On December 12, 2012, the U.S. District Court for the District of Columbia released its decision in Investment Company Institute v. U.S. Commodity Futures Trading Commission, rebuffing the Investment Company Institute (ICI)’s and U.S. Chamber of Commerce (Chamber)’s efforts to overturn recently adopted Commodity Futures Trading Commission (CFTC) amendments to CFTC Rules 4.5 (exclusion from definition of commodity pool operator) (CPO) and 4.27 (CPO and CTA reporting requirements) (the Amended Rules).
The Amended Rules substantially narrowed certain CPO registration and reporting exclusions available to registered investment companies (RICs) and their investment advisers (Advisers). The Amended Rules were adopted in response to the aftermath of the 2008 financial crisis and at the behest of the National Futures Association (NFA), which had asserted that certain mutual funds were effectively operating commodity pools beyond the regulatory reach of the CFTC. Rule 4.5, as amended, reinstated the requirements for a RIC to qualify for exclusion from the definition of CPO to pre-2003 standards, and added further requirements, including a ban on advertising.
The ICI and Chamber asserted that the Amended Rules, among other things, (i) failed to adequately consider factors mandated by the Commodity Exchange Act (CEA), (ii) failed to adequately harmonize the Amended Rules with those of the Securities and Exchange Commission (SEC), and (iii) imposed unwarranted burdens on already highly regulated RICs. The theories underlying the challenge were similar to those that have had a tried-and-true record of recent success before the court in setting aside other controversial rules adopted by other administrative agencies, including the SEC. Here, however, the court was not persuaded by the ICI’s and Chamber’s arguments and concluded that the CFTC’s administrative rule-making process was distinguishable from the other cases.
The court found that the CFTC had adequately acknowledged potential overlap in regulatory regimes and took steps to explore possible harmonization of the regimes, including the suspension of compliance with the reporting obligations in Part 4 of its regulations for RICs until after the release of the final harmonization rule that was proposed at the time of adoption of Amended Rule 4.5.1 The court noted that RICs that do not qualify for the exclusion under Amended Rule 4.5 will be required to register with the CFTC pursuant to Amended Rule 4.5 as of December 31, 2012; however, RICs will not have to comply with recordkeeping, reporting, and disclosure requirements of the Amended Rules, including the Amended Rule 4.27 reporting requirement, until 60 days following the effectiveness of a final harmonization rule. As of the date of this Alert, it is not clear when the final harmonization rules will be adopted.
RICs unable to meet the amended Rule 4.5 exemption from CPO registration must register with the CFTC by December 31, 2012.
- Determine whether you need to register or whether you will be exempt from registration. Also, you should inquire whether any CFTC no-action relief with respect to the implementation of the Amended Rules is applicable. (For instance the CFTC issued no-action relief on November 29, 2012 with respect to certain fund of funds arrangements).
- Determine what entity will register as a CPO (the fund or its investment adviser).
- If you need to register, evaluate your current disclosure, policies and procedures and update your compliance manual as necessary.
- Begin preparations for Rule 4.27 compliance. Emboldened by the victory in the litigation, the CFTC may move quickly to finalize adoption of the proposed harmonization rules and comprehensive disclosure and reporting scheme for RICs.