Tag Archives: CEA

Dodd-Frank Establishes New Laws Regarding Spot Commodities and Spot Forex

The Dodd-Frank Wall Street Reform and Consumer Protection Act (“Act”) has changed a number of laws in all of the securities acts including the Commodity Exchange Act. Two specific changes deal with certain transactions in commodities on the spot market. Specifically, Section 742 of the Act deals with retail commodity transactions. In this section, the text of the Commodity Exchange Act is amended to include new Section 2(c)(2)(D) (dealing with retail commodity transactions) and new Section 2(c)(2)(E) (prohibiting trading in spot forex with retail investors unless the trader is subject to regulations by a Federal regulatory agency, i.e. CFTC, SEC, etc.). According to a congressional rulemaking spreadsheet, these are effective 180 days from the date of enactment.

We provide an overview of the new sections and have reprinted them in full below.

New CEA Section 2(c)(2)(D) – Concerning Spot Commodities (Metals)

The central import of new CEA Section 2(c)(2)(D) is to broaden the CFTC’s power with respect to retail commodity transactions. Essentially any spot commodities transaction (i.e. spot metals) will be subject to CFTC jurisdiction and rulemaking authority. There is an exemption for commodities which are actually delivered within 28 days. While the CFTC wanted an exemption in which commodities would need to be delivered within 2 days, various coin collectors were able to lobby congress for a longer delivery period (see here).

It is likely we will see the CFTC propose regulations under this new section and we will keep you updated on any regulatory pronouncements with respect to this new section.

New CEA Section 2(c)(2)(E) – Concerning Spot Forex

The central import of new CEA Section 2(c)(2)(E) is to regulate the spot forex markets. While the section requires the CFTC to finalize regulations with respect to spot forex (which were proposed earlier in January), it also, interestingly, provides oversight of the markets to other federal regulatory agencies such as the CFTC. This means that in the future, different market participants may be subject to different regulatory regimes with respect to trading in same underlying instruments. A Wall Street Journal article discusses the impact of this with respect to firms which engage in other activities in addition to retail forex transactions. The CFTC’s proposed rules establish certain compliance parameters for retail forex transactions, requires registration of retail forex managers and requires such managers to pass a new regulatory exam called the Series 34 exam. We do not yet know whether the other regulatory agencies will adopt rules similar to the CFTC or if they will write rules from scratch.

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CEA Section 2(c)(2)(D)

‘‘(D) RETAIL COMMODITY TRANSACTIONS.—

‘‘(i) APPLICABILITY.—Except as provided in clause (ii), this subparagraph shall apply to any agreement, contract, or transaction in any commodity that is—

‘‘(I) entered into with, or offered to (even if not entered into with), a person that is not an eligible contract participant or eligible commercial entity; and

‘‘(II) entered into, or offered (even if not entered into), on a leveraged or margined basis, or financed by the offeror, the counterparty, or a person acting in concert with the offeror or counterparty on a similar basis.

‘‘(ii) EXCEPTIONS.—This subparagraph shall not apply to—

‘‘(I) an agreement, contract, or transaction described in paragraph (1) or subparagraphs (A), (B), or (C), including any agreement, contract, or transaction specifically excluded from subparagraph (A), (B), or (C);

‘‘(II) any security;

‘‘(III) a contract of sale that—

‘‘(aa) results in actual delivery within 28 days or such other longer period as the Commission may determine by rule or regulation based upon the typical commercial practice in cash or spot markets for the commodity involved; or

‘‘(bb) creates an enforceable obligation to deliver between a seller and a buyer that have the ability to deliver and accept delivery, respectively, in connection with the line of business of the seller and buyer; or

‘‘(IV) an agreement, contract, or transaction that is listed on a national securities exchange registered under section 6(a) of the Securities Exchange Act of 1934 (15 U.S.C. 78f(a)); or

‘‘(V) an identified banking product, as defined in section 402(b) of the Legal Certainty for Bank Products Act of 2000 (7 U.S.C.27(b)).

