[Federal Register Volume 68, Number 49 (Thursday, March 13, 2003)]
[Proposed Rules]
[Pages 12001-12011]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 03-6081]


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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: The Commodity Futures Trading Commission (``CFTC'' or 
``Commission'') is proposing to amend its rules relating to the 
computation and presentation of rate of return information and other 
disclosures concerning partially-funded accounts managed by commodity 
trading advisors (``CTAs'').

DATES: Comments must be received by April 14, 2003.

ADDRESSES: Interested persons should submit their views and comments to 
Jean A. Webb, Secretary of the Commission, Commodity Futures Trading 
Commission, Three Lafayette Centre, 1155 21st Street, NW., Washington, 
DC 20581. In addition, comments may be sent by facsimile transmission 
to (202) 418-5543, or by

[[Page 12002]]

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, (202) 418-5467, 
electronic mail: [email protected], Division of Clearing and 
Intermediary Oversight, Commodity Futures Trading Commission, 1155 21st 
Street, NW., Washington, DC 20581.

SUPPLEMENTARY INFORMATION: 

I. Background

    The Commission is proposing to amend several of its rules \1\ 
affecting the computation and presentation of rate of return 
information and other disclosures by CTAs to prospective clients. The 
proposed amendments will enable CTAs to disclose past performance as 
computed on the basis of the client's nominal account size (the amount 
upon which the CTA bases its trading decisions) rather than on the 
basis of the actual funds the client has placed in an account subject 
to the CTA's control. The amendments will affect past performance 
disclosure made by CTAs to prospective clients, and will not affect the 
manner in which information is provided to existing clients. Existing 
clients will continue to receive information on the status of their own 
accounts on an actual cash basis.\2\
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    \1\ Commission rules cited herein are found at 17 CFR Ch. I 
(2002).
    \2\ Commission Rule 1.33 sets forth the requirements applicable 
to futures commission merchants (``FCMs'') with respect to reporting 
to their customers. Commission rules cited herein are found at 17 
CFR Ch. I (2002).
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    On August 2, 1999, the Commission published in the Federal Register 
\3\ proposed rules regarding the computation and presentation of rate 
of return information and other disclosures concerning past performance 
of accounts over which the CTA has had trading authority.\4\ No final 
action was taken at that time. Now, due to the passage of time, 
intervening legislative and other developments, including reevaluation 
of certain of the issues involved, the Commission is reproposing these 
amendments.
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    \3\ See 64 FR 41843 (August 2, 1999).
    \4\ Those proposed amendments developed out of rules proposed by 
National Futures Association (``NFA'') to permit CTAs to disclose 
past performance as computed on the basis of the client's nominal 
account size (the amount upon which the CTA bases its trading), 
rather than on the basis of the actual funds the client has placed 
in accounts subject to the CTA's control. The NFA proposal was also 
the subject of a concept release published by the Commission in June 
1998 that discussed a number of possible enhancements and 
alternatives to the NFA proposal and sought public comment on those 
issues. See 63 FR 33297 (June 18, 1998).
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II. Proposed Amendments to Commission Regulations 4.25, 4.33, 4.34 and 
4.35

A. Rate of Return Computation

    This proposal addresses how to measure advisors' rates of return in 
a margin- and leverage-based industry. From the CTA's perspective, 
trading is the same for all accounts in a program, regardless of the 
amount of actual funds. The use of margin, however, allows clients to 
fund accounts with much less in actual funds than the account size that 
they have agreed to have the CTA trade. Determination of the amount a 
client deposits with an FCM is between the FCM and the client--the CTA 
is not part of this decision, nor does it affect the CTA's level of 
trading for the client's account. Each existing CTA client will receive 
from its FCM reports of the amount of actual funds in the account, the 
profits or losses that occur, fees charged, and notice of any margin 
calls that may be necessary.
    The rules that the Commission is proposing to revise apply to the 
disclosure of the CTA's past performance to prospective clients. The 
difficulty in basing such performance on actual funding levels arises 
primarily from the use of margin, which permits actual funding levels 
that may be so minimal as to make a return calculated on that basis 
greatly distorted. In addition, clients generally may open accounts 
with an FCM of their own choosing and clients in the same trading 
program may, in fact, have widely divergent amounts of actual funds 
supporting the same level of trading. In order to allow CTAs to present 
to prospective clients composite performance results that will be 
consistent for the accounts within the program, the Commission is 
proposing that the basis for the rate of return calculation be the 
amount on which the CTA is making its trading decisions--the nominal 
account size.
1. Brief History of Methods Used To Compute Rates of Return
    The Commission first required disclosure of the past performance of 
CTAs in 1981.\5\ The rate of return for a period for a particular 
trading program was defined as the net performance \6\ for that period 
divided by the net asset value at the beginning of the period.\7\ At 
that time, the practice of partial funding was not common; clients 
generally deposited in their accounts with FCMs an amount equal to the 
amount that the CTA and its customer had agreed would determine the 
level of trading, which subsequently became known as the ``Nominal 
Account Size.''
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    \5\ See 46 FR 26005, 26009 (May 8, 1981). Pursuant to the 
original Part 4 disclosure rules adopted in 1979, CTAs were 
permitted, but not required, to disclose their past performance in 
accordance with the format specified for commodity pool performance. 
44 FR 1918, 1923 (January 8, 1979).
    \6\ Commission Rule 4.35(a)(6)(i)(D) currently specifies that 
net performance represents the change in the net asset value net of 
additions, withdrawals, redemptions, fees and expenses. Commission 
Rule 4.10(b) currently defines ``net asset value'' as ``total assets 
minus total liabilities, determined in accord with generally 
accepted accounting principles, with each position in a commodity 
interest accounted for at fair market value.''
    \7\ Commission Rule 4.35(a)(6)(i)(A).
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    In later years, Commission staff became aware that some CTA clients 
were not depositing the full nominal account size in their FCM 
accounts. This led the Division of Trading and Markets \8\ to issue 
Advisory 87-2, which stated that only funds under the control of the 
CTA (``Actual Funds'') could be included in beginning net asset value 
(``BNAV'').\9\ Advisory 87-2 stated that ``funds which the client has 
promised orally to provide upon request'' (there described as 
``notional'' funds) could not be included in BNAV.
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    \8\ Following the Commission's reorganization in July 2001, the 
Division of Trading and Markets' role with respect to CPOs and CTAs 
is now carried out by the Division of Clearing and Intermediary 
Oversight.
    \9\ CFTC Advisory 87-2 [1986-87 Transfer Binder] Comm. Fut. L. 
Rep. (CCH) [para] 23,624 (June 2, 1987). Advisory 87-2 specified 
that funds contained in a commodity trading account over which the 
CTA has been given trading authority must be included in BNAV, and 
set forth the conditions under which funds contained in any other 
type of account carried with the FCM could be included in BNAV.
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    After Advisory 87-2 was issued, Commission staff were frequently 
apprised by industry participants of their concerns regarding the 
possible distortions to rates of return calculated based on actual 
funds rather than the account size, designated by the client, upon 
which the CTA made its trading decisions.\10\ In 1993, the Commission 
issued Advisory 93-13, in an effort to alleviate these concerns and to 
reach a compromise between the actual funds and the ``notional'' funds 
methods of computing performance.\11\
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    \10\ These concerns were among the issues addressed by the 
Managed Futures Subcommittee of the Commission's Regulatory 
Coordination Advisory Committee, which existed from 1990 to 1995.
    \11\ CFTC Advisory 93-13, 58 FR 8226 (February 12, 1993). The 
term ``nominal account size'' was introduced in Advisory 93-13.
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    Advisory 93-13 permitted CTAs to disclose, as their past 
performance, the

