The Commodity Futures Trading Commission ("CFTC") on January 26, 2011 released for public comment the latest in a series of proposed regulations under the Dodd-Frank Wall Street Reform and Consumer Protection Act ("Dodd-Frank").1 The proposed regulations, in addition to expanding CFTC compliance obligations for certain commodity market participants, would eliminate certain CFTC exclusions and exemptions widely used by sponsors of private investment funds and registered investment companies ("RICs").

The CFTC proposes to:

  • reinstate and expand the trading and marketing criteria necessary for RICs and certain other persons to qualify for the CFTC Regulation 4.5 commodity pool operator ("CPO") exclusion;
  • rescind registration exemptions available for CPOs offering commodity pools to sophisticated and creditworthy investors under CFTC Regulations 4.13(a)(3) and 4.13(a)(4);
  • require all persons that claim exemptive or exclusionary relief from CPO or commodity trading advisor ("CTA") registration under CFTC Regulations 4.5, 4.13 or 4.14 to re-confirm their qualifications annually;
  • require CPOs and CTAs that are registered solely with the CFTC to file certain new reports regarding their commodity trading activities;
  • implement a change to the reporting requirements and the criteria for participant qualification for CPOs and CTAs relying on CFTC Regulation 4.7; and
  • amend the risk disclosures included in CPO and CTA documents to describe certain risks of swap transactions.2

Although not explicitly mandated by Dodd- Frank, the CFTC has stated that the proposals are "consistent with the tenor of the provisions of the Dodd-Frank Act" in that they will give the CFTC more oversight of market participants and a more comprehensive view of commodity market risk.3 Some elements of the proposals are intended to create corresponding CFTC regulation to new Dodd-Frank-related regulation of investment advisers by the Securities and Exchange Commission ("SEC"). If and when adopted, the CFTC's proposals would bring sweeping changes to registered and private funds participating in the commodity markets.

Background on CPO and CTA Regulation

As amended by Dodd-Frank, a CPO is a person that sponsors, solicits participation in, or operates a collective investment vehicle ("pool") that trades exchange-traded futures contracts, options thereon, or commodity options, commodity swaps and other over-the-counter ("OTC") derivatives, certain foreign currency transactions, certain leverage transactions or interests in other commodity pools ("commodity interests").4 In practice, a CPO is usually the general partner of a limited partnership, the managing member of a limited liability company, the directors of a corporation, the trustees of a trust, or the investment adviser of a non-U.S. company. Unless excluded from the CPO definition or exempted from some or all of the CPO regulatory requirements, a CPO must (among other things):

  • register with the CFTC through the National Futures Association ("NFA");5
  • become a member of the NFA;
  • include specified disclosures (including but not limited to risks, conflicts, fees and costs, and performance) in its pool offering documentation;
  • comply with certain advertising and promotional material requirements; distribute periodic account statements and reports;
  • distribute audited annual financial reports;
  • implement prescribed policies and procedures; and
  • maintain and make accessible prescribed books and records.6

A CTA is a person who, for compensation or profit, advises other persons regarding the value or advisability of transacting in commodity interests.7

Unless exempt from some or all of the CTA regulatory requirements, a CTA must (among other things):

  • register with the CFTC and become a member of the NFA;
  • distribute a disclosure document to prospective clients containing specified disclosures (including but not limited to risks, conflicts, fees and costs, and performance);
  • implement prescribed policies and procedures; and
  • maintain and make accessible prescribed books and records.8

NFA membership for CPOs and CTAs involves making filings and paying fees. NFA members are also subject to periodic NFA examinations. In addition, natural person associates and their supervisors, and certain principals of CPOs and CTAs must register with the NFA and satisfy certain proficiency requirements that include taking and passing the National Commodity Futures Examination, known as the "Series 3 Exam," submitting fingerprints, participating in periodic ethics and other training, and paying fees.9

Current CPO and CTA Exclusions and Exemptions

Several exemptions from certain of the CPO registration and regulation requirements are currently available, including (among others) where investors in a privately offered pool are deemed not in need of regulatory protection, due to:

