CFTC Staff Letter 96-64: No-Action Relief for CPO to Treat Non-QEP Investors as Qualified Eligible Participants

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:
August 12, 1996
Re: Request to Treat Investors as Qualified Eligible Par￾ticipants under Rule 4.7 This is in response to your letter dated July 3, 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 correspon￾dence, you request relief from the qualified eligible participant ( "QEP") criteria of Rule 4. 7 (a) 1/ on behalf of "N", a registered commodity pool operator ("CPO"), with regard to "the Fund", a commodity pool operated by "N" that invests primarily in mort￾gage-backed securities. Based upon your representations, we understand the relevant facts to be as follows. The Fund has been operated pursuant to the criteria of Rule 4.7(a) .'J.7 "N" now wishes to admit certain non-QEP investors ("Non-QEP Investors") into the Fund. All of these Non-QEP Investors are members of "N" or employees of "0", a registered commodity trading advisor that is owned by the persons who own "N". Specifically, the Non-QEP Investors are:
(1) "A", a portfolio manager for "0", who is registered as an associated person ( "AP") of both "N" and "0". "A", who has a master's degree in business, formerly struc￾tured and traded agency collateralized mortgage obliga￾tions ("CMOs") at "P". (2) "B", a certified public accountant, who is the chief financial officer of "0" and is responsible for super￾1/ Commission rules referred to herein are found at 17 C.F.R. Ch . I ( 19 9 6 ) . a/ Pursuant to a Notice of Claim for Exemption under Rule 4.7, filed by "N" on August 1, 1995, interests in the Fund may be sold only to QEPs. As of May 31, 1996, the Fund had approximately $142 million in net assets.

vising the accounting, operations, reporting and com￾pliance functions of the Fund and "0". "B", who has sixteen years of public accounting experience and a master's degree in accounting, formerly was an audit partner at "Q" where she specialized in serving finan￾cial institutions. (3) "C", an 11 0 11 employee, who has primary responsibility at 11 0 11 for clearance and for the collection and tracking of payments on the Fund's mortgage positions. 11 C11 , who has twenty years of experience in fixed income clearing and operations and an associate degree in finance, formerly was responsible for clearing mortgages for II R II ' II S II and " P" . (4) "D", a member of "N", who is responsible for the design of computer models to evaluate and hedge the Fund's portfolio. "D", who is an economics professor and has a doctorate in economics, formerly was a managing director of "P 11 , where he led the design of the firm's proprietary mortgage-backed securities analytical systems. He is an accredited investor as defined in Regulation D under the Securities Act of 1933, as amended. (5) "E", the director of marketing for "0 11 , who has twenty￾three years of experience in the capital markets and a bachelor's degree in economics. "E" formerly was the director of marketing at "T" and a vice president at 11 U". He has passed the Series 3 and Series 7 examina￾tions and is in the process of registering as an AP of "N" and "0". (6) "F", who is a quantitative analyst, systems adminis￾trator and chief programmer for "0". 11 F11 formerly was a vice president at "P 11 , where he was responsible for designing and encoding many of the analytic and struc￾turing tools used by the CMO trading desk. (7) 11G", the chief operating officer of "0 11 , who is primar￾ily responsible for day-to-day operations and clearing. 11G11 has passed the Series 7, 24 and 63 examinations and has a bachelor's degree in accounting. He formerly was responsible for various aspects of accounting, opera￾tions and compliance at "P". (8) "H", a member of "N", who is responsible for the design and implementation of computer systems and analytics. "H", who has a doctorate in mathematics, formerly was a senior vice president at "P", where he was in charge of

all fixed income quantitative research and was active in developing trading, accounting and portfolio valua￾tion systems. He is an accredited investor under Regulation D. (9} "I", an "0" employee, who provides accounting, clearing and cash management services for the Fund and is ac￾tively involved in the origination of bridge financing for real estate loans. "I", who has passed the Series 3, 7 and 63 examinations, is "J's" brother.d./ He formerly was a trader in "P"'s municipal bond depart￾ment and oversaw the hedging and turnover of the department's inventory. In support of your request, you represent that "by virtue of their positions, all of the [Non-QEP] Investors have ready access to information pertinent to an investment in11 the Fund. In addition, "N11 wishes to permit another non-QEP investor, "K", "J's" father, to receive an assignment of a portion1 of the return that "J" receives on his investment in the Fund . .1 The Agreement states that "W" assigns, as of January 1, 1996, to "K 11 an economic interest in "W"'~ investment account attributable to the Fund equal to $100,000.~/ d./ "J" formed the Fund with "V", a non-managing member of "N", and five other investment professionals who are managing members of "N" ("Managers"}: "AA", 11BB", "CC", "D 11 and "H11 • Acompany controlled by "J 11 , "W", serves as the managing member of "N". "J", "V" and the Managers own "0". Commission records show that "W", "V", "J", "AA" and "BB" are listed as principals of both "N" and "0". "J", "AA", "BB" and "CC" are registered as APs of "N" and "0" . .1/ You provided a copy of the Assignment Agreement ("Agree￾ment"} and a portion of "N's" Limited Liability Company Operating Agreement ("Operating Agreement"} by facsimiles transmitted on July 24 and July 25, 1996, respectively. ~/ The Agreement states that the assignment shall be governed by and subject to all of the terms and conditions of the Operat￾ing Agreement and any subsequent amendments. The Operating Agreement defines "economic interest" as a "Member's rights to share in profits, losses and distributions of ["N"] and to receive interim and liquidating distributions and withdrawals from ["N"] in respect of the balances from time to time in such Member's Capital Accounts, and no other rights or entitlement of such Member." Accordingly, it does not grant "K" membership or (continued ... )

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Based upon your representations, 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 take any enforcement action against "N" for failure to comply with Rule 4.7(a) if it continues to claim relief pursuant to Rule 4.7, notwithstanding investment by the Non - QEP Investors in the Fund and assignment of an economic interest to "K", and treats the Non-QEP Investors as QEPs. This relief is, however, subject to the condition that each Nqn-QEP Investor consents in writing to being treated as a QEP.Q/ We note that this letter relieves "N" solely from compliance with certain requirements of Rule 4.7 and does not excuse it from compliance with any other applicabl~ requirements contained in the Commodity Exchange Act ("Act").11 or the Commission's regu￾lations issued thereunder . For example, it remain~ subject to the antifraud provisions of Section 4Q of the Act,- the re￾porting requirements for traders set forth in Parts 15, 18 and 19 of the Commission's regulations, and all other applicable re￾quirements of Part 4. Further, this letter is applicable to "N" solely in connection with its operation of the Fund. This letter is based upon the representations you have made to us and is subject to compliance with the condition stated above. Any differe~t, 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 the Fund, including the composition of its investors, change in any way from those as represented to us. This letter represents the position of the 21 ( ... continued) any rights of membership in "N 11 or any portion of the incentive compensation received by members of "N". Q/ You also have requested relief from Rule 4.7 such that 11 N" may treat as QEPs any investment or operations personnel who are hired by "0" in the future for positions that would afford access to information pertinent to investing in the Fund, provided that they have qualifications "substantially similar" to the Non-QEP Investors. As you know, the Division considers requests for relief from the requirements of Rule 4.7 on a case-by-case basis. Accordingly, "N" should request any such relief in writing at such time as it can provide specific information pertinent to its request . .1/ 7 u.s.c. § 1 et seg. (1994). ~/ 7 u.s.c. § 6Q (1994).

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 Natalie A. Markman, an attorney on my staff, at (202) 418-5450. Very truly yours, Susan C. Ervin Chief Counsel