8112 Federal Register / Vol. 56, No. 39 / Wednesday, February 27, 1991 / Rules and Regulations

weighting would be 20% !4, but the
VAM, provided it were correctly stated,
would increase 10 percent '® from the
initial $1,000 to $1,100, thereby tracking
the change in the underlying portfolio.?®
Therefore, in order to compute a VAMI
which tracks the underlying portfolio, in
some cases the month's ROR may not be
used and, in such cases, a separate
computation must be made. ,

Distortions in VAMI may be
aggravated by compounding. For
example, if there were an overstatement
of $100 in the VAMI of December 1989
and the compounded annual ROR for
1990 were 80 percent, such $100
distortion from 1989 would increase to
$180 by December 1990. fone

VAMI is the most meaningful when
presented on an annual basis. The
Commission believes that most readers
of performance tables review past
performance in incremental periods, e.g.,
the past year, the year before last, etc.
For this reason the most meaningful
VAMI would be one which facilitates
such annual performance review, i.e.,
where the VAM1I is reset to the initial
amount annually. Therefore, for this
reason and for the additional advantage
of the mitigation of distortions, the
Commission strongly encourages the
annual resetting of VAMI to the initial
amount.

In view of the foregoing, the
Commission's policies respecting the
presentation and restatement of prior
period VAMIs are as follows:

(1) Periodic ROR may be used to
compute VAMI, provided no material
distortion results. However, if the
resulting VAMI would be misleading, an
alternative computation to achieve an
accurate VAMI, which is parallel to the
actual change in the portfolio due to -
profits and losses, must be made.

(2) Where there are material
distortions in the VAMI of the most
recent three years presented, such
‘VAMI must be recomputed and restated
for each year.

(3) Where VAMI for periods earlier
than the most recent three years
presented contains material distortions,
such distortions need not be corrected,

24 Time-weighting computation of ROR: 15 days
divided by 30 days=50 percent: 50 percent times
‘$100,000 = $50,000; $10,000 divided by $50,000=20
percent ROR for the month.

+* Computed by dividing the $10,000 by $100.00.

+# Example of Incorrect VAMI Computation:

ROR | VAMI | Computation
4,100 | (1,000 times
4.20=1,220).
1,440 | (1,200 times
1.20= 1,440).
1,656 | (1,440 times
1.15=1,656).

provided the VAM1 is reset to the initial
amount annually for all periods
presented.

(4) VAMI is a disclosure not required
by Commission regulations and,
therefore, need not be included in a
performance record.

TV. Application of the Advisory to
Historical Performance Records

Where prior period RORs otherwise
would be materially distorted,
registrants should amend the
performance tables and/or the footnotes
to the extent necessary to ensure that
the historical performance record used
in a current disclosure document is not
misleading.?7 In order to reduce the
burdens of full retroactive application of
this Advisory registrants should
consider the adequacy of: Limiting
restatements of prior periods to those
periods where distortions are likely to
be the most serious; making changes to
the VAMI presentation, such as
resetting to the initial amount annually,
as discussed above; providing additional
explanatory disclosures in the notes;
and whether any possible distortions
may be in reporting periods which are of
lesser concern, e.g. prior to the past
three years of performance which is
required by Commission rules.
Registrants who are concerned that their
performance tables as originally
presented may be considered misleading

" may request the views and guidance of

the Division of Trading and Markets
staff on a case-by-case basis.

Issued in Washington, DC on
February 21, 1991, by the Commission.
Lynn K. Gilbert,

Deputy Secretary of the Commission.
{FR Doc. 91-4519 Filed 2-26-91; 8:45 am]
BILLING CODE 6351-01-01


Federal Register / Vol. 56, No. 39 / Wednesday, February 27, 1991 / Rules and Regulations 8109

U.S. Department of Commerce, 14th
Street and Constitution Avenue, NW.,
room H4886, Washington, DC 20230.
Records in this facility, including written
public comments and memoranda
summarizing the substance of oral
communications, may be inspected and
copied in accordance with regulations -
published in part 4 of title 15 of the Code
of Federal Regulations. Information
about the inspection and copying of
records at the facility may be obtained
from Ms. Margaret Cornejo, the Bureau
of Export Administration Freedom of
Information Officer, at the above
address, or by calling 202/377-2593.

List of Subjects in 15 CFR Part 700

Administrative practice and
procedure, Business and industry,
Government contracts, National
defense, Reporting and recordkeeping
requirements, Strategic and critical
materials.

