2023-22324
[Federal Register Volume 88, Number 196 (Thursday, October 12, 2023)]
[Proposed Rules]
[Pages 70852-70884]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2023-22324]
[[Page 70851]]
Vol. 88
Thursday,
No. 196
October 12, 2023
Part VI
Commodity Futures Trading Commission
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17 CFR Part 4
Commodity Pool Operators, Commodity Trading Advisors, and Commodity
Pools: Updating the `Qualified Eligible Person' Definition; Adding
Minimum Disclosure Requirements for Pools and Trading Programs;
Permitting Monthly Account Statements for Funds of Funds; Technical
Amendments; Proposed Rule
Federal Register / Vol. 88 , No. 196 / Thursday, October 12, 2023 /
Proposed Rules
[[Page 70852]]
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COMMODITY FUTURES TRADING COMMISSION
17 CFR Part 4
RIN 3038-AF25
Commodity Pool Operators, Commodity Trading Advisors, and
Commodity Pools: Updating the `Qualified Eligible Person' Definition;
Adding Minimum Disclosure Requirements for Pools and Trading Programs;
Permitting Monthly Account Statements for Funds of Funds; Technical
Amendments
AGENCY: Commodity Futures Trading Commission.
ACTION: Notice of proposed rulemaking.
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SUMMARY: The Commodity Futures Trading Commission (Commission or CFTC)
is proposing amendments to certain provisions of its regulations that
would: update the Portfolio Requirement thresholds within the
``Qualified Eligible Person'' definition; require commodity pool
operators (CPOs) and commodity trading advisors (CTAs) operating pools
and trading programs under the applicable Commission regulations to
provide certain minimum disclosures to their prospective pool
participants and advisory clients; include revisions that are
consistent with long-standing Commission exemptive letters addressing
the timing of certain pools' periodic financial reporting; and several
technical amendments related to the structure of the regulations that
are the subject of this proposal.
DATES: Comments must be received by December 11, 2023.
ADDRESSES: You may submit comments, which must be in writing and
identified by RIN 3038-AF25, by any of the following methods:
CFTC Comments Portal: https://comments.cftc.gov. Select
the ``Submit Comments'' link for this rulemaking and follow the
instructions on the Public Comment Form.
Mail: Send to Christopher Kirkpatrick, Secretary of the
Commission, Commodity Futures Trading Commission, Three Lafayette
Centre, 1155 21st Street NW, Washington, DC 20581.
Hand Delivery/Courier: Follow the same instruction as for
Mail, above. Please submit your comments using only one of these
methods. Submissions through the CFTC Comments Portal are encouraged.
All comments must be submitted in English, or if not, accompanied
by an English translation. Comments will be posted as received to
https://comments.cftc.gov. You should only submit information that you
wish to make available publicly. If you wish the Commission to consider
information that you believe is exempt from disclosure under the
Freedom of Information Act (FOIA), a petition for confidential
treatment of the exempt information may be submitted according to the
procedures in Sec. 145.9 of the Commission's regulations. The
Commission reserves the right, but shall have no obligation, to review,
prescreen, filter, redact, refuse, or remove any or all of your
submission from https://comments.cftc.gov that it may deem to be
inappropriate for publication, such as obscene language. All
submissions that have been redacted or removed that contain comments on
the merits of the rulemaking will be retained in the public comment
file and will be considered as required under the Administrative
Procedure Act (APA) and other applicable laws and may be accessible
under the FOIA.
FOR FURTHER INFORMATION CONTACT: Amanda L. Olear, Director, 202-418-
5283 or [email protected]; Pamela M. Geraghty, Acting Deputy Director,
202-418-5634 or [email protected]; Elizabeth Groover, Special Counsel,
202-418-5985 or [email protected]; or Andrew Ruggiero, Special Counsel,
202-418-5712 or [email protected]; each in the Market Participants
Division at the Commodity Futures Trading Commission, Three Lafayette
Centre, 1155 21st Street NW, Washington, DC 20581.
SUPPLEMENTARY INFORMATION:
Table of Contents
I. Background
II. The Proposal
a. Updating Financial Thresholds in the Portfolio Requirement of
the ``Qualified Eligible Person'' Definition
b. Establishing Minimum Disclosure Requirements Under Regulation
4.7
c. Permitting Monthly Account Statements Consistent With
Commission Exemptive Letters
d. Other Technical Amendments
III. Related Matters
a. Regulatory Flexibility Act
b. Paperwork Reduction Act
c. Cost-Benefit Considerations
d. Antitrust Considerations
I. Background
As amended by the Dodd-Frank Wall Street Reform and Consumer
Protection Act (Dodd-Frank Act),\1\ section 1a(11) of the Commodity
Exchange Act (CEA or Act) defines the term ``commodity pool operator''
as any person engaged in a business that is of the nature of a
commodity pool, investment trust, syndicate, or similar form of
enterprise, and who, with respect to that commodity pool, solicits,
accepts, or receives from others, funds, securities, or property,
either directly or through capital contributions, the sale of stock or
other forms of securities, or otherwise, for the purpose of trading in
commodity interests.\2\ CEA section 1a(10) defines a ``commodity pool''
as any investment trust, syndicate, or similar form of enterprise
operated for the purpose of trading in commodity interests.\3\ CEA
section 1a(12) defines the term ``commodity trading advisor'' as any
person who, for compensation or profit, engages in the business of
advising others, either directly or through publications, writing, or
electronic media, as to the value of or the advisability of trading in
commodity interests.\4\
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\1\ Public Law 111-203, 124 Stat. 1376 (2010).
\2\ 7 U.S.C. 1a(11).
\3\ 7 U.S.C. 1a(10).
\4\ 7 U.S.C. 1a(12).
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Generally, CEA section 4m(1) requires each person whose
intermediary activities satisfy either the CPO or CTA definition to
register as such with the CFTC.\5\ With respect to both CPOs and CTAs,
the CEA also authorizes the Commission to include persons within, or
exclude them from, such definitions, by rule, regulation, or order, if
the Commission determines that such action will effectuate the purposes
of the CEA.\6\ In addition to the general registration authority set
forth in CEA section 4m(1), CEA section 4n specifically empowers the
Commission to impose compliance obligations related to the registration
process, recordkeeping, disclosure, and reporting.\7\ Finally, the CEA
also gives the Commission authority to make and promulgate such rules
and regulations, as in the judgment of the Commission, are reasonably
necessary to effectuate the provisions or to accomplish any purposes of
the CEA.\8\
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\5\ 7 U.S.C. 6m(1) (noting that it is unlawful for any CTA or
CPO, unless registered under the provisions of that chapter, to make
use of the mails or any means or instrumentality of interstate
commerce with his business as such CTA or CPO). See also 17 CFR
3.10.
\6\ 7 U.S.C. 1a(11)(B); 7 U.S.C. 1a(12)(B)-(C).
\7\ 7 U.S.C. 6n.
\8\ 7 U.S.C. 8a(5).
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Part 4 of the Commission's regulations specifically governs the
operations and activities of CPOs and CTAs.\9\ These regulations
implement the statutory authority provided to the Commission by the CEA
and also establish registration exemptions and definitional
[[Page 70853]]
exclusions for CPOs and CTAs.\10\ Part 4 also contains detailed
regulations that establish the ongoing compliance requirements
applicable to registered CPOs and CTAs. These compliance requirements
pertain to the commodity pools and separate accounts that CPOs and CTAs
operate and advise, and provide customer protection, disclosures, and
regular reporting to a registrant's pool participants or advisory
clients.
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\9\ 17 CFR part 4.
\10\ See 7 U.S.C. 6n; 17 CFR 4.5, 4.6, 4.13, 4.14.
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Regulation 4.7 provides exemptions from certain part 4 compliance
requirements regarding disclosure, periodic reporting, and
recordkeeping for registered CPOs and CTAs, whose prospective and
actual pool participants and/or advisory services are restricted to
individuals and entities considered ``Qualified Eligible Persons,'' and
who claim the desired exemptions, pursuant to paragraph (d) of that
section.\11\ As of the end of FY 2022, 837 registered CPOs operated
approximately 4,304 commodity pools pursuant to claimed Regulation 4.7
exemptions (4.7 pools, and together with CTA programs operated under
Regulation 4.7, the 4.7 pools and trading programs).\12\ Relatedly,
approximately 865 CTAs claim an exemption under Regulation 4.7 for
their trading programs, which the Commission estimates to number in the
thousands. During discussions with CFTC staff, the National Futures
Association (NFA), the registered futures association to whom the
Commission has delegated many of its regulatory oversight functions
with respect to CPOs and CTAs, has predicted that this population of
CPOs, CTAs, commodity pools, and trading programs operating pursuant to
Regulation 4.7 will only continue to grow in the future.\13\ Since its
adoption over thirty years ago, the Commission has occasionally amended
Regulation 4.7 to enhance its usability and ensure that it remains fit
for purpose.\14\ For the reasons discussed below, however, it is the
Commission's preliminary view that certain aspects of Regulation 4.7 no
longer align with the Commission's intentions and thus require
amendment.
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\11\ 17 CFR 4.7.
\12\ These numbers are drawn from data in National Futures
Association Form PQR filings for Q4 2022.
\13\ In fact, as of March 31, 2023, there were approximately
1,128 CPOs registered with the Commission, and on average,
approximately 5,257 pools were reported via CFTC Form CPO-PQR on a
quarterly basis in FY 2022. Assuming there is no material difference
in the number of registered CPOs and pools reported between the
closings of Q4 2022 and of Q1 2023, NFA and CFTC data show that
approximately 69% of registered CPOs operate 4.7 pools, and
approximately 81% of all pools reported on CFTC Form CPO-PQR are 4.7
pools. After amendments to Form CPO-PQR and Regulation 4.27 adopted
in 2020, the Commission accepts NFA Form PQR as substituted
compliance for the required completion of its own Form CPO-PQR. See
17 CFR 4.27. Therefore, the data sources for both NFA and CFTC are
fundamentally the same, if not identical.
\14\ See, e.g., 84 FR 67355 (Dec. 10, 2019).
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After a careful review of the existing language and structure of
Regulation 4.7, and considering the clear public and regulatory
interest of maintaining and modernizing older, but still widely
utilized provisions, the Commission is issuing this Notice of Proposed
Rulemaking (NPRM or Proposal) comprised of targeted amendments to
update the regulation in several ways. In particular, the Commission is
proposing amendments that would: (1) increase the financial thresholds
in the Portfolio Requirement of the ``Qualified Eligible Person'' (QEP)
definition in Regulation 4.7(a) to reflect inflation; (2) require
certain minimum disclosures for 4.7 pools and trading programs operated
and offered by CPOs and CTAs; (3) add a process under Regulation
4.7(b)(3) permitting CPOs to elect an alternative account statement
schedule for certain 4.7 pools consistent with long-standing exemptive
letters issued by the Commission; \15\ and (4) improve the structure
and utility of Regulation 4.7 through several technical adjustments
(for example, reorganizing the QEP definition, updating cross-
references, etc.).
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\15\ Such exemptive letters are routinely drafted by Commission
staff in the Market Participants Division (MPD) and constitute an
exercise of the authority in Regulation 4.12(a), which is delegated
by the Commission to MPD's predecessor division, the Division of
Swap Dealer and Intermediary Oversight, through Regulation 140.93.
See 17 CFR 4.12(a) and 140.93.
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II. The Proposal
a. Updating Financial Thresholds in the Portfolio Requirement of the
``Qualified Eligible Person'' Definition
As discussed above, Regulation 4.7 provides exemptions to CPOs and
CTAs for their 4.7 pools and trading programs from various compliance,
disclosure, and recordkeeping requirements within part 4 of the
Commission's regulations, provided that their prospective and actual
pool participants and advisory clients are restricted to QEPs.
Regulation 4.7(a) bifurcates the definition of QEP into paragraphs
(a)(2) and (a)(3) representing two different QEP categories: (1) those
persons \16\ who do not need to satisfy an additional ``Portfolio
Requirement,'' as defined in Regulation 4.7(a)(1)(v), to be considered
a QEP,\17\ and (2) those persons who do.\18\ Notably, natural persons
are among those listed under Regulation 4.7(a)(3) and are thus required
to satisfy the Portfolio Requirement to be considered QEPs. Pursuant to
Regulation 4.7(a)(3), to be considered QEPs, such natural persons must
meet the ``accredited investor'' definition adopted by the Securities
and Exchange Commission (SEC) under Regulation D applicable to private
securities offerings exempt from registration under the Securities Act,
as well as the Portfolio Requirement adopted by the Commission.\19\
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\16\ 17 CFR 1.3 (defining ``person'' as ``includ[ing]
individuals, associations, partnerships, corporations, and
trusts'').
\17\ 17 CFR 4.7(a)(2). Generally, this list includes, but is not
limited to: (1) registered futures commission merchants (FCMs),
registered retail foreign exchange dealers (RFEDs), registered swap
dealers, and principals thereof; (2) a registered broker or dealer,
or principal thereof; (3) certain registered CPOs, and principals
thereof; (4) certain registered CTAs, and principals thereof; (5)
certain investment advisers registered under the Investment Advisers
Act of 1940 (IAA), and principals thereof; (6) ``qualified
purchasers'' as defined in section 2(a)(51)(A) of the Investment
Company Act of 1940 (ICA); (7) ``knowledgeable employees'' as
defined in 17 CFR 270.3c-5 pursuant to the ICA; (8) certain persons
associated with an exempt pool or account, outlined in Regulation
4.7(a)(2)(viii)(A) and (B), respectively; (9) certain trusts; (10)
organizations described in section 501(c)(3) of the Internal Revenue
Code (IRC), subject to some conditions; (11) non-United States
persons; and (12) exempt pools. Id.
\18\ 17 CFR 4.7(a)(3). Generally, this list includes, but is not
limited to: (1) certain investment companies registered under the
ICA or a business development company as defined in section 2(a)(48)
of the ICA; (2) banks as defined in section 3(a)(2) of the
Securities Act of 1933 (Securities Act), or any savings and loan
association or other institution as defined in section 3(a)(5)(A) of
the Securities Act acting for its own account or for the account of
a QEP; (3) certain insurance companies acting for their own account
or that of a QEP; (4) certain state employee benefit plans; (5)
certain employee benefit plans within the meaning of the Employee
Retirement Income Security Act of 1974 (ERISA); (6) private business
development companies; (7) certain corporations, Massachusetts or
similar business trusts, or partnerships, limited liability
companies or similar business ventures; (8) natural persons meeting
the individual net worth or joint net worth tests within the
``accredited investor'' definition; (9) natural persons who would
otherwise be considered accredited investors; (10) certain pools,
trusts, insurance company separate accounts, or bank collective
trusts; and (11) certain government entities.
\19\ 17 CFR 4.7(a)(3)(ix) and (x). For the SEC's ``accredited
investor'' definition, see 17 CFR 230.501.
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Currently, the Portfolio Requirement contains two thresholds; if
either (or some combination of the two) is satisfied by a person listed
under Regulation 4.7(a)(3), then a CPO or CTA may consider them a QEP
eligible to invest in the offered 4.7 pool or trading program. More
specifically, a person can satisfy the Portfolio Requirement by: (1)
owning securities (including pool participations) of issuers not
affiliated with such person and other investments
[[Page 70854]]
with an aggregate market value of at least $2,000,000 \20\ (Securities
Portfolio Test); (2) having on deposit with a futures commission
merchant, for its own account at any time during the six months
preceding either the date of sale to that person of a pool
participation in the exempt pool or the date the person opens an exempt
account with the CTA, at least $200,000 in exchange-specified initial
margin and option premiums, together with required minimum security
deposit for retail forex transactions for commodity interest
transactions \21\ (Initial Margin and Premium Test); or (3) owning a
portfolio comprised of a combination of the funds or property specified
in the Securities Portfolio Test and the Initial Margin and Premium
Test, which, when expressed as percentages of the required amounts,
meet or exceed 100%.\22\
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\20\ 17 CFR 4.7(a)(1)(v)(A).
\21\ 17 CFR 4.7(a)(1)(v)(B).
\22\ 17 CFR 4.7(a)(1)(v)(C).
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The Portfolio Requirement has remained unchanged since its original
adoption by the Commission in 1992.\23\ When it developed the QEP
definition and the associated Portfolio Requirement, the Commission
sought to create ``objective criteria'' by which one could assess a
person's commodity interest experience, believing that appropriate
experience would involve an investment portfolio of a size sufficient
to indicate that the participant has substantial investment experience
and thus a high degree of sophistication with regard to investments as
well as financial resources to withstand the risk of their
investments.\24\ The Commission sought in the 1992 Final Rule to
harmonize Regulation 4.7 with existing securities laws and regulations
for sophisticated investors by incorporating the SEC's ``accredited
investor'' definition into the QEP definition, which was intended to
capture similarly experienced and sophisticated persons participating
in the commodity interest markets.\25\ However, the Commission
determined that an additional, higher standard of experience was
necessary for certain natural and other persons, citing the differences
between futures and securities investments.\26\
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\23\ 57 FR 34853 (Aug. 7, 1992) (1992 Final Rule).
\24\ 57 FR 3148, 3152 (Jan. 28, 1992) (1992 Proposed Rule).
\25\ See the persons listed within 17 CFR 4.7(a)(2) and (3); cf.
17 CFR 230.501.
\26\ 1992 Proposed Rule, 57 FR at 3151.
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The 1992 Proposed and Final Rules provide insight into the level of
sophistication the Commission then considered necessary for natural
persons (and other persons listed within Regulation 4.7(a)(3)) to
qualify as QEPs. For example, in response to comments suggesting that
the Commission not adopt any Portfolio Requirement, and instead rely
solely on the parameters of the SEC's ``accredited investor''
definition, the Commission explicitly declined to do so.\27\ The
Commission continues to believe that a Portfolio Requirement provides a
reasonable proxy for the experience, acumen, and resources necessary
for certain persons, including natural persons, to be considered QEPs
eligible to invest in complex commodity interest products without
receiving the full panoply of information otherwise required under part
4.\28\ These dollar thresholds have not been modified since their
adoption over 30 years ago, and the Commission preliminarily believes
it is long overdue to update these measures.
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\27\ Id.
\28\ Although in the 1992 Final Rule the Commission cited the
lack of disclosure requirements as one of the reasons for adopting a
Portfolio Requirement, it was not the only policy justification; the
inherent differences between futures and securities investments, as
discussed above, were also cited. See 1992 Final Rule, 57 FR at
34855. Despite the Commission's original rationale in adopting the
QEP definition including the policy decision of not requiring
disclosures, the Commission has preliminarily concluded that
retaining and increasing the Portfolio Requirement, while also
proposing new disclosure requirements, is necessary given the
increased variety and general evolution of the commodity interest
markets since 1992. See infra Proposal, pt. II.b.
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In determining an appropriate increase for each threshold, the
Commission preliminarily believes two inflation indexes published by
the United States Bureau of Labor Statistics (BLS) are appropriate to
consider. Specifically, the Commission consulted the Consumer Price
Index for All Urban Consumers (CPI-U) and the Consumer Price Index for
Urban Wage Earners and Clerical Workers (CPI-W).\29\ The CPI-U and CPI-
W indexes indicate that inflation has had a considerable impact on the
monetary thresholds established in the 1992 Final Rule. The CPI-U and
CPI-W data reveal that the current monetary thresholds in Regulation
4.7(a)(1)(v) may no longer reasonably indicate the high level of
investor sophistication, acumen, and resources that the Commission
intended when the Portfolio Requirement was adopted. For example, based
on analysis using CPI-U data, as of February 2023, the $2,000,000
threshold in the Securities Portfolio Test has the same buying power as
approximately $4,270,000, and the $200,000 threshold in the Initial
Margin and Premiums Test has the same buying power as approximately
$427,000.\30\
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\29\ See the U.S. BLS Handbook of Methods, for more information
on the CPI, CPI-U, and CPI-W, available at https://www.bls.gov/opub/hom/cpi/presentation.htm. As described by the BLS Handbook of
Methods, ``CPI-U represents the buying habits of the residents of
urban and metropolitan areas in the United States and covers over 90
percent of the U.S. population.'' Id. Comparatively, ``the CPI-W is
computed using the same prices as the CPI-U, but the weights of the
CPI-W are based on a subset of the CPI-U population, covering
approximately 30 percent of the U.S. population.'' Id. The CPI-W
also includes ``households where more than one-half of the
household's earners must have been employed for at least 37 weeks
during the previous 12 months.'' Id. Given the relevance of these
indexes to the population of natural persons that may qualify as
QEPs via the Portfolio Requirement, the Commission believes these
indexes are the most appropriate to use in determining today's
buying power of the Portfolio Requirement's monetary thresholds
established in 1992.
\30\ The actual calculator for CPI-U can be found at https://www.bls.gov/data/inflation_calculator.htm. The Commission is
preliminarily choosing to include the February 2023 CPI-U data above
because it provides a clear example of today's buying power of the
Portfolio Requirement, as it was established in 1992, and because
the data can be easily accessed and verified via the BLS inflation
calculator link provided herein. In comparing the results of each
index, as applied to the Portfolio Requirement thresholds, the
Commission found no material difference between the CPI-W and CPI-U.
Analysis using the CPI-W provided similar buying power figures to
those produced by the CPI-U analysis. Given that the Commission is
proposing updated thresholds rounded down to the nearest million and
hundred thousand, the Commission believes that providing the CPI-U
analysis is sufficient for purposes of this Proposal.
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Given these results, the Commission is proposing to update the
Portfolio Requirement's thresholds by doubling the Securities Portfolio
Test in Regulation 4.7(a)(1)(v)(A) to $4,000,000, and the Initial
Margin and Premium Test in Regulation 4.7(a)(1)(v)(B) to $400,000.
Although these figures do not match the results provided by the CPI-U
and CPI-W indexes exactly, being slightly lower than the February 2023
buying power stated above, the Commission preliminarily believes that
Portfolio Requirement thresholds rounded down to the nearest million
and hundred thousand would be simpler for CPOs and CTAs relying on
Regulation 4.7 to apply in determining if a prospective pool
participant or advisory client is a QEP. Additionally, the Commission
would continue to permit persons to meet the Portfolio Requirement
through a combination of the two Portfolio Requirement thresholds as
currently allowed under Regulation 4.7(a)(1)(v)(C), which would largely
remain unchanged by this NPRM, except to update the example provided
therein of how the two tests could be combined to reflect the higher
proposed thresholds.
The Commission recognizes that these increases to the Portfolio
Requirement will likely result in a certain portion of currently-
qualifying QEPs no longer
[[Page 70855]]
meeting the thresholds. Regulation 4.7(a)(3) provides that CPOs must
assess a person's QEP status, including satisfaction of the Portfolio
Requirement, at the time of sale of any pool participation units, and
that CTAs must make a similar assessment at the time that a person
opens an exempt account.\31\ The Commission believes that continuing
this requirement, as opposed to requiring mandatory redemptions or
terminations of advisory relationships for those current QEPs who may
not meet the proposed heightened thresholds, minimizes the potential
for disruption to the 4.7 pool or trading program, as well as possible
negative consequences for the current QEPs. Therefore, the Commission
is proposing to retain the requirements of current Regulation 4.7(a)(3)
in Proposed Regulation 4.7(a)(6)(ii), and requests comment on this
aspect of the proposal.
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\31\ 17 CFR 4.7(a)(3).
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The Commission solicits comment on these proposed increases to the
Portfolio Requirement in the QEP definition. In addition, the
Commission also seeks comment on the following:
1. Are the CPI-U and the CPI-W indexes the most appropriate for
considering the impact of inflation on the thresholds within the
Portfolio Requirement, and if they are not, what other suggested
indexes or methods should the Commission consider using to assess
inflationary effects?
2. The Commission is also seeking any data or information, from
CPOs and CTAs that utilize Regulation 4.7, on the estimated number of
advisory clients and pool participants that currently qualify as QEPs
via the existing Portfolio Requirement, but would not so qualify if the
increased monetary thresholds in the Portfolio Requirement described
above are adopted.
3. How much time would CPOs and CTAs need to determine that their
existing QEP pool participants and clients would continue to satisfy
the increased Securities Portfolio or Initial Margin and Premium Tests,
if adopted as proposed?
b. Establishing Minimum Disclosure Requirements Under Regulation 4.7
As stated above, Regulation 4.7 provides exemptions from the
broader part 4 compliance requirements, including those regulations
requiring disclosures of general and performance information about a
pool or trading program, for CPOs with respect to pools offered solely
to QEPs, and for CTAs advising or managing the accounts of QEPs. More
specifically, Regulation 4.7(b)(2) provides an exemption for CPOs with
respect to their pools offered solely to QEPs regarding: (1) the
requirement to deliver a disclosure document in Regulation 4.21; (2)
the general disclosures required by Regulation 4.24; (3) the
performance disclosures required by Regulation 4.25; and (4) the use
and amendment requirements in Regulation 4.26; so long as the CPO
provides a form statement on the cover page of any offering memorandum
it chooses to distribute to its prospective pool participants (or near
the signature line of the pool's subscription agreement, if its CPO
chooses not to distribute an offering memorandum).\32\ Similarly,
Regulation 4.7(c)(1) provides an exemption for CTAs with respect to
their trading programs offered to QEPs regarding: (1) the requirement
to deliver a disclosure document in Regulation 4.31; (2) the general
disclosures required by Regulation 4.34; (3) the performance
disclosures required by Regulation 4.35; and (4) the use and amendment
requirements in Regulation 4.36; provided that the CTA includes a form
statement on the cover page of any brochure or disclosure statement it
chooses to distribute to its prospective advisory clients (or near the
signature line of the advisory agreement, if the CTA chooses not to
distribute a brochure or disclosure statement).\33\ Currently, because
of Regulations 4.7(b)(2) and (c)(1), CPOs and CTAs claiming these
exemptions \34\ are not required to deliver or disseminate any offering
memoranda, brochures, or disclosure statements to their prospective QEP
pool participants or advisory clients (QEP Disclosures). Rather, these
CPOs and CTAs are only required to ensure that any QEP Disclosures they
elect to provide, ``include all disclosures necessary to make the
information contained therein, in the context in which it is furnished,
not misleading.'' \35\
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\32\ 17 CFR 4.7(b)(2) (providing an exemption from the specific
requirements of Sec. Sec. 4.21, 4.24, 4.25, and 4.26 with respect
to each exempt pool). The prescribed ``form statement'' indicates
that the CPO's offering memorandum has not been, nor is it required
to be, filed with the Commission, and that the CFTC has not reviewed
or approved such offerings or any related offering memoranda for the
4.7 pool. Id.
\33\ 17 CFR 4.7(c)(1) (providing an exemption ``from the
specific requirements of Sec. Sec. 4.31, 4.34, 4.35, and 4.36'').
The prescribed ``form statement'' indicates that the CTA's brochure
has not been, nor is it required to be, filed with the Commission,
and that the CFTC has not reviewed or approved such trading program
or brochure. Id.
