[authors: Heather Cruz, Lawrence D. Frishman, Michael K. Hoffman, Anastasia T. Rockas, Mark D. Young, Maureen A. Donley, Daniel S. Konar II]
On November 29, 2012, the Commodity Futures Trading Commission (CFTC) Division of Swap Dealer and Intermediary Oversight (Division) issued temporary no-action relief from commodity pool operator (CPO) registration to operators of funds-of-funds1 that cannot reasonably know whether indirect exposure to commodity interests would prevent them from satisfying the trading restrictions in CFTC Rule 4.5 or 4.13(a)(3), as applicable.2 In order to claim this no-action relief, an eligible operator must submit a notice to the Division.
Fund-of-Funds No-Action Relief
Last February, the CFTC amended the exclusion from the definition of CPO under CFTC Rule 4.5 as it applies to registered investment companies (RICs) and repealed an exemption from CPO registration under CFTC Rule 4.13(a)(4) that was widely relied upon by CPOs of private funds.3 The amended exclusion under Rule 4.5 and a surviving exemption under Rule 4.13(a)(3) each contain de minimis restrictions on the amount of commodity interest activity in which a RIC or private fund, respectively, can engage. As part of the same rulemaking, Appendix A to Part 4 of the CFTC’s rules, which provided guidance on how to apply the de minimis trading restrictions in Rule 4.13(a)(3) to funds-of-funds, was deleted. In August, the Division instructed CPOs of funds-of-funds to continue relying on the guidance in former Appendix A for purposes of determining compliance with Rule 4.13(a)(3), but it was silent on whether the guidance in former Appendix A also could be applied by RICs relying on the amended exclusion in Rule 4.5.4
Given the expansion of the CFTC’s jurisdiction to include swaps and the changes to the exclusions and exemptions available under Part 4 (many of which will take effect December 31, 2012), many funds-of-funds have questioned whether the guidance in Appendix A could be interpreted to apply to their specific facts (which are, in general, more complicated than any of the six enumerated situations in former Appendix A) and, if so, whether they would be able to collect the information necessary to determine compliance with the guidance in former Appendix A in advance of the December 31st deadline for CPO registration. These questions prompted the Investment Adviser Association and the Managed Funds Association, among others, to urge the Commission to adopt new guidance to replace former Appendix A and to provide a delayed compliance date for CPO registration for operators of funds-of-funds.
The no-action letter responded to the latter of these requests by providing operators of funds-of-funds with relief from CPO registration until the later of June 30, 2013, or six months after the Division issues revised guidance on the application of the trading restrictions in Rule 4.5 and 4.13(a)(3) to funds-of-funds. Specifically, the Division has stated that it will not recommend that the CFTC take enforcement action against the operator of a fund-of-funds if its fails to register as such, provided that:
(a) The amount of direct commodity interest trading by the fund-of-funds does not exceed the trading restrictions in Rule 4.5 or 4.13(a)(3), as applicable;
(b) The operator does not know and could not reasonably have known that the fund-of-funds’ indirect exposure to commodity interests exceeds the trading restrictions in Rule 4.5 or 4.13(a)(3), as applicable, “either calculated directly or through [the application of the guidance in former] Appendix A;”5 and
(c) The fund-of-funds is either a RIC or is compliant with the provisions of Rule 4.13(a)(3)(i), (iii) and (iv).
Procedure to Claim No-Action Relief
The relief provided in the no-action letter is not self-executing. Operators of funds-of-funds are required to file a claim with the Division via email, and, as long as it is materially complete, such claim will become effective upon filing. The claim must:
(a) State the name, main business address, and main business telephone number of the operator;
(b) State the capacity of the operator (i.e., acting as a CPO or operator) and the name of each fund-of-funds with respect to which the claim is being filed;
(c) Be signed by the operator; and
(d) Be filed with the Division via email at email@example.com with the subject line “Fund-of-Funds” prior to December 31, 2012.
The Division noted in the no-action letter that the relief will not excuse the operator from compliance with any other applicable requirements set forth in the Commodity Exchange Act or in CFTC regulations (such as the antifraud provisions).
1The no-action letter defines a “fund-of-funds” as a vehicle that holds interests in separately managed vehicles. See CFTC Staff Letter No. 12-38, available here.
3 For a more complete discussion of the changes resulting from the CFTC’s February rulemaking, please see our client alert of February 22, 2012, “CFTC Curtails Commodity Pool Operator Exemptions for Registered Investment Companies and Private Funds and Commodity Trading Exemptions for Their Advisers.”
4 The guidance was made available in the Division’s FAQs of August 14, 2012, “CFTC’s Division of Swap Dealer and Intermediary Oversight Responds to Questions Regarding Recent Amendments to Compliance Obligations for Commodity Pool Operators and Commodity Trading Advisors.”
5 The Division does not provide guidance on what facts would satisfy the reasonableness standard for the absence of knowledge about indirect exposure to commodity interests. As a practical matter, we are aware that certain funds-of-funds have been distributing surveys designed to measure the amount of an investee fund’s commodity interest activity. It remains to be seen whether, in most cases, the responses to these surveys produce information sufficient to form a reasonable basis for measuring a fund-of-funds, indirect exposure to commodity interests for purposes of Rule 4.5 or 4.13(a)(3).