“Lite-Touch” Regulatory Approach for Certain CFTC Registrants
In general, CFTC registered CPOs and CTAs must adhere to certain disclosure and reporting requirements as specified in the Commodity Exchange Act (“CEA”) and regulations thereunder. However, some CFTC registered firms can operate under a “lite-touch” regulatory regime if the firm only provides investment management services to qualified eligible persons. The lite-touch regulatory regime is available under CFTC Rule 4.7 to both CPOs and CTAs who file the exemption with the NFA.
This post will provide an overview of the firms which are eligible for the exemption and an overview of the relief granted. We post the entire text of the exemption at the end of this post.
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Eligibility for Exemption
In general, the exemption is available for firms which meet the following requirements:
- Registered with the CFTC as a CPO or CTA
- Investors/Clients are only qualified eligible persons (QEPs)
- 4.7 Exemption filed with the NFA
- Offering/Disclosure Documents contain CFTC disclaimer
The central reason why some firms will want to utilize the exemption is to keep from going through the disclosure document review process with the NFA which can take anywhere from 3 weeks to 3 months depending on a number of factors. Please note that firms must already be registered with the CFTC which means that Principals and APs will generally need to have the Series 3 exam license. If a CPO wants to remain unregistered, the firm may be able to use the 4.13(a)(4) exemption instead of the 4.7 exemption.
Filing the Exemption
To file the notice for exemption, the firm will need to access the NFA’s online registration system and complete the required exemption filing. In order to claim the exemption, the CPO or CTA will be required to certify that:
- neither the CPO/CTA nor its Principals are subject to statutory disqualifications under sections 8a(2) or 8a(3) of the CEA;
- the CPO/CTA will comply with the applicable requirements of Rule 4.7 (see below for full text of rule);
- and for CPOs, that the exempt pool will be offered and operated in compliance with the requirements of Rule 4.7.
Generally, the exemption becomes effective upon filing, assuming there are no errors with the filing. It is important to note that the exemption ceases to be effective once a CPO’s/CTA’s circumstances change rendering it ineligible for the exemption. The CPO/CTA must promptly notify the NFA of such change.
Requirements From Which CPO/CTA is Exempt
Under the 4.7 exemption, CPOs are granted the following:
- Disclosure Relief
- exempt from delivering to potential investors disclosure documents pursuant to Rule 4.21 or file/submit amendments of disclosure documents with the NFA pursuant to Rule 4.26
- exempt from the specific disclosure document requirements pursuant to Rule 4.24 (e.g. risk disclosure statements, potential conflicts of interest, risk factors, etc.)
- exempt from the performance disclosure requirements pursuant to Rule 4.25
*If the CPO chooses to provide investors with an offering memorandum, it must not be misleading and must contain the risk disclosure statement pursuant to Rule 4.7(b)(1).
- Reporting Relief
- exempt from the full reporting requirements to Rule 4.22(a)( and (b) but the CPO must provide investors with a quarterly statement within 30 days of the end of the quarter which includes: (i) NAV of the exempt pool, (ii) change in NAV, and (iii) NAV per outstanding interest
- Annual Report Relief
- exempt from the annual reporting requirements of Rule 4.22(c) and (d) but the CPO must file and distribute, within 90 days of the end of the year, an annual report for the exempt pool that contain: (i) a statement of financial condition, (ii) statement of income, (iii) footnote disclosures and other material information
- Recordkeeping relief
- exempt from the full recordkeeping requirements of Rule 4.23 but the CPO must maintain the reports discussed above and all books and records related to the exempt pool in accordance with Rule 1.31
Under the 4.7 exemption, CTAs are granted the following:
- Disclosure Relief
- the CTA is similarly exempt from disclosure documents requirements pursuant to Rule 4.31, 4.34, 4.35, and 4.36
- Recordkeeping Relief
- exempt from the full recordkeeping requirements of Rule 4.33 but the CTA must maintain all books and records related to the exempt accounts in accordance with Rule 1.31
Important Items to Note
- 4.7 Exempt CPOs will still need to file quarterly NFA Rule 2-46 reports for the funds which they manage.
