[Federal Register: August 2, 1999 (Volume 64, Number 147)]
[Proposed Rules]
[Page 41843-41851]
From the Federal Register Online via GPO Access [wais.access.gpo.gov]
[DOCID:fr02au99-43]
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COMMODITY FUTURES TRADING COMMISSION
17 CFR Part 4
Performance Data and Disclosure for Commodity Trading Advisors
AGENCY: Commodity Futures Trading Commission.
ACTION: Proposed rules.
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SUMMARY: On June 18, 1998, the Commodity Futures Trading Commission
(``CFTC'' or ``Commission'') published in the Federal Register a
``Concept Release'' seeking public comment on issues relating to the
computation and presentation of rate of return information and other
disclosures concerning partially-funded accounts managed by commodity
trading advisors (``CTAs''). The Concept Release discussed rules
proposed by National Futures Association (``NFA'') as well as several
other issues related to the presentation of CTA and commodity pool
operator disclosure which appeared to warrant further study and
analysis. The Concept Release requested public comment on both the NFA
proposal and the other issues. Based on its consideration of comments
received in response to the Concept Release, the Commission has
determined to propose revisions to its rules concerning the
documentation, computation, and disclosure of CTA's past performance
information. The rules are intended to simplify the recordkeeping and
computational requirements for CTAs who accept partially-funded client
accounts, while providing for meaningful and focused disclosure to
clients regarding the past performance of the CTA, and the risks
attendant upon trading on a partially-funded basis.
DATES: Comments must be received by October 1, 1999.
ADDRESSES: Comments on the proposed rules may be sent to Jean A. Webb,
Secretary of the Commission, Commodity Futures Trading Commission, 1155
21st Street, NW., Washington, DC 20581. In addition, comments may be
sent by facsimile transmission to facsimile number (202) 418-5221, or
by electronic mail to [email protected]. Reference should be made to
``Performance Data and Disclosure for Commodity Trading Advisors.''
FOR FURTHER INFORMATION CONTACT: Robert B. Wasserman, Associate
Director, (202) 418-5092, electronic mail: ``[email protected],'' or
Eileen R. Chotiner, Futures Trading Specialist,
[[Page 41844]]
(202) 418-5467, electronic mail: ``[email protected],'' Division of
Trading and Markets, Commodity Futures Trading Commission, 1155 21st
Street, NW., Washington, DC 20581.
SUPPLEMENTARY INFORMATION:
I. The Concept Release
The Concept Release sought public comment on computational and
disclosure matters relating to participation in programs of commodity
trading advisors (``CTAs'') on a partially-funded basis and raised
specific questions regarding a number of issues: (1) Improving risk
profile data for clients considering participation in CTA programs on a
partially-funded basis; (2) providing CTA client account information to
futures commission merchants (``FCMs'') to aid the FCM's risk
management; (3) improving risk profile data on commodity pools; (4)
providing a theoretically sound basis of computation and presentation
for rate of return (``ROR'') and related risk profile data; (5)
improving the presentation of historical performance and risk profile
data; and (6) providing periodic statements of program activity and
results to CTA clients.
The Commission initially provided a 60-day comment period on the
Concept Release, through August 17, 1998. On August 6, 1998, the
Commission extended the comment period for 30 days, through September
16, 1998. The Commission received 19 comments on the release: four from
firms registered as both CTAs and commodity pool operators (``CPOs'');
three from registered CTAs; one from a registered CPO; one from a bar
association; one from a futures self-regulatory organization; one from
a futures industry trade association; two from academicians; one from
an administrative law judge; two from accounting/compliance firms; two
from other financial services firms; and one from an individual
investor.
The Concept Release addressed in particular rules proposed by the
National Futures Association (``NFA'').\1\ In the rule submissions, NFA
proposed that ROR be computed on the basis of the nominal account size,
rather than the beginning net asset value (``BNAV'') of the account, as
currently required by Commission Rule 4.35(a)(6). NFA asserted that the
amount of actual funding in a client's account does not control the
CTA's trading decisions. In the Concept Release, the Commission raised
questions about whether nominal account size is a legitimate basis for
the computation of ROR, as well as whether NFA's proposed documentation
and disclosure requirements were sufficient to address concerns about
the impact of partial funding on a client's account.
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\1\ By letters dated March 15, 1994 and March 15, 1995, NFA
submitted to the Commission for its approval, pursuant to Section
17(j) of the Act, NFA Compliance Rule 2-34 and its Interpretive
Notice regarding documentation and disclosure for partially-funded
accounts. By letter dated February 26, 1998, NFA submitted a
revision to NFA Compliance Rule 2-29 regarding the rate of return
computation.
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In response to the questions raised in the Concept Release, some
commenters indicated concern regarding the validity of the nominal
account size and the ability of clients to interpret and compare
performance data presented on a basis other than the actual funds
deposited in a client's account. However, the majority of commenters,
including NFA, the Managed Funds Association (``MFA''), and several
CPOs and CTAs, expressed support for the use of nominal account size as
the basis for computing ROR and presenting the CTA's past performance.
