State Regulation of Hedge Funds and Spot Forex
This memorandum contains information regarding the ability of the several states to regulate spot forex with specific attention to pooled investment vehicles. Specifically you wanted to know whether anything in the Commodity Exchange Act preempts the states from regulating over-the-counter spot forex.
This memo is structured in two parts: (i) I summarize the states ability to regulate over-the-counter spot forex; and (ii) I discuss Colorado’s regulation of pooled investment vehicles engaged in over-the-counter spot forex transactions.
Federal Preemption in OTC Spot Forex
Managers of pooled investment vehicles that affect transactions in spot forex with an eligible counterparty for the account of the Fund fall into a space not regulated by the Commodity Exchange Act (“CEA”) and thus not regulated by the Commodity Futures Trading Commission (“CFTC”).
While the CEA does grant exclusive jurisdiction to the CFTC regarding transactions affected through a recognized board of trade, exchange, or market, the CEA does not have any such preemptive provisions addressing over-the-counter spot forex transactions.
This is to say, generally, that if a transaction is not a future or option contract then it is probably not preempted by the CEA. Further, in general, if the CEA or Commodity Futures Modernization Act (“CFMA”) does not regulate an area, then the states are free to step in and regulate on their own.
Colorado’s Regulation of Spot Forex
The Colorado Commodity Code (the “Code”) includes foreign currency within its definition of “commodity,” and includes contracts that are primarily for speculation of commodities for immediate or subsequent delivery within its definition of “commodity contract.” The Code also states that no person shall sell or purchase any commodity through any commodity contract unless they meet one of several requirements as an “exempt person,” a term which includes a CFTC registered Futures Commission Merchant.
It is unclear at present whether the manager of a pooled investment vehicle that affects transactions in spot forex would fall under the provisions of the Code requiring CFTC registration. The language of the Code seems clear enough that someone affecting forex transactions would have to register, however it may be that the manager of a pooled investment vehicle, required to register as an Investment Adviser, that affects some transactions in spot forex in addition to the IA’s security transactions, would not be required to register under the Code since many of the principle regulatory concerns would already be dealt with by the regulation incumbent upon an IA.
There is a no-action letter due to be released by Colorado sometime in the next week which was submitted by a manager operating a commodity pool. The question presented is whether the operator of a commodity pool that affects few or no security transactions must register as an Investment Adviser. This no-action letter may shed some light on the scope of the Code in regard to other pooled investment vehicles, as well.
For a specific answer regarding whether an Investment Adviser conducting transactions in spot forex falls under the Code, it would be necessary to request an interpretive opinion or submit a no-action letter to the Colorado Securities Commission.
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