www.colefrieman.com

December 29, 2014

Clients, Friends, Associates:

December is the busiest month of the year for most private fund managers. In addition to end of year administrative upkeep, the regulatory landscape has shifted dramatically over the past twelve months. As a result, year-end processes and 2015 planning are particularly important, especially for General Counsels, CCOs and key operations personnel. As we head into 2015, we have put together this checklist to help managers stay on top of the business and regulatory landscape for the coming year.

This overview includes the following:

• Annual Compliance & Other Items
• Annual Fund Matters
• Annual Management Company Matters
• Regulatory & Other Changes in 2014
• Focus for Next Year
• CFTC Regulation
• Compliance Calendar

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Annual Compliance & Other Items:

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 FINRA Rules 5130 and 5131.  Most managers reconfirm investors’ eligibility via negative consent (i.e. investors are informed of their status on file with the manager and are asked to inform the manager of any changes).  No response 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.  This reconfirmation can also be obtained through negative consent.

Annual Privacy Policy Notice.  On an annual basis, a registered investment adviser must provide its natural person clients with a copy of its privacy policy, even if there are no changes to the policy.

Annual Compliance Review.  On an annual basis, the CCO of a registered investment adviser 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 that you discuss the annual review with your outside counsel or compliance firm, who can provide guidance about the review process as well as a template for the assessment and documentation.  Advisers should be careful that sensitive conversations regarding the annual review 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.  Registered investment advisers (“RIAs”), or managers filing as exempt reporting advisers (“ERAs”), with the SEC or a state securities authority must file an annual amendment to Form ADV within 90 days of the end of their fiscal year.  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”.  Note that for SEC-registered advisers to private investment vehicles, a “client” for purposes of this rule include the vehicle(s) managed by the adviser.  State-registered advisers need to examine their state’s rules to determine who constitutes the “client”.

Switching to/from SEC Regulation.  

SEC Registration. Managers who no longer qualify for SEC registration as of the time of filing the annual amendment must withdraw from SEC registration within 180 days after the end of their fiscal year by filing Form ADV-W.  Managers should consult their state securities authorities to determine whether they are required to register in their home states.  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.

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

Practices under the Rule require specific implementation, and RIAs advising separately managed accounts will have different obligations than those generally outlined above.  Certain RIAs also may qualify for exemptions under the Rule, and thus RIAs are encouraged to consult with legal counsel about their specific obligations under the new regime.

Trade Errors.  Managers should make sure that all trade errors are properly addressed pursuant to the manager’s trade errors polices 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.

Custody Rule Annual Audit.

SEC Registered IA. SEC registered advisers must comply with certain 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.

Advisers to pooled investment vehicles may avoid both the quarterly statements and surprise examination requirements by having audited financial statements prepared in accordance with GAAP by an independent public accountant registered with the Public Company Accounting Oversight Board.  Statements must be sent to the fund or, in certain cases, investors in the fund, within 120 days after the fund’s fiscal year end.  Managers should review their custody procedures to ensure compliance with the rules.  Requirements for state-registrants may differ, and we encourage you to contact us if you have any questions or concerns about your custody arrangements.

California Registered IA. California-registered investment advisers that manage pooled investment vehicles and are deemed to have custody of client assets must, among other things, (1) provide notice of such custody on the Form ADV, (2) maintain client assets with a qualified custodian; (3) engage an independent party to act in the best interest of investors to review fees, expenses and withdrawals; and (4) retain an independent certified public accountant to conduct surprise examinations of assets.  Advisers to pooled investment vehicles may avoid the independent party and surprise examinations requirements by having audited financial statements prepared by an independent public accountant registered with the Public Company Accounting Oversight Board and distributing such audited financial statements to all limited partners (or members or other beneficial owners) of the pooled investment vehicle.

Advisers registered in other states should consult with legal counsel about those states’ custody requirements. 

Annual Re-Certification of CFTC Exemptions.  CPOs and CTAs currently relying on certain exemptions from registration with the CFTC will be required to re-certify their eligibility within 60 days of the calendar year end.  CPOs currently relying on CFTC Regulation 4.13(a)(3) will need to evaluate whether the commodity pool is still eligible for the exemption when taking into account the new CFTC regulated products. 

CPO and CTA Annual Updates. Registered CPOs and CTAs must prepare and file Annual Questionnaires and Annual Registration Updates with the 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 and CTAs must file their fourth quarter report on Form CTA-PR (the NFA recently made some changes to both forms, as described in a Notice to Members). 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 the corrected version must be promptly distributed to pool participants.