[[Page 12003]]

rate of return of a ``fully-funded subset'' of their accounts, provided 
that two standards were met.\12\ The first standard required that the 
aggregate of the actual funds for the fully-funded accounts be at least 
ten percent of the aggregate of the nominal account sizes of the 
accounts included in the program. The second standard required that the 
gross trading profit ratio for the subset be ``materially the same'' as 
the gross trading profit ratio for the aggregate.\13\ In other words, 
the performance of the subset had to be, in fact, representative of the 
performance of the aggregate, considered on the basis of the nominal 
account sizes.
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    \12\ ``Fully-funded'' refers to an account where the amount of 
Actual Funds equals the nominal account size.
    \13\ Advisory 93-13 included a specific definition of 
``materially the same'' in the context of comparing two percentages, 
depending on the individual size of the two percentages (i.e., 5 
percent or less, between 5 percent and 10 percent, or 10 percent or 
more) and the difference between the two percentages. See 58 FR at 
8229.
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    For example, if the CTA had 15 accounts, three of which were fully 
funded, the CTA could treat the rate of return of the three fully-
funded accounts as representative of all 15 accounts as long as the two 
tests were met. Thus, if all 15 accounts had nominal account sizes of 
$100,000, the first standard would be met by the three fully-funded 
accounts--i.e., $300,000/$1,500,000 is twenty percent, which exceeds 
the ten percent minimum. This test could also be met by one 
sufficiently large fully-funded account. If each of the 15 accounts 
experienced gross profits of $10,000, the gross trading profits ratio 
of the subset would be the same as the gross trading profits ratio of 
the aggregate, meeting the second test. Advisory 93-13 explicitly 
permitted a number of adjustments and exceptions to these two 
standards. For example, an account could use the fully-funded subset 
method despite failures to meet the ten percent test ``for a limited 
number of periods.''
    Advisory 93-13 ameliorated disclosure problems for those CTAs that 
had sufficiently fully-funded accounts to meet the ten percent test. 
Commission staff nonetheless have increasingly encountered 
circumstances where CTAs have lacked (or lost) sufficient fully-funded 
accounts, but where disclosure based on actual funds levels would be 
misleading or confusing.
2. Proposed Changes to Commission Regulation 4.35(a)(6)(i) To Adopt 
Nominal Account Size as the Denominator in the Rate of Return 
Calculation
    Existing Commission Regulation 4.35(a)(6)(i) requires that, in 
presenting past performance to prospective participants, the rate of 
return for a period be calculated by dividing net performance by the 
beginning net asset value. The proposed amendment to Regulation 
4.35(a)(6)(i) would require that the rate of return be computed by 
dividing net performance by the nominal account size at the beginning 
of the period.\14\ It is the proposed change in the denominator of the 
rate of return computation--from net asset value to nominal account 
size--that underlies the framework for performance presentation set 
forth in the rule proposal.
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    \14\ Additional changes to Rule 4.35(a)(6)(i)(A)-(F) have been 
proposed to accommodate the use of nominal account size. These 
changes will be discussed further below.
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    The Commission recognizes that each of the methods that has been 
used or proposed-the actual funds method, the fully-funded subset 
method, and the nominal account size method--has flaws. For example, 
under the actual funds method, two accounts with the same nominal 
account size, which hold the same market positions and number of 
contracts, and which experience the same gains or losses, would show 
different performance if the clients choose to fund their accounts 
differently.\15\ Further, the CTA's presentation of its past 
performance for accounts in the same trading program could combine, in 
the same actual funds-based performance table, accounts with vastly 
different amounts of actual funds in relation to their nominal 
size.\16\ The resulting composite presentation would blend the results 
of these accounts into a rate of return that would not be 
representative of any client's actual results. Some might argue that if 
the actual funds-based returns of these varyingly funded accounts 
differed materially from each other, their performance should be 
presented in separate tables.\17\ This could result in numerous 
performance tables for each of the CTA's programs, overwhelming clients 
with excessive amounts of data and severely impeding the usefulness of 
the performance disclosure.
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    \15\ For example, Client A and Client B each have a nominal 
account size of $100,000. The CTA treats the two accounts 
identically, trading two S&P 500 futures contracts for each account. 
Each account experiences a $10,000 profit. Client A deposits $25,000 
in actual funds, while Client B fully funds the account with 
$100,000. Using the actual funds method, Client A's rate of return 
would be 40%, and Client B's rate of return would be 10%, even 
though each client has the same nominal account size, has been 
traded identically, and has received the same dollar amount in 
profits.
    \16\ In practice, prior to the issuance of Advisory 93-13, 
Division of Trading and Markets staff interpreted the actual funds 
method to require one composite table that was based solely on 
actual funds, and to permit a supplemental table including 
``notional funds'' (57 FR 53457, 53459 (November 10, 1992). This 
interpretation appears to have been based on provisions regarding 
retroactive application of Advisory 87-2, as described in an 
Addendum to CFTC Advisory 87-2 ([1986-87 Transfer Binder] Comm. Fut. 
L. Rep. (CCH) [para] 23,759 (August 12, 1987)).
    \17\ Rule 4.35(a)(3)(ii) specifies that accounts whose rates of 
return differ materially from each other may not be presented in the 
same composite.
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    The fully-funded subset method has turned out to be unworkable for 
a number of reasons. The primary reason is that many CTAs lack fully-
funded accounts. Although Advisory 93-13 allows for limited periods 
during which the fully-funded subset requirement is not met, this 
allowance is predicated on the anticipated resumption of the fully-
funded subset in the near future. The Division has received numerous 
questions over the years from CTAs who have qualified for the fully-
funded subset method for a period of time, but due to the closing of 
fully-funded accounts and inability to obtain new fully-funded 
accounts, cannot continue to use the fully-funded subset method.
    Further, in recent years, the use of ``master accounts'' by 
commodity pools and clients who allocate to multiple CTAs has greatly 
increased. A master account is a central account in which a client 
deposits funds with the FCM to support trading done by several CTAs. 
Each of the CTAs is given trading authority for a sub-account, which 
will reflect the positions implemented by that CTA, and profits and 
losses on these positions, but to which no funds will be deposited. The 
margin requirements for these positions will be met by funds maintained 
in the master account. Although the CTA will know the nominal account 
size, the actual funds reported to the CTA will include only the value 
of the positions held in the sub-account (which could, in fact, be a 
negative amount due to unrealized losses). While in the past staff have 
permitted the allocation of funds in a master account to various CTAs 
to be computed and reported pursuant to a Liquid Asset Allocation 
(``LAA'') method,\18\ LAA methods have not proven to be workable for 
the majority of CPOs and other clients with master accounts. Further, 
it is unclear that such