  • their financial or investment sophistication or regulatory status;10
  • the relatively small size of the pool;11 and/or
  • the limited amount of commodity interest trading in the pool.12

A RIC that would otherwise constitute a pool is currently excluded from the definition of a CPO (rather than exempt from CPO registration and regulation) because the CFTC has previously considered the extensive regulation of such entities by the SEC under the Investment Company Act of 1940 as amended ("1940 Act") to afford sufficient investor protection without additional regulation by the CFTC.13

Several exemptions from certain CTA registration and regulation requirements and exclusions from the definition of CTA are also currently available, including (among others):

  • where the person is exempt from registration as a CPO and provides commodity trading advice solely to the pools for which the person is exempt;14
  • where in the past year the person provided advice to a limited number of clients (15 or fewer) and did not hold itself out to the public as a CTA;15
  • where the advice the person provides is not tailored to an individual customer's account, such as with the provision of a newsletter;16
  • where the person is registered in another capacity and provides commodity trading advice that is solely incidental to the principal business;17 or
  • where the person is otherwise excluded under the Commodity Exchange Act as amended ("CEA").18

In addition, if a person is registered as an investment adviser ("RIA") with the SEC, it may qualify for a CTA exemption if (1) the person's business does not consist primarily of acting as a CTA, and (2) the person does not provide commodity trading advice to commodity pool that is engaged primarily in commodity interests.19 Alternatively, an RIA may qualify for a CTA exemption if it is providing commodity trading advice to certain qualifying entities such as RICs.20

The CFTC proposes to modify or rescind several of the foregoing CPO and CTA exclusions and exemptions as follows.

Reinstate and Expand on Trading and Marketing Criteria Necessary to Qualify for CFTC Regulation 4.5 Exclusion

In August 2010, the NFA petitioned the CFTC to amend CFTC Regulation 4.5, which currently excludes RICs (among others) from the CPO definition under the CEA.21 The NFA requested that the CFTC place limitations on the blanket exclusion for RICs, thereby requiring RICs with greater than de minimis investments in commodities to register and be regulated as CPOs.

Limitations similar to those proposed by the NFA were in place prior to 2003.

Under CFTC Regulation 4.5 as in effect prior to 2003, a RIC could qualify for the CPO exclusion only if its commodity interest trading above a five-percent threshold was conducted solely for bona fide hedging purposes as defined by CFTC Regulation 1.3(z)(1).22 For commodity interest positions not held for bona fide hedging purposes, the aggregate initial margin and premiums for those positions could not exceed five percent of the liquidation value of the RIC's portfolio after taking into account unrealized profits and unrealized losses on such positions ("five-percent trading test"). Any "in-the-money" amount on commodity options was excluded from the five-percent calculation. In addition, the RIC could not be marketed as a commodity pool or vehicle for trading in commodity interests ("marketing restriction"), but this restriction did not extend to trading in swap and other OTC transactions, structured notes, or other instruments providing indirect exposure to the commodity markets.23

In 2003, the five-percent trading test and marketing restriction were removed; accordingly, CFTC regulation has not limited the amount of commodity interest trading a RIC may conduct in order to qualify for the CPO exclusion.24 The CFTC has now stated that, in order to meet its aims of increasing commodity market transparency and its ability to oversee market risk, the CFTC has incorporated the NFA's proposed changes into its Dodd-Frank rulemaking. The CFTC would reinstitute and expand the five-percent trading test and the marketing restriction that previously applied to the CFTC Regulation 4.5 exclusion.25 The proposed expanded five-percent trading test would include positions in certain swap transactions. The proposed expanded marketing restriction would prevent a RIC from being marketed as a pool or otherwise as a vehicle for trading in "or otherwise seeking investment exposure to" commodity interests "or swaps markets."26 Depending on what the CFTC considers "marketing," for RICs, the expanded marketing restriction could potentially include indirect commodity investment exposure obtained through investments in structured notes or other securities in subsidiaries or other vehicles engaged in commodity interest trading.

