)
    • Frank Pusateri (Adriondack Portfolio Management, Inc)
    • Bucky Isaacson (Future Funding Consultants)
  • 9:00 – 9:30 – Marketing in Europe (Sponsored by Horizon Cash Management, LLC)
    • Cecilia Mortimore (Credit-Suisse Securities (USA) LLC)
  • 9:30 – 10:00 – Institutional Marketing (Sponsored by Mallon P.C.)
    • Laurie Posner (PNC Capital Advisors)
  • 10:00 – 10:30 – Coffee Break (Sponsored by Firm 58)
  • 10:30 – 11:00Manager Selection and Portfolio Creation at a Fund of Funds (Sponsored by Ruddy Law Office, PLLC)
    • Speaker To Be Confirmed (The Kenmar Group)
  • 11:00 – 12:00Innovations in Investment Products and Marketing Exchange Traded Funds (Sponsored by Michael Coglianese CPA, PC)
    • Tim Pickering (Auspice Capital Advisors Ltd)
  • 11:00 – 12:00 – Product Structuring and Marketing to The Broker Dealer Community (Sponsored by Michael Coglianese CPA, PC)
    • Michael Tannenbaum (Tannenbaum Helpern Syracuse and Hirschtritt)
    • Others: To Be Confirmed
    • Moderator: Mark Omens (CME Group)
  • 12:00 – 12:45 – Lunch (Sponsored by ICE)
  • 12:45 – 1:30 – Keynote Speaker (Sponsored by Dorman Trading)
    • Suk Kim (Samsung Asset Management Company LTD)
  • 1:30 – 2:00Marketing Emerging CTAs (Sponsored by eSignal)
    • Brad Cole (Cole Partners)
  • 2:00 – 2:30Generate a Positive Impact with Your Marketing Materials (Sponsored by TraderView)
    • Kristin Fox (FoxInspires LLC)
  • 2:30 – 3:00 – Coffee Break
  • 3:00 – 3:30 – Internet Social Networking (Sponsored by Arthur Bell, Certified Public Accountants)
    • Bart Mallon (Mallon P.C.)
  • 3:30 – 4:00Internet Publishing and Marketing (Sponsored by CCS Financial Services, Inc.)
    • John Lothian (John Lothian Newsletter)
  • 4:00 – 4:30Managed Futures – Yesterday and Today (Sponsored by Woodfield Fund Administration LLC)
    • Leon and Joy Rose
  • 4:30 – 6:00Cocktail Party

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Other related hedge fund law articles:

Cole-Frieman & Mallon LLP provides CTA registration and compliance services.  Bart Mallon, Esq. can be reached directly at 415-868-5345.

NFA Changes Post CFTC Audit

The results of the CFTC’s audit of the NFA were released a few weeks ago and we have already begun to see a few changes to the way the NFA operates.

Access to BASIC Security Manager

Previously newly formed entities which were registering with the CFTC could start the registration process prior to formally being established.  Now, the NFA must have proof that the entity is in existence prior to granting security manager status.  Accordingly, groups wishing to register must wait until the entity is in existence and then submit the security manager form.  This will usually delay an initial application by about a week. We believe it would be more effective if the NFA made sure that the entity was established prior to submitting a registration application.  Absent such procedures, we believe that the security manager process should be streamlined and that access should be granted next day via email.  There is no good reason to have such a slow process just to access the online registration system.

Client withdrawals from account

Previously it was common for some CTAs to have some sort of lock-up period with respect to a trading program.   Now, the NFA will not allow a CTA to have a lock-up period because the client is always able to go to the FCM and cancel the account.  While from a technical perspective the client always has access to its own account and the CTA can’t control access to the account, many CTAs preferred the implicit protection afforded through the contractual agreement that the account would stay open during the lock-up.   By not allowing the lock-up language, CTAs will potentially be subject to greater and more frequent withdrawals from investors.

Revising Disclosure Documents

Many NFA Member firms will find out about the various new NFA procedures during the disclosure document revision process.  Moving forward, various deficiencies with disclosure documents that have been approved by the NFA in the past will need to be fixed (even though the documents were previously approved) as the managers revise the documents and seek instant filing or regular filing.

