The Bureau of Economic Analysis at the U.S. Department of Commerce (the “BEA”) requires certain U.S. Financial Service Providers (including investment advisers, funds and their general partners) that engaged in a financial services transaction with a foreign person during their 2019 fiscal year to file a report on Form BEA-180 (the “Form”). This requirement will apply to any of our U.S.-based clients that are investment advisers or general partners to an offshore fund, and certain other clients as well. Some of our clients may have been notified to complete this Form directly by the BEA, however even clients who have not been contacted may be required to submit the Form.
The Form is a 5-year benchmark survey and the deadline to file the Form electronically is October 30, 2020. Please note the deadline of September 30, 2020 for paper filers has passed. The Form requires additional transaction-specific information from Financial Service Providers that either sold financial services to foreign persons in excess of $3,000,000, or purchased financial services from foreign persons in excess of $3,000,000. Please note that sales and purchases are calculated separately, meaning if a Financial Service Provider exceeds the threshold with respect to sales but not purchases, the requirement to provide additional transaction-specific information on the Form would only apply with respect to sales transactions.
“Financial Service Provider” is broadly defined by the BEA and includes domestic investment advisers, funds and their general partners. Examples of covered financial services transactions include brokerage services, financial management services and security lending services. A direct investment in a foreign person is not a covered financial services transaction, however brokerage fees to a foreign person tied to underwriting the transaction, for example, do qualify as a covered financial service transaction if the purchase occurred in 2019. More information about each category of covered financial services transactions may be found in Section VI of the Form’s instructions.
If the BEA has contacted a Financial Service Provider directly, it must complete the Form even if it has no transactions to report.
We have outlined below a few common scenarios that may apply to our clients:
Management Company
A domestic investment adviser or general partner that receives fees (including management and/or performance fees) from an offshore investment fund must complete the Form. Depending on the offshore fund structure, a management company may receive a fee either from the offshore fund itself, or directly from the underlying foreign investors in the offshore fund. In either example, the offshore fund and the underlying foreign investors, as applicable, are “foreign persons” and the investment adviser’s services are “financial services transactions” for purposes of the Form. Management companies should only report fees received from foreign investors in a U.S. fund if the fee is charged directly to a foreign investor, rather than charged to the U.S. fund itself.
Domestic Fund
If a domestic fund has engaged in any covered financial services transactions with foreign persons, the fund may also need to complete the Form.
We would like to note for our clients that entities in a parent-subsidiary relationship may be able to file as a consolidated domestic U.S. enterprise. The parent-subsidiary relationship turns on whether one entity owns more than 50% of the other’s voting securities, and the instructions specifically state that for a limited partnership, the general partner is presumed to control and have a 100% voting interest unless there is a clause to the contrary in the limited partnership agreement. As such, it is likely that many of our clients will be able to report as a consolidated enterprise, completing just one Form for the general partner and domestic fund, as applicable (and filing a separate Form on behalf of the investment adviser in bifurcated management company structures).
Failure to submit the Form or comply with any of its reporting requirements may result in a civil penalty between $2,500 and $25,000 and/or injunctive relief. Further criminal penalties may arise upon willful violation of the reporting requirements under this Form.
The Form must be submitted via the BEA’s e-filing system here, and the paper copy can be found here (for reference only). Please contact us if you have any questions as to your requirements.
Frequently Asked Questions About New Accredited Investor Definition
There has been much discussion about the recent amendments to the “accredited investor” definition adopted on August 26, 2020 (the “Amendments”) by the Securities and Exchange Commission (“SEC”). We have provided a more detailed overview of all the Amendments here, but wanted to address many of the common questions we are receiving from clients specifically regarding the Amendments to the accredited investor definition. Please send us any other questions and we will update the below as they come in…
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Will a person who is a contractor to the management company or fund qualify as an accredited investor now?
The Amendments provide that a “knowledgeable employee” (as defined in Rule 3c-5(a)(4) of the Investment Company Act of 1940) of a 3(c)(1) or 3(c)(7) fund will now be considered an accredited investor. We have been asked by a few clients whether this expanded definition includes contractors. Because the definition of a knowledgeable employee does not include contractors and has not been altered by the Amendments or otherwise, contractors do not currently qualify as accredited investors under this expanded definition.
What about the professional certification designation?
A natural person holding at least one professional certification or designation or credential in good standing from a qualifying educational institution will now be considered an accredited investor.
To determine whether an investor meets this criteria, the SEC will consider: (i) whether the certification, designation or credential results from an examination or series of examinations administered by a self-regulatory organization, other industry body or accredited educational institution; (ii) whether the examination(s) are reliably designed to demonstrate an individual’s comprehension and sophistication in the areas of securities and investing; (iii) whether an investor obtaining such certification, designation or credential can reasonably be expected to have sufficient knowledge and experience in financial and business matters to evaluate the merits and risks of a prospective investment; and (iv) whether it is publicly made available by the self-regulatory organization or other industry body (or is otherwise independently verifiable) that an investor holds the certification, designation or credential.
