Clients, Friends, Associates:

As we officially say goodbye to summer and enter the fall season, we would like to highlight some of the recent industry updates and occurrences that we found to be both interesting and impactful. While we strive to present an informative, albeit brief, overview of these topics to allow you to stay on top of the business and regulatory landscape in the coming months, we are also available should you have any related questions.

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SEC Matters

New Qualified Client Standard in Effect. The Securities and Exchange Commission’s (the “SEC”) revised dollar thresholds for Qualified Clients (as such term is defined in Rule 205-3 under the Investment Advisers Act of 1940) became effective on August 16, 2021. Specifically, the “net worth” threshold has been increased from $2,100,000 to $2,200,000 and the dollar amount for the “assets-under-management” test has been raised from $1,000,000 to $1,100,000. As a reminder, investment advisers in many jurisdictions, including SEC registered investment advisers (“RIAs”), are prohibited from charging performance fees and incentive allocations to investors who are not Qualified Clients. The new standard will not be applied retroactively to contractual relationships existing prior to the effective date of the Order, provided that if a new person or entity becomes a party to the contract, the new standard will apply with regard to that person or entity.

SEC Brings Action for Personal Information Exposures. The SEC settled three actions against eight firms after hackers exposed deficiencies in the firms’ cybersecurity policies and procedures. Each firm was charged with violating Rule 30(a) of Regulation S-P (the “Safeguards Rule”). The Safeguards Rule calls for SEC RIAs to adopt written policies and procedures to secure personal information and prevent unauthorized access. The SEC found that the firms either (i) failed to adopt the required policies and procedures or (ii) failed to follow their own internal cybersecurity policies and procedures. In addition, the SEC found two firms provided misleading notifications to clients regarding the length of time between when the breach was discovered and when notice was provided. Each firm in question has agreed to cease and desist from future violations, to be censured, and to pay fines. The SEC’s message was clear—written policies and procedures are insufficient to avoid liability if those policies are ignored or clients and customers are misled.

FINRA Member Fined for Failure to Retain Text Messages. In July 2021, a United Kingdom-based firm settled with the Financial Industry Regulatory Agency (“FINRA”) after FINRA alleged the firm failed to preserve “business-related text messages” sent between employees and customers. The settlement agreement states that employees used their personal cell phones to discuss business matters internally and with customers and failed to forward the messages to higher management and the compliance team for review and retention. This conduct violates Rule 17a-4 of the Securities Exchange Act of 1934, as amended (“Exchange Act”), which requires certain exchange members, brokers, and dealers to preserve all business records for three years. The violations were brought under FINRA’s purview through FINRA Rule 4511, which mandates that such exchange member, broker, or dealer’s record retention policy must adhere to the rules established in the Exchange Act. The blurring of business and personal communications through the use of texting and other instant messaging platforms, while convenient, adds a new layer of complexity regarding the preservation of business records. These actions emphasize the importance of investment advisers maintaining internal policies on the use of messaging platforms as a form of business communication and implementing appropriate retention methods.

SEC Brings Enforcement Action for Securities Fraud Against an Alternative Data Provider. Alternative data provider App Annie Inc. (“App Annie”) and its CEO have agreed to settle with the SEC following charges of securities fraud. App Annie is a seller of market data on mobile app performance such as number of downloads, usage rates and revenue figures (also referred to as “alternative data”). The Commission’s Order states App Annie’s “Terms of Service” provided certain limitations on how App Annie could compile and use its subscribers alternative data—specifically, App Annie represented that it would aggregate the data it received, thereby making the data “non-identifiable.” However, App Annie used non-aggregated data in contravention of its Terms of Service, and manually altered app performance estimates in order to increase the accuracy of the estimates it provided. In addition, App Annie assured potential and existing trading firm subscribers that it had safeguards in place to prevent the sharing and selling of material non-public information (“MNPI”), but failed to properly implement such internal controls. This conduct violates SEC rules for manipulative and deceptive practices (Rule 10b-5). The terms of App Annie’s settlement require the company to pay a $10 million fine and cease the creation of non-aggregated estimates. This and other recent SEC statements have shown the SEC’s increased focus on how alternative data is used in investment research and underscores the importance of advisers performing adequate due diligence on their data vendors to ensure the data they receive does not contain MNPI, rather than solely relying on representations made by such data vendors.

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Digital Asset Matters

Emergence of NFTs as an Area to Watch. Non-fungible tokens (“NFTs”) have seen a massive surge in interest over the course of the last year, with large companies, including the Fox Corporation, who invested $100 million into a creators’ fund for NFTs, and Google Cloud, who recently partnered with the operator of a NFT marketplace network, entering the market. However, with the growth in interest in the sector, the opportunities for malicious actors to profit has also increased, with certain marketplaces seeing an increase in wash sales and OpenSea, one of the largest NFT marketplaces, recently announcing that they have accepted the resignation of an employee who used inside information to profit on the purchase and sale of NFTs from his personal account. As the NFT ecosystem continues to grow, we are likely to see increased attention from regulators as they seek to protect investors.

