A proposed CFTC Rule focusing on preventing conflicts of interest between researchers and traders, and a proposed amendment to another Rule designed to enhance record-keeping and recording requirements, were two of the key topics discussed at the NIBA Sales and Marketing Conference on September 12. The Dodd-Frank Wall Street Reform and Consumer Protection Act mandates the implementation of these Rules, in some form, despite a perceived absence of any problem needing remediation and despite the clear increase in costs that compliance would entail. Feedback from member IBs in attendance confirmed that, if the final versions of the Rules resemble the CFTC’s initial proposals, compliance will require them to materially change their current operations. A brief recap of the Panel discussion on these two topics follows for the benefit of those IBs not in attendance.
In effect, proposed Rule 1.71 would require each IB to implement a Chinese wall to ensure that its research personnel are not influenced by traders or other non-research personnel when issuing reports. The goal is to impose preventive, rather than punitive, measures to ensure that researchers report their research objectively even when the report may conflict with the IB’s financial interests. Under the proposed Rule, no research analyst may be supervised or controlled by non-research personnel, and communications relating to research reports would need to be conducted via the legal and compliance department. Research reports would be required to include a disclosure of any financial interest maintained by the analyst in the derivatives discussed in the report. Other key elements include: a “no material omissions” policy, under which research reports must include all information necessary not to be misleading; a “no retaliation” policy, under which no IB may retaliate against any research analyst based on a report issued in good faith; and a “no coercion” policy, under which no IB may offer favorable research, or threaten less favorable research, in exchange for business or compensation.
There were a number of criticisms of Rule 1.71 commonly seen in industry comment letters. For instance, it is industry practice for traders and analysts to collaborate on research reports such as daily market updates. Particularly in smaller IBs, one person often wears several hats including that of trader, analyst and report author, and to separate them would substantially increase costs. Further, there are already rules that exist to address inappropriate conduct in connection with research reports. For example, NFA Compliance Rule 2-29(a) prohibits public communications that operate as a fraud or deceit, or employ high pressure tactics. Applying a cost-benefit analysis, several comment letters implied that the Rule is not warranted. Some criticized the proposed rule as being fundamentally flawed in that it incorrectly presumes that there is a problem with traders collaborating with analysts to generate research reports.
CFTC Rule 1.35(a) currently requires each IB to retain complete records of its commodities business, including all records of filled, unfilled and canceled orders. Proposed revisions to this rule would impose an obligation on each IB to create additional records by recording all communications leading to the execution of transactions in a commodity interest or cash commodity, and to categorize these communications by counterparty and transaction so that they are readily accessible. The forms of communication covered by the proposed amendment include mobile telephone calls, texts, chat room posts and “other digital or electronic media.”
Criticisms of the proposed revisions point to the costs and burdens associated with acquiring, implementing and maintaining new information technology to effect compliance. The amendment seems to encompass technologies not yet developed, which could put IBs in the difficult position of playing catch-up as digital media continues to evolve. Moreover, guidance may be needed as to how to “classify” communications that may cover multiple topics. As with Rule 1.71, the comments emphasized that no obstacles or issues appear to have been identified with current practices that would necessitate the proposed revisions.
The Commission is considering the concerns voiced by industry participants, and we may see some revisions to the final rules designed to alleviate some of the burdens. Examples may include an exemption from compliance with Rule 1.71 for small IBs that should not be considered to pose systemic risk, or a grace period for compliance with Rule 1.35(a) while IBs determine the technologies necessarily for compliance. However, since the Commission must operate under the mandates of Dodd-Frank, IBs should be prepared to see versions of these rules become effective in due course.
About the Author
Jeffrey E. Kopiwoda is a member of the law firm of Funkhouser Vegosen Liebman & Dunn Ltd., and his practice areas include the futures industry. This article is merely informational and does not constitute legal advice. Mr. Kopiwoda welcomes questions or comments and may be reached directly at +1.312.701.6820 JKopiwoda@fvldlaw.com.
