On October 9, 2018, the Commodity Futures Trading Commission (CFTC) proposed a number of changes in its regulations applicable to commodity pool operators (CPOs) and commodity trading advisors (CTAs) (the Proposal). The Proposal comes out of the CFTC’s Project KISS, which is an agency-wide review of rules with an aim to identify areas that can be simplified. In many respects, the Proposal seeks to codify no-action and interpretive positions previously taken by the CFTC staff, providing increased legal certainty via formal CFTC rules, but it also seeks to expand regulatory relief to CPOs and CTAs.
If adopted in its current form, the Proposal will codify and expand CPO and CTA registration relief in eight ways:
- Registered CPOs operating non-U.S. pools will be exempted from compliance with most of the CFTC’s disclosure, reporting and recordkeeping rules.
- U.S.-registered CPOs operating non-U.S. pools may maintain books and records in the location of the non-U.S. pool.
- CPOs will not be eligible for certain CPO exemptions if they or any of their principals are subject to statutory disqualification.
- Certain family offices will no longer be required to register as CPOs or CTAs.
- Advisors to business development companies will not be treated as CPOs.
- General solicitation and marketing will be expressly permitted for certain exempt pools, consistent with the Jumpstart Our Business Startups Act (JOBS Act).
- Non-U.S. persons will be explicitly listed as permitted participants in pools operated under Rule 4.13(a)(3), regardless of sophistication.
- CPOs and CTAs that are registered but not required to be registered will no longer be required to file Form CPO-PQR and Form CTA-PR, respectively.
The Proposal will be open for public comment through December 17, 2018.
Codification and Expansion of Staff Advisory 18-96
In 1996, the CFTC’s Division of Trading and Markets issued Advisory 18-96 that made generally available relief that the division had previously issued on a case-by-case basis to registered CPOs that operated offshore commodity pools. This relief came in two parts: (1) relief for registered CPOs operating offshore pools from most of the CFTC’s disclosure, reporting and recordkeeping rules, provided that the participants and source of funds are outside the United States; and (2) relief for U.S.-located registered CPOs from the requirement that that each maintain original books and records at its main business office (i.e., in the United States). CPOs claiming relief under Advisory 18-96 were required to file a notice of claim with the CFTC (this was later changed to a filing with the National Futures Association (NFA)).
Advisory 18-96 has been a useful source of regulatory relief but has one significant gap. While it provides relief from most applicable CFTC disclosure, reporting and recordkeeping rules with respect to pools operated under the first part of Advisory 18-96, it provides no relief from CFTC Rule 4.27, which was enacted in 2012, well after Advisory 18-96 was issued. Rule 4.27 sets forth the CFTC’s Form CPO-PQR reporting regime, which imposes significant reporting obligations on CPOs.
The Proposal would create a new CPO registration exemption under new Rule 4.13(a)(4), which would permit a CPO operating a pool pursuant to the first part of Advisory 18-96 to claim a registration exemption with respect to the pool. That is, the new exemption under Rule 4.13(a)(4) would operate just like other exemptions under Rule 4.13, including Rule 4.13(a)(3), in that it would provide an outright exemption from CFTC disclosure, reporting and recordkeeping requirements, including Form CPO-PQR reporting. Further, the exemption would be capable of being claimed by either a registered CPO or an exempt CPO and combined with other exemptions. A registered or exempt CPO could therefore claim Rule 4.13(a)(3) exemptions for some pools and Rule 4.13(a)(4) exemptions for other pools.
For a CPO to qualify for the new exemption under Rule 4.13(a)(4) with respect to a pool, that pool would have to satisfy the following requirements:
- The pool must be and remain organized and operated outside of the United States.
- The pool must not hold meetings or conduct administrative activities within the United States.
- No shareholder of or other participant in the pool may be a U.S. person.
- The pool may not receive, hold or invest any capital directly or indirectly contributed from sources within the United States.
- The CPO, the pool and any person affiliated therewith must not undertake any marketing activity for the purpose, or that could reasonably be expected to have the effect, of soliciting participation in the pool from U.S. persons.