[[Page 12004]]

allocation provides insight into the return based on ``actual'' funds.
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    \18\ See CFTC Interpretative Letter 88-1, ``Application of 
Division of Trading and Markets Advisory 87-2,'' [1987-1990 Transfer 
Binder] Comm. Fut. L. Rep. (CCH) [para]24058 at 34639-40 (December 
16, 1987).
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3. Objections to the Nominal Account Size Method Addressed
    Concerns have been raised that CTAs might manipulate their nominal 
account sizes.\19\ A CTA that can establish nominal account sizes 
without being required to find customers willing to fully fund accounts 
at such sizes might be unrestrained in setting the nominal account 
size, and thus could minimize the apparent size of losses and smooth 
the apparent volatility of its trading over time. Increasing the 
nominal account size to minimize the apparent size of losses, however, 
will unavoidably have the effect of minimizing the apparent size of 
gains. CTAs will thus be faced with countervailing incentives. Some 
have noted a converse problem posed by the existing rules: futures and 
derivatives positions can be taken by depositing very small amounts of 
actual funds for margin, relative to the value of the contract. 
Positive rates of return computed on the basis of a relatively small 
amount of actual funds in accounts whose level of trading is based on a 
much greater nominal account size would be magnified and could provide 
a potentially misleading measure of the CTA's success. As NFA's comment 
letter on the earlier rule amendment proposal observed, in its 
experience, ``* * * unwary customers are more likely to be lured into 
the futures markets by allusions to large profits than by information 
implying that futures trading is a conservative investment.'' The 
Commission's own experience in this area has been similar, and it has 
no basis to believe that this proposal creates any additional 
incentives for CTAs to set unreasonable nominal account sizes.
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    \19\ See, e.g., ``Proposed Rule Could Help Mask Commodity 
Trading Volatility,'' New York Times, September 2, 1999; and 
``Commodity-Adviser Reporting Rule May Change,'' Wall Street 
Journal, September 7, 1999.
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    Some have stated that using nominal account size to compute rates 
of return would create an appearance of lowered volatility and that 
disclosure of volatility experienced by program participants would be 
undermined if nominal account size were used to compute rates of 
return. But the rules proposed in this release are no more likely to 
mask volatility than the fully-funded subset method permitted since 
1993. The funding level--full or partial--chosen by past participants 
neither helps nor harms prospective participants who will be receiving 
past performance data based on nominal account size. A prospective 
participant who chooses to partially fund will experience volatility 
magnified by his or her partial funding level, and will not be helped 
by the fact that other participants chose to fully fund in the past. 
Conversely, a prospective participant who chooses to fully fund will 
experience volatility corresponding to the nominal account size, and 
will not be harmed by the fact that other participants chose to 
partially fund in the past. Moreover, the performance table will 
contain a pointed numerical example of the effect of partial funding on 
volatility in the context of worst monthly and peak-to-valley draw-
downs. This example-based either on the lowest actual funding level or 
a straight 20% funding level--will demonstrate the enhanced volatility 
of partially funded accounts in a form calculated to draw the 
participant's attention.
    Investors should consider not only the ``cash they must put up'' 
initially, but the losses to which they are exposed. In this context, 
participation in managed futures accounts is far different from 
investment in stocks, real estate, or even commodity pools. As has been 
noted: ``Commodity trading intrinsically involves leverage, the only 
purchase is a futures contract (not the actual asset) and the amount of 
cash required is artificially determined by exchange rules, broker 
policies, CTA negotiated agreements and regulatory requirements and can 
change day by day.'' \20\
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    \20\ Arthur F. Bell, Jr. & Associates commenting on the earlier 
rule amendment proposal.
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    Investments in stock, real estate, or collective investment 
vehicles such as mutual funds or commodity pools can be quantified in 
advance, even if purchased on margin or through other borrowing. An 
investor can purchase 100 shares of Example Co., Inc. (or Example Fund, 
Inc.) at $50 a share for $5,000. Even if these shares are purchased on 
margin, $5,000 is generally the limit of the loss to which the investor 
is exposed.\21\ This relative certainty is absent in the context of 
futures. A managed futures account participant who enters into, for 
example, a stock index futures contract gains (or loses) the change in 
value of the collection of stocks. The participant must post margin, 
but the margin does not represent the limit of the participant's 
liability. If the participant's losses exceed the initial margin, the 
participant will owe the excess. Commission Rule 4.34(b) requires that 
CTAs disclose these facts to prospective clients, and a CTA which 
encouraged participants to think of the ``cash they have put up'' as 
the limit of their losses could run afoul of Section 4o of the 
Commodity Exchange Act (the ``Act'').\22\
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    \21\ Transaction fees and interest are being ignored for the 
purposes of these examples.
    \22\ 7 U.S.C. 6o (2000).
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    To be sure, the Commission has observed that there is no standard 
among CTAs for the setting of nominal account sizes.\23\ The Commission 
does not intend to impose a standard for the setting of nominal account 
sizes on CTAs. The proposed rule does require that the CTA disclose the 
factors it considers 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. Moreover, adopting nominal account 
size as the denominator for the rate of return calculation would 
provide a uniform basis for all CTAs to present rate of return, which 
does not exist under the reporting scheme that has been in effect since 
the adoption of Advisory 93-13. Use of nominal account size would 
permit a much more meaningful comparison of the performance results of 
CTAs.
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    \23\ See 63 FR 33297 (June 18, 1998).
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    After consideration of the benefits and drawbacks of each of these 
methods of calculating CTAs' rates of return, the Commission is 
proposing the nominal account size method, coupled with a framework of 
documentation and disclosure requirements, as the method that best 
reflects the reality of how managed accounts are traded, including 
information regarding volatility and draw-downs. As discussed more 
fully below, the existence of a written agreement that documents the 
nominal account size in advance of the CTA's trading for the account is 
a critical component of the performance calculation and reporting 
scheme the Commission is proposing.

