Author Archives: Hedge Fund Lawyer

Karl Cole-Frieman Quoted on Expert Networks

Insider Trading Remains Popular Topic in Hedge Fund Regulation

Insider trading by hedge funds and the use of expert networks has been a hot compliance topic in 2010 and 2011. The topic remains in the spotlight as Massachusetts recently passed new expert network regulations. Under the new regulations, registered investment advisers in Massachusetts will be required to maintain certain records with respect to transactions with expert network firms. [Note: we will be detailing these and other regulations recently adopted by Massachusetts which will become effective as of December 1, 2011.]

Karl Cole-Frieman was quoted by Law360.com in an article on the new Massachusetts expert network regulations (subscription required). In the article Karl is attributed with providing information on the effect the regulations may have on expert networking firms, how expert networking firms may respond to the Massachusetts regulations and how hedge fund managers may modify their compliance programs to adhere to Massachusetts (and potentially other state) regulations.

We expect to see more states come out with similar laws and we will provide updates and more information as appropriate.

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Karl Cole-Frieman is a managing partner at Cole-Frieman & Mallon LLP and he provides advice to fund managers with respect to insider trading and the use of expert network firms. He can be reached

at 415-352-2300 or through our contact form.

Family Office Definition

SEC Releases New Rule on Family Offices for IA Registration Exclusion

The Dodd-Frank Act created a new “family office” exclusion from the definition of investment adviser because the private advisor exemption was repealed. While Congress believed that family offices should not be subject to the SEC registration requirements, it did grant authority to the SEC to define what constitutes a “family office”. On June 22, 2011 the SEC issued a final rule which narrowly defined a family office to essentially include only an office which represents a single family that does not exceed 10 generations. The new regulation takes effect on August 29, 2011 and those companies which do not fall within the new family office definition will be required to register with the SEC by March 30, 2012.

Family Office Definition

The term “family office” means a company that :

provides investment advice only to certain “family clients”;
is wholly owned by the “family clients” and controlled by family members or family entities; and
does not hold itself out to the public as an investment adviser.

The term “family clients” includes:

current and former family members,
certain employees of the family office (and, under certain circumstances, former employees),
charities funded exclusively by family clients,
estates of current and former family members or key employees,
trusts existing for the sole current benefit of family clients,
revocable trusts funded solely by family clients,
certain key employee trusts, and
companies wholly owned exclusively by and operated for the sole benefit of, family clients.

The term “family member” includes:

all lineal descendants of a common ancestor (who may be living or deceased)*
current spouses or spousal equivalents of those descendants
former spouses or spousal equivalents of those descendants

* The common ancestor cannot be more than 10 generations removed from the youngest generation of family members. For an example of how this works, please see this ancestor diagram.

Notably, the exclusion does not extend to family offices serving multiple families.

Also, it is important to note that family offices are excluded from the definition of investment adviser as opposed to being exempted from registration requirements. Previously family offices would have been exempt from registration because of the private adviser exemption.

Grandfathering Provision & Exemptive Orders

The Dodd-Frank Act included a grandfathering provision that precluded the SEC from excluding certain persons from the definition of “family office” solely because those persons provide investment advice to certain clients and provided that advice prior to January 1, 2010. The SEC’s rule incorporated that grandfathering provision such that employees of a family officer who are accredited investors (as defined by Regulation D) and companies controlled by a family member are permitted clients of a family office.

A family office that previously received a SEC exemptive order under section 202(a)(11)(G) of the Advisers Act will be able to continue to rely on the exemptive order and will thus not be required to register as an investment adviser.

Our Thoughts

The family office definition may have received more attention recently than it normally would have because of the Soros news. However, it seems more important that the new rule does not include in the definition those groups which provide advisory services to more than one family. This means that groups traditionally deemed to be family offices (albeit that services were provided to multiple families) will need to register with the SEC by March 30, 2012. While we encourage managers to begin the registration process as soon as possible, we believe that managers will not begin the process en mass until the fourth quarter of 2011 and into the first quarter of 2012.

The full rule is reprinted below.

The full adopting release can be found here: IA-3220 – Final Family Office Rule.

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§ 275.202(a)(11)(G)-1 Family offices.

(a) Exclusion. A family office, as defined in this section, shall not be considered to be an investment adviser for purpose of the Act.

