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Cole Frieman & Mallon 2017 End of Year Update

Below is our quarterly newsletter. If you would like to be added to our distribution list, please contact us.


December 15, 2017

Clients, Friends, Associates:

Holiday celebrations bring welcomed joy and excitement to the busiest time of year for most investment managers.  As we prepare for a new year, we also reflect on an eventful 2017 year that included the emergence of a new asset class, a steady upswing in the stock market, and proposed legislation to revise the United States tax code. Regardless of all of the changes to the investment management space, year-end administrative upkeep and 2018 planning are always particularly important, especially for General Counsels, Chief Compliance Officers (“CCO”), and key operations personnel. As we head into 2018, we have put together this checklist and update to help managers stay on top of the business and regulatory landscape for the coming year.

This update includes the following:

  • Cryptocurrency Leadership
  • Annual Compliance & Other Items
  • Annual Fund Matters
  • Annual Management Company Matters
  • Regulatory & Other Changes in 2016
  • Compliance Calendar


Cryptocurrency Leadership:

This year digital assets and cryptocurrencies have emerged in force as a separate and distinct asset class. An increased interest in this asset class from fund managers, financial institutions and various government leaders and regulators throughout the world has led to an exponential growth of cryptocurrency investments, the CFTC’s approval of two exchanges to trade Bitcoin futures contracts has increased attention on the asset class.

For SEC registered investment advisers who are adding cryptocurrencies to their fund investment programs and for cryptocurrency focused fund managers who may be relying on SEC exemptions from registration, the need to understand the regulatory implication of certain practices is of utmost importance. Specifically, managers face uncertainty regarding the application of the qualified custodian requirement under Rule 206(4)-2 (“Custody Rule”) under the Investment Advisers Act of 1940, as amended (“Advisers Act”).  Under the Custody Rule, if a registered investment adviser has custody of “client funds or securities”, then it must maintain those client assets with a qualified custodian (generally a bank, broker-dealer, FCM or other financial institution), subject to certain exceptions. Currently we know of only one qualified custodian capable of holding certain cryptocurrencies or digital assets. Our firm participated in a meeting with the SEC in November about custody issues for cryptocurrency managers and continues to engage with the SEC on this issue as well as work with the SEC and other service providers in this space to help lead the way to comply with SEC rules and regulations.


Annual Compliance & Other Items:

Annual Privacy Policy Notice. On an annual basis, registered investment advisers (“RIAs”) are required to provide natural person clients with a copy of the firm’s privacy policy if (i) the RIA has disclosed nonpublic personal information other than in the connection with servicing consumer accounts or administering financial products; or (ii) the firm’s privacy policy has changed.

Annual Compliance Review. On an annual basis, the CCO of an RIA must conduct a review of the adviser’s compliance policies and procedures. This annual compliance review should be in writing and presented to senior management. We recommend that firms discuss the annual review with their outside counsel or compliance firm, who can provide guidance about the review process as well as a template for the assessment and documentation. Advisers should be careful that sensitive conversations regarding the annual review are protected by attorney-client privilege. CCOs may also want to consider additions to the compliance program. Advisers that are not registered may still wish to review their procedures and/or implement a compliance program as a best practice.

Form ADV Annual Amendment. RIAs or managers filing as exempt reporting advisers (“ERAs”) with the SEC or a state securities authority, must file an annual amendment to Form ADV within 90 days of the end of their fiscal year. For most managers, the Form ADV amendment would be due on March 31, 2018. This year, because March 31st is a Saturday and March 30th is a market holiday, annual amendments to the Form ADV shall be filed no later than the business day following the 90-day deadline (April 2, 2018). RIAs must provide a copy of the updated Form ADV Part 2A brochure and Part 2B brochure supplement (or a summary of changes with an offer to provide the complete brochure) to each “client”. Note that for SEC-registered advisers to private investment vehicles, a “client” for purposes of this rule includes the vehicle(s) managed by the adviser, and not the underlying investors. State-registered advisers need to examine their state’s rules to determine who constitutes a “client”.

Switching to/from SEC Regulation.

SEC Registration. Managers who no longer qualify for SEC registration as of the time of filing the annual Form ADV amendment must withdraw from SEC registration within 180 days after the end of their fiscal year by filing Form ADV-W. Such managers should consult with their state securities authorities to determine whether they are required to register in the states in which they conduct business. Managers who are required to register with the SEC as of the date of their annual amendment must register with the SEC within 90 days of filing the annual amendment.

Exempt Reporting Advisers. Managers who no longer meet the definition of an ERA will need to submit a final report as an ERA and apply for registration with the SEC or the relevant state securities authority, if necessary, generally within 90 days after the filing of the annual amendment.

Custody Rule Annual Audit.

SEC Registered IA. SEC registered investment advisers (“SEC RIAs”) must comply with certain custody procedures, including (i) maintaining client funds and securities with a qualified custodian; (ii) having a reasonable basis to believe that the qualified custodian sends an account statement to each advisory client at least quarterly; and (iii) undergoing an annual surprise examination conducted by an independent public accountant.

SEC RIAs to pooled investment vehicles may avoid both the quarterly statement and surprise examination requirements by having audited financial statements prepared for each pooled investment vehicle in accordance with generally accepted accounting principles by an independent public accountant registered with the Public Company Accounting Oversight Board (“PCAOB”). Statements must be sent to the fund or, in certain cases, investors in the fund, within 120 days after the fund’s fiscal year-end. Managers should review their custody procedures to ensure compliance with the rules.

California Registered IA. California registered investment advisers (“CA RIAs”) that manage pooled investment vehicles and are deemed to have custody of client assets must, among other things, (i) provide notice of such custody on the Form ADV; (ii) maintain client assets with a qualified custodian; (iii) engage an independent party to act in the best interest of investors to review fees, expenses, and withdrawals; and (iv) retain an independent certified public accountant to conduct surprise examinations of assets. CA RIAs to pooled investment vehicles may avoid the independent party and surprise examinations requirements by having audited financial statements prepared by an independent public accountant registered with the PCAOB and distributing such audited financial statements to all limited partners (or members or other beneficial owners) of the pooled investment vehicle, and to the Commissioner of the California Department of Business Oversight (“DBO”).

