On October 9, 2018, as part of its Project KISS initiative to streamline and simplify its rules, the U.S. Commodity Futures Trading Commission (the “Commission” or “CFTC”) issued a notice of proposed rulemaking (the “CFTC Rule Proposal”) to amend its Part 4 Rules, which govern the operations and activities of commodity pool operators (“CPOs”) and commodity trading advisors (“CTAs”). Among other things, these amendments would add certain exemptions from registration based upon relief provided under existing CFTC staff letters and advisories such as CFTC Staff Advisory 18-96 (“Advisory 18-96”), and codify other existing regulatory relief, including that provided by CFTC Staff Letter 14-116 (the “JOBS Act Relief Letter”).
The Commission is requesting comment on all aspects of the CFTC Rule Proposal, as well as on a number of specific questions. The proposed amendments are expected to be published in the Federal Register in the near future for a sixty-day comment period. This memorandum is intended to provide a high-level overview of the most significant aspects of the CFTC Rule Proposal.
New Exemption in Rule 4.13(a)(4) to Supersede Advisory 18-96
The CFTC Rule Proposal would codify the relief currently available under Advisory 18-96 and expand it in certain respects by replacing it with a new exemption from CPO registration set forth in proposed Rule 4.13(a)(4).1 Subject to meeting certain criteria, Advisory 18-96 permits a registered CPO operating an offshore commodity pool to claim relief with respect to such pool from the disclosure requirements and many of the reporting and recordkeeping requirements that otherwise would apply. Proposed Rule 4.13(a)(4) generally would incorporate the same eligibility criteria as in Advisory 18-96.2 Significantly, however, Rule 4.13(a)(4) would provide an exemption from CPO registration and would be available to a CPO operating an offshore commodity pool, whether or not it is otherwise registered as a CPO. The CFTC Rule Proposal makes explicit that the exemption is available on a pool-by-pool basis.3 Unlike Advisory 18-96, proposed Rule 4.13(a)(4) also would provide relief from reporting obligations on Form CPO-PQR with respect to the exempt pool. A CPO claiming this exemption, as proposed, would still be subject to the anti-manipulation and anti-fraud provisions of the U.S. Commodity Exchange Act, and by virtue of Rule 4.13(c), would be required to make and keep books and records for the exempt pool, and to submit to such special calls as the CFTC may make to demonstrate eligibility for and compliance with the applicable criteria.
As with other exemptions in Rule 4.13, proposed Rule 4.13(a)(4) would require a notice filing which would need to be affirmed on an annual basis. We expect that commenters will seek clarification regarding the timing of the notice filing requirement, particularly for CPOs transitioning to reliance on this exemption. Additionally, the CFTC Rule Proposal solicits comment on whether disclosure to prospective investors should be required regarding an exempt CPO’s reliance on Rule 4.13(a)(4). Finally, commenters may request that the Commission confirm the continuing applicability of the positions taken in various CFTC staff letters interpreting Advisory 18-96 in the many years since its inception in any final rule release.4
Currently, CPOs and CTAs of family offices are eligible for relief from registration pursuant to, respectively, CFTC No-Action Letters 12-37 and 14-143. The CFTC Rule Proposal would codify exemptions consistent with these letters in Rules 4.13 and 4.14. In an effort to harmonize further the CFTC’s treatment of family offices with that of the Securities and Exchange Commission (the “SEC”), the eligibility criteria for these exemptions would refer to the definitions of “family office” and “family clients” as set forth in the SEC’s rules. Nonetheless, unlike the SEC’s exclusion for family offices under the definition of investment adviser, which is self-executing, the CFTC’s proposed family office CPO exemption would require a notice filing with the National Futures Association (“NFA”). The family office CTA exemption, however, would be self-executing under the CFTC Rule Proposal. The Commission is requesting comment on whether the CPO exemption notice filing should be included on NFA’s public BASIC database and whether an annual recertification requirement is appropriate. Notably, in setting out the rationale for the family office exemption, the Commission cites to historical staff letters concluding that various types of family investment vehicles are not commodity pools. Commenters may request that the Commission confirm the continuing applicability of these longstanding interpretations in any final rule release.
