(additions are underscored and deletions are
* * *
PART 1 - DEFINITIONS
RULE 1-1. DEFINITIONS.
(a) "Act" - means the Commodity Exchange Act.
(b) "Actual Funds" - means the equity in a commodity trading account over which a CTA has trading authority and funds that can be transferred to that account without the client's consent to each transfer.
(c) "Appeals Committee" - means the Appeals Committee established under NFA Bylaw 702.
(c)(d) "Associate" - means a person who is associated with a Member within the meaning of the term "associated person" as used in the Act and Commission Rules and who is required to be registered as an "associated person" with the Commission. (d)(e) "Business Conduct Committee" - means the Business Conduct Committee established under NFA Bylaw 704. (e)(f) "Commission" or "CFTC" - means the Commodity Futures Trading Commission. (f)(g) "Commodity Pool Operator" or "CPO" - means a person who is required to register or is registered as a commodity pool operator under the Act and Commission Rules. (g)(h) "Commodity Trading Advisor" or "CTA" - means a person who is required to register or is registered as a commodity trading advisor under the Act and Commission Rules. (h)(i) "Contract Market" - means an exchange designated by the Commission as a contract market in one or more commodities or licensed by the Commission for the trading of options. (i)(j) "Exchange Act" - means the Securities Exchange Act of 1934. (j)(k) "Foreign Board of Trade" - means a board of trade, exchange, or market located outside the United States, its territories or possessions. (k)(l) "Foreign Futures" and "Foreign Options" - means futures and options transactions made or to be made on or subject to the rules of a foreign board of trade. (l)(m) "Foreign Futures or Foreign Options Customer" - means any person located in the United States, its territories or possessions who trades in foreign futures or foreign options. (m)(n) "Futures" includes-
(2) option contracts granted by a person that has registered with the Commission under Section 4c(d) of the Act as a grantor of such option contracts or has notified the Commission under the Commission's rules that it is qualified to grant such option contracts;
(3) foreign futures and foreign options made or to be made on or subject to the rules of a foreign board of trade for or on behalf of foreign futures or foreign options customers as those terms are defined in the Commission's rules;
(4) leverage transactions as that term is defined in the Commission's rules; and
(5) security futures products, as that term is defined in Section 1a(32) of the Act.
(n)(o) "Futures Commission Merchant" or "FCM" - means a person who is required to register or is registered as a futures commission merchant under the Act and Commission Rules. (o)(p) "Hearing Committee" - means the Hearing Committee established under NFA Bylaw 707. (p)(q) "Introducing Broker" or "IB" - means a person who is required to register or is registered as an introducing broker under the Act and Commission Rules. (q)(r) "Leverage Transaction Merchant" or "LTM" - means a person who is required to register or is registered as a leverage transaction merchant under the Act and Commission Rules. (r)(s) "Member" - means a Member of NFA other than a contract market.
(t) "Nominal Account Size" - means the account size agreed to by the client that establishes the level of trading in the particular trading program.
(u) "Partially-Funded Account" - has the same meaning as in CFTC Regulation 4.10(m).
(s)(v) "Person" - includes individuals, corporations, limited liability companies, partnerships, trusts, associations and other entities.
(w) "Qualified Eligible Person or QEP" - has the same meaning as in CFTC Regulation 4.7(a).
(t)(x) "Requirements" - includes any duty, restriction, procedure or standard imposed by a charter, bylaw, rule, regulation, resolution or similar provision. (u)(y) "Security Futures Products" - has the same meaning as in Section 1a(32) of the Act.
PART 2 - RULES GOVERNING THE BUSINESS CONDUCT OF MEMBERS REGISTERED WITH THE COMMISSION
* * *
RULE 2-29. COMMUNICATIONS WITH THE PUBLIC AND PROMOTIONAL MATERIAL
* * *
(b) Content of Promotional Material
No Member or Associate shall use any promotional material which:
(ii) in the case of rate of return figures, unless such figures are calculated in a manner consistent with
that required under CFTC Regulation 4.25(a)(7) (i)(F) for commodity pools and with CFTC Regulation 4.35(a)(6), as modified by NFA Compliance Rule 2-34(a), for figures based on separate accounts, or
RULE 2-34. CTA PERFORMANCE REPORTING AND DISCLOSURES
(a) Performance Information
(2) Draw-down information reported under CFTC Regulation 4.35(a)(1)(v) and (vi) must be based on rate of return figures using nominal account size as the denominator.
(3) In calculating net performance, Member CTAs may include interest earned on actual funds but may not impute interest on other funds.
(b) Written Confirmation for Partially-Funded Accounts
(ii) the nominal account size agreed to by the client and the CTA.
(2) For new clients, the written confirmation must be received from or delivered to the client before the CTA places the first trade for the client.
(3) For existing clients, the written confirmation must be received from or delivered to the client before the CTA places the first trade after any of the information required under Section (b)(1) of this rule changes. The written confirmation must include the new information and the effective date of the change but need not include any information that will remain the same.
(c) Additional Disclosures for Partially-Funded Accounts
CTAs must provide the following information to clients with partially-funded accounts if the clients are not QEPs:
(2) An explanation of how cash additions, cash withdrawals, and net performance will affect the nominal account size,
(3) A brief explanation regarding the effect of partial funding on margin and leverage,
(4) A statement that partial funding increases the fees and commissions as a percentage of actual funds but does not increase the dollar amount of those fees, and
(5) A description, by example or formula, of the effect of partial funding on rate of return and drawdown percentages.
(d) CPO Use of CTA Performance Information
Member CPOs who are required by CFTC Regulation 4.25(c) to disclose CTA performance must report the CTA performance on the same basis as the CTA is required to report it.
