The Commodity Futures Trading Commission (the “Commission” or “CFTC”) recently published certain proposed amendments to its rules governing the Annual Report requirement for commodity pool operators (“CPOs”) (the “Proposal”), 81 Fed. Reg. 51828 (Aug. 5, 2016). If adopted as proposed, the Proposal generally would codify certain forms of exemptive relief which Commission staff has previously issued to CPOs on a case-by-case basis. In summary, the Proposal is intended to accomplish the following three modifications:
- Permit CPOs to use certain alternative accounting standards when preparing their Annual Reports in addition to those currently permitted;
- Provide an exemption from the audit requirement applicable to the Annual Report for a commodity pool’s first fiscal year when the period from formation of the pool to the end of the pool’s first fiscal year is a short period of time; and
- Restrict the availability of existing audit requirement relief where a CPO has not previously distributed an audited Annual Report to pool participants or submitted the audited Annual Report to the National Futures Association (“NFA”).
Comments on the Proposal are due on or before September 6, 2016.
Use of Alternative Accounting Standards
CFTC Rule 4.22 generally requires that each CPO registered or required to be registered with the CFTC distribute to each participant in each commodity pool it operates, and to submit to NFA, an “Annual Report” for the pool within 90 calendar days after the end of such pool’s fiscal year.
The rule currently requires that financial statements required to be included in the Annual Report be presented and computed in accordance with U.S. GAAP. It also includes an exception to this requirement by permitting the use of International Financial Reporting Standards (“IFRS”) where certain criteria are met.
A CPO seeking to rely on the existing exception must claim the relief by filing a signed notice with NFA representing that:
- The pool is organized under the laws of a foreign jurisdiction;
- the Annual Report will include a schedule of investments (condensed, unless a full schedule is required under IFRS);·
- the use of IFRS to prepare the Annual Report is not inconsistent with representations set forth in the pool’s disclosures to participants;
- any special allocations of ownership equity will be reported in accordance with the requirements for the pool’s Statement of Operations to be included in the Annual Report; and
- in the event that IFRS requires consolidated financial statements for the pool (e.g., in a master-feeder fund structure), all applicable disclosures required by U.S. GAAP will be provided.
In practice, the CFTC staff has also been providing relief on a case-by-case basis to CPOs to use the accounting principles, standards or practices followed in the U.K., Ireland, Luxembourg and Canada in their Annual Reports.
The Proposal would now permit the use of the accounting practices of these jurisdictions in the same manner as for IFRS. Thus, a CPO would be able to claim this relief by filing a notice with NFA containing the same representations required for a CPO seeking to use IFRS.
Relief from the Audit Requirement Where the First Fiscal Year Is a Period of Three Months or Less from the Date of Formation of the Pool
Rule 4.22 also requires that the Annual Report distributed to pool participants and submitted to NFA within 90 days of the fiscal year-end be audited. Yet, the Commission recognizes in the Proposal that this audit requirement may be unduly burdensome in the case of pools formed close to the end of the fiscal year, and the CFTC staff has previously issued exemptive relief in these circumstances.
For example, under the current rule, the CPO of a pool formed two months before the end of the pool’s first fiscal year would be required to distribute and submit an audited Annual Report for that two-month fiscal year, regardless of the particular circumstances involved, even where the pool has few investors and has accepted limited contributions, absent exemptive relief.
Accordingly, the Commission is proposing to amend Rule 4.22 to provide for an exemption from the audit requirement for a pool’s first fiscal year when the period from formation of the pool to the end of the pool’s first fiscal year is three months or less, subject to certain terms and conditions.
Among other things, the exemption would be subject to compliance with the condition that the next Annual Report the CPO distributes and submits is audited and covers the time period from the formation of the pool to the end of the pool’s first 12-month fiscal year.
Specifically, a CPO could claim this relief where:
- The time period from the formation of the pool to the end of the pool’s first fiscal year is three months or less (referred to as the “stub period”);
- from the formation of the pool to the end of the pool’s first fiscal year, the pool had no more than fifteen participants; and
- from the formation of the pool to the end of the pool’s first fiscal year, the total gross capital contributions received by the CPO for units of participation in the pool did not exceed $1,500,000.
For purposes of determining eligibility for the relief, the following persons and their capital contributions would not be counted:
- the pool’s CPO, its commodity trading advisor and any of their principals;
- a child, sibling or parent of the participants described in item (1);
- the spouse of any of the participants described in item (1) or (2);
- any relative of one of the participants described in items (1) through (3); and
- an entity that is wholly-owned by one or more of the participants described in the items above.
The Commission notes that the CPO could count a non-natural person as a single participant. However, if that non-natural person was also a commodity pool, its CPO would have to separately qualify for this relief under the Proposal in order for that second CPO to claim the relief.
Notably, the Commission is proposing to draw on the 15-participant limit and the categories of participants and respective contributions from CFTC Rule 4.13(a)(2), which provides a CPO registration exemption for the operator of a family, club or small pool.
In addition to the criteria described above, a CPO would be required to:
- obtain, prior to the date on which the Annual Report for the pool’s first fiscal year is due, a specified written waiver of the right to receive an audited Annual Report for that fiscal year from each person who has been a participant in the pool during the first fiscal year;
- retain the waiver in accordance with the CPO recordkeeping rules in CFTC Rule 4.23; and
- on or before the date on which the Annual Report for the pool’s first fiscal year is due, file a notice of claim with NFA, along with a certification that the CPO had received the specified written waiver from each of the pool’s participants.
This notice filing would be based on the notice required to claim relief to present and compute an Annual Report in accordance with IFRS.
Additionally, the CPO would be required to include on the cover of each Annual Report for which relief had been claimed a prescribed statement that provided information on whether the Annual Report was unaudited or audited and the period of time that the Annual Report covered.
Limitation on Availability of Existing Audit Requirement Exception
Finally, Rule 4.22 contains an exception from the audit requirement, subject to certain specified conditions, for the CPO of a pool that ceases operation prior to, or at the end of, the pool’s fiscal year. To ensure that an audit is conducted at least once in the life of a commodity pool, the Commission is proposing to make this audit requirement relief unavailable where a CPO has not previously distributed an audited Annual Report to pool participants or submitted the audited Annual Report to NFA.
For example, this exception would no longer be available where the CPO has claimed the proposed relief in respect of a pool formed close to the end of the fiscal year (discussed above), and the pool has ceased operations before the end of its first twelve-month fiscal year. Thus, the CPO of a pool that is opened and closed in the same fiscal year would be required to distribute and submit an audited Annual Report.
The proposed amendments generally would provide somewhat greater flexibility for CPOs with respect to their reporting obligations under Rule 4.22. The proposed restriction on the availability of the existing audit requirement exception may be problematic in certain circumstances, but the proposed amendments would for the most part ease burdens on CPOs by permitting them greater flexibility with respect to accounting standards for Annual Reports and affording them relief from the audit requirement where it would be costly and not obviously beneficial.