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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
  • Other hot topics


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.

Cole-Frieman & Mallon 2019 First Quarter Update

Below is our quarterly newsletter. If you would like to be added to our distribution list, please contact us.

Clients, Friends, Associates:

The first quarter of each year is typically a busy time for both investment managers and services providers.  The first quarter of 2019 was no exception.  Now that many of the filing deadlines have passed, and audit work should be completed (or nearly so), we enter the second quarter of 2019 with regulatory changes and developments on the horizon.  Below is 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.


SEC Matters

SEC Publishes Examination Priorities for 2019.  On December 20, 2018, the SEC announced its Examination Priorities for this year.  In 2019, the SEC intends to place emphasis on matters concerning digital assets, cybersecurity, and matters of importance to retail investors, including fees, expenses, and conflicts of interest.  Specifically, the SEC will focus on (i) compliance and risks in critical market infrastructure; (ii) retail investors, including seniors and those saving for retirement; (iii) FINRA and MSRB; (iv) cybersecurity; and (v) anti-money laundering programs.  We recommend speaking with your compliance firm to ensure your books and records as well as operations are in compliance with the securities rules.

SEC Adopts Final Rules Allowing Exchange Act Reporting Companies to Use Regulation A.  Regulation A provides an exemption from registration under the Securities Act for offerings of securities up to $50 million within a 12-month period.  On December 19, 2018, the SEC amended Regulation A to enable companies that are subject to the reporting requirements of Section 13 or 15(d) of the Securities Exchange to use Regulation A.  The amendments also permit such reporting companies to meet their Regulation A ongoing reporting obligations through their Securities Exchange Act reports.

SEC Proposes Rule Changes for Fund of Fund Arrangements.  On December 19, 2018, the SEC voted to propose a new rule and related amendments designed to streamline and enhance the regulatory framework for fund of fund arrangements.  The SEC’s proposal would allow a fund to acquire the shares of another fund in excess of the limits of Section 12(d)(1) of the Investment Company Act without obtaining an individual exemptive order from the SEC.  To rely on the rule, funds must comply with conditions designed to enhance investor protection, including conditions restricting the ability of funds to improperly influence other funds, charge excessive fees, or create overly complex fund of fund structures.

SEC Takes Action Against Robo-Advisers.  On December 21, 2018, the SEC settled proceedings against two robo-advisers for making false statements about investment products and publishing misleading advertising.  The proceedings were the SEC’s first enforcement actions against robo-advisers, which provide automated, software-based portfolio management services.

SEC Opens Registration in Compliance Outreach Seminar. The SEC will be sponsoring a seminar on May 16, 2019 as part of its compliance outreach program. The program seeks to aid chief compliance officers and other investment adviser or investment company personnel in the development of their compliance programs. The seminar will be held in Pittsburgh, Pennsylvania, and the topics include 2019 exam and enforcement priorities, common deficiencies, cybersecurity, and what to expect in an examination. Those interested in attending the seminar may register here.

CFTC Matters 

CFTC Releases a Primer about Smart Contracts. On December 11, 2018, LabCFTC, the CFTC’s hub for engagements with the FinTech innovation community, released a primer to help explain smart contract technology and related risks and challenges. The primer looks to provide a definition for smart contracts by looking at smart contract history, characteristics, and potential application in daily life.

NFA Adopts Proficiency Requirements for Swap-Related Associated Persons. On March 25, 2019, the NFA adopted an interpretive notice regarding its amendments to NFA Bylaw 301 and NFA Compliance Rule 2-24 which will implement changes to the NFA’s Swaps Proficiency Requirements. These new rules will go into effect on January 1, 2020 and will require all Associated Persons who engage in, or supervise activities involving, swaps at futures commission merchants, introducing brokers, commodity pool operators, commodity trading advisers, swap dealers, and major swap participants to take and pass a proficiency exam. The exam tests both market knowledge and knowledge of regulatory requirements, and there is no grandfathering provision within the new requirements. The new rules provide for two tracks of testing: the Long Track for swap dealers and the Short Track for all others. The NFA’s Swaps Proficiency Requirements must be completed by January 31, 2021.

