Comment Text:
April 11, 2011
Submitted Electronically
David A. Stawick, Secretary
Commodity Futures Trading Commission
Three Lafayette Centre
1155 21st Street, NW
Washington, DC 20581
Re: Commodity Pool Operators and Commodity Trading Advisors: Amendments to Compliance Obligations; RIN 3038-AD30
Dear Secretary Stawick:
K&L Gates LLP respectfully submits this letter in response to the request of the Commodity Futures Trading Commission (the “Commission” or the “CFTC”) for comment concerning the Commission’s Notice of Proposed Rulemaking on Commodity Pool Operators and Commodity Trading Advisors: Amendments to Compliance Obligations (the “Proposing Release”).
In the Proposing Release, the CFTC proposed rescinding CFTC Rules 4.13(a)(3), 4.13(a)(4) and 4.14(a)(8)(i)(D) (the “Private Fund Exemptive Rules”), on which many operators of private funds that trade futures contracts and commodity options, and advisers to such funds, rely for exemptions from registration under the Commodity Exchange Act (“Act”) as commodity pool operators (“CPOs”) or commodity trading advisers (“CTAs”). For the reasons discussed below, we believe that the Private Fund Exemptive Rules should continue to apply to a narrowly-drawn category of market participants, namely, operators of and advisers to funds that are wholly-owned by family members (collectively, “family entities”).
The CFTC’s Division of Clearing and Intermediary Oversight and its Predecessor (the “Division”) Have Historically Determined that Family Fund Operators are Exempt from Registration
The Commission has the power to exempt from registration certain entities if there is no substantial public interest that would be furthered from such registration, and we believe that no substantial public interest would be served by requiring family entities to register:
In adding the CPO and CTA definitions to the Act, and the corresponding registration requirement in Section 4m(1) of the Act, Congress intended to establish the foundation for eliminating certain undesirable practices by unscrupulous operators and advisors who had ‘enticed unsuspecting traders into the markets with, far too often, substantial loss of funds.’ However, discretion was vested in the Commission by Congress enabling the Commission “to exempt from registration those persons who would otherwise meet the criteria for registration . . . if, in the opinion of the Commission, there is no substantial public interest served by such registration.”
Consistent with this approach, the Division has repeatedly in the past determined that family fund operators are exempt from registration as CPOs, as such registration does not further any substantial public interest. We highlight the following exemptive actions (among many others), which we believe justify the CFTC’s expressly stating in final rulemaking that family entities continue to be exempt from CPO, and therefore CTA, registration:
(1) The Division determined a fund operator to be exempt from registration where each member of the fund was effectively an immediate family member, or a long-time business associate, of another member, stating that “the operation of the [fund operator] is not the kind of activity Congress and the Commission intended to regulate in adopting the CPO and pool definitions, respectively. Nor is there a substantial public interest to be served by requiring [the fund operator] to register as a CPO.”
(2) The Division confirmed that a limited partnership, the limited partners of which were family members, was not a commodity pool within the meaning and intent of Rule 4.10(d)(1) and, consequently, the partnership’s general partner was not a CPO thereof, and was not required to register as a CPO. In so doing, the Division stated that its determination was consistent with its prior practice, citing three interpretative letters in which it: (i) confirmed that a limited partnership that was composed of family members was not a commodity pool, and, therefore, the registered CPO for the limited partnership was permitted to withdraw its CPO registration; (ii) found that a partnership, the limited partners of which were a husband and wife, custodial accounts for their children, and trusts established for the benefit of the husband or wife and their descendents was not a commodity pool within the meaning and intent of Rule 4.10(d)(1) and, consequently, that the general partner was not a CPO thereof; and finally (iii) confirmed that a partnership made available only to immediate family members is not a “pool” within the meaning and intent of Rule 4.10(d), and that the general partner thereof is not required to register as a CPO.
The Rescission of the Private Fund Exemptive Rules as They Apply to Family Entities Would Render the Commission’s Registration Regime Substantially Incongruent with that of the SEC and Would Implicate Privacy Issues
While Section 403 of the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”) repealed the private adviser exemption in Section 203(b)(3) of the Investment Advisers Act of 1940, as amended (the “Advisers Act”), Section 409 of the Dodd-Frank Act created a new exclusion from the Advisers Act in Section 202(a)(11)(G), under which family offices, as defined by the Securities and Exchange Commission (“SEC”), are not investment advisers subject to the Advisers Act.
In passing Section 409 of the Dodd-Frank Act, Congress recognized that the clients of family offices do not require the protections afforded to other types of investors. The related Senate Committee Report states that “family offices are not investment advisers intended to be subject to registration under the Advisers Act” and that “the Advisers Act is not designed to regulate the interactions of family members, and registration would unnecessarily intrude on the privacy of the family involved.” The SEC has proposed to implement the exclusion with a broad definition of “family office” that would ensure that most family offices would be covered by the exclusion.
