[Federal Register Volume 68, Number 139 (Monday, July 21, 2003)]
[Rules and Regulations]
[Pages 42964-42967]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 03-18413]


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COMMODITY FUTURES TRADING COMMISSION

17 CFR Part 4

RIN 3038-AB39


Performance Data and Disclosure for Commodity Trading Advisors

AGENCY: Commodity Futures Trading Commission.

ACTION: Final rule.

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SUMMARY: The Commodity Futures Trading Commission (``Commission'' or 
``CFTC'') is adopting regulations establishing a core principle for 
commodity trading advisors (``CTAs'') with regard to performance 
disclosures concerning partially-funded accounts. The core principle 
specifies that such disclosure must be offered in a manner that is 
balanced and is not in violation of the antifraud provisions of the 
Commodity Exchange Act (the ``Act'') or the Commission's regulations 
thereunder.

EFFECTIVE DATE: August 20, 2003.

FOR FURTHER INFORMATION CONTACT: Kevin P. Walek, Assistant Director, 
telephone: (202) 418-5463 or Eileen Chotiner, Futures Trading 
Specialist, telephone: (202) 418-5467, Division of Clearing and 
Intermediary Oversight, Commodity Futures Trading Commission, Three 
Lafayette Centre, 1155 21st Street, NW., Washington, DC 20581. E-mail: 
[email protected] or [email protected].

SUPPLEMENTARY INFORMATION:

I. Background

    On March 13, 2003, the Commission published in the Federal Register 
\1\ proposed rule amendments 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. 
In that release, the Commission also sought comment on whether a core 
principle should replace detailed performance requirements.
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    \1\ 68 FR 12001 (Mar. 13, 2003).
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    The Commission received thirteen comments on the proposal. The 
commenters included one industry association,\2\ one CTA,\3\ one bar 
association,\4\ one consumer organization,\5\ one accounting firm,\6\ 
the National Futures Association (``NFA''), and seven members of the 
public.\7\ The industry and bar associations, NFA, and the CTA 
supported the amendments, particularly the use of nominal account size 
as the basis for computing rates of return. The seven members of the 
public and the consumer organization submitted comments expressing 
concern over the use of nominal account size rather than actual funds 
as the basis for presentation of a CTA's past performance. Commenters 
who addressed the core principle approach indicated that specific 
standards for performance presentation should exist in an area in which 
continuity and comparability are important, although several indicated 
that additional flexibility in the application of those standards would 
be welcome. These comments are discussed more fully below.
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    \2\ Managed Funds Association (``MFA'').
    \3\ John Henry & Company, Inc.
    \4\ Association of the Bar of the City of New York, Committee on 
Futures Regulation.
    \5\ Consumer Federation of America (``CFA'').
    \6\ Arthur F. Bell, Jr., & Associates, LLC.
    \7\ One of these commenters, Paul H. Bjarnason, Jr., is an 
accountant and former Commission employee. Six commenters, Elizabeth 
M. Buckman, Bonnie Kayser, James S. Finucane, Christine E. Schoen, 
Laura M. Stephens, and Ray Weaver, submitted identical letters.

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[[Page 42965]]