- CPOs must remember that while they may file a Rule 4.7 exemption for a particular pool and thus be exempt from the above requirements, the CPO is not exempt as related to the other non-exempt pools that it may operate.
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The full text of Rule 4.7 is reprinted below:
§ 4.7 Exemption from certain part 4 requirements for commodity pool operators with respect to offerings to qualified eligible persons and for commodity trading advisors with respect to advising qualified eligible persons.
This section is organized as follows: Paragraph (a) contains definitions for the purposes of §4.7; paragraph (b) contains the relief available to commodity pool operators under §4.7; paragraph (c) contains the relief available to commodity trading advisors under §4.7; paragraph (d) concerns the Notice of Claim for Exemption under §4.7; and paragraph (e) addresses the effect of an insignificant deviation from a term, condition or requirement of §4.7.
(a) Definitions…..[intentionally omitted
(b) Relief available to commodity pool operators. Upon filing the notice required by paragraph (d) of this section, and subject to compliance with the conditions specified in paragraph (d) of this section, any registered commodity pool operator who offers or sells participations in a pool solely to qualified eligible persons in an offering which qualifies for exemption from the registration requirements of the Securities Act pursuant to section 4(2) of that Act or pursuant to Regulation S, 17 CFR 230.901 et seq., and any bank registered as a commodity pool operator in connection with a pool that is a collective trust fund whose securities are exempt from registration under the Securities Act pursuant to section 3(a)(2) of that Act and are offered or sold, without marketing to the public, solely to qualified eligible persons, may claim any or all of the following relief with respect to such pool:
(1) Disclosure relief.
(i) Exemption from the specific requirements of §§4.21, 4.24, 4.25 and 4.26 with respect to each exempt pool; Provided, That if an offering memorandum is distributed in connection with soliciting prospective participants in the exempt pool, such offering memorandum must include all disclosures necessary to make the information contained therein, in the context in which it is furnished, not misleading; and that the following statement is prominently disclosed on the cover page of the offering memorandum, or, if none is provided, immediately above the signature line on the subscription agreement or other document that the prospective participant must execute to become a participant in the pool:
“PURSUANT TO AN EXEMPTION FROM THE COMMODITY FUTURES TRADING COMMISSION IN CONNECTION WITH POOLS WHOSE PARTICIPANTS ARE LIMITED TO QUALIFIED ELIGIBLE PERSONS, AN OFFERING MEMORANDUM FOR THIS POOL IS NOT REQUIRED TO BE, AND HAS NOT BEEN, FILED WITH THE COMMISSION. THE COMMODITY FUTURES TRADING COMMISSION DOES NOT PASS UPON THE MERITS OF PARTICIPATING IN A POOL OR UPON THE ADEQUACY OR ACCURACY OF AN OFFERING MEMORANDUM. CONSEQUENTLY, THE COMMODITY FUTURES TRADING COMMISSION HAS NOT REVIEWED OR APPROVED THIS OFFERING OR ANY OFFERING MEMORANDUM FOR THIS POOL.”
(ii) Exemption from disclosing the past performance of exempt pools in the Disclosure Document of non-exempt pools except to the extent that such past performance is material to the non-exempt pool being offered; Provided, That a pool operator that has claimed exemption hereunder and elects not to disclose any such performance in the Disclosure Document of non-exempt pools shall state in a footnote to the performance disclosure therein that the operator is operating or has operated exempt pools whose performance is not disclosed in this Disclosure Document.
(2) Periodic reporting relief . Exemption from the specific requirements of §§4.22(a) and (b); Provided, That a statement signed and affirmed in accordance with §4.22(h) is prepared and distributed to pool participants no less frequently than quarterly within 30 calendar days after the end of the reporting period. This statement must be presented and computed in accordance with generally accepted accounting principles and indicate:
(i) The net asset value of the exempt pool as of the end of the reporting period;
(ii) The change in net asset value from the end of the previous reporting period; and
(iii) The net asset value per outstanding unit of participation in the exempt pool as of the end of the reporting period.