B. Documentation of Nominal Account Size

    The proposed rules would add new paragraph (c) to Rule 4.33 to 
require documentation of the nominal account size agreed upon by the 
CTA and client, as well as other terms applicable to the CTA's trading 
for the client's account. 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 computation of 
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

[[Page 12005]]

account. The requirement that the nominal account size must be 
documented in advance of the CTA's trading for the client's account 
will also minimize the possibility that CTAs will manipulate their 
returns to appear either less volatile or more positive by frequent 
adjustment of their nominal account sizes, particularly since any 
revision to the nominal account size must be documented in a new 
agreement, or an addendum to the existing agreement, signed by the 
client.
    The Commission believes that documentation of the agreement between 
CTAs and their clients is important, even if all the CTA's client 
accounts are fully-funded, and therefore the proposed requirements of 
Rule 4.33(c) would apply to CTAs whether or not they accept partially 
funded accounts. As the proposed rule indicates, CTAs would not need to 
use a separate agreement to respond to the requirements specified in 
Rule 4.33(c), but could incorporate the requirements into their 
existing client agreements.
    In addition, Rule 4.33(c) would require that changes to nominal 
account size, other than those explicitly provided for in the existing 
agreement (e.g., the effect of gains/losses), must be in writing, must 
be signed by the client, and must explicitly indicate the current date, 
the change in the nominal account size and the effective date of that 
change.\24\ This requirement could be met by a simple one-sentence note 
from the client requesting the change in nominal account size and 
including the dollar amount of the new nominal account size, the 
effective date of the change, the signature and typed or printed name 
of the client, and the date the request was signed.\25\
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    \24\ The effective date would be on or after the date that the 
change is made.
    \25\ Commission Rule 1.4 permits use of electronic signatures 
with respect to compliance with Commission rules that require a 
document to be signed by a customer, participant or client. An 
electronic signature could therefore be used for the agreement 
required by Rule 4.33(c), in accordance with the provisions of Rule 
1.4 (i.e., that the electronic signature complies with applicable 
Federal laws and other Commission rules, and that the CTA must adopt 
and utilize reasonable safeguards regarding the use of electronic 
signatures).
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C. Changes to Definitions

    The Commission proposed revisions to Rule 4.10(l) to accommodate 
use of nominal account size as the denominator in the calculation of 
the peak-to-valley draw-down figures.\26\ Additional changes are being 
proposed to codify definitions of nominal account size (Rule 4.10(m)), 
actual funds (Rule 4.10(n)), partially-funded account (Rule 4.10(o)) 
and most recent five years (4.10(p)).
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    \26\ Rule 4.10(k) defines ``draw-down'' as ``losses experienced 
by a pool or account over a specified period.'' Since the definition 
in Rule 4.10(k) does not refer to a method for computing such 
losses, no revision to this definition would be necessary.
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    The Commission wishes to make clear that Advisories 87-2 and 93-13, 
as well as Interpretative Letter 88-1, would be, on a prospective 
basis, superseded in their entirety by the proposed rules or any final 
rules resulting from this rulemaking. Questions have been raised about 
the continuing applicability of the quantitative materiality standard 
that was established in Advisory 93-13 to determine whether a CTA's 
accounts qualified for use of the fully-funded subset method. Although 
Advisory 93-13 clearly stated that the standard was intended to be 
applicable only in the context of the Advisory, the Commission 
understands that these standards have come to be relied on more broadly 
in ascertaining compliance with composite performance requirements of 
Rule 4.35(a)(3). The Commission would accept those standards as 
guidance, but not to the exclusion of other approaches that may fall 
outside the threshold of Advisory 93-13. Registrants should continue to 
consider all relevant facts and circumstances in making determinations 
regarding materiality.

D. Disclosure of Actual Funding Levels and Funds Under Management

    The Commission believes that it would be misleading to describe 
``notional funds,'' which the client has chosen not to place in an 
account over which the CTA has trading authority, as ``funds under 
management.'' The proposed revisions to Rule 4.35(a)(1)(iv), therefore, 
would clarify that the disclosure of funds under management must 
reflect only the actual funds committed to the CTA's trading program 
rather than the aggregate of nominal account sizes.
    The Commission's proposed adoption of nominal account size for 
purposes of computing the CTA's trading program rate of return is not 
intended to eliminate the distinction between actual funds and nominal 
account size. As we have noted before, nominal account size is not a 
commitment of actual funds to the CTA's control, nor does it represent 
the maximum amount of the client's potential losses or of the client's 
obligations to the FCM. The Commission continues to believe that 
knowledge of the amount of funds that a CTA's clients have been willing 
to entrust to the control of the CTA, or the fact that the CTA does not 
possess such information, may be considered valuable by prospective 
clients. In addition, CTAs would not be precluded from disclosing the 
aggregate of nominal account sizes, and in fact may choose to present 
such information in their performance capsules adjacent to the 
disclosure of actual funds under management (See proposed Rule 
4.35(a)(1)(ix)(D)). Therefore, the Commission is proposing revisions to 
Rule 4.35(a)(1)(iv).
    To accommodate those situations where CTAs do not have access to 
information regarding clients' actual funds, proposed Rule 
4.35(a)(1)(iv) would permit a CTA simply to make a statement of the 
fact that it does not have sufficient information regarding the funding 
of its clients' accounts to determine the aggregate of actual funds 
committed to its programs. Cases involving the use of master accounts, 
or other funding arrangements between the client and FCM, that preclude 
the CTA from having access to information regarding the client's actual 
funds, might lead CTAs to state that they do not know the amount of 
actual funds. The representation by the CTA of its lack of knowledge of 
this amount will provide clients with valuable information regarding 
the extent to which they may rely on that factor. The CTA would 
continue to be required to maintain the documentation on which its 
performance presentation is based \27\ and such documentation should be 
sufficient to support the information in the performance capsule 
regarding the disclosure, if any, of actual funds under management.
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    \27\ See Rules 4.33(a) and 4.35(a)(6)(ii).
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E. Disclosures Regarding Partial Funding of Accounts

