Author Archives: Hedge Fund Lawyer

Important Hedge Fund Articles

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As of the date we published this list of important hedge fund articles, the Hedge Fund Law Blog has over 600 posts.  In order to highlight some of the more important items on this website we have created the following list of articles which we think will be useful for most of our readers.  Articles without links will be forthcoming and we look forward to hearing your feedback on what information you would like to see in the future.  The categories include:

  1. Basics & Structure
  2. Offering Documents
  3. Service Providers
  4. Investment Adviser Regulation
  5. Futures & Commodities Regulation
  6. Marketing & Advertising
  7. Operational Issues

We would also like to remind managers who are thinking of starting a fund to view our Start Up Presentation.

BASICS & STRUCTURE

OFFERING DOCUMENTS

INVESTMENT ADVISER

FUTURES & COMMODITIES

MARKETING & ADVERTISING

OPERATIONAL ISSUES

ERISA

LAWS & REGULATIONS

OTHER ISSUES

FOREX

COLE-FRIEMAN & MALLON LLP QUARTERLY NEWSLETTERS

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Cole-Frieman & Mallon LLP, a hedge fund law firm, sponsors the Hedge Fund Law Blog.  Bart Mallon, Esq. can be reached directly at 415-868-5345.

Litigation Statement for CTA and CPO Disclosure Documents

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One of the more important requirements with respect to drafting the CTA and CPO Disclosure Documents is making sure that all appropriate litigation statements are included in the documents.  Under CFTC Regulations 4.24 (CPOs) and 4.34 (CTAs) the manager is required to disclose the litigation history of: (i) the management company, (ii) principals of the management company and (iii) the FCM and IB.  While (i) and (ii) are generally going to be easy to prepare, getting the litigation history for the FCM and IB will be dependent on the FCM and IB providing the manager or the manager’s attorney with a litigation statement.  Some FCMs and IBs do not have a litigation history and a statement to that effect will need to be included in the disclosure documents.

Below we have included more information on this requirement from the NFA Disclosure Document Guide and we have included the text of the CFTC Regulations.

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From the NFA guide to disclosure documents:

Litigation

The Document must disclose any material administrative, civil or criminal action, whether pending or concluded, within five years preceding the date of the Document, against the following persons (a concluded action that resulted in adjudication on the merits in favor of such person need not be disclosed):

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• The pool’s FCM and IBs, if any.

With respect to an FCM or an IB, an action is material if:

• The action would be required to be disclosed in the notes to the FCM’s or IB’s financial statements prepared pursuant to generally accepted accounting principles;

• The action was brought by the Commission (unless the action was concluded, did not result in civil monetary penalties exceeding $50,000, and did not involve allegations of fraud or other willful misconduct); or

• The action was brought by any other federal or state regulatory agency, a non-United States regulatory agency or a self-regulatory organization and involved allegations of fraud or other willful misconduct.

Where a matter is material, its description must include a recital of the nature of the action, the parties involved, the allegations or findings, the status of the action and the size of any fine or settlement.

Source: pages 34 and 35 of the disclosure document guide.

CFTC Regulation 4.24(l)

Litigation.

(1) Subject to the provisions of §4.24(l)(2), any material administrative, civil or criminal action, whether pending or concluded, within five years preceding the date of the Document, against any of the following persons; Provided, however, that a concluded action that resulted in an adjudication on the merits in favor of such person need not be disclosed:

(i) The commodity pool operator, the pool’s trading manager, if any, the pool’s major commodity trading advisors, and the operators of the pool’s major investee pools;

(ii) Any principal of the foregoing; and

(iii) The pool’s futures commission merchants and introducing brokers, if any.

CFTC Regulation 4.34(k)

Litigation.

(1) Subject to the provisions of §4.34(k)(2), any material administrative, civil or criminal action, whether pending or concluded, within five years preceding the date of the Document, against any of the following persons; Provided, however, that a concluded action that resulted in an adjudication on the merits in favor of such person need not be disclosed:

(i) The commodity trading advisor and any principal thereof:

(ii) Any futures commission merchant with which the client will be required to maintain its commodity interest account; and

(iii) Any introducing broker through which the client will be required to introduce its account to the futures commission merchant.

