CFTC Adopts Harmonization Rules for Registered Fund Advisers that are Commodity Pool Operators
[27469]
August 15, 2013
TO: ACCOUNTING/TREASURERS COMMITTEE No. 23-13BOARD OF GOVERNORS No. 12-13
CLOSED-END INVESTMENT COMPANY MEMBERS No. 69-13
COMPLIANCE MEMBERS No. 32-13
DERIVATIVES MARKETS ADVISORY COMMITTEE No. 60-13
ETF (EXCHANGE-TRADED FUNDS) COMMITTEE No. 32-13
ETF ADVISORY COMMITTEE No. 33-13
FIXED-INCOME ADVISORY COMMITTEE No. 21-13
ICI GLOBAL MEMBERS
INTERNATIONAL MEMBERS No. 36-13
INVESTMENT ADVISER MEMBERS No. 57-13
INVESTMENT COMPANY DIRECTORS No. 15-13
OPERATIONS MEMBERS No. 17-13
SEC RULES MEMBERS No. 75-13
SMALL FUNDS MEMBERS No. 45-13
TRANSFER AGENT ADVISORY COMMITTEE No. 61-13
UNIT INVESTMENT TRUST MEMBERS No. 17-13
VARIABLE INSURANCE PRODUCTS ADVISORY COMMITTEE No. 17-13 RE: CFTC ADOPTS HARMONIZATION RULES FOR REGISTERED FUND ADVISERS THAT ARE COMMODITY POOL OPERATORS
On August 13, 2013, the Commodity Futures Trading Commission (“CFTC” or “Commission”) adopted final rules (“Final Rules”) with respect to the compliance obligations of advisers to registered investment companies (“registered funds”) that are required to register as commodity pool operators (“CPOs”) due to the CFTC’s amendments to Rule 4.5 under the Commodity Exchange Act (“CEA”). [1] The Final Rules, which are summarized below, permit registered fund CPOs to satisfy most of the compliance obligations imposed on CPOs under the CEA by:
(1) filing a notice of exemption with the National Futures Association (“NFA”); (2) complying with applicable requirements imposed by the Securities and Exchange Commission (“SEC”) under the federal securities laws; and (3) satisfying several conditions imposed by the CFTC under the Final Rules. [2] To ensure accuracy, we have used the exact language from the Adopting Release in several places throughout this memorandum.
In addition, as further discussed below, the NFA deferred compliance with certain of its rules applicable to CPOs until the compliance date of the Final Rules. Registered fund CPOs therefore should expect to have to comply with those NFA rules shortly.
We will hold a conference call next week to discuss the Final Rules and their implications for registered fund CPOs and commodity trading advisors (“CTAs”). The call will be open to ICI members only. More information will be forthcoming.
Disclosure Requirements
The Commission amended Rule 4.12 under the CEA to exempt registered fund CPOs from certain compliance obligations otherwise applicable to CPOs. [3] In order to take advantage of this relief, a registered fund CPO must file a claim of exemption with the NFA as described in paragraph (d) of the rule as amended. A registered fund CPO relying on paragraph (c) of Rule 4.12 as amended will be exempt from the requirements of Rules 4.21 (delivery of disclosure document), 4.24 (disclosure requirements), 4.25 (performance disclosure), and 4.26 (use, amendment and filing of disclosure document) under the CEA, provided that:
- The pool operator of an offered pool with less than a three-year operating history discloses the performance of all accounts and pools that are managed by the pool operator and that have investment objectives, policies, and strategies substantially similar to those of the offered pool; and
- The disclosure provided with respect to the offered pool complies with the provisions of the Investment Company Act, the Securities Act, the Securities Exchange Act of 1934 (“Exchange Act”), the regulations promulgated thereunder, and any guidance issued by the SEC or any division thereof.
These and related requirements are described in more detail below.
Updating Requirements
The Final Rules extend to twelve months, from nine months, the disclosure document update cycle requirement for all CPOs. [4] The CFTC declined to adopt a sixteen-month update period for disclosure documents, but recognized that not doing so could create inconsistencies and inefficiencies for CPOs of registered funds. [5] To address that concern, the Commission will deem CPOs of open-end registered funds to have complied with their obligation under Rule 4.26 under the CEA if they update fund registration statements in accordance with the SEC’s sixteen-month timeframe.