NFA Amends its Interpretive Notice on Information Systems Security Programs. In March 2016, the NFA issued an interpretive notice requiring each member to adopt a written information systems security program (ISSP) to combat and effectively respond to unauthorized access of their information technology systems. On January 7, 2019, the NFA announced that it amended the notice to provide more clarification on ISSP approval and the corresponding training requirements for members. Additionally, the amended notice now requires NFA members (other than FCMs) to notify the NFA when certain cybersecurity incidents occur. The amendments to the March 2016 notice became effective April 1, 2019.

NFA Adopts Interpretive Notice Regarding CPO Internal Controls Systems. On April 1, 2019 the NFA adopted an interpretive notice applicable to CPO NFA members that have the ability to control customer funds. The notice specifically requires these CPO NFA members to implement an internal controls framework meant to protect customer funds and provide reasonable assurance that the CPO is in compliance with all CFTC and NFA rules, especially rules regarding maintenance of books and records for each commodity pool.

CFTC Announces 2019 Examination Priorities. On February 12, 2019, the CFTC announced its 2019 examination priorities–the first time the CFTC has done so in its history. In the announcement, the Division of Market Oversight (DMO), the Division of Swap Dealer and Intermediary Oversight, and the Division of Clearing and Risk each summarized their respective priorities. Of note, one of the DMO’s 2019 priorities include cryptocurrency surveillance practices.

Digital Asset Matters

SEC Commissioner Discusses Regulatory Considerations Concerning Digital Assets.  On February 8, 2019, SEC Commissioner Hester Peirce provided remarks concerning regulation and innovation.  Commissioner Peirce stated that digital asset tokens sold for use in a functioning network, rather than as investment contracts, fall outside the definition of securities.  Commissioner Peirce also acknowledged the uncertainty of the regulatory environment concerning digital assets as well as the novel challenges presented by digital asset trading platforms.  Additionally, Commissioner Peirce suggested that there will be further development of the digital asset regulatory environment in 2019.

SEC Issues a Public Statement on Digital Assets as Investment Contracts. On April 3, 2019, the SEC released a public statement discussing whether digital assets are considered securities by virtue of being offered and sold as investment contracts. The public statement references both a published framework of analysis by FinHub and a response to a no-action request by the Division of Corporation Finance. FinHub’s published framework identifies the relevant factors in determining whether a digital asset is offered or sold as an investment contract. Further, the no-action letter demonstrates the type of digital asset that the Division of Corporation Finance would not consider an investment contact or, accordingly, a security.

District Court Reconsiders Previous Ruling, Grants SEC Preliminary Injunction.  Last November, in what was seen as a victory for ICO issuers, a District Court denied the SEC’s attempt to obtain a preliminary injunction against a digital asset company, holding that the SEC failed to prove the company’s token was a security.  On February 14, 2019, the District Court reversed its position and granted a preliminary injunction to the SEC, holding that the contents of the company’s website, whitepaper, and social media posts concerning the company’s ICO constituted an offer of securities.

CFTC is Seeking Comments on Digital Asset Mechanics and Markets.  On December 11, 2018, the CFTC announced it is seeking public comment and feedback to better inform the CFTC’s understanding of the underlying technology, opportunities, risks, mechanics, use cases, and markets for virtual currencies beyond Bitcoin, namely Ether and its use on the Ethereum Network.  The CFTC is seeking to understand the similarities and distinctions between Ether and Bitcoin, as well as Ether-specific opportunities, challenges, and risks.