The NFA Letter expressed concern regarding the use by commodity-based mutual funds of "a subsidiary for tax and mutual fund regulatory purposes."27 In its petition to the CFTC, the NFA stated that these subsidiaries are not themselves subject to the 1940 Act, although in fact they are subject to certain investment restrictions applicable to their parent funds and certain conditions the IRS has mandated for their use. The Proposing Release does not directly address commodity-based mutual fund use of subsidiaries; however, commodity-based mutual funds should be aware that the CFTC is proposing to rescind the CPO exemptions that many of these subsidiaries qualify for and rely upon under CFTC Regulation 4.13(a)(3) or (a)(4) (discussed below).28

CFTC Questions to Industry Regarding Proposals

In September 2010, the CFTC published a Notice of Petition regarding the NFA's request and solicited industry comments on the proposed rule amendment. The CFTC did not modify the proposed rule amendment included in the Notice of Petition based on the comments it received, except to expand the five-percent trading test to include swap transactions and expand the marketing restriction to include RICs marketed as vehicles for trading in swap markets. The comment letters appear to have informed the CFTC's questions and solicitation of further comments at this point in the proposal process. The CFTC also appears to have signaled its receptiveness to industry comment when it stated that it "believes that the NFA's proposed language is an appropriate point at which to begin discussions regarding the [CFTC]'s concerns (emphasis added)."29

CFTC Questions Regarding Potential Effect on Marketing Certain RICs

In the Proposing Release, the CFTC reports that commenters responding to the Notice of Petition argued that it would be impossible or cost-prohibitive to market RICs that currently qualify for the CFTC Regulation 4.5 exclusion, if the regulation is amended as proposed. The CFTC has asked whether "the proposed restriction on marketing as a commodity pool or as a vehicle for providing exposure to commodity interests [should] be broader or more narrow."30 The CFTC has also solicited comments regarding the term "marketing," asking whether the CFTC's use of the term should be clarified.31

Commodity-focused RICs have been a fixture in the asset management space for many years. Fund companies had been able to comply with the pre-2003 five-percent trading test restriction on substantial investments in commodity interests, in part, because RICs had invested in securities or derivatives linked to commodity interests, rather than in the actual commodity interest contracts. Fund companies had been able to comply with the earlier marketing restriction because the RICs were not marketed as commodity pools or vehicles for trading commodity interests. Instead, they were marketed as providing exposure to commodity interests indirectly through commodity-linked securities and derivatives as well as commodity interests. Many such RICs trade commodity interests and managed futures trading programs indirectly through their ownership of subsidiaries established for tax purposes.

The proposed expansion of the marketing restriction to include any RIC providing exposure to commodity interests or swap markets has the potential to affect every commodity-focused RIC in the industry. All RICs that provide commodity exposure through exchange-traded and OTC derivatives or through securities in subsidiaries and other vehicles engaged in such trading potentially would be unable to rely on the CFTC Regulation 4.5 exclusion, even if those RICs met the five-percent trading test. Such RICs and their principals (including directors and trustees) and associated persons would likely need to register with the CFTC and NFA, and they and their RICs would become subject to the full panoply of applicable marketing and operating laws and regulations, including the disclosure, reporting, recordkeeping, advertising and promotional material, and other operating and compliance restrictions and requirements.

CFTC Questions Regarding Regulatory Conflicts and Feasibility of Compliance

In response to the Notice of Petition, Dechert LLP and other industry commenters pointed out to the CFTC that, if some RICs are no longer eligible for the CFTC Regulation 4.5 exclusion and become subject to CFTC regulation, they would face directly conflicting regulatory requirements. The CFTC has requested a detailed inventory of the conflicts, as well as input regarding RICs' abilities to meet CFTC disclosure, reporting, advertising, recordkeeping, and performance disclosure requirements, and how long industry participants believe it would take RICs to come into compliance with such CFTC regulation.32

If RICs (and their sponsors, directors, and/or trustees) were required to register as CPOs, the CFTC's proposed amendments to CFTC Regulation 4.5 would unquestionably create excessive and duplicative or conflicting regulation, forcing RICs to incur significant costs in complying with firm, director, trustee, and employee registration and disclosure, reporting, recordkeeping, advertising, and compliance requirements. For example:

