On June 4, 2020, the Commodity Futures Trading Commission (CFTC) unanimously approved the adoption of a final rule (Final Rule)1 prohibiting a commodity pool operator2 (CPO) that has, or whose principals have, in its background conduct that would result in automatic statutory disqualification under the Commodity Exchange Act (CEA) from claiming an exemption from CPO registration under Rule 4.13.
The final rule closes a loophole whereby a bad actor who is barred from registering a CPO or a principal thereof was not similarly barred from taking advantage of an exemption from registration. We answer the following key questions about the rule below.
The Final Rule
The Final Rule requires any person claiming an exemption from registration as a CPO under Regulation 4.13 to represent that, subject to certain exceptions, neither the claimant nor any of its principals has a CEA Section 8a(2) disqualification (Statutory Disqualification) that would require disclosure if the claimant sought registration with the CFTC (Representation). The Statutory Disqualifications under the CEA include, among other things, serious types of financial crimes, such as theft, fraud, bribery, embezzlement, and misappropriation and findings or settlements consenting to findings that a person has violated a U.S. investment-related statute and/or rules and regulations.3 The Final Rule’s prohibition on Statutory Disqualifications, however, does not include offenses listed in CEA Section 8(a)(3), which would require a hearing prior to disqualification.
The Final Rule also excludes Statutory Disqualifications that were previously disclosed to the CFTC in a registration application if the CFTC chose to permit the registration despite the disqualification. This exclusion is noteworthy because some CPOs register with the CFTC with respect to certain pools that it manages, but claim a registration exemption with respect to other pools.
Persons having a Statutory Disqualification may seek exemptive letter relief from the Representation individually or on a firm-by-firm basis. Such persons would have to demonstrate, through facts and legal rationale, that such relief is consistent with public interest and customer protection. The CFTC has stated that it expects to grant the relief infrequently and only when strongly supported by the facts and the law.
The CFTC further advised that a CPO may apply for CPO registration, in which the CPO would have to disclose all of its Statutory Disqualifications, if exemptive letter relief is not granted. The CPO may provide a detailed analysis of each Statutory Disqualification in its application. The CFTC can then assess whether any conditions or restrictions might sufficiently mitigate customer protection risks posed by persons or principals with Statutory Disqualifications.
The CFTC declined to exclude investment advisers registered under the Investment Advisers Act of 1940 (Advisers Act) from the Final Rule’s scope. Family offices, however, relying on the new exemption in Regulation 4.13(a)(6) (published December 2019), which are not subject to the notice filing requirement, are not required to make the Representation.
The Final Rule’s effective date is 60 days after publication in the Federal Register. Persons who are then currently relying on a CPO registration exemption under Regulation 4.13 are required to comply with the Final Rule when such persons next file a notice of exemption for the 2021 filing cycle (i.e., March 1, 2021). Persons claiming a Regulation 4.13 exemption for the first time on or after the Final Rule’s effective date are required to comply with the Final Rule when first filing a notice of exemption.
Based on the requirements of the rule, persons currently relying on a CPO registration exemption under Regulation 4.13 will need to determine whether they, or a principal, have a non-excluded Statutory Disqualification under the Final Rule in time for the 2021 filing cycle. This requires a close review of CEA Section 8a(2) (and the Statutory Disqualifications thereunder) and each relevant parties’ disciplinary history.
If there are no Statutory Disqualifications, such persons may continue relying on their CPO registration exemption. However, if a person does find itself or its principals with a non-excluded Statutory Disqualification, such person will need to seek exemptive letter relief from the Final Rule in order to maintain its CPO registration exemption after the 2021 filing cycle. As stated above, those seeking exemptive relief will need to present a strong showing that such relief is consistent with public interest and customer protection.
CPOs that have Statutory Disqualifications or have principals with Statutory Disqualifications in their backgrounds and that are registering as CPOs must disclose the Statutory Disqualifications in their registration applications filed with the National Futures Association (NFA). The NFA, however, may nevertheless permit such registration. On the other hand, exempt CPOs do not have this avenue available as they do not file registration applications with the NFA. Nevertheless, a CPO and its principals that have Statutory Disqualifications in their backgrounds and would otherwise be precluded from seeking an exemption under Rule 4.13 may seek individual exemptive relief from the Division of Swap Dealer and Intermediary Oversight.
Further, the Statutory Disqualifications materially differ from the disqualification provisions applicable to registered investment advisers under Section 203(e) of the Advisers Act. As such, a registered investment adviser relying on a Rule 4.13 CPO exemption should assess and confirm that their policies and procedures suit the provisions under each statute.