The professional certifications, designations or credentials currently recognized by the SEC to satisfy this criterion will be posted on the SEC’s website. One important item to note is that an investor does not need to practice in the field(s) related to the certification, designation or credential to meet the good standing requirement, except to the extent that continued affiliation with a firm is required to maintain such certification, designation or credential.
What has prompted this modernization of the accredited investor definition?
Whether an investor meets the definition of an accredited investor has been one of the most important considerations when determining whether an investor is eligible to invest in private capital markets. The primary purpose of this qualification has been to determine whether an investor based solely on an investor’s income or net worth (because they presumably would be able to withstand a loss in the investment). The effects of the limited tests have prevented many investors from partaking in private capital markets, regardless of their actual financial sophistication. Thus, after years of discussions, the SEC has expanded the accredited investor definition to provide new measures of determining financial sophistication that more holistically determine financial sophistication. These Amendments should decrease the economic barrier-to-entry in our private capital markets and result in the participation of newly qualified accredited investors with more diverse backgrounds.
When do the Amendments become effective?
The Amendments will become effective 60 days after publication in the Federal Register. As of the date we are posting this FAQ, the Amendments have not yet been posted to the Federal Register.
What kind of legal documents need to be updated to reflect the Amendments?
The accredited investor definition is used in many different legal documents in many different contexts so the the exact document that will need to be revised or updated will depend on the facts of the situation.
In the private fund context, the Amendments will generally only trigger necessary updates to the private fund subscription documents. While the “old” language is still accurate, it does not encompass all potential accredited investor categories so the language could still be used once the Amendments are effective but will not encompass all categories of potential accredited investor.
Once the Amendments are posted to the Federal Register, we will reach out to our clients to discuss updating their subscription documents.
No. The private fund adviser exemption in California, which is available only to advisers who provide advice solely to “qualifying private funds”, only permits CA ERAs to charge performance fees to “qualified clients”, as defined in the Investment Advisers Act of 1940. The Amendments do not change this limitation.
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Cole-Frieman & Mallon is a boutique law firm focused on providing institutional quality legal services to the investment management industry. For more information on this topic, please contact us.
On September 2nd we held our crypto discussion forum where we discussed legal, tax and compliance issues related to the digital asset space. The below is a quick recap the event from panelist Justin Schleifer of Aspect Advisors. We’ll keep updating everyone through this blog on future events as well.
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Thank you for attending our “Cryptocurrency and Digital Asset Forum: Trends in Legal, Tax, and Compliance” webinar last week. I would also like to extend many thanks to my fellow panelists, Ryan David Williams of Ashbury Legal and Nick Cerasuolo of Blockchain Tax Partners, and to Bart Mallon of Cole-Frieman & Mallon for hosting.
We had a very interesting and lively interactive discussion about putting crypto investments to work through yield and lending, and DeFi implications including market-making, governance and custody issues.
Here are my favorite tidbits from the various speakers:
Each state has their own regulations as well, and everyone is on different parts of the learning curve. People have to address the nuances of each individual state. States may not agree with the idea of a custodian. DeFi is just way out there for them. They’re still on this idea of what is a custodian in the crypto space? Just getting over that hurdle has proven to be very difficult. – Bart
With the advent of crypto/blockchain, we almost went back in time because are used to dealing with USD. It’s obvious when something is taxable. Crypto took us back to the stone age where we’re back to barter model; property for property (BTC for ETH). You have transactions that don’t involve fiat at all. Tax event triggers are traps for the unwary. It’s not always obvious when a transaction is taxable. – Nick
Insider trading is absolutely an issue in this industry, and it’s getting more nuanced. Firms in the venture capital space get involved with companies on working on their protocols and Dapps. You can very well come in contact with all types of MNPI, so both sides must evaluate what is material or public. You have to restrict yourself in certain areas and not commit to certain trading activities. – Justin
There was a fantasy that once you achieve decentralization, laws are gone. This is an ethos that a decentralized exchange doesn’t need KYC/AML. We are now dispelled of that notion (i.e. the SEC went after the founder of a crypto exchange). The CFTC has also said they will go after software developers. This is the concept of causing a violation of securities law. The expectation of profits is based on the efforts of others. The manager is doing all the work, but what do we do when there is no sponsor and the work is done by community participants? We haven’t finalized this yet. ETH is officially decentralized, so it doesn’t make sense to apply traditional securities laws. – Ryan
If you (or your friends or colleagues) would like to review any of the webinar content, please email Amanda Brown for a link to the recording. If you have any questions about any of the above topics, please reach out to any of our panelists.
We hope you enjoyed this event and if you have any feedback, we would love to hear from you. We look forward to seeing you at our next event!
Best regards, Justin Schleifer
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Bart Mallon is a founding partner of Cole-Frieman & Mallon LLP. Cole-Frieman & Mallon LLP has been instrumental in structuring the launches of some of the first cryptocurrency focused hedge funds. If there are any questions on this post, please contact Mr. Mallon directly at 415-868-5345.
