NFA Member Firms are all required to complete a yearly self-examination checklist to ensure that the Member Firm is complying with all the NFA Rules (as well as the CFTC Regulations and other applicable laws).  The NFA has provided some resources on their website.  We believe that the resources are good, but they are not easy to use for NFA Member Firms.  Accordingly, Mallon P.C. has reworked the forms into a more easy-to-use format.  Below is a description on how you should proceed with this process along with the various checklists that each Member Firm should print off and complete.

All of the checklists below are based on, and contain the same information, as the NFA checklists which can be found here.

Overview of Process

The whole process should take anywhere from 1 to 3 hours (or more) depending on the exact structure of the NFA Member Firm.  Firm authorized personnel should complete the following steps:

1. Print off the General Checklist
2. Print off the Registration Specific Checklist
3. Print off the Attestation Sheet
4. Go through the checklists step by step and write notes and initial the appropriate areas.  If a certain area is not applicable, write N/A.
5. Sign the Attestation Sheet
6. File the Checklists according to the Firm’s internal compliance procedures

If there are compliance issues which arise during the course of the self-examination process, please record the issue and how the issue has been or will be addressed.  Do not try to cover up the issue - the NFA is more interested in the fact that a firm identifies and appropriately deals with compliance issues than a firm that has a perfect self-exam checklist (through a cover-up).  Do not be afraid to take ample notes in the appropiate places on the checklist - this will show the NFA examiners that the Firm is committed to thinking about the relevant compliance issues.

* Note: there are other yearly compliance procedures that a firm will need to complete in addition to the self-examination checklist.  For more information, please see the Mallon P.C. NFA Compliance Guide or contact your compliance consultant.  Please note that the compliance guide may not cover all compliance requirements.

Checklists

Each Member Firm will need to complete at least two checklists - (1) a general NFA Member Firm checklist and (2) a specific registration category checklist (i.e. FCM, IB, CPO, CPA).

General Checklist

• NFA Self-Exam Checklist (General - All Firms)

Registration Specific Checklist

• NFA Self-Exam Checklist (FCM)
• NFA Self-Exam Checklist (IB)
• NFA Self-Exam Checklist (CPO)
• NFA Self-Exam Checklist (CTA)

Attestation

Each Member Firm will need to complete an attestation sheet which acknowledges that the Firm has completed the annual self-examination checklists.

• NFA 2010 Checklist Attestation

Appendices

Each of the checklists makes reference to certain appendices.  Below we have created links to those appendices.

• Appendix A - General, FCM, IB
• Appendix B - General
• Appendix C - General
• Appendix D - General

Acronyms

Each of the checklists include acronyms.  We have listed them below for your convenience.

• AML - Anti-Money Laundering
• AP - Associated Person
• BASIC - Background Affiliation Status Information Center
• BSA - Bank Secrecy Act
• CIP - Customer Identification Program
• CRD - Central Registration Depository
• DSRO - Designated Self-Regulatory Organization
• FATF - Financial Action Task Force
• FIFO - First-in, First-out
• FinCEN - Financial Crimes Enforcement Network
• NAV - Net Asset Value
• NCCT - Non-Cooperative Countries and Territories
• OFAC - Office of Foreign Assets Control
• SAR - Suspicious Activity Report
• SDN - Specially Designated Nationals
• SPAN - Standard Portfolio Analysis

Rules & Regulations

Some of the checklists have references to certain CFTC Regulations and NFA Rules.  We have listed them below for your convenience.

• CFTC Part 4 Regulations
• CFTC Regulation 160
• CFTC Interpretation #10
• NFA Compliance Rule 2-7
• NFA Compliance Rule 2-29
• NFA Compliance Rule 2-30
• NFA Bylaw 1301
• Securities Exchange Act of 1933 - Sections 9(a), 9(b), 10(b)

Forms

Some of the checklists have references to forms and these are included below.

• CFTC Form 40
• CFTC Form 8-T
• Form U5

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Other related NFA compliance articles include:

• NFA Annual Questionnaire Requirements
• NFA Provides Guidance on Social Networking
• CFTC Provides Annual Guidance to CPOs

Bart Mallon, Esq. of Mallon P.C. runs the Hedge Fund Law Blog.  He can be reached directly at 415-868-5345

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February 1-2

• Sponsor: Financial Research Associates
• Event: Investment Advisor Compliance and Hedge Fund Regulation and Compliance
• Location: New York, NY

February 2

• Sponsor: Eze Castle Integration
• Event: The Future & Implications of Hedge Fund Regulations
• Location: London

February 2

• Sponsor: 100 Women in Hedge Funds
• Event: Trivia Challenge and Fundraiser
• Location: London

