Category Archives: News and Commentary

Cole-Frieman & Mallon 2017 First Quarter Update

Below is our quarterly update which went out via email today to our firm’s clients and friends.  Links coming soon.

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April 27, 2017

Clients, Friends, Associates:

We hope that you are enjoying an auspicious start to 2017. The first quarter of the year is typically one of the busiest for fund managers from a regulatory standpoint. As a variety of filing deadlines have passed and audit work is completed (or will be soon), we enter the second quarter with a number of important regulatory issues on the horizon, as well as many other topics worthy of discussion. Below, we have prepared a short overview of some of these items.

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Regulations and Proposed Regulations:

Trump Executive Order Could Reform Dodd-Frank. President Trump issued an executive order on February 3, 2017, setting out seven “Core Principles” which will serve as general guidelines for financial regulatory reform. The Core Principles include making regulation more efficient, effective and appropriately tailored, as well as rationalizing the Federal financial regulatory framework. The order appears implicitly targeted at reforming the Dodd-Frank Wall Street Reform and Consumer Protection Act (“Dodd-Frank”) and decreasing many of the current financial regulations, but we note that any changes to the current regulatory landscape may not be as immediate as many initial reactions assumed. According to the order, the Treasury Secretary is to meet with the various agencies that oversee and implement Dodd-Frank (including the SEC), to discuss areas that may be amended. While a repeal of Dodd-Frank is unlikely, the coming months may bring a number of deregulatory changes. We will be following any resulting changes and will discuss significant impacts of such changes in future quarterly updates.

Department of Labor Delays Fiduciary Rule. On April 7, 2017, in response to a presidential memo from President Trump, the Department of Labor (“DOL”) issued a Final Rule delaying the applicability of the “Fiduciary Rule” until June 9, 2017, although full compliance with the Fiduciary Rule is still expected by January 1, 2018. We had previously discussed the Fiduciary Rule, which expanded the scope of who is considered a “fiduciary”, imposing fiduciary obligations on firms which were historically free from such obligations. While the DOL will use the delay to reexamine the Fiduciary Rule and consider modifications to it, if you have not already done so, we recommend that you review and speak with your counsel about whether you would be considered a fiduciary and what additional obligations and implementation processes will need to be incorporated into your business practices.

CFTC Regulation of Bitcoin and Virtual Currencies. There has been an increasing interest in investments in Bitcoin and other cryptocurrencies as the financial and technological landscape evolves, but determining the regulations applicable to such products is less clear. While the CFTC established that Bitcoin and other virtual currencies are “commodities” within the definition of the Commodity Exchange Act of 1936, as amended (“CEA”), under the CEA, only commodity interests (which include futures, options, derivatives and certain spot transactions) based on the commodity are within the scope of the CFTC’s jurisdiction. Recent enforcement actions brought by the CFTC have helped clarify whether a transaction is subject to CFTC regulation. In an Order issued against the Coinflip, Inc. platform (“Coinflip”), the CFTC imposed sanctions against Coinflip for operating a facility for trading Bitcoin derivatives without being registered as a futures exchange or swap execution facility. In a contrasting enforcement action brought against the Bitfinex platform (“Bitfinex”), which did not list or permit the trading of derivatives, the CFTC asserted its jurisdiction over Bitfinex on the basis that the platform dealt in “retail commodity transactions”— leveraged, margined or financed transactions involving a commodity that are offered to persons that are not “eligible contract participants” — without being registered as a futures commission merchant with the CFTC. Certain retail commodity transactions are exempt from CFTC jurisdiction if the seller “actually delivers” the commodity to the buyer within 28 days of the date the contract was entered into; the CFTC deemed that Bitfinex did not “actually deliver” the cryptocurrencies to buyers because among other reasons, Bitfinex held the private key controlling access to the wallet where the buyers’ cryptocurrencies were held.

Managers investing in Bitcoin or other virtual currencies should consider whether and to what extent the types of transactions may subject them to CFTC jurisdiction and potential registration as a CPO or CTA. In the current regulatory landscape, we believe managers who invest purely in virtual currencies and who do not employ virtual currency derivatives or leverage are outside the scope of the CFTC’s jurisdiction, and should not be required to register as a CPO or CTA. Although further regulation is expected, firms should speak with outside counsel to confirm their status in light of the current regulatory framework.

Other Regulation of Bitcoin and Virtual Currencies. While the CFTC has been the most active regulatory authority to address investments in cryptocurrencies, managers should be cognizant that states (including New York), the SEC, FINRA and FinCEN are also deliberating the question of appropriate regulatory oversight. We will continue to monitor regulatory developments and more information about certain regulatory aspects applicable to private funds can be found in our blog post on Bitcoin / Cryptocurrency Hedge Funds.

NFA Provides Guidance on Amended CPO Financial Report Requirements. In our previous 2016 End of Year Update we discussed the CFTC’s amendments providing relief from certain financial report requirements for commodity pool operators (“CPOs”), which became effective on December 27, 2016. The NFA released a Notice setting forth instructions regarding how CPOs can file the appropriate notices with the NFA to claim any of the relief provided for in the amendments. CPOs who are eligible for the amended regulations should contact counsel or compliance consultants, or review the Notice, to determine whether any further action may be warranted to claim the appropriate relief.

U.S. and Global Regulators Relax March 1st Deadline for Swap Variation Margin Compliance. The Federal Reserve and the International Organization of the Securities Commission have provided some flexibility for swap dealers facing a March 1, 2017, deadline to implement certain variation margin compliance requirements for uncleared swaps. The rules require swap dealers to collect and post variation margin with no credit threshold unless an exception applies. Further, covered counterparties would be required to enter into new or amended credit support documentation, limit the types of collateral that may be posted and prescribe minimum transfer amounts. Compliance with the requirements can be challenging for swap entities and their counterparties as they work to implement the necessary documentation and underlying operational processes. Except for transactions with financial end users that present “significant exposures,” the Federal Reserve’s guidance directs examiners of CFTC-registered swap dealers to focus on the dealer’s good faith efforts to comply as soon as possible but by no later than September 1, 2017.

