January 23, 2014
Request for Comments - CPO/CTA Capital Requirement and Customer Protection Measures-Comments Due by April 15, 2014
NFA regularly reviews the continued effectiveness of its regulatory requirements. Over the past three years, NFA has issued 26 Member Responsibility Actions (MRAs), and 92% of those MRAs were against CPO and/or CTA Members. Most of these matters involved misuse of customer funds (including one CPO that improperly used pool funds because it had insufficient assets to operate as a going concern) and/or misstating net asset values and/or performance information. In light of these actions, NFA is reviewing the current regulatory structure applicable to CPO and CTA operations. In particular, NFA is looking at ways to strengthen the regulatory structure governing CPO operations to provide greater protection for customer funds. Additionally, NFA is exploring ways to ensure that CPOs and CTAs have sufficient assets to operate as a going concern. NFA's Executive Committee approved the issuance of this request for comments to solicit CPO and CTA Member input on the concept of imposing a capital requirement on CPO/CTA Members and other customer protection measures. Each of these concepts is discussed more fully below.
A. CPO/CTA Capital Requirement
As you know, the current regulatory structure governing CPO and CTA Members does not require these entities to maintain a minimum amount of capital. A strong argument can be made that the rationale that requires independent introducing brokers, which are prohibited from holding customer funds, to maintain minimum capital should apply to CPOs, which have control over customer funds, and CTAs, which manage client accounts. CPOs and CTAs act as a fiduciary to their pool participants and clients, respectively, and should have adequate funds to operate and ensure that they are a going concern.
NFA is seeking input from CPO and CTA Members on the concept of imposing a capital requirement on CPOs and CTAs. In particular, NFA requests input on the following:
- Should NFA impose a minimum capital requirement on CPO Members? CTA Members? If not, why?
- If you do not favor a minimum capital requirement for CPOs/CTAs, please indicate what alternatives, if any, exist for ensuring that CPOs/CTAs have sufficient funds to operate as a going concern.
- Assuming a capital requirement is imposed on CPOs and/or CTAs, should net capital be defined as current assets minus liabilities? If not, please describe alternative calculation(s).
- Assuming a capital requirement is imposed on CPOs and/or CTAs, how should the amount of the requirement be determined?
Assuming a capital requirement is imposed on CPOs and CTAs, should there be any difference in the method of determining the required amount for CPOs or CTAs? If yes, please explain the difference(s) and the reasons for the difference(s).
Assuming a capital requirement is imposed on CPOs and CTAs, how often should CPOs and CTAs have to file financial reports with NFA? Additionally, should NFA require CPOs and CTAs to file certified financial reports annually with NFA?
Other comments or suggestions.
- A minimum dollar amount that applies to all CPOs/CTAs?
- A minimum dollar amount that applies to all CPOs/CTAs based on a certain amount of funds under management with incremental increases to the minimum amount based on additional levels of funds under management?
- A minimum dollar amount that applies to all CPOs/CTAs with incremental increases based on factors other than funds under management (please identify the other factors)
B. Other Customer Protection Measures
Over the last 18 months, NFA has focused significant regulatory efforts on implementing protections over customer funds held at FCMs. NFA also recognizes that there are risks associated with customer assets held by CPOs. The recent disciplinary actions taken against CPOs have involved the improper use of pool funds. To address this issue, NFA is considering several customer protection measures described below, and we request comment on the following:
Independent Third Party Authorization for Disbursements of Pool Funds
An NFA CPO/CTA Board member has recommended that NFA adopt a rule that requires an independent third party to review and authorize a CPO's disbursement of any pool funds.
- Would you support the adoption of this type of NFA rule imposed on CPOs? If not, why?
- Do you currently have an independent third party review and authorize the disbursement of pool funds? If so:
Assuming this requirement is imposed on CPOs, who should be permitted to act as the independent third party? What, if any, qualification standards should exist for these independent third parties?
Assuming this requirement is imposed on CPOs, what should be the scope of the independent party's role-what should the review and approval of disbursements from pools entail?
What advantages/disadvantages do you see in this practice to your business operation? To your pool participants?
- Is this internal control in place for all disbursements? If not, please describe the circumstances under which it is required or is not required.
- Who is the independent third party and what qualification standards does this party meet to perform this role?
- What is the cost per year for using the independent third party?
NAV Valuation and Monthly or Quarterly Reporting
- Are your pool's monthly or quarterly account statements prepared in-house or are they prepared by an independent third party?
- Would it be beneficial for a CPO to have an independent third party prepare or verify account statements at various times throughout the year concerning the value of the pool? What advantages and/or disadvantages do you see in such a practice?
- Would the preparation or verification of account statements by an independent third party make it more difficult for a CPO to misrepresent NAV or misappropriate funds and thus provide greater integrity to the managed funds industry? Would the benefit of having independent third party verification outweigh the added costs?
- Are your pool's performance results prepared in house or are they prepared by an independent third party?
- If performance results are prepared in house, would independent verification of those results by a third party be beneficial? If not, why?
- Would the preparation or verification of performance results by an independent third party make it more difficult for a CPO to misrepresent NAV or misappropriate funds and thus provide greater integrity to the managed funds industry? Would the benefit of having independent third party verification outweigh the added costs?
Verification of Pool Assets
NFA currently requires depositories with accounts holding customer segregated funds for an FCM to report the balances in those accounts to NFA on a daily basis. NFA compares the reported information to the customer segregated funds balances reported by the FCM and reconciles any material discrepancies. NFA is exploring ways to implement a similar system for pool assets.
- Do you see any impediments to NFA developing such a system for pool assets? If yes, please describe.
- Do you have any suggestions on how NFA could obtain the balances from entities holding pool assets that are not banks or FCMs?
- If NFA is able to develop such a system, how frequently should NFA require CPOs to report pool assets and entities holding pool assets to independently report balances?
Currently, NFA has several hundred inactive CPO/CTA Members-those that do not engage in any commodity interest trading. We are evaluating whether it is appropriate for inactive CPOs and CTAs to be NFA Members, which results in NFA expending certain regulatory resources on these firms. Therefore, we seek comments on the following:
- Should NFA permit inactive firms (i.e., those that do not engage in commodity interest trading) to remain NFA Members? Please explain your rationale?
- Is there any valid reason for CPOs and CTAs to become NFA Members and remain inactive?
- Assuming we adopt a requirement that withdraws a firm's NFA membership if the firm is inactive, how should we define inactivity?
- Assuming we adopt a requirement that withdraws a firm's NFA membership if the firm is inactive, should NFA allow some period of inactivity (e.g., a year) before the firm is withdrawn?
We also welcome any other comments or suggestions on these topics. Comments are due by April 15, 2014. Written comments should be submitted by email to CPOandCTAfeedback@nfa.futures.org. If you have any questions, please contact Mary McHenry, Associate Director, Compliance (firstname.lastname@example.org or 312-781-1420 or Julia Wood, Attorney (email@example.com or 312-781-7459).