[authors: Scott H. Moss, Esq., George Danenhauer, Esq. and Cole Beaubouef, Esq.]
On August 14, 2012, the Commodity Futures Trading Commission’s ("CFTC") Division of Swap Dealer and Intermediary Oversight ("DSIO") provided written responses to a number of frequently asked questions ("FAQs") relating to the CFTC's February 2012 final rules addressing compliance obligations for Commodity Pool Operators ("CPOs") and Commodity Trading Advisors ("CTAs"). The matters addressed by the FAQs include: compliance dates, wholly owned subsidiaries, trading limits, and the process for transitioning from an exemption from registration under CFTC regulation 4.13(a)(4) to either registering as a CPO or claiming another exemption from registration.
A brief overview of certain responses set forth in the FAQs is provided below, along with additional commentary on their implications. While certain of the FAQs address treatment of controlled foreign corporations and registered investment companies, as well as regulation 4.5, this alert focuses on those FAQs that are of particular interest to sponsors/managers of private commodity pools.
Who Is the Commodity Pool Operator?
Consistent with previous CFTC guidance, the FAQs provide that a general partner, managing member, or board of directors of a commodity pool may delegate its rights and responsibilities with respect to the commodity pool to a registered CPO, subject to satisfaction of certain stated conditions, including such persons remaining jointly and severally liable with respect to violations of the Commodity Exchange Act. This guidance may provide managers with administrative relief in instances where the manager is affiliated with more than one entity that may be considered a CPO (thereby avoiding a duplicative and burdensome administrative process with respect to CPO registrations for numerous affiliated entities).
Wholly Owned Subsidiaries
The FAQs provide that a wholly owned trading subsidiary of a commodity pool that is operated by a parent registered as a CPO will be deemed to be, and regulated as, a commodity pool. Moreover, the FAQs provide that any such wholly owned subsidiary formed for the purpose of trading in derivatives will be deemed to be a commodity pool. This guidance is important for those CPOs that routinely trade through wholly owned special purpose vehicles and are required to complete and file Form CPO-PQR. Specifically, these CPOs may be required to provide details on such form with respect to these wholly owned subsidiaries.
Forms CPO-PQR and CTA-PR
The FAQs address certain instances where CPOs claiming an exemption under the regulation 4.13(a)(3) “de minimis” exemption exceed the trading thresholds established by that exemption due to entering into a swap or other commodity interest position prior to entering into other non-commodity interest positions. Consequently, the FAQs provide that such CPOs will have a “reasonable time to comply” with the required trading thresholds established by regulation 4.13(a)(3). The FAQs do not, however, provide guidance on trade errors that cause a violation of the de minimis thresholds or what constitutes a “reasonable time to comply” with the regulation. Therefore, CPOs may still face uncertainty in determining if they may continue to rely upon regulation 4.13(a)(3) in certain instances, such as a one-time breach of the de minimis thresholds during an advised pool’s trading life. The FAQs also do not address the timing of registration if and when the 4.13(a)(3) limits are breached by a pool relying upon 4.13(a)(3).
The FAQs provide that entities that claimed relief under regulation 4.13(a)(4) before April 24, 2012 must register or claim an exemption under regulation 4.13(a)(3) by December 31, 2012.
The FAQs provide that swaps will be included for purposes of calculating "commodity interest" exposure after October 12, 2012.
The FAQs provide that CPOs are not required to file 2012 annual reports for pools that have their exemption under regulation 4.13(a)(4) withdrawn on January 1, 2013. CPOs coming into registration will be required to file their first annual report for such pools for fiscal year 2013. The FAQs do not, however, provide any similar guidance with respect to any CTA obligations for such pools.
The FAQs provide that CPOs that have claimed exemption under regulation 4.13 no action relief will be required to refile their exemption to designate that the exempt pools are operating under regulation 4.13(a)(3).
The FAQs provide that a CPO is required to be in compliance with the trading thresholds established by regulation 4.13(a)(3) only at the time a commodity interest position is established. A CPO is not otherwise required to reconfigure its portfolio to comply with such thresholds.
The FAQs provide that the "liquidation value of the pool's portfolio" referenced in regulation 4.13(a)(3) should be read to include cash as well as the commodity pool's commodity interest positions.
The FAQs provide that commodity options with the same underlying instrument can be netted across designated contract markets and foreign boards of trade.