February 2

• Sponsor: 100 Women in Hedge Funds
• Event: Securitisation - “Past, Present and Future”
• Location: London

February 2

• Sponsor: Pierson & Smith, Inc.
• Event: Hedge Fund Compensation Tactics
• Location: Stamford, CT

February 2-5

• Sponsor: IQPC
• Event: Investment Performance Analysis & Risk Management Asia 2010
• Location: Kowloon Shangri La, Hong Kong

February 3-4

• Sponsor: Buy-Side Tech
• Event: High Frequency Trading Summit
• Location: Chicago

February 4

• Sponsor: Felix Slim & Co. Ltd.
• Event: Middle East Hedge Funds Group Networking Event
• Location: Dubai

February 7-10

• Sponsor: IMN
• Event: The 16th Annual International Beneficial Owners’ Securities Lending & Repo Summit
• Location: San Diego

February 8-9

• Sponsor: EDHEC Risk
• Event: EDHEC Alternative Investment Days
• Location: London

February 8-10

• Sponsor: Opal Financial Group
• Event: Investment Education Symposium
• Location: New Orleans

February 9

• Sponsor: Financial Times
• Event: Hedge Fund Insights Winter Series
• Location: Amsterdam

February 10

• Sponsor: Alternative Decisions
• Event: UCITS Thought Leaders. The Good, the Bad and Potentially UGLY of UCITS III Hedge Funds
• Location: London

February 10-12

• Sponsor: Infocast, Inc.
• Event: Wind Power Finance & Investment Summit
• Location: San Diego

February 16

• Sponsor: HedgeAnswers
• Event: Hedge Answers Tele-Conference Call Series
• Location: Telephone conference

February 17

• Sponsor: Portland Alternative Investment Association
• Event: Networking Event
• Location: Portland

February 18

• Sponsor: DerivSource & TwistedTree
• Event: Capital Raising Panel Event
• Location: Virtual event

February 18

• Sponsor: Seattle Alternative Investment Association
• Event: Central Clearing of Credit Default Swaps - What’s Next?
• Location: Seattle

February 23

• Sponsor: Institute for International Research
• Event: Hedge Fund Re-domiciliation for Managers
• Location: London

February 23

• Sponsor: Kruse Asset Management
• Event: Advantages and Disadvantages of TIPS for 2010 and Beyond
• Location: Virtual event

February 23

• Sponsor: IVY Plus
• Event: Hedge Fund - Private Equity Networking Event
• Location: New York, NY

February 24

• Sponsor: Global M&A Network, LLC
• Event: Global Major Market Symposium and the M&A Atlas Awards Gala
• Location: New York, NY

February 25

• Sponsor: Hedge Funds Care
• Event: Annual Hedge Funds Care - Open Your Hear to the Children Benefit
• Location: New York, NY

February 25

• Sponsor: InVantage Group
• Event: HIFREQ TRADE - Exploring the Potential and New Techniques in High Frequency Trading
• Location: London

February 25-26

• Sponsor: Informa Finance
• Event: Clearing Settlement & Custody Asia 2009
• Location: Singapore

February 25-26

• Sponsor: Euromoney Legal Forums
• Event: AIFM Directive Conference
• Location: London

February 26

• Sponsor: Infoline
• Event: Hedge Funds Regulation, Reporting and Controls
• Location: London

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Bart Mallon, Esq. runs the Hedge Fund Law Blog and provides hedge fund information and manager registration services through Mallon P.C. He can be reached directly at 415-868-5345.

On Thursday evening at the Roxie Theatre in San Francisco, the professional women’s organization 100 Women in Hedge Funds sponsored the showing of Floored, a documentary by ex-floor trader James Allen Smith that offers a peek inside the lives, successes, and struggles of former traders of the Chicago trading floor (a.k.a. the “pit”).

Those who showed up to watch the film made for the perfect audience–traders, hedge fund managers, and other financial industry professionals schmoozed over wine and cheese before the showing, during which boos, laughter, applause, and verbal comments erupted each time the audience could relate to traders’ stories or make fun of their often idiosyncratic comments. Upon leaving trading, one notable former trader (and quite the character) Mike Walsh took up the hobby of hunting lions, giraffes, and other wild animals.

Through interviews and live footage of pit trading, the documentary tells the story of the Chicago Board of Trade’s (now the Chicago Mercantile Exchange, CME) humble beginnings–it opened in 1898 as the Chicago Butter and Egg Board because it only traded butter and egg contracts!–to the roller coaster ride experienced by floor traders during the peak of futures and options floor trading in the mid-1990s.

