Stop Tax Haven Abuse Act Introduced by Senator Levin

Bill Would Have Significant Impact on Private Funds

On July 12, 2011, United States Senator Carl Levin (D – Michigan) introduced the Stop Tax Haven Abuse Act of 2011 (the “Bill”). A prior version of the Bill was introduced in 2009. The Bill contains several provisions of interest to private fund managers, including provisions that:

  • Treat foreign corporations whose management and control occur primarily in the United States as U.S. domestic corporations for income tax purposes;
  • Clarify under the Foreign Account Tax Compliance Act (“FATCA”) when foreign financial institutions and U.S. persons must report foreign financial accounts to the IRS;
  • Treat Credit Default Swap (“CDS”) payments sent offshore from the United States as taxable U.S. source income; and
  • Require Anti-Money Laundering (“AML”) programs for hedge funds, private equity funds, and formation agents to ensure screening of offshore clients.

The Bill also authorizes the Treasury Secretary to take special measures against foreign jurisdictions or financial institutions that impeded U.S. tax enforcement as well as imposes additional disclosure requirements on multinational corporations by requiring them to include basic information on a country-by-country basis in their filings with the SEC. Notably, the Bill does not include a controversial proposal in the 2009 bill that specifically identified 34 “Offshore Secrecy Jurisdictions,” including the Cayman Islands and British Virgin Islands.

Foreign Corporations Treated as Domestic Corporations

Section 103 of the Bill prevents companies that are run from the United States from claiming foreign tax status if those foreign corporations

have gross assets of $50 million or more. The provisions indicate that gross assets includes “assets under management for investors, whether held directly or indirectly.” For corporations primarily holding investment assets, the management and control is treated as occurring primarily in the United States if “decisions about how to invest the assets are made in the United States.” These provisions if enacted could potentially eliminate any benefits of establishing offshore funds, which are primarily established for offshore and U.S. tax-exempt investors.

Strengthening FATCA Provisions

The U.S. Foreign Account Tax Compliance Act (“FATCA”) imposes a 30% withholding tax on U.S. persons holding offshore accounts on certain “withholdable payments” to “foreign financial institutions” which do not provide information about their U.S. accounts to the Internal Revenue Service. A “withholdable payment” is generally any U.S. source income, such as interest, dividends, rents, royalties and other fixed or determinable income (“FDAP”). Non-U.S. private funds will generally qualify as foreign financial institutions (“FFI”). In order for an offshore fund to avoid withholding, it must enter into an agreement with the U.S. Treasury to identify its U.S. investors, if there are any.

Section 102 of the Bill would expand the definition of a foreign financial institution to include entities that engage in derivative transactions. Section 102 also creates presumptions of U.S. control for purposes of certain legal proceedings for entities with accounts opened at non-FATCA institutions when those entities are established by or receive assets from U.S. persons.

Treatment of Credit Default Swaps

Existing tax laws allow CDS payments to avoid taxation if sent from the United States to persons offshore, such as an offshore hedge fund or foreign bank. Section 104 of the Bill would treat CDS payments sent offshore from the United States as taxable U.S. source income.

Anti-Money Laundering Programs for Hedge Funds

Sections 203 and 204 of the Bill would impose anti-money laundering requirements on unregistered investment companies, including hedge funds and private equity funds, and formation agents. Hedge funds would be required to establish AML programs; ascertain the identity of investors, including beneficial owners of foreign entities; and submit suspicious activity reports. Agents engaged in the business of forming corporations or other legal entities would also be required to establish AML programs.

Our Thoughts

The Bill will still need to survive a vote by both the Senate and the House and ultimately be signed by the President before becoming law.  There is likely to be some time before this Bill moves forward (especially considering the current focus on the debt ceiling) which means plenty of time for the industry to lobby against this effort.  However, the bill highlights the unpopularity of the investment management industry with certain members of Congress and it is no surprise we see proposed taxing provisions- the U.S. needs more tax revenue and investment managers are an easy group to target.  We see this every couple of years when various members of Congress propose to increase the carried interest for fund managers.  It will be interesting to see how this plays out and we will provide periodic updates on the situation.