‘‘(iii) ENFORCEMENT.—Sections 4(a), 4(b), and 4b apply to any agreement, contract, or transaction described in clause (i), as if the agreement, contract, or transaction was a contract of sale of a commodity for future delivery.

‘‘(iv) ELIGIBLE COMMERCIAL ENTITY.—For purposes of this subparagraph, an agricultural producer, packer, or handler shall be considered to be an eligible commercial entity for any agreement, contract, or transaction for a commodity in connection with the line of business of the agricultural producer, packer, or handler.’’.

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CEA Section 2(c)(2)(E)

‘‘(E) PROHIBITION.—

‘‘(i) DEFINITION OF FEDERAL REGULATORY AGENCY.—In this subparagraph, the term ‘Federal regulatory agency’ means—

‘‘(I) the Commission;

‘‘(II) the Securities and Exchange Commission;

‘‘(III) an appropriate Federal banking agency;

‘‘(IV) the National Credit Union Association; and

‘‘(V) the Farm Credit Administration.

‘‘(ii) PROHIBITION.—

‘‘(I) IN GENERAL.—Except as provided in subclause (II), a person described in subparagraph (B)(i)(II) for which there is a Federal regulatory agency shall not offer to, or enter into with, a person that is not an eligible contract participant, any agreement, contract, or transaction in foreign currency described in subparagraph (B)(i)(I) except pursuant to a rule or regulation of a Federal regulatory agency allowing the agreement, contract, or transaction under such terms and conditions as the Federal regulatory agency shall prescribe.

‘‘(II) EFFECTIVE DATE.—With regard to persons described in subparagraph (B)(i)(II) for which a Federal regulatory agency has issued a proposed rule concerning agreements, contracts, or transactions in foreign currency described in subparagraph (B)(i)(I) prior to the date of enactment of this subclause, subclause (I) shall take effect 90 days after the date of enactment of this subclause.

‘‘(iii) REQUIREMENTS OF RULES AND REGULATIONS.—

‘‘(I) IN GENERAL.—The rules and regulations described in clause (ii) shall prescribe appropriate requirements with respect to—

‘‘(aa) disclosure;

‘‘(bb) recordkeeping;

‘‘(cc) capital and margin;

‘‘(dd) reporting;

‘‘(ee) business conduct;

‘‘(ff) documentation; and

‘‘(gg) such other standards or requirements as the Federal regulatory agency shall determine to be necessary.

‘‘(II) TREATMENT.—The rules or regulations described in clause (ii) shall treat all agreements, contracts, and transactions in foreign currency described in subparagraph (B)(i)(I), and all agreements, contracts, and transactions in foreign currency that are functionally or economically similar to agreements, contracts, or transactions described in subparagraph (B)(i)(I), similarly.’’.

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Eligible Contract Participant (ECP) Definition

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The term “eligible contract participant” is important with regard to managers who provide advice on futures and commodities investments (including off-exchange spot foreign currency or “forex”). In general there are exemptions from various CTA, CPO and IB registration provisions for those managers who only provide advisory services to those clients who fall within the definition of eligible contract participant (ECP). The definition is also important for those managers who may be subject to the proposed CFTC forex registration regulations.

This post provides a short general description of the definition and also the full definition.

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Short Definition

An Eligible Contract Participant generally means:

Financial Institutions
Insurance Companies
Mutual Funds
Certain commodity pools with $5 million or more of assets
Certain organizations with, generally, $10 million or more of assets
ERISA plans with $5 million or more of assets
Certain governmental entities
Certain broker-dealers and investment banks
FCMs
Floor brokers
An individual with generally $10 million or more of assets
Certain brokers or investment advisers

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Full Definition

The following definition is found in the Section 1a(12) of the Commodity Exchange Act.