Starting in 1992 and still in use today in the pit is the combination of open outcry, the system of loudly shouting over competitors often associated with floor trading, and GLOBEX, an electronic trading system which works alongside open outcry to make trading more efficient. The idea behind trading revolves around buying a commodity at one price and then trying to sell it for a better price in order to make a profit.  In the film, the traders described this system as a game–one trader stated that when the bell goes off (to initiate the opening of trading hours), he experiences an adrenaline rush as if he were playing a sports game.  Another trader commented, “Trading is not a normal job. When you are in there [the pit] from 8:30 to 3:15, it’s all about money!”

The main issue traders discussed was the shift from floor trading to electronic trading. The majority opinion was that computers changed the dynamic of trading in an unfavorable way and that trading in person helps make the price of commodities more efficient. One trader commented that open outcry was more “honorable”. There is also a generational issue, as older traders who did not grow up using computers had trouble figuring out complicated electronic trading platforms. Essentially, those traders who still had enough money to continue trading and who were able to use the electronic systems continued trading, while those who lost too much money in the pit were forced to leave trading altogether.

According to the CME, the options and futures trading floor remains grounded in floor trading, which accounts for 90% of trades with the remaining 10% occurring electronically. The futures pit, however, has seen the biggest crossover to electronic trading, with approximately 85% of trades taking place on the computer and the remaining ones in the pit.

After the film, Smith, who watched the film alongside his audience, stood at the front of the theatre for a Q&A session. He was asked about his background–he went to art school then found himself doing web design for finance businesses in Chicago, where a friend suggested he make a movie about floor traders. He even dabbled in trading and reached out to his network when casting traders for the film. When asked why former traders were willing to open up about their personal lives on film, he commented that less successful traders are often more likely to talk, while more successful traders remain tighter-lipped. Finally, when asked what impression of traders he wanted to leave with audiences, Smith replied that traders are usually stereotyped as “greedy a**holes”, and he wanted to show that traders are more “dynamic than just that part of their personalities” by offering a “more rounded impression [of traders]” through his film.

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For information about future Floored showings, click here.

Other related Floored and CME articles include:

• Floored Screening in San Francisco ¦ 100 Women in Hedge Funds
• New Forex Product Launched by CME
• Forex Registration
• Series 34 Exam

Bart Mallon, Esq. runs the Hedge Fund Law Blog.  He can be reached directly at 415-868-5345.

In a recent release, which we have reprinted in full below, the CFTC reminds CPOs of their annual reporting requirements under Regulation 4.22.  The release includes a link to the 2010 CPO Annual Guidance Letter.  In general the letter provides another reminder to CPOs to file their annual reports with the NFA and provide a copy to the investors in the pool.  I have outlined below the major parts of the letter.

General Issues to consider

• Commodity pool annual reports must be distributed to pool participants within 90 clendar days of the pool’s fiscal year end.  For most funds this means by March 31, 2010.
• Commodity pool annual reports must be filed with the NFA within 90 clendar days of the pool’s fiscal year end.  For most funds this means by March 31, 2010.
• All documents must be filed electronically through the NFA’s filing system.
• Extensions are available in certain circumstances.

Other Issues

For groups which have different or more complex structures, additional considerations need to be addressed.  Such groups include:

• Master/feeder commodity pool structures
• Commodity pool fund of funds
• Offshore commodity pools
• CPOs claiming an exemption under Regulation 4.13
• Reports of commodity pools which are liquidating
• Commodity pools established as a series structure (such as a series LLC)
• Commodity pools which invest in non-exchange traded instruments may have additional issues

Moreover, the letter includes references to the recently amended CPO relations.

If a CPO will not be able to file on time, the CPO should file for an extension.  ”Automatic” extensions can be granted to CPOs to fund of fund structures.  If you have questions with making a filing, please feel free to contact Mallon P.C. The following press release can be found here.

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CFTC’s Division of Clearing and Intermediary Oversight Provides Annual Report Guidance to Commodity Pool Operators

Washington, DC — The Commodity Futures Trading Commission’s Division of Clearing and Intermediary Oversight has issued its annual guidance letter to registered commodity pool operators (CPOs). The letter is intended to assist CPOs and their public accountants in complying with the Commission’s regulations on the preparation and filing of commodity pool annual financial reports.

The highlights contained in this year’s letter include:

• Recent amendments to Commission regulations pertaining to various reporting issues;
• Annual report filing procedures and due dates;
• Special considerations that apply to filings made for Master/Feeder and Fund of Funds structures;
• Use of International Financial Reporting Standards in lieu of U.S. generally accepted accounting principles;
• Reporting requirements for pools in liquidation;
• Reporting requirements for series funds with limitation of liability among the different series; and
• Various accounting developments that may impact report preparation.

For more information on CPO Annual Guidance Letter 2009, please see the Related Documents link.

