Tag Archives: cftc rule 4.5

CFTC Rescinds 4.13(a)(4) CPO Registration Exemption

Increases Other Compliance Obligations for CPOs and CTAs 

The CFTC recently adopted final rules amending regulations applicable to both CPOs and CTAs. The CFTC also proposed rules with respect to Regulation 4.5 that would require managers to managed futures mutual funds to register as CPOs. Some of the other changes included:

  • CPOs subject to “lite-touch” regulation under the 4.7 exemption must now provide annual audited returns to investors in their funds
  • Changes the 4.5 exemption from CPO registration for managers to managed futures mutual funds
  • Requires CTAs and CPOs who file exemptions under 4.5, 4.13 and 4.14 to reconfirm the exemption on a yearly basis
  • Adds new Regulation 4.27 requiring CTAs and CPOs to file Form PFForm CPO-PQR and From CTA-PR
  • Requires CTAs and CPOs to provide investors with new disclosures regarding swap transactions, if applicable

Additionally, the CFTC has proposed regulations with respect to harmonizing CFTC regulations and SEC regulations with respect to managed futures mutual funds.  We will be providing additional information on these proposals in the coming days and weeks.

The full CFTC notice can be found here.

The final CFTC regulations can be found here: CPO & CTA Compliance Final Rules

Fact sheet: CTA & CPO Compliance Fact Sheet

Proposed Regulations for Managed Futures Mutual Funds: Proposed CPO Registration Requirement for Mutual Fund Managers


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

Managed Futures Regulation Post-MF Global Bankruptcy

Below is an article I wrote about how the managed futures industry is likely to react after the MF Global bankruptcy. I originally began drafting the article at the end of 2011 and finished it in the first week of January 2012.  As we have already seen, the industry is in fact moving towards addressing some of these issues and ultimately I believe that regulatory and other changes will increase the vitality of the managed futures industry.

The article was originally published as part of the Marcum Private Investment Forum newsletter and can be found here.  Please feel free to contact us if you have any questions or comments on the article.


MF Global Bankruptcy to Shape Managed Futures Regulation in 2012

By Bart Mallon, Esq. Partner, Cole-Frieman & Mallon LLP

It was a combination of the Lehman bankruptcy and the Madoff fraud that led an angry and embarrassed Congress to publicly castigate the SEC for not properly doing its job. What came to bear was the passage of the Dodd-Frank Act which ushered in new laws for the SEC and the CFTC to implement in short order and with limited budgets. The CFTC is in the middle of a similar event which saw the 8th largest bankruptcy in U.S. history as MF Global (MFG) declared bankruptcy on October 31, 2011. The biggest revelation, however, might have been that $1.2 billion of customer money was missing. The fact that there was the potential for a “shortfall” in a managed futures account was shocking – the industry that had prided itself so much on the sacrosanct customer account was now trying to make sense of how something like this happened.

While the various investigators, including the FBI, are trying to figure out where the money is and what transactions are valid, Congress and others are debating the future of regulation for the industry. The Commodity Futures Trading Commission (CFTC), the governmental agency which oversees the managed futures industry, is dealing with not only the MFG bankruptcy but a whole host of other issues. The MFG bankruptcy has brought to light issues with the regulation of the managed futures industry – (1) the practice of utilizing self regulatory organizations (SROs) to oversee important entities within the industry, (2) no “insurance” for margin in managed futures customer accounts and (3) lack of proper funding for the CFTC. Ultimately these issues will need to be addressed and will shape how the industry is regulated moving forward.

Self-Regulation – Is the Fox Watching the Henhouse?

Prior to MFG bankruptcy, the managed futures industry prided itself on the fact that “not a single cent” was ever lost in a customer account due to theft from a futures commission merchant (FCM). Perhaps because of this, the industry seemed unconcerned about the hodge-podge of government agency oversight combined with self-regulation over the managed futures participants. The central SRO for MFG was the CME Group, the world’s largest futures exchange which includes the CME, CBOT, NYMEX and COMEX exchanges. The CME Group is a publicly traded company subject to oversight by the CFTC with respect to its own operations and is also subject to oversight of its supervision of MFG.

MFG ran most of its clearing business through the CME. This means that while the CME derived substantial revenue from MFG, it also was in charge of overseeing MFG to make sure the laws and regulations under the Commodities Exchange Act (CEA) were being followed. While it seems like this will be a conflict of interest on its face, this is how the futures industry works. The argument for having the CME Group act as the SRO to MFG is that as the central exchange, it was in the best position to regulate MFG. The futures industry is an altogether different beast from the securities industry and the CME Group, because of its understanding of the relationships between the firms, was in the best position to oversee MF Global and make sure the firm was complying with all of the requirements of the Commodities Exchange Act. The CME Group is now being investigated – what did it know about MFG’s shortfall and when?

