Performance Data and Disclosure for Commodity Trading Advisors

COMMODITY FUTURES TRADING COMMISSION

17 CFR Part 4

Performance Data and Disclosure for Commodity Trading Advisors

AGENCY: Commodity Futures Trading Commission.

ACTION: Proposed rules.

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SUMMARY: On June 18, 1998, the Commodity Futures Trading Commission

(``CFTC'' or ``Commission'') published in the Federal Register a

``Concept Release'' seeking public comment on issues relating to the

computation and presentation of rate of return information and other

disclosures concerning partially-funded accounts managed by commodity

trading advisors (``CTAs''). The Concept Release discussed rules

proposed by National Futures Association (``NFA'') as well as several

other issues related to the presentation of CTA and commodity pool

operator disclosure which appeared to warrant further study and

analysis. The Concept Release requested public comment on both the NFA

proposal and the other issues. Based on its consideration of comments

received in response to the Concept Release, the Commission has

determined to propose revisions to its rules concerning the

documentation, computation, and disclosure of CTA's past performance

information. The rules are intended to simplify the recordkeeping and

computational requirements for CTAs who accept partially-funded client

accounts, while providing for meaningful and focused disclosure to

clients regarding the past performance of the CTA, and the risks

attendant upon trading on a partially-funded basis.

DATES: Comments must be received by October 1, 1999.

ADDRESSES: Comments on the proposed rules may be sent to Jean A. Webb,

Secretary of the Commission, Commodity Futures Trading Commission, 1155

21st Street, NW., Washington, DC 20581. In addition, comments may be

sent by facsimile transmission to facsimile number (202) 418-5221, or

by electronic mail to [email protected]. Reference should be made to

``Performance Data and Disclosure for Commodity Trading Advisors.''

FOR FURTHER INFORMATION CONTACT: Robert B. Wasserman, Associate

Director, (202) 418-5092, electronic mail: ``[email protected],'' or

Eileen R. Chotiner, Futures Trading Specialist,

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(202) 418-5467, electronic mail: ``[email protected],'' Division of

Trading and Markets, Commodity Futures Trading Commission, 1155 21st

Street, NW., Washington, DC 20581.

SUPPLEMENTARY INFORMATION:

I. The Concept Release

The Concept Release sought public comment on computational and

disclosure matters relating to participation in programs of commodity

trading advisors (``CTAs'') on a partially-funded basis and raised

specific questions regarding a number of issues: (1) Improving risk

profile data for clients considering participation in CTA programs on a

partially-funded basis; (2) providing CTA client account information to

futures commission merchants (``FCMs'') to aid the FCM's risk

management; (3) improving risk profile data on commodity pools; (4)

providing a theoretically sound basis of computation and presentation

for rate of return (``ROR'') and related risk profile data; (5)

improving the presentation of historical performance and risk profile

data; and (6) providing periodic statements of program activity and

results to CTA clients.

The Commission initially provided a 60-day comment period on the

Concept Release, through August 17, 1998. On August 6, 1998, the

Commission extended the comment period for 30 days, through September

16, 1998. The Commission received 19 comments on the release: four from

firms registered as both CTAs and commodity pool operators (``CPOs'');

three from registered CTAs; one from a registered CPO; one from a bar

association; one from a futures self-regulatory organization; one from

a futures industry trade association; two from academicians; one from

an administrative law judge; two from accounting/compliance firms; two

from other financial services firms; and one from an individual

investor.

The Concept Release addressed in particular rules proposed by the

National Futures Association (``NFA'').\1\ In the rule submissions, NFA

proposed that ROR be computed on the basis of the nominal account size,

rather than the beginning net asset value (``BNAV'') of the account, as

currently required by Commission Rule 4.35(a)(6). NFA asserted that the

amount of actual funding in a client's account does not control the

CTA's trading decisions. In the Concept Release, the Commission raised

questions about whether nominal account size is a legitimate basis for

the computation of ROR, as well as whether NFA's proposed documentation

and disclosure requirements were sufficient to address concerns about

the impact of partial funding on a client's account.

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\1\ By letters dated March 15, 1994 and March 15, 1995, NFA

submitted to the Commission for its approval, pursuant to Section

17(j) of the Act, NFA Compliance Rule 2-34 and its Interpretive

Notice regarding documentation and disclosure for partially-funded

accounts. By letter dated February 26, 1998, NFA submitted a

revision to NFA Compliance Rule 2-29 regarding the rate of return

computation.

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In response to the questions raised in the Concept Release, some

commenters indicated concern regarding the validity of the nominal

account size and the ability of clients to interpret and compare

performance data presented on a basis other than the actual funds

deposited in a client's account. However, the majority of commenters,

including NFA, the Managed Funds Association (``MFA''), and several

CPOs and CTAs, expressed support for the use of nominal account size as

the basis for computing ROR and presenting the CTA's past performance.

