CFTC Staff Letter 96-59: No-Action Relief from Rule 4.7(a) Ten Percent Restriction for Pool Investment

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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 TRADING & MARKETS Dear July 23, 1996 Re: Rule 4.7: Request for No-Action Relief from the Ten Percent Restriction for a Pool That Has Non-QEPs This is in response to your letter dated April 24, 1996 to the Division of Trading and Markets ("Division") of the Commodity Futures Trading Commission ("Commission") as supplemented by telephone conversations with Division staff. By your corre￾spondence, you request relief on behalf of "U11 , a registered commodity pool operator ( 11 CP0 11 ) ,1./ in connection with its operation of 11V11 , from the restrictions of Commission Rule
4. 7 (a) (·1) (ii) (B) (2) (xi) ,'J/ which would prevent 11 U11 from
investing more than ten percent of the assets of 11 V11 in a Rule 4.7 exempt pool ( 11 ten percent restriction11 ) because not all investors in "V" are qualified eligible participants ( 11 QEPs 11 ) as that term is defined in Rule 4.7(a). Based upon the representations made in your correspondence, we understand the pertinent facts to be as follows. 11V11 was formed on August 11, 1986 to seek capital appreciation through the speculative trading of futures. 11A11 I the sole/ principal of 11 U11 I has acted as general partner and CPO of 11V11 .1 As of March 31, 1996, 11V11 had net assets of approximately $5,352,000. Approximately, thirty-nine percent of 11V's 11 asset!;l are invested in "W11 I a pool for which 11 U11 serves as the CPO .1./ The remaining 1./ 11 U11 is also registered as a commodity trading advisor ( 11 CTA"). £1 Commission rules referred to herein are found at 17 C.F.R. Ch. I (1995), as amended gy 60 Fed. Reg. 38,146, (July 25, 1995). l/ In addition to being the listed principal of 11 U", "A11 is also registered as a CTA and CPO in his individual capacity. 1./ 11W" is not opera ted pursuant to an exemption under Rule 4.7 and is therefore subject to the disclosure requirements of Rules (continued ... )

assets are invested in other pools or under the management of registered CTAs. The limited partnership agreement of "V" is currently in the process of being amended to (a) substitute "U" for "A" as the general partner of nvn; (b) allow nvn to invest in securities both directly and indirectly through the purchase of interests in other investment funds, including investment funds associated with "U"; and (c) make certain other amendments not relevant to the no-action relief requested herein. Once these amendments have been approved, "V'sn entire interest in "W" will be redeemed and the proceeds of the redemption will be invested in the nxn, a new pool organized as a Delaware limited partnership on March 1, 1996 and of which "U" serves as general partner and CPO. Prior to any change in the allocation of "V'sn assets, each limited partner in nvn will be notified of the intended change and will have the opportunity to redeem any limited partnership interests in nvn within ten days of receipt of suGh notice. "U" intends to operate nxn as a Rule 4.7 exempt pool.~/ 11 X" was organized for the purpose of seeking capital appreciation through investments in commodity interests, securities and hybrid instruments. Initially up to approximately fifty percent of 11 X' s" net assets will be invested in "W". The remaining (approximately) fifty percent of "X's" assets will be managed by "U" in a managed account pursuant to "U' s" proprietary "Y" securities trading program. "V' s" investment represents "X' s" "seed capital n and will allow "X n to begin trading immediately. However, "U11 intends to offer interests in "X" to (other) members of the public who qualify as QEPs. The changes described above are being undertaken to allow nvn to diversify its portfolio and include equity investments. This will be done through its investment in IIXII 1 which, as already mentioned, will invest part of its assets in securities. You indicated that to the extent these changes would result in a material Change in the fee load paid by investOrS in nvn I this fact would be fully disclosed to "V's 11 limited partners in connection ~/ ( ... continued) 4.21, 4.24, 4.25 and 4.26 and the reporting requirements of Rule 4.22. ~/ You indicated that since "U's" ability to operate "X" as a Rule 4.7-exempt pool is dependent in part on receiving the relief requested herein, "U" does not expect to file a notice of a claim of exemption under Rule 4.7(a) until it receives this response. Neither "V" nor "W" is a Rule 4.7 exempt pool.

with their receiving notice of the contemplated transaction and an opportunity to redeem their interests. "V" is now operated, and will continue to be operated after its investment in "X", as a non-exempt pool, subject to the disclosure requirements of Rules 4.21, 4.24, 4.25 and 4.26, the reporting requirements of Rule 4. 22 and all other applicable requirements of Part 4. Although "V" itself qualifies as a QEP, it does not qualify as a Rule ]·7 exempt pool because not all the investors in "V11 are QEPs . .2. Thus, it remains subject to the ten percent restriction of Rule 4. 7 (a) and therefore could not invest more than ten percent of its assets in 11 X11 , if 11 X11 were operated as a Rule 4.7 exempt pool. Since 11V11 wishes to invest initially approximately thirty-nine percent of its assets in 11 X11 , you are requesting that the Division confirm that it will not recommend enforcement action against 11 U11 , upon "U's 11 becoming the general partner and CPO of "V", for violation of the ten percent restriction of Rule 4. 7 (a) , if 11 V11 invests more than ten percent of its assets in "X" as described above. Based upon the facts you have represented to us, including your representations that "U" will be the general partner and CPO of 11V", 11 X", and "W", it appears that granting the requested relief would ·not be contrary to the public interest and the purposes of Rule 4.7. Accordingly, the Division will not recommend that the Commission commence any enforcement action against 11 U" for violation of the ten percent restriction of Rule 4.7(a) if, upon its becoming the general partner and CPO of "V", "U11 commits more than ten percent of "V's" assets to "X". We note that this letter relieves "U" of the requirements of the ten percent restriction of Rule 4.7(a) solely in connection with "V's" investment in "X", and does not excuse "U" from compliance with any other applicable requirem~nts contained in the Commodity Exchange Act ("Act")21 or the Commission's regulations issued thereunder. For example, "U" remains, subject to the antifraud provisions of
Section 4Q of the Act,~' the reporting requirements for traders
set forth in Parts 15, 18 and 19 of the Commission's regulations, and all other applicable requirements of Part 4 . .§./ "V" qualifies as a QEP because it meets the portfolio tests of Rule 4. 7 (a) (1) (B) (1), and is a pool with assets $5,000,000 and not formed for the specific purpose interests in an exempt pool, as required 4 . 7 (a) (1 (ii) (B) (2 (xi). 2/ 7 U.S.C. § 1 et seg. (1994). ~/ 7 u.s.c. § 6Q ( ) 1994 . in excess of of purchasing under Rule

This letter is based upon your representations. Any different, changed or omitted facts or circumstances might require us to reach a different conclusion. In this regard, we request that you notify us immediately in the event that the operations or activities of "U", "V" or "X" change in any way from those represented to us . This letter represents the position of this Division only. It does not necessarily represent the views of the Commission or any other division or office of the Commission. If you have any questions concerning this correspondence, please contact me or Thomas E. Joseph, an attorney on my staff, at (202) 418-5450. Very truly yours, Susan C. Ervin Chief Counsel