Copies of the letter also may be obtained by contacting the Commission’s Office of the Secretariat, Three Lafayette Centre, 1155 21st Street, N.W., Washington, D.C. 20581, (202) 418-5100.

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Other related compliance articles for CPOs and CTAs include:

• CTA & CPO Registration & Compliance Guide
• CTA and CPO Registration
• NFA Social Networking Compliance Information
• Forex Registration

Bart Mallon, Esq. runs the Hedge Fund Law Blog.  He can be reached directly at 415-868-5345.

NFA Member Firms are required to have their disclosure documents reviewed by the NFA generally before such firms can distribute the documents to potential investors.  One issue which sometimes arises is when the firm (generally either a CTA or CPO) has potential clients/investors who are non-U.S. citizens and do not speak English.  In these cases the question arises as to whether the CTA or CPO can translate their disclosure documents into another language.

I just recently spoke with a compliance representative at the NFA and the answer I received is: Yes, the CTA or CPO can have the document translated into another language.  The big issue obviously is that the NFA Member Firm must be able to represent to the NFA that the translation is exact and the firm must generally make the translated copy available to the NFA during examination.  Also, there are two central ways which firms will typically approch this situation:

Disclose to NFA - some firms will proactively disclose to the NFA that they have translated a disclosure document into another language.  This can be done in a number of ways including: (i) providing a note to the NFA during the document submission or (ii) calling the NFA directly and talking with a representative or compliance manager.

Do not disclose to the NFA - some firms will not disclose to the NFA that a document has been translated.  According to my phone conversation, this is fine, but the Member Firm will need to have a copy of the translated document and verify to the NFA that the translated version is exactly the same as the English language based version.

NFA Compliance Issues

Compliance.  CTAs and CPOs must remember that, as Member Firms, there are ongoing recordkeeping responsibilities.  Accordingly, the firm should have policies and procedures in place that address the issue of having translated disclosure documents.  Additionally, firms should remember that disclosure documents are usually good for nine (9) months and must be updated thereafter (or if there are any material changes to the document which must be disclosed) - this means that the translated copy should also be appropriately updated.

Forex.  These same rules will also apply to Forex CTAs and Forex CPOs.  The CFTC just recently announced that forex managers will need to register with the CFTC and become NFA member firms.  When forex managers register then, this will apply to them and they will need to follow these rules as well.

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Other articles applicable to NFA member firms include:

• CTA & CPO Registration & Compliance Guide
• CTA and CPO Registration
• NFA Social Networking Compliance Information
• Forex Registration

Bart Mallon, Esq. of Mallon P.C. runs the Hedge Fund Law Blog.  He can be reached directly at 415-868-5345.

There has been a clear trend over the last 12-18 months for hedge funds to focus on a number of operational issues in order to become more attractive to institutional investors.  While much of focus has been on the risk management side, I have seen more recent emphasis placed on brand building and image refinement.  This can take many forms of course, including making sure that your hedge fund marketing pieces look professional. However, it is becoming evident managers will need to go further and make sure their entire product offering is designed for the needs of their target investors.

In a recent white paper, produced BK Communications Group, this argument was expanded upon and discussed in depth.  The following are the overview highlights of the white paper:

• Performance alone isn’t enough to get allocations.  Recent surveys of institutional investors find reputation has become a primary consideration when choosing a hedge fund manager.  And with institutions now representing up to 70% of hedge fund investors, the demand has increased for high-level communications that speak to a sophisticated audience.
• A step-by-step program to build a strong brand identity – the sum total of associations people have with an organization – can help a fund manager heighten name recognition and credibility.  Professional-level materials that reflect the brand identity can position a fund to take advantage of opportunities in the institutional space and beyond.
• A strong brand identity can also help fund managers weather severe setbacks by allowing them to draw on a reservoir of good associations already in place.
• Managers often underestimate the importance of marketing communications, and can be misinformed about what they are allowed to communicate.  Many lack the internal resources or capability to effectively build a brand identity and get their message out across a spectrum of materials and media.

While many in the industry understand that performance is not everything, many managers do not believe this (…for some managers, growth is an offshoot of fantastic performance, see David Einhorn, but this is not always the case).  I think that this paper presents important information for such managers.  As the industry continues to become more instiutionalized, I believe we will see a greater emphasis placed on brandbuilding and I believe consultants will play a larger part in the investment process (including helping the manager to complete the due diligence process).

For the full white paper, please see: BKCG White Paper: Brand Identity for Hedge Funds

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Please contact us if you have a question on this issue or if you would like to start a hedge fund.  Other related hedge fund law articles include:

• Hedge Fund Audits Post Madoff
• Hedge Fund Consultant
• Hedge Fund Websites

Bart Mallon, Esq. of Mallon P.C. runs the Hedge Fund Law Blog.  He can be reached directly at 415-868-5345.