Schedule 13G/D and Section 16 Filings.  Managers who exercise investment discretion over accounts (including funds and separately managed accounts) that are beneficial owners of 5% or more of a registered voting equity security must report these positions on Schedule 13G.  Schedule 13G filings are updated annually within 45 days of the end of the year. For managers who are also making Schedule 13D filings and/or Section 16 filings, this is an opportune time to review your filings to confirm compliance and anticipate needs for Q1.

Schedule 13D is required when a manager is ineligible to file the short form Schedule 13G, and is due ten days after acquisition of more than 5% beneficial ownership of a registered voting equity security.

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 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 the SEC’s large trader thresholds (in general, 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 the 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.

SEC Form D.  Form D filings for most funds need to be amended on an annual basis, on or before the anniversary of the initial SEC Form D filing.  Copies of Form D can be obtained by potential investors via the SEC’s 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 renewal requirements.  States are increasingly imposing late fees or rejecting late filings altogether.  Accordingly, it is critical to stay on top of filing deadlines for both new investors and renewals.

IARD Annual Fees.  Preliminary annual renewal fees for state registered and SEC registered investment advisers are due by December 12, 2014 (submit payment by December 9 in order for payment to post prior to the deadline).

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 political contributions.  State and local governments are following suit, 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. Investment professionals (employees who spend at least one-third of their time managing the assets or securities of the manager) are statutorily excluded from California’s “placement agent” definition, and thus do not have to register as lobbyists. Note that managers offering or selling investment advisory services to local government entities have to register as lobbyists in the applicable cities and counties.

State laws on lobbyist registration differ widely, so we recommend reviewing your reporting requirements in the states in which you operate to make sure you are in compliance with the rules.

Form PF.  Managers to private funds that are either registered with the SEC or required to be registered with the SEC and have at least $150 million must file Form PF.  Smaller private advisers (fund managers with fewer than $1.5 billion in regulatory AUM) 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 regulatory AUM) must file Form PF within 60 days of the end of each fiscal quarter.

Electronic Schedule K-1s. The has IRS authorized 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 your investors electronically you should discuss your options with your service providers.

“Bad Actor” Recertification Requirement. Last year the SEC adopted bad actor disqualification provisions for Rule 506 of Regulation D. These new provisions provide that an issuer is disqualified from relying on Rule 506(b) and 506(c) of a Regulation D offering if the issuer or any other “covered person” has a relevant disqualifying event. Under the rule, fund managers are required to 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 issued a Q&A in December 2013 further clarifying, among other things, 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, for example, contractual covenants, bylaw requirements, or an undertaking in a questionnaire or certification. However, if an offering is continuous, delayed or long-lived, the issuer must update its 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 fund 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.

Annual Fund Matters:

Wash Sales. Managers should carefully manage wash sales for year end. Failure to do so could result in embarrassing 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 the 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 managed account agreement and the fund constituent documents.

NAV Triggers and Waivers.  Managers should promptly seek waivers of any applicable termination events set forth 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 2014 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.

Annual Management Company Matters:

Management Company Expenses.  Managers who distribute profits on an annual basis 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 important to reduce 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 Insurance or other liability insurance, the policy should be reviewed on an annual basis to make sure that the manager has provided notice to the carrier of all claims and all potential claims.  Also, newly launched funds should be added to the policy as appropriate.

Regulatory & Other Changes in 2014:

Second Circuit Overturns Insider Trading Convictions. On December 10, 2014, the Second Circuit Court of Appeals reversed convictions of two former hedge fund managers for insider trading; a result that may make it harder for prosecutors to prove the crime in the future.  The issue on appeal in the case – United States v. Newman – was whether, in order to be convicted of insider trading, a downstream tippee of the material, non-public information has to know that the insider who leaked the information received a personal benefit from doing so.  The three-judge panel ruled unequivocally that “a jury must find that a tippee knew that the insider disclosed confidential information in exchange for a personal benefit.”  This case will likely impact how far down a tipper/tippee chain prosecutors can go in prosecuting “remote tippees” for insider trading.

FATCA Updates.

Implementing Regulations.  Many jurisdictions in which offshore funds are commonly domiciled, such as the Cayman Islands and the British Virgin Islands, have entered into intergovernmental agreements (“IGAs”) with the U.S. regarding the Foreign Account Tax Compliance Act (“FATCA”).  Such IGAs generally provide that a foreign government office in the country of domicile will collect the information required by FACTA and transmit it to the IRS.  However, until each jurisdiction passes domestic implementing legislation to enact its IGA, it is often unclear exactly what information must be provided, how it will be collected, and to which government entity it should be directed.

