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News Facts Actions - Winter 2012

In this issue:



Compliance Activity related to MF Global

In response to MF Global, Inc.'s collapse and bankruptcy filing in October, NFA took a number of immediate measures to help our member firms.  One of the first steps was to establish how many Member firms were impacted by the bankruptcy.  When the shortfall in customer segregated funds became known, NFA focused on the 5 FCMs for which it is the DSRO that had customer funds on deposit with MF Global.  Our goal was to ensure that those FCMs could meet their obligations to customers and that they were in compliance with all segregation and capital requirements.  NFA worked closely with the CFTC in that effort.

"In addition to the FCMs, we determined that approximately 250 IBs either had receivables in the form of commission or security deposits with MF Global or were guaranteed by the firm.  We monitored and continue to work with the IBs to ensure they have new guarantors and sufficient capital to meet regulatory requirements," said Sharon Pendleton, Director of Compliance.

NFA also determined that approximately 150 commodity pools operated by NFA Member firms were impacted by MF Global.  NFA worked with these Members to ensure their pool participants received adequate disclosures and made sure that participant redemption requests were handled fairly.
 
Work Still Needs to be Done

In light of the unprecedented events associated with MF Global's bankruptcy and shortfall in customer funds, NFA has been analyzing possible changes to rules and regulatory practices that would better protect customers from losses due to FCM insolvencies.  With respect to the regulatory changes that should be considered, there are two broad issues to be addressed.  First, what changes can be made to rules or regulatory practices that would be better designed to prevent customer losses due to an FCM's insolvency.   Second, since we cannot completely eliminate the possibility of FCM insolvencies, how can we improve the way we handle those insolvencies to limit the impact on customers and markets.  

NFA and CME Group recently announced, in conjunction with the InterContinental Exchange, the Kansas City Board of Trade and the Minneapolis Grain Exchange, the formation of a joint committee to review how SROs can strengthen the current safeguards for customer segregated funds held at the firm level.

"Self-regulation has served the futures industry and its customers very well for a very long time," said Dan Roth, President of NFA.  "However, the MF Global bankruptcy has dealt a severe blow to the public's confidence in the financial integrity of our futures markets and it is incumbent upon the industry's SROs - in collaboration with the Commodity Futures Trading Commission - to take the necessary steps to enhance customer protection, particularly in the area of segregated funds."

The committee will hold its first meeting within the next two weeks and plans to issue a series of recommendations by the end of the first quarter of this year.

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FORTRESS Brings Greater Transparency to Opaque Forex Markets

In February 2011, NFA Compliance Rule 2-48 became effective requiring forex dealer Members (FDMs) to submit daily electronic trade reports.  It's been almost a year since NFA implemented its electronic Forex Transaction Review System (FORTRESS).  This system was developed to monitor FDM forex trading activity in order to identify potential price manipulations and problematic patterns of trading activity.  The system receives daily information from FDMs and produces exception reports that assist NFA staff in identifying potential trade practice abuses.  NFA is able to simulate the trading day and pinpoint unusual trades or patterns.  It has also brought greater transparency to the forex environment, provided in-depth information about FDMs as well as their customers, and enabled NFA to conduct audits and investigations in a more efficient manner.

"Since each FDM operates its own market for its customers and is the counterparty to each transaction, there is both the ability and the incentive to manipulate prices and/or control when orders are executed," said Regina Thoele, Senior Vice President of Compliance.  "Our Business Conduct Committee has issued at least two Complaints against two of our FDMs for programming its trading platform to favor the firm instead of the customer when price slippage occurs."

On a daily basis, FDMs submit in-depth data representing trading activity for what NFA has determined to be the "trading day."  The required information includes: all order transaction records, all data relating to both filled and unfilled orders, customer details, price adjustments as well as information on market events and other unusual events, such as a system outage or "fast market."  "FORTRESS receives all this data, processes it and essentially re-builds the trading day," said Tim McHenry, Director of Information Systems.  "We then look for patterns in the data that may point to manipulative practices."  McHenry believes that the system has been successful for several reasons.  Not only has FORTRESS been able to better protect forex customers but it also shed light on how the forex markets work.

"One of the first things we noticed was that a lot of the firms use the same pricing feeds or liquidity providers so when one entity has a problem, the market experiences a ripple effect," said Ryan Olszewski, a senior analyst in Market Regulation.  Olszewski also explained that the data collection has led to some FDMs re-examining and potentially adjusting their business model and/or execution policies to allow for more transparent price discovery.

The information collected in FORTRESS has also been useful when conducting audits for CTAs and CPOs that do business with FDMs.  "FDMs are required to give us information about their third party trading managers," said Ed Dasso, Vice President of Market Regulation.  "In addition, we can compare the information we receive from FDMs about their customers with the information we receive through FORTRESS to see if there are any inconsistencies.  This capability is also helpful when we get a tip from another agency to look into a certain firm.  We are able to speed up our investigations because some of the information has already been collected."

