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[Federal Register: October 30, 1998 (Volume 63, Number 210)]
[Rules and Regulations]
[Page 58300-58303]
From the Federal Register Online via GPO Access [wais.access.gpo.gov]
[DOCID:fr30oc98-7]

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COMMODITY FUTURES TRADING COMMISSION

17 CFR Part 4


Two-Part Documents for Commodity Pools

AGENCY: Commodity Futures Trading Commission.

ACTION: Final rule.

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SUMMARY: On March 30, 1998, the Commodity Futures Trading Commission
("CFTC" or "Commission") published for comment the National Futures
Association's ("NFA") Compliance Rule 2-35 subsections (a) through
(c) 1 ("the Rule"), its related Interpretive Notice, and
proposed amendments to Commission rules concerning the use of two-part
documents for commodity pools (collectively "the Proposal"). The
comment period for the Proposal was 30 days and closed on April 29,
1998. The Commission has carefully considered the comments received on
the Proposal and, based upon its review of these comments and its
consideration of the Rule, the Interpretive Notice and the proposed
Commission rule amendments, is approving the Proposal pursuant to
Section 17(j) of the Commodity Exchange Act 2 ("Act")
subject to the revisions discussed herein.
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    \1\  NFA has since submitted new subsections (d) and (e) to NFA
Rule 2-35, which are not related to the use of a two-part document.
NFA Rule 2-35 subsections (d) and (e) will be reviewed by the
Commission as a separate submission pursuant to Sec. 17(j) of the
Commodity Exchange Act.
    \2\ 7 U.S.C. Sec. 21(j) (1994).

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EFFECTIVE DATE: April 30, 1999.

FOR FURTHER INFORMATION CONTACT: Leanna L. Morris, Staff Attorney,
Division of Trading and Markets, Commodity Futures Trading Commission,
1155 21st Street, NW, Washington, DC 20581. Telephone: (202) 418-5466.

SUPPLEMENTARY INFORMATION:

I. Background

    Pursuant to Commission Rule 4.21,3 no commodity pool
operator ("CPO") registered or required to be registered under the
Act may, directly or indirectly, solicit, accept or receive funds,
securities or other property from a prospective participant in a pool
that it operates or intends to operate unless, on or before the date it
engages in that activity, the CPO delivers or causes to be delivered to
the prospective participant a Disclosure Document for the pool
containing the information set forth in Commission Rule
4.24.4 NFA and the Commission have worked to identify ways
in which the required disclosures could be more succinct and clear,
while adhering to the objective of protecting pool participants by
ensuring that participants are informed about the material facts
concerning the pool before committing funds.
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    \3\ Commission rules referred to herein can be found at 17 CFR
Ch. I (1998).
    \4\ Commission Rule 4.24 also contains a proviso that, where the
prospective participant is an accredited investor as defined in 17
CFR 230.501(a), a notice of intended offering and statement of the
terms of the intended offering may be provided prior to delivery of
a Disclosure Document, subject to compliance with the rules
promulgated by a registered futures association pursuant to section
17(j) of the Act.
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    Over the years, however, pool Disclosure Documents have become more
voluminous and more difficult to understand. In an effort to address
concerns that essential information is not reaching investors in a form
that can be easily understood, NFA submitted NFA Compliance Rule 2-35
subsections (a) through (c) and its related Interpretive Notice for
Commission approval. The purpose of the Rule is to provide potential
investors with material information concerning the commodity pool in a
concise, readable format prior to their deciding whether to invest in a
commodity pool.
    The comment period for the Proposal ended on April 29, 1998. The
Commission received seven comment letters. The commenters consisted of:
one self-regulatory organization; one registered futures commission
merchant ("FCM"); one formerly registered associated person of an
FCM; one law firm; one futures industry trade association; one bar
association; and one academician.
    All commenters supported the rulemaking in general. Some
commenters, however, advocated various changes to the proposed rules.
The Commission has carefully considered the comments received and,
based upon its review of the comments and its own consideration of the
Rule, the Interpretive Notice and the proposed Commission rule
amendments, has determined to adopt the Proposal, subject to the
modifications discussed herein. Comments received on the Proposal are
discussed below.

