SEC Compliance Manual Violations Mean Enforcement Action for Investment Adviser

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Manager Subject to Enforcement Action for Compliance Manual and Books and Records Violations

The SEC recently announced a settlement with a former federally registered Investment Adviser that will, among other things, bar the firm and its sole owner from the financial services industry for two years. Citing violations of the Investment Advisers Act, perhaps the SEC’s most impactful charge involved lack of compliance with Rule 206(4)-7, which requires a firm to adopt and implement written policies and procedures reasonably designed to prevent violations of the Advisers Act and its rules.

Background

The respondent, Barthelemy Group LLC (“the firm”) and its sole owner and adviser Evens Barthelemy, was a SEC registered adviser from 2009-2011. Mr. Barthelemy formed the firm in 2009 after having worked as a registered representative for two broker-dealers since 2000. In 2011, the firm withdrew its SEC registration after the SEC found that it did not meet the multi-state exemption nor did it have the required amount of assets under management ($25 million at the time). Since then, the firm has been registered in New York and New Jersey.

Summary of Violations

Compliance Failures

The SEC found that the firm did not institute written policies and procedures in accordance with Adviser Act Rule 206(4)-7. That rule requires advisers to adopt written policies and procedures that are designed to prevent violation (by the principal and all supervised persons) of the Act and SEC rules related to it. The settlement order noted that Mr. Barthelemy prepared the firm’s compliance manual in 2010 but that he had “largely adopted it verbatim from a 2009 version he obtained from his prior employment at a registered broker-dealer”. Given that the broker-dealer did not engage in the advisory business, the SEC found that the firm’s compliance manual violated Rule 206(4)-7, noting that the manual referred to the Securities Act of 1933 and the Securities Exchange Act of 1934 but made no reference to the Advisers Act. In the same vein, the manual referred to duties of suitability and fairness but never mentioned the fiduciary duty that advisers owe their clients. The firm’s manual also referenced commission-based compensation and broker-dealer filings, none of which are relevant to comply with Rule 206(4)-7. Finally, the SEC found that the firm did not undertake an annual review of the adequacy of the compliance manual.

Books and Records Failures

The firm was found to be non-compliant with Rule 204-2(a) which requires advisers to make and keep true, accurate and current certain books and records relating to the advisory business. Specifically, the SEC stated that the firm did not have copies of the written acknowledgements of the firm’s code of ethics. Additionally, in connect with Rule 204-3 which requires delivery of a firm’s Form ADV to clients or prospective clients, the firm did not have records of such delivery also required by Rule 204-2(a).

Overstating Assets Under Management on Form ADV

The SEC found that the firm was not eligible for SEC registration under both the multi-state exemption or by meeting the minimum threshold test ($25 million at the time). The now rescinded multi-state exemption permitted those advisers subject to regulation by thirty or more states, to register with the SEC. However, the SEC found that the firm was subject to at most three states’ regulatory regimes. In addition, the SEC found that the firm managed nowhere near the $26.5 million it claimed, but rather the total was around $2.6 million. This misrepresentation violated Section 207 of the Act, which makes it unlawful for any person to willfully make untrue statements of material fact in a registration statement. In addition, this conduct violated Section 203A of the Act, which prohibits SEC registration as an adviser unless the firm meets a relevant exemption.

Penalties

Given the adviser’s inability to pay, no civil penalty was asserted. However, the following penalties were instituted:

  • The firm must furnish a copy of the SEC order to each existing client;
  • The firm must post a copy of the order on its website for a period of two years;
  • Certify evidence in writing of the steps taken to comply with all violations of the Act and its rules;
  • Mr. Barthelemy is barred from employment in the financial services industry for a period of two years; and
  • Mr. Barthelemy is censured.

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Cole-Frieman & Mallon LLP provides legal services to the investment management industry. The firm provides regulatory and compliance support and other legal services to hedge fund managers. The firm can be reached here and Bart Mallon can be reached directly at 415-868-5345.

Cole-Frieman & Mallon LLP 2012 End of Year Checklist

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Below is our end of year checklist we send out to our mailing list.  If you would like to be added to the mailing list, please contact us here.

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December 14, 2012

Clients and Friends:

December is the busiest month of the year for most hedge fund managers. In addition to all of the administrative details involved in closing out the year, the regulatory landscape has shifted dramatically over the past year. As a result, year-end processes and 2013 planning are particularly important, especially for General Counsels, Chief Compliance Officers and key operations and financial personnel. We have updated our own year-end checklist to help managers stay on top of these priorities.

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Adviser Registration:

Form ADV Annual Amendment. Registered investment advisers, or managers filing as exempt reporting advisers (an “ERA”), 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. Registered investment advisers 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 private fund managers, a “client” for purposes of this rule is the fund.

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. Mangers should consult their state securities authority to determine if they are required to register in the state. Managers who are required to register with the SEC as 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 state securities authority, if necessary, generally within 90 days after the filing of the annual amendment.