According to McHenry, the system is a cost-effective and successful measure NFA took to monitor FDM trading practices.  "We are happy with how the system is operating and look forward to our continued review of forex trading practices."

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NFA Assists FBI in Catching White Collar Criminals

NFA's Business Conduct Committee has issued about 400 complaints against Member firms and individuals for various rule violations in the past ten years.  The majority of those cases are handled solely by NFA; however, there are some instances where violations are so serious that NFA has referred them to other regulatory organizations and law enforcement agencies. 

From scammed investors that tip NFA off to independent investigations leading to questionable website material, this first article, in a two-part series, looks at cases where NFA has worked with the Commodity Futures Trading Commission, other regulatory organizations and enforcement authorities to catch criminals and improve the safety and soundness of our markets.

Victor E. Cilli

This first case was brought to NFA's attention in May 2008 when an FCM Member called into question the legitimacy of the Progressive Managed Futures Fund (PMFF) operated by Progressive Investment Funds (Progressive).  Records indicated that Progressive was a Commodity Pool Operator (CPO) and NFA Member firm since 2006.  Located in Glen Rock, New Jersey, Victor Eugene Cilli was the president, sole owner, principal and AP of the firm. 

A PMFF investor had called the FCM about her $65,000 investment and stated that her monthly payments from PMFF had stopped.  NFA had further discussions with the investor and learned that she had requested a $3,000 withdrawal from the fund but never received the requested money.

NFA records indicated that the fund had five participants and consisted of customer funds.  However, when NFA auditors talked to Cilli, he said that the $400,000 fund was made up of loans from family and friends in an effort to establish a performance record for trading futures.  He said he made a mistake in listing the investors as participants on the fund's annual questionnaire and planned to pay the money back with interest.  NFA was not convinced and requested detailed information about the fund and its participants.

It was at this time that the case took an interesting twist.  The Cilli investor that initiated the investigation with her complaint retracted her statement.  She said that she actually loaned Cilli the money to have him do with it what he pleased.  While the motive for investigating Cilli may have disappeared, the case did not because Cilli never provided NFA with the requested information.  

"NFA issued a Member Responsibility Action prohibiting Cilli and Progressive, the pool operator from, among other things, soliciting or accepting any funds, placing trades and disbursing money.  NFA also immediately brought this serious matter to the attention of the CFTC," said Cheryl Tulino, Compliance Director at National Futures Association.  NFA provided all of the information obtained during the investigation to both the CFTC and the FBI.  In June 2011, FBI agents arrested Cilli in Manhattan, charging him with two bank fraud schemes totaling $2 million.

It was alleged that he conned four commodity pool investors into giving him over $500,000 during a ten month period in 2007. He traded and lost about $200,000 of the money and misappropriated the rest for personal expenses such as hair salon visits, skin care treatments, motorcycle payments and other personal entertainment like meals and travel expenses.

Cilli is scheduled to be sentenced in March 2012 for one count of securities fraud, one count of conspiracy to commit bank fraud and one count of tax evasion.  The securities charge alone carries a maximum potential penalty of 20 years in prison and a $5 million fine.

One World Capital Group

This next case involves One World Capital Group, an FCM and forex dealer Member of NFA located in Winnetka, Illinois.  One World's principal business was the handling of customer accounts trading off-exchange foreign currency transactions (forex).  Led by president and managing member John Walsh, the firm first registered with NFA in December 2005. 

In November 2007, NFA started receiving calls from One World's forex customers complaining that they were having difficulty withdrawing funds from their trading accounts.  At least two customers told NFA that they had requested withdrawals in October 2007 and were still waiting for their funds in late November 2007.

"Redemption cases arise mostly in connection with commodity pools and not retail forex," said Ronald Hirst, Associate General Counsel and Enforcement Coordinator at NFA.  "When we questioned Walsh, he didn't have an adequate response to explain the delay in processing withdrawals."

NFA immediately went to One World's office to further investigate these customer complaints.  NFA provided Walsh a detailed list asking documents regarding the firm's capital requirements as well as customer account information including records to be provided promptly.  Walsh was unable to provide many of the requested items including customer information, balances and trading activity.  He blamed his failure to produce records on the firm's electronic trading platform which allegedly produced unreliable account information. 

There were also problems with documents related to the firm's bank accounts.  When NFA requested bank statements, they were met with more inconsistencies.  Walsh was only able to provide October 2007 month end statements for four of the six accounts and produced online November 2007 statements for only three accounts.  When questioned further, Walsh said he did not have access to all of One World's accounts.

Since Walsh could not demonstrate the firm met capital requirements or provide the requested documentation, NFA issued an MRA and shut down One World's operations.  NFA also referred the matter to both the CFTC and the U.S. Attorney's Office in Chicago.

In January 2009, the U.S. Attorney's Office filed a federal criminal complaint in this matter.  Walsh and another One World employee, Charles Martin, were arrested on federal fraud charges for allegedly operating a Ponzi-like scheme in which they diverted millions to finance lavish lifestyles including purchasing luxury vehicles, private jets and jewelry.  They even financed the production of an unreleased movie.

