As we turn the page on 2021, we would like to highlight the following legal, regulatory and business matters that may affect you or your clients heading into the new year. As always, feel free to reach out to us should you have any questions.
Investment Advisers and Exempt Reporting Advisers
Annual Amendment of Form ADV. Each registered investment adviser (RIA) and exempt reporting adviser (ERA) must file an annual updated amendment to its Form ADV. The annual amendment must be filed within 90 days of the adviser’s fiscal year-end.
Each RIA should also provide to each client an updated Form ADV Part 2A brochure and a summary of material changes to the brochure, if any (or simply a summary of material changes, if any, accompanied by an offer to provide the updated brochure).
Investment Adviser Registration Depository (IARD) Renewal Fees. Annual renewal fees for Securities and Exchange Commission (SEC) and state RIAs, as well as SEC ERAs, were due to the IARD by December 13, 2021. Please visit www.iard.com for more information.
Form PF. An investment adviser must file Form PF if it (i) is registered or required to be registered with the SEC; (ii) advises one or more private funds; and (iii) has at least $150 million in private fund assets under management. Investment advisers must file Form PF on an annual basis within 120 days of the fund’s fiscal year-end.
Form 13H Amendments. All large traders who have made a Form 13H filing with the SEC are required to submit an annual filing within 45 days of the end of each calendar year.
New Rules for New York Investment Adviser Representatives. Prior to February 1, 2021, New York did not require investment adviser representatives, principals, supervisors or solicitors (IARs) to register with the state. Effective as of February 1, 2021, IARs representing a New York RIA or SEC RIA with a New York place of business are required to register. Absent a waiver, IARs must either pass the Series 65 exam or a combination of the Series 7 and Series 66 exams within 2 years prior to filing for registration. IARs were generally required to register by August 31, 2021, absent certain exemptions.
SEC Increases Qualified Client Thresholds. On June 17, 2021, the SEC adopted amendments to the definition of “qualified client” under the Securities Act of 1933. The amendments increased the dollar amount thresholds for the “assets-under-management” test and the “net worth” test, respectively, from $1 million to $1.1 million and from $2.1 million to $2.2 million. Adjustments to the net worth and assets-under-management thresholds are made every five years to account for inflation.
The amendments became effective on August 16, 2021, and do not apply retroactively to contractual relationships entered prior to the effective date. Advisers to separately managed accounts and/or private funds relying on Section 3(c)(1) of the Investment Company Act of 1940 should review and update their investment advisory contracts and/or offering documents to reflect the new thresholds. Further details regarding the amendments can be found here.
SEC Adopts Modernized Marketing Rule for Investment Advisers. On December 22, 2020, the SEC adopted amendments to Rule 206(4)-1 under the Advisers Act to create a single, consolidated rule (Marketing Rule) that replaced separate advertising and cash solicitation rules. The Marketing Rule represents a significant overhaul of adviser marketing rules with a stated goal of shifting to “principles-based provisions designed to accommodate the continual evolution and interplay of technology and advice.” Among other changes, the Marketing Rule: (i) expands the scope of which communications, materials and activities are considered “advertisements”; (ii) replaces the per se violations of the Advisers Act with a more flexible, principles-based approach (potentially granting advisers the ability to use marketing materials in certain circumstances that include specific recommendations, testimonials, third-party ratings, etc.); and (iii) allows the use of hyperlinks and layered disclosures under certain conditions.
Advisers should reevaluate all methods by which they currently communicate with current and prospective clients, including their current marketing materials, solicitation arrangements, recordkeeping practices and social media policies. The Marketing Rule became effective on May 4, 2021, but advisers have until November 4, 2022, to comply with the new rule. More information regarding the Marketing Rule and the current transition period can be found here.
Commodity Trading Advisors and Commodity Pool Operators
Annual Reaffirmation of CPO Exemption. Commodity pool operators (CPOs) and commodity trading advisors (CTAs) relying on an exemption from registration with the Commodity Futures Trading Commission (CFTC) are required to reaffirm their exemption eligibility within 60 days of the calendar year-end.
