Tag Archives: CPO exemption

CFTC Issues No-Action Letters for CPO Registration Relief

Hedge Fund General Partner CPO Registration Relief 

In a series of no-action letters issued in March, the CFTC has granted no-action relief from registration as a commodity pool operator (“CPO”) for a general partner of a fund (or a managing member, if the fund is an LLC) that delegates its entire management authority over the fund to another entity – typically an “investment manager” entity – that is under common control with the general partner. Under this relief, the investment manager is required to register as a CPO, but the general partner is relieved from the CPO registration requirement.

Background on CPO Registration

Based on the legal structure of a fund organized as a limited partnership or limited liability company, typically the general partner or managing member (respectively) has the operational authority over the fund that makes CPO registration process necessary. Under the Commodity Exchange Act of 1936 (the “Act”), an entity that engages in the following activities on behalf of a fund (a “pool” in CFTC parlance) is generally required to register as a CPO:

“any person engaged in a business that is of the nature of a commodity pool, 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 commodity interests.”  See text here.

In some fund structures, however, the general partner may wish to delegate its CPO responsibilities to an investment manager. This is often (but not exclusively) done in the context where a fund’s performance allocation is paid to the general partner, in order to obtain favorable tax treatment, but the investment manager runs the fund on a day-to-day basis, often receiving management fees as compensation. In this situation, it would be costly and burdensome to register both the general partner and the investment manager as separate CPOs of the fund, so it may be worthwhile to request CFTC no-action relief.

Requirements for No-Action Relief

The CFTC issued four no-action letters outlining the general guidelines for how to take advantage of the CPO registration relief described in this article: CFTC Letter No. 13-17, CFTC Letter No. 13-18, CFTC Letter No. 13-19, and CFTC Letter No. 13-20. Although the facts of each no-action letter differ somewhat, the following basic requirements apply. The general partner and investment manager should be able to make representations to the CFTC with respect to each of the following:

Common Ownership and Control. The general partner entity and the investment manager entity should have the same owners and be subject to the control of the same persons.

Delegation Agreement – All Management Authority. The general partner and investment manager should enter into a “Delegation Agreement” whereby all of the CPO-related authority of the general partner is delegated to the investment manager.

Soliciting Clients and Managing Assets. The general partner must not engage in the solicitation of investors to the fund, and must not manage the property of the fund.

Books and Records. All books and records related to the CPO activities should be maintained at the offices of the investment manager.

CPO Registration. The investment manager must be registered or be in the process of registering as a CPO, and must maintain its registration on an ongoing basis.

Employees and Agents. The general partner must not have any employees or others acting on its behalf, and must not engage in any other activities that would subject it to the Act or the CFTC’s regulations.

Joint & Several Liability. The general partner and investment manager entities must agree to be jointly and severally liable for any violation of the Act or the CFTC’s regulations.

Statutory Disqualification. The general partner cannot be subject to statutory disqualification from CPO registration under section 8a(2) or 8a(3) of the Act.

How to Apply for No-Action Relief

If you wish to apply for the no-action relief described above, you will need to draft a letter to the CFTC to request the relief. This letter should comply with the requirements of CFTC Regulation 140.99. Please reach out to us if you would like any assistance with drafting such a letter.

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Cole-Frieman & Mallon LLP acts as legal counsel to the investment management industry.  If you have questions on the above please contact us or call Bart Mallon directly at 415-868-5345.

Qualified Eligible Person (QEP) Definition

The securities laws can be written obtusely and the definition of a qualified eligible person (QEP) may be one of the best examples of this.  There is no quick and easy definition of a what a QEP is so we are trying to make it as easy as possible to understand.  This post discusses the importance of the classification, provides the overview of the definition and then provides a link to the actual statutory language.

Why QEP Definition is Important for CPOs

The definition of QEP is important for commodity pool operators (CPOs) in a couple of situations.  The first is the 4.13(a)(4) exemption from the registration provisions for a CPO that provides advice to a commodity pool with only QEPs.  The second situation where a CPO will need to make sure the investors are QEPs is if they want to take advantage of the Rule 4.7 exemption.  The Rule 4.7 exemption allows CPOs to follow less-strict reporting requirements with regard to the commodity pool they manage.  These two exemptions essentially provide for reduced regulatory oversight of a CPO who provides advisory services to these class of investors.