The Concept Release also discussed the current requirements for

disclosure of draw-down information pursuant to Rules 4.35(a)(1)(v) and

(vi), and asked for comment on the possibility of expanding draw-down

disclosure in two areas. First, the Concept Release sought comment on

the advisability of requiring draw-down percentage data to be presented

at two or three partial-funding levels that are representative of those

offered by the CTA, in addition to the fully-funded level. Second, the

Concept Release sought comment on the concept of enhancing disclosure

of a program's historical volatility, possibly by expanding the time

period for historical performance disclosure; reducing the amount of

monthly data; and requiring more detailed information concerning the

volatility of the CTA's program, either through an expanded number of

worst draw-down months, or by requiring presentation of the standard

deviation of the monthly returns.

A number of commenters expressed concern that requiring too many

items of data would result in less attention being paid to that

information. The Commission has been attentive to those concerns. In

seeking to highlight the increased leverage--and consequent increased

risk--in partially funding accounts, the Commission has proposed a set

of disclosures that is significantly limited compared to that discussed

in the Concept Release.

A number of other ideas discussed in the Concept Release generated

substantial opposition from commenters. These include a requirement

that a CTA provide a copy of its agreement with the client to the

client's FCM and additional reporting requirements for CTAs. The

Commission has determined not to include these in the proposed rules.

II. The Proposed Rules

The Commission has carefully considered the comments received, and

has determined to revise its rules to provide a comprehensive framework

for addressing certain of the issues raised in the Concept Release. In

making the current proposal, which incorporates most of the concepts

included in the NFA proposal, the Commission seeks to simplify the

recordkeeping and computational requirements for CTAs who accept

partially-funded client accounts, while providing for meaningful and

focused disclosure to clients regarding the past performance of the

CTA, and the risks attendant upon trading on a partially-funded basis.

In particular, the Commission has determined to revise its rules to

require that ROR be computed by dividing net performance by the nominal

account size. This change is intended to reduce regulatory burdens by

relieving CTAs of the responsibility for tying nominal account size to

actual funding levels, and to permit a uniform method for CTAs to

calculate their RORs, regardless of whether they accept partially-

funded client accounts. As discussed below, CTAs who wish to measure

performance on an actual funds basis may do so by setting the nominal

account size equal to the actual funding level.

The risk disclosure requirements included in the proposed rules are

intended to highlight critical information without overloading the

client with excessive data. Other changes are proposed primarily to

codify certain definitions and other information currently contained in

Commission advisories.\2\

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\2\ CFTC Advisory 87-2 [1986-87 Transfer Binder] Comm. Fut. L.

Rep. (CCH) para. 23,624 (June 2, 1987); CFTC Advisory 93-13, 58 FR

8226 (February 12, 1993).

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A. Documentation of Nominal Account Size

In order to address concerns regarding documentation of the nominal

account size and other terms of the CTA's trading for clients'

accounts, the Commission is proposing to add new paragraph (c) to Rule

4.33. This provision would require that the CTA execute a written

agreement with each client that specifies: The nominal account size;

the name or description of the trading program in which the client is

participating; the basis for the

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computation fees; how additions or withdrawals of actual funds, or

profits and losses will affect each of (a) the nominal account size and

(b) the computation of fees; and whether the client will fully or

partially fund the account. The provisions of proposed Rule 4.33(c) are

substantially similar to the documentation requirements that were

included in NFA's Proposal.

These requirements will apply to all CTAs, regardless of whether

they accept partially-funded accounts. A CTA that intends to continue

to measure its performance using actual funds may establish a nominal

account size which is defined on an actual funds basis. The information

specified by Rule 4.33(c) need not be contained in a separate

agreement, but may be included as part of any other signed written

agreement between the CTA and the client.

B. Changes to Calculations

The Commission is proposing to amend and re-order paragraphs (A)--

(F) of Rule 4.35(a)(6)(i) to accommodate the use of nominal account

size, rather than net asset value, as the basis for performance

computation.\3\ Rule 4.10(l) would also be amended to define the

measurement of a CTA's worst peak-to-valley draw-down by net

performance relative to nominal account size, rather than changes in

net asset value. Proposed Rules 4.35(a)(6)(i)(D) and (E) address the

fact that changes to the nominal account size may result either from

changes in actual amounts, such as additions, withdrawals, profits or

losses; or from changes to the nominal account size, pursuant to the

terms of the CTA's agreement with the client in accordance with

proposed Rule 4.33(c)(1). Proposed Rule 4.35(a)(6)(i)(B) defines net

performance as the sum of the realized gain or loss on positions closed

during the period plus the change during the period in unrealized gain

or loss, plus interest on funds deposited with the client's FCM, less

fees and expenses. This proposed rule also provides that no interest

income may be imputed with respect to nominal account sizes or

otherwise computed on a pro-forma basis.

