Category Archives: cftc

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:

  1. Financial Institutions
  2. Insurance Companies
  3. Mutual Funds
  4. Certain commodity pools with $5 million or more of assets
  5. Certain organizations with, generally, $10 million or more of assets
  6. ERISA plans with $5 million or more of assets
  7. Certain governmental entities
  8. Certain broker-dealers and investment banks
  9. FCMs
  10. Floor brokers
  11. An individual with generally $10 million or more of assets
  12. 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.

Retail FOREX Registration Regulations Proposed

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Forex Managers Required to be Registered Under New Regulations

The much anticipated off-exchange retail foreign currency regulations were proposed today by the CFTC.  The release announcing the publication in the Federal Register is reprinted below and can be found here.  We will be providing an overview of the major provisions shortly.

The full proposed rules are posted here: Proposed Retail Forex Registration Rules

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Release: 5772-10

For Release: January 13, 2010

CFTC Seeks Public Comment on Proposed Regulations Regarding Retail FOREX Transactions

Washington, DC – The U.S. Commodity Futures Trading Commission (CFTC) today announced the publication in the Federal Register of proposed regulations concerning off-exchange retail foreign currency transactions. The proposed rules follow the passage of the Food, Conservation, and Energy Act of 2008, Pub. L. No. 110-246, 122 Stat. 1651, 2189-2204 (2008), also known as the “Farm Bill,” which amended the Commodity Exchange Act in several significant ways. In particular, the Farm Bill:

  • clarified the scope of the CFTC’s anti-fraud authority with respect to retail off-exchange foreign currency transactions;
  • provided the CFTC with the authority to register entities wishing to serve as counterparties to retail forex transactions as well as those who solicit orders, exercise discretionary trading authority and operate pools with respect to retail off-exchange foreign currency transactions; and
  • mandated minimum capital requirements for entities serving as counterparties to such transactions.

“These proposed rules for retail foreign exchange trading are important steps in implementing the additional consumer protections authorized in the 2008 Farm Bill,” CFTC Chairman Gary Gensler said. “The Commission looks forward to receiving and considering the public’s comments on this important issue.”

Pursuant to this authority, the Commission is proposing a comprehensive scheme that would put in place requirements for, among other things, registration, disclosure, recordkeeping, financial reporting, minimum capital, and other operational standards. Specifically, the proposed regulations would require the registration of counterparties offering retail foreign currency contracts as either futures commission merchants (FCMs) or retail foreign exchange dealers (RFEDs), a new category of registrant created by the Farm Bill. Persons who solicit orders, exercise discretionary trading authority and operate pools with respect to retail forex would also be required to register, either as introducing brokers, commodity trading advisors, commodity pool operators, or as associated persons of such entities. As was the case prior to the passage of the Farm Bill, “otherwise regulated” entities such as financial institutions and SEC-registered brokers or dealers remain able to serve as counterparties in such transactions under the oversight of their primary regulators.

The proposed regulations also include financial requirements designed to ensure the financial integrity of firms engaging in retail forex transactions and robust customer protections. For example, FCMs and RFEDs would be required to maintain net capital of $20 million plus 5% of the amount, if any, by which liabilities to retail forex customers exceed $10 million. Leverage in retail forex customer accounts would be subject to a 10-to-1 limitation. All retail forex counterparties and intermediaries would be required to distribute forex-specific risk disclosure statements to customers, and comply with comprehensive recordkeeping and reporting requirements.

Comments regarding the proposed regulations may be submitted by any of the means listed in the Federal Register release and should be received by the Commission within 60 days of the date of publication.

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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.

NFA Provides Social Networking Compliance Guidance

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Member Firms Subject to Increased Oversight & Compliance Responsibilities

In early December the National Futures Association (“NFA”) submitted two proposed amendments proposed amendments to the Commodity Futures Trading Commission (“CFTC”) regarding NFA Member Firms and their use of the internet and social media networks.  The amendments focus on communications by firms over the internet in various capacities including blogs, chat rooms, forums, and various social media websites (i.e. Facebook, Twitter, etc). While these amendments will increase the oversight responsibilities for Member Firms, it makes sense for the NFA to alert members to their responsibilities with regard to these growing forms of communication.  This post describes the two amendments, application to forex managers, the NFA social media podcast and the impact these amendments are likely to have on all NFA Member firms.  The NFA’s Notice to Members on this issue is also reprinted at the end of this post.

Overview of Amendments

Amendment to Rule 2-29

Rule 2-29 was broadened by the following changes (underline and strikethrough):

(h) Radio and Television Advertisements.

No Member shall use or directly benefit from any radio or television advertisement or any other audio or video advertisement distributed through media accessible by the public if the advertisement that makes any specific trading recommendation or refers to or describes the extent of any profit obtained in the past that can be achieved in the future unless the Member submits the advertisement to NFA’s Promotional Material Review Team for its review and approval at least 10 days prior to first use or such shorter period as NFA may allow in particular circumstances.

By broadening the rule the NFA effectively is requiring Member Firms to make sure all audio and video internet advertising (i.e. podcasts, youtube, voiceover presentations, etc) be reviewed prior to use.  Effectively groups who have used these channels to market their services will need to (i) have all such media reviewed by the NFA or (ii) take all media off of the internet.

Interpretive Notice: Internet Communication & Social Media

This interpretive notice is not so much an amendment of an existing Interpretive Notice as it is simply the creation of a new notice.  The full Interpretive Notice can be found in the proposed amendments link above, but I have also reprinted some of the more interesting parts of the notice:

The form of communication does not change the obligations of Members and Associates who host or participate in these groups, and electronic communications must comply with Compliance Rules 2-9, 2-29, 2-36, and 2-39.

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Therefore, content generated by the Member or Associate is subject to the requirements of NFA Compliance Rules 2-29, 2-36, or 2-39. The same is true for futures, options, or forex content written by a Member or Associate and posted on a third party’s site.

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Members should have policies regarding employee conduct. These policies could require employees to notify the employer if they participate in any on-line trading or financial communities and provide screen names so that the employer can monitor employees’ posts periodically. Alternatively, the policy could simply prohibit participation in such communities. The Member must, of course, take reasonable steps to enforce whatever policies it adopts.

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The issue becomes more complicated for user-generated comments responding to a Member or Associate’s blog and for Members and Associates who host chat rooms or forums. What is their responsibility for posts from customers or others over whom the Member or Associate has no direct control? When inadequately monitored, social networking sites may contain misleading information, lure customers into trades that they would not normally make, or be used in an attempt to manipulate prices.

The biggest take-away is that the NFA is expecting NFA Members to integrate a social media awareness into their current compliance program.  Accordingly, compliance programs (especially those parts dealing with Compliance Rules 2-9, 2-29, 2-36, and 2-39) will need to be updated appropriately to reflect the requirements of the Interpretive Notice.  Member Firms will also need to vigillantly follow their new/revised compliance procedures and monitor their employees – it will be very easy for the NFA to do simple internet searches and potentially “catch” firms who do not adequately comply the Interpretive Release.

Issues for Forex Managers

Forex is specifically discussed throughout the Interpretive Notice so it is clear that the NFA’s intent is to make sure that forex communications, especially, are subject to monitoring and oversight.  Currently this rule applies to those firms who are NFA Member Firms (currently registered) and, in the future, after the forex registration rules have been adopted, it will apply to all registered forex firms (CTAs, CPOs, IBs and FDMs/FCMs).  The NFA has made it clear before that forex managers/traders are in the NFA’s regulatory cross-hairs and this Interpretive Notice reinforces that impression.