II. Transitional Provision

    To facilitate the transition to compliance with the Rule and the
Commission rule amendments, NFA and the Commission have determined that
the revisions being announced today will become effective six months
from the date hereof, but Disclosure Documents may be prepared, filed
and used in accordance with the revised rules prior to the effective
date. For pools that are continuously offered, amendment of the
Disclosure Document is not required solely due to the rule revisions
announced herein, and operators of such pools may make conforming
changes as part of their next regular update in accordance with
CommissionRule 4.26.

III. Discussion

A. Delivery of a Two-Part Document

    The Rule requires that the CPO of a commodity pool required to
register its securities under the Securities Act of 1933 ("public
pool") deliver a two-part document. The first part of the document
must be the Disclosure Document required by Commission Rule 4.21(a),
written using plain English principles 5 and limited to
specific

[[Page 58301]]

disclosure information, as discussed in detail below. The second part
is the Statement of Additional Information ("SAI"), which may include
information that is not in the Disclosure Document, provided that the
information is not misleading or otherwise inconsistent with applicable
statutes, rules or regulations.
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    \5\ NFA's Interpretive Notice to Rule 2-35 provides guidance on
what is meant by the use of "plain English principles." Such
principles include: using active voice; using short sentences and
paragraphs; breaking up the document into short sections; using
titles and sub-titles that specifically describe the contents of
each section; using words that are definite, concrete, and part of
everyday language; avoiding legal jargon and highly technical terms;
using glossaries to define technical terms that cannot be avoided;
avoiding multiple negatives; and using tables and bullet lists,
where appropriate. The Rule does not affect the prescribed
statements of Commission Rules 4.24(a) and 4.24(b).
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    The CPO of a commodity pool that is not required to register its
securities under the Securities Act of 1933 ("private pool")
6 must prepare and distribute a Disclosure Document and may
prepare and distribute an SAI, but is not required to do so. If the CPO
of a private pool chooses to prepare an SAI, it may be bound together
with the Disclosure Document, so long as the Disclosure Document comes
first. If the CPO of a private pool binds the SAI separately, the CPO
is not required to provide it to a prospective participant unless
requested by the prospective participant.
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    \6\ Pursuant to Commission Rule 4.24(d)(3)(i), a "private
pool" is one that is privately offered pursuant to section 4(2) of
the Securities Act of 1933 or pursuant to Regulation D thereunder.
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    One commenter stated that the use of the two-part format should be
optional for CPOs of private pools. The Commission notes that the
intent of the Rule is to provide all investors with a more concise and
readable document. Accordingly, it would defeat the purpose of the Rule
if CPOs of private pools were allowed to choose whether to adhere to
the format and disclosure requirements of the Rule. As discussed in
detail below, if the CPO of a private pool chooses not to disclose
supplemental information as defined in Commission Rule 4.24(v), the CPO
needs to prepare and distribute only the Disclosure Document containing
the information required by the Rule and does not need to prepare a
separate SAI. Also, CPOs of private pools have the choice of binding
the SAI to the Disclosure Document or separately providing the SAI upon
request of the prospective participant. Accordingly, the Commission
does not believe that CPOs of private pools should be given the option
of choosing between the new two-part format or the previous disclosure
format of Part 4 of the Commission's rules.

