By Myles J. Edwards, Esq. & Teresa Cooper. Introduction. The Dodd Frank Act ( DFA ) 1

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1 The 3 R s : Registration, Reporting and Recordkeeping for Investment Advisers, Private Funds and NFA Members: How The Dodd-Frank Act Forever Changed the Regulatory Landscape By Myles J. Edwards, Esq. & Teresa Cooper Introduction The Dodd Frank Act ( DFA ) 1 Myles J. Edwards, Esq. is the General Counsel and Chief Compliance Officer for Constellation Wealth Advisors LLC ( CWA ) in New York City. CWA is a multi-billionaire dollar independent multi-family investment office which provides opportunities globally and is registered with the SEC, and a member of FINRA, MSRB and the NFA. Mr. Edwards is recognized as one of the leading experts in compliance and risk and is a noted speaker and author on this topic. He can be reached directly at MylesE@cwallc.com. Teresa Cooper is the Compliance Associate for Constellation Wealth Advisors LLC ( CWA ) in New York City. Ms. Cooper acts as the primary compliance and registration liaison for the firm s FINRA, SEC and NFA registrants. Ms. Cooper has also been instrumental in developing the infrastructure for satisfying the firm s NFA CPO and CTA reporting and recordkeeping requirements. It has long been recognized that the foundation of American education is predicated upon the 3 Rs ; reading, writing and arithmetic. 2 As such, many of us in the halcyon days of our youth looked upon this precept as a method toward gaining understanding and knowledge which would ultimately further our education. Even today, when complexity has become ubiquitous especially as it relates to compliance and regulation, our contention is that reverting to the basics can ultimately result in creating effective and nimble compliance programs that are adroitly positioned to accommodate new initiatives such as the Dodd-Frank Act. This article will explore how the regulatory 3 Rs, Registration, Reporting and Recordkeeping will assist in complying with the requirements found under the Dodd-Frank Act. A renewed call for increased transparency and accountability for participants in the fi nancial services industry and the goal of strengthening enforcement through statutory means employing a riskbased approach led to the enactment of the DFA. 3 Many trace the desire to enact comprehensive legislative to the repeal of the Glass-Steagall Act 4 which some have argued led to the ensuing financial crisis 5. The Glass-Steagall Act was the law of the land for financial services firms until November 12, 1999 when President Bill Clinton signed into law the Gramm-Leach Bliley Act, which, among other things, repealed it. One of the effects of the repeal was that it allowed commercial and investment banks to consolidate, a result highly criticized on a bipartisan basis. 6 The DFA has implemented far-reaching rules and regulations that affect domestic financial services firms. A synopsis of these requirements will be explored here. 2013, Myles Edwards and Teresa Cooper PRACTICAL COMPLIANCE & RISK MANAGEMENT FOR THE SECURITIES INDUSTRY MAY JUNE

2 Investment Advisers & Private Funds 1st R Registration The DFA eliminated the private investment adviser exemption contained in Section 203(b)(3) of the Investment Advisers Act and the intrastate registration exemption for investment advisers with any private fund client. This created a broader category of firms that are eligible to be registered with the United States Securities and Exchange Commission ( SEC ) as an Investment Adviser. Reverting to the basics can ultimately result in creating effective and nimble compliance programs that are adroitly positioned to accommodate new initiatives such as the Dodd-Frank Act. The primary litmus test for investment adviser registration is based on Regulatory Assets under Management ( RAUM ), 7 and generally firms with $100 million or more in RAUM are required to be registered with the SEC. Firms between $25 million and $100 million in RAUM are required to be registered with the respective state(s) where they conduct business and would be eligible for SEC registration only if (1) they would not be subject to registration and examination by their home states or (2) would otherwise be required to register with 15 or more states. Firms that act solely as an Adviser to Private (Hedge and Private Equity) Funds 8 and have RAUM less than $150 million are exempt from registration but are still subject to recordkeeping and reporting requirements as determined by the SEC. Other firms, such as those who advise Venture Capital Funds, Small Business Investment Companies and Family Offices, may be exempt from registration. It is advisable for those firms seeking to enjoy the Family Office exemption to review carefully these requirements 9 for exemption from registration, as they may be strictly interpreted. 