For more information about the Bill, refer to Senator Levin’s July 12, 2011 press release.  Senator Levin has also released a summary of the bill as well as his floor statement introducing the bill.

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Cole-Frieman & Mallon LLP is a law firm which provides advice with respect to domestic and offshore hedge fund operations.  Bart Mallon can be reached directly at 415-868-5345; Karl Cole-Frieman can be reached at 415-352-2300.

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Private Equity Fund Manager Registration Exemption Approved by House Committee

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Small Business Capital Access and Job Preservation Act Moves Toward Vote

The SEC recently finalized the new investment adviser registration regulations and under those regulations private equity fund managers will be required to be registered with the SEC.  However, Congress has recently been taking steps that may ultimately mean that private equity fund managers will escape registration requirements.

The Small Business Capital Access and Job Preservation Act (the “Bill”) proposed in March, would amend the Investment Advisers Act to provide an exemption from registration for some private equity fund managers.  Recently the House Committee on Financial Services (“Committee”) amended and approved the Bill which will ultimately need to be passed by the full House and Senate before being presented to the President for signature. The amended text makes an exemption from registration available to advisers of private funds that have outstanding debt that is less than twice the amount investors have committed to the private funds (less than a 2-1 leverage ratio).

Proposed Requirements for Private Equity Fund Managers

The amended Bill would require the SEC to define “private equity fund” and to promulgate reporting and record-keeping requirements for those private equity fund managers who utilize the exemption. Specifically, the SEC would have to enact rules that require the managers “to maintain

such records and provide to the Commission such annual or other reports as the Commission taking into account fund size, governance, investment strategy, risk, and other factors, as the Commission determines necessary and appropriate in the public interest and for the protection of investors….”  The SEC will be required to issue any regulations within 6 months of the date the Bill is signed into law.

This means that while PE fund managers would be exempt from registration, there would still be fairly significant compliance responsibilities.  Essentially these managers would face a regulatory regime similar to exempt reporting advisers.

Support for the Bill

Supporters of the Bill essentially assert that because private equity funds neither caused nor contributed to the financial crisis, it would be unduly burdensome for these fund managers to register with the SEC. Specifically, supporters point to the costs associated with registration, the jobs created by the funds, and the general lack of systemic risk posed by the funds.

According to the Committee report, registration would be burdensome because:

“advisers to private equity funds will be required to calculate the value and performance of each of their funds on a monthly basis, which will in turn require advisers to private equity funds to calculate the value of each company in which the fund has invested on a monthly basis as well. Such valuations are time consuming and costly, and they divert much-needed capital and effort away from job creation and investment activities.”

The Committee received testimony stating:

“As of June 30, 2009, companies that received backing from private equity investment funds employed more than 6 million people. Studies show that the workforces of companies acquired by private equity firms increased by an average annual rate of 5.7 percent, compared to 1.1 percent for all U.S. companies. The Committee also received testimony about the costs of registering with the SEC, which some have estimated to be as high as $500 million industry-wide…”

The concerns were primarily that the burden imposed by the registration requirements could inhibit the creation of more jobs, with struggling or growing companies receiving less capital from such funds. The amended Bill would provide relief from registration for advisers to private equity funds that are levered by less than a 2-1 ratio.

Final Thoughts

Private equity fund managers should not stop beginning preparations to register as investment advisers with the SEC.

The Bill is a long way from being enacted into law – it still must be passed by the full House, the full Senate, and signed by the President. It will then take (at least) another 6 months for the SEC to issue final rules regarding record-keeping and reporting and to clarify the definition of “private equity fund.” Even with the Dodd-Frank registration deadline pushed back to March 30, 2012, waiting until the Bill and its accompanying rules and regulations are finalized would leave managers of these funds with little time to register in the event they ultimately do not fall within the exemption in its final form.

The Committee’s report is available here.

The full text of the Bill is available here.

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Cole-Frieman & Mallon LLP is a law firm which provides adviser registration, compliance and legal support to SEC registered fund managers.  Bart Mallon can be reached directly at 415-868-5345; Karl Cole-Frieman can be reached at 415-352-2300.

