Category Archives: Commodities and Futures

CFTC Regulation 15.03 – Reporting Levels

CFTC Form 40 Reporting Levels 

Managers who trade in the futures and commodities markets should be aware of the amount of contracts they are trading.  For certain products, once a manager reaches a reporting level, the CFTC may request that the manager complete and submit a Form 40 to the CFTC.  CFTC Regulation 15.03, reprinted in full below, provides the number of contracts for each commodity which is deemed to be a reporting level for CFTC Form 40.

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TITLE 17–COMMODITY AND SECURITIES EXCHANGES

CHAPTER I–COMMODITY FUTURES TRADING COMMISSION

PART 15 REPORTS GENERAL PROVISIONS–Table of Contents

Sec. 15.03 Reporting levels.

(a) Definitions. For purposes of this section:

Broad-based security index is a group or index of securities that does not constitute a narrow-based security index.

HedgeStreet products are contracts offered by HedgeStreet, Inc., a designated contract market, that pay up to $10.00 if in the money upon expiration.

Major foreign currency is the currency, and the cross-rates between the currencies, of Japan, the United Kingdom, Canada, Australia, Switzerland, Sweden and the European Monetary Union.

Narrow-based security index has the same meaning as in section 1a(25) of the Commodity Exchange Act.

Security futures product has the same meaning as in section 1a(32) of the Commodity Exchange Act.

(b) The quantities for the purpose of reports filed under parts 17 and 18 of this chapter are as follows:

Commodity (Number of contracts)

Agricultural:

Cocoa (100)

Coffee (50)

Corn (250)

Cotton (100)

Feeder Cattle (50)

Frozen Concentrated Orange Juice (50)

Lean Hogs (100)

Live Cattle (100)

Milk, Class III (50)

Oats (60)

Rough Rice (50)

Soybeans (150)

Soybean Meal (200)

Soybean Oil (200)

Sugar No. 11 (500)

Sugar No. 14 (100)

Wheat (150)

Broad-Based Security Indexes:

Municipal Bond Index (300)

S&P 500 Stock Price Index (1,000)

Other Broad-Based Securities Indexes (200)

Financial:

30-Day Fed Funds (600)

3-Month (13-Week) U.S. Treasury Bills (150)

2-Year U.S. Treasury Notes (1,000)

3-Year U.S. Treasury Notes (750)

5-Year U.S. Treasury Notes (2,000)

10-Year U.S. Treasury Notes (2,000)

30-Year U.S. Treasury Bonds (1,500)

1-Month LIBOR Rates (600)

3-Month Eurodollar Time Deposit Rates (3,000)

3-Month Euroyen (100)

2-Year German Federal Government Debt (500)

5-Year German Federal Government Debt (800)

10-Year German Federal Government Debt (1,000)

Goldman Sachs Commodity Index (100)

Major Foreign Currencies (400)

Other Foreign Currencies (100)

U.S. Dollar Index (50)

Natural Resources:

Copper (100)

Crude Oil, Sweet (350)

Crude Oil, Sweet–No. 2 Heating Oil Crack Spread (250)

Crude Oil, Sweet–Unleaded Gasoline Crack Spread (150)

Gold (200)

Natural Gas (200)

No. 2 Heating Oil (250)

Platinum (50)

Silver Bullion (150)

Unleaded Gasoline (150)

Unleaded Gasoline–No. 2 Heating Oil Spread Swap (150)

Security Futures Products:

Individual Equity Security (1,000)

Narrow-Based Security Index (200)

Hedge Street Products. (125,000) \1\

TRAKRS (50,000) \1\

All Other Commodities (25)

 

\1\ For purposes of part 17, positions in HedgeStreet Products and TRAKRS should be reported by rounding down to the nearest 1,000 contracts and dividing by 1,000.

[69 FR 76397, Dec. 21, 2004, as amended at 71 FR 37817, July 3, 2006]

* The above CFTC Regulation 15.03 can be found on the government website here.

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Cole-Frieman & Mallon LLP provides legal advice and compliance consulting for the managed futures industry.  Bart Mallon can be reached directly at 415-868-5345.

 

Series 31 Exam – Futures Managed Funds Examination

Overview of Series 31 Exam for Managed Futures Industry

In general persons who are selling futures related products are going to be required to have a Series 3 exam license.  However, some broker-dealer representatives may be able to take the Series 31 exam instead of the Series 3 exam if their activities are limited to selling interests in commodity pools and other similar activities.  This exam is required by the NFA for all individuals who want to sell futures funds, or those who want to receive trailing commissions on commodity pools or managed accounts guided by CTAs.

Series 31 Exam Basics

The following are some of the important items related to the exam:

  • Prerequisites – person taking the exam must (1) be registered with FINRA as a General Securities Representative and (2) limit their futures activities on behalf of their sponsor to soliciting funds, securities or property for participation in a commodity pool, soliciting discretionary accounts to be managed by CTAs or supervising persons who perform these same limited activities.
  • Time Limit – 60 minutes
  • Questions – 45 multiple choice questions.
  • Passing grade – 70%
  • Cost – $70
  • Who – exam is required for those individuals who intend to sell managed futures.
  • Exam topics –
    • Exchange Rules and Regulations
    • CPO and CTA Rules and Regulations
    • Advertising and Disclosure (including NFA Compliance Rule 2-29)
    • Customer Accounts
    • Discretionary Rules
    • Market Terminology.
    • For more information on the exam topics, please see the NFA Study Outline – Series 31.

Other Items

Signing up

A person can take the exam at most Pearson VUE or Prometric testing centers.  You can register for the exam by submitting a Form U-10 through the IARD system.  Please note that, effective September 15, 2010, FINRA requires individuals to use either their CRD number or FINRA ID number in order to schedule an exam and no longer accepts social security numbers.  For more information, please see the NFA Guide to Sign up for Futures Exams.

Studying for the Series 31 Exam

Like the other FINRA and NFA exams, you should use a study guide and practice exams to prepare.  The Series 31 does not have as many materials available as some of the more popular exams (Series 7, 65, 3, etc) but there are some materials which can be found through a simple Google search.   [Note: we have not reviewed any Series 31 exam study guide so we cannot make any recommendations on any materials.]  As with other exams, we recommend taking at least two to three practice exams prior to taking the actual test; persons not familiar with the managed futures industry might want to take more.

