Investment Management Commentary
APRIL 2003
CFTC Proposes Major Relief from the CFTC Registration
Requirements for CPOs and CTAs
On March 17, 2003, the Commodity Futures Trading
Commission (“CFTC”) proposed new rules to reduce
the registration and other regulatory requirements
applicable to commodity pool operators (“CPOs”),
commodity trading advisors (“CTAs”), and others
who trade or deal in commodity futures and
commodity options. The proposed rules would,
among other things, expand the current exclusions
and exceptions from the definition of CPO in CFTC
Rules 4.5 and 4.13. If adopted, these changes will
dramatically expand the ability of mutual funds,
banks, insurance companies and pension plans to use
futures and commodity options without being
required to register as CPOs. In addition, the
proposed rules would expand the exemption from
CTA registration in Rule 4.14, allowing investment
advisers much greater flexibility to use commodity
futures and commodity options in pooled investment
vehicles (such as hedge funds) without having to
register as CTAs. The CFTC release also alters the
no-action positions relating to CPOs and CTAs
previously issued on October 28, 2002 and
November 13, 2002.
PROPOSED NEW EXCLUSIONS FROM THE
DEFINITION OF CPO
The Commodity Exchange Act (“CEA”) generally
defines a CPO to include any natural person or entity
that operates an investment vehicle that pools the
assets of two or more persons and trades any
commodity futures or commodity options contract.
Unless excluded from the definition of CPO or
exempted from registration, CPOs are required to
register under the CEA and are subject to a variety of
disclosure, reporting and recordkeeping
requirements.
The Current Rule. Current Rule 4.5 generally
excludes from the definition of CPO specific types of
entities that are regulated under certain other federal
or state regulatory regimes (such as those for
securities, banking and insurance) and do not market
their pools as vehicles for speculating or trading in
commodity futures or commodity options. Thus, for
example, the following persons, and their principals
and employees, typically are eligible to rely on Rule
4.5: (i) registered investment companies (“mutual
funds”); (ii) insurance companies subject to state
regulation; (iii) banks, trust companies and other
financial depository institutions subject to federal or
state regulation; and (iv) trustees of, named
fiduciaries of, and employers maintaining pension
plans that are subject to Title I of the Employee
Retirement Income Security Act of 1974, as amended
(“ERISA”).
Rule 4.5 excludes such persons from the definition of
CPO with respect to the operation of any “qualifying
entity.” For a registered investment company, the
qualifying entity is the registered investment
company; for insurance companies, it is an insurance
company’s separate accounts; for banks, trust
companies and other financial depository institutions,
it is the assets of any trust, custodial account or other
separate unit of investment for which the bank is
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acting as a fiduciary with investment authority; and
for trustees of pension plans, it is a pension plan
subject to Title I of ERISA.
Rule 4.5 imposes certain restrictions on the operation
of a qualifying entity. The most significant of these
concerns the use of commodity futures and
commodity options for other than bona fide hedging
purposes. Pursuant to Rule 4.5, as modified by the
CFTC no-action position issued October 28, 2002,
the qualifying entity must either:
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limit the aggregate initial margin and premiums
required to establish non-bona fide hedging
positions to 5% of the liquidation value of the
qualifying entity’s portfolio, after taking into
account unrealized profits and unrealized
losses on any such contracts into which it has
entered (the “5% test”); or
limit the aggregate “notional value” of its nonbona fide hedging futures contract and
commodity option positions to the liquidation
value of its portfolio, after taking into account
unrealized profits and unrealized losses on any
such contracts (the “notional test”).
The Proposed Rule. The CFTC’s proposed new
rule eliminates both the 5% and the notional tests.
Thus, if adopted, there would be no CFTC limitation
on the use of commodity futures or options by
qualifying entities. Therefore, among other things, it
would be much easier to operate registered fund-offunds whose underlying funds trade commodity
futures and commodity options. However, the ability
of qualifying entities to use commodity futures and
commodity options may still be limited under other
applicable laws and regulations, such as Section 18
of the Investment Company Act of 1940, in the case
of mutual funds.
The rule would continue to require that a qualifying
entity not be marketed to the public as a commodity
pool and that the person operating the pool consent
to accept and respond to any special inquiries as the
CFTC may require. The CFTC’s release notes that
the no-action relief announced on October 28, 2002
with respect to the notional test will remain available
pending final action on the proposed rule.
EXEMPTION FROM CPO REGISTRATION FOR
POOLS WITH SOPHISTICATED INVESTORS
The proposed amendments to CFTC Rule 4.13 would
expand the types of pools that are exempt from CPO
registration. Rule 4.13 currently exempts CPOs of
“family, club or small pools” (as defined in the Rule)
from CPO registration requirements.
Proposed Rule 4.13(a)(3) would exempt a CPO from
registration if, among other conditions, it (1) restricts
participation in the pool to “accredited investors” as
defined in Rule 501 of Regulation D under the
Securities Act of 1933, (2) limits the commodity
interest positions (whether or not entered into for
bona fide hedging purposes) in each of its pools such
that either (i) the aggregate initial margin and
premiums required to establish such positions will
not exceed 2% of the liquidation value of the pool’s
portfolio or (ii) the aggregate net notional value of
such positions does not exceed 50% of the
liquidation value of the pool’s portfolio, and (3) does
not market participations in the pool to the public as
a commodity pool or otherwise as or in a vehicle for
trading in futures and commodity options markets.
