Category Archives: Legal Resources

California Adopts New Part 2 of Form ADV

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At the end of July, the SEC adopted amendments to Form ADV Part 2 and the related rules.  The amended Form ADV Part 2 will be used by SEC-registered advisers to meet their disclosure obligations and generally describe the adviser’s services, fees, and strategies.

On September 1, 2010, the California Department of Corporations followed suit and announced its adoption of the new Part 2 as well, effective October 12, 2010 (see California ADV Part 2 Announcement).  This effective date corresponds with the effective date of the SEC’s rule changes.  The Department’s decision will help bring consistency between state and SEC investment adviser registration requirements.

New ADV Part 2

The amended Form ADV Part 2 consists of three parts:

  • the “Firm Brochure” (Part 2A),
  • a Wrap Fee Program Brochure (Part 2A, Appendix 1), and
  • the “Brochure Supplement (Part 2B).

Every investment adviser must complete the Firm Brochure and the Brochure Supplement.  The Firm Brochure, which is filed electronically with the SEC on the IARD system, will include information about the adviser and its business. The Brochure Supplement, which is a brief disclosure document about certain personnel of the adviser, will be provided to clients but not filed with the SEC.

In addition, the new Part 2 will no longer be in the check-the-box format.  Instead, it will take the form of a narrative brochure written in plain English–the purpose of which is to provide clients with a more clear disclosure of the adviser’s business practices, conflicts of interest, and background.

Compliance Dates

Effective October 12, 2010,  for California registered investment advisers, the relevant compliance dates for the new ADV Part 2 are:

  • As of January 1, 2011 all new investment adviser applicants will have to file, through the IARD, the new Part 2 of Form ADV as part of their application.
  • As of January 1, 2011 all licensed investment advisers will need to incorporate the new Part 2 of Form ADV with their next filing of an amendment to Form ADV, or their annual updating amendment to Form ADV.
  • Between October 12, 2010 and January 1, 2011 applicants and current licensed investment advisers filing amendments to their Part II of Form ADV may use either the current Part II or the new Part 2.

With this change, investment advisers should review and become familiar with the new Part 2.  Advisers that are currently registered with the California Securities Regulation Division will have to incorporate the new Part 2 when they file amendments to Form ADV and also when they file the required annual update.  For most advisers with a December 31, 2010 year-end, the deadline for the annual update will be March 31, 2011.

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Bart Mallon, Esq. runs the Hedge Fund Law Blog and provides investment adviser registration and compliance services through Cole-Frieman & Mallon LLP.  He can be reached directly at 415-868-5345.

Series 66 Exam

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This exam is required by certain states for an individual who wants to register as an investment adviser representative and securities agent.  Passing the Series 66 would be equivalent to passing both the Series 63 and Series 65 exams.  Additionally, individuals are required to pass the Series 7 exam as a prerequisite for taking the Series 66.  This post will provide an overview on the Series 66 exam and some thoughts on both taking and passing the exam.

The Series 66 Basics

What: The exam has a time limit of two hours and 30 minutes and a total of 110 questions, 10 of which are “pretest” questions and do not count in your final score.  The exam covers the following topics: Economic Factors and Business Information; Investment Vehicle Characteristics; Client Investment Recommendations and Strategies; and Laws, Regulations, and Guidelines, including Prohibition on Unethical Business Practices.  You must earn at least 75% to pass the exam.

Where: You can take the exam at most Pearson VUE or Prometric testing centers.

When: You should probably sign up for the exam at least a week prior to taking it, and you can choose the time and date on either the Pearson or Prometric website when you register.

Why: The exam is required for those individuals who want to become both securities agents (generally brokers) and investment adviser representatives.

How to sign up

You can register for the exam by submitting a Form U-4 or Form U-10 through the IARD system online.  Please not that, effective September 15, 2010, FINRA requires individuals to use either their CRD number or FINRA ID number in order to schedule an exam and no longer accepts social security numbers.  If you have any questions regarding registering for an exam, be sure to ask your law firm, compliance consultant, or feel free to contact us.

The cost to take the exam is $128.