In early July, the Cayman Islands passed such implementing legislation as well as corresponding regulations that detail a fund’s obligations.  BVI regulators released implementing legislation in October, but to date it has not been passed.  Managers should remain in touch with both U.S. and offshore fund counsel regarding the regulatory landscape and to plan any changes to the fund’s offering documents, and/or any investor communications that may become necessary.

UK FATCA. The United Kingdom and its Overseas and Crown Dependences, including the British Virgin Islands and the Cayman Islands, have entered into intergovernmental agreements (“UK IGAs”) to implement an automatic exchange of information for tax purposes.  These UK IGAs are similar to FATCA in that they will require investment funds domiciled in those jurisdictions to undertake due diligence and annual reporting on specified UK persons, however, unlike FATCA, there are no withholding taxes assessed in the event of non-compliance.

New Investors to funds will have to identify themselves as either a “Specified UK Person” or “Passive Non-Financial Foreign Entity”.  Funds ought to perform thorough searches on pre-existing investors regarding UK mailing addresses and UK account numbers.  Managers should discuss the implications with their tax advisor and legal counsel.

 Global FATCA. On October 29, over 50 jurisdictions (notably including the Cayman Islands and British Virgin Islands but excluding the United States) signed on to the Organisation for Economic Co-operation and Development’s (“OECD”) Multilateral Competent Authority Agreement (“MCAA”) for the implementation of the automatic exchange of tax information pursuant to the OECD’s Common Reporting Standard.

 Like many IGAs implementing FATCA, the MCAA requires each signatory jurisdiction to implement standardized customer due-diligence procedures and reporting requirements for financial institutions and to automatically exchange the reported information with other governments signatory to the MCAA. The MCAA will be activated when the tax authorities in each signatory jurisdiction confirm to the OECD that they have the necessary implementing legislation in place. The Cayman Islands’ implementing legislation discussed above should suffice for purposes of MCAA implementation as well.

The MCAA signifies the increasing global importance of tax transparency regimes like FATCA, and will result in expanded international tax compliance obligations for financial institutions in signatory jurisdictions. Managers should monitor the OECD’s website (available here) for implementation updates.

SEC Guidance on “Reasonable Steps” to Verify Accredited Investors. We receive a lot of questions about general solicitations, but few managers have actually taken steps to engage in them. In order to engage in general solicitation under Rule 506(c), fund managers must, among other items, take “reasonable steps” to verify that each subscriber for fund interests meets the accredited investor standard. The SEC has previously described “safe harbors” with steps that, if followed, constitute sufficient evaluation of a prospective investor’s accredited investor status. The SEC this year released a new Q&A that addresses common questions regarding income and net worth calculations under the safe harbor rules.   

AIFMD Annex IV Reporting. The European Union’s Alternative Investment Fund Managers Directive (“AIFMD”), generally requires alternative investment fund managers (“AIFMs”) that manage or market alternative investment funds (“AIFs”) to EU investors to comply with heightened reporting and disclosure requirements. Notable is the imposition of a new Annex IV reporting requirement on AIFMs with assets under management of at least €100 million. Annex IV is a large complex filing, similar to the Form PF filed with the SEC, and it must be filed either semiannually or quarterly (depending on various factors) in each EU Member State where AIFs are marketed. The first Annex IV filings are due no later than January 30, 2015.

Annex IV requires substantial information reporting, and although it shares almost 60% of data points with Form PF, a number of differences (including differences in how AUM is calculated) prevent merely transferring Form PF data to Annex IV.

The UK’s Financial Conduct Authority (“FCA”) recently issued guidance specifying that managers marketing an AIF in the UK that is a feeder fund need only report on the assets of the feeder (whose only investment may be the master fund) on Annex IV, significantly reducing the burden of such reporting.

NFA Late Disciplinary Disclosure Fee. This year the NFA began imposing a $1,000 late fee when a firm or individual does not disclose a disciplinary matter upon registration or fails to promptly update an existing registration to disclose a new disciplinary matter. Generally, the NFA considers a matter to have been promptly disclosed if the firm discloses the matter before the NFA discovers the matter and requests disclosure. Managers that are members of the NFA should make sure they have sufficient compliance policies in place to ensure that all disciplinary matters are promptly disclosed.