Business Development Company (“BDC”) CPO Exclusion
The CFTC Rule Proposal would revise Rule 4.5 to treat investment advisers of BDCs in the same manner as investment advisers of registered investment companies, permitting them to claim an exclusion from the definition of CPO thereunder. This proposal would codify existing relief set out in CFTC No-Action Letter 12-40.
JOBS Act Relief
Consistent with the exemptive relief currently provided in the JOBS Act Relief Letter, which permits the use of general solicitation by qualifying CPOs, as contemplated by the Jumpstart Our Business Start-ups Act of 2012 (the “JOBS Act”), the CFTC is proposing to amend Rules 4.7(b) and 4.13(a)(3) to eliminate language that restricts marketing to the public. Under the proposed revisions, marketing to the public, if any, would need to be conducted in compliance with Regulation D or Rule 144A. As with the JOBS Act Relief Letter, these revisions are intended to align the CFTC’s Part 4 rules with amendments adopted by the SEC pursuant to the JOBS Act. If adopted, these proposed amendments should obviate the need to make a separate notice filing to claim relief as is currently required under the JOBS Act Relief Letter.
Non-U.S. Investors in Rule 4.13(a)(3) Exempt Pools
The CFTC Rule Proposal would amend the de minimis commodity pool exemption in Rule 4.13(a)(3) to explicitly permit participation by non-U.S. persons irrespective of their financial sophistication (i.e., participation in such pools would no longer be limited to investors that qualify as “accredited investors”). The Commission states its understanding that that this reflects current market practice in reliance on the interpretation in CFTC Staff Letter 04-13.
Consistent with the relief available under Advisory 18-96, the Commission is proposing to amend the recordkeeping provisions in Rule 4.23 to allow U.S.-based CPOs of offshore commodity pools to maintain the commodity pool’s original books and records in the offshore location of the pool, in lieu of the CPO’s main U.S. business location, subject to certain conditions. The CFTC Rule Proposal also includes certain other amendments to Rule 4.23, which the CFTC states are intended to promote readability and ease of application, but in any event should be carefully reviewed to assess fully their impact.
CPO-PQR and CTA-PR Reporting Relief
Pursuant to the CFTC Rule Proposal, a registered CPO that operates only commodity pools for which it is exempt or excluded from registration would not be required to file Form CPO-PQR. Similarly, a registered CTA that advises only its own commodity pools or does not direct trading for client accounts would not be required to file Form CTA-PR. These proposed amendments are consistent with the exemptive relief currently available under CFTC Staff Letters 14-115 and 15-47, respectively.
Statutory Disqualification Representation
The Commission is proposing to require any person claiming an exemption from CPO registration under paragraphs (a)(1) through (a)(5) of Rule 4.13 to represent that neither the person nor any of its principals is subject to a statutory disqualification, unless such disqualification arises from a matter which was previously disclosed in connection with a previous application, if such registration was granted, or which was disclosed more than thirty days prior to the claim of this exemption. This proposed amendment would extend the requirement currently contained in Advisory 18-96 to most categories of the Rule 4.13 exemption. Under the CFTC Rule Proposal, the CPO of a family office would not be subject to this requirement, however.
Though the CFTC Rule Proposal, if adopted as proposed, would largely codify existing relief and interpretations, the proposed amendments represent a constructive development that could simplify compliance in a number of respects. Perhaps most significantly, the proposed amendments would reduce the need for market participants and counsel to navigate a complex patchwork of letters and advisories to rely on longstanding relief and would provide greater certainty in certain areas where interpretative consensus has developed. However, as discussed supra, some ambiguity remains with respect to several aspects of the proposed amendments, and they should be reviewed in further detail to identify any potential unintended consequences or other possible adverse effects. We expect that commenters will address many of the Commission’s provision-specific questions, as well as provide additional input on various other issues.