(A) Either the net asset value per outstanding participation unit in the exempt pool as of the end of the reporting period, or
(B) The total value of the participant’s interest or share in the exempt pool as of the end of the reporting period.
(iv) Where the pool is comprised of more than one ownership class or series, the net asset value of the series or class on which the account statement is reporting, and the net asset value per unit or value of the participant’s share, also must be included in the statement required by this paragraph (b)(2); except that, for a pool that is a series fund structured with a limitation on liability among the different series, the account statement required by this paragraph (b)(2) is not required to include the consolidated net asset value of all series of the pool.
(v) A commodity pool operator of a pool that meets the conditions specified in §4.22(d)(2)(i) of this part to present and compute the commodity pool’s financial statements contained in the Annual Report in accordance with International Financial Reporting Standards issued by the International Accounting Standards Board and has filed notice pursuant to §4.22(d)(2)(ii) of this part also may use such International Financial Reporting Standards in the computation and presentation of the account statement.
(3) Annual report relief.
(i) Exemption from the specific requirements of §4.22(c) and (d) of this part; Provided, That within 90 calendar days after the end of the exempt pool’s fiscal year
or the permanent cessation of trading, whichever is earlier, the commodity pool operator electronically files with the National Futures Association and distributes to each participant in lieu of the financial information and statements specified by those sections, an annual report for the exempt pool, affirmed in accordance with §4.22(h) which contains, at a minimum:
(A) A Statement of Financial Condition as of the close of the exempt pool’s fiscal year (elected in accordance with §4.22(g));
(B) A Statement of Operations for that year;
(C) Appropriate footnote disclosure and such further material information as may be necessary to make the required statements not misleading. For a pool that invests in other funds, this information must include, but is not limited to, separately disclosing the amounts of income, management and incentive fees associated with each investment in an investee fund that exceeds five percent of the pool’s net assets. The income, management and incentive fees associated with an investment in an investee fund that is less than five percent of the pool’s net assets may be combined and reported in the aggregate with the income, management and incentive fees of other investee funds that, individually, represent an investment of less than five percent of the pool’s net assets. If the commodity pool operator is not able to obtain the specific amounts of management and incentive fees charged by an investee fund, the commodity pool operator must disclose the percentage amounts and computational basis for each such fee and include a statement that the CPO is not able to obtain the specific fee amounts for this fund;
(D) Where the pool is comprised of more than one ownership class or series, information for the series or class on which the financial statements are reporting should be presented in addition to the information presented for the pool as a whole; except that, for a pool that is a series fund structured with a limitation on liability among the different series, the financial statements are not required to include consolidated information for all series.
(ii) Except as provided in §4.22(d)(2) of this part, such annual report must be presented and computed in accordance with generally accepted accounting principles consistently applied and, if certified by an independent public accountant, so certified in accordance with §1.16 of this chapter as applicable.
(iii) Legend.
(A) If a claim for exemption has been made pursuant to this section, the commodity pool operator must make a statement to that effect on the cover page of each annual report.
(B) If the annual report is not certified in accordance with §1.16, the pool operator must make a statement to that effect on the cover page of each annual report and state that a certified audit will be provided upon the request of the holders of a majority of the units of participation in the pool who are unaffiliated with the commodity pool operator.
(4) Recordkeeping relief. Exemption from the specific requirements of §4.23; Provided, That the commodity pool operator must maintain the reports referred to in paragraphs (b)(2) and (b)(3) of this section and all books and records prepared in connection with his activities as the pool operator of the exempt pool (including, without limitation, records relating to the qualifications of qualified eligible persons and substantiating any performance representations) at his main business address and must make such books and records available to any representative of the Commission, the National Futures Association and the United States Department of Justice in accordance with the provisions of §1.31.
(c) Relief available to commodity trading advisors. Upon filing the notice required by paragraph (d) of this section, and subject to compliance with the conditions specified in paragraph (d) of this section, any registered commodity trading advisor who anticipates directing or guiding the commodity interest accounts of qualified eligible persons may claim any or all of the following relief with respect to the accounts of qualified eligible persons who have given due consent to their account being an exempt account under §4.7:
(1) Disclosure relief.