Hedge Fund Registration Rules Finalized

Registration required by March 30, 2012

We are obviously a bit late on reporting that the hedge fund registration regulations were finalized by the SEC recently (see releases at end of the post).  We are not going to detail all aspects of the regulations in this post, but we will be examining some of the more important issues related to the release over the coming weeks and months.

We do want to provide a quick overview of some of the more important items with respect to the new regulations.  These include:

  1. registration for many hedge fund managers will be required by March 30, 2012 [note: managers will need to file Form ADV with the SEC no later than February 14, 2012 to meet this deadline]
  2. Form ADV has been amended in a number of ways which provide more information regarding a fund’s activities and counterparties
  3. Exempt Reporting Advisers (“ERAs”) will need to complete and file a truncated version of Form ADV by March 30, 2012 [note: ERAs will be subject to recordkeeping requirements and will be subject to SEC examination]
  4. many currently registered fund managers will need to switch from SEC registration to state registration during the first part of 2012

IA Registration Overview and Exemptions

After the passage of the Dodd-Frank Act it was clear than many fund managers would be required to register as investment advisers with the SEC.  In general the following are the registration requirements/exemptions for asset managers:

  • managers to only hedge funds (no managed accounts) must register as an IA with the SEC if Regulatory AUM (discussed below) is over $150M
  • managers to hedge funds and managed accounts must register as an IA with the SEC if Regulatory AUM is over $100M
  • mid-sized advisers ($25M to $100M) will be subject to state registration, if applicable [note: some mid-sized advisers will be subject to SEC registration regardless]
  • managers to only VC funds are exempt from registration;
    • VC funds may have up to 20% of their assets in non-VC investments
    • while managers to VC funds will not be required to register as IAs with the SEC, they will still be Exempt Reporting Advisers and will thus need to completed the truncated Form ADV by March 30, 2012
  • non-U.S. managers who have a place of business in the U.S. and have U.S. clients (either directly or as investors in their fund) will generally be required to register as an IA with the SEC or will be deemed to be an ERA [note: non-U.S. managers with U.S. clients or investors will only be exempt from IA registration with the SEC in only limited circumstances]
  • private equity fund managers are generally going to be treated the same as hedge fund managers according to these regulations

Other Items

The following are some of the important items from the releases:

  • Form PF – Release 3221 makes specific reference to a “Form PF release” which indicates that the SEC will be moving forward with the highly controversial reporting form.
  • Regulatory AUM – a new definition for AUM called regulatory assets under management will be used when determining the thresholds for registration. The big issue is that the definition will include leverage (gross assets) and will also include uncalled capital commitments.  The Release 3221 essentially states that the new Regulatory AUM definition is necessary for more consistent

    reporting of AUM and because Form PF will essentially rely on the new definition.

  • Buffer for Mid-Sized Advisers – there is a buffer zone around the $100M mark for certain managers.  This buffer is put into place so that managers do not have to continually switch to and from SEC registration as AUM increases or decreases.  The buffer is $10M each way meaning a manager will not be required to register with the SEC until AUM reaches $110M and a SEC registered manager would not need to de-register or switch to state registration until the manager had less than $90M AUM.
  • Family Office – family offices are exempt from SEC IA registration.  The SEC defined the term “family office” (see Release IA-3220).

The SEC press release announcing the new regulations and providing an overview of the new regulatory requirements can be found here.

The full releases are below:

  • Release IA-3222 [Exemptions for Advisers to Venture Capital Funds, Private Fund Advisers With Less Than $150 Million in Assets Under Management, and Foreign Private Advisers]
  • Release IA-3221 [Rules Implementing Amendments to the Investment Advisers Act of 1940]
  • Release IA-3220 [Family Offices]

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Cole-Frieman & Mallon LLP provides registration, compliance and other legal services for hedge fund managers.  Bart Mallon can be reached directly at 415-868-5345; Karl Cole-Frieman can be reached at 415-352-2300.