Other State Registered IA. Advisers registered in other states should consult with legal counsel about those states’ custody requirements.

California Minimum Net Worth Requirement and Financial Reports.

RIAs with Custody. Every CA RIA that has custody of client funds or securities must maintain at all times a minimum net worth of $35,000. Notwithstanding the foregoing, the minimum net worth is $10,000 for a CA RIA (i) deemed to have custody solely because it acts as general partner of a limited partnership, or a comparable position for another type of pooled investment vehicle; and (ii) that otherwise complies with the California custody rule described above (such advisers, the “GP RIAs”).

RIAs with Discretion. Every CA RIA that has discretionary authority over client funds or securities, whether or not they have custody, must maintain at all times a minimum net worth of $10,000.

Financial Reports. Every CA RIA that either has custody of, or discretionary authority over, client funds or securities must file an annual financial report with the DBO within 90 days after the adviser’s fiscal year end. The annual financial report must contain a balance sheet, income statement, supporting schedule, and a verification form. These financial statements must be audited by an independent certified public accountant or independent public accountant if the adviser has custody and is not a GP RIA.

Annual Re-Certification of CFTC Exemptions. Commodity pool operators (“CPOs”) and commodity trading advisers (“CTAs”) currently relying on certain exemptions from registration with the CFTC are required to re-certify their eligibility within 60 days of the calendar year-end. CPOs and CTAs currently relying on relevant exemptions will need to evaluate whether they remain eligible to rely on such exemptions.

CPO and CTA Annual Updates. Registered CPOs and CTAs must prepare and file Annual Questionnaires and Annual Registration Updates with the NFA, as well as submit payment for annual maintenance fees and NFA membership dues. Registered CPOs must also prepare and file their fourth quarter report for each commodity pool on Form CPO-PQR, while CTAs must file their fourth quarter report on Form CTA-PR. Unless eligible to claim relief under Regulation 4.7, registered CPOs and CTAs must update their disclosure documents periodically, as they may not use any document dated more than 12 months prior to the date of its intended use. Disclosure documents that are materially inaccurate or incomplete must be corrected promptly, and the corrected version must be distributed promptly to pool participants.

Trade Errors. Managers should make sure that all trade errors are properly addressed pursuant to the manager’s trade errors policies by the end of the year. Documentation of trade errors should be finalized, and if the manager is required to reimburse any of its funds or other clients, it should do so by year-end.

Soft Dollars. Managers that participate in soft dollar programs should make sure that they have addressed any commission balances from the previous year.

Schedule 13G/D and Section 16 Filings. Managers who exercise investment discretion over accounts (including funds and separately managed accounts (“SMAs”)) that are beneficial owners of 5% or more of a registered voting equity security must report these positions on Schedule 13D or 13G. Passive investors are generally eligible to file the short form Schedule 13G, which is updated annually within 45 days of the end of the year. Schedule 13D is required when a manager is ineligible to file Schedule 13G and is due 10 days after acquisition of more than 5% beneficial ownership of a registered voting equity security. For managers who are also making Section 16 filings, this is an opportune time to review your filings to confirm compliance and anticipate needs for the first quarter.

Section 16 filings are required for “corporate insiders” (including beneficial owners of 10% or more of a registered voting equity security). An initial Form 3 is due within 10 days after becoming an “insider”; Form 4 reports ownership changes and is due by the end of the second business day after an ownership change; and Form 5 reports any transactions that should have been reported earlier on a Form 4 or were eligible for deferred reporting and is due within 45 days after the end of each fiscal year.

Form 13F. A manager must file a Form 13F if it exercises investment discretion with respect to $100 million or more in certain “Section 13F securities” within 45 days after the end of the year in which the manager reaches the $100 million filing threshold. The SEC lists the securities subject to 13F reporting on its website.

Form 13H. Managers who meet the SEC’s large trader thresholds (in general, managers whose transactions in exchange-listed securities equal or exceed two million shares or $20 million during any calendar day, or 20 million shares or $200 million during any calendar month) are required to file an initial Form 13H with the SEC within 10 days of crossing the threshold. Large traders also need to amend Form 13H annually within 45 days of the end of the year. In addition, changes to the information on Form 13H will require interim amendments following the calendar quarter in which the change occurred.

Form PF. Managers to private funds that are either registered with the SEC or required to be registered with the SEC and who have at least $150 million in regulatory assets under management (“RAUM”) must file Form PF. Smaller private advisers (fund managers with less than $1.5 billion in RAUM) must file Form PF annually within 120 days of their fiscal year-end. Larger private advisers (fund managers with $1.5 billion or more in RAUM) must file Form PF within 60 days of the end of each fiscal quarter.

SEC Form D. Form D filings for most funds need to be amended on an annual basis, on or before the anniversary of the most recently filed Form D. Copies of Form D is publicly available on the SEC’s EDGAR website.

Blue Sky Filings. On an annual basis, a manager should review its blue sky filings for each state to make sure it has met any renewal requirements. Several states impose late fees or reject late filings altogether. Accordingly, it is critical to stay on top of filing deadlines for both new investors and renewals. We also recommend that managers review blue sky filing submission requirements. Many states now permit blue sky filings to be filed electronically through the Electronic Filing Depository (“EFD”) system, and certain states will now only accept filings through EFD.

IARD Annual Fees. Preliminary annual renewal fees for state-registered and SEC-registered investment advisers are due on December 18, 2017. If you have not already done so, you should submit full payment into your Renewal Account by E-Bill, check or wire now.

Pay-to-Play and Lobbyist Rules. SEC rules disqualify investment advisers, their key personnel and placement agents acting on their behalf, from seeking to be engaged by a governmental client if they have made political contributions. State and local governments have similar rules, including California, which requires internal sales professionals who meet the definition of “placement agents” (people who act for compensation as finders, solicitors, marketers, consultants, brokers, or other intermediaries in connection with offering or selling investment advisory services to a state public retirement system in California) to register with the state as lobbyists and comply with California lobbyist reporting and regulatory requirements. Note that managers offering or selling investment advisory services to local government entities must register as lobbyists in the applicable cities and counties.

