K&L GATES LLP
2013 NEW YORK INVESTMENT MANAGEMENT CONFERENCE
CURRENT ISSUES IN CFTC REGULATION AND DERIVATIVES
REGULATION: UPDATE AND PRACTICAL CONSIDERATIONS
December 10, 2013
Cary J. Meer
K&L Gates LLP
1601 K Street, NW
Washington, D.C. 20006
(202) 778-9107
cary.meer@klgates.com
A.
Commodity Pool Operators (“CPOs”).1
1.
Definition.
1
Effective April 24, 2012, the Commodity Futures Trading Commission (“CFTC”) amended its regulations
to rescind the exemption from CPO registration under CFTC Regulation 4.13(a)(4) for the operators of private funds
that limit investors therein to highly sophisticated persons. The CFTC also rescinded the exemption from
registration as a commodity trading advisor (“CTA”) under CFTC Regulation 4.14(a)(8) for persons who act as
advisors to pools operated in accordance with CFTC Regulation 4.13(a)(4). The CFTC retained the CPO
registration exemption under CFTC Regulation 4.13(a)(3), which limits the amount of commodity interest trading
that a private fund may engage in, despite its having proposed to rescind that as well. Commodity Pool Operators
and Commodity Trading Advisors: Compliance Obligations, 77 Fed. Reg. 11252 (February 24, 2012); correction
notice published at 77 Fed. Reg. 17328 (March 26, 2012) (“Amendment Release”).
The CFTC amendments became effective on April 24, 2012. Investment advisers to private funds that filed
notices under CFTC Regulation 4.13(a)(4) prior to April 24, 2012 had until December 31, 2012 to register as CPOs
or CTAs or rely upon a different exemption (such as CFTC Regulation 4.13(a)(3)). See the Division of Swap Dealer
and Intermediary Oversight Responds to Frequently Asked Questions – CPO/CTA: Amendments to Compliance
Obligations (August 14, 2012, as amended) (“FAQ”) (answer to question 3 under the heading “Regulation 4.13”).
Please note, however, that the term “commodity interest” includes swaps as of December 31, 2012.
Accordingly, if the only commodity interests a person has been involved in are swaps, and the person is unable as of
that date to claim an exemption from registration under, for example, CFTC Regulations 4.13(a)(3) or 4.14(a)(8),
given the amount of swap activity in pools operated by the person or about which the person has provided advice,
registration as a CPO or CTA was required as of December 31, 2012. See the FAQ (answer to question 4 under the
heading “Regulation 4.13”).
This outline is current as of October 22, 2013.
© 2013 K&L Gates LLP. All rights reserved.
DC 9723734v7 0950000-00102
a.
Pre-Dodd-Frank Act Definition.
Section 1a(5) of the Commodity Exchange Act (“CEA”) defined a CPO
as:
“any person engaged in a business that is of the nature of an investment
trust, syndicate, or similar form of enterprise, and who, in connection
therewith, solicits, accepts, or receives from others, funds, securities, or
property, either directly or through capital contributions, the sale of stock
or other forms of securities, or otherwise, for the purpose of trading in
[commodity futures] on or subject to the rules of any contract market or
derivatives transaction execution facility [“DTEF”].”
CFTC Regulation 1.3(cc) expands the definition of CPO to include
persons engaged in such business for the purpose of trading options on
exchange-traded futures contracts.
See CFTC Regulation 1.3(cc)
(definition of “CPO”); CFTC Regulation 1.3(hh) (definition of
“commodity option”). In addition, although the CEA and CFTC
definitions of CPO do not refer to foreign futures or options, CFTC
Regulation 30.4(c) effectively treats certain operators of pooled
investment entities that trade in foreign futures or options as CPOs and
requires them to register under the CEA in that category.
b.
Dodd-Frank Act Definition.
Title VII of the Dodd-Frank Wall Street Reform and Consumer Protection
Act (the “Dodd-Frank Act”) amended the definitions of CPO and CTA to,
among other things, include swaps.2
Title VII of the Dodd-Frank Act defines a CPO as:
any person who is registered with the CFTC as a CPO or is engaged in a
business that is of the nature of a commodity pool, investment trust,
syndicate, or similar form of enterprise, and who, in connection therewith,
solicits, accepts, or receives from others, funds, securities, or property,
either directly or through capital contributions, the sale of stock or other
forms of securities, or otherwise, for the purpose of trading in commodity
interests, including any:
2
On July 10, 2012, the Securities and Exchange Commission (the “SEC”) and the CFTC jointly adopted
several final rules and provided interpretive guidance with respect to the definitions of the terms “swap,” “securitybased swap,” “security-based swap agreement,” and “mixed swap.” Further Definition of “Swap,” “Security-Based
Swap,” and “Security-Based Swap Agreement”; Mixed Swaps; Security-Based Swap Agreement Recordkeeping, 74
Fed. Reg. 48208 (Aug. 13, 2012) (Release Nos. 33-9338 and 34-67453, July 18, 2012). See also Determination of
Foreign Exchange Swaps and Foreign Exchange Forwards under the Commodity Exchange Act, 77 Fed. Reg.
69,694 (Nov. 20, 2012) (which is a written determination by the Secretary of the Treasury that certain foreign
exchange forwards and swaps are not “swaps” for this purpose).
2
c.
(i)
commodity for future delivery, security futures product, or
swap;
(ii)
agreement, contract, or transaction described in Section
2(c)(2)(C)(i) of the CEA or Section 2(c)(2)(D)(i) of the
CEA;
(iii)
commodity option authorized under Section 4c of the CEA;
or
(iv)
leverage transaction authorized under Section 19 of the
CEA.
Effective Date of the Dodd-Frank Act Definition.
The effective date for the inclusion of “swaps” in what constitutes a
commodity interest for purposes of the CPO definition was December 31,
2012.3
2.
Regulatory Requirements.
a.
Registration – Introduction.
The CPO and its APs must register as such under the CEA.4 The CPO
must also become a member of the National Futures Association (“NFA”)
and its APs must become associate members of NFA. NFA handles
registration processing on behalf of CFTC. NFA converted from a paperbased to an online registration system (“ORS”) in June 2002.
i.
Who is the CPO?
In making the CFTC Regulation 4.13(a)(4) exemption filings for
private funds organized as corporations in non-United States
jurisdictions, firms frequently listed the CPO as the investment
adviser to the private fund. However, the CFTC’s long-standing
position is that the board of directors of a fund set up as a corporate
entity is the CPO. The CFTC’s Division of Swap Dealer and
Intermediary Oversight (“DSIO”) has confirmed that the board of
directors of a commodity pool may delegate its rights and
3
See the FAQ (answer to question 4 under the heading “Regulation 4.13”).
4
An AP of a CPO is defined as a natural person associated with a CPO as a “partner, officer, employee,
consultant, or agent (or any natural person occupying a similar status or performing similar functions), in any
capacity which involves (i) the solicitation of funds, securities, or property for participation in a commodity pool or
(ii) the supervision of any person or persons so engaged.” CFTC Regulation 1.3(aa)(3). This means that marketing
personnel, and persons who supervise marketing personnel up to and including a CPO’s chief executive officer, may
need to register as APs. CFTC Regulation 3.12(h) does, however, provide certain relief from AP registration.
3
obligations as a CPO to an investment adviser, provided that the
investment adviser is qualified to serve as a CPO, is registered as a
CPO and the board of directors agrees to remain jointly and
severally liable with respect to any violations of the CEA. See the
FAQ (answer to question 2 under the heading “Who is the
Commodity Pool Operator?”). In order to comply with the DSIO’s
recent guidance, advisers should prepare a delegation agreement
for each private fund organized as a corporation in a non-United
States jurisdiction whereby the board of directors delegates its
rights and obligations, particularly with respect to registration as
the CPO and compliance with the CEA and the CFTC regulations,
and agrees to remain jointly and severally liable with the adviser
with respect to any violations of the CEA.5 In making the CFTC
Regulation 4.13(a)(4) exemption filings for private funds
organized as limited partnerships or limited liability companies,
the CPO is generally the general partner or the managing member.
As long as the investment adviser itself is the general partner or
managing member, delegation agreements are not required in order
to comply with the DSIO’s recent guidance. If the investment
adviser serves as the investment adviser or investment manager to
the fund, and there is a separate special purpose general partner or
managing member, delegation agreements may be required if the
investment adviser is to serve as the CPO.
ii.
Principals.
The CPO must also list its principals on its registration application.
A principal is generally, for a corporation, the president, chief
executive officer, chief operating officer, chief financial officer
and chief compliance officer (collectively, “executive officers”),
any director, any person in charge of a principal business unit,
division or function subject to regulation by the CFTC; the
executive officers, managers or managing members of a limited
liability company or limited liability partnership and those
members vested with the management authority for the entity, and
any person in charge of a principal business unit, division or
function subject to regulation by the CFTC; any general partner
and the chief compliance officer of a partnership; and any person
occupying a similar status or performing similar functions, having
the power, directly or indirectly, through agreement or otherwise,
to exercise a controlling influence over the entity’s activities that
are subject to regulation by the CFTC. Additionally, a principal
5
In addition to preparing a delegation agreement for each fund, it may be necessary to obtain individualized
no-action relief from the CFTC staff each time the CPO function is delegated. We have discussed whether this
relief is required with the staff of the DSIO in light of the answer to question 2 in the FAQ. We understand that the
staff is considering whether relief is truly required or whether more general no-action relief may be issued by the
DSIO. We hope that this issue will be resolved in the next couple of months.
4
includes any natural person who, directly or indirectly, owns, is
entitled to vote, or has the power to sell or direct the sale of, 10%
or more of any class of voting securities,6 or is entitled to receive
10% or more of the profits of the entity, or who has the power to
exercise a controlling influence over the entity’s activities that are
subject to regulation by the CFTC. A principal also includes any
person, other than a natural person, that is the direct owner of 10%
or more of the voting securities of the entity. Furthermore, any
person who has contributed 10% or more of the capital of the
entity is a principal, except for unaffiliated banks or insurance
companies that contribute capital through subordinated debt that is
not guaranteed by another party not listed as a principal. Finally,
the definition of principal includes any natural person who, directly
or indirectly, creates or uses a trust, proxy, power of attorney,
pooling arrangement or any other contract, arrangement, or device
with the purpose or effect of divesting such person of direct or
indirect ownership of a voting security of the entity, or preventing
the vesting of such ownership, or of avoiding making a
contribution of 10% or more of the capital of the entity, as part of a
plan or scheme to evade being deemed a principal of the entity.
CFTC Regulation 3.1(a).
iii.
Applications.
Applicants for registration as a CPO and membership in NFA must
file Form 7-R and must submit a Form 8-R for each AP and natural
person principal.7 The Form 8-R must include a fingerprint card,
which will be sent to the Federal Bureau of Investigation as part of
the determination of the person’s fitness.
As part of the application for an AP, the applicant must submit a
Sponsor’s Certification stating that the sponsor intends to employ
the applicant as an AP and will do so within 30 days after the
registration is granted, that the sponsor has verified the information
supplied by the applicant as to his or her education and
employment history during the preceding three years, and that all
6
The CFTC has clarified that the ownership threshold regarding securities does not include non-voting
securities. However, between the proposal and adoption of final regulations, the CFTC added to paragraph (a)(2)(i)
of the principal definition in CFTC Regulation 3.1 the phrase “or has the power to exercise a controlling influence
over the entity’s activities that are subject to regulation by the Commission.” There is essentially identical language
in paragraph (a)(1) of CFTC Regulation 3.1, which pertains to persons occupying certain roles at a registrant. The
CFTC explained that it added the quoted language “to capture an owner who might indirectly have the power – such
as through a membership agreement – to dictate upfront the entity’s activities” subject to CFTC regulation. 77 Fed.
Reg. 51898, 51904 (August 28, 2012).
7
Note that NFA Bylaw 301(iii) states that a firm will not be registered as a CPO unless at least one person is
both a principal and an AP.
5
of the information supplied by the applicant on the form is, to the
best of the sponsor’s knowledge, accurate and complete.
iv.
Proficiency Examination Requirements.
Generally, APs must satisfy proficiency requirements by taking
and passing the National Commodity Futures Examination (Series
3), unless they have taken and passed the exam within the previous
two years or, since having passed the exam, there has not been a
period of two consecutive years in which they have not been
registered as an AP or as a floor broker.8 Applicants may satisfy
the proficiency requirements by taking an exam other than the
Series 3, if they meet the appropriate qualifications.9
1.)
For example, individuals registered as General Securities
Representatives (Series 7) that limit their futures activities
on behalf of their sponsors to soliciting customers for
participation in a commodity pool, or for discretionary
accounts to be managed by CTAs, may take the Futures
Managed Funds Examination (Series 31) instead of the
Series 3 exam. The Series 31 alternative is not available to
a Series 7 representative of an affiliate of the CPO; rather
the Series 7 must be held by the CPO, which would require
the CPO to be a registered broker-dealer.
2.)
Individuals may use the Limited Futures Examination
(Series 32) if, within the two years prior to filing the
application, they have been registered or licensed to solicit
customer business in futures in the United Kingdom or
Canada.
3.)
