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Digital Assets and Energy

Our law firm, Cole-Frieman & Mallon, has been a leader in helping fund managers form private investment funds focused on the digital asset space. We’ve seen the space mature from 2014 when programs were focused on long tokens, to later investment strategies that included long/short, jurisdictional and exchange arbitrage, VC-focused or hybrid, to the more recent focus on staking, yield-farming, long NFTs, etc. What these changing strategies show are two things: (1) the crypto space will continue to incorporate traditional investment management strategies as it iterates to find the most compelling investment scenarios and (2) the future of finance will also include crypto-centric strategies that cannot be achieved through traditional markets. The crypto space is dynamic and advances without the constraints of traditional markets. However, the crypto space, like the rest of the world we live in, requires energy to move forward. The time is now for the crypto industry to focus on how the next generation of blockchains (and infrastructure to support those blockchains) will coexist with a society that is starved for energy-efficient industry. This focus on energy consumption is vital and will have numerous consequences for the space moving forward. And because the crypto industry is so dynamic, led by visionary actors, we expect to see great movements in how the industry thinks about and uses energy in the future.

Bart Mallon


Overview of Energy Issues Related to Crypto Mining

By Emily Irigoyen & Bart Mallon

In this post, we will explore energy consumption and its relation to cryptocurrency as well as discuss the factors that will shape this relationship moving forward. This article also provides insight into the different influences of various stakeholders in the digital asset space and identifies other important aspects that will guide the development of the industry going forward.

Proof of Work (PoW) versus Proof of Stake (PoS)

Depending on which protocol for validating transactions a particular blockchain uses, the energy intensity of its mining will vary. This is because cryptocurrencies that run on Proof of Work (PoW), such a Bitcoin, require substantial amounts of computer power and energy to mine versus Proof of Stake (PoS) which is more energy efficient. While these aren’t the only protocols that exist in the crypto space, these are the most well-known, and highlight a stark difference in a cryptocurrency’s expected energy consumption.

What are Miners Doing?

There are various groups who oppose crypto adoption because of the perceived negative environmental impacts of crypto mining. While it is true the mining process can be energy-intensive, the practical value of crypto and the diverse ways that mining facilities have been incorporating green practices into their business models, have transformed environmental concerns into a nuanced set of issues that deserve exploration.

When discussing mining’s environmental impact, the notion of high energy consumption and negative environmental externalities are often erroneously conflated. While some cryptocurrency mining operations use substantial amounts of energy, such as Bitcoin, the nature of the energy source used will ultimately determine a miner’s environmental impact. As evidenced by our own interactions with crypto miners, many operations are currently or, in the process of, implementing more sustainable fuel sources. By using renewable energy sources to power their operations, these miners are minimizing their negative environmental impact in comparison to operations based solely on fossil fuels.

Furthermore, while mining facilities abandon China, the hashrate in the United States continues to increase steadily. This phenomenon reflects a recent trend in mining facilities’ international expansion, with a particular focus on US areas that boast cheap renewable energy and pro-crypto politicians, such as Texas. The former grants them a huge reputation boost, as facilities based in renewable energy sources cause significantly less environmental harm than those based in fossil fuels, and the latter allows facility owners to stay secure in the knowledge that state and county regulations will remain lax for the foreseeable future.

Some mining facilities have also taken extra steps to engage in grid balancing, a process by which the facility — in conjunction with their local utility company — can ensure the stability of the power grid. Grid balancing ensures electricity supply meets electricity demand. Large mining facilities can take part in this process by shutting down their operations for small periods of time when the grid is experiencing a surge of demand. This prevents blackouts and can bolster the push for renewable energy, as more balanced grids mean fewer that must rely on increased fossil fuel consumption to respond to demand peaks. Essentially, when large electricity consumers such as crypto miners change their usage as needed, renewable energy can handle more of the grid’s electricity needs.

Is High Energy Use for Mining Any Less Valid Than Other Energy-Intensive Operations?

Almost all business activity consumes energy. In the same way commercial landlords power their warehouses and offices, so too crypto companies use energy to power their mining centers. This perspective contends crypto mining’s energy use is no more inherently wasteful or less legitimate than that of any other business operation. The flaw in this argument is the scale to which crypto mining has grown and will continue to grow, along with its extremely high energy consumption in comparison to other businesses. According to the University of Cambridge Bitcoin Electricity Consumption Index, the global bitcoin network annually consumes approximately 80 terawatt-hours of electricity, which is roughly equal to the annual output of 23 coal-fired power plants. While the scale of this electricity consumption cannot be ignored, it must be understood in the context of crypto mining’s growing reliance and impact on availability of renewables. Cryptocurrency mining could be a driver encouraging adoption of renewable sources until they become the predominant source of electricity generation.

ESG, the SEC and (Potential Future) Institutional Mandates

It’s clear that the demand for ESG investments is increasing and is currently on the forefront of the SEC’s agenda. In response, more institutional investors are committing to ESG investments, which in turn, has or will encourage cryptocurrency miners to follow in this direction.

This desire to offer more sustainable cryptocurrency has manifested in large private sector initiatives that focus on decarbonizing the cryptocurrency industry, such as the Crypto Climate Accord. These forms of risk management have shaped the crypto mining space environmentally and allow us to better predict how crypto mining will evolve in the future. Naturally, as the demand for ESG cryptocurrency increases — as well as the desire to get in front of regulatory uncertainty grows — more mining facilities will green their operations.

Currently, the main barrier that miners face is ensuring that both regulators and the public at large take note of their ESG initiatives and sustainability protocols. Since environmental critiques of the crypto mining industry have been incorporated so heavily into the national narrative surrounding cryptocurrency, many mining and general crypto users have been working together to publicize information that highlights their evolving green initiatives and the many benefits that crypto mining can provide. This has taken the form of both sustainable initiatives and intense lobbying, which brings us to our next point.

Issues That Will Influence This Discussion Going Forward

While the future of the crypto industry will be influenced by everything we discussed above. We also predict the following will increasingly affect the development of the industry in the coming years:

  • Lobbying the Government for Less Regulation & More Renewable Energy. As shown by the recent stalling of the 2021 Infrastructure Bill because of the crypto tax provision, lobbying pressure in the cryptocurrency community in unified and persistent. In the future, we can expect a larger lobbying contingent, and we can expect Representatives and Senators fighting for interests that affect their states. This is especially true in states like Texas where politicians are particularly friendly to crypto miners and business, boasting both lax state regulations and large renewable energy capacity to attract miners fleeing from Chinese regulatory scrutiny. Despite potential movement on the federal level, some states are going to fight hard to ensure bitcoin mining continues to flourish in their states so that they can continue to reap the current (and future) tax revenue.

    Lobbying for more and cheaper renewable energy in the US will also benefit the crypto market and has already started to manifest itself in the new Infrastructure Bill. The new bill proposes a $73 billion government investment to rebuild the electric grid, build thousands of miles of new power lines, and expand renewable energy. As the US naturally moves to a cleaner power grid, it’s expected crypto miners will gradually follow.
  • International Crackdowns Affecting Bitcoin Value and Mining Hubs. Previously a major hub for bitcoin mining, China’s latest crackdowns on bitcoin mining and cryptocurrency exchanges have created space for other countries to become bigger players in the bitcoin arena. This explains why countries like the US have had an increasing number of bitcoin miners move their operations in their jurisdiction. While China justifies their harsher regulation in the name of their 2060 carbon neutrality plans, their regulatory scrutiny has also pushed many bitcoin miners towards countries with less renewable energy capacity, such as neighboring Kazakhstan, a former Soviet republic that is primarily dependent on coal and gas. This demonstrates how China’s actions may be hampering Bitcoin’s transition to cleaner energy sources, thus creating a larger carbon emissions problem. While some former Chinese miners that are now based elsewhere internationally are implementing greener operations in their new locations, it’s unclear whether these miners are outnumbered by miners who were forced out of China into countries with even less access to renewables. Also, it seems that China’s actions weren’t solely based on their national environmental plan, but also aimed to weaken Bitcoin in general so that the digital Yuan, their national digital currency, can run without competition. This greenwashing tactic has worked — China’s actions have brought Bitcoin’s value down substantially while also allowing them to claim their regulations are in response to their environmental concerns. This instance further demonstrates the impact stringent regulations in key mining countries can have on the crypto markets.
  • Elon Musk’s Comments on Cryptocurrency. On July 21, at the B-Word conference hosted by the Crypto Council for Innovation, Musk claimed that Tesla will once again receive Bitcoin as tender once it is clear Bitcoin’s mining operations and exchange are powered by 50% or more of renewable energy and is steadily growing its renewable energy sources. This announcement correlated to a rise in the price of bitcoin and comes after Musk’s original statement in May on Twitter that said Tesla would suspend vehicle purchases using Bitcoin citing environmental concerns. This statement dropped the value of bitcoin within minutes and demonstrates the power Elon Musk and the Tesla brand have on the perceived worth of cryptocurrency. If a tweet by Elon Musk can cause immediate volatility to crypto prices, investors and crypto advocates alike should take note of his future remarks.
  • Cryptocurrencies Moving Towards More Energy-Efficient Protocols. As Ethereum transitions from the consensus mechanism of Proof of Work (PoW) to Proof of Stake (PoS), it is expected that more digital assets will move towards “greener” protocols. Ethereum has already noted the benefits of their new protocol, such as its increased energy-efficiency, which signals to us that other protocol developers in the crypto space will also be mindful of energy consumption when creating their consensus mechanisms.


Because energy is such a broad topic in the crypto space, and encompasses so many parts, it is difficult to neatly address all of the factors that shape energy’s role in the crypto movement. Obviously, the people leading crypto are part of a generation that is focused on the environmental impact of their behaviors. This form of self-imposed environmental regulation, combined with the external pressure from other stakeholders concerned about crypto’s energy use, will not only affect the value and sustainability of cryptocurrency in the long term, but also potentially inform broader discussions of renewable energy capacity generally.


Emily Irigoyen is an EDICT intern at Cole-Frieman & Mallon LLP. She is currently a senior at Vanderbilt University majoring in environmental sociology and will be attending Harvard Law School after graduation.

Bart Mallon is a founding partner of Cole-Frieman & Mallon LLP. Cole-Frieman & Mallon has been instrumental in structuring the launches of some of the first digital currency-focused hedge funds. For more information on this topic, please contact Mr. Mallon directly at 415-868-5345.

