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Compliance Issues for Forex IBs, CPOs and CTAs

NFA Produces Compliance Webinar for Retail Forex Firms

Since the CFTC passed its final rules on retail participation in off-exchange foreign currency markets back in October 2010, there has been an influx of newly registered introducing forex brokers (IBs), commodity pool operators (CPOs), and commodity trading advisors (CTAs).  On June 8, 2011, the NFA hosted a webinar that focused on common regulatory deficiencies that NFA staff members have found during compliance audits of these IBs, CPOs and CTAs.  The following is a brief overview of the common regulatory deficiencies the NFA staff found regarding registration issues, disclosure documents, recordkeeping requirements, promotional materials, and anti-money laundering programs.

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Forex Registration Issues

Any entity intermediating retail forex transactions is required to be registered as forex IB, CPO, or CTA.  Common deficiencies for these

firms include having unlisted APs, failing to register supervisory APs, failing to withdraw APs, or failing to list branch offices.  Additionally, the following are areas emphasized in the webinar:

Listing All Principals – Criteria for being listed as a Principal of the firm generally are (1) job title, (2) ownership (direct or indirect), and (3) job duties and ability to control business activities.  More detail is available in NFA Rule 101.  Tips for ensuring the proper individuals are listed, include:

  • After any board of directors’ meetings, ensure any new directors/officers become listed as Principals of firm.
  • Periodically review the owners of any holding company of the firm to ensure indirect owners are listed if required.

Associated Person (AP) Registration – Essentially anyone who is a salesperson or supervises salespersons is required to be registered as an AP.  It is important to look at the supervisory chain of command–an individual must be registered, no matter how high he/she is on the supervisory chain of command.

  • Exam requirements – The APs must pass the Series 3 exam and the Series 34 exam.  If a person was registered as an AP, sole proprietor, or floor broker as of May 22, 2008 and there has not been more than a 2-year gap since that registration, the person is not required to pass the Series 34.
  • Tips for ensuring the proper individuals are registered:
    • Terminate an AP’s registration within 30 days of an AP leaving the firm.
    • After any shifts in control, ensure those with controlling influence are listed as Principals, and those that supervise APs are registered as APs themselves.

Branch Office Registration – Common deficiencies include:

  • Branch Office Address – Each branch office must be registered. Each branch office must use the name of the firm and hold itself out as a branch of the firm.  It cannot be a separate entity.
  • Payment of APs – Each AP in the branch office must be paid directly by the firm (payment by an intermediary would lead to the assumption the intermediary needs to be registered with the NFA).

Recordkeeping

Information in Customer File – This information is normally initially obtained upon account opening, but the firm must also maintain up-to-date and readily accessible information.   The firm shouldn’t rely on the FCM for this information unless it has been agreed upon before account opening.  The following information must be in the firm’s file for each customer and must be obtained before account opening:

  • name, address, date of birth, and principal occupation,
  • for individuals – current estimated annual income and net worth,
  • notes about the customer’s previous investment and trading experience and any other information that would assist the firm to accurately and fully disclose all the risks of trading,
  • signed customer acknowledgment that he/she has received all of the required risk disclosures, which include:
    • CFTC Regulation 5.5 risk disclosures (e.g. the FCM is the counterparty to all trades and forex trading is extremely risky and not suitable for all investors),
    • performance for the last 4 quarters for all non-discretionary accounts held at customer’s FCM (broken down by profitable/non-profitable accounts in percentage form), and
    • some customers need to receive additional risk disclosure statements based on age, trading experience, and net worth.

Business with Member Firms – Firms need to make sure they are not conducting business with any non-NFA member firms that are required to be registered (or are suspended).  Make sure counterparties are registered as FCMs or RFEDs, or solicitors are registered IBs.  The firm should also review their list of customers–if a customer’s name indicates he/she might be engaged in the trading business, inquire as to the customer’s registration/membership status.  The firm can also check on the NFA’s BASIC system to see if the customer is properly registered or operating under an exemption from registration.  The firm should document this process to show it did proper due diligence on the account.

Forex Disclosure Documents

All nonexempt CPOs operating a pool and CTAs that manage forex accounts for retail customers must distribute a forex disclosure document to their clients.  Three common problems are:

Risk Disclosures – The firm needs to make sure all risks associated with forex trading are disclosed.  This can include volatility, leverage, liquidity, counterparty creditworthiness, and others risks relevant to the program.

Fee Description – The fee description must be complete and all defined terms must be fully explained.

Performance Results -

  • CTA disclosure documents must include the actual performance of all clients directed by the CTA and each trading principal for the last 5 years to date (any past performance must be calculated net of all fees, including mark ups associated with bid/ask spread, etc.). If the CTA directed accounts prior to be being registered as a CTA, the disclosure document must still disclose those accounts.
  • The NFA has a guide on disclosure documents available here.

Forex Promotional Materials

Policies & Procedures – The firm must develop written procedures for how it creates and reviews promotional materials, as well as how the firm supervises employees on these matters.  Promotional materials:

  • must present a balanced discussion of the risk of loss (any discussion of profits should also discuss the risk of loss),
  • must provide a discussion of fees associated with trading forex,
  • must provide appropriate disclaimers for past performance, and
  • must not suggest forex trading is appropriate for everyone or guarantee success.
Social Media – Any communications with the public is considered promotional materials (e.g. emails, LinkedIn, Twitter, Facebook, etc.).  All information on social media must be in accordance with the NFA’s promotional materials rules.