Accordingly, part 700 of the National
Security Industrial Base Regulations (15
CFR part 700) is amended as follows:

PART 700 [AMENDED]

1. The authority citation for part 700 is
revised to read as follows:

Authority: Secs. 101-103, 701-707, 709, and
713, Defense Production Act of 1950 (Pub. L
61-774, 64 Stat. 796,) as amended (50 U.S.C.
app. 2071-2073, 2151-2157, 2159, and 2163);
E.O. 10480, 3 CFR 1949-53 Comp. p. 962, as
amended; E.O. 12148, 8 CFR 1979 Comp. p.
412, as amended: Defense Mobilization Order
(DMO) 3, 44 CFR part 322; DMO-12, 44 CFR
part 329; DMO-13, 44 CFR part 330, 50 U.S.C.
486, 10 U.S.C. 4501 and 9501, 50 U.S.C. 82, and
Executive Order 12742 of January 8, 1991, 56
FR 1079.

2 Schedule I to part 700 is amended
by adding a new entry to read as
follows:

Schedule I to Part 700—Authorized Programs
and Delegate Agencies

vsorelcanon

Program

pipe ‘agency
C1___. Food resources... Department of
. . . Pelenee
Dated: February 19, 1991.
John A. Richards,
Deputy Assistant Secretory for Industrial
Resource Administration.

1FR Doc. 91-4276 Filed 2-26-81; 8:45 am}
BILLING CODE 3510-DT-

COMMODITY FUTURES TRADING
COMMISSION

17 CFR Part 4

Adjustment for Additions and
Withdrawals to Computation of Rate
of Return in Performance Records of
Commodity Pool Operators and
Commodity Trading Advisors

acency: Commodity Futures Trading
Commission.
action: Advisory.

SUMMARY: A ance record
contains information required to be
presented by commodity pool operators
(‘CPOs” or “registrants”) and
commodity trading advisors (“CTAs” or
“registrants”) pursuant to Commodity
Futures ing Commission
(“Commission”) rules 4.21(a)(4),
4.21(a)(5) and 4.31(a)(3) ! and is intended
to present the historical periodic
performance of accounts operated or
directed by such registrants in a
prescribed format for purposes of
disclosure to customers or prospective
customers. The prescribed format
includes periodic rate of return ("ROR")
information. By this Advisory the
Commission is providing guidance as to
the acceptable methods of computation
of ROR. This Advisory also provides
guidance as to the use of Value Added
Monthly Index (“VAMI") columns in
performance table presentations.

The Commission is aware that many
registrants have already adopted the
alternative methods of computation
discussed herein, which Commission
staff have reviewed and determined to
be acceptable in specific cases. As a
result, the Commission believes that the
accuracy of ROR information appearing
in performance disclosure generally has
been improved. This Advisory is
intended to provide guidance concerning
those circumstances in which the ROR
computed in accordance with the
method currently specified in
Commission rules could be misleading
and to make generally available
alternative methods of ROR
computation that have been previously
reviewed and accepted for many
registrants on a case-by-case basis. The
guidance provided by this Advisory also
should assist registrants in more
efficiently preparing their performance

tables, reduce the necessity for inquiries”

concerning specific ROR computations,
and afford registrants more latitude in
the presentation of ROR.

DATES: The Advisory is to be effective
March 29, 1991.

* Commission rules referred to herein are found at
17 CFR Ch. 1 (1290).

appresses: Comments should be sent
to Commodity Futures Trading
Commission, 2033 K Street NW.,
Washington, DC 20581. Attn: Secretariat.

FOR FURTHER INFORMATION CONTACT:
Paul Bjarnason, Chief Accountant,
Division of Trading and Markets,
Commodity Futures Trading
Commission, 2033 K Street NW.,
Washington, DC 20581. Telephone: (202)
(254-8955.

‘SUPPLEMENTARY INFORMATION:
I Introduction

‘The account information required by
Commission rules to be provided in CPO
and CTA performance records includes:
Beginning net asset value (“~BNAV"};?
additions of funds; withdrawals of
funds; net performance; ending net asset
value; ROR; and, for pools, the number
of units outstanding at the end of the
period.* ROR is currently defined in
Commission rules as net performance
for a period divided by the BNAV for
that period.‘ It has come to the
Commission's attention that distortions
in computed ROR under the method
currently specified can result under
some circumstances. For example,
distortions can result where additions -
and/or withdrawals are large and are
made early in the reporti iod,
because such additions] witberawals
couse the petal amount of funds
available for trading during a period to
be materially aan from BNAV.

