The National Futures Association (“NFA”) Rules and Commodity Futures Trading Commission (“CFTC”) regulations that govern the futures, forex, and swap trading industry are subject to continuous interpretation, amendment, and update. Staying abreast of these changes is a critical component of maintaining regulatory and operational compliance for your next examination. NFA regularly emails member firms to advise them of pertinent rule changes, amendments, and interpretive notices. These Notices to Members are archived on the NFA website and are an excellent resource for Introducing Brokers (“IB”) and Commodity Trading Advisors (“CTA”) to stay up to date with the most recent industrywide regulation and rule adjustments.
While NFA does it’s best to provide firm’s notice of changes, there are subtle nuances to the rules and expectations placed on regulated entities that may not necessarily be conveyed in these publications. Oftentimes, NFA Members are caught unawares or ill prepared in an NFA examination as a result of how NFA applies a rule even when the Member firm may be fully aware of its implementation. This is because NFA examinations not only encompass new rules and interpretations, but are continuously evolving in response to Member activities that examiners witness in the field. Subtle changes in the application of rules may occur that affect areas of focus, and nebulous expectations can morph into de facto requirements over time even if they aren’t published within the rules and regulations governing the industry.
Turnkey Trading Partners provides assistance and support to clients during their NFA examinations. During any given period of time we typically are involved in or have five to ten open audits with our customers. We also have former NFA staff working for us which provides us with both a long standing and recent expectation or understanding as to NFA’s current examination approach and expectations. Routine regulatory examinations of Introducing Brokers and CTA’s still primarily concentrate on record-keeping, written procedures, promotional material, and IB financials or CTA performance. However, we have observed a shift in attention during many recent NFA exams of our customers.
2016 NFA Audit Focus
NFA examiners have become incredibly thorough with Bylaw 1101 testing and there have been several actions taken against Member firms for doing business with non-Members within the last year. In particular, NFA has uncovered the payment of commissions or referral fees to unregistered individuals via outside branch office locations or even in some instances through a main office location. As NFA focuses on payments and bylaw 1101 they now also include additional questions and testing related to internal controls. This change was implemented in the wake of the PFG collapse in response to allegations that NFA should have done more to uncover how the fraud that brought the firm down was perpetuated. In Turnkey Trading Partner’s experience we have found that mid-size and small firms don’t typically have written internal control procedures or know how to respond to NFA’s questions. It can be challenging for these firms to address this topic during an NFA examination due to the uncertainty of their obligations. In particular our customers often wonder what is reasonable for small to mid-size firm internal control policies given how hard they can be to apply given the size and structure of a company.
Introducing Brokers can expect a great deal of time to be spent on financial records testing during an NFA examination. While this has always been an area of focus, complete and accurate accounting is essential, especially considering the minimum net capital requirements Independent IB’s must adhere to. NFA auditors will pay particular attention to accruals; often the most difficult area for small to mid-size IBs doing accounting internally. Brokers must provide whomever is doing the accounting with the detail for expenses and income to ensure the proper accruals are made. In addition, IIB’s need to monitor their payables and receivables, as they need to be properly marked as current or non-current for purposes of calculating minimum net capital. This calculation can be particularly daunting for those firms who deal in cleared swaps and/or block futures activity.
During regulatory examinations of Commodity Trading Advisors, we’ve noticed a shift in the approach and focus related to the subject of trade allocations. While CTA performance testing is still predominant in NFA audits, particular attention is being paid to rate-of-return variance between accounts within the same trading program. While there are several factors that can cause such a variance, we have found NFA will assume that there is a problem with trade allocations and work backwards from there. It is important for CTA’s to keep detailed allocation records, which is especially important for occurrences of partial fills or split fills not subject to average pricing (“APS”). Partial fills, in particular, can be problematic, and need to be completely documented. Additionally, it is essential to evaluate rate-of-return variances regularly and review the efficacy of your allocation methodology no less than quarterly in writing.
Beginning in March, NFA will start considering how member firms have implemented their respective cybersecurity, or Information Systems Security Programs (“ISSP”). An Interpretive Notice was adopted at the end of October 2015 that expanded on the guidance issued by the CFTC in November 2014. All Member firms are required to have written programs that address security and risk analysis, safeguards, training, and the evaluation, mitigation, and response to cybersecurity breaches. A previous article written on the subject can be found on the Turnkey website as well as at the NIBA website (theniba.com).
Annual Compliance Obligations
Consistent and comprehensive recordkeeping is the key to being prepared for a regulatory examination. Member firms have many annual requirements, the beginning of the New Year is a good time to review them. To quickly recap some of the requirements to consider are:
-Review your operations manual and update where needed
-Senior Management sign-off on updated manual
-Review and complete the NFA Self-Exam Questionnaire. As noted above NFA subtly changes how they apply rules and regulations. Please be aware that significant changes to the questionnaire were made in October 2015, and it was revised again in January 2016 with little to no notice.
-Complete Annual Questionnaire and Annual Registration Update with NFA
-Pay your NFA dues on the anniversary of your firm’s registration
-Send out annual Privacy Policy notice to customers, maintain proof of delivery
-Send out annual BASIC notice to customers, maintain proof of delivery
-Conduct annual AML training for applicable employees (IBs)
-Complete an audit of your AML procedures and training (IBs)
-Obtain and renew FCM reliance agreements; double check them for content shifts (IBs)
-Complete an annual on-site review of your branch offices (if applicable)
-Test your Business Continuity and Disaster Recovery plan; document in writing
-Complete ethics training as outlined in your firm’s written Ethics Training Procedures
There are many things to consider for all CFTC and NFA member firms going into 2016. For those companies looking for assistance it may be advisable to contact an industry professional to answer any questions you might have. With the list above it is our intent to give the industry a jump start on the New Year and what to expect from NFA.
Turnkey Trading Partners is a consulting firm that specializes in assisting CFTC registrants and NFA members (FCM, IB, CTA, CPO, Futures, Forex, and Swap Firms) with their regulatory and operational needs. For more information about our services please contact us at any time by calling (312) 324-0040 or emailing us at info@turnkeytradingpartners.com.