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SEC Increases Threshold for Performance Fees

New Qualified Client Definition Effective September 19, 2011

The Dodd-Frank Act required the SEC to revise upward the dollar thresholds for a person to be deemed a “qualified client” pursuant to Rule 205-3. The qualified client definition is important because SEC registered investment advisers (including hedge fund managers) cannot charge performance fees to those investors who are not qualified clients. Previously an individual needed to have a net worth of $1.5 million or have $750,000 of AUM with the investment adviser. The new thresholds are $2 million and $1 million respectively.

It does not appear that there are any grandfathering provisions that will be applicable and it is currently unclear whether managers will need to seek confirmation from current investors/clients as to whether such investors meet the new qualified client definition. If managers are required to seek additional confirmation from current investors, this will obviously create additional legal and administrative expenses for managers. Regardless, for any future investors/clients, SEC registered investment

advisers (and those groups that will be registering within the next 9 months) should make sure that the new qualified client definition is included in all subscription documents and other investment advisory contracts.

Another important issue is how this change will affect state registered investment advisers. Many state laws and regulations either mirror the federal laws and regulations or make specific reference to Rule 205-3. It is likely that many states will be coming out with guidance on this issue either through notifications or orders, or through legislative changes. Nonetheless, most state registered investment advisers should begin making plans to adapt to the changes at the federal level.

As more information from the states become available, we will be providing updates on this blog.

The notice of the SEC order is reprinted below and can be found here.

The actual SEC Order can be found here: SEC Order – Qualified Client Definition

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SEC Issues Order Raising Performance Fee Rule Dollar Limit to Adjust for Inflation

FOR IMMEDIATE RELEASE

2011-145

Washington, D.C., July 12, 2011 – The Securities and Exchange Commission today issued an order that raises, to adjust for inflation, two of the thresholds that determine whether an investment adviser can charge its clients performance fees. The order carries out a requirement of the Dodd-Frank Wall Street Reform and Consumer Protection Act.

SEC's Order

Rule 205-3 under the Investment Advisers Act allows an investment adviser to charge a client performance fees if the client meets certain criteria, including two tests that have dollar amount thresholds. Under today’s order, an investment adviser will be able to charge performance fees if the client has at least $1 million under the management of the adviser, or if the client has a net worth of more than $2 million. Either of these tests must be met at the time of entering into the advisory contract. The previous thresholds were $750,000 and $1.5 million respectively, and were last revised in 1998.

The Dodd-Frank Act requires that the Commission issue an order to adjust for inflation these dollar amount thresholds by July 21, 2011 and every five years thereafter. The Commission published a notice of its intent to issue the order on May 10, 2011. The Commission also proposed amendments to rule 205-3, which are currently under consideration.

The order will be effective on September 19, 2011, which will be approximately 60 days after its publication in the Federal Register.

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Bart Mallon is an attorney with a practice focused on hedge funds and investment adviser registration. He can be reached directly at 415-868-5345.

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CFTC Proposed Regulation 1.71 Article Published in NIBA Journal

Just a quick note that we had an article published in the June issue of the NIBA Journal titled How will the Proposed Swaps Regulations Affect IBs? In the article we discuss how the OTC derivatives regulations have essentially overshadowed some of the CFTC's other rulemaking initiatives like Proposed Regulation 1.71.  Proposed Regulation 1.71 would essentially require certain CFTC registered firms, inc

luding introducing brokers, to implement certain compliance procedures to separate research activities from execution activities.  Proposed Regulation 1.71 has not yet been finalized by the CFTC and we provide updates if new rules are adopted.

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Cole-Frieman & Mallon LLP provides legal services to the managed futures industry including CTA, CPO, and Introducing Broker registration and compliance services.  Bart Mallon can be reached directly at 415-868-5345.

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SEC Open Meeting re: Hedge Fund Registration

We are currently watching the webcast live and are posting our comments below.  You can watch the meeting live here: http://sec.gov/news/openmeetings.shtml.

We will be posting our review of the adopted regulations sometime later today.