Individuals are not required to take an examination if they
are registered with FINRA as a General Securities
8
Every location from which sales activity is conducted that is not the headquarters of a firm is generally
considered a branch office and generally must have a branch office manager. See NFA Interpretive Notice 9002:
Registration Requirements; Branch Offices (Staff: September 6, 1985; revised July 1, 2000; December 9, 2005; and
September 30, 2010). In addition to Series 3, the branch office manager is generally required to pass the Series 30
examination within the two years preceding his application. However, a person may not be required to take the
Series 30 examination if: (i) he is currently approved as a branch office manager; or (ii) he was approved as a branch
office manager and, since the last date the applicant was withdrawn as a branch office manager, there has not been a
period of two consecutive years during which he was not either temporarily licensed as an AP or registered as an
AP; or (iii) his sponsor is a registered securities broker-dealer that provides proof that the person is qualified to act
as a branch office manager or designated supervisor under rules of the Financial Industry Regulatory Authority, Inc.
(“FINRA”).
9
In addition, the NFA appears in some circumstances to be allowing persons whose Series 3 license has
lapsed for more than two years to take the Series 32 examination rather than the Series 3 examination, upon written
request to the NFA describing the circumstances.
6
Representative with their sponsor and they are going to
limit their futures activities on behalf of their sponsor to
referring clients to APs of the sponsor, which referrals are
solely incidental to their business as a General Securities
Representative, or supervising persons who perform these
same limited activities. See NFA Registration Rule 401(b).
4.)
The NFA’s Director of Compliance will, upon request,
grant waivers from the Series 3 examination requirement to
individuals associated with CPOs if:
a.)
the CPO or the pool is subject to regulation by a
federal or state regulator, or the pool is privately
offered pursuant to an exemption from the
registration requirements of the Securities Act of
1933, as amended (“Securities Act”), and the CPO
limits its activities to operating a pool that (1)
engages principally in securities transactions, (2)
commits only a small percentage of its assets as
initial margin deposits and premiums for futures
and options on futures, and (3) uses futures and
options on futures only for hedging or risk
management purposes; or
b.)
the individual requesting the waiver is a general
partner of a CPO or a pool that is primarily involved
in securities investments; there is at least one
registered general partner of the CPO or pool who
has taken and passed the Series 3 examination; and
the person requesting the waiver is not involved in
soliciting or accepting pool participations, trading
futures or options, handling customer funds, or
supervision of these activities or engaging in any
other activity that is integral to the operation of the
fund as a pool. NFA Interpretive Notice 9018:
Registration Rule 402: CPOs of Pools Trading
Primarily in Securities (Board of Directors: August
1, 1992; revised December 10, 2007).
c.)
NFA Registration Rule 401(e) provides that, if the
only commodity interests a firm trades are swaps,
then the APs of that firm will be eligible for an
automatic examination waiver. To the extent that a
firm engages in other commodity interest trading
activities in addition to swaps, and if trading swaps
is what triggers the firm’s CPO registration
obligation (i.e., but for trading in swaps, the firm
7
would satisfy the trading limits under Regulation
4.13(a)(3)), the firm can apply for an examination
waiver for particular APs only involved in
marketing pools where swaps are what cause
registration to be required. This examination
waiver is initially temporary and only available
until the NFA develops an examination for swaps.
However, it may become a permanent exemption.
Alternatively, persons relying on the waiver in
connection with January 1, 2013 registrations may
be grandfathered. NFA Notice I-12-24 (October 3,
2012).
b.
Disclosure.
The CPO must furnish a disclosure document (“Disclosure Document”) to
each prospective pool participant by no later than the time it delivers to the
prospective participant a subscription agreement for the pool. CFTC
Regulation 4.21.10 This Disclosure Document must contain, among other
things, actual performance information for the offered pool for the most
recent five calendar years and year-to-date, or the life of the pool,
whichever is shorter. If the offered pool has traded commodity interests
for at least three years in which 75% or more of the contributions to the
offered pool were made by persons unaffiliated with the CPO, the trading
manager (if any), the pool’s CTAs, or the principals of any of the
foregoing, only past performance of the offered pool is required. A pool’s
trading manager is a person other than the CPO who has sole or partial
authority to allocate pool assets to CTAs or investee pools. CFTC
Regulation 4.10(h).
If the pool has less than a three-year operating history, performance
information must be supplied for other persons and entities as well. This
includes the performance of other pools and managed accounts operated or
traded by the CPO and the trading manager of the offered pool, if there is
a trading manager; however, if the trading manager has been delegated
complete authority over the offered pool’s trading, and the trading
manager’s performance is not materially different from that of the CPO,
the performance of the other pools operated, and managed accounts
traded, by the CPO need not be disclosed. If the CPO and trading
manager do not have a three-year history, then performance of the trading
principals of the CPO must also be disclosed, unless such performance
does not differ materially from the performance of the offered pool, CPO
and trading manager that is disclosed in the Disclosure Document. If the
10
The Harmonization Release (as defined in Section A.2.d below) rescinded the requirement for all CPOs to
obtain a signed acknowledgement of receipt of the Disclosure Document from each pool participant, effective
August 22, 2013.
8
CPO, its trading principals, and the trading manager have never operated
pools or traded managed accounts before, that must be prominently
disclosed. Disclosure is also required of performance of accounts,
including pools, traded by a major CTA (a CTA that is allocated 10% of
pool funds available for trading) and major investee pools, which include
any pool that is allocated at least 10% of the net asset value of the investor
pool. CFTC Regulation 4.25(a)(5), (b), (c).
The Disclosure Document generally must be filed electronically with NFA
and pre-cleared by NFA, and updated every twelve months. CFTC
Regulation 4.26(a)(2), (d).11
c.
Reporting.
The CPO must furnish to each pool participant certain prescribed reports.
Electronic means may be used if the CPO first discloses its intent to use
such means and the participant fails to object within ten business days of
such disclosure. CFTC Regulation 4.22. If the CPO is unable to meet the
reporting deadline, it must request an extension from the CFTC and NFA
under CFTC Regulation 4.22. Under CFTC Regulation 4.22(f)(1), a CPO
may receive up to an additional 90 calendar days to send the audited
financial statements. A CFTC Regulation 4.22(f)(1) application provides
relief on a one-time basis and requires a letter from the CPO’s
accountants. Under CFTC Regulation 4.22(f)(2), CPOs of commodity
pools that invest in other collective investment vehicles may obtain an
“automatic” 90-day extension of the distribution and filing due date by
submitting an application to the NFA prior to the original due date. A
CFTC Regulation 4.22(f)(1) application need only be made once per pool.
d.
Recordkeeping.
Until recently, the CPO was required by CFTC Regulation 4.23 to keep, at
its main business office, accurate books and records regarding each pool it
operates. These books and records are prescribed by regulation and are
subject to inspection by the CFTC, NFA, and the U.S. Department of
Justice. However, on August 13, 2013, the CFTC adopted final rules
implementing harmonization of compliance obligations for registered
investment companies (“RICs”), which were published in the Federal
Register on August 22, 2013 (the “Harmonization Release”).12 In the
Harmonization Release, the CFTC also granted recordkeeping relief to
11
The Harmonization Release amended the requirement that the Disclosure Documents be updated every nine
months and provided for a twelve month cycle instead, effective September 23, 2013.
12
Harmonization of Compliance Obligations for Registered Investment Companies Required to Register as
Commodity
Pool
Operators,
78
Fed.
Reg.
52308
(Aug.
22,
2013),
available
at:
http://www.cftc.gov/ucm/groups/public/@lrfederalregister/documents/file/2013-19894a.pdf.
9
CPOs of private funds. Accordingly, CFTC Regulations 4.23 and 4.7(b)
were amended by the Commission to delete the requirement that books
and records be kept at the main business location of the CPO. All CPOs
are now allowed to use third-party service providers to manage their
recordkeeping obligations, provided that, if the CPO does so, the CPO
notifies the CFTC through the NFA as required under amended CFTC
Regulation 4.23(c). Additionally, the records must be available for
inspection within 48 hours (72 hours if held outside the United States).13
e.
Separate Legal Entity.
A CPO must operate each pool as a separate legal entity, separate from
that of the CPO. The CFTC may exempt a corporation from this
requirement if: (i) the corporation represents in writing to the CFTC that
each participant in its pool will be issued stock or other evidences of
ownership in the corporation for all funds, securities or other property that
the participant contributes for the purchase of an ownership interest in the
pool; (ii) the corporation demonstrates to the satisfaction of the CFTC that
it has established procedures adequate to assure compliance with the
requirements in the paragraph set forth below; and (iii) the CFTC finds
that the exemption is not contrary to the public interest and to the purposes
of the provision from which the exemption is sought.
All funds, securities or other property received by a CPO from an existing
or prospective pool participant for the purchase of an interest or as an
assessment (whether voluntary or involuntary) on an interest in a pool that
it operates or that it intends to operate must be received in the pool’s
name. Finally, each pool’s property may not be commingled with the
property of any other person. CFTC Regulation 4.20.
f.
Advertising.
Fraudulent advertising by CPOs and their principals is prohibited, and
restrictions are placed upon the use of testimonials and simulated or
hypothetical trading results. CFTC Regulation 4.41; NFA Compliance
Rule 2-29. The NFA also requires members to maintain written
supervisory procedures for the preparation and review of promotional
materials, and imposes recordkeeping requirements as well. NFA
Compliance Rule 2-29.
g.
Supervision.
CPOs should develop and follow written supervisory procedures for APs
that are appropriate for their operations. These procedures should cover:
13
These amendments are effective September 23, 2013.
10
(1) hiring policies; (2) registration; (3) customer information; (4) account
activity; (5) discretionary accounts; (6) promotional material; (7) customer
complaints; and (8) ongoing training for firm personnel. This training
should include monitoring of APs, which should include listening to sales
solicitations and reviewing trading activity in customer and employee
trading accounts, as well as providing additional training to APs regarding
how to handle customers.
CPOs must also oversee their branch offices, if any, including conducting
on-site visits of these offices and maintaining a documented examination
program. CFTC Reg. 166.3 and NFA Compliance Rule 2-9 and related
Interpretive Notices.
h.
Swaps Firm.
To the extent a CPO’s pool trades swaps, the CPO must also register as a
“swaps firm” and designate one of its principals who is also registered as
an AP as a “swaps AP.”
3.
Exclusions and Exemptions.
a.
Exemption for Persons Who Operate Pools Composed Solely of
“Qualified Eligible Persons.”
CFTC Regulation 4.7(b) provides an exemption from almost all the
disclosure, reporting, and recordkeeping requirements otherwise
applicable to registered CPOs.14 However, this exemption is available
only to a registered CPO, and only with respect to a pool composed solely
of persons that the CPO “reasonably believes” are “qualified eligible
persons” (“QEPs”).15 Furthermore, the pool must be sold in an offering
exempt from the registration requirements of the Securities Act pursuant
to Section 4(2) of the Securities Act (for example, under Rule 506 of
Regulation D) or Regulation S, or by a bank registered as a CPO with
respect to a collective trust fund exempt from registration under Section
14
The DSIO indicated that a CPO that has relied on CFTC Regulation 4.13(a)(4) with respect to a fund prior
to April 24, 2012, and wishes to transition to reliance on CFTC Regulation 4.7(b) for that fund, may claim all of the
relief offered by subsections (1), (2) and (3) of CFTC Regulation 4.7(b) even though interests or shares of the fund
were offered and sold, and commodity interest transactions were entered into, prior to the filing of the required
notice under CFTC Regulation 4.7(d) because the interests that were offered and sold were done so in compliance
with then-effective provisions of Part 4. See the FAQ (answer to question 1 under the heading “Transitioning”).
15
CPOs of existing CFTC Regulation 4.13(a)(4) pools that become CFTC Regulation 4.7(b) pools as of
January 1, 2013 will not be required to confirm that all participants in the existing CFTC Regulation 4.13(a)(4) pool
continue to meet the QEP standard. However, the CPO must reasonably believe that any new participants meet the
QEP standard at the time of investment to maintain regulatory relief under CFTC Regulation 4.7. Similar treatment
and the ability to claim relief under CFTC Regulation 4.7 is accorded to CTAs that advised previously exempted
pools. See the FAQ (answer to question 6 under the heading “Transitioning”).
11
3(a)(2) of the Securities Act. These pools may not be marketed to the
public.16
i.
Definition of Qualified Eligible Person.
The definition of QEP is contained in CFTC Regulation 4.7(a)(2)
and (a)(3). CFTC Regulation 4.7(a)(2) identifies persons who do
not need to meet the “Portfolio Requirement” to be QEPs and
CFTC Regulation 4.7(a)(3) identifies persons who must meet the
Portfolio Requirement. Because both “qualified purchasers” and
“knowledgeable employees” are defined as QEPs without having
to meet the Portfolio Requirement, the eligibility requirements for
Section 3(c)(7) of the Investment Company Act of 1940, as
amended (“Investment Company Act”), and CFTC Regulation
4.7(b) funds are the same.
1.)
Under CFTC Regulation 4.7(a)(1)(v),
Requirement” means that a person must:
“Portfolio
a.)
own securities (including pool participations) of
issuers not affiliated with such person and other
investments with an aggregate market value of at
least $2 million;
b.)
have had on deposit with a futures commission
merchant (“FCM”), for its own account, at any time
during the six months preceding the date it
purchases the pool participation in the exempt pool,
or opens an exempt account with a CTA, at least
$200,000 in exchange-specified initial margin and
option premiums, together with the required
minimum security deposit for retail forex
transactions for commodity interest transactions; or
c.)
own a portfolio comprised of a combination of the
funds or property specified in paragraphs a.) and b.)
immediately above in which the sum of the funds or
property includable under a.) above, expressed as a
percentage of the minimum amount required, and
16
On July 10, 2013, the Securities and Exchange Commission (the “SEC”) adopted final rules to eliminate
the prohibition against general solicitation and general advertising in certain securities offerings under Rule 506 of
Regulation D and Rule 144A under the Securities Act, as mandated by the Jumpstart Our Business Startups Act (the
“JOBS Act”). The final rules will take effect on September 23, 2013. Investment pools that trade commodity
interests may be unable to engage in general solicitations despite the adoption of Rule 506(c) if their general
partners, managers or advisers rely on CFTC Regulation 4.7(b), which, as stated above, requires interests in the
commodity pool to be offered and sold without marketing to the public. We understand that CFTC staff intends to
consider whether to modify these exemptions in response to the adoption of Rule 506(c), but not before the
September 23 effective date.
