[Federal Register: August 8, 2003 (Volume 68, Number 153)]
[Rules and Regulations]
[Page 47221-47237]
From the Federal Register Online via GPO Access [wais.access.gpo.gov]
[DOCID:fr08au03-11]
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COMMODITY FUTURES TRADING COMMISSION
17 CFR Part 4
RIN 3038-AB97
Additional Registration and Other Regulatory Relief for Commodity
Pool Operators and Commodity Trading Advisors; Past Performance Issues
AGENCY: Commodity Futures Trading Commission.
ACTION: Final rules.
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SUMMARY: The Commodity Futures Trading Commission (Commission or CFTC)
is amending rules which provide an exclusion from the definition of the
term ``commodity pool operator'' (CPO) for certain persons, and which
provide exemption from CPO and commodity trading advisor (CTA)
registration, respectively, for certain other persons, so as to expand
the availability of the relief provided by these rules. These
amendments supercede the no-action relief the Commission previously
issued with respect to the trading criteria for certain persons and the
need to register as a CPO or CTA for certain other persons. The
Commission also is amending its rules to facilitate communications by
CPOs and CTAs, by permitting certain communications prior to Disclosure
Document delivery; relieving CPOs from duplicative disclosure and
reporting requirements in the ``master/feeder fund'' context;
permitting CPOs to distribute Account Statements and Annual Reports
electronically; permitting CPOs to use facsimile signatures on Account
Statements and Annual Reports; and conforming various signature
requirements. Further, the Commission is addressing certain issues
related to the calculation and presentation of past performance by CPOs
and CTAs not addressed in the recent final rulemaking on CPO and CTA
past performance.
DATES: Effective August 8, 2003 except Sec. 4.35(a)(1)(viii) which is
effective September 8, 2003.
FOR FURTHER INFORMATION CONTACT: For all rules other than Rule 4.35(a),
Barbara S. Gold, Associate Director, or Christopher W. Cummings,
Special Counsel, and for Rule 4.35(a), Kevin P. Walek, Assistant
Director, or Eileen Chotiner, Futures Trading Specialist, Division of
Clearing and Intermediary Oversight, Commodity Futures Trading
Commission, 1155 21st Street, NW., Washington, DC 20581, telephone
numbers: (202) 418-5450, (202) 418-5445, (202) 418-5463, or (202) 418-
5467, respectively; facsimile number: (202) 418-5528; and electronic
mail: bgold@cftc.gov, ccummings@cftc.gov, kwalek@cftc.gov or
echotiner@cftc.gov, respectively.
SUPPLEMENTARY INFORMATION:
Table of Contents
I. Background on the Proposal for Additional Registration and Other
Regulatory Relief for CPOs and CTAs
A. Statutory and Regulatory Authorities
B. The Proposal
C. The Comments on the Proposal
D. Significant Changes from the Proposal
II. Responses to the Comments on the Proposal
A. Amendment to Rule 4.5: Deleting Trading and ``No Marketing''
Criteria for Exclusion from the CPO Definition
B. Amendments to Rule 4.13: Adding CPO Registration Exemptions
1. Use of Terms under the Federal Securities Laws
2. New Rule 4.13(a)(3): Adding an Exemption where Commodity
Interest Trading is Limited and Pool Participants are Sophisticated
a. In General
b. New Appendix A to Part 4: ``Fund-of-Funds''
3. New Rule 4.13(a)(4): Adding an Exemption where Pool
Participants are Highly Sophisticated
4. Alternative Proposal for Relief
C. Amendments to Rule 4.14: Adding and Expanding CTA
Registration Exemptions
1. New Rule 4.14(a)(8)(i)(D): Adding an Exemption where Advice
is to Rules 4.13(a)(3) and (a)(4) Pools
2. New Rule 4.14(a)(10): Counting Legal Organizations as a
Single ``Person''
D. Amendments to Rules 4.21, 4.22 and 4.31
1. Amended Rules 4.21(a) and 4.31(a): Permitting Communications
Prior to Disclosure Document Delivery
[[Page 47222]]
2. New Rule 4.22(i): Distributing Account Statements and Annual
Reports Electronically
E. Amendments to Rules 4.5, 4.7, 4.12, 4.13, 4.14 and 4.22:
Conforming Signature Requirements
F. Effect of Final Rulemaking
1. Effect on Prior Claimants
2. Effect of Withdrawal from CPO Registration on Rule 4.22(c)
Annual Report Requirement
G. Continued Availability of No-Action Relief from Commission
Staff
III. Past Performance Presentation Issues
A. Range of Rates of Return for Closed Accounts
B. Use of Composite Draw-down
C. Treatment of Additions and Withdrawals in Computing Rate of
Return
D. New Appendix B to Part 4
IV. Other Matters
A. Regulatory Flexibility Act
B. Paperwork Reduction Act
C. Cost-Benefit Analysis
D. Administrative Procedure Act
I. Background on the Proposal for Additional Registration and Other
Regulatory Relief for CPOs and CTAs
A. Statutory and Regulatory Authorities
Section 1a(5) of the Commodity Exchange Act (Act) defines the term
``commodity pool operator'' to mean:
[A]ny 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 any commodity for future
delivery on or subject to the rules of any contract market or
derivatives transaction execution facility,* * *\1\
\1\ 7 U.S.C. 1a(5) (2000). Section 1a(5) also provides the
Commission with authority to exclude persons from the CPO
definition.
Commission Rule 4.10(d)(1) correspondingly defines the term
``pool'' to mean ``any investment trust, syndicate or similar form
of enterprise operated for the purpose of trading commodity
interests.'' Unless otherwise noted, Commission rules cited to
herein are found at 17 CFR Ch. I (2003). Both the Act and the
Commission's rules issued thereunder can be accessed through the
Commission's Web site, at: http://www.cftc.gov/cftc/cftclawreg.htm.
CFTC Staff Letters issued since 1995 may be accessed through
http://www.cftc.gov/opaletters.htm.
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Section 4m(1) of the Act \2\ provides, in relevant part, that it is
unlawful for any CPO, ``unless registered under (the Act), to make use
of the mails or any means or instrumentality of interstate commerce''
in connection with its business as a CPO. Rules 4.5 and 4.13, provide
exemptions from CPO registration.
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\2\ 7 U.S.C. 6m(1) (2000).
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Section 1a(6)(A) of the Act defines the term commodity trading
advisor to mean 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 contract of sale of a commodity for future delivery made
or to be made on or subject to the rules of a contract market or
derivatives transaction execution facility;
(II) any commodity option authorized under section 6c of this
title; or
(III) any leverage transaction authorized under section 23 of
this title; or
(ii) For compensation or profit, and as part of a regular
business, issues or promulgates analyses or reports concerning any
of the activities referred to in clause (i).\3\
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\3\ 7 U.S.C. 1a(6)(A) (2000).
Section 1a(6) also excludes certain persons not at issue here
from the CTA definition, and provides the Commission with authority
to exclude addditional persons from that definition.
Section 4m(1) of the Act also requires CTAs to register as such with
the Commission and, along with section 4m(3) and Rule 4.14, provides
exemption from CTA registration.
If a person is exempt from registration as a CPO or CTA, its
associated persons (APs) are not required to register as such. Further,
neither the exempt CPO or CTA, nor any of its APs, is required to
become a member of a registered futures association.
Generally, CPOs and CTAs who are, or who are required to be,
registered with the Commission, must provide prospective pool
participants or advisory clients, as the case may be, with a Disclosure
Document containing specified information \4\--e.g., the business
background of the CPO or CTA and its principals, past performance, fees
and other expenses, and conflicts of interest--and they must make and
keep specified books and records.\5\ These CPOs also must provide
unaudited periodic financial reports and certified annual reports to
participants in their pools.\6\ Additionally, regardless of
registration status, all persons who come within the CPO or CTA
definition are subject to certain operational \7\ and advertising
requirements \8\ under part 4, to all other provisions of the Act and
the Commission's rules prohibiting fraud that apply to CPOs and CTAs,
and to all other relevant provisions of the Act and the Commission's
rules that apply to all commodity interest market participants, such as
the general antifraud provisions, prohibitions on manipulation and the
trade reporting requirements.
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\4\ Rule 4.21 for CPOs and Rule 4.31 for CTAs.
\5\ Rule 4.23 for CPOs and Rule 4.33 for CTAs.
\6\ Rule 4.22.
\7\ Rule 4.20 for CPOs and Rule 4.30 for CTAs.
\8\ Rule 4.41.
While Rules 4.7 and 4.12(b) provide relief for certain
registered CPOs from the Disclosure Document, periodic and annual
reporting, and recordkeeping requirements of Rules 4.21, 4.22, and
4.23, they do not affect the applicability of Rules 4.20 and 4.41 to
these CPOs. Similarly, CTAs who have claimed relief under Rule 4.7
continue to remain subject to Rules 4.30 and 4.41.
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B. The Proposal
On March 17, 2003, the Commission published proposed revisions to
Rules 4.5, 4.13, and 4.14 and various other rules under part 4 of its
regulations (Proposal).\9\ The Commission based the Proposal on a prior
Rule 4.5 proposal; \10\ an Advance Notice of Proposed Rulemaking (ANPR)
setting forth additional CPO and CTA registration exemptions submitted
by the National Futures Association (NFA) and an additional CPO
registration exemption submitted by the Managed Funds Association
(MFA); \11\ the Commission's Roundtable on CPO and CTA Issues
(Roundtable); \12\ and generally on its staff's experience in
administering part 4 of the regulations (Part 4 Rules).
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\9\ 68 FR 12622. The Proposal may be accessed through http://www.cftc.gov/foia/fedreg03/foi030317b.htm
.
\10\ 67 FR 65743 (Oct. 28, 2002). Both the prior Rule 4.5
proposal and the comment letters the Commission received thereon may
be accessed through http://www.cftc.gov/foia/fedreg02/foi021028a.htm
.
\11\ 67 FR 68785 (Nov. 13, 2002). Both the ANPR and the comment
letters the Commission received thereon may be accessed through
http://www.cftc.gov/foia/fedreg02/foi021113a.htm.
\12\ See 68 FR 12622, 12624-25 for a discussion of the origin
and outcome of the Roundtable. Comments received in connection with
the Roundtable may be accessed through http://www.cftc.gov/opa/press02/opa4700-02.htm
.
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Specifically, the Commission proposed to amend: (1) Rule 4.5, by
deleting from the rule any trading criteria and corresponding
disclosure requirement for eligibility for an exclusion from the CPO
definition; (2) Rule 4.13, by expanding the availability of existing
relief from CPO registration and providing for additional CPO
registration exemptions thereunder; (3) Rule 4.14, similarly by
expanding the availability of existing relief from CTA registration and
providing for additional CTA registration exemptions thereunder; (4)
Rules 4.21 and 4.31, by permitting certain communications with
prospective pool participants and managed account clients,
respectively, prior to Disclosure Document delivery; (5) Rules 4.21 and
4.22, by removing duplicative disclosure and reporting requirements in
the ``master/feeder fund'' context; (6) Rule 4.22, by providing for
electronic distribution of Account Statements and Annual
[[Page 47223]]
Reports; and (7) Rules 4.7, 4.12, 4.13 and 4.22, by conforming the
various signature requirements thereof.\13\
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\13\ See 68 FR 12622, 12625-30.
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In announcing the Proposal, the Commission stated:
The relief the Commission is proposing today is consistent with
the purpose and intent of the CFMA (Commodity Futures Modernization
Act of 2000), and with the input the Commission has received in
connection with its prior initiatives. . . . Accordingly, it is
intended to allow greater flexibility and innovation, and to take
into account market developments and the current investment
environment, by modernizing the requirements for determining who
should be excluded from the CPO definition, and who should remain
within the CPO and CTA definitions but be exempt from registration.
Thus, this relief is intended to encourage and facilitate
participation in the commodity interest markets by additional
collective investment vehicles and their advisers, with the added
benefit to all market participants of increased liquidity.\14\
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\14\ 68 FR 12622, 12625.
In connection with issuing the Proposal, the Commission also
provided temporary no-action relief to Rule 4.5 eligible persons and
CPOs and CTAs who met the trading and other criteria specified therein
(Temporary No-Action Relief).\15\ The Proposal required that the
Temporary No-Action Relief be claimed by filing a notice with the
Commission. The effect of this final rulemaking on claimants under the
Temporary No-Action Relief is discussed below.\16\
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\15\ See 68 FR 12622, 12630-32.