ICO Issuer Settles Unregistered ICO Charges After Self-Reporting to the SEC. On February 20, 2019, the SEC announced a settlement regarding an unregistered ICO by a company that raised over $12 million in digital assets in late 2017 to finance its operations. In the summer of 2018, the company self-reported to the SEC and cooperated with the SEC’s investigation. The SEC stated that it did not impose a penalty on the company because the company self-reported, agreed to compensate investors, and will register the tokens in compliance with securities laws.

Although the company conducted an ICO after the SEC released the DAO Report on July 25, 2017, the SEC’s decision to forgo fining the company suggests the SEC’s approach to the digital asset space is to focus on fraudulent conduct rather than stifling innovation in the space.

Nasdaq Offers Bitcoin and Ethereum Liquid Indices.  As of February 25, 2019, Nasdaq is offering spot Bitcoin and Ethereum indices, quoted in USD, based on real-time prices.  This move by Nasdaq, which lists over 3,300 companies and carries out approximately 1.8 billion trades per day, could serve as a step towards mainstream adoption of digital assets.

Florida Court Rules Direct Sales of Bitcoin Constituted Money Transmission.  On January 30, 2019, the Third District Court of Appeals in Florida held that an individual’s sale of Bitcoin for cash constituted money transmission and the sale of a payment instrument.  The Court held that since the seller was not licensed to act as a money services business, he could be charged with engaging in unlawful money transmitter services in connection with sales of Bitcoin for cash.

JPMorgan Creates Digital Asset Payment Coin.  On February 14, 2019, JPMorgan announced that it is the first U.S. bank to create and successfully test a digital coin representing a fiat currency, JPM Coin.  JPMorgan claims the JPM Coin will be used to make instantaneous payments using blockchain technology.  While JPMorgan claims that the JPM Coin is designed for institutional use and not for public investment, the company hopes to further develop JPM Coin’s utility in the future.

Other Matters 

FINRA Issues Panel Decision Regarding Transaction-Based Compensation. On January 29, 2019, FINRA’s Department of Enforcement released its decision in an enforcement hearing involving transaction-based compensation. In the decision, FINRA found that the respondent violated such  rules by paying compensation to (i) an unregistered finder’s non-member, unregistered entity and (ii) non-member, unregistered entities owned by its brokers. Additionally, FINRA held that the respondent failed to reasonably supervise its business and had inadequate written supervisory procedures that neither prevented nor detected deficiencies.

Atlanta Panel.  On April 24, 2019, Cole-Frieman & Mallon will be co-hosting a panel with Harneys and Trident Fund Services at Atlanta Tech Village.  The panel will cover developing topics in the investment management space including developments in the digital asset space, the rise of cannabis, and qualified opportunity zone funds.

Qualified Opportunity Zones.  This continues to be a hot topic:

Qualified Opportunity Fund Panel.  In February, Cole-Frieman & Mallon and Anderson Tax hosted a panel regarding qualified opportunity zone funds.  The panel addressed the tax and legal considerations that investment managers and investors should be aware of when creating or investing in a qualified opportunity zone fund.

IRS Holds a Public Hearing on Qualified Opportunity Funds.  On February 14, 2019, the IRS held a public hearing seeking input related to the first round of proposed rulemaking it issued in October 2018.  In the next round of proposed rules, the IRS is expected to provide (i) clarity on the definition of qualified opportunity zone business; (ii) data reporting requirements; (iii) clarity on interactions with other tax incentives; and (iv) guidance on interim gain reinvestment.  Further rule clarifications are expected in Spring 2019.


Compliance Calendar.


