Author Archives: CFM Admin

Cole-Frieman & Mallon 2024 End of Year Update

December 13, 2024

Clients, Friends, and Associates:

As we near the end of 2024, we have highlighted in this update certain recent industry developments that will impact many of our clients. We have also developed a checklist to help managers effectively navigate the business and regulatory landscape for the coming year. While we strive to present an informative, albeit brief, overview of these topics, we are also available should you have any related questions.

This update includes the following:

CFM Items
Q4 Matters
Annual Compliance & Other Items
Annual Fund Matters
Annual Management Company Matters
Notable Regulatory & Other Items from 2024
Other Items
Compliance Calendar

****

CFM Items

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

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

****

Q4 Matters

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

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

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

****

Annual Compliance & Other Items

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

Annual Compliance Review. The Chief Compliance Officer (“CCO”) of an RIA must conduct a review of the RIA’s compliance policies and procedures annually. This annual compliance review should be in writing and presented to senior management. CCOs should consider additions, revisions, and updates to the compliance program as may be necessary. We recommend advisers discuss the annual review with their outside counsel or compliance ﬁrm to obtain guidance about the review process and a template for the assessment. Conversations regarding the annual review may raise sensitive matters, and advisers should ensure that these discussions are protected by attorney-client privilege. Advisers that are not registered may still wish to review their procedures and/or implement a compliance program as a best practice.

Form ADV Annual Amendment. RIAs or managers ﬁling as exempt reporting advisers (“ERAs”) with the SEC or a state securities authority must ﬁle an annual amendment to their Form ADV within 90 days of the end of their ﬁscal year. For most managers, the Form ADV amendment will be due on March 31, 2025. RIAs must provide a copy of the updated Form ADV Part 2A brochure and Part 2B brochure supplement (or a summary of changes with an oﬀer to provide the complete brochure) to each “client” and, if applicable, Part 3 (Form CRS: Client Relationship Summary) to each “retail investor” with whom the RIA has entered into an investment advisory contract. Note that for advisers who are SEC RIAs or California RIAs to private investment vehicles, a “client,” for purposes of this rule, refers to the vehicle(s) managed by the adviser and not the underlying investors. State-registered advisers should examine their states’ regulations to determine who constitutes a “client.” For purposes of the Form ADV Part 3, a “retail investor” means a natural person, or the legal representative of such natural person, who seeks to receive or receives services primarily for personal, family, or household purposes.

Switching to/from SEC Regulation.

SEC Registration. RIAs who no longer qualify for SEC registration as of the time of ﬁling the annual Form ADV amendment must withdraw from SEC registration within 180 days after the end of their ﬁscal year (the end of June 2025 for most managers) by ﬁling a Form ADV-W. Such managers should consult with legal counsel to determine whether they are required to register in the states in which they conduct business. ERAs or state-level RIAs who report regulatory assets under management on their annual amendment in excess of SEC registration thresholds must register with the SEC within 90 days of ﬁling the annual amendment (the end of June 2025, if the annual amendment is filed on March 31, 2025).

Exempt Reporting Advisers. Managers who exceed the assets under management thresholds to qualify as an ERA will need to submit a ﬁnal report as an ERA and apply for registration with the SEC or the relevant state securities authority, as applicable, generally within 90 days after the ﬁling of the annual amendment (the end of June 2025 for most managers, assuming the annual amendment is filed on March 31, 2025).

Custody Rule Annual Audit.

SEC RIAs to pooled investment vehicles may avoid both the quarterly statement and surprise examination requirements by having audited ﬁnancial statements prepared for each pooled investment vehicle in accordance with generally accepted accounting principles (“GAAP”) by an independent public accountant registered with the Public Company Accounting Oversight Board (“PCAOB”). Audited financial statements must be sent to investors in the fund within 120 days after the fund’s ﬁscal year-end (or for fund-of-fund clients, within 180 days after fiscal year-end). SEC RIAs should review their internal procedures to ensure compliance with the custody rules.

California RIAs. California registered investment advisers (“CA RIAs”) that manage pooled investment vehicles and are deemed to have custody of client assets are also subject to surprise examinations conducted by a certified public accountant. However, CA RIAs can avoid these additional requirements by engaging a PCAOB-registered auditor to prepare and distribute audited ﬁnancial statements to all beneficial owners of the pooled investment vehicle, and the Commissioner of the California Department of Financial Protection and Innovation (“DFPI”). Those CA RIAs that do not engage an auditor must, among other things: (i) provide notice of such custody on the Form ADV; (ii) maintain client assets with a qualiﬁed custodian; (iii) engage an independent party to act in the best interest of investors to review fees, expenses, and withdrawals; and (iv) retain an independent certiﬁed public accountant to conduct surprise examinations of assets.

Other State RIAs. Advisers registered in other states should consult their legal counsel about those states’ specific custody requirements.

California Minimum Net Worth Requirement and Financial Reports.

CA RIAs with Discretion. Every CA RIA (other than those also registered as broker-dealers) that has discretionary authority over client funds or securities, regardless of whether they have custody, must maintain a net worth of at least $10,000 (CA RIAs with custody are subject to heightened minimum net worth requirements discussed further below).

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

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

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

Trade Errors. Managers should ensure that all trade errors are properly addressed pursuant to the managers’ trade errors policies by the end of the year. Documentation of trade errors should be ﬁnalized, and if the manager is required to reimburse any of its funds or other clients, it should do so by year-end.

Soft Dollars. Managers that participate in soft dollar programs should make sure that they have addressed any commission balances from the previous year.

Schedule 13G/D Filings. Managers who exercise investment discretion over accounts (including funds and separately managed accounts) that are beneﬁcial owners of 5% or more of a registered voting equity security must report these positions on Schedule 13D or 13G. Passive investors are generally eligible to ﬁle the short-form Schedule 13G. The SEC adopted amendments to the Schedule 13D and 13G reporting deadlines which are now in effect. For managers who are also making Section 16 ﬁlings, this is an opportune time to review your ﬁlings to conﬁrm compliance and anticipate needs for the ﬁrst quarter. Schedule 13D is required when a manager is ineligible to ﬁle Schedule 13G and is due five days after acquiring more than 5% beneﬁcial ownership of a registered voting equity security. Any amendments to Schedule 13D must be filed within two business days. For Schedule 13G filers that are qualified institutional investors, the initial filing must be completed at the earlier of (x) 45 days after the end of the calendar quarter in which the filer’s beneficial ownership exceeds 5% at quarter-end or (y) five business days after the end of the first month in which the filer’s beneficial ownership exceeds 10% at month-end. For Schedule 13G filers that are passive investors, the initial filing must be completed within five business days after acquiring more than 5% beneficial ownership. For Schedule 13G filers that are exempt investors, the initial filing must be completed within 45 days after the end of the calendar quarter in which the filer’s beneficial ownership exceeds 5% at quarter-end. To the extent there are any material changes to the information last reported, an amendment to Schedule 13G must be filed within 45 days after the end of the calendar quarter. Qualified institutional investors will need to file an amendment to Schedule 13G (i) within five business days after the end of the first month in which the filer’s beneficial ownership exceeds 10% at month-end and (ii) thereafter, within five business days after the end of any month in which the filer’s month-end beneficial ownership increases or decreases by more than 5%. Passive investors will need to file an amendment to Schedule 13G (i) within two business days after acquiring greater than 10% beneficial ownership and (ii) thereafter, within two business days after the filer’s beneficial ownership increases or decreases by more than 5%.

Section 16 Filings. Section 16 ﬁlings are required for “corporate insiders” (including beneﬁcial owners of 10% or more of a registered voting equity security). An initial Form 3 is due within 10 days after becoming an “insider”; Form 4 reports ownership changes and is due by the end of the second business day after an ownership change; and Form 5 reports any transactions that should have been reported earlier on a Form 4 or were eligible for deferred reporting and is due within 45 days after the end of each fiscal year.

Form 13F. A manager must ﬁle a Form 13F if it exercises investment discretion with respect to $100 million or more in certain “Section 13F securities” within 45 days after the end of the year in which the manager reaches the $100 million ﬁling threshold. The SEC lists the securities subject to 13F reporting on its website.

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

Form 13H. Managers who meet one of the SEC’s large trader thresholds (generally, managers whose transactions in exchange-listed securities equal or exceed two million shares or $20 million during any calendar day, or 20 million shares or $200 million during any calendar month) are required to ﬁle an initial Form 13H with the SEC within 10 days of crossing a threshold. Large traders also need to amend Form 13H annually within 45 days of the end of the year. In addition, changes to the information on Form 13H will require interim amendments following the calendar quarter in which the change occurred.

Form PF. Managers to private funds that are either registered with the SEC or required to be registered with the SEC and that have at least $150 million in regulatory assets under management (“RAUM”) must ﬁle a Form PF. Private advisers with less than $1.5 billion in RAUM must ﬁle Form PF annually within 120 days of their ﬁscal year-end. Private advisers with $1.5 billion or more in RAUM must ﬁle Form PF within 60 days of the end of each fiscal quarter.

Form MA. Managers that provide advice on municipal financial products are considered “municipal advisors” by the SEC and must file a Form MA annually, within 90 days of their fiscal year-end.

SEC Form D. Form D ﬁlings for most funds need to be amended annually, on or before the anniversary of the most recently ﬁled Form D. Copies of Form D are publicly available on the SEC’s EDGAR website.

Blue Sky Filings. On an annual basis, a manager should review its blue sky ﬁlings for each state to make sure it has met any initial and renewal filing requirements. Several states impose late fees or reject late ﬁlings altogether. Accordingly, it is critical to stay on top of ﬁling deadlines for both new investors and renewals. We also recommend that managers review blue sky ﬁling submission requirements. Many states permit blue sky ﬁlings to be ﬁled electronically through the Electronic Filing Depository (“EFD”) system, and certain states will only accept ﬁlings through EFD.

IARD Annual Fees. Preliminary annual renewal fees for state-registered and SEC-registered investment advisers are due on December 9, 2024. Failure to submit electronic payments by the deadline may result in registrations terminating due to a “failure to renew.” If you have not already done so, you should submit full payment into your Renewal Account by E-Bill, check, or wire as soon as possible.

Pay-to-Play and Lobbyist Rules. SEC rules disqualify investment advisers, their key personnel, and placement agents acting on their behalf from seeking to be engaged by a governmental client if they have made certain political contributions. State and local governments have similar rules, including California, which requires internal sales professionals who meet the deﬁnition of “placement agents” (people who act for compensation as ﬁnders, solicitors, marketers, consultants, brokers, or other intermediaries in connection with oﬀering or selling investment advisory services to a state public retirement system in California) to register with the state as lobbyists and comply with California lobbyist reporting and regulatory requirements. Note that managers oﬀering or selling investment advisory services to local government entities must register as lobbyists in the applicable cities and counties. State laws on lobbyist registration diﬀer significantly, so managers should carefully review reporting requirements in the states in which they operate to make sure they comply with the relevant rules.

****

Annual Fund Matters

Wash Sales. Managers should carefully manage wash sales for year-end. Failure to do so could result in book/tax differences for investors. Certain dealers can provide managers with swap strategies to manage wash sales, including basket total return swaps and split strike forward conversion. These strategies should be considered carefully to make sure they are consistent with the investment objectives of the fund.

Redemption Management. Managers with signiﬁcant redemptions at the end of the year should carefully manage unwinding positions to minimize transaction costs in the current year (that could impact performance) and prevent transaction costs from impacting remaining investors in the next year. When closing funds or managed accounts, managers should pay careful attention to the liquidation procedures in the fund constituent documents and the managed account agreement.

NAV Triggers and Waivers. Managers should promptly seek waivers of any applicable termination events specified in a fund’s International Swaps and Derivatives Association or other counterparty agreement that may be triggered by redemptions, performance, or a combination of both at the end of the year (NAV declines are common counterparty agreement termination events).

Fund Expenses. Managers should wrap up all fund expenses for 2024 if they have not already done so. In particular, managers should contact their outside legal counsel to obtain accurate and up-to-date information about legal expenses for inclusion in the NAV for year-end performance.

Electronic Schedule K-1s. The Internal Revenue Service (“IRS”) authorizes partnerships and limited liability companies taxed as partnerships to issue Schedule K-1s to investors solely by electronic means, provided the partnership has received the investors’ aﬃrmative consent. States may have diﬀerent rules regarding electronic K-1s, and partnerships should check with their counsel whether they may be required to send hard copy state K-1s. Partnerships must also provide each investor with speciﬁc disclosures that include a description of the hardware and software necessary to access the electronic K-1s, how long the consent is eﬀective, and the procedures for withdrawing the consent. If you would like to send K-1s to your investors electronically, you should discuss your options with your service providers.

“Bad Actor” Recertiﬁcation Requirement. A security oﬀering cannot rely on the Rule 506 safe harbor from SEC registration if the issuer or its “covered persons” are “bad actors.” Fund managers must determine whether they are subject to the bad actor disqualiﬁcation any time they are oﬀering or selling securities in reliance on Rule 506. The SEC has advised that an issuer may reasonably rely on a covered person’s agreement to provide notice of a potential or actual bad actor triggering event pursuant to contractual covenants, bylaw requirements, or undertakings in a questionnaire or certiﬁcation. However, if an oﬀering is continuous, delayed, or long-lived, issuers must periodically update their factual inquiry through a bring-down of representations, questionnaires, certiﬁcations, negative consent letters, and reexamination of public databases or other means, depending on the circumstances. Fund managers should consult with counsel to determine how frequently such an update is required. As a matter of practice, most fund managers should perform these updates at least annually.

U.S. FATCA. Funds should monitor their compliance with the U.S. Foreign Account Tax Compliance Act, as amended (“FATCA”). Generally, FATCA reports are due to the IRS on March 31, 2025, or September 30, 2025, depending on where the fund is domiciled. However, reports may be required by an earlier date for jurisdictions that are parties to intergovernmental agreements (“IGAs”) with the U.S. Additionally, the U.S. may require that reports be submitted through the appropriate local tax authority in the applicable IGA jurisdiction, rather than the IRS. Given the varying FATCA requirements applicable to diﬀerent jurisdictions, managers should review and conﬁrm the speciﬁc FATCA reporting requirements that may apply. As a reminder, we strongly encourage managers to ﬁle the required reports and notiﬁcations, even if they already missed previous deadlines. Applicable jurisdictions may be increasing enforcement and monitoring of FATCA reporting and imposing penalties for each day late.

CRS. Funds should also monitor their compliance with the Organisation for Economic Cooperation and Development’s Common Reporting Standard (“CRS”). All “Financial Institutions” in the British Virgin Islands and the Cayman Islands must register with the respective jurisdiction’s Tax Information Authority and submit various reports with the applicable regulator via the associated online portal. Managers to funds domiciled in other jurisdictions should also conﬁrm whether any CRS reporting will be required in such jurisdictions and the procedures required to enroll and file annual reports. We recommend managers contact their tax advisors to stay on top of the U.S. FATCA and CRS requirements and avoid potential penalties.

****

Annual Management Company Matters

Employee Reviews. An eﬀective annual review process is vital to reduce the risk of employment-related litigation and protect the management company in the event of such litigation. Moreover, it is an opportunity to provide context for bonuses, compensation adjustments, employee goals, and other employee-facing matters at the ﬁrm. It is never too late to put an annual review process in place.

Compensation Planning. In the fund industry, and the ﬁnancial services industry in general, the end of the year is the appropriate time to adjust compensation programs. Because much of a manager’s revenue is tied to annual income from incentive fees, any changes to the management company structure, affiliated partnerships, or any shadow equity programs should be eﬀective on the ﬁrst of the year. Partnership agreements and operating agreements should be appropriately updated to reflect any such changes.

Insurance. If a manager carries director and officer or other liability insurance, the policy should be reviewed annually to ensure that the manager has provided notice to the carrier of all claims and all potential claims. Newly launched funds should also be added to the policy as necessary.

Other Tax Considerations. Fund managers should assess their overall tax position and consider several steps to optimize tax liability. Several steps are available to optimize tax liability, including: (i) changing the incentive fee to an incentive allocation; (ii) use of stock-settled stock appreciation rights; (iii) if appropriate, terminating swaps and realizing net losses; (iv) making a Section 481(a) election under the Internal Revenue Code of 1986, as amended (“Code”); (v) making a Section 475 election under the Code; and (vi) making charitable contributions. Managers should consult legal and tax professionals to evaluate whether any of these options are appropriate.

****

Notable Regulatory & Other Items from 2024

SEC Matters

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

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

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

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

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

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

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

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

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

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

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

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

CFTC Matters

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

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

Digital Asset Matters

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

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

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

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

Other Items

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

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

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

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

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

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

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

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

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

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

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

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

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

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

****

Compliance Calendar

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

December 9, 2024

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

January 10, 2025

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

January 15, 2025

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

January 31, 2025

“Annex IV” AIFMD filing.

February 14, 2025

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

March 1, 2025

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

March 31, 2025

Form ADV Annual Update Amendment. Deadline to update and file Form ADV Parts 1, 2A, 2B (and Form CRS, if applicable).

Periodic

Fund Managers should perform “Bad Actor” certifications annually.
Form D and Blue-Sky Filings should be current.
CPO/CTA Annual Questionnaires must be submitted annually, and promptly upon material information changes, through the NFA Annual Questionnaire system.

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

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

Sincerely,

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

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

Corporate Transparency Update: Court Issues Injunction for 2025 Filing Requirement

Leave a reply

Clients and Associates,

We write with a recent update on the enforceability of the Corporate Transparency Act (the “CTA”). As we have previously discussed, the CTA would require certain U.S. and foreign entities registered to do business in the U.S. (“Reporting Companies”) to file a Beneficial Ownership Information Report (a “BOIR”) with the Financial Crimes Enforcement Network (commonly known as “FinCEN”). Many of our firm clients have filed or were preparing to file the BOIR in anticipation of the December 31, 2024 filing deadline for entities formed before January 1, 2024.

On December 3, 2024, the U.S. District Court for the Eastern District of Texas issued a nationwide preliminary injunction blocking enforcement of the CTA. While the court made the necessary findings to issue this preliminary injunction, it also noted that it has not made an affirmative final finding that the CTA is contrary to law or in violation of the U.S. Constitution. On December 5, 2024, the U.S. government filed a notice of appeal to the U.S. Court of Appeals for the Fifth Circuit.

FinCEN has issued an alert confirming that it will honor the injunction, and that Reporting Companies are not currently required to file a BOIR, however may continue to voluntarily do so while the injunction is in place.

We will continue to monitor and communicate developments.

Please contact us with any questions.

Cole-Frieman & Mallon 2024 Q3 Update

Leave a reply

October 21, 2024

Clients, Friends, and Associates:

As we say goodbye to summer and welcome fall, we would like to highlight recent industry updates that we found interesting and impactful. While we strive to present an informative, albeit brief, overview of these topics to allow you to stay on top of the business and regulatory landscape in the coming months, we are also available should you have any related questions.

****

CFM Items

CoinAlts Fund Symposium – October 16. Cole-Frieman & Mallon LLP (“CFM”) is again one of the Premier sponsors of the CoinAlts Fund Symposium. This annual event, being held at the Four Seasons Hotel in San Francisco on October 16, 2024, is the anchor event of SF Fund Week 2024. It brings together the digital asset community to address investment, legal, and operational issues relevant to private fund managers. Join us for expert panels, top-notch speakers, and the chance to stay ahead of the curve in this rapidly evolving industry. More information is available at https://coinalts.xyz/.

CFM Celebrates 15 Years. CFM recently celebrated its 15th anniversary with firm attorneys, staff, clients, and friends gathered to mark this important milestone and reflect on the firm’s success and growth over the years.

CFM People. We are excited to introduce the newest members of our dedicated team at CFM. Gwennaelle Fotso joined us as a Legal Assistant, Benjamin Hung joined us as a Law Clerk, and Lezel Legados joined us as an Executive Assistant. Please join us in warmly welcoming them as they begin this exciting chapter with us.

****

SEC Matters

SEC Charges Company for Unlawful Securities Activities. The Securities and Exchange Commission (the “SEC”) charged a blockchain software company with engaging in the unregistered offer and sale of securities and operating as an unregistered broker.

The SEC claims that since January 2023, the company has offered and sold tens of thousands of what the SEC alleges to be unregistered securities for certain liquid staking program providers. These providers create and issue liquid staking tokens (stETH and rETH) in exchange for staked assets, which can be bought and sold freely. The SEC’s complaint alleges that the company operates as an unregistered broker with respect to these transactions and, furthermore, that its participation in the distribution of these staking programs constitutes the unregistered offer and sale of securities.

The SEC complaint further alleges repeated violations of the registration provisions of the Securities Act of 1933 and the Securities Exchange Act of 1934 (the “Exchange Act”). Such alleged violations include brokering transactions in crypto asset securities, providing pricing and other investment information regarding crypto asset securities, purporting to provide investors with the “best” quote, accepting and routing customer orders, facilitating order execution, handling customer assets, and receiving transaction-based compensation. The SEC seeks injunctive relief and penalties for these alleged violations.

