Tag Archives: Commodity Pool Operator

CFTC Provides Annual Guidance to CPOs

Annual Report Guidance for Commodity Pool Operators

In a recent release, which we have reprinted in full below, the CFTC reminds CPOs of their annual reporting requirements under Regulation 4.22. The release includes a link to the 2010 CPO Annual Guidance Letter. In general the letter provides another reminder to CPOs to file their annual reports with the NFA and provide a copy to the investors in the pool. I have outlined below the major parts of the letter.

General Issues to consider

Commodity pool annual reports must be distributed to pool participants within 90 calendar days of the pool’s fiscal year end. For most funds this means by March 31, 2010.
Commodity pool annual reports must be filed with the NFA within 90 clendar days of the pool’s fiscal year end. For most funds this means by March 31, 2010.
All documents must be filed electronically through the NFA’s filing system.
Extensions are available in certain circumstances.

Other Issues

For groups which have different or more complex structures, additional considerations need to be addressed. Such groups include:

Master/feeder commodity pool structures
Commodity pool fund of funds
Offshore commodity pools
CPOs claiming an exemption under Regulation 4.13
Reports of commodity pools which are liquidating
Commodity pools established as a series structure (such as a series LLC)
Commodity pools which invest in non-exchange traded instruments may have additional issues

Moreover, the letter includes references to the recently amended CPO relations.

If a CPO will not be able to file on time, the CPO should file for an extension. “Automatic” extensions can be granted to CPOs to fund of fund structures. If you have questions with making a filing, please feel free to contact Cole-Frieman & Mallon LLP. The following press release can be found here.

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CFTC’s Division of Clearing and Intermediary Oversight Provides Annual Report Guidance to Commodity Pool Operators

Washington, DC — The Commodity Futures Trading Commission’s Division of Clearing and Intermediary Oversight has issued its annual guidance letter to registered commodity pool operators (CPOs). The letter is intended to assist CPOs and their public accountants in complying with the Commission’s regulations on the preparation and filing of commodity pool annual financial reports.

The highlights contained in this year’s letter include:

Recent amendments to Commission regulations pertaining to various reporting issues;
Annual report filing procedures and due dates;
Special considerations that apply to filings made for Master/Feeder and Fund of Funds structures;
Use of International Financial Reporting Standards in lieu of U.S. generally accepted accounting principles;
Reporting requirements for pools in liquidation;
Reporting requirements for series funds with limitation of liability among the different series; and
Various accounting developments that may impact report preparation.

For more information on CPO Annual Guidance Letter 2009, please see the Related Documents link.

Copies of the letter also may be obtained by contacting the Commission’s Office of the Secretariat, Three Lafayette Centre, 1155 21st Street, N.W., Washington, D.C. 20581, (202) 418-5100.

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Other related compliance articles for CPOs and CTAs include:

Bart Mallon, Esq. runs the Hedge Fund Law Blog. He can be reached directly at 415-868-5345.

CPO Reporting Requirements | Commodity Pool Operator Compliance

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CFTC Regulation 4.22 Overview

CFTC registered commodity pool operators have a number of regulatory and compliance issues to be aware of. In addition to a having a compliance program which addresses the business and regulatory issues applicable to the manager, one of the more important compliance requirements is found in CFTC Regulation 4.22 which provides the reporting framework with respect to (i) periodic reports to investors and (ii) annual reports to investors and the NFA. While many hedge fund administration firms provide a monthly or quarterly report/statement, generally those reports/statements do not provide the detailed information that is required for commodity pools. This article provides an overview of the information required to be included in the periodic and annual statements and will also discuss other aspects of the regulation.

Overview of the Statements

Generally CPOs are required to distribute, within 30 days of end of the required period (see below), an account statement to each investor the fund. The account statement must included an itemized “statement of operations” and “statement of changes in net assets” which is presented and computed in accordance with generally accepted accounting principles (“GAAP”).

The statement of operations must separately itemize the following:

Realized net gain/loss on commodity interest positions
Unrealized net gain/loss on commodity interest positions
Total net gain/loss on other transactions (including interest and dividends earned), unless the gain/loss from trading are part of a related trading strategy (see 4.22(e)(3))
Total management fees during period
Total advisory fees during period (including performance fees/allocations)
Total brokerage commissions during period
Total of other fees for investment transactions
Total of other expenses incurred or accrued by the fund during period

Note: most of the above items must be itemized according to 4.22(e)(1) and special allocations should be noted according to 4.22(e)(2).

