[Federal Register Volume 85, Number 131 (Wednesday, July 8, 2020)]
[Rules and Regulations]
[Pages 40877-40892]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2020-12607]
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COMMODITY FUTURES TRADING COMMISSION
17 CFR Part 4
RIN 3038-AE76
Registration and Compliance Requirements for Commodity Pool
Operators and Commodity Trading Advisors: Prohibiting Exemptions on
Behalf of Persons Subject to Certain Statutory Disqualifications
AGENCY: Commodity Futures Trading Commission.
ACTION: Final rules.
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SUMMARY: The Commodity Futures Trading Commission (CFTC or Commission)
is adopting as final (Final Rule) an amendment to Regulation 4.13,
which contains the regulations applicable to commodity pool operators
(CPOs) and commodity trading advisors. The Final Rule generally
prohibits persons who have, or whose principals have, in their
backgrounds any of the statutory disqualifications listed in section
8a(2) of the Commodity Exchange Act (CEA or the Act) from claiming a
CPO registration exemption under Regulation 4.13. Specifically, the
Final Rule will require any person filing a notice claiming such
exemption to represent that, subject to limited exceptions, neither the
claimant nor any of its principals has in their backgrounds a CEA
section 8a(2) disqualification that would require disclosure, if the
claimant sought registration with the Commission.
DATES:
Effective Date: The effective date for this Final Rule is September
8, 2020.
Compliance Date: Compliance with the Final Rule will generally be
required through the existing notice filing under Regulation
4.13(b)(1), 17 CFR 4.13(b)(1). Therefore, persons who, as of the Final
Rule's effective date, have filed that notice and are currently relying
on an exemption from CPO registration under Regulation 4.13 will be
required to comply with the Final Rule when those persons next file a
notice of exemption for the 2021 filing cycle, i.e., on March 1, 2021.
Persons claiming a Regulation 4.13 exemption for the first time on or
after the Final Rule's effective date will be required to comply with
the Final Rule when the person first files a notice of exemption.
FOR FURTHER INFORMATION CONTACT: Joshua Sterling, Director, at 202-418-
6056 or [email protected]; Amanda Lesher Olear, Deputy Director, at
202-418-5283 or [email protected]; Elizabeth Groover, Special Counsel, at
202-418-
[[Page 40878]]
5985 or [email protected], Division of Swap Dealer and Intermediary
Oversight, Commodity Futures Trading Commission, Three Lafayette
Centre, 1151 21st Street NW, Washington, DC 20581.
SUPPLEMENTARY INFORMATION:
Table of Contents
I. Background
a. Statutory and Regulatory Background
b. The Commission's October 2018 Proposal, Request for Public
Comment, and Recent Final Rules
II. Final Rules
a. Proposed Regulation 4.13(a)(6): A Proposal To Prohibit
Statutory Disqualifications in CPOs Claiming Exemption Under
Regulation 4.13
b. General Comments
c. The Final Rule: New Regulation 4.13(b)(1)(iii) and Responses
To Specific Comments
i. Prohibition v. Disclosure: Clarifying the Consequences of New
Regulation 4.13(b)(1)(iii)
ii. Scope of the Final Rule: Which statutory disqualifications
will be grounds for prohibiting a claim to a CPO exemption?
iii. The Representation Requirement Under New Regulation
4.13(b)(1)(iii) and Retaining One of the Proposed Exceptions
iv. Principal Classification and Treatment of RIAs
v. Persons with Covered Statutory Disqualifications May Seek
Individual Exemptive Letter Relief or Apply for CPO Registration
vi. Timeframe for Exempt CPO Compliance With New Regulation
4.13(b)(1)(iii)
III. Related Matters
a. Regulatory Flexibility Act
b. Paperwork Reduction Act
c. Cost-Benefit Considerations
i. General Costs and Benefits
ii. Benefits and Costs of the Final Rule
iii. Section 15(a) Considerations
1. Protection of Market Participants and the Public
2. Efficiency, Competitiveness, and Financial Integrity of
Markets
3. Price Discovery
4. Sound Risk Management
5. Other Public Interest Considerations
d. Anti-Trust Considerations
I. Background
a. Statutory and Regulatory Background
Title VII of the Dodd-Frank Wall Street Reform and Consumer
Protection Act (Dodd-Frank Act) \1\ established a statutory framework
for the regulation of the swaps market to reduce risk, increase
transparency, and promote market integrity within the financial system.
As amended by the Dodd-Frank Act, section 1a(11) of the CEA defines the
term ``commodity pool operator,'' as any person \2\ engaged in a
business that is of the nature of a commodity pool, investment trust,
syndicate, or similar form of enterprise, and who, with respect to that
commodity pool, solicits, accepts, or receives from others, funds,
securities, or property, either directly or through capital
contributions, the sale of stock or other forms of securities, or
otherwise, for the purpose of trading in commodity interests.\3\ CEA
section 4m(1) generally requires each person who satisfies the CPO
definition to register as such with the Commission.\4\ Additionally,
CEA section 8a generally authorizes the Commission to register
intermediaries and their associated persons, including CPOs, and also
to refuse, condition, or revoke such registration.\5\
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\1\ Public Law 111-203, 124 Stat. 1376 (2010), available at
https://www.govinfo.gov/content/pkg/PLAW-111publ203/pdf/PLAW-111publ203.pdf (last retrieved Apr. 20, 2020).
\2\ Regulation 1.3 defines ``person'' as including individuals,
associations, partnerships, corporations, and trusts. 17 CFR 1.3.
The Commission's regulations are found at 17 CFR Ch. I (2020).
\3\ 7 U.S.C. 1a(11). The CEA is found at 7 U.S.C. 1, et seq.
(2018). Both the Act and the Commission's regulations are accessible
through the Commission's website, https://www.cftc.gov.
\4\ 7 U.S.C. 6m(1).
\5\ 7 U.S.C. 12a.
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CEA section 8a(2) lists the offenses for which the Commission may
upon notice, but without a hearing and pursuant to such rules,
regulations or orders as the Commission may adopt, refuse to register,
to register conditionally, or to suspend or place restrictions upon the
registration of, any person, and for which the Commission may revoke
the registration of any person with such a hearing as may be
appropriate.\6\ Commission regulations require all persons applying for
registration with the Commission to complete Form 7-R.\7\ Each natural
person principal of an applicant is also required to complete Form 8-R,
to submit fingerprints, and to undergo a criminal background check.\8\
One of the purposes of Forms 7-R and 8-R, as well as the fingerprinting
requirement, is to determine whether any applicant for registration or
any of its principals has in its background one of the enumerated
statutory disqualifications in the CEA.\9\ If a statutory
disqualification enumerated in CEA section 8a(2) is disclosed or
otherwise revealed through that process, such applicant is generally
refused registration on that basis, and such statutorily disqualified
principals will generally not be listed with the Commission. The
Commission also has the authority under CEA section 8a(5) to make and
promulgate such rules and regulations as, in the judgment of the
Commission, are reasonably necessary to effectuate the provisions or to
accomplish any of the purposes of the CEA.\10\ Finally, CEA section
4(c) provides that the Commission, to promote responsible economic or
financial innovation and fair competition, by rule, regulation, or
order, after notice and opportunity for hearing, may exempt, among
other things, any person or class of persons offering, entering into,
rendering advice or rendering other services with respect to commodity
interests, from any provision of the CEA.\11\ CEA section 4(c) provides
a statutory basis for the Commission's promulgation of the various
regulatory exemptions available to CPOs.
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\6\ 7 U.S.C. 12a(2). Such decisions to refuse, condition,
revoke, or place restrictions on registration are subject to appeal
by the affected person or registration in the manner provided in
section 6(c) of the CEA. Id.
\7\ See 17 CFR 3.10(a)(1)(i).
\8\ 17 CFR 3.10(a)(2).
\9\ See Adoption of Revised Registration Form 8-R, 82 FR 19665,
19665 (Apr. 28, 2017) (describing Form 8-R as designed to ``assess
the applicant's fitness to engage in business as a derivatives
professional''). See also Firm Application (Form 7-R), pp. 12-16
(making various inquiries as to the criminal and disciplinary
background of the firm and its principals), and p. 22 (requiring the
applicant to certify that it would not be statutorily disqualified
from registration under section 8a(2) or section 8a(3) of the Act),
available at https://www.nfa.futures.org/registration-membership/templates-and-forms/Form7-R-entire.pdf (last retrieved June 1,
2020).
\10\ 7 U.S.C. 12a(5).
\11\ 7 U.S.C. 4(c)(1).
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Part 4 of the Commission's regulations governs, among other things,
the operations and activities of CPOs.\12\ Those regulations implement
the statutory authority provided to the Commission by the CEA and
establish multiple registration exemptions and definitional exclusions
for CPOs, as discussed above.\13\ Part 4 also contains regulations that
establish the ongoing compliance obligations applicable to CPOs,
whether registered or exempt, as well as to those persons operating in
the commodity interest markets pursuant to an exclusion from that
definition. These requirements pertain to the commodity pools that CPOs
operate and advise, and among other things, dictate matters of customer
protection, disclosure, and reporting to a CPO's commodity pool
participants.
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\12\ See 17 CFR pt. 4, generally.
\13\ See, e.g., 17 CFR 4.13 (providing multiple registration
exemptions to qualifying persons meeting the CPO definition).
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The Commission has previously promulgated, pursuant to these
statutory authorities, the various exemptions from registration as a
CPO that are
[[Page 40879]]
enumerated in Regulation 4.13,\14\ and the Commission is today
utilizing them to revise the basic eligibility criteria and amend the
notice filing required to claim certain exemptions set forth in that
regulation.\15\ As discussed above, persons seeking registration with
the Commission, and their principals, are generally refused
registration with the Commission on the basis that they have disclosed
or are found to have in their backgrounds one of the statutory
disqualifications enumerated in CEA section 8a(2). Conversely, prior to
this Final Rule, persons claiming an exemption from CPO registration
under Regulation 4.13 were not required to disclose any previous
matters that might impact their eligibility or fitness for
registration, or to otherwise meet any basic conduct standards beyond
the substantive conditions of their claimed exemption. The Final Rule
amendment seeks to close that regulatory gap by effectively prohibiting
any person who has, or whose principals have, in their backgrounds a
statutory disqualification listed in CEA section 8a(2) (Covered
Statutory Disqualification, or CSD) from claiming a CPO exemption under
Regulation 4.13. As a result of the Final Rule, persons who have a CSD
in their background will generally be foreclosed from acting as a CPO,
whether in a registered or exempt capacity, subject to limited
exceptions discussed further below.
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\14\ See 17 CFR pt. 4 (citing as statutory authority, 7 U.S.C.
1a, 2, 6(c), 6b, 6c, 6l, 6m, 6n, 6o, 12a, and 23).
\15\ The Commission notes that the title of the Final Rule,
``Amendments to Compliance Requirements for Commodity Pool Operators
and Commodity Trading Advisors,'' is consistent with the related
notice of proposed rulemaking published in 2018, notwithstanding
that the amendment adopted by the Final Rule does not have any
effect on commodity trading advisors.
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b. The Commission's October 2018 Proposal, Request for Public Comment,
and Recent Final Rules
In response to information received from members of the public, as
well as CFTC staff's own internal review of its regulatory regime, the
Commission published for public comment in the Federal Register on
October 18, 2018, a Notice of Proposed Rulemaking (NPRM, or the
Proposal), proposing to adopt several regulatory amendments applicable
to CPOs and commodity trading advisors.\16\ Commission staff had
previously become aware of a number of statutorily disqualified CPOs
operating commodity pools pursuant to the registration exemption
formerly available in Regulation 4.13(a)(4), which the Commission
rescinded in 2012.\17\ Since the passage of the Dodd-Frank Act, the
Commission has proposed and adopted amendments to Regulation 4.13,
which have, in general, been designed to identify, accurately and in a
timely manner, the exempt CPOs operating in its markets, to incorporate
additional registration exemptions where appropriate, and to facilitate
customer protection by requiring annual notice filings. The Commission
is adopting this Final Rule because it believes that requiring persons
to attest to both their and their principals' lack of Covered Statutory
Disqualifications through an additional representation in the notice
filing required by Regulation 4.13(b)(1) will further enhance the
customer protection of exempt pool participants, and more generally,
promote the public interest.
