A group of 10 investors decide to form a limited partnership to trade futures, but none of them has the time or experience to act as general partner (GP). Nor does anyone want to assume the unlimited risk that falls on the shoulders of the GP. They take this challenge to a commodity pool operator (CPO).

A CPO is an individual, corporation, or organization in the business of operating and promoting commodity pools. On occasion, a CTA can also be a CPO who promotes his or her own trading programs. In this case, our investors seek a CPO independent of CTAs. They take this approach to get an unbiased analysis of potential traders.

CPOs are required to register with the NFA, unless the total capital contribution to all pools they manage is less than $200,000 and there are no more than 15 participants in any one pool. Earlier we discussed the advantages of dealing with registered entities, such as customer complaint resolution procedures. All these hold true here, and there are several more.

FundsProbably the most important is the financial control the NFA has over its registrants, backed by its ability to conduct unannounced audits. CPOs are required to establish and maintain routine accounting records (cash receipt, dispersement, and general journals and ledgers), plus a special ledger on each pool they control. This daily ledger contains an itemized record of each transaction, including date, quantity, commodity, price, the FCM carrying the account, the IB (if applicable), whether the commodity interest was purchased or sold, and the gain/loss realized. For options, the record indicates if it was a put/call, strike price, or premium, and the expiration date. All records received from FCMs and CTAs must be kept. Records of the CPO’s, and its principals’, personal trading accounts are open to inspection by the NFA. On demand, the CPO must produce canceled checks, bank statements, invoices, computer-generated records, statements, and almost any pool-related documents the NFA requests, such as copies of sales promotional materials, advertisements, and correspondence. If there is a problem, the NFA has the authority to resolve it and this is why these investors went the CPO route.

They were also interested in the reporting and tracking capabilities of CPOs, since none of them have the time or experience to do it properly. For example, CPOs must distribute account statements within thirty days of the end of the accounting period, in this case monthly. Annual reports are also mandatory and are due by 45 days after the end of the fiscal year, which could be set to meet the tax needs of the investors. The annual report must include statements of income or loss and changes in net asset value.

They also found it comforting to learn that CPOs must reveal any material dealings between themselves and the pool, the CTAs selected to do the actual trading, and all other individuals or organizations involved, such as FCMs, IBs, brokers, etc. It is always good to know who is getting any part of the action. This way, unneeded expenses can be kept to a minimum. Even the annual report must be certified by an independent public accountant.

As for tracking, most CPOs keep in daily contact with the CTAs doing the actual trading. They review daily computer runs of all transactions. Some use sophisticated computer models to make sure pools are balanced as to traders and markets. As we learned, diversification as to CTA trading styles (systematic vs. discretionary) as well as to markets traded (financials vs. grains vs. energies, etc.) is important. The best CPOs know their CTAs up close and personal. They know who’s sick, tired, having personal problems—there isn’t anything that doesn’t impact trading. Most importantly, they know when to change CTAs and when to weather out storms.

All this analysis, paperwork, reporting, oversight—not to mention the equipment and staff—costs money. CPOs usually charge a monthly management fee as a percentage of funds in the pools. In most cases, it is well worth it, particularly if you do not have the capabilities and experience to do it yourself. Fees are generally in line with those charged by financial managers on the security side of the business.

Last of all is the formation of the limited partnership itself. Some CPOs are attorneys and can do this themselves. Others farm it out, or the investment group provides their own attorney. One of the key issues to pay particular attention to is the transfer or partnership interests to new partners, if they are needed.

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