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NFA Board approves new compliance rule to provide uniform performance standards for CTAs

Under a new Compliance Rule approved by NFA's Board of Directors in November 2003, Member CTAs will be required to use a uniform calculation to make it easier for clients to compare the performance of different CTAs. Compliance Rule 2-34 and a related interpretive notice were reviewed by the CFTC in January and will become effective May 1, 2004.

On July 21, 2003, the CFTC issued final rules outlining a core principle approach to CTA performance reporting for partially-funded accounts. The core principle states that CTAs may present the performance of partially-funded accounts in any manner that is balanced and does not violate the antifraud provisions of the Commodity Exchange Act or CFTC regulations. The release accompanying the new rules stated that the core principle approach would not preclude the development of more explicit guidance or performance standards by self-regulatory organizations.

"NFA and some members of the industry advocated using a uniform calculation so that clients can compare the performance of different managers and funds more easily," said Kathryn Camp, NFA's associate general counsel. "We asked several industry representatives to help us develop rules requiring CTA Members to calculate rate-of-return (ROR) based on nominal account size."

Members of this group included: Theresa Becks, Campbell & Company, Inc.; Arthur F. Bell, Jr., Arthur F. Bell Jr. & Associates, L.L.C.; J. Allen Como, Jr., Dunn Capital Management, Inc.; John G. Gaine, Managed Funds Association; James R. Klingler, Eclipse Capital Management, Inc.; David M. Kozak, John W. Henry & Co.; J. Paula Pierce, Law Offices of J. Paula Pierce; and Emily M. Zeigler, Willkie Farr & Gallagher.

"Working with these individuals helped us develop a rule and interpretive notice that reflects the realities of the industry," said Camp. "We are grateful for the time and energy they voluntarily spent on this project."

Compliance Rule 2-34: CTA Performance Reporting and Disclosures contains four sections. Section (a) requires CTAs to calculate ROR based on nominal account size. It allows CTAs to include interest earned on actual funds in their performance calculations. NFA Compliance Rule 1-1 defines "nominal account size" as the account size agreed to by the client that establishes the level of trading in that program and "actual funds" as the equity in the account plus funds that can be transferred to the account without the client's consent to each transfer (known in the industry as "committed funds").

Section (b) requires a written confirmation for each partially funded account. This confirmation must contain the name or description of the trading program and the nominal account size agreed to by the client and the CTA. It must be updated whenever that information changes.

Section (c) requires CTAs to provide certain disclosures designed to ensure that clients understand the consequences of partially funding their accounts. The disclosures do not have to be given to clients with fully-funded accounts or to qualified eligible persons.

The final section of the rule requires CPOs to report CTA performance on the same basis that the CTA is required to report it. This will ensure that the performance reported in a commodity pool disclosure document is the same as the performance reported in the CTA's disclosure document.

NFA has also prepared an interpretive notice that further explains the requirements in Compliance Rule 2-34. It is also contains four sections:

  • The section on "Documenting the Nominal Account Size" describes how the written confirmation can be given and provides the CTA with flexibility in complying with the confirmation requirement.
  • The section on "Disclosure" provides examples of the type and manner of acceptable disclosure.
  • The section on "Actual Funds" provides a test for determining whether funds that are not in the trading account will qualify as actual funds.
  • The section on "Materiality Standards" provides a materiality test for determining whether accounts can be included in the same performance capsule.

"When the new rule becomes effective, the confirmation requirements will apply to all existing accounts and the disclosure requirements will apply to all accounts opened on or after the effective date of the rule," said Camp. "CTAs will not have to restate their previous performance but should disclose any material differences."

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