COLE-FRIEMAN & MALLON LLP
www.colefrieman.com

July 10, 2014

FATCA Transitional Period. The IRS and U.S. Treasury Department issued a notice (the “Notice”) announcing that calendar years 2014 and 2015 will be deemed a “transition period” with respect to IRS enforcement and administration of certain due diligence, reporting and withholding provisions of FATCA. In order to rely on this relief, the withholding agent, Foreign Financial Institution (“FFI”) or other subject entity must make a “good faith” effort to comply with FATCA requirements. In addition, the Notice:

• extended the cutoff date for “pre-existing obligations” to January 1, 2015 (however this extension not apply to individual accounts opened on or after July 1, 2014);
• provides transitional rules for documentation of expiration dates for account holders;
• relaxes the requirements for treatment as a “Limited FFI” or “limited branch”; and
• clarifies the requirements of a reasonable explanation of foreign status for an individual under FATCA.

Fund managers should work with their tax advisers, administrators and legal counsel to properly address the new account on-boarding and due diligence procedures required under FATCA, including updating their offering documents and subscription materials.

FATCA IRS Tax Forms. The IRS has finally issued instructions for new Form W-8BEN-E, one of the IRS forms that includes specific FATCA certifications investment funds will need to obtain from non-U.S. investors in order to satisfy their obligations under FATCA. U.S. withholding agents and FFIs will be required to begin withholding on payments beginning July 1, 2014. In addition, maintaining updated documentation regarding the FATCA status of the fund and its investors is necessary for FATCA compliance. Fund managers should make sure to use the new FATCA compliant IRS forms and applicable instructions to obtain information regarding non-U.S. investors prior to the deadline and for new investors after July 1, 2014. The new versions of Form W-8BEN for individuals and entities can be found on the IRS website (see Form W-8BEN and Form W-8BEN-E).

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. U.S. fund managers would need to structure their incentive fee arrangements with offshore funds based on a multi-year, rather than annual, calculation of the incentive fee. The incentive fee allocated in such manner would not be taxable until the fund shares are distributed to the manager pursuant to the terms of the SAR, i.e. until the manager actually receives the payment of the incentive fees.  However, once received, the value of the shares would be subject to U.S. income taxation as ordinary compensation and will not be eligible to be treated as capital gains irrespective of the underlying character of the gains 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.

Upcoming Deadline for an Annual Report of Foreign Bank and Financial Accounts (“FBAR”). Every U.S. person who holds a financial interest in or signature authority over any financial accounts outside of the U.S. with the aggregate maximum value exceeding $10,000 at any time during the calendar year must file an FBAR. “Financial account” includes mutual funds or similar pooled funds which issue shares to the general public and have a regular net asset value determination and regular redemptions. According to the IRS FBAR Reference Guide, foreign hedge funds and private equity funds are generally not reportable on the FBAR. However, a U.S. hedge fund itself, as well as officers and employees of the fund’s investment manager or general partner, may still have a filing obligation under certain circumstances. For instance, a U.S. feeder fund may have to file the FBAR if it owns more than 50% of a foreign master fund that owns a foreign bank account.

The FBAR for the 2013 calendar year has to be filed electronically on or before June 30, 2014. Certain individuals who have signature authority over, but no financial interest in, one or more foreign financial accounts (including officers and employees of the SEC-registered investment advisers who have only signature authority over foreign financial accounts) have been given an extension until June 30, 2015.

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 the following criteria:

1. The Delegating CPO must: (a) delegate all of its investment management authority with respect to the commodity pool to the Designated CPO; (b) not participate in the solicitation of participants for the pool; and, (c) not manage any property of the pool.

2. The Designated CPO is a registered CPO.
3. The Delegating CPO is not subject to a statutory disqualification from registration.

4. There is a business purpose for the Designated CPO being a separate entity from the Delegating CPO that is not solely to avoid CPO registration by the Delegating CPO.

5. The Designated CPO maintains the Delegating CPO’s books and records with respect to the commodity pool in accordance with Regulation 1.31.

In addition, depending on whether the Delegating CPO and Designated CPO are entities or individuals, one or both of the parties will need to comply with additional requirements.  The Delegating CPO seeking registration relief through the streamlined approach must submit a request to the CFTC’s Division of Swap Dealer and Intermediary Oversight using the forms attached to the no-action letter. Delegating CPOs who do not meet all the criteria may still submit a request for relief to the CFTC for review.

NFA Late Disciplinary Disclosure Fee. The National Futures Association (“NFA”) announced that effective on June 1, 2014 it will impose 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, NFA considers a matter to have been promptly disclosed if the firm, whether for itself or its associated persons (“AP”) and principals, discloses the matter before NFA discovers the matter and requests disclosure. The sponsor of a principal or AP is responsible for performing sufficient due diligence to ensure that all matters requiring disclosure are promptly disclosed as well as for the payment of the late disclosure fee. Managers that are members of NFA should make sure they have sufficient compliance policies in place to ensure that all disciplinary matters of the firm, its APs and principals 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.

