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CFTC Commissioners Discuss New Rules for Commodity Mutual Funds to Increase Customer Protections after MF Global Failure

Friday, February 17, 2012
Fanni Koszeg | Bloomberg LawCFTC, Statements of Support, Amendments to Compliance Obligations and Harmonization Proposal (Feb. 9, 2012); CFTC, Dissenting Statement, Commodity Pool Operators and Commodity Trading Advisors: Amendments to Compliance Obligations (Feb. 9, 2012); CFTC, Statement of Concurrence, Commodity Pool Operators and Commodity Trading Advisors: Amendments to Compliance Obligations (Feb. 2, 2012). The Commodity Futures Trading Commission (CFTC) issued a final rule (Final Rule) changing Part 4 of the CFTC's regulations on registration and compliance obligations for commodity pool operators (CPO) and commodity trading advisors. In effect, the CFTC reinstated oversight of these entities as it existed prior to 2003 for futures, and expanded its jurisdiction to mutual funds trading commodity swaps. The CFTC adopted the Final Rule by a 4-1 vote, with Commissioner Jill Sommers delivering a strongly worded dissent. The CFTC also released a proposed rule (Proposed Rule) seeking public comments on how to reduce compliance burdens for registered investment advisers, who would be required to register as CPOs under the Final Rule, so as to avoid duplicative or conflicting obligations to the CFTC and the Securities and Exchange Commission (SEC).

CFTC Authority to Adopt Final Rule

Gary Gensler supported the Final Rule, arguing that the new regulations are consistent with the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank), even if not explicitly required by it. He also said that the Final Rule addresses concerns raised in a 2010 petition by the National Futures Association (NFA) requesting that the CFTC reinstate its prior oversight of CPOs. The NFA argued that these mutual funds have increasingly been marketing their investments in commodity futures and swaps to retail investors without adequate supervision. Commissioner Scott O'Malia, who often speaks up against excessive regulation, argued in his concurring opinion that it was well within the CFTC's purview to promulgate the Final Rule. He pointed out that Dodd-Frank does not include CFTC-regulated products under the umbrella of "consumer financial products and services" regulated by the new Consumer Financial Protection Bureau. Therefore, he said, it is the CFTC's responsibility to provide more accessible and effective consumer protections in the wake of the financial crisis and MF Global's collapse. On the other hand, his Republican colleague, Commissioner Sommers, contended that the Final Rule is not mandated by Dodd-Frank and had the CFTC "limited the amendments to issues raised by the NFA's petition, [it] could have met [its] regulatory objectives without disrupting a significant number of business structures." In addition, Commissioner Sommers contended that it was unlikely that the CFTC's cost-benefit analysis supporting the Final Rule would survive judicial scrutiny.

Are the New Rules Necessary to Protect Customers?

O'Malia argued that the amendments to CFTC Rule 4.5 and rescission of the exemption from CPO registration provided in CFTC Rule 4.13(a)(4) were necessary because thousands of funds, which are not registered with the CFTC, have been accepting billions of dollars in investments in futures and swaps markets in recent years. He said that the Final Rule will remove a "major loophole that has allowed certain funds to market and sell investments in commodity futures markets" remaining outside the CFTC's jurisdiction through the use of, among others, Internal Revenue Service private letter rulings. Gensler explained that, in addition to reinstating registration requirements, the Final Rule also restricts the group of funds that will be exempted from certifying annual reports to qualified persons under CFTC Rule 4.7(b)(3) and brings foreign advisers with U.S. customers back under CFTC supervision. This—together with new reporting and recordkeeping requirements—would afford the same basic consumer protections to commodity mutual fund customers as other customers protected by the CFTC. Gensler also contended that the Final Rule would increase transparency to regulators who would now have access to important data, providing a much more complete understanding of how these CPOs are operating and what potential risks they pose in futures and swaps markets. Commissioner Sommers had a different take on the value of data collection: she warned that the Final Rule "gives a false impression that the data we gather will enable us to actively monitor pools for systemic risk, that we have the resources to do so, and that we will do so."

Proposed Rule Meant to Ensure Harmonization with the SEC

The CFTC unanimously adopted the Proposed Rule to deal with certain consequences of the Final Rule for registered investment advisers that will now also be required to register with the CFTC. Gensler said that the CFTC seeks to balance compliance requirements for the operators of these funds. O'Malia argued that the SEC supported the Final Rule since it "recognizes that the increased use and complexity of derivatives by SEC registrants was not contemplated when the Investment Company Act was enacted in 1940." Crucially, registration gives the CFTC the authority to take punitive or remedial action to address wrongful conduct, and customers will be able to access the CFTC's reparations program and the NFA's arbitration service. Despite her dislike of the Final Rule, Sommers acknowledged the need to harmonize reporting and other compliance requirements with the SEC. Both she and O'Malia voiced concerns with the current version of the Proposed Rule and invited those affected by it to actively participate in its finalization. DisclaimerThis document and any discussions set forth herein are for informational purposes only, and should not be construed as legal advice, which has to be addressed to particular facts and circumstances involved in any given situation. Review or use of the document and any discussions does not create an attorney-client relationship with the author or publisher. To the extent that this document may contain suggested provisions, they will require modification to suit a particular transaction, jurisdiction or situation. Please consult with an attorney with the appropriate level of experience if you have any questions. Any tax information contained in the document or discussions is not intended to be used, and cannot be used, for purposes of avoiding penalties imposed under the United States Internal Revenue Code. Any opinions expressed are those of the author. The Bureau of National Affairs, Inc. and its affiliated entities do not take responsibility for the content in this document or discussions and do not make any representation or warranty as to their completeness or accuracy.©2014 The Bureau of National Affairs, Inc. All rights reserved. Bloomberg Law Reports ® is a registered trademark and service mark of The Bureau of National Affairs, Inc.

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