FINRA Proposes Amendments to Rule 5122

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Proposal to Require Greater Involvement in Private Placements by Broker-Dealers

FINRA recently proposed amendments to Rule 5122 which would increase Broker-Dealer compliance responsibilities with respect to private placements in which the Broker-Dealer “participates.”  FINRA noted that the vast majority of private placements currently remain outside the purview of the rule as it is currently written.  As FINRA’s stated intention is to increase investor protection, the amended rule is designed to combat fraud and abuse, by expanding oversight to all private placements in which a FINRA member participates, subject to certain exemptions.

Current FINRA Rule 5122

In general FINRA Rule 5122 requires a FINRA member firm which acts as the issuer of a private placement to adhere to the following requirements:

  • the private placement offering document must include the indended use of offering proceeds, expenses, and the amount of selling compensation to be paid to the broker-dealer and its associated person;
  • 85% of the offering proceeds must be used for the business purposes described in the offering documents (i.e. only up to 15% of the proceeds from the offering may be used to pay for offering costs, discounts, commissions or any other cash or non-cash sales incentives); and
  • the offering documents must be submitted to FINRA for review at or prior to the time the offering documents are provided to any prospective investor (but the firm does not need to delay the offering until it receives a “no-objections” letter from FINRA).

There are various exemptions available under the rule including if the private placement offering is sold to:

  • Institutional accounts
  • Qualified purchasers
  • Qualified institutional buyers
  • Investment Companies
  • Banks
  • Employees of the issuers

In addition, certain private placements are not subject to the rule.

Major Part of Proposal

In general the major part of the proposed amendment is to apply the requirements of the rule to broker-dealers who “participate” (within the meaning of FINRA Rule 5110(a)(5), see below) in a private placement offering as opposed to only those broker-dealers (and control entities) who act as the cheap celebrex online issuer in a private placement.  The proposal will significantly expand the scope of the current rule – third-party marketers who enter into selling arrangements with respect to private fund interests will now be subject to greater oversight with respect to these arrangements.

Participation

Rule 5110(a)(5) defines “participation” as the following:

Participation in the preparation of the offering or other documents, participation in the distribution of the offering on an underwritten, non-underwritten, or any other basis, furnishing of customer and/or broker lists for solicitation, or participation in any advisory or consulting capacity to the issuer related to the offering, but not the preparation of an appraisal in a savings and loan conversion or a bank offering or the preparation of a fairness opinion pursuant to SEC Rule 13e-3.

The proposal also would remove the wholesaling exemption (i.e. selling through affiliated broker-dealers) for member firms.

Conclusion

It is not clear now how this would affect the business of third-party marketers and whether this will have a chilling affect on selling agreements.  This proposed amendment also highlights FINRA’s aggressive expansion of regulatory oversight.

If you have specific comments on the proposal, especially with respect to certain elements (investor protection, filing requirements, burdens/efficiencies, 85% of offering proceeds go to the use of proceeds), you should submit comments on the proposal by March 14, 2011

For more information, please see FINRA Regulatory Notice 11-04.

Other good information for broker-dealers FINRA Regulatory Notice 10-22.

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Bart Mallon is an attorney focused on the investment management industry and provides regulatory and compliance services to the broker-dealer community through Cole-Frieman & Mallon LLP.  He can be reached directly at 415-868-5345.

New Form ADV Part 2 Update & Overview

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Registered investment advisers (both SEC and state) will need to file their annual form ADV update within 90 days of the end of the fiscal year, which for most firms will be March 31, 2011.  For many firms this will mean that they will also need to draft and submit the new Form ADV 2 which was adopted by the SEC in July of 2010 (see previous post). As many firms have had many questions about the new form, including what new content is required and how long it will take to complete the new form, this article will provide a summary of:

  • Background on the new Part 2
  • The structure and disclosure items of the Firm Brochure (Part 2A)
  • The structure and disclosure items of the Brochure Supplement (Part 2B)
  • Overview of states which have adopted new Part 2

Background

On July 21, 2010, the Securities and Exchange Commission (“SEC”) adopted a new Part 2 that became effective October 12, 2010.  The old Part II (and Schedule F which qualifies much of the information on the old Part II) contained a series of check-the-box options and also provided much of the same information which is also provided on Form ADV.  The new Part 2 will no longer be in the check-the-box format.  Instead, it will take the form of a narrative brochure written in plain English–the purpose of which is to provide clients with a more clear disclosure of the adviser’s business practices, conflicts of interest, and background.

The new Part 2 consists of three parts:

  1. The “Firm Brochure” (Part 2A)
    • SEC-registered firms and firms registered in states that have adopted the new Part 2 must complete.
    • Filed electronically on the IARD system.
    • Publicly available.
  2. A Wrap Fee Program Brochure (Part 2A, Appendix 1)
  3. The “Brochure Supplement” (Part 2B)
    • SEC-registered firms and firms registered in states that have adopted the new Part 2 must complete.
    • Not filed electronically.
    • Not publicly available.

The SEC has not provided a specific form that IAs must use when preparing the new Part 2.  The following provides general guidelines on how to structure the Firm Brochure and Brochure Supplement, as well as what content to include.  A full version of the new Part 2 instructions is available here.  Firms applying for SEC registration for the first time after January 1, 2011 are required to use the new Part 2.  Existing SEC-registered firms may use either the old Part II or the new Part 2 between October 12, 2010 and December 31, 2010.  However, beginning January 1, 2011, firms will have to use the new Part 2 for their 2011 annual updating amendment.

More information about the filing and delivery deadlines for the new Part 2A and 2B are available here.