California Private Fund Adviser Exemption. The California private fund adviser exemption (“Private Fund Adviser Exemption”) is available to advisers who provide advice solely to “qualifying private funds,” which include venture capital funds, Section 3(c)(1) funds and Section 3(c)(7) funds. Advisers who qualify for the Private Fund Adviser Exemption and manage less than $100 million can file as an ERA in California and avoid registration and compliance requirements.

CFTC Matters:

Expanded CFTC Regulation. As of October 12, 2012 an investment manager that trades certain swaps will be subject to regulation by the CFTC, even if the manager does not trade futures or commodity interests. Managers should review the recently expanded list of CFTC regulated products to determine whether they will be subject to CFTC regulation. Managers subject to CFTC regulation will need to evaluate whether they are eligible for an exemption or need to register with the CFTC by December 31, 2012.

Annual Re-Certification of CFTC Exemptions. CPOs and CTAs currently relying on exemptions from registration with the CFTC will be required to re-certify their eligibility by December 31, 2012. 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. Managers who had previously relied on the 4.13(a)(4) exemption from CPO registration will need to determine whether they are eligible to rely on another exemption or will need to register with the CFTC by December 31, 2012.

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 an annual report for each commodity pool. 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 9 months prior to the date of its intended use. Disclosure documents that are materially inaccurate or incomplete must be promptly corrected and the correction must be promptly distributed to pool participants.

General Regulatory Matters:

New Issue Status. On an annual basis, a manager needs to confirm or reconfirm the eligibility of investors that participate in initial public offerings or new issues. Most managers reconfirm this via negative consent, i.e., investors are informed of their status as on file with the manager and 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 its investors. This is particularly important for managers that track the underlying percentage or 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 Chief Compliance Officer (“CCO”) of a registered investment adviser must conduct an annual review of the manager’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, who can provide guidance about the review as well as a template for the assessment and documentation. Managers 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. Managers who 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 addressed by the end of the year pursuant to the manager’s polices regarding trade errors. Documentation of trade errors should be finalized, and if the manager is required to reimburse the 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 will need to file amended annually within 45 days of the end of the year. In addition, changes to the information on 13H will require interim amendments following the calendar quarter in which the change occurred.

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 any renewals.

SEC Form D. Form D filings for most funds need to be amended on an annual basis, on or before the anniversary of the initial SEC Form D filing. Copies of Form D can be obtained by potential investors via the SEC’s website.

IARD Annual Fees. Preliminary annual renewal fees for state registered and SEC registered investment advisers were due by December 13, 2012. Managers filing after the deadline will likely be subject to additional late filing fees and these must be paid through the IARD by February 1, 2013.

Pay-to-Play Rules. In 2010, the SEC adopted Rule 206(4)-5, which disqualified 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 such persons to register with the state as lobbyists and mandates lobbyist registration in California’s cities and counties. We recommend reviewing your reporting requirements 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 began filing Form PF earlier this year. Managers to private funds with less than $5 billion in regulatory AUM will need to make Form PF filings with the SEC beginning on December 15, 2012, on either a quarterly or annual basis, depending on the types of private funds managed and regulatory AUM.

Foreign 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% FATCA tax. Foreign financial institutions, which include hedge funds, funds of funds, commodity pools and other offshore investment vehicles, will be required to enter into an agreement with the IRS (an “FFI Agreement”) by January 1, 2014 to avoid being subject to the FATCA tax. Domestic funds will also be required to determine the FATCA status of their investors and will need to institute specific withholding and reporting procedures for recalcitrant investors. Managers should discuss FATCA compliance methods with their administrators and other third party service providers to ensure proper document collection and due diligence procedures. Managers may want to update their documents to include FATCA disclosure and representations.

Jumpstart Our Business Startups Act (“JOBS Act”). The JOBS Act, enacted earlier this year, directed the SEC to remove the prohibitions on general solicitation or general advertising for certain private securities offerings. The proposed rule amendments, which are still awaiting final approval by the SEC, would allow issuers to use general solicitation and general advertising to offer securities, provided that the issuer takes reasonable steps to verify that the purchasers of the securities are accredited investors. Managers should remember that while general solicitations may be allowable in the future, these rules are not yet final. In addition, all registered investment advisers will still be subject to applicable advertising regulations under the Investment Advisers Act. CFTC registered managers are still subject to certain CFTC regulations that prohibit marketing to the public, and managers that intend to rely on the 4.13(a)(3) “de minimus” exemption (discussed above) are also prohibited from marketing to the public.

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 shall 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 termination events that may be triggered by redemptions, performance or a combination of redemptions and performance in a fund’s ISDA or other counterparty agreement at the end of the year (NAV declines are typically included in these provisions).

Fund Expenses. Managers should wrap up all fund expenses for 2012 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 hedge fund industry, and the financial services industry in general, the end of the year is the appropriate time to make adjustments to the compensation program. 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 program 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.

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 2012 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 (www.hedgefundlawblog.com) which focuses on legal issues that impact the hedge fund community. For more information please visit us at: www.colefrieman.com.

