Tag Archives: Quarterly Update

Cole-Frieman & Mallon 2020 Q3 Update

October 16, 2020

Clients, Friends, Associates:

We hope you have had an enjoyable summer. While the third quarter is typically quieter than the second quarter from a compliance perspective, we continue to see meaningful enforcement actions pursued by regulatory authorities. As we move into the fourth quarter, we want to provide an overview of items we hope will help you stay up to date with regulatory requirements.

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SEC Matters

SEC Expands the “Accredited Investor” and “Qualified Institutional Buyer” Definitions. On August 26, 2020, the Securities and Exchange Commission (“SEC”) adopted amendments to the “accredited investor” definition under Rule 501(a) of Regulation D under the Securities Act of 1933, as amended (the “Securities Act”), which include additional categories of natural persons or entities who may qualify as accredited investors. Notably, certain of the new categories will enable natural persons to qualify as accredited investors on the basis that they have the requisite ability to assess an investment opportunity based on measures of professional knowledge, experience or certifications, irrespective of whether these persons meet any income or net worth thresholds. The SEC also amended the “qualified institutional buyer” definition under Rule 144A of the Securities Act to include institutional investors contained in the accredited investor definition so long as they meet the $100 million in securities owned and invested threshold. The amendments were published in the Federal Register on October 9, 2020 and will become effective within 60 days after such publication (i.e., December 8, 2020). Managers should review their fund documents to determine which documents will need to be updated to include the amendments to the accredited investor definition. Our recent blog post addresses FAQs we have received on the updated definition.

Private Funds Risk Alert. The SEC’s Office of Compliance Inspections and Examinations (“OCIE”) published a Risk Alert identifying commonly observed key deficiencies in OCIE’s examinations of advisers to private funds. Notably, OCIE found investors in private funds may have paid more in fees and expenses as a result of these deficiencies, which included inaccurate allocations of fees and expenses, failures to value client assets in accordance with valuation policies and failures to track, apply and/or calculate fees received from portfolio companies (whether or not such fees were used to offset management fees received by the adviser). OCIE also highlighted inadequate conflicts of interest disclosures, finding that many advisers did not provide investors with sufficient detail regarding conflicts related to allocation of investments among the adviser’s clients and conflicts related to investments in the same portfolio company made by multiple clients of an adviser and co-investments. Managers should review their allocation policies as well as disclosures regarding potential allocations of investments among clients to ensure that adequate and clear disclosures are included. 

Reg BI FAQ Updated with Guidance for Broker-Dealers When Using “Adviser/Advisor”. In response to confusion raised by broker-dealers, the SEC has indicated in a handful of recent updates to its FAQs regarding Regulation Best Interest (Reg BI) that a broker-dealer generally may not use the term “adviser” or “advisor” to refer to itself unless it is registered as an investment adviser (an “RIA”), subject to certain limited exceptions. The SEC’s responses included examples of common situations when broker-dealers typically may refer to themselves as “advisers” or “advisors” when not so registered, including when such broker-dealer is acting in a role defined by statute such as a municipal advisor or commodity trading advisor. Reg BI’s disclosure obligation requires in-scope broker-dealers and investment advisers to disclose to retail customers all material facts relating to the nature and terms of the relationship between them as well as all material facts relating to conflicts of interest that are associated with the recommendation. As discussed in our previous update, compliance with Reg BI was required as of June 30, 2020. Given the nascence of the Reg BI requirements we expect the SEC to continue updating the Reg BI FAQs to address other common confusion or Reg BI deficiencies identified in examinations of investment advisers and broker-dealers.

SEC Charges CA Adviser for Misappropriating Client Funds. In a recent enforcement action, the SEC charged a California adviser with violating the antifraud provisions of the Securities Exchange Act of 1934, as amended, the Securities Act and the Investment Advisers Act of 1940, as amended (the “Advisers Act”). The SEC alleges that during the adviser’s association with other SEC-registered firms, the adviser acted alone and through his company to misappropriate client funds (including the sale of client securities and diverting the proceeds for his use) and make other material misrepresentations and omissions. The SEC’s complaint further alleges that the adviser actively took steps to conceal his misconduct from existing and future advisory clients, including forging a letter from his client indicating that the client had gifted him the misappropriated funds. The adviser further failed to disclose to prospective clients that his affiliation with one of the SEC-registered firms had been terminated for stealing client funds. While the alleged conduct is particularly egregious, this action serves as a reminder that investment advisers owe their advisory clients a fiduciary duty to place the clients’ interest ahead of their own and to disclose all material facts to the clients about their investment. 

SEC Charges Fund Adviser with Antifraud Violations. The SEC was granted emergency relief to stop an RIA (and its sole individual owner) from continuing to offer interests in a private fund it managed and destroying documents which may contain evidence of fraudulent conduct. In soliciting investors for the fund, the SEC alleges that the RIA not only misrepresented the fund’s past performance, the amount of assets managed and the owner’s experience as a portfolio manager, but also falsified brokerage records and investor account statements, and sent fake audit opinions to investors and third parties. As an example of the fraudulent conduct, the SEC’s complaint alleges that a document provided to the fund’s investors and potential investors showed 37 months of positive monthly performance when the fund actually had approximately 26 months of negative monthly performance during the applicable time period. The SEC charged the RIA and its owner with violating the antifraud provisions of federal securities laws and charged the individual owner with aiding and abetting the RIA’s violations of the Advisers Act. The SEC is seeking injunctions, disgorgement of allegedly ill-gotten gains with prejudgment interest and financial penalties.

SEC Brings Action Against Manager for Expense Disclosure and Allocation Failures. In a recent enforcement action demonstrating the SEC’s continued scrutiny of the adequacy of fund managers’ expense disclosures and expense allocation procedures, the SEC censured a Florida-based RIA for failing to properly disclose and allocate to the applicable funds the expenses of “third party tasks” performed by the RIA “in-house.” The SEC cited the firm for failing to properly allocate these expenses between the applicable funds and co-investment vehicles managed alongside the funds, resulting in the funds being charged more than their pro rata share of the costs and expenses of reimbursing the firm for the third party tasks. In violation of the Advisers Act, the SEC found that the firm failed to adopt any written policies and procedures reasonably designed to properly disclose, calculate and allocate such that third party task expenses. Managers should review their fund documents and consider whether they sufficiently disclose expenses borne by the applicable fund as well as whether the manager has adequate policies and procedures in place regarding allocating expenses between the applicable fund and other funds or clients of the manager.

SEC Charges NY Firm and CCO for Compliance Failures. The SEC recently censured a dually-registered investment adviser and broker-dealer firm and its chief compliance officer (“CCO”) for failing to adhere to written policies and procedures implemented to remedy deficiencies discovered in a previous examination of the firm’s compliance program. The SEC further found that the CCO not only failed to conduct the monthly compliance reviews required under the program, but also altered monthly review documents that were provided to the SEC in a subsequent examination to give the appearance that the reviews had been conducted during the period covered by the SEC’s examination. To settle the charges, the firm and CCO paid a penalty of $1,745,000 and agreed to cease and desist from committing future violations of the antifraud provisions of the Advisers Act. The CCO was also barred from associating with any broker-dealer or investment adviser, subject to a right to reapply for association in the future, and prohibited from serving or acting as an employee or similar of an advisory board, investment adviser or depositor of, or principal underwriter for, a registered investment company, or an affiliated person of such investment adviser, depositor or principal underwriter.

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Offshore Matters

Cayman Islands Amends the Private Funds Law. On July 7, 2020, the Cayman Islands Monetary Authority (“CIMA”) further amended the Cayman Islands Private Funds Law 2020 (the “PF Law”) to expand the definition of a private fund (“Private Fund”), thereby extending the scope of the PF Law to additional closed-ended entities which must now register with CIMA. The revised definition provides that a Private Fund is any company, unit trust or partnership that offers or issues (or has issued) investment interests to investors with the aim of providing such investors profits or gains from investments; provided that, (i) the investors do not have day-to-day control of the entity’s investments and (ii) the investments are managed by or on behalf of the entity’s operator. The PF Law also specifies narrow categories of persons or any non-fund arrangements that are not included in the Private Fund definition and, thus, do not need to register with CIMA. Entities that now fall under the Private Fund definition were required to register with CIMA by August 7, 2020. Managers of Cayman Islands closed-ended vehicles that have not registered with CIMA should discuss this matter with counsel. 

BVI Financial Services Commission Issues Guidance on Digital Assets. On July 13, 2020, the British Virgin Islands (“BVI”) Financial Services Commission (“FSC”) issued guidance clarifying the regulatory framework applicable to digital assets. The guidance, which is part of the FSC’s burgeoning regulation of digital assets and investment activities related to digital assets, clarifies the types of digital asset products that may be captured under the Securities and Investment Business Act, 2010 (“SIBA”), either (i) when the products are initially issued or (ii) when the products are in the hands of a holder or the subject of a regulated investment activity after issuance. The guidance provides an illustrative table of the types of digital asset products that may be regulated under SIBA, although additional analysis may be required for certain types of digital asset products, such as digital assets that create an entitlement to shares, interests or debentures. The FSC is allowing a 6-month compliance period from the date of publication during which any relevant entity may submit an application for the applicable license or certificate. If a digital asset product falls within the definition of an “investment” under SIBA, persons carrying on an investment business activity with respect to such digital asset products will need to be licensed with the FSC by January 13, 2021. Managers should review and consider whether they are or may be engaged in any regulated investment activities in or from within the BVI such that a license from the FSC is required.

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Digital Asset Matters

INX Launches First SEC-Approved Blockchain IPO. INX Ltd., a Gibraltar-based company (“INX”), launched the first SEC-registered token IPO after the SEC declared that the registration statement relating to the offering of INX’s security tokens was effective on August 20, 2020. INX will allow investors to purchase INX tokens with certain cryptocurrencies and stablecoins as well as the U.S. dollar as it raises funds to further develop a multiservice digital asset platform aimed at providing its customers with a single entry-point for the trading of cryptocurrencies, security tokens and their derivatives. INX notes that INX tokens have both security and utility benefits for their holders: (i) as a security, by entitling the holders to a mandatory profit share of INX’s profit and a liquidation preference and (ii) as a utility, by providing a discount on transaction fees charged via INX’s platform when used to pay the fees and when used for staking on INX’s platform. 

ConsenSys Acquires Quorum, JP Morgan’s Blockchain Platform. ConsenSys, a blockchain software company, recently announced its acquisition of Quorum, an enterprise-variant of the Ethereum blockchain developed by J.P. Morgan. Through the acquisition, ConsenSys seeks to increase the availability of Quorum’s features and capabilities, such as digital asset functionality and document management, by offering a range of products, services and support for Quorum, which will become interoperable with other blockchain products offered by ConsenSys. J.P. Morgan, which also made a strategic investment in ConsenSys in connection with the acquisition, will become a customer of ConsenSys and will utilize the advanced features and services ConsenSys will provide for Quorum. J.P. Morgan’s development of Quorum and its partnership with ConsenSys are additional examples of the growing institutional adoption of blockchain technology and acceptance of digital assets. 

SEC Charges Virginia-based Issuer of Unregistered ICO. In a recent enforcement action, the SEC found that a company and its CEO conducted an unregistered initial coin offering (“ICO”) in connection with its development of a platform to link employers and freelancers. The company raised approximately $5 million in the ICO, selling 125 million tokens to approximately 1,500 investors. The SEC found that the tokens were “securities” under the Howey Test since an investor would have had a reasonable expectation of profit based upon the company’s efforts. Therefore, the tokens could have only been sold through a registered offering or under an exemption from registration requirements. The order also describes the company’s and the CEO’s misrepresentations related to the technical capabilities of the platform and the stability and security of the tokens. The company was ordered to disgorge the monies raised in the ICO and to pay pre-judgment interest of over $600,000. The CEO was individually required to pay a penalty of $150,000, and was barred from serving as an officer or director of a public company and from participating in future offerings of digital asset securities.

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CFTC Matters

CFTC Prohibits Regulation 4.13 CPO Exemptions to Certain Persons Subject to Statutory Disqualifications. The CFTC approved a final rule amendment to Regulation 4.13 of the Commodity Exchange Act of 1934, as amended (the “CEA”), which prohibits a person from claiming an exemption from registration as a commodity pool operator (“CPO”) pursuant to Regulation 4.13 if the person or any of its principals are subject to any of the statutory disqualifications listed in Section 8a(2) of the CEA (the “Covered Statutory Disqualifications”). Previously a person claiming an exemption under Regulation 4.13, which includes the often-used “de minimis exemption” pursuant to Regulation 4.13(a)(3), was not required to represent that it was not subject to a Covered Statutory Disqualification to qualify for such exemption. Notably, the changes are not applicable to family office CPOs claiming the exemption under Regulation 4.13(a)(6). The amendment became effective on August 4, 2020. After the effective date, persons who wish to claim an exemption under Regulation 4.13 will need to represent that neither they nor their principals are subject to the Covered Statutory Disqualifications. For a CPO relying on an exemption prior to the effective date, the CFTC has determined not to mandate compliance until March 1, 2021, which is also the deadline for CPOs to file an annual reaffirmation notice for continued reliance on an exemption. As such, firms that wish to claim or reaffirm an exemption under Regulation 4.13, with the exception family office CPOS, will need to determine whether any of their principals have a Covered Statutory Disqualification in their background.  

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Other Matters

Form BE-180 Requirement for U.S. Managers and Funds. The Bureau of Economic Analysis at the U.S. Department of Commerce (the “BEA”) requires certain U.S. Financial Service Providers (including investment advisers, funds and their general partners) that engaged in a financial services transaction with a foreign person during their 2019 fiscal year to file a report on Form BEA-180 (the “Form”). This requirement will apply to any of our U.S.-based clients that are investment advisers or general partners to an offshore fund, and certain other clients as well. The Form is a 5-year benchmark survey and the deadline to file the Form electronically is October 30, 2020.

The Form requires additional transaction-specific information from Financial Service Providers that either sold financial services to foreign persons in excess of $3,000,000, or purchased financial services from foreign persons in excess of $3,000,000. Please note that sales and purchases are calculated separately, meaning if a Financial Service Provider exceeds the threshold with respect to sales but not purchases, the requirement to provide additional transaction-specific information on the Form would only apply with respect to sales transactions.

Please see our previous post for more information as to who is considered a “Financial Service Provider” and what types of transactions are covered, as well as common scenarios that may apply to some of our clients.

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CFM Events

In early September our own Bart Mallon hosted a discussion forum with panelists from tax, compliance and legal firms which explored issues currently affecting digital asset managers, including among others DeFi, custody and regulatory developments. You can find a useful recap of the event on our blog. Later in the month, Cole-Frieman & Mallon LLP also co-sponsored a very well received fireside chat with Matthew Goetz of BlockTower Capital, in the second of an ongoing series of CoinAlts Fund Symposium webinars.

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

DeadlineFiling
September 30Review holdings to determine Form PF filing requirements.
October 13Amendment to Form 13H due if there were changes during Q3.
October 15SEC deadline to file 3rd Quarter 2020 Form PF for quarterly filers (Large Liquidity Fund Advisers), through PFRD.
October 15*Extended deadline to file Reports of Foreign Bank and Financial Accounts (FBAR).
October 30Form BE-180 due for managers and funds filing electronically to report sales or purchases to foreign persons for covered financial transactions, through BEA eFile
October 30Registered CPOs must distribute (i) monthly account statements to pool participants (pools with net asset value of more than $500,000) and (ii) quarterly account statements to pool participants (pools with net asset value less than $500,000 or CPOs claiming the 4.7 exemption).
October 30Registered investment advisers must collect access persons’ personal securities transactions.
November 14National Futures Association (“NFA”) deadline to file Form PR for registered CTAs. through NFA EasyFile.
November 16Investment adviser firms may view, print and pay preliminary notice filings for all appropriate states, through IARD.
November 16SEC deadline to file Form 13F for 3rd Quarter of 2020.
November 16*Cayman Islands FATCA and CRS reporting deadlines.
November 29Form CPO-PQR due for CPOs, through NFA EasyFile.
December 14Deadline for paying annual IARD charges and state renewal fees, through IARD.
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 in order to avoid 2021 CIMA fees.
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 the NFA Annual Questionnaire system.
*Extended deadline pursuant to COVID-19 pandemic-related relief

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

Cole-Frieman & Mallon 2020 Q2 Update

July 15, 2020

Clients, Friends, Associates:

We hope that you are staying safe and healthy while finding ways to enjoy the summer. As you endeavor to re-establish your routine in our ever-changing “new normal,” we would like to highlight some items we hope will help you stay on top of the business and regulatory landscape in the coming months.

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SEC Matters

Compliance with Regulation Best Interest (Reg BI) was Required as of June 30, 2020. Reg BI established a “best interest” standard applicable to SEC-registered investment advisers (“SEC RIAs”), broker-dealers, and associated persons when making securities recommendations to retail customers. Moving forward, SEC RIAs with “retail customers” must file the new Form ADV, Part 3 (“Form CRS”) electronically via IARD in addition to providing the Form CRS to prospective and existing clients as well as posting the form on their official website. Also, broker-dealers with retail customers must file Form CRS electronically via Web CRD with the understanding that its Form CRS will be made publicly available through BrokerCheck.

The SEC’s Office of Compliance Inspections and Examinations (“OCIE”) has published Risk Alerts for Reg BI and Form CRS, shedding light on the practical considerations to be aware of during initial examinations following June 30, 2020. For further instructions, please see the SEC’s guidance in response to frequently asked questions on Form CRS. For more complete analysis as to how this new regulatory requirement may apply to you, please visit our LinkedIn page.

“Volcker Rule” Restrictions Eased. Five federal regulatory agencies, including the SEC and Federal Reserve Board, have approved the proposed changes to the “Volcker Rule” which are to take effect as of October 1, 2020. The new final rule effectively narrows the definition of covered funds and gives banks the green light to offer financial services to certain venture capital funds and engage in other activities that the original Volcker Rule was not intended to prohibit. Separately, regulators also relaxed margin requirements applicable to derivatives trades between affiliates.

SEC Turns an Eye Toward Business Continuity Plans (“BCPs”). In light of the widespread disruption caused by COVID-19, the SEC has been submitting requests for information to firms regarding their BCPs. Such information requests have included: (i) the firm’s formal BCP; (ii) company techniques and procedures tailored to address the continuity of operations specific to pandemics; (iii) cybersecurity policies and procedures applicable to remote working; and (iv) general inquiries regarding critical systems and operations impacted by the pandemic. It should be expected that regular examinations will involve a heightened focus on BCPs as well. Please contact us for further information or to request assistance in making sure your BCP is up to date.