Please let us know if you have experienced any other changes with the NFA.

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Other related hedge fund law articles:

Cole-Frieman & Mallon LLP provides comprehensive hedge fund start up and regulatory support for commodity pool operators.  Bart Mallon, Esq. can be reached directly at 415-868-5345.

CFTC Issues Report on NFA Registration Process

Report Indicates Many Areas Needing Improvement

The CFTC registration process is handled almost exclusively by the NFA and last year the CFTC audited the NFA to see how successful the organization was at conducting the registration process.  The audit report, issued this week, indicates that the NFA needs to improve on many different areas.  One of the most important items which was mentioned a number of times in the report is that the NFA has not standardized the registration process in some areas.

While the CFTC report focuses only on the registration process, there are a number of other issues with the NFA which should have been highlighted.  The first and most important for many managed futures professionals, is the lack of standardization with respect to the disclosure document review process.  CTAs and CPOs both need to have their disclosure documents reviewed by the NFA and during this review process, depending on which examiner is assigned to the review, the process can be relatively straight-forward or quite difficult.  This obviously increases the time before the disclosure document is approved and most likely increases the legal costs involved.  Because our firm completes a number of CTA and CPO registrations each month we see this first hand.

As an anecdote, I have one CPO group who has two separate programs represented by two separate disclosure documents.  The documents are exactly the same except for slightly different investment programs.  These documents went to the NFA for review at the same time and were assigned to two different examiners.  Each deficiency letter came back with about 16 items that needed to be changed for the next draft – however, only 5 were the same!  The fact that two almost exactly same documents receive such disparate treatment is amazing and shows no standardization.  It also perfectly illustrates the oft said statement that “it depends on who you get” when discussing how long it will take for the disclosure documents to be approved.

Below I have included some of the statements I found in the report as well as the CFTC notice.

CFTC Notice: Press Release

The full report: CFTC Report on NFA Registration Process

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Quotes from the Report

The Registration Department does not have a procedures manual that documents all of the procedures followed in processing registrations and withdrawals.

The Registration Department’s procedures manual for the Information Center is, in various areas, incomplete, inconsistent and/or outdated.

[T]he Registration Department tends to concentrate responsibility in a small number of staff members and to depend heavily on these staff members’ institutional knowledge in executing certain registration processing procedures. … This reliance on key persons’ institutional knowledge, coupled with the sparseness of the Registration Department’s documented procedures … interjects an unnecessary level of key person risk to the Registration Department.

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June 24, 2010

CFTC Releases Report on the Registration Program of the NFA

Washington, DC – The Commodity Futures Trading Commission (CFTC) Division of Clearing and Intermediary Oversight (Division) today notified the National Futures Association (NFA) of the results of the Division’s “Report on the Registration Program of the NFA”. In the Report, the Division assessed whether the NFA has sufficient procedures to execute the Commission’s delegated registration and fitness functions.

The Division found that NFA has sufficient procedures to execute the Commission’s delegated functions with respect to the vast majority of registrants. However, the Division also identified nine areas in which the Commission’s and/or NFA’s procedures must be improved.

Copies of the Report are available the Commission’s website at www.cftc.gov.
Last Updated: June 24, 2010

Media Contacts

Scott Schneider
202-418-5174

R. David Gary
202-418-5085

Office of Public Affairs

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Other related hedge fund law articles:

Cole-Frieman & Mallon LLP provides comprehensive hedge fund start up and regulatory support for commodity pool operators.  Bart Mallon, Esq. can be reached directly at 415-868-5345.

NFA Announces Effective Date of New CPO Reporting Rule 2-46

First CPO Quarterly Report Due May 17, 2010

As we recently discussed in an earlier article on NFA Compliance Rule 2-46, the NFA has adopted a new compliance rule which will require commodity pool operators to provide certain information to the NFA on a quarterly basis.  In general CPOs will need to provide the NFA with the following information about their pool: the names of certain service providers/ counterparties, change in NAV over the quarter, monthly ROR for the fund, and information on large investments (greater than 10% of the fund’s NAV).