Accordingly, to assure that
performance records reflect accurate
RORs notwithstanding unusual
circumstances, this Advisory
guidance as to the circumstances in
which ROR computations under the
method currently specified in
Commission rules can result in
distortions, and thus an alternate
method of computation is required, and
as to acceptable alternate methods for
such computations. In addition,
concurrently with the publication of this
Advisory, the Commission is publishing

* With respect to the calculation of BNAV,
Commission staff has stated that fands contained in
2 commodity account over which the CTA has been
given discretionary trading authority must be
included in the BNAV calculation and specifies
conditions under which funds in other types of
‘accounts of the customer at the futures commission
merchant that are committed to the registrant's
trading program are required to be inchided in the
computation of BNAV. Division of Trading and
Markets Advisary No. 67-2, [1986-87 Transfer
Binder] Comm, Fut Rep. (OCH) 173.824 Gane 2
ct

In some cases. pools are not denominated in
unite and, therefore, the number of unite outstanding
at the end of the period would not be required This
fact should be indicated in a note to the
performance record.

“Rule 4.21(a){4){iiNF). 27 CFR 4.21(0)(4)ii)(F)-



Federal Register / Vol. 56, No. 39 / Wednesday, February 27, 1991 / Rules and Regulations

8110

proposed rule amendments which,
among other things, will clarify that
presentation of ROR may be made by
the method currently specified in Rule
4.21 as well as by such other methods as
the Commission may approve. The
proposed revision to Rule 4.21(a}(4)
would provide that the rate of return for
the performance period being shown
“shall be calculated by dividing the net
performance by the beginning net asset
value or by a method otherwise
approved by the Commission”
{emphasis added). The Commission
also has proposed to amend Rule
140.93{a) to add new paragraph (a){7). a
delegation of authority to the Director of
the Division of Trading and Markets to
perform “[a]l functions reserved to the
Commission in [Rules] 4.21 and 4.31.”
This Advisory specifies five methods
of computation of ROR. Each of the
methods is acceptable to the
Commission provided resultant RORs
are not misleading. This Advisory
provides guidance as to what
circumstances might lead to inaccurate
RORs and emphasizes that in
circumstances in which material
distortions occur, an accurate
alternative calculation must be made.
For example, in those cases where
additions and withdrawals occur only at
the end of the reporting period, or are 80
distributed as to result in no distortion,
the previously specified method of
calculating ROR, net performance for a
period divided by BNAV for that period,
would be acceptable. When additions or
withdrawals could distort performance
results, the methods for computing ROR
as provided herein, including “‘time-
weighting”, average daily equity
(“ADE”) and only accounts traded
{OAT}, will be accepted by the
Commission for purposes of compliance
with ROR requirements under Rules
4.21(a)(4), 4.21(a)(5), and 4.31(a)(5). The
Commission will also accept a
compounded ROR method, provided
compounding is done at least as
frequently as additions and withdrawals
occur, because such a method
accurately matches trading performance
for a period against the actual equity
which was available for trading during
that period. These types of computations
were suggested in comments responding

© CPOs and CTAs are required to disclose all
‘material information to existing ot prospective pool
Participante or existing or prospective clients,
respectively, even if such information is not
otherwise specifically required by the Commission's
isclosure rules. See 54 FR 5597, 5590 (1980),
Commission Rules 4.21(h) and 4.31(g) and section 40
of the Commodity Exchange Act, 7 U.S.C. 60 (1088).

* Rules 421{a)(5) and 4.31(a)(3) incorporate by
reference the rate of return calculation of Rule
AZa}iA).

to a Commission interpretive statement
and request for comments issued in
1989, which raised the issue of
distortions to performance reporting
caused by additions or withdrawals.”

Il. Proposed Adjustments to
Computation of Rate of Return

A. General Requirements

Whichever method of computing ROR
is selected, registrants are required to
indicate the method in notes to the
performance records and are required to
maintain complete and clear records to
support the computation. Accounting
data which underlie the computation
must be prepared in accordance with
generally accepted accounting principles
("GAAP") as required by Commission
regulations. All additions and
withdrawals should be set forth in
separate columns. GAAP and other
Commission rules require accounting on
an accrual basis for all items of income
and expense; preclude pro forma
adjustments unless specifically
disclosed; require inclusion of all
accounts, including short-term loss
accounts, except as provided in the
OAT method discussed herein; and
require inclusion of all fees and
expenses pertaining to the account and
its trading, even those paid with funds
from outside of the trading account.