Use of the Word “may” Could be Misleading. The SEC has maintained that the use of the word “may” in disclosures to investors can be considered misleading if the underlying conduct or condition is, in fact, actually occurring. The SEC demonstrated its commitment to this position in a recent enforcement action against the manager of a private equity fund which provided operational services to its portfolio companies for which the manager charged additional fees. The manager’s Form ADV disclosed that “under specific circumstances, certain [of the manager’s] operating professionals may provide services to portfolio companies that typically would otherwise be performed by third parties” and that the manager “may be reimbursed” for associated costs. The SEC reasoned that this method of disclosure did not sufficiently disclose the fact that the manager did perform such services and receive such compensation on a routine basis. The manager was ordered to pay approximately $1.5 million in disgorgement of fees plus interest and a $200,000 penalty. The action serves as a reminder to all managers that required disclosures must be routinely reviewed to ensure clear and complete descriptions of existing conflicts of interest.

SEC Proposes Modernized Framework for Fund Valuation. In April, the SEC proposed a new rule which will allow a fund’s board to delegate the determination of fair value to the fund’s investment adviser, subject to certain conditions. The new rule is aimed at clarifying how fund boards can meet their valuation obligations which require them to identify and address significant risks associated with fair value determinations; select, implement, and verify fair value determination methods; actively monitor any third-party services used; adopt and implement policies and procedures; and maintain certain records. 

SEC Brings Action Against Manager for Violation of the Custody Rule.  As a method of satisfying the “Custody Rule” (Rule 206(4)-2 of the Investment Advisers Act of 1940, as amended (the “Advisers Act”)), many managers of private funds rely on the “Audited Financials Alternative” which requires the delivery of audited financial statements to all limited partners of a fund within 120 days of the end of the fund’s fiscal year. In a recent enforcement action, the SEC censured a New Jersey-based manager and issued a $60,000 fine for violations of the Custody Rule which took place from 2014-2018 when the firm attempted to avail itself of the Audited Financials Alternative. In 2014 and 2015, the firm mailed the audited financial statements to investors 686 days and 927 days late, respectively; while in 2016-2018, the firm failed to engage an audit firm at all. In addition to these violations, the SEC also cited the firm for failing to implement reasonable policies and procedures aimed at preventing such violations of the Custody Rule.

SEC Charges Los Angeles Private Equity Firm with MNPI-Related Compliance Violations.  In a recent enforcement action, the SEC issued a stern reminder of the requirement under the Advisers Act that investment advisers must enact and follow written policies reasonably designed to prevent violations of the rules governing the use of material non-public information (“MNPI”), particularly in the case where an investment adviser maintains employee board representation on a public company in its investment portfolio. Despite the fact that the manager had written policies in place during the relevant time period to prevent misuse of MNPI, the SEC reasoned that such policies afforded the manager’s compliance staff too much discretion to be adequately enforced. The SEC ordered the payment of a $1 million penalty.

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Offshore Matters

Cayman Island Monetary Authority (“CIMA”) Provides Further Guidance on the Definition of a “Private Fund.” As discussed in our previous update, the Cayman Islands Private Funds Law 2020 (the “PF Law”) now requires any Cayman Islands closed-ended fund that falls under the definition of a private fund (“Private Fund”) to register with CIMA. On May 7, 2020, CIMA issued a notice clarifying such definition under the PF Law. Per CIMA’s new guidance, any “collective investment scheme” is considered to be a Private Fund if all of the following factors are “present or otherwise established”: (i) the undertaking does not have a general commercial or industrial purpose; (ii) the undertaking pools together funds gathered for the purpose of investment with the goal of creating pooled returns for investors; and (iii) the undertaking’s investors have no collective daily control. Notably, the fact that one or more investors exercises daily control over the undertaking does not establish that the undertaking is not a “collective investment scheme” and, thus the undertaking may well still qualify as a Private Fund that must register.

The notice also provides further guidance regarding the treatment of segregated portfolio companies, alternative investment vehicles, practical instructions on the CIMA registration process, as well as valuation and cash monitoring requirements applicable to Private Funds.

CIMA Publishes New Marketing Rules. Effective May 2020, CIMA enacted new rules governing the contents of the offering documents of mutual funds regulated under the Mutual Funds Law (2020 Revision) (“Regulated Mutual Funds”). CIMA published separate rules applicable to the contents of all marketing materials (including offering documents) of Private Funds registered under the Private Funds Law (2020 Revision) (“Registered Private Funds”) which apply prospectively as well as to the marketing materials of all Registered Private Funds with ongoing offerings. Since the new rules applicable to Regulated Mutual Funds and those applicable to Registered Private Funds each mandate a particular disclosure which must be included verbatim in the offering documents, all new offering documents (and all future updates to offering documents) of Regulated Mutual Funds and all marketing materials of Registered Private Funds will be impacted. Please contact us if you think you may be in need of an update to your offering documents or marketing materials.

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Digital Asset Matters

Coinbase Announces Agreement to Acquire Crypto Prime Brokerage Platform. Yet another indicator of the burgeoning demand for digital assets among institutional and professional investors, Coinbase announced its intention to buy Tagomi, a leading cryptocurrency brokerage platform. In addition to providing custody solutions and professional trading features, Tagomi provides its users access to 14 digital asset exchanges from a single account. The acquisition is aimed at creating a digital asset trading experience more aligned with the expectations of professional traders in equities and other traditional markets. The terms of the deal are yet to be announced as the acquisition is pending regulatory review.

SEC Charges San Jose-based Issuer of Unregistered ICO. A blockchain services start-up conducted an unregistered ICO in which it issued Consumer Activity Tokens (“CAT”) to approximately 9,500 investors between June and November of 2017. The SEC determined that the CAT were sold as investment contracts and, as such, were indeed “securities” under the Howey Test which can only be lawfully issued as part of a registered offering or pursuant to a valid exemption under the Securities Act of 1933, as amended. In support of its determination, the SEC’s order reasoned that the issuer’s offering materials (i) created a reasonable expectation by the investor of earning a future profit based on the issuer’s plans of development and marketing of the CAT protocol following the offering; and (ii) assured investors of the liquidity of the CAT on digital asset trading platforms. To settle the charges, the issuer has agreed to pay $25.5 million in disgorgement of funds raised in addition to pre-judgment interest of over $3 million and a penalty of $400,000.

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FINRA Matters

FINRA Shares Remote Working Best Practices.  In an effort to help firms navigate challenges associated with many of their employees working from home, FINRA’s recent Regulatory Notice provides guidance to brokerage firms regarding (i) operational considerations during the transition to a remote working model and (ii) maintenance of adequate supervision while doing so. The regulatory notice does not impose further obligations on FINRA regulated entities, but is meant to share best practices which have been and continue to be implemented by firms of all sizes. The notice provided tips and feedback on ways of assisting customers, providing additional support and communication to employees, and maintaining cybersecurity in this new environment. Additionally, the notice discussed methods of maintaining oversight of trading and staff communication with customers, as well as adjustments to ongoing branch inspection programs.

FINRA Warns of Increased Threat of Fraudulent Activity and Scams During COVID-19. The onset of significant economic disruption creates increased opportunities for fraudulent behavior. In a recent Regulatory Notice, FINRA outlined the following four frequently occurring scams: (i) fraudulent account openings and transfers of funds; (ii) firm impersonation schemes; (iii) false information technology inquiries; and (iv) email phishing scams. Most notably, FINRA reminds firms to examine their own compliance policies relating to the opening of accounts to ensure such policies meet the requirements of the following implicated FINRA Rules: 2090 (Know Your Customer), 4512 (Customer Account Information), and 3310 (Anti-Money Laundering Compliance Program). FINRA provides suggested best practices as to how to be a hard target against such behavior and also encourages firms to report any suspicious activity. 

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CFTC Matters

CFTC Extends Certain COVID-19 Relief Measures. No-action relief measures enacted by the CFTC during the first quarter of 2020 which were set to expire on June 30 have been extended in large part until September 30, 2020. Included in those extended relief measures are the measures applicable to members of designated contract markets and swap execution facilities, futures commission merchants (“FCMs”) and introducing brokers (“IBs”), floor brokers, retail foreign exchange dealers, swap dealers, swap execution facilities and designated contract markets. In CFTC Letter No. 20-19, the Division of Swap Dealer and Intermediary Oversight (“DSIO”) and the Division of Market Oversight (“DMO”) listed the specific relief measures which will not be extended including (i) audit trail and associated requirements applicable to members of designated contract markets; and (ii) requirements pertaining to the recording of voice communications applicable to swap execution facilities. The DSIO and DMO have also stated that affected market participants should reach out to the applicable contact person at each division with requests for specific relief which shall be considered on a case-by-case basis. Inquiries should be sent to Frank Fisanich, Chief Counsel, DSIO or Roger Smith, Special Counsel, DMO, as appropriate.

Further Relief Provided to FCMs and IBs. In CFTC Letter No 20-15, the DSIO has allowed eligible FCMs and IBs who have received loans under the Paycheck Protection Program, pursuant to the CARES Act, to add back certain amounts under covered forgivable loans when making net capital calculations. DSIO has also allowed FCMs and IBs to add back accrued annual FINRA assessment fees so long as such FCM or IB is a registered broker-dealer with the SEC, qualifies as a small firm as defined by FINRA, and is otherwise eligible for the add-back of accrued unpaid annual assessments per FINRA guidance.

CFTC Extends Phase 5 Compliance Date of Initial Margin Requirements for Uncleared Swaps. In light of continued COVID-19-related disruption, the CFTC has announced it has extended the deadline for compliance with the amended margin requirements for uncleared swaps as applicable to swap dealers and major swap participants for which there is no prudential regulator. The deadline for compliance has been extended a full year until September 20, 2021.

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Other Matters

Private Equity Industry Continues to Battle for Access to Defined Contribution Market. The private equity industry seems to have won a small victory in the form of an Information Letter from the Department of Labor which suggested that private equity investments could be used in multi-asset class investment vehicles such as target-date or target-risk funds. CFM’s own Bart Mallon was quoted in the article released by Barrons discussing this exciting new development which could one day lead to private equity investments being made from investors’ 401(k)s.

Enforcement of California Consumer Privacy Act (“CCPA”) Began July 1, 2020. The CCPA, which has been in effect since January 1, 2020, was not delayed beyond the scheduled enforcement date of July 1, 2020. The California Attorney General confirmed the enforcement date despite the formal request for an extension submitted by more than 60 businesses and trade groups led by the Association of National Advertisers due to COVID-19-related disruption. Please see our previous update for a more complete discussion of the CCPA and its implications for fund managers.

New York’s Stop Hacks and Improve Electronic Data Security Act (“SHIELD Act”) Fully Implemented as of March 21, 2020. The SHIELD Act, New York’s version of the CCPA, made several significant changes to the state’s data protection regime including: (i) expanded definitions of “private information” and covered “breaches”; (ii) increased scope of applicability of data protection laws to include any business that owns or licenses private information of a New York resident; and (iii) a requirement for companies to adopt a program of policies and procedures designed to protect the private information of individuals. Although the SHIELD Act’s data breach notification requirements have been effective since the fall of 2019, covered businesses were required to establish the requisite data protection program as of March 21, 2020.

Reminder: Sexual Harassment Training Requirement under California Law. California state law now requires that all employers with five or more employees provide company-wide sexual harassment training. The first training must be held by January 1, 2021 and thereafter must be held every two years. The law formerly only applied to employers with 50 or more employees but has been expanded under Senate Bill No. 778, which was approved by the governor of California on August 30, 2019.

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CFM Events

CoinAlts Webinar. In lieu of the CoinAlts Fund Symposium, the CoinAlts Webinar Series was held on May 14, 2020. The widely attended event featured updates and analysis of the latest trends in the digital asset space from Cynthia Pederson of Cohen & Co., Lewis Chong of Harneys, Matt Stover and Seth Altman of MG Stover, and our own, Bart Mallon. The event was capped with an enlightening Q&A session featuring Gary Newlin of MG Stover and Matt Perona of Polychain Capital. For a summary of the event, please contact us. On behalf of the CFM team, as well as our co-sponsors, we want to thank all who attended this iteration of the CoinAlts Webinar and we look forward to hosting you at the next installment. Please stay tuned for the announcement of the details of the next event and let us know if you have any specific questions or interesting topics you would like discussed.

Regulation Best Interest (Reg BI) Webinar with Aspect Advisors. CFM co-sponsored a live webinar with Aspect Advisors on May 28, 2020. The discussion covered practical, regulatory, and other considerations regarding Reg BI and the new Form CRS, as described earlier in this update. We would like to thank Justin Schleifer of Aspect Advisors for hosting and look forward to future events. Aspect Advisors is a 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.).

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

DeadlineFiling
June 30Deliver audited financial statements to investors (private fund managers to fund of funds, including SEC, state and CFTC registrants.
June 30SEC deadline for initial Form CRS (ADV Part 3) submission through IARD for SEC-registered investment advisers (if necessary).
June 30CIMA deadline for Cayman Island registered funds with a fiscal year end of December 31 to file the Fund Annual Return and audited financial statements.
June 30Deadline for making available AIFMD annual report for funds operating in or advertising in the EU (Alternative Investment Funds with a financial year ending on December 31).
July 10Review holdings to determine Form PF filing requirements.
July 15SEC deadline to file 2nd Quarter 2020 Form PF for quarterly filers (Large Liquidity Fund Advisers), through PFRD.
July 15*CFTC 1st Quarter extended deadline for CPOs to file Schedules A and B of CFTC Form CPO-PQR, through NFA EasyFile
July 20FINRA deadline to complete annual account Entitlement Certification through IARD (firms with more than one IARD user).
July 30Collect quarterly Transaction Reports from access persons for their personal securities transactions (SEC registered advisers).
July 30*Quarterly account statements due (CPOs claiming the 4.7 exemption). DSIO will not recommend an enforcement action against a CPO provided that the statements are distributed by August 14. 
July 30Deliver initial Form CRS (ADV Part 3) to clients qualifying as “retail investors” for SEC-registered investment advisers.
August 14SEC deadline to file Form 13F for 2nd Quarter of 2020.
August 14NFA deadline to file Quarterly Commodity Trading Advisor Form PR filing, through NFA EasyFile.
August 28SEC deadline to file 2nd Quarter 2020 Form PF filing for quarterly filers (Large Hedge Fund Advisers), through PFRD.
August 28CFTC deadline for CPOs to file Schedules A, B, and C of CFTC Form CPO-PQR, for 2nd Quarter of 2020, through NFA EasyFile.
September 18*Cayman Islands CRS reporting deadline. The deadline for reports under US FATCA has been extended to November 16, 2020.
October 9Review transactions and assess whether Form 13H needs to be amended.
October 15SEC deadline to file 3rd Quarter 2020 Form PF for quarterly filers (Large Liquidity Fund Advisers), through PFRD.
VariableDistribute copies of K-1 to fund investors.
Periodic FilingsForm D and Blue Sky filings should be current.
*Extended deadline pursuant to COVID-19 pandemic-related relief

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

Cole-Frieman & Mallon 2020 Q1 Update

April 16, 2020

Clients, Friends, Associates:

The first quarter of 2020 saw an unprecedented combination of challenges, not only industry-wide but on a global scale as well. Notwithstanding the prevailing circumstances, the first quarter was busy for investment managers and service providers with filing deadlines, regulatory changes, and compliance updates. As we continue through 2020, we have put together this update and checklist to help managers stay on top of the business and regulatory landscape in consideration of the global pandemic affecting nearly every aspect of the industry and our lives. 

Please note COVID-19 related matters appear at the end of this update.

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SEC Matters

SEC Releases 2020 Examination Priorities. The SEC Office of Compliance Inspections and Examinations (“OCIE”), which conducts examinations of SEC-registered investment advisers, investment companies, broker-dealers, and others, publishes an annual list of examination priorities for the upcoming year that provides insight to managers regarding issues that will be examined and an opportunity for advisers to prepare and improve such areas before examination.OCIE’s 2020 exam priorities are as follows: Retail Investors (including seniors and those saving for retirement); Market Infrastructure; Information Security; Focus Areas Relating to Investments Advisers, Investment Companies, Broker-Dealers, and Municipal Advisors; Anti-Money Laundering Programs; Financial Technology and Innovation (including Digital Assets and Electronic Investment Advice); and oversight of the Financial Industry Regulatory Authority (FINRA) and Municipal Securities Rulemaking Board (MSRB). In particular, Information Security and Cybersecurity were focuses of the publication. OCIE released observations that focus on certain approaches taken by market participants in regards to governance and risk management, access rights and controls, data loss prevention, mobile security, incident response and resiliency, vendor management, and training and awareness. 

SEC Division of Trading and Markets Releases FAQ on Regulation Best Interest (Reg BI). Reg BI establishes a “best interest” standard for broker-dealers and associated persons when making recommendations to retail customers involving securities. Since adopting Reg BI on June 5, 2019, the SEC has released responses to frequently asked questions about the regulation, covering topics surrounding Retail Customers, Recommendations, Disclosure Obligations, Care Obligations, Conflict of Interest Obligations, and Compliance Obligations. It should be noted that like all staff guidance, the FAQ does not have legal force or effect, but represents the views of the staff of the Division of Trading and Markets. Reg BI was met with much skepticism as critics found the new regulation ambiguous in many regards. Hopefully the SEC’s guidance will be the first step in addressing this perceived ambiguity. Firms are expected to comply with Reg BI by June 30, 2020.

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FINRA Matters

Amendments to the FINRA New Issue Rule (Rule 5130) and Anti-Spinning Rule (Rule 5131) Became Effective as of January 1, 2020. Generally, the amendments to the FINRA New Issue Rules broaden the types of investors that are exempt from the rules’ restrictions and narrow the types of the securities offerings that are subject to the New Issue Rules. As a result of the amendment, among other things, FINRA member broker-dealers may now sell new issues to additional kinds of investors directly or through investments in private investment funds. Amendment to Rules 5130 and 5131 includes expanding the ways that foreign investment companies can fall within the general exemption, broadening the definition of family investment vehicles, including foreign employee retirement benefits plans under the exemption, excluding sovereign entities from the definition of “Restricted Persons,” and other changes. 

FINRA Releases 2020 Risk Monitoring and Examination Priorities Letter. The 2020 Risk Monitoring and Examination Priorities Letter outlines the priorities for FINRA’s risk monitoring, surveillance, and examination programs for the year. The letter includes a list of practical considerations and questions for firms to use as guidance in evaluating their compliance, supervisory, and risk management program. Among the new or emerging areas in the industry, FINRA discusses compliance with obligations relating to Regulation BI, Form CRS, communications with the public, communications via digital channels, sales of initial public offering (IPO) shares, digital assets, cybersecurity, and other items.  

