Articles Tagged with CFTC

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In a press release yesterday, the CFTC issued an exemptive letter, CFTC Letter No. 14-116, providing relief from certain provisions of CFTC Regulations 4.7(b) and 4.13(a)(3) that restrict marketing to the public.  The exemptive relief was issued to make CFTC Regulations 4.7(b) and 4.13(a)(3) consistent with SEC Rule 506(c) of Reg. D and Rule 144A, which were amended by the Jumpstart Our Business Startups Act (JOBS Act), to permit general solicitation or advertising subject to certain limitations.

Generally, the JOBS Act adopted SEC Rule 506(c) to permit an issuer, subject to the conditions of the rule, to engage in general solicitation or general advertising when offering and selling securities, and amended SEC Rule 144A to permit the use of general solicitation, subject to the limitations of the rule, when securities are sold to qualified institutional buyers (“QIBs”) or to purchasers that the seller reasonably believes are QIBs.  Prior to the CFTC’s exemptive relief, commodity pool operators (“CPOs”) relying on CFTC Regulations 4.7(b) and 4.13(a)(3) were not able to use general solicitation under Rule 506(c) or Rule 144A, as the CFTC exemptions prohibited general solicitation.

The new relief from provisions in CFTC Regulations 4.7(b) and 4.13(a)(3) is subject to the following conditions:

  1. The exemptive relief is strictly limited to CPOs who are 506(c) Issuers or CPOs using 144A Resellers.
  2. CPOs claiming the exemptive relief must file a notice with the Division.  The notice of claim of exemptive relief must:
  • State the name, business address, and main business telephone number of the CPO claiming the relief;
  • State the name of the pool(s) for which the claim is being filed;
  • State whether the CPO claiming relief is a 506(c) Issuer or is using one or more 144A Resellers;
  • Specify whether the CPO intends to rely on the exemptive relief pursuant to Regulation 4.7(b) or 4.13(a)(3), with respect to the listed pool(s);

 i.      If relying on Regulation 4.7(b), represent that the CPO meets the conditions
of the exemption, other than that provision’s requirements that the offering be
exempt pursuant to section 4(a)(2) of the 33 Act and be offered solely to QEPs,
such that the CPO meets the remaining conditions and is still required to sell
the participations of its pool(s) to QEPs;
ii.       If relying on Regulation 4.13(a)(3), represent that the CPO meets the
conditions of the exemption, other than that provision’s prohibition against
marketing to the public;

  • Be signed by the CPO; and
  • Be filed with the Division via email using the email address dsionoaction@cftc.gov and stating “JOBS Act Marketing Relief” in the subject line of such email.
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On May 16, 2014, a federal court in Florida entered an Order finding in favor of the Commodity Futures Trading Commission (CFTC) following a trial against four Hunter Wise related companies and their owners on charges that they had fraudulently misrepresented the nature of precious metals transactions that resulted in millions of dollars in customer losses.

Hunter Wise was found to have orchestrated a multi-level marketing scheme in which so-called retail dealers served a sales function for Hunter Wise, soliciting customer accounts. The dealers advertised and claimed that they sold physical metals, including gold, silver, platinum, palladium, and copper, to retail customers on a financed basis and forwarded customer funds to Hunter Wise, whose identity was not disclosed to the customers.  Using deceptive marketing materials provided to them by Hunter Wise, the dealers claimed to arrange loans for the purchase of physical metals and advised customers that their physical metals would be stored in a secure depository.  Customers were then charged “exorbitant interest” on the purported loans and storage fees for the metal they thought they had purchased.  In fact, neither Hunter Wise nor any of the dealers purchased any physical metals, arranged actual loans for their customers to purchase physical metals, or stored physical metals for any customers participating in their retail commodity transactions.  Over 90 percent of the retail customers lost money.

Hunter Wise Commodities, LLC, Hunter Wise Services, LLC, Hunter Wise Credit, LLC, and Hunter Wise Trading, LLC and the individuals running the companies, have been ordered to pay, jointly and severally, $52.6 million in restitution to the defrauded customers and to pay a civil monetary penalty, jointly and severally, of $55.4 million, the maximum provided by law.  The CFTC charged Hunter Wise, its principals, and other related parties in December 2012.  The Court found that the principals of Hunter Wise knowingly defrauded more than 3,200 retail customers for more than 16 months, between July 2011 and February 2013, and engaged in fraudulent conduct that was “repeated, callous and blatant.”