2nd R Reporting Form ADV The SEC substantially revised the format and requirements for advisers ADV filings in 2012 based on mandates found under the DFA. It is important to reiterate these requirements as failure to abide by them may result in serious consequences. Every registered investment adviser must update its Form ADV within 90 days of its fiscal year-end. This includes filing all amendments to Part 1A and Part 2A ( Brochure ) of Form ADV with the SEC electronically. Additionally, every registered investment adviser must also deliver Part 2A (or provide a summary of material changes to Part 2A with an offer to provide the Part 2A) to its advisory clients. While Part 2B (the brochure supplement ) is not required to be filed electronically, a registered investment adviser must complete and deliver one or more brochure supplement[s] to its advisory clients, as appropriate. We recommend that a registered investment adviser whose clients are private investment funds deliver its brochure and brochure supplement[s] to all investors in the funds, as appropriate. The delivery of an adviser s disclosure documents is both a reporting and recordkeeping requirement because an adviser is required to maintain documentation regarding delivery to its advisory clients. A registered investment adviser may be required to make a state notice filing in any state in which an adviser has a specified number of clients. Notice filings may be made on Form ADV Part 1A with a deposit of the appropriate state fee(s) into the adviser s IARD account. As notice filing and investment adviser registration requirements differ from state to state, each adviser should check the requirements for each state in which it operates or has clients (or investors, in certain circumstances). Form PF The DFA mandated that the SEC create a process to provide private fund transparency for regulators. Rule 204(b)-1 under the Investment Advisers Act of 1940 requires that SEC registered investment advisers who manage private funds report risk exposure statistics on a consistent basis on Form PF. As we will examine with CFTC/NFA reporting below, it is very important to define who you are based on the statutory definitions of hedge, private equity and liquidity funds. For our purposes here, we will only examine the requirements for hedge funds. Large hedge fund advisers whose RAUM exceeded $5 billion would have already made their first filing by August 29, Large hedge fund advisers whose RAUM are between 30 MAY JUNE 2013 PRACTICAL COMPLIANCE & RISK MANAGEMENT FOR THE SECURITIES INDUSTRY

3 $1.5 billion and $5 billion would have made their first filing by March 1, 2013 (assuming a December 31st year end). In both scenarios, the completed FORM PF, Sections 1 & 2 must be filed initially and then subsequently on a quarterly basis based on their year-end electronically through FINRA s PFRD system. Smaller hedge fund advisers whose RAUM are less than $1.5 billion would have made their first filing by April 30, 2013 (assuming a December 31st year end). After their initial filings, they must subsequently complete Form PF Sections 1a through 1c (Funds of Funds only need to complete Sections 1a and 1b) on an annual basis within 120 days of the end of their fiscal year. Similar to the treatment of the Form ADV, the SEC considers this filing necessary to satisfy both reporting and recordkeeping requirements. Unlike the Form ADV, the Form PF will generally not be publicly available. 3rd R Recordkeeping The DFA enhanced the recordkeeping requirement for registered investment advisers, especially for those who advise private funds. As a result, advisers to private funds must now maintain (but not necessarily file with the SEC), certain records and reports pertaining to the following items: amount of assets under management; use of leverage (including off-balance-sheet leverage); counterparty exposure; trading and investment positions; valuation policies and practices, types of assets held; side arrangements or side letters; trading practices and other information deemed necessary by the SEC. Additionally, all records of a private fund maintained by an adviser are subject