I. Introduction and Executive Summary
At an open meeting held on November 25, 2019, the Commodity Futures Trading Commission (the “CFTC” or the “Commission”) adopted two sets of final rule amendments to its Part 4 regulations governing commodity pool operators (“CPOs”) and commodity trading advisors (“CTAs”).1 These amendments finalize a subset of the Part 4 amendments the CFTC proposed last fall (the “2018 Proposal” or “Proposal”).2 The amendments are effective as of January 9, 2020 (the “Effective Date”). Required actions and compliance dates for each component are indicated below.
As described by CFTC Chairman Heath Tarbert in his opening remarks at the open meeting at which the amendments were adopted:
Each amendment is designed to simplify the rules governing CPOs and CTAs, advancing our strategic goal of “encouraging innovation and enhancing the regulatory experience for market participants at home and abroad.” In particular, today’s amendments to Part 4 will also improve harmonization for market participants subject to concurrent CFTC and SEC jurisdiction.3
A. Overview of Final Amendments – Required Actions and Compliance Dates
The final rule amendments, which for the most part, codify and supersede existing relief granted in CFTC staff letters or provide clarification with respect to existing industry practices, comprise six separate components, which are summarized below. A more detailed discussion of the amendments is provided in Part III.
1. Rule 4.5 Designation of the Adviser to a Registered Fund as the Excluded CPO. Amendment of Rule 4.5(a) to designate the investment adviser to an SEC-registered investment company (a “Registered Fund” or “RIC”), rather than the RIC itself, as the person to claim the Rule 4.5 CPO exclusion for operation of the RIC (reflecting a practice currently permitted by National Futures Association (“NFA”) guidance and used for many Registered Funds).4
Required Actions and Compliance Date. As a result of the amendment, the investment adviser to a RIC, rather than the RIC, is now required to claim the Rule 4.5 CPO exclusion and to make the related notice filing under Rule 4.5(c). Many advisers to RICs already do so and will not need to take any action. Advisers to RICs for which the Rule 4.5 CPO exclusion was previously filed by the RIC will be required to make a new Rule 4.5 notice filing claiming the exclusion on behalf of the adviser. The compliance date for Rule 4.5 notice filings by advisers to RICs affected by the amendment (that is, where the claim was previously made by the RIC) is March 1, 2021, giving such advisers an extra year to make the filing. The compliance date for Rule 4.5 notice filings by advisers to new RICs is the Effective Date.5
2. Business Development Company CPO Exclusion. Amendments to Rule 4.5(a)(1) and (b)(1) that provide a new Rule 4.5 CPO exclusion for investment advisers to business development companies that engage in limited commodity interest activities (“BDCs”) (codifying and superseding an existing no-action letter).
Required Actions and Compliance Date. Advisers to BDCs seeking to rely on the new exclusion should file a notice to claim the exclusion with the NFA, pursuant to Rule 4.5(c), as soon as practicable after the Effective Date. The adviser should also put in place a process for annual reaffirmation of the claim (which was not required under the prior no-action letter).
3. JOBS Act Harmonization. Amendments to Rule 4.7(b) and Rule 4.13(a)(3) that permit CPOs relying on these rules to conduct general solicitation activities permitted by the Jumpstart Our Business Startups Act of 2012 (“JOBS Act”) and related SEC rules (codifying and superseding an existing exemptive letter).
Required Actions and Compliance Date. No additional filings are required beyond the notice filings already required for CPOs relying on either Rule 4.7(b) or Rule 4.13(a)(3).6
4. Form CPO-PQR and CTA-PR Reporting Persons Relief. Amendments to Rule 4.27 eliminating the requirement to file Forms CPO-PQR and CTA-PR for certain categories of registered CPOs and CTAs (generally CPOs and CTAs providing services only to exempt pools or accounts) (codifying and expanding existing exemptive letters).
Required Actions and Compliance Date. No further action is required.
5. Acceptance of Non-U.S. Persons and other Rule 4.7 “QEPs” in Rule 4.13(a)(3) Exempt Pools. Amendments to Rule 4.13(a)(3) clarifying that all qualified eligible persons (“QEPs”) as defined in Rule 4.7, including Non-U.S. Persons, are permissible participants in Rule 4.13(a)(3) “de minimis” pools (superseding prior staff interpretive relief).
Required Actions and Compliance Date. No further action is required.