  • If the firm hosts a blog, chat room, or other discussion forum that allows the general public to comment, those comments must be reviewed regularly to ensure they are not misleading or one-sided. Such comments must be removed immediately and the firm should also ban those users who repeatedly post comments that violate the rules.
  • Keep records of which posts are deleted, which users are blocked, how often a review is conducted, and how employees are supervised.
  • If employees have personal blogs, Facebook accounts, etc., the firm should monitor the posts periodically.  Any references to the firm can be seen as promotional materials.  If after monitoring employees’ personal pages, there are never any references to the firm’s business, then the procedures can change and require less frequent monitoring.
  • Special rules apply for the use of audio/visual ads.  If the firm provides trade recommendations or discuss past/potential profits through radio or webcasts (such as YouTube), the firm is required to submit them to the NFA for approval at least 10 days prior to use.

Anti-Money Laundering Program

An anti-money laundering program is required for IBs (guaranteed and independent), FCMs and RFEDs (even if they don’t hold customer funds).  These procedures are designed to guard against someone using the firm to facilitate money laundering or other terrorist financing.  The program should include:

  • written policies and procedures,
  • the appointment of a chief compliance officer,
  • ongoing training, and
  • an annual, independent audit.

The NFA has an Anti-Money Laundering webinar available on its website.

The NFA’s “Compliance Issues for Forex IBs, CPOs and CTAs” webinar is archived on the NFA’s website and can be found here .

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Bart Mallon is an attorney with a practice focused on hedge funds managed futures and forex regulatory issues.  He can be reached directly at 415-868-5345.

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NFA Forex Alert

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NATIONAL FUTURES ASSOCIATION

FOREX INVESTOR ALERT

OCTOBER 18, 2010

New Forex Rules Become Effective on October 18

On August 30, the Commodity Futures Trading Commission (CFTC) issued its final rules regarding retail off-exchange foreign currency (forex) trading in the United States. The rules, which become effective on October 18, 2010, have far-reaching implications for all forex investors in the United States.

The rules require, with certain exceptions, any firm acting as a counterparty to certain retail forex transactions to register as a Retail Foreign Exchange Dealer (RFED) or Futures Commission Merchant (FCM). In addition, the rules require, with certain exceptions, any individual acting as a forex solicitor, account manager or pool operator to register with the CFTC as Introducing Brokers (IBs), Commodity Trading Advisors (CTAs) or Commodity Pool Operators (CPOs) or as an associated usa pharmacy cheapest viagra person of one of these entities and become Members of NFA.

Effective October 18, all CFTC-registered forex firms and individuals will be subject to CFTC regulations and NFA rules covering every aspect of their business, including recordkeeping, promotional material and sales practices.

Investors can check the registration status of any forex firm through NFA’s Background Affiliation Status Information Center (BASIC) available on the Association’s website (www.nfa.futures.org). BASIC contains current and historical registration information concerning all current and former CFTC registrants, including name, business address and registration history.

BASIC also provides information concerning disciplinary actions taken by NFA, the CFTC and all the U.S. futures exchanges. If you are researching a firm, you should also conduct a background check of all the individuals listed as principals of the firm. Sometimes the firm will have no disciplinary history, but one or more of the principals may have been disciplined while working at other firms.

Forex investors can register complaints with NFA against any CFTC-registered firm or individual either by telephone or through NFA’s website.

In addition, investors who believe that they have been treated unfairly by their forex firm have the ability to file an arbitration claim with NFA. In most cases, arbitration is mandatory for all NFA Members and Associates required to be registered with the CFTC. NFA arbitration provides an effective and cost-efficient method for the settlement of futures and forex-related disputes.

For additional information, contact NFA’s Information Center at 1-800-621-3570 or (312) 781-1410.

NFA is a self-regulatory organization subject to oversight by the CFTC. NFA’s primary mission is to protect investors and safeguard market integrity.

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Cole-Frieman & Mallon LLP is a law firm and provides legal support and forex registration and compliance services to forex managers.  Bart Mallon, Esq. can be reached directly at 415-868-5345.

NFA Issues NTM Regarding Retail Forex

In a Notice to Members (NTM) issued today, the NFA provides guidance to certain players in the retail forex markets.  The NTM discusses some issues which the NFA levitra online cheap has received inquiries about.  The guidance by the NFA is based on consultations with the CFTC staff.

The NFA has done a nice job of helping forex managers with the registration process and has also held a forex registration and compliance workshop recently.  The full notice is reprinted below.

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Notice to Members I-10-21

October 13, 2010

NFA offers guidance on CFTC’s final forex regulations

The Commodity Futures Trading Commission’s (CFTC) final Forex regulations are effective on October 18, 2010. NFA staff has received a number of inquiries from Members seeking further guidance and clarification on certain requirements. Based on further consultation with CFTC staff on Friday, October 8th, this Notice provides additional guidance on the following areas:

Risk Disclosure Statement Required by CFTC Regulation 5.5

CFTC Regulation 5.5 prohibits FCMs, RFEDs, and in the case of an introduced account, IBs from opening a retail Forex account until the FCM, RFED or IB has provided the customer with the required disclosure statement, along with the most recent quarterly customer account performance information, and obtained a signed acknowledgement of receipt of the disclosure document from the customer. Firms are not required to provide this disclosure statement to, or obtain the disclosure document acknowledgement from, a customer who opened an account prior to October 18, 2010 (existing customers). Additionally, firms are not required to provide the most recent quarterly customer account performance information to existing customers unless the customer requests the information.