In considering the appropriate penalties, the Court noted that the fraudulent scheme was “egregious and recurrent” and “calculated to deceive retail customers.” The Court held that the likelihood of future violations was “strong” given that Hunter Wise principals did not acknowledge any wrongdoing.  Further, the “systematic and pervasive nature” of the fraud necessitated full restitution for all customers who lost money between July 16, 2011 and February 25, 2013.

This case follows a CFTC “Precious Metals Fraud Advisory” alert issued in January of 2012 in which the CFTC indicated that it was aware of an increase in the number of companies offering customers the opportunity to buy or invest in precious metals.  The CFTC’s Consumer Fraud Advisory specifically warned that frequently companies do not purchase any physical metals for the customer, but instead simply keep the customer’s funds.  The Consumer Fraud Advisory further cautioned consumers that leveraged commodity transactions are unlawful unless executed on a regulated exchange.

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The Commodity Futures Trading Commission (“CFTC”) staff recently issued guidance to registered CPOs regarding the delegation of commodity pool operator (“CPO”) functions from persons that might otherwise be subject to CPO registration.  For non-natural persons delegating CPO functions to a registered CPO, the relief from registration is conditioned on the CPO that is delegating its authority (the “Delegating CPO”) controlling, being controlled by, or being under common control with, the registered CPO (the “Designated CPO”).  The new staff letter removed the previous requirement that “unaffiliated directors” of the commodity pool that would be considered CPOs agree to be jointly and severally liable with the registered CPO for violations of the Commodity Exchange Act or the CFTC‘s regulations by the registered CPO.  This new no-action relief is not self-executing.  Each Delegating CPO must apply to the CFTC in order to take advantage of this new CFTC staff position.

In order to coordinate filing obligations for the CFTC and the Securities and Exchange Commission (SEC), many CPOs, which may also be registered investment advisers, seek to delegate their obligations to affiliated commodity trading advisors or registered CPOs.  Information provided in Form PF may be used to fulfill portions of the filing requirements for Form CPO-PQR under CFTC regulations, if the same entity is filing both reports.  However, previous CFTC guidance on this point was ambiguous at best. The new staff letter is meant to provide clear and consistent guidance for when CPO delegation will be permitted, but will not adversely affect no-action relief that was previously granted under the former CFTC position.

The new staff letter sets forth specific criteria for the approval of CPO delegations. The criteria in the new CFTC letter for obtaining CFTC delegation approval are as follows:

  • The Delegating CPO must have delegated to the Designated CPO all of its investment management authority with respect to the commodity pool pursuant to a legally binding document.
  • The Delegating CPO must not participate in the solicitation of participants for the commodity pool or manage any property of the commodity pool.
  • The Designated CPO must be registered as a CPO with the CFTC.
  • The Delegating CPO must not be subject to a statutory disqualification.
  • There must be a business purpose for the Designated CPO being a separate entity from the Delegating CPO other than solely to avoid the Delegating CPO registering with the CFTC.
  • The books and records of the Delegating CPO with respect to the commodity pool must be maintained by the Designated CPO in accordance with CFTC Regulation 1.31.
  • If the Delegating CPO and the Designated CPO are each a non-natural person, then one must control, be controlled by, or be under common control with the other.
  • Delegating CPOs that are (i) non-natural persons or (ii) board members other than “unaffiliated board members” must execute a legally binding document with the Designated CPO in which each party undertakes to be jointly and severally liable for any violation of the Commodity Exchange Act or the CFTC’s regulations by the other party in connection with the operation of the commodity pool.
  • “Unaffiliated board members” that are Delegating CPOs must be subject to liability as a Board member in accordance with the laws under which the commodity pool is established.

The new staff letter itself includes a form of no-action request that a Delegating CPO would file with the CFTC, including identifying information about the Delegating CPO and the Designated CPO, and certifications by the Designated CPO and Delegating CPO regarding satisfaction of the criteria set forth in the new staff letter. Unfortunately, the no-action letter request must be submitted pursuant to the process set forth in CFTC Regulation 140.99 in paper form instead of by e-mail.

