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Regulatory Update – Mid-February

February 16, 2022
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For Investment Advisors

  • Observations from Examinations of Private Fund Advisors. The SEC’s Division of Examinations (“EXAMS”) continues to focus on private funds, evidenced by this recent Risk Alert. Common deficiencies noted by EXAMS are summarized below and covered in greater detail in a recent Foreside blog post by Royce Suba.

 

This alert follows the SEC’s June 2020 Risk Alert – Observations from Examinations of Investment Advisers to Private Funds, which as a refresher focused on a different host of common deficiencies related to (1) undisclosed conflicts regarding allocation, co-investments, and liquidity rights, (2) fee issues including expense allocations, valuation, deal fees, and operating partners, and (3) material nonpublic information and  Code of Ethics issues.   Although this alert does not take the next step to share best practices, suffice it to say that private fund managers should take a fresh look at their compliance programs to head off these common deficiencies – especially with annual review season upon us!  Contributed by Cari Hopfensperger, Senior Director.

  • Wisconsin Becomes Latest State to Adopt Continuing Ed Requirements for Investment Advisor Representatives. The Wisconsin Department of Financial Institutions will now require annual continuing education requirements for both state-registered and federal-covered investment adviser representatives.  Wisconsin marks the first state in 2022 to adopt CE requirements, which are effective January 1, 2023, and, on par with the NASAA Model Rule, require IARs to complete 12 continuing education credits annually to maintain their registration.  This brings the total number of states adopting IAR CE requirements to four, and similar rules are proposed but not yet adopted in Michigan and Nevada.  Follow along with NASAA and the states as the CE story develops – NASAA maintains its own resource page as does IARD.

CE Requirements Effective January 1, 2022

Completion of credits due Dec. 31, 2022
Maryland
Mississippi
Vermont

CE Requirements Effective January 1, 2023
Completion of credits due Dec. 31, 2023
Wisconsin

CE Requirements Proposals Pending Adoption
If adopted in 2022, requirements will be effective January 1, 2023
Michigan
Nevada

Contributed by Jaqueline Hummel, Managing Director.

For Private Funds

  • Private Fund Managers Holding More Than $200 Million in Foreign Assets Face Form SHC Filing Obligation. U.S. private fund advisors holding foreign securities may have an obligation to file a Form SHC through the Federal Reserve Bank of New York, disclosing their holdings of foreign securities.  The U.S. Treasury’s International Capital System (TIC) SHC Survey is a benchmark report and is filed every five years with the Federal Reserve Bank of New York.  U.S. end investors and custodians are required to file the report in the following two circumstances:
  • If the entity is contacted by the Federal Reserve Bank of New York requiring it to file Form SHC.
  • All U.S. resident investors holding foreign securities that exceed the reporting threshold for either Schedule 2 or 3 of Form SHC, regardless of whether they are contacted.
    • Schedule 2 threshold: fair value of reportable foreign securities held directly by the U.S. resident reporter or by a foreign-resident custodian is at least $200 million
    • Schedule 3 threshold: fair value of reportable foreign securities held by a U.S. custodian on the reporter’s behalf is a least $200 million

The due date is March 4, 2022, and covers the five-year period ending December 31, 2021.  The instructions for Form SCH are on the Treasury Department’s website.  Filers will need a Reporter Identification Number, which can be obtained by contacting FRBNY staff at 212-720-6300 or SHC.Help@ny.frb.org.

According to the Federal Reserve Bank of New York’s FAQs, the securities to be reported include “all securities issued by companies incorporated outside of the United States (including companies incorporated offshore in countries such as the Cayman Islands and Bermuda) as of the report date, even if the securities issued by entities organized outside of the U.S. or by a certain international organization.”   Contributed by Jaqueline M. Hummel, Managing Director.

For Broker-Dealers

For Commodity Pool Operators & Commodity Trading Advisors

  • NFA Also Extends Relief for Remote Inspections in 2022. Member firms must still conduct annual inspections of branch offices and guaranteed introducing brokers (IB) in 2022; however, the NFA extended its relief permitting firms to conduct these reviews remotely.  Further, Member Notice I-22-05 confirms that firms opting for remote inspections in 2022 may do the same in 2023 if their risk assessment suggests that would be appropriate.  Contributed by Cari Hopfensperger, Senior Director.