BEA Makes Changes to Direct Investment Survey Reporting Requirements for Certain Private Funds. The Bureau of Economic Analysis’ (“BEA”) changes to its direct investment surveys went into effect on January 1, 2017. The reporting changes apply to investments by U.S. entities of a 10% or more voting interest in a private fund, and to investments by foreign entities of a 10% or more voting interest in a U.S. domiciled fund. Under these changes, any cross-border voting investments of 10% or more in, or by, private funds will be subject to BEA reporting only if such investments involve, directly or indirectly, a direct investment in an “operating company” that is not another private fund or a holding company. The changes will simplify reporting for private funds because certain direct investments in private funds will be re-characterized as portfolio investments depending on the nature of the private fund’s investments. Many hedge funds that were traditionally subject to BEA direct investment reporting because of cross-border voting interests will instead only be required to report on portfolio investments to the Treasury Department on Treasury International Capital (“TIC”) surveys. The BEA will notify any filers that may be potentially affected by these changes, but we recommend that advisers consult with counsel to determine what, if any, BEA and/or TIC reporting obligations they may have.

Treasury Department Proposes New Anti-Money Laundering Rules for Investment Advisers. The Treasury Department’s Financial Crimes Enforcement Network previously proposed extending the requirements of maintaining a formal anti-money-laundering (“AML”) program under the Bank Secrecy Act of 1970 to SEC-registered investment advisers (“RIAs”). The final rule is expected to be published soon, and would require SEC RIAs to establish a robust AML program with policies and procedures to identify questionable activity, periodic testing of the program and ongoing training of appropriate personnel.

Other Items:

California’s Public Investment Fund Disclosure Requirements Now Effective. In our third quarter update, we reported that California passed a bill requiring increased disclosure by private fund managers for funds with investments by California state and local public pension and retirement systems. The legislation went into effect on January 1, 2017. All public pension and retirement systems in California must require hedge funds, private equity funds, venture capital funds and any other alternative investment vehicles in which they invest to disclose certain information regarding the fund’s fees, expenses and performance. In addition to applying to new contracts entered into on or after January 1, 2017, and pre-existing contracts with new capital commitments made on or after January 1, 2017, the legislation requires that public pension and retirement systems make “reasonable” efforts to obtain the increased disclosure information for contracts entered into prior to January 1, 2017. Fund managers with California public plan investors should review the types of information that will need to be provided to such investors and prepare to provide the required information.

SEC No-Action Letter and Guidance Clarify Inadvertent Custody. On February 21, 2017, the SEC issued a no-action letter responding to a request for clarification from the Investment Advisers Association as to whether an investment adviser has custody of a client’s assets if the adviser acts pursuant to a standing letter of instruction or other similar arrangement established between the client and its custodian (“SLOA”), that grants the adviser limited authority to direct transfers of the client’s funds to one or more third parties. The SEC’s position is that an SLOA that authorizes the adviser to determine the amount and timing of payments, but not the payee’s identity, is sufficient authority to result in the adviser having custody of the assets. However, the SEC agreed that it would not recommend an enforcement action against an adviser that does not obtain a surprise examination, if the adviser acts pursuant to an SLOA under certain specific circumstances set forth in the SEC’s letter. The SEC also reaffirmed that advisers will not be deemed to have custody of client assets if the adviser is given limited authority to transfer client assets between the client’s accounts maintained at one or more custodians.

To further clarify its views on inadvertent custody, the SEC also issued a guidance update highlighting certain circumstances where an investment adviser may inadvertently have custody of client funds or securities. An adviser may have custody because of the wording or rights of custodial and advisory agreements, even if the adviser did not intend to have custody and was not aware it was granted the authority that resulted in its having custody. We urge advisers to separately managed accounts to review their client agreements and any SLOAs they have entered into to determine whether their specific arrangements may cause them to have custody, and to evaluate their policies and practices related to custody of client assets.

SEC Published Examination Priorities for 2017. The SEC announced its Examination Priorities for 2017, which focus on themes of examining matters of importance to retail investors, focusing on risks specific to elderly and retiring investors and assessing market-wide risks. Specifically, the SEC will focus on: (i) identifying initiatives designed to assess risk in the context of retail investors, including never-examined investment advisers and exchange-traded funds, and notably, robo-advisers and other automated, electronic investment advice platforms, including the investment advisers and broker-dealers that offer them; (ii) services provided to retirement accounts, such as variable insurance products and fixed-income cross-transactions, as well as investment advisers to pension plans and other large holders of U.S. investor retirement assets; and (iii) cybersecurity, and systems and technology procedures and controls.

FINRA Published Examination Priorities for 2017. Similar to the SEC, the Financial Industry Regulatory Authority, Inc. (“FINRA”) recently published its 2017 Regulatory and Examination Priorities Letter, outlining the organization’s enforcement priorities for the current year. FINRA’s specific focus areas for 2017 will include: (i) supervisory policies and compliance controls for high-risk and recidivist brokers; (ii) sales practices and product suitability for specific investors; (iii) firm liquidity management practices; and (iv) cybersecurity issues. We recommend that you speak with your firm’s outside counsel and service providers to learn more about these specific priorities and review your firm’s compliance with the applicable regulations.

