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, 70852-70884 [2023-22324]
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70852
Federal Register / Vol. 88, No. 196 / Thursday, October 12, 2023 / Proposed Rules
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
Commodity Futures Trading
Commission.
ACTION: Notice of proposed rulemaking.
AGENCY:
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
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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 § 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 aolear@cftc.gov; Pamela M.
Geraghty, Acting Deputy Director, 202–
418–5634 or pgeraghty@cftc.gov;
Elizabeth Groover, Special Counsel,
202–418–5985 or egroover@cftc.gov; or
Andrew Ruggiero, Special Counsel,
202–418–5712 or aruggiero@cftc.gov;
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
1 Public
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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
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
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
27
U.S.C. 1a(11).
U.S.C. 1a(10).
4 7 U.S.C. 1a(12).
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).
9 17 CFR part 4.
37
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Federal Register / Vol. 88, No. 196 / Thursday, October 12, 2023 / Proposed Rules
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.
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
10 See
7 U.S.C. 6n; 17 CFR 4.5, 4.6, 4.13, 4.14.
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.
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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.
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.).
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
14 See,
e.g., 84 FR 67355 (Dec. 10, 2019).
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.
16 17 CFR 1.3 (defining ‘‘person’’ as ‘‘includ[ing]
individuals, associations, partnerships,
corporations, and trusts’’).
15 Such
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70853
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
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
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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Federal Register / Vol. 88, No. 196 / Thursday, October 12, 2023 / Proposed Rules
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
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
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.
20 17
CFR 4.7(a)(1)(v)(A).
CFR 4.7(a)(1)(v)(B).
22 17 CFR 4.7(a)(1)(v)(C).
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.
21 17
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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.
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
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.
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.
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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
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
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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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.
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
31 17
CFR 4.7(a)(3).
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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
At the time of Regulation 4.7’s
adoption in 1992, the Commission’s
rationale for providing these broad
32 17 CFR 4.7(b)(2) (providing an exemption from
the specific requirements of §§ 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 §§ 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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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.
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
36 1992
Final Rule, 57 FR at 34857.
at 34858.
38 Id. (citing pension plan regulations as an
example).
39 Id.
37 Id.
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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.
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
40 1992
Proposed Rule, 57 FR at 3149.
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.
41 Public
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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
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/hedgefund-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
https://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
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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
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,
YouTube apology after losing $150 million, Tampa
Bay Times, Feb. 11, 2019, available at https://
www.tampabay.com/business/how-tampas-jamescordier-went-from-high-roller-to-youtube-apologyafter-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-ViralLaughingstock-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-fromhigh-roller-to-youtube-apology-after-losing-150million-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).
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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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.
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 exchangetraded 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
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-quarterof-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’’).
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development of new and complex
commodity interest products.52
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
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.
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-bitcoinratio-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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70857
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.
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.
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,
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.
56 1992 Proposed Rule, 57 FR at 3149.
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and that such disclosures are subject to
Commission and NFA oversight.
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
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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.
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
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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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.
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
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.’’
59 See, e.g., 17 CFR 4.26(d).
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standard than that imposed on nonrequired 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-todate, 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.
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
60 17
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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
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
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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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
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
62 1992 Proposed Rule, 57 FR at 3151; 1992 Final
Rule, 57 FR at 34858.
63 17 CFR 1.31.
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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
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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.
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.
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.
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
65 17
CFR 4.24(h).
CFR 4.24(h)(1)(iii).
67 17 CFR 4.24(i)(1).
66 17
64 17
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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.
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,
68 17
CFR 4.24(j).
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).
70 17 CFR 4.25.
71 17 CFR 4.25(a).
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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 threeyear 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.
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
72 17
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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 nonQEP 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
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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 non4.7 trading programs under part 4.
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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.
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.
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.
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),
75 17
CFR 4.34(h).
CFR 4.34(i).
77 17 CFR 4.34(j).
73 17
CFR 4.34(e).
74 17 CFR 4.34(g).
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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.
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 partiallyfunded 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
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).
79 17 CFR 4.35.
80 17 CFR 4.35(a)(3) through (9).
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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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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 30day 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
81 17
CFR 4.35(b).
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.
82 17
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more accurate and more frequent
reporting.
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 crossreferences 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.
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70863
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.
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.
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
86 5
U.S.C. 601, et seq.
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).
87 See,
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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.
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.
89 Id.
at 18620.
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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
90 7
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91 As of June 2023, there were approximately
1,280 CTAs registered with the Commission.
U.S.C. 6m, 6n.
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Fmt 4701
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.
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
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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
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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
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70865
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
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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
92 5
U.S.C. 601, et seq.
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‘‘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
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.
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
93 See
44 U.S.C. 3507(a)(3); 5 CFR 1320.5(a)(3).
44 U.S.C. 3501.
95 See 44 U.S.C. 3502(3).
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).