The CFTC will also deem CPOs of registered funds that comply with the updating rules under the “SEC RIC Rules” [6] with respect to material inaccuracies to have satisfied the requirements of Rule 4.26(c) under the CEA. Without this relief, Rule 4.26(c) would otherwise require a CPO to correct material inaccuracies in a disclosure document within twenty-one days of the date upon which the CPO first becomes aware of the defect.
Filing and Review
The CFTC will not require CPOs of registered funds to file their disclosure documents with the NFA for review, although those documents must be made available to NFA during the course of an examination. The Commission states that it will deem CPOs of registered funds that are in compliance with the filing and review regime administered by the SEC under the SEC RIC Rules to be in compliance with Rule 4.26 under the CEA.
Prospectus Delivery Obligations
Rule 4.21 under the CEA requires a CPO to deliver a disclosure document to each prospective participant in a commodity pool, and obtain from that participant a signed acknowledgment of receipt of the disclosure document before accepting or receiving funds from that participant. The Commission states that it will deem registered fund CPOs to be in compliance with Rule 4.21 if the CPO complies with the disclosure delivery requirements under the SEC RIC Rules. The Commission also rescinded the signed acknowledgement requirement under Rule 4.21(b) for all CPOs.
The Adopting Release addresses the ability of registered funds to use the summary prospectus. It explains that the SEC’s RIC Rules permit open-end registered funds to provide investors or prospective investors with a summary prospectus, provided that the statutory prospectus and other information are available on a website, the address of which is provided on the cover page or at the beginning of the summary prospectus. The Commission confirms that registered funds may continue to use the summary prospectus in its current form without modification. The Commission will deem CPOs of registered funds to be in compliance with Rules 4.24 and 4.25 under the CEA, which specify the disclosure obligations for CPOs, if these funds are in compliance with the SEC RIC Rules. The Adopting Release states that any website permitted under the SEC’s RIC Rules also will be deemed to comply with Rule 4.21.
The Adopting Release specifically addresses the disclosure delivery obligations related to closed-end funds, noting that CPOs are not required to maintain a current disclosure document for a pool if they are not soliciting participants for that pool. The Commission will deem a closed-end fund CPO to be in compliance with Rule 4.21 if it meets its obligations under the SEC RIC Rules.
Risk Disclosures
Rule 4.24(a) and (b) under the CEA require that a cautionary statement and specific risk disclosure language must be included in a CPO’s disclosure document. The Proposal would have required that, instead of the required cautionary statement, the cover page of a registered fund’s prospectus be required to include a statement combining the language required by Rule 4.24 with the language required by Rule 481(b)(1) under the Securities Act.
Instead, the CFTC will permit registered funds to use the cautionary statement permitted by Rule 481(b)(1) with minor modifications, as specified in the Adopting Release. [7] The Commission also acknowledges that the standard risk disclosure statement required by Rule 4.24(b) under the CEA may not be appropriate for registered funds and thus determined not to require it. The Commission therefore will deem CPOs of registered funds to be in compliance with the requirements of Rule 4.24(a) and (b) provided that the CPO complies with the related regime administered by the SEC pursuant to the SEC RIC Rules, including the disclosure requirements in Section 10 of the Securities Act, other provisions of the Securities Act, the Investment Company Act, Rule 498 under the Securities Act, and Forms N-1A and N-2 (and use of the modified statement as outlined above and in footnote 7).
Rule 4.24(g) under the CEA requires a discussion in a pool’s disclosure document of the principal risk factors of participation in the offered pool. The Commission will permit CPOs of registered funds to satisfy this obligation through substituted compliance. It states that the disclosure requirements on Forms N-1A and N-2, along with guidance from the SEC staff, including the 2010 letter from the Division of Investment Management regarding disclosure about derivatives, [8] should satisfy the Commission’s concern that participants receive complete and accurate disclosure about the risks associated with investment in commodity interests. The Commission also notes that CPOs of registered funds must comply with any applicable SEC guidance that may be issued in the future regarding these disclosure requirements, “which the Commission will evaluate for consistency with its own regulatory interests.” The Adopting Release states that the SEC’s Division of Investment Management intends to issue additional guidance to registered funds (and in fact the Division issued such guidance on the same day the Commission issued the Adopting Release). [9]
Break-Even Point and Fee Disclosure
The Proposal would have required CPOs of registered funds to include in a fund’s prospectus information about the break-even point for an investment, as required by Rule 4.24(d)(5) under the CEA. The Commission concluded that the disclosure required by the SEC regarding fees and costs achieves the same purposes as the break-even point analysis and therefore will deem CPOs of registered funds to be in compliance with the requirements under Rule 4.24(d)(5) if they are in compliance with the SEC RIC Rules.