Firm Brochure (Part 2A)

The Firm Brochure requires an adviser to provide information about the firm’s business practices and conflicts of interest. Many of the disclosure items are similar to those required in the old Part II, such as a discussion of the advisory business and the types of clients.  However, new disclosure items include a discussion of material changes since the last annual amendment as well as a discussion of potential conflicts of interest and how the firm will address such conflicts.

The Brochure consists of 18 separate disclosure items for SEC-registrations and additional items specifically for state-registrations.  Each item must be addressed, even if it is not applicable to the adviser.  The adviser may simply state it is not applicable.  The following is a summary of the disclosure items in the Firm Brochure:

  • Item 1 – Cover Page
    • Firm name, business address, contact information, website (if any) and the date of the Brochure.
    • Specific disclaimer stating the Brochure was not approved by the SEC or any state authority.
    • If the firm refers to itself as a “registered investment adviser,” a specific disclaimer that registration does not imply a certain level of skill or training.
  • Item 2 – Material Changes
    • If the firm is making an annual update, the Brochure must discuss material changes in the Brochure since the last annual update in a summary.  The summary can also be a separate document attached to the Brochure.
  • Item 3 – Table of Contents
    • Must be detailed enough so that clients can locate topics easily.
    • Must list items in the same order as they are listed in the Brochure, and contain the same headings.
  • Item 4 – Advisory Business
    • Describe the firm, how long it’s been in business, and identify the principals.
    • Describe the types of advisory services offered.
      • If the firm specializes in a particular type of services, e.g. financial planning, quantitative analysis, etc. provide greater detail.
      • If the firm provides investment advice only with respect to limited types of investments, explain and disclose that advice is limited in such way.
    • Explain whether the firm tailors advisory services and whether clients can impose restrictions on investments.
    • If the firm participates in wrap fee programs, describe the differences in how such accounts are managed versus other accounts and disclose that the firm receives a wrap fee.
    • If the firm manages client assets, disclose the amount managed on a discretionary basis and the amount managed on a non-discretionary basis.
  • Item 5 – Fees and Compensation
    • Describe how the firm is compensated and provide a fee schedule.  Note: This requirement is not required for Brochures delivered solely to qualified purchasers.
    • Provide other compensation-related disclosures: whether fees are deducted from client assets or whether clients will be billed for fees; any other types of fees (custodian fees, mutual fund expenses, brokerage/transaction costs); payment of fees in advance or arrears; and asset-based sales charges or service fees.
  • Item 6 – Performance-Based Fees and Side-By-Side Management
    • Discuss whether the firm charges performance-based fees or supervised persons manage accounts that pay such fees; and discuss how the fees are charged.
    • In addition, if the firm or supervised persons also manage accounts that do not charge such fees, discuss the potential conflicts of interest and how the firm will address such conflicts.
  • Item 7 – Types of Clients
    • Describe the firm’s clients.
    • Describe any requirements for opening/maintaining an account.
  • Item 8 – Methods of Analysis, Investment Strategies and Risk of Loss
    • Describe the methods of analysis and investment strategies used to formulate investment advice.  Disclose that investing in securities involves risk of loss.
    • For significant investment strategies or methods of analysis, discuss material risks involved with such strategies and methods.  If there are significant or unusual risks, discuss in detail.  If strategies involve frequent trading, discuss how frequent trading affects performance.
    • If the firm recommends primarily a particular type of securities, explain the material risks.  If there are significant or unusual risks, discuss in detail.
  • Item 9 – Disciplinary Information
    • Disclose material facts about legal or disciplinary events about the firm or a management person.  This item lists events that are presumed to be material if they occurred in the prior 10 years, unless (1) the event was resolved in the firm’s or the management person’s favor, or was reversed, suspended or vacated, or (2) the firm rebutted the presumption of materiality to determine that the event is not material.
    • In the interest of full and fair disclosure of material facts, disclose events not on the list, events not presumed material, and/or events that are more than 10 years old.
    • The Firm can rebut events that are presumed material.
  • Item 10 – Other Financial Industry Activities and Affiliations
    • Discuss whether the firm or management persons are registered or have pending applications to register as broker-dealers, broker-dealer reps, FCMs, CPOs, CTAs, or associate persons.
    • Describe material relationships with related financial industry participants (e.g. broker-dealers, registered reps of broker-dealers, investment companies or other pooled investment vehicles, FCMs, CPOs, CTAs, accounting firms, law firms, real estate brokers, etc.).
    • Describe material conflicts of interest that arise from such relationships and how those conflicts are addressed.
    • If the firm selects or recommends other investment advisers for clients, the firm must disclose compensation arrangements (if any) with those advisers and any other business relationships with such advisers, as well as any material conflicts of interest and how the firm address them.
  • Item 11 – Code of Ethics, Participation or Interest in Client Transactions and Personal Trading
    • Include a summary of the code of ethics and state a copy is available upon request.
    • If the firm or a related person:
      • (i) recommends to clients, or buys or sells for client accounts, securities in which the firm or a related person has a material financial interest;
      • (ii) invests in the same securities (or related securities, e.g., warrants, options or futures) that the firm or a related person recommends to clients; or
      • (iii) recommends securities to clients, or buys or sells securities for client accounts, at or about the same time that the firm or a related person buys or sells the same securities for the firm’s own (or the related person’s own) account, then the firm must describe the practice and discuss conflicts of interest (including how such conflicts are addressed).
  • Item 12 – Brokerage Practices
    • Describe how the firm selects brokers and determines the reasonableness of brokers’ compensation
    • If the firm receives research or other products or services other than execution from a broker-dealer or a third party in connection with client securities transactions (“soft dollar benefits”), disclose the firm’s practices and discuss the conflicts of interest they create.  Provide more detail for products/services that do not qualify under the Section 28(e) safe harbor.
    • If the firm considers, in selecting or recommending broker-dealers, whether the firm or a related person receives client referrals from a broker-dealer or third party, disclose this practice and discuss the conflicts of interest it creates.
    • If the firm routinely recommends, requests or requires that a client direct the firm to execute transactions through a specified broker-dealer, describe the firm’s practice or policy.
    • If the firm permits a client to direct brokerage, describe the practice.
    • Describe whether and under what conditions the firm aggregates the purchase or sale of securities for various accounts.
  • Item 13 – Review of Accounts
    • If the firm periodically reviews client accounts, describe the frequency and nature of review, as well as the titles of the persons who conduct the review.
    • If accounts are reviewed on other than a period basis, describe what triggers review.
    • Describe the content and indicate the frequency of regular reports.
  • Item 14 – Client Referrals and Other Compensation
    • If a non-client provides economic benefit to the firm for providing investment advice or services to clients, describe the arrangement, potential conflicts of interest and how such conflicts are addressed.
    • If the firm or related persons compensate any non-supervised persons for referrals, describe the arrangement and compensation.
  • Item 15 – Custody
    • If the firm has custody of client assets and a qualified custodian sends quarterly, or more frequent, account statements directly to your clients, explain that clients will receive account statements from the broker-dealer, bank or other qualified custodian and that clients should carefully review those statements.
    • If the firm also provides statements, urge clients to compare such statements with those provided by the qualified custodian.
  • Item 16 – Investment Discretion
    • If the firm has discretionary authority over accounts, disclose this, along with any limitations clients may place on that authority.
    • Discuss procedures before discretionary authority is assumed.
  • Item 17 – Voting Client Securities
    • Describe voting policies for client securities, if any.  Discuss any conflicts of interest and how such conflicts are addressed.  Explain that a copy of the policies are available upon request.
    • If the firm does not vote client securities, disclose that fact.
  • Item 18 – Financial Information
    • If the firm requires or solicits prepayment of more than $1,200 in fees per client, 6 months or more in advance, include a balance sheet for the most recent fiscal year.
    • If the firm has discretionary authority over client assets, custody of client funds or securities, or require prepayment discussed above, discuss any financial conditions that purchase nolvadex are reasonably likely to impair the ability to meet contractual commitments with clients.
    • Discuss any bankruptcy petitions during the past 10 years.
  • Item 19 – Requirements for State-Registered Advisers
    • Identify and describe the formal education and business background of principal executive officers and management persons.
    • Describe any business in which the firm is actively engaged (other than the provision of investment advice) and amount of time spent.
    • In addition to the fees discussed in Item 5, if the firm or a supervised person is compensated for advisory services with a performance-based fee, explain how the fees are calculated and discuss the conflict of interest.
    • Disclose material facts about certain disciplinary items and other financial industry relationships or arrangements.