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Cole-Frieman & Mallon LLP provides comprehensive hedge fund start up and regulatory support for commodity pool operators.  Bart Mallon, Esq. can be reached directly at 415-868-5345.

Bart Mallon Quoted in Wall Street Journal on Hedge Fund Registration

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(www.hedgefundlawblog.com)

In an article published today in the Wall Street Journal, Bart Mallon of Cole-Frieman & Mallon LLP was quoted discussing the current and future role of the state securities divisions with respect to hedge funds.  After the implementation of the new SEC registration thresholds under Dodd-Frank, previously SEC registered hedge fund managers will be required to de-register from the SEC and register with the states.  Outside of the logistical hurdles involved with this process, the central issue for managers and investors is whether the states have the resources or expertise to deal with an increased workload.  This is an especially important question as more and more states like California face budget shortfalls and institute furlough days.

For more information on this specific topic, please see our survey on state securities divisions which includes information on number of examiners, number of furlough days, and the frequency of audits of investment advisers.

The Wall Street Journal article can be found here.

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Other related hedge fund law articles:

Cole-Frieman & Mallon LLP provides legal support and hedge fund start up services to all types of investment managers.  Bart Mallon, Esq. can be reached directly at 415-868-5345.

Costs to Complete New Form ADV Part 2

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SEC Estimates Preparation Costs of $3,000 to $5,000 for SEC Registered Advisers

We have been reviewing the SEC release related to the amendments to Form ADV Part 2.  Specifically we were interested, like many managers, in the amount of time it will likely take to complete the new Part 2.  Unlike the old Part 2, which was mostly check the box answers along with a Schedule F which required some prose, the new Part 2 will be in full “plain English” prose.  While most SEC registered firms have not yet begun the process to switch to the new Part 2, such advisers will likely begin the process soon and will want to know how much it will cost to complete new Part 2.

According to the SEC, most small and mid-sized SEC registered investment advisers will likely pay anywhere from $3,000 to $5,000 to have a law firm or compliance group complete the new Part 2 on their behalf.  Additionally, many states will be requiring new Part 2 so this means that state registered investment advisers will likely need to budget for these expected compliance costs.  Below we have reprinted the discussion from the release which specifically discusses the costs involved.

Please note that Mallon P.C. can help registered investment advisers complete new Form ADV Part 2.

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Release No. IA-3060; File No. S7-10-00
Amendments to Form ADV

Starting at page 84

We estimate that some advisers may incur a one-time initial cost for outside legal and compliance consulting fees in connection with preparation of Part 2 of Form ADV. While we received no specific comments on our estimate regarding outside legal costs in the Proposing Release, one commenter did state that compliance consultants assist a significant percentage of advisers in preparing their Form ADV.  As a result, we are changing our estimate to reflect a quarter of small advisers using compliance consulting services and a quarter of small advisers using outside legal services and to reflect half of medium advisers using compliance consulting services in lieu of outside legal services and a quarter of medium advisers still using outside legal services. We estimate that the initial per adviser cost for legal services related to preparation of Part 2 of Form ADV would be $3,200 for small advisers, $4,400 for medium-sized advisers, and $10,400 for larger advisers. [324]

[324] Outside legal fees are in addition to the projected hourly per adviser burden discussed above. $400 per hour for legal services x 8 hours per small adviser = $3,200. $400 per hour for legal services x 11 hours per medium-sized adviser = $4,400. $400 per hour for legal services x 26 hours per large adviser = $10,400. The hourly cost estimate of $400 on average is based on our consultation with advisers and law firms who regularly assist them in compliance matters.

We estimate that the initial per adviser cost for compliance consulting services related to initial preparation of the amended Form ADV will range from $3,000 for smaller advisers to $5,000 for medium-sized advisers.[325]

[325] Outside compliance consulting fees are in addition to the projected hourly per adviser burden discussed above. Based on consultation with compliance consulting firms who regularly assist investment advisers in Form ADV preparation, we estimate that small advisers will incur expenses of $3000 per year for the initial preparation of the new Form ADV and medium advisers will incur expenses of $5000 per year for the initial preparation of the new Form ADV.