    Proposed Rule 4.34(p) would require 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. The discussion 
would be required to include: (1) How the management fees would 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

[[Page 12006]]

positive and negative rates of return, and that the greater the 
disparity between the nominal account size and the amount deposited, 
maintained or made accessible to the FCM, 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 CTA 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.

F. Disclosures Concerning Draw-down

1. Disclosure of Draw-Down at the Lowest Funding Level
    Proposed 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.\28\ If the CTA did not have sufficient information 
regarding the funding level of its client accounts, or if the lowest 
ratio was zero, the draw-down information would be presented at a 
funding level of 20 percent. These additional draw-down figures would 
be presented adjacent to the worst monthly and peak-to-valley draw-down 
percentages based on the aggregate nominal account sizes.
---------------------------------------------------------------------------

    \28\ For example, if the lowest funding level is 25 percent and 
the greatest monthly draw-down is 15 percent, the draw-down shown on 
the basis of actual funding would be 60 percent (15 percent / 25 
percent).
---------------------------------------------------------------------------

    If a client funds its account traded by the CTA at a level of 
actual funds that is less than the nominal account size, then gains or 
losses will represent a larger percentage of the client's actual funds. 
Further, the smaller the amount of actual funds is in relation to the 
nominal account size, the faster losses will reduce the amount of 
actual funds, increasing both the likelihood of margin calls and the 
amount of additional margin that may be required. The purpose of 
disclosing draw-downs at the least-funded level is to highlight these 
effects to prospective clients who may be considering partially funding 
their accounts with the CTA. The option of using a 20% level is 
intended to accommodate situations where the CTA does not have 
sufficient information regarding the funding level of its client 
accounts, or where the lowest funding ratio is zero, precluding 
calculation of a meaningful number.
    Proposed Rule 4.35(a)(1)(ix)(A) would require the addition of only 
two percentage draw-down figures, adjacent to the worst monthly and 
peak-to-valley draw-down percentages for the aggregate nominal account 
sizes. This would not amount to data overload. Further, since the 
intent of the disclosure is to convey the impact of draw-downs on the 
actual funds in partially-funded accounts, use of the 20% funding level 
where CTAs do not have any accounts with actual funding or do not know 
the amount of actual funds would enable their performance capsules to 
convey information about the increased impact of draw-downs on the 
actual funds in partially-funded accounts.
    2. Use of Composite Draw-down
    Proposed Rules 4.35(a)(1)(v) and (vi) would require that the worst 
monthly and peak-to-valley draw-down amounts be based on the aggregate 
of nominal account sizes, i.e., the composite of accounts, rather than 
the worst individual account.\29\ A variety of factors, including, but 
not limited to, differences due to trade execution, fees, commissions, 
and the timing of opening or closing accounts, may have an impact on 
the returns for individual accounts. The effect of these factors must 
be considered by the CTA in the development of its composite 
performance tables and any material differences among the accounts in 
the composite must be discussed.\30\ For a performance table that 
complies with the Commission's rules on use of composites, disclosure 
of draw-down information on a composite basis would not be misleading. 
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.
---------------------------------------------------------------------------

    \29\ Current Rule 4.10(k) defines the term ``Draw-down as 
``losses experienced by a pool or account over a specified period: 
Rule 4.10(l) defines the term ``Worst peak-to-valley draw-down'' for 
a pool, account or trading program. In its adopting release for the 
most recent revisions to the Part 4 rules, the Commission noted that 
`` . . . the draw-down figures in a composite in a CTA Disclosure 
Documents are the worst experienced by any one of the accounts 
included in the composite'' (emphasis added). 60 FR 38146, 38162 
(July 25, 1995).
    \30\ Rule 4.35(a)(3) states:
    (i) Unless such presentation would be misleading, the 
performance of accounts traded pursuant to the same trading program 
may be presented in composite form on a program-by-program basis * * 
*.
    (ii) Accounts that differ materially with respect to rate of 
return may not be presented in the same composite.
    (iii) The commodity trading advisor must discuss all material 
differences among the accounts included in a composite.
---------------------------------------------------------------------------

G. Treatment of Interest Income

    The proposed definition of net performance in Rules 4.10(l)(3) and 
4.35(a)(6)(i)(B)\31\ would permit CTAs to include interest income on 
funds deposited in the client's commodity interest account directed by 
the CTA, as well as any other income on positions held as part of the 
CTA's program. The fact that trading fees are charged against the CTA's 
performance, even where the commission rate is negotiated by the client 
and the FCM, supports the inclusion of interest earned at the FCM in 
the CTA's performance to maintain parity. In addition, interest is, in 
a real sense, part of the return on the funds. Regardless of the amount 
of actual funds a client deposits with the FCM, whether influenced by 
the CTA's trading strategies, the FCM's credit determination, or the 
client's wishes, income on these funds is part of the account's 
performance. Further, the computation of net performance under the 
regulations that have been in effect since 1981 has included interest 
income. The components of net performance--the numerator of the rate of 
return computation--will not be affected by the change of the 
denominator from net asset value to nominal account size. It is the 
adoption of nominal account size, rather than net asset value, as the 
basis for performance calculation that will require changes to the 
definition of net performance in proposed Rules 4.10(l)(3) and 
4.35(a)(6)(i)(B).
---------------------------------------------------------------------------

