Monthly Archives: June 2011

CFTC Proposed Regulation 1.71 Article Published in NIBA Journal

Just a quick note that we had an article published in the June issue of the NIBA Journal titled How will the Proposed Swaps Regulations Affect IBs? In the article we discuss how the OTC derivatives regulations have essentially overshadowed some of the CFTC's other rulemaking initiatives like Proposed Regulation 1.71.  Proposed Regulation 1.71 would essentially require certain CFTC registered firms, inc

luding introducing brokers, to implement certain compliance procedures to separate research activities from execution activities.  Proposed Regulation 1.71 has not yet been finalized by the CFTC and we provide updates if new rules are adopted.


Cole-Frieman & Mallon LLP provides legal services to the managed futures industry including CTA, CPO, and Introducing Broker registration and compliance services.  Bart Mallon can be reached directly at 415-868-5345.


SEC Open Meeting re: Hedge Fund Registration

We are currently watching the webcast live and are posting our comments below.  You can watch the meeting live here:

We will be posting our review of the adopted regulations sometime later today.


11:05 AM ET: the open meeting has started and Chairman Schapiro (“CS”) is currently providing an overview of the meeting today.

11:12 AM ET: the registration requirements will not go into effect until the first quarter of 2012 to allow the SEC time to prepare their systems to accept all the hedge fund registration applications.

11:15 AM ET: Bob Plaze discussing new rulemakings – hedge fund registration will be extended to March 30, 2012.  [No March 31, 2012 next year because of leap year.]

11:19 AM ET: Devin Sullivan discussing Form ADV amendments – important data on the private funds as well as service providers – auditors, prime brokers, custodians.  Competitively sensitive information will not be required.

11:20 AM ET: Devin Sullivan discussing Exempt Reporting Advisers will be required to complete certain parts of Form ADV.

11:21 AM ET: Devin Sullivan discussing switch for certain SEC registered managers to state registration.  Uniform method to calculate AUM.  Current SEC registered advisers will need to file an amendment to show they can remain SEC registered.

11:22 AM ET: Devin Sullivan discusses pay to play rules and Municipal Advisers.

11:24 AM ET: VC advisers get a break – they can have up to 20% of fund's assets in non-qualifying VC investments.  Other parts of the rule sound similar to the proposal.

11:25 AM ET: VC funds get grandfathering provision.

11:27 AM ET: $150M exemption rule is recommended to be adopted substantially as proposed.

11:28 AM ET: Foreign private adviser rule is recommended to be adopted substantially as proposed.

11:29 AM ET: Commissioner Casey (“CC”) talking about VC funds and congressional intent.  Supports VC rule and 20% basket of non-VC investments.  Does not support some of the other rules – especially because of the exempt reporting advisers rule.

11:32 AM ET: CC disagrees with the reporting requirem

ents.  Does not think there is distinction between exempt advisers and registered advisers with respect

to disclosure information on the ADV.  Essentially she thinks this is a slippery slope.

11:34 AM ET: CC says the reporting requirements for exempt advisers needlessly imposes compliance requirements on incubating businesses.

11:36 AM ET: Commissioner Walter (“CW”) generally support the rulemaking.  Believes information from exempt reporting advisers (ERAs) will be important for the SEC.  But would have required broader information from the advisers.  Seems like she wants more information from ERAs; wants to revisit the disclosures in a year.

11:38 AM ET: CW – can we get more information on the 20% basket for VC funds?

11:38 AM ET: Sullivan – Designed to provide flexibility for VC funds.  The big question is whether it is 20% of invested or committed capital.  20% on committed, but the committment m

11:39 AM ET: CW – which states will examine advisers?

11:40 AM ET: Plaze – we asked all of the states about examination; MN would not be subject to examination.  SEC will treat NY advisers as not subject to examination.

11:42 AM ET:  Commissioner Aguilar (“CA”) makes a short statement and thank-yous.

11:44 AM ET:  Commissioner Varedes (“CV”) supports the 20% basket for VC funds.  Would have liked even more flexibility.

11:45 AM ET:  CV disagrees with ERA reporting requirements – reporting requirements too close to registered advisers.

