CFTC Staff Issues Advisory on Annual Reports by Chief Compliance Officers of Swap Dealers, Major Swap Participants and Futures Commission Merchants
SUMMARY On December 22, 2014, the Division of Swap Dealer and Intermediary Oversight (the “Division”) of the Commodity Futures Trading Commission (the “CFTC”) released CTFC Staff Advisory 14-153 (the “Advisory”) to provide guidance to chief compliance officers (“CCOs”) of all provisionally registered swap dealers (“SDs”) and major swap participants (“MSPs”) and all registered futures commission merchants (“FCMs”) relating to annual reports required under Section 3.3(e) of the CFTC’s regulations (the “CFTC Regulations”) under the Commodity Exchange Act, as amended (the “CEA”). On the same day, the Division also released a no-action letter (CFTC Letter No. 14-154) providing relief from compliance with the timing requirements of the annual reports by the CCOs. I. BACKGROUND The Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (the “Dodd-Frank Act”) amended the CEA by, among other things, adding provisions relating to the regulation of swap transactions generally and SDs, MSPs, and FCMs, in connection with such transactions, in particular. Section 731 of the Dodd-Frank Act added Section 4s(k) to the CEA, which requires SDs and MSPs to designate a CCO to perform duties and responsibilities enumerated therein. Similarly, Section 732 of the Dodd-Frank Act added Section 4d(d) to the CEA requiring that each FCM designate a CCO and that the CFTC promulgate specific rules concerning the duties of a CCO of an FCM. -2- CFTC Staff Guidance on Chief Compliance Officer Annual Reports January 12, 2015 On February 23, 2012, the CFTC adopted final rules (“Final Rules”), which, among other things, set forth the requirements for appointing a CCO and the duties of an appointed CCO.1 In particular, CFTC Regulation 3.3(d)(6) requires CCOs of SDs, MSPs and FCMs to prepare, certify and provide to the board of directors (“Board”) or senior officer, and furnish to the CFTC, an annual compliance report (“Annual Report”) that covers the most recently completed fiscal year. This Annual Report must, at a minimum, contain: A description of the written policies and procedures (“WPP”), including the code of ethics and conflicts of interest policies, of the registrant; A review of requirements under the CEA and CFTC Regulations (“Regulatory Requirements”) applicable to the registrant, the identification and assessment of the WPPs reasonably designed to ensure compliance with each applicable Regulatory Requirement and discussion of potential areas for improvement; A discussion of any material changes to the compliance program of the registrant; A description of resources set aside for compliance with the CEA and CFTC Regulations, including any material deficiency in such resources; and A description of any material non-compliance issues identified and the corresponding remediating actions. Pursuant to CFTC Regulation 3.3(f), the CCO or the Chief Executive Officer (“CEO”) must certify under penalty of law that to the best of his or her knowledge and reasonable belief, the Annual Report is accurate and complete. The Division has received the first set of CCO Annual Reports from registrants. Due to the absence of established practices, various registrants and industry groups have requested guidance concerning the content and format of the Annual Reports. In response, on December 22, 2014, the Division issued the Advisory, which is intended to provide non-exhaustive guidance and recommendations for best practices with respect to CCO Annual Reports to CCOs of all provisionally registered SDs and MSPs and all registered FCMs (referred to herein as registrants). Notwithstanding the highly prescriptive nature of the Advisory, the stated purpose of the Advisory is to “provide market participants guidance and recommendations for best practices” with regard to the Annual Report and the Division noted that the Advisory should not be interpreted as establishing new regulatory requirements. Furthermore, the Advisory noted that CCOs may face issues in preparing the Annual Report that are not addressed in the Advisory and some of the recommendations and practices described in the Advisory do not need to be used if a CCO does not believe that they will improve the Annual Report. Finally, given that the Division issued the Advisory near the end of the calendar year, which corresponds to the fiscal year-end of many registrants, the Division does not expect registrants to fully incorporate all of the recommendations into their 2014 Annual Reports. Nonetheless, the Division stated that it expects registrants “to make efforts to incorporate” the recommendations in the Advisory in -3- CFTC Staff Guidance on Chief Compliance Officer Annual Reports January 12, 2015 their current Annual Reports and that it believes that the Advisory should be considered to improve registrants’ compliance efforts and the quality of Annual Reports going forward. II. CFTC STAFF ADVISORY ON CHIEF COMPLIANCE OFFICER ANNUAL REPORTS In the Advisory, the Division set forth three distinct policy objectives of the CCO Annual Reports, all of which it recommended that registrants keep in mind when providing the Annual Reports to the Board (or senior officer) or furnishing them to the CFTC. The objectives are: To enhance compliance through periodic self-evaluation by registrants in order to increase industry-wide compliance, market security and stability; To notify the CFTC of any weaknesses in compliance; and To assist in the CFTC’s determination of whether registrants remain in compliance with the CEA and CFTC Regulations. The Division emphasized that the Annual Reports are a useful means to communicate to the Board and the CFTC the performance of the compliance programs over the past year, the progress of the programs