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Written by:  Jessica M. Brown and Michael G. Wu

On March 10, 2014, the U.S. Commodity Futures Trading Commission and the Financial Services Agency of Japan signed a Memorandum of Cooperation which expresses the agencies’ intent to work together to supervise and oversee regulated entities that operate on a cross-border basis in Japan and the United States.  The agencies intend to cooperate in the interest of their respective derivative market regulations. The full text of the Memorandum can be found here.

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As the new year is upon us, there are some important annual compliance obligations Investment Advisers either registered with the Securities and Exchange Commission (the “SEC”) or with a particular state (“Investment Adviser”) and Commodity Pool Operators (“CPOs”) or Commodity Trading Advisors (“CTAs”) registered with the Commodity Futures Trading Commission (the “CFTC”) should be aware of.

See upcoming deadlines below and in red throughout this document.

The following is a summary of the primary annual or periodic compliance-related obligations that may apply to Investment Advisers, CPOs and CTAs.  The summary is not intended to be a comprehensive review of an Investment Adviser’s securities, tax, partnership, corporate or other annual requirements, nor an exhaustive list of all of the obligations of an Investment Adviser under the Investment Advisers Act of 1940, as amended (the “Advisers Act”) or applicable state law.  Although many of the obligations set forth below apply only to SEC-registered Investment Advisers, state-registered Investment Advisers may be subject to similar and/or additional obligations depending on the state in which they are registered.  State-registered Investment Advisers should contact us for additional information regarding their specific obligations under state law.

List of annual compliance deadlines in chronological order:

 

State registered advisers pay IARD fee November-December (of 2013)
Form 13F (for 12/31/13 quarter-end) February 14, 2014
Form 13H annual filing February 14, 2014
Schedule 13G annual amendment February 14, 2014
Registered CTA Form PR (for December 31, 2012 year-end) February 14, 2014
TIC Form SLT Every 23rdcalendar day of the month following the report as-of date
TIC Form SHCA March 3, 2014
Affirm CPO exemption March 3, 2014
Registered Large CPO Form CPO-PQR December 31 quarter-end report March 3, 2014
Registered CPOs filing Form PF in lieu of Form CPO-PQR December 31 quarter-end report March 31, 2014
Registered Mid-Size and Small CPO Form CPO-PQR year-end report March 31, 2014
SEC registered advisers and ERAs pay IARD fee Before submission of Form ADV annual amendment by March 31, 2014
Annual ADV update March 31, 2014
Delivery of Brochure April 30, 2014
Form PF filers pay IARD fee Before submission of Form PF
Form PF (for advisers required to file within 120 days after December 31, 2013 fiscal year-end) April 30, 2014
FBAR Form TD F 90-22.1 (for persons meeting the filing threshold in 2013) June 30, 2014
FATCA registration Must be completed by April 25, 2014
Form D annual amendment One year anniversary from last amendment filingIf the fund will be using 506(c) to generally solicit, the Form D must be amended to check the box that indicates the offering will be made under 506(c) 

 

CONTINUE READING…

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Written by: Jay B. Gould

On September 23, 2013, the JOBS Act rules that roll back the 80 year old ban on the use of general advertising and public solicitation by issuers of unregistered securities will be a reality. At least it will be a reality for fund managers that do not rely on an exemption from the Commodity Futures Trading Commission. Private funds managers will decide over time whether they would like to avail themselves of the new rules, which will allow them to post performance numbers on their websites, talk openly about their funds on CNBC and Bloomberg, sponsor NASCAR events, and just generally be more open and transparent about their businesses. The responsibilities associated with these new rights are the requirements that the fund manager verify the accredited status of each investor, refrain from committing financial fraud, and file a revised Form D to indicate that the fund is following the new rules. Whether to use these new rules will be a tough call for many fund managers as they consider whether greater transparency provides a benefit for their specific business model. Hedge funds have often avoided the glare of public scrutiny, but the trade-off of building a more recognizable brand and more easily reaching potential investors could provide motivation for some fund managers to give these new rules a try.