II. Final Rules

A. Use of Nominal Account Size and Other Detailed Performance 
Requirements in the Proposal

    The key component of the Commission's rule proposal is the use of 
nominal account size, rather than actual funds, as the basis for CTAs' 
computation of rates of return. The consumer organization and members 
of the public noted that investors look at actual funds when making 
investment decisions, and expressed concern that performance based on 
nominal account size would reduce the appearance of volatility of the 
CTA's trading program. Commenters who supported use of nominal account 
size noted that it is the amount both the CTA and the client consider 
to be the account size. They also pointed out that use of actual funds 
can result in widely divergent return figures for similarly traded 
accounts; exaggerates positive and negative rates of return; and 
measures the cash management strategies of clients rather than the 
performance of the CTA.
    The Commission has not found persuasive the comments opposing use 
of nominal account size rather than actual funds as the basis for 
computing CTA rates of return. Some commenters and press reports appear 
to have misunderstood the intent of past performance reporting under 
Commission rules--to present to prospective clients information on how 
the trading program, which the CTA is offering, has performed. The 
amount of actual funds in a client's account is determined by the 
client and its FCM, not the CTA, and does not affect the CTA's trading 
decisions based on nominal account size. Use of nominal account size 
would permit CTAs to present to prospective clients composite 
performance results that will be consistent for the accounts within the 
program, even if those accounts have widely divergent amounts of actual 
funds supporting the same level of trading. The alternatives--either 
blending all accounts, regardless of the variation in funding levels, 
into a single actual funds-based table, or presenting multiple 
performance tables to address each individual funding level--could be 
less informative and potentially more confusing to prospective clients.
    The Commission similarly does not agree that disclosure of the 
volatility and risk of a CTA's trading program will be reduced if the 
nominal account size is used. As NFA noted in its comment letter, the 
proposed use of nominal account size would not understate either 
volatility or risk, as the dollar amount of any profit or loss will be 
the same for accounts with the same nominal account size, regardless of 
the funding level. Further, whatever incentive a CTA may have to make 
its losses appear smaller would be offset by the fact that calculating 
rate of return on a larger nominal account size would reduce the 
appearance of profits as well.

B. Adoption of a Core Principle

    In seeking comment on the desirability of implementing a core 
principle in the proposing release, the Commission cited Congressional 
intent as expressed in the Commodity Futures Modernization Act of 2000 
(``CFMA'').\8\ Section 125 of the CFMA required 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 could be replaced with core 
principles.\9\ While commenters participating in the study expressed 
concerns regarding replacement of regulations with core principles in 
certain contexts, they did identify a number of areas where existing 
rules could be modified or eliminated.\10\ Several commenters on the 
current proposal noted that the flexibility offered by a core principle 
might not adequately address the need for a standard method of 
calculating performance that will enable continuity and comparability 
in the presentation of CTAs' rates of return. The Commission believes, 
however, that a core principle adopted by the Commission would not 
preclude the development of more explicit guidance or performance 
standards by the Commission, self-regulatory organizations, and/or an 
independent organization, as one commenter suggested, that is otherwise 
consistent with the core principle.\11\ The Commission understands that 
NFA plans in the near future to adopt specific rules regarding 
presentation of partially funded accounts that would apply to all 
member CTAs,\12\ and that would be consistent with the rules proposed 
by the Commission.\13\ Although the Commission agrees that nominal 
account size is an appropriate basis for calculating performance 
results, the Commission encourages NFA, in the development of guidance 
carrying out a core principle approach, to consider whether or not 
these nominal account performance results can be supplemented with 
other performance measures or statistics that enable customers with 
accounts that are not fully funded to generally gauge performance 
results for these types of accounts. The Commission further notes that 
CTAs presenting partially funded account performance in accordance with 
the detailed requirements in its March 2003 rule proposal \14\ will be 
considered to be in compliance with the core principle.
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    \8\ Pub. L. 106-554, 114 Stat. 2763 (2000) (codified as amended 
in scattered sections of 7 U.S.C.).
    \9\ A copy of the study may be viewed on the Commission's Web 
site at: www.cftc.gov/files/opa/opaintermediarystudy.pdf.
    \10\ Report on the Study of the Commodity Exchange Act and the 
Commission's Rules and Orders Governing the Conduct of Registrants 
Under the Act, p. 25. In certain areas, commenters mentioned 
concerns with regard to the practicability and legal certainty of 
core principles.
    \11\ For example, the Association for Investment Management 
Research (``AIMR''), an international nonprofit organization of 
investment practitioners and educators, has developed voluntary 
standards for presentation of investment performance that are used 
by many investment managers and advisers. AIMR's Investment 
Performance Council recently issued an invitation to comment on 
proposed guidance regarding leverage and derivatives to be added to 
its Global Investment Performance Standards (GIPS). Neither the 
existing GIPS standards nor the proposed guidance directly addresses 
the partial funding issue that is the subject of the core principle 
adopted herein. As standards such as AIMR's evolve to address this 
issue, they may provide additional guidance to persons or 
organizations seeking to comply with this core principle or seeking 
to develop best practices in this area.
    \12\ With exceptions not otherwise pertinent here, a CTA that 
conducts futures business with the public and is required to 
register with the Commission must be a member of NFA, pursuant to 
NFA Bylaw 1101.
    \13\ Any rules adopted by NFA would be submitted to the 
Commission according to the review process for rules of a registered 
futures association provided in Section 17(j) of the Act.
    \14\ See note 1.
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    After evaluating the comments received on both the detailed 
proposed amendments and the alternative of a core principle described 
in the proposal, the Commission has determined not to adopt the 
detailed proposed rules, but rather to amend Commission Rule 4.35(a) 
\15\ so as to permit CTAs to comply with a core principle with respect 
to the performance of partially-funded accounts. While the Commission 
is fully supportive of the content and approach of its detailed rule 
proposal of March 2003, the history of discourse on this issue suggests 
that any prescriptive rule adopted by the Commission could soon be 
inconsistent with evolving industry developments and practices in this 
area. The flexibility of a core principle, rather than a single set of 
rigid requirements, would ensure that core Commission regulatory 
concerns are complied with without impeding legitimate business needs. 
The Commission believes that this approach is consistent with the 
objective of the CFMA that the Commission, when