(b) Family office. A family office is a company (including its directors, partners, members, managers, trustees, and employees acting within the scope of their position or employment) that:

(1) Has no clients other than family clients; provided that if a person that is not a family client becomes a client of the family office as a result of the death of a family member or key employee or other involuntary transfer from a family member or key employee, that person shall be deemed to be a family client for purposes of this section 275.202(a)(11)(G)-1 for one year following the completion of the transfer of legal title to the assets resulting from the involuntary event;

(2) Is wholly owned by family clients and is exclusively controlled (directly or indirectly) by one or more family members and/or family entities; and

(3) Does not hold itself out to the public as an investment adviser.

(c) Grandfathering. A family office as defined in paragraph (a) above shall not exclude any person, who was not registered or required to be registered under the Act on January 1, 2010, solely because such person provides investment advice to, and was engaged before January 1, 2010 in providing investment advice to:

(1) Natural persons who, at the time of their applicable investment, are officers, directors, or employees of the family office who have invested with the family office before January 1, 2010 and are accredited investors, as defined in Regulation D under the Securities Act of 1933;

(2) Any company owned exclusively and controlled by one or more family members; or

(3) Any investment adviser registered under the Act that provides investment advice to the family office and who identifies investment opportunities to the family office, and invests in such transactions on substantially the same terms as the family office invests, but does not invest in other funds advised by the family office, and whose assets as to which the family office directly or indirectly provides investment advice represents, in the aggregate, not more than 5 percent of the value of the total assets as to which the family office provides investment advice; provided that a family office that would not be a family office but for this subsection (c) shall be deemed to be an investment adviser for purposes of paragraphs (1), (2) and (4) of section 206 of the Act.

(d) Definitions. For purposes of this section:

(1) Affiliated Family Office means a family office wholly owned by family clients of another family office and that is controlled (directly or indirectly) by one or more family members of such other family office and/or family entities affiliated with such other family office and has no clients other than family clients of such other family office.

(2) Control means the power to exercise a controlling influence over the management or policies of a company, unless such power is solely the result of being an officer of such company.

(3) Executive officer means the president, any vice president in charge of a principal business unit, division or function (such as administration or finance), any other officer who performs a policy-making function, or any other person who performs similar policy-making functions, for the family office.

(4) Family client means:

(i) Any family member;

(ii) Any former family member;

(iii) Any key employee;

(iv) Any former key employee, provided that upon the end of such individual’s employment by the family office, the former key employee shall not receive investment advice from the family office (or invest additional assets with a family office-advised trust, foundation or entity) other than with respect to assets advised (directly or indirectly) by the family office immediately prior to the end of such individual’s employment, except that a former key employee shall be permitted to receive investment advice from the family office with respect to additional investments that the former key employee was contractually obligated to make, and that relate to a family-office advised investment existing, in each case prior to the time the person became a former key employee.

(v) Any non-profit organization, charitable foundation, charitable trust (including charitable lead trusts and charitable remainder trusts whose only current

beneficiaries are other family clients and charitable or non-profit organizations), or other charitable organization, in each case for which all the funding such foundation, trust or organization holds came exclusively from one or more other family clients;

(vi) Any estate of a family member, former family member, key employee, or, subject to the condition contained in paragraph (d)(4)(iv) of this section, former key employee;

(vii) Any irrevocable trust in which one or more other family clients are the only current beneficiaries;

(viii) Any irrevocable trust funded exclusively by one or more other family clients in which other family clients and non-profit organizations, charitable foundations, charitable trusts, or other charitable organizations are the only current beneficiaries;

(ix) Any revocable trust of which one or more other family clients are the sole grantor;

(x) Any trust of which: (A) each trustee or other person authorized to make decisions with respect to the trust is a key employee; and (B) each settlor or other person who has contributed assets to the trust is a key employee or the key employee’s current and/or former spouse or spousal equivalent who, at the time of contribution, holds a joint, community property, or other similar shared ownership interest with the key employee; or

(xi) Any company wholly owned (directly or indirectly) exclusively by, and operated for the sole benefit of, one or more other family clients; provided that if any such entity is a pooled investment vehicle, it is excepted from the definition of “investment company” under the Investment Company Act of 1940.

(5) Family entity means any of the trusts, estates, companies or other entities set forth in paragraphs (v), (vi), (vii), (viii), (ix), or (xi) of subsection (d)(4) of this section, but excluding key employees and their trusts from the definition of family client solely for purposes of this definition.