NFA Podcast on Social Media

The NFA has produced a podcast titled “Use and Supervision of Online Social Networking Communication” and can be found with other NFA produced podcasts.  This podcast is helpful to provide Member Firms with some helpful guidance on some of the major issues to consider when developing a social media policy to comply with the Interpretive Notice and Rule amendment.  There are a number of considerations that firms will need to make and the social media policy must be tailored to the business practices of the firm.  There are likely to be a number of hot button issues which will develop regarding Member Firms and this policy, especially concerning oversight of associated persons.  The podcast also hints at one of the big compliance issues which managers should be aware of – the reposting of content.  Because internet posts are routinely “scraped” from the original website and reposted on other websites, Member Firms should be aware of this issue and create appropriate procedures.

It is recommended that compliance officers listen to this podcast when developing their social media compliance policies and procedures.

Impact on NFA Members

I view these amendments as relatively major – because so many firms use the internet for marketing and because prior NFA rules essentially did not address the issues of social networks there has been a bit of a regulatory gap.  However, I do think that the NFA is doing the right thing by publicly notifying Member Firms that this will be a compliance issue going forward – this is much better than a retroactive interpretation of existing NFA compliance rules. One thing I think that member firms should be especially concerned with is potential liability for what 3rd parties do with information which is posted online.  On the podcast, the NFA specifically suggested that firms should be policing their content and actively follow how it might be used by 3rd parties which is obviously problematic given the way the internet works.

Because these amendments affect both a current NFA Rule as well as the NFA’s Interpretive Releases, these amendments may make their way (eventually) onto the various exams (Series 3, Series 30, Series 34 especially).

These rules are also likely to create a compliance nightmare for many firms which have utilized the internet previously (and social media specifically).

Compliance Recommendations

The safest approach to social media compliance for all NFA Member Firms is to not allow the use any social media websites or other means of internet communication which would subject the firm to have a robust social media policy (including record retention policy for such media).  It will be much less costly to put a blanket prohibition on these types of activities than to develop and monitor such a policy.  For those firms who are willing to spend the time and money to implement a policy, such firms should make sure that all major aspects of the amendments are included in the policy.  Such items to consider will include: internet and social media content review, recordkeeping and storage, oversight of employees (including spot-checking internet posts and activity), and reposting review procedures, among other issues to consider.  It will be absolutely critical to make sure the policy addresses all issues raised in the Interpretive Notice and podcast because the NFA has not minced words – this is going to be a hot-button issue and it will be something the NFA will actively pursue during examinations.

Of course we will be able to provide greater guidance over the next few months as we see how the NFA handles this issue during and outside of examinations.

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Notice to Members I-10-01

January 5, 2010

Effective Dates of NFA Requirements Regarding On-Line Advertising and Social Networking Groups

NFA has received notice from the Commodity Futures Trading Commission (“CFTC”) that NFA may make effective certain proposed amendments regarding the use of internet and on-line social networking groups when communicating with the public. The Interpretive Notice entitled “Use of On-Line Social Networking Groups to Communicate with the Public” makes clear that on-line communications are subject to the same standards as other types of communications with the public and provides guidance to Members to meet their responsibilities in this area. The Interpretive Notice became effective on December 24, 2009.

A related amendment to Compliance Rule 2-29(h) requires that any audio or video distributed through media accessible by the public (e.g., through the internet) that makes any specific trading recommendation or refers to the extent of profit previously obtained or achievable in the future must be submitted to NFA for review and approval at least 10 days prior to first use. In this way the amendment subjects certain on-line advertising to the same requirements as similar television and radio advertising. To allow Members sufficient time to submit these types of advertisements to NFA for approval, the amendment becomes effective as of February 1, 2010. Accordingly, any audio or video advertisements that a Member posts on-line after January 31, 2010, must have been previously reviewed and approved by NFA.

NFA’s December 8, 2009, submission letter to the CFTC contains a more detailed explanation of the changes. You can access an electronic copy of the submission letter at: http://www.nfa.futures.org/news/PDF/CFTC/CR2-29_IntNotc_re_OnLine_Social_Networking_120209.pdf.

Questions concerning these changes should be directed to Sharon Pendleton, Director, Compliance ([email protected] or 312-781-1401) or Michael A. Piracci, Senior Attorney ([email protected] or 312-781-1419).

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Other related hedge fund law blog articles include:

If you are a manager or firm that needs to register as a CTA or CPO, or if you are contemplating registration, please contact Bart Mallon, Esq. of Cole-Frieman & Mallon LLP at 415-868-5345.

NFA Annual Questionnaire

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Reminder to NFA Member Firms

As part of the annual processes and procedures NFA Members will need to make sure that they complete the NFA Annual Questionnaire.  As discussed below in the NFA’s most recent notice to members, it is important that NFA Members complete the questionnaire because some of the answers will appear as BASIC entries sometime within the first half of 2010 (for an image of this, please see Notice to Members I-10-02, reprinted in full below).  Below we have provided an overview of the major items which are addressed on the questionnaire.  NFA Members are urged to complete the NFA’s Self Exam Checklist prior to logging in to complete the questionnaire.

Questionnaire Items

The annual questionnaire actually requires the NFA Member to provide fairly detailed information on the nature of the Member’s business and the extent in which the Member participates in certain aspects of the industry such as trading in the forex markets.  Each firm will need to complete a section called “Firm & DR Information” as well as one section (or multiple sections if applicable) devoted to CTA, CPO, IB, or FCM specific questions.  Below we’ve outlined the major categories.

CTA Questionnaire

The central part of the CTA questionnaire focuses on information related to the trading program.  Such information requested includes: nominal AUM, forex account information, number of accounts trading Securities Futures Products (SFPs)*, most recent disclosure document date, whether any exemptions exist, types of investors, etc.

* A securities futures contract is a legally binding agreement between two parties to purchase or sell in the future a specific quantity of shares of a single equity security or narrow-based securities Index (e.g. products traded on One Chicago or NQLX). It does not include broad-based indices such as the S&P 500 or Dow.

CPO Questionnaire

The central part of the CPO questionnaire focuses on information related to the commodity pool.  Such information requested includes: pool trading information, question on restrictions (if any), forex trading information (if applicable), SFP trading (if applicable), most recent disclosure document date, whether any exemptions exist, etc.

Firm & DR Information

In the Firm & DR Information section you will need to include certain information on the preparer (name, title, phone, email) and you will need to complete firm information and disaster recovery information.

Firm Information

For the firm information there are a number of questions regarding the number of accounts to which the firm is currently providing advice, whether the firm is engaged in forex activities, the extent to which the firm utilizes advertising (tv/radio, print, internet), and/or whether the firm is registered in other capacity.  Importantly, there is a question regarding whether the firm has completed the self-exam checklist within the last 12 months.

Disaster Recovery Information

All NFA Member firms are required to have addressed disaster recovery.  For the purposes of the questionnaire, Members are required to provide primary and secondary contact information.  Specifically, the instructions are as follows:

For purposes of business continuity and disaster recovery, members are required to provide NFA with the name and contact information for one or two persons who NFA can contact during an emergency. Since this information will serve as an alternative contact in the event you are unable to continue doing business at your main location, the contact information that you provide should be different from that of your main location.