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\16\ Several of the proposed amendments were consistent with, or
expansions of, relief that had been previously available through a
staff advisory or through no-action and exemptive letters issued
over the years by staff of the Commission's Division of Swap Dealer
and Intermediary Oversight (DSIO) and its predecessors. See
Registration and Compliance Requirements for Commodity Pool
Operators and Commodity Trading Advisors, 83 FR 52902 (Oct. 18,
2018) (Proposal).
\17\ After the rescission, such CPOs would have been required to
modify their operations to comply with a different exemption under
Regulation 4.13, cease their operations, or receive relief from the
Commission permitting them to register and continue operating.
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In the NPRM, the Commission included a proposed amendment to
Regulation 4.13 that would have required any person claiming an
exemption from CPO registration under Regulations 4.13(a)(1)-(a)(5) to
represent that neither the person nor any of its principals is subject
to any statutory disqualification under section 8a(2) or 8a(3) of the
Act, unless such disqualification arises from a matter which was
previously disclosed in connection with a previous application, if such
registration was granted, or which was disclosed more than thirty days
prior to the claim of this exemption (Proposed Regulation
4.13(a)(6)).\18\ The Commission noted its belief then that ``it poses
an undue risk from a customer protection standpoint for its regulations
in their current form to permit statutorily disqualified persons or
entities to legally operate exempt commodity pools, especially when
those same persons would not be permitted to register with the
Commission.'' \19\ Additionally, the Commission solicited comment on
that particular proposed amendment, raising several specific questions
for the public's consideration.\20\ In December 2019, the Commission
published final amendments (2019 Final Rules) adopting several aspects
of the Proposal with the general intent of simplifying the regulatory
landscape for CPOs without reducing the customer protection and other
benefits provided by those regulations.\21\ In describing the scope of
the 2019 Final Rules, the Commission stated that certain aspects of the
Proposal, including Proposed Regulation 4.13(a)(6), elicited a
significant number of responsive and detailed public comments, and as a
result, the Commission found that those proposed amendments required
further consideration before they could be finalized.\22\
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\18\ Proposal, 83 FR at 52906-07; see also Proposal, 83 FR at
52927 (proposing to adopt the prohibition at paragraph (a)(6) of
Regulation 4.13).
\19\ Proposal, 83 FR at 52906.
\20\ Proposal, 83 FR at 52916 (raising questions regarding the
scope of the proposed prohibition and its potential impact on
currently exempt CPOs, among several other issues).
\21\ Registration and Compliance Requirements for Commodity Pool
Operators and Commodity Trading Advisors: Registered Investment
Companies, Business Development Companies, and Definition of
Reporting Person, 84 FR 67343 (Dec. 10, 2019); and Registration and
Compliance Requirements for Commodity Pool Operators (CPOs) and
Commodity Trading Advisors: Family Offices and Exempt CPOs, 84 FR
67355 (Dec. 10, 2019) (2019 Final Rules).
\22\ 2019 Final Rules, 84 FR at 67357.
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After additional consideration of Proposed Regulation 4.13(a)(6),
as well as the ideas, questions, and suggestions received in public
comments, the Commission has determined it appropriate to adopt, with
specific modifications from the Proposal, the amendment, such that,
subject to limited exceptions, persons subject to the Covered Statutory
Disqualifications (i.e., those listed in CEA section 8a(2)) will
generally no longer be able to claim CPO exemptions under Regulation
4.13, absent a separate determination by the Commission (or its staff,
pursuant to delegated authority) under CEA section 8a(2) or Regulation
4.12(a), as more fully described below. The following sections describe
the amendment as presented in the Proposal, respond to the substantive
comments received, and finally, explain the amendment in its final form
and how the Commission intends it to apply in the future.
II. Final Rules
a. Proposed Regulation 4.13(a)(6): A Proposal To Prohibit Statutory
Disqualifications in CPOs Claiming Exemption Under Regulation 4.13
In the Proposal, the Commission, for the first time, proposed that
CPOs exempt under Regulation 4.13, and principals of the foregoing, who
have statutory disqualifications in their backgrounds be subject to
conduct
[[Page 40880]]
standards similar to those of their registered counterparts. The
Commission has now determined to exercise its statutory authority to
amend the Commission's CPO exemption regime, such that both registered
and exempt CPOs will be required to represent that they and their
respective principals are not subject to the Covered Statutory
Disqualifications listed in the CEA. The Commission continues to
believe that ``preserving the prohibition on statutory
disqualifications . . . and applying it to exemptions under Sec. 4.13
would provide a substantial customer protection benefit by prohibiting
statutorily disqualified persons from operating and soliciting
participants for investment in exempt commodity pools.'' \23\
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\23\ Proposal, 83 FR at 52916.
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Proposed Regulation 4.13(a)(6) would have required any person who
desires to claim an exemption under paragraphs (a)(1), (a)(2), (a)(3),
(a)(4), or (a)(5) of the section to represent that neither the person
nor any of its principals is subject to any statutory disqualification
under section 8a(2) or 8a(3) of the Act, unless such disqualification
arises from a matter which was previously disclosed in connection with
a previous application, if such registration was granted, or which was
disclosed more than thirty days prior to the claim of this
exemption.\24\ The Commission did not propose to require that
representation from CPOs of Family Offices, which it concurrently
proposed to exempt from CPO registration, because ``such CPOs would be
prohibited from soliciting non-family members/clients to participate in
their pool(s), necessarily limiting their contact with prospective
participants drawn from the general public, and as a result, reducing
the Commission's customer protection concerns in that context.'' \25\
The Commission stated its preliminary belief that this proposed
approach ``addresses customer protection concerns regarding statutory
disqualifications, while preserving flexibility in Commission
regulations applicable to CPOs.'' \26\
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\24\ Proposal, 83 FR at 52927. This language is nearly identical
to the representation required by paragraph C.4. of Staff Advisory
18-96. See Offshore Commodity Pools Relief for Certain Registered
CPOs From Rules 4.21, 4.22, and 4.23(a)(10) and (a)(11) and From the
Location of Books and Records Requirement of Rule 4.23, available at
https://www.cftc.gov/sites/default/files/tm/advisory18-96.htm (last
visited Apr. 22, 2020).
\25\ Proposal, 83 FR at 52906. The Commission formally adopted a
CPO exemption for qualifying Family Offices in the 2019 Final Rules.
See 2019 Final Rules, 84 FR at 67358, 67368.
\26\ Proposal, 83 FR at 52906.
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The Commission further explained that Proposed Regulation
4.13(a)(6) would ``provide additional customer protection because
statutorily disqualified, unregisterable persons would no longer be
able to claim the CPO exemptions under Sec. [Sec. ] 4.13 (a)(1)
through (a)(5).'' \27\ With respect to its future application, the
Commission stated its intent that CPOs currently claiming an exemption
under Regulation 4.13 would comply, ``as they renew their claims on an
annual basis--i.e., existing claimants would be required to represent
that neither they nor their principals are subject to statutory
disqualifications under CEA sections 8a(2) or 8a(3), when they annually
affirm their continued reliance on a Sec. 4.13 exemption next year.''
\28\ In contrast, ``CPOs filing new claims of a Sec. 4.13 exemption,
however, would be required to comply with this prohibition upon filing,
if and when the amendments are adopted as proposed, and become
effective.'' \29\
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\27\ Proposal, 83 FR at 52914.
\28\ Proposal, 83 FR at 52907.
\29\ Proposal, 83 FR at 52907.
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The Commission requested comment generally on all aspects of the
Proposal, and also solicited comment through targeted questions about
each of the proposed amendments, including Proposed Regulation
4.13(a)(6).\30\ In particular, the Commission requested comment on
``the impact of adopting this provision on industry participants and
currently exempt CPOs, and also, on what, if any, other statutory
disqualifications should be permissible for exempt CPOs and their
principals.'' \31\ The Commission also asked the following questions:
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\30\ Proposal, 83 FR at 52916.
\31\ Proposal, 83 FR at 52916.
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(1) What are the concerns and benefits associated with the
expansion of the prohibition on statutory disqualifications to the CPO
registration exemptions set forth in Sec. [Sec. ] 4.13(a)(1), (a)(2),
(a)(3), and (a)(5), or proposed to be set forth in Sec. 4.13(a)(4)?
(2) Do the limited exceptions that would permit certain statutory
disqualifications successfully address any unintended consequences of
adding the prohibition to Sec. 4.13, while still providing a base
level of customer protection by preventing statutorily disqualified
individuals from legally operating exempt commodity pools?
(3) Generally, how should the Commission handle the implementation
of the statutory disqualification prohibition?
(4) Specifically, how should the prohibition apply to current
claimants under Sec. 4.13? How much time should the Commission allow
for filing updated exemption claims subject to the prohibition?
(5) How much time should the Commission allow for an exempt CPO to
replace statutorily disqualified principals, in order to maintain
eligibility for a Sec. 4.13 exemption? \32\
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\32\ Proposal, 83 FR at 52916.
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The discussion below outlines the public comments received in
response to the Proposal, focusing on the substantive comments received
regarding Proposed Regulation 4.13(a)(6). The Commission will also
explain how it has taken those comments into consideration, via
specific adjustments to the Commission's approach in adopting the new
statutory disqualification representation as a condition of receiving
exemptive relief under Regulation 4.13.
b. General Comments
The Commission received 28 individual comment letters responsive to
the NPRM: Six from legal and market professional groups; 13 from law
firms; seven from individual family offices; one from a government-
sponsored enterprise (GSE) actively involved in the housing industry;
and one from the National Futures Association (NFA), a registered
futures association,\33\ who through delegation by the Commission,
assists Commission staff in administering its CPO regulatory
program.\34\ Additionally, Commission
[[Page 40881]]
staff participated in multiple ex parte meetings concerning the
Proposal.\35\ Seven of the comment letters provided comment
specifically on Proposed Regulation 4.13(a)(6).
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\33\ See 7 U.S.C. 21.
\34\ Comments were submitted by the following entities: Alscott,
Inc.* (Dec. 7, 2018); Alternative Investment Management Association
(AIMA) (Letter 1: Dec. 17, 2018, and Letter 2: Oct. 7, 2019);
Buchanan, Ingersoll, and Rooney, PC * (Dec. 12, 2018); Commodore
Management Company * (Dec. 12, 2018); Dechert, LLP (Dechert) (Dec.
17, 2018); Freddie Mac (Dec. 17, 2018); Fried, Frank, Harris,
Shriver, & Jacobson, LLP (Fried Frank) (Dec. 17, 2018); Investment
Adviser Association (IAA) (Dec. 17, 2018); Kramer, Levin, Naftalis,
& Frankel, LLP * (Dec. 17, 2018); LBCW Investments * (Dec. 5, 2018);
Managed Funds Association (MFA) (Dec. 14, 2018); Marshall Street
Capital * (Dec. 13, 2018); McDermott, Will, & Emery, LLP * (Dec. 17,
2018); McLaughlin & Stern, LLP * (Dec. 5, 2018); Moreland Management
Company * (Dec. 13, 2018); Morgan, Lewis, & Bockius, LLP * (Dec. 18,
2018); NFA (Dec. 17, 2018); New York City Bar Association, the
Committee on Futures and Derivatives (NYC Bar Derivatives Committee)
(Jan. 4, 2019); Norton, Rose, Fulbright US, LLP * (Dec. 17, 2018);
Perkins Coie, LLP :* (Dec. 17, 2018); the Private Investor
Coalition, Inc. (PIC) (Nov. 28, 2018); Ridama Capital * (Dec. 13,
2018); Schiff Hardin, LLP (two offices) * (Dec. 13 and 17, 2018);
the Securities Industry and Financial Management Association Asset
Management Group (SIFMA AMG) (Letter 1: Dec. 17, 2018, and Letter 2:
Sept. 13, 2019); Vorpal, LLC * (Dec. 17, 2018); Willkie, Farr, and
Gallagher, LLP (Willkie) (Dec. 11, 2018); and Wilmer Hale, LLP
(Wilmer Hale) (Dec. 7, 2018). Those entities marked with an `` *''
submitted substantively identical, brief comments, specifically
supporting the detailed comments and suggested edits submitted to
the Commission by PIC.
\35\ See ``Comments for Proposed Rule 83 FR 52902,'' available
at https://comments.cftc.gov/PublicComments/CommentList.aspx?id=2925
(last retrieved May 4, 2020).
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Commenters generally understood the customer protection goals of
the Commission, and many supported the amendment; other commenters
opposed it and raised several questions regarding its implementation.
