Tuesday, 28 February 2017
Last updated 5 hours ago
Jul 31 2009 | 9:06am ET
By Lawrence Cohen, Esq. -- May the Commodity Futures Trading Commission require the manager of a “feeder fund,” one that does not execute commodity futures transactions but serves as a conduit for another fund that undertakes such trades, to register as a commodity pool operator? This question was answered, affirmatively, in the U.S. Court of Appeals for the Third Circuit in an opinion by Chief Judge Anthony J. Scirica filed on July 13, 2009. As a result of this decision, managers of feeder funds that invest in other vehicles with strategies that include trading in commodity futures should immediately examine whether their circumstances require them to register as CPOs, absent an available registration exemption or exclusion from the CPO definition.
This litigation involved a civil enforcement action brought by the CFTC against several parties, including Equity Financial Group, its president and sole shareholder, and its lawyer. Equity Financial was the manager of a private investment fund, Shasta Capital Associates. Equity Financial invested the capital of Shasta’s investors in four other funds, collectively referred to by Judge Scirica as “Tech Traders.” Tech Traders combined Shasta’s investment capital with that of other feeder funds, and executed commodity trades as a “master pool.”
The appellants argued that because Shasta Capital was a feeder fund that did not execute commodity futures trades in its own name, but invested only in Tech Traders, Shasta Capital’s manager, Equity Financial, was not a CPO. Chief Judge Scirica’s opinion analyzed the definition of a CPO under Section 1a(5) of the Commodity Exchange Act. He determined that its plain language requires only that a CPO have the proper form (“investment trust, syndicate or similar form of enterprise”) and that it “solicits, accepts or receives [funds] . . . for the purpose of trading in any commodity for future delivery . . .” Nothing in the Act requires that the entity itself actually be engaged in trading. Even the regulations under the Act define the term “pool” without reference to a trading requirement, stating only that the entity be “operated for the purpose of trading commodity interests.”
Looking at the legislative history of the CPO definition, Chief Judge Scirica noted that Congress sought to regulate the solicitation of investment capital and protect customers from fraudulent and other harmful activities. “The statute would be undermined,” he wrote, “if one entity could escape regulation merely by having another execute its trades.” The opinion concluded that the Act does not require that a CPO execute commodity futures transactions, and that all an investment trust, syndicate or other form of enterprise need to do is solicit, accept or receive funds for the purpose of trading (by itself or others) in order to be deemed a CPO.
The opinion also addressed the nature of an investment trust, syndicate or other the form of enterprise. It clarified that such a business must provide a vehicle for a collective or group investment, combining investors’ capital into a single, commingled account that divides profits and losses pro rata and invests or trades those assets collectively, on behalf of the entire account rather than for individual investors. Accordingly, based on Equity Financial’s activities and the nature of Shasta Capital’s enterprise, Equity Financial, as manager of Shasta Capital, was a CPO.
We have not confirmed whether the appellants have decided to appeal this decision, nor have we examined whether there are supporting or conflicting decisions on this topic in other federal circuits. If you wish to obtain a copy of the Equity Financial opinion or have any questions on this decision, feel free to contact the author at firstname.lastname@example.org.*
Lawrence Cohen is a director in the corporate department at law firm Gibbons P.C. As a former legal officer and compliance director of mutual fund groups, he brings practical experience to the regulation and registration of public investment companies and the formation and operation of private investment companies.
*This article should not be construed or relied upon as legal advice or legal opinion on any specific facts or circumstances. Any invitation to contact the author is not a solicitation to provide professional services and should not be construed as a statement as to any availability to perform legal services in any jurisdiction in which the author is not permitted to practice.