Tag Archives: Quarterly Update

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.

****

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.

****

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.

****

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.

****

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.

****

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

****

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

Hedge Fund Bits and Pieces for April 28, 2017

Happy last Friday of April.

****

Cole-Frieman & Mallon LLP 2017 1st Quarter Update – we were a little late for this first quarter but the update addresses a number of items including:

  • Trump and Dodd-Frank Reform
  • DOL Fiduciary Rule Delay
  • Bitcoin Regulatory Matters
  • California’s Public Investment Fund Disclosure Requirements
  • SEC No-Action Letter and Guidance Clarify Inadvertent Custody
  • SEC / FINRA 2017 Exam Priorities
  • Compliance Calendar

Trump Tax Plan & Financial Industry – while our quarterly update talked in part about potential future reform of the financial system, there is not really much to say yet about Trump’s one page tax plan.  We do know, obviously, that the details will be forthcoming, but this plan leaves a lot of open questions and (surprise) remains silent on the carried interest issue. One item to note is that the tax plan proposes to repeal the 3.8% Obamacare tax – this is important because many fund managers have established structures to minimize the impact of this tax to the manager.  As more information rolls out, we expect to hear from both accountants and tax planners about how any new tax plan would affect the private funds industry.

Blockchain / Cryptocurrency / Altcoin Items – there continues to be an onslaught of items dealing with blockchain technology in the financial services sector, and we included some discussion of these items in our quarterly update linked above.  On Wednesday of this week I attended EY’s Global Blockchain Summit in San Francisco (more on this coming soon). In addition, FINRA just announced a Blockchain Symposium which will be held in New York on July 13.  According to the announcement, the “half-day program is designed to bring together regulators and industry leaders to discuss the use of blockchain and related opportunities and challenges.”  It is important to note that blockchain appears to be an inevitable new structure/paradigm in business generally and investment management specifically – surprisingly, the regulators seem to be aware of this sea change and ready to work with the industry to implement appropriate regulatory structures to address investor protection concerns.

Other Items

Connecticut Hedge Fund Tax – there have been a few news articles about a potential tax on private fund managers in Connecticut.  I have not kept up on this issue in depth, but it should be interesting to see how this plays out and whether any other states will follow suit.

FINRA Insider Trading Information – FINRA has begun to take an active role in finding and dealing with insider trading.  Just recently they released an interesting video with Cam Funkhouser, Executive Vice President of FINRA’s Office of Fraud Detection and Market Intelligence (OFDMI), about insider trading and some “red flags” to look out for.

FINRA Bootcamps – FINRA announced three compliance boot camps for may – Dallas (May 11), Memphis (May 17) and Charolette (May 31).

****

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

Cole-Frieman & Mallon 2017 First Quarter Update

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

****

April 27, 2017

Clients, Friends, Associates:

We hope that you are enjoying an auspicious start to 2017. The first quarter of the year is typically one of the busiest for fund managers from a regulatory standpoint. As a variety of filing deadlines have passed and audit work is completed (or will be soon), we enter the second quarter with a number of important regulatory issues on the horizon, as well as many other topics worthy of discussion. Below, we have prepared a short overview of some of these items.

****

Regulations and Proposed Regulations:

Trump Executive Order Could Reform Dodd-Frank. President Trump issued an executive order on February 3, 2017, setting out seven “Core Principles” which will serve as general guidelines for financial regulatory reform. The Core Principles include making regulation more efficient, effective and appropriately tailored, as well as rationalizing the Federal financial regulatory framework. The order appears implicitly targeted at reforming the Dodd-Frank Wall Street Reform and Consumer Protection Act (“Dodd-Frank”) and decreasing many of the current financial regulations, but we note that any changes to the current regulatory landscape may not be as immediate as many initial reactions assumed. According to the order, the Treasury Secretary is to meet with the various agencies that oversee and implement Dodd-Frank (including the SEC), to discuss areas that may be amended. While a repeal of Dodd-Frank is unlikely, the coming months may bring a number of deregulatory changes. We will be following any resulting changes and will discuss significant impacts of such changes in future quarterly updates.

Department of Labor Delays Fiduciary Rule. On April 7, 2017, in response to a presidential memo from President Trump, the Department of Labor (“DOL”) issued a Final Rule delaying the applicability of the “Fiduciary Rule” until June 9, 2017, although full compliance with the Fiduciary Rule is still expected by January 1, 2018. We had previously discussed the Fiduciary Rule, which expanded the scope of who is considered a “fiduciary”, imposing fiduciary obligations on firms which were historically free from such obligations. While the DOL will use the delay to reexamine the Fiduciary Rule and consider modifications to it, if you have not already done so, we recommend that you review and speak with your counsel about whether you would be considered a fiduciary and what additional obligations and implementation processes will need to be incorporated into your business practices.

