CFTC Adopts Rule Requiring Registrants to Join NFA
The CFTC has adopted a final rule which will require virtually all IBs, CTAs and CPOs to become members of a registered futures association. The NFA is the only registered futures association. Prior to the adoption of the new rule - CFTC Rule 170.17, existing CFTC rules only required FCMs, SDs and MSPs to be members of a registered futures association. At the same time, NFA Bylaw 1101 ensured that most IBs, CTAs and CPOs in the futures industry were NFA members because NFA Bylaw 1101 prohibits NFA Members from transacting business in commodity futures contracts with any nonmember that is required to be registered with the CFTC. However, swap firm intermediaries, such as IBs, CTAs and CPOs required to register with the CFTC, but not doing business in the futures industry, were not required to join NFA until the adoption of CFTC Rule 170.17.
The only exception to CFTC Rule 170.17 is for registered CTAs that can rely upon the exemption provided in CFTC Rule 4.14(a)(9), which exempts from registration those CTAs who do not direct client accounts and do not provide personalized advice. Currently, there are approximately 700 registered IBs, CTAs and CPOs that are not members of NFA and presumably will be affected by the rule. CFTC Rule 170.17 will become effective on December 31, 2015.
NFA Adopts Cybersecurity Requirements for its Members
NFA recently adopted an Interpretive Notice addressing requirements for Information Systems Security Programs (“ISSPs”) in the context of NFA Rule 2-9 (Supervision), NFA Rule 2-36 (Forex Transactions), and NFA Rule 2-49 (SD and MSP Regulations). The Interpretive Notice requires all NFA members to (1) adopt a written ISSP reasonably designed to provide safeguards to protect against security threats and (2) create an incidence response plan. The written ISSP, at a minimum, must address security and risk analysis, deployment of protective measures against the identified threats and vulnerabilities, response and recovery from events that threaten the security of the member’s electronic systems, and employee training. NFA members should also plan on reviewing and updating their ISSPs as appropriate. In addition, member firms will need to assess risks posed by permitting third-party service providers access to their systems. Finally, all records related to an NFA member’s ISSP will be subject to NFA recordkeeping requirements.
NFA’s Interpretive Notice recognizes that each NFA member’s ISSP may vary depending on its size, sophistication and role in the financial services industry. However, regardless of whether the NFA member is a sole proprietor working out of his house or a thirty-person brokerage firm with multiple branch offices, every NFA member will need to consider and adopt an appropriate ISSP in line with the requirements of the Interpretive Notice. While the Interpretive Notice will not become effective until March 1, 2016, NFA members should review the Interpretive Notice in connection with their compliance manual and begin the process of implementing an appropriate ISSP that meets the requirements of the Interpretive Notice.
CFTC Approves Stricter Compliance Requirements for Retail Forex Dealer Members Requested by NFA
The CFTC has approved proposed amendments to NFA rules based on an NFA rule submission in an effort to enhance protection for retail forex customers. The proposed amendments are in response to losses suffered as a result of the unexpected move by the Swiss National Bank earlier this year when it abandoned its cap on the Swiss franc's exchange rate against the Euro earlier this year.
The amendments require forex dealer members (“FDMs”) to adopt a comprehensive risk management program similar to those required for FCMs and SDs and also require annual certification by the chief compliance officer. The risk management program would require, at a minimum, written procedures addressing market risk, credit risk, liquidity risk, foreign currency risk, legal risk, operational risk, counterparty risk and customer liabilities. The FDM would also be required to engage in routine review and testing, maintain sufficient supervisory procedures, and create a risk management unit.
The amendments also increase capital requirements for FDMs if they, or their offshore affiliates, act as counterparties to eligible contract participants (“ECPs”). This particular requirement stems from losses suffered by one U.S. FDM as a result of losses suffered by its UK affiliate. Amendments to the financial requirements also require the FDM to collect security deposits from ECP counterparties, and to not act as a counterparty to a dealer that does not collect security deposits from ECP counterparties. This last requirement would seem to prevent a U.S. FDM from acting as a counterparty to one of its offshore affiliates if the affiliate does not collect security deposits from ECPs. The amended NFA rules will become effective on January 4, 2016.
Recent NFA Enforcement Matters
The second half of this year saw an increase in the resolution of NFA enforcement matters. Since July 2015, NFA has obtained 16 decisions in Business Conduct Committee matters against a variety of registrants. Aside from individuals, most of the respondents were CTAs, CPOs or both CTA/CPOs. However, respondents also included four independent IBs, one guaranteed IB and one FCM. The most prevalent claims were violations of Rule 2-9 for failure to supervise, which was cited in at least 7 of the 16 cases followed by Rule 2-29 violations for misleading or deficient promotional material that was cited in at least 6 of the 16 cases. In one case involving a CPO/CTA, the registrant was fined $30,000 for repeatedly failing to file its quarterly reports, annual pool financial statements and CTA pool reports.
In two matters involving IBs, NFA alleged that the respondents recommended trades that were not in the best interests of the customers, but rather, were recommended to maximize commissions. Such conduct violates Rule 2-4, which requires NFA members to observe high standards of commercial honor and just and equitable principles of trade. It has been some time since these types of claims have been at issue in NFA enforcement matters, as they frequently arose in the past in the context of broker-assisted trading. Two matters, one involving an IB and one involving an FCM, also highlight the need to ensure any written compliance policies and procedures are not simply adopted, but also properly implemented. In both cases, the respondents had failed to properly implement their AML procedures resulting in a $15,000 fine in the case of the IB, and a $25,000 fine in the case of the FCM.
Penalties in NFA enforcement matters during this timeframe included at least 10 permanent bars as well as temporary bars ranging from 3 to 5 years. Fines ranged from $5,000 to $300,000 in the case of a CPO who misappropriated pool assets.