Directors of Covered Entities should be contacted by the relevant registered office service provider for their Covered Entity, however, if you have not been contacted and you serve as a director for a CIMA registered fund you should contact your registered office provider or counsel. Individual directors must submit their applications no later than September 3, 2014.  Once registered, the director must provide certain information to CIMA and the annual fee of $855. Failure to comply with the director registration requirements under the DRLL is an offence and conviction carries a maximum fine of approximately $60,000 and/or up to 12 months imprisonment.

California Custody Rule. Effective April 1, 2014, a new custody rule (the “Rule”) applies to California-registered investment advisers (“RIAs”) deemed to have custody of client assets.  Generally, an RIA will be deemed to have “custody” of assets if it directly or indirectly holds client funds or securities or has the authority to obtain them, such as where an RIA can deduct fees directly from client accounts.

Under the Rule, RIAs with custody that manage pooled investment vehicles must provide notice of such custody on the Form ADV.  As well, these RIAs must implement certain additional practices pursuant to the Rule, including (1) maintaining client assets with a qualified custodian; (2) engaging an independent party to act in the best interest of investors to review fees, expenses and withdrawals; and (3) retaining an independent certified public accountant to conduct surprise examinations of assets.  RIAs also are obligated to provide certain quarterly statements to investors, with the first statements required to report Q2 2014.

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.

Segregation of Initial Margin for Non-Cleared Swaps. 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.

Washington State Amendments to Investment Adviser Regulations. On June 19, 2014, Washington State Department of Financial Institutions issued a notice regarding amendments of certain rules governing the registration and activities of investment advisers. The amendments update various provisions, including the requirements for financial reporting, custody, books and records, and unethical practices.

One of the amendments, effective July 13, 2014, provides an exemption from investment adviser registration for advisers solely to one or more qualifying private funds (excluding private funds that rely on the Section 3(c)(1) exemption from registration under the Investment Company act of 1940) or venture capital funds. In order to take advantage of the exemption, an investment adviser will need to make an annual exempt reporting adviser filing with the Washington Securities Division. Furthermore, the amendments codified the code of ethics requirements such that advisers registered with the Washington Securities division will need to adopt and implement and administer a written code of ethics. More information can be found here.

OTHER ITEMS

SEC Cybersecurity Initiative. On April 15, 2014, the SEC issued a risk alert announcing that it would conduct examinations of more than 50 registered investment advisers to assess cybersecurity preparedness in the securities industry and to obtain information about the industry’s recent experiences with certain types of cyber threats. The examinations will focus on the entity’s cybersecurity governance;identification and assessment of cybersecurity risks; protection of networks and information;risks associated with remote customer access and funds transfer requests;risks associated with vendors and other third parties;detection of unauthorized activity; and experiences with certain cybersecurity threats. This announcement reaffirms the SEC’s increased interest in cybersecurity preparedness of regulated entities-the concern that was initially raised and identified as an examination priority for 2014.

SEC’s Responses to the FAQs regarding the Volcker Rule. On June 10, 2014, the SEC provided some guidance regarding the recently implemented Volcker Rule by issuing responses to the frequently asked questions. Among other things, the guidance provides clarification regarding a banking entity’s ownership/interest in covered funds. The SEC may update or modify these questions and answers periodically.

Upcoming Second Circuit’s Ruling on Tippee’s Liability in Insider Trading Cases. On April 22, 2014, the Second Circuit Court of Appeals heard oral arguments in United States v. Newman, a joint appeal from two former hedge fund managers who were found guilty of insider trading. The issue on appeal is whether, in order to be convicted of insider trading, a downstream tippee of the material, non-public information (“MNPI”) has to know that the insider who leaked the information received a personal benefit from doing so. This case may implicate how far down a tipper/tippee chain prosecutors can go in prosecuting “remote tippees” for insider trading. In Newman, the appellants received and traded on MNPI, but they were four or five degrees removed from the initial source of the inside information. One of the appellants did not even know the identity of the sources. It is unclear how the Court will rule on the issue. If the Court rules for the appellants, the government will face a greater challenge to proving insider trading cases where the tippee is several degrees removed from the insider, which will likely decrease the number of the insider trading cases against downstream tippees. On the contrary, if the Court rules in favor of the government, hedge funds and trading firms may need to re-evaluate and revise their insider trading policies and the ways they receive information about securities.

Qualified Institutional Buyer (“QIB”). Although this is not a new rule, we receive frequent inquiries from managers regarding qualifying as a QIB for purposes of purchasing certain restricted securities exempted from the registration requirements of the Securities Act under Rule 144A (the “144A Securities”). In order for the broker to rely on Rule 144A, it must reasonably believe that the offerees/purchasers are QIBs and will usually require the manager to complete a QIB certification.

In general, a QIB is an entity that, acting for its own account of the accounts of other QIBs, owns and invests on a discretionary basis of at least $100 million in securities of issuers not affiliated with the QIB as of a specific date on or after the close of the entity’s most recent fiscal year. For these purposes, the aggregate value of securities is calculated on a cost basis, except where the entity reports its securities holdings in its financial statements on the basis of their market value, and no current information with respect to the cost of those securities has been published. In the latter event, the securities may be valued at market.