CFTC Regulation of Bitcoin and Virtual Currencies. There has been an increasing interest in investments in Bitcoin and other cryptocurrencies as the financial and technological landscape evolves, but determining the regulations applicable to such products is less clear. While the CFTC established that Bitcoin and other virtual currencies are “commodities” within the definition of the Commodity Exchange Act of 1936, as amended (“CEA”), under the CEA, only commodity interests (which include futures, options, derivatives and certain spot transactions) based on the commodity are within the scope of the CFTC’s jurisdiction. Recent enforcement actions brought by the CFTC have helped clarify whether a transaction is subject to CFTC regulation. In an Order issued against the Coinflip, Inc. platform (“Coinflip”), the CFTC imposed sanctions against Coinflip for operating a facility for trading Bitcoin derivatives without being registered as a futures exchange or swap execution facility. In a contrasting enforcement action brought against the Bitfinex platform (“Bitfinex”), which did not list or permit the trading of derivatives, the CFTC asserted its jurisdiction over Bitfinex on the basis that the platform dealt in “retail commodity transactions”— leveraged, margined or financed transactions involving a commodity that are offered to persons that are not “eligible contract participants” — without being registered as a futures commission merchant with the CFTC. Certain retail commodity transactions are exempt from CFTC jurisdiction if the seller “actually delivers” the commodity to the buyer within 28 days of the date the contract was entered into; the CFTC deemed that Bitfinex did not “actually deliver” the cryptocurrencies to buyers because among other reasons, Bitfinex held the private key controlling access to the wallet where the buyers’ cryptocurrencies were held.

Managers investing in Bitcoin or other virtual currencies should consider whether and to what extent the types of transactions may subject them to CFTC jurisdiction and potential registration as a CPO or CTA. In the current regulatory landscape, we believe managers who invest purely in virtual currencies and who do not employ virtual currency derivatives or leverage are outside the scope of the CFTC’s jurisdiction, and should not be required to register as a CPO or CTA. Although further regulation is expected, firms should speak with outside counsel to confirm their status in light of the current regulatory framework.

Other Regulation of Bitcoin and Virtual Currencies. While the CFTC has been the most active regulatory authority to address investments in cryptocurrencies, managers should be cognizant that states (including New York), the SEC, FINRA and FinCEN are also deliberating the question of appropriate regulatory oversight. We will continue to monitor regulatory developments and more information about certain regulatory aspects applicable to private funds can be found in our blog post on Bitcoin / Cryptocurrency Hedge Funds.

NFA Provides Guidance on Amended CPO Financial Report Requirements. In our previous 2016 End of Year Update we discussed the CFTC’s amendments providing relief from certain financial report requirements for commodity pool operators (“CPOs”), which became effective on December 27, 2016. The NFA released a Notice setting forth instructions regarding how CPOs can file the appropriate notices with the NFA to claim any of the relief provided for in the amendments. CPOs who are eligible for the amended regulations should contact counsel or compliance consultants, or review the Notice, to determine whether any further action may be warranted to claim the appropriate relief.

U.S. and Global Regulators Relax March 1st Deadline for Swap Variation Margin Compliance. The Federal Reserve and the International Organization of the Securities Commission have provided some flexibility for swap dealers facing a March 1, 2017, deadline to implement certain variation margin compliance requirements for uncleared swaps. The rules require swap dealers to collect and post variation margin with no credit threshold unless an exception applies. Further, covered counterparties would be required to enter into new or amended credit support documentation, limit the types of collateral that may be posted and prescribe minimum transfer amounts. Compliance with the requirements can be challenging for swap entities and their counterparties as they work to implement the necessary documentation and underlying operational processes. Except for transactions with financial end users that present “significant exposures,” the Federal Reserve’s guidance directs examiners of CFTC-registered swap dealers to focus on the dealer’s good faith efforts to comply as soon as possible but by no later than September 1, 2017.

BEA Makes Changes to Direct Investment Survey Reporting Requirements for Certain Private Funds. The Bureau of Economic Analysis’ (“BEA”) changes to its direct investment surveys went into effect on January 1, 2017. The reporting changes apply to investments by U.S. entities of a 10% or more voting interest in a private fund, and to investments by foreign entities of a 10% or more voting interest in a U.S. domiciled fund. Under these changes, any cross-border voting investments of 10% or more in, or by, private funds will be subject to BEA reporting only if such investments involve, directly or indirectly, a direct investment in an “operating company” that is not another private fund or a holding company. The changes will simplify reporting for private funds because certain direct investments in private funds will be re-characterized as portfolio investments depending on the nature of the private fund’s investments. Many hedge funds that were traditionally subject to BEA direct investment reporting because of cross-border voting interests will instead only be required to report on portfolio investments to the Treasury Department on Treasury International Capital (“TIC”) surveys. The BEA will notify any filers that may be potentially affected by these changes, but we recommend that advisers consult with counsel to determine what, if any, BEA and/or TIC reporting obligations they may have.

Treasury Department Proposes New Anti-Money Laundering Rules for Investment Advisers. The Treasury Department’s Financial Crimes Enforcement Network previously proposed extending the requirements of maintaining a formal anti-money-laundering (“AML”) program under the Bank Secrecy Act of 1970 to SEC-registered investment advisers (“RIAs”). The final rule is expected to be published soon, and would require SEC RIAs to establish a robust AML program with policies and procedures to identify questionable activity, periodic testing of the program and ongoing training of appropriate personnel.