Cayman Islands Revised Licensing Regime. The Directors Registration and Licensing Law (the “DRLL”), effective as of June 4, 2014, established a new registration and licensing regime for directors of certain Cayman Island regulated entities, including directors of entities registered as mutual funds with the Cayman Islands Monetary Authority (“CIMA” and such entities “Covered Entities”).  The DRLL does not, at present, apply to Covered Entities which are partnerships.  All directors of Covered Entities will need either to (i) register with CIMA; or (ii) apply to be licensed by CIMA in the case of corporate directors, or directors acting for 20 or more entities.

NFA Pursuing Net Capital Requirements for CPOs and CTAs.  The NFA is currently in the process of reviewing comments submitted on a proposal that would require CPOs and CTAs to maintain minimum amounts of capital and follow other customer protection measures. While the full scope of the proposed regulations has yet to be determined, likely changes to the regulatory regime include requirements that (1) CPOs and CTAs maintain a minimum amount of capital and file periodic reports with the NFA to demonstrate compliance; and (2) CPOs retain an independent third party to approve pool disbursements (i.e., a “gatekeeper” requirement).  For more information, please see our article and the NFA notice.

Amendments to FINRA Rule 5131.  FINRA has issued amendments to its Rule 5131, which bans certain practices related to allocating and distributing shares in initial public offerings.  Pursuant to the amendments, FINRA now may exempt a person from any provisions of Rule 5131 if, in light of the facts and circumstances, FINRA deems an exemption to be consistent with the protection of investors and the public interest.  As a result, FINRA members may apply for relief from Rule 5131.

Deferral of Tax on Incentive Fee Arrangements with Offshore Funds. On June 10, 2014, the IRS issued a ruling which may expand the ability of U.S. managers to offshore funds to defer performance-based compensation through nonstatutory stock options and stock-settled stock appreciation rights (“SAR”) in the offshore fund. Managers that want to explore the alternative fee arrangement should discuss the implications with their tax advisor and legal counsel.  More information can be found here.

Focus for Next Year:

Cybersecurity Focus.  Cybersecurity preparedness was a major focus of the SEC’s Office of Compliance Inspections and Examinations in 2014.  Awareness about the dangers posed by inadequate cybersecurity to capital markets is growing.  Both the SEC and the North American Securities Administrators Association (“NASAA”) put particular emphasis on the type of hardware and forms of communication that are used at firms.  Additionally, the SEC and NASAA recommend that firms should have a written policy regarding cybersecurity prevention and how to respond to an attack. Although 2014 is quickly coming to an end, cybersecurity preparedness will continue to be a concern for investment managers.  Managers should make sure they have sufficient policies in place regarding cybersecurity prevention and response.

SEC Charges Fraud and Breach of Fiduciary Duty for Improper Expense Sharing Among Funds. This year, the SEC charged a fund manager, Lincolnshire Management, with violating fraud and policy requirement provisions of the Investment Advisers Act, and breaching its fiduciary duty to a pair of private equity funds that it managed, by sharing portfolio company expenses in a way that benefited one fund over the other.  The factual situation was that each fund owned a separate portfolio company, but the manager integrated the portfolio companies and operated them as one.  However, an SEC investigation found that the expense allocation practices between the two funds occasionally caused one fund to pay more than its fair share of joint expenses that equally benefited both funds’ portfolio companies.  The SEC found that this preferential practice of commingling the funds’ assets violated the manager’s fiduciary duty to the funds.  In September, Lincolnshire Management settled the SEC’s charges for more than $2.3 million.  In light of this settlement, fund managers should be cognizant that fiduciary duties are owed separately to each fund, and that shared but uneven expense allocations may be recognized not only as a breach of fiduciary duties, but also as defrauding the investors that overpaid.

CFTC Regulation:

CFTC Grants Relief for General Solicitation.  After the JOBS Act relaxation of the general solicitation rules, fund managers exempt from CPO registration pursuant to CFTC Regulations 4.13(a)(3) or 4.7 were still prohibited from engaging in general solicitation with respect to the offering of private fund interests under Rule 506(c). However, a recent CFTC Letter 14-116 now allows such fund managers to engage in public offerings under Rule 506(c) without risking their exemptions, subject to the following conditions:

1. The fund issuing interests must do so under Rule 506(c) or as a reseller under SEC Rule 144A.
2. The fund manager must file a notice with the CFTC.
3. The fund manager must represent that it meets all other requirements of the CFTC exemption on which it is relying.

