As part of implementing new statutory provisions enacted by the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”), the Commodity Futures Trading Commission (the “CFTC”) is proposing rules that would (i) rescind exemptions from commodity pool operator (“CPO”) registration under CFTC Rules 4.13(a)(3) and 4.13(a)(4); (ii) reinstate trading criteria for registered investment companies to qualify for the CFTC Rule 4.5 exclusion; (iii) implement new reporting requirements for CPOs and commodity trading advisors (“CTAs”); (iv) eliminate exemptive relief from the annual report certification requirement for pools operated pursuant to CFTC Rule 4.7; (v) require all persons claiming exclusionary or exemptive relief under Rules 4.5, 4.13, and 4.14 to confirm their notice of an exclusion or an exemption annually; (vi) amend the required risk disclosure statement in CPO and CTA disclosure documents to describe risks specific to swaps transactions; and (vii) incorporate by reference the Securities and Exchange Commission’s (“SEC”) accredited investor standard. Comments on the proposed rules are due sixty days following the date of publication in the Federal Register, which is expected to occur shortly. We have set forth below a brief summary of this rulemaking proceeding.
Rescind Exemptions from CPO Registration Under CFTC Rules 4.13(a)(3) and 4.13(a)(4)
The CFTC is proposing to rescind the exemptions from registration as a CPO under Rules 4.13(a)(3) and 4.13(a)(4).
- Rule 4.13(a)(3) provides an exemption from CPO registration for the operators of commodity pools that are directed to certain sophisticated investors and that engage in limited commodity interest trading activities. A CPO is not required to register provided that: (i) interests in the pool are exempt from registration under the Securities Act of 1933 (the “Securities Act”); (ii) interests in the pool are offered and sold in the United States without marketing to the public; (iii) participation in the pool is limited to: (a) “accredited investors” as defined in Rule 501 under the Securities Act, (b) family trusts formed by accredited investors, (c) “knowledgeable employees” as defined in Rule 3c-5 under the Investment Company Act of 1940 (the “Investment Company Act”), and (d) the CPO itself and certain other qualified eligible persons as defined in Rule 4.7; (iv) the CPO limits the commodity interest positions in the pool at all times such that either: (a) the aggregate initial margin and premiums required to establish such positions do not exceed 5% of the liquidation value of the pool’s portfolio, or (b) the aggregate net notional value of such positions does not exceed 100% of the liquidation value of the pool’s portfolio, and (v) the CPO does not market the pool to the public as a commodity pool or otherwise as a vehicle for trading in the commodity markets.*
- Rule 4.13(a)(4) provides another exemption from CPO registration for the operators of commodity pools with sophisticated investors. A CPO is not required to register provided that: (i) interests in the pool are exempt from registration under the Securities Act and are offered and sold without marketing to the public in the United States and (ii) participation in the pool is limited to: (a) natural persons who are qualified eligible persons as defined in Rule 4.7(a)(2), such as a “qualified purchaser” as defined in Section 2(a)(51)(A) of the Investment Company Act; a “knowledgeable employee” as defined in Rule 3c-5 under the Investment Company Act; and a non-U.S. person as defined in Rule 4.7(a)(1)(iv); and (b) non-natural persons who are qualified eligible persons as defined in Rule 4.7 or accredited investors as defined in Rule 501(a)(1)-(3), (a)(7) and (a)(8) under the Securities Act. Unlike Rule 4.13(a)(3), Rule 4.13(a)(4) does not impose any limitations on the size of a pool’s commodity interest positions relative to its portfolio. For example, CPOs of most “qualified purchaser” Section 3(c)(7) hedge funds typically rely on this exemption.*
In proposing rescission of these exemptions, the CFTC expressed the view that Rules 4.13(a)(3) and 4.13(a)(4), which were promulgated in 2003 and resulted in the exemption of a substantial number of CPOs from its oversight, are no longer appropriate in light of the new regulatory framework established by the Dodd-Frank Act. The CFTC views this proposal as consistent with the repeal of Section 203(b)(3) of the Investment Advisers Act of 1940, which had provided for an exemption from investment adviser registration for numerous advisers to private investment funds, and with SEC regulation of similarly situated investment advisers.
The CFTC is soliciting comments regarding, among other things, how much time will be necessary for entities that have previously claimed an exemption under Rule 4.13(a)(3) or 4.13(a)(4) to comply with the proposed rescission of such rules and whether any entities that have claimed exemption under these provisions should be exempted from compliance with the proposed changes. If the CFTC finalizes the proposed rescission of these exemptions and does not provide grandfather relief with respect to existing pools, it is expected that CPOs of Rule 4.13(a)(4) pools will generally seek to convert these pools to Rule 4.7 exempt pools.
Reinstate Trading Criteria for Registered Investment Companies to Qualify for the CFTC Rule 4.5 Exclusion
Rule 4.5 currently provides an exclusion from the definition of CPO for operators of certain otherwise regulated entities, such as companies registered under the Investment Company Act, without regard to the extent of futures trading engaged in by such entities. To reestablish oversight over the operators of such entities that seek to offer investors exposure to the commodities markets, the CFTC is proposing to reinstate the restrictions that were in effect prior to 2003, requiring the operators of such entities to (i) limit their use of commodity futures and options contracts (and additionally swaps) for non-bona fide hedging purposes to five percent of the relevant entity’s liquidation value and (ii) refrain from marketing such entities to the public as commodity pools or otherwise as vehicles for trading in, or seeking investment exposure to, the commodity markets.