(6) Family member means all lineal descendants (including by adoption, stepchildren, foster children, and individuals that were a minor when another family member became a legal guardian of that individual) of a common ancestor (who may be living or deceased), and such lineal descendants’ spouses or spousal equivalents; provided that the common ancestor is no more than 10 generations removed from the youngest generation of family members.

(7) Former family member means a spouse, spousal equivalent, or stepchild that was a family member but is no longer a family member due to a divorce or other similar event.

(8) Key employee means any natural person (including any key employee’s spouse or spouse equivalent who holds a joint, community property, or other similar shared ownership interest with that key employee) who is an executive officer, director, trustee, general partner, or person serving in a similar capacity of the family office or its affiliated family office or any employee of the family office or its affiliated family office (other than an employee performing solely clerical, secretarial, or administrative functions with regard to the family office) who, in connection with his or her regular functions or duties, participates in the investment activities of the family office or affiliated family office, provided that such employee has been performing such functions and duties for or on behalf of the family office or affiliated family office, or substantially similar functions or duties for or on behalf of another company, for at least 12 months.

(9) Spousal equivalent means a cohabitant occupying a relationship generally equivalent to that of a spouse.

(e) Transition.

(1) Any company existing on July 21, 2011 that would qualify as a family office under this section but for it having as a client one or more non-profit organizations, charitable foundations, charitable trusts, or other charitable organizations that have received funding from one or more individuals or companies that are not family clients shall be deemed to be a family office under this section until December 31, 2013, provided that such non-profit or charitable organization(s) do not accept any additional funding from any non-family client after August 31, 2011 (other than funding received prior to December 31, 2013 and provided in fulfillment of any pledge made prior to August 31, 2011).

(2) Any company engaged in the business of providing investment advice, directly or indirectly, primarily to members of a single family on July 21, 2011, and that is not registered under the Act in reliance on section 203(b)(3) of this title on July 20, 2011, is exempt from registration as an investment adviser under this title until March 30, 2012, provided that the company:

(i) During the course of the preceding twelve months, has had fewer than fifteen clients; and

(ii) Neither holds itself out generally to the public as an investment adviser nor acts as an investment adviser to any investment company registered under the Investment Company Act of 1940 (15 U.S.C. 80a), or a company which has elected to be a business development company pursuant to section 54 of that Act (15 U.S.C. 80a-54) and has not withdrawn its election.

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Cole-Frieman & Mallon LLP is a hedge fund law firm which provides investment adviser registration and compliance services to hedge fund managers and other members of the investment management community such as family offices. Bart Mallon can be reached directly at 415-868-5345; Karl Cole-Frieman can be reached at 415-352-2300.

CTA Expo 2011 Chicago

Ronnie Lott Keynote Speaker at CTA Conference

We are gearing up for the CTA Expo in Chicago next month. The CTA Expo, which is also held in New York and London, has become the go-to event for CTAs and others member of the managed futures industry. As always, the NIBA will be having its own conference the day before the CTA Expo and there will be a joint NIBA/CTA Cocktail Party.

The NIBA event will be September 12, 2011 and the agenda includes:

Rules, Regulations, Revenue: Round III with Moderator Steve Pherson from Schuyler Roche
Grow Your Business by Hiring the Right People by Pat Lunkes of Parkway Consulting Group
Marketing Strategy Makeover by Candyce Edelen & Phil Donaldson of Propel Growth
A Bubble in Commodities: What to Look for by Darin Newsom of Telvent DTN
Anatomy of an Online Marketing Campaign: Generating Leads Online by Shane Stiles of Gate 39 Media

The CTA Expo will be September 13, 2011 and the agenda includes:

Welcoming Remarks by Bucky Isaacson and Frank Pusateri
Maximizing the Value of your Conference Attendance by Ron Suber of Merlin Securities
Successful Marketing in Asia by Rumi Morales of the CME Group
Reputation – Creating Power Through Personal Branding by Lida Citroen
Keynote Speach by Ronnie Lott of All Stars Helping Kids<
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/a> – Professional Sports and Business – Lessons Learned
Marketing Managed Futures in Europe –
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Tips from the Trenches by Simon Rostron of Rostron Parry
The Regulatory Environment in 2011 and Beyond by Dan Driscoll of the National Futures Association
The Role of Emerging Managers in a Portfolio by Joseph Schlater of Busara Advisors
Institutional Investors and What They Look For in a Manager by Keith Palzer of Bank of America Merrill Lynch
The Marketing Impact of a Professional Back Office by Dana Comolli of DMAXX
Promoting Managed Futures as an Investment by Mark Melin of High Performance Managed Futures

Cole-Frieman & Mallon LLP has been a sponsor of the CTA Expo since 2009 and this year we will be introducing Ron Suber of Merlin Securities on Tuesday morning. For more information on the events, please see the CTA Expo program and NIBA Conference schedule.