Cayman Islands Extends CRS First Notification and Reporting Deadlines. The Cayman Islands Department for International Tax Cooperation (“DITC”) has issued an industry advisory stating that it is adopting a “soft opening” to the notification and return deadlines required for Financial Institutions’ (“FIs”) compliance with the Common Reporting Standard (“CRS”). All FIs in the Cayman Islands are required to register with the Cayman Islands Tax Information Authority (“TIA”) by April 30, 2017, and to submit returns to the TIA by May 31, 2017. With the DTIC’s adoption of a “soft opening,” FIs may submit CRS notifications on or before June 30, 2017, and file “accepted” CRS returns on or before July 31, 2017, without any compliance measures or penalties.

Ninth Circuit Rules Internal Reports Protected under Whistleblower Rules. On March 8, 2017, the Ninth Circuit followed a ruling by the Second Circuit in finding that an employee who makes a report internally, rather than to the SEC, is protected under Rule 21F-17 of the Securities Exchange Act of 1934, as amended (“Whistleblower Rule”) enacted under Dodd-Frank. In contrast, the Fifth Circuit previously ruled that the provisions of the Whistleblower Rule only apply when an employee makes disclosures directly to the SEC. The Ninth Circuit and Second Circuit rulings reflect a broad interpretation of the definition of a whistleblower, and signal a split among the circuit courts on who may be considered a whistleblower for purposes of protection under the Whistleblower Rule.

Regulatory Assets Under Management. We have observed that many managers have expressed confusion regarding the calculation of assets under management (“AUM”) for purposes of filing the Form ADV and determining when the manager may be subject to SEC registration. We thought it would be helpful to clarify that investment advisers must look to their “regulatory assets under management” (“RAUM”), a specific metric designed by the SEC, which is calculated differently from the more common and more traditionally understood calculation of AUM. In calculating RAUM, managers should include the value of all assets managed without deducting for any offsetting liabilities. Managers with questions about the calculation of specific assets or managers seeking further clarification of RAUM should speak with their firm’s outside counsel or compliance consultants.

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

Deadline – Filing

  • March 31, 2017 – Deadline to update and file Form ADV Parts 1, 2A & 2B
  • April 10, 2107 – Amendment to Form 13H due if necessary
  • April 15, 2107 – 1st Quarter 2017 Form PF filing for quarterly filers (Large Liquidity Fund Advisers)
  • April 28, 2107 – Collect quarterly reports from access persons for their personal securities transactions
  • April 28, 2107 – Distribute code of ethics and compliance manuals to employees. Require acknowledgement form to be executed in connection with such delivery
  • April 28, 2107 – Annual Privacy Notice sent to all clients or fund investors (for Advisers with Fiscal Year ending December 31)
  • April 28, 2107 – Distribute audited financial statements to investors (most private fund managers, including SEC, state and CFTC registrants)
  • April 28, 2107 – Distribute Form ADV Part 2 to clients
  • April 30, 2107 – Quarterly NAV Report (registered commodity pool operators claiming the 4.7 exemption)
  • May 1, 2107 – 2016 Annual Form PF due date for annual filers (Large Private Equity Fund Advisers and Smaller Private Fund Advisers)
  • May 15, 2017 – Quarterly Commodity Trading Advisor Form PR filing
  • May 15, 2017 – File Form 13F for first quarter 2017
  • May 31, 2017 – First deadline for Cayman Islands Financial Institutions to submit their CRS returns to the Cayman Islands Tax Authority
  • May 31, 2017 – Third reporting deadline (full reporting) for Cayman Islands Financial Institutions with reporting obligations under the Cayman FATCA regulatory framework to report their U.S. Reportable Accounts to the Cayman Islands Tax Authority
  • June 30, 2017 – Distribute audited financial statements to investors (private fund managers to funds of funds, including SEC, state and CFTC registrants)

Variable

  • Distribute copies of K-1 to fund investors
  • Ongoing All Limited Non-U.S. Financial Institutions and limited branches that seek to continue such status during the 2017 calendar year must edit and resubmit their registrations after December 31, 2015, on the FATCA registration website; SEC form D must be filed within 15 days of first sale of securities

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

Sincerely,
Karl Cole-Frieman, Bart Mallon & Lilly Palmer

Hedge Fund Bits and Pieces for April 14, 2017

Happy Friday.  Markets are closed today for the holiday and it is tax day this Tuesday.  Enjoy the weekend!

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SEC Brings Actions Against Authors on Investment Article Platforms – platforms like Seeking Alpha and SumZero have been popular places for investment managers to post articles about their investment ideas.  Managers post for a number of reasons including to hone their own investment thesis, hear counterarguments and to generally be part of a community actively involved in the discussion of ideas.  We routinely work with managers who are posting articles on these platforms and help them think about the compliance obligations they have with respect to any postings.

The SEC just announced a major series of enforcement actions against 27 individuals for posting fake and fraudulent articles on these platforms.  Settlements have already ranged from $2,200 to almost $3 million.  While the standard hedge fund manager we deal with is unlikely to be involved in the creation of fake or fraudulent articles (or using these platforms to manipulate positions), these enforcement actions show that the SEC is actively looking at information posted on the internet as a way to find persons involved in securities violations.   Most registered managers will already have social media policies in place that should deal with situations like this, including how to document the posting, but we also recommend that managers discuss articles with their attorneys or compliance personnel before posting.  We believe that (to the extent it has not already happened) the SEC will be closely scrutinizing internet postings during routine manager examinations and that managers need to make sure any such actions are not manipulating the markets (in addition to making sure there is no appearance of manipulation).