Cole-Frieman & Mallon 2021 Half Year Update

July 13, 2021

Clients, Friends, Associates:

We hope that this message finds you well and that you are enjoying the first months of summer. As we move into the third quarter, we would like to provide you with a brief overview of some items that we hope will help you stay on top of the business and regulatory landscape in the coming months. We are also delighted to report our firm and Co-Managing Partner, Karl Cole-Frieman, were highlighted as leading crypto and blockchain lawyers by Business Insider. For additional firm updates, please follow us on LinkedIn


SEC Matters

SEC Revises Qualified Client Threshold. The SEC recently published an order approving adjustments to the tests which define a “Qualified Client” under the Investment Advisers Act of 1940, as amended (the “Advisers Act”). Specifically, the “net worth” threshold has been increased from $2,100,000 to $2,200,000 and the dollar amount for the “assets-under-management” test has been raised from $1,000,000 to $1,100,000. The Qualified Client threshold is critically important for investment advisers because in nearly all jurisdictions, including for SEC registered investment advisers, performance fees and incentive allocations can only be charged to investors who are Qualified Clients. The new definitions become effective August 16, 2021 (the “Effective Date”), but will not be applied retroactively to contractual relationships existing as of such date. Additionally, an investor who satisfied the previous Qualified Client test and who subscribed for interests in a private fund prior to the Effective Date will remain subject to any applicable performance fees, and may make additional subscriptions (subject to performance fees) without needing to satisfy the new threshold amounts.

All investment advisers should promptly update their subscription documents to ensure that new investors who agree to make investments on or after the Effective Date have provided accurate representations regarding their Qualified Client status.

SEC adopts Marketing Rule (replaces Advertising Rule and Cash Solicitation Rule). On May 4, 2021, the SEC adopted new marketing rules for investment advisers. The new rules drastically overhaul and replace the prior cash solicitation and advertising rules applicable to investment advisers, their marketing materials, and their advertising practices to replace. SEC no-action letters pertaining to the prior cash solicitation rule will be nullified as the rule is being rescinded in practice. The most significant changes include the allowance of testimonials and endorsements, which under the prior rules were conditionally permitted to be used in advisers’ marketing materials. The new marketing rule now permits such use only if the adviser complies with specific disclosure, oversight, and disqualification provisions. Third-party ratings are now also permitted, though, just like testimonials and endorsements, they are subject to detailed disclosure and other presentation criteria.

The new marketing rule also overhauls how investment advisers can utilize social media. The SEC created concepts of “adoption” and “entanglement” with respect to posts on social media and, depending on whether an investment adviser has “adopted” a social media post or “entangled” itself in one, there are a series of rules applicable to each such post. More importantly, social media posts of persons associated with an investment adviser can also be viewed as the investment adviser’s communication or advertisement. Thus, investment advisers should adopt policies and procedures which distinguish their associated persons’ personal social media posts from those of the investment adviser. 

Specific rules and guidance now apply to various types of performance advertising, including gross, net, hypothetical, related, and extractive performance. Many of these rules now codify prior SEC no-action letter guidance on these topics. 

Investment advisers have some room to breathe since the compliance period for these new marketing rules begins on November 4, 2022.

SEC Brings Action for Defrauding Investors in Scheme Involving Pre-IPO Shares. On April 27, 2021, the SEC charged a former broker barred by FINRA with fraudulently raising funds. The complaint alleges that the defendant solicited investors by claiming to purchase shares of notable “unicorn” companies prior to their initial public offerings. However, the defendant failed to invest the funds and instead stole the money, using it to pay family members and purchase a Maserati. The defendant is charged with violating the antifraud provisions of Section 10(b) of the Securities and Exchange of 1934 and Rule 10b-5 thereunder and Section 17(a) of the Securities Act of 1933. 

SEC Announces Partially Settled Charges After Investment Adviser Fails to Report Bad Investments. On April 15, 2021, the SEC filed a complaint against the co-founder and COO of an investment adviser for violating the anti-fraud provisions of the Securities Exchange Act of 1934 and the Securities Act of 1933. The SEC alleges the defendant defrauded hedge fund clients by creating fake “performing” loans to replace defaulted loans in order to hide losses. The SEC further alleges that the defendant created liquidity or met redemption requests by selling overvalued loans to new investors to pay off earlier investors. Collectively, the series of fraudulent acts hid tens of millions of losses. The SEC has already obtained final judgement against the investment adviser itself, requiring it to pay in excess of $35 million in prejudgement interest and disgorgement.

SEC Brings Action for Failure to Follow Stated Investment Criteria. In a recent enforcement action, the SEC has alleged that a Texas-based registered investment advisor (“RIA”) defrauded investors by failing to follow stated investment criteria. The complaint alleges that the principal along with its investment adviser representative (“IAR”) targeted older and unsophisticated investors with promises of high returns from secure investments in “proven” companies which met the firm’s stated investment criteria. However, the complaint goes on to allege that the firm only invested in high-risk and fraudulent companies which were affiliated with and owned by the firm’s principal and/or his older brother. The SEC alleges that this Texas-based RIA made materially false and misleading statements to investors about expected financial returns and the financial health of these companies. Moreover, the principal and his older brother allegedly falsified the financial documents of their companies to inflate their assets, misused funds for their own benefit, failed to make adequate disclosures of the conflicts of interests, failed to comply with rules governing the custody of client assets, and overall violated federal securities laws, including antifraud provisions. The SEC is seeking permanent injunctive relief, disgorgement of ill-gotten gains plus prejudgement interest, civil penalties, and any equitable and ancillary relief deemed necessary by the court.

SEC Obtains Asset Freeze After Uncovering Cherry-picking Scheme. On June 17, 2021, the SEC announced that it obtained an asset freeze and filed fraud charges in connection to a cherry-picking scheme where a Miami-based investment professional and two investment firms allegedly funneled trading profits to preferred accounts. The complaint alleges defendants engaged in a long-running fraudulent trade allocation scheme. Approximately $4.6 million in profitable trades were allocated to accounts held by relatives of the defendants while several other investment advisory clients bore first day losses totaling more than $5.5 million. This investigation originated in the Market Abuse Unit’s Analysis and Detection Center, which uses data analysis to detect suspicious activity such as impossibly successful trading. The SEC is currently seeking permanent injunctions, disgorgement, prejudgment interest, and civil penalties. It also intends to recover any unlawful gains and prejudgment interest from the preferred accounts.


Digital Asset Matters

Update on BitMEX Lawsuit. On October 1, 2020, the Department of Justice filed a criminal complaint against specific individuals associated with BitMex for violating and conspiring to violate the Bank Secrecy Act. The CFTC also filed a civil complaint against BitMEX, alleging failure to register with the CFTC and violation of various laws and regulations under the Commodity Exchange Act. Both actions are pending in the U.S. District Court for the Southern District of New York. On February 10, 2021, the Department of Justice intervened in the CFTC case and sought a stay of discovery pending the criminal case’s resolution. On February 11, the CFTC submitted a letter not to oppose the DOJ’s stay. On March 24, United States District Judge Mary Kay Vyskocil granted the motion to permit the DOJ to intervene in the CFTC case for the purpose of seeking a stay of discovery, further noting that the DOJ is permitted to file a motion to stay discovery after the defendants have responded to the complaint. Both cases remain pending. These two lawsuits signal that the DOJ and the CFTC has and will continue to monitor the digital asset market. 

SEC Files Action Against Ripple for Unregistered Securities Offering. In December 2020, the SEC filed an action against Ripple Labs Inc. (“Ripple”) and two of its executives in the U.S. District Court for the Southern District of New York, alleging that they raised over $1.3 billion through an unregistered, ongoing digital asset securities offering. The SEC’s case rests on the proposition that XRP is a security because investors who purchased XRP anticipated that profits would be dependent upon Ripple’s efforts to manage and develop the market for XRP. The case remains pending. The outcome of this lawsuit, although uncertain at this point, may have significant impact on the future regulation on cryptocurrencies and blockchain technologies.

South Korea to Introduce 20% Tax on Crypto Trading Profits. South Korea will implement a 20% capital gains tax on Bitcoin (BTC) and cryptocurrency profits starting January 1, 2022. The tax is expected to be triggered when profits exceed 2.5 million Won, with gain made up to this point being tax-exempt.

Yield Farming Strategies. As decentralized finance (“DeFi”) applications continue to develop, the interest in yield farming has grown exponentially. At a high level, the goal of yield farming is to maximize returns by leveraging various DeFi protocols, and this can be done in a few different ways. To employ a yield farming strategy, a liquidity provider essentially locks its digital assets in a liquidity pool (where users can lend, borrow, or exchange tokens), thus providing liquidity to that pool. In return, the liquidity provider receives an annual percentage return. Liquidity mining, a type of yield farming, provides liquidity providers with reward tokens on top of that annual return. Liquidity providers can then deposit reward tokens into other liquidity pools to earn more rewards and repeat this process countless times. To increase the potential return of an investment, yield farmers can also deposit tokens as collateral to a liquidity pool, then use the borrowed tokens as further collateral to then borrow more tokens, and so on. It is important to note that if a position becomes undercollateralized, there is a risk that the DeFi protocol may liquidate the collateral which could result in a total loss to the liquidity provider. While the potential of impressive returns is enticing, those interested in yield farming strategies should consider the many risks inherent in such strategies, including impermanent loss, price slippage, smart contract code bugs leading to hacks or fraud, “rug pulling” scams, as well as the risk of under collateralization, which can incidentally result from price movements of the borrowed token.

El Salvador Adopts Bitcoin Legal Tender. On June 8, 2021, the Salvadorian Congress approved new legislation, making it the first country to adopt Bitcoin as legal tender. “The purpose of this law is to regulate Bitcoin as unrestricted legal tender with liberating power, unlimited in any transaction, and to any title that public or private natural or legal person require carrying out,” the law reads. Under the new law, prices can be displayed in Bitcoin, taxes can be paid in Bitcoin, and transactions conducted using the digital currency will not be subject to a capital gains tax. The exchange rate with the U.S. Dollar (El Salvador’s current official currency) will be established by the market. The law also adds that the Salvadorian government will implement trainings and other mechanisms to ensure that its citizens can access Bitcoin transactions.

