Exemptive Relief from CPO Annual Audit Requirement

Leave a reply

Managers starting a commodity fund at the end of the year may seek relief from annual audit requirement

CFTC Regulations 4.22(c) and (d) require that each registered CPO file a certified annual report with the CFTC and distribute copies to pool participants within 90 calendar days after the pool’s fiscal year (“audit requirement”).  The principal purpose of these requirements is to ensure that pool participants (fund investors) receive accurate, fair, and timely information on the overall trading performance and financial condition of the pool.  In a situation where a futures/commodities hedge fund was established only a few months or so before the end of the fiscal year, conducting a certified audit at the end of the fiscal year may not be desirable due to costs.  Relief may be available to managers in this situation.  The CPO can request an exemption from the audit requirement from the CFTC.

This article explains how a manager can go about requesting and obtaining an exemption.

Exemptions on a Case-by-Case Basis

The CFTC’s Division of Clearing and Intermediary Oversight (“DCIO”) will grant or deny exemptive relief from the audit requirement on a case-by-case basis, based on each individual CPO’s factual circumstances.  When we spoke informally to a staff member at DCIO, he said that there is no prescriptive list of conditions that will automatically result in exemptive relief but the main factors they seem to take into account are:

  1. the pool has only a handful of participants,
  2. the pool has only a nominal amount of capital contributed and a nominal amount of total net assets, and
  3. each of the participants in the pool has provided a written waiver consenting to the CPO’s exemption from the audit requirement.

In many cases where the exemption was granted, DCIO still placed the following conditions on the CPO:

  1. the CPO must distribute unaudited annual reports to each of the pool’s participants (these unaudited annual reports must otherwise comply with the provisions of CFTC Regulations 4.22(c) and (d)–reprinted in full below), and
  2. at the close of the following fiscal year, the CPO must file an audited annual report that includes the previous unaudited period.

Requesting the Exemption by Email or Letter

DCIO seems to grant exemptions from the audit requirement in response to email or letter  requests from CPOs.  In a 2009 DCIO letter granting exemptive relief, the CPO sent an email to DCIO requesting the exemption.  DCIO found that granting relief in the CPO’s situation was not contrary to Regulation 4.22 nor the public interest.  In particular, it focused on the following facts:

  • the pool began operations in September of 2008,
  • the pool only had 8 participants,
  • the pool had total capital contributions between $300,000-$400,000 as of December of 2008,
  • the pool’s net asset value was between $60,000-$70,000, and
  • the CPO attached waivers from the 8 participants indicating their consent to the exemption.

In a 2010 DCIO letter, DCIO granted the exemption after a CPO sent DCIO a letter requesting the relief and attaching the client waivers.  DCIO reviewed the facts and found granting the exemption was not contrary to Regulation 4.22 nor the public interest.

It is important to note that exemptive letters bind DCIO only with respect to the specific fact situation and persons addressed by the letter and third parties may not rely upon it.  For a full explanation of the CFTC’s exemptive letters, visit the CFTC’s discussion on this topic.  If you are interested in filing for such exemptive relief with respect to your commodity pool, please contact Mallon P.C.

****

Other related hedge fund law articles:

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.

Important Hedge Fund Articles

Leave a reply

As of the date we published this list of important hedge fund articles, the Hedge Fund Law Blog has over 600 posts.  In order to highlight some of the more important items on this website we have created the following list of articles which we think will be useful for most of our readers.  Articles without links will be forthcoming and we look forward to hearing your feedback on what information you would like to see in the future.  The categories include:

  1. Basics & Structure
  2. Offering Documents
  3. Service Providers
  4. Investment Adviser Regulation
  5. Futures & Commodities Regulation
  6. Marketing & Advertising
  7. Operational Issues

We would also like to remind managers who are thinking of starting a fund to view our Start Up Presentation.

BASICS & STRUCTURE

OFFERING DOCUMENTS

INVESTMENT ADVISER

FUTURES & COMMODITIES

MARKETING & ADVERTISING

OPERATIONAL ISSUES

ERISA

LAWS & REGULATIONS

OTHER ISSUES

FOREX

COLE-FRIEMAN & MALLON LLP QUARTERLY NEWSLETTERS

****

Cole-Frieman & Mallon LLP, a hedge fund law firm, sponsors the Hedge Fund Law Blog.  Bart Mallon, Esq. can be reached directly at 415-868-5345.