State laws on lobbyist registration differ widely, so we recommend reviewing your reporting requirements in the states in which you operate to make sure you are in compliance with the rules.

Annual Fund Matters:

New Issue Status. On an annual basis, managers need to confirm or reconfirm the eligibility of investors that participate in initial public offerings or new issues, pursuant to both FINRA Rules 5130 and 5131. Most managers reconfirm investor eligibility via negative consent (i.e. investors are informed of their status on file with the manager and are asked to inform the manager of any changes). A failure to respond by any investor operates as consent to the current status.

ERISA Status. Given the significant problems that can occur from not properly tracking ERISA investors in private funds, we recommend that managers confirm or reconfirm on an annual basis the ERISA status of their investors. This is particularly important for managers who may be deemed a fiduciary under the Department of Labor’s (“DOL”) Fiduciary Rule (as further discussed below).

Wash Sales. Managers should carefully manage wash sales for year-end. Failure to do so could result in embarrassing book/tax differences for investors. Certain dealers can provide managers with swap strategies to manage wash sales, including Basket Total Return Swaps and Split Strike Forward Conversion. These strategies should be considered carefully to make sure they are consistent with the investment objectives of the fund.

Redemption Management. Managers with significant redemptions at the end of the year should carefully manage unwinding positions so as to minimize transaction costs in the current year (that could impact performance) and prevent transaction costs from impacting remaining investors in the next year. When closing funds or managed accounts, managers should pay careful attention to the liquidation procedures in the fund constituent documents and the managed account agreement.

NAV Triggers and Waivers. Managers should promptly seek waivers of any applicable termination events set forth in a fund’s ISDA or other counterparty agreement that may be triggered by redemptions, performance, or a combination of both at the end of the year (NAV declines are common counterparty agreement termination events).

Fund Expenses. Managers should wrap up all fund expenses for 2017 if they have not already done so. In particular, managers should contact their outside legal counsel to obtain accurate and up to date information about legal expenses for inclusion in the NAV for year-end performance.

Electronic Schedule K-1s. The IRS authorizes partnerships and limited liability companies taxed as partnerships to issue Schedule K-1s to investors solely by electronic means, provided the partnership has received the investor’s affirmative consent. States may have different rules regarding electronic K-1s and partnerships should check with their counsel whether they may still be required to send state K-1s on paper. Partnerships must also provide each investor with specific disclosures that include a description of the hardware and software necessary to access the electronic K-1s, how long the consent is effective and the procedures for withdrawing the consent. If you would like to send K-1s to your investors electronically, you should discuss your options with your service providers.

“Bad Actor” Recertification Requirement. A security offering cannot rely on the Rule 506 safe harbor from SEC registration if the issuer or its “covered persons” are “bad actors”. Fund managers must determine whether they are subject to the bad actor disqualification any time they are offering or selling securities in reliance on Rule 506. The SEC has advised that an issuer may reasonably rely on a covered person’s agreement to provide notice of a potential or actual bad actor triggering event pursuant to contractual covenants, bylaw requirements or undertakings in a questionnaire or certification. If an offering is continuous, delayed or long-lived, however, issuers must update their factual inquiry periodically through bring-down of representations, questionnaires, and certifications, negative consent letters, periodic re-checking of public databases and other steps, depending on the circumstances. Fund managers should consult with counsel to determine how frequently such an update is required. As a matter of practice, most fund managers should perform such an update at least annually.

U.S. FATCA. Funds should monitor their compliance with U.S. Foreign Account Tax Compliance Act (“FATCA”) U.S. FATCA reports are due to the IRS on March 31, 2018 or September 30, 2018, depending on where the fund is domiciled. Reports may be required by an earlier date for jurisdictions that are parties to intergovernmental agreements (“IGAs”) with the U.S. Additionally, the U.S. may require that reports be submitted through the appropriate local tax authority in the applicable IGA jurisdiction, rather than the IRS. Given the varying U.S. FATCA requirements applicable to different jurisdictions, managers should review and confirm the specific U.S. FATCA reporting requirements that may apply. As a reminder for this year, we strongly encourage managers to file the required reports and notifications, even if they already missed previous deadlines. Applicable jurisdictions may be increasing enforcement and monitoring of FATCA reporting and imposing penalties for each day late.

CRS. Funds should also monitor their compliance with the Organisation for Economic Cooperation and Development’s Common Reporting Standard (“CRS”). All “Financial Institutions” in the Cayman Islands and British Virgin Islands are required to register with the respective jurisdiction’s Tax Information Authority and submit returns to the applicable CRS reporting system by May 31, 2018. Managers to funds domiciled in other jurisdictions should also confirm whether any CRS reporting will be required in such jurisdictions. CRS reporting must be completed with the CRS XML v1.0 or a manual entry form on the  Automatic Exchange of Information portal.  We recommend managers contact their tax advisors to stay on top of the U.S. FATCA and CRS requirements and avoid potential penalties.

Annual Management Company Matters:

Management Company Expenses. Managers who distribute profits on an annual basis should attempt to address management company expenses in the year they are incurred. If ownership or profit percentages are adjusted at the end of the year, a failure to manage expenses could significantly impact the economics of the partnership or the management company.

Employee Reviews. An effective annual review process is important to reduce the risk of employment-related litigation and protect the management company in the event of such litigation. Moreover, it is an opportunity to provide context for bonuses, compensation adjustments, employee goals and other employee-facing matters at the firm. It is not too late to put an annual review process in place.

Compensation Planning. In the fund industry, and the financial services industry in general, the end of the year is the appropriate time to make adjustments to compensation programs. Since much of a manager’s revenue is tied to annual income from incentive fees, any changes to the management company structure, affiliated partnerships, or any shadow equity programs should be effective on the first of the year. Make sure that partnership agreements and operating agreements are appropriately updated to reflect such changes.

Insurance. If a manager carries D&O insurance or other liability insurance, the policy should be reviewed on an annual basis to ensure that the manager has provided notice to the carrier of all claims and all potential claims. Newly launched funds should also be added to the policy as appropriate.

