Hedge Funds Alert
December 2009
Author:
Lawrence B. Patent
lawrence.patent@klgates.com
CFTC Amends Reporting Requirements for
Commodity Pool Operators
+1.202.778.9219
Introduction
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America, Europe, Asia and the Middle
East, and represents numerous GLOBAL
500, FORTUNE 100, and FTSE 100
corporations, in addition to growth and
middle market companies,
entrepreneurs, capital market
participants and public sector entities.
For more information, visit
www.klgates.com.
On November 9, 2009, the Commodity Futures Trading Commission (CFTC)
published amendments to its regulations governing periodic account statements and
annual reports that commodity pool operators (CPOs) must prepare for the
commodity pools that they operate.1 Several of these amendments will affect those
registered CPOs that operate pools in accordance with CFTC Regulation 4.7,2 and
address (1) the reporting of the amount of a participant’s interest in a pool, (2) pools
with more than one class or series of ownership interest, (3) when annual reports
must be prepared, and how certain fees must be disclosed, in the “fund of funds”
context, (4) the use of international financial reporting standards (IFRS), and (5) the
report required upon a pool’s termination. In addition, one of the amendments
eliminates the requirements that CPOs who are exempt from registration under
CFTC Regulation 4.13 and that distribute an annual report to pool participants must
(1) prepare the report in accordance with generally accepted accounting principles
(GAAP), and (2) have the report certified in accordance with CFTC Regulation 1.16,
if the pool’s financial statements are audited by an independent public accountant.
These amendments are effective generally on December 9, 2009, and the provisions
related to annual reports will be applicable to pool annual reports for fiscal years
ending December 31, 2009, and later.
CFTC Regulation 4.7
CFTC Regulation 4.7 provides registered CPOs with an exemption from the specific
requirements of CFTC Regulations 4.21, 4.22(a)-(d), and 4.23-4.26 concerning
disclosure, recordkeeping, and periodic and annual reporting, provided the CPO
restricts the participants in its pools to “qualified eligible persons” (QEPs). QEPs
generally include industry professionals, a “qualified purchaser” as defined in
Section 2(a)(51)(A) of the Investment Company Act of 1940, a “knowledgeable
employee” as defined in Securities and Exchange Commission (SEC) Regulation
270.3c-5, a non-U.S. person, certain trusts and charitable organizations, as well as
“accredited investors” as defined in Rule 501 of Regulation D under the Securities
Act of 1933 that meet a portfolio requirement of (1) $2 million in securities, (2)
$200,000 in initial margin and option premiums on deposit with a futures
commission merchant for six months, or (3) some combination of (1) and (2),
expressed as a percentage of those minimum requirements, that equals 100 percent.
1
2
74 Fed. Reg. 57585 (November 9, 2009).
CFTC Regulations may be found in Title 17 of the Code of Federal Regulations.
Hedge Funds Alert
Participant’s Interest in a Pool
Although a registered CPO operating a pool in
accordance with CFTC Regulation 4.7 is exempt
from the specific requirements of CFTC Regulation
4.22(a) and (b) regarding periodic reporting, the
CPO is required by CFTC Regulation 4.7(b)(2) to
prepare and distribute to pool participants, on a
periodic basis (at least quarterly), a statement in
accordance with GAAP that includes (i) the net asset
value (NAV) of the pool as of the end of the
reporting period, and (ii) the change in NAV from
the end of the previous reporting period. In addition,
registered CPOs operating in accordance with CFTC
Regulation 4.7 have been required to include, in the
periodic statement, the NAV per outstanding unit of
participation in the pool as of the end of the
reporting period. With respect to the last amount, the
CFTC is now permitting CPOs to report either that
amount or the total value of the participant’s interest
or share in the pool as of the end of the reporting
period. This change is intended to provide pool
participants with sufficient information to determine the value of their investment in the pool
from the periodic statement, particularly for nonunitized pools. This amendment also conforms the
periodic account statement requirements with
respect to a participant’s interest in a pool that is
operated in accordance with CFTC Regulation 4.7
with the requirements applicable to periodic
reporting of a participant’s interest in a non-exempt
pool under CFTC Regulation 4.22(a).