FINRA 360 Announced – FINRA just announced a new initiative to “evaluate various aspects of its operations and programs to identify opportunities to more effectively further its mission.”  The initiative is was announced as FINRA 360 in Regulatory Notice 17-14 and focuses on the following, in addition to other FINRA rules: CAB Rules, Funding Portal Rules, Numerous FINRA rules and the Trading Activity Fee.  The goal of FINRA 360 is to ”increase efficiency and reduce unnecessary burdens on the capital-raising process without compromising important protections for issuers and investors” which we think is a step in the right direction.  However, we have previously discussed two FINRA initiatives (here re CABs and here re scrapping the 7) as perhaps a bit misguided.  In any event, we think FINRA is taking a great step here and we also believe that this provides an opportunity for the industry to provide FINRA with meaningful feedback and ideas.  All are encouraged to comment and comments are due by May 30, 2017.

Greyline Solutions Expands Compliance Offering to Broker-Dealers – the regulatory compliance consulting company Greyline Solutions (editors note: I am a minority owner in this business) announced the upcoming acquisition of Vista Compliance which will add significant broker-dealer expertise to its RIA offerings.  For more information, please see the press release.

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Bart Mallon is a founding partner of Cole-Frieman & Mallon LLP and focuses his legal practice on the investment management industry. He can be reached directly at 415-868-5345.

Hedge Fund Bits and Pieces for March 31, 2017

Happy Friday and congrats to everyone on making it though the first quarter!  Our firm will be sending out a 2017 first quarter update sometime in the next couple of weeks – if you are not on the distribution list and would like to be, please contact us.  We will also post the update to this blog.

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Annual ADV Updatedue TODAY by 11pm ET (when IARD system shuts down).  The ADV annual updates are due today.  Most firms have submitted their updates by now but if you have not done so, please call your legal or compliance professional immediately.  Additionally, fund managers generally will have their audits completed by today and those should be sent to investors as per the firm’s compliance procedures.

Another Bitcoin Trust Rejected by SEC – on Tuesday the SEC rejected an application by NYSE Arca to list shares of SolidX Bitcoin Trust.  The trust was set to a publicly traded vehicle designed to track the price of bitcoins as measured by an index of unregulated bitcoin exchanges (Bitfinex, Bitstamp, GDAX, itBit, and OKCoin International).  In rejecting the application, the SEC stated that it believes that the bitcoin markets are unregulated.  This is the second rejected listing of a bitcoin product for retail investors (see earlier post discussing the rejection of the Winklevoss bitcoin ETF).

SEC Focus on FinTech – it is abundantly clear that technology is beginning to change the capital markets in profound ways.  As practitioners, we are working with our clients to figure out how new ways of investing fit within the current regulatory structures applicable to both products and managers.  As these changes take deeper root, there will be growing pains and the SEC realizes this – below are recent remarks made on Monday in Washington by acting SEC Chairman Michael Piwowar about the FinTech industry and how the SEC will be working in the space in the future.  The full speech, made at the beginning of the SEC’s 27th Annual International Institute for Securities Market Growth and Development, can be found here.

Financial technology (“FinTech”) is also revolutionizing our industry. FinTech can bring tremendous benefits – streamlined market operations and more affordable ways to raise capital and advise clients.  Fifty-nine percent of all adults in developing nations do not have a bank account – but this is changing fast. With cell phones now in the pockets of many individuals in even the poorest of nations, mobile technology has greatly cut down on barriers to accessing capital. In Kenya, for example, I saw firsthand the transformative power of FinTech. Sixty-eight percent of Kenyan adults use their mobile phones for monetary transactions. In 2013, over 25% of the Kenyan GNP was transferred via M-PESA, the leading mobile money transfer service in the country. Services like M-PESA are not only for the transfer of money, but also can be used to take out micro-loans that would have been previously unavailable to small businesses.  The question for us regulators is how can we encourage this innovation and all the potential benefits that it promises, while also managing the risks? At the SEC, we started a FinTech working group. Not surprisingly, FinTech firms report that their greatest struggle is navigating a complex regulatory environment. The SEC, and other securities regulators, should take the leading role in working with the FinTech community to adapt longstanding laws and regulations to newfangled technology. (footnotes omitted)

Other Items:

  • CFTC Announces Committee Meeting on Cybersecurity – the CFTC just announced that the Market Risk Advisory Committee (MRAC) will meet on April 25, 2017 to discuss a number of important issues related to the futures and commodities markets.  A central focus of this meeting will be focused on cybersecurity trends in the futures markets.  The discussion will also cover “how well the derivatives markets are currently functioning, including the impact and implications of the evolving structure of these markets on the movement of risk across market participants” – we anticipate that some part of the discussion will focus on certain new instruments like cryptocurrencies and the emerging derivate products linked to such instruments.  The MRAC’s meeting will be public and be held at the CFTC’s Washington, DC, headquarters.
  • Adidas Trademark Issue – while not directly related to the investment management industry, this blog post (produced by our Of Counsel trademark attorney Bill Samuels) highlights the technical nature of the enforcement of trademarks.  It also highlights the strength of a registered mark (the sale of only two hats, which contain a trademarked phrase, are enough to implicate interstate commerce and allow a trademarked phrase to be protected under the trademark laws).  It is important for managers with questions on their trademarks and other intellectual property to discuss these matters with counsel.

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Bart Mallon is a founding partner of Cole-Frieman & Mallon LLP and focuses his legal practice on the investment management industry. He can be reached directly at 415-868-5345.

Hedge Fund Bits and Pieces for March 17, 2017

Happy Friday. This week’s updates below.

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Bitcoin ETF Rejected by SEC – an application to establish an ETF which would be based on a basket of Bitcoins was rejected by the SEC on March 10. The Winklevoss brothers, noted Bitcoin investorss, were the sponsors of the vehicle which was to be called the Winklevoss Bitcoin Trust. In rejecting the proposal, the SEC stated that the Bitcoin markets are unregulated and that the exchange the ETF would be traded on (Bats BZX Exchange) would not be able to enter into “surveillance-sharing” agreements that would be able combat fraudulent or manipulative acts and practices in the Bitcoin market. We expect that there will be future ETF proposals submitted to the SEC and that as the cryptocurrency industry (and specifically the exchanges hosting Bitcoin exchange) becomes more developed, a Bitcoin ETF will at some time be approved for trading. The SEC release can be found here.

