Client Update

CFTC Rescinds CPO Registration Exemption Relied on by Many Fund Managers and General Partners of Qualified Purchaser/ 3(c)(7) Funds

Various Swaps to be Treated as Commodity Interests, Which May Impact CPO/CTA Registration and Exemption Status of Certain Fund Managers

Investment advisers to private funds should note that the Commodity Futures Trading Commission (the “CFTC”) has rescinded CFTC Rule 4.13(a)(4),1 which provided an exemption from registration as a commodity pool operator (“CPO”)2 that has in recent years been relied upon by many investment advisers to private funds that invest in “commodity interests.”3 An investment adviser that has been relying on Rule 4.13(a)(4) for exemption from CPO registration must register with the CFTC by December 31, 2012 unless another registration exemption is available. In addition, investment advisers to private funds should note that most swaps (as broadly defined in the Commodity Exchange Act) that are not based upon a single security, single loan or issuer, or narrow-based security index will soon be included within the definition of “commodity interest” for purposes of the Commodity Exchange Act and CFTC rules. As a result, the investment adviser and general partner of any private fund (including hedge fund or private equity fund) that invests in such contracts will be required to either register with the CFTC or qualify for an exemption from registration. The effective date of the relevant amendments to the Commodity Exchange Act is October 12, 2012. The CFTC has indicated that such contracts will not be included for purposes of calculating commodity interest exposure in connection with the Rule 4.13(a)(3) exemption (described in this Client Update) until December 31, 2012.

1 References herein to rules are to CFTC rules adopted under the Commodity Exchange Act, as amended, unless otherwise indicated. 2 A “commodity pool operator” is a person who engages in a business that meets the definition of a commodity pool (generally an enterprise operated for the purposes of trading in commodity interests) and who, in connection therewith, solicits, accepts or receives from others, funds, securities or property for the purpose of trading in commodity interests. 3 The term “commodity interest” currently includes futures, options on futures and retail forex. As discussed in this Client Alert, effective October 12, 2012, the term will also include all swaps that are not “security-based swaps” (e.g., the term will include swaps on interest rates, currencies, commodities and broad-based indices, but will not include total return swaps on single securities or credit default swaps on individual entities or on single obligations of individual entities). For purposes of certain calculations of commodity interest exposure, swaps will be not be included until December 31, 2012.

FINN DIXON & HERLING LLP Ÿ 177 BROAD STREET, 15TH FLOOR, STAMFORD, CT 06901-2048 Ÿ T 203.325.5000 Ÿ F 203.325.5001 Ÿ WWW.FDH.COM Since the CFTC issued its initial release regarding the rescission of Rule 4.13(a)(4),4 the CFTC’s Division of Swap Dealer and Intermediary Oversight has also provided no-action relief regarding certain transition issues (the “No-Action Letter”)5 and published responses to frequently asked questions regarding registration, exemption and transition matters (the “FAQ”).6 The CFTC has also amended existing rules to require the filing of annual notices by firms relying on the remaining registration exemptions, including the exemption provided by CFTC Rule 4.13(a)(3) (discussed below). Rescission of Rule 4.13(a)(4)

Many investment advisers and general partners of private funds that invest in commodity interests have until now relied on Rule 4.13(a)(4) for exemption from CPO registration with the CFTC. Rule 4.13(a)(4) exempts from registration CPOs of private funds of which all investors are “qualified eligible persons” as defined in CFTC Rule 4.7. The term “qualified eligible person” includes all “qualified purchasers” (as such term is defined in the Investment Company Act of 1940, as amended (the “Investment Company Act”)). As a result, the Rule 4.13(a)(4) exemption has commonly been relied upon by many investment advisers and general partners of private funds that are offered solely to “qualified purchasers” (referred to as “qualified purchaser funds” or “Section 3(c)(7) funds”).