\16\ See II.F.1. above.
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C. The Comments on the Proposal
The Commission received thirty-one comment letters on the Proposal,
as follows: Six from registered CPOs and CTAs; two from registered
introducing brokers; two from registered securities investment
advisers; one from a registered futures association; one from a futures
industry trade association; two from securities industry trade
associations; nine from law firms; one from a bar association; one from
a certified public accounting firm; and six from retail investors. The
majority of these commenters voiced strong support for the Proposal, by
such statements as that it would fulfill the Commission's express
purposes in making the Proposal, would better harmonize CFTC and
Securities and Exchange Commission (SEC) regulation of investment
management professionals, and would go a long way toward addressing the
issues raised at the Roundtable.\17\
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\17\ The six retail investors submitted nearly identical
letters, each of which stated in general terms that the Commission
should do more rather than less to protect investors, and that hedge
funds should be subject to ``full and fair'' disclosure standards.
These letters did not, however, refer to any specific proposed rule
or any of the Commission's specific requests for comments. One of
the other commenters on the Proposal suggested changes to Rules 4.5
and 4.13 that would have made the relief thereunder available to
additional types of pension plan entities. This suggestion is
outside the scope of this rulemaking. Accordingly, the Commission
intends to consider the merits of the application of Rule 4.5 or
4.13 to any such plan on a case-by-case basis. (However, some of
those plans are now covered by the rules the Commission is
publishing today. See, e.g., Rule 4.14(a)(8)(i)(C)(2).)
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In light of these comments, the Commission generally is adopting
the revisions to the Part 4 Rules that it proposed. Where the
Commission is making a change from the Proposal, it discusses the
change below.\18\ In the Federal Register release announcing the
Proposal (Proposing Release), the Commission gave a detailed
explanation of each rule amendment it had proposed to make.\19\
Accordingly, the scope of this Federal Register release generally is
restricted to the comments received on the Proposal and to the changes
to, and clarifications of, the Proposal that the Commission is making
in response thereto. The Commission encourages interested persons to
read the Proposing Release for a fuller discussion of the purpose of
each of the amendments contained in the Proposal.
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\18\ In addition, the Commission is adopting certain clarifying
amendments to Rule 4.7, such that Rule 4.7(a)(2)(vi) now refers to
section 2(a)(51)(A) of the Investment Company Act of 1940 and Rule
4.7(a)(3)(viii) now includes ``a limited liability company or
similar business venture.'' Also, to clarify the availability of
Rule 4.13(a)(2), the Commission is employing the term
``participant'' in lieu of the term ``person'' in Rule
4.13(a)(2)(iii).
\19\ Supra n.13.
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D. Significant Changes From the Proposal
The significant changes from the Proposal that the Commission is
making in the rules it is adopting today are as follows: (1) Rule 4.5
no longer contains a `` marketing'' restriction, but it does require
disclosure of the fact, and effect, of a claim for exclusion from the
CPO definition; (2) Rule 4.13(a)(3) expands the trading limit criterion
thereunder to ``5 percent'' and ``100 percent,'' from the proposed ``2
percent'' and ``50 percent'' limits; (3) Rule 4.13(a)(3) expands the
investor eligibility criterion thereunder to ``knowledgeable
employees'' and certain other persons, in addition to ``accredited
investors,'' as proposed; and (4) Rule 4.22 now provides for electronic
distribution of Annual Reports, in addition to Account Statements, as
proposed, where a CPO furnishes a one-way disclosure notice and the
pool participant does not timely object to such distribution.
In addition, the Commission is clarifying: (1) The meaning of the
term ``aggregate net notional value'' in Rule 4.13(a)(3); (2) the
effect of this final rulemaking on the Temporary No-Action Relief; (3)
the applicability of the Annual Report requirement to CPOs who withdraw
from registration in reliance upon Rule 4.13(a)(3) or (a)(4); and (4)
in new Appendix A to Part 4, the application of the Rule 4.13(a)(3)
trading limit criteria to a broad range of fund-of-fund situations.
II. Responses to the Comments on the Proposal
A. Amendment to Rule 4.5: Deleting Trading and ``No Marketing''
Criteria for Exclusion From the CPO Definition
The Commission proposed to amend the operating criteria of Rule 4.5
by deleting therefrom provisions concerning commodity interest trading
restrictions and related disclosures.\20\ The Commission explained that
the operating criteria of the rule would continue to include the ``no
marketing'' and submission to special calls requirements. The
Commission reasoned that ``it is appropriate to maintain the marketing
restriction because, unlike the case with the proposed CPO registration
exemption, members of the retail public may participate in the trading
vehicles subject to Rule 4.5.'' \21\ The Commission nonetheless
requested comment on the merits of retaining the ``no marketing''
criterion--i.e., that a Rule 4.5 qualifying entity ``will not be, and
has not been, marketing participations to the public as or in a
commodity pool or otherwise as or in a vehicle for trading in the
commodity futures or commodity options markets.''
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\20\ See 68 FR 12622, 12625-26.
\21\ 68 FR 12622, 12626.
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In response to this request, one commenter agreed with the proposed
retention of the ``no marketing'' criterion (and with the Commission's
rationale therefore) but several commenters disagreed with it. This
latter group supported its position with claims that, in the absence of
any trading restriction, the ``otherwise regulated'' nature of the
qualifying entities specified in Rule 4.5 would provide adequate
customer protection, and, further, that compliance with the subjective
nature of the marketing restriction could give rise to the possibility
of unequal enforcement where commodity interest trading was restricted.
[[Page 47224]]
In light of these comments, the Commission is amending Rule 4.5
such that it no longer contains any restrictions relating either to
commodity interest trading or to marketing of the entity. The rule
does, however, continue to require disclosure to investors `` now, that
the qualifying entity's operator has claimed exclusion from the CPO
definition, and that therefore the person is not subject to CPO
registration and regulation under the Act. This requirement is set
forth in paragraph (c)(2)(i) of the amended rule. The Commission did
not propose to change the ``special call'' provision of Rule 4.5, and,
accordingly, the rule continues to contain this provision, in paragraph
(c)(2)(ii).\22\
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\22\ The special call provision previously was set forth in
paragraph (c)(2)(iv) of Rule 4.5.
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The disclosure requirement the Commission is adopting today may be
satisfied in the same manner that the Commission previously established
for the (albeit now deleted) disclosure of commodity interest trading
limits under Rule 4.5--i.e.:
through inclusion of the specified information in any document which
is required by the qualifying entity's other Federal or State
regulator to be routinely furnished to participants or, if no such
document is required to be routinely furnished, through disclosure
in any instrument that is required by the other regulator to
establish the entity's investment policies and objectives and which
is required by such other regulator to be made available (but not
specifically furnished) to the entity's participants.\23\
\23\ 50 FR 15868, 15879 (Apr. 23, 1985).
The Commission further stated that it was aware that: certain
qualifying entities--e.g., registered investment companies--are
required by their other regulators to make disclosures directly to
their participants but that other qualifying entities--e.g., a
commingled trust fund of a federally regulated bank--may not be
subject to any such direct disclosure requirement. The Commission
intends that those other entities may satisfy this representation by
indirect disclosure. For example, in the case of a bank commingled
trust fund that intends to trade commodity interests on behalf of
the various trust accounts comprising the commingled fund, the bank
only needs to make the disclosure representation to the trustee of
each underlying trust account. Id., n.69.
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At the request of other commenters, the Commission confirms that
Rule 4.5 does not affect the ability of a person who has claimed an
exclusion from the CPO definition thereunder: (1) To invest in any
other trading vehicles--e.g., a commodity pool that engages in
unlimited commodity interest trading; and (2) to qualify for an
exemption from registration as a CPO under Rule 4.13 in connection with
its operation of another trading vehicle that is not covered under Rule
4.5--e.g., a trading vehicle that is not a registered investment
company covered under Rule 4.5(b)(1) or a non-pool covered under Rule
4.5(a)(4). This latter confirmation is contained in new Rule 4.5(g),
and new Rule 4.13(f) contains a reciprocal provision for CPOs claiming
registration relief thereunder. Also, the Commission is discussing
below the effect of this rulemaking generally on persons who previously
have claimed relief under Rule 4.5.\24\
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\24\ See II.F.1.
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The Commission did not propose, and is not now adopting, any other
amendments to Rule 4.5. Thus, the proviso to Rule 4.5(c) continues to
state that compliance with the operating criteria of the rule:
shall not be deemed a substitute for compliance with any criteria
applicable to commodity futures or commodity options trading
established by any regulator to which (an eligible) person or
qualifying entity is established.
Moreover, eligible persons and qualifying entities remain subject to
all relevant provisions of the Act and the Commission's rules that
apply to all commodity interest market participants, such as the
general antifraud rules, the prohibitions on manipulation and the trade
reporting requirements.\25\
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\25\ As stated in I. A. above, these provisions also apply to
persons exempt from registration as a CPO or CTA.
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B. Amendments to Rule 4.13: Adding CPO Registration Exemptions
1. Use of Terms Defined Under the Federal Securities Laws
Various of the new CPO registration exemptions under Rule 4.13 that
the Commission is adopting today base eligibility on pool participants
coming within the meaning of a term that is defined under the federal
securities laws--e.g., that of ``accredited investor,''; defined in
Rule 501(a) under the Securities Act of 1933 ('33 Act).\26\ As
requested by commenters, by this Federal Register release the
Commission confirms that it intends to follow interpretations issued by
the SEC and its staff of these definitions and in the event any of
these definitions are amended, the Commission will utilize the revised
definitions in the applicable Rule 4.13 exemption. However, as the
Commission stated in connection with adopting revisions to Rule 4.7
that similarly base relief on certain of these terms:
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\26\ 17 CFR 230.501(a) (2003). Other such terms found in Rule
4.13 are ``knowledgeable employee,'' defined in the Investment
Company of 1940 (ICA), 17 CFR 270.3c-5 (2003), and ``qualified
purchaser'' (QP), defined in Section 2(a)(51)(A) of the ICA.
The Commission has the right further to interpret or to amend
Rule 4.7 to exclude from the (qualified eligible person definition)
any person that the SEC or its staff found to be a QP or
knowledgeable employee or to include in the (qualified eligible
person definition) any person the SEC or its staff excluded from the
QP or knowledgeable employee definition, if such action is found to
be necessary to effectuate the purposes of the Act and the
Commission's regulations. The Commission expects that it would
exercise this right infrequently.\27\
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\27\ 65 FR 47848, 47852 (Aug. 4, 2000).
2. New Rule 4.13(a)(3): Adding an Exemption Where Commodity Interest
Trading Is Limited and Pool Participants are Sophisticated
a. In General
The Commission proposed new Rule 4.13(a)(3) to provide an exemption
from CPO registration where: (1) The pool a person operates engages in
a limited amount of commodity interest trading--i.e., by committing no
more than 2 percent of the liquidation value of the pool's portfolio to
establish commodity interest trading positions, whether entered into
for bona fide hedging purposes or otherwise, or where the aggregate net
notional value of the pool's commodity interest trading does not exceed
50 percent of the pool's liquidation value; (2) the CPO reasonably
believes that each investor in the pool is an ``accredited investor'';
and (3) the CPO does not market participations in the pool as or in a
vehicle for trading in the commodity futures or commodity options
markets.\28\ After explaining how and why this proposal differed from
the CPO registration exemption proposal submitted to the Commission by
the National Futures Association (NFA) as set forth in the ANPR,\29\
and after noting the comments received on the ANPR,\30\ the Commission
specifically requested comment on whether under the rule there should
be: (1) A higher percentage of assets that may be committed to
establish commodity interest positions; and (2) any greater ability to
trade commodity interests for bona fide hedging purposes than for non-
hedging purposes, including whether there should be any restriction
whatsoever on trading for hedging purposes.
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\28\ See 68 FR 12622, 12626-27.
\29\ See 67 FR 68785, 68786-87.
\30\ See 68 FR 12622, 12626-27.