DeFi “Raises Challenges” for Investors, Regulators, SEC’s Gensler Says. In a written testimony before the House Appropriations Committee, SEC Chairman Gary Gensler discussed the challenges posed by decentralized finance. Examples of the challenges of DeFi given include market volatility and novel product offerings. Gensler’s concerns surrounding DeFi did not come as a surprise. In January, SEC Commissioner Hester Peirce offered the following quote: “It’s going to be challenging to us because most of the way we regulate is through intermediaries and when you really build something that’s decentralized, there’s no intermediary…. It’s great for resilience of a system but it’s much harder for us when we’re trying to go in and regulate to figure out how to do that”. Gensler has also previously suggested establishing a dedicated market regulator for cryptocurrency in order to provide protection against market manipulation and fraud. As DeFi continues to grow, it will be interesting to watch regulator’s approach to DeFi as it may have a large impact on the emerging space. 

SEC Petitioned on NFTs as NFT Platform is Sued in Class Action. On April 12, 2021, a broker-dealer registered with the SEC and FINRA issued a petition to the SEC, calling for a concept release of regulations for nonfungible tokens (NFTs) and rules addressing when NFTs are considered securities. The petitioner notes that the existing definition of a security does not explicitly include NFTs, but NFTs that promise a “return on investment from the efforts of others”, could be deemed a security under the Howey test. The petitioner further clarifies that if an NFT “relates to an existing asset and is marketed as a collectible with a public assurance of authenticity on the blockchain, it should not be deemed a security.” To date, the SEC has not issued interpretive guidance on NFTs and has not initiated any enforcement actions against an NFT creator or NFT trading platform.

This petition arrives as Dapper Labs, the creator of the popular NFT marketplace NBA Top Shot, faces a class action lawsuit. The plaintiffs assert that NBA Top Shot’s “moments”, NFTs sold as collectable video highlights, are securities. These allegations center on the argument that moments increase in value as NBA Top Shot rises in popularity, therefore satisfying the Howey Test. The complaint also alleges that Dapper Labs has controlled the marketplace in way that prevents users from “cashing out” their purchases, keeping their value artificially high. It will be interesting to see how these issues are resolved by the SEC and the courts, as if NFTs are determined to be a security either by the SEC or the courts, NFT marketplaces and issuers may be forced to register with the SEC.


CFTC Matters

Changes for Form CPO-PQR. Beginning with the March 31, 2021 reporting date, a revised and streamlined Form CPO-PQR will be used based on recent CFTC amendments. The revised Form CPO-PQR has been reduced to one schedule (Schedule A), and all reporting commodity pool operators (“CPOs”) will file the revised Form CPO-PQR every quarter, regardless of size. Technical updates have also been made, which make the form easier to fill out. 

Default Judgment Entered Against Operator of Cryptocurrency Pool. On March 29, 2021, the U.S. District Court for the District of Nevada entered a default judgement against an Australian national and his Nevada corporation in connection with a cryptocurrency fraud and misappropriation scheme. The court concluded that the defendants made false claims about the individual’s trading acumen and baselessly guaranteed high rates of return in soliciting investors into a pool operated by the Nevada corporation. The pool engaged in off-exchange binary options trading on forex and cryptocurrency pairs; however, the defendants also stole participants’ funds and comingled assets in the individual’s personal cryptocurrency wallet. Additionally, the defendants effected a Ponzi scheme by paying investor redemptions with funds from other investors. Although the default judgment orders the defendants to pay restitution, disgorgement of profits and penalties totaling more than $32 million, the CFTC cautions investors that such order does not guarantee participants a full recovery.

CFTC Establishes Climate Risk Unit. In March, Acting CFTC Chairman Rostin Behnam announced the establishment of the Climate Risk Unit (“CRU”), which will assess the efficacy of derivatives products in addressing climate and weather-related risks in the financial system. Also, in an effort to reduce carbon emissions world-wide, the CRU will represent the CFTC in industry discussions in furtherance of this mission. The CRU also intends to, inter alia, facilitate dialogue regarding emerging climate risks, develop new products to help transition to a “net-zero” economy, support development of climate-related market risk data, and evaluate the utility of other tools (e.g., regulatory sandboxes) in accelerating such products and services.

NFA’s New Notice Requirements for CPOs Became Effective as of June 30, 2021. The NFA’s newly adopted Compliance Rule 2-50 requires CPOs to notify the NFA upon the occurrence of certain events such as a commodity pool’s ability to fulfill its obligations to investors or a potential unplanned liquidation of the pool. CPOs are now required to notify the NFA if they: (1) operate a pool that cannot meet a margin call, (2) operate a pool that cannot satisfy redemption requests in accordance with their subscription agreements, (3) operate a pool that has stopped redemptions unrelated to existing lockups or gates, and pre-planned cessation of operations or (4) receive notice from a swap counterparty that a pool operated by the CPO is in default. This rule applies to all pools operated by a CPO, including pools that meet the “de minimis” threshold pursuant to CFTC Regulation 4.13(a)(3). Generally, notice of a specified event must occur no later than 5:00 pm CT of the next business day; provided that, Interpretive Notice 9080 gives examples of when notice is not required (e.g., if a CPO reasonably expects to meet the margin call within the time prescribed by its FCM).


Other Matters

Corporate Transparency Act Requires Disclosure of Ownership Information of Certain Entities. Overriding President Trump’s veto, Congress enacted the National Defense Authorization Act for Fiscal Year 2021 on January 1, 2021, which, among other things, includes the Corporate Transparency Act (the “CT Act”) requiring certain ‘reporting companies’ to report their beneficial ownership information to the Financial Crimes Enforcement Network (“FinCEN”). Today, the CT Act excludes from the definition of ‘reporting companies’ registered investment advisers, venture capital fund advisers that file Form ADV, and private investment funds advised by investment advisers and identified by name on such advisers Form ADV. However, investment advisers relying on the private fund exemption are not exempt from the CT Act and, absent changes in the regulations adopted by the U.S. Treasury, will be required to report their beneficial ownership information to FinCEN. The CT Act goes into effect on the date regulations are issued by the U.S. Treasury, which shall occur no later than January 1, 2022. FinCEN is currently soliciting public comment on questions about the new reporting requirements.

Executive Orders Prohibit the Purchase of Publicly Traded Communist Chinese Military Company Securities by U.S. Persons. President Trump signed Executive Order 13959 on November 12, 2020, and subsequently amended it with Executive Order 13974 on January 13, 2021, to prohibit the purchase of publicly traded Communist Chinese Military Company (“CCMC”) securities, including securities that are derivative of or designed to provide investment exposure to such CCMC securities. The orders prohibit the purchase by U.S. persons of any such securities beginning 60 days after an entity is designated as a CCMC, and require U.S. persons to divest from those securities within one year of such designation. Therefore, for the CCMCs initially designated on November 12, purchase of such securities was prohibited beginning January 11, 2021, and all U.S. persons must divest by November 11, 2021. While the Office of Foreign Asset Control has issued an FAQ clarifying the orders, neither the orders nor the FAQ provide clarity on whether U.S. persons must divest from foreign private funds that hold CCMC securities, and it remains to be seen if the new administration will seek to amend the order before divestment is required. A list of entities designated CCMCs as of June 16, 2021 can be found here.

New York Eliminates Pre-Offer Filing Requirements for Rule 506 Offerings under Regulation D. The New York Attorney General announced on December 1, 2020, an amendment to New York’s antiquated and controversial securities regulations applicable to offerings made under Rule 506 of Regulation D. The old rule required issuers to file a Form 99 prior to any sale or offering of such “covered securities” in the state. Beginning on December 2, 2020, the updated rule eliminated the Form 99 requirement and provided that notice filings shall be made within 15 days following the date of the first sale of applicable securities via the North American Association of Securities Administrators electronic filing depository system. The filing fee continues to be based on the offering amount and is unchanged from the fees required prior to the adoption of the new rule.  

Registration of New York IARs. Starting February 1, 2021, IARs who engage in business within or from New York and principals or supervisors of New York-state registered investment advisers must register with the New York Investor Protection Bureau (the “NYIPB”) by filing a Form U4 or updating an existing Form U4, and must also meet certain exam requirements. IARs with a place of business in New York that represent SEC-registered investment advisers that notice-file in New York must also register with the NYIPB. The new regulations grant IARs operating in New York prior to February 1, 2021, a grace period to submit their Form U4 until August 31, 2021, and such IARs may continue such service without an approval until December 2, 2021.

Employers can Inquire about the Vaccination Status of Employees. On May 28, 2021, the U.S. Equal Employment Opportunity Commission (“EEOC”) updated its guidelines on the COVID-19 vaccine and Americans with Disabilities Act (“ADA”) compliance. The guidelines reaffirmed the EEOC’s previous position that employers can ask their employees whether or not they have received the COVID-19 vaccine but added that any vaccination status documentation must be kept confidential and stored separately from the employee’s personnel file. It is recommended for employers to only ask for the bare minimum, such as a vaccination card or survey response, to prevent employees from providing additional medical information and implicating the ADA. Additionally, employers can “encourage” employee vaccinations by providing information on approved vaccines, addressing common questions and concerns, or by offering incentives to employees who receive the vaccine. As of the date of publication, there are no examples of states passing laws conflicting with EEOC guidance, but this may change as companies continue to return to the office.


Compliance Calendar

Please consult our Compliance Calendar for key dates as you plan your regulatory compliance timeline for the coming months and contact us with any questions for assistance with any of the above topics.

We wish you and yours a safe and healthy summer.

Sincerely, Karl Cole-Frieman, Bart Mallon, Lilly Palmer, David Rothschild, & Scott Kitchens


Cole-Frieman & Mallon LLP is one of the top investment management law firms in the United States, known for providing top-tier, innovative, and collaborative legal solutions for complex financial services matters. Headquartered in San Francisco, Cole-Frieman & Mallon LLP services both start-up investment managers and multi-billion-dollar firms. The Firm provides a full suite of legal services to the investment management community, including hedge fund, private equity fund, venture capital fund, mutual fund formation, adviser registration, counterparty documentation, SEC, CFTC, NFA and FINRA matters, seed deals, hedge fund due diligence, employment and compensation matters, and routine business matters. The Firm also publishes the prominent Hedge Fund Law Blog, which focuses on legal issues that impact the hedge fund community. For more information, please add us on LinkedIn and visit us at   

Cole-Frieman & Mallon 2020 End of Year Update

December 16, 2020

Clients, Friends, Associates:

As we prepare for a new year, we also reflect on an eventful, sometimes chaotic, 2020, dominated by the emergence of the novel coronavirus (“COVID-19”). The COVID-19 pandemic, the global response to it, and other worldwide events created a great deal of market volatility. Despite that volatility, we saw robust investment funds activity in the second-half of the year, particularly in the digital asset space.

