May 27, 2005
Upfront fees may require FCMs and IBs to provide customers with additional disclosure
NFA staff has recently noted that some FCMs and IBs marketing trading programs on behalf of CTAs are implementing fee structures that differ from the traditional per trade or round-turn commission. For example, NFA staff has found IBs that charge a load fee or upfront fee equal to a certain percentage of the customer's initial investment. This is sometimes accompanied by a round-turn commission in addition to that charged by the FCM or a lower round-turn commission plus a percentage fee based upon the month-ending equity in the customer's account. Since the CTA being promoted by the FCM or IB does not typically participate in these upfront fees, their overall impact is not reflected in the CTA's performance.
While the customer is given a description of each fee that will be charged by each of the parties, the customer does not always get a clear picture of the cumulative impact of those fees. In fact, NFA staff has found individual cases in which the total fees have a substantial impact on a customer's ability to achieve a profit.
NFA is issuing this Member Advisory to remind Members that NFA Interpretive Notice, "NFA Compliance Rule 2-4: Guidelines for the Disclosure by FCMs and IBs of Costs Associated with Futures Transactions," Para. 9005, NFA Manual (March 1, 2004), requires FCMs and IBs to provide a complete written explanation of any costs and fees that are not determined on a per trade or round-turn basis. This Interpretive Notice was one of the first Notices adopted by NFA's Board. It was approved by the CFTC and has the same effect as a rule.
In the instances noted above, NFA staff required the FCM and/or the IB to provide a more detailed explanation of the fees being charged to the customer in the form of a break-even analysis outlining all fees charged by each of the parties - the CTA, FCM, and IB - similar to that required of CPOs in the Interpretative Notice entitled "Compliance Rule 2-13: Break-even Analysis," Para. 9023, NFA Manual (March 1, 2004). This analysis reflects the rate of return the customer must realize on an investment in order to break even in the first year.
For example, NFA staff required the FCM and/or IB to provide customers with a break-even analysis for each CTA for which the FCM or IB is soliciting and will charge upfront fees. Further, NFA staff required that any material used by the FCM or IB to promote the performance of the CTA disclose the existence and amount of the FCM's or IB's fees and discuss their impact on the customer's ability to achieve returns similar to those being promoted.
While FCMs and IBs may employ various compensation arrangements, Members must ensure that all fees and charges are fully disclosed when or before a customer opens an account. FCMs and IBs that elect to charge upfront fees should consider the total impact of all fees being charged to their customers, including those charged by CTAs. If the FCM's or IB's fees have a material impact on their customers' ability to make profits, Members should provide a break-even analysis.
If you have any questions regarding the material discussed in this Advisory, please contact Sharon Pendleton (312-658-6540 or firstname.lastname@example.org) or Mary McHenry (312-781-2237 or email@example.com).
NFA Members can file many of their required documents electronically.