Dechert, for instance, opposed Proposed Regulation 4.13(a)(6), stating
that the Commission should not extend to exempt CPOs a prohibition
generally applicable only to registered CPOs.\36\ Dechert further
commented that the proposed amendment would impose one of the most
costly aspects of registration, that of principal classification and
screening, on CPOs that are intended to be exempt from
registration.\37\ SIFMA AMG additionally opposed Proposed Regulation
4.13(a)(6) and expressed the need for the Commission's consumer
protection goals to be balanced appropriately with compliance burdens
and costs.\38\
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\36\ Dechert, at 7 (arguing that the Commission has generally
determined it does not need to apply as close regulatory oversight
to exempt CPOs as it does for registered CPOs, and that it is
inconsistent with that conclusion for the Commission to apply this
prohibition to exempt CPOs).
\37\ Dechert, at 7-8. Dechert emphasized the difficulty in
determining who is and is not a principal of a CPO, pointing out
that some types of principal do not involve a ``bright line test,''
but rather a ``facts-and-circumstances analysis.'' Id.
\38\ SIFMA AMG, at 17. SIFMA AMG also requested that the
Commission consider performing a study to determine if the
prohibition against statutory disqualifications was actually needed
in the population of exempt CPOs. Id.
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Commenters also compared the process surrounding Proposed
Regulation 4.13(a)(6) to the Commission's registration processes
currently outlined in part 3 of its regulations. Dechert and other
commenters requested more detail on how the proposed amendment would
operate and how exceptions would be considered or accepted.\39\
Although the majority of comments indicated that their submitters
understood the Commission's intention in proposing the prohibition on
statutory disqualifications, Dechert expressed confusion as to whether
Proposed Regulation 4.13(a)(6) was intended to require disclosure of
such disqualifications, or whether it was actually designed to bar
disqualified CPOs from relying on an exemption entirely.\40\
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\39\ Dechert, at 11-12; see also IAA, at 11, and AIMA, at 9-10.
\40\ Dechert, at 9.
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Some commenters cited a lack of clarity on process and other
significant uncertainties associated with the proposed amendment, and a
couple of commenters requested that the Commission reconsider and/or
re-propose it.\41\ Alternatively, Dechert requested that the Commission
develop processes regarding: (a) The identification and screening of
principals; (b) disputing a determination by CFTC or NFA to bar a
person from claiming exemption under Regulation 4.13; (c) the
``disclosure exception;'' and (d) the winding down of operations for
affected CPOs in a manner that minimizes market disruption and any
disadvantages to pool participants.\42\ MFA shared this concern,
requesting clarity on the timing of disclosure for CPOs already exempt
under a Regulation 4.13 exemption and pointing out the lack of
procedure specified in the Proposal.\43\ MFA further suggested that the
Commission consider adopting regulations that would establish a clear
process for currently exempt CPOs to update their disclosures of
statutory disqualifications to the Commission or NFA, including the
disclosure of violations of requirements of other regulators.\44\
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\41\ Dechert, at 12; SIFMA AMG, at 17.
\42\ Dechert, at 11. IAA also requested that the Commission
develop a hearing process for denying persons the CPO exemptions,
based on a statutory prohibition. IAA, at 11. See also AIMA, at 9.
\43\ MFA, at 4.
\44\ MFA, at 4.
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Several commenters were concerned about the scope of Proposed
Regulation 4.13(a)(6), including that offenses enumerated in CEA
section 8a(3) would be considered statutory disqualifications.\45\
AIMA, for instance, explained that the disqualifications listed under
that statutory paragraph, in particular, provide the Commission grounds
only for potentially disallowing registration, rather than an automatic
bar to registration.\46\ Consequently, AIMA requested that any required
representation include only offenses under CEA section 8a(2), or that
the Commission exclude from consideration offenses listed in CEA
section 8a(3)(B) and generally limit the incorporation of offenses in
CEA section 8a(3) to those that are no more than ten years old.\47\ MFA
similarly pointed out that even recordkeeping violations would need to
be disclosed pursuant to CEA section 8a(3)(A); MFA also questioned the
breadth and meaning of CEA section 8a(3)(M) disqualifications, known
only in the statute as ``other good cause.'' \48\
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\45\ See, e.g., Dechert, at 8 (stating that the statutory
disqualifications impacting a person's eligibility for exemption are
very broad).
\46\ AIMA, at 10.
\47\ AIMA, at 10.
\48\ MFA, at 4. See also SIFMA AMG, at 19 (arguing that offenses
under CEA section 8a(3) are much less serious, more remote in time,
or may be difficult to verify at the time a claim for exemption is
filed); AIMA, at 10 (stating that including CEA section 8a(3) would
be too broad, as it lists as disqualifying: Misdemeanor offenses
regardless of age, regulatory offenses routinely cleared by NFA in
administering the Commission's registration process for CPOs, and
the ``amorphous `other good cause''').
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Like AIMA, IAA and SIFMA AMG similarly requested that the
representation cover only offenses listed under CEA section 8a(2).\49\
SIFMA AMG additionally requested clarification from the Commission that
a person would not be ``statutorily disqualified'' pursuant to a
violation under CEA section 8a(3), unless and until the person receives
a hearing and the Commission has made the filing with respect to the
conduct at issue required by that statutory provision.\50\ Dechert
requested that the Commission further limit the scope of Proposed
Regulation 4.13(a)(6), such that the provision would only effectively
prohibit statutory disqualifications involving instances of fraud and
similar offenses involving commodities, securities, and other financial
instruments, like CEA section 8a(2)(D).\51\ Additionally, Dechert
requested that the Commission also consider: (a) Applying Proposed
Regulation 4.13(a)(6) to only the person itself claiming the CPO
exemption, rather than both the claimant and principals, and (b)
grandfathering exempt CPOs currently in existence, in conjunction with
the proposed amendment's adoption.\52\
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\49\ IAA, at 11; SIFMA AMG, at 19.
\50\ SIFMA AMG, at 20.
\51\ Dechert, at 11 (stating that, as the prohibition was
proposed, any violations of the CEA ``could require disclosure of a
Statutory Disqualification'' and may prohibit a person from claiming
a CPO exemption in Regulation 4.13).
\52\ Dechert, at 11.
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IAA also requested that the Commission not require compliance with
the proposed amendment from registered investment advisers (RIAs)
because those entities are already subject to the statutory
disqualification regime under the Investment Advisers Act of 1940 (IA
Act), which, the IAA argued, Proposed Regulation 4.13(a)(6) would
duplicate.\53\ SIFMA AMG also supported a carve-out for RIAs,
explaining that RIAs are subject to a robust statutory disqualification
regime under the IA Act, are required to disclose disciplinary events
on their
[[Page 40882]]
Forms ADV, and are also subject to fiduciary duties to their
clients.\54\
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\53\ IAA, at 10.
\54\ SIFMA AMG, at 18. SIFMA AMG stated that accepting the SEC's
statutory disqualification and disclosure regime for RIAs as
substituted compliance for purposes of relying on the CPO exemptions
under Regulation 4.13 would eliminate unnecessary costs without
sacrificing the Commission's customer protection goals, and would
also count as harmonization of SEC and CFTC regulations. Id.
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NFA generally supported Proposed Regulation 4.13(a)(6) and agreed
with the Commission's underlying rationale.\55\ NFA provided comments
specifically regarding the two exceptions the Commission proposed: (a)
If the statutory disqualification was previously disclosed in relation
to a registration application, which was later granted, or (b) if the
statutory disqualification was disclosed within the previous 30
days.\56\ NFA stated that the exception for disqualifications disclosed
within 30 days would not be practical, and was further inappropriate to
apply to CPOs exempt from registration under Regulation 4.13, because
such persons, in contrast to registered CPOs, generally have no ongoing
obligation to update Commission registration forms if they should
become inaccurate.\57\ Thus, NFA stated, there is no mechanism
requiring this population of exempt CPOs to update the Commission or
NFA as to new or recent statutory disqualifications to which they or
their principals may be subject.\58\ As a result, NFA suggested that
the Commission either abandon this exception entirely, or limit its
application to persons that are already registered with the Commission
and extend the amount of time.\59\ SIFMA AMG likewise raised questions
about how currently exempt CPOs that are not registered with the
Commission would update the Commission or NFA as to new statutory
disqualifications, suggesting that the Commission accept updates by
RIAs to their Forms ADV as substituted compliance for such
disclosures.\60\
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\55\ NFA, at 2.
\56\ NFA, at 2 (stating that the source of the second exception
stems from the ongoing obligation of registered CPOs claiming Staff
Advisory 18-96 and/or exemptive relief under Regulation 4.7 to
update their registration forms whenever something occurs to make
them inaccurate, like the recent commission of a statutory
disqualification by the registrant or one of its principals).
\57\ NFA, at 2.
\58\ NFA, at 2.
\59\ NFA, at 3 (explaining that 30 days is simply not enough
time to evaluate new statutory disqualifications and/or determine if
a registration action or ineligibility determination for exemption
is necessary as a result, but failing to specify an alternative
amount of time that would be sufficient).
\60\ SIFMA AMG, at 19-20.
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Still other commenters expressed concern over the timing of
compliance with Proposed Regulation 4.13(a)(6). AIMA requested that the
Commission allow at least 12 months for persons with such statutory
disqualifications to come into compliance, so that the issue of whether
those disqualifications should be a bar to claiming a CPO registration
exemption could be determined.\61\ Similarly, Willkie requested that
the Commission provide sufficient time for industry to absorb a
significant rule change like this one, suggested that the effectiveness
of the provision coincide with the annual update filings typically due
in the first quarter of each year, and requested further that the
Commission generally clarify the process around the proposed
prohibition.\62\ IAA also requested that the Commission delay
compliance with the proposed prohibition to allow CPOs to adjust their
operations, in case of disqualified principals in their entities.\63\
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\61\ AIMA, at 10.
\62\ Willkie, at 8.
\63\ IAA, at 12.
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c. The Final Rule: New Regulation 4.13(b)(1)(iii) and Responses to
Specific Comments
After carefully considering Proposed Regulation 4.13(a)(6) as well
as all of the public comments received, the Commission has determined
it to be an appropriate exercise of its authorities under the CEA to
finalize and adopt the proposed amendment with substantive adjustments
responsive to those comments. The Commission will additionally provide
guidance herein regarding the Final Rule's implementation. The
Commission believes that, in conjunction with the substantive and
procedural clarifications and the compliance schedule discussed below,
the Final Rule will facilitate compliance by exempt CPOs with new
Regulation 4.13(b)(1)(iii), while also minimizing costs associated with
implementing the amendment.\64\
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\64\ Further, the Commission has determined that moving forward
with the Final Rule, rather than re-proposing this amendment as
requested by a few commenters, is an appropriate and acceptable
course of action, consistent with the Commission's regulatory
policies and goals, particularly given the substantive adjustments
made in direct response to public comments and the provision of
additional compliance time and guidance.
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i. Prohibition v. Disclosure: Clarifying the Consequences of New
Regulation 4.13(b)(1)(iii)
The Final Rule's amendment to Regulation 4.13 prohibits a person
who has, or whose principals have, in their backgrounds a Covered
Statutory Disqualification from claiming a CPO exemption thereunder, as
opposed to requiring the disclosure of such disqualifications. As the
Commission has previously stated, there is an undue risk posed to
potential customers in the commodity interest markets, when a person
can act as a CPO, including soliciting participants and accepting
capital contributions in the name of its operated pool, without meeting
the basic conduct standards set forth in the CEA. To address that risk,
the Commission wishes to eliminate this inconsistent treatment between
exempt and registered CPOs (and the principals thereof), in which
certain persons may, by claiming an exemption from CPO registration,
avoid the CEA's basic conduct requirements established for all persons
registering as intermediaries with the Commission. The Commission
understands that several commenters were generally opposed to
prohibiting statutorily disqualified persons from claiming an exemption
from CPO registration under Regulation 4.13.\65\ After further
consideration of the Proposal, the comments, and regulatory policy
goals, the Commission believes that, for the purpose of ensuring its
customer protection goals are met, it is important that all persons
falling within the CPO definition not be subject to the most serious
statutory disqualifications, prior to operating or soliciting
participants for participation in their pools. The Commission finds
this regulatory outcome of the Final Rule appropriate because, as
discussed further below, persons claiming an exemption under Regulation
4.13 are exempt from the various regulatory obligations resulting from
operating in a registered capacity.
