The Commodity Futures Trading Commission (CFTC) has proposed rule 1.71 that establishes conflicts of interest requirements for futures commission merchants (FCMs) and introducing brokers (IBs). The proposed rule is meant to deter non-research employees such as sales and trading personnel from influencing the content of research reports prepared by research analysts employed at the same company or an affiliate.
The CFTC had a comment period which closed January 18th. There is no timeline for when a final rule may be published.
The proposed rule was brought on by Title VII of the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank Act), which directs FCMs and IBs to implement informational partitions between those researching or analyzing prices or markets for commodities and those involved in trading or clearing activities. Specifically, the rule in pertinent part requires:
- Persons researching or analyzing the price or market for any commodity are separated by “appropriate informational partitions” within the firm from review, pressure, or oversight of persons whose involvement in trading or clearing activities might potentially bias the judgment or supervision of the persons;
- That analyst compensation cannot factor in trading volume and cannot be set by the sales and trading group;
- Disclosure of financial interest in a commodity (e.g., a disclaimer that a commodity covered in an analyst recommendation is held in such party’s own portfolio);
- That personnel make a record of public appearances; and
- That written research does not omit any material fact.
The CFTC’s proposed rules are modeled after similar rules adopted in the securities industry that came about after the downturn in the prices of technology stocks in 2000 which highlighted the conflicts of interest of research analysts employed by brokerage firms that also engage in investment banking.
Received Comment Letters
The majority of the comment letters received on the proposed rule questioned both the necessity and practicality of the rule. Many comment letters to the proposed rule have rightfully noted that comparing this realm of the securities industry to the commodity futures industry is like comparing apples and oranges. The securities industry rules were drafted in response to a series of enforcement actions – most notably, the Stet New York State Attorney General Stet investigation into Merrill Lynch and its payments to analyst Henry Blodget that were tied to investment banking business generated by his analyst recommendations. These investigations ultimately led to Spitzer’s obtaining a court order requiring Merrill Lynch to take steps to reform its investment counseling activities. In contrast, the CFTC has cited no enforcement actions or areas of concern regarding FCM and IB research practices, leaving a question as to why regulations have been proposed for a non-existing issue.
A silver lining in the proposal is that the CFTC has queried and the National Futures Association has supported the idea of a small firm exemption from the rule. Therefore, an FCM or IB whose business generates an amount of trading volume that would not have a material impact on the market will likely be carved out from any final rule.
About the Author
Mark Ruddy is the founder of the Ruddy Law Office, PLLC, a Washington, DC based law firm that services all types of commodity futures registrants. Mark’s complete bio and further information about his firm may be found on their web site, www.ruddylaw.com.