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Many commenters provided input on proposed Rule 4.13(a)(3). Several
of them stated that the proposed trading limits were too low, such that
the exemption would be unavailable to many CPOs who should not be
subject to the Commission's registration,
[[Page 47225]]
disclosure, reporting and recordkeeping requirements. One of these
commenters recommended that the rule treat bona fide hedging and non-
hedging positions alike, claiming that this would simplify trading
limit calculations under the rule by avoiding the need to determine
whether a particular ``risk management position'' qualifies as a
hedging position, but another commenter recommended that no trading
limits should be applicable to the CPO of a pool that trades commodity
interests solely for hedging purposes. Two commenters urged that the
rule should permit a limited number of non-accredited investors, such
as ``knowledgeable employees.'' Commenters also requested clarification
on the meaning of the term ``aggregate net notional value''; on whether
security futures products (SFPs) are included in the Rule 4.13(a)(3)
trading limit tests; and on whether, to qualify for relief under Rule
4.13(a)(3), a CPO must operate its pool pursuant to an exemption from
registration under the '33 Act, as a ``privately-offered'' pool.\31\
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\31\ This is a requirement under Rule 4.13(a)(4) as proposed and
as adopted.
One commenter stated that since the investor criteria of Rules
4.13(a)(3) and (a)(4) include, among other persons, certain
``accredited investors,'' then it logically follows that the pool
must be privately offered. That is the context in which the rules of
the SEC (e.g., Regulation D under the '33 Act) employ the term
``accredited investor.''
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In response to these comments, and in light of its own further
deliberations on proposed Rule 4.13(a)(3), the Commission is making
various changes from the Proposal in the final rule. Specifically, Rule
4.13(a)(3) as adopted requires: (1) That interests in the pool for
which a CPO is seeking to claim relief thereunder must be exempt from
registration under the ``33 Act and may not be marketed to the public
in the United States (U.S.) (paragraph (a)(3)(i)); (2) that the pool
may not commit more than 5 percent of assets to establish commodity
interest positions or have a notional value of its commodity interest
positions that exceeds 100 percent of the pool's liquidation value
(paragraphs (a)(3)(ii)(A) and (a)(3)(ii)(B), respectively); \32\ and
(3) that the pool may include, as proposed, participants who are
``accredited investors,'' and in addition, certain family trusts formed
by accredited investors; ``knowledgeable employees;'' and persons who
are QEPs under Rule 4.7(a)(2)(viii)(A) (paragraph (a)(3)(iii)).\33\
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\32\ Thus, the rule continues to include both hedging and non-
hedging positions in the calculation of either test.
\33\ As proposed and as adopted, Rule 4.13(a)(3) also generally
prohibits the CPO from marketing participations in the pool ``as or
in a vehicle for trading in the commodity futures or commodity
options markets.''
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Further, Rule 4.13(a)(3) as adopted now clarifies that: (1) At all
times the pool must meet one or the other of the specified trading
limits (paragraph (a)(3)(ii)); (2) security futures products are
included in each test (paragraph (a)(3)(ii)); (3) the notional value of
an option contract must reflect an adjustment for the delta of the
contract (paragraph (a)(3)(ii)(B)(1)); and (4) contracts may be netted
by underlying commodity and across designated contract markets,
registered derivatives transaction execution facilities and foreign
boards of trade (paragraph (a)(3)(ii)(B)(2)).
b. New Appendix A to Part 4: ``Fund-of-Funds''
Most of the commenters on proposed Rule 4.13(a)(3), and in fact, on
the Proposal as a whole, expressed concern over the application of the
Rule 4.13(a)(3) trading limits in the ``fund-of-funds'' context.\34\
They requested the Commission to confirm in its final rulemaking
statements it had made in the Proposal on this issue.\35\ They also
presented numerous scenarios involving ``fund-of-funds'' structures for
the Commission to consider.
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\34\ In the ANPR, the Commission defined a ``fund-of-funds'' as
an investor fund that indirectly trades commodity interests through
participation in one or more investee funds that directly trades
commodity interests. See 67 FR 68785, 68788, n.15.
\35\ See 68 FR 12622, 12631.
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To address these concerns, the Commission is adopting today
Appendix A to Part 4. The introductory text explains that:
The following provides guidance on the application of the
trading limits of Rule 4.13(a)(3)(ii) to commodity pool operators
(CPOs) who operate ``fund-of-funds.'' For the purpose of this
Appendix A, it is presumed that the investor fund CPO can comply
with all of the other requirements of Rule 4.13(a)(3). It also is
presumed that where the investor fund CPO is relying on its own
computations, the investor fund is participating in each investee
fund that trades commodity interests as a passive investor, with
limited liability (e.g., as a limited partner of a limited
partnership or a non-managing member of a limited liability
company). Fund-of-fund CPOs who seek to claim exemption from
registration under Rule 4.13(a)(1), (a)(2) or (a)(4) may do so
without regard to the trading engaged in by an investee fund,
because none of the registration exemptions set forth in those rules
concerns limits on or levels of commodity interest trading. Persons
whose fact situations do not fit any of the scenarios below should
contact Commission staff to discuss the applicability of the
registration exemption in Rule 4.13(a)(3) to their particular
situations.
In adopting Appendix A, the Commission has been guided by the
following principles, i.e., that relief under Rule 4.13(a)(3) should be
available where:
(1) The CPO of each investee fund is either: (i) Itself claiming
exemption from CPO registration under Rule 4.13(a)(3); or (ii) a
registered CPO that is complying with the trading restrictions of Rule
4.13(a)(3). In this regard, the CPO of the investor fund should be able
to rely upon the representations of the investee fund CPOs to the
foregoing effect.
(2) The CPO of an investor fund has actual knowledge of the trading
and commodity interest positions of the investee funds (e.g., where the
investee funds are operated by the CPO or one or more affiliates of the
CPO). In this case the investor fund CPO may aggregate the commodity
interest positions across the investee funds to determine compliance
with the trading restrictions of Rule 4.13(a)(3).
(3) An investor fund does not trade commodity interests directly,
and the CPO has allocated no more than 50 percent of the investor
fund's assets to investee funds that trade commodity interests
(regardless of the level of commodity interest trading engaged in by
those investee pools). The investor fund CPO may claim exemption under
Rule 4.13(a)(3) because the investor fund's exposure to the futures
markets may be said to be comparable to that of a stand-alone pool that
meets the aggregate net notional value test.
(4) An investor fund engages in direct commodity interest trading
in addition to its allocation of assets to investee funds, provided the
CPO treats the assets committed to direct trading as a separate pool
with its own liquidation value and applies the trading restrictions of
Rule 4.13(a)(3) to that ``separate pool.''
3. New Rule 4.13(a)(4): Adding an Exemption Where Pool Participants Are
Highly Sophisticated
The Commission proposed new Rule 4.13(a)(4) to provide an exemption
from CPO registration where: (1) Interests in the pool for which the
CPO seeks to claim relief (a) are exempt from registration under the
Securities Act of 1933, and (b) are offered and sold without marketing
in the United States (U.S.); and (2) the CPO reasonably believes that
(a) natural person participants are QEPs under Rule 4.7(a)(2), and (b)
non-natural person participants are QEPs under Rule 4.7 or
[[Page 47226]]
``accredited investors.'' \36\ After explaining how and why this
proposal differed from the CPO registration exemption proposal
submitted to the Commission by the MFA, as set forth in the ANPR,\37\
the Commission requested comment on what investor qualifications would
be appropriate under proposed Rule 4.13(a)(4) and whether all natural
person QEPs should be included for purposes of the rule.
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\36\ See 68 FR 12622, 12627.
\37\ See 67 FR 68785, 68787-88.
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The comments received in response to this request were mixed, with
some stating that the proposed investor eligibility qualifications
would be appropriate, yet others claiming that the proposal was
unnecessarily restrictive and that the rule should include all natural
person QEPs--i.e., natural persons who are QEPs under either Rule
4.7(a)(2) or (a)(3). Inasmuch as Rule 4.13(a)(4) does not contain any
trading limits whatsoever, and the operators in question are not
``otherwise regulated'', the Commission is not persuaded by this latter
set of comments and, accordingly, it is adopting the rule as proposed.
4. Alternative Proposal for Relief
As an alternative to the foregoing registration exemption proposals
for certain CPOs, and to various registration exemption proposals for
certain CTAs under Rule 4.14, the Commission sought comment on adoption
of a notice registration scheme that would be comparable to the
proposed exemption approach with respect to information required to be
filed with the Commission and compliance with Part 4 requirements.\38\
Specifically, the Commission asked for comment on whether a notice
registration scheme could make it more clear to the public and other
regulatory authorities that this group of CPOs and CTAs remained
subject to the CFTC's jurisdiction under the Act, the Bank Secrecy Act
and other statutes, while providing the same amount of regulatory
relief as the proposed exemption.
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\38\ See 68 FR 12622, 12628.
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The Commission received several comments in response to this
request, each of which recommended that the Commission not adopt a
notice registration scheme. The arguments advanced to the Commission
were that such a scheme: (1) Might confuse prospective pool
participants into thinking that a notice registrant was subject to more
oversight and regulation than it actually would be; \39\ (2) was
unnecessary because CPOs exempt from registration remain subject to
CFTC jurisdiction, which includes the antifraud provisions of the Act
and the Commission's rules; and (3) would not improve the information
available to the Commission but, rather, would raise recordkeeping,
supervision and audit requirement issues for all concerned. In light of
these comments, the Commission is not adopting a notice registration
scheme.
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\39\ Cf. Rule 3.10(a)(3), which generally provides for notice
registration as a futures commission merchant or introducing broker
for certain brokers and dealers that are registered with the SEC,
are members of a registered national securities association, and
solely trade security futures products.
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C. Amendments to Rule 4.14: Adding and Expanding CTA Registration
Exemptions
1. New Rule 4.14(a)(8)(i)(D): Adding an Exemption Where Advice Is to
Rules 4.13(a)(3) and (a)(4) Pools
As proposed and as adopted, new Rule 4.14(a)(8)(i)(D) provides CTA
registration relief for advisors to commodity pools that meet the
requirements of the new CPO registration exemptions based on, among
other things, trading limits, as discussed above.\40\ Several persons
have asked whether the Commission intends that this CTA registration
exemption will define the term ``primarily'' as used in section 4m(3)
of the Act,\41\ which also provides an exemption from CTA registration,
for any CTA that--
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\40\ See the discussion of Rule 4.13(a)(3)(ii) in II. B. 2.
above.
\41\ 7 U.S.C. 6m(3) (2000).
is registered with the [SEC] as an investment adviser whose
business does not consist primarily of acting as a (CTA) * * * and
that does not act as a (CTA) to any investment trust, syndicate or
similar form of enterprise that is engaged primarily in trading in
any commodity for future delivery on or subject to the rules of any
contract market or registered derivatives transaction execution
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facility. (Emphasis added.)
The Commission does not intend that the CTA registration exemption
in Rule 4.14(a)(8)(i)(D) have any bearing whatsoever on the meaning of
the term ``primarily'' in section 4m(3). Rather, the Commission intends
to employ the criteria of Rule 4.14(a)(8)(i)(D) solely for the purposes
of the rule itself.\42\
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\42\ The CFMA added section 4m(3) to the Act and a corresponding
Section 203(b)(6) to the Investment Advisers Act of 1940 (IAA),
which provides an exemption from registration for:
any investment adviser that is registered with the (CFTC) as a
(CTA) whose business does not consist primarily of acting as an
investment adviser, . . . and that does not act as an investment
adviser to--
(A) (a registered) investment company; or
(B) a company which has elected to be a business development
company . . . and has not withdrawn its election.
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2. New Rule 4.14(a)(10): Counting Legal Organizations as a Single
``Person''
As the Commission explained in the Proposing Release, the single
``persons'' specified in Rule 4.14(a)(10) for the purposes of section
4m(1) of the Act are patterned after the single ``clients'' specified
in Rule 203(b)(3) under the IAA.\43\ By this release, and at the
request of a commenter, the Commission confirms that it intends to
follow interpretations of Rule 203(b)(3) issued by the SEC and its
staff. As stated above in connection with the discussion of Rules
4.13(a)(3) and 4.13(a)(4), however, the Commission has the right to
provide its own interpretations concerning the counting of single
``persons,'' if such action is found to be necessary to effectuate the
Act and the Commission's regulations, and, further, the Commission
expects that it would exercise this right infrequently.\44\
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\43\ See 66 FR 12622, 12628-29.
\44\ See II.B.1. above. The Commission also has clarified in
Rule 4.14(a)(10) as adopted that the source of this exemption is
section 4m(1).