Other Items:

California’s Public Investment Fund Disclosure Requirements Now Effective. In our third quarter update, we reported that California passed a bill requiring increased disclosure by private fund managers for funds with investments by California state and local public pension and retirement systems. The legislation went into effect on January 1, 2017. All public pension and retirement systems in California must require hedge funds, private equity funds, venture capital funds and any other alternative investment vehicles in which they invest to disclose certain information regarding the fund’s fees, expenses and performance. In addition to applying to new contracts entered into on or after January 1, 2017, and pre-existing contracts with new capital commitments made on or after January 1, 2017, the legislation requires that public pension and retirement systems make “reasonable” efforts to obtain the increased disclosure information for contracts entered into prior to January 1, 2017. Fund managers with California public plan investors should review the types of information that will need to be provided to such investors and prepare to provide the required information.

SEC No-Action Letter and Guidance Clarify Inadvertent Custody. On February 21, 2017, the SEC issued a no-action letter responding to a request for clarification from the Investment Advisers Association as to whether an investment adviser has custody of a client’s assets if the adviser acts pursuant to a standing letter of instruction or other similar arrangement established between the client and its custodian (“SLOA”), that grants the adviser limited authority to direct transfers of the client’s funds to one or more third parties. The SEC’s position is that an SLOA that authorizes the adviser to determine the amount and timing of payments, but not the payee’s identity, is sufficient authority to result in the adviser having custody of the assets. However, the SEC agreed that it would not recommend an enforcement action against an adviser that does not obtain a surprise examination, if the adviser acts pursuant to an SLOA under certain specific circumstances set forth in the SEC’s letter. The SEC also reaffirmed that advisers will not be deemed to have custody of client assets if the adviser is given limited authority to transfer client assets between the client’s accounts maintained at one or more custodians.

To further clarify its views on inadvertent custody, the SEC also issued a guidance update highlighting certain circumstances where an investment adviser may inadvertently have custody of client funds or securities. An adviser may have custody because of the wording or rights of custodial and advisory agreements, even if the adviser did not intend to have custody and was not aware it was granted the authority that resulted in its having custody. We urge advisers to separately managed accounts to review their client agreements and any SLOAs they have entered into to determine whether their specific arrangements may cause them to have custody, and to evaluate their policies and practices related to custody of client assets.

SEC Published Examination Priorities for 2017. The SEC announced its Examination Priorities for 2017, which focus on themes of examining matters of importance to retail investors, focusing on risks specific to elderly and retiring investors and assessing market-wide risks. Specifically, the SEC will focus on: (i) identifying initiatives designed to assess risk in the context of retail investors, including never-examined investment advisers and exchange-traded funds, and notably, robo-advisers and other automated, electronic investment advice platforms, including the investment advisers and broker-dealers that offer them; (ii) services provided to retirement accounts, such as variable insurance products and fixed-income cross-transactions, as well as investment advisers to pension plans and other large holders of U.S. investor retirement assets; and (iii) cybersecurity, and systems and technology procedures and controls.

FINRA Published Examination Priorities for 2017. Similar to the SEC, the Financial Industry Regulatory Authority, Inc. (“FINRA”) recently published its 2017 Regulatory and Examination Priorities Letter, outlining the organization’s enforcement priorities for the current year. FINRA’s specific focus areas for 2017 will include: (i) supervisory policies and compliance controls for high-risk and recidivist brokers; (ii) sales practices and product suitability for specific investors; (iii) firm liquidity management practices; and (iv) cybersecurity issues. 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.

Cayman Islands Extends CRS First Notification and Reporting Deadlines. The Cayman Islands Department for International Tax Cooperation (“DITC”) has issued an industry advisory stating that it is adopting a “soft opening” to the notification and return deadlines required for Financial Institutions’ (“FIs”) compliance with the Common Reporting Standard (“CRS”). All FIs in the Cayman Islands are required to register with the Cayman Islands Tax Information Authority (“TIA”) by April 30, 2017, and to submit returns to the TIA by May 31, 2017. With the DTIC’s adoption of a “soft opening,” FIs may submit CRS notifications on or before June 30, 2017, and file “accepted” CRS returns on or before July 31, 2017, without any compliance measures or penalties.

Ninth Circuit Rules Internal Reports Protected under Whistleblower Rules. On March 8, 2017, the Ninth Circuit followed a ruling by the Second Circuit in finding that an employee who makes a report internally, rather than to the SEC, is protected under Rule 21F-17 of the Securities Exchange Act of 1934, as amended (“Whistleblower Rule”) enacted under Dodd-Frank. In contrast, the Fifth Circuit previously ruled that the provisions of the Whistleblower Rule only apply when an employee makes disclosures directly to the SEC. The Ninth Circuit and Second Circuit rulings reflect a broad interpretation of the definition of a whistleblower, and signal a split among the circuit courts on who may be considered a whistleblower for purposes of protection under the Whistleblower Rule.

Regulatory Assets Under Management. We have observed that many managers have expressed confusion regarding the calculation of assets under management (“AUM”) for purposes of filing the Form ADV and determining when the manager may be subject to SEC registration. We thought it would be helpful to clarify that investment advisers must look to their “regulatory assets under management” (“RAUM”), a specific metric designed by the SEC, which is calculated differently from the more common and more traditionally understood calculation of AUM. In calculating RAUM, managers should include the value of all assets managed without deducting for any offsetting liabilities. Managers with questions about the calculation of specific assets or managers seeking further clarification of RAUM should speak with their firm’s outside counsel or compliance consultants.