\34\ See 17 CFR 4.7(d).
\35\ 17 CFR 4.7(b)(2); 17 CFR 4.7(c)(1).
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At the time of Regulation 4.7's adoption in 1992, the Commission's
rationale for providing these broad disclosure exemptions was, in part,
based on the belief that QEPs are able to identify and obtain the
information they deem necessary to evaluate the investment offered and
thus that prescriptive rules imposing specific disclosure requirements
are not essential.\36\ The 1992 Final Rule further stated that the QEP
definition is designed to assure that 4.7 offerings are made only to
investors with sufficient sophistication and expertise to assess the
appropriateness of the investment for their purposes and to obtain all
the information they need to evaluate and monitor the contemplated
investment, and placed the responsibility for obtaining such
information about 4.7 pools and trading programs squarely on the
prospective QEP pool participant or advisory client.\37\ The Commission
also noted that requirements under other regulatory structures may
apply to investor pools or their principals and require the CPO of an
investor pool to make disclosure[s] to such participants.\38\ The
Commission explained then that, despite the relief provided by
Regulation 4.7, CPOs and CTAs relying on those exemptions with respect
to the disclosure requirements in part 4 remain subject to the
generally applicable statutory provisions in the CEA that prohibit
defrauding or misleading investors, as well as those that specifically
prohibit CPOs, CTAs, and their associated persons from defrauding or
deceiving their participants and clients.\39\ In sum, the Commission
sought in 1992 to create a simplified regulatory and compliance
framework for CPO and CTA offerings to QEPs, leveraging the
applicability of other Federal regulations to require disclosures to
investors, and relying upon its broader enforcement powers to safeguard
against fraud at inception, and throughout the lifecycle of the 4.7
offering, as well as the ability of QEPs to demand and receive such
disclosures on their own.
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\36\ 1992 Final Rule, 57 FR at 34857.
\37\ Id. at 34858.
\38\ Id. (citing pension plan regulations as an example).
\39\ Id.
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In proposing Regulation 4.7, the Commission explained that, with
respect to its oversight of CPOs and CTAs, it had endeavored to
construct a regulatory framework that avoids unnecessary burdens
without reducing investor protection and refined that framework as
appropriate to respond to changing market conditions and to simplify
and streamline the regulatory structure without creating regulatory
[[Page 70856]]
gaps.\40\ Although the Commission expects QEPs meeting a properly
calibrated Portfolio Requirement to generally possess the level of
financial sophistication, as described by the Commission in 1992, the
Commission preliminarily concludes in this proposalthat current market
conditions and industry practices support proposing an evolved
disclosure regime in Regulation 4.7. The Commission is concerned that
the absence of minimal disclosure obligations and an ongoing
requirement to keep them accurate fails to ensure that all QEPs have
the leverage and resources to demand the information necessary for QEPs
to make informed investment decisions, or to engage in ongoing close
monitoring to confirm that the information provided remains accurate
and complete to facilitate their continued understanding of their
investments. The definition of QEP in Regulation 4.7 encompasses a
broad spectrum of market participants from large fund complexes and
other institutional investors with significant assets under management
to individuals with varying backgrounds and experience, each of which
has vastly different resources available to insist upon the disclosure
of information regarding the offered 4.7 pool or trading program and
then to analyze whatever information is provided.
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\40\ 1992 Proposed Rule, 57 FR at 3149.
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In 2014, staff in the Commission's Division of Swap Dealer and
Intermediary Oversight (DSIO) convened a roundtable on the risk
management practices of CPOs.\41\ As part of that discussion,
participants addressed the manner in which CPOs of pools that are
``Funds of Funds,'' \42\ or that allocate some or all of their assets
under management to unaffiliated asset managers, engage with their
underlying funds and asset managers. Specifically, several large CPOs
discussed the ongoing oversight that they engage in regarding their
investee funds, from analyzing past performance and understanding
liquidity limitations, both of which require a deep understanding of
the investment activities of the underlying funds, to addressing issues
of governance, organization, and staffing; these CPOs explained that
all of these efforts are undertaken to ensure that underlying
investments remain the right fit for their investor fund's strategy and
their participants.\43\ Such large asset managers have the market power
necessary to demand detailed investment information across all aspects
of their underlying funds and managers, due to their role as
gatekeepers for enormous pools of investor capital.\44\ Moreover, they
also possess the resources necessary to develop sophisticated internal
systems and technology to digest that information and engage in real-
time monitoring of whether the underlying fund or manager's actual
trading and conduct is consistent with the information being
provided.\45\ Conversely, individual natural persons, who meet the QEP
definition through the Portfolio Requirement, but nonetheless do not
command the assets of large financial institutions, likely lack the
ability to demand the same level of transparency afforded through the
prospect of additional significant asset allocations, and thus are more
likely to be reliant upon whatever information the CPO or CTA is
providing as its baseline disclosure with limited ability to demand
more, or analyze its accuracy and completeness.\46\ This perceived
disparity may increase the likelihood of CPOs and CTAs with less
rigorous risk management and controls to seek capital from such
individuals who are generally less able to engage in the same rigorous
monitoring.\47\
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\41\ Public Roundtable to Discuss Risk Management Practices by
Commodity Pool Operators (Mar. 18, 2014), available at www.cftc.gov/idc/groups/public/@newsroom/documents/file/transcript031814.pdf
(Roundtable Transcript).
\42\ ``Funds of funds'' as used in this document means pools
that invest in unrelated funds, pools, or other collective
investment vehicles.
\43\ See, e.g., id. at 31-35 (comments from representative of
UBS Alternative and Quantitative Investments); id. at 39-41
(comments from representative of Mesirow Advanced Strategies, Inc.).
\44\ See, e.g., Blackstone Alternative Asset Management, a
registered CPO, manages approximately $81bn in client assets and
uses the services of other asset managers, available at https://www.blackstone.com/our-businesses/hedge-fund-solutions-baam/
(noting, ``Our size also gives us the ability to negotiate
customized mandates and improved terms with managers,'' and touting
their ``rigorous process for evaluating managers and
opportunities''); Lighthouse Investment Partners, LLC, another
registered CPO that similarly allocates assets to other managers,
manages approximately $15bn, available at https://www.linkedin.com/company/lighthouse-investment-partners-llc and http://lighthousepar.wpengine.com/our-funds/ (noting that their portfolio
of hedge funds uses a ``proprietary managed account framework'' that
enables them to ``negotiate better terms'' and ensures that
Lighthouse retains the ``ability to revoke manager trading authority
at any time'').
\45\ Roundtable Transcript, at 40-41 (comments from
representative of Mesirow Advanced Strategies, Inc., describing how
the firm had their ``tracking index running next to their
performance at all times and if at any time their performance
deviates from that basic tracking index, [they] are on the phone
with that manager trying to understand why that happens'').
\46\ See, e.g., Herbert Moskowitz and Ari Moskowitz v.
Accredited Investment Management Corp., Peter G. Catranis, and
Russell E. Tanner, CFTC Docket Nos. 13-R15 and 13-R20, Default
Judgment, Apr. 20, 2018, available at https://www.cftc.gov/idc/groups/public%40lrdispositions/documents/legalpleading/idmoskowitz05122016.pdf (finding in favor of the plaintiffs
regarding a 4.7 CTA's failure to provide ``fair and balanced''
disclosures regarding the risks and rewards of the offered trading
program); Susan Taylor Martin, How Tampa's James Cordier went from
high roller to YouTube apology after losing $150 million, Tampa Bay
Times, Feb. 11, 2019, available at https://www.tampabay.com/business/how-tampas-james-cordier-went-from-high-roller-to-youtube-apology-after-losing-150-million-20190206/ (describing how Mr.
Cordier, according to deposition testimony from a former client,
failed to provide an accurate statement regarding the treatment of
customer funds held at a futures commission merchant and
characterized the only risk to the client's funds as ``market
risk''); Leanna Orr, Remember Wall Street's Viral Laughingstock,
OptionSeller.com?, Institutional Investor, May 13, 2020, available
at https://www.institutionalinvestor.com/article/b1lm2xg8g69vbc/Remember-Wall-Street-s-Viral-Laughingstock-OptionSeller-com (quoting
counsel to the failed 4.7 CTA's clients, many of whom were retirees,
``These people work their whole lives to make a nice middle class
life, and then the bottom drops out and they drop out of the middle
class. They don't even understand why it happened . . . They rely on
these [expletives] who said they knew what they were doing.'').
\47\ Susan Taylor Martin, How Tampa's James Cordier went from
high roller to YouTube apology after losing $150 million, Tampa Bay
Times, Feb. 11, 2019, available at https://www.tampabay.com/business/how-tampas-james-cordier-went-from-high-roller-to-youtube-apology-after-losing-150-million-20190206/ (reciting allegations
from a complaint against a 4.7 CTA stating that the CTA promised
``fastidious'' risk management, but failed to hedge its naked
options appropriately for the risk profile of its clients).
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Moreover, particularly once their relationship with a CPO or CTA is
established, QEPs of all types may have diminished power over time to
demand the same level of information about their investments as they
had received at the outset, due to the presence of lock-up periods or
infrequently permitted redemptions that may require extended notice
periods following initial investment.\48\ The Commission understands
that, with respect to CPOs and CTAs who claim and operate under
Regulation 4.7 exemptions, NFA staff has observed situations where the
quality and provision of the information presented to the customer may
be inconsistent.\49\ The Commission preliminarily believes that these
factors warrant reconsideration of the disclosure exemptions.
Furthermore,
[[Page 70857]]
these circumstances, acting together, could foster an environment in
which QEPs seeking to participate in a pool or advisory program must
choose between a very limited number of offerings subject to the full
panoply of compliance requirements under part 4 that provide them with
more complete and regular information about their holdings, or a more
varied and growing collection of QEP offerings, with substantially
lower compliance obligations and no formal regulatory requirements with
respect to disclosure that would ensure QEPs receive consistent,
accurate, and current information about these products.
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\48\ See, e.g., In the Matter of: Highland Quantitative Driven
Investments LLC and Michael Todd Zatorski, NFA Case No. 20-BCC-004
(alleging that the named CPO and its principal failed to update
their private placement memoranda, and thereby inform their current
and prospective 4.7 pool participants, with respect to significantly
increased fees, while simultaneously imposing a one- to two-year
lock up period, which foreclosed the possibility of threatening to
withdraw their capital contributions absent updated disclosures).
\49\ See id.; see also U.S. CFTC v. Mankad, 2022 WL 17752224
(D.C. Ariz. Oct. 19, 2022) (finding that the defendant and his CPO
failed to update the private placement memorandum for its 4.7 pool
following changes to their trading strategy).
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In addition to the aforementioned concerns about the unequal
bargaining power of QEPs, in the 30 years since that provision was
adopted, the Commission has, as described above, witnessed a
significant expansion and growth in the complexity and diversity of
commodity interest products offered to QEPs via 4.7 pools and trading
programs, as well as an expansion in the asset classes subject to the
Commission's jurisdiction and oversight. Broadly speaking, since the
CFTC's authority over swaps and the swap markets was expanded under the
Dodd-Frank Act, there has been a considerable change in the way that
swaps trade. For example, when Regulation 4.7 was adopted in 1992,
swaps trading occurred over-the-counter and the total estimated size of
the market was approximately $9T in today's dollars; \50\ whereas,
after the Dodd-Frank Act's implementation, many swaps products are
exchange-traded and the total size of the swaps market has increased
exponentially,\51\ and many CPOs and CTAs today incorporate swaps into
the portfolios of their pools and trading programs. Regarding the
products themselves, there has also been considerable development of
new and complex commodity interest products.\52\
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\50\ See Adam R. Waldman, OTC Derivatives and Systemic Risk:
Innovative Finance or the Dance into the Abyss?, 43 a.m. U. L. Rev.
1023, 1025 n.5 (1994) (citing Andrew Barry, BARRON'S, Sept. 13,
1993, at 49, reporting a swaps market size of $3.8T, as compiled by
the International Swaps and Derivatives Association, Inc. (ISDA),
which equates to roughly $8.8T based on CPI-U).
\51\ See the ISDA SwapsInfo First Quarter 2023 Review, May 2023,
available at https://www.isda.org/2023/05/02/swapsinfo-first-quarter-of-2023-review-summary/ (stating that the interest rate
derivatives market alone was valued at $106.1T notional in the first
quarter of 2023); Bank for International Settlements, ``OTC
derivatives statistics at end-June 2022,'' available at https://www.bis.org/publ/otc_hy2211.pdf (stating that ``the notional value
of outstanding over-the-counter (OTC) derivatives rose to $632
trillion at end-June 2022, up from $598 trillion at end-2021'').
\52\ Most notable, and as widely covered in the press, is the
recent development and availability of commodity interest products
linked to digital assets, such as bitcoin, discussed infra.
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Although the Commission in 1992 considered the commodity interest
products then available in developing existing customer protections for
QEPs in Regulation 4.7, product innovation in the commodity interest
markets has continued at a rapid and unrelenting pace \53\ raising
concern that certain QEP participants and clients may not have the
level of information necessary to fully appreciate the nature of the
risk associated with their trading. For example, futures are now
available on digital assets, which, although subject to the same
regulatory regime as other futures products, often experience higher
levels of volatility than more traditional commodity reference
assets.\54\ Moreover, the technology underlying these assets is highly
complex, subject to rapid innovation, and can pose substantially
different principal risks as compared to traditional commodities,
including unique cybersecurity risks and the potential for hacks and
vulnerabilities in the storage and transmission of these assets. Given
the relatively recent development of digital assets, it remains unclear
as to whether the underlying markets, to which the futures and other
derivatives are tied, are subject to market fundamentals similar to
those of the traditional commodities markets. The Commission
preliminarily believes that this can result in unpredictable movements
in both the spot and commodity interest markets. As the financial
system continues to experience a period of rapid evolution in the era
of artificial intelligence and other technological advancements, the
Commission expects to see continued development of novel investment
products that, although structured like the traditional asset classes
enumerated under the CEA, may in fact deviate from the typical
operations of markets now subject to the Commission's oversight. In
view of these developments, the Commission believes that minimum
disclosure requirements are essential to ensure that pool participants
and advisory clients fully understand the risks associated with their
investments.
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\53\ See Katherine Ross, CME Group to add ether/bitcoin ratio
futures in July pending regulatory approval, Blockworks, June 29,
2023, available at https://blockworks.co/news/cme-adds-ether-bitcoin-ratio-futures.
\54\ The risks of these products to investors are of such
concern that the CFTC and SEC have both acknowledged their
volatility in various publications. In fact, and most relevant to
this discussion, the SEC and CFTC released a joint investor alert to
investors thinking about investing in a fund with exposure to
bitcoin futures. The alert emphasized that investors should
understand the unique characteristics and heightened risks compared
to other funds. See CFTC/SEC Investor Alert: Funds Trading in
Bitcoin Futures, available at https://www.cftc.gov/LearnAndProtect/AdvisoriesAndArticles/fraudadv_funds_trading_in_bitcoin_futures.html. Although these are
not the only new products that have launched over the last 30 years,
the Commission believes they are examples that highlight a need for
updating the customer protections provided under Regulation 4.7. See
Hannah Smith, Bitcoin crash: what was behind the crypto collapse?,
The Times (May 22, 2023), available at https://www.thetimes.co.uk/money-mentor/article/is-bitcoin-crash-coming/#Why-is-bitcoin-so-volatile? (noting that bitcoin ``has no underlying asset'' and that
``means that the movements in its price are solely based on
speculation among investors about whether it will rise or fall in
the future''); Nicole Lapin, Explaining Crypto's Volatility, Forbes
(Dec. 23, 2021), available at https://www.forbes.com/sites/nicolelapin/2021/12/23/explaining-cryptos-volatility/?sh=1640938f7b54 (noting that ``it isn't intrinsically valuable,''
which ``means the investment's value isn't very grounded, which
makes its price incredibly sensitive to even slight changes in
investors' expectations or perceptions'').
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In addition to developments regarding products, market structure
has also evolved in the years following the initial adoption of
Regulation 4.7. Commodity pools and CTA advisory clients can access the
futures markets either directly \55\ or through an FCM, which present
different risks and benefits to pool participants and advisory clients.
Where FCMs are not part of the market structure, there may be fewer
independent sources of information available to pool participants and
advisory clients, making it even more important that QEPs receive full
and accurate information regarding the risks related to their
investments.
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\55\ See, e.g., In the Matter of the Application of LedgerX, LLC
For Registration as a Derivatives Clearing Organization, Amended
Order of Registration, available at https://www.cftc.gov/media/4556/ledgerxllcamededdcoorder9-2-2020/download.
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Thus, given these developments in the commodity interest markets,
among others, and similar to the circumstances underlying the 1992
Final Rule, with respect to Regulation 4.7, the Commission continues
seeking to construct a regulatory framework that avoids unnecessary
burdens without reducing investor protection and to respond to changing
market conditions without creating regulatory gaps.\56\ The Commission
preliminarily believes that requiring the provision of specific minimum
disclosures for CPOs and CTAs operating 4.7 pools and trading programs
will assist in mitigating the customer protection gaps that have
developed since 1992 by ensuring that QEPs receive the information
necessary to make informed investment decisions,
[[Page 70858]]
and that such disclosures are subject to Commission and NFA oversight.
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\56\ 1992 Proposed Rule, 57 FR at 3149.
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Importantly, the Commission does not intend this NPRM to dissuade
registered CPOs and CTAs from structuring their pools and trading
programs to qualify for and utilize the exemptions in Regulation 4.7.
Rather, the Commission preliminarily believes that, as a result of the
changing market conditions described above, an evolved approach to QEP
Disclosures under Regulation 4.7 is necessary to ensure that QEPs
consistently receive specific, baseline information with respect to
their investments in the commodity interest markets, and further, that
such proposed regulatory adjustments would not greatly reduce the
benefits intermediaries currently derive from relying upon the relief
in Regulation 4.7.
With this Proposal, the Commission is not proposing to rescind the
disclosure exemptions in Regulations 4.7(b)(2) and (c)(1) in their
entirety. Rather, the Commission aims to make targeted updates to these
provisions that are designed to enhance customer protection,
transparency, and fairness within the market of 4.7 pools and trading
programs. The proposed amendments are intended to: (1) recognize the
increasingly complex and diverse commodity interest investment products
offered to QEPs today, and reflect the resulting evolution in view by
the Commission that requiring basic disclosures to encourage informed
investment decisions is the necessary and preferred approach for 4.7
pools and trading programs; (2) create a formalized Commission
regulatory regime for promotional, advertising, and disclosure
practices for CPOs and CTAs relying on Regulation 4.7 with respect to
their QEP offerings, allowing for prospective and current participants
and clients to better compare strategies, fees, and other
characteristics of 4.7 pools and trading programs through consistent
QEP Disclosures; and (3) strengthen intermediary oversight by
incorporating the review of QEP Disclosures into existing examination
processes used by the Commission and NFA, which, in turn, would
increase their accuracy and quality over time.
By creating a formalized regulatory regime in part 4 for the
promotional, advertising, and disclosure practices of CPOs and CTAs
with respect to their 4.7 pools and trading programs, the Commission
preliminarily believes that this would strengthen its oversight of CPOs
and CTAs relying on Regulation 4.7 and that QEPs and the commodity
interest markets overall would benefit as a result. The promotional,
advertising, and disclosure practices of CPOs and CTAs utilizing
Regulation 4.7 have changed a great deal since the original adoption of
these exemptions. The Commission has observed that, despite there being
no such requirements in Regulation 4.7, many CPOs and CTAs currently
provide and distribute some disclosures and information regarding their
4.7 pools and trading programs to prospective QEP pool participants and
advisory clients. These QEP Disclosures are commonly delivered in the
form of private placement memoranda or trading program brochures, and
typically include much of the information the Commission is proposing
to require in this rule proposal. This practice results both from
investor demand seeking to understand the 4.7 pools and trading
programs offered in the current marketplace, as described above, as
well as the requirements of other applicable regulatory regimes, like
the Federal securities laws.\57\ The Commission notes, however, that
some CTAs, which are not also regulated as registered investment
advisers by the SEC, may not be otherwise required to provide any
disclosures and may, in fact, only provide cursory promotional
material.
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\57\ See, e.g., Rule 502(b)(2) of Regulation D, 17 CFR
230.502(b)(2) (requiring certain disclosures for offerings under
Rule 506(b) of Regulation D, 17 CFR 230.506(b)). Additionally, many
CPOs and CTAs operating under Regulation 4.7 are also registered
with the SEC as investment advisers. All investment advisers
registered with the SEC under the IAA, 15 U.S.C. 80b-1, et seq., are
required to comply with the applicable disclosure requirements under
the IAA and the SEC's regulations promulgated thereunder, regardless
of the financial sophistication of any or all of their clients.
Conversely, ``Exempt Reporting Advisers'' have limited reporting
requirements with the SEC under the IAA, but otherwise are not
required to register, and therefore, are not required to comply with
the disclosure requirements imposed on registered investment
advisers. See 15 U.S.C. 80b-3(l) and (m) (providing registration
exemptions for advisers to venture capital funds and certain
advisers to private funds).
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The Commission preliminarily believes that establishing minimum
content requirements would ensure that existing QEP Disclosures are
consistent in structure, accurate, kept up-to-date, and contain
materially complete information regarding 4.7 pools and trading
programs. As a result, current and prospective QEP participants and
clients would be able to better compare investment programs, trading
strategies, fees, and other characteristics of 4.7 pools and trading
programs. Additionally, even if the QEP Disclosures provided by CPOs
and CTAs relying upon Regulation 4.7 differ in form and detail, the
minimum required disclosures proposed in this NPRM would result in all
QEPs receiving the same level of basic information prior to making an
investment decision. The Commission preliminarily concludes that
replacing the existing broad exemptions with a targeted minimum
disclosure regime under Regulation 4.7 will ultimately bring discipline
to the current ad hoc QEP Disclosure process, resulting in more uniform
and consistent disclosures for prospective and current QEP advisory
clients and pool participants.
Finally, the Commission believes that amending Regulation 4.7 to
require CPOs and CTAs to disclose certain information about their 4.7
pools and trading programs, as well as to keep such QEP Disclosures as
business records, would facilitate more effective oversight of
registered CPOs and CTAs and their offerings by the Commission and NFA.
The Commission expects that creating a formalized, affirmative
regulatory requirement that materially accurate QEP Disclosures be
delivered and kept current, would likely enhance investor confidence in
commodity interest products generally by providing an increased level
of transparency for the Commission and NFA into these registrants'
activities for examination and enforcement purposes, thereby improving
oversight.\58\ Moreover, by facilitating Commission and NFA access to
QEP Disclosures kept amongst CPO and CTA business records, the
Commission believes that the proposed affirmative recordkeeping
requirements in Regulations 4.7(b)(5) and (c)(2) would serve as an
additional deterrent to CPOs or CTAs engaging in fraud or providing
misleading representations in QEP Disclosures.
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\58\ The Commission notes here its belief and understanding that
the current applicable requirement that any information in QEP
Disclosures a CPO or CTA decides to provide is, ``in the context in
which it is furnished, not misleading'' is fundamentally different
and a much lower standard than the proposed requirement that QEP
Disclosures be generally required and regularly updated so that they
remain ``materially accurate and complete.''
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The amendments proposed in this NPRM strike an appropriate balance,
in the Commission's opinion, by establishing minimum content
requirements for QEP Disclosures regarding 4.7 pools and trading
programs, and mandating that they be kept as business records of the
intermediary, while still retaining exemptions from the provisions of
part 4 that require filing and pre-approval of non-4.7 Disclosure
Documents by the Commission and NFA.\59\ These proposed amendments
would elevate the disclosure provided for 4.7 pools and trading
programs to a higher
[[Page 70859]]
standard than that imposed on non-required promotional material under
Regulation 4.41.\60\ In particular, the Commission believes that, if
adopted, these amendments would permit it and NFA to monitor and assess
the accuracy of distributed QEP Disclosures, as compared to a CPO's or
CTA's actual trading activities, via existing examination processes, as
well as through comparison to information these intermediaries
regularly provide in other filings, like Forms CPO-PQR and/or CTA-PR.
Having the ability to review QEP Disclosures during routine
examinations, combined with an affirmative requirement that CPOs and
CTAs provide information that is materially complete, accurate and up-
to-date, would, in the Commission's preliminary opinion, provide the
CFTC and NFA with an additional level of oversight that simply does not
exist under the current regulatory framework. Moreover, the Commission
further preliminarily believes that QEP Disclosures would likely
qualitatively improve over time, should these proposed amendments be
adopted, by virtue of the QEP Disclosures being regularly examined and/
or reviewed by Commission and NFA staff possessing the unique, deep
subject matter expertise with respect to commodity interests that other
Federal agencies simply do not and are not reasonably expected to
possess.
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\59\ See, e.g., 17 CFR 4.26(d).
\60\ 17 CFR 4.41.
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Among the existing disclosures outlined in part 4 for registered
CPOs and CTAs not claiming Regulation 4.7, the Commission believes that
both the general disclosures, as described in Regulations 4.24 and
4.34, and performance disclosures, as described in Regulations 4.25 and
4.35, form the foundational level of information about a pool's or
advisory program's trading strategies, material risks, fees, and
conflicts associated therewith; furthermore, the Commission
preliminarily believes that disclosure by a CPO or CTA is the primary
source of information a prospective or actual participant or client
would rely upon to make an appropriately informed investment decision,
even for those financially sophisticated persons who are QEPs.
Specifically, the subset of general disclosures listed in Regulations
4.24 and 4.34 that the Commission is proposing to now be required for
4.7 pools and trading programs would provide prospective QEP pool
participants and clients with important information on principal risk
factors, investment programs, use of proceeds, custodians, fees and
expenses, and conflicts of interest. The subset of performance
disclosures from Regulations 4.25 and 4.35 that the Commission is
proposing to require would further involve the presentation of vital
current and past performance metrics in a format consistent with that
already developed for non-QEP pool participants and advisory clients.
Combined, the Commission intends the proposed addition of these
disclosures to Regulation 4.7 to both provide appropriate customer
protection safeguards and to support its intermediary oversight through
methods that have been assessed and further developed since their
adoption, nearly thirty years ago.\61\
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\61\ The Commission notes that it developed these part 4
required disclosures originally in response to changing market
conditions and to implement its statutory mandates in regulating and
overseeing CPO and CTA activities. In fact, in the final rule
establishing the initial requirements under Regulations 4.24, 4.25,
4.34, and 4.35, the Commission explicitly highlighted that, since
the adoption of the part 4 framework, the number of registered CPOs
had more than doubled and the number of CTAs had increased
threefold; assets under the management of CPOs had grown
dramatically; and the range of available futures and option
contracts had increased substantially. 60 FR 38147 (July 25, 1995)
(1995 Final Rule). This justification, cited in 1995, is arguably
even more relevant to today's CPO and CTA population using
Regulation 4.7 because the growth of that specific category of
intermediaries and that sector of the commodity interest markets has
continued significantly since the 1995 Final Rule.
