The Corporate Transparency Act: What Fund Managers Need to Know

Introduction

The Corporate Transparency Act (the “CTA”) is a new federal law that went into effect on January 1, 2024 (the “Effective Date”) and requires certain entities (a “Reporting Company”) to file a report (a BOI Report”) with the Financial Crimes Enforcement Network (“FinCEN”) disclosing, among other things, beneficial ownership information (including names, dates of birth, residential addresses, and passport details) of individuals who either own or substantially control these entities. A willful failure to timely comply with the reporting requirements can result in civil and criminal penalties. The CTA broadly applies to most common entities formed in the U.S., as well as certain non-U.S. formed entities if they are registered to conduct business in the U.S., unless one of the CTA’s 23 exemptions apply (each an “Exemption”).

Synopsis for Fund Managers

The CTA provides an Exemption for each of: (i) an investment adviser registered with the Securities and Exchange Commission (the “SEC”) (an “RIA”); (ii) a fund manager that has filed as a venture capital fund adviser with the SEC (“VC Adviser”)[i]; (iii) an entity that is included as a “relying adviser” in an RIA’s Form ADV umbrella registration; and (iv) U.S. private funds that are exempt from registration under Section 3(c)(1) or 3(c)(7) of the Investment Company Act of 1940 (the “Investment Company Act”) and are managed by an RIA, a VC Adviser, or a “relying adviser.” Investment Advisers registered with a state are not exempt from the CTA. An Exempt Reporting Adviser (an “ERA”) is not exempt from the CTA, unless it is a VC Adviser. General partner and managing member entities of such funds and fund complexes are not expressly exempt but, under certain circumstances may qualify for an Exemption.

Notwithstanding the numerous Exemptions, the CTA will likely affect many fund managers vis-à-vis their affiliated entities who may be required to file BOI Reports. As discussed further below, in light of the complexity and nuance of the CTA’s application, as well as its breadth, the timing and content of its reporting requirements and its penalties, fund managers should consider developing appropriate internal and/or external procedures and controls to adequately prepare for these compliance obligations. The CTA’s reporting obligations are continuing and therefore fund managers should continuously assess whether the CTA applies to them, as their business evolves. 

FinCEN has published numerous materials to assist with complying with the CTA including (i) a reference guide; (ii) FAQs; and (iii) a compliance guide. If you have any questions regarding the CTA, please reach out to your CFM contact or email us here [email protected].

Discussion

Background

While the CTA appears to be ministerial or administrative in nature, it is rooted in broader national security initiatives as it was originally passed by the U.S. Congress in connection with the Anti-Money Laundering Act of 2020 and the National Defense Authorization Act of 2021 to combat money laundering, tax fraud, terrorism, and other illicit activities; therefore, fund managers should take a thoughtful and methodical approach to complying with the CTA.  

FinCEN is a bureau of the U.S. Department of Treasury whose mission is to safeguard the financial system from illicit use, combat money laundering and its related crimes, and promote national security by strategically using financial authorities and collecting, analyzing, and disseminating financial intelligence.

Compliance Timeline

A Reporting Company formed on or after the Effective Date, but before January 1, 2025, must file its BOI Report within 90 days from its formation.

A Reporting Company formed prior to the Effective Date must file its BOI Report by January 1, 2025.

A Reporting Company formed on or after January 1, 2025 must file its BOI Report within 30 days from its formation.

The BOI Report is a continuing obligation and therefore, certain events may require an updated BOI Report (discussed below) which must be filed within 30 days of the date of such events.

Reporting Companies

As described above, a Reporting Company under the CTA includes any corporation, limited liability company or other similar entity that is created by filing a document with a secretary of state or similar office under the law of a state, or formed under the law of a foreign country and registered to do business in the United States by filing a document with a secretary of state or similar office under the laws of a state.

The CTA exempts 23 categories of entities from the definition of a Reporting Company. A complete list of Exemptions can be found in the FinCEN compliance guide. Of the 23 Exemptions, the following are relevant to entities that operate in the investment management space:

  1. Any broker or dealer of securities that is registered under Section 15 of the Securities Exchange Act of 1934 (the “Exchange Act”);
  2. Any entity registered with the SEC under the Exchange Act;
  3. An investment company under Section 3 of the Investment Company Act and registered with the SEC;
  4. An RIA (please note that state registered investment advisers and ERAs that are not VC Advisers are not exempt);
  5. A VC Adviser (please note that venture capital advisers under the venture capital exemption of certain states may not qualify for this Exemption);
  6. Any entity registered with the Commodity Futures Trading Commission under the Commodity Exchange Act—this includes (i) futures commission merchant; (ii) introducing broker; (iii) swap dealer; (iv) major swap participant; (v) commodity pool operator; (vi) commodity trading adviser; and (vii) retail foreign exchange dealer;
  7. A pooled investment vehicle that is operated or advised by an RIA or a VC Adviser, provided that the pooled investment vehicle relies on the 3(c)(1) or 3(c)(7) exemption under the Investment Company Act and is identified, or will be identified on its adviser’s Form ADV;
  8. Operating companies that have (i) more than 20 full-time U.S. employees; (ii) an operating presence at a physical office in the United States; and (iii) filed U.S. federal taxes showing more than $5 million in gross receipts for the previous year; and
  9. Wholly owned subsidiaries of the above, excluding wholly owned subsidiaries of pooled investment vehicles.

Investment Managers

RIAs, VC Advisers, “relying advisers” of an RIA, and U.S. private funds that are either 3(c)(1) or 3(c)(7) funds and managed by the foregoing entities are exempt from the definition of Reporting Companies and are not required to comply with the CTA. Notwithstanding the foregoing, state registered investment advisers and ERAs (excluding VC Advisers) are not expressly exempt from complying with the CTA, however, this does not preclude any such entity from qualifying for a separate Exemption. Similarly, general partner and/or managing member entities of 3(c)(1) and 3(c)(7) funds are not expressly exempt from complying with the CTA unless they fall under a separate Exemption.

Additionally, holding companies that own, in part or in whole, entities that are exempt from complying with the CTA cannot rely on the Exemption of its subsidiary and will need to comply with the CTA unless an alternative Exemption is available. This will likely affect RIAs that are structured as limited partnerships and will require the general partner of the RIA to comply with the CTA and submit a BOI Report.

Foreign Pooled Investment Vehicles

Foreign pooled investment vehicles that are registered with a U.S. state do not qualify for the Exemption for pooled investment vehicles discussed above (even if managed by an RIA or VC Adviser). However, in such cases, the CTA expressly provides for limited exemptive relief by requiring such entities to only identify the one individual who exercises the greatest control over the entity in their BOI reports.

BOI Report

BOI Reports should include information about (i) the Reporting Company, and for Reporting Companies formed after the Effective Date, information about the Reporting Company Applicant; and (ii) the Reporting Company’s Beneficial Owners.

Reporting Company Information

Reporting Companies, formed or registered to do business in the United States before the Effective Date, are required to disclose the following information as part of the BOI Report:

  1. Full legal name of the company.
  2. Any trade names, including all fictitious business names.
  3. Principal place of business and, if that address is not in the United States, the primary location of the company in the United States.
  4. Jurisdiction of formation.
  5. Employer Identification Number or Taxpayer Identification Number.

Company Applicants

Reporting Companies formed or registering to do business in the United States after the Effective Date must disclose the following additional information about the person(s) who were involved in the formation of the Reporting Company:

  1. Name and address of the individual who actually files (physically or electronically) the formation paperwork of the Reporting Company with the Secretary of State. This may be an individual at a service provider who assists with the entity formation.
  2. Name and address of the individual who is responsible for directing or controlling such filing vis-à-vis instructing the filer to make the filing.

With respect to company applicants, the BOI Report should include their residential address unless such individual forms or registers companies in the normal course of their business.

Beneficial Ownership

In addition to providing company information, Reporting Companies must disclose all of their Beneficial Owners (as defined below). Under the CTA, a beneficial owner is any individual who directly or indirectly (i) owns or controls at least 25% of the ownership interests of the reporting company; or (ii) exercises substantial control over a reporting company (“Beneficial Owner”).

Ownership interests as used in the CTA refer to equity, stock, voting rights, profits interest, options, or any other instrument used to establish ownership.

For purposes of beneficial ownership, someone exercises substantial control over a Reporting Company if the individual (i) is a senior officer (including a general counsel); (ii) has the authority to appoint or remove certain officers or a majority of directors of the company; (iii) is an important decision maker (including senior portfolio managers and investment committee members); or (iv) has any other form of substantial control over the reporting company.

Reporting Companies are required to disclose the following information of each of their Beneficial Owners on the BOI Report:

  1. Full legal name.
  2. Date of birth.
  3. Current residential address.
  4. Identifying number (i.e., U.S. passport number; U.S. driver’s license number; or a foreign passport number if U.S. identification is not available).
  5. Image of the proof of identification.

FinCEN Identifier

Individuals may request a unique identifier from FinCEN by providing the above information to FinCen. If an individual is a Beneficial Owner of multiple Reporting Companies, the FinCen identifier can alleviate the burden of repeatedly providing the individual’s identifying information for each Reporting Company. The FinCEN ID can be obtained here.

Updated BOI Reports

After filing the initial BOI Report, Reporting Companies are not required to reaffirm or renew their BOI Report on a periodic basis; however, an updated BOI Report should be filed within 30 days after the previously reported information changes—this includes, but is not limited to, the entity obtaining or using a new trade name, the addition of a new Beneficial Owner, the change of residential address of a Beneficial Owner, the change or renewal of an identification document of a Beneficial Owner, and the removal of a Beneficial Owner. Because a Beneficial Owner relates to either ownership or control, installing a new executive that can exercise control over the entity, such as a new manager, managing member, general partner or director, or removing any of the foregoing, could also require an updated BOI report.

In the event that there are inaccuracies in a BOI Report, a Reporting Company should file an updated BOI Report within 30 days after the Reporting Company becomes aware of the inaccuracy or has a reason to know of the inaccuracy.

If a company ceases to qualify for an Exemption, it must submit a BOI Report within 30 days after it no longer qualifies for such Exemption. In contrast, if a Reporting Company qualifies for an Exemption after submitting a BOI Report, that entity must submit an updated BOI Report and check the box noting its newly exempt status. With respect to investment managers, the most common scenario would be if an ERA becomes an RIA—this would require the investment adviser entity, and all 3(c)(1) and 3(c)(7) funds managed by that entity, to file updated BOI Reports within 30 days after the investment adviser becomes an RIA.

Penalties

A willful failure to report or update the beneficial owner information or willfully providing false or fraudulent beneficial owner information shall result in civil penalties equal to $500/day up to a maximum of $10,000 as well as criminal penalties up to two years in jail.

If you have any questions about your compliance obligations, or whether your company is exempt from the definition of a reporting company under the CTA, please reach out to your CFM contact or email us here [email protected].


[i] Any investment adviser that (i) is described in Section 203(l) of the Investment Advisers Act of 1940; and (ii) has filed Item 10, Schedule A, and Schedule B of Part 1A of the Form ADV, or any successor thereto, with the SEC. Note that investment advisers that qualify for a venture capital fund adviser exemption under the laws of specific states (i.e. California) may not qualify insomuch as their Form ADV is filed with their state regulator rather than the SEC.

Tokenized Private Funds (Hedge Funds & VC Funds)

Overview of the Legal Process to Tokenize a Hedge Fund

By Bart Mallon, with Malhar Oza

As the digital asset industry continues to evolve, we see more use cases for tokenization, including tokenization of private investment funds like hedge, VC and PE funds.  While currently we see more examples of tokenizing various real world assets (RWAs) such as investments in real estate, many groups are now choosing to tokenize private investment funds for a variety of new and innovative reasons.   This blog post is intended to provide information about the legal and operational processes to take into account when tokenizing a private investment fund.

What is being tokenized?

When tokenizing a hedge fund or other private investment fund, we are talking about creating a separate instrument (essentially a digital ledger) on the blockchain in addition to creating all the “real world” formation documents. The total process is more akin to launching an existing private investment fund rather than foregoing the current fund formation and record-keeping process.  In this way we tokenize the RWA of a fund offering – because of this, we first examine the RWA parts of the tokenized fund.

Similarities between Tokenized and Non-Tokenized Funds

While there are many differences between traditional and tokenized funds, from a high level overview, they have essentially equivalent legal/regulatory and operational requirements for the non-tokenized features.  These similarities include: 

Structure – like a traditional fund, a tokenized fund is going to be structured with (1) a management level entity or entities and (2) the fund level entity or entities (including potentially offshore feeder funds).  For any private investment fund, the driving considerations for structure will involve business questions (e.g., where are investors located, where are investments made, etc) and tax (where is the manager physically located, do investors have specific tax needs, etc).  Like traditional funds, managers are going to need to think about how regulatory requirements may affect structure generally (see below for more information here).  For tokenized private investments funds there may also be a token issuing entity as well (discussed below) that will interact with this traditional structure.

Offering Documents – as with a traditional private fund, a tokenized fund needs to have fund offering documents.  Specifically, a tokenized fund will have a PPM, limited partnership (or operating) agreement and subscription documents that will be substantially similar in structure and content to traditional non-tokenized funds.  These documents describe the standard items for any private fund, and also make reference to many of the token-specific characteristics of the investment.

Investment program – while many will assume that a tokenized fund will be a crypto fund, these vehicles can be established to invest in any asset class (traditional securities (publicly or privately traded), real estate, art, commodities, etc.).  The requirement to accurately describe the major aspects of the investment program in the fund offering documents are the same for both tokenized and traditional funds alike. 

Service providers – the main service providers will be the same – this means that the manager will need to engage an administrator, an auditor, a broker/prime broker (if investing in securities on a securities exchange), a digital asset exchange (if trading in digital assets), a custodian, lawyer, etc.  It is important for the manager to work with service providers who are comfortable with the tokenized aspects of the fund.  Sometimes some fund managers will have two sets of attorneys for the fund launch – one set devoted to the standard fund aspects and one set devoted to the tokenized aspects. Where managers engage two sets of counsel, it is paramount each group of attorneys is in sync with the other to ensure proper compliance with securities laws.

Regulation – managers of tokenized funds will need to consider all of the same regulatory items that apply to normal funds.  These items include:

  • RIA or CPO/CTA registration – there may be a requirement for the manager to obtain certain licenses based on the fund’s underlying investments or economic activity; for example, RIA registration is required if the manager invests in securities and CPO/CTA registration is required if the fund transacts in futures or commodities.  
  • Regulation D – the manager will need to determine whether to utilize Section 506(b) or Section 506(c).  Section 506(c) allows for general solicitation and many tokenized fund managers choose this safe harbor despite there being additional investor qualification requirements.  [Note: some funds may try to tokenize via the Regulation A process, but we don’t think this is optimal.]
  • Form D and blue sky filings – as with a normal fund, after fund interests have been sold, the manager will also need to make sure to make Form D and blue sky filings.
  • Investment Company Act – the manager will need to choose whether to have the fund use the 3c1 or 3c7 exemptions
  • Investor qualifications – based potentially on whether the fund will be 3c1 or 3c7, the investors may need to have accredited investor status, qualified client status, or qualified purchaser status.
  • Other items to be aware about – AML/KYC (standard in subscription documents, though there should be heightened AML/KYC practices when launching a tokenized product), adequate description of conflicts of interest, whether the fund will be subject to ERISA, making sure marketing materials are accurate, etc.

Token Specific Aspects of a Tokenized Fund

While the many similarities between the two types of funds are clear, there are specific technical items to consider with respect to the tokenized fund.

What blockchain? – perhaps this is going to be the most important technical question for the manager and will influence the characteristics and usefulness of the fund token.  Normally this part is determined by the manager after discussion with their tech team (internal or external) and then relayed to the attorney.  It will be very important for the manager to detail all technical aspects of the generation and potential movement of the fund token to the attorney for appropriate legal analysis. 

When and how are tokens created? – mechanically the fund tokens will need to be generated pursuant to some sort of token creation protocol.  This will depend on other qualities of the fund token including how whitelisting (discussed below) will be done, what blockchain is being utilized, and whether the fund token will interact with certain smart contracts.  

Smart contracts? – depending on the native blockchain and functionality of the fund tokens, managers may choose to allow the fund tokens to interact with certain smart contracts.  The ability for investors to use fund tokens to interact with smart contracts is one of the potential emerging use cases of the fund tokenization process.  Managers should understand what the smart contracts will be doing, and care must be taken such that at all points in the smart contract process all applicable laws and regulations are followed.  The use of whitelisting, among other safeguarding techniques, is a common tool to comply with securities laws among other purposes.  Obviously allowing smartcontract functionality with the fund tokens will increase various technical and legal risks with respect to the fund tokens. 

Transfers and Whitelists – one of the reasons to tokenize private investment fund interests is to allow for easier transfer between token holders through a faster speed of settlement as well as the potential creation of a more robust secondary market.  As these fund tokens represent private fund interests (or only certain features of private fund interests in some cases), any transfers require compliance with all applicable securities regulations and laws.  This means that like in the traditional fund context, the tokenized fund manager will need to continually understand the fund’s investor base (for example: accredited investor, qualified client, qualified purchaser status, number of purchasers/holders, etc,) and may need to be aware of other items as well (holding periods, AML/KYC, etc.) in order to conform to applicable securities laws and regulations.  

Like with traditional funds, the manager ultimately still approves transfers of fund tokens (representing fund interests), even when the transfer is done on the blockchain.  To aid with this, most tokenized funds will need to have some kind of a whitelist of wallet addresses (where the manager knows the identity of the person and/or entity that controls the whitelisted wallet address). This knowledge allows the manager to make sure that any fund token transfers are between parties whom the manager knows and/or are investors in the fund.  Any transfer of the fund tokens needs to abide by securities laws and regulations and the utilization of a whitelist helps the manager ensure compliance.

Offshore lawyers/ jurisdiction – there are two ways that offshore lawyers are important to the tokenized fund launch process.  The first is with respect to normal offshore structuring in the event the fund will have non-US investors.  The second way deals with the jurisdiction of the token itself.  Many times there will be a foundation or other offshore entity that issues the token.  The foundation may or may not be the token issuing entity.  In many cases, the token issuing entity is likely to be an offshore company and offshore counsel is needed in the creation of this entity.

No NY investors in a tokenized fund – it is likely that tokenized funds run afoul of the New York bitlicense requirement.  Unless a manager goes through the process to obtain a bitlicense in New York, the manager will need to make sure that there are no New York resident investors in the fund. Given the potential of each state to implement similar regulations, your choice of counsel should remain up-to-date about all such regulatory regimes.

Tax – on the fund side, these vehicles are taxed like normal private fund vehicles and generally are structured to act as passthroughs for US taxable investors and as “blockers” for non-US investors.  On the investor side, care needs to be taken with respect to any transfers of the fund tokens.  Investors should also talk with tax counsel before using the fund tokens in smart-contracts or other programs because there may be certain tax consequences.  The IRS has been slow to issue guidance, and the asset class is novel and kinetic, so we urge managers to connect with tax counsel throughout the structuring process.

Limitations

Some of the limitations of tokenized fund products stems from uncertain regulatory regimes like the New York Bit License requirement and other states’ similar regulatory regimes. Additionally, the cost and expense of developing the fund token on the blockchain, retaining a tech team, engaging and potentially educating service providers, and the constant regulatory scrutiny of digital assets in general may make fund tokenization unattractive for certain groups. While any private investment fund in any asset class has the potential to become tokenized, groups should internally assess whether tokenization makes sense for the product seeking to be launched.

