NFA Petitions CFTC to Amend Rule 4.5

Wants Managers of Commodity/Futures Mutual Funds to Register as CPOs

On August 18, 2010, the NFA filed a revised Petition for Rulemaking with the CFTC requesting that it amend CFTC Rule 4.5 with respect to managers to mutual funds which offer futures and commodities investment opportunities.  Generally, a manager operating a mutual fund that invests in futures and commodities would be a commodity pool operator and would need to register as such with the CFTC.  However, under current CFTC Rule 4.5, the manager could seek exclusion from such registration.  The NFA has become concerned about mutual funds that are not subject to the CFTC/NFA regulatory regime and that are marketed to retail customers as a way to invest in futures and commodities.  The NFA is requesting amendment of Rule 4.5 to restrict this kind of activity.


CFTC Rule 4.5 provides an exclusion from the definition of the term “commodity pool operator” for certain otherwise regulated persons in connection with their operation of specified trading vehicles, including investment companies registered under the Investment Company Act of 1940.

Prior to August 2003, mutual fund managers seeking eligibility for exclusion under Rule 4.5 were required to meet the following requirements:

  • they could not market participation in the mutual fund as participation in a commodity pool or a vehicle for trading commodities or futures;
  • they had to represent that commodity futures or options contracts entered into by the fund were for bona fide hedging purposes; and
  • they had to demonstrate that the aggregate initial margin and/or premiums for non-hedging positions did not exceed 5% of the liquidating value of the fund’s portfolio (after taking into account unrealized profits and losses).

In August 2003, the CFTC eliminated these requirements as a condition to be eligible under Rule 4.5.  The NFA is now petitioning for the CFTC to restore these conditions for eligibility.

NFA Petition for Rulemaking

The NFA’s Petition discusses the context for requesting this amendment.  In particular, the NFA has become aware of three mutual funds that recently filed for exclusions under Rule 4.5.  These funds are marketed as vehicles for commodity futures investment, with investments in derivatives and futures products made indirectly through their wholly-owned and controlled subsidiaries (for tax and mutual fund regulatory purposes).  In one case, a fund invests up to 25% of its total assets in a subsidiary that leverages assets at a 4:1 ratio–achieving a futures exposure of the full net value of the fund.

The NFA is concerned that such funds, which are active in the commodity futures industry, are not regulated as CPOs by the CFTC and NFA.  The futures mutual fund manager can file a notice with the NFA claiming the Rule 4.5 exclusion under the Commodity Exchange Act, as amended.  Accordingly, the fund is not subject to registration or regulation as a commodity pool.  Through its Petition, the NFA seeks to ensure that managers of registered investment companies that are marketed as a commodity pool or an investment vehicle for trading in commodity futures and options and whose funds engage in more than 5% of futures are subject to the appropriate oversight and regulatory requirements.

“No-Marketing” and the 5% Limitation

At the time the CFTC amended Rule 4.5, it also adopted Rule 4.13(a)(4) to provide an exemption to CPO registration if every natural person pool participant is a “qualified eligible person.”  The NFA argues that to the extent this exemption served as a reason to eliminate the “no marketing” and “5% trading test” from Rule 4.5, the CFTC should reexamine whether such reasoning is still valid.

When the CFTC amended these rules, it did so under the presumption that the qualifying entities, such as the mutual funds discussed in this article, were “otherwise regulated” and “may not need to be subject to any commodity interest trading criteria.”  But, the NFA is asserting that things have changed since the 2003 amendment and the rationale for the amendments is arguably no longer appropriate or valid.  Such registered investment companies that market themselves as a commodity pools or vehicles for trading in commodity futures or options to retail customers, who may be unsophisticated investors, or engage in more than 5% of non-hedging futures trading should be subject to the rules and regulations of the CFTC and NFA, the appropriate regulatory regime that protects customers participating in the commodity futures markets.

Comments by CFTC Commissioner

On September 1, 2010, CFTC Commissioner Scott O’Malia released a statement regarding the NFA petition which urged the CFTC to “expeditiously” move forward and adopt the NFA’s requested amendments.  The Commissioner stated:

Until the recent influx of new mutual funds specializing in futures trading, the use of the exclusion, in effect a form of regulatory arbitrage, was innocuous. However, continuing to allow FMFs to operate by evading CFTC oversight and its substantial disclosure obligations now poses increased risks to the market and to retail investors.


Without CFTC and NFA oversight, FMFs and other such funds that mimic CPOs, but do not abide by the same structure, will continue to avoid specific disclosures mandated for CPOs in the interest of consumer protection including: disclosures over fund risk exposure; performance returns; fee structures; and advisor conflict of interest information.

Future of Rule 4.5

It is clear that a new Rule 4.5 would be fiercely contested by current mutual fund managers who are investing in futures/commodities.  The big issue for managers will be an increase in start-up and compliance costs as well an increase in infrastructure requirements to comply with CFTC Regulations.  This will undoubtedly increase costs to mutual fund investors (and, the NFA argues, potentially increase investor protection).

However, nothing has happened yet.  Although the NFA asked the CFTC to amend the regulation, the CFTC will need to publish proposed amendments for public comment.  After receiving comments, the CFTC would be permitted to issue final regulations.  However, we do not think it is likely that the CFTC is going to focus its rule making (amending) efforts on issues that don’t fall under the Dodd-Frank act.  As the CFTC is under-resourced for this requirements of Dodd-Frank, it is unlikely to take up any outside initiatives over the next 9-12 months as they focus on other rule making efforts such as the OTC derivatives reform.

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

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