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The Commission requests comment on all aspects of the proposed
amendments outlined below that would require certain information be
disclosed to prospective QEP pool participants and advisory clients
under Regulation 4.7, that QEP Disclosures are regularly updated and
materially complete, and that they be included in the business records
of CPOs and CTAs claiming Regulation 4.7 exemptions. In addition, the
Commission seeks comment on the following questions:
1. Should the Commission increase or decrease the types of
information included in Proposed Regulations 4.7(b)(2) and (c)(1)? In
particular, should additional disclosure requirements listed in
Regulations 4.24 and 4.34 be included for CPOs and CTAs, respectively?
If so, what disclosures?
2. The Commission is seeking specific data or information
regarding: (i) the current number of CPOs and CTAs utilizing Regulation
4.7 that provide the proposed minimum disclosures to their QEP
participants and clients; (ii) the level of disclosure currently
provided by CPOs and CTAs to their QEP participants and clients; (iii)
if disclosures are provided, the general format, tenor, and manner used
in both structuring and delivering the disclosures; and (iv) the
context and timing of when any such disclosures are provided (e.g.,
whether during solicitation or otherwise during the course of the
investment relationship).
3. What specific challenges would CPOs and CTAs face in complying
with the disclosure requirements in Proposed Regulations 4.7(b)(2) and
(c)(1)? Should the Commission consider an implementation period for the
proposed amendments, and if so, how much time should the Commission
allow for CPOs and CTAs to develop and prepare QEP Disclosures that
would comply with the proposed amendments?
The following sections explain the proposed amendments in more
detail.
i. Proposed Amendments to Regulations 4.7(b)(2) and (b)(5)
The Commission is proposing to amend the disclosure relief outlined
in Regulations 4.7(b)(2)(i) and (ii) to require CPOs to deliver to
their 4.7 pools' prospective participants QEP Disclosures that
enumerate certain specific disclosures, including descriptions of the
4.7 pool's principal risk factors, its investment program, use of
proceeds, custodians, fees and expenses, conflicts of interest, and
certain performance disclosures, including basic past performance
information. As a consequence of requiring these minimum disclosures
for 4.7 pools, the Commission is also proposing a corresponding
amendment to remove the exemption from disclosing the past performance
of 4.7 pools in the Disclosure Documents of non-4.7 pools. That
provision had been proposed and adopted ``in connection with'' the
previous policy position that 4.7 pools had no minimum or mandatory
disclosure requirements,\62\ which the Commission, as just discussed,
now seeks to change through the amendments in this NPRM; the Commission
further preliminarily believes such information would be valuable to
commodity pool participants of all types. Finally, the Commission
proposes to amend Regulation 4.7(b)(5) to additionally require that
CPOs maintain such QEP Disclosures among the other books and records of
their 4.7 pools, and made available upon request to the Commission,
NFA, and the U.S. Department of Justice, in accordance with Regulation
1.31.\63\
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\62\ 1992 Proposed Rule, 57 FR at 3151; 1992 Final Rule, 57 FR
at 34858.
\63\ 17 CFR 1.31.
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As proposed, Regulation 4.7(b)(2)(i) would no longer provide an
exemption from Regulation 4.21, and instead of requiring compliance
with Regulations
[[Page 70860]]
4.24 and 4.25 in their entirety, the proposed amendments include new
Regulations 4.7(b)(2)(i)(A) through (E) that enumerate the specific
disclosures the Commission preliminarily believes prospective QEP pool
participants should receive, and that incorporate certain subparagraphs
of those part 4 disclosure regulations by reference. As mentioned
above, the specific disclosures proposed to be required for 4.7 pools
include: descriptions of the 4.7 pool's principal risk factors, its
investment program, use of proceeds, custodians, fees and expenses,
conflicts of interest, and certain performance disclosures, including
past performance. Importantly, the Commission is not proposing to
require that CPOs provide QEP Disclosures identical to the Disclosure
Documents subject to the full panoply of requirements under Regulations
4.24 and 4.25. Rather, the Commission has specifically chosen what it
believes to be the most meaningful and important information for
prospective QEP pool participants, and is proposing to require that
CPOs provide this information in QEP Disclosures, subject to the
substance and formatting requirements of Regulations 4.24 and 4.25. The
Commission is also proposing to retain, but reformat, the existing
language in Regulation 4.7(b)(2)(i) into Proposed Regulations
4.7(b)(2)(i)(F) and (G). Proposed Regulation 4.7(b)(2)(i)(F) would
include the requirement that QEP Disclosures provide all disclosures
necessary to make the information contained therein, in the context in
which it is furnished, not misleading, and Proposed Regulation
4.7(b)(2)(i)(G) would continue to require a form disclaimer like that
currently required by Regulation 4.7(b)(2)(i).
Furthermore, it is crucial that QEP Disclosures used and
distributed by CPOs be kept current and that they be maintained as
business records to ensure compliance with the proposed general and
performance disclosure requirements and to facilitate Commission and
NFA oversight of these intermediaries. The Commission is therefore
proposing to amend Regulation 4.7(b)(5) to require that QEP Disclosures
be maintained among a CPO's other books and records for a 4.7 pool and
made available to any representative of the Commission, NFA, or the
U.S. Department of Justice in accordance with Regulation 1.31. This
amendment would allow the Commission and NFA to review QEP Disclosures
as part of routine examinations and civil enforcement actions. Finally,
Proposed Regulation 4.7(b)(2)(i) no longer provides an exemption from
Regulation 4.26 in its entirety; the Commission is proposing to
restrict this exemption to Regulation 4.26(d) only, such that
compliance with Regulations 4.26(a) through (c), provisions that
generally govern the use and amendment of this information, would
otherwise be required. Because the Commission is not proposing to
require that QEP Disclosures for 4.7 pools be filed and approved by NFA
prior to their first use, Proposed Regulation 4.7(b)(2)(i) retains an
exemption from Regulation 4.26(d).
A. Principal Risk Factors
The Commission is proposing to add Proposed Regulation
4.7(b)(2)(i)(A) that would require QEP Disclosures distributed in
connection with soliciting prospective participants in a 4.7 pool to
include a description of the principal risk factors as required by
Regulation 4.24(g). Specifically, Regulation 4.24(g) requires CPOs to
describe, in their Disclosure Documents, the principal risk factors of
a pool investment including, without limitation, risks relating to
volatility, leverage, liquidity, counterparty creditworthiness, as
applicable to the types of trading programs to be followed, trading
structures to be employed and investment activity (including retail
forex and swap transactions) expected to be engaged in by the offered
pool.\64\ Proposed Regulation 4.7(b)(2)(i)(A) would incorporate
Regulation 4.24(g) by reference and would similarly require CPOs to
provide a description of their 4.7 pool's principal risk factors in
their QEP Disclosures.
---------------------------------------------------------------------------
\64\ 17 CFR 4.24(g).
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B. Investment Program and Use of Proceeds
The Commission is also proposing to require that QEP Disclosures
include the information mandated by Regulation 4.24(h), i.e., a 4.7
pool's investment program, custodians, and use of proceeds.
Specifically, Regulation 4.24(h) requires CPOs to disclose: (1) the
types of commodity interests and other interests which the pool will
trade; (2) a description of the trading and investment programs and
policies that will be followed by the offered pool; (3) a summary
description of the pool's major CTAs, including their respective
percentage allocations of the pool assets and a description of the
nature and operation of the trading programs such CTAs will follow; (4)
a summary description of the pool's major investee pools or funds,
including their respective percentage allocations of pool assets and a
description of the nature and operation of such investee pools and
funds; and (5) certain use of proceeds information, including the
manner in which the pool will fulfill its margin requirements, the
percentage of the pool's assets held in segregation pursuant to the
CEA, and information regarding to whom income from margin or security
deposits will be paid.\65\ Additionally, Regulation 4.24(h)(1)(iii)
requires CPOs to disclose both the types of commodity interests and
other interests the pool will be trading, including the custodian or
other entity (e.g., bank or broker-dealer) that will hold such
interests, and if such interests will be held in jurisdictions outside
of the United States, the jurisdiction in which such interests or
assets will be held.\66\ Proposed Regulation 4.7(b)(2)(i)(B) would
require QEP Disclosures to include the information described above by
incorporating Regulation 4.24(h) by reference.
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\65\ 17 CFR 4.24(h).
\66\ 17 CFR 4.24(h)(1)(iii).
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C. Fees and Expenses
The Commission is also proposing to require that CPOs disclose
information regarding their fees and expenses for their 4.7 pools in a
manner consistent with Regulation 4.24(i). Regulation 4.24(i) requires
CPOs to provide a complete description of each fee, commission, and
other expense, which the CPO knows or should know has been incurred by
the pool for its preceding fiscal year and is expected to be incurred
by the pool in its current fiscal year, including fees and other
expenses incurred in connection with the pool's participation in
investee pools and funds.\67\ Proposed Regulation 4.7(b)(2)(i)(C) would
incorporate Regulation 4.24(i) by reference and require, without
limitation, the disclosure of all the fees specifically enumerated in
Regulation 4.24(i), subject to the other provisions therein, including
the requirement to provide, in a tabular format, an analysis setting
forth how the break-even point for a 4.7 pool was calculated, including
all fees, commissions, and other expenses of the 4.7 pool.
---------------------------------------------------------------------------
\67\ 17 CFR 4.24(i)(1).
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D. Conflicts of Interest
The Commission is proposing to amend Regulation 4.7(b)(2)(i) to
require the disclosure of conflicts of interest in QEP Disclosures for
4.7 pools, as required by Regulation 4.24(j). Regulation 4.24(j)
requires CPOs to provide a full description of any actual or potential
conflicts of interest
[[Page 70861]]
regarding any aspect of the pool on the part of: (1) the CPO; (2) the
pool's trading manager, if any; (3) any major CTA; (4) the CPO of any
major investee pool; (5) any principal of the foregoing; and (6) any
other person providing services to the pool, soliciting participants
for the pool, acting as a counterparty to the pool's retail forex or
swap transactions, or acting as a swap dealer with respect to the
pool.\68\ Additionally, Regulation 4.24(j) requires the disclosure of
any other material conflict involving the offered pool, as well as a
description of any arrangements described in Regulation 4.24(j)(3).\69\
Proposed Regulation 4.7(b)(2)(i)(D) would incorporate Regulation
4.24(j) by reference, requiring comparable disclosure of these
conflicts of interest by CPOs with respect to their 4.7 pools.
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\68\ 17 CFR 4.24(j).
\69\ 17 CFR 4.24(j)(2) and (3). Regulation 4.24(j)(3) requires a
description of the conflicts of interest of any arrangements whereby
someone may benefit, directly or indirectly, from the pool's account
maintenance with an FCM or RFED; from maintenance of the pool's swap
positions with a swap dealer; from the introduction of the pool's
account by an introducing broker to an FCM, RFED, or swap dealer; or
from the investment of the pool's assets in other investee pools or
funds or other investments. 17 CFR 4.24(j)(3).
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E. Past Performance of 4.7 Pools
The Commission is further proposing to require CPOs to disclose
certain performance information as required by Regulation 4.25 in the
QEP Disclosures for their 4.7 pools. Specifically, the Commission is
proposing to partially remove the existing complete exemption from
Regulation 4.25 by requiring CPOs to disclose all performance
information listed under Regulation 4.25 with respect to their 4.7
pools, with the exception of performance information for pools other
than the 4.7 pool. Regulation 4.25 requires CPOs to include capsule
performance information for both pools and accounts, subject to certain
presentation and content requirements outlined in paragraph (a) of that
section.\70\ Regulation 4.25(a) also provides requirements for the time
period for required performance, trading programs, the calculation of
and recordkeeping concerning performance information, proprietary
trading results, as well as a legend for all performance disclosures,
whether mandatory or voluntary, that is prominently displayed and
states, ``PAST PERFORMANCE IS NOT INDICATIVE OF FUTURE RESULTS.'' \71\
Among the additional requirements within Regulation 4.25, paragraph
(a)(3) requires CPOs to disclose certain past performance information
for pools other than the offered pool. Finally, Regulations 4.25(b) and
(c) clarify and establish the required performance disclosures for
offered pools that have at least a three-year operating history, and
for those with less than a three-year operating history,
respectively.\72\ For the purposes of targeting this NPRM to requiring
performance disclosures the Commission preliminarily believes are most
important and valuable to prospective QEP participants, and to lessen
the potential burden on CPOs resulting from incorporating minimum QEP
Disclosures in Regulation 4.7, the Commission is not proposing to
require that CPOs of 4.7 pools provide the disclosures referenced in
paragraphs (a)(3) or (c)(2) of Regulation 4.25 regarding past
performance information for pools other than the 4.7 pool in their QEP
Disclosures, which the Commission preliminarily believes strikes the
appropriate balance of these potentially competing interests.
Therefore, Proposed Regulation 4.7(b)(2)(i) would no longer provide the
specific exemption from Regulation 4.25, and the Commission is
proposing to add Regulation 4.7(b)(2)(i)(E), which would require QEP
Disclosures to include performance disclosures that comply with
Regulation 4.25, except paragraphs (a)(3) and (c)(2) of that section.
---------------------------------------------------------------------------
\70\ 17 CFR 4.25.
\71\ 17 CFR 4.25(a).
\72\ 17 CFR 4.25(b) and (c).
---------------------------------------------------------------------------
ii. Proposed Amendments to Regulations 4.7(c)(1) and (c)(2)
Consistent with the proposed amendments regarding additional
disclosures for 4.7 pools discussed above, the Commission is also
proposing to specifically enumerate additional disclosure requirements
for 4.7 trading programs in Regulation 4.7(c)(1). Specifically,
Proposed Regulation 4.7(c)(1)(i) would no longer provide an exemption
from Regulation 4.31, and, in lieu of requiring compliance with
Regulations 4.34 and 4.35 in their entirety, the Commission is
proposing to enumerate specific disclosure requirements it wishes to
prioritize for 4.7 trading programs. Proposed Regulation 4.7(c)(1)(i)
would also include new paragraphs (c)(1)(i)(A) through (F) that list
the specific disclosures the Commission is proposing to require for
CTAs and their 4.7 trading programs, including descriptions of certain
persons to be identified, the principal risk factors of the investment,
the CTA's trading program, fees, conflicts of interest, and performance
disclosures. The Commission also proposes to relocate the existing
disclosure requirements in current Regulation 4.7(c)(2)(i) into
Proposed Regulations 4.7(c)(2)(i)(G) and 4.7(c)(2)(i)(H). Proposed
Regulation 4.7(c)(2)(i)(G) continues to require that QEP Disclosures
provide all additional disclosures necessary to make the information
contained therein, in the context in which it is furnished, not
misleading, and Proposed Regulation 4.7(c)(2)(i)(H) continues to
require a form statement like that currently required by Regulation
4.7(c)(1)(i).
Additionally, the Commission is proposing to remove the exemption
from disclosing past performance of 4.7 trading programs in the
Disclosure Documents of non-4.7 trading programs. That provision had
been proposed and adopted in connection with the previous policy
position that 4.7 trading programs offered by CTAs had no minimum or
mandatory disclosure requirements for their prospective QEP advisory
clients, which the Commission is proposing to change through this NPRM.
Moreover, the Commission preliminarily believes such information would
be valuable to all prospective CTA clients, regardless of their
sophistication or experience, and therefore, proposes to require more
complete disclosure of a CTA's programs, whether 4.7 or not, in
Disclosure Documents provided to non-QEP advisory clients.
Further, as discussed in relation to 4.7 pools above, the
Commission preliminarily believes that it is crucial that QEP
Disclosures used by CTAs be maintained as business records of the CTA
to ensure compliance with the general and performance disclosure
requirements proposed in this NPRM and to facilitate Commission and NFA
oversight of these intermediaries. Therefore, the Commission is also
proposing to amend Regulation 4.7(c)(2), such that CTAs would be
required to maintain the QEP Disclosures among the other books and
records for their 4.7 trading programs, making them available to the
Commission, NFA, and the U.S. Department of Justice, in accordance with
Regulation 1.31. Finally, Proposed Regulation 4.7(c)(1)(i) would also
no longer provide an exemption from Regulation 4.36 in its entirety;
the Commission is proposing to restrict this exemption to Regulation
4.36(d) only, such that compliance with Regulations 4.36(a) through
(c), provisions that generally govern the use and amendment of this
information, would be required. Because the Commission is not proposing
to require that QEP
[[Page 70862]]
Disclosures used by CTAs for their 4.7 trading programs be filed and
approved by the Commission or NFA prior to their first use, Proposed
Regulation 4.7(c)(1)(i) purposefully retains an exemption from
Regulation 4.36(d).
A. ``Persons To Be Identified''
The Commission is proposing to require that CTAs provide their
prospective QEP clients with information on certain persons to be
identified, as mandated by Regulation 4.34(e). Specifically, Regulation
4.34(e) requires CTAs to identify by name each principal of the CTA,
the FCM and/or RFED with which the CTA will require its client to
maintain an account, and the introducing broker through which the CTA
will require the client to introduce its account (or, if the client is
free to choose which FCM, RFED, or introducing broker it uses, then a
statement to that effect).\73\ Proposed Regulation 4.7(c)(1)(A) would
incorporate Regulation 4.34(e) by reference and require CTAs offering
4.7 trading programs to identify the persons listed therein in their
QEP Disclosures in the same manner as required for non-4.7 trading
programs under part 4.
---------------------------------------------------------------------------
\73\ 17 CFR 4.34(e).
---------------------------------------------------------------------------
B. Principal Risk Factors
The Commission is proposing to require that QEP Disclosures contain
a discussion of the 4.7 trading program's principal risk factors,
identical to that required by Regulation 4.34(g). Regulation 4.34(g)
requires CTAs to discuss in their Disclosure Documents the principal
risk factors of their trading programs, including, without limitation,
risks due to volatility, leverage, liquidity, and counterparty
creditworthiness, as applicable to the offered trading program and the
types of transactions and investment activity expected to be engaged in
pursuant to such program (including retail forex and swap transactions,
if any).\74\ Proposed Regulation 4.7(c)(1)(i)(B) would incorporate
Regulation 4.34(g) by reference, and thus require CTAs to similarly
discuss in QEP Disclosures their 4.7 trading programs' principal risk
factors.
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\74\ 17 CFR 4.34(g).
---------------------------------------------------------------------------
C. Description of the 4.7 Trading Program
The Commission is also proposing to require CTAs to provide in
their QEP Disclosures a description of the 4.7 trading program as
required by Regulation 4.34(h). Regulation 4.34(h) requires CTAs to
include a description of their trading programs in their Disclosure
Documents; such description must include: (1) the method chosen by the
CTA concerning how FCMs and/or RFEDs carrying accounts it manages treat
offsetting positions pursuant to Regulation 1.46, if the method is
other than to close out all offsetting positions or to close out
offsetting positions on other than a first-in, first-out basis; and (2)
the types of commodity interests and other interests the CTA intends to
trade, with a description of any restrictions or limitations on such
trading established by the CTA or otherwise.\75\ Proposed Regulation
4.7(c)(1)(i)(C) would incorporate Regulation 4.34(h) by reference, and
thus require CTAs to provide the same description of their 4.7 trading
programs in QEP Disclosures.
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\75\ 17 CFR 4.34(h).
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D. Fees
The Commission is further proposing to require CTAs to provide in
the QEP Disclosures a description of each fee they will charge QEP
advisory clients, as required by Regulation 4.34(i). Regulation 4.34(i)
requires CTAs to include within their Disclosure Documents a complete
description of fees they will charge their clients. Pursuant to this
requirement, the description must specify the dollar amount of each
fee, wherever possible, and must provide additional detail and
explanation of certain fees, where the fees are dependent on
specifically listed base amounts, or on any increase in a client's
commodity interest account.\76\ Proposed Regulation 4.7(c)(1)(i)(D)
would incorporate Regulation 4.34(i) by reference, and thus require
CTAs offering 4.7 trading programs to provide the same description of
their fees in QEP Disclosures.
---------------------------------------------------------------------------
\76\ 17 CFR 4.34(i).
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E. Conflicts of Interest
With respect to conflicts of interest, the Commission is proposing
to require CTAs offering 4.7 trading programs to disclose their
conflicts of interest as required by Regulation 4.34(j) in their QEP
Disclosures. Regulation 4.34(j) requires CTAs to include a full
description of any actual or potential conflicts of interest regarding
any aspect of their trading programs on the part of: (1) the CTA; (2)
any FCM and/or RFED with which the client will be required to maintain
its commodity interest account; (3) any introducing broker through
which the client will be required to introduce its account to an FCM
and/or RFED; and (4) any principal of the foregoing, within their
Disclosure Documents.\77\ Under Regulation 4.34(j), such description of
the conflicts of interest must also include any other material
conflicts involving any aspect of the offered trading programs and any
certain specified direct or indirect arrangements where the CTA or any
principal thereof may benefit.\78\ Proposed Regulation 4.7(c)(1)(i)(E)
would incorporate Regulation 4.34(j) by reference, and thus require
CTAs to list and fully describe any conflicts of interest in QEP
Disclosures for their 4.7 trading programs.
---------------------------------------------------------------------------
\77\ 17 CFR 4.34(j).
\78\ Regulation 4.34(j)(3) requires a description of the
conflicts of interest of any arrangements whereby the CTA or any of
its principals may benefit, directly or indirectly, from the
client's account maintenance with an FCM or RFED, and/or from the
maintenance of the client's swap positions with a swap dealer or
from the introduction of such an account through an introducing
broker (such as payment for order flow or soft dollar arrangements).
17 CFR 4.34(j)(3).
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F. Past Performance of 4.7 Trading Programs
Finally, the Commission is also proposing to require CTAs offering
4.7 trading programs to include past performance information in their
QEP Disclosures as required by Regulation 4.35. Currently, CTAs are
exempt from disclosing performance information for their 4.7 trading
programs. Because the Commission preliminarily believes such
performance information regarding 4.7 trading programs would be
valuable and provide necessary detail to prospective QEP advisory
clients, the Commission is proposing to require CTAs include all
performance information required under Regulation 4.35 with respect to
the offered 4.7 trading program in their QEP Disclosures.
Regulation 4.35 requires CTAs to include in their Disclosure
Documents capsule performance information for past performance of an
account or trading program, subject to certain presentation and content
requirements as outlined paragraph (a) of that section.\79\ Regulation
4.35(a) also provides detailed requirements for composite presentation,
how current the disclosed information must be, the time period that
must be covered in the performance disclosures, the calculation of and
recordkeeping concerning the disclosed performance information,
disclosing the performance of partially-funded accounts, the
presentation of proprietary trading results, and a mandatory legend for
all performance disclosures, stating, ``PAST PERFORMANCE IS NOT
NECESSARILY INDICATIVE OF FUTURE RESULTS.'' \80\ Additionally,
Regulation 4.35(b) provides that a CTA
[[Page 70863]]
must disclose the actual performance of all accounts directed by the
CTA and by each of its trading principals, unless the CTA or its
trading principals previously have not directed any accounts; in that
case, the CTA must disclose this using one of three form disclosures
listed thereunder.\81\ Proposed Regulation 4.7(c)(1)(i) would remove
the existing exemption from Regulation 4.35, and Proposed Regulation
4.7(c)(2)(i)(F) would require QEP Disclosures to include performance
information as required by Regulation 4.35 with respect to 4.7 trading
programs.
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\79\ 17 CFR 4.35.
\80\ 17 CFR 4.35(a)(3) through (9).
\81\ 17 CFR 4.35(b).
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c. Permitting Monthly Account Statements for Certain 4.7 Pools
Consistent With Commission Exemptive Letters
Regulation 4.7(b)(3) currently provides an exemption from the
requirement in Regulations 4.22(a) and (b) that CPOs provide monthly
account statements containing specific information to participants in
their commodity pools.\82\ For 4.7 pools, CPOs are permitted to
distribute account statements ``no less frequently than quarterly
within 30 days after the end of the reporting period.'' \83\ CPOs of
4.7 pools that are Funds of Funds \84\ have reported to Commission
staff that they often have difficulty complying with this quarterly
account statement schedule in Regulation 4.7(b)(3). Such CPOs regularly
request exemptive letters from the Commission to permit them to follow
an alternate account statement schedule, explaining that they cannot
control the timing of when they receive financial information from the
underlying investee collective investment vehicles, which often results
in the investor Fund of Funds CPO not receiving the requisite
information for its own 4.7 pool reporting until the 30-day period for
distribution is nearly expired. The Commission has routinely granted
these exemptive letter requests, thereby permitting the requesting CPOs
to distribute monthly, rather than quarterly, account statements for
their 4.7 Fund of Funds pools within 45 days of the month-end.\85\ This
approach of providing exemptive letter relief from Regulation 4.7(b)(3)
has allowed these CPOs additional time to receive and gather the
information required for their account statements required by
Regulation 4.7, while also ensuring that their QEP participants receive
both more accurate and more frequent reporting.
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\82\ 17 CFR 4.7(b)(3), 4.22(a) and (b).
\83\ 17 CFR 4.7(b)(3)(i); cf. 17 CFR 4.22(a) and (b).
\84\ See supra n. 42 (defining ``Funds of Funds'').
\85\ See, e.g., CFTC Letters 18-29, 19-01, 19-03, 20-11, 21-16,
23-04.
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Consistent with past Commission efforts to memorialize routinely
granted Commission letter relief via regulatory amendments that
streamline availability, provide consistency, and eliminate the need to
process and respond to requests individually, the Commission proposes
to amend Regulation 4.7 in a manner that would allow the CPOs of 4.7
pools that are Funds of Funds to distribute monthly account statements
within 45 days of the month-end, provided that a CPO notifies its QEP
pool participants, so they are aware of the schedule for the
distribution of account statements. The Commission solicits comment
generally on Proposed Regulation 4.7(b)(3)(iv); in particular, the
Commission requests comment on whether the proposed amendment
effectively creates a mechanism in Regulation 4.7(b)(3) that is
equivalent to the exemptive letters currently issued by the Commission,
and whether the alternate account statement distribution schedule and
notice requirements are clear.
d. Other Technical Amendments
Finally, the Proposal also includes a number of technical
amendments to Regulation 4.7 that are designed to improve its
efficiency and usefulness for intermediaries and their prospective and
actual QEP pool participants and advisory clients, as well as the
general public. For example, the Commission is proposing to delete the
introductory paragraph to Regulation 4.7 and to generally restructure
the definitions section in Regulation 4.7(a), eliminating what it
preliminarily views as unnecessary subparagraph levels in the QEP
definition and alphabetizing the definitions. The Commission has also
proposed amendments to ensure that cross-references within Regulation
4.7 and other part 4 regulations are accurate. The Commission is
seeking comment on these and any other technical amendments that it
should consider for ease of use, as well as whether there are any other
cross-references within Regulation 4.7 not addressed by the Proposal
that should also be corrected. The Commission intends to include
additional conforming amendments correcting cross-references to
Regulation 4.7 provisions found in other parts of the Commission's
regulations as technical amendments in a future final rule. The
Commission requests comment and public input on this approach as well.
