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Commodity Pool Operators (CPOs) & Commodity Trading Advisors (CTAs)

  • January 12, 2001

    To: All Commodity Pool Operators
    Attention: Chief Financial Officer

    Subject: 2000 Annual Reports for Commodity Pools

    This is the third annual letter that the Division of Trading and Markets (“Division”) of the Commodity Futures Trading Commission (“Commission”) is sending to all registered commodity pool operators (“CPOs”) to share the results of our experience reviewing prior years’ annual pool reports. These letters are intended to assist CPOs and their public accountants in complying with Part 4 of the Commission’s regulations under the Commodity Exchange Act (“CEAct”) in connection with the preparation and filing of a pool’s annual financial report.

    The total number of reports filed increased in each of the last three years. About 86% of the 1999 reports were acceptable as filed, compared to 82% of the1998 reports and 77% of the 1997 filings. Although the trend is favorable, there is room for further improvement.

    In our previous letters regarding pool annual reports (dated January 19, 2000 and February 10, 1999), we described certain recurring deficiencies. Both this letter and those letters are available at our website at www.cftc.gov/tm/mgdfund.htm. Therefore, we will not repeat all the details mentioned in our prior letters, but will emphasize and expand on some of them. In particular, please see Fund of Funds Considerations below for an update on that important topic. Because many of the deficiencies noted below occur in reports for offshore pools, it may be helpful for you to share this letter with your offshore correspondents and their local auditors.

    In order to avoid some of the most common and easily remedied deficiencies, please do the following:

    · File one copy of the report with the National Futures Association (NFA) and two copies with the Commission at the regional office in whose jurisdiction the CPO’s principal place of business is located (See Attachment A for addresses).1

    · File the report as soon as possible, but no later than the due date. For pools with a December 31, 2000 year-end, the due date is Monday, April 2, 2001 (unless an extension of time has been granted). CPOs operating a fund-of-funds pool should review the new streamlined procedures described in the revised Regulation 4.22(f)(2) for requesting an extended due date (this topic is discussed later in this letter).

    · If the pool is operating under a Rule 4.7 or 4.12 exemption, the rule requires that a notation of that fact be made on the cover page of the report. Note that, effective August 4, 2000, the 4.7 rules were amended making them available to more CPOs and commodity trading advisors (“CTAs”) in more situations. The new rules were published at 65 Fed. Reg. 47848 and are available at the CFTC website at www.cftc.gov/foia/fedreg00/000804b.htm or .pdf. Please note that the revised 4.7 resulted in a renumbering from the former rules. A cross-reference page is included at the end of the Federal Register notice.

    · Report special allocations of partnership equity as required by CFTC Interpretive Letter 94-3, Special Allocations of Investment Partnership Equity (CCH ¶25943). This document is available on the CFTC website at www.cftc.gov/tm/94-03.htm.

    · Include information concerning net asset values or schedules of participants’ interests where that is required.

    · Include a signed oath or affirmation with each and every copy of the report filed with NFA, the Commission and all pool participants. (Binding the oath as part of the report package or attaching it to the cover page is a helpful practice followed by a number of CPOs.)

    Applicability of GAAP to Commodity Pools’ Annual Financial Statements

    In reviewing 1999 annual reports we noted instances where CPOs filed pool financial statements that failed to comply with generally accepted accounting principles (“GAAP”). CFTC rules require that financial statements of pools be presented and computed in accordance with GAAP. That requirement applies even when financial statements are exempt from independent audit, such as those of pools qualifying under Regulation 4.7. Significant departures from GAAP may necessitate revising a pool’s financial statements and sending them to investors along with revised account statements.

    Schedule of Investments Likely to be Required by GAAP

    Non-public investment partnerships have been required to include a schedule of investments as specified by the AICPA Statement of Position 95-2, Financial Reporting by Nonpublic Investment Partnerships (“SOP 95-2”). Investment partnerships that are commodity pools subject to regulation under the Commodity Exchange Act of 1974 are currently exempt from SOP 95-2. That exemption is likely to be revoked by an SOP that is being finalized by the AICPA. The rationale for revocation is to help improve the transparency and comparability of financial statement disclosures made by commodity pools, hedge funds, and other kinds of funds. The amended SOP would be effective for commodity pools’ financial statements for periods ending after December 15, 2001. (The amended SOP would encourage application of these principles to earlier periods). It is likely to require that commodity pools’ financial statements include a schedule of investments as prescribed by SOP 95-2. (Check website www.AICPA.org/ for the current status of this proposal.) While this will not be a required schedule for December 31, 2000 annual reports, CPOs should consider the impact of this schedule on periodic reports which will be prepared during 2001 and future annual reports.

    Final Reports

    When a CPO ceases trading, the CPO must file a final report for each of its pools. The final report should be in the same format and include the same information as the annual report, even if the final report is not for a full 12 month period. A CPO should emphasize when it intends a report to be its final report. A legend on the cover of the report is an effective way to do so.

    Fund of Funds Considerations

    The Division of Trading and Markets is particularly concerned with the level of disclosure regarding a pool’s investments in other investment companies. This one topic accounted for a substantial portion of the non-compliance letters we sent for 1999 and 1998 annual reports.

