United States: Commodities Traders, Know Thyself: Are You A Pool Or Prop Shop?

Do you trade commodity futures, options or swaps with a partner or a group of partners? If so, you need to know if your business model is properly described as a commodity pool or as a proprietary trading firm. The answer is not always clear and the regulatory guidance is very limited. The answer is important in determining whether your business is subject to CFTC and NFA registration and regulatory requirements. It's also important because your clearing broker will want to know who its customer is, and may refuse to hold your account if the clearing broker  believes you are a pool operator that has failed to register (or claim an applicable exemption).

By way of example, assume John and Jane are both employed as traders for Oldco. They decide to open their own trading shop, Newco. Their budget is tight but John's Dad has a deep pocket, and he offers to bankroll Newco by investing $1 million. John and Jane agree to handle all of the trading decisions. John, Dad, and Jane each own one-third of Newco and will share profits equally. Leaving aside registration exemptions that might be available, what is the nature of this enterprise: Is it a commodity pool or a proprietary trading firm?

CFTC Rule 4.10(d)(1) defines "pool" as "any investment trust, syndicate or similar form of enterprise operated for the purpose of trading commodity interests." (Italics added). The regulations do not define "investment trust" or "syndicate." However, an "investment trust" may be defined as a closed-end fund established to produce income through investments." Webster's describes "syndicate" as "a group of persons ... who combine to carry out a particular transaction." To most lawyers, in common usage, reference to a "pool" or a "fund" speak to an investment vehicle in which (a) an ongoing offering (typically private) occurs, (b) investors have liquidity in and out, (c) the investment is passive insofar as someone else runs the pool and the investor merely writes a check, and (d) whoever is running the pool receives fees from the investors. In contrast, the typical proprietary trading firm is a closely-held business that engages in speculative trading for its own account. It does not manage money for outsiders and does not act as an advisor in any capacity. Its business model is P&L driven, not fee driven.

Unfortunately, the ostensible clarity of the regulatory definition of "pool" is sometimes stretched by regulators in practice. In the context of routine regulatory exams and NFA Bylaw 1101 compliance, some futures commission merchants have reported regulatory insistence that any account beneficially owned by more than person must be treated as a "pool" unless there are two owners who are married. We respectfully disagree. The definition of "pool" does not state that a pool is any business that is owned by two or more people and trades commodity futures. If that were the case, one can imagine that the definition in Rule 4.10(d)(1) would simply be "A combination of two or more persons who trade commodity interests." Instead, the phrase "or similar form of enterprise" clearly signifies that the business model must look like an "investment trust" or "syndicate" to fall within the definition of "pool."

Prop shop or pool?

Here are several key considerations that could impact whether your trading firm is a "prop shop" or a pool:

  1. Pools need investors to operate. Accordingly, in the typical pool, there is an ongoing solicitation of investors. If this is true for your business?  If so, it is likely it is a pool absent other unusual facts.
  2. Are the people who contributed capital to your enterprise involved in management decisions or trading decisions? If not, it looks like a purely passive investment by the investor, which speaks to a pool.
  3. The typical pool holds itself as such because it needs to promote itself in order to attract new investors, grow its assets under management, and earn more fees. The business model of prop shops, on the other hand, is not fee-based. As such, they do not need to promote themselves because they don't need to grow their investor base. Typically they only promote themselves in order to attract new hires.
  4. Investment lock-ups are not commonplace in commodity pools, where investors typically expect liquidity. How easy is it for the beneficial owners of the enterprise to withdraw their investments? The greater the liquidity, the more likely a pool.
  5. In the typical pool or investment offering, the business model for the organizers is to profit through management fees or incentive fees. Are any fees being paid in your enterprise, or are the beneficial owners simply dividing the net trading profits?
  6. On several occasions, through Interpretive Letters, the CFTC has expressed the view that certain "small pool" enterprises would not be treated as pools. An example is a general partnership consisting of four friends and business associates, all of whom were trading industry professionals, and all were involved in defining the partnership's activities. None were statutorily disqualified. (CFTC Interpretive Letter 94-26). This is sometimes informally referred to as the "small pool" exception, but it is not codified.  