The registrant is responsible for the
accuracy of any method chosen to
address the impact of additions and

- withdrawals upon ROR; is required to

apply the chosen method consistently
from period to period; and may not
depart from the chosen method, unless
performance would otherwise not be
properly represented. In such cases,
corrective adjustments may be made
and explanation must be included in the
notes.

B. Standard of Materiality .

As previously stated, registrants may
use the prior Commission method for
calculating ROR unless it results in
material distortion of performance
results. However, all the methods
described herein are potentially subject
to distortion and where such distortion
would occur the registrant must choose
one of the alternative methods for that
reporting period. For purposes of this
Advisory the following summarizes the
materiality threshold below which a .
registrant would not need to consider

7 See “Statement of the Commodity Futures
‘Trading Commission Regarding Disclosure by
Commodity Pool Operators of Past Performance
Records and Pool Expenses and Request for
Comments”, 54 FR 5597 (February 6, 1989).

whether additions or withdrawals could
distort the performance record: ®

{1) The change in ROR, between the
adjusted and the unadjusted ROR, is
less than 10 percent of adjusted ROR;

(2) Additions and withdrawals are
each less than 10 percent of BNAV;

(3) Unadjusted ROR is greater than 5
but no greater than 10 percent and the
absolute difference between the
unadjusted and the adjusted ROR is less
than 1.5° percentage points; or

(4) Unadjusted ROR is 5 percent or
less and the absolute difference
between the unadjusted and the
adjusted ROR is less than 1 percentage
point.

C. Alternative Computations Under Rule
4.21(a)(4)(F)

In addition to the currently specified
method of calculating rate of return by
dividing net performance by the
beginning net asset value, the following
four alternative methods are acceptable
for computing ROR: (1) The average
daily equity (“ADE”) method; (2) the
time-weighting method; (3) the only
accounts traded ("OAT") method; and

_ compounded ROR method, which are

described below.
Average Daily Equity (“ADE”)

The ADE method for computing ROR
involves the division of periodic net
performance by ADE, which is an
arithmetic average of the daily net
liquidating equity available for trading
for each day of the reporting period, ie.,
the total of the net liquidating equities
for each day of the period divided by the
number of days in the period. For
Saturdays, Sundays, and other days
when no commodity trading occurs, the
preceding business day's net liquidating
equity should be used. ADE as indicated
on the account statement must be
adjusted daily to accrue for material
expenses and fees not already charged
against the account in computing daily
net liquidating equity, if any.

Although the ADE method is generally
very accurate, it is subject to distortion
during periods when because of severe
losses, account equity is being drawn
down rapidly.

© These standards apply equally to positive and
negative RORs.

* For example, if the unadjusted (originally ~~
computed) ROR were 6 percent and the adjusted
ROR were 8 percent, the absolute difference would
be 2 percentage points and the relative difference
would be 33% percent If the unadjusted ROR
exceeds 10 percent, then only the first threshold set
forth above would apply.


Federal Register / Vol. 56, No. 39°-/ Wednesday, February 27, 1991 / Rules and Regulations 8111

Time-Weighting of Additions and
Withdrawals (“time-weighting”)

‘Under the time-weighting method
BNAV is adjusted by the time-weighted
value of additions and withdrawals, i.e.,
adjusting BNAV upwards by time-
weighted additions and downwards by
time-weighted withdrawals, occurring
during the period. The time-weighting
method is easily computed by taking the
number of days funds were available for
trading divided by the total number of
days in the period. For example, if
actual BNAV were $100,000 and en
additional $150,000 was deposited on
the 10th of the month, and $90,000 was
withdrawn on the 20th of the month, the
$100,000 BNAV would have to be
adjusted: (1) Upward by two-thirds of
the $150,000, ar $100,000, because these
funds were available for 20 days of the
month; end (2) downward by one-third
of the $90,000, or $30,000, because these
funds were not available for one-third of
the month. Therefore, the adjusted
BNAV which should be used in
computing ROR would be $170,000 or a
70 percent increase over actual BNAV.?°

Although the time-weighting method
is generally very accurate, it is subject
to distortion during periods of very large
changes in account equity due to severe
losses or large profits.

Only Accounts Traded (“OAT”)

The OAT method for computing ROR
uses the formula contained in
Commission regulations, i.e., dividing
Periodic net performance by BNAV,
except that it differs from the
Commission's method in that certain
accounts could be excluded from the
computation. The exclusions are
permitted in order to reduce the
complexity and burden of the
‘computation and are predicated on the
assumption that the accounts excluded
would distort ROR if they had been
included. The conditions set forth below
for the use of OAT are intended to
assure that the exclusion of certain of
the accounts will not result in the
computation of periodic ROR that is
materially different from the other
methods.