The SEC argues that the company is depriving investors of the protections afforded by federal securities laws by engaging in the unregistered offer and sale of securities.

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

Regarding custody of client assets, the SEC concluded that the investment adviser had custody of the Fund’s assets, as defined in Rule 206(4)(2) of the Investment Advisers Act of 1940 (“Advisers Act”), and accordingly was required to ensure that client funds and securities were maintained by a qualified custodian. The investment adviser held certain crypto assets of the Fund on crypto asset trading platforms and exchanges, including FTX Trading Ltd. (“FTX”) which was not a qualified custodian. To our knowledge, this is the first public enforcement action in which the SEC has decided to bring an action against a crypto asset manager relating to the qualified custodian rule.

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

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

SEC Updates PAUSE List of Soliciting Entities, Subject to Investor Complaints. The SEC recently added 34 unregistered entities to their list known as the Public Alert: Unregistered Soliciting Entities (“PAUSE”) list, which tracks unregistered agencies soliciting investors that falsely claim to be registered, licensed, and/or located in the United States. The newly added entities, which include 24 soliciting entities, six impersonators of genuine firms, and four bogus regulators, are known to use misleading or fraudulent information to solicit primarily non-U.S. investors. Inclusion on the PAUSE list does not mean that the SEC has found violations of U.S. federal securities laws or made a judgement about the securities offered by relevant entities. If you receive a communication that seems suspicious, do not share any personal information without verification of the source.

SEC Charges Business with Cybersecurity-Related Controls Violations. The SEC charged a global integrated communications company with a violation of section 13(b)(2)(B) and Rule 13a-15a of the Exchange Act for failing to create and maintain a sufficient internal cybersecurity-related control system. These findings were primarily based on the facts that the company (i) did not have adequate policies and procedures in place to report relevant cybersecurity information to management responsible for such oversight, (ii) failed to timely assess and respond to unusual activity alerts, and (iii) did not adequately assure that all access to proprietary information required management authorization.

The company entered into a settlement with the SEC, agreeing to cease and desist from any further violations, pay a civil penalty, and update its cybersecurity technology and controls. This enforcement action serves as a reminder to the industry that the SEC is taking a vested interest in cybersecurity compliance issues.

SEC Charges Firm with Failing to Inform Affiliates of a Cyber Intrusion in a Timely Manner. In mid-April of this year, a multinational financial services firm received an alert of a potential cybersecurity vulnerability and an impacted system, which triggered an immediate reporting obligation to the SEC by the firm and its affected affiliated entities. Although it was later found that all appropriate measures were followed to secure the vulnerability, the firm did not inform its nine affiliates of the issue immediately and in enough time for the affiliates to make their formal reports with the SEC, thereby causing all affected entities to be in violation of cyber intrusion reporting rules. A settlement was entered into a settlement with the SEC whereby the firm agreed to cease and desist from any future violations and pay a $10 million civil money penalty.

SEC Chairman Gensler Reaffirms Importance of T+1 Settlements. In February, the SEC implemented a new rule to shorten the settlement timing—the actual exchange of securities and payments—from trade date plus two business days (“T+2”) to trade date plus one business day (“T+1”).This rule follows the SEC’s trend to shorten the time period to settle securities transactions every few years.The last update to the settlement cycle was in 2017, when the SEC changed the settlement timing from trade date plus three business days to T+2.

This rule aims to improve market efficiencies and investors’ ability to access their money in a timely manner. Chairman Gensler emphasizes that the increased settlement time, “will make our market plumbing more resilient, timely, and orderly.” Thenew settlement cycle, T+1, went into effect on May 28, 2024.Additionally, Chairman Gensler outlined three future policy areas: (i) enhancing customer clearing, (ii) shortening settlement cycle for currency trading, and (iii) determining if the settlement cycle should be shortened even further than T+1.

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

****

CFTC Items

Chairman Behnam Promotes Ted Kaouk to New Office Focused on AI. The Commodity Futures Trading Commission (the “CFTC”) announced Ted Kaouk as its first Chief Artificial Intelligence Officer.Prior to being named First Chief Artificial Intelligence Officer, Dr. Kaouk served as the CFTC’s Chief Data Officer and Director of the Division of Data. “The CFTC has been deeply engaged in efforts to deploy an enterprise data and artificial intelligence strategy,” said CFTC Chairman Benham, continuing that, “Ted has the requisite technical and leadership experience needed to lead and implement the CFTC’s data and AI roadmap.” Dr. Kaouk will lead the development of the CFTC’s enterprise data and artificial intelligence strategy, integrating the CFTC’s ongoing efforts to advance its data-driven capabilities. This move is part of the CFTC’s efforts to enhance oversights, surveillance, and enforcement, and modernize the agency.

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

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

****

Crypto and Digital Asset Items

Defendants to Pay $4.5 Billion Following Fraud Verdict. A unanimous jury delivered a verdict in the SEC’s fraud case against a digital asset software company and its Chief Executive Officer. During the nine-day trial, the SEC offered evidence that the company lied to investors about the use of its blockchain to settle transactions, misled investors about the stability of its crypto assets, and de-pegged the coin from the U.S. dollar, wiping out $40 billion in market value “nearly overnight.” SEC Enforcement Director Grewal noted this is the “largest securities fraud in U.S. history,” and Chairman Gensler reaffirmed, “the economic realities of a product—not the labels, the spin, or the hype—determine whether it is a security under the securities laws.”

SEC Charges Brothers Behind $60 Million Crypto Ponzi Scheme. Two brothers ran a $60 million Ponzi scheme marketed as a cryptocurrency investment opportunity. According to the SEC complaint against them, the brothers claimed their proprietary bot had monthly returns of 13.5% and were able to lure more than 80 investors into contributing to a “lending pool.” These investors were told that the automated bot would enter into smart contracts, which would then provide flash loans to arbitrage traders. The brothers repeatedly misrepresented their backgrounds, qualifications and expertise, previous business ventures, and more to gain unsuspecting investors’ trust.

In reality, according to the allegations, the brothers diverted $53.9 million out of $61.5 million raised from investors. Some of that money was used to finance their expensive lifestyles, which included the purchase of two luxury vehicles and a multimillion-dollar condominium in Miami. Some remaining funds were used to pay earlier investors – a classic sign of a Ponzi-style scheme. It has since come to light that one of the brothers covered up three prior convictions for securities fraud. The SEC obtained an emergency asset freeze and charged them with violating the antifraud provisions of federal securities laws. No response has been filed against these allegations.

SEC Names NFTs Sold on Platform as ‘Securities.’ A well-known NFT marketplace received a Wells Notice from the SEC alleging that certain non-fungible tokens (“NFTs”) sold on its platform are securities. In the past, these Wells Notices have led to settlements with the SEC. Two NFT projects were subject to SEC enforcement actions in 2023 as well, alleging the projects broke certain securities laws, and both actions led to settlements with the SEC. In response to the current Wells Notice, the company’s CEO expressed shock at this move by the SEC and warned that it could force creators to stop making digital art due to regulatory boundaries.

****

Other Items

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

The Federal Reserve Issues Enforcement Action Against Customers Bank. The Federal Reserve Bank of Philadelphia (the “Federal Reserve”) issued an enforcement action against a bank for not properly reducing risk to its clients from its digital asset business. The Federal Reserve identified “significant deficiencies related to the bank’s risk management practices and compliance,” and ordered the bank to submit several plans within 60 days of its settlement with the Federal Reserve, outlining the bank’s improved risk assessment efforts and compliance with the Bank Secrecy Act of 1970 (the “Bank Secrecy Act”) and certain anti-money laundering requirements therein. These plans include: (i) revising its customer due diligence program, (ii) developing a third-party monitoring system for transactions, and (iii) updating its program to monitor and report violations of the law. This bank is a primary provider of banking services for digital asset customers, specifically for large crypto firms, and this action may signal a new area of targeted enforcement in the crypto industry.

Investment Advisers now Responsible for Compliance with Bank Secrecy Act. The Financial Crimes Enforcement Network (“FinCEN”) at the United States Department of Treasury issued a final regulation including investment advisers in the definition of “financial institution” under the Bank Secrecy Act.This change means that investment advisers registered with the SEC, or filing as an exempt reporting adviser with the SEC, will have to comply with anti-money laundering and countering the financing of terrorism requirements. Investment advisers will have until January 1, 2026, to file Suspicious Activity Reports and comply with other requirements of the Bank Secrecy Act.

Pay-to-Play Rules for the 2024 Elections. Investment advisers need to be aware of Pay-to-Play rules under Rule 206(4)-5 of the Advisers Act, as well as any applicable state or local rules or regulations during the 2024 election season. If an investment adviser or its covered associates make political contributions to officials who can influence the governmental entities’ selection of advisers, these rules could prohibit such adviser from receiving compensation for advising governmental entities.

Corporate Transparency Act Compliance. The requirements of the Corporate Transparency Act became effective on January 1, 2024. Reporting companies formed before January 1, 2024, must file their initial beneficial ownership report (“BOI Report”) with FinCEN before January 1, 2025. Companies formed between January 1, 2024, and December 31, 2024, are required to file a BOI Report within 90 days of formation, and companies formed on or after January 1, 2025, will be required to file their initial report within 30 days of formation. To learn more about the Corporate Transparency Act and its implications, please refer to this post on our blog.

Accelerated Deadlines for Schedule 13G Filings Now in Effect. In 2023, the SEC adopted amendments to its beneficial ownership rules including accelerated deadlines for Schedule 13G filings – effective as of September 30, 2024. The filing deadlines for Schedule 13G depend on whether a person files as a qualified institutional investor (“QII”), a passive investor, or an exempt investor, as those terms are defined in the Exchange Act.

Below are the updated filing deadlines:

Initial Filing Deadlines

QIIs: The earlier of (a) 45 days after the end of the calendar quarter in which beneficial ownership exceeds 5% and (b) five business days after month-end in which beneficial ownership exceeds 10%.
Passive Investors: Within five business days of acquiring a beneficial ownership of more than 5%.
Exempt Investors: Within 45 days after the end of the calendar quarter in which beneficial ownership exceeds 5%.

Amendment Filing Deadlines

All Schedule 13G Filers: Within 45 days after calendar quarter-end in which there was any material change in the information previously reported on Schedule 13G.

The first quarterly amendment deadline under the updated filing schedule will be November 14, 2024.

QIIs: Within five business days after month-end in which beneficial ownership exceeds 10% or there is a 5% increase or decrease in beneficial ownership.
Passive Investors: Within two business days after exceeding 10% beneficial ownership or a 5% increase or decrease in beneficial ownership.

****

Compliance Calendar

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

October 10, 2024

Changes to proxy voting and form N-PX go into effect.

November 11, 2024

Preliminary Statements for Annual Renewal fees are available through E-Bill and can be accessed through FINRA Firm Gateway.

November 14, 2024

Form 13F Quarterly Filing. Filing is for the calendar quarter that ended September 30, 2024, and should be submitted within 45 days of quarter end.
Form 13G Quarterly Filing. Filing is for the calendar quarter that ended September 30, 2024, and should be submitted within 45 days of quarter end if there have been any material changes since the previous filing.
CTA Form PR. Filing is for the calendar quarter that ended September 30, 2024, and should be submitted within 45 days of quarter end.

November 29, 2024

Form PF for Large Hedge Fund Advisers. Filing is for the calendar quarter that ended September 30, 2024, and should be submitted within 60 days of quarter end.
CPO-PQR Form. Filing is for the calendar quarter that ended September 30, 2024, and should be submitted within 60 days of quarter end.

December 9, 2024

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

December 31, 2024

Initial beneficial ownership reports due to FinCEN for reporting companies created before January 1, 2024.

Periodic

Form D and Blue Sky Filings should be current.
CPO/CTA Annual Questionnaires must be submitted annually, and promptly upon material information changes, through the NFA Annual Questionnaire system.
Initial beneficial ownership reports due to FinCEN:

For reporting companies created in 2024, within 90 days of their creation or registration.
For reporting companies on or after January 1, 2025, within 30 days of their creation or registration.
For updated reports, within 30 days after previously reported information changes.

Consult our complete Compliance Calendar for all 2024 critical dates as you plan your regulatory compliance timeline for the year.

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

Sincerely,

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

Cole-Frieman & Mallon 2024 Q2 Update

Leave a reply

July 11, 2024

Clients, Friends, and Associates:

As we welcome the summer season, we would like to highlight the recent industry updates that we found to be both interesting and impactful. While we strive to present an informative, albeit brief, overview of these topics to allow you to stay on top of the business and regulatory landscape in the coming months, we are also available should you have any related questions.

****

CFM Items

CoinAlts Fund Symposium – October 16. Cole-Frieman & Mallon LLP is again one of the Premier sponsors of the CoinAlts Fund Symposium. This annual event, being held at the Four Seasons Hotel in San Francisco on October 16, 2024, is the anchor event of SF Fund Week 2024. It brings together the digital asset community to address investment, legal, and operational issues relevant to private fund managers. Join us for expert panels, top-notch speakers, and the chance to stay ahead of the curve in this rapidly evolving industry. More information is available at https://coinalts.xyz/.

Hedgeweek Law Firm of the Year. We are thrilled to share that Cole-Frieman & Mallon LLP was named “Law Firm of the Year – Overall” at Hedgeweek’s US Emerging Manager Awards in New York on June 6, 2024. This recognition highlights the firm’s commitment to excellence and innovation in providing legal services to the investment management industry. Thank you to our clients for your votes and ongoing trust.

CFM People. We are pleased to announce the promotions of Marisa Krueger to Legal Support Services Manager and Emma Kaplan to Paralegal. Congratulations to them both! Also, we are excited to introduce the newest members of our dedicated team at Cole-Frieman & Mallon LLP. Tae Kim has joined us as a Senior Associate and Maryam Najam has joined us as an Associate in our Hedge Funds practice, alongside our Summer Associates Alexandria Criner and Alisha Parikh. Please join us in warmly welcoming them as they begin this exciting chapter with us.

****

SEC Matters

SEC Drops Investigation Against Ethereum. While the Securities and Exchange Commission’s (“SEC”) decision to close its investigation of Ethereum is a welcomed victory (or sigh of relief) for digital assets, the positive news was both expected and likely a hollow victory given that it does not change the short-term reality for many in the digital asset industry.

Without additional forward movement, such as with current SEC and other regulatory guidance on digital assets shifting to a more crypto-friendly tone or proposed crypto-friendly legislation being passed (especially relating to tokens and other potential digital assets that may or may not be securities), the SEC continues to police the digital asset industry with a heavy enforcement hand. Consequently, this creates a high barrier to entry, filled with complex legal, business, and other practical challenges for those doing business in the digital asset space. As such, for those parties investing or otherwise participating in the digital asset class, having an open dialogue with your attorneys and advisors can help navigate through the uncertainty.

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

Fifth Circuit Strikes Down SEC Private Fund Advisers Rule. In August 2023, the SEC adopted the Private Fund Advisers Rule which imposed new requirements and prohibitions on private fund advisers, including the disclosure of preferential treatment of certain investors and quarterly reporting of private fund performance. Despite a swift challenge by a group of trade associations, many investment advisers were prepared with modified fund documents and side letters in anticipation of complying with the new Private Fund Advisers Rule.

Given its industry altering impact, the recent ruling from the U.S. Court of Appeals for the Fifth Circuit finding the Private Fund Advisers Rule to be invalid and unenforceable was a welcome reprieve; though, the SEC retains the ability to challenge or appeal the ruling. In striking down the Private Fund Advisers Rule, the Court found that the SEC exceeded its statutory authority because the term “investor,” as used within the Investment Advisers Act of 1940’s (the “Advisers Act”), was limited to “retail customers” and not private funds. While we await the SEC’s response to the Court’s ruling, private fund advisers can continue business as usual as if the Private Fund Adviser Rule was never passed.

SEC Charges Investment Advisers for Marketing Rules Violations. On April 14, 2024, the SEC announced charges against five registered investment advisers for violations of Section 275.206(4)-1 of the Advisers Act (the “Marketing Rule”) for misleading advertisements of hypothetical performance on their public-facing websites. In addition to the violations surrounding hypothetical performance, one adviser was also found to have (i) made false and misleading statements, (ii) advertised misleading model performance, (iii) been unable to substantiate performance shown in its advertisements, (iv) failed to enter into written agreements with people it compensated for endorsements, and (v) violated recordkeeping and compliance standards including filing a prospectus with the SEC which contained misleading statements about its performance. The advisers agreed to civil penalties, censure, and a cease and desist from further violations.

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

SEC Charges Investment Advisers for Misleading Investors. The SEC continued its focus on violations of the Marketing Rule, including fraudulent and deceptive practices, by initiating an enforcement action against an investment adviser and its founder for a breach of fiduciary duty for failing to disclose conflicts of interest and making misleading statements to their clients. According to the SEC’s investigation, the investment adviser advised its clients to invest into films produced by a specific production company without disclosing that the production company paid the founder approximately $530,000 in exchange for investments by its clients. The investment adviser subsequently misrepresented to investors that the monies were paid as compensation for work as an executive producer on the films. The SEC disgorged fees, levied civil penalties, and issued a censure and a cease and desist from committing or causing any violation of these rules.

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

Cumulatively, these enforcement actions demonstrate the SEC’s present focus on consumer protection through complete and accurate reporting at all stages of the investment lifecycle and underscore the importance of investment advisers closely reviewing all materials, including any potential conflicts of interests, with legal counsel to ensure adequate and proper disclosure.

SEC Charges Firms for Recordkeeping Violations. On February 9, 2024, the SEC announced charges against multiple broker-dealers and investment advisers for longstanding failures to maintain and preserve electronic communications under the recordkeeping requirements of the Advisers Act and the Securities Exchange Act of 1934. In its investigation, the SEC found (i) use of off-channel communications, including personal text messages, to discuss work-related matters such as recommendations and advice to be given or proposed to be given and (ii) failure to maintain and preserve such off-channel communications. The SEC also found firms failed to reasonably supervise their employees to detect and prevent such violations. The firms agreed to civil penalties, censure, a cease and desist from further violations, and to retain independent compliance consultants to conduct comprehensive reviews of policies and procedures.

Clients should develop policies and procedures to ensure that all employees conduct work-related communications and activities utilizing sanctioned mediums. These policies and procedures should be reviewed regularly with employees and updated as needed. Additionally, registered investment advisers should develop protocols for regularly collecting and storing data from employee devices, including all work-related communications.

****

CFTC Items

CFTC Issues Order Against Crypto Prime Brokerage Firm. On May 13, 2024, the Commodity Futures Trading Commission (“CFTC”) issued an order against Falcon Labs, Ltd. (“Falcon Labs”) for facilitating United States based customers’ access to cryptocurrency derivatives trading platforms without registering as a futures commission merchant (“FCM”). Falcon Labs agreed to cease and desist from acting as an unregistered FCM, disgorge fees, and pay civil penalties. Additionally, Falcon Labs also updated its know-your-customer (“KYC”) policies and procedures to require customers to identify the location of ultimate beneficial owners as well as the person controlling the account. The retroactive application of the enhanced KYC policies resulted in the offboarding of approximately half of those Falcon Labs customers that were utilizing the underlying product. As regulatory bodies become more familiar with the cryptocurrency asset class, we anticipate more service providers will adopt similar enhanced KYC procedures to further limit restricted users’ access to certain digital asset products.

****

Crypto and Digital Asset Items

Uniswap Labs Responds to the SEC’s Wells Notice. In April 2024, Uniswap Labs (“Uniswap”) published a blog post informing investors that it received a Wells notice from the SEC indicating that the SEC was planning to initiate legal action against Uniswap on the basis that the UNI token is security and that Uniswap is an unregistered securities broker and exchange.

On May 21, 2024, Uniswap filed a response to the Wells notice, asserting four main defenses: that Uniswap and its affiliated entities (i) do not meet the definition of an exchange, (ii) do not meet the definition of brokers because they do not solicit users or provide advice to users, (iii) do not engage in clearing activity because they do not take custody of users’ tokens, and (iv) did not engage in an unregistered offer or sale of securities because their distribution of UNI tokens did not involve the investment of money or property. In addition to the foregoing, Uniswap also contends that the SEC’s attempt to regulate Uniswap and the crypto industry violates the major questions doctrine and the due process right to fair notice. Given that Uniswap’s legal counsel also represented Ripple in its recent victory over the SEC, it comes as no surprise that Uniswap utilizes similar defenses and also references Ripple’s recent victory in its response to the Wells notice.

Congress Repeals SAB 121, Biden Vetoes. In what appears to be an effort to further constrict the digital asset industry, in March 2022, the SEC passed Staff Accounting Bill 121 (“SAB 121”) which required firms that custody cryptocurrency to record customer cryptocurrency holdings as liabilities on their balance sheets. With bipartisan support, Congress voted to repeal SAB 121 as it created an undue burden on financial institutions and may deter firms from providing cryptocurrency custodial services. Despite support from industry leaders, Wall Street, and lobbyists, in a blow to the industry, President Biden vetoed the Congressional repeal of SAB 121 stating that his “Administration will not support measures that jeopardize the well-being of consumers and investors.” While we agree with President Biden’s sentiment that “appropriate guardrails that protect consumers and investors are necessary to harness the potential benefits and opportunities of crypto-asset innovations,” we disagree with President Biden’s decision as it will inevitably lead to fewer options to custody digital assets, and the reduced competition will ultimately stifle innovation.