This post provides a short general description of the definition and also the full definition.

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Short Definition

An Eligible Contract Participant generally  means:

1. Financial Institutions
2. Insurance Companies
3. Mutual Funds
4. Certain commodity pools with $5 million or more of assets
5. Certain organizations with, generally, $10 million or more of assets
6. ERISA plans with $5 million or more of assets
7. Certain governmental entities
8. Certain broker-dealers and investment banks
9. FCMs
10. Floor brokers
11. An individual with generally $10 million or more of assets
12. Certain brokers or investment advisers

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Full Definition

The following definition is found in the Section 1a(12) of the Commodity Exchange Act.

Eligible contract participant

The term “eligible contract participant” means—

(A) acting for its own account—

(i) a financial institution;

(ii) an insurance company that is regulated by a State, or that is regulated by a foreign government and is subject to comparable regulation as determined by the Commission, including a regulated subsidiary or affiliate of such an insurance company;

(iii) an investment company subject to regulation under the Investment Company Act of 1940 (15 U.S.C. 80a–1 et seq.) or a foreign person performing a similar role or function subject as such to foreign regulation (regardless of whether each investor in the investment company or the foreign person is itself an eligible contract participant);

(iv) a commodity pool that—

(I) has total assets exceeding $5,000,000; and

(II) is formed and operated by a person subject to regulation under this chapter or a foreign person performing a similar role or function subject as such to foreign regulation (regardless of whether each investor in the commodity pool or the foreign person is itself an eligible contract participant);

(v) a corporation, partnership, proprietorship, organization, trust, or other entity—

(I) that has total assets exceeding $10,000,000;

(II) the obligations of which under an agreement, contract, or transaction are guaranteed or otherwise supported by a letter of credit or keepwell, support, or other agreement by an entity described in subclause (I), in clause (i), (ii), (iii), (iv), or (vii), or in subparagraph (C); or

(III) that—

(aa) has a net worth exceeding $1,000,000; and

(bb) enters into an agreement, contract, or transaction in connection with the conduct of the entity’s business or to manage the risk associated with an asset or liability owned or incurred or reasonably likely to be owned or incurred by the entity in the conduct of the entity’s business;

(vi) an employee benefit plan subject to the Employee Retirement Income Security Act of 1974 (29 U.S.C. 1001 et seq.), a governmental employee benefit plan, or a foreign person performing a similar role or function subject as such to foreign regulation—

(I) that has total assets exceeding $5,000,000; or

(II) the investment decisions of which are made by—

(aa) an investment adviser or commodity trading advisor subject to regulation under the Investment Advisers Act of 1940 (15U.S.C. 80b–1 et seq.) or this chapter;

(bb) a foreign person performing a similar role or function subject as such to foreign regulation;

(cc) a financial institution; or

(dd) an insurance company described in clause (ii), or a regulated subsidiary or affiliate of such an insurance company;

(vii)

(I) a governmental entity (including the United States, a State, or a foreign government) or political subdivision of a governmental entity;

(II) a multinational or supranational government entity; or

(III) an instrumentality, agency, or department of an entity described in subclause (I) or (II);

except that such term does not include an entity, instrumentality, agency, or department referred to in subclause (I) or (III) of this clause unless (aa) the entity, instrumentality, agency, or department is a person described in clause (i), (ii), or (iii) of paragraph (11)(A) of this section; (bb) the entity, instrumentality, agency, or department owns and invests on a discretionary basis $25,000,000 or more in investments; or (cc) the agreement, contract, or transaction is offered by, and entered into with, an entity that is listed in any of subclauses (I) through (VI) of section 2(c)(2)(B)(ii) of this title;

(viii)

(I) a broker or dealer subject to regulation under the Securities Exchange Act of 1934 (15 U.S.C. 78a et seq.) or a foreign person performing a similar role or function subject as such to foreign regulation, except that, if the broker or dealer or foreign person is a natural person or proprietorship, the broker or dealer or foreign person shall not be considered to be an eligible contract participant unless the broker or dealer or foreign person also meets the requirements of clause (v) or (xi);

(II) an associated person of a registered broker or dealer concerning the financial or securities activities of which the registered person makes and keeps records under section 15C(b) or 17(h) of the Securities Exchange Act of 1934 (15 U.S.C. 78o–5 (b), 78q (h));

(III) an investment bank holding company (as defined in section 17(i) of the Securities Exchange Act of 1934 (15 U.S.C. 78q (i)); [1]

(ix) a futures commission merchant subject to regulation under this chapter or a foreign person performing a similar role or function subject as such to foreign regulation, except that, if the futures commission merchant or foreign person is a natural person or proprietorship, the futures commission merchant or foreign person shall not be considered to be an eligible contract participant unless the futures commission merchant or foreign person also meets the requirements of clause (v) or (xi);

