Monthly Archives: November 2013

Delegating CPO Recordkeeping Responsibilities

Effective September 30, 2013, the Commodity Futures Trading Commission (the “CFTC”) issued a rule permitting commodity pool operators (“CPOs”) to allow certain third party service providers to maintain the CPO’s books and records. CPOs can take advantage of this relief by filing certain notices and representations with the NFA, and by obtaining representations from the third party service provider(s) and filing these with the NFA. This exemptive relief, and the requirements for claiming it, apply to all registered CPOs, including those relying on the relief provided under CFTC Regulation 4.7(b).

The Rule

All CPOs are required to maintain certain books and records, as provided under either CFTC Regulation 4.23 (for non-exempt CPOs) or CFTC Regulation 4.7(b) (for 4.7 Exempt CPOs). Under the new rule, rather than maintain these books and records at the CPO’s main business office, a CPO may maintain them at one or more of the following: the pool’s administrator, distributor or custodian, or a bank or registered broker or dealer acting in a similar capacity with respect to the pool.

Notice Filing with NFA

If a CPO uses such third party service providers to maintain its books and records, it must file a notice of exemption with the NFA, via the NFA Exemption System. The CPO must make a separate notice filing for each of the following:

• The CPO, if any of the CPO’s books and records are maintained by third parties

• Each pool that has books and records maintained by third parties

Notice filings are made through the NFA Exemption System. Each filing must be accompanied by two statements containing certain representations:

1. Statement by CPO

In connection with each notice filing, the CPO will be required to upload via the NFA Exemption System a statement containing the following information and representations from the CPO:

• The name, main business address, and main business telephone number of the third party service provider, and the name and phone number of a contact person at such provider

• The books and records to be maintained by the third party service provider (by reference to the applicable CFTC Regulation sections requiring such books and records)

• A representation that the CPO will promptly amend the statement if the contact information or location of any of the books and records required to be kept changes

• A representation that the CPO remains responsible for ensuring that all required books and records are kept in accordance with CFTC Regulation 1.31

• A representation that, within 48 hours after a request by the CFTC (72 hours if the service provider is outside the U.S.), the CPO will obtain the original books and records from the location at which they are maintained, and provide them for inspection at the CPO’s main business office

• A representation that the CPO will disclose the location of its required books and records in the applicable pool’s disclosure document [note: the CFTC has not provided explicit guidance on how specific this disclosure must be. Please see below for a more detailed discussion.]

2. Statement by Third Party Record Keeper

In connection with each notice filing, the CPO will be required to upload via the NFA Exemption System a statement containing the following acknowledgments and representations from the third party service provider:

• An acknowledgment that the CPO intends for the service provider to keep and maintain the applicable books and records;

• A statement that the service provider agrees to keep and maintain such books and records in accordance with CFTC Regulation 1.31; and,

• A statement that the service provider agrees to keep such books and records open to inspection as required under CFTC regulations.

Disclosure Document

As described above, a CPO is required to represent that it will disclose in its pool’s disclosure document the location of its required books and records. The new rule does not specify the amount of detail that must be included in the disclosure document. In an informal phone conversation, a representative from the National Futures Association indicated that the disclosure must be sufficient to inform an investor where to go to obtain the books and records.

4.7 Exempt CPOs

Before this new rule was issued, CPOs relying on CFTC Regulation 4.7(b) were relieved from the specific disclosure requirements that applied to the disclosure documents of non-exempt CPOs, as long as their offering memorandum (if any) was not misleading and contained a disclosure statement on the cover page. Now, however, under the plain language of the new rule, even 4.7 exempt CPOs must disclose the location of the pool’s required books and records in a “disclosure document.”

Presumably this new rule was not intended to impose a new CFTC requirement that 4.7 exempt CPOs must have disclosure documents. And in practice, nearly every CPO that offers interests in a pool will have an offering memorandum for such pool, regardless of whether CFTC rules require this. The more relevant question for 4.7 exempt CPOs, then, will be the same as the question for non-exempt CPOs: how much detail must be included in the offering memorandum about the location of the pool’s books and records? We await further guidance from the CFTC to definitively answer this question.