The Concept Release also discussed the current requirements for
disclosure of draw-down information pursuant to Rules 4.35(a)(1)(v) and
(vi), and asked for comment on the possibility of expanding draw-down
disclosure in two areas. First, the Concept Release sought comment on
the advisability of requiring draw-down percentage data to be presented
at two or three partial-funding levels that are representative of those
offered by the CTA, in addition to the fully-funded level. Second, the
Concept Release sought comment on the concept of enhancing disclosure
of a program's historical volatility, possibly by expanding the time
period for historical performance disclosure; reducing the amount of
monthly data; and requiring more detailed information concerning the
volatility of the CTA's program, either through an expanded number of
worst draw-down months, or by requiring presentation of the standard
deviation of the monthly returns.
A number of commenters expressed concern that requiring too many
items of data would result in less attention being paid to that
information. The Commission has been attentive to those concerns. In
seeking to highlight the increased leverage--and consequent increased
risk--in partially funding accounts, the Commission has proposed a set
of disclosures that is significantly limited compared to that discussed
in the Concept Release.
A number of other ideas discussed in the Concept Release generated
substantial opposition from commenters. These include a requirement
that a CTA provide a copy of its agreement with the client to the
client's FCM and additional reporting requirements for CTAs. The
Commission has determined not to include these in the proposed rules.
II. The Proposed Rules
The Commission has carefully considered the comments received, and
has determined to revise its rules to provide a comprehensive framework
for addressing certain of the issues raised in the Concept Release. In
making the current proposal, which incorporates most of the concepts
included in the NFA proposal, the Commission seeks to simplify the
recordkeeping and computational requirements for CTAs who accept
partially-funded client accounts, while providing for meaningful and
focused disclosure to clients regarding the past performance of the
CTA, and the risks attendant upon trading on a partially-funded basis.
In particular, the Commission has determined to revise its rules to
require that ROR be computed by dividing net performance by the nominal
account size. This change is intended to reduce regulatory burdens by
relieving CTAs of the responsibility for tying nominal account size to
actual funding levels, and to permit a uniform method for CTAs to
calculate their RORs, regardless of whether they accept partially-
funded client accounts. As discussed below, CTAs who wish to measure
performance on an actual funds basis may do so by setting the nominal
account size equal to the actual funding level.
The risk disclosure requirements included in the proposed rules are
intended to highlight critical information without overloading the
client with excessive data. Other changes are proposed primarily to
codify certain definitions and other information currently contained in
Commission advisories.\2\
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\2\ CFTC Advisory 87-2 [1986-87 Transfer Binder] Comm. Fut. L.
Rep. (CCH) para. 23,624 (June 2, 1987); CFTC Advisory 93-13, 58 FR
8226 (February 12, 1993).
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A. Documentation of Nominal Account Size
In order to address concerns regarding documentation of the nominal
account size and other terms of the CTA's trading for clients'
accounts, the Commission is proposing to add new paragraph (c) to Rule
4.33. This provision would require that the CTA execute a written
agreement with each client that specifies: The nominal account size;
the name or description of the trading program in which the client is
participating; the basis for the
[[Page 41845]]
computation fees; how additions or withdrawals of actual funds, or
profits and losses will affect each of (a) the nominal account size and
(b) the computation of fees; and whether the client will fully or
partially fund the account. The provisions of proposed Rule 4.33(c) are
substantially similar to the documentation requirements that were
included in NFA's Proposal.
These requirements will apply to all CTAs, regardless of whether
they accept partially-funded accounts. A CTA that intends to continue
to measure its performance using actual funds may establish a nominal
account size which is defined on an actual funds basis. The information
specified by Rule 4.33(c) need not be contained in a separate
agreement, but may be included as part of any other signed written
agreement between the CTA and the client.
B. Changes to Calculations
The Commission is proposing to amend and re-order paragraphs (A)--
(F) of Rule 4.35(a)(6)(i) to accommodate the use of nominal account
size, rather than net asset value, as the basis for performance
computation.\3\ Rule 4.10(l) would also be amended to define the
measurement of a CTA's worst peak-to-valley draw-down by net
performance relative to nominal account size, rather than changes in
net asset value. Proposed Rules 4.35(a)(6)(i)(D) and (E) address the
fact that changes to the nominal account size may result either from
changes in actual amounts, such as additions, withdrawals, profits or
losses; or from changes to the nominal account size, pursuant to the
terms of the CTA's agreement with the client in accordance with
proposed Rule 4.33(c)(1). Proposed Rule 4.35(a)(6)(i)(B) defines net
performance as the sum of the realized gain or loss on positions closed
during the period plus the change during the period in unrealized gain
or loss, plus interest on funds deposited with the client's FCM, less
fees and expenses. This proposed rule also provides that no interest
income may be imputed with respect to nominal account sizes or
otherwise computed on a pro-forma basis.