(x) a floor broker or floor trader subject to regulation under this chapter in connection with any transaction that takes place on or through the facilities of a registered entity (other than an electronic trading facility with respect to a significant price discovery contract) or an exempt board of trade, or any affiliate thereof, on which such person regularly trades; or

(xi) an individual who has total assets in an amount in excess of—

(I) $10,000,000; or

(II) $5,000,000 and who enters into the agreement, contract, or transaction in order to manage the risk associated with an asset owned or liability incurred, or reasonably likely to be owned or incurred, by the individual;

(B)

(i) a person described in clause (i), (ii), (iv), (v), (viii), (ix), or (x) of subparagraph (A) or in subparagraph (C), acting as broker or performing an equivalent agency function on behalf of another person described in subparagraph (A) or (C); or

(ii) an investment adviser subject to regulation under the Investment Advisers Act of 1940 [15 U.S.C. 80b–1 et seq.], a commodity trading advisor subject to regulation under this chapter, a foreign person performing a similar role or function subject as such to foreign regulation, or a person described in clause (i), (ii), (iv), (v), (viii), (ix), or (x) of subparagraph (A) or in subparagraph (C), in any such case acting as investment manager or fiduciary (but excluding a person acting as broker or performing an equivalent agency function) for another person described in subparagraph (A) or (C) and who is authorized by such person to commit such person to the transaction; or

(C) any other person that the Commission determines to be eligible in light of the financial or other qualifications of the person.

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Other related FOREX law articles include:

• Forex Hedge Fund Articles
• Forex Registration
• Series 34 Exam

Bart Mallon, Esq. of runs the Hedge Fund Law Blog and provides forex registration service through Mallon P.C. Mr. Mallon also runs the Forex Law Blog.  He can be reached directly at 415-868-5345.

The much anticipated off-exchange retail foreign currency regulations were proposed today by the CFTC.  The release announcing the publication in the Federal Register is reprinted below and can be found here.  We will be providing an overview of the major provisions shortly.

The full proposed rules are posted here: Proposed Retail Forex Registration Rules

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Release: 5772-10

For Release: January 13, 2010

CFTC Seeks Public Comment on Proposed Regulations Regarding Retail FOREX Transactions

Washington, DC – The U.S. Commodity Futures Trading Commission (CFTC) today announced the publication in the Federal Register of proposed regulations concerning off-exchange retail foreign currency transactions. The proposed rules follow the passage of the Food, Conservation, and Energy Act of 2008, Pub. L. No. 110-246, 122 Stat. 1651, 2189-2204 (2008), also known as the “Farm Bill,” which amended the Commodity Exchange Act in several significant ways. In particular, the Farm Bill:

• clarified the scope of the CFTC’s anti-fraud authority with respect to retail off-exchange foreign currency transactions;
• provided the CFTC with the authority to register entities wishing to serve as counterparties to retail forex transactions as well as those who solicit orders, exercise discretionary trading authority and operate pools with respect to retail off-exchange foreign currency transactions; and
• mandated minimum capital requirements for entities serving as counterparties to such transactions.

“These proposed rules for retail foreign exchange trading are important steps in implementing the additional consumer protections authorized in the 2008 Farm Bill,” CFTC Chairman Gary Gensler said. “The Commission looks forward to receiving and considering the public’s comments on this important issue.”

Pursuant to this authority, the Commission is proposing a comprehensive scheme that would put in place requirements for, among other things, registration, disclosure, recordkeeping, financial reporting, minimum capital, and other operational standards. Specifically, the proposed regulations would require the registration of counterparties offering retail foreign currency contracts as either futures commission merchants (FCMs) or retail foreign exchange dealers (RFEDs), a new category of registrant created by the Farm Bill. Persons who solicit orders, exercise discretionary trading authority and operate pools with respect to retail forex would also be required to register, either as introducing brokers, commodity trading advisors, commodity pool operators, or as associated persons of such entities. As was the case prior to the passage of the Farm Bill, “otherwise regulated” entities such as financial institutions and SEC-registered brokers or dealers remain able to serve as counterparties in such transactions under the oversight of their primary regulators.

The proposed regulations also include financial requirements designed to ensure the financial integrity of firms engaging in retail forex transactions and robust customer protections. For example, FCMs and RFEDs would be required to maintain net capital of $20 million plus 5% of the amount, if any, by which liabilities to retail forex customers exceed $10 million. Leverage in retail forex customer accounts would be subject to a 10-to-1 limitation. All retail forex counterparties and intermediaries would be required to distribute forex-specific risk disclosure statements to customers, and comply with comprehensive recordkeeping and reporting requirements.

