On August 13, the Commodity Futures Trading Commission (CFTC) issued a final rule (Final Rule) regarding the reporting and compliance obligations applicable to certain investment companies registered (RICs) under the Investment Company Act of 1940, as amended, whose investment advisers are required to register with the CFTC as commodity pool operators (CPOs).

The industry had significant concerns that the CFTC’s disclosure, reporting, and recordkeeping requirements were inconsistent with or even conflicting with those of the Securities and Exchange Commission (SEC). The purpose of the Final Rule was to harmonize the CFTC and SEC’s rules for RICs that are subject to CFTC rules.


CFTC Rule 4.5, as amended in February 2012, changed previous exclusions to the definition of CPO and instead mandated that investment advisers to RICs that trade a significant amount of derivative contracts such as futures contracts or market the RIC as a futures product would be required to register with the CFTC as CPOs. Prior to the amendments, mutual funds, exchange-traded funds and other registered entities were exempted from all CFTC regulation. The amendments restored the previous conditions to being eligible for the exemption, i.e., not to exceed a de minimis threshold for commodity trading and not to market the RIC as a vehicle for trading in commodity futures, commodity options, or swaps. As of December 31, 2012, any RIC not meeting this limited exception became subject to CFTC registration. When amending Rule 4.5, the CFTC also issued a companion release proposing regulations that would harmonize the compliance obligations for RICs subject to both CFTC and SEC regulation. Many of the previously proposed regulations were incorporated into the Final Rule.

CFTC Rule Compliance

The Final Rule deems a RIC to be in compliance with CFTC rules for CPOs if it complies with the relevant SEC rule. For these dually registered entities, the CFTC will accept the SEC’s disclosure, reporting, and recordkeeping requirements as “substituted compliance” for substantially all of Part 4 of the CFTC’s regulations. To meet the substitute compliance requirements, registered CPOs of RICs must follow certain conditions the next time an updated prospectus is filed with the SEC, including:

  • notifying the National Futures Association (NFA) of the intent to follow the substitute compliance requirements;
  • filing with the NFA all financial statements prepared to meet SEC requirements; and
  • notifying the NFA when using or intending to use a third-party provider for recordkeeping services.

There was one substantive CPO disclosure where the CFTC did not defer to the SEC’s disclosure rules. The Final Rule requires a CPO that has less than three years of operating history to disclose the performance of every account or pool managed by the CPO that has substantially similar investment objectives, policies and strategies as those of the offered pool. The CFTC made specific reference to two SEC no-action letters that set forth the limited circumstances under which the SEC would permit a RIC to present related account performance. The Final Rule, however, does not give the CPO the option of including such performance information – it is required. The Final Rule seems to put CPOs in a potential regulatory bind. The CPO will have to decide whether the SEC no-action letters, using an SEC analysis, would permit the inclusion of the related performance and if so, the CFTC will require its disclosure. If the CPO concludes that their situation is outside the standards in the SEC no-action letters, it can not include such past performance. CPOs could find themselves in a bind: if the CPO includes the past performance, the SEC could object that the SEC standard has not been met for inclusion of the performance. And, if the CPO does not include the performance, the CFTC could object that the omission of the related performance is a violation.

However, as explained below, within days of the CFTC’s Final Rule, the SEC issued Guidance for RICs that invest in futures. In the Guidance, the SEC staff said it would “expect” the RIC to include the performance information of all other funds and private accounts managed by the investment adviser that have investment objectives, policies and strategies substantially similar to the fund. The Guidance is a shift by the SEC toward requiring disclosure of related account performance as opposed to simply permitting it.

Additionally, the Final Rule amends certain provisions of Part 4 of the CFTC’s regulations that are applicable to CPOs and commodity trading advisors (CTAs). First, CPOs will be allowed to use third-party service providers for maintaining books and records. Next, the CFTC rescinded the requirement that a CPO must receive a signed acknowledgment indicating receipt of the disclosure document from a prospective investor before the CPO can accept or receive any funds. Finally, CPOs and CTAs will be permitted to update their disclosure documents every 12 months, instead of every nine months.

SEC Guidance

As mentioned above, immediately after the CFTC’s release of the Final Rule, the SEC’s Division of Investment Management (Division) issued guidance on the use of derivatives that are commodity interests by RICs, entitled “Disclosure and Compliance Matters for Investment Company Registrants that Invest in Commodity Interests” (Guidance). In addition to the related account performance issue described above, the Guidance addressed the disclosure of derivatives and associated risks, legend requirement, and compliance and risk management. The Division reiterated its previously expressed view that RICs need to adequately and accurately disclose the risks associated with investing in commodity interests under both Forms N-1A and N-2 using plain English. RICs should also regularly assess the completeness of their derivative-related disclosures in light of actual operations.

Regarding the mandatory legend that is required by Rule 481 under the Securities Act of 1933 on the outside front cover page, the Division will now permit a RIC that invests in commodity interests to also indicate that, in addition to the SEC, the CFTC has not approved or disapproved of the securities or passed upon the accuracy or adequacy of the disclosure in the prospectus. Finally, the Division expects RICs and investment advisers to adopt compliance policies and procedures that address the accuracy of disclosures about derivatives use. The Division reminds RICs that the statement of additional information must also disclose the extent of the board’s role in overseeing risks, including derivatives.

To view the CFTC’s press release on the Final Rule click here and to view the final rule, click here.

To view the SEC’s Guidance click here.

The previous Investment Management Alert summarizing the CFTC’s February 2012 changes to the Rule 4.5 can be read here.