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Cole-Frieman & Mallon LLP provides legal advice to CTAs and CPOs, including NFA compliance and regulatory guidance. For more information, please see our CTA and CPO Registration and Compliance Guide or call Bart Mallon directly at 415-868-5345.

NFA Reminds CPOs of Rule 2-46 Reporting Requirement

Late Filers Possibly Subject to Disciplinary Action

The NFA issued a Notice to Members on July 21, 2011 (the “Notice”) reminding commodity pool operators (“CPOs”) registered with the NFA to file their quarterly pool reports in a timely manner. Most importantly, the NFA stated that beginning with the June 30, 2011 report, which is due on Monday, August 15, 2011, the NFA will review the filing history of any CPO that files the report late and determine whether disciplinary action is appropriate. The Notice stressed the importance of filing in a timely manner, as the value to the NFA of the information reported diminishes the later a report is filed. Below is our quick summary of what is required in the quarterly report.

CPO Quarterly Report Requirements

NFA Rule 2-46 requires CPOs to file a pool’s quarterly report within 45 days after the end of the quarter. The report should be filed through the NFA’s EasyFile system and will include the following information:

Key Relationships – the CPO must report the identities of the pool’s administrator, carrying broker(s), trading manager(s), and custodian(s).

Statement of Changes of NAV – the CPO must report the change in the pool’s net asset value for the quarter. Information required includes beginning net asset value, net income, additions, withdrawals, ending net asset value, and special allocations to the CPO. Data for each of these fields will be broken down into values for the participants (generally limited partners) and the

CPO (the General Partner). Additionally, the CPO will be required to report information on any halts or material restrictions applicable to redemptions during the quarter.

Monthly Rates of Return – the CPO must report the monthly performance of the pool for each of the three (3) months comprising the quarter.

Schedule of Investments – the CPO must report a schedule of investments that identifies any investments that are 10% or more of the pool’s net asset value at the end of the quarter. The schedule will be separated into dollar-value breakdowns across seven categories of investments: (1) equities, (2) alternative investments, (3) fixed income, (4) derivatives, (5) options, (6) funds, and (7) cash.

CPOs should be sure to file the June 30, 2011 quarterly report for each pool that is subject to the reporting requirement by the August 15, 2011 due date. The full NFA Notice is reprinted below and can also be found here.

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Notice I-11-13

July 21, 2011

Regulatory Reminder to CPOs of Quarterly Reporting Requirements

In March 2010, NFA Compliance Rule 2-46 became effective. Rule 2-46 requires each CPO Member to report quarterly to NFA specific information on each pool that it operates (for which it has a reporting requirement under CFTC Regulation 4.22). The reports are due within 45 days after the end of the quarterly reporting period. NFA adopted this quarterly reporting requirement in order to regularly obtain certain performance and operational data that NFA staff utilizes to assess risks and identify trends related to Member CPOs.

Obviously, if a Member CPO does not file this report within the specified time frame, then the value of the report to NFA diminishes since the information becomes less useful as it ages. Beginning with the June 30, 2011 report, which is due on Monday, August 15, 2011, NFA will review the filing history of any CPO Member that files the report after its due date and determine whether disciplinary action is appropriate.

All Member CPOs with reporting requirements under Compliance Rule 2-46 must be aware of the filing deadlines for these quarterly reports on an ongoing basis and ensure that these quarterly reports are filed in a timely manner. NFA staff remains available to assist CPO Members in meeting this filing requirement. Anyone needing additional information regarding these quarterly reports should contact Tracey Hunt at (312) 781-1284. You may also review NFA's two-part brief video series that walks through the process of filing a pool quarterly report:

NFA's Expanded Filing Requirements for Commodity Pool Operators – Part One

NFA's Expanded Filing Requirements for Commodity Pool Operators – Part Two

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Cole-Frieman & Mallon LLP provides legal advice to NFA Member firms with respect to CFTC Regulations and NFA Rules. Bart Mallon can be reached directly at 415-868-5345.