6. Family Office Exemptions. Exemptions from CPO and CTA registration for “family offices,” as defined in Securities and Exchange Commission (“SEC”) rules, adopted as new Rules 4.13(a)(6) (for CPOs) and 4.14(a)(11) (for CTAs) (codifying and superseding existing no-action letters).
Required Actions and Compliance Date. Persons relying on the new family office exemptions should, as soon as practicable after the Effective Date, create and maintain an internal record documenting the relevant exemption they wish to claim, as well as their qualifications for that exemption. No filings are required.
B. Two Roads Not Taken – Withdrawal of the “18-96 Exemption” Proposal; Deferral of Consideration of the Proposed “Statutory Disqualification Bar” for Rule 4.13 Exemptions
The CFTC determined that it would not, at this time, adopt final rules relating to two components of the 2018 Proposal that had generated substantial concerns in the comment process: (1) the proposed “18-96 Exemption,” a new exemption for CPOs of offshore funds modeled after existing CFTC Staff Advisory 18-96,7 and (2) a proposal to add a “statutory disqualification bar” to a number of existing CPO exemptions, as well as to the proposed offshore CPO exemption.
The 18-96 Exemption Proposal. In light of the comments received, the Commission withdrew the 18-96 Exemption proposal.8 Commenters raised concerns about both (1) the proposed criteria for claiming the new exemption and (2) the interaction of the proposed exemption with CFTC Rule 3.10(c)(3)(i), the Commission’s existing exemption for offshore CPOs of offshore pools, on which offshore CPOs currently rely. Generally, these commenters expressed concerns that the criteria for claiming the exemption would be overly narrow and burdensome relative to the Commission’s regulatory goals, as well as outdated and out of step with the realities of current global markets and global business practices. With respect to interaction with Rule 3.10(c)(3)(i), several commenters said that certain statements in the Proposing Release relating to the 18-96 Exemption proposal were inconsistent with widespread industry understanding, and would represent a departure from Commission precedent and its historic approach to application of CPO exemptions. The Adopting Release states that the Commission may undertake a more comprehensive review of the extraterritorial application of its regulation in the CPO-CTA space in the future.9
The statutory disqualification bar proposal. This proposal was intended to “provid[e] additional protection to members of the public by reducing the possibility of fraud and other illegal conduct in exempt pools offered by [unregisterable] persons.”10 Concerns about the proposal included logistical questions about how the prohibition would operate in the context of exempt CPOs, procedural and interpretive questions about the statutory disqualification provisions in Section 8a(2) and (3) based on the wording of the statute and the breadth of the conduct covered, concerns about procedural protections, and skepticism about whether the additional burdens of the condition were justified by the regulatory concerns. The Adopting Release states that the Commission believes that those comments require consideration and that it intends to reconsider these amendments in a future rulemaking.11
C. Open Meeting and Open Discussion – Food for Thought The open meeting provided a forum for substantive discussion by all of the Commissioners on the matters before them, as well as more generally on the appropriate scope and manner of CFTC regulation of asset managers. The Commissioners participated actively in the open meeting, expressed their views and areas of concern, and asked a number of questions of DSIO staff, all of which indicated appreciation of the importance of CFTC regulation of the asset management industry and recognition of the related challenges.12
For market participants and practitioners that follow the CFTC’s regulation of asset managers, and that may be interested in engaging with the Commission in this area, both Adopting Releases, the formal statements submitted, and the exchanges of views at the open meeting are all well worth careful review for possible indications of what can be expected on the CFTC’s agenda, and in its approach for regulating asset managers, in the months to come. Additional suggestions of “food for thought” that may be found in these materials are noted in the last section of this Client Alert.
II. Discussion of the Amendments
A. Amendment of Rule 4.5(a)(1) to Designate the Investment Adviser to a Registered Fund as the Excluded CPO
The Commission amended Rule 4.5(a)(1), which provides an exclusion from the definition of CPO for operators of Registered Funds (investment companies registered with the SEC under the Investment Company of Act of 1940 (the “ICA”)) that meet the commodity interest trading and marketing criteria in the rule. The amendment expressly designates the Registered Fund’s investment adviser (“RIA”) as the person excluded from the CPO definition.
In its current form, the terms of Rule 4.5 provide a CPO exclusion for the Registered Fund itself, rather than for the Registered Fund’s RIA. The CFTC proposed this amendment in order to align the terms of Rule 4.5 with its determination in 2012 that, for Registered Funds that do not qualify for the Rule 4.5 CPO exclusion, the Registered Fund’s RIA is the appropriate person to register and serve as the Fund’s CPO for regulatory purposes.