The CFTC’s rescission of Rule 4.13(a)(4) became effective on April 24, 2012, but CPOs relying on the rule with respect to private funds existing on April 24, 2012, and private funds created on or after July 10, 2012,7 have until December 31, 2012 to either register with the CFTC (and become members of the National Futures Association (“NFA”)) or switch to reliance on another registration exemption, if one is available.

Treatment of “Swaps” as Commodity Interests

Title VII of the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (the “Dodd-Frank Act”) substantially amended the Commodity Exchange Act to include, among other things, detailed statutory definitions of the terms “swaps” and “security-based swaps” (the products that are included in such terms are commonly referred to as “Title VII Instruments”). Recently, the CFTC and the Securities and Exchange Commission (the “SEC”) jointly adopted final rules that provide guidance regarding how Title VII Instruments will be treated for both CFTC and SEC regulatory purposes.8 Generally speaking, “swaps”

4 See Commodity Pool Operators and Commodity Trading Advisors: Amendments to Compliance Obligations, CFTC RIN 3038-AD30, http://www.cftc.gov/ucm/groups/public/@newsroom/documents/file/federalregister020912b.pdf, 5 See Request for No-Action Relief from Rescission of Regulation 4.13(a)(4) and Amendments to Regulation 4.5, http://www.cftc.gov/ucm/groups/public/@lrlettergeneral/documents/letter/12-03.pdf. 6 See Division of Swap Dealer and Intermediary Oversight Responds to Frequently Asked Questions – CPO/CTA: Amendments to Compliance Obligations, http://www.cftc.gov/ucm/groups/public/@newsroom/documents/file/faq_cpocta.pdf. 7 CPOs are subject to additional requirements with respect to private funds created between July 10, 2012 and December 31, 2012, pursuant to the No-Action Letter). 8 See “Further Definition of ‘Swap,’ ‘Security-Based Swap,’ and ‘Security-Based Swap

Client Bulletin Page 2 will be regulated by the CFTC pursuant to the Commodity Exchange Act, and “security- based swaps” will be regulated by the SEC pursuant to the federal securities laws.9 The term “swaps” includes a broad range of instruments including, without limitation, swaps on interest rates, currencies, commodities and “broad-based security indices.” The specifics of the definitions, the guidance provided by the final rules, and the various regulatory implications for fund managers (and other investment advisers), are beyond the scope of this Client Update.

The effective date of the amendments to the Commodity Exchange Act that will cause Title VII Instruments that fall within the definition of “swaps” to be “commodity interests” is October 12, 2012. Fund managers of funds that trade even one such swap contract and that are not currently required to be exempt from CPO/CTA registration because such contracts are not presently defined as commodity interests must file an exemption notice by October 12, 2012 in order to rely upon the Rule 4.13(a)(3) exemption from CPO registration described below.

The effective date of the inclusion of swaps as commodity interests for purposes of calculating Rule 4.13(a)(3) commodity interest exposures is December 31, 2012. CPOs that will not be able to satisfy the requirements of Rule 4.13(a)(3) after such date are required to be registered by such date.

The members of our Investment Management practice group are available to discuss the specifics of the Dodd-Frank Act and the CFTC/SEC joint rule release, as well as the types of investment products that are considered to be Title VII Instruments (specifically, “swaps” vs. “security-based swaps”).

Rule 4.13(a)(3)

Eligibility. CPOs that currently rely on Rule 4.13(a)(4) and fund managers that are CPOs based upon the inclusion of swaps as commodity interests may be able to rely on Rule 4.13(a)(3) for exemption from CPO registration. Rule 4.13(a)(3) exempts CPOs from registration with respect to private funds that engage in a de minimis amount of commodity interest investing. Specifically, in order for the CPO of a private fund to rely on the Rule 4.13(a)(3) exemption, the fund must:

· limit initial margin, premiums and required minimum security deposits to 5% of the liquidation value of the fund’s portfolio, or

· limit the aggregate net notional value of the fund’s commodity interest positions to 100% of the liquidation value of the fund’s portfolio,

Agreement’; Mixed Swaps; Security-Based Swap Agreement Recordkeeping,” CFTC RIN 3038-AD46, SEC Release No. 33-9338; 34-67453; File No. S7-16-11, http://www.cftc.gov/ucm/groups/public/@newsroom/documents/file/federalregister071012c.pdf 9 Title VII Instruments that have characteristics of both swaps and security-based swaps will be regulated jointly by the CFTC and the SEC.