The actual exam

The exam is computer-based and will initially instruct you on how to properly answer and mark the following questions.  Note that the beginning of the exam will most likely include the easiest questions, and then the questions will proceed to get harder as you reach the middle.  Always attempt to make the most educated guess on questions that you do not understand.

The exam is fairly short so you should not need to take a break in the middle of the exam.  You should remember that there is always have the option of marking the question for review so you should not spend an extended period of time  on any one question. After you have completed the questions, you will

have the option of changing any of your answers.  After completely answering everything, you will receive your score immediately.

If you don’t pass

A number of individuals who take the exam do not pass.  If this is the case, you will need to wait 30 days before re-taking the exam.  If you do not pass the exam the second time, you will need to wait another 6o days before taking the exam.  If you do not pass either the third or fourth attempt, you will need to wait at least 180 days before taking the exam again.  There is no limit on the number of times allowed for taking a test.

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Cole-Frieman & Mallon LLP provides legal advice to the managed futures industry.  Bart Mallon can be reached directly at 415-868-5345.

CTA Expo 2011 Chicago

Ronnie Lott Keynote Speaker at CTA Conference

We are gearing up for the CTA Expo in Chicago next month. The CTA Expo, which is also held in New York and London, has become the go-to event for CTAs and others member of the managed futures industry. As always, the NIBA will be having its own conference the day before the CTA Expo and there will be a joint NIBA/CTA Cocktail Party.

The NIBA event will be September 12, 2011 and the agenda includes:

  • Rules, Regulations, Revenue: Round III with Moderator Steve Pherson from Schuyler Roche
  • Grow Your Business by Hiring the Right People by Pat Lunkes of Parkway Consulting Group
  • Marketing Strategy Makeover by Candyce Edelen & Phil Donaldson of Propel Growth
  • A Bubble in Commodities: What to Look for by Darin Newsom of Telvent DTN
  • Anatomy of an Online Marketing Campaign: Generating Leads Online by Shane Stiles of Gate 39 Media

The CTA Expo will be September 13, 2011 and the  agenda includes:

  • Welcoming Remarks by Bucky Isaacson and Frank Pusateri
  • Maximizing the Value of your Conference Attendance by Ron Suber of Merlin Securities
  • Successful Marketing in Asia by Rumi Morales of the CME Group
  • Reputation – Creating Power Through Personal Branding by Lida Citroen
  • Keynote Speach by Ronnie Lott of All Stars Helping Kids<

    /a> – Professional Sports and Business – Lessons Learned

  • Marketing Managed Futures in Europe –

    Tips from the Trenches by Simon Rostron of Rostron Parry

  • The Regulatory Environment in 2011 and Beyond by Dan Driscoll of the National Futures Association
  • The Role of Emerging Managers in a Portfolio by Joseph Schlater of Busara Advisors
  • Institutional Investors and What They Look For in a Manager by Keith Palzer of Bank of America Merrill Lynch
  • The Marketing Impact of a Professional Back Office by Dana Comolli of DMAXX
  • Promoting Managed Futures as an Investment by Mark Melin of High Performance Managed Futures

Cole-Frieman & Mallon LLP has been a sponsor of the CTA Expo since 2009 and this year we will be introducing Ron Suber of Merlin Securities on Tuesday morning.  For more information on the events, please see the CTA Expo program and NIBA Conference schedule.

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Cole-Frieman & Mallon LLP provides legal advice to CTAs and CPOs, including NFA compliance and regulatory guidance.  For more information, please see our CTA and CPO Registration and Compliance Guide or call Bart Mallon directly at 415-868-5345.

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NFA Reminds CPOs of Rule 2-46 Reporting Requirement

Late Filers Possibly Subject to Disciplinary Action

The NFA issued a Notice to Members on July 21, 2011 (the “Notice”) reminding commodity pool operators (“CPOs”) registered with the NFA to file their quarterly pool reports in a timely manner. Most importantly, the NFA stated that beginning with the June 30, 2011 report, which is due on Monday, August 15, 2011, the NFA will review the filing history of any CPO that files the report late and determine whether disciplinary action is appropriate.  The Notice stressed the importance of filing in a timely manner, as the value to the NFA of the information reported diminishes the later a report is filed. Below is our quick summary of what is required in the quarterly report.

CPO Quarterly Report Requirements

NFA Rule 2-46 requires CPOs to file a pool’s quarterly report within 45 days after the end of the quarter. The report should be filed through the NFA’s EasyFile system and will include the following information:

Key Relationships – the CPO must report the identities of the pool’s administrator, carrying broker(s), trading manager(s), and custodian(s).

Statement of Changes of NAV – the CPO must report the change in the pool’s net asset value for the quarter. Information required includes beginning net asset value, net income, additions, withdrawals, ending net asset value, and special allocations to the CPO. Data for each of these fields will be broken down into values for the participants (generally limited partners) and the

CPO (the General Partner). Additionally, the CPO will be required to report information on any halts or material restrictions applicable to redemptions during the quarter.

Monthly Rates of Return – the CPO must report the monthly performance of the pool for each of the three (3) months comprising the quarter.

Schedule of Investments – the CPO must report a schedule of investments that identifies any investments that are 10% or more of the pool’s net asset value at the end of the quarter. The schedule will be separated into dollar-value breakdowns across seven categories of investments: (1) equities, (2) alternative investments, (3) fixed income, (4) derivatives, (5) options, (6) funds, and (7) cash.

CPOs should be sure to file the June 30, 2011 quarterly report for each pool that is subject to the reporting requirement by the August 15, 2011 due date. The full NFA Notice is reprinted below and can also be found here.

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Notice I-11-13

July 21, 2011

Regulatory Reminder to CPOs of Quarterly Reporting Requirements

In March 2010, NFA Compliance Rule 2-46 became effective. Rule 2-46 requires each CPO Member to report quarterly to NFA specific information on each pool that it operates (for which it has a reporting requirement under CFTC Regulation 4.22). The reports are due within 45 days after the end of the quarterly reporting period. NFA adopted this quarterly reporting requirement in order to regularly obtain certain performance and operational data that NFA staff utilizes to assess risks and identify trends related to Member CPOs.