The Adopting Release explains the Commission’s reasoning as follows:
Consistent with its prior statements concerning the person that should claim the CPO exclusion in Regulation 4.5 with respect to the operations of a RIC, and with the Commission’s conclusion that the [RIC’s] RIA is the most appropriate person to register as a CPO of a RIC that exceeds the trading thresholds in Regulation 4.5, the Commission believes it appropriate to specify the [RIC’s] RIA as that excluded person, instead of the RIC.13
Notwithstanding the current wording of the rule, however, the NFA has provided guidance to the effect that it is permissible for either the Registered Fund or the RIA to claim the exclusion, and there are certain advantages to having the RIA, rather than the Registered Fund, claim the exclusion.14 Accordingly, consistent with the NFA guidance, many fund groups already take the approach that is now reflected in the amended rule – the RIA rather than the Registered Fund claims the exclusion – and thus will not be affected by the amendment.
The Adopting Release addresses comments raised about logistical issues for RICs where the Rule 4.5 claim is currently filed by the RIC rather than the RIA, specifically practical implications and compliance costs involved in making the change and potential impact on fund disclosure. With respect to disclosure, Rule 4.5 requires a person claiming the exclusion with respect to a RIC to disclose reliance on the exclusion to Fund shareholders. This disclosure is typically made in the Fund’s registration statement and would identify the person claiming the exclusion (either the Fund itself or the Fund’s adviser). One commenter noted that changing the excluded CPO from the Registered Fund to the RIA could be considered a material change that would necessitate an off-cycle amendment to the Fund’s registration statement, the costs of which would be borne by the Fund and its shareholders.
In response to these comments, the Commission took two steps to mitigate these concerns regarding compliance transition. First, as indicated above, the Commission adopted a compliance date of March 1, 2021, for RIAs that will be affected by the amendment.15
The Commission recognizes that it may be overly burdensome for RIAs of RICs to file the revised annual notices pursuant to Regulation 4.5(c)(5) when they are due in early 2020. Therefore, the Commission has determined that compliance with Regulation 4.5(c)(5) by RIAs with respect to RICs affected by the amendment to Regulation 4.5(a)(1) shall not be required until within 60 days of the end of the calendar year 2020, i.e., March 1, 2021. The Commission believes this approach will minimize any inconvenience or cost associated with the transition to designating the RIA as the excluded CPO for the RIC.16
In addition, the Commission adopted an interpretation designed to address the regulatory transition and future compliance with the filing requirement in Rules 4.5(c) and (d). Rule 4.5(d) requires a person who has claimed an exclusion under Rule 4.5 to file an amended notice within 15 business days after certain events, including if the notice becomes inaccurate or incomplete. The interpretation adopted by the Commission clarifies that RIAs affected by the amendment are not, by virtue of the amendment, required to file an amended notice under Rule 4.5(d).
[I]f a person other than a RIC’s RIA has claimed the CPO exclusion with respect to such RIC through the required notice filing, the Commission interprets Regulations 4.5(d)(1)-(d)(2) not to apply in such a manner that an amended notice within 15 business days would be required to reflect changing the excluded CPO entity to the RIC’s RIA. Rather, the Commission interprets Regulation 4.5(c)(5) to require that, when the excluded CPO of such RIC is required to annually reaffirm its notice of exclusion, (i.e., within 60 days of the calendar year-end), the excluded CPO entity will simply allow the existing notice to expire, and the RIA of such RIC will file a new notice pursuant to Regulation 4.5(c), prior to the expiration of the other existing notice. Where an RIA has claimed the exclusion with respect to a RIC through a notice filing, the RIA will simply continue to affirm the notice as usual.17
With respect to the concern that changing the excluded CPO to the RIA could constitute a material change necessitating an “off-cycle” amendment to the RIC’s registration statements, the Commission stated that it is not in a position to make a determination as to whether this is, in fact, a material change, and that the RIC must make that determination. The Adopting Release notes, however, that notwithstanding the change in the language of the rule, the intent behind Rule 4.5(a)(1) remains the same – no person acting as the CPO of a RIC is required to register as a CPO with respect to the operation of the RIC, provided that the applicable requirements and conditions of the rule are satisfied. Accordingly, from the Commission’s perspective, “there is no substantive change with respect to the RIC’s legal posture under the Commission’s regulations.”18
B. Adoption of CPO Exclusion for Investment Advisers to BDCs
The CFTC amended Rule 4.5 to provide a CPO exclusion for investment advisers to BDCs (as that term is defined in the ICA) that meet the same commodity interest trading and marketing restrictions imposed by the rule on Registered Funds. The proposed amendments would be consistent with no-action relief from the CPO registration requirement previously provided to investment advisers of BDCs (the “BDC No-Action Letter”) and would impose the same operational conditions as the BDC No-Action Letter.19 However, the relief provided by the amendment would be somewhat broader, in that it would provide an exclusion from the definition of CPO rather than, effectively, an exemption from registration. The Rule 4.5 amendment would also change the filing requirement for advisers to BDCs, from an initial notice to DSIO, as required by the BDC No-Action Letter, to a Rule 4.5 filing with NFA through its electronic filing system that would require annual reaffirmation.