III. Related Matters
a. Regulatory Flexibility Act
The Regulatory Flexibility Act (RFA) requires that Federal
agencies, in promulgating regulations, consider whether the regulations
they propose will have a significant economic impact on a substantial
number of small entities, and if so, to provide a regulatory
flexibility analysis regarding the economic impact on those
entities.\86\ The regulatory amendments proposed by the Commission
hereinwould affect only persons registered or required to be registered
as CPOs and CTAs and those commodity pools and trading programs
operated under Regulation 4.7 and offered solely to QEPs.
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\86\ 5 U.S.C. 601, et seq.
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i. CPOs
The Commission has previously established certain definitions of
``small entities'' to be used by the Commission in evaluating the
impact of its rules on such entities in accordance with the
requirements of the RFA.\87\ With respect to CPOs, the Commission
previously has determined that a CPO is a small entity for purposes of
the RFA, only if it meets the criteria for an exemption from
registration under Regulation 4.13(a)(2).\88\ The regulations proposed
herein apply to persons registered or required to be registered as CPOs
with the Commission (specifically, those registered CPOs whose
prospective and actual pool participants are restricted to QEPs) and/or
provide relief to qualifying registrants from certain periodic
reporting burdens. Accordingly, the Chairman, on behalf of the
Commission, certifies pursuant to 5 U.S.C. 605(b) that this NPRM will
not have a significant economic impact on a substantial number of small
entities, with respect to CPOs.
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\87\ See, e.g., Policy Statement and Establishment of
Definitions of ``Small Entities'' for Purposes of the Regulatory
Flexibility Act, 47 FR 18618, 18620 (Apr. 30, 1982).
\88\ Id. at 18619-20. Regulation 4.13(a)(2) exempts a person
from registration as a CPO when: (1) none of the pools operated by
that person has more than 15 participants at any time, and (2) when
excluding certain sources of funding, the total gross capital
contributions the person receives for units of participation in all
of the pools it operates or intends to operate do not, in the
aggregate, exceed $400,000. See 17 CFR 4.13(a)(2).
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ii. CTAs
Regarding CTAs, the Commission has previously considered whether
such registrants would be deemed small entities for purposes of the RFA
on a case-by-case basis, in the context of the particular Commission
regulation at
[[Page 70864]]
issue.\89\ Because certain of these registered CTAs may besmall
entities for the purposes of the RFA, the Commission is considering
whether this Proposal would have a significant economic impact on such
registrants.
---------------------------------------------------------------------------
\89\ Id. at 18620.
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The portions of this NPRM directly impacting CTAs would affect only
CTAs registered or required to register with the Commission that offer
and operate trading programs designed for QEPs. These proposed
amendments would, in particular: (1) require CTAs claiming the
Regulation 4.7 exemption to provide certain general and performance
disclosures enumerated in other part 4 regulations regarding their 4.7
trading programs to their prospective and current QEP advisory clients;
(2) require such CTAs to include past performance information for their
4.7 trading programs in any Disclosure Documents they use and
distribute for their non-4.7 trading programs' advisory clients; and
(3) require such registered CTAs to retain the proposed limited QEP
Disclosures regarding their 4.7 trading programs as business records of
the intermediary. As stated above, these proposed requirements
primarily impact registered CTAs offering 4.7 trading programs to QEP
advisory clients and claiming the compliance exemptions currently
offered by Regulation 4.7. Although data on the specific size of
registered CTAs offering 4.7 trading programs is limited, it is the
Commission's anecdotal experience that such CTAs claiming compliance
exemptions in Regulation 4.7 for the purposes of soliciting and serving
QEP advisory clients are frequently large financial institutions with
substantial financial assets and advisory experience, or affiliates
thereof. Given that registered CTAs do not have a capital requirement
applicable to them, it is not possible for the Commission to readily
determine the typical or average size of registered CTAs, or even of
registered CTAs who solely offer 4.7 trading programs; moreover,
registered CTAs frequently offer a mix of 4.7 trading programs and
trading programs or strategies subject to the full application of the
Commission's part 4 regulations. Therefore, although the Commission has
previously determined whether CTAs are small entities for RFA purposes
on a case-by-case basis, the Commission is not currently in a position
to determine whether registered CTAs affected by this NPRM would
include a substantial number of small entities, on which the NPRM would
have a significant economic impact. Therefore, pursuant to 5 U.S.C.
603, the Commission offers for public comment this initial regulatory
flexibility analysis addressing the impact of the Proposal on small
entities:
A. A description of the reasons why action by the agency is being
considered.
As discussed in detail above in this Preamble, since the 1992 Final
Rule adopting Regulation 4.7, the Commission has witnessed substantial
increases in the intermediary population utilizing those exemptions for
4.7 pools and trading programs offered and available to QEPs. This
development also coincides with current commodity interest market
conditions, in which the Commission has also seen significant expansion
and growth in the complexity and diversity of commodity interest
products offered via 4.7 pools and trading programs, which may be more
challenging to fully understand. Given further that QEPs, for a variety
of reasons, may have varying levels of resources and leverage to demand
and monitor the information necessary for them to make informed
investment decisions, the Commission believes it is no longer
appropriate to rely solely on QEPs' individual ability to obtain such
information, absent formal regulatory requirements that such
information be provided.
B. A succinct statement of the objectives of, and legal basis for,
the Proposal.
The objective of these proposed amendments is to establish minimum
disclosure requirements applicable to all CTAs offering 4.7 trading
programs, replacing the current ad hoc methods of informing QEPs that
have developed over time, and leveling the playing field amongst QEP
advisory clients who may currently receive varying levels of investment
information dependent upon their size and available resources. The
proposed amendments are also intended to raise the quality and
consistency of QEP Disclosures provided by registered CTAs by requiring
them to be materially complete, accurate, and subject to regular
updates by the CTA, and to enable the consistent review of such QEP
Disclosures by the Commission or NFA through regular examinations of
registered CTAs' business records. As stated above, the CEA grants the
Commission the authority to regulate and register CTAs, as well as to
require the maintenance of books and records and filing of reports that
the Commission believes is necessary to accomplish its regulatory
mission and the goals of the CEA.\90\
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\90\ 7 U.S.C. 6m, 6n.
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C. A description of and, where feasible, an estimate of the number
of small entities to which the Proposal would apply.
As mentioned above, CTAs are generally not subject to any minimum
capital requirements, nor does the Commission collect data on the
``size'' of registered CTAs via Commission registration applications or
other required Commission filings or reports. Therefore, the Commission
has no data to analyze that would enable it to estimate how many
registered CTAs \91\ may be considered small entities for RFA purposes.
It is the Commission's experience that registered CTAs claiming
Regulation 4.7 exemptions and offering 4.7 trading programs to QEP
advisory clients are frequently large financial institutions offering a
variety of trading programs and strategies. Nonetheless, the Commission
acknowledges that a certain percentage or portion of the population of
CTAs affected by this Proposal, i.e., those registered or required to
register with the Commission and utilizing the exemptions in Regulation
4.7, may, in fact, be considered small entities as defined by the RFA,
though the Commission lacks the information or data necessary to
determine or estimate how many.
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\91\ As of June 2023, there were approximately 1,280 CTAs
registered with the Commission.
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D. A description of the projected reporting, recordkeeping, and
other compliance requirements of the Proposal, including an estimate of
the classes of small entities which will be subject to the requirement
and the type of professional skills necessary for preparation of the
report or record.
The proposed amendments would require CTAs registered and claiming
the exemption in Regulation 4.7(c)(1) to provide certain general and
performance disclosures regarding their 4.7 trading programs to
prospective and current QEP advisory clients, to ensure that the
information provided is materially complete and accurate, and to
periodically update such information as needed. As noted above, the
proposed amendments would, in particular: (1) require CTAs relying on
the Regulation 4.7 exemption to provide certain general and performance
disclosures enumerated in other part 4 regulations regarding their 4.7
trading programs to their prospective and current QEP advisory clients;
(2) require such CTAs to include past performance information for their
4.7 trading programs in the Disclosure Documents they use and
distribute for their non-4.7 trading programs; and (3) require such
[[Page 70865]]
registered CTAs to retain the proposed QEP Disclosures regarding their
4.7 trading programs as business records of the intermediary. The
Commission expects that some CTAs may already be disclosing some of
this information, via the existing ad hoc industry practices that have
developed for QEP Disclosures like private placement memoranda and
trading program brochures, as discussed above. Additionally, the
proposed amendments would require registered CTAs to provide past
performance information regarding their 4.7 trading programs in the
Disclosure Documents of other trading programs they operate that are
subject to broader part 4 compliance. Finally, CTAs offering 4.7
trading programs would be required to keep their QEP Disclosures
containing the information the Commission proposes to require as
business records, subject to routine examination and inspection by the
Commission and/or NFA.
The Commission anticipates that the proposed amendments would
affect registered CTAs claiming Regulation 4.7 and offering 4.7 trading
programs, which, as stated above, may include some small entities for
RFA purposes. Nonetheless, regardless of whether a CTA is considered a
small entity, the Commission believes that all registered CTAs offering
and managing 4.7 trading programs generally possess the professional
skills necessary to generate and distribute the subset of disclosures
proposed to be required and to appropriately retain such QEP
Disclosures as business records of their registered intermediary, i.e.,
the CTA, as such skills are not significantly different from those
already necessary to establish, register, and operate a CTA subject to
the broader part 4 compliance requirements beyond Regulation 4.7.
E. An identification, to the extent practicable, of all relevant
Federal rules which may duplicate, overlap or conflict with the
Proposal.
The Commission is generally unaware of any Federal rules or
regulations which may conflict with the proposed amendments. Federal
securities laws and regulations do govern investment disclosures by
registered investment advisers, which may result in those entities that
are dually registered with the SEC and CFTC being subject to more than
one regulatory regime. The Commission does not expect the proposed
amendments to conflict with those laws and regulations, based on its
understanding of those disclosure requirements. Moreover, some 4.7 CTAs
are registered only with the Commission and thus, are not currently
subject to any other regulations mandating disclosures to their QEP
advisory clients.
F. A description of any significant alternatives to the Proposal
which accomplish the stated objectives of applicable statutes and which
minimize significant economic impact of the Proposal on small entities.
Potential alternatives to the proposed amendments would be: (1) to
not amend Regulation 4.7 to add disclosure requirements for 4.7 trading
programs; or (2) to amend Regulation 4.7(c)(1) to require compliance
with the entirety of the disclosure regulations generally applicable to
registered CTAs offering trading programs to non-QEP advisory clients.
Additionally, the Commission could also consider limiting the
application of the proposed amendments to registered CTAs claiming
Regulation 4.7 and offering 4.7 trading programs to those CTAs who are
not small entities for RFA purposes.
The Commission believes that there have been significant
developments in the commodity interest markets since Regulation 4.7 was
adopted in 1992. Based on current market conditions and the increasing
complexity of commodity interest products, among other factors, the
Commission preliminarily believes it necessary to establish minimum
disclosures for CTAs offering 4.7 trading programs at this time.
Although declining to require any disclosures would certainly minimize
the economic impact on registered CTAs that are also small entities,
the Commission believes that, due to the circumstances explained above,
including the varying resources available to QEPs to independently
demand and assess the accuracy of such disclosures, certain information
should be required to be disclosed to all QEP advisory clients, in
furtherance of the Commission's regulatory goals and the purposes of
the CEA. Additionally, the Commission believes it would be overly
burdensome if registered CTAs offering 4.7 trading programs were
required to comply with the entirety of Regulations 4.34 and 4.35, and
to comply with the review and filing requirements in Regulation 4.36,
given the characteristics of their advisory clients. Through these
proposed amendments, the Commission is seeking to balance its customer
protection and regulatory concerns for QEP advisory clients and 4.7
trading programs with the existing compliance burdens of registered
CTAs. Thus, the proposed amendments prioritize and require certain
disclosures, while providing relief from others, and permit CTAs to use
and distribute QEP Disclosures containing that information without
filing or advance review by the Commission or NFA, provided that they
are complete, accurate, and kept as business records of the CTA. In the
Commission's opinion, the proposed amendments offer a more tailored
approach to QEP Disclosure requirements applicable to CTAs' 4.7 trading
programs and would have less of an economic impact on CTAs claiming
Regulation 4.7 than requiring compliance with the entirety of the part
4 disclosure requirements.
Finally, as stated above, CTAs are generally not subject to capital
requirements under the Commission's regulatory regime, and CTAs manage
the assets of their advisory clients, whether QEPs or not, without
receiving or taking custody of those assets, due to the statutory and
regulatory provisions defining the permitted activities of CTAs. The
Commission also does not collect data on the size of CTAs registered or
required to register with it, beyond their assets under management, and
it would be difficult to determine or estimate the number of registered
CTAs that may be considered small entities for RFA purposes. Therefore,
the Commission is unable to limit the application of the proposed
amendments to CTAs offering 4.7 trading programs who are not small
entities for RFA purposes, though anecdotally the Commission believes
that the majority of CTAs utilizing Regulation 4.7 would not be
considered small entities. As noted earlier, regardless of whether a
CTA is considered a small entity, the Commission believes that all
registered CTAs offering and managing 4.7 trading programs generally
possess the resources and know-how necessary to generate and distribute
the subset of disclosures proposed to be required and to appropriately
retain such QEP Disclosures as business records of their registered
intermediary.
To the extent the proposed amendments may apply to an unknown
number of small entities who are registered CTAs offering 4.7 trading
programs, the Commission believes that its customer protection and
oversight concerns under the CEA in ensuring that QEP advisory clients
are adequately and consistently informed regarding 4.7 trading
programs, and that the Commission can effectively oversee the
activities of all CTAs claiming exemptions under Regulation 4.7,
nevertheless outweigh that concern. The Commission understands that the
direct effect of these proposed amendments would be an increase in the
operating costs of CTAs utilizing Regulation 4.7, due to the addition
of minimum content, dissemination, and recordkeeping requirements for
QEP
[[Page 70866]]
Disclosures. The Commission also understands, however, that some of the
information proposed to be required is similar in content to
information many CTAs are already providing based on the demands of
their QEP advisory clients, or because they are required to provide
them by other applicable regulatory regimes. Notwithstanding these
additional operating costs, the Commission preliminarily believes that
mandating the provision of certain foundational information to all
QEPs, which the proposed amendments would require to be kept up-to-date
and accurate, is expected to result in more consistent disclosures to
all persons gaining exposure to the commodity interest markets through
registered CTAs, which may include small entities for RFA purposes. The
Commission preliminarily concludes that the proposed amendments would
result in better informed QEP advisory clients, who may, as a result of
consistent, detailed disclosures, possess enhanced confidence in their
intermediaries and the commodity interest markets overall, by virtue of
their increased understanding of the nature of the advisory services
they are procuring. The Commission therefore believes that the QEP
Disclosures proposed in this NPRM would benefit both the CTAs and their
QEP advisory clients by requiring certain general and performance
disclosures, thereby promoting transparency and consistency, as well as
increasing confidence in the CTAs and the commodity interest markets
overall.
Therefore, in comparing the aforementioned alternatives of (1) not
amending Regulation 4.7 to impose disclosure requirements for 4.7
trading programs, and (2) amending Regulation 4.7(c)(1) to require
compliance with the entirety of the disclosure regulations generally
applicable to registered CTAs offering trading programs to non-QEP
advisory clients, the Commission believes that the proposed minimum
disclosure requirements strike an appropriate balance that achieves the
Commission's regulatory objectives without burdening the small entity
population of CTAs offering 4.7 trading programs with the compliance
costs and burdens that would be associated with the full disclosure
regime required under part 4.
b. Paperwork Reduction Act
The Paperwork Reduction Act of 1995 (PRA) \92\ imposes certain
requirements on Federal agencies, including the Commission, in
connection with their conducting or sponsoring any ``collection of
information,'' as defined by the PRA. Under the PRA, an agency may not
conduct or sponsor, and a person is not required to respond to, a
collection of information unless it displays a valid control number
from the Office of Management and Budget (OMB).\93\ The PRA is
intended, in part, to minimize the paperwork burden created for
individuals, businesses, and other persons as a result of the
collection of information by Federal agencies, and to ensure the
greatest possible benefit and utility of information created,
collected, maintained, used, shared, and disseminated by or for the
Federal Government.\94\ The PRA applies to all information, regardless
of form or format, whenever the Federal Government is obtaining,
causing to be obtained, or soliciting information, and includes
required disclosure to third parties or the public, of facts or
opinions, when the information collection calls for answers to
identical questions posed to, or identical reporting or recordkeeping
requirements imposed on, ten or more persons.\95\
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\92\ 5 U.S.C. 601, et seq.
\93\ See 44 U.S.C. 3507(a)(3); 5 CFR 1320.5(a)(3).
\94\ See 44 U.S.C. 3501.
\95\ See 44 U.S.C. 3502(3).
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This NPRM, if adopted, would result in a collection of information
within the meaning of the PRA, as discussed below. The Proposal affects
a collection of information for which the Commission has previously
received a control number from OMB. The title for this collection is,
``Rules Relating to the Operations and Activities of Commodity Pool
Operators and Commodity Trading Advisors and to Monthly Reporting by
Futures Commission Merchants'' (Collection 3038-0005).\96\ Collection
3038-0005 primarily accounts for the burden associated with the
Commission's part 4 regulations that concern compliance generally
applicable to CPOs and CTAs, as well as certain exemptions from
registration as such and exclusions from those definitions, and
available relief from compliance with certain regulatory requirements,
e.g., Regulation 4.7.
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\96\ See Notice of Office of Management and Budget Action, OMB
Control No. 3038-0005, available at https://www.reginfo.gov/public/do/PRAViewICR?ref_nbr=202011-3038-006 (last visited Sept. 27, 2023).
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The Commission is therefore submitting this NPRM to OMB for
review.\97\ Responses to this collection of information would be
mandatory. The Commission will protect any proprietary information
according to FOIA and part 145 of the Commission's regulations.\98\ In
addition, CEA section 8(a)(1) strictly prohibits the Commission, unless
specifically authorized by the CEA, from making public any ``data and
information that would separately disclose the business transactions or
market positions of any person and trade secrets or names of
customers.'' \99\ Finally, the Commission is also required to protect
certain information contained in a government system of records
according to the Privacy Act of 1974.\100\
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\97\ See 44 U.S.C. 3507(d) and 5 CFR 1320.11.
\98\ See 5 U.S.C. 552; see also 17 CFR part 145 (Commission
Records and Information).
\99\ 7 U.S.C. 12(a)(1).
\100\ 5 U.S.C. 552a.
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i. Collection 3038-0005: Revisions to the Collection of Information
Collection 3038-0005 governs responses made pursuant to part 4 of
the Commission's regulations, pertaining to the operations of CPOs and
CTAs, including the itemization of compliance burdens remaining after
CPOs and CTAs elect certain exemptions from broader compliance
obligations in the part 4 regulations. The Commission is proposing to
amend Collection 3038-0005 to account for the amendments proposed in
this NPRM, as follows: (a) adding reporting burdens for the proposed
required general and performance disclosures to prospective or actual
QEP pool participants and advisory clients by CPOs and CTAs, pursuant
to the proposed amendments to Regulations 4.7(b)(2) and (c)(1); (b)
increasing the existing recordkeeping requirements of Regulations
4.7(b)(5) and (c)(2) to include the proposed maintenance of QEP
Disclosures as business records by CPOs and CTAs utilizing Regulation
4.7; and (c) adding monthly account statements as a permissible
reporting schedule by CPOs of 4.7 pools that are Funds of Funds through
Proposed Regulation 4.7(b)(3)(iv). In addition, and more generally, the
Commission is proposing to update its estimates of the number of
respondents subject to the information collection requirements under
Regulation 4.7, such that they are better aligned with more recent NFA
data provided to the Commission on the number of CPOs (and pools) and
CTAs subject to those requirements. Accordingly, the Commission
proposes to revise Collection 3038-0005 to address the reporting and
recordkeeping burdens associated with these proposed amendments as
described in further detail below.
[[Page 70867]]
A. Proposed Amendments Affecting CPOs
As stated above, Regulation 4.7 currently provides exemptions from
the broader part 4 compliance requirements, and Regulation 4.7(b)(2),
in particular, provides exemptions for CPOs with respect to 4.7 pools
offered solely to QEPs from the requirements of Regulations 4.21, 4.24,
4.25, and 4.26, under certain additional conditions further specified
in the regulation.\101\ As a result, Collection 3038-0005 does not
currently include any reporting burden with respect to Regulation
4.7(b)(2). Proposed Regulation 4.7(b)(2), if adopted, however, would
result in additional reporting burdens for CPOs offering and operating
4.7 pools because certain general and performance disclosures would
become required for their prospective and actual QEP pool participants.
Therefore, the Commission is proposing to amend Collection 3038-0005 in
a manner that accounts for the additional reporting burden associated
with Proposed Regulation 4.7(b)(2). To that end, the Commission has
endeavored to add reporting burden for this proposed amendment that is
based upon the burden already itemized in Collection 3038-0005 for
compliance with Regulations 4.21/4.26, but that is proportionate to the
more limited scope of disclosures the Commission is proposing to
require from CPOs with respect to their 4.7 pools. Accordingly, the
aggregate annual estimate for the reporting burden associated with
Proposed Regulation 4.7(b)(2) would be as follows:
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\101\ See supra Section II.b for additional discussion of these
regulations.
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Estimated number of respondents: 1,000.
Estimated frequency/timing of responses: At least annually, or as-
needed.
Estimated number of annual responses per respondent: 5.
Estimated number of annual responses for all respondents: 5,000.
Estimated annual burden hours per response: 1.5.
Estimated total annual burden hours per respondent: 7.5.
Estimated total annual burden hours for all respondents: 7,500.
Additionally, this NPRM proposes to amend Regulation 4.7(b)(5) to
require that CPOs retain the QEP Disclosures they use and distribute to
their prospective and actual QEP pool participants as business records
of the CPO. Collection 3038-0005 currently contains a recordkeeping
burden associated with Regulation 4.7(b)(5) which estimates that each
CPO expends approximately 2 hours maintaining business records related
to its 4.7 pool(s), as that provision requires. The Commission
recommends an increase of 0.5 hours to this existing burden, to account
for the additional burden of retaining the QEP Disclosures as CPO
business records, and estimates that the respondents include 1,000 CPOs
each operating up to five 4.7 pools. Accordingly, the aggregate annual
estimate for the recordkeeping burden associated with Proposed
Regulation 4.7(b)(5) would be as follows:
Estimated number of respondents: 1,000.
Estimated frequency/timing of responses: Annual.
Estimated number of annual responses per respondent: 5.
Estimated number of annual responses for all respondents: 5,000.
Estimated annual burden hours per response: 2.5.
Estimated total annual burden hours per respondent: 12.5.
Estimated total annual burden hours for all respondents: 12,500.
Finally, the Commission is also proposing amendments to Regulation
4.7(b)(3) that would, consistent with routinely issued Commission
exemptive letters, permit CPOs of 4.7 pools that are Funds of Funds to
distribute monthly account statements within 45 days of the month-
end.\102\ Collection 3038-0005 currently lists a reporting burden
associated with Regulation 4.7(b)(3) that accounts for the quarterly
account statements currently required to be distributed by such CPOs to
their 4.7 pools' QEP participants. The Commission is proposing to add
an additional reporting burden associated with Proposed Regulation
4.7(b)(3)(iv), the provision that, if adopted, would add this monthly
reporting as an option for 4.7 pools that are Funds of Funds. The
Commission believes that a smaller subset of CPOs and 4.7 pools would
rely on this reporting schedule, and therefore, burden estimates below
are based on 100 CPOs utilizing this alternative monthly account
statement schedule for up to three 4.7 pools each. Accordingly, the
aggregate annual estimate for the reporting burden associated with
Proposed Regulation 4.7(b)(3)(iv) would be as follows:
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\102\ See supra Section II.c for additional discussion of this
proposed amendment.
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Estimated number of respondents: 100.
Estimated frequency/timing of responses: Monthly.
Estimated number of annual responses per respondent: 36.
Estimated number of annual responses for all respondents: 3,600.
Estimated annual burden hours per response: 1.
Estimated total annual burden hours per respondent: 36.
Estimated total annual burden hours for all respondents: 3,600.
B. Proposed Amendments Affecting CTAs
Similar to Regulation 4.7(b)(2), Regulation 4.7(c)(1) provides
exemptions for CTAs with respect to their 4.7 trading programs offered
to QEPs from Regulations 4.31, 4.34, 4.35, and 4.36, subject to
additional conditions specified in that regulation.\103\ Consequently,
Collection 3038-0005 does not currently include any reporting burden
associated with Regulation 4.7(c)(1). Proposed Regulation 4.7(c)(1), if
adopted, would result in CTAs incurring additional burden because
certain general and performance disclosures with respect to their 4.7
trading programs would be required to be distributed to their
prospective and actual QEP advisory clients. Therefore, the Commission
is proposing to amend Collection 3038-0005 in a manner that would
account for the additional reporting burden associated with Proposed
Regulation 4.7(c)(1). To that end, the Commission has endeavored to add
reporting burden for this proposed amendment that is based upon the
burden already itemized in this information collection for compliance
with Regulations 4.31/4.36, but that is proportionate to the more
limited scope of disclosures the Commission is proposing to require
from CTAs with respect to their 4.7 trading programs. Accordingly, the
aggregate annual estimate for the reporting burden associated with
Proposed Regulation 4.7(c)(1) would be as follows:
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\103\ See supra Section II.b for additional discussion of these
regulations.
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Estimated number of respondents: 1,000.
Estimated frequency/timing of responses: At least annually, or as-
needed.
Estimated number of annual responses per respondent: 12.
Estimated number of annual responses for all respondents: 12,000.
Estimated annual burden hours per response: 1.5.
Estimated total annual burden hours per respondent: 18.
Estimated total annual burden hours for all respondents: 18,000.
Additionally, this NPRM proposes to amend Regulation 4.7(c)(2) to
require that CTAs retain the QEP Disclosures they use and distribute to
their
[[Page 70868]]
prospective and actual QEP advisory clients as business records of the
CTA. Collection 3038-0005 currently contains a recordkeeping burden
associated with Regulation 4.7(c)(2) which estimates that each CTA
expends approximately 2 hours maintaining business records related to
its 4.7 trading program(s), as that provision requires. The Commission
recommends an increase of 0.5 hours to account for the additional
burden of retaining QEP Disclosures as business records of the CTA, and
estimates that the respondents include 1,000 CTAs offering and
operating up to 12 4.7 trading programs each. Accordingly, the
aggregate annual estimate for the recordkeeping burden associated with
Proposed Regulation 4.7(c)(2) would be as follows:
Estimated number of respondents: 1,000.