Eligible contract participant

The term “eligible contract participant” means—

(A) acting for its own account—

(i) a financial institution;

(ii) an insurance company that is regulated by a State, or that is regulated by a foreign government and is subject to comparable regulation as determined by the Commission, including a regulated subsidiary or affiliate of such an insurance company;

(iii) an investment company subject to regulation under the Investment Company Act of 1940 (15 U.S.C. 80a–1 et seq.) or a foreign person performing a similar role or function subject as such to foreign regulation (regardless of whether each investor in the investment company or the foreign person is itself an eligible contract participant);

(iv) a commodity pool that—

(I) has total assets exceeding $5,000,000; and

(II) is formed and operated by a person subject to regulation under this chapter or a foreign person performing a similar role or function subject as such to foreign regulation (regardless of whether each investor in the commodity pool or the foreign person is itself an eligible contract participant);

(v) a corporation, partnership, proprietorship, organization, trust, or other entity—

(I) that has total assets exceeding $10,000,000;

(II) the obligations of which under an agreement, contract, or transaction are guaranteed or otherwise supported by a letter of credit or keepwell, support, or other agreement by an entity described in subclause (I), in clause (i), (ii), (iii), (iv), or (vii), or in subparagraph (C); or

(III) that—

(aa) has a net worth exceeding $1,000,000; and

(bb) enters into an agreement, contract, or transaction in connection with the conduct of the entity’s business or to manage the risk associated with an asset or liability owned or incurred or reasonably likely to be owned or incurred by the entity in the conduct of the entity’s business;

(vi) an employee benefit plan subject to the Employee Retirement Income Security Act of 1974 (29 U.S.C. 1001 et seq.), a governmental employee benefit plan, or a foreign person performing a similar role or function subject as such to foreign regulation—

(I) that has total assets exceeding $5,000,000; or

(II) the investment decisions of which are made by—

(aa) an investment adviser or commodity trading advisor subject to regulation under the Investment Advisers Act of 1940 (15U.S.C. 80b–1 et seq.) or this chapter;

(bb) a foreign person performing a similar role or function subject as such to foreign regulation;

(cc) a financial institution; or

(dd) an insurance company described in clause (ii), or a regulated subsidiary or affiliate of such an insurance company;

(vii)

(I) a governmental entity (including the United States, a State, or a foreign government) or political subdivision of a governmental entity;

(II) a multinational or supranational government entity; or

(III) an instrumentality, agency, or department of an entity described in subclause (I) or (II);

except that such term does not include an entity, instrumentality, agency, or department referred to in subclause (I) or (III) of this clause unless (aa) the entity, instrumentality, agency, or department is a person described in clause (i), (ii), or (iii) of paragraph (11)(A) of this section; (bb) the entity, instrumentality, agency, or department owns and invests on a discretionary basis $25,000,000 or more in investments; or (cc) the agreement, contract, or transaction is offered by, and entered into with, an entity that is listed in any of subclauses (I) through (VI) of section 2(c)(2)(B)(ii) of this title;

(viii)

(I) a broker or dealer subject to regulation under the Securities Exchange Act of 1934 (15 U.S.C. 78a et seq.) or a foreign person performing a similar role or function subject as such to foreign regulation, except that, if the broker or dealer or foreign person is a natural person or proprietorship, the broker or dealer or foreign person shall not be considered to be an eligible contract participant unless the broker or dealer or foreign person also meets the requirements of clause (v) or (xi);

(II) an associated person of a registered broker or dealer concerning the financial or securities activities of which the registered person makes and keeps records under section 15C(b) or 17(h) of the Securities Exchange Act of 1934 (15 U.S.C. 78o–5 (b), 78q (h));

(III) an investment bank holding company (as defined in section 17(i) of the Securities Exchange Act of 1934 (15 U.S.C. 78q (i)); [1]

(ix) a futures commission merchant subject to regulation under this chapter or a foreign person performing a similar role or function subject as such to foreign regulation, except that, if the futures commission merchant or foreign person is a natural person or proprietorship, the futures commission merchant or foreign person shall not be considered to be an eligible contract participant unless the futures commission merchant or foreign person also meets the requirements of clause (v) or (xi);