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

Deadline – Filing

  • March 31, 2017 – Deadline to update and file Form ADV Parts 1, 2A & 2B
  • April 10, 2107 – Amendment to Form 13H due if necessary
  • April 15, 2107 – 1st Quarter 2017 Form PF filing for quarterly filers (Large Liquidity Fund Advisers)
  • April 28, 2107 – Collect quarterly reports from access persons for their personal securities transactions
  • April 28, 2107 – Distribute code of ethics and compliance manuals to employees. Require acknowledgement form to be executed in connection with such delivery
  • April 28, 2107 – Annual Privacy Notice sent to all clients or fund investors (for Advisers with Fiscal Year ending December 31)
  • April 28, 2107 – Distribute audited financial statements to investors (most private fund managers, including SEC, state and CFTC registrants)
  • April 28, 2107 – Distribute Form ADV Part 2 to clients
  • April 30, 2107 – Quarterly NAV Report (registered commodity pool operators claiming the 4.7 exemption)
  • May 1, 2107 – 2016 Annual Form PF due date for annual filers (Large Private Equity Fund Advisers and Smaller Private Fund Advisers)
  • May 15, 2017 – Quarterly Commodity Trading Advisor Form PR filing
  • May 15, 2017 – File Form 13F for first quarter 2017
  • May 31, 2017 – First deadline for Cayman Islands Financial Institutions to submit their CRS returns to the Cayman Islands Tax Authority
  • May 31, 2017 – 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, 2017 – Distribute audited financial statements to investors (private fund managers to funds of funds, including SEC, state and CFTC registrants)

Variable

  • Distribute copies of K-1 to fund investors
  • Ongoing All Limited Non-U.S. Financial Institutions and limited branches that seek to continue such status during the 2017 calendar year must edit and resubmit their registrations after December 31, 2015, on the FATCA registration website; SEC form D must be filed within 15 days of first sale of securities

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

Third Quarter 2013 Business & Regulatory Update

Below is the third quarter of 2013 update we have sent out to our mailing list.  We will be sending out our end of the year update soon so if you would like to be added to the mailing list, please contact us here.

****

Cole-Frieman & Mallon Third Quarter Update

Clients and Friends:

In the third quarter of 2013 we have seen dramatic developments in the world of investment management regulatory compliance. As we move into the fourth quarter, we would like to provide you with a brief overview of some items that we hope will help you stay on top of the business and regulatory landscape in the coming months.

****

JOBS Act Update.  Over a year after the Jumpstart Our Business Startups Act (the “JOBS Act”) was signed into law, the Securities and Exchange Commission (“SEC”) issued certain long-awaited  implementing regulations and other proposed rules:

  • General Solicitation Ban Lifted. On July 10, 2013, the SEC adopted New Rule 506(c) under Regulation D, commonly relied upon by private investment funds for selling securities without registration under the Securities Act of 1933 (the “Securities Act”). Effective September 23, 2013, Rule 506(c) permits private funds to engage in general solicitation and advertising to the public, provided that the issuer takes “reasonable steps to verify” that all investors are “accredited investors.” This may be done by (i) reviewing IRS forms that report income, such as Form W-2, Form 1099, Schedule K-1 and Form 1040; (ii) reviewing financial records, such as bank statements, (iii) obtaining written confirmation from a registered broker dealer, SEC-registered investment adviser, licensed attorney, or certified public accountant, or (iv) obtaining a certificate from a current investor who invested prior to September 23, 2013 confirming “accredited investor” status. Reliance on investors’ representations in a questionnaire or subscription agreement is insufficient. It is currently unclear whether private funds utilizing registration exemptions from the Commodity Futures Trading Commission (“CFTC”) may take advantage of the Rule 506(c), as certain such exemptions prohibit general solicitation.
  • Bad Actors Prohibited from Rule 506 Reliance.  As of September 23, 2013, the SEC’s “Bad Actors” prohibition effectively prevents issuers from relying on Rule 506 if the issuer or certain persons affiliated with the issuer (“Covered Persons”) have been subject to certain “Disqualifying Events,” including but not limited to certain criminal convictions, court injunctions, commission disciplinary actions, and suspensions from membership in a self-regulatory organization. Advisers should take immediate steps to obtain representations regarding Disqualifying Events from all Covered Persons, which include holders of at least 20% of an issuer’s outstanding “voting securities.” The SEC has noted that securities conferring on holders the right to elect or remove the directors or General Partner of the issuer, or to approve significant transactions such as acquisitions, dispositions, or financings, are considered voting securities. For offshore funds structured as companies, the adviser should examine whether the share capital structure provides that all shareholders hold voting Common Shares that have the right to remove directors, or that shares are split between voting Management Shares and non-voting Participating Shares. Covered Persons also include third-party marketers, and may include certain other arrangements, such as fee rebates. Issuers whose Covered Persons are subject to Disqualifying Events that occurred after September 23 are prohibited from relying on Rule 506 unless the issuer is able to establish that it did not know and, in the exercise of reasonable care, could not have known that a Disqualifying Event existed. Disqualifying Events that occurred prior to September 23 must be disclosed to offerees in writing a reasonable time prior to sale.
  • Rule 144A Clarification.  The SEC has clarified that there is no ban on general solicitation in offers made pursuant to Rule 144A of the Securities Act. As such, Rule 144A securities may be offered to persons other than “qualified institutional buyers” (“QIBs”), provided that the restricted securities are sold only to persons that the seller reasonably believes are QIBs.
  • Proposed Form D Amendment. The SEC has proposed certain amendments to Form D requirements in response to Rule 506(c). The proposed rules would require issuers relying on Rule 506(c) to make an “Advance Form D” filing at least 15 days before engaging in general solicitation or advertising, and to make certain additional disclosures on Form D, including a description of the type of general solicitation used and the methods used to verify accredited investor status. The SEC also proposed requiring issuers relying on Rule 506 generally to file amendments no later than 15 days after the first sale of securities, and make a closing Form D filing within 30 days after the termination of the offering.
  • Proposed Rule 156 Amendment.  The SEC has proposed an amendment to Rule 156 of the Securities Act to address concerns of potential fraudulent and misleading sales literature arising out of Rule 506(c) reliance. The current version of Rule 156 applies only to registered investment companies, prohibiting the use of any communications, including by writing, radio, or television, to sell or induce the sale of securities if such communication includes information that could be materially misleading. As amended, the new rule would apply to private funds making general solicitations under Rule 506(c). Additionally, the SEC has proposed a requirement that certain legends be included on all written general solicitation materials.
  • Proposed New Rule 510T. The SEC has proposed New Rule 510T of Regulation D to require that an issuer conducting an offering in reliance on Rule 506(c) submit any written general solicitation materials used in connection with the offering to the SEC. If adopted, this would be a temporary rule that would expire two years after its effective date.