Other Tax Considerations. Fund managers should assess their overall tax position and consider several steps to optimize tax liability. Managers should also be aware of self-employment taxes, which can be minimized by structuring the investment manager as a limited partnership. Managers can take several steps to optimize their tax liability, including: (i) changing the incentive fee to an incentive allocation; (ii) use of stock-settled stock appreciation rights; (iii) if appropriate, terminating swaps and realizing net losses; (iv) making a Section 481(a) election under the Internal Revenue Code of 1986, as amended (the “Code”); (v) making a Section 475 election under the Code; and (vi) making charitable contributions. Managers should consult legal and tax professionals to evaluate these options.

Regulatory & Other Changes in 2017:

SEC Updates.

SEC Adopts Form ADV Amendments. On July 1, 2017, a technical amendment to Form ADV and ADV-W was implemented to reflect a new Wyoming Law that now requires investment advisers with $25 million to $100 million in RAUM and a principal place of business in Wyoming to register with the state as an investment adviser instead of the SEC.

On October 1, 2017, additional SEC amendments to Form ADV went into effect, which will apply to both RIAs and ERAs. Among other technical amendments, the new Form ADV requires investment advisers to provide detailed information with regard to their separately managed accounts SMAs, including aggregate level reporting of asset types across an adviser’s SMAs and reporting of custodian information under certain circumstances. Investment advisers that utilize borrowing or derivatives on behalf of SMAs will also need to report the RAUM attributable to various levels of gross notional exposure and corresponding borrowings and derivatives exposure. The SEC noted that advisers may not need to report this SMA information until its annual amendment. The SEC concurrently adopted an amendment to the books and records rule (Rule 204-2 under the Advisers Act), requiring RIAs to keep records of documentation necessary to demonstrate the performance or rate of return calculation distributed to any person as well as all written performance-related communications received or sent by the RIA. Advisers who have questions on any changes to the new Form ADV should contact their compliance groups.

SEC Action Against Outsourced CCO. On August 15, 2017, the SEC reached a settlement with an outsourced CCO and his consulting firm, which offered compliance consulting and outsourced CCO services to investment advisory firms. The outsourced CCO served as CCO for two registered investment advisers (collectively, “Registrants”). The SEC found the Registrants either filed their Form ADV annual amendments late or not at all, and the outsourced CCO relied on and did not confirm estimates provided by the Registrants’ CIO. It was established that the RAUM and number of advisory accounts reported on the Form ADV was greatly overstated. The SEC held that the outsourced CCO violated the Advisers Act by failing to amend the Form ADV annually and willfully submitting a false statement. The SEC suspended the outsourced CCO from association or affiliation with any investment advisers for one year and ordered him to pay a $30,000 civil penalty. Outsourced compliance persons solely relying on internal estimates of RAUM and number of advisory contracts, without further confirmation, should be aware of the risk of filing false reports and potential SEC enforcement actions.

CFTC and NFA Updates.

CFTC Amendments to Recordkeeping Requirements. On August 28, 2017, amendments to Regulation 1.31 allow the manner and form of recordkeeping to be technology-neutral (i.e. not requiring or endorsing any specific record retention system or technology, and not limiting retention to any format).

Digital Asset Updates.

CFTC Grants Permission for Bitcoin Futures Trading. On December 1, 2017, the CFTC issued a statement granting permission to the Chicago Mercantile Exchange Inc. (“CME”) and the Chicago Board Options Exchange Inc. (“CBOE”) to list Bitcoin futures contracts on the respective exchanges. Less than two weeks after the release of CFTC’s statement, Bitcoin futures contracts trading began on the CBOE futures exchange on December 10, 2017. Early reports suggest a strong interest in Bitcoin futures contracts set to expire in early 2018. CME is set to begin Bitcoin futures contracts trading next week.

CFTC Grants SEF and DCO Registration to LedgerX. The CFTC granted LedgerX registration status as both a swap execution facility (“SEF”) and a  derivative clearing organization. Now that the exchange is live, LedgerX is the first CFTC-approved exchange to facilitate and clear options on digital assets. Previously, the CFTC granted SEF registration to TeraExchange, which offers forwards and swaps on Bitcoin. LedgerX offers physically-settled and day-ahead swaps on Bitcoin to U.S.-based eligible contract participants and has a fully-collateralized clearing model where customers must post collateral to cover maximum potential losses prior to trading.

Other Updates.

DOL Implements Fiduciary Rule. On June 9, 2017, the DOL partially implemented its amended fiduciary rule (the “Fiduciary Rule”), which expands the definition of a “fiduciary” to apply to anyone that makes a “recommendation” as to the value, disposition or management of securities or other investment property for a fee or other compensation, to an employee benefit plan or a tax-favored retirement savings account such as an individual retirement account (“IRA”) (collectively “covered account”) will be deemed to be providing investment advice and, thus, a “fiduciary”, unless an exception applies. Fund managers with investments from covered accounts or that wish to accept contributions from covered accounts will need to consider whether their current business activities and communications with investors could constitute a recommendation, including a suggestion that such investors invest in the fund. The Fiduciary Rule provides an exception for activity that would otherwise violate prohibited transaction rules, which is applicable to investments made by plan investors who are represented by a qualified independent fiduciary acting on the investor’s behalf in an arms’ length transaction (typically for larger plans). The Fiduciary Rule also contemplates a Best Interest Contract (“BIC”) Exemption, which permits investment advisers to retail retirement investors to continue their current fee practices, including receiving variable compensation, without violating prohibited transactions rules, subject to certain safeguards. Managers with questions regarding the applicability of these exemptions should discuss with counsel.

Two New California Employment Laws Limit Inquiries into Certain Information During the Hiring Process. In October, California Governor Jerry Brown approved Assembly Bill No. 168 and Assembly Bill No. 1008, restricting certain information a California employer may inquire about and consider during its hiring process. Assembly Bill No. 168 restricts employers from requiring prospective employees to disclose salary history. An employer may not inquire or rely on such information when deciding whether to extend an offer to a job applicant or deciding an amount to offer to a job applicant. Assembly Bill No. 1008 restricts California employers with five or more employees from including, inquiring and considering information about an employee applicant’s criminal history until a conditional offer has been extended to a job applicant. Assembly Bill No. 1008 further provides certain requirements an employer must comply with after such information has been legally acquired and is taken into consideration when deciding whether to hire a job applicant, as well as certain procedures to comply with when deciding a job applicant is not suitable for the position. Both laws become effective January 1, 2018. With respect to California employees, you should review before year end, your job application, offer letter template, and compliance manual if they contain questions regarding salary or criminal history.