But what happens if a fund manager is initially enamored of the new rules and decides to advertise generally, but later changes his mind? Can a fund manager go back to the old “pre-existing, substantial relationship” days, and how do you do that once the fund has been “generally offered” to the public? This could happen for any number of reasons. Perhaps the most prevalent would be that the manager reaches capacity in the fund in either assets, such as a quant fund, or investor slots, which would more likely be the case for a fund that relies on Section 3(c)(1) for its exemption from investment company registration. A fund manager in one of these situations may have originally liked the idea of generally advertising, but subsequently finds public solicitation of limited utility and not worth the potential added scrutiny from regulators and market participants.

If a fund commences an offering pursuant to Rule 506(c) using general solicitation, and later wants to go back and use the old rules, (i.e., rule 506(b)), the issue is one of integration. Rule 506(b) prohibits general solicitation; accordingly, the only way to stop using the public offering rules once a fund manager has done so, would be to wait a period of time so the rule 506(c) offering is not integrated with the rule 506(b) offering. Rule 502(a) of Regulation D provides for a safe harbor from integration so long as the selling effort of the earlier offering ceases for six months, and the fund does not commence a subsequent offering for 6 months after completion of the earlier offering. Therefore, a fund manager would need to cease the offering, file the Form D to indicate that the offering is over, and wait six months before commencing the “private” offering. A new Form D would need to be filed for the private offering under Rule 506(b) once that offering commences.

There is another way whereby fund managers could go straight from the public offering to the private offering without the six month cooling off period. It is possible that a fund manager could use the five factor test safe harbor of Rule 502(a) to avoid integration and commence a new private offering immediately. For most hedge fund managers, this would be fairly tough test to meet. The five factors that a fund would need to consider are as follows:

(a) Whether the sales are part of a single plan of financing;
(b) Whether the sales involve issuance of the same class of securities;
(c) Whether the sales have been made at or about the same time;
(d) Whether the same type of consideration is being received; and
(e) Whether the sales are made for the same general purpose.

In order to meet the requirements of the five factor test, the fund seeking to avoid integration would need to offer a different class of shares/interests, for a different investment purposes, with different terms and conditions. For many hedge fund managers, this will be a difficult standard to meet. So the bottom line here appears to be that you can put Humpty Dumpty back together again, he will just need six months in intensive care.

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Written by:  Jay B. Gould and Jessica Brown

On July 10, 2013, the Securities and Exchange Commission (“SEC”) voted to lift the ban on general solicitation and advertising by private funds (and other private company issuers) as mandated by Congress in the Jumpstart Our Business Startups Act (“JOBS Act”). In addition to lifting the ban on general solicitation, the SEC approved a disqualification rule that will prospectively prohibit any felon or “bad actor” from relying on Rule 506 exemptions. Finally, the SEC voted to propose amendments to the current private offering rules.

I.          New Rule 506(c) 

Summary

Rule 506(c), as adopted by the SEC, permits private issuers to use general solicitation and general advertising when making a securities offering, provided the issuer only sells to accredited investors.[1] Issuers must take affirmative and reasonable steps to verify that each investor is accredited under the Rule 501 definition, and cannot simply rely upon a representation from the investor.

Verification Rule

The burden now shifts to private fund managers to determine “reasonableness” when making a determination of an investor’s accredited status. In response to comments it received, the SEC has provided some ideas an issuer can consider when determining its verification procedures. The non-exclusive, non-required verification methods published by the SEC include: (i) review federal tax forms, (ii) confirm net worth through documentation, or (iii) obtain written confirmation from a registered broker-dealer, registered investment adviser, licensed attorney in good standing, or registered CPA.  Accordingly, private fund managers will be able to rely upon certain third parties to make a determination of accreditation.

Current Rule 506 Exemptions

Rule 506(c) does not modify or repeal any of the current Rule 506 exemptions and issuers may still rely on those exemptions as written.   Therefore, private fund managers that do not see the value in advertising or soliciting to the public, or find the conditions of the new rules too onerous, may continue under the current private offering regime and will remain subject to all of the same restrictions on communications with the public to which they are currently subject. 