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Notice to Members I-10-02

January 6, 2010

Reminder to all Members to complete new questions in Annual Questionnaire assessing Member’s futures-related and off-exchange forex business

On November 30, 2009, NFA issued Notice to Members I-09-21 [HFLB Note: reprinted directly below] requesting all Members to complete a series of new questions located in the Annual Questionnaire assessing their futures-related business. Although some NFA Members have complied with this request, many have not. It is critical that Members access and complete questions in the Firm and DR Information section of the Annual Questionnaire as soon as possible. This applies not only to Members trading on-exchange futures products but also Members trading in the off-exchange foreign currency (forex) market.

Beginning in early 2010 NFA’s BASIC system will display information reflecting whether firms are actively engaged in futures-related business activity or not. If the questions are not answered, the answers will default to no activity, which is what will be displayed in BASIC, as illustrated below.

For additional information and instructions on accessing the Annual Questionnaire, click here.

If you have any questions, please contact NFA’s Information Center at 800-621-3570 or 312-781-1410.

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Notice I-09-21

November 30, 2009

NFA adds new questions to Annual Questionnaire to assess Member’s futures-related business

NFA has approximately 500 firms that are NFA Members but have represented to NFA via their Annual Questionnaire that they are not doing any business that requires membership (“Inactive firms”). Almost universally, these Members indicate that they maintain their membership because they may do business in the future.

Since 2006, NFA has taken several Member Responsibility Actions against Member firms that had told NFA they were inactive. These actions were taken after NFA obtained information from reviewing the internet, through contacts with other NFA Members, and by receiving customer complaints suggesting that these firms were in fact active.

Due to these disciplinary actions, NFA’s Board of Directors requested that beginning in early 2010 NFA’s BASIC system display information reflecting whether firms are actively engaged in futures-related business activity or not. Presumably, if a Member is identified in BASIC as not conducting futures-related business, this will raise a “red flag” to potential customers who are being solicited by an Inactive Firm.

Specifically, BASIC will contain information regarding whether or not the Member has on-exchange customer accounts, manages customer accounts, operates pools, is engaged in retail off-exchange foreign currency activities and/or is soliciting customer business. This information will be based solely on information that Member firms provide in their responses to the questions in the Firm and DR Information section of the Annual Questionnaire.

NFA has re-designed this portion of the Annual Questionnaire by adding new questions and moving certain questions from other sections. Firms may update the answers in the Firm and DR Information section of the Annual Questionnaire at any time.

It is critical that Members access and complete questions in the Firm and DR Information section of the Annual Questionnaire as soon as possible. If the questions are not answered, the answers will default to no activity, which is what will be displayed in BASIC.

Please follow these instructions to access the Annual Questionnaire and provide the required information.

1. Open the Questionnaire system using this link: https://www.nfa.futures.org/AppEntry/Redirect.aspx?app=SPECIAL_QUESTION

2. Enter your ORS ID and password to logon.

3. From the “Online Questionnaire Index” screen, select “Firm and DR Information” under “Questionnaire Type.” (In addition, if you have not completed your most recent Questionnaire, you should update the previous version at this time.)

4. Update the Preparer Information on the next screen, if necessary, and then click “Next.”

5. To respond to this special request,

a. Answer the questions listed at the top of the screen under the heading “Please address the following questions regarding you firm’s business operations”.

b. After answering the applicable question(s), scroll to the bottom of the screen and click the “Submit Filing” button.

c. The system will then confirm that you submitted the updated Questionnaire to NFA.

If you have any questions about this Notice, please contact NFA’s Information Center at 800.621.3570 or 312.781.1410.

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Other articles related to CTAs and CPOs include:

If you are a manager or firm that needs to register as a CTA or CPO, or if you are contemplating registration, please contact Bart Mallon, Esq. of Cole-Frieman &  Mallon LLP at 415-868-5345.

Qualified Eligible Person (QEP) Definition

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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 Reporting Requirements | Commodity Pool Operator Compliance

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CFTC Regulation 4.22 Overview

CFTC registered commodity pool operators have a number of regulatory and compliance issues to be aware of.  In addition to a having a compliance program which addresses the business and regulatory issues applicable to the manager, one of the more important compliance requirements is found in CFTC Regulation 4.22 which provides the reporting framework with respect to (i) periodic reports to investors and (ii) annual reports to investors and the NFA.  While many hedge fund administration firms provide a monthly or quarterly report/statement, generally those reports/statements do not provide the detailed information that is required for commodity pools.  This article provides an overview of the information required to be included in the periodic and annual statements and will also discuss other aspects of the regulation.

Overview of the Statements

Generally CPOs are required to distribute, within 30 days of end of the required period (see below), an account statement to each investor the fund.  The account statement must included an itemized “statement of operations” and “statement of changes in net assets” which is presented and computed in accordance with generally accepted accounting principles (“GAAP”).

The statement of operations must separately itemize the following:

  • Realized net gain/loss on commodity interest positions
  • Unrealized net gain/loss on commodity interest positions
  • Total net gain/loss on other transactions (including interest and dividends earned), unless the gain/loss from trading are part of a related trading strategy (see 4.22(e)(3))
  • Total management fees during period
  • Total advisory fees during period (including performance fees/allocations)
  • Total brokerage commissions during period
  • Total of other fees for investment transactions
  • Total of other expenses incurred or accrued by the fund during period

Note: most of the above items must be itemized according to 4.22(e)(1) and special allocations should be noted according to 4.22(e)(2).

The statement of changes in net assets must separately itemize the following:

  • Fund NAV at beginning of period
  • Fund NAV at end of period
  • Total contributions to fund during period
  • Total redemptions (voluntary or involuntary) during period
  • Total fund income/loss during period
  • Total value of investor’s interest in the fund at the end of the period

Monthly or Quarterly Commodity Pool Reporting

For funds which have more than $500,000 of assets, the account statements must be sent to investors on a monthly basis.  The account statement is due to the investor within 30 days of the end of the month.  For funds which have less than $500,000 of assets, the account statements must be sent to investors on (at least) a quarterly basis.  The account statement is due to the investor within 30 days of the end of the quarter.  In both cases, a final report for the year does not need to be sent to fund investors if the CPO’s annual report (described below) is sent to pool participants within 45 calendar days after the end of the fiscal year.

Annual Reporting Requirement

The CPO will need to provide, within 90 days after the end of the fund’s fiscal year (or within 90 days of the cessation of trading if the fund closes), an annual report to (i) each investor in the fund and (ii) the NFA.  The annual report must be presented and computed in accordance with GAAP consistently applied and must be audited by an independent public accountant.*

Annual report must include:

  • Fund NAV for the preceding two fiscal years
  • Total value of investor’s interest in the fund at the end of the preceding two fiscal years
  • Statement of Financial Condition for the fund’s fiscal year and preceding fiscal year
  • “statement of operations” and “statement of changes in net assets”
  • Footnotes if required to make statements not misleading (including certain information on underlying funds if the fund invests in other commodity pools)
  • Certain information if there is more than onve ownership class or series.

In the event that the CPO will not be able to file the annual report with the NFA within the 90 day period, the CPO can file an extension under certain circumstances.  It is very important that the CPO provides the annual report on time or files for the exemption.  If a CPO cannot file the report within the time frame required and does not file for the exemption, the NFA will take action against the CPO see CFTC Fines CPOs For Late Annual Reports.

*Note: if the fund is organized offshore then the CPO may be able to prepare and calculate the annual report in accordance with International Financial Reporting Standards issued by the International Accounting Standards Board, please generally see 4.22(d)(2).

Statements Required to be Signed by Principals

Both the account statement and the annual report must contain a signed affirmation (usually provided by a principal or associated person of the CPO) that the information contained in the account statement is accurate and complete.