Estimated frequency/timing of responses: Annual.
Estimated number of annual responses per respondent: 12.
Estimated number of annual responses for all respondents: 12,000.
Estimated annual burden hours per response: 2.5.
Estimated total annual burden hours per respondent: 30.
Estimated total annual burden hours for all respondents: 30,000.
e. Request for Comment
The Commission invites the public and other Federal agencies to
comment on any aspect of the proposed information collection
requirements discussed above. Pursuant to 44 U.S.C. 3506(c)(2)(B), the
Commission solicits comment in order to (1) evaluate whether the
proposed collections of information are necessary for the proper
performance of the functions of the Commission, including whether the
information will have practical utility; (2) evaluate the accuracy of
the estimated burden of the proposed information collection
requirements, including the degree to which the methodology and
assumptions the Commission employed were valid; (3) determine whether
there are ways to enhance the quality, utility, and clarity of the
information proposed to be collected; and (4) minimize the burden of
the proposed collections of information on those who are required to
respond, i.e., CPOs and CTAs, including through the use of appropriate
automated, electronic, mechanical, or other technological information
collection techniques.
The public and other Federal agencies may submit comments directly
to the Office of Information and Regulatory Affairs, Office of
Management and Budget, Room 10235, New Executive Office Building,
Washington, DC 20503, Attn: Desk Officer of the Commodity Futures
Trading Commission, by fax at (202) 395-6566, or by email at
[email protected]. Please provide the Commission with a copy
of submitted documents, so that all comments can be summarized and
addressed in the final rule preamble. Refer to the ADDRESSES section of
this NPRM for comment submission instructions to the Commission. A copy
of the supporting statements for the collections of information
discussed above may be obtained by visiting https://www.RegInfo.gov.
OMB is required to make a decision concerning the collections of
information between 30 and 60 days after publication of this document
in the Federal Register. Therefore, a comment to OMB is best assured of
receiving full consideration if OMB (and the Commission) receives it
within 30 days of the publication of this document. Nothing in the
foregoing affects the deadline enumerated above for public comment to
the Commission on the proposed regulations.
c. Cost-Benefit Considerations
i. Statutory and Regulatory Background
Section 15(a) \104\ of the CEA requires the Commission to consider
the costs and benefits of its actions before promulgating a regulation
under the CEA or issuing certain orders. CEA section 15(a) further
specifies that the costs and benefits shall be evaluated in light of
five broad areas of market and public concern: (1) protection of market
participants and the public; (2) efficiency, competitiveness, and
financial integrity of markets; (3) price discovery; (4) sound risk
management practices; and (5) other public interest considerations. The
Commission considers the costs and benefits resulting from its
discretionary determinations with respect to the section 15(a) factors.
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\104\ 7 U.S.C. 19(a).
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The Commission recognizes that the proposed amendments to
Regulation 4.7 in this NPRM will result in additional costs for CPOs
and CTAs operating 4.7 pools and trading programs. However, the
Commission lacks the data necessary to reasonably quantify all of the
costs and benefits considered below. Additionally, any initial and
recurring compliance costs for any particular CPO or CTA will depend on
its size, existing infrastructure, practices, and cost structures. The
Commission welcomes comments on such costs, particularly from existing
CPOs and CTAs utilizing Regulation 4.7 exemptions, who may be better
able to provide quantitative cost data or estimates, based on their
respective experiences. Commenters may also suggest other
alternative(s) to the proposed approach that would be expected to
further the Commission's stated policy and regulatory goals as
described in this NPRM.
The Commission is also including a number of questions herein for
the purpose of eliciting direct cost estimates from public commenters
wherever possible. Quantifying other costs and benefits, such as the
effects of potential induced changes in the behavior of CPOs, CTAs, and
their QEPs resulting from the proposed amendments are inherently harder
to measure ex ante. Thus, the Commission is similarly requesting
comment through questions to help it better quantify these impacts. Due
to these quantification difficulties, for this NPRM, the Commission
offers the following qualitative discussion of its costs and benefits.
ii. Increasing Financial Thresholds in the Portfolio Requirement of the
``Qualified Eligible Person'' Definition
A. Baseline
As described in more detail above, the QEP definition in Regulation
4.7 outlines two categories, those that do not have to satisfy the
Portfolio Requirement, listed in Regulation 4.7(a)(2), and those that
do, listed in Regulation 4.7(a)(3). Persons listed in Regulation
4.7(a)(3), including natural persons who must also be considered
``accredited investors,'' must meet the Portfolio Requirement by
either: (1) owning securities and other assets worth at least
$2,000,000; (2) having on deposit with an FCM for their own account at
least $200,000 in initial margin, option premiums, or minimum security
deposits; or (3) owning a portfolio of funds and assets that, when
expressed as percentages of the first two thresholds, have a combined
value of at least 100%.
B. The Proposal
The Commission is proposing in this NPRM to increase the Portfolio
Requirement in Regulation 4.7 such that persons listed in Regulation
4.7(a)(3) could satisfy the QEP definition by either: (1) owning
securities and other assets worth at least $4,000,000; (2) having on
deposit with an FCM for their own account at least $400,000 in initial
margin, option premiums, or minimum security deposits; or (3) owning a
portfolio of funds and assets that, when expressed as percentages of
the prior two thresholds, have a combined value
[[Page 70869]]
of at least 100%. As stated previously in this release, the Commission
preliminarily believes that increasing such thresholds appropriately
accounts for the impacts of inflation on the Portfolio Requirement's
ability to adequately address the Commission's concerns regarding the
financial sophistication of QEPs required to meet its terms.
C. Benefits
The Portfolio Requirement was adopted to identify those prospective
participants in the commodity interest markets that are of a size
sufficient to indicate that the participant has substantial investment
experience and thus a high degree of sophistication with regard to
investments as well as financial resources to withstand the risk of
their investments.\105\ As discussed in detail above in this NPRM,
these Portfolio Requirement thresholds have not been changed since
their adoption in 1992. The Commission preliminarily believes that
updating these thresholds would have the benefit of bringing the
Portfolio Requirement back in line with the Commission's original
intent when adopting the QEP definition.
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\105\ 1992 Proposed Rule, 57 FR at 3152.
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The Commission understands that raising the Portfolio Requirement
thresholds may cause some QEPs to no longer be so qualified, turning
them into non-QEP participants in the commodity interest markets. The
Commission nonetheless believes preliminarily that this proposed
amendment would benefit the commodity interest markets and the general
public by realigning financial thresholds in its most commonly used
regulations to account for the impacts of inflation since its original
adoption and to more accurately reflect the current economic reality,
such that the scope of Regulation 4.7 would be more closely aligned
with the Commission's original intent in the 1992 Final Rule.
Additionally, to the extent that former QEPs choose to continue
investing in commodity pools or allocate their funds to be managed by
CTAs, such persons may then purchase participations in pools or utilize
the services of CTAs not operating pursuant to Regulation 4.7. This, in
turn, could result in the creation and offering of additional pools and
trading programs by registered CPOs and CTAs outside of the Regulation
4.7 regime, given the potential additional demand by non-QEPs. Because
more capital may, as a result, likely be deployed to such pools and
trading programs subject to the full panoply of the Commission's part 4
compliance requirements, this could indirectly lead to greater
transparency in the offerings of registered CPOs and CTAs, as well as
improved customer protection for persons engaging with CPOs and CTAs.
Moreover, if additional pools and trading programs are created for the
non-QEP investing public, this would be expected to enhance the variety
and vibrancy of the non-QEP pool and trading program marketplace. As a
result, more options for non-QEP individuals and entities to gain
access to the commodity interest markets in a manner consistent with
their individual risk appetites and exposure needs would become
available.
D. Costs
If the proposed amendments are adopted, CPOs that currently offer
pools operated under Regulation 4.7 may no longer accept additional
investment from pool participants that fall in the gap between the old
and new Portfolio Requirement thresholds. Such registered CPOs and CTAs
may decide to offer pools and trading programs not exempt under
Regulation 4.7 that would necessarily have higher operating and
compliance costs, due to the unavailability of Regulation 4.7
compliance exemptions for those investment products.
E. Questions
The Commission poses the following questions to better assess the
costs and benefits of the proposed increases to the QEP definition's
Portfolio Requirement in Regulation 4.7(a)(1)(v). The Commission
requests further that, to the extent possible, commenters please
provide quantitative bases for your responses.
1. How many QEPs would intermediaries expect to no longer be
considered QEPs, if the Portfolio Requirement threshold increases are
adopted?
2. How many CPOs and CTAs that currently offer pools and trading
programs exclusively to QEPs have participants and clients that would
no longer be QEPs under the new thresholds?
3. If the increased thresholds are adopted, will registered CPOs
and CTAs form and begin offering new pools and trading programs
designed for non-QEPs?
F. Section 15(a) Factors
Section 15(a) of the CEA requires the Commission to consider the
costs and benefits of the proposed amendments to Regulation 4.7 with
respect to the following factors: protection of market participants and
the public; efficiency, competitiveness, and financial integrity of
markets; price discovery; sound risk management practices; and other
public interest considerations. As discussed above, the proposed
revision of Regulation 4.7(a)(1)(v) would increase the financial
thresholds for the Portfolio Requirement in the definition of QEPs.
These proposed updates to the thresholds would, in the Commission's
preliminary opinion, more closely align the QEP definition with the
intent of the regulation, which is to assure that offerings operated
pursuant to Regulation 4.7 compliance exemptions are only made to
persons with sufficient expertise and assets.
a. Protection of Market Participants and the Public
As stated above, the Commission believes preliminarily that this
proposed amendment would benefit the commodity interest markets and the
general public by realigning financial thresholds in its most commonly
used regulations in a manner that accounts for the impacts of inflation
since their original adoption and more accurately reflects current
economic circumstances; the Commission expects that this would result
in persons investing in commodity interest products offered by
registered CPOs and CTAs being more accurately categorized as QEPs, and
thus, more appropriately limited in their investment choices. Moreover,
raising the Portfolio Requirement thresholds, as a practical matter,
would likely limit the prospective investor population for 4.7 pools
and trading programs to a smaller number of persons. To the extent
persons who meet the higher Portfolio Requirement thresholds are (on
average) more financially sophisticated or resilient than those who no
longer qualify, this proposed amendment should result in individuals
and entities, both QEPs and non-QEPs, being offered pools and trading
programs that are regulated in a manner commensurate with their
respective needs for customer protection. If the increased thresholds
further lead to the creation of more commodity pools and trading
programs subject to the full part 4 compliance requirements by
registered CPOs and CTAs, this too would potentially lead to greater
transparency in their activities, which also protects persons investing
in commodity interest investment products. Additionally, greater
variety in the commodity pools and trading programs available to non-
QEPs would provide more options for this population to consider, which
may further enable them to make more appropriate investment decisions
by choosing the offerings best suited to
[[Page 70870]]
their individual risk appetite or other portfolio needs.
b. Efficiency, Competitiveness, and Financial Integrity of Markets
The proposed amendments to the Portfolio Requirement may also
affect the size, composition, or number of commodity pools and trading
programs in the commodity interest markets, especially those offered
solely to QEPs. This may, in turn, affect the flow of investing in
commodity interests. Financial economics literature suggests that, to
the extent changing the QEP definition reduces the flow of non-
commercial funds into commodity interest markets, the cost to
commercial traders using futures markets to hedge their risks may
increase.\106\ Via this mechanism, this proposed amendment may have an
indirect effect on efficiency of the futures markets with respect to
the hedging costs of operating companies, commodity producers, or other
commercial traders.
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\106\ Goldstein and Yang, ``Commodity Financialization and
Information Transmission,'' 2022, Journal of Finance, 77, 2613-2668.
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c. Price Discovery
The increased Portfolio Requirement thresholds are likely to result
in fewer persons being considered QEPs, which may further result in
fewer participants and clients in offered pools and trading programs
operated under Regulation 4.7. An additional indirect effect of the
proposed rule change could be a change in the flow of investment in
commodity interests by non-commercial traders. The financial economics
literature has found ambiguous results regarding the relationship
between increased investment by non-commercial traders in commodity
interest markets and price discovery.\107\ As such, it is difficult to
ex ante predict how changes in the Portfolio Requirement thresholds
would impact price discovery.
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\107\ Id.
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d. Sound Risk Management Practices
Increasing the Portfolio Requirement thresholds may result in
registered CPOs and CTAs that previously only offered pools and trading
programs to QEPs creating and offering pools and trading programs
designed for persons that are not QEPs. Consequently, these non-QEP
pools and trading programs operated by registered CPOs and CTAs would
then be subject to the full complement of part 4 compliance
requirements, which could result in more diligent risk management
practices by the CPOs and CTAs.
e. Other Public Interest Considerations
The original Portfolio Requirement thresholds in the QEP definition
were intended to ensure that only persons possessing an appropriate and
high level of trading experience, acumen, and financial resources would
be eligible to invest in complex commodity interest investments offered
and operated under Regulation 4.7. The Commission determined it
appropriate to lessen the compliance burdens for registered CPOs and
CTAs limiting their prospective participants and clients to financially
sophisticated QEPs through the exemptions provided by Regulation 4.7
for their 4.7 pools and trading programs. The 1992 Portfolio
Requirement thresholds were adopted to provide a metric by which CPOs
and CTAs could approximately assess the experience and financial
wherewithal of potential pool participants or advisory clients,
ensuring that they truly possessed the sophistication and resilience of
other QEPs not subject to such thresholds. Updating these thresholds to
account for inflation would realign the Portfolio Requirement with the
original intent of the QEP definition and modernize its provisions
consistent with today's economic circumstances.
iii. Requiring Minimum Disclosures for 4.7 Pools and Trading Programs
A. Baseline
In general, registered CPOs and CTAs are required by several part 4
regulations (i.e., Regulations 4.24-4.26 for CPOs and 4.34-4.36 for
CTAs) to provide Disclosure Documents containing specific types of
information about their commodity pools and trading programs to
prospective pool participants and advisory clients; such Disclosure
Documents must be filed with and reviewed and approved by NFA prior to
being used and distributed. Currently, Regulation 4.7 makes available
exemptions from these regulatory requirements for the 4.7 pools and
trading programs of registered CPOs and CTAs. While registered CPOs and
CTAs are not required to disclose any information to prospective QEP
pool participants or advisory clients about their 4.7 pools or trading
programs, if they do choose to provide any disclosures, Regulation 4.7
requires the CPO or CTA to include a form disclaimer and to ensure that
they provide all disclosures necessary to make the information, in the
context in which it is being provided, not misleading.\108\
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\108\ 17 CFR 4.7(b)(2); 17 CFR 4.7(c)(1).
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B. The Proposal
The Proposal would narrow the existing exemptions in Regulation 4.7
by proposing to require compliance with portions of the broader
disclosure requirements in part 4, thereby establishing minimum
content, use, and recordkeeping requirements applicable to QEP
Disclosures, and bringing the disclosure requirements for 4.7 pools and
trading programs closer to those applicable to pools and trading
programs offered to non-QEPs by registered CPOs and CTAs. Specifically,
CPOs and CTAs utilizing Regulation 4.7 would be required by the
proposed amendments to provide QEP Disclosures containing, at a
minimum, the information outlined above through offering memoranda or
trading program brochures delivered to their prospective QEP pool
participants or advisory clients. Although the extent of information
proposed to be required under Regulation 4.7 is less than that required
by the part 4 regulations for non-QEP pools and trading programs, these
proposed amendments represent a significant policy change from the
current status quo, where Regulation 4.7 currently provides broad
exemptions from the entirety of the CPO and CTA disclosure regulations.
Under the Proposal, CPOs and CTAs offering and operating 4.7 pools and
trading programs would be required to provide information to their
prospective QEP participants and clients regarding principal risk
factors, investment programs, use of proceeds, custodians, fees and
expenses, conflicts of interest, and certain performance information.
Importantly, the Proposal also includes amendments to Regulation 4.7
that would require that the QEP Disclosures be materially complete and
accurate, be kept up-to-date through routine reviews and updated as
needed to reflect any changes to a 4.7 pool or trading program, and be
maintained among an intermediary's other books and records for the pool
or trading program and made available to any representative of the
Commission, NFA, or the U.S. Department of Justice, in accordance with
Regulation 1.31.
C. Benefits
The direct effects of these proposed amendments would include
greater availability and increased accuracy and reliability of the
information QEPs receive prior to making their investment decisions.
Mandating the provision of certain foundational information to all
QEPs, which the proposed amendments would require to be kept up-to-date
and accurate, is expected to result in more
[[Page 70871]]
consistent disclosures to all persons gaining exposure to the commodity
interest markets through CPOs and CTAs; better informed pool
participants and advisory clients are likely to enhance market
participant confidence in intermediaries and the commodity interest
markets as a whole, as they better understand the nature of the
services they are procuring. Moreover, the Commission preliminarily
believes that this potential benefit is likely to be further bolstered
by the proposed change in the material accuracy required of the QEP
Disclosures. Rather than any disclosures being acceptable provided that
they are, in totality, not materially misleading--meaning that material
information could be permissibly omitted provided that it does not
render the information that is disclosed false--the Proposal would
further require that the QEP Disclosures be materially complete and
accurate, which would mandate that all material information be included
and be correct. This change is expected to result in more complete
disclosures by CPOs and CTAs operating under Regulation 4.7, which is
likely to result in a better-informed universe of market participants
served by such intermediaries. Additionally, by requiring that specific
topics be addressed by all CPOs and CTAs offering 4.7 pools and trading
programs, QEPs could more readily compare and understand the
differences between offered pools and trading programs, and as such,
the Proposal could lead to better quality investment decisions by
QEPs.\109\
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\109\ Sirra and Tufano (``Costly Search and Mutual Fund Flows,''
Journal of Finance, 1998, 53, 1589-1622) show that investments in
mutual funds are highly influenced by both past returns and fees.
Although there is some disagreement in the literature regarding the
reason for this relationship, Berk and van Binsbergen (``Measuring
Skill in the Mutual Fund Industry'' Journal of Financial Economics,
2015, 118, 1-20) provide evidence that this reflects investor money
flowing to more skillful managers. Although the Commission is not
aware of any analogous studies for investments in commodity pools,
it seems plausible that the same factors matter in commodity
interest markets.
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Several aspects of the Proposal may also indirectly enhance
Commission and NFA oversight of CPOs and CTAs utilizing Regulation 4.7.
First, the improved ability of QEPs to more easily compare and
understand critical information about 4.7 pools and trading programs
offered to them may provide incentives for better governance of those
commodity interest investment products by CPOs and CTAs.\110\ Second,
as discussed above, QEP Disclosures would be required by the Proposal
to be materially complete and accurate, kept current by CPOs and CTAs,
and maintained by them as business records available to the CFTC and
NFA during routine examinations; these proposed amendments would likely
also ensure that QEPs receive accurate information in QEP Disclosures,
while also incentivizing good management and operational practices by
CPOs and CTAs.
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\110\ For example, Del Guercio and Reuter (``Mutual Fund
Performance and the Incentive to Generate Alpha,'' Journal of
Finance, 2014, 1673-1704) show that investors who buy directly from
mutual funds managers are highly responsive to funds' risk-adjusted
returns.
---------------------------------------------------------------------------
Disclosure of information about an offered 4.7 pool or trading
program may also result in additional benefits inuring to QEP pool
participants and advisory clients. One such benefit would be the
expectation that CPOs and CTAs may seek to compete with one another to
offer lower or more cost-efficient fees and expenses, or to minimize
potential conflicts of interest, for the purposes of presenting more
attractive and competitive investment products to prospective QEP
participants and clients. This may result in CPOs and CTAs attempting
to eliminate any fees and expenses extraneous to their 4.7 pools and
trading programs, and/or to mitigate or resolve their conflicts of
interest, each of which would benefit QEPs investing in these
offerings. Additionally, by requiring the provision of standard
disclosures to QEP pool participants and advisory clients, and the
maintenance of such disclosures by the CPO or CTA in its books and
records (which are subject to routine review by the Commission and NFA
as part of their examination functions), the Commission preliminarily
believes that these proposed amendments would result in higher quality
disclosures on an on-going basis, even after a QEP participant or
client receives information initially, due to the consistent and
regular review of such QEP Disclosures by subject matter expert
regulators, i.e., the Commission and NFA, that this NPRM would
facilitate. As previously acknowledged in this Proposal, many, if not
most, CPOs and CTAs offering 4.7 pools and trading programs currently
provide some level of disclosure, due to other applicable Federal
statutory and regulatory requirements and/or investor demand. Given the
complexity and unique nature of the commodity interest markets,
especially in light of market and product developments in the past 30
years, the Commission preliminarily believes, however, that
participants therein would benefit overall from the application of deep
market and product expertise regarding the appropriate disclosure of
risks, costs, and investing strategies for such products by the
Commission and NFA to QEP Disclosures they may already regularly
receive. By enabling this review of QEP Disclosures and requiring
updates by CPOs and CTAs when necessary, the Commission preliminarily
believes that these proposed amendments would thereby improve the
quality and accuracy of QEP Disclosures, and as a result, enhance the
understanding of market participants accessing the commodity interest
markets through 4.7 pools and trading programs.
D. Costs
The direct effect of these proposed amendments would be an increase
in the operating costs of CPOs and CTAs utilizing Regulation 4.7, due
to the addition of minimum content requirements for QEP Disclosures and
requirements that such information be produced, disseminated to
prospective pool participants and advisory clients, updated regularly,
and kept as business records of the CPO or CTA. Regarding information
production, CPOs and CTAs claiming Regulation 4.7 would be required to
disclose information on several important features of their 4.7 pools
and trading programs relevant to expected future performance and
activities of the CPO or CTA, including past performance, fees and
expenses, principal risk factors, and potential conflicts of interest.
The Commission understands that some of the information proposed to
be required is similar in content to information that many CPOs and
CTAs are already providing based on the demands of such QEPs, or
because they are otherwise required to produce such information for
compliance requirements in other regulatory regimes, like that of the
SEC. Additionally, though, the QEP Disclosures would also require the
provision of information that CPOs and CTAs already produce to comply
with other CFTC regulations. For example, CPOs are already required by
Regulations 4.7(b)(3) and 4.22(a) and (b) to calculate the net asset
value of 4.7 pool(s), accounting for fees, expenses, commissions, and
other financial information, no less frequently than on a quarterly
basis, for the purposes of producing account statements for QEP pool
participants. The Proposal would also require CPOs and CTAs to provide
past performance information prospectively to QEP pool participants.
The Commission expects that the information required to produce a 4.7
pool's or trading program's performance
[[Page 70872]]
history is already calculated by CPOs and CTAs for the purposes of
providing periodic account statements, as required by other part 4
regulations.
In addition to this direct effect, the proposed disclosure
requirements may affect how CPOs and CTAs operate more generally. For
example, providing descriptions of 4.7 pools' and trading programs'
investment program information, principal risk factors and past returns
routinely may likely make such information more publicly
available,\111\ in turn potentially making it easier for new pools and
trading programs to replicate or copy such investment plans and
activities of previously formed successful ones. Although this could
theoretically discourage CPOs and CTAs from developing more innovative
or novel investment offerings, the Commission believes that this
potential risk, however, is mitigated by the fact that the complexity,
variety, and novelty of commodity interest products appear to be
increasing constantly and are expected to continue to generate and
propel innovation by asset managers in the future.
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\111\ For example, the JOBS Act of 2012 required the SEC to
adopt regulations that would permit the use of ``general
solicitation'' and/or general advertising in private placements
under its existing Regulation D. Public Law 112-106, 126 Stat. 306
(Apr. 5, 2012). As a result, the SEC adopted Regulation 506(c),
which permits the use of general solicitation in Regulation D
securities offerings, subject to certain conditions, including that
all purchasers in the offering are accredited investors and that the
issuer takes reasonable steps to verify their accredited investor
status. See also Registration and Compliance Requirements for
Commodity Pool Operators and Commodity Trading Advisors, 83 FR
52902, 52909-11 (Oct. 18, 2018); ``Eliminating the Prohibition
Against General Solicitation and General Advertising in Rule 506 and
Rule 144A Offerings,'' A Small Entity Compliance Guide, SEC,
available at https://www.sec.gov/info/smallbus/secg/general-solicitation-small-entity-compliance-guide. When relying on the
exemption in Regulation 506(c), offerors today may comfortably use
general solicitation and advertising in their Regulation D
offerings, which has led to the use of advertisements, press
releases, and other broadly available publications discussing the
details of this type of investment.
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E. Questions
The Commission poses the following questions to better assess the
costs and benefits of the proposed disclosure requirements that would
be added to Regulations 4.7(b) and (c). The Commission requests further
that, to the extent possible, commenters please provide quantitative
bases for your responses.
1. To what extent is the information necessary to provide past
performance and fees already gathered in order to provide account
information under Regulations 4.7 and 4.22? What additional steps would
be required to process and disseminate that information in QEP
Disclosures, as required under the Proposal?
2. What are the costs of gathering and disseminating the other
types of information required to be included in QEP Disclosures?
3. How will the fees and expenses charged by CPOs and CTAs for
pools and trading programs operated under Regulation 4.7 be affected by
the proposed disclosure requirements?
4. To what extent would CPOs' and CTAs' trading strategies be
revealed in QEP Disclosures? How would such proposed disclosure
requirements impact the development of such trading strategies and/or
directly affect the behaviors of CPOs and CTAs utilizing Regulation
4.7?
F. Section 15(a) Factors
Section 15(a) of the CEA requires the Commission to consider the
costs and benefits of the proposed amendments to Regulations 4.7(b)(2),
(b)(5), (c)(1), and (c)(2), with respect to the following factors:
protection of market participants and the public; efficiency,
competitiveness, and financial integrity of markets; price discovery;
sound risk management practices; and other public interest
considerations.
As discussed above, for CPOs and CTAs operating pools and trading
programs under Regulations 4.7, the NPRM would narrow the existing
exemptions from the part 4 disclosure regulations available under
Regulations 4.7(b)(2) and (c)(1). Under the Proposal, such CPOs and
CTAs would be required to provide QEP Disclosures containing
information regarding past performance, fees and expenses, principal
risk factors, potential conflicts of interest, and other aspects of
their investments to prospective QEP pool participants and advisory
clients.
a. Protection of Market Participants and the Public
These proposed amendments to Regulation 4.7 would mandate a minimum
amount of transparency into pools and trading programs trading
commodity interests and restricting their offerings to QEPs. This could
help such QEPs protect themselves against excessive fees and self-
dealing, and generally help insure that the products offered by such
CPOs and CTAs are performing and being operated, as anticipated. In
addition, mandating QEP Disclosures and requiring that they be
materially accurate and complete, rather than just optional and not
materially misleading, will benefit market participants and the public
by ensuring that prospective investors would receive QEP Disclosures
containing, at a minimum, certain important general and performance
information that they can reliably assume is kept current and
materially complete with respect to the items proposed to be required.
