The amendments to the Commission’s Part 4 regulations we are adopting with these final rules were prompted by a petition from the NFA seeking to reinstate certain operating restrictions that were in place prior to 2003 for entities excluded from the definition of CPO under § 4.5. Had we limited the amendments to address the issues raised by the NFA’s petition, we could have met our regulatory objectives without disrupting a significant number of business structures. I would have supported such an approach. As it is, we have gone far beyond what was needed to resolve NFA’s concerns and I must dissent.
Section 404 of the Dodd-Frank Act requires certain advisors of private funds to register with the SEC and to report to the SEC information “as necessary and appropriate . . . for the protection of investors or for the assessment of systemic risk by the Financial Stability Oversight Council.” With the finalization of these rules, the Commission has determined that the “sources of risk delineated in the Dodd-Frank Act with respect to private funds are also presented by commodity pools” and that registration of certain previously exempt or excluded CPOs is therefore necessary “to assess the risk posed by such investment vehicles in the derivatives markets and the financial system generally.” The Commission states that the data it will collect as a consequence of registration is necessary “in order to fulfill the Commission’s systemic risk mitigation mandate.” While I agree that the Commission has a regulatory interest in the activities of commodity pools, this overstates the case and gives a false impression that the data we gather will enable us to actively monitor pools for systemic risk, that we have the resources to do so, and that we will do so. Moreover, Congress was aware of the existing exclusions and exemptions for CPOs when it passed Dodd-Frank and did not direct the Commission to narrow their scope or require reporting for systemic risk purposes. The Commission justifies the new rules as a response to the financial crisis of 2007 and 2008 and the passage of Dodd-Frank, yet there is no evidence to suggest that inadequate regulation of commodity pools was a contributing cause of the crisis, or that subjecting entities to a dual registration scheme will somehow prevent a similar crisis in the future.
I could nevertheless support a revision of the current exclusions and exemptions that would give us access to information we determine is necessary to carry out our regulatory mission if supported by a sufficient cost-benefit analysis. The rationale underlying a number of the decisions encompassed by the rules is sorely lacking, however, and is not supported by the existing cost-benefit analysis. The Commission concludes, for example, that bona fide hedging transactions are unlikely to present the same level of risk as risk mitigation positions because they are offset by exposure in the physical markets. A risk mitigation position is, by definition, a position that mitigates or “offsets” exposure in another market. Both are hedges and there is no explanation as to why the Commission believes that bona fide hedges are less risky. The preamble states that the alternative net notional test under § 4.5 is meant to be consistent with the net notional test set forth in § 4.13(a)(3), except the § 4.5 test allows unlimited use of futures, options or swaps for bona fide hedging purposes, while the § 4.13(a)(3) test does not. No explanation is given for the differing treatment. We reject an exemption for foreign advisors similar to the exemption allowed by the Investment Advisors Act of 1940 under Section 403 of Dodd-Frank because we lack information on the activities of foreign pools, even though, as some commenters observed, this may result in nearly all non-U.S. based CPOs operating a pool with at least one U.S. investor having to register and report all of their derivatives activities to the Commission, including activity that may be subject to comparable foreign regulation. While we leave open the possibility of future exemptions based on information we collect on Forms CPO-PQR and CTA-PR, the more likely result of this new policy is that U.S. participants will be excluded from investing in foreign pools. The Commission may have good reasons for this course of action, but no rationale is given.
Our “split the baby” approach on the issue of family offices is illogical. The Commission states that it is “essential that family offices remain subject to the data collection requirements” to fulfill our regulatory mission and to develop a comprehensive view of such firms to determine whether an exemption may be appropriate in the future. At the same time, we are allowing an unknown percentage of family offices to rely on previously issued interpretive letters to avoid registration, reporting and other compliance obligations. This makes no sense. We either need this data or we do not. Family offices may fit within the parameters of the existing interpretive letters, in which case we will not develop the comprehensive view we are seeking. On the other hand, we ignore the fact that we have consistently found, for more than three decades, that family offices are not the type of collective investment vehicle that Congress intended to regulate in adopting the CPO and commodity pool definitions, a finding that Congress confirmed in § 409 of Dodd-Frank with respect to investment advisors. Moreover, our repeal of the family office exemption is inconsistent with the exclusion recently adopted by the SEC pursuant to § 409 at a time when Dodd-Frank has urged us to harmonize our rules to the fullest extent possible.
It is unlikely, in my view, that the cost-benefit analysis supporting the rules will survive judicial scrutiny if challenged. And, although I am relieved that the recordkeeping, reporting and disclosure obligations required by the rules will be delayed until after proposed harmonization rules are finalized, the rules contain a confusing and needlessly complicated set of compliance dates for other provisions.
While I have felt that many of the rules we have finalized in the last few months were far too overreaching, our justification that a particular rule was required by statute was largely accurate. With regard to these rules the same justification does not hold true. These rules are not mandated by Dodd-Frank, and I do not believe that the benefits articulated within the final rules outweigh the substantial costs to the fund industry. We admit in the preamble that we do not have enough information to determine the validity of requiring some of these entities to register. A more prudent approach would have been to gather the information first and then decide what constitutes sound policy. For these and other reasons, I cannot support the final rules.
Last Updated: February 9, 2012