The NFA will be holding a webinar so that members can see how to complete the quarterly filing through the EasyFile system.

The announcement is reprinted in full below and can be found here.

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Notice I-10-10

March 17, 2010

Effective Date of NFA Compliance Rule 2-46: CPO Quarterly Reporting Requirements

NFA Compliance Rule 2-46: CPO Quarterly Reporting Requirements will become effective on March 31, 2010. Rule 2-46 requires each CPO Member to report on a quarterly basis to NFA specific information on certain pools that it operates within 45 days after the end of each quarterly reporting period. The CPO must provide the information for each pool that it operates that has a reporting requirement under CFTC regulation 4.22 (which includes exempt pools under CFTC Regulation 4.7). Using a new web-based system that was specifically designed for this rule, the CPO must enter the following information:

(a) the identity of the pool’s administrator, carry broker(s), trading manager(s) and custodian(s);

(b) a statement of changes in net asset value for the quarterly reporting period;

(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.

The first quarterly report will be due by May 17, 2010 for the quarter ended March 31, 2010 and must be filed electronically using NFA’s EasyFile System. In order to ensure that CPO Members understand the new requirements, NFA will host a webinar on April 13, 2010 at 12:00 p.m. (Eastern Time), which will outline the new reporting requirements and how to file using the new system. Click here to register for the webinar. NFA staff will also provide detailed information on the new requirements and filing instructions at NFA’s CPO/CTA Regulatory Seminar being held on April 22, 2010 in New York. Click here to register for the seminar.

More information about NFA Compliance Rule 2-46 can be found in NFA’s August 25, 2009 Submission Letter to the CFTC. Questions concerning the reporting requirements should be directed to Tracey Hunt, Senior Manager, Compliance (thunt@nfa.futures.org or 312-781-1284) or Mary McHenry, Senior Manager, Compliance (mmchenry@nfa.futures.org or 312-781-1420).

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Other related hedge fund law blog posts include:

Cole-Friman & Mallon LLP can provide CPOs with comprehensive support during the filing process.  Bart Mallon, Esq. can be reached directly at 415-868-5345.

CFTC Regulation 4.8 for Commodity Pool Operators

CFTC Regulation 4.8 (“Rule 4.8”) is a little known regulation which allows CPOs to distribute disclosure documents and accept investor money prior to the NFA’s approval of the CPO’s disclosure document.  In order to take advantage of Rule 4.8, the CPO must make sure that pool interests are only offered or sold to accredited investors, in a Regulation D 506 offering.  The CPO will also need to initially file the disclosure document with the NFA prior to distribution to potential investors.  Rule 4.8 also applies to managers using the 4.12(b) exemption (futures/commodities trading is solely incidental to securities trading and margin does not exceed 10% of pool’s NAV).

Rule 4.8 should be used sparingly, if ever.  Managers should note that if Rule 4.8 is used prior to approval of the disclosure document the NFA will require the manager to provide investors in the fund with the approved disclosure document and an overview of the revisions which were made.  This creates a potentially awkward situation for both the manager and the investor and may, under certain circumstance, provide the investor with a right of rescission.  As with all maters in the securities industry, it is vital for a manager to provide the investor with all material information and the manager may not make any material omissions.

The full rule is reprinted below and can be found here.

Note: please see disclaimer.  Mallon P.C. is not providing legal advice through this post.

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§ 4.8   Exemption from certain requirements of rule 4.26 with respect to pools offered or sold in certain offerings exempt from registration under the Securities Act.

(a) Notwithstanding paragraph (d) of §4.26 and subject to the conditions specified herein, the registered commodity pool operator of a pool offered or sold solely to “accredited investors” as defined in 17 CFR 230.501 in an offering exempt from the registration requirements of the Securities Act of 1933 pursuant to Rule 505 or 506 of Regulation D, 17 CFR 230.505 or 230.506, may solicit, accept and receive funds, securities and other property from prospective participants in that pool upon filing with the National Futures Association and providing to such participants the Disclosure Document for the pool.