In order to be eligible to purchase 144A Securities, both the manager and each account for which orders are placed must be a QIB. This means that while the manager can aggregate its proprietary holdings and the assets it manages in determining whether the manager is a QIB, this determination is not useful unless each fund or account has $100 million in securities to qualify as a QIB as well. As a practical matter, if a manager’s fund or account is a QIB, the manager will also be a QIB, assuming it has discretion over the account.

SEC Charges Private Equity Firm with “Pay-to-Play” Violations.  On June 20, 2014, the SEC charged a Philadelphia-based private equity firm TL Ventures Inc. (“TLV”) with violating “pay-to-play” rules. Under these rules, investment advisers are prohibited from receiving compensation for advisory services from government entities for two years if the firm or its associates make contributions (above a certain de minimus threshold) to a government official who can influence the hiring of the investment adviser. TLV continued receiving advisory fees from two public pension funds within two years following campaign contributions made to the governor of Pennsylvania and a candidate for mayor of Philadelphia by a TLV associate. TLV has agreed to settle the charges by paying nearly $300,000. This is the first case the SEC brings under the “pay-to-play” rules after they were adopted in 2010.

The SEC Guidance on Application of the Custody Rules to Private Funds Using SPVs and Escrows.  The SEC has issued a guidance update (the “Update”) regarding the application of Rule 206(4)-2 of the Investment Advisers Act of 1940, as amended (“Custody Rule”) to special purpose vehicles used to facilitate investments in certain securities private funds (“Investment SPVs”) and escrows.

Investment SPVs: An investment adviser (“IA”) or its related persons can, in certain cases, treat the assets of an Investment SPV as assets of the pooled investment vehicles they manage and do not have to comply with the Custody Rule audited financial statement distribution requirements with respect to such Investment SPV. An Investment SPV may be treated as assets of the pooled investment vehicle as long as (1) the assets of this SPV are considered within the scope of the pooled investment vehicle client’s financial statement audit; and (2) the SPV has no owners other than the IA or IA’s related persons (i.e. investment funds that have owners other than an IA or IA’s related persons would not qualify).

Escrow Accounts:  The Update clarifies that maintaining client funds with other client and non-client assets in an escrow account in connection with a sale or merger of a portfolio company owned by a pooled investment fund would not violate the Custody Rule if the pooled investment vehicle relies on the audit provision of the Custody Rule and includes its portion of the escrow in its financial statements.  In addition, the escrow funds must be maintained at a qualified custodian and the certain escrow formalities are adhered to.

COMPLIANCE CALENDAR

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

Deadline              Description

June 1, 2014        Limited   partnerships    and    limited   liability   companies formed in                                      Delaware were required to pay an annual tax in the amount of $250 by June                             1 of each year. For the tax year 2015, the annual tax amount will be $300.

June 30, 2014      Delivery of audited financial statements to investors (fund of funds)

June 30, 2014      Annual Report of Foreign Bank and Financial Accounts (FBAR) Filing

July 30, 2014       Quarterly NAV Reports (CPOs claiming the 4.7 exemption)

August 14, 2014   Form 13F filing (advisers managing $100 million in 13F Securities)

August 14, 2014   CTA-PR filing with NFA

August 29, 2014   CPO-PQR filing with NFA

August 29, 2014   Form PF filing for quarterly filers

Periodic Filings      Form D and Blue Sky filings should be current

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

Sincerely,

Karl Cole-Frieman & Bart Mallon

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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
[email protected]          [email protected]
415-762-2841                              415-868-5345

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.                    

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.

The following are various hedge fund events happening this month.  Please email us if you would like us to add your event to this list.

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Date: July 2, 2014

• Sponsor: exane asset management
• Event: Education Session No 484 – Summer Cocktails at exane asset management
• Location: Paris, France

Date: July 2, 2014

• Sponsor: CACEIS
• Event: Education Session No. 483 – EMIR Regulation: The Impacts on Italian Financial Market
• Location: Milan, Italy

Date: July 8, 2014

• Sponsor: Chicago Board Options Exchange
• Event: Education Session No. 485 – Volatility Strategies: Is Now the Time to Be More Active?
• Location: London, United Kingdom

Date: July 9, 2014

• Sponsor: IMI
• Event: Alternative Investment Consultants Summit
• Location: Greenwich, CT

Date: July 9, 2014

• Sponsor: Bardays
• Event: Education Session No. 471 – Exploring Partnerships between Hedge Funds and Investors
• Location: New York, NY

Date: July 9, 2014

• Sponsor: IMI and HFA
• Event: IMI and Co-host HFA Present: 8th Annual Alternative Investment Consultants Summit
• Location: Greenwich, CT

Date: July 10, 2014

• Sponsor: J.P. Morgan Private Bank, C. Parker Gallery & Horseneck Liquors
• Event: Art, Champagne and Fundraiser for Cerebral Palsy International Research Foundation (CPIRF)
• Location: Geenwich CT