Comments regarding the proposed regulations may be submitted by any of the means listed in the Federal Register release and should be received by the Commission within 60 days of the date of publication.

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Other related FOREX law articles include:

• Forex Hedge Fund Articles
• Forex Registration
• Series 34 Exam

Bart Mallon, Esq. of runs the Hedge Fund Law Blog and provides forex registration service through Mallon P.C. Mr. Mallon also runs the Forex Law Blog.  He can be reached directly at 415-868-5345.

event invitation

Bart Mallon, Esq. of runs the Hedge Fund Law Blog and provides hedge fund manager registration service through Mallon P.C. He can be reached directly at 415-868-5345.

In early December the National Futures Association (“NFA”) submitted two proposed amendments proposed amendments to the Commodity Futures Trading Commission (“CFTC”) regarding NFA Member Firms and their use of the internet and social media networks.  The amendments focus on communications by firms over the internet in various capacities including blogs, chat rooms, forums, and various social media websites (i.e. Facebook, Twitter, etc). While these amendments will increase the oversight responsibilities for Member Firms, it makes sense for the NFA to alert members to their responsibilities with regard to these growing forms of communication.  This post describes the two amendments, application to forex managers, the NFA social media podcast and the impact these amendments are likely to have on all NFA Member firms.  The NFA’s Notice to Members on this issue is also reprinted at the end of this post.

Overview of Amendments

Amendment to Rule 2-29

Rule 2-29 was broadened by the following changes (underline and strikethrough):

(h) Radio and Television Advertisements.

No Member shall use or directly benefit from any radio or television advertisement or any other audio or video advertisement distributed through media accessible by the public if the advertisement that makes any specific trading recommendation or refers to or describes the extent of any profit obtained in the past that can be achieved in the future unless the Member submits the advertisement to NFA’s Promotional Material Review Team for its review and approval at least 10 days prior to first use or such shorter period as NFA may allow in particular circumstances.

By broadening the rule the NFA effectively is requiring Member Firms to make sure all audio and video internet advertising (i.e. podcasts, youtube, voiceover presentations, etc) be reviewed prior to use.  Effectively groups who have used these channels to market their services will need to (i) have all such media reviewed by the NFA or (ii) take all media off of the internet.

Interpretive Notice: Internet Communication & Social Media

This interpretive notice is not so much an amendment of an existing Interpretive Notice as it is simply the creation of a new notice.  The full Interpretive Notice can be found in the proposed amendments link above, but I have also reprinted some of the more interesting parts of the notice:

The form of communication does not change the obligations of Members and Associates who host or participate in these groups, and electronic communications must comply with Compliance Rules 2-9, 2-29, 2-36, and 2-39.

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Therefore, content generated by the Member or Associate is subject to the requirements of NFA Compliance Rules 2-29, 2-36, or 2-39. The same is true for futures, options, or forex content written by a Member or Associate and posted on a third party’s site.

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Members should have policies regarding employee conduct. These policies could require employees to notify the employer if they participate in any on-line trading or financial communities and provide screen names so that the employer can monitor employees’ posts periodically. Alternatively, the policy could simply prohibit participation in such communities. The Member must, of course, take reasonable steps to enforce whatever policies it adopts.

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The issue becomes more complicated for user-generated comments responding to a Member or Associate’s blog and for Members and Associates who host chat rooms or forums. What is their responsibility for posts from customers or others over whom the Member or Associate has no direct control? When inadequately monitored, social networking sites may contain misleading information, lure customers into trades that they would not normally make, or be used in an attempt to manipulate prices.

The biggest take-away is that the NFA is expecting NFA Members to integrate a social media awareness into their current compliance program.  Accordingly, compliance programs (especially those parts dealing with Compliance Rules 2-9, 2-29, 2-36, and 2-39) will need to be updated appropriately to reflect the requirements of the Interpretive Notice.  Member Firms will also need to vigillantly follow their new/revised compliance procedures and monitor their employees - it will be very easy for the NFA to do simple internet searches and potentially “catch” firms who do not adequately comply the Interpretive Release.

Issues for Forex Managers

Forex is specifically discussed throughout the Interpretive Notice so it is clear that the NFA’s intent is to make sure that forex communications, especially, are subject to monitoring and oversight.  Currently this rule applies to those firms who are NFA Member Firms (currently registered) and, in the future, after the forex registration rules have been adopted, it will apply to all registered forex firms (CTAs, CPOs, IBs and FDMs/FCMs).  The NFA has made it clear before that forex managers/traders are in the NFA’s regulatory cross-hairs and this Interpretive Notice reinforces that impression.