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Digital Asset Matters

SEC Commissioner Proposes 3-Year Safe Harbor Period for Crypto Token Sales. As mentioned in Commissioner Peirce’s speech, cryptocurrency and digital asset entrepreneurs are faced with a regulatory Catch 22. In order to build a decentralized network in which a token provides access to a function of the network or serves as a means of exchange, a crypto project needs to get its tokens into the hands of users. However, such would-be networks generally cannot freely distribute their tokens to potential users due to existing federal and/or state securities laws. Consequently, these would-be networks cannot mature into functional decentralized networks that are not dependent upon single persons or groups to carry out the essential managerial or entrepreneurial efforts (under the Howey Test). To address this uncertainty, Commissioner Peirce formally proposed a safe harbor for token projects, allowing a three-year time window for networks to mature and become sufficiently decentralized so as not to fall under the “securities” definition contemplated under the Howey Test. If adopted, the safe harbor would impose strict requirements on such crypto projects, including source code disclosures, transaction history disclosures, personal disclosures, public notices and filings, and other conditions. Additionally, the safe harbor would be available for tokens that were previously sold in a registered offering or pursuant to a valid exemption under the Securities Act of 1933, as amended. 

SEC Wins Injunction against Telegram in Landmark Digital Assets Case.  On March 24, U.S. District Judge Kevin Castel of the Southern District Court of New York issued an injunction against Telegram Group Inc. (“Telegram”), the messaging app company that raised $1.7 billion in 2018 selling Gram tokens to investors in the largest ICO to date. In October 2019, the SEC sought to enjoin Telegram from distributing the Gram tokens on the grounds that the company had violated federal law for the sale of unregistered securities. The SEC was granted the preliminary injunction, preventing Telegram from distributing the Gram tokens to investors. The Court stated it “finds that the delivery of Grams to the Initial Purchasers, who would resell them into the public market, represents a near certain risk of a future harm, namely the completion of a public distribution of a security without a registration statement.” Despite the ruling, it has been reported that the Telegram Open Network (TON) Community Foundation remains optimistic as they believe that TON can always be launched by anyone considering the network code is available.  

Crypto Crash Leads to BitMEX Outage, Liquidations.  As the price of Bitcoin crashed from $8,000 to nearly $3,700 in less than 24 hours on March 13, BitMEX faced a 25 minute outage during a day when nearly $1 billion in leveraged long positions were liquidated industry-wide. BitMEX has faced criticism for the outage, with some speculating that it may have shut down intentionally to avoid the possibility of its Bitcoin perpetual swap collapsing to zero due to forced liquidations. BitMEX has stated that a hardware issue caused the outage. No matter the cause, this event highlights the necessity for digital asset managers, especially those using leverage to trade digital assets, to ensure their fund documents contain the necessary disclosures regarding counterparty risk and digital asset exchange risks.  

Wyoming Plans to Create New Bank Dedicated for Digital Assets. Wall Street and crypto veteran Caitlin Long recently announced a plan for Wyoming corporation, Avanti Financial Group Inc., to apply for a bank charter under Wyoming’s special-purpose depository institution law. Under the name “Avanti Bank & Trust,” the future bank is partnering with Blockstream to provide payment, custody, securities, and commodities activities for institutional customers using digital assets (“Avanti”). Though Avanti has yet to submit the bank charter application, the company has raised $1 million in seed funding and has eight products in the works that are not currently available in the U.S. market, including custody for security tokens. If successful, Avanti will be the first U.S. bank dedicated for digital assets. 

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Offshore Matters

Cayman Islands Mutual Funds Law (2020 Revision). Effective February 7, 2020, the Cayman Islands Government enacted an amendment to the Mutual Funds Law (2020 Revision). The 2020 Revision requires registration of previously exempt Section 4(4) Funds (generally, private funds with not more than 15 investors) with the Cayman Island Monetary Authority (“CIMA”). The 2020 Revision operates retroactively, meaning mutual funds that were previously exempted from registration under Section 4(4) will now need to comply with the registration requirements by August 7, 2020. Registration is similar to the requirements for Section 4(3) Funds, including the ‘four-eyes’ principle that necessitates funds to have at least two natural persons in management roles.  

Cayman Islands Private Funds Law 2020 (“PF Law”). Effective February 7, 2020 (the “Effective Date”), the PF Law requires any Cayman Islands closed-ended fund that falls under the definition of a “private fund” to register with CIMA. Previously, “private funds” were not required to register with CIMA. A vehicle will be a “private fund” where: (1) its principal business is offering and issuing investment interests; (2) its investment interests carry an entitlement to participate in the profits or gains of the vehicle and are not redeemable or re-purchasable at the option of the investor, i.e. are closed-ended; (3) its purpose or effect is the pooling of investor funds with the aim of spreading investment risks and enabling investors to receive profits or gains from such vehicle’s investments; (4) the investors do not have day-to-day control over the investments; (5) its investments are managed as a whole by or on behalf of the operator, directly or indirectly, for reward based on the assets, profits or gains of the vehicle; and (6) it does not constitute a “non-fund arrangement,” as listed in the schedule to the PF Law. The regulations do provide certain transitional provisions for private funds that began business at any time prior to the Effective Date. Such transitional funds will have six months from the Effective Date to register with CIMA and comply with the PF Law. 

European Union (EU) Announces Cayman Islands is a Non-Cooperative Jurisdiction for Tax Purposes. Effective February 18, 2020, the EU Economic and Financial Affairs Council announced that the Cayman Islands was moved to Annex 1 of Non-cooperative jurisdictions (“Annex 1”) for failing to timely implement appropriate regulations relating to economic substance in the area of collective investment vehicles. For investors or clients using Cayman structures, the move to Annex 1 will have limited or no direct practical consequence. The move to Annex 1 is not expected to trigger prevention of the use of special purpose vehicles established in non-EU jurisdictions under Article 4 of the EU Securitisation Regulation, or result in any EU level sanctions. While the Cayman Islands Government has announced the start of the delisting process, the situation is currently being monitored as dialogue continues between the EU and listed jurisdictions.

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Other Matters

Important Second Circuit Opinion on Insider Trading. In United States v. Blaszczak, No. 18-2825 (2d Cir. Dec. 30, 2019) (“Blaszczak”), the Second Circuit denied application of any personal benefit test to insider trading charges brought under both the criminal securities fraud provisions added in the 2002 Sarbanes-Oxley Act (Title 18) and the wire fraud statutes. Although this precedent controls only in criminal cases, this Second Circuit decision has made it significantly easier for prosecutors to obtain insider trading convictions. The personal benefit test requires prosecutors to show that a tipper acquired a personal benefit by disclosing confidential information in order to charge the tipper or tippee with insider trading. The implications of the ruling are potentially far-reaching as Blaszczak may become expansive precedent for prosecutors seeking to lower the bar for insider trading prosecutions. Analysts, such as the two former hedge fund analysts to whom Blaszczak was charged, that usually communicate with company employees and executive insiders may be at higher risk for insider trading prosecution because the government may not need to allege or prove that the tipper breached a duty of confidentiality or exchange for a personal benefit. While the cascading impact following Blaszczak is yet to be known, it is clear that the Second Circuit ruling has the potential to significantly expand insider trading liability. 

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COVID-19 Pandemic-Related Updates

SEC Regulatory Relief for Funds and Investment Advisers Affected by COVID-19. The SEC announced it will provide conditional relief to investment advisers affected by COVID-19. The SEC order grants relief for advisers from certain Form ADV and Form PF filing obligations. Registered investment advisers (“RIAs”) and exempt reporting advisers affected by COVID-19 can expect conditional relief regarding amendments and reports on Form ADV, respectively. Further, the order provides conditional relief for RIAs affected by COVID-19 in regards to delivering amended brochures, brochure supplements or summaries of material changes to clients where the disclosures are not able to be timely delivered. Private fund advisers affected by COVID-19 can also expect relief from Form PF filing requirements. To rely upon the relief, the order requires a statement of notification to Commission staff (promptly via email to the SEC at [email protected]) of the intention to rely upon the order and the disclosure of information in the form of a brief description by the adviser of the reasons why it could not file or deliver its Form ADV or Form PF on time. Clients and investors of the adviser must also be notified. Disclosure in regards to reliance upon the order for Form PF filings should be made promptly via email to the SEC at [email protected]. The order requires filing Form ADV and/or Form PF, as applicable, as soon as practicable, but not later than 45 days from the original deadline. For general questions or concerns related to impacts of coronavirus on the operations or compliance of funds and advisers, please contact us.

California’s Attorney General Announced No Delay on Enforcement of CCPA. On March 17, a group of over 30 trade associations and businesses sent a letter to California’s Attorney General pushing to postpone the enforcement of the California Consumer Privacy Act (“CCPA”). The CCPA, which took effect on January 1, is expected to be enforced by the Attorney General starting July 1. The group who sent the letter requested a January 1, 2021 enforcement date in order to give businesses more time to prepare for enforcement given that, given the current climate of COVID-19, many are unable to prepare for enforcement and most are in need of prioritizing other business concerns, such as the well-being and health of their employees. Press reports of various statements by members of the Attorney General’s office in response to this request strongly suggest that enforcement will not be delayed. In addition, the Attorney General recently released proposed revisions to clarify the service provider exemption. One such revision would allow service providers to use personal information internally to improve their services subject to certain limitations. Nevertheless, fund managers should prepare for enforcement of the CCPA as scheduled.

Investment Management Firms May Be Considered Essential Financial Businesses Under Federal Guidance and State Orders. The Cybersecurity and Infrastructure Security Agency (“CISA”) lists asset management as a vital component of our nation’s critical infrastructure. As the federal risk advisor, CISA created guidance to help state and local governments ensure that employees essential to operations are able to continue working. In consideration of CISA’s guidance, whether or not investment management firms would be considered essential financial businesses may depend upon each State’s directives. Generally, the best practice for firms moving forward is to require workers to telework or work-from-home if possible, but allow supporting personnel to continue selective operations in the office in order to ensure the firm’s continued operation.Please read here for a state-by-state analysis of the exceptions provided in each States’ executive orders regarding essential business activities in light of the COVID-19 public emergency response.

Amidst Extreme Volatility Managers Must Assess Material Terms in Live Trading Agreements. Given extreme market volatility, managers must assess the deal terms governing trading agreements such as ISDA master agreements, prime brokerage agreements, and others as certain provisions and triggering events may detrimentally affect hedge funds in the midst of current market conditions. Provisions regarding NAV triggers, force majeure, material adverse change/effect, counterparty powers, business day determinations, business disruptions, etc. and should be reviewed in light of current market conditions. In particular, for fund managers with ISDAs in place, please read this article by Dave Rothschild, a Partner at Cole-Frieman & Mallon LLP (“CFM”).

Additional Information on COVID-19 for Investment Managers. We have summarized a number of items from various authorities that pertain to investment managers. This article details the following matters:

  • The Coronavirus Aid, Relief, and Economic Security Act (CARES Act). 
  • CFTC Extended Deadlines for CPOs Due to COVID-19. 
  • SEC Update to Form ADV and Custody Rule FAQs, Relating to “Work From Home”. 
  • NFA Relief for Commodity Pool Operators, Relating to “Work from Home”. 
  • FINRA Pandemic-Related BCP, Guidance and Regulatory Relief, Relating to Regulatory Filings, “Work from Home,” Cybersecurity, and Forms U4 and BR. 
  • Employment Considerations for Investment Management Firms Addressing COVID-19.
  • SEC Temporary Final Rule 10(c) to Address Form ID Notarization Issues.
  • SEC’s Office of Compliance Inspections and Examinations Off-Site Exams via Correspondence for Information on Firms’ Business Continuity Plans.
  • SEC Guidance Relating to Federal Proxy Rules for Annual Meetings, “Virtual” Meetings, and Presentations of Shareholder Proposals. 
  • SEC No-Action Relief for Consolidated Audit Trail Obligations. 
  • Short-Selling Bans in Austria, Belgium, France, Italy, and Spain. 
  • Tax Matters for Investment Managers.

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CFM Events

CFM 2020 IA/BD Compliance Update with Aspect Advisors. We held our 2020 compliance update with Aspect Advisors in January. The discussion covered the critical compliance priorities in our industry for the New Year and decade. We’d like to thank Aspect Advisors for their help with this compliance update and look forward to future events. Aspect Advisors is a 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.).  

Bitcoin Mining Panel Event in San Francisco. As we have seen certain venture capital firms increase their investment in bitcoin mining and infrastructure, CFM decided to hold an event discussing the current investing environment, regulatory considerations, and infrastructure landscape for bitcoin mining. The discussion was presented by Michael Fitzsimmons of Williams Trading and featured a panel of bitcoin mining experts – Mathew D’Souza of Blockware Solutions, Thomas Ao of MCredit and Yida Gao of Struck Capital. For a summary of the event, please see our overview

Regulation Best Interest (Reg BI) Webinar. Please stay tuned for more information on an upcoming live webinar, co-sponsored by CFM and Aspect Advisors, discussing practical, regulatory, and other considerations regarding Reg BI and the new Form CRS. We have previously written about Reg BI and how it pertains to private fund managers and investment advisers here. If you are interested in attending and have any questions for us to cover during the webinar, please contact us.

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

Deadline Filing
March 30
SEC deadline to update and file Form ADV – Part 1A, 2A, and Part(s) 2B, as applicable, through IARD.  
April 10
Amendment to SEC Form 13H due if necessary.
April 15SEC deadline to file 1st Quarter 2020 Form PF filing for quarterly filers (Large Liquidity Fund Advisers), through PFRD. 
April 15FinCEN deadline to file Report of Foreign Bank and Financial Accounts on FinCEN Form 114. Required for U.S. person with financial interest in, or signature authority over, one or more foreign financial accounts with total value over $10,000 at any time in 2019.
April 29Distribute Form ADV Part 2 to existing clients.
April 29Distribute audited financial statements to private fund investors that have not invested in fund of funds.
April 29SEC deadline to file Annual Form PF for annual filers (Large Private Equity Fund Advisers and Smaller Private Fund Advisers).
April 29Collect quarterly Transaction Reports from access persons for their personal securities transactions.
May 1SEC filing opens for Form CRS, through IARD. 
May 15*CFTC deadline for Commodity Pool Operators to file Schedules A and B of CFTC Form CPO-PQR, through NFA EasyFile.  

NFA deadline for CFTC-registered CPO of CFTC Regulation 4.7 Pool or Non-Exempt Pool to file 2019 Annual Report and distribute to pool participants. 
May 15SEC deadline to file Form 13F for first quarter of 2020.
May 15NFA deadline to file Quarterly Commodity Trading Advisor Form PR filing, through NFA EasyFile. 
May. 29SEC deadline to file 1st Quarter 2020 Form PF filing for quarterly filers (Large Hedge Fund Advisers), through PFRD.
May 29CFTC deadline for Commodity Pool Operators to file Schedules A, B, and C of CFTC Form CPO-PQR, for first quarter of 2020, through NFA EasyFile.  
May 29CFTC deadline for Commodity Pool Operators to file NFA Form PQR for first quarter of 2020 with CFTC and NFA, through NFA EasyFile.
June 12*Distribute Quarterly NAV Report (registered commodity pool operators claiming the 4.7 exemption) to pool participants.
June 26Distribute audited financial statements to private fund investors that have invested in fund of funds.
June 30SEC deadline to file Form CRS, through IARD if necessary. 
VariableDistribute copies of K-1 to fund investors.
Periodic FIlingsForm D and Blue Sky filings should be current.

*Extended deadline pursuant to COVID-19 pandemic-related relief

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 visit us at colefrieman.com.

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Bart Mallon is a founding partner of Cole-Frieman & Mallon LLP. Cole-Frieman & Mallon is a boutique law firm focused on providing institutional quality legal services to the investment management industry. For more information on this topic, please contact Mr. Mallon directly at 415-868-5345.

Cole-Frieman & Mallon 2019 Third Quarter Update

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

Clients, Friends, Associates:

We hope you had an enjoyable summer. Typically, the third quarter is quieter than the second quarter from a compliance perspective, however we continue to see meaningful enforcement actions taken by regulatory authorities and rapid developments in the digital asset space. Entering the fourth quarter, we would like to highlight some items we hope will help you stay on top of the business and regulatory landscape in the coming months.  But first, a couple of items of firm news:

  • CoinAlts Fund Symposium. In September, In September, founding sponsor CFM broke new ground to host its fourth successful Symposium in Chicago. An impressive line-up of speakers addressed pressing issues for institutions in the digital asset ecosystem, including legal and operational concerns for fund managers, recent trends and innovations in blockchain, and raising capital from institutional allocators.
    • Cole-Frieman & Mallon’s Anniversary. On September 17th CFM celebrated with family, friends, colleagues and clients 10 years of successful growth to become the largest hedge fund practice in the West Coast. We very much appreciate the continued support from our clients and friends in the industry and look forward to the next decade of success.

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Privacy Regulations

Cayman Islands Data Protection Law Effective September 30, 2019. The Cayman Islands Data Protection Law, 2017 (“DPL”) became effective on September 30, 2019 and applies to all investment advisers providing investment advice to Cayman Islands funds. Under the DPL, Cayman investment funds are considered “data controllers” whether or not they are registered with the Cayman Islands Monetary Authority and investment advisers to such funds are considered “data processors.” The DPL requires data controllers to update their Cayman fund’s subscription agreements to include language specific to the DPL and otherwise provide investors with an updated DPL-compliant privacy notice. There is no specific deadline to provide investors with such privacy notice. Fund administrators must also ensure that they are DPL-compliant and updates to the fund’s administration agreement may be required.

California Consumer Privacy Act to be Effective January 1, 2020. The California Consumer Privacy Act (the “Act”) was passed into California law on June 28, 2018 and will be effective on January 1, 2020. The Act will not apply to most fund managers and will generally only impact managers that serve California residents and have at least $25 million in annual gross revenue, have personal data on at least 50,000 Californians, or receive over half their revenues from the sale of personal data of California residents. The Act does not apply to current client data and, on October 11, 2019, Governor Newsom signed seven amendments into law that generally limit the Act’s reach even further. If the Act were to apply to a fund manager, to be in compliance, such fund manager should post a privacy policy on its website disclosing its collection of personal information, maintain an organized data collection process, and provide investors information regarding the use of their information and the right to opt-out of the sale and request the deletion of such information.