    \31\ Although net performance is defined in the context of both 
Rule 4.10(l), with respect to computation of worst peak-to-valley 
draw-down, and Rule 4.35(a)(6)(i)(B), with respect to calculation of 
performance information, the definitions are the same.
---------------------------------------------------------------------------

    The proposed rule also would provide that no interest income may be 
imputed with respect to nominal account sizes or otherwise computed on 
a pro-forma basis. The Commission notes that the reference in the 
proposed rules to ``other income'' on instruments held as part of the 
CTA's program is intended to apply to programs in which the CTA may 
direct the trading of instruments, such as stocks or bonds, on which 
income is earned.\32\ While this provision may not be applicable to 
most CTAs, it is intended to permit those CTAs who direct the trading 
of income-producing

[[Page 12007]]

instruments as part of their trading programs to reflect the 
performance of those instruments in their trading results. In the 
disclosure document review process and compliance audits, close 
attention would be paid to the description of the trading program and 
other documentation regarding the CTA's direction of income-producing 
instruments included in its performance record.
---------------------------------------------------------------------------

    \32\ While this provision acknowledges that CTAs may offer 
programs that trade instruments in addition to futures contracts, it 
in no way implies that such activity may be conducted by CTAs 
outside of the appropriate registration or other regulatory 
requirements of agencies with jurisdiction over those instruments.
---------------------------------------------------------------------------

H. Range of Rates of Return for Closed Accounts

    The Commission proposes 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. The Commission believes that 
disclosing the range of rates of return for closed accounts in the 
offered program provides important summary information on the variation 
in returns experienced by individual clients and will be useful to 
prospective clients considering participation in the CTA's program. 
Because the draw-down information under the revised rules will be 
presented on a composite basis, presentation of the range of rates of 
return for closed accounts provides valuable information on the results 
experienced by individual clients.
    The Commission notes that under the proposed rule amendments, both 
the numbers of accounts closed with positive versus negative rates of 
return, as well as the ranges of rates of return for accounts in each 
category, must be disclosed only for those accounts that both opened 
and closed within the required five-year and year-to-date time period. 
The Commission does not believe that this change will diminish the 
disclosure of material information to prospective clients, because of 
the tendency of clients to quickly close accounts that experience large 
losses. Accounts that experienced strongly negative returns before the 
five-year time period are likely to have been closed before the end of 
that time period, and losses experienced as a result of the offered 
program during the five-year period are likely to have been experienced 
by an account that both opened and closed during that period. The 
Commission wishes to make clear that any additional information that 
the CTA believes is necessary to explain the circumstances affecting 
the ranges of returns presented in the performance capsule may be 
provided, pursuant to existing rules regarding supplemental disclosures 
and material information.\33\
---------------------------------------------------------------------------

    \33\ See, Commission Rules 4.34(n) and 4.34(o).
---------------------------------------------------------------------------

I. Treatment of Additions and Withdrawals in Computing Rate of Return

    In proposing to amend Rule 4.35(a)(6)(i)(B), the Commission notes 
that CTAs would be permitted to choose, for their rate of return 
computation, one of the following three methods: (1) Net performance 
divided by beginning nominal account size; (2) daily compounded rate of 
return; or (3) net performance divided by the average weighted nominal 
account sizes for the month. These proposed changes would incorporate 
alternative methods of computing rate of return to account for 
intramonth additions and withdrawals, as permitted by the CFTC's 1991 
Advisory.\34\ The Commission is not proposing to include the Only 
Accounts Traded Method as an option CTAs may choose prospectively due 
to concerns that it allows for accounts to be excluded entirely from 
the rate of return computation. The Commission will, however, carefully 
consider proposals regarding any alternative method of addressing the 
effect of additions and withdrawals on the rate of return computation, 
whether as part of this rulemaking proposal or otherwise in the future.
---------------------------------------------------------------------------

    \34\ CFTC Advisory, ``Adjustments for Additions and Withdrawals 
to Computation of Rate of Return in Performance Records of Commodity 
Pool Operators and Commodity Trading Advisors,'' 56 FR 8109 
(February 27, 1991).
---------------------------------------------------------------------------

    The rule changes proposed herein would supersede applicability to 
CTAs of the CFTC's 1991 Advisory.\35\ CTA performance computed in 
accordance with any of the alternative methods described in the 1991 
Advisory for periods prior to the date upon which the rule changes 
proposed herein become effective, however, would not need to be 
revised. Because commodity pool performance may only be reported on the 
basis of actual funds, applicability of the 1991 Advisory to CPOs 
reporting commodity pool performance would be unchanged.
---------------------------------------------------------------------------

    \35\ CFTC Advisory, ``Adjustments for Additions and Withdrawals 
to Computation of Rate of Return in Performance Records of Commodity 
Pool Operators and Commodity Trading Advisors,'' 56 FR 8109 
(February 27, 1991).
---------------------------------------------------------------------------

J. Disclosure of CTA Performance in CPO Disclosure Documents

    The Commission is proposing changes to the presentation of CTA 
performance in CPO disclosure documents primarily to conform such 
presentation with the proposed revisions to Rule 4.35(a)(1). The 
Commission emphasizes that narrative disclosure of the pool's 
allocations to its CTAs, as well as the use of leverage in determining 
such allocations, continues to be required pursuant to existing Rules 
4.24(g) and 4.24(h).

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 the beginning of the calendar quarter that is 
at least 90 days after the date of publication of the final rules. The 
Commission seeks comment on any difficulties anticipated in complying 
with these proposed requirements by that date. CTAs and CPOs would be 
permitted to adopt these changes immediately upon the effective date of 
the final rules as adopted.