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Other related hedge fund law articles:

Cole-Frieman & Mallon LLP provides legal support and hedge fund compliance services to all types of investment managers.  Bart Mallon, Esq. can be reached directly at 415-868-5345.

States Securities Divisions Amending Securities Regulations Post Dodd-Frank

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Washington State Proposes Amendment to Definitions

The Dodd-Frank bill has certainly created new responsibilities for the SEC and CFTC.  Also affected are the state securities divisions which have laws and regulations referencing, or based on, various federal securities laws.  Because federal laws have changed under Dodd-Frank, the state securities laws (generally known as “Blue Sky” laws) will eventually need to be amended as well.  Over the coming months we will see various state securities divisions propose changes to regulations designed to correspond to the new laws under Dodd-Frank.  One state, Washington (which is known to have a good securities division), has recently proposed rules to “amend the definition of “accredited investor” contained in its rules to conform to federal law through expedited rule making.”

Additionally, we may see state legislatures rewriting large parts of their securities laws to correspond with the changes at the federal level.  Such effort may be coordinated by NASAA or through another iteration of the Uniform Securities Act.

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Other related hedge fund law articles:

Cole-Frieman & Mallon LLP provides legal support and hedge fund compliance services to all types of investment managers.  Bart Mallon, Esq. can be reached directly at 415-868-5345.

NFA Changes Post CFTC Audit

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The results of the CFTC’s audit of the NFA were released a few weeks ago and we have already begun to see a few changes to the way the NFA operates.

Access to BASIC Security Manager

Previously newly formed entities which were registering with the CFTC could start the registration process prior to formally being established.  Now, the NFA must have proof that the entity is in existence prior to granting security manager status.  Accordingly, groups wishing to register must wait until the entity is in existence and then submit the security manager form.  This will usually delay an initial application by about a week. We believe it would be more effective if the NFA made sure that the entity was established prior to submitting a registration application.  Absent such procedures, we believe that the security manager process should be streamlined and that access should be granted next day via email.  There is no good reason to have such a slow process just to access the online registration system.

Client withdrawals from account

Previously it was common for some CTAs to have some sort of lock-up period with respect to a trading program.   Now, the NFA will not allow a CTA to have a lock-up period because the client is always able to go to the FCM and cancel the account.  While from a technical perspective the client always has access to its own account and the CTA can’t control access to the account, many CTAs preferred the implicit protection afforded through the contractual agreement that the account would stay open during the lock-up.   By not allowing the lock-up language, CTAs will potentially be subject to greater and more frequent withdrawals from investors.

Revising Disclosure Documents

Many NFA Member firms will find out about the various new NFA procedures during the disclosure document revision process.  Moving forward, various deficiencies with disclosure documents that have been approved by the NFA in the past will need to be fixed (even though the documents were previously approved) as the managers revise the documents and seek instant filing or regular filing.

Please let us know if you have experienced any other changes with the NFA.

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Other related hedge fund law articles:

Cole-Frieman & Mallon LLP provides comprehensive hedge fund start up and regulatory support for commodity pool operators.  Bart Mallon, Esq. can be reached directly at 415-868-5345.

NFA Registration for Forex Managers with a Disciplinary Record

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In January 2010, the CFTC proposed rules regarding regulation of retail off-exchange foreign currency (forex) products.  It received over 9,000 comments relating to the forex rules and will start publishing final rules this fall. One component of the proposed rules requires all forex account managers and pool operators to register with the CFTC as forex CTAs and CPOs and to become NFA Members.  For those forex managers with criminal disclosures, a concern is how long it will take to get through the registration process and what registration will entail.

This article describes the registration process for forex managers with disciplinary disclosures and the issues they will likely face.