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\3\ For example: Under the current method of calculation, if a
CTA's program has beginning net asset value (BNAV) of 100, ending
net asset value (ENAV) of 150, additions (ADDS) of 40 and
withdrawals (WDRS) of 0, then net performance (NET-PERF) is 10, and
ROR is 10%:
NET-PERF = ENAV - BNAV - ADDS + WDRS
10 = 150 - 100 - 40 + 0
ROR = NET-PERF/BNAV
10% = 10/100
Under the proposal, the CTA is not required to monitor net asset
values, and thus net performance must be calculated directly. Under
the proposed method of calculation, if the total of the nominal
account sizes for the CTA's program (BNOM) is 100 at the beginning
of the month, the realized gain on positions closed during the
period (RG) is 7, the change in unrealized gains (UN-RG) is 5, and
fees and expenses (FEES) are 2, then NET-PERF is still 10, and ROR
is still 10%:
NET-PERF = RG + UN-RG - FEES
10 = 7 + 5 - 2
ROR = NET-PERF/BNOM
10% = 10/100
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Although proposed rule 4.35(a)(6)(i)(B) would include, as part of
net performance, interest on actual funds deposited with the client's
FCM, this raises questions regarding whether such interest should be
credited as part of the CTA's performance where the interest is earned
on investments directed by the FCM (as opposed to the CTA). Reasons
supporting the inclusion of the interest include the following: (1)
Since trading fees are charged against the CTA's performance, even
though the commission rate may be negotiated by the client and the FCM,
interest earned at the FCM should be credited to the CTA's performance
to maintain parity; and (2) the interest is, in a real sense, part of
the return on the funds. Reasons against the inclusion of the interest
include the following: (1) Since the objective of performance reporting
is to convey the results from the trading which a CTA performed on
behalf of a client, it may be misleading to include interest earned on
investments managed by the FCM (as opposed to the CTA); and (2) as one
commenter explained, ``(i)f a CTA agrees with each of several clients
to a nominal account size and each account is traded similarly, the
performance results of the CTA as they relate to these accounts should
be the same.'' But, if interest on the funds on deposit with the
client's FCM is included in the CTA's performance results, then the CTA
will have different performance results, depending on each client's
arbitrarily selected funding level. The Commission solicits comment on
this issue.
C. Disclosure of Actual Funding Levels and Funds Under Management
In accepting the use of nominal account size to compute ROR, the
Commission intends to permit CTAs to disclose their trading results as
they relate to the account size which governs their trading decisions.
However, the Commission believes that disclosure of the amount of
client assets managed by the CTA--the funds under management--should
continue to reflect the amount of actual funds committed by clients to
the CTA's trading program, rather than the aggregate of nominal account
sizes. It would be misleading to describe ``notional funds,'' \4\ which
the client has chosen not to place in an account over which the CTA has
trading authority, as ``funds under management.'' Rule 4.35(a)(1),
therefore, would be revised to clarify that the disclosure of funds
under management must reflect only the actual funds committed to the
CTA's trading program. The term ``Actual Funds'' is defined in new Rule
4.10(n), which codifies the definitions included in Commission
Advisories 87-2 and 93-13.\5\ Rule 4.35(a)(1) would permit a CTA that
does not posses information about the amount of actual funds a client
has deposited to meet this disclosure requirement by simply disclosing
that lack of information. New provisions, set forth in Rule
4.35(a)(1)(ix), would require that the performance capsule state the
percentage of client accounts in the program that are fully funded and
specify that any disclosure of aggregate nominal account sizes must be
identified clearly as such and presented adjacent to the actual funds
amounts.
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\4\ The difference between the nominal account size and the
actual funding level frequently been referred to as ``notional
funds.''
\5\ See supra, note 2.
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D. Disclosure Concerning Draw-Downs
If the client funds the account traded by the CTA at a level less
than the nominal account size, then gains or losses will represent a
greater percentage of the amount funded. In other words, the leverage
will be increased. This increased leverage increased both the
likelihood that the client will be faced with a margin call and the
size of such a potential margin call. It also increases the risk that
the client will lose more than the funds it has advanced. In order to
indicate clearly to potential clients the increased leverage--and the
consequent increased risk--inherent in partial funding, new Rule
4.35(a)(1)(ix)(A) would require CTAs who accept partially-funded
accounts to present draw-down figures computed on the basis of the
actual funds committed to the CTA's program by the client with the
lowest ratio of actual funds to nominal account size in the trading
program.\6\ If the CTA does not have sufficient information regarding
the funding level of its client accounts, or if the lowest ratio is
zero, the draw-down information would be presented at a funding level
of 20%. These additional draw-down figures would be presented adjacent
to the worst monthly and peak-to-valley draw-
[[Page 41846]]
down percentages based on the aggregate nominal account sizes.