MSRB Establishes Continuing Education Requirements for Municipal Advisors. Beginning January 1, 2018, the Municipal Securities Rulemaking Board (“MSRB”) will implement amendments requiring municipal advisors to maintain a continuing education program in place for “covered persons”. The amendment will require an annual analysis to evaluate training needs, develop a written training plan, and implement training in response to the needs evaluated. The amendments promote compliance with the firms record-keeping policies regarding the continuing education program. Municipal advisors will have until December 31, 2018 to comply with the new requirements.

SIPC and FINRA Adopt Streamlined Reporting Process. As of September 1, 2017, investment advisory firms who are members of both the Securities Investor Protection Corporation (“SIPC”) and the Financial Industry Regulatory Authority (“FINRA”) now only need to file one annual report to both agencies through FINRA’s reporting portal. This will ease the reporting burden as well as cut down on compliance costs, for firms.

SEC Provides Guidance to Address MiFID II. On October 26, 2017, the SEC issued three no-action relief letters to provide guidance on the Markets in Financial Instruments Directive II (“MiFID II”). Effective January 3, 2018, MiFID II most notably introduces the requirement for UK broker-dealers to “unbundle” investment research from trading commissions, requiring distinct pricing for each of the services rendered. The first no-action letter provides that for the first 30 months from when MiFID II becomes effective, U.S. broker-dealers will not be considered an investment adviser upon accepting payments from an investment manager. The second no-action letter states that broker-dealers may continue to rely on the safe harbor under Section 28(e) of the Securities and Exchange Act of 1934, as amended, for payments made from client assets made alongside payments for execution to an executing broker-dealer. The final no-action letter addresses MiFID II’s various payment arrangements surrounding research activities and provides that an investment adviser may aggregate client orders, although research payments may differ for each client.

Tax Cuts and Jobs Act Impact on Hedge Funds. In late 2017, the House Ways and Means Committee and the Senate Finance Committee passed companion legislation in an attempt to reform the US tax system. One of the proposed revisions included in H.R. 1 or the Tax Cut and Jobs Act (“Tax Act”) is a reduction in the tax rate for a pass-through entity’s “capital percentage” business income. The applicable tax rate would be 25%, with the non-professional services entity’s “capital percentage” business income capped at 30%, and the remaining amount of income characterized as “labor”.

Offshore Updates.

Cayman and BVI Update Beneficial Ownership Regimes. Amendments to the Cayman Islands beneficial ownership laws went into effect on July 1, 2017, which require certain entities, including exempted funds, to take reasonable steps to identify their beneficial owners (generally persons holding more than 25% interests in such an entity). Of interest to fund managers, the following types of funds are exempted from the scope of these amendments: funds that are regulated by the Cayman Islands Monetary Authority, that employ a Cayman regulated administrator, or funds that are managed by an adviser regulated in an approved jurisdiction, such as a state or SEC RIA. The British Virgin Islands (the “BVI”) also implemented amendments to its beneficial ownership regime effective July 1, 2017, which requires registered agents of non-exempt BVI companies, such as unregulated private funds, to input beneficial ownership information into a platform called the BOSS (Beneficial Ownership Secure Search) System. The BOSS System is accessible only to select regulators and fulfills BVI commitments to the United Kingdom under the UK Exchange of Notes Agreement.

U.K. Transitions from U.K. FATCA to CRS. The U.K. transitioned from U.K. FATCA to CRS on July 1, 2017, and now joins more than 85 countries, including the Cayman Islands and the BVI, in the automatic exchange of information between participating countries. The full list of signatory countries is available here. Similar to U.S. FATCA, CRS sets forth a standard by which signatory countries can more easily and automatically exchange certain reportable tax information. We recommend that managers consult their tax advisors to determine whether they are subject to any CRS reporting requirements.

Cayman Islands Introduces New AML Regulations. New Cayman Islands AML regulations came into effect on October 2, 2017. The new regulations expand AML/CFT (anti-money laundering/ countering the financing of terrorism) obligations to unregulated investment entities and  additional  financial  vehicles,  which  are  seen  to  align  more  closely  with  the Financial Action Task Force (FATF) recommendations and global practice. In a shift to a risk- based approach to AML regulations, there will be two separate due diligence procedures depending on the risk assessment of investors. Certain investors that are deemed to be high-risk, such as politically exposed persons, will be required to go through a more extensive verification process, while low-risk investors will be able to submit to a simplified due diligence process. If you have any questions, we recommend that you reach out to your administrator or offshore counsel.

New PRIIPs Disclosure Requirements for EEA Retail Investors. Regulation (EU) No 1286/2014 (“Regulation”), effective January 1, 2018, requires manufacturers of Packaged Retail and Insurance-based Investment Products (“PRIIPs”) to make available Key Information Documents (“KIDs”) to “retail investors” (generally any investor that does not meet the “professional client” status) in member states of the European Union and the Economic European Area (collectively, “EEA”). If a PRIIP manufacturer, such as a fund manager, accepts additional investments or a new investment from an EEA retail investor on or after January 1, 2018, it must comply with the Regulation’s technical requirements pertaining to KIDs. “Retail investors” under the Regulation can include investors such as high net worth individuals, who are not traditionally considered retail investors. Fund managers should consider the applicability of the Regulation given the types of EEA investors they may be marketing to, and managers who wish to forego complying with the Regulation should not accept investments from EEA retail investors and implement additional procedures to ensure such investors are not marketed to or admitted in the fund.  Fund managers with questions regarding the Regulation should discuss with counsel.