Cole-Frieman & Mallon LLP provides legal advice to CTAs and CPOs and other firms in the investment management space.  Please contact us directly or reach out to Bart Mallon at 415-868-5345.

Investment Management Law Weekly Overview – Week Ending November 22

Please see below our notes on the past week. If you have questions on any of these items, please feel free to contact us.


Regulation S-ID Identity Theft Red Flag Rules went into Effect

On Wednesday the new Red Flag rules went into effect for many SEC and CFTC registered managers. In general, certain managers are now required to have identity theft programs in place which will include: staff training for appearance of red flags, procedures for dealing with red flags, certification of procedures from administrators and/or custodians dealing with investor/customer accounts. Managers who have not yet discussed program implementation with their outside counsel or compliance firm should reach out with respect to this issue. For more information, please see our post on Regulation S-ID Identity Theft Rules.

IARD Renewal – Fees Due by December 13, 2013 

SEC and state registered investment advisers will have until December 13th of this year to pay their renewal fees for 2014. To begin, managers will need to retrieve their preliminary statement to find out the amount they owe. Managers will then need to use the IARD’s new E-Bill system (which replaces the old E-Pay system) to pay the total amount due by December 13, 2013, the renewal payment deadline. Firms should submit their electronic renewal payments no later than December 10 in order for payment to post to the renewal accounts by the deadline. For more information, please see the IARD Renewal Checklist.

MF Global Ordered to Fully Reimburse Customers; Subject to $100 Million Fine

It now appears as if all of the futures customers at MF Global will be fully reimbursed. A federal court in New York recently ordered MF Global to pay over $1 billion in restitution to customers. The court also imposed a $100 million civil penalty on the company. For more information, please see the CFTC press release.

Manager Fined $250,000 for Numerous Compliance Violations Including Misstatements in PPM

It is vitally important that fund managers accurately describe their operating procedures in their fund offering documents. This includes such matters as valuation on fund assets. Additionally, managers need to be vigilant in making sure that statements made in the offering documents continue to be accurate. The SEC recently announced the issueance of an order that found, among other items, that the management company failed to adopt and implement written compliance policies and procedures reasonably designed to prevent violations applicable laws and regulations concerning three important areas of private fund management: (i) valuation of fund assets, (ii) the accuracy of disclosures to fund investors about the valuation practice, and (iii) cross trades between clients. In addition to the monetary penalty, the manager was censured and is now required to provide a copy of the SEC order to certain of its clients and investors. The full complaint can be found here.

Enforcement Actions


• There were a number of enforcement actions at the SEC level for run-of-the-mill financial crimes such as preying on elderly investors and receiving fraudulent kick-backs (note: interestingly, the SEC also charged the firm with aiding and abetting another firm with violation of the SEC’s custody rule).  Additionally, the SEC charged another tipper in the Galleon insider-trading scandal.


Forex Pool Fraud – November 19, 2013. Specifically, the Order finds that, from at least June 2010 through April 2013, Prescott fraudulently solicited individuals to invest in Cambridge’s off-exchange forex pool and misappropriated $455,098 of pool participants’ monies, using some of those funds for air travel, hotel accommodations, and gambling. According to the Order, Prescott defrauded pool participants and prospective pool participants by misrepresenting the risks involved in forex trading and executing demand promissory notes in their favor that promised the repayment of the note amount and monthly interest payments, knowing or recklessly disregarding that he could not make those payments by his forex trading. Press release can be found here.


Cole-Frieman & Mallon LLP is a premier boutique investment management law firm, providing top-tier, responsive, and cost-effective legal solutions for financial services matters. Bart Mallon can be reached directly at 415-868-5345.

Regulation S-ID Identity Theft Rules

Identity Theft Red Flag Rules Effective November 20, 2013

Pursuant to new SEC and CFTC rules, many registered managers, including private fund managers are now required to have identity theft programs in place.  Such managers will need to have robust policies in place in order to be compliant with the new rules.  Such policies will include: staff training for appearance of red flags, procedures for dealing with red flags, certification of procedures from administrators and/or custodians dealing with investor/customer accounts.