Specific risks of tokenized funds 

The tokenized fund has both standard risks associated with a private fund, as well risks related solely to the tokenized aspect.  Standard risks include operation of the fund structure, general risks with respect to trading/investment program (including normal liquidity), standard legal and regulatory risks, etc.  In addition to those risks, the following will be applicable to tokenized funds:

  • Unclear regulations – investment adviser, IRS, etc
  • Risk related to the technology (blockchain generally, DeFi, smart contracts, hacks, private keys, malicious actors, network outages and bugs)
  • Token units may have a different “value” than the underlying NAV related to the fund interest, depending on how the manager operates the private fund

Cost and Timing 

Tokenized funds are inherently more resource-intensive to launch given the various structuring components and specialization of the service providers.  Timing for a launch will also be longer than a traditional fund launch to allow for coordination between the lawyers, manager, operations, and technical fund token deployment teams.  A good rule of thumb is that a tokenized fund will probably cost about twice as much in both cost and time than would apply for a non-tokenized fund product.

Issues and Conclusion

Tokenized funds are new vehicles and with any new structure (and unclear regulatory guidance), there are going to be issues that pop up during the launch process.  As discussed above, most issues are likely to be with respect to the mechanical or technical aspects of tokenizing the fund (as opposed to the drafting of the fund offering documents and legal agreements).  We recommend taking more time on the front end to make sure all of the service providers truly understand how the fund token will work during all stages of the token lifecycle – it is vital for the technical functionality of the token is understood and appropriately disclosed in applicable documents.

By some accounts, tokenized funds will become a big part of the future financial world.  If it comes to pass that there is and continues to be a compelling use case for tokenizing a private fund, then we believe that this process will become more and more streamlined.  But, tokenized funds are still novel and relatively untested and complete functionality with respect to a token’s potential will be limited by applicable laws/regulations.  These structures will continue to develop both in standardization in terms of process, cost and timing as more groups seek to tokenized private fund products, and in functionality as more people come to the digital asset space and try to do new and novel things. 

We are very early in this space and are excited for the future.  If you have any questions on how to tokenized a private fund, please contact us or call Bart Mallon directly at 415-868-5345.

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Bart Mallon, co-founder of Cole-Frieman & Mallon LLP, has established himself as a leader in the private fund space for digital assets and has helped to launch some of the first tokenized private funds.  For more information on his practice please see his bio or reach out to him directly at 415-868-5345.

Malhar Oza works as Counsel at Cole-Frieman & Mallon LLP and assists clients on various operational, transactional and regulatory matters related to digital assets, including fund formation (domestic and offshore). Malhar also counsels crypto managers, investment advisers, digital asset fund managers, and other members of the digital asset investment management industry on complex compliance matters related to state and federal securities laws. He also specializes in launching tokenized fund products, including closed-end and evergreen private investment funds.  To contact Malhar, please email him at [email protected] or give him a call at 415-762-2879.

Cole-Frieman & Mallon 2023 End of Year Update

December 18, 2023

Clients, Friends, and Associates:

As we near the end of 2023, we have highlighted some recent industry developments that will likely impact many of our clients. We have also developed a checklist to help managers effectively oversee the business and regulatory landscape for the coming year. While we strive to present an informative, albeit brief, overview of these topics, we are also available should you have any related questions.

This update includes the following:

  • CFM Items
  • Q4 Matters
  • Annual Compliance & Other Items
  • Annual Fund Matters
  • Annual Management Company Matters
  • Notable Regulatory & Other Items from 2023
  • Compliance Calendar

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CFM Items

We are pleased to welcome Jon Tong as a Senior Associate in our Funds practice group. His experience and expertise in the field will greatly contribute to the success and growth of our Funds practice group. Please join us in welcoming Jon to our firm.

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Q4 Matters

SEC Charges Kraken for Operating as an Unregistered Securities Exchange.  On November 20, 2023, the Securities and Exchange Commission (“SEC”) charged Payward Inc. and Payward Ventures Inc., together known as Kraken, with operating Kraken’s trading platform as an unregistered securities exchange, broker, dealer, and clearing agency. The SEC’s complaint also alleges that Kraken lacks sufficient internal controls and recordkeeping practices, and that Kraken commingles customer money and crypto assets with its own, presenting serious risks for its customers. The complaint seeks injunctive relief, conduct-based injunctions, disgorgement of ill-gotten gains plus interest, and penalties. This enforcement action comes just months after Kraken agreed to cease offering or selling securities through its staking service and pay a civil penalty of $30 million, as described further in Notable Regulatory & Other Items from 2023, below.

SEC Issues Risk Alert Clarifying Exam Selection Process for Registered Investment Advisers.  On September 6, 2023, the SEC’s Division of Examinations issued a Risk Alert outlining its examination selection process for SEC-registered investment advisers (“SEC RIAs”). The SEC noted that it relies on a risk-based approach, utilizing industry- and firm-level data as well as information provided on disclosure documents such as Form ADV and Form PF to identify high-risk advisers. In addition, the SEC considers numerous factors, such as the results of past examinations, disciplinary history of adviser affiliates, potential conflicts of interest in business activities, vulnerability to financial or market stresses, media reports and complains, access to client assets, as well as an adviser’s specific products, services, or practices. The scope of an examination, and consequently the documents requested, will vary depending on the firm’s business model, associated risks, and the reason for conducting the examination. However, examinations typically include reviewing advisers’ operations, disclosures, conflicts of interest, and compliance practices with respect to certain core areas, including but not limited to, custody and safekeeping of client assets, valuation, portfolio management, fees and expenses, and brokerage and best execution.

The Division of Examinations publishes an annual list of priorities to signal its interest in particular compliance risk areas, of which advisers should be mindful.

The National Venture Capital Association Revises its Model Legal Documents.  The National Venture Capital Association (“NVCA”) recently revised its model legal documents for the first time since 2014. These changes are particularly relevant to our clients engaged in venture capital transactions, offering enhanced legal frameworks and protections in this rapidly evolving sector. Changes include: (i) provisions specifically tailored to evolving markets such as life science transactions and cryptocurrency- and blockchain-related offerings; (ii) enhanced ethical and legal standards, such as inclusion in the Investor Rights Agreement of a covenant requiring adoption of a workplace code of conduct and anti-harassment policies; and (iii) adaptations to legal developments, such as new drafting options in response to the Delaware Rapid Arbitration Act (2015), offering more efficient dispute resolution mechanisms. The revised model documents can be found on the NVCA’s website.

CFTC’s Proposed Amendments to Regulation 4.7.  On October 2, 2023, the Commodity Futures Trading Commission (“CFTC”) proposed amendments to modernize Regulation 4.7, significantly increasing monetary thresholds and expanding disclosure requirements. Currently, Regulation 4.7 exempts commodity pool operators (“CPOs”) and commodity trading advisors (“CTAs”) from certain compliance requirements if their offerings are limited to qualified eligible persons (“QEPs”). The CFTC proposes four amendments: (1) doubling the monetary thresholds for QEP portfolio requirements; (2) adding certain disclosure requirements for CPOs and CTAs relying on the Regulation 4.7 exemption; (3) adding an option for CPOs of funds of funds operated under Regulation 4.7 to distribute their monthly account statements within 45 days after the end of the month; and (4) technical amendments to improve the Regulation’s readability.

The proposed disclosure requirements for CPOs include descriptions of principal risk factors for the exempt pool, investment program and use of proceeds, fees, conflicts, and performance. Regulation 4.7 pool offerings would require an offering memorandum. Similarly, CTAs would also have to make disclosures, including: the identities and descriptions of certain persons such as principals, futures commission merchants, any foreign exchange dealers, and introducing brokers; risk factors; trading programs; fees; conflicts; and performance.

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Annual Compliance & Other Items

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

Annual Compliance Review. The Chief Compliance Officer (“CCO”) of a registered investment advisor (“RIA”) must conduct a review of the adviser’s compliance policies and procedures annually. This annual compliance review should be in writing and presented to senior management. CCOs should consider additions, revisions, and updates to the compliance program as may be necessary. We recommend firms discuss the annual review with their outside counsel or compliance firm to obtain guidance about the review process and a template for the assessment. Conversations regarding the annual review may raise sensitive matters, and advisers should ensure that these discussions are protected by attorney-client privilege. Advisers that are not registered may still wish to review their procedures and/or implement a compliance program as a best practice.

Form ADV Annual Amendment. RIAs or managers filing as exempt reporting advisers (“ERAs”) with the SEC or a state securities authority must file an annual amendment to their Form ADV within 90 days of the end of their fiscal year. For most managers, the Form ADV amendment will be due on March 31, 2024. RIAs must provide a copy of the updated Form ADV Part 2A brochure and Part 2B brochure supplement (or a summary of changes with an offer to provide the complete brochure) to each “client” and, if applicable, Part 3 (Form CRS: Client Relationship Summary) to each “retail investor” with which the RIA has entered into an investment advisory contract. Note that for SEC RIAs to private investment vehicles, a “client” for purposes of this rule refers to the vehicle(s) managed by the adviser and not the underlying investors. State-registered advisers need to examine their states’ regulations to determine who constitutes a “client.” For purposes of the Form ADV Part 3, a “retail investor” means a natural person, or the legal representative of such natural person, who seeks to receive or receives services primarily for personal, family, or household purposes.

Switching to/from SEC Regulation.

SEC Registration. Managers who no longer qualify for SEC registration as of the time of filing the annual Form ADV amendment must withdraw from SEC registration within 180 days after the end of their fiscal year (June 30, 2024, for most managers), by filing a Form ADV-W. Such managers should consult with legal counsel to determine whether they are required to register in the states in which they conduct business. Managers who are required to register with the SEC as of the date of their annual amendment must register with the SEC within 90 days of filing the annual amendment (June 30, 2024, for most managers, assuming the annual amendment is filed on March 31, 2024).

Exempt Reporting Advisers. Managers who no longer meet the definition of an ERA will need to submit a final report as an ERA and apply for registration with the SEC or the relevant state securities authority, as applicable, generally within 90 days after the filing of the annual amendment (June 30, 2024, for most managers, assuming the annual amendment is filed on March 31, 2024).

Custody Rule Annual Audit.

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

SEC RIAs to pooled investment vehicles may avoid both the quarterly statement and surprise examination requirements by having audited financial statements prepared for each pooled investment vehicle in accordance with generally accepted accounting principles (“GAAP”) by an independent public accountant registered with the Public Company Accounting Oversight Board (“PCAOB”). Audited financial statements must be sent to investors in the fund within 120 days after the fund’s fiscal year-end (or for fund-of-fund clients, within 180 days after fiscal year-end). SEC RIAs should review their internal procedures to ensure compliance with the custody rules.

California RIAs. California-registered investment advisers (“CA RIAs”) that manage pooled investment vehicles and are deemed to have custody of client assets are also subject to independent party surprise examinations. However, CA RIAs can avoid these additional requirements by engaging a PCAOB-registered auditor to prepare and distribute audited financial statements to all beneficial owners of the pooled investment vehicle, and the Commissioner of the California Department of Financial Protection and Innovation (“DFPI”). Those CA RIAs that do not engage an auditor must, among other things: (i) provide notice of such custody on the Form ADV; (ii) maintain client assets with a qualified custodian; (iii) engage an independent party to act in the best interest of investors to review fees, expenses, and withdrawals; and (iv) retain an independent certified public accountant to conduct surprise examinations of assets.

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

California Minimum Net Worth Requirement and Financial Reports.

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

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

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

Annual Re-Certification of CFTC Exemptions.  CPOs and 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. A common example includes the 4.13(a)(3) exemption also known as the “de minimis” exemption. CPOs and CTAs currently relying on relevant exemptions should consult with legal counsel to evaluate whether they remain eligible to rely on such exemptions.

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

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

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

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

Managers should be aware that the SEC recently adopted amendments to the Schedule 13D and 13G reporting deadlines:

Revised Schedule 13D Deadlines. For Schedule 13D, the amendments shorten the initial filing deadline from 10 days to 5 business days and require that amendments be filed within 2 business days. Compliance with the new Schedule D filing deadlines will be required as of the amendments’ effective date, February 5, 2024.

Revised Schedule 13G Deadlines. For certain Schedule 13G filers (i.e., qualified institutional investors and exempt investors), the amendments shorten the initial filing deadline from 45 days after the end of a calendar year to 45 days after the end of the calendar quarter in which the investor beneficially owns more than 5% of the covered class. For other Schedule 13G filers (i.e., passive investors), the amendments shorten the initial filing deadline from 10 days to 5 business days. In addition, for all Schedule 13G filers, the amendments generally require that an amendment be filed 45 days after the calendar quarter in which a material change occurred rather than 45 days after the calendar year in which any change occurred. Finally, the amendments accelerate the Schedule 13G amendment obligations for qualified institutional investors and passive investors when their beneficial ownership exceeds 10% or increases or decreases by 5%. Compliance with the new Schedule G filing deadlines will be required as of September 30, 2024.

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

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

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

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

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

SEC Form D. Form D filings for most funds need to be amended annually, on or before the anniversary of the most recently filed Form D. Copies of Form D are publicly available on the SEC’s EDGAR website.

Blue Sky Filings. On an annual basis, a manager should review its blue sky filings for each state to make sure it has met any initial and renewal filing requirements. Several states impose late fees or reject late filings altogether. Accordingly, it is critical to stay on top of filing deadlines for both new investors and renewals. We also recommend that managers review blue sky filing submission requirements. Many states now permit blue sky filings to be filed electronically through the Electronic Filing Depository (“EFD”) system, and certain states will now only accept filings through EFD.

IARD Annual Fees. Preliminary annual renewal fees for state-registered and SEC-registered investment advisers are due on December 13, 2023. Failure to submit electronic payments by the deadline may result in registrations terminating due to a “failure to renew.” If you have not already done so, you should submit full payment into your Renewal Account by E-Bill, check, or wire as soon as possible. 

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

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Annual Fund Matters

New Issue Status. On an annual basis, managers need to confirm or reconfirm the eligibility of investors that participate in initial public offerings, or new issues, pursuant to both Financial Industry Regulatory Authority, Inc. (“FINRA”) Rules 5130 and 5131. Most managers reconfirm investor eligibility via negative consent (i.e., investors are informed of their status on file with the manager and are asked to notify the manager of any changes), whereby a failure to respond by any investor operates as consent to its current status.
 
ERISA Status. Given the significant problems that can occur from not properly tracking ERISA investors in private funds, we recommend that managers confirm or reconfirm on an annual basis the ERISA status of their investors. This is particularly important for managers that track the underlying percentage of ERISA funds for each investor, with respect to each class of interests in a pooled investment vehicle.
 
Wash Sales. Managers should carefully manage wash sales for year-end. Failure to do so could result in book/tax differences for investors. Certain dealers can provide managers with swap strategies to manage wash sales, including Basket Total Return Swaps and Split Strike Forward Conversion. These strategies should be considered carefully to make sure they are consistent with the investment objectives of the fund.
 
Redemption Management. Managers with significant redemptions at the end of the year should carefully manage unwinding positions to minimize transaction costs in the current year (that could impact performance) and prevent transaction costs from impacting remaining investors in the next year. When closing funds or managed accounts, managers should pay careful attention to the liquidation procedures in the fund constituent documents and the managed account agreement.
 
NAV Triggers and Waivers. Managers should promptly seek waivers of any applicable termination events specified in a fund’s International Swaps and Derivatives Association (“ISDA”) or other counterparty agreement that may be triggered by redemptions, performance, or a combination of both at the end of the year (NAV declines are common counterparty agreement termination events).
 
Fund Expenses. Managers should wrap up all fund expenses for 2023 if they have not already done so. In particular, managers should contact their outside legal counsel to obtain accurate and up to date information about legal expenses for inclusion in the NAV for year-end performance.
 
Electronic Schedule K-1s. The Internal Revenue Service (“IRS”) authorizes partnerships and limited liability companies taxed as partnerships to issue Schedule K-1s to investors solely by electronic means, provided the partnership has received the investors’ affirmative consent. States may have different rules regarding electronic K-1s, and partnerships should check with their counsel whether they may be required to send hard copy state K-1s. Partnerships must also provide each investor with specific disclosures that include a description of the hardware and software necessary to access the electronic K-1s, how long the consent is effective, and the procedures for withdrawing the consent. If you would like to send K-1s to your investors electronically, you should discuss your options with your service providers.
 
“Bad Actor” Recertification Requirement. A security offering cannot rely on the Rule 506 safe harbor from SEC registration if the issuer or its “covered persons” are “bad actors.” Fund managers must determine whether they are subject to the bad actor disqualification any time they are offering or selling securities in reliance on Rule 506. The SEC has advised that an issuer may reasonably rely on a covered person’s agreement to provide notice of a potential or actual bad actor triggering event pursuant to contractual covenants, bylaw requirements, or undertakings in a questionnaire or certification. However, if an offering is continuous, delayed or long-lived, issuers must periodically update their factual inquiry through a bring-down of representations, questionnaires, and certifications, negative consent letters, reexamination of public databases or other means, depending on the circumstances. Fund managers should consult with counsel to determine how frequently such an update is required. As a matter of practice, most fund managers should perform these updates at least annually.
 
U.S. FATCA. Funds should monitor their compliance with the U.S. Foreign Account Tax Compliance Act (“FATCA”). Generally, U.S. FATCA reports are due to the IRS on March 31, 2024, or September 30, 2024, depending on where the fund is domiciled. However, reports may be required by an earlier date for jurisdictions that are parties to intergovernmental agreements (“IGAs”) with the U.S. Additionally, the U.S. may require that reports be submitted through the appropriate local tax authority in the applicable IGA jurisdiction, rather than the IRS. Given the varying U.S. FATCA requirements applicable to different jurisdictions, managers should review and confirm the specific U.S. FATCA reporting requirements that may apply. As a reminder, we strongly encourage managers to file the required reports and notifications, even if they already missed previous deadlines. Applicable jurisdictions may be increasing enforcement and monitoring of FATCA reporting and imposing penalties for each day late.
 
CRS. Funds should also monitor their compliance with the Organisation for Economic Cooperation and Development’s Common Reporting Standard (“CRS”). All “Financial Institutions” in the British Virgin Islands (“BVI”) and the Cayman Islands must register with the respective jurisdiction’s Tax Information Authority and submit various reports with the applicable regulator via the associated online portal. Managers to funds domiciled in other jurisdictions should also confirm whether any CRS reporting will be required in such jurisdictions and the procedures required to enroll and file annual reports. We recommend managers contact their tax advisors to stay on top of the U.S. FATCA and CRS requirements and avoid potential penalties.

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Annual Management Company Matters

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

Employee Reviews. An effective annual review process is vital to reduce the risk of employment-related litigation and protect the management company in the event of such litigation. Moreover, it is an opportunity to provide context for bonuses, compensation adjustments, employee goals, and other employee-facing matters at the firm. It is never too late to put an annual review process in place.

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

Insurance. If a manager carries director and officer or other liability insurance, the policy should be reviewed annually to ensure that the manager has provided notice to the carrier of all claims and all potential claims. Newly launched funds should also be added to the policy as necessary.