Investment Adviser and IA Representative Registration Renewal 2013

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If your firm is registered as an investment adviser (IA) then you may have received notice from FINRA to renew your firm’s registration for 2013. If you have not received the notice or have not paid the renewal fees, the following provides an overview of the process.

Background

IA firms and IA representatives (RAs) should be aware that registrations expire annually on December 31. In order for an IA firm to maintain their active registrations and/or notice filing statuses and for RAs to maintain active registration statuses, the IA firms must pay applicable renewal fees annually. The IARD Renewal Program facilitates the annual renewal process. A Preliminary Renewal Statement which is made available on the IARD system, will include an amount that must be paid to FINRA by December 13, 2012. Remember to allow sufficient

time for payments made by check and sent through the postal service. Online payments made via E-Pay should be made by December 10, 2012 in order for the funds to be posted by December 13, 2012.

Submitting Payment

The preliminary renewal statement have been made available. IA firms can access this statement via IARD by following these steps:

1. Log onto IARD here.

2. Enter your firm’s ID and password.

3. Review and accept the terms and conditions.

4. Under the “Accounting” tab at the top of the page, select “Renewal Account.”

5. One the left column, select “Renewal Statement.”

The bottom of the page provides an itemized list of all applicable fees.

Payment by Check

If you choose to submit payment by check, print the statement and mail it, along with the check to the following address:

U.S. Mail:

FINRA

FINRA/CRD

P.O. Box 7777-9995

Philadelphia, PA 19175-0001

(Note: this P.O. Box address will not accept courier or overnight deliveries.)

Express Delivery:

FINRA/CRD

Attn: 9995

500 Ross Street 154-0455

Pittsburgh, PA 15262

(240) 386-4848

The check should be made payable to: FINRA. Be sure to write your CRD Number and the word “Renewal” on the face of the check. Be sure to also include the first page of the Renewal Statement.

Payment via CRD/IARD E-Pay

Payment can also be submitted online via CRD/IARD E-Pay. To do so, follow these instructions:

Go to the E-Pay website and:

1. Enter your login and password. If you have not yet created an account, do so by clicking “sign up.”

2. On the left column under “Payments,” click “Pay my accounts.”

3. Select the account and click “Continue.”

4. Enter the total Payment Amount and check “Renewal” under Account Type. Then enter the payment method and click “continue.”

5. Review the information and click “Make Payment.”

6. Log out and the money should post within about 2 days.

Automatic Daily Account-to-Renewal Account Transfer

If your firms has sufficient funds in the Daily Account to cover the total renewal amount, FINRA will automatically process the renewal payment by the payment deadline.

Other Payment Methods

Wire payments sent by 2 p.m. (ET), should post the next business day. Wire payments sent after 2 p.m., ET, may take up to 2 business days to post. Instructions for initiating a wire can be found here.

Confirming Payment

After payment is submitted, you will be able to retrieve your firm’s online Final Renewal Statement on IARD on or after January 2, 2013. These statements will reflect the final registration status of the IA firm and RAs. To do so, follow the instructions above to log onto IARD. Under the “Renewal Statement” link in the “Accounting” section, you can retrieve the Final Renewal Statement, which will state “Paid in Full” or “Amount Due.” If an amount is due, the balance must be paid by February 1, 2013.

It is important to make sure payment is made by the deadline, otherwise the registration may be terminated. The firm will then have to contact each regulator to request re-registration instructions.

More information about the Renewal Program can be found on the IARD website. FINRA has also posted a bulletin on the 2013 IARD Renewal Program, available here.

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Cole-Frieman & Mallon LLP provides legal services to hedge fund managers and investment advisers. Bart Mallon can be reached directly at 415-868-5345.

NFA Guidance on CPO / CTA Yearly Exemption Affirmations

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Yesterday the NFA issued a notice to persons that are currently relying on exemptions or exclusions from registration as a Commodity Pool Operator or Commodity Trading Advisor. The notice explains that certain exemptions and exclusions must be “affirmed” on an annual basis via the NFA’s online Exemption System. The first annual affirmation is due within the first 60 days after December 31, 2012. Exemptions that are not affirmed within this period will be automatically withdrawn. The NFA notice also contains a number of FAQs.

We have reprinted the notice below.

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Notice to Members I-12-30

December 3, 2012

Guidance on the Annual Affirmation Requirement for those Entities that are currently operating under an exemption or exclusion from CPO or CTA registration

In February 2012, the CFTC issued final rules that now require any person that claims an exemption or exclusion from CPO registration under CFTC Regulation 4.5, 4.13(a)(1), 4.13(a)(2), 4.13(a)(3), 4.13(a)(5) or an exemption from CTA registration under 4.14(a)(8) to annually affirm the applicable notice of exemption or exclusion within 60 days of the calendar year end. The first notice affirming these exemptions is due for the calendar year ending December 31, 2012 and annually thereafter. Failure to affirm any of the above exemptions or exclusions will be deemed as a request to withdraw the exemption or exclusion and therefore, result in the automatic withdrawal of the exemption or exclusion once the 60 day period has elapsed.