Walsh and Martin were released on bond; however, in May 2011, they pleaded guilty to the federal charges and will be sentenced in February 2012.

Conclusion

The two cases involving Victor Cilli and John Walsh demonstrate how NFA coordinates its enforcement efforts with other regulatory agencies to catch white collar criminals.  From bank frauds and tax evasion to Ponzi schemes and million dollar scams, NFA inquiries are sometimes just the tip of the iceberg when it comes to regulatory investigations. 

In part two of this series, scheduled for next quarter's Member Newsletter, cases involve misappropriating customer funds and misleading investors to website discrepancies and extraditing one criminal from Germany.

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Board Actions

The following actions were taken by NFA's Board of Directors at its meeting on November 17, 2011.

The Board approved an amendment to NFA Registration Rule 203 to establish a $15,000 registration fee for swap dealers (SDs) and major swap participants (MSPs).  The Board also approved an amendment to Rule 802 to adopt a CFTC requested certification regarding an SD's and MSP's associated persons.  Finally, the Board approved an amendment to NFA Registration Rule 501 to require that a designated Subcommittee of the Membership Committee in registration cases in which an SD or MSP applicant is the respondent include a person affiliated with an SD or MSP.

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News Briefs

NFA signs agreements with additional firms to provide regulatory services to their Swap Execution Facility
Under the Dodd-Frank Act and the rules and regulations currently being written by the CFTC, Swap Execution Facilities (SEFs) will have surveillance and other self regulatory responsibilities. The CFTC has proposed to allow SEFs to contract with a registered futures association, such as NFA, or another registered entity for regulatory services.

NFA has entered into separate Pre-Launch Services Agreements with several potential SEFs that pave the way for NFA to perform regulatory services for their trading activities. Each agreement establishes a preliminary framework for the exchange of information and the development of technology standards that will enable NFA to develop, test and launch automated trade practice and surveillance systems and also develop procedures and processes necessary for the SEFs to fulfill their self-regulatory obligations.  Upon the issuance of the CFTC's final SEF rules, NFA anticipates entering into Regulatory Services Agreement with each organization that has signed a Pre-Launch Services Agreement with NFA.

NFA amends Bylaws 1301 and 1302 regarding Forex Dues and Assessments
The CFTC recently approved amendments to NFA's Bylaws 1301 and 1302 and the related Interpretive Notice entitled Forex Transactions. These amendments, which modify the current dues and assessment fee structure applicable to Forex Dealer Members (FDMs) and non-FDM Forex Members, are effective February 1, 2012.

In summary, the amendments modify NFA's current dues and assessment fee structure, including increasing annual membership dues from $750 to $2,500 for non-FDM Forex Members and adding a $.002 assessment fee on all order segments processed by NFA's Forex Transaction Reporting Execution Surveillance System.  In addition, the amendments eliminate the current FDM assessment fee of .0002% on the notional value of each initiating (non-rollover) forex transaction and significantly increase FDM annual membership dues.  Visit NFA's website for more information and a detailed explanation of the amendments.

NFA introduces new Member orientation section on website
NFA recently introduced a new Member orientation section, which aims to help our new Member firms understand their regulatory obligations and the regulatory environment in which they will be conducting their business.  Members can find information about required procedures, links to NFA's brochures and regulatory guides as well as frequently asked questions. 

NFA publishes 2011 Annual Review
NFA has published its 2011 Annual Review, "Protecting Today, Preparing for Tomorrow", summarizing the Association's accomplishments during its most recent fiscal year (July 1, 2010 through June 30, 2011). Visitors to NFA's website can view and download the publication. Complimentary hard copies of the publication can be obtained by calling NFA's Information Center (312-781-1410 or 800-621-3570) or by email. If ordering by email, please include your complete name and mailing address.

NFA to sponsor International Regulators Dinner
NFA will sponsor an International Regulators Dinner in Boca Raton on March 12. The dinner will be held in conjunction with a day-long meeting for international regulators that coincides with the Futures Industry Association (FIA) 37th annual Futures Industry Conference (March 13-16). CFTC commissioners and senior staff, exchange representatives and regulators from around the world are expected to attend. Visit FIA's website for more information on the conference.

NFA staff to participate in Traders Expo in New York
NFA staff members will participate in the upcoming MoneyShow's Traders Expo New York held from February 19-22 at the Marriott Marquis.  NFA is sponsoring a booth at the conference and will be distributing information about National Futures Association. More information on the conference can be found on the Expo's website.

NFA participated in the American Association of Individual Investors conference
Larry Dyekman, NFA's Director of Communications and Education led a presentation entitled, "Diversifying Your Portfolio with Managed Futures and Forex: What Investors Need to Know," at the American Association of Individual Investors (AAII) conference on November 10-12 in Las Vegas. NFA also sponsored an informational booth at the conference to provide information to attendees and to distribute educational material. For more information or audio from the conference, please visit AAII's website

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