Forms CPO-PQR and CTA-PR. Registered CPOs and CTAs must file Form CPO-PQR and Form CTA-PR, respectively, using the NFA’s EasyFile system. Registered CPOs must file Form CPO-PQR on a quarterly basis within 60 days of the quarters ending in March, June, and September, and within 90 days of the calendar year-end. Registered CTAs must file Form CTA-PR on a quarterly basis within 45 days of each quarter-end.
Advisers that are dually registered with the SEC and the CFTC may satisfy certain Form CPO-PQR filing requirements when they file Form PF. In order to take advantage of this, such advisers must file Form PF by the Form CPO-PQR deadline.
CPO and CTA Annual Report Updates. Registered CPOs, including CPOs utilizing the CFTC Regulation 4.7 exemption, must distribute an Annual Report to each participant in each pool that they operate, as well as submit a copy of the Annual Report and key financial balances to the National Futures Association (NFA), within 90 days of the pool’s fiscal year-end. An independent certified public accountant must certify the Annual Report.
CPOs should also check the date of the most recent disclosure document of each pool they operate. CPOs are generally prohibited from soliciting clients with a disclosure document that is more than 12 months old.
CFTC and NFA Matters
Changes to Form CPO-PQR. As of the March 31, 2021, reporting date, the CFTC has revised and streamlined Form CPO-PQR. The revised Form CPO-PQR now has one schedule (Schedule A), and all reporting CPOs must file the revised Form CPO-PQR every quarter, regardless of size. The CFTC has also attempted to make the form more user-friendly.
CFTC Establishes Climate Risk Unit. On March 17, 2021, Acting CFTC Chairman Rostin Behnam announced the establishment of the Climate Risk Unit (CRU). The CRU will assess the efficacy of derivatives products in addressing climate-related risks in the financial system. As part of its mission, the CRU will represent the CFTC in industry discussions to reduce carbon emissions worldwide. The CRU also intends to facilitate dialogue regarding emerging climate risks, aid in the development of new “net-zero” products, support development of climate-related market risk data and evaluate effectiveness of other tools in accelerating products and services that promote climate-friendly practices.
New Notice Requirements for CPOs. Effective as of June 30, 2021, CPOs are subject to newly adopted NFA Compliance Rule 2-50 (Rule 2-50). Rule 2-50 requires CPOs to report the following occurrences to the NFA with respect to each commodity pool they operate: (i) the inability to fulfill its obligations to investors or an unplanned liquidation of the pool; (ii) the inability to meet margin calls; (iii) the inability to make redemptions in accordance with subscription agreements; (iv) freezing redemptions in preparation for ceasing operations; and (v) receiving notice from a counterparty that the pool is in default. All pools operated by a CPO—including pools relying on the CFTC Regulation 4.13(a)(3) de minimis exemption—are subject to Rule 2-50. The NFA released Interpretive Notice 9080 to provide examples of when notice is not required (e.g., if a CPO reasonably expects to meet the margin call within the time prescribed by its Futures Commission Merchant (FCM)).
NFA Updates Branch Office Inspection Requirement and Physical Examination Requirement. In light of the pandemic, the NFA released a notice to allow Members who were temporarily working from home to exempt their home office from the definition of a “branch office.” The notice, released in March 2021, was made permanent starting September 23, 2021. In NFA Interpretive Notice 9002, the definition of a “branch office” was revised to exclude “any location where one or more associated persons (APs) from the same household live or rent/lease (e.g., a shared or co-workspace).”
The exemption for home offices was not the only change caused by the pandemic. Through the end of 2021, Members are allowed to conduct their annual inspection of each branch office remotely. While the annual inspection is still required, the ability to do so virtually is in line with current public health policies. The NFA will also allow Members to conduct virtual inspections of branch offices in 2022, if appropriate given applicable risks.