Please note the following important dates as you plan your regulatory compliance timeline for the coming months:

Deadline Filing
March 31, 2019 Deadline to update and file Form ADV Parts 1 & 2
April 10, 2019 Amendment to Form 13H due if necessary
April 15, 2019 1st Quarter 2019 Form PF filing for quarterly filers (Large Liquidity Fund Advisers)
April 30, 2019 Collect quarterly reports from access persons for their personal securities transactions
April 30, 2019 Distribute code of ethics and compliance manuals to employees.  Require acknowledgement form to be executed in connection with such delivery
April 30, 2019 Annual Privacy Notice sent to all clients or fund investors (for Advisers with Fiscal Year ending December 31)
April 30, 2019 Distribute audited financial statements to private fund investors that have not invested in fund of funds
April 30, 2019 Distribute Form ADV Part 2 to clients
April 30, 2019 Quarterly NAV Report (registered commodity pool operators claiming the 4.7 exemption)
April 30, 2019 Annual Form PF due date for annual filers (Large Private Equity Fund Advisers and Smaller Private Fund Advisers)
May 15, 2019 Quarterly Commodity Trading Advisor Form PR filing
May 15, 2019 File Form 13F for first quarter 2019
May 31, 2019 First deadline for Cayman Islands Financial Institutions to submit their CRS returns to the Cayman Islands Tax Authority
May 31, 2019 Third reporting deadline (full reporting) for Cayman Islands Financial Institutions with reporting obligations under the Cayman FATCA regulatory framework to report their U.S. Reportable Accounts to the Cayman Islands Tax Authority
June 29, 2019 Distribute audited financial statements to private fund investors that have invested in fund of funds
Variable Distribute copies of K-1 to fund investors
Periodic Filings Form D and Blue Sky filings should be current

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

Cole-Frieman & Mallon 2018 Third Quarter Update

Below is our quarterly newsletter. If you would like to be added to our distribution list, please contact us.

Clients, Friends, Associates:

We hope that you had an enjoyable summer. The past quarter saw further interest in digital assets from regulators, as well as enforcement actions and indications of possible regulatory changes. In the traditional investment management space, this summer saw a continuation of the bull market. As we move into the fourth quarter, we would like to provide an overview of items we hope will help you stay up-to-date with regulatory developments.

In addition to the discussion below, we would like to announce a couple of firm-related items:

  • CoinAlts Fund Symposium. In September, preceded by a well-attended Women in Crypto networking event sponsored by Coinbase, founding sponsor Cole-Frieman & Mallon hosted its third successful full day Symposium in San Francisco. Speakers including keynote Tim Draper, founder of Draper Associates, DFJ and the Draper Venture Network and Joe Eagan of Polychain Capital explored issues key to fund managers and investors in the digital asset space.
  • CFM San Francisco. We are delighted to announe our overflowing San Francisco team will shortly relocate to expanded premises at 255 California Street.


SEC Matters

SEC Chairman Hints at Changes in Investor Standards. On August 29, Securities and Exchange Commission (“SEC”) Chairman Jay Clayton spoke at the Nashville 36|86 Entrepreneurship Festival. He discussed issues the SEC is focused on or intends to focus on, including initial coin offerings (“ICOs”), promoting capital formation for public companies or companies considering going public, and rethinking the SEC’s current private offering exemption framework. Of note, Chairman Clayton stated that the SEC should explore how the current private offering exemption landscape could be simplified and streamlined. In particular, the Chairman noted that the SEC should examine the possibility of focusing on factors beyond investor wealth (i.e. accredited investor status), such as investor sophistication or investment amount.

SEC Releases Best Execution Deficiencies Alert. On July 11, the Office of Compliance Inspections and Examinations of the SEC released an alert outlining common deficiencies observed in examinations of advisers’ “best execution” obligations. These requirements come from the Investment Advisers Act of 1940, as amended, and impose a duty on advisers to execute trades so that total costs and proceeds are most favorable to clients. While best execution obligations depend on the facts of each situation, the SEC observed the following common deficiencies:

  • Not Performing Reviews – advisers were unable to provide evidence that they periodically and systematically reviewed the broker-dealers used to execute transactions.
  • Not Considering Materially Relevant Factors in Broker-Dealer Services – advisers did not consider the full range and quality of broker-dealers’ services.
  • Not Seeking Other Broker-Dealers – advisers often used only one broker-dealer for all of their clients without evaluating the services, quality, and costs of others.
  • Not Disclosing Best Execution Practices – advisers did not fully disclose best execution practices to their clients.
  • Not Disclosing Soft Dollar Arrangements – soft dollar arrangements (i.e. commissions in exchange for brokerage and research services) were not fully and fairly disclosed in advisers’ Form ADVs.
  • Not Properly Allocating Mixed Use Products and Services – advisers did not properly allocate the costs of mixed use products or services (i.e. products or services obtained using soft dollars, where that product or service is also used for non-investment purposes, such as accounting or marketing). Additionally, advisers did not properly document the reasons for mixed use product or service allocations.
  • Inadequate Policies and Procedures – advisers lacked policies, had insufficient internal controls, or did not have policies tailored to their investment strategy.
  • Not Following Policies and Procedures – advisers failed to follow their own best execution policies and procedures.

In light of the deficiencies listed above, advisers should review their best execution policies and procedures, and contact legal counsel or a compliance professional with any questions.

Hedge Fund Adviser Charged with Short-and-Distort Scheme. On September 12, the SEC charged a hedge fund advisor with illegally profiting from a “short-and-distort” scheme. The adviser is alleged to have released false information about a public pharmaceutical business after shorting the company. The adviser allegedly used reports, interviews, and social media to spread false claims that, for example, the pharmaceutical company was “teetering on the brink of bankruptcy”. The SEC is seeking a permanent restraining order, disgorgement of ill-gotten gains, and civil penalties.

SEC Charges Adviser for Risky Investments and Secret Commissions. On July 18, the SEC charged an adviser and its CEO with misleading investors by putting their capital in risky investments and secretly pocketing large commissions from such investments. The adviser and CEO are accused of misleading investors about the risks of the investments, overbilling, concealing financial conflicts, and violating the anti-fraud and registration provisions of federal securities laws. The SEC is seeking a permanent injunction, disgorgement of ill-gotten gains and losses avoided plus prejudgment interest, and civil monetary penalties. 

CFTC/NFA Matters 

CFTC Chairman Outlines Increased CFTC Enforcement. On October 2, the Commodities Futures Trading Commission (“CFTC”) Chairman Christopher Giancarlo summarized the CFTC’s increased enforcement efforts from the prior fiscal year in a speech to the Economic Club of Minnesota. These efforts include:

  • Enforcement Actions – in the prior fiscal year, the CFTC filed approximately 25% more enforcement actions than each of the prior three fiscal years.
  • Large-Scale Matters – the CFTC has increased enforcement actions against large-scale matters (i.e. matters that threaten basic market integrity). In the CFTC’s last fiscal year, it brought more than three times the average number of large-scale actions as the previous administration.
  • Manipulative Conduct – the CFTC has brought more than five times the previous average number of actions against manipulative conduct in the past fiscal year. Such conduct includes fraud, spoofing (i.e. bidding with the intent to cancel before execution), and the use of technology to manipulate order books.
  • Accountability – the CFTC has prioritized individual accountability, and approximately 70% of the past fiscal year’s cases involved charges against individuals who committed illegal acts.
  • Partnership with Criminal Enforcement – the CFTC has filed “far more actions in parallel” with criminal law enforcement partners than in any previous year.
  • Whistleblower Awards – with respect to whistleblowers, the CFTC has strengthened protections, granted a record number of awards, and received a record number of tips and complaints.

With these increased enforcement efforts in mind, managers of funds subject to CFTC jurisdiction should ensure they are up-to-date with CFTC filings and regulations.

CTA Associated Person and Introducing Broker Charged with Fraud. On August 10, the CFTC settled charges against an associated person of a commodity trading adviser (“CTA”) and introducing broker. The charges were based on a fraudulent trading scheme where the trader entered unauthorized commodities trades in customers’ accounts, transferred profitable trades to his own account, and left losses in the clients’ accounts. The settlement included a cease and desist order, a permanent ban from engaging in trading with any CFTC-registered entity, and a $100,000 civil monetary penalty.