[BM to update the votes]


Family Office Definition

11:51 AM ET: CS providing background on family offices and proposed definition.  See earlier post:

11:52 AM ET: Staff member discussing exclusion.  Certain conditions to prevent the family office to provide advice outside of the family, unless there is registration.

11:54 AM ET: Staff member discusses more technical parts of the proposal.

11:56 AM ET: CC, CW and CA did not have any questions for the staff.

11:58 AM ET: CP discusses some issues with respect to some of the changes made from the proposal.

11:59 AM ET: Plaze thanks commenters, especially the ABA, for their comments from a public policy perspective – the staff appreciates such comment letters.

11:59 AM ET: All Commissioners support adopting new family office rule.


California Extends Hedge Fund Registration Exemption

Emergency Action “Necessary” because of SEC Inaction

The California Department of Corporations has provided a temporary six-month extension of Section 260.204.9 which exempts hedge fund managers from registration in California if the manager has more than $25M of AUM.  The exemption will be slightly modified to account for the changes to federal law as a result of the Dodd-Frank Act.  The exemption is also scheduled to become inoperative on January 21, 2012.

The emergency action was taken by California because the SEC recently announced that they intended to delay implementation of the federal hedge fund registration regulations until 2012.  The SEC is expected to formally announce that registration will be delayed until next year in an Open Meeting on June 22.  On such date we are expected to have a better timeline of when registration might be required.

Reasons for the Emergency Action

California provides the following background on the emergency action and why the state decided to move forward with extending the exemption:

… persons that may be required to register under final SEC rules would have a very limited time period in which to prepare their registration documents. In order to allow such persons to determine how SEC rules will ultimately affect their registration status, it is necessary to provide sufficient time for regulated persons to analyze the final rules and prepare any required application materials.

Additionally, the extension is necessary to allow the Department to study how best to regulate advisers to alternative investment vehicles, while balancing the regulatory burden on such advisers, with any corresponding investor protections issues.

Lastly, this extension is necessary to ensure the stability of California capital and labor markets. Alternative investment vehicles, including venture capital funds, have historically provided a crucial source of financing for California businesses.

These emergency regulations address the marketplace uncertainty that exists as a consequence of the operative date of the change in federal law, by temporarily continuing the existing California registration exemption for private advisers. The emergency regulations further will provide the Department and industry the opportunity for thoughtful dialogue on the appropriate measure of state oversight after the federal adoption of rules. These emergency regulations are intended to prevent a marketplace reaction of seeking registration in the face of uncertainly; resulting in businesses prematurely incurring costs to comply with a regulatory scheme that ultimately may prove unnecessary for some private advisers. Moreover, it is likely that most private advisers would not be able to secure registration prior to July 21, 2011, thus requiring that they immediately cease providing investment advisory services for compensation in California.

Other States Next?

There are a number of other states which have IA registration exemptions which are similar to the California exemption.  We expect to see similar pronouncements in the coming weeks from other states.  Then, after the SEC finalizes the registration regulations, we will see states drafting new laws that better integrate with the

new federal regulations.

The modified exemption can be found here: Section 260.204.9 (Effective July 21, 2011)

Background information and the finding of emergency can be found here: California Finding of Emergency

The notice can be found here: Notice of Emergency Action


Bart Mallon is an attorney with a practice focused on hedge funds and investment adviser registration. He can be reached directly at 415-868-5345.


Compliance Issues for Forex IBs, CPOs and CTAs

NFA Produces Compliance Webinar for Retail Forex Firms

Since the CFTC passed its final rules on retail participation in off-exchange foreign currency markets back in October 2010, there has been an influx of newly registered introducing forex brokers (IBs), commodity pool operators (CPOs), and commodity trading advisors (CTAs).  On June 8, 2011, the NFA hosted a webinar that focused on common regulatory deficiencies that NFA staff members have found during compliance audits of these IBs, CPOs and CTAs.  The following is a brief overview of the common regulatory deficiencies the NFA staff found regarding registration issues, disclosure documents, recordkeeping requirements, promotional materials, and anti-money laundering programs.


