[Federal Register Volume 63, Number 210 (Friday, October 30, 1998)]
[Rules and Regulations]
[Pages 58300-58303]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 98-29102]


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COMMODITY FUTURES TRADING COMMISSION

17 CFR Part 4


Two-Part Documents for Commodity Pools

AGENCY: Commodity Futures Trading Commission.

ACTION: Final rule.

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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.
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    \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).

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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.
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    \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.
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    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.
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    \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).
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    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.
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    \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.
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    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.
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    \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.
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    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.
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    \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.
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    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.
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    \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.
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    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.
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    \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.
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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.
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    \13\ 47 FR 18618-18621 (April 30, 1982).
    \14\ 47 FR 18619-18620.
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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.
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    \15\ Pub. L. 104-13 (May 13, 1995).
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    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:

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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