Saturday, June 11, 2011

Specter of Dual Registration for Advisers Leads MFA to Ask CFTC Not to Rescind Private Pool Exemptions

The hedge fund industry has asked the CFTC not to rescind the Private Pool Exemptions, but rather to preserve and amend the exemption for an investment adviser who is registered with the SEC and for an SEC-registered investment adviser whose underlying fund does not engage primarily in trading commodity interests. In a letter to the CFTC, the Managed Funds Association said that rescission of the Private Pool Exemptions would likely require many SEC-registered investment advisers to dually register as commodity pool operators and potentially frustrate the intention of the Dodd-Frank Act to limit duplicative regulation. Rescission is unnecessary to achieve the public policy objectives of the Dodd-Frank Act, noted the MFA, and the preservation of the exemptions is consistent with and embedded in current law and inter-agency comity. Moreover, the CFTC will still receive the information it needs from the SEC and exchanges even if the Private Pool Exemptions are retained.

Also, the MFA cautioned that the rescission of the Private Pool Exemptions would require US registered advisers to expend proportionately greater time and money on compliance than their foreign competitors, putting them at a competitive disadvantage. In this context, the MFA pointed out that fund managers in the U.K., Hong Kong and Singapore have a single registration regime, which simplifies registration and compliance and greatly reduces the time and costs associated with compliance.

The Private Pool Exemptions in the CFTC’s regulations provide, in Section 4.13(a)(3), that a person is exempt from registration as a commodity pool operator if the interests in the pool are exempt from registration under the Securities Act and offered only to qualified eligible persons, accredited investors, or knowledgeable employees, and the pool's aggregate initial margin and premiums attributable to commodity interests do not exceed five percent of the liquidation value of the pool's portfolio; and, in Section 4.13(a)(4), that a person is exempt from registration as a CPO if the interests in the pool are exempt from registration under the Securities Act and the operator reasonably believes that the participants are all qualified eligible persons.

The MFA is concerned that rescission of the Private Pool Exemptions would dramatically increase for hedge funds and other participants in the U.S. futures markets the cost of responsibly operating an investment adviser in the United States and decrease the competitiveness of U.S.-based advisers vis-à-vis their European and Asian-based competitors, while providing limited incremental regulatory benefit to the Commission and the other federal financial regulators.

While the MFA has consistently supported well-informed regulation of the U.S. securities and futures markets, the association does not believe that rescission of the Private Pool Exemptions for entities registered with the SEC under the Investment Advisers Act is a step mandated, or even expressly contemplated, by the Dodd-Frank Act, or necessary to achieve the public policy objectives of the Act.

The MFA emphasized that it is not necessary for the Commission to repeal the Private Pool Exemptions for investment advisers registered with the SEC to have effective regulatory oversight of an adviser’s pool that is currently exempt under the Private Pool Exemptions. The SEC and CFTC have proposed new rules and new Form PF under the Commodity Exchange Act and the Investment Advisers Act to collect extensive information from advisers of private funds with respect to the size, strategies and positions of large private funds.

The Dodd-Frank Act requires the SEC to share such information with the CFTC. As such, the CFTC will have access to information on registered advisers trading commodity interests through Form PF and will be able to use information obtained through Form PF to assist with its regulatory programs. This information should address the Commission’s concern over any feared lack of accountability with respect to private pools advised by a registered adviser.


The section 4.13(a)(4) exemption operates under the same rationale and principle as Regulation D under the Securities Act and Section 3(c)(7) of the Investment Company Act of 1940 that sophisticated investors have the ability to fend for themselves and do not require the protections of registration under the federal securities laws. The Dodd-Frank Act left these provisions intact and, rather than amend the 1940 Act, Congress chose to achieve regulatory oversight of private funds through investment advisers registered with the SEC. The MFA believes that this is indicative of Congress’ intent for the regulatory framework to continue to provide relief from registration with respect to private offerings and to maintain a private offering framework.

In the MFA’s view, the rescission of Section 4.13(a)(4) would be inconsistent with the private offering framework established under the Securities Act as it would eliminate the availability of a private offering with respect to an investment vehicle investing in commodity interests, thereby singling out commodity investment vehicles from all other types of investments.

The MFA urged the CFTC to amend Section 4.13(a)(3) to provide pool operators with relief from registration in a manner consistent with the Dodd-Frank Act, which would be that a pool operator should not have to register with the CFTC as a CPO if its commodity pool is not engaged primarily in trading commodity interests. The CFTC is also urged to coordinate with the SEC as it develops further guidance on the meaning of ``engaged primarily’’ and for the both Commissions to harmonize registration and compliance requirements to the extent possible to lessen the burden on those firms that are required to, or choose to, register with both the SEC and CFTC.

The MFA asked the CFTC to issue guidance providing that a commodity pool will not be presumed to be engaged primarily in trading commodity interests if its initial margin and premiums required to establish the commodity interest positions do not exceed 20 percent of the pool’s average annual net asset value measured on a rolling quarterly basis and, that such CPO would not have to register with the Commission. The Commission could also stipulate that in order for such exemption to apply to a CPO, the commodity pool must have an investment adviser registered with the SEC.

The MFA favors a 20 percent test since the association believes it would provide market participants with a bright-line test that is practical to administer. The SEC staff, through no-action letters, has provided guidance on the meaning of being engaged primarily in the business of investing securities for purposes of determining whether an entity is an investment company. In its analysis of determining whether an entity was otherwise engaged primarily in the business of investing in securities so as to be an investment company, the SEC staff 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 Peavey Test).

Previously, the MFA has supported with respect to advisers the SEC’s approach for determining the meaning of engaged primarily for purposes of determining whether an entity is an investment company. However, the MFA determined that a 20 percent test is superior to the Peavey Test for analyzing whether an entity is engaged primarily in trading commodity interests because it provides market participants with greater regulatory certainty and is a less subjective test.

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