  • Under CFTC Regulation 4.21(a)(1), a CPO must deliver a disclosure document to a prospective participant no later than the time it delivers a subscription agreement to the potential participant.33 However, under Section 5(b)(2) of the Securities Act of 1933 as amended ("1933 Act"), sales of RIC securities must be accompanied or preceded by the fund's then-current prospectus. While investors often receive the prospectus before making their investment decision, it is customary for the prospectus to be sent with the trade confirmation, which can be sent as late as three days after the trade date.
  • Under CFTC Regulation 4.25, commodity pool performance disclosure must include the performance data for other pools that the CPO operates.34 However, disclosure of performance for other RICs is not permitted, although predecessor fund performance may be used in limited circumstances.35

Unless the CFTC provides RICs with relief from aspects of the CPO disclosure and substantive requirements, these costs would be passed on to funds and their investors.

CFTC Questions Regarding Five-Percent Trading Test

The CFTC has requested industry input regarding whether a percent of portfolio liquidation value used for non-bona fide hedging is the appropriate criterion for determining whether a RIC should be subject to CPO registration. If so, the CFTC asks whether the five-percent trading test is the correct threshold. In addition, the CFTC has asked whether the test should include only exchange-traded futures and options contracts or be expanded to OTC instruments.36

Rescission of Registration Exemptions for CPOs

The CFTC is proposing to rescind the exemptions from registration available to CPOs under CFTC Regulations 4.13(a)(3) and (a)(4). Under the current regulations, a person is exempt from registration as a CPO with respect to a pool if interests in the pool are exempt from registration under the 1933 Act and are not marketed to the public in the United States, and where:

  • the pool's use of commodity interests is very limited,37 and the interests are offered only to accredited investors, knowledgeable employees, and members of certain categories of "qualified eligible persons" ("QEPs") defined in CFTC Regulation 4.7;38 or
  • the pool's use of commodity interests is not limited but the person reasonably believes that the pool participants are all members of certain categories of QEPs.39

The Proposing Release notes that the current exemptions, which were adopted in 2003, have permitted a large group of market participants to fall outside the oversight of regulators, and states that "continuing to grant an exemption from registration and reporting obligations for these market participants is outweighed by the [CFTC's] concerns of regulatory arbitrage."40 The Proposing Release also states that eliminating the exemptions under Regulations 4.13(a)(3) and (a)(4) would be analogous to the Dodd- Frank mandate that the SEC require advisers to certain private investment funds to register with the SEC as investment advisers, and is in line with one of the primary purposes of Dodd-Frank —"to promote transparency with respect to the activities of the financial markets."

Many sponsors and advisers to pools that would otherwise be required to register with the CFTC as CPOs and/or CTAs rely on these exemptions from registration and the corollary exemptions from registration as CTAs under CFTC Regulations 4.14(a)(5) and (a)(8).41 As discussed above, the wholly-owned subsidiaries that RICs use for commodity interest investing are part of this group. If adopted, this proposal would mean that the sponsors of such private pools would be required to register with the CFTC and become subject to the disclosure, reporting, recordkeeping, advertising, and compliance requirements imposed under the CFTC's regulatory scheme.42 CTAs relying on an exemption from registration (such as under CFTC Regulations 4.14(a)(5) and (a)(8)) would need to register as CTAs because the corresponding CPO of the pool that they are advising would no longer be exempt from registration. Many sponsors and advisers to pools, however, could claim exemptions available to registered CPOs and CTAs under CFTC Regulation 4.7 from certain disclosure, reporting, and recordkeeping requirements discussed below.

Among other things, the CFTC is seeking comment on this proposal regarding: (1) the time that would be necessary for compliance with the proposal; and (2) whether there are persons who should be exempted from compliance with the proposed revisions.

New Annual Filings of Notices of Claims of Exemption and Exclusion for CPOs and CTAs

Current CPO and CTA exemptions and exclusions from registration under CFTC Regulations 4.5, 4.13, and 4.14 require the CPO or CTA to submit a one-time notice to the NFA to claim such exemption or exclusion.