Such information shall include:

  • Name of individual signing
  • Capacity of individual signing
  • Name of the CPO
  • Name of the fund

Other Items

Regulation 4.22 is intricate and there are many specifics for certain fund managers.  Specifically, if a commodity fund invests in other commodity funds there are certain rules which I have not covered in-depth in this overview.

With regard to the fiscal year, most commodity pools will elect to have their fiscal year be the calendar year.  A fund can elect to have the fiscal year end on a different date under certain circumstances, see generally 4.22(g).

With regard to account statements and annual reports, these can be provided to fund investors electronically (either through email or through a password-protected website).  In the event a fund manager wants to provide statements in this way, the manager will need to make sure the commodity pool’s offering documents specifically discusses this possibility.  Additionally, the manager should make sure the fund’s subscription documents include a specific place for the investor to consent to the electronic delivery of the account statement or annual report.

Conclusion

Regulation 4.22 is detailed and, for some groups, complicated.  The NFA has shown a willingness to send a message to firms which do not follow NFA rules or CFTC regulations.  If you are a CPO and have questions with regard to your account statements or annual reports, please feel free to contact us.

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Other related hedge fund law articles include:

Bart Mallon, Esq. of Cole-Frieman & Mallon LLP runs the Hedge Fund Law Blog as well as the forex registration website.  He can be reached directly at 415-868-5345.

CFTC Amends CPO Reporting Regulations

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CFTC Regulation 4.22 Amended

Earlier this year the Commodities Futures Trading Commission (“CFTC”) proposed amendments to certain Part 4 Regulations.  Last week, after a lengthy comment and revision period, the CFTC published the amendments in the Federal Register.  The effective date of the amendments is December 9, 2009 and will apply to commodity pool annual reports for fiscal years ending December 31, 2009 and later.  [HFLB note: as we have discussed earlier, spot forex hedge fund managers generally are not required to be registered as forex CPOs with the CFTC.  However, when the forex registration rules go into effect, such forex CPOs are going to need to be aware of these reporting requirements.]

The following press release can be found here. The full discussion of the CFTC’s amendment making process and the amendments can be found in Federal Register at 74 FR 57585.  For more information regarding commodity trading and regulation, please see our CTA/CPO Registration and Compliance Guide.

The full amended text of CFTC Regulation 4.22 is reprinted below.

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Release: 5746-09
For Release: November 9, 2009

CFTC Adopts Amendments to Reporting Requirements for Commodity Pool Operators

Washington, DC —The Commodity Futures Trading Commission (CFTC) has adopted amendments to its regulations regarding periodic and annual reporting requirements applicable to commodity pool operators (CPOs). The amendments:

  • specify detailed information that must be included in the periodic account statements and annual reports for commodity pools with more than one series or class of ownership interest;
  • clarify that the periodic account statements must disclose either the net asset value per outstanding participation unit in the pool or the total value of a participant’s interest or share in the pool;
  • extend the time period for filing and distributing annual reports of commodity pools that invest in other funds;
  • codify existing Commission staff interpretations regarding the proper accounting treatment and financial statement presentation of certain income and expense items in the periodic account statements and annual reports;
  • codify exemptions staff has provided to CPOs that operate offshore funds that elected to use non-United States GAAP in the preparation of pool financial statements;
  • streamline annual reporting requirements for pools ceasing operation; and
  • clarify and update several other requirements for periodic and annual reports prepared and distributed by CPOs.

The amendments will become effective 30 days from publication in the Federal Register; changes that affect annual reporting requirements will be applicable to commodity pool annual reports for fiscal years ending December 31, 2009 and later.

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Full Text of Regulation 4.22 (effective December 9, 2009)

PART 4—COMMODITY POOL OPERATORS AND COMMODITY TRADING ADVISORS
Subpart B—Commodity Pool Operators

§ 4.22   Reporting to pool participants.

(a) Except as provided in paragraph (a)(4) or (a)(6) of this section, each commodity pool operator registered or required to be registered under the Act must periodically distribute to each participant in each pool that it operates, within 30 calendar days after the last date of the reporting period prescribed in paragraph (b) of this section, an Account Statement, which shall be presented in the form of a Statement of Operations and a Statement of Changes in Net Assets, for the prescribed period. These financial statements must be presented and computed in accordance with generally accepted accounting principles consistently applied. The Account Statement must be signed in accordance with paragraph (h) of this section.

(1) The portion of the Account Statement which must be presented in the form of a Statement of Operations must separately itemize the following information:

(i) The total amount of realized net gain or loss on commodity interest positions liquidated during the reporting period;

(ii) The change in unrealized net gain or loss on commodity interest positions during the reporting period;

(iii) The total amount of net gain or loss from all other transactions in which the pool engaged during the reporting period, including interest and dividends earned on funds not paid as premiums or used to margin the pool’s commodity interest positions;

(iv) The total amount of all management fees during the reporting period;

(v) The total amount of all advisory fees during the reporting period;

(vi) The total amount of all brokerage commissions during the reporting period;

(vii) The total amount of other fees for commodity interest and other investment transactions during the reporting period; and

(viii) The total amount of all other expenses incurred or accrued by the pool during the reporting period.

(2) The portion of the Account Statement that must be presented in the form of a Statement of Changes in Net Assets must separately itemize the following information:

(i) The net asset value of the pool as of the beginning of the reporting period;

(ii) The total amount of additions to the pool, whether voluntary or involuntary, made during the reporting period;

(iii) The total amount of withdrawals from and redemption of participation units in the pool, whether voluntary or involuntary, for the reporting period;

(iv) The total net income or loss of the pool during the reporting period;

(v) The net asset value of the pool as of the end of the reporting period; and

(vi)(A) The net asset value per outstanding participation unit in the pool as of the end of the reporting period, or

(B) The total value of the participant’s interest or share in the pool as of the end of the reporting period.

(3) The Account Statement must also disclose any material business dealings between the pool, the pool’s operator, commodity trading advisor, futures commission merchant, or the principals thereof that previously have not been disclosed in the pool’s Disclosure Document or any amendment thereto, other Account Statements or Annual Reports.

(4) For the purpose of the Account Statement delivery requirement, including any Account Statement distributed pursuant to §4.7(b)(2) or 4.12(b)(2)(ii), the term “participant” does not include a commodity pool operated by a pool operator that is the same as, or that controls, is controlled by, or is under common control with, the pool operator of a pool in which the commodity pool has invested.

(5) Where the pool is comprised of more than one ownership class or series, information for the series or class on which the account statement is reporting should be presented in addition to the information presented for the pool as a whole; except that, for a pool that is a series fund structured with a limitation on liability among the different series, the account statement is not required to include consolidated information for all series.

(6) A commodity pool operator of a pool that meets the conditions specified in paragraph (d)(2)(i) of this section and has filed notice pursuant to paragraph (d)(2)(ii) of this section may elect to follow the same accounting treatment with respect to the computation and presentation of the account statement.

(b) The Account Statement must be distributed at least monthly in the case of pools with net assets of more than $500,000 at the beginning of the pool’s fiscal year, and otherwise at least quarterly; Provided, however, That an Account Statement for the last reporting period of the pool’s fiscal year need not be distributed if the Annual Report required by paragraph (c) of this section is sent to pool participants within 45 calendar days after the end of the fiscal year. The requirement to distribute an Account Statement shall commence as of the date the pool is formed as specified in paragraph (g)(1) of this section.

