Archives: CFTC Compliance

This week, the CFTC approved a NFA Interpretative Notice that prohibits a Member from accepting credit card payments from customers to fund retail forex accounts.  The NFA recently reviewed how customers fund their retail forex accounts and found that customers overwhelmingly funded their trading accounts using a credit card.  The NFA noted that credit cards permit easy access to borrowed funds and the highly volatile nature of the forex and futures markets create a significant risk of substantial loss in a short period of time.  The NFA cautioned that it is not prohibiting other forms of electronic funding so long as the funds come directly from a customer’s bank account.  Members will be permitted to accept debit card transactions assuming that Members are able to distinguish between a debit card and a credit card transaction.  Member firms must comply with the interpretative notice by January 31, 2015.

For some Members, the new guidance will cause a substantial change in the way they accept customer funds and will add to the long list of regulatory compliance requirements.  Members that want to allow customers to fund their accounts using debit cards will likely have to retain a third party vendor to help in differentiating between debit card and credit card transactions.  Also, Members will have to ensure that they do not accept funds from electronic payment facilitators (i.e. Paypal) that commonly draw funds from a customer’s credit cards.  Certain customers may also ask why the NFA is no longer allowing them to get frequent flyer miles before they start forex and futures trading.

Suspicious Activity Reports (SARs) have been a useful tool for financial institutions to report financial fraud while, at the same time, prohibiting the reporting institution from disclosing the existence of a SARs in response to a third-party request.  In 2010, the Financial Crimes Enforcement Network (FinCEN), amended this regulation to extend the prohibition against disclosure to futures commission merchants (FCMs) and introducing brokers (IBs).  The amendments permitted FCMs and IBs to make a SAR and related information available to any SRO that examines the FCM or IB. 

The CFTC has recently tweaked the playing field.  FCMs and IBs that are subject to examination by the National Futures Association are now requested to make all SARs, information revealing the existence of a SAR, and supporting documentation available to the NFA upon request.robber.jpg 

Just as important, the CFTC cautioned the NFA and its officers, directors employees and agents that they are prohibited from revealing the existence of a SAR, except as required to fulfill its self-regulatory duties upon the request of the CFTC.  If the NFA wants to disclose the existence of a SAR or related information to a third party, it must first seek the authorization of the CFTC. 

If you are an FCM or IB and you make a SAR, you are still obligated to keep the existence of the SAR a secret.  When faced with a request for a SAR (or even the existence of one) make sure you know who is requesting it.  Always look before you leap when it comes to protecting the secrecy of a SAR.

* Photo from freedigitalphotos.com

In the wake of several high profile failures of futures market participants, the NFA and others recently completed a study of how customer asset protection insurance (“CAPI”) would work in the futures industry.  The CAPI program would provide additional customer asset protection and limit the risk of loss to customers.  The study found that insurers were not in favor of individual futures customers or FCMs on behalf of their customers purchasing CAPI directly from primary insurance carriers because neither the individual customers nor the FCMs would retain any “first-loss retention”.  Insurers require their beneficiaries to have some “first-loss retention” so they retain some material exposure to first losses to mitigate “moral hazard” – the risk that insurance coverage reduces the incentives of the insured party to manage risk.

As a result, the study focused on an alternative scenario where several FCMs jointly form an FCM Captive insurance company that would provide CAPI to customers of its FCM participants.  The FCM Captive would retain first-loss retention, meaning the claims would be paid by the non-failing FCMs, and reinsurance would cover claims in excess of the first-loss retention.  The insurance industry supported the FCM Captive with reinsurance scenario.  The study also analyzed government-mandated universal insurance, similar to SIPC.  The study concluded that customers of small and medium sized FCMs would disproportionally benefit from government-mandated coverage.

Although insurance protection for FCM customers is probably a long way off, it is certainly possible that some form of additional protection for customers is on the horizon.

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.

Its not often I write about criminal cases but this is one that all executives in the commodities industry need to know about.  In Brooks v. United States, 681 F.3d 678 (5th Cir. 2012), the Court affirmed the convictions of three executives in the natural gas industry for falsely reporting natural gas trades in violation of the Commodity Exchange Act.  The government claimed that the energy executives reported false data to two privately owned industry publications in a manner that would benefit their corporate financial positions.  According to the Court, market index prices for physical gas (meaning the gas is sold by physically delivering it to a particular location) are prominently published in two privately owned newsletters.  Both publications are highly influential to the market price for physical gas.

The CEA provides that it is unlawful for any person who knowingly delivers inaccurate reports concerning market information or conditions that affect or tend to affect the price of any commodity.  The issue in front of the Court was whether the reports to the publications were “reports” pursuant to the CEA.  The defendants argued that the term “reports” in the CEA refers only to formal reports under the statute that are submitted to regulators or customers.  In a matter of first impression, the Court held that the defendants’ communications to the industry publications constituted “reports” under the CEA.  The United States Supreme Court declined to review the Court’s ruling last month.

Energy executives should take note of the case and its potential impact.  As a result of the Court’s ruling, any false or fraudulent statements made to third parties could result in a potential criminal liability to the individual executives, and civil liability for the corporate entity.

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. 

By October 1, 2012, FCMs that are regulated by a U.S. prudential regulator or are also registrants of the SEC must have a designated Chief Compliance Officer under CFTC Regulation 3.3.  The CCO must be listed as a principal of the firm and the CCO will be required to file annual report containing the following information:

  • a description of the written policies and procedures, including the code of ethics and conflict of interest policies;
  • an assessment of the policies and procedures that are designed to ensure compliance with statutory and regulatory requirements and a discussion of the potential areas for improvement;
  • a listing of any material changes to the compliance policies and procedures;
  • a description of the financial, managerial, operational and staffing resources set aside for compliance; and
  • a description of any material non-compliance issues and any corresponding actions taken.

The report must be submitted to the CFTC through the Winjammer system within 90 days of the end of the FCM’s fiscal year.  The first report should be filed for the period from October 1, 2012 through the date of the FCM’s fiscal year end. 

All other FCMs – those not regulated by a U.S. prudential regulator and not registered with the SEC – must comply with the CCO requirements by March 29, 2013.  IB, CPO and CTA members are not required to have a CCO.

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

The Board of Governors of the Federal Reserve, the SEC and the CFTC jointly confirmed recently that entities subject to the Volcker Rule would the have the full two year period provided by Section 619 of the Dodd-Frank Act to fully conform its activities and investments, unless the Board extends the conformance period.  Banking entities now have until July 21, 2014 to fully conform their activities and investments to the Volcker Rule. 

The Volcker Rule has caused significant debate among politicians, regulators and Wall Street, making it possible, if not probable, that the conformance period may be extended in the future.  However, some regulators have stated that they expect a final Volcker Rule to be completed by September and possibly earlier.  

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.