Bitcoin Hedge Funds Article – we recently wrote about Bitcoin/ AltCurrency / Cryptocurrency hedge funds.  We believe that this is a burgeoning asset class and we will begin to see more private fund products launched in this space in the coming months.

FINRA Proposal to Scrap Series 7 – last week FINRA filed a proposed rule change with the SEC that would eliminate the Series 7 exam in favor of a more “streamlined” representative-level qualification exam that would include a general knowledge exam and specialized knowledge exam. We have strong thoughts about FINRA’s use of their time to create a new regulatory structure for exams when there has been no specific mandate for this update (no one is asking for this and we don’t know what problem this complete revamp is solving). We also (personally) believe that FINRA could better spend its time focused on matters that its member firms are asking to be addressed. While we are all for streamlining at Federal Agencies and self-regulatory organizations, we believe that streamlining should be reasonable and should serve a purpose – I am not sure if there was a purpose to this, but I also have not read through the entire 619 page FINRA submission to the SEC.

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Bart Mallon is a founding partner of Cole-Frieman & Mallon LLP and focuses his legal practice on the investment management industry. He can be reached directly at 415-868-5345.

Anecdotal Evidence of Strong Investor Appetite in 2017

Hedge funds to be attractive investments in new year?

By: Bart Mallon

Over the past couple of years hedge funds have seemingly taken a back seat to private equity, which has seen a significant amount of attention and inflows from institutional investors.  However, it is beginning to feel as though hedge funds are poised for a banner year – in the past two weeks we’ve received more investor due diligence inquires (confirmation of our law firm’s relationship with a manager) than we’ve had over the past six months.  Perhaps even more interesting is that investor demand is coming from all sources (fund of funds, institutional allocators, due diligence specialist firms and individual investors) and has been for potentially large subscription amounts.

Although our firm saw some managers receive major allocations from large pension funds and other investors in 2016, a high percentage of managers were seeing mild to poor interest in their products last year and it is no secret that fund launches were down significantly as well, continuing the trend of fewer fund launches over the last few years.  While to some extent investor appetite is driven by individual managers (right performance, right strategy, right time), it seems to us that we are seeing diligence inquiries that are not solely focused on the hot investment strategy du jour.  The inquiries also fall along various parts of the asset spectrum and can’t be solely classified as pertaining only to funds over say $250M AUM.

I did not expect this surge in inquiries, but I was not surprised it – in late November to early December (after the post-election market surge), we were hearing anecdotal evidence from some of our asset-raising friends that capital was ready to flow and that investors were inquiring about hedge fund products.  It seems the bullishness of late November and December has continued into this new year.  If this continues, we may see more launches in Q2 and Q3 of this year as portfolio managers decide to leave firms after bonus season, whether or not they have investors already lined up.  In any event, we hope we see both more launches in 2017 and more investment in those launches.

Here’s to the new year and my best wishes to all of you – managers, investors, allocators, compliance firms, service providers – for a fantastic 2017.

Bart Mallon
www.colefrieman.com/bart-mallon
415-868-5345

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Other related hedge fund law articles:

Cole-Frieman & Mallon LLP is a boutique hedge fund law firm and provides comprehensive formation and regulatory support for hedge fund managers.  Bart Mallon, Esq. can be reached directly at 415-868-5345.

Regulation A+ Deadline Passed by Congress

Part of JOBS Act Regulations to be Finalized by October 31, 2013

On Wednesday May 15, the House of Representatives passed H.R. 701 which requires the SEC to finalize regulations with respect to “Regulation A+” of the JOBS Act. Regulation A+ would allow companies to more effectively raise money from the public, increasing the current offering limit of $5 million over 12 months to a limit of $50 million over 12 months.

House Statement on Regulation A+

The House Financial Services Committee released a statement which includes the following:

Specifically, H.R. 701 requires the SEC to implement Title IV of the JOBS Act by October 31, 2013. Title IV requires the SEC to adopt or amend regulations to encourage capital formation without requiring an SEC registration statement. These exemptions, referred to as “Regulation A+,” create a new category of public offerings exempt from SEC registration of up to $50 million raised over a 12-month period through issuance of equity securities, debt securities or debt securities convertible or exchangeable to equity interests, including any guarantees of such securities. Under current law, Regulation A provides a similar exemption for public offerings up to $5 million over 12 months.

To protect investors, the JOBS Act requires companies that make offerings under Regulation A+ to file audited financial statements with the SEC on an annual basis and gives the SEC the ability to require these issuers to make periodic disclosures about their operations, financial condition, use of proceeds and other information it deems appropriate.

What this means for the hedge fund industry

Right now this means little to the hedge fund industry except perhaps that Congress is getting tired of the SEC dragging their feet with respect to implementing the JOBS Act. As we have discussed previously, the major provision for fund managers is going to be the lifting of the ban on general solicitation. Perhaps this action indicates that Congress is going to continue to push the SEC to finalize all of the provisions of the JOBS Act.

Additionally, depending on the final Regulation A+ regulations, fund managers may be more inclined to start using that exemption instead of Rule 506 Regulation D, which is the de facto safe harbor used by fund managers. Our guess is that we will not see any real action on this issue until after mid-year and so we cannot know how this particular regulation may or may not affect managers for a few months.

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Cole-Frieman & Mallon LLP provides legal advice to the hedge fund industry.  Bart Mallon can be reached directly at 415-868-5345.