(c) Except as provided in paragraph (c)(7) or (c)(8) of this section, each commodity pool operator registered or required to be registered under the Act must distribute an Annual Report to each participant in each pool that it operates, and must electronically submit a copy of the Report and key financial balances from the Report to the National Futures Association pursuant to the electronic filing procedures of the National Futures Association, within 90 calendar days after the end of the pool’s fiscal year or the permanent cessation of trading, whichever is earlier; Provided, however, that if during any calendar year the commodity pool operator did not operate a commodity pool, the pool operator must so notify the National Futures Association within 30 calendar days after the end of such calendar year. The Annual Report must be affirmed pursuant to paragraph (h) of this section and must contain the following:

(1) The net asset value of the pool as of the end of each of the pool’s two preceding fiscal years.

(2)(i) The net asset value per outstanding participation unit in the pool as of the end of each of the pool’s two preceding fiscal years, or (ii) The total value of the participant’s interest or share in the pool as of the end of each of the pool’s two preceding fiscal years.

(3) A Statement of Financial Condition as of the close of the pool’s fiscal year and preceding fiscal year.

(4) Statements of Operations, and Changes in Net Assets, for the period between (i) The later of: (A) The date of the most recent Statement of Financial Condition delivered to the National Futures Association pursuant to this paragraph(c); or (B) The date of the formation of the pool; and (ii) The close of the pool’s fiscal year, together with Statements of Operations, and Changes in Net Assets for the corresponding period of the previous fiscal year.

(5) Appropriate footnote disclosure and such further material information as may be necessary to make the required statements not misleading. For a pool that invests in other funds, this information must include, but is not limited to, separately disclosing the amounts of income, management and incentive fees associated with each investment in an investee fund that exceeds five percent of the pool’s net assets. The management and incentive fees associated with an investment in an investee fund that is less than five percent of the pool’s net assets may be combined and reported in the aggregate with the income, management and incentive fees of other investee funds that, individually, represent an investment of less than five percent of the pool’s net assets. If the commodity pool operator is not able to obtain the specific amounts of management and incentive fees charged by an investee fund, the commodity pool operator must disclose the percentage amounts and computational basis for each such fee and include a statement that the CPO is not able to obtain the specific fee amounts for this fund;

(6) Where the pool is comprised of more than one ownership class or series, information for the series or class on which the financial statements are reporting should be presented in addition to the information presented for the pool as a whole; except that, for a pool that is a series fund structured with a limitation on liability among the different series, the financial statements are not required to include consolidated information for all series.

(7) For a pool that has ceased operation prior to, or as of, the end of the fiscal year, the commodity pool operator may provide the following, within 90 days of the permanent cessation of trading, in lieu of the annual report that would otherwise be required by § 4.22(c) or § 4.7(b)(3):

(i) Statements of Operations and Changes in Net Assets for the period between—

(A) The later of: (1) The date of the most recent Statement of Financial Condition filed with the National Futures Association pursuant to this paragraph (c); or (2) The date of the formation of the pool; and (B) The close of the pool’s fiscal year or the date of the cessation of trading, whichever is earlier; and

(ii)(A) An explanation of the winding down of the pool’s operations and written disclosure that all interests in, and assets of, the pool have been redeemed, distributed or transferred on behalf of the participants;

(B) If all funds have not been distributed or transferred to participants by the time that the final report is issued, disclosure of the value of assets remaining to be distributed and an approximate timeframe of when the distribution will occur. If the commodity pool operator does not distribute the remaining pool assets within the timeframe specified, the commodity pool operator must provide written notice to each participant and to the National Futures Association that the distribution of the remaining assets of the pool has not been completed, the value of assets remaining to be distributed, and a time frame of when the final distribution will occur.

(C) If the commodity pool operator will not be able to liquidate the pool’s assets in sufficient time to prepare, file and distribute the final annual report for the pool within 90 days of the permanent cessation of trading, the commodity pool operator must provide written notice to each participant and to National Futures Association disclosing:

(1) The value of investments remaining to be liquidated, the timeframe within which liquidation is expected to occur, any impediments to liquidation, and the nature and amount of any fees and expenses that will be charged to the pool prior to the final distribution of the pool’s funds;

(2) Which financial reports the commodity pool operator will continue to provide to pool participants from the time that trading ceased until the final annual report is distributed, and the frequency with which such reports will be provided, pursuant to the pool’s operative documents; and

(3) The timeframe within which the commodity pool operator will provide the final report.

(iii) A report filed pursuant to this paragraph (c)(7) that would otherwise be required by this paragraph (c) is not required to be audited in accordance with paragraph (d) of this section if the commodity pool operator obtains from all participants written waivers of their rights to receive an audited Annual Report, and at the time of filing the Annual Report with National Futures Association, certifies that it has received waivers from all participants. The commodity pool operator must maintain the waivers in accordance with § 1.31 of this chapter and must make the waivers available to the Commission or National Futures Association upon request.

(8) For the purpose of the Annual Report distribution requirement, including any annual report distributed pursuant to §4.7(b)(3) or 4.12(b)(2)(iii), the term “participant” does not include a commodity pool operated by a pool operator that is the same as, or that controls, is controlled by, or is under common control with, the pool operator of a pool in which the commodity pool has invested; Provided, That the Annual Report of such investing pool contain financial statements that include such information as the Commission may specify concerning the operations of the pool in which the commodity pool has invested.

(d)

(1) The financial statements in the Annual Report must be presented and computed in accordance with generally accepted accounting principles consistently applied and must be audited by an independent public accountant. The requirements of § 1.16(g) of this chapter shall apply with respect to the engagement of such independent public accountants, except that any related notifications to be made may be made solely to the National Futures Association, and the certification must be in accordance with § 1.16 of this chapter, except that the following requirements of that section shall not apply:

(i) The audit objectives of § 1.16(d)(1) concerning the periodic computation of minimum capital and property in segregation;

(ii) All other references in § 1.16 to the segregation requirements; and

(iii) Section 1.16(c)(5), (d)(2), (e)(2), and (f).

(2)

(i) The financial statements in the Annual Report required by this section or by § 4.7(b)(3) may be presented and computed in accordance with International Financial Reporting Standards issued by the International Accounting Standards Board if the following conditions are met:

(A) The pool is organized under the laws of a foreign jurisdiction;

(B) The Annual Report will include a condensed schedule of investments, or, if required by the alternate accounting standards, a full schedule of investments;

(C) The preparation of the pool’s financial statements under International Financial Reporting Standards is not inconsistent with representations set forth in the pool’s offering memorandum or other operative document that is made available to participants;

(D) Special allocations of ownership equity will be reported in accordance with § 4.22(e)(2); and

(E) In the event that the International Financial Reporting Standards require consolidated financial statements for the pool, such as a feeder fund consolidating with its master fund, all applicable disclosures required by generally accepted accounting principles for the feeder fund must be presented with the reporting pool’s consolidated financial statements.

(ii) The commodity pool operator of a pool that meets the conditions specified in this paragraph (d)(2) may claim relief from the requirement in paragraph (d)(1) of this section by filing a notice with the National Futures Association, within 90 calendar days after the end of the pool’s fiscal year.

(A) The notice must contain the name, main business address, main telephone number and the National Futures Association registration identification number of the commodity pool operator, and name and the identification number of the commodity pool.

(B) The notice must include representations regarding the pool’s compliance with each of the conditions specified in § 4.22(d)(2)(A) through (D), and, if applicable, (E); and

(C) The notice must be signed by the commodity pool operator in accordance with paragraph (h) of this section.