C. JOBS Act Amendments – Harmonization with SEC JOBS Act Rules Permitting “General Solicitation”
The CFTC adopted amendments to Rules 4.7(b) and 4.13(a)(3) that will permit qualifying CPOs of private funds to engage in general solicitation in their pool offerings under the limited circumstances contemplated by Congress in adopting the JOBS Act and as permitted by related SEC rules adopted in 2013.20 In accordance with the JOBS Act, SEC Rules 506(c) and 144A permit persons relying on certain private offering exemptions from the SEC’s registration requirements to engage in general solicitation, as long as the person takes reasonable steps to ensure that all purchasers in the offerings meet the investor qualification standards for the relevant exemption (accredited investor status for Rule 506(c) and qualified institutional buyer status for Rule 144A).
Prior to the new amendments, the terms of both Rule 4.7(b) and Rule 4.13(a)(3) imposed a restriction on marketing to the public, without an exception for general solicitation activities permitted by the SEC’s JOBS Act rules.
The amendments generally codify a letter previously issued by DSIO that provides exemptive relief under both rules in order to achieve harmonization of CFTC and SEC rules in this respect.21 In addition, the amendments include certain organizational changes to Rule 4.7(b)(1) and a minor amendment to Regulation 4.13(a)(3)(i), designed to clarify which exempt CPOs are eligible for relief from the offering restrictions pursuant to the JOBS Act amendments and to improve the readability and clarity of the Rules.
D. Forms CPO-PQR and CTA-PR Filing Relief for Certain Registered CPOs and CTAs
The Commission adopted amendments to Rule 4.27, the reporting rule requiring registered CPOs and CTAs to file with the NFA reports on Forms CPO-PQR and CTA-PR, respectively, that eliminate the relevant filing requirement for the following categories of registered CPOs and CTAs:
- Registered CPOs that operate only pools for which they rely on the CPO exclusion provided by Rule 4.5 and/or the exemption from CPO registration under Rule 4.13 (collectively “exempt pools”); and
- Registered CTAs that either (a) do not direct the trading of any commodity interest accounts or (b) direct only the accounts of commodity pools for which the CTA also serves as a registered or exempt CPO and relies on the CTA exemptions available for such CPOs.
The amendment revises the definition of “reporting person” in Rule 4.27, which identifies the types, classes, or categories of CPOs and CTAs that are required to file the forms, by excluding the types of CPOs and CTAs described above from the definition.
These amendments reflect the Commission’s recognition that, for certain types of CPOs and CTAs, the filing of Form CPO-PQR or Form CTA-PR would provide limited additional information regarding the CPO or CTA beyond the information already available to the Commission (as part of the registration process and the CPO’s or CTA’s ongoing reporting and other obligations as registrants). Therefore, requiring these registrants to file Form CPO-PQR or Form CTA-PR, and to incur the related costs and burdens, would not further the purposes of the CFTC’s regulations.22
E. Amendment to Rule 4.13(a)(3) to Clarify that all Rule 4.7 QEPs, Including Non-U.S. Persons, are Permitted Investors
The Commission adopted an amendment to Rule 4.13(a)(3), which provides an exemption for CPOs of pools that are sold in limited offerings and engage in only de minimis commodity interest trading activities, that clarifies the categories of permissible investors in these pools.¬¬ Specifically, the Commission amended Rule 4.13(a)(3)(iii)(D) to clarify that all QEPs, as that term is defined in Rule 4.7, are permitted investors in Rule 4.13(a)(3) pools. As a result of this change, permitted investors in Rule 4.13(a)(3) pools expressly include both all Non-U.S. persons, as defined in Rule 4.7, regardless of whether they meet a financial sophistication test, and any other persons that qualify as QEPs under Rule 4.7.