House of Representatives Passed Federal Guidance for Digital Assets. The House of Representatives recently passed the Financial Innovation and Technology for the 21st Century (“FIT21”) Act, seeking to build a regulatory framework for the governance of digital assets by distributing regulatory responsibilities between the SEC and the Commodities Futures and Trade Commission by dividing digital assets into three separate classes: (i) restricted digital assets that would be subject to SEC jurisdiction, (ii) digital commodities which would be subject to CFTC jurisdiction, and (iii) permitted payment stablecoin which, depending on facts and circumstances, would be subject to either body’s jurisdiction. Unfortunately for the industry, neither FIT21 nor a similar bill is currently being considered by the Senate which keeps this asset class in a regulatory limbo.

As the United States slowly but surely progresses towards developing a viable regulatory regime for the digital asset industry, CFM continues to monitor the various developments in the legal and regulatory landscape.

****

Other Items

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

In the past, Florida-based investment advisers to private funds were often faced with the choice of either (i) registering as an investment adviser in Florida, (ii) relocating to another state to avoid registering as an investment adviser in Florida, or (iii) taking the position that they were not holding themselves out as an investment adviser in Florida. With its adoption, Florida’s private fund adviser exemption now provides a welcome fourth option for private fund advisers who are based in Florida.

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

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

Although the SEC has effectively set a minimum standard for data breach notification requirements, it is likely that going forward, investment advisers will have to comply with other additional incident response requirements, such as those contemplated by the SEC’s impending Cybersecurity Risk Management rule. As to Regulation S-P’s effect on private fund advisers, even if such an adviser could successfully argue it is somehow exempt, similar requirements would still apply under the FTC’s Safeguards Rule and potentially under any applicable state and/or foreign laws, making any such exemption moot from at least a practical perspective. We recommend that all registered investment advisers, including those solely advising private funds, prepare for compliance with these new amendments.

Qualified Plan Asset Manager (“QPAM”) Updates. As discussed in our previous quarterly update, investment advisers using the QPAM exemption must notify the Department of Labor via email at [email protected] no later than September 15, 2024, of their reliance on the QPAM exemption. Additionally, investment advisers should be aware that the assets under management threshold required to qualify for the QPAM exemption are increasing from $85,000,000 to $101,956,000 as of December 31, 2024. Similarly, the equity threshold required to qualify for the QPAM exemption is increasing from $1,000,000 to $1,346,000. These thresholds are set to further increase in 2027 and 2030. Please reach out to the team at CFM if you have any questions or need support with this transition.

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

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

The Supreme Court essentially held that the ALJ system violates the Constitution’s Seventh Amendment right to a jury trial and further found that Congress had unconstitutionally delegated legislative power to the SEC by allowing it to choose between civil proceedings in federal court and administrative proceedings. As this decision effectively restricts the SEC’s ability to pursue civil penalties solely through administrative proceedings, the SEC will need to bring more cases to federal court, where defendants are entitled to a jury trial.

NVCA Model Documents. In May 2024, the National Venture Capital Association (“NVCA”) updated their model legal documents in light of a recent ruling by the Delaware Chancery Court. Clients who currently utilize the NVCA model documents should review the revised documents and consult with their legal counsel to determine if any changes or updates are needed.

****

Compliance Calendar

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

July 1, 2024

Changes to proxy voting and form N-PX go into effect.

July 10, 2024

Form 13H Quarterly Filling. Filling is for the calendar quarter that ended June 30, 2024 and should be submitted within 10 days of the quarter’s end.

July 15, 2024

Quarterly Form PF due for Large Liquidity Fund Advisers. Filing is for the calendar quarter that ended June 30, 2024.

July 30, 2024

ERISA Schedule C of DOL Form 5500 Disclosure.

August 14, 2024

Form 13F Quarterly Filing. Filing is for calendar quarter that ended June 30, 2024, should be submitted within 45 days of quarter end.
CTA Form PR. Filing is for calendar quarter that ended June 30, 2024, and should be submitted within 45 days of quarter end.

August 29, 2024

Form PF for Large Hedge Fund Advisers. Filing is for calendar quarter that ended June 30, 2024, and should be submitted within 60 days of quarter end.
CPO-PQR Form. Filing is for calendar quarter that ended June 30, 2024, and should be submitted within 60 days of quarter end.

August 30, 2024

Initial Form N-PX Filing. This filing covers the 12-month period that ended June 30, 2023.

Periodic

Form D and Blue Sky Filings should be current.
CPO/CTA Annual Questionnaires must be submitted annually, and promptly upon material information change, through the NFA Annual Questionnaire system.

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

Sincerely,

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

Cole-Frieman & Mallon 2024 Q1 Update

Leave a reply

April 19, 2024

Clients, Friends, and Associates:

As we end the first quarter and enter the spring season, we would like to highlight some of the recent industry updates and occurrences we found to be both interesting and impactful. Please feel free to explore the links included and reach out to us if you have any related questions.

****

CFM Items

We would like to highlight the promotions of Aaron Humes, Brandon Leppke, Kendra Snyder, and Erica Stefanik to Senior Associates. Congratulations to them! Also, we are thrilled to announce the latest additions to our distinguished team at Cole-Frieman & Mallon LLP. Iva Rukelj joins us as a Senior Associate in our Intellectual Property practice. Additionally, we’re pleased to welcome Afruz Sayah as an Associate and Stephanie Cepeda as a Paralegal for the Corporate and Transactional practice group. Please join us in extending a warm welcome to them as they embark on this exciting journey with us.

Cole-Frieman & Mallon LLP, along with industry leaders MG Stover, Harneys, and KPMG, is a premier sponsor of the CoinAlts Annual Fund Symposium. This annual event, being held at the Four Seasons Hotel in San Francisco on October 16, 2024, is the anchor event of SF Fund Week 2024. It brings together the digital asset community to address investment, legal, and operational issues relevant to private fund managers. It is a must-attend gathering for industry professionals, providing unparalleled insights and networking opportunities. Join us for expert panels, top-notch speakers, and the chance to stay ahead of the curve in this rapidly evolving industry. More information is available at https://coinalts.xyz/.

****

SEC Matters

SEC Approves Spot Bitcoin ETFs. The Securities and Exchange Commission (“SEC”) approved 11 spot Bitcoin exchange-traded funds (“ETFs”) on January 10, 2024, marking a historic moment in the crypto industry. The approved applications included those from BlackRock, Ark Investments/21 Shares, Fidelity, Invesco, Valkyrie, and WisdomTree.

Despite the approval, SEC chairman Gensler reiterated the agency’s stance on crypto by asserting that “… while [they] approved the listing and trading of certain spot Bitcoin ETP shares … [they] did not approve or endorse Bitcoin.” Chairman Gensler went on to advise investors to remain cautious about the risks associated with Bitcoin and any other products tied to crypto.

The statement came one day after the agency’s X (formerly Twitter) account was hacked, allowing the hacker to prematurely announce the agency approval. The agency subsequently deleted the post and launched an investigation into the security compromise.

Court Rules in Favor of SEC in Case Against Terraform. On December 28, 2023, Judge Radkoff issued an opinion and order on the motions and cross motions for summary judgment in the SEC enforcement action against crypto entrepreneur Do Kwon and his company, Terraform Labs. The court granted the SEC’s summary judgment motion in part, holding that the defendants had offered and sold unregistered securities since it found that TerraUSD, LUNA and MIR tokens were investment contracts under United States v. Howey. Additionally, the court granted summary judgment in part for the defendants regarding mAssets since it found that those tokens did not meet the statutory definition of security-based swaps. Of note, the Terraform ruling is in conflict with the same district court’s ruling in SEC v. Ripple Labs Inc. For more information on SEC v. Ripple Labs Inc., check out our October 2023 Update. The clear takeaway from these conflicting rulings is that the application of Howey to digital assets remains unclear, even to judges in the same court, acting as further evidence that a regulatory framework specific to cryptocurrency and digital assets is needed.

Judge Radkoff moved the trial from January 29, 2024, to March 25, 2024, to accommodate Do Kwon’s extradition proceedings in Montenegro. Terraform also filed a voluntary petition for Chapter 11 bankruptcy protections on January 21. On February 5, Do Kwon was extradited to South Korea, where he faces a potential life sentence.

Court Rules in Favor of SEC on Coinbase’s Motion to Dismiss. On January 17, 2024, during oral argument on Coinbase’s motion to dismiss, the SEC referenced the recent SEC v. Terraform Labs ruling (see above) and argued that the holding in Howey was sufficient to regulate Coinbase’s activities. Coinbase disagreed and argued that the tokens in dispute were not securities, but instead commodities. While the SEC has accepted Bitcoin as a commodity, the thirteen tokens identified in the SEC’s complaint have not been officially classified. For more information about the lawsuit in general, please refer to an earlier blog post.

On March 27, 2024, the Court ruled on the motion, rejecting nearly all of Coinbase’s arguments and allowing the case to proceed beyond the pleading stage. In so ruling, the Court held that the SEC alleged facts sufficient to permit a finding that certain assets made available for trading on Coinbase’s platform constitute “investment contracts” under the Howey test. The Court rejected several of Coinbase’s arguments about the application of Howey, noting that Howey does not recognize a distinction between tokens purchased directly from an issuer and those purchased on the secondary market. The Court further rejected Coinbase’s contention that the Court’s broad construction of Howey would effectively extend SEC jurisdiction to all investment activity, noting the need for a “common enterprise,” which the Court found was sufficiently alleged in the SEC’s complaint as to the tokens at issue.

Notably, however, the Court did grant the motion to dismiss the claim that Coinbase acted as an unregistered broker through its self-custodial wallet service, since the wallet does not provide brokerage services such as order routing or making investment recommendations.

SEC Adopts Market Participant Dealer Rule. On February 6, 2024, the SEC adopted new rules 3a5-4 and 3a44-2 under the Securities Exchange Act of 1934, as amended (the “Exchange Act”), which expand the definitions of “dealer” and “government securities dealer” to cover additional market participants engaged in liquidity-providing activities.

Currently, Section 3(a)(5) of the Exchange Act provides an exception to the dealer definition for persons buying or selling securities for their own account, but “not as part of a regular business.” Liquidity providing market participants have historically relied on this exception.

The newly adopted rules alter the standard for determining what is considered “as part of a regular business,” including where the activity has the effect of providing liquidity to other market participants by either of the following means:

regularly expressing trading interest that is at or near the best available prices on both sides of the market for the same security and that is communicated and represented in a way that makes it accessible to other market participants; or

earning revenue primarily from capturing bid-ask spreads, by buying at the bid and selling at the offer, or from capturing any incentives offered by trading venues to liquidity-supplying trading interest.

The new rules provide certain exceptions to the above, including one for persons having or controlling total assets of less than $50 million.

Of note, neither private funds nor investment advisers (trading for their own account) are exempt from the dealer or government securities dealer registration requirements. If a private fund or investment manager employs arbitrage, market-making, or similar liquidity-providing strategies, those funds and managers should be mindful of the new standards set forth in the rules and may need to register as dealers.

The rule will become effective 60 days after the date of publication of the adopting rule in the Federal Register, and the date of compliance for the final rules will be one year after the date the rule becomes effective.

Amendments to Schedule 13D and 13G. The SEC adopted amendments to rules governing beneficial ownership information reporting on Schedules 13D and 13G under Section 13 of the Exchange Act. These amendments, which become effective on February 5, 2024 or September 30, 2024, depending on Schedule 13D or 13G, change the timing of filing deadlines. For more information about the amendments and accelerated deadlines for the filings, please refer to our previous blog post.

SEC Proposes Updated Definition of Qualifying Venture Capital Funds. On February 14, 2024, the SEC proposed an updated definition increasing the threshold for “qualifying venture capital funds” from $10 million to $12 million, meant to represent adjustment for inflation since the qualifying venture capital fund exemption was introduced in the Economic Growth, Regulatory Relief, and Consumer Protection Act of 2018. A qualifying venture capital fund is a venture capital fund which, by virtue of its being under the applicable dollar threshold in aggregate capital contributions and uncalled committed capital, is exempted from the 100 beneficial owner limitation of Section 3(c)(1) of the Investment Company Act of 1940, as amended, and may instead raise capital from up to 250 beneficial owners.

The enacting law requires the SEC to index the dollar figure for this threshold to inflation every five years. The SEC’s proposed rule would provide such an inflation adjustment, allowing qualifying venture capital fund managers to raise additional capital within the limit of the proposed threshold and would establish a process for future inflation adjustments every five years.

SEC Charges Two Investment Advisers with Making False Statements Concerning Use of Artificial Intelligence. On March 18, 2024, the SEC announced settled charges against two registered investment advisers for making false and misleading statements about their use of artificial intelligence (“AI”). Without admitting or denying the SEC’s findings, the advisers agreed to settle the charges and pay $400,000 aggregate penalties. The SEC’s orders against the advisers found that they had exaggerated the capabilities and use of their AI and machine learning software. The SEC in its release remarked on the current industry buzz around AI and urged investment advisers to be vigilant that, where an adviser claims to use AI in its investment processes, it needs to ensure that its representations are not false or misleading. Highlighting AI as an area of increased enforcement focus, the SEC also released this quarter an investor alert concerning the prevalence of AI-related fraudulent representations.

CFTC Items

CFTC Advisory Committee Submits DeFi Report. The CFTC’s Digital Asset and Blockchain Technology Subcommittee released a report regarding decentralized finance (“DeFi”), including examining the factors that affect the risks and benefits of DeFi and suggests that federal regulators proactively interact with the DeFi sector to clarify the specific application of pertinent laws.

In April of 2023, the Department of Treasury released a report on illicit financial risks in the DeFi industry, recommending that policymakers and regulators strengthen supervision of anti-money laundering policies by DeFi services to ensure compliance with obligations presented by the Bank Secrecy Act, by engaging with the industry. This new report evidences the start of such engagement. The report notes that the benefits and risks of DeFi technology depend on the schematics and design of each specific system, and that there is a concern about the lack of accountability built into the design of these systems. The report recommends certain steps and actions to mitigate the risks borne by investors and consumers, such as: increasing the technical capacity to understand DeFi, surveying existing regulatory guidelines, identifying gaps in regulatory frameworks, identifying, and assessing risks, and identifying policy responses to address such risks. Overall, the committee recommends that policymakers and regulators use a more comprehensive approach to understand the DeFi industry.

Digital Asset Items

Digital Asset Reporting Requirements from the IRS and the Treasury. On January 16, 2024, the Treasury Department (“Treasury”) and the Internal Revenue Service (“IRS”) issued an announcement informing the public that businesses do not have to report transactions involving the receipt of digital assets the same way businesses report the receipt of cash, until the Treasury or the IRS issue further regulations.

Announcement 2024-4 serves as transitional guidance to taxpayers on the status of the rules on digital asset reporting pursuant to Section 6050I of the Internal Revenue Code. This section requires that taxpayers engaged in business must report the receipt of $10,000 or more in cash within 15 days of receiving the cash. Historically, “cash” included currency, foreign currency, or any monetary instrument amounting to no more than $10,000. Digital assets were included in this definition on November 15, 2021, through the Infrastructure Investment and Jobs Act.

The Treasury and the IRS intend to issue regulations to provide additional procedures to report the receipt of digital assets and will give the public an opportunity to submit any comments. However, there is no proposed date or timeline for regulatory guidance yet.

Binance Pleads Guilty to Violating Federal AML and Sanctions Laws. Binance recently consented to multiple orders with federal regulators for violating regulations in its international exchange operations. A U.S. district judge approved Binance’s guilty plea in February, leading to $1.8 billion in fines and $2.5 billion in forfeiture. The settlement includes up to five years of independent firm monitorship, focusing on ethics programs, policies, and systems. Binance acknowledged its actions in a blog post and pledged to adhere to compliance and security guidelines.

The CFTC’s consent order with Binance and CEO Changpeng Zhao, for breaching the Commodity and Exchange Act, includes a permanent injunction and civil penalties. The CFTC imposed a monetary penalty of $150 million against Zhao, and Binance must disgorge $1.25 billion in transaction fees and pay $1.35 billion to the CFTC.

FinCEN accused Binance of failing to report over 100,000 suspicious transactions and insufficient AML and KYC compliance. Specifically, Binance did not implement comprehensive know-your-customer (KYC) protocols or systematically monitor transactions, never filed a suspicious activity report (SAR) with FinCEN, and, for years, Binance allowed users to open accounts and trade without submitting any identifying information beyond an email address. As a result, Binance must appoint an independent monitor for the safe removal of U.S. users from the platform.

Binance’s onboarding processes and KYC requirements have since been updated to include an assessment of applying entities with connections to the U.S., which will be used to determine whether an entity user is a U.S. user and thus prohibited from accessing the Binance platform. The new assessment includes questions for different types of entities, including look-through for U.S. beneficial owners, and a U.S. ownership/control attestation, requiring the signatory to attest that no U.S. person will make decisions related to the function of the entity user, including day-to-day management activities and trading activities.

Zhao’s sentencing is scheduled for April 30, 2024, while the SEC’s action against Binance for allegedly violating securities laws continues. For more on SEC and CFTC actions against Binance, see our previous blog post.

Wyoming Recognizes New Form of DAO Structured as Nonprofit Organization. On March 7, 2024, Wyoming Governor Mark Gordon approved the Wyoming Decentralized Unincorporated Nonprofit Association Act. The law will permit Decentralized Autonomous Organizations (“DAOs”) of at least 100 members to form as decentralized unincorporated nonprofit associations (“DUNAs”), allowing them to generate revenue as a nonprofit entity. Under the new law, DUNAs will have legal identity, with the ability to contract with third parties, initiate legal actions, address tax issues, and acquire and transfer property (including digital assets), while remaining decentralized in nature, consistent with the structure of a DAO. DUNAs are permitted to engage in profit-making activities so long as the proceeds of such activities are put toward the not-for-profit “purpose” of the DUNA. The statutory provisions permit the payment of “reasonable compensation” for services provided to a DUNA, but the definition of “reasonable” is still unclear.

This follows Wyoming’s landmark 2021 law enabling individuals and organizations to create legally recognized DAOs as limited liability companies in the state. The new bill comes into effect July 1, 2024.

****

Other Items

Federal Court Finds Corporate Transparency Act Unconstitutional. On March 1, 2024, the U.S. District Court of Northern Alabama ruled that the Corporate Transparency Act (“CTA”) was unconstitutional as it “exceeded the Constitution’s limits on Congress’ power,” consequently enjoining enforcement of the CTA against the plaintiffs. Shortly after the final rule was released by Financial Crimes Enforcement Network (“FinCEN”), plaintiffs National Small Business United and Isaac Winkles (collectively, “NSBA”) filed suit against the Treasury, Treasury Secretary Janet Yellen, and Acting Director of FinCEN, Himmauli Das (collectively, “Defendants”). NSBA argued that Congress lacked the authority under the Constitution to enforce the reporting requirements of the CTA. They alleged that the federal government was infringing upon the states’ sovereign authority over entity formation and governance, and by compelling disclosure of personal information, the CTA violated the First, Fourth, Fifth, Ninth, and Tenth Amendments of the Constitution.

The court declined to comment on NSBA’s arguments that the CTA violated several amendments but affirmed that the Act was unconstitutional. Importantly, the holding was limited to NBSA in the case.

On March 11, on behalf of the Department of the Treasury, the Department of Justice filed a Notice of Appeal. In a press release, FinCEN confirmed their compliance with the court order and stated it would not enforce the CTA against the NSBA, but emphasized all other reporting companies are still required to comply with the CTA.

New Guidance from FinCEN on Corporate Transparency Act Compliance. Prior to the NSBA decision, in January, FinCEN released an updated list of FAQs to address queries and provide additional guidance on compliance with the CTA.

As mentioned in a previous post, the requirements of the CTA became effective on January 1, 2024, requiring reporting companies to file their initial beneficial ownership reports with FinCEN before January 1, 2025. Companies created in 2024 will be required to file with FinCEN within 90 days of their creation or registration, and companies created on or after January 1, 2025, will be required to file their initial report within 30 days of its creation or registration. To learn more about the CTA and its implications, please refer to this post on our blog.

California Court Restores CPPA Authority to Enforce Privacy Regulations. On February 9, 2024, the Third District Court of Appeal in California ruled in favor of the California Privacy Protection Agency (“CPPA”), restoring the agency’s authority to enforce the regulations in the California Privacy Rights Act (the “CPRA”). This ruling follows the prior ruling in favor of the California Chamber of Commerce, which sought to delay the enforcement of the CPRA until the CPPA finalized the Act’s regulations. The appellate court stated that the one-year gap could be interpreted as allowing for the agency to have time to prepare for the enforcement of the rules.