The statement of changes in net assets must separately itemize the following:

Fund NAV at beginning of period
Fund NAV at end of period
Total contributions to fund during period
Total redemptions (voluntary or involuntary) during period
Total fund income/loss during period
Total value of investor’s interest in the fund at the end of the period

Monthly or Quarterly Commodity Pool Reporting

For funds which have more than $500,000 of assets, the account statements must be sent to investors on a monthly basis. The account statement is due to the investor within 30 days of the end of the month. For funds which have less than $500,000 of assets, the account statements must be sent to investors on (at least) a quarterly basis. The account statement is due to the investor within 30 days of the end of the quarter. In both cases, a final report for the year does not need to be sent to fund investors if the CPO’s annual report (described below) is sent to pool participants within 45 calendar days after the end of the fiscal year.

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.*

Annual 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 onve ownership class or series.

In the event that the CPO will not be able to file the annual report with the NFA within the 90 day period, the CPO can file an extension under certain circumstances. It is very important that the CPO provides the annual report on time or files for the exemption. If a CPO cannot file the report within the time frame required and does not file for the exemption, the NFA will take action against the CPO see CFTC Fines CPOs For Late Annual Reports.

*Note: if the fund is organized offshore then the CPO may be able to prepare and calculate the annual report in accordance with International Financial Reporting Standards issued by the International Accounting Standards Board, please generally see 4.22(d)(2).

Statements Required to be Signed by Principals

Both the account statement and the annual report must contain a signed affirmation (usually provided by a principal or associated person of the CPO) that the information contained in the account statement is accurate and complete.

Such information shall include:

Name of individual signing
Capacity of individual signing
Name of the CPO
Name of the fund

Other Items

Regulation 4.22 is intricate and there are many specifics for certain fund managers. Specifically, if a commodity fund invests in other commodity funds there are certain rules which I have not covered in-depth in this overview.

With regard to the fiscal year, most commodity pools will elect to have their fiscal year be the calendar year. A fund can elect to have the fiscal year end on a different date under certain circumstances, see generally 4.22(g).

With regard to account statements and annual reports, these can be provided to fund investors electronically (either through email or through a password-protected website). In the event a fund manager wants to provide statements in this way, the manager will need to make sure the commodity pool’s offering documents specifically discusses this possibility. Additionally, the manager should make sure the fund’s subscription documents include a specific place for the investor to consent to the electronic delivery of the account statement or annual report.

Conclusion

Regulation 4.22 is detailed and, for some groups, complicated. The NFA has shown a willingness to send a message to firms which do not follow NFA rules or CFTC regulations. If you are a CPO and have questions with regard to your account statements or annual reports, please feel free to contact us.

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Other related hedge fund law articles include:

Bart Mallon, Esq. of Cole-Frieman & Mallon LLP runs the Hedge Fund Law Blog as well as the forex registration website. He can be reached directly at 415-868-5345.

CTA and CPO Registration and Compliance Guide

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Practical guidance for CTA and CPO firms

Commodity Trading Advisors (CTAs) and Commodity Pool Operators (CPOs) have been contacting me with greater regularity and we have decided to provide those firms with more detailed information on their registration and compliance requirements. Over the course of the next few weeks we will be continually updating this page with more legal and business guidance for CTAs and CPOs. Specifically, we will be providing information on the following topics:

CTA and CPO Registration – this article discusses the how-to’s of registration with the CFTC. The article details the general requirements for firms, principals, and associated persons. Included in this discussion is information on CTA/CPO exam requirements and an overview of the registration process through the NFA’s electronic registration system.

CTA and CPO Registration Exemptions – while the Commodities Exchange Act will generally require CTA and CPO firms to register with the CFTC, there are some important exemptions from the registration provisions. Review this article to see if your firm might be able to claim an exemption from the registration provisions.

