Proposed Exemptions from Commodity Pool Operator and Commodity Trading Advisor Registration

In general, unless exempt an operator of an investment pool (including private investment funds) that trades futures contracts or options on futures ("financial commodities") must be registered with the CFTC as a commodity pool operator ("CPO") and/or a commodity trading advisor ("CTA").

The Commodity Futures Trading Commission (the "CFTC") recently proposed new exemptions from registration as CPO and CTA aimed at persons who engage in limited financial commodity trading activities.¹ The CFTC is also providing temporary immediately available no-action relief from CPO and CTA registration for persons who meet specified criteria pending final action on the proposed exemptions. The CFTC must receive comments on its proposals by January 13, 2003.

Certain exemptions from the CPO registration requirement already exist. For example, CFTC Rule 4.13 exempts operators of small pools that do not advertise the pool or receive compensation for operating the pool. CFTC Rule 4.5 exempts persons operating certain types of "qualifying" pools (including registered mutual funds, but excluding private investment funds) who limit their use of financial commodities (other than for bona fide hedging purposes) to five percent of the liquidation value of the pool’s portfolio.

The National Futures Association (the "NFA") has proposed that the CFTC adopt new CPO and CTA registration exemptions.

CPO Exemption. Under the NFA’ s proposal, a person would not be required to register as a CPO if:

• the pool’s use of financial commodities (other than solely for bona fide hedging purposes) is limited to no more than 5% of the pool’s liquidation value;
• the pool is not marketed to the public as a commodity pool;
• the pool limits participation to "accredited investors," as defined in Regulation D under the Securities Act of 1933 (the "Securities Act");
• the purpose and scope of the pool’s financial commodity trading is disclosed to each prospective pool participant;
• the operator submits to calls by the CFTC to demonstrate its compliance with the exemption; and
• the operator maintains its exempt pool related books and records for five years.

A person exempt from registration under this proposal would need to deliver a written disclosure regarding the exemption to prospective participants in the pool before soliciting or accepting funds, securities or property. The operator must also file this disclosure with the CFTC and the NFA.

CTA Exemption. The NFA has also proposed a corresponding registration exemption for CTAs. As proposed, a person need not register as a CTA if the commodity trading advice:

• is directed solely to commodity pools operated by a person exempt from registration as a CPO as described above;
• is solely incidental to the person’s business of providing investment advice regarding instruments that are either exempt or excluded from CFTC regulation (e.g., securities); and
• is consistent with the pool’s exempt status under the above described CPO exemption.

In addition, the person seeking the exemption must not hold itself out as a CTA, must submit to CFTC calls to provide information, and must file a notice of exemption with the CFTC.

CPO Exemption. The Managed Funds Association (the "MFA") has proposed an exemption applicable to pool operators that limit participation in pools to "qualified eligible persons," as defined in the Commodity Exchange Act (the "Act"), and to certain "accredited investors," as defined in Regulation D under the Securities Act. The exemption would apply to persons who:

• operate pools that are exempt from registration under the Securities Act and that are not marketed to the public in the U. S.;
• reasonably believe that all individual pool participants (i.e., natural persons) are "qualified eligible persons";
• reasonably believe that all entity pool participants are qualified eligible persons or accredited investors; and
• are not subject to certain disqualifications.

Under the proposed exemption, the pool operator would remain subject to the Act’s anti-fraud and anti-manipulation provisions, and the operator must deliver to pool participants certified year-end financial statements within 180 days after the end of each fiscal year. The operator would also be required to file these statements and a notice of eligibility with the CFTC, and must submit to calls by the CFTC to demonstrate compliance.

The MFA proposal does not include a corresponding exemption for registration as a CTA.

The CFTC has issued temporary, immediately available, no-action exemptive relief from CPO and CTA registration while the proposed exemptions are under review. To claim this relief, an operator or adviser must file a claim notice with the CFTC and the NFA and disclose the claim to its prospective and existing pool participants. Materially complete claims will be effective upon filing. The no-action relief appears to apply only with respect to investment pools and not to separately managed accounts.

CPO Registration No-Action Relief. The CFTC will not commence enforcement action for failure to register as a CPO if:

• participation in the pool is restricted to accredited investors, as defined in Regulation D under the Securities Act, knowledgeable employees, as defined in the Investment Company Act of 1940, non-U.S. persons, as defined under the Act, and the operator and adviser and their affiliates and employees; and
• the aggregate notional value of the pool’s commodity interest positions, whether or not entered into for bona fide hedging purposes, does not exceed 50% of the liquidation value of the pool’s portfolio.

CTA Registration No-Action Relief. The CFTC will not commence enforcement action for failure to register as a CTA if the adviser:

• claims no-action relief from CPO registration and its commodity trading advice is directed solely to pools it operates; or
• is registered as an investment adviser with the SEC or with a state securities regulatory agency, or it is exempt from such registration, so long as the adviser does not hold itself out as a CTA, and the adviser’s commodity interest trading advice:

Persons who have filed an effective claim of no-action relief will remain subject to the Act’s prohibitions against fraud. Any final action taken by the CFTC on the proposed exemptions will supersede this no-action relief, and persons relying on the no action relief will have a "sufficient" period of time either to comply with the final exemption provisions, or register as a CPO and/or CTA.