IV. Request for Comments Regarding a Core Principle Alternative

    The Commission has received a number of requests from the managed 
funds industry that Commission policy pertaining to CTA disclosure of 
past performance to prospective clients be made consistent with the 
approach undertaken in the securities industry.\36\ Under Federal 
securities laws there are no rules that mandate the manner in which 
investment advisers disclose past performance. Generally, investment 
advisers may present past performance in any manner that does not run 
afoul of general anti-fraud provisions.\37\ It has been suggested that 
the Commission adopt a core principle in order to achieve parity with 
applicable securities laws and regulations as they relate to the 
disclosure of past performance made by CTAs to prospective clients.\38\ 
Such a core principle would permit CTAs to present past performance to 
prospective clients in any manner they choose so long as such 
information is offered in a manner that is factual and balanced and is 
not misleading or fraudulent.
---------------------------------------------------------------------------

    \36\ See Transcript from CFTC Roundtable on Managed Funds Issues 
<http://www.cftc.gov/files/opa/press02/oparoundtable091902.pdf.
    \37\ See the Investment Advisers Act of 1940 section 206(4) (15 
U.S.C. 80b-6(4)) and Securities and Exchange Commission Rule 
275.206(4)-1(a)(5) (17 CFR 275.206(4)-(1)(a)(5)). For a more 
complete discussion regarding the use of past performance by 
investment advisers for soliciting clients, see Robert J. Zutz, 
Compliance Review, Schwab Institutional, Vol. 10, Issue 8, Aug. 
2001.
    \38\ See, e.g., Testimony of George Crapple at the CFTC 
Roundtable on Managed Funds Issues. Transcript from CFTC Roundtable 
on Managed Funds Issues at 84.
---------------------------------------------------------------------------

    Consistent with the intention of the Commodity Futures 
Modernization Act

[[Page 12008]]

of 2000,\39\ the Commission is requesting comment on the desirability 
of implementing a core principle that would replace the current rules, 
and ameliorate the need for the amendments proposed herein, regarding 
the manner in which a CTA presents past performance to prospective 
clients. In particular, the Commission is requesting comments on the 
following questions:
---------------------------------------------------------------------------

    \39\ Pub. L. No. 106-554, 114 Stat. 2763 (2000) (codified as 
amended in scattered sections of 7 U.S.C.). See, e.g., section 125 
(requiring the Commission to conduct a study of the Act and the 
Commission's rules and orders governing the conduct of registrants 
under the Act, identifying, among other things, Commission rules 
that may be replaced by core principles).

    (1) What form should such core principle take? Commenters are 
requested to provide specific language for the core principle.
    (2) Should certain presentations of past performance be 
specifically prohibited or limited?
    (3) Should the rules proposed herein serve as a safe harbor in 
the event the Commission determines to adopt a core principle 
approach, and/or should the Commission develop more general guidance 
concerning compliance with the core principle?
    (4) Would the implementation of a core principle approach lead 
to more or less meaningful and useful information being provided to 
prospective clients?
    (5) Is the experience of the securities industry with the use of 
a core principle approach for performance presentation relevant to 
the use of such an approach in the futures industry?

In offering the above questions, the Commission does not intend to 
limit the scope of the discussion regarding the alternative of a core 
principle. These questions are meant only as a starting point and the 
Commission encourages the submission of comments that address these, as 
well as any other pertinent questions.

V. Related Matters

A. Regulatory Flexibility Act

    The Regulatory Flexibility Act (``RFA''), 5 U.S.C. 601-611 (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.\40\ The Commission previously has determined 
that registered CPOs are not small entities for the purpose of the 
RFA.\41\ 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.\42\ In this regard, the 
Commission notes that the rule revisions adopted herein create some 
changes to the content of the documentation and disclosure requirements 
for CTAs, but do not 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.\43\ 
Therefore, the Chairman, on behalf of the Commission, hereby certifies, 
pursuant to 5 U.S.C. 605(b), that these regulations will not have a 
significant economic impact on a substantial number of small entities.
---------------------------------------------------------------------------

    \40\ 47 FR 18618-18621 (April 30, 1982).
    \41\ 47 FR 18619-18620.
    \42\ 47 FR 18618-18620.
    \43\ See 60 FR 38146, 38181 (July 25, 1995) and 48 FR 35248 
(August 3, 1983).
---------------------------------------------------------------------------

B. Paperwork Reduction Act

    These rules [Sections 4.31 and 4.33] contain information collection 
requirements. As required by the Paperwork Reduction Act of 1995,\44\ 
the Commission has submitted a copy of this rule to the Office of 
Management and Budget (OMB) for its review.\45\
---------------------------------------------------------------------------

    \44\ Pub. L. 104-13 (May 13, 1995).
    \45\ 44 U.S.C. 3504(h).
---------------------------------------------------------------------------

Collection of Information
    Rules relating to the operations and activities of Commodity Pool 
Operators and Commodity Trading Advisors and to monthly reporting by 
Futures Commission Merchants, OMB control number 3038-0005.
    The proposed amendments would not affect the paperwork burdens 
associated with the above collections of information, which have 
previously been approved by OMB in connection with the Commission's 
previous submission of the proposed rules.
    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.
    Persons wishing to comment on the information collection 
requirements that would be required by these proposed rules should 
contact the Office of Information and Regulatory Affairs, Office of 
Management and Budget, Room 10235, New Executive Office Building, 
Washington, DC 20503, Attn: Desk Officer for the Commodity Futures 
Trading Commission.
    The Commission considers comments by the public on this proposed 
collection of information in--

    Evaluating whether the proposed collection of information is 
necessary for the proper performance of the functions of the 
Commission, including whether the information will have a practical 
use;
    Evaluating the accuracy of the Commission's estimate of the 
burden of the proposed collection of information including the 
validity of the methodology and assumptions used;
    Enhancing the quality, utility, and clarity of the information 
to be collected; and
    Minimizing the burden of the collection of the information on 
those who are to respond, including through the use of appropriate 
automated, electronic, mechanical or other technological collection 
techniques or other forms of information technology, e.g., 
permitting electronic submissions of responses.

    OMB is required to make a decision concerning the collection of 
information contained in these proposed regulations between 30 and 60 
days after publication of this document in the Federal Register. 
Therefore, a comment to OMB is best assured of having its full effect 
if OMB receives it within 30 days of publication. This does not affect 
the deadline for the public to comment to the Commission on the 
proposed regulations.
    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 
1a(4), 4k, 4l, 4m, 4n, 4o and 8a, 7 U.S.C. 1a(4), 6k, 6l, 6m, 6n, 6o, 
and 12a, the Commission hereby proposes to amend Chapter I 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 4.10 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.

