Cole-Frieman & Mallon 2020 End of Year Update

December 16, 2020

Clients, Friends, Associates:

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

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

This update includes the following:

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


CFM & Aspect January Compliance Update Event

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

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

Topics will include:

  • Trends and happenings in the industry impacting fintech companies, broker dealers, investment advisors and fund managers
  • Major issues from the SEC and courts in 2020
  • The year of Bitcoin and DeFi
  • Fintech regulations and best practices
  • Other hot topics


Sexual Harassment Training Required under California Law

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


Annual Compliance & Other Items

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

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

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

Switching to/from SEC Regulation.

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

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

Custody Rule Annual Audit.

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

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

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

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

California Minimum Net Worth Requirement and Financial Reports.

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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


Annual Fund Matters

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

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

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

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

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

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

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

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

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

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


Annual Management Company Matters

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

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

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

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

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


Regulatory & Other Items from 2020

SEC Updates.

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

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

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

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

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

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

Highlights of the amendments include:

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

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

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

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

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

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

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

CFTC and NFA Updates.

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

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

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

The new rules are effective February 5, 2021.

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

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

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

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

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

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

Digital Asset Updates.

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

Coinbase Eliminated Margin Trading; Will Others Follow? As we previously discussed, the CFTC considers certain digital currencies (including Bitcoin and Ether) to be “commodities” within the definition of the Commodity Exchange Act of 1936, as amended. In 2017, the CFTC took action against the Bitfinex platform on the basis that the platform dealt in “retail commodity transactions”— leveraged, margined or financed transactions involving a commodity that are offered to persons that are not “eligible contract participants” — without being registered as a “futures commission merchant” with the CFTC. However, certain retail commodity transactions are exempt from CFTC jurisdiction if the seller “actually delivers” the commodity to the buyer within 28 days of the date the contract was entered into.

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

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


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

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

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


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

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

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