How to study for the exam

It is recommended that you obtain a study guide and thoroughly read the entire guide.  NASAA (North American Securities Administration Association) provides a study guide available for download on their website.  Also, Kaplan provides a useful study guide that presents the study material in a simple and easy-to-understand way, and their practice questions are very similar to questions you are likely to see on the actual exam.

Take at least two to three practice exams prior to taking the test, possibly more.  Use memory refreshers such as note cards or other review materials.  Do not cram the morning of the test, as this will probably only make you more anxious.  In fact, it is recommended that you take the exam in the morning after a full night’s rest.

Day of exam

Arrive at the testing center at least 45 minutes prior to taking the exam to allow yourself time to review some of your notes beforehand.  The proctor will require you take off your jackets and place your belongings, including your study material, in a provided locker.  Be sure to have woken up early enough to eat breakfast beforehand and be fully alert during the test.

The exam

The exam is computer-based and will initially instruct you on how to properly answer and mark the following questions.  Note that the beginning of the exam will most likely include the easiest questions, and then the questions will get harder as you reach the middle.  Always attempt to make the most educated guess on questions you do not understand.

The length of the exam might require you to pause and use the restroom or take a break.  Allow yourself time to step away from the computer for a moment, take a drink, and gather your thoughts.  When you encounter difficult questions, you always have the option of marking the question for review.  Never spend an extended period of time on a question, as you will just waste time on answering other questions you might know better.

After you have completed the questions, you will have the option of changing any of your answers.  After completely answering everything, you will receive your score immediately.

If you don’t pass

A number of managers who take the exam do not pass or only come close to passing.  If this is the case, you will need to wait another 30 days before re-taking the exam.  If you do not pass the exam the second time, you will need to wait another 60 days before taking the exam.  If you do not pass either the third or fourth attempt, you will need to wait at least 180 days before taking the exam again.  There is no limit on the number of times allowed for taking a test.

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Bart Mallon, Esq. runs the Hedge Fund Law Blog and provides hedge fund start up and legal services through Cole-Frieman & Mallon LLP. He can be reached directly at 415-868-5345.

SEC Requires Municipal Advisors to Register

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New Form MA-T Released

Under the Dodd-Frank FinReg bill, municipal advisors are required to register with the SEC by October 1, 2010.  Municipal advisors are firms or individuals who provide advice to state and local governments and other borrowers involved in the issuance of municipal securities.  The definition includes financial advisors, guaranteed investment contract brokers, third-party marketers, placement agents, solicitors, finders, and certain swap advisors that provide municipal advisory services.

Interim Final Temporary Rule 15Ba2-6T

In the SEC’s adopting release, the

The Commission is adopting an interim final temporary rule, Rule 15Ba2-6T, in order to provide a method for municipal advisors to temporarily satisfy the statutory registration requirement of Section 15B(a)(1) of the Exchange Act (as amended by Section 975(a)(1) of the Dodd-Frank Act) until the Commission has promulgated a final permanent registration program. The interim final temporary rule will expire on December 31, 2011.

Form MA-T Requirements

Form MA-T is a short six page form which requires municipal advisors to provide the following information:

  • Identifying information (name, EIN, place of business, contact person, website, etc.)
  • Type of advisory services
  • Disciplinary information
  • Execution

Municipal advisors should take note that the above information will be publicly available on the SEC website.

The release can be found here.

Further information can be found here.

Adopting Release can be found here.

Please also see the complete Form MA-T

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Bart Mallon, Esq. runs the hedge fund law blog and provides hedge fund registration and compliance services to hedge fund managers through Cole-Frieman & Mallon LLP, a hedge fund law firm.  He can be reached directly at 415-868-5345.

