United States: CFTC Adopts "Substituted Compliance" Approach For Registered Investment Companies That Are Commodity Pools

Last Updated: August 19 2013
Article by Kelley A. Howes and Jay G. Baris

In a dramatic change of course, the Commodity Futures Trading Commission (CFTC) adopted final rules that apply a "substituted compliance" approach for disclosure and compliance obligations of registered investment companies (RICs) that are also commodity pools. At the same time, the Division of Investment Management of the Securities and Exchange Commission (SEC) issued guidance to facilitate compliance with SEC and CFTC disclosure and reporting requirements by funds and their advisers that are subject to regulation by both agencies.

Last year, the CFTC modified its Rule 4.5 to exclude from the definition of a commodity pool operator (CPO) only those advisers of RICs that invest a de minimis amount of their assets in commodity interests other than for bona fide hedging purposes. An adviser that does not qualify for the exemption must register as a CPO, thus requiring the RIC to comply not only with existing SEC regulations but also with CPO disclosure, compliance and financial reporting obligations under CFTC rules. At the same time, the CFTC adopted the changes to Rule 4.5, it proposed rule amendments designed to "harmonize" the myriad of inconsistent regulations that would apply to RICs that are also commodity pools.

In public comment letters on the harmonization proposal, many market participants voiced the concern that the proposal did not go far enough and that RICs would still be subject to duplicative, inconsistent and possibly conflicting regulations. The CFTC listened. Its final harmonization rules are firmly grounded in the concept of "substitute compliance." That is, with some modifications, a CPO of a RIC that complies with the SEC's disclosure and compliance rules will be deemed to comply with CFTC regulations.


Currently, a CPO can use a disclosure document dated no more than nine months prior to its use. Open-end investment companies may use registration statements that are up to 16 months old. The new rules provide that CPOs of RICs will be deemed to comply with CFTC disclosure obligations if they comply with the SEC's rules. The rules will not require CPOs of open-end RICs to submit their disclosure documents for separate review by the National Futures Association (NFA).

The CFTC requires that CPOs update disclosure documents to correct material inaccuracies within 21 days of the date they first learn of the defect. The SEC, in contrast, does not apply a specific schedule for corrections. Rather, the SEC generally prohibits the sale of shares of a RIC by means of a materially misleading prospectus and imposes liability for the use of such a prospectus. The CFTC has determined that compliance with SEC regulations will be adequate for CPOs of RICs.


The CFTC will consider CPOs of RICs that comply with the SEC's prospectus delivery rules to have complied with the corresponding CFTC requirements. Unlike the CFTC, which treats a series trust as a discrete legal entity, the SEC allows series funds organized within a single trust to produce financial reports and disclosure documents on a series-by-series basis. The CFTC's final rules will accept compliance with the SEC's approach.


The CFTC will allow CPOs of RICs to use the cautionary statement prescribed in SEC Rule 481, with minor modifications, to comply with the requirements for cautionary legends on the cover page of commodity pool disclosure documents. Therefore, RICs must update their cover page disclosure to read either:

The Securities and Exchange Commission and the Commodity Futures Trading Commission have not approved or disapproved these securities or passed upon the adequacy of this prospectus. Any representation to the contrary is a criminal offense.


The Securities and Exchange Commission and the Commodity Futures Trading Commission have not approved or disapproved these securities or determined if this prospectus is truthful or complete. Any representation to the contrary is a criminal offense.

Commodity pools must also include standard risk disclosure in their disclosure documents regarding, among other things, the liquidity of commodity investments. The CFTC will not require RICs to comply with this disclosure requirement since open-end funds must honor redemption requests within seven days, and thus the CFTC's concerns related to liquidity are mitigated. Similarly, since closed-end funds generally trade on the open market, the risks of inability to redeem in a timely manner also appear mitigated.


The CFTC requires commodity pools to disclose "the trading profit that a pool must realize in the first year of a participant's investment to equal all fees and expenses such that such participant will recoup its initial investment." The CFTC originally proposed requiring this disclosure in RIC prospectuses. Commenters apparently persuaded the CFTC that the RIC fee table and other fee and cost disclosures, taken together, sufficiently communicate the fees and costs associated with a RIC that uses derivatives. The final rules do not require additional break-even point disclosure.


A CPO with less than a three-year operating history must disclose the past performance of each other pool it operates. Under the new rules, the CFTC will generally accept compliance with SEC requirements for disclosure of past performance. However, RICs with less than three years of performance history must disclose the performance of all accounts and pools that are managed by the CPO and that have investment objectives, policies and strategies substantially similar to the offered pool. The CFTC believes that this disclosure obligation is consistent with SEC positions that permit - but do not require - disclosure of such similar accounts, and thus it should be consistent with SEC rules.


