United States: Recent CFTC And SEC Actions Impacting Private Fund Managers

This private funds alert summarizes (i) a recent relief letter issued by the CFTC harmonizing certain of its commodity pool operator (CPO) registration exemptions with recently issued rules by the SEC under the JOBS Act, and (ii) recent enforcement actions by the SEC against numerous financial firms for violating the Rule 105 proscription against short selling within the restricted period before a public offering.

CFTC Issues Exemptive Relief to CPOs Consistent with the SEC's Adoption of Rule 506(c) under the JOBS Act

In a letter dated September 9, 2014, the CFTC granted exemptive relief permitting CPOs who rely on CFTC Regulation 4.7(b) or 4.13(b) to engage in general solicitation or general advertising under certain circumstances. The CFTC letter was issued in response to the SEC's amendments to Rule 506, which implemented the JOBS Act provisions permitting general solicitation or general advertising in private offerings under Regulation D.  Until now, certain CPOs exempt under the foregoing CFTC regulations could not take advantage of the newly liberalized marketing rules under Regulation D without jeopardizing their exempt status with the CFTC.


Regulation 4.13(b) provides a registration exemption for CPOs who operate pools engaged in a de minimis amount of futures trading and which meet certain other conditions, including that the interests in each pool for which the CPO claims the exemption be exempt from registration under the Securities Act and be offered and sold without marketing to the public.

Regulation 4.7(b) provides relief to certain registered CPOs from certain CFTC disclosure, periodic and annual reporting and record keeping requirements, provided that the registered CPO offers or sells interests in a pool solely to qualified eligible persons (i.e., persons who meet certain financial thresholds) and the offering is exempt from registration under the Securities Act pursuant to Section 4(a)(2) or Regulation S.  Similar to the requirement under Regulation 4.13(b), the exemption under Regulation 4.7(b) is only available if the interests are offered and sold without marketing to the public.

Rule 506(c), which was adopted by the SEC to implement the JOBS Act, generally permits an issuer to engage in general solicitation or general advertising in offering and selling securities pursuant to Rule 506 provided that the issuer takes reasonable steps to ensure that all purchasers are accredited investors. Until now, a fund manager who is also a CPO relying on the exemption under Regulation 4.7(b) or 4.13(b), could not take advantage of Rule 506(c)'s allowance of general solicitation or general advertising in connection with the fund's marketing activities because such activities may violate the Regulation 4.7(b) or 4.13(b) requirement that the fund interests be offered and sold without marketing to the public. In addition, a fund manager who is also a CPO relying on the Regulation 4.7(b) exemption might be ineligible to rely on Rule 506(c) because the exemption provided by Rule 506(c) is not an exemption pursuant to Section 4(a)(2) of the Securities Act, which is one of the requirements under Regulation 4.7(b).

Exemptive Relief

Based on the foregoing, the CFTC granted exemptive relief from the requirement (i) under Regulation 4.7(b) that an offering be exempt pursuant to Section 4(a)(2) of the Securities Act and (ii) under both Regulations 4.7(b) and 4.13(b) that securities be offered and sold without marketing to the public. However, the CFTC noted that this relief is not self-executing.  CPOs relying on the new exemptive relief must file a notice with the CFTC providing certain basic identifying information with respect to the CPO and the pool for which the claim is being filed. Although the CFTC letter provides important temporary exemptive relief which harmonizes the CFTC's regulations with the SEC's adoption of Rule 506(c), it is important to note that this CFTC exemptive relief will be superseded by any final rulemaking by the CFTC in this area which may modify or revise the terms and conditions set forth in the current CFTC exemptive letter.

Overall, the recent action by the CFTC provides much needed clarity to hedge fund managers who trade futures in their funds and wish to engage in general solicitation or general advertising under SEC Rule 506(c) in connection with the fund's marketing activities without jeopardizing the manager's exempt status under CFTC regulations.

SEC's Ongoing Rule 105 Initiative

On September 16, 2009, the SEC announced its latest sanctions against 19 financial firms and one individual trader in a continuing enforcement initiative targeting violations of Rule 105 which prohibits short selling within the restricted period in advance of a follow-on public equity offering. Rule 105 of Regulation M was designed to preserve the independent pricing mechanisms of the securities markets and to prevent stock price manipulation by individuals with an interest in the outcome of an offering.

Specifically, Rule 105 prohibits any person that has sold short a security that is the subject of a registered offering from purchasing securities in the offering from an underwriter, broker or dealer participating in the offering if the short sale took place during a specified period prior to the pricing of the offered securities.  Such period begins on the later of the fifth business day before pricing or the initial filing of the registration statement and ends with the pricing of the securities. The SEC has emphasized that Rule 105 is a strict liability regulation in that a person need not act with scienter to violate the rule and that no violation is too small to warrant attention. Since the SEC launched its recent crackdown on Rule 105 violations, it has brought dozens of actions against firms and individuals and collected millions in disgorgement, interest and penalties.

The SEC's recent investigations found that 19 firms and one individual trader engaged in illegal short selling of particular stocks shortly before they bought shares in a follow-on public offering.  The SEC announced that each firm and the individual trader have agreed to settle the charges and pay a combined total of more than $9 million in disgorgement, interest and penalties, including agreements by certain firms to pay over $1 million in disgorgement. Just a year ago, the SEC charged 23 firms with short selling violations resulting in more than $14.4 million in monetary sanctions, including disgorgement amounts ranging from $8,000 by one firm to over $1 million by several other firms.

In view of the SEC's continuing focus on Rule 105 violations, fund managers would be wise to adopt strong compliance policies in this area. This should involve oversight of any fund participation in follow-on equity offerings to ensure that the fund has not engaged in any short sales within the relevant restricted period before such offering.  In this area, there is no defense for good intentions if you make a mistake.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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