12
the amount of futures margin and option premiums
includable in b.) above, expressed as a percentage
of the minimum amount required, equals at least
100%. (For example, $l million of securities (50%
of $2 million under a.)) plus $100,000 of initial
margin and option premiums (50% of $200,000
under b.)) would equal 100%.)
2.)
17
QEPs who do not have to meet the Portfolio Requirement
at the time of participation in an exempt pool or when an
exempt account is opened include the following:
a.)
A registered FCM or its principals;
b.)
A registered retail foreign exchange dealer or a
principal thereof;
c.)
A swap dealer registered pursuant to Section
4s(a)(1) of the CEA (“SD”), or a principal thereof;
d.)
A registered broker or dealer or a principal
thereof;17
e.)
A registered CPO, registered and active for at least
two years or who operates pools that have total
assets in excess of $5 million, or a principal thereof;
f.)
A registered CTA, registered and active for at least
two years or who provides advice to commodity
accounts that have total assets in excess of $5
million, or a principal thereof;
g.)
An investment adviser registered under federal or
state law, registered and active for at least two years
or that provides advice to accounts with total assets
in excess of $5 million on deposit with a brokerdealer;
h.)
A “qualified purchaser” as defined in Section
2(a)(51)(A) of the Investment Company Act;
i.)
A “knowledgeable employee” as defined in Rule
3c-5 under the Investment Company Act;
The inclusion of swap dealers became effective on November 5, 2012.
13
j.)
A trust, not formed for the specific purpose of either
participating in the exempt pool or opening an
exempt account, if the trustee or other person
authorized to make investment decisions for the
trust, and each settlor or other person who has
contributed assets to the trust, are QEPs;
k.)
An organization described in Section 501(c)(3) of
the Internal Revenue Code of 1986, if the trustee or
other person authorized to invest for the
organization, and the person who established the
organization, are QEPs;
l.)
A “Non-United States Person” as defined in CFTC
Regulation 4.7(a)(1)(iv); and
m.)
An entity in which all participants or unit holders
are QEPs.
The CPO and CTA of the exempt pool or account
are also exempt, as well as their affiliates and
principals. Certain relatives of principals and other
employees are also exempt.
3.)
QEPs who must meet the Portfolio Requirement include:
a.)
Certain RICs and certain business development
companies;
b.)
Certain banks and savings and loan associations
acting for their own account or for the account of a
QEP;
c.)
Certain insurance companies acting for their own
account or for the account of a QEP;
d.)
Certain governmental and private pension plans
with total assets in excess of $5 million;
e.)
Certain private business development companies;
f.)
Section 501(c)(3) organizations with total assets in
excess of $5 million;
g.)
Certain corporations, Massachusetts or similar
business trusts, or partnerships, other than pools,
with total assets in excess of $5 million;
14
h.)
Natural persons with individual net worths, or joint
net worths with their spouses, in excess of $1
million;
i.)
Natural persons with individual incomes of
$200,000 in each of the two most recent years, or
joint net incomes with their spouses of $300,000 in
each of the two most recent years, and reasonable
expectations of reaching the same level in the
current year;
j.)
Certain pools, trusts, insurance company separate
accounts, or bank collective trusts with total assets
in excess of $5 million; and
k.)
Certain U.S. and foreign governmental entities.
If one of the above participants is a pooled vehicle
(such as an investment company or collective
investment fund), it also must not have been formed
for the specific purpose of being a QEP.
ii.
Disclosure Document Requirements.
The CPO may, but need not, deliver an offering memorandum to a
QEP that describes, among other things, its use of commodity
interests for the pool. However, if the CPO does deliver an
offering memorandum to a QEP, it must (1) include all disclosures
necessary to make the information contained therein, in the context
furnished, not misleading, and (2) contain a prescribed legend on
the cover page of the offering memorandum. If no offering
memorandum is provided by the CPO, the legend must appear
immediately above the signature line of the agreement that the
participant must execute to become a pool participant. CFTC
Regulation 4.7(b)(1)(i).
CFTC Regulation 4.7(b) also provides an exemption from
disclosing the past performance of exempt pools in Disclosure
Documents for non-exempt pools unless such past performance “is
material to the non-exempt pool being offered.” CFTC Regulation
4.7(b)(1)(ii). A CPO that is relying upon this exemption must state
in a footnote to the performance disclosure in a Disclosure
Document for a non-exempt pool that the operator is operating or
has operated exempt pools whose performance is not included in
this Disclosure Document.
15
iii. Periodic Reporting Requirements.
CPOs of exempt pools generally are exempt from most of the other
periodic reporting requirements applicable to CPOs. However,
certain quarterly and annual reports must be furnished to pool
participants. Annual reports also must be filed electronically with
NFA. CFTC Regulation 4.7(b)(2) and (3). CFTC Regulation 4.22
gives CPOs the opportunity to obtain a filing extension for annual
reports in certain circumstances, such as, in the fund-of-funds
context, when financial information from underlying funds is not
timely. See CFTC Regulation 4.22(f).
iv. Recordkeeping Requirements.
CFTC Regulation 4.7(b)(4) was amended by the CFTC in the
Harmonization Release to delete the requirement that the CPO
keep at the main business location of the CPO the prescribed
annual and quarterly reports and all books and records prepared in
connection with its activities as a CPO of exempt pools. All CPOs
are now allowed to use certain third-party service providers18 to
manage their recordkeeping obligations, provided that, if the CPO
does so, the CPO notifies the CFTC through the NFA as required
under amended CFTC Regulation 4.23(c). For existing funds, this
notice was due by September 23, 2013. These books and records
must demonstrate the qualifications of the CPO’s QEPs (i.e., how
the CPO reasonably believes that its participants are QEPs) and
substantiate any performance representations made by the CPO to
participants. The books and records must be available for
inspection within 48 hours (72 hours if held outside the United
States) to representatives of the CFTC, NFA and the U.S.
Department of Justice.
If a CPO would like to maintain some or all of its required records
solely in electronic format, before doing so, it must enter into an
arrangement with at least one third party Technical Consultant.
The purpose of requiring the Technical Consultant is to provide the
CFTC or U.S. Department of Justice (“DOJ”) with access to
records in a readable format. If the CPO uses an electronic storage
system, it (or the storage system vendor or another third party with
appropriate expertise) must provide a representation to the CFTC
that the storage system meets the requirements of CFTC
Regulation 1.31(b)(1)(ii). Christopher Cummings, an attorney in
18
Permissible recordkeepers include the pool’s administrator, distributor or custodian, or a bank or registered
broker or dealer acting in a similar capacity with respect to the pool. The CFTC is considering adding additional
permissible recordkeepers to this list.
16
DSIO, is the individual who accepts undertakings from Technical
Consultants regarding electronic records.
v.
Notice.
The notice of a claim for exemption under CFTC Regulation 4.7(b)
must comply with the requirements listed under CFTC Regulation
4.7(d)(1) and must be filed electronically with NFA before the date
the pool first enters into a commodity interest transaction if the
relief requested is limited to reporting and recordkeeping
requirements, and received prior to any offer or sale of any
participation in the pool if the relief requested also includes the
disclosure requirements.
If pool participations were sold in full compliance with CFTC
regulations, the CPO may convert to operating the pool in
accordance with CFTC Regulation 4.7, provided that is consistent
with the rights of pool participants. A majority of participants
unaffiliated with the CPO must approve of the change and those
who object must be treated like participants in non-exempt pools or
be given the chance to redeem within three months of the filing of
a notice under CFTC Regulation 4.7.19
If any CPO that has filed a notice under CFTC Regulation 4.7
ceases to be eligible for the relief claimed, the CPO is required to
file a notice promptly with NFA advising it of such change. CFTC
Regulation 4.7(d)(3).
4.
Exemption for CPOs Whose Use of Commodity Interests is Limited.
The exemption contained in CFTC Regulation 4.12(b) is available only for a
person who is registered as a CPO or who has applied for CPO registration.
Further, it exempts the CPO from only some of the disclosure (primarily,
disclosure of past performance of the pool and its principals, and the pool’s CTA
and its principals), reporting, and recordkeeping requirements generally
applicable to CPOs. The CFTC Regulation 4.12(b) exemption often is used by
managers of privately-placed limited partnerships or limited liability companies
that invest in commodity interests, in addition to securities.
19
The DSIO has not precisely addressed the issue of whether a CPO transitioning from CFTC Regulation
4.13(a)(4) status into CFTC Regulation 4.7(b) status would be required to provide participants who object to this
change with disclosure and reporting in accordance with what is required for full compliance under the Part 4
regulations or a three-month window in which to redeem their units of participation in the pool. Because
transitioning from operating under CFTC Regulation 4.13(a)(4) to operating under CFTC Regulation 4.7 results in
greater regulatory coverage for participants, full Part 4 reporting and disclosure or the right to redeem should not be
necessary or required, but a notice of the change of exemption should be provided to investors.
17
In order to meet the exemption requirements of CFTC Regulation 4.12(b), the
pool must:
a.
Be offered and sold in compliance with the registration requirements of
the Securities Act, or an exemption from such registration requirements;20
b.
Be engaged generally and routinely in the buying and selling of securities
and securities-derived instruments;
c.
Trade commodity interests in a manner “solely incidental” to its securities
trading activities; and
d.
Not enter into commodity interest transactions for which the aggregate
initial margin and premiums, and required minimum security deposit for
retail forex transactions, exceed 10% of the fair market value of the pool’s
assets, after taking into account unrealized profits and unrealized losses on
such contracts. In the case of an option that is in-the-money at the time
of purchase, the in-the-money amount (as defined in CFTC Regulation
190.01(x)) may be excluded in computing such 10%.
Each existing and prospective pool participant also must be informed in
writing of the limitations described in paragraphs c. and d. immediately
above before the pool commences trading commodity interests.
To use this exemption, the CPO must file a notice with NFA electronically
before the pool enters into a commodity interest transaction. CFTC
Regulation 4.12(b)(3) and (4).
Certain disclosures regarding the
utilization of the exemption must also be made in the pool’s offering
memorandum and annual reports. CFTC Regulation 4.12(b)(3).
5.
Exclusion for Certain “Otherwise Regulated Persons.”
CFTC Regulation 4.5 excludes from the definition of CPO persons that operate
pools that are regulated by some other regulatory authority. As this is an
exclusion, all the CFTC’s CPO requirements are not applicable. CFTC
Regulation 4.6(a)(2) excludes from the definition of CTA any person who is
excluded from the definition of CPO under CFTC Regulation 4.5.
a.
Persons Excluded.
The following persons, and principals and employees thereof, are
excluded from the definition of CPO with respect to the operation of the
respective “qualifying entities.” However, they must comply with other
requirements of CFTC Regulation 4.5. A qualifying entity is:
i.
20
a RIC;21
See note 16 regarding the JOBS Act.
18
ii.
an insurance company subject to state regulation with respect to
the operation of a separate account;
iii.
a bank, trust company or any financial depository institution
subject to regulation by any state or the United States with
respect to the assets of a trust, custodial or other separate unit of
investment for which it is acting as a fiduciary and for which it
is vested with investment discretion; or
iv.
a trustee of, named fiduciary of, or an employer maintaining, a
pension plan that is subject to Title I of the Employee
Retirement Income Security Act of 1974, as amended
(“ERISA”).22
In the Amendment Release, the CFTC made clear that a wholly-owned subsidiary
of a RIC, generally referred to as a controlled foreign corporation or “CFC” (used
by many RICs to invest directly in commodity interests to obtain favorable tax
treatment), may not rely upon the exclusion of CFTC Regulation 4.5 and thus
must have a registered CPO operating it, unless the operator may take advantage
of an exemption from registration. The RIC-CFC relationship may be treated like
a master-feeder structure to avoid the need for the operators of the CFC to furnish
a Disclosure Document or other reports to the RIC. Further, DSIO issued Staff
Letter 13-51 on September 5, 2013, stating that it will not recommend that the
CFTC take enforcement action against operators of RICs for failure to provide a
separate report for their CFCs to the NFA pursuant to CFTC Regulation 4.27(c),
and a separate annual report for their CFCs to the NFA pursuant to CFTC
Regulation 4.22(c), provided that such operators consolidate the reporting for the
CFCs with those of the RIC.
b.
Other Excluded Pools.
The CFTC also has excluded certain other employee benefit plans from
the definition of a commodity pool, thereby excluding the operators of
these plans from the definition of CPO under CFTC Regulation 4.5.
These employee benefit plans are:
21
In the Amendment Release, effective April 24, 2012, the CFTC amended CFTC Regulation 4.5 as it applies
to RICs. Under the amendments, RICs wishing to continue to claim the CFTC Regulation 4.5 exclusion from CPO
status are required to limit their use of commodity interests, and comply with certain marketing restrictions.