97 See 44 U.S.C. 3507(d) and 5 CFR 1320.11.
94 See
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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
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.
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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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:
Estimated number of respondents:
1,000.
Estimated frequency/timing of
responses: At least annually, or asneeded.
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:
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.
101 See supra Section II.b for additional
discussion of these regulations.
102 See supra Section II.c for additional
discussion of this proposed amendment.
103 See supra Section II.b for additional
discussion of these regulations.
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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:
Estimated number of respondents:
1,000.
Estimated frequency/timing of
responses: At least annually, or asneeded.
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
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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
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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
OIRAsubmissions@omb.eop.gov. 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.
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.
c. Cost-Benefit Considerations
A. Baseline
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.
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
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%.
104 7
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ii. Increasing Financial Thresholds in
the Portfolio Requirement of the
‘‘Qualified Eligible Person’’ Definition
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
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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.
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 nonQEPs. 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
105 1992
Proposed Rule, 57 FR at 3152.
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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.
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.
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.
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 nonQEPs 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
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 nonQEPs?
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
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e. Other Public Interest Considerations
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 noncommercial 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.
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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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.
106 Goldstein and Yang, ‘‘Commodity
Financialization and Information Transmission,’’
2022, Journal of Finance, 77, 2613–2668.
107 Id.
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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
108 17
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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
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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 betterinformed 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
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
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.
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
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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.
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
managers are highly responsive to funds’ riskadjusted returns.
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70871
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
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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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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
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/generalsolicitation-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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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
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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.
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
112 Goldstein and Yang, ‘‘Commodity
Financialization and Information Transmission,’’
2022, Journal of Finance, 77, 2613–2668.
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
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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.
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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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
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.
114 Goldstein and Yang, ‘‘Commodity
Financialization and Information Transmission,’’
2022, Journal of Finance, 77, 2613–2668.
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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 30day 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.
115 17
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70873
Nevertheless, the regulatory baseline
remains the reporting requirements of
Regulation 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
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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.
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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
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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
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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 noncommercial 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 noncommercial 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.
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
116 Goldstein and Yang, ‘‘Commodity
Financialization and Information Transmission,’’
2022, Journal of Finance, 77, 2613–2668.
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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.
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.
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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
117 Id.
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.
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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.
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
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.
2. In § 4.7:
a. Remove the introductory text;
b. Revise paragraphs (a) and (b)(2)(i);
c. Add paragraphs (b)(2)(i)(A) through
(G);
■ d. Remove and reserve paragraph
(b)(2)(ii);
■ e. Add paragraph (b)(3)(iv);
■ f. Revise paragraphs (b)(5) and
(c)(1)(i);
■ g. Add paragraphs (c)(1)(i)(A) through
(H);
■
■
■
■
119 7
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U.S.C. 19(b).
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70875
h. Remove and reserve paragraph
(c)(1)(ii); and
■ i. Revise paragraphs (c)(2) and (d)(4)(i)
and (ii).
The revisions and additions read as
follows:
■
§ 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 NonUnited 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
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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 sixmonth 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 exchangespecified initial margin and option
premiums, together with any required
minimum security deposits for retail
forex transactions (defined in § 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;
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(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 § 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
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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 § 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),
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(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 § 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;
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(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 § 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
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70877
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 § 230.501(a)(5) of this title;
(J) A natural person who would
qualify as an accredited investor as
defined in § 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
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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 §§ 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 § 4.21 and include:
(A) A description of principal risk
factors for the exempt pool, as required
by § 4.24(g);
(B) A description of the exempt pool’s
investment program and use of
proceeds, as required by § 4.24(h);
(C) A description of fees and
expenses, as required by § 4.24(i);
(D) A description of conflicts of
interest, as required by § 4.24(j);
(E) Performance disclosures, as
required by § 4.25, with the exception of
information required by paragraphs
(a)(3) and (c)(2) of § 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
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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 § 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 § 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 § 1.31 of this
chapter.
*
*
*
*
*
(c) * * *
(1) * * *
(i) Exemption from the specific
requirements of §§ 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 § 4.31 and include:
(A) A description of persons to be
identified, as required by § 4.34(e);
(B) A description of principal risk
factors, as required by § 4.34(g);
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(C) A description of the exempt
commodity trading advisor’s trading
program, as required by § 4.34(h);
(D) A description of fees, as required
by § 4.34(i);
(E) A description of conflicts of
interest, as required by § 4.34(j);
(F) Performance disclosures, as
required by § 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 § 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 § 1.31 of this
chapter.
(d) * * *
(4)(i) Any exemption from the
requirements of §§ 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
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Federal Register / Vol. 88, No. 196 / Thursday, October 12, 2023 / Proposed Rules
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 §§ 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.