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

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Notable Regulatory & Other Items from 2023

SEC Matters

SEC Charges Staking-as-a-Service Provider. On February 9, 2023, the SEC charged Payward Ventures, Inc. and Payward Trading Ltd. (“Kraken”) with failing to register the offer and sale of their crypto asset staking-as-a-service program. In operation since 2019, Kraken’s program allowed public investors to transfer crypto related assets to Kraken for staking in exchange for annual investment returns advertised by Kraken to be as high as 21%. Kraken’s model depended on pooling the assets transferred by investors and staking them on behalf of those investors. The SEC’s complaint alleged that the program produced benefits derived from Kraken’s effort on behalf of investors and that the program should be considered an investment contract subject to registration, disclosure, and safeguard protections required by securities laws. As a result of the charge, Kraken agreed to cease offering or selling securities through crypto asset staking services and pay $30 million in settlement fees. Although the SEC’s complaint did not allege that staking necessarily always constitutes a security offering, it was determined the service did meet the 4-prong Howey test to be considered an investment contract. This illustrates the SEC’s increasingly more aggressive regulation of crypto under existing rules and regulations, and managers should consider whether staking services offered by third parties would fit into the Kraken fact pattern.

SEC Enforcement Action Against Ripple. On July 13, 2023, the U.S. District Court of the Southern District of New York entered an order which granted in part and denied in part the cross-motions for summary judgment filed by the SEC and Ripple Labs, Inc. (“Ripple”). In December 2020, the SEC charged Ripple and two executives for engaging in unlawful offer and sales of securities in violation of the Exchange Act. The complaint alleged that since 2013, Ripple issued over 14.6 billion units of its native token, XRP, in exchange for consideration of over $1.38 billion without registering the offer and the sale of such token with the SEC. Notably, the July 2023 order stated that XRP “is not in and of itself a ‘contract, transaction[,] or scheme’ that embodies the Howey requirements of an investment contract”. In other words, XRP itself is not a security, and all the facts and circumstances surrounding specific transactions in XRP must be examined to determine whether an “investment contract,” as defined under the Howey test, was issued. As a reminder, the U.S. Supreme Court ruled in Howey that an investment contract requires a finding of an investment of money in a common enterprise with the reasonable expectation of profits derived from the efforts of others.

The District Court examined the sale and distribution of XRP in three types of transactions – direct sales of XRP to institutional investors, sales of XRP through crypto exchanges in blind bid/ask transactions, and distributions of XRP as payment for services to employees and service providers – and held that only the direct sales of XRP to institutional investors constituted an investment contract under the Howey test.

Terraform Labs Ruling Rejects Ripple Holding. On July 31, 2023, the U.S. District Court for the Southern District of New York sided with the SEC in the case of SEC v. Terraform Labs Ptd. Ltd. after it denied the defendants’ motion to dismiss. In doing so, the court rejected outright the holding in the recent summary judgment granted by another judge in the same District Court in SEC v. Ripple Labs Inc. For more information on SEC v. Ripple Labs Inc., check out our July 2023 Quarterly Update from the Hedge Fund Law Blog.

The court in Terraform Labs found that both direct institutional investment sales and secondary market transactions involving retail investors were investment contracts, arguing that Howey makes no distinction between institutional and retail investors and concluded that the nature and type of purchases have no bearing on “whether a reasonable individual would objectively view the defendants’ actions and statements as evincing a promise of profits based on their efforts.” The court opted to apply the Howey test in a different manner than in Ripple Labs. In Ripple Labs, the court drew a distinction between sales of the XRP token to retail investors and institutional investors, holding that the sales of XRP to retail investors was not an investment contract because the purchasers did not have a reasonable expectation of profits from the efforts of Ripple Labs, Inc.

The inconsistent application of the Howey test from within the Southern District of New York illustrates the regulatory uncertainty surrounding the digital asset industry. We will continue to monitor similar cases brought by the SEC and other regulators.

SEC Adopts Final Rules for Private Fund Advisers. On August 23, 2023, the SEC issued final rules focused on investment advisers who manage private funds (the “New Private Fund Adviser Rules”). A summary of the key elements of the New Private Fund Adviser Rules appears in our October 2023 Quarterly Update.

The SEC’s New Proposed Rule Regarding Safeguarding Advisory Client Assets. In February, the SEC announced a proposed rule to amend the existing “custody rule” applicable to SEC RIAs that have custody of client assets. The proposed rule, redesignated as the “safeguarding rule,” would impose significant new requirements on RIAs, including RIAs operating in the digital asset space. As discussed more fully in our April 2023 Quarterly Update, the new rule would expand the existing custody requirements to cover all “client assets” over which an RIA has custody, explicitly including digital assets, and require RIAs operating in the digital asset space to custody their digital assets with “qualified custodians” at all times. The proposed rule, and any revisions to it, would only become effective after the SEC commissioners vote to approve it as a final rule.

The SEC’s Proposed Cyber Risk Management Rule for Investment Advisers. Last February, the SEC released a proposed rule that portends to create an entirely new cybersecurity compliance regime for investment advisers and certain funds. This new set of cybersecurity risk management rules (the “Cyber Risk Management Rule”) will be codified by amendments to both the Investment Advisers Act and the Investment Company Act. As drafted, the Cyber Risk Management Rule has four (4) cornerstone components: (i) appropriately scaled policies and procedures; (ii) a new regulatory cybersecurity breach-reporting regime (which contemplated a 48-hour notification period for alerting the SEC of a cybersecurity breach); (iii) cybersecurity disclosure obligations; and (iv) cybersecurity recordkeeping requirements. The Cyber Risk Management Rule was set for a final vote in April 2023, however on March 15, 2023, the SEC unexpectedly reopened its comment period for an additional sixty (60) days, while simultaneously issuing three (3) additional cybersecurity related rule proposals, each with some connective tissue with the Cyber Risk Management Rule. In June, the SEC set a goal to finalize the Cyber Risk Management Rule by October, however the SEC has not yet done so and has indicated that the rule’s formal adoption will take place in early 2024. Cybersecurity continues to be a top priority at the SEC, and it has made clear that a new, more mature and comprehensive cybersecurity compliance regime is imminent. This new regime will not only heighten the SEC’s current cybersecurity requirements (i.e., the requirement to have certain cybersecurity policies, procedures and controls, including annual assessments) but will also create entirely new categorical obligations, to wit, the aforementioned reporting, disclosure and recordkeeping requirements. The Firm’s Cybersecurity Law Practice Group is available to assist our clients with any questions or concerns regarding virtually any aspect of cybersecurity compliance.

SEC and NYDFS Commence Actions Against Paxos. The New York Department of Financial Services (“NYDFS”) in February ordered Paxos Trust Company (“Paxos”) to cease minting Paxos-issued BUSD, a fiat-backed stablecoin issued by Binance and Paxos. Each BUSD token is backed 1:1 with US dollars held in reserve. On February 13, 2023, Paxos notified customers of its intent to end its relationship with Binance as a result of the order. In conjunction with the order from the NYDFS, Paxos reported that it received a Wells notice from the SEC on February 3, 2023. According to a press release from Paxos, the Wells notice stated the SEC was considering enforcement action against Paxos alleging that BUSD is an unregistered security. No enforcement action has yet been brought.

SEC Releases a “Frequently Asked Questions” Page for the Marketing Rule. In January, the SEC released a FAQ page for questions stemming from its recently enacted rule 206(4)-1 under the Investment Advisers Act of 1940 (the “Marketing Rule”). The page currently provides responses to three commonly asked questions—most notably regarding its gross and net performance rules—clarifying that when an RIA displays the gross performance of one investment or a group of investments from a private fund, the RIA must show the net performance of the single investment and/or the group of investments, respectively. The SEC noted that they will be updating this page periodically to respond to questions related to the Marketing Rule, and clients should reach out with any specific questions relating to the new Marketing Rule.

Judge Rules that Emojis in a Tweet may Constitute “Financial Advice.” A United States District Court judge ruled that the use of emojis can be construed in certain circumstances to meet a factor in the legal test to determine whether an individual is providing financial advice. Specifically, the judge denied the defendant’s Motion to Dismiss, finding that the defendant-company’s use of a rocket ship, stock chart, and money bag emojis in a recent tweet “objectively meant one thing: a financial return on investment.” The emojis were displayed alongside statements touting recent NFT purchase prices on the company’s website, presumably indicating future gains on such NFTs. While the decision specifically rules on the three emojis mentioned above, we advise our clients to use caution in their use of any emojis, whether that be in public or private communications regarding fund matters. In any event, any communications should not be misleading and should be in accordance with the Advisers Act and the new marketing rule (if applicable).

SEC Enforcement Action Against Coinbase. On June 6, 2023, the SEC charged Coinbase, Inc. and Coinbase Global, Inc. (collectively, “Coinbase”) for failure to register as an exchange, a broker-dealer and a clearing agency, and for failure to register the offering and sale of securities via the Coinbase trading platform in accordance with the Securities Exchange Act of 1934, as amended (the “Exchange Act”). This proceeding follows the Wells notice that Coinbase received from the SEC in March 2023. The complaint alleges that Coinbase acted as an unregistered exchange, a broker-dealer, and a clearing agency by making available at least 13 crypto assets that are offered and sold as investment contracts on its platform. Additionally, the complaint alleges that Coinbase’s staking program should be considered an investment contract under the Howey test.

On June 28, 2023, Coinbase filed an answer to the SEC complaint denying that the digital assets listed on its platform constitute an investment contract or a security. Additionally, the answer noted that half of the tokens traded on Coinbase’s platform that the SEC alleged are securities were custodied and traded on its platform since April 2021 (i.e., when the SEC approved and declared Coinbase’s S-1 filing to be effective), and, at the time, the SEC did not identify such tokens as investment contracts or securities, nor allege that Coinbase was operating as an unregistered exchange, broker, and clearing agency within the meaning of federal securities law. Coinbase’s answer also denied the SEC’s allegation that its staking program is a security. In addition to filing the answer, Coinbase filed a letter with the court indicating its intention to file a motion to dismiss the complaint, which motion to dismiss was filed on August 4, 2023. Our firm will continue to closely monitor the situation with Coinbase for new developments.  

SEC Enforcement Action Against Bittrex and Bittrex’s Chapter 11 Bankruptcy. On April 17, 2023, the SEC charged Bittrex, Inc., Bittrex Global GmbH, and William Hiroaki Shihara, co-founder and former chief executive officer (collectively, “Bittrex”) for the failure to register as an exchange, a broker-dealer, and a clearing agency, pursuant to the Exchange Act. On March 31, 2023, Bittrex issued a statement that it began the process of winding down its U.S. operations.  Shortly after the SEC’s complaint, Bittrex ceased its operations in the U.S. and filed for Chapter 11 bankruptcy. On June 13, 2023, the U.S. Bankruptcy Court for the District of Delaware entered an order permitting Bittrex to allow its customers to access and withdraw crypto assets and fiat currency from Bittrex’s trading platform.

On August 10, 2023, the SEC announced that crypto trading platform Bittrex agreed to settle charges that the company was operating an unregistered exchange, brokerage, and clearing house. Bittrex agreed to settle for a total payment of $24 million, which is to be paid within two months of filing a liquidation plan.

The Hinman Speech Documents. On June 13, 2023, the SEC internal communication documents related to William Hinman’s speech on digital asset transactions on June 14, 2018, were released to the public. The documents were made available to the public following an order entered by the U.S. District Court Southern District of New York denying the SEC’s motion to seal the SEC internal communication documents related to William Hinman’s 2018 speech in connection with its lawsuit against Ripple.

SEC Begins Enforcement for Violations of the New Marketing Rule. In a September 11, 2023 press release, the SEC announced that it charged nine registered investment advisers for showing hypothetical performance results on their websites without adopting the necessary policies and procedures required under the SEC’s new marketing rules and regulations (the “New Marketing Rules”). This targeted sweep is the first of its kind following the New Marketing Rules’ compliance deadline in November 2022. The SEC’s active approach to enforce the New Marketing Rules sends a stern reminder to SEC-registered fund managers to remain diligent when preparing marketing materials. We encourage managers to review their marketing materials to ensure compliance if they have not done so already.

SEC Proposes New Rules to Address Conflicts of Interest Presented by Predictive Data Analytics. On July 26, 2023, the SEC proposed new rules aiming to address conflicts of interest associated with the use of predictive data analytics (“PDA”) and other similar AI-powered tools. This announcement comes at a time when AI has supercharged the adoption of such tools by investment management professionals. The proposed rules reflect the SEC’s primary concern that PDA technologies may produce biased data or suggest biased outcomes, favoring investment advisers and broker-dealers over investors. The proposed rules aim to combat conflicts of interests created by these “covered technologies,” which the SEC defines broadly as “analytical, technological, or computational functions, algorithms, models, correlation matrices, or similar methods or processes that optimize for, predict, guide, forecast, or direct investment-related behaviors or outcomes of an investor.” The proposed rules serve as a poignant reminder that while AI continues to bring exciting new breakthroughs to the investment advisory business, it remains important to understand any biases or other pitfalls that such tools can present.

SEC Proposes Amendments to the Internet Adviser Exemption. On July 26, 2023,  the SEC proposed new amendments to rule 203A-2(e) of the Investment Advisers Act, otherwise known as the “Internet Adviser Exemption.” In keeping with the spirit of the original rule while modernizing it to reflect new technologies, the proposed amendments clarify that an internet investment adviser is required to have an “operational” interactive website (which includes smartphone applications) at all times while relying on the Internet Adviser Exemption. To be considered operational, the website or application must provide “digital investment advisory services” on an ongoing basis to more than one client, which the SEC defines as advice generated by software-based models, algorithms, or applications. Once the proposed amendments are implemented, an investment adviser relying on this exemption can only provide investment advice through the operational interactive website. The proposed amendments aim to modernize the Internet Adviser Exemption in response to the technological advancements and evolution of the investment advisory industry since its original adoption in 2002.

SEC Adopts Cybersecurity Rule for Public Companies. On July 26, 2023, the SEC adopted a final rule that will require public companies to disclose information about cybersecurity risk management, strategy, governance, and incident reporting. This rule was approved by the SEC ahead of a similar cybersecurity risk management rule specific to investment advisers, which was anticipated to be approved and finalized in October 2023, but as of yet has not been approved and finalized by the SEC.

This rule will require public companies to adopt a myriad of cybersecurity practices and controls that encompass a variety of new compliance and disclosure obligations, including: (i) the disclosure of information regarding material cybersecurity incidents within four days after determining such event was material; (ii) describing in a public filing the material aspects of the scope, nature, and timing of any such incidents; (iii) creating detailed company policies for detecting and mitigating cybersecurity threats; and (iv) describing in a public filing the role of the public companies’ board of directors in assessing and managing cyber threats.

The SEC’s new cybersecurity risk management rule for investment advisers is expected to significantly expand the cybersecurity compliance obligations required of investment advisers. We intend to provide a detailed update on these rules once they are approved.

CFTC Matters

CFTC Enforcement Action Against Ooki DAO. On June 8, 2023, the U.S. District Court for the Northern District of California entered an order granting the CFTC’s motion for default judgment in its lawsuit against Ooki Dao (formerly bZx DAO), a decentralized autonomous organization and an unincorporated association comprised of holders of OokiDAO Tokens. For background, on September 22, 2022, the CFTC charged Ooki DAO for engaging in unlawful off-exchange leveraged and margined retail commodity transactions, engaging in activities performed by a registered futures commission merchant, and failing to implement appropriate Customer Information Program/KYC/AML procedures in violation of the Commodity Exchange Act of 1936, as amended (the “CEA”). The court granted the motion for default judgement in part due to neither Ooki Dao nor a representative of Ooki Dao appearing or participating in the action (the court previously held that the CFTC had properly served Ooki Dao when it provided notice of the action via the “Help Chat Box” and the discussion forum on Ooki Dao’s public website). In addition to granting default judgment against Ooki DAO on all accounts, the court also enjoined Ooki DAO from further violation of the CEA and ordered Ooki DAO to pay a civil penalty of $643,542. Importantly, Ooki DAO token holders bear some responsibility of the civil penalty, and the case underscores the need of fund managers to limit their investments in DAOs to those that have been legally wrapped and make such investments via special purpose vehicle in an attempt to achieve another layer of liability protection, as noted in our July 2022 Quarterly Update.

Digital Asset Matters

Liability Issues and Third-Party Engagement in DAOs. As the formation of and investment in Decentralized Autonomous Organizations (“DAOs”) continue to garner attention within the investment community, it is important for DAO participants to continue to analyze how they participate. First, as noted in our July 2022 Quarterly Update, managers should consider only participating or investing in DAOs that are wrapped in a liability blocking entity in order to reduce the risk of personal liability. Second, as an added measure of liability protection, managers should consider participating or investing through special purpose vehicles specific to such activity (e.g., a fund making two DAO investments could segregate each investment through separate, wholly-owned subsidiaries). Third, managers should consider only participating or investing in DAOs that have engaged reputable third-party service providers such as administrators, accountants, tax counsel and, in the case of foreign foundations, independent directors. The use of such independent third-party service providers may help ensure proper functioning and allocation of resources of the DAO, thereby helping to protect its participants.

SEC and CFTC Enforcement Actions Against Binance. On June 5, 2023, the SEC charged Binance Holdings Limited, BAM Trading Services Inc., BAM Management US Holdings Inc., and Changpeng Zhao, founder and chief executive officer (collectively, “Binance”), for failure to register as an exchange, a broker-dealer, and a clearing agency, and failure to register the offering and sale of securities via the Binance trading platform in accordance with the Exchange Act. Notably, the complaint also charged Binance for making false representations about the presence of trading surveillance for the detection and prevention of manipulative trading and false statements with respect to the trading volumes on its platform to the public (the SEC did not include such allegations in its complaint against Coinbase).

The SEC complaint was preceded by the CFTC’s complaint filed against Binance on March 27, 2023. The CFTC complaint included an allegation that despite Binance’s implementation of an IP address-based compliance control, such measure had not been effective in preventing U.S.-based customers from accessing and trading on the Binance platform. In fact, Binance’s financial reports reflect that U.S.-based customers contributed substantially to Binance’s revenues. The CFTC complaint also contains detailed and specific allegations regarding Binance’s reliance upon “prime brokers” to facilitate such U.S-based customers’ access to Binance. The prime brokers are alleged to have provided details to such U.S.-based customer to assist in their access to the exchange.

In November 2023, Zhao agreed to step down as CEO of Binance and pleaded guilty to breaking U.S. anti-money laundering laws as part of a plea agreement. Binance entered into a $4.3 billion settlement with the U.S. Department of Justice, the Treasury Department, and the CFTC.

Proposed Legislation – Digital Asset Market Structure Bill. Representatives Patrick McHenry (R-NC) and Glenn Thompson (R-PA) proposed the Digital Asset Market Structure Bill (the “Bill”) in a discussion draft reflecting a joint-committee effort to add clarity to the regulatory uncertainty surrounding digital assets in the U.S. The Bill included a proposal to delegate authority to the SEC and the CFTC to jointly issue rules for (i) the definition of a number of digital asset-related terms, including blockchain, blockchain network, digital assets, etc., and (ii) rules to exempt the requirement to register with both the CFTC as a digital commodity exchange and the SEC as an alternative trading system to the extent such exemption would foster the development of digital assets for the benefit of the public interest and protection of investors. The Bill also proposed the establishment of a strategic hub for innovation and financial technology and a LabCFTC within the SEC and the CFTC, respectively, with the purpose of educating and advising the regulators on financial technology. Additionally, the Bill further proposed that the SEC and the CFTC form a joint committee on digital assets with the purpose of providing advice on rules, regulations, and policies relating to digital assets, as well as harmonizing policies between the SEC and the CFTC.