Below we have reprinted an article from the Compliance Focus blog maintained by Sansome Strategies LLC, a regulatory and compliance consulting company described in greater depth below.  The article reprinted below can be found here.


Identity Theft Issues for Investment Advisers and Futures Participants
Jennifer Dickinson, Sansome Strategies

A little-known provision of the Dodd-Frank Act shifted responsibility over existing identity theft rules from the Federal Trade Commission to the Securities and Exchange Commission (“SEC”) and the Commodity Futures Trading Commission (“CFTC”). The rules became effective May 20, 2013 and certain entities regulated by the SEC and CFTC will need to comply by November 20, 2013.


SEC and CFTC registrants that are “financial institutions” or “creditors” and that offer or maintain “covered accounts” for their clients will need to comply with the identity theft rules:

  • Financial institution: a bank, credit union or other person who holds a transaction account belonging to a consumer (a transaction account is one that permits withdrawals, payment orders, transfers or similar means for making payments to third parties);
  • Creditor: any person that regularly extends, renews or continues credit to others.
  • Covered account: any account that a financial institution or creditor offers or maintains:
    1. Primarily for personal, family or household purposes that involves or is designed to permit multiple payments or transactions; and
    2. There is a reasonably foreseeable risk to customers or to the safety and soundness of the financial institution or creditor from identity theft, including financial, operational, compliance, reputation or litigation risks. Examples include: for the SEC, brokerage or mutual fund accounts that permit wire transfers or other payments to third parties; for the CFTC, margin accounts.

Who will be affected, and how?

On the SEC side, broker-dealers, investment companies and investment advisers are considered financial institutions. On the CFTC side, commodity pool operators and commodity trading advisers will be considered creditors if they:

  • Regularly extend, renew or continue credit or arrange for the extension, renewal or continuation of credit; or
  • Acting as an assignee of an original creditor, participate in the decision to extend, renew or continue credit.

Firms that meet these definitions are required to implement reasonable policies and procedures that:

  • Identify “red flags” to prevent identity theft in the covered accounts they manage, and document them in the compliance program. Red flags can exist in the types of accounts the firm manages, the manner in which accounts are opened or accessed, and the firm’s previous experiences (if any) with identity theft;
  • Provide for monitoring accounts on an ongoing basis to detect red flags;
  • Respond appropriately to red flags;
  • Is periodically updated to reflect any changes in risks; and
  • Describe the various appropriate responses to red flags.

Whether a firm will meet the definitions will depend significantly on its client base and account structures. Traditional RIAs and other firms that manage accounts for individuals or family offices should look closely at those accounts to determine the types of activities that will be processed in them. A firm that handles bills or other third-party payments on behalf of its clients will need to undertake the most review and implement the most rigorous compliance program contemplated by the rules.

At first blush, fund managers may assume that these rules will not apply to them; however, care should be taken to ensure that investors’ accounts are set up to receive and hold investment amounts, and the only transfers permitted will be for management fees, performance allocations to the manager/general partner as applicable, and withdrawals by (and most importantly, back to) the investor to minimize identity theft risks. Even so, additional procedures around investor intake and withdrawal may need to be implemented.

CPOs and CTAs may undertake a similar evaluation and should also look at their investment strategies to determine the extent to which they meet the creditor definition.

Finally, even if a firm is not registered with the SEC or CFTC, identity theft can be a significant reputational and litigation risk for if they handle third-party payments on behalf of clients or investors. Accordingly state registrants and exempt firms should consider implementation as a best practice.

Compliance Strategies

The rules identify five specific categories that every compliance program should address:

  • Alerts, notifications or other warnings received from consumer reporting agencies or other service providers;
  • Presentation of suspicious documents;
  • Presentation of suspicious personal information (e.g., an unexpected or unusual address change);
  • Unusual usage of a particular account; and
  • Notices from customers, victims of identity theft, law enforcement agencies or others regarding possible identity theft in an account.

Employees should be trained to identify the above and any other red flags that are specific to the firm’s business.

Appropriate responses to a red flag incident will vary significantly depending on the circumstances. The rules mention:

  • Monitoring an account for evidence of identity theft;
  • Contacting the customer;
  • Changing passwords, security codes or other devices that permit access to an account;
  • Reopening accounts with new numbers;
  • Refusing to open an account;
  • Closing an existing account;
  • Refraining from collection activities on an account;
  • Notifying law enforcement; and

Determining that a response is warranted in a particular instance.