Pools with More Than One Class or
Series of Ownership Interest
CPOs may decide to establish more than one class or
series of ownership interests in a particular pool to
provide for different fees and expenses to be
assessed on different classes or series, as well as
differences in currency denomination, trading or
cash management strategy, or other aspects of a
pool’s operation. Previously, the CFTC regulations
governing periodic statements and annual reports of
pools did not address the issue of the information
that should be included about other classes or series
of pool ownership, either with respect to non-exempt
pools or to pools operated in accordance with CFTC
Regulation 4.7. The amendments provide that, for
both types of pools, where one class or series is not
responsible for the liabilities of any other class or
series, the periodic statement and annual report need
include only information for the class or series
being reported. CPOs who have established such
liability limitations among the different classes or
series of pool ownership interests, thereby
essentially ring fencing each class or series and
creating a structure of separate “silos,” are free to
present information on the pool as a whole, and if
the CPO has not established such limitations on
liability, it must provide consolidated information.
Fund of Funds
A. Distribution of Annual Reports
Over the last few years, the CFTC and National
Futures Association (NFA) have expressed greater
concern about, and brought several enforcement and
disciplinary actions charging, the failure to
distribute and file pool annual reports in a timely
manner.3 This issue has been especially difficult for
CPOs of pools that make any investment in other
pools, commonly referred to as a “fund of funds”
(i.e., where there is no minimum level of investment
by the investor pool required for the relationship
between the pools to be considered a fund of funds).
The general rule has been that registered CPOs,
whether operating a non-exempt pool or a pool in
accordance with CFTC Regulation 4.7, must
provide each participant in each pool that the CPO
operates an annual report for the pool within 90
days4 of the end of the pool’s fiscal year. The CPO
is further required to submit a copy of the annual
report electronically to NFA.
In the fund of funds context, a CPO operating a
non-exempt pool has been able to claim up to an
additional 60 days to distribute and file the annual
report by filing a notice with NFA making specified
representations. This ability to claim an automatic
60-day extension has not been available to CPOs of
funds of funds that distribute unaudited annual
reports in accordance with CFTC Regulation 4.7;
3
See, e.g., In the Matter of Citigroup Private Bank GP, Inc.,
CFTC Docket No. 10-01 (October 1, 2009), available at:
http://www.cftc.gov/ucm/groups/public/@lrenforcementactions
/documents/legalpleading/enfcitigrouporder10012009.pdf; In
the Matter of JST Capital Management LLC, NFA Case No.
07-BCC-038 (July 2, 2008), available at:
http://www.nfa.futures.org/basicnet/CaseDocument.aspx?seq
num=1636
4
All time periods referred to are based upon calendar days.
December 2009
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Hedge Funds Alert
such CPOs may, however, petition NFA for an
extension of up to 90 days, in accordance with
CFTC Regulation 4.22(f)(1).
The amendments will permit registered CPOs
operating in the fund of funds context, whether
under CFTC Regulation 4.7 or a non-exempt pool,
to claim an automatic extension of 90 days, for a
total of 180 days from the pool’s fiscal year-end, for
distributing and filing an annual report.5 The CFTC
recognized that, even where annual reports prepared
under CFTC Regulation 4.7 are unaudited, the
reports must be prepared in accordance with GAAP.
Accordingly, CPOs need information from the
acquired funds to establish the value of the investor
fund’s investment. Because such information is
frequently unavailable until the acquired funds
complete their own audited financial statements, all
registered CPOs are now able to claim an automatic
90-day extension of time, even when operating a
pool in accordance with CFTC Regulation 4.7.6
The CFTC also eliminated the requirement that a
CPO who filed a claim of automatic extension of
time to distribute and file an annual report for a
particular pool must restate certain representations in
a statement filed with the pool’s annual reports in
subsequent years. The amendments presume that the
CPO continues to operate the pool as a fund of funds
and to qualify for the automatic extension.