Obviously, if a Member CPO does not file this report within the specified time frame, then the value of the report to NFA diminishes since the information becomes less useful as it ages. Beginning with the June 30, 2011 report, which is due on Monday, August 15, 2011, NFA will review the filing history of any CPO Member that files the report after its due date and determine whether disciplinary action is appropriate.

All Member CPOs with reporting requirements under Compliance Rule 2-46 must be aware of the filing deadlines for these quarterly reports on an ongoing basis and ensure that these quarterly reports are filed in a timely manner. NFA staff remains available to assist CPO Members in meeting this filing requirement. Anyone needing additional information regarding these quarterly reports should contact Tracey Hunt at (312) 781-1284. You may also review NFA's two-part brief video series that walks through the process of filing a pool quarterly report:

NFA's Expanded Filing Requirements for Commodity Pool Operators – Part One

NFA's Expanded Filing Requirements for Commodity Pool Operators – Part Two

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Cole-Frieman & Mallon LLP provides legal advice to NFA Member firms with respect to CFTC Regulations and NFA Rules.  Bart Mallon can be reached directly at 415-868-5345.

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Social Media Regulation &amp; Managed Futures Industry

Futures Magazine Publishes Article on Social Media by Bart Mallon

In this month’s issue of Futures Magazine I wrote a featured article about the legal and regulatory issues that managers in the futures industry face with respect to the use of social media. The article, Social Media Considerations for Financial Firms, provides a broad overview of the many issues which managers should be aware of when utilizing social media in any sort of marketing campaign. Specifically the article discusses the NFA rules which member firms must follow and also discusses some best practices and common deficiencies.

I believe that the article comes at an important time – managers

are using social media more often to communicate with clients.  These managers are also using various platforms to communicate and market to potential clients.  The necessity of creating compliance programs with respect to these activities has been clearly communicated to the managed futures community by the NFA and we have written a number of posts on the use of social media. Many of these posts are informed by information provided to the NFA either through more formal discussions or informally at

various conferences. The posts include:

We recommend that NFA member firms implement robust compliance policies with respect to the use of such media. Additionally, these programs should be reviewed and revised, as appropriate, on a periodic basis to respond to new marketing and communication practices and any guidance promulgated by the NFA or CFTC.

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Bart Mallon’s is a managing partner at Cole-Frieman & Mallon LLP and his practice focuses on the hedge fund industry. He routinely works with managers who trade commodities and futures on corporate and regulatory matters. He can be reached through our contact form or by phone at 415-868-5345.

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Managed Futures Industry Conference & Networking Event

NIBA Conference / CTA Expo 2011 – New York, April 20-21

The NIBA and the CTA Expo are having their New York event this week.  Both events have a number of good sponsors and speakers and provide members of the managed futures industry with a great opportunity to network.  Bart Mallon of Mallon P.C. will be a speaking at the NIBA event on a panel entitled “Rules, Regulations and Your Revenue” which is expected to touch on a number of important legal and compliance issues.  For more information, please see the CTA Expo website and the NIBA website.

The agendas for both events are reprinted below.  We look forward to seeing you in New York.

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NIBA 2011 IB/CTA Spring Conference
New York City, April 20, 2011
NYMEX Building CME Group, 1pm-4:30pm

Compliance, Marketing and Technology–all concepts integral to your Brokerage or CTA. Register to attend the largest independent conference for Introducing Brokers, CTAs and futures industry professionals. Complete agenda below and at www.theniba.com

Rules, Regulations and Your Revenue
Panel Discussion

Moderator: Steve Pherson | Schuyler, Roche, & Crisham P.C.

PANELISTS:

  • Bart Mallon | Bart Mallon, PC
  • Mark Ruddy | Ruddy Law Office PLLC
  • Sharon Pendleton | Director, Compliance of NFA

Whether you trade traditional futures and options, forex or swaps and derivatives, you will not want to miss this session. Topics:

  • CFTC Porposals that will affect your business
  • NFA Rules you need to know about
  • Understanding Dodd-Frank
  • Commissioner's response to your suggestions for the CFTC

Got Leads?
Panel Discussion

  • Candyce Edelen | CEO of PropelGrowth
  • Rodney Dow | President, The Dow Corporation
  • Laurie Gavin | Sr. Manager, Compliance of NFA

Candyce is a leading speaker on the subject of attracting and nurturing leads. Rodney will share ideas his IIB uses to cultivate relationships with both new and existing clients. And Laurie will tell us how to stay in compliance with NFA regulations while you're building your client base. You will leave this session with actionable ideas you can use as soon as you get back to your office!

Online Marketing: How You Can Improve Your Website Now

  • Shane Stiles | President of gate39media

Drive traffic to your website, capture more leads, utilize social media, and cost effective tips you can do to improve the performance of your website today. Tips for both IBs and CTAs alike.

Joint NIBA/CTA EXPO Networking and Cocktail Reception
Network with contacts old and new with your peers i

n the futures industry! This networking event will be held in conjunction with CTA EXPO participants

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CTA EXPO New York
April 21, 2011 Program

8:30-9:30 Continental Breakfast

  • Sponsored by: DMAXX

9:15-9:30 Welcoming Remarks-

  • Frank Pusateri and Bucky Isaacson
  • Sponsored by: Strategic Compliance Solutions

9:30-10:00 Monitoring Portfolio Exposure, Key Risk Metrices, and Manager Mandates-

  • James Goldcamp | HedgeFacts LLP

10:00-10:30 A Marketing Plan for Managers-

  • Ron Suber | Senior Partner, Head of Global Sales and Marketing, Merlin Securities
  • Sponsored by: Arthur Bell CPAs

10:30-11:00 Coffee Break Sponsored by: National Eagles and Angels

11:00-11:30 Manager Seeding-

  • Daniel J. Barnett | CEO, Revere Capital Advisors
  • Sponsored by: Dorman Trading

11:30-12:30 Adding Value Through L/S Commodity Investing-

  • Moderator: Ray McKenzie | ICE Futures US
  • Mike Dubin | Managing Director, Silvercrest Asset Management
  • Toby Elliman | Managing Partner, Guidance Capital LLC

12:30-1:30 Lunch

  • Sponsored by: ICE

1:15-2:00 (KEYNOTE) The Capital Markets, U.S. Policy, and the Future of Innovation-

  • The Honorable Robert Grady | Chair of the New Jersey Council of Economic Advisors; Chair of the State of New Jersey Investment Council, Division of Investment; Managing Director of Cheyenne Capital
  • Sponsored by: Trading Technologies

2:00-2:30 Institutional Marketing in Europe-

  • Cecilia Mortimore de Santa Cruz | Director of Capital Services, Credit Suisse Securities LLC
  • Sponsored by: Michael Coglianese CPA, P.C.