Qualifying Institutions for Holding Assets Equal to Retail Forex Obligation

CFTC Regulation 5.8 identifies the financial entities that may be used to hold assets equal to the total amount owed to U.S. customers for Forex transactions. Assets may only be held in the U.S. or a money center country defined in Regulation 1.49. Qualifying institutions in the U.S. are limited to U.S. regulated banks or trust companies, SEC registered broker-dealers that are also members of FINRA and CFTC registered FCMs that are also members of NFA. Qualifying Institutions in a money center country are limited to banks or trust companies with regulatory capital in excess of $1 billion; broker-dealer or FCM equivalents with regulatory capital in excess of $100 million; and FCMs registered with the CFTC and members of NFA. RFEDs are not a qualifying entity for holding these assets. However, pursuant to CFTC Regulation 5.7, funds held at an RFED may be included as a current asset for minimum net capital purposes.

IB, CPO and CTA Registration

Otherwise regulated entities set forth in Section 2(c)(2)(B)(ii)(II)(aa), (bb), (ee) or (ff) of the Commodity Exchange Act do not have to be registered in the appropriate capacity with the CFTC in order to solicit retail Forex orders, manage retail Forex accounts or operate a retail Forex pool. This includes an otherwise regulated entity, such as a broker-dealer, that introduces retail Forex business to an FCM or RFED.

Other Registration Issues

Every firm that is required to be registered as an FCM, RFED, IB, CPO or CTA in connection with its Forex activity must be approved by NFA as a Forex firm. NFA Members are prohibited from engaging in retail Forex transactions with these firms unless the firm has received this designation. In addition, Forex firms must have at least one principal who is registered as an Associated Person (AP) and is approved as a Forex AP. All individuals who solicit retail Forex business or who supervise that activity must have taken and passed two exams — the National Commodity Futures Examination (Series 3) and the Retail Off Exchange Forex Examination (Series 34), which is a new exam focusing exclusively on Forex-related questions. However, individuals who were registered as APs, sole proprietors or floor brokers on May 22, 2008, do not need to take the Series 34 exam unless there has been a two year gap in their registration since that date.

Anyone needing additional information on these regulations should contact Sharon Pendleton (312-781-1401 or spendleton@nfa.futures.org) or Lauren Brinati (312-781-1215 or lbrinati@nfa.futures.org).

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Other related hedge fund law articles:

Bart Mallon, Esq. runs the hedge fund law blog and provides forex registration and compliance services to forex managers through Cole-Frieman & Mallon LLP.  He can be reached directly at 415-868-5345.

NFA Provides Guidance on Forex Registration Requirements

Bart Mallon, Esq. – Mallon P.C.
(www.forexregistration.com)

NFA Releases Notice Regarding Forex Registration

As we discussed in our post yesterday about outstanding issues with retail forex regulations, the NFA posted guidance regarding the final retail forex regulations passed by the CFTC earlier this week.  In general, the notice answers a few of the questions regarding implementation of the regulations, but many questions are left unanswered.

The central take-aways from the notice below include the following:

  • NFA will begin taking registration applications from forex firms on September 2
  • Retail forex firms not registered by October 18, 2010 must cease conducting retail forex business until registration is finalized
  • Forex only FCMs will need to register as an RFED even though they are already registered as a FCM
  • Forex APs will need to pass both the Series 3 and Series 34 exams (with certain exceptions)
  • Forex IBs, if guaranteed, can only have a guarantee agreement with one FCM/RFED

The release below is silent on the following issues:

  • Disclosure documents for Forex CTAs and CPOs - do these need to be reviewed and approved by the NFA prior to use by the registered forex firm?  If so, is the NFA providing expedited review for these forex applications?
  • Currently registered CTAs and CPOs who conduct a small amount of retail forex transactions – do APs at these firms also need to take and pass the Series 34 exam?  Are there additional items in the NFA online registration system which need to be completed?
  • Open positions on October 19, 2010 – what happens if a forex CTA or CPO is not registered by October 19, 2010?

Other questions deal with issues which we will seek clarification from the CFTC – the big open question is whether individuals will be able to open accounts at offshore forex firms.

It is also currently unknown what sort of paperwork or procedures the forex dealers will be requiring from the forex CTAs and CPOs in order to comply with the provisions of the CEA.

The following notice can be found here.

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Notice I-10-17

September 01, 2010

NFA to begin accepting registration applications from forex firms and individuals on September 2

The Commodity Futures Trading Commission has issued final forex rules which become effective on October 18, 2010. NFA will begin accepting registration applications from forex firms and individuals beginning Thursday, September 2.

Any retail forex entity that does not complete the registration process by October 18, 2010 will be unable to conduct retail forex business until registration and all necessary approvals and designations are granted.

As part of the reauthorization of the CFTC in May 2008, Congress amended the Commodity Exchange Act to require, with certain exceptions, including a Futures Commission Merchant (FCM) acting primarily or substantially as a traditional FCM, any firm acting as a counterparty to certain retail forex transactions to register as a Retail Foreign Exchange Dealer (RFED).