CTA and CPO Compliance Overview – CTAs and CPOs are subject to a number of laws, regulations and rules. Not only must CTAs and CPOs follow CFTC laws and regulations, but as Members of the NFA, these groups must also follow all of the rules developed by the NFA. We will be discussing compliance best practices, major examination issues, major deadlines and the CTA/CPO compliance manual. Being prepared for an NFA examination is of great importance.

Recent NFA Actions against CTA and CPO Managers – the NFA and the CFTC have been quite active lately. In this article we will be discussing some of the most recent actions against NFA member firms. This article will also provide common-sense advice on what managers can do the protect themselves from examination deficiencies.

Important NFA Rules for CTA and CPO Firms – there are a number of rules which the NFA has regarding the conduct of CTAs and CPOs. In general CTAs and CPOs must hold themselves out with the utmost professionalism. This article will detail this and other important NFA rules.

CTA and CPO advertising – there are a number of important rules regarding advertising for CTAs and CPOs. CPOs, especially, must be careful about advertising because of the restrictions under Rule 506 of Regulation D, an exemption that many CPOs utilize in offering their fund interests. Websites will be touched upon in this post and will also be discussed in greater depth in a subsequent posting.

CTA and CPO websites – many CTA firms utilize the internet to advertise their services. CPO firms will also sometimes have a (minimal) internet presence. This article will detail the considerations that both CTA and CPO firms face when creating and maintaining an internet presence and how to deal with internet based inquiries from potential investors.

NFA Exam Requirements for CTAs and CPOs – individuals of NFA member firms will generally need to have a Series 3 exam license and potentially a Series 30 exam. Some individuals may need to have a Series 31 exam license and, potentially in the future, forex CTAs and CPOs will need to have a Series 34 exam license. This article will discuss these exams and the process an individual will go through in order to register to take the exams.

CTA Expo Blog – the unofficial blog of the CTA Expo most recently held in October of 2009. Information for CTA managers on business, legal and compliance issues. Included is a directory of CTA firms and service providers.

Forex CTAs and CPOs – the regulatory light has been focused on retail spot forex managers recently. Read this article to get up to speed on recent CFTC and NFA pronouncements regarding this area of the industry. We will also provide information on Forex IBs and Forex FCMs.

In addition to the above topics we are hoping to add others over time. We welcome all feedback and encourage you to leave comments below. We will also attempt to answer CTA and CPO frequently asked questions.

If you are a manager or firm that needs to register as a CTA or CPO, or if you are contemplating registration, please contact Bart Mallon, Esq. of Cole-Frieman & Mallon LLP at 415-868-5345.

NFA Rule Compliance Rule 2-45 Approved

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CPOs Prohibited From Taking Loans From Commodity Hedge Funds

The CFTC just recently approved a new NFA compliance rule which prohibits commodity pool operators (CPOs) from taking loans from the commodity pools which they manage. Additionally, if a CPO currently has some sort of a loan arrangement with their fund, such CPO will have until October 22, 2009 to notify the NFA of the arrangement and surrounding facts and circumstances.

With regard to this new rule, we urge CPOs to take the following notes:

If you currently have a loan arrangement with your fund, please contact an attorney immediately. If you have such an arrangement and do not disclose this to the NFA within the allowed time frame, you will be subject to significant action in the future if it is found that you did not comply with this requirement.
CPOs should think about updating their commodity pool offering documents to include a discussion of this new prohibition (if it is not already discussed in the pool offering documents).
CPOs should update their compliance manuals and procedures to specifically address this issue – it is likely that this will be a specific examination item in the near future and a well prepared CPO should have procedures in place to ensure compliance.

Below we have reprinted the notice announcing the new rule as well as the interpretive release which provides color on the new rule. If you have any questions on this new rule and its applicability to you CPO or your commodity pool, please contact us. Related article:

NFA Cracks Down on Loans to CPOs

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Notice I-09-17

September 22, 2009

Effective Date of NFA Requirements Prohibiting Loans by Commodity Pools to CPOs and Related Entities

NFA has received notice that the Commodity Futures Trading Commission (“CFTC”) has approved new NFA Compliance Rule 2-45. This Rule and its accompanying Interpretive Notice, which both became effective September 11, 2009, prohibit commodity pools from making direct or indirect loans or advances of pool assets to the CPO or any other affiliated person or entity.