to periodic and special examination by the SEC. The records subject to examination are not limited to the records required to be kept by law. The DFA directs the SEC to conduct periodic examinations of all records of private funds maintained by an adviser and authorizes it to conduct special examinations as may be necessary and appropriate in the public interest and for the protection of investors or for the assessment of systemic risk. CFTC & NFA 10 1st R Registration The DFA compelled the U.S. Commodity Futures Trading Commission ( CFTC ) to rescind the exemption from registration as a Commodity Pool Operator ( CPO ) 11 and Commodity Trading Advisor ( CTA ) 12 relied upon by many Private Funds that may have been previously exempt from registering as a CPO under Rule 4.13(a)(4), and as a CTA under a corollary exemption contained in Rule 4.14(a)(8). To continue to remain exempt from registration, investment advisers (sometimes also referred to as investment managers) as sponsors and advisers to Private Funds must either stop trading in commodity futures, retail foreign exchange contracts and most swaps or limit such trading and seek to qualify under Regulation 4.13(a)(3) 13 and file for such exemption with the NFA. Otherwise, the sponsor should have been registered as a CPO and the adviser registered as a CTA (absent another exemption) by December 31, 2012, and they would then be subject to compliance and disclosure obligations. Therefore, Private Funds and their sponsors who had previously relied on the unlimited trading exemption provided by Rule 4.13(a)(4) had until December 31, 2012 to become compliant, which meant; (1) relying on another exemption from the requirement to register as a CPO, (2) registering as a CPO and seeking to qualify for relief under Rule 4.7, CFTC Lite, from certain disclosure, reporting and recordkeeping requirements or (3) ceasing to operate commodity pools subject to CFTC jurisdiction by either redeeming all U.S. investors or ceasing to trade commodity interests, including exchange traded futures and options on futures and most swaps in transactions anywhere in the world. It should be noted that certain relief has been provided to sponsors of Fund of Funds by the CFTC. 14 2nd R Reporting The NFA employs methodology similar to the SEC s, determining reporting requirements by defining entities by size based on their assets under management. 15 For example, a Large CPO (and in most cases, the underlying Fund being advised and sponsored is the Pool) has over $1.5 billion Pool Assets under Management ( PAUM ) as of the Reporting Date. Similarly, a Mid-Size CPO has between $150 million and $1.5 billion PAUM, and a Small CPO has less than $150 million PAUM. Therefore, unlike investment advisers where RAUM below $25 million may not require either federal or state registration, with the NFA everyone is covered regardless of the amount of assets they have under management. The DFA mandated new fi ling requirements for fi rms registered with the CFTC as a CPO and a CTA. For the CPO, there is the annual and quarterly filing of the CPO- PQR. For the CTA, there is the annual filing of the Form CTA-PR (though there is discussion regarding making this PRACTICAL COMPLIANCE & RISK MANAGEMENT FOR THE SECURITIES INDUSTRY MAY JUNE

4 requirement quarterly). Form CPO-PQR is divided into three separate schedules and reporting requirements, which are tied to calendar year and quarter ends and which vary depending on the size of the CPO. Therefore, it is imperative to defi ne what size CPO you are in order to understand your fi ling requirements. Large CPOs would have had to make their initial filing by November 29, 2012, while other CPOs, depending on when their registration date became effective, would have made their initial filings during the first quarter of Filings will be accomplished electronically though the NFA website and a rule to remember is that all CPOs are required to file the Schedule A of the CPO-PQR. Large and Mid-Size CPOs will also have to file the Schedule B and only Large CPOs will have to file the Schedule C. 17 It is important to note that if the entity is also a FORM PF filer, it only needs to complete Schedule A of the Form CPO-PQR, and must report a Schedule of Investments quarterly. CTAs have lighter reporting requirements, as their first quarterly filing of the CTA-PR would have been due on February 14, The Form CTA-PR is a brief one-page form. Entities that are registered both as a CPO and a CTA must complete Schedule A of