Lessons Learned 

  • SEC Rules that Investors Win in Battle over Inconsistent Documentation. A private fund advisor learned that the details matter in this case brought by the SEC challenging the firm’s fee offset practices.  Like many private equity funds, the underlying portfolio companies paid fees to the advisor and its affiliates, which, according to the private placement memorandum (PPM), were supposed to be offset against fund management fees. Long story short, the PPM and the partnership agreements were inconsistent about the treatment of partial dispositions. The PPM stated that management fees would be reduced in this situation, while the partnership agreement said no.  Ultimately, the SEC found that the firm violated Advisers Act Rule 206(4)-7, the Compliance Program Rule, and Section 206(2)’s fraud standard.  Without admitting or denying the SEC’s findings, the firm agreed to a cease-and-desist order and to pay a $4.5 million penalty.

Private fund managers should understand that the details matter, and it is crucial to ensure that the offering documents align with fund governance documents.  When developing policies and procedures around allocation and offsets of fees and expenses, firms should review both the PPM and the partnership agreement to ensure consistency.  Contributed by Andrea Penn, Senior Director.

  • No Harm but Still Foul — SEC Nit Picks Backtested Performance.  A Pennsylvania-based investment advisor learned a harsh lesson when using tear sheets with backtested performance results for one of its investment styles.  While using these tear sheets, the firm ran live portfolios with this strategy.  The SEC scrutinized the differences between the two sets of performance results and found that “the backtest and the live strategy relied on different securities when constructing a model portfolio, and a small number of the funds used in the backtest were not adequately correlated with the securities they replaced in the live strategy.”  Since the SEC did not include the degree of difference between the backtested and live performance numbers, one could assume that this difference was not that great.  Moreover, the firm was only fined $70,000, a relatively small penalty in SEC terms.

The SEC’s message to advisors is Do Not Use Backtested Performance.  Examiners will put these performance calculations under a microscope, and minor discrepancies can end up in an enforcement action.  See Les Abramovitz’s blog post, Hypothetical Performance Advertisements May Create Real Compliance Problems on this case for more details.   Contributed by Jaqueline Hummel, Managing Director.

  • SEC Takes Hard Stance on Hedge Clauses Used With Retail Clients. The SEC settled charges against a New Jersey-based RIA for various misdeeds. Still, the big headline is the finding that the limitation of liability clause (aka “hedge clause”) in the firm’s standard investment management agreement violated its fiduciary duty to its clients.  It is no secret that the SEC does not like hedge clauses since the Commission believes that such clauses may lead retail clients to think they cannot exercise their legal rights under federal or state law.

More specifically, the SEC found that the hedge clause in this case, which stated that the firm and its IARs would be liable only for their own acts of “gross negligence or willful misconduct,” misstated the liability standards under federal securities laws.  As a result, the Firm agreed to pay $375,000 in disgorgement and penalties. Foreside’s Senior Director, Les Abromovitz, provided excellent coverage of this case in this blog post, Hedge Clauses in Advisory Contracts Expose RIAs to Problems with the SEC. Contributed by Andrea Penn, Senior Director.

Worth Reading, Watching, and Hearing  

To-Do Checklists for the Month of March 2022

INVESTMENT ADVISORS

  • Form ADV Annual Updating Amendment: Existing registered advisors must update and file an amended Form ADV within 90 days of their fiscal year-end (Forms 1A and 2A). The filing fee must be deposited into the advisor’s IARD account before the filing can be submitted. The 2022 due date for advisers with a December 31 fiscal year-end is March 31, 2022. Check out the Form ADV quick reference guide here.
  • IARD Fees: SEC-registered advisers and exempt reporting advisers are required to pay IARD fees before the submission of the Form ADV annual amendment (by March 31, 2022).
  • State Filings: A registered investment adviser and an exempt reporting adviser may be required to make a state notice filing in any state in which an advisor has a specified number of clients, called “Notice Filings.” Notice filings may be made on Form ADV by checking the relevant box in Part 1A and depositing the appropriate state fees into the adviser’s IARD account. Exempt reporting advisers may also be required to register as an investment advisor in some states. Notice filing and investment advisor registration requirements differ from state to state. Each advisor should check the requirements for any relevant state in which it operates or has clients. The due date is within 90 days of the advisor’s fiscal year-end, so March 31, 2022, for firms with a December 31 fiscal year-end.