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\6\ For example, if the lowest funding level is 25% and the
greatest monthly drawdown is 15%, the drawdown shown on the basis of
actual funding would be 60% (15%<divide>25%).
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The concept release discussed the Commission's concern regarding
disclosure of the historical volatility of CTA programs and suggested
that, since extreme market events do not always occur within the five-
year time-frame specified by the regulations, this time-frame may
permit some CTAs to omit their greatest draw-downs from their
historical risk profiles. In order to address these concerns, the
Commission proposes to revise Rules 4.35(a)(1)(v) and (vi) to require
that the worst monthly and peak-to-valley draw-down, which will be
based on the composite of accounts, be included in the performance
capsule for the most recent five years and, in addition, for the life
of the program, if longer than five years. The Commission does not
intend that this requirement create a significant additional
recordkeeping burden for CTAs, and is proposing a corresponding change
to Rule 4.35(a)(6)(ii) to clarify that only the monthly figures derived
from the supporting documentation, and not the supporting documentation
itself, must be maintained beyond the five-year period specified in
Rule 1.31. However, the Commission specifically invites comment
regarding the extent to which the additional draw-down disclosure would
provide a benefit to clients and details regarding the extent of any
additional burden that is anticipated.<SUP>7</SUP>
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\7\ Of course, prior to the effective date of these proposed
rule changes, commodity trading advisors would not be obligated to
maintain records for this purpose longer than the five years
required under Rule 1.31.
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E. Disclosure Concerning Range of Rates of Return
The Commission believes that disclosing the range of RORs for
closed accounts in the offered program provides an important measure of
the returns experienced by clients and will be useful to prospective
clients considering participation in the CTA's program. Therefore, the
Commission is also proposing to revise Rule 4.35(a)(1)(viii) to require
that the performance capsule for the offered program include, in
addition to the number of accounts closed with profits and the number
closed with losses, the range of rates of return for the accounts
closed with net lifetime profits and accounts closed with net lifetime
losses, during the five-year period. As previously noted, Rules
4.35(a)(1)(v) and (vi) would be revised to specify that the worst draw-
down information be based on the composite of accounts. Thus, the draw-
down figures in the CTA's capsule would not reflect the ROR of a client
account that performed worse than other accounts in composite
<SUP>8</SUP> In light of the proposed changes to Rules 4.35(a)(1)(v)
and (vi), the Commission believes that presentation of the range of
RORs for closed accounts would provide a valuable additional
perspective on the results experienced by individual clients. The
Commission does not anticipate a significant additional burden as a
result of this change due to the existing requirement of Rule
4.35(a)(1)(viii) that CTAs disclose the number of accounts closed with
profits and the number of accounts closed with losses.
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\8\ However, CTAs would remain subject to the requirement of
Rule 4.34(o) to disclose all material information to existing or
prospective clients even if such information is not specifically
required by these regulations.
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F. Disclosure of Monthly Performance
The Commission wishes to explore the possibility of requiring that
the monthly RORs be presented in a bar graph, in order to provide a
more direct visual representation of the variations in RORs from month
to month. Currently, Rule 4.35(a)(2)(ii) specifies that monthly RORs
for the offered program must be presented either in a numerical table
or in bar graph. Proposed revisions to Rule 4.35(a)(2)(ii) would
require the bar graph to be disclosed in addition to the tabular
presentation of monthly ROR figures. The Commission is requesting
comment regarding whether use of a bar graph may communicate the month-
to-month changes in customer returns more effectively than a tabular
presentation, as well as whether the bar graph should be required in
lieu of the tabular presentation of RORs. In addition, the Commission
seeks comment regarding the significance of any additional burden that
may result from the requirements.
G. Illustrative Performance Capsule
An example of a performance capsule that would meet the disclosure
requirements, modified as discussed in Secs. II(C-F) above, is attached
as Appendix A. This example is not intended to mandate a particular
format, but only to serve as an illustration.
H. Changes to Definitions and Disclosure Requirements
Changes are also being proposed to codify definitions and other
information currently contained in Commission advisories as well as to
clarify existing rules and definitions in the context of the proposed
rule revisions. New Rule 4.34(p), in the main, codifies certain of the
requirements currently set forth in Commission Advisory 93-13, and also
discussed as part of the NFA Proposal, for disclosure to prospective
clients of material information concerning the practice of partially
funding an account and the factors considered by the CTA in determining
the trading level for a given nominal account size. Definitions of
``nominal account size,'' ``actual funds'' and ``partially-funded
account'' are proposed to be added as Rules 4.10(m), (n) and (o),
respectively.