the Form CTA-PR and complete the applicable schedules of the Form CPO-PQR. 3rd R Recordkeeping A CTA s and CPO s recordkeeping will be based upon a number of factors including its size, complexity and business model. Unlike other regulatory schemes, one size does not fit all, and a good place to start is to codify recordkeeping policies and procedures into one source such as a Written Supervisory Procedures ( WSPs ) and Compliance Manual. In the WSPs, the combined CTA and CPO can present the framework for periodic filings protocols, including the quarterly and annual reporting. New NFA registrants must be completely fluent in the requirements they must adhere to predicated upon their exemption from registration or registration itself. The NFA does provide a comprehensive overview of their requirements on its website and points to its own Compliance Rule 2-10 as a starting point. It is suggested that immediately after an entity becomes registered with the NFA, it must subject itself to an internal self-examination 18 modeled upon the annual requirements imposed by the NFA. This self-examination may expose critical weaknesses in the registrant s infrastructure which can be corrected before any on-site inspection occurs. More importantly, this process will validate the firm s compliance with CFTC and NFA rules and regulations. Conclusion A ll records of a private fund maintained by an adviser are subject to periodic and special examination by the SEC. Though the Dodd-Frank Act is considered burdensome by many who are subject to it, and though it is sometimes misunderstood by the investors whom it seeks to protect, its provisions will continue to be implemented and will be subject to examination and inspection. The SEC has recently outlined best practices for an adviser operating in a heightened regulatory environment. These practices include setting the tone at the top, and developing narrowly tailored compliance programs focused toward examination. 19 Though these comments were directed at the alternative hedge fund space, they ring true for all entities subject to SEC jurisdiction and validate the 3Rs approach. These comments mirror those of other regulatory bodies tasked with enforcement of the DFA. In conclusion, we believe that the 3Rs provide a methodology to address systematically the DFA requirements, satisfy the business requirements of your respective firm, and result in a position whereby you can successfully withstand regulatory scrutiny and inspection. ENDNOTES 1 See Dodd-Frank Wall Street Reform and Consumer Protection Act, Title IV available at: Title IV - Regulation of Advisers to Hedge Funds and Others also known as the Private Fund Investment Advisers Registration Act of Original attribution has been given to Sir William Curtis and first appeared in The Mirror of Literature, Amusement, and Instruction, Volume V, printed and published by J. Limbird, London It is interesting to note some of the comments expressed during deliberation over Dodd-Frank included: Years without accountability for Wall Street and big banks brought us the worst financial crisis since the Great Depression, the loss of 8 million jobs, failed businesses, a drop in housing prices, and wiped out personal savings. The failures that led to this crisis require bold action. We must restore responsibility and accountability in our financial system to give Americans confidence that there is a system in place that works for and protects them. We must create a sound foundation to grow the economy and create jobs MAY JUNE 2013 PRACTICAL COMPLIANCE & RISK MANAGEMENT FOR THE SECURITIES INDUSTRY

5 4 Officially known as The Banking Act of 1933 (Pub.L , 48 Stat. 162, enacted June 16, 1933), Glass-Steagall was codified under Sections 16, 20, 21 and 32 of this Act. 5 See Repeal of Glass - Steagall Caused the Financial Crisis, by James Rickards, August 27, 2012, U.S. News & World Report on line. Available at: usnews.com/opinion/blogs/economic-intelligence/2012/08/27/repeal-of-glasssteagall-caused-the-financial-crisis 6 During the 2009 House of Representatives consideration of H.R. 4173, the bill that became the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010, Representative Maurice Hinchey (D-NY) proposed an amendment to the bill that would have reenacted Glass Steagall Sections 20 and 32 and also prohibited bank insurance activities. The amendment was not voted on by the House. 7 RAUM is defined by the formula found under Item 5.F: Calculating Your Regulatory Assets under Management, as found under the FORM ADV: Instructions for Part 1A, page 7. 