New Reporting Requirements for CPOs and CTAs that Are not Dual Registrants
The CFTC is proposing Forms CPO-PQR and CTA-PR to collect information from registered CPOs and CTAs, that are not registered as investment advisers with the SEC, to permit the CFTC to oversee more effectively pool operators and trading advisors within its jurisdiction. These new reporting requirements are designed to solicit information that is generally identical to that which would be required from investment advisers registered with the SEC through proposed Form PF.1 The amount of information that a CPO or CTA would be required to disclose and the frequency of reporting would vary depending on both the size of the CPO or CTA (i.e., assets under management) and size of the advised pool. These reports would generally be required to be filed on a quarterly basis. The CFTC currently anticipates that these new reporting requirements would become effective six months after the adoption of the proposed forms.
Information required on Form CPO-PQR includes the following:
- All registered CPOs would be required to provide, among other things, (i) basic identifying information about the CPO, including its name, National Futures Association (“NFA”) identification number and the CPO’s assets under management and (ii) information about each of the CPO’s pools, including the names and NFA identification numbers for the pools operating during the reporting period, certain position information and the pool’s key relationships with brokers, other advisors, administrators, etc.
- Registered CPOs that have assets under management equal to or exceeding $150 million would be required to provide, among other things, detailed information for all operated pools, including information regarding each pool’s investment strategy, borrowings by geographic area and the identities of significant creditors; credit counterparty exposure; and entities through which the pool trades and clears its positions.
- Registered CPOs that have assets under management equal to or exceeding $1 billion would be required to provide, among other things, certain aggregate information about the commodity pools that they advise, such as the market value of assets invested, on both a long and short basis, in different types of securities and derivatives, turnover in these categories of financial instruments, and the tenor of fixed income portfolio holdings. These CPOs would also be required to report certain additional information about any commodity pool that they advise with a net asset value of at least $500 million, including, among other things, a geographic breakdown of the reportable pool’s assets as well as information regarding asset liquidity, concentration of positions, material investment positions, collateral practices with significant counterparties, and clearing relationships.
Information required on Form CTA-PR includes the following:
- All registered CTAs would be required to provide general information about the CTA and its pool assets under management, including, among other things, the name of the CTA; the CTA’s NFA identification number; the number of offered trading programs and whether any pool assets are directed under those trading programs; the total assets directed by the CTA; and the total pool assets directed by the CTA.
- Registered CTAs that direct pool assets equal to or exceeding $150 million would be required to provide, among other things, (i) detailed position, performance and trading strategy information for each trading program, (ii) the identity of the pools advised under each program and the percentage of the pool’s assets that are directed by the CTA and (iii) whether it uses the services of an administrator.
The CFTC intends to treat proprietary information (such as position information) collected on Forms CPO-PQR and CTA-PR as confidential, thereby protecting such information from public disclosure.
Eliminate Exemptive Relief from the Annual Report Certification Requirement for Pools Operated Pursuant to Rule 4.7
In light of the Dodd-Frank Act’s emphasis on the transparency and accuracy of financial information distributed to investors, the CFTC is proposing to eliminate an exemption from the annual report certification requirement currently available to operators of Rule 4.7-exempt pools. The CFTC believes that requiring certification of financial information by an independent accountant in accordance with established accounting standards will ensure the accuracy of registrants’ financial information.
Require All Persons Claiming Exclusionary or Exemptive Relief under Rules 4.5, 4.13, and 4.14 to Confirm Their Notice of an Exclusion or an Exemption Annually
The CFTC is proposing to require that CPOs and CTAs claiming exclusionary or exemptive relief under Rules 4.5, 4.13 and 4.14 to confirm their notice of an exclusion or an exemption on an annual basis. Currently, CPOs and CTAs claiming such relief file a single notice of such claim for relief with the NFA and generally need not make any subsequent filing, absent a change in information requiring an amendment to the filing. The CFTC believes that an annual notice requirement would promote improved transparency and enable it to determine whether exclusions and exemptions should be modified, repealed, or maintained as part of the CFTC’s ongoing assessment of its regulatory scheme.
Amend the Required Risk Disclosure Statement in CPO and CTA Disclosure Documents to Describe Risks Specific to Swaps Transactions
The CFTC is proposing to expand the risk disclosure statement that must be included in CPO and CTA disclosure documents to include a description of certain risks specific to swaps transactions. This amendment reflects the CFTC’s expanded authority to regulate swaps pursuant to the Dodd-Frank Act.
Incorporate by Reference the Accredited Investor Standard
The definition of qualified eligible person currently contained in Rule 4.7 restates the terms of a prior version of the “accredited investor” qualification standard contained in Regulation D under the Securities Act. The CFTC is proposing to modify the definition of qualified eligible person to incorporate the accredited investor standard by reference in order to maintain consistency with the SEC’s definition, as it may be amended from time to time.