• December 31st Deadline to Register as a Commodity Pool Operator Approaches
  • November 22, 2012 | Author: Peter J. Bilfield
  • Law Firm: Shipman & Goodwin LLP - Stamford Office
  • On February 9, 2012, the Commodity Futures Trading Commission (the “CFTC”) adopted final rules rescinding the Rule 4.13(a)(4) exemption from registration as a commodity pool operator (“CPO”) (otherwise known as the “sophisticated investor” exemption). This exemption has been previously relied upon by many hedge fund and private equity fund managers. Consequently, fund managers may need to register with the National Futures Association (“NFA”), unless another exemption is available.

    Fund managers currently utilizing the sophisticated investor exemption may only avail themselves of this exemption until December 31, 2012.

    Notwithstanding the foregoing, a CPO may qualify for the de minimis exemption under Rule 4.13(a)(3) (“the de minimis exemption”). Under the de minimis exemption, a fund may engage in limited trading of commodity interests. The trading limitations are measured by satisfying one of two tests: (1) the aggregate initial margin and premiums do not exceed 5% of the liquidation value of the pool’s portfolio (after taking into account unrealized profits and losses); and (2) the aggregate net notional value of positions do not exceed 100% of the liquidation value of the pool’s portfolio (after taking into account unrealized profits and losses). It is important to note that “swaps,” as defined by Title VII of the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010, and further defined by recent CFTC and Securities and Exchange Commission joint regulation, are now included within the above trade limitation calculations.

    CPOs that may rely on the de minimis exemption will need to pre-file before December 31, 2012 with the NFA to qualify for the exemption. CPOs utilizing the pre-filing option will not become subject to the additional reporting and disclosure requirements associated with the newly claimed exemption until January 1, 2013. If a CPO cannot comply with the foregoing requirements for the de minimis exemption, or an alternative exemption, it will be required to register with the NFA.

    CPO Registration Process

    If a CPO is unable to rely on another exemption, a CPO previously relying on the sophisticated investor exemption would be required to register with, and become a member of, the NFA prior to December 31, 2012. As a NFA member, fund managers that are CPOs are required to, among other things: (1) provide certain disclosures to pool participants; (2) comply with advertising and marketing rules; (3) distribute annual audited financial statements to pool participants; and (4) implement compliance policies and procedures.

    Further, certain employees or beneficial owners of a CPO may have to register as either a “principal” or “associated person” (“AP”) or both. At least one principal must be registered as an AP of the CPO. Non-exempt APs must submit a Form 8-R, along with fingerprint cards to the NFA and are required to pass the Series 3 examination within the two years preceding their application. The NFA may, however, waive the examination requirement in certain limited circumstances. In addition, the NFA has recently adopted Registration Rule 401(e), which exempts from the Series 3 proficiency requirement APs whose activities are limited to swaps that are subject to CFTC jurisdiction.

    Counterparties Will Require Strict Compliance from Fund Managers

    After December 31, 2012, any NFA member who carries an account or transacts business with an exempt CPO or a registered CPO claiming exemptive relief under Rule 4.7 (also known as “registration lite”) must ensure that such CPO properly files the notice reaffirming the exemption in order to continue to conduct business with the CPO. Failure to take these steps could expose NFA members, including their counterparties (e.g., prime brokers who are registered commodity trading advisers and/or CPOs), to violations of NFA Bylaw 1101 and/or NFA Compliance Rule 2-36(d).