Advisers to RICs that were relying on the CFTC Regulation 4.5 exclusion as of the effective date of the amendment,
April 24, 2012, had until December 31, 2012 to confirm that they can rely on amended CFTC Regulation 4.5 or
register as CPOs, as appropriate. Compliance with the CFTC’s recordkeeping, reporting and disclosure
requirements pursuant to Part 4 of the CFTC’s regulations was postponed until 60 days after the effectiveness of the
Harmonization Release. Amendment Release, 77 Fed. Reg. 11252.
22
In CFTC No-Action Letter 12-72 (Dec. 21, 2012), the DSIO extended the relief in Regulation 4.5 to an
investment adviser sponsor of a group trust formed and operated exclusively to invest the assets of certain defined
benefit plans.
19
c.
i.
noncontributory plans, whether defined benefit or defined
contribution, covered by Title I of ERISA;
ii.
contributory defined benefit plans covered under Title IV of
ERISA if, with respect to any such plan to which an employee
may voluntarily contribute, no portion of an employee’s
contribution is committed as margin or premiums for futures
contracts or commodity options;
iii.
“governmental plans” as defined in Section 3(32) of Title I of
ERISA;
iv.
employee welfare benefit plans that are subject to the fiduciary
responsibility provisions of ERISA; and
v.
a plan defined as a “church plan” in Title I, Section 3(33) of
ERISA and with respect to which no election has been made
under 26 U.S.C. § 410(d) (e.g., participation, vesting and
funding provisions of ERISA).
Other Requirements.
To take advantage of the exclusion provided by CFTC Regulation 4.5, the
persons listed in the first group above must make certain representations to
NFA.
The representations must be contained in a notice filed
electronically, and the notice, which is effective upon filing, must be filed
before the person may claim the exclusion offered by CFTC Regulation
4.5 and operate the qualifying entity. This notice must be reaffirmed
annually within 60 days of calendar year end.
i.
Disclosure to Participants.
The qualifying entity must disclose in writing to each participant,
whether existing or prospective, that the qualifying entity is
operated by a person who has claimed an exclusion from the
definition of CPO, and who therefore is not subject to registration
or regulation as a CPO. This disclosure must be made in
accordance with the requirements of any other federal or state
regulatory authority to which the qualifying entity is subject.
ii.
Special Calls.
The qualifying entity must agree to submit to special calls as the
CFTC may make to require the qualifying entity to demonstrate
that it is complying with CFTC Regulation 4.5.
20
If any of the information or representations in the notice becomes
inaccurate or incomplete, a supplemental notice must be filed with NFA
electronically within 15 business days.
The filing of a notice of eligibility or the application of “non-pool status”
under CFTC Regulation 4.5 does not affect the ability of a person to
qualify for an exemption from registration as a CPO under CFTC
Regulation 4.13 in connection with the operation of another trading
vehicle that is not covered under CFTC Regulation 4.5.
6.
CFTC Regulation 4.13: Exemptions to CPO Registration for Pools.
a.
CFTC Regulation 4.13(a)(3).
CFTC Regulation 4.13(a)(3) exempts a CPO from registration if, among
other conditions: (1) interests in the pool are exempt from registration
under the Securities Act and such interests are offered and sold without
marketing to the public in the United States;23 (2) it restricts participation
in the pool to “accredited investors,” as defined in Rule 501 of Regulation
D under the Securities Act, certain family trusts formed by accredited
investors, “knowledgeable employees” as defined in Rule 3c-5 under the
Investment Company Act, persons who are QEPs under CFTC Regulation
4.7(a)(2)(viii)(A) (this category includes QEPs that have a relationship
with a CPO), or persons eligible to participate in a pool for which the pool
operator may claim exemption from registration under rescinded CFTC
Regulation 4.13(a)(4) discussed below;24 (3) it 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, premiums and required minimum security deposit for retail forex
transactions required to establish such positions will be limited to 5% of
the liquidation value of the pool’s portfolio, after taking into account
unrealized profits and unrealized losses on any such positions it has
entered into; or (ii) the aggregate net notional value (as described below)
of such positions, determined at the time the most recent position was
established, does not exceed 100% of the liquidation value of the pool’s
portfolio, after taking into account unrealized profits and unrealized losses
on any positions it has entered into; and (4) it does not market
participation in the pool as or in a vehicle for trading in the commodity
futures or commodity options markets.
CFTC Regulation 4.13(a)(3) describes how “notional value” is calculated
for these purposes. For futures contract positions, notional value is
calculated by multiplying the number of contracts by the size of the
23
See note 16 regarding the JOBS Act.
24
See the FAQ (answer to question 2 under the heading “Regulation 4.13”).
21
contract, in contract units (taking into account any multiplier specified in
the contract), by the current market price per unit. For commodity
options, notional value is calculated by multiplying the number of
contracts by the size of the contract, adjusted by its delta, in contract units
(taking into account any multiplier specified in the contract), by the strike
price per unit. For a retail forex transaction, notional value is calculated as
the value in U.S. Dollars of such transaction, at the time the transaction
was established, excluding for this purpose the value in U.S. Dollars of the
offsetting long and short transactions, if any. For cleared and uncleared
swaps, the notional value is generally the amount reported by the reporting
counterparty as the notional amount of the swap under the CFTC’s Part 45
regulations.25 A CPO of a fund may net futures contracts and commodity
options with the same underlying commodity across designated contract
markets and foreign boards of trade26 and may net swaps cleared on the
same derivatives clearing organization, where appropriate.
In the Amendment Release, the CFTC rescinded Appendix A to Part 4 of
its Regulations, which provided guidance on the application of CFTC
Regulation 4.13(a)(3) to a fund of funds (an “FoF”).27 Appendix A
generally provided that the CPO of an FoF may rely on the representations
of the underlying funds in assessing the FoF’s compliance with CFTC
Regulation 4.13(a)(3). For example, if an FoF invests exclusively in
underlying funds that themselves comply with the trading limitation in
CFTC Regulation 4.13(a)(3), then the FoF itself would comply with the
trading limitation in CFTC Regulation 4.13(a)(3). Similarly, the CPO of
an FoF may comply with CFTC Regulation 4.13(a)(3) by obtaining
contractual assurances from its underlying funds regarding the commodity
interest trading activities of the underlying funds and aggregating the
percentage limitations to determine the FoF’s compliance with the 5% or
100% limitation. Appendix A noted, however, that CPOs of FoFs must
still comply with all of the other requirements of CFTC Regulation
4.13(a)(3) to avail themselves of the exemption from CPO registration.
In the DSIO’s no-action letter dated November 29, 2012 (“No-Action
Letter 12-38”), the DSIO addressed the effects of the rescission of
Appendix A of Part 4 of the CFTC’s regulations on operators of FoFs. In
this letter, the DSIO indicated that it will not recommend that the CFTC
take enforcement action against CPOs of FoFs for failure to register as
25
See the FAQ (answer to questions 4 and 5 under the heading “Trading Limits”).
26
See the FAQ (answer to question 3 under the heading “Trading Limits”).
27
The CFTC staff has indicated that the guidance contained in Appendix A is being reviewed and likely will
be revised and republished by the end of 2013. In the FAQ, the DSIO has indicated that funds of funds may
continue to rely on Appendix A until the CFTC adopts revised guidance. See the FAQ (answer to question 1 under
“Funds-of-Funds”).
22
such until the later of June 30, 2013, or six months from the date the DSIO
issues revised guidance on the application of the calculation of the de
minimis thresholds in CFTC Regulations 4.5 and 4.13(a)(3), provided that
the CPOs comply with the following requirements: (i) the CPO file a
claim with the DSIO to take advantage of the relief prior to December 31,
2012,28 and (ii)(1) the CPO currently structures its operations in whole or
in part as a CPO of one or more FoFs; (2) the amount of commodity
interest positions to which the FoF is directly exposed does not exceed the
levels specified in CFTC Regulation 4.5 or 4.13(a)(3)(ii)(A) or (B); (3) the
CPO “does not know and could not have reasonably known” that the
FoF’s indirect exposure to commodity interests derived from contributions
to investee funds exceeds the levels specified in CFTC Regulations 4.5 or
4.13(a)(3)(ii)(A) or (B), either calculated directly, or through the use of
prior Appendix A; and (4) the commodity pool for which the CPO seeks
relief is either (x) an investment company registered as such under the
Investment Company Act of 1940, or (y) compliant with the provisions of
CFTC Regulation 4.13(a)(3)(i), (iii), and (iv).29
Finally, the CFTC staff issued an interpretive letter confirming that a CPO
claiming an exemption from registration under CFTC Regulation
4.13(a)(3) may permit “Non-United States Persons,” as defined in CFTC
Regulation 4.7, to participate in pools operated pursuant to such exemptive
relief, regardless of whether such Non-United States Persons meet the
investor sophistication requirements of CFTC Regulation 4.13(a)(3)(iii).
The CFTC staff reasoned that, because a CPO claiming exemption under
CFTC Regulation 4.13(a)(4) may admit Non-United States Persons to a
pool that is not subject to trading restrictions regardless of those persons’
income, net worth, or other indicia of financial sophistication, the same
principle should apply to a CPO exempted under CFTC Regulation
4.13(a)(3). CFTC Staff Letter 04-13, [2003-2004 Transfer Binder] Comm.
Fut. L. Rep. (CCH) ¶29,753 (April 14, 2004).
28
CPOs can continue to file a claim with the DSIO to take advantage of the relief for new funds, according to
a conversation with Gary Barnett, the Director of the DSIO.
29
The DSIO’s No-Action Letter No. 12-67 (Dec. 21, 2012) provides relief for the operator of a fund that
invests in a legacy securitization vehicle that satisfies the criteria of no-action relief in CFTC Interpretive and NoAction Letter No. 12-45 (Dec. 7, 2012). The DSIO will therefore not recommend that the CFTC take enforcement
action against the operator of a fund that invests in a legacy securitization vehicle whose operator is entitled to noaction relief under CFTC Letter No. 12-45, and who otherwise would not be required to register as a CPO, for
failure to register as a CPO with the CFTC.
23
b.
Rescinded CFTC Regulation 4.13(a)(4).30
Rescinded CFTC Regulation 4.13(a)(4) exempted a CPO from registration
if, among other conditions: (1) it restricted participation in the pool to
natural persons who are QEPs under CFTC Regulation 4.7(a)(2) and nonnatural persons who are either QEPs under CFTC Regulation 4.7 or
“accredited investors”; and (2) interests in the pool were exempt from
registration under the Securities Act and such interests were offered and
sold without marketing to the public in the United States. This exemption,
unlike that of CFTC Regulation 4.13(a)(3), did not impose any restrictions
on commodity interest trading activities, ostensibly because the QEP
sophistication standard for natural persons in CFTC Regulation 4.13(a)(4)
was higher than the sophistication standards in CFTC Regulation
4.13(a)(3).
c.
Notice.
To avail itself of the exemption in CFTC Regulation 4.13(a)(3), the CPO
must file a prescribed notice electronically with NFA and reaffirm its
ability to rely on the exemption annually within 60 days of December 31
of each year. The notice, if materially complete, is effective upon filing.
If the information or representations contained in the notice become
inaccurate or incomplete, an amendment must be filed within 15 business
days. In addition, the CPO must disclose to each prospective participant
in the pool: (1) that the person is exempt from registration as a CPO and,
unlike a registered CPO, is not required to deliver a Disclosure Document
and a certified annual report to participants in the pool; and (2) a
description of the criteria pursuant to which it qualifies for an exemption
from CPO registration. The regulation also contains certain recordkeeping
and annual report requirements, and persons who rely on the exemption
are subject to special calls by CFTC staff.
d.
Registration Withdrawal.
A registered CPO may withdraw its registration to claim exemption from
registration under CFTC Regulation 4.13(a)(3), if it provides participants
with written notice of its intention to withdraw and a right to redeem prior
to the CPO filing its exemption notice with NFA.
30
In the Amendment Release, the CFTC rescinded CFTC Regulation 4.13(a)(4). The rescission became
effective on April 24, 2012. Advisers to private funds that filed notices under CFTC Regulation 4.13(a)(4) prior to
April 24, 2012 had until December 31, 2012 to register as CPOs or CTAs or rely upon a different exemption (such
as CFTC Regulation 4.13(a)(3)).
24
e.
Multiple Pools.
It is permissible for a registered CPO that operates pools for which it must
be registered to operate other pools for which registration as a CPO is not
required as if they are exempt pools under CFTC Regulation 4.13(a)(3).
f.
Certain Requirements Still Apply.
Persons exempt from registration as CPOs remain subject to the antifraud
prohibition in Section 4o of the CEA, advertising restrictions in CFTC
Regulation 4.41, and large trader reporting requirements under Parts 15-21
of the CFTC’s regulations.
7.
CFTC Regulation 3.10(c)(3)
CFTC Regulation 3.10(c)(3) provides an exemption for certain CPOs and CTAs
organized as non-United States entities. To qualify for this exemption, (i) the
CPO or CTA must be organized as a non-United States CPO or CTA and must be
located outside the United States, its territories or possessions, (ii) any such fund
or client operated or advised by the CPO or CTA must be organized as a nonUnited States entity and located outside the United States, its territories or
possessions, and all investors in any such fund must be located outside the United
States, its territories or possessions (and a majority of the board of directors of
such fund, if applicable, must be non-United States residents and citizens), (iii)
the CPO must not solicit prospective investors located in the United States,31 and
(iv) any commodity interest transaction executed bilaterally or made on or subject
to the rules of any designated contract market or swap execution facility in the
United States markets must be submitted for clearing through a registered FCM.