Social Media Regulation & Managed Futures Industry

Futures Magazine Publishes Article on Social Media by Bart Mallon

In this month’s issue of Futures Magazine I wrote a featured article about the legal and regulatory issues that managers in the futures industry face with respect to the use of social media. The article, Social Media Considerations for Financial Firms, provides a broad overview of the many issues which managers should be aware of when utilizing social media in any sort of marketing campaign. Specifically the article discusses the NFA rules which member firms must follow and also discusses some best practices and common deficiencies.

I believe that the article comes at an important time – managers

are using social media more often to communicate with clients. These managers are also using various platforms to communicate and market to potential clients. The necessity of creating compliance programs with respect to these activities has been clearly communicated to the managed futures community by the NFA and we have written a number of posts on the use of social media. Many of these posts are informed by information provided to the NFA either through more formal discussions or informally at

various conferences. The posts include:

We recommend that NFA member firms implement robust compliance policies with respect to the use of such media. Additionally, these programs should be reviewed and revised, as appropriate, on a periodic basis to respond to new marketing and communication practices and any guidance promulgated by the NFA or CFTC.

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Bart Mallon’s is a managing partner at Cole-Frieman & Mallon LLP and his practice focuses on the hedge fund industry. He routinely works with managers who trade commodities and futures on corporate and regulatory matters. He can be reached through our contact form or by phone at 415-868-5345.

Announcing Cole-Frieman & Mallon LLP

Friends:

We are pleased to announce today the merger of our respective firms to form Cole-Frieman & Mallon LLP, a law firm focused on the hedge fund industry. Below is our press release announcing the merger. We look forward to continuing to provide top-tier legal services to both large and start-up managers and will continue to focus on bringing useful information to the hedge fund community through the Hedge Fund Law Blog.

Many thanks to everyone who has supported this website and our practices over the years.

– Karl Cole-Frieman & Bart Mallon

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Cole-Frieman LLP & Mallon P.C. merge to form 3rd largest hedge fund practice based in San Francisco

– Combined firm has over 200 hedge fund industry clients

San Francisco, July 27th, 2011 – Two fast-growing San Francisco based law firms, Cole-Frieman LLP and Mallon P.C., today announced an agreement to combine businesses. The combined firm, known as Cole- Frieman & Mallon LLP, will be a boutique generalist firm focusing on hedge fund managers and hedge fund investors. Karl Cole-Frieman and Bart Mallon will be Co-Managing Partners of the eight person firm, which is headquartered in San Francisco and has a satellite office in New York. With 215 clients in the hedge fund industry, the firm also managed over 100 hedge fund launches in the last two years.

Cole-Frieman & Mallon LLP provides advice on a broad range of corporate, regulatory and litigation matters including hedge fund formation, adviser registration, CFTC and NFA matters, ISDAs and counterparty documentation, loan trading and distressed debt transactions, seed deals, employment and compensation matters and regulatory inquiries.

The firm will also manage the widely read and highly influential Hedge Fund Law Blog (http://www.hedgefundlawblog.com), which focuses on legal issues that impact the hedge fund community.

“This merger will create an industry leading firm that provides a full suite of services to hedge funds and others in the alternative investment community,” says Karl Cole-Frieman. Mallon notes, “Many larger managers are opting to bifurcate their legal work between our firm and a large law firm. Whether the client needs start-up support or more tailored advice, we are able to provide high level, cost-effective services which consider the manager’s needs from a business as well as a legal perspective.”

“There are few firms that can provide an institutional quality product at a reasonable price point. With Cole-Frieman & Mallon LLP we get the benefit of top notch expertise, as well as the personalized service and attention of a boutique firm” said Dennis Carlton, General Counsel of WMD Asset Management, LLC.

Bruce Wilson at North Creek Advisors, LLC adds “Cole-Frieman & Mallon LLP bring to the table a deep understanding of the hedge fund business and hedge fund operations. They are business partners, as well as counselors, who engineer the solutions for their clients.”

About Cole-Frieman & Mallon LLP

Informed by significant in-house and private practice experience at some of the most prestigious Wall Street firms, hedge funds, and law firms Cole-Frieman & Mallon LLP has the business acumen and market knowledge to

provide legal solutions for a wide range of financial services matters. With offices in San Francisco and New York, Cole-Frieman & Mallon LLP has a nationwide practice that services both start-up managers as well as multi-billion dollar firms. Cole-Frieman & Mallon LLP provides a variety of services including: hedge fund formation, advisor registration and counterparty documentation, CFTC and NFA matters, seed deals, internal investigations, operational compliance, regulatory risk management, hedge fund due diligence, marketing and investor relations, employment and compensation matters, and routine business matters. For more information please visit us at: http://www.colefrieman.com/.