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11:05 AM ET: the open meeting has started and Chairman Schapiro (“CS”) is currently providing an overview of the meeting today.

11:12 AM ET: the registration requirements will not go into effect until the first quarter of 2012 to allow the SEC time to prepare their systems to accept all the hedge fund registration applications.

11:15 AM ET: Bob Plaze discussing new rulemakings – hedge fund registration will be extended to March 30, 2012.  [No March 31, 2012 next year because of leap year.]

11:19 AM ET: Devin Sullivan discussing Form ADV amendments – important data on the private funds as well as service providers – auditors, prime brokers, custodians.  Competitively sensitive information will not be required.

11:20 AM ET: Devin Sullivan discussing Exempt Reporting Advisers will be required to complete certain parts of Form ADV.

11:21 AM ET: Devin Sullivan discussing switch for certain SEC registered managers to state registration.  Uniform method to calculate AUM.  Current SEC registered advisers will need to file an amendment to show they can remain SEC registered.

11:22 AM ET: Devin Sullivan discusses pay to play rules and Municipal Advisers.

11:24 AM ET: VC advisers get a break – they can have up to 20% of fund's assets in non-qualifying VC investments.  Other parts of the rule sound similar to the proposal.

11:25 AM ET: VC funds get grandfathering provision.

11:27 AM ET: $150M exemption rule is recommended to be adopted substantially as proposed.  http://www.hedgefundlawblog.com/rule-203m-1-%E2%80%93-private-fund-adviser-exemption.html

11:28 AM ET: Foreign private adviser rule is recommended to be adopted substantially as proposed.  http://www.hedgefundlawblog.com/rule-202a30-1-investment-advisers-act.html

11:29 AM ET: Commissioner Casey (“CC”) talking about VC funds and congressional intent.  Supports VC rule and 20% basket of non-VC investments.  Does not support some of the other rules – especially because of the exempt reporting advisers rule.

11:32 AM ET: CC disagrees with the reporting requirem

ents.  Does not think there is distinction between exempt advisers and registered advisers with respect

to disclosure information on the ADV.  Essentially she thinks this is a slippery slope.

11:34 AM ET: CC says the reporting requirements for exempt advisers needlessly imposes compliance requirements on incubating businesses.

11:36 AM ET: Commissioner Walter (“CW”) generally support the rulemaking.  Believes information from exempt reporting advisers (ERAs) will be important for the SEC.  But would have required broader information from the advisers.  Seems like she wants more information from ERAs; wants to revisit the disclosures in a year.

11:38 AM ET: CW – can we get more information on the 20% basket for VC funds?

11:38 AM ET: Sullivan – Designed to provide flexibility for VC funds.  The big question is whether it is 20% of invested or committed capital.  20% on committed, but the committment m

11:39 AM ET: CW – which states will examine advisers?

11:40 AM ET: Plaze – we asked all of the states about examination; MN would not be subject to examination.  SEC will treat NY advisers as not subject to examination.

11:42 AM ET:  Commissioner Aguilar (“CA”) makes a short statement and thank-yous.

11:44 AM ET:  Commissioner Varedes (“CV”) supports the 20% basket for VC funds.  Would have liked even more flexibility.

11:45 AM ET:  CV disagrees with ERA reporting requirements – reporting requirements too close to registered advisers.

[BM to update the votes]

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Family Office Definition

11:51 AM ET: CS providing background on family offices and proposed definition.  See earlier post: http://www.hedgefundlawblog.com/sec-proposes-family-office-definition.html

11:52 AM ET: Staff member discussing exclusion.  Certain conditions to prevent the family office to provide advice outside of the family, unless there is registration.

11:54 AM ET: Staff member discusses more technical parts of the proposal.

11:56 AM ET: CC, CW and CA did not have any questions for the staff.

11:58 AM ET: CP discusses some issues with respect to some of the changes made from the proposal.

11:59 AM ET: Plaze thanks commenters, especially the ABA, for their comments from a public policy perspective – the staff appreciates such comment letters.

11:59 AM ET: All Commissioners support adopting new family office rule.

