CFTC Staff Announces No-Action Relief for Delegating CPOs Regarding Self-Executing Registration (CFTC Letter 14-126)
Commentary by Steven Lofchie
The CFTC Division of Swap Dealer and Intermediary Oversight ("DSIO") issued self-executing registration no-action relief for certain commodity pool operators ("CPOs") who delegate certain activities to another registered CPO. The relief is contained in CFTC Letter 14-126 ("Revised Letter") which supersedes DSIO's prior letter on CPO delegations set forth in CFTC Letter 14-69 ("Original Letter").
Specifically, the Revised Letter provides relief from CEA Section 4m(1) to a person who has delegated certain responsibilities as a CPO ("Delegating CPO") of a commodity pool to another person who is registered as a CPO ("Designated CPO"), such that the Designated CPO will serve as the CPO of the pool in lieu of the Delegating CPO.
DSIO also stated that it will no longer consider requests for no-action relief pursuant to the approach described in the Original Letter, including any requests submitted previously to DSIO that were pending; however, DSIO provided that any person who received a no-action letter pursuant to the Original Letter can continue to rely on that relief.
Additionally, DSIO noted that the Revised Letter does not cover all possible situations in which CPO registration relief might be appropriate. DSIO explained that it will continue to consider other requests for CPO registration relief involving other circumstances that are not addressed in the Revised letter.
CPO Delegation Criteria under the Revised Letter:
The criteria for CPO delegations under the Revised Letter appear below. For a comparison of the requirements in the Original Letter with those in the Revised Letter, please see this chart. For an analysis of the principal changes between the Original Letter and the Revised Letter, please see the comment that follows the list of criteria.
(1) Contractual Authority of Designated CPO and Restriction on Activities of Delegating CPO. The Revised Letter maintains the requirement that the Delegating CPO delegate all "investment management authority" for the pool to the Designated CPO pursuant to a legally binding document. However, the Revised Letter permits board directors of funds structured as corporate investment vehicles to (i) conduct marketing activities as associated persons ("APs") of the Designated CPO, where such individuals are registered as APs, as required, and (ii) conduct investment management activities as principals or employees of the Designated CPO or CTA, subject to supervision under CFTC Rule 166.3. In addition, the Revised Letter permits the Designated CPO to appoint another entity to act as CTA to the fund.
(2) CPO Is a Registered CPO. The Revised Letter maintains the requirement that a Designated CPO must be a registered CPO.
(3) Statutory Disqualification. The Revised Letter maintains the requirement that the Delegating CPO may not be subject to any statutory disqualification under CEA Sections 8(a)(2) and 8(a)(3).
(4) Business Purpose. The Revised Letter maintains the requirement that, for the Designated CPO to be a separate entity from the Delegating CPO, there be a business purpose (e.g., for tax reasons) that is not the avoidance of CPO registration.
(5) Books and Record Requirement. The Revised Letter maintains the requirement that books and records be maintained by the Designated CPO. However, the Revised Letter does not require records to be maintained in accordance with CFTC Rule 1.31.
(6) Common Control for Entity CPO Delegations. If the Delegating CPO and the Designated CPO are each entities, then one such CPO must control, be controlled by, or be under common control with, the other CPO.
(7) Joint and Several Liability Undertaking for Entity CPO Delegations. The Revised Letter maintains the requirement that if a Delegating CPO is an entity, then the Delegating CPO and the Designated CPO must have executed a legally binding document whereby each undertakes to be jointly and severally liable for any violation of the CEA or the CFTC's Rules by the other in connection with the operation of the commodity pool.
(8) Joint and Several Liability Undertaking for Affiliated or Inside Natural Person Director CPO Delegations. The Revised Letter maintains the requirement that if a Delegating CPO is a natural person and not an "Unaffiliated Board Member" as defined in the Letter, then the Delegating CPO and Designated CPO must execute a legally binding document whereby each undertakes to be jointly and severally liable for any violation of the CEA or CFTC Rules by the other in connection with the operation of the commodity pool.
(9) No Requirement for Joint and Several Liability Undertaking for Unaffiliated Board Member Delegations. The Revised Letter maintains the requirement that if a Delegating CPO is an Unaffiliated Board Member, then the Delegating CPO must be subject to liability as a board member in accordance with the laws under which the commodity pool is established.
(10) No Filing Requirement. The Revised Letter does not require firms meeting the conditions set forth therein to file a request letter with the CFTC.
See: CFTC No-Action Letter 14-126.
See also: Comparison of CFTC No-Action Letters 14-69 and 14-126.
Related news: CFTC Streamlines Process for CPO Delegation (CFTC Letter 14-69) (with Mehta Comment) (May 12, 2014); MFA Files Follow-up Letter with CFTC on Delegation of CPO Obligations (with Mehta Comment) (July 18, 2014).
Commentary
The Original Letter contained criteria that raised difficult compliance issues for firms. While the Revised Letter goes a long way toward resolving these difficulties, firms still should be aware of certain important issues.