Brochure Supplement (Part 2B)

The Brochure Supplement requires an adviser to provide information about the certain advisory personnel.  The following is a summary of the disclosure items in the Brochure Supplement.

The Firm must prepare a Brochure Supplement for (i) any supervised person who formulates investment advice for the client and has direct client contact and (ii) any supervised person who has discretionary authority over the client’s assets.  A Supplement is not required if the supervised person has no direct client contact and has discretionary authority over client assets only as part of a team. Note: If investment advice is provided by a team of more than five supervised persons, Brochure Supplements only need to be prepared for the five supervised persons with the most significant responsibility for the day-to-day advice.

  • Item 1 – Cover Page
    • Identify the advisory firm and the supervised persons covered in the Supplement (include name, business address, and phone number).
    • Standard disclaimer similar to the one in the Firm Brochure.
  • Item 2 – Educational Background and Business Experience
    • Describe the supervised person’s formal education and business background for the past 5 years.
    • Include professional designations, if any.
  • Item 3 – Disciplinary Information
    • Discuss the material facts related to any legal or disciplinary events that are material to a (prospective) client’s evaluation of supervised persons. This item lists events that are presumed to be material if they occurred in the prior 10 years, unless (1) the event was resolved in the supervised person’s favor, or was reversed, suspended or vacated, or (2) the firm rebutted the presumption of materiality to determine that the event is not material.
    • In the interest of full and fair disclosure of material facts, disclose events not on the list, events not presumed material, and/or events that are more than 10 years old.
    • The Firm can rebut events that are presumed material.
    • Disclose any event for which the supervised person has ever resigned or otherwise relinquished a professional attainment, designation or license in anticipation of it being suspended or revoked (other than for suspensions or revocations for failure to pay membership dues), if the firm knows or should have known that the supervised person relinquished his or her designation or license.
    • Note: If a Brochure Supplement is delivered electronically, the firm may disclose that a supervised person has a disciplinary event and provide a ink to BrokerCheck or IAPD (along with an explanation of how the client can access the disciplinary history).
  • Item 4 – Other Business Activities
    • If the supervised person is actively engaged in any investment-related business, including registration (or pending registrations) as a broker-dealer, registered representative of a broker-dealer, futures commission merchant (“FCM”), commodity pool operator (“CPO”), commodity trading advisor (“CTA”), or an associated person of an FCM, CPO, or CTA, disclose this fact and describe the business relationship.
  • Item 5 – Additional Compensation
    • If a non-client provides an economic benefit to the supervised person, describe the arrangement (not including regular salary).
  • Item 6 – Supervision
    • Discuss how supervised persons are supervised, including how the firm monitors advice provided to clients.
    • Provide the name, title, and phone number of the person responsible for supervising the supervised persons.
  • Item 7 – Requirements for State-Registered Advisers
    • Disclose material facts about certain disciplinary items.
    • Discuss any bankruptcy petitions.

