Cftc Eliminates Registration Exemption Used by Many Hedge Fund Managers

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CLIENT MEMORANDUM

CFTC ELIMINATES REGISTRATION EXEMPTION USED BY MANY HEDGE FUND MANAGERS

The Commodity Futures Trading Commission eliminated a widely used exemption from commodity pool operator (“CPO”) registration on February 9, 2012. Since 2003, in connection with offerings to sophisticated investors, many hedge fund managers have relied on CFTC Rule 4.13(a)(4) to avoid CPO registration. The practical effect of the change is that sponsors of many hedge funds will have to register with the CFTC as CPOs and become subject to some, but probably not all, of the CFTC’s disclosure, reporting and recordkeeping requirements.1 As part of the registration process, the principals and certain employees of the CPO will need to submit fingerprint cards and may be required to pass the Series 3 or another proficiency examination.

The CFTC has retained the de minimis registration exemption in Rule 4.13(a)(3).

CPOs currently relying on Rule 4.13(a)(4) with respect to any pool may continue to do so until December 31, 2012. CPOs may claim relief under Rule 4.13(a)(4) with respect to any other pool until 60 days after the final rule is published in the Federal Register (the “Effective Date”), and may continue to rely on such exemption until December 31, 2012. No CPO may claim exemptive relief under Rule 4.13(a)(4) with respect to any pool after the Effective Date.

The CFTC has also adopted an annual confirmation requirement for certain exclusions and exemptions relied upon by CPOs.

Rule 4.13(a)(3) Survives

Some CPOs will still be exempt from registration with the CFTC. The CFTC has retained the CPO registration exemption in Rule 4.13(a)(3). Generally, that rule exempts from registration the operator of a pool (i) sold to accredited investors, (ii) that trades only a de minimis amount of futures (and soon, swaps), and (iii) that is not marketed as a vehicle for trading in futures (and soon, swaps). As currently in effect, trading in a 4.13(a)(3) fund must be limited so that at all times either (a) the required initial margin and premiums for futures do not exceed

1 Registered CPOs generally have to comply with CFTC and NFA disclosure, reporting, recordkeeping and pool audit requirements, including, among others, (1) filing with the NFA a disclosure document for the pool that complies with CFTC rules or qualifying for an exemption from such filing, (2) updating the pool’s document every nine months, or sooner in the event of a material amendment, (3) delivering periodic statements to investors, (4) delivering annual reports (prepared in accordance with GAAP and certified by an independent public accountant) to investors and filing such reports with the NFA, (5) maintaining certain books and records, and (6) conforming the CPO’s compliance policies and procedures to CFTC and NFA rules. Registered CPOs that claim relief under CFTC Rule 4.7 will be exempt from complying with nearly all of the disclosure and most of the reporting and recordkeeping requirements listed above.

NEW YORK WASHINGTON PARIS LONDON MILAN ROME FRANKFURT BRUSSELS in alliance with Dickson Minto W.S., London and Edinburgh

5%2 of the pool’s liquidation value, or (b) the aggregate net notional value of the pool’s futures does not exceed 100% of the pool’s liquidation value.

Rule 4.13(a)(4) Rescinded

National Futures Association (“NFA”) supported retaining Rule 4.13(a)(3) on the grounds that regulatory resources should be focused on vehicles where trading commodity interests is more than de minimis. The CFTC agreed. The CFTC was not, however, persuaded by comments in opposition to the rescission of Rule 4.13(a)(4). The CFTC determined that because Rule 4.13(a)(4) permitted the trading of an unlimited amount of commodity interests, the rescission of the exemption was necessary to ensure adequate customer protection and market oversight. The CFTC also declined requests to provide at this time automatic exemptive relief to family offices, operators of funds of funds and non-U.S. CPOs.

The Registration Process

Unless a CPO qualifies for another exemption, it will have to register with the CFTC. 3 Registration is effected through the NFA Online Registration System. Among other things, the CPO must (i) file an application and pay a registration fee and NFA membership dues for the CPO and (ii) file applications and fingerprint cards for the CPO’s principals and associated persons. In addition, associated persons must satisfy certain proficiency requirements (the Series 3 or certain other exams).

