Articles Tagged with Rules Regulations

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Written by: Jay Gould and Peter Chess

On July 1, 2010, the Securities and Exchange Commission (the “SEC”) adopted Rule 206(4)-5 under the Investment Advisers Act of 1940, as amended, which prohibited an investment adviser from providing advisory services for compensation to a government client for two years after the advisers or certain of its executives or employees make a contribution to certain elected officials or candidates.  Rule 206(4)-5, also known as the Pay to Play Rule, also included a third-party solicitor ban that prohibited an adviser or its covered associates from providing or agreeing to provide, directly or indirectly, payment to any third-party for a solicitation of advisory business from any government entity on behalf of such adviser, unless such third-party was an SEC-registered investment adviser or a registered broker or dealer subject to pay to play restrictions. 

As originally adopted, the third-party solicitor ban’s compliance date was September 13, 2011.  However, not long after the Pay to Play Rule was adopted, Congress created a new category of SEC registrants called “municipal advisors” in the Dodd-Frank Wall Street Reform and Consumer Protection Act.  Municipal advisors include persons that undertake a solicitation of a municipal entity.  The SEC then amended the Pay to Play Rule on June 22, 2011 in order to add municipal advisors to the category of registered entities excepted from the third-party solicitor ban and extended the original compliance date of the third-party solicitor ban.

On June 8, 2012, the SEC released a final rule that extends (for a second time) the compliance date for the third-party solicitor ban.  The SEC explained that it was necessary to ensure an orderly transition for advisers and third-party solicitors as well as to provide additional time for them to adjust compliance policies and procedures after the transition.  The new compliance date for the third-party solicitor ban will now be nine months after the required registration date for municipal advisers with the SEC under the Securities Exchange Act of 1934, as amended.  This compliance date has yet to be finalized as the SEC has not yet adopted the applicable rule.

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Written by: Jay Gould and Peter Chess

The Financial Industry Regulatory Authority (“FINRA”) released new guidance last month regarding new FINRA Rule 2111 (the “Suitability Rule”), which requires a broker-dealer to have a reasonable basis to believe that a recommended transaction or investment strategy involving a security or securities is suitable for the customer, based on the information obtained through reasonable diligence by the broker-dealer.  The Suitability Rule codifies and clarifies the three main suitability obligations that previously had been discussed largely in case law:

  • Reasonable-basis suitability.  A broker must perform reasonable diligence to understand the nature of the recommended security or investment strategy involving a security or securities, as well as the potential risks and rewards, and determine whether the recommendation is suitable for at least some investors based on that understanding.
  • Customer-specific suitability.  A broker must have a reasonable basis to believe that a recommendation of a security or investment strategy involving a security or securities is suitable for the particular customer based on the customer’s investment profile.
  • Quantitative suitability.  A broker who has control over a customer account must have a reasonable basis to believe that a series of recommended securities transactions are not excessive.

In general, the Suitability Rule retains the core features of the previous National Association of Securities Dealers (“NASD”) suitability rule, NASD Rule 2310.  However, the new Suitability Rule imposes broader obligations on firms regarding recommendations of investment strategies.  Existing guidance and interpretations regarding suitability obligations continue to apply to the extent that they are not inconsistent with the new rule.  The guidance provided by FINRA on the Suitability Rule includes the following:

  • The suitability requirement that a broker make only those recommendations that are consistent with the customer’s best interests prohibits a broker from placing their interests ahead of the customer’s interests.
  • The customer’s investment profile is critical to the assessment of the suitability of a particular recommendation.
  • The recently passed Jumpstart Our Business Startups Act (the “JOBS Act”) does not affect the suitability obligations regarding private placements, including those private placements made in reliance on the JOBS Act’s elimination of the prohibition on general solicitation.
  • The term “investment strategy” is to be interpreted broadly and would apply to cases where the strategy results in a securities transaction or even mentions a specific security.
  • The extent to which a firm needs to document its suitability analysis depends on an assessment of the customer’s investment profile and the complexity of the recommended security or investment strategy.
  • Although the reasonableness of a firm’s effort to perform “reasonable diligence” will depend on the facts and circumstances, asking a customer for the information ordinarily will suffice.