(e)

(1) The Statement of Operations required by this section must itemize brokerage commissions, management fees, advisory fees, incentive fees, interest income and expense, total realized net gain or loss from commodity interest trading, and change in unrealized net gain or loss on commodity interest positions during the pool’s fiscal year. Gains and losses on commodity interests need not be itemized by commodity or by specific delivery or expiration date.

(2)

(i) Any share of a pool’s profits or transfer of a pool’s equity which exceeds the general partner’s or any other class’s share of profits computed on the general partner’s or other class’s pro rata capital contribution are ‘‘special allocations.’’ Special allocations of partnership equity or other interests must be recognized in the pool’s Statement of Operations in the same period as the net income, interest income, or other basis of computation of the special allocation is recognized. Special allocations must be recognized and classified either as an expense of the pool or, if not recognized as an expense of the pool, presented in the Statement of Operations as a separate, itemized allocation of the pool’s net income to arrive at net income available for pro rata distribution to all partners.

(ii) Special allocations of ownership interest also must be reported separately in the Statement of Partners’ Equity, in addition to the pro-rata allocations of net income, as to each class of ownership interest.

(3) Realized gains or losses on regulated commodities transactions presented in the Statement of Operations of a commodity pool may be combined with realized gains or losses from trading in non-commodity interest transactions, provided that the gains or losses to be combined are part of a related trading strategy. Unrealized gains or losses on open regulated commodity positions presented in the Statement of Operations of a commodity pool may be combined with unrealized gains or losses from open positions in non-commodity positions, provided that the gains or losses to be combined are part of a related trading strategy.

(f)

(1)

(i) In the event the commodity pool operator finds that it cannot distribute the Annual Report for a pool that it operates within the time specified in paragraph (c) of this section without substantial undue hardship, it may file with the National Futures Association an application for extension of time to a specified date not more than 90 calendar days after the date as of which the Annual Report was to have been distributed. The application must be made by the pool operator and must:

(A) State the name of the pool for which the application is being made;

(B) State the reasons for the requested extension;

(C) Indicate that the inability to make a timely filing is due to circumstances beyond the control of the pool operator, if such is the case, and describe briefly the nature of such circumstances;

(D) Contain an undertaking to file the Annual Report on or before the date specified in the application; and

(E) Be filed with the National Futures Association prior to the date on which the Annual Report is due.

(ii) The application must be accompanied by a letter from the independent public accountant answering the following questions:

(A) What specifically are the reasons for the extension request?

(B) Do you have any indication from the part of your audit completed to date that would lead you to believe that the commodity pool operator was or is not meeting the recordkeeping requirements of this part 4 or was or is not complying with the §4.20(c) prohibition on commingling of property of any pool with the property of any other person?

(iii) Within ten calendar days after receipt of an application for an extension of time, the National Futures Association shall:

(A) Notify the commodity pool operator of the grant or denial of the requested extension, or

(B) Indicate to the pool operator that additional time is required to analyze the request, in which case the amount of time needed will be specified.

(2) In the event a commodity pool operator finds that it cannot obtain information necessary to prepare annual financial statements for a pool that it operates within the time specified in either paragraph (c) of this section or § 4.7(b)(3)(i), as a result of the pool investing in another collective investment vehicle, it may claim an extension of time under the following conditions:

(i) The commodity pool operator must, within 90 calendar days of the end of the pool’s fiscal year, file a notice with the National Futures Association, except as provided in paragraph (f)(2)(v) of this section.

(ii) The notice must contain the name, main business address, main telephone number and the National Futures Association registration identification number of the commodity pool operator, and name and the identification number of the commodity pool.

(iii) The notice must state the date by which the Annual Report will be distributed and filed (the ‘‘Extended Date’’), which must be no more than 180 calendar days after the end of the pool’s fiscal year. The Annual Report must be distributed and filed by the Extended Date.

(iv) The notice must include representations by the commodity pool operator that:

(A) The pool for which the Annual Report is being prepared has investments in one or more collective investment vehicles (the ‘‘Investments’’);

(B) For all reports prepared under paragraph (c) of this section and for reports prepared under § 4.7(b)(3)(i) that are audited by an independent public accountant, the commodity pool operator has been informed by the independent public accountant engaged to audit the commodity pool’s financial statements that specified information required to complete the pool’s annual report is necessary in order for the accountant to render an opinion on the commodity pool’s financial statements. The notice must include the name, main business address, main telephone number, and contact person of the accountant; and

(C) The information specified by the accountant cannot be obtained in sufficient time for the Annual Report to be prepared, audited, and distributed before the Extended Date.

(D) For unaudited reports prepared under § 4.7(b)(3)(i), the commodity pool operator has been informed by the operators of the Investments that specified information required to complete the pool’s annual report cannot be obtained in sufficient time for the Annual Report to be prepared and distributed before the Extended Date.

(v) For each fiscal year following the filing of the notice described in paragraph (f)(2)(i) of this section, for a particular pool, it shall be presumed that the particular pool continues to invest in another collective investment vehicle and the commodity pool operator may claim the extension of time; Provided, however, that if the particular pool is no longer investing in another collective investment vehicle, then the commodity pool operator must file electronically with the National Futures Association an Annual Report within 90 days after the pool’s fiscal year-end accompanied by a notice indicating the change in the pool’s status.

(vi) Any notice or statement filed pursuant to this paragraph (f)(2) must be signed by the commodity pool operator in accordance with paragraph (h) of this section.

(g)

(1) A commodity pool operator may initially elect any fiscal year for a pool, but the first fiscal year may not end more than one year after the pool’s formation. For purposes of this section, a pool shall be deemed to be formed as of the date the pool operator first receives funds, securities or other property for the purchase of an interest in the pool.

(2) If a commodity pool operator elects a fiscal year other than the calendar year, it must give written notice of the election to all participants and must file the notice with the National Futures Association within 90 calendar days after the date of the pool’s formation. If this notice is not given, the pool operator will be deemed to have elected the calendar year as the pool’s fiscal year.

(3) The commodity pool operator must continue to use the elected fiscal year for the pool unless it provides written notice of any proposed change to all participants and files such notice with the National Futures Association at least 90 days before the change and the National Futures Association does not disapprove the change within 30 days after the filing of the notice.

(h)

(1) Each Account Statement and Annual Report, including an Account Statement or Annual Report provided pursuant to §4.7(b) or 4.12(b), must contain an oath or affirmation that, to the best of the knowledge and belief of the individual making the oath or affirmation, the information contained in the document is accurate and complete; Provided, however, That it shall be unlawful for the individual to make such oath or affirmation if the individual knows or should know that any of the information in the document is not accurate and complete.

(2) Each oath or affirmation must be made by a representative duly authorized to bind the pool operator, and

(i) for the copy of a commodity pool’s Annual Report submitted to the National Futures Association, such representative shall satisfy the required oath or affirmation through compliance with the National Futures Association’s electronic filing procedures, and

(ii) for a commodity pool Account Statement or Annual Report distributed to participants, a facsimile of the manually signed oath or affirmation of such representative may be used so long as the manually signed original is retained in accordance with §4.23.

(3) For each manually signed oath or affirmation, there must be typed beneath the signed oath or affirmation:

(i) The name of the individual signing the document;

(ii) The capacity in which he is signing;

(iii) The name of the commodity pool operator for whom he is signing; and

(iv) The name of the commodity pool for which the document is being distributed.