Definition of QEP

A qualified eligible person is an investor who fits into one of two distinct groups: (1) investors who do not need to meet the portfolio requirement and (2) investors who need to meet the portfolio requirement.

1.  Investors who do not need to meet the portfolio requirement:

The following are considered to be QEPs regardless of whether or not they meet the portfolio requirement:

  • registered futures commission merchants
  • registered broker or dealers
  • registered commodity pool operators (under certain conditions, see rule for more details)
  • registered commodity trading advisors (under certain conditions, see rule for more details)
  • state or SEC registered investment advisers (under certain conditions, see rule for more details)
  • qualified purchasers
  • knowledgeable employee of the CPOs
  • certain persons related to advisers to exempt from registration as a CPO or CTA
  • trusts (under certain conditions, see rule for more details)
  • 501(c)(3) organizations (under certain conditions, see rule for more details)
  • non-United States persons
  • certain entities in which all of the owners/participants are QEPs

2.  Investors who need to meet the portfolio requirement:

The following will be considered to be QEPs only if they meet the portfolio requirement described below:

  • investment companies registered under the Investment Company Act (i.e. mutual funds)
  • certain business development companies (defined under both the Investment Company Act and Investment Advisers Act)
  • banks, savings and loan associations, and other like institutions acting for their own accounts or for the account of a QEP
  • insurance companies acting for their own account or for the account of a qualified eligible person
  • plans established and maintained by various governments and related bodies for the benefit of their employees, if such plan has total assets in excess of $5,000,000
  • employee benefit plans within the meaning of the ERISA (under certain conditions, see rule for more details)
  • 501(c)(3) organizations with total assets in excess of $5,000,000
  • corporations, business trusts, partnerships, LLCs or similar business ventures with total assets in excess of $5,000,000 and not formed for the specific purpose of participating in the exempt investment program
  • a natural person whose individual net worth, or joint net worth with that person’s spouse, at the time of either his purchase in the exempt pool or his opening of an exempt account exceeds $1,000,000 [HFLB note: this is one part of the accredited investor definition]
  • a natural person who had an individual income in excess of $200,000 in each of the two most recent years or joint income with that person’s spouse in excess of $300,000 in each of those years and has a reasonable expectation of reaching the same income level in the current year [HFLB note: this is one part of the accredited investor definition]
  • pools, trusts, insurance company separate accounts or bank collective trusts, with total assets in excess of $5,000,000 (under certain conditions, see below)
  • other entities authorized by law to engage in such transactions (under certain conditions, see rule for more details)

3.  Portfolio Requirement

If an investor is one of the entities described in (2) above, it will also need to meet the portfolio requirement.  The portfolio requirement can be met in one of three ways:

  • Owns securities and other investments with an aggregate market value of at least $2MM;
  • Has had on deposit with a FCM at least $200K in exchange-specified initial margin and option premiums for commodity interest transactions in the 6 months prior to the investment; or
  • Has a combination of the two above.  For example, has $1MM in securities/investments and $100K in exchange-specified initial margin in the 6 months prior to the investment

The above definitions have been shortened for the purpose of providing a general overview.  When determining whether an investor meets the qualified eligible person definition the CPO should take special care to make sure that the investor meets the full definition which can be found here.  Generally the investor will make these representations in the subscription documents which are drafted by the hedge fund attorney.

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Other related Hedge Fund Law Blog articles include:

Bart Mallon, Esq. runs the Hedge Fund Law Blog.  He can be reached directly at 415-868-5345.