HEDGE/PRIVATE FUND ADVISORS

  • Reaffirm CPO and CTA Exemptions: Firms that claim exemptions from Commodity Pool Operator (“CPO”) registration under CFTC Rule 4.5 or CTFC Regulation 4.13(a)(3) (the “de minimis exemption”), or Rules 4.13(a)(1), 4.13(a)(2), 4.13(a)(5), and firms that claimed an exemption from Commodity Trading Adviser (“CTA”) registration pursuant to CFTC Rule 4.14(a)(8) must re-affirm those exemptions annually within 60 days of the calendar year-end – by March 1, 2022. Notice to Members 1-21-38 contain guidance related to this annual affirmation process.
  • Reminder: Firms taking advantage of Rule 4.13(a)(3) CPO exemption must represent for the annual affirmation that neither the person making the filing nor any of its principals are subject to any statutory disqualification included in Section 8a(2) of the Commodity Exchange Act, as amended (the “CEA”) (each a “Covered Statutory Disqualification”).   
  • Initial Form PF: Hedge Fund Advisors that have reached $1.5 billion regulatory assets under management (“RAUM”) attributable to hedge funds as of December 31, 2021, must make initial filing (the initial quarterly Form PF filing within 60 days of quarter end if an advisor’s hedge fund RAUM exceeds $1.5 billion as of the previous quarter-end). Due March 1, 2022.
  • Form PF for Large Hedge Fund Advisors: Large Fund Advisors must file Form PF with the SEC on the IARD system within 60 days of each fiscal quarter-end. For funds with a December 31 fiscal quarter end, Form PF is due March 1, 2022.
  • Blue Sky Filings (Form D): Advisors to private funds should review fund blue sky filings and determine whether any amended or new filings are necessary.  Generally, most states require a notice filing (“blue sky filing”) within 15 days of the first sale of interests in a fund, but state laws vary. Did you know that Foreside offers a convenient and economical blue sky filing service to help firms manage this complicated monthly task?  Give us a call to discuss your needs further.  Due March 15, 2022.
  • Exempt Reporting Advisors Form ADV Filing: Exempt Reporting Advisors (i.e., exempt private funds advisors and venture capital advisors) need to update Form ADV Part 1A within 90 days of the advisor’s fiscal year-end. Due for firms with a December 31 fiscal year-end on March 31, 2022.
  • Annual Reports for 4.7 Exempt CPOs: Exempt CPOs must electronically file audited annual reports, including statements of financial condition, statements of operations, and appropriate footnotes, for their pools with the NFA and distribute them to their investors by March 31, 2022.