Financial Industry Regulatory Authority (FINRA) Matters
FINRA Amends Rules 5122 and 5123 to Include Retail Communications. Effective October 1, 2021, FINRA amended Rules 5122 and 5123 to expand the filing requirements of broker dealers. Under the previous versions of the rules, member firms were required to file any private placement memorandum (PPM), term sheet or other offering documents used in connection with a private placement offering. Under the amended rules, such firms are also required to file any “retail communications” used in connection with private placement offerings (e.g., pitchbooks, slide presentations, fact sheets). The amended rules effectively formalize a common practice—most broker dealers have historically filed such retail communications simultaneously alongside the required PPMs or term sheets.
Digital Assets Matters
El Salvador Adopts Bitcoin as Legal Tender. On September 7, 2021, EL Salvador became the first country to adopt Bitcoin as legal tender. With the change, each company in El Salvador became required to accept Bitcoin as payment, and each citizen was gifted $30 in Bitcoin for utilizing the government’s e-wallet. President Nayib Bukele hoped the adoption of Bitcoin would stimulate the country’s economy in part by reducing transaction costs and increasing efficiency in international transactions. El Salvador remains the only country to adopt such a policy.
Rulemaking Petition Sent to SEC on Non-Fungible Tokens (NFTs). On April 12, 2021, Arkonis Capital, a registered broker dealer, submitted a rulemaking petition to the SEC requesting guidance on NFTs. In the petition, Arkonis posits scenarios under which an NFT may be deemed a “security”. They also argue that if an NFT relates to an existing asset and is marketed as a collectible with a public assurance of authenticity on the blockchain, it should not be considered a security.
Arkonis further states that should the SEC deem an NFT to be a security, the platform facilitating the sale and/or trading of such NFT could be required to register with the SEC as an exchange. Given these regulatory implications, Arkonis petitioned the SEC to publish guidance regarding when an NFT is a security and the resulting registration requirements. As of December 2021, the SEC has not released the requested guidance.
SEC Chair Gensler Discusses the Regulation of Cryptocurrency Under Existing Authorities. On September 14, 2021, Gary Gensler, the SEC Chair, testified before the Senate Banking Committee regarding the SEC’s authority to regulate the cryptocurrency market. During the testimony, Gensler responded to questions about gaps in the current regulatory regime by stating the SEC and the CFTC have “a great deal of authority” with regard to digital assets and “a great deal of clarity” in determining which digital assets meet the definition of a security. The gaps, he clarified, exist in the coordination amongst the different regulatory agencies—specifically, the SEC, the CFTC and the banking agencies.
Gensler also testified in October before the House Committee on Financial Services regarding cryptocurrency regulation. When asked about whether certain cryptocurrencies are securities, Gensler declined to comment on any specific token and reiterated that any token that passes the Howey Test is a security. Specifically, he stated “[T]he securities laws are quite clear. If you’re raising money from somebody else, and the investing public has a reasonable anticipation of profits based on the efforts of others, that fits within the securities law.”
First Bitcoin Futures ETF Launches. On October 18, 2021, ProShares launched the Bitcoin Strategy ETF, the first Bitcoin-focused exchange traded fund listed on a national exchange. Trading under “BITO”, the fund does not directly invest in Bitcoin but provides exposure to Bitcoin futures contracts. As of November 11, 2021, BITO had net assets of over $1.4 billion. Two other national Bitcoin futures ETFs launched shortly after the launch of BITO.
SEC Rejects Spot Bitcoin ETF. On November 12, 2021, the SEC rejected a proposed rule change to list shares of the VanEck Bitcoin Trust on the Cboe BZX Exchange. In its rejection, the SEC stated that the exchange did not meet its burden as a national securities exchange under the Securities Exchange Act of 1934 “to prevent fraudulent and manipulative acts and practices” and “to protect investors and the public interest.” The ruling is consistent with past statements from SEC Chair Gensler and other SEC actions demonstrating a preference for Bitcoin futures ETFs over spot Bitcoin ETFs.