Especially in these turbulent times, year-end administrative upkeep and planning for the next year are crucial, particularly for general counsels, Chief Compliance Officers (“CCOs”), and key operations personnel. As we head into 2021, we have put together this checklist and update to help managers stay on top of the business and regulatory landscape for the coming year.

This update includes the following:

  • Sexual Harassment Training Required under California Law
  • Annual Compliance & Other Items
  • Annual Fund Matters
  • Annual Management Company Matters
  • Regulatory & Other Items from 2020
  • Items from 2021 Compliance Calendar


CFM & Aspect January Compliance Update Event

We would like to invite you to our next compliance-focused event. Last year, Cole-Frieman & Mallon hosted a well attended presentation and networking event with regulatory compliance firm Aspect Advisors. The event was so popular we’re bringing it back for 2021 as a webinar and we hope to see you there!

Please save the date on your calendar: January 21, 2021 @10:00am PT
You can also Register Here

Topics will include:

  • Trends and happenings in the industry impacting fintech companies, broker dealers, investment advisors and fund managers
  • Major issues from the SEC and courts in 2020
  • The year of Bitcoin and DeFi
  • Fintech regulations and best practices
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Sexual Harassment Training Required under California Law

California state law now requires all employers with five or more employees to provide interactive sexual harassment training to their employees. The law formerly only applied to employers with 50 or more employees but was expanded under Senate Bill No. 778, approved by the governor of California on August 30, 2019. Notably, covered employers must provide at least two hours of interactive training to all supervisory employees and at least one hour to all nonsupervisory employees in California. The first training must be held by January 1, 2021 and thereafter must be held every two years. The State of California is providing free training resources, which you can access here.


Annual Compliance & Other Items

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

Annual Compliance Review. On an annual basis, the CCO of an RIA must conduct a review of the adviser’s compliance policies and procedures. This annual compliance review should be in writing and presented to senior management. We recommend firms discuss the annual review with their outside counsel or compliance firm, who can provide guidance about the review process and a template for the assessment and documentation. Conversations regarding the annual review may raise sensitive matters, and advisers should ensure that these discussions are protected by attorney-client privilege. CCOs may also want to consider additions to the compliance program. Advisers that are not registered may still wish to review their procedures and/or implement a compliance program as a best practice.

Form ADV Annual Amendment. RIAs or managers filing as exempt reporting advisers (“ERAs”) with the SEC or a state securities authority must file an annual amendment to their Form ADV within 90 days of the end of their fiscal year. For most managers, the Form ADV amendment will be due on March 31, 2021. RIAs must provide a copy of the updated Form ADV Part 2A brochure and Part 2B brochure supplement (or a summary of changes with an offer to provide the complete brochure) to each “client” and, if applicable, Part 3 (Form CRS client relationship summary) to each “retail investor” with which the RIA has entered into an investment advisory contract. Note that for SEC RIA’s to private investment vehicles, a “client” for purposes of this rule refers to the vehicle(s) managed by the RIA and not the underlying investors. State-registered advisers need to examine their states’ regulations to determine who constitutes a “client”. For purposes of the Form ADV Part 3, a “retail investor” means a natural person, or the legal representative of such natural person, who seeks to receive or receives services primarily for personal, family, or household purposes.

Switching to/from SEC Regulation.

SEC Registration. Managers who no longer qualify for SEC registration as of the time of filing the annual Form ADV amendment must withdraw from SEC registration within 180 days after the end of their fiscal year (June 30, 2021, for most managers), by filing a Form ADV-W. Such managers should consult with legal counsel to determine whether they are required to register in the states in which they conduct business. Managers who are required to register with the SEC as of the date of their annual amendment must register with the SEC within 90 days of filing the annual amendment (June 30, 2021, for most managers, assuming the annual amendment is filed on March 31, 2021).

Exempt Reporting Advisers (“ERAs”). Managers who no longer meet the definition of an ERA will need to submit a final report as an ERA and apply for registration with the SEC or the relevant state securities authority, as applicable, generally within 90 days after the filing of the annual amendment.

Custody Rule Annual Audit.

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

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

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

Other State RIAs. Advisers registered in other states (collectively with CA RIAs, “State RIAs”) should consult their legal counsel about those states’ specific custody requirements.

California Minimum Net Worth Requirement and Financial Reports.

CA RIAs with Discretion. Every CA RIA that has discretionary authority over client funds or securities, whether or not they have custody, must maintain at all times a net worth of at least $10,000 (CA RIAs with custody are subject to heightened minimum net worth requirements).

CA RIAs with Custody. Generally, every CA RIA that has custody of client funds or securities must maintain at all times a minimum net worth of $35,000. However, a CA RIA that (i) is deemed to have custody solely because it acts as the general partner of a limited partnership, or a comparable position for another type of pooled investment vehicle, and (ii) otherwise complies with the California custody rule described above (such advisers, “GP RIAs”) is exempt from the $35,000 minimum (and thus must maintain at all times a minimum net worth of $10,000).

Financial Reports. Every CA RIA subject to the above minimum net worth requirements must file certain reports with the DFPI.

  • In the event a CA RIA breaches its minimum net worth requirement, it must file a report of its financial condition with DFPI by the close of business on the business day immediately following the date of the breach.
  • If a CA RIA’s net worth is less than 120% of its minimum net worth requirement, it must file at least three “interim reports” with DFPI. The first such report is due within 15 days of the date on which the CA RIA’s net worth was less than 120% of its minimum net worth and then within 15 days of each monthly accounting period thereafter until three consecutive interim reports show a net worth that is greater than 120% of the required minimum net worth.
  • Annually, within 90 days of a CA RIA’s fiscal year-end, the CA RIA must file a financial report with DFPI containing a balance sheet and income statement (prepared in accordance with generally accepted accounting principles), supporting schedule, and verification form. If the CA RIA has custody (and is not a GP RIA), the financial report must be audited by an independent public accountant.

Annual Re-Certification of CFTC Exemptions. Commodity pool operators (“CPOs”) and commodity trading advisers (“CTAs”) currently relying on certain exemptions from registration with the Commodity Futures Trading Commission (“CFTC”) are required to re-certify their eligibility within 60 days of the calendar year-end. CPOs and CTAs currently relying on relevant exemptions will need to evaluate whether they remain eligible to rely on such exemptions.

CPO and CTA Annual Updates. Registered CPOs and CTAs must prepare and file Annual Questionnaires and Annual Registration Updates with the National Futures Association (“NFA”), as well as submit payment for annual maintenance fees and NFA membership dues. Registered CPOs must also prepare and file their fourth-quarter report for each commodity pool on Form CPO-PQR, while CTAs must file their fourth-quarter report on Form CTA-PR. For more information on Form CPO-PQR, please see our earlier post. While not applicable for this filing, we note that Form CPO-PQR is changing (as discussed in more detail below), which will apply to the filing relating to Q1 2021. Unless eligible to claim relief under Regulation 4.7, registered CPOs and CTAs must update their disclosure documents periodically, as they may not use any document dated more than 12 months prior to the date of its intended use. Disclosure documents that are materially inaccurate or incomplete must be promptly corrected, and redistributed to pool participants.

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

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

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

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

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

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

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

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

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

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

IARD Annual Fees. Preliminary annual renewal fees for state-registered and SEC-registered investment advisers were due on December 14, 2020. Failure to submit electronic payments by the deadline may result in registrations terminating due to a “failure to renew.” If you have not already done so, you should submit full payment into your Renewal Account by E-Bill, check or wire as soon as possible.

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


Annual Fund Matters

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

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

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

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

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

Fund Expenses. Managers should wrap up all fund expenses for 2020 if they have not already done so. In particular, managers should contact their outside legal counsel to obtain accurate and up to date information about legal expenses for inclusion in the NAV for year-end performance.

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

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

U.S. FATCA. Funds should monitor their compliance with the U.S. Foreign Account Tax Compliance Act (“FATCA”). Generally, U.S. FATCA reports are due to the IRS on March 31, 2021 or September 30, 2021, depending on where the fund is domiciled. However, reports may be required by an earlier date for jurisdictions that are parties to intergovernmental agreements (“IGAs”) with the U.S. Because of COVID-19, the Cayman Islands has extended its FATCA reporting deadline for the 2019 period until December 16, 2020. Additionally, the U.S. may require that reports be submitted through the appropriate local tax authority in the applicable IGA jurisdiction, rather than the IRS. Given the varying U.S. FATCA requirements applicable to different jurisdictions, managers should review and confirm the specific U.S. FATCA reporting requirements that may apply. As a reminder, we strongly encourage managers to file the required reports and notifications, even if they already missed previous deadlines. Applicable jurisdictions may be increasing enforcement and monitoring of FATCA reporting and imposing penalties for each day late.

CRS. Funds should also monitor their compliance with the Organisation for Economic Cooperation and Development’s Common Reporting Standard (“CRS”). All “Financial Institutions” in the British Virgin Islands (BVI) and the Cayman Islands must register with the respective jurisdiction’s Tax Information Authority and submit various reports with the applicable regulator via that regulator’s online portal. While the BVI 2020 filing deadlines for 2019 CRS reporting have passed, because of COVID-19, the Cayman Islands have extended its CRS filing declaration and reporting deadline for the 2019 reporting period until December 16, 2020 and the “compliance report” deadline for the 2019 reporting period until March 31, 2021. Managers to funds domiciled in other jurisdictions should also confirm whether any CRS reporting will be required in such jurisdictions and the procedures to follow to enroll and file annual reports. We recommend managers contact their tax advisors to stay on top of the U.S. FATCA and CRS requirements and avoid potential penalties.


Annual Management Company Matters

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

Employee Reviews. An effective annual review process is vital to reduce the risk of employment-related litigation and protect the management company in the event of such litigation. Moreover, it is an opportunity to provide context for bonuses, compensation adjustments, employee goals and other employee-facing matters at the firm. It is not too late to put an annual review process in place.

