To be 4.7 Exempt or Not To Be, That is the Question

Despite the having the odds stacked against them, we hear from new CTAs and hedge fund managers every day. This isn’t to say that we discourage new CTAs, our 108 Tools to Help grow your CTA Business can speak to that, and we recently discussed how these emerging managers are typically better performers.

But we won’t sugar coat things, it isn’t easy going from $0 to $10 million, $10 to $100 million, or $100 million to $1 Billion under management. Which led many CTAs to RCM’s Alternative Investment Conference this week to hear best practices and so forth. And one question among new CTAs that got debated after the event with some fervor was whether CTAs should be “4.7 exempt” CTA or not.

This is a little inside baseball, but it’s an important question when a CTA is just starting out. For those of you that have no idea what a 4.7 exemption is; filing a 4.7 exemption means that a CTA is exempt from certain regulations such as filing a Disclosure Document with the National Futures Association (“NFA”) – but in exchange for that relief, can only accept QEP investors (Qualified Eligible Investors, which are essentially investment/insurance/bank type companies and private investors with over $2 million in investments) into their program or fund.  Conversely, a CTA can file a Disclosure Document with the NFA and accept any investor they deem suitable for the investment, with the regulatory thinking perhaps that the well-heeled investors don’t need everything spelled out for them.

So, the decision facing a CTA when starting out is whether to:

  1. Avoid the regulators and cost of drafting a Disclosure Document, but only go after the $2million in investable assets and up QEP investors.

Or

  1. Deal with the regulators and draft a Disclosure Document (and re-submit it annually), and go after any investor who can afford the minimum investment.

Now, what we were hearing at the Expo was that the general rule of thumb CTAs get from lawyers is to file the exemption to avoid the hassle of filing D-Docs with the NFA. Most new CTAs, it seems, are being coached to avoid the 4.7 Exemption. To which we say… get a new coach. If you’ve got a golden Rolodex filled with names of multi-millionaires, heads of banks, and Chief Investment Officers at pensions and endowments – sure, the 4.7 exemption can save you some hassle.  But what if you’re trying to grow organically and need every set of eyeballs you can get on your program. Is avoiding a few days of hassle with the regulators each year worth eliminating a big portion of the investing public?

We say no… but haven’t ever really looked at the statistics to see just how many potential investors 4.7 exempt CTAs are ignoring by saving some hassle.  Now, this gets a little difficult, as there are a lot of definitions for both that include insurance companies, pool operators, and foreign individuals (all of whom are QEPs regardless of net worth or income… in a blatant example of the US regulators saying ‘you’re not our problem’). But if we assume all the non-human type of investors basically balance each other out, and represent just a small portion of the overall numbers – then we’re down to looking at how many investors fall in each net worth bucket.
For sake of argument, let’s assume that accredited investors have $1 million in net worth, and QEPs have $2 mm and up in net worth, remembering that all QEPs are also accredited. If you meet the higher standard, you automatically meet the lower standard; and do some quick back of the napkin math to see that there are:

Over $2 million net worth, QEPs = 1.8 million households

Accredited = 8.5 million households

Non Accredited, with investment accounts = 20 million house holds

US Wealth

(Disclaimer: Past performance is not necessarily indicative of future results)
Chart Courtesy: CNN
(Note = We know the data is from 2007. It’s the most recent data we could find)

Now, this ignores a big part of the puzzle, which is how much money each of those buckets has. It’s well documented that the top 1% command more than 48% of the world’s wealth. But ignoring for a fact that there might be 4, or 40, times more money concentrated at the top, there’s still about 4 times more investors with more than $1 million than there are with over $2 million, meaning, for us – to ditch that 4.7 and go ahead and file that D-Doc.

Sources:

QEPs = Wealth in America — (CNN)

Accredited = How Many Accredited Households Exist in the US — (InvestGeorgia)

Non-Accredited with Investment Accounts = (Census)

For more on the 4.7 exemption and others at NFA, see here:

CFTC 4.7 Exemption

NFA Exemption Descriptions

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Disclaimer
The performance data displayed herein is compiled from various sources, including BarclayHedge, and reports directly from the advisors. These performance figures should not be relied on independent of the individual advisor's disclosure document, which has important information regarding the method of calculation used, whether or not the performance includes proprietary results, and other important footnotes on the advisor's track record.

Benchmark index performance is for the constituents of that index only, and does not represent the entire universe of possible investments within that asset class. And further, that there can be limitations and biases to indices such as survivorship, self reporting, and instant history.

Managed futures accounts can subject to substantial charges for management and advisory fees. The numbers within this website include all such fees, but it may be necessary for those accounts that are subject to these charges to make substantial trading profits in the future to avoid depletion or exhaustion of their assets.

Investors interested in investing with a managed futures program (excepting those programs which are offered exclusively to qualified eligible persons as that term is defined by CFTC regulation 4.7) will be required to receive and sign off on a disclosure document in compliance with certain CFT rules The disclosure documents contains a complete description of the principal risk factors and each fee to be charged to your account by the CTA, as well as the composite performance of accounts under the CTA's management over at least the most recent five years. Investor interested in investing in any of the programs on this website are urged to carefully read these disclosure documents, including, but not limited to the performance information, before investing in any such programs.

Those investors who are qualified eligible persons as that term is defined by CFTC regulation 4.7 and interested in investing in a program exempt from having to provide a disclosure document and considered by the regulations to be sophisticated enough to understand the risks and be able to interpret the accuracy and completeness of any performance information on their own.

RCM receives a portion of the commodity brokerage commissions you pay in connection with your futures trading and/or a portion of the interest income (if any) earned on an account's assets. The listed manager may also pay RCM a portion of the fees they receive from accounts introduced to them by RCM.

See the full terms of use and risk disclaimer here.

Disclaimer
The performance data displayed herein is compiled from various sources, including BarclayHedge, and reports directly from the advisors. These performance figures should not be relied on independent of the individual advisor's disclosure document, which has important information regarding the method of calculation used, whether or not the performance includes proprietary results, and other important footnotes on the advisor's track record.

Benchmark index performance is for the constituents of that index only, and does not represent the entire universe of possible investments within that asset class. And further, that there can be limitations and biases to indices such as survivorship, self reporting, and instant history.

Managed futures accounts can subject to substantial charges for management and advisory fees. The numbers within this website include all such fees, but it may be necessary for those accounts that are subject to these charges to make substantial trading profits in the future to avoid depletion or exhaustion of their assets.

Investors interested in investing with a managed futures program (excepting those programs which are offered exclusively to qualified eligible persons as that term is defined by CFTC regulation 4.7) will be required to receive and sign off on a disclosure document in compliance with certain CFT rules The disclosure documents contains a complete description of the principal risk factors and each fee to be charged to your account by the CTA, as well as the composite performance of accounts under the CTA's management over at least the most recent five years. Investor interested in investing in any of the programs on this website are urged to carefully read these disclosure documents, including, but not limited to the performance information, before investing in any such programs.

Those investors who are qualified eligible persons as that term is defined by CFTC regulation 4.7 and interested in investing in a program exempt from having to provide a disclosure document and considered by the regulations to be sophisticated enough to understand the risks and be able to interpret the accuracy and completeness of any performance information on their own.

RCM receives a portion of the commodity brokerage commissions you pay in connection with your futures trading and/or a portion of the interest income (if any) earned on an account's assets. The listed manager may also pay RCM a portion of the fees they receive from accounts introduced to them by RCM.

See the full terms of use and risk disclaimer here.

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