December 13, 2024

Clients, Friends, and Associates:

As we near the end of 2024, we have highlighted in this update certain recent industry developments that will impact many of our clients. We have also developed a checklist to help managers effectively navigate 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 2024
• Other Items
• Compliance Calendar

****

CFM Items

CoinAlts Fund Symposium. Cole-Frieman & Mallon LLP was proud to be a premier sponsor of the annual CoinAlts Fund Symposium, held at the Four Seasons Hotel in San Francisco on October 16, 2024. This sold-out event was a resounding success, bringing together leaders in the digital asset community for a day of insightful discussions on investment, legal, and operational trends impacting private fund managers. The annual CoinAlts Fund Symposium was the anchor event of the inaugural San Francisco Fund Week, providing an unparalleled opportunity to connect with industry experts and stay on the cutting edge of this rapidly evolving space. Planning is already underway for next year’s CoinAlts Fund Symposium and we look forward to making the event an even greater success! Keep an eye on coinalts.xyz for updates.

Cole-Frieman & Mallon Integrates Harvey AI to Enhance Client Service. In our ongoing commitment to providing innovative legal solutions, Cole-Frieman & Mallon LLP has integrated Harvey, a secure, OpenAI-backed legal AI platform, to enhance our client service offerings. Harvey supports our attorneys with tasks like legal research, document analysis, and drafting assistance, enabling us to streamline workflows while maintaining the highest professional and ethical standards. We are pleased to be featured on Harvey’s website as a customer story, showcasing how this integration helps us deliver efficient and cost-effective legal services tailored to our clients’ complex financial services needs. Read the full story here. This integration aligns with our firm’s AI Acceptable Use Policy, which ensures thoughtful, responsible use of AI tools as a complement to our attorney expertise and judgment.

****

Q4 Matters

Preliminary Injunction Enjoins Enforcement of the Corporate Transparency Act of 2021, as amended (the “Corporate Transparency Act”). On December 3, 2024, the U.S. District Court for the Eastern District of Texas issued a nationwide preliminary injunction blocking enforcement of the Corporate Transparency Act. As we described in a Hedge Fund Law Blog article earlier this year, the Corporate Transparency Act became effective on January 1, 2024, and required certain U.S. and foreign entities registered to do business in the U.S. to file a beneficial ownership information report with the Financial Crimes Enforcement Network (“FinCEN”), with various deadline dates based on when the reporting entity is formed. The court held that the Corporate Transparency Act likely exceeds Congress’s authority under the U.S. Constitution and is thus likely unconstitutional. This is only a preliminary injunction – not an affirmative finding that the Corporate Transparency Act violates the U.S. Constitution – and the U.S. government filed a notice of appeal to the U.S. Court of Appeals for the Fifth Circuit on December 5, 2024, so this may not be the last word on the Corporate Transparency Act. But as of now, given the nationwide preliminary injunction, reporting companies are not required to submit any beneficial ownership information reports to FinCEN.

SEC’s Division of Examinations Publishes its 2025 Priorities List. The U.S. Securities and Exchange Commission’s (the “SEC”) Division of Examinations (the “Division”) has published its Examination Priorities for the upcoming fiscal year 2025. The Division’s examination priorities cover a broad array of issues affecting investment advisers and broker-dealers. For private fund managers, the Division will prioritize, among other things, adequacy and accuracy of disclosures, adherence to fiduciary obligations (particularly when a fund experiences market volatility or is exposed to interest rate fluctuations), calculations and allocations of fees and expenses, adequacy of conflicts of interest policies and procedures, and compliance with recently adopted SEC rules.

With respect to digital assets, the Division intends to examine registrants that offer digital asset-related services. These examinations will focus on whether registrants (i) meet and follow their standards of conduct when advising customers and clients regarding digital assets, (ii) routinely review and enhance their compliance policies, risk disclosures, and operational resiliency practices, and (iii) have implemented policies to address technological and security risks of digital assets.

****

Annual Compliance & Other Items

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

Annual Compliance Review. The Chief Compliance Officer (“CCO”) of an RIA must conduct a review of the RIA’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 advisers 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, 2025. 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 whom the RIA has entered into an investment advisory contract. Note that for advisers who are SEC RIAs or California 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 should 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. RIAs 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 (the end of June 2025 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. ERAs or state-level RIAs who report regulatory assets under management on their annual amendment in excess of SEC registration thresholds must register with the SEC within 90 days of filing the annual amendment (the end of June 2025, if the annual amendment is filed on March 31, 2025).