These requirements are identical to those under the first part of Advisory 18-96, but because Rule 4.13(a)(4) would be styled as an exemption from CPO registration, a CPO claiming this relief would no longer need to be a registered CPO (which is a condition under the first part of Advisory 18-96). Having relief under Rule 4.13(a)(4) available on a pool-by-pool basis, as it is under Rule 4.13(a)(3), would prove important to non-U.S. CPOs that operate U.S.-facing pools and non-U.S. facing pools, allowing them to silo their non-U.S. business from most CFTC requirements.
The Proposal would also amend Rule 4.13(b) to incorporate relief under Rule 4.13(a)(4) into the existing timing and claims process under Rule 4.13; that is, CPOs relying on new Rule 4.13(a)(4) would need to notify investors of their reliance on the exemption and file a notice of claim with NFA, to be affirmed annually. The Proposal indicates that the CFTC intends to permit existing claimants under Advisory 18-96 to claim the new Rule 4.13(a)(4) exemption and that CPOs currently relying on Advisory 18-96 would need to switch to the exemption.
In addition, the CFTC Proposal would modify Rule 4.23 to preserve the recordkeeping relief under the second part of Advisory 18-96 for registered onshore CPOs that operate non-U.S. commodity pools. New Rule 4.23(c) would allow these CPOs to seek relief from the requirement to maintain books and records at the CPO’s main business office as long as the CPO files a claim for relief with NFA representing that:
- The CPO will maintain the original books and records of the commodity pool at the pool’s main business office located outside the United States and state the name, title, full mailing address, telephone number and relationship to the CPO of the person who will have custody of the pool’s original books and records and the location outside the United States where those books and records will be kept.
- The CPO desires to maintain such books and records outside the United States in furtherance of compliance with Internal Revenue Service requirements for relief from United States federal income taxation.
- The CPO will maintain duplicated books and records of the commodity pool at a designated office in the United States.
- The claim is electronically signed by an individual duly authorized to bind the pool operator.
- Within 72 hours after the request of a representative from the CFTC, the United States Department of Justice or the NFA, the original books and records will be provided to such representative at a place located in the United States that the representatives specify.
These requirements are substantively identical to those found in the second part of Advisory 18-96, but codification of the exemption will require CPOs to claim relief pursuant to new Rule 4.23(c) with NFA.
The Proposal would also make organizational, non-substantive changes to current recordkeeping requirements in Rule 4.23 to enhance understanding and readability.
Addition of Statutory Disqualification to Rule 4.13 CPO Registration Exemptions
Advisory 18-96, described above, prohibits CPOs that are, or have principals who are, subject to statutory disqualification under Sections 8a(2) or 8a(3) of the Commodity Exchange Act from qualifying for relief under either part of that advisory, subject to limited exceptions. The Proposal would apply statutory disqualifications to claims for relief under new Rule 4.13(a)(4) (the codification of the first type of relief provided under Advisory 18-96) but would do so in a way that would expand statutory disqualification to any CPO claiming relief from registration under Rule 4.13. The exemptions provided in CFTC Rules 4.13(a)(1), (2), (3) and (5) currently are available to a CPO, notwithstanding whether the CPO or any of its principals are subject to a statutory disqualification. The Proposal would make any claim for, or affirmation of a CPO exemption under Rule 4.13 conditional on the absence of any statutory disqualification. Borrowing from Advisory 18-96, statutory disqualification would not apply when (a) the statutory disqualification was previously disclosed in a CPO registration application that was ultimately granted, or (b) the statutory disqualification was disclosed to the CFTC or NFA more than 30 days prior to the claim of exemption.
CPOs claiming registration exemptions under Rule 4.13 are required to annually reaffirm their exemptions via a filing with NFA. This requirement would not be modified under the Proposal. As such, CPOs exempt under any part of Rule 4.13 would be required to reaffirm annually that they and their principals are not subject to any statutory disqualification. When this requirement is added to the upfront requirements associated with the initial notice of claim of exemption that must be filed with NFA, exempt CPOs may be required to do substantially more ongoing due diligence on their principals to ensure that they are not subject to a statutory disqualification.