[Note: the SEC recently extended the date for compliance with Part 2B.]

States That Have Adopted the New Part 2

The following states have followed suit and adopted the new Part 2 or informally indicated an intent to do so.

  • Alaska – adopted the new Part 2 (more information available here)
    • October 12, 2010 – December 31, 2010: IA applicants and currently registered IAs may use either the old Part II or new Part 2.
    • As of January 1, 2011: IA applicants are required to use the new Part 2 and registered IAs must file the new Part 2 by no later than the registrant’s next amendment filing or its annual updating amendment filing, whichever comes first.
  • Arizona – adopted the new Part 2 (more information available here)
    • October 12, 2010 – January 1, 2011: currently registered IAs will need to incorporate the new Part 2 as part of any amendment or required annual update
    • As of January 1, 2011: IA applicants must use the new Part 2.
  • California – adopted the new Part 2 (more information available here)
    • October 12, 2010 – January 1, 2011: IA applicants and currently registered IAs may use either the old Part II or the new Part 2.
    • As of January 1, 2011: IA applicants will have to file the new Part 2 and registered IAs will need to incorporate the new Part 2 as part of any amendment or required annual update.
  • Colorado – will require but not sure starting when
  • Connecticut – adopted the new Part 2 (more information available here)
    • October 12, 2011 – December 31, 2010: IA applicants and currently registered IAs may use either the old Part II or the new Part 2.
    • As of January 1, 2011: IA applicants will have to use the new Part 2 and registered IAs will need to incorporate the new Part 2 as part of any amendment or required annual update.
    • As of January 1, 2011: IAs registered on or before December 31, 2010 should file the new Part 2, no later than June 1, 2011.
  • Illinois – will require but not sure starting when
  • Indiana – adopted the new Part 2 (timelines may have been updated) (more information available here)
    • October 12, 2010 – January 1, 2011: IA applicants and currently registered IAs may use either the old Part II or new Part 2.
    • As of January 1, 2011: IA applicants are required to use the new Part 2 and registered IAs will need to incorporate the new Part 2 as part of any amendment or required annual update.
  • Maine – adopted the new Part 2 (more information available here)
    • October 12, 2010 – January 1, 2011: IA applicants and currently registered IAs may use either the old Part II or new Part 2.
    • As of January 1, 2010: IA applicants must use the new Part 2 and registered IAs will need to incorporate the new Part 2 as part of any amendment or required annual update.
  • Maryland – adopted the new Part 2 (more information available here)
    • As of October 12, 2010: IA applicants must use the new Part 2 as part of its initial application and any amendment.
    • October 12, 2010 – December 31, 2010: currently registered IAs and those pending registration as of October 12, 2010 may use either the old Part II or the new Part 2 for any amendments
    • As of January 1, 2011: registered IAs must file the new Part 2 by no later than the registrant’s next amendment filing or its annual updating amendment filing, whichever comes first.
  • Massachusetts – adopted the new Part 2 (more information available here)
    • October 12, 2010 – December 31, 2010: currently registered IAs are required to file the registrant’s next annual updating amendment using the new Part 2; until such time, the registrant may use the old Part II for regular amendment filings.
  • Ohio – adopted the new Part 2 (more information available here)
    • October 12, 2010 – December 31, 2010: IA applicants and currently registered IAs filing amendment may use either the old Part II or the new Part 2.
    • As of January 1, 2011: currently registered IAs will need to incorporate the new Part 2 as part of any amendment or required annual update.  IA applicants are required to use the new Part 2.
    • As of April 30, 2011: registered IAs must have converted to the new Part 2.
  • Oregon – adopted the new Part 2 (more information available here).
    • October 12, 2010 – January 1, 2011: IA applicants and currently registered IAs filing amendment may use either the old Part II or the new Part 2.
    • As of January 1, 2011: IA applicants must use the new Part 2 and registered IAs will need to incorporate the new Part 2 as part of any amendment or required annual update.
  • Tennessee – adopted the new Part 2 (more information available here).
    • October 12, 2010 – December 31, 2010: IA applicants and currently registered IAs filing amendment may use either the old Part II or the new Part 2.
    • As of January 1, 2011: applicants must use the new Part 2 and registered IAs must file the new Part 2 by no later than the registrant’s next amendment filing or its annual updating amendment filing, whichever comes first.
  • Texas – currently in comment period, final approval expected in mid-2011, encouraging use of the new Part 2 (more information available here).

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Bart Mallon Esq. is a hedge fund attorney and provides hedge fund compliance services through Cole-Frieman & Mallon LLP.  He can be reached directly at 415-868-5345.

NFA Annual Compliance Overview 2011

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CTA and CPO firms which are registered with the CFTC will need to make sure that they are completing all necessary annual compliance items in accordance with CFTC regulations and NFA rules.

Below we have provided a list of the major items which registered firms should address with respect to annual compliance.  Many registered CTA and CPO firms have compliance manuals which address (or should address) these items.

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Rule 2-46 Quarterly Report (CPO only)

  • Due 2/14/2011
  • The following information must be submitted to the NFA:
    • Summary of Itemized Balances
    • Key Relationships
    • NAV
    • Monthly Performance – Rates of Return
    • Schedule of Investments
  • More information:
  • Once the report has been filed, complete and keep the Acknowledgment of Quarterly Report Filed (Rule 2-46) form and any related documents with your books and records.