B. Information Required To Be in the Disclosure Document

    The Rule provides that the Disclosure Document required by
Commission Rule 4.21(a) be clear and concise, written using plain
English principles, and limited to the information required by
Commission Rules 4.24 and 4.25, provided, however, that the CPO may
provide the performance information required by Commission Rule
4.25(c)(5) in the SAI. It should be noted that, if the CPO does not
prepare an SAI, the performance information required under Commission
Rule 4.25(c)(5) must be included in the Disclosure Document. The
Disclosure Document must also include any other information necessary
to understand the fundamental characteristics of the pool or to keep
the Disclosure Document from being misleading.
    In support of the Rule, the Commission has amended Commission Rule
4.25(c)(5) to permit the summary description of the performance history
of the CTAs and investee pools for which performance is not required to
be disclosed pursuant to Commission Rules 4.25(c)(3) and 4.25(c)(4)
(hereinafter "non-major CTAs" and "non-major investee pools")
7 to be provided in the SAI.
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    \7\ Commission Rule 4.10(d)(5) defines major investee pool as
any investee pool that is allocated or intended to be allocated at
least ten percent of the net asset value of the pool. Commission
Rule 4.10(i) defines major commodity trading advisor as, with
respect to a pool, any CTA that is allocated or intended to be
allocated at least ten percent of the pool's funds available for
commodity interest trading. Accordingly, "non-major CTAs" and
"non-major investee pools" do not meet the ten percent allocation
requirement.
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    The Rule originally proposed also permitting the CPO to provide the
monthly rate of return information of the offered pool, required under
Commission Rule 4.25(a)(1)(i)(H), in the SAI, separated from the
remainder of the required performance capsule. One commenter stated,
however, that the monthly performance information of the offered pool
is too crucial to the evaluation of a CPO to permit the information to
be placed in the SAI, where it may be missed or overlooked. The
commenter stated that the "[r]eliance on a single yearly rate of
return will allow a CPO to better disguise wildly aberrant performance
of the pool."
    The Commission has considered the Proposal and has concluded that
the monthly rate of return information of the offered pool is necessary
to disclose the volatility of the pool to investors. The Commission
does not believe that such material information concerning the pool's
performance should be separated between two parts of a Disclosure
Document. Thus, NFA has revised its Rule by deleting that specific
provision from the final rule. Commission Rule 4.25(a)(2)(i) also will
not be revised as originally proposed. Accordingly, the offered pool's
monthly rate of return information must be provided in the first part
of a two-part document in the performance capsule required by
Commission Rule 4.25.

C. Commission Rule 4.24(v)--Supplemental Information

    The Rule provides that the Disclosure Document must be limited to
and include all of the required information of Commission Rules 4.24
and 4.25, with the noted exception that the summary performance
information required by Commission Rule 4.25(c)(5) may be provided in
an SAI if one is prepared. Accordingly, Commission Rule 4.24(v) has
been revised to require that supplemental information, which is not
required information 8 be contained only in the second part
of a two-part document. Such information may not be presented in the
Disclosure Document.
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    \8\ Pursuant to Commission Rule 4.24(v), supplemental
information is any information that is not required by Commission
rules, the antifraud provisions of the Act, other federal or state
laws or regulations, rules of a self-regulatory agency or laws of a
non-United States jurisdiction.
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    Several commenters stated that the provisions should not be so
restrictive on what is allowed to be included in the Disclosure
Document. They maintained that, because of the varying structure and
objectives of each commodity pool, discretion should be provided to
CPOs in deciding what information to include in the Disclosure
Document. For example, some CPOs may want to include the limited
partnership agreement in the Disclosure Document. One commenter also
stated that CPOs should be permitted to include supplemental
performance information with the required performance disclosures,
since "[s]upplemental performance information is often closely related
to the required performance disclosures and is often based [on]
required performance figures."
    As discussed earlier, the intent behind providing investors with a
two-part document is to provide a more understandable Disclosure
Document that discloses essential information about a pool in such a
way that will assist investors in making informed decisions about
whether to invest in the pool. Accordingly, permitting the inclusion of
supplemental information, such as a limited partnership agreement or
non-required performance information which will increase the length of
the Disclosure Document, is not in accordance with the intent of the
two-part document format. Such information would be more

[[Page 58302]]

appropriately placed in the SAI, where it will not distract the
investor from the material disclosures contained in the Disclosure
Document.
    That is not to say that the information provided in the SAI may not
be useful information to prospective participants. The SAI may include
information that expands upon the required information found in the
Disclosure Document, provided that such information is not misleading
or inconsistent with applicable statutes, rules or regulations.
However, the Commission believes that it is more useful to the typical
or average investor to provide essential information concerning an
investment in the pool in a shorter and simpler Disclosure Document.