The FAQs provide that the notional value for cleared and uncleared swaps is to be determined by reference to the amount reported by the reporting counterparty under Part 45 of the CFTC's regulations.
A CPO may avail itself of regulation 4.7 (which provides an exemption from certain regulatory disclosure, recordkeeping, and reporting requirements with respect to registered CPOs and registered CTAs whose pool participants/clients are limited to “qualified eligible persons,” ("QEPs")) even though interests were offered and sold prior to the filing of the notice required under regulation 4.7(d). Similarly, a CTA may claim relief under regulation 4.7(c) even though advice was provided prior to the required notice filing. In each case, such offers, sales and advice must have been pursuant to another then-effective exemption from registration.
The FAQs provide that a CPO operating one or more pools pursuant to the 4.13(a)(4) exemption is not required to ensure that all current participants in such pools are QEPs to claim a regulation 4.7 exemption for such pools. Rather, any such CPO will be required only to ensure that new participants in such pools are QEPs. This clarification is helpful to those managers that currently operate pools pursuant to the exemption from registration under the Investment Company Act provided by Section 3(c)(7)1 of such Act, since participants in such pools are generally considered QEPs (and these managers typically relied upon the 4.13(a)(4) exemption for such pools). Importantly, however, the FAQs do not address whether CPOs operating one or more pools pursuant to the exemption from registration under the Investment Company Act provided by Section 3(c)(1)2 of such Act will be required to ensure that all current participants in such pools are QEPs for the purpose of claiming a regulation 4.7 exemption, or whether such managers may avail themselves of similar grandfathering relief. Absent relief to the contrary, these managers must ensure that all participants in their 3(c)(1) pools are QEPs prior to claiming a regulation 4.7 exemption for such pools.
The FAQs provide guidance on the proper steps to be taken with the NFA and CFTC to transition to an exemption under regulation 4.7 effective January 1, 2013. No grace period is expected.
Sponsors/managers of private commodity pools (which include many hedge funds) should begin the process of determining whether a currently claimed or anticipated exemption from registration remains viable. We note, in particular, that managers to private pools currently relying on the exemption provided by regulation 4.13(a)(4) should begin promptly the process of preparing for registration (to the extent required) and applicable reporting (and other) obligations. We advise our clients to begin this process well before the December 2012 deadline in order to effectively manage any unexpected delays. As noted in this alert, the FAQs provide some guidance and clarification on certain items that may assist managers in these endeavors. However, as discussed above, the FAQs do not fully clarify certain matters relating to CPO and CTA registration and applicable exemptions therefrom.
In particular, managers that are required to register, or that choose to register, as CPOs and claim the regulation 4.7 exemption for one or more pools that currently operate as 3(c)(1) funds may wish to ascertain the extent to which current participants in those pools would qualify as QEPs (to the extent not already known). Also, managers that operate funds-of-funds should remain aware that the CFTC may provide additional guidance on determining eligibility for the 4.13(a)(3) exemption in the near future, and remain vigilant in understanding how a change in status or trading of its underlying portfolio managers affects its status. Finally, we advise our clients to begin reviewing Forms CPO-PQR and CTA-PR (particularly where sponsored commodity pools are not otherwise reported on Form PF, including wholly owned subsidiaries) and submit comments to the CFTC relating to any areas of concern raised by such forms.
Lowenstein Sandler’s Investment Management Group is available to assist our clients with navigating the exemptions, exclusions, and administrative requirements discussed in the FAQs. We will also provide you with any updated information relating to these matters to the extent that the CFTC or other regulatory bodies amend or supplement the FAQs.
Our previous client alerts summarizing and analyzing the new CPO/CTA registration and exemption landscape, as well as the new swaps definitions are available here and here, respectively.
The text of the FAQs may be found here. The text of the final rules to which the FAQs relate may be found here.
Please contact any of the attorneys listed, or any other member of Lowenstein Sandler’s Investment Management Group, for further information on the matters discussed herein.
1Section 3(c)(7) of the Investment Company Act provides an exemption from registration under that Act for private funds (including commodity pools), the interests of which are owned solely by “qualified purchasers” and certain “knowledgeable employees,” as each term is described under that Act.
2Section 3(c)(1) of the Investment Company Act provides an exemption from registration under that Act for private funds (including commodity pools), the interests of which are beneficially owned by not more than 100 investors.