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\65\ See, e.g., Dechert, at 7; SIFMA AMG, at 17.
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Dechert commented that with respect to exempt CPOs, ``the CFTC has
generally determined it does not need to apply as close regulatory
oversight . . . as it does for registered CPOs.'' \66\ The Commission
does not consider the Final Rule to be inconsistent with that
statement. The Commission notes that, notwithstanding the Final Rule's
amendment to Regulation 4.13, exempt CPOs will continue to be exempt
from registration, and as a result, from the compliance obligations
applicable to CPOs registered or required to be registered, which are
primarily set forth in part 4 of the Commission's regulations. Each
determination to exempt certain persons from CPO registration is
inextricably linked to the eligibility criteria of the regulatory
exemption being claimed. The Commission has previously concluded
[[Page 40883]]
that such eligible persons generally implicate fewer of the
Commission's regulatory and oversight interests, which supports the
provision of a regulatory exemption from registration under those
circumstances.\67\ The Commission therefore believes it appropriate to
recognize the unique regulatory status of exempt CPOs, but also to
ensure that the Final Rule's amendment applies as intended and in a
logical fashion.
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\66\ Dechert, at 7.
\67\ See, e.g., 17 CFR 4.13(a)(3)(ii) (requiring CPOs claiming
this exemption to comply with one of two de minimis thresholds for
commodity interest trading in their exempt pool(s)).
---------------------------------------------------------------------------
Dechert further noted that, as an alternative to Proposed
Regulation 4.13(a)(6) and to CPO registration generally, the Commission
has multiple authorities it might employ and rely upon with respect to
CPOs exempt under Regulation 4.13, citing the anti-fraud authority in
CEA section 4o, as well as the recordkeeping and special call
authorities in Regulation 4.13(c)(1).\68\ Although the Commission
agrees that exempt CPOs are subject to these authorities, which the
Commission may employ on an as-needed basis, none of them is equivalent
to or establishes a basic conduct standard applicable to CPOs exempt
under Regulation 4.13. Moreover, each of the cited provisions is most
useful to the Commission where a discrete issue has been identified
that requires the Commission to act; in contrast, the Commission
intends new Regulation 4.13(b)(1)(iii) to apply prophylactically,
providing a foundational level of customer protection to exempt pool
participants. Therefore, the Commission believes that this approach to
remedying the fundamental customer protection risk discussed above is
appropriate, notwithstanding the logistical and regulatory concerns
asserted by commenters regarding the implementation of new Regulation
4.13(b)(1)(iii).\69\
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\68\ Dechert, at 7.
\69\ As discussed in further detail below, the Final Rule will
address those concerns by removing the proposed reference to the
disqualifications in CEA section 8a(3) in the required
representation and also by providing a meaningful period of time for
compliance by currently exempt CPOs.
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ii. Scope of the Final Rule: Which statutory disqualifications will be
grounds for prohibiting a claim to a CPO exemption?
After consideration of the comments received regarding the
statutory disqualifications that would be grounds for prohibiting a
person from seeking to claim a CPO exemption, the Commission has
determined not to include those violations enumerated in CEA section
8a(3) in the Covered Statutory Disqualifications. The Commission finds
persuasive commenters' arguments that the offenses listed in CEA
section 8a(3), in the context of Regulation 4.13, warrant different
treatment than those offenses listed in CEA section 8a(2).\70\ The
Commission notes that due to their characteristics, CEA section 8a(3)
offenses (unlike those enumerated in CEA section 8a(2)) serve as a bar
to registration with the Commission, only after a hearing is conducted
to formally find both that the disqualification has occurred, and that
the disqualification should prevent a person from registering with the
Commission.\71\ The Commission further believes that limiting the
Covered Statutory Disqualifications that would result in a person being
unable to rely upon Regulation 4.13 is consistent with the Commission's
longstanding view that persons claiming an exemption from CPO
registration generally implicate fewer of its regulatory concerns than
those persons registered or required to be registered as CPOs.
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\70\ See CEA section 8a(3), 7 U.S.C. 12a(3) (enumerating various
disqualifications including: Any violations of CEA or Commission
regulations; any violations of the Securities Act of 1933, the
Securities Exchange Act of 1934, the IA Act, the Investment Company
Act of 1940, among other federal statutes, as well as any similar
state statutes and any related regulations; any failure to supervise
that results in persons subject to such supervision violating the
CEA or Commission regulations; willfully making materially false
statements or omissions of fact in Commission reports, applications,
disqualification proceedings, and other Commission proceedings;
being subject to a denial, suspension, or expulsion order from a
registered entity, registered futures association, or other self-
regulatory organization; having a principal who has been or could be
refused registration; and where there is other good cause).
\71\ This process should be contrasted with that of CEA section
8a(2), the offenses of which may serve as the Commission's
justification, upon notice, but without a hearing to refuse to
register, to register conditionally, or to suspend or place
restrictions upon the registration, of any person. 7 U.S.C. 12a(2).
For persons already registered with the Commission, offenses under
CEA section 8a(2) may also be cited by the Commission during such a
hearing as may be appropriate to revoke the registration of any
person. Id.
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The Commission notes further that Regulation 4.13 was designed to
provide registration relief to CPOs with relatively limited activities
in the commodity interest markets. Specifically, exempt CPOs are
subject to substantive limitations impacting their exempt pools'
commodity interest footprint or trading strategy, the types of pool
participants they may solicit for investment in those exempt pools, as
well as the exempt pools' overall size and marketing activities. The
terms of the regulatory exemptions consequently cause the operations
and activities of these exempt CPOs to be more narrowly circumscribed
than those of registered CPOs. The Commission believes, as a result,
that new Regulation 4.13(b)(1)(iii) should be tailored to the most
serious offenses, which can trigger a statutory disqualification
without a prior hearing, i.e., those listed in CEA section 8a(2).
Commenters also expressed confusion regarding the procedural
implications of including the statutory disqualifications in CEA
section 8a(3), particularly the hearing requirement, and how they might
be incorporated into a new prohibition process under Regulation 4.13.
IAA specifically requested that the Commission adopt a ``reasonable
person standard,'' with respect to a person's knowledge of statutory
disqualifications, similar to Rule 506(d) of Regulation D, as adopted
by the Securities and Exchange Commission (SEC).\72\ The Commission
believes, however, that limiting the representation in new Regulation
4.13(b)(1)(iii) to those offenses listed in CEA section 8a(2) will
generally allow for effective implementation and will adequately
address the Commission's customer protection concerns.
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\72\ IAA, at 11 (requesting for disqualifications not to apply
``if the entity did not know, and, in the exercise of reasonable
care, could not have known that a disqualification exists,'' and
citing 17 CFR 230.506(d)(2)(ii)-(iv) as example).
---------------------------------------------------------------------------
By focusing only on the offenses listed in CEA section 8a(2), the
Commission is removing from the representation's purview those
disqualifications that do not necessarily serve as a general bar to
registration because they require a formal procedural hearing before
they can impact a person's registration status with the Commission. By
narrowing the scope of Covered Statutory Disqualifications in this
manner, the Commission is also recognizing its historical position that
the commodity interest activities of exempt CPOs generally implicate
fewer of the Commission's regulatory concerns. As a result, the
Commission believes that new Regulation 4.13(b)(1)(iii) will
appropriately bar persons subject to the CSDs from claiming exemption
under Regulation 4.13, without the adoption of additional procedural
requirements and without the adoption of a ``reasonable person''
standard, which may be difficult to apply in this circumstance. As
such, the Commission believes that the Final Rule will still ensure
that persons with the most egregious and recent offenses are unable to
solicit and accept funds for participations in commodity pools, even if
they are
[[Page 40884]]
exempt, thereby strengthening overall confidence in pooled investment
vehicles engaged in limited commodity interest trading.
iii. The Representation Requirement Under New Regulation
4.13(b)(1)(iii) and Retaining One of the Proposed Exceptions
The Final Rule will amend the notice requirement in Regulation 4.13
to require a representation that neither the person nor any of its
principals has in their backgrounds a Covered Statutory
Disqualification, subject to one limited exception discussed below.\73\
The Commission intends for this representation to be a threshold
requirement for any persons claiming an exemption subject to the notice
requirement in Regulation 4.13. If a person cannot truthfully make the
required representation regarding the person and its principals, then
that person will not qualify for an exemption from CPO registration. As
discussed in detail above, the representation in its final form has
been narrowed in scope to the CSDs, i.e., those offenses listed in CEA
section 8a(2). Additionally, consistent with the Proposal, Family
Offices relying on the new exemption in Regulation 4.13(a)(6), which
are not subject to the notice filing requirement, will therefore also
not be required to make the new representation. The Commission
concludes that this is an appropriate regulatory outcome because Family
Offices, by definition and by the substantive requirements of that
exemption, only serve ``family clients,'' and thus, generally pose
little customer protection risk to the investing public.
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\73\ See infra new Regulation 4.13(b)(1)(iii).
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Proposed Regulation 4.13(a)(6) contained two exceptions: Unless
such disqualification arises from a matter which was previously
disclosed in connection with a previous application, if such
registration was granted, or which was disclosed more than thirty days
prior to the claim of this exemption.\74\ As mentioned above, NFA
commented that the second exception ``appears premised on the idea that
the person claiming the exemption would be under an obligation, and
have a method, to report an existing statutory disqualification to the
Commission or NFA,'' and therefore, if the Commission or NFA did not
act on it within thirty days, then the statutory disqualification would
have no effect on the person.\75\ NFA further pointed out that ``unlike
entities claiming relief under Advisory 18-96 and Regulation 4.7, which
are registered and under an affirmative obligation to notify the
Commission and NFA by updating their [registration forms] if they
become subject to a statutory disqualification after they become
registered, the vast majority of persons seeking an exemption under
Regulation 4.13 are not [so] registered.'' \76\
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\74\ Proposal, 83 FR at 52927. As discussed above, this language
is derived from other relief containing similar prohibitions. See
supra pt. II.A.
\75\ NFA, at 2.
\76\ NFA, at 2 (suggesting therefore that the Commission
``either eliminate this exception or limit it to persons that are
currently registered'').
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The Commission agrees with NFA's description of how the second
proposed exception was intended to apply, and also with NFA's assertion
that many persons claiming a Regulation 4.13 exemption are not
registered with the Commission in another capacity, meaning they have
neither filed, nor have they any ongoing obligation to update,
registration forms with the Commission or NFA. After considering these
comments, the Commission is therefore not adopting the second proposed
exception. As a result, the remaining exception in new Regulation
4.13(b)(1)(iii) adopted by this Final Rule will apply to the Covered
Statutory Disqualifications that have been previously disclosed by the
person or its principal in prior registration applications that were
granted. The Commission believes that this result maintains the
strength of the amendment, while permitting flexibility for
circumstances where the Commission has affirmatively determined that a
CSD in a person's background should not impede that person's ability to
register.
iv. Principal Classification and Treatment of RIAs
The Commission also received other substantive and procedural
questions in response to Proposed Regulation 4.13(a)(6). Several
commenters, for instance, claimed that it would be very burdensome for
persons claiming exemption under Regulation 4.13 to identify, classify,
and examine the principals within their business entities, and that
requiring them to do so was effectively subjecting exempt CPOs to the
most significant costs of intermediary registration with the
Commission.\77\ Regulation 3.1(a) defines the term ``principal,'' by
providing examples of who would be considered principals in a variety
of legal entity structures, e.g., sole proprietorship, limited
liability company, limited partnership, or corporation.\78\
Consistently though, the ``principal'' definition is, generally
speaking, limited to those individuals and entities within the CPO who
have either management authority and responsibilities, or significant
power derived from stock ownership or capital contributions. Principals
usually include, therefore, managing members, company presidents,
corporate executives, chief compliance officers, and any legal person
who is a ten percent or more shareholder of the person.\79\ Dechert
explained that ``certain aspects of the [Commission's principal]
definition . . . do not create a bright-line test, but rather require a
facts-and-circumstances analysis.'' \80\ Dechert further asserted that
``the principal classification and screening process creates the
majority of the work necessary to register CPOs and CTAs, and is
costly,'' requested that the Commission provide guidance ``as to how an
exempt CPO could conduct such processes,'' and also asked that the
Commission ``establish[ ] a process for disagreement by the CFTC or NFA
with an exempt CPO's determination.'' \81\
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\77\ See, e.g., Dechert, at 7-8.