2:30-3:00 The Regulatory Environment in 2011-

  • Daniel J. Roth | President and CEO, National Futures Association
  • Sponsored by Telluride Asset Management LLC

3:00-3:45 Coffee Break

  • Sponsored by Bank of America Merrill Lynch

3:45-4:30 The Lessons Learned from Madoff-

  • Mike Ocrant | Director, Alternative Investment Conferences, Conference Group, Institutional Investor
  • Co-Author of No One Would Listen
  • Sponsored by: Horizon Cash Management

4:30-5:00 Protecting Your Intellectual Property-

  • Alex Montagu | Montagu Law, P.C.
  • Sponsored by: TraderView

6:00-8:00 Closing Cocktail Party- NYSE Trading Floor

  • Sponsored by NYSE Liffe U.S. and NYSE Liffe

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Cole-Frieman & Mallon LLP provides legal and compliance services to the managed futures industry.  Bart Mallon can be reached directly at 415-868-5345.

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Form CPO-PQR

Proposed Form CPO-PQR Released

For your review, we have published the proposed Form CPO-PQR which can be found here: Form CPO-PQR

As recently proposed by the CFTC, registered commodity pool operators will be required to file proposed From CPO-PQR on either a quarterly or annual basis depending on assets under management and scope of business activities.  There are special rules for those managers who are also registered as an investment adviser with the SEC and who file Form PF.

This post will provide an overview of the major aspects of the Form COP-PQR as it is currently proposed.

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Who is required to file Form CPO-PQR?

All CPOs are required to file at least parts of Form CPO-PQR.

When do managers need to file Form CPO-PQR?

Most managers will need to file some parts of Form CPO-PQR on a quarterly basis.  Some managers, depending on assets under management, will need to file additional sections of the form on either an annual or quarterly basis.

The sections of the form will need to be filed within 15 days of the end of the quarter; however, for some managers, some sections will not need to be completed until 90 days after

the end of the quarter.

What are the sections of Form CPO-PQR?

Form CPO-PQR has 3 major sections.  F

  • Schedule A – must be filed by all CPOs which operate at least one pool during the quarter within 15 days of the end of the quarter.
  • Schedule B – must be filed by Mid-Sized CPOs annually within 90 days of the end of the year and Large CPOs quarterly within 15 days of the end of the quarter.
  • Schedule C – must be filed by Large CPOs quarterly within 15 days of the end of the quarter.

A Mid-Sized CPO is a CPO that had at least $150 million in pool AUM as of the close of business on any day during a quarter.

A Large CPO is a CPO that had at least $1 billion in pool AUM as of the close of business on any day during a quarter.

Note: Schedule B and Schedule C may not have to be filed with the CFTC if the CPO has completed certain sections of Form PF and meet other certain requirements.

Details of the Schedules

Schedule A

Part 1 – includes information with respect to the firm such as name, NFA ID #, contact person, chief compliance officer, # of employees, # of owners, # of pools

Part 2 – includes information on each pool which was operated during the quarter.  For each commodity pool this information includes:

  • Identifying information: mame of pool, NFA ID#, jurisdiction of organization, fiscal year end, structure
  • Outside Administrator: name, contact info, NFA ID#, start of relationship, services provided, % of pool assets valued by outside administrator
  • Broker – name, NFA ID #, contact info
  • Other service providers – carrying broker, trading manager, custodian, auditor, marketer
  • Information regarding assets over quarte
    • Beginning AUM & NAV
    • Ending AUM & NAV
    • Income over quarter
    • Additions, withdrawals and redemptions over quarter
  • Monthly ROR calculated in accordance with CFTC regulations
  • Schedule of investments – there is a drill down on cash, equities, alternatives, fixed income, derivatives, options, investment funds, longs/shorts, positive/negative OTE, long/short option value, pool positions exceeding 5% of NAV
  • Subscriptions & redemption information

Schedule B

Schedule B applies to both Mid-Sized and Large CPOs.  The information is essentially the same information as required in Sections 1.b and 1.c of Form PF.  The following information is required for each pool which is managed by the CPO:

  • Pool Information – name, NFA ID#, strategy,  % of assets traded using algorythim, investor information
  • Borrowings & types of creditors – total borrowings, listing of creditors
  • Counterparty credit exposure – aggregate counterparty exposure, listing of counterparties
  • Trading & clearing – for derivatives, securities and repos
  • Value of aggregate derivative positions

Schedule C

Schedule C is only completed by Large CPOs.  Schedule C will not need to be completed if the Large CPO has completed certain parts of Form PF.

Part 1 – the following information is required for each CPO:

  • Geographical breakdown of pools investments
  • Turnover rate of aggregate portfolio of pools
  • Duration of pools’ fixed income investments

Part 2 – the following information is required for each Large Pool:

  • Basic information – name, NFA ID#, unencumbered cash at end of month, monthly open positions
  • Liquidity of portfolio
  • Pool counterparty credit exposure
  • Pool risk metrics
  • Pool borrowing information
  • Pool derivative positions and posted collateral
  • Pool financing liquidity
  • Information on pool investors
  • Duration of fixed income assets

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Cole-Frieman & Mallon LLP provides comprehensive legal services for CPOs including completing Form CPO-PQR.  Bart Mallon can be reached directly at 415-868-5345.

CFTC Notice to CPOs re: Annual Reporting Requirement

As we discussed in our post on NFA annual compliance obligations, commodity pool operators will need to submit annual audited reports to the NFA by March 31 of this year.  This requirement applies generally to all CPOs unless the CPO requests exemptive relief from the annual audit requirement.

The CFTC has provided the following notice to remind CPOs about this annual requirement and to also provide some resources to managers regarding the technical aspects of the audit requirement.  The CFTC is recommending that managers provide their audit firms with the notice below so the firm can appropriate prepare the audited finacial statements.

The full notice is reprinted in full below.

