N7\ NATIONAL FUTURES ASSOCIATION

August 18,2010

Via E-Mail and Overniqht Mail

Mr. David Stawick

Office of the Secretariat

Commodity Futures Trading Commission

Three Lafayette Centre

1155 21st, N.W.

Washington, DC 20581

Re: Petition for Rulemaking to Amend CFTC Regulation 4.5

Dear Mr. Stawick:

National Futures Association (NFA) respectfully petitions the Commission

under CFTC Regulation 13.2to amend CFTC Regulation 4.5, which provides an

exclusion from the definition of the term "commodity pool operator" for otherwise

regulated persons operating certain qualifying entities.' Prior to 2003, persons claiming

this exclusion had to file a notice of eligibility pursuant to CFTC Regulation 4.5(c) and

represent, in part, that the person will operate the qualifying entity such that it (1) will not

be, and has not been, marketing participations to the public as or in a commodity pool

or otherwise as or in a vehicle for trading in the commodity futures or commodity options

markets; and (2) will use commodity futures or commodity options contracts solely for

bona fide hedging purposes and, with respect to positions held for non-bona fide

hedging purposes the aggregate initial margin and premiums required to establish such

positions will not exceed five percent of the liquidation value of the qualifying entity's

portfolio, after taking into account unrealized profits and unrealized losses on any such

contracts it has entered into.

For the reasons set forth below, we request that the CFTC amend

Regulation 4.5(c) to restore operating restrictions on registered investment companies

that are substantially similar to those in effect prior to 2003. The information required by

CFTC Regulation 13.2 follows:

1 NFA withdrew its June 29,2O1O Petition for Rulemaking to Amend CFTC Regulation 4.5 by separate

letter dated August 18,2010.

300 S. Riverside Plaza Suite iB00 Chicago,lllinois 60606 312.781.1300 800.621.3570 312.781.1467 fax vvww.nfa.futures.ors
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l. Text of Proposed Rule Amendments [additions are underlinedl

Part 4 - COMMODITY POOL OPERATORS AND COMMODITY TRADING

ADVISORS

4.5 Exclusion from the definition of the term "commodity pool operator."

(c)

(2) The notice of eligibility must contain r*r"r"n,"tions that such person will operate

the qualifying entity specified therein in a manner such that the qualifying entity:

Will disclose in writing to each participant, whether existing or prospective,

that the qualifying entity is operated by a person who has claimed an

exclusion from the definition of the term "commodity pool operator" under the

Act and, therefore, who is not subject to registration or regulation as a pool

operator under the Act; Provided, that such disclosure is made in accordance

with the requirements of any other federal or state regulatory authority to

which the qualifying entity is subject. The qualifying entity may make such

disclosure by including the information in any document that its other federal

or state regulator requires to be furnished routinely to participants or, if no

such document is furnished routinely, the information may be disclosed in any

instrument establishing the entity's investment policies and objectives that the

other regulator requires to be made available to the entity's participants; and

Will submit to such special calls as the Commission may make to require the

qualifying entity to demonstrate compliance with the provision of this S a.5(c);

Furthermore, if the person claiminq the exclusion is an investment company

reqistered under the lnvestment Companv Act of 1940, then the notice of

(i)

( ii)

0ii)
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August 18,2010

eliqibility must also contain representations that such person will operate the

qualifying entity as described in S 4.5(bX1) in a manner such that the

qualifyinq entity:

(g) Will use commodity futures or commodity options contracts solelv for

bona fide hedqinq purposes within the meaning and intent of $

1 .3(zX1): Provided, however. That in addition. with respect to positions

in commodity futures or commodity option contracts that may be held

by a qualifyinq entity only which do not come within the meaninq and

intent of S 1.3(zX1). a qualifyinq entity may represent that the

aqgreqate initial marqin and premiums required to establish such

positions will not exceed five percent of the liquidation value of the

qualifving entity's portfolio, after takinq into account unrealized profits

and unrealized losses on any such contracts it has entered into: and.

