Monthly Archives: June 2012

CPO Required Performance Information for Fund Offering Documents

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.

Overview of

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.

Conclusion

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.

NFA Provides Guidance on Rule 4.13(a)(4) Recission

Managers Allowed to Pre-File New Exemption

In earlier posts, we briefly discusssed the Rule 4.13(a)(4) exemption recission (we also discussed the topic as part of an article on the managed futures industry post-MF Global bankruptcy). In essence the old 4.13(a)(4) exemption allowed certain fund managers to escape CPO and CTA registration if all of the investors in a fund were qualified eligible persons. While managers who were previously relying on the exemption can maintain their exempt status until December 31 of this year, new managers may not rely on the exemption. Additionally, previously exempt managers are going to need to register or find another CPO exemption that may be applicable.

Many managers are going to be able to seek an exemption under Rule 4.7, the so-called “lite-touch” regulatory regime. In order to facilitate a transition from a 4.13(a)(4) exemption to the 4.7 exemption, the NFA has modified its systems to allow managers to make the transition automatic as of December 31, 2012 through a pre-filing. Managers who pre-file, will not be subject to the regulatory requirements for the new exemption in 2012. Managers who withdraw the 4.13(a)(4) exemption without pre-filing may become subject to certain CFTC requirements. For more information, we have reprinted the NFA notice in full below.

If you have questions with respect to the exemption, please contact us.

****

Notice to Members I-12-09

June 22, 2012

Guidance to NFA Member CPOs and CTAs that Operate or Advise Pools Pursuant to an Exemption under CFTC Regulation 4.13(a)(4)

On February 24, 2012, the CFTC issued final rules amending CFTC Part 4 Regulations to rescind the exemption from registration available to CPOs offering certain qualifying pools under CFTC Regulation 4.13(a)(4). Although Member CPOs that currently operate a pool(s) pursuant to a 4.13(a)(4) exemption may continue to operate the pool pursuant to that exemption until December 31, 2012, those CPOs must determine whether the 4.13(a)(4) exempt pool qualifies for an exemption from registration under CFTC Regulation 4.13(a)(3) or whether the CPO will become subject to CFTC Part 4 reporting and disclosure requirements for that pool subsequent to December 31, 2012. Similarly, any CTA that advises a 4.13(a)(4) exempt pool pursuant to an exemption under CFTC Regulation 4.14(a)(8)(D) may only continue to advise that pool after December 31 if the CTA continues to be eligible for that exemption because the CPO has filed a 4.13(a)(3) exemption for that pool. Otherwise, the CTA must comply with the applicable Part 4 requirements with respect to that pool.

The final rules also amend a number of CFTC Regulations to require CPOs and CTAs that claim an exemption under CFTC Regulation 4.5, 4.13(a)(1), 4.13(a)(2), 4.13(a)(3), 4.13(a)(5) and 4.14(a)(8) to annually reaffirm the applicable notice of exemption. CPOs and CTAs will have 60 days after the calendar year-end to reaffirm the notice of exemption through NFA’s Electronic Exemption System. The first notice reaffirming these exemptions is due for the calendar year ending December 31, 2012 and annually thereafter. Any CPO or CTA that fails to file a notice reaffirming the exemption will be deemed to have requested a withdrawal of the exemption. If the exemption is deemed withdrawn, the CPO or CTA would be required to comply with the applicable Part 4 Requirements with respect to that pool.

Member CPOs and CTAs are encouraged to review the status of their exempt pools in order to ensure that they are in compliance with the new regulatory requirements.

Other Available Exemptive Relief

A CPO that currently operates a pool(s) pursuant to 4.13(a)(4) that will not qualify for a exemption under 4.13(a)(3) after December 31, 2012 may be able to avail itself of relief from certain regulatory requirements for qualifying pools by filing an exemption under Regulations 4.7, 4.12 or CFTC Advisory 18-96. Similarly, a CTA may be eligible under Regulation 4.7 for certain relief with respect to accounts of qualified eligible persons (QEPs). To determine whether you qualify for any of these exemptions, please consult CFTC Regulations – Part 4. All exemptions other than an exemption under CFTC Advisory 18-96 must be filed through NFA Electronic Exemption System at http://www.nfa.futures.org/NFA-electronic-filings/exemptions.HTML. An exemption under CFTC Advisory 18-96 must be filed in hard copy form with NFA’s Compliance Department.

