Keywords: family offices, commodity pool, commodity pool operator, CPO registration
Family offices or high net worth clients often create investment funds to manage commingled family assets. Recent regulatory changes caused by amendments to the Commodity Exchange Act of 1936 ("CEA") by the Dodd-Frank Act1 may force family offices that have created any pooled investment vehicle falling within the definition of a "commodity pool"2 to consider whether or not they are required to register, or file a notice for exemption from registration, as a commodity pool operator ("CPO"). The Commodity Futures Trading Commission ("CFTC"), which regulates commodity pools, has adopted, amended or rescinded various rules; this includes the rescission of CEA Rule 4.13(a)(4), which used to exempt from CPO registration certain institutional entities such as investment partnerships and other pooled vehicles sponsored and managed by single family offices.3
The CFTC is considering whether to exempt family offices from the CPO definition, but no such exemption is currently in effect.4 For pools existing prior to April 24, 2012, pools managed and sponsored by single family offices that relied on Rule 4.13(a)(4) for exemption from CPO registration by filing the required notice may continue to so rely until December 31, 2012. They must register as a CPO after that date, unless otherwise exempted.
Generally speaking, any pooled investment vehicle that invests directly or indirectly (e.g., when it invests in another pooled investment vehicle that is also a commodity pool) in commodity interests will be deemed a commodity pool. Commodity5 interests have long included traditional futures contracts. However, the Dodd-Frank Act added a new "commodity pool" definition to the CEA6 and amended the CPO definition7 to include certain swaps.
Because the term "swap" required further definition, many entities, including family offices, awaited the CTFC's final rulemaking to determine whether the amended CPO definition would apply to their pooled vehicles. The final rule defining swaps was published in the Federal Register on August 13, 2012.8 Swaps include, among other things, certain derivatives intended to protect equity positions. In addition, unless further exemptive relief is granted by the Secretary of the Treasury, swaps also include foreign exchange forwards and foreign exchange swaps.9
Absent the availability of an exemption, each operator of the pool will generally be subject to registration as a commodity pool operator. Equally important, the CFTC has taken the view that a single swap or other commodity interest can cause a pooled vehicle to constitute a commodity pool.10 Thus, a family office that owns a pooled fund with one or more swaps may be a commodity pool. To the extent that the family office sponsors the fund, it may be subject to CPO registration and regulatory oversight by the CFTC. A family office may be able to delegate its CPO registration obligation to another manager, such as a registered investment adviser acting as a manager of the pooled vehicle and registered as a CPO, but it would still have certain obligations under the CEA.11
CPO registration requires membership in the National Futures Association ("NFA"), a selfregulatory body authorized and overseen by the CFTC. NFA members are subject to periodic examination and their "associated persons" are generally required to pass proficiency examinations. CPO registration also entails compliance and disclosure obligations, including filing certified annual reports.
Given that the CFTC has yet to adopt a specific family office exemption, managers of family offices with pooled investment vehicles falling within the definition of a "commodity pool" essentially have three choices: (i) register in accordance with the rules; (ii) if available, file a notice to rely on an existing exemption; or (iii) seek individual exemptive or no-action relief, or seek interpretative relief on behalf of all similarly situated family offices.12
With respect to existing exemptions from registration, a family office may be exempt from CPO registration under CEA Rule 4.13(a)(1) if it: (i) operates only one commodity pool; (ii) receives no compensation; and (iii) is not otherwise required to be registered (i.e. as a CTA). Alternatively, a family office may avoid CPO registration under CEA Rule 4.13(a)(2) if its commodity pools have aggregate contributions of $400,000 or less, and have fewer than 15 participants in the pools.
The contribution and participant limits are not quite as onerous as they appear, as they do not apply to the CPO, its principals, or immediate family members of the principals or other relatives living in the principals' households. These exemptions are not self-executing and require notice filings with the NFA to be effective. However, given the structure of many family offices, these exemptions have historically been of limited use.