Client Bulletin Page 3 in each case determined at the time the most recent commodity interest position was established. Note that there are additional criteria that must be satisfied for a CPO to rely on Rule 4.13(a)(3) with respect to a fund.10 A CPO wishing to rely on Rule 4.13(a)(3) must make an electronic notice filing with the NFA in advance of such reliance.

Funds of funds. For CPOs of funds of funds, application of the de minimis tests for compliance with Rule 4.13(a)(3) is somewhat more complicated. The CFTC previously provided guidance on how CPOs of funds of funds may rely on Rule 4.13(a)(3) in an appendix to Part 4 of the CFTC rules. The CFTC removed the text of the appendix as part of its new rulemaking, but indicated in the FAQ that CPOs may continue to rely on the appendix until the CFTC provides revised guidance. In general terms, the appendix provides that in order for a CPO of a fund of funds to rely on Rule 4.13(a)(3), one of the following criteria must be satisfied with respect to the fund of funds, the CPO must:

· know that the aggregate commodity interest positions of the funds in which the fund of funds has invested satisfy the de minimis test on a look-through basis; or

· allocate the fund of funds’ assets solely to funds that satisfy the Rule 4.13(a)(3) de minimis test; or

· allocate the fund of funds’ assets solely to funds whose CPOs are registered as such with the CFTC; or

· allocate no more than 50% of the fund of funds’ assets to funds that trade commodity interests.

Annual notices. As part of the rulemaking that rescinded Rule 4.13(a)(4), the CFTC revised the notice filing requirements for CPOs relying on Rule 4.13(a)(3) to require an initial notice of claim of exemption (as currently required) and, in addition, an annual re-affirmation of the claim of exemption within 60 days after each calendar year end. The filings are made electronically with the NFA.

Transitioning to Rule 4.13(a)(3). To transition from reliance upon Rule 4.13(a)(4) to reliance upon Rule 4.13(a)(3) with respect to a fund, a CPO must first submit a written request to the NFA to withdraw the exemption under Rule 4.13(a)(4). The NFA will then contact the CPO when the exemption has been withdrawn. After the withdrawal has been finalized, the CPO may file the new exemption notice under Rule 4.13(a)(3) electronically. The CPO must provide notice to fund investors of the change in exemption.

10 Additional criteria for the Rule 4.13(a)(3) exemption include: (i) all investors in the fund that are U.S. persons must be “accredited investors” (as such term is defined in SEC Regulation D adopted under the Securities Act of 1933, as amended), “knowledgeable employees” (as such term is defined in SEC Rule 3c-5 adopted under the Investment Company Act), or “qualified eligible persons” (as such term is defined in Rule 4.7; (ii) interests in the fund must be offered and sold without marketing to the public in the United States; and (iii) interests in the fund may not be marketed as or in a vehicle for trading in the commodity futures or commodity options markets.

Client Bulletin Page 4 Commodity Trading Advisers

The investment adviser to a commodity pool must register with the CFTC as a commodity trading adviser (“CTA”) unless it qualifies for an exemption from such registration. For many qualified purchaser funds organized as U.S. limited partnerships for which the general partner is a separate entity from the investment adviser, the general partner is deemed to be the CPO and has relied upon Rule 4.13(a)(4) for exemption from CPO registration, and the investment adviser has relied upon Rule 4.14(a)(8) for exemption from CTA registration. Rule 4.14(a)(8) previously exempted a CTA that directs its advice solely to pools for which the CPO is exempt from registration pursuant to Rule 4.13(a)(3) or Rule 4.13(a)(4) (or is registered as a CPO but would qualify for such exemption if not so registered). In light of the rescission of Rule 4.13(a)(4), advisers will no longer be able to rely on the Rule 4.14(a)(8) exemption with respect to a fund for which the CPO of such fund relied upon Rule 4.13(a)(4), unless the CPO transitions to reliance on Rule 4.13(a)(3) instead.