Tax, Compliance and Legal for the Digital Asset Space – Ask Your Questions
Tomorrow, September 2nd, at 10am PT we will be hosting an open question and answer discussion forum on issues affecting the digital asset space. We have a number of interesting topics to explore from the legal, tax and compliance side including:
Yield and lending trends and consequences
DeFi, DeFi, DeFi
Market Making
Custody
Regulatory update and what this means for different groups (managers, stakers, custodians, etc)
Bart Mallon is a founding partner of Cole-Frieman & Mallon LLP. Cole-Frieman & Mallon is a boutique law firm focused on providing institutional quality legal services to the investment management industry. For more information on this topic, please contact Mr. Mallon directly at 415-868-5345.
On August 26, 2020, the SEC Commissioners voted to adopt amendments to expand the definition of “accredited investor” and “qualified institutional buyer”. Historically the test for accredited investor status was only based on a person’s income or net worth but has now been expanded in a limited fashion to include persons with certain financial designations. The amendments will become effective 60 days after publication in the Federal Register, which is expected within 1-2 weeks. Below we have highlighted the applicable updates and we will continue to provide information on this topic as it develops.
With respect to individuals, the following will now also be accredited investors:
(1) individuals with certain qualifying professional certifications, designations and other credentials (currently includes Series 7, Series 65, and Series 82 licensed individuals); and
(2) individuals who are “knowledgeable employees” (which expands the definition from only certain directors, executive officers, etc).
For individuals, the amendments also clarify that natural persons may include the income from “spousal equivalents” for the purposes of calculating joint income and net worth. “Spousal equivalent” is generally defined as a cohabitant occupying a relationship generally equivalent to that of a spouse.
Entities
With respect to entities, the following will now also qualify as accredited investors:
(1) SEC and state-registered investment advisers;
(2) rural business investment companies;
(3) limited liability companies with total assets in excess of $5 million and not formed for the specific purpose of acquiring the securities offered;
(4) entities owning “investments,” as defined in Rule 2a51-1(b) of the Act, in excess of $5 million [note: the intent of this category (4) entities meeting an investments-owned test is to include Native American tribes and other federal, state, territorial, and local government bodies within the accredited investor definition]; and
(5) family offices with at least $5 million in assets under management and their family clients.
Qualified Institutional Buyer Definition Update
Along with the accredited investor update, the definition of “qualified institutional buyer” in Rule 144A will be updated to include entities and any institutional investors that meet the $100 million in securities owned and invested threshold. The scope of the new amendments include Native American tribes, governmental bodies, and bank-maintained collective investment trusts.
Conclusion
While these changes are incremental rather than radical, they are a step in the right direction and hopefully portend further expansion of the definition to allow greater access to the private capital markets. Those parties (investment managers and private placement sponsors) who want to take advantage of the expanded definition will need to speak with legal counsel about updating applicable subscription documents. We will be providing further updates on timing and other matters as they develop.
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Bart Mallon is a founding partner of Cole-Frieman & Mallon LLP. Cole-Frieman & Mallon is a boutique law firm focused on providing institutional quality legal services to the investment management industry. For more information on this topic, please contact Mr. Mallon directly at 415-868-5345.
Open Forum on September 2nd for Legal, Tax & Compliance Questions
There are a ton of hot topics in the digital asset space right now – the price of Bitcoin, DeFi, staking, lending, venture capital, etc – and we want to answer your questions in a unique format where the experts answer your questions directly. Our firm is teaming up with Asbury Legal, Aspect Advisors and Blockchain Tax Partners to host a live discussion where we will talk about what you want to talk about.
September 2, 2020 10:00am Pacific / 1:00pm Eastern
The Host: Bart Mallon, Cole-Frieman & Mallon as Host
The Panel:
Ryan David Williams, Ashbury Legal
Justin Schleifer, Aspect Advisors
Nick Cerasuolo, Blockchain Tax Partners
Join us to get your questions answered by an expert panel during a Live Discussion. Experience a unique collaborative event to explore the latest developments in the Cryptocurrency and Digital Asset sector. Suggested topics for this session include (but are in no way limited to):
• Putting Crypto Investments to Work: Unlocking Full Potential Through Yield and Lending
• DeFi Implications: Market-Making (Liquidity), Governance, and Custody
• Evolving Landscape: Latest Products/Services, Regulations, and Enforcements
Submit your questions in advance and we’ll have answers prepared. You’ll also be able to ask questions during the interactive discussion. We’re excited to talk about anything you want!
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Bart Mallon is a founding partner of Cole-Frieman & Mallon LLP. Cole-Frieman & Mallon is a boutique law firm focused on providing institutional quality legal services to the investment management industry. For more information on this topic, please contact Mr. Mallon directly at 415-868-5345.
Over the past few months, many of our hedge fund clients have breached default triggers in their counterparty agreements that are tied to a decline in net asset value (“NAV” resulting in a “NAV Trigger”). NAV Triggers are typically drafted to capture a month over month NAV decline of 15% to 20%, and sometimes that decline includes redemptions.