The Proposing Release notes that this one-time filing "is the end of these entities' interaction with the [CFTC] or NFA . . . ."43

The CFTC proposes to require all persons claiming an exemption or exclusion under these three regulations to confirm their exemption or exclusion within 30 days of the anniversary date of their initial claim, which "would promote improved transparency regarding the number of entities either exempt or excluded from the [CFTC's] registration and compliance programs," consistent with a primary purpose of Dodd-Frank. The CFTC also proposes requiring such exempt or excluded CPOs and CTAs to file a notice of withdrawal should they choose to withdraw a claim of exemption or exclusion "other than due to the cessation of activities requiring registration or exemption thereon."44

Require Solely-Registered CPOs and CTAs to File New Reports Regarding Commodity Trading Activities

Citing a lack of transparency and enhanced concerns regarding systemic market stability, the CFTC has proposed new CFTC Regulation 4.27, requiring CPOs and CTAs to file Forms CPO-PQR and CTA-PR, respectively. The CFTC plans for the new forms to parallel the proposed Form PF45 and to allow the CFTC to provide systemic risk information to the Financial Stability Oversight Counsel ("FSOC") and other regulators. Understanding that such disclosure contains valuable and non-public information, the CFTC has examined issues of confidentially regarding these disclosures, and determined that the proprietary information provided by these forms would not be subject to release under the Freedom of Information Act.

The CFTC has also attempted to address the burden of regulatory compliance by balancing its concerns regarding systemic risk with the cost of compliance obligations. As such, the CFTC has proposed a tiered system of regulation, with more frequent and detailed disclosures required for CPOs and CTAs with over $150 million in assets under management ("AUM"), and additional disclosures for CPOs and CTAs with over $1 billion in AUM, as detailed below.46

Schedule A of Form CPO-PQR is comprised of two parts. Part One requires the disclosure of general information required by the NFA's current pool quarterly reports, including the CPO's name and AUM.47 Part Two requires disclosure of information regarding each of the CPO's pools, including position information for positions comprising more than five percent of the pool's net asset value, monthly and quarterly performance, and redemption terms and restrictions.48 A separate Part Two must be filed for each pool advised by the CPO.

Schedule B of Form CPO-PQR requires more detailed disclosure concerning the pools operated by the CPO, including investment strategy, borrowing by geographic area, and credit counterparty exposure. Schedule C of Form CPO-PQR is comprised of two parts and is required only for the largest CPOs. Part One requires aggregate information concerning the pools advised by the CPO, including the market value of assets invested in different types of securities and derivatives.49 Part Two requires similar disclosure for each individual pool with a net asset value of $500 million or more advised by the CPO, as well as additional disclosure including collateral practices of the pool, investor composition, and liquidity information.50

Similar to Schedule A of Form CPO-PQR, Schedule A of Form CTA-PR requires general disclosure, including the total assets directed by the CTA and total pool assets directed by the CTA. Schedule B of Form CTA-PR requires more detailed disclosure, including position, performance, and trading strategy for each of the CTA's trading programs as well as the pools advised by each program and the percentage of each pool's assets that are directed by the CTA.51

Modifications to Reporting Requirements and Participant Qualification Criteria under CFTC Regulation 4.7

The CFTC is proposing to require registered CPOs that operate pools in reliance on an exemption from certain disclosure, reporting, and recordkeeping obligations under CFTC Regulation 4.7 ("exempt pools") to include certified financial statements in their annual reports to pool participants. CFTC Regulation 4.7 currently exempts registered CPOs and CTAs from a significant amount of the CFTC's disclosure, reporting, and recordkeeping requirements with regard to their management of exempt pools, including relief from the requirement that financial statements accompanying annual reports to pool participants be certified by an independent public accountant. In support of this proposal, the Proposing Release notes that, in 2009, 85% of pools operated under the Regulation 4.7 exemption filed certified annual reports with the NFA notwithstanding the availability of this exemption, and the CFTC believes that removing this exemption will "ensure the accuracy of the financial information submitted by its registrants."52