Finally, requiring that such QEP Disclosures be maintained among CPOs'
and CTAs' other books and records, and thus made available to the
Commission and NFA, would allow for improved oversight of the regulated
activities of CPOs and CTAs.
b. Efficiency, Competitiveness, and Financial Integrity of Markets
The proposed amendments regarding QEP Disclosures may also
indirectly affect the functioning of commodity interest markets. To the
extent that the proposed changes would increase transparency and affect
the number or composition of pools and trading programs operated under
Regulation 4.7, the NPRM might also affect the flow of investing in
commodity interests. Financial economics literature suggests that, to
the extent greater transparency into pools and trading programs
increases the flow of non-commercial funds into commodity interest
markets, that may also tend to reduce the costs to commercial traders
using the futures market to hedge.\112\ In that sense, the NPRM may
have an indirect effect on the efficiency of the futures market in
regard to the hedging costs of operating companies, commodity
producers, and other commercial traders.
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\112\ Goldstein and Yang, ``Commodity Financialization and
Information Transmission,'' 2022, Journal of Finance, 77, 2613-2668.
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This increase in transparency resulting from the Proposal may also
lead to QEPs having better information about fees and expenses,
performance, and potential returns on their investments in 4.7 pools
and trading programs, which may lead further to enhanced competition
amongst CPOs and CTAs relying on Regulation 4.7. There is considerable
evidence that eliminating prohibitions on price advertising, or
mandating transparency of prices can lead to more ``competitive
markets,'' in the sense that service providers and vendors compete to
offer lower prices to consumers of their products.\113\ This general
trend suggests
[[Page 70873]]
that by increasing transparency of information about 4.7 pools and
trading programs through requiring minimum QEP Disclosures, CPOs and
CTAs may, as a result, compete to offer lower fees and expenses and
more efficiently and honestly implement their investment programs,
resulting in better returns for QEPs.
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\113\ Milyo and Waldfogel (``The Effect of Price Advertising on
Prices: Evidence in the Wake of 44 Liquormart,'' 1999, American
Economic Review, 89, 1081-1096) show that the removal of a ban on
liquor price advertising led to decreases in the prices of
advertised products, and an associated increase in quantity of sales
by retailers who chose to advertise. More recently, Itern and Rigbi
(``Price Transparency, Media, and Informative Advertising,'' 2023,
American Economic Journal: Microeconomics, 15, 1-29) show that a law
requiring price transparency on grocery prices led to 4-5% lower
prices, as well as less price dispersion. Similarly, Brown
(``Equilibrium Effects of Health Care Price Information,'' 2019, The
Review of Economics and Statistics, 101, 699-712) finds that
providing online information on health care procedure pricing led to
lower prices and less price dispersion. In a paper on hedge fund
returns, Aragon, Liang and Park (``Onshore and Offshore Hedge Funds:
Are They Twins?'' 2014, Management Science, 60, 74-91) show that
advertising restrictions on hedge funds reduce the impact of past
returns on new investment.
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c. Price Discovery
As noted above, an indirect effect of the Proposal could be a
change in the flow of investment into commodity interests by non-
commercial traders. Financial economics literature has found ambiguous
results regarding the relationship between increased investment by non-
commercial traders in commodity interest markets and price
discovery.\114\ As such, it is difficult for the Commission to ex ante
predict how increasing transparency in the returns, fees, etc. of pools
and trading programs operating under Regulation 4.7 would impact price
discovery.
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\114\ Goldstein and Yang, ``Commodity Financialization and
Information Transmission,'' 2022, Journal of Finance, 77, 2613-2668.
---------------------------------------------------------------------------
d. Sound Risk Management Practices
The NPRM may also help some QEPs better manage their business
risks. For example, some QEPs are insurance companies and pensions
funds that have specific operational risks that may be mitigated
through appropriate financial investment. The availability and
provision of more accurate and complete information about 4.7 pools and
trading programs, including their fees and principal risk factors, may
assist such QEPs in making more appropriate and targeted investment
decisions that support their operations.
As discussed above, the Proposal may also promote sound risk
management by CPOs and CTAs. Specifically, requiring QEP Disclosures be
maintained among CPOs' and CTAs' other books and records would allow
for greater regulatory oversight of such intermediaries by the
Commission and NFA. This requirement would help identify those
intermediaries that lack suitable risk management practices, or that
are engaging in practices that do not match their QEP Disclosures and
other regulatory filings, potentially encouraging the adoption of
better risk management practices. Finally, the anticipation of greater
regulatory oversight and transparency in their operations might also
provide an incentive for CPOs and CTAs to adopt and follow sound risk
management practices.
e. Other Public Interest Considerations
The proposed requirement for CPOs and CTAs to include past
performance information in their QEP Disclosures may enable regulators
and the general public to gain a better understanding of the trading
behavior of CPOs and CTAs utilizing Regulation 4.7, and consequently,
the impact they have on commodity interest markets through their 4.7
pools and trading programs.
iv. Permitting Monthly Account Statements Consistent With Commission
Exemptive Letters for Certain 4.7 Pools
A. Baseline
CPOs operating pools under Regulation 4.7 are required to provide
account statements to investors ``no less frequently than quarterly
within 30 days after the end of the reporting period.'' \115\ Some of
these 4.7 pools invest some or all of their assets in other pools or
other types of collective investment vehicles, and are colloquially
referred to, as discussed above, as ``Funds of Funds.'' It is the
Commission's understanding that the requirement that a 4.7 Fund of
Funds pool provide account statements within 30 days of the end of each
quarter may become difficult to meet when its CPO may not receive an
account statement regarding underlying investment returns until nearly
the end of the required 30-day period. For example, if a 4.7 Fund of
Funds pool regularly receives account statements from its investee
pool's CPO 29 days after the end of the quarter, the CPO of the 4.7
Fund of Funds pool will likely find it difficult to provide accurate
and complete account statements to its 4.7 Fund of Funds pool
participants within 30 days of quarter end, as Regulation 4.7(b)(3)
requires. In recognition of this potential difficulty, the Commission
has routinely issued exemptive letters providing relief from this
requirement, upon individual request, that permit the requesting CPO to
distribute account statements for its 4.7 Fund of Funds pool(s) on a
monthly basis within 45 days of the month-end. Nevertheless, the
regulatory baseline remains the reporting requirements of Regulation
4.7(b)(3).
---------------------------------------------------------------------------
\115\ 17 CFR 4.7(b)(3).
---------------------------------------------------------------------------
B. Proposal
Consistent with longstanding exemptive letter relief described
herein, the Proposal would add a provision to Regulation 4.7(b)(3)
allowing CPOs of 4.7 pools that are Funds of Funds to distribute
account statements on a monthly basis, within 45 days of the end of the
month-end, provided that such CPOs notify their pool participants, so
they know when to expect to receive their account statements.
C. Benefits
Relative to the baseline, the primary benefit of this proposed
amendment is to make it more feasible for 4.7 pools to invest in other
pools or collective investment vehicles without potentially violating
the periodic reporting requirements in Regulation 4.7. This proposed
amendment may also allow CPOs of 4.7 pools to seek higher returns and/
or better diversification for their participants by investing in other
pools or other collective investment vehicles, without having to seek
an exemptive letter to ensure they can meet their periodic reporting
requirements, or without risking chronic compliance violations.
Consequently, this proposed amendment may encourage more CPOs to
operate their 4.7 pools as Funds of Funds, and that may further result
in higher returns and/or more effective diversification for their QEP
pool participants. Additionally, offering this alternative account
statement schedule would allow CPOs of 4.7 Fund of Funds pools to
provide more accurate and complete account statements to their QEP
participants more frequently, rather than generating quarterly account
statements containing estimates of such information, if they have not
yet received it. The Commission further predicts that an overall
benefit of this proposed amendment would be more frequent, accurate,
and complete periodic reporting to QEP participants in 4.7 Fund of
Funds pools.
Finally, as noted above, exemptive letters providing relief from
this reporting requirement have been commonly issued by the Commission
for many years. Hence, as a practical matter, a primary benefit from
this proposed amendment is CPOs of 4.7 Fund of Funds pools being able
to adopt an alternative account statement schedule at their convenience
or immediately when necessary, rather than being required to seek an
exemptive letter individually from the
[[Page 70874]]
Commission and potentially delaying operational decisions or changes
until such letter is received. Moreover, the proposed amendment would
also ensure that similarly situated registrants are treated in a
consistent manner by making the alternative schedule available to all
qualifying CPOs and 4.7 pools without the need for individual requests.
Finally, if this proposed amendment were adopted, such CPOs would no
longer have to expend legal and other compliance resources for the
purpose of seeking such exemptive letters from the Commission for each
of their 4.7 Fund of Funds pools needing this account statement
schedule.
D. Costs
Relative to the baseline, the primary cost of the proposed
amendment would be the offering of a monthly account statement
schedule, provided such monthly statements are provided within 45 days
of the end of the month, as an alternative to the current at least
quarterly statement schedule provided within 30 days of the end of the
quarter. Although the addition of 15 days may slightly delay the
arrival of account information to QEP pool participants each month,
such participants would also be receiving account statements containing
more complete and accurate information more often, as a monthly
schedule is more frequent than that required by Regulation 4.7(b)(3)
currently, and the 15 days is designed to allow CPOs to compile more
information about the 4.7 pool's underlying investments in such
statements. CPOs of 4.7 Fund of Funds pools may also incur costs to
effectively notify QEP participants of their adoption of this
alternative account statement schedule. To the extent this alternative
account statement schedule encourages CPOs to operate more of their 4.7
pools as Funds of Funds, QEP participants therein may experience
slightly higher costs, as the fees and expenses from underlying pools
or other collective investment vehicles could possibly be passed along
to them by their 4.7 Fund of Funds pool's CPO.
E. Questions
The Commission poses the following questions to better assess the
costs and benefits of the proposed amendment permitting an alternative
monthly account statement schedule for Fund of Funds pools operated by
CPOs utilizing Regulation 4.7. The Commission requests further that, to
the extent possible, commenters please provide quantitative bases for
your responses.
1. How many CPOs operate their 4.7 pools as Funds of Funds, meaning
such pools invest in other 4.7 pools, other commodity pools, or other
collective investment vehicles?
2. How many CPOs operating 4.7 pools provide sufficiently timely
account statements to their participants that are other 4.7 commodity
pools, so as to allow their CPOs to also produce their own account
statements within 30 days of the quarter-end?
3. How many 4.7 Fund of Funds pools are currently able to provide
quarterly account statements within 30 days of the end of the quarter,
without the alternative monthly schedule currently provided exemptive
relief?
F. Section 15(a) Factors
Section 15(a) of the CEA requires the Commission to consider the
costs and benefits of the proposed amendments to Regulation 4.7(b)(3)
with respect to the following factors: protection of market
participants and the public; efficiency, competitiveness, and financial
integrity of markets; price discovery; sound risk management practices;
and other public interest considerations. As discussed above, the
addition to Regulation 4.7(b)(3) of a permissible monthly account
statement schedule would facilitate compliance with periodic reporting
deadlines for CPOs of 4.7 Fund of Funds pools. Absent this change (and
assuming such 4.7 pool has received no exemptive letter from the
Commission), it may otherwise be impractical for such 4.7 pools to
operate as Funds of Funds.
a. Protection of Market Participants and the Public
The baseline requirement in Regulation 4.7(b)(3) for at least
quarterly account statements distributed within 30 days of the quarter-
end helps ensure that QEP pool participants have access to timely
information about the 4.7 pool's performance, and serves to protect
such participants from malfeasance and other sources of poor pool
performance. As discussed above, relative to the baseline, the proposed
amendment would permit CPOs of 4.7 Fund of Funds pools to adopt an
alternative monthly account statement schedule, provided such
statements are provided within 45 days of the end of each month, and
provided that they notify their QEP pool participants of such reporting
schedule. To the extent the proposed amendment may encourage QEPs to
participate in 4.7 Fund of Funds pools, rather than other 4.7 pools, it
may require them to adjust to a different account statement schedule,
but would likely ultimately provide them with more complete and
accurate account statements on a more frequent basis. Additionally, the
proposed amendment may facilitate the formation of 4.7 Fund of Funds
pools by making it easier for their CPOs to comply with the applicable
periodic reporting requirements under Regulation 4.7; this trend may
also serve to benefit QEP participants, in that the CPOs of 4.7 Fund of
Funds pools may be able to operate them in a manner that achieves
exposure to a wider variety of underlying investment strategies through
their investee pools, while continuing to remain compliant with their
regulatory obligations. Finally, such CPOs would also have greater
incentive and may possess more resources to monitor the behavior of
their 4.7 Fund of Funds pools' underlying investments in other pools or
funds, than QEPs directly investing therein.
b. Efficiency, Competitiveness, and Financial Integrity of Markets
The proposed amendment to Regulation 4.7(b)(3) may indirectly
affect the functioning of commodity interest markets. To the extent
that the proposed amendment affects the behavior of CPOs or the size
and composition of their 4.7 Fund of Funds pools, it might also affect
the flow of investing in commodity interests. The financial economics
literature suggests that increased investment by non-commercial traders
in commodity interest markets will generally reduce the difference
between futures prices and expected future spot prices.\116\ This
effect means that, to the extent that offering an alternative schedule
for periodic reporting in 4.7 Fund of Funds pools increases the flow of
non-commercial funds into commodity interest markets, it will tend to
also reduce the cost to commercial traders of using the futures market
to hedge their risks. In that sense, this proposed amendment may have
an indirect effect on efficiency of the futures markets in regard to
the hedging costs of operating companies, commodity producers, or other
commercial market participants.
---------------------------------------------------------------------------
\116\ Goldstein and Yang, ``Commodity Financialization and
Information Transmission,'' 2022, Journal of Finance, 77, 2613-2668.
---------------------------------------------------------------------------
c. Price Discovery
To the extent that the proposed amendment to Regulation 4.7(b)(3)
affects the size or composition of 4.7 pools, it might also affect the
flow of investing in commodity interests. The financial economics
literature has found ambiguous results regarding the relationship
between increased investment by non-commercial traders
[[Page 70875]]
in commodity interest markets and commodity price discovery.\117\ As
such, it is difficult for the Commission to ex ante predict how the
addition of an alternative account statement schedule for 4.7 Fund of
Funds pools would impact price discovery.
---------------------------------------------------------------------------
\117\ Id.
---------------------------------------------------------------------------
d. Sound Risk Management Practices
Periodic reporting requirements in the form of regular account
statements provided to pool participants serve as an effective means
for participants as well as CPOs to monitor pools' risk management.
Because the amount of funds a CPO manages through its operated pools is
likely responsive to its past performance,\118\ requiring the provision
of complete financial information on pool performance through regular
account statements can serve to provide an incentive for sound risk
management by such CPOs. As discussed above, relative to the baseline,
the proposed amendment to Regulation 4.7(b)(3) may encourage the
formation of 4.7 Fund of Funds pools, whose CPOs may be better able to
monitor the performance of underlying commodity pools or funds in which
they invest, as compared to QEP participants investing directly
therein. This also may positively influence CPOs' risk management
practices in their pools, to the extent their participants are other
4.7 pools.
---------------------------------------------------------------------------
\118\ Sirra and Tufano, ``Costly Search and Mutual Fund Flows,''
Journal of Finance, 1998, 53, 1589-1622; Del Guercio and Reuter,
``Mutual Fund Performance and the Incentive to Generate Alpha,''
Journal of Finance, 2014, 1673-1704.
---------------------------------------------------------------------------
e. Other Public Interest Considerations
A key practical consideration is that, absent exemptive letters
issued by the Commission, the existing Regulation 4.7(b)(3) appears to
make it very difficult for CPOs to operate their 4.7 pools as Funds of
Funds, while complying with applicable periodic reporting requirements.
To the extent that facilitating the operation of such 4.7 pools as
Funds of Funds is a legitimate policy goal of the Commission (as
suggested by its routine granting of exemptive letters on this topic),
changing the regulations to explicitly permit this alternative account
statement schedule would be a more effective and direct means of
accomplishing that objective that further ensures more consistent
treatment of similarly situated registrants.
d. Antitrust Considerations
Section 15(b) of the CEA requires the Commission to take into
consideration the public interest to be protected by the antitrust laws
and endeavor to take the least anticompetitive means of achieving the
purposes of the CEA in issuing any order or adopting any Commission
rule or regulation.\119\ The Commission believes that the public
interest to be protected by the antitrust laws is generally to protect
competition. The Commission requests comment on whether the Proposal
implicates any other specific public interest to be protected by the
antitrust laws.
---------------------------------------------------------------------------
\119\ 7 U.S.C. 19(b).
---------------------------------------------------------------------------
The Commission has considered the proposed amendments in this NPRM
to determine whether they are anticompetitive and has preliminarily
identified no anticompetitive effects. The Commission requests comment
on whether the NPRM is anticompetitive and, if it is, what the
anticompetitive effects are.
Because the Commission has preliminarily determined that the
Proposal is not anticompetitive and has no anticompetitive effects, the
Commission has not identified any less anticompetitive means of
achieving the purposes of the CEA. The Commission requests comment on
whether there are less anticompetitive means of achieving the relevant
purposes of the CEA that would otherwise be served by adopting the
amendments proposed in this NPRM.
List of Subjects in 17 CFR Part 4
Advertising, Brokers, Commodity futures, Commodity pool operators,
Commodity trading advisors, Consumer protection, Reporting and
recordkeeping requirements.
For the reasons stated in the preamble, the Commodity Futures
Trading Commission proposes to amend 17 CFR part 4 as follows:
PART 4--COMMODITY POOL OPERATORS AND COMMODITY TRADING ADVISORS
0
1. The authority citation for part 4 continues to read as follows:
Authority: 7 U.S.C. 1a, 2, 6(c), 6b, 6c, 6l, 6m, 6n, 6o, 12a,
and 23.
0
2. In Sec. 4.7:
0
a. Remove the introductory text;
0
b. Revise paragraphs (a) and (b)(2)(i);
0
c. Add paragraphs (b)(2)(i)(A) through (G);
0
d. Remove and reserve paragraph (b)(2)(ii);
0
e. Add paragraph (b)(3)(iv);
0
f. Revise paragraphs (b)(5) and (c)(1)(i);
0
g. Add paragraphs (c)(1)(i)(A) through (H);
0
h. Remove and reserve paragraph (c)(1)(ii); and
0
i. Revise paragraphs (c)(2) and (d)(4)(i) and (ii).
The revisions and additions read as follows:
Sec. 4.7 Exemption from certain part 4 requirements for commodity
pool operators with respect to offerings to qualified eligible persons
and for commodity trading advisors with respect to advising qualified
eligible persons.
(a) Definitions. (1) Affiliate of, or a person affiliated with, a
specified person means a person that directly or indirectly through one
or more persons, controls, is controlled by, or is under common control
with the specified person.
(2) Exempt account means the account of a qualified eligible person
that is directed or guided by a commodity trading advisor pursuant to
an effective claim for exemption under this section.
(3) Exempt pool means a pool that is operated pursuant to an
effective claim for exemption under this section.
(4) Non-United States person means:
(i) A natural person who is not a resident of the United States;
(ii) A partnership, corporation or other entity, other than an
entity organized principally for passive investment, organized under
the laws of a foreign jurisdiction and which has its principal place of
business in a foreign jurisdiction;
(iii) An estate or trust, the income of which is not subject to
United States income tax regardless of source;
(iv) An entity organized principally for passive investment such as
a pool, investment company or other similar entity; Provided, that
units of participation in the entity held by persons who do not qualify
as Non-United States persons or otherwise as qualified eligible persons
represent in the aggregate less than 10% of the beneficial interest in
the entity, and that such entity was not formed principally for the
purpose of facilitating investment by persons who do not qualify as
Non-United States persons in a pool with respect to which the operator
is exempt from certain requirements of this part by virtue of its
participants being Non-United States persons; and
(v) A pension plan for the employees, officers or principals of an
entity organized and with its principal place of business outside the
United States.
(5) Portfolio Requirement means that a person:
(i) Owns securities (including pool participations) of issuers not
affiliated
[[Page 70876]]
with such person and other investments with an aggregate market value
of at least $4,000,000;
(ii) Has had on deposit with a futures commission merchant, for its
own account at any time during the six-month period preceding either
the date of sale to that person of a pool participation in the exempt
pool or the date that the person opens an exempt account with the
commodity trading advisor, at least $400,000 in exchange-specified
initial margin and option premiums, together with any required minimum
security deposits for retail forex transactions (defined in Sec.
5.1(m) of this chapter), for commodity interest transactions; or
(iii) Owns a portfolio comprised of a combination of the funds or
property specified in paragraphs (a)(5)(i) and (ii) of this section, in
which the sum of the funds or property includable under paragraph
(a)(5)(i) of this section, expressed as a percentage of the minimum
amount required thereunder, and the amount of initial margin, option
premiums, and minimum security deposits includable under paragraph
(a)(5)(ii) of this section, expressed as a percentage of the minimum
amount required thereunder, equals at least one hundred percent. An
example of a composite portfolio acceptable under this paragraph
(a)(5)(iii) would consist of $2,000,000 in securities and other
property (50% of paragraph (a)(5)(i) of this section) and $200,000 in
initial margin, option premiums, and minimum security deposits (50% of
paragraph (a)(5)(ii) of this section).
(6) Qualified eligible person means any person, acting for its own
account or for the account of a qualified eligible person, who the
commodity pool operator reasonably believes, at the time of the sale to
that person of a pool participation in the exempt pool, or who the
commodity trading advisor reasonably believes, at the time that person
opens an exempt account, is eligible to invest in the exempt pool or
open the exempt account and is included in the following list of
persons that is divided into two categories: Persons who are not
required to satisfy the Portfolio Requirement defined in paragraph
(a)(5) of this section to be qualified eligible persons, and those
persons who must satisfy the Portfolio Requirement in paragraph (a)(5)
of this section to be qualified eligible persons.
(i) Persons who need not satisfy the Portfolio Requirement to be
qualified eligible persons. (A) A futures commission merchant
registered pursuant to section 4d of the Act, or a principal thereof;
(B) A retail foreign exchange dealer registered pursuant to section
2(c)(2)(B)(i)(II)(gg) of the Act, or a principal thereof;
(C) A swap dealer registered pursuant to section 4s(a)(1) of the
Act, or a principal thereof;
(D) A broker or dealer registered pursuant to section 15 of the
Securities Exchange Act of 1934, or a principal thereof;
(E) A commodity pool operator registered pursuant to section 4m of
the Act, or a principal thereof; Provided, that the pool operator:
(1) Has been registered and active as such for two years; or
(2) Operates pools which, in the aggregate, have total assets in
excess of $5,000,000;
(F) A commodity trading advisor registered pursuant to section 4m
of the Act, or a principal thereof; Provided, that the trading advisor:
(1) Has been registered and active as such for two years; or
(2) Provides commodity interest trading advice to commodity
accounts which, in the aggregate, have total assets in excess of
$5,000,000 deposited at one or more futures commission merchants;
(G) An investment adviser registered pursuant to section 203 of the
Investment Advisers Act of 1940 (``Investment Advisers Act'') or
pursuant to the laws of any state, or a principal thereof; Provided,
that the investment adviser:
(1) Has been registered and active as such for two years; or
(2) Provides securities investment advice to securities accounts
which, in the aggregate, have total assets in excess of $5,000,000
deposited at one or more registered securities brokers;
(H) A ``qualified purchaser'' as defined in section 2(a)(51)(A) of
the Investment Company Act of 1940 (``Investment Company Act'');
(I) A ``knowledgeable employee'' as defined in Sec. 270.3c-5 of
this title;
(J) With respect to an exempt pool:
(1) The commodity pool operator, commodity trading advisor or
investment adviser of the exempt pool offered or sold, or an affiliate
of any of the foregoing;
(2) A principal of the exempt pool or the commodity pool operator,
commodity trading advisor or investment adviser of the exempt pool, or
an affiliate of any of the foregoing;
(3) An employee of the exempt pool or the commodity pool operator,
commodity trading advisor or investment adviser of the exempt pool, or
of an affiliate of any of the foregoing (other than an employee
performing solely clerical, secretarial or administrative functions
with regard to such person or its investments) who, in connection with
his or her regular functions or duties, participates in the investment
activities of the exempt pool, other commodity pools operated by the
pool operator of the exempt pool or other accounts advised by the
trading advisor or the investment adviser of the exempt pool, or by the
affiliate; Provided, that such employee has been performing such
functions and duties for or on behalf of the exempt pool, pool
operator, trading advisor, investment adviser or affiliate, or
substantially similar functions or duties for or on behalf of another
person engaged in providing commodity interest, securities or other
financial services, for at least 12 months;
(4) Any other employee of, or an agent engaged to perform legal,
accounting, auditing or other financial services for, the exempt pool
or the commodity pool operator, commodity trading advisor or investment
adviser of the exempt pool, or any other employee of, or agent so
engaged by, an affiliate of any of the foregoing (other than an
employee or agent performing solely clerical, secretarial or
administrative functions with regard to such person or its
investments); Provided, that such employee or agent:
(i) Is an accredited investor as defined in Sec. 230.501(a)(5) or
(a)(6) of this title; and
(ii) Has been employed or engaged by the exempt pool, commodity
pool operator, commodity trading advisor, investment adviser or
affiliate, or by another person engaged in providing commodity
interest, securities or other financial services, for at least 24
months;
(5) The spouse, child, sibling or parent of a person who satisfies
the criteria of paragraph (a)(6)(i)(J)(1), (2), (3) or (4) of this
section; Provided, that:
(i) An investment in the exempt pool by any such family member is
made with the knowledge and at the direction of the person; and
(ii) The family member is not a qualified eligible person for the
purposes of paragraph (a)(6)(ii)(K) of this section;
(6) Any person who acquires a participation in the exempt pool by
gift, bequest or pursuant to an agreement relating to a legal
separation or divorce from a person listed in paragraph
(a)(6)(i)(J)(1), (2), (3), (4) or (5) of this section;
(7) The estate of any person listed in paragraph (a)(6)(i)(J)(1),
(2), (3), (4) or (5) of this section; or
(8) A company established by any person listed in paragraph
(a)(6)(i)(J)(1),
[[Page 70877]]
(2), (3), (4) or (5) of this section exclusively for the benefit of (or
owned exclusively by) that person and any person listed in paragraph
(a)(6)(i)(J)(6) or (7) of this section;
(K) With respect to an exempt account:
(1) An affiliate of the commodity trading advisor of the exempt
account;
(2) A principal of the commodity trading advisor of the exempt
account or of an affiliate of the commodity trading advisor;
(3) An employee of the commodity trading advisor of the exempt
account or of an affiliate of the trading advisor (other than an
employee performing solely clerical, secretarial or administrative
functions with regard to such person or its investments) who, in
connection with his or her regular functions or duties, participates in
the investment activities of the trading advisor or the affiliate;
Provided, that such employee has been performing such functions and
duties for or on behalf of the trading advisor or the affiliate, or
substantially similar functions or duties for or on behalf of another
person engaged in providing commodity interest, securities or other
financial services, for at least 12 months;
(4) Any other employee of, or an agent engaged to perform legal,
accounting, auditing or other financial services for, the commodity
trading advisor of the exempt account or any other employee of, or
agent so engaged by, an affiliate of the trading advisor (other than an
employee or agent performing solely clerical, secretarial or
administrative functions with regard to such person or its
investments); Provided, that such employee or agent:
(i) Is an accredited investor as defined in Sec. 230.501(a)(5) or
(a)(6) of this title; and
(ii) Has been employed or engaged by the commodity trading advisor
or the affiliate, or by another person engaged in providing commodity
interest, securities or other financial services, for at least 24
months; or
(5) The spouse, child, sibling or parent of the commodity trading
advisor of the exempt account or of a person who satisfies the criteria
of paragraph (a)(6)(i)(K)(1), (2), (3) or (4) of this section;
Provided, that:
(i) The establishment of an exempt account by any such family
member is made with the knowledge and at the direction of the person;
and
(ii) The family member is not a qualified eligible person for the
purposes of paragraph (a)(6)(ii)(K) of this section;
(6) Any person who acquires an interest in an exempt account by
gift, bequest or pursuant to an agreement relating to a legal
separation or divorce from a person listed in paragraph
(a)(6)(i)(K)(1), (2), (3), (4) or (5) of this section;
(7) The estate of any person listed in paragraph (a)(6)(i)(K)(1),
(2), (3), (4) or (5) of this section;
(8) A company established by any person listed in paragraph
(a)(6)(i)(K)(1), (2), (3), (4) or (5) of this section exclusively for
the benefit of (or owned exclusively by) that person and any person
listed in paragraph (a)(6)(i)(K)(6) or (7) of this section;
(L) A trust; Provided, that:
(1) The trust was not formed for the specific purpose of either
participating in the exempt pool or opening an exempt account; and
(2) The trustee or other person authorized to make investment
decisions with respect to the trust, and each settlor or other person
who has contributed assets to the trust, is a qualified eligible
person;
(M) An organization described in section 501(c)(3) of the Internal
Revenue Code (the ``IRC''); Provided, that the trustee or other person
authorized to make investment decisions with respect to the
organization, and the person who has established the organization, is a
qualified eligible person;
(N) A Non-United States person;
(O) An entity in which all of the unit owners or participants,
other than the commodity trading advisor claiming relief under this
section, are qualified eligible persons;
(P) An exempt pool; or
(Q) Notwithstanding paragraph (a)(6)(ii) of this section, an entity
as to which a notice of eligibility has been filed pursuant to Sec.
