Third Quarter 2013 Business & Regulatory Update

Below is the third quarter of 2013 update we have sent out to our mailing list.  We will be sending out our end of the year update soon so if you would like to be added to the mailing list, please contact us here.


Cole-Frieman & Mallon Third Quarter Update

Clients and Friends:

In the third quarter of 2013 we have seen dramatic developments in the world of investment management regulatory compliance. As we move into the fourth quarter, we would like to provide you with a brief overview of some items that we hope will help you stay on top of the business and regulatory landscape in the coming months.


JOBS Act Update.  Over a year after the Jumpstart Our Business Startups Act (the “JOBS Act”) was signed into law, the Securities and Exchange Commission (“SEC”) issued certain long-awaited  implementing regulations and other proposed rules:

  • General Solicitation Ban Lifted. On July 10, 2013, the SEC adopted New Rule 506(c) under Regulation D, commonly relied upon by private investment funds for selling securities without registration under the Securities Act of 1933 (the “Securities Act”). Effective September 23, 2013, Rule 506(c) permits private funds to engage in general solicitation and advertising to the public, provided that the issuer takes “reasonable steps to verify” that all investors are “accredited investors.” This may be done by (i) reviewing IRS forms that report income, such as Form W-2, Form 1099, Schedule K-1 and Form 1040; (ii) reviewing financial records, such as bank statements, (iii) obtaining written confirmation from a registered broker dealer, SEC-registered investment adviser, licensed attorney, or certified public accountant, or (iv) obtaining a certificate from a current investor who invested prior to September 23, 2013 confirming “accredited investor” status. Reliance on investors’ representations in a questionnaire or subscription agreement is insufficient. It is currently unclear whether private funds utilizing registration exemptions from the Commodity Futures Trading Commission (“CFTC”) may take advantage of the Rule 506(c), as certain such exemptions prohibit general solicitation.
  • Bad Actors Prohibited from Rule 506 Reliance.  As of September 23, 2013, the SEC’s “Bad Actors” prohibition effectively prevents issuers from relying on Rule 506 if the issuer or certain persons affiliated with the issuer (“Covered Persons”) have been subject to certain “Disqualifying Events,” including but not limited to certain criminal convictions, court injunctions, commission disciplinary actions, and suspensions from membership in a self-regulatory organization. Advisers should take immediate steps to obtain representations regarding Disqualifying Events from all Covered Persons, which include holders of at least 20% of an issuer’s outstanding “voting securities.” The SEC has noted that securities conferring on holders the right to elect or remove the directors or General Partner of the issuer, or to approve significant transactions such as acquisitions, dispositions, or financings, are considered voting securities. For offshore funds structured as companies, the adviser should examine whether the share capital structure provides that all shareholders hold voting Common Shares that have the right to remove directors, or that shares are split between voting Management Shares and non-voting Participating Shares. Covered Persons also include third-party marketers, and may include certain other arrangements, such as fee rebates. Issuers whose Covered Persons are subject to Disqualifying Events that occurred after September 23 are prohibited from relying on Rule 506 unless the issuer is able to establish that it did not know and, in the exercise of reasonable care, could not have known that a Disqualifying Event existed. Disqualifying Events that occurred prior to September 23 must be disclosed to offerees in writing a reasonable time prior to sale.
  • Rule 144A Clarification.  The SEC has clarified that there is no ban on general solicitation in offers made pursuant to Rule 144A of the Securities Act. As such, Rule 144A securities may be offered to persons other than “qualified institutional buyers” (“QIBs”), provided that the restricted securities are sold only to persons that the seller reasonably believes are QIBs.
  • Proposed Form D Amendment. The SEC has proposed certain amendments to Form D requirements in response to Rule 506(c). The proposed rules would require issuers relying on Rule 506(c) to make an “Advance Form D” filing at least 15 days before engaging in general solicitation or advertising, and to make certain additional disclosures on Form D, including a description of the type of general solicitation used and the methods used to verify accredited investor status. The SEC also proposed requiring issuers relying on Rule 506 generally to file amendments no later than 15 days after the first sale of securities, and make a closing Form D filing within 30 days after the termination of the offering.
  • Proposed Rule 156 Amendment.  The SEC has proposed an amendment to Rule 156 of the Securities Act to address concerns of potential fraudulent and misleading sales literature arising out of Rule 506(c) reliance. The current version of Rule 156 applies only to registered investment companies, prohibiting the use of any communications, including by writing, radio, or television, to sell or induce the sale of securities if such communication includes information that could be materially misleading. As amended, the new rule would apply to private funds making general solicitations under Rule 506(c). Additionally, the SEC has proposed a requirement that certain legends be included on all written general solicitation materials.
  • Proposed New Rule 510T. The SEC has proposed New Rule 510T of Regulation D to require that an issuer conducting an offering in reliance on Rule 506(c) submit any written general solicitation materials used in connection with the offering to the SEC. If adopted, this would be a temporary rule that would expire two years after its effective date.