\78\ 17 CFR 3.1(a). Additionally, Regulation 4.10(e)(1) also
uses that ``principal'' definition for purposes of the Commission's
part 4 regulations. 17 CFR 4.10(e)(1). NFA Registration Rule 101(t)
is similar in design, and defines principal, in pertinent part, as
``a proprietor of a sole proprietorship; a general partner of a
partnership; a director, president, chief executive officer, chief
financial officer or a person in charge of a business unit, division
or function subject to regulation by the Commission of a
corporation, limited liability company, or limited liability
partnership; a manager, managing member, or member vested with
management authority for a limited liability company or limited
liability partnership; or a chief compliance officer.'' NFA
Registration Rule 101(t), available at https://www.nfa.futures.org/rulebook/rules.aspx?RuleID=RULE%20101&Section=8 (last retrieved Apr.
7, 2020).
\79\ 17 CFR 3.1(a)(1)-(a)(3). Regulation 3.1(a)(4) additionally
defines as a principal any person who employs a trust, proxy,
contract, or other device to avoid becoming a ten percent or more
shareholder for the purpose of evading being deemed a principal of
the entity. 17 CFR 3.1(a)(4).
\80\ Dechert, at 8 (citing ``the head of business unit, division
or function subject to CFTC regulation'' as an example). Regulation
3.1(a)(1) includes in the ``principal'' definition, regardless of
the entity's legal structure, any person in charge of a principal
business unit, division or function subject to regulation by the
Commission. 17 CFR 3.1(a)(1).
\81\ Dechert, at 8 and 11.
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The Commission believes that preventing persons who have one or
more statutorily disqualified principals from operating as exempt CPOs
will generally increase the customer protection provided to
participants in exempt pools, particularly because of the decision-
making authority such principals may exercise regarding the operations
of an exempt CPO and its exempt pool(s). The Commission also notes that
several hundred CPOs currently maintain registration simultaneously
with one or more CPO
[[Page 40885]]
exemptions, due to the nature of the various commodity pools they
operate. The Commission believes that such exempt CPOs may be slightly
advantaged because they will likely spend less time identifying and
classifying principals than persons or entities who have no prior
contact with commodity interest markets or the Commission, or who only
operate pools pursuant to one or more exemptions from registration.
Registered CPOs, who may be also claiming a CPO exemption, will have
already gone through those processes for purposes of applying for
registration with respect to their non-exempt commodity pools. Further,
such CPOs would also be much less likely to have to remove and replace
principals with Covered Statutory Disqualifications. In the event such
an otherwise registered CPO or a principal thereof did have a CSD, it
would likely fall under the exception discussed above for CSDs
identified by the person and/or principal in a prior approved
application for registration, in light of their existing status as a
registrant and the obligation to disclose such offenses as they occur.
With respect to persons claiming a CPO exemption under Regulation
4.13 for the first time, and persons who are exempt CPOs and not also
registered with the Commission, the Commission understands that such
persons will possibly be required to devote time and resources to
determining who in their organization is a principal and whether any of
them has a Covered Statutory Disqualification in their background. Some
classes of principals under the Commission's regulations may involve a
factual analysis to determine status. The Commission continues to
believe, however, that most persons will be able to determine their
principals relatively easily, due to the standard forms of business
organization typically used by exempt CPOs and the detailed definitions
provided by the Commission in its regulations.\82\ In particular,
Regulation 3.1 details the roles, titles, ownership, and
responsibilities that can give rise to a person being a ``principal''
of a registrant, which the Commission believes reduces the challenges
associated with identifying principals within an organization such as
an exempt CPO. As discussed above, the Commission also believes that
some persons claiming Regulation 4.13 exemptions may have already been
required to identify their principals as part of their registration
with the Commission as a CPO with respect to the operation of one or
more other pools. The Commission believes that the substantive changes
made in this Final Rule address the Commission's concerns about
providing some customer protection to participants in pools operated by
an exempt CPO, while permitting flexibility and facilitating compliance
with Regulation 4.13 through additional compliance time. Therefore, the
Commission is adopting new Regulation 4.13(b)(1)(iii), such that the
required representation covers both persons claiming the exemption and
their principal(s).
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\82\ 17 CFR 3.1(a).
---------------------------------------------------------------------------
The Commission also received several requests for the Commission to
exclude RIAs from the proposed amendment, on the basis that such RIAs
are already subject to robust conduct requirements in the IA Act,
which, commenters argue, the new representation would only serve to
duplicate.\83\ Though the Commission agrees with commenters that RIAs
are subject to conduct requirements under the IA Act, the Commission is
declining to exclude RIAs from the scope of new Regulation
4.13(b)(1)(iii). IA Act section 203(e) covers censures, denials, or
suspensions of registration for investment advisers and provides the
SEC the authority to censure, limit, suspend, or revoke the
registration of any investment adviser, if, after notice and
opportunity for a hearing, certain statutory disqualifications of the
adviser or persons associated with it are proven and such adverse
action is in the public interest.\84\ The Commission finds that the
statutory disqualification regime of the IA Act differs materially from
the corresponding provisions in the CEA. Of particular relevance to the
Final Rule, the IA Act does not specify any statutory disqualifications
that bar investment advisers from registration in a manner similar to
the mechanism in CEA section 8a(2), i.e., without a procedural hearing
or order.
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\83\ See, e.g., IAA, at 10; SIFMA AMG, at 18.
\84\ IA Act section 203(e), 15 U.S.C. 80b-3(e).
---------------------------------------------------------------------------
The Commission notes that preserving its independent authority to
determine which persons should be permitted to operate commodity pools
in its markets subject to an exemption is consistent with the
Commission's independent assessment of RIAs seeking registration with
the Commission regarding their commodity interest activities. Under
those circumstances, notwithstanding the RIA's registration with the
SEC, the Commission assesses the registration application of the RIA
under the terms of the CEA and the Commission's regulations promulgated
thereunder, which reflect the unique regulatory concerns associated
with intermediaries in the commodity interest markets. Although the
Commission recognizes that most RIAs would not present any cause for
reservation in permitting them to operate in the commodity interest
markets, the Commission believes that retaining the ability to engage
in an independent assessment regarding an RIA's fitness to act as an
exempt CPO best serves its customer protection interests. Therefore,
the Commission is not adopting the suggestion to exclude RIAs from the
scope of new Regulation 4.13(b)(1)(iii).\85\
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\85\ The Commission notes, however, that the majority of RIAs,
based on their registration status with the SEC, should be able to
easily comply with the representation regarding Covered Statutory
Disqualifications required by amended Regulation 4.13.
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v. Persons With Covered Statutory Disqualifications May Seek Individual
Exemptive Letter Relief or Apply for CPO Registration
As explained herein, the Commission believes that the adoption of
this representation regarding the Covered Statutory Disqualifications
for persons, and their principals, claiming exemption under Regulation
4.13 is generally necessary to protect the participants in exempt
commodity pools; however, the Commission recognizes that there may be
facts and circumstances, pursuant to which permitting such disqualified
CPOs and principals to operate exempt commodity pools may not be
inconsistent with the Commission's customer protection concerns. The
Commission notes its authority under Regulation 4.12(a) to ``exempt any
person or any class or classes of persons from any provision of this
part 4, if it finds that the exemption is not contrary to the public
interest and the purposes of the provisions from which exemption is
sought.'' \86\ The Commission has, by rule, delegated that authority to
the Director of DSIO.\87\ Pursuant to that delegated authority and
Regulation 140.99, those persons who have a Covered Statutory
Disqualification, but nonetheless believe that it should not negatively
affect their ability to claim a CPO exemption, may seek, on an
individual or firm-by-firm basis, exemptive letter relief from the
[[Page 40886]]
representation adopted by this Final Rule by presenting the facts and
legal rationale demonstrating that such exemptive letter relief would
be consistent with the public interest and not contrary to the specific
purposes of Regulation 4.13(b)(1), i.e., providing some customer
protection to exempt pool participants.\88\ The Commission notes that
it expects the granting of such requests to be infrequent and supported
by a strong factual and legal basis, so as to avoid undermining the
purposes of the Final Rule.
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\86\ 17 CFR 4.12(a).
\87\ 17 CFR 140.93 (delegating the authority in Regulation
4.12(a) to the DSIO Director, further facilitating the issuance of
exemptive letter relief with respect to provisions in 17 CFR part
4). As with all Commission delegations to staff generally: (1) The
relevant Division Director (in this case, DSIO) may submit such a
request regarding the delegated matter to the Commission for its
consideration; and (2) the Commission may, at its election, exercise
the delegated authority to consider such a request for relief. See
17 CFR 140.93(b)-(c).
\88\ 17 CFR 140.99(a)(1) (defining an exemptive letter as ``a
written grant of relief issued by the staff of a Division of the
Commission from the applicability of a specific provision of the Act
or of a rule, regulation or order issued thereunder by the
Commission''). Such exemptive letters are typically issued subject
to conditions determined by Commission staff to be necessary or
appropriate, and further, these letters are subject to Commission
review prior to issuance.
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The Commission further advises that, at any time, even if a CPO is
unsuccessful in its request for such exemptive letter relief, persons
with CSDs may submit an application for CPO registration, in which any
and all statutory disqualifications would be disclosed as required by
Forms 7-R and 8-R, and reviewed through the existing registration
process.\89\ Utilizing this existing process allows for the detailed
analysis of each disqualification, and all of the facts related
thereto, specifically with respect to the propriety of the Commission
permitting such person to register as a CPO, and/or to list a principal
with any such disqualifications in its background. This assessment
further includes determining whether any conditions or restrictions
might sufficiently mitigate the customer protection risks posed by the
statutorily disqualified person or principals.\90\ Should the
determination be made to permit the registration, such persons would be
subject to the Commission's ongoing oversight regarding their commodity
pool operations, and subject to all statutory and regulatory
obligations applicable to registered CPOs and their principals. The
Commission believes that these existing procedures for seeking
individualized exemptive letter relief under part 4 of the Commission's
regulations, as well as the registration process, present appropriate
methods for considering alternative outcomes, where appropriate, from
the prohibition of Covered Statutory Disqualifications in exempt CPOs
adopted herein.
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\89\ See, e.g., 17 CFR 3.10.
\90\ 7 U.S.C. 12a(2) (providing that the Commission has the
authority to condition, restrict, or suspend the registration of any
person under the Act). See also 17 CFR 3.60 (establishing the
Commission's regulatory procedure to deny, condition, suspend,
revoke, or place restrictions upon registration pursuant to sections
8a(2), 8a(3), and 8a(4) of the Act). The Commission has delegated
the implementation of its registration authority to NFA. Performance
of Registration Functions by National Futures Association, 49 FR
39593 (Oct. 9, 1984) (delegating by Commission Order the
registration function to NFA with respect to futures commission
merchants, CPOs, commodity trading advisors, and the associated
persons thereof).
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vi. Timeframe for Exempt CPO Compliance With New Regulation
4.13(b)(1)(iii)
The Commission also received and considered multiple comments
regarding the exact timing of the effective and compliance dates
regarding Proposed Regulation 4.13(a)(6). As stated above, the
Commission anticipates that the changes in approach employed in this
Final Rule should reduce the analysis required in order to comply.
Nonetheless, the Commission believes it appropriate to facilitate
persons claiming an exemption under Regulation 4.13 in transitioning
and adjusting to the application of new Regulation 4.13(b)(1)(iii).
Although the Final Rule will be effective within 60 days of
publication, the Commission has determined not to mandate compliance
with the additional representation required by new Regulation
4.13(b)(1)(iii) for CPOs currently relying on an exemption in
Regulation 4.13, as of that effective date. The Commission is
establishing for these particular CPOs a compliance date of March 1,
2021, which coincides with the deadline for persons filing annual
reaffirmation notices under Regulation 4.13(b)(1) in the upcoming 2021
filing cycle.
Although the Commission is declining to ``grandfather'' existing
exempt CPOs with respect to the Final Rule, because it believes doing
so may dilute any positive effect on customer protection the amendment
would have, persons currently claiming an exemption from CPO
registration may continue to do so, while identifying, classifying, and
checking the backgrounds of the claiming person and its principals. The
additional compliance period will allow currently exempt CPOs to
continue operating their exempt pools, while they conduct the necessary
inquiries regarding the claimant and principals (if they have not
already been required to do so due to being otherwise registered).