Litigation Statement for CTA and CPO Disclosure Documents

Leave a reply

One of the more important requirements with respect to drafting the CTA and CPO Disclosure Documents is making sure that all appropriate litigation statements are included in the documents.  Under CFTC Regulations 4.24 (CPOs) and 4.34 (CTAs) the manager is required to disclose the litigation history of: (i) the management company, (ii) principals of the management company and (iii) the FCM and IB.  While (i) and (ii) are generally going to be easy to prepare, getting the litigation history for the FCM and IB will be dependent on the FCM and IB providing the manager or the manager’s attorney with a litigation statement.  Some FCMs and IBs do not have a litigation history and a statement to that effect will need to be included in the disclosure documents.

Below we have included more information on this requirement from the NFA Disclosure Document Guide and we have included the text of the CFTC Regulations.

****

From the NFA guide to disclosure documents:

Litigation

The Document must disclose any material administrative, civil or criminal action, whether pending or concluded, within five years preceding the date of the Document, against the following persons (a concluded action that resulted in adjudication on the merits in favor of such person need not be disclosed):

…

• The pool’s FCM and IBs, if any.

With respect to an FCM or an IB, an action is material if:

• The action would be required to be disclosed in the notes to the FCM’s or IB’s financial statements prepared pursuant to generally accepted accounting principles;

• The action was brought by the Commission (unless the action was concluded, did not result in civil monetary penalties exceeding $50,000, and did not involve allegations of fraud or other willful misconduct); or

• The action was brought by any other federal or state regulatory agency, a non-United States regulatory agency or a self-regulatory organization and involved allegations of fraud or other willful misconduct.

Where a matter is material, its description must include a recital of the nature of the action, the parties involved, the allegations or findings, the status of the action and the size of any fine or settlement.

Source: pages 34 and 35 of the disclosure document guide.

CFTC Regulation 4.24(l)

Litigation.

(1) Subject to the provisions of §4.24(l)(2), any material administrative, civil or criminal action, whether pending or concluded, within five years preceding the date of the Document, against any of the following persons; Provided, however, that a concluded action that resulted in an adjudication on the merits in favor of such person need not be disclosed:

(i) The commodity pool operator, the pool’s trading manager, if any, the pool’s major commodity trading advisors, and the operators of the pool’s major investee pools;

(ii) Any principal of the foregoing; and

(iii) The pool’s futures commission merchants and introducing brokers, if any.

CFTC Regulation 4.34(k)

Litigation.

(1) Subject to the provisions of §4.34(k)(2), any material administrative, civil or criminal action, whether pending or concluded, within five years preceding the date of the Document, against any of the following persons; Provided, however, that a concluded action that resulted in an adjudication on the merits in favor of such person need not be disclosed:

(i) The commodity trading advisor and any principal thereof:

(ii) Any futures commission merchant with which the client will be required to maintain its commodity interest account; and

(iii) Any introducing broker through which the client will be required to introduce its account to the futures commission merchant.

****

Other related hedge fund law articles:

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.

Bart Mallon Quoted in Wall Street Journal on Hedge Fund Registration

Leave a reply

(www.hedgefundlawblog.com)

In an article published today in the Wall Street Journal, Bart Mallon of Cole-Frieman & Mallon LLP was quoted discussing the current and future role of the state securities divisions with respect to hedge funds.  After the implementation of the new SEC registration thresholds under Dodd-Frank, previously SEC registered hedge fund managers will be required to de-register from the SEC and register with the states.  Outside of the logistical hurdles involved with this process, the central issue for managers and investors is whether the states have the resources or expertise to deal with an increased workload.  This is an especially important question as more and more states like California face budget shortfalls and institute furlough days.

For more information on this specific topic, please see our survey on state securities divisions which includes information on number of examiners, number of furlough days, and the frequency of audits of investment advisers.

The Wall Street Journal article can be found here.