Coinbase Files for Futures and Derivatives Trading. On September 16, 2021, Coinbase confirmed that it filed an application with the NFA to register as an FCM. As an FCM, Coinbase would be able to offer cryptocurrency futures and derivatives trading to U.S. persons on its platform. The application is still pending.
Ripple Lawsuit. In December 2020, the SEC sued Ripple Labs Inc. and two of its executives for allegedly conducting a $1.3 billion unregistered securities offering for XRP, its token. The SEC claims that XRP is a security because it was distributed by Ripple in a centralized manner and represents an investment in the company. Ripple disputes these claims, asserting that the SEC failed to release proper guidance on digital asset regulation and is attempting to utilize an outdated regulatory scheme on a novel industry. The Ripple case is ongoing, and its outcome could significantly affect the digital asset industry in the U.S.
SEC Fines Poloniex for Operating Unregistered Digital Asset Exchange. On August 9, 2021, the SEC announced that Poloniex LLC agreed to pay more than $10 million to settle charges of operating an unregistered digital asset exchange. The order states that Poloniex’s platform facilitated buying and selling digital assets, including digital assets that met the definition of a security. While operating the exchange, Poloniex instituted an internal review mechanism where it determined how likely certain digital assets were to be deemed securities. However, the SEC stated that Poloniex offered the ability to trade digital assets that were at “medium risk” under Poloniex’s policy and, as a result, certain digital assets meeting the definition of a security were available to trade on the platform. This case reinforces the SEC’s authority over the digital asset industry, but the SEC did not go into detail on which specific digital assets met the definition of a security.
CFTC Fines Kraken for Offering Margin Trading in the U.S. On September 28, 2021, the CFTC issued an order settling charges against Payward Ventures, Inc. d/b/a Kraken for illegally offering margined retail commodity transactions in digital assets and failing to register as an FCM. From June 2020 to July 2021, Kraken allowed customers to purchase digital assets (including Bitcoin) using margin. The CFTC found that “actual delivery” of the underlying assets did not occur, meaning the transactions met the definition of “retail commodity transactions.” Such transactions fall under the CFTC’s jurisdiction and are treated similarly to traditional futures contracts. The CFTC found the transactions to be unlawful because they did not take place on a designated contract market and Kraken acted as an unregistered FCM by soliciting and accepting the transactions.
BitMEX Moves All Operations Offshore as Remedial Measures in CFTC Action. On August 10, 2021, the CFTC announced that a U.S. district court entered a consent order against five companies that operated the BitMEX cryptocurrency derivatives trading platform. The order required BitMEX to pay a $100 million civil monetary penalty. As part of its remedial measures, BitMEX no longer maintains any substantive operations or business functions in the U.S. BitMEX also certified to the CFTC that anyone located in the U.S. is prohibited from accessing the platform. BitMEX’s remedial measures places it in line with other platforms offering digital asset derivative transactions solely outside the U.S.
Additional Compliance Matters
Verification of New Issues Status. Fund managers must conduct an annual verification of each account to ensure investors are eligible to participate in initial public offerings or new issues pursuant to FINRA Rules 5130 and 5131. While the initial verification requires affirmative representations by account holders, FINRA allows subsequent verifications to be completed using negative consent letters.
Annual Audited Financial Statements. RIAs that manage private funds are generally required to distribute audited financial statements to each fund investor within 120 days of each year-end.
Form D Annual Amendments. Form D filings for funds maintaining continuous offerings must be amended annually, on or before the anniversary of the Form D filing or the filing of the most recent amendment. When amending Form D, the fund must update the entire form.
Blue Sky Filings. Fund managers should review their state blue sky filings to ensure they have met any applicable state renewal requirements. Note that issuers selling securities in New York in reliance on an exemption under Regulation D are required to file Form D and pay related filing fees through the Electronic Filing Depository. As of February 1, 2021, New York does not accept any Form 99 submissions and no longer requires issuers to file a notarized Form U-2.