(x) a floor broker or floor trader subject to regulation under this chapter in connection with any transaction that takes place on or through the facilities of a registered entity (other than an electronic trading facility with respect to a significant price discovery contract) or an exempt board of trade, or any affiliate thereof, on which such person regularly trades; or

(xi) an individual who has total assets in an amount in excess of—

(I) $10,000,000; or

(II) $5,000,000 and who enters into the agreement, contract, or transaction in order to manage the risk associated with an asset owned or liability incurred, or reasonably likely to be owned or incurred, by the individual;

(B)

(i) a person described in clause (i), (ii), (iv), (v), (viii), (ix), or (x) of subparagraph (A) or in subparagraph (C), acting as broker or performing an equivalent agency function on behalf of another person described in subparagraph (A) or (C); or

(ii) an investment adviser subject to regulation under the Investment Advisers Act of 1940 [15 U.S.C. 80b–1 et seq.], a commodity trading advisor subject to regulation under this chapter, a foreign person performing a similar role or function subject as such to foreign regulation, or a person described in clause (i), (ii), (iv), (v), (viii), (ix), or (x) of subparagraph (A) or in subparagraph (C), in any such case acting as investment manager or fiduciary (but excluding a person acting as broker or performing an equivalent agency function) for another person described in subparagraph (A) or (C) and who is authorized by such person to commit such person to the transaction; or

(C) any other person that the Commission determines to be eligible in light of the financial or other qualifications of the person.

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Other related FOREX law articles include:

Bart Mallon, Esq. of runs the Hedge Fund Law Blog and provides forex registration service through Cole-Frieman & Mallon LLP. Mr. Mallon also runs the Forex Law Blog. He can be reached directly at 415-868-5345.

FINRA to Regulate Member’s Retail Forex Activities

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Comments on Proposed Retail Forex Rules Sought

The Finanacial Industry Regulatory Authority (FINRA) requested comments on a proposed rule to limit the leverage available to retail investors trading in the off-exchange foreign currency (forex) markets. The proposed rule would be applicable to FINRA member firms and would limit leverage in forex transactions to 1.5 to 1. The proposed leverage limits are significantly lower than the leverage limits currently offered in the industry (which can reach up to 100 to 1 or higher). The leverage limitation would not be applicable to eligible contract participants. The FINRA proposal is the latest step in a series of regulatory tightening measures which have been instituted with the goal of protecting retail investors from the risks of the forex markets (for more information please see New Forex Registration Requirements). Comments on the proposal are due February 20, 2009. Continue reading →

CTA registration requirement and exemption

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Question: does my commodity/futures trading firm need to register as a CTA?

Answer: Generally Section 6m(1) of the Commodities Exchange Act (“CEA”) requires that any person (or firm) which falls within the definition of a CTA be registered as such. Section 6m(1) of the CEA states:

“It shall be unlawful for any commodity trading advisor or commodity pool operator, unless registered under this chapter, to make use of the mails or any means or instrumentality of interstate commerce in connection with his business as such commodity trading advisor or commodity pool operator”

The Commodities Exchange Act (“CEA”) specifically defines a Commodity Trading Adviser (“CTA”) as:

“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 [the CEA]; or (III) any leverage transaction authorized under section 23 of [the CEA]; 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)”

Because the above definition is quite broad, Congress specifically excluded certain groups from the definition. These groups include:

any bank or trust company or any person acting as an employee thereof;
any news reporter, news columnist, or news editor of the print or electronic media, or any lawyer, accountant, or teacher;
any floor broker or futures commission merchant;
the publisher or producer of any print or electronic data of general and regular dissemination, including its employees;
the fiduciary of any defined benefit plan that is subject to the Employee Retirement Income Security Act of 1974 (29 U.S.C. 1001 et seq.);
any contract market or derivatives transaction execution facility; and
such other persons not within the intent of this paragraph as the Commission may specify by rule, regulation, or order.

I have previously discussed how to register as a CTA in the article titled How to register as a CPO or CTA.