NFA Podcast on Social Media

The NFA has produced a podcast titled “Use and Supervision of Online Social Networking Communication” and can be found with other NFA produced podcasts.  This podcast is helpful to provide Member Firms with some helpful guidance on some of the major issues to consider when developing a social media policy to comply with the Interpretive Notice and Rule amendment.  There are a number of considerations that firms will need to make and the social media policy must be tailored to the business practices of the firm.  There are likely to be a number of hot button issues which will develop regarding Member Firms and this policy, especially concerning oversight of associated persons.  The podcast also hints at one of the big compliance issues which managers should be aware of - the reposting of content.  Because internet posts are routinely “scraped” from the original website and reposted on other websites, Member Firms should be aware of this issue and create appropriate procedures.

It is recommended that compliance officers listen to this podcast when developing their social media compliance policies and procedures.

Impact on NFA Members

I view these amendments as relatively major - because so many firms use the internet for marketing and because prior NFA rules essentially did not address the issues of social networks there has been a bit of a regulatory gap.  However, I do think that the NFA is doing the right thing by publicly notifying Member Firms that this will be a compliance issue going forward - this is much better than a retroactive interpretation of existing NFA compliance rules. One thing I think that member firms should be especially concerned with is potential liability for what 3rd parties do with information which is posted online.  On the podcast, the NFA specifically suggested that firms should be policing their content and actively follow how it might be used by 3rd parties which is obviously problematic given the way the internet works.

Because these amendments affect both a current NFA Rule as well as the NFA’s Interpretive Releases, these amendments may make their way (eventually) onto the various exams (Series 3, Series 30, Series 34 especially).

These rules are also likely to create a compliance nightmare for many firms which have utilized the internet previously (and social media specifically).

Compliance Recommendations

The safest approach to social media compliance for all NFA Member Firms is to not allow the use any social media websites or other means of internet communication which would subject the firm to have a robust social media policy (including record retention policy for such media).  It will be much less costly to put a blanket prohibition on these types of activities than to develop and monitor such a policy.  For those firms who are willing to spend the time and money to implement a policy, such firms should make sure that all major aspects of the amendments are included in the policy.  Such items to consider will include: internet and social media content review, recordkeeping and storage, oversight of employees (including spot-checking internet posts and activity), and reposting review procedures, among other issues to consider.  It will be absolutely critical to make sure the policy addresses all issues raised in the Interpretive Notice and podcast because the NFA has not minced words - this is going to be a hot-button issue and it will be something the NFA will actively pursue during examinations.

Of course we will be able to provide greater guidance over the next few months as we see how the NFA handles this issue during and outside of examinations.

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Notice to Members I-10-01

January 5, 2010

Effective Dates of NFA Requirements Regarding On-Line Advertising and Social Networking Groups

NFA has received notice from the Commodity Futures Trading Commission (”CFTC”) that NFA may make effective certain proposed amendments regarding the use of internet and on-line social networking groups when communicating with the public. The Interpretive Notice entitled “Use of On-Line Social Networking Groups to Communicate with the Public” makes clear that on-line communications are subject to the same standards as other types of communications with the public and provides guidance to Members to meet their responsibilities in this area. The Interpretive Notice became effective on December 24, 2009.

A related amendment to Compliance Rule 2-29(h) requires that any audio or video distributed through media accessible by the public (e.g., through the internet) that makes any specific trading recommendation or refers to the extent of profit previously obtained or achievable in the future must be submitted to NFA for review and approval at least 10 days prior to first use. In this way the amendment subjects certain on-line advertising to the same requirements as similar television and radio advertising. To allow Members sufficient time to submit these types of advertisements to NFA for approval, the amendment becomes effective as of February 1, 2010. Accordingly, any audio or video advertisements that a Member posts on-line after January 31, 2010, must have been previously reviewed and approved by NFA.

NFA’s December 8, 2009, submission letter to the CFTC contains a more detailed explanation of the changes. You can access an electronic copy of the submission letter at: http://www.nfa.futures.org/news/PDF/CFTC/CR2-29_IntNotc_re_OnLine_Social_Networking_120209.pdf.

Questions concerning these changes should be directed to Sharon Pendleton, Director, Compliance (spendleton@nfa.futures.org or 312-781-1401) or Michael A. Piracci, Senior Attorney (mpiracci@nfa.futures.org or 312-781-1419).

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Other related hedge fund law blog articles include:

• NFA Annual Questionnaire
• CTA & CPO Registration & Compliance Guide
• CTA Regulatory and Compliance Discussion
• Forex Disclosure Documents Part I
• Forex Registration

If you are a manager or firm that needs to register as a CTA or CPO, or if you are contemplating registration, please contact Bart Mallon, Esq. of Mallon P.C. at 415-868-5345.