On January 26, 2011, the Commodity Futures Trading Commission (the “CFTC”) proposed a series of amendments to its regulations, one of which is to eliminate certain exemptions from registration as a commodity pool operator (“CPO”), currently available to managers of private funds.1 These proposed amendments are designed to, among other things, improve accountability and increase transparency in connection with the activities of Commodity Pool Operators (“CPOs”), Commodity Trading Advisers (“CTAs”) and the investment vehicles that they advise. This is a summary of the proposed amendments.
Commodity Pool Operator Exemptions
The CFTC has proposed the elimination of the exemptions from registration as a CPO provided by Rules 4.13(a)(3) and 4.13(a)(4) that are typically relied on by advisers to private funds. If this proposal is adopted, many managers that operate 3(c)(1) or 3(c)(7) funds trading in commodity interests, including any commodity for future delivery, security futures product, swap or commodity option, will be required to register as a CPO with the CFTC. The CFTC believes that “a large group of market participants have fallen outside of the oversight of regulators” and that continuing to grant these exemptions “is outweighed by . . . concerns of regulatory arbitrage.” The CFTC, however, does not address the fact that many managers who would have to register with the CFTC if these exemptions are eliminated (i) are primarily trading in instruments not subject to the CFTC’s jurisdiction and (ii) will be registering as investment advisers with the Securities and Exchange Commission (the “SEC”). The proposed rules do not include any grandfathering provision for existing funds currently relying on these exemptions. The proposing release does, however, seek comments on whether a grandfathering provision should be included.
If Rules 4.13(a)(3) and (4) are rescinded as proposed, many managers that are exempt from registration with the SEC will be required to register as a CPO or CTA with the CFTC, in which case, such managers will be required to complete one or more Schedules of Forms CPO-PQR or CTA-PR (as described in more detail below).
Data Collection for CPOs and CTAs
The CFTC has proposed Rule 4.27 and Forms CPO-PQR and CTA-PR to collect information from CPOs and CTAs registered with the CFTC.2
Description of Forms
CPO Form. Form CPO-PQR is divided into three schedules, Schedules A, B and C.
Proposed Schedule A is divided into two parts. Part 1 seeks basic identifying information about the CPO. Part 2 seeks information about each pool operated by the CPO, including position information for positions representing 5% or more of the pool’s net asset value, relationships with service providers and performance information of each pool.
Proposed Schedule B seeks detailed information for all operated pools, including information regarding each pool’s investment strategy, borrowings by geographic area, the identities of significant creditors, credit counterparty exposure and entities through which the pool trades and clears its positions.
Proposed Schedule C is also divided into two parts. Part 1 seeks aggregate information about the pools operated by the CPO, including the market value of assets invested on both a long and a short basis in different types of securities and derivatives, and turnover in these categories of financial instruments. Part 2 solicits the same information as Part 1 for each commodity pool operated by the CPO with a net asset value exceeding $500 million (a “qualifying pool”). In addition, Part 2 seeks additional information, including a report of the geographic breakdown of each such qualifying pool’s assets as well as information regarding its asset liquidity, concentration of positions, material investment positions, collateral practices with significant counterparties, clearing relationships, pool risk metrics, certain financing information, investor composition and pool liquidity terms.
CTA Form. Form CTA-PR is divided into two schedules. Proposed Schedule A seeks basic identifying information of the CTA, as well as information regarding the trading programs it offers, and assets it directs for pools. Proposed Schedule B seeks more detailed information, including information regarding positions, performance and trading strategy for each trading program.
Tiered Approach to Reporting
The CFTC has proposed a tiered approach to reporting such that the level of reporting required is based on assets under management. All registered CPOs will be required to complete Schedule A of Form CPO-PQR. A registered CPO with assets under management equal to or greater than $150 million will also be required to complete Schedule B of the Form. CPOs with assets under management equal to or greater than $1 billion will be required to complete Schedules A, B and C of the Form.
All registered CTAs will be required to complete Schedule A of Form CTA-PR, while a CTA with commodity pool assets under management equal to or exceeding $150 million will also be required to complete Schedule B of Form CTA-PR.
