This is what it looks like when mutual funds first wander into CFTC country.

In this SEC filing, you see the first potential headaches that Columbia Funds [profile] will go through as three out of its ten Variable Portfolio funds now fall under the authority of the Commodities Future Trading Commission.

In particular, the three funds, the Variable Portfolio — AQR Managed Futures Strategy Fund, Variable Portfolio — Eaton Vance Global Macro Advantage Fund and the Variable Portfolio — Goldman Sachs Commodity Strategy Fund, no longer qualify "for an exclusion from the definition of a commodity pool pursuant to Rule 4.5 under the Commodity Exchange Act (CEA)."

The situation is the result of a move in early 2012 by the CFTC to place more funds dabbling in commodities and futures trading under its authority. In particular, the stratagem involved removing language in an amendment to Rule 4.5 of the federal Commodity Exchange Act that previously allowed mutual funds to exclude themselves.

With many of the exclusions tightened, more mutual fund managers faced the prospect of being policed by two agencies: the CFTC in addition to the SEC. The issue is far from academic, as more alternatives managers turn to such CFTC-sensitive assets in their mutual funds.

Industry leaders, such as Paul Stevens of the ICI, lambasted the CFTC for the move, even taking on the issue in in U.S. District Court, with none-other than Eugene Scalia, son of U.S. Supreme Court Justice Antonin Scalia, as industry champion.

The court later threw the case out, but industry leaders vow to continue fighting.

In the meantime, firms like Columbia have to deal with the nuts-and-bolts of functioning as a manager operating in two regulatory worlds.

Columbia is bracing for at least some headaches, as can be seen from the language of its SEC filing:

Accordingly, the Investment Manager has applied for registration as a "commodity pool operator" under the CEA with respect to these Funds, to be effective January 1, 2013. Until the CFTC’s and SEC’s overlapping regulations on matters such as disclosure, reporting and recordkeeping are harmonized, the nature and extent of the impact of the new CFTC requirements on these Funds is uncertain. Compliance with the CFTC’s new regulatory requirements could increase Fund expenses, adversely affecting a Fund’s total return.

As for the other funds that still remain eligible for exclusion? Here is what Columbia has to say on the subject:

Each of the other Funds listed on the cover of this SAI qualifies for an exclusion from the definition of a commodity pool under the CEA and has filed a notice of exclusion under CFTC Rule 4.5. Accordingly, the Investment Manager is not subject to registration or regulation as a "commodity pool operator" under the CEA with respect to these Funds. To remain eligible for the exclusion, each of the Funds will be limited in its ability to use certain financial instruments regulated under the CEA ("commodity interests"), including futures and options on futures and certain swaps transactions. In the event that a Fund’s investments in commodity interests are not within the thresholds set forth in the exclusion, the Investment Manager may be required to register as a "commodity pool operator" with the CFTC with respect to that Fund. The Investment Manager’s eligibility to claim the exclusion with respect to a Fund will be based upon, among other things, the level and scope of a Fund’s investments in commodity interests, the purposes of such investments and the manner in which the Fund holds out its use of commodity interests. Each Fund’s ability to invest in commodity interests (including, but not limited to, futures and swaps on broad-based securities indexes and interest rates) is limited by the Investment Manager’s intention to operate the Fund in a manner that would permit the Investment Manager to continue to claim the exclusion under CFTC Rule 4.5, which may adversely affect the Fund’s total return. In the event the Investment Manager becomes unable to rely on the exclusion in Rule 4.5 and is required to register with the CFTC as a commodity pool operator with respect to a Fund, the Fund’s expenses may increase, adversely affecting that Fund’s total return.

In the meantime, both the SEC and CFTC have vowed to do what they can to harmonize their regulatory and enforcement operations with regard to mutual fund firms. Some politicos have gone so far as to suggest merging the two agencies and be done with it. 

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