CFTC Staff Letter 96-29: No-Action Relief for CPO Hedging CBOE Market-Making Activities with SPX Futures

U.S. COMMODITY FUTURES TRADING COMMISSION Three Lafayette Centre 1155 21st Street, NW, Washington, DC 20581 Telephone: (202) 418-5430 Facsimile: (202} 418-5536 DIVISION OF 1RADING & MARKETS Dear April 12, 1996 Re: Request for Relief Permitting a Registered Commodi￾ty Pool Operator ("CPO") and Sole General Partner of a Market-Maker on the Chicago Board Options Ex￾change ("CBOE") To Use Standard & Poor's 500 Stock Index ( "SPX") Futures To Hedge Such Market-Making Activities without Complying with the Disclosure, Reporting and Recordkeeping Requirements of Commis - sion Rules 4.21 through 4.26 This is in response to your letter dated February 9, 1996 to the Division of Trading and Markets (the "Division") of the Commodity Futures Trading Commission (the "Commission11 ), as supplemented by your letters dated February 26 and February 29, 1996, your memorandum dated March 11, 1996 and by telephone conver￾sations with Division staff. By your correspondence, you request on behalf of "A", the general partner of limited Partnership, an Illinois limited partnership "U", relief permitting 11A" to use SPX futures to hedge temporary portfolio imbalances in the course of 11U's" activities as a market-maker on the CBOE, without complying with the disclosure, reporting and re~ordkeeping requirements of Commission Rules 4. 21 through 4. 26 ):.! You also request relief from the requirement to register as a CPO on behalf of 11V11 the sole general partner of 11W11 J in connection with 11 W's 11 limited partner￾ship interest in "U 11 .~ ~/ Commission rules referred to he rein are found at 17 C.F.R. Ch. I (1995), as amended by 60 Fed. Reg. 38146 (July 25, 1995, effective August 24, 1995). ~/ Absent such relief for "V", "U's" use of SPX f utur e s and "W's 11 resulting commodity pool status would require "V" to r egiste r as a CPO.

Based upon the representations made in your February 9, 1996 letter, as supplemented, we understand the relevant facts to be as follows. "U" began its operations as a market-maker in OEX options on the CBOE in October 1995.'J./ "U's" general partner, "A", is a re~istered CPO who currently operates one commodity pool, "X" . .11 "A" is a CBOE member, and he trades on the CBOE as a nominee of "X", which is itself a CBOE member. "A" makes all securities trading decisions for "U", and he will make all trading decisions involving commodity interests for 11U11 • In your February 9, 1996 letter, you stated that nyu was one of two limited partners of 11 U"~;having contributed approximately two percent of "U' s" capital.- "Y" is a commodity pool, and its general partner is nzn, a registered CPO owned by "B" I 11 C11 I 11 D" and 11 E11 • The general partner of "Y" is "Z", a registered CPO owned by 11 B11 , 11 C", "D 11 and 11 E11 • Ten of the nineteen limited p~~tners of "Y" are accredited investors (as defined in Rule 5.01(a)-1 promulgated under the Securities Act of 1933) ]/ including 11 C" and 11 E11 • The remaining nine limited partners are family members of, or entities controlled by, the accredited investors. Approxi￾matel¥ thirty-five percent of the assets of nyu are invested in nxn .~7 The bulk of 11 U' S 11 capital was contributed by partner I "W". The general partner of "W11 is corporation, owned by 11 E" and "D 11 .2.1 Thirteen three limited partners are accredited investors, its other limited 11 V" I an Illinois Of 11 W' S II twenty￾inClUding 11 C11 and J./ "U" leases its CBOE seat from 11 F 11 and it trades on the CBOE through a nominee, "G" . .1/ "A" has filed a claim of exemption under Rule 4.12(b) with respect to "X n • 2/ As of February 29, 1996, you state that 11 W11 has no invest￾ment in "U". Q./ 1 7 C . F . R . § 2 3 0 . 5 0 1 (a) ( 19 9 5 ) . ]/ 15 U.S.C. §§ 77a ~ ~- ( 1994 ) . ~/ You represent that in addition to its investment in 11 X", "Y" "has other investments that trade futures." 2./ "E" and "D 11 are also listed principals of a registered independent introducing broker.