Karl Cole-Frieman can be reached at 415-352-2300.

Bart Mallon can be reached directly at 415-868-5345.

Form 13H – Large Trader Reporting Requirement

Rule 13h-1 Adopted by SEC

Today the SEC adopted new Rule 13h-1 which requires certain large traders to provide certain information regarding their trading activities to the SEC through a New Form 13H. A gross overview of the new reporting requirement are provided below.

Who is required to file Form 13H?

All “large traders” must file Form 13H.

A “large trader” is defined as a person 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.

The Form 13H is expected to look substantially similar to the Proposed Form 13H.

Large Trader Identification Number (LTID)

Each large trader which filed Form 13H will be given a LTID. The large trader will be required to provide their broker with the LTID so the broker can track all transactions attributable to the large trader and report such transactions to the SEC.

Large Trader Recordkeeping & Compliance Requirements

Broker-dealers with large trader clients are required to maintain certain records with respect to the transactions of their large trader clients. Such broker-dealers will be required to have large trader transaction data available the day after transactions are effected.

Effective Date

The effective date of new SEC Rule 13h-1 will be 60 days after the rule is published in the Federal Register. Large traders will have 60 days from the effective date of the new rule to file Form 13H with the SEC.

We will be able to provide more background on the rule as adopted shortly.

The final rule is likely to be similar to the Proposed Rule 13h-1.

The SEC release is reprinted below and can be found here.

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SEC Adopts Large Trader Reporting Regime

FOR IMMEDIATE RELEASE

2011-154

Washington, D.C., July 26, 2011 – The Securities and Exchange Commission today voted unanimously to adopt a new rule establishing large trader reporting requirements to enhance the agency’s ability to identify large market participants, collect information on their trading, and analyze their trading activity.

The new rule requires large traders to identify themselves to the SEC, which will then assign each trader a unique identification number. Large traders will provide this number to their broker-dealers, who will be required to maintain transaction records for each large trader and report that information to the SEC upon request.

“May 6 dramatically demonstrated the need to enhance the SEC’s ability to quickly and accurately analyze market events. The large trader reporting rule will significantly bolster our ability to oversee the U.S. securities markets in a time when trades can be transacted in milliseconds or faster,” said SEC Chairman Mary L. Schapiro. “This new rule will enable us to promptly and efficiently identify significant market participants and collect data on their trading activity so that we can reconstruct market events, conduct investigations, and bring enforcement actions as appropriate.”

The new rule has two primary components:

First, it requires large traders to register with the Commission through a new form, Form 13H.

Second, it imposes recordkeeping, reporting, and limited monitoring requirements on certain registered broker-dealers through whom large traders execute their transactions.

The new rule will be effective 60 days after its publication in the Federal Register.

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Cole-Frieman & Mallon LLP is a hedge fund law firm which provides legal advice to both large and

start-up fund managers. Bart Mallon can be reached directly at 415-868-5345; Karl Cole-Frieman can be reached at 415-352-2300.

New York Hedge Fund Manager Registration Post Dodd-Frank Act

SEC Releases Information on Mid-Sized Advisers – New York Managers may be Required to Register with SEC

Currently managers with a place of business in New York are not required to register as investment advisers at the state level with the New York Department of State. Until the Dodd-Frank Act was passed last year, these managers also were exempt from registration with the SEC because of the old Section 203(b)(3) exemption. After the Dodd-Frank Act repealed the 203(b)(3) exemption, it was unclear how certain managers (like those managers with a place of business in New York) would be regulated. Recently the SEC passed final hedge fund registration regulations which, among other things, clarifies how certain mid-sized hedge fund managers will be regulated. The SEC also recently released a FAQ on how the mid-sized advisers. The import of the Dodd-Frank Act and the new regulations means that certain New York hedge fund managers will be required to register as investment advisers with the SEC.