Digital Asset Taxation Updates. On July 11, 2023, the U.S. Senate Finance Committee issued a letter to the digital asset community, requesting feedback on existing digital asset tax law. In an effort to identify gaps and address uncertainties in digital asset taxation, the Committee is seeking input from stakeholders, experts, and other interested parties. This presents an opportunity for the digital asset community to proactively engage with the regulation and taxation of digital assets.

On July 31, 2023 the IRS announced in Revenue Ruling 2023-14 that a cash-method taxpayer who received staking rewards must include the fair market value of those rewards in the taxpayer’s gross income for the taxable year in which the taxpayer “gains dominion and control over the validation rewards.” This ruling is consistent with previous IRS views on the tax treatment of mining income, as per Notice 2014-21.

SEC Charges Media Company for Unregistered Offering of NFTs. On August 28, 2023, the SEC announced charges against NFT issuer Impact Theory, LLC (“Impact Theory”), arguing that Impact Theory’s NFT launch constituted an unregistered securities offering. This is the first time the SEC has brought an enforcement action against an NFT issuer. According to the order, Impact Theory alluded to the investment potential of the NFTs by emphasizing to purchasers that their NFTs would provide “tremendous value.” The SEC, applying the Howey Test, argued that Impact Theory’s statements “invited potential investors to view the purchase…as an investment into the business” and that the NFTs constituted investment contracts. Impact Theory neither admitted to nor denied the charges, but did agree to pay $6.1 million in disgorgement, prejudgment interest, and civil penalties.

Other Items

Corporate Transparency Act Provisions Coming into Effect. The Corporate Transparency Act of 2019, as amended (the “CTA”), becomes effective on January 1, 2024, and will require virtually all U.S. entities and all foreign entities registered to do business in the U.S. to file detailed beneficial ownership reports with the Financial Crimes Enforcement Network (FinCEN). Pursuant to the CTA, legal entities incorporated, organized, or registered to do business in a state must disclose certain information related to its owners, officers, and controlling persons. Companies that will be required to provide such information include domestic or foreign corporations, limited liability companies, or other entities created or registered to do business in a state by virtue of such entity making a filing with the respective secretary of state. The required disclosure for beneficial owners includes legal name, date of birth, address, and ID with a unique identifying number (i.e., a driver’s license or a passport). There are a handful of exemptions to the CTA, including for (i) SEC-registered investment advisers, (ii) venture capital fund advisers relying on the exemption pursuant to Section 203(l) of the Investment Advisers Act that file Form ADV with the SEC, and (iii) “pooled investment vehicles” managed by a bank, credit union, broker-dealer, registered investment company, SEC-registered investment adviser, or a venture capital fund adviser as described in (ii).

Under the CTA, entities formed or registered before January 1, 2024, must file their initial reports by January 1, 2025. Entities formed or registered between January 1, 2024, and December 31, 2024, must file their initial reports within 90 days of the entity’s formation or registration, as applicable. Entities formed or registered after 2024 must file their initial reports within 30 days of the entity’s formation or registration, as applicable. Entities required to file reports under the CTA that either fail to comply or provide false or fraudulent information will be subject to civil and criminal penalties. The CTA contains a safe harbor, however, which enables an individual representing a reporting company to voluntarily correct any false information within 90 days of submitting an inaccurate report.

To learn more about the Corporate Transparency Act and its implications, please refer to this article by CFM Partner Tony Wise.

The Ninth Circuit Blocks California’s Ban on Mandatory Arbitration Agreements. On February 15, 2023, a three-judge panel for the Ninth Circuit Court of Appeals struck down a California bill which would have prevented employers from requiring employees to sign arbitration agreements as a condition of employment. The court held that California Assembly Bill 51 is preempted by the Federal Arbitration Act, which “embodies a national policy favoring arbitration.” After years of uncertainty surrounding the issue, the decision solidifies that employers in California can continue to include mandatory arbitration provisions in their employment agreements.

SEC Amendments to Form PF. On May 3, 2023, the SEC adopted certain amendments to Form PF, a regulatory filing requirement that mandates certain SEC registered investment advisers to report information to the Financial Stability Oversight Council (“FSOC”). Form PF was created in 2011 by Title IV of the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010, as amended (the “Dodd-Frank Act”). The amendments included a number of changes to the existing Form PF. Specifically, the amendments introduced a new Section 5 to Form PF and required, upon an occurrence of a trigger event, large hedge fund advisers of qualifying hedge funds to file a current report as soon as practicable but no later than 72 hours after such event. Triggering events include extraordinary investment loss, a significant margin and default event, fund margin default or inability to meet margin call, and significant disruption or degradation of the reporting fund’s key operations. Additionally, Section 6 of Form PF has been amended to require private equity fund advisers to report certain trigger events within 60 days of the end of each fiscal quarter. Such trigger events include the execution of an adviser-led secondary transaction and the investor’s election for the removal of the general partner to the fund, termination of the fund’s investment period, or termination of the fund. Section 4 of Form PF also introduced a new annual reporting event to large advisers of private equity funds with respect to the implementation of a general partner or limited partner clawbacks.

The amendments to Form PF Sections 5 and 6 will become effective on December 11, 2023, with the remainder of the amendments to Form PF becoming effective on June 11, 2024.

Enforcement of California Privacy Rights Act. The California Consumer Privacy Act of 2018 (the “CCPA”), as amended by the California Privacy Rights Act of 2020 (the “CPRA”, and together with the CCPA, the “Act”), was scheduled to become fully enforceable by the California Privacy Protection Agency (the “CPPA”) on July 1, 2023; however, a recent California court case has delayed this enforcement date, at least in relation to some of the statute’s requirements. By way of background, the CPRA amended the CCPA to add additional consumer data protections and created the CPPA, a state agency empowered to not only enforce these requirements jointly with the Attorney General of California, but also to promulgate final regulations thereunder.  Incidentally, the CPRA required the regulations to be completed by July 1, 2022, and contemplated a one-year “pre-enforcement period” by providing that enforcement of the regulations, “[n]otwithstanding any other law, civil and administrative enforcement…shall not commence until July 1, 2023[.]” Unfortunately, the CPPA failed to complete the regulations by July 1, 2022. On March 29, 2023, the CPPA issued final (but incomplete) regulations, relating to twelve of the fifteen topics contemplated by the CPRA.  Currently, there are still no regulations concerning three key elements of the CPRA – cybersecurity audits, risk assessments, and automated decision-making technology.

The California Chamber of Commerce sued the CPPA, seeking to delay the enforcement of the Act, arguing that since the regulations were only finalized on March 29, 2023, an enforcement date of July 1, 2023 would violate the one-year pre-enforcement period required by the CPRA’s express language. On June 30, 2023, the Sacramento County Superior Court held that the CPPA cannot enforce any of the regulations of the Act before one year has passed from the date any such regulation has been finalized by the CPPA. On August 4, 2023, the CPPA filed a petition with California’s Third District Court of Appeals to overturn the trial court decision imposing a 12-month temporary delay on enforcement of the privacy regulations. CFM will continue to monitor this situation and advise our clients accordingly.

Establishment of an Ethical Artificial Intelligence Framework for Investment Advisors. On April 6, 2023, the SEC Investor Advisory Committee (the “IAC”) wrote an open letter to SEC Chair Gary Gensler outlining its views on implementing an ethical artificial intelligence (“AI”) framework for investment advisers and financial institutions. The letter referenced the use of algorithmic models and code by investment advisory firms and warned that the use of AI in other industries has highlighted important risks such as harmful algorithmic biases.
             
The letter encouraged the SEC and its staff to consider the following key tenets in developing guidance to investment advisers on the ethical use of AI:

  • Equity – understanding of the contextual, historical, and structural problems of the underlying data selected for input, including seeking consultation of experts.
  • Consistent and Persistent Testing – consistent testing of algorithms for performance during pre and post implementation stage.
  • Governance and Oversight – incorporation of a comprehensive risk management and compliance policy. 

The letter concluded with additional proposals to the SEC for consideration in developing its best practices guidance on ethical use of AI, including the hiring of staffs with experience in AI and machine learning, the reviewing of AI-related frameworks developed by other regulators such the Federal Trade Commission and the National Institute of Standards of Technology, and tasking the Division of Examinations to monitor the compliance on ethical use of AI.

User Fees and Third-Party Examination of SEC Registered Investment Adviser. On June 5, 2023, the IAC drafted a list of recommendations on oversight of SEC RIAs, which was discussed at the IAC meeting on June 22, 2023. The draft included two recommendations. First, the imposition of “user fees” on SEC RIAs to fund the SEC’s investment adviser examination program and to achieve an acceptable frequency of examination of SEC RIAs once every four to five years. Second, the adoption of a rule requiring SEC RIAs to undergo examination conducted by an outside firm, with a copy of the exam results submitted to the SEC. 

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Compliance Calendar

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

December 11, 2023

  • Annual Renewal Payments Due for Preliminary Statement Issued in E-bill for Registration/Notice Filings. Payment can be made through FINRA Firm Gateway in the E-bill tab.

December 26, 2023

  • Last day to submit form filings or renewal payments via IARD prior to year-end.

December 31, 2023

  • Review RAUM to determine 2023 Form PF filing requirement.
  • Registered CPOs must submit a pool quarterly report (CPO-PQR).
  • 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 to avoid 2023 CIMA fees.

January 10, 2024

  • Form 13H Quarterly Filing for Changes. Filing is for calendar quarter that ended December 31, 2023, and should be submitted within 10 days of quarter end.

January 15, 2024

  • Quarterly Form PF due for Large Liquidity Fund Advisers (if applicable).

January 31, 2024

  • “Annex IV” AIFMD filing.

February 14, 2024

  • Form 13F Quarterly Filing for Changes. Filing is for Calendar Quarter that ended December 31, 2023, and should generally be submitted within 45 days of quarter end.
  • Form 13H Annual Filing for Calendar Year that ended December 31, 2023.
  • Form 13G Annual Filing for Calendar Year that ended December 31, 2023.

February 29, 2024

  • Quarterly Form PF due for larger hedge fund advisers (if applicable).
  • Deadline for annual affirmation of NFA/CFTC exemptions. Exemptions must be affirmed within 60 days of Calendar Year end or exemptions will be withdrawn by the NFA.

March 30, 2024

  • Form ADV Annual Update Amendment. Deadline to update and file Form ADV Parts 1, 2A, 2B (and Form CRS, if applicable).

Periodic

  • Fund Managers should perform “Bad Actor” certifications annually.
  • Form D and Blue Sky Filings should be current.
  • CPO/CTA Annual Questionnaires must be submitted annually, and promptly upon material information changes, through NFA Annual Questionnaire system.

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

Sincerely,

Karl Cole-Frieman, Bart Mallon, John T. Araneo, Garret Filler, Scott Kitchens, Frank J. Martin, Lilly Palmer, David Rothschild, Bill Samuels, Tony Wise, and Alex Yastremski

Cole-Frieman & Mallon LLP is a leading investment management law firm known for providing top-tier, innovative, and collaborative legal solutions for complex financial services matters. Headquartered in San Francisco, Cole-Frieman & Mallon LLP services both start-up investment managers and multibillion-dollar funds. The firm provides a full suite of legal services to the investment management community, including fund formation (hedge, VC, PE, real estate), investment adviser and CPO registration, counterparty documentation (digital and traditional prime brokerage, ISDA, repo, and vendor agreements), SEC, CFTC, NFA and FINRA matters (inquiries, exams, and compliance issues), seed deals, cybersecurity regulatory matters, full-service intellectual property counsel, manager due diligence, employment and compensation matters, and routine business matters. The firm also publishes the prominent Hedge Fund Law Blog. For more information, please add us on LinkedIn, follow us on Twitter, and visit us at colefrieman.com.

Cole-Frieman & Mallon 2023 Q3 Update

October 20, 2023

Clients, Friends, and Associates:

As we end the third quarter and enter the fall season, we would like to highlight some of the recent industry updates and occurrences we found to be both interesting and impactful. The summaries below are intentionally brief. Please feel free to explore the links included and reach out to us if you have any related questions.

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CFM Items

Cole-Frieman & Mallon LLP, along with industry leaders MG Stover, Harneys, and KPMG, is a premier sponsor of the CoinAlts Annual Fund Symposium, which is being held in San Francisco on October 26, 2023. This annual event brings together the digital asset community to address investment, legal, and operational issues relevant to private fund managers. The CoinAlts Annual Fund Symposium is a must-attend gathering for industry professionals, providing unparalleled insights and networking opportunities. Join us for expert panels, top-notch speakers, and the chance to stay ahead of the curve in this rapidly evolving industry. More information is available at https://coinalts.xyz/.

Our firm was proud to sponsor the 14th annual Sohn San Francisco Investment Conference that took place on September 26, 2023. The event brought together top investment managers and allocators to discuss specific investment ideas and the fund investment environment. The conference supported Bay Area organizations focused on improving educational opportunities and life outcomes for underserved youth. A portion of the proceeds also benefitted the Sohn Conference Foundation in its dedicated efforts to treat and cure pediatric cancer and other public health priorities. We were excited to be a part of this important event where attendees learned from some of the brightest minds in the investment world and supported a great cause. Cole-Frieman & Mallon LLP was also a proud sponsor of the Help For Children 2023 Denver Golf Tournament in Littleton, Colorado on September 22, 2023. The organization focuses on the prevention and treatment of child abuse and neglect.

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SEC Matters

SEC Begins Enforcement for Violations of the New Marketing Rule. In a September 11, 2023 press release, the Securities and Exchange Commission (“SEC”) announced that it charged nine registered investment advisers for showing hypothetical performance results on their websites without adopting the necessary policies and procedures required under the SEC’s new marketing rules and regulations (the “New Marketing Rules”). This targeted sweep is the first of its kind following the New Marketing Rules’ compliance deadline in November 2022.

As discussed in our July 2021 Update, the New Marketing Rules permit the use of hypothetical performance metrics if the investment adviser follows certain requirements aimed at protecting investors. These requirements include implementing policies and procedures that are “reasonably designed to ensure that the hypothetical performance is relevant to the likely financial situation and investment objectives of the intended audience of the advertisement.”

The press release noted that all nine firms published hypothetical performance results to the public rather than to their specific intended audience. In doing so, the accused could not ensure that all viewers had the necessary context to accurately understand the hypothetical performance results. The SEC’s Division of Enforcement Director, Gurbir Grewal, noted the “attention-grabbing power” of hypothetical performance on prospective investors who may conflate the advertised strategies with their own investment objectives. Additionally, two of the firms also failed to comply with record-keeping rules which required their firms to keep a copy of every advertisement disseminated.

These nine enforcement actions came quickly on the heels of the SEC’s first enforcement action alleging violations of the New Marketing Rules. In August 2023, the SEC charged a New York-based FinTech investment adviser of misleading investors with hypothetical performance results. The complaint alleged that the adviser’s marketing materials made claims of annualized returns of 2700%, but the underlying data was taken from only a three-week period.

The SEC’s active approach to enforce the New Marketing Rules sends a stern reminder to SEC-registered fund managers to remain diligent when preparing marketing materials. We encourage managers to review their marketing materials to ensure compliance if they have not done so already.

SEC Charges Fund Administrator for Missing Red Flags. On August 7, 2023, the SEC instituted cease and desist proceedings against a fund administrator (the “Administrator”) for failing to identify and appropriately respond to red flags involving a private fund client. The SEC asserted that the Administrator, at the behest of the fund’s sponsor, calculated the fund’s net asset value without including trading losses, resulting in materially overstated values in the investors’ account statements. The SEC has since accepted the Administrator’s settlement offer, which includes a civil penalty of $100,000, a disgorgement of $18,000, and a prejudgment interest of $4,271.

SEC Adopts Final Rules for Private Fund Advisers. On August 23, 2023, the SEC issued final rules focused on investment advisers who manage private funds (the “New Private Fund Adviser Rules”). We provide a brief summary of the key elements of the New Private Fund Adviser Rules below.

Rules for SEC-Registered Investment Advisers

The Quarterly Statement Rule requires SEC-registered investment advisers (“RIAs”) to provide new quarterly disclosures to fund investors about fees, expenses, and the fund’s performance metrics. This rule also introduces standardized reporting metrics to be used by private funds.

The Audit Rule requires RIAs to obtain annual audited financial statements for each of its fund clients. However, the SEC notes that any adviser who remains in compliance with the audit requirements of rule 206(4)-2 (i.e., the custody rule) of the Investment Advisers Act of 1940, as amended (the “Investment Advisers Act”), will also be in compliance with the Audit Rule.

The Adviser-Led Secondaries Rule requires RIAs to obtain a fairness opinion or valuation opinion and provide a summary of any material business relationships when asking investors to approve an adviser-led secondary transaction.

The Annual Review Rule will amend current rule 206(4)-7 (i.e., the compliance procedures and practices rule) of the Investment Advisers Act, which will now require all RIAs to document their annual compliance review in writing.

The Recordkeeping Rule will amend the current rule 204-2 (i.e., the recordkeeping rule) of the Investment Advisers Act to require RIAs to retain books and records related to the provisions of the New Private Fund Adviser Rules.

Rules for all Private Fund Investment Advisers

The Restricted Activities Rule restricts advisers from engaging in the following activities unless they are sufficiently disclosed or investor consent is obtained, as applicable: (i) allocating fees and costs from any governmental or regulatory investigation of the adviser to the fund; (ii) allocating regulatory or compliance fees, or fees or expenses associated with an examination, of the adviser to the fund; (iii) reducing carried interest clawbacks based on the adviser’s actual or estimated taxes incurred; and (iv) allocating fees from a portfolio investment among the adviser’s funds and other clients on a non-pro rata basis.

The Preferential Treatment Rule prohibits an adviser from giving preferential treatment to a prospective investor relating to (i) redemption rights and (ii) information rights of portfolio holdings which the adviser believes would have a material, negative effect on other investors. The rule allows for other forms of preferential treatment to certain investors, but the material terms of this preferential treatment must generally be disclosed, in writing, to all other investors and prospective investors. Advisers must also distribute an annual notice to all investors disclosing any preferential treatment provided to investors since the most recent notice was provided.

Next Steps

The compliance date for the New Private Fund Adviser Rules is determined by the size of the funds, and many deadlines remain years away. Ongoing litigation initiated by industry participants may further delay the effectiveness of these rules. On September 1, 2023, the Managed Funds Association, along with a number of other organizations, jointly filed a lawsuit against the SEC to prevent the adoption of the finalized rules, claiming the SEC has overstepped its authority and that these changes may increase costs, reduce opportunity, and harm both private funds and their investors.

The New Private Fund Adviser Rules have the potential to bring widespread change to the private funds industry, and managers must review their policies and procedures to ensure compliance. However, pending litigation against the SEC reflects the fierce resistance from some within the industry and reminds us that further changes may be introduced in the following months as compliance deadlines draw nearer.

SEC Proposes New Rules to Address Conflicts of Interest Presented by Predictive Data Analytics. On July 26, 2023, the SEC proposed new rules aiming to address conflicts of interest associated with the use of predictive data analytics (“PDA”) and other similar AI-powered tools. This announcement comes at a time when AI has supercharged the adoption of such tools by investment management professionals. The proposed rules reflect the SEC’s primary concern that PDA technologies may produce biased data or suggest biased outcomes, favoring investment advisers and broker-dealers over investors. The proposed rules aim to combat conflicts of interests created by these “covered technologies,” which the SEC defines broadly as “analytical, technological, or computational functions, algorithms, models, correlation matrices, or similar methods or processes that optimize for, predict, guide, forecast, or direct investment-related behaviors or outcomes of an investor.”