CPOs that currently have existing loan or advance arrangements between their pools and the CPO, the CPO’s principals, or related entities must notify NFA of these arrangements by October 22, 2009. The written notification to NFA should describe the reason for the loan or advance; indicate the interest the CPO is paying, if any; provide evidence that the loan or advance is secured by marketable, liquid assets; explain arrangements the CPO has made to pay back the loan or advance, if any; and include an executed copy of the loan or advance agreement. In addition, the CPO must provide NFA with written evidence that pool participants were informed about the loan or advance through a disclosure contained in the disclosure document, offering memorandum or other correspondence.

NFA will review the information provided to ensure, among other things, that participants received a full disclosure of the arrangements and that the loans and advances are secured by marketable liquid assets. Depending on the results of the review, NFA will determine if a CPO needs to take any additional steps regarding a particular loan or advance. NFA may also recommend disciplinary action if warranted by our review of the circumstances.

More information about NFA Compliance Rule 2-45, and the accompanying Interpretive Notice, can be found in NFA’s August 26, 2009 Submission Letter to the CFTC. Questions concerning these changes should be directed to Mary McHenry, Senior Manager, Compliance ([email protected] or 312-781-1420) or Tracey Hunt, Senior Manager, Compliance ([email protected] or 312-781-1284).

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August 26, 2009

Via Federal Express

Mr. David A. Stawick
Office of the Secretariat
Commodity Futures Trading Commission
Three Lafayette Centre
1155 21st Street, N.W.
Washington, DC 20581

Re: National Futures Association: Prohibition of Loans by Pools to Commodity Pool Operators and Related Parties – Proposed Adoption of Compliance Rule 2-45 and Interpretive Notice*

Dear Mr. Stawick:

On May 27, 2009, National Futures Association (“NFA”) submitted proposed new Compliance Rule 2-45 to the Commodity Futures Trading Commission (“CFTC” or “Commission”) for its review and approval. NFA hereby withdraws that submission and, pursuant to Section 17(j) of the Commodity Exchange Act, as amended, hereby resubmits the proposed Compliance Rule 2-45 and related Interpretive regarding prohibition of loans by pools to CPOs and related parties.

Compliance Rule 2-45 was approved by NFA’s Board of Directors (“Board”) on May 21, 2009, and the Interpretive Notice was approved by the Board on August 20, 2009. NFA is invoking the “ten-day” provision of Section 17(j) of the Commodity Exchange Act (“CEA”) and will make these proposals effective ten days after receipt of this submission by the Commission unless the Commission notifies NFA that the Commission has determined to review the proposals for approval.

PROPOSED AMENDMENTS
(additions are underscored)
COMPLIANCE RULES

* * *
PART 2 – RULES GOVERNING THE BUSINESS CONDUCT OF MEMBERS REGISTERED WITH THE COMMISSION
* * *

RULE 2-45. PROHIBITION OF LOANS BY COMMODITY POOLS TO CPOS AND AFFILIATED ENTITIES.

No Member CPO may permit a commodity pool to use any means to make a direct or indirect loan or advance of pool assets to the CPO or any other affiliated person or entity.

* * *
INTERPRETIVE NOTICES
* * *

COMPLIANCE RULE 2-45: PROHIBITION OF LOANS BY COMMODITY POOLS TO CPOS AND RELATED ENTITIES

NFA has recently taken a number of Member Responsibility Actions (MRAs) against commodity pool operators (CPOs) and CPO principals who directly or indirectly loaned or advanced pool assets to themselves or an affiliated person or entity. Many of these arrangements were used by these principals to purchase luxury items, while others went to related entities that did not have sufficient assets to repay the loans. In each case, the transaction resulted in significant losses to participants’ funds.

The Board of Directors has determined that direct or indirect loans or advances from pools to their CPOs, the CPO’s principals, or related entities should be prohibited. Therefore, NFA Compliance Rule 2-45 prohibits CPOs 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 other affiliated person or entity.

NFA understands that a few pools may have made these types of loan or advance arrangements prior to Compliance Rule 2-45’s effective date. These CPOs are required to notify NFA of these existing arrangements within thirty (30) days of Compliance Rule 2-45’s effective date.