The institutional-customer exemption under NASD Rule 2130 and its definition of “institutional customer” has been replaced with the more common definition of “institutional account.”  In addition, the new institutional-customer exemption focuses on whether (1) a broker has a reasonable basis to believe the institutional customer is capable of evaluating risks independently and (2) the institutional customer affirmatively indicates that it is exercising independent judgment (a new requirement).

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Written by:  Jay B. Gould 

The recently enacted JOBS Act[1] requires the Securities and Exchange Commission (“SEC”) to promulgate rules that would effectively repeal the ban on general solicitation and general advertising under Rule 506 of Regulation D by private issuers, including private funds.  Pursuant to the JOBS Act, the SEC has 90 days from the date of enactment (July 4, 2012) to adopt rules implementing this provision.   In advance of publishing proposed rules, the SEC has started accepting comment letters on all aspects of the JOBS Act, including the repeal of the ban on general advertising.  

Unsurprisingly, the Investment Company Institute (“ICI”), the lobby organization for mutual funds and other registered funds, has submitted a comment letter requesting that the SEC take a slow and deliberate approach to permitting private funds to generally advertise and solicit investors.  How slow and deliberate?  The ICI suggests that performance advertising by hedge funds should be prohibited altogether until the SEC has had the opportunity to study hedge fund advertising, “gain experience with private fund advertisements,” and craft a rule similar to Rule 482 to which mutual fund advertising is subject.  The ICI tells us that Rule 482 is the culmination of 60 years of experience and that the SEC “should follow the same path here,” referring to advertising by hedge funds and other private funds.  60 years?  Really? 

The ICI has a long and storied history of blocking financial innovation and expansion of investment opportunities for the investing public.  You may recall that the ICI sued the Office of the Comptroller of the Currency in an attempt to block banks from acting as investment advisers to mutual funds, a case that they ultimately lost at the Supreme Court.  It is hardly surprising then that the mutual fund lobby would line up against competition by the private funds industry, even at a time when the registered funds and private funds businesses are converging at a rapid pace in terms of product offerings, investment strategies, and regulatory oversight and reporting.  Last August the SEC issued a “concept release” that requested comment on whether registered funds should be able to use the same sorts of investment techniques and to the same extent as private funds, such as hedging, shorting, and use of leverage.  Further action in this regard, coupled with the new reporting obligations of private funds as a result of Dodd Frank (e.g., Form PF) will serve to further blur the lines between registered and unregistered funds. 

In addition to “urging” a ban on performance advertising and promoting the idea of other “content restrictions” by hedge funds and other private funds, the ICI suggests that private fund advertising should be subject to FINRA review to the same extent as mutual fund advertising, and that private fund advertising be clearly distinguished from mutual fund advertising.  The ICI further suggests that the SEC should raise the net worth threshold for “accredited investors” in order to insure that private fund investors have the requisite sophistication to withstand the riskiness associated with private funds (See legalaffairs March–April 2004 issue).  The ICI endorses a $600,000 annual income and $3 million net worth standard, a measure that would further reduce the potential private fund investor pool and drive more investors to the registered world. 

More balanced voices have also started to comment on this issue, so it remains to be seen how much weight the SEC will ultimately attribute to the ICI comment letter.  You may view all of the comment letters regarding the repeal of the ban on general solicitations here.    And you are encouraged to submit your own.

[1]   The Jumpstart Our Business Startups Act.

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Written by:  Jay B. Gould, Michael Wu and Peter Chess

Note: Pillsbury and KPMG, along with the California Hedge Fund Association, will be sponsoring a “Managers Only” event on the JOBS Act and the new world of “general solicitation” for Funds on June 14.

The Jumpstart Our Business Startups Act (the “JOBS Act” or the “Act”), signed into law by President Obama on April 5, 2012, seeks to encourage economic growth through the easing of certain restrictions on capital formation and by improving access to capital.  The JOBS Act contains a number of provisions that will directly impact private funds and their general partners, managers and sponsors.  Below is a summary of the Act’s provisions that directly affect private funds, including ongoing requirements for funds that at this time do not appear to be affected by the Act.