(b) Notwithstanding paragraph (d) of §4.26 and subject to the conditions specified herein, the registered commodity pool operator of a pool offered or sold in an offering exempt from the registration requirements of the Securities Act of 1933 pursuant to Rule 505 or 506 of Regulation D, 17 CFR 230.505 or 230.506, that is operated in compliance with, and has filed the notice required by §4.12(b) may solicit, accept and receive funds, securities and other property from prospective participants in that pool upon filing with the National Futures Association and providing to such participants the Disclosure Document for the pool.

(c) The relief provided under §4.8 is not available if an enforcement proceeding brought by the Commission under the Act or the regulations is pending against the commodity pool operator or any of its principals or if the commodity pool operator or any of its principals is subject to any statutory disqualification under §§8a(2) or 8a(3) of the Act.

[57 FR 34865, Aug. 7, 1992; 57 FR 41173, Sept. 9, 1992, as amended at 60 FR 38182, July 25, 1995; 72 FR 1662, Jan. 16, 2007]

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Other related hedge fund law blog posts include:

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

New Forex Regulations: Overview of Public Comments

Leverage, Inaccessibility for Smaller Traders, and Offshore Threat are Focus of Public Comments

As we’ve discussed in related posts, the CFTC has proposed rules regulating the off-exchange spot forex industry (see Retail FOREX Registration Regulations Proposed).  The CFTC has requested comments from the public and there are currently about 100 public comments on CFTC’s website written in response to the new rule. The comments mainly focus on:

  • Leverage reduction rule (approx. 75/100 comments)
  • Forex industry becoming inaccessible to smaller traders (approx. 35/100 comments)
  • Threat of investors moving their money to offshore firms (approx. 25/100 comments)
  • Opposition to government interference/regulation (approx. 20/100 comments)

[Note: over the weekend the CFTC published some of the backlog of comments it received.  Much of this article was written prior to review of these extra comments (which total approximately 3,663).  We will provide an update on such comments in the future.]

To view all of the comments, click here.

The following is our summary of the comments which have been made thus far.

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Leverage Reduction

Approximately 75 of the 100 comments mention a strong or very strong opposition to the new leverage proposal of 10:1. The issue with a reduction of leverage to 10:1 is that investors will have to invest much more money in order to trade what they can currently trade with less capital. Comments regarding leverage include phrases like “strongly object”, “terrible idea”, “unintelligent”, and “strongly oppose”.  The majority opinion is that people should have the freedom and the choice to trade with a higher amount of leverage, and that the federal government’s attempts to lower leverage to 10:1 are “unnecessary” and “intrusive”. John Yeatman Jr. writes,

Please DO NOT reduce leverage in US Forex trading to 10:1…THIS WOULD HAVE A MAJOR IMPACT ON TENS OF THOUSANDS OF TRADERS AND THEIR FAMILIES WHO RELY ON 100:1 LEVERAGE AVAILABILITY TO SUPPORT THEIR FAMILY AND THIS ECONOMY. Please do your part in helping to keep this country great and it’s [sic] freedoms true BY NOT ALLOWING ANYTHING LESS THAN 100:1.

Other comments regarding the leverage proposal include:

  • … strongly objects to new leverage of 10:1
  • … proposed reduction not consistent with futures, which allow a significantly higher leverage
  • … virtually no flexibility trading at 10:1 leverage unless trader has gigantic account balance
  • …reduction in leverage not fair to public…bad for America
  • … new leverage line “out of line with general idea of protecting consumers”
  • …limiting leverage to 10:1 is “a bad idea”
  • …current leverage limit is “more than enough”
  • … CFTC is “unintelligent” to change leverage to 10:1
  • … terrible idea to lower leverage
  • … leverage change is “perversion of the free markets”
  • …leverage restriction “grave injustice” for many who work to secure the American dream of prosperity for themselves and families
  • …leverage limits would delay achievement of financial independence
  • …leverage not dangerous; misuse is
  • …leverage decrease will kill forex business and worsen economic situation in states and worldwide
  • …amount of leverage needs to be at discretion of investors

