New Rule Forces Some Hedge Funds, Investment Pools To File Quarterly Reports

Mar 26 2010 | 9:20am ET

By James Bibbings, Turnkey Trading Partners -- On March 17 the self regulatory organization for commodities trading and retail foreign currency transactions in the United States, the National Futures Association, announced a major change to the way hedge, commodity, and forex funds operate.  The change, titled “Compliance Rule 2-46” is NFA’s latest effort to work towards detecting and eliminating Madoff-style investment frauds. 

In order to comply with any set of new regulatory standards one has to first understand the intentions and implications of the adjusted policy.  So what then does this adjustment mean for the commodity and forex industries?

Understanding 2-46

Beginning March 31, NFA Compliance Rule 2-46 will go into effect and be applicable to all NFA CPO members who currently have reporting obligations under the CFTC’s existing section 4.22 regulations.   Since it is reasonable to assume that most people are not familiar with regulation 4.22, let’s recap.  Briefly section 4.22 requires that all commodity pool operators (unless they have been granted specific exemption status by the CFTC) distribute an annual report.  This report is required to be certified by an independent public accountant and provided to participants, as well as the NFA, within 90 days of the funds fiscal year end.  Regulation 4.22 further requires that funds deliver client account statements to participants within 30 calendar days after the last date of a specified reporting period (monthly or quarterly).  These statements must also reflect specific customer and fund investment information.

If an NFA member CPO manages a fund or funds which have a reporting obligation under section 4.22, as of the quarter beginning April 1, they will have to adhere to new quarterly reporting guidelines.  For managers who may be wondering, this new rule affects funds which are designated 4.7 exempt as well.

New Reporting Requirements

During the second quarter of 2010 NFA member CPO’s of all types will have much more stringent reporting requirements; No longer will one financial filing per year be satisfactory for affected firms. On Monday, May 17, the first of many quarterly financial reports will be due to NFA via an extension to the regulators “Easy File” system.  From that date forward NFA will require that CPO members submit to them the following financial information for all applicable funds 45 days after the close of each subsequent quarter they operate:

(a) The identity of the pool's administrator, carry broker(s), trading manager(s) and custodian(s);
(b) A statement of changes in net asset value for the quarterly reporting period;
(c) The monthly performance for the three months comprising the quarterly reporting period; and
(d) A schedule of investments identifying any investment that exceeds 10% of the pool's net asset value at the end of the quarterly reporting period.

How to Comply

The introduction of compliance rule 2-46 greatly increases the reporting obligations for most NFA member CPOs.  Firms now more than ever will have to ensure that meticulous books and records are kept to properly support the information they will be filing with NFA.  The very nature of this rule change also suggests that after May 17 of this year NFA will begin to include additional financial testing requirements within its audits of pool operators.  Moreover, the requirement for CPOs to file financial information quarterly in many ways goes beyond what is currently required of independent introducing brokerages who file only semi annually.  This puts CPOs behind only Futures Commission Merchants for the greatest number of financial filings in the industry. Based on that fact alone, one thing is certain, NFA will be taking a much closer look at the activity of its member CPOs.  This also seems to suggest that NFA now potentially views funds as the second greatest financial risk to the industry. 

Developing proper procedures and internal policies to accurately and efficiently produce financial records has never been more important for NFA’s CPO membership.  Simply knowing that the quarterly figures submitted to NFA will be subject to further audit scrutiny validates this fact.  In order to best comply with these new requirements, fund managers should begin looking for additional assistance in preparing their monthly performance and quarterly NFA filings ahead of the March 31 effective date.  Those managers who are looking for outside assistance should also be mindful to select a firm that is well versed in commodity regulation and has a strong understanding of the CFTC’s financial reporting requirements.  It is important when looking for outside help to remember that many public accountants and attorneys have never worked in the commodities industry and as a result can be unfamiliar with its standards. 

Funds seeking to bring on third party help should consider hiring a commodity specific consulting and compliance. Regardless of what you believe your firm requires to meet NFA’s new standards, a full inventory of your existing policies and procedures must be taken.  Fund managers would be wise to start this self assessment process ahead of March 31 to ensure their continued compliance with CFTC and NFA requirements.

James Bibbings is the President and CEO of Turnkey Trading Partners (“TTP”), a firm that supports all commodity and forex specific regulatory and business needs. Prior to founding TTP, Bibbings worked with the National Futures Association (“NFA”) as a supervising auditor. During his time with NFA he was involved in over 100 investigative audits and was able to gain a deep working knowledge of FDM, FCM, IB, CTA, and CPO operations.  Bibbings has provided financial markets content for MSN, Yahoo, Financial Times, FinAlternatives, Wiki-Investments, Safe Haven, Financial Sense, WSJ’s Market Watch, Forex Journal, Commodity News Center and many other highly acclaimed investment publications. He has also authored two highly sought after informational pamphlets regarding futures and forex registration which are available for free upon request through his company website.


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