Other, proactive safeguards can include standardizing the forms and processes used to effect transactions in client accounts, designating a person or team of people to handle those transactions under supervision (and training them to detect identity theft), preparing and reviewing a daily transaction blotter, requiring additional approvals and documentations for higher risk transactions and implementing PINs or security questions and client call-backs, to name a few.

To the extent that safeguards are client or investor-facing (such as call-backs, PINs or other identity verification tools), these should be standardized and clients/investors notified of the procedures so they know what to expect. Obtaining client’s acknowledgment of these processes via the investment advisory or subscription agreement is a good way to handle this clearly and consistently.

To ensure compliance by November 20, 2013, we encourage all firms to reach out to their compliance consultant or legal counsel as soon as possible. Rolling out the program early will afford plenty of time to refine it by the deadline.


About Cole-Frieman & Mallon LLP

Cole-Frieman & Mallon LLP provides legal services to the investment management community.  Please reach out to us through our contact form or call Bart Mallon directly at 415-868-5345 if you have questions on implementation. 

About Sansome Strategies LLC

Sansome Strategies is a compliance consulting firm specializing in high-touch, outsourced compliance services for businesses in the investment management industry. Clients include investment advisers, futures managers, broker-dealers, hedge funds, and private equity firms. Sansome Strategies provides tailored compliance management solutions to the unique needs of each client and is focused on helping clients build and enhance their business by simplifying the compliance and regulatory process.  Sansome Strategies is wholly owned by Karl Cole-Frieman and Bart Mallon.  For more information, please contact Sansome Strategies here.

Investment Management Law Weekly Overview – Week Ending November 15

Please see below our notes on the past week.  If you have questions on any of these items, please feel free to contact us.


Pay to Play Fee Prohibition Relief Granted

Pursuant to Pay to Play Regulations (Rule 206 (4)-5 under the Investment Advisers Act) a fund manager is prohibited from making political contributions in certain situations. If a fund manager (or employee of the fund manager) makes political contributions to an elected official who could influence the allocation of assets to the adviser, the manager is prohibition from receiving fees on those assets for two years from the date of the political contribution. Managers can, however, ask for relief in certain situations from the prohibition on collecting fees. In this order (summary below), the SEC permits the manager to receive fees based on the facts of situation:

An order has been issued on an application filed by Davidson Kempner Capital Management LLC (“DKCM”) under Section 206A of the Investment Advisers Act of 1940 and Rule 206(4)-5(e) thereunder. The order permits DKCM to receive compensation from three government entities for investment advisory services provided to the government entities within the two-year period following a contribution by a covered associate of DKCM to an official of the government entities.

Insider Trading – Hedge Fund Manager

In a press release, the SEC announced insider trading charges against a hedge fund trader. The trader had a consulting agreement with a former high-level employee of a public company. The former high-level employee maintained connections at the public company and passed along inside information which he received from friends within the public company. According to the release, the trader was able to avoid approximately $2.4 million in losses and make $853,655 in illicit profits by trading shares ahead of positive or negative news. The SEC’s complaint charges Megalli with violating the antifraud provisions of the federal securities laws, and seeks a permanent injunction, disgorgement with prejudgment interest, and financial penalties.  For more information, please see the SEC press release.

CFTC Approves Two Position-Limits Proposals

With a 3-1 vote, CFTC Commissioners approved Proposed Regulation on Position Limits for Derivatives. The proposed rulemaking would establish limits on speculative positions in 28 physical commodity futures contracts traded pursuant to the rules of a designated contract market (“DCM”) as well as swaps that are economically equivalent to those contracts, as mandated by the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010. Additionally, CFTC Commissioners unanimously approved the Proposed Regulations for Aggregation of Accounts Under Part 150, Position Limits. The comment period for these proposals is now open.  More information (including an overview and a Q&A sheet) can be found here.  

