CFTC and NFA Update Rules Affecting Investment Managers

On August 15, 2019, the National Futures Association (NFA) approved amendments to NFA Compliance Rule 2-29.² NFA’s stated purposes were to better reflect current technology and business practices utilizing such technology, clarify to whom the rule applies and what activities fall within its scope and implement consistent requirements for the use of hypothetical performance in promotional materials directed toward qualified eligible persons (QEPs).

The amendments to the CFTC Rules will be effective January 9, 2020. Compliance with the amendments to CFTC Rule 4.5(a)(1), which are described below, will not be required until March 1, 2021. The amendments to NFA Compliance Rule 2-29 will be effective January 1, 2020.

Introduction

The CFTC amendments include the following:

1. Certain Family Offices will be exempt from registration as CPOs or CTAs.
2. Clarification that it is the SEC-registered investment adviser of a registered investment company that should claim the CPO exemption under CFTC Rule 4.5(a)(1).
3. Advisers to business development companies will be excluded from the definition of CPO.
4. General solicitation and marketing will be expressly permitted for certain exempt pools, consistent with the Jumpstart Our Business Startups Act (JOBS Act).
5. U.S. registered CPOs operating non-U.S. pools may maintain books and records in the location of the non-U.S. pool.
6. Non-U.S. persons will be explicitly listed as permitted participants in pools operated pursuant to the CPO registration exemption under Rule 4.13(a)(3), regardless of their level of sophistication.
7. CPOs and CTAs that are registered despite not being required to register will no longer be required to file Form CPO-PQR and Form CTA-PR, respectively.

The CFTC amendments adopt the changes described in the Proposal with modifications in response to comments. However, the finalized amendments do not include two aspects of the Proposal:

1. Codification of the relief provided under CFTC Advisory 18-96 exempting registered CPOs operating non-U.S. pools from most CFTC disclosure, reporting and recordkeeping rules.³ Advisory 18-96 will remain in place and available to CPOs.
2. A prohibition against those subject to statutory disqualifications under Commodity Exchange Act (CEA) Sections 8a(2) and 8a(3) taking advantage of certain CPO registration exemptions.

The CFTC noted that it chose not to finalize those particular proposals based on comments received and the recommendations of its staff, but noted that it intends to reconsider these amendments in the future.

NFA’s amendments to Rule 2-29: “Communications with the Public and Promotional Material,” include the following:

1. Expansion of the rule to include all commodity interests, including swaps, instead of just futures.
2. Clarification of the rule to require NFA review of all audio and video promotional material.
3. Modification of the rule with respect to the use of hypothetical performance in promotional material.

CFTC Developments

CFTC Registration Exemptions for Family Offices

Following the passage of the Dodd-Frank Act in 2010, the CFTC rescinded former CFTC Rule 4.13(a)(4), on which many Family Offices relied for relief from CPO registration with respect to pooled investment vehicles that traded commodity interests. Many Family Offices then requested case-by-case CPO and CTA registration and reporting relief from the CFTC. While the SEC issued post-Dodd-Frank regulations that excluded Family Offices from the definition of “investment adviser” and its accompanying registration requirements under the Investment Advisers Act of 1940 (the Advisers Act),⁴ the CFTC did not adopt a similar rule. Instead, the CFTC staff issued two No-Action Letters providing registration relief to Family Offices – No-Action Letter No. 12-37 (CPO) and No-Action Letter No. 14-143 (CTA).

The new amendments essentially codify the relief provided under these CFTC staff letters as follows:

• New CFTC Rule 4.13(a)(6) exempts “Family Offices” from being required to be operated by registered CPOs with respect to their operation of commodity pools that offer interests exclusively to “family clients” in offers and sales that are exempt from registration under the Securities Act of 1933 (1933 Act).
  • “Family Office” and “family client” are defined by cross-reference to the SEC’s Family Office rule.⁵
  • The Family Office must reasonably believe, at the time of investment or at the time of conversion of an existing pool into a pool for which the CPO relies on Rule 4.13(a)(6), that each participant is a family client of the Family Office.
  • The amendments do not include a notice requirement. The registration exemption is self-executing. However, CPOs relying on the exemption should maintain documentation sufficient to support their reliance on the exemption.
  • While the SEC’s regulations exclude Family Offices from the definition of “investment adviser,” the CFTC’s amendments merely exempt Family Offices from CPO registration. As such, Family Offices relying on CFTC Rule 4.13(a)(6) will remain subject to non-registration provisions of the CEA and CFTC Rules applicable to CPOs, such as the recordkeeping and anti-fraud provisions.
• New CFTC Rule 4.14(a)(11) exempts a Family Office’s investment manager from registration as a CTA, provided the manager’s commodity trading advice is solely directed to and is for the sole use of “family clients.”
  • “Family client” is defined by cross-reference to the SEC’s Family Office rule.
  • Managers relying on Rule 4.14(a)(11) are not required to file any notice with the NFA. The relief is self-executing. However, managers relying on the exemption should maintain documentation sufficient to support their reliance on the exemption.
  • While the SEC’s regulations exclude Family Offices from the definition of “investment adviser,” the CFTC’s amendments merely exempt managers that provide commodity trading advice solely to family clients from CTA registration. As such, managers relying on CFTC Rule 4.14(a)(11) will remain subject to non-registration provisions of the CEA and CFTC rules applicable to CTAs, such as the recordkeeping and anti-fraud provisions.

