The Commodity Futures Trading Commission (CFTC) has recently proposed new amendments to regulations pursuant to the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank) that would:

The recently issued proposals would eliminate or narrow exemptions from registration that are currently available to investment funds. Many funds rely on such exemptions to avoid CPO and CTA registration and associated regulatory requirements.  Specifically, the CFTC has proposed repealing existing exemptions from certain CPO regulations for operators of privately offered funds; requiring additional annual filings pertaining to claims of exemption from registration as a CPO or CTA; requiring additional disclosures pertaining to swap transactions to customers; and extending existing CPO and CTA reporting obligations, client disclosure obligations, recordkeeping requirements and conflict of interest restrictions to CPOs and CTAs investing in or advising with respect to swaps. Certain of these changes, including those narrowing or rescinding existing exemptions from CPO and CTA regulations, are not specifically required by the statutory language of Dodd-Frank and thus likely to catch many entities off-guard.

With respect to the proposed narrowing or removal of existing exemptions from CPO/CTA regulations, while not specifically required by Dodd-Frank, the CFTC has determined that "[f]ollowing the recent economic turmoil," it is appropriate to reconsider the level of regulation for entities participating in the commodity futures and derivatives markets.¹ To that end, the CFTC has proposed the elimination of the exemption from registration as a CPO for commodity pools with interests: (1) that are exempt from registration under the Securities Act of 1933; (2) that are only offered to qualified eligible persons, accredited investors or knowledgeable employees; and (3) with aggregate initial margin and premiums on futures and futures options not exceeding 5% of the pool liquidation value. In its proposal to remove this exemption from CPO registration, the CFTC has reasoned that Dodd-Frank's goal of transparency will be served by extending CPO registration (and resulting transparency) to these privately offered pools. In a parallel proposal, the CFTC is proposing to remove exemptions from registration as CTAs for these funds' advisors.

In addition, the CFTC has proposed reinstating criteria previously used in an exception to the definition of CPO for "otherwise regulated persons," including investment companies registered under the Investment Company Act of 1940, in connection with the operation of a specified trading vehicle. Prior to certain amendments made to the regulations in 2003, an entity claiming exemption from CPO registration on the grounds of its regulation as an investment company had to represent that its use of commodity futures for non-bona fide hedging purposes would be limited to 5% of the liquidation value of the entity's portfolio, and that the entity would not market the fund as a commodity pool to the public. The CFTC has now proposed to reinstate these conditions for entities to qualify for the "otherwise regulated" exception from CPO registration, and has explained that this proposal is driven in part by a petition to do so from the National Futures Association (NFA).

The CFTC has also proposed to increase requirements for, or end existing exemptions from, various reporting and notice requirements for CPOs and CTAs. For example, the CFTC proposes to eliminate an existing exemption for CPOs from a requirement to file certified financial statements in annual CFTC reports. The CFTC has reasoned that independent certification of financial statements comports with Dodd-Frank's overall goals of transparency and verifiable accuracy in public reporting of financial information. The proposal also would require entities claiming exemptions from various rules pertaining to CPOs, including from registration requirements, to file annual affirmations of their exemptions, or to formally withdraw from previously applicable exemptions due to a change in eligibility.

With respect to Dodd-Frank's pervasive grant of authority to the CFTC with regard to the over-the-counter swap markets, the CFTC has separately made multiple proposals to extend its existing CPO and CTA regulation to cover pools trading in swaps. Both terms under Dodd-Frank now contemplate, respectively, commodity pool investment vehicles that include swaps, and persons who provide advice pertaining to swap trading. To the extent a Swap Dealer or Major Swap Participant would fall into the latter category, it will be subject to the revised CFTC regulations applicable to Commodity Trading Advisors. Obligations include certain reporting obligations to advisors of large commodity pools, prohibitions on soliciting funds for margin purposes that will not be applicable to Swap Dealers or Major Swap Participants, client disclosures regarding trading and positions taken, recordkeeping requirements for required client disclosures, and conflicts of interest restrictions.

Taken together, the CFTC's recent proposals regarding its CPO and CTA regulations would restrict and remove existing exemptions from regulation, and extend existing regulations to the trading in (and advising of commodity pools trading in) swaps. While Dodd-Frank itself contemplates the incorporation of swap trading vehicles and their advisors into the existing CPO/CTA regulatory regime, market participants who have long relied on exemptions from the CFTC's regulations are likely to be taken by surprise by the new initiatives to remove their exemptions in the name of Dodd-Frank. Significant pushback is likely to come from these market participants. Comments on the Commission's proposals to roll back these existing exemptions are due on April 12, 2011. We will provide further updates to our clients with any additional information related to these proposals as it becomes available.

___________________

¹ Commodity Pool Operators and Commodity Trading Advisors: Amendments to Compliance Obligations, 76 Fed. Reg. 7976 at 7977 (Feb. 11, 2011).