Author: Doug Cornelius

You can find out more about Doug on the About Doug page

Corporate Transparency Act Hits a Snag

On March 1, the US District Court in Northern Alabama ruled that the “Corporate Transparency Act is unconstitutional because it exceeds the Constitution’s limits on Congress’ power.” It’s not clear what effect this ruling is going to have on other parties and other jurisdictions.

Congress passed the 2021 National Defense Authorization Act which included a bill called the Corporate Transparency Act (“CTA”). The CTA requires most entities incorporated under State law to disclose personal stakeholder information to the Treasury Department’s criminal enforcement arm.

There are two dozen exemptions, mostly for entities that are otherwise regulated. Many private fund managers have been trying to figure out how the exemptions apply. There is still some uncertainty on these exemptions. For example, registered investment advisers are exempt and private funds listed on Form ADV are exempt. Subsidiaries can be exempt, but FinCEN Seems to want to keep that exemption very narrow.

L. 6. Does a subsidiary whose ownership interests are partially controlled by an exempt entity qualify for the subsidiary exemption?

No. If an exempt entity controls some but not all of the ownership interests of the subsidiary, the subsidiary does not qualify. To qualify, a subsidiary’s ownership interests must be fully, 100 percent owned or controlled by an exempt entity.

A subsidiary whose ownership interests are controlled or wholly owned, directly or indirectly, by certain exempt entities is exempt from the BOI reporting requirements. In this context, control of ownership interests means that the exempt entity entirely controls all of the ownership interests in the reporting company, in the same way that an exempt entity must wholly own all of a subsidiary’s ownership interests for the exemption to apply.

[Issued January 12, 2024] https://www.fincen.gov/boi-faqs#L_6

Back to the case…

The Government argued that it has three sources of constitutional authority for enactment of the CTA. First, the Government argues that Congress has the power to enact the CTA under its foreign affairs powers. The CTA comes from the government’s interest in curbing foreign money laundering and other bad foreign money influences. The second sources is the Commerce Clause authority. Because many entities engage in activities that qualify as or affect “commerce,” the act of corporate formation itself is enough to invoke Congress’ Commerce Clause powers. Third, the Government argued that the CTA is a necessary and proper exercise of Congress’ taxing power, because one purpose of the FinCEN database created by the CTA is to assist in efficient tax administration.

The Court didn’t agree with any of these three arguments.

So now what?

Unless you are Isaac Winkles or the National Small Business Association, the court’s ruling does not apply to you. I suppose if you are in Alabama, you could argue that it might cover you. For the rest of us, who have created a new non-exempt entity in 2024, I think we still have to make that filing it 90 days.

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Revisiting Managed Accounts

SEC IA Rule 204A-1 requires all of an investment adviser’s access persons to report, and compliance to review, their personal securities transactions and holdings periodically. Section (3)(I) has an exception for

(3) Exceptions from reporting requirements. Your code of ethics need not require an access person to submit:
(i) Any report with respect to securities held in accounts over which the access person had no direct or indirect influence or control;

Way back in 2015 the Division of Investment Management released Guidance 2015-03 about what it means for an access person to have no direct or indirect influence or control over the account for purposes of relying on the reporting exception.

There are three themes that fail the exception:

  • suggesting purchases or sales of investments to the trustee or third-party discretionary manager;
  • directing purchases or sales of investments; or
  • consulting with the trustee or third-party discretionary manager as to the particular allocation of investments to be made in the account.

Effectively, the SEC asks compliance to do some diligence on the account and the person running the account to make sure the access person is blocked from making investment decisions.

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The One with the Divorce

We’ve seen many insider trading cases involving friends, spouses, domestic partners, and dates. We can guess what the end result would be. I think the Tyler Loudon case is the first one that has taken us all the way to the end.

Tyler and Mrs. Loudon lived in Houston. Mrs. Loudon worked as a mergers and acquisitions manager at BP p.l.c., the big energy company. As many couples did during the pandemic, they worked in home offices and in relatively close proximity to each other. Mrs. Loudon was working on BP’s acquisition of TravelCenters of America.

Apparently, Mrs. Loudon shared some of the acquisition information with Tyler. Of course, she expected that he would not do something stupid with the information.

He did. He did do something stupid.

Tyler bought shares in TravelCenters. That alone of course is illegal. Then he took the stupidity to a higher level. He sold all of his other positions in his brokerage account and Roth IRA and put all of that money into purchasing TravelCenters shares. I’m sure that was flagged by his brokerage firm as suspicious activity.

FINRA opened an investigation. Tyler confessed to his wife. Mrs. Loudon told her BP supervisor about he husband’s trading. BP fired Mrs. Loudon. Mrs. Loudon moved out of the marital home and filed for divorce.

We generally assume that a violation of spousal secrets to do stupid insider trading is going to lead to relationship issues. This is the first SEC complaint I remember that has take us all the way to the end of the marriage.