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

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

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


Regulatory & Other Items from 2020

SEC Updates.

The SEC Expands its Definition of “Accredited Investor” and “Qualified Institutional Buyer”. On August 26, 2020, the SEC Commissioners voted to adopted amendments to expand the definition of “accredited investor” and “qualified institutional buyer”. A more detailed breakdown can be found in our blog post here.

With respect to investors who are natural persons, historically, the “accredited investor” qualification status was based mainly on an individual’s income or net worth. These categories remain and have been broadened slightly to include the income or net worth from an investor’s “spousal equivalent,” which generally is a cohabitant occupying a relationship generally equivalent to that of a person’s spouse. Additionally, the SEC expanded the definition of “accredited investor” to account for certain knowledge qualifications, including (i) persons with certain professional financial designations such as those holding the Series 7, Series 65 or Series 85 licenses and (ii) “knowledgeable employees” (as defined in Rule 3c-5 of the Investment Company Act of 1940, as amended (the “Investment Company Act”)).

The SEC also expanded the definition of “accredited investor” with respect to entity investors. The new definition encompasses (i) SEC RIAs and State RIAs, (ii) rural business investment companies, (iii) limited liability companies with total assets in excess of $5,000,000 (not also formed for the specific purpose of acquiring the securities offered), (iv) entities owning in excess of $5,000,000 of “investments” (as defined in Rule 2a51-1(b) of the Investment Company Act), and (v) family offices with at least $5,000,000 in assets under management.

The SEC has updated the definition of “qualified institutional buyer” in Rule 144A to include entities and any individual investors that have at least $100,000,000 in securities owned and invested in issuers unaffiliated with the qualified institutional buyer. The scope is intended to include Native American tribes, governmental bodies, and bank-maintained collective investment trusts.

These amendments became effective on December 8, 2020. Private fund advisers should consider updating their subscription documents to incorporate these new categories.

SEC Revises Rules to Harmonize Exempt Offerings. On November 2, 2020 the SEC adopted amendments to certain rules under the Securities Act of 1933, as amended (the “Securities Act”), seeking to harmonize various “private offering” exemptions to the registration requirement of the Securities Act. In summary, these amendments are intended to establish a singular and broadly applicable rule giving issuers the ability to move from one exemption to another. Offering limits for Regulation A (“Reg A”), Regulation Crowdfunding (“Reg CF”), and Rule 504 offerings are also to be increased. The adopted amendments are anticipated to become effective in early 2021.

Highlights of the amendments include:

  • Integration – when companies engage in multiple offerings near in time, it may be necessary to analyze whether the offerings are integrated into a single offering. The amendments provide four non-exclusive safe harbors from integration, thereby making it easier for companies to engage in multiple offerings without the fear of integration.
  • Offering limitations – as discussed above, the amendments would also raise offering limits to various exemptions. For example, under Tier 2 of Reg A, the amendments would increase both the maximum offering amount from $50MM to $75MM and secondary sales from $15MM to $22.5MM. The Reg CF offering limit would increase from $1.07MM to $5MM. Accredited investors would also have their investment limits removed for a Reg CF offering. Non-accredited investors utilizing Reg CF would also be able to use the greater of their annual income or net worth when calculating investment limitations. For Rule 504 under Regulation D – the amendments would raise the maximum offering amount from $5MM to $10MM. Accredited investors would also have their investment limits removed for a Reg CF offering. Non-accredited investors utilizing Reg CF would also be able to use the greater of their annual income or net worth when calculating investment limitations. For Rule 504 under Regulation D – the amendments would raise the maximum offering amount to $10MM up from $5MM previously.
  • Exemption Improvements – the SEC amendments also would improve certain exemptions. In Rule 506(b) offerings, the mandatory information and disclosures provided to non-accredited investors will align with those provided to investors in a Reg A offering. Reg A offerings are to have certain requirements simplified and there would be greater consistency between a Reg A offering and a registered offering. The amendments would also harmonize the bad actor disqualification provisions under a Regulation D, Reg A and Reg CF offering.
  • Rule 506(c) Offerings – Issuers, including private funds, sometimes rely on Rule 506(c), which allows the issuer to engage in “general solicitation” with respect to a private offering so long as the issuer, among other things, takes “reasonable steps” to verify that each investor is, in fact, an “accredited investor.” To that end, the SEC has published a non-exclusive list of methods an issuer may undertake to verify that a person is an “accredited investor.” The adopted amendment adds to that list by allowing an issuer selling securities to a person that was (or is) an investor in that issuer to rely on its prior verification of that person’s “accredited investor” status, so long as (i) the verification occurred within five years of the date on which the person will again invest, (ii) the issuer receives a written representation by that person that it continues to qualify as an “accredited investor”, and (iii) the issuer is not aware of contrary information. The SEC believes this simplification will make it easier for issuers to utilize a Rule 506(c) offering, such that unnecessary efforts will not be expended to verify a known investor’s “accredited investor” status.

RIA Compliance Risk Alert. On November 19, 2020, the SEC Office of Compliance Inspections and Examinations (“OCIE”) issued a risk alert related to certain compliance-related deficiencies it had found during the course of its examination of SEC RIAs. Notably, OCIE identified the following deficiencies:

  • A lack of compliance personnel and authority. OCIE found advisers who had inadequate staffing to maintain compliance or who did not give their compliance officers sufficient authority to discipline breaches of the adviser’s compliance policies and procedures.
  • Relatedly, OCIE observed advisers that failed to implement or perform actions required by the adviser’s policies and procedures, including failing to maintain up-to-date information and failing to perform required annual reviews or, if performed, failing to address identified deficiencies.
  • OCIE also found advisers that lacked written policies and procedures entirely or who implemented “off the shelf” policies and procedures that were not tailored to their business.

This risk alert serves as a good reminder that all investment advisers registered with the SEC must maintain tailored compliance policies and procedures, must devote adequate resources towards compliance and endow their compliance officers with authority to enforce the policies and procedures, must conduct an annual review of the policies and procedures, and must work to correct deficiencies in the policies and procedures as they are identified.

SEC Annual Enforcement Report. On November 2, 2020, the SEC Division of Enforcement published its Annual Report, which highlighted its response to the COVID-19 pandemic, the success of its whistleblower program, and it’s continued focus on protecting “main street investors” and bringing actions against individuals (as opposed to just the organizations that employ them). 2020 also saw the SEC continue to police the digital asset arena. So far this year, the SEC brought a total of 715 enforcement actions (down from 862 actions in 2019) and obtained monetary judgments totaling 4.68 billion dollars (up from 4.35 billion dollars in 2019).

Federal Judge Grants SEC Preliminary Injunction Against Telegram. The SEC was granted a preliminary injunction against Telegram Group Inc. (“Telegram”) for an unregistered offering of securities under the Securities Act in connection with their sale of Simple Agreement for Future Tokens (“SAFTs”). The SEC argued, and the court agreed, that the initial sale of the SAFTs to investors and the subsequent sale by the investor of the tokens in the market was one continuous transaction, and thus Telegram’s SAFT sale was an unregistered sale of securities, and the SAFT investors were underwriters to that sale. The SEC argued that because the SAFTs did not require the purchasers to comply with holding periods applicable to the resale of restricted securities, it was a foregone conclusion that the SAFT investors purchased the SAFT with the intention to sell their tokens once received, and therefore Telegram was unable to rely on an offering exemption for the sale requiring the purchaser to not purchase with a view to reselling. Further, as the initial SAFT sale was not compliant with an exemption from registration, the SAFT investors would be unable to rely on Rule 144 or other applicable exemptions when reselling the tokens. As this was a district court case that was settled before appeal, it is not clear that the court’s ruling and analysis in this case would be used as precedent for subsequent cases, however the decision does call into question the suitability of SAFTs for both issuers and investors.

SEC Charges Investment Adviser with Late Filing of Schedule 13D Amendment. The SEC instituted cease-and-desist proceedings against an investment adviser for failure to promptly amend a Schedule 13D under Section 13(d)(2) of the Securities Exchange Act of 1934, as amended. The investment adviser caused its managed funds to acquire 7% of the outstanding stock of a healthcare company with the intention of taking the company private and filed a Schedule 13D as required. Subsequently, however, the investment adviser abandoned its efforts to take the company private and liquidated its positions, but failed to amend their Schedule 13D filing to reflect the change of intent and the sale of 1% or more of the healthcare company’s underlying stock promptly, doing so more than two months after the sale. Notably, the SEC brought this proceeding as an isolated action. It should serve as a warning that the SEC may institute disciplinary actions for failure to comply with mandatory reporting requirements, even for a single, late Schedule 13D filing. The SEC’s action is a reminder to all investment advisers filing Schedule 13D and 13G to monitor their beneficial ownership levels, reporting obligations, and internal compliance processes to ensure amendments to Schedule 13D and 13G are made within the appropriate time limits.

CFTC and NFA Updates.

CFTC Streamlines Form CPO-PQR. On October 6, 2020, the CFTC adopted amendments to Form CPO-PQR that “streamlined” the form and eliminated many of the prior reporting requirements by conforming the substantive and filing requirements of CFTC Form CPO-PQR with the NFA’s version of Form PQR, which registered CPOs also currently file. In addition, the amendments eliminate the “large”, “mid-sized,” and “small” CPO reporting threshold concept so that all registered CPOs will file the same Form CPO-PQR on a quarterly basis within sixty days of the end of the calendar quarter (as is already required by the NFA). Although the rule is effective December 10, 2020, the CFTC intends for the new form to be used starting with reporting related to Q1 2021. As such, the compliance date for the new form is May 30, 2021 (sixty days after March 31, 2021).

CFTC Revises, Broadens Rule 3.10(c)(3). On October 14, 2020, the CFTC adopted revisions to CFTC Rule 3.10(c)(3), which currently provides a registration exemption for a non-U.S. CPO that operates solely qualifying non-U.S. funds with non-U.S. investors. The revised Rule 3.10(c)(3) will:

  • apply on a “pool-by-pool” basis, allowing a CPO to rely on it for one or more qualifying non-U.S. pools while relying on different exemptions for other pools;
  • institute a safe harbor for unintended U.S. investments in a non-U.S. pool; provided, that the CPO (i) undertakes certain reasonable efforts (such as disclosures, subscription and other diligence measures, and controls on solicitation activities) to minimize the possibility of U.S. persons being solicited for, or sold, interests or shares in an offshore pool and (ii) maintains documentation adequate to demonstrate compliance with the safe harbor; and
  • allow seed investments in the relevant pool from qualifying U.S.-based affiliates of the non-U.S. CPO.