* * * * *

[[Page 12009]]

    (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 net 
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 (l)(2) of this section, net 
performance for a period is defined as the total of:
    (A) The realized gain or loss on positions closed during the 
period; plus
    (B) The change during the period in unrealized gain or loss; plus
    (C) Interest income on funds on deposit in an account at a futures 
commission merchant to margin the client account which a commodity 
trading advisor directs; plus
    (D) Other income earned on positions held as part of the commodity 
trading advisor's program; minus
    (E) Fees and expenses.
    (ii) No interest or other income may be imputed with respect to 
nominal account sizes or otherwise computed on a pro-forma basis.
    (4) For purposes of Sec. Sec.  4.25 and 4.35, a peak-to-valley 
draw-down, which began prior to the beginning of the most recent five 
calendar years and continues into or ends during the most recent five 
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), that establishes the 
client's level of trading in a commodity trading advisor's program.
    (n) Actual funds means the amount of margin-qualifying assets, 
either:
    (1) On deposit in an account at a futures commission merchant to 
margin the client account which a commodity trading advisor directs; or
    (2) In another account, so long as the commodity trading advisor 
has written evidence demonstrating the following:
    (i) The client owns the funds;
    (ii) The futures commission merchant carrying the client's account 
that the commodity trading advisor directs (the ``trading account'') 
has the power readily to use all, or a designated portion of, the funds 
in the other account for the purpose of meeting margin requirements in 
connection with the trading account, on a routine operational basis and 
without advance notice to the client; and
    (iii) The commodity trading advisor has ready access to information 
concerning the balance in the other account available to meet margin 
requirements for the trading account.
    (o) Partially-funded account means a client participation in the 
program of a commodity trading advisor in which the amount of actual 
funds is less than the nominal account size.
    (p) For purposes of Sec. Sec.  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(a)(1)(ii) is proposed to be amended by revising 
paragraphs (a)(1)(ii)(D)(1) and (2), (a)(1)(ii)(E) and (a)(1)(ii)(F) to 
read as follows:


Sec.  4.25  Performance disclosures.

    (a) * * *
    (1) * * *
    (ii) * * *
    (D)(1) The aggregate of actual funds for 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 clients' accounts to determine the aggregate of actual funds for 
its programs, a statement of that fact;
    (2) The aggregate of actual funds for 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 for the specified trading program, a 
statement of that fact.
    (E) The greatest monthly draw-down during the most recent five 
years for the trading program specified, expressed as a percentage of 
aggregate nominal account sizes, and indicating the month and year of 
the draw-down.
    (F) The greatest peak-to-valley draw-down during the most recent 
five years for the trading program specified, expressed as a percentage 
of aggregate nominal account sizes at the beginning of the period, and 
indicating the month(s) and year(s) of the draw-down.
* * * * *
    4. Section 4.33 is proposed to be amended by adding paragraphs (c) 
and (d) 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 additions or withdrawals of actual funds, profits, and 
losses will each affect the nominal account size and the computation of 
fees; and
    (5) Whether the client will fully or partially fund the account.
    (d) Any changes to nominal account size (other than changes 
resulting from the factors listed in Sec.  4.33(c)(4) and documented as 
required by that subsection) must be in writing, must be signed by the 
client, and must explicitly indicate the current date, the new nominal 
account size and the effective date of the change.
    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 positive and negative rates of return, and 
that the greater the disparity between the nominal account

[[Page 12010]]

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)(iv), (a)(6)(i)(A) through (F), 
and (a)(6)(ii) to read as follows:


Sec.  4.35  Performance disclosures.

* * * * *
    (a) General principles.--(1) * * *
    (iv)(A) The aggregate of actual funds for 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 clients' accounts to determine the aggregate of actual funds for 
its programs, a statement of that fact;
    (B) The aggregate of actual funds for 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 for the specified trading program, a 
statement of that fact.
    (v) The greatest monthly draw-down during the most recent five 
years for the trading program specified, expressed as a percentage of 
aggregate nominal account sizes, and indicating the month and year of 
the draw-down;
    (vi) The greatest peak-to-valley draw-down during the most recent 
five years for the trading program specified, expressed as a percentage 
of aggregate nominal account sizes at the beginning of the period, and 
indicating the month(s) and year(s) of the draw-down;
    (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 specified 
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 opened and closed during the period specified 
in Sec.  4.35(a)(5) with a positive net lifetime rate of return as of 
the date the account was closed; and
    (2) The range of rates of return for accounts that were both opened 
and closed during the period specified in Sec.  4.35(a)(5) and closed 
with positive net lifetime rates of return; and
    (B)(1) The number of accounts traded pursuant to the offered 
trading program that were opened and closed during the period specified 
in Sec.  4.35(a)(5) with negative net lifetime rates of return as of 
the date the account was closed; and
    (2) The range of rates of return for accounts that were both opened 
and closed during the period specified in Sec.  4.35(a)(5) and closed 
with negative net lifetime rates of return.
    (C) The net lifetime rate of return shall be calculated as the 
compounded product of the monthly rates of return for each month the 
account is open.
    (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) 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.
* * * * *
    (iv) The commodity trading advisor must make 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 income on funds on deposit in an account at a 
futures commission merchant to margin the client account which a 
commodity trading advisor directs, plus
    (iv) Other income earned on positions held as part of the CTA's 
program, minus
    (v) Fees and expenses.
    (2) No interest or other income may be imputed with respect to 
nominal account sizes or otherwise computed on a pro-forma basis.
    (C) The nominal rate of return for the period, which must be 
compounded no less frequently than monthly and which shall be 
calculated by one of the following three methods, consistently applied:
    (1) Computing the net performance divided by the beginning nominal 
account size for each trading day in the period and compounding each 
daily rate of return to determine the rate of return for the period;
    (2) Dividing the net performance by the arithmetic mean of the 
nominal account sizes for each trading day during the period; or,
    (3) 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 commodity trading advisor's agreement with the 
client in accordance with Sec.  4.33(c)(4). The records should clearly 
delineate 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 commodity trading advisor's agreement with the client in accordance 
with Sec.  4.33(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

[[Page 12011]]

size be changed effective at the beginning of a period, the change 
shall be reflected at the end of the prior period.
    (F) The nominal account size at the end of the period, defined as 
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) subparagraphs (D) and (E).
    (ii) All supporting documents necessary to substantiate the 
computation of such amounts must be maintained in accordance with Sec.  
1.31.
* * * * *

    Issued in Washington, DC on March 10, 2003 by the Commission.
Jean A. Webb,
Secretary of the Commission.
[FR Doc. 03-6081 Filed 3-12-03; 8:45 am]
BILLING CODE 6351-01-U