214-996-0937 | [email protected]| www.blueriverpartnersllc.com ANNUAL COMPLIANCE UPDATE REGULATORY CHANGES & HIGHLIGHTS FROM 2015 As 2015 comes to a close, we review our current regulatory climate and highlight compliance obligations for the coming year. The U.S. Securities and Exchange Commission (“SEC”) has bolstered its examination process and clarified expectations for compliance programs. This year’s Annual Compliance Update will cover (i) notable examination topics; (ii) regulatory guidance that has clarified how to fine-tune compliance programs; (iii) discussion points on how filings and the regulatory environment in general have changed; and (iv) regulatory requirements for firms in specific circumstances. We close with a cursory overview of compliance obligations for the first quarter, as well as annual obligations to keep in mind throughout the year. If you have any questions about this year’s Annual Compliance Update, please do not hesitate to contact your local Blue River representative.
As 2015 comes to a close, we review our current regulatory climate and highlight compliance obligations for the coming year. The U.S. Securities and Exchange Commission (“SEC”) has bolstered its examination process and clarified expectations for compliance programs. This year’s Annual Compliance Update will cover (i) notable examination topics; (ii) regulatory guidance that has clarified how to fine-tune compliance programs; (iii) discussion points on how filings and the regulatory environment in general have changed; and (iv) regulatory requirements for firms in specific circumstances. We close with a cursory overview of compliance obligations for the first quarter, as well as annual obligations to keep in mind throughout the year.
If you have any questions about this year’s Annual Compliance Update, please do not hesitate to contact your local Blue River representative.
1 Blue River Partners is not a law firm or CPA firm.
Contents of Annual Compliance Update I. Regulatory Examinations and Enforcement Actions ........................................................................... 2
An Examiner’s Expectation for Chief Compliance Officers ................................................................... 2
Cybersecurity Remains a Focus for the SEC in 2015 and beyond ......................................................... 2
The SEC Focuses on Adviser’s Allocation of Fees and Expenses ........................................................... 3
The CFTC Concludes its First Insider Trading Case ................................................................................ 4
Popular Hart-Scott-Rodino Act (“HSR Act”) Premerger Filing Exemption is Narrow ............................ 4
II. Notable Regulatory Guidance .............................................................................................................. 5
Personal Securities Transactions: Reporting Exception Clarified......................................................... 5
National Futures Association’s (“NFA”) Cybersecurity Interpretive Notice ......................................... 6
III. Changing Regulatory Landscape .......................................................................................................... 7
Proposal to Amend the Form ADV ........................................................................................................ 7
Changes to Insider Trading Laws........................................................................................................... 7
SEC Administrative Hearings are Put Into Question ............................................................................. 7
New IRS Rules May Influence Fund Documents and Procedures ......................................................... 8
Bureau of Economic Analysis (“BEA”) Filing Obligations are Becoming More Common for Fund Managers .............................................................................................................................................. 9
Removal of Annual Privacy Notice Requirement .................................................................................. 9
SEC Registration of Security - Based Swap Entities ............................................................................. 10
IV. Requirements Under Specific Circumstances .................................................................................... 11
Transitioning to SEC Regulation or State Registration ........................................................................ 11
CFTC Form 40 ...................................................................................................................................... 11
V. Q1 2016 Compliance Calendar ........................................................................................................... 12
VI. Annual Compliance Obligations for 2016 .......................................................................................... 13
2 Blue River Partners is not a law firm or CPA firm.
I. Regulatory Examinations and Enforcement Actions
An Examiner’s Expectation for Chief Compliance Officers
On October 14, 2015, Andrew J. Donohue, Chief of Staff of the SEC’s Office of Compliance Inspections and Examinations (“OCIE”) delivered a speech at the NRS 30th Annual Fall Investment Adviser and Broker-Dealer Compliance Conference. His speech centered on several major themes: (i) the role of a compliance professional within a firm; (ii) the role of the SEC in supporting compliance professionals; and (iii) what a CCO needs in his/her role.
In addressing the group, Mr. Donohue encouraged compliance professionals to be proactive by building comprehensive compliance programs that will keep pace in a constantly evolving marketplace.
Mr. Donohue outlined a list of attributes that, although not exhaustive, he believes are essential for Chief Compliance Officers to fulfill their role within their firms:
“First-hand knowledge of the various laws and regulations that apply to [the] firm and its activities,” as well as the “interplay of the requirements of the various regulatory regimes”;
“A deep understanding of the firm, its structure,” and internal operations and “detailed knowledge of the supervisory structure of the firm”;
“Clear understanding of how the firm identifies” and resolves all of the conflicts of interest that might exist and “how frequently potential conflicts are reviewed”;
A detailed understanding of who the clients/customers of the firm are and what products and services are being provided to them by the firm;
“Deep understanding of the compliance and other technology platforms utilized by the firm”;
“Detailed knowledge of the policies and procedures of the firm”;
“An understanding of the various markets in which the firm operates”; and
Sufficient resources devoted to compliance, which include empowering the CCO to foster a culture of compliance.