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

Qualified Plan Asset Manager (“QPAM”) Exemption Updated. Investment Managers who advise ERISA plan asset funds under the QPAM exemption should be aware of recent amendments to the QPAM exemption, which was adopted on April 3, 2024 and is expected to become effective June 17, 2024. The amendment will (i) require the QPAM to notify the Department of Labor, via email at [email protected], that it is relying on the QPAM exemption no later than September 15, 2024, or within 90 days of reliance on the Exemption; (ii) incrementally increase the assets under management threshold, in three separate increments (2024, 2027, and 2030) from $85,000,000 to $135,868,000; and (iii) incrementally increase the shareholder equity threshold, in three separate increments (2024, 2027, and 2030) from $1,000,000 to $2,040,000. We expect to provide further guidance in our next update.

FinCEN Proposes New Regulations to Combat Money Laundering. On February 13, 2024, FinCEN proposed a new rule to prevent money laundering and the financing of terrorism and other crimes. The rule intends to supplement recent Treasury actions to combat illicit financial risks through anonymous companies and cash-based real estate transactions by increasing the transparency of the financial system. The Treasury also published a risk assessment for investment advisers, which outlined threats and vulnerabilities posed by investors and other actors.

The rule would classify SEC-registered investment advisers and SEC exempt reporting advisers as “financial institutions” under The Bank Secrecy Act of 1970 (“BSA”) and require such advisers to adopt Anti-Money Laundering and Countering the Financing of Terrorism (“AML” and “CFT”) guidelines pursuant to the BSA. Such investment advisers would be required to report suspicious financial activity to FinCEN and fulfil certain recordkeeping requirements.

The period for public commentary has opened and FinCEN will accept comments regarding the proposed rule until April 15, 2024.

Reminder Regarding SEC Pay-to-Play Rules. As an election year reminder to the firm’s investment adviser clients, pursuant to Rule 206(4)-5 under the Investment Advisers Act of 1940, as amended (the “Advisers Act”), if you make a political contribution to an elected official who is in a position to influence the selection of the adviser to provide advisory services to a government entity, then you will be barred for two years from providing advisory services for compensation to that government entity. The rule applies to advisers registered or required to be registered with the SEC, advisers exempt from registration under Advisers Act Section 203(b)(3) as “foreign private advisers,” and advisers that are exempt reporting advisers as defined in Rule 275.204–4(a) under the Advisers Act, as well as to certain executives and employees of the adviser.

Under Rule 206(4)-5 you also may not pay a third party, such as a solicitor or placement agent, to solicit a government client on your behalf, unless the solicitor or placement agent is a “regulated person” subject to prohibitions against engaging in pay-to-play practices. Further, you may not coordinate or ask another person or political action committee (PAC) to make contributions to an elected official, candidate or political party for purposes of influencing the selection of the adviser. Finally, you and certain of the adviser’s executive officers and employees may not engage in pay-to-play conduct indirectly, such as by directing or funding contributions through third parties such as spouses, lawyers or companies affiliated with the adviser, if that conduct would violate the rule if the adviser engaged in it directly.

****

Compliance Calendar

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

April 7, 2024

Form N-MFP Filing for Monthly Schedule of Portfolio Holdings of Money Market Funds, if applicable.

April 10, 2024

Form 13H Quarterly Filing for Changes. Filing is for calendar quarter that ended March 31, 2024, and should be submitted within 10 days of quarter end.
Form 13G Monthly Filing for Applicable Reporting Persons. Filing is for month end of March 31, 2024, and should be submitted within 10 days of month end.

April 15, 2024

Form PF Quarterly Filing for Large Liquidity Fund Advisers. Filing is for calendar quarter that ended March 31, 2024.

April 29, 2024

Form ADV Part 2A Delivery to Existing Clients.
Audited Financials Distribution to Private Fund Investors (excluding Funds of Funds).
Form PF Annual Filing. Filing is for fiscal year end December 31, 2023, and should be submitted within 120 days of fiscal year end.

May 7, 2024

Form N-MFP Filing for Monthly Schedule of Portfolio Holdings of Money Market Funds, if applicable.

May 10, 2024

Form 13G Monthly Filing for Applicable Reporting Persons. Filing is for month end of April 30, 2024, and should be submitted within 10 days of month end.

May 15, 2024

Form 13F Quarterly Filing for Changes. Filing is for calendar quarter that ended March 31, 2024, and should generally be submitted within 45 days of quarter end.
CTA Form-PR Filing with the NFA, which can be filed through NFA’s EasyFile.

May 30, 2024

CPO-PQR Form Filing with the NFA, which can be filed through NFA’s EasyFile.
Form PF Quarterly Filing for Large Hedge Fund Traders and Large Liquidity Fund Advisers, if applicable.
Form N-PORT Filing Monthly Schedule of Portfolio Holdings of Funds other than Money Markey Funds and SBICs, if applicable.

June 7, 2024

Form N-MFP Filing for Monthly Schedule of Portfolio Holdings of Money Market Funds, if applicable.

June 10, 2024

Form 13G Monthly Filing for Applicable Reporting Persons. Filing is for month end of May 31, 2024, and should be submitted within 10 days of month end.
Audited Financials Distribution to Fund of Funds Investors.

Periodic

Fund Managers should perform “Bad Actor” certifications annually.
Form D and Blue Sky Filings should be current.
CPO/CTA Annual Questionnaires must be submitted annually, and promptly upon material information changes, through NFA Annual Questionnaire system.

Consult our complete Compliance Calendar for all 2024 critical dates as you plan your regulatory compliance timeline for the year.

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

Sincerely,

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

The Corporate Transparency Act: What Fund Managers Need to Know

Leave a reply

Introduction

The Corporate Transparency Act (the “CTA”) is a new federal law that went into effect on January 1, 2024 (the “Effective Date”) and requires certain entities (a “Reporting Company”) to file a report (a “BOI Report”) with the Financial Crimes Enforcement Network (“FinCEN”) disclosing, among other things, beneficial ownership information (including names, dates of birth, residential addresses, and passport details) of individuals who either own or substantially control these entities. A willful failure to timely comply with the reporting requirements can result in civil and criminal penalties. The CTA broadly applies to most common entities formed in the U.S., as well as certain non-U.S. formed entities if they are registered to conduct business in the U.S., unless one of the CTA’s 23 exemptions apply (each an “Exemption”).

Synopsis for Fund Managers

The CTA provides an Exemption for each of: (i) an investment adviser registered with the Securities and Exchange Commission (the “SEC”) (an “RIA”); (ii) a fund manager that has filed as a venture capital fund adviser with the SEC (“VC Adviser”)[i]; (iii) an entity that is included as a “relying adviser” in an RIA’s Form ADV umbrella registration; and (iv) U.S. private funds that are exempt from registration under Section 3(c)(1) or 3(c)(7) of the Investment Company Act of 1940 (the “Investment Company Act”) and are managed by an RIA, a VC Adviser, or a “relying adviser.” Investment Advisers registered with a state are not exempt from the CTA. An Exempt Reporting Adviser (an “ERA”) is not exempt from the CTA, unless it is a VC Adviser. General partner and managing member entities of such funds and fund complexes are not expressly exempt but, under certain circumstances may qualify for an Exemption.

Notwithstanding the numerous Exemptions, the CTA will likely affect many fund managers vis-à-vis their affiliated entities who may be required to file BOI Reports. As discussed further below, in light of the complexity and nuance of the CTA’s application, as well as its breadth, the timing and content of its reporting requirements and its penalties, fund managers should consider developing appropriate internal and/or external procedures and controls to adequately prepare for these compliance obligations. The CTA’s reporting obligations are continuing and therefore fund managers should continuously assess whether the CTA applies to them, as their business evolves.

FinCEN has published numerous materials to assist with complying with the CTA including (i) a reference guide; (ii) FAQs; and (iii) a compliance guide. If you have any questions regarding the CTA, please reach out to your CFM contact or email us here [email protected].

Discussion

Background

While the CTA appears to be ministerial or administrative in nature, it is rooted in broader national security initiatives as it was originally passed by the U.S. Congress in connection with the Anti-Money Laundering Act of 2020 and the National Defense Authorization Act of 2021 to combat money laundering, tax fraud, terrorism, and other illicit activities; therefore, fund managers should take a thoughtful and methodical approach to complying with the CTA.

FinCEN is a bureau of the U.S. Department of Treasury whose mission is to safeguard the financial system from illicit use, combat money laundering and its related crimes, and promote national security by strategically using financial authorities and collecting, analyzing, and disseminating financial intelligence.

Compliance Timeline

A Reporting Company formed on or after the Effective Date, but before January 1, 2025, must file its BOI Report within 90 days from its formation.

A Reporting Company formed prior to the Effective Date must file its BOI Report by January 1, 2025.

A Reporting Company formed on or after January 1, 2025 must file its BOI Report within 30 days from its formation.

The BOI Report is a continuing obligation and therefore, certain events may require an updated BOI Report (discussed below) which must be filed within 30 days of the date of such events.

Reporting Companies

As described above, a Reporting Company under the CTA includes any corporation, limited liability company or other similar entity that is created by filing a document with a secretary of state or similar office under the law of a state, or formed under the law of a foreign country and registered to do business in the United States by filing a document with a secretary of state or similar office under the laws of a state.

The CTA exempts 23 categories of entities from the definition of a Reporting Company. A complete list of Exemptions can be found in the FinCEN compliance guide. Of the 23 Exemptions, the following are relevant to entities that operate in the investment management space:

Any broker or dealer of securities that is registered under Section 15 of the Securities Exchange Act of 1934 (the “Exchange Act”);
Any entity registered with the SEC under the Exchange Act;
An investment company under Section 3 of the Investment Company Act and registered with the SEC;
An RIA (please note that state registered investment advisers and ERAs that are not VC Advisers are not exempt);
A VC Adviser (please note that venture capital advisers under the venture capital exemption of certain states may not qualify for this Exemption);
Any entity registered with the Commodity Futures Trading Commission under the Commodity Exchange Act—this includes (i) futures commission merchant; (ii) introducing broker; (iii) swap dealer; (iv) major swap participant; (v) commodity pool operator; (vi) commodity trading adviser; and (vii) retail foreign exchange dealer;
A pooled investment vehicle that is operated or advised by an RIA or a VC Adviser, provided that the pooled investment vehicle relies on the 3(c)(1) or 3(c)(7) exemption under the Investment Company Act and is identified, or will be identified on its adviser’s Form ADV;
Operating companies that have (i) more than 20 full-time U.S. employees; (ii) an operating presence at a physical office in the United States; and (iii) filed U.S. federal taxes showing more than $5 million in gross receipts for the previous year; and
Wholly owned subsidiaries of the above, excluding wholly owned subsidiaries of pooled investment vehicles.

Investment Managers

RIAs, VC Advisers, “relying advisers” of an RIA, and U.S. private funds that are either 3(c)(1) or 3(c)(7) funds and managed by the foregoing entities are exempt from the definition of Reporting Companies and are not required to comply with the CTA. Notwithstanding the foregoing, state registered investment advisers and ERAs (excluding VC Advisers) are not expressly exempt from complying with the CTA, however, this does not preclude any such entity from qualifying for a separate Exemption. Similarly, general partner and/or managing member entities of 3(c)(1) and 3(c)(7) funds are not expressly exempt from complying with the CTA unless they fall under a separate Exemption.

Additionally, holding companies that own, in part or in whole, entities that are exempt from complying with the CTA cannot rely on the Exemption of its subsidiary and will need to comply with the CTA unless an alternative Exemption is available. This will likely affect RIAs that are structured as limited partnerships and will require the general partner of the RIA to comply with the CTA and submit a BOI Report.

Foreign Pooled Investment Vehicles

Foreign pooled investment vehicles that are registered with a U.S. state do not qualify for the Exemption for pooled investment vehicles discussed above (even if managed by an RIA or VC Adviser). However, in such cases, the CTA expressly provides for limited exemptive relief by requiring such entities to only identify the one individual who exercises the greatest control over the entity in their BOI reports.

BOI Report

BOI Reports should include information about (i) the Reporting Company, and for Reporting Companies formed after the Effective Date, information about the Reporting Company Applicant; and (ii) the Reporting Company’s Beneficial Owners.

Reporting Company Information

Reporting Companies, formed or registered to do business in the United States before the Effective Date, are required to disclose the following information as part of the BOI Report:

Full legal name of the company.
Any trade names, including all fictitious business names.
Principal place of business and, if that address is not in the United States, the primary location of the company in the United States.
Jurisdiction of formation.
Employer Identification Number or Taxpayer Identification Number.

Company Applicants

Reporting Companies formed or registering to do business in the United States after the Effective Date must disclose the following additional information about the person(s) who were involved in the formation of the Reporting Company:

Name and address of the individual who actually files (physically or electronically) the formation paperwork of the Reporting Company with the Secretary of State. This may be an individual at a service provider who assists with the entity formation.
Name and address of the individual who is responsible for directing or controlling such filing vis-à-vis instructing the filer to make the filing.

With respect to company applicants, the BOI Report should include their residential address unless such individual forms or registers companies in the normal course of their business.

Beneficial Ownership

In addition to providing company information, Reporting Companies must disclose all of their Beneficial Owners (as defined below). Under the CTA, a beneficial owner is any individual who directly or indirectly (i) owns or controls at least 25% of the ownership interests of the reporting company; or (ii) exercises substantial control over a reporting company (“Beneficial Owner”).

Ownership interests as used in the CTA refer to equity, stock, voting rights, profits interest, options, or any other instrument used to establish ownership.

For purposes of beneficial ownership, someone exercises substantial control over a Reporting Company if the individual (i) is a senior officer (including a general counsel); (ii) has the authority to appoint or remove certain officers or a majority of directors of the company; (iii) is an important decision maker (including senior portfolio managers and investment committee members); or (iv) has any other form of substantial control over the reporting company.

Reporting Companies are required to disclose the following information of each of their Beneficial Owners on the BOI Report:

Full legal name.
Date of birth.
Current residential address.
Identifying number (i.e., U.S. passport number; U.S. driver’s license number; or a foreign passport number if U.S. identification is not available).
Image of the proof of identification.

FinCEN Identifier

Individuals may request a unique identifier from FinCEN by providing the above information to FinCen. If an individual is a Beneficial Owner of multiple Reporting Companies, the FinCen identifier can alleviate the burden of repeatedly providing the individual’s identifying information for each Reporting Company. The FinCEN ID can be obtained here.

Updated BOI Reports

After filing the initial BOI Report, Reporting Companies are not required to reaffirm or renew their BOI Report on a periodic basis; however, an updated BOI Report should be filed within 30 days after the previously reported information changes—this includes, but is not limited to, the entity obtaining or using a new trade name, the addition of a new Beneficial Owner, the change of residential address of a Beneficial Owner, the change or renewal of an identification document of a Beneficial Owner, and the removal of a Beneficial Owner. Because a Beneficial Owner relates to either ownership or control, installing a new executive that can exercise control over the entity, such as a new manager, managing member, general partner or director, or removing any of the foregoing, could also require an updated BOI report.

In the event that there are inaccuracies in a BOI Report, a Reporting Company should file an updated BOI Report within 30 days after the Reporting Company becomes aware of the inaccuracy or has a reason to know of the inaccuracy.

If a company ceases to qualify for an Exemption, it must submit a BOI Report within 30 days after it no longer qualifies for such Exemption. In contrast, if a Reporting Company qualifies for an Exemption after submitting a BOI Report, that entity must submit an updated BOI Report and check the box noting its newly exempt status. With respect to investment managers, the most common scenario would be if an ERA becomes an RIA—this would require the investment adviser entity, and all 3(c)(1) and 3(c)(7) funds managed by that entity, to file updated BOI Reports within 30 days after the investment adviser becomes an RIA.

Penalties

A willful failure to report or update the beneficial owner information or willfully providing false or fraudulent beneficial owner information shall result in civil penalties equal to $500/day up to a maximum of $10,000 as well as criminal penalties up to two years in jail.

If you have any questions about your compliance obligations, or whether your company is exempt from the definition of a reporting company under the CTA, please reach out to your CFM contact or email us here [email protected].

[i] Any investment adviser that (i) is described in Section 203(l) of the Investment Advisers Act of 1940; and (ii) has filed Item 10, Schedule A, and Schedule B of Part 1A of the Form ADV, or any successor thereto, with the SEC. Note that investment advisers that qualify for a venture capital fund adviser exemption under the laws of specific states (i.e. California) may not qualify insomuch as their Form ADV is filed with their state regulator rather than the SEC.

Tokenized Private Funds (Hedge Funds & VC Funds)

Leave a reply

Overview of the Legal Process to Tokenize a Hedge Fund

By Bart Mallon, with Malhar Oza

As the digital asset industry continues to evolve, we see more use cases for tokenization, including tokenization of private investment funds like hedge, VC and PE funds. While currently we see more examples of tokenizing various real world assets (RWAs) such as investments in real estate, many groups are now choosing to tokenize private investment funds for a variety of new and innovative reasons. This blog post is intended to provide information about the legal and operational processes to take into account when tokenizing a private investment fund.

What is being tokenized?

When tokenizing a hedge fund or other private investment fund, we are talking about creating a separate instrument (essentially a digital ledger) on the blockchain in addition to creating all the “real world” formation documents. The total process is more akin to launching an existing private investment fund rather than foregoing the current fund formation and record-keeping process. In this way we tokenize the RWA of a fund offering – because of this, we first examine the RWA parts of the tokenized fund.

Similarities between Tokenized and Non-Tokenized Funds

While there are many differences between traditional and tokenized funds, from a high level overview, they have essentially equivalent legal/regulatory and operational requirements for the non-tokenized features. These similarities include:

Structure – like a traditional fund, a tokenized fund is going to be structured with (1) a management level entity or entities and (2) the fund level entity or entities (including potentially offshore feeder funds). For any private investment fund, the driving considerations for structure will involve business questions (e.g., where are investors located, where are investments made, etc) and tax (where is the manager physically located, do investors have specific tax needs, etc). Like traditional funds, managers are going to need to think about how regulatory requirements may affect structure generally (see below for more information here). For tokenized private investments funds there may also be a token issuing entity as well (discussed below) that will interact with this traditional structure.

Offering Documents – as with a traditional private fund, a tokenized fund needs to have fund offering documents. Specifically, a tokenized fund will have a PPM, limited partnership (or operating) agreement and subscription documents that will be substantially similar in structure and content to traditional non-tokenized funds. These documents describe the standard items for any private fund, and also make reference to many of the token-specific characteristics of the investment.

Investment program – while many will assume that a tokenized fund will be a crypto fund, these vehicles can be established to invest in any asset class (traditional securities (publicly or privately traded), real estate, art, commodities, etc.). The requirement to accurately describe the major aspects of the investment program in the fund offering documents are the same for both tokenized and traditional funds alike.

Service providers – the main service providers will be the same – this means that the manager will need to engage an administrator, an auditor, a broker/prime broker (if investing in securities on a securities exchange), a digital asset exchange (if trading in digital assets), a custodian, lawyer, etc. It is important for the manager to work with service providers who are comfortable with the tokenized aspects of the fund. Sometimes some fund managers will have two sets of attorneys for the fund launch – one set devoted to the standard fund aspects and one set devoted to the tokenized aspects. Where managers engage two sets of counsel, it is paramount each group of attorneys is in sync with the other to ensure proper compliance with securities laws.

Regulation – managers of tokenized funds will need to consider all of the same regulatory items that apply to normal funds. These items include:

RIA or CPO/CTA registration – there may be a requirement for the manager to obtain certain licenses based on the fund’s underlying investments or economic activity; for example, RIA registration is required if the manager invests in securities and CPO/CTA registration is required if the fund transacts in futures or commodities.
Regulation D – the manager will need to determine whether to utilize Section 506(b) or Section 506(c). Section 506(c) allows for general solicitation and many tokenized fund managers choose this safe harbor despite there being additional investor qualification requirements. [Note: some funds may try to tokenize via the Regulation A process, but we don’t think this is optimal.]
Form D and blue sky filings – as with a normal fund, after fund interests have been sold, the manager will also need to make sure to make Form D and blue sky filings.
Investment Company Act – the manager will need to choose whether to have the fund use the 3c1 or 3c7 exemptions.
Investor qualifications – based potentially on whether the fund will be 3c1 or 3c7, the investors may need to have accredited investor status, qualified client status, or qualified purchaser status.
Other items to be aware about – AML/KYC (standard in subscription documents, though there should be heightened AML/KYC practices when launching a tokenized product), adequate description of conflicts of interest, whether the fund will be subject to ERISA, making sure marketing materials are accurate, etc.

Token Specific Aspects of a Tokenized Fund

While the many similarities between the two types of funds are clear, there are specific technical items to consider with respect to the tokenized fund.

What blockchain? – perhaps this is going to be the most important technical question for the manager and will influence the characteristics and usefulness of the fund token. Normally this part is determined by the manager after discussion with their tech team (internal or external) and then relayed to the attorney. It will be very important for the manager to detail all technical aspects of the generation and potential movement of the fund token to the attorney for appropriate legal analysis.

