CFTC Finalizes Rule 4.7 Amendments, Defers Key Disclosure Requirements

The Commodity Futures Trading Commission (Commission or CFTC) announced final rule amendments on September 12, 2024, that update the Portfolio Requirement (defined below) that certain investors and account participants must meet for registered CPOs of private funds and registered CTAs to treat them as sophisticated investors and clients for purposes of CFTC Rule 4.7.¹ The Commission also codified exemptive relief that it had been granting to CPOs of funds-of-funds with regard to the time period in which they have to distribute periodic account statements to participants. The codification of the funds-of-funds account statement relief will become available on November 25, 2024. The increased Portfolio Requirement thresholds will go into effect on March 26, 2025.²

The Commission determined not to finalize new disclosure requirements for CPOs and CTAs relying on CFTC Rule 4.7 that it had proposed at the same time as the other amendments, opting instead to continue to consider the “concerns articulated” by commenters on that portion of the proposal and the alternative approaches commenters had offered.

CPOs and CTAs operating private funds and exempt accounts in reliance on CFTC Rule 4.7 will likely need to update their disclosure documents and subscription agreements to reflect references to the updated Portfolio Requirement, and will be prohibited from taking additional pool investments and opening new exempt accounts for persons and entities that do not meet the amended standard under the regulation. CPOs of fund-of-funds wishing to take advantage of the new periodic statement distribution requirement will also need to update their disclosure documents. However, these rule amendments will be significantly less disruptive than the full set of amendments to CFTC Rule 4.7 the Commission had originally proposed in October 2023.³

Dechert LLP along with six industry associations and the National Futures Association (NFA) filed comment letters in response to the CFTC’s October 2023 proposed rulemaking.⁴

Background on CFTC Rule 4.7

Adopted in 1992, CFTC Rule 4.7 provides exemptions from certain Part 4 compliance requirements regarding disclosure, periodic reporting and recordkeeping for registered CPOs and CTAs whose pool participants and/or advisory services are restricted to individuals and entities that qualify as qualified eligible persons (QEPs). The definition of QEP has two “classes.” Under CFTC Rule 4.7(a)(2), the first class includes investors and clients that do not need to satisfy the Portfolio Requirement to qualify as QEPs (i.e., “qualified purchasers,” “knowledgeable employees” and “non-United States persons”). Under CFTC Rule 4.7(a)(3), a second class of investors and clients includes registered investment companies, business development companies, banks and savings and loan associations trading for their own accounts, insurance companies, state pension plans, ERISA plans, non-profits, operating companies and individuals who are accredited investors, among others, which must meet the Portfolio Requirement to qualify as QEPs.⁵

A registered CPO that has claimed the CFTC Rule 4.7(b) exemption by filing an electronic notice with the NFA with regard to the operation of a private fund restricted to QEP participants currently is subject to only two disclosure requirements under the operational exemption: (i) it must include all disclosures necessary to make the information contained therein not misleading, and (ii) it must include a prescribed disclaimer on the front page of the offering memorandum for the fund, or if no offering memorandum is provided, the disclaimer must appear immediately above the signature line on the investor’s subscription agreement. So long as these conditions are met, the CPO is currently exempt from the CFTC Part 4 retail commodity pool disclosure requirements that encompass: (1) the requirement to deliver a disclosure document in CFTC Rule 4.21; (2) the general disclosures required by CFTC Rule 4.24; (3) the performance disclosures required by CFTC Rule 4.25; and (4) the use and amendment requirements in CFTC Rule 4.26 (e.g., the requirement to keep the disclosure document up-to-date on a certain schedule).⁶ In fact, there is no requirement that the CPO provide prospective pool participants with a disclosure document at all; however, in practice, most do.