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\3\ For example: Under the current method of calculation, if a

CTA's program has beginning net asset value (BNAV) of 100, ending

net asset value (ENAV) of 150, additions (ADDS) of 40 and

withdrawals (WDRS) of 0, then net performance (NET-PERF) is 10, and

ROR is 10%:

NET-PERF = ENAV - BNAV - ADDS + WDRS

10 = 150 - 100 - 40 + 0

ROR = NET-PERF/BNAV

10% = 10/100

Under the proposal, the CTA is not required to monitor net asset

values, and thus net performance must be calculated directly. Under

the proposed method of calculation, if the total of the nominal

account sizes for the CTA's program (BNOM) is 100 at the beginning

of the month, the realized gain on positions closed during the

period (RG) is 7, the change in unrealized gains (UN-RG) is 5, and

fees and expenses (FEES) are 2, then NET-PERF is still 10, and ROR

is still 10%:

NET-PERF = RG + UN-RG - FEES

10 = 7 + 5 - 2

ROR = NET-PERF/BNOM

10% = 10/100

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Although proposed rule 4.35(a)(6)(i)(B) would include, as part of

net performance, interest on actual funds deposited with the client's

FCM, this raises questions regarding whether such interest should be

credited as part of the CTA's performance where the interest is earned

on investments directed by the FCM (as opposed to the CTA). Reasons

supporting the inclusion of the interest include the following: (1)

Since trading fees are charged against the CTA's performance, even

though the commission rate may be negotiated by the client and the FCM,

interest earned at the FCM should be credited to the CTA's performance

to maintain parity; and (2) the interest is, in a real sense, part of

the return on the funds. Reasons against the inclusion of the interest

include the following: (1) Since the objective of performance reporting

is to convey the results from the trading which a CTA performed on

behalf of a client, it may be misleading to include interest earned on

investments managed by the FCM (as opposed to the CTA); and (2) as one

commenter explained, ``(i)f a CTA agrees with each of several clients

to a nominal account size and each account is traded similarly, the

performance results of the CTA as they relate to these accounts should

be the same.'' But, if interest on the funds on deposit with the

client's FCM is included in the CTA's performance results, then the CTA

will have different performance results, depending on each client's

arbitrarily selected funding level. The Commission solicits comment on

this issue.

C. Disclosure of Actual Funding Levels and Funds Under Management

In accepting the use of nominal account size to compute ROR, the

Commission intends to permit CTAs to disclose their trading results as

they relate to the account size which governs their trading decisions.

However, the Commission believes that disclosure of the amount of

client assets managed by the CTA--the funds under management--should

continue to reflect the amount of actual funds committed by clients to

the CTA's trading program, rather than the aggregate of nominal account

sizes. It would be misleading to describe ``notional funds,'' \4\ which

the client has chosen not to place in an account over which the CTA has

trading authority, as ``funds under management.'' Rule 4.35(a)(1),

therefore, would be revised to clarify that the disclosure of funds

under management must reflect only the actual funds committed to the

CTA's trading program. The term ``Actual Funds'' is defined in new Rule

4.10(n), which codifies the definitions included in Commission

Advisories 87-2 and 93-13.\5\ Rule 4.35(a)(1) would permit a CTA that

does not posses information about the amount of actual funds a client

has deposited to meet this disclosure requirement by simply disclosing

that lack of information. New provisions, set forth in Rule

4.35(a)(1)(ix), would require that the performance capsule state the

percentage of client accounts in the program that are fully funded and

specify that any disclosure of aggregate nominal account sizes must be

identified clearly as such and presented adjacent to the actual funds

amounts.

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\4\ The difference between the nominal account size and the

actual funding level frequently been referred to as ``notional

funds.''

\5\ See supra, note 2.

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D. Disclosure Concerning Draw-Downs

If the client funds the account traded by the CTA at a level less

than the nominal account size, then gains or losses will represent a

greater percentage of the amount funded. In other words, the leverage

will be increased. This increased leverage increased both the

likelihood that the client will be faced with a margin call and the

size of such a potential margin call. It also increases the risk that

the client will lose more than the funds it has advanced. In order to

indicate clearly to potential clients the increased leverage--and the

consequent increased risk--inherent in partial funding, new Rule

4.35(a)(1)(ix)(A) would require CTAs who accept partially-funded

accounts to present draw-down figures computed on the basis of the

actual funds committed to the CTA's program by the client with the

lowest ratio of actual funds to nominal account size in the trading

program.\6\ If the CTA does not have sufficient information regarding

the funding level of its client accounts, or if the lowest ratio is

zero, the draw-down information would be presented at a funding level

of 20%. These additional draw-down figures would be presented adjacent

to the worst monthly and peak-to-valley draw-

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down percentages based on the aggregate nominal account sizes.