Forex Registration Issues

Any entity intermediating retail forex transactions is required to be registered as forex IB, CPO, or CTA.  Common deficiencies for these

firms include having unlisted APs, failing to register supervisory APs, failing to withdraw APs, or failing to list branch offices.  Additionally, the following are areas emphasized in the webinar:

Listing All Principals – Criteria for being listed as a Principal of the firm generally are (1) job title, (2) ownership (direct or indirect), and (3) job duties and ability to control business activities.  More detail is available in NFA Rule 101.  Tips for ensuring the proper individuals are listed, include:

  • After any board of directors’ meetings, ensure any new directors/officers become listed as Principals of firm.
  • Periodically review the owners of any holding company of the firm to ensure indirect owners are listed if required.

Associated Person (AP) Registration – Essentially anyone who is a salesperson or supervises salespersons is required to be registered as an AP.  It is important to look at the supervisory chain of command–an individual must be registered, no matter how high he/she is on the supervisory chain of command.

  • Exam requirements – The APs must pass the Series 3 exam and the Series 34 exam.  If a person was registered as an AP, sole proprietor, or floor broker as of May 22, 2008 and there has not been more than a 2-year gap since that registration, the person is not required to pass the Series 34.
  • Tips for ensuring the proper individuals are registered:
    • Terminate an AP’s registration within 30 days of an AP leaving the firm.
    • After any shifts in control, ensure those with controlling influence are listed as Principals, and those that supervise APs are registered as APs themselves.

Branch Office Registration – Common deficiencies include:

  • Branch Office Address – Each branch office must be registered. Each branch office must use the name of the firm and hold itself out as a branch of the firm.  It cannot be a separate entity.
  • Payment of APs – Each AP in the branch office must be paid directly by the firm (payment by an intermediary would lead to the assumption the intermediary needs to be registered with the NFA).


Information in Customer File – This information is normally initially obtained upon account opening, but the firm must also maintain up-to-date and readily accessible information.   The firm shouldn’t rely on the FCM for this information unless it has been agreed upon before account opening.  The following information must be in the firm’s file for each customer and must be obtained before account opening:

  • name, address, date of birth, and principal occupation,
  • for individuals – current estimated annual income and net worth,
  • notes about the customer’s previous investment and trading experience and any other information that would assist the firm to accurately and fully disclose all the risks of trading,
  • signed customer acknowledgment that he/she has received all of the required risk disclosures, which include:
    • CFTC Regulation 5.5 risk disclosures (e.g. the FCM is the counterparty to all trades and forex trading is extremely risky and not suitable for all investors),
    • performance for the last 4 quarters for all non-discretionary accounts held at customer’s FCM (broken down by profitable/non-profitable accounts in percentage form), and
    • some customers need to receive additional risk disclosure statements based on age, trading experience, and net worth.

Business with Member Firms – Firms need to make sure they are not conducting business with any non-NFA member firms that are required to be registered (or are suspended).  Make sure counterparties are registered as FCMs or RFEDs, or solicitors are registered IBs.  The firm should also review their list of customers–if a customer’s name indicates he/she might be engaged in the trading business, inquire as to the customer’s registration/membership status.  The firm can also check on the NFA’s BASIC system to see if the customer is properly registered or operating under an exemption from registration.  The firm should document this process to show it did proper due diligence on the account.

Forex Disclosure Documents

All nonexempt CPOs operating a pool and CTAs that manage forex accounts for retail customers must distribute a forex disclosure document to their clients.  Three common problems are:

Risk Disclosures – The firm needs to make sure all risks associated with forex trading are disclosed.  This can include volatility, leverage, liquidity, counterparty creditworthiness, and others risks relevant to the program.

Fee Description – The fee description must be complete and all defined terms must be fully explained.

Performance Results

  • CTA disclosure documents must include the actual performance of all clients directed by the CTA and each trading principal for the last 5 years to date (any past performance must be calculated net of all fees, including mark ups associated with bid/ask spread, etc.). If the CTA directed accounts prior to be being registered as a CTA, the disclosure document must still disclose those accounts.
  • The NFA has a guide on disclosure documents available here.

Forex Promotional Materials

Policies & Procedures – The firm must develop written procedures for how it creates and reviews promotional materials, as well as how the firm supervises employees on these matters.  Promotional materials:

  • must present a balanced discussion of the risk of loss (any discussion of profits should also discuss the risk of loss),
  • must provide a discussion of fees associated with trading forex,
  • must provide appropriate disclaimers for past performance, and
  • must not suggest forex trading is appropriate for everyone or guarantee success.
Social Media – Any communications with the public is considered promotional materials (e.g. emails, LinkedIn, Twitter, Facebook, etc.).  All information on social media must be in accordance with the NFA’s promotional materials rules.