Consequently, any existing Forex Dealer Member of NFA that is currently registered as an FCM must register as an RFED unless the firm’s business is primarily or substantially that of a traditional FCM. Moreover, even if the firm’s business is primarily or substantially that of a traditional FCM, the firm must access NFA’s Online Registration System (ORS) and request approval as a Forex Firm and designation as a Forex Dealer Member.

The Commodity Exchange Act was also amended to require any individual acting as a forex solicitor, account manager or pool operator to register with the CFTC as Introducing Brokers (IBs), Commodity Trading Advisors (CTAs) or Commodity Pool Operators (CPOs) and become Members of NFA. Also, any Associated Person (AP) soliciting or supervising persons soliciting business on behalf of a forex firm must request approval as a Forex AP.

If you are not currently registered, you must comply with all registration and forex requirements.

If you are currently registered as an IB, CPO, CTA or AP that is conducting forex business, you must still apply for Forex Firm or Forex AP approval.

All individuals who solicit retail off-exchange forex business or who supervise that activity must take and pass two exams. One is the National Commodity Futures Examination (Series 3) and the other is the Retail Off-Exchange Forex Examination (Series 34), a new exam focusing exclusively on forex-related questions.

Individuals who were registered as APs, sole proprietors or floor brokers (FBs) on May 22, 2008 will not need to take the Series 34 exam unless there has been a two-year gap in their registration since that date.

Every approved Forex Firm (RFED, FCM, IB, CPO or CTA) must have at least one principal who is registered as an AP or FB and who is approved as a Forex AP.

In addition, any RFED branch office must have a branch office manager who has taken the Series 30 exam and is an approved Forex AP.

The Commission’s final forex rules do not require Forex Firm IBs to be guaranteed. However, if a Forex Firm IB is guaranteed, the IB can only have one guarantor. In other words, an IB cannot be guaranteed by an FCM for futures business and a different RFED for forex business.

NFA has prepared a “Registration Overview for Retail Foreign Exchange Dealers and Forex IB, CTA and CPO Applicants” that provides additional registration information. You can also find information and guidance on NFA’s website.

Additionally, NFA’s Information Center (800-621-3570) is available from 8:00 a.m. – 5:00 p.m. CT, Monday through Friday.

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Cole-Frieman & Mallon LLP is a law firm and provides legal support and forex registration and compliance services to forex managers.  Bart Mallon, Esq. can be reached directly at 415-868-5345.

CFTC Releases Final Retail Forex Rules

New Regulations Effective as of October 18, 2010

The final retail Forex regulations (which requires registration for forex CTAs, CPOs and IBs) have been published in the Federal Register.  The final regulations will be effective as of October 18, 2010.  The regulations were adopted essentially as written with the execption of two major issues:

  • Leverage – while the proposed rules called for a maximum leverage of 10:1, the final rules allow the NFA to determine the margin requirements for the currencies within a defined set of CFTC parmeters.  Currently the parameters include 50:1 leverage for major currencies and 20:1 leverage for all other currencies.
  • Forex Introducing Brokers – the proposed rules called for all forex introducing brokers to be guaranteed by a single FCM or RFED.  The final rules allow a forex introducing broker to be either guaranteed or independent, consistent with other regulated futures IBs.

We have not yet had a chance to talk with the NFA or the CFTC about the new rules, but we recommend that all groups who may have to register with the NFA to begin the forex registration process as soon as possible (which includes taking the Series 34 exam) because of the large amount of applications the NFA will receive because of the final regulations.

The full CFTC press release is reprinted below.

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August 30, 2010

CFTC Releases Final Rules Regarding Retail Forex Transactions

Washington, D.C. – The U.S. Commodity Futures Trading Commission (CFTC) today announced the publication in the Federal Register of final regulations concerning off-exchange retail foreign currency transactions. The rules implement provisions of the Dodd-Frank Wall Street Reform and Consumer Protection Act and the Food, Conservation, and Energy Act of 2008, which, together, provide the CFTC with broad authority to register and regulate entities wishing to serve as counterparties to, or to intermediate, retail foreign exchange (forex) transactions.

“These rules of the road will help protect the American public in the largest area of retail fraud that the CFTC oversees: retail foreign exchange,” CFTC Chairman Gary Gensler said. “All CFTC registrants involved in soliciting and selling retail forex contracts to consumers will now have to comply with rules to protect the investing public. This is also the first final rule that the Commission has published to implement the Dodd-Frank Wall Street Reform and Consumer Protection Act. We look forward to publishing additional rules to protect the American public.”

The final forex rules put in place requirements for, among other things, registration, disclosure, recordkeeping, financial reporting, minimum capital and other business conduct and operational standards. Specifically, the regulations 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. Persons who solicit orders, exercise discretionary trading authority or operate pools with respect to retail forex also will be required to register, either as introducing brokers, commodity trading advisors, commodity pool operators (as appropriate) or as associated persons of such entities. “Otherwise regulated” entities, such as United States 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 final rules 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 are required to maintain net capital of $20 million plus 5 percent of the amount, if any, by which liabilities to retail forex customers exceed $10 million. Leverage in retail forex customer accounts will be subject to a security deposit requirement to be set by the National Futures Association within limits provided by the Commission. All retail forex counterparties and intermediaries will be required to distribute forex-specific risk disclosure statements to customers and comply with comprehensive recordkeeping and reporting requirements.

