On May 12, the Commodity Futures Trading Commission staff issued guidance for so-called “CPO delegation” arrangements, which are situations where an individual or entity that could otherwise be obligated to register with the CFTC as a commodity pool operator (a “CPO”) seeks to delegate its commodity pool operator authority to another person.
Recent scrutiny of CPO delegation arrangements has resulted in numerous requests being made to the CFTC’s Division of Swap Dealer and Intermediary Oversight for an individual no-action letter covering particular CPO delegation requests. In response to industry requests for more broad-based relief, the CFTC issued guidelines on May 12 that create a “streamlined” process to obtain no-action letters.
In the May 12 guidance, the CFTC staff also modified its longstanding view of requiring independent directors of a private fund, as a condition of delegation, to agree to remain jointly and severally liable for any violations of the Commodity Exchange Act.
Historical Practice. The CFTC staff historically considered a private fund’s general partner or managing member and each member of its board of directors (each, a potential “Delegator”) to be a CPO. The CFTC staff, however, has issued numerous no-action letters allowing a Delegator not to register as a CPO if, among other things, it:
- Delegates its rights and obligations with respect to the operation of the fund (i.e., its commodity pool operator duties) to another person (a “Delegatee”); and
- Agrees to remain jointly and severally liable for any violations of the CEA.
Common delegation situations involve the members of a non-U.S. fund’s board of directors (or a U.S. fund’s general partner) delegating their respective commodity pool operator duties to the fund’s investment manager.
May 2014 Guidance. CPO delegations within the private funds space often fall into a small number of common patterns and the industry has, on a number of fronts, engaged in an effort to obtain more broad-based relief. While recognizing the need for more efficiency and certainty in this process, however, in the May guidance, the CFTC staff held to the position that CPO delegation requires individual no-action relief. The CFTC staff did, however, establish a more streamlined process for obtaining this relief and issued a form CPO delegation no-action request letter. The CFTC staff has indicated that it will still review and respond to these individual requests.
The eligibility criteria for the streamlined no-action letter process outlined in the May guidance include:
1. The Delegator has delegated all investment management authority to the Delegatee;
2. The Delegator does not manage any property of the commodity pools for which it is delegating its CPO authority;
3. The Delegator does not engage in any marketing for the commodity pools for which it is delegating its CPO authority;
4. The Delegator is not subject to a statutory disqualification;
5. There is a business purpose for the Delegator’s separate entity status (i.e., the structure is not employed solely to avoid registration by the Delegator);
6. The Delegatee will maintain its books and records in compliance with CFTC Rule 1.31;
7. Where both are non-natural persons, each of the Delegator and the Delegatee controls or is controlled by the other (or both are under common control); and
8. The Delegator and the Delegatee agree to continue to remain jointly and severally liable for violations of the CEA (this is not required for “unaffiliated board members”).
It is worth noting that the guidance is not specifically limited to general partners, managing members and board members; other entities that qualify as a CPO and that meet the criteria described in the letter could also be eligible for the streamlined no-action letter process.
Another item of relief in the May 2014 Guidance relates to independent directors. While the CFTC staff still requires members of a private fund’s board of directors to formally delegate any commodity pool operator authority to a Delegatee, an agreement by each “unaffiliated board member” to remain jointly and severally liable will not be required as a condition to relief under the streamlined no-action letter process.
While it has yet to take action, the National Futures Association may also implement a notice filing requirement for every CPO delegation, which would be in addition to what is required by the CFTC.
While the streamlined process is a much-appreciated initiative, managers should consult with their counsel before submitting a request, as there are a number of open questions and interpretative considerations. Managers should also remember that the new streamlined process is not an exclusive option; the CFTC staff will continue to consider individualized CPO delegation no-action requests from CPOs who cannot meet the criteria specified in the guidance.