(www.hedgefundlawblog.com)

Article by Bart Mallon (www.forexregistration.com)

Thursday’s installment of the Forex Disclosure Documents Overview focused on much of the routine disclosure items which a manager must provide in the disclosure document.  Today we focus mainly on the performance reporting side of the disclosure documents.

Performance Reporting

Overview

Basically the performance reporting aspect of the disclosure documents requires the manager to provide very detailed summaries of the performance of the offered program (either managed account or fund), the manager’s other trading programs, and potentially the performance of key employees.  Any other performance which is material will also need to be reported.  These performance disclosures will usually take up a few pages of the disclosure document and will face the greatest scrutiny by the NFA reviewers.

If the has been no prior performance history of the offered program or by the manager, then there are specific disclaimers which will need to be provided.  One of the outstanding questions which we assume will be answered in the coming weeks and months is to what extent a forex manager will need to provide performance reporting from other programs which do not relate to forex (for example, securities or managed futures).  Because the characteristics of other investment instruments often differ greatly from off-exchange foreign currency transactions, I am not sure it would be helpful to require such information to be included in the forex disclosure document.

The Performance Capsule and Monthly Rates of Return

The two main performance disclosure items are (1) the capsule and (2) the monthly rates of return.  Below is a sample performance capsule for a fictional Forex CPO.  We expect that the regulations will require a performance capsule to look substantially similar to the one we’ve presented below.

SAMPLE FOREX CPO PERFORMANCE CAPSULE

Name of Pool                                     Forex Hedge Fund I, LP
Name of Forex CPO                            Forex CPO Advisors, LLC
Name of Forex Trading Program         Forex Trading Program I
Inception of Trading                           January 1, 2009
Aggregate subscriptions                     $15,250,000
Current NAV                                        $17,344,000
Largest monthly draw-down               5.2%/ May 2009
Worst peak-to-valley draw-down      9.3%/ April 2009 through May 2009

Below is a sample table of monthly results for a fictional Forex CPO.  We expect that the regulations will require a table to look substantially similar to the one we’ve presented below.

Rate of Return

Month          2009
January        2.2%
February      1.6%
March          (0.7)%
April            4.1%
May             (5.2)%
June
July
August
September
October
November
December
Year

*Numbers are approximate and for example only

Of course both the capsule and the table above will need to have disclaimers provided by the NFA, as well as any other additional disclaimers as suggested by the forex attorney or compliance professional.  Please note that the capsule above was prepared for a Forex CPO and the capsule for a Forex CTA is likely to be slightly different.

Hypothetical Performance Results

With regard to hypothetical results, there are significant items that must be considered when displaying these in the disclosure documents.  In addition to a fairly lengthy disclaimer (or disclaimers depending on the nature and extent of the hypothetical performance results), the manager will need to include all of the same information as presented in the performance capsule above.

Extracted Performance Results

Extracted performance results may potentially be used in certain circumstances.  You should discuss this option with your attorney or compliance professional.

Additional Information Required for Forex CPOS

Because there are structural differences between a forex hedge fund and a forex separately managed account, there are additional disclosure items for a forex hedge fund.  Some of the items that the Forex CPO is going to have to provide is information on the forex hedge fund’s breakeven point (the return needed to break even given the fund’s management fees and other fees and expenses including the amortization of legal costs, if applicable), ownership of the forex hedge fund, and when the fund will provide reports to investors in the fund.

Material Information

The forex manager will need to disclose all information that is material to an investment in the program.  All such information must be disclosed in the document even if it is not required by the CFTC rules.

Supplemental Information

The forex manager may include supplemental information (i.e. information not required by the CFTC rules, the CEA, or other federal or state laws) in the disclosure document.  However, the forex manager should note that such supplemental information is subject to the same requirements as the other information in the disclosure document and may not be misleading or inconsistent.  Generally all supplemental information must be presented after the main disclosure required by the CFTC – this can be accomplished through a separate supplemental information document called the “Statement of Additional Information,” or at the end of the forex disclosure document.

Conclusion

While we do not have any clear guidance on what will be required in forex disclosure documents, we believe that this overview (combined with part I) will give forex managers an idea of what the rules are likely to require.  We urge forex managers to discuss the registration process with their attorneys during the coming weeks and months as more information is provided by the CFTC and the NFA.  Additionally, keep your eyes pealed for information on the Series 34 exam as this will be a prerequisite to registration as a Forex CPO, Forex CTA or Forex IB.

Please feel free to contact us with any questions.  Other related HFLB articles include:

• Forex Registration Requirements
• Forex Disclosure Documents Overview Part I