In addition to the above-enumerated necessities, Mr. Donohue also made it clear that the SEC does not expect CCOs to know everything. In fact, Mr. Donohue stated, “[i]t is very important that, as a CCO, I have an appreciation for what I don’t know or recognize when I am relying on the knowledge or expertise of others.”
Mr. Donohue’s speech echoes the OCIE’s expectations that CCO’s need to take their job seriously by spending time becoming familiar—as well as maintaining familiarity—with their firms’ compliance programs.
To see the full speech, click here.
Cybersecurity Remains a Focus for the SEC in 2015 and beyond
During 2015, the SEC issued several risk alerts and announcements signaling that cybersecurity is a compliance concern that examiners will continue to emphasize moving into 2016. For instance, in January, given the continued importance of cybersecurity and the positive response from broker-dealers and advisers on the OCIE’s efforts, the OCIE announced a focus on cybersecurity compliance and controls as part of its 2015 Examination Priorities. Then, in February, the OCIE issued a
3 Blue River Partners is not a law firm or CPA firm.
Risk Alert summarizing sweep exams conducted to analyze cybersecurity threats faced by investment advisers and broker-dealers. Subsequently, in late April, the SEC Division of Investment Management released a Guidance Update outlining cybersecurity concerns and advice for registered investment companies and registered investment advisers. Most recently, in September, the SEC issued another Risk Alert describing the OCIE’s Cybersecurity Examination Initiative, which provides additional information on areas of focus for the OCIE’s second round of cybersecurity examinations, which will involve specific testing to evaluate the effectiveness of a firm’s procedures and controls. The Risk Alert provides a sample list of information that the OCIE may review in conducting examinations of registered entities regarding cybersecurity matters. These announcements provide guidance on what your firm’s cybersecurity program should look like as we enter 2016. To read the SEC's 2015 Examination Priorities, click here. To read the SEC's February Cybersecurity Examination Sweep Summary, click here. To read the SEC's April Cybersecurity Guidance Update, click here. To read the SEC's September Risk Alert describing the Cybersecurity Examination Initiative, click here.
The SEC Focuses on Adviser’s Allocation of Fees and Expenses
The SEC stated in its annual Examination Priorities letter that it was focusing on improper fee and expense practices by private equity firms. This warning quickly manifested, and numerous firms found themselves paying sanctions and undergoing disgorgement of profits. In November 2015, the SEC found that Cherokee Investment Partners, LLC and Cherokee Advisers, LLC (collectively, “Cherokee”) breached its fiduciary duty to its private equity funds (“Funds”) in violation of the Investment Advisers Act of 1940 (“Advisers Act“) and violated other requirements under the Adviser’s Act.
Between July 2011 and March 2015, Cherokee had incurred compliance consulting fees, compliance related costs and legal expenses for: (i) investment adviser registration, (ii) legal obligations arising from registration, (iii) SEC examination preparation, and (iv) addressing an investigation triggered by the myriad of compliance issues discovered during an examination. Cherokee allocated $455,698 of these compliance costs to the Funds. The Funds’ limited partnership agreements disclosed that the Funds would be charged for expenses that in the good faith judgment of the General Partner arose out of the Funds’ operation and activities, including the legal and consulting expenses of the Funds. Nonetheless, the SEC found that Cherokee breached its fiduciary duties because Cherokee never disclosed that the Funds would also be charged for Cherokee’s legal and consulting expenses, separate and apart from the legal and consulting expenses attributable to the Funds. Further, in connection with this breach, the SEC found that Cherokee, in direct violation of the Advisers Act: (i) failed to adopt written policies or procedures reasonably designed to prevent violations of the Advisers Act arising from the allocation of expenses to the Funds, and (ii) failed to annually review the adequacy of its policies and procedures to prevent violations of the Advisers Act, the rules thereunder, and the effectiveness of their implementation. Cherokee was not the only firm subject to penalties due to past fee and expense practices. Kohlberg Kravis Roberts & Co. L.P. (“KKR”) paid approximately $30 million for allegedly failing to properly allocate broken deal expenses among its private funds and co-investors. Blackstone Management Partners LLC, Blackstone