    Regulation 4.22(c)(5) requires annual reports to include appropriate disclosures and such further material information as necessary to make the statements not misleading. (Similar obligations are found in Regulations 4.7(b)(3)(C) and 4.12(b)(2)(iii)(A)). The Division of Trading and Markets believes that complete disclosure to the participants in a commodity pool requires that the pool’s financial statements provide them information about other funds to which the pool devotes significant portions of its capital (“major investee funds”). The objective is to allow the participant to see the performance of the pool’s major assets and the fees associated with these investments.

    If a pool’s investment in an investee fund is greater than or equal to ten percent of the pool’s net assets, the investee fund is considered a major investee fund. See Regulation 4.10(d)(5). Moreover, once there is at least one major investee fund, disclosure for all investee funds is appropriate (smaller funds may be aggregated and reported as a single group). The total of the net income or loss for each investee fund in the capsule information in the notes to the financial statements should agree with the single-line reported on the statement of operations for the investor fund’s investment in other funds.

    At a minimum, the pool’s financial statements should disclose, for each major investee fund:

    (1) The name of the fund,

    (2) The carrying value of the investment,

    (3) Liquidity information (such as limitations on withdrawals from the investee fund), and

    (4) The summary income statement information discussed in Regulation 4.22(e). This should include fees paid by the investee pool expressed in dollars. In those unusual cases where dollar amounts cannot be obtained and are unknown to the CPO, a statement to that effect should be made by the CPO and the percentages used by the investee to calculate fees should be reported as illustrated in Attachment B to this letter.

    This disclosure should be made regardless of whether the investee funds are commodity pools.

    Even if no single investment is ten percent of the reporting pool’s net assets, if the aggregate investment in other funds is at least 20 percent, the CPO should strongly consider providing the information discussed above with respect to the pool’s investments in other funds, and should be prepared to justify a failure to do so. The CPO should exercise discretion in determining the best method of presenting this information. While it may not be necessary to provide information on each of the individual investee funds, the CPO should find an appropriate method of classifying the investments and reporting on each class.

    Enclosed as Attachment B is an illustration that satisfies the objectives of fund-of-funds reporting.

    In cases where a pool has invested all, or substantially all, of its net assets in one other pool (such as in a master-feeder structure), complete financial statements of the investee pool should be included with those of the investor pool. The financial statements of the investee pool should also include disclosures described herein for its own investee pools.

    Extended Due Date for Fund-of-Funds Pools

    Revisions to Regulation 4.22(f) make it easier for fund of fund pools to obtain extensions of time for filing their annual reports. (65 Fed. Reg. 80741 (December 26, 2000)). These revised regulations are available at the CFTC website (www.cftc.gov/foia/fedreg00/001226a.htm or .pdf. ) These revisions to Regulation 4.22(f) would permit CPOs to file a claim for an extension of time to file the pool’s annual report where the pool is invested in other collective investment vehicles, and the CPO’s independent accountant cannot obtain the information necessary to comply with the rule in a timely manner.

    Notices for the first year: The CPO’s first notice claiming the extension must be filed within 90 days after the end of the pool’s fiscal year (that is, by the normal deadline for filing the annual report). This notice must contain the following:

    1) The name, main business address, main telephone number and the National Futures Association registration identification number of the commodity pool operator, and the name and NFA identification number of the commodity pool

    2) The date by which the Annual Report will be distributed and filed (the “Extended Date”). The Extended Date must be no more than 150 calendar days after the end of the pool’s fiscal year.

    3) Representations by the commodity pool operator that:

    (A) The pool for which the Annual Report is being prepared has investments in one or more collective investment vehicles (the “Investments”);

    (B) The commodity pool operator has been informed by the certified public accountant selected to audit the commodity pool’s financial statements that specified information establishing the value of the Investments is necessary in order for the accountant to render an opinion on the commodity pool’s financial statements. The notice must include the name of the accountant; and

    (C) The information specified by the accountant cannot be obtained in sufficient time for the Annual Report to be prepared, audited, and distributed before the Extended Date.

    Before claiming the extension, the CPO must analyze the circumstances related to the operation of its pool and specify the period for which relief is needed. The CPO is not required to obtain a written statement from the independent accountant selected to audit the pool confirming that information in the CPO’s notice. As noted above, however, the CPO will be required to name the independent accountant who has informed the CPO of the necessity of that information.

    Notices for subsequent years: In subsequent years, the requisite representations may be made in a statement filed at the same time as the annual report.

    The CPO responsible for the pool’s operation must sign the notice or statement.

    Applicability to Regulation 4.7 Pools. Under Regulation 4.7, CPOs may claim relief from the requirement that the exempt pool’s financial statements distributed to pool participants be certified by an independent public accountant. Most CPOs operating pools for which relief under Regulation 4.7 has been claimed, nonetheless include certified financial statements in their annual reports. In changing Rule 4.22, the Commission noted that it did not wish to discourage this practice and it will allow such CPOs to claim the relief provided in Regulation 4.22(f)(2).