The CFTC staff has indicated that the requirement concerning submission for
clearing through a registered FCM will apply to swaps with a U.S. counterparty,
even if the CFTC has not mandated the swap for clearing.
A CPO or CTA acting in accordance with CFTC Regulation 3.10(c)(3) remains
subject to Section 4(o) of the CEA (Fraud and Misrepresentation by CTAs, CPOs
and Associated Persons), but otherwise is not required to comply with those
provisions of the CEA and of the rules, regulations and orders thereunder
applicable to CPOs or CTAs.
The Dodd-Frank Act amended the CEA to establish comprehensive regulation of
swaps by the CFTC. On July 12, 2013, the CFTC adopted interpretive guidance
regarding the cross-border application of the swaps provisions of the Dodd-Frank
31
See Exemption from Registration for Certain Foreign Persons, 72 Fed. Reg. 63976 (November 14, 2007)
(adopting release). The line of no-action letters that preceded adoption of CFTC Regulation 3.10(c)(3) required that
none of the participants in the pool be a resident or citizen of the U.S., and none of the funds or capital contributed
to the pool come from U.S. sources. Accordingly, this exemption is likely available with respect to a pool or
account only if no U.S. investors are permitted in such pool or account. Reliance on the definition of “Non-United
States person” in CFTC Regulation 4.7(a) appears to be insufficient for this purpose.
25
Act. Among other things, this guidance provides an eight-prong definition of the
term “U.S. person,” effective as of October 9, 2013, to be used in the context of
Section 2(i) of the CEA. Unfortunately, CFTC Regulations 3.10(c)(3) and 4.7(a),
and the Dodd-Frank Act definition, have different definitions of “U.S. person.”
B.
Commodity Trading Advisors.
1.
Definition.
a.
Pre-Dodd-Frank Act Definition.
Section 1a(6)(A) of the CEA defined a CTA as “any person who – (i) for
compensation or profit, engages in the business of advising others, either directly
or through publications, writings, or electronic media, as to the value of or the
advisability of trading in . . . [(I) any futures contract traded on a contract market
or DTEF; or (II) any commodity option subject to the CFTC’s authority; or (III)
any leverage transaction]; or (ii) for compensation or profit, as part of a regular
business, issues or promulgates analyses or reports concerning any of the
activities referred to in clause (i).”
In addition, although the CEA and CFTC definitions of CTA do not refer to
providing advice with respect to foreign options or foreign futures, CFTC
Regulation 30.4(d) effectively treats any person who provides such advice for
compensation as a CTA. CFTC Regulation 30.4(d) prohibits any person from
soliciting or entering into an agreement to direct a customer’s account with
respect to specific transactions in foreign futures or foreign options, or to guide a
customer’s account by means of a systematic program that recommends specific
transactions in any foreign futures or foreign options, unless the person is
registered as a CTA or is otherwise excluded or exempt from CTA registration.
b.
Dodd-Frank Act Definition.
The Dodd-Frank Act defines a CTA as any person who, for compensation or
profit:
(i)
engages in the business of advising others, either directly or
through publications, writings, or electronic media, as to the value
of or the advisability of trading in:
(a)
any contract of sale of a commodity for future delivery,
security futures product, or swap; or
(b)
any agreement, contract, or transaction described in Section
2(c)(2)(C)(i) of the CEA or Section 2(c)(2)(D)(i)1a-1 of the
CEA; or
26
(ii)
c.
(c)
any commodity option authorized under Section 4c of the
CEA; or
(d)
any leverage transaction authorized under Section 19 of the
CEA; or
as part of a regular business, issues or promulgates analyses or
reports concerning any of the activities referred to in clause (i).
Effective Date of Dodd-Frank Act Definition.
The effective date for the inclusion of swaps in what constitutes a commodity
interest for purposes of the CTA definition was December 31, 2012.32
2.
Regulatory Requirements.
a.
Registration – Introduction.
The CTA and its APs33 must register as such under the CEA. The CTA
must also become a member of NFA and its APs must become associate
members of NFA.
i.
Principals.
The CTA must also list its principals on its registration application.
See Section A.2.a.ii of this outline for the definition of the term
“principal.” CFTC Regulation 3.1(a).
ii.
Applications.
Applicants for registration as a CTA and membership in NFA must
file Form 7-R and must submit a Form 8-R for each AP and natural
person principal.34 The Form 8-R must include a fingerprint card,
which will be sent to the Federal Bureau of Investigation as part of
the determination of the person’s fitness.
32
See note 3.
33
An AP of a CTA is defined as a natural person “partner, officer, employee, consultant, or agent (or any
natural person occupying a similar status or performing similar functions), in any capacity which involves (i) the
solicitation of a client’s or prospective client’s discretionary account or (ii) the supervision of any person or persons
so engaged.” CFTC Regulation 1.3(aa)(4). This means that marketing personnel, and persons who supervise
marketing personnel up to and including a CTA’s chief executive officer, may need to register as APs. CFTC
Regulation 3.12(h) does, however, provide certain relief from AP registration.
34
Note that NFA Bylaw 301(iii) states that a firm will not be registered as a CTA unless at least one person is
both a principal and an AP.
27
As part of the application for an AP, the applicant must submit a
Sponsor’s Certification stating that the sponsor intends to employ
the applicant as an AP and will do so within 30 days after the
registration is granted, that the sponsor has verified the information
supplied by the applicant as to his or her education and
employment history during the preceding three years, and that all
of the information supplied by the applicant on the form is, to the
best of the sponsor’s knowledge, accurate and complete.
iii.
Proficiency Examination Requirements.
Generally, APs must satisfy proficiency requirements by taking
and passing the National Commodity Futures Examination (Series
3), unless they have taken and passed the exam within the previous
two years or, since having passed the exam, there has not been a
period of two consecutive years in which they have not been
registered as an AP or as a floor broker.35 Applicants may satisfy
the proficiency requirements by taking an exam other than the
Series 3, if they meet the appropriate qualifications.36
1.)
For example, individuals registered as General Securities
Representatives (Series 7) that limit their futures activities
on behalf of their sponsors to soliciting customers for
participation in a commodity pool, or for discretionary
accounts to be managed by CTAs, may take the Futures
Managed Funds Examination (Series 31) instead of the
Series 3 exam. The Series 31 alternative is not available to
a Series 7 representative of an affiliate of the CTA; rather
the Series 7 must be held by the CTA, which would require
the CTA to be a registered broker-dealer.
2.)
Individuals may use the Limited Futures Examination
(Series 32) if, within the two years prior to filing the
application, they have been registered or licensed to solicit
35
Every location from which sales activity is conducted that is not the headquarters of a firm is generally
considered a branch office and generally must have a branch office manager. See NFA Interpretive Notice 9002:
Registration Requirements; Branch Offices (Staff: September 6, 1985; revised July 1, 2000; December 9, 2005; and
September 30, 2010). In addition to Series 3, the branch office manager is generally required to pass the Series 30
examination within the two years preceding his application. However, a person may not be required to take the
Series 30 examination if: (i) he is currently approved as a branch office manager; or (ii) he was approved as a branch
office manager and, since the last date the applicant was withdrawn as a branch office manager, there has not been a
period of two consecutive years during which he was not either temporarily licensed as an AP or registered as an
AP; or (iii) his sponsor is a registered securities broker-dealer that provides proof that the person is qualified to act
as a branch office manager or designated supervisor under rules of FINRA.
36
In addition, the NFA appears in some circumstances to be allowing persons whose Series 3 license has
lapsed for more than two years to take the Series 32 examination rather than the Series 3 examination, upon written
request to the NFA describing the circumstances.
28
customer business in futures in the United Kingdom or
Canada.
3.)
Individuals are not required to take an examination if they
are registered with FINRA as a General Securities
Representative with their sponsor and they are going to
limit their futures activities on behalf of their sponsor to
referring clients to APs of the sponsor, which referrals are
solely incidental to their business as a General Securities
Representative, or supervising persons who perform these
same limited activities. See NFA Registration Rule 401(b).
4.)
The NFA’s Director of Compliance will, upon request,
grant waivers from the Series 3 examination requirement to
individuals associated with CTAs if:
5.)
b.
a.)
The CTA is subject to regulation by a federal or
state regulator (e.g., it is a registered broker-dealer
or registered investment adviser);
b.)
The CTA’s futures and options trading advice to
each of its clients is incidental to its securities
advice; and
c.)
The CTA’s futures and options trading advice is
only for hedging or risk management purposes.
NFA Interpretive Notice 9022: Registration Rule
402: CTAs Trading Primarily in Securities (Board
of Directors: September 21, 1993; revised
December 10, 2007).
NFA Registration Rule 401(e) provides that, if the only
commodity interests a firm trades are swaps, then the APs
of that firm will be eligible for an automatic examination
waiver. This examination waiver is initially temporary and
only available until the NFA develops an examination for
swaps. However, it may become a permanent exemption.
Alternatively, persons relying on the waiver in connection
with January 1, 2013 registrations may be grandfathered.
Notice I-12-24 (October 3, 2012).
Disclosure.
The CTA must furnish a Disclosure Document to each prospective client.
CFTC Regulation 4.31. This Disclosure Document must contain, among
other things, actual performance information for the CTA and its trading
principals during the past five years and year-to-date, or the life of the
program or account, if its history is shorter than five years. CFTC
29
Regulation 4.35(a)(5). If the CTA and its trading principals have not
previously directed any managed accounts, this fact must be prominently
disclosed. CFTC Regulation 4.35(b). The Disclosure Document generally
must be filed with NFA electronically and updated every twelve months.
CFTC Regulation 4.36(b), (d).
c.
Recordkeeping.
The CTA must keep accurate books and records, including all powers-ofattorney and other documents authorizing the CTA to direct each client’s
account. These books and records are prescribed by regulation and are
subject to inspection by the CFTC, NFA and the U.S. Department of
Justice. CFTC Regulation 4.33. The Harmonization Relief did not
provide CTAs with any of the recordkeeping relief provided to CPOs.
Accordingly, a firm that is dually-registered as a CPO and a CTA must
continue to maintain CTA-related records at its main business office rather
than an alternative recordkeeper, thereby limiting the usefulness of the
CPO recordkeeping relief.
With respect to sub-advisers to RICs that cannot comply with CFTC
Regulation 4.5, the Harmonization Release does not address the subadviser’s obligations under the Part 4 regulations with respect to the RIC.
The DSIO’s frequently asked questions, in the answer to question 3 under
the heading “Compliance Dates,” indicated that sub-advisers to RICs that
can no longer rely on CFTC Regulation 4.14(a)(8), which is predicated on
the RIC CPO being excluded from being a CPO under CFTC Regulation
4.5, would have until 60 days following the effective date of the
Harmonization Rules to come into compliance with the CFTC’s Part 4
regulations. Thus, the question remains as to whether such a sub-adviser
will be required to prepare a fully compliant CTA Disclosure Document,
pre-clear it with the NFA staff, deliver it to the RIC CPO and update it
every twelve months, or whether compliance with the SEC’s rules under
the Investment Company Act would be sufficient for the RIC’s CTA.
Importantly, if relief is not available to such CTAs, they would, among
other things, be required in some cases to provide copious amounts of
performance information. The CFTC staff has indicated some willingness
to reconsider whether a CTA Disclosure Document is required in all cases,
and we understand that there may be further discussions of this issue with
the CFTC staff.
d.
Client Funds.
The CTA may not solicit, accept, or receive client funds, securities, or
property in the CTA’s name (or extend credit in lieu thereof) to purchase,
margin, guarantee or secure any commodity interest of the client. CFTC
Regulation 4.30. The prohibition on holding such funds does not apply to
a registered FCM, a leverage transaction merchant that is registered as a
30
CTA under the CEA, a registered retail foreign exchange dealer or a
registered swap dealer in connection with a swap that was not cleared
through a derivatives clearing organization.37
e.
Advertising.
Fraudulent advertising by CTAs and their principals is prohibited. There
are also restrictions upon the use of testimonials and simulated or
hypothetical trading results. CFTC Regulation 4.41; NFA Compliance
Rule 2-29. NFA members must establish written supervisory procedures
for preparing and reviewing promotional materials, and maintain all such
materials for five years after their last use. NFA Compliance Rule 2-29.
f.
Supervision.
CTAs should develop and follow written supervisory procedures for APs
that are appropriate for their operations. These procedures should cover:
(1) hiring policies; (2) registration; (3) customer information; (4) account
activity; (5) discretionary accounts; (6) promotional material; (7) customer
complaints; and (8) ongoing training for firm personnel. This training
should include monitoring of APs, which should include listening to sales
solicitations and reviewing trading activity in customer and employee
trading accounts, as well as providing additional training to APs regarding
how to handle customers.
CTAs must also oversee their branch offices, if any, including conducting
on-site visits of these offices and maintaining a documented examination
program. CFTC Reg. 166.3 and NFA Compliance Rule 2-9 and related
Interpretive Notices.
g.
Swaps Firm.
To the extent a CTA provides advice regarding swaps, the CTA must also
register as a “swaps firm” and designate one of its principals who is also
registered as an AP as a “swaps AP.”
h.
Post Execution Allocation of Bunched Orders.
Almost any CTA38 is permitted to enter bunched orders (i.e., discretionary
orders entered on behalf of multiple customers) without including specific
37
The inclusion of swap dealers became effective on November 5, 2012.