(i) The Account Statement or Annual Report may be distributed to a pool participant by means of electronic media if the participant so consents; Provided, That prior to the transmission of any Account Statement or Annual Report by means of electronic media, a commodity pool operator must disclose to the participant that it intends to distribute electronically the Account Statement or Annual Report or both documents, as the case may be, absent objection from the participant, which objection, if any, the participant must make no later than 10 business days following its receipt of the disclosure.

(Approved by the Office of Management and Budget under control number 3038–0005)

(Secs. 2(a)(1), 4c(a)–(d), 4d, 4f, 4g, 4k, 4m, 4n, 8a, 15 and 17, Commodity Exchange Act (7 U.S.C. 2, 4, 6c(a)–(d), 6f, 6g, 6k, 6m, 6n, 12a, 19 and 21; 5 U.S.C. 552 and 552b))

[46 FR 26013, May 8, 1981, as amended at 46 FR 63035, Dec. 30, 1981; 47 FR 57011, Dec. 22, 1982; 52 FR 41986, Nov. 2, 1987; 65 FR 81334, Dec. 26, 2000; 67 FR 77411, Dec. 18, 2002; 68 FR 47234, Aug. 8, 2003; 68 FR 52837, Sept. 8, 2003; 71 FR 8942, Feb. 22, 2006]

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Other related hedge fund law articles include:

Bart Mallon, Esq. of Cole-Frieman & Mallon LLP runs the Hedge Fund Law Blog as well as the forex registration website.  He can be reached directly at 415-868-5345.

CTA Lead List Basics

5 Replies

By Bart Mallon, Esq. (www.colefrieman.com)

“Purchased Lead Lists and How to Use Them”

A good resource for CTAs that are actively trying to raise money are lead lists – lists of names and contact information of potential future clients or investors.  This overview is for the CTA Expo 2009 program entitled Purchased Lead Lists and How to Use Them.  The program was sponsored by Patke & Associates and featured Jacques DeRouen of Pinnacle Alternative Investments.

Jacques started off by telling all of the CTAs that they need to get out and market to investors.  The point is to get your story to willing listening.  He then provided us with a brief background of how he got involved with lists and how he learned to use lists effectively.  The biggest takeaway is that getting good at using lead lists takes time and dedication – but don’t let the list intimidate you.  From here he discussed a number of items about lead lists in general.

Lead Lists in General

There are many different types of lists and the lists come in a variety of different formats and include various different types of information.  CTAs should research exactly what they will get with these lists and some questions which the purchaser should ask include the following:

  • Has the list maker described their list and what they provide?
  • What is the reputation of the list maker?
  • Does the list have references, if no, then why?
  • Is there a free sample?
  • What information is on the list – key contact names, size of the investor, email addresses.

CTA managers should think about making some calls to the investors on the sample lists which are released.  Basically the manager wants to make sure that the list is not something that was simply culled from the phone book – the leads need to be warmer.  If they are providing a general list of investors, this is ok but it will probably take you more time.

Budget

The biggest thing to consider is your budget.  If you don’t have money in the budget to buy a list, then don’t buy it.  A CTA should always be aware of the fees coming in and be able to justify any expenses, which includes a list.

Prepping an Investor Database

When you get a lead list it will typically be in some sort of spreadsheet like excel and it will be up to the CTA to clean up the data and make it user friendly.  There are a number of different ways to establish databases that will work for keeping track of investors contacted and to contact.  After formatting a database or input, the CTA should always back-up the new, manipulated data.  From here the CTA will want to export the manipulated data to a CRM.  There are a number of customer relationship management (CRM) software solutions which allow managers to manipulate large raw sets of data, such as the lead lists. It is very important for the CTA to take good notes about the interactions with the leads.

Notes About Emailing Investors from Lead Lists

Emailing your marketing presentation can be a very effective way to market to some of the investors on the lead lists.  However, CTAs should not send every piece of marketing material that they have.  A CTA may want to think about emailing a summary presentation with bullett points.  A teaser like this sets the plate so that when the CTA follows up with the lead (with a phone call), the lead has a little bit of background on the manager, but is not overwhelmed (or worse, annoyed).  CTAs should be aware that even with the best lead lists there is likely to be some email kickback from natural changes in the composition of the company.  The best systems are likely to have 2-3% kickback, the middle tiered lists are likely to have 5-10% kickback and the lower quality lists are likely to have much more.

Approaching Fund of Fund Investors

While many fund of fund investors don’t actively advertise that they allocate to emerging managers, they do and CTA firms should be calling these managers.  Even if a FOF manager decided not to invest with the CTA manager, calling is still a good way to connect and develop a relationship – potentially that relationship can develop down the line.  Fund of fund managers do like CTA and other emerging managers not only because of the potential returns but also because the FOF managers are likely to be able to negotiate carve-outs of the CTA manager’s future capacity.

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This article first appeared in the CTA Expo Blog run by Bart Mallon, Esq.  Mr. Mallon also runs the Hedge Fund Law Blog and is committed to providing useful and easy to understand information for CTAs and CPOs which can be found in our CTA and CPO Registration and Compliance Guide. For more information on CTA registration or compliance services please contact Mr. Mallon at 415-868-5345.

CTA Regulatory and Compliance Discussion

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By Bart Mallon, Esq. (www.colefrieman.com)

“Compliance in a Changing Environment”

As we are all well aware both the investing and the regulatory environments have experienced a dramatic refocusing on compliance and related issues in the wake of the 2008 meltdown and the Bernie Madoff affair.  This overview is for the CTA Expo 2009 program entitled Compliance in a Changing Environment.  The program was sponsored by Woodfield Fund Administration and featured Kate Dressel of Strategic Compliance Solutions as well as Patty Cushing of the National Futures Association.

Ms. Dressel announced that compliance and processes and procedures have become increasingly important, especially since investors are now concerned about fraud.  The best defense with regard to fraud, and an theme that pervaded this and other discussions, is that a CTA needs to have a reputable accountant and auditor.  Having reputable service providers (including administrators, auditors and legal firms) will help potential investors/clients to feel more comfortable with the CTA and the investment program.

Ms. Cushing, who is the associate director for Risk Management and Member Education at the NFA, began by emphasizing that CTA performance information needs to be accurate.  She also mentioned that CTAs really need to be focused on trading and the other business issues, especially accounting and legal, should be done by experienced people or service providers.  Ms. Cushing made reference to the NFA’s spreadsheet (although I could not find this on the NFA’s website) as well as an informative webscast by the NFA discussing CTA Performance Reporting webcast.  Basically she said that if you don’t want to spend the time making sure that all of the numbers are perfect, then you are going to need to use a consulting firm.

If you self administrer you are going to need to think about an outside administrator so that there will be increased oversight.

Ms. Dressel talked about the current industry buzzword – transparency.  Transparency is important, she went on, not just in trading but in all aspects of the CTA business.  Compliance and operations, especially, need well ordered and solid procedures in place.  Oversight is the key and it is very important that the principals are aware of everything that is going on in the firm.

[Note: Ms. Cushing talked about forex managers and noted that forex managers needed to make sure they were submitting their forex disclosure documents to the NFA for review.  I spoke with Ms. Cushing after the session was over to gain clarification over her statement and also discuss the forex registration rules which were supposed to be proposed by the CFTC some time ago.  For clarification, I want to point out that forex managers only need to have the NFA review their forex disclosure documents if they are already a member of the NFA – that is, if they are already registered as a CTA or CPO.  Forex only managers who are currently not registered with the NFA (and who trade only in the off-exchange spot markets) currently do not need to register with the NFA.  I discussed this with Ms. Cushing and asked if she had seen a draft of the registration rules or if she had heard anything from the CFTC as to when the rules might be proposed – she said that the CFTC has been working on the rules but that she has no idea when or if the rules will be proposed.  She seemed to be parroting the CFTC on this issue – the agency has told me a number of times that they are working on the rules and that they will be proposed shortly.]