D. Coordination With Other Regulatory Agencies

    Several commenters expressed concern over CFTC and Securities and
Exchange Commission ("SEC") coordination of regulatory requirements
for publicly offered commodity pools. Specifically, the commenters want
the Commission to be certain that the use of the two-part format and
plain English requirements will not conflict with any disclosure
requirements of the SEC for commodity pools. The commenters urge the
CFTC and the SEC to develop uniform standards on the use of two-part
documents and plain English principles.
    In drafting the Rule and its related Interpretive Notice, NFA
considered the disclosure and formatting requirements of the SEC and
state securities administrators in an effort to avoid any conflicting
regulatory requirements. Accordingly, the Rule provides that any
information required by the SEC or state securities administrators to
be included in the first part of a two-part document must be included
in the Disclosure Document.
    The Rule also substantially adopts the "plain English" initiative
of the SEC.9 The Rule, however, requires that all parts of
the Disclosure Document must be written using plain English principles,
rather than limiting the plain English principles to a few specific
disclosures, as provided in the SEC's rule.10 Accordingly,
although the Rule expands the use of plain English principles, it does
not conflict with the SEC's requirements.
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    \9\ See 63 FR 6370 (February 6, 1998).
    \10\ SEC Rule 421(b), however, does require that the entire
prospectus be clear, concise and understandable and requires using
the following techniques, among others: present information in
clear, concise sections, paragraphs and sentences; avoid legal and
highly technical business terminology; avoid legalistic or overly
complex presentations that make the substance of the disclosure
difficult to understand; and avoid repetitive disclosure that
increases the size of the document, but does not enhance the quality
of the information.
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    In preparing the related Interpretive Notice, which provides
guidance on plain English principles and the disclosures that must be
provided in the Disclosure Document, NFA's Subcommittee for the Review
of Non-Performance CPO/CTA Disclosure Issues ("Subcommittee") looked
at what was then SEC Form N-1A. SEC Form N-1A sets out the disclosures
required to be included in the prospectus and the SAI for mutual funds.
The Subcommittee used SEC Form N-1A as a general guide for determining
what disclosures the SEC might require to be included in the Disclosure
Document for publicly offered commodity pools. Although the SEC has
since adopted amendments to SEC Form N-1A,11 the Commission
believes that NFA Compliance Rule 2-35 and its related Interpretive
Notice provide sufficient guidance on what disclosures the SEC and
state securities administrators will require to be included in the
Disclosure Document. Additionally, the Rule and the Interpretive Notice
have been written to contain the necessary flexibility to address the
disclosure requirements of the SEC and state securities administrators
as they may change over time.12 Accordingly, the Commission
believes that any concerns about conflicting regulatory requirements
have been addressed adequately. The Commission will continue to
coordinate with the SEC on maintaining consistent requirements for
publicly offered commodity pools.
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    \11\ 63 FR 13916 (March 23, 1998).
    \12\ The Interpretive Notice to NFA Compliance Rule 2-35
provides: "The Disclosure Document may also include information
required by the Securities and Exchange Commission and state
securities administrators. Such information currently includes items
such as * * *" (emphasis added). The language of the Interpretive
Notice acknowledges that the disclosures required by the SEC and
state securities administrators may differ over time from the
requirements as of the date of the Interpretive Notice.
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IV. Related Matters

