New Self-Executing Registration Relief for Delegating CPOs
On October 15, 2014, the Division of Swap Dealer and Intermediary Oversight (the “Division”) of the Commodity Futures Trading Commission (“CFTC”) issued CFTC Letter No. 14-126 (“Letter 14-126”). Letter 14-126 grants self-executing no-action relief from the requirement to register as a commodity pool operator (“CPO”) under the Commodity Exchange Act (the “CEA”) to persons that have delegated certain of their responsibilities as a CPO (“Designating CPO”) to another person that is registered as a CPO (“Designated CPO”), such that the Designated CPO will serve as the CPO of the pool in lieu of the Delegating CPO. In essence, Letter 14-126 is a progression of the relief previously addressed in CFTC Staff Letter No. 14-69 (“Letter 14-69”), which granted relief under essentially the same circumstances as Letter 14-126 but pursuant to a formal request for relief (as opposed to self-executing relief).
In addition to providing self-executing relief to relieve the CFTC’s administrative burden of reviewing a large volume of requests, Letter 14-126 also provides important clarifications that effectively expand the scope of the intended relief. In particular, Letter 14-126 clarifies that the relief is intended to cover: (1) when the Delegating CPO provides investment management authority to the Designated CPO as well as to a commodity trading advisor (“CTA”), (2) when the Delegating CPO is registered as an associated person (“AP”) of the Designated CPO or is exempt from registration, and participates in the solicitation of pool participants solely in its capacity as an AP of the Designated CPO, and (3) when the Delegating CPO is a pool director and a principal of the Designated CPO. As a result, the criterion for availability of relief under Letter 14-126 is essentially the same (if not more expansive) than that of Letter 14-69.
Any person that already received a no-action letter pursuant to Letter 14-69 can continue to rely on that relief. Persons that still have a pending Letter 14-69 request will need to assess whether they are entitled to rely on the self-executing relief provided by Letter 14-126, which is likely the case since the criterion for availability under Letter 14-126 is essentially the same as under Letter 14-69 (if not even more expansive). Persons that fall outside the scope of Letter 14-126 can submit requests for relief pursuant to Rule 140.99.
To be eligible for the relief described in Letter 14-126, the following requirements must be satisfied. We note that any undefined terms are as defined in Letter 14-126, and that the CFTC staff’s clarifications to the relief provided in Letter 14-69 are indicated below in italics:
1. a. Pursuant to a legally binding document, the Delegating CPO has delegated to the Designated CPO all of its investment management authority with respect to the commodity pool at issue; provided, however, that satisfaction of this criterion is not precluded where: (i) a Delegating CPO or the Designated CPO appoints one or more third parties to serve as investment manager(s) of the pool; and (ii) each such third party investment manager is registered as a CTA or is exempt from such registration pursuant to the CEA or the CFTC’s regulations;
b. The Delegating CPO does not participate in the solicitation of participants for the pool; provided, however, that satisfaction of this criterion is not precluded where the Delegating CPO: (i) is registered as an AP of the Designated CPO or is exempt from registration as such pursuant to the CEA or the CFTC’s regulations; and (ii) participates in the solicitation of pool participants solely in its capacity as an AP of the Designated CPO; and
c. The Delegating CPO does not manage any property of the pool; provided, however, that satisfaction of this criterion is not precluded where the Delegating CPO: (i) is a principal or employee of the Designated CPO or of a CTA of the pool at issue; and (ii) has management responsibilities over pool property; provided further, however, that such Delegating CPO: (1) exercises these management responsibilities solely in the capacity of a principal or employee of the Designated CPO or as a CTA of the pool and not as the Delegating CPO of the pool; and (2) in connection with exercising these management responsibilities, is subject to supervision as a principal or an employee by either the Designated CPO or a CTA of the pool in accordance with CFTC Rule 166.3. For purposes of this Criterion, management of pool property does not include responsibilities with respect to pool property of an administrative, clerical or ministerial nature.
2. The Designated CPO is registered as a CPO.
3. The Delegating CPO is not subject to a Statutory Disqualification.
4. There is a business purpose for the Designated CPO being a separate entity from the Delegating CPO that is not solely to avoid registration by the Delegating CPO under the CEA and the CFTC’s regulations.