These arrangements violate NFA’s existing compliance rules if the arrangements are not consistent with the pool’s current disclosure document or offering materials and both the loan(s) or advance(s) and the conflict of interest are not fully disclosed to participants. Existing arrangements also violate NFA’s rules if the loan or advance is not secured by marketable, liquid assets (e.g. a CPO participant’s pro-rata interest in the pool’s liquid assets) and, therefore, the arrangement could have a material effect upon the pool’s ability to meet its obligations to participants.

EXPLANATION OF PROPOSED AMENDMENTS

In February, NFA took two Member Responsibility Actions (“MRAs”) against three NFA Member commodity pool operators (“CPOs”). Although the basis of both MRAs was the CPOs’ failure to cooperate with NFA in an investigation, the limited investigation that NFA was able to perform revealed that the CPOs had misappropriated pool funds through improper loans from pools to the CPOs or related entities. The CFTC charged all three of the CPOs with misappropriating pool assets through improper loans, and all three were charged criminally with fraud.

These two matters are not the first instances of CPOs misappropriating pool participant funds through direct or indirect loans from a pool to the CPO or a related entity. Over the years, there have been a number of regulatory actions involving this type of fraud. Given the significant losses suffered by pool participants as a result of these improper loans, NFA is proposing to prohibit direct or indirect loans from commodity pools to the CPO or any affiliated person or entity.

At its May 2009 meeting, the Board approved Compliance Rule 2-45. Although the rule provides for a complete prohibition, the Board was somewhat concerned that there might be some unforeseen very limited circumstances where a carve-out to this prohibition would be appropriate. As a result, the Board instructed staff to handle these situations on a case-by-case basis, with the CPO seeking no-action relief from NFA.

After NFA submitted the proposed rule to the Commission for approval, Commission staff informed NFA that although they supported the overall concept, they had concerns regarding NFA’s granting of no-action relief. In light of the Commission’s concerns and the fact that there are few, if any, foreseeable situations in which NFA should permit a loan arrangement, the Board reconsidered its original position regarding no-action relief.

Nonetheless, the Board recognizes that there are a few loan arrangements currently in place that have been fully disclosed and are adequately collateralized. Therefore, the Interpretive Notice provides that CPOs will not be required to immediately sell other assets to repay these existing loans. CPOs will, however, be required to notify NFA of any such current arrangements within 30 days of Compliance Rule 2-45’s effective date. NFA will review these arrangements to ensure, among other things, that participants were provided with full disclosure of the arrangements and that the loans are secured by marketable, liquid assets. Moreover, as NFA has done in several recent MRAs, we will not hesitate to recommend disciplinary action if we find those loans involve fraud, inadequate disclosure or are not properly collateralized.

As mentioned earlier, NFA is invoking the “ten-day” provision of Section 17(j) of the Commodity Exchange Act. NFA intends to make proposed Compliance Rule 2-45 and the related Interpretive Notice regarding the prohibition of loans by pools to CPOs and related parties effective ten days after receipt of this submission by the Commission, unless the Commission notifies NFA that the Commission has determined to review the proposal for approval.

Respectfully submitted,

Thomas W. Sexton
Senior Vice President and
General Counsel
_________
* The proposed adoption of Compliance Rule 2-45 and Interpretive Notice became effective September 11, 2009.

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Other related hedge fund law articles include:

Bart Mallon, Esq. runs hedge fund law blog and has written most all of the articles which appear on this website. Mr. Mallon’s legal practice is devoted to helping emerging and start up hedge fund managers successfully launch a hedge fund. If you are a hedge fund manager who is looking to start a hedge fund, or if you have questions about the CPO or CTA registration process, please call Mr. Mallon directly at 415-296-8510.

Commodity Pool Operators Scrambling After Surprise CFTC Decision

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CFTC Withdraws Two No-Action Letters

In a surprise move the CFTC has withdrawn two no-action letters which is had just recently issued. Under the new Chairman Gary Gensler, the CFTC has made an about face on this issue with regard to two commodity pool operators who were relying on the no-action letters issued in 2006. Under the no-action letters, the CFTC provided no-action relief to the CPOs from certain speculative position limits. According to the release reprinted below, the reason for the change is because Chairman Gensler “believe[s] that position limits should be consistently applied and vigorously enforced.” While we generally believe that rules should be applied uniformly, we also believe that the governmental agencies (the CFTC and the SEC) should not make it a practice of revoking previously issued no-action letters. We also believe that the CFTC and the SEC should not be in the business of express politicking, which may have been the case here – it sets a horrible precedent for new/changing administrations. Additionally, we believe that the same “tough line” on position limits could have been effected in a less onerous manner.