Besides divorce, Tyler is also facing up to five years in prison and a $250,000 fine with the Department of Justice and possible more in SEC fines. Of course, Tyler also had to forfeit all of the trading profits.

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The One With Buzz

If you can grab the trading symbol “BUZZ” you should be able to make some money with it. Right? A company that owns beehives? or sells honey? or sells honey products? Or social buzz? VanEck Associates wanted to ride the social media wave and created an ETF that would

“Track the performance of the 75 large cap U.S. stocks which exhibit the highest degree of positive investor sentiment and bullish perception based on content aggregated from online sources including social media, news articles, blog posts and other alternative datasets.”

The investment thesis is that “Investor sentiment has proven to be an important factor in stock performance”. Sure. Why not. The tracker is the BUZZ NextGen AI US Sentiment Leaders Index. That index targets the most mentioned stocks online, determines whether the mention is positive or negative and then takes the 75 large cap stocks that have the most positives.

The initial proposal was that VanEck would license the BUZZ index for the ETF in exchange for 20% of the management fee it earned from the ETF. Then the BUZZ index provider decided to partner with an “Influencer” who would promote the ETF.

The “Influencer” goes unnamed in the SEC complaint, but it was fairly easy to find out that it was Dave Portnoy, the founder of BarStool Sports and “bro-influencer-in-chief.”

Before the launch of the ETF, a new agreement was struck with Mr. Portnoy getting a sliding scale of the ETF fees depending on how big the ETF grew in AUM. It would go up to 60% if the ETF reached $1.25 billion in AUM in 18 months.

All of that seems fine, as long as its disclosed. That is where VanEck came up short according to the SEC order. VanEck didn’t fully disclose the terms of the license agreement with the Buzz index to the ETF board. Van Eck didn’t tell the ETF board about Mr. Portnoy involvement or the details about the planned fee structure of the fund.

Under the Investment Company Act, the adviser needs to provide the board information about the advisory contract, including the following (see Form N-1A, Item 27(d)(6)(i))

  • “the extent to which economies of scale would be realized as the [f]und grows,”
  • “whether fee levels reflect these economies of scale for the benefit of [f]und investors.”
  • “the costs of the services to be provided and profits to be realized by the investment adviser and its affiliates from the relationship with the [f]und.”

Under the Investment Advisers Act, VanEck was tagged with a failure to have adequate policies and procedures about furnishing the ETF board with accurate information reasonably necessary for the ETF board to evaluate the terms of the advisory contract, as well as material information related to a proposed ETF launch.

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Anti-Money Laundering Rule for Investment Advisers – Take 3

We’ve been here before. FinCEN proposed anti-money laundering rules for investment advisers in 2003 and 2015. The pushback has been the Custody Rule, which requires a third-party to hold the client assets. That third-party will be doing the AML-KYC review. Those that are doing self-custody fall under existing AML rules.

Since 2015, there has been expansion in the weaponization of the dollar against persons and countries that the United States has issues with. The current hot button being Russian wealth. So, I think the rule is going to end up being promulgated this time.

It’s a lighter version of the rule that would require registered investment advisers and exempt reporting advisers to:

  • implement an AML/CFT program;
  • file certain reports, such as Suspicious Activity Reports, with FinCEN;
  • keep records such as those relating to the transmittal of funds (i.e., comply with the Recordkeeping and Travel Rule); and
  • fulfill other obligations applicable to financial institutions subject to the BSA and FinCEN’s implementing regulations.

It would not require customer identification program requirements. At this time. That requirement is specifically called out for a future joint rulemaking with the SEC.

The rule also proposes to delegate examination authority to the SEC.

The proposal has a 60-day comment period and a 12-month compliance deadline. No need to act currently. I think we’ll need to pencil it in for workplans in the second half of 2024.

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Reviewing the Accredited Investor Definition


The Securities and Exchange Commission issued a Staff Review of the “Accredited Investor” Definition at the end of 2023. The Dodd-Frank Wall Street Reform and Consumer Protection Act directs the SEC to review the accredited investor definition every four years.  The Staff previously reviewed the definition in 2015 and in 2019 (as part of the Concept Release on Harmonization of Securities Offering Exemptions).

There were several changes in 2020 to the definition of “accredited investor” as a result of the 2019 report. The SEC allowed those meeting the “knowledgeable employee” standard to meet the “qualified purchaser” standard would also be deemed an “accredited investor.” The SEC added a qualification-based standard, initially allowed holders in good standing of the Series 7, Series 65, and Series 82 licenses as accredited investors. And lastly, the SEC added the term “spousal equivalent” to the accredited investor definition, so that spousal equivalents may pool their finances for the purpose of qualifying as accredited investors. There were a few other tweaks to the definition.

But the financial thresholds remained unchanged. I think that is likely to change this year. On the Fall 2023 RegFlex Agenda the SEC listed Regulation D and Form D Improvements (3235-AN04) letting us know that the SEC is thinking about “amendments to Regulation D, including updates to the accredited investor definition, and Form D to improve protections for investors.”