Quarterly Review of Emails

  • Registered CPO and CTA firms are responsible for supervising employees and should periodically review employee emails.  It is a good idea to complete a quarterly review of employee emails, document the review and keep the documentation as part of the firm’s books and records.

Yearly Review of Email Procedures

  • The firm’s compliance officer should review the effectiveness of the firm’s email review procedures on a yearly basis.  The compliance office should document the review and keep the documentation as part of the firm’s books and records.

Compliance Manual Review

  • The compliance officer should review the firm’s compliance manual on an annual basis.  After the compliance manual has been reviewed and updated as necessary, the compliance officer should have each Principal, Associated Person, and Agent certify that he or she has read and understands the compliance manual and has complied with its requirements.

NFA Self-Examination Checklist

  • The NFA self-examination needs to be completed on a yearly basis.  The compliance office will need to review the firm’s operations using the NFA’s Self-Examination Checklist (http://www.nfa.futures.org/nfa-compliance/publication-library/self-exam-checklist.HTML), document the self-examination and keep the documentation as part of the firm’s books and records.
  • Mallon P.C. has provided an overview of the NFA Self-Examination process.

Privacy Policy

  • All firms should provide each fund investor or client with a copy of the firm’s Privacy Policy within 30 days of the close of the fiscal year.  If the firm provides monthly or other periodic statements, the firm might want to include the Privacy Policy with such normal communication.

Ethics Training

  • The firm’s compliance officer should review the firm’s ethics training program.  If the program changes, the compliance officer must make sure that all Principals, APs and Agents have completed the appropriate ethics training.  If the policy has not changed, this is a good time to confirm all Principals, APs and Agents have completed all appropriate ethics training.

Annual Report (CPO only)

We have outlined the reporting requirements for CPOs before which include an annual reporting requirement.  The CPO will need to provide, within 90 days after the end of the fund’s fiscal year (or within 90 days of the cessation of trading if the fund closes), an annual report to (i) each investor in the fund and (ii) the NFA.  The annual report must be presented and computed in accordance with GAAP consistently applied and must be audited by an independent public accountant.  [Please note that some CPOs may be able to request a waiver from the annual audit requirement.]

The report must include:

  • Fund NAV for the preceding two fiscal years
  • Total value of investor’s interest in the fund at the end of the preceding two fiscal years
  • Statement of Financial Condition for the fund’s fiscal year and preceding fiscal year
  • “Statement of operations” and “Statement of changes in net assets”
  • Footnotes if required to make statements not misleading (including certain information on underlying funds if the fund invests in other commodity pools)
  • Certain information if there is more than one ownership class or series.

Bunched Orders Allocation (CTA only)

  • CTA firms should periodically review the allocation of bunched orders.  Many firms will have a policy to review these allocations on a quarterly basis.  For more information, please see our post on CTA Bunched Orders.

Other Important Items

  • Annual Questionnaire – the annual questionnaire is due within 1 year of the date of registration.  This form is available through the NFA’s ORS (Online Registration System).  For more information see our post on this topic.
  • Annual Registration Update – the annual registration update is due within 1 year of the date of registration.  This form is available through the NFA’s ORS (Online Registration System).  In general the NFA will send a letter (and email) and invoice for annual fees and dues.
  • Other – some firms have policies regarding their Disaster Recovery Program which may need to be revisited during the annual review process.  Additionally, both CTA and CPO firms should take the opportunity to review their disclosure documents and see if any revisions to those documents should be made.  Other business issues, like bank reconciliations and general bookkeeping matters, should be reviewed in light of the firm’s compliance policies.

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The above list is not indended to be exhaustive and each firm has different compliance requirements depending on unique circumstances.  If your firm would like help with developing a compliance program or if you have questions with respect to these topics, please don’t hesitate to contact us.

Cole-Frieman & Mallon LLP provides comprehensive compliance and regulatory support for CTAs and CPOs.  Bart Mallon, Esq. can be reached directly at 415-868-5345.

NFA Provides Guidance for CPOs on Performance Fees

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Notice to Members I-11-01

As many CFTC registered entities understand, having disclosure documents approved by the NFA can be a lengthy and frustrating process.  While the NFA has done a decent job explaining to firms that disclosure documents must meet all of the requirements under the CFTC’s Part 4 Regulations, it can feel as though the NFA has a target which is constantly moving.  As we explained earlier in a post describing the NFA Changes after the CFTC audit (see also CFTC Report on NFA Registration Process, the CFTC will occasionally communicate to the NFA certain items which the CFTC would like to see emphasized or changed in the disclosure documents.

Recently, the CFTC provided guidance to the NFA with respect to incentive or performance fee arrangements in CTA and CPO  investment programs.  Essentially the CFTC asked the NFA to make sure that all disclosure documents for programs with performance fees include a discussion of the conflicts of interest involved with performance fee arrangements.  Specifically:

[The CFTC] staff’s guidance prescribes that every CPO or CTA that charges a typical incentive fee include in its Disclosure Document a discussion that the incentive fee may encourage a CPO or CTA to take excessive risks to earn an outsized incentive fee, and that such risk-taking may place the interests of the CPO and CTA in conflict with the interests of its clients. Furthermore, [CFTC staff] has indicated that the fact that Regulations 4.24(i) and 4.34(i) require the disclosure of fees and expenses (from which conflicts of interest frequently arise) does not mitigate or lessen the required discussion of conflicts of interest.

Many firms will have already provided this information in the disclosure documents.  For those groups who have not, this means that the disclosure document will need to be amended and reviewed by the NFA according to normal amendment procedures.

The full notice to members is reprinted below and can be found here.

