The Commodity Futures Trading Commission (the “Commission” or “CFTC”) recently adopted final rules amending its rules governing the Annual Report requirements for commodity pool operators (“CPOs”) (the “Final Rules”), 81 Fed. Reg. 85147 (Nov. 25, 2016). The Final Rules substantially track the rules proposed by the Commission several months ago (the “Proposed Rules”), 81 Fed. Reg. 51828 (Aug. 5, 2016), albeit with certain modifications and clarifications made in response to comments received by the Commission and the Commission’s further consideration of these issues. As contemplated in the Proposed Rules, the Final Rules codify certain forms of exemptive relief which Commission staff has previously issued to CPOs on a case-by-case basis. In summary, the Final Rules: (1) permit CPOs to use certain alternative accounting standards when preparing their Annual Reports in addition to those currently permitted; (2) provide an exemption from the audit requirement applicable to the Annual Report for a commodity pool’s first fiscal year when the period from the day that the CPO first receives non-insider funds to the end of the pool’s first fiscal year is four months or less; and (3) clarify that an audited Annual Report must be distributed and submitted at least once during the life of a pool. The Final Rules become effective on December 27, 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 submit to the National Futures Association (“NFA”), an “Annual Report” for the pool within 90 calendar days after the end of such pool’s fiscal year, containing financial statements presented and computed in accordance with U.S. generally accepted accounting principles (“GAAP”). The rule also includes an exception to this requirement that permits the use of International Financial Reporting Standards (“IFRS”) when certain criteria are met. Specifically, under Rule 4.22(d)(2), a CPO seeking to rely on the exception must claim the relief by filing a signed notice with NFA representing that the following conditions are met: 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 offering memorandum or other operative documents made available 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 masterfeeder 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 or Canada (each, an “Additional Alternative GAAP”) in their Annual Reports. The Final Rules amend Rule 4.22(d)(2) to permit the use of the accounting practices of these jurisdictions in the same manner as for IFRS. Thus, a CPO may now claim this relief by filing a notice with NFA containing the same representations required for a CPO seeking to use IFRS. In response to commenters concerned about disparate treatment of Annual Reports under revised Rule 4.22 and periodic reports under Rule 4.7(b), the Commission also is amending Rule 4.7(b)(2)(v) to permit the use of an Additional Alternative GAAP for periodic financial statements prepared and distributed for a pool for which the CPO has claimed relief under Rule 4.7(b). In a similar conforming change, the Commission is amending Rule 4.27(c)(2) to allow CPOs that elect to use an Additional Alternative GAAP for the pool’s Annual Report also to use such Additional Alternative GAAP in connection with reporting financial information on Form CPO-PQR. Relief from the Audit Requirement Where the First Fiscal Year Is a Period of Four Months or Less from the Date on Which the CPO First Receives Non-Insider Funds Rule 4.22 also generally requires that the Annual Report distributed to pool participants and submitted to NFA within 90 days of the fiscal year-end be audited. For example, the CPO of a pool formed two months before the end of the pool’s first fiscal year is 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. The Commission recognized in the Proposed Rules that this audit requirement may be unduly burdensome in the case of pools formed close to the end of the fiscal year and, consistent with that view, CFTC staff has previously issued exemptive relief in such circumstances.1 Accordingly, the Commission is amending Rule 4.22 to provide for an exemption from the audit requirement for a pool’s first fiscal year when the period from the date that the CPO first receives funds, securities or other property from a person who is not a pool “insider”, as further discussed below (the “Initial Date”) to the end of the pool’s first fiscal year is four months or less, subject to certain terms and conditions.
