UK: CFTC Proposes Relief from Certain Disclosure, Reporting and Recordkeeping Requirements for CPOs of Commodity ETFs

Last Updated: 11 October 2010
Article by Brendan C. Fox, Joseph J. Muscatiello, Stuart M. Strauss and M. Holland West

The Commodity Futures Trading Commission ("CFTC") is proposing changes to its regulations as they affect certain CFTC-registered commodity pool operators ("CPOs") of pools whose units of participation are listed and traded on a national securities exchange.1 The proposals would essentially codify relief from certain disclosure, reporting and recordkeeping requirements that the CFTC Staff has provided on a case-by-case basis to CPOs of Commodity ETFs ("Prior Relief Letters"). A "Commodity ETF" is an exchange-traded fund that passively seeks to track or replicate the performance of a specific commodity index through investment in commodity interests, or that may actively trade commodity interests without regard to an index or benchmark. The proposals would also provide exemptive relief from CPO registration for independent directors or trustees of actively-managed Commodity ETFs.

Proposed Rule Changes

Disclosure Document and Delivery/ Acknowledgement Requirements

Registered CPOs are required under CFTC Rule 4.21 to deliver a CFTC-compliant disclosure document to prospective investors (and obtain a signed acknowledgment receipt of the disclosure document from prospective investors), which contains information about the commodity pool. This document must include: information about risk factors associated with an investment in the pool; the business background of the CPO and its principals; conflicts of interest on the part of the CPO, commodity trading advisors ("CTAs") for the pool and other professionals who provide services to the pool; fees incurred by the pool; the pool's performance record; and material legal proceedings over the past five years against the CPO, CTAs and other related persons. The CFTC Staff has previously provided exemptions to CPOs of Commodity ETFs from the physical delivery and acknowledgement requirements, based on arguments that compliance with the SEC prospectus delivery requirements provides substantially similar disclosure, and that compliance with the delivery obligations is not practical for purchases of exchange-listed securities. In lieu of physical delivery, CPOs have agreed to post the disclosure document on their website and direct the registered broker-dealers offering shares in Commodity ETFs to deliver a copy of the disclosure document to prospective investors or explain to them how to obtain the current disclosure document.

The proposals would codify this relief by eliminating the requirement for a CPO of a Commodity ETF to physically deliver a disclosure document to prospective investors (or obtain a signed acknowledgment receipt from prospective investors), if the CPO provides a readily accessible disclosure document on its website (the address of which must be disclosed to prospective investors). The CPO also must amend and keep the disclosure document current in accordance with CFTC Rule 4.26 and otherwise maintain the disclosure document in compliance with the form and content requirements under CFTC regulations.

Periodic Account Statement Distribution Requirements

Under CFTC Rule 4.22, registered CPOs must deliver to prospective pool participants monthly account statements (for pools with net assets exceeding $500,000), and an annual report within 90 days of a pool's fiscal year-end, prepared in accordance with generally accepted accounting principles and certified by an independent public accountant. The annual report also must be electronically filed with the CFTC. In Prior Relief Letters, the CFTC Staff has granted exemptions from the account statement delivery requirements, provided that the CPO posts on its website all information otherwise required under CFTC regulations to be included in the account statements. Under the proposals, CPOs of Commodity ETFs may, in lieu of physical delivery of an account statement, maintain the account statement on a website for at least 30 days. The internet address of the website must be set forth in the disclosure document and the disclosure document must state that the account statement will be readily accessible on the website. The proposals do not provide relief from the requirement that a CPO prepare and physically distribute an annual audited report to pool participants.

Record Location Requirements

Pursuant to CFTC Rule 4.23, registered CPOs must maintain books and records at their main business office and make such records available for inspection by Staff of the CFTC, the National Futures Association ("NFA") and the Department of Justice. In Prior Relief Letters, the CFTC Staff has granted exemptions from the location requirement, if an alternate recordkeeper for the CPO has signed an acknowledgement that the CPO's records are available for inspection by such regulators. The proposals would permit required books and records to be kept at the office of the pool's administrator, distributor, or bank or registered brokerdealer providing similar services to the pool. In order to do so: the CPO's disclosure document must comply with the content and access requirements under the amended regulations; the CPO must disclose in its exemption filing information about the storage and location of its records; and the CPO must make certain representations regarding its responsibilities with respect to the records, including its obligations to promptly amend its exemption filing to reflect changes in information provided. In addition, the CPO must represent that it will comply within 48 hours with any request by the CFTC, NFA or Department of Justice to inspect the records.

