Two-Part Documents for Commodity Pools

COMMODITY FUTURES TRADING COMMISSION

17 CFR Part 4

Two-Part Documents for Commodity Pools

AGENCY: Commodity Futures Trading Commission.

ACTION: Final rule.

-----------------------------------------------------------------------

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.

---------------------------------------------------------------------------

\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).

---------------------------------------------------------------------------

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.

---------------------------------------------------------------------------

\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.

---------------------------------------------------------------------------

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.

---------------------------------------------------------------------------

\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).

---------------------------------------------------------------------------

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.

---------------------------------------------------------------------------

\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.

---------------------------------------------------------------------------

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.

---------------------------------------------------------------------------

\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.

---------------------------------------------------------------------------

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.

---------------------------------------------------------------------------

\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.

---------------------------------------------------------------------------

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.

---------------------------------------------------------------------------

\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.

---------------------------------------------------------------------------

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.

---------------------------------------------------------------------------

\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.

---------------------------------------------------------------------------

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.

---------------------------------------------------------------------------

\13\ 47 FR 18618-18621 (April 30, 1982).

\14\ 47 FR 18619-18620.

---------------------------------------------------------------------------

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.

---------------------------------------------------------------------------

\15\ Pub. L. 104-13 (May 13, 1995).

---------------------------------------------------------------------------

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