The hedge fund industry has urged the SEC to clarify the exemption from registration in the Dodd-Frank Act for CFTC-registered commodity trading advisors to private funds. In a letter to the SEC, the Managed Funds Association, reasoning by analogy, suggested that the SEC use the factors in a 1983 no-action letter determining a fund’s primary business in adopting regulations on whether a commodity trading advisor is predominantly engaged in providing advice on securities, which would cause the exemption to be lost.
Section 403 of the Dodd-Frank Act amended the Investment Advisers Act to provide a new exemption from registration with the SEC for an investment adviser that is registered with the CFTC as a commodity trading advisor and advises a private fund. However, if after the date of enactment of Dodd-Frank, the business of the advisor should become predominately the provision of securities-related advice, then the adviser must register with the Commission. In determining whether the new exemption is available, an investment adviser that is currently registered as a commodity trading advisor must assess whether its business is, or becomes, predominately the provision of securities-related advice. In the view of the MFA, such a determination depends in significant part on the definition of the term “predominately,” but that term is not defined in the Dodd-Frank Act.
In addition to adding a new exemption for commodity trading advisors to private funds, Dodd-Frank retained the existing section 203(b)(6) exemption for any investment adviser that is registered with the CFTC as a commodity trading advisor whose business does not consist primarily of acting as an investment adviser and that does not act as an investment adviser to a registered investment company or a business development company.
According to the MFA, the legislative intent of Section 403 is to recognize that CTAs to private investment funds, which are primarily engaged in the business of providing advice regarding futures and are already subject to a comprehensive regulatory framework, do not have to be dually registered. It further reflects the congressional view that requiring these CTAs to register with both the SEC and the CFTC would subject them to a duplicative regulatory framework and potentially inconsistent regulations.
Clarification of the Dodd-Frank exemption is necessary. In this regard, the MFA noted that in September of 2009, it filed a comment letter with the SEC and the CFTC recommending that they consider the factors addressed in the SEC’s Peavey Commodity Futures Fund no-action letter. The comment letter was in connection with the pre-Dodd-Frank registration exemption for commodity trading advisors whose business does not consist of acting as an investment adviser. But the MFA believes that the factors addressed in the Peavey no-action letter provide an appropriate framework for determining the predominant business of an investment adviser that is also a commodity trading advisor pursuant to the new Dodd-Frank exemption. Thus, the MFA believes that the factors under the Peavey analysis are appropriate for determining the primary business activity of an adviser and whether it should be registered with the CFTC, SEC or both.
Under the Peavey analysis, in determining whether an entity investing in futures was
otherwise primarily engaged in the business of investing in securities so as to be an investment company, the SEC considered the composition of the entity’s assets, the sources of its income, the area of business in which it anticipated realization of the greatest gains and exposure to the largest risks of loss, the activities of its officers and employees, its representations, its intentions as revealed by its operations, and its historical development.
The SEC recognized that with respect to a commodity pool, a snapshot picture of its balance sheet contrasting the value of its futures contracts (unrealized gain on such contracts) with the value of its other assets may not reveal the primary nature of the business as a pool’s reserves and margin deposits are generally in the form of United States government notes and other securities. In Peavey, the SEC stated that of greatest importance in its analysis was the area of business in which the entity anticipated realization of the greatest gains and exposure to the largest risks of loss as revealed by its operations on an annual or other suitable basis For example, a company’s anticipated gains and losses in futures trading as compared to its anticipated gains and losses on its government securities and other securities.
By analogy, the MFA believes that the Peavey factors are appropriate for determining the primary business activity of an adviser and whether it should be registered with the CFTC, SEC or both. Accordingly, the MFA recommend that the Commissions, in determining whether an adviser is acting primarily or predominantly as an investment adviser or a commodity trading advisor, consider the Peavey analysis, which in this context would mean the composition of the adviser’s assets, the sources of its income, the area of business in which the adviser anticipates realization of the greatest gains and exposure to the largest risks of loss, the activities of its officers and employees, its representations, its intentions as revealed by its operations, and its historical development.