Futures Industry Releases Study on Insurance for Customer Accounts

After the MF Global and PFG implosions, we have become acutely aware that the SIPC does not insure customer accounts with respect to futures positions. No one does. So members of the futures industry commissioned a study on the viability of insurance for futures positions.  The main author of the study stated:

The objective of the study was to analyze and quantify the potential costs of various scenarios, including a government-mandated solution similar to what exists today in the securities industry as well as voluntary market-based solutions provided by private insurance companies. The study does not provide any policy recommendations, but the hope is that it will assist policy makers by clarifying the amount of insurance coverage that could be obtained through these solutions and the potential costs for each.

It is likely this is the first step towards some sort of insurance and protection mechanism for futures customers.  More information on the study can be found here.  Full text of the study can be found here.

FINRA Makes Broker Check Easier to Use

The Financial Industry Regulatory Authority (FINRA) announced that it has released an enhanced version of BrokerCheck that allows investors to more quickly access and more intuitively understand the professional background of investment professionals.  For more information, please see the FINRA release.

Next Week Items

Regulation S-ID Becomes Effective November 20, 2013 – for more information on the new red flag rules for certain SEC and CFTC registrants, please see this article from the ComplianceFocus blog.

SEC Announces Panelists for Small Business Forum – on Thursday, November 21, the SEC will again have an annual forum that focuses on the capital formation concerns of small business. A major purpose of the Forum is to provide a platform to highlight perceived unnecessary impediments to small business capital formation and address whether they can be eliminated or reduced.  There will be two panels throughout the day.  The first panel will focus on evolving practices in the new world of Regulation D exempt offerings. The second panel will focus on what might be next for small business and markets once the JOBS Act is fully implemented.  The forum agenda can be found here, and information on the panelists and what they will be discussing (powerpoint presentations) can be found here.

SEC Dodd-Frank Investor Advisory Committee Meeting – On Friday November 22, the SEC will have a meeting where a fiduciary duty standard for broker-dealers will be discussed as well as legislation to fund investment adviser examinations. The meeting will be webcast on the SEC website and more information can be found here.

Enforcement Proceedings


BD Rep Barred for Undisclosed Outside Business Activities – November 15, 2013.  A registered representative was effectively barred from the industry for, among other things, conducting an outside business activity without disclosing the activity to the representative’s employer and also for transferring customer assets to the outside business without the receiving the customer’s informed consent. The SEC order can be found here


Fraud Charges against Unregistered CPO – November 13, 2013. Among other items the unregistered CPO: (1) falsely claimed to have a successful and experienced trader for the pool, (2) misrepresented the likelihood of profits and the risks associated with trading commodity futures, (3) failed to disclose that they were not properly registered with the CFTC to operate a pool, and (4) failed to disclose their intended uses of pool participant funds. Press release can be found here.

Forex Fraud Charges – November 12, 2013. The forex trader made many misrepresentions with respect to its trading and other aspects of firm operations, including that almost 80 percent of customer funds were never traded or invested in any manner. The forex trader also misappropriated over $3.3 million of customer funds to pay personal and entertainment expenses, including Las Vegas casino expenses, purchase automobiles and clothing, and ATM or cash withdrawals. Press release can be found here.


Cole-Frieman & Mallon LLP is a premier boutique investment management law firm, providing top-tier, responsive, and cost-effective legal solutions for financial services matters.  Bart Mallon can be reached directly at 415-868-5345.

Hedge Fund Events November 2013

The following are various hedge fund events happening this month. Please contact us if you would like to add your event to this list.


November 4

November 4

November 4

November 4-5

November 4-6

November 5

November 5-6

November 5-7

November 6

November 6

  • Sponsor: Mankoff & Co.
  • Event: Fireside Chat
  • Location: Chicago, IL

November 6

November 6

November 6

November 6-7

November 7

November 7

November 7

November 7

November 7

November 7-8

November 11

November 11-12

November 12

November 12

November 13

November 13-14

November 14

November 14

November 19

November 19

November 19-20

November 19-20

November 19-22

November 20

November 20

November 20

November 20

November 20-21

November 21

November 21


Cole-Frieman & Mallon LLP provides legal services for hedge fund managers and other groups within the investment management industry. Bart Mallon can be reached directly at 415-868-5345.