Proposed Rule 4.10(p) contains a definition of ``most recent five
years'' that is intended to simplify the terminology used to designate
the five calendar years and year-to-date time period for which
performance is required to be disclosed pursuant to Rules 4.25(a)(5)
and 4.35(a)(5). This clarification does not affect the existing
provisions of Rules 4.25(a)(7) and 4.35(a)(4) that require performance
information in a Disclosure Document to be current as of a date not
more than three months preceding the date of the Disclosure Document.
I. Commodity Pool Disclosure
The Concept Release included a detailed discussion of disclosure by
CPOs. Due to the complexity of pool performance issues, the Commission
is, generally, deferring consideration of changes to the requirements
for disclosure of past performance by CPOs, other than changes
primarily intended to conform the requirements for presentation of CTA
past performance in pool disclosure documents with the revisions to
Rule 4.35(a)(1) proposed herein. Other issues relating to pools will be
considered in the context of the Commission's implementation of
recommendations included in the President's Working Group on Financial
Markets' April 1999 study, ``Hedge Funds, Leverage and the Lessons of
Long-Term Capital Management.''
In order to highlight a use of leverage by commodity pools, the
Commission is proposing one substantive revision to commodity pool
disclosure in Rule 4.25(a)(1)(ii)(H). This provision would be
applicable only where the CPO allocates, to any of the pool's CTAs, an
amount of actual funds which is less than the nominal account size
stated in the pool's written agreement with the CTA. In such cases, the
CPO would be required to include in the performance capsule for each
such CTA, in a column adjacent to the presentation of data based on
nominal account size, the draw-down information required by Rule
4.25(a)(1)(ii)(E) and (F), computed on the basis of the ratio of the
nominal account size to the pool's actual funds allocated to the CTA's
program.
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III. Transitional Provisions
The Commission proposes to require CTAs and CPOs to comply with the
revisions proposed herein, including the requirement to obtain the
documentation required by new Rule 4.33(c) for both new and existing
clients, by no later than July 1, 2000. The Commission seeks comment on
any difficulties anticipated in complying with these proposed
requirements by July 1, 2000. CTAs and CPOs would be permitted to adopt
these changes immediately upon the effective date of the proposed
rules.
IV. Related Matters
A. Regulatory Flexibility Act
The Regulatory Flexibility Act (``RFA''), U.S.C. 606-11 (1994),
requires that agencies, in proposing rules, consider the impact of
those rules on small businesses. 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 RFA.\9\ The Commission previously has determined
that registered CPOs are not small entities for the purpose of the
RFA.\10\ With respect to CTAs, the Commission has stated that it would
evaluate within the context of a particular rule proposal whether all
or some affected CTAs would be considered to be small entities and, if
so, the economic impact on them of any rule.\11\ In this regard, the
Commission notes that the rule revisions being proposed herein create
some changes to the content of the documentation and disclosure
requirements for CTAs, but are not expected to increase such
requirements, and, in fact, are expected ultimately to ease the
computational and recordkeeping requirements for CTAs who manage
partially-funded client accounts. The Commission has previously
determined that the disclosure requirements governing this category of
registrant will not have a significant economic impact on a substantial
number of small entities \12\ Therefore, the Acting Chairman, on behalf
of the Commission, hereby certifies, pursuant to 5 U.S.C. 605(b), that
these proposed regulations will not have a significant economic impact
on a substantial number of small entities. Nonetheless, the Commission
specifically requests comment on the impact these proposed rules may
have on small entities.
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\9\ 47 FR 18618-181621 (April 30, 1982).
\10\ 47 FR 18619-18620.
\11\ 47 FR 18618-18620.
\12\ See 60 FR 38146, 38181 (July 25, 1995) and 48 FR 35248
(August 3, 1983).
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B. Paperwork Reduction Act
The Paperwork Reduction Act of 1995 (Pub. L. 104-13 (May 13, 1995))
imposes certain requirements on federal agencies (including the
Commission) in connection with their conducting or sponsoring any
collection of information as defined by that Act.
The group of rules contained in all of Part 4, ``Commodity Pool
Operators and Commodity Trading Advisers,'' of which Rules 4.10, 4.25,
4.33, 4.34 and 4.35 are a part, was approved on September 4, 1998 and
assigned OMB control number 3038-0005. The Commission does not
anticipate that the proposed revisions to the rules will affect the
total burden of this group of rules. The group of rules contained in
OMB control number 3038-0005 has the following burden:
Average burden hours per response: 4.95
Number of respondents: 4,624
Frequency of response: On occasion
Copies of the information collection submission to OMB are available
from the CFTC Clearance Officer, 1155 21st Street, NW, Washington, DC
20581, (202) 418-5160.
List of Subjects in 17 CFR Part 4
Brokers, Commodity futures, Commodity pool operators, Commodity
trading advisors.
PART 4--COMMODITY POOL OPERATORS AND COMMODITY TRADING ADVISORS
1. The authority citation for part 4 continues to read as follows
Authority: 7 U.S.C. 1a, 2, 4, 6b, 6c, 6l, 6m, 6n, 6o, 12a and
23.