Exempt Reporting Advisers. Managers who exceed the assets under management thresholds to qualify as 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 (the end of June 2025 for most managers, assuming the annual amendment is filed on March 31, 2025).

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 surprise examinations conducted by a certified public accountant. 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 whether they have custody, must maintain a net worth of at least $10,000 (CA RIAs with custody are subject to heightened minimum net worth requirements discussed further below).

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

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

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

CPO and CTA Annual Updates. Registered CPOs and CTAs must prepare and file Annual Questionnaires and Annual Registration Updates with the National Futures Association (“NFA”), as well as submit payment for annual maintenance fees and NFA membership dues. Registered CPOs must also prepare and file their fourth quarter report for each commodity pool on Form CPO-PQR, while CTAs must file their fourth quarter report on Form CTA-PR. Unless eligible to claim relief under CFTC Rule 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 managers’ 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. The SEC adopted amendments to the Schedule 13D and 13G reporting deadlines which are now in effect. 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. Schedule 13D is required when a manager is ineligible to file Schedule 13G and is due five days after acquiring more than 5% beneficial ownership of a registered voting equity security. Any amendments to Schedule 13D must be filed within two business days. For Schedule 13G filers that are qualified institutional investors, the initial filing must be completed at the earlier of (x) 45 days after the end of the calendar quarter in which the filer’s beneficial ownership exceeds 5% at quarter-end or (y) five business days after the end of the first month in which the filer’s beneficial ownership exceeds 10% at month-end. For Schedule 13G filers that are passive investors, the initial filing must be completed within five business days after acquiring more than 5% beneficial ownership. For Schedule 13G filers that are exempt investors, the initial filing must be completed within 45 days after the end of the calendar quarter in which the filer’s beneficial ownership exceeds 5% at quarter-end. To the extent there are any material changes to the information last reported, an amendment to Schedule 13G must be filed within 45 days after the end of the calendar quarter. Qualified institutional investors will need to file an amendment to Schedule 13G (i) within five business days after the end of the first month in which the filer’s beneficial ownership exceeds 10% at month-end and (ii) thereafter, within five business days after the end of any month in which the filer’s month-end beneficial ownership increases or decreases by more than 5%. Passive investors will need to file an amendment to Schedule 13G (i) within two business days after acquiring greater than 10% beneficial ownership and (ii) thereafter, within two business days after the filer’s beneficial ownership increases or decreases by more than 5%.

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.

Rule 13f-2 and Form SHO. Starting January 2, 2025, institutional investment managers that engage in short sales of equity securities that meet or exceed certain regulatory thresholds for a given equity security in a given calendar month must file a Form SHO within 14 calendar days after the end of each calendar month, providing certain information about those short positions. If one of the reporting thresholds is met in the month of January 2025, the first filing of Form SHO would be due by February 14, 2025. Equity securities for the purpose of Rule 13f-2 include exchange-listed and over-the-counter equity securities, exchange-traded funds, certain derivatives and options, warrants, and other convertibles. Managers must make a determination as to whether a Form SHO needs to be filed on a month-by-month basis.

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 that 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. Managers 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 permit blue sky filings to be filed electronically through the Electronic Filing Depository (“EFD”) system, and certain states will only accept filings through EFD.

IARD Annual Fees. Preliminary annual renewal fees for state-registered and SEC-registered investment advisers are due on December 9, 2024. 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. Investment Managers who advise ERISA plan asset funds under the qualified plan asset manager (“QPAM”) exemption should be aware of the amendments to the QPAM exemption, which were adopted on April 3, 2024, and became effective on June 17, 2024. For additional information on the amendments to the QPAM exemption, please refer to the section “Qualified Plan Asset Manager Updates” below.