SALT Conference 2013

Today the SALT conference starts in Las Vegas.  Continuing through the end of the week, the hedge fund industry will be descending upon the Bellagio for scheduled speakers, general information sessions and, of course, networking.  This year featured speakers include Nicolas Sarkozy, John Paulson and Coach K; other speakers include major players in the industry including my friend and law school classmate Omeed Malik who is head of the Emerging Manager Program at Bank of America Merrill Lynch.

For more information on the conference, see their website here.

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Cole-Frieman & Mallon LLP provides legal services to the investment management industry.  Bart Mallon can be reached directly at 415-868-5345.

Outsourced Compliance Company – Sansome Strategies LLC

Clients, Friends and Readers:

We are pleased to announce the launch of Sansome Strategies LLC, a high-touch outsourced compliance company.  Sansome Strategies will focus on RIAs and hedge fund managers as well as those firms operating in the commodities/futures and derivatives spaces.

As we all know, increased regulatory oversight, through both the passage of laws and the promulgation of new regulations, have changed (and will continue to change) the operating landscape for investment managers.  This is no more true than in the derivatives space where managers have now found themselves subject to CFTC oversight.  Combined with the Dodd-Frank mandate requiring hedge fund and private equity fund managers to register as investment advisers, the demand for outsourced compliance consulting services has dramatically increased.

Sansome Strategies enters the consulting space at this important time and aims to provide both large and small managers with competent and practical consulting advice.

The press release announcing the launch is found below.  For more information, please see the Sansome Strategies website.

Please also visit the Sansome Strategies blog, ComplianceFocus.

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Sansome Strategies LLC Introduced as New Compliance Consulting Firm with Commodities Focus

San Francisco-Based Firm Specializes in Outsourced CCO Services

SAN FRANCISCO, CA – May 2, 2013 – Announced today is the launch of Sansome Strategies LLC, a compliance consulting firm specializing in high-touch, outsourced compliance services for firms in the investment management industry. Aiding hedge fund managers, commodity pool operators and CTAs, private equity firms, futures managers, and other investment managers, Sansome Strategies offers expertise in streamlining regulatory processes and tailoring compliance outsourcing arrangements to a business’ specific needs.

Sansome Strategies’ head of compliance operations is Jennifer Dickinson, who has extensive experience with private fund compliance, both with respect to investment adviser and futures regulation. Prior to joining Sansome Strategies, Dickinson was a Senior Compliance Consultant at Gordian Compliance Solutions, LLC. Dickinson has been a Chief Compliance Officer at several large investment managers, and worked at the law firms of Cole-Frieman & Mallon LLP and Pillsbury Winthrop Shaw Pittman LLP. “Sansome Strategies will be a perfect fit for those firms seeking one-off compliance solutions, as well as firms that need an institutional quality compliance consultant,” Dickinson said. Ghufran Rizvi, COO of Standard Pacific Capital, LLC in San Francisco agrees, “I have known Ms. Dickinson for many years. She is a great business partner and Sansome Strategies will be a valuable addition to the compliance consulting space.”

Sansome Strategies’ expertise with futures managers and commodity pool operators differentiates the firm in a crowded field and is unique in the compliance consulting industry. The firm is backed by Karl Cole-Frieman and Bart Mallon, partners and founders of Cole-Frieman & Mallon LLP, which has one of the largest private fund practices in California. “There is significant and increasing demand for a compliance firm that understands both registered investment advisers and CFTC registered firms,” according to Karl Cole-Frieman. “Changes in the CFTC’s registration and exemption requirements have forced more managers into registration,” Bart Mallon notes, “and we have not seen the existing compliance companies prepared to address this demand.”

With Sansome Strategies, clients can pick and choose from an array of options, including a completely or partially outsourced compliance program, or opt for advisory, educational, or training services only. Sansome Strategies collaborates with business management and staff to structure, implement, and maintain their compliance program. Sansome Strategies features a client-centric business model, putting a heavy focus on customized services and collaboration.

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About Sansome Strategies

Headquartered in San Francisco and with a nation-wide scope of services, Sansome Strategies is a compliance consulting firm specializing in high-touch, outsourced compliance services for businesses in the investment management industry. Serving investment advisers, futures managers, hedge funds, broker-dealers, private equity firms and businesses ranging from entrepreneurial start-ups to multi-billion dollar international institutions, Sansome Strategies prides itself on tailoring compliance management solutions to the unique needs of each client. Comprised of securities industry professionals with years of experience in the financial and regulatory industries, Sansome Strategies’ mission is to simplify the compliance process, minimize risk, and lower costs, with the core goal of helping clients focus on building and enhancing their business. The firm also publishes ComplianceFocus a compliance blog designed to be a practical and accessible resource to the investment management community. For more information please visit Sansome Strategies at: http://sansomestrategies.com.

For more information, please contact:

Jennifer Dickinson
Sansome Strategies LLC
415-762-8753

ERISA 408(b)(2) Disclosure Requirements

Disclosures Required From Service Providers to Certain Plans

On February 3, 2012, the Department of Labor (“DOL”) issued the long awaited final regulation requiring certain pension plan service providers to disclose information ab

out their compensation and potential conflicts of interest (the “Final Regulation”). The Final Regulation was established under Section 408(b)(2) of the Employee Retirement Income Security Act of 1974 (“ERISA”). While ERISA generally prohibits the furnishing of goods, services, or facilities between a plan and a party in interest to the plan, Section 408(b)(2) provides relief from such prohibited transactions. It allows service contracts or arrangements if they are reasonable, the services are necessary for the establishment or operation of the plan, and no more than reasonable is paid for the services. The Final Regulation became effective on July 1, 2012.

Covered Service Providers and Covered Plans

The Final Regulation applies to the following covered service providers (“CSPs”) who expect to receive at least $1,000 in compensation for services to a covered plan:

• ERISA fiduciaries providing services directly to a covered plan (including fund managers).