If you have an ISDA in place, a NAV Trigger will result in an Additional Termination Event (“ATE”) under your ISDA, and you are obligated to formally notify the dealer of that fact. Once notified, you should explicitly request that the dealer waive the ATE. A formal waiver should be in writing, should clearly state the facts that triggered the ATE, and should explicitly waive the dealer’s right to declare an Early Termination Date under the ISDA in respect of that ATE. Below, we have provided a sample waiver that any manager should feel free to use for their funds. Certain of the bracketed facts should be modified to fit a given fund’s particular circumstances, and defined terms should be changed to fit those found in your ISDA.
If you have any questions about the ATEs in your funds’ ISDAs, or about the ATE waiver, please contact us for assistance.
David Rothschild is a partner of Cole-Frieman & Mallon LLP and routinely focuses on ISDA matters. Cole-Frieman & Mallon is a boutique law firm focused on the investment management industry. For more information on this topic, please contact Mr. Rothschild directly at 415-762-2854.
We hope that you are staying safe and healthy while finding ways to enjoy the summer. As you endeavor to re-establish your routine in our ever-changing “new normal,” we would like to highlight some items we hope will help you stay on top of the business and regulatory landscape in the coming months.
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SEC Matters
Compliance with Regulation Best Interest (Reg BI) was Required as of June 30, 2020. Reg BI established a “best interest” standard applicable to SEC-registered investment advisers (“SEC RIAs”), broker-dealers, and associated persons when making securities recommendations to retail customers. Moving forward, SEC RIAs with “retail customers” must file the new Form ADV, Part 3 (“Form CRS”) electronically via IARD in addition to providing the Form CRS to prospective and existing clients as well as posting the form on their official website. Also, broker-dealers with retail customers must file Form CRS electronically via Web CRD with the understanding that its Form CRS will be made publicly available through BrokerCheck.
The SEC’s Office of Compliance Inspections and Examinations (“OCIE”) has published Risk Alerts for Reg BI and Form CRS, shedding light on the practical considerations to be aware of during initial examinations following June 30, 2020. For further instructions, please see the SEC’s guidance in response to frequently asked questions on Form CRS. For more complete analysis as to how this new regulatory requirement may apply to you, please visit our LinkedIn page.
“Volcker Rule” Restrictions Eased. Five federal regulatory agencies, including the SEC and Federal Reserve Board, have approved the proposed changes to the “Volcker Rule” which are to take effect as of October 1, 2020. The new final rule effectively narrows the definition of covered funds and gives banks the green light to offer financial services to certain venture capital funds and engage in other activities that the original Volcker Rule was not intended to prohibit. Separately, regulators also relaxed margin requirements applicable to derivatives trades between affiliates.
SEC Turns an Eye Toward Business Continuity Plans (“BCPs”). In light of the widespread disruption caused by COVID-19, the SEC has been submitting requests for information to firms regarding their BCPs. Such information requests have included: (i) the firm’s formal BCP; (ii) company techniques and procedures tailored to address the continuity of operations specific to pandemics; (iii) cybersecurity policies and procedures applicable to remote working; and (iv) general inquiries regarding critical systems and operations impacted by the pandemic. It should be expected that regular examinations will involve a heightened focus on BCPs as well. Please contact us for further information or to request assistance in making sure your BCP is up to date.
Use of the Word “may” Could be Misleading. The SEC has maintained that the use of the word “may” in disclosures to investors can be considered misleading if the underlying conduct or condition is, in fact, actually occurring. The SEC demonstrated its commitment to this position in a recent enforcement action against the manager of a private equity fund which provided operational services to its portfolio companies for which the manager charged additional fees. The manager’s Form ADV disclosed that “under specific circumstances, certain [of the manager’s] operating professionals may provide services to portfolio companies that typically would otherwise be performed by third parties” and that the manager “may be reimbursed” for associated costs. The SEC reasoned that this method of disclosure did not sufficiently disclose the fact that the manager did perform such services and receive such compensation on a routine basis. The manager was ordered to pay approximately $1.5 million in disgorgement of fees plus interest and a $200,000 penalty. The action serves as a reminder to all managers that required disclosures must be routinely reviewed to ensure clear and complete descriptions of existing conflicts of interest.
SEC Proposes Modernized Framework for Fund Valuation. In April, the SEC proposed a new rule which will allow a fund’s board to delegate the determination of fair value to the fund’s investment adviser, subject to certain conditions. The new rule is aimed at clarifying how fund boards can meet their valuation obligations which require them to identify and address significant risks associated with fair value determinations; select, implement, and verify fair value determination methods; actively monitor any third-party services used; adopt and implement policies and procedures; and maintain certain records.
SEC Brings Action Against Manager for Violation of the Custody Rule. As a method of satisfying the “Custody Rule” (Rule 206(4)-2 of the Investment Advisers Act of 1940, as amended (the “Advisers Act”)), many managers of private funds rely on the “Audited Financials Alternative” which requires the delivery of audited financial statements to all limited partners of a fund within 120 days of the end of the fund’s fiscal year. In a recent enforcement action, the SEC censured a New Jersey-based manager and issued a $60,000 fine for violations of the Custody Rule which took place from 2014-2018 when the firm attempted to avail itself of the Audited Financials Alternative. In 2014 and 2015, the firm mailed the audited financial statements to investors 686 days and 927 days late, respectively; while in 2016-2018, the firm failed to engage an audit firm at all. In addition to these violations, the SEC also cited the firm for failing to implement reasonable policies and procedures aimed at preventing such violations of the Custody Rule.