The final rules become effective October 18, 2010.

Last Updated: August 30, 2010

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Other related hedge fund law articles:

Cole-Frieman & Mallon LLP is a forex law firm and provides legal support and forex registration services to forex managers.  Bart Mallon, Esq. can be reached directly at 415-868-5345.

NFA Registration for Forex Managers with a Disciplinary Record

In January 2010, the CFTC proposed rules regarding regulation of retail off-exchange foreign currency (forex) products.  It received over 9,000 comments relating to the forex rules and will start publishing final rules this fall. One component of the proposed rules requires all forex account managers and pool operators to register with the CFTC as forex CTAs and CPOs and to become NFA Members.  For those forex managers with criminal disclosures, a concern is how long it will take to get through the registration process and what registration will entail.

This article describes the registration process for forex managers with disciplinary disclosures and the issues they will likely face.

Anticipated Forex Registration Process

The forex registration procedures are likely going to be the same as those currently in place for regular CPOs and CTAs.  CPOs and CTAs must file the following:

  • a completed online Form 7-R (including NFA membership sections)
  • a non-refundable application fee
  • CPO/CTA Membership Dues

Principals and Associated Persons of a CPO or CTA must also file the following:

  • a completed online Form 8-R
  • Fingerprint Cards
  • Proficiency Requirements (e.g. Series 3)
  • a non-refundable Principal Application Fee
  • a non-refundable Associated Person Application Fee

In addition to providing the application materials discussed above, forex managers will likely have to meet regulatory exam requirements–the Series 34 and Series 3 exams.

Disciplinary Disclosures on Forms 7-R and 8-R

On Forms 7-R and 8-R, the manager must provide disciplinary information for the firm, the Principals, and the Associated Persons.  This includes criminal disclosures, regulatory disclosures, and financial disclosures.  The NFA has indicated that if any of the disciplinary information disclosed is a disqualification from registration under Sections 8a(2) or 8a(3) of the Commodity Exchange Act, the application will probably be reviewed by an internal NFA committee.

Disqualifications under Sections 8a(2) and (3) include, for example:

  • suspension or revocation of prior NFA registration
  • a permanent or temporary injunction from (i) acting as an FCM, IB, floor broker, floor trader, CTA, CPO, associated person, securities broker, etc.; or (ii) activity involving embezzlement, theft, extortion, fraud, misappropriation of funds, etc.
  • a conviction within 10 years for a felony that (i) involves transactions or advice concerning futures contracts; (ii) arises out of the conduct of the business of an FCM, IB, floor broker, CTA, CPO, etc.; or (iii) involves embezzlement, theft, extortion, fraud, misappropriation of funds, securities or property, forgery, etc.
  • a finding, by a federal or state regulatory body, that the manager has violated various securities and commodities laws

It is important to disclose all disciplinary matters.  Failure to disclose such matters could be an additional ground for disqualification from registration.  It is also important that if the forex manager answers “Yes” to any of the disciplinary information questions, he or she provides a written explanation detailing the events and conduct involved.  In addition to this explanation, other documents may also be required by the NFA (e.g. court records).  Failure to provide the additional documentation will inevitably delay the registration process.

Providing Additional Documents for Criminal Matters

If a criminal matter is disclosed, the NFA will want documents that reflect the following information:

  • the complaint;
  • the entry of a plea or plea agreement, or judgement/conviction;
  • the sentence;
  • proof that you completely satisfied your sentence; and
  • the final outcome of the court’s action .

It is probably best to request your entire court file so that the documents are available for the NFA.

Review by an Internal NFA Committee or Scheduling a Hearing

Upon receiving the application materials listed above (and any required supplemental documents (e.g. court records)), the reviewer will forward the case on to the internal NFA committee.  We spoke informally to an NFA reviewer who stated that the committee hears cases once a week, on a first-in, first-out basis.  That committee will review the circumstances of each disqualification independently and decide whether to approve registration or to recommend a proceeding to deny registration.  The NFA reviewer we spoke to said that a decision by this committee is generally made within 24 hours.  Upon approval, the firm will appear on the NFA’s BASIC search engine.  If the application is denied, a denial letter is sent to the manager.  A hearing can then be scheduled with the legal department and additional information regarding the registration may be provided.

At the end of the hearing, the registration is essentially either denied, approved, or approved with conditions.  It is difficult to predict the amount of time it would take for a forex manager with a criminal record to get through the NFA registration process.  If supplemental documents (e.g. court records) are missing, the reviewer will have to send deficiency letters to the manager, which will delay the registration process.

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Other related hedge fund law articles:

Cole-Frieman & Mallon LLP provides legal support and forex registration services to forex managers.  Bart Mallon, Esq. can be reached directly at 415-868-5345.

Forex Registration Workshop Announced

NFA to Discuss Forex Registration in Vegas

The NFA announced a workshop to inform forex managers about the various registration and compliance matters that managers will need to be especially aware of during the registration process.  While we do not yet know what the final rules will look like, we do know a few things and believe that managers will need to focus on the following issues:

  • Series 34 exam – this is an exam specifically for forex managers.  In addition to the Series 34, the managers will most likely need to have passed the Series 3 exam as well.
  • Forex Compliance – all NFA registrants will need to make sure they are compliant with all CFTC laws and regulations in addition to NFA rules.
  • Forex Disclosure Documents – all forex CTAs and CPOs will need disclosure documents.  While these disclosure documents will be similar to traditional futures/commodities disclosure documents, there are some specific forex disclosures managers will also need to include in the documents.  As always, managers should remember that the disclosure documents and the managed account agreement are legal documents and should be drafted by an attorney.