Provided furfher. That in the case of an option that is in-the-money at

the time of purchase. the in-the-money amount as defined in S

190,01(x) may be excluded in computinq such 5 percent:

(b) Will not be, and has not been, marketinq participations to the public as

or in a commodity pool or othenryise as or in a vehicle for tradinq in (or

otherwise seekinq investment exposure to) the commoditv futures or

commod itv options markets:

Provided further, however, That the making of such representations shall not

be deemed a substitute for compliance with any criteria applicable to

commodity futures or commodity options trading established by any regulator

to which such person or qualifying entity is subject.

ll. Nature of NFA's lnterest

As you know, NFA is a futures association registered under Section 17 of

the Commodity Exchange Act. One of NFA's primary purposes is to ensure the

protection of customers participating in the commodity futures markets. Recently, NFA

has become aware of at least three entities filing for exclusions under Regulation 4.5

with respect to registered investment companies that they operate. These mutual funds

are marketed to customers, including retail investors, as commodity futures investments
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August 18,2010

and are indirectly invested substantially in derivatives and futures products. ln fact,

although these funds are structured differently than public commodity pools and conduct

the futures trading through a subsidiary for tax and mutual fund regulatory purposes,

their aim is the same-targeting retail investors with in some cases minimum

investment amounts of as little as $1,000 who want exposure to actively managed

futures strategies.

lmportantly, as noted above, these three funds invest in commodity

futures instruments and/or other managed futures trading programs through a whollyowned and controlled subsidiary. The fund invests up to 25% of its total assets in this

subsidiary, and by leveraging assets at a 4 to 1 ratio, a fund is able to achieve a

managed futures exposure equal to the full net value of the fund.

NFA is interested in ensuring that registered investment companies that

engage in more than a de minimis amount of futures trading and that are offered to

retail customers or are marketed to retail customers as a commodity pool or othenvise

as or in a vehicle for trading in (or othenruise seeking investment exposure to) the

commodity futures or commodity options markets are subject to the appropriate

regulatory requirements and oversight by regulatory bodies with primary expertise in

commodity futures. NFA believes that requiring persons that market commodity funds

to the retail public and whose funds engage in more than a de minimis amount of

futures trading or investment to be registered as commodity pool operators ("CPOs")

furthers that goal.

I ll. Supporting Arguments

CFTC Regulation 4.5 currently makes available to eligible persons an

exclusion from the definition of CPO with respect to the operation of certain qualifying

entities, including registered investment companies, that would othenruise constitute

commodity pools but that are already subject to extensive federal and/or state operating

requirements. Prior to 2003, eligible persons claiming this exclusion were required to

represent that commodity futures and option contracts were used solely for bona fide

hedging purposes, and that for positions in commodity futures and option contracts that

were not used for bona frde hedging purposes, the aggregate initial margin and

premiums do not exceed 5% of the liquidating value of the qualifying entity's portfolio

after taking into account unrealized profits and losses. ln addition, eligible persons were
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Mr. David Stawick

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required to represent that the qualifying entity will not be, and has not been, marketing

participations to the public as or in a commodity pool or otherwise as or in a vehicle for

trading in the commodity futures or commodity options markets.

In March 2003, the Commission proposed amendments to Regulation 4.5

to eliminate the limitation on non-hedge trading. At the same time, the Commission

proposed formally adopting CFTC Regulation 4.13(aX4) to provide an additional

exemption from CPO registration based solely on a pool participant's purported

sophistication, without any requirement that the pool operator must be subject to

another regulatory scheme and without any restriction whatsoever on the purpose and

scope of the pool's commodity interest trading. The Commission further stated that

"since the eligible persons and qualifying entities of Rule 4.5 are, as stated in the title of

the rule, 'othenruise regulated,'the Commission believes that, like the unregulated CPOs

for whom it is proposing relief below, these persons and entities may not need to be

subject to any'commod-ity interest trading ciiteria to qualify for relief under Rule 4.5."2

At this time, the Commission also stated its view that Regulation 4.5's "nomarketing" restriction should remain in place. The Commission noted that eligible

persons should remain prohibited from marketing a qualifying entity as a commodity

pool or otherwise as a vehicle to trade commodity interests and indicated that this

restriction was necessary because members of the retail public may participate in the

trading vehicles subject to a Regulation 4.5 exclusion. The Commission nonetheless

requeited commenion the merits of maintaining this marketing prohibition.3

By letter dated May 1, 2003 to the CFTC, NFA supported maintaining

Regulation 4.5's "no marketing" restriction. ln particular, NFA stated that "current and

proposed Rule 4.5 both provide that the exclusion is not available if the vehicles are

marketed as commodity pools. Since Rule 4.5 is an exclusion rather than an

exemption, the anti-fraud provisions of Section 4(o) of the CEA do not apply.

lnvestments in these vehicles can be - and often are - sold to unsophisticated

customers. While the sale of these investment vehicles is subject to the anti-fraud

provisions in other statutes, unsophisticated customers should also have the benefit of

Section 4(o) if the investment is marketed as a commodity pool. Therefore, we agree

I See 68 Fed. Reg. 12622,12626 (March 17,2003).

o See ld.
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that the exclusion should not be available if the vehicles are marketed as commodity

pools." NFA felt that with this "no-marketing" restriction in place, it made sense to

eliminate the limitation on non-hedge commodity trading due to certain concerns

regarding margin levels expressed at that time.