Smaller Traders

Another argument is that lower leverage will making trading inaccessible for smaller traders but leave the door wide open for larger institutions, since lower leverage requires higher margin (meaning that more money needed to be invested in order to trade). Comments regarding this proposed rules potential affect on smaller traders include:

  • …will stamp out small-time investor
  • …drive smaller guys out of market or offshore
  • …anything lower would be insane for small-time traders
  • …gets rid of investors with small capital so rich can stay rich and poor can stay poor
  • …pushes out small-time investor
  • …denies small trader opportunity
  • …disparate and unintended impact on small traders with lower capital
  • …leave the small, independent traders alone
  • …small businesses are heart of US economy
  • …all small-scale actors will be stifled
  • …10:1 leverage will have unintended consequence of locking out hundreds or thousands of small traders
  • …quit treating the small guy like an idiot
  • …are you trying to allow only rich to trade forex?

Government Interference/Regulation

Many of the comments suggest anger with the government for interfering too much with the forex industry. Michael Thomas writes,

I do not live here in this “free” society to have someone from the government babysitting me. The message that your proposed rules send is that 1) we are not free to make our own choices. 2) The federal government believes that we the general public are too stupid to make decisions for ourselves….I don’t need you, or do I want you getting in the way of my being able to trade as I wish in the United States of America.

Other comments regarding an opposition to increased government interference include:

  • …don’t add more government
  • …not intention of our ancestors to create government which controlled/regulated all aspects of citizens’ lives
  • …the government has no right to control my ability to make profit
  • …unnecessary for Federal government to regulate against individual’s ability to take risks
  • …don’t need government protection; we’re adult traders
  • …not responsibility of government to take away choice from consumers
  • …”big brother” attempt to protect people from “evil” traders and forex hedge funds
  • …stay out of trying to run my personal life

Offshore Threat

In at least 25 of the comments, the public is arguing that the new rules, specifically lower leverage, will drive traders offshore to overseas brokers who may or may not be regulated. Further, a major argument is that the forex industry in the United States will essentially cease altogether as a result of traders moving their forex activities offshore. Comments regarding this offshore threat include:

  • …will send business to London and unregulated offshore markets
  • …consumers will take accounts offshore
  • …will drive smaller guys out of markets entirely or to offshore, unregulated brokers
  • …when traders move accounts offshore, CFTC and NFA will have no control of clients’ trading
  • …I’ve already moved my account offshore
  • …people will do business with offshore brokers

Government Regulation

In terms of the new regulation proposal as a whole, some people support more industry regulation while others are against the idea entirely. Bradford Smith writes,

I feel that regulation of firms is needed…regulation is needed to help people understand the risks such as risk disclosure. [Regulating] the  retail forex market in a similar fashion to how commodities and futures are regulated is a good idea. Stopping companies from trading against their clients is a high priority issue that needs to be stopped.

John M. Bland, on the other hand, who views the proposal as “unfair”,  writes,

…the CFTC has done a lot in recent years to correct many of the problems in the industry…this decision is unfair and anti-competitive.

Other comments regarding opposition to the proposal and/or government interference include:

  • …new rules will destroy US financial firms business and lead to loss of thousands of jobs during the worst economy in decades
  • …regulation should be aimed at encouraging economic growth and innovation vs. restricting it
  • …against proposal
  • …how did forex regulation get in the Farm Bill?
  • …whoever initiated proposal has no knowledge of forex…this rule is utter nonsense…rules for forex in the USA are already quite strict
  • …you are busybody bureaucrats with intrusive minds…you are interested in only one thing: bureaucratic power and complete control of every microscopic aspect of life…you are monsters
  • …rules will harm people who make an honest living trading currency
  • …important to educate and inform, not regulate and ban
  • …proposal is a disaster-in-warning for traders
  • …if it ain’t broke, don’t fix it
  • …proposal is lunacy-communist-legislation
  • …I do not support the proposal…proposal closes doors for forex investors and will make forex market accessible to financial institutions only
  • …vehemently against new, narrow-sighted legislation