Returning now to our hypothetical start-up, a starting point for analysis is whether Dad is merely a passive investor, or whether he is involved in management of the company. Let's break it down:

  • The more involved Dad is, the better (assuming we want this enterprise to operate as a prop shop). We know that John and Jane do the trading but Dad may be involved in the decision-making process for the company's operations.
  • Second, have John and Jane promised Dad any liquidity? Can he take his money out at any time? If not, Dad looks more like the third partner in Newco who is merely contributing capital, and less like a traditional investor in a pooled investment vehicle.
  • Third, are John and Jane collecting any fees for making trading decisions before the net profit is divided into thirds? Fees are traditionally something collected by sponsors of pools, not by owners of prop trading firms.

If you have any questions about how to structure your trading operations, it's best to consult with an attorney well versed in the legal and regulatory aspects of the financial markets. 

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.

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.

Authors
 
In association with
Related Topics
 
Related Articles
 
Related Video
Up-coming Events Search
Tools
Print
Font Size:
Translation
Channels
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
Password
Confirm Password
Position
Mondaq Topics -- Select your Interests
 Accounting
 Anti-trust
 Commercial
 Compliance
 Consumer
 Criminal
 Employment
 Energy
 Environment
 Family
 Finance
 Government
 Healthcare
 Immigration
 Insolvency
 Insurance
 International
 IP
 Law Performance
 Law Practice
 Litigation
 Media & IT
 Privacy
 Real Estate
 Strategy
 Tax
 Technology
 Transport
 Wealth Mgt
Regions
Africa
Asia
Asia Pacific
Australasia
Canada
Caribbean
Europe
European Union
Latin America
Middle East
U.K.
United States
Worldwide Updates
Registration (you must scroll down to set your data preferences)

Mondaq Ltd requires you to register and provide information that personally identifies you, including your content preferences, for three primary purposes (full details of Mondaq’s use of your personal data can be found in our Privacy and Cookies Notice):

  • To allow you to personalize the Mondaq websites you are visiting to show content ("Content") relevant to your interests.
  • To enable features such as password reminder, news alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our content providers ("Contributors") who contribute Content for free for your use.

Mondaq hopes that our registered users will support us in maintaining our free to view business model by consenting to our use of your personal data as described below.

Mondaq has a "free to view" business model. Our services are paid for by Contributors in exchange for Mondaq providing them with access to information about who accesses their content. Once personal data is transferred to our Contributors they become a data controller of this personal data. They use it to measure the response that their articles are receiving, as a form of market research. They may also use it to provide Mondaq users with information about their products and services.

Details of each Contributor to which your personal data will be transferred is clearly stated within the Content that you access. For full details of how this Contributor will use your personal data, you should review the Contributor’s own Privacy Notice.

Please indicate your preference below:

Yes, I am happy to support Mondaq in maintaining its free to view business model by agreeing to allow Mondaq to share my personal data with Contributors whose Content I access
No, I do not want Mondaq to share my personal data with Contributors

Also please let us know whether you are happy to receive communications promoting products and services offered by Mondaq:

Yes, I am happy to received promotional communications from Mondaq
No, please do not send me promotional communications from Mondaq
Terms & Conditions

Mondaq.com (the Website) is owned and managed by Mondaq Ltd (Mondaq). Mondaq grants you a non-exclusive, revocable licence to access the Website and associated services, such as the Mondaq News Alerts (Services), subject to and in consideration of your compliance with the following terms and conditions of use (Terms). Your use of the Website and/or Services constitutes your agreement to the Terms. Mondaq may terminate your use of the Website and Services if you are in breach of these Terms or if Mondaq decides to terminate the licence granted hereunder for any reason whatsoever.

Use of www.mondaq.com

To Use Mondaq.com you must be: eighteen (18) years old or over; legally capable of entering into binding contracts; and not in any way prohibited by the applicable law to enter into these Terms in the jurisdiction which you are currently located.

You may use the Website as an unregistered user, however, you are required to register as a user if you wish to read the full text of the Content or to receive the Services.

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 or with the prior written consent of Mondaq. You may not use electronic or other means to extract details or information from the Content. Nor shall you extract information about users or Contributors in order to offer them any services or products.