In August 2003, after receiving comments that supported eliminating both

the limitation on non-hedge commodity trading and the prohibition on marketing these

qualifying entities, the Commission adopted amendments to Regulation 4.5 to eliminate

both these provisions. In doing so, the Commission stated that "one commenter agreed

with the proposed retention of the 'no marketing' criterion (and with the Commission's

rationale therefore) but several commenters disagreed with it. The Commission noted,

in part, that these commenters claimed that, in the absence of any trading restriction,

the "othenvise regulated nature" of the qualifying entities specified in Regulation 4.5

would provide adequate customer protection.a

Over the past several months, at least three entities that previously filed

notices for exclusions under Regulation 4.5 with respect to certain registered investment

companies launched these mutual funds. These mutual funds are marketed to

customers, including retail investors, as commodity futures investments and are

indirectly invested via a subsidiary structure substantially in derivatives and futures

products. Customers may use an electronic brokerage account to trade one of these

mutualfunds, which are sold by broker/dealers on internet platforms in which retail

investors only need to point and click to either buy or redeem shares in a fund that

offers exposure to an actively managed futures product.

NFA staff has reviewed the prospectuses and promotional material

prepared for these funds.s One fund's prospectus indicates that it pursues its

investment strategy by mainly investing in a combination of exchange traded futures

] See 68 Fed. Reg.47221,47223 (August B, 2003).

' See MutualHedge Frontier Legends Fund-http://mutualhedge.com/default.aspx;

AQR Fund-http://www. aqrfu nds. com/

Our_Funds/lndividual/FundlD_12lOverview/Managed_Futures_Strategy_Fund.fs;and Highbridge Fundhttps://www.jpmorganfunds.com/cm/Satellite?pagename=jpmfVanityWrapper&UserFriendlyURL=fundove

rview&cusip=48 1 2 1 A696
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and options contracts, fonruard contracts, swaps, and other over the counter derivatives

and fixed income securities, often referred to as a "managed futures strategy."6

This fund's promotional material indicates that the fund's inception date

was December 31, 2009, and the fund has a minimum investment amount of $2,500

(subsequent investments of $500) and offers two share classes, A and C. Class A has

a maximum sales charge of 5.75% and a net expense ratio of 2.20% and Class C has

no sales charge but a net expense ratio of 2.95o/o.' The fund's promotional material

also states that the fund is "A Pioneering Managed Futures lnvestment" that is

accessible, comprehensive, innovative,lnd has proven management.s The material

also specifically notes that the fund has a "lower cost structure than most retail

managed futures funds" and is "the first mutual fund to generate managed futures

returns through net-long, actively managed CTAs." The fund's assets are traded

pursuant to five managed futures trading programs. In particular, the fund's prospectus

states that the subsidiary's investment adviser (which is also the fund's adviser) expects

to invest the assets of the subsidiary in a manner designed to provide exposure to five

global macro programs.

ln adopting the 2003 changes to Regulation 4.5, the CFTC eliminated the

prior "no-marketing" restriction and did not place any qualification standards on the type

of customers who may invest in a qualifying entity. Without these types of operating

6 A second fund's prospectus states that in order to pursue its investment objective, the fund invests in

futures contracts and futures-related instruments including, but not limited to, equity index futures,

currency forwards, commodity futures, swaps on commodity futures, fixed income futures, bond futures

and swaps on bond futures (collectively, the Instruments) either by investing directly in those lnstruments,

or indirectly by investing in a subsidiary that invests in those Instruments. The third fund's prospectus

states that the fund seeks to achieve its objective by investing in a diversified portfolio of commoditylinked derivatives and fixed income securities. The prospectus additionally states that the fund invests in

commodity-linked derivative instruments, such as commodity-linked notes, swap agreements, commodity

options, futures and options on futures that provide exposure to the investment returns of the

commodities markets without investing directly in physical commodities.

t The other two funds also commenced in January 2010 and these also have various share classes with

minimum investment amounts ranging from $5,000 to $1 million and $1,000 to $1 million, respectively.