The full NFA announcement is reprinted below.

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NFA’s Registration/Compliance Workshops for Currently Unregistered Forex IBs, CPOs and CTAs in Conjunction with the Upcoming Futures and Forex Expo

Caesars Palace in Las Vegas
Saturday, September 25, 2010

In early 2010, the Commodity Futures Trading Commission (CFTC) published its proposed rules regarding the regulation of retail off-exchange foreign currency (forex) products. One component of the proposed rules requires all forex introducing brokers, account managers and pool operators to register with the CFTC as forex IBs, CTAs and CPOs and to become Members of National Futures Association (NFA).

In anticipation of the publication of the CFTC’s final rules, NFA will be offering registration/compliance workshops in conjunction with the upcoming Futures and Forex Expo to be held on September 23-25 at Caesars Palace in Las Vegas. These workshops will outline the registration process and discuss regulatory requirements for each registration category.

The schedule for the workshops is as follows:

  • 8:30 – 10:30 a.m. Registration workshop for all registration categories. This session will cover who has to register and will present a walkthrough of the registration process.
  • 10:30 a.m. – 12:00 p.m. General compliance workshop for all registration categories. This session will include discussion of NFA rules regarding promotional material/sales practices, supervisory procedures (including ethics training requirements, supervision of branch offices and disaster recovery/business continuity planning) and anti-money laundering requirements.
  • 1:30 – 3:00 p.m. Disclosure documents/financial requirements workshop for CPOs and CTAs, including performance reporting.
  • 3:00 – 5:00 p.m. NFA staff available for one-on-one consultations.

All workshops will be held in the Tribune Room in the Convention Center at Caesar’s Palace.

Although there is no fee to attend the workshops, advanced registration is recommended.

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Other related forex law articles:

Cole-Frieman & Mallon LLP provides legal support, registration and compliance services to all types of forex managers.  Bart Mallon, Esq. can be reached directly at 415-868-5345.

Cole-Frieman & Mallon LLP Comments on Proposed Retail Forex Regulations

www.hedgefundlawblog.com

Text of the Cole-Frieman & Mallon LLP comment is provided below.

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[Footnotes ommitted]

March 22, 2010

VIA ELECTRONIC MAIL
AND COURIER

Mr. David Stawick
Secretary
Commodity Futures Trading Commission
1155 21st Street, NW
Washington, DC 20581

Re: Request for Comment on Proposed Regulation of Off-Exchange

Retail Foreign Exchange Transactions and Intermediaries

Dear Mr. Stawick:

This letter is in response to the request of the Commodity Futures Trading Commission (the “Commission”) in RIN 3038–AC61 (the “Release”)  for comment on certain proposed regulations (the “Proposed Regulations”) under the Commodity Exchange Act (“CEA”)  as amended by the CFTC Reauthorization Act of 2008 (the “CRA”).  The Proposed Regulations as drafted would establish requirements for, among other things, registration, disclosure, recordkeeping, financial reporting, minimum capital, and other operational standards with respect to retail off-exchange foreign currency (“forex”) transactions.

Cole-Frieman & Mallon LLP is a law firm which represents a substantial number of clients who are domestic forex market participants and who would be directly affected by the Proposed Regulations. We appreciate the opportunity to comment on the Proposed Regulations, especially considering that the regulations, if adopted as proposed, would significantly affect the business of many of our clients. While we have discussed these views with our clients, and they share many of the same views, the comments expressed in this letter are our own.

Overview of Proposed Retail Forex Regulations

The Proposed Regulations would, among other things, (i) require certain retail forex market participants to register with the Commission, (ii) require counterparties dealing in retail forex to increase the security deposit for forex transactions, (iii) establish certain net capital levels for forex counterparties, and (iv) require introducing brokers to retail forex transactions to operate pursuant to a guarantee agreement with only one forex counterparty.

The landscape in which the Proposed Regulations were developed is important. Prior to the CRA, the Commission did not have an explicit grant of jurisdiction over the off-exchange spot forex markets  and there was, accordingly, little regulatory oversight of certain market participants. Without a mandate to require registration of such market participants, run-of-the-mill common law fraud proliferated  as regulators were impotent to stop these scams. While state laws were able to address many of these cases after the fact, the Commission sought to regulate the industry as a proactive means to prevent fraud. At the same time, many legitimate domestic forex businesses sought ways to distinguish themselves from the fraudulent players in the industry by voluntarily registering with the Commission as commodity pool operators (“CPOs”), commodity trading advisers (“CTAs”), introducing brokers (“IBs”) and futures commission merchants (“FCMs”).  These businesses, like many of the firms and individuals who have responded to the Commission’s request for comments, fully appreciate the important role that regulatory bodies play in “cleaning up” the industry and making sure that bad actors do not continue to tarnish the names of hard working individuals who have helped to create a competitive and robust industry in the United States.