Date: July 12, 2014

• Sponsor: Hedge Funds Care – Help for Children
• Event: 9th Annual West Coast Bike Ride
• Location: San Francisco, CA

Date: July 15, 2014

• Sponsor: Incisive Media
• Event: FX Week USA
• Location: New York, NY

Date: July 15-16, 2014

• Sponsor: FMW
• Event: Risk Management for Non-Quants
• Location: Chicago, IL

Date: July 16, 2014

• Sponsor: Institutional Investor
• Event: Delivering Alpha
• Location: New York, NY

Date: July 17, 2014

• Sponsor: HFA
• Event: HFA Presentation: Navigating the Affordable Care Act
• Location: New York, NY

Date: July 17, 2014

• Sponsor: SEHFA
• Event: Networking Event
• Location: Atlanta, GA

Date: July 17, 2014

• Sponsor: Hedge Funds Care – Help for Children
• Event: Midwest Committee of Hope Bags and Tournament
• Location: Chicago, IL

Date: July 17, 2014

• Sponsor: Hedge Funds Care – Help for Children
• Event: Twin Cities Social Night
• Location: Minneapolis, MN

Date: July 21-23, 2014

• Sponsor: Opal Financial
• Event: Public Funds Summit East
• Location: Newport, RI

Date: July 21-23, 2014

• Sponsor: Opal Financial
• Event: Family Office & Private Wealth Management Forum
• Location: Newport, RI

Date: July 23, 2014

• Sponsor: Hedge Funds Care – Help for Children
• Event: 7th Annual Denver Golf Tournament
• Location: Littleton, CO

Date: July 24, 2014

• Sponsor: HFA
• Event: HFA Presentation: Navigating the Affordable Care Act
• Location: Stamford, CT

Date: July 24-25, 2014

• Sponsor: FRA
• Event: Winning & Retaining Institutional Mandates
• Location: New York, NY

Date: July 24-25, 2014

• Sponsor: Financial Research Associates, LLC
• Event: Winning and Retaining Institutional Mandates
• Location: New York, NY

Date: July 28-29, 2014

• Sponsor: FRA
• Event: Private Inv. Fund Acctg., Operations & Compliance Forum
• Location: New York, NY

 

Date: July 30, 2014

• Sponsor: Hedge Funds Care – Help for Children
• Event: New York Young Professionals Summer Event
• Location: New York, NY

 

Date: July 31-Aug 1, 2014

• Sponsor: Financial Advisor
• Event: Alternative Investments Strategies
• Location: Denver, CO

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Cole -Frieman & Mallon provides legal services for hedge fund managers and other groups within the investment management industry.  Bart Mallon can be reached directly at 415-868-5345.

 

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Date: April 28-May 1, 2014

• Sponsor: High Quest Partners
• Event: Global AgInvesting 2014
• Location: New York City. NY

Date: April 29-May 1, 2014

• Sponsor: Market Nexus Media
• Event: The Growth Capital Expo
• Location: Las Vegas, NV

Date: April 30-May 1, 2014

• Sponsor: LISA
• Event: 20th Annual Spring Life Settlement Conference
• Location: Washington, DC

Date: May 1-2, 2014

• Sponsor: Financial Research Associates
• Event: FRA’s ETP Distribution Summit
• Location: New York, NY

Date: May 3, 2014

• Sponsor: 100WHF
• Event: 100WHF Inaugural Cayman Gala to benefit Cayman Islands Crisis Centre
• Location: Grand Cayman, Cayman Islands

Date: May 5, 2014

• Sponsor: Mergermarket
• Event: Middle Eastern M&A Equity Forum 2014
• Location: Dubai, United Arab

Date: May 6, 2014

• Sponsor: Factset StreetAccount
• Event: Education Session No. 464 – Are Equity Valuations Overstretched?
• Location: Zurich, Switzerland

Date: May 6, 2014

• Sponsor: Hedge Funds Care – Help for Children
• Event: Spring Soiree
• Location: Boston, MA

Date: May 6-7, 2014

• Sponsor: Terrapinn USA
• Event: Private Equity World Latin America
• Location: Miami, FL

Date: May 7, 2014

• Sponsor: Managed Funds Association
• Event: Compliance 2014
• Location: New York, NY

Date: May 7-9, 2014

• Sponsor: IAA
• Event: IAA Annual Leadership Conference 2014
• Location: Palm Beach, FL

Date: May 8, 2014

• Sponsor: Hedge Funds Care – Help for Children
• Event: 12th Annual Midwest Open Your Hear to the Children Benefit
• Location: Chicago, IL

Date: May 13-14, 2014

• Sponsor: EVCA
• Event: EVCA CFO-COO Summit
• Location: London, United Kingdom

Date: May 12-15, 2014

• Sponsor: AFC & EMPEA
• Event: Global Private Equity Conference
• Location: Washington, DC

Date: May 13-16, 2014

• Sponsor: Skybridge Capital
• Event: SALT Las Vegas
• Location: Las Vegas, NV

Date: May 15, 2014

• Sponsor: MSCI
• Event: Education Session No. 449 – Factor Investing: The Next Wave
• Location: London, United Kingdom