I A second fund's Fact Sheet makes similar statements and indicates that "The Fund delivers an active

long/short Managed Futures strategy in a mutualfund vehicle." The fund's investment objective states

the fund "seeks to generate positive absolute returns."
NFA

Mr. David Stawick

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August 18,2010

restrictions, these mutual funds are marketed and sold to customers, including retail

investors, who may be unsophisticated in commodity futures investments. NFA

believes that any commodity futures investment that is marketed to retail customers as

a commodity pool or otherwise as or in a vehicle for trading or investing in (or othenruise

seeking exposure to) the commodity futures or commodity options markets should be

subject to the regulatory requirements and protections contained in the CFTC's Part 4

regulations.

In reviewing these funds' prospectuses, NFA found that the offering

material omits substantial disclosures that would otheruuise be mandated by Part 4.

Among other things, the prospectuses do not include detailed information about the

fund's futures commission merchants and potential conflicts of interest, and

performance information for the fund (assuming it has three months performance) or

other funds operated by the investment adviser. Additionally, to the extent the funds'

prospectuses state that the fund and/or subsidiary will invest in other actively managed

futures trading programs, the prospectuses provide little information about these

managed futures trading programs, these programs'fee structures, and the past

performance results of their trading managers.

NFA also has customer protection concerns relating to these mutual funds'

use of a wholly-owned and controlled subsidiary to invest in commodity futures

transactions on behalf of the fund. NFA understands from reviewing some of these

funds' prospectuses that the funds' investment in a subsidiary is intended to provide the

funds with exposure to futures and commodities in a manner consistent with the

limitations of the federal tax requirements in Sub-chapter M of the IRS Code. Subchapter M requires, in part, that at least 90% of a fund's income be derived from

securities or derived with respect to its business of investment in securities (i.e.,

qualifying income). The funds rely upon IRS private letter rulings to other mutual funds,

which indicate income from a fund's investment in a subsidiary will constitute qualifying

income.

However, while these funds'offering materials indicate that the

subsidiaries are subject to certain investment restrictions applicable to the funds

themselves, these subsidiaries are neither commodity pools regulated by the CFTC and

NFA nor registered investment companies. Additionally, the prospectuses make clear

that the subsidiaries are not subject to the Investment Company Act of 1940's customer
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protection regime. The vast majority of the regulated funds' holdings appear to be

money market instruments to serve as collateral for the subsidiaries' derivatives

positions; yet, the subsidiaries'daily operations, including their actual derivatives

positions (including the positions' leverage amounts) and fees charged are not entirely

transparent.

Given these funds'offerings, NFA proposes the aforementioned

amendments to Regulation 4.5 since we believe the premises underlying the

Commission's elimination in 2003 of the "no-marketing" and "five-percent trading test"

limitations as applied to registered investment companies may no longer be valid. To

the extent the Commission used proposed Regulation afi@)@) as a rationale to

eliminate the "five-percent trading test", NFA believes that the Commission should

review whether this rationale remains appropriate in light of these actively managed

retail futures funds.e

NFA believes at this time that Regulation afi@)(\'s exemption from

CPO registration does not support the 2003 elimination of the "five-percent trading test."

Specifically, although Regulation 4.13(aXa) does not contain any restriction on the

purpose or scope of a pool's commodity interest trading, we believe a critical distinction

between a Regulation 4.5 qualifying entity and a Regulation 4.13(a)(4) pool is the

qualifications of the fund participants'u-Regulation a.13(aXa)(iiXA) requires every

natural person pool participant to be a "qualified eligible person" as defined in

Commission Regulation 4.7(a)(2). In contrast, Regulation 4.5 has no qualification

requirement for customers who may invest in a qualifying entity, including a registered

investment company. Moreover, NFA strongly believes that in circumstances in which

no qualification requirement exists for fund participants, then NFA and the CFTC should

t NFA recognizes that registered investment companies may need to engage in futures transactions for

bona fide neOging purposes and believes they should be permitted to engage a de minimis amount of

speculative futures trading without the necessity to be registered with and regulated by the CFTC.

10 Another distinction is interests in Regulation a.13(a)(a) pools are exempt from registration under the

Securities Act of 1933 while Regulation 4.5 qualifying entities are operated by otherwise regulated

persons. For the reasons explained in this letter, however, NFA believes that to the extent that the