2. Section 4.10 is proposed to be amended by revising paragraph (l)
and adding paragraphs (m), (n), (o) and (p) to read as follows:
Sec. 4.10 Definitions.
* * * * *
(l) Worst peak-to-valley draw-down means:
(1) For a commodity pool, the greatest cumulative percentage
decline in month-end net asset value due to losses sustained during any
period in which the initial month-end net asset value is not equaled or
exceeded by a subsequent month-end net asset value. Such decline must
be expressed as a percentage of the initial month-end net asset value,
together with an indication of the months and year(s) of such decline
from the initial month-end net asset value to the lowest month-end
asset value of such decline.
(2) For an account directed by a commodity trading advisor or for a
commodity trading advisor's trading program, the greatest negative net
performance during any period, beginning at the start of one month, and
ending at the conclusion of that month or a subsequent month. The worst
peak-to-valley draw-down must be expressed as a percentage of the
nominal account size at the beginning of the period, together with an
indication of the months and year(s) of such draw-down.
(3)(i) For purposes of paragraph (2) of this section, net
performance for a period is defined as the total of:
(A) the realized gain or loss on position closed during the period,
plus
(B) The change during the period in unrealized gain or loss, plus
(C) Interest accrued on funds deposited in the client's account at
a futures commission merchant, plus
(D) Other income accrued on positions held as part of the CTA's
program, minus
(E) Fees and expenses.
(ii) No income may be imputed with respect to nominal account sizes
or otherwise computed on a pro-forma basis.
(4) For purposes of Secs. 4.25 and 4.35, a peak-to-valley draw-down
which began prior to the beginning of the most recent five calendar
years is deemed to have occurred during such five-calendar-year period.
(m) Nominal account size means the account size, designated in the
written agreement specified in Sec. 4.33(c), which establish he
client's level of trading in a commodity trading advisor's program.
(n) Actual funds means the amount of margin-qualifying assets
committed to a commodity trading advisor's program, either:
(1) On deposit in an account at a futures commission merchant to
margin the client account for which a commodity trading advisor has
trading authority; or
(2) In another account, so long as the commodity trading advisor
has written evidence demonstrating the following:
(i) The client owns the funds and has designated such funds as
committed to the commodity trading advisor's trading program;
(ii) The futures commission merchant carrying the client's account
for which the commodity trading advisor directs trades has the power to
transfer the funds readily from the other account for the purpose of
meeting margin requirements in connection with such trades, on a
routine operational basis
[[Page 41848]]
and without advance notice to the client; and
(iii) The commodity trading advisor has ready access to information
concerning the designated balance in the account.
(o) Partially-funded account means a client participation in the
program of a commodity trading advisor in which the amount of actual
funds committed to the trading program is less than the nominal account
size.
(p) For purposes of Secs. 4.25 and 4.35, the term most recent five
years means:
(1) The time period beginning January 1 of the calendar year five
years prior to the date of the Disclosure Document and ending as of the
date of the Disclosure Document or
(2) The life of the trading program, if less than five years.
3. Section 4.25 is proposed to be amended by revising paragraphs
(a)(1)(ii)(D)(1) and (2) and (E) and (F) and by adding paragraph
(a)(l)(i)(H) to read as follows:
Sec. 4.25 Performance disclosures.
(a) * * *
(1) * * *
(ii) * * *
(D)(1) The aggregate of actual funds committed to all of the
trading programs of the trading advisor or other person trading the
account, as of the date of the Disclosure Document or, if the commodity
trading advisor does not have sufficient information regarding the
funding of its client's accounts to determine the aggregate of actual
funds committed to its programs, a statement of that fact;
(2) The aggregate of actual funds committed to the specified
trading program of the commodity trading advisor, as of the date of the
Disclosure Document or, if the commodity trading advisor does not have
sufficient information regarding the funding of its clients' accounts
to determine the aggregate of actual funds which are committed to the
specified trading program, a statement of that fact.
(E) The greatest monthly draw-down for the trading program
specified, expressed as a percentage of aggregate nominal account
sizes, and indicating the month and year of the draw-down during the
most recent five years.
(F) The greatest peak-to-valley draw-down for the trading program
specified, expressed as a percentage of aggregate nominal account
sizes, and indicating the month(s) and year(s) of the draw-down during
the most recent five years.
* * * * *
(H) In addition to the information specified in
Sec. 4.25(a)(1)(ii)(A)-(G), where the CPO allocates, to any of the
pool's, CTAs, an amount of funds which is less than the nominal account
size states in the written agreement with the CTA, the performance
capsule for each such CTA must include, in a column adjacent to the
presentation of data based on nominal account size, the draw-down
information required by Sec. 4.25(a)(1)(ii)(E) and (F), computed on the
basis of the ratio of the nominal account size to the pool's actual
funds allocated to the commodity trading advisor's program.