38
CTAs who are exempt from registration as CTAs in accordance with CFTC Regulations 4.14(a)(4) and
(a)(5), based upon their being registered or exempt from registration as a CPO and providing trading advice solely
for the pools for which they are so registered or exempt, respectively, may also take advantage of the bunched order
regulation. Accordingly, the discussion herein referring to CTAs should also be applicable to a CPO who is
executing commodity interest transactions on behalf of a fund.
31
customer account identifiers for the accounts in the bunched order, subject
to certain conditions.39 CFTC Regulation 1.35(a-1)(5). There are no
affirmative disclosures that a CTA must make to clients about the postexecution allocation of bunched orders, but, upon a client’s request, the
CTA must make available (a) the general nature of the allocation
methodology; (b) whether accounts in which the CTA has an interest may
be included with client accounts in the bunched order;40 and (c) summary
or composite data sufficient for the client to compare its results of
executions to those of comparable clients and, if applicable, any account
in which the CTA has an interest. The CTA also has related
recordkeeping obligations. See also Appendix C to Part 1 of the CFTC
Regulations.
i.
Swap Block Trading.
The CFTC has adopted regulations that are intended to limit block trading
in swaps to about one-third of the market. Block trades are large trades
that are executed in accordance with exchange rules, but occur away from
the trading system or platform. The reporting party is permitted to delay
real-time reporting of the block transaction so that the liquidity provider
for the block transaction may be afforded some additional time to re-enter
the market to offset its exposure on the block trade before transaction and
pricing data of the block trade are reported publicly.
The regulations prohibit the aggregation of orders for different trading
accounts in an attempt to satisfy the minimum block size requirements,
except that aggregation would be permissible if done on a designated
contract market (“DCM”) or a swap execution facility (“SEF”) by a
person who: (1)(a) is a CTA registered under the CEA or exempt from
such registration, or a principal thereof, and who has discretionary trading
authority or directs client accounts, (b) is an investment adviser who has
discretionary trading authority or directs client accounts and satisfies the
criteria of CFTC Regulation 4.7(a)(2)(v), or (c) is a foreign person who
performs a similar role or function as the persons described in (1)(a) or
(1)(b) and is subject as such to foreign regulation; and (ii) has more than
$25 million in total assets under management. Therefore, a CTA may
wish to review the documentation of individual managed accounts and
39
These conditions require that the post-execution allocation of the trades in the bunched order to specific
accounts is (i) made as soon as practicable after execution, and no later than sufficiently before the end of the trading
day during which the order is executed to permit clearing records to identify the ultimate customer for each trade;
(ii) fair and equitable, so that no account or group of accounts receives consistently favorable or unfavorable
treatment; and (iii) sufficiently objective and specific to permit independent verification by regulatory and selfregulatory organization authorities, as well as outside auditors.
40
If the CTA is registered as an investment adviser with the SEC, the disclosures in clauses (a) and (b) could
be made in the adviser’s Form ADV Part 2A. For a fund, it might be preferable to include the disclosure in the
fund’s private placement memorandum or prospectus.
32
funds to make sure that it has consent to elect block trade treatment if
available.41
3.
Exclusions and Exemptions.
a.
Exemption for Persons Who Provide Advice to “Qualified Eligible
Persons.”
CFTC Regulation 4.7(c) provides an exemption from almost all the
disclosure and recordkeeping requirements otherwise applicable to
registered CTAs. However, this exemption is available only to registered
CTAs and only with respect to commodity interest trading advice provided
to persons that the CTA “reasonably believes” are QEPs as defined in
CFTC Regulation 4.7(a)(2-3). See Section A.3.a.i. above.
i.
Disclosure Document Requirements.
The CTA may, but need not, deliver a brochure or other document
to a QEP that describes, among other things, its use of futures
contracts and commodity options for the client’s account.
However, if the CTA does deliver a brochure or other Disclosure
Document to a QEP, it must (1) include all disclosures necessary to
make the information contained therein, in the context furnished,
not misleading, and (2) contain a prescribed legend on the cover
page of the brochure or document. If no brochure or Disclosure
Document is provided by the CTA, the legend must appear
immediately above the signature line of the agreement that the
client must execute before it opens an account. CFTC Regulation
4.7(c)(1)(i).
If the CTA advises non-exempt as well as exempt accounts, CFTC
Regulation 4.7(c)(1)(ii) also provides an exemption from
disclosing the past performance of exempt accounts in Disclosure
Documents for non-exempt accounts, unless such past performance
is material to the non-exempt account being offered. A CTA that
is relying upon this exemption must state in a footnote to the
performance disclosure in a Disclosure Document for a nonexempt account that the CTA is advising or has advised exempt
accounts whose performance is not included in this Disclosure
Document.
41
The CFTC Division of Market Oversight issued No-Action Letter 13-48 (July 30, 2013) to provide relief
through October 1, 2013 regarding aggregation of orders included in block trades by CTAs and investment advisers
because DCMs and SEFs are not yet ready to handle such trades, so they must be done off-facility. This no-action
letter also provides relief until further notice with respect to swaps that are not listed or offered for trading on a
DCM or SEF.
33
ii.
Recordkeeping Requirements.
Although CFTC Regulation 4.7(c)(2) provides a general exemption
from the recordkeeping requirements, the CTA must maintain at its
main business office all books and records prepared in connection
with its activities as a CTA of QEPs. These books and records
must demonstrate the qualifications of the CTA’s QEPs (i.e., how
the CTA reasonably believes that its client is a QEP) and
substantiate any performance representations made by the CTA to
a client. The CTA must make those books and records available to
representatives of the CFTC, NFA and the U.S. Department of
Justice.
iii. Notice.
Before the CTA enters into an agreement to direct or guide the
commodity interest account of a QEP, the CTA must file a notice
electronically with NFA. If the CTA, in the future, ceases to be
eligible for the relief claimed, the CTA is required to file a notice
promptly with NFA advising it of such change. CFTC Regulation
4.7(d)(3).
b.
Exemption for Registered Investment Advisers.
Persons who are registered as investment advisers under the Investment
Advisers Act of 1940, as amended (“Advisers Act”), whose business does
not consist primarily of acting as CTAs, who do not act as CTAs to any
commodity pool that is engaged primarily in trading in commodity
interests and who do not hold themselves out to the public as such, are
exempt from registration as CTAs. See CEA Section 4m(3). What is
considered a commodity interest for this purpose is broader than what is
considered a commodity interest for the CPO and CTA definitions. See
CEA Section 4m(3)(C).
In addition, certain persons may be exempt from registration as CTAs and
from complying with the CFTC’s CTA disclosure and recordkeeping
requirements in accordance with CFTC regulations. CFTC Regulation
4.14(a)(8). They include persons who are (1) registered as investment
advisers under the Advisers Act, (2) excluded from the definition of
“investment adviser” pursuant to Sections 202(a)(2) (certain banks and
trust companies) or 202(a)(11) of the Advisers Act, (3) U.S. stateregistered investment advisers, or (4) investment advisers that are exempt
from federal and state registration. However, to qualify for this
exemption, the investment adviser must comply with the following
requirements:
34
i.
Advice Must Be Furnished Only to Certain Entities Excluded
from the Commodity Pool Definition.
The investment adviser must direct its commodity interest trading
advice solely to, and for the sole use of, (1) “qualifying entities”
(as defined in CFTC Regulation 4.5) for which notices of
eligibility have been filed or that are excluded from the definition
of the term “commodity pool” in CFTC Regulation 4.5(a)(4) (see
Section A. 5. a. and b. above), (2) commodity pools operated by
CPOs that have claimed an exemption from registration under
CFTC Regulation 4.13(a)(3), or, if the CPO is registered, pools
that are operated in accordance with the provisions of those
regulations, and/or (3) commodity pools organized and operated
outside of the United States that meet the following criteria: (i) the
CPO has not organized and is not operating a pool for the purpose
of avoiding CPO registration; (ii) with the exception of the pool’s
operator, advisor and their principals, only “Non-United States
Persons” (as defined in CFTC Regulation 4.7(a)(1)(iv)) may
contribute funds or other capital to, and own beneficial interests in,
the pool (provided that units of participation in the pool held by
persons who do not qualify as Non-United States Persons or
otherwise as QEPs must represent in the aggregate less than 10%
of the beneficial interest in the pool); (iii) 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 Non-United States Persons; and (iv) no person
affiliated with the pool may conduct any marketing activity from
within the United States, its territories or possessions.
ii.
Advice Must Be “Solely Incidental.”
The investment adviser’s commodity interest trading advice must
be “solely incidental” to its business of providing securities trading
advice to each entity.
iii. No Holding Out as a CTA.
The investment adviser must not otherwise hold itself out as a
CTA.
iv. Other Requirements.
CFTC Regulation 4.14(a)(8) also contains certain recordkeeping
requirements, and persons who rely upon the exemption are subject
to special calls by CFTC staff.
35
v.
Adviser Must File Notice.
The investment adviser must file a prescribed notice electronically
with NFA no later than the time it delivers an advisory agreement
for the trading program pursuant to which it will offer commodity
interest advice to a client. The notice, if materially complete, is
effective upon filing. If the information or representations
contained in the notice become inaccurate or incomplete, an
amendment must be filed within 15 business days. The notice
must be reaffirmed annually within 60 days of calendar year end.
vi. Registration Withdrawal.
A registered CTA may withdraw its registration and operate in
accordance with the exemption provided under CFTC Regulation
4.14(a)(8) if, prior to filing its notice of exemption, the CTA
provides to each client (1) written notice that it intends to withdraw
its registration and claim the exemption, and (2) a right to
terminate its advisory agreement prior to the CTA filing a notice of
exemption from registration.
c.
Exclusion for Banks and Trust Companies.
“[A]ny bank or trust company or any person acting as an employee
thereof” is excluded from the definition of CTA, but only if the furnishing
of its commodity interest trading advice “is solely incidental to the
conduct of [its] business or profession.” CEA Section 1a(6)(B)(i), (C);
CFTC Regulation 1.3(bb). Persons falling within this exclusion are not
subject to any of the CFTC’s CTA requirements. See CFTC Staff Letter
84-16, [1984-1986 Transfer Binder] Comm. Fut. L. Rep. (CCH) ¶22,347
at 29,634 (September 7, 1984); CFTC Staff Letter 83-2, [1982-84 Transfer
Binder] Comm. Fut. L. Rep. (CCH) ¶21,788 at 27,176 (March 18, 1983).
d.
Exemption for Persons with 15 or Fewer Clients.
Section 4m(1) of the CEA exempts from registration a CTA who provides
commodity interest trading advice to 15 or fewer persons within the
preceding 12 months and who does not hold itself out to the public as a
CTA. The CFTC adopted CFTC Regulation 4.14(a)(10) in 2003 to
provide that any entity advised by a CTA that receives commodity interest
trading advice based on its investment objectives, rather than on the
individual investment objectives of its investors, would count as only one
“person” for purposes of determining eligibility for the exclusion from
registration under Section 4m(1) of the CEA. This exemption, if
applicable, also exempts the CTA from the CFTC’s CTA disclosure and
recordkeeping requirements. However, if a CTA holds itself out to the
36
public as a CTA, this exemption does not apply, regardless of how many
persons the CTA advises.
e.
Exclusion for Publishers.
“[T]he publisher or producer of any print or electronic data of general and
regular dissemination, including its employees” is excluded from the
definition of CTA, but only if the furnishing of advisory services is solely
incidental to its business. CEA Section 1a(6)(B)(iv), (C); CFTC
Regulation 1.3(bb). On March 10, 2000, the CFTC published new CFTC
Regulation 4.14(a)(9), which exempts from registration certain CTAs that
provide standardized commodity trading advice by means of media such
as newsletters, Internet websites and non-customized software. To be
exempt, “Section 4.14(a)(9) CTAs” may not direct client accounts or
provide commodity trading advice based on or tailored to the
circumstances of particular clients. See 65 Fed. Reg. 12938 (March 10,
2000).
f.
Certain Requirements Still Apply.
Persons exempt from registration as CTAs remain subject to the antifraud
prohibition in Section 4o of the CEA, advertising restrictions in CFTC
Regulation 4.41, and large trader reporting requirements under Parts 15-21
of the CFTC’s regulations.
C.
NFA Membership and Other Requirements.
1.
Membership.
Membership in NFA is mandatory for any FCM, introducing broker (“IB”), CTA
and CPO that transacts futures business with the public. The mandatory
membership requirement also extends to APs of all such industry registrants.
NFA is under a statutory mandate to provide training standards and proficiency
tests for its members who solicit transactions.
2.
Bylaw 1101.
NFA Bylaw 1101 states that no NFA member may carry an account, accept an
order or handle a commodity interest transaction for or on behalf of any nonmember of the NFA or suspended member that is required to be registered with
the CFTC as an FCM, an IB, a CPO, a CTA or a leverage transaction merchant
and is not so registered. What this means in practice is that a registered
CPO/CTA must make sure that all of the investors in its funds, its separate
account clients, the counterparties with which its funds and accounts enter into
commodity interest transactions and its solicitors42 are appropriately registered or
42
If a solicitor is a broker-dealer and it solicits persons to invest in commodity pools, CFTC registration and
NFA membership should not be required.
37
exempt. This requirement applies to current investors, counterparties and
solicitors, as well as to new ones.