    These regulations are applicable for fund-of-funds situations only. CPOs requesting extensions for other reasons or for whom the automatic extension is insufficient must follow the provisions of 4.22(f)(1) and file those requests with the CFTC’s Washington office.

    All CPOs that have requested filing extensions for their fund-of-funds pools in the past must re-file under this new rule provision. The extensions granted in the past are no longer applicable.

    Conclusion

    In addition to noting the issues discussed in this letter, CPOs and their accountants should be familiar with the AICPA Practice Aid Audits of Futures Commission Merchants, Introducing Brokers, and Commodity Pools.

    If you or your accountant have any questions on the foregoing, please feel free to contact the appropriate regional CFTC staff member listed in Attachment A to this letter.

    Thank you for your attention to these matters.

    Very truly yours,

    John C. Lawton
    Acting Director
    Division of Trading and Markets

    ADDRESSES OF CFTC’s DIVISION OF TRADING AND MARKETS OFFICES

    Regional Offices and Contacts

    Location of CPO’s Principal Office

    Eastern Region

    One World Trade Center
    Suite 3747
    New York, NY 10048

    Ronald A. Carletta
    Phone: 212-488-1289
    FAX: 212-466-5575
    E-Mail: rcarletta@cftc.gov

    All states east of the Mississippi River, except Illinois, Indiana, Michigan, Ohio, and Wisconsin.

    Any location outside of the United States

    Central Region

    300 South Riverside Plaza
    Suite 1600 North
    Chicago, IL 60606

    John S. Dixon
    Phone: 312-886-3207
    FAX: 312-353-3690
    E-Mail: jdixon@cftc.gov

    Illinois, Indiana, Michigan, Ohio, and Wisconsin

    Southwest Region

    4900 Main Street
    Suite 721
    Kansas City, MO 64112

    Ralph L. White
    Phone: 816-931-9502
    FAX: 816-931-9643
    E-Mail: rwhite@cftc.gov

    All states west of the Mississippi River



    NFA ADDRESS

    National Futures Association
    Compliance Department
    200 West Madison 16th Floor
    Chicago, IL 60606

    Phone: 312-781-1300
    website: nfa.futures.org

    ILLUSTRATION - FUND OF FUNDS DISCLOSURES

    Note X. Investments
    As of December 31, 2000, ABC Fund invested in other funds, none of which were related parties. The Fund’s investments are summarized below based on the investment objectives of the specific funds, as described in the disclosure documents for those funds:

    Investment Objective

    Fair Value

    [Objective 1]

    $ 700,000

    [Objective 2]

    550,000

    [Objective 3]

    500,000

    [Other]

    155,485

    Total

    $1,905,485



    The following table summarizes ABC Fund’s investments in other funds as of December 31, 2000. Funds in which ABC Fund invested 10% or more of its net assets are individually identified, while smaller investments in three other funds are aggregated . The management agreements of the investee funds provide for compensation to the managers in the form of fees ranging from 1% to 3% annually of net assets and performance incentive fees ranging from 5% to 25% of net profits earned.

                 

    Investment

    % of ABC’s Net Assets

    Fair Value

    Income (Loss)

    Fees
           Mgnt        Incentive

    Redemptions
    Permitted

    Hejmat Fund Ltd.

    11.2

    $ 500,000

    $145,000

    $ 5,200

    $30,000

       Quarterly

    Carron Int’l Fund

    10.7

    475,000

    118,000

    4,800

    24,000

       Monthly

    Marvelous Fund NV

    10.1

    450,000

    (24,000)

    4,500

    0

       Semi-Annual

    Other funds:

    10.8

    480,485

    18,221

    5,500

    3,500

       Monthly-Annually

    Total

    42.8%

    $1,905,485

    $257,221

    $20,000

    $57,500

     



    An alternative illustrative table, for unusual cases, where the fee information cannot be obtained is shown below:

                   

    Investment

    % of ABC’s Net Assets

    Fair Value

    Income (Loss)

    Fees
           Mgnt    Incentive

    Redemptions Permitted

    Hejmat Fund Ltd.

    11.2

    $ 500,000

    $145,000

    $ 5,200

    $30,000

       Quarterly

    Marvelous Fund NV

    10.1

    450,000

    (24,000)

    4,500

    0

       Semi-Annual

    Other funds:

    10.8

    480,485

    18,221

    5,500

    3,500

       Monthly-Annually

    Subtotal

    32.1

    1,430,485

    139,221

    $15,200

    $33,500

     

    Carron Int’l Fund

    10.7

    475,000

    118,000

    *

    *

       Monthly

     

     

     

     

     

     

     

    Total

    42.8%

    $1,905,485

    $257,221

     

     

     

    * =

    The fund operator is not able to obtain the specific fee amounts for this fund and does not know what those amounts are. However, management fees are computed based on 1% per year of net asset balances at the beginning of each month; incentive fees are computed based on 20% per year of net income.

    1 While Regulation 4.2 directs that materials required under Part 4 be filed at the Commission's Washington office, CPOs are strongly encouraged, and by this letter authorized (pursuant to Regulation 4.12(a) and 140.93(a)(1)), instead to file pool annual reports at the appropriate regional office of the Commission.

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