In your use of the Website and/or Services you shall: comply with all applicable laws, regulations, directives and legislations which apply to your Use of the Website and/or Services in whatever country you are physically located including without limitation any and all consumer law, export control laws and regulations; provide to us true, correct and accurate information and promptly inform us in the event that any information that you have provided to us changes or becomes inaccurate; notify Mondaq immediately of any circumstances where you have reason to believe that any Intellectual Property Rights or any other rights of any third party may have been infringed; co-operate with reasonable security or other checks or requests for information made by Mondaq from time to time; and at all times be fully liable for the breach of any of these Terms by a third party using your login details to access the Website and/or Services

however, you shall not: do anything likely to impair, interfere with or damage or cause harm or distress to any persons, or the network; do anything that will infringe any Intellectual Property Rights or other rights of Mondaq or any third party; or use the Website, Services and/or Content otherwise than in accordance with these Terms; use any trade marks or service marks of Mondaq or the Contributors, or do anything which may be seen to take unfair advantage of the reputation and goodwill of Mondaq or the Contributors, or the Website, Services and/or Content.

Mondaq reserves the right, in its sole discretion, to take any action that it deems necessary and appropriate in the event it considers that there is a breach or threatened breach of the Terms.

Mondaq’s Rights and Obligations

Unless otherwise expressly set out to the contrary, nothing in these Terms shall serve to transfer from Mondaq to you, any Intellectual Property Rights owned by and/or licensed to Mondaq and all rights, title and interest in and to such Intellectual Property Rights will remain exclusively with Mondaq and/or its licensors.

Mondaq shall use its reasonable endeavours to make the Website and Services available to you at all times, but we cannot guarantee an uninterrupted and fault free service.

Mondaq reserves the right to make changes to the services and/or the Website or part thereof, from time to time, and we may add, remove, modify and/or vary any elements of features and functionalities of the Website or the services.

Mondaq also reserves the right from time to time to monitor your Use of the Website and/or services.

Disclaimer

The Content is general information only. It is not intended to constitute legal advice or seek to be the complete and comprehensive statement of the law, nor is it intended to address your specific requirements or provide advice on which reliance should be placed. Mondaq and/or its Contributors and other suppliers make no representations about the suitability of the information contained in the Content for any purpose. All Content provided "as is" without warranty of any kind. Mondaq and/or its Contributors and other suppliers hereby exclude and disclaim all representations, warranties or guarantees with regard to the Content, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. To the maximum extent permitted by law, Mondaq expressly excludes all representations, warranties, obligations, and liabilities arising out of or in connection with all Content. In no event shall Mondaq 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 of the Content or performance of Mondaq’s Services.

General

Mondaq may alter or amend these Terms by amending them on the Website. By continuing to Use the Services and/or the Website after such amendment, you will be deemed to have accepted any amendment to these Terms.

These Terms shall be governed by and construed in accordance with the laws of England and Wales and you irrevocably submit to the exclusive jurisdiction of the courts of England and Wales to settle any dispute which may arise out of or in connection with these Terms. If you live outside the United Kingdom, English law shall apply only to the extent that English law shall not deprive you of any legal protection accorded in accordance with the law of the place where you are habitually resident ("Local Law"). In the event English law deprives you of any legal protection which is accorded to you under Local Law, then these terms shall be governed by Local Law and any dispute or claim arising out of or in connection with these Terms shall be subject to the non-exclusive jurisdiction of the courts where you are habitually resident.

You may print and keep a copy of these Terms, which form the entire agreement between you and Mondaq and supersede any other communications or advertising in respect of the Service and/or the Website.

No delay in exercising or non-exercise by you and/or Mondaq of any of its rights under or in connection with these Terms shall operate as a waiver or release of each of your or Mondaq’s right. Rather, any such waiver or release must be specifically granted in writing signed by the party granting it.

If any part of these Terms is held unenforceable, that part shall be enforced to the maximum extent permissible so as to give effect to the intent of the parties, and the Terms shall continue in full force and effect.

Mondaq shall not incur any liability to you on account of any loss or damage resulting from any delay or failure to perform all or any part of these Terms if such delay or failure is caused, in whole or in part, by events, occurrences, or causes beyond the control of Mondaq. Such events, occurrences or causes will include, without limitation, acts of God, strikes, lockouts, server and network failure, riots, acts of war, earthquakes, fire and explosions.

By clicking Register you state you have read and agree to our Terms and Conditions