Important Hedge Fund Articles

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

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

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

BASICS & STRUCTURE

OFFERING DOCUMENTS

INVESTMENT ADVISER

FUTURES & COMMODITIES

MARKETING & ADVERTISING

OPERATIONAL ISSUES

ERISA

LAWS & REGULATIONS

OTHER ISSUES

FOREX

COLE-FRIEMAN & MALLON LLP QUARTERLY NEWSLETTERS

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

Wall Street Reform Bill Issues – Performance of State Securities Regulators

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As we move closer to the signing of the Dodd-Frank Wall Street Reform and Consumer Protection Act, more groups are highlighting the fact that state securities divisions are going to be affected by the act.  After pressure from NASAA, the association of state securities regulators, Congress has provided that state regulators will be required to provide oversight of investment advisers with up to $100 million of AUM – a significant increase from the current level of $30 million of AUM.  Of course this will increase the number of advisers that the states oversee and will make the job of the securities divisions much more difficult.  We have consistently stated that we do not think the states, collectively, are going to be capable to provide proper oversight with the increase in responsibility – mostly because of budget issues.  We have been surveying the states to see which divisions have budget issues and will be reporting on that shortly.  Until then we will examine one securities division which has faced scrutiny from members of the investment community and the state legislature.

Overview of Utah Division of Securities Audit

Over the years there has been a number of complaints about the manner in which the Utah Division of Securities conducts business – a simple Google search will reveal a number of interesting stories.  After repeated complaints the state legislature decided to audit the division and released a report in July of 2008 entitled A Performance Audit of the Division of Securities.

The results are nothing less than shocking.

Faith in government agencies is based on the belief that they will act fairly and effectively.  The report shows capricious behavior and essentially a belief that members of the investment management community are ‘guilty’ until proven ‘innocent’.  Special attention should be paid to the fact that the state securities divisions do have power to make life miserable for a business owner, even if that business owner has not acted wrongly.  Redress is difficult and “the Division Always Wins” (see below).  It is in with this understanding that we question whether the states will be in the best position to oversee the investment management industry.

Below are a number of direct quotes from the audit – many should make any ready angry and sick.  [Please note that we are not saying that all securities divisions have these problems.  Additionally, we have not conducted any follow up with Utah so we do not express any opinion on the current state of the division.]

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Reason for audit:

The credibility of the Division of Securities has been challenged by those investigated by the division. Their concerns are with procedural errors, an alleged overzealous pursuit of securities violations, and the perception that those investigated do not receive fair treatment.

While the division protects securities investors, it is alleged the division has abused its power and damaged reputations. The division has significant authority but its credibility depends on using that authority judiciously.

Page i

Ad Hoc Manner of Conducting Investigations:

There does not appear to be a consistent relationship between the number of complaints, number of cases opened, and the number of actions filed. This is because cases can be opened without a resulting action, there can be multiple actions on one case, or the action may not be filed until the following year. In addition, our evaluation leads us to believe the information is not reliable.

Page 3

Reason for Division Audit

Legislators requested this audit based on concerns about how the division managed three cases. We reviewed the division’s administrative process followed in these cases and a number of others brought to our attention. We did not address the legal issues of any of the cases. Our work has been complicated by the desire of many interviewees to keep their names confidential. They fear reprisal for criticizing the division’s actions.

Page 9

Lack of Policies & Procedures Equals Inconsistent Decisions

The division has not been operating under set, written policies and procedures. As a result, division decisions for actions against the regulated industry and the treatment of its employees rest solely with department and division management. Frequent management changes have brought changes in management philosophy and an increased likelihood for inconsistent decisions.

Page 9

Years of No Policies & Procedures

During the course of this audit, we were told that the division did have policies and procedures a number of years ago. However, there have been no written policies and procedures in place, or operational procedures followed, for at least the last four years under the direction of three division directors.  Shortly before this audit’s completion, division staff found a discarded copy of a 1993 policies and procedures manual. It is disconcerting that the division has faced procedural control difficulties for a number of years, yet no one in either departmental or divisional leadership noted the lack of policies and procedures.

Page 9 and 10

HUGE ISSUE FOR STATE REGISTERED MANAGERS

Complaints surfaced that those charged with securities violations could not get a fair hearing.

Page 10

Division Bias Ignored

In several cases, it was questionable if the former director had maintained an independent and unbiased perspective. For example, the former director did not recuse himself from serving as the presiding officer after helping to draft the pleadings for the case. It was apparent he was no longer impartial. Even the perception that the presiding officer is biased is concerning as it can give the appearance of unfair treatment.