On the other hand, persons claiming a Regulation 4.13 exemption for
the first time on or after the Final Rule's effective date will not be
provided additional compliance time. Publication of the Final Rule
serves as notice to such persons that, to successfully claim an
exemption from CPO registration, they will be thereafter required to
identify their principals, conduct background checks, and represent
that neither the person nor its principals are subject to the Covered
Statutory Disqualifications, unless such offenses were disclosed in a
registration application already approved by the Commission or NFA. The
Commission believes this distinction between existing and new claimants
under Regulation 4.13 is reasonable because persons establishing a new
exempt CPO generally would have the opportunity to identify and check
principals as part of the start-up process for the CPO and pool
business, and prior to operating an exempt pool for the first time.
III. Related Matters
a. Regulatory Flexibility Act
The Regulatory Flexibility Act (RFA) requires that Federal
agencies, in promulgating regulations, consider whether the regulations
they propose will have a significant economic impact on a substantial
number of small entities, and if so, to provide a regulatory
flexibility analysis regarding the economic impact on those
entities.\91\ Each Federal agency is required to conduct an initial and
final regulatory flexibility analysis for each rule of general
applicability for which the agency issues a general notice of proposed
rulemaking. The regulatory amendments adopted herein affect only
persons registered or required to be registered as CPOs and persons
claiming exemptions from registration as such. The Commission
previously has determined that a CPO is a small entity for purposes of
the RFA, if it meets the criteria for an exemption from registration
under Regulation 4.13(a)(2).\92\ Such CPOs will generally continue to
qualify for the exemption from registration, though the Commission
believes that such exempt CPOs claiming Regulation 4.13(a)(2) may incur
some costs as a result of the Final Rule. Like most other exempt CPOs,
they will also be required to identify their principals and affirm that
neither they nor the claiming entity
[[Page 40887]]
have in their backgrounds a Covered Statutory Disqualification. The
Commission notes that this requirement will apply equally to all
persons filing a notice of exemption under Regulation 4.13, after the
effective date of the Final Rule, and that all CPOs currently claiming
an exemption, including those that are small entities for RFA purposes,
are subject to the guidance herein, requiring them to comply with new
Regulation 4.13(b)(1)(iii) by March 1, 2021. The Commission did not
receive any comments on its analysis of the application of the RFA to
the Proposal or Proposed Regulation 4.13(a)(6).
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\91\ 5 U.S.C. 601, et seq.
\92\ Policy Statement and Establishment of Definitions of
``Small Entities'' for Purposes of the Regulatory Flexibility Act,
47 FR 18618, 18619-20 (Apr. 30, 1982). Regulation 4.13(a)(2) exempts
a person from registration as a CPO when: (1) None of the pools
operated by that person has more than 15 participants at any time,
and (2) when excluding certain sources of funding, the total gross
capital contributions the person receives for units of participation
in all of the pools it operates or intends to operate do not, in the
aggregate, exceed $400,000. See 17 CFR 4.13(a)(2). As of April 20,
2020, there are approximately 313 entities claiming this exemption.
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The costs of new Regulation 4.13(b)(1)(iii), which are expected to
vary depending on the size and complexity of the CPO in question, will
generally be incurred once by exempt CPOs: Either at the compliance
date required by the Final Rule, or at the formation of a new exempt
CPO after the Final Rule is effective. The Commission believes further
that, as small entities which are typically less complex
organizationally, CPOs exempt under Regulation 4.13(a)(2) may
potentially have an easier time identifying, classifying, and verifying
the backgrounds of their principals. As such, the Commission believes
that such small CPOs will incur, in general, lower costs, especially
when compared to other types of exempt CPOs that are more likely to
employ complex business structures or have more principals to identify
and review.\93\ If an exempt CPO or its principal has a Covered
Statutory Disqualification in its background, the Commission recognizes
that such person could be significantly impacted, as the person would
therefore likely be required to replace the disqualified principal to
continue operating, or under some circumstances, may be required to
even wind up and cease operating their pool(s) as an exempt CPO.
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\93\ Persons claiming an exemption under Regulation 4.13(a)(3),
for example, include persons operating complex pooled investment
vehicle structures that typically have at least several principals
operating the CPO and pools.
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Throughout this Final Rule, the Commission has evaluated and taken
into consideration the amendment's impact on small exempt CPOs. Though
the Commission lacks sufficient data to predict exactly how many exempt
CPOs may ultimately be required to cease pool operations by virtue of
the Final Rule, the Commission expects very few CPOs exempt under
Regulation 4.13(a)(2) will be required to cease operations as a result.
The current number of exempt CPOs that are also small entities is
relatively low (approximately 313), and the costs of new Regulation
4.13(b)(1)(iii) are generally limited in occurrence, as discussed
above. Finally, the Commission is also providing guidance in the Final
Rule that provides additional time for certain affected persons to
comply and incur costs resulting from this amendment, as an effort to
mitigate disruption to these businesses. Therefore, the Commission
concludes that the Final Rule does not create a significant economic
impact on a substantial number of small entities.
Accordingly, the Chairman, on behalf of the Commission, hereby
certifies pursuant to 5 U.S.C. 605(b) that the regulation adopted by
the Commission in the Final Rule will not have a significant economic
impact on a substantial number of small entities.
b. Paperwork Reduction Act
The Paperwork Reduction Act (PRA) imposes certain requirements on
Federal agencies in connection with their conducting or sponsoring any
collection of information as defined by the PRA.\94\ Under the PRA, an
agency may not conduct or sponsor, and a person is not required to
respond to, a collection of information unless it displays a currently
valid control number from the Office of Management and Budget (OMB).
The Commission believes that as adopted, the Final Rule results in a
collection of information within the meaning of the PRA, as discussed
below. As such, the publication of a PRA notice soliciting comment
regarding the Commission's estimated burden calculation for new
Regulation 4.13(b)(1)(iii) will be required.
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\94\ See 44 U.S.C. 3501, et seq.
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As discussed in the Proposal, the Commission's proposed regulations
would have impacted or amended two collections of information for which
the Commission has previously received control numbers from OMB:
Collections 3038-0005 and 3038-0023.\95\ In the 2019 Final Rules, the
Commission adopted amendments to 17 CFR part 4, submitted those final
amendments for OMB approval, and amended those information collections
to reflect the regulatory changes adopted by that final rulemaking.\96\
Significantly, because Proposed Regulation 4.13(a)(6) was initially
proposed as a substantive requirement to be applicable to any person
who desires to claim an exemption under paragraphs (a)(1), (a)(2),
(a)(3), (a)(4), or (a)(5) in this section, the Commission never
considered the proposed amendment in the context of the PRA or those
collections of information. In the Proposal, the Commission invited the
public and other Federal agencies to comment on any aspect of the
information collection requirements discussed therein.\97\ The
Commission did not receive any such comments.
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\95\ Proposal, 83 FR at 52918.
\96\ See 2019 Final Rules, 84 FR at 67348; 84 FR at 67353.
\97\ Proposal, 83 FR at 52920.
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As discussed above, the Final Rule adopts new Regulation
4.13(b)(1)(iii), which requires a person filing a notice of exemption
under Regulation 4.13(b)(1) to represent that neither the claimant nor
any of its principals has in their backgrounds a Covered Statutory
Disqualification that would require disclosure, if the claimant sought
registration with the Commission. Because Proposed Regulation
4.13(a)(6) did not require any additional information to be provided as
part of the notice filed to claim an exemption under Regulation 4.13,
the Commission did not account in the Proposal for any PRA burden
associated with an additional representation in the notice filing
required under Regulation 4.13(b)(1). Therefore, concurrent with the
Final Rule, the Commission is updating the estimated burden associated
with Regulation 4.13(b)(1), as amended by this Final Rule, and seeking
public comment on those estimates in a PRA notice, separately published
in this Federal Register.
c. Cost-Benefit Considerations
Section 15(a) of the CEA requires the Commission to consider the
costs and benefits of its actions before promulgating a regulation
under the CEA.\98\ Section 15(a) further specifies that the costs and
benefits shall be evaluated in light of the following five broad areas
of market and public concern: (1) Protection of market participants and
the public; (2) efficiency, competitiveness, and financial integrity of
futures markets; (3) price discovery; (4) sound risk management
practices; and (5) other public interest considerations. The Commission
considers the costs and benefits resulting from its discretionary
determinations with respect to the CEA section 15(a) considerations.
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\98\ 7 U.S.C. 19(a).
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i. General Costs and Benefits
The baseline for the Commission's consideration of the costs and
benefits of the Final Rule is the regulatory status quo, as determined
by the CEA and the Commission's existing regulations. The Commission
has endeavored to assess the costs and benefits of the Final Rule
[[Page 40888]]
in quantitative terms wherever possible. Where estimation or
quantification is not feasible, however, the Commission has provided
its assessment in qualitative terms.
The Commission notes that the consideration of costs and benefits
below is based on the understanding that the markets function
internationally, with many transactions involving U.S. firms taking
place across international boundaries; with some Commission registrants
being organized outside of the United States; with leading industry
members commonly following substantially similar business practices
wherever located. Therefore, the below discussion of costs and benefits
refers to the effects of the Final Rule on all activity covered by the
amended regulations. Consequently, the Commission notes that some
entities affected by the Final Rule are located outside of the United
States.
ii. Brief Overview of the Final Rule
The Final Rule adds new paragraph (b)(1)(iii) to the annual notice
filing requirement in Regulation 4.13(b)(1), which will, once
effective, require all persons filing a notice of exemption under
Regulation 4.13 to represent that neither they nor their principals
have in their backgrounds a Covered Statutory Disqualification, unless
such disqualification arises from a matter which was disclosed in
connection with a previous application for registration, if such
registration was granted. The Commission intends for CPOs claiming a
notice of exemption as of the Final Rule's effective date to first make
this representation in the 2021 reaffirmation of the exemption, i.e.,
March 1, 2021. The Commission believes that the adjustments to the
Final Rule, discussed in detail above, as well as its guidance
establishing an extended compliance period for currently exempt CPOs,
address the majority of public comments received in response to
Proposed Regulation 4.13(a)(6). The Commission concludes therefore that
these efforts appropriately balance the Commission's regulatory
interests with the costs of compliance to affected persons. New
Regulation 4.13(b)(1)(iii) will effectively prohibit Covered Statutory
Disqualifications, i.e., those listed in CEA section 8a(2), in persons
filing a notice of exemption under Regulation 4.13, as well as in their
principals, in a more tailored manner than the proposed amendment. As a
result, the Commission believes the Final Rule addresses the
Commission's customer protection concerns with respect to the exempt
CPO population, while still reducing the regulatory burdens for exempt
CPOs and their commodity pools.
ii. Benefits and Costs of the Final Rule
The Commission believes that prohibiting persons who are
statutorily disqualified under CEA section 8a(2), or who employ
principals so disqualified, from claiming exemptions under Regulation
4.13 will result in several benefits. As discussed in further detail
above and in the Proposal, the Commission has concerns that ``pool
participants may be exposed to risk posed by regulations permitting the
operation of an offered [exempt] pool by a person who, generally, would
not otherwise be permitted to register with the Commission.'' \99\ The
Commission has noted that, ``even if the activities of a CPO do not
rise to a level warranting Commission oversight through registration, a
prospective participant should be able to be confident that a
collective investment vehicle using commodity interests is not operated
by a person,'' who, for example, has previously been the subject of an
injunction relating to fraud or embezzlement.\100\
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\99\ See Proposal, 83 FR at 52921.
\100\ Proposal, 83 FR at 52921-22 (citing 7 U.S.C. 12a(2)(C)(ii)
as an example of a disqualification proposed to be prohibited by
this amendment).
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Prior to the Final Rule, persons claiming an exemption from CPO
registration under Regulation 4.13 generally were not required to meet
any basic conduct standards, in contrast to persons registered or
required to register as CPOs with the Commission.\101\ The Final Rule
remedies that regulatory gap by requiring that a person filing a notice
of exemption from CPO registration under Regulation 4.13 meets
substantively similar basic conduct standards as a person registered or
required to be registered as a CPO. The Commission expects that
correcting this regulatory inconsistency will increase overall investor
confidence by setting a standard applicable to the vast majority of
exempt CPOs operating pooled investment vehicles in the commodity
interest markets. The result of the Final Rule will be that persons
and/or principals who have a Covered Statutory Disqualification not
previously disclosed in a prior approved application for registration
will generally be prohibited from operating or soliciting the public
for investment in exempt pools, or from serving as a principal of an
exempt CPO.
