On August 13, the CFTC adopted final rules setting forth a harmonization scheme that would apply to mutual funds and closed-end funds (RICs) that participate in commodity investments (e.g., futures and most swaps) beyond a de minimis trading level or that market themselves as participating in commodity investments. Sponsors, distributors and/or managers of these non-exempt funds were required to register with the CFTC as a Commodity Pool Operator (CPO) by December 31, 2012. However, these CPOs' disclosure, recordkeeping and reporting obligations were suspended pending the CFTC's adoption of proposals seeking to harmonize the CFTC and SEC compliance schemes applicable to CPOs of RICs.

With the harmonization scheme adopted last week, RIC CPOs will be required to meet applicable CFTC disclosure, reporting and recordkeeping obligations. However, their compliance burden is significantly mitigated as the adopted rules permit a "substituted compliance" approach, under which the CFTC will deem, in large part, the RIC CPO's compliance with the SEC's disclosure, reporting and recordkeeping requirements as dual compliance with applicable CFTC rules. If, however, at any time, the CPO of a RIC is not in compliance with SEC parallel requirements, the CPO will be deemed to have violated CFTC regulations and could be subject to both SEC and CFTC enforcement actions.

Substituted Compliance Approach

Under the harmonization scheme, RIC CPOs can choose whether to comply with the CFTC compliance obligations in full, or rely on the "substituted compliance" regime. To rely on the "substituted compliance" regime, the CPO of the RIC must:

  • file a notice with the National Futures Association (NFA) that it will use the substituted compliance regime; 
  • for funds that have less than 3 years of operations, they must disclose the performance of all accounts and pools that are managed by the CPO and that have investment objectives, policies, and strategies substantially similar to those of the fund; 
  • file financial statements with the NFA that it prepares pursuant to SEC requirements; and 
  • file a notice with the NFA indicating use or intent to use third-party service providers for recordkeeping purposes, and file a statement from a third party record-keeper acknowledging its agreement to keep the RIC's records covered by CFTC rules and to make those records available for inspection.

Each open-end RIC must meet all conditions of the rule by the time of its filing of its next post-effective amendment with the SEC (for new RICs, at the time of filing its initial registration statement). Closedend RICs also must meet the requirements by the time of the filing of their next registration statement.

SEC's Guidance Update

The SEC staff (Staff) issued a guidance update summarizing the views of the SEC's Division of Investment Management on disclosure and compliance matters concerning RICs' investments in commodities and derivatives. The Staff reiterated its concern that funds must clearly and adequately disclose their use of commodities and derivatives, and their associated risks. The Staff also reminded funds about their obligation to disclose information about the Board's role in risk oversight, including investment risk.

The guidance also discusses how funds with fewer than three years of performance may, in conformity with the new CFTC rules, disclose in prospectuses performance of other accounts or pools with substantially similar investment objectives, policies and strategies. The Staff suggested that these performance disclosures should generally include the performance of all other funds and accounts meeting the criteria (unless their exclusion would not cause the performance shown to be materially misleading).

The Staff also reiterated that fund and adviser compliance programs should include policies to ensure consistency of investments with disclosed investment strategies. Finally, the Staff noted that, for RICs investing in commodities, the mandated legend under Rule 481 ("the SEC has not approved or disapproved of the securities . . .") should be amended to indicate also that the CFTC has not approved of the disclosures in a registration statement.

Final Rule: Harmonization of Compliance Obligations for Registered Investment Companies Required to Register as Commodity Pool Operators, Commodity Futures Trading Commission (RIN 3038-AD75) (August 13, 2013).

Disclosure and Compliance Matters for Investment Company Registrants that Invest in Commodity Interests, Securities & Exchange Commission, IM-Guidance Update No. 2013-05 (August 2013).