We agree with many of the Proposed Regulations and believe they serve important investor protection functions, however we are concerned that some of the Proposed Regulations will not protect investors and will have a deleterious effect on the United States forex industry. It is within this context, and with the goal of helping to create a considered regulatory regime that emphasizes both investor protection and the continued economic viability of the domestic retail forex industry, we make the following comments.

Registration of Forex Market Participants

Registration of Forex CPOs, CTAs and IBs

The Proposed Regulations require persons to register with the Commission as forex CPOs, forex CTAs, and forex IBs, as appropriate.  The Proposed Regulations also create a new registration category for retail foreign exchange dealers (“RFEDs”) and require RFEDs to register as such with the Commission.  Certain employees of the foregoing registrants would be required to register with the Commission as associated persons (“APs”), as appropriate.  The registered firms and APs would also be required to become members of a registered futures association.  In addition to registration, Proposed Regulation 5.4 would require certain disclosure, recordkeeping and reporting requirements for forex CPOs and CTAs.

We broadly believe that requiring forex CPOs, CTAs, and IBs to register with the Commission is reasonable.  It is clear that the standards to operate as a Commission registered firm and National Futures Association (“NFA”) Member Firm are high. In order to complete registration, each firm needs to designate at least one person as an AP/Principal, and that person needs to meet certain proficiency requirements,  background checks, and other investigations into the person’s fitness to provide services to customers.  Once registered, forex CPOs and CTAs are generally required to have their disclosure documents reviewed by the NFA prior to soliciting customers.  These measures provide both the Commission and the NFA with ample opportunity to review firms and individual applicants. Once registered, Member Firms will be required to implement recordkeeping and compliance programs under both Commission regulations and NFA Rules.  In addition to self-examination and compliance mandates, NFA Member Firms are subject to routine audit and the NFA has made it clear that it intends to heavily monitor Member Firms involved in the retail forex industry.  It is our belief the foregoing measures are sufficient to achieve the goal of investor protection while remaining within with the Commission’s statutory duty to utilize the least anti-competitive means possible.

Lower Leverage Requirement

The heavily criticized Proposed Regulation 5.9 requires RFEDs and FCMs engaging in retail forex transactions to collect from the retail customer a security deposit of ten percent of the notional value of the transaction. The regulation would also require the RFED or FCM to collect an additional security deposit or liquidate the position if the account value drops below the 10:1.  The Release cites a number of reasons for limiting leverage including: (i) extreme volatility of the forex markets; (ii) potential customer liability for losses if positions are not closed out; (iii) counterparty risk; and, (iv) current and proposed margin requirements by other regulatory bodies, including FINRA.  It is unknown if the Commission spoke with any industry participants such as FCMs or forex customers when considering this provision.

We strongly oppose Proposed Regulation 5.9. We believe that reducing leverage for retail forex transactions to 10:1 will not serve to protect customers and will likely, instead, harm the domestic forex industry. Many of the reasons cited by the Commission for the reduction of leverage are simply ill-founded and have previously been examined by the NFA.  We believe that the Commission should not pass the proposed regulation as written because the NFA’s current leverage requirement adequately protects investors and it is clear that there are serious anti-competition issues with the proposed regulation.

NFA Section 12 Provides Greater Leverage

Proposed Regulation 5.9 was promulgated notwithstanding that the NFA just recently implemented a rule, approved by the Commission on November 30, 2009, requiring leverage for Forex Dealer Members (“FDMs”) of 100:1 for major currencies and 25:1 for non-major currencies.  In proposing the rule change (in which the NFA actually increased the leverage allowances), the NFA took a considered approach to the issue. The NFA (i) researched then current FCM and FDM practices with respect to leverage, (ii) researched the practices of other industry groups, (iii) solicited comments from FDMs on proposed rules, (iv) discussed the issue with an FDM advisory committee, and (v) independently investigated the issue.  In proposing the leverage rule, the NFA stated that it “believes that the amendments [100:1 and 25:1 leverage] are the best way to address NFA’s customer protection concerns with certain FDMs’ use of leverage.”  The NFA further stated that:

Based on our experience with FDM practices, including that most FDMs use systems that liquidate customer positions before they reach a negative balance, NFA believes that the 1% and 4% security deposit requirement amounts remain sufficient at this time to protect against financial harm to FDMs and their customers even though they are significantly lower than margin requirements for on-exchange equivalents.  [emphasis added]

We strongly agree with the NFA’s current leverage requirements. We believe that the NFA took the appropriate time and care necessary to properly research this issue and that significant deference should be given to the NFA’s margin requirements for Commission registrants.

Unprecedented Industry Resistance to Lower Leverage

As of March 22, 2010, the Commission published on its website almost 9,000 comments. These comments were prepared and submitted by all types of participants within the retail forex industry including: forex investors, market participants such as forex CPOs, forex CTAs, forex IBs, FCMs, FDMs, and two newly formed coalitions – the Forex Exchange Dealers Coalition and the IB Coalition. The comments were overwhelmingly against leverage reduction and a majority have cited a number of reasons including: (i) liberty/freedom to contract; (ii) job loss from trading going overseas;  and, (iii) lack of protections to domestic investors in offshore jurisdictions.

We share the views expressed in many of the comments, especially with respect to the viability of the forex industry in the United States if lower leverage is required. As many comments noted, if lower leverage is instituted, customers will simply move their accounts to offshore brokers who provide leverage of 200:1 or more. It is common knowledge that these offshore brokers can be unreputable and may actually provide investors with fewer safeguards than domestic brokers who are (and will continue to be) subject to oversight by both the Commission and the NFA.

