In an October 15th letter, the CFTC’s Division of Swap Dealer and Intermediary Oversight (“DSIO”) issued self-executing no-action relief that allows a person to not register as a commodity pool operator (“CPO”), if that person (the “Delegating CPO”) delegates certain of their responsibilities as a CPO of a commodity pool to another person who is registered as a CPO (the “Designated CPO”) under applicable requirements of the Commodity Exchange Act (“CEA”).  The letter, which replaces CFTC Staff Letter No 14-69, will be of primary interest to the investment management community, since the letter allows the CPO of a private fund (such as the corporate general partner of a “hedge fund” organized as a limited partnership) to avoid CPO registration, if the following conditions are met.

1) Investment Management Authority Must Be Delegated Pursuant to Legally Binding Document 

There must be a legally binding document by which the Delegating CPO delegates to the Designated CPO all of the investment management authority with respect to the particular pool at issue.  The DSIO clarified that this condition will be satisfied, even if:

(i) a third-party investment manager is appointed by a Delegating CPO or the Designated CPO; and

(ii) that third-party manager is registered as a commodity trading advisor (“CTA”) or exempt from CTA registration pursuant to the CEA or the CFTC’s rules.

The letter specifically stated that legally binding document can take any number of forms, such as: a separate delegation agreement; the pool’s organizational document (for example, the limited partnership or limited liability company agreement); or an investment management agreement between the two CPOs.

2) No Solicitation by the Delegating CPO, Unless In Capacity As Registered or Exempt AP of Designated CPO

The Delegating CPO may not participate in the solicitation of participants for the pool, unless:

i) the CPO participates in such solicitation in its capacity as an associated person (“AP”) of the Designated CPO; and

ii) is either registered as an AP or exempt from AP registration pursuant to the CEA or CFTC Rules.

3) Delegating CPO May Not Manage Pool Property, Unless In Capacity As Principal / Employee of Designated CPO or CTA

The Delegating CPO may not, in its capacity as such, manage pool property.  However, that CPO can have management responsibilities over pool property, as long as:

(i)  the Delegating CPO is a principal or employee of the Designated CPO or of a CTA of the pool at issue and is exercising these management responsibilities in that capacity; and

(ii) is subject to supervision as a principal or an employee by either the Designated CPO or a CTA of the pool in accordance with a CFTC customer protection rule that establishes supervisory responsibilities of any CFTC registrant (CFTC Rule 166.3).

The DSIO expressly stated that management of pool property does not include responsibilities with respect to pool property of an administrative, clerical or ministerial nature.

4) Designated CPO Must Be Registered

The Designated CPO must be registered under the CEA as a CPO.

5) Delegating CPO Must Not Be Subject to Statutory Disqualification

The Delegating CPO must not be subject to any of the conditions described in Sections 8a(2) and 8a(3) of the CEA that would prevent the CPO from being eligible to register under the CEA as a CPO.

6) Valid Business Purpose for Separate Entity Status of Designated CPO

There must be a business purpose, other than allowing the Delegating CPO to avoid registration under the CEA, in support of the status of the Designated CPO as an entity separate from the Delegating CPO.

7) Designated CPO Must Maintain Books and Records of Delegating CPO With Respect to Pool

The Designated CPO must maintain the books and records of the Delegating CPO with respect to the commodity pool.

8) Commonly Controlled CPOs (Only Applies Where Both CPOs Are Entities)

If the Delegating and Designated CPOs are each a non-natural person (i.e., both are entities), then one such CPO must control, be controlled by, or be under common control with the other CPO.

9) Legally Binding Agreement Must Provide for Joint and Several Liability for Violation of CEA

The Delegating CPO and the Designated CPO must execute a legally binding document whereby each undertakes to  be jointly and severally liable for any violation of the CEA or the CFTC’s rules by the other in connection with the operation of the pool.  This requirement applies if the Delegating CPO is either:

i) an entity; or

ii) the Delegating CPO is a natural person and is not an Unaffiliated Board Member.

As used in Letter 14-126, the term “Unaffiliated Board Member” means a natural person who is a voting member of the pool’s board of directors (or other equivalent governing body) and who meets all of following conditions.

1) The person must not be a member of the management or an employee of the Designated CPO or any affiliate of that CPO.

2) The person must not be a substantial beneficial owner of: the Designated CPO or any affiliate of that CPO; or of any company holding more than five percent of such Designated CPO’s beneficial ownership interests or any affiliate of such company.

3) The person must have no other interest or relationship that could interfere with his or her ability to act independently of management of: the Designated CPO or any affiliate of that CPO; or of any company holding more than five percent of such Designated CPO’s beneficial ownership interests or any affiliate of such company.  (Note Re: Director Independence – The DSIO indicated that, for purposes of this condition,  the independence of a director will be a facts and circumstances based analysis. The following examples were provided of interests or relationships that were indicative of an affiliation with the Designated CPO that would interfere with the director’s independence: i) the director is a material service provider or investment counterparty to a Designated CPO or any of its affiliates; ii) the director is, or within the past three years was, employed in an executive capacity by, or was a principal or employee of, a material services provider or investment counterparty to, the Designated CPO or any of its affiliates.)

10) Delegating CPO Who Is An Unaffiliated Board Member Must Remain Fully Responsible As a Board Member

If a Delegating CPO is an Unaffiliated Board Member, then that individual must remain fully responsible as a board member in accordance with the laws under which the commodity pool is established.

As noted earlier, the relief afforded by CFTC Letter 14-126 is self-executing.  CFTC Letter 14-126 is available here.

Good morning.  Good claiming, if you can. DR2