Applicability to Managers
A manager that is jointly registered with the SEC and CFTC will at least be required to complete Schedule A of Forms CPO-PQR and/or CTA-PR (as applicable), in addition to the satisfaction of any Form PF filing obligation it may have with the SEC.3
Confidentiality of Forms
Because Forms CPO-PQR and CTA-PR solicit sensitive and proprietary information, the CFTC has proposed to treat responses to certain sections of the forms as nonpublic and therefore protected from public disclosure under the Freedom of Information Act (FOIA). Specifically, portions of Schedule A and all of Schedules B and C to Form CPO-PQR, will be treated as nonpublic, while portions of Schedule B to Form CTA-PR will be treated as nonpublic.
Proposed Amendments to Rule 4.5
The CFTC has proposed amendments to Rule 4.5, which excludes registered investment companies (“RICs”) from the definition of CPOs, that would reinstate the restrictions on the exclusion that were in effect prior to 2003. The CFTC’s proposal responds to concerns, represented in, among other things, a rulemaking petition submitted by the National Futures Association (“NFA”), that certain RICs are offering series of “de facto” commodity pools under the exclusion provided by Rule 4.5.
Prior to 2003, a RIC could claim the exclusion provided by Rule 4.5 if it used futures and options for bona fide hedging purposes and its aggregate initial margin and premiums did not exceed 5% of the liquidation value of the RIC’s portfolio. In addition, the RIC could not be marketed as a vehicle for trading in the futures or options market. The CFTC eliminated these restrictions in 2003 because RICs were subject to the requirements of the Investment Company Act of 1940 and regulated by the SEC, which served to provide adequate customer protection.
The CFTC stated that it believed that it was necessary to reinstate the restrictions to halt the practice of RICs offering futures-only investments without CFTC oversight and engaging in regulatory arbitrage. The reinstatement of these restrictions on the exclusion from registration would severely limit RICs trading in futures and options, which has expanded in recent years. RICs are currently subject to extensive regulation and it would be difficult and costly to comply with the requirements applicable to CPOs. The CFTC and the NFA petition cited only a few examples of alleged futures-only RICs and it appears to be a very broad and burdensome response to reinstate the restrictions for all RICs. The CFTC recognized these difficulties and requested comments on specific issues for consideration with respect to the regulation of RICs as CPOs.
Other Amendments Applicable to CPOs and CTAs
Annual Report Requirements for 4.7 Exempt Pools The CFTC has proposed the elimination of the exemption in Rule 4.7(b)(3)(ii), thereby extending the requirement that certified financial statements be included in annual reports, to reports of commodity pools for which relief has otherwise been granted under Rule 4.7.
Annual Filings of Notices of Claims of Exemptions/Exclusion Under the proposed amendments, in addition to the filing of an initial notice, any person claiming exemptive or exclusionary relief under Rules 4.5, 4.13 or 4.14 of the CFTC’s regulations will be required to confirm its notice of claim of exemption or exclusion on an annual basis. A person that does not comply with the annual notice requirement will be deemed to have withdrawn the relevant exemption or exclusion.
Risk Disclosure Statement Regarding Swaps The CFTC has proposed to amend the mandatory Risk Disclosure Statements under Rules 4.24(b) and 4.34(b) to require CPOs and CTAs to describe certain risks specific to swap transactions.
Incorporating Accredited Investor Definition to Rule 4.7. The CFTC is proposing to amend Rules 4.7(a)(3)(ix) and 4.7(a)(3)(x), which describe the net worth and net income standards, respectively, of an “accredited investor,” in connection with satisfaction of the criteria to be a qualified eligible person, by adding a reference to the “accredited investor” definition under Regulation D, rather than a direct inclusion of its terms.
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Comments may be submitted within 60 days after publication of the proposed rules in the Federal Register, which has not yet occurred. If you have any questions about the proposed rule amendments discussed above, please contact an attorney in the Investment Management Group at Seward & Kissel LLP.
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1 See the proposing release.
2 Forms CPO-PQR and CTA-PR solicit information that is similar to that sought through Form PF, which has recently been proposed by the SEC.
3 See the Seward & Kissel LLP Memorandum regarding the SEC’s proposed filing obligations for private fund advisers dated February 9, 2011.