Form D

The current Form D filing document will be amended to include a “check-the-box” option to designate if the issuer is relying on the new Rule 506(c) in its present offering.  For those private funds and other issuers that do intend to generally advertise, the SEC has proposed that a Form D would need to be filed with the SEC 15 days in advance of the offering and again within 30 days after the offering closes.  It is proposed that an issuer that fails to make these filings would be prohibited from using the public advertising rules in the future.

II.        Rule 144A

Similar to the changes to Rule 506, under the new rules, securities sold pursuant to Rule 144A may be “offered” to investors other than qualified institutional buyers, because information about such offerings would be made public by way of general advertising, but the securities may only be sold to investors the seller reasonably believes to be qualified institutional buyers.[2]

III.       Felons and “Bad Actors” Disqualification

The SEC unanimously adopted a rule that disqualifies certain felons and “bad actors” from relying on any Rule 506 exemption.[3] This disqualification will be effective sixty days after the publication of the final rules in the Federal Register. 

The SEC identified a number of events that would disqualify an issuer from relying on Rule 506, such as securities-related criminal convictions, court injunctions and restraining orders, final orders from regulators and agencies, certain SEC disciplinary orders, anti-fraud or registration-related cease-and-desist orders from the SEC, SEC stop orders, suspension or expulsion from membership or association with a self-regulated organization, or recent U.S. Postal Service false representation orders. 

However, much to the consternation of the lone dissenting Commissioner Luis Aguilar, this provision will not bar persons who have committed financial and other crimes in the past.  It will only bar such bad actors on a going forward basis. Presumably, the fact that a principal of an issuer is a convicted felon would be a material fact that would be required to appear in the offering materials of the issuer, and for private funds, this information would, in most cases, get picked up in the Form ADV of the fund manager.

IV.       What Happens Next

Timing

The effective date of Rule 506(c) and the disqualification rule is 60 days following the date the rule is published in the Federal Register. For an ongoing offering under Rule 506 that began before the effective date of Rule 506(c), the issuer may elect to continue the offering after the effective date in accordance with the requirements of either the current Regulation D rule or new Rule 506(c), which permits general solicitation and advertising.  Accordingly, if an issuer chooses to continue its offering under Rule 506(c), any general solicitations that take place after the effective date, will not impact the exempt status of offers and sales that took place prior to the effective date in reliance on Rule 506(b).

What Funds Can Do Now

After the effective date of Rule 506(c), private funds that are not otherwise disqualified from using the Rule 506 exemptions may begin advertising and soliciting generally. An issuer that chooses to advertise or solicit generally must put policies and procedures in place to ensure that reasonable steps are taken to verify that each purchaser is accredited and that no sales are made to non-accredited investors.

Limitations, CFTC Considerations and Fund Advertising

Since February 2012, when the Commodity Futures Trading Commission (“CFTC”) rescinded Rule 4.13(a)(4), most private funds have relied upon the de minimus exemption of Rule 4.13(a)(3) in order to be exempt from CFTC registration. Other funds that trade futures or other instruments that are subject to CFTC oversight above the de minimus threshold, avail themselves of the “registration lite” exemption in Rule 4.7, pursuant to which all fund investors must be “qualified eligible persons.”  However, both of these exemptions require that the fund securities must be offered and sold without any marketing to the public in the United States.  Therefore, until the CFTC acts to amend these exemptive rules on which many private fund managers rely, none of these private funds will be able to use the general solicitation provisions of new Rule 506(c).  The Managed Funds Association submitted an outline of proposed rule amendments to the CFTC that would harmonize the CFTC rules with the SEC’s JOBS Act rules, but it is uncertain when the CFTC will act on this matter.

For a discussion of these provisions, see this discussion on Bloomberg. 

Proposed Amendments to Regulation D, Form D and Rule 156

In connection with the approval of Rule 506(c), the SEC proposed amendments to Regulation D, Form D and Rule 156 under the Securities Act. These proposed “investor protection” amendments are intended to enhance the SEC’s ability to evaluate market changes, the nature of advertising used by issuers, the steps taken by the issuer to verify that all investors were accredited and the intended use of the proceeds of the sale. It is likely that these provisions will soon become part of the new Form D and be applicable to private fund managers that advertise or solicit to the public. 