Commission's 2003 amendments to Regulation 4.5 were, in part, premised on the "otherwise regulated

nature" of the qualifying entities, this premise may no longer be valid.
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have regulatory oversight of collective investment vehicles that engage in more than a

de minimis amount of futures trading. 11

Additionally, to the extent that the Commission's 2003 amendments to

Regulation 4.5 were, in part, premised on the "othenruise regulated nature" of the

qualifying entities, this premise may no longer be valid. As noted above, despite the

fact that these registered investment companies are marketed to retail customers as an

actively managed futures fund, they are not subject to customer protection rules entirely

comparable to the CFTC's Parl4 Regulations and NFA's Compliance Rules. NFA

believes that a registered investment company that is marketed, in part, to

unsophisticated retail customers as a commodity pool or otherwise as or in a vehicle for

trading in (or othenryise seeking exposure to) the commodity futures or commodity

options markets or that engages in more than a de minimis amount of non-hedge

futures trading should be subject to the CFTC's Part 4 regulatory requirements and

protections, and the oversight of the CFTC and NFA who have the experience and

expertise in regulating managed retail futures products. The CFTC alone has the

Congressional mandate to regulate retail managed futures trading and products, and

over the years has developed the specialized body of skill and knowledge necessary to

fulfillthis mandate.

Additionally, NFA is deeply concerned that a number of CPOs who

currently operate public pools will avail themselves of this alternative registered

investment company structure. Given our concern with this registered investment

company structure and the lack of adequate retail customer protections in some areas

comparable to those afforded prospective investors in a public commodity pool subject

to Part 4, NFA does not believe that retail futures customers would be served well if this

migration were to occur.

tt NFA notes that Commission Regulation 4.13(a)(3) provides an exemption from CPO registration,

which requires a pool to meet one of two tests with respect to its commodity interest positions, including

positions in security futures products, whether entered into for bona fide hedging purposes or otherwisethe aggregate initial margin and premiums required to establish such positions will not exceed 5% of the

liquidation value of the pool's portfolio, after taking into account unrealized profits and unrealized losses

on any such positions it has entered into or the aggregate net notional value of such positions does not

exceed 100% of the liquidation value of the pool's portfolio, after taking into account unrealized profits and

unrealized losses on any such positions it has entered into. Moreover, CFTC Regulation 4.13(aX3Xiii)

requires natural person pool participants to at least meet the accredited investor qualification standards.
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For these reasons, NFA respectfully requests that the Commission amend

Regulation a.s(c) to require a registered investment company claiming an exclusion

from the definition of the term "commodity pool operator" to represent in the notice of

eligibility that the qualifying entity (i.e. registered investment company) will be operated

such that it (1) will not be, and has not been, marketing participations to the public as or

in a commodity pool or otherwise as or in a vehicle for trading in (or othenvise seeking

investment exposure to) the commodity futures or commodity options markets; and (2)

will use commodity futures or commodity options contracts solely for bona fide hedging

purposes and, with respect to positions that may be held by the qualifying entity only for

non-bona fide hedging purposes the aggregate initial margin and premiums required to

establish such positions will not exceed five percent of the liquidation value of the

qualifying entity's portfolio, after taking into account unrealized profits and unrealized

losses on any such contracts it has entered into.

Lastly, NFA recognizes that, if adopted, the proposed amendments to

Regulation 4.5 will impose the same operating restrictions on registered investment

companies that were in place prior to 2003. Obviously, since 2003, a number of

persons have filed notices of eligibility pursuant to Regulation 4.5(c) on behalf of

registered investment companies, and those entities may no longer be eligible for

exclusion from CPO registration in the future if the proposed amendments are adopted.

Therefore, NFA encourages the Commission to provide adequate time for these

registered investment companies to comply with the Commission's applicable

regulations or seek the appropriate relief therefrom.

Additionally, to the extent that the Commission has granted operational

relief from certain Part 4 Regulations (e.9. disclosure document and reporting and

recordkeeping) to exchange traded funds-that are commodity pools organized as

Delaware statutory trusts-NFA encourages the CFTC to determine whether it is

appropriate to grant similar and/or other relief to public commodity pools and listed

pools that may want to continue operating as registered investment companies. lf the

Commission desires, NFA is willing to participate in discussions in the future with

Commission staff to achieve this result, which may necessitate harmonizing CFTC and

SEC regulatory requirements.
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NFA respectfully petitions the Commission to amend Regulations 4.5 as

described above.

Senior Vice President

and General Counsel

Via Email:

Honorable Gary Gensler, CFTC Chairman

Honorable Michael Dunn, CFTC Commissioner

Honorable Scott O'Malia, CFTC Commissioner

Honorable Jill E. Sommers, CFTC Commissioner

Honorable Bart Chilton, CFTC Commissioner

Mr. Ananda Radhakrishnan, CFTC Director

Mr. William Penner, CFTC Deputy Director

m:\cawvegulatory\ rev.Petition for Rulemaking 4.5(c).doc