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California Extends Hedge Fund Registration Exemption

Emergency Action “Necessary” because of SEC Inaction

The California Department of Corporations has provided a temporary six-month extension of Section 260.204.9 which exempts hedge fund managers from registration in California if the manager has more than $25M of AUM.  The exemption will be slightly modified to account for the changes to federal law as a result of the Dodd-Frank Act.  The exemption is also scheduled to become inoperative on January 21, 2012.

The emergency action was taken by California because the SEC recently announced that they intended to delay implementation of the federal hedge fund registration regulations until 2012.  The SEC is expected to formally announce that registration will be delayed until next year in an Open Meeting on June 22.  On such date we are expected to have a better timeline of when registration might be required.

Reasons for the Emergency Action

California provides the following background on the emergency action and why the state decided to move forward with extending the exemption:

… persons that may be required to register under final SEC rules would have a very limited time period in which to prepare their registration documents. In order to allow such persons to determine how SEC rules will ultimately affect their registration status, it is necessary to provide sufficient time for regulated persons to analyze the final rules and prepare any required application materials.

Additionally, the extension is necessary to allow the Department to study how best to regulate advisers to alternative investment vehicles, while balancing the regulatory burden on such advisers, with any corresponding investor protections issues.

Lastly, this extension is necessary to ensure the stability of California capital and labor markets. Alternative investment vehicles, including venture capital funds, have historically provided a crucial source of financing for California businesses.

…

These emergency regulations address the marketplace uncertainty that exists as a consequence of the operative date of the change in federal law, by temporarily continuing the existing California registration exemption for private advisers. The emergency regulations further will provide the Department and industry the opportunity for thoughtful dialogue on the appropriate measure of state oversight after the federal adoption of rules. These emergency regulations are intended to prevent a marketplace reaction of seeking registration in the face of uncertainly; resulting in businesses prematurely incurring costs to comply with a regulatory scheme that ultimately may prove unnecessary for some private advisers. Moreover, it is likely that most private advisers would not be able to secure registration prior to July 21, 2011, thus requiring that they immediately cease providing investment advisory services for compensation in California.

Other States Next?

There are a number of other states which have IA registration exemptions which are similar to the California exemption.  We expect to see similar pronouncements in the coming weeks from other states.  Then, after the SEC finalizes the registration regulations, we will see states drafting new laws that better integrate with the

new federal regulations.

The modified exemption can be found here: Section 260.204.9 (Effective July 21, 2011)

Background information and the finding of emergency can be found here: California Finding of Emergency

The notice can be found here: Notice of Emergency Action

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Bart Mallon is an attorney with a practice focused on hedge funds and investment adviser registration. He can be reached directly at 415-868-5345.

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Compliance Issues for Forex IBs, CPOs and CTAs

NFA Produces Compliance Webinar for Retail Forex Firms

Since the CFTC passed its final rules on retail participation in off-exchange foreign currency markets back in October 2010, there has been an influx of newly registered introducing forex brokers (IBs), commodity pool operators (CPOs), and commodity trading advisors (CTAs).  On June 8, 2011, the NFA hosted a webinar that focused on common regulatory deficiencies that NFA staff members have found during compliance audits of these IBs, CPOs and CTAs.  The following is a brief overview of the common regulatory deficiencies the NFA staff found regarding registration issues, disclosure documents, recordkeeping requirements, promotional materials, and anti-money laundering programs.

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Forex Registration Issues

Any entity intermediating retail forex transactions is required to be registered as forex IB, CPO, or CTA.  Common deficiencies for these

firms include having unlisted APs, failing to register supervisory APs, failing to withdraw APs, or failing to list branch offices.  Additionally, the following are areas emphasized in the webinar:

Listing All Principals – Criteria for being listed as a Principal of the firm generally are (1) job title, (2) ownership (direct or indirect), and (3) job duties and ability to control business activities.  More detail is available in NFA Rule 101.  Tips for ensuring the proper individuals are listed, include:

  • After any board of directors’ meetings, ensure any new directors/officers become listed as Principals of firm.
  • Periodically review the owners of any holding company of the firm to ensure indirect owners are listed if required.