Coinbase Files to become Futures Commission Merchant. On September 15, Coinbase Financial Markets Inc, a subsidiary of Coinbase Global, Inc. (“Coinbase”) filed an application with the National Futures Association (“NFA”) to register as a Future Commission Merchant. Coinbase announced their application via tweet, stating their next step is to “broaden our offerings and offer futures and derivatives trading on our platforms.” Other platforms offer futures and derivatives for cryptocurrencies, but if successful in their application, Coinbase would be one of the first cryptocurrency-specific exchanges to register as a Future Commission Merchant.

Amid Increased Regulatory Attention on Stablecoins, Coinbase Abandons Lend Product. Janet Yellen, the U.S. Secretary of the Treasury, spoke to regulators in late July, stating the U.S. government needs to establish rules for stablecoins, a rapidly growing class of cryptocurrencies that peg their value to an asset, often fiat currencies. As reported by Reuters early in September, the U.S. Treasury has begun discussions with financial industry executives to discuss potential regulation of stablecoins.

The SEC threatened a lawsuit against Coinbase if it continued to launch its Lend product, which would have offered interest on deposits of the stablecoin USDC. In recent weeks, Coinbase shared through its blog that it had attempted to discuss the matter directly with the SEC, but those discussions have not been productive. Coinbase’s CEO, Brian Armstrong, suggested in a series of tweets that the SEC has been unwilling to engage with Coinbase to offer guidance or clarify its position. In addition, the New Jersey Bureau of Securities has issued a Cease and Desist Order against BlockFi, Inc. (“BlockFi”) for its BlockFi Interest Account, alleging that they are engaging in the sale of unregistered securities in the form of cryptocurrency interest-earning accounts, and the Texas Securities Board has filed a Show-Cause Order alleging the same. While BlockFi offers interest on stablecoins and more traditional cryptocurrencies such as Bitcoin and Ethereum, it is clear their stablecoin interest accounts are part of the focus of the regulators as they each mentioned the interest rate offered on the Gemini dollar (GUSD) specifically in their Orders. While the BlockFi Orders are pending resolution and it is not yet known whether Coinbase plans to launch Lend in the future or to scrap the project entirely, it is clear that products offering interest on stablecoins and stablecoins in general are going to face increased regulatory scrutiny in the coming months.

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CFTC Matters

Update to NFA Branch Office Inspection Requirement and Physical Examination Requirement. In March 2020, the NFA issued Notice to Members I-20-12 exempting temporary work from home locations from being deemed a branch office of the registrant, thus exempting such locations from the substantive provisions of NFA Interpretative Notice 9002. Effective September 23, 2021, the NFA permanently codified this guidance (and allowed I-20-12 to expire) by revising NFA Interpretive Notice 9002, excluding from the concept of “branch office” “any location where one or more associated persons (“APs”) from the same household live or rent/lease (e.g., a shared or co-work space)” so long as certain requirements are met:

• the exempt location is not held out to the public as an office of the Member;
• the relevant APs do not meet in-person with customers at the exempt location;
• the relevant APs do not physically handle customer funds at the exempt location; and
• any CFTC or NFA required records created at the non-branch office location are accessible for inspection at the Member firm’s main or applicable listed branch office as required under CFTC and NFA rules.

In Notice to Members I-21-25, the NFA also extended through the end of 2021 its temporary relief of the requirement that a Member conduct an annual physical inspection of each of its branch offices. Although Members are still required to conduct an annual inspection of each branch office, Members may conduct such inspection remotely. Further, the NFA will also allow Members to conduct a remote inspection in 2022 if that Member’s “risk assessment indicates it is appropriate to do so,” and such assessment should explicitly take into account if no physical inspection has occurred during the prior two years.

Collectively, these modifications to NFA’s rules should, in the short-term, continue to permit NFA Members to prioritize COVID safety, while, in the long-term, allow NFA Members greater flexibility in offering remote work opportunities to their APs.

NFA Orders NY Introducing Broker to Pay Fines. A New York City Introducing Broker (“IB”) has been ordered to pay a $150,000 fine after the Business Conduct Committee (“BCC”) of the NFA uncovered a series of alleged record-keeping violations. The BCC Complaint stated the IB failed to meet NFA and CFTC compliance standards for “full, complete, and systemic records” pertaining to the IB’s commodity interest dealings. Specifically, the IB had limited their voice recording retention period to 96 hours for Associated Persons (“APs”) dealing in future and securities transactions. The Complaint further alleged that the IB failed to supervise record keeping activities and AP communications because the recording violations went undetected for 18 months. This action underscores the importance for NFA Members to not only implement, but also regularly test the effectiveness and adequacy of required policies and procedures.