Compliance Calendar. As you plan your regulatory compliance timeline for the coming months, please keep the following dates in mind:

Deadline – Filing

  • December 18, 2017 –  IARD Preliminary Renewal Statement payments due (submit early to ensure processing by deadline)
  • December 26, 2017 – Last day to submit form filings via IARD prior to year-end
  • December 31, 2017 – Review RAUM to determine 2018 Form PF filing requirement
  • January 15, 2018 – Quarterly Form PF due for large liquidity fund advisers (if applicable)
  • January 31, 2018 – “Annex IV” AIFMD filing
  • February 15, 2018–  Form 13F due
  • February 15, 2018 – Annual Schedule 13G updates due
  • February 15, 2018 – Annual Form 13H updates due
  • February 28, 2018 – Deadline for re-certification of CFTC exemptions
  • March 1, 2018 – Quarterly Form PF due for larger hedge fund advisers (if applicable)
  • April 2, 2018 – Annual ADV amendments due (for December 31st fiscal year end)
  • April 2, 2018 – Annual Financial Reports due for CA RIAs (if applicable)
  • April 18, 2018 – FBAR deadline for certain individuals with signature authority over, but no financial interest in, one or more foreign financial accounts
  • April 29, 2018 – Annual Form PF due for all other advisers (other than large liquidity fund advisers and large hedge fund advisers)
  • Periodic – Form D and blue sky filings should be current
  • Periodic – Fund managers should perform “Bad Actor” certifications annually


Bart Mallon is a founding partner of Cole-Frieman & Mallon LLP.  Mr. Mallon can be reached directly at 415-868-5345.

IA Annual Form ADV Update for 2017

Investment Adviser Registration Update Due March 31

Under SEC and state regulations, registered investment advisers and exempt reporting advisers (“ERAs”) must file an annual amendment to Form ADV within 90 days of the end of its fiscal year. For most firms this means that the annual updating amendment is due by March 31, 2017.

Process and Major ADV Update Items

The annual update can be completed through the IARD system either (i) internally by the firm’s CCO or (ii) externally by a firm’s compliance consultant or fund attorney. The process generally will entail a review of the current Form ADV, and Form ADV Part 2 if applicable, to make sure that all information is up to date and accurate. In general, once the review process has begun, the update can be completed in a few days depending on the complexity of firm’s operations and the capacity of the updater to make changes in the system. For many firms whose operations have not changed throughout the year, the update should be fairly straight forward – for private fund managers in this situation, the focus mostly will be on the Schedule D, Item 7.B.(1) items (Private Fund Reporting) which include updates to the following items for each fund:

  • Gross asset value of the private fund as of 12/31/16 (essentially RAUM of the fund, described below)
  • Total number of investors
  • % of the fund owned by the advisor and/or its related persons
  • % of the fund that is owned by fund of funds
  • % of the fund that is owned by non-US persons

Private Fund RAUM

The SEC has defined regulatory assets under management (“RAUM”) in Item 5b of the Form ADV instructions (see Form ADV and Filing Instructions for more information).  Generally, RAUM should include the securities portfolios for which a manager provides continuous and regular supervisory or management services as of the date of filing or update of the Form ADV. Unlike AUM, the RAUM calculation requires managers to report assets managed without the deduction of any outstanding indebtedness or other accrued but unpaid liabilities (including accrued fees or expenses) that remain in a client’s account. A fund manager’s RAUM may be higher than its normally reported AUM because it includes:

  • Cash and cash equivalents (i.e., bank deposits, certificates of deposit, bankers acceptances, and similar bank instruments)
  • Long and short positions (on a gross basis)
  • Leverage
  • Margin
  • Family or proprietary accounts
  • Accounts for which the manager receives no compensation for its services
  • Accounts of clients who are not United States persons

RAUM should be calculated based on the current market value of the assets as determined within 90 days prior to the date of filing the Form ADV.  For private funds, the SEC has stated that a manager may rely on the gross assets as reflected on the fund’s balance sheet, and the manager may assess the value of financial instruments under the applicable accounting standards, which is GAAP in this industry.  We urge managers to reach out to their accounting firm if they are unsure about the treatment of any financial instruments for purposes of the RAUM calculation.

Other Items

While it is important to make sure all parts of the Form ADV are accurate and complete, special attention should also be paid to the Part 2 brochures. Some firms also take this opportunity to review their compliance program but given this update requirement and the audit deadline for pooled investment vehicles, the annual compliance review will often be pushed back until later in the year.  While we are quickly coming up to March 31, there is still plenty of time to complete the update and private fund managers should reach out to us if they would like our assistance preparing the amendment for this year.


Bart Mallon provides investment adviser registration and compliance services to investment advisers and private fund managers through Cole-Frieman & Mallon LLP.   Mr. Mallon can be reached directly at 415-868-5345.

SEC Guidance on Registration of Investment Advisory Affiliates

The SEC’s Division of Investment Management issued a no-action letter on January 18, 2012 that provides guidance for registered investment advisers who have multiple entities in control relationships. The no-action letter affirms prior SEC guidance for investment advisers who have entities that serve as general partners and managing members to private funds and other similar special purpose vehicles (“SPVs”). Additionally, other investment advisers who “conduct a single advisory business” through multiple separate legal entities may use a single registration (i.e. register on a single Form ADV) under certain circumstances.

Affiliates Serving as Fund General Partners, Managing Members and Similar SPVs

Entities that function as fund general partners, fund managing members, and similar SPVs are not required to separately register as an investment adviser, as long as the following conditions are satisfied:

1. The investment adviser to a private fund establishes the SPV to act as the fund’s general partner or managing member;

2. The SPV’s formation documents designate the investment adviser to manage the private fund’s assets;

3. All of the investment advisory activities of the SPV are subject to the Investment Advisers Act of 1940 (the “Advisers Act”), Advisers Act rules, and SEC examination; and

4. All employees and persons acting on behalf of the registered investment adviser and/or an SPV are subject to supervision and control of the investment adviser.

For SPVs that have independent directors, the independent directors are excepted from the condition that they be under the registered investment adviser’s supervision and control, and thus are not “persons associated with” the registered investment adviser.