Family offices may also seek relief under CEA Rule 4.13(a)(3) to the extent that their commodity pool meets certain conditions such as restricting participation to certain categories of individuals13 and satisfying at least one of two alternative de minimis trading tests.14 While exemption from CPO registration reduces certain compliance and disclosure obligations, family offices should understand that exempt CPOs are still subject to antifraud regulation under the CEA.15
Family office managers may also seek exemptive or no-action letters from the CFTC. Several letters were granted to certain family offices prior to the enactment of the Dodd-Frank Act and CFTC adoption of related rules. The letters generally took the position that vehicles comprised solely of immediate family members are not commodity pools and, therefore, their managers are not CPOs. These letters are factspecific and the CFTC does not permit them to be relied on by others.16 In addition, family offices may seek a CFTC interpretive letter on behalf of all similarly situated persons, but no such relief exists under the new rules.
The extra-territorial reach of the new commodity pool and CPO requirements is also unclear.17 As such, foreign family offices that operate pooled vehicles within the definition of a "commodity pool" may also trigger the CPO registration obligation. Family offices with commingled investment vehicles investing in commodity interests should consult with counsel regarding their specific situation.
1 The Dodd-Frank Wall Street Accountability and Consumer Protection Act ("Dodd-Frank Act") includes Title VII, also called the "Over-the-Counter Derivatives Reform and Transparency Act." Title VII is intended to establish a comprehensive regulatory framework to reduce risk, increase transparency, and promote market integrity within the financial system. See, e.g., Final Rule: "Further Definition of ''Swap,'' ''Security-Based Swap,'' and ''Security-Based Swap Agreement;' Mixed Swaps; Security-Based Swap Agreement Recordkeeping," 77 Fed. Reg. 48,208 at 48,209, n. 3 (August 13, 2012) [hereinafter, Final Swaps Rule].
2 A "commodity pool" is defined to include "any investment trust, syndicate, or similar form of enterprise operated for the purpose of trading in commodity interests, including any—(i) commodity for future delivery, security futures product, or swap". CEA §1a(10)(A).
3 See Commodity Pool Operators and Commodity Trading Advisors: Amendments to Compliance Obligations; Final Rules, 77 Fed. Reg. 11252 (Feb. 24, 2012), as amended by 77 Fed. Reg. 13728 (Mar. 26, 2012).
4 See Harmonization of Compliance Obligations for Registered Investment Companies Required to Register as Commodity Pool Operators; Proposed Rules, 77 Fed. Reg. 11345 at 11348 (Feb. 24, 2012) ("the Commission is considering adopting a family offices exemption from CPO registration akin to the exemption adopted by the SEC"). In accordance with Dodd-Frank Act Section 409(a), the Securities and Exchange Commission ("SEC") adopted a rule defining "family office" for purposes of a new statutory exclusion of "family office" from the definition of "investment adviser" under the Investment Advisers Act of 1940 ("Advisers Act"). See 124 Stat. at 1575, Section 409(a), "Family Offices" adding new Subsection 202(a)(11)(G) to the Advisers Act; See also Family Offices, SEC Rel. No. IA-3220 (June 22, 2011) [76 Fed. Reg. 37983, June 29, 2011]. The SEC exclusion is limited to family offices providing advice to a single family, not multiple families.
5 "Commodity" is defined to include, among other things, "all services, rights, and interests ... in which contracts for future delivery are presently or in the future dealt in." CEA §1a(9).
6 Dodd-Frank Act §721(a)(5), 124 Stat. 1659, added a new statutory definition of "commodity pool" to appear at CEA §1a(10). The new definition is based on a prior regulatory definition contained in CEA Rule 4.10, but it adds the term "swaps" subject to that term's definition in the Final Swaps Rule.
7 Dodd-Frank Act §721(a)(6), 124 Stat. 1659, added the term "swap" to a revised version of the statutory definition of "commodity pool operator" to appear at CEA §1a(11).