(i) Exemption from the specific requirements of §§4.31, 4.34, 4.35 and 4.36; Provided, That if the commodity trading advisor delivers a brochure or other disclosure statement to such qualified eligible persons, such brochure or statement shall include all additional disclosures necessary to make the information contained therein, in the context in which it is furnished, not misleading; and that the following statement is prominently displayed on the cover page of the brochure or statement or, if none is provided, immediately above the signature line of the agreement that the client must execute before it opens an account with the commodity trading advisor:
“PURSUANT TO AN EXEMPTION FROM THE COMMODITY FUTURES TRADING COMMISSION IN CONNECTION WITH ACCOUNTS OF QUALIFIED ELIGIBLE PERSONS, THIS BROCHURE OR ACCOUNT DOCUMENT IS NOT REQUIRED TO BE, AND HAS NOT BEEN, FILED WITH THE COMMISSION. THE COMMODITY FUTURES TRADING COMMISSION DOES NOT PASS UPON THE MERITS OF PARTICIPATING IN A TRADING PROGRAM OR UPON THE ADEQUACY OR ACCURACY OF COMMODITY TRADING ADVISOR DISCLOSURE. CONSEQUENTLY, THE COMMODITY FUTURES TRADING COMMISSION HAS NOT REVIEWED OR APPROVED THIS TRADING PROGRAM OR THIS BROCHURE OR ACCOUNT DOCUMENT.”
(ii) Exemption from disclosing the past performance of exempt accounts in the Disclosure Document for non-exempt accounts except to the extent that such past performance is material to the non-exempt account being offered; Provided, That a commodity trading advisor that has claimed exemption hereunder and elects not to disclose any such performance in the Disclosure Document for non-exempt accounts shall state in a footnote to the performance disclosure therein that the advisor is advising or has advised exempt accounts for qualified eligible persons whose performance is not disclosed in this Disclosure Document.
(2) Recordkeeping relief. Exemption from the specific requirements of §4.33; Provided, That the commodity trading advisor must maintain, at its main business office, all books and records prepared in connection with his activities as the commodity trading advisor of qualified eligible persons (including, without limitation, records relating to the qualifications of such qualified eligible persons and substantiating any performance representations) and must make such books and records available to any representative of the Commission, the National Futures Association and the United States Department of Justice in accordance with the provisions of §1.31.
(d) Notice of claim for exemption.
(1) A notice of a claim for exemption under this section must:
(i) Provide the name, main business address, main business telephone number and the National Futures Association commodity pool operator or commodity trading advisor identification number of the person claiming the exemption;
(ii)
(A) Where the claimant is a commodity pool operator, provide the name(s) of the pool(s) for which the request is made; Provided, That a single notice representing that the pool operator anticipates operating single-investor pools may be filed to claim exemption for single-investor pools and such notice need not name each such pool;
(B) Where the claimant is a commodity trading advisor, contain a representation that the trading advisor anticipates providing commodity interest trading advice to qualified eligible persons;
(iii) Contain representations that:
(A) Neither the commodity pool operator or commodity trading advisor nor any of its principals is subject to any statutory disqualification under section 8a(2) or 8a(3) of the Act unless such disqualification arises from a matter which was previously disclosed in connection with a previous application for registration if such registration was granted or which was disclosed more than thirty days prior to the filing of the notice under this paragraph (d);
(B) The commodity pool operator or commodity trading advisor will comply with the applicable requirements of §4.7; and
(C) Where the claimant is a commodity pool operator, that the exempt pool will be offered and operated in compliance with the applicable requirements of §4.7;
(iv) Specify the relief claimed under §4.7;
(v) Where the claimant is a commodity pool operator, state the closing date of the offering or that the offering will be continuous;
(vi) Be filed by a representative duly authorized to bind the commodity pool operator or commodity trading advisor;
(vii) Be filed electronically with the National Futures Association through its electronic exemption filing system; and
(viii)
(A)
( 1 ) Where the claimant is a commodity pool operator, except as provided in paragraph (d)(1)(ii)(A) of this section with respect to single-investor pools and in paragraph (d)(1)(viii)(A)( 2 ) of this section, be received by the National Futures Association:
( i ) Before the date the pool first enters into a commodity interest transaction, if the relief claimed is limited to that provided under paragraphs (b)(2), (3) and (4) of this section; or
( ii ) Prior to any offer or sale of any participation in the exempt pool if the claimed relief includes that provided under paragraph (b)(1) of this section.