A. Regulatory Flexibility Act

    The Regulatory Flexibility Act ("RFA"), 5 U.S.C. 601-611,
requires that agencies, in proposing rules, consider the impact of
those rules on small businesses. The rule amendments discussed herein
will affect registered CPOs. The Commission has previously established
certain definitions of "small entities" to be used by the Commission
in evaluating the impact of its rules on such entities in accordance
with the RFA.13 The Commission previously has determined
that registered CPOs are not small entities for the purpose of the
RFA.14 Therefore, the Chairperson, on behalf of the
Commission, hereby certifies, pursuant to 5 U.S.C. 605(b), that the
action taken herein will not have a significant economic impact on a
substantial number of small entities.
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    \13\ 47 FR 18618-18621 (April 30, 1982).
    \14\ 47 FR 18619-18620.
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B. Paperwork Reduction Act

    The Paperwork Reduction Act of 1995 15 imposes certain
requirements on federal agencies (including the Commission) in
connection with their conducting or sponsoring any collection of
information as defined by the Paperwork Reduction Act.
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    \15\ Pub. L. 104-13 (May 13, 1995).
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    There is no burden associated with the amendments to Commission
Rules 4.24(v) or 4.25(c)(5) to implement the NFA rule. The group of
rules contained in all of Part 4, "Commodity Pool Operators and
Commodity Trading Advisors," of which Rules 4.24(v) and 4.25(c)(5) are
a part, was approved on September 4, 1998 and assigned OMB control
number 3038-0005. The group of rules contained in OMB control number
3038-0005 has the following burden:

Average burden hours per response: 124.65
Number of respondents: 4,624
Frequency of response: On occasion

    Copies of the information collection submission to OMB are
available from the CFTC Clearance Officer, 1155 21st Street, NW,
Washington, DC 20581, (202) 418-5160.

List of Subjects in 17 CFR Part 4

    Brokers, Commodity futures, Commodity pool operators, Commodity
trading advisors.

    In consideration of the foregoing and pursuant to the authority
contained in the Commodity Exchange Act and in particular sections
2(a)(1), 4l, 4m, 4n, 4o, and 8a, 7 U.S.C. 2, 6l, 6m, 6n, 6o, and 12(a),
the Commission hereby amends Chapter I of Title 17 of the Code of
Federal Regulations as follows:

PART 4--COMMODITY POOL OPERATORS AND COMMODITY TRADING ADVISORS

    1. The authority citation for part 4 continues to read as follows:

    Authority: 7 U.S.C. 1a, 2, 4, 6b, 6c, 6l, 6m, 6n, 6o, 12a and
23.

    2. Section 4.24(v) is amended by revising paragraph (v)(3)
introductory text to read as follows:

[[Page 58303]]

Sec. 4.24  General disclosures required.

* * * * *
    (v) * * *
    (3) Must be placed as follows, unless otherwise specified by
Commission rules, provided that where a two-part document is used
pursuant to rules promulgated by a registered futures association
pursuant to Section 17(j) of the Act, all supplemental information must
be provided in the second part of the two-part document:
* * * * *
    3. Section 4.25 is amended by revising paragraph (c)(5)
introductory text to read as follows:


Sec. 4.25  Performance disclosures.

    (c) * * *
    (5) With respect to commodity trading advisors and investee pools
for which performance is not required to be disclosed pursuant to
Sec. 4.25(c)(3) and (4), the pool operator must provide a summary
description of the performance history of each of such advisors and
pools including the following information, provided that where the pool
operator uses a two-part document pursuant to the rules promulgated by
a registered futures association pursuant to Section 17(j) of the Act,
such summary description may be provided in the second part of the two-
part document:
* * * * *
    Dated: October 26, 1998.

    By the Commission.
Jean A. Webb,
Secretary of the Commission.
[FR Doc. 98-29102 Filed 10-29-98; 8:45 am]
BILLING CODE 6351-01-P
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