4 Blue River Partners is not a law firm or CPA firm.
Management Partners III LLC, and Blackstone Management Partners IV LLC (collectively, “Blackstone”) agreed to pay a $39 million settlement involving claims that the firm did not fully disclose information about monitoring fees and business discounts that benefited the firm. Fenway Partners, LLC (“Fenway”) and certain owners of Fenway paid approximately $10.2 million for failing to disclose conflicts of interests related to charging fees to portfolio companies of private funds managed by the firm. Cranshire Capital Advisors, LLC, (“Cranshire”) paid $250,000 to settle claims that it improperly charged fund clients for multiple expenses not disclosed in offering and organizational documents, including payments covering compliance consultant fees. These cases reiterate the importance of (i) having written policies and procedures in place that ensure fees and expenses are properly allocated among clients especially when an adviser has co-investors or parallel “friends and family” funds, (ii) periodically reviewing such policies and procedures to ensure they adequately address compliance concerns associated with each firm’s business, and (iii) properly disclosing fee and expense practices to investors. To read the Cherokee case, click here. To read the KKR case, click here. To read the Blackstone case, click here. To read the Fenway case, click here. To read the Cranshire case, click here.
The CFTC Concludes its First Insider Trading Case
Prior to the Dodd-Frank Wall Street Reform and Consumer Protection Act (“Dodd-Frank”), the CFTC did not have the authority to pursue insider-trading allegations. However, Dodd-Frank vested the CFTC with power to promulgate anti-fraud regulations that have been broadly interpreted to include insider trading cases.
In re Motazedi, a December 2015 CTFC case, concerned the activities of Arya Motazedi, a trader for a large, publicly traded company. From September to November, Motazedi took part in 34 trades in which he used the information from his employer’s account to benefit his personal account and to the detriment of his employer’s account. He allegedly engaged in both roundtrip transactions—in which he bought and sold contracts at different prices, ultimately offsetting the transactions such that neither the employer’s account nor his account saw a net change in open positions—and front running—in which he placed orders in his personal account ahead of his employer’s account to exploit price movements from his employer’s account’s trading activity.
The CFTC concluded these activities were intentional and violated the CFTC’s anti-fraud regulations. In the end, among other penalties, Motazedi was required to pay back the entire amount of his profits, amounting to $216,955.80, as well as a civil penalty of $100,000.
For more information on this case, click here. To read the case, click here.
Popular Hart-Scott-Rodino Act (“HSR Act”) Premerger Filing Exemption is Narrow
Pursuant to the HSR Act, acquisitions of securities or assets of a company that exceed HSR thresholds trigger notification requirements to certain federal antitrust agencies as well as waiting periods prior to the acquisition—unless the acquirer avails itself of an exemption. (See below for more information on HSR thresholds.) The notice and waiting period requirements provide antitrust agencies with the ability to
5 Blue River Partners is not a law firm or CPA firm.
analyze the transaction and determine if there are any potential antitrust law violations.
In August 2015, the Federal Trade Commission (“FTC”), announced a settlement with Third Point LLC (“Third Point”) involving charges that Third Point violated the premerger notice and waiting period requirements required under the HSR Act. Third Point attempted to avail itself of the “investment-only” exemption, in which a firm is permitted to acquire the securities of another company in a quantity that exceeds the HSR threshold, but does not trigger the notice and waiting period requirements, as long as the investor “has no intention to influence the management of the target firm.” However, at the time Third Point acquired Yahoo securities exceeding the HSR threshold, it was “communicating with third parties to determine their interest in becoming a CEO or a board candidate of Yahoo,” and engaging in other activities inconsistent with investment-only intent. The FTC concluded that Third Point’s behavior demonstrated Third Point’s intention to have more than a passive interest in Yahoo when it acquired securities in Yahoo that exceeded the HSR threshold.
The FTC’s statement on the settlement demonstrates that the commonly-used investment-only exemption is extremely narrow. As a result, advisors must be aware that many activities may preclude them from relying on this exemption.
For the FTC’s statement, click here.