New York SHIELD Act Heightens the State’s Privacy Regulations. On July 25, 2019, the Stop Hacks and Improve Electronic Data Security Act (the “SHIELD Act”) was signed into New York law and amends the State’s data breach notification law. The SHIELD Act, which is set to take effect in March 2020, requires certain businesses or individuals implement safeguards to protect the security, confidentiality and integrity of information. The SHIELD Act broadens the definition of “private information” to include credit card or debit card numbers, usernames and passwords (or security questions and answers) used to access an individual’s online accounts, and biometric information, like fingerprints. The SHIELD Act also expands the definition of “breach”, from unauthorized acquisition of private information to include unauthorized access to private information, as well as the scope of the breach notification requirement to include any person or business that owns or licenses private information of a New York resident. This means the law is no longer limited to those conducting business in New York, but could affect managers who, for example, only store a New York investor’s private information. Because of the broad scope of the SHIELD Act, managers who own private information of a New York resident should review the updated security requirements the Act imposes on them, including the need to implement a data security program, as more specifically discussed in the SHIELD Act.

SEC Matters

SEC Publishes Risk Alert on Principal and Agency Cross Trading Compliance Issues. On September 4, 2019, the Securities and Exchange Commission (“SEC”) published a Risk Alert advising readers on common compliance issues identified in investment adviser examinations, related to principal and agency cross transactions under Section 206(3) of the Investment Advisers Act of 1940, as amended (the “Advisers Act”). These transactions occur when investment advisers execute client transactions as a broker or dealer, either acting as a broker or dealer for its advisory client or doing so for both its advisory client and its brokerage client on the other end of the same transaction. The examinations the SEC conducted showed advisers either did not know they had engaged in principal trades or did not disclose or obtain the required consent before completing the transactions. With respect to agency cross transactions, the examinations also showed advisers often engaged in agency cross transactions without properly disclosing this to clients or could not show proof they had complied with the applicable consent or disclosure requirements. The Risk Alert also expressed concern that many advisers engaging in these transactions either did not have proper compliance policies and procedures or failed to follow the policies and procedures that had been established. Advisers should look closely at potential transactions to determine whether they qualify as either principal trades or agency cross transactions and if so, what actions need to be taken to comply with the respective requirements.

SEC Charged RIA for Nondisclosure of Conflicts Arising from Revenue Sharing. On August 1, 2019, the SEC  charged an SEC RIA for failure to disclose conflicts of interest relating to a revenue sharing agreement with the broker used by most of its clients. The revenue sharing agreement provided that, if the adviser invested its client assets in certain classes of mutual funds that paid the broker to be listed on its platform, the adviser would receive a portion of those payments. The adviser received over $100 million from the broker from July 2014 to December 2018 because of this arrangement. However, the adviser never disclosed to its clients that there were other mutual fund investments less expensive than the investments subject to the revenue sharing agreement. The SEC considered these to be material omissions and determined the adviser’s clients did not make these investments with full knowledge of the adviser’s incentives. Fund managers should ensure that all pertinent conflicts of interest, including those related to the receipt of compensation from third parties, are properly disclosed to their clients.

FINRA Matters

FINRA Proposes Changes to Restricted Person and Spinning Provisions.  On July 26, 2019, FINRA, along with the SEC, proposed certain amendments to FINRA Rules 5130 and 5131. One of the amendments would exempt certain additional persons and certain types of offerings from the scope of the rules. Among other changes (eight total), the proposals would (i) include the definitions of “family member” and “family client” as defined under the Advisers Act in the definition of “family investment vehicle” under Rule 5130, (ii) exempt foreign employee retirement benefit plans that meet certain conditions from Rules 5130 and 5131 and (iii) exclude unaffiliated charitable organizations from the definition of “covered non-public company” in Rule 5131. If these changes are approved and become effective, fund managers can expect further regulatory consistency and clarity to result.

Digital Asset Matters

Bakkt Announces that it’s “Cleared to Launch” Bitcoin Futures. Bakkt, a bitcoin futures exchange and digital assets platform founded by the Intercontinental Exchange (“ICE”), announced in mid-August that the CFTC gave its go-ahead for Bakkt’s futures contracts. The announcement discussed that Bakkt’s bitcoin futures would be exchange-traded on ICE Futures U.S. and cleared on ICE Clear US, both of which are regulated by the CFTC. Bakkt further announced that it acquired a New York state trust charter through the New York State Department of Financial Services, and that this approval to create Bakkt Trust Company, a qualified custodian, would allow the Bakkt Warehouse, which is part of Bakkt Trust Company, to provide bitcoin custodial services for physically delivered futures. On September 23, 2019, Bakkt launched its custody and physically-settled bitcoin futures contracts products. Many disagree whether the launch, which had a trade volume during the first seven days of $5.8 million, was successful or not, and certain researchers speculate the launch was partially why bitcoin’s price has recently decreased. Despite this, the news of the launch can potentially benefit fund managers as Bakkt aims to provide access to this market and address issues that have slowed institutional participation in this market in the past.

SEC Delays Decision on Three Bitcoin ETFs. On August 12, 2019, the SEC once again delayed a decision on three bitcoin ETF proposals.  As of yet, the SEC has not approved a bitcoin ETF. In previous decisions, the SEC expressed concerns with market manipulation, market surveillance and a possible divergence with futures trading. One of the entities proposing a bitcoin ETF published reports addressing these concerns and indicating that the actual bitcoin market is more regulated and surveilled than expected. This ETF proposal received support from a number of well-known individuals in the industry. In fact, Cole-Frieman & Mallon submitted a comment to the SEC with respect to this ETF proposal in June. Unfortunately, on October 9, 2019, this ETF proposal was rejected as the proposal reportedly did not meet the legal requirements necessary to prevent market manipulation or other fraudulent activities. As another of the entities proposing a bitcoin ETF recently withdrew its proposal from SEC review, there remains only one bitcoin ETF proposal sitting before the SEC. Fund managers interested in the digital asset space should stay apprised of future developments regarding this ETF proposal and others that may follow.

FINRA Approves Membership of Placement Agent for Privately Placed Digital Securities. On August 7, 2019, FINRA approved the membership application of a placement agent for privately placed, digital securities on a permissioned blockchain platform developed by its parent company. It took the placement agent 18 months to get approved, which is longer than what is typically seen, as it had to prove to FINRA that it met regulatory requirements. The approval allows the placement agent to issue securities, provide services as a broker for digital securities, and potentially enter the secondary trading business. This approval stands out as many applications have been waiting to hear back from FINRA for months, and sometimes more than a year. Specifically, this approval will expand investment opportunities for investors and provide fund managers with a streamlined tool to utilize in its investment processes.

SEC Freezes $8 Million in Assets Related to Fraudulent Scheme to Sell Digital Securities to Investors. On August 12, 2019, the SEC froze $8 million in assets raised by an individual and two companies he owns. Allegedly, the parties sold their own token on the internet and induced investors to invest in the token based on material misrepresentations and omissions. The complaint also alleged that the individual manipulated the token price and transferred a significant amount of investor assets to his own personal account. The SEC charged the parties with violating the registration and antifraud provisions of the Federal securities laws and further charged the individual for violating antifraud provisions by manipulating the price of tokens. While this digital asset age has certainly shown promise and innovation, fund managers should be on alert for fraudulent schemes such as this.

SEC Charges Group Operating Unregistered Digital Asset Exchange. On August 29, 2019, the SEC settled charges with a company and its founders who created and sold unregistered tokens to more than 13,000 investors. The founders allegedly falsely claimed each token provided an interest in the company’s cryptocurrency mining facility using below-market rate electricity. In reality, the mining facility did not exist. The company and its founders also allegedly illegally operated an unregistered national security exchange to trade the single token. As new and exciting opportunities in the digital asset space continue to emerge, investors should proceed with caution and should conduct ample due diligence prior to moving forward with such opportunities.

IRS Targets Cryptocurrency Investors with Educational Letter about Back Taxes. In July, the IRS began sending educational letters to taxpayers who have purchased or sold cryptocurrencies but either did not report the income entirely or did not report the income correctly. There are three variations of this letter that more than 10,000 taxpayers will receive, depending on how or if the transactions were reported: Letter 6173, 6174 and 6174-A. In mid-August, the IRS began sending a second round of letters to relevant taxpayers. This notice, which the IRS calls CP2000, is aimed at taxpayers that the IRS has actual records of, showing that there is a discrepancy between the trading profits or losses reported by the taxpayer and what third parties (like exchanges) report to the IRS. The notice includes an amount that each recipient taxpayer is expected to pay in 30 days, with interest. Taxpayers trading cryptocurrency can expect the IRS to ramp up these types of letters and notices and should properly report their transactions to the IRS when filing tax returns to avoid penalties.

SEC Approves First-Ever Reg A+ Token Offering. On July 12, 2019, Blockstack became the first company in history to receive SEC approval for a public securities offering where investors would receive tokens, in this case, called “Stacks”. Blockstack raised a total of $23 million from more than 4,500 investors. $15.5 million was raised through a Reg A+ sale in the United States and the other $7.6 million was raised through a Reg S offering in Asia. Blockstack is working with international exchanges to list Stacks tokens potentially as soon as October 2019. While the full effects of this approval are not yet determined, the SEC’s approval has potential to create a new regulatory roadmap for public token offerings.

FINRA and SEC Issue Joint Statement on Custody of Digital Assets by Broker-Dealers. On July 8, 2019, FINRA and the SEC issued a statement expressing the challenges facing broker-dealer’s custody of digital assets. The statement discussed that a broker-dealer seeking to custody such assets must, like all broker-dealers, comply with the SEC’s Customer Protection Rule. This rule protects customer securities and funds held by broker-dealers by requiring broker-dealers to keep customer assets separate from their firm’s assets, making it more likely that customers’ securities and assets can be returned to them in the case of a broker-dealer’s failure. Many unregistered entities and registered broker-dealers that want to engage in activities involving digital asset securities have been submitting applications to FINRA in the hope that FINRA will allow them to engage in such activities. How these entities could custody digital asset securities while complying with the Customer Protection Rule is still under discussion, but as a start, broker-dealers would need to put in place significant technological enhancements unique to digital asset securities.

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Compliance Calendar.

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

Deadline Filing
October 10, 2019 Form 13H amendment due if there were changes during Q3
October 15, 2019 Quarterly Form PF due for Large Liquidity Fund Advisers
October 15, 2019 Extended deadline to file Reports of Foreign Bank and Financial Accounts (FBAR)
October 30, 2019 Registered investment advisers must collect access persons’ personal securities transactions
November 1, 2019 Registered investment advisers that seek to withdraw registration with the SEC may begin to submit Form ADV-W‘s, which must be dated 12/31/19
November 11, 2019 Firm may view, print and pay preliminary notice filings (RIA) with all appropriate states
November 14, 2019 Form 13F is due for certain institutional investment managers
November 14, 2019 Form PR filings for registered CTAs that msut file for Q3 within 45 days of the end of Q3 2019
November 29, 2019 Form PF filings for Large Hedge Fund Advisers with December 31 fiscal year-ends filing
November 29, 2019 Large registered CPOs must submit a pool quarterly report (CPO-PQR)
December 16, 2019 Deadline for paying annual IARD charges and state renewal fees
December 31, 2019 Small and mid-sized registered CPOs must submit a pool quarterly report (CPO-PQR)
December 31, 2019 Cayman 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 in order to avoid 2020 CIMA fees
January 1, 2020 California Consumer Privacy Act goes into effect
Periodic Fund managers should perform “Bad Actor” certifications annually
Periodic Amendment due on or before anniversary date of prior Form D and blue sky filing(s), as applicable, or for material changes
Periodic CPO/CTA Annual Questionnaires must be submitted annually, and promptly upon material information changes

 

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

Cole-Frieman & Mallon 2019 Second Quarter Update

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

Clients, Friends, Associates:

We hope you are enjoying the start of summer.  Typically the second quarter is quieter than the first quarter from a compliance perspective, however we continue to see meaningful enforcement actions taken by regulatory authorities and rapid developments in the digital asset space.  Entering the third quarter, we would like to highlight some items we hope will help you stay on top of the business and regulatory landscape in the coming months.

First, though, we’d like to announce a few exciting updates regarding Cole-Frieman & Mallon LLP. Scott E. Kitchens has joined the firm as a partner and will be leading the firm’s new Denver office.  Our firm is once again a founding sponsor of the quickly approaching CoinAlts Fund Symposium. The event will be held in Chicago on September 26th and the founding sponsors will be hosting a pre-conference cocktail hour in Chicago on July 18th.  We look forward to seeing many of you there.

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SEC Matters

SEC Adopts New Regulation Best Interest.  On June 5, 2019, the SEC adopted a package of rules and interpretations to bring a new level of transparency between retail investors, investment advisers and broker-dealers, including the new Regulation Best Interest rule and the Form CRS Relationship Summary.  The new Regulation Best Interest requires broker-dealers to act in the “best interest of retail customers when making a recommendation,” whereas previously broker-dealers were only required to recommend “suitable” investments. Broker-dealers are also required to establish and enforce policies designed to comply with this rule.  The Form CRS Relationship Summary, which will become the new Form ADV Part 3, will require RIAs to provide retail investors with “easy-to-understand information about the nature of their relationship with their financial professional,” including information on services, fees, conflicts, their legal standard of conduct, and prior disciplinary history.  The Form CRS, will be a standardized question-and-answer format and must be presented to retail investors at the beginning of their relationship.  The rules are effective 60 days after their publication in the Federal Register, however broker-dealers and investment advisers are given until June 30, 2020 to ensure compliance.

Individual Liable Under Rule 10b-5 for Knowingly Disseminating False or Misleading Statements Made by Another Person.  On March 27, 2019, the Supreme Court ruled that an individual violated Rule 10b-5 by disseminating statements he knew to be false to potential investors, even though he didn’t “make” the statements himself.  The individual sent an email to potential investors stating the assets of a company seeking investment was $10 million at the direction of his boss, who supplied the content and approved the email, while the individual knew the total assets were worth less than $400,000.  The case may result in an expansion of personal liability for those who transmit false or misleading statements that were made by another.  Managers should ensure that their supervised persons are not repeating false statements even if those statements were made by a superior.

SEC’s Office of Compliance Inspections and Examinations (“OCIE”) Issues Risk Alert.  On May 23, 2019, the OCIE issued a risk alert regarding the safeguarding of customer records and information network storage.  The OCIE observed that many firms did not always use their storage solution’s security features to prevent unauthorized access, including failing to use encryption or password protection.  The OCIE identified the following concerns that may give rise to compliance issues: (i) misconfigured network storage solutions; (ii) inadequate oversight of vendor-provided network storage solutions; and (iii) insufficient data classification policies and procedures. The OCIE encourages registered broker-dealers and investment advisers to evaluate their storage of customer information and consider whether security improvements are necessary.

RIA Settles with SEC for $5 Million for Failing to Implement Compliance Policies Reasonably Designed to Prevent Inaccurate Valuations.  On June 4, 2019, the SEC settled charges and instituted cease-and-desist proceedings against an RIA for failing to adopt compliance policies reasonably designed to prevent the risk that its traders were undervaluing securities by failing to maximize relevant observable inputs, such as trade prices. The RIA’s traders were accused of intentionally marking their bond prices below market value to maximize yield and allow them to sell for a profit when needed, in violation of GAAP.  While the RIA did not admit fault, the SEC alleged that the firm’s policies failed to address how their valuations would be conformed with GAAP, and further, that the adviser failed to implement its existing policy.  The SEC stressed the importance of valuation of client assets in the administrative proceeding, calling it “critically important.”

SEC Imposes Cease-And-Desist Order and Remedial Sanctions Against an RIA for “Cherry-Picking” Trades and Misusing Soft-Dollars.  On May 16, 2019, the SEC imposed a cease-and-desist order and remedial sanctions against an RIA for “cherry-picking” trades and misusing soft-dollars.  The RIA disproportionally allocated profitable trades to hedge funds of which the RIA’s portfolio manager was personally invested, while allocating less profitable trades to other clients, including a charitable foundation.  Further, the RIA allegedly used soft-dollar credits in a manner not disclosed to clients, including use in a principal’s divorce settlement, rent paid to a principal owned company, and maintenance fees on a principal’s personal timeshare.  In addition to disgorgement for both the RIA and portfolio manager, the portfolio manager has been banned from the industry.  This case is a reminder for investment advisers to only use soft-dollar credit to pay for disclosed expenses.

SEC Charges RIA Firm and COO for Cross Trades that Defrauded Client.  On March 15, 2019, the SEC charged a fund manager (an RIA) and its chief operating officer with breaching its fiduciary duties, including the obligation to seek the maximum price for an asset to be sold.  The RIA solicited two unwilling buyers to participate in a real estate auction under the promise that they would not win in order to artificially depress the price and allow a second private fund managed by the RIA to purchase it at a discount.  The RIA later resold the asset from the second private fund for a significant profit and received associated performance fees.  With the SEC’s continued focus on cross trades, fund managers should ensure their cross trade policies effectively identify and manage conflicts of interest.

SEC Proposals to Address Cross-Border Application of Security-Based Swap Requirements.  On May 10, 2019, the SEC proposed a series of rule amendments and guidance with the intention of improving the regulatory framework governing cross-border security-based swaps.  The proposals address the application of security-based swap transaction requirements to non-U.S. entities with U.S. personnel involved in “arranging, negotiating or executing the swaps,” and is intended to align the SEC’s regulatory regime with that of the Commodity Futures Trading Commission.  The SEC sought public comment on the proposed amendments and guidance, with comments due July 2, 2019.

CFTC Matters 

CFTC Approves Final Rule to Provide Exception to Annual Privacy Notice Requirement.  On April 25, 2019, the CFTC approved a final rule to remove the requirement that commodity pool operators and commodity trading advisers, among others, provide annual privacy policy notices to customers when certain conditions are met.  The new rule provides an exception to such annual notice when a financial institution (i) does not share nonpublic personal information except in accordance with certain exceptions adopted by the CFTC and (ii) has not changed its policies and practices with regard to disclosing nonpublic personal information from those policies and practices that the institution most recently disclosed.

CFTC Publishes Public Enforcement Manual.  On May 8, 2019, the CFTC’s Division of Enforcement published its Enforcement Manual for the first time, providing clarity on the CFTC’s investigations and pursuit of violations processes.  In addition to increasing predictability of CFTC enforcement actions, the guide underscores the CFTC’s intention to incentivize self-reporting and cooperation, noting that the value of cooperation with the CFTC will be considered in deciding what charges and sanctions to impose and whether an individual or entity is eligible for a non-prosecution agreement or deferred prosecution agreement. The manual also provides a summary of prohibited conduct subject to investigation, which in addition to traditional enforcement action such as fraud, includes misappropriation of material non-public information and disruptive trading practices. The Enforcement Manual promises to provide meaningful information to advisers who suspect they may have committed a violation.

