CFTC Letter 04-06

CFTC letter No. 04-06

January 21, 2004

Interpretation

Division of Clearing and Intermediary Oversight

Mr. Eric A. Bloom 

President & CEO 

Sentinel Management Group, Inc. 

Edens Corporate Center 

650 Dundee Road, Suite 460 

Northbrook, IL 60062 

Re: Segregation and Net Capital Treatment of Funds Held on Deposit at Sentinel 

Dear Mr. Bloom: 

This letter responds to your request concerning Sentinel Management Group, Inc. (“Sentinel”). 

Specifically, you have asked the Division of Clearing and Intermediary Oversight (“Division”) of the 

Commodity Futures Trading Commission (“Commission” or “CFTC”) to confirm its views concerning 

the application of the Commission’s segregation and net capital regulations to certain accounts managed 

by Sentinel. Based upon your representations and the documents you have submitted, the Division 

understands the relevant facts to be as follows. 

Sentinel is registered with the CFTC as a futures commission merchant (“FCM”) and with the Securities 

and Exchange Commission (“SEC”) as an investment adviser. Sentinel is a member of National Futures 

Association (“NFA”) but is not a member of any futures exchange. As such, NFA exercises primary 

financial surveillance of Sentinel under CFTC oversight. The CFTC, SEC, and NFA regulatory 

compliance programs include financial reporting requirements and periodic direct compliance 

examinations by SEC and NFA staff, as well as annual audits by independent public accountants. 

Sentinel does not engage in all of the activities that are permitted for a person registered as an FCM. In 

this regard, Sentinel does not solicit or accept orders for commodity interest transactions and does not 

carry commodity interest positions for itself or for any of its clients. Rather, Sentinel’s business plan is 

to provide services to other FCMs (“Client FCMs”) in the investment of customer funds, as well as for 

other types of entities. Sentinel’s services to Client FCMs include, primarily, investment of excess 

margin funds, protected by the Commodity Exchange Act (“CEAct”). Client FCMs also invest 

proprietary funds with Sentinel. 

Under the Sentinel investment management program, Client FCMs deposit commodity customer funds 

in a custody account maintained at the Bank of New York (“BONY”), which is referred to as the “Seg I 

Account”. Client FCMs also may deposit proprietary funds in a custody account at BONY, referred to as 

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the “Seg III Account”.

[1] The custody accounts require BONY to segregate the funds in the Seg I and 

Seg III accounts from BONY’s own assets and prohibits BONY from using the funds in the Seg I and 

Seg III accounts for BONY’s own purposes. The Seg I Account is titled in the name of Sentinel as agent 

on behalf of Sentinel’s Client FCMs. In compliance with Commission Regulation 1.26, Sentinel has 

obtained from BONY a letter acknowledging that the funds maintained in the Seg I Account are held 

pursuant to Section 4d(a)(2) of the CEAct and CFTC regulations for the benefit of Sentinel’s commodity 

customers. The acknowledgement letter further provides that BONY will not offset any obligation owed 

to BONY by Sentinel by any of the funds maintained in the Seg I Account. 

Under the investment management agreements with the Client FCMs, Sentinel directs the investment of 

the funds maintained in the Seg I Account in accordance with Commission regulations governing the 

investment of commodity customer funds, including Regulation 1.25. Client FCMs do not obtain a direct 

interest in any particular security or other investments maintained in the Seg I or Seg III Accounts. 

Client FCMs share in the profits and losses on the investments made by Sentinel on a pro-rata basis, 

according to each Client FCM’s proportionate share of the total assets held in the respective Seg I and 

Seg III Accounts. 

Sentinel meets, on a same-day basis, client redemption requests from the Seg I and Seg III Accounts 

received by 4:00 pm. Redemption requests received after 4:00 pm, but prior to the 6:00 pm closing of 

the Fed Wire, also will be met on a same-day basis, subject to the client incurring bank overdraft charges 

(i.e., interest costs associated with Sentinel’s borrowings necessary to satisfy such redemption request). 

Sentinel estimates that approximately 85 percent of the total investments held in the Seg I and Seg III 

Accounts could be liquidated in order to satisfy redemption requests received from all of its clients on a 

same-day basis. Sentinel further estimates that the remaining 15 percent of the Seg I and Seg III 

Accounts could be liquidated and the funds returned to the clients within three business days of the 

redemption request. 

