CFTC Staff Letter 84-13 (No-Action): CPO Registration Relief for Registered Investment Company

COMMODITY FUTURES TRADING COMMISSION
2033 K STREET, N.W., WASHINGTON, O,C. 20581
DIVISION OF
TRADING AND MARKETS 1\ugust' 1,' 1984
Re:
Regulation as a commodity pool operator.
Dear
This is in response to your letter dated J'\IDe 19, 1984, as supplerrented by the prospectus dated March 29, 1984 encl~.seCl therewith (the "Prospectus"), in which you requested that we not recamend that the Cc:mnission take any enforcenBnt action against (the "Fund") for failure to register as a comrodity pool operator ("CPO") subject to the conditions and limitations described below. From the representations made in your letter, as supplerrented, we under￾stand the facts concerning the Fund's operation in general to be as follows:
The Fund is a series investrrent canpany registered under the Investrrent Calpany Act of 1940. It currently is offering shares in the following four invest:rrent Portfolios: ( 1) the Governrrent Money Market Portfolio, which seeks high current incCJ!tB and stability of principal by investing in short￾term u.s. obligations; (2) the Money Market Portfolio, which seeks high current income and stability of principal by investing in a variety of short￾term instrurrents; (3) the High Yield Bond Portfolio, which seeks to maximize total return from capital appreciation and current income by investing generally in certain debt securities; and (4) the Aggressive GrONth Portfo￾lio, which seeks to maximize capital appreciation by investing primarily in common stocks and securities convertible into common stocks. The first two Portfolios do not intend to engage in commodity futures transactions. The second two Portfolios, however, do. Specifically, the High Yield Bond Portfolio intends to trade financial futures contracts and the Aggressive Grcwth Portfolio intends to trade stock index futures con￾tracts. Your letter makes the following representations with respect to each sqch Portfolio's camYJdity futures trading: ._ .,. The Fund' s sale and purchase of . • • futures contracts will be for bona fide hedging purposes only and not for speculation, with the purpose of offsetting anticipated price changes in securities held by the particular Portfolio or which the particular Portfolio anticipqtes purchasing. A hedging transaction is intended to reduce risk of loss, not increase it.

In order to protect against an anticipated decline in the value of • • • [a] Portfolio due to general market con9itions or changing interest rates, the particular Portfolio would enter into a short hedge by selling a futures contract, instead of liquidating or adjust￾ing its portfolio securities and incurring the incident transaction charges. To the extent that subsequent decreases in futures prices produced gains in the particular Portfolio's futures position that offset the decline in the value of the Portfolio, gains on the futures position would offset the particular Portfolio's loss on its portfolio securities. Further, to the extent that prices in the futures market moved in correlation to the prices of the securities comprising the hedging Portfolio, any losses in the Portfolio's futures positions should be offset by increases in the value of its portfolio secu￾rities. · When • • • [a] Portfolio wishes to remain in short-term instru￾ments because such instruments are desirable for defensive'purposes or because such are otherwise advantageous, and aF the same time wishes to avoid the risk that it may have to pay higher prices for portfolio securities it intends to acquire in the future, the particular Portfo￾lio would enter into a long hedge by ·purchasing ••• (a] futures contract. • • • [T] o the extent tho,t" an increase in the Portfolio's futures position offset the high~~·prices to be paid by the Portfolio in the future for long-term investments, gains in the Portfolio's futures position would offset such increases in prices, Further, to the extent that futures prices move in correlation to the prices of securities held by the Portfolio, any losses on the Portfolio's futures positions should be offset by any difference between what it pays for the long-term investment and the larger price it would have paid for such investment if it had purchased it with cash. • • • (T]he Fund represents that, to insure that all of its commodity interest trading is for bona fide hedging purposes, the Fund will 11 complete" its purchases of interest rate futures contracts and stock index futures contracts a substantial majority (i.e., approximately 75%) of the time. '.!./ Additionally, the Fund's fundamental policies provide that • • • [each] Portfolio may not enter into • • • futures contracts if, i.m:rediately after such a cornnitment, oore than 5% of the particular Portfolio's total assets would be posted as initial and variation margin. As you are aware, on February 2, 1984, the Cc:m:nission issued proposed Rule 4. 5 , which would exempt certain otherwise regulated persons from regis￾tration as a CPO and from the provisions of Subpart B of Part 4 of the '.!_/ We note that such a representation concerning completion of long commodity interest hedges -- be they in stock index or financial corrm:xlity interests -- is one of the representations we require-to grant relief from CPO regulation.