The CFTC specifically reaffirmed its position that RICs may continue to invest through CFC subsidiaries, but that the investment approach of a CFC may require its CPO to register, even if its parent RIC may rely on the Rule 4.5 exclusion. The CFTC said, however, that it will not require a separate disclosure document for a CFC because a RIC using that CFC to affect its investment strategy must disclose in its prospectus information about the RIC's investment in the CFC and the principal risks associated with the CFC investment. Moreover, if the RIC consolidates the CFC's financial statements with its own and files them with the NFA, the CFTC would not require the CFC to file separate financial statements.


Current CFTC regulations require pools with net assets greater than $500,000 to send each participant monthly account statements containing specific information. Public commenters persuaded the CFTC to drop the monthly requirement, and to allow pools to rely on the SEC rules that require annual and semi-annual shareholder reports. The CFTC specifically noted that the use of electronic distribution of shareholder reports (e.g., through websites) would be acceptable.


The CFTC dropped its proposal to require RICs to maintain full books and records at the CPO's main office. Rather, the CFTC amended its rules to allow all CPOs to use third-party service providers to maintain their books and records, as the SEC's rules now permit. Additionally, the CFTC is exempting RICs from CFTC requirements that books and records be made available for review and copying by individual shareholders. The CFTC recognized that transfer agents or other financial intermediaries may maintain these records with respect to omnibus accounts.


  • The CFTC extended relief to all publicly offered pools to the same extent as it applies to ETFs, regardless of whether those pools trade on an exchange.
  • The CFTC did not extend relief to CPOs that manage privately offered pools, other than certain record-keeping matters.
  • The CFTC rescinded the signed acknowledgment requirement for all registered CPOs, including those that offer private pools.
  • The CFTC adopted, as proposed, a rule that allows all CPOs and commodity trading advisers to use a disclosure document dated no more than 12 months prior to the date of its use.


The harmonized compliance obligations for CPOs of RICs will generally become effective upon publication in the Federal Register. Compliance with the obligation to include certain past performance information will be effective 30 days after publication in the Federal Register. Initial reporting on forms CPO-PQR will begin 60 days after the date of publication.


Under the new rules, a CPO of a RIC that wants to rely on the substituted compliance regime 4097must take the following actions:

  • File notice of its use of the substituted compliance regime with the NFA;
  • If it has less than three years operating history, disclose the performance of all accounts and pools managed by the CPO that have investment objectives, policies and strategies substantially similar to those of the offered fund;
  • File with the NFA the financial statements that it prepares pursuant to SEC requirements; and
  • File notice with the NFA if it intends to use third-party service providers for recordkeeping purposes.


The CFTC's final harmonization rules should come as a big relief to RICs and their investment advisers. The CFTC took a realistic approach, reflecting the practical difficulties in harmonizing two very different regulatory regimes, and recognized that the SEC is best positioned to protect investors in RICs that invest in commodity interests. The public comment process worked.

Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

© Morrison & Foerster LLP. All rights reserved

To print this article, all you need is to be registered on Mondaq.com.

Click to Login as an existing user or Register so you can print this article.

Kelley A. Howes
In association with
Related Video
Up-coming Events Search
Font Size:
Mondaq on Twitter
Register for Access and our Free Biweekly Alert for
This service is completely free. Access 250,000 archived articles from 100+ countries and get a personalised email twice a week covering developments (and yes, our lawyers like to think you’ve read our Disclaimer).
Email Address
Company Name
Confirm Password
Mondaq Topics -- Select your Interests
 Law Performance
 Law Practice
 Media & IT
 Real Estate
 Wealth Mgt
Asia Pacific
European Union
Latin America
Middle East
United States
Worldwide Updates
Check to state you have read and
agree to our Terms and Conditions

Terms & Conditions and Privacy Statement

Mondaq.com (the Website) is owned and managed by Mondaq Ltd and as a user you are granted a non-exclusive, revocable license to access the Website under its terms and conditions of use. Your use of the Website constitutes your agreement to the following terms and conditions of use. Mondaq Ltd may terminate your use of the Website if you are in breach of these terms and conditions or if Mondaq Ltd decides to terminate your license of use for whatever reason.

Use of www.mondaq.com

You may use the Website but are required to register as a user if you wish to read the full text of the content and articles available (the Content). You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these terms & conditions or with the prior written consent of Mondaq Ltd. You may not use electronic or other means to extract details or information about Mondaq.com’s content, users or contributors in order to offer them any services or products which compete directly or indirectly with Mondaq Ltd’s services and products.


Mondaq Ltd and/or its respective suppliers make no representations about the suitability of the information contained in the documents and related graphics published on this server for any purpose. All such documents and related graphics are provided "as is" without warranty of any kind. Mondaq Ltd and/or its respective suppliers hereby disclaim all warranties and conditions with regard to this information, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. In no event shall Mondaq Ltd and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use or performance of information available from this server.

The documents and related graphics published on this server could include technical inaccuracies or typographical errors. Changes are periodically added to the information herein. Mondaq Ltd and/or its respective suppliers may make improvements and/or changes in the product(s) and/or the program(s) described herein at any time.


Mondaq Ltd requires you to register and provide information that personally identifies you, including what sort of information you are interested in, for three primary purposes:

  • To allow you to personalize the Mondaq websites you are visiting.
  • To enable features such as password reminder, newsletter alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our information providers who provide information free for your use.