Finally, fund managers and their compliance officers should familiarize themselves with the requirements of Rule 156, as it appears likely that this anti-fraud rule will soon apply to the sales literature and advertising produced by hedge fund and private equity funds.

Questions regarding new Rule 506(c), the CFTC rules, Rule 156 and other implications regarding this recent SEC action should be directed to your Pillsbury attorney contact.

 

[1] Rule 501 of Regulation D defines an individual as an “accredited investor” if they have individual net worth, or joint net worth with the person’s spouse, in excess of $1 million at the time of the purchase, excluding the value of the primary residence of such person, or with income exceeding $200,000 in each of the two most recent years or joint income with a spouse exceeding $300,000 for those years and a reasonable expectation of the same income level in the current year.

[2] Rule 144A defines “qualified institutional buyers” as certain institutions that own and invest at least $100 million in securities of issuers that are unaffiliated with the institutions, banks and financial institutions must also have a net worth in excess of $25 million. A registered broker-dealer qualifies if it owns and invests on a discretionary basis over $10 million in securities of issuers that are unaffiliated with the broker-dealer. 

[3] An issuer will be disqualified from relying on Rule 506 exemptions if any “covered person” has had a “disqualifying event.” The rule defines “covered persons” as: (i) the issuer, (ii) the issuer’s predecessors and affiliated issuers, (iii) directors and certain officers, general partners and managing members of the issuer, (iv) 20 percent beneficial owners of the issuer, (v) promoters, (vi) investment managers and principals of pooled investment funds, and (vii) persons compensated for soliciting investors as well as the general partners, directors, officers, and managing members of any compensated solicitor.

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Written by: Jeffrey Stern and Anthony H. Schouten

The Commodity Futures Trading Commission has issued new “know your customer” and external business conduct rules to give effect to certain provisions of Title VII of the Dodd-Frank Wall Street Reform and Consumer Protection Act. Under these rules, major dealers in swaps and derivatives (“Swap Dealers”) will be required to, among other things, conduct diligence on counterparties, verify their status as “eligible contract participants” and ensure that swap recommendations are suitable for them. In addition, these rules impose heightened duties on Swap Dealers that trade with employee benefit plans subject to Title I of the Employee Retirement Income Security Act of 1974, governmental plans as defined in ERISA Section 3, endowments, state and federal agencies, and other protected counterparties (“Special Entities”).

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The NFA recently issued a notice entitled “Guidance on the Annual Affirmation Requirement for those Entities that are currently operating under an exemption or exclusion from CPO or CTA registration.”  As of February 2012, each person claiming an exemption or exclusion from CPO registration under CFTC Regulation 4.5, 4.13(a)(1), 4.13(a)(2), 4.13(a)(3), 4.13(a)(5) or an exemption from CTA registration under 4.14(a)(8) is required to annually affirm the exemption or exclusion upon which it relies.  The annual notice affirming the exemption or exclusion is due within 60 days of the calendar year end.  The first notice is due for the calendar year ending December 31, 2012.  The required affirmation must be filed electronically on the NFA’s Exemption System.  A full version of the NFA notice along with FAQs regarding the annual affirmation requirement is available here.

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Under current gift tax law, any individual may make a gift of up to $5.12 million this year to the individual’s children, grandchildren and other beneficiaries without paying gift tax.  Any gift in excess of that amount is taxed at a historically-low 35%.  Unless Congress acts to extend (in whole or part) this benefit, created under the Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010, the gift exemption will decrease to $1 million on January 1, 2013.  Any gift in excess of $1 million will thereafter be taxed at up to 55%.  Fund managers and other financial services professionals who have significant estates should consult their tax and estate planning professionals immediately to take advantage of this enormous opportunity.  Many fund managers are making gifts of carried interests to “dynasty trusts” created in states that permit trusts to continue in perpetuity, where the gift may be held for the benefit of future generations without being reduced by estate or other transfer taxes at each generation.  Pillsbury’s latest Advisory addresses this topic in detail; you can find the Advisory at www.pillsburylaw.com/publications.