CFTC Exemptions for Commodity Pool Operators
The manager of a private investment fund that trades futures, over-the-counter foreign currencies (“FX”), swaps, or any related derivatives, will generally be required to register as a commodity pool operator (“CPO”) with the Commodity Futures Trading Commission (the “CFTC“). However, investment managers that can comply with one of a limited number of available exemptions can avoid registration.
Additionally, fund managers that limit their investors to certain “qualified eligible persons” can benefit from limited relief even as a registered CPO.
Only a few exemptions from CPO registration are available. Managers that can operate within one of these limited exemptions can avoid CPO registration but will generally still be subject to the antifraud provisions contained within the Commodity Exchange Act and the associated regulations. A fund manager that is exempt from CPO registration will not be required to become an NFA Member and will not be subject to NFA’s bylaws or compliance rules.
The three available exemptions from CPO registration are commonly known as the:
- de minimis exemption
- small pool exemption; and
- investment club exemption.
We discuss these three exemptions below in order of how commonly we come across them in our law practice. Thereafter, we discuss the CFTC’s rule 4.7 exemption, which enables a registered CPO to avoid certain registration requirements.
CPO Registration Exemption 3: The De Minimis Exemption
The de minimis exemption is designed to exempt from CPO registration certain private fund managers that trade only a small amount of futures, forex, or swaps in relation to the overall fund’s trading activity. The de minimis exemption is contained in CFTC Regulation 4.13(a)(3) and is widely used by fund managers to avoid CPO registration.
In summary, the de minimis exemption requires that (i) the interests in the fund be offered and sold without any public marketing in the U.S. and that they be exempt from registration under the Securities Act of 1933; (ii) trading in the fund fall under one of two alternative trading thresholds, described below, with respect to trading in CFTC-regulated instruments; (iii) the fund accept only participants that are “accredited investors” and certain other listed investors; and (iv) the manager not market the fund as a vehicle for trading in futures, forex, or swap markets.
The alternative trading thresholds are essentially as follows:
(A) The aggregate initial margin, premiums, and required minimum security deposit required to establish positions in futures, forex, and swaps, determined at the time the most recent position was established, may not exceed 5 percent of the liquidation value of the Fund’s portfolio, after taking into account unrealized profits and unrealized losses on any such positions; provided, that, in the case of an option that is in-the-money at the time of purchase, the in-the-money amount may be excluded in computing the 5 percent applicable to the fund; or
(B) The aggregate net notional value of positions in futures, forex, and swaps, determined at the time the most recent position was established, does not exceed 100 percent of the liquidation value of the fund’s portfolio, after taking into account unrealized profits and unrealized losses on any such positions the fund has entered into.
The other exemption that was contained in Regulation 4.13 was repealed by the CFTC effective December 31, 2012. That exemption, which provided relief to managers who operated pools that only accepted “qualified eligible persons” or “QEPs” as participants, had been used by many established private fund sponsors to avoid CPO registration. Following its repeal, many private fund sponsors have been forced to register with the CFTC or find alternative relief.
CPO Registration Exemption 2: The Small Pool Exemption
A second exemption is available for private fund managers that trade futures, forex, or swaps and accept only a small number of outside investors with limited aggregate capital contributions. The “small pool” exemption is contained under Regulation 4.13(a)(2) and requires that: (i) none of the pools operated by the manager have more than 15 participants at any time; (ii) the total gross capital contributions received from investors not exceed $400,000.
Despite these limitations, certain investors and their contributions can be excluded. In general, these excluded persons include: the manager itself and the manager’s principals; a child, sibling, or spouse of one of the principals; or a relative of one of the foregoing participants that shares the same residence as the earlier participant.
The small pool exemption does not provide the platform to build a major private fund advisory business focused on commodity interest trading. However, the small pool exemption can provide a stepping stone to launching a commodity trading business, allowing a manager to achieve a marketable track record within the small pool structure before opening the fund to outside investors in a more significant way.
CPO Registration Exemption 1: The Investment Club Exemption
A private fund manager that trades futures, forex, or swaps within an “investment club” structure will be exempt from registration as a CPO under Regulation 4.13(a)(1) promulgated under the Commodity Exchange Act. The “investment club” exemption requires that: (i) the manager not receive any compensation, directly or indirectly, for operating the pool except for reimbursement for the pool’s ordinary operating expenses; (ii) the manager operate only one commodity pool at a time; (iii) the manager not be otherwise required to register with the Commodity Futures Trading Commission (“CFTC”); and (iv) interests in the commodity pool not be marketed through any advertising or systematic solicitation efforts.
Obviously, the investment club exemption is available only in limited circumstances and is not applicable for private fund managers that wish to operate a commodity pool as a commercial enterprise.
4.7 Exemption for Registered CPOs
Managers that cannot operate within one of the foregoing exemptions from CPO registration will be required to register with the CFTC and become a member of National Futures Association (“NFA“). This can be an onerous process.
Among other requirements, registered CPOs will be obligated to maintain books and records in accordance with CFTC and NFA rules, distribute specific reports to investors, submit detailed periodic reports to NFA, meet examination requirements for associated persons, and comply with a variety of other compliance rules and regulations.
Full registered CPOs will also be required to have the disclosure document or private placement memorandum of their fund reviewed and approved by NFA. The NFA’s disclosure document review process can take 6 – 10 weeks.
In accordance with CFTC Rule 4.7, CPOs that accept only “qualified eligible persons” can avoid the NFA disclosure document review process and will enjoy somewhat more operational flexibility.
Who is a Qualified Eligible Person
Qualified eligible persons (“QEPs“) include US persons that have more than $2 million in investments or that meet other specified designations. All non-US persons are QEPs, regardless of their financial standing.
CPOs that must register with the CFTC but that are seeking institutional capital and want to minimize compliance friction will generally utilize the relief available under CFTC Rule 4.7.