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CFTC grants relief to commodity pool operators selling securities using general solicitation in reliance upon Rule 506(c)

September 12, 2014
CFTC grants relief to commodity pool operators selling securities using general solicitation in reliance upon Rule 506(c)
Nearly one year ago the Securities and Exchange Commission adopted Rule 506(c), which eliminated the ban on general solicitation and general advertising in the offer and sale of securities if certain criteria set forth in the rule were met.  See my memo A Seismic Shift in the Securities Laws for a detailed discussion of the requirements.  Under the Rule, private investment funds would be treated like any other issuer, and can decide whether to conduct an offering without general solicitation under Rule 506(b), or engage in general solicitation under new Rule 506(c).  The SEC confirmed that an offering relying on Rule 506(c) would not jeopardize a private investment fund’s otherwise available exemptions under Sections 3(c)(1)[i] or 3(c)(7)[ii] of the Investment Company Act of 1940, but did not address the position of commodity pools operators (“CPOs”) under Commodity Futures Trading Commission (CFTC) regulations.
Generally, all CPOs of pools relying on exemptions under the Section 4(a)(2) of the Securities Act, including Rule 506(b) of Regulation D, remain subject to the prohibition against general solicitation or general advertising in order to be eligible to claim relief under Regulation 4.13(a)(3) which provides that fund managers can avoid registration with the CFTC if the fund is not “marketed to the public in the United States”.  Additionally, Regulation 4.7(b) stipulates that securities be offered and sold solely to qualified eligible persons (“QEPs”)[iii].  Therefore, absent guidance from the CFTC, to avoid running afoul of these rules, private investment funds that trade commodity interests regulated by the CFTC may have found it prudent to rely on Rule 506(b) and continue to forego engaging in general solicitation and general advertising.
On September 9, 2014, the CFTC provided exemptive relief[iv] from Regulation 4.7(b) requirements that an offering be offered solely to QEPs, and from the requirement in Regulation 4.13(a)(3)(i) that securities be “offered and sold without marketing to the public,” subject to filing a notice with the Division of Swap Dealer and Intermediary Oversight (“DSIO” or “Division”) of the Commodity Futures Trading Commission (“Commission”) that contains the following information:
a)    The name, business address, and main business telephone number of the CPO claiming the relief;
b)    The name of the pool(s) for which the claim is being filed;
c)    Whether the CPO claiming relief is a 506(c) Issuer or is using one or more 144A Resellers;
d)    Whether the CPO intends to rely on the exemptive relief pursuant to Regulation 4.7(b) or 4.13(a)(3), with respect to the listed pool(s);

i.  If relying on Regulation 4.7(b), represent that the CPO meets the conditions of the exemption, other than that provision’s requirements that the offering be exempt pursuant to section 4(a)(2) of the Securities Act and be offered solely to QEPs, such that the CPO meets the remaining conditions and is still required to sell the participations of its pool(s) to QEPs;

ii.  If relying on Regulation 4.13(a)(3), represent that the CPO meets the conditions of the exemption, other than that provision’s prohibition against marketing to the public;

e)    Be signed by the CPO; and
f)      Be filed with the Division via email using the email address dsionoaction@cftc.gov and stating “JOBS Act Marketing Relief” in the subject line of such email.

 


[i] Section 3(c)(1) of the Investment Company Act of 1940 excludes from the definition of “investment company” a fund whose securities are beneficially owned by not more than 100 persons and which is not making and does not presently plan to make a public offering of its securities.
[ii] Section 3(c)(7) excludes from the definition of “investment company” a fund the outstanding securities of which are owned exclusively by persons who, at the time of acquisition of such securities, are “qualified purchasers” and which is not making and does not at that time propose to make a public offering of such securities.
[iii] A qualified eligible person is, generally, a sophisticated investor who fits into one of two distinct groups: (1) investors who do not need to meet the portfolio requirement and (2) investors who need to meet the portfolio requirement.
Investors who do not need to meet the portfolio requirement:  The following are considered to be QEPs regardless of whether or not they meet the portfolio requirement:

  • registered futures commission merchants
  • registered broker or dealers
  • registered commodity pool operators (under certain conditions, see rule for more details)
  • registered commodity trading advisors (under certain conditions, see rule for more details)
  • state or SEC registered investment advisers (under certain conditions, see rule for more details)
  • qualified purchasers
  • knowledgeable employee of the CPOs
  • certain persons related to advisers to exempt from registration as a CPO or CTA
  • trusts (under certain conditions, see rule for more details)
  • 501(c)(3) organizations (under certain conditions, see rule for more details)
  • non-United States persons
  • certain entities in which all of the owners/participants are QEPs

Investors who need to meet the portfolio requirement: The following will be considered to be QEPs only if they meet the portfolio requirement described below:

  • investment companies registered under the Investment Company Act (i.e. mutual funds)
  • certain business development companies (defined under both the Investment Company Act and Investment Advisers Act)
  • banks, savings and loan associations, and other like institutions acting for their own accounts or for the account of a QEP
  • insurance companies acting for their own account or for the account of a qualified eligible person
  • plans established and maintained by various governments and related bodies for the benefit of their employees, if such plan has total assets in excess of $5,000,000
  • employee benefit plans within the meaning of the ERISA (under certain conditions, see rule for more details)
  • 501(c)(3) organizations with total assets in excess of $5,000,000
  • corporations, business trusts, partnerships, LLCs or similar business ventures with total assets in excess of $5,000,000 and not formed for the specific purpose of participating in the exempt investment program
  • a natural person whose individual net worth, or joint net worth with that person’s spouse, at the time of either his purchase in the exempt pool or his opening of an exempt account exceeds $1,000,000 [HFLB note: this is one part of the accredited investor definition]
  • a natural person who had an individual income in excess of $200,000 in each of the two most recent years or joint income with that person’s spouse in excess of $300,000 in each of those years and has a reasonable expectation of reaching the same income level in the current year [HFLB note: this is one part of the accredited investor definition]
  • pools, trusts, insurance company separate accounts or bank collective trusts, with total assets in excess of $5,000,000 (under certain conditions, see below)
  • other entities authorized by law to engage in such transactions (under certain conditions, see rule for more details)

Portfolio Requirement
If an investor is one of the entities described in (2) above, it will also need to meet the portfolio requirement.  The portfolio requirement can be met in one of three ways:

  • Owns securities and other investments with an aggregate market value of at least $2MM;
  • Has had on deposit with a FCM at least $200K in exchange-specified initial margin and option premiums for commodity interest transactions in the 6 months prior to the investment; or
  • Has a combination of the two above.  For example, has $1MM in securities/investments and $100K in exchange-specified initial margin in the 6 months prior to the investment

17 CFR 4.7.  Generally the investor will make these representations in the subscription documents.

[iv] CFTC Letter No 14-116, September 9, 2014.