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U.S. Commodity Futures Trading Commission
Three Lafayette Centre
1155 21st Street, NW, Washington, DC 20581
Telephone: (202) 418-5430
Facsimile: (202) 418-5536

February 2, 2011

To: All Commodity Pool Operators
Attention: Chief Financial Officer
Subject: Annual Reporting for Commodity Pools

The Division of Clearing and Intermediary Oversight (“DCIO” or “Division”) of the Commodity Futures Trading Commission (“CFTC” or “Commission”) is issuing this letter to assist commodity pool operators (“CPOs”) with the preparation and filing of commodity pool annual financial reports required under the Commodity Exchange Act (“Act”) and Commission regulations.1  This letter highlights current regulatory changes affecting CPOs with respect to financial filings and provides reminders of regulatory requirements in response to common deficiencies observed in prior years’ annual reports.  CPOs, including those that operate in non-U.S. jurisdictions, are encouraged to provide this letter to their public accountants and others assisting in the preparation of commodity pool annual financial statements.

The Division has issued similar guidance letters in prior years, which are available at the Commission’s website.2  Those letters should be consulted as they contain information relevant for many commodity pools, including the following topics:

In addition, CFTC interpretations and other staff letters that provide written guidance concerning the Act and the Commission’s regulations are available on the Commission’s website.  In particular, an illustrative example regarding Regulation 4.22(e)(2) is available in CFTC Interpretative Letter 94-3 (http://www.cftc.gov/tm/tm94-03.htm), Special Allocations of Investment Partnership Equity.

I. Recent Regulatory Activity

The CFTC issued final forex rules, which became effective on October 18, 2010.   Any firm acting as a counterparty to certain off-exchange forex transactions involving retail persons is required to register as a Retail Foreign Exchange Dealer. In addition, any individual acting as a forex solicitor, account manager and/or pool operator is required to register with the Commission as an Introducing Broker, Commodity Trading Advisor (CTA) or CPO, as appropriate, and to become a member of the National Futures Association (NFA).

NFA also adopted compliance rules applicable to CPOs as follows:

  • Rule 2-45 prohibits a CPO from permitting a commodity pool to use any means to make a direct or indirect loan or advance of pool assets to the CPO or any person or entity affiliated with the CPO.
  • Rule 2-46 requires each CPO that is a member of NFA to file, on a quarterly basis, with NFA, the following information for each pool the CPO operates that is subject to a reporting requirement under Regulation 4.22 (which includes exempt pools under Commission Regulation 4.7):
    • the identity of the pool’s administrator, carry broker(s), trading manager(s) and custodian(s);
    • a statement of changes in net asset value for the quarterly reporting period;
    • monthly performance for the three months comprising the quarterly reporting period; and
    • a schedule of investments identifying any investment that exceeds 10% of the pool’s net asset value at the end of the quarterly reporting period.

Such information must be filed with NFA within 45 days of the end of the quarterly reporting period, and must be filed using NFA Easyfile electronic filing system.

NFA also updated the Self Examination Checklist for CPOs and CTAs as of September 2010. NFA Compliance Rule 2-9 (Supervision) requires members to review their operations on a yearly basis using the NFA self-examination checklist

II. Filing Deadlines and Procedures for Commodity Pool Annual Reports

Commission regulations establish the dates by which commodity pool annual reports must be provided to pool participants and received by the NFA.

Specifically, Commission regulations provide that:

  • Commodity pool annual reports must be distributed to pool participants and filed with NFA within 90 calendar days of the pool’s fiscal year end.  The filing date for annual reports with a year end of December 31, 2010 is March 31, 2011.  Copies of the annual reports must be filed with the NFA.  A CPO should not file copies of the annual reports with the Commission.
  • CPOs must submit annual reports to NFA electronically in accordance with NFA’s EasyFile electronic filing system (http://www.nfa.futures.org/NFA-electronic-filings/easyFile-Pool-filers.HTML) and procedures.
  • An annual report may be distributed in hardcopy or electronically to pool participants.  The CPO, however, must obtain a participant’s prior consent to distribute an annual report in electronic format.
  • Applications for an extension of time to file an annual report must be submitted to NFA prior to the annual report due date and must include the information required by Regulation 4.22(f)(1).  Any request for an extension of time that exceeds 90 days from the original due date must be submitted to the Commission, and a copy filed with NFA.  The Commission generally does not grant extensions that would exceed 90 days from the original due date.
  • CPOs of commodity pools that invest in other collective investment vehicles may obtain an “automatic” 90-day extension of the distribution and filing due date by submitting the information specified by Regulation 4.22(f)(2) to NFA prior to the original due date.  In subsequent years, the CPO will be presumed to operate the pool as a fund of funds and continue to qualify for the automatic extension.  However, the CPO is obligated to inform the NFA if those circumstances change and to begin filing within the standard 90-day time frame.  In addition, this extension of time has been made available to Regulation 4.7 exempt pools, even if the report is not audited by a certified public accountant.
  • Draft financial statements.  Some CPOs have filed incomplete, or “draft,” unaudited financial statements for pools exempt under Regulation 4.7 to meet the due dates for such filings.  CPOs are reminded that although Regulation 4.7 provides exemption from certain requirements, including the requirement that financial statements be subject to an audit by a certified public accountant, annual reports filed with NFA and distributed to pool participants must include all required information and be in accordance with U.S. Generally Accepted Accounting Principles (“GAAP”) or, in some instances, International Financial Reporting Standards (“IFRS”) to be considered timely filed.  Draft unaudited financial statements do not satisfy the filing requirements.

III. Master/Feeder and Fund of Funds

Master/Feeder Structures. FASB ASC 946-205-45-6 permits nonpublic feeder pools either to follow the disclosure and reporting provisions of FASB ASC 946-210, or to present a complete set of master financial statements with each feeder financial statement.

Fund of Funds. Year end  pool financial statements must disclose specific income and fee information for investee pools as specified in Regulation 4.22(c)(5).  CPOs must disclose amounts of income and fees associated with investments in investment partnerships that exceed five percent of the commodity pool’s net assets.  Illustrative disclosures are in Attachment B to this letter.

If a commodity pool’s annual financial statements are found deficient with respect to compliance with GAAP, the CPO may be required to revise the commodity pool’s financial statements, distribute the revised statements to participants, and re-file the statements with NFA.