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Notice I-11-01

January 05, 2011

NFA provides guidance for disclosure of conflicts of interests arising from Typical Incentive Fee Arrangements by commodity pool operators and commodity trading advisors

In 1997, the Commodity Futures Trading Commission (CFTC) delegated the review of Disclosure Documents submitted by commodity pool operators (CPO) and commodity trading advisors (CTA) to NFA. The Division levaquin cipro of Clearing and Intermediary Oversight (DCIO) performs periodic oversight of NFA’s implementation of its delegated authority. As part of these reviews, DCIO staff has recently communicated to NFA by letter dated December 2, 2010 its position as to the disclosure of conflicts of interests that arise from typical incentive fee arrangements. NFA is providing the following guidance based upon DCIO’s letter to assist members in complying with the requirements as they relate to the disclosure of conflicts of interests.

CFTC Regulations 4.24(j) and 4.34(j) require CPOs and CTAs to include in their respective Disclosure Documents a “full description of any actual or potential conflicts of interest” regarding “any aspect” of their pools or trading programs as it concerns an enumerated list of entities, including the CPOs and CTAs themselves.

DCIO staff’s guidance relates specifically to the conflicts of interests arising from the collection of incentive fees by CPOs and CTAs. The typical incentive fee collected by a CPO or CTA is usually a fixed percentage of new profits that exceed a pool’s or an account’s previous high-water mark. DCIO stated that from one perspective, the typical incentive fee can be viewed as aligning the interests of the CPOs and CTAs with the interests of their clients as the fee ensures that CPOs and CTAs are compensated in proportion to their clients’ gains, which plainly incentivizes CPOs and CTAs to pursue investment strategies that will seek to maximize returns for their clients. DCIO further states that the typical incentive fee can also be viewed as placing the interests of CPOs and CTAs in conflict with the interests of their clients. From this perspective, the incentive fee could encourage a CPO or CTA to take excessive risks in an attempt to earn an outsized incentive fee. Because the typical fee is generally paid quarterly and is not subject to clawbacks for poor long-term performance, the typical incentive fee can be viewed as an incentive for CPOs and CTAs to take greater short-term risks, which may conflict with their clients’ long-term interests.

DCIO staff’s guidance prescribes that every CPO or CTA that charges a typical incentive fee include in its Disclosure Document a discussion that the incentive fee may encourage a CPO or CTA to take excessive risks to earn an outsized incentive fee, and that such risk-taking may place the interests of the CPO and CTA in conflict with the interests of its clients. Furthermore, DCIO has indicated that the fact that Regulations 4.24(i) and 4.34(i) require the disclosure of fees and expenses (from which conflicts of interest frequently arise) does not mitigate or lessen the required discussion of conflicts of interest.

CPOs and CTAs are encouraged to review their existing Disclosure Documents in light of DCIO’s guidance and make any necessary changes prior to submitting subsequent filings of the document. If you have any questions concerning this notice or Disclosure Documents generally, please contact Mary McHenry, Senior Manager, Compliance ([email protected] or 312-781-1420) or Susan Koprowski, Manager, Compliance ([email protected] or 312-781-1288).

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Cole-Frieman & Mallon LLP provides comprehensive hedge fund start up and regulatory support for commodity pool operators.  Bart Mallon, Esq. can be reached directly at 415-868-5345.

2011 Final Renewal Statement for Registered Investment Advisers

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As we noted previously, registered investment advisory firms and firm representatives must renew their registration annually by paying a fee to FINRA.  In November FINRA issued a Preliminary Renewal Statement for each registered IA firm which stated the amount of renewal fees which were due by December 13, 2010.

While most firms should have by now paid the preliminary statement, each firm can now review their Final Renewal Statement.  The final statement is now available through the IARD system and reflects the firm’s and representatives’ final registration status as of December 31, 2010.  The final statement also reflects any adjustments as a result of registration approvals or terminations since the preliminary statement was issued. Firms and representatives should check their final statement to ensure all renewal fees are paid in full.  If 40 mg levitra the firm has any amounts due, payment should be made by February 4, 2011.

Below is information on how to access your Final Renewal Statement.

Accessing Your Final Renewal Statement

To check your firm’s Final Renewal Statement, follow these instructions:

  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. 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 received by FINRA and posted to the Renewal Account by February 4, 2011.  Any renewal overpayments should have automatically been transferred to your Daily Account.

Additional information about the Final Renewal Statement can be found here.

If you have any questions regarding your renewal statement or any other investment adviser registration issue, please feel free to contact Mallon P.C. for more information.

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Bart Mallon, Esq. runs the hedge fund law blog and provides hedge fund compliance services to hedge fund managers through Cole-Frieman & Mallon LLP.  He can be reached directly at 415-868-5345.

Hedge Fund Events January 2011

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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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January 6

January 12-14

January 11

January 11

January 12

January 18

January 18

January 19

January 19

January 19-21

January 20

January 20

January 20

January 20-21

January 24

January 25

January 26

January 26-27

January lasix without rx 27

January 27

January 27

January 27

January 27

January 27

January 31

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Bart Mallon, Esq. runs the hedge fund law blog and provides hedge fund registration and compliance services to hedge fund managers through Cole-Frieman & Mallon LLP, a leading hedge fund law firm.  He can be reached directly at 415-868-5345.

Form ADV Requirements for Exempt Reporting Advisers

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As we’ve discussed previously, the SEC has proposed two new exemptions from SEC registration for certain firms who would otherwise be required to register with the SEC as investment advisers:

  1. Section 203(l) (see Rule 203(l)-1) generally exempts investment advisers who only advise one or more “venture capital funds” and
  2. Section 203(m) (See Rule 203(m)-1) generally exempts investment advisers who only advise private funds and have AUM in the U.S. of less than $150MM.