Compare CFTC v. Savage, 611 Fed. 270 (9th Cir. 1979). There, the
Court held that section 4m(1) includes ``within the persons to whom
an advisor `furnishes' advice customers of an advisee when the
advisor knows or should know that advice he gives is directly passed
to those customers.'' Id. at 280. The advisee in Savage was a
corporation `` i.e., a legal organization--that was registered as a
futures commission merchant with the Commission. Rule 4.14(a)(10)
counts a legal organization as a single ``person'' where the
organization is receiving commodity interest trading advice based on
its investment objectives. Inasmuch as the advisee in Savage was not
receiving advice based on its investment objectives but, rather, as
a mere conduit for others to receive advice, it would not be counted
as a single ``person'' under Rule 4.10(d).
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D. Amendments to Rules 4.21, 4.22 and 4.31
1. Amended Rules 4.21(a) and 4.31(a): Permitting Communications Prior
to Disclosure Document Delivery
Commission Rules 4.21 and 4.31 respectively require CPOs and CTAs
to provide a Disclosure Document to their prospective pool participants
and advisory clients. The Commission proposed to amend these rules to
provide that the Disclosure Document must be delivered by no later than
the time a CPO delivers a subscription agreement for the pool for which
it is soliciting or a CTA delivers an advisory agreement for the
trading program for which it is soliciting.\45\ To ensure achievement
of the purpose of the Disclosure Document--i.e., that prospective
investors are fully informed about all material facts before committing
their funds--, and consistent with the Roundtable comments, these
proposed rule
[[Page 47227]]
amendments would have been subject to the proviso that ``any material
distributed in advance of the delivery of the Disclosure Document is
consistent with or amended by the information contained in the
Disclosure Document and with the obligations of the [CPO or CTA] under
the Act, the Commission's regulations issued thereunder, and the laws
of any other applicable federal or state authority.'' (Emphasis added.)
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\45\ See 68 FR 12622, 12629.
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One of the commenters on these proposed rule amendments objected to
this proviso, claiming that the phrase ``or amended by'' could be read
to mean that information does not have to be consistent with the
Disclosure Document at the time the information is distributed, as long
as it is corrected when the Disclosure Document is delivered. To avoid
any such misunderstanding, Rules 4.21(a) and 4.31(a) as adopted now
further provide that:
In the event such previously distributed information is amended
by the Disclosure Document in any material respect, the prospective
participant must be in receipt of the Disclosure Document at least
48 hours prior to its (subscription or advisory agreement, as the
case may be) being accepted.
Another commenter on these proposed rule amendments asked for
clarification on the permissibility of distributing performance
materials in advance of delivery of a Disclosure Document. In response,
the Commission states that performance information may be distributed
in advance of the Disclosure Document, provided it is presented in the
format specified by the CFTC.\46\
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\46\ See, e.g., Rules 4.25 and 4.35, which establish performance
disclosure formats for CPOs and CTAs, respectively; Rule 4.41, which
concerns advertising by CPOs, CTAs and their principals; and 46 FR
26004, 26012 (May 8, 1981), wherein the Commission provided guidance
on the advertising of past performance results. See also, Rule 156
under the '33 Act, 17 CFR 230.156 (2003), which sets forth what the
SEC would consider ``materially misleading'' in the context of
investment company sales literature.
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In connection with adopting these amendments to Rules 4.21 and
4.31, the Commission has reviewed its July 1997 interpretation
regarding electronic delivery of CPO and CTA Disclosure Documents (the
``1997 Interpretation'') \47\ for the purpose of considering whether it
should revise certain aspects of that interpretation, such as the
requirement that visitors to a CPO or CTA Web site must view a summary
risk disclosure statement before they may access performance
information. The Commission notes that the 1997 Interpretation was
premised on the now obsolete requirement in Rules 4.21 and 4.31 that a
Disclosure Document respectively be delivered on or before the date
that a CPO solicited, accepted or received funds or other property from
a prospective pool participant, or a CTA solicited or entered into an
advisory agreement with a prospective client. Accordingly, the
provisions of amended Rules 4.21 and 4.31 supercede the 1997
Interpretation.
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\47\ See, ``Interpretation Regarding Use of Electronic Media by
Commodity Pool Operators and Commodity Trading Advisors for Delivery
of Disclosure Documents and Other Materials,'' 62 FR 39104 (July 22,
1997). In that interpretation, the Commission made provision for
delivery of required Disclosure Documents in the context of, for
example, CPO and CTA Internet Web sites by requiring that a summary
risk disclosure be given along with a hyperlink or other comparable
ready access to the full Disclosure Document, in lieu of requiring
that the CPO or CTA make a Web site viewer scroll through the entire
Disclosure Document before viewing any material that might
constitute a solicitation by the CPO or CTA.
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2. New Rule 4.22(i): Distributing Account Statements and Annual Reports
Electronically
The Commission is amending Rule 4.22 by adding a new paragraph (i)
to the rule to establish that, as proposed, a CPO may distribute
periodic Account Statements to pool participants by electronic means,
and, in response to favorable comments, a CPO may so distribute Annual
Reports.\48\ Also in response to comments, for greater flexibility the
rule as adopted does not specify each and every step a CPO must take to
furnish financial information to pool participants. What the rule does
require is that prior to transmission of any Account Statement or
Annual Report to a pool participant by means of electronic media, a CPO
must disclose to the participant that it intends to distribute these
documents electronically, absent objection from the participant, which
objection, if any, the participant must make no later than 10 business
days following its receipt of the disclosure.\49\
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\48\ See 68 FR 12622, 12629-30.
\49\ In light of this action, the Commission may review the
procedures in Rule 1.33 and 1.46 it previously adopted for
electronic transmission of certain information by FCMs to their
customers, with a view towards conforming them to new Rule 4.22(i).
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E. Amendments to Rules 4.5, 4.7, 4.12, 4.13, 4.14 and 4.22: Conforming
Signature Requirements
The Commission proposed to amend certain of the part 4 rules that
list the CPO and CTA signatories who may sign various required
documents.\50\ As the Commission explained:
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\50\ 68 FR 12622, 12630.
Rules 4.7(d), 4.12(b), 4.13(b), and 4.22(h) provide that the
documents required thereunder must be signed by a CPO or CTA as
follows: if it is a sole proprietorship, by the sole proprietor; if
a partnership, by a general partner; and if a corporation, by the
chief executive officer or chief financial officer.
Upon review of this list of permitted signatories, the
Commission believes that it may be unnecessarily restrictive in that
it leaves no room for other organizational structures under which
CPOs and CTAs operate--e.g., limited liability companies.
Accordingly, the Commission is proposing to amend Rules 4.7(d),
4.12(b) and 4.13(b) to provide that the documents required
thereunder must be signed by a duly authorized representative of the
CPO or CTA. This would be consistent with existing signature
requirements under Rules 4.5 and 4.14. * * * However, because the
document required under Rule 4.22(h) pertains to the accuracy and
completeness of certain financial reports (i.e., commodity pool
Account Statements and Annual Reports), the Commission specifically
is proposing that this oath or affirmation be signed by a
representative duly authorized to bind the pool operator.\51\
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\51\ Id.
The Commission received two comments on these proposed rule
amendments. The first comment recommended that the same standard be
applied to each situation where documents are required to be executed.
The Commission agrees with this comment, and, accordingly, is adopting
as the suggested ``universal standard'' the requirement that part 4
documents be manually executed by ``a representative duly authorized to
bind'' an eligible person, CPO or CTA. Specifically, this requirement
is now found in Rules 4.5(f)(2), 4.7(d)(1)(vii), 4.12(b)(3)(vi),
4.13(b)(1)(iii), 4.14(a)(8)(iii)(A)(3) and 4.22(h)(3).
The second comment recommended that the list of permitted
signatories be expanded, such that the applicable rules would
specifically provide that ``any listed principal'' is a permitted
signatory. The Commission does not agree with this comment, because not
all principals of a CPO or a CTA may in fact be duly authorized to bind
the CPO or CTA.\52\
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\52\ Rule 4.10(e)(1) provides that for the purposes of part 4,
the term ``principal'' has the same meaning as the term
``principal'' under Rule 3.1(a).
Rule 3.1(a) generally defines the term ``principal'' of an
entity to include, among others, the following: executive officers;
persons in charge of a function subject to Commission regulation;
persons who have the power to exercise a controlling influence over
the entity's activities that are subject to Commission regulation;
ten percent or greater shareholders; and persons who have
contributed ten percent or more of the capital.
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[[Page 47228]]
F. Effect of Final Rulemaking
1. Effect on Prior Claimants
The amendments to Rules 4.5, 4.13 and 4.14 that the Commission is
publishing today do not require a person who previously has claimed
relief under Rule 4.5 or the Temporary No-Action Relief \53\ to re-file
its claim in order to maintain that relief or to trade in accordance
with amended Rule 4.5, 4.13 or 4.14. Moreover, where the person
continues to comply with the commodity interest trading limitations
applicable to that previously claimed relief, it does not need to take
any other action to take advantage of the exemptions being made
available by these amendments.\54\ The person nonetheless remains
subject to all other applicable requirements of Rule 4.5, 4.13 or 4.14,
as the case may be, to all other applicable provisions of the Act and
the Commission's rules thereunder, and to any and all obligations under
any other applicable Federal and State statutory and regulatory
authorities that may result from its activities under these exemptions.
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\53\ See 68 FR 12622, 12630-32.
\54\ Thus, for example, a person who has claimed relief under
Rule 4.5 or the Temporary No-Action Relief who continues to comply
with the prior limits is not subject to the revised disclosure
requirement of Rule 4.5(c)(2)(i) or Rule 4.13(a)(5), as the case may
be.
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2. Effect of Withdrawal From CPO Registration on Rule 4.22(c) Annual
Report Requirement
A CPO who has withdrawn from registration in order to claim the
Temporary No-Action Relief or who withdraws from registration in order
to claim relief under Rule 4.13(a)(3) or (a)(4) adopted today
nonetheless remains subject to the Annual Report requirement of Rule
4.22(c), as has been the case with CPOs who have withdrawn from
registration for any other reason. This is because the Commission
believes that when a CPO leaves direct CFTC oversight, the CPO's pool
participants should get all of the information they are entitled to up
to that time. The Commission nonetheless is aware that in past cases
its staff has worked with withdrawing CPOs in appropriate cases to
provide these persons with flexibility in complying with Rule 4.22(c).
By this Federal Register release, the Commission instructs its staff to
continue this practice.
G. Continued Availability of No-Action Relief From Commission Staff
The Commission is aware that, notwithstanding the rules it is
adopting today, there may be persons that do not meet the criteria of
Rule 4.5 for eligible persons, section 4m(3) of the Act or Rule 4.13
for CPOs, or section 4m(1) of the Act or Rule 4.14 for CTAs but, that,
nonetheless, under their particular facts or circumstances, merit
relief. The Commission also is aware that, in the past, its staff has
provided no-action relief from the criteria of Rule 4.5 and from the
registration requirement of section 4m(1) of the Act on a case-by-case
basis. Consistent with that practice, the Commission directs its staff
to continue to issue such relief in appropriate cases.\55\
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\55\ For example, under appropriate circumstances, it may be
permissible for a person who seeks to claim an exemption from CPO
registration under Rule 4.13(a)(3) to include contracts such as
swaps when calculating the ``aggregate net notional value''
criterion of the rule.
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III. Past Performance Presentation Issues
On March 13, 2003, the Commission published in the Federal Register
\56\ proposed rule amendments regarding the computation and
presentation of rate of return information and other disclosures
concerning past performance of accounts over which a CTA has had
trading authority (Performance Proposal). In the Performance Proposal,
the Commission also sought comment on whether a core principle should
replace detailed performance requirements. The Commission has adopted a
core principle approach regarding presentation of partially funded
accounts,\57\ but noted in the release adopting the core principle that
proposed changes relating to certain performance issues with
application beyond the partially funded account situation would be
addressed separately.\58\ These issues include: (1) Disclosure of the
range of rates of return for closed accounts, or other measures of
variability in returns experienced by clients for the offered trading
program; (2) computation of program draw-down information on a
composite basis; and (3) methods to account for the effect of
intramonth additions and withdrawals in the computation of rate of
return.
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\56\ 68 FR 12001. The Performance Proposal and comments received
may be accessed through http://www.cftc.gov/foia/comment03/foi03_004_1.htm
.
\57\ 68 FR 42964 (July 21, 2003).
\58\ Id. at 42966.