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\6\ For example, if the lowest funding level is 25% and the

greatest monthly drawdown is 15%, the drawdown shown on the basis of

actual funding would be 60% (15%25%).

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The concept release discussed the Commission's concern regarding

disclosure of the historical volatility of CTA programs and suggested

that, since extreme market events do not always occur within the five-

year time-frame specified by the regulations, this time-frame may

permit some CTAs to omit their greatest draw-downs from their

historical risk profiles. In order to address these concerns, the

Commission proposes to revise Rules 4.35(a)(1)(v) and (vi) to require

that the worst monthly and peak-to-valley draw-down, which will be

based on the composite of accounts, be included in the performance

capsule for the most recent five years and, in addition, for the life

of the program, if longer than five years. The Commission does not

intend that this requirement create a significant additional

recordkeeping burden for CTAs, and is proposing a corresponding change

to Rule 4.35(a)(6)(ii) to clarify that only the monthly figures derived

from the supporting documentation, and not the supporting documentation

itself, must be maintained beyond the five-year period specified in

Rule 1.31. However, the Commission specifically invites comment

regarding the extent to which the additional draw-down disclosure would

provide a benefit to clients and details regarding the extent of any

additional burden that is anticipated.7

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\7\ Of course, prior to the effective date of these proposed

rule changes, commodity trading advisors would not be obligated to

maintain records for this purpose longer than the five years

required under Rule 1.31.

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E. Disclosure Concerning Range of Rates of Return

The Commission believes that disclosing the range of RORs for

closed accounts in the offered program provides an important measure of

the returns experienced by clients and will be useful to prospective

clients considering participation in the CTA's program. Therefore, the

Commission is also proposing to revise Rule 4.35(a)(1)(viii) to require

that the performance capsule for the offered program include, in

addition to the number of accounts closed with profits and the number

closed with losses, the range of rates of return for the accounts

closed with net lifetime profits and accounts closed with net lifetime

losses, during the five-year period. As previously noted, Rules

4.35(a)(1)(v) and (vi) would be revised to specify that the worst draw-

down information be based on the composite of accounts. Thus, the draw-

down figures in the CTA's capsule would not reflect the ROR of a client

account that performed worse than other accounts in composite

8 In light of the proposed changes to Rules 4.35(a)(1)(v)

and (vi), the Commission believes that presentation of the range of

RORs for closed accounts would provide a valuable additional

perspective on the results experienced by individual clients. The

Commission does not anticipate a significant additional burden as a

result of this change due to the existing requirement of Rule

4.35(a)(1)(viii) that CTAs disclose the number of accounts closed with

profits and the number of accounts closed with losses.

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\8\ However, CTAs would remain subject to the requirement of

Rule 4.34(o) to disclose all material information to existing or

prospective clients even if such information is not specifically

required by these regulations.

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F. Disclosure of Monthly Performance

The Commission wishes to explore the possibility of requiring that

the monthly RORs be presented in a bar graph, in order to provide a

more direct visual representation of the variations in RORs from month

to month. Currently, Rule 4.35(a)(2)(ii) specifies that monthly RORs

for the offered program must be presented either in a numerical table

or in bar graph. Proposed revisions to Rule 4.35(a)(2)(ii) would

require the bar graph to be disclosed in addition to the tabular

presentation of monthly ROR figures. The Commission is requesting

comment regarding whether use of a bar graph may communicate the month-

to-month changes in customer returns more effectively than a tabular

presentation, as well as whether the bar graph should be required in

lieu of the tabular presentation of RORs. In addition, the Commission

seeks comment regarding the significance of any additional burden that

may result from the requirements.

G. Illustrative Performance Capsule

An example of a performance capsule that would meet the disclosure

requirements, modified as discussed in Secs. II(C-F) above, is attached

as Appendix A. This example is not intended to mandate a particular

format, but only to serve as an illustration.

H. Changes to Definitions and Disclosure Requirements

Changes are also being proposed to codify definitions and other

information currently contained in Commission advisories as well as to

clarify existing rules and definitions in the context of the proposed

rule revisions. New Rule 4.34(p), in the main, codifies certain of the

requirements currently set forth in Commission Advisory 93-13, and also

discussed as part of the NFA Proposal, for disclosure to prospective

clients of material information concerning the practice of partially

funding an account and the factors considered by the CTA in determining

the trading level for a given nominal account size. Definitions of

``nominal account size,'' ``actual funds'' and ``partially-funded

account'' are proposed to be added as Rules 4.10(m), (n) and (o),

respectively.