Advisers previously relying on Rule 4.14(a)(8) for whom such rule is no longer available may be able to rely on other exemptions from CTA registration, such as the exemption in Section 6m of the Commodity Exchange Act for SEC-registered investment advisers whose business does not consist primarily of acting as a CTA under Section 1a of the Commodity Exchange Act and who does not act as a CTA to any commodity pool that is engaged primarily in trading commodity interests.

An investment adviser to a private fund that also filed for exemption from registration as a CPO with respect to the fund (because it is also the general partner of the fund, or because the general partner and the investment adviser are both filing as co-CPOs) is able to rely on a self-executing exemption from CTA registration found in Rule 4.14(a)(5). Such an investment adviser will be able to continue to rely on the Rule 4.14(a)(5) exemption from CTA registration if it switches from reliance on Rule 4.13(a)(4) to Rule 4.13(a)(3) for exemption from CPO registration with respect to the fund.

Rule 4.7

A CPO that is required to register with the CFTC as a result of the rescission of Rule 4.13(a)(4) may be able to reduce the impact of such registration by relying on Rule 4.7. Rule 4.7 provides registered CPOs and CTAs with relief from certain disclosure, recordkeeping and reporting requirements.

In order for a CPO or CTA to be eligible for Rule 4.7 relief with respect to a particular private fund, each investor in the fund must be a “qualified eligible person” as defined in Rule 4.7 (in addition to any other separately applicable investor eligibility criteria). The definition of a “qualified eligible person” includes, among others, all persons that are “qualified purchasers” under the Investment Company Act, most (but not all) non-U.S. persons, and natural persons and certain entities that have investment portfolios worth at least $2 million. The FAQ provides that CPOs of Rule 4.13(a)(4) funds that transition to Rule 4.7 are not required to confirm that existing fund investors are qualified eligible persons.

Client Bulletin Page 5 In order to claim the Rule 4.7 exemption, a registered CPO or CTA must make a notice filing with the NFA and update the filing annually. CPOs and CTAs relying on the Rule 4.7 exemption with respect to one or more private funds or other clients remain subject to limited disclosure, periodic filing, recordkeeping and other compliance requirements delineated in Rule 4.7.

The Registration Process and the Series 3 Examination

Registration as a CPO can take up to three months. One significant difference from SEC investment adviser registration is the requirement that firm personnel who are “principals” or “associated persons” of the CPO become individually licensed with the NFA.

· The term “principal” includes the founders and principal officers or general partners of a CPO, as well as 10% or greater owners.

· The term “associated person” means an individual who solicits orders, customers or customer funds, or who supervises persons so engaged, on behalf of a CPO. The registration requirements apply to any person in the supervisory chain-of-command and not only to persons who directly supervise the solicitations of orders, customers or funds.

Generally, all associated persons of a CPO or CTA must pass the NFA Series 3 exam, unless granted a waiver.11 The NFA has recently proposed to exempt an associated person from the requirement to pass the Series 3 exam if the only activity of the private funds for which the associated person is soliciting that would require registration by the CPO of the private funds is the trading of swaps. This change is subject to CFTC approval, which has not yet been granted.

The NFA has also recently proposed changes to NFA Bylaw 301 to require that all CPOs and CTAs that engage in activities involving swaps subject to the jurisdiction of the CFTC must be approved as “swaps firms” by the NFA, and their associated persons must be approved as “swaps associated persons” by the NFA. Application for these designations would be made electronically. These changes are also subject to CFTC approval, which has not yet been granted.

All registered CPOs must also be members of the NFA. The application forms for registration as a CPO or CTA include a section regarding NFA membership.