BROKER-DEALERS

  • Annual Reports for the Fiscal Year-End December 31st FINRA requires that member firms submit their annual reports in electronic form. Firms must also file the report at the regional office of the SEC in which the firm has its principal place of business and the SEC’s principal office in Washington, DC. Firms registered in Arizona, Hawaii, Louisiana, or New Hampshire may have additional filing requirements. Due March 1, 2022 (Conditional 30-Day Extension may be available).
  • Supplemental Inventory Schedule (“SIS”): For the month ending January 31. The SIS must be filed by a firm that is required to file FOCUS Report Part II, FOCUS Report Part IIA, or FOGS Report Part I, with inventory positions as of the end of the FOCUS or FOGS reporting period, unless the firm has (1) a minimum dollar net capital or liquid capital requirement of less than $100,000; or (2) inventory positions consisting only of money market mutual funds. A firm with inventory positions consisting only of money market mutual funds must affirmatively indicate through the eFOCUS system that no SIS filing is required for the reporting period. Due March 1, 2022.
  • SIPC-6 Assessment: For firms with a Fiscal Year-End of July 31. SIPC members are required to file for the first half of the fiscal year a SIPC-6 General Assessment Payment Form together with the assessment owed within 30 days after the period covered. Due March 1, 2022.
  • SIPC-7 Assessment: For firms with a Fiscal Year-End of December 31. SIPC members are required to file the SIPC-7 General Assessment Reconciliation Form, together with the assessment owed (less any assessment paid with the SIPC-6) within 60 days after the Fiscal Year-End. Due March 1, 2022
  • SIPC-3 Certification of Exclusion from Membership: For firms with a Fiscal Year-End of January 31 AND claiming an exclusion from SIPC Membership under Section 78ccc(a)(2)(A) of the Securities Investor Protection Act of 1970. This annual filing is due within 30 days of the beginning of each fiscal year. Due March 1, 2022.
  • Rule 17a-5 Monthly and Fifth FOCUS Part II/IIA Filings: For the period ending February 28, 2021. For firms required to submit monthly FOCUS filings and those firms whose fiscal year-end is a date other than a calendar quarter. Due March 23, 2022.
  • Supplemental Inventory Schedule (“SIS”): For the month ending February 28. The SIS must be filed by a firm that is required to file FOCUS Report Part II, FOCUS Report Part IIA or FOGS Report Part I, with inventory positions as of the end of the FOCUS or FOGS reporting period, unless the firm has (1) a minimum dollar net capital or liquid capital requirement of less than $100,000; or (2) inventory positions consisting only of money market mutual funds. A firm with inventory positions consisting only of money market mutual funds must affirmatively indicate through the eFOCUS system that no SIS filing is required for the reporting period. Due March 28, 2022.
  • SIPC-6 Assessment: For firms with a Fiscal Year-End of August 31. SIPC members are required to file for the first half of the fiscal year a SIPC-6 General Assessment Payment Form together with the assessment owed within 30 days after the period covered. Due March 30, 2022.
  • SIPC-3 Certification of Exclusion from Membership: For firms with a Fiscal Year-End of February 28 AND claiming an exclusion from SIPC Membership under Section 78ccc(a)(2)(A) of the Securities Investor Protection Act of 1970. This annual filing is due within 30 days of the beginning of each fiscal year. Due March 31, 2022.
  • SIPC-7 Assessment: For firms with a Fiscal Year-End of January 31. SIPC members are required to file the SIPC-7 General Assessment Reconciliation Form, together with the assessment owed (less any assessment paid with the SIPC-6) within 60 days after the Fiscal Year-End. Due March 31, 2022.

REGISTERED COMMODITY POOL OPERATORS

  • Form CPO-PQR (All Schedules): Large Commodity Pool Operators are required to file Form CPO-PQR annually with the NFA by March 1, 2022.
  • CFTC Form CPO-PQR Schedule A must be filed by small CPOs (i.e., CPOs with less than $150 million in aggregated gross pool AUM as of the close of business on any business day during a calendar year), by March 31, 2022.
  • CFTC Form CPO-PQR Schedules A and B must be filed by mid-sized CPOs (at least $150 million to $1.5 billion in aggregated gross pool AUM as of the close of business on any business day during a calendar year) by March 31, 2022.
  • CPO Members must distribute an Annual Report, certified by an independent public accountant, to pool participants within 90 days of the pool’s fiscal year-end. CPOs are also required to file this report electronically with NFA using EasyFile. The filing must be made by March 31, 2022.

MUTUAL FUNDS

  • Form N-PORT Funds with a fiscal quarter end of December 31 must file Form N-PORT reporting month end information for each month-end in each fiscal quarter no later than 60 days after fiscal quarter-end. Due date is March 1, 2022. Funds must also prepare the information reported on Form N-PORT within 30 days after every month-end and retain these records, which are subject to SEC inspection.
  • Form N-MFP. Form N-MFP (Monthly Schedule of Portfolio Holdings of Money Market Funds) reports information about the fund’s holdings as of the last business day of the prior calendar month and must be filed no later than the fifth business day of each calendar month. Due date is March 7, 2022.
  • Form N-CEN. Form N-CEN reports should be filed no later than 75 days after a registered investment company’s fiscal year-end. For funds with a December 31 fiscal year-end, the due date is March 16, 2022. Note: This due date applies to all funds, except for unit investment trusts, whose Form N-CEN reports are due no later than 75 days of the calendar year-end.

 

 

 

 

This article is not a solicitation of any investment product or service to any person or entity. The content contained in this article is for informational use only and is not intended to be and is not a substitute for professional financial, tax or legal advice.