Section 4 of the Securities Act.  The JOBS Act amends Section 4 of the Securities Act of 1933, as amended (“Securities Act”), so that offers and sales exempt under Rule 506 of Regulation D will not be deemed public offerings as a result of general advertising or general solicitation.  Private funds relying on the exception in Section 3(c)(1) (“3(c)(1) Fund”) of the Investment Company Act of 1940, as amended (“Investment Company Act”), will be able to continue to avail themselves of this exception so long as all of their investors are accredited investors, as defined in Rule 501 of Regulation D (“Accredited Investors”).  We expect that private funds relying on the exception in 3(c)(7) (“3(c)(7) Fund”) of the Investment Company Act will obtain the greatest benefit from the JOBS Act, as these funds, which accept only “qualified purchasers,” as defined in Section 2(a)(51) of the Investment Company Act, may now have up to 2000 investors (as discussed below) before they would be required to register as a public reporting company under the Securities Exchange Act of 1934, as amended (“Exchange Act”).  3(c)(1) Funds will continue to be limited to 99 investors, although a fund manager may organize and offer both a 3(c)(1) Fund and a 3(c)(7) Fund with the same investment objective and strategies without the two funds being subject to “integration” under the Securities Act.

General Solicitation and General Advertising.  The JOBS Act requires the Securities and Exchange Commission (“SEC”) to amend Regulation D under the Securities Act to eliminate the prohibition on general solicitation and general advertising for offerings under Rule 506, provided that all purchasers are Accredited Investors.  The Act mandates that the SEC implement rule amendments ninety days after the enactment of the Act, or by July 4, 2012.

It is unlikely that the SEC will be able to meet this deadline given the requirement to provide public notice and comment prior to adopting any final rules; accordingly, these rule amendments are expected to be adopted by the fall with very little transition period.  Although the Act leaves little in the way of discretion to the SEC in the rulemaking process there are two areas in which the SEC may seek to provide substantive guidance.  The SEC is required to amend Regulation D such that any issuers relying on Rule 506 must take reasonable steps to verify that purchasers are Accredited Investors.  Some observers believe that the SEC may require issuers that avail themselves of the general advertising provisions to obtain sufficient financial information from prospective purchasers so that the “accredited status” of such investors can be more precisely determined.  This could take the form of requiring all such issuers to obtain an income statement or verified financial statement from investors.  The other area in which the SEC may attempt to provide additional oversight is with respect to the offering of private fund interests through broker-dealers. 

Brokers and Dealers.  The JOBS Act provides that with regard to securities offered and sold under Rule 506 and subject to certain conditions, registration as a broker or dealer under Section 15(a)(1) of the Exchange Act will not be required for certain persons solely because of the performance of specific functions.[1]  This exemption from registration is available only if such persons: (i) receive no compensation in connection with the purchase and sale of the securities; (ii) do not have possession of customer funds or securities in connection with the purchase and sale of securities; and (iii) are not subject to statutory disqualification (sometimes referred to as “bad boy” provisions).  Although it is uncertain at this time, the SEC may take this opportunity to require private funds that avail themselves of the ability to advertise generally to conduct all offers and sales of their fund interests through a registered broker-dealer.  The SEC realizes that as a result of the fast moving and innovative private funds industry, the regulator lost control of Regulation D as well as the “issuer’s exemption” in Rule 3a4-1 under the Exchange Act, the exemption that fund managers rely upon to offer their securities directly to purchasers.  It is not clear that Rule 3a4-1 was ever intended for this purpose, and the SEC may take this opportunity to clarify how offers and sales are conducted generally by private fund managers.

Record Holders.  The JOBS Act increases from 500 to 2,000 the number of record holders of equity securities an issuer may have before the issuer is required to register under Section 12(g) of the Exchange Act, so long as the number of non-Accredited Investors does not exceed 499.  3(c)(1) Funds will be unable to have any non-Accredited Investors if they want to employ general advertising even though, under Regulation D rules that predate the JOBS Act, sales could be made to up to 35 non-Accredited Investors (with no general solicitation).  There is an outstanding question as to whether the SEC will “grandfather” in existing non-Accredited Investors in 3(c)(1) Funds, or if perhaps some form of Rule 506 will survive whereby sales to non-Accredited Investors will be permissible if no general solicitation takes place.      

