CFTC Amends Rule 4.7: Key Changes Impacting Commodity Pool Operators (CPOs) and Commodity Trading Advisors (CTAs)

R Tamara de Silva

On September 12, 2024, the U.S. Commodity Futures Trading Commission (CFTC) adopted amendments to Rule 4.7 - the first changes since the regulation's adoption in 1992.[1] This rule provides compliance exemptions for Commodity Pool Operators (CPOs) and Commodity Trading Advisors (CTAs), exempting them from many disclosure, reporting, and recordkeeping requirements otherwise applicable under the Commodity Exchange Act (CEA).

CFTC Rule 4.7 exemptions are applicable when pool participants or advisory services are limited to individuals and entities that qualify as qualified eligible persons (QEPs). QEPs are defined in two categories. The first category, under CFTC Rule 4.7(a)(2), includes investors and clients who do not need to meet the monetary thresholds or “Portfolio Requirement,” of Rule 4.7 to qualify as QEPs, such as “qualified purchasers,” among others.[2] The second category, under CFTC Rule 4.7(a)(3), encompasses many types of investors including, registered investment companies, business development companies, banks and savings and loan associations trading for their own accounts, insurance companies, state pension plans, ERISA plans, non-profits, operating companies, and accredited investors, who must meet the Portfolio Requirement to qualify as QEPs.

Key Changes to the Final Rule

The amendments to Rule 4.7 impact both U.S. and non-U.S. institutional investment managers relying on this exemption:

1. Monetary Thresholds Increased

The CFTC has amended the definition of the “Portfolio Requirement” to account for the effects of inflation over the 32 years since the Rule was initially adopted. The monetary thresholds for QEP qualification have been doubled, reflecting inflationary changes since 1992. The updated monetary requirements mandate that investors must have the following to qualify as QEPs:

• Own securities and other investments with a combined market value of at least $4 million, up from the previous $2 million threshold.
• Have on deposit at least $400,000 in initial margin and option premiums, doubling the earlier $200,000 requirement.
• Alternatively, own a combination of securities and margin deposits meeting the revised thresholds, such as $2 million in securities and $200,000 in margin.

2. Codification of Exemptive Letters for Account Statement Distribution

The rule also formally incorporates previously issued exemptive relief, allowing CPOs of funds of funds operating under Rule 4.7 more time for distributing account statements. Specifically, these operators may now choose to distribute monthly statements within 45 days of the month-end rather than quarterly statements within 30 days of the quarter-end. As funds of funds get their performance data from other funds, the extension provides more time to compile complex data from these other sources thereby easing administrative burdens on CPOs.

Commissioner Perspectives

Commissioner Summer K. Mersinger supported the amendments, emphasizing that they modernize Rule 4.7 by aligning it with current economic realities. Mersinger highlighted the importance of maintaining balance, as the CFTC opted not to impose additional disclosure requirements that could have increased compliance burdens on CPOs and CTAs, arguing that these would not necessarily enhance investor protections.

Commissioner Caroline D. Pham echoed this sentiment, stressing that the CFTC’s careful recalibration of the QEP thresholds addresses inflation while recognizing the sophistication of today’s investors. Pham noted that this approach respects the original intent of Rule 4.7, which was to provide flexibility for institutional and sophisticated investors while reducing unnecessary regulatory burdens.

Implications for CPOs and CTAs

CPOs and CTAs have six months after the rule's publication in the Federal Register to comply. The increased thresholds could reduce the pool of eligible investors, prompting funds to reassess their structures and marketing strategies. Although firms with institutional investors may experience minimal impact, funds targeting individual QEPs could face limitations in their client base.

Current participants or clients who met prior thresholds will not be required to redeem their interests but will be restricted from making additional investments unless they meet the new requirements. The rule applies prospectively meaning that if a CTA operating under the 4.7 exemption has customers who do not meet the new increased monetary thresholds to be QEPs, the CTA can keep them, but the customers cannot increase their investments without complying with the new monetary thresholds.

The increased monetary thresholds will impact firms differently, depending on their client base. For example, institutional funds that operate under Section 3(c)(7) of the Investment Company Act and invest in pools with QEPs not subject to the Portfolio Requirement will see little change. In contrast, some CTAs managing non-pool trading programs with natural person QEPs may see their potential investor universe shrink.

The CFTC’s proposed rule would have imposed disclosure requirements for QEPs that would have removed the present exemptions from disclosure of Rule 4.7. The CFTC’s decision not to adopt the rule as originally proposed- that would have required firms relying on the exemption to distribute disclosure documents to their investors similar to the disclosure documents that non-exempt CPOs and CTAs are required to distribute to retail investors is sound. QEPs are presumed to be among the most sophisticated of investors having met higher net worth and income requirements than Accredited Investors.[3] QEPs do not need the same level of disclosures that retail investors or even accredited investors do because they have more knowledge and resources by which to protect themselves. In adopting the final rule the CFTC strikes a balance between investor protection without imposing undue burdens on investment managers.

CPOs and CTAs should review their investor qualifications and reporting processes to ensure compliance with the updated requirements. If you need guidance about this rule, please contact us.