Fund managers utilizing the CFTC Regulation 4.13(a)(3) exemption should take special note of the third requirement listed above. Even under the relief granted by CFTC Letter 14-116, such managers must refrain from marketing funds “as or in a vehicle for trading in the commodity futures or commodity options markets.”

SEC Guidance on Cross-Border Security-Based Swaps. Last year the CFTC issued guidance on cross-border swaps transactions. This guidance did not apply to security-based swaps, which are regulated instead by the SEC. Now the SEC has adopted final rules governing cross-border security-based swaps. This set of rules is the first in what is expected to be a series of SEC rules on these transactions, and it covers only a few select topics, including certain compliance-related rules and which entities must register as security-based swap dealers or security-based major swap participants. Although the rules technically went into effect on September 7, 2014, they will not have practical effect until the SEC adopts additional final rules on topics such as the actual registration process for security-based swap dealers and security-based major swap participants.

 CFTC Announces Streamlined Approach for Considering Requests for Relief From Registration for Delegating CPOs. In May, the CFTC issued a no-action letter adopting a streamlined approach for requesting CPO registration relief. The letter clarifies the conditions under which a CPO otherwise required to register (“Delegating CPO”) may delegate its CPO functions to another CPO (“Designated CPO”) and be relieved from a registration requirement under Section 4m(1) of the Commodity Exchange Act (the “CEA”). To request a relief through the streamlined approach, the Delegating CPO and its Designated CPO must meet a number of criteria. CPOs wishing to request relief under this streamlined approach should consult with their legal counsel.

Segregation of Initial Margin for Non-Cleared Swaps. This year, the CFTC adopted new rules relating to segregation of initial margin with respect to non-cleared swap transactions. Under these new rules, a swap dealer (“SD”) is required to segregate the initial margin of non-cleared swaps at a third-party custodian upon request from its swap counterparties (the “Segregation Rule”). The Segregation Rule requires the SD to notify counterparties of the right to require segregation of initial margin and to provide one or more non-affiliated custodians and price information for each. An SD will be required to obtain confirmation of notification and election prior to entering into any swap transaction, however a counterparty may change its election at any time.  If a counterparty elects segregation, the counterparty and SD must put in place a tri-party custodial agreement between the SD, counterparty and custodian to segregate the initial margin, which must include certain specific CFTC prescribed provisions. More information can be found here.

Compliance Calendar:

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

Please feel free to reach out to us if you have any questions regarding your end-of-the-year compliance. We will you all the best as 2014 comes to a close.

Sincerely,

Karl Cole-Frieman, Bart Mallon & Lilly Palmer

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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 has an international practice that 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, and venture capital 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: www.colefrieman.com.

Cole-Frieman & Mallon LLP

One Sansome Street, Suite 1895

San Francisco, CA  94104

     Karl Cole-Frieman                                   Bart Mallon                                             Lilly Palmer

[email protected]                 [email protected]                  [email protected]

415-762-2841                                    415-868-5345                                          415-762-2845

This newsletter is published as a source of information only for clients and friends of the firm and should not be construed as legal advice or opinion on any specific facts or circumstances.  The mailing of this publication is not intended to create, and receipt of it does not constitute, an attorney-client relationship.  Circular 230 Disclosure: Pursuant to regulations governing practice before the Internal Revenue Service, any tax advice contained herein is not intended or written to be used and cannot be used by a taxpayer for the purpose of avoiding tax penalties that may be imposed on the taxpayer.  Cole-Frieman & Mallon LLP is a California limited liability partnership and this publication may be considered attorney advertising in some jurisdictions.

Please see below information on the Seattle Investment Association event on November 20th.

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The Seattle Alternative Investment Association, together with the CFA Society of Seattle, invites you to join us on November 20th, 2014 for the 3rd Annual Alternative Investments Summit.  Joshua Harris, Senior Managing Director and Co-Founder of Apollo Global Management will be sharing his views as to “Identifying Private Equity Opportunities in a Challenging Market.”  Mr. Harris is also the Managing Partner of the Philadelphia 76ers, and a member of the Federal Reserve Bank of New York Investors Advisory Committee on Financial Markets.