How to complete the affirmation process

Starting on December 3, 2012, any person or entity that claims an exemption or exclusion under CFTC Regulation 4.5, 4.13(a)(1), 4.13(a)(2), 4.13(a)(3), 4.13(a)(5) or 4.14(a)(8) will be able to complete the affirmation process by accessing NFA’s Exemption System at http://www.nfa.futures.org/NFA-electronic-filings/exemptions.HTML.

Once logged into the system, you will be directed to the Exemption Index, which lists all Firm Level (at the top) and Pool Level (at the bottom) exemptions on file with NFA. Exemptions requiring affirmation will be identified with an icon in the ‘Affirm’ column. After clicking

on the icon, a pop-up box will appear requesting affirmation that the exemption continues to be effective. By clicking ‘OK’, the current date will replace the ‘Affirm’ icon and effectively complete the affirmation requirement for the given exemption for the year. The same process must be completed for each and every exemption on file that requires affirmation.

Failure to affirm an active exemption or exclusion from CPO or CTA registration will result in the exemption/exclusion being withdrawn after the 60 day period has ended. For registered CPOs or CTAs, withdrawal of the exemption/exclusion will result in the firm being subject to Part 4 Requirements for that pool regardless of whether the firm otherwise remains eligible for the exemption/exclusion. For non-registrants, the withdrawal of the exemption may subject you to enforcement action by the CFTC.

Frequently Asked Questions for Exemptions

How often will I need to affirm my exemptions?

You will need to affirm each applicable exemption on an annual basis, within 60 days after December 31. NFA will provide an annual email reminder of the affirmation process. The email reminder will be sent to the email contact on file in NFA’s Exemption System. In order to ensure that your firm receives NFA’s annual reminder, you must ensure a current email address has been provided in NFA’s Exemption System. If the contact information changes during the year, firms are urged to promptly update this information.

What if NFA records reflect an exemption for a pool that is no longer active?

A registered CPO can update NFA’s records with the applicable information. The CPO must first withdraw the exemption by accessing NFA’s Electronic Exemption System at http://www.nfa.futures.org/NFA-electronic-filings/exemptions.HTML. At the time you withdraw the exemption, you will be directed to the Annual Questionnaire to delete or cease the pool.

A non-registered entity must notify NFA with specific information about the pool by sending written notification to [email protected]. The written notification should include the full name of the entity and the pool.

If I can no longer qualify for an exemption or exclusion from CPO or CTA registration, what should I do?

If you do not affirm the applicable exemption or exclusion within the 60 day period, it will be automatically withdrawn. As a result, in order to continue to operate the pool, you may be required to be registered as a CPO and/or CTA and be an NFA Member. You can apply for registration and NFA membership in NFA’s Online Registration System (ORS), which is available on NFA’s website. For assistance in the process, NFA has a number of video tutorials available at http://www.nfa.futures.org/NFA-registration/videos/index.HTML.

I currently operate pools exempt under 4.13(a)(3), but I will no longer meet the requirements of this exemption as of January 1, 2013. I understand that NFA currently offers certain entities the ability to pre-register as a CPO, which allows a firm to defer registration until that date. Is this available to entities that operate pools exempt under 4.13(a)(3)?

No, the pre-registration option is not available to entities operating 4.13(a)(3) pools. It is only available to entities operating pools that are exempt under 4.13(a)(4), 4.5, CPO 12-03 No-Action, or 4.13 No Action.

How will firms that I do business with know that I have completed the Affirmation Process?

Once an entity affirms the applicable exemptions, NFA’s BASIC System will reflect the affirmation date for each exemption held. Further, BASIC will also reflect a withdrawal date if the exemption is not affirmed in the required 60-day period.

If I currently conduct business with an exempt CPO or CTA, how do I ensure that these entities have properly affirmed their exemptions in order to satisfy my Bylaw 1101 requirements?

NFA’s BASIC System will reflect whether an exemption held by a particular CPO or CTA has been successfully affirmed by including an affirmation date. A withdrawal date will be reflected for any exemption that was not affirmed for a given CPO or CTA. NFA has also provided Members with access to a spreadsheet that includes a list of all entities that have exemptions on file with NFA that must be affirmed on an annual basis. This spreadsheet can be found in the Member’s Annual Questionnaire at http://www.nfa.futures.org/NFA-electronic-filings/annual-questionnaire.HTML. Once logged in, you will see a link to a spreadsheet which is updated nightly. The spreadsheet will include all entities with an exemption(s) that requires affirmation, as well as the affirmation date, if applicable. If the spreadsheet does not reflect an affirmation date, the exemption has not been affirmed.

Any questions regarding these processes should be directed to:

Susan Koprowski, Manager, Compliance ([email protected] or 312-781-1288) or

Michael Mason, Manager, Compliance ([email protected] or 312-781-1447).