The proposed rules require the users of PDA technologies to evaluate whether the technology could reasonably create a conflict of interest. The SEC did not create strict guidelines for this evaluation process, instead noting that the complexity of the evaluation will likely correlate to the complexity of the tool. Certain covered technologies, such as “black-box” tools where data inputs are not disclosed to end users, may be impossible to fully evaluate. In these cases, the SEC forbids the use of such a tool if the user cannot identify all potential conflicts from a PDA technology. Investment advisers will also be required to have written policies and procedures in place describing a tool’s conflict evaluation process and the processes for neutralizing and eliminating any identified conflicts. The proposed rules also introduce six new types of records that must be kept relating to covered technologies.   

The proposed rules serve as a poignant reminder that while AI continues to bring exciting new breakthroughs to the investment advisory business, it remains important to understand any biases or other pitfalls that such tools can present.

SEC Proposes Amendments to the Internet Adviser Exemption. On July 26, 2023,  the SEC proposed new amendments to rule 203A-2(e) of the Investment Advisers Act, otherwise known as the “Internet Adviser Exemption.”

In keeping with the spirit of the original rule while modernizing it to reflect new technologies, the proposed amendments clarify that an internet investment adviser is required to have an “operational” interactive website (which includes smartphone applications) at all times while relying on the Internet Adviser Exemption. To be considered operational, the website or application must provide “digital investment advisory services” on an ongoing basis to more than one client, which the SEC defines as advice generated by software-based models, algorithms, or applications. Once the proposed amendments are implemented, an investment adviser relying on this exemption can only provide investment advice through the operational interactive website. Investment advisers relying on this exemption will further be required to amend their Form ADV. The proposed amendments aim to modernize the Internet Adviser Exemption in response to the technological advancements and evolution of the investment advisory industry since its original adoption in 2002.

SEC Adopts Cybersecurity Rule for Public Companies. On July 26, 2023, the SEC adopted a final rule that will require public companies to disclose information about cybersecurity risk management, strategy, governance, and incident reporting. This rule was approved by the SEC ahead of a similar cybersecurity risk management rule specific to investment advisers, which the SEC is slated to approve sometime in October of 2023.

This rule will require public companies to adopt a myriad of cybersecurity practices and controls that encompass a variety of new compliance and disclosure obligations, including: (i) the disclosure of information regarding material cybersecurity incidents within four days after determining such event was material; (ii) describing in a public filing the material aspects of the scope, nature, and timing of any such incidents; (iii) creating detailed company policies for detecting and mitigating cybersecurity threats; and (iv) describing in a public filing the role of the public companies’ board of directors in assessing and managing cyber threats.

This new rule will impose more affirmative and stringent obligations on public companies to report cybersecurity incidents and to provide greater transparency about their cybersecurity practices. However, when compared to the impending cybersecurity risk management rule being directed at investment advisers, this public company version is more streamlined and requires fewer proscribed controls for these enterprise-level public companies whose resources and capabilities ironically far outweigh those of its investment adviser counterparts.

The SEC’s new cybersecurity risk management rule for investment advisers is expected to significantly expand the cybersecurity compliance obligations required of investment advisers. We intend to provide a detailed update on these rules once they are approved.

SEC Adopts Final Rules on Investment Company Names. On September 20, 2023, the SEC adopted amendments to rule 35d-1 of the Investment Company Act of 1940, as amended (the “Investment Company Act”). Commonly referred to as the “Names Rule”, the purpose of rule 35d-1 is to protect investors by requiring advisers to use names for their investment funds that align with the funds’ investment focus and risks.

The amendments expand the scope of the “80% investment policy” and now require any fund with a name suggesting specific types of investment invest at least 80% of its assets into those types of investments. This also includes any insinuations of particular characteristics such as the key words “growth” or “value.” The SEC also clarified that derivative investments can be counted toward the 80% benchmark, but advisers must use the investment’s notional value. Funds will be required to review their portfolio on a quarterly basis to ensure compliance with the rule. If a fund is found to be noncompliant, the fund will be granted a 90-day grace period to return to the 80% investment threshold.

The final rules will prohibit unlisted registered closed-end funds and business development companies that are required to comply with the 80% policy from changing that policy without a shareholder vote, unless: (i) the fund initiates a tender or repurchase offer and provides at least 60 days’ prior notice of the change to the policy; (ii) the offer is not oversubscribed; and (iii) the fund purchases shares at net asset value. Additionally, funds subject to the 80% investment policy must include definitions of any fund terms in their prospectus and such terms must follow their plain English meaning.

These amendments underscore the SEC’s view that an investment fund’s name can have a strong impact on potential investors, making it important that names accurately reflect the fund itself.

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Digital Asset Items

Terraform Labs Ruling Rejects Ripple Holding. On July 31, 2023, the U.S. District Court for the Southern District of New York sided with the SEC in the case of SEC v. Terraform Labs Ptd. Ltd. after it denied the defendants’ motion to dismiss. In doing so, the court rejected outright the holding in the recent summary judgment granted by another judge in the same District Court in SEC v. Ripple Labs Inc. For more information on SEC v. Ripple Labs Inc., check out our July 2023 Update from the Hedge Fund Law Blog.

The court in Terraform Labs found that both direct institutional investment sales and secondary market transactions involving retail investors were investment contracts, arguing that Howey makes no distinction between institutional and retail investors and concluded that the nature and type of purchases have no bearing on “whether a reasonable individual would objectively view the defendants’ actions and statements as evincing a promise of profits based on their efforts.” The court opted to apply the Howey test in a different manner than in Ripple Labs. In Ripple Labs, the court drew a distinction between sales of the XRP token to retail investors and institutional investors, holding that the sales of XRP to retail investors was not an investment contract because the purchasers did not have a reasonable expectation of profits from the efforts of Ripple Labs, Inc.

The inconsistent application of the Howey test from within the Southern District of New York illustrates the regulatory uncertainty surrounding the digital asset industry. We will continue to monitor similar cases brought by the SEC and other regulators.

Bittrex Settles with the SEC. On August 10, 2023, the SEC announced that crypto trading platform Bittrex agreed to settle charges that the company was operating an unregistered exchange, brokerage, and clearing house. As reported in our July 2023 Update, the SEC filed a complaint against Bittrex, alleging that the platform encouraged digital asset issuers to delete any public statements that insinuated that their tokens violate national securities laws. Bittrex agreed to settle for a total payment of $24 million, which will be paid within two months of filing a liquidation plan.

Digital Asset Taxation Updates. On July 11, 2023, the U.S. Senate Finance Committee issued a letter to the digital asset community, requesting feedback on existing digital asset tax law. In an effort to identify gaps and address uncertainties in digital asset taxation, the Committee is seeking input from stakeholders, experts, and other interested parties. This presents an opportunity for the digital asset community to proactively engage with the regulation and taxation of digital assets.

On July 31, 2023 the IRS announced in Revenue Ruling 2023-14 that a cash-method taxpayer who received staking rewards must include the fair market value of those rewards in the taxpayer’s gross income for the taxable year in which the taxpayer “gains dominion and control over the validation rewards.” This ruling is consistent with previous IRS views on the tax treatment of mining income, as per Notice 2014-21.

SEC Charges Media Company for Unregistered Offering of NFTs. On August 28, 2023, the SEC announced charges against NFT issuer Impact Theory, LLC (“Impact Theory”), arguing that Impact Theory’s NFT launch constituted an unregistered securities offering. This is the first time the SEC has brought an enforcement action against an NFT issuer. According to the order, Impact Theory alluded to the investment potential of the NFTs by emphasizing to purchasers that their NFTs would provide “tremendous value.” The SEC, applying the Howey Test, argued that Impact Theory’s statements “invited potential investors to view the purchase…as an investment into the business” and that the NFTs constituted investment contracts. Impact Theory neither admitted to nor denied the charges, but did agree to pay $6.1 million in disgorgement, prejudgment interest, and civil penalties.

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Other Items

Corporate Transparency Act Provisions Coming into Effect. The Corporate Transparency Act of 2019, as amended (the “CTA”), becomes effective on January 1, 2024, and will require virtually all U.S. entities to file detailed beneficial ownership reports with the Financial Crimes Enforcement Network (FinCEN). Pursuant to the CTA, legal entities incorporated, organized, or registered to do business in a state must disclose certain information related to its owners, officers, and controlling persons. Companies that will be required to provide such information include domestic or foreign corporations, limited liability companies, or other entities created or registered to do business in a state by virtue of such entity making a filing with the secretary of state. The required disclosure for beneficial owners includes legal name, date of birth, address, and ID with a unique identifying number (i.e., a driver’s license or a passport). There are a handful of exemptions to the CTA, including for (i) SEC-registered investment advisers, (ii) venture capital fund advisers relying on the exemption pursuant to Section 203(l) of the Investment Advisers Act that file Form ADV with the SEC, and (iii) “pooled investment vehicles” managed by a bank, credit union, broker-dealer, registered investment company, SEC-registered investment adviser, or a venture capital fund adviser as described in (ii).

Under the CTA, entities formed before January 1, 2024 must comply within one year. Entities formed after January 1, 2024 will have 30 days to comply once they are officially formed. Additionally, FinCEN recently published a proposal to extend the 30-day deadline to 90 days for reporting entities created or registered between January 1, 2024 and December 31, 2024. Applicable entities that fail to comply or provide false or fraudulent information will be subject to civil and criminal penalties. The CTA contains a safe harbor, however, which enables an individual representing a reporting company to voluntarily correct any submitted false information within 90 days of submitting an inaccurate report.

To learn more about the Corporate Transparency Act and its implications, please refer to this article by CFM Partner Tony Wise.

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Compliance Calendar

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

November 6, 2023

  • Preliminary Statements for Annual Renewal fees are available through E-Bill and can be accessed through FINRA Firm Gateway.

November 14, 2023

  • Form 13F Quarterly Filing. Filing is for the calendar quarter that ended September 30, 2023, and should be submitted within 45 days of quarter end.
  • CTA Form PR. Filing is for the calendar quarter that ended September 30, 2023, and should be submitted within 45 days of quarter end.

November 29, 2023

  • Form PF for Large Hedge Fund Advisers. Filing is for the calendar quarter that ended September 30, 2023.
  • CPO-PQR Form. Filing is for the calendar quarter that ended September 30, 2023, and should be submitted within 60 days of quarter end.

December 11, 2023

  • Annual Renewal Payments Due for Preliminary Statement Issued in E-bill for Registration/Notice Filings. Payment can be made through FINRA Firm Gateway.

Periodic

  • Form D and Blue Sky Filings should be current.
  • CPO/CTA Annual Questionnaires must be submitted annually, and promptly upon material information changes, through the NFA Annual Questionnaire system.

Consult our complete Compliance Calendar for all 2023 critical dates as you plan your regulatory compliance timeline for the year. 

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

Sincerely,

Karl Cole-Frieman, Bart Mallon, John T. Araneo, Garret Filler, Scott Kitchens, Frank J. Martin, Lilly Palmer, David Rothschild, Bill Samuels, Tony Wise, and Alex Yastremski

Cole-Frieman & Mallon LLP is a leading investment management law firm known for providing top-tier, innovative, and collaborative legal solutions for complex financial services matters. Headquartered in San Francisco, Cole-Frieman & Mallon LLP services both start-up investment managers and multibillion-dollar funds. The firm provides a full suite of legal services to the investment management community, including fund formation (hedge, VC, PE, real estate), investment adviser and CPO registration, counterparty documentation (digital and traditional prime brokerage, ISDA, repo, and vendor agreements), SEC, CFTC, NFA and FINRA matters (inquiries, exams, and compliance issues), seed deals, cybersecurity regulatory matters, full-service intellectual property counsel, manager due diligence, employment and compensation matters, and routine business matters. The firm also publishes the prominent Hedge Fund Law Blog. For more information, please add us on LinkedIn, follow us on Twitter, and visit us at colefrieman.com.

Cole-Frieman & Mallon 2023 Q2 Update

July 20, 2023

Clients, Friends, and Associates:

As we end the second quarter and enter the summer season, we would like to highlight recent industry news that we found to be both interesting and impactful. While we try to summarize these topics at a higher level, please feel free to explore the links included and reach out to us if you have any related questions.  

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CFM Items

We are excited to announce that Cole-Frieman & Mallon LLP has added more expertise to its already stellar team. First, we welcome back Lilly Palmer as a Partner, whose extensive digital asset experience will benefit the firm and all its clients. We also welcome Bill Samuels to the firm, where he will lead a newly launched Intellectual Property practice with new Associate, Stavros Papadopoulos. Finally, we’re pleased to welcome Brett Bunnell as a Counsel and Thomas Gaffney as an Associate in our Corporate and Transactional practice group. We expect these additions to meaningfully contribute to our unwavering commitment to provide excellent legal services to all our clients. Please join us in welcoming them all to our firm.

Cole-Frieman & Mallon LLP, along with industry leaders MG Stover, Harneys, and KPMG, are premier sponsors of the CoinAlts Annual Fund Symposium on October 26, 2023, in San Francisco. Founded in 2017, this event brings together the digital asset community to address investment, legal, and operational issues relevant to private fund managers. The CoinAlts Annual Fund Symposium is a must-attend gathering for industry professionals, providing unparalleled insights and networking opportunities. Join us for expert panels, top-notch speakers, and the chance to stay ahead of the curve in this rapidly evolving industry. More information available at https://coinalts.xyz/.

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SEC Matters

SEC Enforcement Action Against Ripple. On July 13, 2023, the U.S. District Court of the Southern District of New York entered an order which granted in part and denied in part the cross-motions for summary judgment filed by the SEC and Ripple Labs, Inc. (“Ripple”). In December 2020, the SEC charged Ripple and two executives for engaging in unlawful offer and sales of securities in violation of the Exchange Act. The complaint alleged that since 2013, Ripple issued over 14.6 billion units of its native token, XRP, in exchange for consideration of over $1.38 billion without registering the offer and the sale of such token with the SEC. Notably, the July 2023 order stated that XRP “is not in and of itself a ‘contract, transaction[,] or scheme’ that embodies the Howey requirements of an investment contract”. In other words, XRP itself is not a security, and all the facts and circumstances surrounding specific transactions in XRP must be examined to determine whether an “investment contract,” as defined under the Howey test, was issued. As a reminder, the U.S. Supreme Court ruled in Howey that an investment contract requires a finding of an investment of money in a common enterprise with the reasonable expectation of profits derived from the efforts of others.

The District Court examined the sale and distribution of XRP in three types of transactions – direct sales of XRP to institutional investors, sales of XRP through crypto exchanges in blind bid/ask transactions, and distributions of XRP as payment for services to employees and service providers – and held that only the direct sales of XRP to institutional investors constituted an investment contract under the Howey test. While this order constitutes a significant win for Ripple, since it is a District Court order, it may not be the last word.

SEC Enforcement Action Against Coinbase. On June 6, 2023, the SEC charged Coinbase, Inc. and Coinbase Global, Inc. (collectively, “Coinbase”) for failure to register as an exchange, a broker-dealer and a clearing agency, and for failure to register the offering and sale of securities via the Coinbase trading platform in accordance with the Securities Exchange Act of 1934, as amended (the “Exchange Act”). This proceeding follows the Wells Notice that Coinbase received from the SEC in March 2023. The complaint alleges that Coinbase acted as an unregistered exchange, a broker-dealer, and a clearing agency by making available at least 13 crypto assets that are offered and sold as investment contracts on its platform. Additionally, the complaint alleges that Coinbase’s staking program should be considered an investment contract under the Howey test.

On June 28, 2023, Coinbase filed an answer to the SEC complaint denying that the digital assets listed on its platform constitute an investment contract or a security. Additionally, the answer noted that half of the tokens traded on Coinbase’s platform that the SEC alleged are securities were custodied and traded on its platform since April 2021 (i.e., when the SEC approved and declared Coinbase’s S-1 filing to be effective), and, at the time, the SEC did not identify such tokens as investment contracts or securities, nor allege that Coinbase was operating as an unregistered exchange, broker, and clearing agency within the meaning of federal securities law. Coinbase’s answer also denied the SEC’s allegation that its staking program is a security. In addition to filing the answer, Coinbase filed a letter to the court indicating its intention to file a motion to dismiss the complaint. Our firm will continue to closely monitor the situation with Coinbase for new developments.  

SEC Enforcement Action Against Bittrex and Bittrex’s Chapter 11 Bankruptcy. On April 17, 2023, the SEC charged Bittrex, Inc., Bittrex Global GmbH, and William Hiroaki Shihara, co-founder and former chief executive officer (collectively, “Bittrex”) for the failure to register as an exchange, a broker-dealer, and a clearing agency, pursuant to the Exchange Act.  

On March 31, 2023, Bittrex issued a statement that it began the process of winding down its U.S. operations.  Shortly after the SEC’s complaint, Bittrex ceased its operations in the U.S. and filed for Chapter 11 bankruptcy. On June 13, 2023, the U.S. Bankruptcy Court for the District of Delaware entered an order permitting Bittrex to allow its customers to access and withdraw crypto assets and fiat currency from Bittrex’s trading platform.

The Hinman Speech Documents. On June 13, 2023, the SEC internal communication documents related to William Hinman’s speech on digital asset transactions on June 14, 2018 were released to the public. The documents were made available to the public following an order entered by the U.S. District Court Southern District of New York denying the SEC’s motion to seal the SEC internal communication documents related to William Hinman’s 2018 speech in connection with its lawsuit against Ripple.

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CFTC Items

CFTC Enforcement Action Against Ooki DAO. On June 8, 2023, the U.S. District Court for the Northern District of California entered an order granting the CFTC’s motion for default judgment in its lawsuit against Ooki Dao (formerly bZx DAO), a decentralized autonomous organization and an unincorporated association comprised of holders of OokiDAO Tokens. For background, on September 22, 2022, the CFTC charged Ooki DAO for engaging in unlawful off-exchange leveraged and margined retail commodity transactions, engaging in activities performed by a registered futures commission merchant, and failing to implement appropriate Customer Information Program/KYC/AML procedures in violation of the Commodity Exchange Act of 1936, as amended (the “CEA”). The court granted the motion for default judgement in part due to neither Ooki Dao nor a representative of Ooki Dao appearing or participating in the action (the court previously held that the CFTC had properly served Ooki Dao when it provided notice of the action via the “Help Chat Box” and the discussion forum on Ooki Dao’s public website). In addition to granting default judgment against Ooki DAO on all accounts, the court also enjoined Ooki DAO from further violation of the CEA and ordered Ooki DAO to pay a civil penalty of $643,542. Importantly, Ooki DAO token holders bear some responsibility of the civil penalty, and the case underscores the need of fund managers to limit their investments in DAOs to those that have been legally wrapped and make such investments via special purpose vehicle in an attempt to achieve another layer of liability protection, as noted in our July 2022 Quarterly Update.

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Digital Asset Items

SEC and CFTC Enforcement Actions Against Binance. On June 5, 2023, the SEC charged Binance Holdings Limited, BAM Trading Services Inc., BAM Management US Holdings Inc., and Changpeng Zhao, founder and chief executive officer (collectively, “Binance”), for failure to register as an exchange, a broker-dealer, and a clearing agency, and failure to register the offering and sale of securities via the Binance trading platform in accordance with the Exchange Act. Notably, the complaint also charged Binance for making false representations about the presence of trading surveillance for the detection and prevention of manipulative trading and false statements with respect to the trading volumes on its platform to the public (the SEC did not include such allegations in its complaint against Coinbase).  
 