The new rules are effective February 5, 2021.

CFTC Adopts New Position Limits. On October 15, 2020, the CFTC adopted new rules regarding federal position limits for certain commodity interest contracts (“Referenced Contracts,” as defined in the new rules and discussed below). This is the CFTC’s latest attempt to adopt federal position limits, having had its last attempt set aside in court in 2012.

The new rules (i) modify existing spot month, single month, and all-months-combined position limits for Referenced Contracts regarding nine “legacy” agricultural commodities and (ii) impose new spot month position limits for Referenced Contracts regarding certain seven addition agricultural commodities, five metals commodities, and four energy commodities. Subject to certain exemptions, “Referenced Contracts” means specifically referenced futures contracts on the 25 commodities, futures contracts and options on futures contracts directly or indirectly linked to those specified contracts, and “economically equivalent swaps” (as defined in the new rules).

With respect to spot month limits, market participants cannot net cash-settled positions and physically-settled positions (although participants can net within those two categories). Other than for spot month limits, cash-settled and physically settled positions can be netted against each other.

The new rules also (i) establish an expedited regime for market participants to receive approval to exceed federal position limits; (ii) change the self-effecting, bona fide hedge exemption by, among other things, expanding the list of enumerated bona fide hedges; (iii) adopt a self-effecting “spread transaction” exemption; and (iv) clarify that market participants generally may hedge positions either on a gross basis or on a net basis, so long as the market participant does so consistently over time and in a manner that is not designed to evade the federal position limits.

The rules do not allow exchanges to set more lenient position limits than those adopted by the rules. However, with respect to commodity interest contracts that are not subject to the rules, the new rules grant exchanges greater flexibility to (i) set position limits or position accountability levels for those contracts and (ii) grant exemptions from those exchange-established limits.

Generally, the new rules will come into force on January 1, 2022, but certain of the rules will come into force on January 1, 2023.

Digital Asset Updates.

Department of Justice Releases Cryptocurrency Enforcement Framework. The Cyber-Digital Task Force of the Attorney General released “Cryptocurrency: An Enforcement Framework,” (the “Framework”) providing the Department of Justice’s (the “DOJ”) view of the threats and enforcement challenges associated with digital assets. The Framework outlines in detail the DOJ’s view of the threats posed by digital assets associated with crime, money laundering and the avoidance of tax, reporting and other legal requirements and the methods and techniques the various governmental agencies use to enforce federal law. The DOJ emphasized that for digital assets to reach their transformative potential, private industry, and regulators will need to work together to address these threats.

Coinbase Eliminated Margin Trading; Will Others Follow? As we previously discussed, the CFTC considers certain digital currencies (including Bitcoin and Ether) to be “commodities” within the definition of the Commodity Exchange Act of 1936, as amended. In 2017, the CFTC took action against the Bitfinex platform 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. However, 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.

Based on its experience in that case, the CFTC proposed guidance regarding “actual delivery” of digital assets in late 2017, which it adopted as final on March 23, 2020 and began enforcing on September 22, 2020 (the “Guidance”). The Guidance stated that, in the CFTC’s view, “actual delivery” occurs when a customer has complete control over the asset.

On November 24, 2020, Coinbase announced that they are disabling margin trading on Coinbase Pro because they believe that retention of control over digital assets in accordance with the terms of a margin contract would cause them to violate the Guidance. In light of the difficultly in complying with this Guidance, Coinbase ceased the initiation of new margin trades as of November 25th, and will disable margin trading entirely once all existing margin positions have expired. Advisors that advise persons that are not “eligible contract participants” and that utilize margin trading as part of their trading of digital assets should consider how to alter their trading strategies in case more platforms follow Coinbase’s lead.


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

December 14IARD Preliminary Renewal Statement payments due (submit early to ensure processing by deadline)
December 16Cayman Islands FATCA and CRS reporting deadlines
December 26Last day to submit form filings via IARD prior to year-end
December 31Review RAUM to determine 2020 Form PF filing requirement
December 31Small and mid-sized registered CPOs must submit a pool quarterly report (CPO-PQR)
December 31Cayman funds regulated by CIMA that intend to de-register (i.e., wind down or continue as an exempted fund) should do so before this date in order to avoid 2020 CIMA fees
January 11Amended Form 13H filing due if any information on the previously filed Form 13H became inaccurate during the prior quarter
January 15Quarterly Form PF due for large liquidity fund advisers (if applicable)
January 31“Annex IV” AIFMD filing
February 16Form 13F due
February 16Annual Schedule 13G updates due
February 16Annual Form 13H updates due
March 1Deadline for re-certification of CFTC exemptions
March 1Quarterly Form PF due for larger hedge fund advisers (if applicable)
March 31Deadline to update and file Form ADV Parts 1, 2A & 2B
March 31Cayman Islands CRS Compliance Form deadline
PeriodicFund managers should perform “Bad Actor” certifications annually
PeriodicAmendment due on or before anniversary date of prior Form D and blue sky filing(s), as applicable, or for material changes
PeriodicCPO/CTA Annual Questionnaires must be submitted annually, and promptly upon material information changes

Please contact us with any questions or for assistance with any of the above topics. We wish you and yours a safe and healthy new year.


Karl Cole-Frieman, Bart Mallon, Lilly Palmer, David Rothschild, & Scott Kitchens

Cole-Frieman & Mallon LLP is a premier boutique investment management law firm, providing top-tier, responsive, and cost-effective legal solutions for financial services matters. Headquartered in San Francisco, Cole-Frieman & Mallon LLP services both start-up investment managers, as well as multi-billion-dollar firms. The firm provides a full suite of legal services to the investment management community, including hedge fund, private equity fund, venture capital fund, mutual fund formation, adviser registration, counterparty documentation, SEC, CFTC, NFA and FINRA matters, seed deals, hedge fund due diligence, employment and compensation matters, and routine business matters. The firm also publishes the prominent Hedge Fund Law Blog, which focuses on legal issues that impact the hedge fund community. For more information, please add us on LinkedIn and visit us at

Recap of Crypto Discussion Forum

On September 2nd we held our crypto discussion forum where we discussed legal, tax and compliance issues related to the digital asset space. The below is a quick recap the event from panelist Justin Schleifer of Aspect Advisors. We’ll keep updating everyone through this blog on future events as well.


Thank you for attending our “Cryptocurrency and Digital Asset Forum: Trends in Legal, Tax, and Compliance” webinar last week. I would also like to extend many thanks to my fellow panelists, Ryan David Williams of Ashbury Legal and Nick Cerasuolo of Blockchain Tax Partners, and to Bart Mallon of Cole-Frieman & Mallon for hosting.

We had a very interesting and lively interactive discussion about putting crypto investments to work through yield and lending, and DeFi implications including market-making, governance and custody issues.

Here are my favorite tidbits from the various speakers:

Each state has their own regulations as well, and everyone is on different parts of the learning curve. People have to address the nuances of each individual state. States may not agree with the idea of a custodian. DeFi is just way out there for them. They’re still on this idea of what is a custodian in the crypto space? Just getting over that hurdle has proven to be very difficult. – Bart

With the advent of crypto/blockchain, we almost went back in time because are used to dealing with USD. It’s obvious when something is taxable. Crypto took us back to the stone age where we’re back to barter model; property for property (BTC for ETH). You have transactions that don’t involve fiat at all. Tax event triggers are traps for the unwary. It’s not always obvious when a transaction is taxable. – Nick

Insider trading is absolutely an issue in this industry, and it’s getting more nuanced. Firms in the venture capital space get involved with companies on working on their protocols and Dapps. You can very well come in contact with all types of MNPI, so both sides must evaluate what is material or public. You have to restrict yourself in certain areas and not commit to certain trading activities. – Justin

There was a fantasy that once you achieve decentralization, laws are gone. This is an ethos that a decentralized exchange doesn’t need KYC/AML. We are now dispelled of that notion (i.e. the SEC went after the founder of a crypto exchange). The CFTC has also said they will go after software developers. This is the concept of causing a violation of securities law. The expectation of profits is based on the efforts of others. The manager is doing all the work, but what do we do when there is no sponsor and the work is done by community participants? We haven’t finalized this yet. ETH is officially decentralized, so it doesn’t make sense to apply traditional securities laws. – Ryan

If you (or your friends or colleagues) would like to review any of the webinar content, please email Amanda Brown for a link to the recording. If you have any questions about any of the above topics, please reach out to any of our panelists.

We hope you enjoyed this event and if you have any feedback, we would love to hear from you. We look forward to seeing you at our next event!

Best regards, Justin Schleifer


Bart Mallon is a founding partner of Cole-Frieman & Mallon LLP.  Cole-Frieman & Mallon LLP has been instrumental in structuring the launches of some of the first cryptocurrency focused hedge funds. If there are any questions on this post, please contact Mr. Mallon directly at 415-868-5345.

Sample NAV Trigger Waiver

Over the past few months, many of our hedge fund clients have breached default triggers in their counterparty agreements that are tied to a decline in net asset value (“NAV” resulting in a “NAV Trigger”). NAV Triggers are typically drafted to capture a month over month NAV decline of 15% to 20%, and sometimes that decline includes redemptions.

If you have an ISDA in place, a NAV Trigger will result in an Additional Termination Event (“ATE”) under your ISDA, and you are obligated to formally notify the dealer of that fact. Once notified, you should explicitly request that the dealer waive the ATE. A formal waiver should be in writing, should clearly state the facts that triggered the ATE, and should explicitly waive the dealer’s right to declare an Early Termination Date under the ISDA in respect of that ATE. Below, we have provided a sample waiver that any manager should feel free to use for their funds. Certain of the bracketed facts should be modified to fit a given fund’s particular circumstances, and defined terms should be changed to fit those found in your ISDA.

If you have any questions about the ATEs in your funds’ ISDAs, or about the ATE waiver, please contact us for assistance.