Prior Relief Letters permitted a CPO-affiliated national banking association, a state-regulated bank, a registered broker-dealer, a state- and Federal Reserve Board-regulated bank and a registered broker-dealer performing distribution-related services to serve as alternate recordkeepers. In response to CPOs' previous requests for confirmation that such recordkeepers would not be considered CPOs solely by keeping books and records of a pool, the CFTC Staff has stated that certain service providers, such as a registered investment company's depositor, sponsor, underwriter or investment adviser, were not CPOs under the statutory definition. Prior Relief Letters provided that, in making the determination of whether an alternate recordkeeper is a CPO, the CFTC Staff would typically consider factors such as "who will be promoting the pool by soliciting, accepting or receiving from others property for the purpose of commodity interest trading – and who will have the authority to hire (and fire) the pool's CTA and to select (and change) the pool's [futures commission merchant]." The proposals do not elaborate on the factors that the CFTC will consider in determining whether a particular service provider is outside the CPO definition.

New Exemption from CPO Registration for Independent Directors and Trustees of Actively-Managed Commodity ETFs

Rule 10A-3 under the Securities Exchange Act of 1934 ("Exchange Act"), adopted by the SEC in accordance with the Sarbanes-Oxley Act of 2002, requires each member of an issuer's audit committee to be independent, in order for the issuer to list its securities on a national securities exchange. Commodity ETFs, which only seek to track the holdings or correspond to the performance of a particular index or index subset, may rely on an exemption provided by SEC Rule 10A-3(c)(7), from the independence requirement for trusts or other unincorporated organizations whose activities are limited to passively owning or holding securities or other assets for the benefit of its security holders. Actively-managed Commodity ETFs, which are not limited to passively holding securities, cannot currently rely on this exemption. Accordingly, the independent directors or trustees of actively-managed Commodity ETFs must satisfy the independence standards of the listing requirements. Additionally, because a director or trustee of a commodity pool is presumed to be a CPO by virtue of the control he or she can exercise over a pool, directors and trustees of actively-managed Commodity ETFs must register as CPOs or seek relief from such registration requirements. The CFTC is proposing to provide a new exemption from the CPO registration requirements for individuals who serve as a director, trustee or in a similar position with respect to an actively-managed Commodity ETF, solely for the purposes of complying with the audit committee requirements of SEC Rule 10A-3.

Claiming Relief

Registered CPOs may file with the NFA a claim of exemption with respect to any Commodity ETF that offers and sells participation interests pursuant to an effective registration statement under the Securities Act of 1933 (the "Securities Act") and that is registered under the Exchange Act as listed for trading on a national securities exchange. This claim of exemption must be filed electronically with the NFA through the NFA's electronic exemption filing system no later than the time the CPO delivers a subscription agreement for the pool to a prospective investor, and the claim will be effective upon filing.

Directors or trustees applying for relief from the requirement to register as a CPO must individually make an electronic filing with the NFA by the later of the Commodity ETF's registration statement becoming effective under the Securities Act or the date on which the individual first becomes a director or trustee, and the claim will be effective upon filing. A director or trustee registered as a CPO who intends to withdraw his or her CPO registration in order to claim relief under this exemption must notify the investors of the Commodity ETF by an electronically or physically delivered written communication, and provide each investor with the right to withdraw its interest prior to the director or trustee filing a notice of exemption.

The CFTC is accepting written comments on the proposals, received on or before October 25, 2010.

Footnote

1. Commodity Pool Operators: Relief From Compliance With Certain Disclosure, Reporting and Recordkeeping Requirements for Registered CPOs of Commodity Pools Listed for Trading on a National Securities Exchange: CPO Registration Exemption for Certain Independent Directors or Trustees of These Commodity Pools, 75 FR 54794 (Sept. 9, 2010).

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