Continuing Restrictions and Obligations.  Although the JOBS Act will potentially ease the burdens presented by capital raising for private funds, the following should be noted: 

  • Private fund offerings pursuant to Rule 506 will continue to be subject to the anti-fraud provisions of federal and state securities laws and the restrictions on advertising found in the Investment Advisers Act of 1940, as amended (“Advisers Act”).  For example, Rule 206(4)-1 of the Advisers Act (the advertising rule) and its general prohibition against advertisements that are false and misleading still necessitates compliance.  Managers of private funds that advertise generally must understand the advertising rules against “testimonials” in their public marketing materials.  To be “liked” on Facebook or similarly endorsed on other social networking sites would likely be considered to be an illegal testimonial by the SEC which could result in and administrative action accompanied by fines and penalties.   
  • Private funds should continue to rely on the guidance provided in the Clover Capital Management, Inc. SEC no-action letter and the subsequent line of letters when contemplating activities such as performance presentations by following practices so as not to present misleading performance results.  Further, private funds should continue to comply with Rule 206(4)-8 of the Advisers Act and its prohibition on making untrue statements or omitting material facts or otherwise engaging in fraudulent, deceptive or manipulative conduct regarding interactions with investors in pooled investment vehicles.  To the extent a private fund manager avails itself of the ability to advertise past performance, special care will need to be taken to ensure that all documents are consistent and performance information is presented in a manner that is complete and accurate.
  • Private funds should consider and continue to comply with advertising and disclosure rules as applicable to registered advisers and members of the Financial Industry Regulatory Authority (“FINRA”).  FINRA rules also apply to broker-dealers acting as placement agents or intermediaries in Rule 506 transactions.  Private funds making use of exemptions from registration under the Advisers Act and/or the Investment Company Act must continue to comply with the restrictions set forth in such exemptions.  For example, although the JOBS Act provides that offers and sales exempt from registration under Rule 506 will not be deemed public offerings by virtue of the use of general advertising and general solicitation, 3(c)(1) Funds must not exceed the one hundred beneficial owner limit.

Foreign Private Advisers.  A “foreign private adviser” that qualifies for the exemption from registration under the Advisers Act is an adviser that has no place of business in the U.S., fewer than 15 U.S. clients, less than $25 million attributable to U.S. clients and does not hold itself out generally to the public in the U.S. as an investment adviser.  The SEC in the past has construed certain types of advertising, including information available on websites, as an example of an adviser holding itself out to the public in the U.S. as an investment adviser.  Given the increased freedom for advertising under the JOBS Act, the SEC may look more closely at advisers taking advantage of the foreign private adviser exemption and whether any activities that could be construed as advertising may violate the terms of the exemption.

Regulation S.  Regulation S under the Securities Act, the safe harbor from registration for offshore sales of securities to non-U.S. persons, does not allow for “directed selling efforts” in the U.S.  It remains to be seen if general solicitation or advertising in connection with the amendments to Regulation D will be seen as “directed selling efforts” under Regulation S and whether the SEC will clarify how this will affect the potential use of Regulation S in connection with offerings under Rule 506.

 State Blue Sky Laws.  Many private funds have relied on self-executing exemptions in certain states in order to avoid filings and/or fees required under applicable state statutes or rules.  These self-executing exemptions are commonly conditioned on a prohibition on general solicitation or general advertising.  Private funds employing general solicitation and/or advertising in reliance on the amended Rule 506 should note the mechanics of such Blue Sky laws of the states where securities are being offered and sold and comply accordingly.

[1]   This applies to persons that: (a) maintain a platform or mechanism that permits the offer, sale, purchase, or negotiation of or with respect to securities, or permits general solicitations, general advertisements, or similar or related activities by issuers of such securities, whether online, in person, or through any other means; (b) co-invest in such securities; or (c) provide ancillary services with respect to such securities.