Proposed Rule 4.10(p) contains a definition of ``most recent five

years'' that is intended to simplify the terminology used to designate

the five calendar years and year-to-date time period for which

performance is required to be disclosed pursuant to Rules 4.25(a)(5)

and 4.35(a)(5). This clarification does not affect the existing

provisions of Rules 4.25(a)(7) and 4.35(a)(4) that require performance

information in a Disclosure Document to be current as of a date not

more than three months preceding the date of the Disclosure Document.

I. Commodity Pool Disclosure

The Concept Release included a detailed discussion of disclosure by

CPOs. Due to the complexity of pool performance issues, the Commission

is, generally, deferring consideration of changes to the requirements

for disclosure of past performance by CPOs, other than changes

primarily intended to conform the requirements for presentation of CTA

past performance in pool disclosure documents with the revisions to

Rule 4.35(a)(1) proposed herein. Other issues relating to pools will be

considered in the context of the Commission's implementation of

recommendations included in the President's Working Group on Financial

Markets' April 1999 study, ``Hedge Funds, Leverage and the Lessons of

Long-Term Capital Management.''

In order to highlight a use of leverage by commodity pools, the

Commission is proposing one substantive revision to commodity pool

disclosure in Rule 4.25(a)(1)(ii)(H). This provision would be

applicable only where the CPO allocates, to any of the pool's CTAs, an

amount of actual funds which is less than the nominal account size

stated in the pool's written agreement with the CTA. In such cases, the

CPO would be required to include in the performance capsule for each

such CTA, in a column adjacent to the presentation of data based on

nominal account size, the draw-down information required by Rule

4.25(a)(1)(ii)(E) and (F), computed on the basis of the ratio of the

nominal account size to the pool's actual funds allocated to the CTA's

program.

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III. Transitional Provisions

The Commission proposes to require CTAs and CPOs to comply with the

revisions proposed herein, including the requirement to obtain the

documentation required by new Rule 4.33(c) for both new and existing

clients, by no later than July 1, 2000. The Commission seeks comment on

any difficulties anticipated in complying with these proposed

requirements by July 1, 2000. CTAs and CPOs would be permitted to adopt

these changes immediately upon the effective date of the proposed

rules.

IV. Related Matters

A. Regulatory Flexibility Act

The Regulatory Flexibility Act (``RFA''), U.S.C. 606-11 (1994),

requires that agencies, in proposing rules, consider the impact of

those rules on small businesses. 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.\9\ The Commission previously has determined

that registered CPOs are not small entities for the purpose of the

RFA.\10\ With respect to CTAs, the Commission has stated that it would

evaluate within the context of a particular rule proposal whether all

or some affected CTAs would be considered to be small entities and, if

so, the economic impact on them of any rule.\11\ In this regard, the

Commission notes that the rule revisions being proposed herein create

some changes to the content of the documentation and disclosure

requirements for CTAs, but are not expected to increase such

requirements, and, in fact, are expected ultimately to ease the

computational and recordkeeping requirements for CTAs who manage

partially-funded client accounts. The Commission has previously

determined that the disclosure requirements governing this category of

registrant will not have a significant economic impact on a substantial

number of small entities \12\ Therefore, the Acting Chairman, on behalf

of the Commission, hereby certifies, pursuant to 5 U.S.C. 605(b), that

these proposed regulations will not have a significant economic impact

on a substantial number of small entities. Nonetheless, the Commission

specifically requests comment on the impact these proposed rules may

have on small entities.

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\9\ 47 FR 18618-181621 (April 30, 1982).

\10\ 47 FR 18619-18620.

\11\ 47 FR 18618-18620.

\12\ See 60 FR 38146, 38181 (July 25, 1995) and 48 FR 35248

(August 3, 1983).

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B. Paperwork Reduction Act

The Paperwork Reduction Act of 1995 (Pub. L. 104-13 (May 13, 1995))

imposes certain requirements on federal agencies (including the

Commission) in connection with their conducting or sponsoring any

collection of information as defined by that Act.

The group of rules contained in all of Part 4, ``Commodity Pool

Operators and Commodity Trading Advisers,'' of which Rules 4.10, 4.25,

4.33, 4.34 and 4.35 are a part, was approved on September 4, 1998 and

assigned OMB control number 3038-0005. The Commission does not

anticipate that the proposed revisions to the rules will affect the

total burden of this group of rules. The group of rules contained in

OMB control number 3038-0005 has the following burden:

Average burden hours per response: 4.95

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.

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 4.10 is proposed to be amended by revising paragraph (l)

and adding paragraphs (m), (n), (o) and (p) to read as follows:

Sec. 4.10 Definitions.