* * *
COMPLIANCE RULE 2-34: Performance Reporting and Disclosures
In July 2003, the Commodity Futures Trading Commission adopted a core principle for calculating rate of return (ROR) for partially-funded accounts. The Commission noted, however, that its core principle approach would not preclude NFA from developing more explicit guidance or performance standards.
NFA's Board of Directors believes that Member CTAs should use a uniform calculation to make it easier for clients to compare the performance of different CTAs. The Board also believes that ROR should be based on the amount that is the basis for the CTA's trading decisions so that ROR measures the CTA's true performance rather than its client's various cash management practices. Therefore, NFA's Board has adopted NFA Compliance Rule 2-34 to provide performance standards for Member CTAs and to require certain disclosures to ensure that clients understand the consequences of partially funding their accounts. The Board has also adopted this Interpretive Notice to provide additional guidance to CTA Members regarding performance reporting and disclosure.
CTAs will not be required to restate their previous performance, although they may choose to do so. As with any other information, however, a CTA must make any additional disclosures that are necessary to ensure that its performance record is not misleading.
Documenting the Nominal Account Size
The Board recognizes a client may elect to partially fund its account by depositing less funds with the FCM carrying its account than the client has directed the CTA trading the account to use as the basis for trading decisions. The Board believes that the nominal account size should be documented to provide "discipline in the denominator" by assuring that the client and the CTA have agreed on the account size before the account begins trading. This documentation will also provide an objective audit trail to verify past performance records.
Compliance Rule 2-34(b) requires the CTA to document the trading program and nominal account size for each client who partially funds its account by either receiving a written confirmation from or providing a written confirmation to the client with the required information. For example, the information could be included in the advisory agreement or delivered to the client as a separate document. Although NFA assumes that most CTAs will receive or provide this confirmation at the same time the CTA enters into an advisory agreement to direct or guide the client's account, NFA Compliance Rule 2-34(b) only requires that it occur before the CTA places the first trade.
The Rule does not require the CTA to get the client's written acknowledgement to a confirmation provided by the CTA, although the CTA may choose to do so. If the CTA does not require a written acknowledgement, the confirmation should inform the client that the client must notify the CTA, within a reasonable period specified in the confirmation, if the client does not agree with the terms included in the confirmation. The confirmation may be delivered in any manner consistent with CFTC requirements for delivery of account statements by commodity pool operators under CFTC Regulation 4.22(i).
Compliance Rule 2-34(c) requires CTAs to provide certain information to clients with partially-funded accounts if those clients are not QEPs. This information is designed to ensure that less sophisticated customers understand the effects of partial funding so that they can make informed decisions when funding their accounts.
Subsection (c)(2) requires the CTA to explain how each element of cash additions, cash withdrawals, and net performance will affect the nominal account size. If these items will not affect the nominal account size, the CTA may make an affirmative statement to that effect.
Under Compliance Rule 2-34(c)(5), the CTA must provide a description, by example or formula, of the effect of partial funding on ROR and drawdown percentages. A CTA may provide this information by example using a simple matrix showing the effect of partial funding at different funding levels. In the alternative, it may provide the client with the formula for converting ROR percentages based on the nominal account size to ROR percentages based on the partial funding level, e.g.:
(nominal account size / actual funds) * n = a
where n is the ROR percentage based on the nominal account size and a is the ROR percentage based on actual funds
The disclosures required by Compliance Rule 2-34(c) can be included in the CTA's disclosure document or the advisory agreement. They can also be provided in a separate document delivered to the client before the CTA places the first trade for the client.
Compliance Rule 1-1(b) defines actual funds as the equity in a commodity trading account over which a CTA has trading authority and funds that can be transferred to that account without the client's consent to each transfer. Funds that are not in the trading account, often referred to as committed funds, qualify as actual funds only if they meet the following four tests:1
1. The ownership of the accounts must be identical;
2. The funds must be available for transfer (e.g., free credit balances that are not committed to another CTA's trading program);
3. The client must agree in writing that the FCM can transfer the funds to the managed account at the CTA's request; and
4. The CTA must be able to verify the amount of these funds.2
As a general rule, accounts in the same trading program will be included in the same composite performance capsule.3 Since Compliance Rule 2-34(a) requires ROR to be calculated on nominal account size, the RORs for these accounts should be materially the same. Accounts with materially different RORs should not, however, be included in the same performance capsule.4
Whether RORs are materially the same may vary depending on the circumstances. However, as long as the accounts are part of the same trading program, the following test provides a safe harbor for determining whether the accounts have materially the same ROR.5
All performance information must be presented in a manner that is balanced and is not misleading. CTAs have an obligation to disclose all material information even if it is not specifically required by CFTC or NFA rules. Compliance Rule 2-34 and this Interpretive Notice do not relieve CTAs of that obligation.
1 These tests are derived from CFTC Advisory 87-2, [1986-1987 Transfer Binder] Comm. Fut. L. Rep. (CCH) paragraph 23,624 (June 2, 1987).
2 Compliance Rule 2-34(a) provides that Member CTAs may include interest earned on actual funds but may not impute interest on other funds when calculating net performance. The CTA must be able to verify the amount of interest earned on the funds if the CTA includes that interest as part of its net performance.
3 Accounts in the same trading program generally have the same pattern of trading.
4 Accounts that use different trading strategies should not be included in the same performance capsule even if their RORs are materially the same.
5 This same materiality test can be used in other contexts. For example, NFA's interpretive notice entitled "NFA Compliance Rule 2-10: The Allocation of Bunched Orders for Multiple Accounts" (paragraph 9029) requires CTAs to modify their allocation methods if accounts in the same trading program have materially different performance results. This is another instance where materiality would be measured using gross trading profits and losses.
6 As with the test for material differences in trading results, whether the account has a material effect on net performance is determined by comparing the net performance of the composite with and without the account.