Anticipated Forex Registration Process

The forex registration procedures are likely going to be the same as those currently in place for regular CPOs and CTAs.  CPOs and CTAs must file the following:

  • a completed online Form 7-R (including NFA membership sections)
  • a non-refundable application fee
  • CPO/CTA Membership Dues

Principals and Associated Persons of a CPO or CTA must also file the following:

  • a completed online Form 8-R
  • Fingerprint Cards
  • Proficiency Requirements (e.g. Series 3)
  • a non-refundable Principal Application Fee
  • a non-refundable Associated Person Application Fee

In addition to providing the application materials discussed above, forex managers will likely have to meet regulatory exam requirements–the Series 34 and Series 3 exams.

Disciplinary Disclosures on Forms 7-R and 8-R

On Forms 7-R and 8-R, the manager must provide disciplinary information for the firm, the Principals, and the Associated Persons.  This includes criminal disclosures, regulatory disclosures, and financial disclosures.  The NFA has indicated that if any of the disciplinary information disclosed is a disqualification from registration under Sections 8a(2) or 8a(3) of the Commodity Exchange Act, the application will probably be reviewed by an internal NFA committee.

Disqualifications under Sections 8a(2) and (3) include, for example:

  • suspension or revocation of prior NFA registration
  • a permanent or temporary injunction from (i) acting as an FCM, IB, floor broker, floor trader, CTA, CPO, associated person, securities broker, etc.; or (ii) activity involving embezzlement, theft, extortion, fraud, misappropriation of funds, etc.
  • a conviction within 10 years for a felony that (i) involves transactions or advice concerning futures contracts; (ii) arises out of the conduct of the business of an FCM, IB, floor broker, CTA, CPO, etc.; or (iii) involves embezzlement, theft, extortion, fraud, misappropriation of funds, securities or property, forgery, etc.
  • a finding, by a federal or state regulatory body, that the manager has violated various securities and commodities laws

It is important to disclose all disciplinary matters.  Failure to disclose such matters could be an additional ground for disqualification from registration.  It is also important that if the forex manager answers “Yes” to any of the disciplinary information questions, he or she provides a written explanation detailing the events and conduct involved.  In addition to this explanation, other documents may also be required by the NFA (e.g. court records).  Failure to provide the additional documentation will inevitably delay the registration process.

Providing Additional Documents for Criminal Matters

If a criminal matter is disclosed, the NFA will want documents that reflect the following information:

  • the complaint;
  • the entry of a plea or plea agreement, or judgement/conviction;
  • the sentence;
  • proof that you completely satisfied your sentence; and
  • the final outcome of the court’s action .

It is probably best to request your entire court file so that the documents are available for the NFA.

Review by an Internal NFA Committee or Scheduling a Hearing

Upon receiving the application materials listed above (and any required supplemental documents (e.g. court records)), the reviewer will forward the case on to the internal NFA committee.  We spoke informally to an NFA reviewer who stated that the committee hears cases once a week, on a first-in, first-out basis.  That committee will review the circumstances of each disqualification independently and decide whether to approve registration or to recommend a proceeding to deny registration.  The NFA reviewer we spoke to said that a decision by this committee is generally made within 24 hours.  Upon approval, the firm will appear on the NFA’s BASIC search engine.  If the application is denied, a denial letter is sent to the manager.  A hearing can then be scheduled with the legal department and additional information regarding the registration may be provided.

At the end of the hearing, the registration is essentially either denied, approved, or approved with conditions.  It is difficult to predict the amount of time it would take for a forex manager with a criminal record to get through the NFA registration process.  If supplemental documents (e.g. court records) are missing, the reviewer will have to send deficiency letters to the manager, which will delay the registration process.

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Cole-Frieman & Mallon LLP provides legal support and forex registration services to forex managers.  Bart Mallon, Esq. can be reached directly at 415-868-5345.

