NFA Requires Detailed Performance Information
In general, commodity pool operators (“CPO”) registered with the NFA must submit pool offering documents (also known as Disclosure Documents or “DDocs”), to the NFA for review before the documents can be used to solicit investors. The DDocs must comply with CFTC Part 4 Regulations, which require the documents to include certain risk disclosure statements, risk factors, business backgrounds of the CPO and its principals, a break-even analysis, past performance results, and other relevant information. This post provides an overview of what performance is required to be included in the DDocs.
Process and Exemptions
In general the review process for CPO DDocs can take anywhere from 4-12 weeks and will usually entail a number of comment letters from the NFA. Those CPOs that are CFTC registered but have filed a Rule 4.7 exemption with respect to a particular pool are exempt from certain disclosure requirements, including those discussed below, and are not required to have the NFA review the offering documents for that pool. Instead, the documents must not be misleading and must contain certain risk disclosure statements provided under Rule 4.7(b)(1). For more information on 4.7, please see the linked article above.
All performance information presented in the DDoc must be current as of not more than 3 months of the date of the DDoc.
If the offered pool has at least 3 years of operating history, during which at least 75% of the contributions were made by investors unaffiliated with the CPO, the trading manager (if any), the pool’s CTA (if any), or the principals of each (collectively referred to as “outside investments”) then only the performance of the offered pool must be included (for the most recent 5 years or the life of the pool).
If the offered pool does not have at least 3 years of operating history then the following must be included for the most recent 5 years or the life of the pool (or account):
- Offered Pool – the performance of the offered pool (discussed further below).
Note: If the offered pool has no operating history, then the following disclaimer must be included: THIS POOL HAS NOT COMMENCED TRADING AND DOES NOT HAVE ANY PERFORMANCE HISTORY.
- The CPO and Trading Manager (if any) – the performance of each other pool operated or account traded by the CPO or trading manager (if any).
Note: Only the performance of other pools operated and accounts traded by the trading manager is required if (1) the trading manager has complete authority over the offered pool’s trading and (2) the trading manager’s performance is not materially different from that of the CPO.
- Trading Principals – the performance of each other pool operated or account traded by a trading principal is required if the CPO or trading manager has not operated any pool for at least 3 years, during which at least 75% of the contributions are outside investments.
Note: Such performance is not required if the performance does not differ in any material respect from the performance of the offered pool, the CPO, and trading manager (if any).
Note: If neither the CPO, trading manager (if any), nor any trading principals has operated any other pools or traded any other accounts, then the following disclaimer must be included: NEITHER THIS POOL OPERATOR (TRADING MANAGER, IF APPLICABLE) NOR ANY OF ITS TRADING PRINCIPALS HAS PREVIOUSLY OPERATED ANY OTHER POOLS OR TRADED ANY OTHER ACCOUNTS.
- Major Commodity Trading Adviser (CTA) – the performance of any accounts (including pools) directed by a major CTA. A major CTA is any CTA that is currently or will be allocated 10% or more of the offered pool’s assets.
Note: If a major CTA has no trading history, then the following disclaimer must be included: (name of the major commodity trading advisor), A COMMODITY TRADING ADVISOR THAT HAS DISCRETIONARY TRADING AUTHORITY OVER (percentage of the pool’s funds available for commodity interest trading allocated to that trading advisor) PERCENT OF THE POOL’S COMMODITY INTEREST TRADING HAS NOT PREVIOUSLY DIRECTED ANY ACCOUNTS.
Note: The DDoc must only include a summary of performance for non-major CTAs.
- Major Investee Pool – the performance of any major investee pool. A major investee pool is any pool in which 10% or more of the offered pool’s net asset value is invested.
Note: If a major investee pool has no trading history, then the following disclaimer must be included: (name of the major investee pool), AN INVESTEE POOL THAT IS ALLOCATED (percentage of the pool assets allocated to that investee pool) PERCENT OF THE POOL’S ASSETS HAS NOT COMMENCED TRADING.
Note: The DDoc must only include a summary of performance for non-major investee pools.
Specific Information for the Offered Pool
The offered pool’s performance must be presented first. It must also include the following information:
- name of the pool
- type of pool (privately offered, a multi-advisor pool, or a principal protected pool)
- date trading started
- aggregate subscriptions (total amount of all additions to the pool over the entire operating history, not reduced by any withdrawals)
- current net asset value
- largest monthly draw-down during the most recent 5 years (must include the % and the month and year of the draw-down)
- a definition of “draw-down”
- worst peak-to-valley draw-down during the most recent 5 years (must include the % and the period the draw-down happened, including month and year of the peak and month and year of the valley)
- monthly rates of return (RORs) for the most recent 5 years and year to date, presented in a table or bar graph
- annual and year to date RORs for the most recent 5 years
- disclaimer: PAST PERFORMANCE IS NOT NECESSARILY INDICATIVE OF FUTURE RESULTS.
Performance of Other Pools and Accounts
Any additional performance that is required to be included in the DDocs as discussed above (e.g. other pools operated and accounts traded by the CPO, trading manager, trading principals, major CTAs, and major investee pools) does not need to include monthly RORs. However, if presented, such performance must be presented as follows:
- Same Type as the Offered Pool – performance for pools that are the same type as the offered pool (e.g. all privately offered) must be presented after the performance of the offered pool. They must be presented on a pool-by-pool basis.
- Different Type Than the Offered Pool – performance for pools of a different type than the offered pool (e.g. single-advisor vs. multi-advisor) must be less prominent than the performance of the offered pool.
- Composite Results – performance of multiple pools of the same type may be presented in composite form as long as their rates of return are not materially different and doing so would not be misleading. The DDoc must discuss how the composite was developed and any material differences between the pools.
Performance Not Required
The following is a brief summary of performance information that is not necessarily required to be included:
- Proprietary Performance – proprietary performance is generally not required. A proprietary pool or account is one in which 50% or more of contributions are from:
- the CPO, trading manager (if any), CTA or any principal of each;
- an affiliate or family member of the CPO, trading manager (if any), or CTA; or
- any person providing services to the pool.
If presented, they must be clearly labeled as such and must appear separately after all required and non-required disclosures in the DDoc. It must also include discussion of differences between the proprietary results and the offered pool (e.g. differences in leverage, trading methodology).
Pro forma adjustments must be made to the proprietary results if fees, commission, margin/equity ratios, or any other items are materially different from the offered pool. It should be clearly labeled “pro forma.”
In addition, if any proprietary futures accounts are included in the DDoc, all such accounts must be disclosed.
- Hypothetical and Extracted Performance – the NFA generally discourages the use of hypothetical and extracted results. If included, the CPO should review the various disclaimers that must accompany these results.
NFA examiners will review DDocs thoroughly. When it comes to performance information, all required information (or the appropriate disclaimer if there is no performance) must be clearly presented. The CPO will also be required to disclose any other material information, even if it is not specifically required in the NFA or CFTC rules and regulations.
Bart Mallon is a partner with Cole-Frieman Mallon & Hunt LLP, an investment management law firm with a practice area focused on managed futures laws and regulations. Bart can be reached directly at 415-868-5345.