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 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 2024 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, certifications, negative consent letters, and 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, as amended (“FATCA”). Generally, FATCA reports are due to the IRS on March 31, 2025, or September 30, 2025, 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 FATCA requirements applicable to different jurisdictions, managers should review and confirm the specific 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 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 adjust 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. 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 2024

SEC Matters

Court Vacates SEC Market Participant Dealer Rule. On February 6, 2024, the SEC adopted new Rules 3a5-4 and 3a44-2 (the “New Dealer Rules”) of the Securities Exchange Act of 1934, as amended (the “Exchange Act”), which expanded the definitions of “dealer” and “government securities dealer” to cover additional market participants engaged in liquidity-providing activities. The New Dealer Rules would have required additional market participants to register as broker-dealers under the Exchange Act. However, on November 21, 2024, the United States District Court Northern District of Texas, Fort Worth Division ruled that the New Dealer Rules exceeded the SEC’s statutory authority and ordered that the New Dealer Rules be vacated in their entirety. The SEC has until January 2025 to determine whether to file a notice of appeal.

SEC Enhances Reporting of Proxy Votes to Increase Transparency for Investors. Certain amendments to the Form N-PX, passed by the SEC in November 2022, went into effect on August 31, 2024, and require managers who must file a Form 13F with the SEC (such managers, the “Institutional Investment Managers”) to file a Form N-PX with the SEC, disclosing all proxy votes cast in the preceding 12 months where the Institutional Investment Manager exercised voting power over a security. Institutional Investment Managers with a policy to not vote proxies, and who indeed did not vote proxies, are still required to file a truncated Form N-PX with the SEC. In preparation for this upcoming filing, Institutional Investment Managers should collect all proxy votes cast from July 1, 2023, to June 30, 2024, and provide them to their legal counsel.

Fifth Circuit Strikes Down SEC Private Fund Advisers Rule. In August 2023, the SEC adopted the Private Fund Advisers Rule which imposed new requirements and prohibitions on private fund advisers, including the disclosure of preferential treatment of certain investors and quarterly reporting of private fund performance.

Given its industry-altering impact, the recent ruling from the U.S. Court of Appeals for the Fifth Circuit finding the Private Fund Advisers Rule to be invalid and unenforceable was a welcome reprieve. In striking down the Private Fund Advisers Rule, the court found that the SEC exceeded its statutory authority because the term “investor,” as used within the Investment Advisers Act of 1940, as amended, (the “Investment Advisers Act”) was limited to “retail customers” and not private funds.

SEC Charges Investment Advisers for Marketing Rules Violations. On April 14, 2024, the SEC announced charges against five RIAs for violations of Section 275.206(4)-1 of the Investment Advisers Act (the “Marketing Rule”) for misleading advertisements of hypothetical performance on their public-facing websites. The advisers agreed to civil penalties, censure, and a cease and desist from further violations.

On May 14, 2024, the SEC announced charges against an investment adviser and its founder for a breach of fiduciary duty for failing to disclose conflicts of interest and making misleading statements to their clients. According to SEC’s investigation, the investment adviser advised its clients to invest in films produced by a specific production company without disclosing that the production company paid the founder approximately $530,000 in exchange for investments by its clients. The investment adviser subsequently misrepresented to investors that the money was paid as compensation for work as an executive producer on the films. The SEC disgorged fees, levied civil penalties, and issued a censure and a cease and desist from committing or causing any violation of these rules.

On May 29, 2024, the SEC announced charges against an investment adviser and its co-founder for false and misleading statements in communications with investors. The SEC’s investigation found that the misleading statements were a result of improper modifications to underlying portfolio data made by the co-founder. Despite previous orders from the SEC, the investment adviser failed to disclose a conflict of interest arising from a different co-founder operating a separate hedge fund in China. The investment adviser and the co-founder paid civil penalties, and the investment adviser also agreed to a censure and a cease and desist from further violations.

These enforcement actions, coupled with a similar enforcement action in September 2023, demonstrate the SEC’s focus on compliance with the Marketing Rule as an important safeguard to protect investors from “misleading advertising claims.” As such, we recommend that our clients remain vigilant and review all marketing materials (including content on public-facing websites) with their legal counsel and ensure that all policies and procedures are actively followed.

SEC Charges Investment Adviser with Violation of the Advisers Act for Failing to Safeguard Client Assets. The SEC recently settled a case against a digital asset registered investment adviser for: (i) violating the SEC’s custody rule, (ii) misleading investors about certain redemption practices of its private investment fund, and (iii) failing to adopt and implement written compliance policies.