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A. Range of Rates of Return for Closed Accounts
The Commission proposed to revise Rule 4.35(a)(1)(viii) to require
that the performance capsule for the offered program include, in
addition to the number of accounts closed with profits and the number
closed with losses, the range of rates of return for the accounts
closed with net lifetime profits and accounts closed with net lifetime
losses, during the five-year period for which past performance must be
disclosed.\59\ The Commission based this proposal on its belief that
such disclosure would provide important summary information on the
variation in returns experienced by individual clients and would be
useful to prospective clients considering participation in the CTA's
program. Several commenters on the Performance Proposal expressed the
belief that this disclosure would not provide useful information to
prospective clients, with one commenter noting that the requirement
would increase the burden on CTAs without any corresponding benefit.
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\59\ See Rule 4.35(a)(5).
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After consideration of these comments, the Commission has
determined that the objective of the proposed change--to enhance the
information available to prospective clients about the experience of
the CTA's prior clients--continues to be an important goal of the past
performance reporting required under Commission rules. However, the
Commission believes that it is appropriate to permit flexibility in the
manner in which CTAs meet this objective. Accordingly, the Commission
is amending Rule 4.35(a)(1)(viii) to require that the performance
capsule include a measure of the variability of returns experienced by
clients in the offered trading program who both opened and closed their
accounts during the period for which performance is required to be
disclosed, for accounts closed with positive net lifetime rates of
return and for those closed with negative net lifetime rates of return.
The Commission notes that this requirement may be satisfied by
disclosing the ranges of returns for accounts closed with positive net
lifetime rates of return and those closed with negative net lifetime
rates of return, as the Commission proposed, or by another method, such
as standard deviation, that meets the objective.
The Commission indicated in the Performance Proposal that both the
numbers of accounts closed with positive versus negative rates of
return, as well as the measure of variability of returns for accounts
in each category, must be disclosed only for those accounts that both
opened and closed within the required five-year and year-to-date time
period. One commenter noted that this change from the prior rule, which
required information on all accounts that closed during the required
[[Page 47229]]
time period even if they were opened more than five years earlier, may
result in a reduction in useful information. As it noted in the
Performance Proposal, the Commission does not believe that this change
will diminish the disclosure of material information to prospective
clients, because of the tendency of clients to quickly close accounts
that experience large losses. Accounts that experienced strongly
negative returns before the five-year time period are likely to have
been closed before the end of that time period, and losses experienced
as a result of the offered program during the five-year period are
likely to have been experienced by an account that both opened and
closed during that period. The Commission wishes to make clear that any
additional information that the CTA believes is necessary to explain
the circumstances affecting the measure of the variability of returns
presented in the performance capsule may be provided, pursuant to
existing rules regarding supplemental disclosures and material
information.\60\
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\60\ See Rules 4.34(n) and 4.34(o).
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B. Use of Composite Draw-Down
Although the Commission is not adopting the proposed revision to
Rules 4.35(a)(1)(v) and (vi) which would have required that the worst
monthly and peak-to-valley draw-down amounts be based on the aggregate
of nominal account sizes, based on the comments received, the
Commission believes it is necessary to clarify the issue of presenting
draw-down information on the composite of accounts, rather than on the
worst individual account.
Rule 4.10(k) defines the term ``Draw-down'' as ``losses experienced
by a pool or account over a specified period.'' Rule 4.10(l) defines
the term ``Worst peak-to-valley draw-down'' for a pool, account or
trading program. In the adopting release for the most recent revisions
to the Part 4 rules, the Commission noted that ``the draw-down figures
in a composite in a CTA Disclosure Documents are the worst experienced
by any one of the accounts included in the composite'' (emphasis
added).\61\ Several commenters expressed concern that composite draw-
down would not provide sufficient information as to how bad things
might have been for individual accounts. However, other commenters
noted that performance of a single account may be misleading due to
factors beyond the CTA's control, such as the client's determination of
when to open or close the account. Another commenter stated that the
purpose of draw-down disclosure in performance capsules is to highlight
the historical risk and volatility of a particular trading program, not
the general risk of futures trading, which is adequately addressed by
other rules.
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\61\ 60 FR 38146, 38163 (July 25, 1995).
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As noted in the Performance Proposal, a variety of factors,
including, but not limited to, differences due to trade execution,
fees, commissions, and the timing of opening or closing accounts, may
have an impact on the returns for individual accounts. The effect of
these factors must be considered by the CTA in the development of its
composite performance tables and any material differences among the
accounts in the composite must be discussed.\62\ The Commission
continues to believe that for a performance table that complies with
the Commission's rules on use of composites, disclosure of draw-down
information on a composite basis would not be misleading. The
Commission therefore confirms that presentation of monthly and peak-to-
valley draw-down information on a composite basis for performance
tables that comply with Rule 4.35(a)(3) will be acceptable. CTAs remain
subject to the requirement of Rule 4.34(o) to disclose all material
information to existing or prospective clients even if such information
is not specifically required by these regulations.
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\62\ Rule 4.35(a)(3) states:
(i) Unless such presentation would be misleading, the
performance of accounts traded pursuant to the same trading program
may be presented in composite form on a program-by-program basis. *
* *
(ii) Accounts that differ materially with respect to rate of
return may not be presented in the same composite.
(iii) The commodity trading advisor must discuss all material
differences among the accounts included in a composite.
---------------------------------------------------------------------------
C. Treatment of Additions and Withdrawals in Computing Rate of Return
The changes to the rate of return computation in the Performance
Proposal would have codified, in a streamlined fashion, several methods
of accounting for additions and withdrawals in computing rate of return
that were permitted by the Commission's 1991 Advisory.\63\ In addition
to the method currently required by Rule 4.35(a)(6)(i)(F), these
methods would include daily compounding and time-weighting of additions
and withdrawals. However, the Only Accounts Traded Method, which had
been permitted by the 1991 Advisory, was not included as an option CTAs
could choose prospectively due to concerns that it allows for accounts
to be excluded entirely from the rate of return calculation. One
commenter noted that CTAs can reach the same result as the proposed
daily compounded rate of return when the calculation is compounded
based on each sub-period in which an addition or withdrawal is made.
Two commenters requested that CTAs continue to be permitted to exclude
from the return calculation accounts that opened or closed intramonth,
to avoid material distortions that can occur. Although the Commission
adopted a core principle for partially funded account performance and
therefore did not implement the proposed changes to the rate of return
calculation, based on the comments received on the Performance
Proposal, the Commission believes it is appropriate to provide guidance
regarding the treatment of additions and withdrawals in computing rate
of return.
---------------------------------------------------------------------------
\63\ ``Adjustments for Additions and Withdrawals to Computation
of Rate of Return in Performance Records of Commodity Pool Operators
and Commodity Trading Advisors,'' 56 FR 8109 (Feb. 27, 1991). Rule
4.35(a)(6) states that performance information may be calculated as
specified therein ``or by a method otherwise approved by the
Commission.''
---------------------------------------------------------------------------
D. New Appendix B to Part 4
New appendix B to part 4 provides guidance concerning alternate
methods by which CPOs and CTAs may calculate the rate of return
information required by Rules 4.25(a)(7)(i)(F) and 4.35(a)(6)(i)(F).
Performance computed in accordance with any of the alternative methods
described in the 1991 Advisory for periods prior to the effective date
of these rule changes would not need to be revised. However, the 1991
Advisory is superseded prospectively by Appendix B adopted herein.
IV. Related Matters
A. Regulatory Flexibility Act
The Regulatory Flexibility Act (RFA) \64\ requires that agencies,
in proposing rules, consider the impact of those rules on small
businesses. The Commission has previously established certain
definitions of ``small entities'' to be used by the Commission in
evaluating the impact of its rules on such entities in accordance with
the RFA.\65\ With respect to CPOs, the Commission has previously
determined that a CPO is a small entity if it meets the criteria for
exemption from registration under current Rule 4.13(a)(2).\66\
Therefore, the requirements
[[Page 47230]]
of the RFA do not apply to CPOs who do not meet those criteria. With
respect to CTAs, the Commission has previously stated that it would
evaluate within the context of a particular rule proposal whether all
or some affected CTAs would be considered to be small entities and, if
so, the economic impact on them of the proposal.\67\ The Commission
believes that the rules it is adopting today will not place any
burdens, whether new or additional, on CPOs and CTAs who would be
affected hereunder. This is because these rules provide registration
relief for more CPOs and CTAs and, for CPOs and CTAs who are not
eligible for that relief, they reduce, clarify, streamline and simplify
existing requirements.
---------------------------------------------------------------------------
\64\ 5 U.S.C. 601 et seq.
\65\ 47 FR 18618 (April 30, 1982).
\66\ Id. at 18619-20.
\67\ Id. at 18620.
---------------------------------------------------------------------------
The Commission's definitions of small entities do not address the
persons and qualifying entities set forth in Rule 4.5 because, by the
very nature of the rule, the operations and activities of such persons
and entities generally are regulated by federal and state authorities
other than the Commission. Assuming, arguendo, that Rule 4.5 eligible
persons or qualifying entities would be small entities for purposes of
the RFA, the Commission believes that the amendment to Rule 4.5 it is
adopting today will not have a significant economic impact on them
because it will permit greater operational flexibility for persons
currently claiming relief under the rule, and it will make relief under
the rule available to more persons (each of whom will only have to file
a notice to be relieved from the requirement to register as a CPO and
from the disclosure, reporting and recordkeeping requirements
applicable to registered CPOs).
The Commission did not receive any comments on its analysis of the
application of the RFA to the instant Part 4 rule amendments.
B. Paperwork Reduction Act
This rulemaking contains information collection requirements. As
required by the Paperwork Reduction Act of 1995,\68\ the Commission has
submitted a copy of these amendments to part 4 to the Office of
Management and Budget for its review. The Commission did not receive
any public comments relative to its analysis of paperwork burdens
associated with this rulemaking.
---------------------------------------------------------------------------
\68\ 44 U.S.C. 3507(d).
---------------------------------------------------------------------------
C. Cost-Benefit Analysis
Section 15(a) of the Act, as amended by section 119 of the CFMA,
requires the Commission to consider the costs and benefits of its
action before issuing a new regulation under the Act. By its terms,
section 15(a) does not require the Commission to quantify the costs and
benefits of a new regulation or to determine whether the benefits of
the proposed regulation outweigh its costs. Rather, section 15(a)
simply requires the Commission to ``consider the costs and benefits''
of its action.
Section 15(a) further specifies that costs and benefits shall be
evaluated in light of five broad areas of market and public concern:
Protection of market participants and the public; efficiency,
competitiveness, and financial integrity of futures markets; price
discovery; sound risk management practices; and other public interest
considerations. Accordingly, the Commission could in its discretion
give greater weight to any one of the five enumerated areas and could
in its discretion determine that, notwithstanding its costs, a
particular rule was necessary or appropriate to protect the public
interest or to effectuate any of the provisions or to accomplish any of
the purposes of the Act.
These amendments to the part 4 rules are intended to facilitate
increased flexibility and consistency, and to rationalize application
of Commission regulations to entities subject to other regulatory
frameworks. The Commission is considering the costs and benefits of
these rules in light of the specific provisions of section 15(a) of the
Act:
1. Protection of market participants and the public. While certain
of the amendments are expected to lessen the burden imposed upon CPOs
and CTAs, any exclusion or exemption of persons from regulatory
requirements are based on such factors as financial sophistication of
pool participants and advisory clients or a limited level of trading in
the commodity interest markets. Accordingly, the amendments should have
no effect on the Commission's ability to protect market participants
and the public. Also, there should be no decrease in the protection of
market participants and the public where the amendments relax existing
requirements under the Act and the Commission's rules in order to be
consistent with existing requirements under the federal securities laws
and the SEC's rules.
2. Efficiency and competition. The amendments are expected to
benefit efficiency and competition by removing barriers to
participation in the commodity interest markets, resulting in greater
liquidity and market efficiency.
3. Financial integrity of futures markets and price discovery. The
amendments should have no effect, from the standpoint of imposing costs
or creating benefits, on the financial integrity or price discovery
function of the commodity futures and options markets.
4. Sound risk management practices. The proposed amendments should
increase the available range of risk management alternatives for Rule
4.5 eligible persons, as well as for CPOs and CTAs.