Proposed Rule 4.13(a)(4) would exempt a CPO from
registration if, among other conditions, it (1) restricts
participation in the pool to natural persons who are
“qualified eligible persons” (“QEPs”) as defined in
CFTC Rule 4.7 and non-natural persons who are
either QEPs or “accredited investors” and (2)
interests in the pool are exempt from registration
under the Securities Act and offered and sold without
marketing to the public in the United States. This
proposed exemption, unlike that proposed as Rule
4.13(a)(3), does not impose any restrictions on
options and futures trading activities. The CFTC
release notes that pool operators could
simultaneously rely on both exemptions.
The CFTC also announced that it was issuing noaction relief that will allow CPOs to rely immediately
on the exemption in proposed Rule 4.13(a)(3) (but
not on the exemption in proposed Rule 4.13(a)(4)) if
the CPO makes certain disclosures to pool
participants and makes a notice filing with the CFTC
and National Futures Association.
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capital to, and own beneficial interests in, the
pool;
EXEMPTIONS FROM CTA REGISTRATION
The CFTC release also proposes relief for CTAs
from registration, which corresponds to that for
CPOs. The CEA generally defines a CTA as any
person that provides trading advice regarding
commodity futures and commodity options to others
for compensation. Like CPOs, CTAs must register
under the CEA unless they are excluded or exempted
from registration requirements.
The Current Rule. CFTC Rule 4.14(a)(8) exempts
CTAs from registration that give trading advice
solely to Rule 4.5 qualifying entities, such as mutual
funds, and are registered as investment advisers with
the SEC or excluded from the definition of
investment adviser under the Investment Advisers
Act of 1940 (“Advisers Act”) pursuant to Sections
202(a)(2) or 202(a)(11) (certain banks, lawyers and
other professionals, brokers, dealers and publishers).
Currently, the Rule does not exempt smaller
investment advisers (those with under $25 million in
assets under management) that are registered with a
state securities regulator and not with the SEC.
The Proposed Rule. One of the proposed
amendments to Rule 4.14(a)(8) would expand the
exemption to cover state-registered investment
advisers.
In addition, the CFTC proposes to extend the Rule
4.14(a)(8) exemption to CTAs that (1) advise
“qualifying entities” (as defined in CFTC Rule
4.5(b)) for which notices of eligibility have been
filed or that are excluded from the definition of the
term “commodity pool” in CFTC Rule 4.5(b), (2)
advise CPOs that have claimed an exemption from
registration under proposed CFTC Rule 4.13(a)(3)
or 4.13(a)(4) or (3) provide commodity interest
trading advice to commodity pools organized and
operated outside of the United States that meet the
following criteria:
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The CPO has not organized and is not
operating the pool for the purpose of avoiding
CPO registration;
With the exception of the pool’s operator,
advisor and their principals, only “Non-United
States persons” may contribute funds or other
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No person affiliated with the pool may conduct
any marketing activity for the purpose of, or
that could reasonably have the effect of,
soliciting participation from other than NonUnited States persons; and
No person affiliated with the pool may conduct
any marketing activity from within the United
States, its territories or possessions.
To qualify for the exemption, a CTA also must limit
its commodity interest trading advice to only that
which is “solely incidental” to its business of
providing securities or other investment advice to the
trading vehicles specified in the rule, and it must not
hold itself out as a CTA.
TREATING AN ENTITY AS A SINGLE CLIENT
Section 4m of the CEA provides that the registration
requirements for CTAs do not apply to any CTA
who, during the course of the preceding 12 months,
has not furnished commodity interest trading advice
to more than 15 persons and who does not hold itself
out generally to the public as a CTA. For purposes
of determining the number of persons a CTA advises,
the CFTC staff has long interpreted the statute to
require CTAs to “look through” any entities they
advise (such as partnerships or corporations) and to
count each limited partner, shareholder or other
investor as a “person” advised by the CTA.
Proposed Rule 4.14(a)(10) would eliminate this
“look through” position, such that any entity advised
by a CTA would count as only one “person” for
purposes of determining eligibility for the exclusion
from registration under Section 4m of the CEA. The
new interpretation would be consistent with Rule
203(b)(3)-1 under the Advisers Act. We note,
however, that there have been indications by the
SEC’s staff that they are contemplating changes to
Rule 203(b)(3)-1 that would be exactly opposite to
the CFTC’s proposal here. The SEC staff has
indicated that it is considering proposing changes to
this rule that would require advisers to “look
through” entities they advise and count each
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underlying investor in them as a separate person for
purposes of determining whether registration is
required under the Advisers Act.