• Federal or state law registered investment advisers.

• Record-keepers or brokers who make designated investment alternatives to the covered plan.

• Providers of one or more of the following services to the covered plan who also receive indirect compensation in connection with such services: accounting, auditing, actuarial, banking, consulting, custodial, insurance, investment advisory, legal, recordkeeping, securities brokerage, third party administration, or valuation services.

The Final Regulation applies to ERISA-covered defined benefit and defined contribution plan such as pension plans and 401(k) plans.

Final Regulation Disclosure Requirements

Covered service providers must provide responsible ERISA fiduciaries with the information they need to:

• Evaluate the reasonableness of total direct and indirect compensation received by the CSP, its affiliates, and/or subcontractors;

• Ascertain potential conflicts of interest; and

• Fulfill reporting and disclosure requirements under Title I of ERISA.

The required information must be furnished in writing reasonably in advance of the date any service contract or arrangement is entered into. Such writing must describe the provided services and all compensation to be received. CSPs who disclose indirect compensation must describe the arrangements between the payer and CSP pursuant to which such compensation is paid, identifying the sources of such compensation and the services to which it relates. Furthermore, CSPs must disclose whether they are providing recordkeeping services and the compensation attributable to such services.

Conclusion for Fund Managers

Fund managers with ERISA clients will need to begin drafting and providing these disclosures to such clients. This will be another requirement for start up fund managers to consider when deciding whether to take on ERISA clients. While ultimately the disclosures are not extremely onerous, they do add another to-do to a manager’s list.

Please contact us if you have questions or if you would like help drafting the disclosure required under 408(b)(2).

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Bart Mallon is a partner with Cole-Frieman Mallon & Hunt LLP, an investment management law firm which provides legal services to the hedge fund industry. Bart can be reached directly at 415-868-5345.

 

JOBS Act Opportunities for Hedge Fund Managers

The JOBS Act has already sparked a number of interesting questions from hedge fund managers who want to begin more aggressive advertising campains under the new laws. We have generally been cautioning managers on starting any campaign until after the SEC has promulgated regulations. However, we do think that managers may want to start thinking about how they may implement a more robust marketing program as part of their overall capital raising plan. The article below, contributed by Meredith Jones and Joseph Pacello of Rothstein Kass, provides some insights into the opportunities available for fund managers post JOBS Act.

[HFLB Note: all links in the article below were not links in the original. The links in the article below are to other posts on this website and are not necessarily endorsed by the writers of the article.]

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JOBS Act Opens New Window of Opportunity for Hedge Fund Marketing

The Jumpstart Our Business Startups (JOBS) Act, signed into law by President Obama on April 5, offers hedge funds and other private investment vehicles more latitude for their marketing efforts. In this article, Meredith Jones and Joseph Pacello discuss some of the implications of the bill and issues that need to be on the agenda of savvy fund managers.

Since the launch of the first hedge funds in the 1940s, hedge funds have been subject to Securities and Exchange Commission (SEC) prohibitions on advertising and general solicitation. While “namebrand” funds with widespread name recognition and extensive investor relationships have generally not been impacted by these restrictions, the inability to solicit capital from accredited investors who were not previously known significantly curtailed the marketing and capital raising efforts of smaller funds. Over the last three years, in the wake of the global economic contraction of 2008, managers with less than $1 billion particularly chafed under these restrictions, as they chased scarce investors, often with fewer resources.

The JOBS Act potentially removes those prohibitions, pending formal rulemaking by the SEC, who will have final say on how the JOBS Act is implemented. Under the new rules, the SEC would eliminate the prohibition on general solicitation as it relates to hedge funds, provided that the only purchasers are accredited investors. As a result, accredited investors will no longer have to be previously known to the fund. In addition, the Act theoretically removes the prohibition on general advertising, giving funds greater opportunity to and options for communication with potential investors.

While managers with more than $1 billion under management appear to be taking the rule change in stride, for funds with less than $1 billion under management, this new freedom to communicate with investors presents a wealth of potential new capital raising avenues. Fully leveraging this opportunity, however, will require funds to become more sophisticated and strategic in their marketing efforts. Those that fail to do so risk being alsorans in what is sure to be a more competitive period ahead.

Frankly, the previous regulations made “hedge fund marketing” almost a contradiction in terms. Much of the capital raising success of a fund was predicated on the fund’s existing relationships, or their ability to develop new contacts through limited resources, such as hedge fund databases, conferences and networking events. While relationships—not to mention performance—will always be important, the JOBS Act should result in a greater emphasis on marketing strategy and execution in the capital-raising process.

The fact that all funds will be able to solicit all accredited investors means that more investors will be hearing from more funds. The increased volume of conversations means that funds will have to “rise above the noise” to succeed in capital raising. Firms that plan and communicate effectively will therefore have a strategic advantage over those who do not.

The implementation of changes to the existing solicitation and advertising restrictions will not occur before early July, the deadline by which the SEC must complete rulemaking for this section of the JOBS Act. To be clear, we have yet to see how the SEC will interpret this change. For example, fund-sponsored mailings or events could be permitted, but not without extensive records of investor qualification documents being collected in advance. Press releases could be more common, but there could be limitations on what can be discussed. As a result, in this interim period it is probably wise not to be overly aggressive with new marketing avenues or advertisements. However, this doesn’t mean that funds should sit back and wait for the SEC’s final rule to begin preparations.

Because the capital raising environment was already becoming more competitive, particularly at the smaller and emerging ends of the alternative investment spectrum, funds should use the next 90 days to carefully review the quality of their marketing materials. In particular, funds should examine their marketing through the eyes of a potential investor and ask:

Does the fund know its competition and can it differentiate itself with a clearly defined value proposition? This is particularly important if the fund operates in a highly saturated area, such as long-short equity, macro, futures trading and private equity.