Associated Person (AP) Registration – Essentially anyone who is a salesperson or supervises salespersons is required to be registered as an AP.  It is important to look at the supervisory chain of command–an individual must be registered, no matter how high he/she is on the supervisory chain of command.

  • Exam requirements – The APs must pass the Series 3 exam and the Series 34 exam.  If a person was registered as an AP, sole proprietor, or floor broker as of May 22, 2008 and there has not been more than a 2-year gap since that registration, the person is not required to pass the Series 34.
  • Tips for ensuring the proper individuals are registered:
    • Terminate an AP’s registration within 30 days of an AP leaving the firm.
    • After any shifts in control, ensure those with controlling influence are listed as Principals, and those that supervise APs are registered as APs themselves.

Branch Office Registration – Common deficiencies include:

  • Branch Office Address – Each branch office must be registered. Each branch office must use the name of the firm and hold itself out as a branch of the firm.  It cannot be a separate entity.
  • Payment of APs – Each AP in the branch office must be paid directly by the firm (payment by an intermediary would lead to the assumption the intermediary needs to be registered with the NFA).

Recordkeeping

Information in Customer File – This information is normally initially obtained upon account opening, but the firm must also maintain up-to-date and readily accessible information.   The firm shouldn’t rely on the FCM for this information unless it has been agreed upon before account opening.  The following information must be in the firm’s file for each customer and must be obtained before account opening:

  • name, address, date of birth, and principal occupation,
  • for individuals – current estimated annual income and net worth,
  • notes about the customer’s previous investment and trading experience and any other information that would assist the firm to accurately and fully disclose all the risks of trading,
  • signed customer acknowledgment that he/she has received all of the required risk disclosures, which include:
    • CFTC Regulation 5.5 risk disclosures (e.g. the FCM is the counterparty to all trades and forex trading is extremely risky and not suitable for all investors),
    • performance for the last 4 quarters for all non-discretionary accounts held at customer’s FCM (broken down by profitable/non-profitable accounts in percentage form), and
    • some customers need to receive additional risk disclosure statements based on age, trading experience, and net worth.

Business with Member Firms – Firms need to make sure they are not conducting business with any non-NFA member firms that are required to be registered (or are suspended).  Make sure counterparties are registered as FCMs or RFEDs, or solicitors are registered IBs.  The firm should also review their list of customers–if a customer’s name indicates he/she might be engaged in the trading business, inquire as to the customer’s registration/membership status.  The firm can also check on the NFA’s BASIC system to see if the customer is properly registered or operating under an exemption from registration.  The firm should document this process to show it did proper due diligence on the account.

Forex Disclosure Documents

All nonexempt CPOs operating a pool and CTAs that manage forex accounts for retail customers must distribute a forex disclosure document to their clients.  Three common problems are:

Risk Disclosures – The firm needs to make sure all risks associated with forex trading are disclosed.  This can include volatility, leverage, liquidity, counterparty creditworthiness, and others risks relevant to the program.

Fee Description – The fee description must be complete and all defined terms must be fully explained.

Performance Results –

  • CTA disclosure documents must include the actual performance of all clients directed by the CTA and each trading principal for the last 5 years to date (any past performance must be calculated net of all fees, including mark ups associated with bid/ask spread, etc.). If the CTA directed accounts prior to be being registered as a CTA, the disclosure document must still disclose those accounts.
  • The NFA has a guide on disclosure documents available here.

Forex Promotional Materials

Policies & Procedures – The firm must develop written procedures for how it creates and reviews promotional materials, as well as how the firm supervises employees on these matters.  Promotional materials:

  • must present a balanced discussion of the risk of loss (any discussion of profits should also discuss the risk of loss),
  • must provide a discussion of fees associated with trading forex,
  • must provide appropriate disclaimers for past performance, and
  • must not suggest forex trading is appropriate for everyone or guarantee success.
Social Media – Any communications with the public is considered promotional materials (e.g. emails, LinkedIn, Twitter, Facebook, etc.).  All information on social media must be in accordance with the NFA’s promotional materials rules.