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SEC Proposes Updated Definition to Help Three Funds

The press release for changes to “qualifying venture capital fund” caught my attention. I didn’t recall that definition, so I took a closer look. It’s in Section 3(c)(1) of the Investment Company Act, which makes it part of the “private fund” definition.

Section 504 of the Economic Growth, Regulatory Relief, and Consumer Protection Act of 2018 (“EGRRCPA”) amended section 3(c)(1) of the Investment Company Act by adding “qualifying venture capital funds” into the exemptions from the investment company definition. Other companies can only have 100 people. Qualifying venture capital funds can have up to 250 people. EGRRCPA created the new definition of “qualifying venture capital fund” as:

“a venture capital fund that has not more than $10,000,000 in aggregate capital contributions and uncalled committed capital.”

That seems like an really small fund and I would think that a change to the definition if it added an extra zero would be very meaningful. Then I read that the SEC was only proposing to increase the amount from $10 million to $12 million.

Why bother? The statutory definition in EGRRCPA requires this $10,000,000 threshold “be indexed for inflation once every 5 years by the SEC. Here it is five years later.

I rarely read the economic analysis of a proposed rule, but I was really interested in the impact.

Based on the Form ADV filings there are at least 23,759 venture capital funds. Of those, there are 14,822 qualifying venture capital funds. Of those, 653 have more than 100 beneficial owners.

Ultimately, the SEC estimates that there are three (3!) venture capital funds that are not currently excluded from registration under section 3(c)(1) but that could be defined as a qualifying venture capital fund if the threshold were adjusted for inflation to $12,000,000 as proposed.

I was floored to read how many small venture capital fund are out there. I was not surprised that the rule only helped a handful of funds.

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New Marketing Rule FAQ

The Division of Examinations has been taking a close look at investment adviser marketing since the Marketing Rule rule compliance deadline last fall. We’re getting dribbles of updates as a result of those exams, with the SEC just starting to point out things it hasn’t liked in exams.

The first was extracted performance from a private fund in January 2023.

“[A]n adviser may not show gross performance of one investment or a group of investments without also showing the net performance of that single investment or group of investments, respectively.”

The latest FAQ focuses on the calculation of net and gross performance.

Q: Must gross and net performance shown in an advertisement always be calculated using the same methodology and over the same time period?

Yes, is the answer. The extra point made in the answer is taking into account the use of a subscription credit facility when calculating returns. If you exclude the use of the facility in one calculation you have to exclude it in the other calculation. And vice versa.

The FAQ goes on to make another point about calculating new IRR when a fund uses a credit facility.

“[A]n adviser would violate the general prohibitions (e.g., Rule 206(4)-1(a)(1) and Rule 206(4)-1(a)(6)) if it showed only Net IRR that includes the impact of fund-level subscription facilities without including either (i) comparable performance (e.g., Net IRR without the impact of fund-level subscription facilities) or (ii) appropriate disclosures describing the impact of such subscription facilities on the net performance shown.”

The new Private Fund Quarterly Reporting Rule also requires calculation of returns with and without the use of the credit facility. (Assuming the rule is not vacated by the courts after the recent hearing.) Add in this FAQ and I see the SEC having a very negative view on private fund’s use of credit facilities.

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SEC Begrudgingly Approves Bitcoin ETP

We all saw this train coming down the tracks. Even the hacker who took over the SEC’s Twitter account announcing the approval, merely jumped the gun. The Securities and Exchange Commission, by a 3-2 vote, authorized a dozen spot Bitcoin exchange traded products.

Gary Gensler’s SEC has been trying stem the tide and prevent crypto from becoming more legitimate by denying any form of SEC authorization. Last year’s loss in the Grayscale’s court case was the break that could not be plugged. In the original Grayscale Order, the SEC determined that the proposal had not established that the CME bitcoin futures market was a market of significant size related to spot bitcoin, or that the “other means” asserted were sufficient to satisfy the statutory standard. The U.S. Court of Appeals for the D.C. Circuit held that the SEC failed to adequately explain its reasoning. The court vacated the Grayscale Order and remanded the matter to the SEC. “Because we don’t like it” is not a sufficient reason.

That didn’t stop Chair Gensler from slapping crypto.

“While we approved the listing and trading of certain spot bitcoin ETP shares today, we did not approve or endorse bitcoin. Investors should remain cautious about the myriad risks associated with bitcoin and products whose value is tied to crypto.”

He points out that “the vast majority of crypto assets are investment contracts and thus subject to the federal securities laws.”

Commissioner Peirce countered:

“[O]ur actions here have muddied people’s understanding of what the SEC’s role is. Congress did not authorize us to tell people whether a particular investment is right for them, but we have abused administrative procedures to withhold investments that we do not like from the public.”

The SEC has allowed crypto to take step towards more credibility, liquidity and lower costs.

Personally, I don’t see ordinary people using crypto. They just trade it. I appreciate the blockchain infrastructure and potential innovation to move money cheaply. Criminals love it. It’s an easy way to move money around anonymously.

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