II. Notable Regulatory Guidance
Personal Securities Transactions: Reporting Exception Clarified
The Advisers Act requires advisers to maintain and enforce written policies and procedures reasonably designed to prevent the firm or its employees from misusing material nonpublic information. More specifically, registered investment advisers must require their directors, officers, partners, and supervised persons who have access to nonpublic information regarding securities transactions (together “Access Persons”) to report their personal securities holdings and transactions. However, reporting requirements do not apply when an Access Person’s securities are held in accounts over which he or she had “no direct or indirect influence or control” (the “Reporting Exception”). This guidance was issued because the OCIE has encountered situations in which advisers have maintained that certain trusts qualify for the Reporting Exception. These advisers have asserted that these types of trusts and discretionary accounts are similar to a blind trust in terms of an Access Person’s influence or control. (The SEC indicated that blind trusts, for example, can be established where an Access Person would have no direct or indirect influence or control.) In the guidance, the SEC unequivocally stated “that the fact that an [A]ccess [P]erson provides a trustee with management authority over a trust for which he or she is grantor or beneficiary, or provides a third-party manager discretionary investment authority over his or her personal account, by itself, is insufficient for an adviser to reasonably believe that the [A]ccess [P]erson had no direct or indirect influence or control over the trust or account for purposes of relying on the [R]eporting [E]xception.” Therefore, it is incumbent on advisers to determine whether an Access Person had direct or indirect influence or control over a particular account before relying on the Reporting Exception. Advisers need to ask whether Access Persons can (i) propose specific purchases or sales of investments to the trustee or third-party manager, (ii) direct specific purchases or sales of investments, or (iii) consult with the trustee
6 Blue River Partners is not a law firm or CPA firm.
or third-party discretionary manager as to the allocation of investments made in the Access Person’s account. To read the Reporting Exception guidance, click here.
National Futures Association’s (“NFA”) Cybersecurity Interpretive Notice
In August 2015, the NFA adopted the Cybersecurity Interpretive Notice, which requires each NFA Member (“Member”) to adopt and enforce an Information Systems Security Program (“ISSP”) appropriate to its circumstances by March 1, 2016. The Cybersecurity Interpretive Notice requires an ISSP to cover several key areas, similar to those addressed in guidance issued by other regulators such as the SEC (as discussed above): (i) a security and risk analysis (including risks posed by critical third-party service providers); (ii) a description of the safeguards against identified system threats and vulnerabilities; (iii) the process used to evaluate the nature of a detected security event, understand its potential impact, and take appropriate measures to contain and mitigate the breach; and (iv) a description of the Member's ongoing education and training related to information systems security for all appropriate personnel. Further, the ISSP must be approved by an executive-level firm official and the effectiveness of the ISSP must be monitored and regularly reviewed (i.e., at least every 12 months) and adjustments made as needed. Members must also provide employees upon hiring, and periodically during their employment, with cybersecurity training that is appropriate to the security risks the Member faces. In order to develop and adopt an appropriate ISSP, the notice offers several resources for Members to consider. And, although the NFA does not require Members to utilize any of the resources listed, the NFA expects each Member to use a formal process that it can demonstrate was used to develop an ISSP appropriate for the Member’s business. The NFA expects to dedicate appropriate resources, such as providing additional guidance, to assist Members in this process. As a result, keep an eye out for additional resources and guidance on the expectations of the NFA with regard to ISSPs. To see the NFA Cybersecurity Interpretive Notice, click here.
Revised HSR Antitrust Thresholds
Effective February 20, 2015, the FTC has completed its annual adjustments to the filing thresholds under the HSR Act. The new, higher thresholds apply to all transactions which close on or after this date, but before the next round of adjustments take effect in early 2016. The most significant threshold in determining reportability is the minimum size of transaction threshold. This is often referred to as the “$50 million (as adjusted)” threshold because it started at $50 million and is now adjusted annually. For 2015, that threshold will be $76.3 million. For more information on the current thresholds, click here.
7 Blue River Partners is not a law firm or CPA firm.
III. Changing Regulatory Landscape
Proposal to Amend the Form ADV
The ADV is an adviser’s primary disclosure document and is used by the OCIE to prepare for, conduct, and implement risk-based examination programs for investment advisers. The data in Form ADVs is also used as a source for examiners during examinations, investigations, and enforcement actions. The SEC aggregates data obtained through ADVs to obtain census data and monitor industry trends, which is used to inform the SEC’s regulatory program and assess emerging risks. The SEC has proposed amendments to the ADV in three primary areas: (i) fill certain data gaps and enhance current reporting requirements (for example, “[t]he proposed amendments to Form ADV would require an adviser to provide certain aggregate information on separately managed accounts it advises, including information on regulatory assets under management, investments and use of derivatives and borrowings”) (ii) amendments to modify the use of “umbrella registration” for private fund advisers; and (iii) clarify technical and other amendments to existing items and instructions. As the ADV adapts over time, fund managers must stay cognizant of these changes to ensure proper disclosures are made. To read the full proposal, click here.
Changes to Insider Trading Laws
In December 2014, the United States Court of Appeals for the Second Circuit overturned multiple, high-profile insider trading convictions. In doing so, it imposed greater limits on the government when prosecuting alleged insider traders by further defining the boundaries that delineate whether an actor willfully participated in insider trading activity. For instance, to succeed in obtaining an insider trading conviction in the Second Circuit based on an allegation of “tipping,” prosecutors must identify a benefit received by the tipper, and this benefit must now be tangible, as opposed to something as simple as friendship among the tipper and the tippee. This change in standards has impacted other cases, including the recent dismissal of charges against former SAC Capital Advisors LP employee, Michael Steinberg, as well as the charges against six other insider trading defendants who were cooperating witnesses in the Steinberg case.