* * * * *

(l) Worst peak-to-valley draw-down means:

(1) For a commodity pool, the greatest cumulative percentage

decline in month-end net asset value due to losses sustained during any

period in which the initial month-end net asset value is not equaled or

exceeded by a subsequent month-end net asset value. Such decline must

be expressed as a percentage of the initial month-end net asset value,

together with an indication of the months and year(s) of such decline

from the initial month-end net asset value to the lowest month-end

asset value of such decline.

(2) For an account directed by a commodity trading advisor or for a

commodity trading advisor's trading program, the greatest negative net

performance during any period, beginning at the start of one month, and

ending at the conclusion of that month or a subsequent month. The worst

peak-to-valley draw-down must be expressed as a percentage of the

nominal account size at the beginning of the period, together with an

indication of the months and year(s) of such draw-down.

(3)(i) For purposes of paragraph (2) of this section, net

performance for a period is defined as the total of:

(A) the realized gain or loss on position closed during the period,

plus

(B) The change during the period in unrealized gain or loss, plus

(C) Interest accrued on funds deposited in the client's account at

a futures commission merchant, plus

(D) Other income accrued on positions held as part of the CTA's

program, minus

(E) Fees and expenses.

(ii) No income may be imputed with respect to nominal account sizes

or otherwise computed on a pro-forma basis.

(4) For purposes of Secs. 4.25 and 4.35, a peak-to-valley draw-down

which began prior to the beginning of the most recent five calendar

years is deemed to have occurred during such five-calendar-year period.

(m) Nominal account size means the account size, designated in the

written agreement specified in Sec. 4.33(c), which establish he

client's level of trading in a commodity trading advisor's program.

(n) Actual funds means the amount of margin-qualifying assets

committed to a commodity trading advisor's program, either:

(1) On deposit in an account at a futures commission merchant to

margin the client account for which a commodity trading advisor has

trading authority; or

(2) In another account, so long as the commodity trading advisor

has written evidence demonstrating the following:

(i) The client owns the funds and has designated such funds as

committed to the commodity trading advisor's trading program;

(ii) The futures commission merchant carrying the client's account

for which the commodity trading advisor directs trades has the power to

transfer the funds readily from the other account for the purpose of

meeting margin requirements in connection with such trades, on a

routine operational basis

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and without advance notice to the client; and

(iii) The commodity trading advisor has ready access to information

concerning the designated balance in the account.

(o) Partially-funded account means a client participation in the

program of a commodity trading advisor in which the amount of actual

funds committed to the trading program is less than the nominal account

size.

(p) For purposes of Secs. 4.25 and 4.35, the term most recent five

years means:

(1) The time period beginning January 1 of the calendar year five

years prior to the date of the Disclosure Document and ending as of the

date of the Disclosure Document or

(2) The life of the trading program, if less than five years.

3. Section 4.25 is proposed to be amended by revising paragraphs

(a)(1)(ii)(D)(1) and (2) and (E) and (F) and by adding paragraph

(a)(l)(i)(H) to read as follows:

Sec. 4.25 Performance disclosures.

(a) * * *

(1) * * *

(ii) * * *

(D)(1) The aggregate of actual funds committed to all of the

trading programs of the trading advisor or other person trading the

account, as of the date of the Disclosure Document or, if the commodity

trading advisor does not have sufficient information regarding the

funding of its client's accounts to determine the aggregate of actual

funds committed to its programs, a statement of that fact;

(2) The aggregate of actual funds committed to the specified

trading program of the commodity trading advisor, as of the date of the

Disclosure Document or, if the commodity trading advisor does not have

sufficient information regarding the funding of its clients' accounts

to determine the aggregate of actual funds which are committed to the

specified trading program, a statement of that fact.

(E) The greatest monthly draw-down for the trading program

specified, expressed as a percentage of aggregate nominal account

sizes, and indicating the month and year of the draw-down during the

most recent five years.

(F) The greatest peak-to-valley draw-down for the trading program

specified, expressed as a percentage of aggregate nominal account

sizes, and indicating the month(s) and year(s) of the draw-down during

the most recent five years.

* * * * *

(H) In addition to the information specified in

Sec. 4.25(a)(1)(ii)(A)-(G), where the CPO allocates, to any of the

pool's, CTAs, an amount of funds which is less than the nominal account

size states in the written agreement with the CTA, the performance

capsule for each such CTA must include, in a column adjacent to the

presentation of data based on nominal account size, the draw-down

information required by Sec. 4.25(a)(1)(ii)(E) and (F), computed on the

basis of the ratio of the nominal account size to the pool's actual

funds allocated to the commodity trading advisor's program.

4. Section 4.33 is proposed to be amended by adding paragraph (c)

to read as follows:

Sec. 4.33 Recordkeeping.