at the time of the Annual Report and various issues the registrant faces in complying with the CEA and CFTC Regulations. In order for registrants to comply fully with CFTC Regulation 3.3(e), the Division provided subsection-bysubsection recommendations on the content and format of CCO Annual Reports. However, the Advisory does not provide a standard form of Annual Report, as had been requested by certain market participants. A. CFTC REGULATION 3.3(E)(1) CFTC Regulation 3.3(e)(1) requires the CCO to provide a description of the WPPs of the registrant, including the code of ethics and conflict of interest policies. The Advisory stated that, given the large number of WPPs a registrant must implement to comply with the regulations, it would be acceptable to provide an appropriately brief description of each WPP that identifies its purpose and describes how it operates to achieve its purpose. The Division recommended that this be done on two levels: the first-level narrative should provide an overview of the forms and types of WPPs with an emphasis on how the system of WPP works as a whole and how the registrant puts the WPPs into practice; and the second-level narrative should provide a description of each WPP, including the specific purposes and procedures of each WPP. The Advisory explained that the provision of only a summary of the registrant’s WPPs would be considered insufficient. However, the Advisory did not expressly limit the set of WPPs to be described to those that are specific to the registrant, such as the registrant’s compliance manual, but recommended -4- CFTC Staff Guidance on Chief Compliance Officer Annual Reports January 12, 2015 the inclusion of relevant WPPs that apply to the global corporate entity and/or specific business-units that provide support for the applicable Regulatory Requirements. Moreover, the Division clarified that the CCO should describe the conflict of interest policy specific to the registrant and address specific requirements of Regulation 1.71 and Regulation 23.605 of the CEA. The description should relate to the registrant’s futures and swap-dealing activities as required by Regulation 1.71 and Regulation 23.605 as well as any enterprise-wide conflict of interest policy that covers employees of the registrant. B. CFTC REGULATION 3.3(E)(2) CFTC Regulation 3.3(e)(2) requires the CCO to review the applicable Regulatory Requirements under the CEA and CFTC Regulations, identify the WPPs designed to ensure compliance with each Regulatory Requirement, provide an assessment of the effectiveness of the WPPs, and discuss areas of the compliance program where improvement or changes may be necessary. The Advisory explained that, by requiring each registrant to review all applicable Regulatory Requirements under the CEA and CFTC Regulations, the registrant would be aware of all relevant Regulatory Requirements. In preparing this section of the Annual Report, the Advisory explained that a registrant is permitted to group certain Regulatory Requirements together if the Regulatory Requirements are sufficiently related. In identifying the WPPs designed to comply with each relevant Regulatory Requirement, the Advisory explained that the Annual Report should include information that would be helpful in understanding the registrant’s processes for identifying and reviewing the various WPPs. For example, the Advisory explained that it may be useful to include a description of any mandatory review periods for, and the persons responsible for reviewing, the relevant WPPs. In evaluating the effectiveness of WPPs, the Division emphasized that, in addition to a description of the general process used in the assessment, the Annual Report should identify the specific assessment methods and conclusions with respect to each applicable Regulatory Requirement. Moreover, the conclusions with regard to evaluating the effectiveness of the WPPs for each Regulatory Requirement should be more nuanced than a binary yes-or-no conclusion and the Annual Report should explain the reason why any WPP was determined to be ineffective and the steps to be taken to address its ineffectiveness. In addition, the Advisory also explained that each registrant’s Annual Report should provide a description of the procedures used to collect the relevant information and make the abovedescribed assessments. This section of the Annual Report should also identify and discuss areas for improvement and recommend any relevant changes to WPPs. The Division recommended that this analysis include three components:-5- CFTC Staff Guidance on Chief Compliance Officer Annual Reports January 12, 2015 A description in sufficient detail of the reasons why the CCO believes a specific compliance area requires improvement; A discussion of appropriate improvement recommendations and the time frame for implementation of each improvement; and A cross-reference to particular regulations that the improvement recommendation is designed to address. The Division explained that if the Annual Report does not provide recommendations for changes or improvements to the compliance program, the Division staff will likely question “the robustness of the CCO’s active review of the compliance program.”2 In addition, the Advisory noted that there should be continuity between a registrant’s Annual Report from year to year, with a discussion of the implementation and outcome of improvement recommendations made in previous Annual Reports. C. CFTC REGULATION 3.3(E)(3) CFTC Regulation 3.3(e)(3) requires the Annual Report to list any material changes made to the compliance policies and procedures during the fiscal year and provide a substantive discussion of the material changes. Because the rule requires that only material changes be reported, it is recommended that the Annual Report include a description of the standard of materiality