his wife, nEn, 10/ 11 H11 , 111 11A11 and two CBOE traders. 12/ Ninety to one hundred percent of the assets of 11W" are invested in nun, with the remainder, if any, maintained in bank accounts. In support of your request you represent that none of nun, 11 zn, "Y", nwn, nvn or any of their respective principals is subject to statutory disqualification under ~~ction 8a(2) or 8a(3) of the Commodity Exchange Act (the nAct 11 ) .L/ 11 U11 hedges its OEX option positions by trading baskets. of the stocks comprising the OEX or by using CBOE- traded options to construct synthetic equity positions. nun endeavors to conclude each trading day in a neutral position, but this is not always possible, due to market conditions. Consequently, nun seeks to use the SPX futures contract to hedge temporarily any day- end imbalance in its trading portfolio. You represent that "U's 11 SPX futures trading would probably. occur only after market ho~rs (i.e., on the Chicago Mercantile Exchange's Globex® system) . 141 Except in circumstances involving extreme illiquidity in either the futures or securities markets (such that near simulta￾neous trading of the position would be impossible, as would be true if futures trading were locked limit-up or limit-down), any futures position would be liquidated and replaced by a corresponding securities (i.e., equity or equity option) position during the next CBOE trading day. nun is willing to restrict to five percent of its net assets the funds it may use as initial margin for its futures and commodity option positions. You represent that at the 1 0/ 11 E11 is also a principal of 11V11 • 11/ nBn is also a principal of nzn. 121 The other accredited investors are a trader on the Chicago Mercantile exchange, a veterinarian, the retired mother of an options trader, a limousine company, an investment banker and a private investor. The non- accredited investors are four entitie s owned or managed by ncn, the owner/pre sident of a finance compa - ny, a parimutuel handicapper, a CBOE trader, a sportswriter a financial analyst and a trust for the benefit of the parents of one of the accredited investors. 13/ 7 U.S.C. § 12a(2) or § 12a(3) (1994). 14/ 11A11 proposes to use SPX f utures positions solely as a protective measure, but he wishes to be able to makes trades during market hours, should the necessity arise.

present time, nun does not trade in the futures market, either directly or through investments in other funds. We note that, absent relief, at such time as nun commences trading SPX futures, it becomes a commodity pool. As a limited partner of nun, nwn will also become a pool, and nvn will become a CPO /(obligated to register as such pursuant to Section 4m(1) 15 of the Act, and to comply with Part 4 of the Commiss~ on' s regulations, in connection with the operation of nwn) )&! You represent that nwn is not involved, directly or indirec.tly I in commodity interest trading except for nu'sn proposed use of SPX futures. Based upon the representations made in your correspondence, the Division will not recommend that the Commission take any enforcement action against: (1) nA" as CPO of nun for failure to comply with the disclosure, reporting and recordkeeping require￾ments of Commission Rules 4.21 through 4.26 solely in connection with the operation of nun; or (2) nvn as general partner of nwn for failure to register as a CPO and to comply with the disclosure, reporting and recordkeeping requirements of Commission Rules 4.21 through 4.26 solely in connection with the operation of nwn. This position, however, is subject to the conditions that: (1) no more than five percent of the net assets of nun will be used for initial futures margin and commodity option premiums; (2) the only commodity interests traded by or on behalf of nun will be SPX futures contracts; (3) commodity interest trading by or on behalf of nun will be conducted on the nemergencyn basis as described in your correspondence, to hedge any day-end imbalance in its trading portfolio in order that nun can conclude its trading for a given day in a neutral position; and (4) apart from its investment in nun 1 nwn will not 1 directly or indirectly 1 engage in commodity interest trading. This letter is applicable to nAn and to nvn solely in connec￾tion with the operation, respectively, of nun and nwn. Further￾more, this letter does not excuse either nAn or nvn from compliance with any other applicable requirements contained in the Act or in the Commission's regula tions issued thereunder . For example , nAn and nvn remain subject to the antifraud provisions of Sections 4b 15/ 7 u.s.c. § 6m(1) (1994). 16/ As noted above, nyn, nu's" other limited partner at the time of your February 9, 1996 letter, is a commodity pool operated as such by nzn, a registered CPO.

and 4Q of the Act 17 I and traders set forth in Parts regulations. to the reporting 15, 18 and 19 of requirements for the Commission's This letter is based upon the representations provided to us. Any different, changed or omitted facts or circumstances might require us to reach a different conclusion. In this connection, we request that you notify us immediately in the event the operations or activities of "U", "Y", "W", "Z", "V", including their respec￾tive principals or limited partners, change in any way from those represented to us. Further, this letter represents the position of the Division of Trading and Markets only. It does not necessarily reflect the views of the Commission or of any other division or office of the Commission. If you have any questions concerning this corre￾spondence, please contact me or Christopher W. Cummings, an attorney on my staff, at (202) 418 - 5445. 17/ 7 u.s.c. §§ 6b and 6Q (1994). Very truly yours, Susan C. Ervin Chief Counsel