When and how are tokens created? – mechanically the fund tokens will need to be generated pursuant to some sort of token creation protocol. This will depend on other qualities of the fund token including how whitelisting (discussed below) will be done, what blockchain is being utilized, and whether the fund token will interact with certain smart contracts.

Smart contracts? – depending on the native blockchain and functionality of the fund tokens, managers may choose to allow the fund tokens to interact with certain smart contracts. The ability for investors to use fund tokens to interact with smart contracts is one of the potential emerging use cases of the fund tokenization process. Managers should understand what the smart contracts will be doing, and care must be taken such that at all points in the smart contract process all applicable laws and regulations are followed. The use of whitelisting, among other safeguarding techniques, is a common tool to comply with securities laws among other purposes. Obviously allowing smartcontract functionality with the fund tokens will increase various technical and legal risks with respect to the fund tokens.

Transfers and Whitelists – one of the reasons to tokenize private investment fund interests is to allow for easier transfer between token holders through a faster speed of settlement as well as the potential creation of a more robust secondary market. As these fund tokens represent private fund interests (or only certain features of private fund interests in some cases), any transfers require compliance with all applicable securities regulations and laws. This means that like in the traditional fund context, the tokenized fund manager will need to continually understand the fund’s investor base (for example: accredited investor, qualified client, qualified purchaser status, number of purchasers/holders, etc,) and may need to be aware of other items as well (holding periods, AML/KYC, etc.) in order to conform to applicable securities laws and regulations.

Like with traditional funds, the manager ultimately still approves transfers of fund tokens (representing fund interests), even when the transfer is done on the blockchain. To aid with this, most tokenized funds will need to have some kind of a whitelist of wallet addresses (where the manager knows the identity of the person and/or entity that controls the whitelisted wallet address). This knowledge allows the manager to make sure that any fund token transfers are between parties whom the manager knows and/or are investors in the fund. Any transfer of the fund tokens needs to abide by securities laws and regulations and the utilization of a whitelist helps the manager ensure compliance.

Offshore lawyers/ jurisdiction – there are two ways that offshore lawyers are important to the tokenized fund launch process. The first is with respect to normal offshore structuring in the event the fund will have non-US investors. The second way deals with the jurisdiction of the token itself. Many times there will be a foundation or other offshore entity that issues the token. The foundation may or may not be the token issuing entity. In many cases, the token issuing entity is likely to be an offshore company and offshore counsel is needed in the creation of this entity.

No NY investors in a tokenized fund – it is likely that tokenized funds run afoul of the New York bitlicense requirement. Unless a manager goes through the process to obtain a bitlicense in New York, the manager will need to make sure that there are no New York resident investors in the fund. Given the potential of each state to implement similar regulations, your choice of counsel should remain up-to-date about all such regulatory regimes.

Tax – on the fund side, these vehicles are taxed like normal private fund vehicles and generally are structured to act as passthroughs for US taxable investors and as “blockers” for non-US investors. On the investor side, care needs to be taken with respect to any transfers of the fund tokens. Investors should also talk with tax counsel before using the fund tokens in smart-contracts or other programs because there may be certain tax consequences. The IRS has been slow to issue guidance, and the asset class is novel and kinetic, so we urge managers to connect with tax counsel throughout the structuring process.

Limitations

Some of the limitations of tokenized fund products stems from uncertain regulatory regimes like the New York Bit License requirement and other states’ similar regulatory regimes. Additionally, the cost and expense of developing the fund token on the blockchain, retaining a tech team, engaging and potentially educating service providers, and the constant regulatory scrutiny of digital assets in general may make fund tokenization unattractive for certain groups. While any private investment fund in any asset class has the potential to become tokenized, groups should internally assess whether tokenization makes sense for the product seeking to be launched.

Specific risks of tokenized funds

The tokenized fund has both standard risks associated with a private fund, as well risks related solely to the tokenized aspect. Standard risks include operation of the fund structure, general risks with respect to trading/investment program (including normal liquidity), standard legal and regulatory risks, etc. In addition to those risks, the following will be applicable to tokenized funds:

Unclear regulations – investment adviser, IRS, etc
Risk related to the technology (blockchain generally, DeFi, smart contracts, hacks, private keys, malicious actors, network outages and bugs)
Token units may have a different “value” than the underlying NAV related to the fund interest, depending on how the manager operates the private fund

Cost and Timing

Tokenized funds are inherently more resource-intensive to launch given the various structuring components and specialization of the service providers. Timing for a launch will also be longer than a traditional fund launch to allow for coordination between the lawyers, manager, operations, and technical fund token deployment teams. A good rule of thumb is that a tokenized fund will probably cost about twice as much in both cost and time than would apply for a non-tokenized fund product.

Issues and Conclusion

Tokenized funds are new vehicles and with any new structure (and unclear regulatory guidance), there are going to be issues that pop up during the launch process. As discussed above, most issues are likely to be with respect to the mechanical or technical aspects of tokenizing the fund (as opposed to the drafting of the fund offering documents and legal agreements). We recommend taking more time on the front end to make sure all of the service providers truly understand how the fund token will work during all stages of the token lifecycle – it is vital for the technical functionality of the token is understood and appropriately disclosed in applicable documents.

By some accounts, tokenized funds will become a big part of the future financial world. If it comes to pass that there is and continues to be a compelling use case for tokenizing a private fund, then we believe that this process will become more and more streamlined. But, tokenized funds are still novel and relatively untested and complete functionality with respect to a token’s potential will be limited by applicable laws/regulations. These structures will continue to develop both in standardization in terms of process, cost and timing as more groups seek to tokenized private fund products, and in functionality as more people come to the digital asset space and try to do new and novel things.

We are very early in this space and are excited for the future. If you have any questions on how to tokenized a private fund, please contact us or call Bart Mallon directly at 415-868-5345.

****

Bart Mallon, co-founder of Cole-Frieman & Mallon LLP, has established himself as a leader in the private fund space for digital assets and has helped to launch some of the first tokenized private funds. For more information on his practice please see his bio or reach out to him directly at 415-868-5345.

Malhar Oza works as Counsel at Cole-Frieman & Mallon LLP and assists clients on various operational, transactional and regulatory matters related to digital assets, including fund formation (domestic and offshore). Malhar also counsels crypto managers, investment advisers, digital asset fund managers, and other members of the digital asset investment management industry on complex compliance matters related to state and federal securities laws. He also specializes in launching tokenized fund products, including closed-end and evergreen private investment funds. To contact Malhar, please email him at [email protected] or give him a call at 415-762-2879.

Cole-Frieman & Mallon 2023 End of Year Update

Leave a reply

December 18, 2023

Clients, Friends, and Associates:

As we near the end of 2023, we have highlighted some recent industry developments that will likely impact many of our clients. We have also developed a checklist to help managers effectively oversee the business and regulatory landscape for the coming year. While we strive to present an informative, albeit brief, overview of these topics, we are also available should you have any related questions.

This update includes the following:

CFM Items
Q4 Matters
Annual Compliance & Other Items
Annual Fund Matters
Annual Management Company Matters
Notable Regulatory & Other Items from 2023
Compliance Calendar

****

CFM Items

We are pleased to welcome Jon Tong as a Senior Associate in our Funds practice group. His experience and expertise in the field will greatly contribute to the success and growth of our Funds practice group. Please join us in welcoming Jon to our firm.

****

Q4 Matters

SEC Charges Kraken for Operating as an Unregistered Securities Exchange. On November 20, 2023, the Securities and Exchange Commission (“SEC”) charged Payward Inc. and Payward Ventures Inc., together known as Kraken, with operating Kraken’s trading platform as an unregistered securities exchange, broker, dealer, and clearing agency. The SEC’s complaint also alleges that Kraken lacks sufficient internal controls and recordkeeping practices, and that Kraken commingles customer money and crypto assets with its own, presenting serious risks for its customers. The complaint seeks injunctive relief, conduct-based injunctions, disgorgement of ill-gotten gains plus interest, and penalties. This enforcement action comes just months after Kraken agreed to cease offering or selling securities through its staking service and pay a civil penalty of $30 million, as described further in Notable Regulatory & Other Items from 2023, below.

SEC Issues Risk Alert Clarifying Exam Selection Process for Registered Investment Advisers. On September 6, 2023, the SEC’s Division of Examinations issued a Risk Alert outlining its examination selection process for SEC-registered investment advisers (“SEC RIAs”). The SEC noted that it relies on a risk-based approach, utilizing industry- and firm-level data as well as information provided on disclosure documents such as Form ADV and Form PF to identify high-risk advisers. In addition, the SEC considers numerous factors, such as the results of past examinations, disciplinary history of adviser affiliates, potential conflicts of interest in business activities, vulnerability to financial or market stresses, media reports and complains, access to client assets, as well as an adviser’s specific products, services, or practices. The scope of an examination, and consequently the documents requested, will vary depending on the firm’s business model, associated risks, and the reason for conducting the examination. However, examinations typically include reviewing advisers’ operations, disclosures, conflicts of interest, and compliance practices with respect to certain core areas, including but not limited to, custody and safekeeping of client assets, valuation, portfolio management, fees and expenses, and brokerage and best execution.

The Division of Examinations publishes an annual list of priorities to signal its interest in particular compliance risk areas, of which advisers should be mindful.

The National Venture Capital Association Revises its Model Legal Documents. The National Venture Capital Association (“NVCA”) recently revised its model legal documents for the first time since 2014. These changes are particularly relevant to our clients engaged in venture capital transactions, offering enhanced legal frameworks and protections in this rapidly evolving sector. Changes include: (i) provisions specifically tailored to evolving markets such as life science transactions and cryptocurrency- and blockchain-related offerings; (ii) enhanced ethical and legal standards, such as inclusion in the Investor Rights Agreement of a covenant requiring adoption of a workplace code of conduct and anti-harassment policies; and (iii) adaptations to legal developments, such as new drafting options in response to the Delaware Rapid Arbitration Act (2015), offering more efficient dispute resolution mechanisms. The revised model documents can be found on the NVCA’s website.

CFTC’s Proposed Amendments to Regulation 4.7. On October 2, 2023, the Commodity Futures Trading Commission (“CFTC”) proposed amendments to modernize Regulation 4.7, significantly increasing monetary thresholds and expanding disclosure requirements. Currently, Regulation 4.7 exempts commodity pool operators (“CPOs”) and commodity trading advisors (“CTAs”) from certain compliance requirements if their offerings are limited to qualified eligible persons (“QEPs”). The CFTC proposes four amendments: (1) doubling the monetary thresholds for QEP portfolio requirements; (2) adding certain disclosure requirements for CPOs and CTAs relying on the Regulation 4.7 exemption; (3) adding an option for CPOs of funds of funds operated under Regulation 4.7 to distribute their monthly account statements within 45 days after the end of the month; and (4) technical amendments to improve the Regulation’s readability.

The proposed disclosure requirements for CPOs include descriptions of principal risk factors for the exempt pool, investment program and use of proceeds, fees, conflicts, and performance. Regulation 4.7 pool offerings would require an offering memorandum. Similarly, CTAs would also have to make disclosures, including: the identities and descriptions of certain persons such as principals, futures commission merchants, any foreign exchange dealers, and introducing brokers; risk factors; trading programs; fees; conflicts; and performance.

****

Annual Compliance & Other Items

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

Annual Compliance Review. The Chief Compliance Officer (“CCO”) of a registered investment advisor (“RIA”) must conduct a review of the adviser’s compliance policies and procedures annually. This annual compliance review should be in writing and presented to senior management. CCOs should consider additions, revisions, and updates to the compliance program as may be necessary. We recommend ﬁrms discuss the annual review with their outside counsel or compliance ﬁrm to obtain guidance about the review process and a template for the assessment. Conversations regarding the annual review may raise sensitive matters, and advisers should ensure that these discussions are protected by attorney-client privilege. Advisers that are not registered may still wish to review their procedures and/or implement a compliance program as a best practice.

Form ADV Annual Amendment. RIAs or managers ﬁling as exempt reporting advisers (“ERAs”) with the SEC or a state securities authority must ﬁle an annual amendment to their Form ADV within 90 days of the end of their ﬁscal year. For most managers, the Form ADV amendment will be due on March 31, 2024. RIAs must provide a copy of the updated Form ADV Part 2A brochure and Part 2B brochure supplement (or a summary of changes with an oﬀer to provide the complete brochure) to each “client” and, if applicable, Part 3 (Form CRS: Client Relationship Summary) to each “retail investor” with which the RIA has entered into an investment advisory contract. Note that for SEC RIAs to private investment vehicles, a “client” for purposes of this rule refers to the vehicle(s) managed by the adviser and not the underlying investors. State-registered advisers need to examine their states’ regulations to determine who constitutes a “client.” For purposes of the Form ADV Part 3, a “retail investor” means a natural person, or the legal representative of such natural person, who seeks to receive or receives services primarily for personal, family, or household purposes.

Switching to/from SEC Regulation.

SEC Registration. Managers who no longer qualify for SEC registration as of the time of ﬁling the annual Form ADV amendment must withdraw from SEC registration within 180 days after the end of their ﬁscal year (June 30, 2024, for most managers), by ﬁling a Form ADV-W. Such managers should consult with legal counsel to determine whether they are required to register in the states in which they conduct business. Managers who are required to register with the SEC as of the date of their annual amendment must register with the SEC within 90 days of ﬁling the annual amendment (June 30, 2024, for most managers, assuming the annual amendment is filed on March 31, 2024).

Exempt Reporting Advisers. Managers who no longer meet the deﬁnition of an ERA will need to submit a ﬁnal report as an ERA and apply for registration with the SEC or the relevant state securities authority, as applicable, generally within 90 days after the ﬁling of the annual amendment (June 30, 2024, for most managers, assuming the annual amendment is filed on March 31, 2024).

Custody Rule Annual Audit.

SEC RIAs. SEC RIAs must comply with specific custody procedures, including: (i) maintaining client funds and securities with a qualiﬁed custodian; (ii) having a reasonable basis to believe that the qualiﬁed custodian sends an account statement to each advisory client at least quarterly; and (iii) undergoing an annual surprise examination conducted by an independent public accountant.

SEC RIAs to pooled investment vehicles may avoid both the quarterly statement and surprise examination requirements by having audited ﬁnancial statements prepared for each pooled investment vehicle in accordance with generally accepted accounting principles (“GAAP”) by an independent public accountant registered with the Public Company Accounting Oversight Board (“PCAOB”). Audited financial statements must be sent to investors in the fund within 120 days after the fund’s ﬁscal year-end (or for fund-of-fund clients, within 180 days after fiscal year-end). SEC RIAs should review their internal procedures to ensure compliance with the custody rules.

California RIAs. California-registered investment advisers (“CA RIAs”) that manage pooled investment vehicles and are deemed to have custody of client assets are also subject to independent party surprise examinations. However, CA RIAs can avoid these additional requirements by engaging a PCAOB-registered auditor to prepare and distribute audited ﬁnancial statements to all beneficial owners of the pooled investment vehicle, and the Commissioner of the California Department of Financial Protection and Innovation (“DFPI”). Those CA RIAs that do not engage an auditor must, among other things: (i) provide notice of such custody on the Form ADV; (ii) maintain client assets with a qualiﬁed custodian; (iii) engage an independent party to act in the best interest of investors to review fees, expenses, and withdrawals; and (iv) retain an independent certiﬁed public accountant to conduct surprise examinations of assets.

Other State RIAs. Advisers registered in other states should consult their legal counsel about those states’ specific custody requirements.

California Minimum Net Worth Requirement and Financial Reports.

CA RIAs with Discretion. Every CA RIA (other than those also registered as broker-dealers) that has discretionary authority over client funds or securities, regardless of if they have custody, must maintain a net worth of at least $10,000 (CA RIAs with custody are subject to heightened minimum net worth requirements, discussed further below).

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

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

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

CPO and CTA Annual Updates. Registered CPOs and CTAs must prepare and ﬁle Annual Questionnaires and Annual Registration Updates with the National Futures Association (“NFA”), as well as submit payment for annual maintenance fees and NFA membership dues. Registered CPOs must also prepare and ﬁle their fourth-quarter report for each commodity pool on Form CPO-PQR, while CTAs must ﬁle their fourth-quarter report on Form CTA-PR. Unless eligible to claim relief under Regulation 4.7, registered CPOs and CTAs must update their disclosure documents periodically, as they may not use any document dated more than 12 months prior to the date of its intended use. Disclosure documents that are materially inaccurate or incomplete must be promptly corrected and redistributed to pool participants.

Trade Errors. Managers should ensure that all trade errors are properly addressed pursuant to the manager’s trade errors policies by the end of the year. Documentation of trade errors should be ﬁnalized, and if the manager is required to reimburse any of its funds or other clients, it should do so by year-end.

Soft Dollars. Managers that participate in soft dollar programs should make sure that they have addressed any commission balances from the previous year.

Schedule 13G/D Filings. Managers who exercise investment discretion over accounts (including funds and separately managed accounts) that are beneﬁcial owners of 5% or more of a registered voting equity security must report these positions on Schedule 13D or 13G. Passive investors are generally eligible to ﬁle the short-form Schedule 13G, which is updated annually within 45 days of the end of the year. Schedule 13D is required when a manager is ineligible to ﬁle Schedule 13G and is due 10 days after acquiring more than 5% beneﬁcial ownership of a registered voting equity security. For managers who are also making Section 16 ﬁlings, this is an opportune time to review your ﬁlings to conﬁrm compliance and anticipate needs for the ﬁrst quarter.

Managers should be aware that the SEC recently adopted amendments to the Schedule 13D and 13G reporting deadlines:

Revised Schedule 13D Deadlines. For Schedule 13D, the amendments shorten the initial filing deadline from 10 days to 5 business days and require that amendments be filed within 2 business days. Compliance with the new Schedule D filing deadlines will be required as of the amendments’ effective date, February 5, 2024.

Revised Schedule 13G Deadlines. For certain Schedule 13G filers (i.e., qualified institutional investors and exempt investors), the amendments shorten the initial filing deadline from 45 days after the end of a calendar year to 45 days after the end of the calendar quarter in which the investor beneficially owns more than 5% of the covered class. For other Schedule 13G filers (i.e., passive investors), the amendments shorten the initial filing deadline from 10 days to 5 business days. In addition, for all Schedule 13G filers, the amendments generally require that an amendment be filed 45 days after the calendar quarter in which a material change occurred rather than 45 days after the calendar year in which any change occurred. Finally, the amendments accelerate the Schedule 13G amendment obligations for qualified institutional investors and passive investors when their beneficial ownership exceeds 10% or increases or decreases by 5%. Compliance with the new Schedule G filing deadlines will be required as of September 30, 2024.

Section 16 Filings. Section 16 ﬁlings are required for “corporate insiders” (including beneﬁcial owners of 10% or more of a registered voting equity security). An initial Form 3 is due within 10 days after becoming an “insider”; Form 4 reports ownership changes and is due by the end of the second business day after an ownership change; and Form 5 reports any transactions that should have been reported earlier on a Form 4 or were eligible for deferred reporting and is due within 45 days after the end of each fiscal year.

Form 13F. A manager must ﬁle a Form 13F if it exercises investment discretion with respect to $100 million or more in certain “Section 13F securities” within 45 days after the end of the year in which the manager reaches the $100 million ﬁling threshold. The SEC lists the securities subject to 13F reporting on its website.

Form 13H. Managers who meet one of the SEC’s large trader thresholds (generally, managers whose transactions in exchange-listed securities equal or exceed two million shares or $20 million during any calendar day, or 20 million shares or $200 million during any calendar month) are required to ﬁle an initial Form 13H with the SEC within 10 days of crossing a threshold. Large traders also need to amend Form 13H annually within 45 days of the end of the year. In addition, changes to the information on Form 13H will require interim amendments following the calendar quarter in which the change occurred.

Form PF. Managers to private funds that are either registered with the SEC or required to be registered with the SEC and who have at least $150 million in regulatory assets under management (“RAUM”) must ﬁle a Form PF. Private advisers with less than $1.5 billion in RAUM must ﬁle Form PF annually within 120 days of their ﬁscal year-end. Private advisers with $1.5 billion or more in RAUM must ﬁle Form PF within 60 days of the end of each fiscal quarter.

Form MA. Investment advisers that provide advice on municipal financial products are considered “municipal advisors” by the SEC and must file a Form MA annually, within 90 days of their fiscal year-end.

SEC Form D. Form D ﬁlings for most funds need to be amended annually, on or before the anniversary of the most recently ﬁled Form D. Copies of Form D are publicly available on the SEC’s EDGAR website.

Blue Sky Filings. On an annual basis, a manager should review its blue sky ﬁlings for each state to make sure it has met any initial and renewal filing requirements. Several states impose late fees or reject late ﬁlings altogether. Accordingly, it is critical to stay on top of ﬁling deadlines for both new investors and renewals. We also recommend that managers review blue sky ﬁling submission requirements. Many states now permit blue sky ﬁlings to be ﬁled electronically through the Electronic Filing Depository (“EFD”) system, and certain states will now only accept ﬁlings through EFD.