5. The books and records of the Delegating CPO with respect to the commodity pool are maintained by the Designated CPO.
6. If the Delegating CPO and the Designated CPO are each a non-natural person, then one such CPO controls, is controlled by, or is under common control with the other CPO.
7. If a Delegating CPO is a non-natural person, then such Delegating CPO and the Designated CPO have executed a legally binding document whereby each undertakes to be jointly and severally liable for any violation of the CEA or the CFTC’s regulations by the other in connection with the operation of the commodity pool.
8. If a Delegating CPO is a natural person and is not an Unaffiliated Board Member, as defined below, then such Delegating CPO and the Designated CPO have executed a legally binding document whereby each undertakes to be jointly and severally liable for any violation of the CEA or the CFTC’s regulations by the other in connection with the operation of the commodity pool.
9. If a Delegating CPO is an Unaffiliated Board Member, then such Delegating CPO must remain fully responsible as a Board member in accordance with the laws under which the commodity pool is established.
Although books and records must still be maintained by the Designated CPO to be afforded the self-executing relief, Letter 14-126 removed the requirement of an attestation to compliance with CFTC Rule 1.31.
http://www.cftc.gov/LawRegulation/CFTCStaffLetters/No-ActionLetters/index.htm
CME’s New Rule on Disruptive Trading Practices
Effective September 15, 2014, the Chicago Mercantile Exchange, Chicago Board of Trade, New York Mercantile Exchange and Commodity Exchange, Inc. (collectively, the “CME”) adopted a new Rule 575 to prohibit:
(1) “spoofing” (i.e., submitting or cancelling bids or offers to create a misleading appearance of market depth or artificial price movements);
(2) “quote stuffing” (i.e., submitting or cancelling bids or offers to overload the quotation system of a registered entity or delay another person’s execution of transactions during the closing period); and
(3) the disorderly execution of transactions during the closing period.
The text of the new Rule 575 reads as follows:
“All orders must be entered for the purpose of executing bona fide transactions. Additionally, all non-actionable messages must be entered in good faith for legitimate purposes.
A. No [P]erson shall enter or cause to be entered an order with the intent, at the time of order entry, to cancel the order before execution or to modify the order to avoid execution;
B. No Person shall enter or cause to be entered an actionable or non-actionable message or messages with intent to mislead other market participants;
C. No Person shall enter or cause to be entered an actionable or non-actionable message or messages with intent to overload, delay, or disrupt the systems of the Exchange or other market participants; and
D. No [P]erson shall enter or cause to be entered an actionable or non-actionable message with intent to disrupt, or with reckless disregard for the adverse impact on, the orderly conduct of trading or the fair execution of transactions.
To the extent applicable, the provisions of this Rule apply to open outcry trading as well as electronic trading activity. Further, the provisions of this Rule apply to all market states, including the pre-opening period, the closing period and all trading sessions” (emphasis added).
The CME also prepared CME Group RA1405-5 (the “Advisory Notice”) to provide additional guidance in interpreting the new rule. The Advisory Notice provides a non-exhaustive list of examples considered to be disruptive and in violation of the rule. As to the standard of proof, under A16 of the Advisory Notice, it states that:
“Proof of intent is not limited to instances in which a market participant admits its state of mind. Where the conduct was such that it more likely than not was intended to produce a prohibited disruptive consequence without justification, intent may be found. Claims of ignorance, or lack of knowledge, are not acceptable defenses to intentional or reckless conduct. Recklessness has been commonly defined as conduct that “departs so far from the standards of ordinary care that it is very difficult to believe the actor was not aware of what he or she was doing.” See Drexel Burnham Lambert, Inc. v. CFTC, 850 F.2d 742, 748 (D.C. Cir. 1988).”
As a result, the “intent” required under A-C for the new rule is fairly low, requiring simply that the conduct “more likely than not” was intended to produce a prohibited disruptive consequence without justification. Further, claims of ignorance, or lack of knowledge, would not be acceptable defenses to intentional (or reckless) conduct. For the D catchall for the new rule, only a plain recklessness standard applies. Such low thresholds for the CME to show intent and/or recklessness could have a particularly sharp impact on high frequency trading and algorithmic trading firms.