The SEC complaint was preceded by the CFTC’s complaint filed against Binance on March 27, 2023. The CFTC complaint included an allegation that despite Binance’s implementation of an IP address-based compliance control, such measure had not been effective in preventing U.S.-based customers from accessing and trading on the Binance platform. In fact, Binance’s financial reports reflect that U.S.-based customers contributed substantially to Binance’s revenues. The CFTC complaint also contains detailed and specific allegations regarding Binance’s reliance upon “prime brokers” to facilitate such U.S-based customers’ access to Binance. The prime brokers are alleged to have provided details to such U.S.-based customer to assist in their access to the exchange. Given the details of such allegations, digital asset fund managers should continue to assess how they are accessing digital asset exchanges.
 
Proposed Legislation – Digital Asset Market Structure Bill. Representatives Patrick McHenry (R-NC) and Glenn Thompson (R-PA) proposed the Digital Asset Market Structure Bill (the “Bill”) in a discussion draft reflecting a joint-committee effort to add clarity to the regulatory uncertainty surrounding digital assets in the U.S. The Bill included a proposal to delegate authority to the SEC and the CFTC to jointly issue rules for (i) the definition of a number of digital asset related terms, including blockchain, blockchain network, digital assets, etc., and (ii) rules to exempt the requirement to register with both the CFTC as a digital commodity exchange and the SEC as an alternative trading system to the extent such exemption would foster the development of digital assets for the benefit of the public interest and protection of investors. The Bill also proposed the establishment of a strategic hub for innovation and financial technology and a LabCFTC within the SEC and the CFTC, respectively, with the purpose of educating and advising the regulators on financial technology. Additionally, the Bill further proposed that the SEC and the CFTC form a joint committee on digital assets with the purpose of providing advice on rules, regulations, and policies relating to digital assets, as well as harmonizing policies between the SEC and the CFTC.

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Other Items

SEC Amendments to Form PF. On May 3, 2023, the SEC adopted certain amendments to Form PF, a regulatory filing requirement that mandates certain SEC registered investment advisers to report information to the Financial Stability Oversight Council (“FSOC”). Form PF was created in 2011 by Title IV of the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010, as amended (the “Dodd-Frank Act”).
      
The amendments included a number of changes to the existing Form PF. Specifically, the amendments introduced a new Section 5 to Form PF and required, upon an occurrence of a trigger event, large hedge fund advisers of qualifying hedge funds to file a current report as soon as practicable but no later than 72 hours after such event. Triggering events include extraordinary investment loss, a significant margin and default event, fund margin default or inability to meet margin call, and significant disruption or degradation of the reporting fund’s key operations. Additionally, Section 6 of Form PF has been amended to require private equity fund advisers to report certain trigger events within 60 days of the end of each fiscal quarter. Such trigger events include the execution of an adviser-led secondary transaction and the investor’s election for the removal of the general partner to the fund, termination of the fund’s investment period, or termination of the fund. Section 4 of Form PF also introduced a new annual reporting event to large advisers of private equity funds with respect to the implementation of a general partner or limited partner clawbacks.
 
The amendments to Form PF Sections 5 and 6 will become effective on December 11, 2023, with the remainder of the amendments to Form PF becoming effective on June 22, 2024.
 
Enforcement of California Privacy Rights Act. The California Consumer Privacy Act of 2018 (the “CCPA”), as amended by the California Privacy Rights Act of 2020 (the “CPRA”, and together with the CCPA, the “Act”), was scheduled to become fully enforceable by the California Privacy Protection Agency (the “CPPA”) on July 1, 2023; however, a recent California court case has delayed this enforcement date, at least in relation to some of the statute’s requirements. By way of background, the CPRA amended the CCPA to add additional consumer data protections and created the CPPA, a state agency empowered to not only enforce these requirements jointly with the Attorney General of California, but also to promulgate final regulations thereunder.  Incidentally, the CPRA required the regulations to be completed by July 1, 2022, and contemplated a one-year “pre-enforcement period” by providing that enforcement of the regulations, “[n]otwithstanding any other law, civil and administrative enforcement…shall not commence until July 1, 2023[.]”
 
Unfortunately, the CPPA failed to complete the regulations by July 1, 2022. On March 29, 2023, the CPPA issued final (but incomplete) regulations, relating to twelve of the fifteen topics contemplated by the CPRA.  Currently, there are still no regulations concerning three key elements of the CPRA – cybersecurity audits, risk assessments, and automated decision-making technology.

The California Chamber of Commerce sued the CPPA, seeking to delay the enforcement of the Act, arguing that since the regulations were only finalized on March 29, 2023, an enforcement date of July 1, 2023 would violate the one-year pre-enforcement period required by the CPRA’s express language. On June 30, 2023, the Sacramento County Superior Court held that the CPPA cannot enforce any of the regulations of the Act before one year has passed from the date any such regulation has been finalized by the CPPA.
 
As the saga of California’s privacy statute continues to play out, businesses subject to the Act should resist the urge to fall into a false sense of security that compliance with the Act is neither imminent nor important.  The Act requires fundamental privacy controls that must be imbued into an organization on numerous planes — culturally, operationally, and technologically – simultaneously. CFM will continue to monitor this situation and advise our clients accordingly.

Establishment of an Ethical Artificial Intelligence Framework for Investment Advisors. On April 6, 2023, the SEC Investor Advisory Committee (the “IAC”) wrote an open letter to SEC Chair Gary Gensler outlining its views on implementing an ethical artificial intelligence (“AI”) framework for investment advisers and financial institutions. The letter referenced the use of algorithmic models and code by investment advisory firms and warned that the use of AI in other industries has highlighted important risks such as harmful algorithmic biases.
             
The letter encouraged the SEC and its staff to consider the following key tenets in developing guidance to investment advisers on the ethical use of AI:

  • Equity – understanding of the contextual, historical, and structural problems of the underlying data selected for input, including seeking consultation of experts.
  • Consistent and Persistent Testing – consistent testing of algorithms for performance during pre and post implementation stage.
  • Governance and Oversight – incorporation of a comprehensive risk management and compliance policy. 

The letter concluded with additional proposals to the SEC for consideration in developing its best practices guidance on ethical use of AI, including the hiring of staffs with experience in AI and machine learning, the reviewing of AI-related frameworks developed by other regulators such the Federal Trade Commission and the National Institute of Standards of Technology, and tasking the Division of Examinations to monitor the compliance on ethical use of AI.

User Fees and Third-Party Examination of SEC Registered Investment Adviser. On June 5, 2023, the IAC drafted a list of recommendations on oversight of SEC registered investment advisers (“RIAs”) to be discussed at the IAC meeting on June 22, 2023. The draft included two recommendations. First, the imposition of “user fees” on SEC RIAs to fund the SEC’s investment adviser examination program and to achieve an acceptable frequency of examination of SEC RIAs once every four to five years. Second, the adoption of a rule requiring SEC RIAs to undergo examination conducted by an outside firm, with a copy of the exam results submitted to the SEC. 

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Compliance Calendar

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

July 10, 2023

  • Form 13H Filing for Changes. Filing is for calendar quarter that ended June 30, 2023 and should be submitted within 10 days of quarter end.

July 14, 2023

  • Form PF Quarterly Filing for Large Liquidity Fund Advisers. Filing is for the calendar quarter that ended June 30, 2023.

July 31, 2023

  • ERISA Schedule C of DOL Form 5500 Disclosure.

August 14, 2023

  • Form 13F Quarterly Filing. Filing is for calendar quarter that ended June 30, 2023 and should be submitted within 45 days of quarter end.
  • CTA Form PR. Filing is for calendar quarter that ended June 30, 2023 and should be submitted within 45 days of quarter end.

August 29, 2023

  • Form PF for Large Hedge Fund Advisers. Filing is for calendar quarter that ended June 30, 2023.
  • CPO-PQR Form. Filing is for calendar quarter that ended June 30, 2023 and should be submitted within 60 days of quarter end.

Periodic

  • Form D and Blue Sky Filings should be current.
  • CPO/CTA Annual Questionnaires must be submitted annually, and promptly upon material information changes, through the NFA Annual Questionnaire system.

Consult our complete Compliance Calendar for all 2023 critical dates as you plan your regulatory compliance timeline for the year. 

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

Sincerely, Karl Cole-Frieman, Bart Mallon, Lilly Palmer, David Rothschild, Scott Kitchens, Tony Wise, Alex Yastremski, Garret Filler, John T. Araneo, Frank J. Martin, and Bill Samuels 

Cole-Frieman & Mallon LLP is a leading investment management law firm known for providing top-tier, innovative, and collaborative legal solutions for complex financial services matters. Headquartered in San Francisco, Cole-Frieman & Mallon LLP services both start-up investment managers and multibillion-dollar funds. The firm provides a full suite of legal services to the investment management community, including fund formation (hedge, VC, PE, real estate), investment adviser and CPO registration, counterparty documentation (digital and traditional prime brokerage, ISDA, repo, and vendor agreements), SEC, CFTC, NFA and FINRA matters (inquiries, exams, and compliance issues), seed deals, cybersecurity regulatory matters, full-service intellectual property counsel, manager due diligence, employment and compensation matters, and routine business matters. The firm also publishes the prominent Hedge Fund Law Blog. For more information, please add us on LinkedIn, follow us on Twitter, and visit us at colefrieman.com.

Save the Date! CoinAlts Fund Symposium on October 26th in San Francisco

Mark your calendar! CoinAlts presents the annual Fund Symposium on October 26, 2023, in San Francisco. Founded in 2017, this premier event brings together the digital asset community to address investment, legal, and operational issues specifically relevant to private fund managers. Premier sponsor industry leaders Cole-Frieman & Mallon LLP, MG Stover LLC, Harneys, and KPMG are dedicated to supporting fund managers in the digital asset space.

The Fund Symposium is a must-attend gathering for industry professionals, providing unparalleled insights and networking opportunities. Join us for expert panels, top-notch speakers, and the chance to stay ahead of the curve in this rapidly evolving industry. Registration is now open on the CoinAlts Fund Symposium website: https://coinalts.xyz/event/coinalts-2023/#tribe-tickets. #CoinAlts2023

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About the CoinAlts Fund Symposium

The CoinAlts Fund Symposium is organized by four firms with practices significantly devoted to fund managers in the cryptocurrency and digital asset space. Cole-Frieman & Mallon LLP is a leading investment management law firm known for providing top-tier, innovative, and collaborative legal solutions for complex financial service matters. MG Stover & Co. is a full-service fund administration firm built by former auditors and fund operators to deliver world-class solutions to the global alternative investment industry. Harneys is a leading international offshore law firm that acts for both issuers of digital assets and investment funds that invest in them. KPMG is a global leader in professional services that specializes in providing comprehensive advisory and consulting services to fund managers in the cryptocurrency and digital asset industry.

Launching a Retail Forex Hedge Fund

Recently, there seems to be a substantial uptick in manager demand to launch hedge funds that primarily invest in off-exchange forex transactions with retail customers (such transactions, “Retail Forex”). Retail Forex differs from traditional exchange-traded foreign currency futures (e.g., CME Swiss Franc or Japanese Yen futures) in that the trading does not take place on an “organized exchange” (such as the CME, CBOT or other board of trade), but rather occurs on specialized electronic venues that are registered as a futures commission merchant (“FCM”) or a retail foreign exchange dealer (“RFED”).

Before launching a hedge fund that invests in Retail Forex, managers must be aware of the registration requirements imposed by the Commodity Futures Trading Commission (“CFTC”) as enforced by the National Futures Association (“NFA”). In most instances, a manager will need to register as a commodity pool operator (“CPO”) if it plans to trade Retail Forex. Cole-Frieman & Mallon LLP (“CFM”) has extensive experience assisting clients navigate this complex regulatory environment.

CFTC Jurisdiction and Registration Requirements

Following the 2008 Financial Crisis, Congress enacted the Dodd-Frank Wall Street Reform and Consumer Protection Act (“Dodd-Frank”) which amended the Commodity Exchange Act (“CEA”) to provide the CFTC with jurisdiction over Retail Forex. Specifically, Sections 2(c)(2)(B) and 2(c)(2)(C) of the CEA confer jurisdiction over any agreement, contract, or transaction in foreign currency:

  • that is a future entered into with a person that is not an eligible contract participant (“ECP”) (i.e., a derivatives Retail Forex transaction); or
  • offered to, or entered into with a person that is not an ECP on a leveraged or margined basis (i.e., a leveraged spot Retail Forex transaction).

A retail customer is any party to a Retail Forex trade who is not an ECP. ECPs generally include (i) individuals and entities with assets of more than $10 million and (ii) entities formed by a registered CPO with assets of more than $5 million. However, except as discussed below, a pooled investment vehicle does not qualify as an ECP with respect to Retail Forex unless all of its direct participants qualify as ECPs, even if the pool has assets in excess of the thresholds denoted above (the “Look-Through Rule”). Importantly, unless the manager is registered as a CPO, a non-ECP pool generally may not trade Retail Forex on an FCM or an RFED.

Therefore, a manager that trades in Retail Forex on behalf of a pooled investment vehicle must generally register with the NFA as a CPO and “Forex Firm.” This means that at least one principal and associated person of the manager must pass the Series 3 (National Commodities Future Exam) and Series 34 (Retail Off-Exchange Forex Exam) administered by FINRA.

Disclosure Document and Disclosure Obligations

Generally, absent any exemptive relief (discussed below), a registered CPO of a Retail Forex hedge fund must deliver an NFA-approved “Disclosure Document” (i.e., a PPM) to prospective investors by no later than the time it delivers a subscription agreement to such prospective investors. Importantly, the Disclosure Document must be filed with the NFA using the NFA’s Electronic Disclosure Document Filing System prior to its delivery to prospective investors. The Disclosure Document must include:

  • general disclosures (e.g., risk factors [including Retail Forex-specific risk factors], general information about the CPO’s principal(s), and description of the investment program);
  • performance disclosures (e.g., past performance of other pools/accounts, monthly rate of return of the pool, and
  • fee disclosures (e.g., brokerage commissions, fees incurred to maintain open Retail Forex positions, and fees or costs included in the bid/ask spread).

Retail Forex pools must also include additional risk disclosures related to the potential insolvency of their counterparties, their status as a creditor in such insolvency, and the fact that they may receive lesser protections on their margin deposits versus exchange-traded futures.

Qualifying as an ECP, Exemptions from CPO Registration and Disclosure Relief

As may be evident, full CPO registration and Disclosure Document approval can be a long, resource-intensive journey; however, our process-oriented approach at CFM can help shorten lead times and preserve resources. Additionally, there are a number of potential exemptions we analyze for clients that may reduce certain disclosure obligations or eliminate the need to register as a CPO altogether.

Pools that Qualify as ECPs/De Minimis Exemption

Notwithstanding the Look-Through Rule mentioned above, a Retail Forex pool can qualify as an ECP if the pool:

  • is not formed for the purpose of evading the CEA;
  • has total assets exceeding $10 million; and
  • is formed and operated (i) by a registered CPO or (ii) by a CPO who is exempt from registration pursuant to CFTC Rule 4.13(a)(3) (the “De Minimis Exemption”).

Assuming the assets test is met, and while not relieving the CPO registration requirement, clause (i) allows pools in which not all participants are themselves ECPs to engage in Retail Forex. Clause (ii) provides a similar result (the pool can trade Retail Forex), but is particularly helpful for managers that only trade a de minimis amount (perhaps as a minor element of the pool’s overall investment program) since the manager would not have to register as a CPO. Among other requirements, the De Minimis Exemption requires that:

  • the pool at all times meets one of the following tests:
    • the aggregate initial margin required to establish commodity interest positions (including Retail Forex) does not exceed 5% of the liquidation value of the pool’s portfolio; or
    • the aggregate net notional value of the pool’s commodity interest positions does not exceed 100% of the liquidation value of the pool’s portfolio; and
  • the exempt CPO makes the required notice filing with the NFA.

Actual Delivery

A leveraged spot Retail Forex transaction as described above does not constitute Retail Forex if it results in “actual delivery” (i.e., a physical exchange of one currency for another) within two days. In such situations, there is no CPO registration requirement assuming all such leveraged transactions fulfill the actual delivery requirement.

CFTC Rule 4.13(a)(2)

CFTC Rule 4.13(a)(2) provides an exemption from CPO registration for managers that:

  • only operate pools with 15 or fewer participants at any time; and
  • the total gross capital contributions such pools receive do not in the aggregate exceed $400,000.

Notably, contributions by the principals and certain of their family members do not count toward the $400,000 limit. This exemption may be particularly useful for managers intending to operate a Retail Forex incubator fund.

CFTC Rule 4.7

CFTC Rule 4.7 exemptive relief is available to pools whose participants all meet the higher qualified eligible persons (“QEPs”) standard (generally, (i) an accredited investor with a $2 million investment portfolio or (ii) a qualified purchaser). Although the manager of such a pool must still fully register as a CPO, the upshot is that the Disclosure Document does not need to be reviewed and approved by the NFA and the pool obtains certain other disclosure, reporting, and recordkeeping relief. This partial exemptive relief could be beneficial for large Retail Forex pools with institutional investors that otherwise do not qualify for the De Minimis Exemption.

Conclusion

The Retail Forex regulatory landscape has become increasingly complex post-Dodd-Frank and managers wishing to pursue investment strategies in Retail Forex should map out a process early on to ensure their trading is CFTC/NFA compliant. CFM specializes in this process and helps both emerging and established managers alike register as CPOs, if necessary, and confidently launch funds that invest in Retail Forex.

Authored by Anthony Wise, Partner at Cole-Frieman & Mallon LLP

Cole-Frieman & Mallon 2023 Q1 Update

April 20, 2023

Clients, Friends, and Associates:

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

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CFM Items

We are pleased to announce the addition of John T. Araneo to our firm as Partner to lead our Cybersecurity Law practice. We’d also like to highlight the promotion of Frank J. Martin to Partner and Firm General Counsel. Additionally, we have hired Marcia Delgadillo as Director of Marketing & Business Development to manage our firm’s marketing and business development activities. Please join us in welcoming them all to our firm.

Cole-Frieman & Mallon is hosting a panel discussion on “Navigating the SEC Marketing Rule: Practical Considerations for Fund Managers,” on May 4th in San Francisco. CFM Partner David Rothschild and Senior Associate Malhar Oza will be joined by Managing Director Michael Fitzgerald of TD Cowen and Chief Executive Officer Fizza Khan of Silver Regulatory Associates LLC for a lively discussion. For details, contact [email protected].

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SEC Matters


SEC Charges Staking-as-a-Service Provider. On February 9, 2023, the Security and Exchange Commission (“SEC”) charged Payward Ventures, Inc. and Payward Trading Ltd. (“Kraken”) with failing to register the offer and sale of their crypto asset staking-as-a-service program. In operation since 2019, Kraken’s program allowed public investors to transfer crypto related assets to Kraken for staking in exchange for annual investment returns advertised by Kraken to be as high as 21%. Kraken’s model depended on pooling the assets transferred by investors and staking them on behalf of those investors. The SEC’s complaint alleges that the program produced benefits derived from Kraken’s effort on behalf of investors and that the program should be considered an investment contract subject to registration, disclosure, and safeguard protections required by securities laws. As a result of the charge, Kraken has agreed to cease offering or selling securities through crypto asset staking services and pay $30 million in settlement fees. Although the SEC’s complaint did not allege that staking necessarily always constitutes a security offering, it was determined that this service offered by Kraken did meet the 4-prong test to be considered an investment contract. This signals that the SEC may be increasingly more aggressive at regulating crypto under existing rules and regulations, and managers should consider whether staking services offered by third parties would fit into the Kraken fact pattern.