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The Form PF (PF is short for “private funds”) is a new Securities and Exchange Commission reporting form for investment advisers to private funds that have at least $150 million in private fund assets under management.  Comprising 42 pages and divided into 4 sections with corresponding subsections, Form PF may appear daunting at first.  The task of completing and filing the Form also entails categorizations, specific and nuanced reporting requirements and Form-specific calculations, not to mention the fact that improperly completed Forms may be delayed or even rejected.  However, with the proper tools and plan of attack, an adviser will be able to fulfill its reporting requirements and improve its data platform for a host of other reporting and filing requirements.  Form PF necessitates working with large amounts of data.  So, early planning, coordination and organization are essential for success.  In a guest article, Jay Gould, a Partner at Pillsbury Winthrop Shaw Pittman LLP and leader of Pillsbury’s Investment Funds & Investment Management practice team, and Kelli Brown, Director of Private Funds at Data Agent, LLC, describe ten steps that a hedge fund manager should take for successful Form PF completion and filing.  The article can be accessed on the Hedge Fund Law Report’s website (www.hflawreport.com – subscription required). 

Please contact Jay Gould if you have any further questions or seek further information about Form PF.

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by Joseph J. Kaufman

New guidance outlines key rules for the new confidential review option for initial public offerings by emerging growth companies in the United States. 

The Jumpstart Our Business Startups Act (also known as the JOBS Act) became a U.S. federal law on April 5, 2012 and immediately authorized a confidential submission option for registered securities offerings in the United States by emerging growth companies (EGCs). The U.S. Securities and Exchange Commission (SEC)’s Division of Corporation Finance staff promptly announced its procedure for accepting confidential draft registration statements using this option. The staff has also given written and oral guidance on a number of relevant frequently asked questions. This alert explains the background and expected benefits of the confidential submission option and reviews the SEC staff guidance.

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Written by: Jay B. Gould and Peter Chess

On April 18, 2012, the Securities and Exchange Commission (“SEC”) and the Commodity Futures Trading Commission (“CFTC”) voted to adopt rules defining “swap dealer,” “security-based swap dealer,” “major swap participant,” and “major security-based swap participant,” among other terms, as mandated by the Dodd-Frank Wall Street Reform and Consumer Protection Act (“Dodd-Frank Act”).  The Dodd-Frank Act assigns to the SEC the regulatory authority for security-based swaps[1] and assigns to the CFTC the regulatory authority for swaps. 

Under the adopted rules, the definitions are as follows:

A swap dealer is defined as any person who:

  • Holds itself out as a dealer in swaps;
  • Makes a market in swaps;
  • Regularly enters into swaps with counterparties as an ordinary course of business for its own account; or
  • Engages in activity causing itself to be commonly known in the trade as a dealer or market maker in swaps.

The definition of security-based swap dealer tracks the definition of swap dealer, with “security-based swap” inserted where “swap” appears.

A major swap participant is a person that satisfies any one of the three parts of the definition:

  • A person that maintains a “substantial position” in any of the major swap categories, excluding positions held for hedging or mitigating commercial risk and positions maintained by certain employee benefit plans for hedging or mitigating risks in the operation of the plan.
  • A person whose outstanding swaps create “substantial counterparty exposure that could have serious adverse effects on the financial stability of the United States banking system or financial markets.”
  • Any “financial entity” that is “highly leveraged relative to the amount of capital such entity holds and that is not subject to capital requirements established by an appropriate Federal banking agency” and that maintains a “substantial position” in any of the major swap categories.

The definition of major security-based swap participant tracks the definition of major swap participant with “security based-swap” inserted where “swap” appears.

The newly adopted rules contain further definitions for the terms “substantial position,” “hedging or mitigating commercial risk,” “substantial counterparty exposure,” “financial entity,” “highly leveraged,” and “eligible contract participant.”  In addition, the adopting release provides interpretative guidance on the definitions of swap dealer and security-based swap dealer, and the CFTC provides further details on the exclusion for swaps in connection with originating a loan, the exclusion of certain hedging swaps and the exclusion of swaps between affiliates.  Finally, the new rules call for a de minimis exemption from the definition of swap dealer and security-based swap dealer wherein a person who engages in a de minimis amount of swap or security-based swap dealing will be exempt from the respective definition.  