FINRA Matters 

FINRA Begins Effort to Simplify Firms’ Digital Experience.  On May 14, 2019, FINRA announced the launching of its Digital Experience Transformation, with the goal of simplifying digital interactions between firms and FINRA to create more efficient and effective compliance programs. The transformation is set to be implemented in stages through 2022, focusing on six solution areas identified as priorities by FINRA member firms, including enhanced interaction with FINRA staff and a simplified experience for users.

FINRA Introduces Peer-2-Peer Compliance Library.  FINRA launched its Peer-2-Peer Compliance Library providing a resource for member firms in locating templates, checklists and other materials to supplement FINRA provided materials. The library includes documents provided by FINRA registered firms on six compliance topics: (i) Customer Information, (ii) Cybersecurity, (iii) New Product Review, (iv) Outside Business Activities, (v) Outsourcing & Vendor Management, and (vi) Supervision.  The Library promises to be a useful resource for FINRA registered firms.

Digital Asset Matters

SEC Delays Decision on Two Bitcoin ETFs.  On May 14 and May 20, 2019, the SEC again delayed a decision on two bitcoin ETFs.  The SEC has yet to approve a bitcoin ETF, and is again seeking public comment on the ETF proposals.  The SEC will ultimately need to make a final decision by mid-October.  Cole-Frieman & Mallon LLP submitted a comment in support of approval, arguing it is in the best interest of the bitcoin market that the ETF be approved as it will allow the continued expansion of the digital asset industry and the related ecosystems.

SEC Publishes First Framework in Determining if an ICO Constitutes a Security.  On April 3, 2019, the SEC published its first framework for analyzing whether U.S. securities laws apply to an initial coin offering.  The SEC has confirmed their view that the Howey test should be used to determine if an “investment contract” exists with respect to the sale of a digital asset, thus requiring the sale to either be registered or qualify for an exemption from registration.  The framework gives insight on each of the prongs of the Howey test, which states that an “investment contract exists when there is an investment of money in a common enterprise with a reasonable expectation of profits to be derived from the efforts of others.”  The framework gives examples of several characteristics that are indicative of an investment contract, which promises to provide helpful guidance for those seeking to raise funds through an initial coin offering.

SEC Publishes First No-Action Letter for Cryptocurrency Token Sale. On April 3, 2019, the SEC published the first no-action letter for the offer and sale of tokens by a jet leasing business.  The SEC stated that their no-action position was based on (i) the tokens being fully operational at the time of sale, (ii) the business selling the tokens for $1 each and redeeming each token for $1 of air charter services per token with the business only repurchasing tokens at a discount to face value, and (iii) the restriction on transfer of the tokens to external wallets.  Taken together, the SEC appears to have been satisfied that any purchase of the token would not be for investment purposes.

SEC Sues Online Messaging Application for Conducting $100 Million Unregistered Securities Offering of Digital Tokens.  On June 4, 2019, the SEC sued a Canadian company running a messaging app with conducting an illegal securities offering for raising over $100 million through an initial coin offering without registering the offer and sale as required under securities law.  The complaint alleges that the company advertised the tokens as an investment opportunity and promised to work to promote demand of the token through company efforts, including incorporating the tokens on their messaging app. This case underscores the importance of complying with securities laws when attempting to raise money through coin offerings, as the SEC will seek to enforce such laws if they deem the ICO a securities offering.

IRS Commissioner Announces Cryptocurrency Tax Guidance to be Released Soon.  On May 30, 2019, IRS Commissioner Charles Rettig stated in a letter to congressman Tom Emmer that cryptocurrency tax guidance is a priority of the IRS and should be released “soon.” The Commissioner stated that the IRS is considering several issues, including: (i) acceptable methods for calculating cost basis; (ii) acceptable methods of cost basis assignment; and (iii) tax treatment of forks.  Guidance promises to be welcome by crypto investors as the IRS last issued guidance in 2014, which left several key questions unanswered.  The cryptocurrency market has also seen itself become increasingly complicated since that time with the emergence of forks, airdrops and staking.

SEC Hosts Public Forum to Discuss Distributed Ledger Technology and Digital Assets.  The SEC held a public forum to discuss digital assets on May 31, 2019.  As the second forum on digital assets held by the SEC, it aimed to facilitate greater communication on digital assets between industry, academia, and regulators.  SEC staff moderated panels with fintech insiders covering capital formations, trading and markets, investment management, and distributed ledger technology industry trends.  The SEC also announced at the forum a new program for visiting scholars, seeking qualified professors or PhDs with expertise in blockchain to assists the SEC for one year with their oversight and regulatory processes.  The forum is available to view online.

FinCEN Takes First Enforcement Action Against a Virtual Currency Exchanger.  On April 18, 2019, the Financial Crimes Enforcement Network (“FinCEN”) assessed a $35,350 penalty against a peer-to-peer exchanger of bitcoin for the willful violation of the Bank Secrecy Act’s registration and reporting requirements.  FinCEN found the exchanger was not merely a “user” of virtual currency, but a “money transmitter,” and thus was required to register as a money services business and comply with regulatory requirements applicable to them, including having an effective written AML program, filing SARs on transactions they “know, suspect, or have reason to suspect” are suspicious, and filing currency transaction reports on transactions over $10,000.  Exchangers of virtual currency must be aware they are considered money transmitters and must comply with the Bank Secrecy Act’s regulations or risk monetary penalties and a ban from the industry by FinCEN.  FinCEN has indicated that they will continue to seek enforcement action against exchangers who fail to register as money services businesses.

CFM Summarizes Blockstack Regulation A+ Offering.  We have provided a summary of Blockstack’s Regulation A+ “Tier 2” offering to the SEC.  While Regulation A+ has previously been discussed as a potential avenue for blockchain groups to raise capital, it had been untested until now.  The post summarizes many of the legal and regulatory aspects of Blockstack’s offering, and also highlights interesting business aspects that were revealed.  As Blockstack’s offering was just “qualified” by the SEC, their offering circular promises to work as a guide for future blockchain token projects seeking to raise capital through Regulation A+.

Offshore Matters 

Cayman Islands Announce No Penalties for Delayed Filings.  On April 9, 2019, Cayman Islands announced that while the deadline for Cayman Financial Institutions’ to satisfy their CRS/FATCA reporting obligations was May 31, 2019.  Financial Institutions that report by July 31, 2019 will not be subject to enforcement measures or penalties.

Bermuda Proposes Legislation Exempting Non-Tax Residents from Economic Substance Requirements.  On June 28, 2019, Bermuda’s Economic Substance Amendment Act 2019 became law.  The Amendment creates an exemption from Economic Substance requirements for ‘non-resident entities,’ which is an entity which is a resident for tax purposes in a jurisdiction outside Bermuda, not including those countries in Annex 1 to the EU list of non-cooperative jurisdiction (the so called “black list”).  The change brings Bermuda’s regulations in line with the regulations of the British Virgin Islands and the Cayman Islands, both of which exclude non-resident entities from their substance requirements.

Other Matters 

IRS Issues Qualified Opportunity Fund Guidance.  On April 17, 2019, the IRS issued additional guidance for the deferral of capital gains through investment in qualified opportunity funds.  Crucially, the IRS clarified the “substantially all” requirement for the holding period and use of tangible business property.  Under the regulations, property can qualify as “qualified opportunity zone business property” if substantially all of the use of the property is in a qualified opportunity zone for substantially all of the qualified opportunity fund’s holding period of such property.  The IRS has clarified that the threshold for “substantially all” is (i) 70% with respect to the use of the property; and (ii) 90% with respect to the qualified opportunity fund’s holding period of such property.

IRS Issues Proposed Regulations for Determining Global Intangible Low-Taxed Income.  On  June 14, 2019, the IRS published proposed regulations that provide taxpayers with guidance for determining the amount of global intangible low-taxed income (“GILTI”) to include in gross income.  Importantly for fund managers, the proposed regulations change how the GILTI regime applies to domestic partnerships, adopting an aggregate approach where GILTI is computed at the partner level rather than the entity level.  As the regulations are retroactive to 2018, fund managers who paid GILTI should discuss with their tax advisers if filing an amended tax return is advisable.

Legislature Presented with Two Bills Reforming Cannabis Banking.  Two bills are being considered by Congress that attempt to provide cannabis-related businesses and service providers with access to the banking and financial markets. On March 28, 2019, the House of Representatives Financial Services Committee approved the Secure and Fair Enforcement Banking Act (“SAFE Act”), which would prohibit federal banking and financial regulators and law enforcement from taking action against institutions solely because they provide financial services to cannabis-related businesses and also excludes legitimate cannabis related business from being deemed proceeds from unlawful activity under anti-money laundering laws. On April 4, 2019, the Strengthening the Tenth Amendment Through Entrusting States Act (“STATES Act”) was re-introduced in both the House and the Senate.  The STATES Act would remove state-legal marijuana-related activity from the Controlled Substances Act, significantly restricting federal enforcement abilities of cannabis.  Both bills would significantly alter the cannabis industry, allowing them to access and interact with the economy in ways previously denied to them.

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Compliance Calendar.

 

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

Deadline Filing
June 29, 2019 Delivery of audited financial statements to investors (private fund managers to fund of funds, including SEC, State, and CFTC registrants)
June 30, 2019 Deadline for Cayman Island registered funds with a fiscal year end of December 31 to file the Fund Annual Return and audited financial statements with Cayman Islands Monetary Authority
June 30, 2019 Deadline for making available AIFMD annual report for funds in or advertising in the EU (Alternative Investment Funds with a financial year ending on December 31)
June 30, 2019 Review holdings to determine Form PF filing requirements
July 10, 2019 Review transactions and assess whether Form 13H needs to be amended
July 15, 2019 Quarterly Form PF due for large liquidity fund advisers
July 30, 2019 Quarterly account statements due (Commodity Pool Operators (“CPOs”) claiming the 4.7 exemption)
July 31, 2019 Cayman Islands CRS and US FATCA reporting deadline without adverse consequences (for those who missed the initial May 31, 2018 deadline)
August 14, 2019 Form 13F filing (advisers managing $100 million in 13F Securities)
August 14, 2019 CTA-PR filing with NFA
August 29, 2019 Quarterly Form PF due for large hedge fund advisers
August 29, 2019 CPO-PQR filing with NFA
September 30, 2019 Review transactions and assess whether Form 13H needs to be amended
September 30, 2019 Deadline to designate a MLRO, DMLRO, and AMLCO for Cayman Islands AML compliance
October 15, 2019 Quarterly Form PF due for large liquidity fund advisers
October 15, 2019 Annual Foreign Bank and Financial Accounts Report deadline (for those who missed the April 17 deadline

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

Cole-Frieman & Mallon 2018 Second Quarter Update

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

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July 12, 2018

Clients, Friends, Associates:

We hope that you are enjoying the start of summer.  Although the second quarter is typically not as busy as the first quarter from a regulatory or compliance perspective, we continue to see rapid developments in the digital asset space.  As we move into the third quarter, we would like to provide a brief overview of some items we hope will help you stay abreast of these developments.

In addition to the discussion below, we would like to announce a couple of firm items:

CFM Atlanta.  Our Atlanta office has just moved into new space in the heart of Buckhead.  The new office address is 3348 Peachtree Road NE, Suite 1030, Atlanta, GA 30326.

CoinAlts Fund Symposium. In April founding sponsor Cole-Frieman & Mallon hosted its second full day Symposium attended by over 300 professionals, students, and investors in New York.  Featuring twenty eight speakers, including key-notes, John Burbank of Passport Capital and Mark Yusko of Morgan Creek Capital Management, CoinAlts East presented a broad spectrum of content essential to managers and investors in the digital asset space.  Our next CoinAlts Fund Symposium will take place in San Francisco on September 20, 2018. More details to follow.

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GDPR

GDPR Effective May 25.  The General Data Protection Regulation (“GDPR”) went into effect on May 25, 2018 as part of the European Union’s effort to protect personal data.  Any person or business that handles EU residents’ personal data must comply with the regulation.  GDPR also applies to businesses established outside of the EU if their activities involve processing personal data related to offering goods or services to persons within the EU.  US fund managers with EU resident investors will need to: (i) maintain records of any data processing activities; (ii) obtain EU clients’ affirmative consent to process data; and (iii) provide EU clients with access to the fund’s privacy policy.

Managers with EU resident investors, but no presence within in the EU may also be required to appoint an EU local representative unless they can demonstrate processing is “occasional”, does not include special categories of EU resident personal data, including criminal, on a large scale, and is unlikely to result in a risk to the rights and freedoms of natural persons.  We believe most of our clients generally fall into this exclusion and will not need to appoint an EU representative, but it may be challenging at present to find EU counsel that will advise on this requirement in the absence of more guidance from EU regulators.  For more information on GDPR, including compliance items for hedge fund managers, please see our earlier post.

Legal and Regulatory Developments

SEC Proposes Rules Regarding Form CRS, Form ADV, and Disclosures in Retail Communications.  On April 18, 2018, the Securities and Exchange Commission (“SEC”)  proposed new rules and amendments to certain rules and forms under the Investment Advisers Act of 1940, as amended (“Advisers Act”) and the Securities Exchange Act of 1934, as amended.  One proposal would require both registered investment advisers and broker-dealers to provide a summary (“Form CRS”) disclosing the nature and details of their relationship to retail investors.  Form CRS would be added as a section to Form ADV and would disclose: (i) the relationships and services the firms offer; (ii) the standard of conduct and fees and costs associated with the services; (iii) specified conflicts of interest; and (iv) reportable legal or disciplinary events on the firm’s part or its financial professionals.

The SEC also proposed two new rules to reduce investor confusion caused by communications with broker-dealers and investment advisers by placing additional requirements on retail investor communications.  One rule would restrict broker-dealers’ use of the terms “adviser” and “advisor” when communicating with retail investors.  The other rule would require broker-dealers and investment advisers to disclose their SEC registration status in retail investor communications.  It would also require associated natural persons and supervised persons to disclose their relationships with broker-dealers or investment advisers in retail investor communications.  Comments to the SEC are due on or before August 7, 2018.

SEC Proposes Interpretation of Standard of Conduct for Investment Advisers.  On April 18, 2018, the SEC proposed an interpretation of the conduct standard for investment advisers under the Advisers Act and requested comment on its proposal.  The SEC also seeks comment on the following proposed requirements for SEC registered investment advisers (“RIAs”): (i) federal licensing and continuing education; (ii) periodic account statements; and (iii) financial responsibility requirements similar to those required of broker-dealers.  Comments to the SEC are due on or before August 7, 2018.

SEC Charges 13 Private Fund Advisers for Repeated Form PF Filing Failures.  On June 1, 2018, the SEC  announced settlements with 13 SEC RIAs for repeatedly failing to provide risk monitoring information.  The SEC found that the advisers continually failed to file annual reports on Form PF.  Section 204(b) of the Advisers Act requires large fund managers to report information such as assets under management, fund strategy, and fund performance on Form PF.  The SEC uses these reports to inform their rulemaking process and to target examinations and enforcement investigations.  The SEC found that each of the advisers violated the Form PF reporting requirements under the Advisers Act.  Although the advisers did not admit or deny the SEC’s findings, they agreed to be censured, cease and desist, and to each pay a $75,000 civil penalty.

SEC Charges Hedge Fund Adviser with Deceiving Investors.  On May 9, 2018, the SEC charged a hedge fund adviser and certain principals, including the CEO and a former portfolio manager, for fraudulently overvaluing its funds by hundreds of millions of dollars.  Defendants are alleged to have placed trades in exchange for inflated broker-dealer quotes and applied “imputed” mid-point valuations in a manner that further inflated the value of securities.  The SEC is seeking permanent injunctions, the return of illicit profits with interest, and civil penalties.

SEC Charges Hedge Fund Firm for Asset Mismarking and Insider Trading.  The SEC announced on May 8, 2018 that a manager agreed to settle charges regarding insider trading and fraudulent overvaluation of certain assets held by its hedge funds.  The SEC found that two of the portfolio managers overstated the values of their hedge funds’ securities.  In a separate order, the SEC alleged that the CFO failed to supervise the two portfolio managers appropriately and respond to red flags regarding the mismarking.  The SEC also found that the portfolio managers violated insider trading laws by trading pharmaceutical securities on confidential information obtained through a former U.S. Food and Drug Administration official.

Second Circuit Amends Martoma Decision.  On June 25, 2018, the U.S. Court of Appeals for the Second Circuit amended its decision in United States v. Martoma to clarify tippee liability in insider trading cases.  As we discussed in a previous Quarterly Update, the Second Circuit once again upheld a former portfolio manager’s 2014 conviction for insider trading.  In its amended decision, the court confirmed that a “meaningfully close personal relationship” is not required for tippee liability in insider trading cases.

Digital Asset Matters

We see many thought-provoking items in the digital asset sector as the industry moves towards greater institutional infrastructure.  After numerous public statements by SEC officials, token issuers understand that there are several compliant ways to raise capital through token offerings.  One way is through Regulation A+, which has many advantages over other securities offering mechanisms.  We are also seeing many groups use airdrops as a way to try to circumvent the private placement regulatory regime.  One item to specifically note, is that privately placed tokens may have resale restrictions that could create issues for both the token issuers and token purchasers.  We are also aware of several groups beginning the process of registering as alternative trading systems or otherwise becoming broker-dealers and/or qualified custodians.

Outside of these items, we have summarized some notable regulatory developments in the second quarter.  For a complete review of these developments, please consult our Digital Asset Regulatory Items blog post.

CFTC Issues Advisory on Virtual Currency Derivatives.  On May 21, 2018, the Commodity Futures Trading Commission (“CFTC”) Division of Market Oversight and the Division of Clearing and Risk issued an advisory regarding virtual currency derivative products.  The CFTC outlined key expectations for exchanges and clearinghouses operating in the virtual currency derivatives space:

  • Enhanced Market Surveillance – an adequate market surveillance program would include sharing information on the underlying spot markets, allowing the CFTC to access a broad range of exchange trade data (i.e., trader identity, volumes, times, prices, and quotes), and real-time monitoring of all trading activity to identify red flags.
  • Close Coordination with the CFTC Surveillance Group – exchanges should engage in regular discussions with the CFTC on surveillance of virtual currency derivatives contracts and allow access to data on settlement processes referenced in such contracts.
  • Large Trader Reporting – exchanges should set large trader reporting thresholds for any contract at five BTC (or equivalent) to increase their ability to focus on relevant market information.
  • Outreach to Members and Market Participants – exchanges should obtain comments from stakeholders on listing issues beyond contract terms and conditions.  Comments should include explanations of opposing views and the exchanges’ perspectives.
  • Derivative Clearing Organization’s Risk Management – the CFTC requests information from derivative clearing organizations (“DCOs”) necessary to assess the suitability of proposed initial margin requirements.  The CFTC may require DCOs to amend inadequate initial margins.  They may also request information regarding the approval process of proposed contracts.