As of December 31, 2012, registered investment advisers that advise a RIC must
register as a CPO if the RIC no longer qualifies from the exclusion from CPO
registration under CFTC Regulation 4.5. These advisers will become subject to
Bylaw 1101 but may not be able to comply fully because the CPO does not have
access to information relating to the RIC’s underlying participants. The NFA has
determined that, until further notice, a CPO member of NFA that advises a RIC
will be considered in compliance with Bylaw 1101 if the CPO ensures that any
FCM through which the RIC transacts any commodity interest transactions and
any sub-adviser that provides investment management services to the RIC is
properly registered in the appropriate capacity and a member of NFA, or in the
case of a sub-adviser, exempt from CTA registration. The CPO member to a RIC
will not be required to conduct Bylaw 1101 due diligence on the RIC’s underlying
participants. See NFA Notice to Members I-12-34 (Nov. 19, 2012).
Furthermore, pursuant to NFA Notice to Members I-12-35 (Dec. 19, 2012), NFA
stated that, during the period between January 1 and March 31, 2013, members
who take reasonable steps to determine the registration and membership status of
previously exempt persons under certain CFTC regulations will not be in
violation of Bylaw 1101 if they transact customer business with a previously
exempt person that fails to either become registered and a member of NFA, file a
notice affirming its exemption from CPO registration, or provide a written
representation as to why the person is not required to register or file the notice
affirming the exemption. If the member learns the person does not intend to file a
notice affirming exemption or the person does not file such an affirmation by
March 1, 2013, then the member must promptly obtain a written representation as
to why the person is not required to register or file a notice exemption, and
evaluate whether the representation appears adequate based on information
known to the member. If the member determines the written representation is
inadequate and the person must be registered, the member must put a plan in
place to cease transacting customer business with the person or risk violating
Bylaw 1101.
3.
Primary Functions of NFA.
NFA is responsible for: (1) auditing and conducting surveillance of FCMs and
IBs to enforce compliance with NFA financial requirements; (2) establishing and
enforcing rules and standards for customer protection, which includes conducting
disciplinary proceedings against NFA members; (3) conducting arbitration of
commodity interest-related disputes; (4) performing screening to determine fitness
to become or remain an NFA member; (5) performing the registration functions
under the CEA; and (6) conducting reviews of Disclosure Documents for CTAs,
privately-offered commodity pools, and public commodity pools (i.e., those that
are required to have their participation interests registered under the Securities
Act). NFA staff will also periodically examine registered CPOs and CTAs. NFA
38
rules are subject to CFTC approval. NFA decisions are subject to CFTC review.
NFA also has responsibility for processing floor broker and floor trader
registration applications.
4.
Ethical Standards.
NFA is charged with establishing ethical standards to help prevent fraud,
manipulation, and other unfair sales and trading practices. For example, NFA
regulates advertising and has adopted a “know your customer” rule. See NFA
Compliance Rules 2-9, 2-29 and 2-30 and NFA Interpretive Notice 9051: NFA
Compliance Rule 2-9: Ethics Training Requirements (Board of Directors: July 1,
2003).
5.
Other Requirements Applicable to NFA Members.
The following is a summary of some of the more important aspects of NFA
membership:
a.
Self-Examination Checklist.
NFA Compliance Rule 2-9 places a continuing responsibility on every
member firm to diligently supervise its employees and agents in all
aspects of their futures-related activities. To satisfy their continuing
supervisory responsibilities under NFA Compliance Rule 2-9, NFA
member firms must review their operations on an annual basis using a
self-examination checklist. NFA Interpretive Notice 9020: Compliance
Rules 2-9, 2-36 and 2-39: Self-Audit Questionnaires (Board of Directors:
October 6, 1992; revised July 24, 2000 and April 8, 2011). The checklist
is intended to assist firms in identifying potential problem areas and alert
them to procedures that may need to be revised or strengthened.
The checklist is divided into five sections. The first section is a general
checklist that must be completed by all firms. Each of the other four
sections is a separate supplemental checklist for each of the four
registration categories (FCM, IB, CPO, and CTA).
After the annual review of a member firm’s operations, the appropriate
supervisory personnel must sign and date a written attestation that they
have reviewed the firm’s operations in light of the matters covered by the
checklist. A separate attestation must be made for each branch office, if
any.43
43
A branch office is “any location, other than the main business address, at which . . . [a] CPO or CTA
employs persons engaged in activities requiring registration as an AP.” An office is a branch office even if there is
only one person at the location. See NFA Interpretive Notice 9002: Registration Requirements; Branch Offices
(Staff: September 6, 1985; revised July 1, 2000; December 9, 2005; and September 30, 2010).
39
b.
Annual Questionnaire.
The NFA also requires that its member firms complete an annual
questionnaire. The questionnaire provides the NFA with information
about its member firms and allows the NFA to better understand the
composition of its membership as a whole and to tailor its regulatory
programs accordingly. The annual questionnaire is also designed to elicit
whether member firms are actively engaged in commodity interest related
activity, which will be added to the website display of information about
firms. The NFA encourages firms to update their questionnaire data on a
regular basis, but must, at a minimum, complete the annual questionnaire
on the anniversary of their NFA membership date. NFA Bylaw 1301(d).
c.
Registration Update.
The other annual requirement is the annual registration update. CFTC
Regulation 3.31 and NFA Registration Rule 210 require that firms
promptly correct any deficiencies or inaccuracies in their registration
application as they occur by means of a Form 3-R, filed in accordance
with the instructions thereto. If a firm were to add a new individual
principal or AP, a Form 8-R accompanied by a fingerprint card and the
appropriate fee must be filed for that person, unless the person has a
current Form 8-R on file with the NFA,44 and, if a firm terminates an
individual principal or AP, it must file a notice of termination on Form 8-T
within 30 days of such termination. See CFTC Regulations 3.10, 3.12 and
3.31(c). The NFA imposes a fee of $100 for each Form 8-T that is not
filed within 30 days of termination. NFA Registration Rules 203(a)(10)
and 214. In addition, however, a firm must complete the annual
registration update and pay the annual registration records maintenance
fee of $100 for each registration category ($100 if registering only as a
CPO, $200 if registering as both a CPO and a CTA), in accordance with
NFA Registration Rules 203(a)(9) and 204(d).
d.
Ethics Training.
Firms are able to determine the frequency, duration and provider of ethics
training for APs, but they are still required to have a written ethics training
policy and must have evidence to support that the firm is adhering to the
policy.
If the branch office reviews its own operations, the main office must receive a copy of the attestation.
These attestations need not be filed with NFA, but should be retained by the firm. As with all required records,
signed attestations should be readily available for the last two (2) years and retained for the last five (5) years.
44
If the person being added as a principal or AP was originally registered prior to the implementation of ORS
in 2002, the system may request that the person answer the disciplinary history questions, because those questions
are slightly different under ORS than they were under the previous paper-based registration application system.
40
The NFA has prepared a questionnaire for firms to follow when preparing
an ethics training policy, which firms may access through the NFA’s
website. At a minimum, an ethics training policy should include the
following: (1) the topics covered in the training program; (2) the name of
the provider of the training;45 (3) the format of the training, such as inperson classes or an interactive mechanism; (4) the frequency and duration
of the training to be completed, including the requirements for new APs or
those who have previously completed ethics training with another firm;
and (5) a description of the documentation that the firm will maintain to
show that the policy is being followed.
A firm’s employees should receive ethics training on an ongoing basis.
The commodity interest industry is always evolving and employees need
to be aware of changes within the industry so that they can perform their
jobs properly. This training should discuss changes in the markets,
describe new products, review new rules and regulations, update
technology developments and explain the firm’s policies and procedures.
The format and formality of the training depends upon the size of the firm
and the nature of its business. Appendix B to Part 3 of CFTC Regulations;
NFA Interpretive Notice 9051: NFA Compliance Rule 2-9: Ethics
Training Requirements (Board of Directors: July 1, 2003).
e.
NFA Reporting.
The NFA requires quarterly reporting by CPOs of the following
information: (i) the identity of the pool’s administrator, carrying
broker(s), trading manager(s), and custodian(s); (ii) a statement of changes
in net asset value for the quarterly reporting period; (iii) monthly
performance for the three months comprising the quarterly reporting
period; and (iv) a schedule of investments identifying any investment that
exceeds 5% of the pool’s net asset value at the end of the quarterly
reporting period. NFA Compliance Rule 2-46. To the extent that large
CPOs file information quarterly in accordance with CFTC Regulation
4.27, the NFA will accept that filing in lieu of the filing under its
Compliance Rule 2-46. 46 However, if a CPO only has an annual reporting
requirement under CFTC Regulation 4.27 (e.g., because it is a small or
mid-sized CPO), it is still required to make quarterly filings with the NFA.
In addition, CPOs that file Form PF with the SEC in lieu of Form CPO-
45
If the provider of the training has not taken and passed the Series 3 examination, it may be necessary to
obtain a waiver from NFA’s Vice President of Registration. See NFA Interpretive Notice 9051, NFA Compliance
Rule 2-9: Ethics Training Requirements (July 1, 2003). However, we understand that, in an examination, NFA staff
does not insist that a waiver been obtained if the staff believes that the provider is suitably competent and
experienced.
46
Regulation 4.27 requires, among other things, that registered CPOs file with the CFTC information about
non-exempt pools on Form CPO-PQR.
41
PQR are required to file NFA Form PQR with the NFA on a quarterly
basis. Form NFA-PQR is due within 60 days of the quarter end, except
for the quarter ending December 31, in which the CPO can satisfy the
NFA’s quarterly requirement by filing Form CPO-PQR (Schedule A) plus
a Schedule of Investments (Item 6 of Schedule B) within 60 or 90 days,
depending on the size of the CPO.
Additionally, all registered CTAs must file a quarterly NFA Form PR
within 45 days of the end of each quarter. NFA Compliance Rule 2-46.
No NFA Form PR filing is due for the first two quarters of 2013, but
filings are required for the September 2013 quarter and thereafter.47
The CFTC also operates a large trader reporting system (“LTRS”), to
collect information on market participants and their positions as part of its
market surveillance program. The LTRS is designed to capture 70 to 90%
of the total open interest in any given market. Under Parts 15-19 and 21
of its regulations, the CFTC collects data and position information on
futures and commodity option markets from exchanges, clearing members,
FCMs, foreign brokers, and traders.
6.
Financial Standards.
The NFA establishes and enforces minimum financial standards for FCMs and
IBs. Supervision of compliance with these requirements for exchange members
has been delegated to the exchanges.
7.
Retail Off-Exchange Foreign Currency Transactions.
NFA is the front-line regulator of retail foreign currency transactions. These are
transactions involving persons who do not meet the criteria for “eligible contract
participants” dealing with a counterparty that is a retail foreign exchange dealer,
FCM, securities broker-dealer, financial institution, financial holding company,
insurance company, or certain affiliates of some of the foregoing entities.
8.
Customer Complaints.
NFA performs a significant role in dealing with customer disputes. For example,
the NFA provides an extensive arbitration procedure for resolving customer
disputes.
9.
Position Limits.
On January 26, 2011, the CFTC adopted a position limits regime in Part 151 of its
regulations, which was effective on January 17, 2012. On October 18, 2011, the
CFTC adopted additional position limits, which were to be phased in over the
succeeding few years, for 28 exempt (certain energy and metal products) and
47
See NFA Notice to Members I-13-12 (April 24, 2013); NFA Notice to Members I-13-24 (Sept. 16, 2013)..
42
agricultural commodity futures and options contracts and physical commodity
swaps that are economically equivalent to such contracts.48 The CFTC’s position
limit regulations were challenged by the International Swaps and Derivatives
Association and the Securities Industry and Financial Markets Association, and,
on September 28, 2012, the federal District Court for the District of Columbia
vacated and remanded those regulations to the CFTC for proceedings consistent
with its opinion.49 The CFTC appealed the district court’s decision to the United
States Court of Appeals for the District of Columbia Circuit.50 The CFTC has
also indicated that it is working on revised position limit regulations for the 28
additional commodities.
The court decision vacating and remanding the regulations to the CFTC does not
affect the CFTC’s currently existing position limit regulations for commodity
futures and exchange-traded commodity options on grains and cotton set forth in
Part 150 of its regulations, or the speculative position limits and position
accountability levels set forth in the rules of the futures exchanges. Those
previously adopted CFTC regulations were not challenged in the court proceeding
and remain in full force and effect, as do the exchange limits and position
accountability levels.
10.
CFTC Information Filings.
On October 31, 2011, the CFTC and the SEC (together, the “Commissions”)
adopted regulations requiring the reporting of information by investment advisers
to private funds and certain CPOs and CTAs on Form PF to the SEC.51 CFTC
Regulation 4.27 was further revised when the CFTC recently adopted the
rescission of the CPO registration exemption under CFTC Regulation 4.13(a)(4),
and requires registered CPOs and CTAs to file information about non-exempt
pools with the CFTC on Forms CPO-PQR and CTA-PR, respectively.52 The
information required by these filings is intended, among other things, to assist the
Financial Stability Oversight Council in its assessment of systemic risk in the U.S.
financial system.
Form CPO-PQR includes three Schedules, A, B and C. Schedule A seeks basic
identifying information about the CPO, including:
•
48
General census information (name, number of employees, number of
pools operated)
Position Limits for Futures and Swaps, 76 Fed. Reg. 71626 (Nov. 18, 2011).
49
See International Swaps and Derivatives Association, et al. v. United States Commodity Futures Trading
Commission, No. 11-cv-2146, Memorandum Opinion at 39 (D.D.C. Sept. 28, 2012).
50
51
52
This appeal is still underway, with oral argument yet to be scheduled.
76 Fed. Reg. 71128 (November 16, 2011).
77 Fed. Reg. 11252 (February 24, 2012).
43
•
•
•
•
•
Total and net assets under management
Information about each non-exempt pool operated (names of co-CPOs,
foreign registrations, master/feeder status)
Information on third parties used (administrators, auditors, brokers,
custodians, marketers, etc.)