You are receiving this message because you are either a Member of National Futures Association (NFA) or you subscribed to the email subscription list on NFA’s Website. Additionally, you may be receiving this message because NFA records indicate you previously filed notice of exemption from CPO or CTA registration. To cancel or change your subscription at any time, visit the Email Subscriptions page on our Website at http://www.nfa.futures.org/news/subscribe.asp.

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Cole-Frieman & Mallon LLP provides legal services to CFTC registered firms and NFA member firms. Bart Mallon can be reached directly at 415-868-5345.

Hedge Fund Events December 2012

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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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December 2-4

December 2-4

December 2-5

December 3

December 3

December 3-4

December 3-4

December 4

December 4

December 4

December 4

December 4-5

December 4-5

December 4-5

December 5

December 5

December 5

December 5

December 6

December 6

December 6

December 6

December 10

December 10

December 11-12

December 11-12

December 12

December 12

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Cole-Frieman & Mallon LLP 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.

Hedge Fund Events November 2012

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

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November 1-2

November 6

November 7

 November 8

  • Sponsor: Investment Adviser Association
  • Event: 2012 Compliance Workshop
  • Location: Atlanta, GA

November 8

 November 14

November 15

November 15

 November 27 

Cole-Frieman & Mallon LLP provides legal services for hedge fund managers and other groups within the investment management industry.  Bart Mallon can be reached at 415-762-2841.

Hedge Fund Seed Deals Overview

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Seed Capital Arrangements for Hedge Fund Managers

We receive numerous inquiries from new managers seeking capital sources in today’s challenging financial climate. Recent regulatory changes have increased legal and compliance costs associated with launching a hedge fund and many smaller investors are wary to invest with first time managers, despite their potential to generate alpha. One way emerging managers can secure the much needed capital is via a “seed deal” whereby a seed capital provider (the “Seeder”) makes a significant capital investment (the “Investment’) in the manager’s fund (the “Fund”) in exchange for a share of the management fees and/or incentive fees. In addition to providing the manager with start-up operating and investment capital, the manager gets additional credibility with prospective investors. This article will summarize some of the basic terms involved in seed deals, as well as a number of issues a manager should consider. Please note that each seed deal is unique and a manager should work with experienced counsel to negotiate the appropriate terms.

Seed Deal Basics

Investment.

The amount of Investment can range greatly, the initial funding can be as much as $150 million

or as little as $1 million depending on a variety of factors.

Lock-Up Period.

Depending on the size of the Investment and other negotiated terms, the Seeder will generally commit keep the Investment in the Fund for a period 2 to 4 years, subject to certain early withdrawal rights, including but not limited to:

    • Violation of proscribed investment guidelines;
    • Decline of Investment by a certain percentage;
    • Misconduct by the manager or its principals;
    • Key man provisions or change of control; and
    • Reaching a certain AUM threshold.

Share of Revenues.

In exchange for the Investment, the Seeder receives a percentage of the manager’s revenues (including management fees and/or incentive fees) lasting in perpetuity or for a specified term. This arrangement is usually accomplished in one of two ways:

1. Equity Interest: The Seeder receives a direct equity interest in the management entity and typically receives revenues “net” of expenses. In this type of deal, the Seeder will generally require limitations or consent for expenses.

2. Fee Sharing Agreement: The Seeder enters into a profit/fee sharing agreement with the manager whereby the Seeder will be entitled to a portion of the management and/or incentive fees received by the manager. Fee sharing agreements have been more common as they offer greater freedom for the manager to operate its business. In this type of arrangement, the fees will generally be calculated on a gross basis. The actual sharing percentage varies depending on the amount of the Investment; however, amounts from 15 to 30% are common.

Seeder Rights and Obligations

Depending on the size of the Investment, the Seeder may obtain certain special rights, including but not limited to:

  • Access to Fund records and accounts, including “side letters” with other investors;
  • Portfolio transparency;
  • Most Favored Nation treatment;
  • Capacity rights
  • Right of first refusal on launch of subsequent funds, service providers or corporate events;
  • Management and oversight rights, including budget approval, fund terms, investment guidelines and restrictions;
  • Special liquidity terms;
  • Notification of significant matters and periodic meetings with principals of the manager.

The Seeder may agree to serve on an advisory committee for the manager, assist in the marketing of the Fund, and/or provide office space or other specified services to the manager.

Fund Manager Obligations

Depending on the size of the Investment, the manager may agree to additional obligations, including but not limited to:

Principal Investment

Principals of the manager agree to make and maintain a certain investment in the Fund, and may be required to re-invest a portion of received inventive allocation.

Revenue Share of All Fees

The fee sharing agreement will include all fees the manager receives from its investment management related activities (including other funds or managed accounts managed by the manager).

Non-Compete/Non-Solicitation

Principals of the manager will be prohibited from forming other management companies or funds for a period of time and may agree to a specific time commitment. In addition, the principals will agree to not solicit other employees of the manger or the Seeder for a period of time after they leave.

