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Notice I-12-14

July 18, 2012

Effective Date of NFA Financial Requirements Section 16 and the Related Interpretive Notice - FCM Financial Practices and Excess Segregated Funds/Secured Amount Disbursements

The Commodity Futures Trading Commission (CFTC) has approved NFA Financial Requirements Section 16 and the related interpretive notice entitled FCM Financial Practices and Excess Segregated Funds/Secured Amount Disbursements. As described below, NFA Financial Requirements Section 16 and the related interpretive notice impose new requirements on FCMs with respect to customer segregated funds and secured amount funds accounts and require reporting of specific information regarding financial and operational information on a monthly or semi-monthly basis. The CFTC has also approved a minor amendment to NFA Financial Requirements Section 4, which codifies the requirement that any FCM that violates CFTC Regulation 30.7 is deemed to be in violation of an NFA Requirement. These requirements are effective September 1, 2012. Although this Notice provides a summary of the requirements of Section 16 and the Interpretive Notice, FCMs should review Section 16 and the Interpretive Notice carefully to ensure a complete understanding of the requirements.

Specifically, NFA Financial Requirements Section 16 requires the following:

Written Policies and Procedures

Subsection (a) requires FCMs to maintain written policies and procedures regarding the maintenance of the FCM's residual interest in customer segregated and customer secured amount funds. These policies and procedures must identify a target amount (either by a percentage or dollar amount) that the FCM will seek to maintain as its residual interest. The target amount must be designed to reasonably ensure that the FCM remains in compliance with the segregated funds and secured amount funds requirements. This subsection also requires that the target residual amount and any changes to the amount, as well as any material changes to the written policies and procedures, be approved in writing by the FCM's Board of Directors (or similar governing body), CEO or CFO.

Approval and Notification of Certain Disbursements

Subsection (b) address FCM practices with respect to disbursements from customer segregated funds account(s). Under this subsection, no FCM via a single or multiple transaction(s) may withdraw, transfer or otherwise disburse funds from any customer segregated funds account(s) exceeding 25% of the FCM's residual interest in those accounts based upon the most recent daily segregated funds calculation unless the FCM's CEO, CFO or other designated individual(s) who holds a position with knowledge of the firm's financial requirements and financial position and is listed as a principal on the firm's Form 7-R (Financial Principal) pre-approves in writing the segregated funds disbursement whereby the FCM exceeds the 25% threshold. For purposes of calculating the 25% threshold, an FCM excludes any segregated funds disbursement(s) that are made to or for the benefit of commodity and option customers. The Interpretive Notice provides examples of certain disbursements, transactions and/or occurrences that are for the benefit of customers.

Subsection (b) further requires the FCM to file written notice through WinJammerTM immediately after the FCM's CEO, CFO or Financial Principal pre-approves in writing the disbursement whereby the FCM exceeds the 25% threshold. The notice must include the following: (1) notification that the FCM has or will make a disbursement from segregated funds that exceeds 25% of the FCM's residual interest in customer segregated funds based upon the most current daily segregated funds calculation performed pursuant to CFTC Regulation 1.32; (2) a description of the reason(s) for, the amount and recipients of the single or multiple transaction(s) that results or will result in the disbursement(s) that exceeds the twenty-five percent (25%) threshold; (3) confirmation that the CEO, CFO or Financial Principal pre-approved in writing the disbursement; and (4) the current estimate of the FCM's remaining total residual interest in the customer segregated funds account(s) after the disbursement, and a representation that to the best of the person's (i.e., notice signatory's) knowledge and reasonable belief the FCM remains in compliance with the segregation requirements after the disbursement.

Subsection (b) also addresses an FCM's disbursement(s) from a segregated funds account(s) subsequent to an FCM making a disbursement(s) that exceeds the 25% threshold. In those circumstances, from the time of the original disbursement that exceeds the 25% threshold until the FCM completes its next required daily segregated funds calculation, an FCM may not make any subsequent disbursement(s) in any amount from any customer segregated funds accounts (except to or for the benefit of commodity and option customers) without for each disbursement obtaining the required approval and filing a written notice signed by the CEO, CFO or Financial Principal that discloses the amount and recipient(s) of the disbursement and the reason(s) for the disbursement, confirming that the CEO, CFO or Financial Principal (and the identity of that person if different from the person who signed the notice) pre-approved the disbursement in writing, indicating the current estimate of the FCM's remaining total residual interest in the customer segregated funds account(s) after the disbursement, and containing a representation that to the best of the person's (i.e., notice signatory's) knowledge and reasonable belief the FCM remains in compliance with the segregation requirements after the disbursement.

Subsection (c) replicates subsection 16(b)'s approval and notice requirements applicable to segregated funds account(s) for foreign futures and foreign options customer secured amount funds account(s) as identified under CFTC Regulation 30.7.