Registration Exemptions for Family Offices
Prior to the passage of the Dodd-Frank Act in 2010, most Family Offices1 operating pooled investment vehicles that traded futures relied on the exemption from CPO registration found in old CFTC Rule 4.13(a)(4).2 The CFTC rescinded Rule 4.13(a)(4) shortly after Dodd-Frank was enacted and thereafter many Family Offices sought registration and reporting exemptions from the CFTC on a case-by-case basis. Subsequently, the Securities and Exchange Commission (SEC) adopted regulations that excluded Family Offices from the definition of “investment adviser” as defined by the Investment Advisers Act of 1940 (the Advisers Act).3 As a result, the CFTC eventually provided standing CPO and CTA registration relief in two staff letters. CFTC Staff Letter 12-37 provides an exemption from registration for CPOs that operate Family Offices, while CFTC Staff Letter 14-143 provides an exemption from registration for CTAs whose advisory services are limited to Family Offices and/or Family Clients. The Proposal would amend Rules 4.13 and 4.14 to incorporate the relief provided under CFTC Staff Letters 12-37 and 14-143, respectively.
The Proposal would not alter the requirements under Rule 4.13(b) for exempt CPOs claiming relief under Rule 4.13 to file notices of claim for the exemptions with NFA, so a Family Office seeking relief from CPO registration under new Rule 4.13(a)(8) (the new Family Office CPO registration exemption) would be required to file an initial claim with NFA and affirm that claim on an annual basis. This would replace the existing claims process under CFTC Staff Letter 12-37, which required a filing with the CFTC staff. Importantly, notices under CFTC Staff Letter 12-37 were not made public, whereas all exemption filings with NFA are made publicly available. This may be problematic for the Family Office community, which is generally private about the details of their businesses. Note that there would not be any required filing for the new CTA exemption for Family Offices under proposed Rule 4.14(a)(11), whereas a filing with the CFTC staff is required under CFTC Staff Letter 14-143.
Business Development Companies as “Qualifying Entities”
CFTC Rule 4.5 excludes certain persons from the definition of a CPO with respect to certain “qualifying entities.” These entities include registered investment companies under the Investment Company Act of 1940 (the ICA). Business development companies (BDCs) are closed-end companies regulated by the SEC under the ICA. However, BDCs are not “registered” investment companies. Instead, they are exempt from registration by virtue of filing an election with the SEC. Despite not being registered with the SEC under the ICA, BDCs are operated in a manner similar to closed-end registered investment companies, and they are subject to many of the same requirements under the ICA.
Even though a BDC is operated similarly to a registered investment company, it is not a qualifying entity under Rule 4.5. In response to correspondence requesting interpretive guidance, the CFTC staff issued CFTC Staff Letter 12-40 in 2012 to provide the operators of BDCs relief from CPO registration, subject to certain conditions. The Proposal would codify the relief provided in CFTC Staff Letter 12-40 by amending Rule 4.5 to exclude investment advisers of BDCs from the definition of CPO with respect to the BDCs they advise and to include BDCs as “qualifying entities.” Investment advisers of BDCs claiming CPO registration relief under Rule 4.5 would be required to affirm the exclusion annually, just as investment advisers of registered companies must do at present. The CFTC is not proposing modifications to Rule 4.6, which provides a parallel CTA exemption for CPOs relying on Rule 4.5, because the CFTC believes the existing language of Rule 4.6 is sufficient to exclude investment advisers of BDCs from being CTAs.
General Solicitation by CPOs Pursuant to the JOBS Act
Section 5 of the Securities Act of 1933 (the Securities Act) requires that any securities offering must be registered with the SEC. However, Section 4(a)(2) of the Securities Act provides an exemption from Section 5 registration for “transactions by an issuer not involving any public offering.”4 SEC Rule 506 provides a safe harbor for Section 4(a)(2) offerings, allowing securities offerings by an issuer to an unlimited number of “accredited investors” and no more than 35 nonaccredited sophisticated investors. These offerings are subject to other requirements, including a longstanding prohibition on general marketing or solicitation in the sale of those securities.