A registered CTA that has claimed the exemption at the firm level under CFTC 4.7(c) is currently not required to meet the following otherwise applicable CFTC Part 4 requirements with regard to CTA services provided to QEPs: (1) the requirement to deliver a disclosure document in CFTC Rule 4.31; (2) the general disclosures required by CFTC Rule 4.34; (3) the performance disclosures required by CFTC Rule 4.35; and (4) the use and amendment requirements in CFTC Rule 4.36. The CTA must provide a prescribed disclaimer on the cover page of any brochure or disclosure statement it chooses to distribute to its prospective advisory clients or near the signature line of the advisory agreement if the CTA chooses not to distribute a brochure or disclosure statement. The CTA is also subject to quarterly risk reporting about its registered CTA business on CFTC Form CTA-PR/NFA Form PR, but it is possible that a registered CTA operating under CFTC Rule 4.7 would not need to produce any disclosure document for its qualifying advisory clients nor is it required to provide periodic reports of any kind to advisory clients that are QEPs.

The Final Rule Amendments

The CFTC is increasing the two thresholds in the Portfolio Requirement under CFTC Rule 4.7(a)(1)(v) from $2 million to $4 million for the securities portfolio test, and from $200,000 to $400,000 for the initial margin and premium test. The ability to meet the Portfolio Requirement through a mix of the securities portfolio test and the initial margin and premiums test will remain available using the new threshold dollar amounts.

The changes are intended to reflect the effect of inflation since the Portfolio Requirement was adopted in 1992, as by various inflation index metrics the CFTC had determined that the value of each threshold has been halved in the last thirty years. Importantly, existing pool participants and exempt account clients that met the pre-amendment QEP definition at the time of their initial investment or exempt account opening but would not meet the new QEP standard when it goes into effect would not be required to be redeemed or have their exempt account terminated, but they would not be permitted to make additional pool investments or open new exempt accounts.

The CFTC is also granting commodity pools operated under CFTC Rule 4.7(b) that are funds-of-funds (i.e., pools that invest in one or more pools or funds operated by third parties) an extra 15 days for a total of 45 days to distribute their periodic participant account statements to pool participants so long as those statements are distributed on a monthly basis. Under CFTC Rule 4.7(b), CPOs may distribute quarterly participant account statements, but must do so within 30 days following fiscal quarter-end. Funds-of-funds often must wait for information from underlying pools and funds to prepare their own participant account statements. This change is intended to grant CPOs operating these types of pools under CFTC Rule 4.7 additional time to process information from underlying funds and pools, so long as they notify participants of the reporting schedule in the fund-of-funds’ offering memorandum. This rule amendment codifies exemptive relief that CPOs have until now had to seek on an individual basis, and that the CFTC staff has granted on a wide basis.

Finally, the CFTC is making technical amendments to CFTC Rule 4.7 to reorder its content and to other regulations including CFTC Rules 1.35, 3.10, 30.6, 43.6 and 75.10 that cross-reference amended CFTC Rule 4.7.

What Was Left Out of the Final Rulemaking

The item included in the Commission’s October 2023 proposal with the most significant potential impact on CPOs and CTAs was a proposed requirement that CPOs that operate private funds under the operational exemption in CFTC Rule 4.7(b) deliver to prospective pool participants disclosure documents containing many of the substantive disclosure that have historically only applied to “retail” commodity pools. The changes would have imposed a similar requirement for CTAs’ brochures provided to clients receiving CTA advice under CFTC Rule 4.7(c). These disclosures would have needed to cover information about a pool or advisory program’s trading strategies, principal risk factors, fees and expenses, associated conflicts of interest and past performance over certain time periods. In some instances, these new requirements would have been redundant with disclosures already required by regulation or investor expectations. In other instances, these new requirements would have entailed different disclosures than other regulators require of—in many cases—the same asset managers.⁷ All of the commenters opposed the proposed disclosure requirements, with some offering alternative solutions to meet the CFTC’s stated rationale for the changes. In the Final Rule Release, the CFTC stated that it is continuing to consider the concerns articulated by commenters on that portion of the proposed amendments and the alternative approaches offered by commenters; however, the Final Rule Release did not include a re-proposal of the disclosure requirements.