Regarding custody of client assets, the SEC concluded that the investment adviser had custody of its private investment fund’s assets, as defined in Rule 206(4)(2) of the Investment Advisers Act, and accordingly was required to ensure that client funds and securities were maintained by a qualified custodian. The investment adviser held certain crypto assets of its private investment fund on crypto asset trading platforms and exchanges, including FTX Trading Ltd., which was not a qualified custodian. To our knowledge, this is the first public enforcement action in which the SEC has decided to bring an action against a crypto asset manager relating to the qualified custodian rule.

With respect to its redemption practices, the SEC found that the private investment fund’s offering documents provided for investor redemption from the private investment fund upon 30 days’ notice, unless the private investment fund’s general partner, who is an affiliate of the investment manager, allowed for a shorter notice period. In practice, the private investment fund’s general partner allowed investors to redeem upon five business days’ notice if requested, and this practice was made known to investors in the private investment fund. However, the general partner occasionally approved redemption requests made with even less than five business days’ notice, including for affiliated investors. The SEC determined that straying from the redemption policy communicated to investors through its offering documents was misleading. We encourage investment advisers to review their redemption policies to ensure alignment with historical redemption practices and to avoid preferential treatment of affiliated investors. 

The investment adviser was found to have violated Sections 206(4), 206(4)-2, and 206(4)-7 of the Investment Advisers Act and agreed to pay a civil penalty of $225,000 to be distributed to harmed investors in its private investment fund. 

SEC Adopts Rule to Update Definition of Qualifying Venture Capital Funds. The SEC expanded the definition of “qualifying venture capital fund” under the Investment Company Act of 1940, as amended, raising the threshold to $12 million in aggregate capital contributions and uncalled committed capital (up from $10 million). As a reminder, a qualifying venture capital fund is subject to an expanded 250 beneficial ownership limit. The rule also establishes a process for the SEC to make future inflation adjustments every five years in compliance with the Economic Growth, Regulatory Relief, and Consumer Protection Act of 2018, as amended. The rule becomes effective 30 days after publication in the Federal Register, the date of which has not yet been announced.

CFTC Matters

CFTC Doubles Financial Thresholds for Qualified Eligible Person Status. The CFTC adopted amendments to CFTC Rule 4.7, which, in part, affect the financial requirements for certain investors in commodity pools. CFTC Rule 4.7 exempts CPOs and CTAs from certain disclosure, reporting, and record-keeping requirements so long as pool participants are restricted to qualified eligible persons (“QEPs”). Notably, the CFTC doubled the financial threshold for certain investors to qualify as QEPs suitable to invest in a CFTC Rule 4.7 pool or fund to reflect inflation. Managers of vehicles who rely on CFTC Rule 4.7 should consider that updates will be needed to such vehicles’ offering documents to account for this change.

The final rule will be effective 60 days after publication in the Federal Register, and the compliance date for the updated portfolio requirement will be six months after publication.

Digital Asset Matters

Digital Asset Reporting Requirements from IRS and Department of the Treasury. On January 16, 2024, the Department of the Treasury and the IRS issued an announcement informing the public that businesses do not have to report transactions involving the receipt of digital assets the same way businesses report the receipt of cash, until the Department of the Treasury or the IRS issues further regulatory guidance.

Announcement 2024-4 serves as guidance to taxpayers on digital asset reporting pursuant to Section 6050I of the Code, which requires that taxpayers engaged in business must report the receipt of $10,000 or more in cash within 15 days of receiving the cash. Digital assets were included in the definition of “cash” on November 15, 2021, through the Infrastructure Investment and Jobs Act of 2021, as amended. To date, neither the Department of the Treasury nor the IRS has provided a proposed date or timeline for regulatory guidance.

Cryptocurrency Exchange Platform Pleads Guilty of Violating Federal AML and Sanctions Laws. A well-known cryptocurrency exchange platform consented to multiple orders with federal regulators for violating regulations in its international exchange operations. A U.S. district judge approved the cryptocurrency exchange platform’s guilty plea in February 2024. The cryptocurrency exchange platform acknowledged its actions in a blog post and pledged to adhere to compliance and security guidelines.

The cryptocurrency exchange platform’s onboarding processes and know-your-customer requirements have since been updated to include an assessment of applying entities with connections to the U.S. The new assessment includes questions for different types of entities, including look-through for U.S. beneficial owners, and a U.S. ownership/control attestation, requiring the signatory to attest that no U.S. person will make decisions related to the function of the entity user, including day-to-day management activities and trading activities. For more on SEC and CFTC actions against the cryptocurrency exchange platform, see our previous blog post.