To implement these new exemptions and to assist the SEC with identifying such advisers, their owners, their business models, and any potential risks to investors, proposed Rule 204-4 would require these “exempt reporting advisers” (“ERAs”) to submit, and to periodically update, reports to the SEC by completing specific items on Form ADV.

This article provides an overview of what information ERAs would have to report.

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ERA Reporting Items

Proposed Rule 204-4 requires exempt reporting advisers to provide the SEC with the following items on Form ADV:

  • Item 1 – Identifying Information
    • A new question would require ERAs (and registered advisers) to indicate whether the adviser had $1 billion or more in AUM to assist the SEC in identifying excessive incentive-based compensation arrangements.
    • ERAs (and registered advisers) would be required to provide contact information for the adviser’s chief compliance officer, indicate whether any control person is a public reporting company, and add “limited partnership” as a cohise advisers can select to indicate how their organization is formed.
  • Item 2C – SEC Reporting by Exempt Reporting Advisers
  • Item 3 – Form of Organization
  • Item 6 – Other Business Activities:  this item would require the ERAs to indicate the advisers other business activities.  The list of activities would be expanded to include trust companies, registered municipal advisors, registered security-based swap dealers, majority security-based swap participants, and accountant firms.
  • Item 7 – Financial Industry Affiliations from Private Fund Reporting: this item would be expanded as Item 6 will be expanded.
  • Item 10 – Control Persons
  • Item 11 – Disclosure Information
    • ERAs (and registered advisers) would have to indicate whether the disclosure (i.e. criminal, regulatory) pertains to the adviser or any of its supervised persons
  • Schedule A – Direct Owners
  • Schedule B – Indirect Owners
  • Schedule C – Amendments to Schedule A and B
  • Schedule D
    • Items 6 and 7.A. would require additional information corresponding with the answers provided in Items 6 and 7 in the main part of Form ADV.
    • Item 7.B. would require ERAs (and registered advisers) to provide more information about the private funds they (and not their related persons) advise, which generally includes all pooled investment vehicles, regardless of whether they are organized as limited partnerships.
    • Item 7.B.1. would require ERAs (and registered advisers) to provide more information about the basic organizational, operation, and investment characteristics of the fund, amount of assets, nature of the investors, and service providers.
    • Part A of Item 7.B.1. would also require additional information including:
      • the name of the fund (including an option to preserve the anonymity of the private fund client);
      • the state or country where the fund is organized;
      • the name of the general partner, directors, trustees or other persons with similar positions;
      • the organization of the fund (e.g. master-feeder);
      • regulatory status of the fund; and
      • other questions about the fund’s investment activities (e.g. size of the fund, gross/net assets, minimum investment amounts, conflicts of interest, etc.)
    • Part B of Item 7.B.1. would require ERAs (and registered advisers) to provide information about the 5 types of service providers that generally perform the “gatekeeper” role for a fund–auditors, prime brokers, custodians, administrators and marketers.

The ERA would not be required to prepare a client brochure (Form ADV Part 2).

Updates to Form ADV

In addition to filing an initial Form ADV, ERAs would also be required to file updating amendments (pursuant to the new amendment to Rule 204-1).  Rule 204-1 would require ERAs, like registered advisers, to amend Form ADV:

  • at least annually, within 90 days of the fiscal year end;
  • more frequently, as required by Form ADV.  The new General Instruction 4 of Form ADV would require ERAs to update Items 1, 3, and 11 if they become inaccurate in any way.  They would be required to update Item 10 if it becomes materially inaccurate; and
  • pursuant to Rule 204-4, the ERA would have to amend Form ADV when it ceases to be an ERA (indicate it is filing a final report pursuant to Rule 204-4).  Note: many times, the adviser would be simultaneously applying for registration.

Filing Deadlines

ERAs would be required to file their initial report on Form ADV by August 20, 2011.

Filing Fee

The ERAs would have to pay a filing fee charged by FINRA.   Currently, the SEC anticipates that the fees would be the same as those for registered IAs and range from $40 to $200, based on AUM.

Other Items

Why Form ADV?

The SEC has proposed for ERAs to use Form ADV to meet their reporting requirement because the Buy viagra china Form ADV and IARD system are already established and doing so avoids additional delay and expense related to creating a new form.  In addition, many ERAs will already have to use Form ADV for their state registrations – using Form ADV allows such advisers to satisfy the state requirement and Rule 204-4 in a single filing.  The ERA reports filed via Form ADV will be publicly available on the SEC’s website.

Other Changes to Form ADV

Form ADV would be re-titled to reflect its dual purpose–as the “Uniform Application for IA Registration” and “Report by Exempt Reporting Advisers.”  The ERA would indicate that it was reporting to the SEC, rather than registering with the SEC.

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Bart Mallon Esq. is a hedge fund attorney and provides hedge fund compliance services through Cole-Frieman & Mallon LLP.  He can be reached directly at 415-868-5345.

SEC Extends Compliance Date for “Brochure Supplement,” Part 2B of Form ADV

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On July 21, 2010, the Securities and Exchange Commission (“SEC”) adopted amendments to cheap viagra brand Part 2 of Form ADV that became effective October 12, 2010.  Part 2A of Form ADV, the “firm brochure,” contains information about the advisory firm itself.  Part 2B of Form ADV, the “brochure supplement,” contains information about the advisory personnel.