Among other things, the exemption is subject to compliance with the condition that the next Annual Report that the CPO distributes and submits is audited and covers the time period from the Initial Date to the end of the pool’s first 12-month fiscal year. Specifically, a CPO may claim this relief where: the time period from the Initial Date to the end of the pool’s first fiscal year is four months or less (referred to as the “stub period”); throughout the stub period, the pool has no more than fifteen participants; and throughout the stub period, the aggregate gross capital contributions received by the CPO for units of participation in the pool (notwithstanding any subsequent withdrawals) does not exceed $3,000,000. For purposes of determining eligibility for the relief, the following persons are considered pool “insiders” – they do not need to be counted towards the fifteen-participant limit and their capital contributions do not need to be counted toward the $3,000,000 limit: (1) the pool’s CPO, its commodity trading advisor, any person controlling, controlled by, or under common control with the CPO or trading advisor, and any principal of the foregoing; (2) a child, sibling or parent of the participants described in item (1); (3) the spouse of any of the participants described in item (1) or (2); (4) any relative of one of the participants described in items (1) through (3), their spouse or a relative of their spouse, who has the same principal residence as such participant; and (5) an entity that is wholly-owned by one or more of the participants described in items (1) – (4) above. In addition to the criteria described above, a CPO claiming this relief must: obtain, prior to the date on which the Annual Report for the pool’s first fiscal year is due, a written waiver of the right to receive an audited Annual Report for that fiscal year from each pool participant other than the pool’s CPO, its commodity trading advisor, any person controlling, controlled by, or under common control with the CPO or trading advisor, and any principal of the foregoing; Note that the waiver may be included in the subscription agreement for the pool or other agreement with the participant, but the waiver must be on a separate page in the agreement that the participant must separately sign and date. The language of the waiver must be in a form substantially as follows: “[Name of participant], a participant in [Name of pool], voluntarily waives the right under CFTC Regulation 4.22(d) to receive an audited Annual Report for the fiscal year ended [end date of the pool’s first fiscal year] and will accept in lieu thereof an unaudited Annual Report covering [the stub period] and an audited Annual Report covering [the start date of the stub period] through [the end date of the pool’s first twelve-month 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 received the specified written waiver from each of the pool’s participants (other than the CPO, its commodity trading advisor, any person controlling, controlled by, or under common control with the CPO or trading advisor, and any principal of the foregoing). This notice filing is based substantially on the notice required to claim relief to present and compute an Annual Report in accordance with IFRS. Additionally, the CPO is required to include on the cover of each Annual Report for which relief has been claimed a prescribed statement that provides information regarding whether the Annual Report is unaudited or audited and the period of time that the Annual Report covers. In response to commenters’ questions, the Commission further clarified that, once the Final Rules are effective, it will entertain requests for relief from the audit requirement with respect to stub-period Annual Reports only under exceptional circumstances involving unique situations. The Final Rules also provide that a pool’s Annual Report does not need to be audited for any fiscal year during which the only participants in the pool are one or more of the following: the pool’s CPO, its commodity trading advisor, any person controlling, controlled by, or under common control with the CPO or trading advisor, and any principal of the foregoing; provided that the CPO: (1) obtains written waivers from the participants of their right to receive an audited Annual Report for that fiscal year; (2) keeps those waivers as records pursuant to Rule 4.23; and (3) distributes an audited Annual Report at least once during the life of the pool. Limitation on Availability of Existing Audit Requirement Relief Finally, Rule 4.22(c)(7) generally allows CPOs to provide pool participants with certain information and disclosures (a “Final Report”) in lieu of an Annual Report if the pool ceases operation prior to, or as of, the end of its fiscal year. Generally, the Final Report information must be audited, but the rule provides a mechanism for relief in that auditing is not required if the CPO obtains waivers from all of the pool’s participants.2 However, to ensure that an audit is conducted at least once during the life of a commodity pool, the Commission is making the audit relief unavailable where a CPO has not previously distributed an audited Annual Report to pool participants or submitted the audited Annual Report to NFA, pursuant to amendments adopted as part of the Final Rules. For example, the option to provide participants with an unaudited Final Report will no longer be available where the CPO has claimed relief from issuing an audited Annual Report in respect of a pool formed close to the end of the fiscal year (as 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.
Conclusion The Final Rules generally provide somewhat greater flexibility for CPOs with respect to their reporting obligations under Rule 4.22. The restriction on the availability of audit requirement relief for Final Reports may be problematic in certain circumstances, but the fact that CPOs now are able to forego providing audited Annual Reports if the pool’s participants are solely insiders (as long as at least one audited Annual Report has been issued during the life of the pool) may assist in ameliorating some of those concerns. Ultimately, the Final Rules ease burdens on CPOs by permitting them greater flexibility with respect to accounting standards for Annual Reports and affording them relief from the Annual Report audit requirement where it would be costly and not obviously beneficial. Note that, although CPOs may continue to request relief from the staff with respect to financial reporting requirements, the Commission intends that staff restrict the issuance of any such relief from the standards set forth in the Final Rules to exceptional circumstances involving unique situations.3