****

Other related hedge fund law articles:

Cole-Frieman & Mallon LLP provides legal support and hedge fund start up services to all types of investment managers.  Bart Mallon, Esq. can be reached directly at 415-868-5345.

Costs to Complete New Form ADV Part 2

Leave a reply

SEC Estimates Preparation Costs of $3,000 to $5,000 for SEC Registered Advisers

We have been reviewing the SEC release related to the amendments to Form ADV Part 2.  Specifically we were interested, like many managers, in the amount of time it will likely take to complete the new Part 2.  Unlike the old Part 2, which was mostly check the box answers along with a Schedule F which required some prose, the new Part 2 will be in full “plain English” prose.  While most SEC registered firms have not yet begun the process to switch to the new Part 2, such advisers will likely begin the process soon and will want to know how much it will cost to complete new Part 2.

According to the SEC, most small and mid-sized SEC registered investment advisers will likely pay anywhere from $3,000 to $5,000 to have a law firm or compliance group complete the new Part 2 on their behalf.  Additionally, many states will be requiring new Part 2 so this means that state registered investment advisers will likely need to budget for these expected compliance costs.  Below we have reprinted the discussion from the release which specifically discusses the costs involved.

Please note that Mallon P.C. can help registered investment advisers complete new Form ADV Part 2.

****

Release No. IA-3060; File No. S7-10-00
Amendments to Form ADV

Starting at page 84

We estimate that some advisers may incur a one-time initial cost for outside legal and compliance consulting fees in connection with preparation of Part 2 of Form ADV. While we received no specific comments on our estimate regarding outside legal costs in the Proposing Release, one commenter did state that compliance consultants assist a significant percentage of advisers in preparing their Form ADV.  As a result, we are changing our estimate to reflect a quarter of small advisers using compliance consulting services and a quarter of small advisers using outside legal services and to reflect half of medium advisers using compliance consulting services in lieu of outside legal services and a quarter of medium advisers still using outside legal services. We estimate that the initial per adviser cost for legal services related to preparation of Part 2 of Form ADV would be $3,200 for small advisers, $4,400 for medium-sized advisers, and $10,400 for larger advisers. [324]

[324] Outside legal fees are in addition to the projected hourly per adviser burden discussed above. $400 per hour for legal services x 8 hours per small adviser = $3,200. $400 per hour for legal services x 11 hours per medium-sized adviser = $4,400. $400 per hour for legal services x 26 hours per large adviser = $10,400. The hourly cost estimate of $400 on average is based on our consultation with advisers and law firms who regularly assist them in compliance matters.

We estimate that the initial per adviser cost for compliance consulting services related to initial preparation of the amended Form ADV will range from $3,000 for smaller advisers to $5,000 for medium-sized advisers.[325]

[325] Outside compliance consulting fees are in addition to the projected hourly per adviser burden discussed above. Based on consultation with compliance consulting firms who regularly assist investment advisers in Form ADV preparation, we estimate that small advisers will incur expenses of $3000 per year for the initial preparation of the new Form ADV and medium advisers will incur expenses of $5000 per year for the initial preparation of the new Form ADV.

****

Other related hedge fund law articles:

Cole-Frieman & Mallon LLP provides legal support and hedge fund compliance services to all types of investment managers.  Bart Mallon, Esq. can be reached directly at 415-868-5345.

States Securities Divisions Amending Securities Regulations Post Dodd-Frank

Leave a reply

Washington State Proposes Amendment to Definitions

The Dodd-Frank bill has certainly created new responsibilities for the SEC and CFTC.  Also affected are the state securities divisions which have laws and regulations referencing, or based on, various federal securities laws.  Because federal laws have changed under Dodd-Frank, the state securities laws (generally known as “Blue Sky” laws) will eventually need to be amended as well.  Over the coming months we will see various state securities divisions propose changes to regulations designed to correspond to the new laws under Dodd-Frank.  One state, Washington (which is known to have a good securities division), has recently proposed rules to “amend the definition of “accredited investor” contained in its rules to conform to federal law through expedited rule making.”