Digital Asset Matters

Regulators continued to show interest and initiate enforcement actions in the digital asset space. Below is a summary of certain key digital asset items from the third quarter. For a complete review of these and other crypto developments, please consult our Third Quarter Digital Asset Regulatory Items blog post.

SEC Charges Digital Asset Hedge Fund Manager. On September 11, the SEC announced the settlement of charges against a digital asset hedge fund and its manager. The charges include misleading investors, offering and selling unregistered securities, and failing to register the hedge fund as an investment company. After being contacted by the SEC, the fund offered rescission and disclosed its previous misstatements to investors. The settlement included cease-and-desist orders, censure, and a $200,000 penalty. This is the first action the SEC has taken against a digital asset fund based on violations of the investment company registration requirements.

SEC Charges ICO Platform for Operating as Unregistered Broker-Dealer. On September 11, the SEC settled charges against an ICO platform. The business was charged with failing to register as a broker-dealer, as well as offering and selling unregistered securities. This is the SEC’s first charge against an unregistered broker-dealer in the digital asset space following the SEC’s 2017 DAO Report, which cautioned anyone offering or selling digital assets to comply with federal securities laws.

New York Attorney General Releases Report on Digital Asset Exchanges. On September 18, the Office of the Attorney General of New York (the “OAG”) released a report summarizing a crypto exchange fact-finding initiative. Based on the digital asset exchanges examined, the OAG outlined three primary areas of concern: potential conflicts of interest, lack of anti-abuse controls, and limited customer fund protection.

NFA Requires CPOs and CTAs to Disclose Digital Asset Activity. On July 20, the National Futures Association (“NFA”) released a notice that imposed new disclosure requirements on futures commission merchants, commodity pool operators (“CPOs”), and CTAs that are NFA members engaged in certain digital asset activities. The new disclosures cover, for example, the volatility and cybersecurity risks of digital assets. Additional details are available in our recent blog post.

Offshore Matters

Cayman Islands Delays AML Officer Deadline. Under new Cayman Islands requirements, investment funds that conduct business in or from the Cayman Islands must appoint individuals to new anti-money laundering officer positions. The Cayman Islands Monetary Authority (“CIMA”) has delayed certain deadlines for funds that launched prior to June 1, 2018:

  • CIMA-Registered Cayman Funds – registered funds still must have appointed the new officers by September 30, 2018, but now do not need to confirm the identity of the officers via CIMA’s Regulatory Enhanced Electronic Forms Submission (“REEFS”) portal until December 31, 2018.
  • Unregistered Cayman Funds – unregistered funds do not need to appoint the new officers until December 31, 2018, and they do not need to confirm the identity of these officers via the REEFS portal.

Funds formed on or after June 1, 2018 must have appointed the officers (and confirmed such officers through REEFS for registered funds) at launch. The new roles must be filled by individuals, and some service providers may be willing to provide individuals to serve such roles. We recommend fund managers discuss anti-money laundering compliance with offshore counsel and the fund’s administrator.

Other Matters 

FINRA Warns of Regulator Impersonators. On July 13, FINRA issued a warning that persons claiming to be working for FINRA have been calling firms and attempting to obtain confidential information. In particular, FINRA warned that the use of overseas telephone numbers or email addresses indicates a likely scam, as well as emails from suspicious domains that do not end with “” and that contain attachments or embedded links. If you have questions about the legitimacy of purported FINRA communications, contact your FINRA Coordinator.

