That is not a completely accurate statement. The typical CTA is a direct managed futures account. My clients, for example, maintain their own account with the FCM. They don't wait for me to supply quarterly statements, but instead have access to their account at any time. They can see what trades are being made, and PnL whenever they so desire. Madoff wasn't just acting as the adviser. He was also the broker/merchant. Two different companies. He was sending fabricated statements generated by his own company. Thus having the ability to show trades that were never made. To do this, the CTA must also own the FCM and require clients to use that FCM. This isn't typical. If I were to try to do what Madoff did, I would need to bribe Interactive Brokers or another FCM to creating false software for me. An impossible task. Conversely, If I were running a CPO, I wouldn't need to include the FCM in the fraud. I would simply need to send out false statements. The only way that I could be caught is by not being able to accommodate a withdrawal request, or if I were randomly audited. So for all but the very large advisers, it is virtually impossible for me to present false trade statements.
Note that CPOs (and in fact, all limited partnerships) must be audited annually, and offer an audited financial report to their investors. But yes, I've also heard of managers falsifying audits. My auditor (Rothstein Kass) actually locks the .pdf file of the completed report + auditor opinion, so that it can't be modified. I'm sure there are ways around that too... so certainly, an investor does need to tread carefully.
Gotcha. So, let's say you make $100 in fees...that is reported section 1256 and assume you have no income tax (sole job is the GP of CPO) you would pay 60/40 or a blended rate of 10%/15% or about 12% ($12)?
Can you give a bit more detail on that? As I understand it, section 1256 is part of only the capital gains section. TITLE 26 - INTERNAL REVENUE CODE Subtitle A - Income Taxes CHAPTER 1 - NORMAL TAXES AND SURTAXES Subchapter P - Capital Gains and Losses PART IV - SPECIAL RULES FOR DETERMINING CAPITAL GAINS AND LOSSES In my understanding, there is no such thing as 1256 income, except in the broader context that all capital gains are considered income. Accountants have always explained it to me as a simple disproportionate allocation of profits. Example: You own $100,000 of the pool's $1,000,000 capital. There is only one other partner (Pete) You charge 20% of net new profits There was a gain of 10% During that period, Pete's account shows capital gains of $72,000 During that period your account shows capital gains of $28,000
Rothstein Kass are one of the best in the business. I meet with them about 7 years ago when working with another fund. Do you pay them a fixed fee or a % of assets (if you don't mind me asking)?
I'm too small to pay a % of assets... they'd go broke. I pay a fixed fee, although some unexpected surcharges were added on the last billing cycle at the end of the year.
You know, I don't want to get into tax advice... I only know enough to get myself in trouble. Bottom line, section 1256 results (marked to market) end up on this form: http://www.irs.gov/pub/irs-pdf/f6781.pdf
Yes, I'm sure that you (and most CPOs) follow the rules just fine. I'm not trying to harp on you guys, as my original intent was to operate as a CPO. The point is just that even though you are required to provide audits, they don't come directly from the auditor to the member. They would really have to go out of their way to determine if the audit is false. In the typical smaller CTA structure, the statements are initiated by the client within their own account direct with the FCM. All but impossible to falsify. And at no time do I ever have possession of client funds.
I'm assuming that you wouldn't be willing to give a ballpark cost for fixed fee service...? I also don't pay % of assets as the audit requirements are much different for me. Mine really charge me based on trade frequency. More trades equal more work for them. But they aren't as close to the top rung as your guys.