Agreement/Disagreement with Proposal

Many of the comments discuss that education about forex and trading risk is the best solution. On a similar note, many traders expressed the fact that anyone who trades in the forex market is aware of the inherent risks, so people who decide to trade are willing to take these risks. There is a general consensus that it is the individual’s, and not the government’s, responsibility to evaluate the level of risk that s/he is willing to take. Remember, higher leverage will be reflected in both your profits and your losses. Thus, if you have high leverage and profit, you will profit a lot more than if your trading had not been leveraged. But the same goes for losses; if you lose, you will lose a lot more based on the higher leverage.

Conclusions Thus Far

The biggest concern thus far is the proposed reduction in leverage to 10:1. Almost every comment mentioned a strong opposition to this rule. Furthermore, most people seem to be concerned that the new regulations will significantly decrease forex activity in the US—if not kill it off—and drive most investors overseas to offshore firms. We will continue to monitor comments received until the March 22 due date. Please leave us a comment below with your feedback. Should you feel inclined, you may submit your own comment to the CFTC through the methods listed above.

To view CFTC’s proposed rules, click here.

How to Comment

Comments must be received by March 22, 2010 and can be submitted the following ways:

  • Through the Federal eRulemaking Portal: http://www.regulations.gov/search/index.jsp. Follow the instructions for submitting comments.
  • By e-mail: secretary@cftc.gov. Include “Regulation of Retail Forex” in the subject line of the message.
  • By fax: (202) 418-5521.
  • By mail: Send to David Stawick, Secretary, Commodity Futures Trading Commission, 1155 21st Street, NW., Washington, DC 20581.
  • Courier: Same as Mail above.

(Note that all comments received will be posted without change to http://www.cftc.gov, including any personal information provided.)

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Other related CFTC articles include:

Bart Mallon, Esq. of Cole-Frieman & Mallon LLP runs the Hedge Fund Law Blog and provides forex registration services to forex managers. Mr. Mallon also runs the Forex Law Blog.  He can be reached directly at 415-868-5345.

CPO Annual Financial Report Filing

Information on Filing Annual Report with NFA

Commodity Pool Operators (“CPOs”) are required to distribute an Annual Report, certified by an independent public accountant, to each participant in each pool it operates (i.e. the investors in the commodity/futures hedge fund) within 90 days after the pool’s fiscal year-end (normally December 31).  CPOs are also required under the Commodity Exchange Act and commission regulations to file this report electronically with the National Futures Association (“NFA”) through the NFA’s EasyFile system.  Alternate due dates exist for pools that are operated as a “fund of funds“.  CPOs can monitor their filings and review their due dates for each pool in the EasyFile system.  We have included an overview of the requirements and process below and Cole-Frieman & Mallon LLP would be able to help CPOs to make this filing as well.

Filing Overview

  • Who – all CPOs must file the annual financial report unless they are exempt under the CFTC Regulation 4.13.
  • What – a certified financial statement (PDF of the exact statement distributed to the pools limited partners) from an auditor needs to be filed with the NFA.  (Please note that CPOs who are exempt under the CFTC Regulation 4.7 does not need to have their statements audited.)
  • When – commodity pool annual reports must be distributed to pool participants and filed with the NFA within 90 calendar days of the pool’s fiscal year end.  (Mallon P.C. can also check the due date by logging into the EasyFile system on the Filing Index page.)
  • How – CPOs must submit annual reports to NFA electronically in accordance with NFA’s EasyFile electronic filing system and procedures.

NFA EasyFile System

Pool operators should have their NFA login and password to access the EasyFile system.  Submitting pool financial statements using EasyFile involves a three step process:

  1. The CPO (or compliance group) will upload a PDF of the identical pool financial statement provided to the pool’s limited partners, including the balance sheet, income statement, schedule of investments, footnotes, and the Independent Auditor’s Opinion, if applicable.
  2. The CPO (or compliance group) will then enter approximately 30 key financial balances into an electronic schedule. These balances will be pulled directly from the balance sheet, income statement and statement of changes in net asset value included in the pool’s PDF filing.
  3. The CPO (or compliance group) will finally submit the electronic filing, the system will run some basic edit checks. It will also prompt the CPO to read and agree to an electronic oath or affirmation. This oath or affirmation will apply to the information included in the PDF, as well as, the information entered into the schedule of key financial balances.

