CFTC Staff Letter 87-08: No-Action Relief for CPO Registration of Partnership General Partners

Dear
87-8
November 9, 1987
Re: CPO Registration No-Action Position Where Investors Have 20-Year History This is in response to your letter dated September 25, 1987, as supplerrented by your telephone conversation with Division staff held on October 20, 1987, wherein you requested confinnation that the Division will not recommend that the Commission take any enforcement action for failure to register as a carm:xlity pool operator ("CPO") against the General Partners of the Partnership. 1/ Based upon the representations made in your letter, as supplerrented, we understand the facts to be as follows:
Although the Partnership was formed on January 22, 1987, it may cla:im an indirect affiliation with two corporations no longer in existence. "X" was formed in the early 1900s to engage in the wholesale distribution of certain products •.•• "X' s" assets were sold in 1966 to an unrelated campany, for cash and stock. However, the cash and stock 1/ Alternatively, you requested an opinion that the Partnership would not be deeired to be a carm:xlity "pool" within the meaning and intent of Rule 4.10(d), 17 C.F.R. §4.10(d) (1987). Among other reasons, because the Partnership is not a registered inves"t:Irent canpany we are unable to provide such an opinion. See Rule 4.5, 17 C.F.R. §4.5 (1987); see also n. 4, infra. -- ----

received in the transaction were not distrib￾uted to "X's" shareholders, but rather were left in the company, which was renamed "Y". In 1968 "Y" changed its state of incorporation to Delaware by :rrerging into "Z", a corporation for:rred for that purpose. Neither "Y" nor "Z" ever sold additional shares of its stock. Shareholders in "Z" were in all instances for:rrer shareholders of "X" or the successors-in-interest to for:rrer shareholders of "X". ]:/ During its existence, "Z" invested the proceeds of the sale of "X" in stocks, bonds, and other securities • . • • 'lb assist it in these transactions, "z" engaged a registered investirent advisor • • • • At no t.iire during their respective existence did "Y" or "Z" ever engage in the purchase or sale of carm:xli ties, the trading of carm:xli ty op￾tions, or the purchase or sale of ccrrm:xli. ty futures contracts. In 1986, in response to adverse tax law changes contained in the Tax Refonn Act of 1986, "z 's" directors recarm:mded and the shareholders approved a dissolution of the corporation. At the request of a number of major shareholders of "Z", the directors of "Z" agreed to fonn a limited partnership which 'WOuld be engaged in essentially the same investJ.rent activities as "z" . For:rrer shareholders of "Z" were encouraged, though not required, to invest the liquidation proceeds (after deducting approximately 20% for federal inc:are taxes) in this partner￾ship. "Z" was dissolved on December 30, 1986, and a private place:rrent of limited partner￾ship interests in the Partnership was can- :rrenced in January 1987 •• OUt of approximately $15.5 million distributed arrong the 44 for:rrer shareholders ]:/ In your telephone conversation you explained that the tenn "successors-in-interest" refers to the heirs of the for:rrer shareholders.

of 11Z11 at liquidation, 12 fonrer shareholders chose to invest approximately $6.7 million in the Partnership. In addition, two other investors who were not fonrer shareholders chose to invest in the Partnership. The first of these is a stockbroker with E.F. Hutton, the company which had handled m:my of the trades for 11 Z 11 during its existence. This person's li1vestrnent amounted to $6,000. 'Ihe other investor is [your] minor son • • • , whose invest:rrent amounted to $8,000. Each of the Partnership's six general partners is a fonrer director of "z 11 • Furthenrore, the investment advisor for the Partnership's Grcwth Fund • • • is the investment advisor which had been used by 11 z 11 • 'Ihe only major operational differences between the Partnership and 11 Z 11 reflect the general partners' decision to use this opportunity to correct same problems which had plagued "Z". Easily the most significant of these problems was a dispute over whether the corporation's assets should be invested to yield current income or for capital appreciation. 'Ihe Partnership sought to address this conflict by creating two funds, an Income Fund whose twin purposes were preservation of capital and maintenance of a high but consistent level of current income, and a Growth Fund whose purpose was capital appreciation. Each limited partner was offered the opportunity to allocate his investment between these Funds and to reallo￾cate his investment at the end of each calendar year. Your letter further explains that, consistent with the Partnership's investment philosophy, neither fund ever conterrplated trading in camodity interests. In fact, your letter notes several provisions in the Partner￾ship's Agreement which specifically prohibit such trading. 'Ihe instant request arose, then, out of the need to protect the Income Fund -- which had been invested in tax-exerrpt municipal bonds -- fran a decline in value. As your letter states:
Accordingly, in August 1987, the general partners interviewed four investrt'ent counsel and selected one of them. Alrong the reasons for E: 'lpr;l i~ng this counsel was this counsel's