Date: May 15, 2014

• Sponsor: CounselWorks
• Event: Education Session No. 473 – A Legislative and Regulatory Perspective
• Location: Boston, MA

Date: May 15, 2014

• Sponsor: Hedge Funds Care – Help for Children
• Event: HFC Southeast Wine Tasting
• Location: Atlanta, GA

Date: May 19-20, 2014

• Sponsor: Latin Markets
• Event: Private Equity Latin America Forum
• Location: New York, NY

Date: May 20, 2014

• Sponsor: 100WHF
• Event: After Hours Fundraising at the WellChild Garden at the Chelsea Flower Show 2014 sponsored by CQS in association with 100 Women in Hedge Funds
• Location: London, United Kingdom

Date: May 21-22, 2014

• Sponsor:  Financial Research Associates
• Event: FRA’s Private Investment Funds Tax Master Class
• Location: New York, NY

Date: May 29, 2014

• Sponsor: Alternative Investment General Counsel Summit
• Event: Strategies for In-House Counsel and CCOs From Fund Managers and Investors
• Location: New York, NY

Date: May 29, 2014

• Sponsor: Hedge Funds Care Ireland – Help for Children
• Event: HFC Ireland Launch Event!
• Location: Dublin, Ireland

Date: May 29-30, 2014

• Sponsor: Financial Research Associates
• Event: Mutual Fund Distribution Forum
• Location: Boston, MA

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Cole-Frieman & Mallon provides legal services for hedge fund managers and other groups within the investment management industry.  Bart Mallon can be reached directly at 415-868-5345.

California Requirements for Hedge Funds and Private Equity Funds Engaged in Lending Businesses

Investment advisers, private equity managers, private fund managers, and other businesses that are engaged in making loans should be aware of whether their activities fall under the purview of the lending laws of any state such that they would be required to obtain a license and comply with certain ongoing regulatory requirements.

Under California law, finance lenders (defined as “any persons who are engaged in the business of making consumer loans or making commercial loans”) and finance brokers (defined as “any persons engaged in the business of negotiating or performing any act as brokers in connection with loans made by a finance lender”) are required to obtain a California Finance Lenders License. Private investment funds, such as hedge funds and private equity funds, that engage in such activities are no exception.

Notwithstanding the foregoing, the California Finance Lenders Law (“CFLL”) exempts certain transactions from its licensing requirements. Lenders relying on these exemptions will be able to avoid a lengthy application process with the California Department of Business Oversight and its associated requirements and costs.

New and Existing Exemptions under the California Finance Lenders Law

Effective January 1, 2014, section 22050(e) of the California Financial Code was amended to exempt persons who make five or fewer commercial loans in a 12-month period, provided that the loans are incidental to the business of the person relying upon the exemption. This amendment expanded the previous de minimis exemption for any person making just one commercial loan in a 12-month period. As such, investment advisers, private fund managers, and other members of the investment management industry that occasionally provide commercial loans may take advantage of this expanded safe harbor as long as such loans are incidental to their primary business.

A full list of exemptions is set forth under Sections 22050 – 22065 of the California Financial Code, providing relief from CFLL regulation for other types of transactions and specific entities licensed by other regulatory agencies. Among those exempt are the following:

• Banks, trust companies, savings and loan associations, insurance premium finance agencies, credit unions, small business investment companies, community advantage lenders, California business and industrial development corporations, or licensed pawnbrokers;

• Loans made or arranged by persons licensed as a real estate broker by the state and secured by a lien on real property, or to any licensed real estate broker when making such loan;

• Commercial bridge loans made by a venture capital company to an operating company, subject to certain requirements.

If you are engaged in lending transactions, we encourage you to contact your legal counsel to determine if you are eligible for one of the exemptions under the CFLL.

Licensing and Regulation under the California Finance Lenders Law

Finance lenders unable to avail themselves of an exemption from CFLL regulation will need to submit an application to the California Department of Business Oversight. Currently, the application must include the following attached items:

• Balance sheet

• Surety bond in the amount of $25,000

• Proof of Legal Presence (for sole proprietor applicants)

• California Customer Authorization for Disclosure of Financial Records Form

• Fictitious Business Name Statement (if applicable)

• Certificate of Status or Good Standing in the applicant’s state of formation and in CA

• Partnership Agreement (for general partnership applicants)

• Federal Taxpayer Identification Number or Social Security Number (for sole proprietors)

• Organization Chart for the Applicant

In addition, each individual responsible for the applicant’s lending activities must complete a “Statement of Identity and Questionnaire” and provide fingerprints. The application fee is currently $200 (nonrefundable), plus an investigation fee of $100 and fingerprint processing fees ($20 per California resident; $80 per non-California resident).

It should be noted that the licensing process for residential mortgage providers (mortgage lenders and brokers) is a separate application, filed through the Nationwide Mortgage Licensing System.