A common pitfall with this process include miscalculations with the key financial balances. In order to prevent this from occurring, the CPO should make sure the values/balances input into the system correspond with the PDF certified financial statement.  After submission, the CPO should ensure the updated status of the filing becomes “Received” by logging into Pool Index page the in the EasyFile system.  This status should show up within a few days after the filing has been submitted.

Conclusion

In addition to the various yearly compliance measures, such as the NFA Self-Examination Checklist, CPOs should be aware that they need to file their audited reports with the NFA.  This is especially important because the NFA has fined large firms for failing to file on time (see previous NFA Action).  If you need help with filing your annual financials, please contact Cole-Frieman & Mallon LLP for further information on our commodities and futures compliance services.

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Other related NFA compliance articles include:

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

CFTC Provides Annual Guidance to CPOs

Annual Report Guidance for Commodity Pool Operators

In a recent release, which we have reprinted in full below, the CFTC reminds CPOs of their annual reporting requirements under Regulation 4.22.  The release includes a link to the 2010 CPO Annual Guidance Letter.  In general the letter provides another reminder to CPOs to file their annual reports with the NFA and provide a copy to the investors in the pool.  I have outlined below the major parts of the letter.

General Issues to consider

  • Commodity pool annual reports must be distributed to pool participants within 90 calendar days of the pool’s fiscal year end.  For most funds this means by March 31, 2010.
  • Commodity pool annual reports must be filed with the NFA within 90 clendar days of the pool’s fiscal year end.  For most funds this means by March 31, 2010.
  • All documents must be filed electronically through the NFA’s filing system.
  • Extensions are available in certain circumstances.

Other Issues

For groups which have different or more complex structures, additional considerations need to be addressed.  Such groups include:

  • Master/feeder commodity pool structures
  • Commodity pool fund of funds
  • Offshore commodity pools
  • CPOs claiming an exemption under Regulation 4.13
  • Reports of commodity pools which are liquidating
  • Commodity pools established as a series structure (such as a series LLC)
  • Commodity pools which invest in non-exchange traded instruments may have additional issues

Moreover, the letter includes references to the recently amended CPO relations.

If a CPO will not be able to file on time, the CPO should file for an extension.  “Automatic” extensions can be granted to CPOs to fund of fund structures.  If you have questions with making a filing, please feel free to contact Cole-Frieman & Mallon LLP. The following press release can be found here.

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CFTC’s Division of Clearing and Intermediary Oversight Provides Annual Report Guidance to Commodity Pool Operators

Washington, DC — The Commodity Futures Trading Commission’s Division of Clearing and Intermediary Oversight has issued its annual guidance letter to registered commodity pool operators (CPOs). The letter is intended to assist CPOs and their public accountants in complying with the Commission’s regulations on the preparation and filing of commodity pool annual financial reports.

The highlights contained in this year’s letter include:

  • Recent amendments to Commission regulations pertaining to various reporting issues;
  • Annual report filing procedures and due dates;
  • Special considerations that apply to filings made for Master/Feeder and Fund of Funds structures;
  • Use of International Financial Reporting Standards in lieu of U.S. generally accepted accounting principles;
  • Reporting requirements for pools in liquidation;
  • Reporting requirements for series funds with limitation of liability among the different series; and
  • Various accounting developments that may impact report preparation.

For more information on CPO Annual Guidance Letter 2009, please see the Related Documents link.

Copies of the letter also may be obtained by contacting the Commission’s Office of the Secretariat, Three Lafayette Centre, 1155 21st Street, N.W., Washington, D.C. 20581, (202) 418-5100.

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Other related compliance articles for CPOs and CTAs include:

Bart Mallon, Esq. runs the Hedge Fund Law Blog.  He can be reached directly at 415-868-5345.