4. Section 4.33 is proposed to be amended by adding paragraph (c)
to read as follows:
Sec. 4.33 Recordkeeping.
* * * * *
(c) A commodity trading advisor must obtain a written agreement
signed by each client which, at a minimum, clearly specifies:
(1) The nominal account size;
(2) The name or description of the trading program in which the
client is participating;
(3) The basis for the computation of fees;
(4) How each of the following will affect each of the nominal
account size and the computation of fees: additions or withdrawals of
actual funds or profits or losses; and
(5) Whether the client will deposit, maintain or make accessible to
the FCM an amount equal to or less than the nominal account size, i.e.,
to fully or partially fund the account.
5. Section 4.34 is proposed to be amended by adding paragraph (p)
to read as follows:
Sec. 4.34 General disclosures required.
* * * * *
(p) Additional Disclosure by Commodity Trading Advisors Accepting
Partially-funded Accounts. A commodity trading advisor that accepts a
partially-funded account (as defined in Sec. 4.10(o)) must disclose:
(1) How the management fees will be computed, expressed as a
percentage of the nominal account size, and an explanation of the
effect of partially funding an account on the management fees as a
percentage of actual funds.
(2) An estimated range of the commissions generally charged to an
account expressed as a percentage of the nominal account size and an
explanation of the effect of partially funding an account on the
commissions as a percentage of actual funds;
(3) A statement that partial funding increases leverage, that
leverage will magnify both profits and losses, and that the greater the
disparity between the nominal account size and the amount deposited,
maintained or made accessible to the futures commission merchant, the
greater the likelihood and frequency of margin calls, and the greater
the size of margin calls as a percentage of the amount of actual funds
committed to the commodity trading advisor's program; and
(4) A description of the factors considered by the commodity
trading advisor in determining the level of trading for a given nominal
account size in the offered trading program and an explanation of how
those factors are applied.
6. Section 4.35 is proposed to be amended by revising paragraphs
(a)(1)(iv) through (a)(1)(ix), (a)(2), (a)(6)(i) and (a)(6)(ii) to read
as follows:
Sec. 4.35 Performance disclosures.
* * * * *
(a) * * * (1) * * *
(iv)
(A) The aggregate of actual funds committed to all of the trading
programs of the trading advisor or other person trading the account, as
of the date of the Disclosure Document, of, if the commodity trading
advisor does not have sufficient information regarding the funding of
its clients' accounts to determine the aggregate of actual funds
committed to its programs, a statement of that fact;
(B) The aggregate of actual funds committed to the specified
trading program of the commodity trading advisor, as of the date of the
Disclosure Document, or, if the commodity trading advisor does not have
sufficient information regarding the funding of its client accounts to
determine the aggregate of actual funds which are committed to the
specified trading program, a statement of that fact.
(v) The greatest monthly draw-down for the trading program
specified, expressed as a percentage of aggregate nominal account
sizes, and indicating the month and year of the draw-down during each
of the following periods:
(A) The most recent five years and
(B) If the commodity trading advisor has traded client accounts
pursuant to the trading program for longer than the most recent five
years, since the commodity trading advisor began trading the program
for client accounts.
(vi) The greatest peak-to-valley draw-down for the trading program
specified expressed as a percentage of aggregate nominal account sizes,
and indicating the month(s) and year(s) of the draw-down, during each
of the following periods:
(A) The most recent five years and
(B) If the commodity trading advisor has traded client accounts
pursuant to
[[Page 41849]]
the trading program for longer than the most recent five years, since
the commodity trading advisor began trading the program for client
accounts.
(vii) Subject to Sec. 4.35(a)(2) for the offered trading program,
the annual and year-to-date rate-of-return for the program for each of
the five most recent calendar years and year-to-date, computed on a
compounded monthly basis; and
(viii) In the case of the offered trading program:
(A)(1) The number of accounts traded pursuant to the offered
trading program that were closed during the period specified in
Sec. 4.35(a)(5) with positive net lifeline performance (profits) as of
the date the account was closed, and
(2) The range of rates of return for the accounts closed with net
lifetime profits; and
(B)(1) The number of accounts traded pursuant to the offered
trading program that were closed during the period specified in
Sec. 4.35(a)(5) with negative net lifeline performance (losses) as of
the date the account was closed, and
(2) The range of rates of return for the accounts closed with net
lifetime profits; and
(ix) In addition to the information specified in
Sec. 4.35(a)(1)(i)-(viii), where the commodity trading advisor accepts
partially-funded accounts, the performance capsule must include:
(A) A statement that rates of return are based on nominal account
size.
(B) In a column adjacent to the presentation of data based on
nominal account size, the draw-down information required by
Sec. 4.35(a)(1)(v) and (vi), divided by the percentage of actual funds
committed to the commodity trading advisor's program by the client with
the lowest ratio of actual funds to nominal account size in the trading
program.
