Monthly Archives: May 2015

Cole-Frieman & Mallon LLP 2015 First Quarter Update


May 13, 2015

Clients and Friends:

The first quarter of 2015 was a busy period for investment managers and service providers alike and we find ourselves sending out this update very late.  As a variety of filing deadlines have passed and audit work is completed (or will be soon), we enter the second quarter with a number of new regulatory changes on the horizon, as well as many other topics worthy of discussion.  Below, we have prepared a short overview of some of these items.  Please note there are some items from the start of the second quarter which will be included in the next update.


SEC Cybersecurity Sweep Examination Results.  The Office of Compliance Inspections and Examinations (“OCIE”) of the SEC recently released a Risk Alert in connection with its examination of over 100 broker-dealers (“BDs”) and registered investment advisers (“RIAs”) with respect to the cybersecurity preparedness and practices of such registered firms. The examinations focused on if and how the examined BDs and RIAs establish (1) cybersecurity policies, procedures, and oversight processes, (2) protect their networks and information, and (3) detect and handle unauthorized activities and other cyber-attacks.

Key findings from the examinations include:

  • More than 80% of RIAs and 90% of BDs examined have adopted written cybersecurity policies and conduct periodic firm-wide cybersecurity assessments.
  • Less than 25% of RIAs examined incorporate cybersecurity requirements into their contracts with vendors, service providers, and other business partners. However, more than 70% of BDs incorporate such provisions into their contracts.
  • More than 50% of BDs examined maintain insurance coverage for cybersecurity-related incidents, while only 21% of RIAS examined hold such policies. (Note that only one BD and one RIA reported that they had filed a claim with their insurance provider in connection with a cybersecurity incident.)

As shown in the statistics above, many RIAs and BDs could bolster their cybersecurity preparedness by including cybersecurity requirements in all of their vendor contracts and by obtaining insurance coverage for cybersecurity-related incidents. The OCIE has stated that the cybersecurity practices and preparedness of BDs and RIAs will be a focus for 2015, so we encourage our clients to contact their service providers to ensure that they are adequately protected against such cybersecurity risks.

The SEC has issued a Guidance Update in connection with the Risk Alert described above.  We will be discussing the “best practices” recommended by the SEC in a future quarterly update.

SEC 2015 Examination Priorities.  The SEC recently announced its 2015 examination priorities, which are intended to address market-wide issues, such as fraud detection/prevention and corporate governance, as well as those specific to particular business models and organizations.  In 2015, the SEC will focus on its efforts on: matters of importance for retail investors and investors saving for retirement, including whether the information, advice, products, and services being offered are consistent with applicable laws, rules and regulations; market-wide risks, such those created by clearing agencies, cybersecurity compliance and controls, and equity order routing conflicts; and, using data analytics to identify signals of potential illegal activity. Despite the SEC’s stated focus, its priorities list is not exhaustive and may be adjusted throughout the year in response to ongoing risk evaluation.

FINRA 2015 Exam Priorities.  FINRA published its 2015 Regulatory and Examinations Priorities Letter, outlining the organization’s enforcement priorities for the current year. While the priorities listed in the letter are too numerous to describe here, focus areas for 2015 will include:

  • Sale and supervision of interest-rate-sensitive and complex products, including alternative mutual funds;
  • Controls around the handling of wealth events in investors’ lives;
  • Management of cybersecurity risks;
  • Treatment of senior investors; and,
  • High-risk brokers and removing bad actors from the securities industry.

FINRA noted that they will increasingly rely on data analytics to identify potential problem areas within firms, and it encourages firms to use data analytics themselves to self-identify such problems.

Improperly Registered Investment Advisers.  Although not listed as an exam priority for 2015, investment advisers should be mindful that the SEC actively pursues improperly registered investment advisers. Several recent enforcement actions targeted SEC-registered investment advisers claiming to be Wyoming-based after investigations conducted by the SEC revealed that the investment advisers primarily directed their advising services from locations outside of Wyoming and should have been registered with the relevant state authority. We caution investment advisers against abusing the “Wyoming exception” or from exaggerating assets in order to secure SEC registration and avoid registration with state securities agencies.