The CFTC also proposes to modify the criteria for participant qualification in a Regulation 4.7-exempt pool to reflect the SEC's "accredited investor" standard as it may change from time to time. CFTC Regulation 4.7 currently defines QEPs to include (among others) persons who satisfy specific net worth and annual income criteria that are the same as those specified in the SEC's Regulation D "accredited investor" definition.53 The Proposing Release notes that Dodd- Frank mandates that the SEC change the accredited investor definition to increase significantly the applicable thresholds, and the CFTC has therefore determined to incorporate the new standard by reference to Regulation D to maintain consistency between the regulatory provisions without further amendments.54

As a result of these changes, CPOs to exempt pools will need to arrange for an annual independent audit of the exempt pools' financial statements, and the CPOs and CTAs to exempt pools relying on CFTC Regulation 4.7 will need to ensure that the interests in such exempt pools are offered and sold, or that advice is given, respectively, solely to QEPs that satisfy the new definition.

New Risk Disclosure Statement for CPOs and CTAs

In light of Dodd-Frank's expansion of the CFTC's authority to regulate OTC swaps, the CFTC is proposing new components of the "Risk Disclosure Statements" for CPOs and CTAs to describe risks attendant to swap transactions. The proposed changes would amend CFTC Regulations 4.24 and 4.34 to require standard risk disclosures, at the beginning of a CPO or CTA disclosure document, that all swap transactions present market, credit, funding, and operational risks, and that certain swap transactions also present liquidity risk and heightened risk of loss. The disclosures would also note that swaps "may be modified or terminated only by mutual consent of the original parties."55 The CFTC is seeking comment on whether these disclosures accurately represent the risks faced by CPO pool participants and CTA clients.

* * * * * * * * * *

Given the expanded jurisdiction that Dodd-Frank has granted the CFTC and the general regulatory tenor post-2008, the CFTC appears intent to scale back CPO and CTA exclusions and exemptions. However, there is ample room in the CFTC's Proposing Release for public and private fund industry input—drawing on regulatory and operational expertise—to ensure that the proposed changes provide sensible and harmonized regulation, avoid duplicative, conflicting, and unnecessary regulation, provide sufficient lead time for compliance, and exempt and grandfather logical participants.

The period for public comment will be 60 days from the day the Proposing Release is published in the Federal Register. Market participants that could be affected by the Proposing Release should consider submitting a comment letter.

Footnotes

1. At the time of this DechertOnPoint, the proposed rulemaking had not been published in the Federal Register; however, a copy of the proposed rulemaking is available on the CFTC's website at http://www.cftc.gov/ucm/groups/public/@newsroom/documents/file/federalregister012611b.pdf ("Proposing Release"). On January 27, 2011, Dechert LLP issued a NewsFlash client alert regarding the proposed rulemaking available here.

2. Proposing Release, supra note 1 at 10.

3. Proposing Release, supra note 1 at 5.

4. Dodd-Frank § 721(a)(6) (2010) (amending 7 U.S.C. §1a(5)).

5. The NFA is the registered self-regulatory organization for the U.S. futures industry. 7 U.S.C. § 17.

6. 17 C.F.R. §§ 4.20-4.26.

7. 7 U.S.C. § 1a(6).

8. 17 C.F.R. §§ 4.30-4.36.

9. For a more detailed description of the registration requirements for CPOs, CTAs and their respective principals and associated persons, refer to the NFA website, available at http://www.nfa.futures.org.

10. 17 C.F.R. § 4.13(a)(4).

11. 17 C.F.R. § 4.13(a)(2).

12. 17 C.F.R. § 4.13(a)(3). See also 17 C.F.R. § 4.12, applicable to both publicly and privately offered pools.

13. 17 C.F.R. § 4.5. The antifraud provisions of the CEA (as defined below, 7 U.S.C. § 6(o)) do not apply to excluded persons, but do apply to exempted persons.

14. 17 C.F.R. § 4.14(a)(5).