CPOs Can Use Additional Third-Party Recordkeepers
On September 8, 2014, the Division issued CFTC Letter No. 14-114 (“Letter 14-114”), which grants exemptive relief from the main office requirement of CFTC Rules 4.7(b)(4) and 4.23 to allow CPOs to use any third-party recordkeeper. Prior to Letter 14-114, CPOs were only allowed to use the specific recordkeepers enumerated in “Harmonization of Compliance Obligations for Registered Investment Companies Required to Register as Commodity Pool Operators.”
To be eligible for such relief, the following requirements must be satisfied:
(i) the CPO’s timely access to such records be maintained, such that the CPO will satisfy the obligations of the applicable CFTC regulations, particularly with respect to providing such records for inspection; and
(ii) the CPO timely and completely filing the statements required pursuant to CFTC Rule 4.7(b)(5) or 4.23(c), as applicable.
A link to Letter 14-114 can be found here:
CPO-PQR Relief for Certain CPOs
On September 8, 2014, the Division issued CFTC Letter No. 14-115 (“Letter 14-115”), which grants exemptive relief from the requirement to file a Form CPO-PQR under CFTC Rule 4.27(c) where the CPO is registered but only operates pools pursuant to a claim of exemption from registration under CFTC Rule 4.13(a)(3) or for which they maintain an exclusion from the definition of CPO under CFTC Rule 4.5. The relief is being granted since these CPOs only operate pools for which they do not have a reporting requirement. Reporting on a Form CPO-PQR would provide limited additional information regarding such CPOs beyond what is already available to the CFTC as part of the registration process and the CPO’s ongoing obligations as a registrant.
A link to Letter 14-115 can be found here:
http://www.cftc.gov/LawRegulation/CFTCStaffLetters/ExemptiveLetters/index.htm
CFTC Relief from Provisions of Rules 4.7(b) and 4.13(a)(3) to Harmonize with JOBS Act Amendments to Rule 506(c) and Rule 144A
On September 9, 2014, the Division issued CFTC Letter No. 14-116 (“Letter 14-116”). Letter 14-116 grants exemptive relief from specific provisions of CFTC Rules 4.7(b) and 4.13(a)(3) to CPOs to be consistent with the Jumpstart Our Business Startups Act’s (the “JOBS Act”) amendments to the Securities and Exchange Commission (“SEC”) Regulation D adding Rule 506(c) and revising Rule 144A.
In essence, Letter 14-116 provides relief from the CFTC Rule 4.7(b) requirement that an offering be exempt pursuant to section 4(a)(2) of the Securities Act of 1933 (the “33 Act”)(i.e., no public offerings) and be offered solely to qualified eligible persons (“QEPs”). Letter 14-116 also provides relief from the requirement of CFTC Rule 4.13(a)(3)(i) that securities be “offered and sold without marketing to the public.”
To be eligible for the relief described in Letter 14-116, the following requirements must be satisfied:
(ii) the CPO must be relying on either CFTC Rule 4.7 or 4.13(a)(3); and
(ii) the CPO must meet all of the remaining requirements of the applicable exemption (such as only selling to eligible investors).
The exemptive relief described herein is not self-executing. A notice of claim must be filed in the form described below:
(b) state the name of the pool(s) for which the claim is being filed;
(c) state whether the CPO claiming relief is a Rule 506(c) issuer or is using one or more Rule 144A resellers;
(d) specify whether the CPO intends to rely on the exemptive relief pursuant to Rule 4.7(b) or 4.13(a)(3), with respect to the listed pool(s);
(i) If relying on Rule 4.7(b), represent that the CPO meets the conditions of the exemption, other than that provision’s requirements that the offering be exempt pursuant to section 4(a)(2) of the 33 Act and be offered solely to QEPs, such that the CPO meets the remaining conditions and is still required to sell the participations of its pool(s) to QEPs;
(ii) If relying on Rule 4.13(a)(3), represent that the CPO meets the conditions of the exemption, other than that provision’s prohibition against marketing to the public;
(e) be signed by the CPO, which may be accomplished by attaching a portable document format (PDF) file with a signature of the CPO; and
(f) be filed with the Division via email using the email address of dsionoaction@cftc.gov with the subject line of: “JOBS Act Marketing Relief.”
Once obtained, the relief will not expire absent any final CFTC action in consideration of the JOBS Act and the SEC’s regulatory amendments.