  • If the firm hosts a blog, chat room, or other discussion forum that allows the general public to comment, those comments must be reviewed regularly to ensure they are not misleading or one-sided. Such comments must be removed immediately and the firm should also ban those users who repeatedly post comments that violate the rules.
  • Keep records of which posts are deleted, which users are blocked, how often a review is conducted, and how employees are supervised.
  • If employees have personal blogs, Facebook accounts, etc., the firm should monitor the posts periodically.  Any references to the firm can be seen as promotional materials.  If after monitoring employees’ personal pages, there are never any references to the firm’s business, then the procedures can change and require less frequent monitoring.
  • Special rules apply for the use of audio/visual ads.  If the firm provides trade recommendations or discuss past/potential profits through radio or webcasts (such as YouTube), the firm is required to submit them to the NFA for approval at least 10 days prior to use.

Anti-Money Laundering Program

An anti-money laundering program is required for IBs (guaranteed and independent), FCMs and RFEDs (even if they don’t hold customer funds).  These procedures are designed to guard against someone using the firm to facilitate money laundering or other terrorist financing.  The program should include:

  • written policies and procedures,
  • the appointment of a chief compliance officer,
  • ongoing training, and
  • an annual, independent audit.

The NFA has an Anti-Money Laundering webinar available on its website.

The NFA’s “Compliance Issues for Forex IBs, CPOs and CTAs” webinar is archived on the NFA’s website and can be found here .


Bart Mallon is an attorney with a practice focused on hedge funds managed futures and forex regulatory issues.  He can be reached directly at 415-868-5345.


SEC Announces Open Meeting on Hedge Fund Regulations

SEC Considers Whether to Adopt Registration Requirement

Yesterday the SEC announced that they will conduct an Open Meeting on June 22 to determine whether to adopt the new hedge fund registration requirements and related rules. At the Open Meeting the SEC is expected to delay implementation of the regulations until next year.   While the SEC announced in a letter to NASAA that they would likely extend the registration deadline, there has been no official action on this issue.  This has left managers (and lawyers and compliance personnel) unsure of how to proceed.  We will know more after the June 22 meeting.

The notice of the Open Meeting, reprinted below in full, can be found here.  Hat tip to Doug Cornelius at Compliance Building for publishing this story earlier today.


Notice is hereby given, pursuant to the provisions of the Government in the Sunshine Act, Pub. L. 94-409, that the Securities and Exchange Commission will hold an Open Meeting on June 22, 2011 at 10:00 a.m., in the Auditorium, Room L-002.

The subject matters of the Open Meeting will be:

Item 1: The Commission will consider whether to adopt new rules and rule amendments under the Investment Advisers Act of 1940 to implement provisions of the Dodd-Frank Wall Street Reform and Consumer Protection Act. These rules and rule amendments are designed to gi

ve effect to provisions of Title IV of the Dodd-Frank Act that, among other things, increase the statutory threshold for registration of investment advisers with the Commission, require advisers to hedge funds and other private funds to register with the Commission, and address reporting by certain investment advisers that are exempt from registration.

Item 2: The Commission will consider whether to adopt rules that would implement new exemptions from the registration requirements of the Investment Advisers Act of 1940 for advisers to venture capital funds and advisers with less than $150 million in private fund assets under management in the United States. These exemptions were enacted as part of the Dodd-Frank Wall Street Reform and Consumer Protection Act. The new rules also would clarify the meaning of certain terms included in a new exemption for foreign private advisers.

Item 3: The Commission will consider whether to adopt a rule defining “family offices” that will be excluded from the definition of an

investment adviser under the Investment Advisers Act of 1940.

At times, changes in Commission priorities require alterations in the scheduling of meeting items.

For further information and to ascertain what, if any, matters have been added, deleted or postponed, please contact:

The Office of the Secretary at (202) 551-5400.

Elizabeth M. Murphy


June 8, 2011


Bart Mallon is an attorney with a practice focused on hedge funds and investment adviser registration.  He can be reached directly at 415-868-5345.