Change in assets under management and performance
Subscription and redemption activity
Schedule B requires information on each pool operated by a CPO, including:
•
•
•
•
•
•
Breakdown of the assets of the pool by investment strategy
Borrowings of the pool and types of creditors
Pool counterparty and credit exposure
Pool trading and clearing mechanisms
Value of the pool’s derivative positions
Listing of investments by asset types
Schedule C requires that “Large CPOs” (at least $1.5 billion pool assets under
management, calculated on a gross basis)53 report information on an aggregate
basis as well as on an individual pool basis for each “Large Pool,” i.e., any pool
that has a net asset value individually, or in combination with any parallel pool
structure, of at least $500 million. Section 1 requires a geographical breakdown
of all non-exempt pools operated by the CPO and the aggregate turnover rate of
the pools. Section 2 requires information about each Large Pool, including (i)
liquidity, unencumbered cash, and number of open positions; (ii) counterparty
credit exposure; (iii) risk metrics; (iv) secured and unsecured borrowing
information; (v) derivative positions and the collateral posted to secure such
positions; and (vi) duration of fixed income assets.
If an investment adviser has filed information regarding particular pools on Form
PF filed with the SEC (information that will be available to the CFTC as well),
the CPO need not duplicate the same information by filing Schedules B and C
with respect to those pools. The CPO would only be required to file Schedule A,
the basic identifying information, if there is a separate adviser that has reported on
the CPO’s pools on Form PF. Those CPOs that are dually registered with the
SEC and CFTC and file Sections 1 and 2 of Form PF, as applicable, that include
information with respect to all pools for which they act as CPO (not only the
private funds required by Form PF) must generally file Schedule A of Form CPOPQR only.
In a fund-of-funds context, the CPO generally may exclude any pool assets
invested in other unaffiliated pools, but must do so consistently for purposes of
both the reporting thresholds and responding to questions in Form CPO-PQR.
However, for Question 10 on Schedule A, which requires reporting of changes in
53
Id., at 11267.
44
AUM, assets invested in other unaffiliated pools must be included. Further, even
if a CPO generally disregards investments in other pools, for Question 11 on
Schedule A, which asks for a pool’s monthly rates of return, the performance of
the entire pool may be reported and a CPO is not required to recalculate
performance to exclude the investments in other pools. If the CPO operates a
pool that invests substantially all of its assets in other pools for which it is not the
CPO, and otherwise holds only cash and cash equivalents and instruments
acquired to hedge currency exposure, only Schedule A must be completed for that
pool. The SEC has clarified the exclusion of investments in the equity of other
private funds to include investments in affiliated or unaffiliated funds. While the
CFTC has not issued guidance on this issue, most filers are taking the same
position with respect to Form CPO-PQR.
For CTAs, the CFTC adopted only Schedule A of Form CTA-PR, which requires
all CTAs (whether or not they are also registered with the SEC), to provide basic
information about the CTA’s business and the pools for which it provides advice.
Both Forms CPO-PQR and CTA-PR must be filed electronically using the NFA’s
EasyFile System.54 Based upon a CPO’s aggregated gross pool assets under
management, a measurement that differs from the SEC’s “regulatory assets under
management” for Form PF, the schedules of Form CPO-PQR that a CPO must
file, the frequency of filing and the time frame within which they must be filed,
will vary based upon its assets under management, as follows:
54
On July 12, 2013, the NFA announced that beginning with Forms CPO-PQR and NFA Form PQR (the
quarterly report required of member CPOs by the NFA, as discussed below) for the quarter ended June 30, 2013,
CPOs will have the option of filing these forms using XML upload in EasyFile, which will significantly reduce the
amount of data entry necessary for these filings. In order to use the XML upload feature, the CPO must submit a
request for approval to the NFA through EasyFile. Once the request is approved, instructions on how to submit
PQR filings using the XML upload feature will become available to the CPO in EasyFile. See NFA Notice to
Members I-13-20 (July 12, 2013).
45
Assets Under
Management
Dually registered (at
least $1.5 billion
assets under
management)
Schedule A
Schedule B
Schedule C
Quarterly, within 60
days (also filing Form
PF)
Dually registered (less Annually, within 90
than $1.5 billion
days (also filing Form
assets under
PF)
management)
Large CPO (at least
$1.5 billion assets
under management)
Quarterly, within 60
days (not filing Form
PF)
Quarterly, within 60
days (for each pool)
Mid-Sized CPO (at
least $150 million
assets under
management)
Annually, within 90
days (not filing Form
PF)
Annually, within 90
days (for each pool)
Small CPO (less than
$150 million)
Annually, within 90
days (not filing Form
PF)
Quarterly, within 60
days (for each “Large
Pool”)
Form CTA-PR must be filed annually within 45 days after the end of the CTA’s
fiscal year, and the initial filing for most CTAs was February 14, 2013.
11.
Swaps Recordkeeping.
A party to a swap that is neither an SD nor a major swap participant (“MSP”) was
required to begin complying with recordkeeping requirements for swaps as of
April 10, 2013. Non-SDs/MSPs must “keep full, complete, and systematic
records, together with all pertinent data and memoranda, with respect to each
swap.” In addition, there are certain recordkeeping requirements for “historical
swaps,” of which there are two types: (1) “pre-enactment swaps,” which are
swaps that were entered into prior to the enactment of Dodd-Frank on July 21,
2010 and remained open as of that date (even if now closed); and (2) “transition
swaps,” which are swaps entered into on or after July 21, 2010 and prior to the
April 10, 2013 compliance date.
Historical Swaps That Expired Prior to April 25, 2011. For historical swaps that
expired prior to April 25, 2011, each counterparty must retain the information and
documents relating to the terms of the transaction that were in its possession on or
after the date of the relevant Interim Final Rule (October 14, 2010 for pre-
46
enactment swaps and December 17, 2010 for transition swaps). The final
regulations do not require parties to create or retain records of information
regarding such swaps that were not in their possession as of those dates, or to alter
how the records are organized or stored. These records must be retrievable within
five (5) business days.
Historical Swaps That Were in Existence on or After April 25, 2011. The final
regulations require parties to a historical swap in existence on or after April 25,
2011 to keep records of the minimum primary economic terms data specified in
Appendix 1 to Part 46 of the CFTC’s regulations,55 as well as copies (if they have
them) of confirmation documentation, master agreements, credit support or
similar agreements. If the swap remains unexpired after the applicable
compliance date (April 10, 2013 for a non-SD/MSP), parties must also keep any
records required by CFTC Regulation 45.2.
Non-SD/MSPs may keep records in either paper or electronic form so long as
they are retrievable and reportable as required. For all swaps, the regulations
require maintenance of records throughout the existence of the swap and for five
(5) years following expiration of the swap. Non-SDs/MSPs must be able to
retrieve records within five (5) business days throughout the retention period.
All required records are open to inspection by any representative of the CFTC, the
SEC, the DOJ, or banking regulator authorized by the CFTC to inspect such
records. Copies of such records must be provided upon request at the
recordkeeper’s expense in the form that the records are kept, paper or electronic.
12.
Red Flag Rules.
On April 19, 2013, the Commissions published final rules (“Red Flag Rules”)
requiring each “financial institution” or “creditor” that offers a “covered account”
to develop and implement by November 20, 2013 a written identity theft
prevention program designed to detect, prevent, and mitigate identity theft in
connection with certain existing accounts and the opening of new accounts (a
“Program”).
The Red Flag Rules serve as the Commissions’ versions of the “red flag” rules
that the banking regulators and the Federal Trade Commission (“FTC”) adopted
in 2007 (the “Joint Red Flag Rules”) and in effect transfer jurisdiction from the
FTC to the Commissions for entities under their regulation. For entities that
adopted programs under the Joint Red Flag Rules, there will be little change.
However, entities such as investment advisers, CPOs and CTAs that did not
previously comply with the Joint Red Flag Rules will need to carefully assess
whether they fall within the scope of the Red Flag Rules.
55
77 Fed. Reg. 35200, at 35231-39. The minimum primary economic terms include, among others, Legal
Entity Identifiers, status of the parties, contract type, execution timestamp and venue, and start and end date.
Various other terms are required depending upon the asset class. For the credit and equity class of swaps, some of
the other required terms would be the price and payment frequency, and whether and, if so, where cleared.
47
Unlike a number of regulations that apply simply because an entity is registered
with the SEC or CFTC, determining whether a financial institution is subject to
the Red Flag Rules requires a two step analysis. First, for the Red Flag Rules to
apply, a financial institution must meet the definition of “financial institution” or
“creditor.” Second, a financial institution must offer and maintain one or more
“covered accounts.” If a financial institution meets both prongs, then it will need
to adopt a Program. If the institution meets only the first prong, then it is not
required to adopt a Program but will need to periodically assess its accounts and
relationships to determine whether it has covered accounts. Thus, allowing a
customer to do something new, such as send account proceeds to a third party,
may trigger the Program requirement, even if the financial institution was not
subject to the rule before.
The CFTC definition of creditor in the Red Flag Rules states that creditor includes
any FCM, retail foreign exchange dealer, CTA, CPO, IB, SD, or MSP that
regularly (1) extends, renews, or continues credit; (2) arranges for the extension,
renewal, or continuation of credit; or (3) in acting as an assignee of an original
creditor, participates in the decision to extend, renew, or continue credit.
A number of commenters on the proposed rule argued that investment advisers do
not “hold” transaction accounts because they do not have custody of client assets
(i.e., the assets are custodied at a bank or broker-dealer) and thus would not be
“financial institutions” and thus subject to the Red Flag Rules. As stated in the
Rules, the SEC has concluded otherwise. For example, the SEC states that, even if
an investor’s assets are physically held with a qualified custodian, an adviser that
has authority, by power of attorney or otherwise, to withdraw money from the
investor’s account and direct payments to third parties according to the investor’s
instructions would hold a transaction account. An adviser that has authority to
withdraw money from an investor’s account solely to deduct its own advisory fees
would not hold a transaction account because the adviser would not be making
payments to third parties.
It appears that, like SEC-registered investment advisers that do not have custody,
CPOs and CTAs would be treated as potentially having transaction accounts even
though by law they cannot have custody of client assets (generally, the assets
must be held at a FCM). Thus, if the financial institution does not currently
maintain a Program, it should revisit the question of whether it is required to
adopt one.
Under the Red Flag Rules, a financial institution must establish a Program if it
offers or maintains “covered accounts.” Account is defined as a continuing
relationship established by a person with a financial institution or creditor to
obtain a product or services for personal, family, household or business purposes
(e.g., a brokerage account or mutual fund account). The Commissions define the
term “covered account” as: (1) an account that a financial institution or creditor
offers or maintains, primarily for personal, family, or household purposes, that
involves or is designed to permit multiple payments or transactions; and (2) any
48
other account that the financial institution or creditor offers or maintains for
which there is a reasonably foreseeable risk to customers or to the safety and
soundness of the financial institution or creditor from identity theft, including
financial, operational, compliance, reputation, or litigation risks. The CFTC’s
definition includes a margin account as an example of a covered account, and the
SEC’s definition includes, as examples of a covered account, a brokerage account
with a broker-dealer or an account maintained by a mutual fund (or its agent) that
permits wire transfers or other payments to third parties.
The Red Flag Rules require all financial institutions and creditors to assess
whether they offer or maintain covered accounts and must do so periodically. As
part of this determination, a financial institution must conduct a risk assessment
that takes into consideration: (1) the methods it provides to open accounts; (2) the
methods it provides to access its accounts; and (3) its previous experience with
identity theft. A financial institution should consider whether a reasonably
foreseeable risk of identity theft may exist in connection with accounts opened or
accessed remotely, such as through the internet or by telephone. Even if the
financial institution determines that it does not need a Program, it must
periodically reassess that decision to account for changes in its business model,
accounts, or identity theft experience.
A Program must include reasonable policies and procedures to:
•
•
•
•
Identify relevant “red flags”56 for covered accounts and incorporate those
red flags into the Program;
Detect red flags that have been incorporated into the Program;
Respond appropriately to any red flags that are detected to prevent and
mitigate identity theft; and
Ensure that the Program (including the red flags determined to be
relevant) is updated periodically to reflect changes in risks to customers
and to the safety and soundness of the entity from identity theft.
Like anti-money laundering (“AML”) programs, if a financial institution adopts a
Program, it must be appropriate to the size and complexity of the entity and the
nature and scope of its activities. A financial institution can leverage its AML
programs, policies and procedures to safeguard customer records and information
under Regulation S-P, the CFTC’s privacy rules and internal antifraud policies
and procedures in order to develop a Program.
The Program must be approved by a designated senior management employee of
the financial institution (e.g., the chief compliance officer), and must involve that
56
A “red flag” is a pattern, practice, or specific activity that indicates the possible existence of identity theft.
Guidelines in the appendix to the Red Flag Rules include a number of examples of red flags. The examples include
inconsistencies in personal indentifying information, incomplete account opening information, changes in account
usage, adding an authorized person to an account shortly after the account address has changed, and mail being
returned as undeliverable although transactions continue.
49
individual in the oversight, development, implementation and administration of
the Program. Furthermore, the financial institution must train staff, as necessary,
to effectively implement the Program. Finally, the financial institution must
exercise appropriate and effective oversight of service provider arrangements.
Unfortunately, the Rules provide little guidance on what such oversight of service
providers means in practice.
50