Foreign Account Tax Compliance Act (“FATCA”) Deadline Extended. The U.S. Internal Revenue Services (“IRS”) has postponed by six months the effective date for certain requirements under FATCA. Pursuant to IRS Notice 2013-43, foreign financial institutions (“FFIs”) such as offshore funds now have until April 25, 2014 to complete the following steps in order to avoid being subject to a 30% U.S. withholding tax on payments they receive from U.S. sources starting July 1, 2014: (1) register with the IRS through the online web portal found here; (2) enter into an FFI agreement with the IRS via the web portal, or comply with an applicable intergovernmental agreement; and (3) meet the other due diligence, reporting and withholding requirements under FATCA. Offshore fund managers should contact their tax advisers and compliance counsel to prepare for FATCA compliance and, if required, to register with the IRS before April 25, 2014. In addition, fund managers to domestic funds should work with their tax advisers, administrators and legal counsel to properly address the new account onboarding and due diligence procedures required under FATCA, including updating their offering documents and subscription materials.

Futures and Derivatives. Futures and derivatives regulators and self-regulatory organizations have continued to be very active over the last quarter. Important developments include:

  • ISDA 2013 EMIR Protocol and Dodd-Frank Protocol Extension. As of September 15, 2013, all EU-domiciled entities party to over-the-counter derivatives transactions are required to comply with certain portfolio reconciliation, dispute resolution, and disclosure requirements pursuant to the EU’s European Market Infrastructure Regulation legislation (“EMIR”). EMIR compliance also requires the assent and cooperation of each counterparty. As such, the International Swaps and Derivatives Association has provided a standardized protocol (“EMIR Port Rec Protocol“) that can be used by counterparties to amend their agreements.  For U.S. counterparties who have already adhered to the ISDA March 2013 DF Protocol (“DF 2.0,” which contains certain portfolio reconciliation provisions), ISDA published the ISDA DF Protocol Extension on September 10, 2013, the explanatory memorandum for which can be found here, allowing such U.S. counterparties to amend their responses to DF 2.0 as necessary to comply with EMIR rather than simultaneously participating in the EMIR Port Rec Protocol.
  • Upcoming Deadline of New Quarterly Filing Requirement for CTAs. Pursuant to the NFA’s Notice, CTAs are reminded to file Form CTA-PR with the NFA on a quarterly basis via the NFA’s EasyFile system for CTAs within 45 days of the end of each calendar quarter. The first filing will be for the quarter ending September 30, 2013 and will be due on November 14, 2013. If you are a CTA and would like assistance with the filings, please contact us.
  • Changes to CPO and CTA Requirements. The CFTC has recently adopted amended rules affecting CPOs and CTAs. Beginning September 23, 2013, all CPOs and CTAs are permitted to use a Disclosure Document for up to 12, rather than nine months. As of August 22, 2013, CPOs are no longer required to obtain a signed acknowledgment of receipt of disclosure documents from a participant before accepting funds. Additionally, CPOs may, as of September 23, 2013, use third-party service providers to maintain their books and records, provided that certain conditions are met.
  • CFTC Harmonization Rule for CPOs of RICs. The CFTC has changed the requirements for CPOs of Registered Investment Companies (“RICs”) to harmonize its disclosure and compliance requirements with those of the SEC. This “Harmonization Rule” effectively adopts a substituted compliance regime for CPOs of RICs premised upon such entities’ adherence to the compliance obligations under the SEC statutory and regulatory compliance regime. As such, participating CPOs of RICs will now be exempt from certain Commodity Exchange Act (“CEA”) requirements, such as the requirement that CPOs submit their disclosure documents to the NFA prior to distribution. In order to take advantage of this relief, CPOs of RICs must file a notice with the NFA by October 21, 2013 and may do so through the NFA’s Exemption System. The SEC’s staff has issued guidance on the Harmonization Rule, and noted that its recently created Risk and Examinations Office will monitor, among other things, investment companies’ risk management related to commodity interests.
  • New Recordkeeping Requirements for FCMs, IBs, and RFEDs. CFTC Regulation 1.35(a) requires FCMs, IBs, and RFEDs to keep complete, systematic records, including all pertinent data and memoranda, of all transactions relating to their business of dealing in commodity interests and related cash or forward transactions. Starting December 21, 2013, amendments to the rule require FCMs, certain IBs, and RFEDs to tape record all oral communications provided or received concerning quotes, solicitations, bids, offers, instructions, trading and prices that lead to the execution of such transactions. Oral communications include a wide range of media including telephone, voicemail, mobile device, or other digital or electronic media, and must be kept for one year. The CFTC has issued guidance that these groups may reasonably rely on a designated contract market, swap execution facility, or other CFTC registrant to maintain certain records on their behalf.
  • New Rules for Swaps and Clearing Organizations. The CFTC has recently adopted new rules regarding swaps and clearing organizations to implement the Dodd-Frank Act’s new statutory framework. Effective September 23, 2013, cooperatives meeting certain conditions may elect not to submit for clearing certain swaps otherwise required under Section 2(h)(1) of the CEA. The CFTC has also adopted rules, effective October 15, 2013, to implement enhanced risk management standards for systemically important derivatives clearing organizations, including increased financial resources requirements and prohibiting the use of assessments in calculating available default resources. Additionally, the CFTC has issued interpretive guidance regarding the cross-border application of the swaps provisions of the CEA, as added by Dodd-Frank.