4.5 which is operated in accordance with such rule and in which all
unit owners or participants, other than the commodity trading advisor
claiming relief under this section, are qualified eligible persons.
(ii) Persons who must satisfy the Portfolio Requirement to be
qualified eligible persons. With respect to the persons listed in this
paragraph (a)(6)(ii), the commodity pool operator must reasonably
believe, at the time of the sale to such person of a participation in
the exempt pool, or the commodity trading advisor must reasonably
believe, at the time such person opens an exempt account, that such
person satisfies the Portfolio Requirement in paragraph (a)(5) of this
section.
(A) An investment company registered under the Investment Company
Act or a business development company as defined in section 2(a)(48) of
such Act not formed for the specific purpose of either investing in the
exempt pool or opening an exempt account;
(B) A bank as defined in section 3(a)(2) of the Securities Act of
1933 (the ``Securities Act'') or any savings and loan association or
other institution as defined in section 3(a)(5)(A) of the Securities
Act acting for its own account or for the account of a qualified
eligible person;
(C) An insurance company as defined in section 2(13) of the
Securities Act acting for its own account or for the account of a
qualified eligible person;
(D) A plan established and maintained by a state, its political
subdivisions, or any agency or instrumentality of a state or its
political subdivisions, for the benefit of its employees, if such plan
has total assets in excess of $5,000,000;
(E) An employee benefit plan within the meaning of the Employee
Retirement Income Security Act of 1974; Provided, that the investment
decision is made by a plan fiduciary, as defined in section 3(21) of
such Act, which is a bank, savings and loan association, insurance
company, or registered investment adviser; or that the employee benefit
plan has total assets in excess of $5,000,000; or if the plan is self-
directed, that investment decisions are made solely by persons that are
qualified eligible persons;
(F) A private business development company as defined in section
202(a)(22) of the Investment Advisers Act;
(G) An organization described in section 501(c)(3) of the IRC, with
total assets in excess of $5,000,000;
(H) A corporation, Massachusetts or similar business trust, or
partnership, limited liability company or similar business venture,
other than a pool, which has total assets in excess of $5,000,000, and
is not formed for the specific purpose of either participating in the
exempt pool or opening an exempt account;
(I) A natural person whose individual net worth, or joint net worth
with that person's spouse, at the time of either his purchase in the
exempt pool or his opening of an exempt account would qualify him as an
accredited investor as defined in Sec. 230.501(a)(5) of this title;
(J) A natural person who would qualify as an accredited investor as
defined in Sec. 230.501(a)(6) of this title;
(K) A pool, trust, insurance company separate account or bank
collective trust, with total assets in excess of $5,000,000, not formed
for the specific purpose of either participating in the exempt pool or
opening an exempt
[[Page 70878]]
account, and whose participation in the exempt pool or investment in
the exempt account is directed by a qualified eligible person; or
(L) Except as provided for the governmental entities referenced in
paragraph (a)(6)(ii)(D) of this section, if otherwise authorized by law
to engage in such transactions, a governmental entity (including the
United States, a state, or a foreign government) or political
subdivision thereof, or a multinational or supranational entity or an
instrumentality, agency, or department of any of the foregoing.
(7) United States means the United States, its states, territories
or possessions, or an enclave of the United States government, its
agencies or instrumentalities.
(b) * * *
(2) * * *
(i) Exemption from the specific requirements in Sec. Sec. 4.24 and
4.26(d) with respect to each pool; Provided, that any offering
memorandum distributed in connection with soliciting prospective
participants in the exempt pool be distributed consistent with the
requirements of Sec. 4.21 and include:
(A) A description of principal risk factors for the exempt pool, as
required by Sec. 4.24(g);
(B) A description of the exempt pool's investment program and use
of proceeds, as required by Sec. 4.24(h);
(C) A description of fees and expenses, as required by Sec.
4.24(i);
(D) A description of conflicts of interest, as required by Sec.
4.24(j);
(E) Performance disclosures, as required by Sec. 4.25, with the
exception of information required by paragraphs (a)(3) and (c)(2) of
Sec. 4.25;
(F) All other disclosures necessary to make the information
contained therein, in the context in which it is furnished, not
misleading; and
(G) The following statement, prominently disclosed on the cover
page of the offering memorandum:
``PURSUANT TO AN EXEMPTION FROM THE COMMODITY FUTURES TRADING
COMMISSION IN CONNECTION WITH POOLS WHOSE PARTICIPANTS ARE LIMITED TO
QUALIFIED ELIGIBLE PERSONS, AN OFFERING MEMORANDUM FOR THIS POOL IS NOT
REQUIRED TO BE, AND HAS NOT BEEN, FILED WITH THE COMMISSION. THE
COMMODITY FUTURES TRADING COMMISSION DOES NOT PASS UPON THE MERITS OF
PARTICIPATING IN A POOL OR UPON THE ADEQUACY OR ACCURACY OF AN OFFERING
MEMORANDUM. CONSEQUENTLY, THE COMMODITY FUTURES TRADING COMMISSION HAS
NOT REVIEWED OR APPROVED THIS OFFERING OR ANY OFFERING MEMORANDUM FOR
THIS POOL PRIOR TO FIRST USE.''
(3) * * *
(iv) Where the exempt pool is invested in one or more other pools
or funds operated by third parties, the commodity pool operator may
choose instead to prepare and distribute to its pool participants
statements signed and affirmed in accordance with Sec. 4.22(h) on a
monthly basis within 45 days of the month-end; Provided, that the
statements otherwise meet the conditions of paragraphs (b)(3)(i)
through (ii) of this section, and that the commodity pool operator
notifies its pool participants of this alternate distribution schedule
in the exempt pool's offering memorandum distributed prior to the
initial investment, or upon its adoption of this reporting schedule,
for then existing pool participants.
* * * * *
(5) Recordkeeping relief. Exemption from the specific requirements
of Sec. 4.23; Provided, that the commodity pool operator must maintain
the offering memoranda and reports referred to in paragraphs (b)(2),
(3), and (4) of this section, and all other books and records prepared
in connection with its activities as the pool operator of the exempt
pool (including, without limitation, records relating to the
qualifications of qualified eligible persons and substantiating any
performance representations). Books and records that are not maintained
at the pool operator's main business office shall be maintained by one
or more of the following: 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. Such books and records must be made
available to any representative of the Commission, the National Futures
Association and the United States Department of Justice in accordance
with the provisions of Sec. 1.31 of this chapter.
* * * * *
(c) * * *
(1) * * *
(i) Exemption from the specific requirements of Sec. Sec. 4.34 and
4.36(d); Provided, that any brochure or other disclosure statement
delivered by a commodity trading advisor to its prospective qualified
eligible person clients be distributed consistent with the requirements
of Sec. 4.31 and include:
(A) A description of persons to be identified, as required by Sec.
4.34(e);
(B) A description of principal risk factors, as required by Sec.
4.34(g);
(C) A description of the exempt commodity trading advisor's trading
program, as required by Sec. 4.34(h);
(D) A description of fees, as required by Sec. 4.34(i);
(E) A description of conflicts of interest, as required by Sec.
4.34(j);
(F) Performance disclosures, as required by Sec. 4.35;
(G) All additional disclosures necessary to make the information
contained therein, in the context in which it is furnished, not
misleading; and
(H) The following statement, prominently displayed on the cover
page of the brochure or other disclosure statement:
``PURSUANT TO AN EXEMPTION FROM THE COMMODITY FUTURES TRADING
COMMISSION IN CONNECTION WITH ACCOUNTS OF QUALIFIED ELIGIBLE PERSONS,
THIS BROCHURE OR ACCOUNT DOCUMENT IS NOT REQUIRED TO BE, AND HAS NOT
BEEN, FILED WITH THE COMMISSION. THE COMMODITY FUTURES TRADING
COMMISSION DOES NOT PASS UPON THE MERITS OF PARTICIPATING IN A TRADING
PROGRAM OR UPON THE ADEQUACY OR ACCURACY OF COMMODITY TRADING ADVISOR
DISCLOSURE. CONSEQUENTLY, THE COMMODITY FUTURES TRADING COMMISSION HAS
NOT REVIEWED OR APPROVED THIS TRADING PROGRAM OR THIS BROCHURE OR
ACCOUNT DOCUMENT PRIOR TO FIRST USE.''
* * * * *
(2) Recordkeeping relief. Exemption from the specific requirements
of Sec. 4.33; Provided, that the commodity trading advisor must
maintain, at its main business office, the trading brochure or
disclosure statement referred to in paragraph (c)(1) of this section,
and all other books and records prepared in connection with its
activities as the commodity trading advisor of qualified eligible
persons (including, without limitation, records relating to the
qualifications of such qualified eligible persons and substantiating
any performance representations). Such books and records must be made
available to any representative of the Commission, the National Futures
Association, and the United States Department of Justice in accordance
with the provisions of Sec. 1.31 of this chapter.
(d) * * *
(4)(i) Any exemption from the requirements of Sec. Sec. 4.22,
4.23, 4.24, 4.25, and 4.26 claimed hereunder with respect to a pool
shall not affect the obligation of the commodity pool
[[Page 70879]]
operator to comply with all other applicable provisions of this part,
the Act and the Commission's rules and regulations, with respect to the
pool and any other pool the pool operator operates or intends to
operate.
(ii) Any exemption from the requirements of Sec. Sec. 4.33, 4.34,
and 4.36 claimed hereunder shall not affect the obligation of the
commodity trading advisor to comply with all other applicable
provisions of this part, the Act and the Commission's rules and
regulations, with respect to any qualified eligible person and any
other client to which the commodity trading advisor provides or intends
to provide commodity interest trading advice.
* * * * *
0
3. In Sec. 4.14, revise paragraph (a)(8)(i)(C)(2) to read as follows:
Sec. 4.14 Exemption from registration as a commodity trading
advisor.
(a) * * *
(8) * * *
(i) * * *
(C) * * *
(2) With the exception of the pool's operator, advisor, and their
principals, solely ``Non-United States persons,'' as that term is
defined in Sec. 4.7(a)(7), will contribute funds or other capital to,
and will own beneficial interests in, the pool; Provided, that units of
participation in the pool held by persons who do not qualify as Non-
United States persons or otherwise qualified eligible persons represent
in the aggregate less than 10 percent of the beneficial interest of the
pool;
* * * * *
0
4. In Sec. 4.21, revise paragraph (a)(2) to read as follows:
Sec. 4.21 Required delivery of pool Disclosure Document.
(a) * * *
(2) For the purpose of the Disclosure Document delivery
requirement, including any offering memorandum delivered pursuant to
Sec. 4.7(b)(2)(i) or Sec. 4.12(b)(2)(i), the term ``prospective pool
participant'' does not include a commodity pool operated by a pool
operator that is the same as, or that controls, is controlled by, or is
under common control with, the pool operator of the offered pool.
* * * * *
0
5. In Sec. 4.22:
0
a. Revise paragraphs (a)(4), (c)(7) introductory text, (c)(8), (d)(1)
introductory text, (d)(2)(i) introductory text, (f)(2) introductory
text, and (f)(2)(iv)(B) and (C); and
0
b. Remove paragraph (f)(2)(iv)(D).
The revisions read as follows:
Sec. 4.22 Reporting to pool participants.
(a) * * *
(4) For the purpose of the Account Statement delivery requirement,
including any Account Statement distributed pursuant to Sec. 4.7(b)(3)
or Sec. 4.12(b)(2)(ii), the term ``participant'' does not include a
commodity pool operated by a pool operator that is the same as, or that
controls, is controlled by, or is under common control with, the pool
operator of a pool in which the commodity pool has invested.
* * * * *
(c) * * *
(7) For a pool that has ceased operation prior to, or as of, the
end of the fiscal year, the commodity pool operator may provide the
following, within 90 days of the permanent cessation of trading, in
lieu of the annual report that would otherwise be required by Sec.
4.22(c) or Sec. 4.7(b)(4):
* * * * *
(8) For the purpose of the Annual Report distribution requirement,
including any annual report distributed pursuant to Sec. 4.7(b)(4) or
Sec. 4.12(b)(2)(iii), the term ``participant'' does not include a
commodity pool operated by a pool operator that is the same as, or that
controls, is controlled by, or is under common control with, the pool
operator of a pool in which the commodity pool has invested; Provided,
that the Annual Report of such investing pool contain financial
statements that include such information as the Commission may specify
concerning the operations of the pool in which the commodity pool has
invested.
(d)(1) Subject to the provisions of paragraphs (d)(2) and (g)(2) of
this section, the financial statements in the Annual Report required by
this section or by Sec. 4.7(b)(4) must be presented and computed in
accordance with United States generally accepted accounting principles
consistently applied and must be audited by an independent public
accountant; Provided, however, and subject to the exception in
paragraph (c)(7)(iii)(B) of this section, that the requirement that the
Annual Report be audited by an independent public accountant does not
apply for any fiscal year during which the only participants in the
pool are one or more of the pool operator, the pool's commodity trading
advisor, any person controlling, controlled by, or under common control
with the pool operator or trading advisor, and any principal of the
foregoing; and Provided further, that the commodity pool operator
obtains a written waiver from each such pool participant of their right
to receive an audited Annual Report for such fiscal year, maintains
such waivers in accordance with Sec. 4.23, and makes such waivers
available to the Commission or National Futures Association upon
request. The requirements of Sec. 1.16(g) of this chapter shall apply
with respect to the engagement of such independent public accountants,
except that any related notifications to be made may be made solely to
the National Futures Association, and the certification must be in
accordance with Sec. 1.16 of this chapter, except that the following
requirements of that section shall not apply:
* * * * *
(2)(i) Where a pool is organized in a jurisdiction other than the
United States, the financial statements in the Annual Report required
by this section or by Sec. 4.7(b)(4) may be presented and computed in
accordance with the generally accepted accounting principles, standards
or practices followed in such other jurisdiction; Provided, that:
* * * * *
(f) * * *
(2) In the event a commodity pool operator finds that it cannot
obtain information necessary to prepare annual financial statements for
a pool that it operates within the time specified in paragraph (c) of
this section or Sec. 4.7(b)(4)(i), as a result of the pool investing
in another collective investment vehicle, it may claim an extension of
time under the following conditions:
* * * * *
(iv) * * *
(B) For all reports prepared under paragraph (c) of this section
and for reports prepared under Sec. 4.7(b)(4)(i) that are audited by
an independent public accountant, the commodity pool operator has been
informed by the independent public accountant engaged to audit the
commodity pool's financial statements that specified information
required to complete the pool's Annual Report is necessary in order for
the accountant to render an opinion on the commodity pool's financial
statements. The notice must include the name, main business address,
main telephone number, and contact person of the accountant; and
(C) The information specified by the accountant cannot be obtained
in sufficient time for the Annual Report to be prepared, audited, and
distributed before the Extended Date.
* * * * *
[[Page 70880]]
Issued in Washington, DC, on October 3, 2023, by the Commission.
Christopher Kirkpatrick,
Secretary of the Commission.
Note: The following appendices will not appear in the Code of
Federal Regulations.
Appendices to Commodity Pool Operators, Commodity Trading Advisors, and
Commodity Pools: Updating the `Qualified Eligible Person' Definition;
Adding Minimum Disclosure Requirements for Pools and Trading Programs;
Permitting Monthly Account Statements for Funds of Funds; Technical
Amendments--Commission Voting Summary and Commissioners' Statements
Appendix 1--Commission Voting Summary
On this matter, Chairman Behnam and Commissioners Johnson and
Goldsmith Romero voted in the affirmative. Commissioner Pham
concurred. Commissioner Mersinger voted in the negative.
Appendix 2--Statement of Commissioner Kristin N. Johnson History of
Disclosure-Centered Regulation
Federal regulation expressly establishes that customer
protection is a core principle of and central to the oversight
mission of the Commodity Futures Trading Commission (CFTC or
Commission). For almost a century, mandatory disclosure has played a
critical role in market regulation, directly shaping the development
of the U.S. capital and derivatives markets.\1\ Requiring disclosure
of material information mitigates inherent asymmetries of
information.
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\1\ Mandatory disclosure serves as a theoretical and practical
linchpin in capital markets regulation. Unless an offering is
otherwise exempt from registration, Section 5 of the Securities Act
requires issuers who seek to raise capital to register the offering
with the Securities and Exchange Commission (SEC) prior to offering
the securities to investors for sale. See 15 U.S.C. 77a-77mm. To
complete the registration process, issuers must compile and
distribute extensive disclosures describing, among other matters,
the nature of the issuer's business; the educational and
professional profiles of executives appointed to senior management
positions and individuals selected to serve on the board of
directors; tangible and intangible property; risk factors; and the
financial health--current and forecasted earnings and revenues--of
the firm.
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The Commission allocates resources among registration and
supervision responsibilities and enforcement actions to foster
effective oversight of market participants and transactions. This
approach not only enhances the integrity of markets, but effectively
protects customers from material misrepresentations and fraud.
Congress has judiciously introduced Federal markets legislation,
often in response to nationwide or global market-wide crises, and
has carefully balanced Federal regulation with the role and
significance of state regulatory oversight.
One hundred years ago, Congress passed the Grain Futures Act--
the statute that was superseded by the Commodity Exchange Act (CEA)
and that established the Grain Futures Administration (GFA, the
predecessor of the CFTC)--authorizing the GFA to regulate certain
commodity futures. A decade later, in the wake of the stock market
crash of 1929 and the conclusion of the roaring '20s--a period
characterized by a surging economy and intense market speculation
accompanied by pervasive fraud in retail securities markets \2\--
Congress adopted the Securities Act of 1933 (the Securities Act).
The stock market crash of 1929 triggered staggering losses by retail
investors and initiated a long period of industrial decline and
widespread unemployment, ultimately leading to deeply depressed
macroeconomic conditions.
---------------------------------------------------------------------------
\2\ Investigative Congressional hearings revealed that more than
half of the $25 billion in securities distributed between the end of
World War I and the stock market crash of 1929 were worthless. H.R.
REP. NO. 73-85, at 2 (1933); see also U.S. Senate Hist. Off.,
Subcommittee on Senate Resolutions 84 and 239, https://www.senate.gov/about/powers-procedures/investigations/pecora.htm.
Detailed accounts of issuers' intentional dissemination of false and
misleading information punctuated evidence of fraud and stunning
acts of avarice. During this period, securities listed on the New
York Stock Exchange declined from a pre-crash high of $89 billion to
$15 billion in 1932. One critical investigative report suggested
that ``had there been full disclosure,'' issuers' schemes ``could
not long have survived the fierce light of publicity and
criticism.'' Ferdinand Pecora, Wall Street Under Oath: The Story of
Our Modern Money Changers (1939).
---------------------------------------------------------------------------
Consistent with an adage made popular by U.S. Supreme Court
Justice Louis Brandeis--``[s]unlight is said to be the best of
disinfectants; electric light the most efficient policeman'' \3\--
Congress adopted a disclosure-centric approach.
---------------------------------------------------------------------------
\3\ Louis D. Brandeis, Other People's Money And How The Bankers
Use It, 92 (1914).
---------------------------------------------------------------------------
Disclosure increases transparency, reduces asymmetries of
information, and mitigates fraud and manipulation as well as other
misconduct in our financial markets. In the absence of mandatory
disclosures, investors may have limited access to the material
information needed to make a reasonable investment decision.
Mandatory disclosure neutralizes incentives to misrepresent material
information.
It is incumbent upon the Commission to continue to carry out
this mandate reflected in the principles of Federal markets
regulation and firmly established in the CEA.
Novel Financial Products and Evolving Derivatives Markets
Novel financial products, such as digital assets and innovative
technologies like distributed digital ledger or blockchain
technology and generative artificial intelligence, increasingly
dominate regulatory discourse and popular discussions. The
derivatives markets offer futures on digital assets, which are
priced on a volatile spot market, employ technology that is highly
complex and rapidly changing, and offer novel market structures
including market structures designed to permit retail customers
direct access to trading and clearing platforms. In some contexts,
trading structures eliminate intermediaries such as a futures
commission merchants (FCM), raising important questions regarding
the best approach for preserving important customer protections such
as segregation of customer assets.
As our markets are evolving, more and more vulnerable customers
increasingly engage in complex derivatives activities. It is
important that these customers have an opportunity to consider
critical, material information when making an investment decision.
Disclosure serves a valuable role in protecting customers.
Consequently, regulators must continuously revisit regulation to
ensure that it remains fit for purpose. Our regulations must keep
pace with innovation in our evolving markets. In particular, we must
refresh our understanding of which customers may benefit from
disclosure when investing, directly or indirectly, in derivatives
markets.
* * * * *
I support the notice of proposed rulemaking (NPRM) regarding
commodity pool operators (CPOs), commodity trading advisors (CTAs),
and commodity pools operated under CFTC Regulation 4.7. The NPRM
addresses regulatory gaps that have arisen due to, at least in part,
the changing dynamics in the derivatives markets. The proposed
amendments adapt the CFTC's existing regulations to reinforce,
preserve, and promote customer protection safeguards. CFTC
Regulation 4.7 dictates the disclosure obligations of CPOs and CTAs
by establishing the test for classifying a natural person as a
retail investor to whom extensive disclosures and financial reports
must be delivered or a financially sophisticated investor with
respect to whom a more streamlined process may be warranted.
Updating Our Understanding of the Legal Standard for ``Financial
Sophistication''
Adopted in 1979, part 4 of the CFTC's regulations requires CPOs
and CTAs to deliver disclosures and regular financial reports to
pool participants or advisory clients.\4\ This framework acts as an
important layer of protection for customers, by providing customers
with material information about the commodity pool or trading
platform, which may include investment objectives, past performance
record, conflicts of interest, risk disclosures, or other prescribed
information.
---------------------------------------------------------------------------
\4\ 17 CFR 4.7. On January 2, 1979, the CFTC adopted rules for
the regulation of CPOs and CTAs. See Commodity Pool Operators and
Commodity Trading Advisors; Final Rules, 44 FR 1918 (Jan. 8, 1979).
These rules became effective April 1, 1979.
---------------------------------------------------------------------------
CFTC Regulation 4.7, adopted in 1992, creates an exemption from
certain part 4 requirements for CPOs and CTAs that privately offer
or sell pool participations solely to qualified eligible persons
(QEPs) pursuant to an exemption under the Securities Act or direct
or guide the commodity trading accounts of QEPs. As a result, QEPs
or wealthy individuals do not
[[Page 70881]]
receive any of the specific disclosures otherwise provided to non-
QEPs or retail investors (e.g., offering memoranda, brochures, or
disclosure statements) and receive streamlined financial reporting.
A natural person, investing capital in a commodity pool or whose
trading account invests in derivatives, would be a QEP if the
individual is an ``accredited investor,'' as defined by the SEC in
Regulation D under the Securities Act, and also meets the CFTC's
portfolio requirement.\5\ The portfolio requirement is designed to
ensure that a person's investments reach a specified threshold
related to the person's securities portfolio and derivatives
account. This functions as a proxy for identifying individuals who,
based on the size of their investments, have ``substantial
investment experience and thus a high degree of sophistication with
regard to investments as well as financial resources to withstand
the risk of their investments.'' \6\
---------------------------------------------------------------------------
\5\ 17 CFR 4.7(a)(3)(ix) and (x). The portfolio test applies to
certain legal entities and natural persons. Generally, the portfolio
test is satisfied if the natural person owns securities of
unaffiliated issuers and other investments with a market value of at
least $2,000,000 (Securities Portfolio Test); has on deposit with an
FCM for such person's account at least $200,000 in initial margin,
option premiums, or minimum security deposits (Initial Margin and
Premium Test); or owns a portfolio of funds and assets that, when
expressed as percentages of the first two thresholds, meet or exceed
100%. 17 CFR 4.7(a)(1)(v).
\6\ Exemption for Commodity Pool Operators With Respect to
Offerings to Qualified Eligible Participants; Exemption for
Commodity Trading Advisors With Respect to Qualified Eligible
Clients, 57 FR 34853, 34854 (Aug. 7, 1992). To clarify, in respect
of natural persons, the portfolio requirement does not facilitate
the concurrent use of an exemption from registration under the
Securities Act and the CFTC Regulation 4.7 exemption because the QEP
status is not completely harmonized with the accredited investor
status of the SEC.