Mondaq (and its affiliate sites) do not sell or provide your details to third parties other than information providers. The reason we provide our information providers with this information is so that they can measure the response their articles are receiving and provide you with information about their products and services.

If you do not want us to provide your name and email address you may opt out by clicking here .

If you do not wish to receive any future announcements of products and services offered by Mondaq by clicking here .

Information Collection and Use

We require site users to register with Mondaq (and its affiliate sites) to view the free information on the site. We also collect information from our users at several different points on the websites: this is so that we can customise the sites according to individual usage, provide 'session-aware' functionality, and ensure that content is acquired and developed appropriately. This gives us an overall picture of our user profiles, which in turn shows to our Editorial Contributors the type of person they are reaching by posting articles on Mondaq (and its affiliate sites) – meaning more free content for registered users.

We are only able to provide the material on the Mondaq (and its affiliate sites) site free to site visitors because we can pass on information about the pages that users are viewing and the personal information users provide to us (e.g. email addresses) to reputable contributing firms such as law firms who author those pages. We do not sell or rent information to anyone else other than the authors of those pages, who may change from time to time. Should you wish us not to disclose your details to any of these parties, please tick the box above or tick the box marked "Opt out of Registration Information Disclosure" on the Your Profile page. We and our author organisations may only contact you via email or other means if you allow us to do so. Users can opt out of contact when they register on the site, or send an email to unsubscribe@mondaq.com with “no disclosure” in the subject heading

Mondaq News Alerts

In order to receive Mondaq News Alerts, users have to complete a separate registration form. This is a personalised service where users choose regions and topics of interest and we send it only to those users who have requested it. Users can stop receiving these Alerts by going to the Mondaq News Alerts page and deselecting all interest areas. In the same way users can amend their personal preferences to add or remove subject areas.


A cookie is a small text file written to a user’s hard drive that contains an identifying user number. The cookies do not contain any personal information about users. We use the cookie so users do not have to log in every time they use the service and the cookie will automatically expire if you do not visit the Mondaq website (or its affiliate sites) for 12 months. We also use the cookie to personalise a user's experience of the site (for example to show information specific to a user's region). As the Mondaq sites are fully personalised and cookies are essential to its core technology the site will function unpredictably with browsers that do not support cookies - or where cookies are disabled (in these circumstances we advise you to attempt to locate the information you require elsewhere on the web). However if you are concerned about the presence of a Mondaq cookie on your machine you can also choose to expire the cookie immediately (remove it) by selecting the 'Log Off' menu option as the last thing you do when you use the site.

Some of our business partners may use cookies on our site (for example, advertisers). However, we have no access to or control over these cookies and we are not aware of any at present that do so.

Log Files

We use IP addresses to analyse trends, administer the site, track movement, and gather broad demographic information for aggregate use. IP addresses are not linked to personally identifiable information.


This web site contains links to other sites. Please be aware that Mondaq (or its affiliate sites) are not responsible for the privacy practices of such other sites. We encourage our users to be aware when they leave our site and to read the privacy statements of these third party sites. This privacy statement applies solely to information collected by this Web site.

Surveys & Contests

From time-to-time our site requests information from users via surveys or contests. Participation in these surveys or contests is completely voluntary and the user therefore has a choice whether or not to disclose any information requested. Information requested may include contact information (such as name and delivery address), and demographic information (such as postcode, age level). Contact information will be used to notify the winners and award prizes. Survey information will be used for purposes of monitoring or improving the functionality of the site.


If a user elects to use our referral service for informing a friend about our site, we ask them for the friend’s name and email address. Mondaq stores this information and may contact the friend to invite them to register with Mondaq, but they will not be contacted more than once. The friend may contact Mondaq to request the removal of this information from our database.


This website takes every reasonable precaution to protect our users’ information. When users submit sensitive information via the website, your information is protected using firewalls and other security technology. If you have any questions about the security at our website, you can send an email to webmaster@mondaq.com.

Correcting/Updating Personal Information

If a user’s personally identifiable information changes (such as postcode), or if a user no longer desires our service, we will endeavour to provide a way to correct, update or remove that user’s personal data provided to us. This can usually be done at the “Your Profile” page or by sending an email to EditorialAdvisor@mondaq.com.

Notification of Changes

If we decide to change our Terms & Conditions or Privacy Policy, we will post those changes on our site so our users are always aware of what information we collect, how we use it, and under what circumstances, if any, we disclose it. If at any point we decide to use personally identifiable information in a manner different from that stated at the time it was collected, we will notify users by way of an email. Users will have a choice as to whether or not we use their information in this different manner. We will use information in accordance with the privacy policy under which the information was collected.

How to contact Mondaq

You can contact us with comments or queries at enquiries@mondaq.com.

If for some reason you believe Mondaq Ltd. has not adhered to these principles, please notify us by e-mail at problems@mondaq.com and we will use commercially reasonable efforts to determine and correct the problem promptly.