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In 1995, NFA's Board of Directors (the "Board") appointed a Special Committee for the Review of CPO/CTA Disclosure Issues (the "Special Committee), which in turn formed the Subcommittee for the Review of Non-Performance CPO/CTA Disclosure Issues (the "Subcommittee"). The goal of this Subcommittee was to design a concise and readable disclosure document that ensured that prospective pool participants received all the information needed to make an informed investment decision. The Subcommittee concluded the best way to achieve this goal would be to adopt a two-part disclosure document format similar to the Securities and Exchange Commission's ("SEC") format for mutual funds.
On August 17, 1995, the Board endorsed a proposal by the Subcommittee to implement a two-part disclosure document. The Subcommittee determined that disclosure documents must be as clear and concise as possible and limit the information that could be included to that information required by the Commission's Part 4 Rules, information required by other applicable laws, and any other information necessary to understand the fundamental characteristics of the pool or make the disclosure document not misleading. The original proposal recommended changes to the Part 4 Rules to require a CPO of a public pool to prepare a separate statement of additional information ("SAI") containing certain enumerated information which closely tracked the SEC requirements for mutual fund SAIs. The CPO would not have been required to provide this document, however, unless requested by a prospective or current participant. Private pool offerings would not have been required to prepare an SAI. However, if the CPO of a private pool offering wanted to provide additional information to prospective participants, the information would have to be provided in an SAI. For a private pool, the SAI could either be provided as a separate document or bound together with the disclosure document.
The requirement that Part I of the document include information required by other applicable laws was intended to cover information that public pools are required to disclose by the SEC and state securities regulators. The Subcommittee hoped to gain some concessions from the SEC regarding the information that needed to be included in Part I of the document. Specifically, the Subcommittee sought to get the SEC's agreement that Part I of the document could be limited to the types of disclosures currently required of mutual funds in Part I of the mutual fund prospectus.
As you are aware, the CFTC Part 4 Rules require that the disclosure document include the monthly rate of return for the pool for the most recent five calendar years and year-to-date, computed on a compounded monthly basis. The Part 4 Rules also require a summary description of the performance history of non-core CTAs. Under the Subcommittee's proposal, pool performance information computed on a yearly basis would have been included in Part I. Monthly rates of return and the summary performance history description for non-core CTAs could, however, have been included in the SAI.
Obviously, full implementation of this proposal would have required the approval of the SEC and various state regulators as well as the CFTC. As you know, the CFTC has adopted a resolution supporting the concept of two-part disclosure documents. However, CFTC staff has encountered resistance from the SEC. Although the SEC supports a "plain English" initiative to simplify disclosure documents, it seems leery of a mutual fund disclosure format for pools. In fact, in a recent Wall Street Journal article, Meredith Cross, deputy of the SEC's Division of Corporate Finance, stated that it was unlikely that futures funds would move towards using a two-part disclosure document.
Given the SEC's apparent reluctance to approve a two-part disclosure format for pools, CFTC staff recently suggested to NFA staff that the Subcommittee's proposal be amended to apply only to privately offered pools. Commission staff reasoned that this amended proposal would be more viable because it could become effective without any approvals by the SEC or state regulators. Although NFA's Subcommittee would like to see some progress on this proposal, it concluded that publicly offered pools should not be exempt from a two-part disclosure format as they, more than privately offered pools, tend to have the longest and least understandable documents. Recognizing, however, that its original proposal was not viable in the current environment, the Subcommittee revisited its original proposal to consider whether any changes could be made to make the proposal more palatable to the SEC.
Under the Subcommittee's revised proposal, public pools will be required to prepare a two-part document, with mandatory delivery of both parts. Although the customer will still receive the same total amount of information, if the first part of the document is limited to the most salient required disclosures, he will receive the information in a more concise, more readable format. The firm may also achieve some savings if changes to its disclosure information only require it to reprint one of the two documents, rather than the entire document. The long-term benefit, however, will hopefully stem from the acceptance of the two-part format, with the ultimate goal to further reduce the required disclosures or eliminate the mandatory delivery of the second part of the document.
For private pools, the original proposal is essentially unchanged. Disclosure documents for private pools would have to be clear and concise, and the preparation and delivery of an SAI would be optional.
The Subcommittee made two other significant changes to its original proposal. First, the Subcommittee adopted the SEC's "plain English" initiative, which will help make disclosure documents clearer and more concise. Second, the Subcommittee decided that the final proposal should be done through an NFA Rule proposal. The Subcommittee felt that an NFA Rule governing disclosure documents would be appropriate since NFA has assumed responsibility for the initial review of disclosure documents.
Having considered the recommendations of the Subcommittee, the Board adopted NFA Compliance Rule 2-35 which requires the use of a two-part document, with mandatory delivery of the second part by public pools. The rule requires that Part I be clear and concise, written in plain English, and be limited to most of the information required by the CFTC's Part 4 Rules, other information required to be in Part I of a two-part document by the SEC or other regulatory authorities, and any other information necessary to understand the fundamental characteristics of the pool or make the disclosure document not misleading. As with the Subcommittee's original proposal, CFTC required monthly rates of return for the pool's most recent five calendar years and, for multi-advisor pools, performance information on non-core CTAs, could be included in the SAI.
The proposed interpretive notice explains what the rule means when it requires the disclosure documents to be clear and concise and use plain English principles. The plain English principles described in the interpretive notice are taken from the SEC's pending proposal to require plain English in the front and back cover pages, the summary, and the risk factors discussion in prospectuses. Rule 2-35 extends the use of plain English to the entire disclosure document but not to the SAI. The interpretive notice also spells out some of the information that is currently required by the SEC and state securities administrators to be included in Part I of a two-part document. In drafting the interpretive notice, the Subcommittee looked at SEC Form N-1A, which sets out the disclosures to be included in the prospectus and SAI for mutual funds. However, in March of this year, the SEC proposed amendments to Form N-1A, and that proposal is still pending. Therefore, the Subcommittee had to make some assumptions in drafting the interpretive notice. It assumed that the disclosures the SEC has proposed to eliminate will not be required when the SEC's proposal is finalized, so the Subcommittee left those disclosures out of the interpretive notice. The Subcommittee also left out those disclosures that the SEC has proposed adding to Form N-1A.
Obviously, it takes a significant amount of time and effort to make changes in disclosure documents. Therefore, the Board determined that the rule and 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.
NFA respectfully requests that the Commission review and approve the proposed adoption of NFA Compliance Rule 2-35 and its interpretive notice and requests that they be declared effective as determined by NFA after receiving Commission approval.