---------------------------------------------------------------------------
Recognizing that classifying individuals as QEPs may result in
reduced regulatory protections, it is therefore critical that the
Commission is careful in setting out the standard for determining
that an individual is a QEP.
An individual customer may experience substantial losses if the
market moves against the customer's positions. This concern is
heightened by the fact that the participation interests acquired in
an exempt pool offering are not registered offerings subject to the
SEC's robust public offering disclosure regime outlined in public
offering registration obligation.
Commodity pools are commonly hedge funds that may use leverage
to magnify returns, engage in speculation, and take directional
positions. These types of structured investment strategies may
result in amplified losses for customers.
While our markets are undergoing unprecedented changes, robust
customer protections must remain consistent and effective. Natural
persons who currently meet the outdated thresholds in the portfolio
requirement test introduced in 1992 are not necessarily
sophisticated investors in today's markets. What's worse, under the
existing regulation, individuals that meet the QEP test may not be
receiving disclosures to be fully apprised of the risks associated
with investing in novel derivatives instruments, whether directly or
through a commodity pool, and our evolving markets.
Two-Part Recalibration of Customer Protection Measures
This NPRM has two important objectives.\7\
---------------------------------------------------------------------------
\7\ The NPRM also revises the timing of certain pools' periodic
financial reporting, based on long-standing no-action letters, to
permit funds of funds to provide account statements within 45 days
of the month-end rather than 30 days of the quarter-end and makes
technical adjustments to reorganize CFTC Regulation 4.7 to improve
its structure and utility (e.g., to fix cross-references).
---------------------------------------------------------------------------
First, it doubles the financial thresholds of the portfolio
requirement test to account for inflation since the exemption was
adopted in 1992, thereby recalibrating the standard for determining
which pool investors or advisory clients are QEPs.\8\ If this
proposed amendment is adopted, certain pool participants and
advisory clients that do not receive disclosures or receive
streamlined financial reporting under the existing regulation will
benefit from the full range of customer protection measures in part
4 of the CFTC's regulations. The proposed thresholds are not even as
high as those that were originally proposed in 1992, and so I do not
find the amended portfolio requirement to be too restrictive or
limiting today, more than 30 years later.\9\ Perhaps the thresholds
could be higher.
---------------------------------------------------------------------------
\8\ The Commission is proposing to update the portfolio
requirement's thresholds by doubling the Securities Portfolio Test
to $4,000,000 and the Initial Margin and Premium Test to $400,000.
\9\ As originally proposed in 1992, the portfolio requirement
had two components: (1) $5,000,000 in securities or (2) $1,000,000
deposited as initial margin and options premiums with an FCM for
commodity interest trading. 57 FR at 34855.
---------------------------------------------------------------------------
Second, the NPRM sets a new minimum standard of disclosure
regarding pools and trading programs that must be provided to all
QEPs or wealthy investors, while retaining the more robust
disclosure and reporting requirements applicable to non-QEPs or
retail investors.\10\ The adoption of this amendment will result in
heightened customer protections for QEPs that currently are entitled
to none. I strongly believe that as a market regulator, we must,
when warranted, carefully recalibrate how investors participate in
our evolving markets to ensure that CPOs and CTAs provide a
prospective or actual investor, whether such investor is a QEP or
not, with information that is sufficient and adequate to enable the
investor to assess the material risks and rewards of the commodity
pool or trading program. Disclosure is key to remediating the
dangers of information asymmetry.
---------------------------------------------------------------------------
\10\ The new minimum standards will require the disclosure of
principal risk factors, investment programs, use of proceeds,
custodians, conflicts of interest, fees and expenses, and past
performance, and the retention of disclosures as business records.
---------------------------------------------------------------------------
I appreciate the staff's efforts in heightening disclosure and
enhancing customer protections and their cooperation in implementing
my comments to refine the preamble and regulatory text concerning
the specific disclosures that will be required under the proposed
rule.
I am looking forward to thoughtful comments and responses from
market participants. In particular, I welcome perspectives on the
potential impact of the proposed rule changes on natural persons who
are investing in exempt pools operated by a CPO, or are advisory
clients of a CTA, that is relying on the exemptions under CFTC
Regulation 4.7 and navigating our complex and evolving derivatives
markets.
Appendix 3--Dissenting Statement of Commissioner Summer K. Mersinger
I regrettably dissent from the Commission's \1\ proposed
rulemaking to amend Rule 4.7,\2\ which for the past 30 years has
provided exemptions to registered commodity pool operators
(``CPOs'') and commodity trading advisors (``CTAs'') that operate
commodity pools or trading programs for Qualified Eligible Persons
(``QEPs''). I say ``regrettably'' because there are two aspects of
this proposal that are consistent with views I have expressed
before, and which I support.
---------------------------------------------------------------------------
\1\ This Statement will refer to the Commodity Futures Trading
Commission as the ``CFTC'' or the ``Commission.''
\2\ CFTC Rule 4.7, 17 CFR 4.7.
---------------------------------------------------------------------------
First, I agree that it is time for the Commission to consider
increasing the monetary thresholds in the ``Portfolio Requirement''
in the definition of a QEP in Rule 4.7(a) to account for inflation.
As I previously have stated, ``I believe that it is incumbent upon
the CFTC, like any regulatory agency, to continually review its rule
set to evaluate whether rules . . . need to be updated because they
have simply failed to keep up with the times.'' \3\
---------------------------------------------------------------------------
\3\ Opening Statement of Commissioner Summer Mersinger Regarding
CFTC Open Meeting on June 7, 2023, section regarding Amendments to
part 17 Large Trader Reporting Requirements Proposed Rule (June 7,
2023), available at https://www.cftc.gov/PressRoom/SpeechesTestimony/mersingerstatement060723.
---------------------------------------------------------------------------
Second, I support proposing a process in our rules that would
permit CPOs relying on Rule 4.7 to elect an alternate account
statement schedule that is consistent with exemptive letters issued
regularly by the Commission. This schedule would address the fact
that our current rule is not workable in the context of funds-of-
funds, and also would generate more frequent reporting. As I
previously have stated, ``when one of our rules needs to be fixed
because it is unworkable, ambiguous, or inefficient, corrective
action by notice-and-comment rulemaking is the gold standard because
it allows the Commission to hear from stakeholders and develop
regulatory solutions that provide certainty.'' \4\
---------------------------------------------------------------------------
\4\ Dissenting Statement of Commissioner Summer K. Mersinger
Regarding CFTC's Regulatory Agenda, section entitled `` `Kicking the
Can Down the Road' Rather than Working on Rulemaking Solutions''
(January 9, 2023), available at https://www.cftc.gov/PressRoom/SpeechesTestimony/mersingerstatement010923.
---------------------------------------------------------------------------
However, I cannot support the proposal to narrow the scope of
the historical exemptions in Rule 4.7 by imposing universal
disclosure requirements to QEPs. It represents a ``mandate first,
evaluate later'' approach based on assumptions, speculation, and
poor
[[Page 70882]]
sourcing. It also fails to fulfill certain fundamental functions of
sound notice-and-comment rulemaking.
Rule 4.7 in Brief
Rule 4.7 provides exemptions for registered CPOs and CTAs
operating commodity pools and trading programs restricted to QEPs
(``4.7 CPOs and CTAs'') from, among other things, disclosure,
recordkeeping, and use-and-filing requirements that otherwise would
apply pursuant to the CFTC's rules. The rationale for the exemptions
is that QEPs are sufficiently financially sophisticated, and have
sufficient leverage and resources, to protect their own interests
when participating in such pools and trading programs.
As explained in the Proposing Release, the definition of a QEP
is bifurcated into two categories: (1) those pool participants or
advisory clients that need to satisfy a ``Portfolio Requirement'' to
be considered a QEP; and (2) those that do not. The Portfolio
Requirement, in turn, can be met by satisfying either a Securities
Portfolio Test of $2 million or an Initial Margin and Premium Test
of $200,000, or a combination of the two.\5\
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\5\ See Proposing Release at 7-9.
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The Commission is proposing to double the monetary thresholds of
the Portfolio Requirement in the QEP definition to $4 million for
the Securities Portfolio Test and $400,000 for the Initial Margin
and Premium Test. This proposal is intended to account for inflation
since Rule 4.7 was adopted in 1992.
The ``Mandate First, Evaluate Later'' Approach to Disclosures to QEPs
Is Not Good Government
At the same time, the Commission also is proposing to narrow the
scope of Rule 4.7 by eliminating a significant portion of the
current disclosure exemptions available to 4.7 CPOs and CTAs,
thereby imposing universal disclosure requirements to QEPs. This is
a ``mandate first, evaluate later'' approach to regulation that I
strongly oppose.
1. We May Already be Taking Care of the Stated Concern
The Proposing Release begins by observing that the number of 4.7
CPOs and CTAs, and the number of commodity pools and trading
programs relying on Rule 4.7, have ballooned over the years.\6\ It
then states its primary justification for significantly narrowing
the scope of the 4.7 exemptions by imposing universal disclosure
requirements to QEPs as follows:
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\6\ See id. at 5-6.
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The definition of QEP in Regulation 4.7 encompasses a broad
spectrum of market participants from large fund complexes and other
institutional investors with significant assets under management to
individuals with varying backgrounds and experience, each of which
has vastly different resources available to insist upon the
disclosure of information regarding the offered 4.7 pool or trading
program and then to analyze whatever information is provided.\7\
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\7\ Id. at 16.
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Yet, this justification fails to consider that the increasing
numbers of pools and trading programs relying on Rule 4.7, and of
QEPs that may not have the wherewithal to protect their interests,
may result from the erosion in the Portfolio Requirement's monetary
thresholds due to inflation--which the Commission is now proposing
to address. If the Commission appropriately adjusts the Portfolio
Requirement thresholds for becoming a QEP to return them to levels
comparable to when the Commission adopted the disclosure exemptions
in Rule 4.7, then there is no logical reason why it should also
eliminate those disclosure exemptions with respect to QEPs that
still satisfy the new (higher) thresholds and are entirely capable
of protecting their interests.\8\
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\8\ The analysis of costs and benefits in the Proposing Release
suggests that there is reason to believe the proposal to increase
the Portfolio Requirement's monetary thresholds may take care of the
stated concern based on differences in QEPs' ability to protect
their interests. It states: ``To the extent persons who meet the
higher Portfolio Requirement thresholds are (on average) more
financially sophisticated or resilient than those who no longer
qualify, this proposed amendment [to increase the Portfolio
Requirement thresholds] should result in individuals and entities,
both QEPs and non-QEPs, being offered pools and trading programs
that are regulated in a manner commensurate with their respective
needs for customer protection.'' Proposing Release at 66-67.
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In short: Before imposing universal disclosure requirements that
many QEPs do not need, the Commission should evaluate whether
adjusting the Portfolio Requirement, as it is proposing to do, will
address its stated concern about differences between QEPs. As
regulators, we should always evaluate first, and then, if
appropriate, adopt regulations based on the results of that
evaluation. This proposal's ``mandate first, evaluate later''
approach has it exactly backwards.
2. We Should Not Act Based on Speculation and Assumptions
Another rationale the Proposing Release offers for imposing
universal disclosure requirements to QEPs is that ``the Commission
has . . . witnessed a significant expansion and growth in the
complexity and diversity of commodity interest products offered to
QEPs via 4.7 pools and trading programs,'' and ``product innovation
in the commodity interest markets has continued at a rapid and
unrelenting pace.'' \9\ The primary examples cited are swaps and
digital assets.
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\9\ Id. at 19, 20.
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Yet, the Proposing Release offers no evidence to support its
paternalistic conjecture that QEPs may not appreciate the nature of
the risk associated with trading swaps in commodity pools and
trading programs that rely on the exemptions in Rule 4.7. And there
is no logical reason why such swap trading should now require a
significant narrowing of the exemptions in Rule 4.7 more than a
decade after Congress enacted a full regulatory regime for swaps in
the Dodd-Frank Act \10\--which the Commission has fully implemented.
The Proposing Release does not cite to any provision of the Dodd-
Frank Act or its legislative history suggesting Congress felt that
the development of swap trading warranted a reconsideration of the
scope of the exemptions provided by Rule 4.7 in general--or
universal disclosure requirements to QEPs in particular.
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\10\ Dodd-Frank Wall Street Reform and Consumer Protection Act,
Public Law 111-203, 124 Stat. 1376 (2010) (``Dodd-Frank Act'').
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As for digital assets and technological innovation, the
Proposing Release recognizes that it is relying on mere speculation.
It candidly acknowledges that: (1) ``Given the relatively recent
development of digital assets, it remains unclear as to whether the
underlying markets . . . are subject to market fundamentals similar
to those of the traditional commodities''; and (2) ``As the
financial system continues to experience a period of rapid evolution
in the era of artificial intelligence and other technological
advancements, the Commission expects to see continued development of
novel investment products that . . . may in fact deviate from the
typical operations of markets now subject to the Commission's
oversight.'' \11\
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\11\ Proposing Release at 21 (emphases added).
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Throughout the 30 years since Rule 4.7 was adopted, there has
been a steady expansion of the number, complexity, and diversity of
available derivatives products, and derivatives markets have
undergone transformational changes resulting from technological
innovation (none greater than the migration from open-outcry pit
trading to all-electronic trading). Yet, through it all, there has
never been any suggestion that the exemptions under Rule 4.7 needed
to be significantly narrowed as a result.
We should not act based on what we don't know. More
specifically, we should not impose universal disclosure requirements
to QEPs based on speculation about hypothetical future developments.
As markets continue to evolve and innovate as they always have done,
we as regulators should evaluate first and then adopt regulations
only as appropriate based on the results of that evaluation. Once
again, this proposal has it exactly backwards.
3. The Justifications for Acting Now Are Poorly Sourced
Certainly, regulators must often act quickly when confronted
with urgent circumstances. But that is hardly the case here.
The Proposing Release contains no indication that QEPs are
clamoring for the Commission to require disclosures by 4.7 CPOs and
CTAs. Indeed, one of the principal sources cited in support of the
assertion that there is a problem that needs to be addressed is a
roundtable--on CPO risk management practices--convened by CFTC staff
way back in 2014.\12\
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\12\ See id. at 16-17.
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Other support for the claim that the Commission needs to act
consists of footnote citations to individual cases of alleged
wrongdoing by 4.7 CPOs and CTAs. These footnotes cite news clippings
reporting on allegations in deposition testimony, statements of
litigation counsel, and litigation documents--with no indication
whether these allegations were proved to be true.\13\ And in some of
the cases, it appears
[[Page 70883]]
that the 4.7 CPO or CTA was alleged to have committed fraud, or
violated the Commission's existing requirement ``to provide all
disclosures necessary to make information provided, in the context
in which it is furnished, not misleading.'' \14\
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\13\ See id. at 17-18 n.46-47. Footnote no. 46 also cites to a
CFTC reparations case from 2018 that resulted in a default judgment
and thus was not litigated.
\14\ CFTC Rules 4.7(b)(2) (CPOs) and 4.7(c)(1) (CTAs), 17 CFR
4.7(b)(2), 4.7(c)(1).
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Overall, the sourcing in the Proposing Release is woefully
insufficient to support a proposal to impose universal disclosure
requirements to QEPs on 4.7 CPOs and CTAs. There is no reason the
Commission cannot undertake a proper evaluation of whether there
really is a problem that needs to be addressed and, if so, the
appropriate means to address it.
The Commission has a variety of tools at its disposal to
undertake such an evaluation. For starters, our staff could convene
a roundtable specifically devoted to this issue, so that the
Commission would not have to look to comments at a roundtable in
another context that occurred nine years ago. The Commission or
staff also could issue a Request for Comment or an Advance Notice of
Proposed Rulemaking--both tools that have been utilized recently
\15\--in order to evaluate the necessity of taking action (and what
action might be appropriate to take).
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\15\ See Request for Comment on the Impact of Affiliations on
Certain CFTC-Regulated Entities (June 28, 2023), available at
https://www.cftc.gov/PressRoom/PressReleases/8734-23, and Risk
Management Programs for Swap Dealers, Major Swap Participants, and
Futures Commission Merchants, 88 FR 45826 (July 18, 2023),
respectively.
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In sum: Given its poor sourcing, the proposal to impose
universal disclosure requirements to QEPs is a solution in search of
a problem. The Proposing Release fails to justify its ``mandate
first, evaluate later'' approach. The Commission should evaluate
first, and act later based on that evaluation, if appropriate,
consistent with established principles of good government.
The Proposal Fails To Fulfill Fundamental Functions of Sound Rulemaking
A sound notice of proposed rulemaking is characterized by, among
other things: (1) transparency as to the agency's plans; and (2)
requests for comment on key issues. This Proposing Release is
deficient on both counts.
1. The Commission Should Be Fully Transparent About Its Plans
The Proposing Release is not fully transparent about the
Commission's plans on two key issues.\16\ First, it says little
about how the proposed amendments to Rule 4.7 would be implemented.
This is especially critical with respect to the proposed increases
to the Portfolio Requirement monetary thresholds, which would create
a class of pool participants and advisory clients that qualify as
QEPs under existing Rule 4.7, but would no longer qualify as QEPs
under amended Rule 4.7.
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\16\ One of the Commission's Core Values is ``Clarity,'' i.e.,
``Providing transparency to market participants about our rules and
processes.'' See The Commission, CFTC Core Values, Clarity,
available at https://www.cftc.gov/About/AboutTheCommission.
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Would these ``former QEPs'' be permitted to make additional
investments in commodity pools and trading programs that are exempt
under Rule 4.7 and in which they currently are investing? The
Proposing Release explains that it would continue the requirement of
existing Rule 4.7(a)(3) \17\ that a CPO must assess QEP status at
the time of sale of a pool participation, and that a CTA must do so
at the time the person opens an exempt account.\18\ But it does not
explain that, as a result, ``former QEPs'' would not be able to make
additional investments in exempt commodity pools they are currently
participating in (although they could make additional investments to
trading programs in these circumstances).
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\17\ CFTC Rule 4.7(a)(3), 17 CFR 4.7(a)(3).
\18\ Proposing Release at 12.
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I appreciate the rationale of existing Rule 4.7(a)(3) with
respect to a participant in an exempt commodity pool whose financial
resources drop below QEP thresholds. But I am not sure that same
rationale should apply where a participant drops below QEP
thresholds because the Commission is ``moving the goalposts'' by
increasing those thresholds. I imagine there may be QEPs that are
comfortable with their 4.7 CPOs, pleased by the performance of the
4.7 exempt pools in which they are participating, and satisfied with
the information disclosures they have received--and that would like
to be able to contribute additional funds to those investments.
The Commission should be forthright that the proposal would deny
them this opportunity if they fall on the wrong side of the
increased thresholds being proposed, and seek comment from
potentially affected QEPs specifically on that issue. To shroud the
issue in mystery in the Proposing Release is inconsistent with sound
notice-and-comment rulemaking.
Second, the Proposing Release does transparently reveal that the
CFTC would use universal disclosure requirements to QEPs imposed on
4.7 CPOs and CTAs as ``an additional level of oversight'' by
``incorporating the review of [the new mandatory disclosures] into
existing examination processes used by the Commission . . .'' \19\
What it does not reveal, however, is where the Commission plans to
find the resources for ``an additional level of oversight'' by
reviewing the disclosures that would be required of the
approximately 1700 CPOs and CTAs that rely on Rule 4.7 with respect
to thousands of commodity pools and trading programs.\20\
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\19\ Id. at 26 and 23, respectively.
\20\ See id. at 5-6 (citing statistics).
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What Commission programs or functions will have to be cut or
curtailed in order for it to perform this new task? The public is
entitled to know whether the CFTC's review of required disclosures
to QEPs that are capable of protecting their own interests may come
at the expense of, say, reductions in enforcement resources to
prosecute those who defraud retail customers, or the Commission's
oversight of derivatives exchanges and clearinghouses for which we
are responsible by statute. But once again, the Proposing Release is
silent.\21\
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\21\ The Commission also should be more transparent about the
estimates in its analysis required by the Paperwork Reduction Act
(``PRA''). The Proposing Release estimates the annual burden hours
per response of the disclosures proposed to be required of 4.7 CPOs
and CTAs to be 1.5 hours. See Proposing Release at 56 (CPOs) and 59
(CTAs). But the Proposing Release does not explain how it arrived at
this estimate--which strikes me as very low.
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2. Putting the ``Comment'' Back in ``Notice-and-Comment''
Rulemaking
It is somewhat startling how few questions the Proposing Release
asks regarding its proposed amendments to Rule 4.7. Most notably, it
does not even request comment on the foundational question of
whether universal disclosure requirements to QEPs are needed. As
discussed above, the Commission's justifications for the proposed
requirements are poorly sourced and based largely on assumptions and
allegations--but the Proposing Release does not ask the public if
those assumptions and allegations are accurate.\22\ It appears that
the Commission has already made up its mind that universal
disclosure requirements to QEPs are necessary, and is not interested
in whether QEPs, other market participants, or the public agree with
that.
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\22\ After presenting its justifications for imposing universal
disclosure requirements to QEPs, the Proposing Release ``requests
comment on all aspects of the proposed amendments outlined below
that would require certain information be disclosed to prospective
QEP pool participants and advisory clients under Regulation 4.7 . .
.'' Proposing Release at 27 (emphasis added). That is, the Proposing
Release requests comment on the disclosures to QEPs ``outlined
below'' that it is proposing to require of 4.7 CPOs and CTAs--but
not on the preceding discussion of whether universal disclosure
requirements to QEPs are needed in the first place.
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Nor does the Proposing Release ask: (1) whether current QEPs
that fall below the increased Portfolio Requirement monetary
thresholds for QEP status should be permitted to make additional
investments in a commodity pool exempt under Rule 4.7; or (2)
whether reviewing mandatory disclosures to QEPs that are able to
protect their own interests is an appropriate use of the
Commission's limited resources.
Accordingly, since the Commission declines to ask these
questions, I will. I invite comment--especially, but not
exclusively, from QEPs--on the following questions regarding the
amendments that the Commission is proposing to Rule 4.7:
1. Do QEPs agree that the Commission should impose universal
disclosure requirements on 4.7 CPOs and CTAs? Why or why not?
2. Is the Commission correct in its preliminary belief that
universal disclosure requirements to QEPs are necessary to address
unequal bargaining power of QEPs? Would they be necessary if the
Commission's proposed increases to the Portfolio Requirement
monetary thresholds in the QEP definition are adopted?
3. Is the Commission correct in its preliminary belief that
universal disclosure requirements to QEPs are necessary in light
[[Page 70884]]
of significant expansion and growth in the complexity and diversity
of commodity interest products offered to QEPs via 4.7 pools and
trading programs, and in light of the rapid pace of innovation in
the commodity interest markets?
4. Is the Commission correct in its preliminary belief that the
development of markets for swaps and digital assets necessitates
universal disclosure requirements to QEPs?
5. Are there alternative, more tailored, means by which the
Commission could achieve its policy objectives than the universal
disclosure requirements to QEPs that it is proposing? If so, please
describe.
6. Should QEPs under existing Rule 4.7 that would no longer
qualify as QEPs under the proposed amendments to the Portfolio
Requirement thresholds in Rule 4.7 be permitted to contribute
additional funds to exempt commodity pools operated by 4.7 CPOs in
which they currently are participating? Why or why not?
7. Should the Commission impose universal disclosure
requirements to QEPs that are capable of protecting their own
interests in order to incorporate the review of such disclosures
into its existing examination processes if such review comes at the
expense of other Commission responsibilities? Why or why not?
8. To what extent will the proposed universal disclosure
requirements to QEPs impact the benefits that 4.7 CPOs and CTAs
derive from relying on the exemptions in Rule 4.7? Is it likely that
4.7 CPOs and CTAs will decide to no longer rely on the remaining
exemptions afforded by Rule 4.7 if the proposed universal disclosure
requirements to QEPs are adopted?
9. If a 4.7 CPO or CTA is registered as an investment adviser
with the SEC and not subject to an exemption regarding disclosures
required by the SEC, should the CFTC accept compliance with
disclosures required by the SEC as sufficient to satisfy the
proposed universal disclosure requirements to QEPs under Rule 4.7,
too?
10. Is the Commission's PRA estimate of 1.5 annual burden hours
per response for the disclosures proposed to be required of 4.7 CPOs
and CTAs appropriate? If not, what would be an appropriate estimate?
Conclusion
Given my support for certain aspects of this proposal, and given
my support for obtaining public input on initiatives to improve our
rulebook generally, I wish that I could support the issuance of the
Proposing Release. Unfortunately, because of its ``mandate first,
evaluate later'' approach to the issue of disclosures to QEPs by 4.7
CPOs and CTAs, and its serious omissions in transparency and
requests for comment, I cannot do so. Accordingly, I respectfully
dissent.
Appendix 4--Concurring Statement of Commissioner Caroline D. Pham
I respectfully concur on the Notice of Proposed Rulemaking
Regarding Commodity Pool Operators, Commodity Trading Advisors, and
Commodity Pools Operated under Regulation 4.7: Updating the
``Qualified Eligible Person'' Definition; Adding Minimum Disclosure
Requirements for Pools and Trading Programs; Permitting Monthly
Account Statements for Funds of Funds; Technical Amendments (CPO/CTA
NPRM), because I am concerned that the proposed changes for
commodity pool operators (CPOs) and commodity trading advisors
(CTAs) offering to or advising sophisticated clients, or ``qualified
eligible persons'' (QEPs), are burdensome and unnecessary for
entities that are already subject to extensive CFTC regulation or
banking, securities, insurance, or other financial services
regulation.\1\ I thank staff in the Market Participants Division for
their engagement with my office on the CPO/CTA NPRM.
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\1\ See Exemption for Commodity Pool Operators with Respect to
Offerings to Qualified Eligible Participants; Exemption for
Commodity Trading Advisors with Respect to Qualified Eligible
Clients, 57 FR 34853 (Aug. 7, 1992).
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I reiterate the concerns in my prior dissent on the CFTC's
proposed amendments to Form PF.\2\ This CPO/CTA NPRM, like the
CFTC's proposed amendments to Form PF, seem to impose overly broad
obligations that would be burdensome and unnecessary for
sophisticated clients, and would present operational challenges and
costs without a persuasive cost-benefit analysis under the Commodity
Exchange Act.
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\2\ See Dissenting Statement of Commissioner Caroline D. Pham
Regarding the Proposed Amendments to Form PF, U.S. Commodity Futures
Trading Commission (August 10, 2022), https://www.cftc.gov/PressRoom/SpeechesTestimony/phamstatement081022.
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In a time of economic challenges, including rising inflation, we
must be careful when considering proposals that could inhibit
positive economic activity that supports American businesses and
jobs. I look forward to hearing from commenters as to the proposed
amendments, including practical implementation issues and the
relative costs and benefits of the proposal.
[FR Doc. 2023-22324 Filed 10-11-23; 8:45 am]
BILLING CODE 6351-01-P