Mid-Sized Adviser Overview

A mid-sized adviser is generally an investment adviser with between $25M and $100M of AUM. Mid-sized advisers are not allowed to register with the SEC unless the mid-sized adviser is located in New York state or Wyoming, in which case they will be required to register with the SEC. Those mid-sized advisers who are currently registered with the SEC (under the applicable regulations effective prior to the Dodd-Frank Act) will be required to “switch” to state registration by June 28, 2012. Any mid-sized adviser starting their business after July 21, 2011 will be required to register with the state securities commission or with the SEC if they are in New York or Wyoming. More technical guidance on accomplishing the “switch” from SEC to state registration is expected to be provided by the SEC and various state regulators in the coming months.

Overview of IA Registration Requirement for New York Managers

Based on the new federal regulations, managers with a principal place of business in New York will be subject to registration/exemption as follows:

Manager provides advice to hedge funds only –> has AUM of between $25M and $150M –> no registration with SEC or state (but will be an Exempt Reporting Adviser required to submit a truncated Form ADV by March 30,2012)

Manager provides advice to hedge funds only –> has AUM of over $150M –> registration with SEC required

Manager provides advice to hedge funds and separate accounts –> has AUM of at least $25M –> registration with SEC required

Managers should note that if they are initially commencing operations they will need to follow the new regulations immediately.

Next Steps for New York Managers

New York based managers who fall within the Mid-Sized category and will need to start making preparations with respect to registering as an investment adviser with the SEC. The deadline for registration with the SEC will be March 30, 2012.

The SEC FAQ on Mid-Sized Advisers is reprinted in full below and can be found

here.

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Division of Investment Management:

Frequently Asked Questions Regarding Mid-Sized Advisers

What is a “mid-sized adviser”?

A “mid-sized adviser” is an investment adviser that has between $25 million and $100 million of assets under management.

Are mid-sized advisers required to register with the Securities and Exchange Commission?

After July 21, 2011, a mid-sized adviser must register with the Securities and Exchange Commission if it:

i. is not required to be registered as an adviser with the state securities authority in the state where it maintains its principal office and place of business; or

ii. is not subject to examination as an adviser by the state where it maintains its principal office and place of business.

A mid-sized adviser that does not meet either one of these two requirements is prohibited from registering as an adviser with the Commission after July 21, 2011, but will have to register with the state securities authorities. There are a few exceptions to the general prohibition from SEC registration in rule 203A-2, such as for certain multi-state investment advisers and pension consultants. In addition, a mid-sized adviser that is required to register with the SEC, may elect to not register if it can rely on an exemption from registration, such as those for certain advisers to private funds.

In which states would a mid-sized adviser not be “subject to examination” by the state securities authority?

New York or Wyoming.

A mid-sized adviser with its principal office and place of business in either of those states is not “subject to examination” by the state securities authority and would have to register with the SEC. A mid-sized adviser with its principal office and place of business in any other state is “subject to examination.” This information will be updated promptly upon notification by a state securities authority of any change to examination status.

How does a mid-sized adviser determine if it is “required to be registered” in the state where it maintains its principal office and place of business?

A mid-sized adviser should consult the investment adviser laws or the state securities authority for that state to determine if it is required to register as an investment adviser in that state.

When is a mid-sized adviser that is no longer eligible for Commission registration required to switch to state registration?

A mid-sized adviser registered with the Commission as of July 21, 2011 must remain registered with the Commission until January 1, 2012 (unless an exemption from Commission registration is available). Each adviser registered with the Commission on January 1, 2012 must file an amendment to its Form ADV no later than March 30, 2012, which for most advisers will be their annual updating amendment. A mid-sized adviser that is no longer eligible for Commission registration will need to be registered with the state securities authorities by June 28, 2012, and must withdraw its Commission registration by filing Form ADV-W, indicating it is filing a “partial withdrawal,” no later than that date.

The adopting release amending Form ADV, dated June 22, 2011 (the “Adopting Release”) can be found at:http://www.sec.gov/rules/final/2011/ia-3221.pdf .

Amended Form ADV can be found at:http://www.sec.gov/rules/final/2011/ia-3221-appd.pdf .

Amended Form ADV instructions can be found at:http://www.sec.gov/rules/final/2011/ia-3221-appa.pdf andhttp://www.sec.gov/rules/final/2011/ia-3221-appb.pdf .

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Cole-Frieman & Mallon LLP is a law firm which provides advice hedge fund managers on state registration and compliance matters. Bart Mallon can be reached directly at 415-868-5345; Karl Cole-Frieman can be reached at 415-352-2300.

