Earlier this year, the CFTC proposed the following amendments to certain Sections of Part 4 of the Regulations which affect the registration and reporting requirements of CTAs and CPOs, including:
- Requiring a new data collection system for CPOs and CTAs, including monthly and quarterly performance information for each commodity pool managed by a CPO.
- Rescinding the exemptions from registration of CPOs and CTAs.
- Increasing the threshold for qualification as a QEP.
- Requiring annual audited financial statements for previously exempted pools operating under Regulation §4.7.
- Require the annual filing of notices claiming exemptive relief.
- New risk disclosure requirements for CPOs and CTAs.
The rescinding of the exemptions for registration may result in the newly registered CPOs and CTAs to comply with the performance reporting rules under Regulations §4.25 and §4.35.
As a result of the proposed new registration and as a refresher for existing CTAs and CPOs, the following is a general discussion addressing an overview of the performance reporting requirements.
It appears that the current exemption from the performance reporting requirements by CTAs operating pursuant to the §4.7 exemption would remain intact. However, if performance information is to be provided regardless of the exemption, the CTA may do so, provided that such information is “not misleading”.
Consequently, the following discussion is directed towards CTAs and CPOs which do not operate pursuant to the §4.7 exemption.
CPO Performance Reporting
A CPO is required to present the past performance of all pools that it has managed over the past five calendar years and year-to-date. The performance is presented in capsule format (see example below) which presents monthly and annual rates of return and must include: the name of the pool, type of pool, date of inception, aggregate gross capital subscriptions to the pool, the pool’s current NAV, the largest monthly draw-down and worst peak-to-valley drawdown during the most recent five calendar years and year-to-date, expressed as a percentage of the pool’s net asset value and indicating the periods represented by the drawdowns.
There is currently some controversy amongst practitioners as to the most appropriate way of presenting the pool’s rates of return in situations where certain participants are charged no or reduced fees or, due to the timing of subscriptions into the pool and where incentive allocations or fees are charged on an investor by investor basis, some investors are subject to an incentive fee/allocation and some are not. This may cause perceived distortions in presented performance since the pool would be presented on a blended basis and may actually show better rates of return than what typical, full-fee paying investors would have experienced.
Some practitioners believe that non-fee paying participants, especially, the respective CPO’s capital account, should be excluded from the computation of rate of return. Some also believe that presenting the performance of the oldest, full fee paying investor in the fund is most representative of historical returns. Unfortunately, at this time, the Regulations define rate of return as aggregate net performance divided by beginning net asset value which can yield some distortive reporting results as noted above.
CPOs must include in the pool’s performance all costs associated with the pool presented, including up-front fees, organizational and offering costs and operating expenses.
If the pool has not yet commenced trading or if the CPO has never before managed a pool, both items must be disclosed using wording required in the regulations.
All performance reporting must be accompanied by the bold disclaimer that “PAST PERFORMANCE IS NOT NECESSARILY INDICATIVE OF FUTURE RESULTS.”
CTA Performance Reporting
A CTA is required to present the past performance of all customer accounts that it has directed over the past five calendar years and year-to-date. Trading Principals of the CTA must also present the performance of all customer accounts that they directed (if not already included in the CTA’s performance capsule) over the past five calendar years and year-to-date.
CTA performance is typically presented by the trading programs offered. They may be presented on a composite basis provided that the customer accounts included in the Performance Capsule are each traded pursuant to the same overall trading program and their gross rates of return are reasonably homogeneous.
The performance is presented in capsule format which presents monthly and annual rates of return (see example below) and must include the name of the CTA or other person trading the account, the name of the trading program, the date on which the CTA or other person began trading client accounts and the date when client funds began being traded pursuant to the trading program, the number of accounts directed, the total assets under management as of the date of the performance capsule, the largest monthly draw-down and worst peak-to-valley drawdown during the most recent five calendar years and year-to-date, expressed as a percentage of client funds managed during the respective period, the number of accounts traded pursuant to the offered trading program that were opened and closed during the period and the measure of variability of returns for accounts that were both opened and closed during eh period and closed with positive and negative net lifetime returns pool’s net asset value and indicating the periods represented by the drawdowns.
If the CTA is directing an account of a commodity pool, but is not the CPO or otherwise affiliated with the respective CPO, it should exclude from its performance, the pool’s up-front fees (assuming that the CTA does not receive nor is affiliated with the persons receiving such fees), organizational and offering costs and operating expenses.
A number of rate of return methods are allowable, including time-weighting, Only-Accounts Traded (“OAT”) and daily compounded equity methods. Although the daily compounded equity method is considered most accurate, time-weighting and OAT may be easier to compute, though not as accurate.
If the CTA or its Trading Principals have not previously directed client accounts, this must be disclosed using wording required in the Regulations.
All performance reporting must be accompanied by the bold disclaimer that “PAST PERFORMANCE IS NOT NECESSARILY INDICATIVE OF FUTURE RESULTS.”
Proprietary Performance Results
The results of the CTAs or CPOs own proprietary trading is not required to be disclosed. However, if the CTA or CPO chooses to present their proprietary trading performance, it must be presented separately from customer accounts and be included only as supplementary information at the back of the disclosure document or offering circular. Moreover, it must be presented on a “pro forma” basis, meaning that it should be presented in an adjusted fashion that simulates the trading levels, brokerage commissions, management and incentive fees and other costs that an independent customer would have experienced under the program being offered.
Extracted and Hypothetical Performance Results
NFA Compliance Rule 2-29 issued restrictions against the presentation of extracted performance results (i.e. where only a portion of actual trading results is presented) and the limited use of hypothetical trading results.
Hypothetical results must include all hypothetical costs and must be accompanied by required disclaimers as to the limitations of hypothetical performance presentations. However, once the CTA or CPO has at least three (3) months of actual trading results, hypothetical results are not allowed to be continued to be presented.
The above material is an overview of the performance reporting area, which can have a number of complexities, some of which are not mentioned in the Regulations, but rather have evolved over a period of years under CFTC and NFA interpretations. It is recommended that a CTA or CPO consult with their attorney, accountant or compliance professional.
About the Author
Mr. Liccar is a Director of the Michael J. Liccar & Company, LLC, CPAs in Chicago, Illinois. He has over 30 years experience in public accounting and has specialized exclusively in the securities/futures industry since 1982. A graduate of Northern Illinois University in 1979, he is a CPA, a FINRA Series-24 (General Securities Principal) and Series-27 (Financial and Operations Principal), had successfully passed the Series7 (General Securities Representative) and Series-3 (Commodity Futures Representative) and has completed various graduate courses in Taxation at DePaul University.
He currently serves as an elected township official in Crete, Illinois, previously served as an elected municipal official of Riverdale, Illinois and is a Compatriot Member of the Sons of the American Revolution. Mr. Liccar served on the original Accounting & Legal Committee and is a current member of the Managed Funds Association, and is a member of the National Society of Compliance Professionals, the American Institute of Certified Public Accountants and the Illinois CPA Society.
