Earlier this year, the CFTC ordered Summit Energy Services, Inc. ("Summit Energy") to pay a $140,000 civil penalty to resolve allegations that it violated Section 4m(1) of the Commodity Exchange Act by failing to register as a CTA. The CFTC held that Summit Energy engaged in the business of advising 15 or more clients as to the trading of natural gas swaps and futures and generally held itself out to the public as a CTA. Additionally, Summit Energy included descriptions of its “risk management services” on its website and sale brochures, which the CFTC considered to be holding itself out publicly as a CTA. The CFTC also noted that Summit Energy had brokered some OTC natural gas swaps trades, and that Summit Energy’s commodity trading advice was not just solely incidental to its business.
Since the CFTC Order was the result of a settlement and not following a hearing on the merits, only select facts (including the above) are included in the CFTC Order. While we do not know the extent of Summit Energy’s activities which led to the enforcement action, the CFTC made an effort to note that a company’s description of risk management services on its website or other promotional material could be considered, “holding” oneself out to the general public as a CTA. The CFTC Order does not directly address relevant exemptions from registration, but based on the CFTC’s focus, those CTAs relying upon exemptions provided in CFTC Rule 4.14(a)(1) or (10) should take special note of the select facts that were mentioned.
CFTC Rule 4.14(a)(1), the cash markets exemption, exempts a dealer, processor, broker, or seller in cash market transactions of any commodity (or product thereof) when the person’s commodity trading advice is solely incidental to the conduct of its cash market business. While not knowing all of the underlying facts, the CFTC stated that Summit Energy’s commodity trading advice was “part of, and not solely incidental” to its business. We can surmise from the CFTC Order that Summit Energy’s commodity trading advice services were significant enough to have been advertised as risk management services in promotional material. While there may not be a bight line for when the level of CTA services becomes, “part of” a business (requiring registration) versus “solely incidental” to a business (satisfying the exemption), anyone relying on the cash markets exemption should evaluate how often they are required to provide commodity trading advice, in a broad sense, and whether such activities are truly “incidental” to their business.
CFTC Rule 4.14(a)(10), a widely relied upon de minimis exemption, requires that the person providing commodity trading advice not have more than 15 clients over the course of the last 12 months, and such person not hold itself out generally to the public as a commodity trading advisor. Many times, when determining whether this exemption could apply, parties will focus on the 15 or fewer clients requirement and lose sight of, or even ignore, the requirement that the person not hold itself out generally to the public as a CTA. In this case, the CFTC noted that Summit Energy had more than 15 clients and held itself out generally to the public as a CTA by publicly offering prospective clients risk management services (which included commodity trading advice) on its website and in its brochures. Regardless of the number of clients, persons relying upon this exemption should ensure that their promotional material does not contain representations similar to those made by Summit Energy.
In prior matters, the CFTC has also provided additional color on what constitutes “holding” oneself out generally to the public as a CTA. For example, in CFTC Interpretive Letter No. 91-9, CFTC staff stated that a person “holding himself or herself out” as a CTA includes “such conduct as promoting advisory services through mailings, directory listings, and stationery, or otherwise initiating contacts with prospective clients.” Additionally, the CFTC could also examine how a purportedly exempt CTA obtained a client. In this regard, staff also stated in CFTC Interpretive Letter No. 91-9 that “unless the CTA restricts his or her clients to family, friends, and existing business associates, a CTA will generally be viewed as holding himself or herself out to the public.” Finally, in a 1996 Interpretation Regarding the Use of Electronic Media, CFTC staff held that a person that identifies itself as a CTA and refers to its advisory services on a “public electronic forum such as portions of the Internet or a proprietary on-line service” may not avail himself of the exemption under §4m(1). Generally, this is a more narrow view of “holding” oneself out generally to the public as a CTA than many people realize or would have assumed. Overall, the Summit Energy case serves as a warning that the CFTC remains as vigilant as ever in policing the use of CTA exemptions.
- Matthew Kluchenek is a Partner at Baker & McKenzie LLP and leads the firm’s Derivatives & Futures practice group. He can be reached at matt.kluchenek@bakermckenzie.com and (312) 861-8803. Michael Sefton is a Senior Associate at Baker & McKenzie LLP and can be reached at michael.sefton@bakermckenzie.com and (312) 861-2884.