NASAA Combats ICO Fraud.  On May 21, 2018, the North American Securities Administrators Association (“NASAA”) announced its involvement in “Operation Cryptosweep,” one of the largest coordinated enforcement efforts against fraudulent Initial Coin Offerings (“ICOs”), crypto-related products, and cryptocriminals.  Operation Cryptosweep is a combined effort between NASAA’s members, spanning more than 40 jurisdictions in the United States and Canada.  Since April 2018, the operation has produced almost 70 inquiries and investigations in addition to 35 pending or completed enforcement actions related to digital assets and ICOs, including multiple actions against private funds.  According to NASAA President Joseph Borg, these recent actions are only the beginning of further enforcement against ICO fraud.

Other Items

5th Circuit Issues Mandate on Fiduciary Rule.  On June 21, 2018, the U.S. Court of Appeals for the Fifth Circuit issued a mandate regarding the Department of Labor’s (“DOL’s”) Fiduciary Rule (“Fiduciary Rule”) after months of uncertainty.  The Fifth Circuit’s mandate effectuates its March 15 decision to vacate the Fiduciary Rule.  Although the DOL’s Fiduciary Rule appears defeated, the court’s decision may prompt the SEC and other regulators to revisit their plans for fiduciary reform.

Section 3(c)(1) of the Investment Company Act Amended.  President Trump authorized the Economic Growth, Regulatory Relief, and Consumer Protection Act (“Growth Act”) on May 24, 2018.  A portion of the Growth Act amends Section 3(c)(1) of the Investment Company Act of 1940, as amended, by increasing the number of investors allowed in a qualifying venture capital fund from 100 to 250 investors.  The Growth Act —  which will take effect in late 2019 —  defines a qualifying venture capital fund as one with less than $10 million “in aggregate capital contributions and uncalled committed capital.”

The CFTC and NASAA Sign Information Sharing Memorandum.  The CFTC and NASAA signed a Memorandum of Understanding (“MOU”) regarding the sharing of non-public information on May 21, 2018.  The MOU aims to forge a closer working relationship between the CFTC and individual state securities agencies— represented by the NASAA— to better enforce the U.S. Commodity Exchange Act of 1936, as amended (“CEA”) by promoting voluntary, inter-agency sharing of non-public information.  NASAA President Joseph Borg believes the MOU could assist NASAA members in enforcing both securities and commodities law violations, particularly against schemes related to digital assets and other modern commodities.

NFA Develops Swaps Proficiency Program and Exam.  The National Futures Association (“NFA”) announced on June 5, 2018 that its board approved the creation of an online proficiency requirements program and exam for all associated persons participating in swaps activities.  The swaps proficiency program is part of the NFA’s mandate under the CEA, which requires the NFA to set training standards and proficiency testing for individuals and activities governed thereunder.  The online program and exam are expected to launch in early 2020.

Cayman Islands Revises and Clarifies AML Regulations.  As mentioned in previous updates, the Cayman Islands released the 2018 revisions to its Anti-Money Laundering (“AML”) regulations earlier this year.  The following are some notable changes:

  • Non-Cayman Islands Monetary Authority (“CIMA”) registered funds (i.e., 4(4) funds) will be subject to AML regulations;
  • All investment funds (registered and unregistered) must designate natural persons to act as Anti-Money Laundering Compliance Officers (“AMLCOs”), Money Laundering Reporting Officers (“MLROs”), and Deputy Money Laundering Reporting Officers (“DMLROs”) by September 30, 2018 or, for funds registering after June 1, 2018, upon submission of the registration application; and
  • All investment funds (registered and unregistered) will be subject to enhanced AML processes and procedures.

CIMA also released a notice on April 6, 2018 to clarify its guidance notes on the AML regulations.

The guidance clarified that a fund could designate the same individual to serve as its AMLCO and MLRO.  Also, if an MLRO, DMLRO, and AMLCO have been appointed, a person carrying out the relevant financial business of a fund may delegate to another the performance of functions outlined in the AML regulations.  Significantly, managers should also note that these officers may be exposed to criminal sanctions for breach of their obligations.  Failure to comply with CIMA’s AML regulations could result in an unlimited fine and imprisonment for two years.  We recommend that fund managers discuss AML compliance and implementation issues with offshore counsel and the fund’s administrator.

Cayman Islands Appeals Court Holds That a Liquidator May Not Adjust a Shareholder’s NAV.  The Cayman Islands Court of Appeal held that an official liquidator of a fund could not change a contractually agreed upon net asset value (“NAV”), even if it were based upon fraudulent numbers.  The judge agreed with the lower court that allowing adjustment of the NAV would “interfere with the shareholders’ proprietary rights,” an action that legislators did not intend to permit.  This outcome may benefit shareholders by providing certainty regarding a fund’s NAV and the benefits derived from “their rights under a valid and subsisting contract.”

Cayman Issues AEOI Portal Update.  On May 29, 2018, the Cayman Islands issued an update regarding the Automatic Exchange of Financial Account Information Portal (“AEOI”).  The statutory deadline for filing Common Reporting Standard (“CRS”) and US Foreign Account Tax Compliance Act, as amended, (“FATCA”) reporting was May 31, 2018.  However, the Cayman Islands Department for International Tax Cooperation will allow Cayman Financial Institutions until July 31, 2018 to fulfill their 2017 CRS and US FATCA reporting obligations without facing adverse consequences, compliance measures, or penalties.

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

Deadline – Filing

  • June 29, 2018 – Delivery of audited financial statements to investors (private fund managers to fund of funds, including SEC, state, and CFTC registrants)
  • June 30, 2018 – Deadline for Cayman Island registered funds with a fiscal year end of December 31 to file the Fund Annual Return and audited financial statements with CIMA
  • June 30, 2018 – Deadline for making available AIFMD annual report for funds in or advertising in the EU (Alternative Investment Funds with a financial year ending on December 31st)
  • June 30, 2018 – Review transactions and assess whether Form 13H needs to be amended
  • July 15, 2018 – Quarterly Form PF due for large liquidity fund advisers
  • July 30, 2018 – Quarterly account statements due (CPOs claiming the 4.7 exemption)
  • July 30, 2018 – Collect quarterly reports from access persons for their personal
    securities transactions
  • July 31, 2018 – Cayman Islands CRS and US FATCA reporting deadline without adverse consequences (for those who missed the initial May 31, 2018 deadline)
  • August 14, 2018 – Form 13F filing (advisers managing $100 million in 13F Securities)
  • August 14, 2018 – CTA-PR filing with NFA
  • August 29, 2018 – Quarterly Form PF due for large hedge fund advisers
  • August 29, 2018 – CPO-PQR filing with NFA
  • September 30, 2018 – Review transactions and assess whether Form 13H needs to amended
  • September 30, 2018 – Deadline to designate an MLRO, DMLRO, and AMLCO for Cayman Islands AML compliance
  • October 15, 2018 – Quarterly Form PF due for large liquidity fund advisers
  • October 15, 2018 – Annual Foreign Bank and Financial Accounts Report deadline (for those who missed the April 17 deadline)
  • Periodic – Fund managers should perform “Bad Actor” certifications annually
  • Periodic – Amendment due on or before anniversary date of prior Form D filing(s), or for material changes
  • Periodic – CPO/CTA Annual Questionnaires must be submitted annually, and promptly upon material information changes
  • Periodic – Form D and blue sky filings should be current

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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.

Cole-Frieman & Mallon 2018 First Quarter Update

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

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April 5, 2018

Clients, Friends, Associates:

The first quarter of 2018 has seen many developments impacting traditional hedge fund managers as well as those in the digital asset space. We enter the second quarter with many topics worthy of discussion, including a number of important regulatory issues currently on the horizon.  Below, is our short overview of some of these items.

Before we begin though we’d like to quickly provide a couple of significant updates on Cole-Frieman & Mallon LLP. Effective January 1, 2018 we are delighted to announce that David C. Rothschild has been promoted to partner and welcome Kevin Cott as head of our Atlanta office following the merger of Cott Law Group, P.C. with our firm.

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CoinAlts East

CFM is a founding sponsor of the one-day symposium for digital asset managers in New York on April 19, 2018. The CoinAlts East Fund Symposium will feature a number of panelists (including Bart Mallon and Karl Cole-Frieman) with expertise in the legal and operational aspects of running a digital asset strategy. Keynote speakers are John Burbank of Passport Capital and Mark Yusko of Morgan Creek Capital Management, with opening remarks from Corey Johnson of Ripple and closing remarks by Don Wilson of DRW. The inaugural symposium, held in September in San Francisco, sold out with more than 450 attendees.

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SEC Matters

SEC Published Examination Priorities for 2018. The SEC announced its Examination Priorities for 2018, with a continued focus on examining matters of importance to retail investors, particularly risks to elderly and retiring investors. Specifically, the SEC will focus on: (i) disclosure and calculation of fees and other compensation, robo-advisers and other automated electronic investment advice platforms, never-examined investment advisers and exchange-traded funds, services offered to investors with retirement accounts, and regulatory compliance of advisers and broker-dealers in the cryptocurrency and initial coin offering (ICO) space; (ii) compliance and risk in critical market infrastructure, including clearing agencies, national securities exchanges, transfer agents, and Regulation Systems Compliance and Integrity (SCI) entities; (iii) FINRA and MSRB; (iii) cybersecurity; and (iv) anti-money laundering programs.

SEC Chairman Testifies on The Roles of the SEC and CFTC Concerning Virtual Currencies. On February 6, 2018, SEC Chairman Jay Clayton offered testimony to the Senate Committee on Banking, Housing, and Urban Affairs about the role of the SEC and CFTC in the regulation of cryptocurrencies, ICOs and related activities. Chairman Clayton expressed his support for new technological innovations in the financial markets, while emphasizing that these innovations should not be made at the expense of protecting investors and markets. The Chairman reaffirmed that whenever securities are bought and sold, investors are entitled to the protections and benefits of state and federal securities laws.

The Chairman also stressed that ICOs should be viewed in the context of securities laws and that many ICOs claiming to be “utility tokens” may be securities, notwithstanding labels or the provision of some utility. Further, the Chairman stated most ICOs to date that he has seen have been offers and sales of securities. As a sign of the SEC’s commitment to this policy, Clayton pointed to the establishment of a new cyber unit focused on misconduct involving ICOs and distributed ledger technology, and enforcement actions initiated against fraudulent ICOs.

SEC Staff Letter on Digital Asset Funds. On January 18, 2018, Dalia Blass, the Director of Investment Management at the SEC, published a staff letter addressing issues the SEC has identified for registered funds and products focused on cryptocurrency. While the letter does not address private funds, it outlines various questions addressing how cryptocurrency funds would satisfy the securities laws. The key concerns outlined in the letter include:

  • Uncertainty around valuation of cryptocurrencies;
  • Ensuring liquidity for fund investors;
  • Ability to satisfy custody requirements given the lack of qualified custodians;
  • Compliance by ETFs given market volatility; and
  • Potential manipulation of cryptocurrency markets.

In light of the questions and uncertainties identified, the letter expresses the belief that cryptocurrency funds should withdraw registration statements.

SEC Action against Initial Coin Offering. On January 30, 2018, the SEC obtained a court order for an immediate asset freeze to halt an allegedly fraudulent ICO targeting retail investors and claiming to be the world’s first “decentralized bank”. The complaint alleges among other violations, the ICO was an illegal offering of securities and the sponsors made multiple false and misleading statements, including that its customers could be covered under federal deposit protections due to its purchase of a bank. The SEC is seeking preliminary and permanent injunctions, disgorgement of ill-gotten gains plus interest and penalties, and bars against the two co-founders to prohibit them from serving as officers or directors of a public company or offering digital securities again in the future. This SEC complaint highlights the SEC’s increased vigilance in pursuing securities violations in the cryptocurrency and ICO space.

SEC Statement on Unregistered Digital Asset Exchanges. On March 7, 2018, the SEC released a public statement affirming its view that platforms that trade securities and operate as exchanges must register as a national securities exchange or operate under an exemption from registration. This announcement reflects the SEC’s growing interest in online virtual currency trading platforms. The public statement offers advice to investors about how to stay safe while investing on these platforms. Additionally, the statement lists considerations for market participants operating online trading platforms and encourages those market participants to consult with legal counsel and contact SEC staff for assistance in analyzing and applying the federal securities laws.

CFTC Matters

CFTC Issues Virtual Currency Pump-and-Dump Customer Protection Advisory. On February 15, 2018 the CFTC issued its first Customer Protection Advisory focused on virtual currency, specifically warning against “pump-and-dump” schemes. As described in the advisory, pump-and-dump schemes are coordinated online efforts to artificially drive up demand for a virtual currency then quickly sell. In the advisory, the CFTC asserted its general anti-fraud and manipulation enforcement authority over virtual currency cash markets as a commodity. The CFTC advises all customers to only purchase virtual currency or tokens after thorough research.

District Judge Agrees with CFTC Jurisdiction Over Virtual Currencies. On March 6, 2018, a district court judge in the eastern district of New York found that the CFTC has standing in a case related to virtual currency fraud. The judge agreed with the CFTC that virtual currencies can be regulated as a commodity, despite other regulatory agencies asserting jurisdiction over virtual currencies in some cases. The judge also agreed the CFTC’s jurisdiction can be justifiably expanded into spot trade commodity fraud, beyond the classic “futures” contracts for commodities traditionally focused on by the CFTC. The court granted the CFTC a preliminary injunction against the defendants as the case continues.

CFTC Launches Virtual Currency Resource Web Page. The CFTC launched its own resource dedicated to virtual currency, designed to provide information to the public regarding possible risks involved with investing or speculating in virtual currencies. It includes a primer on virtual currency, tips to avoid fraud, a podcast that includes CFTC staff discussing virtual currencies, and other reference sources relating to the CFTC and virtual currency.

FINRA Matters

FINRA Published Regulatory and Examination Priorities Letter for 2018. Similar to the SEC, the Financial Industry Regulatory Authority, Inc. (“FINRA”) recently published its 2018 Regulatory and Examination Priorities Letter, outlining the organization’s enforcement priorities for the current year. FINRA’s specific focus areas for 2018 will include: (i) fraud, particularly microcap fraud schemes that target senior investors; (ii) hiring and supervisory practices for high-risk firms and brokers; (iii) cybersecurity; (iv) anti-money laundering; (v) sales practices and product suitability for specific investors, including the supervisory, compliance, and operational infrastructure firms have put in place with respect to ICOs; and (vi) investor protections related to market manipulation. We recommend that you speak with your firm’s outside counsel and service providers to learn more about these specific priorities and review your firm’s compliance with the applicable regulations.

Other Digital Asset Matters

We have detailed some of the major digital asset regulatory releases for the first quarter of this year in a separate post.  In addition to this information, there are some other items of note below.

U.S. Deputy Secretary of Treasury Provides Testimony On Financial Threats. On January 17, 2018, the U.S. Deputy Secretary of Treasury, Sigal Mandelker, testified before the Senate Committee on Banking, Housing, and Urban Affairs regarding a litany of financial threats to national security as well as the U.S. and global financial systems. Among the threats mentioned were emerging technologies including virtual currency. Mandelker emphasized FinCEN’s global focus on ensuring virtual currency providers and exchangers improve compliance activities. Mandelker’s testimony further evidences governmental agencies’ increasing focus on virtual currencies.

Proposed Virtual Currency Regulations Introduced in Hawaii and Nebraska. Multiple bills proposing to regulate cryptocurrency have been introduced in Hawaii and Nebraska. In Hawaii, one  proposal defines virtual currency and exempts virtual currency money transmitters from the state requirement to possess reserves to cover all outstanding customer investments. A second  proposal in Hawaii requires certain persons engaging the exchange, transfer, or storage of virtual currency in the state to be licensed. The proposal also outlines various other requirements for such a licensee, including the requirement to provide extensive personal information. Additionally, proposals in Hawaii, Connecticut, and Nebraska have been introduced to adopt the Uniform Regulation of Virtual-Currency Businesses Act (URVCBA) developed by the Uniform Law Commission (ULC), which provides a three-tiered structure for registration and licensing.

In Wyoming, multiple bills were passed related to virtual currency. A law was passed that exempts virtual currency from the Wyoming Money Transmitter Act. The Wyoming legislature also passed a law that specifies criteria by which an issuer of virtual currency will not be deemed an issuer of a security in Wyoming. Another law was also passed in Wyoming that exempts virtual currency from Wyoming property tax.

President issues executive order on Venezuela’s Digital Currency. On March 19, 2018, the President of the United States issued an executive order prohibiting transactions by United States persons or within the United States related to any digital currency issued by the Venezuelan government on or after January 9, 2018. This order was made in response the Venezuelan’s government’s issuance of a digital currency in an attempt to avoid United States sanctions. The order also provides that no prior notice is necessary for this order given the ability to transfer assets instantaneously.

Other Items

Fifth Circuit Vacates DOL Fiduciary Rule. On March 15, 2018, the Fifth Circuit Court of Appeals  issued a judgment vacating the Department of Labor Fiduciary Rule in its entirety, which we  discussed in an earlier update. The Fiduciary Rule expanded the definition of a “fiduciary” to include anyone making a securities or investment property “recommendation” to an employee benefit plan or retirement account. The rule also included 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. The Court vacated the rule, finding that the Department of Labor lacked the authority to enact the rule under ERISA. The Court stated, in part, that Congress did not intend to expand the definition of fiduciary in passing ERISA in 1974. Just days earlier, the Tenth Circuit upheld a portion of the Fiduciary Rule, opening up additional uncertainty about the rule and inviting the Supreme Court to provide clarification.

CIMA Releases Guidance Notes for changes to its AML regulations. The Cayman Islands Monetary Authority (CIMA) has released guidance notes on its 2017 revisions to its Anti-Money Laundering Regulations, which were discussed in our previous quarterly update. The new guidance, in part, provides details of the requirements when compliance under the revisions are outsourced or delegated. If you have any questions, we recommend that you reach out to your administrator or offshore counsel.

Supreme Court Narrows Dodd-Frank Whistleblower Protection. On February 21, 2018, in a unanimous decision, the Supreme Court of the United States held in Digital Realty Trust, Inc. v. Somers, that the anti-retaliation provision of the 2010 Dodd-Frank Act covers only individuals who have reported a violation of the securities laws to the SEC. The Dodd-Frank Act does not protect individuals who only report violations internally. This ruling does not affect the anti-retaliation provisions of the Sarbanes-Oxley Act which protects whistleblowers who report certain types of misconduct internally in public companies.

IRS Clarifies Carried Interest Taxation Regulation. On December 22, 2017, Congress passed the Tax Reform Act which, among other items, alters the taxation of carried interest. Under section 1061 of the Act, carried interest must be held for at least three years in order to recognize long-term capital gains on the distribution of that interest. Section 1061 provides an exception for partnership interests held by a corporation.