Page 10

Intimidation…and…the Division always wins…

Those accused of securities violations told us they felt intimidated into settling, given that the division’s former director would likely serve as the presiding officer. One business owner perceived the system as “a stacked deck” because the investigator, jury, and judge are all in the same office. He informed us that during an investigation, a division employee boasted that the division always wins.

Page 11

State Lawyer Effectively Pushed Out

poor communication between the former director and an attorney resulted in the exclusion of the attorney from a decision on how a case would be handled, even though the attorney had been involved in the case for a number of months. The attorney was frustrated and raised concerns when the former director drafted and sent out documents over the attorney’s name, thus implying the AG gave his approval, even though the attorney was not aware a decision had been made and had not reviewed the final document. He learned about the legal action when defendants contacted him because they assumed he represented the division. The former director contends that the attorney was familiar with the document.

Pages 12-13

Questionable Actions

During the audit, many individuals associated with various cases contacted us with complaints about the division. Our review of case files resulted in a number of questionable actions including: inappropriate publicity, emphasis on punishment rather than compliance, the use of intimidation tactics, violating terms of settlement agreements, failure to notify those being investigated, and inconsistent case management.

Page 15

Fear of Retaliation!!??

To evaluate these complaints, we reviewed case files, listened to tapes of hearings, and interviewed staff and attorneys involved with the cases. Many of those who talked with us requested confidentiality because they feared retaliatory action by the division if they were identified.

Page 15

Inconsistent Procedures…

questionable actions often can be attributed to the divisions lack of clearly defined procedures. A discarded policy manual states that “the manual will be reviewed and updated on a yearly basis to reflect current or additional practices.” Not complying with this requirement has resulted in division policies and procedures that are inconsistently applied.

Page 15

Emphasis on Punishment Rather than Compliance

The division appears to emphasize punishment of offenders rather than compliance with securities laws. A number of those involved in the division’s actions believe the division has overzealously pursued securities violations. They criticize that charges are brought one after another, cases are drawn out over long periods of time, and decisions on who to investigate can be arbitrary.

Page 17

Threats and Coercion

The division’s use of intimidation to obtain information has been cited by both those being investigated and others involved with the division. In one case, the accused stated that an investigator attempted to coerce cooperation by intimidating and threatening that the person would be arrested. In another case, investigators seized personal information by copying all information from the business owner’s computer without distinguishing business and personal information. The owner said that he complied with the investigator’s demands only because they threatened to immediately close him down if he refused.

Page 18-19

Does not Honor Settlement Agreements

The division has, at times, violated the terms of its settlement agreements. In one case, the division agreed to not publicize the action or commence further administrative actions and then violated both terms of the agreement. The person accused told us he felt compelled to plead guilty to a lesser criminal charge rather than place his business in jeopardy defending a greater charge. The division agreed to not seek additional charges but nevertheless pursued an administrative action. The respondent then signed the settlement agreement after the division agreed to not publicize it. However, the day the settlement was signed, the division publicized the information on its web page and also published the information in its newsletter the following month.

Page 19-20

Surprised Charges Filed…Harming Innocent Business

According to the business owner, he learned about the investigation only after it was completed and charges were filed. Before he had an opportunity to respond, the media called to ask about the division revoking his license and issuing fraud charges. The media release was damaging to the business and the resulting retraction and apology was damaging to the division.

Page 21

Fines Arbitrary!!??

The division has been criticized for not identifying how fines are set. Board minutes disclosed the former director explained that fines are set to “make it hurt,” which is troublesome to those in the securities industry. The former director explained to us that fines are set based on an evaluation of the seriousness, nature, circumstances, and persistence of the conduct which is consistent with the Financial Industry Regulatory Authority (FINRA) guidelines. However, because the division does not have written guidelines or procedures identifying the process used to set fines, they appear to be set arbitrarily, based solely at the discretion of the division.