5. Other public interest considerations. The amendments also take
into account certain effects of legislative changes (e.g., in the case
of exemption for registered investment advisers) and the passage of
time (e.g., revising the contribution limit for the small commodity
pool exemption and permitting electronic delivery of pool Annual
Reports and Account Statements).
After considering these factors, the Commission has determined to
adopt the Part 4 rule amendments discussed above. The Commission did
not receive any comments relative to its analysis of the cost-benefit
provision.
D. Administrative Procedure Act
The Administrative Procedure Act provides that the required
publication of a substantive rule shall be made not less than 30 days
before its effective date, but provides an exception for ``a
substantive rule which grants or recognizes an exemption or relieves a
restriction.'' Each of the amendments to Rules 4.5, 4.7, 4.12, 4.13,
4.14, 4.21, 4.22 and 4.31 the Commission is publishing today ``grants
or recognizes an exemption or relieves a restriction.'' Accordingly,
the Commission has determined to make the amendments to Rules 4.5, 4.7,
4.12, 4.13, 4.14, 4.21, 4.22 and 4.31.
List of Subjects in 17 CFR Part 4
Advertising, Commodity pool operators, Commodity trading advisors,
Commodity futures, Commodity options, Customer protection, Reporting
and Recordkeeping.
0
For the reasons presented above, the Commission hereby amends Chapter I
of Title 17 of the Code of Federal Regulations as follows:
PART 4--COMMODITY POOL OPERATORS AND COMMODITY TRADING ADVISORS
0
1. The authority citation for part 4 continues to read as follows:
Authority: 7 U.S.C. 1a, 2, 6(c), 6b, 6c, , 6l, 6m, 6n, 6o, 12a
and 23.
0
2. Section 4.5 is amended by:
0
a. Removing paragraph (c)(2)(i);
0
b. Removing paragraph (c)(2)(ii);
[[Page 47231]]
0
c. Redesignating paragraph (c)(2)(iii) as paragraph (c)(2)(i) and
revising redesignated paragraph (c)(2)(i);
0
d. Redesignating paragraph (c)(2)(iv) as paragraph (c)(2)(ii);
0
e. Revising paragraph (f)(2); and
0
f. Adding new paragraph (g).
The revisions and addition read as follows:
Sec. 4.5 Exclusion from the definition of the term ``commodity pool
operator.''
* * * * *
(c) * * *
(2) * * *
(i) Will 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 the term ``commodity
pool operator'' under the Act and, therefore, who is not subject to
registration or regulation as a pool operator under the Act; Provided,
that such disclosure is made in accordance with the requirements of any
other federal or state regulatory authority to which the qualifying
entity is subject; and
* * * * *
(f) * * *
(2) Manually signed by a representative duly authorized to bind a
person specified in paragraph (a) of this section; and
* * * * *
(g) The filing of a notice of eligibility or the application of
``non-pool status'' under this section will not affect the ability of a
person to qualify for an exemption from registration as a commodity
pool operator under Sec. 4.13 in connection with the operation of
another trading vehicle that is not covered under this Sec. 4.5.
3. Section 4.7 is amended by revising paragraphs (a)(2)(vi),
(a)(3)(viii) and (d)(1)(vii), to read as follows:
Sec. 4.7 Exemption from certain part 4 requirements for commodity
pool operators with respect to offerings to qualified eligible persons
and for commodity trading advisors with respect to advising qualified
eligible persons.
(a) * * *
(2) * * *
(vi) A ``qualified purchaser'' as defined in section 2(a)(51)(A) of
the Investment Company Act of 1940 (the ``Investment Company Act'');
* * * * *
(3) * * *
(viii) A corporation, Massachusetts or similar business trust, or
partnership, limited liability company or similar business venture,
other than a pool, which has total assets in excess of $5,000,000, and
is not formed for the specific purpose of either participating in the
exempt pool or opening an exempt account;
* * * * *
(d) * * *
(1) * * *
(vii) Be manually signed by a representative duly authorized to
bind the commodity pool operator or commodity trading advisor;
* * * * *
0
4. Section 4.12 is amended by revising paragraph (b)(3)(vi) to read as
follows:
Sec. 4.12 Exemption from provisions of part 4.
* * * * *
(b) * * *
(3) * * *
(vi) Be manually signed by a representative duly authorized to bind
the pool operator; and
* * * * *
0
5. Section 4.13 is amended by:
0
a. Adding introductory text;
0
b. Removing the ``or'' at the end of paragraph (a)(1)(iv);
0
c. Revising paragraph (a)(2);
0
d. Adding new paragraphs (a)(3), (a)(4) and (a)(5);
0
e. Revising paragraph (b);
0
f. Redesignating paragraph (c) and paragraph (d) as paragraphs (d) and
(e) and revising newly redesignated paragraphs (d) and (e);
0
g. Adding new paragraph (c);
0
h. Adding new paragraph (f).
The additions and revisions read as follows:
Sec. 4.13 Exemption from registration as a commodity pool operator.
This section is organized as follows: Paragraph (a) of this section
specifies the criteria that must be met to qualify for exemption from
registration under this section; paragraph (b) of this section governs
the notice that must be filed to claim exemption from registration;
paragraph (c) of this section sets forth the continuing obligations of
a person who has claimed exemption under this section; paragraph (d) of
this section specifies information certain persons must provide if they
subsequently register; and paragraph (e) of this section specifies the
effect of registration on a person who has claimed an exemption from
registration under this section or who is eligible to claim an
exemption from registration hereunder.
(a) * * *
(2)(i) None of the pools operated by it has more than 15
participants at any time; and
(ii) The total gross capital contributions it receives for units of
participation in all of the pools it operates or that it intends to
operate do not in the aggregate exceed $400,000.
(iii) For the purpose of determining eligibility for exemption
under paragraph (a)(2) of this section, the person may exclude the
following participants and their contributions:
(A) The pool's operator, commodity trading advisor, and the
principals thereof;
(B) A child, sibling or parent of any of these participants;
(C) The spouse of any participant specified in paragraph
(a)(2)(iii)(A) or (B) of this section; and
(D) Any relative of a participant specified in paragraph
(a)(2)(iii)(A), (B) or (C) of this section, its spouse or a relative of
its spouse, who has the same principal residence as such participant;
(3) For each pool for which the person claims exemption from
registration under this paragraph (a)(3):
(i) Interests in the pool are exempt from registration under the
Securities Act of 1933, and such interests are offered and sold without
marketing to the public in the United States;
(ii) At all times, the pool meets one or the other of the following
tests with respect to its commodity interest positions, including
positions in security futures products, whether entered into for bona
fide hedging purposes or otherwise:
(A) The aggregate initial margin and premiums required to establish
such positions, determined at the time the most recent position was
established, will not exceed 5 percent 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; Provided,
That in the case of an option that is in-the-money at the time of
purchase, the in-the-money amount as defined in Sec. 190.01(x) of this
chapter may be excluded in computing such 5 percent; or
(B) The aggregate net notional value of such positions, determined
at the time the most recent position was established, does not exceed
100 percent 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. For the purpose of this paragraph:
(1) The term ``notional value'' shall be calculated for each such
futures position by multiplying the number of contracts by the size of
the contract, in contract units (taking into account any multiplier
specified in the contract), by the current market price per unit, and
for each such option position by multiplying the
[[Page 47232]]
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; and
(2) The person may net contracts with the same underlying commodity
across designated contract markets, registered derivatives transaction
execution facilities and foreign boards of trade; and
(iii) The person reasonably believes, at the time of investment
(or, in the case of an existing pool, at the time of conversion to a
pool meeting the criteria of paragraph (a)(3) of this section), that
each person who participates in the pool is:
(A) An ``accredited investor,'' as that term is defined in Sec.
230.501 of this title;
(B) A trust that is not an accredited investor but that was formed
by an accredited investor for the benefit of a family member;
(C) A ``knowledgeable employee,'' as that term is defined in Sec.
270.3c-5 of this title; or
(D) A ``qualified eligible person,'' as that term is defined in
Sec. 4.7(a)(2)(viii)(A) of this chapter; and
(iv) Participations in the pool are not marketed as or in a vehicle
for trading in the commodity futures or commodity options markets;
Provided, That nothing in paragraph (a)(3) of this section shall
prohibit the person from claiming an exemption under this section if it
additionally operates one or more pools for which it meets the criteria
of paragraph (a)(4) of this section; or
(4) For each pool for which the person claims exemption from
registration under this paragraph (a)(4):
(i) Interests in the pool are exempt from registration under the
Securities Act of 1933, and such interests are offered and sold without
marketing to the public in the United States;
(ii) The person reasonably believes, at the time of investment (or,
in the case of an existing pool, at the time of conversion to a pool
meeting the criteria of paragraph (a)(4) of this section), that:
(A) Each natural person participant (including such person's self-
directed employee benefit plan, if any), is a ``qualified eligible
person,'' as that term is defined in Sec. 4.7(a)(2); and
(B) Each non-natural person participant is a ``qualified eligible
person,'' as that term is defined in Sec. 4.7, or an ``accredited
investor,'' as that term is defined in Sec. 230.501(a)(1)-(3), (a)(7)
and (a)(8) of this title; Provided, That nothing in paragraph (a)(4) of
this section will prohibit the person from claiming an exemption under
this section if it additionally operates one or more pools that meet
the criteria of paragraph (a)(3) of this section.
(5)(i) Eligibility for exemption under this section is subject to
the person furnishing in writing to each prospective participant in the
pool:
(A) A statement that the person is exempt from registration with
the Commission as a commodity pool operator and that therefore, unlike
a registered commodity pool operator, it is not required to deliver a
Disclosure Document and a certified annual report to participants in
the pool; and
(B) A description of the criteria pursuant to which it qualifies
for such exemption from registration.
(ii) The person must make these disclosures by no later than the
time it delivers a subscription agreement for the pool to a prospective
participant in the pool.
(b)(1) Any person who desires to claim the relief from registration
provided by this section must file a notice of exemption from commodity
pool operator registration with the National Futures Association (ATTN:
Director of Compliance). The notice must:
(i) Provide the name, main business address, main business
telephone number, main facsimile number and main email address of the
person claiming the exemption and the name of the pool for which it is
claiming exemption;
(ii) Contain the section number pursuant to which the operator is
filing the notice (i.e., Sec. 4.13(a)(1), (a)(2), (a)(3), or (a)(4),
or both (a)(3) and (a)(4)) and represent that the pool will be operated
in accordance with the criteria of that paragraph or paragraphs; and
(iii) Be manually signed by a representative duly authorized to
bind the person.
(2) The person must file the notice by no later than the time it
delivers a subscription agreement for the pool to a prospective
participant in the pool; Provided, That where a person registered with
the Commission as a commodity pool operator intends to withdraw from
registration in order to claim exemption hereunder, the person must
notify its pool's participants in writing that it intends to withdraw
from registration and claim the exemption, and it must provide each
such participant with a right to redeem its interest in the pool prior
to the person filing a notice of exemption from registration.
(3) The notice will be effective upon filing, provided the notice
is materially complete.
(4) Each person who has filed a notice of exemption from
registration under this section must, in the event that any of the
information contained or representations made in the notice becomes
inaccurate or incomplete, file a supplemental notice with the National
Futures Association to that effect which, if applicable, includes such
amendments as may be necessary to render the notice accurate and
complete. This supplemental notice must be filed within 15 business
days after the pool operator becomes aware of the occurrence of such
event.
(c)(1) Each person who has filed a notice of exemption from
registration under this section must:
(i) Make and keep all books and records prepared in connection with
its activities as a pool operator for a period of five years from the
date of preparation;
(ii) Keep such books and records readily accessible during the
first two years of the five-year period. All such books and records
must be available for inspection upon the request of any representative
of the Commission, the United States Department of Justice, or any
other appropriate regulatory agency; and
(iii) Submit to such special calls as the Commission may make to
demonstrate eligibility for and compliance with the applicable criteria
for exemption under this section.
(2) In the event the person distributes an annual report to
participants in the pool for which it has filed the notice, the annual
report must be presented and computed in accordance with generally
accepted accounting principles consistently applied and, if certified
by an independent public accountant, so certified in accordance with
Sec. 1.16 of this chapter as applicable.
(3) Each person who has filed a notice of exemption from
registration pursuant to paragraph (a)(1) or (a)(2) of this section
must:
(i) Promptly furnish to each participant in the pool a copy of each
monthly statement for the pool that the pool operator received from a
futures commission merchant pursuant to Sec. 1.33 of this chapter; and
(ii) Clearly show on such statement, or on an accompanying
supplemental statement, the net profit or loss on all commodity
interests closed since the date of the previous statement.