* * * * *

(c) A commodity trading advisor must obtain a written agreement

signed by each client which, at a minimum, clearly specifies:

(1) The nominal account size;

(2) The name or description of the trading program in which the

client is participating;

(3) The basis for the computation of fees;

(4) How each of the following will affect each of the nominal

account size and the computation of fees: additions or withdrawals of

actual funds or profits or losses; and

(5) Whether the client will deposit, maintain or make accessible to

the FCM an amount equal to or less than the nominal account size, i.e.,

to fully or partially fund the account.

5. Section 4.34 is proposed to be amended by adding paragraph (p)

to read as follows:

Sec. 4.34 General disclosures required.

* * * * *

(p) Additional Disclosure by Commodity Trading Advisors Accepting

Partially-funded Accounts. A commodity trading advisor that accepts a

partially-funded account (as defined in Sec. 4.10(o)) must disclose:

(1) How the management fees will be computed, expressed as a

percentage of the nominal account size, and an explanation of the

effect of partially funding an account on the management fees as a

percentage of actual funds.

(2) An estimated range of the commissions generally charged to an

account expressed as a percentage of the nominal account size and an

explanation of the effect of partially funding an account on the

commissions as a percentage of actual funds;

(3) A statement that partial funding increases leverage, that

leverage will magnify both profits and losses, and that the greater the

disparity between the nominal account size and the amount deposited,

maintained or made accessible to the futures commission merchant, the

greater the likelihood and frequency of margin calls, and the greater

the size of margin calls as a percentage of the amount of actual funds

committed to the commodity trading advisor's program; and

(4) A description of the factors considered by the commodity

trading advisor in determining the level of trading for a given nominal

account size in the offered trading program and an explanation of how

those factors are applied.

6. Section 4.35 is proposed to be amended by revising paragraphs

(a)(1)(iv) through (a)(1)(ix), (a)(2), (a)(6)(i) and (a)(6)(ii) to read

as follows:

Sec. 4.35 Performance disclosures.

* * * * *

(a) * * * (1) * * *

(iv)

(A) The aggregate of actual funds committed to all of the trading

programs of the trading advisor or other person trading the account, as

of the date of the Disclosure Document, of, if the commodity trading

advisor does not have sufficient information regarding the funding of

its clients' accounts to determine the aggregate of actual funds

committed to its programs, a statement of that fact;

(B) The aggregate of actual funds committed to the specified

trading program of the commodity trading advisor, as of the date of the

Disclosure Document, or, if the commodity trading advisor does not have

sufficient information regarding the funding of its client accounts to

determine the aggregate of actual funds which are committed to the

specified trading program, a statement of that fact.

(v) The greatest monthly draw-down for the trading program

specified, expressed as a percentage of aggregate nominal account

sizes, and indicating the month and year of the draw-down during each

of the following periods:

(A) The most recent five years and

(B) If the commodity trading advisor has traded client accounts

pursuant to the trading program for longer than the most recent five

years, since the commodity trading advisor began trading the program

for client accounts.

(vi) The greatest peak-to-valley draw-down for the trading program

specified expressed as a percentage of aggregate nominal account sizes,

and indicating the month(s) and year(s) of the draw-down, during each

of the following periods:

(A) The most recent five years and

(B) If the commodity trading advisor has traded client accounts

pursuant to

[[Page 41849]]

the trading program for longer than the most recent five years, since

the commodity trading advisor began trading the program for client

accounts.

(vii) Subject to Sec. 4.35(a)(2) for the offered trading program,

the annual and year-to-date rate-of-return for the program for each of

the five most recent calendar years and year-to-date, computed on a

compounded monthly basis; and

(viii) In the case of the offered trading program:

(A)(1) The number of accounts traded pursuant to the offered

trading program that were closed during the period specified in

Sec. 4.35(a)(5) with positive net lifeline performance (profits) as of

the date the account was closed, and

(2) The range of rates of return for the accounts closed with net

lifetime profits; and

(B)(1) The number of accounts traded pursuant to the offered

trading program that were closed during the period specified in

Sec. 4.35(a)(5) with negative net lifeline performance (losses) as of

the date the account was closed, and

(2) The range of rates of return for the accounts closed with net

lifetime profits; and

(ix) In addition to the information specified in

Sec. 4.35(a)(1)(i)-(viii), where the commodity trading advisor accepts

partially-funded accounts, the performance capsule must include:

(A) A statement that rates of return are based on nominal account

size.

(B) In a column adjacent to the presentation of data based on

nominal account size, the draw-down information required by

Sec. 4.35(a)(1)(v) and (vi), divided by the percentage of actual funds

committed to the commodity trading advisor's program by the client with

the lowest ratio of actual funds to nominal account size in the trading

program.

