Below is our end of year checklist we send out to our mailing list. If you would like to be added to the mailing list, please contact us here.
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December 14, 2012
Clients and Friends:
December is the busiest month of the year for most hedge fund managers. In addition to all of the administrative details involved in closing out the year, the regulatory landscape has shifted dramatically over the past year. As a result, year-end processes and 2013 planning are particularly important, especially for General Counsels, Chief Compliance Officers and key operations and financial personnel. We have updated our own year-end checklist to help managers stay on top of these priorities.
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Adviser Registration:
Form ADV Annual Amendment. Registered investment advisers, or managers filing as exempt reporting advisers (an “ERA”), with the SEC or a state securities authority must file an annual amendment to Form ADV within 90 days of the end of their fiscal year. Registered investment advisers 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”. Note that for private fund managers, a “client” for purposes of this rule is the fund.
Switching to/from SEC Regulation.
SEC Registration. Managers who no longer qualify for SEC registration as of the time of filing the annual amendment must withdraw from SEC registration within 180 days after the end of their fiscal year by filing Form ADV-W. Mangers should consult their state securities authority to determine if they are required to register in the state. Managers who are required to register with the SEC as of their annual amendment must register with the SEC within 90 days of filing the annual amendment.
Exempt Reporting Advisers. Managers who no longer meet the definition of an ERA will need to submit a final report as an ERA and apply for registration with the SEC or the state securities authority, if necessary, generally within 90 days after the filing of the annual amendment.
California Private Fund Adviser Exemption. The California private fund adviser exemption (“Private Fund Adviser Exemption”) is available to advisers who provide advice solely to “qualifying private funds,” which include venture capital funds, Section 3(c)(1) funds and Section 3(c)(7) funds. Advisers who qualify for the Private Fund Adviser Exemption and manage less than $100 million can file as an ERA in California and avoid registration and compliance requirements.
CFTC Matters:
Expanded CFTC Regulation. As of October 12, 2012 an investment manager that trades certain swaps will be subject to regulation by the CFTC, even if the manager does not trade futures or commodity interests. Managers should review the recently expanded list of CFTC regulated products to determine whether they will be subject to CFTC regulation. Managers subject to CFTC regulation will need to evaluate whether they are eligible for an exemption or need to register with the CFTC by December 31, 2012.
Annual Re-Certification of CFTC Exemptions. CPOs and CTAs currently relying on exemptions from registration with the CFTC will be required to re-certify their eligibility by December 31, 2012. CPOs currently relying on CFTC Regulation 4.13(a)(3) will need to evaluate whether the commodity pool is still eligible for the exemption when taking into account the new CFTC regulated products. Managers who had previously relied on the 4.13(a)(4) exemption from CPO registration will need to determine whether they are eligible to rely on another exemption or will need to register with the CFTC by December 31, 2012.
CPO and CTA Annual Updates. Registered CPOs and CTAs must prepare and file Annual Questionnaires and Annual Registration Updates with the NFA, as well as submit payment for annual maintenance fees and NFA membership dues. Registered CPOs must also prepare and file an annual report for each commodity pool. Unless eligible to claim relief under Regulation 4.7, registered CPOs and CTAs must update their disclosure documents periodically, as they may not use any document dated more than 9 months prior to the date of its intended use. Disclosure documents that are materially inaccurate or incomplete must be promptly corrected and the correction must be promptly distributed to pool participants.
General Regulatory Matters:
New Issue Status. On an annual basis, a manager needs to confirm or reconfirm the eligibility of investors that participate in initial public offerings or new issues. Most managers reconfirm this via negative consent, i.e., investors are informed of their status as on file with the manager and asked to inform the manager of any changes. No response operates as consent to the current status.
ERISA Status. Given the significant problems that can occur from not properly tracking ERISA investors, we recommend that managers also confirm or reconfirm on an annual basis the ERISA status of its investors. This is particularly important for managers that track the underlying percentage or ERISA funds for each investor. This reconfirmation can also be obtained through a negative consent.
Annual Privacy Policy Notice. On an annual basis, a registered investment adviser must also provide its investors with a copy of its privacy policy, even if there are no changes to the policy.
Annual Compliance Review. On an annual basis, the Chief Compliance Officer (“CCO”) of a registered investment adviser must conduct an annual review of the manager’s compliance policies and procedures. This annual compliance review should be in writing and presented to senior management. We recommend that you discuss the annual review with your outside counsel, who can provide guidance about the review as well as a template for the assessment and documentation. Managers should be careful that sensitive conversations regarding the annual review are protected by attorney-client privilege. CCOs may also want to consider additions to the compliance program. Managers who are not registered may still wish to review their procedures and/or implement a compliance program as a best practice.
Trade Errors. Managers should make sure that all trade errors are addressed by the end of the year pursuant to the manager’s polices regarding trade errors. Documentation of trade errors should be finalized, and if the manager is required to reimburse the funds, 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.
Custody Rule Annual Audit. SEC registered advisers must comply with certain 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.
Advisers to pooled investment vehicles may avoid both the quarterly statements and surprise examination requirements by having audited financial statements prepared in accordance with GAAP by an independent public accountant registered with the Public Company Accounting Oversight Board. Statements must be sent to the fund or, in certain cases, investors in the fund, within 120 days after the fund’s fiscal year end. Managers should review their custody procedures to ensure compliance with the rules. Requirements for state-registrants may differ, and we encourage you to contact us if you have any questions or concerns about your custody arrangements.
Schedule 13G/D and Section 16 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 13G. Schedule 13G filings are updated annually within 45 days of the end of the year. For managers who are also filing Schedule 13D and/or Section 16 filings, this is an opportune time to review your filings to confirm compliance and anticipate needs for Q1.
