Securities Compliance Sentinel - Analysis of Cutting Edge Securities Industry Issues

In another example of regulators struggling with the general mandates of the Dodd-Frank Act, the CFTC was forced to delay a vote on establishing trading platforms for swaps.  The new trading platforms were called for by Congress to bring transparency and competition into the over-the-counter markets.  The law requires that swaps, which are currently traded over-the-counter, be traded on exchanges or on alternative platforms known as swap execution facilities or SEFs. 

The CFTC pushed its Tuesday meeting to March 1st because Commissioner Mark Wetjen, a Democrat, stated that he was concerned that the platform regulations would “push the markets precipitously in a way that ends up being counterproductive.”  Many consider Commissioner Wetjen to be a swing vote with the respect to the proposed regulations. 

The CFTC continues to debate the mechanics of the trading platforms.  Firms that are creating the SEFs have put pressure on the CFTC to finalize the rules so that they can compete with exchanges.  Unfortunately, the firms will have to wait at least several more weeks before the CFTC meets to consider the final regulations.

The NFA recently announced that it would provide a limited time relief to Bylaw 1101’s prohibition for members transacting business with unregistered persons.  NFA Bylaw 1101 prohibits an NFA member from transacting business with or on behalf of a non-member that is required to be registered with the CFTC.  Although Bylaw 1101 imposes strict liability on any member in violation of the rule, the NFA has applied a “knew or should have known” standard to violations. 

As readers of this blog are aware, in February, the CFTC issued final rules amending CFTC regulations relating to exemptions, which have a compliance date of December 31, 2012.  The rules rescinded the 4.13(a)(4) exemption and require all CPOs that were exempt pursuant to 4.13(a)(4) to register after December 31, 2012.  The final rules also required most persons claiming an exemption to annually affirm the notice of exemption within 60 days of each calendar year end, starting on December 31, 2012.  Persons who fail to file the annual notice will be deemed to have withdrawn their request for an exemption.

In light of the new rules, the NFA realized that exempt CPOs/CTAs will have until March 1, 2013 to complete the affirmation process, which would make it difficult for a member to conclusively determine prior to March 1, 2013 if a previously exempt CPO/CTA continues to be eligible for a current exemption.  As a result, NFA announced that any member that conducts business with a previously exempt person will not be in violation of Bylaw 1101 if they take reasonable steps to determine the registration and membership status of the persons between January 1, 2013 and March 31, 2013. 

After March 31, 2013, if a member is transacting business with a previously exempt person that is not properly registered, NFA expects the member to contact the person and determine if the person intends to file a notice affirming exemption.  If the member believes that such person should be registered, then the member must put a plan in place to cease transacting customer business with the person.

Although the NFA is providing this limited relief from Bylaw 1101, members should remember that the NFA still expects members to act reasonable and make a good faith effort in determining if they are violating any NFA bylaws or CFTC regulations. 

As we previously reported, the CFTC issued new regulations eliminating the exemption from registration available to CPOs that offered funds solely to sophisticated investors pursuant to Regulation 4.13(a)(4).  For more information on this new CFTC regulation, click here.  Earlier today, the NFA issued a notice to members to provide guidance to CPOs who operate pursuant to Regulation 4.13(a)(4).  After December 31, 2012, all member CPOs operating pursuant to Regulation 4.13(a)(4) must register with CFTC or file an exemption under a different regulation.

A CPO that does not qualify for the de minimus exemption under Regulation 4.13(a)(3) (pools that have less than 15 participants and aggregate capital contributions do not exceed $400,000) may be eligible for other exemptions.  Specifically, a CPO could file an exemption under Regulations 4.7, 4.12 or CFTC Advisory Rule 18-96.  Regulation 4.7 exempts CPOs from certain regulatory requirements where the pool participants are all qualified eligible persons.  Regulation 4.12 exempts CPOs from certain regulatory requirements if less than 10% of the pool’s assets are invested in futures or if the pool is a commodity ETF.  CFTC Advisory Rule 18-96 provides relief from certain regulatory requirements to CPOs that operate offshore commodity pools.

To assist CPOs in withdrawing a 4.13(a)(4) exemption and claiming another exemption, the NFA will modify its electronic exemption system and allow CPOs to pre-file for an exemption that would become effective on January 1, 2013.  Any CPO that does not pre-file for a new exemption and withdraws its 4.13(a)(4) exemption will become subject to CFTC and NFA regulatory requirements for 2012.  Any CPO that wishes to withdraw an exemption may do so by accessing the NFA’s electronic exemption system here. 

A special committee of representatives from the futures industry’s SROs proposed a series of recommendations for changes to SRO rules and regulatory practices.  The recommendations include: 

• Requiring all FCMs to file daily segregation and secured reports, which will provide SROs with an additional means to monitoring firm compliance;
• Requiring all FCMs to file bimonthly Segregation Investment Detail Reports, which reflect how customer segregated funds and secured funds are invested and where they are held;
• Performing more periodic spot checks to monitor FCM compliance with segregation and secured requirements; and
• Requiring a principal to approve any disbursement of customer segregated and secured funds not made for the benefit of the customer and that exceed 25% of the firm’s excess segregated or secured funds.  The firm must also provide immediate notice to the SROs.

Given how serious the NFA has been treating the issue of customer segregated funds, it is possible that at least some form of these recommendations could be made into final rules over the next several months. 