( 2 ) Where participations in a pool have been offered or sold in full compliance with part 4, the notice of a claim for exemption may be filed with the National Futures Association at any time; Provided, That the claim for exemption is otherwise consistent with the duties of the commodity pool operator and the rights of pool participants and that the commodity pool operator notifies the pool participants of his intention, absent objection by the holders of a majority of the units of participation in the pool who are unaffiliated with the commodity pool operator within twenty-one days after the date of the notification, to file a notice of claim for exemption under §4.7 and such holders have not objected within such period. A commodity pool operator filing a notice under this paragraph (d)(1)(viii)(A)( 2 ) shall either provide disclosure and reporting in accordance with the requirements of part 4 to those participants objecting to the filing of such notice or allow such participants to redeem their units of participation in the pool within three months of the filing of such notice.
(B) Where the claimant is a commodity trading advisor, be received by the Commission before the date the trading advisor first enters into an agreement to direct or guide the commodity interest account of a qualified eligible person pursuant to §4.7.
(2) The notice will be effective upon receipt by the National Futures Association with respect to each pool for which it was made where the claimant is a commodity pool operator and otherwise generally where the claimant is a commodity trading advisor; Provided, That any notice which does not include all the required information shall not be effective, and that if at the time the National Futures Association receives the notice an enforcement proceeding brought by the Commission under the Act or the regulations is pending against the pool operator or trading advisor or any of its principals, the exemption will not be effective until twenty-one calendar days after receipt of the notice by the National Futures Association and that in such case an exemption may be denied by the Commission or the National Futures Association or made subject to such conditions as the Commission or the National Futures Association may impose.
(3) Any exemption claimed hereunder shall cease to be effective upon any change which would cause the commodity pool operator of an exempt pool to be ineligible for the relief claimed with respect to such pool or which would cause a commodity trading advisor to be ineligible for the relief claimed. The pool operator or trading advisor must promptly file a notice advising the National Futures Association of such change.
(4)
(i) Any exemption from the requirements of §4.21, 4.22, 4.23, 4.24, 4.25 or 4.26 claimed hereunder with respect to a pool shall not affect the obligation of the commodity pool operator to comply with all other applicable provisions of part 4, the Act and the Commission’s rules and regulations, with respect to the pool and any other pool the pool operator operates or intends to operate.
(ii) Any exemption from the requirements of §4.31, 4.33, 4.34, 4.35 or 4.36 claimed hereunder shall not affect the obligation of the commodity trading advisor to comply with all other applicable provisions of part 4, the Act and the Commission’s rules and regulations, with respect to any qualified eligible person and any other client to which the commodity trading advisor provides or intends to provide commodity interest trading advice.
(e) Insignificant deviations from a term, condition or requirement of §4.7.
(1) A failure to comply with a term or condition of §4.7 will not result in the loss of the exemption with respect to a particular pool or client if the commodity pool operator or the commodity trading advisor relying on the exemption shows that:
(i) The failure to comply did not pertain to a term, condition or requirement directly intended to protect that particular qualified eligible person;
(ii) The failure to comply was insignificant with respect to the exempt pool as a whole or to the particular exempt account; and
(iii) A good faith and reasonable attempt was made to comply with all applicable terms, conditions and requirements of §4.7.
(2) A transaction made in reliance on §4.7 must comply with all applicable terms, conditions and requirements of §4.7. Where an exemption is established only through reliance upon paragraph (e)(1) of this section, the failure to comply shall nonetheless be actionable by the Commission.
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Cole-Frieman & Mallon LLP provides comprehensive legal, registration and compliance services for CFTC registered firms. Bart Mallon can be reached directly at 415-868-5345.