(d) Each person who applies for registration as a commodity pool
operator subsequent to claiming relief under paragraph (a)(1) or (a)(2)
of this section must include with its application the financial
statements and other information required by Sec. 4.22(c)(1) through
(5) for each pool that it has operated as an operator
[[Page 47233]]
exempt from registration. That information must be presented and
computed in accordance with generally accepted accounting principles
consistently applied. If the person is granted registration as a
commodity pool operator, it must comply with the provisions of this
part with respect to each such pool.
(e)(1) Subject to the provisions of paragraph (e)(2) of this
section, if a person who is eligible for exemption from registration as
a commodity pool operator under this section nonetheless registers as a
commodity pool operator, the person must comply with the provisions of
this part with respect to each commodity pool identified on its
registration application or supplement thereto.
(2) If a person operates one or more commodity pools described in
paragraph (a)(3) or (a)(4) of this section, and one or more commodity
pools for which it must be, and is, registered as a commodity pool
operator, the person is exempt from the requirements applicable to a
registered commodity pool operator with respect to the pool or pools
described in paragraph (a)(3) or (a)(4) of this section; Provided, That
the person:
(i) Furnishes in writing to each prospective participant in a pool
described in paragraph (a)(3) or (a)(4) of this section that it
operates:
(A) A statement that it will operate the pool as if the person was
exempt from registration as a commodity pool operator;
(B) A description of the criteria pursuant to which it will so
operate the pool; and
(ii) Complies with paragraph (c) of this section.
(f) The filing of a notice of exemption from registration under
this section will not affect the ability of a person to qualify for
exclusion from the definition of the term ``commodity pool operator''
under Sec. 4.5 in connection with its operation of another trading
vehicle that is not covered under this Sec. 4.13.
0
6. Section 4.14 is amended by:
0
a. Adding introductory text;
0
b. Revising paragraph (a)(8);
0
c. Removing the period and adding a semi-colon followed by the word
``or'' at the end of paragraph (a)(9)(ii);
0
d. Adding new paragraph (a)(10); and
0
e. Revising paragraph (c).
The additions and revisions read as follows:
Sec. 4.14 Exemption from registration as a commodity trading advisor.
This section is organized as follows: Paragraph (a) of this section
specifies the criteria that must be met to qualify for exemption from
registration under this section, including the notice of exemption from
registration and continuing obligations of persons who have claimed
exemption under paragraph (a)(8) of this section; paragraph (b) of this
section concerns ``cash market transactions''; and paragraph (c) of
this section specifies the effect of registration on a person who has
claimed an exemption from registration under this section or who is
eligible to claim an exemption from registration hereunder.
(a) * * *
(8) It is registered as an investment adviser under the Investment
Advisers Act of 1940 or with the applicable securities regulatory
agency of any State, or it is exempt from such registration, or it is
excluded from the definition of the term ``investment adviser''
pursuant to the provisions of sections 202(a)(2) and 202(a)(11) of the
Investment Advisers Act of 1940, Provided, That:
(i) The person's commodity interest trading advice is directed
solely to, and for the sole use of, one or more of the following:
(A) ``Qualifying entities,'' as that term is defined in Sec.
4.5(b), for which a notice of eligibility has been filed;
(B) Collective investment vehicles that are excluded from the
definition of the term commodity ``pool'' under Sec. 4.5(a)(4); and
(C) Commodity pools that are organized and operated outside of the
United States, its territories or possessions, where:
(1) The commodity pool operator of each such pool has not so
organized and is not so operating the pool for the purpose of avoiding
commodity pool operator registration;
(2) With the exception of the pool's operator, advisor and their
principals, solely ``Non-United States persons,'' as that term is
defined in Sec. 4.7(a)(1)(iv), will contribute funds or other capital
to, and will 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 qualified eligible persons
represent in the aggregate less than 10 percent of the beneficial
interest of the pool;
(3) No person affiliated with the pool conducts 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
(4) No person affiliated with the pool conducts any marketing
activity from within the United States, its territories or possessions;
and
(D) A commodity pool operator who has claimed an exemption from
registration under Sec. 4.13(a)(3) or 4.13(a)(4), or, if registered as
a commodity pool operator, who may treat each pool it operates that
meets the criteria of Sec. 4.13(a)(3) or 4.13(a)(4) as if it were not
so registered;
(ii) The person:
(A) Provides commodity interest trading advice solely incidental to
its business of providing securities or other investment advice to
qualifying entities, collective investment vehicles and commodity pools
as described in paragraph (a)(8)(i) of this section; and
(B) Is not otherwise holding itself out as a commodity trading
advisor.
(iii)(A) A person who desires to claim the relief from registration
provided by this Sec. 4.14(a)(8) must file a notice of exemption from
commodity trading advisor registration with the National Futures
Association (ATTN: Director of Compliance). The notice must:
(1) Provide the name, main business address, main business
telephone number, main facsimile number and main email address of the
trading advisor claiming the exemption;
(2) Contain the section number pursuant to which the advisor is
filing the notice (i.e., Sec. 4.14(a)(8)(i) or (a)(8)(ii), or both
(a)(8)(i) and (a)(8)(ii)) and represent that it will provide commodity
interest advice to its clients in accordance with the criteria of that
paragraph or paragraphs; and
(3) Be manually signed by a representative duly authorized to bind
the person.
(B) The person must file the notice by 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; Provided,
That where the advisor is registered with the Commission as a commodity
trading advisor, it must notify its clients in writing that it intends
to withdraw from registration and claim the exemption and must provide
each such client with a right to terminate its advisory agreement prior
to the person filing a notice of exemption from registration.
(C) The notice will be effective upon filing, provided the notice
is materially complete.
(D) Each person who has filed a notice of registration exemption
under this section must, in the event that any of the information
contained or representations made in the notice becomes inaccurate or
incomplete, file a supplemental notice with the National Futures
Association to that effect which, if applicable, includes such
amendments as may be necessary to
[[Page 47234]]
render the notice accurate and complete. This supplemental notice must
be filed within 15 business days after the trading advisor becomes
aware of the occurrence of such event.
(iv) Each person who has filed a notice of registration exemption
under this Sec. 4.14(a)(8) must:
(A)(1) Make and keep all books and records prepared in connection
with its activities as a trading advisor, including all books and
records demonstrating eligibility for and compliance with the
applicable criteria for exemption under this section, for a period of
five years from the date of preparation; and
(2) Keep such books and records readily accessible during the first
two years of the five-year period. All such books and records must be
available for inspection upon the request of any representative of the
Commission, the United States Department of Justice, or any other
appropriate regulatory agency; and
(B) Submit to such special calls as the Commission may make to
demonstrate eligibility for and compliance with the applicable criteria
for exemption under this section;
* * * * *
(10) If, as provided for in section 4m(1) of the Act, during the
course of the preceding 12 months, it has not furnished commodity
trading advice to more than 15 persons and it does not hold itself out
generally to the public as a commodity trading advisor.
(i) For the purpose of paragraph (a)(10) of this section, the
following are deemed a single person:
(A) A natural person, and:
(1) Any minor child of the natural person;
(2) Any relative, spouse, or relative of the spouse of the natural
person who has the same principal residence;
(3) All accounts of which the natural person and/or the persons
referred to in paragraph (a)(10)(i)(A) of this section are the only
primary beneficiaries; and
(4) All trusts of which the natural person and/or the persons
referred to in paragraph (a)(10)(i)(A) of this section are the only
primary beneficiaries;
(B)(1) A corporation, general partnership, limited partnership,
limited liability company, trust (other than a trust referred to in
paragraph (a)(10)(i)(A)(4) of this section), or other legal
organization (any of which are referred to hereinafter as a ``legal
organization'') that receives commodity interest trading advice based
on its investment objectives rather than the individual investment
objectives of its shareholders, partners, limited partners, members, or
beneficiaries (any of which are referred to hereinafter as an
``owner''); and
(2) Two or more legal organizations referred to in paragraph
(a)(10)(i)(B)(1) of this section that have identical owners.
(ii) Special Rules. For the purpose of paragraph (a)(10) of this
section:
(A) An owner must be counted in its own capacity as a person if the
commodity trading advisor provides advisory services to the owner
separate and apart from the advisory services provided to the legal
organization; Provided, That the determination that an owner is a
client will not affect the applicability of paragraph (a)(10) of this
section with regard to any other owner;
(B)(1) A general partner of a limited partnership, or other person
acting as a commodity trading advisor to the partnership, may count the
limited partnership as one person; and
(2) A manager or managing member of a limited liability company, or
any other person acting as a commodity trading advisor to the company,
may count the limited liability company as one person.
(C) A commodity trading advisor that has its principal office and
place of business outside of the United States, its territories or
possessions must count only clients that are residents of the United
States, its territories and possessions; a commodity trading advisor
that has its principal office and place of business in the United
States or in any territory or possession thereof must count all
clients.
(iii) Holding Out. Any commodity trading advisor relying on
paragraph (a)(10) of this section shall not be deemed to be holding
itself out generally to the public as a commodity trading advisor,
within the meaning of section 4m(1) of the Act, solely because it
participates in a non-public offering of interests in a collective
investment vehicle under the Securities Act of 1933.
* * * * *
(c)(1) Subject to the provisions of paragraph (c)(2) of this
section, if a person who is eligible for exemption from registration as
a commodity trading advisor under this section nonetheless registers as
a commodity trading advisor, the person must comply with the provisions
of this part with respect to those clients for which it could have
claimed an exemption from registration hereunder.
(2) If a person provides commodity interest trading advice to a
client described in paragraph (a) of this section and to a client for
which it must be, and is, registered as a commodity trading advisor,
the person is exempt from the requirements applicable to a registered
commodity trading advisor with respect to the clients so described;
Provided, That the person furnishes in writing to each prospective
client described in paragraph (a) of this section a statement that it
will provide commodity interest trading advice to the client as if it
was exempt from registration as a commodity trading advisor.
0
7. Section 4.21 is amended by revising paragraph (a) to read as
follows:
Sec. 4.21 Required delivery of pool Disclosure Document.
(a)(1) Subject to the provisions of paragraph (a)(2) of this
section, each commodity pool operator registered or required to be
registered under the Act must deliver or cause to be delivered to a
prospective participant in a pool that it operates or intends to
operate a Disclosure Document for the pool prepared in accordance with
Sec. Sec. 4.24 and 4.25 by no later than the time it delivers to the
prospective participant a subscription agreement for the pool;
Provided, That any information distributed in advance of the delivery
of the Disclosure Document to a prospective participant is consistent
with or amended by the information contained in the Disclosure Document
and with the obligations of the commodity pool operator under the Act,
the Commission's regulations issued thereunder, and the laws of any
other applicable federal or state authority; Provided, further, That in
the event such previously distributed information is amended by the
Disclosure Document in any material respect, the prospective
participant must be in receipt of the Disclosure Document at least 48
hours prior to its subscription being accepted by the pool operator.
(2) For the purpose of the Disclosure Document delivery
requirement, including any offering memorandum delivered pursuant to
Sec. 4.7(b)(1) or 4.12(b)(2)(i), the term ``prospective pool
participant'' does not include a commodity pool operated by a pool
operator that is the same as, or that controls, is controlled by, or is
under common control with, the pool operator of the offered pool.
* * * * *
0
8. Section 4.22 is amended by:
0
a. Revising paragraph (a) introductory text;
0
b. Adding new paragraph (a)(4),
0
c. Revising paragraph (c) introductory text,
0
d. Adding a new paragraph (c)(6),
0
e. Revising paragraph (h)(1),
0
f. Revising paragraph (h)(3),
[[Page 47235]]
0
g. Adding new paragraph (i) and
0
h. Adding new paragraph (j).
The revisions and additions read as follows:
Sec. 4.22 Reporting to pool participants.
(a) Except as provided in paragraph (a)(4) of this section, each
commodity pool operator registered or required to be registered under
the Act must periodically distribute to each participant in each pool
that it operates, within 30 calendar days after the last date of the
reporting period prescribed in paragraph (b) of this section, an
Account Statement, which shall be presented in the form of a Statement
of Income (Loss) and a Statement of Changes in Net Asset Value, for the
prescribed period. These financial statements must be presented and
computed in accordance with generally accepted accounting principles
consistently applied. The Account Statement must be signed in
accordance with paragraph (h) of this section.