However, it is important to note that this area of law remains unsettled. The Seventh and Ninth Circuits have not embraced the heightened standard, and the U.S. Supreme Court has yet to grant certiorari to resolve the issue.
To read the Second Circuit case, United States v. Newman and Chiasson, click here. To read the petitions for certiorari, click here.
SEC Administrative Hearings are Put Into Question
Pursuant to power granted to the SEC under the Dodd-Frank Wall Street Reform and Consumer Protection Act, the SEC has granted internal administrative law judges the power to carry-out proceedings against individuals who are perceived to be violating, have violated, or are about to violate certain securities laws. Much of the logic behind this system is rooted in the expertise and sophistication of the administrative law judges, which allows them to understand complicated securities-related issues. These administrative law judges have been active. In the SEC’s 2015 fiscal year, its administrative law judges issued 207 initial
8 Blue River Partners is not a law firm or CPA firm.
decisions, held by 27 hearings, and ordered over $20 million in civil penalties with over $12 million in disgorgement.
However, the legitimacy of the SEC’s administrative hearings are being brought into question. In both June and November, Judge May of the Northern District of Georgia placed preliminary injunctions on SEC enforcement actions against firms, holding that the U.S. Constitution’s Appointments Clause likely bars the SEC from operating a court system that hires its own judges. Furthermore, administrative hearings have been criticized for numerous reasons including limited discovery rights, lack of a jury trial, and most notably—as illustrated by Judge May’s order—the plaintiff employing the judge. However, this landscape may change, and the SEC responded to this criticism by proposing amendments that would enact procedural changes, including providing additional time for discovery practices.
To read the proposed changes by the SEC, click here. To read Judge May’s June order, click here. To read Judge May’s November order, click here.
New IRS Rules May Influence Fund Documents and Procedures
The Bipartisan Budget Act of 2015 (the “Act”), which became law in November, modified future audit procedures for partnerships followed by the IRS. These changes may require fund managers to modify their fund documents before these procedures come into effect on December 31, 2017.
Under current law, partnerships are not taxed at the partnership level and instead taxed at the partner level. However, the Act replaced the partnership audit rules and, as a result, unless an election is available, the new rules will require the determination, assessment, and collection of tax liabilities at the partnership level. Two elections that permit election out of partnership level liability are: (i) the opt-out election (which may apply if a partnership has 100 or fewer partners) or (ii) the pass-through election (also known as Section 6226 election). The opt-out election is unavailable to partnerships containing investors that are partnerships or trusts, and since most private equity and hedge funds have at least one partnership or trust as an investor, the opt-out election is likely unavailable.
Because of the varying ownership interests at the fund level, the pass-through election will likely be preferable. However, it is important to note that when a partnership uses the pass-through election, the interest rate due to underpayment is 2% higher than the interest rate imposed on those who opt-out or those who do not use any election. As a result, the fund documents should include language to determine if these elections will be made. If neither election is used, an indemnification clause should be included to have the partner and/or former partners indemnify the partnership for the applicable shares of any tax liabilities imposed as a result of the new partnership audit rules.
Additionally, the “Tax Matters Partner” concept—in which one partner is appointed to be responsible for representing the partnership in the case of an IRS audit—will be replaced with a concept of a “Partnership Representative.” The Partnership Representative will have absolute authority to act for the partnership in the case of an IRS audit, with the notable difference that the Partnership Representative is not required to be a partner of the partnership, and instead only needs to have a “substantial presence in the United States.” This is a favorable change for private equity and hedge funds since it allows non-partners, such as management companies, to represent the partnership. However, the new partnership audit rules eliminate the right of the partners to participate or receive notices related to any IRS partnership tax audits. Therefore, fund documents will need to replace “Tax Matters Partner” with “Partnership Representative” and include a clause to provide both notice to and consent from partners prior to binding the partnership.
9 Blue River Partners is not a law firm or CPA firm.
Since there is still time before the Act comes into effect and there is a significant amount of uncertainty involving implementation of the Act (e.g., what is behind the meaning of a “substantial presence in the United States”?), fund managers have time to determine how to best modify their procedures and documents.
For the full text of the Bipartisan Budget Act of 2015, click here.