IV. Requests for Limited Relief from U.S. GAAP Compliance for Certain Offshore Commodity Pools

Regulation 4.22(d)(2), applicable to year end  annual reports,  permits CPOs that operate commodity pools organized under the laws of a non-U.S. jurisdiction to prepare financial statements for such pools using IFRS, provided that:

  • The use of IFRS does not conflict with any representations made in the pool’s offering memorandum or other operative document;
  • The IFRS financial statements contain a condensed schedule of investments as required by U.S. GAAP (FASB ASC 946-210-50), or, if required, a full schedule of investments;
  • The IFRS financial statements report any special allocations of partnership equity in accordance with Commission Regulation 4.22(e)(2); and
  • If IFRS would require that the pool consolidate its financial statements with another entity, such as a feeder fund consolidating with its master fund, all applicable disclosures required by U.S. GAAP for the feeder fund must be presented with the reporting pool’s consolidated financial statements.

To claim the relief to use IFRS accounting standards, the CPO must file a notice with NFA within 90 days after the end of the pool’s fiscal year.  Furthermore, Regulations 4.22(a)(5) and 4.7(b)(2) permit a CPO to present a pool’s periodic account statements and other disclosure documents on the same basis as that of its annual report.

In addition, Division staff has, on a case-by-case basis, provided limited relief to CPOs that operate offshore pools by allowing such commodity pools to prepare and to present their financial statements in accordance with another comprehensive basis of accounting other than IFRS, such as United Kingdom or Irish accounting standards, instead of U.S. GAAP.  In each case, the Division’s relief to use accounting standards other than U.S. GAAP was conditioned upon the offshore pool following the additional elements now required by Regulation 4.22(d)(2)(i).

CPOs seeking to prepare and present their offshore pools’ financial statements on another comprehensive basis of accounting other than IFRS may request relief from the U.S. GAAP requirement by submitting their requests, enumerating compliance with each of the elements specified in Regulation 4.22(d)(2), to the undersigned at the address shown on this letterhead.  If you have any further questions, contact Ronald Carletta, Branch Chief, or Al Goll, Auditor, at the phone numbers or addresses listed in Attachment A.

V. Reports of Liquidating Pools

Commission Regulation 4.22(c)(7) provides for the filing and distribution of a final annual report within 90 days of a pool’s permanent cessation of trading.  Alternatively, the CPO of a liquidating pool may provide the following information within 90 days of the permanent cessation of trading in lieu of an otherwise required final annual report:

  • Statements of Operations and Changes in Net Assets for the relevant period as contained in the regulation; and,
  • An explanation of the winding down of the pool’s operations with written disclosure that all interests in, and assets of, the pool have been redeemed, distributed, or transferred on behalf of participants; or
  • In the event that all interests in, and assets of, the pool have not been distributed, redeemed, or transferred to participants by the time the final report is issued, the CPO must disclose the value of assets remaining to be distributed and an approximate timeframe for when the CPO expects distribution to occur.  If the CPO is unable to complete distribution within the estimated timeframe, the CPO must update the above detailed information to both NFA and the pool’s participants in writing.

If the CPO is not able to liquidate the pool’s assets within time to prepare, file, and distribute the final annual report as prescribed by the regulation, Commission Regulation 4.22(c)(7) requires the CPO to provide written notice to each participant and NFA, disclosing the following:

  • The value of assets remaining to be liquidated, the timeframe within which liquidation is expected to occur, any impediments to liquidation and any fees or expenses that will be charged to the pool prior to final distribution;
  • Which financial reports the CPO will continue to provide to participants from the time of the cessation of trading until the final annual report is distributed, and the frequency of such reports, pursuant to the pool’s constitutive documents; and
  • The timing of the final annual report.

Additionally, a CPO who is availing itself of the alternative filing in lieu of a final annual report may file unaudited information provided that the CPO obtains waivers from all participants and certifies the same to NFA when the final report is filed.

This relief also is applicable for pools that have claimed an exemption under Regulations 4.7 or 4.12.

VI. Accounting Resources

A. FASB Accounting Standards Codification

On July 1, 2009 the Financial Accounting Standards Board (FASB) launched the FASB Accounting Standards Codification (the Codification) as the single source of authoritative nongovernmental U.S. GAAP.  Although the FASB does not provide guidance in how specific requirements of GAAP are referred to in footnotes of financial statements, it notes that prior to the issuance of the Codification it was not unusual for footnotes to refer to specific standard numbers (for example, “as required by Statement 133”). Because these references are no longer the source of GAAP, such references will change. The FASB encourages the use of plain English to describe broad Topic references in the future. For example, to refer to the requirements of the Derivatives and Hedging Topic, they suggest a reference similar to “as required by the Derivatives and Hedging Topic of the FASB Accounting Standards Codification” and not use the specific numeric reference.

B. AICPA Commodities Audit Practice Aid

The AICPA Audit Practice Aid, Audits of Futures Commission Merchants, Introducing Brokers, and Commodity Pools Second Edition (product number 006639), is a useful tool for auditors and accountants of commodity entities.  It can be purchased at the AICPA website: http://www.CPA2biz.com.  CPOs and public accountants should also ensure that they monitor the Commission for recent developments which may not be reflected in the Audit Practice Aid.

C. AICPA Audit Risk Alert

The AICPA 2010 Audit Risk Alert (“ARA”) Financial Institutions Industry Developments, Including Depository and Lending Institutions and Brokers and Dealers in Securities contains sections on the commodities industry.  The ARA can be purchased at the AICPA website: http://www.CPA2biz.com.

D. FASB ASC Topic 820 (Formerly FAS 157, Fair Value Measurements)

Resources that may be helpful in understanding and applying FASB ASC Topic 820 are:

  • Measurements of Fair Value in Illiquid (or Less Liquid) Markets, issued by the AICPA Center for Audit Quality available at http://www.thecaq.org/resources/pdfs/MeasurementsIlliquidMarkets.pdf.
  • ASC 275-10-50, Risks and Uncertainties (AICPA Statement of Position 94-6, Disclosure of Certain Significant Risks and Uncertainties, when auditing financial statements that contain complex fair value measurements);
  • ASC 820-10, Fair Value Measurements and Disclosure: Investments in Certain Entities That Calculate Net Asset Value per Share (or Its Equivalent) –  (guidance that generally the net asset value reported by investee investment companies will continue to be an acceptable fair value indicator, with certain exceptions.)

