On April 17, the Investment Company Institute (ICI) and the U.S. Chamber of Commerce (the Chamber, and together with the ICI, the Organizations) filed suit against the U.S. Commodity Futures Trading Commission (CFTC) challenging the legality of newly amended CFTC Rule 4.5 (the Rule). The Rule, amended in February 2012, stipulates that registered investment advisers (RIAs) to certain registered investment companies (RICs) trading in commodity contracts and derivatives would be required to register with the CFTC as commodity pool operators (CPOs). The Organizations allege that the CFTC violated the Commodity Exchange Act (CEA) and Administrative Procedure Act (APA) by failing to perform the proper cost-benefit analysis on the amended Rule's impact. The lawsuit seeks to block the CFTC from implementing changes to the Rule.

Background of Rule 4.5

In February 2012, the CFTC issued the amended Rule, which changes Part 4 of its regulations involving registration and compliance obligations for CPOs and commodity trading advisors. The amended Rule reinstated prior limitations that were removed in 2003, allowing RICs to develop managed futures products while being exempted from CFTC regulations. The Rule, as amended, limits investments in commodities through futures contracts and derivatives, including swaps and options, to no more than 5 percent of a fund's liquidation value. The CFTC declined to differentiate in the amended Rule between active and passive use of futures. RICs that use futures to replicate an index fund or to simulate equity exposure, such as mutual funds and exchange-traded funds (ETFs), would be subject to the trading threshold. The amended Rule also limits the ability of RICs to market themselves as vehicles for trading in the futures markets. Funds that exceed the 5 percent threshold or market themselves in a prohibited manner would not be able to claim relief from the Rule and would be subject to the CFTC rules for retail CPOs, many of which conflict with the Securities and Exchange Commission's rules.

Lawsuit Overview

The Organizations filed the complaint against the CFTC in the U.S. District Court for the District of Columbia. In the complaint, the Organizations claim that by amending the Rule, the CFTC failed to:

  • Perform the proper cost-benefit analysis on the amended Rule's impact, which violates the CEA;
  • Give the public a sufficient opportunity to participate in the rule-making process, which violates the APA;
  • Explain its reversal of its 2003 decision that CFTC regulation of mutual funds and ETFs was unnecessary, burdensome and would impair liquidity;
  • Articulate any discernible benefits from the amended Rule above and beyond those already provided to investors through existing regulation; and
  • Provide rational - much less adequate - justifications for the changes to the Rule as well as the added regulatory requirements and restrictions faced by funds that can no longer rely on the Rule.

The lawsuit seeks injunctive relief to prevent the CFTC from implementing the Rule, as amended. If this relief is denied, the amended Rule is set to take effect on April 24, 2012. RIAs will have until December 31, 2012, to register as CPOs. Importantly, the Organizations have not challenged the CFTC's repeal of Rule 4.13(a)(4), which exempted many advisers to private funds from CFTC registration.

The Organizations' complaint may be accessed at: http://www.ici.org/cftc_challenge

The previous Investment Management Alert summarizing the CFTC's changes to the Rule can be read at: http://www.drinkerbiddle.com/files/ftpupload/pdf/ CFTCIssuesFinalRuleAmending.pdf

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