In light of the recent economic turmoil, the Commodity Futures Trading Commission (CFTC) recently proposed to amend its existing regulations and enact one new regulation regarding Commodity Pool Operators (CPOs) and Commodity Trading Advisors (CTAs). The proposed changes to CPO and CTA compliance obligations are intended to be consistent with the tenor of the provisions of the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank). The CFTC is also proposing a new data collection mandate for CPOs and CTAs that is consistent with the data collection required under Dodd-Frank. Notably, the proposed amendments would: (i) modify the criteria for claiming relief under Regulation 4.5 of the CFTCs regulations; (ii) rescind the relief from the certification requirement for annual reports provided to operators of certain pools only offered to qualified eligible persons (QEPs); (iii) rescind the exemptions from registration provided in Regulations 4.13(a)(3) and 4.13(a)(4) of the CFTCs regulations; and (iv) require the annual filing of notices claiming exemptive relief. Finally, the proposal includes new risk disclosure requirements for CPOs and CTAs regarding swap transactions.
Section 406 of Dodd-Frank requires that the Securities Exchange Commission (SEC) and CFTC jointly issue rules establishing the form and content of reports required to be filed by advisers registered with both regulatory bodies. To fulfill this statutory mandate, the SEC and the CFTC are jointly proposing sections 1 and 2 of Form PF. For dually registered CPOs and CTAs, filing Form PF will be deemed a filing with both the SEC and the CFTC.
In addition, the CFTC is proposing Forms CPO-PQR and CTA-PR under new rule Regulation 4.27 to collect information from CPOs and CTAs, respectively, that are solely registered with the CFTC. The information sought through Forms CPO-PQR and CTA-PR is generally identical to the information sought through Form PF. All dual registrants will also be required to file Schedule A of proposed Form CPO-PQR or Schedule A of proposed Form CTA-PR, as applicable. The amount of information that a CPO or CTA will be required to disclose on the proposed forms and the frequency of reporting will vary depending on both the size of the adviser and the size of the advised pools.
Proposed Amendments to Regulation 4.5
Prior to amendments that the CFTC made in 2003, qualifying entities (including sponsors of registered investment companies) relying on the exclusion from the CPO definition under Regulation 4.5 were required to file a notice of eligibility confirming that the use of commodity futures for non bona fide hedging purposes would be limited to five percent of the liquidation value of the qualifying entitys portfolio and that the entity would not market the fund as a commodity pool to the public. To stop the practice of registered investment companies from offering futures-only investment products without CFTC oversight, the CFTC is proposing to amend Regulation 4.5 to reinstate the aforementioned pre-2003 operating criteria.
Proposed Amendments to Regulation 4.7
The CFTC is proposing two changes to Regulation 4.7, which currently makes available relief from certain disclosure, reporting and recordkeeping requirements to CPOs of pools that are offered solely to QEPs: (1) the first proposal would remove exemptive relief from the certification requirement for financial statements in annual reports of Regulation 4.7-exempt pools (i.e., require annual audited financials); and (2) the second proposal would modify the QEP qualification criteria to incorporate the SEC’s amended definition of accredited investor.
Proposed Amendments to Regulations 4.13(a)(3) and 4.13(a)(4)
The CFTC has proposed to rescind certain exemptions from registration provided in Regulations 4.13(a)(3) and 4.13(a)(4), which could potentially be the most impactful amendments for CPOs currently relying on either such exemption from registration. Regulation 4.13(a)(3) (i.e., the de minimis exemption) currently provides relief from registration to CPOs trading a minimal amount of commodity interest positions (including retail forex transactions) and offering interests in the pool to QEPs, accredited investors, and/or knowledgeable employees only. Regulation 4.13(a)(4) currently provides relief from registration to CPOs that reasonably believe that all participants in the pool are QEPs. As a result of the creation of such exemptions, a large group of market participants have fallen outside the oversight of regulators. The CFTC is seeking to eliminate the Regulations 4.13(a)(3) and 4.13(a)(4) exemptions so that the operators of such pools will be subject to regulatory obligations, including proposed Form CPO-PQR, in order to provide improved transparency and increased accountability with respect to such pools. Advisers currently relying on either exemption should be prepared to register as CPOs in the near future or adjust their trading programs to cease trading commodity interest positions entirely.
Requiring Annual Filings of Notice of Claims of Exemption
Under the proposed rules, all persons claiming exemptive or exclusionary relief from registration under Regulations 4.5, 4.13 or 4.14 will be required to confirm their notices of claim of exemption or exclusion on an annual basis. In contrast, under the current rules the initial notice filing by such persons is effectively the end of their interaction with the CFTC or National Futures Association (NFA).
New Risk Disclosure Statement Regarding Swaps
Finally, due to the expansion of the CFTCs jurisdiction, the CFTC has determined that it is necessary to amend the mandatory risk disclosure statements under Regulations 4.24(b) and 4.34(b) for CPOs and CTAs to describe certain risks specific to swap transactions.