E. AICPA Technical Guidance

Beginning at paragraph 8.23, the AICPA Audit and Accounting Guide, Investment Companies (May 1, 2010 edition) discusses organization and offering costs.  The AICPA issued technical guidance regarding accounting treatment of offering costs incurred by investment partnerships.3  This guidance:

  • Provides that investment partnerships that continually offer interests should defer offering costs incurred prior to commencement of operations and then amortize such costs, generally on straight-line basis, over the time period that it continually offers interests, up to a maximum of 12 months; and
  • Defines the phrase “continually offer interests.”

Registrants are reminded that organization costs are not affected by this guidance and must be charged to expense as incurred as required by FASB Codification Section 720-15-25-1 (AICPA SOP No. 98-5,

Reporting on the Costs of Start-up Activities.)  However, if appropriately disclosed to investors and potential investors, net asset value used to compute investment entrance and exit values, may be adjusted to amortize such costs differently, but generally not to exceed a period of 60 months.

IX. DCIO and NFA Contact Information

If a CPO, a public accountant, or other member of the public has any questions on the foregoing, please feel free to contact the DCIO staff or NFA staff listed in Attachment A to this letter.

Very truly yours,

Thomas J. Smith
Director and
Chief Accountant

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1 The Act is codified at 7 U.S.C. paragraph 1 et seq.  The Commission’s regulations are found in Title 17 of the Code of Federal Regulations.  The Commission’s internet website, www.cftc.gov, provides links to both the Act and Commission regulations.

2 Prior letters from 1998 forward are available at the Commission’s website at http://www.cftc.gov/industryoversight/intermediaries/guidancecporeports.html.

3 See paragraph 8.33 of the AICPA Audit and Accounting Guide, Investment Companies (May 1, 2010 edition).

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ATTACHMENT A
CFTC DIVISION OF CLEARING AND INTERMEDIARY OVERSIGHT CONTACT INFORMATION

Regional Office Locations
Eastern Region
140 Broadway, 19th Floor
New York, NY 10005-1146

Contacts
Ronald A. Carletta
Phone: (646)-746-9726
E-Mail: [email protected]

Al Goll
Phone: (646)-746-9723
E-Mail: [email protected]

Fax: (646)-746-9937

Location of CPO’s Principal Office
All states east of the Mississippi River, except Illinois, Indiana, Michigan, Ohio, and Wisconsin. Any location outside of the United States

Regional Office Locations
Central Region
525 West Monroe Street
Suite 1100
Chicago, IL 60661

Contacts
Lisa M. Marlow
Phone: 312-596-0566
Fax: 312-596-0711
E-Mail: [email protected]

Location of CPO’s Principal Office
Illinois, Indiana, Michigan, Ohio, and Wisconsin

Regional Office Locations
Southwestern Region
Two Emanuel Cleaver II Boulevard, Suite 300
Kansas City, MO 64112

Contacts
Kurt Harms
Phone: 816-960-7711
Fax: 816-960-7750
E-Mail: [email protected]

Location of CPO’s Principal Office
All states west of the Mississippi River

National Futures Association Contact Information

National Futures Association
300 South Riverside Plaza,
Suite 1800
Chicago, IL 60606

Tracy Hunt, Senior Manager, Compliance
Phone: 312-781-1284
Fax: 312-559-3453

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Cole-Frieman & Mallon LLP provides comprehensive compliance and regulatory support for CTAs and CPOs.  Bart Mallon, Esq. can be reached directly at 415-868-5345.

NFA Annual Compliance Overview 2011

CTA and CPO firms which are registered with the CFTC will need to make sure that they are completing all necessary annual compliance items in accordance with CFTC regulations and NFA rules.

Below we have provided a list of the major items which registered firms should address with respect to annual compliance.  Many registered CTA and CPO firms have compliance manuals which address (or should address) these items.

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Rule 2-46 Quarterly Report (CPO only)

  • Due 2/14/2011
  • The following information must be submitted to the NFA:
    • Summary of Itemized Balances
    • Key Relationships
    • NAV
    • Monthly Performance – Rates of Return
    • Schedule of Investments
  • More information:
  • Once the report has been filed, complete and keep the Acknowledgment of Quarterly Report Filed (Rule 2-46) form and any related documents with your books and records.

Quarterly Review of Emails

  • Registered CPO and CTA firms are responsible for supervising employees and should periodically review employee emails.  It is a good idea to complete a quarterly review of employee emails, document the review and keep the documentation as part of the firm’s books and records.

Yearly Review of Email Procedures

  • The firm’s compliance officer should review the effectiveness of the firm’s email review procedures on a yearly basis.  The compliance office should document the review and keep the documentation as part of the firm’s books and records.

Compliance Manual Review

  • The compliance officer should review the firm’s compliance manual on an annual basis.  After the compliance manual has been reviewed and updated as necessary, the compliance officer should have each Principal, Associated Person, and Agent certify that he or she has read and understands the compliance manual and has complied with its requirements.

NFA Self-Examination Checklist

  • The NFA self-examination needs to be completed on a yearly basis.  The compliance office will need to review the firm’s operations using the NFA’s Self-Examination Checklist (http://www.nfa.futures.org/nfa-compliance/publication-library/self-exam-checklist.HTML), document the self-examination and keep the documentation as part of the firm’s books and records.
  • Mallon P.C. has provided an overview of the NFA Self-Examination process.

Privacy Policy

  • All firms should provide each fund investor or client with a copy of the firm’s Privacy Policy within 30 days of the close of the fiscal year.  If the firm provides monthly or other periodic statements, the firm might want to include the Privacy Policy with such normal communication.

Ethics Training

  • The firm’s compliance officer should review the firm’s ethics training program.  If the program changes, the compliance officer must make sure that all Principals, APs and Agents have completed the appropriate ethics training.  If the policy has not changed, this is a good time to confirm all Principals, APs and Agents have completed all appropriate ethics training.

Annual Report (CPO only)

We have outlined the reporting requirements for CPOs before which include an 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.  [Please note that some CPOs may be able to request a waiver from the annual audit requirement.]

The 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 one ownership class or series.