The Final Rules also provide relief to CPOs of registered funds from all other provisions of Rule 4.24, including the fee disclosure requirements of Rule 4.24(i).
Performance Disclosure
Rules 4.24(n) and 4.25 under the CEA require a significant amount of disclosure regarding a pool’s past and current performance. Among other things, the Proposal would have required that a CPO to a registered fund with less than a three year operating history disclose the past performance of each other pool and account it has operated, as required by Rule 4.25(c) under the CEA. As ICI and other commenters noted, such disclosure would be inconsistent with well-established positions of the SEC staff. The Commission determined, in light of comments received, to deem CPOs of registered funds with less than three years of performance history to be in compliance with Rule 4.25(c), provided that the CPO 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 fund. [10]
The Adopting Release states that the Commission will deem CPOs of registered funds to be in compliance with the remainder of Rule 4.25, to the extent that these CPOs comply with applicable SEC rules. In taking this position, the Commission explains that, other than in the case of funds with limited performance history, the SEC rules generally achieve the same disclosure objectives as those of the CFTC.
Series Companies
The Adopting Release also addresses the unique characteristics of registered funds organized in series form. [11] The Commission states that, under its rules, the pool is considered to be the discrete legal entity, and therefore the Commission’s rules require that filings be prepared at the legal entity level, rather than the series level. The Commission acknowledges, however, that registered funds may be organized as series entities, and that the SEC permits reporting and disclosure to be provided on a series by series basis. The Commission recognizes that under part 4 of its regulations, registered funds “would be required to undertake substantial efforts to reorganize their filings to comply with both regimes.” It therefore agrees that such funds may continue to be able to make such filings consistent with SEC guidance on series companies.
Controlled Foreign Corporations
In the Adopting Release, the Commission reaffirms that registered funds may continue to use controlled foreign corporations (“CFCs”) to invest in commodity interests, and such CFCs “depending on their investment activities, may fall within the statutory and regulatory definitions of ‘commodity pool.’” The Commission states, however, that if a registered fund provides full disclosure of material information about the activities of its CFC as required by the SEC, the CFC is not required to separately prepare a disclosure document that complies with part 4 of the Commission’s regulations. The Commission further states that, if the registered fund consolidates the financial statements of the CFC with those of the registered fund in the financial statements that are filed by the registered fund with the NFA, the CFC is not required to file separate financial statements. According to the Adopting Release, the Commission “does not believe that additional relief pertaining to CFCs is necessary.”
Periodic Reports
The Proposal would have required CPOs of registered funds to meet the monthly account statement requirement of Rule 4.22 under the CEA, but would have permitted registered fund CPOs to satisfy the distribution requirements under the rule by posting the account statements on the fund’s website. Amended Rule 4.12(c) provides that a registered fund CPO will be exempt from the account statement distribution requirement of Rule 4.22(a) and (b) provided that the pool operator:
- (A) causes the current net asset value per share to be available to participants;
- (B) causes the pool to clearly disclose:
- that the information will be readily accessible on an Internet Web site maintained by the pool operator or its designee or otherwise made available to participants and the means through which the information will be made available; and
- the Internet address of such Web site, if applicable.
It does not appear that the Commission provided relief from the annual report requirements of Rule 4.22(c) under the CEA. The Commission also did not provide any relief from the periodic regulatory reporting requirements of Rule 4.27 under the CEA, which require that reports be filed on Forms CPO-PQR and CTA-PR.
Books and Records
The Final Rules permit the use of certain third-party recordkeepers to maintain a CPO’s books and records. [12] Specifically, a CPO that does not maintain books and records at its main business office may instead maintain such books and records with the pool’s administrator, distributor or custodian, or a bank or registered broker or dealer acting in a similar capacity with respect to the pool, subject to certain conditions. [13] Among other things, the CPO must file a statement with the Commission describing the third-party recordkeeper and representing that the CPO will (i) remain responsible for ensuring that all books and records are kept in accordance with Rule 1.31 under the CEA and (ii) obtain its original books and records for inspection at its main business office upon request from a Commission representative. The CPO also must file electronically with the NFA a statement containing certain representations from each person who will be keeping books and records on behalf of the CPO.
It appears, however, that the Commission did not grant relief from the requirement to maintain books and records in accordance with the provisions of Rule 4.23.