It is easy to paint MFG as simply the bad actor by hiding transactions from the CME Group. But we will learn more as the investigation moves on and if we find that the CME Group was deficient in its oversight of MFG, the SRO model (especially in instances where there is potential conflicts of interest) will need to be reexamined. If it is discovered that there were deficiencies with the SRO oversight of MFG, this will likely create liabilities for the CME Group and may change which SROs can oversee which organizations.

No Insurance for Futures Accounts

The second issue which the MFG bankruptcy highlighted is that there is no insurance for managed futures accounts. In the segregated account structure, the margin required for each futures contract is supposed to be kept in the customer’s name. With respect to the MFG bankruptcy, the $1.2 billion in missing customer assets meant that when customer accounts were transferred from MFG to the various other FCMs only a certain percentage of the margin was transferred to the new FCM, initiating additional margin calls at the new FCM. Many investors were not able to meet the additional margin calls at the new FCM and thus their positions were liquidated. Forced liquidations left a number of investors either unhedged or worse. Small farmers that held accounts at MFG for hedging their crops were especially hard hit.

On the securities side there is the Securities Investor Protection Corporation (SIPC) which provides insurance coverage of up to $500,000 of securities and up to $250,000 in cash in the event that a broker-dealer fails. During the Lehman bankruptcy and Madoff fraud investigation, the SIPC was available to assuage the fears of smaller investors by acting as a backstop to potential losses. Indeed, the SIPC was formed for events just like Lehman. There is no similar insurance program for the margin held in segregated accounts at FCMs.

There have been calls for creating an insurance-like mechanism for futures accounts. The benefits are clear – a guarantee of customer accounts will protect the smaller investors like the farmers and other smaller hedgers. However, there are cost issues to consider and the creation of an SIPC-like mechanism for the managed futures industry needs to be initiated at the Congressional level. The managed futures industry will likely push back any such proposal because of the significant costs involved with implementing such a structure. Timing may also be an issue – the CFTC faces a funding shortfall in addition to Dodd-Frank mandates and other proposed rulemaking functions.

CFTC Funding Issues Present Big Problems for Industry

The CFTC lacks proper funding to adequately protect investors and maintain the integrity of the managed futures industry. The Congressional appropriations process is obviously a political game at which both the SEC and CFTC have failed. The two federal agencies charged with maintaining the integrity of the investment universe are woefully underfunded given their mandates. It is this underfunding that is perhaps the biggest issue for the integrity of the managed futures industry which is why the CFTC needs more money from Congress. More money also helps the CFTC to properly implement parts of the Dodd-Frank Act as well as other adopted and/or proposed regulations.

Dodd-Frank & Swaps Clearing

One of the central pieces of the Dodd-Frank Act is the requirement that swaps be traded and cleared on exchanges. The multi-trillion dollar industry has been unregulated – making counterparties liable to one another and subject to counterparty risk. The intermediation of a clearing house not only creates logistical issues (who, how, when, at what price) but also requires complex, detailed regulations. The CFTC, in conjunction with the SEC with respect to certain matters, was tasked with creating these regulations from scratch. This will be the largest undertaking for the CFTC in 2012 and will likely consume more resources than the MFG investigation.

Other Regulatory Proposals

In addition to the swaps regulations, there are a number of other important regulatory proposals which, if implemented, drastically changes how the managed futures industry operates.

Repeal of Regulation 4.5

CFTC Regulation 4.5 essentially exempts certain mutual funds that invest in managed futures from the commodity pool operator (CPO) registration provisions. This means that mutual funds that are essentially publicly traded commodity pools are only regulated by the SEC, who has no experience dealing with the ultimate underlying investments.

In January of 2011 the CFTC proposed repealing Regulation 4.5. If this proposal is adopted as written, managers to managed futures mutual funds need to register as CPOs with CFTC (and become members of the NFA, subject to NFA oversight). This requirement increases the cost burden for these mutual funds and subjects them to great regulatory oversight.

Repeal of Regulation 4.13(a)(4) and 4.13(a)(3)

Regulation 4.13(a)(4) provides an exemption from CPO registration to those managers who provide advice to a fund (commodity pool) which only has investors who are qualified eligible persons (QEPs). In general, QEPs are investors who meet a higher net worth requirement than accredited investors.

The CFTC also proposed the repeal of Regulation 4.13(a)(3) which provides a “de minimis” exemption from CPO registration to those commodity pool (i.e. hedge fund) managers who only trade a small amount of futures in addition to securities. If 4.13(a)(3) was repealed, all fund managers who trade any amount of futures will be required to become registered as a CPO. It seems that right now this proposal will likely fail, leaving hedge fund managers with the possibility of escaping CPO registration.

Proposed with the Regulation 4.5 repeal, the Regulation 4.13(a)(4) and (a)(3) repeal requires a large number of managers who are not currently registered with the CFTC to register and become NFA members. Again, this will increase the number of firms subject to NFA (and ultimately CFTC) oversight.