8 See Final Swaps Rule, footnote 1, supra. It becomes effective, in part, on October 12.
9 The Secretary of the Treasury has issued a proposal to exempt foreign exchange forwards and swaps from the newly defined term "swaps" under the CEA. However, the proposal has yet to be adopted. See id., 77 Fed. Reg. at 48353 and n. 508.
10 See, e.g., Commodity Pool Operators and Commodity Trading Advisors: Compliance Obligations, 77 Fed. Reg. 11,252, 11,258, 11,263 (Feb. 24, 2012).
11 CFTC Staff recently stated as follows: Where the general partner, managing member or board of directors of a commodity pool is legally permitted to delegate its rights and responsibilities with respect to the operation of the commodity pool to one or more persons, the manager may delegate its rights and obligations as CPO to another person, provided that such person is qualified to serve as CPO and is registered as a CPO ... [However], the delegating entity must agree to remain jointly and severally liable with respect to any violations of the Commodity Exchange Act.
Division of Swap Dealer and Intermediary Oversight Responds to Frequently Asked Questions – CPO/CTA: Amendments to Compliance Obligations (released August 14, 2012) at p. 1.
12 See 17 C.F.R. §140.99. Under this rule, the CFTC may issue three different kinds of personalized relief letters, including exemptive letters, no-action letters and interpretive letters. Only interpretive letters may be relied on persons other than the specific beneficiary of the relief granted.
13 Rule 4.13(a)(3) limits participants to those who meet one of the following categories: "accredited investor" as defined by Rule 501 under the Securities Act of 1933, a trust formed by an accredited investor for the benefit of a family member, "knowledgeable employee" as defined by Rule 3c-5 under the Investment Company Act of 1940, and "qualified eligible person" as defined by CEA Rule 4.7(a)(2)(viii)(A).
14 The alternative trading tests are: (1) aggregate initial margin and premiums do not exceed 5% of the liquidation value of the pool's portfolio; or (2) aggregate net notional value of positions does not exceed 100% of the liquidation value of the pool's portfolio.
15 Acting as a CPO without registration or exemption from registration violates the CEA and may result in civil or criminal penalties. For example, felony violations of the CEA are punishable by fines of up to $1 million, imprisonment for up to 10 years or both. See 7 USC 13(a).
16 See 17 C.F.R. §140.99(a)(1) ("Only the Beneficiary may rely upon the exemptive letter") and (a)(2) ("Only the Beneficiary may rely upon the no-action letter.").
17 See Cross-Border Application of Certain Swaps Provisions of the Commodity Exchange Act, RIN 3038- AD57 (June 29, 2012), 77 Fed. Reg. 41213 (July 12, 2012). For more information, please see our Legal Update dated August 15, 2012, entitled Sure, My Project Has Swaps (In Fact, My Lenders Required These Hedges), But Why Does That Make It A Commodity Pool and Why Am I Now A Commodity Pool Operator?
Originally published on October 3, 2012
Visit us at mayerbrown.com
Mayer Brown is a global legal services provider comprising legal practices that are separate entities (the "Mayer Brown Practices"). The Mayer Brown Practices are: Mayer Brown LLP and Mayer Brown Europe – Brussels LLP, both limited liability partnerships established in Illinois USA; Mayer Brown International LLP, a limited liability partnership incorporated in England and Wales (authorized and regulated by the Solicitors Regulation Authority and registered in England and Wales number OC 303359); Mayer Brown, a SELAS established in France; Mayer Brown JSM, a Hong Kong partnership and its associated entities in Asia; and Tauil & Chequer Advogados, a Brazilian law partnership with which Mayer Brown is associated. "Mayer Brown" and the Mayer Brown logo are the trademarks of the Mayer Brown Practices in their respective jurisdictions.
© Copyright 2012. The Mayer Brown Practices. All rights reserved.
This Mayer Brown article provides information and comments on legal issues and developments of interest. The foregoing is not a comprehensive treatment of the subject matter covered and is not intended to provide legal advice. Readers should seek specific legal advice before taking any action with respect to the matters discussed herein.