To assist CPOs in the process of withdrawing a 4.13(a)(4) exemption and claiming another available exemption, NFA will modify the Electronic Exemption System to give CPOs that currently hold a 4.13(a)(4) exemption the ability to pre-file for an available exemption that would become effective on January 1, 2013. A CPO that elects to use the pre-filing option will not become subject to the additional reporting and disclosure requirements related to the newly claimed exemption until 2013. Please be aware that a CPO that elects not to use the pre-filing option and withdraws its 4.13(a)(4) exemption and files for another available exemption (other than a 4.13(a)(3) exemption) prior to December 31, 2012 will immediately become subject to the CFTC and NFA regulatory requirements related to the new exemption, including the requirement to file a certified annual report for 2012.

Withdrawing the 4.13(a)(4) Exemption

CPOs may withdraw an exemption by accessing NFA’s Electronic Exemption System at http://www.nfa.futures.org/NFA-electronic-filings/exemptions.HTML. Any CPO that elects to withdraw a 4.13(a)(4) exemption prior to December 31, 2012 and does not file a 4.13(a)(3) exemption or other available exemption, will become subject to all reporting and disclosure requirements under CFTC regulations and NFA rules for that pool. CPOs that are not eligible to claim another exemption for a current 4.13(a)(4) pool are not required to affirmatively withdraw that exemption since NFA will automatically terminate 4.13(a)(4) exemptions for all pools on December 31, 2012.

Cessation of Pool

CPOs that filed a 4.13(a)(3) or 4.13(a)(4) exemption for a pool that never commenced operations or that has subsequently ceased operating should update NFA’s records with the applicable information. The CPO must first withdraw the exemption by accessing NFA’s Electronic Exemption System at http://www.nfa.futures.org/NFA-electronic-filings/exemptions.HTML. At the time you withdraw the exemption, you will be directed to the Annual Questionnaire to delete or cease the pool.

Questions concerning these changes should be directed to Mary McHenry, Senior Manager, Compliance ([email protected] or 312-781-1420) or Tracey Hunt, Senior Manager, Compliance ([email protected] or 312-781-1284).

****

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.

Hedge Fund Schedule K-1 Update

New IRS Procedure Allows Partnerships to Electronically Deliver Schedule K-1s to Investors

Effective February 12, 2012, a new IRS Revenue Procedure allows partnerships to exclusively deliver electronic Schedule K-1 Statements (“K-1s”) instead of paper statements. In order to send electronic K-1s, a partnership (such as a hedge fund) must follow certain steps and obtain each partner’s consent. Many fund managers either have or will want to go through the process of switching to electronic K-1s. This post will provide more information on how to complete the process and managers should also feel free to contact us if there are additional questions.

Switching from Paper to Electronic K-1s

Provided that the electronic K-1 is an exact copy of the official Schedule K-1 and the partnership follows the procedures in the revenue procedure above, a partnership does not need to gain the approval of the IRS before switching to electronic K-1s. However, a partnership should be careful to comply with the requirements of the revenue procedure because a failure to do so could be deemed a failure to furnish a Schedule K-1 to partners possibly triggering penalties under Revenue Code Section 6722.

In general, a partnership must (1) provide certain disclosures, (2) obtain each partner’s consent in a manner that demonstrates that such partner has access to the technology required to access the electronic K-1, and (3) follow certain policies and procedures detailed in the revenue procedure.

1. Required Disclosures

When obtaining a partner’s consent the partnership must disclose the following:

i) That a partner will continue to receive paper K-1s unless the partner consents to receive electronic K-1s;

ii) If consent is effective until withdrawn or for a shorter duration;

iii) The procedure for obtaining a paper copy after consent;

iv) The procedure to withdraw consent, and when withdrawal of consent becomes effective;

v) Under what conditions the partnership will cease providing electronic K-1s to a partner;

vi) How a partner can update his contact information; and

vii) The hardware and software required to access electronic K-1s.

2. Obtaining Effective Consent

In addition to the disclosures above, a partnership must obtain consent from each partner

in a manner that demonstrates that the consenting partner has access to the technology that will be used to deliver the electronic K-1s. The simplest way to do this is to create a consent form that uses the same technology through which electronic K-1s will be delivered. For example, if a partnership intends to send electronic K-1s via secure email it should it send its consent form via secure email and require that each partner signs and sends back the consent form via secure email. Section 4 of the revenue procedure contains additional examples of how a partnership may obtain effective consent.