Bureau of Economic Analysis (“BEA”) Filing Obligations are Becoming More Common for Fund Managers
In the past, advisers were not obligated to make many BEA filings unless they were contacted by the BEA. Certain filings, such as the BE-15, still maintain this requirement. However, the requirements for several BEA filings, including the BE-13 and BE-180 filings, now impose filing obligations on advisers that meet certain thresholds, regardless of whether the adviser was contacted by the BEA.
In general, a BE-13 filing obligation may be triggered when a U.S. entity is linked to a transaction involving a foreign entity’s ownership in a U.S. entity. Additionally, a BE-180 filing obligation may be required when a U.S. financial services provider (including an investment advisor) provides financial services to foreign entities that exceed specific monetary thresholds.
This change is consequential since, as a bureau of the U.S. Department of Commerce, the BEA can impose civil and criminal penalties for failure to file, ranging from significant fines to imprisonment. As a result, it is important for fund managers to stay aware of BEA filings and analyze whether their activities may have triggered a filing obligation.
For more information on the BE-13 and BE-15 filing, click here. For more information on the BE-180 filing, click here.
Removal of Annual Privacy Notice Requirement
Pursuant to Regulation S-P, investment advisers registered with the SEC are required to distribute privacy policy notices upon establishing a customer relationship and on at least an annual basis.
In an effort to reduce costs for financial institutions, in December 2015, the Gramm-Leach-Bliley Act was modified to create an exception to the annual privacy notice requirement required under Regulation S-P. This is referred to as the “Privacy Notice Modernization Act of 2015.”
An investment adviser is exempt if it: (i) “provides nonpublic personal information only in accordance with specified requirements,” (ii) “has not changed its policies and practices with respect to disclosing nonpublic personal information from those disclosed in the most recent disclosure sent to consumers,” and (iii) “otherwise provides customers access to such most recent disclosure in electronic or other form permitted by specified regulations.”
Investment advisers that meet the requirements above can benefit from the exception and should change their annual distribution procedures accordingly.
For more information on the Privacy Notice Modernization Act of 2015, click here.
10 Blue River Partners is not a law firm or CPA firm.
SEC Registration of Security - Based Swap Entities
In August 2015, the SEC adopted final registration rules (with an effective date of October 13, 2015) for security-based swap dealers1 and major security-based swap participants2 (collectively, “SBS Entities”). The new rules address all components of SBS Entity registration, including the extensive information that must be provided and kept up-to-date. In addition, the rules require senior officers to make certifications about the SBS Entity’s policies and procedures for compliance with the federal securities laws at the time of registration. The SEC established a “Compliance Date” that is the latest of: (1) six months after the date of publication in the Federal Register of a final rule release adopting rules establishing capital, margin, and segregation requirements for SBS Entities; (2) the compliance date of final rules establishing recordkeeping and reporting obligations for SBS Entities; (3) the compliance date of final rules establishing business conduct requirements for SBS Entities under the Securities & Exchange Act of 1934; or (4) the compliance date for final rules establishing a process for a SBS Entity to make an application to the SEC to permit an associated person, who is subject to a statutory disqualification, to effect or be involved in effecting security-based swaps on its behalf. Therefore, firms that have engaged in security-based swap business will need to determine whether they are required to register as SBS Entity based on security-based swap dealing activity and positions; however, firms are not required to begin calculating whether their activities meet or exceed the thresholds until two months prior to the Compliance Date (which is referred to as the “Counting Date”) As of the writing of this Annual Update, the Compliance Date is unspecified, as four factors set forth in the rule release have not been established. Therefore, in 2016, firms that are likely subject to these rules need to be mindful of related SEC Rule Releases. To see the SEC Press Release, click here. To see the Federal Register, click here.
Currently, most investment advisers are not subject to the same AML regime as banks, broker dealers, and other financial institutions. However, on August 25, 2015, FinCEN proposed a rule that would subject investment advisers that are registered with the SEC to greater AML requirements, and provided that compliance with these requirements would be examined by the SEC.
1 Section 1a(49) of the Commodity Exchange Act defines, in general, a swap dealer as a person (which includes entities) that: holds itself out as a dealer in swaps; makes a market in swaps; regularly enters into swaps with counterparties as an ordinary course of business for its own account; or engages in any activity causing the entity to be commonly known in the trade as a dealer or market maker in swaps. An insured depository institution that enters into a swap with a customer in connection with originating a loan with that customer is not considered to be a swap dealer. 2 Section 1a(33) of the Commodity Exchange Act defines, in general, a major swap participant as a person (which includes entities) that is not an swap dealer and: maintains a substantial position in swaps for any of the major swap categories (with certain hedging and benefit plan exclusions); whose outstanding swaps create substantial counterparty exposure that could have serious adverse effects on the financial stability of the US banking system or financial markets; or is a financial entity that is highly leveraged relative to the amount of capital it holds and that is not subject to capital requirements established by an appropriate federal banking agency and maintains a substantial position in outstanding swaps in any major category as determined by the CFTC.