Guidance Update Regarding Key Employee Trusts and Family Office Rule.  The Division of Investment Management of the SEC issued an Investment Management Guidance Update regarding whether certain key employee trusts would qualify as “Family Clients” under Rule 202(a)(11)(G)-1 of the Advisers Act (the “Family Office Rule”).  The Advisers Act defines “Family Clients” as including “any trust of which: each trustee or other person authorized to make decisions with respect to the trust is a key employee; and each settlor or other person who has contributed assets to the trust is a key employee.” The guidance update clarified that if a non-key employee makes non-investment decisions for the trust, the trust may still qualify as a Family Client so long as investment decisions are made by a key employee. “Investment decision” is not defined in the Advisers Act; however, the Division provided an illustrative list of decisions that would qualify as “investment decisions,” including preparing or filing taxes for the trust; keeping records for the trust; and distributing periodic statements or disclosures to trust beneficiaries.

Auditor Independence Violations. The SEC and Public Company Accounting Oversight Board (PCAOB) released an alert in November highlighting certain aspects the independence rules for non-issuer audit and attestation engagements. Auditors engaged to provide financial statement audit and attestation services for (i) non-issuer SEC-registered broker-dealers and (ii) SEC- and state-registered investment advisers and private funds who are subject to the SEC Custody Rule, are required to be “independent” from the clients that they audit. Under Rules 2-01(b) and (c) of Regulation S-X, an auditor is considered not to be “independent” if, at any time during the engagement, the auditor provides prohibited non-auditor services to the client, such as bookkeeping or financial statement preparation services. In December, the SEC sanctioned eight auditing firms for violating these rules when they prepared the financial statements for clients that they were hired to audit. The SEC noted that by preparing the financial statements for their clients, the auditors were effectively auditing their own work and inappropriately aligning themselves with the interests of the clients’ management teams rather than remaining neutral, independent auditors. As a result of the auditors’ non-independence, the auditors’ clients were also deemed to have violated their statutory obligation to provide independently audited financial statements. In light of these sanctions, we encourage our clients to ensure that their auditors remain independent throughout the auditing process and to engage other service providers to prepare their financial statements.

Marketing to Investors in Switzerland.  On March 1, 2015, new regulations came into effect that require specific steps to be taken before marketing to “unregulated qualified investors” in Switzerland. In Switzerland, a fund can be marketed to qualified investors without registering with the Swiss Financial Market Authority (“FINMA”). Qualified investors are divided into two categories: “regulated” and “unregulated.” “Regulated” qualified investors are entities that are already regulated by FINMA, such as banks, securities dealers, fund managers, and insurance companies.  The new regulations do not change the way funds are marketed to regulated qualified investors.

However, the new regulations do change the requirements for funds that wish to market to “unregulated” qualified investors, such as public institutions, pension funds, businesses, and high-net-worth individuals that (a) have made a declaration as such and (b) meet an asset and/or sophistication threshold. The new rules mandate that, before marketing to unregulated qualified investors, the fund must first: (1) appoint a licensed Swiss-representative to represent the fund to FINMA and Swiss investors, (2) appoint a Swiss bank to serve as a paying agent, (3) enter into a distribution agreement with the appointed Swiss-representative, and (4) make necessary disclosures to Swiss investors.

Nonetheless, Swiss investors do not trigger the Annex IV reporting requirements or the remuneration disclosure requirements under AIFMD and the up-front expense associated with marketing to Swiss investors is comparatively cheaper than in other jurisdictions. Funds interested in marketing to Swiss investors should consult with their offshore counsel to discuss whether marketing in Switzerland is worthy of additional attention and focus.