Other Investment Advisory Affiliates Under Common Control

Under the SEC’s guidance, a registered investment adviser (the “filing adviser”) can file a single Form ADV on behalf of itself and each entity that is controlled by or under common control with the filing adviser (each, a “relying adviser”) as long as those entities are conducting a single advisory business. Under the no action letter, using a single registration is appropriate under the following circumstances:

1. The filing adviser and each relying adviser advise only private funds and separate account clients that are “qualified clients” (as defined in Rule 205-3 promulgated under the Investment Advisers Act of 1940 (the “Advisers Act”));

2. Each relying adviser, its employees and the persons acting on its behalf are subject to the filing adviser’s supervision and control;

3. The filing adviser has its principal office and place of business in the United States;

4. The advisory activities of each relying adviser are subject to the Advisers Act and SEC examination;

5. The filing adviser and each relying adviser operate under a single code of ethics and single set of compliance policies and procedures; and

6. The filing adviser discloses in its Form ADV (Miscellaneous Section of Schedule D) that it and its relying advisers are together filing a single Form ADV and each relying adviser is identified by completing a separate Section 1.B, Schedule D, with the notation “relying adviser.”

For more information on whether the above guidance applies to your firm, please contact us directly.


Cole-Frieman & Mallon LLP provides investment adviser registration and compliance services. Bart Mallon can be reached directly at [email protected] and by phone at 415-868-5345.

Annual ADV Updating Amendment for IA Firms

Under SEC and state regulations, a registered investment advisory firm must file its annual amendment to Form ADV within 90 days of the end of its fiscal year.  For most firms this means that the Annual Updating Amendment is due by March 31.  In addition to the traditional updates which firms need to make on Form ADV, advisers will also need to be aware of the new regulations with respect to ADV Part 2 which may require the adviser to complete a new form ADV part 2 during the updating process.  We are making special note of the updating requirement earlier than usual because of the new ADV 2 requirement.

Overview of Major Items on ADV to Update

When a firm completes an annual update to Form ADV, the firm should go through each question and make sure disclosures are accurate and up to date.  In general the firm’s chief compliance officer will complete the update or work with an outside investment adviser compliance firm or law firm to complete the update.

Some of the key items of Form ADV which need to be updated include:

  • Employees (Items 5.A. and 5.B.)
  • Number of clients (Items 5.C. and 5.H.)
  • Number of accounts (Item 5.F.)
  • Assets under management (Item 5.G.)
  • Other material changes can also be disclosed on the Annual Updating Amendment, such as changes to reportable disciplinary and financial disclosures, contact information, custody, and ownership.   [Note: these items need to be updated on Form ADV within 30 days of when they take place.]

While Part 1 of Form ADV can be completed using the online form on the IARD system, the new ADV Part 2 must be filed electronically as a text-searchable PDF.  You will not be able to

submit a PDF file of a scanned copy Part 2 on the IARD system.

New Regulations Regarding ADV Part 2

IA firms applying for SEC registration as of January 1, 2011 and existing firms filing Annual Updating Amendments are now required to use the new Part 2A, the “firm brochure.”  In addition, the SEC has established the following compliance dates regarding Part 2B, the “brochure supplement:”

SEC Compliance Dates for Delivery of Brochure Supplements to Clients

SEC Compliance Dates Extensions*
New/Prospective Clients Existing Clients New/Prospective Clients Existing Clients
New IA registrants Applying as of 01/01/11, deliver upon registering Applying between 01/01/11 and 04/30/11, begin delivering by 05/01/11

Applying after 04/30/11, deliver upon registering

Applying between 01/01/11 and 04/30/11, deliver by 07/01/11.
Existing IAs Upon filing Annual Updating Amendment Within 60 days of filing Annual Updating Amendment Registered as of 12/31/10 with fiscal year ending 12/31/10 through 04/30/11, begin delivering by 07/31/11

Registered as of 12/31/10 with fiscal year ending after 04/30/11, deliver upon filing Annual Updating Amendment

Registered as of 12/31/10 with fiscal year ending 12/31/10 through 04/30/11, deliver by 09/30/11

Registered as of 12/31/10 with fiscal year ending after 04/30/11, deliver within 60 days of filing Annual Updating Amendment

*On December 28, 2010, the SEC extended the compliance dates by four months to provide certain IAs more time to deliver the brochure supplement.

Incorporating the New ADV Part 2 for State Registrations

Because not all states have adopted the new ADV Part 2, state-registered IAs should check their state rules to confirm whether they need to use the new form or if they can continue to use the old form.  In many states, the next amendment to Form ADV must include the new ADV Part 2, even if it is not the Annual Updating Amendment.  For example, as of January 1, 2011, states including Alaska, California, Connecticut, Indiana, Maine, Maryland, Massachusetts, Ohio, Oregon, and Tennessee are requiring that registered IAs use the new ADV Part 2 as part of any amendment, as well as the required Annual Updating Amendment.

For more information on ADV Part 2, especially with respect to state adoptions, please see our update on new ADV Part 2.

For information on expected costs to prepare the new Form ADV 2, please see this post.


Bart Mallon provides investment adviser registration and compliance services through Cole-Frieman & Mallon LLP.  He can be reached directly at 415-868-5345.

Form ADV Requirements for Exempt Reporting Advisers

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.


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.


Other related hedge fund articles:

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

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.


Other related articles:

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.

Form ADV Part 2 and State Registration

A couple of weeks ago the SEC announced that they approved certain updates for Form ADV Part 2 .  While these forms will be required for managers who are subject to registration with the SEC (under the new rules, those managers with either $100 or $150 million of assets under management depending on the circumstance), the states are still determining how they are going to handle new Part 2.  We have done a preliminary investigation by calling a number of the more popular states and found that most states are planning to implement new Part 2, but are not sure when the requirement will be finalized.  From our research, Texas is the only state that has set a date for implementation of new Part 2.

The list of states is below.  We will continue to update this list.


  • Arizona – will require but not sure starting when
  • California – will require but not sure when
  • Colorado – will require but not sure starting when
  • Connecticut – discussing now and will have a decision at the end of the month
  • Illinois – will require but not sure starting when
  • Massachusetts – will require but not sure starting when
  • Texas – will require starting 01/11


Other related hedge fund law articles:

Cole-Frieman & Mallon LLP provides legal support and hedge fund compliance services to all types of investment managers.  Bart Mallon, Esq. can be reached directly at 415-868-5345.