Question: are there any exemptions from CTA registration?

Answer: Yes. Section 6m(1) of the CEA states:

That the [registration] provisions of this section shall not apply to any commodity trading advisor who, during the course of the preceding twelve months, has not furnished commodity trading advice to more than fifteen persons and who does not hold himself out generally to the public as a commodity trading advisor. [emphasis added]

To fall within the above exemption, both elements must be met. That is, the CTA must

have less than 15 clients over the preceeding 12 months and
not hold himself out generally to the public as a CTA

The question then becomes what does “holding out” as a CTA entail?

The CFTC views “holding oneself out as a CTA” to include such conduct as promoting advisory services through mailings, directory listings, and stationery, or otherwise initiating contact with prospective clients. Thus, unless a CTA restricts his clients to family, friends, and existing business associates, a CTA generally will be viewed as holding himself out to the public as a CTA and would not be able to claim the exemption from registration in Section 6m(1).

The CFTC specifically gave such guidance in the following letter.

CFTC Letter No. 97-26
March 26, 1997
Division of Trading & Markets

Re: Section 4m(1): Exemption from CTA Registration

Dear [_______]:

This is in response to your letter dated January 29, 1997 to the Division of Trading and Markets (the “Division”) of the Commodity Futures Trading Commission (the “Commission”), whereby you inquire as to whether you may claim an exemption from registration as a commodity trading advisor (“CTA”) pursuant to Section 4m(1) [now 6m(1)] of the Commodity Exchange Act (the “Act”). *

Based on your letter, we understand the pertinent facts to be as follows. You intend to sell subscriptions to a fax service (the “Service”) entitled “A”, of which you are the sole designer. The Service will provide subscribers with buy and sell recommendations for Eurodollar futures and option contracts traded on “X”.

Section 4m(1) [now 6m(1)] of the Act generally requires that a person who provides commodity interest trading advice to the public must register as a CTA. Section 4m(1) does, however, provide an exemption from registration as a CTA for a person who satisfies two conditions: (1) during the course of the preceding twelve months, he has not furnished commodity trading advice to more than fifteen persons; and (2) he does not hold himself out generally to the public as a CTA. The Division views “holding oneself out as a CTA” to include such conduct as promoting advisory services through mailings, directory listings, and stationery, or otherwise initiating contact with prospective clients.** Thus, unless a CTA restricts his clients to family, friends, and existing business associates, a CTA generally will be viewed as holding himself out to the public as a CTA and would not be able to claim the exemption from registration in Section 4m(1) [now 6m(1)]. This is true whether or not the CTA is advising fifteen or fewer persons, since in order to qualify for the Section 4m(1) exemption, the CTA must satisfy both conditions. [Emphasis added]

Thus, if you plan to solicit clients other than immediate family members, friends, and business associates, you would be holding yourself out as a CTA and would be required to register as such prior to marketing the Service. You would also be required to comply with all other provisions of the Act and Commission’s regulations thereunder applicable to registered CTAs, including Section 4b and Section 4o,*** the antifraud provisions of the Act, Part 4 of the Commission’s regulations applicable to CTAs, and the reporting requirements for traders set forth in Parts 15, 18, and 19 of the Commission’s regulations.

The advice provided herein is based upon the representations that you have made to us. Any different, changed or omitted facts or conditions might require us to reach a different conclusion. In this connection, we request that you notify us immediately in the event your activities change in any way from those as represented to us.

If you have any questions concerning this correspondence, please feel free to contact me or Monica S. Amparo, an attorney on my staff, at (202) 418-5450.

Very truly yours,

Susan C. Ervin

Chief Counsel

* 7 U.S.C. §6m(1) (1994).

** Division of Trading and Markets Interpretative Letter 91-9, [1990-1992 Transfer Binder] Comm. Fut. L. Rep. (CCH) ¶ 25,189 (Dec. 30, 1991). We have enclosed a copy of this letter for your reference.

*** 7 U.S.C. §§ 6b and 6o (1994).