While most of the attention in the futures industry has been focused upon the new swaps regulatory framework, the Commodity Futures Trading Commission (“CFTC”) and the National Futures Association (“NFA”) have adopted several new rules governing a variety of other activities. This article discusses some of these new rules, as well as current and upcoming changes related to NFA audits of Member firms.
CFTC Adopts Transaction Recordkeeping Rules
The CFTC has adopted new recordkeeping rules for registered firms regarding: (1) oral communications that lead to the execution of transactions in commodity interests and (2) written communications that lead to the execution of transactions in commodity interests or related cash or forward transactions. These rules apply to different categories of market participants, depending on the type of communication and transaction. The final rules became effective on February 19, 2013, however, affected registrants have until December 21, 2013, to comply with the oral communication recordkeeping rules. In situations involving technological or economic impracticability, the CFTC will allow market participants to seek an alternative compliance schedule for the oral communication recordkeeping requirement.
Oral Communication Recordkeeping
The new oral communication recordkeeping rules apply to various market participants, including introducing brokers (“IBs”) with aggregate gross revenues exceeding $5 million during the preceding three years, futures commission merchants (“FCMs”), retail foreign exchange dealers (“RFEDs”), and certain derivatives clearing members (“DCMs”) or swaps execution facilities (“SEF”) members required to be registered with the CFTC. The rules require that oral communications, including telephone, voicemail, mobile device or other digital or electronic communications that lead to the execution of a transaction in commodity interests be recorded and maintained. Registrants will also be required to comply with applicable state law recording requirements.
Written Communication Recordkeeping
The new written communication recordkeeping rules apply to IBs, FCMs, RFEDs, and DCM or SEF members. The rules require maintaining records of written communications, including facsimile, instant messaging, chat rooms, e-mail, mobile device or other digital or electronic media, concerning all transactions related to the registrant’s business of dealing in commodity interests or related cash or forward transactions.
Storage of Records
The new rules require that all records, oral and written, be maintained in a form and manner identifiable and searchable by transaction. All oral communications must be retained for one year. All written communications must be retained in their original form (for paper records) or native file format (for electronic records) for five years, and in a readily accessible format for the first two years.
Next Step
Affected market participants should review and amend, if applicable, their compliance manuals or procedures, and take necessary steps to properly advise employees regarding new recordkeeping rules, which are available here.
FCM Supervisory Responsibilities Relating to GIB Promotional Material
NFA rules have long imposed a direct duty on guarantor FCMs to supervise the activities of their guaranteed introducing brokers (“GIBs”), and guarantor FCMs are often held jointly and severally subject to discipline by NFA for violations of NFA rules committed by the FCM's GIBs. For instance, NFA’s Business Conduct Committee can charge a guarantor FCM with the failure to diligently supervise a GIB, including the failure to diligently review its GIB’s promotional materials.
In NFA’s March 2013 Notice to Members, NFA now requires that all submissions of promotional materials by GIBs to NFA’s free Pre-Review Program (“Review Program”) be first reviewed by the supervisory personnel of the GIB’s guarantor FCM. All GIB promotional materials submitted to the Review Program must also be accompanied by an attestation, signed by the appropriate supervisory personnel at the GIB’s guarantor FCM, that the materials have been reviewed and approved in accordance with the requirements of NFA Compliance Rule 2-29 (“Rule 2-29”).
NFA typically performs its review process within 14 days of receipt of the submitted promotional materials. During the review process, NFA will not seek, however, to verify the accuracy of the contents of the promotional material. Submission to the Review Program, as a result, does not grant a safe harbor for any misstatements or omissions that are later discovered.
NFA’s March 2013 Notice to Members is available here.
NFA Adopts New Audit Procedures
On January 31, 2013, NFA announced that it would adopt the twenty-one audit recommendations made by the Berkley Research Group, LLC (“BRG”). These recommendations were based in significant part upon its study of the audit practices and procedures used by NFA’s audit staff in reviewing the operations of Peregrine Financial Group, Inc. (“PFG”). NFA intends to develop a plan to act on the recommendations and appoint a special committee to oversee the implementation process.
Key items from the list of twenty-one recommendations are:
- Revise training to address issues related to reliance on representations of management, and how to handle domineering or other difficult behavior;
- Ensure supervisory personnel spend sufficient on-site time during an audit;
- Employ auditors with diverse backgrounds to increase skill-sets;
- Allow outside auditors to work with NFA audit staff;
- Monitor auditing literature and adopt appropriate aspects into its modules;
- Review past regulatory problems not detected and modify modules accordingly;
- Enhance access by NFA to and scrutiny of outside auditing firms;
- Communicate with outside auditing firms regarding the Member being audited and review the outside auditor’s work-papers concerning the Member;
- Obtain additional information regarding the sources of capital contributions by senior officials;
- Examine a Member’s regulatory and civil actions as part of the audit process;
- Better identify risk factors associated with cash transfers of segregated funds;
- Increase the flow of information with the CFTC and Securities and Exchange Commission (“SEC”) regarding audits/reviews; and
- Obtain and compare the daily segregation balances from the depositories.
NFA has already taken steps to address some of BRG’s recommendations, such as: (1) expanding its use of Certified Fraud Examiner training; (2) recruiting more experienced supervisors; (3) directing supervisory personnel to spend increased time at on-site audit locations; and (4) creating a process to receive and compare daily bank confirmations concerning customer funds with FCM daily reports. Material discrepancies in customer balances will now generate an immediate alert to NFA.
BRG’s Recommendations Report is available here.
About the Authors Nicole M. Kuchera and Christopher H. Mendoza
Nicole M. Kuchera and Christopher H. Mendoza are associates in the Financial Services Practice Group at Henderson & Lyman. Nicole and Chris counsel futures industry clients in connection with a variety of formation, regulatory and compliance matters. Nicole received her law degree and master of laws degree from Chicago-Kent College of Law, and her undergraduate degree from DePaul University. Chris received his law degree from Cornell Law School, and his undergraduate degree from Chapman University.
About Henderson & Lyman
Henderson & Lyman’s attorneys have represented registrants and participants in the financial services industry since the firm's inception. Its clients range from publicly-traded companies to individual traders, Broker-Dealers, Futures Commission Merchants, Forex Dealer Members, Introducing Brokers, Commodity Pool Operators, Commodity Trading Advisors, Investment Advisers, and proprietary trading groups. The firm has a sophisticated managed funds practice, involved in the formation and representation of public funds, hedge funds, private equity funds, offshore funds, and their respective managers. Visit the firm’s website at www.henderson-lyman.com/.