[[Page 42966]]

appropriate, permit the industry flexibility in the manner it complies 
with certain regulatory mandates. Moreover, a core principle regarding 
the presentation of past performance of partially funded accounts is 
consistent with the approach governing use of promotional material by 
CTAs and commodity pool operators (``CPOs'').\16\ In addition, as noted 
in the proposing release, a core principle approach would also be 
consistent with Federal securities laws applicable to investment 
advisers, who generally may present past performance in any manner that 
does not run afoul of general anti-fraud provisions.\17\
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    \15\ Commission rules referred to herein may be found at 17 CFR 
Ch. I (2002).
    \16\ Commission Rule 4.41 reiterates the anti-fraud provisions 
of Section 4o of the Act. NFA has promulgated its Compliance Rule 2-
29 and issued interpretive notices, which provide more detailed 
guidance on the preparation and use of promotional material.
    \17\ 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). The SEC's general 
antifraud approach to performance disclosure, which is analogous to 
the core principle approach adopted herein, has not impeded the 
SEC's ability to bring enforcement actions for inappropriate 
disclosure. 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.
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    The core principle requires that the disclosure must be presented 
in a manner that is balanced and is not in violation of the antifraud 
provisions of the Commodity Exchange Act (the ``Act'') or the 
Commission's regulations thereunder.\18\ Each of these two requirements 
must be complied with in order for the core principle to be met. First, 
the presentation must not violate the antifraud provisions of the 
Commodity Exchange Act. For example, a materially misleading disclosure 
would violate those provisions,\19\ and thus would violate this core 
principle. In addition, the presentation must be balanced. For example, 
a presentation that emphasizes past gains and minimizes past losses 
would fail to meet this requirement, and thus would violate the core 
principle.\20\
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    \18\ 7 U.S.C. 1 et seq. (2000); 17 CFR Ch. I (2002). Antifraud 
provisions under the Act and regulations include Sections 4b, 4o, 
and Regulations 1.1, 4.41, 30.9, 32.9 and 33.10.
    \19\ See, e.g., In re Slusser, [1998-1999 Transfer Binder] Comm. 
Fut. L. Rep. (CCH) para. 27,701 at 48,311 (CFTC July 19, 1999), 
aff'd in part and rev'd in part on other grounds sub nom. Slusser v. 
CFTC, 210 F.3d 783, 784 (7th Cir. 2000).
    \20\ See also National Futures Association Compliance Rule 2-
29(b)(3) (prohibiting the use of promotional material that 
``mentions the possibility of profit unless accompanied by an 
equally prominent statement of the risk of loss.'') NFA has issued 
guidance interpreting this rule, see, e.g., NFA Interpretive Notices 
para. 9003.
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    Although a few commenters expressed concern that a core principle 
might impede the Commission's enforcement efforts, or limit them to 
``the most egregious cases,'' the Commission believes that the adoption 
of a core principle based on existing antifraud provisions, which also 
requires balance, in no way diminishes its current ability to address 
improper disclosure, nor its ability to address violations of that core 
principle consistent with its current authority to enforce the 
antifraud provision of the Act. The SEC has successfully brought 
actions under its anti-fraud authority against those who have used 
misleading performance presentations,\21\ and NFA has successfully 
disciplined members who have used unbalanced promotional material.\22\
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    \21\ See, e.g., In Re F.X.C. Investors Corp. and Francis X. 
Curzio 79 SEC 276 (2002) (Distribution of misleading performance 
information violates section 206(4) of Investment Advisers Act and 
SEC Rule 275.206(4)-1(a)(5)).
    \22\ See, e.g., Minogue Investment Company, Inc. (NFA Case No. 
98-App-006); Vision Limited Partnership (NFA Case No. 00-BCC-005).
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    In addition to the amendment to Rule 4.35, the Commission is also 
adopting the definition of a ``partially-funded account'' and a 
conforming amendment to Rule 4.25 regarding the presentation of a CTA's 
partially-funded account performance in a commodity pool disclosure 
document.
    The rule amendments being adopted herein relate solely to 
partially-funded accounts. In that regard, Advisory 93-13,\23\ which 
the proposing release stated would be superseded by the adoption of the 
proposed rule amendments, will remain in effect until such time as the 
Commission and/or an appropriate self-regulatory organization adopts 
further guidance on the presentation of partially funded accounts. 
Other issues noted in the proposal published March 13, 2003, regarding 
performance presentation generally, such as changes in the calculation 
of drawdown figures and application of the Commission's 1991 Advisory 
concerning additions and withdrawals,\24\ will be addressed in a 
subsequent Federal Register release.
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    \23\ CFTC Advisory 93-13, 58 FR 8226 (February 12, 1993).
    \24\ 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 (Feb. 
27, 1991).
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III. Other Matters