Page 22

Staff Demoralized, Scared of Reprisal

Personnel conflicts within the Division of Securities (division) have resulted in management turnover and a demoralized staff. Both the department executive director and the division’s former director have been open about their beliefs that specific employees have seemed reluctant to accept change and may be subverting management authority. A number of division staff feel their jobs are threatened or other forms of management reprisal may occur should they offend management in some way. The escalating conflicts have resulted in reprimands, restructuring, and ultimately, the resignation of the director, and the threat of legal action by several employees.

Page 25

Division Blatantly Breaks Laws at Director’s Direction

After being hired in October 2005, a number of the former director’s actions have been questionable. He was reprimanded and received a one-day suspension without pay for instructing staff to hold fine payment checks without processing them within the three-day time period required by statute (Utah Code 51-4-1). Delaying the deposit would allow the division to retain funds in the division rather than transfer them to the state general fund. By statute, if a balance in the division’s education fund exceeds $100,000 at the close of a fiscal year, the excess must be transferred to the General Fund (Utah Code 61-1-18.7(6)).

Staff related other instances in which they feel the former director gave them inappropriate directions. For example, staff provided information showing the director:

  • directed staff to sign pleadings that the former director had either drafted or modified, possibly to prevent his name, as the presiding officer, from appearing on documents. Administrative rules state “the signature shall be deemed to be a certification that the signer has read the pleading and that, to the best of his knowledge and belief, there is good ground to support it.”
  • directed staff to provide protected information to an influential person which violates Utah securities law prohibiting employees from disclosing non-public information filed with or obtained by the division (Utah Code 61-1-18.3).
  • used coercive settlement tactics by instructing staff to keep unwarranted allegations in the pleadings to serve as a bargaining chip for the negotiations. The respondent agreed to the settlement after the allegations were removed.
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We hope that this provides another look at the issue of having the states responsible for investment advisers with a wide ranging practice which may involve investors from many states.

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Other related hedge fund law articles:

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

Hedge Fund Court Case | SCERS v. Epsilon Global

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Recently, the U.S. District Court for the Western District of Washington came down with a ruling primarily addressing two issues for hedge fund managers: (1) providing investors with timely annual reports and financial statements and (2) delayed redemptions that could bar the management company from charging management fees (see Seattle City Employees’ Retirement System v. Epsilon Global Active Value Fund II, L.P. ).  Although the decision is not binding authority in any jurisdiction, it sheds light on how the redemption provisions in a fund’s offering documents fund’s offering documents can affect the management company’s right to continue charging those fees when a redemption is suspended or delayed.

Case Background & Remedy Sought

On March 15, 2010, Seattle City Employees’ Retirement System (“SCERS”), an investor of Epsilon Global Active Value Fund II, L.P. (“Epsilon”), filed suit against the Epsilon, the general partner, the investment manager, and officers of the fund for failing to provide a 2008 annual report and audited financial statement to its investors.  When SCERS inquired about the required disclosures and did not receive a satisfactory response from the fund, it decided to request a redemption of its investment on January 28, 2010.  About a week later, on February 4, 2010, an Epsilon officer temporarily suspended the redemption of shares in a letter issued to the investors.  The letter stated that the funds had not received their audited financial statement for 2008 because an SEC investigation of one of the funds was pending.

Ultimately, SCERS sought a preliminary injunction to:

  • to disclose the name/address of undisclosed investors, to disclose the name/address of Epsilon’s directors and officers, and
  • to present documents showing investments into the master fund and the specific fund pending SEC investigation,and
  • bar Epsilon from collecting management fees,

Court Findings

Disclosures

The court found that although SCERS would likely succeed on the merits of its claim–that Epsilon breached its agreement to produce an annual report and audited financial statement–the court had no power to cure that breach because Epsilon’s auditors had not completed the report and the court could not compel the production of a non-existent report.  In addition, SCERS was not entitled to the disclosures that it requested.  Neither the offering documents nor the governing substantive law gives SCERS the right to those documents.

Management Fees

With respect to the management fees, the court found that SCERS was unlikely to succeed on the merits.  The court reviewed the redemption provisions in the fund’s offering documents.  The offering documents grant Epsilon two separate authorities–the power to suspend redemptions and the power to delay redemptions (two very common provisions).  The documents provided that the fund shall not charge management fees when the fund delays redemptions, but the documents did not provide that the fund would not charge fees if there was a suspension of redemptions.  The court found that the language Epsilon used in its February 4, 2010 letter to the investors indicated a suspension of redemptions, not a delay.  Therefore, the court could not bar Epsilon from charging management fees.