Are the fund’s marketing materials clear and concise? It is a common mistake to assume length equals conviction. Indeed, most investors offer approximately one hour for an initial meeting and length can spell repetition of some facts, while having to omit others due to time constraints. A clearly defined value proposition often takes fewer words, not more.

Is there a well defined “story?” Although tempting, particularly for funds where the manager pulls double-duty as a marketer, it is not always advisable to assume the strategy and opportunity speaks for itself. It is vital that the documents and pitch communicate not just what you do, but who you are as a manager and a firm, including how you view risk and run a business.

Do the marketing materials have a sophisticated look and feel? While the content of the materials does the heavy lifting, their look and feel set the tone. Does your firm appear to be institutional? Are the slides dense or wellpaced? Do you have a consistent brand? Aim for crisp and clean layouts that help the reader through the material.

How strong is the fund’s marketing capability? Few hedge funds have the luxury of a full-time dedicated marketing (as opposed to fund-raising) professional on staff. Firms should consider bringing in an experienced outside consultant who can make high-value, targeted improvements.

In this evaluation process, it is also important to recognize that things like pitch books are more than mere props—they structure the conversation a fund has with its potential investors. A poor pitch book means that important points are likely to be skipped over (or blunted from repetition); a good pitch book amplifies the effectiveness of the presenters.

When revising communications materials, remember that anti-fraud regulations remain in place; a fund needs to be scrupulous in its representations and consistent in its themes. For some in the marketing world, “gilding the lily” is a common practice, however in the investment arena, it is one to be avoided. Explanatory notes, review by the firm’s legal counsel and truth in advertising will still be required under the new rules. Also note that as more materials are generated and sent to a wider audience, the ability to track communication will become more important as well. If the SEC audits your firm post JOBS Act, you will need to be able to present full documentation of your marketing efforts.

Regardless of the final interpretation of the JOBS Act by the SEC, funds also need to develop a marketing plan to guide their outreach to potential investors. Again, the competition for assets has gotten more, not less, fierce over the last three years. Putting a strategic marketing plan in place will curtail the impulse to cast the widest possible net and pursue every available audience. Because most funds have limited marketing resources, it is essential to allocate those resources strategically. This requires looking at three factors:

1. Capacity: Marketing efforts need to be scaled to how much capital needs to be raised. A stellar marketing campaign that results in turning away a significant number of investors represents wasted resources. A fund that is making steady progress toward being fully subscribed may in fact be able to meet its goals by continuing its current network-based outreach.

2. Manpower: Pursuing investors takes time, and for many firms, that means time away from other tasks, including investment management. Funds need to determine, given their capacity, which audiences are most likely to result in the largest return on their marketing investment and prioritize accordingly.

3. Money: A firm’s marketing spend needs to be allocated so that it is directed toward strategically valuable efforts and does not cannibalize other functions.

Certainly, the potential benefit of the JOBS Act is that funds, particularly those with less than $1 billion under management, will be able to leverage their capital raising efforts. Blogs, websites, email campaigns, advertisements, press releases and other marketing activities may allow funds to extend their reach, effectively providing a type of “air cover” for their one-on-one capital raising efforts. However, any decisions to engage in these activities should be evaluated in light of the restrictions above.

In conjunction with a review of marketing, funds should also examine their investor relations bandwidth. For 3(c)7 funds directed toward qualified purchasers, the JOBS Act raises the maximum number of holders of record from 499 to 1,999. This means that funds that are near their investor maximum could potentially make the decision to allow more investors (capacity of the strategy permitting), or consolidate existing 3(c)7 funds. It is unlikely that these changes will have a tremendous impact on all but the largest fund complexes at the present time. However, if a manager does decide to increase his investor headcount, then effective and proactive investor relations will undoubtedly become a greater concern, which we will address in a future article.

Rothstein Kass will be monitoring the SEC rulemaking in connection with the JOBS Act and its impact on private funds.

By Meredith Jones, Director and Joseph A. Pacello, CPA, JD, Principal

For more information on this article and for services offered by Rothstein Kass, please contact Meredith Jones, Director at 972.581.7066 or via e-mail at [email protected]

Meredith Jones, Director

Meredith Jones is a director at Rothstein Kass responsible for generating research and content on the alternative investment industry by and on behalf of the firm. She also provides business advisory services to the firm’s clients. Meredith has more than 14 years of experience in the alternative investment industry, with extensive expertise in research, writing, consulting, marketing, business development, due diligence, index construction and asset allocation. Her research has been published in a number of books and journals and in the international press.

Prior to joining Rothstein Kass, Meredith was a director in the Barclays Capital Inc. Strategic Consulting Group, where she was responsible for producing thought leadership content on a variety of manager and investor focused topics, as well as leading consulting projects for BarCap clients. She previously served as a managing director at PerTrac Financial Solutions (PFS), a leading provider of investment analytics. At PFS, Meredith was responsible for research, marketing, investment data, and was a fixture on the international hedge fund conference circuit.

Meredith began her career in alternative investments at Van Hedge Fund Advisors International in 1998, where she became the senior vice president and director of research. Meredith led the team responsible for hedge fund due diligence, manager selection, portfolio construction, hedge fund data, index creation and industry research while at VAN.

Over the past 14 years, Meredith has presented her original research and insights to industry participants around the world and has had her findings published in books, journals, industry publications and major media outlets, including The Economist, The Wall Street Journal, The Journal of Investing, Alternative Investment Quarterly and the Financial Times.

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Cole-Frieman Mallon & Hunt LLP is a law firm to the investment management industry and runs the Hedge Fund Law Blog. Bart Mallon can be reached directly at 415-868-5345.