The release states that the CFTC will work with the affected CPOs, but the damage has been done – how are businesses supposed to operate when these governmental agencies are constantly moving the target?

The no-action letters can be found here:

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Release: 5695-09
For Release: August 19, 2009

CFTC Withdraws Two No-Action Letters Granting Relief from Federal Speculative Position Limits on Soybeans, Corn and Wheat Contracts

Washington, DC – The U.S. Commodity Futures Trading Commission today announced that it is withdrawing two no-action letters that provided relief from federal agricultural speculative positions limits set forth in CFTC regulations (17 C.F.R §150.2).

“I believe that position limits should be consistently applied and vigorously enforced,” CFTC Chairman Gary Gensler said. “Position limits promote market integrity by guarding against concentrated positions.”

In CFTC Letter 06-09 (May 5, 2006), the agency’s Division of Market Oversight (DMO) granted no-action relief to DB Commodity Services LLC, a commodity pool operator (CPO) and commodity trading advisor (CTA), permitting the DB Commodity Index Tracking Master Fund to take positions in corn and wheat futures that exceed federal speculative position limits set forth in CFTC Regulation 150.2. Subsequently, in CFTC Letter 06-19 (September 6, 2006), DMO granted similar no-action relief to a CPO/CTA employing a proprietary commodity investment strategy that includes positions in Chicago Board of Trade corn, soybeans and wheat futures contracts. Among other things, DMO’s no-action position in both cases stated that any change in circumstances or conditions could result in a different conclusion. DMO has previously stated that the trading strategies employed by these entities would not qualify for a bona fide hedge exemption under the Commission’s regulations.

DMO will work with each of these entities as they transition to positions within current federal speculative limits. The withdrawal of these no-action positions is very specific and limited and does not affect any other no-action or regulatory positions taken by the CFTC or its staff with regard to these entities or other market participants.

Last Updated: August 19, 2009

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Please contact us if you have any questions or would like to start a hedge fund. Other related hedge fund law articles include:

Bart Mallon, Esq. runs hedge fund law blog and has written most all of the articles which appear on this website. Mr. Mallon’s legal practice is devoted to helping emerging and start up hedge fund managers successfully launch a hedge fund. If you are a hedge fund manager who is looking to start a hedge fund, or if you have questions about becoming registered as a CPO or CTA, please call Mr. Mallon directly at 415-296-8510.

Series 3 Exam | Commodities & Futures Exam Topics

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Hedge Fund Managers and the Series 3 Exam

Those managers who engage in commodities and futures trading (and who don’t qualify for an exemptions) will need to register as commodity pool operators with the CFTC and become members of the NFA. In order to do this all owners and “associated persons” of the manager/CPO will need to take and pass the Series 3 exam. This article provides a brief overview of the Series 3 exam for hedge fund managers.

Commodities and Futures Contracts License

The NFA requires an individual to successfully complete the Series 3 in order to become qualified to sell commodities or futures contracts. The exam is designed for anyone who is going to act as an Associated Person, Commodity Trading Advisor, Commodity Pool Operator, Introducing Broker, or Futures Commission Merchant. [Note: under the forex registration rules, those managers who trade in the spot forex markets will soon also need to take the Series 3 and a new exam called the Series 34 exam.] The Series 3 is also a prerequisite to the Series 30 Futures Branch Manager exam.

The Series 3 exam is required of individuals who conduct business with the public on the U.S. futures exchanges and:

offer or solicit business in futures or options on futures at a futures commission merchant (FCM) or introducing broker (IB) or who supervise any such person.
are associated with a commodity trading advisor (CTA) who solicits discretionary accounts or who supervises persons so engaged.
are associated with a commodity pool operator (CPO) who solicits funds for participation in a commodity pool or who supervises such persons.

Registration Process

The NFA Series 3 Exam is administered by FINRA. There is a two-step process that a candidate must complete to be able to take the Series 3 Exam.