SEC Charges Los Angeles Private Equity Firm with MNPI-Related Compliance Violations. In a recent enforcement action, the SEC issued a stern reminder of the requirement under the Advisers Act that investment advisers must enact and follow written policies reasonably designed to prevent violations of the rules governing the use of material non-public information (“MNPI”), particularly in the case where an investment adviser maintains employee board representation on a public company in its investment portfolio. Despite the fact that the manager had written policies in place during the relevant time period to prevent misuse of MNPI, the SEC reasoned that such policies afforded the manager’s compliance staff too much discretion to be adequately enforced. The SEC ordered the payment of a $1 million penalty.
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Offshore Matters
Cayman Island Monetary Authority (“CIMA”) Provides Further Guidance on the Definition of a “Private Fund.” As discussed in our previous update, the Cayman Islands Private Funds Law 2020 (the “PF Law”) now requires any Cayman Islands closed-ended fund that falls under the definition of a private fund (“Private Fund”) to register with CIMA. On May 7, 2020, CIMA issued a notice clarifying such definition under the PF Law. Per CIMA’s new guidance, any “collective investment scheme” is considered to be a Private Fund if all of the following factors are “present or otherwise established”: (i) the undertaking does not have a general commercial or industrial purpose; (ii) the undertaking pools together funds gathered for the purpose of investment with the goal of creating pooled returns for investors; and (iii) the undertaking’s investors have no collective daily control. Notably, the fact that one or more investors exercises daily control over the undertaking does not establish that the undertaking is not a “collective investment scheme” and, thus the undertaking may well still qualify as a Private Fund that must register.
The notice also provides further guidance regarding the treatment of segregated portfolio companies, alternative investment vehicles, practical instructions on the CIMA registration process, as well as valuation and cash monitoring requirements applicable to Private Funds.
CIMA Publishes New Marketing Rules. Effective May 2020, CIMA enacted new rules governing the contents of the offering documents of mutual funds regulated under the Mutual Funds Law (2020 Revision) (“Regulated Mutual Funds”). CIMA published separate rules applicable to the contents of all marketing materials (including offering documents) of Private Funds registered under the Private Funds Law (2020 Revision) (“Registered Private Funds”) which apply prospectively as well as to the marketing materials of all Registered Private Funds with ongoing offerings. Since the new rules applicable to Regulated Mutual Funds and those applicable to Registered Private Funds each mandate a particular disclosure which must be included verbatim in the offering documents, all new offering documents (and all future updates to offering documents) of Regulated Mutual Funds and all marketing materials of Registered Private Funds will be impacted. Please contact us if you think you may be in need of an update to your offering documents or marketing materials.
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Digital Asset Matters
Coinbase Announces Agreement to Acquire Crypto Prime Brokerage Platform. Yet another indicator of the burgeoning demand for digital assets among institutional and professional investors, Coinbase announced its intention to buy Tagomi, a leading cryptocurrency brokerage platform. In addition to providing custody solutions and professional trading features, Tagomi provides its users access to 14 digital asset exchanges from a single account. The acquisition is aimed at creating a digital asset trading experience more aligned with the expectations of professional traders in equities and other traditional markets. The terms of the deal are yet to be announced as the acquisition is pending regulatory review.
SEC Charges San Jose-based Issuer of Unregistered ICO. A blockchain services start-up conducted an unregistered ICO in which it issued Consumer Activity Tokens (“CAT”) to approximately 9,500 investors between June and November of 2017. The SEC determined that the CAT were sold as investment contracts and, as such, were indeed “securities” under the Howey Test which can only be lawfully issued as part of a registered offering or pursuant to a valid exemption under the Securities Act of 1933, as amended. In support of its determination, the SEC’s order reasoned that the issuer’s offering materials (i) created a reasonable expectation by the investor of earning a future profit based on the issuer’s plans of development and marketing of the CAT protocol following the offering; and (ii) assured investors of the liquidity of the CAT on digital asset trading platforms. To settle the charges, the issuer has agreed to pay $25.5 million in disgorgement of funds raised in addition to pre-judgment interest of over $3 million and a penalty of $400,000.
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FINRA Matters
FINRA Shares Remote Working Best Practices. In an effort to help firms navigate challenges associated with many of their employees working from home, FINRA’s recent Regulatory Notice provides guidance to brokerage firms regarding (i) operational considerations during the transition to a remote working model and (ii) maintenance of adequate supervision while doing so. The regulatory notice does not impose further obligations on FINRA regulated entities, but is meant to share best practices which have been and continue to be implemented by firms of all sizes. The notice provided tips and feedback on ways of assisting customers, providing additional support and communication to employees, and maintaining cybersecurity in this new environment. Additionally, the notice discussed methods of maintaining oversight of trading and staff communication with customers, as well as adjustments to ongoing branch inspection programs.