Other similar posts on this topic:

Monitoring NAV Triggers Amidst Volitility


David Rothschild is a partner of Cole-Frieman & Mallon LLP and routinely focuses on ISDA matters. Cole-Frieman & Mallon is a boutique law firm focused on the investment management industry. For more information on this topic, please contact Mr. Rothschild directly at 415-762-2854.

Monitoring NAV Triggers Amidst Volatility

Managers Should Be Aware of Additional Termination Events

By David Rothschild

At this time of extreme market volatility, it is critical for managers with ISDA Master Agreements (“ISDAs”) in place to understand the NAV Trigger Additional Termination Events described in their ISDAs, and what actions to take if they trip one. 

As quick background, the Schedule to almost every ISDA Master Agreement to which a hedge fund is party will include an Additional Termination Event (“ATE”) pegged to a specific percentage decline in the fund’s net asset value over various periods (usually monthly, quarterly and annually). Some ISDAs will also include a “NAV Floor” concept triggering an ATE any time the fund’s NAV falls below a specific value (expressed either as a dollar value, or a percentage of a prior NAV, or both). If an ATE is triggered and the dealer elects to act on it, the dealer generally has the right close out all of a fund’s open positions, a result every manager wants to avoid.

NAV Trigger ATEs are among the most heavily-negotiated provisions in a hedge fund’s ISDA, and the specific figures for the monthly, quarterly and annual triggers, as well as NAV Floor provisions, will differ from fund to fund. What some managers may not realize is that the language describing these calculations and when they must be performed may also differ. Ideally, your NAV Trigger ATEs will be “point-to-point” and measured only as of the last day of the month – i.e., your NAV on the last trading day of a month is compared to your NAV on the last trading day of the prior month, quarter or year as applicable, to determine whether you have tripped an ATE. Many ISDAs, however, will have “any day” triggers – i.e., a NAV decline on any day as compared to the prior month, quarter or year could trigger an ATE. At this point, managers should review their NAV Trigger language and consult with legal counsel if they have questions regarding when or how these calculations must be performed.

If your fund has experienced a NAV decline that triggers an ATE under your ISDA, you are obligated to formally notify the dealer of that fact. That notice to the dealer should include an explicit request for them to waive the ATE; depending on your specific facts and circumstances and your relationship with a given dealer, they may grant you a waiver. A waiver means the dealer loses the right to close out your positions as a result of that ATE.

If you negotiated your ISDA, it may also include a “fish or cut bait” provision, which essentially gives the dealer a deadline to declare an ATE after you notify them that the relevant ATE was triggered. If you have a “fish or cut bait” provision in your ISDA that applies to a NAV Trigger ATE, pay close attention to the notice procedures described therein (many dealers require multiple forms of notification to specific addresses or emails in order for the “fish or cut bait” provision to be properly invoked), and follow them exactly to put the dealer on notice and start the clock running on the time period. If you properly follow those procedures and deadline passes, the dealer loses the right to close out your positions as a result of that ATE, whether or not they grant an explicit waiver.

Of course, if you have any questions while reviewing your ISDAs or how to interpret these critical provisions, you should reach out to your legal counsel immediately.


David Rothschild is a partner of Cole-Frieman & Mallon LLP and routinely focuses on ISDA matters. Cole-Frieman & Mallon is a boutique law firm focused on the investment management industry. For more information on this topic, please contact Mr. Rothschild directly at 415-762-2854.

Bitcoin Mining Panel Overview

Thank you to everyone who attended our bitcoin mining panel last week. We had a fantastic audience with many questions for our panel of bitcoin mining experts – Mathew D’Souza of Blockware Solutions, Thomas Ao of MCredit and Yida Gao of Struck Capital.  The panel lasted just over one hour and was ably moderated by Michael Fitzsimmons of Williams Trading and was sponsored by Cole-Frieman & Mallon LLP and Aspect Advisors LLC.  

Here is the presentation with slides referenced below:

Here are the take-aways:

  • Many opportunities for BTC mining – there are many different businesses in the mining space including: direct mining, buying/selling mining rigs, making loans backed by mining rigs, developing a mining farm, and cloud mining, among others.  
  • Potential for high returns – successful mining enterprises can make 8-12% ROI per month when BTC is priced around $10,000.  (The panel focused mainly on the economics of BTC mining and did not touch on the mining of other crypto assets.)
  • Large secondary market for mining rigs – because it is relatively difficult to import mining rigs to the US (time and cost/tariffs), some groups buy and sell rigs on the secondary market in the US in addition to directly mining BTC and this can be a profitable strategy in its own right.  Bitmain is the main supplier of new rigs and the prices from both Bitmain and the secondary market can be as volatile as the BTC market. 
  • Cost of producing BTC – the cost to produce one BTC can vary widely depending on cost of electricity and the type of rig used, as the proprietary research from Blockware Solutions demonstrates (see attached presentation).  Blockware’s research also shows that most rigs coming online are the more efficient next generation machines. 
  • The Halvening – in May the halvening is expected to bolster the generally bullish BTC trend we’ve seen in 2020.  This will undoubtedly impact the economics of mining and the secondary market for rigs. 
  • China and mining – a favorable tax regime and lower electricity costs made China a popular location for mining, despite risks associated with the government’s stated aim to eliminate virtual currency mining as an industry. These risks have significantly abated after the recent announcement by the National Development and Reform Commission of China (NDRC) that mining has been removed from the elimination list.
  • Environmental impact – innovation in rig/chip designs are making mining more environmentally friendly as less watts are required per terahash.  The panel generally believes that after the halvening less efficient miners will go offline.
  • Issues – there has been many scams with respect to mining, especially mining farms and cloud mining.  Also, there is high general investment risk in mining operations because many operators just don’t know what they are doing. 
  • Other BTC financial products – miners may decide to hedge their BTC exposure through OTC products, but in general miners are not concerned with BTC financial products unless they affect the demand/price of BTC.

We hope you enjoyed this event and if you have any feedback, we would love to hear it in our quick survey.  Please feel free to forward this email along to anyone you think might be interested.  We look forward to seeing you at our next event.


Bart Mallon & Michael Fitzsimmons

Aspect Advisors LLC

Aspect Advisors LLC is a modern regulatory consultant providing customized compliance solutions to entrepreneurs.  The firm has a focus on fintech companies, broker-dealers, and investment managers (hedge fund, VC, PE, RIA, etc).  We provide compliance and back-office solutions engineered to decrease worry and save time and resources. Among other items, the firm helps clients with regulatory registration, drafting compliance policies and procedures, conducting annual reviews, and other bespoke items.

Cole-Frieman & Mallon LLP

Cole-Frieman & Mallon LLP is a premier boutique investment management law firm, providing top-tier, responsive, and cost-effective legal solutions for financial services matters.   Headquartered in San Francisco, Cole-Frieman & Mallon LLP services both start-up investment managers, as well as multi-billion-dollar firms. The firm provides a full suite of legal services to the investment management community, including hedge fund, private equity fund, venture capital fund, mutual fund formation, adviser registration, counterparty documentation, SEC, CFTC, NFA and FINRA matters, seed deals, hedge fund due diligence, employment and compensation matters, and routine business matters.  The firm also publishes the prominent Hedge Fund Law Blog, which focuses on legal issues that impact the hedge fund community. For more information, please visit us at


Bart Mallon is a founding partner of Cole-Frieman & Mallon LLP. Cole-Frieman & Mallon has been instrumental in structuring the launches of some of the first digital currency-focused hedge funds. For more information on this topic, please contact us or you can call Mr. Mallon directly at 415-868-5345.

Aspect Advisors & CFM 2020 IA/BD Compliance Update

A while ago we mentioned that we were hosting a compliance update for investment advisers and broker-dealers. The below is our summary of that event.


We wanted to take this opportunity to thank everyone who attended and participated in our 2020 compliance update with Justin Schleifer (Aspect Advisors) and Bart Mallon (Cole-Frieman & Mallon).  We understand that compliance sometimes feels like an obligation.  Still, we think that our discussion last week touched on many important items for financial industry professions to keep top of mind in this new year and new decade.

We have attached a copy of the presentation to this email.  Please feel free to forward along to anyone who might be interested.  Some high points included:

  • High level trends influence how the modern investment manager interacts with compliance.  Trends include the ongoing bull market, the movement of investment dollars from public investments (via IPO) to private markets, and the emergence of technology/ fintech.  While these are distinct trends that need to be acknowledged, traditional compliance concepts still apply to managers although the concepts may be deployed or utilized in a different way than before.  
  • Regulation Best Interest (“Reg BI”) will have an impact on the investment management industry in 2020.    Broker-dealer and IA firms will scurry to meet the Reg BI implementation deadline.  The effects will be felt more keenly by broker-dealers as they revise their practices to account for the updated fiduciary standards.  Asset managers will need to address the regulation through a new Form CRS (sometimes referred to as ADV Part 3). 
  • Privacy is paramount.  There is general momentum toward consumers craving privacy.  Governments and regulators are taking baby steps but are expected to do more in the future – we see that things such as the California Consumer Privacy Act and GDPR have already begun to influence the operations of many investment management companies.  While managers should always maintain fundamental compliance records, there will be changes in the way that investor and customer data is ultimately accessed and available.  It is therefore important for managers to stay up to date with those advances and any accompanying compliance processes.
  • Technological innovation (in both traditional and digital asset markets) is stretching the regulators’ ability to keep up.  Regulators have trouble attracting talent to head new divisions to deal with technological innovation.  Accordingly, money managers and entrepreneurs utilizing new technologies will need to understand the necessity of being able to explain the use of technology to regulators.
  • Access to new capital?  The industry is always looking for ways to get new investors involved.  A new accredited investor standard has been proposed but is not likely to significantly expand the pool of potential accredited investors and thus capital available for investment.  Similar initiatives to broaden the distribution of investment products or management to a broader base of end investors (such as Regulation CF, Regulation A+, and 506(c) general solicitation) have seen generally middling to poor results for various reasons.
  • Information Security/Cybersecurity will continue to be a big regulatory focus and focus on this area is a business best practice.  Larger firms will outsource to high tech IT firms or bring IT talent in-house.  Smaller firms have many basic tools at their disposal and should focus on vendor management and selection, employee training, access to information, and other pivotal ways to increase security (2FA, using non-public wifi, port blockers, screen protectors, etc).
  • Taking humans out of investment management.  Many investment management companies are creating organizations to bring services to the masses; these companies scale to limit human involvement.  Questions on how to deal with compliance on a larger scale naturally emerge.  The integration of technology (including with outside compliance vendors) becomes a key focus and commensurately decreases the reliance on human capital.
  • Other smaller trends have emerged.  The focus on private markets is expected to heat up, not decrease (WeWork notwithstanding). Firms will continue to expand with sophisticated financial services, tools, investment strategies, different products, and new market participants, especially as millennials begin investing and saving more.  As technology improves lower-fee products proliferate; many firms charge very low management fees and rely more on performance fees.   