Step 1 – The individual must apply with FINRA to take the exam by completing and submitting an application form and payment, or by submitting the application online. The testing application form can be downloaded from the FINRA’s web site. Effective January 2, 2009, the fee for an individual to take the Series 3 National Commodity Futures Examination will be $105.

Step 2 – Once the U10 registration has been approved and processed by FINRA, a Notice of Enrollment will be emailed to the candidate. FINRA will assign a 120-day window during which the exam can be scheduled and taken. The candidate may then contact their local test center to schedule an appointment to sit for the exam. Due to the many sessions administered at testing centers, the candidate should schedule test-taking as far in advance as possible to secure an appointment on the desired date.

Testing Locations

The exam is delivered via a computer system specifically designed for the administration and delivery of computer-based testing and training. Exams are given at conveniently located test centers worldwide and an appointment to take your exam can be scheduled online or by calling your local center. For a list of test centers in your area (U.S. and International) click here.

Series 3 Exam Overview

The Series 3 Exam for commodity futures brokers is divided into two parts – futures trading theory and market regulations. Each part must be passed with a score of at least 70 percent. There are 120 total multiple choice and true/false questions, and exam takers are provided 2 hours and 30 minutes to complete the exam. The Series 3 Exam also contains 5 additional experimental questions that do not count towards the exam taker’s score, and additional time is built into the exam to accommodate for these questions.

The Series 3 exam is divided into ten topics and is graded in two main parts: Market Knowledge and Rules/Regulations. The Market Knowledge part covers the first nine of the following topics, and consists of 85 questions. The Rules/Regulations part covers category ten, and consists of 35 questions. You must achieve a 70% on each part in order to pass the exam.

Part 1: Market Knowledge – The first part of the Series 3 exam covers the basics of the futures markets. Exam takers will need to understand futures contracts, hedging, speculating, futures terminology, futures options, margin requirements, types of orders, basic fundamental analysis, basic technical analysis and spread trading.

Part 2: Rules/Regulations – The second part of the Series 3 exam consists of market regulations. Exam takers must familiarize themselves with relevant NASD rules and regulations for this part of the exam.

Exam Topics

Futures Trading Theory
Margins, Limits, Settlements
Orders, Accounts, Analysis
Basic Hedging
Financial Hedging
Spreads
General Speculation
Financial Speculation
Options
Regulations

Useful Terms to Know for the Series 3 Exam

Exam takers are expected to be familiar with the following terms and definitions prior to taking the Series 3 exam. The definitions presented below have been extracted from Investopedia.

Bucketing: A situation where, in an attempt to make a short-term profit, a broker confirms an order to a client without actually executing it. A brokerage which engages in unscrupulous activities, such as bucketing, is often referred to as a bucket shop.

Delta: The ratio comparing the change in the price of the underlying asset to the corresponding change in the price of a derivative. Sometimes referred to as the “hedge ratio”.

Double Top: A term used in technical analysis to describe the rise of a stock, a drop, another rise to the same level as the original rise, and finally another drop.

First Notice Day: The first day that a notice of intent to deliver a commodity can be made by a clearinghouse to a buyer in fulfillment of a given month’s futures contract.

Intrinsic Value: 1. The actual value of a company or an asset based on an underlying perception of its true value including all aspects of the business, in terms of both tangible and intangible factors. This value may or may not be the same as the current market value. Value investors use a variety of analytical techniques in order to estimate the intrinsic value of securities in hopes of finding investments where the true value of the investment exceeds its current market value. 2. For call options, this is the difference between the underlying stock’s price and the strike price. For put options, it is the difference between the strike price and the underlying stock’s price. In the case of both puts and calls, if the respective difference value is negative, the intrinsic value is given as zero.

Inverted Market: In the context of options and futures, this is when the current (or short-term) contract prices are higher than the long-term contracts.

Long Hedge: A transaction that commodities investors undertake to hedge against possible increases in the prices of the actuals underlying the futures contracts.

Offset: 1. To liquidate a futures position by entering an equivalent, but opposite, transaction which eliminates the delivery obligation.2. To reduce an investor’s net position in an investment to zero, so that no further gains or losses will be experienced from that position.