Clarification Regarding Rule 4.5 CPO Exclusion with Respect to Registered Investment Companies

CFTC Rule 4.5 provides an exclusion from the CPO definition for certain otherwise regulated persons. As currently written, Rule 4.5(a)(1) confusingly excludes from the CPO definition an SEC-registered investment company with respect to its operation of itself, subject to compliance with the conditions of Rule 4.5. The drafting of this rule has long been viewed by derivatives lawyers as unclear and the CFTC seems to agree, as the amendments include a revision to Rule 4.5(a)(1) that clarifies in a formal rule previous statements by the CFTC that it is the registered investment adviser of a registered investment company that is the appropriate person to claim the Rule 4.5 CPO exclusion. Registered investment companies impacted by the amendment of Rule 4.5(a)(1) will not be required to comply with the changed rule until March 1, 2021.

CPO Exclusion for Business Development Companies

Business development companies (BDCs) are a type of closed-end investment company that Congress established to make capital more accessible to small and developing companies for which accessing capital can be difficult.⁶ Although BDCs are similar to registered investment companies, they are exempt from registration with the SEC. Until 2012, however, BDCs that traded commodity interests were not exempt from the CFTC’s CPO registration requirements. In 2012, the CFTC staff issued No-Action Letter No. 12-40, which provided an exemption from registration as a CPO for operators of BDCs, provided certain conditions were met.

The amendments codify this relief. The CFTC adopted as proposed a modification of CFTC Rule 4.5 that excludes investment advisers of BDCs from the definition of a CPO with respect to the BDCs they advise and includes BDCs as “qualifying entities.” The CFTC also clarified that it is the investment adviser of an applicable BDC that is the appropriate person to claim this exclusion and that such persons must affirm the exclusion annually.

General Solicitation by CPOs Pursuant to the Jobs Act

Section 4(a)(2) of the 1933 Act provides an exemption from the Section 5 registration requirement for “transactions by an issuer not involving any public offering.”⁷ SEC Rule 506 has long provided a safe harbor for Section 4(a)(2) offerings that exempts from registration securities that are offered only to an unlimited number of “accredited investors” and no more than 35 non-accredited sophisticated investors. Such offerings were, however, subject to a longstanding prohibition on general solicitation in the sale of such securities.

Pursuant to a Congressional directive in the 2012 JOBS Act,⁸ the SEC adopted Rule 506(c), which now allows general solicitation in connection with the offer or sale of securities if (a) all purchasers are accredited investors and (b) the issuer takes reasonable steps to verify the accredited investor status of each purchaser.

Notwithstanding the elimination of the prohibition on general solicitation under SEC Rule 506(c), CFTC Rule 4.7 conditions relief under that rule on the offer and sale of participations in the pool being conducted “without marketing to the public.” CFTC Rule 4.13(a)(3) similarly requires that interests in the pool be “offered and sold without marketing to the public in the United States[.]” As these restrictions exist by operation of CFTC rules, as written they may prevent a CPO operating a Rule 4.7 or Rule 4.13(a)(3) pool from conducting a public offering in the manner contemplated by SEC Rule 506(c).

In 2014, the CFTC staff issued an exemption in Letter No. 14-116, aligning the requirements of Rules 4.7 and 4.13(a)(3) with SEC Rule 506(c) for those issuers relying on Rule 506(c). However, Letter No. 14-116 was not self-executing. CPOs relying on the letter were required to file a notice with the CFTC’s Division of Swap Dealer and Intermediary Oversight.