* * * * *
(4) For the purpose of the Account Statement delivery requirement,
including any Account Statement distributed pursuant to Sec. 4.7(b)(2)
or 4.12(b)(2)(ii), the term ``participant'' does not include a
commodity pool operated by a pool operator that is the same as, or that
controls, is controlled by, or is under common control with, the pool
operator of a pool in which the commodity pool has invested.
* * * * *
(c) Except as provided in paragraph (c)(6) of this section, each
commodity pool operator registered or required to be registered under
the Act must distribute an Annual Report to each participant in each
pool that it operates, and must file a copy of the Report with the
National Futures Association, within 90 calendar days after the end on
the pool's fiscal year or the permanent cessation of trading, whichever
is earlier, but in no event longer than 90 days after funds are
returned to pool participants; Provided, however, That if during any
calendar year the commodity pool operator did not operate a commodity
pool, the pool operator must so notify the National Futures Association
within 30 calendar days after the end of such calendar year. The Annual
Report must be signed pursuant to paragraph (h) of this section and
must contain the following:
* * * * *
(6) For the purpose of the Annual Report distribution requirement,
including any annual report distributed pursuant to Sec. 4.7(b)(3) or
4.12(b)(2)(iii), the term ``participant'' does not include a commodity
pool operated by a pool operator that is the same as, or that controls,
is controlled by, or is under common control with, the pool operator of
a pool in which the commodity pool has invested; Provided, That the
Annual Report of such investing pool contain financial statements that
include such information as the Commission may specify concerning the
operations of the pool in which the commodity pool has invested.
* * * * *
(h)(1) Each Account Statement and Annual Report, including an
Account Statement or Annual Report provided pursuant to Sec. 4.7(b) or
4.12(b), must contain an oath or affirmation that, to the best of the
knowledge and belief of the individual making the oath or affirmation,
the information contained in the document is accurate and complete;
Provided, however, That it shall be unlawful for the individual to make
such oath or affirmation if the individual knows or should know that
any of the information in the document is not accurate and complete.
* * * * *
(3) Subject to the provisions of paragraph (j) of this section, the
oath or affirmation must be manually signed by a representative duly
authorized to bind the pool operator.
(i) The Account Statement or Annual Report may be distributed to a
pool participant by means of electronic media if the participant so
consents; Provided, That prior to the transmission of any Account
Statement or Annual Report by means of electronic media, a commodity
pool operator must disclose to the participant that it intends to
distribute electronically the Account Statement or Annual Report or
both documents, as the case may be, absent objection from the
participant, which objection, if any, the participant must make no
later than 10 business days following its receipt of the disclosure.
(j) An Account Statement or Annual Report may contain a facsimile
signature, Provided, That:
(A) The CPO maintains in accordance with Sec. 4.23 the Account
Statement or Annual Report containing the manual signature from which
the facsimile signature was made; and
(B) The Annual Report the CPO files with a registered futures
association is manually signed.
(ii) For each pool for which the CPO distributes an Account
Statement or Annual Report by means of electronic media, the CPO must
make and keep in accordance with Sec. 4.23 a manually signed copy of
the Statement.
0
9. Section 4.31 is amended by revising paragraph (a) to read as
follows:
Sec. 4.31 Required delivery of Disclosure Document to prospective
clients.
(a) Each commodity trading advisor registered or required to be
registered under the Act must deliver or cause to be delivered to a
prospective client a Disclosure Document containing the information set
forth in Sec. Sec. 4.34 and 4.35 for the trading program pursuant to
which the trading advisor seeks to direct the client's commodity
interest account or to direct the client's commodity interest trading
by means of a systematic program that recommends specific transactions
by no later than the time the trading advisor delivers to the
prospective client an advisory agreement to direct or guide the
client's account; Provided, That any information distributed in advance
of the delivery of the Disclosure Document to a prospective client is
consistent with or amended by the information contained in the
Disclosure Document and with the obligations of the commodity trading
advisor under the Act, the Commission's regulations issued thereunder,
and the laws of any other applicable federal or state authority;
Provided further, That in the event such previously distributed
information is amended by the Disclosure Document in any material
respect, the prospective participant must be in receipt of the
Disclosure Document at least 48 hours prior to the advisory agreement
being accepted by the trading advisor.
* * * * *
0
10. Section 4.35 is amended by revising paragraph (a)(1)(viii) to read
as follows:
Sec. 4.35 Performance disclosures.
(a) General principles.--(1) * * *
(viii) In the case of the offered trading program:
(A)(1) The number of accounts traded pursuant to the offered
trading program that were opened and closed during the period specified
in Sec. 4.35(a)(5) with a positive net lifetime rate of return as of
the date the account was closed; and
(2) A measure of the variability of returns for accounts that were
both opened and closed during the period specified in Sec. 4.35(a)(5)
and closed with positive net lifetime rates of return; and
(B)(1) The number of accounts traded pursuant to the offered
trading program that were opened and closed during the period specified
in Sec. 4.35(a)(5) with negative net lifetime rates of return as of
the date the account was closed; and
(2) A measure of the variability of returns for accounts that were
both opened and closed during the period
[[Page 47236]]
specified in Sec. 4.35(a)(5) and closed with negative net lifetime
rates of return.
(C) The measure of variability required by Sec. Sec.
4.35(a)(1)(viii)(A)(2) and (B)(2) may be provided as a range of both
positive and negative net lifetime returns, or by any other form of
disclosure that meets the objective of disclosure of the variability of
returns experienced by clients in the trading program whose accounts
were opened and closed during the period specified in Sec. 4.35(a)(5).
The net lifetime rate of return shall be calculated as the compounded
product of the monthly rates of return for each month the account is
open.
* * * * *
0
11. Appendices A and B are added to part 4 to read as follows:
Appendix A to Part 4--Guidance on the Application of Rule 4.13(a)(3) in
the Fund-of-Funds Context
The following provides guidance on the application of the
trading limits of Rule 4.13(a)(3)(ii) to commodity pool operators
(CPOs) who operate ``fund-of-funds.'' For the purpose of this
Appendix A, it is presumed that the CPO can comply with all of the
other requirements of Rule 4.13(a)(3). It also is presumed that
where the investor fund CPO is relying on its own computations, the
investor fund is participating in each investee fund that trades
commodity interests as a passive investor, with limited liability
(e.g., as a limited partner of a limited partnership or a non-
managing member of a limited liability company). Fund-of-funds CPOs
who seek to claim exemption from registration under Rule 4.13(a)(1),
(a)(2) or (a)(4) may do so without regard to the trading engaged in
by an investee fund, because none of the registration exemptions set
forth in those rules concerns limits on or levels of commodity
interest trading. Persons whose fact situations do not fit any of
the scenarios below should contact Commission staff to discuss the
applicability of the registration exemption in Rule 4.13(a)(3) to
their particular situations.
1. Situation: An investor fund CPO allocates the fund's assets
to one or more investee funds, none of which meets the trading
limits of Rule 4.13(a)(3) and each of which is operated by a
registered CPO. It does not allocate any of the investor fund's
assets directly to commodity interest trading.
Application: The investor fund CPO may claim relief under Rule
4.13(a)(3) provided the investor fund itself meets the trading
limits of Rule 4.13(a)(3).
2. Situation: An investor fund CPO allocates the fund's assets
to one or more investee funds, each having a CPO who is either: (1)
itself claiming exemption from CPO registration under Rule
4.13(a)(3); or (2) a registered CPO that is complying with the
trading restrictions of Rule 4.13(a)(3). It does not allocate any of
the investor fund's assets directly to commodity interest trading.
Application: The investor fund CPO fund may rely upon the
representations of the investee fund CPOs that they are complying
with the trading limits of Rule 4.13(a)(3).
3. Situation: An investor fund CPO allocates the fund's assets
to investee funds, each of which operates under a percentage
restriction on the amount of margin or option premiums that may be
used to establish its commodity interest positions (whether pursuant
to Rule 4.12(b), Rule 4.13(a)(3)(i)(A) or otherwise), by, e.g.,
contractual agreement. It does not allocate any of the investor
fund's assets directly to commodity interest trading.
Application: The CPO of the investor fund may multiply the
percentage restriction applicable to each investee fund by the
percentage of the investor fund's allocation of assets to that
investee fund to determine whether the CPO is operating the investor
fund in compliance with Rule 4.13(a)(3)(i)(A).
4. Situation: An investor fund CPO allocates the fund's assets
to one or more investee funds, and it has actual knowledge of the
trading limits and commodity interest positions of the investee
funds, e.g., where the CPO or one or more affiliates of the CPO
operate the investee funds. (For this purpose, an ``affiliate'' is a
person who controls, who is controlled by, or who is under common
control with, the CPO.) It does not allocate any of the investor
fund's assets directly to commodity interest trading.
Application: The investor fund CPO may aggregate commodity
interest positions across investee funds to determine compliance
with the trading restrictions of Rule 4.13(a)(3). For this purpose,
the aggregate assets of the investee funds would be compared to the
aggregate of their commodity interest positions (as to margin or as
to net notional value). The investor fund CPO should use the results
of this computation to determine its compliance with the trading
limits of Rule 4.13(a)(3).
5. Situation: An investor fund CPO allocates no more than 50
percent of the fund's assets to investee funds that trade commodity
interests (without regard to the level of commodity interest trading
engaged in by those investee pools). It does not allocate any of the
investor fund's assets directly to commodity interest trading.
Application: The investor fund CPO may claim relief under Rule
4.13(a)(3).
6. Situation: An investor fund CPO allocates the fund's assets
to both investee funds and direct trading of commodity interests.
Application: The investor fund CPO must treat the amount of
investor fund assets committed to such direct trading as a separate
pool for purposes of determining compliance with Rule 4.13(a)(3)(i),
such that the commodity interest trading of that pool must meet the
criteria of Rule 4.13(a)(3)(i) independently of the portion of
investor fund assets allocated to investee funds.
Appendix B to Part 4--Adjustments for Additions and Withdrawals in the
Computation of Rate of Return
This appendix provides guidance concerning alternate methods by
which commodity pool operators and commodity trading advisors may
calculate the rate of return information required by Rules
4.25(a)(7)(i)(F) and 4.35(a)(6)(i)(F). The methods described herein
are illustrative of calculation methods the Commission has reviewed
and determined may be appropriate to address potential material
distortions in the computation of rate of return due to additions
and withdrawals that occur during a performance reporting period. A
commodity pool operator or commodity trading advisor may present to
the Commission proposals regarding any alternative method of
addressing the effect of additions and withdrawals on the rate of
return computation, including documentation supporting the rationale
for use of that alternate method.
1. Compounded Rate of Return Method
Rate of return for a period may be calculated by computing the
net performance divided by the beginning net asset value for each
trading day in the period and compounding each daily rate of return
to determine the rate of return for the period. If daily compounding
is not practicable, the rate of return may be compounded on the
basis of each sub-period within which an addition or withdrawal
occurs during a month. For example:
----------------------------------------------------------------------------------------------------------------
Account value Change in value
----------------------------------------------------------------------------------------------------------------
Start of month............................... $10,000 +10% ($1,000 profit).
End of 1st acct. period...................... 11,000 $4,000 addition.
Start of 2nd acct. period.................... 15,000 -20% ($3,000 loss).
End of 2nd acct. period...................... 12,000 $2,000 withdrawal.
Start of 3rd acct. period.................... 10,000 +25% ($2,500 profit).
End of month................................. 12,500
----------------------------------------------------------------------------------------------------------------
Compounded ROR = [(1 + .1)(1 - .2)(1 + .25)] &- 1 = 10%.
[[Page 47237]]
2. Time-weighted method
Time-weighting allows for adjustment to the denominator of the
rate of return calculation for additions and withdrawals, weighted
for the amount of time such funds were available during the period.
Several methods exist for time-weighting, all of which will have the
same arithmetic result. These methods include: dividing the net
performance by the average weighted account sizes for the month;
dividing the net performance by the arithmetic mean of the account
sizes for each trading day during the period; and taking the number
of days funds were available for trading divided by the total number
of days in the period.
Issued in Washington, DC on August 1, 2003 by the Commission.
Jean A. Webb,
Secretary of the Commission.
[FR Doc. 03-20094 Filed 8-7-03; 8:45 am]
BILLING CODE 6351-01-P