Scalpers: A person trading in the equities or options and futures market who holds a position for a very short period of time, attempting to make money off of the bid-ask spread.

Straddle: An options strategy with which the investor holds a position in both a call and put with the same strike price and expiration date.

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Please contact us if you have any questions or would like information on how to start a hedge fund. Other related hedge fund law articles include:

NFA Cracks Down on CPO Fraud with New Compliance Rule

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Proposes Amendments to Compliance Rule 2-45

The National Futures Association (NFA) proposed new amendments to Compliance Rule 2-45 regarding prohibition of loans by pools to commodity pool operators and related parties. The amendment states that no Member CPO may permit a commodity pool to use any means to make a direct or indirect loan or advance of pool assets to the CPO or any other affiliated person or entity. The amendment is proposed in response to a recent NFA investigation which revealed that CPOs had misappropriated pool funds through improper loans from pools to the CPOs or related entities. The full NFA proposal can be viewed below.

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May 27, 2009
Via Federal Express

Mr. David Stawick
Office of the Secretariat
Commodity Futures Trading Commission
Three Lafayette Centre
1155 21st Street, N.W.
Washington, DC 20581

Re: National Futures Association: Prohibition of Loans by Pools to Commodity Pool Operators and Related Parties – Proposed Adoption of Compliance Rule 2-45

Dear Mr. Stawick:

Pursuant to Section 17(j) of the Commodity Exchange Act, as amended, National Futures Association (“NFA”) hereby submits to the Commodity Futures Trading Commission (“CFTC” or “Commission”) proposed Compliance Rule 2-45 regarding prohibition of loans by pools to commodity pool operators and related parties. This proposal was approved by NFA’s Board of Directors (“Board”) on May 21, 2009. NFA respectfully requests Commission review and approval.

PROPOSED AMENDMENTS

(additions are underscored)

COMPLIANCE RULES

* * *

PART 2 – RULES GOVERNING THE BUSINESS CONDUCT OF MEMBERS REGISTERED WITH THE COMMISSION

* * *

RULE 2-45. PROHIBITION OF LOANS BY COMMODITY POOLS TO CPOS AND AFFILIATED ENTITIES.

No Member CPO may permit a commodity pool to use any means to make a direct or indirect loan or advance of pool assets to the CPO or any other affiliated person or entity.

EXPLANATION OF PROPOSED AMENDMENTS

NFA staff discussed this matter with NFA’s CPO/CTA Advisory Committee, which supported prohibiting loans because it believes that absent extraordinary circumstances there is no legitimate reason for a pool to make a direct or indirect loan to its CPO or a related party. The Committee indicated, however, that participants, including a CPO’s principal, should not be prevented from borrowing against their equity interest in the pool.

NFA Compliance Rule 2-45 provides for a complete prohibition of direct or indirect loans or any advance of pool assets between a pool and its CPO or any other affiliated person or entity. NFA recognizes that there may be circumstances where a carve out to this prohibition may be appropriate, such as where a CPO permits participants, including a pool’s general partner, to borrow against their equity interest in the pool in lieu of a withdrawal, provided that the loan is collateralized by the participant’s interest in the pool. NFA believes that these types of situations are best handled on a case by case basis, with the CPO seeking a no-action letter from NFA.

NFA respectfully requests that the Commission review and approve proposed Compliance Rule 2-45 regarding prohibition of loans by pools to commodity pool operators and related parties.

Respectfully submitted,

Thomas W. Sexton
Senior Vice President and General Counsel

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Please contact us if you have any questions or would like to start a hedge fund. Other related hedge fund law articles include:

CPO Exemption for Fund of Hedge Funds

3 Replies

As we have discussed previously, if a hedge fund manager invests fund assets in commodity interests (including futures), then the manager will generally need to be registered as a commodity pool operator (CPO) with the Commodity Futures Trading Commission (CFTC). The registration requirement also applies to fund of fund (FOF) managers who allocate assets to underlying hedge funds which themselves invest in commodity interests. There are a number of CPO exemptions available to hedge fund managers. Likewise, there are two exemptions which may be applicable to fund of fund managers who allocate to funds CPOs or exempt CPOs. Continue reading →

CPOs and CTAs Now Submit Disclosure Documents Electronically

Two Separate CPOs Subject to NFA Action