FINRA Warns of Increased Threat of Fraudulent Activity and Scams During COVID-19. The onset of significant economic disruption creates increased opportunities for fraudulent behavior. In a recent Regulatory Notice, FINRA outlined the following four frequently occurring scams: (i) fraudulent account openings and transfers of funds; (ii) firm impersonation schemes; (iii) false information technology inquiries; and (iv) email phishing scams. Most notably, FINRA reminds firms to examine their own compliance policies relating to the opening of accounts to ensure such policies meet the requirements of the following implicated FINRA Rules: 2090 (Know Your Customer), 4512 (Customer Account Information), and 3310 (Anti-Money Laundering Compliance Program). FINRA provides suggested best practices as to how to be a hard target against such behavior and also encourages firms to report any suspicious activity.
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CFTC Matters
CFTC Extends Certain COVID-19 Relief Measures. No-action relief measures enacted by the CFTC during the first quarter of 2020 which were set to expire on June 30 have been extended in large part until September 30, 2020. Included in those extended relief measures are the measures applicable to members of designated contract markets and swap execution facilities, futures commission merchants (“FCMs”) and introducing brokers (“IBs”), floor brokers, retail foreign exchange dealers, swap dealers, swap execution facilities and designated contract markets. In CFTC Letter No. 20-19, the Division of Swap Dealer and Intermediary Oversight (“DSIO”) and the Division of Market Oversight (“DMO”) listed the specific relief measures which will not be extended including (i) audit trail and associated requirements applicable to members of designated contract markets; and (ii) requirements pertaining to the recording of voice communications applicable to swap execution facilities. The DSIO and DMO have also stated that affected market participants should reach out to the applicable contact person at each division with requests for specific relief which shall be considered on a case-by-case basis. Inquiries should be sent to Frank Fisanich, Chief Counsel, DSIO or Roger Smith, Special Counsel, DMO, as appropriate.
Further Relief Provided to FCMs and IBs. In CFTC Letter No 20-15, the DSIO has allowed eligible FCMs and IBs who have received loans under the Paycheck Protection Program, pursuant to the CARES Act, to add back certain amounts under covered forgivable loans when making net capital calculations. DSIO has also allowed FCMs and IBs to add back accrued annual FINRA assessment fees so long as such FCM or IB is a registered broker-dealer with the SEC, qualifies as a small firm as defined by FINRA, and is otherwise eligible for the add-back of accrued unpaid annual assessments per FINRA guidance.
CFTC Extends Phase 5 Compliance Date of Initial Margin Requirements for Uncleared Swaps. In light of continued COVID-19-related disruption, the CFTC has announced it has extended the deadline for compliance with the amended margin requirements for uncleared swaps as applicable to swap dealers and major swap participants for which there is no prudential regulator. The deadline for compliance has been extended a full year until September 20, 2021.
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Other Matters
Private Equity Industry Continues to Battle for Access to Defined Contribution Market. The private equity industry seems to have won a small victory in the form of an Information Letter from the Department of Labor which suggested that private equity investments could be used in multi-asset class investment vehicles such as target-date or target-risk funds. CFM’s own Bart Mallon was quoted in the article released by Barrons discussing this exciting new development which could one day lead to private equity investments being made from investors’ 401(k)s.
Enforcement of California Consumer Privacy Act (“CCPA”) Began July 1, 2020. The CCPA, which has been in effect since January 1, 2020, was not delayed beyond the scheduled enforcement date of July 1, 2020. The California Attorney General confirmed the enforcement date despite the formal request for an extension submitted by more than 60 businesses and trade groups led by the Association of National Advertisers due to COVID-19-related disruption. Please see our previous update for a more complete discussion of the CCPA and its implications for fund managers.
New York’s Stop Hacks and Improve Electronic Data Security Act (“SHIELD Act”) Fully Implemented as of March 21, 2020. The SHIELD Act, New York’s version of the CCPA, made several significant changes to the state’s data protection regime including: (i) expanded definitions of “private information” and covered “breaches”; (ii) increased scope of applicability of data protection laws to include any business that owns or licenses private information of a New York resident; and (iii) a requirement for companies to adopt a program of policies and procedures designed to protect the private information of individuals. Although the SHIELD Act’s data breach notification requirements have been effective since the fall of 2019, covered businesses were required to establish the requisite data protection program as of March 21, 2020.
Reminder: Sexual Harassment Training Requirement under California Law. California state law now requires that all employers with five or more employees provide company-wide sexual harassment training. The first training must be held by January 1, 2021 and thereafter must be held every two years. The law formerly only applied to employers with 50 or more employees but has been expanded under Senate Bill No. 778, which was approved by the governor of California on August 30, 2019.
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CFM Events
CoinAlts Webinar. In lieu of the CoinAlts Fund Symposium, the CoinAlts Webinar Series was held on May 14, 2020. The widely attended event featured updates and analysis of the latest trends in the digital asset space from Cynthia Pederson of Cohen & Co., Lewis Chong of Harneys, Matt Stover and Seth Altman of MG Stover, and our own, Bart Mallon. The event was capped with an enlightening Q&A session featuring Gary Newlin of MG Stover and Matt Perona of Polychain Capital. For a summary of the event, please contact us. On behalf of the CFM team, as well as our co-sponsors, we want to thank all who attended this iteration of the CoinAlts Webinar and we look forward to hosting you at the next installment. Please stay tuned for the announcement of the details of the next event and let us know if you have any specific questions or interesting topics you would like discussed.