Once approved, licensees are subject to periodic regulatory examinations for which they must pay; pay an annual assessment each year; file an Annual Report by March 15 of each year; are subject to statutory books and record requirements; and must maintain a $25,000 surety bond at all times.

If you are subject to licensing would like our assistance with obtaining a California Finance Lenders License, please contact us.

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Cole-Frieman & Mallon LLP provides legal services to hedge fund and private equity funds.  Bart Mallon can be reached directly at 415-868-5345.

Below is our end of the year update and checklist.  Please contact us directly if you would like to be added to the distribution list.

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www.colefrieman.com

December 4, 2013

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 2014 planning are particularly important, especially for General Counsels, CCOs and key operations personnel. As we head into 2014, 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:

* Regulatory & Other Changes in 2013
* Adviser Registration & Compliance
* CFTC Regulation
* Annual Compliance & Other Items
* Annual Fund Matters
* Annual Management Company Matters
* Compliance Calendar

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Regulatory & Other Changes in 2013:

Foreign Account Tax Compliance Act (“FATCA”). FATCA will require certain financial institutions to identify and disclose direct and indirect U.S. investors and withhold U.S. income tax on nonresident aliens and foreign corporations, or be subject to a 30% U.S. withholding tax on payments they receive from U.S. sources (the “FATCA Tax”). FATCA’s implementation deadline was delayed by six months, such that foreign financial institutions (including offshore funds), now have until April 25, 2014 to complete certain steps in order to avoid being subject to the FATCA Tax. Offshore fund managers should contact their tax advisers and compliance counsel to prepare for FATCA compliance and, if required, to register with the IRS before April 25, 2014. In addition, domestic fund managers should work with their tax advisers, administrators and legal counsel to properly address the new account onboarding and due diligence procedures required under FATCA, including updating their offering documents and subscription materials.

General Solicitation Ban Lifted. Earlier this year, the SEC issued long-awaited implementing regulations and other proposed rules relating to the Jumpstart Our Business Startups Act (“JOBS Act”), including most famously (and potentially least well understood), the New Rule 506(c) under Regulation D. New Rule 506(c) became effective on September 23, 2013, and it permits private investment funds to engage in general solicitation and advertising to the public, provided that the funds take “reasonable steps” to verify that all investors are “accredited investors.” Mere reliance on investors’ representations in a questionnaire or subscription agreement (the most common means of establishing accredited status among private investment funds that do not generally solicit) is insufficient. In addition, to rely on the New Rule 506(c), funds must amend their current Form Ds filed with the SEC to indicate that going forward they will rely on Rule 506(c).

Additional Proposed Rules. Beyond the accredited investor verification requirements noted above, the SEC has proposed several additional new rules in connection with Rule 506(c) offerings, including (i) requiring an “advance” Form D filing at least 15 days before generally soliciting; (ii) requiring a “closing amendment” to Form D at the conclusion of the offering; (iii) temporarily requiring funds to submit all general solicitation materials to the SEC in advance of their use; (iv) mandating that certain legends be included on all general solicitation materials; (v) automatically disqualifying an issuer from using Regulation D for one year if it fails to file a Form D; and (vi) increasing the information disclosed on Form D.

CFTC Issues. While the SEC’s New Rule 506(c) permits general solicitation under the conditions set forth above, the CFTC has yet to revise its rules to reflect this change. As such, managers that rely on the CFTC’s Rule 4.13(a)(3) exemption from registration as a CPO, and managers that are registered CPOs operating under the CFTC Rule 4.7 exemption, remain prohibited from marketing to the public in the United States.

Identity Theft “Red Flag” Rules. This year the SEC and CFTC jointly issued final rules (the “Rules”) that went into effect on November 20, 2013 requiring certain investment advisers and other regulated entities to develop and implement written identity theft prevention programs. The Rules stipulate that such programs should seek to detect, prevent and mitigate potential identity theft associated with accounts the advisers manage.

Application to Investment Advisers. The Rules are detailed and nuanced in nature, but they should generally only apply to investment advisers to the extent the advisers, pursuant to powers of attorney or other arrangements, are authorized by individual clients to direct payment of such clients’ redemption monies to third parties. For this reason, certain investment advisers are revising their offering documents to narrow the scope of the powers of attorney granted thereunder.

What is Included in a Program? To be compliant with the Rules, any program developed and implemented thereunder must include reasonable policies and procedures to identify relevant “red flags” (any activity indicating the possible existence of identity theft), and detect and respond appropriately to any red flags to prevent and mitigate identity theft. Further, the entity must train its staff to properly implement the program, and oversee service providers’ compliance therewith (by, for example, obtaining certifications from their administrators that the administrator understands, and is complying with, the program).

European Union’s Alternative Investment Fund Managers Directive (“AIFMD”). The AIFMD went into effect in July of this year, and generally subjects managers marketing alternative investment funds in the EU to heightened reporting and disclosure obligations. These obligations consist of providing pre-investment and ongoing disclosures to investors, complying with requirements affecting manager remuneration, and preparing annual and regular reports to an EU national regulator. In addition, managers may need to comply with the domestic implementing legislation of the jurisdiction where specifically targeted investors are located.