A. Regulatory Flexibility Act

    The Regulatory Flexibility Act, 5 U.S.C. 601 et seq., requires that 
agencies, in promulgating 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 Regulatory Flexibility Act.\25\ The Commission previously has 
determined that registered CPOs are not small entities for the purpose 
of the Regulatory Flexibility Act.\26\ 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 for purposes of the Regulatory 
Flexibility Act and, if so, to analyze the economic impact on them of 
any such rule at that time.\27\ The Commission has previously 
determined that disclosure requirements governing CTAs do not have a 
significant economic impact on a substantial number of small 
entities.\28\ Moreover, the amendments being adopted herein do not 
impose additional requirements on CTAs, but rather offer CTAs an 
alternative means by which to comply with existing Commission rules. 
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.
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    \25\ 47 FR 18618-18621 (Apr. 30, 1982).
    \26\ 47 FR 18619-18620.
    \27\ 47 FR 18618-18620.
    \28\ See 60 FR 38146, 38181 (July 25, 1995) and 48 FR 35248 
(Aug. 3, 1983).
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B. Paperwork Reduction Act

    The Paperwork Reduction Act of 1995 (``PRA'')\29\ imposes certain 
requirements on federal agencies (including the Commission) in 
connection with their conducting or sponsoring any collection of 
information as defined by the PRA. These rule amendments do not require 
a new collection of information on the part of any entities subject to 
the rule amendments. Accordingly, for purposes of the PRA, the 
Commission certifies that these rule amendments will not impose any new 
reporting or recordkeeping requirements.
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    \29\ 44 U.S.C. 3501 et seq.
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C. Cost-Benefit Analysis

    Section 15(a) of the Act requires the Commission to consider the 
costs and benefits of its action before issuing a new regulation under 
the Act. By its terms, Section 15(a) does not require the Commission to 
quantify the costs and benefits of a new regulation or to determine 
whether the benefits of the proposed regulation outweigh its costs. 
Rather, Section 15(a) simply requires