The CFTC’s release discussing the proposed rules
does not discuss whether pools that are excluded or
exempt from CPO registration pursuant to Rule 4.5
or Rule 4.13 should be counted as “persons” advised
for purposes of determining compliance with the
“15-person” limitation. Proposed Rule 4.14(a)(10)
does not alter the additional statutory prerequisite of
Section 4m—that a CTA not hold itself out generally
to the public as a CTA.
OTHER PROPOSED RULES
The proposals also would amend current rules to:
(1) permit CTAs and CPOs to engage in certain types
of communications with investors prior to
distribution of a required disclosure document,
(2) relieve CPOs from duplicative disclosure and
reporting requirements in the “master/feeder fund”
context, (3) establish criteria for CPOs to distribute
periodic account statements electronically, and
(4) harmonize the various signature requirements of
Part 4 of the CFTC rules.
CARY J. MEER
202.778.9107
cmeer@kl.com
CHARLES R. MILLS
202.778.9096
cmills@kl.com
MARC MEHRESPAND
202.778.9191
mmehrespand@kl.com
RONALD A. HOLINSKY
202.778.9425
rholinsky@kl.com
DAVID J. MICHEHL
202.778.9274
dmichehl@kl.com
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Kirkpatrick & Lockhart LLP maintains one of the leading investment management practices in the United States,
with over 60 lawyers devoting all or a substantial portion of their practice to this area. According to the April 2002
American Lawyer, K&L is a mutual funds “powerhouse” that represents more of the largest 25 investment company
complexes and their affiliates than any other law firm.
We represent mutual funds, insurance companies, broker-dealers, investment advisers, retirement plans, banks and
trust companies, private funds, offshore funds and other financial institutions. We also regularly represent mutual
fund distributors, independent directors of investment companies, retirement plans and service providers to the
investment management industry. In addition, we frequently serve as outside counsel to industry associations on a
variety of projects, including legislative and policy matters.
We work with clients in connection with the full range of investment company industry products and activities,
including all types of open-end and closed-end investment companies, funds of hedge funds, variable insurance
products, private and offshore investment funds and unit investment trusts. Our practice involves all aspects of the
investment company business: from organizing and registering open-end and closed-end funds, both as series and
individual portfolios, to providing ongoing advice and representation to the funds and their advisers, directors and
distributors.
We invite you to contact one of the members of our investment management practice, listed below, for additional
assistance. You may also visit our website at www.kl.com for more information, or send general inquiries via email
to investmentmanagement@kl.com.
BOSTON
Michael S. Caccese
Philip J. Fina
Mark P. Goshko
Thomas Hickey III
Nicholas Hodge
617.261.3133
617.261.3156
617.261.3163
617.261.3208
617.261.3210
mcaccese@kl.com
pfina@kl.com
mgoshko@kl.com
thickey@kl.com
nhodge@kl.com
LOS ANGELES
William P. Wade
310.552.5071
wwade@kl.com
NEW YORK
Beth R. Kramer
Richard D. Marshall
Robert M. McLaughlin
Loren Schechter
212.536.4024
212.536.3941
212.536.3924
212.536.4008
bkramer@kl.com
rmarshall@kl.com
rmclaughlin@kl.com
lschechter@kl.com
SAN FRANCISCO
Eilleen M. Clavere
David Mishel
Mark D. Perlow
Richard M. Phillips
415.249.1047
415.249.1015
415.249.1070
415.249.1010
eclavere@kl.com
dmishel@kl.com
mperlow@kl.com
rphillips@kl.com
WASHINGTON
Clifford J. Alexander
Diane E. Ambler
Catherine S. Bardsley
Arthur J. Brown
Arthur C. Delibert
Robert C. Hacker
Benjamin J. Haskin
Kathy Kresch Ingber
Rebecca H. Laird
Thomas M. Leahey
Cary J. Meer
R. Charles Miller
Dean E. Miller
R. Darrell Mounts
C. Dirk Peterson
Alan C. Porter
Theodore L. Press
Robert H. Rosenblum
William A. Schmidt
Lynn A. Schweinfurth
Donald W. Smith
Robert A. Wittie
Robert J. Zutz
202.778.9068
202.778.9886
202.778.9289
202.778.9046
202.778.9042
202.778.9016
202.778.9369
202.778.9015
202.778.9038
202.778.9082
202.778.9107
202.778.9372
202.778.9371
202.778.9298
202.778.9324
202.778.9186
202.778.9025
202.778.9464
202.778.9373
202.778.9876
202.778.9079
202.778.9066
202.778.9059
calexander@kl.com
dambler@kl.com
cbardsley@kl.com
abrown@kl.com
adelibert@kl.com
rhacker@kl.com
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kingber@kl.com
rlaird@kl.com
tleahey@kl.com
cmeer@kl.com
cmiller@kl.com
dmiller@kl.com
dmounts@kl.com
dpeterson@kl.com
aporter@kl.com
tpress@kl.com
rrosenblum@kl.com
william.schmidt@kl.com
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This publication/newsletter is for informational purposes and does not contain or convey legal advice. The information herein
should not be used or relied upon in regard to any particular facts or circumstances without first consulting a lawyer.
© 2003 KIRKPATRICK & LOCKHART LLP.
ALL RIGHTS RESERVED.