Joint Advisory on Business Continuity and Disaster Recovery Planning. The CFTC, SEC, and FINRA have issued a joint advisory regarding firms’ business continuity and disaster recovery planning (“DRP”) in the wake of Hurricane Sandy, which caused widespread damage to Northeastern states and closed U.S. equity and options markets for two days in October 2012. The advisory encourages the implementation of certain best practices to improve responses to, and reduce recovery time after, such devastating large-scale events. Among its recommendations, the advisory suggests that firms contract with multiple telecommunications carriers in the event that one experiences a disruption; implement a communication plan to allow communication and coordination with regulators, emergency officials, and others; and conduct annual or more frequent DRP testing and training, including the incorporation of stress testing.

Sun Capital Implications for Private Funds. The First Circuit Court of Appeals reversed a lower court ruling, holding that a private equity fund qualified as a “trade or business” under the Multiemployer Pension Plan Amendment Act (“MPPAA”) for purposes of determining whether the fund might be liable for pension plan withdrawal liability of one of its portfolio companies. In the ruling, the court considered the following factors: the fund’s ownership of at least 80% of the portfolio company; the fund’s management rights of the portfolio company; and the offset management fee structure, whereby the portfolio company paid a management fee to the fund’s general partner, which in turn offset the amount owed by the fund. Private fund managers should consider these factors when investing in portfolio companies which participate in union-sponsored multiemployer plans or sponsor a defined benefit pension plan.

Amended Financial Responsibility Rules for Broker-Dealers. The SEC has  finalized amendments requiring broker-dealers to comply with new net capital, customer protection, books and records, and notification rules. Prominent changes include new required deductions for the purpose of calculating net capital under Rule 15c3-1 of the Securities Exchange Act of 1934 (“Exchange Act”) and the removal of the limitation on the SEC’s ability to issue an order temporarily restricting a broker-dealer from withdrawing capital or making loans to stockholders, insiders and affiliates. Rule 15c3-3 of the Exchange Act was also amended to require “carrying broker dealers,” defined as broker-dealers that carry accounts that hold proprietary securities and cash of other broker-dealers (“PAB Accounts”), to comply with certain computation, account formation, and segregation rules with respect to those accounts.   Additionally, pursuant to the Dodd-Frank Act, the SEC has adopted certain amendments to reporting and audit rules for broker-dealers.

European Union’s Alternative Investment Fund Managers Directive (“AIFMD”). Managers marketing alternative investment funds in the EU are now subject to the reporting and disclosure obligations under the AIFMD, which went into effect on July 22, 2013. In addition, managers may also need to take steps to ensure compliance with the domestic implementing legislation of the jurisdiction where the investor is located. Certain countries, including the UK, Sweden and Germany (for existing funds as of July 22, 2013), are allowing a one-year transitional period delaying the application of the AIMFD marketing regime for non-EU managers. Some other jurisdictions, such as France, have adopted much more stringent requirements to restrict marketing efforts by non-EU managers. If you are marketing to EU investors, you should carefully review the directive’s provisions as well as applicable national laws to make sure you comply with all requirements.

“Red Flag” Rules for Identity Theft Effective Date Approaching. The joint final regulations (“Regulation S-ID”) released by the SEC and CFTC requiring “financial institutions” and “creditors” regulated by those regulatory agencies to put in place programs to address identity theft risk in any “covered accounts” will go into effect November 20, 2013. The terms “financial institutions” and “creditors” include certain investment advisers, commodity pool operators, commodity trading advisers, broker-dealers and futures commission merchants. The definition of the term “covered accounts” is broad and includes brokerage accounts with a broker-dealer and margin accounts. Most importantly, to comply with the new regulations, a program must be put in place which includes reasonable policies and procedures to do the following: (1) describe relevant “red flag” situations that, if they arise, could indicate a risk of identity theft; (2) detect such red flags as they arise, (3) respond appropriately to red flags, and (4) periodically update the program. All firms should reach out to their compliance consultant or legal counsel as soon as possible to ensure adequate systems are in place to address identity theft risk by the November 20, 2013 deadline.