IARD Annual Fees. Preliminary annual renewal fees for state-registered and SEC-registered investment advisers are due on December 13, 2023. Failure to submit electronic payments by the deadline may result in registrations terminating due to a “failure to renew.” If you have not already done so, you should submit full payment into your Renewal Account by E-Bill, check, or wire as soon as possible.

Pay-to-Play and Lobbyist Rules. SEC rules disqualify investment advisers, their key personnel, and placement agents acting on their behalf from seeking to be engaged by a governmental client if they have made certain political contributions. State and local governments have similar rules, including California, which requires internal sales professionals who meet the deﬁnition of “placement agents” (people who act for compensation as ﬁnders, solicitors, marketers, consultants, brokers, or other intermediaries in connection with oﬀering or selling investment advisory services to a state public retirement system in California) to register with the state as lobbyists and comply with California lobbyist reporting and regulatory requirements. Note that managers oﬀering or selling investment advisory services to local government entities must register as lobbyists in the applicable cities and counties. State laws on lobbyist registration diﬀer significantly, so managers should carefully review reporting requirements in the states in which they operate to make sure they comply with the relevant rules.

****

Annual Fund Matters

New Issue Status. On an annual basis, managers need to conﬁrm or reconﬁrm the eligibility of investors that participate in initial public oﬀerings, or new issues, pursuant to both Financial Industry Regulatory Authority, Inc. (“FINRA”) Rules 5130 and 5131. Most managers reconﬁrm investor eligibility via negative consent (i.e., investors are informed of their status on ﬁle with the manager and are asked to notify the manager of any changes), whereby a failure to respond by any investor operates as consent to its current status.

ERISA Status. Given the signiﬁcant problems that can occur from not properly tracking ERISA investors in private funds, we recommend that managers conﬁrm or reconﬁrm on an annual basis the ERISA status of their investors. This is particularly important for managers that track the underlying percentage of ERISA funds for each investor, with respect to each class of interests in a pooled investment vehicle.

Wash Sales. Managers should carefully manage wash sales for year-end. Failure to do so could result in book/tax differences for investors. Certain dealers can provide managers with swap strategies to manage wash sales, including Basket Total Return Swaps and Split Strike Forward Conversion. These strategies should be considered carefully to make sure they are consistent with the investment objectives of the fund.

Redemption Management. Managers with signiﬁcant redemptions at the end of the year should carefully manage unwinding positions to minimize transaction costs in the current year (that could impact performance) and prevent transaction costs from impacting remaining investors in the next year. When closing funds or managed accounts, managers should pay careful attention to the liquidation procedures in the fund constituent documents and the managed account agreement.

NAV Triggers and Waivers. Managers should promptly seek waivers of any applicable termination events specified in a fund’s International Swaps and Derivatives Association (“ISDA”) or other counterparty agreement that may be triggered by redemptions, performance, or a combination of both at the end of the year (NAV declines are common counterparty agreement termination events).

Fund Expenses. Managers should wrap up all fund expenses for 2023 if they have not already done so. In particular, managers should contact their outside legal counsel to obtain accurate and up to date information about legal expenses for inclusion in the NAV for year-end performance.

Electronic Schedule K-1s. The Internal Revenue Service (“IRS”) authorizes partnerships and limited liability companies taxed as partnerships to issue Schedule K-1s to investors solely by electronic means, provided the partnership has received the investors’ aﬃrmative consent. States may have diﬀerent rules regarding electronic K-1s, and partnerships should check with their counsel whether they may be required to send hard copy state K-1s. Partnerships must also provide each investor with speciﬁc disclosures that include a description of the hardware and software necessary to access the electronic K-1s, how long the consent is eﬀective, and the procedures for withdrawing the consent. If you would like to send K-1s to your investors electronically, you should discuss your options with your service providers.

“Bad Actor” Recertiﬁcation Requirement. A security oﬀering cannot rely on the Rule 506 safe harbor from SEC registration if the issuer or its “covered persons” are “bad actors.” Fund managers must determine whether they are subject to the bad actor disqualiﬁcation any time they are oﬀering or selling securities in reliance on Rule 506. The SEC has advised that an issuer may reasonably rely on a covered person’s agreement to provide notice of a potential or actual bad actor triggering event pursuant to contractual covenants, bylaw requirements, or undertakings in a questionnaire or certiﬁcation. However, if an oﬀering is continuous, delayed or long-lived, issuers must periodically update their factual inquiry through a bring-down of representations, questionnaires, and certiﬁcations, negative consent letters, reexamination of public databases or other means, depending on the circumstances. Fund managers should consult with counsel to determine how frequently such an update is required. As a matter of practice, most fund managers should perform these updates at least annually.

U.S. FATCA. Funds should monitor their compliance with the U.S. Foreign Account Tax Compliance Act (“FATCA”). Generally, U.S. FATCA reports are due to the IRS on March 31, 2024, or September 30, 2024, depending on where the fund is domiciled. However, reports may be required by an earlier date for jurisdictions that are parties to intergovernmental agreements (“IGAs”) with the U.S. Additionally, the U.S. may require that reports be submitted through the appropriate local tax authority in the applicable IGA jurisdiction, rather than the IRS. Given the varying U.S. FATCA requirements applicable to diﬀerent jurisdictions, managers should review and conﬁrm the speciﬁc U.S. FATCA reporting requirements that may apply. As a reminder, we strongly encourage managers to ﬁle the required reports and notiﬁcations, even if they already missed previous deadlines. Applicable jurisdictions may be increasing enforcement and monitoring of FATCA reporting and imposing penalties for each day late.

CRS. Funds should also monitor their compliance with the Organisation for Economic Cooperation and Development’s Common Reporting Standard (“CRS”). All “Financial Institutions” in the British Virgin Islands (“BVI”) and the Cayman Islands must register with the respective jurisdiction’s Tax Information Authority and submit various reports with the applicable regulator via the associated online portal. Managers to funds domiciled in other jurisdictions should also conﬁrm whether any CRS reporting will be required in such jurisdictions and the procedures required to enroll and file annual reports. We recommend managers contact their tax advisors to stay on top of the U.S. FATCA and CRS requirements and avoid potential penalties.

****

Annual Management Company Matters

Management Company Expenses. Managers who distribute proﬁts annually should attempt to address management company expenses in the year they are incurred. If ownership or proﬁt percentages are adjusted at the end of the year, a failure to manage expenses could significantly impact the economics of the partnership or the management company.

Employee Reviews. An eﬀective annual review process is vital to reduce the risk of employment-related litigation and protect the management company in the event of such litigation. Moreover, it is an opportunity to provide context for bonuses, compensation adjustments, employee goals, and other employee-facing matters at the ﬁrm. It is never too late to put an annual review process in place.

Compensation Planning. In the fund industry, and the ﬁnancial services industry in general, the end of the year is the appropriate time to make adjustments to compensation programs. Because much of a manager’s revenue is tied to annual income from incentive fees, any changes to the management company structure, affiliated partnerships, or any shadow equity programs should be eﬀective on the ﬁrst of the year. Partnership agreements and operating agreements should be appropriately updated to reflect any such changes.

Insurance. If a manager carries director and officer or other liability insurance, the policy should be reviewed annually to ensure that the manager has provided notice to the carrier of all claims and all potential claims. Newly launched funds should also be added to the policy as necessary.

Other Tax Considerations. Fund managers should assess their overall tax position and consider several steps to optimize tax liability. Managers should also be aware of self-employment taxes, which can potentially be minimized by structuring the investment manager as a limited partnership. Several steps are available to optimize tax liability, including: (i) changing the incentive fee to an incentive allocation; (ii) use of stock-settled stock appreciation rights; (iii) if appropriate, terminating swaps and realizing net losses; (iv) making a Section 481(a) election under the Internal Revenue Code of 1986, as amended (“Code”); (v) making a Section 475 election under the Code; and (vi) making charitable contributions. Managers should consult legal and tax professionals to evaluate whether any of these options are appropriate.

****

Notable Regulatory & Other Items from 2023

SEC Matters

SEC Charges Staking-as-a-Service Provider. On February 9, 2023, the SEC charged Payward Ventures, Inc. and Payward Trading Ltd. (“Kraken”) with failing to register the offer and sale of their crypto asset staking-as-a-service program. In operation since 2019, Kraken’s program allowed public investors to transfer crypto related assets to Kraken for staking in exchange for annual investment returns advertised by Kraken to be as high as 21%. Kraken’s model depended on pooling the assets transferred by investors and staking them on behalf of those investors. The SEC’s complaint alleged that the program produced benefits derived from Kraken’s effort on behalf of investors and that the program should be considered an investment contract subject to registration, disclosure, and safeguard protections required by securities laws. As a result of the charge, Kraken agreed to cease offering or selling securities through crypto asset staking services and pay $30 million in settlement fees. Although the SEC’s complaint did not allege that staking necessarily always constitutes a security offering, it was determined the service did meet the 4-prong Howey test to be considered an investment contract. This illustrates the SEC’s increasingly more aggressive regulation of crypto under existing rules and regulations, and managers should consider whether staking services offered by third parties would fit into the Kraken fact pattern.

SEC Enforcement Action Against Ripple. On July 13, 2023, the U.S. District Court of the Southern District of New York entered an order which granted in part and denied in part the cross-motions for summary judgment filed by the SEC and Ripple Labs, Inc. (“Ripple”). In December 2020, the SEC charged Ripple and two executives for engaging in unlawful offer and sales of securities in violation of the Exchange Act. The complaint alleged that since 2013, Ripple issued over 14.6 billion units of its native token, XRP, in exchange for consideration of over $1.38 billion without registering the offer and the sale of such token with the SEC. Notably, the July 2023 order stated that XRP “is not in and of itself a ‘contract, transaction[,] or scheme’ that embodies the Howey requirements of an investment contract”. In other words, XRP itself is not a security, and all the facts and circumstances surrounding specific transactions in XRP must be examined to determine whether an “investment contract,” as defined under the Howey test, was issued. As a reminder, the U.S. Supreme Court ruled in Howey that an investment contract requires a finding of an investment of money in a common enterprise with the reasonable expectation of profits derived from the efforts of others.

The District Court examined the sale and distribution of XRP in three types of transactions – direct sales of XRP to institutional investors, sales of XRP through crypto exchanges in blind bid/ask transactions, and distributions of XRP as payment for services to employees and service providers – and held that only the direct sales of XRP to institutional investors constituted an investment contract under the Howey test.

Terraform Labs Ruling Rejects Ripple Holding. On July 31, 2023, the U.S. District Court for the Southern District of New York sided with the SEC in the case of SEC v. Terraform Labs Ptd. Ltd. after it denied the defendants’ motion to dismiss. In doing so, the court rejected outright the holding in the recent summary judgment granted by another judge in the same District Court in SEC v. Ripple Labs Inc. For more information on SEC v. Ripple Labs Inc., check out our July 2023 Quarterly Update from the Hedge Fund Law Blog.

The court in Terraform Labs found that both direct institutional investment sales and secondary market transactions involving retail investors were investment contracts, arguing that Howey makes no distinction between institutional and retail investors and concluded that the nature and type of purchases have no bearing on “whether a reasonable individual would objectively view the defendants’ actions and statements as evincing a promise of profits based on their efforts.” The court opted to apply the Howey test in a different manner than in Ripple Labs. In Ripple Labs, the court drew a distinction between sales of the XRP token to retail investors and institutional investors, holding that the sales of XRP to retail investors was not an investment contract because the purchasers did not have a reasonable expectation of profits from the efforts of Ripple Labs, Inc.

The inconsistent application of the Howey test from within the Southern District of New York illustrates the regulatory uncertainty surrounding the digital asset industry. We will continue to monitor similar cases brought by the SEC and other regulators.

SEC Adopts Final Rules for Private Fund Advisers. On August 23, 2023, the SEC issued final rules focused on investment advisers who manage private funds (the “New Private Fund Adviser Rules”). A summary of the key elements of the New Private Fund Adviser Rules appears in our October 2023 Quarterly Update.

The SEC’s New Proposed Rule Regarding Safeguarding Advisory Client Assets. In February, the SEC announced a proposed rule to amend the existing “custody rule” applicable to SEC RIAs that have custody of client assets. The proposed rule, redesignated as the “safeguarding rule,” would impose significant new requirements on RIAs, including RIAs operating in the digital asset space. As discussed more fully in our April 2023 Quarterly Update, the new rule would expand the existing custody requirements to cover all “client assets” over which an RIA has custody, explicitly including digital assets, and require RIAs operating in the digital asset space to custody their digital assets with “qualified custodians” at all times. The proposed rule, and any revisions to it, would only become effective after the SEC commissioners vote to approve it as a final rule.

The SEC’s Proposed Cyber Risk Management Rule for Investment Advisers. Last February, the SEC released a proposed rule that portends to create an entirely new cybersecurity compliance regime for investment advisers and certain funds. This new set of cybersecurity risk management rules (the “Cyber Risk Management Rule”) will be codified by amendments to both the Investment Advisers Act and the Investment Company Act. As drafted, the Cyber Risk Management Rule has four (4) cornerstone components: (i) appropriately scaled policies and procedures; (ii) a new regulatory cybersecurity breach-reporting regime (which contemplated a 48-hour notification period for alerting the SEC of a cybersecurity breach); (iii) cybersecurity disclosure obligations; and (iv) cybersecurity recordkeeping requirements. The Cyber Risk Management Rule was set for a final vote in April 2023, however on March 15, 2023, the SEC unexpectedly reopened its comment period for an additional sixty (60) days, while simultaneously issuing three (3) additional cybersecurity related rule proposals, each with some connective tissue with the Cyber Risk Management Rule. In June, the SEC set a goal to finalize the Cyber Risk Management Rule by October, however the SEC has not yet done so and has indicated that the rule’s formal adoption will take place in early 2024. Cybersecurity continues to be a top priority at the SEC, and it has made clear that a new, more mature and comprehensive cybersecurity compliance regime is imminent. This new regime will not only heighten the SEC’s current cybersecurity requirements (i.e., the requirement to have certain cybersecurity policies, procedures and controls, including annual assessments) but will also create entirely new categorical obligations, to wit, the aforementioned reporting, disclosure and recordkeeping requirements. The Firm’s Cybersecurity Law Practice Group is available to assist our clients with any questions or concerns regarding virtually any aspect of cybersecurity compliance.

SEC and NYDFS Commence Actions Against Paxos. The New York Department of Financial Services (“NYDFS”) in February ordered Paxos Trust Company (“Paxos”) to cease minting Paxos-issued BUSD, a fiat-backed stablecoin issued by Binance and Paxos. Each BUSD token is backed 1:1 with US dollars held in reserve. On February 13, 2023, Paxos notified customers of its intent to end its relationship with Binance as a result of the order. In conjunction with the order from the NYDFS, Paxos reported that it received a Wells notice from the SEC on February 3, 2023. According to a press release from Paxos, the Wells notice stated the SEC was considering enforcement action against Paxos alleging that BUSD is an unregistered security. No enforcement action has yet been brought.

SEC Releases a “Frequently Asked Questions” Page for the Marketing Rule. In January, the SEC released a FAQ page for questions stemming from its recently enacted rule 206(4)-1 under the Investment Advisers Act of 1940 (the “Marketing Rule”). The page currently provides responses to three commonly asked questions—most notably regarding its gross and net performance rules—clarifying that when an RIA displays the gross performance of one investment or a group of investments from a private fund, the RIA must show the net performance of the single investment and/or the group of investments, respectively. The SEC noted that they will be updating this page periodically to respond to questions related to the Marketing Rule, and clients should reach out with any specific questions relating to the new Marketing Rule.

Judge Rules that Emojis in a Tweet may Constitute “Financial Advice.” A United States District Court judge ruled that the use of emojis can be construed in certain circumstances to meet a factor in the legal test to determine whether an individual is providing financial advice. Specifically, the judge denied the defendant’s Motion to Dismiss, finding that the defendant-company’s use of a rocket ship, stock chart, and money bag emojis in a recent tweet “objectively meant one thing: a financial return on investment.” The emojis were displayed alongside statements touting recent NFT purchase prices on the company’s website, presumably indicating future gains on such NFTs. While the decision specifically rules on the three emojis mentioned above, we advise our clients to use caution in their use of any emojis, whether that be in public or private communications regarding fund matters. In any event, any communications should not be misleading and should be in accordance with the Advisers Act and the new marketing rule (if applicable).

SEC Enforcement Action Against Coinbase. On June 6, 2023, the SEC charged Coinbase, Inc. and Coinbase Global, Inc. (collectively, “Coinbase”) for failure to register as an exchange, a broker-dealer and a clearing agency, and for failure to register the offering and sale of securities via the Coinbase trading platform in accordance with the Securities Exchange Act of 1934, as amended (the “Exchange Act”). This proceeding follows the Wells notice that Coinbase received from the SEC in March 2023. The complaint alleges that Coinbase acted as an unregistered exchange, a broker-dealer, and a clearing agency by making available at least 13 crypto assets that are offered and sold as investment contracts on its platform. Additionally, the complaint alleges that Coinbase’s staking program should be considered an investment contract under the Howey test.

On June 28, 2023, Coinbase filed an answer to the SEC complaint denying that the digital assets listed on its platform constitute an investment contract or a security. Additionally, the answer noted that half of the tokens traded on Coinbase’s platform that the SEC alleged are securities were custodied and traded on its platform since April 2021 (i.e., when the SEC approved and declared Coinbase’s S-1 filing to be effective), and, at the time, the SEC did not identify such tokens as investment contracts or securities, nor allege that Coinbase was operating as an unregistered exchange, broker, and clearing agency within the meaning of federal securities law. Coinbase’s answer also denied the SEC’s allegation that its staking program is a security. In addition to filing the answer, Coinbase filed a letter with the court indicating its intention to file a motion to dismiss the complaint, which motion to dismiss was filed on August 4, 2023. Our firm will continue to closely monitor the situation with Coinbase for new developments.

SEC Enforcement Action Against Bittrex and Bittrex’s Chapter 11 Bankruptcy. On April 17, 2023, the SEC charged Bittrex, Inc., Bittrex Global GmbH, and William Hiroaki Shihara, co-founder and former chief executive officer (collectively, “Bittrex”) for the failure to register as an exchange, a broker-dealer, and a clearing agency, pursuant to the Exchange Act. On March 31, 2023, Bittrex issued a statement that it began the process of winding down its U.S. operations. Shortly after the SEC’s complaint, Bittrex ceased its operations in the U.S. and filed for Chapter 11 bankruptcy. On June 13, 2023, the U.S. Bankruptcy Court for the District of Delaware entered an order permitting Bittrex to allow its customers to access and withdraw crypto assets and fiat currency from Bittrex’s trading platform.

On August 10, 2023, the SEC announced that crypto trading platform Bittrex agreed to settle charges that the company was operating an unregistered exchange, brokerage, and clearing house. Bittrex agreed to settle for a total payment of $24 million, which is to be paid within two months of filing a liquidation plan.

The Hinman Speech Documents. On June 13, 2023, the SEC internal communication documents related to William Hinman’s speech on digital asset transactions on June 14, 2018, were released to the public. The documents were made available to the public following an order entered by the U.S. District Court Southern District of New York denying the SEC’s motion to seal the SEC internal communication documents related to William Hinman’s 2018 speech in connection with its lawsuit against Ripple.

SEC Begins Enforcement for Violations of the New Marketing Rule. In a September 11, 2023 press release, the SEC announced that it charged nine registered investment advisers for showing hypothetical performance results on their websites without adopting the necessary policies and procedures required under the SEC’s new marketing rules and regulations (the “New Marketing Rules”). This targeted sweep is the first of its kind following the New Marketing Rules’ compliance deadline in November 2022. The SEC’s active approach to enforce the New Marketing Rules sends a stern reminder to SEC-registered fund managers to remain diligent when preparing marketing materials. We encourage managers to review their marketing materials to ensure compliance if they have not done so already.

SEC Proposes New Rules to Address Conflicts of Interest Presented by Predictive Data Analytics. On July 26, 2023, the SEC proposed new rules aiming to address conflicts of interest associated with the use of predictive data analytics (“PDA”) and other similar AI-powered tools. This announcement comes at a time when AI has supercharged the adoption of such tools by investment management professionals. The proposed rules reflect the SEC’s primary concern that PDA technologies may produce biased data or suggest biased outcomes, favoring investment advisers and broker-dealers over investors. The proposed rules aim to combat conflicts of interests created by these “covered technologies,” which the SEC defines broadly as “analytical, technological, or computational functions, algorithms, models, correlation matrices, or similar methods or processes that optimize for, predict, guide, forecast, or direct investment-related behaviors or outcomes of an investor.” The proposed rules serve as a poignant reminder that while AI continues to bring exciting new breakthroughs to the investment advisory business, it remains important to understand any biases or other pitfalls that such tools can present.