used. However, the Advisory does not provide any guidance as to what constitutes a “material” change. D. CFTC REGULATION 3.3(E)(4) CFTC Regulation 3.3(e)(4) requires the Annual Report to describe the financial, managerial, operational, and staffing resources the registrant has set aside for the purpose of complying with the CEA and the CFTC Regulations, highlighting any material deficiency in such resources. The Advisory explained that this section should include qualitative and quantitative descriptions of: the budget allocated to the compliance department for the purpose of complying with the CEA and CFTC Regulations; fully and partially allocated staff counts with information on the time devoted by staff to compliance with CFTC Regulations; management resources devoted to compliance, including the division between staffing and management resources; and infrastructures devoted to compliance. The Division also recommended that the Annual Report describe the experience and education of the CCO or CEO to better assess their qualification in making assessments regarding compliance. To the extent that some compliance resources of the registrant are shared with other parts of a larger corporate enterprise, the Advisory stated that the CCO should not only provide information on resources devoted solely to compliance of the registrant but also describe partially allocated resources in as much detail as necessary to explain how the registrant’s compliance efforts are being resourced.3 -6- CFTC Staff Guidance on Chief Compliance Officer Annual Reports January 12, 2015 Finally, the CCO is required to assess whether the resources are deficient and, if the CCO determines that there are no material deficiencies in resources allocated for compliance, the Advisory indicates that the Annual Report should include a statement to that effect. If there is a decrease in resources allocated for compliance, if relevant, the CCO must explain why the resources are not deficient in light of the changes made. E. CFTC REGULATION 3.3(E)(5) CFTC Regulation 3.3(e)(5) requires that the CCO describe any material non-compliance issues identified and corresponding actions taken. The Advisory states that the Annual Report should include a discussion with respect to each non-compliance issue and the corresponding action taken. As with the provision on reporting material changes, the Annual Report should discuss how material non-compliance issues are identified and the standard of materiality used for purposes of this assessment. Again, the Advisory does not provide any guidance on determining what constitutes a “material” non-compliance issue. The discussion of each non-compliance issue and corresponding corrective actions should be in sufficient detail and should specifically reference relevant provisions of the CEA or CFTC Regulations implicated. This section should also contain a discussion of the registrant’s decision process for: determining remedial actions; the implementation of such remedial actions; and the testing for the effectiveness of such remedial actions. F. USE OF CHARTS The Division acknowledged that for certain information to be provided in the Annual Report, a chart may be an appropriate mechanism to convey the information in an efficient and digestible manner. However, the Division makes it clear that a summary chart is not a substitute for a complete and substantive discussion of the material issues to be addressed in the Annual Report. The Advisory noted three examples of places where a chart may be an effective mechanism: First, a chart may be used to identify each applicable Regulatory Requirement and describe the related WPP with respect to each Regulatory Requirement; Second, a chart may be used to convey the effectiveness of each WPP – although the Advisory noted that it would be helpful if the Annual Report also included the methods used to assess the effectiveness of WPPs; and Third, if there is a large number of material changes to the compliance program in a particular year, a chart could be used to demonstrate the changes. In the case of the second and third examples above, the Advisory explicitly noted that the chart should be accompanied by a substantive discussion covering the Annual Report requirements described in the CFTC Regulation 3.3 and the Advisory. The Advisory also included an example of the format of a chart -7- CFTC Staff Guidance on Chief Compliance Officer Annual Reports January 12, 2015 which may be used to list and describe each applicable Regulatory Requirement and related WPP and assess the effectiveness of each listed WPP. III. NO-ACTION RELIEF In a separate no-action letter issued on December 22, 2014, the Division acknowledged that, because the Advisory was released near the end of the calendar year, which for some registrants, corresponds to their fiscal year-end, registrants may not have sufficient time to incorporate the contents of the Advisory to their Annual Reports in time for the filing deadline (which is 60 days after the end of the fiscal year of a registrant pursuant to CFTC Regulation 3.3(f)(2)). To encourage registrants to incorporate the guidance in the Advisory, the Division stated that it would not recommend enforcement action against a registrant or CCO for failure to furnish an Annual Report within the 60 day time frame as long as the registrant furnishes its Annual Reports within 90 days after the fiscal year-end. In addition, provided that the registrant informs the CFTC within 90 days after the end of the fiscal year of any material non-compliance events that must be included in the Annual Report, the registrant is permitted to file the Annual Report within 120 days after its fiscal year-end. This no-action relief is limited to Annual Reports required to be filed with the CFTC for fiscal year ending on or before January 31, 2015.