Other Items

California Court Restores CPPA Authority to Enforce Privacy Regulations. On February 9, 2024, the Third District Court of Appeal in California ruled in favor of the California Privacy Protection Agency (“CPPA”), restoring the agency’s authority to enforce the regulations in the California Privacy Rights Act, as amended (the “CPRA”). This ruling follows the prior ruling in favor of the California Chamber of Commerce, which sought to delay the enforcement of the CPRA until the CPPA finalized CPRA’s regulations.

The Court’s decision now makes all final CRPA regulations enforceable. The CPPA, therefore, may immediately resume enforcing the privacy regulations, but it is currently unclear whether the agency will provide any time for businesses to comply with the new rules. This ruling will allow for the enforcement of new rules by the agency, which concerns cybersecurity audits, risk assessments, and automated decision-making technology.

Florida Adopts Private Fund Adviser Exemption. Joining other states with similar exemptions, the State of Florida has adopted a private fund adviser exemption based on the North American Securities Administrators Association’s (“NASAA’s”) model rule exempting certain private fund advisors from investment adviser registration. Under Florida’s private fund adviser exemption, a Florida-based investment adviser who provides advice solely to qualifying private funds, such as 3(c)(1) and 3(c)(7) funds excluded from the definition of “investment company” under the Investment Company Act of 1940, as amended, is exempt from having to register as an investment adviser with Florida’s Office of Financial Regulation (the “Office”) provided the investment adviser (i) is not subject to “bad actor” disqualification under SEC Rule 506(d)(1) and (ii) files Part 1 of Form ADV as an ERA with the Office via FINRA’s electronic Investment Adviser Registration Depository. There are additional requirements for a private fund adviser who advises at least one 3(c)(1) fund that is not a venture capital fund. Such advisor must ensure that the interests in the 3(c)(1) fund are only offered to accredited investors, and the advisor must disclose all services, duties, and any other material information affecting the rights or responsibilities of the beneficial owners of the 3(c)(1) fund. These additional requirements for 3(c)(1) funds are similar to NASAA’s model rule except Florida’s exemption only requires the 3(c)(1) fund’s interests to be offered to accredited investors instead of NASAA’s higher financial requirement that the interests be offered to “qualified clients.” Also, unlike the NASAA model rule, Florida’s exemption does not require 3(c)(1) funds to be audited.

SEC Adopts Amendments to Regulation S-P. On May 16, 2024, the SEC adopted certain amendments to Regulation S-P requiring RIAs and certain other financial institutions to implement enhanced data security and incident notification controls. Key requirements include (i) developing incident response programs for data breaches, (ii) notifying affected parties within 30 days of a breach, (iii) overseeing service providers, and (iv) meeting new record retention obligations. The amendments also formally codify certain industry-accepted exceptions regarding annual privacy notice requirements.

For advisers to private funds, the applicability of amended Regulation S-P is ambiguous primarily for two reasons: first, private funds themselves are exempt from Regulation S-P (falling under the Federal Trade Commission’s Safeguards Rule instead); and second, Regulation S-P focuses on the sensitive information of the “customer” (i.e., a natural person), whereas a private fund client to a private fund adviser is an entity and not a natural person. However, the amendments expand Regulation S-P’s definition of “customer information” to now include information of “the customers of other financial institutions where such information has been provided to the covered institution.” Because private fund advisers are in fact provided with the information of the natural person beneficial owners of its private fund client, there appears to be no reasonable basis provided in the express language of amended Regulation S-P to conclude that private fund advisers are somehow exempt.

It is likely that going forward, investment advisers will have to comply with other additional incident response requirements, such as those contemplated by the SEC’s impending Cybersecurity Risk Management rule. We recommend that all RIAs, including those solely advising private funds, prepare for compliance with these new amendments.

Qualified Plan Asset Manager Updates. Investment advisers who advise ERISA plan asset funds under the QPAM exemption should be aware of the amendments to the QPAM exemption, which were adopted on April 3, 2024, and became effective on June 17, 2024. The amendments will (i) require the QPAM to notify the Department of Labor via email at [email protected] that it is relying on the QPAM exemption within 90 days of reliance on the exemption; (ii) incrementally increase the assets under management threshold, in three separate increments (2024, 2027, and 2030) from $85,000,000 to $135,868,000; and (iii) incrementally increase the shareholder equity threshold, in three separate increments (2024, 2027, and 2030) from $1,000,000 to $2,040,000.