On February 9, 2012, the CFTC issued a final rule regarding changes to Part 4 of the CFTC’s regulations involving registration and compliance obligations for commodity pool operators (“CPO”) and commodity trading advisors (“CTA”).  Among other things, the rule rescinds the exemption from registration provided in Rule 4.13(a)(4) and sets forth additional annual reporting requirements for CPOs and CTAs.

Section 4.13(a)(4) exempted operators of private funds offered solely to sophisticated investors from registering as a CPO.  To qualify, the interests in the pool must have been exempt from registration under the Securities Act of 1933 and each participant must be a qualified eligible person or an accredited investor.  Now that the exemption has been rescinded, any private fund operating under the Rule 4.13(a)(4) exemption must register with the CFTC prior to December 31, 2012.

The CFTC also adopted Rule 4.27, which requires CPOs and CTAs to periodically report certain information.  CPOs and CTAs must annually file Form CPO-PQR and Form CTA-PR, respectively.  These forms are analogous to Form PF adopted by the SEC for reporting by registered investment advisors. 

Depending on the aggregate asset value of the CPO, CPOs must complete Schedules A, B and/or C of Form CPO-PQR.  A CPO with over $5 billion in assets as of June 30, 2012 must complete Schedules A, B, and C by November 29, 2012.  A CPO with over $1.5 billion in assets must complete Schedules A, B and C within 60 days after the first calendar quarter ending after December 14, 2012.  A CPO with between $150 million and $1.5 billion in aggregate assets must complete Schedules A and B within 90 days after December 31, 2012.  Finally, a CPO with under $150 million in assets must complete Schedule A within 90 days after December 31, 2012.

The reporting requirements become effective on July 2, 2012 and will apply to all registered CPOs.  Registered CTAs must file Form CTA-PR annually, within 45 days after a CTA’s fiscal year.  The first compliance date is February 14, 2013.

Although the use of social media has been embraced by many industries, it is of particular concern for investment advisors and broker-dealers.

In many situations, the use of these outlets touch upon several areas.  For investment advisors and broker-dealers, the advertising requirements under the Investment Advisors Act of 1940 and certain Securities Exchange Act of 1934 provisions may be implicated when one uses social media, including various features on Linked In or Facebook.  Additionally, recordkeeping is a critical function required by both acts since this information must be maintained.  Further, it is likely that those who work for either and use social media sites, may require supervision.  Additionally, when one uses these types of communications, there are various regulations that require the firms to monitor these third party communications to ensure that, among other things, non-public information is not disclosed.  Firms would also be required to apply their audit function to these media policies and procedures internally, to determine if the procedures are effective.  Moreover, the SEC, FINRA and the states may begin to regulate these types of social media in amore forceful manner. 

As such, although social media venues may present certain benefits, the risk is palpable.

The Dodd-Frank Act required that security based swap dealers or major security based swap participants to register with the SEC.  These swap based entities are required to register with the SEC while all others are under the jurisdiction of the CFTC. 

The SEC proposed rules requiring these entities to register electronically with the SEC on a Form SBSE, similar to the Form BD for broker-dealer registration.  CFTC swap entities register using the shorter Form SBSE-A.  Additionally, the SEC will require that these forms be updated promptly if there are any inaccuracies.  There will also be something new according to one SEC Commissioner.  The rules may require a knowledgeable senior officer to provide a certification as to the firm’s financial, operational and compliance capabilities.  This person will also have to disclose how the firm arrived at those conclusions.  Further, non-U.S. swap entities will have to identify a U.S. Agent, and submit an opinion of counsel that the SEC will be able to access its books and records, as well as a requirement to submit to an on-site inspection. 

The swap dealer registration proposal will be open for a 60 day comment period, and all are encouraged to consider commenting.

Thought you might be interested in a recent podcast I did concerning my securities law practice.  http://web.me.com/cordpar/Client_Development_Tips/Law_Consulting_Coaching_Podcast/Entries/2011/10/28_Developing_a_Securities%2C_White_Collar_and_Complex_Litigation_Practice.html

The CFTC announced earlier today that it will not complete the rule-writing process for the derivatives market until the first quarter of 2012.  Chairman Gensler stated that the CFTC is “focused on considering these rules thoughtfully – not against a clock.”  Under the Dodd-Frank Act, Congress directed the CFTC to regulate the over-the-counter derivatives market, which had been largely unregulated.  The Act required the CFTC to complete more than 60 rules by July 2011, but the rulemaking process has been delayed and only 12 rules have been completed.

The CFTC outlined the rules it will consider in the remainder of this year, which include data recordkeeping and reporting rules, external and internal business conduct (duties, recordkeeping and chief compliance officers), entity definitions and registrations and real-time reporting rules.

The most contentious and anticipated rules will be finalized in the first quarter of 2012.  They include the capital and margin requirements for derivative trading and rules governing the operation of swap-execution facilities, where the trading will take place.  Other rules that will be considered in the first quarter of 2012 include governance, conflict of interest and conforming rules.

Although the rulemaking process has been delayed, leaving areas of the financial markets unregulated, the CFTC will not require companies to comply with the derivative rules until all rules are finalized.  Even if the proposed rules are finalized on time, they will not take effect until the third quarter of 2012, at the earliest.