  • If the firm hosts a blog, chat room, or other discussion forum that allows the general public to comment, those comments must be reviewed regularly to ensure they are not misleading or one-sided. Such comments must be removed immediately and the firm should also ban those users who repeatedly post comments that violate the rules.
  • Keep records of which posts are deleted, which users are blocked, how often a review is conducted, and how employees are supervised.
  • If employees have personal blogs, Facebook accounts, etc., the firm should monitor the posts periodically.  Any references to the firm can be seen as promotional materials.  If after monitoring employees’ personal pages, there are never any references to the firm’s business, then the procedures can change and require less frequent monitoring.
  • Special rules apply for the use of audio/visual ads.  If the firm provides trade recommendations or discuss past/potential profits through radio or webcasts (such as YouTube), the firm is required to submit them to the NFA for approval at least 10 days prior to use.

Anti-Money Laundering Program

An anti-money laundering program is required for IBs (guaranteed and independent), FCMs and RFEDs (even if they don’t hold customer funds).  These procedures are designed to guard against someone using the firm to facilitate money laundering or other terrorist financing.  The program should include:

  • written policies and procedures,
  • the appointment of a chief compliance officer,
  • ongoing training, and
  • an annual, independent audit.

The NFA has an Anti-Money Laundering webinar available on its website.

The NFA’s “Compliance Issues for Forex IBs, CPOs and CTAs” webinar is archived on the NFA’s website and can be found here .

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Bart Mallon is an attorney with a practice focused on hedge funds managed futures and forex regulatory issues.  He can be reached directly at 415-868-5345.

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SEC Announces Open Meeting on Hedge Fund Regulations

SEC Considers Whether to Adopt Registration Requirement

Yesterday the SEC announced that they will conduct an Open Meeting on June 22 to determine whether to adopt the new hedge fund registration requirements and related rules. At the Open Meeting the SEC is expected to delay implementation of the regulations until next year.   While the SEC announced in a letter to NASAA that they would likely extend the registration deadline, there has been no official action on this issue.  This has left managers (and lawyers and compliance personnel) unsure of how to proceed.  We will know more after the June 22 meeting.

The notice of the Open Meeting, reprinted below in full, can be found here.  Hat tip to Doug Cornelius at Compliance Building for publishing this story earlier today.

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Notice is hereby given, pursuant to the provisions of the Government in the Sunshine Act, Pub. L. 94-409, that the Securities and Exchange Commission will hold an Open Meeting on June 22, 2011 at 10:00 a.m., in the Auditorium, Room L-002.

The subject matters of the Open Meeting will be:

Item 1: The Commission will consider whether to adopt new rules and rule amendments under the Investment Advisers Act of 1940 to implement provisions of the Dodd-Frank Wall Street Reform and Consumer Protection Act. These rules and rule amendments are designed to gi

ve effect to provisions of Title IV of the Dodd-Frank Act that, among other things, increase the statutory threshold for registration of investment advisers with the Commission, require advisers to hedge funds and other private funds to register with the Commission, and address reporting by certain investment advisers that are exempt from registration.

Item 2: The Commission will consider whether to adopt rules that would implement new exemptions from the registration requirements of the Investment Advisers Act of 1940 for advisers to venture capital funds and advisers with less than $150 million in private fund assets under management in the United States. These exemptions were enacted as part of the Dodd-Frank Wall Street Reform and Consumer Protection Act. The new rules also would clarify the meaning of certain terms included in a new exemption for foreign private advisers.

Item 3: The Commission will consider whether to adopt a rule defining “family offices” that will be excluded from the definition of an

investment adviser under the Investment Advisers Act of 1940.

At times, changes in Commission priorities require alterations in the scheduling of meeting items.

For further information and to ascertain what, if any, matters have been added, deleted or postponed, please contact:

The Office of the Secretary at (202) 551-5400.

Elizabeth M. Murphy

Secretary

June 8, 2011

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Bart Mallon is an attorney with a practice focused on hedge funds and investment adviser registration.  He can be reached directly at 415-868-5345.

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