You have also represented that in the event of the insolvency of BONY, the funds held in the Seg I and 

Seg III Accounts would be transferred to a solvent banking institution and would not be subject to the 

claims of BONY’s creditors. In the event of the insolvency of Sentinel, funds held in the Seg I account 

would be distributed to the Client FCMs pursuant to CFTC regulations governing the bankruptcy of an 

FCM and funds held in the Seg III Account would be distributed directly to the Client FCMs that 

deposited funds held in the Seg III Account in accordance with provisions set forth in SEC regulations, 

the Advisers Act, and applicable federal bankruptcy law. 

The CFTC’s Division of Trading and Markets issued a no-action position, which provided Sentinel with 

relief from the Commission’s minimum net capital requirements for an FCM.[2] The no-action position 

effectively exempted Sentinel from the requirement to maintain minimum adjusted net capital equal to 

four percent of the commodity customer funds it held, provided Sentinel met certain other conditions, 

including maintaining minimum adjusted net capital equal to the minimum dollar amount required by 

Regulation 1.17 (currently $250,000). This letter does not alter the Division’s previous no-action 

position. 

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Based upon the foregoing, including your representations, it is the Division staff’s view that the Seg I 

Account at BONY satisfies the requirements of Section 4d(a)(2) of the CEAct and Commission 

Regulation 1.20 governing the segregation of customer funds. Accordingly, a Client FCM may include 

its proportionate interest in the total funds held in the Seg I Account in performing the daily segregated 

funds computation required by Regulation 1.32, subject to the appropriate haircuts set forth in 

Regulation 1.17(c)(5)(v) and Securities and Exchange Commission (“SEC”) Rule 15c3-1.[3]

Furthermore, based upon the facts and representations as set forth above, in particular the representation 

that Sentinel can liquidate and return to its clients, including Client FCMs, approximately 85 percent of 

the total investments held in the Seg III Account on a same-day basis and the remaining investments 

within three days, a Client FCM may include proprietary funds held in the Seg III Account as a current 

asset in computing its minimum adjusted net capital pursuant to Regulation 1.17. This opinion is 

conditioned upon Sentinel informing each Client FCM that it should report its proportionate interest in 

the Seg III Account as an investment on financial reports filed with the Commission and self-regulatory 

organizations. The Division’s opinion is further conditioned upon Sentinel calculating the haircuts on all 

investments held in the Seg III portfolio in accordance with Regulation 1.17(c)(5)(v) and SEC Rule 

15c3-1 and reporting to each Client FCM, on a daily basis, the Client FCM’s proportionate interest in 

the investments held in the Seg III Account, the Client FCM’s proportionate interest in the total haircut 

for all of the investments in the Seg III Account, and any other information that is necessary for each 

Client FCM to recognize its proportionate interest in the Seg III Account, less applicable haircuts, as a 

current asset in calculating its adjusted net capital pursuant to Regulation 1.17. 

The Division’s opinions herein are based upon the documents submitted and the representations that 

Sentinel has made regarding its operations. Any different, changed, or omitted facts or conditions might 

cause the Division to come to a different conclusion. Moreover, the opinions expressed herein are that of 

the Division only. They are not necessarily the opinion of the Commission or of any other unit of the 

Commission. If you have any questions regarding this letter, please feel free to contact me, Thomas 

Smith, Associate Director and Chief Accountant, at 202-418-5495, or Carlene Kim, Special Counsel, at 

202-418-5613. 

Very truly yours, 

James L. Carley 

Director 

Division of Clearing and Intermediary Oversight 

cc: Michael Macchiaroli, Associate Director, Division of Market Regulation, U.S. Securities and 

Exchange Commission 

Joseph Sanguedolce, Chairman, Joint Audit Committee, and Director Financial Surveillance, New York 

Mercantile Exchange 

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[1] Sentinel also provides investment management services to non-FCM clients. The funds received from 

such non-FCM clients are deposited in the Seg III Account maintained at BONY. 

[2] Letter from John L. Manley, Director, Division of Trading and Markets, Commodity Futures Trading 

Commission, to Terry L. Claassen, Esquire, O’Neal & Claassen, Chartered, dated May 7, 1981. 

[3] The Division of Trading and Markets has provided guidance to Client FCMs as to how the 

concentration limits set forth in Regulation 1.25(b)(4) and the haircut requirements set forth in 1.17(c)(5)

(v) could be applied to investments in the Seg I Account. (See, letter to Susan C. Ervin, Esq., Law 

Offices of Dechert Price & Rhoads, from John C. Lawton, Acting Director, Division of Trading and 

Markets, dated July 30, 2001.) This letter does not supercede the previous guidance and the July 30, 

2001 letter is still effective. 

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