The Commission responded to concerns raised by ICI and others regarding the requirement under Rule 4.23 under the CEA that investors be provided access to a CPO’s books and records. The Commission acknowledged that this requirement could raise selective disclosure concerns for a registered fund CPO, and accordingly exempted registered fund CPOs from that requirement.
The Commission also recognized the practice of many registered funds to hold shares in omnibus accounts, and stated that “[b]ecause a subsidiary ledger of largely the form and substance required by the Commission is kept by those transfer agents and financial intermediaries, the Commission agrees that in such instances, the maintenance of these records by a transfer agent or financial intermediary, in such form that complies with that as set forth by the Commission, shall satisfy the [subsidiary ledger] requirement of [Rule] 4.23(a)(4).” [14]
Compliance Obligations of Subadvisers
Following adoption of the amendments to Rule 4.5 and issuance of the Proposal, the Commission’s Division of Swap Dealer and Intermediary Oversight noted:
For a sub-advisor of a registered investment company that can no longer rely on Regulation 4.14(a)(8) because the CPO of the registered investment company cannot rely on amended Regulation 4.5, registration for that sub-advisor will be required when the CPO for the registered investment company would be required to register. The CTA’s compliance with the Commission’s recordkeeping, reporting, and disclosure requirements pursuant to Part 4 of the Commission’s regulations is not required until 60 days following the effective date of a final rule implementing the Commission’s proposed harmonization effort. [15]
The Adopting Release, however, is silent regarding the compliance obligations of any subadviser to a registered fund that cannot claim the exclusion under amended Rule 4.5.
Effective and Compliance Dates
The information below is largely verbatim from the Adopting Release:
The harmonized compliance obligations for registered fund CPOs under Rule 4.12, except for amended Rule 4.12(c)(3)(i), will become effective upon publication of the Adopting Release in the Federal Register. [16] Amended Rule 4.12(c)(3)(i) will become effective 30 days after publication in the Federal Register. Compliance with the conditions in amended Rule 4.12(c)(3)(i) will be required for open-end registered funds beginning when a fund files with the SEC an initial registration statement on Form N-1A or, for an existing fund, its first post-effective amendment that is an annual update to an effective registration statement on Form N-1A. For CPOs of closed-end registered funds, compliance will be required when the closed-end fund files an initial registration statement with the SEC, or, for existing closed-end funds, when the closed-end fund is required to update its registration statement. Registered fund CPOs must comply with Rule 4.27, which requires filing on Forms CPO-PQR and CTA-PR, 60 days following the effective date of the Adopting Release. The Commission states that initial reporting on Form CPO-PQR for registered fund CPOs therefore will begin 60 days following the publication of the Adopting Release in the Federal Register. Rule 4.21 will become effective upon publication in the Federal Register. The amendments to Rules 4.7(b)(4), 4.23, 4.26, and 4.36, which are applicable to all registered CPOs, will become effective 30 days after publication of the Adopting Release in the Federal Register and CPOs may comply upon the effective date. The Commission also states, at the beginning of the Adopting Release, that the publication of the Final Rules “trigger[s] the conditional compliance date that was established in the Commodity Pool Operators and Commodity Trading Advisors: Compliance Obligations rulemaking.” [17]
NFA Rules
On December 28, 2012, after discussions with and review by the NFA staff, ICI submitted a final “negative assurance” letter to the NFA identifying the NFA rules with which registered fund CPOs could defer compliance until such time as the compliance date of either (1) the Final Rules or (2) any NFA rules that are amended to conform with the Final Rules. [18] That letter also provided that,
pending further NFA review of how the SEC and FINRA rules addressing the review, approval and supervision of fund promotional materials compare with the NFA rules, NFA will deem compliance by a fund’s principal underwriter or by another broker-dealer with FINRA’s review, approval, filing, recordkeeping, and supervision requirements with respect to fund promotional materials (including, without limitation, radio and television advertisements, emails that are promotional in nature and websites) to satisfy a registered fund CPO’s or CTA’s obligation to comply with NFA Compliance Rules 2-9, 2-29 and related interpretive notices, as applicable. We note that ICI has submitted a letter to NFA regarding the regulation of the content and review of fund promotional materials under SEC and FINRA rules, but we have not yet received a response.