B. Fees Related to Investment in Investee
Pools
The annual report distributed and filed under CFTC
Regulation 4.7(b)(3) has previously been required to
5
Therefore, if a CPO is operating a fund of funds with a
calendar year fiscal year, and it claims this automatic
extension under CFTC regulations, the next annual report will
be due June 29, 2010. The 180-day time frame is also
consistent with the period within which registered investment
advisers must distribute annual reports to investors in funds of
funds to avoid being required to comply with certain provisions
of the SEC custody rule. See 17 C.F.R. § 275.206(4)-2(a)(3),
(b)(3) and (c)(4).
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NFA commented on the proposal that, if multi-tiered funds
were involved, even 180 days might not be sufficient to
distribute and file an annual report, because the level below
may be taking 180 days to prepare its report. NFA suggested
that CPOs be permitted up to 210 days to distribute and file
annual reports in such circumstances, but the CFTC was not
persuaded to provide more than six months from the end of
the fiscal year for distribution of a pool annual report.
include, at a minimum, a Statement of Financial
Condition, a Statement of Income (Loss),7 and
“[a]ppropriate footnote disclosure and any other
material information.” The CFTC is now
mandating that the notes to the financial statements
include (1) the amounts of management and
incentive fees incurred as a result of investing in
any investee pool where the investment exceeded
five percent of the investor pool’s NAV, or (2) if
such specific amounts cannot be obtained by the
registered CPO, a statement to that effect and the
percentage amounts and computational basis for
each fee. In addition, the income derived from
investments in such acquired funds must be
included. The CFTC staff has encouraged CPOs to
make these disclosures for over a decade in its
annual CPO guidance letters, but the information
was not required previously.8
Use of IFRS
CFTC regulations requiring the preparation of
financial statements in accordance with GAAP have
generally been interpreted to mean GAAP as
established in the United States. Nevertheless,
CFTC staff has previously provided relief to certain
CPOs to permit use of IFRS, subject to conditions.
The amendments codify this relief and permit
registered CPOs of non-exempt pools, and pools
operated in accordance with CFTC Regulation 4.7,
to use IFRS. To qualify for using IFRS, the CPO
7
The Statement of Income (Loss) has been renamed by
these amendments as the Statement of Operations.
8
The so-called “Dear CPO” letters issued since 1999 are
available at the following URL:
http://www.cftc.gov/industryoversight/intermediaries/guidancec
poreports.html. The income, management and incentive fees
associated with an investment in an investee fund that is five
percent or less of the pool’s net assets may be combined and
reported in the aggregate with the income, management and
incentive fees of other investee funds that, individually,
represent an investment of five percent or less of the pool’s
net assets. (Although the amended regulation refers to
aggregating investments that are less than five percent of the
pool’s net assets, that would leave a gap for investments of
exactly five percent. Because the particularized disclosure is
only required if the investment exceeds five percent, it is
logical to conclude that aggregation may apply to any
investment of five percent or less of a pool’s assets in another
pool.) The total income on the detail schedule should agree
with the amount of income reported for the income from investments in other funds in the pool’s Statement of
Operations.
December 2009
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Hedge Funds Alert
must file a notice with NFA, within 90 days of the
end of the pool’s fiscal year, representing that:
•
the pool is organized under the laws of a foreign
jurisdiction;
•
the annual report will include a condensed
schedule of investments, or, if required by the
alternate accounting standards, a full schedule of
investments;
•
the preparation of the pool's financial statements
under IFRS is not inconsistent with
representations set forth in the pool's offering
memorandum or other operative documents
made available to participants;
•
special allocations of ownership equity will be
reported in accordance with CFTC Regulation
4.22(e)(2); and
•
if IFRS require consolidated financial
statements for the pool, such as a feeder fund
consolidating with its master fund, all applicable
disclosures required by GAAP for the feeder
fund will be presented with the reporting pool's
consolidated financial statements.