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\101\ See supra pt. II.c.i for additional historical and legal
discussion.
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Because the Final Rule will require such CPOs to assess themselves
and their principals for any CEA section 8a(2) disqualifications, the
Commission believes that once it is fully implemented, new Regulation
4.13(b)(1)(iii) may provide reasonable assurance that persons subject
to the Covered Statutory Disqualifications are not soliciting exempt
pool participants and/or managing their capital via exempt pools.
Moreover, the Commission expects that both prospective and actual
participants in pools operated by exempt CPOs will experience enhanced
customer protection by removing statutorily disqualified CPOs and/or
principals thereof from the commodity interest markets. The Commission
believes further that those participants will likely, as a result, also
experience improved overall confidence in the exempt commodity pool
space.
The Commission understands that the Final Rule could also result in
potentially substantial costs to persons filing a notice of exemption
under Regulation 4.13(b)(1). In the Proposal, the Commission further
identified and described ``costs associated with either divesting from
commodity interests held within a collective investment vehicle, or in
completely winding up a commodity pool's operations,'' that could
result from Proposed Regulation 4.13(a)(6).\102\ In addition to these
``wind-up'' costs, the Commission understands that principal
identification and classification processes will likely result in costs
to each affected exempt CPO, and that those costs will vary based on
the overall structure of the CPO, the number of principals it employs,
and other circumstances unique to its pool operations. Although these
potential costs were a point of significant concern for several
commenters, and the Commission specifically solicited comment in the
Proposal on the ``impact of adopting [Proposed Regulation 4.13(a)(6)]
on industry participants and currently exempt CPOs,'' commenters did
not provide specific data or estimates quantifying the actual costs of
compliance resulting from the proposed amendment.\103\
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\102\ Proposal, 83 FR at 52923 (though the Commission noted that
it ``lacks sufficient data to determine how many CPOs might be
required to cease operating commodity pools pursuant to the
exemptions . . . due to the presence of statutorily disqualified
[persons or] principals'').
\103\ Proposal, 83 FR at 52916.
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Despite the lack of information from commenters regarding potential
or actual costs to affected persons, the Commission nonetheless
considered those public comments, and strove to balance those costs
with its regulatory and policy goals in a way that benefits market
participants, customers, and the
[[Page 40889]]
general public interest. By narrowing the scope of the Covered
Statutory Disqualifications in new Regulation 4.13(b)(1)(iii) to those
listed in CEA section 8a(2), the Commission believes that the Final
Rule strikes an appropriate regulatory balance between customer
protection concerns and increased regulatory requirements. This
adjustment means the required representation will target the most
serious offenses warranting the statutory disqualifications listed in
the CEA within the general population of exempt CPOs, including their
principals. Moreover, the Final Rule further reduces procedural
confusion by limiting the CSDs to those disqualifications that would
serve as a bar to registration with the Commission, absent an
additional hearing or proceeding. Finally, by providing guidance herein
that extends the compliance period for persons currently relying upon a
claim of exemption under Regulation 4.13(b)(1), the Commission wishes
to facilitate compliance with the Final Rule. Specifically, the
Commission intends this guidance to mitigate the risk of business
interruption by providing affected persons with additional time to
assess themselves and their principals, and to identify and address any
CSDs that are found. The Commission is employing this tailored and
gradual approach for the Final Rule and its implementation to, among
other things, generally moderate costs to affected persons caused by
new Regulation 4.13(b)(1)(iii).
iii. Section 15(a) Considerations
1. Protection of Market Participants and the Public
The Commission considered whether the Final Rule will have any
detrimental effect on the customer protections of the Commission's
regulatory regime and has concluded that the Final Rule will generally
have a positive effect on the protection of market participants and the
public. Through new Regulation 4.13(b)(1)(iii), the Commission is
remedying an inconsistency, in which a person who may be prohibited by
the CEA from conducting activities requiring registration could
nonetheless engage in those activities by claiming a CPO registration
exemption instead. The Final Rule will ensure that persons filing a
notice of exemption under Regulation 4.13(b)(1), as amended, and
persons registered or required to be registered as CPOs with the
Commission will be treated similarly--in either instance, all such
persons must be able to represent that they and their principals are,
at a minimum, not disqualified under CEA section 8a(2), prior to
soliciting the public for investment in, or otherwise operating a
commodity pool. The Commission believes that basic conduct standards
applicable to CPOs, regardless of registration status, will improve
customer protection within the Commission's CPO regulatory program.
2. Efficiency, Competitiveness, and Financial Integrity of Markets
Section 15(a)(2)(B) of the CEA requires the Commission to evaluate
the costs and benefits of a regulation in light of efficiency,
competitiveness, and financial integrity considerations. The Commission
believes that the Final Rule may positively impact the efficiency,
competitiveness, and financial integrity of the commodity interest
markets. The Final Rule will require all persons filing a notice under
amended Regulation 4.13(b)(1) to represent that neither they nor their
principals have in their backgrounds a Covered Statutory
Disqualification. To the extent that disqualified persons are prevented
from being an exempt CPO or from serving as a principal of an exempt
CPO, as a result of new Regulation 4.13(b)(1)(iii), the Commission
expects such disqualified persons (and principals) would either exit
the commodity interest markets, or at least, discontinue operating in
the exempt commodity pool space. Therefore, because it will ultimately
cause the removal of entities, persons, and principals disqualified
under CEA section 8a(2) from the exempt commodity pool space, the
Commission believes that the Final Rule could have a positive impact on
the efficiency, competitiveness, and financial integrity of the
commodity interest markets overall.
3. Price Discovery
Section 15(a)(2)(C) of the CEA requires the Commission to evaluate
the costs and benefits of a regulation in light of price discovery
considerations. For the reasons noted above, the Commission believes
that the Final Rule generally results in limited, discrete changes to
regulatory processes and filings that will not have a significant
impact on price discovery.
4. Sound Risk Management
Section 15(a)(2)(D) of the CEA requires the Commission to evaluate
a regulation in light of sound risk management practices. The
Commission believes that the Final Rule will not have a significant
impact on the practice of sound risk management because the manner in
which various CPOs, pooled investment vehicles, and their respective
principals organize, register, or claim an exemption from such
registration has only a small influence on how such market participants
manage their risks overall.
5. Other Public Interest Considerations
Section 15(a)(2)(E) of the CEA requires the Commission to evaluate
the costs and benefits of a regulation in light of other public
interest considerations. The Commission did not identify any additional
public interest considerations not already discussed above.
d. Anti-Trust Considerations
Section 15(b) of the CEA requires the Commission to take into
consideration the public interest to be protected by the antitrust laws
and endeavor to take the least anticompetitive means of achieving the
purposes of the CEA, in issuing any order or adopting any Commission
rule or regulation (including any exemption under CEA section 4(c) or
4c(b)), or in requiring or approving any bylaw, rule, or regulation of
a contract market or registered futures association established
pursuant to section 17 of the CEA.\104\ The Commission believes that
the public interest to be protected by the antitrust laws is generally
to protect competition. The Commission requested comment on whether the
Proposal implicated any other specific public interest to be protected
by the antitrust laws and received no comments addressing this issue.
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\104\ 7 U.S.C. 19(b).
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The Commission has considered the Final Rule to determine whether
it is anticompetitive and has identified no anticompetitive effects.
Because the Commission has determined the Final Rule is not
anticompetitive and has no anticompetitive effects, the Commission has
not identified any less anticompetitive means of achieving the purposes
of the CEA.
List of Subjects in 17 CFR Part 4
Advertising, Brokers, Commodity futures, Commodity pool operators,
Commodity trading advisors, Consumer protection, Reporting and
recordkeeping requirements.
For the reasons stated in the preamble, the Commodity Futures
Trading Commission amends 17 CFR part 4 as follows:
[[Page 40890]]
PART 4--COMMODITY POOL OPERATORS AND COMMODITY TRADING ADVISORS
0
1. The authority citation for part 4 continues to read as follows:
Authority: 7 U.S.C. 1a, 2, 6(c), 6b, 6c, 6l, 6m, 6n, 6o, 12a,
and 23.
0
2. Amend Sec. 4.13 by:
0
a. Revising paragraph (b)(1)(ii); and
0
b. Redesignating paragraph (b)(1)(iii) as (b)(1)(iv), and adding new
paragraph (b)(1)(iii).
The addition and revision read as follows:
Sec. 4.13 Exemption from registration as a commodity pool operator.
* * * * *
(b)(1) * * *
(ii) Specify the paragraph number pursuant to which the person is
filing the notice (i.e., Sec. 4.13(a)(1), (2), (3), or (5)) and
represent that the pool will be operated in accordance with the
criteria of that paragraph;
(iii) Represent that neither the person nor any of its principals
has in its background a statutory disqualification that would require
disclosure under section 8a(2) of the Act if such person sought
registration, unless such disqualification arises from a matter which
was disclosed in connection with a previous application for
registration, where such registration was granted; and
* * * * *
Issued in Washington, DC, on June 5, 2020, by the Commission.
Robert Sidman,
Deputy Secretary of the Commission.
Note: The following appendices will not appear in the Code of
Federal Regulations.
Appendices to Registration and Compliance Requirements for Commodity
Pool Operators and Commodity Trading Advisors: Prohibiting Exemptions
Under Regulation 4.13 on Behalf of Persons Subject to Certain Statutory
Disqualifications--Commission Voting Summary, Chairman's Statement, and
Commissioners' Statements
Appendix 1--Commission Voting Summary
On this matter, Chairman Tarbert and Commissioners Quintenz,
Behnam, Stump, and Berkovitz voted in the affirmative. No
Commissioner voted in the negative.
Appendix 2--Supporting Statement of Chairman Heath P. Tarbert
As Robert Louis Stevenson aptly put it, ``Everybody, sooner or
later, sits down to a banquet of consequences.'' \1\
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\1\ While this is the popular rendering of Stevenson's quote, it
appears to be apocryphal. Stevenson apparently used the phrase
``game of consequences.'' See Spurious Quotations, The Robert Louis
Stevenson Archive, http://www.robert-louis-stevenson.org/richard-dury-archive/nonquotes.htm. Regardless whether Stevenson referred to
a banquet or a game, his point was the same: Everyone must face the
consequences of his or her actions. That is true for life generally,
and for the derivatives markets specifically.
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Today we are focused on the consequences of bad acts that result
in ``statutory disqualification'' under the Commodity Exchange Act
(``CEA''). These acts include the most serious types of financial
crimes, such as embezzlement, theft, extortion, fraud,
misappropriation, and bribery. Once an individual is statutorily
disqualified, the CFTC may deny or revoke his or her registration.
The same is true for corporate entities.
It stands to reason that someone who has been statutorily
disqualified--and thus has no right to register with the CFTC--would
be precluded from managing other people's money and positions in the
derivatives markets the CFTC regulates. But currently, this is not
exactly the case. As it turns out, a statutorily disqualified person
who wishes to operate a fund that trades derivatives may simply
claim one of the exemptions from registration as a commodity pool
operator (``CPO'') under CFTC Rule 4.13. Although each of these
exemptions has a number of conditions, the absence of statutory
disqualification is not currently among them.
Today's final rule closes this loophole for bad actors. Under
our rule as amended, a CPO claiming a registration exemption would
be required to certify that neither the CPO nor any of its
principals has in its background conduct that would result in
automatic statutory disqualification under the CEA. I believe this
rule will enhance customer protections and public confidence in the
integrity of the derivatives markets by ensuring that bad actors
cannot gain access to the funds of innocent, third-party investors
simply by filing an exemption claim.\2\
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\2\ The Commission has adopted a registration exemption for CPOs
that meet the definition of ``family office'' under the Securities
and Exchange Commission's regulations governing investment advisers.