CPO Exemption for Fund of Hedge Funds

As we have discussed previously, if a hedge fund manager invests fund assets in commodity interests (including futures), then the manager will generally need to be registered as a commodity pool operator (CPO) with the Commodity Futures Trading Commission (CFTC).  The registration requirement also applies to fund of fund (FOF) managers who allocate assets to underlying hedge funds which themselves invest in commodity interests.  There are a number of CPO exemptions available to hedge fund managers.  Likewise, there are two exemptions which may be applicable to fund of fund managers who allocate to funds CPOs or exempt CPOs. Continue reading

Hedge Fund CPO Exemptions

As I’ve detailed before, under the Commodities Exchange Act (CEA), hedge funds which invest in commodities/ futures or in other hedge funds which invest in commodities/ futures are deemed to be commodity pools.  The managers of these commodity pools will need to be registered as commodity pool operators (CPOs) unless the manager fits within an exemption from the registration provisions. For more information on registration with the National Futures Association (NFA), please see article on how to register as a CPO.

There are a few rules under the CEA exemptions from the registration provisions which I have detailed below.  Many will not be applicable to the average hedge fund manager.  Generally hedge fund managers are going to rely on 4.13(a)(3) below, or if the fund is a 3(c)(7) hedge fund, then they may rely on 4.13(a)(4).  The CPO exemptions are:

Rule 4.13(a)(1) – closely held pool

This rule provides relief from CPO registration if all of the following provisions are met:

1.    Manager operates only one pool at a time;

2.    Manager does not receive any form of compensation;

3.    Manager does not advertise; and

4.    Manager is not otherwise required to register with the NFA

Please see Rule 4.13(a)(1).

Rule 4.13(a)(2) – small pool

This rule provides relief from CPO registration if the following provisions are met:

1.     The manager does not operate any pools which have 15 or more investors (excluding the manager and certain related persons); and

2.    The total gross capital contributions in all pools operated or intended to be operated by the manager do not in the aggregate exceed $400,000 (certain capital contributions, including those of the manager, will not be counted for the purposes of this rule)

Please see Rule 4.13(a)(2).

Rule 4.13(a)(3) – deminimus rule

This rule provides relief from CPO registration if the following provisions are met:

1.    The commodity pool interests 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;

2.    All of the investors in the pool must be an accredited investors (or similar qualification as specified in the rule); and

3.    One of the following tests is met:

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; 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.

Please see Rule 4.13(a)(3).

Rule 4.13(a)(4) – all QEPs

This rule provides relief from CPO registration if the following provisions are met:

1.    The commodity pool interests 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; and

2.    Investors must generally be qualified purchasers.  (HFLB note: the definition makes reference to qualified eligible persons but in this case it will generally include only those investors who are qualified purchasers.)

Please see Rule 4.13(a)(4).

Rule 4.5 Exemption

Certain management entities which are already registered with other regulatory bodies do not need to also be registered as a CPO with the NFA.  Some of these entities include managers to registered mutual funds, insurance companies, banks and ERISA fiduciaries.  A CPO claiming rule 4.5 exemption must file of notice of the exemption with the NFA and make certain disclosures to the investors in the pool.

Please see Rule 4.5.

Rule 4.7 Exemption

Registered CPOs must adhere to certain disclosure and reporting requirements as specified in the rules under the CEA.  With regard to certain commodity pools which they manage, managers may want to consider running certain funds under the “lite-touch” rule 4.7 which allows CPOs to run their fund pursuant to lighter regulations.  Specifically, the CPO would be exempt from the specific requirements of Rule 4.21, Rule 4.22(a) and (b), Rule 4.24, Rule 4.25 and Rule 4.26 with respect to each exempt pool.  To claim this exemption all of the investors in the commodity pool must be qualified eligible persons which generally will mean that they are qualified purchasers.  CPOs claiming rule 4.5 exemption must still file of notice of the exemption with the NFA.

Please see Rule 4.7.

Rule 4.12 Exemption

Like the rule 4.7 exemption, the rule 4.12 exemption is for registered CPOs.  While under 4.7 there is no limitation to the amount of commodities held by the pool, rule 4.12 limits the amount of commodities held to 10% of the pools assets and requires that all commodity trading be solely incidental to securities trading activity.  Under this exemption the CPO will need to file a notice with the NFA and will need to adhere to certain disclosure regulations. Both the 4.7 and 4.12 exemptions are used less often than the 4.13 exemptions.

Please see Rule 4.12.