11 Blue River Partners is not a law firm or CPA firm.
FinCEN justifies increasing the AML standards by pointing-out that “[i]nvestment advisers are on the front lines of a multi-trillion dollar sector” and this creates the opportunity for clients that are money launderering to “move or stash dirty money.” The new proposal is aimed at alleviating concerns that money launderers view investment advisers as a low-risk method to enter the U.S. financial system.
Firms should stay aware of updates to AML policies, as these proposed changes may lead to significant administrative burdens once enacted.
For more information on FinCEN’s proposal, click here. To read the proposal itself, click here.
IV. Requirements Under Specific Circumstances
Transitioning to SEC Regulation or State Registration
SEC Registration. Registered investment advisers who no longer qualify for SEC registration as of the time of filing the annual amendment must withdraw from SEC registration within 180 days after the end of their fiscal year by filing Form ADV-W and should consult their state securities authorities to determine whether they are required to register in one or more states in which they conduct business. In contrast, state registered advisers who are required to register with the SEC as of the end of their fiscal year must register with the SEC within 90 days of filing the annual amendment.
Exempt Reporting Advisers. Firms or individuals 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 within 90 days after the filing of the annual amendment.
CFTC Form 40
Firms who maintain large positions in certain futures instruments will need to be aware of the speculative position limits with respect to these instruments. In the event a position reaches a certain level, the CFTC will request more information about the position from firm. For firms which are registered CPOs or CTAs, the CFTC may send a request for the manager to complete and file a Form 40 – Statement of Reporting Trader.
12 Blue River Partners is not a law firm or CPA firm.
V. Q1 2016 Compliance Calendar
As you plan the coming months, please keep the following regulatory dates in mind:
Date Compliance Obligation
First week of January Review assets/holdings as of December 31, 2015 to determine filing requirements such as SEC Registration and/or Form PF.
January 4, 2016 IARD Final Renewal Statements become available and are due on January 18, 2016.
February 1, 2016 Annual Securities Holding Reports due from Access Persons.
February 15, 2016 Fourth Quarter CTA-PR Due.
February 15, 2016 Schedule 13G Update Due. Form 13F Due. Form 13H “Large Trader” Amendment Due.
February 29, 2016 Deadline for Annual Re-Affirmation of Commodity Futures Trading Commission (“CFTC”) Exemptions.
March 31, 2016 Form ADV Annual Updating Amendments Due. Once filed, registered investment advisers are required to deliver annually to certain clients (1) a summary of material changes to the brochure (Part 2A) and offer to provide the client with the updated brochure upon request or (2) deliver a complete updated brochure. In addition, registered advisers should also provide any updated Part 2B brochure supplements, as required in the form instructions. Fourth Quarter CPO-PQR Due. CPOs are required to submit to the NFA through the NFA's EasyFile system, and distribute to current participants, a certified Annual Report for each pool as of the close of the pool's fiscal year no later than March 31, 2016 (for a pool with a fiscal year-end of December 31).
Please keep in mind, this list is not exhaustive.
13 Blue River Partners is not a law firm or CPA firm.
VI. Annual Compliance Obligations for 2016
Activity Description
Annual Review of Compliance Policies and Procedures
Pursuant to the Advisers Act, registered investment advisers are required to complete an annual review of their compliance policies and procedures and the review must evaluate the adequacy of the compliance policies and procedures and the effectiveness of their implementation.
Annual Compliance Certifications
Year-end employee certifications covering such items as compliance with the firm’s Code of Ethics and various policies and procedures, disclosure of brokerage accounts and political contributions, and disclosure or affirmation of any outside business activities should be ready to distribute to employees no later than mid-January to ensure that there is adequate time to have them completed by February 1, 2016.
Felon and Bad Actor Re-certification
Fund managers are required to determine whether they are subject to the bad actor disqualification any time they are offering or selling securities in reliance on SEC Rule 506. If a fund offering is continuous, issuers must update their factual inquiry periodically. This is generally done through representations, questionnaires, certifications, negative consent letters, or periodic re-checking of public databases.
CPOs’ Annual Certification pursuant to NFA Bylaw 1101
Registered CPOs whose CPO responsibilities for a particular pool are delegated to them by another CPO are referred to as “Delegated CPOs.” In order to ensure that the BASIC system reflects the delegation, CPOs are now required to indicate the same in NFA's EasyFile system when filing a pool's annual financial statement.
