In recent years, NFA has witnessed a growing number of futures trading systems being marketed to the public. Typically, these are computerized trading systems which are developed by third-party trading system developers ("third-party system developers"), who are not required to be registered with the CFTC or Members of NFA. The Interpretive Notice adopted by the Board provides guidance on two issues that NFA Members face when they offer trade execution services to customers who use these computerized trading systems.
First, the Interpretive Notice summarizes the registration requirements for CTAs. NFA Bylaw 1101 provides, in pertinent part, that no Member may carry an account, accept an order or handle a transaction in commodity futures on behalf of any non-Member that is required to be registered as a CTA or in some other capacity. This section of the Interpretive Notice is designed to assist Members in complying with Bylaw 1101 when they do business with third-party system developers.
Second, the Interpretive Notice addresses Members' potential responsibility under NFA Compliance Rules 2-9 and 2-29 for misleading promotional material that promotes these trading systems. Such promotional material often relies upon extremely favorable hypothetical results which are not clearly identified as hypothetical and which are dramatically better than the actual performance of customers who have used the system, many of whom have sustained large losses. Pursuant to NFA Compliance Rule 2-29(c), a Member firm is prohibited from using these types of hypothetical results unless it meets very stringent requirements, which these non-Member system developers are not required to meet.
For example, NFA recently reviewed a promotional piece used by a non-Member third-party system developer to promote its trading system, which boasted of hypothetical annual rates of return ranging from 86.4% to 151.7%. In this particular case, the NFA Member offering trade execution services for this system claimed no customers had traded this system. Additionally, because the third-party system developer is a non-Member, NFA was unable to determine whether any actual customers had used the trading system and, if so, whether their actual performance corresponded to the advertised favorable hypothetical returns. As you know, the CFTC has also confronted and taken action against third-party system developers using misleading promotional material to promote their trading systems.
The Interpretive Notice reminds Members that they will be directly responsible under NFA Compliance Rule 2-29 if the Member or its Associates prepares or distributes misleading promotional material regarding a third-party system developer or its trading system. It also reminds Members that they may be responsible for misleading promotional material prepared and disseminated by a third-party trading system developer if there is an agency relationship between the NFA Member and the third-party trading system developer.
Finally, the Interpretive Notice states that, even where no agency relationship exists, Members have a supervisory obligation under Compliance Rules 2-9 and 2-29 to diligently supervise their employees and agents who are responsible for creating and maintaining hyperlinks to web sites of or establishing referral agreements with third-party system developers. A Member whose web site links to or otherwise refers customers to a third-party system developer or who has a referral agreement with a third-party trading system developer should conduct a due diligence inquiry into the system developer's advertising practices.
Staff discussed the proposed Interpretive Notice with the FCM, IB, and CPO/CTA Advisory Committees and with FIA's Law and Compliance Committee, and most of their suggestions were incorporated in the final version adopted by the Board. The IB and CPO/CTA Advisory Committees support the Interpretive Notice. The FCM Advisory Committee and FIA's Law and Compliance Committee still have reservations about some of the language regarding Members' supervisory responsibilities when linking to or entering into referral arrangements with third-party system developers.
The Board adopted the Interpretive Notice by a vote of 21 to 1 with one abstention, concluding that the Interpretive Notice accurately describes Members' responsibilities under NFA rules and provides needed guidance to Members who deal with third-party system developers.
NFA respectfully requests that the Commission review and approve the proposed Interpretive Notice contained herein.