Forex CPO

Forex CPO Disclosure Documents

This article will provide an overview of the likely requirements for Forex Disclosure Documents. The items in this Forex Disclosure Document Overview are based on the items discussed in “Disclosure Documents – A Guide for CPOs and CPAs” provided by the NFA and based on CFTC rules and regulations.

Please note that these are only likely requirements as proposed and final rules have not yet been released. For those managers which will be managing forex hedge funds, the disclosure document requirements are in addition to the requirements imposed by other securities laws (please see hedge fund offering documents or a more detailed explanation of the forex hedge fund offering document requirements). Additionally, if the Forex CPO or CTA also trades other instruments besides spot forex then the document will need to address those items as well – your hedge fund forex attorney will be able to help you draft these items.

Who must prepare a Forex Disclosure Document?

The NFA has discussed a new category of CPO and CTA whose business involves retail off-exchange foreign exchange (forex) contracts. These new categories of registered persons, as provided by the NFA, are called “Forex CPOs” and “Forex CTAs.” Like the CPO and CTA disclosure documents, it is likely that both Forex CPOs and Forex CTAs will need to deliver a disclosure document to prospective investors. The Forex CPO or Forex CTA will need to make delivery at the same time or before the delivery of the Forex Pool’s offering documents or the Forex Program’s advisory agreement. The Forex CPO or CTA will need to receive signed acknowledgement by the investor that they have received the disclosure document.

We do not yet know if there are any exceptions to Forex Disclosure Document delivery requirements. One question that the CFTC will need to answer is whether Forex CPOs and CTAs will be able to fall within the 4.7 exemption like traditional CPOs and CTAs.

The Basics of the Forex Disclosure Document

Cover Page. The Forex Disclosure Document will probably need to have a CFTC mandated disclaimer which basically states that the CFTC has not reviewed the disclosure document for the merits of the trading program.

Front Cover Disclaimer. Inside the front cover the Forex disclosure document there will need to be a few paragraphs that serve as a general disclaimer of risk disclosure statement. This disclaimer will be based on a uniform template for all Forex disclosure documents.

Table of Contents. A basic table of contents will be required.

Basic Background Information. The beginning part of the document will need to include such basic information as name of the Forex CPO or CTA, addresses, phone numbers, etc. The business background of each principal (each a “Forex Associated Person” or “Forex AP”) as well as the officers and directors of the firm will need to be provided. The information each of the people will need to provide includes: date of NFA membership, date of CFTC registration, and dates of employment for last five years.

Forex Dealer Member. For Forex CTAs, if the program requires an investor to maintain an account with a Forex Dealer Member (“FDM”) then the name of the FDM must be disclosed. For Forex CPOs, the document should disclose who will be the fund’s FDM.

Forex Introducing Brokers. For Forex CTAs, if the program requires an investor to have an account introduced by a Forex Introducing Broker (“Forex IB”), then the name of the Forex IB must be disclosed.

Principal Forex Risk Factors. For both Forex CPOs and Forex CTAs the document must include a discussion of the main risks involved in the Forex program. Such risks are expected to include: country or sovereign risk, credit risk, exchange rate risk, interest rate risk, liquidity risk, market risk, operational risk, settlement risk and Herstaat risk. In addition, for Forex CPOs, there are other risks involved in the structure of the investment vehicle which will need to be disclosed.

Forex Trading Program. All aspects of the proposed trading program must be disclosed and discussed. A Forex trading program will usually include information on the investment object and the investment strategies as well as a discussion of the risk management procedures the Forex manager will utilize. This area of the program may also discuss the Forex manager’s investment philosophy.

Forex Fees. All aspects of the fee structure of the Forex hedge fund or Forex separately managed account must be discussed. This will include both management fees and performance fees (if applicable) as well as the methods for calculating the fees. The rules require specificity here so this will be one area where precise information is required.

Conflicts of Interest. This will be very important information and the Forex manager will want to discuss this section thoroughly with its attorney or compliance professional. All actual or potential conflicts of interest must be disclosed. All fee and business arrangements must be disclosed. For example, if the forex manager will have any sort of pip sharing arrangement with the Forex Dealer Member, this will need to be disclosed.

Litigation. If any of the persons or entities involved in the trading program have been subject to “material administrative, civil or criminal” actions within the past five years, all information regarding the action must be disclosed. Disclosure is required for the Forex CTA, Forex CPO, Forex IB, Forex Dealer Member or FCM, and any principles of the Forex CPO or CTA. Oftentimes the FCM (with regard to CPO and CTA disclosure documents) must disclose a lengthy list of actions.