program for using "hedging" to protect the asset values of conservative portfolios. 3/ By investing the Incare Fund's assets in - bonds which are included in the Bond Buyer Municipal Bond Index and then selling futures contracts covering bonds owned by the Incare Fund, this program offers substantially increased protection against portfolio losses. Of course, this inves"t:lrent strategy minimizes the potential gain which could be realized by the Incare Fund fran asset appreciation, such as would occur in con￾nection with a drop in prevailing interest rates. HCMever, since the Partnership offers a GrCMth Fund for those partners seeking capital appreciation, the general partners concluded that this was an acceptable price to pay •••• [T]he Partnership must amend both its private placem:mt narorandum and its Limited Partnership Agreement to pennit its invest￾nent counsel to engage even in the limited "hedging" strategy outlined by the inves"t:m:mt counsel. The general partners propose to condition the adoption of the strategy upon obtaining the consent to the necessary amendments to the Limited Partnership Agree￾nent fran 100% of those limited partners with investments in the Inoarne Fund •••• [T]hese proposed amendlrents ••. will be as narrow as possible. They will pennit the Income Fund to engage in carm::x:li. ty trading acti v￾i ties, but only to the extent deerred neces￾sary by its investment counsel to penni t "bona fide hedging transactions" and then only stlbject to the further limitation that the Incare Fund will not enter into carm::x:li.ty futures and carmodi ty options contracts for which the aggregate initial margin and premiums exceed 5% of the fair market value of the Incare Fund's assets. The private placem:mt narorandum will be amended ll You represent that this counsel has applied for registration as a camodity trading advisor.

consistent with these limitations and will contain the follCMing representation:
The Incare Fund is not intended to be, nor it should be regarded by investors as, a corrm:xlity pool. Futures trading helps the Incane Fund to achieve its goal of pre￾serving capital assets while obtaining a high level of current incane, but it is not the principal canponent of the Incare Fund 1 s investment program. Based upon the foregoing representations, we believe that the relief you seek should be issued to the General Partners because of, arrong others, the facts that: (1) the general and limited partners (either directly or as successors-in-interest) have an investment affiliation that dates back to at least 1968, when "Z" was established; (2) the Partnership intends to trade carm:::xlity interests for hedging purposes; and (3) the Partnership will not ccmnit rrore than 5% of that Fund 1 s assets to initial nargin or options premiums. Accordingly, based upon those representations, the Division will not recommend that the Commission take any enforcement action against any General Partner if he fails to register as a CPO in connection with his operation of the Partnership. j_/ You should be aware that the "no-action" position taken by this letter does not excuse any General Partner fran compliance with any otherwise applicable requirements contained in the Act or in the Comnission 1 s regu￾lations thereunder. For e.xanple, each remains subject to Section 4o of the Corrm:xlity Exchange Act, 7 u.s.c. §6o (1982)' and to the reporting require￾nents for traders set forth in Parts 15 and 18 of the Ccmnission 1 s regula￾tions, 17 C.F.R. Parts 15 and 18 (1985). The position taken by this letter is based on the representations that have been nade to us. lmy different, changed or anitted facts or conditions i/ See Division of Trading and Markets Interpretative letter No. 86-19, Ccmn. Fut. L. Rep. (COl) 4][23,202 (July 3, 1986), wherein the Division issued similar relief based on similar facts. Corrpare Division Interpretative letter Nos. 86-1'7, 86-10 and 83-9, Ccmn. Fut. L. Rep. (COl) 4][23,200 (June 24, 1986), 4][23,016 (April 24, 1986) and 4][21,909 (Nov. 3, 1983), 'lherein we concluded that certain trading vehicles would not be pools within the rreaning of Rule 4.10 (d) because they were rrerely joint trading accounts comprised essentially of family members or long-time friends or business associates, not passive investors as in the instant case.

might require us to reach a different conclusion. In this connection, we request that you notify us immediately in the event the Partnership's opera￾tion, including its nernbership composition, changes in any way fran that as represented in your letter and in your telephone conversation with Division staff. BSG/rv Very truly yours, Andrea M. Corcoran Director cc: Daniel A. Driscoll, National Futures Association