Additionally, we may see state legislatures rewriting large parts of their securities laws to correspond with the changes at the federal level.  Such effort may be coordinated by NASAA or through another iteration of the Uniform Securities Act.

****

Other related hedge fund law articles:

Cole-Frieman & Mallon LLP provides legal support and hedge fund compliance services to all types of investment managers.  Bart Mallon, Esq. can be reached directly at 415-868-5345.

NFA Changes Post CFTC Audit

Leave a reply

The results of the CFTC’s audit of the NFA were released a few weeks ago and we have already begun to see a few changes to the way the NFA operates.

Access to BASIC Security Manager

Previously newly formed entities which were registering with the CFTC could start the registration process prior to formally being established.  Now, the NFA must have proof that the entity is in existence prior to granting security manager status.  Accordingly, groups wishing to register must wait until the entity is in existence and then submit the security manager form.  This will usually delay an initial application by about a week. We believe it would be more effective if the NFA made sure that the entity was established prior to submitting a registration application.  Absent such procedures, we believe that the security manager process should be streamlined and that access should be granted next day via email.  There is no good reason to have such a slow process just to access the online registration system.

Client withdrawals from account

Previously it was common for some CTAs to have some sort of lock-up period with respect to a trading program.   Now, the NFA will not allow a CTA to have a lock-up period because the client is always able to go to the FCM and cancel the account.  While from a technical perspective the client always has access to its own account and the CTA can’t control access to the account, many CTAs preferred the implicit protection afforded through the contractual agreement that the account would stay open during the lock-up.   By not allowing the lock-up language, CTAs will potentially be subject to greater and more frequent withdrawals from investors.

Revising Disclosure Documents

Many NFA Member firms will find out about the various new NFA procedures during the disclosure document revision process.  Moving forward, various deficiencies with disclosure documents that have been approved by the NFA in the past will need to be fixed (even though the documents were previously approved) as the managers revise the documents and seek instant filing or regular filing.

Please let us know if you have experienced any other changes with the NFA.

****

Other related hedge fund law articles:

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.

NFA Registration for Forex Managers with a Disciplinary Record

Leave a reply

In January 2010, the CFTC proposed rules regarding regulation of retail off-exchange foreign currency (forex) products.  It received over 9,000 comments relating to the forex rules and will start publishing final rules this fall. One component of the proposed rules requires all forex account managers and pool operators to register with the CFTC as forex CTAs and CPOs and to become NFA Members.  For those forex managers with criminal disclosures, a concern is how long it will take to get through the registration process and what registration will entail.

This article describes the registration process for forex managers with disciplinary disclosures and the issues they will likely face.

Anticipated Forex Registration Process

The forex registration procedures are likely going to be the same as those currently in place for regular CPOs and CTAs.  CPOs and CTAs must file the following:

  • a completed online Form 7-R (including NFA membership sections)
  • a non-refundable application fee
  • CPO/CTA Membership Dues

Principals and Associated Persons of a CPO or CTA must also file the following:

  • a completed online Form 8-R
  • Fingerprint Cards
  • Proficiency Requirements (e.g. Series 3)
  • a non-refundable Principal Application Fee
  • a non-refundable Associated Person Application Fee

In addition to providing the application materials discussed above, forex managers will likely have to meet regulatory exam requirements–the Series 34 and Series 3 exams.

Disciplinary Disclosures on Forms 7-R and 8-R

On Forms 7-R and 8-R, the manager must provide disciplinary information for the firm, the Principals, and the Associated Persons.  This includes criminal disclosures, regulatory disclosures, and financial disclosures.  The NFA has indicated that if any of the disciplinary information disclosed is a disqualification from registration under Sections 8a(2) or 8a(3) of the Commodity Exchange Act, the application will probably be reviewed by an internal NFA committee.

