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Explanation of Proposals
NFAís January 20, 1998 submission of Rule 2-35 concerning two-part disclosure documents gave CPOs the option to present the monthly rate of return information currently required under CFTC Regulation 4.25 in the Statement of Additional Information ("SAI"). If a CPO decided to present this performance information in the SAI, however, annual rate of return information for the pool for the most recent five calendar years and the year-to-date would be required in part one of the document. Since the January 20, 1998 submission, Commission staff suggested that NFA amend the two-part proposal to eliminate the option of providing the monthly information in the SAI. NFAís Board agreed to amend subsection (b) of proposed Rule 2-35 accordingly.
Commission staff also asked NFA to develop a rule proposal similar to the profile document rule implemented by the Securities and Exchange Commission ("SEC") effective June 1, 1998. NFAís Board agreed with the Commission that the futures industry could benefit from a rule similar to the SECís profile rule and therefore added subsection (d) to proposed Rule 2-35 which would permit Member CPOs to solicit prospective investors with a profile document. Unlike the SECís rule, however, CPOs would still be required to deliver a disclosure document prior to accepting any funds or property from a prospective client. The profile document itself would be limited to certain key information about the pool and the CPO and would provide specific cautionary disclosures. With regard to performance disclosures, the CPO would be limited to providing actual performance of the offered pool. The profile document would, however, notify the prospective investor if other performance information is presented in the disclosure document.
The following eight points describe the contents of a profile document and make comparisons to the SECís rule. The main changes from the SECís rule are based on the differing nature of a pool investment and a mutual fund investment.
- Cover Page Ė The SECís rule requires a cover page which contains the Fundís name and, at the Fundís option, the Fundís investment objective or the type of fund offered. A statement identifying the document as a "profile" without using the term "prospectus," the approximate date of the profileís first use, a cautionary legend regarding the summary nature of the profile, and directions on where to get a prospectus or further information are also required. Proposed Rule 2-35 requires all of this information plus, immediately following the cover page, an additional cautionary statement regarding the risky nature of commodity pools and a statement that neither NFA nor the CFTC has passed on the merits of participating in the pool or the adequacy or accuracy of the profile document. Rule 2-35 also requires that the cover page include a break-even analysis with respect to an investment in the pool.
- Objectives/Goals and Principal Investment Strategies Ė The SECís rule requires that the profile include information about the Fundís investment objective or goals as required by the prospectus rules for mutual funds. In addition, the profile must include information about the Fundís principal investment strategies. Proposed Rule 2-35 does not require information about the poolís investment objectives or goals but does require a non-marketing orientated discussion of the trading strategy to be used by the pool.
- Principal Risks of Investing Ė The SECís rule requires narrative disclosure, a bar chart, and a table required by the mutual fund prospectus rule which highlights the principal risks of investing in the Fund. This section must also include information on the Fundís average annual total returns. Proposed Rule 2-35 requires the cautionary statement regarding the risks of investing in the pool and a statement identifying any risks unique to the particular pool. Rule 2-35 also requires, if applicable, a statement in the body of the profile indicating the extent to which a participant may be held liable for obligations of the pool in excess of the funds contributed by the participant for the purchase of an interest in the pool. In addition, NFAís rule requires that the document include the capsule performance for the offered pool, with reference, if applicable, to the fact that the disclosure document contains performance information on other pools operated by the CPO, or for pools with no operating history, performance of major CTAs trading the pool.
- Fees and Expenses Ė The SECís rule requires disclosure of fees and expenses, including commissions, associated with an investment in the Fund. Proposed Rule 2-35 requires this information as part of the break-even analysis.
- Identity of Certain Key Persons Ė The SECís rule requires that the investment adviser, subadviser, and portfolio manager be identified. In addition, for those persons associated with the investment adviser who are primarily responsible for the day-to-day management of the Fundís portfolio, the profile must summarize each personís business experience for the last five years and indicate their length of service with the adviser. Proposed Rule 2-35 requires that the profile identify each principal of the pool operator, the poolís trading manager and its principals and, if any, any major CTA and its principals. Rule 2-35 does not require disclosure of the business background of these individuals. Since prospective participants will still have to receive the disclosure document before investing in the pool, the Board felt it was unnecessary to disclose this information in both documents. Rule 2-35 does, however, require a summary of any material administrative or criminal actions, whether pending or concluded, within five years of the date of the profile, against the commodity pool operator or any of its principals.
- Purchase/Sale of Shares -- The SECís rule requires that the profile disclose the Fundís minimum initial or subsequent investment requirements, the initial sales load and, if applicable, the initial sales load breakpoints or waivers. With regard to the sales of shares, the SECís rule requires that the document disclose the procedures for redeeming shares and identify any charges or sales loads that may be assessed. Proposed Rule 2-35 requires the profile to provide a brief description of any restrictions on transfers of a participantís interest in the pool and information on how a participant may redeem his interest in the pool. As previously noted, NFAís proposal also requires the CPO to include the break-even table on the cover page of the profile document.
- Distributions and Tax Information Ė The SECís profile rule requires a description of how frequently the fund intends to make distributions and what options for reinvestment of distributions are available for investors. The document must also indicate the tax status of these distributions. Proposed Rule 2-35 does not require this information since regular distributions are generally not a feature of a pool investment and the taxable status of any distribution is best determined by an investor and its tax adviser.
- Other Services Available -- Under this section, the SEC requires that the document provide a brief summary of services available to Fund shareholders. This requirement is not contained in the proposed rule because it was not applicable to a pool investment.
The Board felt that the benefits of this profile document are also applicable to CTAs. Therefore, subsection (e) was added to proposed Rule 2-35 to permit CTAs to use a profile document to solicit prospective clients. As with CPOs, however, the CTA will be required to deliver the disclosure document prior to entering into any agreement to direct or guide a clientís commodity futures account.
Subsection (f) was added to proposed Rule 2-35 to require that all profile documents must be filed with NFA and simultaneously filed with the CFTC. It also requires that an initial profile document for each pool offering must be filed with NFA before its first use and may not be used until the later of 30 days after the date of filing the document or the date the full disclosure document is accepted for filing by NFA or the CFTC. Furthermore, an amended profile document must be filed with NFA no later than five business days after the date it is first used.
The Board recognizes that full implementation of this profile document rule will also require amendments to CFTC regulations. Therefore, under separate cover, NFA will submit to the Commission a petition for rulemaking to amend CFTC Regulations 4.21 and 4.31.
Proposed Implementation Date
Obviously, it takes a significant amount of time and effort to make changes in disclosure documents. Therefore, the Board determined that the rule and its Interpretive Notice would only apply to Disclosure Documents filed with NFA or the Commission on or after a date at least six months following Commission approval.