15. 17 C.F.R. § 4.14(a)(10).

16. 17 C.F.R. § 4.14(a)(9).

17. For example, where the person is a cash market dealer in a commodity and provides commodity trading advice solely incidental to the conduct of that cash market business. 17 C.F.R. § 4.14(a)(1).

18. 7 U.S.C. § 1a(6)(B).

19. 7 U.S.C. § 6m(3), as amended by Dodd-Frank § 749(b).

20. 17 C.F.R. § 4.14(a)(8).

21. Letter from Thomas W. Sexton, III, Senior Vice President and General Counsel, NFA, to David Stawick, Office of the Secretariat, CFTC (June 29, 2010), available at http://www.nfa.futures.org/news/newsPetition.asp?ArticleID=2491. On August 18, 2009 in a revised letter, the NFA clarified that the rule amendment should apply only to RICs and not to the other entities eligible for exclusion under CFTC Regulation 4.5. Letter from Thomas W. Sexton, III, Senior Vice President and General Counsel, NFA, to David Stawick, Office of the Secretariat, CFTC (August 18, 2010), available at http://www.nfa.futures.org/news/newsPetition.asp?ArticleID=3630 ("NFA Letter"). For a discussion of the NFA Letter, refer to the August 2010 DechertOnPoint client alert available at http://www.dechert.com/library/FS_21-08-10-NFA_Petitions_for_Rulemaking.pdf.

On September 17, 2010, the CFTC notified the public of the NFA's petition and requested comments. Petition of the National Futures Association, Pursuant to Rule 13.2, to the U.S. Commodity Futures Trading Commission to Amend Rule 4.5, 75 Fed. Reg. 56997 (Sept. 17, 2010) (notice of petition and request for comment) ("Notice of Petition").

The CFTC received 19 comment letters, the majority of which opposed the NFA's petition in whole or in part. The CFTC comment letter file is available at http://comments.cftc.gov/PublicComments/CommentList.aspx?id=764. The file includes a comment letter from Dechert LLP available at http://comments.cftc.gov/PublicComments/ViewComment.aspx?id=26313&SearchText=.

22. 17 C.F.R. § 1.3(z)(1). Since adopting CFTC Regulation 1.3(z)(1) in 1977, the CFTC has clarified, interpreted, and reinterpreted what it means to be engaged in bona fide hedging. See Background on Position Limits and the Hedge Exemption, Statement of Dan M. Berkovitz, General Counsel, CFTC (Jan. 14, 2010), available at http://www.cftc.gov/PressRoom/SpeechesTestimony/proposedrule011410_berkovitz.html.

The CFTC notes that it may revise the definition of bona fide hedging in the future, in which case it may need to modify these proposed rule changes to conform. Proposing Release, supra note 1 at n. 50. It is unlikely that the revision would expand the definition of bona fide hedging in a manner that would encompass more financial entity activity in the markets. The CFTC currently has a proposed modification of bona fide hedging out for public comment with regard to speculative position limits. See Position Limits for Derivatives, 76 Fed. Reg. 4752, 4760-4761 (Jan. 26, 2011) (proposed rule) (proposing new CFTC Regulation 151.5 for exemptions for "referenced contracts," as defined therein).

23. See generally Additional Registration and Other Regulatory Relief for Commodity Pool Operators and Commodity Trading Advisors; Past Performance Issues, 68 Fed. Reg. 47221 (Aug. 8, 2003).

24. However, a RIC's investment in commodities is limited by Subchapter M of the Internal Revenue Code of 1986 as amended ("Code").

25. NFA Letter, supra note 21.

26. Proposing Release, supra note 1 at 53.

27. NFA Letter, supra note 21.

In late 2005, the Internal Revenue Service ("IRS") issued a revenue ruling that the income from commodity-linked swaps did not constitute "qualifying income" under Subchapter M of the Code. In a subsequent revenue ruling, the IRS indicated that income from alternative investment instruments, including commodity-linked notes, could allow RICs to obtain commodity exposure while complying with the "qualifying income" requirements of Subchapter M. The IRS has issued private letter rulings that allow commodity-based mutual funds to use a wholly-owned subsidiary to invest in commodity-linked swaps and commodity futures and options. Income these subsidiaries produce can be qualifying income under Subchapter M. In addition, direct purchases of commodity futures and options through a subsidiary are generally more cost effective and transparent to investors than entering into commodity-linked swaps. Direct purchases of commodity futures and options eliminate the counterparty risk inherent in OTC derivative instruments.