In 2012, the JOBS Act5 directed the SEC to make certain changes to securities regulations, including the prohibition on general solicitation in securities offerings pursuant to Rule 506. As a result, the SEC adopted Rule 506(c), which allows general solicitation in connection with the offer or sale of securities if (1) all purchasers are accredited investors and (2) the issuer takes reasonable steps to verify the accredited investor status of each purchaser. Offers and sales of securities under Rule 506(b) remain subject to the restrictions on general marketing or solicitation.
CFTC Rule 4.7 conditions relief under that rule on the offer and sale of participations in the pool being conducted “without marketing to the public.” CFTC Rule 4.13(a)(3) similarly requires that interests in the pool be “offered and sold without marketing to the public in the United States[.]” As these restrictions exist by operation of CFTC rules, as written they may prevent a CPO operating a Rule 4.7 or Rule 4.13(a)(3) pool from conducting a public offering in the manner contemplated by SEC Rule 506(c).
In response to this issue, the CFTC staff issued CFTC Staff Letter 14-116, which provides exemptive relief to CPOs of pool issuers and certain resellers by allowing general solicitation under certain conditions. The Proposal would codify this relief by modifying Rules 4.7 and 4.13(a)(3) to eliminate the “no public marketing” requirements and instead defer to the SEC rules as to the extent of public marketing that is permissible.
Other Proposed Changes
The Proposal contains two additional minor changes to existing rules.
First, under existing Rule 4.13(a)(3), CPOs are exempt from registration if
- the interests in the pool are offered or sold without marketing to the public;
- commodities trading in the fund falls under certain de minimis trading thresholds;
- the pool is offered only to certain sophisticated investors; and
- the CPO does not market the pool as a vehicle for trading in commodity futures or commodity options markets.
CFTC Letter 04-13, which was issued in 2004 shortly after Rule 4.13(a)(3) was enacted, allowed non-U.S. person investors to participate in pools operated under Rule 4.13(a)(3) regardless of whether they otherwise satisfy the sophisticated investor requirements under that rule. Letter 04-13 was in part predicated on the fact that it did not make sense for non-U.S. persons to be allowed to participate in pools operated under old Rule 4.13(a)(4) (the sophisticated pool exemption) but not allowed to participate in pools operated under Rule 4.13(a)(3) (the de minimis exemption). However, the CFTC subsequently eliminated old Rule 4.13(a)(3), which raises the question of whether CTFC Staff Letter 04-13 continues to allow non-U.S. investors in pools operated under Rule 4.13(a)(3). The Proposal would specifically add non-U.S. persons as permitted participants in Rule 4.13(a)(3) pools, regardless of whether they otherwise satisfy the sophistication requirements under Rule 4.13(a)(3). However, the CFTC has not defined “U.S. person” in the Proposal. Presumably, the CFTC would look to the definition of “non-United States person” under Rule 4.7; however, that is an area which could be clarified by the CFTC.
Second, Rule 4.27(b) requires that all CPOs that are registered or required to be registered must submit information on their operations and each commodity pool that they operate on Form CPO-PQR. Similarly, CTAs that are registered or required to be registered must provide information regarding their operations and the pool assets that they direct on Form CTA-PR. Collectively, these CPOs and CTAs are defined under the rules as “reporting persons.” However, the CFTC has noticed that some CPOs and CTAs maintain their respective registrations, even though they only operate or direct exempt pools and accounts (i.e., they are not required to be registered). These CPOs and CTAs are currently considered reporting persons, and as a result, must submit Form CPO-PQR or CTA-PR. The information gathered from these forms with respect to these voluntarily registered CPOs and CTAs is not, however, meaningful to the CFTC, which caused the CFTC to provide relief for CPOs that are registered but need not be (in CFTC Staff Letter 14-115) and CTAs that are registered but need not be (in CFTC Staff Letter 15-47). Consistent with these letters, the Proposal would amend Rule 4.27(b) to exclude these CPOs and CTAs from the definition of “reporting persons.”