[[Page 42967]]

the Commission to ``consider the costs and benefits'' of its action.
    Section 15(a) further specifies that costs and benefits shall be 
evaluated in light of five broad areas of market and public concern: 
Protection of market participants and the public; efficiency, 
competitiveness, and financial integrity of futures markets; price 
discovery; sound risk management practices; and other public interest 
considerations. Accordingly, the Commission could in its discretion 
give greater weight to any one of the five enumerated areas and could 
in its discretion determine that, notwithstanding its costs, a 
particular rule was necessary or appropriate to protect the public 
interest or to effectuate any of the provisions or to accomplish any of 
the purposes of the Act.
    The Commission is considering the costs and benefits of these rules 
in light of the specific provisions of Section 15(a) of the Act:
1. Protection of Parket Participants and the Public
    The amendments being adopted herein are not expected to result in 
less protection of market participants or the public. Rather, the 
amendments provide the opportunity for a more meaningful and accurate 
disclosure, as demanded by marketplace forces. Moreover, the 
Commission, along with NFA, will continue to monitor the presentation 
of performance by CTAs and take action wherever necessary.
2. Efficiency and Competition
    The amendments are expected to increase efficiency by providing a 
CTA with increased flexibility for providing past performance. With 
this flexibility, a CTA will be better able to respond to changes in 
the industry and demands from the marketplace with regard to the 
disclosure of the CTA's past performance.
3. Financial Integrity of Futures Markets and Price Discovery
    The amendments should have no effect, from the standpoint of 
imposing costs or creating benefits, on the financial integrity or 
price discovery function of the commodity futures and options markets.
4. Sound Risk Management Practices
    The amendments should have no effect on sound risk management 
practices.
5. Other Public Interest Considerations
    The amendments being adopted herein provide more flexibility for 
CTAs in being able to present past performance in a manner that more 
accurately represents the trading results of their systems, while 
maintaining adequate safeguards so as to protect prospective clients 
from misleading or fraudulent solicitations.
    After considering these factors, the Commission has determined to 
issue the amended rules.

List of Subjects in 17 CFR Part 4

    Advertising, Commodity Futures, Customer Protection, Reporting and 
recordkeeping.

0
For the reasons discussed in the foregoing, 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

0
1. The authority citation for Part 4 continues to read as follows:

    Authority: 7 U.S.C. 1a, 2, 6(c), 6b, 6c, 6l, 6m, 6n, 6o, 12a and 
23.

0
2. Section 4.10 is amended by adding paragraph (m) to read as follows:


Sec.  4.10  Definitions.

* * * * *
    (m) Partially-funded account means a client participation in the 
program of a commodity trading advisor in which the amount of funds in 
the client's commodity interest account over which such commodity 
trading advisor has trading authority is less than the account size 
that establishes the client's level of trading in a commodity trading 
advisor's program.
0
3. Section 4.25 is amended by adding paragraph (a)(1)(ii)(H) to read as 
follows:


Sec.  4.25  Performance disclosures.

* * * * *
    (a) * * *
    (1) * * *
    (ii) * * *
    (H) Partially-funded accounts directed by a commodity trading 
advisor may be presented in accordance with Sec.  4.35(a)(7).
* * * * *
0
4. Section 4.35 is amended as follows:

0
a. By redesignating paragraphs (a)(7) and (a)(8) as (a)(8) and (a)(9) 
respectively;
0
b. And adding new paragraph (a)(7) to read as follows:


Sec.  4.35  Performance disclosures.

* * * * *
    (a)(7) Performance of partially-funded accounts. Notwithstanding 
the foregoing, a commodity trading advisor will be deemed in compliance 
with this Sec.  4.35(a) concerning the performance of partially-funded 
accounts if the commodity trading advisor presents the performance of 
such accounts in a manner that is balanced and is not in violation of 
the antifraud provisions of the Commodity Exchange Act or the 
Commission's regulations thereunder.
* * * * *

    Issued in Washington, DC, on July 15, 2003 by the Commission.
Jean A. Webb,
Secretary of the Commission.
[FR Doc. 03-18413 Filed 7-18-03; 8:45 am]
BILLING CODE 6351-01-P