We look forward to seeing you again at a panel event in the future and wish you the best during this first quarter.


Bart Mallon & Justin Schleifer

Aspect Advisors LLC

Aspect Advisors LLC is modern regulatory consultant providing customized compliance solutions to entrepreneurs.   The firm has a focus on fintech companies, broker-dealers, and investment managers (hedge fund, VC, PE, RIA, etc).  We provide compliance and back-office solutions engineered to decrease worry and save time and resources. Among other items, the firm helps clients with regulatory registration, drafting compliance policies and procedures, conducting annual reviews, and other bespoke items.

Cole-Frieman & Mallon LLP

Cole-Frieman & Mallon LLP is a premier boutique investment management law firm, providing top-tier, responsive, and cost-effective legal solutions for financial services matters.   Headquartered in San Francisco, Cole-Frieman & Mallon LLP services both start-up investment managers, as well as multi-billion-dollar firms. The firm provides a full suite of legal services to the investment management community, including hedge fund, private equity fund, venture capital fund, mutual fund formation, adviser registration, counterparty documentation, SEC, CFTC, NFA and FINRA matters, seed deals, hedge fund due diligence, employment and compensation matters, and routine business matters.  The firm also publishes the prominent Hedge Fund Law Blog, which focuses on legal issues that impact the hedge fund community. For more information, please visit us at


Bart Mallon is a founding partner of Cole-Frieman & Mallon LLP. Cole-Frieman & Mallon has been instrumental in structuring the launches of some of the first digital currency-focused hedge funds. For more information on this topic, please contact Mr. Mallon directly at 415-868-5345.

Regulation D 506(c) Exemption

Regulation D 506(c) Exemption

General Solicitation Allowed for Private Fund Managers Under 506(c)

Regulation D (“Reg. D”) offers issuers exemptions from registration of their securities under the Securities Act of 1933, as amended (the “Securities Act”). Most managers rely on Rule 506(b) which allows sale of securities to an unlimited number of accredited investors and up to 35 non-accredited investors, so long as there is no general solicitation. Rule 506(c) was enacted as part of the JOBS Act to permit general solicitation, so long as certain steps are followed. While originally many private fund managers eschewed the exemption because of the additional requirements, the exemption has gained popularity with private fund managers in the digital asset space. The main reason is that such managers can more broadly and generally solicit their fund – something that private fund managers in the traditional securities space would not do.

Background Requirements

Under Rule 506(c) of Reg. D, general solicitation is permitted without having to register the issuer’s securities under the Securities Act, so long as (1) all investors are accredited (as defined under Reg. D); (2) reasonable steps have been taken to verify that all investors are accredited, so long as the issuer does not have prior knowledge that the investor is non-accredited; and (3) certain integration, resale restrictions of securities, and bad actor disqualification rules are followed. If these requirements are met, an issuer can broadly solicit and advertise the offering of its securities and still be in compliance with Reg. D.

The second requirement above imposes an obligation for an issuer to proactively take steps in order to verify that an investor is in fact accredited. The list of verification methods recommended in the statute is non-exhaustive but a common method of verification includes, if confirming on the basis of income, reviewing W-2s or other similar tax forms for the previous two years, and obtaining a written representation from the investor that the investor has a reasonable expectation of qualifying as an accredited investor during the current year. Another method often used is having an investor engage certain parties such as a registered CPA or a licensed attorney to represent that the investor is an accredited investor.

A private fund relying on 506(c) must still follow all other applicable securities regulations, such as the 2,000 investor limit pursuant to Section 12(g) of the Securities Exchange Act of 1934, as amended (unless the investor is relying on a different exemption that limits investor count in the private fund). Additionally, the private fund must file a Form D electronically with the SEC, and reflect its 506(c) reliance in the fund offering documents. Each state also has specific securities requirements which typically are met by making a “blue sky filing” (i.e. filing a copy of the Form D) in the applicable state that the private fund is soliciting in.

Positive Aspects

Rule 506(c) offers managers avenues that were previously prohibited under Rule 506(b). This expands investor base and provides for a less restrictive discussion of the fund’s strategy and terms. Further, there is no limit on dollars that can be raised and no limit on dollars from particular investors.

Converting from 506(b) to 506(c)

Many investment managers in the digital asset space are seeking to convert their offering from 506(b) to 506(c). In order to convert a previous offering to a 506(c) offering, the private fund needs to (1) file a new Form D with the SEC, indicating its reliance on 506(c); (2) amend the private fund’s offering documents; and (3) follow the verification methods described above for all subsequent investors in the private fund. We confirmed the foregoing procedures with the SEC. The SEC further indicated in a Q&A that if a private fund that previously relied on Rule 506(b) followed all applicable requirements of Rule 506(b), the private fund would only need to take reasonable steps to verify the accredited investor status of subsequent investors, not existing investors. If existing investors make an additional investment in the fund, the verification methods will need to be taken. Thus, it is recommended as a best practice to verify that all existing investors in the fund are accredited.


We anticipate that many investment managers in the digital asset space will begin to increasingly rely on this exemption. Although general solicitation is permitted under this exemption, all applicable securities regulations still need to be followed (i.e. the anti-fraud provisions under the Investment Advisers Act of 1940, as amended). Counsel should be contacted to further discuss the applicable requirements if you are considering conducting an offering pursuant to Rule 506 (c).


Bart Mallon is a founding partner of Cole-Frieman & Mallon LLP.  Cole-Frieman & Mallon LLP has been instrumental in structuring the launches of some of the first digital currency-focused hedge funds and works routinely on matters affecting the digital asset industry.  Bart can be reached directly at 415-868-5345.

California Consumer Privacy Act

The California Consumer Privacy Act (the “CCPA”), which was passed as law on June 28, 2019, will be effective as of January 1, 2020. Please be aware most fund managers will not be affected, but given the upcoming date of effectiveness it may be prudent to evaluate the reach of the law.

First, WHO does the CCPA affect?

The CCPA will affect fund managers who do business in California AND either (i) have at least $25 million of annual gross revenue; (ii) buy, sell, share or receive personal data; or (iii) receive over half of their revenue from the sale of personal data of California residents. Most fund managers who do business in California will not meet any of these prongs. The few managers who the CCPA will affect will likely fall under prong (i) – those who do business in California and have at least $25 million in annual gross revenue.

In calculating the $25 million in annual gross revenue, fund managers operating with a bifurcated management structure (separate management company and general partner entities) will likely have to aggregate the revenues of the general partner and management entities. The CCPA expands the definition of a “business” to entities who control or are in common control with another business and which share a common branding. In this case, if the threshold is met across both management entities, each entity will be subject to the provisions of the CCPA. If the general partner and investment manager do not share common branding, our view is that the revenues of the entities will not need to be aggregated.

Second, WHAT information does the CCPA cover?

The CCPA generally covers “personal information” that identifies, relates to, describes, associates with, directly or indirectly, a particular institutional or prospective client. This information includes, without limitation, names, addresses, email addresses, social security numbers, driver’s license or state issued ID number and passport numbers.

Typically, fund managers maintain the personal information of (i) their own employees (ii) individual clients (iii) institutional or entity clients and (iv) prospective clients. Fund managers may be relieved to learn that, due to certain statutory exemptions, information collected (i) about manager’s employees, (ii) via certain business to business transactions and (iii) about individual clients (if a manager is an SEC Registered Investment Adviser), does not constitute personal information and as a result, does not fall under the scope of the CCPA. Thus, the CCPA will generally only cover personal information of a fund manager’s (i) entity or institutional clients and (ii) prospective clients.

The CCPA exempts from coverage all data pre-empted by the Gramm-Leach-Bliley Act (the “GLBA”), which only applies to SEC Registered Investment Advisers (each, an “RIA”). The GLBA protects nonpublic personal information that is provided by a consumer to a financial institution in connection with obtaining financial products/services from the institution. The GLBA’s definition of nonpublic personal information differs from the definition of personal information under the CCPA, and is limited to individual investor information. Thus, while certain individual investor information may be pre-empted from the scope of the CCPA, personal information of entity investors, institutional investors and prospective investors is not within the scope of the GLBA and as such, will be covered by the CCPA.

Third, HOW should fund managers comply?

To the extent that clients or client prospects of fund managers are protected by the CCPA, their rights include the right to request disclosure of information that is collected and shared, the right to delete personal information and the right to non-discrimination. To ensure such compliance with the CCPA, we recommend that managers within the scope of the CCPA take the below actions:

    • Fund managers must broadly be prepared to promptly respond to California client rights and requests including clients’ rights to (i) access specific personal information (ii) data portability (iii) data deletion and (iv) non-discrimination for exercise of any CCPA right. Once a fund manager has received a verifiable consumer request from a client, it must be prepared to disclose and deliver the required information to the client within 45 days.
    • Typical privacy policies currently used by fund managers may need to be updated to (i) inform clients of their rights under the CCPA and instructions on how to exercise those rights and (ii) reword and incorporate as a comprehensive list all personal information (including drivers licenses, passport numbers or any other personal identifiers) collected and shared with service providers (such as the fund administrator, auditor, legal/regulatory service providers and I.T. providers). RIAs should also distribute their annual privacy policy update to all clientele in January.
    • Fund managers operating a website which collects personal information (either through an online portal access, cookies or other website function) must publish a separate CCPA compliant privacy disclosure on such website relating to the collection and use of such personal information. Many fund managers do not collect personal information on their websites, and thus will not need to include such privacy disclosure on their webpage.
    • Fund managers should consider updating their agreements with their fund administrator and possibly other service providers that have access to covered information of clients to include a representation from the service provider that it is in compliance with CCPA regulations.

Bart Mallon is a founding partner of Cole-Frieman & Mallon LLP.  Mr. Mallon can be reached directly at 415-868-5345.