Seeing Commodity Pools More Clearly

Jumping into a commodity pool is one of several ways you can trade in commodity futures markets.

A commodity pool is a shared private pool of money from multiple participants to speculate in futures, swaps, or options markets. The commodity pool operator (CPO) manages and solicits funds for the pool.

Most CPOs must be registered members of the National Futures Association (NFA) to conduct business. You can check the registration status and backgrounds of CPOs using the NFA’s Background Affiliation Status Information Center (BASIC) database.

Trading futures through a pool rather than through an individual trading account has its benefits. Your purchasing power increases significantly when you team up with a pool. You gain more leverage and diversification if you trade a $1 million account as opposed to a $10,000 account, for example. The pool’s participants share in the profits based on how much money they contribute. They also share in the losses.

Commodity pools are generally structured as limited partnerships. That is, as a limited partner with a stake in the pool, the most you might lose is the principal you deposited in the first place. As a limited partner, you are generally not responsible for margin calls. If the pool has a margin call, though, its investors might as well. Everything depends on the terms in the contract between pool participants and the pool. By comparison, if you trade futures on your own, you could lose all your principal and would still have to maintain the minimum margin amount to keep your position open. Before you become a pool participant, find out in writing whether you will be responsible for any fees, margin calls, or any other charges in excess of your deposit.

A commodity pool incurs the same risk as individual traders in other ways, though. The pool still trades in futures contracts and can be highly leveraged in markets that are very volatile. And like an individual trader, the pool can suffer substantial losses in a short period of time.

That’s why it’s important to consider who is managing the pool, their backgrounds, and performance records—the longer the track record the better. Thoroughly scrutinize your CPOs. In addition to everyday trading risks, unregistered CPOs and commodity pools are often fraudulent. Commodity pool fraud and misconduct generally occur in several forms:

Misappropriation of Funds

Fraudulent CPOs could misappropriate funds instead of trading collected funds in commodities or futures as promised. The money can wind up in the con man’s personal account or be used to lead a lavish lifestyle. In other cases, the CPO could take bigger risks or trade the money in ways that aren’t disclosed.

Commodity pools have also been used in Ponzi schemes. A Ponzi scheme is where a con man accepts funds from some people, and uses all or part of those funds to pay off others who had previously deposited their funds with him. In this way the con man maintains the appearance of a legitimate successful trader, but it is really just a shell game. Some red flags for this type of scheme are where the CPO delays returning your funds upon request or blames others for restricting his ability to return your funds.

Misrepresentation

A CPO might make false promises of security or claims of high returns. A CPO may claim falsely that he has qualifications or a winning track record. He could even falsely claim that one can profit from publicly known information—making his strategy a “sure thing.” Remember: Commodity futures and derivatives trading are inherently volatile and risky. You should always be aware that you could lose your entire investment. Further, for every trade there is one winner and one loser, and even the so-called winner of a trade may not make any money if the fees and commissions charged for the trade exceed the amount generated by the trade.

Lack of Registration

Most CPOs must be NFA registered. Such CPOs are subjected to the associated regulations. Other CPOs are not required to be registered. These include the following types of CPOs: Operators of small pools (less than 15 investors and $400,000 in assets); operators of single commodity pools who do not advertise or receive compensation; and operators of pools that only trade a minimal amount of futures, where participation is limited to “accredited investors” or qualified eligible persons and satisfies certain liquidation measurements.

The CFTC recently won a verdict for a case that spanned several years and covered three of the fraud attributes discussed above. The CFTC charged Grace Reisinger of Grand Island, Nebraska and her company, ROF Consulting, LLC, for misappropriating funds, making fraudulent misrepresentations, and omitting material information to actual and prospective pool participants—including that she was exempt from the CFTC’s registration requirement and that the pool only solicited and accepted funds from participants who met the definition of a “qualified eligible person”—and failing to register.

You Are Entitled to Information

CPOs are required to give you information up front and in monthly statements. In most instances, CPOs cannot accept your money until they provide you with disclosure documents that contain information about the essential players in the pool:

• The pool operator
• The pool's principals
• Any outside advisors who provide trading advice or make trading decisions

The documentation must also disclose previous performance records, if there are any, and a clear delineation of the risks involved.

With a new pool, there is frequently a provision that the pool will not begin trading until a certain amount of money is raised by a specified deadline. Defining this deadline is required. If there is no deadline—building up to the fund minimum can go on indefinitely—that should also be indicated.  

Carefully analyze disclosure documents and be clear on the terms. Know how your money will be traded. If you’re waiting for the pool minimum to be met, find out where your money will be held and what interest you might earn, if any. If the pool never begins, know when and how your money will be returned.

Your disclosure documents should indicate whether or not you are responsible for any losses in excess of your investment in the pool. Fees, initial charges, and administrative costs should be noted in the disclosures.

Ask Questions

Remember, if you are considering participating in commodity pools, the following information should be made available to you, and you should request it:

• Disclosures that contain pool operator information, past performance records, and past performance of the pool's principals or any other individual who will provide trading advice or making trading decisions.
• A mandatory disclosure that documents the risks involved.
• A mandatory deadline disclosure indicating the time period for raising funds.
• Explanation of how your money will be traded in the meantime, what interest you will earn (if any), and how and when your investment will be returned in the event the pool does not start trading.
• Disclosures that outline the procedure for redeeming your shares in the pool, any restrictions that may exist, and provisions for liquidating and dissolving the pool if more than a certain percentage of the capital were to be lost.

It is better to be over informed than foggy on the details. If you have questions, are aware of suspicious activities, or believe you have been defrauded, please let the CFTC know quickly. Call the CFTC or visit the File a Tip or Complaint page.