CFTC Market Risk Advisory Committee Submits SOFR First for Consideration. The Commodities and Futures Trading Commission (“CFTC”) Market Risk Advisory Committee (“MRAC”) adopted SOFR First, a new market practice intended to transition trading conventions from LIBOR to Secured Overnight Financing Rate (“SOFR”). SOFR First was designed in response to recent global financial and banking supervisory guidance calling for market participants to move away from LIBOR, including, notably, “that banks cease entering new contracts that reference USD LIBOR post December 31, 2021.” The first two phases, related to linear swaps and cross currency swaps, were introduced on July 26 and September 21, respectively. To date, MRAC has not announced the rollout for phases three and four, which address non-linear derivatives and exchange traded derivatives. Interested parties should review the MRAC’s SOFR First Recommendation (found within the above hyperlink) which includes guidance on the types of products covered and best practices. In addition, as the LIBOR benchmark is phased out, fund managers should review their inventory of contracts to appropriately identify and amend LIBOR references. We recommend that you discuss the effective date of any contractual transitions and the specific remediation approach with your counsel.

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Offshore Matters

CIMA Issues Reminder to AML Officers. The Cayman Islands Monetary Authority (the “Authority”) has reiterated its expectation that relevant financial businesses adhere to the country’s Anti-Money Laundering Regulations (2020 Revision) (“AMLR”). Specifically, the Authority noted that “all Licensees and Registrants…are expected and required to ensure that their Anti-Money Laundering Compliance Officers (“AMLCOs”), Money Laundering Reporting Officers (“MLROs”) and their Deputies (together, the “AML Officers”) are aware of their respective duties and responsibilities as set out in the” AMLR. Such responsibilities include (i) the ability to dedicate sufficient time to effectuate their respective functions, (ii) the requisite foundational knowledge of the underlying business transactions needed to identify opportunities for money-laundering, terrorist financing, and other prohibited activity, and (iii) the need for adequate internal policies and procedures—even in situations where the AML Officer role is outsourced to an external third party. AML Officers are required by Cayman law to be management-level natural persons who report directly to a company’s Board of Directors or equivalent thereof. Companies must provide AML Officers with the access necessary to assess suspicious conduct and the authority to make final decisions on filing suspicious activity reports. Managers with Cayman funds should ensure that (i) the appropriate AML Officer roles are filled, (ii) such appointees have the necessary knowledge, expertise, and time to effectively carry-out their responsibilities, and (iii) internal policies and procedures are in place.

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Other Matters

California Lenders’ License Update. The California Department of Financial Protection and Innovation (“DFPI,” formerly known as the Department of Business Oversight) announced that starting on October 1, 2021 applications under California Financing Law (“CFL”) must be submitted through the Nationwide Multistate System and Registry (“NMLS”). Existing licenses such as company or branch licenses must be transitioned onto NMLS by December 31, 2021. Managers with CFL licenses should begin transitioning onto the NMLS if they have not already done so.

European Union Announces Delay of Sustainable Finance Disclosure Regulation (“SFDR”) Rollout. The EU’s SFDR will now be implemented on July 1, 2022, instead of January 1, 2022. The SFDR is a series of disclosure requirements for asset managers intended to increase the transparency of a fund’s sustainability and environmental impact. The 13 new standards (informally referred to as SFDR Level 2) are still in the drafting stage, but the EU plans to issue formal guidance in January 2022. Given its likely far-reaching and significant impact on the financial investment industry, SFDR Level 2’s rollout will be an important regulatory topic to keep an eye on.

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Compliance Calendar

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

Deadline	Filing
October 12	Amendment to Form 13H due if there were changes during Q3.
October 15	SEC deadline to file quarterly Form PF for Large Liquidity Fund Advisers, through PFRD.
October 30	SEC registered advisers must collect Transaction Reports from access persons for their personal securities transactions.
October 30	Registered CPOs must distribute (i) monthly account statements to pool participants (pools with net asset value of more than $500,000) and (ii) quarterly account statements to pool participants (pools with net asset value less than $500,000 or CPOs claiming the 4.7 exemption).
November 8	Investment adviser firms may view, print and pay preliminary notice filings for all appropriate states, through IARD.
November 15	NFA deadline to file Form PR for registered CTAs, through NFA EasyFile.
November 15	SEC deadline to file Form 13F for 3rd Quarter 2021.
November 29	SEC deadline to file quarterly Form PF for Large Hedge Fund Advisers, through PFRD.
November 29	CPO-PQR Form due for CPOs, through NFA EasyFile.
December 13	Deadline for paying annual IARD charges and state renewal fees, through IARD.
December 31	Cayman funds regulated by CIMA that intend to de-register should do so before this date to avoid 2022 CIMA fees.
Periodic	Fund Managers should perform “Bad Actor” certifications annually.
Periodic	Form D and Blue Sky Filings should be current.
Periodic	CPO/CTA Annual Questionnaires must be submitted annually, and promptly upon material information changes, through NFA Annual Questionnaire system.

Please contact us with any questions or for assistance with any of the above topics.

Sincerely,

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

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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 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 colefrieman.com.