Representations, Warranties and Covenants

The manager will be required to make certain representations, warranties and covenants relating to regulatory and compliance issues.

Indemnification

The Seeder will usually be fully indemnified by the manager against losses arising out of the seed agreement or the investment in the Fund or any Fund document.

Additional Considerations

When contemplating entering into a seed deal arrangement, the manager should also consider the following:

Buyout Rights

The manager may request the right to buyout (in whole or in part) the Seeder’s interest in the Fund, after a specified number of years or upon receiving a certain amount of fees. The buyout price can be determined ahead of time and is generally determined by a formula based on Investor receiving a certain amount of fees or a certain rate of return on the Investment.

Put Rights

Similar to the above, the Seeder may also request the right to sell its interest back to the manager.

Tag Along Rights

In the event of a sale of the manager, the Seeder may request a provision that would require the purchaser to also buy out the Seeder’s interest in the manger on a pro rata basis.

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Cole-Frieman & Mallon LLP is an investment management law firm focused on established and emerging hedge fund managers. If you have questions about hedge fund seed deals, please contact us.

 

Business Development Company (BDC) Overview and Formation

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What is a Business Development Company?

Business Development Companies (“BDCs”) are a type of publicly-traded closed-end fund that are registered under the Investment Company Act of 1940 (the “1940 Act”). BDCs are designed to facilitate the raising of capital by small, developing, and financially troubled companies that historically lacked access to the public capital markets. A BDC is required to make available “significant managerial assistance” to the companies in which it invests including management and operational assistance. As such, BDCs are not intended to be passive investment vehicles. BDCs make investments in the form of long-term debt or equity capital with the goal of generating capital appreciation and/or current income. In recent years, a number of private equity managers have also launched BDCs as a means of accessing public capital.

BDC Advantages

BDCs are preferable to other investment funds for a number of reasons:

  • Unlike mutual funds and other open-end funds, BDCs provide the same liquidity to investors as other publicly traded investments.
  • BDC investors are not limited to “qualified purchasers” and investors need not meet income and net worth requirements.
  • BDC managers have access to permanent capital that is not subject to shareholder redemption.
  • Unlike other registered fund managers, BDC managers may charge performance fees (e.g. “2 and 20” incentive fees).

BDC Limitations

BDCs are subject to a number of restrictions and limitations including the following:

  • BDCs must maintain low leverage – total debt may not exceed total equity.
  • BDCs are restricted in their ability to enter into transactions with affiliates.
  • BDCs must adopt and implement policies and procedures designed to prevent violations of the federal securities laws and must appoint a chief compliance officer to administer these policies and procedures.
  • No single BDC investment can account for more than 25% of total holdings and 70% of all assets must be invested within a limited number of categories.
  • BDCs must distribute at least 90% of their taxable earnings quarterly.

Permissible Investments

Section 55 of the 1940 Act requires that a BDC invest at least 70% of its total assets in the following:

  • Privately issued securities purchased from issuers that are “eligible portfolio companies;”
  • Securities of eligible portfolio companies that are controlled by a BDC and of which an affiliated person of the BDC is a director;
  • Privately issued securities of companies subject to a bankruptcy proceeding, reorganization, insolvency or similar proceeding or otherwise unable to meet their obligations without material assistance;
  • Cash, cash items, government securities or high quality debt securities maturing in one year or less; and
  • Office furniture and equipment, interests in real estate and other similar non-investment assets incidental to the BDC’s operations.

Tax Treatment

BDCs are typically organized as limited partnerships or Subchapter M regulated investment companies in order to obtain pass-through tax treatment. Distributions to shareholders are taxable as either ordinary income or capital gains in the same manner as distributions from mutual funds.

BDC Formation

To become a BDC, a company must file Form N-6 with the SEC (intent to file a notification of election). Then, a company must file a notice on Form N-54A indicating that it elects to be regulated as a BDC under the 1940 Act. In order to elect to be regulated as a BDC, a company must register its equity securities under Section 12 of Securities Exchange Act of 1934. This registration requires BDCs to periodically file Form 10-K, 10-Q and 8-K as well as proxy statements with the SEC. A BDC must also register its securities under the Securities Act of 1933 by preparing and filing a Form N-2 registration statement which describes essential information about the BDC to help investors make informed investment decisions. The registration statement must disclose (i) the terms of the offering including number of shares and price, (ii) the intended use of the proceeds, (iii) investment objectives and strategies, (iv) risks associated with the investment, and (v) a description of the BDC’s management.

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Cole-Frieman & Mallon LLP, an investment management law firm which provides legal services to the hedge fund industry. Bart Mallon can be reached directly at 415-868-5345.

Cole-Frieman & Mallon LLP 4th Quarter Newsletter

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Below is our quarterly newsletter which was sent to our clients and friends last week. If you would like to receive this news letter, please contact us.