Stop Tax Haven Abuse Act Introduced by Senator Levin

Bill Would Have Significant Impact on Private Funds

On July 12, 2011, United States Senator Carl Levin (D – Michigan) introduced the Stop Tax Haven Abuse Act of 2011 (the “Bill”). A prior version of the Bill was introduced in 2009. The Bill contains several provisions of interest to private fund managers, including provisions that:

Treat foreign corporations whose management and control occur primarily in the United States as U.S. domestic corporations for income tax purposes;
Clarify under the Foreign Account Tax Compliance Act (“FATCA”) when foreign financial institutions and U.S. persons must report foreign financial accounts to the IRS;
Treat Credit Default Swap (“CDS”) payments sent offshore from the United States as taxable U.S. source income; and
Require Anti-Money Laundering (“AML”) programs for hedge funds, private equity funds, and formation agents to ensure screening of offshore clients.

The Bill also authorizes the Treasury Secretary to take special measures against foreign jurisdictions or financial institutions that impeded U.S. tax enforcement as well as imposes additional disclosure requirements on multinational corporations by requiring them to include basic information on a country-by-country basis in their filings with the SEC. Notably, the Bill does not include a controversial proposal in the 2009 bill that specifically identified 34 “Offshore Secrecy Jurisdictions,” including the Cayman Islands and British Virgin Islands.

Foreign Corporations Treated as Domestic Corporations

Section 103 of the Bill prevents companies that are run from the United States from claiming foreign tax status if those foreign corporations

have gross assets of $50 million or more. The provisions indicate that gross assets includes “assets under management for investors, whether held directly or indirectly.” For corporations primarily holding investment assets, the management and control is treated as occurring primarily in the United States if “decisions about how to invest the assets are made in the United States.” These provisions if enacted could potentially eliminate any benefits of establishing offshore funds, which are primarily established for offshore and U.S. tax-exempt investors.

Strengthening FATCA Provisions

The U.S. Foreign Account Tax Compliance Act (“FATCA”) imposes a 30% withholding tax on U.S. persons holding offshore accounts on certain “withholdable payments” to “foreign financial institutions” which do not provide information about their U.S. accounts to the Internal Revenue Service. A “withholdable payment” is generally any U.S. source income, such as interest, dividends, rents, royalties and other fixed or determinable income (“FDAP”). Non-U.S. private funds will generally qualify as foreign financial institutions (“FFI”). In order for an offshore fund to avoid withholding, it must enter into an agreement with the U.S. Treasury to identify its U.S. investors, if there are any.

Section 102 of the Bill would expand the definition of a foreign financial institution to include entities that engage in derivative transactions. Section 102 also creates presumptions of U.S. control for purposes of certain legal proceedings for entities with accounts opened at non-FATCA institutions when those entities are established by or receive assets from U.S. persons.

Treatment of Credit Default Swaps

Existing tax laws allow CDS payments to avoid taxation if sent from the United States to persons offshore, such as an offshore hedge fund or foreign bank. Section 104 of the Bill would treat CDS payments sent offshore from the United States as taxable U.S. source income.

Anti-Money Laundering Programs for Hedge Funds

Sections 203 and 204 of the Bill would impose anti-money laundering requirements on unregistered investment companies, including hedge funds and private equity funds, and formation agents. Hedge funds would be required to establish AML programs; ascertain the identity of investors, including beneficial owners of foreign entities; and submit suspicious activity reports. Agents engaged in the business of forming corporations or other legal entities would also be required to establish AML programs.

Our Thoughts

The Bill will still need to survive a vote by both the Senate and the House and ultimately be signed by the President before becoming law. There is likely to be some time before this Bill moves forward (especially considering the current focus on the debt ceiling) which means plenty of time for the industry to lobby against this effort. However, the bill highlights the unpopularity of the investment management industry with certain members of Congress and it is no surprise we see proposed taxing provisions- the U.S. needs more tax revenue and investment managers are an easy group to target. We see this every couple of years when various members of Congress propose to increase the carried interest for fund managers. It will be interesting to see how this plays out and we will provide periodic updates on the situation.

For more information about the Bill, refer to Senator Levin’s July 12, 2011 press release. Senator Levin has also released a summary of the bill as well as his floor statement introducing the bill.

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Cole-Frieman & Mallon LLP is a law firm which provides advice with respect to domestic and offshore hedge fund operations. Bart Mallon can be reached directly at 415-868-5345; Karl Cole-Frieman can be reached at 415-352-2300.

Private Equity Fund Manager Registration Exemption Approved by House Committee