8 The DFA defines the term private fund to be any fund that would be an investment company but for the exemptions contained in Section 3(c)(1) or 3(c)(7) of the Investment Company Act. This definition is similar to the Volcker Rule definition of hedge fund and private equity fund, which covers an issuer that would be an investment company but for the exemptions contained in Section 3(c)(1) or 3(c)(7) of the Investment Company Act, or such similar funds as the appropriate federal banking agencies, the SEC and the CFTC may, by rule, determine. Generally, 3(c)1 Funds have 100 or fewer investors while 3(c)7 Funds have exclusively qualified purchasers as investors who are generally individuals that own Investments of at least $5,000,000 or entities [other than family-owned companies] that own Investments of at least $25,000, Family Offices excluded from the Advisers Act regulation are any companies that provide investment advice only to family clients, as defined by the rule, is wholly owned by family clients and is exclusively controlled by family members and/or family entities, as defined by the rule and does not hold itself out to the public as an investment adviser. See 17 CFR Part 275, [Release No. IA-3220; File No. S ] available at ia-3220.pdf. 10 National Futures Association is the Self-Regulatory Organization for the U.S. futures industry and may be contacted through 11 A commodity pool is a commingled investment vehicle that invests in commodity interests. A commodity pool that invests in other commodity pools is a commodity pool itself (e.g. fund of funds). Each commodity pool must have at least one CPO and one CTA. In most cases, the CPO and the CTA will be the same entity that is the investment manager and or adviser and sponsor to the Private Fund(s). 12 A CTA advises the commodity pool with respect to the trading of, or the advisability of trading in, commodity interests. The investment adviser to a private fund (like each Fund) may serve as both the CPO and CTA. In a fund-of-funds whereby a fund invests in other commodity pools or in a manager-of-managers arrangement, the entity that allocates assets to the underlying commodity pools or to the other CTAs, respectively, is acting as a CTA. 13 Rule 4.13(a)(3) exempts from CPO registration the operator of a commodity pool if interests in the pool are exempt from registration under U.S. Securities Act of 1933 (the Securities Act ) and are not marketed to the public in the United States and where the pool s use of commodity interests is very limited, (In this instance, very limited means either: (a) that the pool s aggregate initial margin and premiums attributable to commodity options and commodity futures, respectively, do not exceed 5% of the liquidation value of the pool s portfolio after taking into account unrealized profits and unrealized losses on any such positions it has entered into, provided that, in the case of an option that is in-the-money at the time of purchase, the inthe-money amount may be excluded in computing such 5%; or (b) that the aggregate net notional value of such positions does not exceed 100% of the liquidation value of the pool s portfolio after taking into account unrealized profits and unrealized losses on any such positions it has entered into. Both tests do not differentiate as to whether the positions are held for bona fide hedging purposes or otherwise, 17 C.F.R. 4.13(a)(3)(ii)) and the interests are offered only to accredited investors. Other exemptions from registration that may be available are Rule 30.4 which exempts from CPO registration the operators of non-u.s. investment pools, provided that (i) the pool does not transact future contracts or options on any U.S. futures markets, (ii) the pool is exempt from registration under the U.S. Investment Company Act of 1940 and the pool s securities are exempt from registration under the Securities Act; and (iii) no more than 10% of the participants in or values of the assets of the pool are held by U.S. investors; or Rule 30.5 which exempts from CPO registration the operators of non-u.s. investment pools, provided that, among other things, (i) the pool does not transact future contracts or options on any U.S. futures markets, (ii) the operator files a petition with the NFA representing that it is located outside the United States and does not engage in trading on U.S. futures markets for its U.S. clients and agrees to submit to U.S. jurisdiction, and (iii) the operator enters into a written agreement appointing a U.S. entity as agent for service of process. 