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

September 23, 2013 SEC “Bad Actors” Rule effective
October 21, 2013 Form CPO-PQR and CTA-PR requirements effective for CPOs and CTAs of RICs
October 21, 2013 Deadline for Harmonization Rule NFA notice filing
November 14, 2013 Deadline for Form CTA-PR quarterly filing
November 20, 2013 “Red Flag” Rule compliance deadline
December 13, 2013 IARD Preliminary Renewal Statement Due (submit payment by Dec. 10 in order for payment to post by deadline)
December 21, 2013 New Recordkeeping Requirements for FCMs, IBs, and RFEDs effective
Periodic Filings Form D and Blue Sky filings should be current

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

Sincerely,

Karl Cole-Frieman & Bart Mallon

****

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.

Second Quarter 2013 Business & Regulatory Update

Below is the second quarter update we have sent out to our mailing list.  If you would like to be added to the mailing list, please contact us here.

****

Cole-Frieman & Mallon Second Quarter Update

Clients and Friends:

In the second quarter of 2013 we have seen accelerating activity in the world of investment management regulatory compliance. As we move into the third quarter, we would like to provide you with a brief overview of some items that we hope will help you stay on top of the business and regulatory landscape in the coming months.

****

Foreign Account Tax Compliance Act (“FATCA”) Deadline Approaching. Foreign financial institutions (“FFIs”) such as offshore funds may be subject to a 30% U.S. withholding tax on payments they receive from U.S. sources as soon as January 1, 2014 if they fail to complete the following steps before October 25, 2013: (1) register with the IRS through an online web portal which will become available on July 15, 2013; (2) enter into an FFI agreement with the IRS via the web portal, or comply with an applicable intergovernmental agreement; and (3) meet the other due diligence, reporting and withholding requirements under FATCA. Offshore fund managers should contact their tax advisers as soon as possible to prepare for FATCA compliance and, if required, to register with the IRS between July 15 and October 25, 2013. In addition, fund managers to domestic funds should work with their tax advisers, administrators and legal counsel to properly address the new account onboarding and due diligence procedures required under FATCA, including updating their offering documents and subscription materials.

JOBS Act Update. The Jumpstart Our Business Startups Act (the “JOBS Act”) was signed into law over a year ago (April 5, 2012) but the SEC has not yet issued implementing regulations. On Wednesday, May 15 the House of Representatives expressed its frustration with the slowness of this process by passing H.R. 701, a House Resolution requiring the SEC to finalize regulations with respect to “Regulation A+” of the JOBS Act. Regulation A+ refers to the part of the JOBS Act which creates a new category of exempt public securities offerings of up to $50 million raised over a 12-month period. In effect this is an expansion of the current “Regulation A” exemption for offerings of up to $5 million over a 12-month period. For fund managers, it remains to be seen whether Regulation A+ might challenge the predominant practice of relying on the exemption “safe harbor” under Rule 506 of Regulation D of the Securities Act of 1933. For more information, please refer to our blog article on this topic.

New “Red Flag” Rules for Identity Theft. The SEC and CFTC released joint final regulations (“Regulation S-ID”) requiring “financial institutions” and “creditors” regulated by the SEC or the CFTC to put in place programs to address identity theft risk in any “covered accounts.” The terms “financial institutions” and “creditors” cover a wide range of participants in the investment management industry, including certain investment advisers, commodity pool operators, commodity trading advisers, broker-dealers and futures commission merchants (among others). The definition of the term “covered accounts” is broad and includes brokerage accounts with a broker-dealer and margin accounts. Most importantly, to comply with the new regulations, a program must be put in place which includes reasonable policies and procedures to do the following: (1) describe relevant “red flag” situations that, if they arise, could indicate a risk of identity theft; (2) detect such red flags as they arise, (3) respond appropriately to red flags, and (4) periodically update the program. Compliance with the new regulations will become mandatory on November 20, 2013. Persons affected by these “Red Flag” rules should take the next few months to assess their compliance programs to ensure adequate systems are in place to address identity theft risk.

Futures and Derivatives. Futures and derivatives regulators and self-regulatory organizations have continued to be very busy over the last quarter. Important developments include:

  • Filings for Newly-Registered CPOs. All CPOs who became registered on January 1, 2013 or during Q1 2013 were required to make their first Form CPO-PQR filing before May 31, 2013. This requirement applies to CPOs relying on the CFTC Rule 4.7 exemption from certain reporting and disclosure requirements. The next due date for Form CPO-PQR is August 29, 2013. If you are a CPO and have not met your filing requirements or would like assistance with the August filing, please do not hesitate to contact us.