(1) If the commodity trading advisor does not have sufficient

information regarding the funding level of its client accounts to

determine the lowest ratio, or if the lowest ratio is zero, present

this information at a funding level of 20 percent.

(2) The percentage basis of the computation, i.e., the actual funds

ratio or the optional 20 percent, must be disclosed in the heading of

the column.

(C) A statement of the percentage of client accounts in the program

for which the actual funds committed equal the nominal account size. If

the commodity trading advisor does not have sufficient information

regarding the amount of actual funds committed by its clients to the

trading program to determine the percentage of client accounts which

have actual funding equal to the nominal account size, the commodity

trading advisor must state that fact.

(D) If the commodity trading advisor elects to include the

aggregate of the nominal account sizes of the client accounts in the

trading program specified, this information must be placed adjacent to

the disclosure of actual funds under management by the commodity

trading advisor as required by Sec. 4.35(a)(1)(iv).

(2) Additional requirements with respect to the offered trading

program.

(i) (The performance of the offered trading program must be

identified as such and separately presented first;

(ii) The rate of return of the offered trading program must be

presented on a monthly basis for the most recent five years, in a

numerical table and in bar graph.

(iii) (The bar graph used to present monthly rates of return for

the offered trading program:

(A) Must show percentage rate of return on the vertical axis and

monthly increments on the horizontal axis; and

(B) Must be scaled in such a way as to clearly show month-to-month

differences in rates of return.

(iv) The commodity trading advisory must made available to

prospective and existing clients upon request a table showing the

information required to be calculated pursuant to Sec. 4.35(a)(6). This

table must be updated at least quarterly.

(6) Calculation of, and recordkeeping concerning, performance

information. (i) * * *

(A) The nominal account size at the beginning of the period,

defined as the previous period's ending nominal account size;

(B)(1) The net performance for the period, which is defined as the

total of:

(i) the realized gain or loss on positions closed during the period

plus

(ii) the change during the period in unrealized gain or loss, plus

(iii) interest accrued on funds deposited in the client's account

at a futures commission merchant, plus

(iv) other income accrued on positions held as part of the CTA's

program, minus

(v) fees and expenses.

(2) no income may be imputed with respect to nominal account sizes

or otherwise computed on a proforma a basis.

(C) The nominal rate of return for the period, which shall be

calculated by dividing the net performance by the nominal account size

at the beginning of the period.

(D) Changes to the nominal account size during the period, pursuant

to the terms of the CTA's agreement with the client in accordance with

Sec. 4.33(c)(4). The records should clearly delinate the source of each

change (additions or withdrawals of actual funds, profits or losses, or

otherwise).

(E) Changes to the nominal account size pursuant to the terms of

the CTA's agrement with the client in accordance with Sec. 433(c)(1).

The records should clearly delineate the source of each change (the

opening or closing of accounts during the period or changes to nominal

account size specifically directed by a client in writing.) If a client

and the advisor agree that a nominal account size be changed effective

at the beginning of a period, the change shall be reflected during the

prior period.

(F) The nominal account size at the end of the period, defined the

sum of the nominal account size at the beginning of the period

(Sec. 4.35(a)(6)(i)(A)) and the changes specified in this

Sec. 4.35(a)(6)(i) (D) and (E).

(ii) All supporting documents necessary to substantiate the

computation of such amounts must be maintained in accordance with

Sec. 1.31. With respect to the disclosures required by

Sec. 4.34(a)(1)(v)(B) and Sec. 4.35(a)(1)(vi)(B), the monthly figures

referred to in Sec. 4.35(a)(6)(i)(a-F) must be maintained for five

years subsequent to the last date on which disclosure document

reflecting the specified trading program is prepared.

Issued in Washington, D.C. on July 26, 1999 by the Commission.

Jean A. Webb,

Secretary of the Commission.

BILLING CODE 6351-01-M

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BILLING CODE 6351-01-C

[[Page 41851]]

Monthly Rates of Return (January 1994-April 1999)

[In percent]

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

1999 1998 1997 1996 1995 1994

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

January............................................. -15 -5 -3 -7 10 -24

February............................................ -2 3 5 8 18 9

March............................................... 4 17 -3 7 -3 4

April............................................... 7 -16 12 -3 -3 3

May................................................. ........ -5 9 -15 27 18

June................................................ ........ -11 29 2 13 -17

July................................................ ........ 2 -13 39 -9 -6

August.............................................. ........ 15 2 14 -2 25

September........................................... ........ -8 15 -8 -1 1

October............................................. ........ 10 -1 -2 12 -20

November............................................ ........ -3 -8 17 8 13

December............................................ ........ 18 12 8 33 -7

Annual/YTD.......................................... -7 10 62 63 149 -13

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

[FR Doc. 99-19572 Filed 7-30-99; 8:45 am]

BILLING CODE 6351-01-M