The SEC and the CFTC adopted the new rules under joint rulemaking, and the SEC rules become effective 60 days after the date of publication in the Federal Register, although dealers and major participants will not have to register with the SEC until the dates that will be provided in the SEC’s final rules for the registration of dealers and major participants.  The CFTC must adopt further rules defining the term “swap,” and swap dealers and major swap participants will need to register by the later of July 16, 2012, or 60 days after the publication of CFTC rules defining “swap.”

The full text of the SEC press release and fact sheet is available here.  The full text of the CFTC release is available here.

[1]               Security-based swaps are broadly defined as swaps based on (i) a single security, (ii) a loan, (iii) a narrow-based group or index of securities, or (iv) events relating to a single issuer or issuers of securities in a narrow-based security index. 

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Written by: Jay B. Gould and Peter Chess

On April 5, 2012, the Jumpstart Our Business Startups Act (the “JOBS Act” or the “Act”) was signed into law, creating a new regulatory on-ramp for emerging growth companies going public.  The JOBS Act also includes provisions that require the Securities and Exchange Commission (the “SEC”) to undertake various initiatives, including rulemaking and studies touching on capital formation, disclosure and registration requirements.  Title II of the Act affects offerings by issuers pursuant to Regulation D under the Securities Act of 1933, as amended (the “Securities Act”), as well as resales under Rule 144A of the Securities Act.  In particular, the Act directs the SEC to amend its rules to:

  • Repeal the ban on general solicitation and general advertising for offerings under Rule 506 of Regulation D when sales are only to accredited investors;
  • Revise Rule 144A to provide that securities sold under Rule 144A may be offered to persons other than qualified institutional buyers (“QIBs”), including by use of general solicitation or general advertising, provided that securities are only sold to persons reasonably believed to be QIBs; and
  • Amend Section 4 of the Securities Act such that offers and sales exempt under Rule 506 shall not be deemed public offerings under the federal securities laws as a result of general advertising or general solicitation.

For Private Funds, Regulation D as we know it is still in effect for the next 90 days as the JOBS Act directs the SEC to make the relevant rule changes to Rule 506 and Rule 144A within 90 days, but it does not modify the current text of those rules.  In addition, Funds should continue to follow applicable terms of SEC interpretative guidance.  Senior members of the SEC staff participated in discussion of the JOBS Act yesterday that provided further guidance on this subject, and the SEC is still currently seeking public comments on SEC regulatory initiatives under the JOBS Act.

Pillsbury and KPMG, along with the California Hedge Fund Association, will be sponsoring a program on the JOBS Act and the new world of “general solicitation” for Funds in June.

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By: Louis A. Bevilacqua, Joseph R. Tiano, Jr., David S. Baxter, Ali Panjwani and K. Brian Joe

On April 5, 2012, President Obama signed into law the Jumpstart Our Business Startups Act (JOBS Act), a bill with widespread bipartisan support and assembled from a combination of legislative initiatives introduced throughout 2011 targeting smaller companies and focusing on cheaper capital raising and job creation. We discuss the key provisions of the JOBS Act and their impact on these companies and securities offerings.

The Jumpstart Our Business Startups Act (JOBS Act) is a consolidation of several bills introduced throughout 20111 with the goal of making it easier for smaller companies to raise money and lessen their regulatory burden while doing so. The House of Representatives passed the JOBS Act on March 8 by a vote of 390-23, and the Senate passed the same bill, with one amendment, on March 22 by a vote of 73-26. The Senate amendment offered a more restrictive take on the House bill’s provisions dealing with the increasingly popular grass-roots financing method known as crowdfunding. On reconsideration of the bill with the Senate amendment, the JOBS Act passed the House by a vote of 380-41 on March 27, and President Obama signed it into law on April 5. The JOBS Act is one of the most comprehensive pieces of legislation in recent years to be specifically targeted at developing companies. This Alert summarizes the most important provisions of the JOBS Act and the implications of those provisions.