Cayman Islands FATCA Reporting.  The Department for International Tax Cooperation of the Cayman Islands (“DITC”) recently released guidance regarding the registration process for financial institutions with reporting requirements under the Cayman Islands FATCA framework on the Cayman Automated Exchange of Information Portal (“CAEIP”). Such reporting institutions are required to notify the DITC of the following information on or before May 21, 2015 (extended from the original deadline of March 31, 2015):

  • Name;
  • FATCA classification;
  • Global Intermediary Identification Number (aka GIIN – can be obtained on IRS website); and,
  • Point of Contact.

Following the initial informational submission on CAEIP described above, each Cayman Islands reporting institution is then required to submit their FATCA reports via the CAEIP by May 31, 2015.

Updated FATCA Guidance – British Virgin Islands.  Last June, the British Virgin Islands (“BVI”) and the United States entered an intergovernmental agreement that requires BVI financial institutions, including hedge funds, to report information about U.S. persons with offshore accounts to the BVI International Tax Authority (the “Authority”). Although BVI has not yet passed legislation or promulgated regulations under the agreement, the Authority has released a detailed guide to help affected entities comply with the new reporting requirements. The guide provides clarification about which entities must register with the IRS and report information to the Authority, due diligence requirements, and other procedural issues.

The initial reporting deadline is June 30, 2015; in subsequent years, the deadline will fall on May 31. Reports can only be filed through the BVI’s Financial Account Reporting System (“BVIFARS”). The Authority expects the website to be accessible by April 15, 2015. In the future, BVI may pass legislation and promulgate rules in accordance with the FATCA agreement. Managers should remain in touch with both U.S. and offshore fund counsel regarding the regulatory landscape and to plan any changes to the fund’s offering documents, and/or any investor communications that may become necessary.

Foreign Corporation Tax for Offshore Funds.  In January, the IRS’s Office of Chief Counsel released a memorandum explaining that an offshore fund and an offshore feeder may be taxed as a foreign corporation if the offshore fund engages in a “trade or business” within the United States. Normally an offshore fund qualifies for an exemption from taxation as a foreign corporation that covers security trading activities (the “Trading Safe Harbors”), but, as the memo clarifies, underwriting and money lending (as well as “other fact patterns”) are considered “trade and business” activities that do not fall within the Trading Safe Harbors. Offshore funds should consult with tax and legal advisors to consider whether their investment activities may fall outside the protection of the Trading Safe Harbors.

Cayman Fund Director Liability.  The Cayman Islands Court of Appeals overturned the contentious Weavering verdict on February 12, 2015.  In Weavering, the lower court found two directors of a Cayman fund “willfully negligent” for signing a quarterly report without reading its contents; the judge determined that a simple review of the quarterly report would have alerted the directors to fraudulent trading occurring within the fund. In reversing the verdict, the appellate court acknowledged that a director can be held willfully negligent for consciously choosing not to perform its duties to a fund, but signing a quarterly statement without reading the content is not in and of itself willfully negligent under Cayman law. Although the original ruling was reversed, the case highlights the importance for directors of Cayman Islands funds to not take their statutory duties lightly.

Finance Lenders Regulatory Reminder. The 2014 Annual Report for Lenders and Brokers Licensed under the California Finance Lenders Law (CFLL) was due on March 15, 2015. The form and instructions are available on the DBO’S website. In order to upload and file the report, licensees must log in to the self-service portal using their username and password. For licensees who have not registered in the DBO’s Self-Service DOCQNET Portal, registration is a three-step process: (1) licensees create an account; (2) DBO staff verify the information; and, (3) following the verification, licensees reenter the portal to complete their registration.  The registration process normally takes five days to complete. The registration portal can be found here.

Municipal Advisor Regulatory Update. The Municipal Securities Rulemaking Board (“MSRB”) and SEC have continued to develop municipal advisor rules in the areas of supervision and compliance, pay-to-play, standards of conduct including fiduciary duty, professional qualifications, and gifts and gratuities. The regulatory environment was discussed during a 2014 Compliance Outreach program for Municipal Advisors hosted by the MSRB, SEC and FINRA.  Notably, registered municipal advisors must be in compliance with the following MSRB Rules by April 23, 2015:

  • Rule G-44 Supervisory and Compliance Obligations of Municipal Advisors
  • Rule G-8 Books and Records
  • Rule G-9 Preservation of Record

The MSRB recently hosted a webinar on compliance with the foregoing rules.  As the municipal advisor regulatory framework is continuously changing, we recommend that registered municipal advisors regularly review the applicable MSRB Rules and register for MSRB email updates.