When: Thursday Eve November 20th, 2014
Registration and Networking: 5:30 to 6:15pm
Program: 6:15 – 7:30pm
Where: The Fairmont Olympic Hotel
411 University Street
Seattle, WA 98101

Special Room Rate for Summit Attendees: $209 per night

More details and registration for this event can be found on our website:
https://www.gosaia.com/events/

Would you like to become a Sponsor for this event?  Contact us: [email protected]

This event is sure to sell out, so please take a moment and register!  If you are already an SAIA member; just click ‘register’ once you log in.

$30 for CFA Members
$75 for Non-Members

We look forward to seeing you on November 20th.

This Event is Co-Hosted with the CFA Society of Seattle.

A special thank you to our Platinum Sponsor, PricewaterhouseCoopers LLP. 

Additional Sponsors include UMB Fund Services, Precedent Consulting, Bank of America Merill Lynch, BlackRock, BNP Paribas and Deutsche Asset & Wealth Management. , 

Academic Sponsors include University of Washington Applied Mathematics and Pacific Lutheran University Science in Finance. 

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Cole-Frieman & Mallon LLP provides legal advice to the managed futures industry and works with FCMs, IBs, CPOs, and CTAs.  Bart Mallon can be reached directly at 415-868-5345.

Doing Business with Non-Members – NFA Action Raises Compliance Questions

Under NFA Bylaw 1101, NFA members are restricted from doing business with individuals or entities that should be, but are not, registered with the CFTC and members of the NFA. In a recent action against a forex firm, the NFA shed some light on its enforcement approach to this rule (among other issues).

Note that this action deals with the NFA rule on doing business with non-members as it applies specifically to Forex Dealer Members (under NFA Compliance Rule 2-36(d)). However, the NFA’s enforcement approach here is analogous to the way it views the rule for all NFA members.

The Complaint

The alleged fact pattern: a firm registered as a Forex Dealer Member, Forex Capital Markets LLC (“FXCM”), was approached by the general partner of Revelation Forex Fund LP (“Revelation”) to open an account. FXCM initially declined to open the account after determining that Revelation’s general partner was not registered as a CPO. FXCM instructed Revelation to contact the NFA regarding its registration requirements. Following this, Revelation’s general partner filed with the NFA a CPO registration exemption – the de minimis exemption under CFTC Rule 4.13(a)(3). FXCM then agreed to open an account for Revelation.

Describing these facts, the NFA stated “It is apparent that FXCM did not take adequate steps” to evaluate the registration status of Revelation’s CPO. The NFA also stated “FXCM should have questioned whether [Revelation] qualified for the de minimis exemption. Had FXCM done this, it would have been apparent to FXCM that [Revelation] did not meet the de minimis requirement of 4.13(a)(3) as it exclusively traded forex – and not in a de minimis amount – and was marketed to the public.”

Analysis – Compliance Implications

The facts of the action as alleged by the NFA certainly make Revelation’s eligibility for 4.13(a)(3) sound suspect. Assuming that FXCM knew Revelation’s business was primarily (or exclusively) trading forex, it does not seem reasonable that FXCM took Revelation at its word that it qualified under 4.13(a)(3). More broadly, though, this action raises important questions for what constitutes “adequate” compliance steps to evaluate a business associate’s reliance on a registration exemption.

Specifically, what did the NFA mean when it said an NFA member should “question” whether a business counterparty qualifies for its claimed exemption? One thing is clear: it is not sufficient to merely request proof that an exemption has been filed. But how far must one go? For example, assume an NFA member does business with a registered CPO that relies on the exemptive relief under CFTC Rule 4.7, which requires all investors to be Qualified Eligible Persons (“QEPs”). How does an NFA member “question” this exemption? Must it request a representation – or even some kind of evidence – that the CPO’s pool investors are QEPs?

Another scenario: assume an NFA member wants to do business with a CTA that relies on the exemption under CFTC Rule 4.14(a)(10), which limits the number of clients to 15 in a rolling 12-month period and forbids holding oneself out to the public as a CTA. Would the NFA member have to ask this CTA for representations and/or information on its number of clients? Should it review the CTA’s website and other public-facing materials? It is unclear what degree of diligence the NFA would deem “adequate” here.

Practical Take-Aways

 In terms of interpreting NFA rules, this NFA action probably raises more questions than it answers. However, one practical consequence that is likely is that NFA member firms – especially FCMs and Introducing Brokers with a high volume of new account openings – will implement increasingly stringent account opening procedures for customers that rely on registration exemptions.

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Cole-Frieman & Mallon LLP acts as legal counsel to the investment management industry.  If you have questions on the above please contact us or call Bart Mallon directly at 415-868-5345.