The SEC’s New Proposed Rule Regarding Safeguarding Advisory Client Assets. In February, the SEC announced a proposed rule to amend the existing “custody rule” applicable to SEC registered investment advisers (“RIAs”) that have custody of client assets. The proposed rule, redesignated as the “safeguarding rule,” imposes potentially significant new requirements on RIAs, including RIAs operating in the digital asset space.

The Existing Custody Rule. As background, the existing custody rule requires any RIA that has custody of client assets to keep “client funds and securities” with a “qualified custodian” at all times. To-date practitioners have debated the extent to which digital assets are captured in the definition of “client funds and securities” and thus whether these requirements apply to RIAs with custody of clients’ digital assets. A qualified custodian generally is a federal or state-chartered bank or savings association, certain trust companies, a registered broker-dealer, a registered futures commission merchant, or certain foreign financial institutions.

Key Elements of the Proposed Safeguarding Rule. The proposed safeguarding rule would make several important changes to the custody rule. Most importantly to digital asset managers, it would expand the existing custody requirements to cover all “client assets” over which an RIA has custody, explicitly including digital assets. It would also require RIAs to enter into written agreements with qualified custodians to ensure basic custodial protections are in place, including requiring a qualified custodian to obtain written internal control reports that include an opinion of an independent public accountant regarding the adequacy of the qualified custodian’s controls. The proposed safeguarding rule would provide a transition period of one year for large advisers and 18 months for smaller advisers to comply with the new rule.

Potential Implications for Crypto RIAs. If implemented as drafted, the proposed safeguarding rule would require RIAs who operate in the digital asset space to custody their digital assets with qualified custodians at all times – no exceptions. While qualified custodians exist today that can custody certain digital assets, there are no qualified custodians that can custody all digital assets. Moreover, when a crypto RIA wants to trade digital assets on an exchange, the crypto RIA would have to move digital assets out of a qualified custodian and on to the crypto exchange. There are currently no crypto exchanges that are qualified custodians, so it may be impossible for crypto RIAs to comply with the proposed safeguarding rule at all times. If adopted as proposed, RIAs could find it much harder to operate in the digital asset space.

Next Steps. We encourage our clients to review the proposed rule and consider submitting comments to the SEC highlighting potential issues and ways to improve the proposed rule. Comments should be received on or before May 8, 2023. Electronic comments may be submitted via the SEC’s internet comment form or by sending an email to [email protected]. Commenters should include File Number S7-04-23 on the subject line if submitting by email. After the May 8, 2023, comment deadline, the staff of the SEC will review the comments and potentially revise the proposed rule. The proposed rule, and any revisions to it, would only become effective after the SEC commissioners vote to approve it as a final rule.

The SEC’s Proposed Cyber Risk Management Rule for Investment Advisers. Last February, the SEC released a proposed rule that portends to create an entirely new cybersecurity compliance regime for investment advisers and certain funds. This new set of cybersecurity risk management rules (the “Cyber Risk Management Rule”) will be codified by amendments to both the Investment Advisers Act and the Investment Company Act. As drafted, the Cyber Risk Management Rule has four (4) cornerstone components: (i) policies and procedures; (ii) a new regulatory reporting regime (including a 48-hour notification period for alerting the SEC of a cybersecurity breach); (iii) cybersecurity disclosure obligations; and (iv) recordkeeping requirements. The Cyber Risk Management Rule was set for a final vote this month, however on March 15, 2023 the SEC unexpectedly reopened its comment period for an additional sixty (60) days, while simultaneously issuing three (3) additional cybersecurity related rule proposals, each with some connective tissue with the Cyber Risk Management Rule.

Cybersecurity continues to be a top priority at the SEC and it has made clear that a new, more mature and comprehensive cybersecurity compliance regime is imminent. Advisers and funds who may mistakenly kick the cybersecurity can down the road in 2023 will likely do so at their peril, primarily for two reasons. First, the SEC still requires registrants to comply with its current cybersecurity requirements, to wit, conducting annual assessments and implementing reasonable policies, procedures, and controls across the core seven (7) elements that constitute a model cybersecurity program (governance and periodic assessments; access rights and controls; data loss prevention; mobile security; incident response; vendor management; and training and awareness (collectively, the “Cyber 7”)). Second, the new regime, via proposed rule 206(4)-9 of the Investment Advisers Act, will actually make it unlawful for a registered adviser to provide investment advice to clients if it fails to adopt and implement these policies and procedures and conduct these periodic assessments. This rule alone is a clear, direct statutory line in the sand that adds one more arrow in the quiver of the SEC’s ample Cyber Unit, which continues to actively pursue penalties against those registrants that fail to meet these threshold requirements.

Fortunately, since the new Cyber Risk Management Rule takes a cumulative approach in setting these new cyber standards, virtually all the advancements asset managers have made in complying with the current Cyber 7 since 2015 will be relevant and accretive to the new requirements. Cybersecurity is indeed a process, as opposed to a project. Demonstrating continued engagement and reasonable progress is the key to cracking the code on cybersecurity compliance, at least in terms of meeting regulatory requirements and the ODD expectations of institutional investors. And thus, advisers need to act now in either creating or sufficiently maintaining an appropriately scaled model cybersecurity set of policies, procedures and controls (a “Cybersecurity Program”). The Firm’s Cybersecurity Law Practice Group is available to assist our clients with any questions or concerns regarding virtually any aspect of cybersecurity compliance.

SEC and NYDFS Commence Actions Against Paxos. The New York Department of Financial Services (“NYDFS”) recently ordered Paxos Trust Company (“Paxos”) to cease minting Paxos-issued BUSD, a fiat-backed stablecoin issued by Binance and Paxos. Each BUSD token is backed 1:1 with US dollars held in reserve. On February 13, 2023, Paxos notified customers of its intent to end its relationship with Binance as a result of the order.

In conjunction with the order from the NYDFS, Paxos reports that it received a Wells notice from the SEC on February 3, 2023. According to a press release from Paxos, the Wells notice states the SEC is considering enforcement action against Paxos alleging that BUSD is an unregistered security. The actions by the NYDFS and SEC could have important implications for stablecoins since it appears that regulators are taking the stance that fiat-backed stablecoins could be securities even though they are intended to function as currency and there would not be an expectation of profit simply by owning them. Moreover, the NYDFS order and SEC Wells notice only appear to target BUSD, while Paxos separately issues a second fiat-backed stablecoin called USDP. It is unclear why USDP appears to be spared so we await further action by regulators and will monitor this situation.

SEC Files Wells Notice Against Coinbase. Coinbase Global Inc. (“Coinbase”) also recently received a Wells notice from the SEC, targeting Coinbase’s staking service Coinbase Earn, Coinbase Prime, and Coinbase Wallet. The Wells notice stems from an SEC investigation conducted into Coinbase in the summer of 2022. Our firm will continue to closely monitor the situation with Coinbase for new developments.

SEC Releases a “Frequently Asked Questions” Page for the Marketing Rule. In January, the SEC released a FAQ page for questions stemming from its recently enacted rule 206(4)-1 under the Investment Advisers Act of 1940 (the “Marketing Rule.”) The page currently provides responses to three commonly asked questions—most notably regarding its gross and net performance rules—clarifying that when an RIA displays the gross performance of one investment or a group of investments from a private fund, the RIA must show the net performance of the single investment and/or the group of investments, respectively. The SEC noted that they will be updating this page periodically to respond to questions related to the Marketing Rule, and clients should reach out with any specific questions relating to the new Marketing Rule. Our firm will be hosting an event on May 4th to be a discussion of the practical considerations for fund managers under the recently reviewed marking rule, and hope that you all will join us.

Judge Rules that Emojis in a Tweet may Constitute “Financial Advice.” A United States District Court judge recently ruled that the use of emojis can be construed in certain circumstances to meet a factor in the legal test to determine whether an individual is providing financial advice. Specifically, the judge denied the defendant’s Motion to Dismiss, finding that the defendant-company’s use of a rocket ship, stock chart, and money bag emojis in a recent tweet “objectively meant one thing: a financial return on investment.” The emojis were displayed alongside statements touting recent NFT purchase prices on the company’s website, presumably indicating future gains on such NFTs. While the decision specifically rules on the three emojis mentioned above, we advise our clients to use caution in their use of any emojis, whether that be in public or private communications regarding fund matters. In any event, any communications should not be misleading and in accordance with the advisers act and the new marketing rule (if applicable).

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Digital Asset Matters

Liability Issues and Third-Party Engagement in DAOs. As the formation of and investment in Decentralized Autonomous Organizations (“DAOs”) continue to garner attention within the investment community, it is important for DAO participants to continue to analyze how they participate. First, as noted in our July 2022 Quarterly Update, managers should consider only participating or investing in DAOs that are wrapped in a liability blocking entity in order to reduce the risk of personal liability. Second, as an added measure of liability protection, managers should consider participating or investing through special purpose vehicles specific to such activity (e.g., a fund making two DAO investments could segregate each investment through separate, wholly-owned subsidiaries). Third, managers should consider only participating or investing in DAOs that have engaged reputable third-party service providers such as administrators, accountants, tax counsel and, in the case of foreign foundations, independent directors. The use of such independent third-party service providers may help ensure proper functioning and allocation of resources of the DAO, thereby helping to protect its participants.

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Other Items

The Ninth Circuit Blocks California’s Ban on Mandatory Arbitration Agreements. On February 15, 2023, a three-judge panel for the Ninth Circuit Court of Appeals struck down a California bill which would have prevented employers from requiring employees to sign arbitration agreements as a condition of employment. The court held that California Assembly Bill 51 is preempted by the Federal Arbitration Act, which “embodies a national policy favoring arbitration.” After years of uncertainty surrounding the issue, the decision solidifies that employers in California can continue to include mandatory arbitration provisions in their employment agreements.

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Compliance Calendar

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

April 7, 2023

  • Form N-MFP Filing for Monthly Schedule of Portfolio Holdings of Money Market Funds, if applicable.

April 10, 2023

  • Form 13H Quarterly Filing for Changes. Filing is for calendar quarter that ended March 31, 2023 and should be submitted within 10 days of quarter end. 
  • Form 13G Monthly Filing for Applicable Reporting Persons. Filing is for month end of March 31, 2023, and should be submitted within 10 days of month end. 

April 15, 2023

  • Form PF Quarterly Filing for Large Liquidity Fund Advisers. Filing is for calendar quarter that ended March 31, 2023.

April 30, 2023

  • Form ADV Part 2A Delivery to Existing Clients. 
  • Audited Financials Distribution to Private Fund Investors (excluding Fund of Funds).
  • Form PF Annual Filing. Filing is for fiscal year end December 31, 2022 and should be submitted within 120 days of fiscal year end. 

May 10, 2023

  • Form 13G Monthly Filing for Applicable Reporting Persons. Filing is for month end of April 31, 2023, and should be submitted within 10 days of month end. 

May 15, 2023

  • Form 13F Quarterly Filing for Changes. Filing is for Calendar Quarter that ended March 31, 2023 and should generally be submitted within 45 days of quarter end.
  • Form CTA-PR Filing with the NFA, which can be filed through NFA’s EasyFile.

May 30, 2023

  • Form CPO-PQR Filing with the NFA, which can be filed through NFA’s EasyFile.
  • Form PF Quarterly Filing for Large Hedge Fund Traders and Large Liquidity Fund Advisers, if applicable.
  • Form N-PORT Filing Monthly Schedule of Portfolio Holdings of Funds other than Money Markey Funds and SBICs, if applicable. 

 June 7, 2023

  • Form N-MFP Filing for Monthly Schedule of Portfolio Holdings of Money Market Funds, if applicable. 

June 10, 2023

  • Form 13G Monthly Filing for Applicable Reporting Persons. Filing is for month end of May 31, 2023, and should be submitted within 10 days of month end. 
  • Audited Financials Distribution to Fund of Funds Investors. 

Periodic

  • Fund Managers should perform “Bad Actor” certifications annually.
  • Form D and Blue Sky Filings should be current.
  • CPO/CTA Annual Questionnaires must be submitted annually, and promptly upon material information changes, through NFA Annual Questionnaire system.

Consult our complete Compliance Calendar for all 2023 critical dates as you plan your regulatory compliance timeline for the year. 

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

Sincerely,

Karl Cole-Frieman, Bart Mallon, Lilly Palmer, David Rothschild, Scott Kitchens, Tony Wise, Alex Yastremski, Garret Filler, Frank J. Martin, and John T. Araneo

Cole-Frieman & Mallon LLP is a leading investment management law firm known for providing top-tier, innovative, and collaborative legal solutions for complex financial services matters. Headquartered in San Francisco, Cole-Frieman & Mallon LLP services both start-up investment managers and multibillion-dollar funds. The firm provides a full suite of legal services to the investment management community, including fund formation (hedge, VC, PE, real estate), investment adviser and CPO registration, counterparty documentation (digital and traditional prime brokerage, ISDA, repo, and vendor agreements), SEC, CFTC, NFA and FINRA matters (inquiries, exams, and compliance issues), seed deals, cybersecurity regulatory matters, full-service intellectual property counsel, manager due diligence, employment and compensation matters, and routine business matters. The firm also publishes the prominent Hedge Fund Law Blog. For more information, please add us on LinkedIn, follow us on Twitter, and visit us at colefrieman.com.

Principals in Transition: Protect, Prevent, Preserve

TRANSITIONS MATTER.

Done well, they are the first step in a new and exciting chapter for senior investment management professionals. Gone wrong, they can lead to years of acrimonious litigation and missed professional opportunities. When senior investment management employees or partners leave their current firms to join another or start their own, navigating this critical moment requires a deep understanding of the legal and contractual basis of their current arrangements, an honest understanding of the relationship between the principal and their current firm, and a clear set of objectives.

At Cole-Frieman & Mallon (“CFM”), our Principals in Transition practice focuses on the Three Ps – Protecting the departing principal’s economics, Preventing limitations on future professional endeavors, and Preserving the relationship with the principal’s current firm. Protect, Prevent, Preserve. We are industry experts, not employment law litigators, and our ecosystem expertise is both our strategic advantage in these negotiations and an important message to the principal’s current organization that preservation of the relationship is important. We come to facilitate a smooth and fair transition, not to write demand letters or instigate litigation. We achieve this by: 1) bringing our fund expertise when analyzing current partnership agreements, 2) our knowledge of California’s and other jurisdictions’ public policy against non-competition including overreaching non-solicit clauses and overly broad confidentiality restrictions that courts have ruled operate as non-competes, and 3) an understanding that while the investment management ecosystem is global in nature, it is a small community and relationships (among managers, allocators, and LPs) matter.

All of this is done without limiting the principal’s ability to escalate if necessary. There is a time and place for litigation, and when it becomes clear that the best route for our client is litigation, transitioning from the Three Ps approach to another tactic with litigation counsel is seamless.

Protect your economics. Partnership agreements and carried interest grant agreements are complex documents with many hidden (and not so hidden) powers vested in the controlling parties. Understanding how investment funds and the economics of investment funds work is our specialty.

Prevent limitations on future professional endeavors. Few people leave investment managers intending to leave the industry. Most, in fact, are leaving to start their own venture or join another investment manager doing substantially similar work. The key to these negotiations is to ensure that whatever limitations are connected to future economic benefits from the principal’s previous organization are narrowly tailored. Central to this is understanding the principal’s statutory and common law rights in California and other jurisdictions that have a public policy against non-competition agreements. In furtherance of this public policy, California and other state courts have become increasingly hostile to non-solicit and overly broad confidentiality agreements that operate to restrain a person’s ability to work.

Preserve your relationship. CFM’s approach is designed to preserve the relationship with the principal’s current investment manager. The elements necessary to achieve this are: 1) being reasonable in the principal’s requests on economics and limitations, 2) approaching the negotiations collaboratively, 3) having a clear understanding of the other side’s objectives and finding ways to get them what they need from the transition, and 4) being thoughtful in whom you hire to handle this transition. Because CFM is embedded in the investment management ecosystem, hiring our firm in these matters signals the principal’s desire to “get the numbers right,” to ensure that the principal has the freedom they need to start their next endeavor, and perhaps most importantly that this will all be achieved in a collaborative way.

Authored by Frank J. Martin, Partner & General Counsel at Cole-Frieman & Mallon LLP

Cole-Frieman & Mallon 2022 End Of Year Update

December 2022

Clients, Friends, Associates:

As we near the end of 2022, we have highlighted some recent industry updates that we believe may impact our clients. We have also developed a checklist to help managers effectively oversee the business and regulatory landscape for the coming year. While we strive to present an informative, albeit brief, overview of these topics, we are also available should you have any related questions.


This update includes the following:

  • Q4 Matters
  • Annual Compliance & Other Items
  • Annual Fund Matters
  • Annual Management Company Matters
  • Notable Regulatory & Other Items from 2022
  • Compliance Calendar

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Q4 Matters

New York Federal Reserve Digital Dollar Pilot Project. In collaboration with the Federal Reserve Bank of New York and several private sector financial institutions, the New York Innovation Center (“NYIC”) recently announced a pilot program to test the operability of digital asset transactions between financial institutions using the U.S. dollar as token. Although the project is being conducted in a purely experimental fashion using simulated data, the pilot can be seen as one of the first steps taken by a governmental agency towards creating a central bank digital currency.

SEC v. LBRY. In November, the U.S. District Court for the District of New Hampshire granted the SEC’s motion for summary judgment against LBRY, Inc., holding that LBRY offered a crypto asset in violation of the registration provisions of federal securities laws. The case addresses a fundamental issue in the crypto universe — whether blockchain tokens are considered securities by the SEC.  The Court concluded that LBRY’s messaging would lead potential investors to understand that the company was pitching speculative value propositions for its digital token that created an expectation of profits under the Howey test.  We generally advise that managers and others in the digital asset space should assume that the SEC considers all blockchain tokens to be securities, subject to SEC regulation and applicable registration requirements. 

FTX. Our firm, like many others, continues to develop our understanding of the recent events related to FTX, what users of the exchange can and should expect going forward, and how it will affect the digital asset space generally. We have included links to our initial blog post and podcast below touching on the FTX situation. Stay tuned for additional information through multiple channels in the days and weeks ahead.

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Annual Compliance & Other Items

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

Annual Compliance Review. The Chief Compliance Officer (“CCO”) of a registered investment advisor (“RIA”) must conduct a review of the adviser’s compliance policies and procedures annually. This annual compliance review should be in writing and presented to senior management. CCOs should consider additions, revisions, and updates to the compliance program as may be necessary. We recommend firms discuss the annual review with their outside counsel or compliance firm to obtain guidance about the review process and a template for the assessment. Conversations regarding the annual review may raise sensitive matters, and advisers should ensure that these discussions are protected by attorney-client privilege. Advisers that are not registered may still wish to review their procedures and/or implement a compliance program as a best practice.

