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

****

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.

****

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.

****

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.

****

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.

****

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.

****

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.

****

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.

Hedge Fund Law Blog

Hedge fund laws, starting a hedge fund, news and events…

Cole-Frieman & Mallon 2023 End of Year Update

Leave a Reply Cancel reply