After the Commodity Futures Trading Commission (“CFTC”) rescinded certain exemptions, numerous advisers must now evaluate their registration requirements (please see our previous communique here on the rescission of Rule 4.13(a)(4) by the CFTC). For those that are required to register with the CFTC and become members of the National Futures Association (“NFA”), one of the most cumbersome elements of registration involves taking the Series 3 by the firm’s principals and associated persons.
As we explained in a previous communique, at least one of the “Principals” of the firm needs to register as an “associated person” (“AP”) in order for the firm to become a member of the NFA and, in addition, all APs must register in order to continue performing their duties lawfully. An AP is defined generally as anyone involved in a marketing capacity and in contact with prospective investors or clients of a CPO/CTA, and anyone in the supervisory chain-of-command.
Since the Series 3 is a difficult exam to take, persons involved in marketing are advised to examine whether they can: 1) fall outside the purview of the definition of “associated person;” (2) rely on an exemption from AP registration altogether; 3) rely on an exemption from taking the Series 3 (this would be only an exemption from meeting the proficiency requirement, not from the registration process); or (4) request a waiver from the Series 3 requirement.
1. The Definition of “Associated Person”: Who is NOT an AP
APs are individuals involved in a capacity that involves the “solicitation or acceptance of customer orders” or “the supervision of any person or persons so engaged.” If a person communicates only with broker-dealers or finders and not directly with investors, that person will not be deemed an “associated person” and can continue interacting with such intermediaries without registration.
2. Exemptions from AP Registration:
When examining exemptions to registration, one has to keep in mind that a CPO or CTA must have at least one registered AP in order for the firm to register as a whole. Therefore, not everyone can seek an exemption even though they may qualify for one. There are three exemptions available for individuals who are:
a) FINRA Registrants (CFTC Rule 3.12(h)(1)(ii))
Any FINRA registrant who (1) engages in AP-related activities consisting solely of soliciting investors for commodity pools or supervising persons who do so, (2) engages in AP-related activity as a registered representative, a registered principal, a limited representative, or a limited principal of a FINRA member firm, and 3) does not engage in any other activity subject to regulation by the CFTC such as trading may be exempt from registration (see CFTC Rule 3.12(h)(1)(ii)). This exemption, however, can be used only by persons who solicit investors for a commodity pool as registered representatives of the broker-dealer and not as representatives of the CPO itself; in other words, all solicitation must be carried out through the broker-dealer firm and not through the CPO. If the solicitation is done through the CPO, such persons have to register as APs of the CPO. This means that this exemption will be of limited interest to fund managers who want to solicit investors in their own pools without the use of brokers.
b) Supervisory Persons of Registrants Engaged in De Minimis Commodity Interest Activity (CFTC Rule 3.12(h)(1)(iii))
If a firm trades primarily in securities and derives no more than 10% of its annual revenue from commodity interests, certain persons in the chain-of-command can be exempt from registration if, among others, they do not solicit investors on behalf of the firm nor supervise such persons, but have instead delegated the authority to solicit or supervise to another person who is a registered AP and has taken the Series 3. To be able to qualify for this exemption, the supervisory persons must not have any firing or hiring authority over the registered AP, a condition that is hard to meet. It is easier for APs of firms that trade primarily in securities to request waivers from taking the Series 3 instead of seeking an exemption from registration (see section on waivers below).
c) Non-U.S. APs (CFTC Rule 3.12(h)(1)(iv))
Individuals who conduct AP activities outside of the U.S. and do not act as an AP towards any U.S. customers, either directly or indirectly, are exempt.
3. Exemptions from AP Proficiency Testing Requirements (Self-Executing):
If an AP does not qualify for an exemption from AP registration, an AP may, nonetheless, under certain circumstances, qualify for an exemption from AP proficiency testing. These exemptions can be self-executing or granted via waiver. The self-executing ones are:
a) Swaps Exemption:
This new exemption is available to an AP of a CPO who does not trade in commodity interests aside from swaps (“Swaps AP”). Swaps APs are automatically exempt from taking the Series 3 (for more information on the exemptions available to Swaps APs, see our previous communique here). There is a similar exemption for Swaps APs of firms who would be operating under the de minimis exemption of CFTC Rule 4.13(a)(3) if swaps were disregarded from the calculation. This exemption however is not self-executing. The sponsor of APs of CPOs that would be exempt from registration under 4.13(a)(3) but for their swaps activities (i.e., the firm would meet the de minimis requirements if swaps were not included), must send a signed request to NFA seeking a waiver for its APs from the Series 3 on the basis that, but for the trading of swaps, it would be eligible for an exemption from registration . (click here for more information)
b) Exemptions for FINRA General Securities Representatives who Refer Clients (see NFA Registration Rule 401(b)):
An applicant will be deemed to have satisfied the proficiency requirements and does not need to take the Series 3 if:
- the applicant is currently registered with FINRA as a General Securities Representative (“GSR”) of his/her sponsor; and
- the applicant’s sole activities are limited to referring clients to an AP of the sponsor who has satisfied the proficiency requirements, but only if the referrals are solely incidental to being a GSR of the sponsor or to the supervision on behalf of the sponsor of persons whose activities are so limited.
4. Waivers from AP Proficiency Testing Requirements:
An AP may apply for a waiver of the Series 3 exam testing requirements by writing to the NFA and describing why they qualify for the waiver. The NFA has issued guidance on what types of circumstances would qualify for a waiver. Specifically, an AP may receive a waiver (1) when, as described above, the firm would be under the de minimis exemption if swaps were disregarded; or (2) when a CPO/CTA firm trades primarily in securities.
Regarding the waiver of testing requirements for CPOs and CTAs who engage primarily in securities, the following applies: (see Interpretative Notice under 402 regarding CPOs here and Interpretative Notice for Rule 402 regarding CTAs here).
For CPOs, the NFA Director of Compliance has the authority to waive the Series 3 examination for certain APs in either of the following two situations:
The CPO of the commodity pool is subject to regulation by a federal or state regulator (e.g., the SEC, federal bank regulators or state insurance agencies), or the pool is privately offered pursuant to an exemption from the registration requirements of the Securities Act of 1933 and the CPO limits its activities for which registration is required for operating a commodity pool which:
- engages principally in securities transactions;
- commits only a small percentage of its assets as initial margin deposits and premiums for futures and options on futures; and
- uses futures transactions and options on futures only for hedging or risk management purposes.; OR
The applicant is a general partner of a CPO or of a commodity pool which:
- is primarily involved with securities investments;
- there is at least one registered general partner of the CPO or pool who has taken and passed the Series 3 examination; and
- the individual requesting the waiver is not involved in soliciting or accepting pool participations, trading futures or options on futures, handling customer funds, supervising any of the above activities or engaging in any other activity that is integral to the operation of the fund as a pool.
For CTAs, the NFA Director of Compliance is authorized to waive the Series 3 examination for a CTA and its APs if:
- the CTA is subject to regulation by a federal or state regulator;
- for each customer for whom the CTA provides futures trading advice, such advice is incidental to the securities advisory services provided by the CTA to such customer; and
- the futures trading advice offered by the CTA is for hedging or risk management purposes.
- See Rule 401(e)(2)(ii)