Sarah A. Bessin
Senior Counsel
Rachel H. Graham
Senior Associate Counsel
endnotes
[1] See Harmonization of Compliance Obligations for Registered Investment Companies Required to Register as Commodity Pool Operators, available at: http://www.cftc.gov/ucm/groups/public/@newsroom/documents/file/federalregister081213.pdf (“Adopting Release”). For information about the proposed rules, see Harmonization of Compliance Obligations for Registered Investment Companies Required To Register as Commodity Pool Operators, 77 Fed. Reg. 11345 (Feb. 24, 2012), available at http://www.cftc.gov/ucm/groups/public/@lrfederalregister/documents/file/2012-3388a.pdf (“Proposal”); ICI Memorandum No. 25889, (Feb. 10, 2012), available at http://www.ici.org/policy/regulation/cftc/memo25889 (memo summarizing the Proposal).
[2] The Commission notes that, under this “substituted compliance” approach, “in the event that the operator of the [registered fund] fails to comply with the SEC administered regime, the operator of the [registered fund] will be in violation of its obligations under part 4 of the Commission’s regulations and subject to enforcement action by the Commission.”
[3] The Commission also amended the rule to extend to publicly offered pools the relief it had previously granted to CPOs of exchange-traded commodity pools.
[4] Amended Rule 4.26(a)(2) under the CEA.
[5] Section 10(a)(3) of the Securities Act states that, “when a prospectus is used more than nine months after the effective date of the registration statement, the information contained therein shall not be as of a date more than sixteen months prior to such use.”
[6] The Adopting Release defines “SEC RIC Rules” as the SEC rules and guidance under the Investment Company Act, the Securities Act, and the Exchange Act regarding disclosure, reporting and recordkeeping by registered funds.
[7] Specifically, the statement may 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; or
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.
[8] See Letter to Karrie McMillan, General Counsel, Investment Company Institute, from Barry D. Miller, Associate Director, Office of Legal and Disclosure, Division of Investment Management, Securities and Exchange Commission, dated July 30, 2010, available at http://www.sec.gov/divisions/investment/guidance/ici073010.pdf.
[9] See IM Guidance Update, Disclosure and Compliance Matters for Investment Company Registrants That Invest in Commodity Interests, No. 2013-05 (Aug. 2013), available at http://www.sec.gov/divisions/investment/guidance/im-guidance-2013-05.pdf.
[10] The Adopting Release indicates that this standard is intended to make this disclosure consistent with the disclosure of prior performance information that is permitted by the SEC staff in a series of no-action letters.
[11] ICI submitted a separate comment letter on the Proposal requesting guidance from the Commission on series funds. See Letter to Ms. Sauntia S. Warfield, Assistant Secretary, Commodity Futures Trading Commission, from Karrie McMillan, General Counsel, Investment Company Institute, dated Nov. 29, 2012.
[12] This recordkeeping relief is available to all CPOs, not just registered fund CPOs. See amended Rule 4.23(c).
[13] While commentators, including ICI, had requested broader relief to use a range of third party recordkeepers, including professional records maintenance and storage companies and commodity trading advisors, amended Rule 4.23 permits only those third-party entities that would have been permitted to maintain records under the Proposal.
[14] This recordkeeping relief is available to all CPOs, not just registered fund CPOs. See amended Rule 4.23(a)(4).
[15] See Division of Swap Dealer and Intermediary Oversight Responds to Frequently Asked Questions – CPO/CTA: Amendments to Compliance Obligations at question 3 under “Compliance Dates,” available at http://www.cftc.gov/ucm/groups/public/@newsroom/documents/file/faq_cpocta.pdf.
[16] Amended Rule 4.12(c)(3)(i) exempts a CPO from the requirements of Rules 4.21, 4.24, 4.25, and 4.26 subject to the conditions that the CPO disclose certain prior performance if the offered pool has less than a three-year operating history, and that the disclosure provided with respect to the offered pool comply with the provisions of the federal securities laws.
[17] 77 Fed. Reg. 11252, 11252 (Feb. 24, 2012). The Commission appears to be referring to the following language: “Entities required to register due to the amendments to [Rule] 4.5 shall be subject to the Commission's recordkeeping, reporting, and disclosure requirements pursuant to part 4 of the Commission's regulations within 60 days following the effectiveness of a final rule implementing the Commission's proposed harmonization effort pursuant to the concurrent proposed rulemaking.”
[18] See Letter to Mr. Daniel A. Driscoll, Executive Vice President, Chief Operating Officer, and Mr. Thomas W. Sexton, III, Senior Vice President, General Counsel and Secretary, National Futures Association, from Karrie McMillan, General Counsel, Investment Company Institute, dated Dec. 28, 2012, available at http://www.ici.org/pdf/26810.pdf.