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Clients and Friends:

There have been a number of new regulatory developments over the past three plus months of concern to investment managers, namely:

  • California Private Fund Adviser Exemption
  • CFTC Regulatory Changes
  • Foreign Account Tax Compliance Act (“FATCA”)
  • JOBS Act

Below we detail these developments, provide some of our thoughts on the current regulatory environment and outline some items that managers should be aware of as this year comes to a close. Please feel free to contact us with any thoughts or questions on these matters.

California Private Fund Adviser Exemption

On August 27, 2012 the California Office of Administrative Law approved the long awaited private fund adviser exemption (“Private Fund Adviser Exemption”). The immediately effective exemption is only available to advisers who provide advice solely to “qualifying private funds,” which include venture capital funds, Section 3(c)(1) funds and Section 3(c)(7) funds. The Private Fund Adviser Exemption is not available to advisers who also manage separate accounts. Advisers to qualifying private funds who qualify for the Private Fund Adviser Exemption and manage less than $100,000,000 can file as “exempt reporting advisers” and thereby avoid the registration and compliance requirements in California. Specific requirements for advisers seeking to rely on the Private Fund Adviser Exemption can be found here.

CFTC Expanded Jurisdiction Over Certain Swaps

With the issuance of new rules from the CFTC affecting swaps, investment managers that trade swaps will need to determine whether the swaps they trade will subject the manager to CFTC regulation; and if so, whether CFTC registration is required or an exemption from registration is available. As of October 12, 2012 an investment manager that trades swaps covered by the new rules may find itself subject to regulation by the CFTC, even if the adviser does not trade futures or commodity interests. Similarly, an adviser to a commodity pool that trades swaps and is currently relying on Regulation 4.13(a)(3) – the “de minimis” exemption from CFTC regulation for advisers who trade only minimal futures, commodity interests and swaps – will need to reassess whether it can still fit within this exemption after taking into account its swaps trading.

CFTC Regulatory Changes

Recent regulatory changes, which become effective on December 31, 2012, require advisers to private funds or accounts using commodity futures, commodity options and other CFTC regulated derivatives to register with the CFTC or rely on an exemption from such registration. These changes include:

  • CFTC Regulation 4.13(a)(4) Exemption Rescinded: Managers to funds offered only to “qualified eligible persons” have previously relied on this exemption from CPO registration. This exemption will no longer be available as of December 31, 2012.
  • CFTC Regulation 4.13(a)(3) De Minimus Exemption: Managers to commodity pools with a limited use of commodity interests can rely on this exemption from registration as a CPO. However, with the CFTC’s extended jurisdiction over swaps, many pools may no longer qualify and must register as a CPO with the CFTC.
  • Annual Re-Certification: CPOs and CTAs relying on exemptions from registration will be required to re-certify their qualifications annually on a calendar-year basis, beginning on December 31, 2012.
  • New Reporting Requirements: Registered CPOs and CTAs must file certain new reports and include standardized risk disclosure to describe risks of swap transactions in the disclosure documents.

FATCA

Enacted by Congress as part of the HIRE Act of 2010 with the goal to combat tax evasion, FATCA will go into effect on January 1, 2013. The new regulations will require 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% FATCA tax. Foreign financial institutions, which include hedge funds, funds of funds, commodity pools and other offshore investment vehicles, will be required to enter into an agreement with the IRS by June 30, 2013 to avoid being subject to the FATCA tax. Domestic funds will also need to determine the FATCA status of each of their investors and will be subject to new withholding and reporting requirements for any recalcitrant investors. Final regulations have not been promulgated, however, managers should discuss compliance methods with their administrators and other third party service providers.

Jumpstart Our Business Startups Act (“JOBS Act”)

The JOBS Act, signed into law in April 2012, has two big implications for the hedge fund industry:

  • The first, which was effective immediately, raised the maximum number of investors permitted in a 3(c)(7) fund from 499 to 1,999. Private funds relying on the 3(c)(1) exemption are still limited to 99 investors.
  • The second, which is still awaiting final rules by the SEC, lifts the ban on general solicitation and advertising under Rule 506 of Regulation D. The proposed amendments would allow issuers to use general solicitation and general advertising to offer securities, provided that the issuer takes reasonable steps to verify that the purchasers of the securities are accredited investors.

Managers should remember that while general solicitations may be allowable in the future, these rules are not yet final. In addition, all registered investment advisers will still be subject to applicable advertising regulations under the Investment Advisers Act. CFTC registered managers are still subject to certain CFTC regulations that prohibit marketing to the public, and managers that intend to rely on the 4.13(a)(3) “de minimus” exemption (discussed above) are also prohibited from marketing to the public.