New Form ADV Part 2 Format Released

SEC Announces New Format for ADV Part 2

Advisors registered with the SEC should have received a notification from the SEC about the new Part 2 format.  We have posted that release below and the communication we received from the SEC.  We have also posted the new release as well as the instructions for the new ADV Part 2.  We will be providing an overview and our thoughts on these changes in the coming days.

Complete Release – New Form ADV Part 2

New Form ADV Part 2 Instructions


Form ADV Part 2: New Format and Brochure Supplements Required

The SEC recently adopted amendments to Part 2 of Form ADV and related rules that require investment advisers to prepare plain English narrative brochures and brochure supplements. You may view the adopting release and amended form at http://www.sec.gov/rules/final/2010/ia-3060.pdf . The revised form and rules require you to file a narrative brochure(s) electronically in a text searchable PDF format on IARD and to deliver the brochure to clients. You must also prepare, and deliver to clients, brochure supplements for certain employees and maintain them in your files. If your fiscal year ends on December 31, you are required to file a narrative brochure(s) with your annual amendment filing that is due by March 31, 2011. If your fiscal year end is other than December 31, you are required to file a narrative brochure(s) with your annual amendment filing for your 2011 year end. Please review the final release, amended rules, and amended Part 2 of Form ADV for additional information on when and how you are required to comply with these amendments. You cannot reply to this email. If you have questions, please email [email protected]


Other related hedge fund law articles:

Cole-Frieman & Mallon LLP provides legal support and hedge fund compliance services to all types of investment managers.  Bart Mallon, Esq. can be reached directly at 415-868-5345.

SEC Approves ADV Part II Update

New Form to Require More Disclosure

On July 21, the SEC approved changes to the Form ADV Part II which are designed to provide more and better information to investors.  Currently Part II (and Schedule F which qualifies much of the information on Part II) contains a series of check the box options and also provides much of the same information which is also provided on Form ADV.  The changed proposed below will go into effect 60 days from the publication in the Federal Register which means that most advisers will need to have the new Part II in place by the first quarter of 2011.  In addition to traditional investment advisers, the new Part II disclosure requirements will also be applicable to hedge fund managers who are subject to registration after the passage of the Dodd-Frank reform bill.

The proposed major changes include the following:

  • Increased narrative – currently Part II and Schedule F are composed of a series of check the box answers describing an adviser’s business.  The SEC wants to move towards more of a narrative, “plain English” approach to disclosure which will be “clear and concise”.
  • Discussion of advisory business and fee structure – more disclosure will be required about the advisor’s business and the fee structure.  Increased disclosure will be required about expenses like brokerage and custody fees.
  • Performance fee discussion – the big issue is that if a manager charges performance fees to some accounts and not others, the manager will need to explain the conflicts of interest which are involved.
  • Discussion of investment methodology and risk factors – the manager will be required to explain the material risks involved in the investment program.
  • Disciplinary information – all disciplinary information material to the adviser’s business will need to be disclosed.  If there is new disciplinary disclosures which become necessary after the relationship has been established, the adviser will need to promptly update the client.
  • Supplements – the adviser will need to provide supplements to the client regarding the specific person who will be providing investment advice to the client.  This supplement will include information about the person’s education, business experience, disciplinary history, etc.

After the changes become effective, both hedge fund managers and other investment advisers will need to update their forms and also update their compliance manuals and policies and procedures.  Managers should also note that the information included in Part II will be publicly available online.

While we completely agree with appropriate and easy to understand disclosure, some of the proposed changes may have the unintended effect of creating brochures which are so long and comprehensive that investors will simply not read them.  For example, we have discussed “prospectus creep” and there is the possibility for this to happen with the Part II -especially with respect to risk disclosures.  Managers and lawyers will certainly err on the side of over-disclosure instead of under-disclosure when faced with a potential risk factor which may or may not be “material” in the eyes of the SEC (see, especially, the Goldman case).

What we see with the supplements is essentially a first step towards developing a self-regulatory organization (SRO) to oversee investment advisers.  FINRA has shown a willingness to take on this responsibility and it has become an even greater likelihood as the SEC is tasked with greater responsibilities under the Dodd-Frank bill.  While we believe that a SRO can relieve much of the regulatory burden of a government agency (see the NFA), we must note that all SROs have their own issues and this must be weighed against the increased costs (both in time and money) to investment advisers.

Text of Chairman Shapiro’s speech can be found here.
SEC News Release can be found here.


Other related hedge fund law articles:

Cole-Frieman & Mallon LLP provides legal support and hedge fund compliance services to all types of investment managers.  Bart Mallon, Esq. can be reached directly at 415-868-5345.

SEC fines adviser and revokes registration

The SEC fined an investment adviser and revoked its registration because of willful refusal to follow simple investment adviser rules such as updating form ADV and submitting to a reasonable examination of its books and records.

From SEC website:

Commission Declares Decision as to Amaroq Asset Management, LLC and Dwight Andre Sean O’Neal Jones Final

The decision of an administrative law judge ordering Amaroq Asset Management, LLC, and Dwight Andree Sean O’Neal Jones to cease and desist from committing or causing any violations or future violations of Section 204 of the Investment Advisers Act of 1940 and Advisers Act Rule 204-1 has been declared final. The law judge further ordered that the registration of Amaroq Asset Management, LLC be revoked; that Dwight Andree Sean O’Neal Jones be barred from association with any investment adviser, with a right to apply for association after one year; and ordered that Jones pay a civil penalty in the amount of $15,000.

The law judge concluded that Jones willfully aided and abetted and was a cause of Amaroq’s failure to: (1) file annual amendments to Form ADV; (2) promptly update its Form ADV to reflect its current business address; (3) submit to a reasonable examination and failing to furnish copies of the required books and records in connection with the scheduled examination. The law judge found that Jones showed indifference and/or a series of broken promises, when Commission attorneys repeatedly and explicitly informed him of the law’s requirements, thereby demonstrating extreme recklessness. (Rel. IA-2770) Finality Order; File No. 3-12822)

For final decision, click here.