Position Limits

Dodd-Frank Act mandated for the CFTC to impose position limits across different markets, including traditional futures markets, option on futures or commodities traded on a regulated exchange, and trading in swaps. These position limits will not apply to bona fide hedging transactions and counterparties to a bona fide hedge may also be eligible for an exemption. In general, position limits set at 25% of estimated physical deliverable supply for spot-month positions and, with respect to non spot-months, at 10% of open interest (based on futures open interest, cleared swap open interest, and uncleared swaps open interest) in the first 25,000 contracts and 2.5% above that level. There will also be additional reporting requirements for traders exceeding a non-spot-month position visibility level in energy and metal contracts. The industry is vehemently fighting this proposal.

Other Proposals

in addition to these proposals, the CFTC has other standard enforcement and regulatory issues that have become focus areas. These include high frequency trading and co-location.

It seems clear that given the Dodd-Frank Act’s inclination toward more oversight and regulation of the investment management industry, as well as the recent regulatory fumbles involving MFG, some of these proposals are likely to be adopted. Therefore, managers are going to be required to register as CPOs and the NFA will be the watchdog. But, the NFA, like the CFTC, is a resource limited organization and the ability to effectively monitor member firms will depend on the NFA’s ability to scale to meet the regulatory requirements.


Over the next several months and potentially years the MFG bankruptcy will be sorted out, and hopefully investors will be made whole. During the process of rebuilding the industry to handle the managed futures markets in a time of significant growth in trading and technology, the focus should be on doing whatever is necessary to bring confidence back into the managed futures markets. This will include examining the role of the SRO industry moving forward, examining an insurance SIPC-like program for futures customers and providing more resources for the CFTC. Moving forward it will be Congress who will need to show leadership and provide the CFTC with the funding it will need and the appropriate legislative tools to make sure the industry becomes safer. Hopefully, that will be the good which arises from the unfortunate events that led to the MFG bankruptcy.


Bart Mallon is a Partner at Cole-Frieman & Mallon LLP where his practice focuses on the investment management industry, specifically working with hedge fund managers and groups in the managed futures industry. Mr. Mallon also founded and runs the widely-read Hedge Fund Law Blog.

CFTC May Consider Vote on CPO Registration for Mutual Fund Managers

Three days ago, reports came out that the CFTC could be putting to a private vote the requirement that managed futures mutual funds be subject to marketing and registration rules when they use derivatives tied to commodities, which include commodity futures, options and swaps.  According to individuals who spoke on anonymity, the proposed regulation has been circulated for a vote by the CFTC’s five commissioners.  The commissioners could end up voting on the proposed regulation or deciding to hold a public vote.  If the proposal passes as adopted, managers to managed futures mutual funds would be required to register as commodity pool operators (CPOs) with the CFTC.

Background on CFTC Rule 4.5

As previously discussed in an earlier article on CFTC Rule 4.5, the issue of requiring mutual funds to register with the CFTC has been on the Commission’s radar for a long time.  In part because of pressure from the NFA, the CFTC proposed changes to Rule 4.5 in February of 2011 which would require CPO registration for most managers to managed futures mutual funds. While the current rule exempts managers from the registration requirements, prior to 2003 mutual fund managers were required to register as CPOs unless they:

  1. restricted their commodities and futures marketing activity,
  2. limited commodity futures or options activity to bona fide hedging transactions, and
  3. limited the aggregate futures margins and/or options premiums for non-hedging positions to 5% of the liquidating value of the entity’s portfolio (after taking into account unrealized profits and losses).

When the CFTC amended Rule 4.5 in 2003, it eliminated the trading and marketing restrictions and as a result managed futures mutual funds currently market participation in their funds as managed futures funds and have more than 5% direct exposure to managed futures for speculative purposes.  The February proposal seeks to reinstate the pre-2003 language in Rule 4.5.

Wholly-Owned Subsidiaries

It is important to note that the 5% limit in the proposed Rule 4.5 would apply to the entity filing for the Rule 4.5 exemption, not subsidiaries. Managed futures mutual funds are currently structured so that the managed futures investments are made through wholly-owned subsidiaries.  Wholly-owned subsidiaries would not qualify for the 4.5 exemption unless each subsidiary independently met all the requirements set forth in the proposed amendment. Therefore, mutual funds (i) with an investment objective to provide exposure to physical commodities as an asset class and (ii) that do so by investing in commodity futures, options, and swaps via wholly-owned subsidiaries, must make sure that those subsidiaries qualify for Rule 4.5 as well.


If the CFTC approves the proposed regulation, it would subject many mutual funds to CFTC registration and oversight by the NFA.


Cole-Frieman & Mallon LLP provides advice to managers in the managed futures industry.  The firm also has a robust alternative mutual fund practice led by Aisha Hunt.  Bart Mallon can be reached directly at 415-868-5345.  Aisha Hunt can be reached directly at 415-762-2854.