Other

The court concluded by indicating that SCERS failed to meet the remaining elements required for a preliminary injunction.  In terms of the requested disclosures, SCERS failed to describe what harm would result if it did not receive them.  The court denied SCERS’ motion for a preliminary injunction and with no remaining causes of action, the suit was resolved.

Manager Take-Aways

First, manager should always be aware of the possibility of litigation when redemptions are delayed or suspended and should plan accordingly.  Although the facts we have about this case are limited to what was included in the opinion, it seems like there may have also been ways that the fund managers could have communicated with the investors to avoid litigation.  Another important aspect to this case is drafting of the offering documents – managers should address the issue of management fees on delayed or suspended redemptions.  In this case, the documents were drafted (perhaps unintentionally) in a way that favored the manager.

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Cole-Frieman & Mallon LLP provides comprehensive regulatory support and hedge fund formation services.  Bart Mallon, Esq. can be reached directly at 415-868-5345.

Massachusetts Hedge Fund Exemption

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Exclusion From Definition of Investment Adviser

Generally Massachusetts will require hedge fund managers with a place of business in Massachusetts to register as an investment adviser with the Massachusetts Securities Division.  However, there is an exemption from registration for some hedge fund managers located in Massachusetts.  [Note: to be more accurate, the “exemption” really is an exclusion from the definition of investment adviser under the Massachusetts Securities Act.]

Definition of Investment Adviser

Under Section 401(m) of the Massachusetts Securities Act, the term investment adviser means:

any person who, for compensation, engages in the business of advising others, either directly or through publications or writings, as to value of securities or as to the advisability of investing in, purchasing, or selling securities, or who, for compensation and as a part of a regular business, issues or promulgates analyses or reports concerning securities. …“Investment adviser” shall not include: … a person whose only clients in this state are federal covered advisers, other investment advisers, broker-dealers, banks, savings institutions, trust companies, insurance companies, investment companies as defined in the Investment Company Act of 1940, employee benefit plans with assets of not less than $5,000,000, governmental agencies or instrumentalities, or other financial institutions or institutional buyers, whether acting for themselves or as trustees with investment control; (emphasis added)

This definition is similar for most states and is based on the Uniform Securities Act which was designed to help standardize state securities laws.  Normally the definition of “other financial institutions or institutional buyers” is not defined under state law or division regulations and will normally be understood to mean large institutions.

Massachusetts has specifically defined “Institutional Buyer”.

Definition of “Institutional Buyer” for Section 401(m)

Under Massachusetts regulations,

Institutional Buyer shall include any of the following:

a. An organization described in Section 501(c)(3) of the Internal Revenue Code with a securities portfolio of more than $ 25 million.

b. An investing entity whose only investors are accredited investors as defined in Rule 501(a) under the Securities Act of 1933 (17 CFR 230.501(a)) each of whom has invested a minimum of $ 50,000.

c. An entity whose only investors are financial institutions and institutional buyers as set forth in M.G.L. c. 110A, § 401(m) and 950 CMR 12.205(1)(a)6.a. and b.

See 950 CMR Section 12.205(1)(a)(6)

For hedge fund managers, section (b) above is important.  A hedge fund would be considered to be an “institutional buyer” if (i) the fund only accepts accredited investors and if (ii) each investor has contributed at least $50,000 to the fund.  If the fund does not meet both parts of the test, the fund will not be an “institutional buyer” and the fund manager would not be excluded from the definition of investment adviser and would need to register as such with the Massachussetts Securities Division.

Consequences for Not Registering

If a fund manager does not meet the two tests above, the manager will need to be registered or face certain consequences.  These consequences may include:

  • An order to cease and desist conducting business
  • A requirement to register with the division
  • Administrative fines
  • Offer of rescission of fund interests to investors
  • Further division scrutiny

Some managers may be tempted to not register but as we can see from a previous Massachussetts Securities Division Complaint against an unregistered hedge fund manager, the consequences and the time/money/effort spent with a formal division complaint will be far more cumbersome than simply registering with the division in the first place.