Form ADV Part 2 and State Registration

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A couple of weeks ago the SEC announced that they approved certain updates for Form ADV Part 2 .  While these forms will be required for managers who are subject to registration with the SEC (under the new rules, those managers with either $100 or $150 million of assets under management depending on the circumstance), the states are still determining how they are going to handle new Part 2.  We have done a preliminary investigation by calling a number of the more popular states and found that most states are planning to implement new Part 2, but are not sure when the requirement will be finalized.  From our research, Texas is the only state that has set a date for implementation of new Part 2.

The list of states is below.  We will continue to update this list.

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  • Arizona – will require but not sure starting when
  • California – will require but not sure when
  • Colorado – will require but not sure starting when
  • Connecticut – discussing now and will have a decision at the end of the month
  • Illinois – will require but not sure starting when
  • Massachusetts – will require but not sure starting when
  • Texas – will require starting 01/11

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Other related hedge fund law articles:

Cole-Frieman & Mallon LLP provides legal support and hedge fund compliance services to all types of investment managers.  Bart Mallon, Esq. can be reached directly at 415-868-5345.

Emerging CTA Contest

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Futures Magazine Looks to Profile “Hot New CTAs”

Futures magazine is looking to profile new CTAs for their annual feature entitled “Hot New CTAs.”  The requirements for potential inclusion in the survey include:

  • have managed customer funds for at least one year as of the end of August
  • have less than $25 million of AUM
  • have a disclosure document
  • have an audited track record

If you are interested, you should pick up a copy of Futures magazine.  The deadline for submissions is August 20.

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Cole-Frieman & Mallon LLP provides legal support as well as CTA and CPO registration services to futures and commodities advisors.  Bart Mallon, Esq. can be reached directly at 415-868-5345.

Cole-Frieman & Mallon LLP Quarterly Newsletter | 2nd Quarter 2010

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Below is our quarterly newsletter.  If you would like to be added to our distribution list, please contact us.

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July 31, 2010
www.colefrieman.com

Clients and Friends,

We take this opportunity to provide you with a brief overview of the major items we have reported on over the last quarter.  While we are a little late with the newsletter, the past couple of weeks have been especially busy with the passage of the Dodd-Frank reform bill.  There will be continuous rulemaking and proposals over the course of the next 12 months and this newsletter will provide an overview of the issues which we will be discussing in the future.  Also, please be sure to skim the ongoing compliance update below to make sure your firm is up to date with compliance.

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Financial Reform Bill – The Dodd-Frank Wall Street Reform and Consumer Protection Act, signed by President Obama on July 21, 2010, will meaningfully change the investment management industry in a number of ways. Important changes include:

  • Manager Registration – Managers to hedge funds and private equity funds will generally be required to  register with the SEC by July 21, 2011 if they have $150 million or more in AUM.
  • Accredited Investor Definition – The definition of accredited investor has changed. Now, investors cannot include the value of their primary residence when computing net worth. The qualified client definition may also be changed in the future.
  • BD Fiduciary Standard – The SEC will study and potentially institute a fiduciary standard for broker-dealer representatives.
  • Increased State Regulation of Investment Advisers – Previously, the states only had jurisdiction over managers up to $25 million of AUM. Now the states have jurisdiction over managers with up to $100 million of AUM. We have provided our comments on the increase in state regulatory jurisdiction in light of state budget shortfalls.
  • Regulation of the OTC Derivatives Markets – Previously unregulated contacts (like credit default swaps) will be subject to a clearing requirement. There will be much written on this over the next few months as the CFTC and SEC begin establishing a framework for such clearing.
  • Imposition of Position Limits on Certain Commodities (see below)

In addition to the changes to the securities and commodities laws, there will be a number of rulemaking initiatives by both the SEC and CFTC which will augment the statutory language of the bill.

Busy, Busy SEC – Notwithstanding preparations for the Dodd-Frank bill, the SEC has been especially busy over the last quarter.  The big news was obviously the Goldman settlement, but there were a number of other SEC initiatives as well. These include:

New ADV Part 2 Released – The SEC just released the requirements for the new Form ADV Part 2 which will now be publicly available through the SEC’s Advisor Search program.  New Part 2 will require registered managers to provide a narrative of their investment program and other relevant information. Managers also need to provide investors with supplements detailing certain background information about the representative directing an investor’s account.  Most currently registered managers are required to post a new Part 2 during the first quarter of 2011.

