The Securities and Exchange Commission (“SEC”) recently adopted the final rules amending Rule 506 of the Securities Act of 1933, which will eliminate the prohibition on general solicitation for private funds provided fund managers only offer interests to “accredited” investors and take reasonable steps to verify each investor’s accredited status. The final rules will go into effect September 23, 2013. While many private fund managers will seek to take advantage of general solicitation under Rule 506(c), some managers of private funds, who trade futures or forex, may run into a problem when relying on Rule 506(c) to generally solicit while also relying on exemptions from Commodity Futures Trading Commission (“CFTC”) registration and CFTC reporting requirements.
CPO’s and CFTC Exemptions
A CPO is generally defined as any person who solicits or accepts funds, securities, or property for the purpose of trading commodity futures contracts, options on futures or forex. CPOs typically rely on Rule 4.13(a)(3) for exemption from CFTC registration and Rule 4.7(b) for exemption from certain CFTC reporting, recordkeeping and disclosure requirements that are otherwise applicable to registered CPO’s. These exemptions are briefly outlined below.
Exemptions under Rule 4.13(a): Generally, a manager is not required to register as a CPO with the CFTC if:
4.13(a)(1) It does not receive any compensation or other payment, directly or indirectly, for operating the pool, except reimbursement for the ordinary administrative expenses of operating the pool and does not advertise;
4.13(a)(2) None of the pools operated by the manager have more than 15 participants at any time, and the total gross capital contributions the manager receives for units of participation in all of the pools it operates or intends to operate do not exceed $400,000 in the aggregate; or
4.13(a)(3) For each pool for which the manager claims exemption from registration under:
(i) Interests in the pool must be exempt from registration under the Securities Act of 1933, and such interests must be sold without marketing to the public; and
(ii) At all times, the pool must meet one of the following tests with respect to its commodity interest positions, including positions in security futures products, whether entered into for bona fide hedging purposes or otherwise:
(A) The aggregate initial margin, premiums, and required minimum security deposit for retail forex transactions required to establish such positions, determined at the time the most recent position was established, will not exceed 5% of the liquidation value of the pool’s portfolio, after taking into account unrealized profits and unrealized losses on any positions it has entered into;
(B) The aggregate net notional value of such positions, determined at the time the most recent position was established, does not exceed 100% of the liquidation value of the pool’s portfolio, after taking into account unrealized profits and unrealized losses on any such positions it has entered into.
Exemption under Rule 4.7(b): Upon filing a “notice of claim for exemption” required by 4.7(d), any registered CPO who offers or sells interests in a pool exempt from registration under the Securities Act of 1933 solely to “qualified” investors, without marketing to the public, may claim exemption from certain CFTC requirements:
(1) Disclosure Relief: CPO’s may claim exemption from the specific requirements of §§ 4.21, 4.24, 4.25 and 4.26, as well as from disclosing the past performance of exempt pools in the Disclosure Document of non-exempt pools, provided the CPO includes a certain statement on the cover page of the offering memorandum.
(2) Periodic Reporting Relief: CPO’s may claim exemption from the specific requirements of §§ 4.22(a) and (b), provided the CPO prepares and distributes a signed statement to pool participants no less frequently than quarterly within 30 calendar days after the end of the reporting period, providing, among other things, the net asset value of the exempt pool, the change in net asset value from the end of the previous reporting period, and the net asset value per outstanding unit of participation in the exempt pool.
(3) Annual Report Relief: CPO’s may claim exemption from the specific requirements of § 4.22(c), and in lieu of the financial information and statements required to be distributed to pool participants, an annual report may instead be distributed to pool participants, which must include a statement of financial condition as of the close of the exempt pool’s fiscal year, a statement of operations for that year, and an appropriate footnote disclosure and such further material information as may be necessary to make the statements not misleading.
(4) Recordkeeping Relief: CPO’s may claim exemption from the specific requirements of § 4.23 provided the CPO maintains the required reports and certain books and records at its main business address, and provided the CPO makes such books and records available to any representative of the CFTC, NFA, and U.S. Department of Justice.
Note that a common requirement to both exemptions is that interests must not be marketed to the public. This implies that CPO’s seeking exemption under Rule 4.13(a)(1), 4.13(a)(3) and/or Rule 4.7 will not be able to simultaneously generally solicit under Rule 506(c). The CFTC has been formally petitioned to issue guidance on this issue, and reveal whether CPO’s that operate exempt pools will be able to take advantage of Rule 506(c).
Until the SEC and CFTC shed light on how Rule 506 will coexist with exemptions under Rules 4.13(a) and 4.7(b), CPO’s that desire to take advantage of general solicitation should consider whether registering with the CFTC is a viable option. CPO’s that fully register with the CFTC may take advantage of Rule 506(c), provided they full comply with the requirements under Rule 506(c) and provided they comply with the NFA’s advertising rule. The NFA’s advertising rule is largely an anti-fraud rule, and among other things, prohibits CPO’s from making fraudulent or misleading communications, or distributing fraudulent or misleading promotional materials, and requires CPO’s to adopt and enforce written procedures for supervising employee compliance with rule.
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