(1) If the commodity trading advisor does not have sufficient
information regarding the funding level of its client accounts to
determine the lowest ratio, or if the lowest ratio is zero, present
this information at a funding level of 20 percent.
(2) The percentage basis of the computation, i.e., the actual funds
ratio or the optional 20 percent, must be disclosed in the heading of
the column.
(C) A statement of the percentage of client accounts in the program
for which the actual funds committed equal the nominal account size. If
the commodity trading advisor does not have sufficient information
regarding the amount of actual funds committed by its clients to the
trading program to determine the percentage of client accounts which
have actual funding equal to the nominal account size, the commodity
trading advisor must state that fact.
(D) If the commodity trading advisor elects to include the
aggregate of the nominal account sizes of the client accounts in the
trading program specified, this information must be placed adjacent to
the disclosure of actual funds under management by the commodity
trading advisor as required by Sec. 4.35(a)(1)(iv).
(2) Additional requirements with respect to the offered trading
program.
(i) (The performance of the offered trading program must be
identified as such and separately presented first;
(ii) The rate of return of the offered trading program must be
presented on a monthly basis for the most recent five years, in a
numerical table and in bar graph.
(iii) (The bar graph used to present monthly rates of return for
the offered trading program:
(A) Must show percentage rate of return on the vertical axis and
monthly increments on the horizontal axis; and
(B) Must be scaled in such a way as to clearly show month-to-month
differences in rates of return.
(iv) The commodity trading advisory must made available to
prospective and existing clients upon request a table showing the
information required to be calculated pursuant to Sec. 4.35(a)(6). This
table must be updated at least quarterly.
(6) Calculation of, and recordkeeping concerning, performance
information. (i) * * *
(A) The nominal account size at the beginning of the period,
defined as the previous period's ending nominal account size;
(B)(1) The net performance for the period, which is defined as the
total of:
(i) the realized gain or loss on positions closed during the period
plus
(ii) the change during the period in unrealized gain or loss, plus
(iii) interest accrued on funds deposited in the client's account
at a futures commission merchant, plus
(iv) other income accrued on positions held as part of the CTA's
program, minus
(v) fees and expenses.
(2) no income may be imputed with respect to nominal account sizes
or otherwise computed on a proforma a basis.
(C) The nominal rate of return for the period, which shall be
calculated by dividing the net performance by the nominal account size
at the beginning of the period.
(D) Changes to the nominal account size during the period, pursuant
to the terms of the CTA's agreement with the client in accordance with
Sec. 4.33(c)(4). The records should clearly delinate the source of each
change (additions or withdrawals of actual funds, profits or losses, or
otherwise).
(E) Changes to the nominal account size pursuant to the terms of
the CTA's agrement with the client in accordance with Sec. 433(c)(1).
The records should clearly delineate the source of each change (the
opening or closing of accounts during the period or changes to nominal
account size specifically directed by a client in writing.) If a client
and the advisor agree that a nominal account size be changed effective
at the beginning of a period, the change shall be reflected during the
prior period.
(F) The nominal account size at the end of the period, defined the
sum of the nominal account size at the beginning of the period
(Sec. 4.35(a)(6)(i)(A)) and the changes specified in this
Sec. 4.35(a)(6)(i) (D) and (E).
(ii) All supporting documents necessary to substantiate the
computation of such amounts must be maintained in accordance with
Sec. 1.31. With respect to the disclosures required by
Sec. 4.34(a)(1)(v)(B) and Sec. 4.35(a)(1)(vi)(B), the monthly figures
referred to in Sec. 4.35(a)(6)(i)(a-F) must be maintained for five
years subsequent to the last date on which disclosure document
reflecting the specified trading program is prepared.
Issued in Washington, D.C. on July 26, 1999 by the Commission.
Jean A. Webb,
Secretary of the Commission.
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Monthly Rates of Return (January 1994-April 1999)
[In percent]
----------------------------------------------------------------------------------------------------------------
1999 1998 1997 1996 1995 1994
----------------------------------------------------------------------------------------------------------------
January............................................. -15 -5 -3 -7 10 -24
February............................................ -2 3 5 8 18 9
March............................................... 4 17 -3 7 -3 4
April............................................... 7 -16 12 -3 -3 3
May................................................. ........ -5 9 -15 27 18
June................................................ ........ -11 29 2 13 -17
July................................................ ........ 2 -13 39 -9 -6
August.............................................. ........ 15 2 14 -2 25
September........................................... ........ -8 15 -8 -1 1
October............................................. ........ 10 -1 -2 12 -20
November............................................ ........ -3 -8 17 8 13
December............................................ ........ 18 12 8 33 -7
Annual/YTD.......................................... -7 10 62 63 149 -13
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[FR Doc. 99-19572 Filed 7-30-99; 8:45 am]
BILLING CODE 6351-01-M
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