Net Capital Requirements

Proposed Regulation 5.7 requires each FCM engaged in retail forex transactions and each RFED to maintain a certain minimum net capital. The net capital requirement would require firms to maintain the greater of: $20 million; $20 million plus 5% of the total retail forex obligation in excess of $10 million; any amount required under Commission Regulation 1.17; or amounts required by a self regulatory organization of which the FCM or RFED is a member.  The purpose of these requirements is to protect retail customers in the absence of bankruptcy protection for segregated funds by making sure that FCMs and RFEDs will be able to remain solvent.

We believe that absent bankruptcy protection for segregated funds, high net capital requirements are the best way to protect the assets of retail investors. We do note, however, that high net capital requirements limit the groups who are able to participate as principals in these markets.

Introducing Broker Guarantee Agreement

Proposed Regulation 1.10 requires forex IBs to enter into a guarantee agreement with a RFED or FCM in connection with retail off-exchange forex transactions.  The Commission will prepare a new Part C guarantee agreement to the Form 1-FR-IB which, according to the Release, will make FCMs and RFEDs jointly and severally liable for all obligations of the IB with respect to the solicitation of, and transactions involving, all retail forex customer accounts of the IB entered into on or after the effective date of the guarantee agreement. The Commission believes that the guarantee requirement serves the public’s interest by creating a marketplace where improper practices by IBs are discouraged while still permitting FCMs and RFEDs to make use of outside salespeople.

We strongly disagree with Proposed Regulation 1.10. We believe it will effectively eliminate almost all forex IBs and put a number of honest and ethical forex IBs out of business. While it would be true that RFEDs and FCMs would still be able to utilize outside sales agents, in practice RFEDs or FCMs are not going to take on the risk of guaranteeing forex IBs.

We also cannot support this proposal because we believe that there is strong oversight of forex IBs and that registration will further weed out unscrupulous players. As we discussed above, the NFA is tasked with significant oversight responsibilities and does not take this mandate lightly. While a forex CPO or CTA may be able to become initially registered within a matter of weeks (assuming the firm and principals have clean regulatory histories), a forex IB application may take three to six months or longer to be approved. Also, unlike forex CPOs and CTAs, the NFA requires forex IBs to have robust Anti-Money Laundering procedures, Business Continuity Plans and other compliance policies and procedures in place prior to registration. During the IB registration process the NFA examiners thoroughly review an applicant’s background and operating procedures. Additionally, the NFA requires independent IBs to maintain a $45,000 net capital requirement and to submit financial information on a semi-annual basis.  In our opinion this existing regulatory framework of review procedures and net capital rules is more than sufficient to ensure investor protection.

Furthermore, we concur with a number of commenters who have noted that there are fairness concerns vis-a-vis introducing brokers to on-exchange traders. We believe that the Commission can achieve its goal of investor protection through less anti-competitive means.

Grandfathering Provision Should be Added

In the event the Commission adopts the proposed regulation as drafted, we believe the Commission should provide a grandfathering provision for current forex IBs who would be put out of business if the proposed regulation was passed as currently written. Additionally, the Commission should clarify the manner in which independent IBs are treated if they make introductions to both exchange traded futures products in addition to retail forex.

Other Issues

Technical Revisions

The Proposed Regulations include a number of revisions to current Commission regulations which are necessary from a technical perspective to ensure the new regulations are properly implemented within the Commission’s statutory framework. We agree that technical adjustments to current rules are necessary and applaud the Commission for trying to streamline regulation as much as possible.  Certain technical aspects of the rules, however, should be revised with appropriate industry input.  Additionally, any adopted leverage regulation will likely necessitate a change to certain provisions which currently reference the NFA leverage rule.

Disclosure Document Risk Statements

Proposed Regulations 4.24 and 4.34 provide certain risk disclosure statements which must be included at the beginning of forex CPO and CTA disclosure documents. We completely understand the purpose of this requirement and we also understand that this practice would mirror the current requirements for CPOs and CTAs. However, we do not believe that consumers actually read long paragraphs of legal disclaimers in large capital letters. In the future, the Commission should consider a succinct bullet point list. We believe that consumers are more likely to read and understand information in such format.

Regulation 5.5(e)

Proposed Regulation 5.5 would require FCMs, RFEDs and forex IBs to provide retail forex customers with a risk disclosure statement similar to the statement currently required for customers engaging in on-exchange trading. Proposed Regulation 5.5(e) would additionally require these firms to disclose additional information which is not required to be disclosed for on-exchange trading.  We believe that Proposed Regulation 5.5(e) should not be deleted because it would not further any true investor protection and would likely be anti-competitive.

Conclusion

The proposed rules seek to develop a comprehensive regulatory structure for the off-exchange retail forex industry. We have provided the Commission with these comments in the hope of helping to create a robust but appropriate regulatory environment while preserving the industry’s ability to succeed in a global forex marketplace. We appreciate the opportunity to comment on the Release. If you have any questions regarding this letter, please contact the undersigned at 415-868-5345.

Very truly yours,

Cole-Frieman & Mallon LLP

Bart Mallon

Retail FOREX Registration Regulations Proposed

Forex Managers Required to be Registered Under New Regulations

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:

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