Certain countries, including the UK, Sweden and Germany (for existing funds as of July 22, 2013), are allowing a one-year transitional period delaying the application of the AIMFD to non-EU managers. Other jurisdictions have adopted much more stringent requirements to restrict marketing efforts by non-EU managers. If you are marketing to EU investors, you should carefully review the directive’s provisions as well as applicable national laws to make sure you comply with all requirements.

Dodd-Frank Protocols. The International Swaps and Derivatives Association’s Dodd-Frank Documentation Initiative aims to facilitate compliance with the Dodd-Frank Act. The Documentation Initiative minimizes the need for bilateral negotiations and reduces disruptions to trading by providing a standard set of amendments, referred to as protocols, to update existing swap documentation. 2013 brought compliance deadlines for two such protocols: the ISDA August 2012 Dodd-Frank Protocol (the “Protocol 1.0”), which had an effective compliance date of May 1, 2013, and the ISDA March 2013 Dodd-Frank Protocol (the “Protocol 2.0”) which had an effective compliance date of July 1, 2013. To indicate participation in Protocol 1.0 and Protocol 2.0, market participants must respond to each Protocol’s questionnaire, submit an adherence letter and pay an adherence fee of $500.00 per Protocol through the online ISDA Amend system. Detailed instructions for (i) Protocol 1.0 can be found here, and (ii) Protocol 2.0 can be found here.

Medicare Tax. As of the beginning of 2013, individuals, estates and trusts are subject to a Medicare tax of 3.8% on “net investment income” (or undistributed “net investment income”, in the case of estates and trusts) for each taxable year. For individuals, the 3.8% tax applies to the lesser of such “net investment income” or the excess of such person’s adjusted gross income (with certain adjustments) over a specified threshold amount. For estates and trusts, the 3.8% tax applies if such entities have undistributed “net investment income” above a certain threshold. Net income and gain attributable to an investment in private investment funds will likely be included in investors’ “net investment income” subject to this Medicare tax. Fund managers should contact their tax advisers and legal counsel to assess whether their corporate structure is ideally configured to reduce the impact of this 3.8% tax.

Adviser Registration & Compliance:

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 is 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.

CFTC Regulation: 

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 (Form CPO-PQR). Further, 2013 saw certain changes in CTA reporting, as the NFA now requires CTAs to file a quarterly Form CTA-PR within 45 days of the end of the quarter (the fourth quarter CTA-PR will be due on February 14, 2014). 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.

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 as 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, we recommend that managers also 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 a negative consent.

Annual Privacy Policy Notice. On an annual basis, a registered investment adviser must also provide its investors 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.

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, 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 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.

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 filing Schedule 13D and/or Section 16 filings, this is an opportune time to review your filings to confirm compliance and anticipate needs for Q1.

Form 13F. A manager must also 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. Form D has changed slightly this year in connection with the lifted ban on general solicitation discussed above. Instead of checking a box to indicate reliance on “Rule 506” there are now separate boxes to indicate reliance on either Rule 506(b) or Rule 506(c). Funds that previously selected “Rule 506” and do not wish to generally solicit will now check the “Rule 506(b)” box. Funds wishing to take advantage of the relaxed rules surrounding general solicitation will check the Rule 506(c) box. Importantly, the SEC has indicated that one offering cannot simultaneously rely on both Rule 506(b) and 506(c), and that once a general solicitation is made, issuers may no longer rely on Rule 506(b). 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 13, 2013 (submit payment by December 10 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 in regulatory AUM began filing Form PF in 2012. 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. This year, the 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.

Other 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 2013 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.

Management Company Issues:

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.

Compliance Calendar

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

Deadline                          Filing

November 20, 2013     “Red Flag” Rules effective

December 13, 2013     IARD Preliminary Renewal Statement Due (submit payment by Dec. 10 in order for payment to post by deadline)

February 14, 2014     Fourth Quarter CTA-PR Due

February 14, 2014     Schedule 13G Update Due; Form 13F Due (if applicable); Form 13H Amendment Due

March 1, 2014     Deadline for Re-Certification of CFTC Exemptions

March 3, 2014     Quarterly Form PF Due for Larger Private Advisers (if applicable)

March 31, 2014     Annual ADV Amendments Due

Periodic Filings     Form D and Blue Sky filings should be current

Please feel free to reach out to us if you have any questions regarding your end-of-the-year compliance. We wish you all the best as 2013 comes to a close.

Sincerely,

Karl Cole-Frieman & Bart Mallon

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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.

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 our notes on the past week.  If you have questions on any of these items, please feel free to contact us.