NFA’s Annual Self-Examination Questionnaire, Annual Registration, and Payment of Dues
Similar to investment advisers, registered CPOs and commodity trading advisers (“CTAs”) are subject to various annual and ongoing compliance obligations. Requirements include completing an updated Self-Examination Questionnaire, payment of annual NFA dues on or before the anniversary date that the CPO’s or CTA’s registration became effective, and updates to registration information on the firm, as well as its Associated Persons and Principals once it becomes stale.
Distribution of Annual Audited Financials
The Advisers Act sets forth extensive requirements for investment advisers who have possession or custody of client funds or securities. The purpose of the rule is to protect client funds and securities from fraud or other abuse by investment advisers. Advisers to pooled investment vehicles may avoid both the quarterly statements and surprise examination requirements by having audited financial statements prepared in accordance with GAAP by an independent public accountant registered with the Public Company Accounting Oversight Board and distributed to fund investors within 120 days after the fund's fiscal year end.
14 Blue River Partners is not a law firm or CPA firm.
Annual Delivery of Privacy Notices
Investment advisers (whether registered or not) and CPOs and CTAs (whether registered or not) are subject to SEC and/or CFTC regulations governing the privacy of certain client confidential information. As such, these investment advisers are required to deliver a privacy notice, along with fund subscription materials, to each new investor and update the policy notice as necessary. Additionally, a privacy notice must be distributed at least once during each 12-month period to each client (assuming the exception under the Privacy Notice Modernization Act of 2015 does not apply).
Annual Confirmation of Investor Eligibility to Participate in New Issues (FINRA Rules 5130 and 5131)
Trading firms will require certain annual representations from investment advisers with respect to how they allocate profits from new issue investments. In order to accurately make any such representations, investment advisers that trade in new issues should obtain annual certifications from all of their investors regarding their status as either a “restricted person” under Rule 5130 or a “covered person” under Rule 5131.
Form D and State Notice Filings
To protect your funds' private placement exemption, a Form D must be filed with the SEC and the state regulator within 15 days of the initial sale of its securities. If a Form D was filed on or after September 15, 2008 and is subject to an ongoing offering, it must be amended annually. In contrast to the annual renewal requirements of the Form D filed with the SEC, a state blue sky notice filing is generally a one-time filing made at the time of the first sale by a private fund (whether a U.S. or non-U.S. private fund) in a state to any U.S. taxable or U.S. tax-exempt investor. However, there are a handful of states that have an annual renewal requirement.
Form PF, Form CPO-PQR and Form CTA-PR
Investment advisers registered with the SEC that manage at least $150 million in private fund assets as of December 31 must periodically file a Form PF with the SEC or in some cases with the CFTC. Investment advisers are required to file Form PF either (i) on an annual basis within 120 days of the end of the manager’s fiscal year or (ii) on a quarterly basis within 60 days of the end of the calendar quarter. Form CPO-PQR and Form CTA-PR require a description of the amount of assets under management, use of leverage, counterparty credit exposure and trading and investment positions for each pool advised. These forms are analogous to the Form PF. Therefore, because a large percentage of the information is duplicative of Form PF, CPOs and CTAs to private funds that file Form PF may not be required to file certain information for the pools reported on Form PF.
Please keep in mind, this list is not exhaustive.
15 Blue River Partners is not a law firm or CPA firm.
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Disclaimer: This publication is intended to inform readers about general matters of current interest in the investment management industry and is for informational purposes only. This communication is not intended, and should not be construed, as legal, tax, public accounting, or auditing advice or opinions. Readers should consult their legal counsel, accountants, and/or tax advisors prior to making any decisions or taking any action (including refraining from certain actions) concerning the matters discussed in this communication.
Blue River Partners, LLC provides a variety of outsourced solutions to Hedge Funds, Private Equity Firms, Registered and Exempt Investment Advisers (IAs), Registered Investment Companies (RICs), Commodity Pool Operators (CPOs), Fund of Funds, Family Offices, and others across the entire spectrum of structures, strategies, and asset classes.
Regulatory Compliance Program Design, Implementation, and Ongoing Management
CFO Back-Office Operational Services
Fund Launch Management and Consulting
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Accounting/CFO/Controller Services for Private Equity Portfolio Companies and Portfolio Assets
Private Equity Tax Advisory & Compliance Services Headquartered in Dallas, with satellite offices in Houston, New York, Chicago, and San Francisco; Blue River is predominantly comprised of experienced Attorneys and CPAs at the management level who have joined us from their prior roles as CCOs, CFOs, COOs, and General Counsel at numerous large and complex alternative and traditional investment entities. To see information about senior management of Blue River Partners, please click here.