Prior to the amendment, Rule 4.13(a)(3)(iii)(D) referred only to QEPs as defined in Rule 4.7(a)(2)(viii)(A), which does not refer to non-U.S. persons or types of QEPs described in other parts of Rule 4.7(a). With respect to permissible investors in rule 4.13(a)(3) pools, market participants historically have relied on relief in a staff interpretative letter (CFTC Letter 04-13) and guidance provided by DSIO in the form of frequently asked questions.23
In connection with this amendment, the Commission also rescinded Rule 4.13(a)(3)(iii)(E). This provision refers to investors permitted under Rule 4.13(a)(4), which the Commission rescinded in 2012.
F. Family Office Exemptions
The Commission adopted amendments to Rules 4.13 and 4.14 that provide new CPO and CTA registration exemptions for “family offices,” as defined in rules adopted by the SEC under the Investment Advisers Act of 1940 (“Advisers Act”). The SEC family office rules exclude family offices from the definition of investment adviser under the Advisers Act (“SEC Family Office Exclusion”).24 The CFTC rule amendments codify and supersede registration relief previously provided in two DSIO no-action letters (the “Family Office No-Action Letters”).25 As of the Effective Date, persons that previously relied on the Family Office No-Action Letters will no longer be able to do so, and must instead rely on the new family office exemptions.26
1. The CPO Exemption
Under new Rule 4.13(a)(6) (originally proposed as Rule 4.13(a)(8)), a CPO is not required to register as such if, for each pool for which the person claims exemption from registration under the new rule:
(i) Interests in the pool are exempt from registration under the Securities Act of 1933 and such interests are offered and sold only to ‘‘family clients’’ as defined in the SEC Family Office Exclusion;
(ii) The person qualifies as a “family office,” as defined in the SEC Family Office Exclusion; and
(iii) The person reasonably believes, at the time of investment, or in the case of an existing pool, at the time of conversion to a pool meeting the criteria of Rule 4.13(a)(6), that each person who participates in the pool is a “family client” of the “family office,” as defined in the SEC Family Office Exclusion.
In a change from both the 2018 Proposal and the current no-action relief, the exemption in Rule 4.13(a)(6) is self-executing; persons claiming CPO registration relief under Rule 4.13(a)(6) will not be required to make a notice filing.27
A CPO relying on new Rule 4.13(a)(6) will be subject to the same recordkeeping requirements and CFTC special call authority that apply to other exempt CPOs. The final rule amendments include an amendment to Rule 4.13(c), which is intended to implement these recordkeeping requirements for persons relying on Rule 4.13(a)(6), as well as on other Rule 4.13(a) exemptions.28
2. The CTA Exemption
For CTAs, new Rule 4.14(a)(11) provides registration relief for any person whose commodity trading advice is solely directed to, and is for the sole use of, “family clients,” as defined in the SEC Family Office Exclusion.29 As proposed, reliance on Rule 4.14(a)(11) will be self-executing and will not require a notice filing.30
III. Outlook for Further CFTC Regulation of Asset Managers
The Commission’s actions at the November 25, 2019, open meeting generally address codification and clarification of matters on which there is widespread consensus and that serve widely supported goals of transparency and certainty in regulation, as well as furthering goals of simplification and harmonization with SEC regulation in specific areas where investor protection is not compromised. The two most substantive and policy-driven components of the 2018 Proposal were withdrawn or withheld for further consideration in light of comments received.
Notwithstanding the limited impact of the specific actions the Commission took on most asset managers, however, there is much food for thought both in the Adopting Releases and the discussion at the open meeting. The open meeting itself showed a commitment to open regulatory dialogue and exchange of ideas, and provided a forum for substantive discussion by all of the Commissioners on the matters before them, as well as more generally on the appropriate scope and manner of CFTC regulation of asset managers. A number of themes reflected in the amendments – for example, the focus on “smart” data collection (elimination of reports with little or no utility); the CFTC’s tailoring its regulation to the appropriate level of regulatory interest; harmonization of regulatory requirements for dual registrants; providing regulatory certainty and transparency; and improving the regulatory experience, in all cases without compromising the Commission’s regulatory mission – can have relevance for a broader set of issues.
For these reasons, while the recent amendments may not, in themselves, have a significant impact, the actions taken and the accompanying process and exchange of views could be harbingers of more significant developments to come, and may provide valuable insight for market participants and practitioners as preparation for future engagement on those developments.