84 FR 67,368 (Dec. 10, 2019). Section 409 of the Dodd-Frank Act
excluded family offices from the definition of ``investment
adviser'' subject to the Investment Advisers Act. Given the clear
legislative intent to remove family offices from regulation, it
would be inappropriate for the CFTC to exert its own oversight over
such offices. As Congress recognized in the Dodd-Frank Act,
regulatory oversight over family offices would be a wasteful use of
taxpayer funds, as such offices are owned and controlled by a single
wealthy family. Given their affluence and familial ties, these
investors generally neither desire nor need investor protections
designed for the retail public at large. Consistent with this
approach, today's prohibition on statutory disqualification does not
apply to CPOs that are family offices. That said, we cannot allow
bad actors to operate a family office in a way that adversely
affects the market as a whole--for example, by engaging in
manipulative or deceptive transactions through the family office. To
that end, I have asked the Division of Swap Dealer and Intermediary
Oversight to conduct a special call to determine how many family
office managers would be prohibited from claiming the exemption if
they were covered by this rule.
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In so doing, we also strike a balance between bad acts that
warrant automatic disqualification and other behavior that requires
the opportunity for a hearing before the subject is disqualified.
Because the CEA itself makes this kind of distinction in the context
of registration, the Commission believes that lesser offenses \3\
warrant different treatment than recent and more serious offenses in
the context of registration exemptions. Thus, today's prohibition on
statutory disqualification does not include offenses for which the
CEA itself requires a hearing prior to disqualification.
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\3\ This includes offenses that are less recent (e.g., felony
convictions that are more than ten years old) or are less relevant
to a person's fitness to handle customer funds (e.g., convictions
for felonies that do not involve financial wrongdoing). See, e.g.,
CEA Section 8a(3)(D).
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I am comfortable with this exclusion, both because it is
consistent with legislative intent and because CPOs relying on a
Rule 4.13 registration exemption generally do not manage the money
and derivatives positions of the retail public at large. Rather,
these CPOs are limited by the terms of their exemption to small
pools of select participants, pools limited to sophisticated
investors, pools with de minimis derivatives positions, and the
like.\4\
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\4\ The rule also excludes statutory disqualifications that were
previously disclosed to the Commission in a registration
application, if the Commission chose to permit registration
notwithstanding the disqualification. This exclusion is relevant
because a CPO may be registered with the CFTC with respect to
certain pools that it manages and claim a registration exemption
with respect to other pools.
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In addition to protecting customers from bad actors and
enhancing the integrity of the derivatives profession, this rule
also furthers the CFTC's strategic goal of ``being tough on those
who break the rules.'' \5\ No longer will financial wrongdoers be
able to use registration exemptions as a loophole to avoid the full
consequences of their actions. For these reasons, I am pleased we
are acting to finalize this rule.
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\5\ See Draft CFTC 2020-2024 Strategic Plan, 85 FR 29,935 (May
19, 2020), https://www.govinfo.gov/content/pkg/FR-2020-05-19/pdf/2020-10676.pdf.
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Finally, it is worth remembering that sound regulation of the
U.S. derivatives markets stems from a robust federal framework that
the CFTC primarily administers, complemented and strengthened by an
equally robust regime of self-regulation. A central pillar of that
regime is the National Futures Association (``NFA''), the main self-
regulatory organization for CPOs. NFA's strong support for this rule
is just one of countless actions that demonstrate their steadfast
commitment to the integrity of the derivatives community.\6\
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\6\ See NFA Comment Letter on Registration and Compliance
Requirements for Commodity Pool Operators and Commodity Trading
Advisors (Dec. 17, 2018).
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[[Page 40891]]
Appendix 3--Supporting Statement of Commissioner Brian Quintenz
I am pleased to support today's final rule amending the
procedures for certain commodity pool operators (CPOs) to claim an
exemption from registration.\1\ It is sound policy to prevent a firm
from claiming a registration exemption if the entity or its
principals are ``statutorily disqualified'' under section 8a(2) of
the Commodity Exchange Act, when the same disqualification would
prevent them from registering with the Commission. The
disqualification applicable under today's amendment covers some of
the most serious offenses under the Act, including fraud. While an
exempt CPO is more limited in its activities than a registered CPO,
for example, no pool has more than 15 participants \2\ or the CPO's
commodity interest activity must remain below certain initial margin
and notional amount thresholds,\3\ an exempt CPO still manages money
for the public. I therefore agree with today's amendment that the
firm should be held to one of the most fundamental customer
protection standards under the Commodity Exchange Act.
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\1\ Amended Commission regulation 4.13(b)(1)(iii) (17 CFR
4.13(b)(1)(iii)).
\2\ Commission regulation 4.13(a)(2).
\3\ Commission regulation 4.13(a)(3).
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I thank the Commission's staff for their work on this
rulemaking, in particular for their thoughtful responses to issues
that had been raised by commenters.
Appendix 4--Concurring Statement of Commissioner Rostin Behnam
I support today's adoption of a final rule (the ``Final Rule'')
requiring any person that files with the CFTC a notice claiming an
exemption from registration as a commodity pool operator (``CPO'')
under Regulation 4.13 of the Commodity Exchange Act (``CEA'' or the
``Act'') to affirmatively represent that neither the claimant nor
any of the CPO's principals has in its background any statutory
disqualifications listed in section 8a(2) of the CEA, which are
required to be disclosed as a part of a CPO registration application
with the Commission. Beyond closing a regulatory gap that allows
certain persons that would generally fail to meet the CEA's basic
conduct requirements to nevertheless claim an exemption from CPO
registration, the Final Rule invigorates the Commission's stance as
an active regulator with respect to the most diverse registration
category within our jurisdiction. As I have said before, CPOs (and
commodity trading advisors or ``CTAs'') are often identifiable by
variable organizational structures, investment focus, participation,
and solicitation, as well as complexity in how they are regulated
within our authority.\1\ These factors demand that when we act, we
do so with a laser focus on customer protections. I am pleased that
this Final Rule aggressively advances customer protection in a
tangible way.
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\1\ Rostin Behnam, Statement of Concurrence by CFTC Commissioner
Rostin Behnam: Amendments to Registration and Compliance
Requirements for Commodity Pool Operators and Commodity Trading
Advisors, Nov. 25, 2019, https://www.cftc.gov/PressRoom/SpeechesTestimony/behnamstatement112519.
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I believe it is fully within our statutory duty to provide, at
the very least, a foundational level of security on which customers,
regardless of their experience and aptitude, can rely when parsing
and considering what can seem like an endless amount of important
information and fine print. Today's Final Rule provides that footing
for exempt commodity pool participants by generally prohibiting
persons who have, or whose principals have, in their backgrounds any
of the statutory disqualifications listed in CEA section 8a(2)--
which are generally egregious, recent in time, and based upon a
previous finding or order by the Commission, a court, or another
governmental body--from soliciting and accepting funds for
participation in commodity pools, even if they are exempt.
I am pleased that the Final Rule and its preamble address the
significant number of responsive public comments, especially those
seeking clarity on process and procedure. Last fall, when the
Commission finalized several amendments to Part 4 of the regulations
addressing various registration and compliance requirements for CPOs
and CTAs, I commended, among other things, its decision to not move
forward at that time on the part of the proposal that led to today's
Final Rule.\2\ That decision has led to a more thoughtful
consideration of the comments received, the practicalities of the
proposal, and the Commission's need to fulfill its regulatory goals
while remaining true to the Act. To that end, I appreciate that the
Final Rule preserves the Commission's direct and delegated
authorities under CEA section 8a(2) and Regulation 4.12(a) to
ultimately evaluate fitness for registration--or exemption, as the
facts may dictate.
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\2\ Id.
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Appendix 5--Statement of Commissioner Dan M. Berkovitz
I support today's final rule to prohibit commodity pool
operators (``CPOs'') or their principals who are subject to
statutory disqualification under Section 8a(2) from claiming an
exemption from registration. This rule narrows a loophole in our CPO
registration framework and strengthens the Commission's regulations
to protect customers and market integrity.
Section 8a(2) of the Commodity Exchange Act (``CEA'') lists the
offenses for which the Commission may refuse, suspend, or condition
registration without a prior hearing. These offenses include major
violations of a number of laws and regulations governing financial
markets, including felony convictions for embezzlement, theft,
extortion, and fraud.\1\ Today's rule will ensure that persons who
are restricted under Section 8a(2) from operating in registered
activities cannot escape such restrictions by engaging in activities
that are exempt from registration.
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\1\ CEA Section 8a(2)(D)(iii).
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Although to a large degree this rule closes an existing loophole
in our regulations, it perpetuates a glaring deficiency by failing
to hold CPOs of family offices or their principals to the same
standards of conduct as other exempt CPOs. The risks to market
integrity presented by this omission are compounded by another
recent rulemaking exempting CPOs of family offices from a
requirement to notify the Commission if they claim an exemption from
registration.\2\ Thus, under this set of new rules completed today,
CPOs of family offices are exempt from registration, exempt from
providing notice that they are using an exemption, and exempt from
the statutory disqualifications that generally apply to all other
CPOs. This triad of exemptions for CPOs of family offices leaves the
Commission uniquely unaware of the activities and integrity of these
entities.
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\2\ Final Rule, Registration and Compliance Requirements for
Commodity Pool Operators (CPOs) and Commodity Trading Advisors:
Family Offices and Exempt CPOs, 84 FR 67355 (Dec. 10, 2019).
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As I noted in my dissent on the final rule that exempted CPOs of
family offices from notifying the Commission that they are claiming
an exemption, family offices today are not ``mom and pop''
operations that invest small sums in commodities, but rather large
and sophisticated asset management enterprises established by and
for mega-millionaires and billionaires.\3\ The Commission justified
these exemptions on the grounds that related family members in these
``sophisticated'' entities do not need the customer protections that
the CFTC otherwise applies to CPO activities. However, regardless of
whether this assessment is accurate, customer protection is just one
of several objectives of the Commission's CPO regulations. The
regulation of CPOs facilitates the Commission's oversight of the
derivative markets, management of systemic risks, and mandate to
ensure safe trading practices.\4\ There is no basis to conclude that
the activities of large family office CPOs pose less of a concern in
these areas than the activities of other exempt or non-exempt CPOs.
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\3\ Dissenting Statement of Commissioner Dan M. Berkovitz:
Rulemaking to Provide Exemptive Relief for Family Office CPOs:
Customer Protection Should be More Important than Relief for
Billionaires, available at https://www.cftc.gov/PressRoom/SpeechesTestimony/berkovitzstatement112519.
\4\ See, e.g., Commodity Pool Operators and Commodity Trading
Advisors: Compliance Obligations, 77 FR 11252, 11253, 11275 (Feb.
24, 2012); upheld in Investment Company Institute v. CFTC, 720 F.3d
370 (D.C. Cir. 2013). In Section 4l of the CEA, Congress declared,
``the activities of commodity trading advisors and commodity pool
operators are affected with a national interest in that, among other
things . . . their operations are directed toward and cause the
purchase and sale of commodities for future delivery . . . and the
foregoing transactions occur in such volume as to affect
substantially transactions in contract markets.'' 7 U.S.C. 6l.
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The regulatory principle here is straightforward. We are not
only responsible for monitoring market participants that pose risk
to customers, but also those who pose risk to the integrity of our
markets. Individuals who commit felonies or other serious violations
affecting the integrity of financial markets should not be permitted
to trade in CFTC markets, particularly without at least some
supervision and oversight. If a
[[Page 40892]]
CPO of a family office or one of its principals has engaged in
conduct serious enough to be subject to the disqualification
provisions of Section 8a(2), such as fraud or misappropriation, then
it should seek registration with the Commission and be subject to
our oversight.
However, I am pleased that at my request, the CFTC staff will be
making a special call to CPOs of family offices to determine how
many, if any, are subject to statutory disqualification under
Section 8a(2). The Commission currently has no information in this
regard. I have consistently supported basing our regulatory
decisions on the best available data. The data we will obtain from
this special call will inform our judgment about whether further
action is necessary to protect customers and the market.
I also am pleased that the Commission has declined to exclude
registered investment advisers from the scope of this rule. The
Securities and Exchange Commission has a different statutory
disqualification regime. Registrants should abide by CFTC rules when
they operate in our markets.
Going forward, the Commission should propose similar
restrictions on the claiming of exemptions by statutorily
disqualified commodity trading advisors. While this rule narrows one
of the gaps in our Part 4 regulatory framework, this additional
significant gap remains and should be closed.
I would like to thank the staff of the Division of Swap Dealer
and Intermediary Oversight for working with my office to incorporate
some of our comments and proposed revisions to this rule. As a
matter of course, a collaborative rulemaking process that takes into
account the input from all five Commissioners will produce better
regulations.
[FR Doc. 2020-12607 Filed 7-7-20; 8:45 am]
BILLING CODE 6351-01-P