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Pay to Play Fee Prohibition Relief Granted

Pursuant to Pay to Play Regulations (Rule 206 (4)-5 under the Investment Advisers Act) a fund manager is prohibited from making political contributions in certain situations. If a fund manager (or employee of the fund manager) makes political contributions to an elected official who could influence the allocation of assets to the adviser, the manager is prohibition from receiving fees on those assets for two years from the date of the political contribution. Managers can, however, ask for relief in certain situations from the prohibition on collecting fees. In this order (summary below), the SEC permits the manager to receive fees based on the facts of situation:

An order has been issued on an application filed by Davidson Kempner Capital Management LLC (“DKCM”) under Section 206A of the Investment Advisers Act of 1940 and Rule 206(4)-5(e) thereunder. The order permits DKCM to receive compensation from three government entities for investment advisory services provided to the government entities within the two-year period following a contribution by a covered associate of DKCM to an official of the government entities.

Insider Trading – Hedge Fund Manager

In a press release, the SEC announced insider trading charges against a hedge fund trader. The trader had a consulting agreement with a former high-level employee of a public company. The former high-level employee maintained connections at the public company and passed along inside information which he received from friends within the public company. According to the release, the trader was able to avoid approximately $2.4 million in losses and make $853,655 in illicit profits by trading shares ahead of positive or negative news. The SEC’s complaint charges Megalli with violating the antifraud provisions of the federal securities laws, and seeks a permanent injunction, disgorgement with prejudgment interest, and financial penalties.  For more information, please see the SEC press release.

CFTC Approves Two Position-Limits Proposals

With a 3-1 vote, CFTC Commissioners approved Proposed Regulation on Position Limits for Derivatives. The proposed rulemaking would establish limits on speculative positions in 28 physical commodity futures contracts traded pursuant to the rules of a designated contract market (“DCM”) as well as swaps that are economically equivalent to those contracts, as mandated by the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010. Additionally, CFTC Commissioners unanimously approved the Proposed Regulations for Aggregation of Accounts Under Part 150, Position Limits. The comment period for these proposals is now open.  More information (including an overview and a Q&A sheet) can be found here.  

Futures Industry Releases Study on Insurance for Customer Accounts

After the MF Global and PFG implosions, we have become acutely aware that the SIPC does not insure customer accounts with respect to futures positions. No one does. So members of the futures industry commissioned a study on the viability of insurance for futures positions.  The main author of the study stated:

The objective of the study was to analyze and quantify the potential costs of various scenarios, including a government-mandated solution similar to what exists today in the securities industry as well as voluntary market-based solutions provided by private insurance companies. The study does not provide any policy recommendations, but the hope is that it will assist policy makers by clarifying the amount of insurance coverage that could be obtained through these solutions and the potential costs for each.

It is likely this is the first step towards some sort of insurance and protection mechanism for futures customers.  More information on the study can be found here.  Full text of the study can be found here.

FINRA Makes Broker Check Easier to Use

The Financial Industry Regulatory Authority (FINRA) announced that it has released an enhanced version of BrokerCheck that allows investors to more quickly access and more intuitively understand the professional background of investment professionals.  For more information, please see the FINRA release.

Next Week Items

Regulation S-ID Becomes Effective November 20, 2013 – for more information on the new red flag rules for certain SEC and CFTC registrants, please see this article from the ComplianceFocus blog.

SEC Announces Panelists for Small Business Forum – on Thursday, November 21, the SEC will again have an annual forum that focuses on the capital formation concerns of small business. A major purpose of the Forum is to provide a platform to highlight perceived unnecessary impediments to small business capital formation and address whether they can be eliminated or reduced.  There will be two panels throughout the day.  The first panel will focus on evolving practices in the new world of Regulation D exempt offerings. The second panel will focus on what might be next for small business and markets once the JOBS Act is fully implemented.  The forum agenda can be found here, and information on the panelists and what they will be discussing (powerpoint presentations) can be found here.

SEC Dodd-Frank Investor Advisory Committee Meeting – On Friday November 22, the SEC will have a meeting where a fiduciary duty standard for broker-dealers will be discussed as well as legislation to fund investment adviser examinations. The meeting will be webcast on the SEC website and more information can be found here.

Enforcement Proceedings

SEC 

• BD Rep Barred for Undisclosed Outside Business Activities – November 15, 2013.  A registered representative was effectively barred from the industry for, among other things, conducting an outside business activity without disclosing the activity to the representative’s employer and also for transferring customer assets to the outside business without the receiving the customer’s informed consent. The SEC order can be found here. 

CFTC

• Fraud Charges against Unregistered CPO – November 13, 2013. Among other items the unregistered CPO: (1) falsely claimed to have a successful and experienced trader for the pool, (2) misrepresented the likelihood of profits and the risks associated with trading commodity futures, (3) failed to disclose that they were not properly registered with the CFTC to operate a pool, and (4) failed to disclose their intended uses of pool participant funds. Press release can be found here.

• Forex Fraud Charges – November 12, 2013. The forex trader made many misrepresentions with respect to its trading and other aspects of firm operations, including that almost 80 percent of customer funds were never traded or invested in any manner. The forex trader also misappropriated over $3.3 million of customer funds to pay personal and entertainment expenses, including Las Vegas casino expenses, purchase automobiles and clothing, and ATM or cash withdrawals. Press release can be found here.

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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.  Bart Mallon can be reached directly at 415-868-5345.