1. No Requirement to File for Relief. While the Original Letter required firms to file requests for registration relief for CPO delegations, the Revised Letter dispenses with this requirement. In addition to relieving the CFTC of the administrative burden of processing numerous requests for relief on virtually identical terms, dispensing with the filing requirement will enable firms to make their own determinations as to whether they meet the requirements of the Revised Letter without having to make unqualified representations to the CFTC regarding compliance with the delegation criteria. While the Revised Letter does not specifically require firms to document this determination, firms should consider doing so, particularly where a firm reaches a reasoned view as to its compliance with any of the criteria. This will facilitate responding to any regulatory inquiries or NFA audits on these issues.
The Revised Letter notes that firms that previously submitted requests for relief under the Original Letter should make a determination as to whether they meet the terms of the Revised Letter, as the CFTC will not process pending requests for relief under the Original Letter. However, firms that have novel issues that are not contemplated by the Revised Letter are free to submit individual requests for registration relief for CPO delegations.
2. Entry into a Legally Binding Document. The Revised Letter maintains that the delegation of CPO activities be agreed to between the Delegating CPO and the Designation CPO in a legally binding document. Firms are advised to maintain records of such documentation, either by way of an investment management agreement or a separate CPO delegation agreement, and to include sufficient terms evidencing the delegation and where appropriate, the agreement to joint and several liability.
3. Appointment of Investment Manager. The Original Letter required the Delegating CPO to delegate all "investment management authority" to the Designated CPO. This created confusion as to whether the Designated CPO could hire a separate entity to act as CTA to the pool. The Revised Letter clarifies that firms will comply with the requirement to delegate all "investment management authority" to the Designated CPO where they appoint a separate CTA that is either registered with the CFTC, or exempt from such registration. This clarification will provide necessary comfort to many CPOs that hire affiliates or third parties to act as advisers or sub-advisers to their pools.
4. Board Directors Conducting Marketing Activities. The Original Letter prohibited Delegating CPOs from participating in the solicitation of investors. In the case of pools structured as corporations, this had the effect of precluding a pool's board of directors (who would be the pool's Delegating CPO) from conducting marketing activities for the pool. In order to address this issue, the Revised Letter permits board directors to conduct pool marketing activities where they do so in their capacity as APs of the pool's Designated CPO, and are registered as such, where necessary. This clarification will provide comfort to CPO personnel who function both as pool directors and who conduct marketing or investor relations activities for the CPO.
5. Board Directors Conducting Investment Management Activities. The Original Letter prohibited Delegating CPOs from managing any pool property. This had the effect of precluding a pool's board of directors (as the Delegating CPO) from conducting investment management activities for the pool, for example, where they also served as portfolio managers for the pool. In order to address this issue, the Revised Letter permits board directors to conduct investment management activities where they (i) do so in their capacity as principals or employees of the Designated CPO or CTA, and (ii) are subject to supervision with respect to these functions in accordance with CFTC Rule 166.3. This clarification will provide comfort to CPO personnel who function both as pool directors and as portfolio managers for the pool.
Firms should consider the requirement that investment management personnel must be supervised in accordance with Rule 166.3. This Rule generally requires CFTC-registered firms to "diligently supervise" their personnel in the conduct of CFTC-regulated activities. This requirement should not be troublesome to Designated CPOs and CFTC-registered CTAs, which are currently required to supervise their investment management personnel under this Rule. However, it is not clear how this requirement would apply with respect to the investment management personnel of an unregistered CTA, which is not subject to Rule 166.3. Query: whether the CFTC would require the Designated CPO to supervise the unregistered CTA's investment management personnel in accordance with the requirements of Rule 166.3 in these circumstances.
6. Maintenance of Books and Records. The Original Letter required the Designated CPO to maintain the books and records of the Delegating CPO with respect to the pool in accordance with Rule 1.31. This created difficulty for many CPOs, as Rule 1.31 contains requirements regarding electronic storage media that do not reflect modern storage technologies commonly employed by firms. The Revised Letter requires the Designated CPO to maintain pool records, but dispenses with the requirement that these records be kept in accordance with Rule 1.31. While the reason for the deletion of this requirement is not spelled out in the Revised Letter, this likely reflects the industry's ongoing dialogue with the CFTC to update Rule 1.31 to reflect current methods for maintaining records electronically. See, e.g., Joint Letter from MFA, IAA and AIMA to CFTC, dated July 21, 2014; see also CFTC Letter 14-114, footnote 5 (acknowledging ongoing dialogue with the industry on Rule 1.31).
We note that the issue of compliance with Rule 1.31 also arises in relation to firms that maintain their records with a third party such as the pool's administrator. Where firms enter into such record-maintenance arrangements with third parties, the CPO is required to obtain a representation from the third party that it will maintain the records in accordance with Rule 1.31. These third-party record-holders have resisted giving this representation for the reasons described above. It will be interesting to see whether the CFTC similarly relaxes this requirement, which would be in line with its approach in the Revised Letter.