On March 1, 2018, the Internal Revenue Service and Department of the Treasury issued Notice 2018-18 announcing their intent to issue regulations providing guidance for section 1061 of the Internal Revenue Code. Specifically, the guidance would exclude “S corporations” from the definition of a “corporation” as applied to carried interest taxation. This guidance will be applied retroactively and is effective for taxable years beginning after December 31, 2017. Managers should discuss further implications with their tax advisor and legal counsel.

Supreme Court Narrows Scope of Bankruptcy Code Securities Clawback Safe Harbor. In a unanimous opinion, the United States Supreme Court narrowed the scope of transactions qualifying for protection under section 546(e) of the Bankruptcy Code. This provision generally provides an exception that disallows a bankruptcy trustee from recovering a settlement payment made by a financial institution in connection with a securities contract. The court’s ruling means that such exception will not apply when the financial institution acts only as an intermediary.

SEC Encourages Self-Reporting of Share Class Selection Disclosures. The SEC announced its Share Class Selection Disclosure Initiative (SCSD Initiative) which encourages investment advisers to self-report securities violations with respect to failure to make disclosures concerning mutual fund share class selection. Investment advisers are required to disclose the conflict of interest that arises when an adviser receives 12b-1 fees for a share class when a less expensive share class is available for the same fund. Generally, qualifying settlements with the SEC will require the adviser to return profits on the transaction to the harmed clients, but not impose any further monetary penalties. For those advisers that do not take advantage of the initiative, the SEC is still focused on violations associated with mutual fund share class selection.

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

Deadline – Filing

  • March 31, 2018 – Deadline to update and file Form ADV Parts 1, 2A & 2B
  • April 10, 2018 – Amendment to Form 13H due if necessary
  • April 16, 2018 – 1st Quarter 2018 Form PF filing for quarterly filers (Large Liquidity Fund Advisers)
  • April 30, 2018 – Collect quarterly reports from access persons for their personal securities transactions
  • April 30, 2018 – Distribute code of ethics and compliance manuals to employees. Require acknowledgement form to be executed in connection with such delivery
  • April 30, 2018 – Annual Privacy Notice sent to all clients or fund investors (for Advisers with Fiscal Year ending December 31)
  • April 30, 2018 – Distribute audited financial statements to investors (most private fund managers, including SEC, state and CFTC registrants)
  • April 30, 2018 – Distribute Form ADV Part 2 to clients
  • April 30, 2018 – Quarterly NAV Report (registered commodity pool operators claiming the 4.7 exemption)
  • April 30, 2018 – 2017 Annual Form PF due date for annual filers (Large Private Equity Fund Advisers and Smaller Private Fund Advisers)
  • May 15, 2018 – Quarterly Commodity Trading Advisor Form PR filing
  • May 15, 2018 – File Form 13F for first quarter 2018
  • May 31, 2018 – First deadline for Cayman Islands Financial Institutions to submit their CRS returns to the Cayman Islands Tax Authority
  • May 31, 2018 – Third reporting deadline (full reporting) for Cayman Islands Financial Institutions with reporting obligations under the Cayman FATCA regulatory framework to report their U.S. Reportable Accounts to the Cayman Islands Tax Authority
  • June 30, 2018 – Distribute audited financial statements to investors (private fund managers to funds of funds, including SEC, state and CFTC registrants)

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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.

Cole Frieman & Mallon 2017 End of Year Update

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

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December 15, 2017

Clients, Friends, Associates:

Holiday celebrations bring welcomed joy and excitement to the busiest time of year for most investment managers.  As we prepare for a new year, we also reflect on an eventful 2017 year that included the emergence of a new asset class, a steady upswing in the stock market, and proposed legislation to revise the United States tax code. Regardless of all of the changes to the investment management space, year-end administrative upkeep and 2018 planning are always particularly important, especially for General Counsels, Chief Compliance Officers (“CCO”), and key operations personnel. As we head into 2018, we have put together this checklist and update to help managers stay on top of the business and regulatory landscape for the coming year.

This update includes the following:

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

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Cryptocurrency Leadership:

This year digital assets and cryptocurrencies have emerged in force as a separate and distinct asset class. An increased interest in this asset class from fund managers, financial institutions and various government leaders and regulators throughout the world has led to an exponential growth of cryptocurrency investments, the CFTC’s approval of two exchanges to trade Bitcoin futures contracts has increased attention on the asset class.

For SEC registered investment advisers who are adding cryptocurrencies to their fund investment programs and for cryptocurrency focused fund managers who may be relying on SEC exemptions from registration, the need to understand the regulatory implication of certain practices is of utmost importance. Specifically, managers face uncertainty regarding the application of the qualified custodian requirement under Rule 206(4)-2 (“Custody Rule”) under the Investment Advisers Act of 1940, as amended (“Advisers Act”).  Under the Custody Rule, if a registered investment adviser has custody of “client funds or securities”, then it must maintain those client assets with a qualified custodian (generally a bank, broker-dealer, FCM or other financial institution), subject to certain exceptions. Currently we know of only one qualified custodian capable of holding certain cryptocurrencies or digital assets. Our firm participated in a meeting with the SEC in November about custody issues for cryptocurrency managers and continues to engage with the SEC on this issue as well as work with the SEC and other service providers in this space to help lead the way to comply with SEC rules and regulations.

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Annual Compliance & Other Items:

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

Annual Compliance Review. On an annual basis, the CCO of an RIA must conduct a review of the adviser’s compliance policies and procedures. This annual compliance review should be in writing and presented to senior management. We recommend that firms discuss the annual review with their outside counsel or compliance firm, who can provide guidance about the review process as well as a template for the assessment and documentation. Advisers should be careful that sensitive conversations regarding the annual review are protected by attorney-client privilege. CCOs may also want to consider additions to the compliance program. Advisers that are not registered may still wish to review their procedures and/or implement a compliance program as a best practice.

Form ADV Annual Amendment. RIAs or managers filing as exempt reporting advisers (“ERAs”) with the SEC or a state securities authority, must file an annual amendment to Form ADV within 90 days of the end of their fiscal year. For most managers, the Form ADV amendment would be due on March 31, 2018. This year, because March 31st is a Saturday and March 30th is a market holiday, annual amendments to the Form ADV shall be filed no later than the business day following the 90-day deadline (April 2, 2018). RIAs must provide a copy of the updated Form ADV Part 2A brochure and Part 2B brochure supplement (or a summary of changes with an offer to provide the complete brochure) to each “client”. Note that for SEC-registered advisers to private investment vehicles, a “client” for purposes of this rule includes the vehicle(s) managed by the adviser, and not the underlying investors. State-registered advisers need to examine their state’s rules to determine who constitutes a “client”.

Switching to/from SEC Regulation.

SEC Registration. Managers who no longer qualify for SEC registration as of the time of filing the annual Form ADV amendment must withdraw from SEC registration within 180 days after the end of their fiscal year by filing Form ADV-W. Such managers should consult with their state securities authorities to determine whether they are required to register in the states in which they conduct business. Managers who are required to register with the SEC as of the date of their annual amendment must register with the SEC within 90 days of filing the annual amendment.

Exempt Reporting Advisers. Managers who no longer meet the definition of an ERA will need to submit a final report as an ERA and apply for registration with the SEC or the relevant state securities authority, if necessary, generally within 90 days after the filing of the annual amendment.

Custody Rule Annual Audit.

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

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 by an independent public accountant registered with the Public Company Accounting Oversight Board (“PCAOB”). Statements must be sent to the fund or, in certain cases, investors in the fund, within 120 days after the fund’s fiscal year-end. Managers should review their custody procedures to ensure compliance with the rules.

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

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

California Minimum Net Worth Requirement and Financial Reports.

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

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

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

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

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

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

Soft Dollars. Managers that participate in soft dollar programs should make sure that they have addressed any commission balances from the previous year.

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

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

Form 13F. A manager must file a Form 13F if it exercises investment discretion with respect to $100 million or more in certain “Section 13F securities” within 45 days after the end of the year in which the manager reaches the $100 million filing threshold. The SEC lists the securities subject to 13F reporting on its website.

Form 13H. Managers who meet the SEC’s large trader thresholds (in general, managers whose transactions in exchange-listed securities equal or exceed two million shares or $20 million during any calendar day, or 20 million shares or $200 million during any calendar month) are required to file an initial Form 13H with the SEC within 10 days of crossing the threshold. Large traders also need to amend Form 13H annually within 45 days of the end of the year. In addition, changes to the information on Form 13H will require interim amendments following the calendar quarter in which the change occurred.

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

SEC Form D. Form D filings for most funds need to be amended on an annual basis, on or before the anniversary of the most recently filed Form D. Copies of Form D is 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 renewal requirements. Several states impose late fees or reject late filings altogether. Accordingly, it is critical to stay on top of filing deadlines for both new investors and renewals. We also recommend that managers review blue sky filing submission requirements. Many states now permit blue sky filings to be filed electronically through the Electronic Filing Depository (“EFD”) system, and certain states will now only accept filings through EFD.

IARD Annual Fees. Preliminary annual renewal fees for state-registered and SEC-registered investment advisers are due on December 18, 2017. If you have not already done so, you should submit full payment into your Renewal Account by E-Bill, check or wire now.

Pay-to-Play and Lobbyist Rules. SEC rules disqualify investment advisers, their key personnel and placement agents acting on their behalf, from seeking to be engaged by a governmental client if they have made political contributions. State and local governments have similar rules, including California, which requires internal sales professionals who meet the definition of “placement agents” (people who act for compensation as finders, solicitors, marketers, consultants, brokers, or other intermediaries in connection with offering or selling investment advisory services to a state public retirement system in California) to register with the state as lobbyists and comply with California lobbyist reporting and regulatory requirements. Note that managers offering or selling investment advisory services to local government entities must register as lobbyists in the applicable cities and counties.

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

Annual Fund Matters:

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

ERISA Status. Given the significant problems that can occur from not properly tracking ERISA investors in private funds, we recommend that managers confirm or reconfirm on an annual basis the ERISA status of their investors. This is particularly important for managers who may be deemed a fiduciary under the Department of Labor’s (“DOL”) Fiduciary Rule (as further discussed below).

Wash Sales. Managers should carefully manage wash sales for year-end. Failure to do so could result in embarrassing book/tax differences for investors. Certain dealers can provide managers with swap strategies to manage wash sales, including Basket Total Return Swaps and Split Strike Forward Conversion. These strategies should be considered carefully to make sure they are consistent with the investment objectives of the fund.

Redemption Management. Managers with significant redemptions at the end of the year should carefully manage unwinding positions so as to minimize transaction costs in the current year (that could impact performance) and prevent transaction costs from impacting remaining investors in the next year. When closing funds or managed accounts, managers should pay careful attention to the liquidation procedures in the fund constituent documents and the managed account agreement.

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

Fund Expenses. Managers should wrap up all fund expenses for 2017 if they have not already done so. In particular, managers should contact their outside legal counsel to obtain accurate and up to date information about legal expenses for inclusion in the NAV for year-end performance.

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

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

U.S. FATCA. Funds should monitor their compliance with U.S. Foreign Account Tax Compliance Act (“FATCA”) U.S. FATCA reports are due to the IRS on March 31, 2018 or September 30, 2018, depending on where the fund is domiciled. 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 for this year, we strongly encourage managers to file the required reports and notifications, even if they already missed previous deadlines. Applicable jurisdictions may be increasing enforcement and monitoring of FATCA reporting and imposing penalties for each day late.

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 Cayman Islands and British Virgin Islands are required to register with the respective jurisdiction’s Tax Information Authority and submit returns to the applicable CRS reporting system by May 31, 2018. Managers to funds domiciled in other jurisdictions should also confirm whether any CRS reporting will be required in such jurisdictions. CRS reporting must be completed with the CRS XML v1.0 or a manual entry form on the  Automatic Exchange of Information portal.  We recommend managers contact their tax advisors to stay on top of the U.S. FATCA and CRS requirements and avoid potential penalties.

Annual Management Company Matters:

Management Company Expenses. Managers who distribute profits on an annual basis should attempt to address management company expenses in the year they are incurred. If ownership or profit percentages are adjusted at the end of the year, a failure to manage expenses could significantly impact the economics of the partnership or the management company.

Employee Reviews. An effective annual review process is important to reduce the risk of employment-related litigation and protect the management company in the event of such litigation. Moreover, it is an opportunity to provide context for bonuses, compensation adjustments, employee goals and other employee-facing matters at the firm. It is not too late to put an annual review process in place.

Compensation Planning. In the fund industry, and the financial services industry in general, the end of the year is the appropriate time to make adjustments to compensation programs. Since much of a manager’s revenue is tied to annual income from incentive fees, any changes to the management company structure, affiliated partnerships, or any shadow equity programs should be effective on the first of the year. Make sure that partnership agreements and operating agreements are appropriately updated to reflect such changes.

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

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

Regulatory & Other Changes in 2017:

SEC Updates.

SEC Adopts Form ADV Amendments. On July 1, 2017, a technical amendment to Form ADV and ADV-W was implemented to reflect a new Wyoming Law that now requires investment advisers with $25 million to $100 million in RAUM and a principal place of business in Wyoming to register with the state as an investment adviser instead of the SEC.

On October 1, 2017, additional SEC amendments to Form ADV went into effect, which will apply to both RIAs and ERAs. Among other technical amendments, the new Form ADV requires investment advisers to provide detailed information with regard to their separately managed accounts SMAs, including aggregate level reporting of asset types across an adviser’s SMAs and reporting of custodian information under certain circumstances. Investment advisers that utilize borrowing or derivatives on behalf of SMAs will also need to report the RAUM attributable to various levels of gross notional exposure and corresponding borrowings and derivatives exposure. The SEC noted that advisers may not need to report this SMA information until its annual amendment. The SEC concurrently adopted an amendment to the books and records rule (Rule 204-2 under the Advisers Act), requiring RIAs to keep records of documentation necessary to demonstrate the performance or rate of return calculation distributed to any person as well as all written performance-related communications received or sent by the RIA. Advisers who have questions on any changes to the new Form ADV should contact their compliance groups.

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 and did not confirm estimates provided by the Registrants’ CIO. It was established that the RAUM and number of advisory accounts reported on the Form ADV was greatly overstated. The SEC held that the outsourced CCO violated the 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. Outsourced compliance persons solely relying on internal estimates of RAUM and number of advisory contracts, without further confirmation, should be aware of the risk of filing false reports and potential SEC enforcement actions.

CFTC and NFA Updates.

CFTC Amendments to Recordkeeping Requirements. On August 28, 2017, amendments to Regulation 1.31 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).

Digital Asset Updates.

CFTC Grants Permission for Bitcoin Futures Trading. On December 1, 2017, the CFTC issued a statement granting permission to the Chicago Mercantile Exchange Inc. (“CME”) and the Chicago Board Options Exchange Inc. (“CBOE”) to list Bitcoin futures contracts on the respective exchanges. Less than two weeks after the release of CFTC’s statement, Bitcoin futures contracts trading began on the CBOE futures exchange on December 10, 2017. Early reports suggest a strong interest in Bitcoin futures contracts set to expire in early 2018. CME is set to begin Bitcoin futures contracts trading next week.

CFTC Grants SEF and DCO Registration to LedgerX. The CFTC granted LedgerX registration status as both a swap execution facility (“SEF”) and a  derivative clearing organization. Now that the exchange is live, LedgerX is the first CFTC-approved exchange to facilitate and clear options on digital assets. Previously, the CFTC granted SEF registration to TeraExchange, which offers forwards and swaps on Bitcoin. LedgerX offers physically-settled and day-ahead swaps on Bitcoin to U.S.-based eligible contract participants and has a fully-collateralized clearing model where customers must post collateral to cover maximum potential losses prior to trading.

Other Updates.

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” to apply to 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. 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. 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). 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. Managers with questions regarding the applicability of these exemptions should discuss with counsel.

Two New California Employment Laws Limit Inquiries into Certain Information During the Hiring Process. In October, California Governor Jerry Brown approved Assembly Bill No. 168 and Assembly Bill No. 1008, restricting certain information a California employer may inquire about and consider during its hiring process. Assembly Bill No. 168 restricts employers from requiring prospective employees to disclose salary history. An employer may not inquire or rely on such information when deciding whether to extend an offer to a job applicant or deciding an amount to offer to a job applicant. Assembly Bill No. 1008 restricts California employers with five or more employees from including, inquiring and considering information about an employee applicant’s criminal history until a conditional offer has been extended to a job applicant. Assembly Bill No. 1008 further provides certain requirements an employer must comply with after such information has been legally acquired and is taken into consideration when deciding whether to hire a job applicant, as well as certain procedures to comply with when deciding a job applicant is not suitable for the position. Both laws become effective January 1, 2018. With respect to California employees, you should review before year end, your job application, offer letter template, and compliance manual if they contain questions regarding salary or criminal history.

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 maintain a continuing education program in place for “covered persons”. 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 promote compliance with the firms record-keeping policies regarding the continuing education program. Municipal advisors will have until December 31, 2018 to comply with the new requirements.

SIPC and FINRA Adopt Streamlined Reporting Process. As of September 1, 2017, investment advisory firms who are members of both the Securities Investor Protection Corporation (“SIPC”) and the Financial Industry Regulatory Authority (“FINRA”) now only need to file one annual report to both agencies through FINRA’s reporting portal. This will ease the reporting burden as well as cut down on compliance costs, for firms.

SEC Provides Guidance to Address MiFID II. On October 26, 2017, the SEC issued three no-action relief letters to provide guidance on the Markets in Financial Instruments Directive II (“MiFID II”). Effective January 3, 2018, MiFID II most notably introduces the requirement for UK broker-dealers to “unbundle” investment research from trading commissions, requiring distinct pricing for each of the services rendered. The first no-action letter provides that for the first 30 months from when MiFID II becomes effective, U.S. broker-dealers will not be considered an investment adviser upon accepting payments from an investment manager. The second no-action letter states that broker-dealers may continue to rely on the safe harbor under Section 28(e) of the Securities and Exchange Act of 1934, as amended, for payments made from client assets made alongside payments for execution to an executing broker-dealer. The final no-action letter addresses MiFID II’s various payment arrangements surrounding research activities and provides that an investment adviser may aggregate client orders, although research payments may differ for each client.

Tax Cuts and Jobs Act Impact on Hedge Funds. In late 2017, the House Ways and Means Committee and the Senate Finance Committee passed companion legislation in an attempt to reform the US tax system. One of the proposed revisions included in H.R. 1 or the Tax Cut and Jobs Act (“Tax Act”) is a reduction in the tax rate for a pass-through entity’s “capital percentage” business income. The applicable tax rate would be 25%, with the non-professional services entity’s “capital percentage” business income capped at 30%, and the remaining amount of income characterized as “labor”.