SEC Proposes Amendments to the Internet Adviser Exemption. On July 26, 2023, the SEC proposed new amendments to rule 203A-2(e) of the Investment Advisers Act, otherwise known as the “Internet Adviser Exemption.” In keeping with the spirit of the original rule while modernizing it to reflect new technologies, the proposed amendments clarify that an internet investment adviser is required to have an “operational” interactive website (which includes smartphone applications) at all times while relying on the Internet Adviser Exemption. To be considered operational, the website or application must provide “digital investment advisory services” on an ongoing basis to more than one client, which the SEC defines as advice generated by software-based models, algorithms, or applications. Once the proposed amendments are implemented, an investment adviser relying on this exemption can only provide investment advice through the operational interactive website. The proposed amendments aim to modernize the Internet Adviser Exemption in response to the technological advancements and evolution of the investment advisory industry since its original adoption in 2002.

SEC Adopts Cybersecurity Rule for Public Companies. On July 26, 2023, the SEC adopted a final rule that will require public companies to disclose information about cybersecurity risk management, strategy, governance, and incident reporting. This rule was approved by the SEC ahead of a similar cybersecurity risk management rule specific to investment advisers, which was anticipated to be approved and finalized in October 2023, but as of yet has not been approved and finalized by the SEC.

This rule will require public companies to adopt a myriad of cybersecurity practices and controls that encompass a variety of new compliance and disclosure obligations, including: (i) the disclosure of information regarding material cybersecurity incidents within four days after determining such event was material; (ii) describing in a public filing the material aspects of the scope, nature, and timing of any such incidents; (iii) creating detailed company policies for detecting and mitigating cybersecurity threats; and (iv) describing in a public filing the role of the public companies’ board of directors in assessing and managing cyber threats.

The SEC’s new cybersecurity risk management rule for investment advisers is expected to significantly expand the cybersecurity compliance obligations required of investment advisers. We intend to provide a detailed update on these rules once they are approved.

CFTC Matters

CFTC Enforcement Action Against Ooki DAO. On June 8, 2023, the U.S. District Court for the Northern District of California entered an order granting the CFTC’s motion for default judgment in its lawsuit against Ooki Dao (formerly bZx DAO), a decentralized autonomous organization and an unincorporated association comprised of holders of OokiDAO Tokens. For background, on September 22, 2022, the CFTC charged Ooki DAO for engaging in unlawful off-exchange leveraged and margined retail commodity transactions, engaging in activities performed by a registered futures commission merchant, and failing to implement appropriate Customer Information Program/KYC/AML procedures in violation of the Commodity Exchange Act of 1936, as amended (the “CEA”). The court granted the motion for default judgement in part due to neither Ooki Dao nor a representative of Ooki Dao appearing or participating in the action (the court previously held that the CFTC had properly served Ooki Dao when it provided notice of the action via the “Help Chat Box” and the discussion forum on Ooki Dao’s public website). In addition to granting default judgment against Ooki DAO on all accounts, the court also enjoined Ooki DAO from further violation of the CEA and ordered Ooki DAO to pay a civil penalty of $643,542. Importantly, Ooki DAO token holders bear some responsibility of the civil penalty, and the case underscores the need of fund managers to limit their investments in DAOs to those that have been legally wrapped and make such investments via special purpose vehicle in an attempt to achieve another layer of liability protection, as noted in our July 2022 Quarterly Update.

Digital Asset Matters

Liability Issues and Third-Party Engagement in DAOs. As the formation of and investment in Decentralized Autonomous Organizations (“DAOs”) continue to garner attention within the investment community, it is important for DAO participants to continue to analyze how they participate. First, as noted in our July 2022 Quarterly Update, managers should consider only participating or investing in DAOs that are wrapped in a liability blocking entity in order to reduce the risk of personal liability. Second, as an added measure of liability protection, managers should consider participating or investing through special purpose vehicles specific to such activity (e.g., a fund making two DAO investments could segregate each investment through separate, wholly-owned subsidiaries). Third, managers should consider only participating or investing in DAOs that have engaged reputable third-party service providers such as administrators, accountants, tax counsel and, in the case of foreign foundations, independent directors. The use of such independent third-party service providers may help ensure proper functioning and allocation of resources of the DAO, thereby helping to protect its participants.

The SEC complaint was preceded by the CFTC’s complaint filed against Binance on March 27, 2023. The CFTC complaint included an allegation that despite Binance’s implementation of an IP address-based compliance control, such measure had not been effective in preventing U.S.-based customers from accessing and trading on the Binance platform. In fact, Binance’s financial reports reflect that U.S.-based customers contributed substantially to Binance’s revenues. The CFTC complaint also contains detailed and specific allegations regarding Binance’s reliance upon “prime brokers” to facilitate such U.S-based customers’ access to Binance. The prime brokers are alleged to have provided details to such U.S.-based customer to assist in their access to the exchange.

In November 2023, Zhao agreed to step down as CEO of Binance and pleaded guilty to breaking U.S. anti-money laundering laws as part of a plea agreement. Binance entered into a $4.3 billion settlement with the U.S. Department of Justice, the Treasury Department, and the CFTC.

Proposed Legislation – Digital Asset Market Structure Bill. Representatives Patrick McHenry (R-NC) and Glenn Thompson (R-PA) proposed the Digital Asset Market Structure Bill (the “Bill”) in a discussion draft reflecting a joint-committee effort to add clarity to the regulatory uncertainty surrounding digital assets in the U.S. The Bill included a proposal to delegate authority to the SEC and the CFTC to jointly issue rules for (i) the definition of a number of digital asset-related terms, including blockchain, blockchain network, digital assets, etc., and (ii) rules to exempt the requirement to register with both the CFTC as a digital commodity exchange and the SEC as an alternative trading system to the extent such exemption would foster the development of digital assets for the benefit of the public interest and protection of investors. The Bill also proposed the establishment of a strategic hub for innovation and financial technology and a LabCFTC within the SEC and the CFTC, respectively, with the purpose of educating and advising the regulators on financial technology. Additionally, the Bill further proposed that the SEC and the CFTC form a joint committee on digital assets with the purpose of providing advice on rules, regulations, and policies relating to digital assets, as well as harmonizing policies between the SEC and the CFTC.

Digital Asset Taxation Updates. On July 11, 2023, the U.S. Senate Finance Committee issued a letter to the digital asset community, requesting feedback on existing digital asset tax law. In an effort to identify gaps and address uncertainties in digital asset taxation, the Committee is seeking input from stakeholders, experts, and other interested parties. This presents an opportunity for the digital asset community to proactively engage with the regulation and taxation of digital assets.

On July 31, 2023 the IRS announced in Revenue Ruling 2023-14 that a cash-method taxpayer who received staking rewards must include the fair market value of those rewards in the taxpayer’s gross income for the taxable year in which the taxpayer “gains dominion and control over the validation rewards.” This ruling is consistent with previous IRS views on the tax treatment of mining income, as per Notice 2014-21.

SEC Charges Media Company for Unregistered Offering of NFTs. On August 28, 2023, the SEC announced charges against NFT issuer Impact Theory, LLC (“Impact Theory”), arguing that Impact Theory’s NFT launch constituted an unregistered securities offering. This is the first time the SEC has brought an enforcement action against an NFT issuer. According to the order, Impact Theory alluded to the investment potential of the NFTs by emphasizing to purchasers that their NFTs would provide “tremendous value.” The SEC, applying the Howey Test, argued that Impact Theory’s statements “invited potential investors to view the purchase…as an investment into the business” and that the NFTs constituted investment contracts. Impact Theory neither admitted to nor denied the charges, but did agree to pay $6.1 million in disgorgement, prejudgment interest, and civil penalties.

Other Items

Corporate Transparency Act Provisions Coming into Effect. The Corporate Transparency Act of 2019, as amended (the “CTA”), becomes effective on January 1, 2024, and will require virtually all U.S. entities and all foreign entities registered to do business in the U.S. to file detailed beneficial ownership reports with the Financial Crimes Enforcement Network (FinCEN). Pursuant to the CTA, legal entities incorporated, organized, or registered to do business in a state must disclose certain information related to its owners, officers, and controlling persons. Companies that will be required to provide such information include domestic or foreign corporations, limited liability companies, or other entities created or registered to do business in a state by virtue of such entity making a filing with the respective secretary of state. The required disclosure for beneficial owners includes legal name, date of birth, address, and ID with a unique identifying number (i.e., a driver’s license or a passport). There are a handful of exemptions to the CTA, including for (i) SEC-registered investment advisers, (ii) venture capital fund advisers relying on the exemption pursuant to Section 203(l) of the Investment Advisers Act that file Form ADV with the SEC, and (iii) “pooled investment vehicles” managed by a bank, credit union, broker-dealer, registered investment company, SEC-registered investment adviser, or a venture capital fund adviser as described in (ii).

Under the CTA, entities formed or registered before January 1, 2024, must file their initial reports by January 1, 2025. Entities formed or registered between January 1, 2024, and December 31, 2024, must file their initial reports within 90 days of the entity’s formation or registration, as applicable. Entities formed or registered after 2024 must file their initial reports within 30 days of the entity’s formation or registration, as applicable. Entities required to file reports under the CTA that either fail to comply or provide false or fraudulent information will be subject to civil and criminal penalties. The CTA contains a safe harbor, however, which enables an individual representing a reporting company to voluntarily correct any false information within 90 days of submitting an inaccurate report.

To learn more about the Corporate Transparency Act and its implications, please refer to this article by CFM Partner Tony Wise.

The Ninth Circuit Blocks California’s Ban on Mandatory Arbitration Agreements. On February 15, 2023, a three-judge panel for the Ninth Circuit Court of Appeals struck down a California bill which would have prevented employers from requiring employees to sign arbitration agreements as a condition of employment. The court held that California Assembly Bill 51 is preempted by the Federal Arbitration Act, which “embodies a national policy favoring arbitration.” After years of uncertainty surrounding the issue, the decision solidifies that employers in California can continue to include mandatory arbitration provisions in their employment agreements.

The amendments to Form PF Sections 5 and 6 will become effective on December 11, 2023, with the remainder of the amendments to Form PF becoming effective on June 11, 2024.

Enforcement of California Privacy Rights Act. The California Consumer Privacy Act of 2018 (the “CCPA”), as amended by the California Privacy Rights Act of 2020 (the “CPRA”, and together with the CCPA, the “Act”), was scheduled to become fully enforceable by the California Privacy Protection Agency (the “CPPA”) on July 1, 2023; however, a recent California court case has delayed this enforcement date, at least in relation to some of the statute’s requirements. By way of background, the CPRA amended the CCPA to add additional consumer data protections and created the CPPA, a state agency empowered to not only enforce these requirements jointly with the Attorney General of California, but also to promulgate final regulations thereunder. Incidentally, the CPRA required the regulations to be completed by July 1, 2022, and contemplated a one-year “pre-enforcement period” by providing that enforcement of the regulations, “[n]otwithstanding any other law, civil and administrative enforcement…shall not commence until July 1, 2023[.]” Unfortunately, the CPPA failed to complete the regulations by July 1, 2022. On March 29, 2023, the CPPA issued final (but incomplete) regulations, relating to twelve of the fifteen topics contemplated by the CPRA. Currently, there are still no regulations concerning three key elements of the CPRA – cybersecurity audits, risk assessments, and automated decision-making technology.

The California Chamber of Commerce sued the CPPA, seeking to delay the enforcement of the Act, arguing that since the regulations were only finalized on March 29, 2023, an enforcement date of July 1, 2023 would violate the one-year pre-enforcement period required by the CPRA’s express language. On June 30, 2023, the Sacramento County Superior Court held that the CPPA cannot enforce any of the regulations of the Act before one year has passed from the date any such regulation has been finalized by the CPPA. On August 4, 2023, the CPPA filed a petition with California’s Third District Court of Appeals to overturn the trial court decision imposing a 12-month temporary delay on enforcement of the privacy regulations. CFM will continue to monitor this situation and advise our clients accordingly.

Establishment of an Ethical Artificial Intelligence Framework for Investment Advisors. On April 6, 2023, the SEC Investor Advisory Committee (the “IAC”) wrote an open letter to SEC Chair Gary Gensler outlining its views on implementing an ethical artificial intelligence (“AI”) framework for investment advisers and financial institutions. The letter referenced the use of algorithmic models and code by investment advisory firms and warned that the use of AI in other industries has highlighted important risks such as harmful algorithmic biases.

The letter encouraged the SEC and its staff to consider the following key tenets in developing guidance to investment advisers on the ethical use of AI:

Equity – understanding of the contextual, historical, and structural problems of the underlying data selected for input, including seeking consultation of experts.
Consistent and Persistent Testing – consistent testing of algorithms for performance during pre and post implementation stage.
Governance and Oversight – incorporation of a comprehensive risk management and compliance policy.

The letter concluded with additional proposals to the SEC for consideration in developing its best practices guidance on ethical use of AI, including the hiring of staffs with experience in AI and machine learning, the reviewing of AI-related frameworks developed by other regulators such the Federal Trade Commission and the National Institute of Standards of Technology, and tasking the Division of Examinations to monitor the compliance on ethical use of AI.

User Fees and Third-Party Examination of SEC Registered Investment Adviser. On June 5, 2023, the IAC drafted a list of recommendations on oversight of SEC RIAs, which was discussed at the IAC meeting on June 22, 2023. The draft included two recommendations. First, the imposition of “user fees” on SEC RIAs to fund the SEC’s investment adviser examination program and to achieve an acceptable frequency of examination of SEC RIAs once every four to five years. Second, the adoption of a rule requiring SEC RIAs to undergo examination conducted by an outside firm, with a copy of the exam results submitted to the SEC.

****

Compliance Calendar

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

December 11, 2023

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

December 26, 2023

Last day to submit form filings or renewal payments via IARD prior to year-end.

December 31, 2023

Review RAUM to determine 2023 Form PF filing requirement.
Registered CPOs must submit a pool quarterly report (CPO-PQR).
Cayman funds regulated by CIMA that intend to de-register (i.e. wind down or continue as an exempted fund) should do so before this date to avoid 2023 CIMA fees.

January 10, 2024

Form 13H Quarterly Filing for Changes. Filing is for calendar quarter that ended December 31, 2023, and should be submitted within 10 days of quarter end.

January 15, 2024

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

January 31, 2024

“Annex IV” AIFMD filing.

February 14, 2024

Form 13F Quarterly Filing for Changes. Filing is for Calendar Quarter that ended December 31, 2023, and should generally be submitted within 45 days of quarter end.
Form 13H Annual Filing for Calendar Year that ended December 31, 2023.
Form 13G Annual Filing for Calendar Year that ended December 31, 2023.

February 29, 2024

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

March 30, 2024

Form ADV Annual Update Amendment. Deadline to update and file Form ADV Parts 1, 2A, 2B (and Form CRS, if applicable).

Periodic

Fund Managers should perform “Bad Actor” certifications annually.
Form D and Blue Sky Filings should be current.
CPO/CTA Annual Questionnaires must be submitted annually, and promptly upon material information changes, through NFA Annual Questionnaire system.

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

Sincerely,

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

Cole-Frieman & Mallon 2023 Q3 Update

Leave a reply

October 20, 2023

Clients, Friends, and Associates:

As we end the third quarter and enter the fall season, we would like to highlight some of the recent industry updates and occurrences we found to be both interesting and impactful. The summaries below are intentionally brief. Please feel free to explore the links included and reach out to us if you have any related questions.

****

CFM Items

Cole-Frieman & Mallon LLP, along with industry leaders MG Stover, Harneys, and KPMG, is a premier sponsor of the CoinAlts Annual Fund Symposium, which is being held in San Francisco on October 26, 2023. This annual event brings together the digital asset community to address investment, legal, and operational issues relevant to private fund managers. The CoinAlts Annual Fund Symposium is a must-attend gathering for industry professionals, providing unparalleled insights and networking opportunities. Join us for expert panels, top-notch speakers, and the chance to stay ahead of the curve in this rapidly evolving industry. More information is available at https://coinalts.xyz/.

Our firm was proud to sponsor the 14^th annual Sohn San Francisco Investment Conference that took place on September 26, 2023. The event brought together top investment managers and allocators to discuss specific investment ideas and the fund investment environment. The conference supported Bay Area organizations focused on improving educational opportunities and life outcomes for underserved youth. A portion of the proceeds also benefitted the Sohn Conference Foundation in its dedicated efforts to treat and cure pediatric cancer and other public health priorities. We were excited to be a part of this important event where attendees learned from some of the brightest minds in the investment world and supported a great cause. Cole-Frieman & Mallon LLP was also a proud sponsor of the Help For Children 2023 Denver Golf Tournament in Littleton, Colorado on September 22, 2023. The organization focuses on the prevention and treatment of child abuse and neglect.

****

SEC Matters

SEC Begins Enforcement for Violations of the New Marketing Rule. In a September 11, 2023 press release, the Securities and Exchange Commission (“SEC”) announced that it charged nine registered investment advisers for showing hypothetical performance results on their websites without adopting the necessary policies and procedures required under the SEC’s new marketing rules and regulations (the “New Marketing Rules”). This targeted sweep is the first of its kind following the New Marketing Rules’ compliance deadline in November 2022.

As discussed in our July 2021 Update, the New Marketing Rules permit the use of hypothetical performance metrics if the investment adviser follows certain requirements aimed at protecting investors. These requirements include implementing policies and procedures that are “reasonably designed to ensure that the hypothetical performance is relevant to the likely financial situation and investment objectives of the intended audience of the advertisement.”

The press release noted that all nine firms published hypothetical performance results to the public rather than to their specific intended audience. In doing so, the accused could not ensure that all viewers had the necessary context to accurately understand the hypothetical performance results. The SEC’s Division of Enforcement Director, Gurbir Grewal, noted the “attention-grabbing power” of hypothetical performance on prospective investors who may conflate the advertised strategies with their own investment objectives. Additionally, two of the firms also failed to comply with record-keeping rules which required their firms to keep a copy of every advertisement disseminated.

These nine enforcement actions came quickly on the heels of the SEC’s first enforcement action alleging violations of the New Marketing Rules. In August 2023, the SEC charged a New York-based FinTech investment adviser of misleading investors with hypothetical performance results. The complaint alleged that the adviser’s marketing materials made claims of annualized returns of 2700%, but the underlying data was taken from only a three-week period.

The SEC’s active approach to enforce the New Marketing Rules sends a stern reminder to SEC-registered fund managers to remain diligent when preparing marketing materials. We encourage managers to review their marketing materials to ensure compliance if they have not done so already.

SEC Charges Fund Administrator for Missing Red Flags. On August 7, 2023, the SEC instituted cease and desist proceedings against a fund administrator (the “Administrator”) for failing to identify and appropriately respond to red flags involving a private fund client. The SEC asserted that the Administrator, at the behest of the fund’s sponsor, calculated the fund’s net asset value without including trading losses, resulting in materially overstated values in the investors’ account statements. The SEC has since accepted the Administrator’s settlement offer, which includes a civil penalty of $100,000, a disgorgement of $18,000, and a prejudgment interest of $4,271.

SEC Adopts Final Rules for Private Fund Advisers. On August 23, 2023, the SEC issued final rules focused on investment advisers who manage private funds (the “New Private Fund Adviser Rules”). We provide a brief summary of the key elements of the New Private Fund Adviser Rules below.

Rules for SEC-Registered Investment Advisers

The Quarterly Statement Rule requires SEC-registered investment advisers (“RIAs”) to provide new quarterly disclosures to fund investors about fees, expenses, and the fund’s performance metrics. This rule also introduces standardized reporting metrics to be used by private funds.

The Audit Rule requires RIAs to obtain annual audited financial statements for each of its fund clients. However, the SEC notes that any adviser who remains in compliance with the audit requirements of rule 206(4)-2 (i.e., the custody rule) of the Investment Advisers Act of 1940, as amended (the “Investment Advisers Act”), will also be in compliance with the Audit Rule.

The Adviser-Led Secondaries Rule requires RIAs to obtain a fairness opinion or valuation opinion and provide a summary of any material business relationships when asking investors to approve an adviser-led secondary transaction.

The Annual Review Rule will amend current rule 206(4)-7 (i.e., the compliance procedures and practices rule) of the Investment Advisers Act, which will now require all RIAs to document their annual compliance review in writing.

The Recordkeeping Rule will amend the current rule 204-2 (i.e., the recordkeeping rule) of the Investment Advisers Act to require RIAs to retain books and records related to the provisions of the New Private Fund Adviser Rules.

Rules for all Private Fund Investment Advisers

The Restricted Activities Rule restricts advisers from engaging in the following activities unless they are sufficiently disclosed or investor consent is obtained, as applicable: (i) allocating fees and costs from any governmental or regulatory investigation of the adviser to the fund; (ii) allocating regulatory or compliance fees, or fees or expenses associated with an examination, of the adviser to the fund; (iii) reducing carried interest clawbacks based on the adviser’s actual or estimated taxes incurred; and (iv) allocating fees from a portfolio investment among the adviser’s funds and other clients on a non-pro rata basis.

The Preferential Treatment Rule prohibits an adviser from giving preferential treatment to a prospective investor relating to (i) redemption rights and (ii) information rights of portfolio holdings which the adviser believes would have a material, negative effect on other investors. The rule allows for other forms of preferential treatment to certain investors, but the material terms of this preferential treatment must generally be disclosed, in writing, to all other investors and prospective investors. Advisers must also distribute an annual notice to all investors disclosing any preferential treatment provided to investors since the most recent notice was provided.