Electronic Blue Sky Notice Filings for Regulation D Offerings.  The North American Securities Administrators Association (“NASAA”) recently announced the launch of an online Electronic Filing Depository (“EFD”) for electronic notice filings made in connection with offerings under Rule 506 of Regulation D. The EFD will permit filers to submit the blue sky notice filings and pay the related filing fees electronically for such Regulation D offerings. Note that while some states currently accept electronic filings made through EFD, many states are expected to require such EFD-submitted filings in the near future.

Other Notes.

  • Basing Claims on Back-Tested Performance Data. Last December, the SEC issued a cease-and-desist order against an investment adviser for exaggerating the “proven track-record” of their proprietary trading technique.  The adviser advertised that their investing model, created in 2008, had been successful in managing client assets going back to 2001. The SEC determined that these claims were based on back-tested data, which snowballed into an assortment of securities law violations. The SEC prohibits substituting historic performance with back-tested data because such a claim, without disclosure, is materially misleading to investors. Investment advisers should be cognizant that back-tested data cannot be used to allege actual historic performance.
  • ESMA Guidelines and Technical Standards Overview. The European Securities and Markets Authority (“ESMA”) published an overview of guidelines and technical standards for an assortment of security-related regulations as well as compliance tables, consultation papers, and other useful information.  The overview is available on the ESMA website.
  • California Management Fee Withholding Tax. Many of you may have received a recent news bulletin that implied hedge funds with California investors will be subject to a new California state tax. The article was largely misleading, as the “new tax hit” the author identified generally reflects the status quo. California uses a “market-based” tax sourcing system: the source of revenues determines where the tax on such revenues should be paid. Most, if not all, fund managers already comply with this tax scheme. Note that there are on-going revisions to this rule and hearings scheduled for this summer, so the status quo may change. For now, this should not raise any “new” concerns for managers; however, we will be on the look-out for any updates on this front.
  • New Irish Legal Entity Designed for Hedge Funds. Ireland, long an attractive alternative to the Caribbean for offshore investment vehicles, recently passed legislation creating a new legal entity specifically tailored for hedge funds. The form of entity, named an Irish Collective Asset-Management Vehicle (“ICAV”), is designed to minimize the administrative burdens of establishing and maintaining an investment vehicle in Ireland, while at the same time permitting the vehicle to “check the box” and be taxed by the U.S. as a partnership. The latter feature allows U.S. taxable investors to circumvent certain adverse tax consequences that typically apply to U.S. investors of passive foreign investment companies.  Additionally, an ICAV will fall under Ireland’s tax regime for regulated funds, meaning that it is generally exempt from Irish income taxes at the fund level, transfer taxes for the issue, transfer, or sale of shares, and withholding taxes on distributions to non-Irish investors. The Irish Parliament hopes that ICAVs will further encourage the formation of new funds, and the re-domiciliation of existing offshore funds, in Ireland.
  • New Registration Requirement for Security-Based SDRs. The SEC has adopted new rules requiring security-based swap data repositories (“SDRs”) to register with the SEC and proposed additional rules relating to the reporting and public dissemination of security-based SDRs.  A notice about the new rule and proposed rules can be found here.
  • Alternative Trading Systems Reporting. FINRA is soliciting comments for proposed rules that would require alternative trading systems (“ATSs”) to report quotation information for corporate and agency debt securities to FINRA.  More information about the proposed rules can be found here.
  • OCR Final Rule. The CFTC issued a no-action letter extending the conditional deadline to comply with the OCR Final Rule’s expanded information reporting requirements. The new deadlines are September 30, 2015 for New Form 102A, New Form 102S and DCM threshold accounts via New Form 102B and February 13, 2017 for SEF volume threshold accounts via New Form 102B.  The deadline for reporting on New Form 40/40S and New Form 71 is February 11, 2016.  The extended deadlines are conditioned on the Reporting Parties continuing to report on Legacy Form 102, Legacy 102S Filing, Legacy Form 40, and Legacy 40S Filing.  The no-action letter can be found here.