New York Issues Sexual Harassment Compliance Mandate. Managers with operations in New York State and New York City should be aware of recent changes to employers’ obligations with respect to sexual harassment. Effective October 9, 2018, all employers in New York State are required to adopt a sexual harassment prevention policy equal to or greater than the standards of the state-issued model policy. Additionally, New York State employers must provide sexual harassment prevention training annually that is equal to or greater than the state-created model. This training must be completed by current employees by January 1, 2019, and by new hires within 30 days of being hired. Managers that may be subject to these new requirements can learn more on New York State’s Combating Sexual Harassment in the Workplace website. New York City has also implemented similar training requirements for employers with 15 or more employees, which will take effect on April 1, 2019. Additionally, effective September 6, 2018, New York City employers must post a sexual harassment poster and distribute a fact sheet to new employees.

SEC Charges Firm for Deficient Cybersecurity. On September 26, the SEC settled charges against a broker-dealer/investment adviser based on the firm’s deficient cybersecurity procedures after parties posing as contractors accessed customers’ personal information. The charges are a reminder of the importance of maintaining strong cybersecurity policies and procedures. Firms should be aware that cybersecurity is an on-going obligation and has become a focus of the SEC.

IRS Ends Voluntary Disclosure Program. On September 28, the Internal Revenue Service ended the 2014 Offshore Voluntary Disclosure Program (“OVDP”). U.S. taxpayers are required to report and pay taxes on certain offshore assets and face potential stiff criminal and civil penalties for failing to do so, and the OVDP was designed to offer taxpayers certain protections from these penalties. Fund managers with unreported foreign assets that were not able to meet the September 28, 2018 deadline should discuss their options with tax counsel.

New Law Expands Disclosure and Approval Requirements for Investments by Foreign Entities. On August 13, the Foreign Investment Risk Review Modernization Act (“FIRRMA”) was signed into law. It expands the scope of investments by non-U.S. investors in critical domestic tech companies that must be disclosed to and approved by the federal government in an effort to strengthen national security. An example investment within the scope of FIRRMA is an investment by a non-U.S. entity in a tech company that gives the investing entity access to material non-public technical information. While there are limits and exemptions to the scope of FIRRMA and the typical fund will not need to worry about its new requirements, venture funds with foreign limited partners or foreign co-investors should be mindful of the expanded approval requirements.


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


Deadline Filing
October 10, 2018 Form 13H amendment due for large traders if the information contained in the filing became inaccurate in Q3
October 15, 2018 Quarterly Form PF due for Large Liquidity Fund Advisers (for funds with December 31 fiscal year-ends) filing for Q3 2018 (if applicable)
October 15, 2018 Extended deadline to file Reports of Foreign Bank and Financial Accounts (FBAR)
October 30, 2018 Registered investment advisers must collect access persons’ personal securities transactions
November 14, 2018 Form PR filings for registered CTAs that must file for Q3 within 45 days of the end of Q3 2018
November 14, 2018 Form 13F is due for certain institutional investment managers
November 30, 2018 Form PF filings for Large Hedge Fund Advisers with December 31 fiscal year-ends filing for Q3 2018
November 30, 2018 Large registered CPOs must submit a pool quarterly report (CPO-PQR)
December 17, 2018 Deadline for paying annual IARD charges and state renewal fees
December 31, 2018 Small and mid-sized registered CPOs must submit a pool quarterly report (CPO-PQR)
December 31, 2018 Deadline for CIMA-registered Cayman funds formed prior to June 1, 2018 to confirm the identity of appointed anti-money laundering officers via REEFS; deadline for unregistered Cayman funds to appoint anti-money laundering officers
December 31, 2018 Cayman funds regulated by CIMA that intend to de-register (i.e. wind down or continue as an exempted fund) should do so before this date in order to avoid 2019 CIMA fees
Periodic Fund managers should perform “Bad Actor” certifications annually
Periodic Amendment due on or before anniversary date of prior Form D and blue sky filing(s), as applicable, or for material changes
Periodic CPO/CTA Annual Questionnaires must be submitted annually, and promptly upon material information changes

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