Trading Forex for Own Account. The disclosure document must disclose whether the Forex manager and/or any employees will be trading for their own accounts. If the Forex manager and/or any employees will be trading for their own accounts then the document must disclose whether the manager or employees will allow investors to review the trading records of the manager or employees.

Performance Reporting

Overview

Basically the performance reporting aspect of the disclosure documents requires the manager to provide very detailed summaries of the performance of the offered program (either managed account or fund), the manager’s other trading programs, and potentially the performance of key employees. Any other performance which is material will also need to be reported. These performance disclosures will usually take up a few pages of the disclosure document and will face the greatest scrutiny by the NFA reviewers.

If the has been no prior performance history of the offered program or by the manager, then there are specific disclaimers which will need to be provided. One of the outstanding questions which we assume will be answered in the coming weeks and months is to what extent a forex manager will need to provide performance reporting from other programs which do not relate to forex (for example, securities or managed futures). Because the characteristics of other investment instruments often differ greatly from off-exchange foreign currency transactions, I am not sure it would be helpful to require such information to be included in the forex disclosure document.

The Performance Capsule and Monthly Rates of Return

The two main performance disclosure items are (1) the capsule and (2) the monthly rates of return. Below is a sample performance capsule for a fictional Forex CPO. We expect that the regulations will require a performance capsule to look substantially similar to the one we’ve presented below.

SAMPLE FOREX CPO PERFORMANCE CAPSULE

Name of Pool Forex Hedge Fund I, LP
Name of Forex CPO Forex CPO Advisors, LLC
Name of Forex Trading Program Forex Trading Program I
Inception of Trading January 1, 2009
Aggregate subscriptions $15,250,000
Current NAV $17,344,000
Largest monthly draw-down 5.2%/ May 2009
Worst peak-to-valley draw-down 9.3%/ April 2009 through May 2009

Below is a sample table of monthly results for a fictional Forex CPO. We expect that the regulations will require a table to look substantially similar to the one we’ve presented below.

Rate of Return

Month 2009
January 2.2%
February 1.6%
March (0.7)%
April 4.1%
May (5.2)%
June
July
August
September
October
November
December
Year

*Numbers are approximate and for example only

Of course both the capsule and the table above will need to have disclaimers provided by the NFA, as well as any other additional disclaimers as suggested by the forex attorney or compliance professional. Please note that the capsule above was prepared for a Forex CPO and the capsule for a Forex CTA is likely to be slightly different.

Hypothetical Performance Results

With regard to hypothetical results, there are significant items that must be considered when displaying these in the disclosure documents. In addition to a fairly lengthy disclaimer (or disclaimers depending on the nature and extent of the hypothetical performance results), the manager will need to include all of the same information as presented in the performance capsule above.

Extracted Performance Results

Extracted performance results may potentially be used in certain circumstances. You should discuss this option with your attorney or compliance professional.

Additional Information Required for Forex CPOs

Because there are structural differences between a forex hedge fund and a forex separately managed account, there are additional disclosure items for a forex hedge fund. Some of the items that the Forex CPO is going to have to provide is information on the forex hedge fund’s breakeven point (the return needed to break even given the fund’s management fees and other fees and expenses including the amortization of legal costs, if applicable), ownership of the forex hedge fund, and when the fund will provide reports to investors in the fund.

Material Information

The forex manager will need to disclose all information that is material to an investment in the program. All such information must be disclosed in the document even if it is not required by the CFTC rules.

Supplemental Information

The forex manager may include supplemental information (i.e. information not required by the CFTC rules, the CEA, or other federal or state laws) in the disclosure document. However, the forex manager should note that such supplemental information is subject to the same requirements as the other information in the disclosure document and may not be misleading or inconsistent. Generally all supplemental information must be presented after the main disclosure required by the CFTC – this can be accomplished through a separate supplemental information document called the “Statement of Additional Information,” or at the end of the forex disclosure document.

Conclusion

While we do not have any clear guidance on what will be required in forex disclosure documents, we believe that this overview (combined with part I) will give forex managers an idea of what the rules are likely to require. We urge forex managers to discuss the registration process with their attorneys during the coming weeks and months as more information is provided by the CFTC and the NFA. Additionally, keep your eyes pealed for information on the Series 34 exam as this will be a prerequisite to registration as a Forex CPO, Forex CTA or Forex IB.