Comment Letters

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May 26, 2006

Via E-Mail (

Ms. Pamela Culpes
IOSCO General Secretariat
C/ Oquendo 12
28006 Madrid

Re: Comment on Consultation Report on Hedge Funds Offered to Retail Investors

Dear Ms. Vulpes:

National Futures Association ("NFA") appreciates the opportunity to comment on the IOSCO Consultation Report entitled "The Regulatory Environment for Hedge Funds." NFA is a registered futures association under the Commodity Exchange Act and a self-regulatory organization for the United States futures industry, subject to oversight and review by the Commodity Futures Trading Commission ("CFTC"). Customer protection is our top priority. We work closely with the CFTC to provide effective and efficient regulation that protects customers without imposing undue burdens on the futures industry, and we believe that our efforts have been an extraordinary success. In the twenty-four years since NFA began operations, trading volume on U.S. futures exchanges has increased by well over 1,000% while customer complaints have actually dropped significantly. Furthermore, commodity pool operators ("CPOs") and commodity trading advisors ("CTAs") have an even better record; although they comprise 60% of NFA's membership they are named in only 20% of NFA's enforcement actions and in only 2% of customer complaints. These numbers are consistent with the comparatively small number of CFTC and SEC enforcement actions involving commodity pool and hedge fund activities.

As of the year ended on December 31, 2005, there were 1,780 registered CPOs. As of December 31, 2005, NFA has approximately 1,500 CPO Members.1 Of those Members, almost 850 are currently active, and between them they operate approximately 2,700 active commodity pools. Many of the largest hedge funds are 4.7 commodity pools operated by CPOs that are registered with the CFTC and are Members of NFA.2 A number of the top 100 hedge fund complexes are operated by NFA Member CPOs or their affiliates.

NFA has a number of programs to monitor CPOs' compliance with applicable rules and regulations. NFA's on-site examinations provide the most comprehensive review. During these examinations, NFA staff looks for and reviews transactions between the CPO and its pools, transfers between the CPO's pools, and the CPO's banking relationships. Staff performs basic testing on all the commodity pools operated by the CPO, including reviewing the pools' participant lists, solicitation materials, additions, and withdrawals. In addition, NFA uses a risk-based approach to select and test one pool in detail. In choosing this pool, NFA considers a number of factors, including the number of participants in the pool, the pool's total net asset value, exemptions held by the pool, and whether NFA conducted detailed testing on the pool in a prior exam. NFA reviews the pool's financial records, including its assets and liabilities, with an emphasis on the pool's futures transactions. NFA reviews the asset valuation procedures for reasonableness and confirms the existence of non-futures assets - including securities, cash, swaps, and other finanical instruments - that have a material effect on the pool. NFA also reviews the pool's trading activity for consistency with its disclosure document or offering memorandum.

NFA currently examines approximately 300 CPOs every year. CPOs are generally examined within three years after becoming active and every three-four years thereafter. Under NFA's risk-based approach, we examine CPOs more frequently when we have reason to believe that a CPO or any of its pools poses undue risks.3

All pools, including 4.7 pools, must provide participants with year-end financial statements and must file those statements with NFA.4 NFA analyzes each one of these statements, most within 30 days of receipt. This review examines whether the financial statement adequately reflects the pool's assets and liabilities and is consistent with any disclosure document on file, and it focuses special attention on unusual balances and significant changes in the pool's net asset value. NFA looks at the pool's entire financial statement, with the greatest emphasis on the pool's futures activities. Within the last 12 months, NFA has analyzed approximately 3,400 pool financial statements.

NFA also reviews each disclosure document filed with NFA. Non-exempt pools are required to provide existing and potential pool participants with a disclosure document that has been filed with and approved by NFA before its first use. NFA's review is designed to ensure that the investing public receives adequate disclosure about the investments being offered. If we have concerns regarding inadequate or misleading disclosure, we require the CPO to revise the disclosure document before using it. In the last year, NFA analyzed approximately 1,100 disclosure documents for public and private pools.

NFA collects a significant amount of information regarding CPOs and hedge funds through its audits; from registration forms and financial statements; and from disclosure documents or offering memoranda filed with NFA or obtained during audits. We also receive an annual questionnaire that, like audits, focuses on the CPO's futures activities.

The Consultation Report states that possible future work should focus on disclosure and valuation issues. NFA believes that adequate disclosure is crucial to customer protection. We also believe that it must be understandable and concise or customers will not read it. Therefore, we would support any work by the Technical Committee to develop guidelines for clear, concise, and effective disclosure of key features of hedge funds offered to retail investors.

NFA also agrees that proper valuation is an important aspect of customer protection. Valuation guidelines and principles must be handled with care, however. As you know, hedge funds invest in a variety of esoteric instruments and engage in a countless number of risk-based strategies, all with different valuation concerns. Therefore, any guidelines developed in this area should be general in nature and should focus on policies and procedures rather than on specific valuation methods.

If you have any questions or would like additional information, please contact me at 312-781-1335 or by e-mail at


Karen K. Wuertz
Senior Vice President,
Planning and Development

1 The number of registered CPOs is higher than the number of CPOs who are NFA Members. For the most part, the registered CPOs who are not NFA Members are inactive.

2 CFTC Regulation 4.7 provides relief from most of the CFTC's recordkeeping, disclosure and reporting requirements if the pool is available only to sophisticated or high net worth participants. Regulation 4.7 does, however, require the pool to provide participants with quarterly net asset information and with an annual report containing financial information about the pool. The annual report must also be filed with NFA.

3 NFA obtains information regarding CPO activity from financial statement filings, annual questionnaires, examinations, disclosure document submissions, regular monitoring of advertising in electronic and print media, and customer complaints. This information is input into NFA's database and helps us determine whether a CPO or a pool presents undue risks. It also alerts us if an inactive firm becomes active without notifying NFA.

4 All non-exempt pools and most 4.7 pools file certified statements.

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