Regulation Best Interest (Reg BI) Webinar with Aspect Advisors. CFM co-sponsored a live webinar with Aspect Advisors on May 28, 2020. The discussion covered practical, regulatory, and other considerations regarding Reg BI and the new Form CRS, as described earlier in this update. We would like to thank Justin Schleifer of Aspect Advisors for hosting and look forward to future events. Aspect Advisors is a modern regulatory consultant providing customized compliance solutions to entrepreneurs. The firm has a focus on fintech companies, broker-dealers, and investment managers (hedge fund, VC, PE, RIA, etc.).
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Compliance Calendar Please note the following important dates as you plan your regulatory compliance timeline for the coming months.
Deadline
Filing
June 30
Deliver audited financial statements to investors (private fund managers to fund of funds, including SEC, state and CFTC registrants.
June 30
SEC deadline for initial Form CRS (ADV Part 3) submission through IARD for SEC-registered investment advisers (if necessary).
June 30
CIMA deadline for Cayman Island registered funds with a fiscal year end of December 31 to file the Fund Annual Return and audited financial statements.
June 30
Deadline for making available AIFMD annual report for funds operating in or advertising in the EU (Alternative Investment Funds with a financial year ending on December 31).
July 10
Review holdings to determine Form PF filing requirements.
July 15
SEC deadline to file 2nd Quarter 2020 Form PF for quarterly filers (Large Liquidity Fund Advisers), through PFRD.
July 15*
CFTC 1st Quarterextended deadline for CPOs to file Schedules A and B of CFTC Form CPO-PQR, through NFA EasyFile.
July 20
FINRA deadline to complete annual account Entitlement Certification through IARD (firms with more than one IARD user).
July 30
Collect quarterly Transaction Reports from access persons for their personal securities transactions (SEC registered advisers).
July 30*
Quarterly account statements due (CPOs claiming the 4.7 exemption). DSIO will not recommend an enforcement action against a CPO provided that the statements are distributed by August 14.
July 30
Deliver initial Form CRS (ADV Part 3) to clients qualifying as “retail investors” for SEC-registered investment advisers.
August 14
SEC deadline to file Form 13F for 2nd Quarter of 2020.
August 14
NFA deadline to file Quarterly Commodity Trading Advisor Form PR filing, through NFA EasyFile.
August 28
SEC deadline to file 2nd Quarter 2020 Form PF filing for quarterly filers (Large Hedge Fund Advisers), through PFRD.
August 28
CFTC deadline for CPOs to file Schedules A, B, and C of CFTC Form CPO-PQR, for 2nd Quarter of 2020, through NFA EasyFile.
September 18*
Cayman Islands CRS reporting deadline. The deadline for reports under US FATCA has been extended to November 16, 2020.
October 9
Review transactions and assess whether Form 13H needs to be amended.
October 15
SEC deadline to file 3rd Quarter 2020 Form PF for quarterly filers (Large Liquidity Fund Advisers), through PFRD.
Variable
Distribute copies of K-1 to fund investors.
Periodic Filings
Form D and Blue Sky filings should be current.
*Extended deadline pursuant to COVID-19 pandemic-related relief
Please contactus with any questions or for assistance with any of the above topics.
Sincerely,
Karl Cole-Frieman, Bart Mallon, Lilly Palmer, David Rothschild, & Scott Kitchens
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Cole-Frieman & Mallon LLP is a premier boutique investment management law firm, providing top-tier, responsive, and cost-effective legal solutions for financial services matters. Headquartered in San Francisco, Cole-Frieman & Mallon LLP services both start-up investment managers, as well as multi-billion-dollar firms. The firm provides a full suite of legal services to the investment management community, including hedge fund, private equity fund, venture capital fund, mutual fund formation, adviser registration, counterparty documentation, SEC, CFTC, NFA and FINRA matters, seed deals, hedge fund due diligence, employment and compensation matters, and routine business matters. The firm also publishes the prominent Hedge Fund Law Blog, which focuses on legal issues that impact the hedge fund community. For more information, please add us on LinkedIn and visit us at colefrieman.com.
We recently announced a Regulation BI webinar that was held in late May. Below is the summary of that webinar from Justin Schleifer of Aspect Advisors. Please reach out to us or Aspect Advisors if you’d like more information on Reg BI or the webinar.
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Thank you – Reg BI webinar overview
Thank you for attending our Regulation Best Interest (Reg BI) webinar last week. I would also like to extend many thanks to my fellow panelists, James Dombach and Paul Merolla from the law firm Murphy & McGonigle, and to Bart Mallon of Cole-Frieman & Mallon for hosting. The webinar provided an overview of Reg BI obligations, defined key terms, reviewed the SEC’s OCIE guidance regarding regulatory expectations, and provided practical suggestions for implementation by broker-dealers (BDs) and registered investment advisers (RIAs) for the June 30 deadline for compliance.