Form 13F. A manager must also file a Form 13F if it exercises investment discretion with respect to $100 million or more in certain securities within 45 days after the end of the year in which the manager reaches the $100 million filing threshold. The SEC lists the securities subject to 13F reporting on its website.
Form 13H. Managers who meet the SEC’s large trader thresholds (in general, 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 the threshold. Large traders will need to file amended annually within 45 days of the end of the year. In addition, changes to the information on 13H will require interim amendments following the calendar quarter in which the change occurred.
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 renewal requirements. States are increasingly imposing late fees or rejecting late filings altogether. Accordingly, it is critical to stay on top of filing deadlines for both new investors and any renewals.
SEC Form D. Form D filings for most funds need to be amended on an annual basis, on or before the anniversary of the initial SEC Form D filing. Copies of Form D can be obtained by potential investors via the SEC’s website.
IARD Annual Fees. Preliminary annual renewal fees for state registered and SEC registered investment advisers were due by December 13, 2012. Managers filing after the deadline will likely be subject to additional late filing fees and these must be paid through the IARD by February 1, 2013.
Pay-to-Play Rules. In 2010, the SEC adopted Rule 206(4)-5, which disqualified 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 political contributions. State and local governments are following suit, including California, which requires such persons to register with the state as lobbyists and mandates lobbyist registration in California’s cities and counties. We recommend reviewing your reporting requirements to make sure you are in compliance with the rules.
Form PF. Managers to private funds that are either registered with the SEC or required to be registered with the SEC began filing Form PF earlier this year. Managers to private funds with less than $5 billion in regulatory AUM will need to make Form PF filings with the SEC beginning on December 15, 2012, on either a quarterly or annual basis, depending on the types of private funds managed and regulatory AUM.
Foreign Tax Compliance Act (“FATCA”). FATCA will require certain financial institutions to identify and disclose direct and indirect U.S. investors and withhold U.S. income tax on nonresident aliens and foreign corporations, or be subject to a 30% FATCA tax. Foreign financial institutions, which include hedge funds, funds of funds, commodity pools and other offshore investment vehicles, will be required to enter into an agreement with the IRS (an “FFI Agreement”) by January 1, 2014 to avoid being subject to the FATCA tax. Domestic funds will also be required to determine the FATCA status of their investors and will need to institute specific withholding and reporting procedures for recalcitrant investors. Managers should discuss FATCA compliance methods with their administrators and other third party service providers to ensure proper document collection and due diligence procedures. Managers may want to update their documents to include FATCA disclosure and representations.
Jumpstart Our Business Startups Act (“JOBS Act”). The JOBS Act, enacted earlier this year, directed the SEC to remove the prohibitions on general solicitation or general advertising for certain private securities offerings. The proposed rule amendments, which are still awaiting final approval by the SEC, would allow issuers to use general solicitation and general advertising to offer securities, provided that the issuer takes reasonable steps to verify that the purchasers of the securities are accredited investors. Managers should remember that while general solicitations may be allowable in the future, these rules are not yet final. In addition, all registered investment advisers will still be subject to applicable advertising regulations under the Investment Advisers Act. CFTC registered managers are still subject to certain CFTC regulations that prohibit marketing to the public, and managers that intend to rely on the 4.13(a)(3) “de minimus” exemption (discussed above) are also prohibited from marketing to the public.
Other Fund Matters:
Wash Sales. Managers should carefully manage wash sales for year end. Failure to do so could result in embarrassing 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 the unwinding positions so as 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 shall pay careful attention to the liquidation procedures in the managed account agreement and the fund constituent documents.
NAV Triggers and Waivers. Managers should promptly seek waivers of any termination events that may be triggered by redemptions, performance or a combination of redemptions and performance in a fund’s ISDA or other counterparty agreement at the end of the year (NAV declines are typically included in these provisions).
Fund Expenses. Managers should wrap up all fund expenses for 2012 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.
Management Company Issues:
Management Company Expenses. Managers who distribute profits on an annual basis 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 important to reduce 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 not too late to put an annual review process in place.
Compensation Planning. In the hedge fund industry, and the financial services industry in general, the end of the year is the appropriate time to make adjustments to the compensation program. Since 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 program should be effective on the first of the year. Make sure that partnership agreements and operating agreements are appropriately updated to reflect such changes.
Insurance. If a manager carries D&O Insurance or other liability insurance, the policy should be reviewed on an annual basis to make sure that the manager has provided notice to the carrier of all claims and all potential claims. Also, newly launched funds should be added to the policy as appropriate.
Please feel free to reach out to us if you have any questions regarding your end-of-the-year compliance. We wish you all the best as 2012 comes to a close.
Sincerely,
Karl Cole-Frieman & Bart Mallon
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Cole-Frieman & Mallon LLP is a premier boutique investment management law firm, providing top-tier, responsive and cost-effective legal solutions for financial services matters. Headquartered in San Francisco, Cole-Frieman & Mallon LLP has an international practice that services both start-up investment managers as well as multi-billion dollar firms. The firm provides a full suite of legal services to the investment management community, including: hedge fund, private equity fund, and venture capital fund formation, adviser registration, counterparty documentation, SEC, CFTC, NFA and FINRA matters, seed deals, hedge fund due diligence, employment and compensation matters, and routine business matters. The firm also publishes the prominent Hedge Fund Law Blog (www.hedgefundlawblog.com) which focuses on legal issues that impact the hedge fund community. For more information please visit us at: www.colefrieman.com.