Pay to Play Rule Adopted – The SEC adopted new Rule 206(4)-5 under the Investment Advisers Act prohibiting certain political contributions by investment advisory firms.  Firms are urged to update their compliance policies and procedures to account for the new rule.

Advisor Representative Disclosures – The SEC updated its Advisor Search program so that information on investment adviser representatives will now be publicly available online.  Prior to the update, disciplinary and other background information was only publicly available to the extent it was disclosed on the adviser’s Form ADV.

Futures/ Commodities Issues – Like the SEC, the CFTC has been very busy over the last quarter and will continue to be busy proposing rules under the Dodd-Frank bill. Accordingly, there are a number of interesting items concerning both the CFTC and NFA. These include:

Position Limits – Dodd-Frank mandates the CFTC to impose position limits across different markets including traditional futures markets, agricultural markets, and with respect to certain swap instruments. The CFTC will be releasing orders or proposed rules establishing limits within 180 days for energy commodities and within 270 days for agricultural commodities.  Position limits will affect commodities transactions that have previously qualified for broad statutory exemptions and traders will need to closely monitor trading activity to avoid violating the limits when they are established and implemented.

CFTC Releases Report on NFA – The CFTC audited the NFA in 2009 to gauge how successfully the self regulatory organization implemented certain CFTC regulations.  The CFTC noted a number of areas where the NFA should improve procedures.  We have already seen some of the suggestions implemented and, accordingly, the registration process (in certain instances) is taking a little longer than usual.

CTA & CPO Disclosure Document Bios – For CTAs and CPOs registering with the CFTC, one area where the NFA seems to spend considerable time is the biography portion of the disclosure documents.  Because of common deficiencies with respect to the biographies (or manager backgrounds), the NFA released guidance on how this part of a disclosure document should be completed.

Form 8-R Revised – Form 8-R applications for principal and associated person registration has been revised to include demographic information on the registrant.  The newly added information includes sex, race, eye color, hair color, height and weight.  The purpose of the additions was to help speed up the background check process for principals and associated persons.

NFA Forex Workshop Announced – In expectation of the CFTC finalizing the forex registration rules for forex CTAs, CPOs and IBs, the NFA is conducting a registration and compliance workshop for forex managers.  The workshop will take place on September 25th, 2010 at Caesar’s Palace in Las Vegas. NFA staff will be on hand to discuss the registration process and to take questions from managers.

Other Notes

Hedge Fund Carried Interest – Every few months the taxation of the carried interest becomes a political football.  Early in the quarter it looked like the carried interest tax would be changed as part of an unemployment extension bill.  However, that bill never passed and the proposal to tax the carried interest as ordinary income died.  We expect to probably hear another proposal like this in the next 12 to 18 months.

Hedge Fund Court Case – Earlier this year a court case was decided in favor of a hedge fund manager when that manager suspended redemptions and was subsequently sued by an investor.  We discussed the facts of the case and the manager takeaways.

Ongoing Compliance – At the end of every quarter, managers should take time to address any ongoing compliance matters.  Managers who are registered in any capacity (state, SEC or CFTC) should review their compliance calendar or policies and procedures to ensure that all quarterly compliance matters are completed.  Additionally managers should always be sure to complete all state blue sky filings and commodity pool operators should make sure they complete their Rule 2-46 quarterly filings.

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For assistance with any compliance, registration, or planning issues with respect to any of the above topics, please contact Bart Mallon of Mallon P.C. (www.mallonpc.com) at 415-868-5345 or [email protected].

Cole-Frieman & Mallon LLP is a hedge fund law firm with a national client base and is focused on the investment management industry.  Our clients include hedge fund managers, investment advisers, commodity advisors, and other investment managers.  We also provide general business and start up legal advice and have an emerging practice in real estate and cleantech.

150 Spear Street, Suite 825
San Francisco, CA 94105
Telephone: (415) 352-2300
Fax: (646) 619-4800