Offshore Updates.

Cayman and BVI Update Beneficial Ownership Regimes. Amendments to the Cayman Islands beneficial ownership laws went into effect on July 1, 2017, which require certain entities, including exempted funds, to take reasonable steps to identify their beneficial owners (generally persons holding more than 25% interests in such an entity). Of interest to fund managers, the following types of funds are exempted from the scope of these amendments: funds that are regulated by the Cayman Islands Monetary Authority, that employ a Cayman regulated administrator, or funds that are managed by an adviser regulated in an approved jurisdiction, such as a state or SEC RIA. The British Virgin Islands (the “BVI”) also implemented amendments to its beneficial ownership regime effective July 1, 2017, which requires registered agents of non-exempt BVI companies, such as unregulated private funds, to input beneficial ownership information into a platform called the BOSS (Beneficial Ownership Secure Search) System. The BOSS System is accessible only to select regulators and fulfills BVI commitments to the United Kingdom under the UK Exchange of Notes Agreement.

U.K. Transitions from U.K. FATCA to CRS. The U.K. transitioned from U.K. FATCA to CRS on July 1, 2017, and now joins more than 85 countries, including the Cayman Islands and the BVI, in the automatic exchange of information between participating countries. The full list of signatory countries is available here. Similar to U.S. FATCA, CRS sets forth a standard by which signatory countries can more easily and automatically exchange certain reportable tax information. We recommend that managers consult their tax advisors to determine whether they are subject to any CRS reporting requirements.

Cayman Islands Introduces New AML Regulations. New Cayman Islands AML regulations came into effect on October 2, 2017. The new regulations expand AML/CFT (anti-money laundering/ countering the financing of terrorism) obligations to unregulated investment entities and  additional  financial  vehicles,  which  are  seen  to  align  more  closely  with  the Financial Action Task Force (FATF) recommendations and global practice. In a shift to a risk- based approach to AML regulations, there will be two separate due diligence procedures depending on the risk assessment of investors. Certain investors that are deemed to be high-risk, such as politically exposed persons, will be required to go through a more extensive verification process, while low-risk investors will be able to submit to a simplified due diligence process. If you have any questions, we recommend that you reach out to your administrator or offshore counsel.

New PRIIPs Disclosure Requirements for EEA Retail Investors. Regulation (EU) No 1286/2014 (“Regulation”), effective January 1, 2018, requires manufacturers of Packaged Retail and Insurance-based Investment Products (“PRIIPs”) to make available Key Information Documents (“KIDs”) to “retail investors” (generally any investor that does not meet the “professional client” status) in member states of the European Union and the Economic European Area (collectively, “EEA”). If a PRIIP manufacturer, such as a fund manager, accepts additional investments or a new investment from an EEA retail investor on or after January 1, 2018, it must comply with the Regulation’s technical requirements pertaining to KIDs. “Retail investors” under the Regulation can include investors such as high net worth individuals, who are not traditionally considered retail investors. Fund managers should consider the applicability of the Regulation given the types of EEA investors they may be marketing to, and managers who wish to forego complying with the Regulation should not accept investments from EEA retail investors and implement additional procedures to ensure such investors are not marketed to or admitted in the fund.  Fund managers with questions regarding the Regulation should discuss with counsel.

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

Deadline – Filing

  • December 18, 2017 –  IARD Preliminary Renewal Statement payments due (submit early to ensure processing by deadline)
  • December 26, 2017 – Last day to submit form filings via IARD prior to year-end
  • December 31, 2017 – Review RAUM to determine 2018 Form PF filing requirement
  • January 15, 2018 – Quarterly Form PF due for large liquidity fund advisers (if applicable)
  • January 31, 2018 – “Annex IV” AIFMD filing
  • February 15, 2018–  Form 13F due
  • February 15, 2018 – Annual Schedule 13G updates due
  • February 15, 2018 – Annual Form 13H updates due
  • February 28, 2018 – Deadline for re-certification of CFTC exemptions
  • March 1, 2018 – Quarterly Form PF due for larger hedge fund advisers (if applicable)
  • April 2, 2018 – Annual ADV amendments due (for December 31st fiscal year end)
  • April 2, 2018 – Annual Financial Reports due for CA RIAs (if applicable)
  • April 18, 2018 – FBAR deadline for certain individuals with signature authority over, but no financial interest in, one or more foreign financial accounts
  • April 29, 2018 – Annual Form PF due for all other advisers (other than large liquidity fund advisers and large hedge fund advisers)
  • Periodic – Form D and blue sky filings should be current
  • Periodic – Fund managers should perform “Bad Actor” certifications annually

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

Cole-Frieman & Mallon 2017 Third Quarter Update

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

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October 26, 2017

Clients, Friends, Associates:

This summer saw many exciting developments in the digital assets space as well as case law evolution that may expand the liability of fund managers. We would like to provide you with a brief overview of those topics and a few noteworthy items as we move into the fourth quarter of 2017.

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SEC Matters:

SEC Adopts Amendments to Form ADV and the Books and Records Rule. SEC amendments to Form ADV went into effect on October 1, 2017, which will apply to both registered investment advisers (“RIAs”) and exempt reporting advisers. Among other technical amendments, the new Form ADV requires investment advisers to provide detailed information with regard to their separately managed accounts (“SMAs”), including aggregate level reporting of asset types across an adviser’s SMAs and reporting of custodian information under certain circumstances. Investment advisers that utilize borrowing or derivatives on behalf of SMAs will also need to report the regulatory assets under management (“RAUM”) attributable to various levels of gross notional exposure and corresponding borrowings and derivatives exposure. The SEC noted that advisers may not need to report this SMA information until its annual amendment.

The SEC concurrently adopted an amendment to the books and records rule (Rule 204-2 under the Investment Advisers Act of 1940, as amended (“Advisers Act”)), requiring RIAs to keep records of documentation necessary to demonstrate the performance or rate of return calculation distributed to any person as well as all written performance-related communications received or sent by the RIA. Advisers who have questions on any changes to the new Form ADV should contact their compliance groups.

SEC Provides Observations from Cybersecurity Examinations. On August 7, 2017, the SEC’s Office of Compliance Inspections and Examinations (“OCIE”) published observations from its “Cybersecurity 2 Initiative” where 75 SEC registered broker-dealers (“BDs”), RIAs and investment funds were examined to assess cybersecurity preparedness. OCIE observed that all BDs and funds, and nearly all RIAs, maintained cybersecurity-related policies and procedures addressing protection of client information. OCIE also noted an increase in cybersecurity preparedness since the “Cybersecurity 1 Initiative” conducted in 2014.

However, key findings from the examinations include:

  • policies and procedures were inadequate and lacking specificity in employee guidance;
  • failure by financial firms to adhere to or enforce their policies and procedures; and
  • Regulation S-P-related issues, including failure to address security vulnerabilities or install other operational safeguards to protect client nonpublic personal information.

OCIE will continue its examination of financial firms’ cybersecurity compliance systems and we will be on the lookout for further guidance in this growing area of concern.

SEC Risk Alert Discusses Most Frequent Advertising Rule Compliance Issues. On September 14, 2017, OCIE published a risk alert based on its recent examination of 70 RIAs related to Rule 206(4)-1 under the Advisers Act (the “Advertising Rule”). The Advertising Rule generally prohibits RIAs from distributing advertisements or other communications that contain untrue, false or misleading statements. The most common Advertising Rule deficiencies observed include: (i) misleading performance results, caused by lack of sufficient disclosures, (ii) misleading one-on-one presentations, (iii) misleading claims of compliance with voluntary performance standards, (iv) cherry-picked profitable stock selections, (v) misleading selection of recommendations, and (vi) failure to implement compliance policies and procedures designed to prevent non-compliant advertising practices. OCIE encourages RIAs to consider their advertising activities within the purview of the Advertising Rule and its prohibitions.

SEC Action Against Hedge Fund Adviser.  On August 21, 2017, the SEC reached a settlement with a hedge fund adviser for failing to establish, maintain, and enforce a compliance system to prevent the misuse of material, nonpublic information (“MNPI”). The settlement comes after the adviser’s analysts were charged with insider trading of MNPI relating to government plans to cut Medicare reimbursement rates. The SEC alleged that analysts received tips from a third-party political intelligence analyst who had a source within the Centers for Medicare and Medicaid Services, and that the adviser then used those tips to generate trading profits. The $4.6 million settlement included a penalty of $3.9 million and a disgorgement of compensation.

CFTC Matters:

CFTC Grants SEF and DCO Registration to LedgerX.  The CFTC granted LedgerX registration status as both a swap execution facility (“SEF”) and a derivative clearing organization (“DCO”). Now that the exchange is live, LedgerX is the first CFTC-approved exchange to facilitate and clear options on digital assets. Previously, the CFTC granted SEF registration to TeraExchange, which offers forwards and swaps on Bitcoin. LedgerX plans to initially offer physically-settled and day-ahead swaps on Bitcoin to U.S.-based eligible contract participants (“ECPs”) and has a fully-collateralized clearing model where customers must post collateral to cover maximum potential losses prior to trading.

Digital Asset Matters:

CBOE Partners with Gemini to Launch Bitcoin Futures Exchange.  On the heels of the CFTC’s LedgerX announcement, the Chicago Board Options Exchange (“CBOE”) announced that it has partnered with Gemini, a digital assets exchange and custodian, to launch the first U.S.-regulated Bitcoin futures exchange. Gemini was founded by the Winklevoss twins, whose proposed “Winklevoss Bitcoin Trust” ETF was rejected by the SEC this past spring. Gemini granted to CBOE an exclusive license to use Gemini’s Bitcoin market data that will allow CBOE to create derivative products, including indices, to trade on a CBOE-created exchange. Although CBOE has not requested approval from the CFTC to form such an exchange, it plans to offer Bitcoin futures by the end of 2017 or early 2018. We will keep managers apprised of ongoing developments.

House Introduces Virtual Currency Tax Act.  In September, The Cryptocurrency Tax Fairness Act of 2017 was introduced in the House of Representatives. The bill was introduced by co-chairs of the Congressional Blockchain Caucus, Jared Polis (D-Co) and David Schweikert (R-Az), and calls for a de minimis exception from gross income for gains related to virtual currency transactions under $600. Such an exception could serve to incentivize small, day-to-day transactions. The bill also calls upon the Treasury Department to issue guidance on whether a gain or loss should be recognized in virtual currency transactions. If approved, the bill will apply to virtual currency transactions beginning January 1, 2018.

SEC Implicates Two ICOs in Alleged Fraud.  On September 29, 2017, the SEC charged a businessman who was allegedly running two fraudulent initial coin offering (“ICO”) schemes by selling unregistered securities in the form of digital tokens that did not exist. The REcoin ICO was marketed as the first token backed by real estate investments and allegedly misrepresented to investors the company’s expertise and the amount of capital raised. The second ICO was marketed similarly but with respect to the diamond industry. In July, the SEC issued an investor alert warning about the risk of ICOs. The SEC is seeking to bar the businessman from participating in any offering of digital securities in the future.

ICOs Banned in China and South Korea. The People’s Bank of China (“PBoC”), China’s central bank and financial regulator, announced an immediate ban of ICOs within China. The announcement sent shockwaves throughout the cryptocurrency industry, highlighted by declines across various token prices. Many see this ban as a temporary stop-gap measure to give PBoC time to develop industry oversight. South Korea’s Financial Services Commission made a similar announcement a few weeks later, stating that all ICO fundraising would be banned and that it would establish tighter anti-money laundering prevention policies for virtual currencies.

Other Items:

Department of Labor (“DOL”) Proposes Amendments to Fiduciary Rule Exemptions. The DOL Fiduciary Rule, discussed in our previous quarterly update, may face further delays before full implementation. Citing a concern that affected parties may incur undue expense in complying with a rule that may be further revised or repealed, the DOL submitted a proposal to the Office of Management and Budget (“OMB”) to extend the transition period from January 1, 2018 to July 1, 2019. The proposal included amendments to a few of the Fiduciary Rule exemptions, including the best interest contract exemption, which permits investment advisers to retail retirement clients to continue their current fee practices. The OMB approved the proposal and the DOL published its proposal on August 31, 2017. Proponents for the amendments point to the SEC’s commitment to work with the DOL to harmonize the Fiduciary Rule with SEC regulations, and that the delay will give the agencies time to develop clear regulations together. Critics claim that the delay will cause more uncertainty in the market during the extended transition period, and that the delay is the first step in an attempt by opponents of the rule to eliminate it completely.

The Cayman Islands Introduce New AML Regulations.  New Cayman Islands AML regulations came into effect on October 2, 2017. The new regulations expand AML/CFT (anti-money laundering/countering the financing of terrorism) obligations to unregulated investment entities and additional financial vehicles, which are seen to align more closely with the Financial Action Task Force (FATF) recommendations and global practice. In a shift to a risk-based approach to AML regulations, there will be two separate due diligence procedures depending on the risk assessment of investors. Certain investors that are deemed to be high-risk, such as politically exposed persons, will have to go through a more extensive verification process, while low-risk investors will be able to submit to a simplified due diligence process. If you have any questions, we recommend that you reach out to your administrator or offshore counsel.

U.S. Court of Appeals for the Second Circuit Clarifies Insider Trading Case.  In August 2017, in a long-awaited opinion, the Second Circuit upheld a former portfolio manager’s 2014 conviction for insider trading in U.S. v. Martoma, in reaction to the US Supreme Court’s intervening ruling in Salman v. United States, which we discussed in a previous update.  The Martoma Court rejected much of its earlier decision in U.S v. Newman by holding its previous requirement that there be a “meaningfully close personal relationship” between tipper and tippee was “no longer good law”.  Instead, the Martoma Court created a new standard requiring the government to prove that the tipper expected the tippee to trade on the information and the tip “resembled trading by the insider followed by a gift of the profits”.  By eliminating Newman’s “close personal relationship” requirement, the Martoma ruling has made it easier for the government to prosecute and win insider trading cases, however, it’s likely this area of law will continue to evolve.

“Group” Theory of Liability Expanded by U.S. District Court.  Continuing a trend of expanding the “group” theory of liability, the Northern District of California’s recent ruling in Sand v. Biotechnology Value Fund, L.P. may have far-reaching ramifications for managers of multiple funds. The defendants in the ongoing Sand case include a general partner and its two hedge funds (the “group funds”). The Court held that the group funds’ aggregate collective ownership of the subject security was directly relevant to the issue of beneficial ownership because the group funds shared the same general partner. Section 16 of the Securities and Exchange Act of 1934, as amended, requires corporate insiders and beneficial owners of 10% or more of a registered security to file statements with the SEC disclosing their ownership interest. Under the Sand Court’s theory of group liability, each of the group funds would be subject to the Section 16 reporting requirements if the group collectively owned 10% or more of the security, even if an individual group fund owned less than 10%, and each group fund could also be directly liable for any Section 16 violations. Given this evolution of Section 16 liability, managers of multiple funds that hold positions in the same security should carefully monitor beneficial ownership and evaluate whether a reporting obligation may exist for their funds.

SIPC and FINRA Adopt Streamlined Reporting Process.  Effective September 1, 2017, investment advisory firms who are members of both the Securities Investor Protection Corporation (“SIPC”) and the Financial Industry Regulatory Authority (“FINRA”) only need to file one annual report to both agencies through FINRA’s reporting portal. This will ease the reporting burden, as well as cut down on compliance costs for firms.

FCA Makes Final Policy Statement on MiFID II. The Financial Conduct Authority (“FCA”), which regulates the financial services industry in the UK, has published its final policy statement regarding the Markets in Financial Instruments Directive II (“MiFID II”). Effective January 1, 2018, MiFID II most notably introduces the requirement for UK BDs to “unbundle” investment research from trading commissions, requiring discrete pricing for each of the services rendered. This requirement is in contrast to the “soft dollar” safe harbor currently available in the U.S. and may have implications for U.S.-based investment advisers who engage UK BDs, as the new requirement could affect pricing of services.

Cayman and BVI Update Beneficial Ownership Regimes.  Amendments to the Cayman Islands beneficial ownership laws went into effect on July 1, 2017, which require certain entities, including exempted funds, to take reasonable steps to identify their beneficial owners (generally persons holding more than 25% interests in an entity). Of interest to fund managers, the amendments exempt from its scope: funds that are regulated by Cayman Islands Monetary Authority (“CIMA”), that employ a Cayman regulated administrator, or funds that are managed by an adviser regulated in an approved jurisdiction, such as a state or SEC RIA.  The British Virgin Islands (the “BVI”) also implemented amendments to its beneficial ownership regime effective July 1, 2017, which now requires registered agents of non-exempt BVI companies, such as unregulated private funds, to input beneficial ownership information into a platform called the BOSS (Beneficial Ownership Secure Search) System. The BOSS System is accessible only to select regulators and fulfills BVI commitments to the United Kingdom under the UK Exchange of Notes agreement.

MSRB to Hold Compliance Outreach Program. In a cross-agency announcement, the SEC is partnering with the Municipal Securities Rulemaking Board (“MSRB”) and FINRA to sponsor the 2017 Compliance Outreach Program for Municipal Advisors, a day-long compliance forum to allow industry professionals to discuss compliance practices with regulators and to promote a more effective compliance structure for municipal advisors. The program will be held on November 8, 2017, from 9am to 4pm ET, in the SEC’s Atlanta Regional Office and will be streamed live on the SEC website. The agenda for this event can be located here, and any advisors who are interested in attending can register here.

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

Deadline – Filing

  • October 1, 2017 – Revised Form ADV 1A goes into effect for all advisers
  • October 16, 2017 – Quarterly Form PF due for large liquidity fund advisers (if applicable).
  • November 14, 2017 – Form PR filings for registered Commodity Trading Advisors (“CTAs”) that must file for Q3 within 45 days of the end of Q3 2017.
  • November 29, 2017 – Form PF filings for Large Hedge Fund Advisers with December 31 fiscal year-ends filing for Q3 2017.
  • November 29, 2017 – Registered Commodity Pool Operators (“CPOs”) must submit a pool quarterly report (“PQR”).
  • December 31, 2017 – Cayman 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 in order to avoid 2018 CIMA fees.
  • Periodic – Fund managers should perform “Bad Actor” certifications annually.
  • Periodic – Amendment due on or before anniversary date of prior Form D filing(s), or for material changes.
  • Periodic – CPO/CTA Annual Questionnaires must be submitted annually, and promptly upon material information changes.

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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.

Cole-Frieman & Mallon 2017 Second Quarter Update

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

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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.