The registration process includes the following actions:

11 Waivers may be available where the relevant private funds causing a firm to be required to register as a CPO engage principally in securities transactions, only use commodity interest transactions for hedging or risk management purposes and satisfy certain other criteria. (See NFA Registration Rule 402 and NFA Interpretive Notice 9018.) The NFA has proposed to also grant waivers for the associated persons of a CPO when the CPO would be eligible to rely on the Rule 4.13(a)(3) exemption from CPO registration but for the trading of swaps in its private funds (i.e., its non-swap commodity interests positions would satisfy the Rule 4.13(a)(3) limits). (See NFA Registration Rules 401 and 402 and NFA Interpretive Notice 9018.)

Client Bulletin Page 6 · Filing registration forms via the NFA’s online registration system (Form 7-R for the firm and Form 8-R for each principal and associated person);

· Payment of applicable filing fees;

· Submission of NFA fingerprint cards for each principal and associated person; and

· Submission of proof of satisfaction of specified proficiency requirements (e.g., the Series 3 exam) by, or granting of waiver to, each associated person.

Action Needed by Investment Advisers

Investment advisers and general partners to private investment funds that trade commodity interests should determine whether they currently rely on the Rule 4.13(a)(4) exemption with respect to such funds.

Investment advisers that are relying on Rule 4.13(a)(4) should determine whether the commodity interest investments of the relevant funds are sufficiently de minimis for the adviser to rely on Rule 4.13(a)(3), as described above, and if the trading strategy of the funds will permit continued adherence to the de minimis limits.12 If not, the adviser must have completed the registration process with the CFTC by December 31, 2012.

We recommend that any party looking to become registered with the CFTC by December 31, 2012 file its registration request as soon as possible, since, as noted above, the CFTC processing time (which includes background checks of principals and associated persons) can take up to three months.

Investment advisers and general partners to private investment funds that invest in swaps and are not currently registered as CPOs or CTAs, or exempt from such registration, should, in the case of CPOs, file a notice to rely on Rule 4.13(a)(3) by October 12, 2012 and, if they expect to be required to register with the CFTC on December 31, 2012, file a registration request as soon as possible. * * * * * *

The foregoing provides only a limited overview of the CFTC’s recent rulemaking and guidance, focusing on the impact of the rescission of Rule 4.13(a)(4) and the inclusion of various swaps as commodity interests on investment advisers to private funds.

If you have questions concerning the matters discussed above, or about other CFTC rulemaking not discussed above, please contact one of the attorneys referenced below.

· Erik A. Bergman, Investment Management, 203-325-5026 or [email protected]

· Matthew S. Eisenberg, Investment Management, 203-325-5084 or [email protected]

12 Note that the Rule 4.13(a)(3) limits must be satisfied at the time that each commodity interest position is established.

Client Bulletin Page 7 · Harold B. Finn III, Investment Management, 203-325-5029 or [email protected]

· Richard D. Kilbride, Investment Management, 203-325-5075 or [email protected] Finn Dixon & Herling LLP is a law firm with extensive experience providing corporate, transactional, investment management, securities, tax, executive compensation, bankruptcy and litigation counsel. Our clients include large and small corporations, venture capital and private equity firms, financial institutions, hedge funds and other investment funds, investment advisers, broker-dealers, public and private businesses, executives, management teams and entrepreneurs. Copyright © 2012 Finn Dixon & Herling LLP. All Rights Reserved. These materials are intended to inform our clients and friends about developments in the law. They are not intended to constitute a legal opinion or advice or to address any client’s legal problems or specific situations. The format of these materials, and the complex nature of the subject matter, required the making of general statements that summarize an extremely complex body of law and that may be incomplete in some respects. In addition, these materials speak as of the version date set forth below and may not reflect subsequent developments in the law or interpretations thereof. Accordingly, the reader is cautioned against using any of this material in specific situations without obtaining the advice of competent counsel. In light of the foregoing, and the general nature of these materials, these materials should not be regarded, or relied upon, as legal advice.

Version: October 1, 2012 {1389935}

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