Ms. Cushing mentioned that some CTA firms will actually use a previous NFA audit as a kind of “stamp of approval” by the regulatory agency.  Although the NFA audit is only designed for the NFA Member who was subject to the audit, some Members will send these to their clients.  Accoring to Ms. Cushing, the NFA is taking no opinion with regard to this practice.  She did note, however, that such reports might not be the best source of information regarding a firm’s procedures as it might be out of date.

Ms. Dressel mentioned that mock audits for CTAs are good to pursue – you can contact a number of outside firms like her own that can help a manager through a mock audit.  Not only does a mock audit help a firm for an actual NFA audit, but it will also help to identify operational issues which the manager can refocus upon.

One of the most important items that CTAs should be aware of is their marketing materials and disclosure documents.  It is imperative that CTA firms make sure that every statement in the disclosure documents and other marketing materials be true.  CTA firms should not try to stretch the truth – potential investors are check and there is a whole new paradigm.  Any stretched truth will be uncovered during the due diligence process which now includes, for some managers, phorensic accounting to make sure that trading parameters have been consistently adheared to.  Investors now need absolute confidence in who you are and what you do.

CTA firms should be vigilant about making sure they stick to the trading parameters in the disclosure documents.

A very good piece of advice is that if there is anything in your disclosure documents which is not true, you need to update your documents.  [BM note: and potentially discuss the change with your current investors/clients.]

Ms. Cushing noted that there a number of ways to that your firm can prepare for an NFA audit.  The first step is to read and be aware of the NFA’s yearly self-examination checklist.  [Note: if you do not know about the self-exam checklist, and if you do not have a compliance program in place, please see a CTA attorney or compliance person immediately to become compliant.  The self-exam checklist is a central part of a good compliance program.]  Ms. Cushing urged those firms who have questions about the checklist to call the NFA (although, in practice, this is usually an effort in futility as the staff will generally not ask questions and tell firms to consult with an attorney or other compliance professionals).

Questions From Audience

After this we had an opportunity to move onto questions from the attendees.  One comment came from Fred Gehm who has worked in due diligence for a fund of funds which allocated to the CTAs through separately managed accounts.  He made the statement that if the manager doesn’t have an external administrator the FOF will not allocate to that CTA – even if the CTA has audited returns.  He also made the comment that 10-15% of the time CTAs (or other managers) will lie to him and he will catch it.  Obviously in these cases the FOF does not allocate to such a group.  He said that many times if the manager had been honest about fact in the first place, it would likely have been something that would have been passed over but for the lied.

Ms. Cushing and Ms. Dressel emphasized that the CTA is ultimately responsible for making sure that the books and records are correct – even if there is an outside administrator, the CTA needs to take an active role in this area.

The next questioner noted that family offices and pensions are beginning to get involved in the CTA space and he wondered how smaller CTAs can set up structures to be well positioned for such investors.  Ms. Dressel suggested that the CTA manager get as much of the program together as possible – this means the manager should try to get the best administrators, auditors and legal counsel that they can afford.  The manager should also be able to completely answer a standard due diligence questionnaire – these questionnaires highlight some of the important structural and governance items that family offices and pensions will be focusing on.

Mr. Gehm mentioned that he is concerned with two central issues when allocating to small CTAs: (1) custody and (2) risk management.  With the first, custody, he said he was especially concerned with who signs the checks and where is the dollar control.  Fred recommended that CTAs have secondary signer for disbursements.  With regard to the second issue, risk management, he said he looked for a structure where someone with independent authority had authority with regard to this issue.  The key here is that the risk manager should have no fear of losing his job, that there is contractual safeguards for him doing his risk management.

There were a couple of other brief questions before the session ended.  One takeaway with regard to risk management is to think about things throughout the organization – key man provisions and plans for odd eventualities.  The more that a CTA manager really thinks about and understands the risk of his business, the better it will be for the investors and the more likely for the CTA manager to have an easier time raising capital.

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This article was first printed on the CTA Expo Blog.  This article was contributed by Bart Mallon, Esq. who runs the Hedge Fund Law Blog and is committed to providing useful and easy to understand information for CTAs and CPOs which can be found in our CTA and CPO Registration and Compliance Guide. For more information on CTA registration or compliance services please contact Bart Mallon, Esq. at 415-868-5345.

CTA Advertising and Marketing Issues to Consider

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By Bart Mallon, Esq. (www.colefrieman.com)

Marketing for Small CTAs

For small commodity trading advisory (CTA) firms, marketing and advertising the expertise of the principals is a central way to gain new clients and make more money.  This overview is for the CTA Expo 2009 program entitled Marketing for Small CTAs. The program was sponsored by Traderview and featured Frank Pusateri of Adirondack Portfolios as well as Bucky Isaacson of Future Funding Consultants. While I was unable to catch this beginning session of the CTA expo 2009, I was able to catch the last ten to fifteen minutes of the session, which I found to be particularly helpful (for small and start up CTAs) as well as interesting.  It seemed like many of the participants were engaged as well.

General Background on CTA Advertising

CTAs are allowed to market and advertise their services.  Unlike hedge fund managers, who are prohibited from marketing pursuant to Regulation D and other federal and state regulations, CTA advertising has the potential to reach a large portion of the investing population – CTAs can and should take advantage of such marketing rules.  [Note: we will be providing information at a later date regarding some of the legal and compliance issues that CTAs should be aware of when developing a marketing program.]

A good marketing program will be multi-faceted and will include a website (including potentially a blog), direct email campaigns, listings in CTA databases, and networking events among other items.  The rest of this article will focus on CTA websites.

CTA Websites and Visitor Information

One way for CTAs to advertise is to put up a good and effective website advertising the manager’s services.  While it will take the manager some time to create the initial content and layout of the website, there is relatively little additional time needed to maintain the webiste.  Many of the updating functions can be outsourced as well, so the manager can concentrate on trading.

Frank noted that he had one CTA ask him what he thought about their website which cost $50,000. Frank said that it looked good but that the CTA firm did not ask for the visitor’s name, address or telephone number and that there was no place on the website to collect that information. This represents a lost opportunity because, presumably, visitors come to your website to find out more information about you – you in essence know that the people visiting your site are potential investors. Having visitors provide you with their basic contact information is equivalent to a warm lead and if you don’t even have a way to collect this then you are wasting opportunities.

Question Period

Frank was able to answer questions from the audience. One participant asked if Frank could name a CTA firm which did a good job at marketing themselves. He mentioned that he thought Northfield Trading did a pretty good job with much of their literature and marketing materials.

Many of the same issues, which were touched on during my brief time at this session, are discussed in later sessions in greater depth. We will examine these in turn.

The next article discusses Compliance in a Changing Environment which is sponsored by Woodfield Fund Administration and which featured Kate Dressel of Strategic Compliance Solutions as well as Patty Cushing of the National Futures Association.

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This article was first printed on the CTA Expo Blog.  Mr. Mallon also runs the hedge fund law blog and is committed to providing useful and easy to understand information for CTAs and CPOs which can be found in our CTA and CPO Registration and Compliance Guide. For more information on CTA registration or compliance services please contact Bart Mallon, Esq. at 415-868-5345.