FCM Reporting Obligations - Financial and Operational Information

Subsection (d) requires that all FCMs report certain financial and operational information to NFA on a monthly or semi-monthly basis. Specifically, FCMs will be required on a monthly basis, within 17 business days after the end of each month, to submit the following information as of the close of business on the last business day of the month: (1) total adjusted net capital, minimum net capital, and excess net capital (listed in U.S. dollar figures); (2) whether any depository used to hold customer segregated funds or secured amount funds during the month is an affiliate of the FCM; and (3) the firm's measure of leverage (i.e., total balance sheet assets, less any instruments guaranteed by the U.S. government and held as an asset or to collateralize an asset (e.g., a reverse repo) divided by total capital (the sum of stockholder's equity and subordinated debt)) all computed in accordance with U.S. GAAP. The first required monthly report is for the month ended September 30, 2012 and will be due on October 23, 2012. FCMs will file this information through WinJammerTM. The capital numbers will be extracted from the firm's 1-FR or FOCUS filing. FCMs will also be required to complete a schedule of information that will calculate the firm's measure of leverage. This schedule will also require the firm to indicate whether any of its depositories holding customer segregated or secured amount funds during the month is an affiliate of the FCM.

FCMs will also be required by 11:59 P.M. Eastern time on the business day following the 15th and the last business day of each month to submit the following information as of the close of business on the 15th (or the following business day if the 15th falls on a weekend) and the last business day of each month: (1) the dollar amount of customer segregated funds held in cash and each type of permitted investment identified in CFTC Regulation 1.25(a); (2) the identity of each depository holding customer segregated funds and the dollar amount held at each depository; (3) the dollar amount of foreign futures and foreign options customer secured amount funds held in cash and each type of permitted investment identified in CFTC Regulation 1.25(a); and (4) the identity of each depository holding foreign futures and foreign options customer secured amount funds and the dollar amount held at each depository. FCMs will report this information on the Segregated Investment Detail Report (SIDR), which is also filed through WinJammerTM. FCMs began complying with this requirement on a semi-monthly basis with the first report filed on July 17, 2012

Subsection (d) requires FCMs to submit by noon of each business day, the daily segregated funds and secured amount funds computations as of the close of the preceding business day. The Interpretive Notice specifies that in determining the secured amount requirement, the FCM must use the method that calculates net liquidating equity plus the market value of any securities held in customers' accounts. FCMs will submit this information by completing the segregated funds or secured amount funds schedule filed through WinJammerTM.

Subsection (d) also provides that the FCM's CEO, CFO or other individual designated by the CEO or CFO to file on his or her behalf (and where applicable a person described in CFTC Regulation 1.10(d)(4)(ii)) must submit the information required by subsection (d) and that by doing so that person certifies to the best of his/her knowledge belief that the information is true, correct and complete. Finally subsection (d) imposes a fee of $1,000 for each business day that any of the required information is late.

Additional Requirements

The newly adopted Interpretive Notice provides a subsection-by-subsection analysis of Section 16. The Notice further describes certain regulatory requirements that FCMs must adopt to implement the specific requirements of Section 16, including:

  • In determining the FCM's secured amount requirement, the FCM must use the method that calculates net liquidating equity plus the market value of any securities held in customers' accounts;

  • In determining the target amount of the firm's residual interest, the FCM's Board (or similar governing body), CEO or CFO must perform a due diligence inquiry and consider various specified factors relating to the nature of the firm's business and create a written record containing a description of the analysis of the factors used by the FCM to determine its targeted residual amount;

  • In instances where an FCM falls below the target residual interest amount (due to a disbursement that is not for the benefit of customers), the FCM must by the close of business on the next business day either deposit funds into the segregated/secured amount funds accounts necessary to restore the respective account balance to the target amount or, if appropriate, revise the target amount in accordance with the requirements under subsection (a) for doing so.

  • In instances where an FCM makes a disbursement from customer segregated or secured amount funds that is not for the benefit of customers, the FCM internal procedures must require the FCM to consider the most current required segregated funds or secured amount calculation, as well as the impact of any known unsecured debit(s), deficit(s), and previous disbursements that could cause material adjustments to its most current segregated and secured funds calculations; and

  • In instances where an FCM fails to complete the required segregated funds calculation or the secured amount funds calculation, the FCM is prohibited from making any disbursements (not for the benefit of customers) from the account(s) for which the calculation was not completed until the required calculation is completed and submitted to NFA.

The notice also provides specific guidance on certain transactions and/or occurrences that are not included in an FCM's calculation of the 25% threshold.

Finally, the notice emphasizes that NFA and the other DSROs will closely monitor the information submitted pursuant to Financial Requirements Section 16 to ensure that an FCM maintains sufficient funds to remain in continual compliance with the customer segregated funds and secured amount requirements. If circumstances indicate that an FCM may not have sufficient funds to remain in continual compliance with these obligations, then NFA may exercise its authority under NFA Compliance Rule 3-15 and issue a Member Responsibility Action suspending or restricting an FCM's operations or imposing remedial action. Such remedial action may include infusing additional residual interest funds into the customer segregated funds and/or secured amount accounts or additional capital into the firm's operating accounts.

As noted above, the first semi-monthly filing of segregated and secured amount funds information was due July 17, 2012. The first monthly filing is due for the month ended September 30, 2012 and must be filed by October 23, 2012.

More information on these requirements can be found in NFA's May 29, 2012 submission letter to the CFTC. If you have any questions on Section 16, please contact Valerie O'Malley, Senior Manager - Compliance (vomalley@nfa.futures.org or 312-781-1290) or Carol Wooding, Associate General Counsel (cwooding@nfa.futures.org or 312-781-1409).

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