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Written by Jay Gould, Michael Wu and Peter Chess

The Commodity Futures Trading Commission (the “CFTC”) recently amended its registration rules regarding Commodity Pool Operators (“CPOs”) and Commodity Trading Advisors (“CTAs”), which will require many general partners and managers of private investment funds that previously relied on an exemption from registration to now register with the CFTC.  After a public comment period in which the industry overwhelmingly supported the continuation of these exemptions, the CFTC decided to rescind the CPO exemption under CFTC Rule 4.13(a)(4) and amend the CPO exemption under CFTC Rule 4.13(a)(3).  Rule 4.13(a)(4) previously exempted private pools from registering as a CPO with the CFTC for funds offered only to institutional qualified eligible purchasers (“QEPs”) and natural persons who meet QEP requirements that hold more than a de minimis amount of commodity interests.

The CFTC’s amendment did not change the application of CFTC Rule 4.13(a)(3) to a fund of a hedge fund (“Fund of Funds”).  However, due to the repeal of these exemptions, many of the general partners or managers of a Fund of Funds’ underlying funds may be required to register as CPOs, thereby requiring registration of the Fund of Funds manager.  The CFTC has provided guidance with respect to when a Fund of Funds manager may continue to rely upon an exemption from registration as a CPO.  We have summarized these circumstances below:     

  • If a fund (i) allocates a Fund of Fund’s assets to one or more underlying funds, which do not satisfy the trading limits of CFTC Rule 4.13(a)(3)[1] (“Trading Limits”) and each of which is operated by a registered CPO, and (ii) does not allocate the Fund of Fund’s assets directly to commodity interest trading, that fund may only rely on Section 4.13(a)(3) if the Fund of Funds itself satisfies the Trading Limits.
  • If a fund (i) allocates a Fund of Fund’s assets to one or more underlying funds, each having a CPO who is either (a) exempt under CFTC Rule 4.13(a)(3) or (b) a registered CPO that complies with the Trading Limits, and (ii) does not allocate the Fund of Fund’s assets directly to commodity interest trading, that fund may rely on Section 4.13(a)(3).
  • If a fund (i) allocates a Fund of Fund’s assets to one or more underlying funds, each of which satisfies the Trading Limits, and (ii) does not allocate the Fund of Fund’s assets directly to commodity interest trading, that fund may multiply the percentage restriction applicable to each underlying fund by the percentage of the Fund of Fund’s allocation of assets to such underlying fund, to determine whether that fund may rely on Section 4.13(a)(3).
  • If a fund (i) allocates the Fund of Fund’s assets to one or more underlying funds, and it has actual knowledge of the Trading Limits of the underlying funds (e.g., where the underlying funds or their CPOs are affiliated with a fund), and (ii) does not allocate the Fund of Fund’s assets directly to commodity interest trading, that fund may aggregate the commodity interest positions across the underlying funds to determine compliance with the Trading Limits and whether or not that fund may rely on CFTC Rule 4.13(a)(3). 
  • If a fund (i) allocates no more than 50% of the Fund of Fund’s assets to underlying funds that trade commodity interests (regardless of the level of trading engaged by such underlying funds), and (ii) does not allocate the Fund of Fund’s assets directly to commodity interest trading, that fund may rely on CFTC Rule 4.13(a)(3).

The CFTC amended Section 4.13(a)(3) to address how to calculate the notional value of swaps and how to net swaps.  In addition, the CFTC will now require a CPO relying on Section 4.13(a)(3) to submit an annual notice to the National Futures Association affirming its ability to continue relying on the exemption.  If a CPO cannot affirm its ability to do so, the CPO will be required to withdraw the exemption and, if necessary, apply for registration as such.

For additional information on whether these rule amendments will require you to register as a CPO or CTA, or whether the CFTC guidance or another exemption might provide a further exemption from registration, please contact your Pillsbury Investment Funds Attorney.

[1]   CFTC Rule 4.13(a)(3) requires that at all times either: (a) the aggregate initial margin and premiums required to establish commodity interest positions does not exceed five percent of the liquidation value of the Fund’s investment portfolio; or (b) the aggregate net notional value of the Fund’s commodity interest positions does not exceed one-hundred percent of the liquidation value of the Fund’s investment portfolio.