A link to Letter 14-116 can be found here:
http://www.cftc.gov/LawRegulation/CFTCStaffLetters/ExemptiveLetters/index.htm
CPO Reporting Relief for a Parent Pool and its Trading Subsidiary
On September 8, 2014, the Division issued CFTC Letter No. 14-112 (“Letter 14-112”), which grants no-action relief to consolidate the annual report financial statements and Form CPO-PQR data between certain commodity pools and their wholly-owned subsidiaries. In particular, the Division will not recommend that the CFTC take an enforcement action against a CPO of a parent commodity pool (“Parent Pool”) that uses a wholly-owned subsidiary to trade in commodity interests (“Trading Subsidiary”) for failure to file with the National Futures Association (“NFA”) a separate annual report for such Trading Subsidiary, pursuant to CFTC Rule 4.7(b) or 4.22(c), or for failure to file a separate Form CPO-PQR with NFA for such Trading Subsidiary, pursuant to CFTC Rule 4.27(c).
To be eligible for the consolidated annual report, the following requirements must be satisfied:
(i) the Parent Pool cannot be registered as an investment company under the Investment Company Act of 1940 (“40 Act”);
(ii) the CPO of the Parent Pool must also be the CPO of the Trading Subsidiary;
(iii) exposure to the Trading Subsidiary by participants in the Parent Pool must be shared pro rata; and
(iv) the CPO must prepare and file with NFA an annual report for the Parent Pool that contains consolidated financial statements for the Parent Pool that includes the holdings, gains and losses, and other financial statement amounts attributable to the Trading Subsidiary.
To be eligible for the consolidated Form CPO-PQR relief, the above requirements (i)-(iii) must be satisfied, and the CPO must provide a consolidated report to NFA for the Parent Pool that includes the data for the Trading Subsidiary, pursuant to CFTC Rule 4.27(c).
The relief described herein is not self-executing. A notice of claim must be filed in the form described below:
(i) state the name, main business address and main business telephone number of the CPO claiming the relief;
(iii) be signed by the CPO, which may be accomplished by attaching a portable document format (PDF) file with a signature of the CPO; and
(iv) be filed with the Division via email using the email address of dsionoaction@cftc.gov with the subject line of: “Trading Subsidiary Letter 14-112.” Once obtained, the relief will not expire absent a future rulemaking or other CFTC action relating to the subject matter of the Relief.
A link to Letter 14-112 can be found here:
http://www.cftc.gov/LawRegulation/CFTCStaffLetters/No-ActionLetters/index.htm
Please do not hesitate to contact us if you have any questions concerning the above updates.
Joseph M. Mannon: T: +1 (312) 609 7883; jmannon@vedderprice.com
Nicole M. Kuchera: T: +1 (312) 609 7763; nkuchera@vedderprice.com
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Joseph M. Mannon, JD is a member of Vedder Price P.C.’s Investment Services Group. Mr. Mannon focuses his practice on legal and compliance matters for investment advisers, mutual funds, closed-end funds and unregistered vehicles such as hedge funds, hedge fund of funds and other investment entities. With regard to unregistered vehicles, he frequently counsels clients on fund formation and structuring matters for funds organized both in the U.S. and abroad. He also counsels clients on issues relating to commodity trading advisors and commodity pool operators.
Mr. Mannon has substantial experience in regulatory and compliance matters affecting investment advisers, including registration and marketing, such as compliance with Global Investment Performance Standards (GIPS), as well as in drafting compliance policies and procedures and trading agreements.
Nicole M. Kuchera, JD, LLM is an attorney in Vedder Price P.C.’s Investment Services Group. She concentrates her practice on legal and compliance support for securities, futures, forex and derivatives industry clients, such as hedge funds, investment advisers, commodity pool operators, commodity trading advisors, broker-dealers, futures commission merchants, introducing brokers and proprietary trading firms. Ms. Kuchera counsels clients regarding a wide range of compliance and regulatory matters involving the rules and regulations of the Securities and Exchange Commission and Commodity Futures Trading Commission, as well as the self-regulatory organizations and exchanges.
Ms. Kuchera also represents clients in general corporate matters, such as business formation, corporate structuring, licensing, industry registration, trade agreements, preparation of disclosure documents and preparation and review of marketing and promotional materials.