Form PF

Managers to private funds who are registered (or required to be registered) as investment advisers with the SEC and have at least $150 million under management, will need to file Form PF with the SEC. The filings must be made either on a quarterly or annual basis, depending on the type of private fund and regulatory assets under management. For managers to hedge funds, the filings and compliance dates are as follows:

  • Greater than $5 billion regulatory AUM – The filing must be made on a quarterly basis, within 60 days of the end of each fiscal quarter, beginning on June 15, 2012.
  • At least $1.5 billion (but less than $5 billion) in regulatory AUM – The filing must be made on a quarterly basis, within 60 days of the end of each fiscal quarter, beginning on December 15, 2012.
  • At least $150 million (but less than $1.5 billion) in regulatory AUM – The filing must be made on an annual basis, within 120 days of the end of each fiscal year, beginning on December 15, 2012.

4th Quarter Items

  • January 1, 2013 Fund Launches – Managers seeking to launch a fund on the first of the year should begin the fund formation process as soon as possible in order to give themselves and service providers ample time to prepare during the busy season.
  • CFTC Regulatory Matters:
    • Managers should review the recently expanded list of CFTC regulated products to determine whether they will be subject to CFTC regulation. CPOs currently relying on CFTC Regulation 4.14(a)(4) will need to assess whether the commodity pool is eligible for the “de minimis” exemption or register with the CFTC as a CPO by December 31, 2012. CPOs currently relying on CFTC Regulation 4.13(a)(3) will need to evaluate whether the commodity pool is still eligible for the exemption.
    • CPOs and CTAs that have exemptive relief under CFTC Regulations will need to reconfirm their qualifications by December 31, 2012.
  • IARD Renewal – FINRA will be sending out notice reminders to facilitate the annual renewal of investment adviser registration. Preliminary Renewal Statements will be made available on IARD on November 12, 2012.
  • Form PF – As discussed above, managers to private funds with less than $5 billion regulatory AUM will need to make Form PF filings with the SEC beginning on December 15, 2012, on either a quarterly or annual basis, depending on the types of private funds managed and regulatory AUM.

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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 (www.hedgefundlawblog.com) 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.

 

Hedge Fund Compliance & Due Diligence Webinar

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Bart Mallon Speaker at Hedge Fund Compliance and Due Diligence Webinar

Due diligence continues to be a hot topic for fund managers; compliance has been a central issue for managers ever since SEC registration was required for those managers with more than $150M of AUM. Below is a release for webinar which will be taking place later this month. Bart Mallon will be speaking about the legal issues involved with compliance and due diligence.

Registration is free and sign up is here.

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Corgentum Consulting Hosts Hedge Fund Operational Due Diligence Webinar on Compliance and Legal Risk

Corgentum Consulting will host a complimentary Webinar titled, ‘Techniques for Analyzing Hedge Fund Compliance and Legal Risks During Operational Due Diligence’ on October 23, 2012, at 10:30am EDT

NEW YORK – Oct. 1, 2012 – Corgentum Consulting, the leading provider of the industry’s most comprehensive hedge fund operational due diligence reviews, will host a complimentary Webinar titled, “Techniques for Analyzing Hedge Fund Compliance and Legal Risks During Operational Due Diligence” on October 23, 2012, at 10:30am EDT. Join the speakers as they examine the effective techniques for evaluating a fund’s legal and compliance risks.

The global hedge fund regulatory landscape has undergone a number of recent significant changes. New SEC registration requirements and Form PF filings in the US continue to challenge hedge funds. Internationally, increased calls for Asian hedge fund regulation in countries such as Singapore and Australia, as well as discussions surrounding MiFID II and the EU passport directive in Europe, continue to complicate the web of legal and regulatory rules.

DATE: October 23, 2012

TIME: 10:30am to 11:30am EDT

SPEAKERS:

• Jason Scharfman, Managing Partner, Corgentum Consulting

• Paul Brook, Principal, Compliance Solutions Associates

• Bart Mallon, Partner, Cole-Frieman Mallon & Hunt LLP

Some of the topics that will be covered during the Webinar include:

• Techniques for evaluating fund compliance programs

• Evaluating legal documentation risk

• Understanding the effects of recent hedge fund case law

• Monitoring ongoing fund adherence to regulatory requirements

If you are interested in joining the “Techniques for Analyzing Hedge Fund Compliance and Legal Risks During Operational Due Diligence” Webinar, please visit https://www1.gotomeeting.com/register/389516416 or contact [email protected].

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About Corgentum Consulting

Corgentum Consulting is a specialist consulting firm which performs operational due diligence reviews of fund managers. The firm works with investors including fund of funds, pensions, endowments, banks and family offices to conduct the industry’s most comprehensive operational due diligence reviews. Corgentum’s work covers all fund strategies globally including hedge funds, private equity, real estate funds, and traditional funds. The firm’s sole focus on operational due diligence, veteran experience, innovative original research and fundamental bottom up approach to due diligence allows Corgentum to ensure that the firm’s clients avoid unnecessary operational risks. Corgentum is headquartered at 26 Journal Square, Suite 1005 in Jersey City, New Jersey, 07306. Phone 201-360-2430. The Web site is www.corgentum.com.

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Cole-Frieman & Mallon LLP provides hedge fund compliance and legal services to investment management community. Bart Mallon can be reached directly at 415-868-5345.