28. Proposing Release, supra note 1 at 37-40.

29. Proposing Release, supra note 1 at 32.

30. Proposing Release, supra note 1 at 33.

31. Proposing Release, supra note 1 at 34.

32. Proposing Release, supra note 1 at 34-35.

33. 17 C.F.R. § 4.21(a)(1).

34. 17 C.F.R. § 4.25.

35. MassMutual Institutional Funds, SEC No-Action Letter (pub. avail. Sept. 25, 1995).

36. Proposing Release, supra note 1 at 34.

37. In this instance, "very limited" means either: (a) that the pool's aggregate initial margin and premiums attributable to commodity options and commodity futures, respectively, do not exceed five percent of the liquidation value of the pool's portfolio after taking into account unrealized profits and unrealized losses on any such positions it has entered into, provided that, in the case of an option that is in-the-money at the time of purchase, the in-the-money amount may be excluded in computing such five percent; or (b) that the aggregate net notional value of such positions does not exceed 100 percent of the liquidation value of the pool's portfolio after taking into account unrealized profits and unrealized losses on any such positions it has entered into. Both tests do not differentiate as to whether the positions are held for bona fide hedging purposes or otherwise. 17 C.F.R. § 4.13(a)(3)(ii).

38. See 17 C.F.R. § 4.13(a)(3).

39. See 17 C.F.R. § 4.13(a)(4) (setting a higher threshold for participation than CFTC Regulation 4.14(a)(3)). "Non- United States Persons" are eligible to participate in pools whose sponsors are exempt from registration under both CFTC Regulations 4.14(a)(3) and 4.14(a)(4) because Non-United States Persons are included as QEPs under § 4.7(a)(2)(xi).

40. See Proposing Release, supra note 1 at 37-40.

41. The CTA exemption under CFTC Regulation 4.14(a)(5) and certain CTA exemptions under CFTC Regulation 4.14(a)(8) require that the exempt CTA be an exempt CPO.

42. In the case of a wholly-owned subsidiary of a RIC, the subsidiary would have disclosure and reporting obligations to its sole shareholder, the mutual fund itself.

43. See Proposing Release, supra note 1 at 40-41.

44. Proposing Release, supra note 1 at 41.

45. Form PF will require private investment funds to disclose certain financial information for use by FSOC (defined below) in monitoring systemic risk. Form PF will be required only for funds registered with the SEC, although CPOs and CTAs registered with both the SEC and the CFTC will also need to complete this form. Reporting by Investment Advisers to Private Funds and Certain Commodity Pool Operators and Commodity Trading Advisors on Form PF, SEC Release No. IA-3145 (Jan. 26, 2011) (proposed rule), available at http://www.sec.gov/rules/proposed/2011/ia-3145.pdf.

46. Proposing Release, supra note 1 at 14-15. CTAs with AUM of $1 billion or more are required to make additional disclosure pursuant to Form PF and Form ADV.

47. Proposing Release, supra note 1 at 17.

48. Proposing Release, supra note 1 at 17-18.

49. Proposing Release, supra note 1 at 19-20.

50. Proposing Release, supra note 1 at 20-22.

51. Proposing Release, supra note 1 at 23-24.

52. Proposing Release, supra note 1 at 35-36.

53. Compare 17 C.F.R. § 4.7(a)(3)(ix) and (a)(3)(x) with 17 C.F.R. 230.501(a)(5) and (a)(6).

54 .Net Worth Standard for Accredited Investors, 76 Fed. Reg. 5307 (Jan. 31, 2011)(proposed rule).

55. See Proposing Release, supra note 1 at 58.

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