Disqualifications under Sections 8a(2) and (3) include, for example:

  • suspension or revocation of prior NFA registration
  • a permanent or temporary injunction from (i) acting as an FCM, IB, floor broker, floor trader, CTA, CPO, associated person, securities broker, etc.; or (ii) activity involving embezzlement, theft, extortion, fraud, misappropriation of funds, etc.
  • a conviction within 10 years for a felony that (i) involves transactions or advice concerning futures contracts; (ii) arises out of the conduct of the business of an FCM, IB, floor broker, CTA, CPO, etc.; or (iii) involves embezzlement, theft, extortion, fraud, misappropriation of funds, securities or property, forgery, etc.
  • a finding, by a federal or state regulatory body, that the manager has violated various securities and commodities laws

It is important to disclose all disciplinary matters.  Failure to disclose such matters could be an additional ground for disqualification from registration.  It is also important that if the forex manager answers “Yes” to any of the disciplinary information questions, he or she provides a written explanation detailing the events and conduct involved.  In addition to this explanation, other documents may also be required by the NFA (e.g. court records).  Failure to provide the additional documentation will inevitably delay the registration process.

Providing Additional Documents for Criminal Matters

If a criminal matter is disclosed, the NFA will want documents that reflect the following information:

  • the complaint;
  • the entry of a plea or plea agreement, or judgement/conviction;
  • the sentence;
  • proof that you completely satisfied your sentence; and
  • the final outcome of the court’s action .

It is probably best to request your entire court file so that the documents are available for the NFA.

Review by an Internal NFA Committee or Scheduling a Hearing

Upon receiving the application materials listed above (and any required supplemental documents (e.g. court records)), the reviewer will forward the case on to the internal NFA committee.  We spoke informally to an NFA reviewer who stated that the committee hears cases once a week, on a first-in, first-out basis.  That committee will review the circumstances of each disqualification independently and decide whether to approve registration or to recommend a proceeding to deny registration.  The NFA reviewer we spoke to said that a decision by this committee is generally made within 24 hours.  Upon approval, the firm will appear on the NFA’s BASIC search engine.  If the application is denied, a denial letter is sent to the manager.  A hearing can then be scheduled with the legal department and additional information regarding the registration may be provided.

At the end of the hearing, the registration is essentially either denied, approved, or approved with conditions.  It is difficult to predict the amount of time it would take for a forex manager with a criminal record to get through the NFA registration process.  If supplemental documents (e.g. court records) are missing, the reviewer will have to send deficiency letters to the manager, which will delay the registration process.

****

Other related hedge fund law articles:

Cole-Frieman & Mallon LLP provides legal support and forex registration services to forex managers.  Bart Mallon, Esq. can be reached directly at 415-868-5345.

Form ADV Part 2 and State Registration

Leave a reply

A couple of weeks ago the SEC announced that they approved certain updates for Form ADV Part 2 .  While these forms will be required for managers who are subject to registration with the SEC (under the new rules, those managers with either $100 or $150 million of assets under management depending on the circumstance), the states are still determining how they are going to handle new Part 2.  We have done a preliminary investigation by calling a number of the more popular states and found that most states are planning to implement new Part 2, but are not sure when the requirement will be finalized.  From our research, Texas is the only state that has set a date for implementation of new Part 2.

The list of states is below.  We will continue to update this list.

****

  • Arizona – will require but not sure starting when
  • California – will require but not sure when
  • Colorado – will require but not sure starting when
  • Connecticut – discussing now and will have a decision at the end of the month
  • Illinois – will require but not sure starting when
  • Massachusetts – will require but not sure starting when
  • Texas – will require starting 01/11

****

Other related hedge fund law articles:

Cole-Frieman & Mallon LLP provides legal support and hedge fund compliance services to all types of investment managers.  Bart Mallon, Esq. can be reached directly at 415-868-5345.

Emerging CTA Contest

Leave a reply

Futures Magazine Looks to Profile “Hot New CTAs”

Futures magazine is looking to profile new CTAs for their annual feature entitled “Hot New CTAs.”  The requirements for potential inclusion in the survey include:

  • have managed customer funds for at least one year as of the end of August
  • have less than $25 million of AUM
  • have a disclosure document
  • have an audited track record

If you are interested, you should pick up a copy of Futures magazine.  The deadline for submissions is August 20.

****

Cole-Frieman & Mallon LLP provides legal support as well as CTA and CPO registration services to futures and commodities advisors.  Bart Mallon, Esq. can be reached directly at 415-868-5345.