Here are the key take-aways about Reg BI:
When making a recommendation of any securities transaction or investment strategy to a retail customer (as defined), BDs must act in the best interest of the retail customer at the time the recommendation is made.
4 components of obligation:
Disclosure: effective Form CRS content and delivery for BDs and RIAs;
Care: sufficiently understanding the product and the customer;
Conflicts of Interest: review, mitigation/elimination, and disclosure; and
Compliance: effective controls and best practices.
SEC Office of Compliance Inspections and Examinations (“OCIE”) expectations include:
Assessment: Has the Firm sufficiently analyzed and documented its business practices, its registered representatives, and its products to make necessary disclosures?
Implementation: BDs and RIAs are required to provide a brief relationship summary (Form CRS) including appropriate disclosures to both new and existing retail investors.
Documentation: Firms must have policies and procedures that assess potential risks, rewards, and costs of recommendations in light of a retail customer’s investment profile; how the 4 components of obligation will be met; and the process for Form CRS delivery.
If you (or your colleagues) would like to review any of the webinar content, please email Amanda Brown for a link to the recording. If you have any questions about Reg BI or need advice about how to implement at your firm, please reach out to any of our panelists.
We hope you enjoyed this event and if you have any feedback, we would love to hear from you. We look forward to seeing you at our next event!
Best regards,
Justin Schleifer
President of Aspect Advisors
Aspect Advisors
Aspect Advisors is a regulatory compliance consulting firm that provides customized compliance solutions for complex challenges. Our clients are financial service innovators, including fintech companies, registered investment advisers (RIAs), broker-dealers and private fund managers. Our back-office services include regulatory registrations and filings, compliance policies and procedures, conducting annual reviews, outsourced Chief Compliance Officer/FinOP support, and other bespoke items.
Murphy & McGonigle
Murphy & McGonigle is a law firm that serves the litigation, enforcement defense, and regulatory needs of clients across the full spectrum of the financial services industry – from national banks, broker-dealers, investment advisers, and hedge funds, to national and international securities markets and exchanges.
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Bart Mallon is a founding partner of Cole-Frieman & Mallon LLP. Cole-Frieman & Mallon is a boutique law firm focused on providing institutional quality legal services to the investment management industry. For more information on this topic, please contact Mr. Mallon directly at 415-868-5345.
Aspect Advisors and Cole-Frieman & Mallon Both Participating
The below is a press release announcing the Regulation Best Interest webinar next week. All are welcome to join.
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Aspect Advisors Presents Regulation Best Interest Webinar
Reg BI Compliance Implementation for Broker-Dealers and Investment Advisers
SAN FRANCISCO (PRWEB) MAY 21, 2020
Aspect Advisors, a regulatory compliance consulting firm, will be presenting best practices for broker-dealers and investment advisers subject to the new Regulation Best Interest (“Reg BI”) requirements ahead of the June 30 deadline for compliance. The presentation will be made through a live webinar, open to all who register, on May 28th at 1:00pm Eastern time and will feature expert speakers on the new regulation.
Reg BI establishes a new “best interest” standard of conduct for broker-dealers when making recommendations to retail customers regarding any securities transaction or investment strategy involving securities and includes four specified components to the obligations: disclosure, care, conflict of interest, and compliance. The regulation also requires broker-dealers and investment advisers to provide a brief relationship summary (Form CRS) to retail investors.
The May 28 webinar will be a “beyond-the-basics” deep dive discussion into how investment management firms can implement Reg BI requirements. Topics will include: the SEC’s OCIE guidance regarding regulatory expectations, common questions from both a compliance and legal perspective, practical strategies for implementation of requirements, and a question and answer period with participants.
“We have seen the government and regulators pull back on the implementation of various regulations during the COIVD-19 crisis,” said Justin Schleifer, president of Aspect Advisors and panelist. He continued, “however, it appears that Reg BI will not be subject to delay and so investment management firms need to be prepared for the June 30 deadline with real world solutions.”
The panelists will include James Dombach and Paul Merolla from the law firm Murphy & McGonigle and Justin Schleifer from Aspect Advisors. Host of the panel Bart Mallon, from the law firm Cole-Frieman & Mallon, stated “the goal of this panel is to provide broker-dealers and investment advisers with practical advice on this important new regulation.” He went on to state that “implementation in normal times would be involved so this webinar is both timely and important.”
About Aspect Advisors: Aspect Advisors is a regulatory compliance consulting firm that provides customized compliance solutions for complex challenges. Our clients are financial service innovators, including fintech companies, registered investment advisers (RIAs), broker-dealers and private fund managers. Our back-office services include regulatory registrations and filings, compliance policies and procedures, conducting annual reviews, outsourced Chief Compliance Officer/FinOP support, and other bespoke items.
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Bart Mallon is a founding partner of Cole-Frieman & Mallon LLP. Cole-Frieman & Mallon is a boutique law firm focused on providing institutional quality legal services to the investment management industry. For more information on this topic, please contact Mr. Mallon directly at 415-868-5345.