  • Changes to CPO Filings. All CPOs must make quarterly filings through the NFA’s EasyFile system for CPOs, and the due dates of such filings and the information required in them varies depending on the CPO’s aggregate pool assets under management. Prior to the recent rule amendments, CPOs were faced with separate quarterly reporting forms from the NFA and the CFTC, along with different filing deadlines. The distinction between the NFA version and the CFTC version of the form still exists; however, each version has been amended to incorporate certain information required by the other regulator. In addition, the NFA changed certain of its filing deadlines to match CFTC deadlines. The NFA also added a “cover page” to the EasyFile system with questions on the CPO’s aggregate pool assets under management, and based on the CPO’s responses the system automatically determines which version of the Form CPO-PQR needs to be filed. The NFA published a chart and other guidance to assist filers with the changes.
  • Upcoming Changes to CTA Filings. The NFA’s recent Notice states that CTAs will soon be required to file Form CTA-PR with the NFA on a quarterly basis, whereas currently this form is filed annually. However, this rule is not yet in effect. The NFA has stated it will send out an alert well in advance of the effective date. When the new rule goes into effect, CTAs will need to file the Form CTA-PR via the NFA’s EasyFile system for CTAs within 45 days of the end of each calendar quarter.
  • Equity Total Return Swaps and CPO Exemption. As of June 30, 2013 equity total return swaps on foreign securities became designated as “mixed swaps” subject to both SEC and CFTC jurisdiction. As a result, they are no longer exempt from being counted toward the de minimis exemption from CPO registration under CFTC Rule 4.13(a)(3). Fund managers that rely on this exemption from CPO registration and that advise funds trading in equity total return swaps should assess their funds’ exposure to these instruments to determine whether they can continue relying on the de minimis exemption.
  • ISDA March 2013 Dodd-Frank Protocol. The International Swaps and Derivatives Association’s Dodd-Frank Documentation Initiative aims to facilitate compliance with the Dodd-Frank Act. The Documentation Initiative minimizes the need for bilateral negotiation and reduces disruptions to trading by providing a standard set of amendments, referred to as protocols, to update existing swap documentation. The first such protocol was the ISDA August 2012 Dodd-Frank Protocol (the “Protocol 1.0”), which had an effective compliance date of May 1, 2013. The ISDA March 2013 Dodd-Frank Protocol (the “Protocol 2.0”) is now open for adherence, and its compliance date is July 1, 2013. This means that swap dealers will require client adherence to both Protocol 1.0 and Protocol 2.0 as of July 1, 2013. To indicate participation in Protocol 2.0, market participants must respond to the Protocol 2.0 questionnaire, submit an adherence letter and pay an adherence fee of $500.00 through the online ISDA Amend system. Detailed instructions can be found here.

Cash Solicitation Rule in California. There are many potential legal pitfalls involving relationships between investment advisers and third party marketers. One such pitfall involves Rule 206(4)-3 of the Investment Advisers Act of 1940, known as the “cash solicitation rule,” which, among other rules, requires that clients must receive written notice of any referral fees paid to marketers. A recent case from the California Court of Appeals, Lloyd v. Metropolitan West Asset Management, LLC highlights at least two important take-aways with respect to the cash solicitation rule. First, the manager could not prove that the client actually received the required notice, emphasizing the importance of documenting such processes and to contractually sharing the burden of such compliance with marketing firms. Second, the court found that the cash solicitation rule applied despite the fact that the client at issue was a non-U.S. client.

New Front-Running Rule for Broker-Dealers. FINRA issued a new rule on front-running of customer block transactions (“Rule 5270”), which took effect on June 1, 2013. Rule 5270 expands the prohibition on front-running by, among other changes, applying the prohibition to fixed income securities and related instruments. It also lays out three categories of “permitted transactions” in which FINRA member firms may engage: (1) transactions that a firm can demonstrate are unrelated to the customer block order; (2) transactions that are undertaken to fulfill or facilitate the execution of the customer block order; and (3) transactions that are executed, in whole or in part, on a national securities exchange and comply with the marketplace rules of that exchange. More information on Rule 5270, including the full FINRA notice, can be found here.

European Union’s Alternative Investment Fund Managers Directive (“AIFMD”). Starting July 22, 2013, managers marketing alternative investment funds in the EU must comply with reporting and disclosure obligations under the AIFMD. These obligations consist of providing pre-investment and ongoing disclosures to investors, complying with requirements affecting manager remuneration, and preparing annual and regular reports to an EU national regulator.  As a caveat, however, full compliance with the AIFMD may be insufficient for certain managers, because until July 21, 2015, the ability to market to EU investors is still subject to the national law of the jurisdiction where the investor is located. There has been speculation that some countries may move to restrict marketing efforts by US-based managers and/or funds. If you are marketing to EU investors, you should carefully review the directive’s provisions as well as applicable national laws to make sure you comply with all requirements.

Launch of Sansome Strategies LLC.   We are pleased to announce the launch of our affiliated compliance consulting company, Sansome Strategies LLC (“Sansome Strategies”). Sansome Strategies specializes in high-touch, outsourced compliance services for firms in the investment management industry. In addition to working with registered investment advisers and hedge fund managers, Sansome Strategies will also focus on firms operating in the commodities/futures and derivatives spaces.

Further information about Sansome Strategies can be found at: sansomestrategies.com

Please also visit the Sansome Strategies blog: www.compliancefocus.com

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

Deadline Filing
July 1, 2013 Dodd-Frank Protocol 2.0 adherence deadline
July 15, 2013 IRS FATCA online registration portal available
August 29, 2013 Form PF (large funds) & Form CPO-PQR due
October 25, 2013 Deadline for registration via IRS FATCA online portal
November 20, 2013 “Red Flag” Rule compliance deadline
Periodic Filings Form D and Blue Sky filings should be current

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

Sincerely,

Karl Cole-Frieman & Bart Mallon

****

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.