The Proposing Release states that “the Commission does not want its registration and reporting regime for pooled investment vehicles and their operators and/or advisors to be incongruent with the registration and reporting regimes of other regulators, such as that of the SEC for investment advisers under the Dodd-Frank Act.”
We believe that the rescission of Rules 4.13(a)(3), 4.13(a)(4), and 4.14(a)(8)(i)(D), as they apply to family entities, would create the very kind of regulatory incongruity that the Commission seeks to avoid, would result in an intrusion on the privacy of family entities, and would impose unnecessary burdens on sophisticated family entities that do not pose a risk to the financial system and are not in need of investor protection.
The Costs of Registration of Family Entities Outweigh the Benefits
In light of the extensive requirements imposed on CPOs and CTAs, the proposed amendments are likely to impose heavy costs on family entities and their clients. In the Commission’s cost-benefit analysis of its proposal to rescind the Private Fund Exemptive Rules, it states that “unless the Commission rescinds the exemptive relief delineated in §§ 4.13(a)(3) and 4.13(a)(4), the information collected under proposed forms CPO-PQR and CTA-PR will not provide a complete understanding of the risks arising from the CPOs and CTAs in the commodity derivatives markets…” However, the Commission does not provide any analysis of the costs of its proposal, and instead invites public comment on the cost-benefit considerations. We believe that the following cost-benefit issues should be considered:
(a) Sufficiency of Other Reporting Obligations. Currently, operators and advisers of private funds, although exempt from registration under the Private Fund Exemptive Rules, are subject to the CFTC’s large trader reporting system, which is the CFTC’s principal market surveillance tool. Large traders are required to complete a CFTC Form 40 when they reach the reportable level of trading in a particular commodity interest, which requires certain identifying information about their trading. In addition, as of July 21, 2011, dual registrants (those with assets under management of at least $150 million) will be required to provide extensive information to the SEC, the CFTC, and the Financial Stability Oversight Council (“FSOC”) on proposed Form PF (if adopted). It is not clear that requiring additional information for CFTC-only family entities would provide enough additional information relevant to systemic risk concerns to the CFTC and the FSOC to justify the costs involved in requiring CPO and CTA registration.
(b) Reporting vs. Registration. Even if requiring additional information from CFTC-only family entities on proposed Forms CPO-PQR and CTA-PR were necessary to protect the financial markets from systemic risk, it is not clear that the CFTC must require CPO and CTA registration for family entities in order to collect this information from them. For example, registration is not required for large traders, who are nevertheless required to report on Form 40.
(c) Registration Protections Not Needed in These Circumstances. The primary purposes of registration, and related disclosure requirements, are so that certain screening is performed and information is furnished regarding persons that seek to solicit the public generally to engage in commodity interest transactions. These requirements are unnecessary in the context of family members that are already otherwise known to one another. See, e.g., Section 4m(1) of the Act (CTA registration not required for a person who, during the course of the preceding 12 months, has not furnished commodity trading advice to more than 15 persons and who does not hold himself out generally to the public as a CTA).
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In summary, we urge the Commission not to rescind Rules 4.13(a)(3), 4.13(a)(4) and 4.14(a)(8)(i)(D) to the extent that they apply to family entities, for the foregoing compelling reasons.
We believe that the regulation of futures and commodity options in general is a praiseworthy undertaking given the 2008 market crises. However, if adopted as proposed, the CFTC’s proposals to rescind Rules 4.13(a)(3), 4.13(a)(4) and 4.14(a)(8)(i)(D) are likely to have a substantial impact on family entities and their clients. If the Private Fund Exemptive Rules are wholly rescinded, it is highly likely that a large number of family entities will be required to register as CPOs and/or CTAs, and, it is possible that some family entities with de minimis commodity interest positions will decide to exit these markets to avoid facing CFTC regulation.
Given the strain on resources that the CFTC experiences as a result of myriad new mandates of the Dodd-Frank Act, existing resources may not realistically be available for the CFTC, or even the National Futures Association, to oversee a large new group of CPO and CTA registrants, including a class of market participants, family entities, which, for the reasons stated in this comment letter, should not be required to register with the CFTC to the extent that they would be exempt from registration under the existing Private Fund Exemptive Rules.
We appreciate the opportunity to comment during this important rulemaking phase of the Dodd-Frank Act implementation process. We reiterate our request that, based on the foregoing, the Commission not rescind Rules 4.13(a)(3), 4.13(a)(4), and 4.14(a)(8)(i)(D) to the extent that they apply to family entities.
Respectfully submitted,
K&L Gates LLP