3. Required Policies and Procedures

In order for electronic delivery of K-1s to be permitted a partnership must institute policies and procedures so that

i) Electronic K-1s are identical copies of official K-1s;

ii) If electronic K-1s will be delivered by publication on the partnership’s website each partner must be given timely notice of the posting;

iii) If any email notice is returned as undeliverable, the partnership must, within 30 days of the return, email the notice to a correct email address or mail a paper copy of the notice;

iv) If electronic K-1s will be delivered by publication on the partnership’s website, a K-1 must be available on the website for the later of 12 months after the taxable year to which K-1 refers or 6 months after K-1 is posted; and

v) A partnership must deliver paper K-1s to any partner that withdraws consent to receive electronic K-1s.

****

Bart Mallon is a partner with Cole-Frieman Mallon & Hunt LLP, an investment management law firm. Bart can be reached directly at 415-868-5345.

FINRA Announces PFRD System for Form PF

Form PF Filing System Active

As we have discussed in previous posts, many hedge fund managers are going to be required to complete Form PF on either a quarterly or annual basis. The filing will be made through a new filing system administered by FINRA called the PFRD (Private Fund Reporting Depository). Many funds will have outside groups who will be accessing the system on their behalf. Smaller funds may be able to complete the form themselves.

If you have questions on the form or accessing the PFRD, please contact us.

The PFRD announcement from FINRA is reprinted below.

****

To: Super Account Administrators of Investment Advisers

From: FINRA Entitlement Group

Date: June 4, 2012

Re: New Electronic Private Fund Reporting Depository (PFRD) System Entitlement

The new electronic Private Fund Reporting Depository (PFRD) System facilitates investment adviser reporting of private fund information via Form PF. Beginning today, if you are an investment adviser that is required to report private fund information, you have the ability to entitle yourself as a user to this new application; update existing accounts; and/or create new accounts with this new application. Your current user ID and password remain valid. To determine if you are required to file Form PF, refer to the criteria below.

Complete and file Form PF if:

• You are registered or required to register with the SEC as an investment adviser, or you are registered or required to register with the Commodity Futures Trading Commission (CFTC) as a commodity pool operator or commodity trading advisor and you are also registered or required to register with the SEC as an investment adviser; and

• You manage one or more private funds; and

• You and your related persons, collectively, had at least $150 million in private fund assets under management as of the last day of your most recently completed fiscal year.

For more information on the PFRD System, refer to the information on the IARD web page: http://www.iard.com/pfrd/default.asp.

For questions concerning:

• Form PF filing requirements or policy issues, contact the SEC at (202) 551-6999 or [email protected]

• Technical questions regarding the PFRD System, contact the FINRA Gateway Call Center at (240) 386-4848.

• FINRA Entitlement, contact the FINRA Entitlement Group at (240) 386-4185.

****

Bart Mallon is a partner with Cole-Frieman Mallon & Hunt LLP, an investment management law firm. Bart can be reached directly at 415-868-5345.

Hedge Fund Events June 2012

The following are various hedge fund events happening this month. Please contact us if you would like us to add your event to this list.

****

June 3-5
Basta De Psoriasis. Nuevo Nicho!

l>

  • Sponsor: Marcus Evans
  • Event: Private Wealth Management Summit
  • Location: Amelia Island, FL
  • June 4

    June 4

    June 4

    June 4-8

    June 5

    June 5-8

    June 6

    June 6

    June 7

    June 7

    June 11

    June 11-12

    June 12-13

    • Sponsor: MFA
    • Event: Forum 2012
    • Location: Chicago, IL

    June 12-14

    June 13

    June 14

    June 14

    June 14

    June 18-19

    June 18-20

    June 19

    June 19

    June 19-20

    June 20-21

    June 21

    June 21

    June 21

    June 25

    June 25-27

    June 25-27

    June 25-27

    June 25-27

    June 26

    June 27

    June 28

    June 28

    ****

    Cole-Frieman Mallon & Hunt LLP provides legal services for hedge fund managers and other groups within the investment management industry. Bart Mallon can be reached directly at 415-868-5345.