Foreign Account Tax Compliance Act (“FATCA”) Deadline Extended. The U.S. Internal Revenue Services (“IRS”) has postponed by six months the effective date for certain requirements under FATCA. Pursuant to IRS Notice 2013-43, foreign financial institutions (“FFIs”) such as offshore funds now have until April 25, 2014 to complete the following steps in order to avoid being subject to a 30% U.S. withholding tax on payments they receive from U.S. sources starting July 1, 2014: (1) register with the IRS through the online web portal found here; (2) enter into an FFI agreement with the IRS via the web portal, or comply with an applicable intergovernmental agreement; and (3) meet the other due diligence, reporting and withholding requirements under FATCA. Offshore fund managers should contact their tax advisers and compliance counsel to prepare for FATCA compliance and, if required, to register with the IRS before April 25, 2014. In addition, fund managers to domestic funds should work with their tax advisers, administrators and legal counsel to properly address the new account onboarding and due diligence procedures required under FATCA, including updating their offering documents and subscription materials.

Futures and Derivatives. Futures and derivatives regulators and self-regulatory organizations have continued to be very active over the last quarter. Important developments include:

  • ISDA 2013 EMIR Protocol and Dodd-Frank Protocol Extension. As of September 15, 2013, all EU-domiciled entities party to over-the-counter derivatives transactions are required to comply with certain portfolio reconciliation, dispute resolution, and disclosure requirements pursuant to the EU’s European Market Infrastructure Regulation legislation (“EMIR”). EMIR compliance also requires the assent and cooperation of each counterparty. As such, the International Swaps and Derivatives Association has provided a standardized protocol (“EMIR Port Rec Protocol“) that can be used by counterparties to amend their agreements.  For U.S. counterparties who have already adhered to the ISDA March 2013 DF Protocol (“DF 2.0,” which contains certain portfolio reconciliation provisions), ISDA published the ISDA DF Protocol Extension on September 10, 2013, the explanatory memorandum for which can be found here, allowing such U.S. counterparties to amend their responses to DF 2.0 as necessary to comply with EMIR rather than simultaneously participating in the EMIR Port Rec Protocol.
  • Upcoming Deadline of New Quarterly Filing Requirement for CTAs. Pursuant to the NFA’s Notice, CTAs are reminded to file Form CTA-PR with the NFA on a quarterly basis via the NFA’s EasyFile system for CTAs within 45 days of the end of each calendar quarter. The first filing will be for the quarter ending September 30, 2013 and will be due on November 14, 2013. If you are a CTA and would like assistance with the filings, please contact us.
  • Changes to CPO and CTA Requirements. The CFTC has recently adopted amended rules affecting CPOs and CTAs. Beginning September 23, 2013, all CPOs and CTAs are permitted to use a Disclosure Document for up to 12, rather than nine months. As of August 22, 2013, CPOs are no longer required to obtain a signed acknowledgment of receipt of disclosure documents from a participant before accepting funds. Additionally, CPOs may, as of September 23, 2013, use third-party service providers to maintain their books and records, provided that certain conditions are met.
  • CFTC Harmonization Rule for CPOs of RICs. The CFTC has changed the requirements for CPOs of Registered Investment Companies (“RICs”) to harmonize its disclosure and compliance requirements with those of the SEC. This “Harmonization Rule” effectively adopts a substituted compliance regime for CPOs of RICs premised upon such entities’ adherence to the compliance obligations under the SEC statutory and regulatory compliance regime. As such, participating CPOs of RICs will now be exempt from certain Commodity Exchange Act (“CEA”) requirements, such as the requirement that CPOs submit their disclosure documents to the NFA prior to distribution. In order to take advantage of this relief, CPOs of RICs must file a notice with the NFA by October 21, 2013 and may do so through the NFA’s Exemption System. The SEC’s staff has issued guidance on the Harmonization Rule, and noted that its recently created Risk and Examinations Office will monitor, among other things, investment companies’ risk management related to commodity interests.
  • New Recordkeeping Requirements for FCMs, IBs, and RFEDs. CFTC Regulation 1.35(a) requires FCMs, IBs, and RFEDs to keep complete, systematic records, including all pertinent data and memoranda, of all transactions relating to their business of dealing in commodity interests and related cash or forward transactions. Starting December 21, 2013, amendments to the rule require FCMs, certain IBs, and RFEDs to tape record all oral communications provided or received concerning quotes, solicitations, bids, offers, instructions, trading and prices that lead to the execution of such transactions. Oral communications include a wide range of media including telephone, voicemail, mobile device, or other digital or electronic media, and must be kept for one year. The CFTC has issued guidance that these groups may reasonably rely on a designated contract market, swap execution facility, or other CFTC registrant to maintain certain records on their behalf.
  • New Rules for Swaps and Clearing Organizations. The CFTC has recently adopted new rules regarding swaps and clearing organizations to implement the Dodd-Frank Act’s new statutory framework. Effective September 23, 2013, cooperatives meeting certain conditions may elect not to submit for clearing certain swaps otherwise required under Section 2(h)(1) of the CEA. The CFTC has also adopted rules, effective October 15, 2013, to implement enhanced risk management standards for systemically important derivatives clearing organizations, including increased financial resources requirements and prohibiting the use of assessments in calculating available default resources. Additionally, the CFTC has issued interpretive guidance regarding the cross-border application of the swaps provisions of the CEA, as added by Dodd-Frank.