Relief Available for Registered CPOs CPOs that wish to continue trading futures and swaps, and thus, are required to register, may be able to rely on exemptions from certain specific rules otherwise applicable to CFTC registrants. For example, CFTC Rule 4.7 provides relief from nearly all of the disclosure and most of the reporting and recordkeeping requirements otherwise applicable to a registered CPO with respect to a fund that is offered only to “qualified eligible persons” (“QEPs”). QEPs include “qualified purchasers” as defined in the Investment Company Act of 1940, as amended, and certain non- United States persons as defined in CFTC Rule 4.7.

2 When swaps are included in this 5% threshold, fewer CPOs may be able to rely on Rule 4.13(a)(3). While the Dodd-Frank Wall Street Reform and Consumer Protection Act introduced a definition of the term “swap” into the Commodity Exchange Act, it also directed the CFTC to further define the term. As of the date of this memorandum, the CFTC has not adopted a final definition of swap. In the adopting release, the CFTC stated that it may consider increasing the 5% limit in the future after the CFTC has collected data from registered CPOs through new Form CPO-PQR. 3 It is important to note that NFA Bylaw 1101 prohibits NFA members from doing business with non-members who are required to be registered with the CFTC but are not. Thus, the CPO of a fund of funds should expect to have to demonstrate to the CPO of any investee fund that it is in compliance with CFTC registration requirements. Similarly, a CPO should expect to have to provide proof of its registration status to any futures commission merchant prior to opening a futures (and soon, swaps) trading account for any of its funds.

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In addition, CFTC Advisory 18-96 generally permits registered CPOs to claim exemption from otherwise applicable disclosure, reporting and recordkeeping requirements with respect to pools offered only to non-U.S. persons. Annual Confirmation Requirements

The final rule also requires any CPO that has filed a notice of exemption or exclusion to confirm such exemption or exclusion, as applicable, within 60 days of the end of each calendar year.4 Failure to comply with the annual affirmation requirement will be treated as a request to withdraw the exemption.

* * * * * * * * * * * * * If you have any questions concerning the foregoing or would like additional information, please contact Rita Molesworth (212-728-8727, [email protected]), Deborah A. Tuchman (212-728-8491, [email protected]), Gabriel Acri (212-728-8833, [email protected]), Jonathan Burwick (212-728-8108, [email protected]), James Lippert (212-728-8945, [email protected]), or the Willkie attorney with whom you regularly work. Willkie Farr & Gallagher LLP is headquartered at 787 Seventh Avenue, New York, NY 10019- 6099 and has an office located at 1875 K Street, NW, Washington, D.C. 20006-1238. Our New York telephone number is (212) 728-8000 and our facsimile number is (212) 728-8111. Our Washington, D.C. telephone number is (202) 303-1000 and our facsimile number is (202) 303- 2000. Our website is located at www.willkie.com. February 13, 2012

All Rights Reserved. This memorandum may not be reproduced or disseminated in any form without the express permission of Willkie Farr & Gallagher LLP. This memorandum is provided for news and information purposes only and does not constitute legal advice or an invitation to an attorney-client relationship. While every effort has been made to ensure the accuracy of the information contained herein, Willkie Farr & Gallagher LLP does not guarantee such accuracy and cannot be held liable for any errors in or any reliance upon this information. Under New York’s Code of Professional Responsibility, this material may constitute attorney advertising. Prior results do not guarantee a similar outcome.

4 The proposed rules would have required an exempt CPO to affirm its exemption within 30 days of the anniversary date of the initial claim for exemptive relief. The release accompanying the final rules, however, stated that an exempt CPO will have 60 days from the calendar year-end to affirm its exemption. Nevertheless, the final rules seem to indicate that a CPO must affirm within 30 days of the calendar year-end. Presumably, this is a technical error that will be corrected in the Federal Register to reflect the 60 days discussed in the adopting release.

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