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

Deadline             Description

March 31, 2015  Form ADV annual updating amendment deadline.

April 15, 2015     1st Quarter 2015 Form PF filing for quarterly filers (Large Liquidity Fund Advisers).

April 30, 2015     2014 Annual Form PF filing for annual filers (Large Private Equity Fund Advisers and Smaller Private Fund Advisers).

April 30, 2015     Offer or delivery of Form ADV Part 2 to clients (most registered investment advisers); Delivery of Privacy Notice.

April 30, 2015     Delivery of audited financial statements to investors (most private fund managers, including SEC, State and CFTC registrants).

April 30, 2015     Quarterly NAV Report (registered commodity pool operators claiming the 4.7 exemption).

May 5, 2015        FATCA registration with the IRS through the online web portal found here. Enter into a foreign financial institution agreement with the IRS via the web portal, or comply with an applicable intergovernmental agreement. Meet the other due diligence, reporting and withholding requirements under FATCA, as applicable.

May 15, 2015      Form 13F filing (advisers managing $100 million in 13F Securities).

May 15, 2015      CTA-PR filing.

May 21, 2015      Deadline for Cayman Islands Financial Institutions with reporting obligations under the Cayman FATCA regulatory framework to register their status on the Cayman Islands Tax Information Authority on the Cayman Automated Exchange of INFORMATION Portal (extended from March 31, 2015).

May 31, 2015      First reporting deadline for Cayman Islands Financial Institutions in respect of the Cayman FATCA regulatory framework.

June 30, 2015     Delivery of audited financial statements to investors (private fund managers to funds of funds, including SEC, State and CFTC registrants).

June 30, 2015     Deadline for filing audited financial statements for preceding financial year and Fund Annual Return with Cayman Islands Monetary Authority.

June 30, 2015     Review transactions and assess whether Form 13H needs to be amended.

Variable               Distribute copies of Schedule K-1 to fund investors.

Periodic Filings  Form D and Blue Sky filings should be current.

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


Karl Cole-Frieman, Bart Mallon & Lilly Palmer


Cole-Frieman & Mallon LLP is a premier boutique investment management law firm, providing top-tier, responsive and cost-effective legal solutions for financial services matters. Headquartered in San Francisco, Cole-Frieman & Mallon LLP has an international practice that services both start-up investment managers as well as multi-billion dollar firms. The firm provides a full suite of legal services to the investment management community, including: hedge fund, private equity fund, and venture capital fund formation, adviser registration, counterparty documentation, SEC, CFTC, NFA and FINRA matters, seed deals, hedge fund due diligence, employment and compensation matters, and routine business matters.

Hedge Fund Events May 2015

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


Date: May 4, 2015

Date: May 5, 2015

Date: May 5, 2015

Date: May 5, 2015

Date: May 5-6, 2015

Date: May 5-8, 2015

  • Sponsor: SkyBridge Capital
  • Event: SALT Las Vegas
  • Location: Las Vegas, NV

Date: May 6, 2015

Date: May 6, 2015

Date: May 6, 2015

Date: May 6, 2015

Date: May 7, 2015

Date: May 10-11, 2015

Date: May 12, 2015

Date: May 12, 2015

Date: May 12-13, 2015

Date: May 13, 2015

Date: May 13, 2015

Date: May 13, 2015

Date: May 13-14, 2015

Date: May 14, 2015

Date: May 18-20, 2015

Date: May 19, 2015

Date: May 19, 2015

Date: May 20, 2015

Date: May 20, 2015

Date: May 21, 2015

Date: May 27-28, 2015

Date: May 27-29, 2015

Date: May 28, 2015

Date: May 30, 2015

Date: May 31-June 2, 2015


Cole-Frieman & Mallon 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.