14 On November 29, 2012, the CFTC issued a no-action letter providing timelimited relief to the operators of funds of funds facing the prospect of registration with the CFTC prior to December 31, 2012 as a result of the rescission of Rule 4.13(a)(4) and amendments to Rule 4.5 See CFTC No-Action Letter No (Nov. 29, 2012). The letter provides that the Division of Swap Dealer and Intermediary Oversight (the Division ) will not recommend that the CFTC take enforcement action against the manager of a fund of funds for failure to register as a commodity pool operator ( CPO ) until the later of June 30, 2013, or six months after the effective date (or compliance date, if later) of any revised guidance that the Division issues on the application to fund of funds managers of the de minimis thresholds in CFTC Rule 4.5 and Rule 4.13(a)(3) See 77 Fed. Reg (Feb. 24, 2012); correction Fed. Reg (Mar. 26, 2012). 15 The SEC and CFTC use different methods for determining AUM; the CFTC requires the use of aggregated gross pool assets that are under a CPO s control whereas the SEC uses regulatory assets under management which is the gross value of the securities portfolios and private funds managed by an adviser as calculated for Form ADV. The asset test for Form PF applies to AUM on the period end date whereas the asset test for CPO-PQR applies if the AUM threshold has been crossed on any particular day during the reporting period. This may result in a manager being in one category for SEC purposes and a non-corresponding tier for CFTC purposes. Given the various substitution and timing deadlines summarized previously, this may lead to complexity when managing a manager s reporting obligations. 16 A synopsis of these dates would be as follows; Registered CPOs with at least $5 billion AUM as of June 30, 2012 must have filed by November 29, Registered CPOs with between $1.5 billion and $5 billion AUM in commodity pools must have filed by March 1, 2013 with respect to the year-ended December 31, Registered CPOs with between $150 million and $1.5 billion AUM must have filed by April 1, 2013 with respect to the year-ended December 31, Registered CPOs with less than $150 million AUM must have filed by April 1, 2013 with respect to the year-ended December 31, A synopsis of these filings would be as follows; for a Large CPO, the Form CPO- PQR Schedules A, B, C filed Quarterly within 60 days of quarter end (If it uses the Form PF to substitute for the Schedules B and C, then it must file the NFA Schedule of Investments). For a Mid-Size CPO, it must file the Form CPO-PQR Schedule A plus the NFA Schedule of Investments Quarterly within 60 days of quarter-end and annually within 90 days of year-end (If it uses the Form PF to substitute for the Schedule B for the annual filing, then it must file the NFA Schedule of Investments). For a Small CPO it must file the Form CPO-PQR Schedule A plus the NFA Schedule of Investments Quarterly within 60 days of quarter-end; and annually within 90 days of year-end. PRACTICAL COMPLIANCE & RISK MANAGEMENT FOR THE SECURITIES INDUSTRY MAY JUNE

6 18 The NFA s self-examination questionnaires are found at org/nfa-compliance/publication-library/self-exam-questionnaire.html. 19 See Enforcement Priorities in the Alternative Space a speech by Bruce Karpati, Chief, SEC Enforcement Division s Asset Management Unit, U.S. Securities and Exchange Commission given Before the Regulatory Compliance Association, New York, New York on December 18, The entire speech can be obtained at spch121812bk.htm. A complement to this speech is the announcement of the SEC s Division of Investment Management s top regulatory initiatives by Norm Champ its Director. This speech was delivered at the Practicing Law Institute s conference, The SEC Speaks in 2013 held on February 22, 2013 in Washington, D.C. This article is reprinted with permission from Practical Compliance and Risk Management for the Securities Industry, a professional journal published by Wolters Kluwer Financial Services, Inc. This article may not be further re-published without permission from Wolters Kluwer Financial Services, Inc. For more information on this journal or to order a subscription to Practical Compliance and Risk Management for the Securities Industry, go to onlinestore.cch.com and search keywords practical compliance 34 MAY JUNE 2013 PRACTICAL COMPLIANCE & RISK MANAGEMENT FOR THE SECURITIES INDUSTRY