Conclusion

Many states have intricate laws with respect to hedge fund manager registration.  These laws will become even more important to understand if/when the Wall Street Reform bill passes in which case many SEC registered advisers will need to switch to state registration.

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Other related hedge fund law articles:

Cole-Frieman & Mallon LLP provides comprehensive hedge fund formation and regulatory support.  Bart Mallon, Esq. can be reached directly at 415-868-5345.

Massachusetts RIA Net Worth Reminder

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Today we received an email reminder from the Massachusetts Securities Division with respect to investment adviser minimum financial requirements.  Essentially hedge fund managers registered as investment advisers with Massachusetts will either need to (i) post a $10,000 surety bond or (ii) establish a separate account with $10,000 and maintain a positve net worth.  Managers who choose to establish the separate account need to provide the Securities Division with a balance sheet on an annual basis.

The email stated:

Please see the attached reminder of the Division’s policy regarding minimum financial requirements for certain Massachusetts-based registered investment advisers.  Please call the Division if you have any questions.

The attachment stated:

POLICY STATEMENT

DEMONSTRATION OF POSITIVE NET WORTH FOR CERTAIN MASSACHUSETTS-BASED, STATE-REGISTERED INVESTMENT ADVISERS

The Massachusetts Securities Division (the “Division”) hereby provides this reminder to certain investment advisers described as follows:  those (1) who are required to be registered with the Division; and (2) whose principal place of business is in Massachusetts; and (3) who (i) exercise investment or brokerage discretion, (ii) have custody of clients’ funds or securities, or (iii) require the payment of more than $500 in advisory fees more than 6 months in advance.  The regulation found at 950 CMR 12.205(5) requires such investment advisers to either (a) post a $10,000 surety bond, or (b) establish a separate, segregated account of $5,000 [for (i) above] or $10,000 [for (ii) and/or (iii) above] and maintain at all times a positive net worth.  The Division requires that those investment advisers who choose option (b) demonstrate, on an annual basis, their positive net worth with a certified balance sheet prepared in accordance with generally accepted accounting principles applied on a consistent basis.  See 950 CMR 14.412(C).

If you are registered as an investment adviser in Massachusetts and have any questions, please feel free to contact us at Mallon P.C.

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Other related hedge fund law articles include:

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

Regulation D Annual & Interim Amendments

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Form D Updating Requirements

Initial Filing Requirement

As discussed in our overview of Regulation D, hedge funds must file a Form D with the SEC within 15 days of the first subscription of hedge fund interests.  This filing is now done completely online through the SEC’s EDGAR filing system.  If you have any questions on your initial Form D filing requirements, please contact Cole-Frieman & Mallon LLP.

Annual Amendment Required

Hedge funds which are continuously offering their interests are required to file an amended electronic Form D on an annual basis (e.g. on or before the anniversary of the most recent amendment (or original filing)).  Real estate funds and private equity funds which have made a “final closing” will not be required to file an annual amendment unless one year lapses from the first sale date and the final closing date.  See generally Rule 503(a)(3)(iii).

Requirement to Correct Errors or Report Changes

Hedge funds must file amendments to Form D to correct material mistakes of fact or errors, and to report changes in information reported on previous Form D filings.  The amendment must be filed as soon as practicable.

Generally changes will require an amendment except for certain more administrative changes.  The changes which do not require instant amendment include:

  • The address or relationship to the issuer of a related person identified in Item 3 of Form D;
  • The fund’s revenues or aggregate net asset value;
  • The minimum investment amount, if the change is an increase, or if the change, together with all other changes in that amount since the previously filed notice of sales on Form D, does not result in a decrease of more than 10%;
  • Any address or state(s) of solicitation shown in response to Item 12 of Form D;
  • The total offering amount, if the change is a decrease, or if the change, together with all other changes in that amount since the previously filed notice of sales on Form D, does not result in an increase of more than 10%;
  • The amount of interests/securities sold in the offering or the amount remaining to be sold;
  • The number of non-accredited investors who have invested in the offering, as long as the change does not increase the number to more than 35;
  • The total number of investors who have invested in the offering; or
  • The amount of sales commissions, finders’ fees or use of proceeds for payments to executive officers, directors or promoters, if the change is a decrease, or if the change, together with all other changes in that amount since the previously filed notice of sales on Form D, does not result in an increase of more than 10%.