*
*
*
*
*
■ 3. In § 4.14, revise paragraph
(a)(8)(i)(C)(2) to read as follows:
§ 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 § 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 NonUnited States persons or otherwise
qualified eligible persons represent in
the aggregate less than 10 percent of the
beneficial interest of the pool;
*
*
*
*
*
■ 4. In § 4.21, revise paragraph (a)(2) to
read as follows:
ddrumheller on DSK120RN23PROD with PROPOSALS2
§ 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 § 4.7(b)(2)(i) or
§ 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.
*
*
*
*
*
■ 5. In § 4.22:
■ 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
■ b. Remove paragraph (f)(2)(iv)(D).
The revisions read as follows:
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§ 4.22
Reporting to pool participants.
(a) * * *
(4) For the purpose of the Account
Statement delivery requirement,
including any Account Statement
distributed pursuant to § 4.7(b)(3) or
§ 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 § 4.22(c) or § 4.7(b)(4):
*
*
*
*
*
(8) For the purpose of the Annual
Report distribution requirement,
including any annual report distributed
pursuant to § 4.7(b)(4) or § 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 § 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
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70879
year, maintains such waivers in
accordance with § 4.23, and makes such
waivers available to the Commission or
National Futures Association upon
request. The requirements of § 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 § 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 § 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
§ 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 § 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.
*
*
*
*
*
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Federal Register / Vol. 88, No. 196 / Thursday, October 12, 2023 / Proposed Rules
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
ddrumheller on DSK120RN23PROD with PROPOSALS2
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.
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
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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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.
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.
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
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/powersprocedures/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).
3 Louis D. Brandeis, Other People’s Money And
How The Bankers Use It, 92 (1914).
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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.
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
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.
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ddrumheller on DSK120RN23PROD with PROPOSALS2
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
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
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.
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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
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.
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.
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.
7 The NPRM also revises the timing of certain
pools’ periodic financial reporting, based on longstanding 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).
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.
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.
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70881
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.
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
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
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
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.
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.
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/mersinger
statement010923.
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sourcing. It also fails to fulfill certain
fundamental functions of sound notice-andcomment 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
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.
ddrumheller on DSK120RN23PROD with PROPOSALS2
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:
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
Yet, this justification fails to consider that
the increasing numbers of pools and trading
5 See
Proposing Release at 7–9.
6 See id. at 5–6.
7 Id. at 16.
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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
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.
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
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.
9 Id. at 19, 20.
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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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.
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
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
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
11 Proposing
Release at 21 (emphases added).
id. at 16–17.
13 See id. at 17–18 n.46–47. Footnote no. 46 also
cites to a CFTC reparations case from 2018 that
12 See
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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
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).
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.
ddrumheller on DSK120RN23PROD with PROPOSALS2
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
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).
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.
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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Rule 4.7, but would no longer qualify as
QEPs under amended Rule 4.7.
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).
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
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
17 CFTC
Rule 4.7(a)(3), 17 CFR 4.7(a)(3).
Release at 12.
19 Id. at 26 and 23, respectively.
20 See id. at 5–6 (citing statistics).
18 Proposing
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70883
are responsible by statute. But once again, the
Proposing Release is silent.21
2. Putting the ‘‘Comment’’ Back in ‘‘Noticeand-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.
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
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.
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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ddrumheller on DSK120RN23PROD with PROPOSALS2
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
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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
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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.
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.
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
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).
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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]]>Agencies
[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.
-----------------------------------------------------------------------
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 https://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.
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\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.
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\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.
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\70\ 17 CFR 4.25.
\71\ 17 CFR 4.25(a).
\72\ 17 CFR 4.25(b) and (c).
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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.
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\73\ 17 CFR 4.34(e).
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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).
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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.
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\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).
---------------------------------------------------------------------------
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.
---------------------------------------------------------------------------
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.
---------------------------------------------------------------------------
\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.
---------------------------------------------------------------------------
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.
---------------------------------------------------------------------------
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.
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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).
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\115\ 17 CFR 4.7(b)(3).
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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.
---------------------------------------------------------------------------
\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.
---------------------------------------------------------------------------
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\
---------------------------------------------------------------------------
\5\ See Proposing Release at 7-9.
---------------------------------------------------------------------------
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:
---------------------------------------------------------------------------
\6\ See id. at 5-6.
---------------------------------------------------------------------------
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\
---------------------------------------------------------------------------
\7\ Id. at 16.
---------------------------------------------------------------------------
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\
---------------------------------------------------------------------------
\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.
---------------------------------------------------------------------------
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.
---------------------------------------------------------------------------
\9\ Id. at 19, 20.
---------------------------------------------------------------------------
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.
---------------------------------------------------------------------------
\10\ Dodd-Frank Wall Street Reform and Consumer Protection Act,
Public Law 111-203, 124 Stat. 1376 (2010) (``Dodd-Frank Act'').
---------------------------------------------------------------------------
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\
---------------------------------------------------------------------------
\11\ Proposing Release at 21 (emphases added).
---------------------------------------------------------------------------
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