Joint Advisory on Business Continuity and Disaster Recovery Planning. The CFTC, SEC, and FINRA have issued a joint advisory regarding firms’ business continuity and disaster recovery planning (“DRP”) in the wake of Hurricane Sandy, which caused widespread damage to Northeastern states and closed U.S. equity and options markets for two days in October 2012. The advisory encourages the implementation of certain best practices to improve responses to, and reduce recovery time after, such devastating large-scale events. Among its recommendations, the advisory suggests that firms contract with multiple telecommunications carriers in the event that one experiences a disruption; implement a communication plan to allow communication and coordination with regulators, emergency officials, and others; and conduct annual or more frequent DRP testing and training, including the incorporation of stress testing.

Sun Capital Implications for Private Funds. The First Circuit Court of Appeals reversed a lower court ruling, holding that a private equity fund qualified as a “trade or business” under the Multiemployer Pension Plan Amendment Act (“MPPAA”) for purposes of determining whether the fund might be liable for pension plan withdrawal liability of one of its portfolio companies. In the ruling, the court considered the following factors: the fund’s ownership of at least 80% of the portfolio company; the fund’s management rights of the portfolio company; and the offset management fee structure, whereby the portfolio company paid a management fee to the fund’s general partner, which in turn offset the amount owed by the fund. Private fund managers should consider these factors when investing in portfolio companies which participate in union-sponsored multiemployer plans or sponsor a defined benefit pension plan.

Amended Financial Responsibility Rules for Broker-Dealers. The SEC has  finalized amendments requiring broker-dealers to comply with new net capital, customer protection, books and records, and notification rules. Prominent changes include new required deductions for the purpose of calculating net capital under Rule 15c3-1 of the Securities Exchange Act of 1934 (“Exchange Act”) and the removal of the limitation on the SEC’s ability to issue an order temporarily restricting a broker-dealer from withdrawing capital or making loans to stockholders, insiders and affiliates. Rule 15c3-3 of the Exchange Act was also amended to require “carrying broker dealers,” defined as broker-dealers that carry accounts that hold proprietary securities and cash of other broker-dealers (“PAB Accounts”), to comply with certain computation, account formation, and segregation rules with respect to those accounts.   Additionally, pursuant to the Dodd-Frank Act, the SEC has adopted certain amendments to reporting and audit rules for broker-dealers.

European Union’s Alternative Investment Fund Managers Directive (“AIFMD”). Managers marketing alternative investment funds in the EU are now subject to the reporting and disclosure obligations under the AIFMD, which went into effect on July 22, 2013. In addition, managers may also need to take steps to ensure compliance with the domestic implementing legislation of the jurisdiction where the investor is located. Certain countries, including the UK, Sweden and Germany (for existing funds as of July 22, 2013), are allowing a one-year transitional period delaying the application of the AIMFD marketing regime for non-EU managers. Some other jurisdictions, such as France, have adopted much more stringent requirements to restrict marketing efforts by non-EU managers. If you are marketing to EU investors, you should carefully review the directive’s provisions as well as applicable national laws to make sure you comply with all requirements.

“Red Flag” Rules for Identity Theft Effective Date Approaching. The joint final regulations (“Regulation S-ID”) released by the SEC and CFTC requiring “financial institutions” and “creditors” regulated by those regulatory agencies to put in place programs to address identity theft risk in any “covered accounts” will go into effect November 20, 2013. The terms “financial institutions” and “creditors” include certain investment advisers, commodity pool operators, commodity trading advisers, broker-dealers and futures commission merchants. The definition of the term “covered accounts” is broad and includes brokerage accounts with a broker-dealer and margin accounts. Most importantly, to comply with the new regulations, a program must be put in place which includes reasonable policies and procedures to do the following: (1) describe relevant “red flag” situations that, if they arise, could indicate a risk of identity theft; (2) detect such red flags as they arise, (3) respond appropriately to red flags, and (4) periodically update the program. All firms should reach out to their compliance consultant or legal counsel as soon as possible to ensure adequate systems are in place to address identity theft risk by the November 20, 2013 deadline.

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

September 23, 2013 SEC “Bad Actors” Rule effective
October 21, 2013 Form CPO-PQR and CTA-PR requirements effective for CPOs and CTAs of RICs
October 21, 2013 Deadline for Harmonization Rule NFA notice filing
November 14, 2013 Deadline for Form CTA-PR quarterly filing
November 20, 2013 “Red Flag” Rule compliance deadline
December 13, 2013 IARD Preliminary Renewal Statement Due (submit payment by Dec. 10 in order for payment to post by deadline)
December 21, 2013 New Recordkeeping Requirements for FCMs, IBs, and RFEDs effective
Periodic Filings Form D and Blue Sky filings should be current

Please contact us with any questions or for assistance with any compliance, registration or planning issues on any of the above topics.


Karl Cole-Frieman & Bart Mallon


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.

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