The conditions which must be met for
use of the OAT method are:

(1) Accounts included in any
performance table using the OAT
method must be similar in all material
respects, i.e. and relative number of
contracts traded, margin/equity ratio,

4° Detailed computation: April 01-10=10

days x 100,000 1.000.000; April 11-20=10

‘days x 250.000 = 2,500,006; April 21-30=20

day's X 160,000 = 1,600,000; Total of above 5,100,000.
5.100.000 divided by 30 days = 170,000 average.

and fees and commissions charged.*! To
avoid distortion of ROR, accounts
excluded from the computation must, as
a group, have the same profile in this
connection as those included in the
computation, for the period used in the
calculation.

(2) Accounts excluded from the ROR
computation must not be charged with
material non-recurring costs, €.g.,
closeout costs charged against customer
accounts in the period that they are
closed. As with all the method, OAT
may not be used if it would result in a
systematic exclusion of any costs which
would be material in amount.

(3) Each account excluded from the
computation must meet at least one of
the following criteria:12

» (a) The account was open for only
part of the period, i.e, it was opened or
permanently closed during that
Teporting period;

(b) The account had no open positions
for any part of the period and it was the
client's intention to close the account as
evidenced by the actual permanent
closure of the account shortly after the
period-end. Accounts for which there
was merely a trading pause may not be
excluded from the computation solely
because of such pause; or

(c) The account had material
additions or withdrawals, ie. additions
or withdrawals which exceeded 10
percent of BNAV attributable to the
particular account

(4) The registrant must disclose
whenever unusual circumstances unique
be the OAT method ave affected ROR

for any period, ing resultant ROR
diverge materially from what might be
expected using one of the other
acceptable methods,?#

Registrants should be particularly
concerned as to possible ROR distortion
should a significant number of the
accounts otherwise included in the table
be excluded from the ROR computation.

+1 This requirement is generally applicable in
determining when separate composite performance
records must be prepared for accounts which are

” maierially different. regardless of the method used
- to calculate ROR. See, e.g., Rules 4.21(a)(4),

4.21(a)(5), and 4.31(0)(3).

42 1t shoudl be noted that itis only the
computation of ROR which may exclude certain
accounts under the OAT method. The other columns
of the performance table. eg.. BNAV, additions,
withdrawals, net performance, etc, would be
comprised of all accounts, including those excluded
under the OAT method in the computation ef ROR.

"9 For example, if « particular sccount or
accounts are left out of an ROR computation for
more than one period in a performance table, the
registrant should consider presenting such accounts
in a separate composite performance table or
otherwise specific disclosure of the
performance revulta of such accounts.

Compaunded ROR Method

The “compounded ROR method" is
computed by dividing the accounting
period, ie. the month or quarter, into
several smaller periods and computing
the ROR for such sub-period.
Compounding may be done on as
frequent a basis as daily, but, ata
minimum, must be done at
least as frequently as additions and
withdrawals are made. An example of
the compounded ROR method in which
an ROR for a sub-period has been
computed each time there is an addition
or withdrawal of capital to/from the
account is provided below. Once,an
ROR has been computed for each sub-
period, such RORs are combined into an
overall ROR by multiplying them'by one
another in sequence, i.e. campounding
them.

An example of an ROR computation is
as follows:
‘account ‘Change in
value
‘Start of month__"__| $10,000 | +10% ($1,000
End of 1st acct. 11,000 | $4,000
4 a
‘Start of 2nd acct. 45,000 | —20% 153,000
End of 2nd acct 12,000 | $2,000
period. (wahdrawaly
‘Start of 3rd acct 10,000 | +25% ($2,500
Period. ‘proht)
End of month... 12,500

ROR=[(1+.1)(1—.2)(1+.25]]=10%
gain forthe period. =~ .

IIL Value Added Monthly Index
(‘VAMI')

Although not required by Commission
regulations, the performance tables of |
many registrants present in an
additional column an index referred to
as “VAMI". VAMI is an index
purporting to reflect how a fixed amount
of initial investment, generally $1,000,
would have changed over the periods
presented in the table. The Division of
Trading and Markets has found cases
where disclosure documents, as filed
initially, bave not accomplished this
objective and the resulting VAMI could
be misleading. In order to accurately
accomplish its objective, the VAMI must
change proportionately with the changes
in the value of the underlying portfolio.
For example. if on the fifteenth of
January $100,000 were deposited in a
new account and during January due to
profits the account equity grew to
$110,000, the ROR computed by time-