The amendments also permit CPOs that use IFRS
for the pool’s financial statements presented in the
annual report to present the periodic account
statements on the same basis.9
Pool Termination
Previously, CFTC Regulation 4.7 did not address the
CPO’s reporting obligation upon the termination of a
pool operated in accordance with that regulation.
However, CFTC staff stated in annual guidance
letters to CPOs that operators of pools under CFTC
Regulation 4.7 are subject to the same requirements
as the operators of non-exempt pools regarding the
final annual report upon the pool’s termination. The
amendments codify this guidance for CPOs
9
A year ago, the SEC proposed a “Roadmap” that could lead
to the required use of IFRS by U.S. issuers of securities in
2014. 73 Fed. Reg. 70815 (November 21, 2008). See also
Statement by SEC Chairman Schapiro on International
Accounting Standards Board and Financial Accounting
Standards Board Commitment to Improve IFRS and U.S.
GAAP and to Bring About Their Convergence (November 5,
2009), available at http://www.sec.gov/news/press/2009/2009237.htm
operating pools in accordance with CFTC
Regulation 4.7 and attempt to streamline the
procedures related to the termination of those pools
as well as non-exempt pools.
The amendments require a CPO to provide a final
report for a pool within 90 days of the cessation of
trading, which must include:
•
Statements of Operations and Changes in Net
Assets;
•
an explanation of the winding down of the
pool’s operations; and
•
a statement, (i) if true, that all interests in, and
assets of, the pool have been redeemed,
distributed or transferred on behalf of the
participants; or, (ii) if all funds have not been
distributed at the time the report is issued,
disclosure of the value of the assets remaining
to be distributed and the expected date of their
distribution.
If the CPO does not complete the distribution of
funds by the date specified in the final report, the
CPO must notify NFA and the pool’s participants
about the value of the pool’s remaining assets, the
expected date of liquidation, any fees and expenses
that will continue to be charged to the pool, and the
extent to which reports will continue to be provided
to participants pursuant to the pool’s operative
documents. In addition, CPOs must continue to
comply with periodic and annual reporting
requirements under CFTC regulations until final
distribution.
CPOs Exempt from Registration Under
CFTC Regulation 4.13
CFTC Regulation 4.13 provides an exemption from
registration for those CPOs, among others, who
restrict the amount of commodity interest trading
undertaken to a de minimis amount and place certain
restrictions on participants (CFTC Regulation
4.13(a)(3)), or who restrict their pool participants to
certain highly sophisticated investors (CFTC
Regulation 4.13(a)(4)). These CPOs are not
required to distribute an annual report to pool
participants; however, if they decide to do so, the
CFTC has previously required that the report be
prepared in accordance with GAAP and, if audited
by an independent public accountant, certified in
December 2009
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Hedge Funds Alert
accordance with CFTC regulations. The
amendments remove these requirements, with the
CFTC explaining that, if the reports are not required,
the CFTC should not prescribe the form of the
reports.
Conclusion
The CFTC’s amendments to its reporting
requirements for registered CPOs provide some
relief on the timing of filing annual reports in the
fund of funds context and on the ability to use IFRS,
provided that the pool operator files the appropriate
notice with NFA. The amendments are also intended
to streamline the report required when a pool
terminates. More detailed information about pools
with more than a single ownership series or class
will be required, and operators of pools in
accordance with CFTC Regulation 4.7 may have to
disclose the total value of a participant’s share of the
pool in the periodic statement. CPOs exempt from
registration under CFTC Regulation 4.13 will no
longer have to prepare an annual report in
accordance with GAAP or have it certified in
accordance with CFTC regulations. The
amendments were well received by those who filed
comments upon them, and they should make the
upcoming reporting season a little easier.
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December 2009
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