Comnission's regulations. 2/ See 49 Fed. Reg. 4778 (February 8, 1984), 49 Fed. Reg. 6910-11 (February 24-;1984) • Based upon our review of the represent￾ations made in your letter, as supplemented, it appears that the Fund would be eligible for this proposed exemption inasmuch as: (1) the Fund is arrong the persons and qualifying entities covered by the proposal -- i.e. , a re￾gistered investroont company; (2) each of its two Portfolios that will engage in commodity interest transactions will do so solely for bona fide hedging purposes; (3) each of these Portfolios will not deposit as initial margin or premiums for it:s ccmrodity interest transactions nore than 5% of its total assets; (4) the Fund will not be, and has not been, marketed as a corrm:xlity pool or otherwise as a vehicle for trading in the carm:x1i.ty interest markets; and (5) the Fund will disclose in writing to its prospective participants the purpose of and the limitations on the .scope of its cc:mn:x:1ity interest trading. Proposed Rule 4,5 does not specifically address the instant situation -- i.e. , where only certain portfolios of a registered series inves-t:n¥mt company intend to engage in commodity interest transactions. --~qwever, in'light of the separate CMnership in and identii:::ies of the Fund's Portfolios -- ~~ separate investment objectives, net asset valuations and dividend policies -- we believe it consistent with the intent of proposed Rule 4.5 to treat· as separate entities each of the two Portfolios Phat intend to engage in commodity interest trading for purposes of determining··whether the criteria of the proposal have been met. 2/ Conversely, where such separate CMnership and identities are not present, we might find it nore consistent with proposed Rule 4.5 to aggregate all of the portfolios of a series investment fund in determining whether the criteria has been met. Accordingly, this Division will not recommend that the Commission take any enforcement action against for failure to register as a CPO or to comply with the provisions of Subpart B of Part 4 of the Corcmission's regulations, 4/ This position is, hooever, subject to the condition that the Fund will cOmply with Rule 4.5 as adopted by the Cammis- ~/ Section 4m(l) of the Act, 7 u.s.c. §6m(l) (1982), requires each person who comes within the CPO definition to register as a CPO with the Com￾mission. The provisions of Subpart B of Part 4 concern the operational, disclosure, reporting and recordkeeping requirements of registered CPOs. See 17 C.P.R. §§4.20-4.23 (1983), as amended by 48 Fed. Reg. 35248 (August 3, 1983). - 2/ vJi th respect to a series investroont company such as the Fund we believe this determination particularly appropriate to the "hedging" and "5%" criteria. A contrary finding would enable a Portfolio to cammit 5% of the Fund's total assets for its co:nm::xli ty interest positions which, in

• turn, might enable the Portfolio to ccmni t nore assets th.cm ere necessary
  to hedge its CMn, separate actual or anticipated cash positions.
  !/ Inasmuch as proposed Rule 4.5 would provide exemption for a registered investment company and any principal or employee thereof, the position we are taking herein also would apply to any principal or employee of the Fund -- ~' its officers.

sion or with any other such rule that the Camnission may adopt to exempt certain otherwise regulated persons from regulation as a CPO. 5/ Therefore, this position will cease upon the effective date of Rule 4.5 or of such other rule. In this connection, we note that previously we have issued opinions to certain registered inves'l:rt¥mt companies that they would not be pools within the rreaning and intent of Rule 4 .10 (d) based upon representations similar to those made by . .the Fund. 6 I HO'v'Vever, in light of the Coomission' s recent proposal in this area, we believe that such a "no-action" position is the appropriate relief that should be afforded at this time. We further note that with respect to such investrrent companies and the filing of certain . notices proposed in Rule 4. 5, the Ccmnission has stated:
[We do] not believe that it should be necessary for the recipients of such interpretative letters to, in effect, . "re-submit" an application for exemption -- i.e., to .file ah initial notice of eligibility -- in the event the proposal is adopted. HO'v'Vever , to insure that these persons (and entities) would be in compliance with the requirements of the proposed rule, the Conmission inten¢ls to take the position that such persons must file ,sUpplemental notices in the event that any of the representations they previously had made to the Corrmission changed or that, to the extent that the proposal would require any additional representa￾tions, they were not in compliance with them. This position would ensure equal treatment of all persons claiming exemption under the rule. 49 Fed. Reg. 4778 at 4782-83. 11 2../ For example, the rule as adopted may or may not contain the sarre standards and indicia of bona fide hedging transactions and positions contained in the rule as proposed. fllbreover, to the extent that the rule as adopted is less restrictive than the rule as proposed -- with respect to the standards and indicia of bona fide hedging transactions and positions or to any other aspect of the proposal -- the Fund would be able to trade commodity interests subject to such other restrictions provided, of course, that such trading is conducted in accordance with the rule as adopted. il See , Comm. Fut. L. Rep. (CCH) ~21,908 (available Noverrber 3, 1983) ~ _ , Comn. Fut. L. Rep. (CCH) ~21,906 (available October 21, 1983)~ _ , Canm. Fut. L. Rep. (CCH) ~21 ,905 (available Septerrber 13, . 1983). See also . , Corm. Fut. L. ~ (CCH) ~21,910Tavailable November 21, 1983). · 11 Your letter represents that the Fund will comply with Rule 4.5 as adopted "to the sane extent as if it had filed an application for exemption from registration as a CPO pursuant to [Rule) 4. 5 and such application had been granted. "

We believe, and intend to reccmrend, that the Carrnission should take this sarre position with respect to the Fund. 8/ You should be aware that the position we have taken in this letter does not excuse the Fund from compliance with any otherwise applicable require￾IOOnts contained in the Act or in the Cc:mnission' s regulations thereunder. For example, it remains subject to the anti-fraud provisions of Section 4o of the Act, 7 u.s.c. §6o (1982), and to the reporting requirements for traders set forth in Parts 15, 18 qnd 19 of the Cc:mnission's regulations, 17 C.F.R. Parts 15, 18 and 19 (1983) , as arrended. The position we have taken herein is based upon the representations that have been made to us. Any different, changed or anitted facts or conditions might require us to reach different conclusions. In this connection, we request that you notify us immediately in the event the Fund's operations and activities change in any way from that as represented to us. ~/ We historically have treated registered investment companies and their officers and directors as those persons subject to CPO regulation. In the unlikely event that Rule 4.5 or any other such rule as the Commission adopts includes investment advisers to and distributors of registered invesbrent companies atrong the persons who could be considered to be CPOs but does not also include provision for exemption from r~on as a CPO for such persons, the Division will not recommend that the Commission take any enforcement action against the Fund's adviser, distributor, or any officer, director or employee thereof pending such persons' compli￾ance with such requirements as the rule may impose. Of course, this position assumes that such persons will endeavor to achieve such compli￾ance as promptly as possible.