Form ADV Annual Amendment. RIAs or managers filing as exempt reporting advisers (“ERAs”) with the SEC or a state securities authority must file an annual amendment to their Form ADV within 90 days of the end of their fiscal year. For most managers, the Form ADV amendment will be due on March 31, 2023. RIAs must provide a copy of the updated Form ADV Part 2A brochure and Part 2B brochure supplement (or a summary of changes with an offer to provide the complete brochure) to each “client” and, if applicable, Part 3 (Form CRS: Client Relationship Summary) to each “retail investor” with which the RIA has entered into an investment advisory contract. Note that for SEC RIAs to private investment vehicles, a “client” for purposes of this rule refers to the vehicle(s) managed by the adviser and not the underlying investors. State-registered advisers need to examine their states’ regulations to determine who constitutes a “client.” For purposes of the Form ADV Part 3, a “retail investor” means a natural person, or the legal representative of such natural person, who seeks to receive or receives services primarily for personal, family, or household purposes.

Switching to/from SEC Regulation.

SEC Registration. Managers who no longer qualify for SEC registration as of the time of filing the annual Form ADV amendment must withdraw from SEC registration within 180 days after the end of their fiscal year (June 30, 2023, for most managers), by filing a Form ADV-W. Such managers should consult with legal counsel to determine whether they are required to register in the states in which they conduct business. Managers who are required to register with the SEC as of the date of their annual amendment must register with the SEC within 90 days of filing the annual amendment (June 30, 2023, for most managers, assuming the annual amendment is filed on March 31, 2023).

Exempt Reporting Advisers. Managers who no longer meet the definition of an ERA will need to submit a final report as an ERA and apply for registration with the SEC or the relevant state securities authority, as applicable, generally within 90 days after the filing of the annual amendment (June 30, 2023, for most managers, assuming the annual amendment is filed on March 31, 2023).

Custody Rule Annual Audit.

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

SEC RIAs to pooled investment vehicles may avoid both the quarterly statement and surprise examination requirements by having audited financial statements prepared for each pooled investment vehicle in accordance with generally accepted accounting principles (“GAAP”) by an independent public accountant registered with the Public Company Accounting Oversight Board (“PCAOB”). Audited financial statements must be sent to investors in the fund within 120 days after the fund’s fiscal year-end (or for fund-of-fund clients, within 180 days after fiscal year-end). SEC RIAs should review their internal procedures to ensure compliance with the custody rules.

California RIAs. California-registered investment advisers (“CA RIAs”) that manage pooled investment vehicles and are deemed to have custody of client assets are also subject to independent party surprise examinations. However, CA RIAs can avoid these additional requirements by engaging a PCAOB-registered auditor to prepare and distribute audited financial statements to all beneficial owners of the pooled investment vehicle, and the Commissioner of the California Department of Financial Protection and Innovation (“DFPI”). Those CA RIAs that do not engage an auditor must, among other things: (i) provide notice of such custody on the Form ADV; (ii) maintain client assets with a qualified custodian; (iii) engage an independent party to act in the best interest of investors to review fees, expenses, and withdrawals; and (iv) retain an independent certified public accountant to conduct surprise examinations of assets.

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

California Minimum Net Worth Requirement and Financial Reports.

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

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

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

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

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

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

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

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

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

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

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

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

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

SEC Form D. Form D filings for most funds need to be amended annually, on or before the anniversary of the most recently filed Form D. Copies of Form D are publicly available on the SEC’s EDGAR website.

Blue Sky Filings. On an annual basis, a manager should review its blue sky filings for each state to make sure it has met any initial and renewal filing requirements. Several states impose late fees or reject late filings altogether. Accordingly, it is critical to stay on top of filing deadlines for both new investors and renewals. We also recommend that managers review blue sky filing submission requirements. Many states now permit blue sky filings to be filed electronically through the Electronic Filing Depository (“EFD”) system, and certain states will now only accept filings through EFD.

IARD Annual Fees. Preliminary annual renewal fees for state-registered and SEC-registered investment advisers are due on December 13, 2022. Failure to submit electronic payments by the deadline may result in registrations terminating due to a “failure to renew.” If you have not already done so, you should submit full payment into your Renewal Account by E-Bill, check, or wire as soon as possible. 

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

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Annual Fund Matters

New Issue Status. On an annual basis, managers need to confirm or reconfirm the eligibility of investors that participate in initial public offerings, or new issues, pursuant to both Financial Industry Regulatory Authority, Inc. (“FINRA”) Rules 5130 and 5131. Most managers reconfirm investor eligibility via negative consent (i.e., investors are informed of their status on file with the manager and are asked to notify the manager of any changes), whereby a failure to respond by any investor operates as consent to its current status.
 
ERISA Status. Given the significant problems that can occur from not properly tracking ERISA investors in private funds, we recommend that managers confirm or reconfirm on an annual basis the ERISA status of their investors. This is particularly important for managers that track the underlying percentage of ERISA funds for each investor, with respect to each class of interests in a pooled investment vehicle.
 
Wash Sales. Managers should carefully manage wash sales for year-end. Failure to do so could result in book/tax differences for investors. Certain dealers can provide managers with swap strategies to manage wash sales, including Basket Total Return Swaps and Split Strike Forward Conversion. These strategies should be considered carefully to make sure they are consistent with the investment objectives of the fund.
 
Redemption Management. Managers with significant redemptions at the end of the year should carefully manage unwinding positions to minimize transaction costs in the current year (that could impact performance) and prevent transaction costs from impacting remaining investors in the next year. When closing funds or managed accounts, managers should pay careful attention to the liquidation procedures in the fund constituent documents and the managed account agreement.
 
NAV Triggers and Waivers. Managers should promptly seek waivers of any applicable termination events specified in a fund’s International Swaps and Derivatives Association (“ISDA”) or other counterparty agreement that may be triggered by redemptions, performance, or a combination of both at the end of the year (NAV declines are common counterparty agreement termination events).
 
Fund Expenses. Managers should wrap up all fund expenses for 2022 if they have not already done so. In particular, managers should contact their outside legal counsel to obtain accurate and up to date information about legal expenses for inclusion in the NAV for year-end performance.
 
Electronic Schedule K-1s. The Internal Revenue Service (“IRS”) authorizes partnerships and limited liability companies taxed as partnerships to issue Schedule K-1s to investors solely by electronic means, provided the partnership has received the investors’ affirmative consent. States may have different rules regarding electronic K-1s, and partnerships should check with their counsel whether they may be required to send hard copy state K-1s. Partnerships must also provide each investor with specific disclosures that include a description of the hardware and software necessary to access the electronic K-1s, how long the consent is effective, and the procedures for withdrawing the consent. If you would like to send K-1s to your investors electronically, you should discuss your options with your service providers.
 
“Bad Actor” Recertification Requirement. A security offering cannot rely on the Rule 506 safe harbor from SEC registration if the issuer or its “covered persons” are “bad actors.” Fund managers must determine whether they are subject to the bad actor disqualification any time they are offering or selling securities in reliance on Rule 506. The SEC has advised that an issuer may reasonably rely on a covered person’s agreement to provide notice of a potential or actual bad actor triggering event pursuant to contractual covenants, bylaw requirements, or undertakings in a questionnaire or certification. However, if an offering is continuous, delayed or long-lived, issuers must periodically update their factual inquiry through a bring-down of representations, questionnaires, and certifications, negative consent letters, reexamination of public databases or other means, depending on the circumstances. Fund managers should consult with counsel to determine how frequently such an update is required. As a matter of practice, most fund managers should perform these updates at least annually.
 
U.S. FATCA. Funds should monitor their compliance with the U.S. Foreign Account Tax Compliance Act (“FATCA”). Generally, U.S. FATCA reports are due to the IRS on March 31, 2023, or September 30, 2023, depending on where the fund is domiciled. However, reports may be required by an earlier date for jurisdictions that are parties to intergovernmental agreements (“IGAs”) with the U.S. Additionally, the U.S. may require that reports be submitted through the appropriate local tax authority in the applicable IGA jurisdiction, rather than the IRS. Given the varying U.S. FATCA requirements applicable to different jurisdictions, managers should review and confirm the specific U.S. FATCA reporting requirements that may apply. As a reminder, we strongly encourage managers to file the required reports and notifications, even if they already missed previous deadlines. Applicable jurisdictions may be increasing enforcement and monitoring of FATCA reporting and imposing penalties for each day late.
 
CRS. Funds should also monitor their compliance with the Organisation for Economic Cooperation and Development’s Common Reporting Standard (“CRS”). All “Financial Institutions” in the British Virgin Islands (“BVI”) and the Cayman Islands must register with the respective jurisdiction’s Tax Information Authority and submit various reports with the applicable regulator via the associated online portal. Managers to funds domiciled in other jurisdictions should also confirm whether any CRS reporting will be required in such jurisdictions and the procedures required to enroll and file annual reports. We recommend managers contact their tax advisors to stay on top of the U.S. FATCA and CRS requirements and avoid potential penalties.

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Annual Management Company Matters

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

Employee Reviews. An effective annual review process is vital to reduce the risk of employment-related litigation and protect the management company in the event of such litigation. Moreover, it is an opportunity to provide context for bonuses, compensation adjustments, employee goals, and other employee-facing matters at the firm. It is never too late to put an annual review process in place.

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

Insurance. If a manager carries director and officer or other liability insurance, the policy should be reviewed annually to ensure that the manager has provided notice to the carrier of all claims and all potential claims. Newly launched funds should also be added to the policy as necessary.

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

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Notable Regulatory & Other Items from 2022

SEC Matters

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

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

Insider Trading in the Digital Asset Space. In 2022, the SEC charged a former Coinbase employee and two others with insider trading and a high-ranking employee of OpenSea was indicted for wire fraud and money laundering. The actions indicate the willingness of federal and state officials to enforce regulations applicable to traditional finance in the digital assets space and that law enforcement is ready to tackle unsavory business practices and to attempt to provide greater consumer protections. While insider trading remains an unsettled area of law in the digital asset space, concepts of fraud are well established, malleable, and largely immune from claims that certain digital assets are not “securities.”

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

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

New Marketing Rule for SEC Registered Investment Advisers. By November 4, 2022, all SEC RIA are required to be in full compliance with the SEC’s new marketing rules. As discussed in our 2021 Half Year Update, the new rule replaces the existing cash solicitation and advertising rules, with the most notable change being the allowance of testimonials and endorsements in a RIA’s marketing materials. Given the new rule’s detailed amendments and its significance to our investment adviser clients, we will soon publish a “Frequently Asked Questions” article addressing the specific changes and what they mean for investment advisers going forward. Please keep an eye out for this post on the Hedge Fund Law Blog in the coming weeks.

SEC Charges Investment Advisers for Non-Compliance with Reporting Requirements. In September, the SEC conducted a compliance sweep and charged nine investment advisers for various violations, including failing to deliver audited financial statements to investors in a timely manner, failing to promptly file required amendments to the adviser’s Form ADV upon receipt of audited financial statements, failing to properly describe the status of financial statement audits in the Form ADV, and other violations of Rule 206(4)-2 (the “Custody Rule”) of the Investment Advisers Act of 1940, as amended (the “Advisers Act”). Without admitting fault, all the advisers settled with the SEC and agreed to censure and penalties totaling over $1 million. These enforcement actions highlight the importance of compliance with the Custody Rule and its associated reporting requirements, as well as serve as a reminder to regularly review the Form ADV for accuracy and file timely updates as needed. Further, as specifically identified by the SEC in many of these enforcement actions, if you select “Report Not Yet Received” in Item 23(h) of Section 7.B(1) of the Form ADV regarding a private fund’s audited financial statements, the Custody Rule and related instructions to the Form ADV mandate the filing of an other than annual amendment to the Form ADV once the audited financial statements are available. 

SEC Charges Venture Capital Adviser for Overcharging Fees. In September, the SEC charged a California-based ERA for overcharging management fees. The excess fees were a result of errors made by the manager, specifically with regard to (i) the failure to adjust its management fee calculations for securities subject to dispositions; (ii) calculations of the management fee based on aggregated invested capital at the portfolio company level instead of at the individual portfolio company level; (iii) including accrued but unpaid interest in its calculation of management fees; and (iv) calculating the funds’ post-investment period management fees on an incorrect date. As a result, the manager was ordered to return the excess management fees to fund investors and pay a penalty. This enforcement action underscores that while ERAs are subject to less regulatory oversight compared to RIAs, they are not exempt from SEC scrutiny. We recommend that all investment advisers routinely review their offering documents to ensure compliance with their fund offering terms.

SEC Pay-to-Play Rule. Rule 206(4)-5 of the Advisers Act bars investment advisers (except state registered investment advisers) from receiving compensation for advisory services provided to a government entity for two years after the adviser or its covered associates have made political contributions to that government entity or official. In September, the SEC investigated and settled four enforcement actions against investment advisers for violations of these pay-to-play rules as a result of political contributions of less than $1,000 by personnel of the investment advisers. The lack of allegations of an intent to exert influence highlights the strict liability enforcement mentality of the SEC with respect to pay-to-play rules as well as the importance of educating employees about political donations and implementing a robust internal compliance and reporting system.

CFTC Matters

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

CFTC & SEC Consider Asking Large Hedge Funds to Disclose Crypto Exposure. In September, the CFTC and the SEC submitted a joint proposal to amend Form PF—a confidential reporting form for certain investment advisers to private funds that are registered with the SEC and/or the CFTC. The proposal observes that investments in digital assets are continuing to grow, and ultimately suggests there is a parallel need to gather information on the exposure of crypto funds. The proposal suggests a new asset class be created for digital assets, which would be reported by firms or funds separately, revealing their exposure to the crypto industry. Both agencies solicited comments through October 11, 2022 and the comments submitted prior to the deadline are available to the public. This proposal is one of many actions underway by U.S. government agencies to better understand and regulate crypto as an asset class. To the extent this proposal is part of a larger regulatory scheme that provides clarity as to how and to what extent digital assets will be regulated, we think this has the potential to increase investments in the crypto industry.

Digital Asset Matters

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

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

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

OFAC/Tornado Cash. In August, the U.S. Office of Foreign Assets Control (“OFAC”) added Tornado Cash, a smart contract mixer that anonymizes Ethereum-based crypto exchanges, to the Specially Designated National (“SDN”) list for the alleged use of its services in laundering over $7 billion of digital assets. By taking this position, OFAC has essentially declared that anonymous exchanges are likely SDNs, effectively denying these exchanges access to the U.S. financial system by making it illegal for any U.S. person to transact using those exchanges – even if the U.S. person does not initiate or authorize the transaction via the SDN.  This is particularly concerning because users may lose real-world access to their cryptocurrency, likely without any recourse and even when they have not actively engaged with an SDN.

SEC Actions Against Sponsors of Unregistered Crypto Offerings. Since October, the SEC ramped up its investigation and enforcement of securities violations in the crypto asset space. Notably, the SEC brought an enforcement action against Kim Kardashian for promoting a crypto asset via social media without disclosing that she was being compensated by the entity offering the security. Several other groups were charged for allegedly raising millions of dollars for tokens and other crypto assets without adequate registration and from unsophisticated investors. The recent expansion of the SEC’s enforcement unit coupled with the wave of enforcement actions in the digital asset space indicates a shift in focus to digital assets.

Other Items

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

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

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

New EU AML Regulator Will Oversee Crypto. In June, the European Union (the “EU”) proposed the establishment of a new Anti-Money Laundering Authority to strengthen the EU’s AML and Countering the Financing of Terrorism (“CTF”) framework. If enacted, this proposal would create a new regulatory body and standardize AML/CTF regulations across the EU and replace the current AML regime which varies across individual nations. The new AML/CTF Authority would have supervisory powers including over selected obliged entities of the financial sector such as crypto-asset service providers and would also be responsible for the monitoring, analysis, and exchange of information concerning money laundering and terrorist financing. With the increasing anonymity provided by cryptocurrency, including through mixers such as Tornado Cash discussed above, the EU’s standardization of a comprehensive AML/CTF regime provides legitimacy to this asset class.

BVI Business Companies Act of 2004. On January 1, 2023, several amendments to the British Virgin Islands (“BVI”) Business Company Act of 2004 relating to voluntary liquidators of solvent BVI business companies will go into effect. Specifically, the amendment requires a voluntary liquidator to be a resident of the BVI (unless a joint voluntary liquidator is a BVI resident) that has at least 2 years of liquidation experience, is competent to perform the liquidation, and is familiar with relevant legislation. Further, voluntary liquidators will now be required to maintain the entity’s accounting records and to provide them to the entity’s registered agent

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Compliance Calendar

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

December 12, 2022

  • Annual Renewal Payments Due for Preliminary Statement Issued in E-bill for Registration/Notice Filings. Payment can be made through FINRA Firm Gateway in the E-bill tab.

December 16, 2022

  • Cayman Islands FATCA and CRS reporting deadlines.

December 22, 2022

  • Last day to submit form filings via IARD prior to year-end. CRD/IARD will be unavailable to submit any filings from 11 PM ET, December 22, 2022 through January 2, 2023, due to year-end renewal processing.

December 31, 2022   

  • Review RAUM to determine 2022 Form PF filing requirement.
  • Registered CPOs must submit a pool quarterly report (CPO-PQR).
  • 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 to avoid 2022 CIMA fees.

January 10, 2023

  • Form 13H Quarterly Filing for Changes. Filing is for calendar quarter that ended December 31, 2022 and should be submitted within 10 days of quarter end.

January 15, 2023

  • Quarterly Form PF due for Large Liquidity Fund Advisers (if applicable).

January 31, 2023

  • “Annex IV” AIFMD filing.

February 14, 2023

  • Form 13F Quarterly Filing for Changes. Filing is for Calendar Quarter that ended December 31, 2022 and should generally be submitted within 45 days of quarter end.
  • Form 13H Annual Filing for Calendar Year that ended December 31, 2022.
  • Form 13G Annual Filing for Calendar Year that ended December 31, 2022.

March 1, 2023

  • Quarterly Form PF due for larger hedge fund advisers (if applicable).
  • Deadline for annual affirmation of NFA/CFTC exemptions. Exemptions must be affirmed within 60 days of Calendar Year end or exemptions will be withdrawn by the NFA.

March 31, 2023

  • Form ADV Annual Update Amendment. Deadline to update and file Form ADV Parts 1, 2A, 2B (and Form CRS, if applicable).

March 31, 2023

  • Cayman Islands CRS Compliance Form deadline.

Periodic

  • Fund Managers should perform “Bad Actor” certifications annually.
  • Form D and Blue Sky Filings should be current.
  • CPO/CTA Annual Questionnaires must be submitted annually, and promptly upon material information changes, through NFA Annual Questionnaire system.

Consult our complete Compliance Calendar for all 2023 critical dates as you plan your regulatory compliance timeline for the year. 

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

Sincerely,

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

Cole-Frieman & Mallon LLP is an investment management law firm known for providing innovative and collaborative legal solutions to clients with complex financial needs in both the traditional and digital asset spaces. Headquartered in San Francisco, CFM services a wide variety of groups, from start-up investment managers to multi-billion-dollar firms. The firm provides a full suite of legal services including: formation of hedge funds, private equity funds, and venture capital funds; adviser compliance and registration; counterparty documentation; equity financings and token offerings; SEC, CFTC, NFA and FINRA matters; seed deals; hedge fund due diligence; employment and compensation matters; and, routine business matters. The Firm also publishes the prominent Hedge Fund Law Blog, which focuses on legal issues that impact the hedge fund community. For more information, please add us on LinkedIn and visit us at colefrieman.com.