Next Steps

The compliance date for the New Private Fund Adviser Rules is determined by the size of the funds, and many deadlines remain years away. Ongoing litigation initiated by industry participants may further delay the effectiveness of these rules. On September 1, 2023, the Managed Funds Association, along with a number of other organizations, jointly filed a lawsuit against the SEC to prevent the adoption of the finalized rules, claiming the SEC has overstepped its authority and that these changes may increase costs, reduce opportunity, and harm both private funds and their investors.

The New Private Fund Adviser Rules have the potential to bring widespread change to the private funds industry, and managers must review their policies and procedures to ensure compliance. However, pending litigation against the SEC reflects the fierce resistance from some within the industry and reminds us that further changes may be introduced in the following months as compliance deadlines draw nearer.

The proposed rules require the users of PDA technologies to evaluate whether the technology could reasonably create a conflict of interest. The SEC did not create strict guidelines for this evaluation process, instead noting that the complexity of the evaluation will likely correlate to the complexity of the tool. Certain covered technologies, such as “black-box” tools where data inputs are not disclosed to end users, may be impossible to fully evaluate. In these cases, the SEC forbids the use of such a tool if the user cannot identify all potential conflicts from a PDA technology. Investment advisers will also be required to have written policies and procedures in place describing a tool’s conflict evaluation process and the processes for neutralizing and eliminating any identified conflicts. The proposed rules also introduce six new types of records that must be kept relating to covered technologies.

The proposed rules serve as a poignant reminder that while AI continues to bring exciting new breakthroughs to the investment advisory business, it remains important to understand any biases or other pitfalls that such tools can present.

In keeping with the spirit of the original rule while modernizing it to reflect new technologies, the proposed amendments clarify that an internet investment adviser is required to have an “operational” interactive website (which includes smartphone applications) at all times while relying on the Internet Adviser Exemption. To be considered operational, the website or application must provide “digital investment advisory services” on an ongoing basis to more than one client, which the SEC defines as advice generated by software-based models, algorithms, or applications. Once the proposed amendments are implemented, an investment adviser relying on this exemption can only provide investment advice through the operational interactive website. Investment advisers relying on this exemption will further be required to amend their Form ADV. The proposed amendments aim to modernize the Internet Adviser Exemption in response to the technological advancements and evolution of the investment advisory industry since its original adoption in 2002.

SEC Adopts Cybersecurity Rule for Public Companies. On July 26, 2023, the SEC adopted a final rule that will require public companies to disclose information about cybersecurity risk management, strategy, governance, and incident reporting. This rule was approved by the SEC ahead of a similar cybersecurity risk management rule specific to investment advisers, which the SEC is slated to approve sometime in October of 2023.

This new rule will impose more affirmative and stringent obligations on public companies to report cybersecurity incidents and to provide greater transparency about their cybersecurity practices. However, when compared to the impending cybersecurity risk management rule being directed at investment advisers, this public company version is more streamlined and requires fewer proscribed controls for these enterprise-level public companies whose resources and capabilities ironically far outweigh those of its investment adviser counterparts.

SEC Adopts Final Rules on Investment Company Names. On September 20, 2023, the SEC adopted amendments to rule 35d-1 of the Investment Company Act of 1940, as amended (the “Investment Company Act”). Commonly referred to as the “Names Rule”, the purpose of rule 35d-1 is to protect investors by requiring advisers to use names for their investment funds that align with the funds’ investment focus and risks.

The amendments expand the scope of the “80% investment policy” and now require any fund with a name suggesting specific types of investment invest at least 80% of its assets into those types of investments. This also includes any insinuations of particular characteristics such as the key words “growth” or “value.” The SEC also clarified that derivative investments can be counted toward the 80% benchmark, but advisers must use the investment’s notional value. Funds will be required to review their portfolio on a quarterly basis to ensure compliance with the rule. If a fund is found to be noncompliant, the fund will be granted a 90-day grace period to return to the 80% investment threshold.

The final rules will prohibit unlisted registered closed-end funds and business development companies that are required to comply with the 80% policy from changing that policy without a shareholder vote, unless: (i) the fund initiates a tender or repurchase offer and provides at least 60 days’ prior notice of the change to the policy; (ii) the offer is not oversubscribed; and (iii) the fund purchases shares at net asset value. Additionally, funds subject to the 80% investment policy must include definitions of any fund terms in their prospectus and such terms must follow their plain English meaning.

These amendments underscore the SEC’s view that an investment fund’s name can have a strong impact on potential investors, making it important that names accurately reflect the fund itself.

****

Digital Asset Items

Bittrex Settles with the SEC. On August 10, 2023, the SEC announced that crypto trading platform Bittrex agreed to settle charges that the company was operating an unregistered exchange, brokerage, and clearing house. As reported in our July 2023 Update, the SEC filed a complaint against Bittrex, alleging that the platform encouraged digital asset issuers to delete any public statements that insinuated that their tokens violate national securities laws. Bittrex agreed to settle for a total payment of $24 million, which will be paid within two months of filing a liquidation plan.

Digital Asset Taxation Updates. On July 11, 2023, the U.S. Senate Finance Committee issued a letter to the digital asset community, requesting feedback on existing digital asset tax law. In an effort to identify gaps and address uncertainties in digital asset taxation, the Committee is seeking input from stakeholders, experts, and other interested parties. This presents an opportunity for the digital asset community to proactively engage with the regulation and taxation of digital assets.

On July 31, 2023 the IRS announced in Revenue Ruling 2023-14 that a cash-method taxpayer who received staking rewards must include the fair market value of those rewards in the taxpayer’s gross income for the taxable year in which the taxpayer “gains dominion and control over the validation rewards.” This ruling is consisten t with previous IRS views on the tax treatment of mining income, as per Notice 2014-21.

SEC Charges Media Company for Unregistered Offering of NFTs. On August 28, 2023, the SEC announced charges against NFT issuer Impact Theory, LLC (“Impact Theory”), arguing that Impact Theory’s NFT launch constituted an unregistered securities offering. This is the first time the SEC has brought an enforcement action against an NFT issuer. According to the order, Impact Theory alluded to the investment potential of the NFTs by emphasizing to purchasers that their NFTs would provide “tremendous value.” The SEC, applying the Howey Test, argued that Impact Theory’s statements “invited potential investors to view the purchase…as an investment into the business” and that the NFTs constituted investment contracts. Impact Theory neither admitted to nor denied the charges, but did agree to pay $6.1 million in disgorgement, prejudgment interest, and civil penalties.

****

Other Items

Corporate Transparency Act Provisions Coming into Effect. The Corporate Transparency Act of 2019, as amended (the “CTA”), becomes effective on January 1, 2024, and will require virtually all U.S. entities to file detailed beneficial ownership reports with the Financial Crimes Enforcement Network (FinCEN). Pursuant to the CTA, legal entities incorporated, organized, or registered to do business in a state must disclose certain information related to its owners, officers, and controlling persons. Companies that will be required to provide such information include domestic or foreign corporations, limited liability companies, or other entities created or registered to do business in a state by virtue of such entity making a filing with the secretary of state. The required disclosure for beneficial owners includes legal name, date of birth, address, and ID with a unique identifying number (i.e., a driver’s license or a passport). There are a handful of exemptions to the CTA, including for (i) SEC-registered investment advisers, (ii) venture capital fund advisers relying on the exemption pursuant to Section 203(l) of the Investment Advisers Act that file Form ADV with the SEC, and (iii) “pooled investment vehicles” managed by a bank, credit union, broker-dealer, registered investment company, SEC-registered investment adviser, or a venture capital fund adviser as described in (ii).

Under the CTA, entities formed before January 1, 2024 must comply within one year. Entities formed after January 1, 2024 will have 30 days to comply once they are officially formed. Additionally, FinCEN recently published a proposal to extend the 30-day deadline to 90 days for reporting entities created or registered between January 1, 2024 and December 31, 2024. Applicable entities that fail to comply or provide false or fraudulent information will be subject to civil and criminal penalties. The CTA contains a safe harbor, however, which enables an individual representing a reporting company to voluntarily correct any submitted false information within 90 days of submitting an inaccurate report.

To learn more about the Corporate Transparency Act and its implications, please refer to this article by CFM Partner Tony Wise.

****

Compliance Calendar

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

November 6, 2023

Preliminary Statements for Annual Renewal fees are available through E-Bill and can be accessed through FINRA Firm Gateway.

November 14, 2023

Form 13F Quarterly Filing. Filing is for the calendar quarter that ended September 30, 2023, and should be submitted within 45 days of quarter end.
CTA Form PR. Filing is for the calendar quarter that ended September 30, 2023, and should be submitted within 45 days of quarter end.

November 29, 2023

Form PF for Large Hedge Fund Advisers. Filing is for the calendar quarter that ended September 30, 2023.
CPO-PQR Form. Filing is for the calendar quarter that ended September 30, 2023, and should be submitted within 60 days of quarter end.

December 11, 2023

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

Periodic

Form D and Blue Sky Filings should be current.
CPO/CTA Annual Questionnaires must be submitted annually, and promptly upon material information changes, through the NFA Annual Questionnaire system.

Consult our complete Compliance Calendar for all 2023 critical dates as you plan your regulatory compliance timeline for the year.

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

Sincerely,

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

Cole-Frieman & Mallon 2023 Q2 Update

Leave a reply

July 20, 2023

Clients, Friends, and Associates:

As we end the second quarter and enter the summer season, we would like to highlight recent industry news that we found to be both interesting and impactful. While we try to summarize these topics at a higher level, please feel free to explore the links included and reach out to us if you have any related questions.

****

CFM Items

We are excited to announce that Cole-Frieman & Mallon LLP has added more expertise to its already stellar team. First, we welcome back Lilly Palmer as a Partner, whose extensive digital asset experience will benefit the firm and all its clients. We also welcome Bill Samuels to the firm, where he will lead a newly launched Intellectual Property practice with new Associate, Stavros Papadopoulos. Finally, we’re pleased to welcome Brett Bunnell as a Counsel and Thomas Gaffney as an Associate in our Corporate and Transactional practice group. We expect these additions to meaningfully contribute to our unwavering commitment to provide excellent legal services to all our clients. Please join us in welcoming them all to our firm.

Cole-Frieman & Mallon LLP, along with industry leaders MG Stover, Harneys, and KPMG, are premier sponsors of the CoinAlts Annual Fund Symposium on October 26, 2023, in San Francisco. Founded in 2017, this event brings together the digital asset community to address investment, legal, and operational issues relevant to private fund managers. The CoinAlts Annual Fund Symposium is a must-attend gathering for industry professionals, providing unparalleled insights and networking opportunities. Join us for expert panels, top-notch speakers, and the chance to stay ahead of the curve in this rapidly evolving industry. More information available at https://coinalts.xyz/.

****

SEC Matters

SEC Enforcement Action Against Coinbase. On June 6, 2023, the SEC charged Coinbase, Inc. and Coinbase Global, Inc. (collectively, “Coinbase”) for failure to register as an exchange, a broker-dealer and a clearing agency, and for failure to register the offering and sale of securities via the Coinbase trading platform in accordance with the Securities Exchange Act of 1934, as amended (the “Exchange Act”). This proceeding follows the Wells Notice that Coinbase received from the SEC in March 2023. The complaint alleges that Coinbase acted as an unregistered exchange, a broker-dealer, and a clearing agency by making available at least 13 crypto assets that are offered and sold as investment contracts on its platform. Additionally, the complaint alleges that Coinbase’s staking program should be considered an investment contract under the Howey test.

On June 28, 2023, Coinbase filed an answer to the SEC complaint denying that the digital assets listed on its platform constitute an investment contract or a security. Additionally, the answer noted that half of the tokens traded on Coinbase’s platform that the SEC alleged are securities were custodied and traded on its platform since April 2021 (i.e., when the SEC approved and declared Coinbase’s S-1 filing to be effective), and, at the time, the SEC did not identify such tokens as investment contracts or securities, nor allege that Coinbase was operating as an unregistered exchange, broker, and clearing agency within the meaning of federal securities law. Coinbase’s answer also denied the SEC’s allegation that its staking program is a security. In addition to filing the answer, Coinbase filed a letter to the court indicating its intention to file a motion to dismiss the complaint. Our firm will continue to closely monitor the situation with Coinbase for new developments.

SEC Enforcement Action Against Bittrex and Bittrex’s Chapter 11 Bankruptcy. On April 17, 2023, the SEC charged Bittrex, Inc., Bittrex Global GmbH, and William Hiroaki Shihara, co-founder and former chief executive officer (collectively, “Bittrex”) for the failure to register as an exchange, a broker-dealer, and a clearing agency, pursuant to the Exchange Act.

On March 31, 2023, Bittrex issued a statement that it began the process of winding down its U.S. operations. Shortly after the SEC’s complaint, Bittrex ceased its operations in the U.S. and filed for Chapter 11 bankruptcy. On June 13, 2023, the U.S. Bankruptcy Court for the District of Delaware entered an order permitting Bittrex to allow its customers to access and withdraw crypto assets and fiat currency from Bittrex’s trading platform.

The Hinman Speech Documents. On June 13, 2023, the SEC internal communication documents related to William Hinman’s speech on digital asset transactions on June 14, 2018 were released to the public. The documents were made available to the public following an order entered by the U.S. District Court Southern District of New York denying the SEC’s motion to seal the SEC internal communication documents related to William Hinman’s 2018 speech in connection with its lawsuit against Ripple.

****

CFTC Items

****

Digital Asset Items

SEC and CFTC Enforcement Actions Against Binance. On June 5, 2023, the SEC charged Binance Holdings Limited, BAM Trading Services Inc., BAM Management US Holdings Inc., and Changpeng Zhao, founder and chief executive officer (collectively, “Binance”), for failure to register as an exchange, a broker-dealer, and a clearing agency, and failure to register the offering and sale of securities via the Binance trading platform in accordance with the Exchange Act. Notably, the complaint also charged Binance for making false representations about the presence of trading surveillance for the detection and prevention of manipulative trading and false statements with respect to the trading volumes on its platform to the public (the SEC did not include such allegations in its complaint against Coinbase).

The SEC complaint was preceded by the CFTC’s complaint filed against Binance on March 27, 2023. The CFTC complaint included an allegation that despite Binance’s implementation of an IP address-based compliance control, such measure had not been effective in preventing U.S.-based customers from accessing and trading on the Binance platform. In fact, Binance’s financial reports reflect that U.S.-based customers contributed substantially to Binance’s revenues. The CFTC complaint also contains detailed and specific allegations regarding Binance’s reliance upon “prime brokers” to facilitate such U.S-based customers’ access to Binance. The prime brokers are alleged to have provided details to such U.S.-based customer to assist in their access to the exchange. Given the details of such allegations, digital asset fund managers should continue to assess how they are accessing digital asset exchanges.

Proposed Legislation – Digital Asset Market Structure Bill. Representatives Patrick McHenry (R-NC) and Glenn Thompson (R-PA) proposed the Digital Asset Market Structure Bill (the “Bill”) in a discussion draft reflecting a joint-committee effort to add clarity to the regulatory uncertainty surrounding digital assets in the U.S. The Bill included a proposal to delegate authority to the SEC and the CFTC to jointly issue rules for (i) the definition of a number of digital asset related terms, including blockchain, blockchain network, digital assets, etc., and (ii) rules to exempt the requirement to register with both the CFTC as a digital commodity exchange and the SEC as an alternative trading system to the extent such exemption would foster the development of digital assets for the benefit of the public interest and protection of investors. The Bill also proposed the establishment of a strategic hub for innovation and financial technology and a LabCFTC within the SEC and the CFTC, respectively, with the purpose of educating and advising the regulators on financial technology. Additionally, the Bill further proposed that the SEC and the CFTC form a joint committee on digital assets with the purpose of providing advice on rules, regulations, and policies relating to digital assets, as well as harmonizing policies between the SEC and the CFTC.

****

Other Items

SEC Amendments to Form PF. On May 3, 2023, the SEC adopted certain amendments to Form PF, a regulatory filing requirement that mandates certain SEC registered investment advisers to report information to the Financial Stability Oversight Council (“FSOC”). Form PF was created in 2011 by Title IV of the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010, as amended (the “Dodd-Frank Act”).

The amendments included a number of changes to the existing Form PF. Specifically, the amendments introduced a new Section 5 to Form PF and required, upon an occurrence of a trigger event, large hedge fund advisers of qualifying hedge funds to file a current report as soon as practicable but no later than 72 hours after such event. Triggering events include extraordinary investment loss, a significant margin and default event, fund margin default or inability to meet margin call, and significant disruption or degradation of the reporting fund’s key operations. Additionally, Section 6 of Form PF has been amended to require private equity fund advisers to report certain trigger events within 60 days of the end of each fiscal quarter. Such trigger events include the execution of an adviser-led secondary transaction and the investor’s election for the removal of the general partner to the fund, termination of the fund’s investment period, or termination of the fund. Section 4 of Form PF also introduced a new annual reporting event to large advisers of private equity funds with respect to the implementation of a general partner or limited partner clawbacks.

The amendments to Form PF Sections 5 and 6 will become effective on December 11, 2023, with the remainder of the amendments to Form PF becoming effective on June 22, 2024.

Enforcement of California Privacy Rights Act. The California Consumer Privacy Act of 2018 (the “CCPA”), as amended by the California Privacy Rights Act of 2020 (the “CPRA”, and together with the CCPA, the “Act”), was scheduled to become fully enforceable by the California Privacy Protection Agency (the “CPPA”) on July 1, 2023; however, a recent California court case has delayed this enforcement date, at least in relation to some of the statute’s requirements. By way of background, the CPRA amended the CCPA to add additional consumer data protections and created the CPPA, a state agency empowered to not only enforce these requirements jointly with the Attorney General of California, but also to promulgate final regulations thereunder. Incidentally, the CPRA required the regulations to be completed by July 1, 2022, and contemplated a one-year “pre-enforcement period” by providing that enforcement of the regulations, “[n]otwithstanding any other law, civil and administrative enforcement…shall not commence until July 1, 2023[.]”

Unfortunately, the CPPA failed to complete the regulations by July 1, 2022. On March 29, 2023, the CPPA issued final (but incomplete) regulations, relating to twelve of the fifteen topics contemplated by the CPRA. Currently, there are still no regulations concerning three key elements of the CPRA – cybersecurity audits, risk assessments, and automated decision-making technology.

The California Chamber of Commerce sued the CPPA, seeking to delay the enforcement of the Act, arguing that since the regulations were only finalized on March 29, 2023, an enforcement date of July 1, 2023 would violate the one-year pre-enforcement period required by the CPRA’s express language. On June 30, 2023, the Sacramento County Superior Court held that the CPPA cannot enforce any of the regulations of the Act before one year has passed from the date any such regulation has been finalized by the CPPA.

As the saga of California’s privacy statute continues to play out, businesses subject to the Act should resist the urge to fall into a false sense of security that compliance with the Act is neither imminent nor important. The Act requires fundamental privacy controls that must be imbued into an organization on numerous planes — culturally, operationally, and technologically – simultaneously. CFM will continue to monitor this situation and advise our clients accordingly.

Equity – understanding of the contextual, historical, and structural problems of the underlying data selected for input, including seeking consultation of experts.
Consistent and Persistent Testing – consistent testing of algorithms for performance during pre and post implementation stage.
Governance and Oversight – incorporation of a comprehensive risk management and compliance policy.

User Fees and Third-Party Examination of SEC Registered Investment Adviser. On June 5, 2023, the IAC drafted a list of recommendations on oversight of SEC registered investment advisers (“RIAs”) to be discussed at the IAC meeting on June 22, 2023. The draft included two recommendations. First, the imposition of “user fees” on SEC RIAs to fund the SEC’s investment adviser examination program and to achieve an acceptable frequency of examination of SEC RIAs once every four to five years. Second, the adoption of a rule requiring SEC RIAs to undergo examination conducted by an outside firm, with a copy of the exam results submitted to the SEC.

****

Compliance Calendar

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

July 10, 2023

Form 13H Filing for Changes. Filing is for calendar quarter that ended June 30, 2023 and should be submitted within 10 days of quarter end.

July 14, 2023

Form PF Quarterly Filing for Large Liquidity Fund Advisers. Filing is for the calendar quarter that ended June 30, 2023.

July 31, 2023

ERISA Schedule C of DOL Form 5500 Disclosure.

August 14, 2023

Form 13F Quarterly Filing. Filing is for calendar quarter that ended June 30, 2023 and should be submitted within 45 days of quarter end.
CTA Form PR. Filing is for calendar quarter that ended June 30, 2023 and should be submitted within 45 days of quarter end.

August 29, 2023

Form PF for Large Hedge Fund Advisers. Filing is for calendar quarter that ended June 30, 2023.
CPO-PQR Form. Filing is for calendar quarter that ended June 30, 2023 and should be submitted within 60 days of quarter end.

Periodic

Form D and Blue Sky Filings should be current.
CPO/CTA Annual Questionnaires must be submitted annually, and promptly upon material information changes, through the NFA Annual Questionnaire system.

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