Now that hedge funds can advertise, what are commodity pools – chopped liver?

New Jobs Act makes a distinction

4.  Advertisements would require certain legends and other disclosures. 

5.   All funds (even those not advertising) would be banned from using the current or new exemption if they failed to comply with the Form D filing requirements.

6.  All funds (even those not advertising) would need to provide additional information on Form D, including: a) the fund’s website (if any); b) the percentage of purchasers who accredited investors and natural persons; c) the use of proceeds and d) the names and SEC file numbers of any SEC registered investment advisers providing advice.  Additionally, those issuers relying on Rule 506(c) would be required to disclose: a) information regarding the issuer’s control persons; b) the types of general solicitation used and c) the methods of verifying that all investors are accredited. 

7. Finally, the SEC is proposing to apply its current rule that regulates sales literature used by mutual funds to Reg D offerings. 

 Can CPOs advertise their pools?

So how can a CPO take advantage of new and proposed SEC rules? Currently, CFTC rules still restrict many CPOs from advertising certain pools. 

Commodity pools fall into two categories: Either “filed” or “exempt.” The offering documents for filed pools have to contain all of the disclosures required by Part 4 of the CFTC rules and be filed with and reviewed by NFA before distributed to investors. Filed pools have no NFA/CFTC restriction from using the new SEC rule permitting public solicitations and advertising, so long as the CPO complies with Rule 506(c) and NFA’s advertising rule (which is essentially an anti-fraud rule). One interesting question is whether the CFTC will want filed pools relying on Rule 506(c) to list their offering as “private” or “public” as required in their offering documents. 

Most exempt pools claim exemptive relief under either Rule 4.7 or Rule 4.13(a)(3). To claim the relief, a CPO must meet each condition of the exemption. Rule 4.7 requires that the offering be exempt under Section 4(a)(2) (the statutory exemption for Reg D discussed above). Public solicitations and advertising can only occur in private offerings that rely on new SEC Rule 506(c), which is the safe harbor regulation, but not the exemption in Section 4(a)(2). Therefore, at the current time, a CPO relying on Rule 4.7 cannot publicly solicit or advertise.

The other popular exemption for pools is Rule 4.13(a)(3). This often is called the “de minimis” exemption because the rule limits the pool’s use of, or exposure to, futures. This rule is only available to pools whose interests “are exempt from registration under the Securities Act of 1933, and such interests are offered and sold without marketing to the public in the United States.” If a CPO complies with new Rule 506(c), it would be entitled to the Reg D exemption from registration of the offering under the Securities Act of 1933. However, the second part of Rule 4.13(a)(3) prohibits marketing to the public in the U.S.  Most forms of public solicitations and advertising would constitute marketing to the public, so, at the current time, a CPO relying on Rule 4.13(a)(3) cannot publicly solicit or advertise. 

The CFTC has been formally petitioned (and informally lobbied) to issue guidance or relief so that CPOs that operate exempt pools can take advantage of new SEC Rule 506(c). The SEC and CFTC are currently working together to harmonize the new CFTC Rule 4.5, which will regulate certain mutual funds as commodity pools. It is hoped that the CFTC also will harmonize its rules for exempt pools with new Rule 506(c) so that CPOs will be able to use public solicitations and advertising to the same extent, and subject to the same constraints, as hedge fund managers not trading futures.

Importantly, the determination of whether a fund relies on the new Rule 506(c) or the old Rule 506(b) is done on a case by case basis. Accordingly, a CPO can choose to advertise certain funds under Rule 506(c) and stick with Rule 506(b) for its other funds. 

With the passage of Rule 506(c), most hedge fund managers and some CPOs now have the ability to widely advertise their products if they choose to jump over the additional regulatory hurdles imposed by Rule 506(c) and the final version of the Proposed Rules. It remains to be seen if the CFTC will act to extend that choice to CPOs relying on a 4.7 or 4.13(a)(3) exemption. The ultimate impact of the JOBS Act on the commodity pool industry will depend on 1) what action the CFTC determines to take for exempt pools and 2) whether CPOs view the SEC’s additional hurdles as too high or too numerous to offset the benefit of advertising their pools.  

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About the Author
David Matteson and Andrew C. Raby

David M. Matteson (pictured)  is a partner and Andrew C. Raby is a senior associate at Drinker Biddle & Reath. They practice in the firm’s Investment Management Group, assisting alternative investment clients, including many CPOs and CTAs

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