Expansion of Internet Advisers Exemption for Investment Advisers. To modernize the law and further ensure protections for investors in the digital age, the SEC adopted amendments to the Investment Advisers Act (otherwise known as the “Internet Adviser Exemption”) allowing for fully remote internet-based investment advisers to register with the SEC. To qualify for the Internet Adviser Exemption, an investment adviser must maintain an operational and interactive website where the adviser exclusively and continually provides digital investment advisory services to more than one client. Internet advisers must comply with the new rule by March 31, 2025. Additionally, all corresponding changes must be reflected on their form ADV, and an adviser that is no longer eligible under the new rules must register in one or more states and file a Form ADV-W by June 29, 2025, signifying their withdrawal.

Supreme Court Limits Powers of Federal Agencies. In a recent U.S. Supreme Court case, the court significantly limited the SEC’s authority to impose civil penalties in agency proceedings via its administrative law judge (“ALJ”) system. The decision, involving allegations of securities fraud against a hedge fund manager, underscores some brewing constitutional concerns regarding the SEC’s in-house adjudication process and reinforces the importance of separation of powers and the right to a jury trial.

The U.S. Supreme Court essentially held that the ALJ system violates the U.S. Constitution’s Seventh Amendment right to a jury trial and further found that U.S. Congress had unconstitutionally delegated legislative power to the SEC by allowing it to choose between civil proceedings in federal court and administrative proceedings.

This ruling will necessarily reshape the SEC’s enforcement strategy, potentially leading to fewer cases being pursued due to the higher burden of federal court proceedings. It also signals increased judicial scrutiny of agency adjudication processes and may inspire challenges to other federal agencies’ administrative proceedings.

California Requires Investment Advisers to Complete New Continuing Education Classes. In May, the State of California issued a new regulatory action requiring investment advisers registered with the State of California to complete 12 credits of continuing education courses by year-end 2024, and each calendar year thereafter. The regulatory action further specifies that courses must be taught by an authorized provider and be split evenly between two categories: (i) ethics and professional responsibility, with at least three credits specifically covering ethics, and (ii) products and practice. We encourage investment advisers registered with the State of California to review the new regulatory action carefully to ensure compliance.

Investment Advisers Now Responsible for Compliance with Bank Secrecy Act. On February 13, 2024, FinCEN proposed a new rule to prevent money laundering and the financing of terrorism and other crimes. The rule intends to supplement recent Department of the Treasury actions to combat illicit financial risks through anonymous companies and cash-based real estate transactions by increasing the transparency of the financial system. The Department of the Treasury also published a risk assessment for investment advisers, which outlined threats and vulnerabilities posed by investors and other actors.

FinCEN has since issued the final regulation including investment advisers in the definition of “financial institution” under the Bank Secrecy Act. This change means that investment advisers registered with the SEC, or filing as an ERA with the SEC, will have to comply with anti-money laundering and countering the financing of terrorism requirements. Investment advisers will have until January 1, 2026, to file Suspicious Activity Reports and comply with other requirements of the Bank Secrecy Act.

****

Compliance Calendar

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

December 9, 2024

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

January 10, 2025

• Form 13H Quarterly Filing for Changes. Filing is for calendar quarter that ended December 31, 2024, and should be submitted within 10 days of quarter end.

January 15, 2025

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

January 31, 2025

• “Annex IV” AIFMD filing.

February 14, 2025

• Form 13F Quarterly Filing for Changes. Filing is for Calendar Quarter that ended December 31, 2024, and should generally be submitted within 45 days of quarter end.
• Form 13H Annual Filing for Calendar Year that ended December 31, 2024.
• Form 13G Annual Filing for Calendar Year that ended December 31, 2024.
• First filing deadline for new Form SHO (short position reporting) if one of the regulatory thresholds is crossed in the month of January 2025. Thereafter, a Form SHO must be filed within 14 days of the end of any calendar month in which a short position regulatory threshold is crossed.

March 1, 2025

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

March 31, 2025

• 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 the NFA Annual Questionnaire system.

Consult our complete Compliance Calendar for all 2025 critical dates as you plan your regulatory compliance timeline for the year.

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

Sincerely,

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

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