Bunched Orders Allocation (CTA only)

  • CTA firms should periodically review the allocation of bunched orders.  Many firms will have a policy to review these allocations on a quarterly basis.  For more information, please see our post on CTA Bunched Orders.

Other Important Items

  • Annual Questionnaire – the annual questionnaire is due within 1 year of the date of registration.  This form is available through the NFA’s ORS (Online Registration System).  For more information see our post on this topic.
  • Annual Registration Update – the annual registration update is due within 1 year of the date of registration.  This form is available through the NFA’s ORS (Online Registration System).  In general the NFA will send a letter (and email) and invoice for annual fees and dues.
  • Other – some firms have policies regarding their Disaster Recovery Program which may need to be revisited during the annual review process.  Additionally, both CTA and CPO firms should take the opportunity to review their disclosure documents and see if any revisions to those documents should be made.  Other business issues, like bank reconciliations and general bookkeeping matters, should be reviewed in light of the firm’s compliance policies.

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The above list is not indended to be exhaustive and each firm has different compliance requirements depending on unique circumstances.  If your firm would like help with developing a compliance program or if you have questions with respect to these topics, please don’t hesitate to contact us.

Cole-Frieman & Mallon LLP provides comprehensive compliance and regulatory support for CTAs and CPOs.  Bart Mallon, Esq. can be reached directly at 415-868-5345.

NFA Provides Guidance for CPOs on Performance Fees

Notice to Members I-11-01

As many CFTC registered entities understand, having disclosure documents approved by the NFA can be a lengthy and frustrating process.  While the NFA has done a decent job explaining to firms that disclosure documents must meet all of the requirements under the CFTC’s Part 4 Regulations, it can feel as though the NFA has a target which is constantly moving.  As we explained earlier in a post describing the NFA Changes after the CFTC audit (see also CFTC Report on NFA Registration Process, the CFTC will occasionally communicate to the NFA certain items which the CFTC would like to see emphasized or changed in the disclosure documents.

Recently, the CFTC provided guidance to the NFA with respect to incentive or performance fee arrangements in CTA and CPO  investment programs.  Essentially the CFTC asked the NFA to make sure that all disclosure documents for programs with performance fees include a discussion of the conflicts of interest involved with performance fee arrangements.  Specifically:

[The CFTC] staff’s guidance prescribes that every CPO or CTA that charges a typical incentive fee include in its Disclosure Document a discussion that the incentive fee may encourage a CPO or CTA to take excessive risks to earn an outsized incentive fee, and that such risk-taking may place the interests of the CPO and CTA in conflict with the interests of its clients. Furthermore, [CFTC staff] has indicated that the fact that Regulations 4.24(i) and 4.34(i) require the disclosure of fees and expenses (from which conflicts of interest frequently arise) does not mitigate or lessen the required discussion of conflicts of interest.

Many firms will have already provided this information in the disclosure documents.  For those groups who have not, this means that the disclosure document will need to be amended and reviewed by the NFA according to normal amendment procedures.

The full notice to members is reprinted below and can be found here.

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Notice I-11-01

January 05, 2011

NFA provides guidance for disclosure of conflicts of interests arising from Typical Incentive Fee Arrangements by commodity pool operators and commodity trading advisors

In 1997, the Commodity Futures Trading Commission (CFTC) delegated the review of Disclosure Documents submitted by commodity pool operators (CPO) and commodity trading advisors (CTA) to NFA. The Division levaquin cipro of Clearing and Intermediary Oversight (DCIO) performs periodic oversight of NFA’s implementation of its delegated authority. As part of these reviews, DCIO staff has recently communicated to NFA by letter dated December 2, 2010 its position as to the disclosure of conflicts of interests that arise from typical incentive fee arrangements. NFA is providing the following guidance based upon DCIO’s letter to assist members in complying with the requirements as they relate to the disclosure of conflicts of interests.

CFTC Regulations 4.24(j) and 4.34(j) require CPOs and CTAs to include in their respective Disclosure Documents a “full description of any actual or potential conflicts of interest” regarding “any aspect” of their pools or trading programs as it concerns an enumerated list of entities, including the CPOs and CTAs themselves.

DCIO staff’s guidance relates specifically to the conflicts of interests arising from the collection of incentive fees by CPOs and CTAs. The typical incentive fee collected by a CPO or CTA is usually a fixed percentage of new profits that exceed a pool’s or an account’s previous high-water mark. DCIO stated that from one perspective, the typical incentive fee can be viewed as aligning the interests of the CPOs and CTAs with the interests of their clients as the fee ensures that CPOs and CTAs are compensated in proportion to their clients’ gains, which plainly incentivizes CPOs and CTAs to pursue investment strategies that will seek to maximize returns for their clients. DCIO further states that the typical incentive fee can also be viewed as placing the interests of CPOs and CTAs in conflict with the interests of their clients. From this perspective, the incentive fee could encourage a CPO or CTA to take excessive risks in an attempt to earn an outsized incentive fee. Because the typical fee is generally paid quarterly and is not subject to clawbacks for poor long-term performance, the typical incentive fee can be viewed as an incentive for CPOs and CTAs to take greater short-term risks, which may conflict with their clients’ long-term interests.

DCIO staff’s guidance prescribes that every CPO or CTA that charges a typical incentive fee include in its Disclosure Document a discussion that the incentive fee may encourage a CPO or CTA to take excessive risks to earn an outsized incentive fee, and that such risk-taking may place the interests of the CPO and CTA in conflict with the interests of its clients. Furthermore, DCIO has indicated that the fact that Regulations 4.24(i) and 4.34(i) require the disclosure of fees and expenses (from which conflicts of interest frequently arise) does not mitigate or lessen the required discussion of conflicts of interest.

CPOs and CTAs are encouraged to review their existing Disclosure Documents in light of DCIO’s guidance and make any necessary changes prior to submitting subsequent filings of the document. If you have any questions concerning this notice or Disclosure Documents generally, please contact Mary McHenry, Senior Manager, Compliance ([email protected] or 312-781-1420) or Susan Koprowski, Manager, Compliance ([email protected] or 312-781-1288).

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Cole-Frieman & Mallon LLP provides comprehensive hedge fund start up and regulatory support for commodity pool operators.  Bart Mallon, Esq. can be reached directly at 415-868-5345.