The only time that changes to these items must be reported on an interim basis is when the issuer is otherwise filing a 503(a) amendment.

Rule 503(a)(4) requires that current information must be provided in response to all parts of the Form D, regardless of the reason for the filing.  Thus, even when filing an amendment to correct a small error, current information must be given for all parts of the form, even those items excepted under 503(a)(3)(ii).  Similarly, when filing to report changes in information that is not under the exception, current information must be provided for all parts of the Form D.  And, of course, when making an annual filing, all information must be current.

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Please contact us if you have a question on this issue or if you would like to start a hedge fund.  Other related hedge fund law articles include:

Bart Mallon, Esq. of Cole-Frieman & Mallon LLP runs the Hedge Fund Law Blog.  He can be reached directly at 415-868-5345.

California Investment Advisor Annual Compliance Reminder | 2010

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State registered investment advisory firms usually have annual compliance requirements.  The following discusses the major issues for investment advisors (both hedge fund and separately managed account managers) who are registered in California.  In general, there is (i) an annual updating requirement and (ii) an annual financial filing requirement.

Annual ADV Updating Amendment

Registered investment advisers will need to update Form ADV (including Part II and Schedule F) on an annual basis.  For California registered investment advisers the annual update is due within 90 days after the end of the firm’s fiscal year end (which will normally end on December 31).  In general the advisor should review the entire ADV, Part II and Schedule F to make sure everything is accurate as of the date of filing.  The advisor may want to make this filing itself (usually the chief compliance officer of the firm will complete) or the advisor may want to have its law firm or compliance firm complete the update for them.

Note: in additional to annual update, each advisor will need to make sure that certain information is updated on a continuous basis.  If the information contained in Part I, Items 1, 2, 3, 4, 5, 8, 11, 13A, 13B, 14A and 14B of Form ADV, Form U-4 or any representation or undertaking contained in any affidavit filed with the state securities division, changes in any respect, or if the information contained in Part I, Items 9 and 10 and all items of Part II of Form ADV changes in any material respect, an amendment shall be filed promptly with the state securities division. Such amendment must be filed in writing no more than ten business days after the registrant has knowledge of the circumstances requiring such notification.

Annual Financial Filing Requirement

California registered advisors will also need to submit annual financial reports to the California Securities Regulation Division.  Such advisors must submit the following to the division:

The above items should be sent directly to the California Securities Regulation Division at:

California Financial Services Division
1515 K Street
Suite 200
Sacramento, CA 95814

Note: in general both hedge fund managers and separately managed account advisors (who directly debit fees from client brokerage accounts) will be deemed to have “custody” of client assets and would need to make sure that, among other requirements, the balance sheet above is audited.  Most advisors, however, will institute certain procedures (including a gatekeeper arrangement) which will allow them to submit unaudited financials.  If you have questions, please contact your lawyer or compliance professional.

Other Compliance Issues

In California, like most of the states, there are a number of items that advisors will need to do a continuous basis.  The most important is probably to properly maintain their books and records.  California has also provided an overview of important issues for California investment advisor and has also provided an overview of the post-effective requirements.

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Please contact us if you have any questions or would like to start an investment advisory business.  Other related hedge fund law articles include:

Bart Mallon, Esq. of Cole-Frieman & Mallon LLP runs Hedge Fund Law Blog and has written most all of the articles which appear on this website.  Mr. Mallon’s legal practice is devoted to helping emerging and start up hedge fund managers successfully launch a hedge fund. Cole-Frieman & Mallon LLP will also help state based Investment Advisors to register with their state securities division.  If you are a hedge fund manager who is looking to start a hedge fund or an investment advisor looking to register, please call Mr. Mallon directly at 415-868-5345.