The amendments harmonize Rules 4.7 and 4.13(a)(3) with SEC Rule 506(c), essentially codifying Letter No. 14-116 as part of the CFTC’s rule. A CPO will now be allowed to market to the public interests in a Rule 4.7 or Rule 4.13(a)(3) exempt pool, but only to the extent such marketing is done in compliance with Rule 506(c). As most pools operated under these rules are currently not offered pursuant to SEC Rule 506(c), the impact of this change will be limited.

Expressly Permitting Non-U.S. Persons to Participate in Rule 4.13(a)(3) Pools

The amendments also provide that CPOs claiming an exemption from registration under Regulation 4.13(a)(3), which provides an exemption for operators of pools that trade a “de minimis” amount of commodity interests, may accept investments from non-U.S. persons regardless of their level of sophistication. In a minor departure from the Proposal, the amendments simply include, within the category of those eligible to invest in de minimis pools, those who meet the definition of a “qualified eligible person” found in Rule 4.7, which encompasses non-U.S. persons as defined in Rule 4.7.

Exclusion of Certain Classes of CPOs and CTAs from the Definition of “Reporting Person”

The amendments also revise the definition of “Reporting Person” in Regulation 4.27, which defines the types and categories of CPOs and CTAs that are required to file Forms CPO-PQR and CTA-PR. The changes to Rule 4.27 codifies relief that the CFTC previously provided through CFTC Letters 14-115 and 15-47. Specifically, this relief exempts from the obligation to file Form CPO-PQR those CPOs that operate only pools for which the CPO has claimed an exclusion under Regulation 4.5 or an exemption from registration under CFTC Rule 4.13. Similarly, it also exempts from the obligation to file Form CTA-PR CTAs that are registered as such, but who do not direct client accounts. In other words, CPOs and CTAs that are optionally registered, but who are not actually required to be registered, need not make these onerous filings.

NFA Developments

Amendments to NFA’s Promotional Material Rule

Applicability and Scope

The amendments to NFA Compliance Rule 2-29 clarify that the rule applies to NFA members that are futures commission merchants, introducing brokers, CPOs and CTAs. It also expands the scope of the rule to apply to all commodity interests, e.g., CFTC-regulated swaps, and related activities, as opposed to only futures.

Review and Approval of Audio and Video Promotional Materials

NFA Compliance Rule 2-29(h) has been amended to clarify that it applies to all forms of audio and video promotional material. The rule now requires NFA members to submit all such material, including internet broadcasts and downloadable media, that make trade recommendations or discuss the profitability of past or future trading performance to NFA for review and approval.

Modification of Relief Available to Members with Respect to Promotional Material Directed to QEPs

Certain NFA restrictions on the use of hypothetical trading results do not apply to promotional material directed exclusively to qualified eligible persons (QEPs), as defined in CFTC Rule 4.7. NFA has added new provisions that will allow NFA members subject to the rule to include in promotional material directed exclusively to QEPs, i.e., to Rule 4.7 exempt pool participants or exempt accountholders, extracted performance or composite performance without including the verbatim legends mandated by Rule 2-29(c). NFA members will be allowed to use either the legend in Rule 2-29 or other language that appropriately describes the performance shown and the limitations of such performance.

¹ See Sidley Update, CFTC Proposes to Streamline CPO and CTA Regulations, October 24, 2018; available at https://www.sidley.com/en/insights/newsupdates/2018/10/cftc-proposes-to-streamline-cpo-and-cta-regulations.

² See National Futures Association: Proposed Amendments to NFA Compliance Rule 2-29: Communications with the Public and Promotional Material, NFA Compliance Rule 2-36: Requirements for Forex Transactions, Related Interpretive Notices and other Technical Amendments to NFA Requirements (August 29, 2019); available at https://www.nfa.futures.org/news/PDF/CFTC/08292019-CR-2-29-CR-2-36-Interp-Notices-Use-of-Promotional-Material.pdf; see also NFA Notice to Members I-19-25: Effective Date for Amendments to NFA’s Promotional Material Rules and Interpretive Notices (November 13, 2019); available at https://www.nfa.futures.org/news/newsNotice.asp?ArticleID=5176.

³ See Advisory 18-96: Offshore Commodity Pools, Relief for Certain Registered CPOs From Rules 4.21, 4.22 and 4.23(a)(10) and (a)(11) and From the Location of Books and Records Requirement of Rule 4.23 (April 11, 1996).

⁴ 15 U.S.C. § 80b-1, et seq.

⁵ See 17 C.F.R. § 275.202(a)(11)(G)-1.

⁶ 15 U.S.C. § 80b-2(a)(48).

⁷ 15 U.S.C. § 77d(a)(2).

⁸ Pub. L. 115-97.