On December 28, 2010, the SEC issued a four-month extension for the Part 2B compliance dates.   The new compliance dates for Part 2B are as follows:

  • New IAs – All newly registered IAs filing their applications for registration with the SEC from January 1, 2011 through April 30, 2011, have until May 1, 2011 to begin delivering Part 2B to new and prospective clients. These advisers have until July 1, 2011 to deliver Part 2B to existing clients. The compliance dates for delivering Part 2B for newly-registered IAs filing applications for registration after April 30, 2011 remain unchanged.
  • Existing registered IAs – All IAs registered with the SEC as of December 31, 2010, and having a fiscal year ending on December 31, 2010 through April 30, 2011, have until July 31, 2011, to begin delivering Part 2B to new and prospective clients. These advisers have until September 30, 2011 to deliver Part 2B to existing clients. The compliance dates for delivering Part 2B for existing registered IAs with fiscal years ending after April 30, 2011 remain unchanged.

The compliance dates for Part 2A remain unchanged.  More information about the compliance dates initially set by the SEC are available here.

For the full SEC release, please see SEC Extends Compliance Deadline for ADV Part 2.

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Bart Mallon Esq. is a hedge fund attorney and provides hedge fund compliance services through Cole-Frieman & Mallon LLP.  He can be reached directly at 415-868-5345.

New York LLC Publication Requirement

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Fund sponsors who have established a limited liability company in New York to serve as the management company for their hedge fund should be aware of the New York publication requirement.  Pursuant to Section 206 of the New York Limited Liability Company Act, within 120 days after the effective date of the initial articles of organization, a LLC must publish a copy of the articles of organization or a notice related to the formation of the LLC in two newspapers.  After publication, the sponsor will need to submit additional paperwork to the New York Department of Corporations to complete the publication requirement process.  This article provides an overview of the process as well as the consequences for not fulfilling the requirement.

Publication in Newspapers

The notice required under the act must be printed in two different newspapers once each week for six successive weeks.  The sponsor does not choose the newspapers in which the notice will be published; instead, the newspapers are predetermined for the LLC.

The first newspaper will be the same for all LLCs – the New York Law Journal.  [Information on the New York Law Journal to be forthcoming.]

The second newspaper will be different for each LLC.  In order to determine the second newspaper, the fund sponsor will need to contact the county clerk of the county in which the LLC’s office is located (as stated in the articles of organization).  After the county clerk provides the sponsor with the information as to which newspaper to publish the notice, the sponsor will need to contact the newspapers for instruction on the manner in which to cialis in the united kingdom submit the materials for publication.

Submitting the Certificate of Publication

After the publication notices have run for six weeks in the two newspapers, the printer or publisher of each newspaper will provide the sponsor with an affidavit of publication.  The sponosor will then need to submit (1) a Certificate of Publication (2) the affidavits of publication of the newspapers, and (3) a filing fee of $50, to:

Department of State, Division of Corporations
One Commerce Plaza
99 Washington Avenue
Albany, NY 12231

Failure to Satisfy the Publication Requirement

According to the law, if an LLC fails to satisfy this requirement, the LLC will be “suspended” from carrying on, conducting or transacting business in the state.  However, a suspension will not invalidate any contract or act of the LLC or the limited liability of the members.  It is therefore unclear exactly what “suspended” means, as the law and the courts have failed to elaborate.  In the future, the New York legislature or courts could institute more serious repercussions, such as the inability to open bank accounts or enter into certain transactions, but presently, the law explicitly states that a suspension does not invalidate the LLC’s contracts or acts and a suspension can be lifted if the LLC substantially complies with the publication requirement.

More information about the LLC publication requirement is available here and here.

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Bart Mallon, Esq. is a hedge fund attorney and provides hedge fund compliance services through Cole-Frieman & Mallon LLP. He can be reached directly at 415-868-5345.

New BVI Hedge Fund Regulations Start 01/01/2011

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Transition Period for BVI Mutual Funds Act of 1996 Ends on December 31, 2010

Sponsors with funds located in the BVI should be aware that at the beginning of next year there will be a new regulatory regime.  Starting on January 1, 2011, all funds must comply with the requirements of the Securities and Investment Business Act, 2010 (“SIBA”) instead of the current Mutual Funds Act, 1996 (“MFA”).

The new laws are much stricter than the previous laws and continue the push by the BVI Financial Services Commission (FSC) to maintain greater oversight of funds located in the BVI.  Managers with BVI funds should pay careful attention to the new laws and make revisions to their documents or operations accordingly.

Below is an overview of the major new requirements under the SIBA:

  • Disclaimer on Offering Documents – in the event a fund offers interests or shares on or after December 31, 2010, the fund offering documents must be amended to include the prescribed investment warning under the new law.  The subscription agreements must also include an acknowledgement from any new investor that it has received, understood and accepted the investment warning.
    • Note: these documents must be filed with the Financial Services Commission (“Commission”) within 14 days of their issue.
  • 2 Directors viagra canada – all private funds must at all times have at least 2 directors (at least 1 of which is an individual).
    • Note: a change of the board (and auditor) must be filed with the Commission within 14 days.
  • Manager, Administrator, and Custodian – all private funds must have a manager, an administrator, and a custodian which is independent from the manager and administrator.
    • Note:  funds may apply to the Commission from an exemption from the requirement to have a custodian or a manager.
  • Notices
    • Appointing a new custodian, administrator, prime broker, or manager must be reported to the Commission at least 7 days prior to the appointment.
    • Audited accounts must be filed within 6 months of the financial year end.
    • 14 days notice to the Commission is also required for change in place of business and amendments of constitutional or offering documents.
    • Annual returns must be filed by June 30 of each year.

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Bart Mallon, Esq. is a hedge fund attorney and works with a variety of domestic and offshore hedge fund manager.  He can be reached directly at 415-868-5345.