|Past Member Newsletters|
January 9, 2014
Dear Members of the National Futures Association,
As we begin 2014, we have an opportunity to reflect and take account of where we have been, where we are, and where we are going. NFA has embraced its newly expanded responsibilities entrusted by Congress, the Commodity Futures Trading Commission (CFTC), and NFA Members and strives to fulfill these responsibilities with the full vigor and dedication of our staff.
We would like to begin by acknowledging that as a result of the changes in the exemption rules set forth by the CFTC, along with the continuing implementation of the Dodd-Frank Wall Street Reform Act, we have gained many new Members. Therefore, we would like to simply begin by saying, "Welcome," to our newest Members. Due largely to the influx of new commodity pool operator registrants, the number of NFA Members has grown 16 percent in the past year. This dramatic increase in our membership has substantially increased the number of pools operated by NFA Members from approximately 1,400 pools in recent years to approximately 5,700 pools in 2013. The net asset value of these pools also rose from about $350 billion to about $2.4 trillion.
The poet T. S. Eliot wrote in “Four Quartets”: “For last year’s words belong to last year’s language/And next year’s words await another voice.” While we at NFA have high principles and attributes that transcend the years, it seems an appropriate thought—"Welcome to 'next year'.” We are grateful for our successes over the last years and yet we accept our imperfections with a commitment and determination to excel at our tasks. And, with new authority comes a renewed sense of commitment to excellence.
As we are all well aware, the last two years have been the most challenging for the futures industry in the almost 80 years the two of us, collectively, have been in the business. The collapse of MF Global and the uncovering of the Peregrine Financial Group (PFG) fraud brought about the questioning of systems and procedures believed to be safe and beyond reproach. Our industry has prided itself on a long track record of protecting customer funds, and on our weathering the 2008 financial crisis. Now, this hard-earned, previously impeccable reputation for safeguarding customer funds was suddenly badly tarnished. We have now embarked down the long, hard road of rebuilding trust.
NFA approached the issues revealed by MF Global and PFG on two parallel paths: regulatory enhancements achieved by rule modifications and improved processes at NFA. Allow us to describe some of these improvements.
Shortly after the discovery of the PFG fraud, we formed a special committee made up of NFA's public directors, chaired by Dr. Todd Petzel. The Board directed the committee to be independent, thorough, and timely in its review of the circumstances surrounding the PFG fraud and all of the NFA audit practices and procedures. The committee engaged Berkeley Research Group (BRG) to gather the information and to analyze processes. The BRG team included former Securities and Exchange Commission (SEC) personnel who conducted a review of the SEC's practices in light of the Madoff scandal. During its investigation, BRG conducted a comprehensive review of NFA's exams of PFG from 1995 through 2012. BRG examined more than 190,000 NFA documents containing over 3 million pages, and more than 166,000 emails and related attachments. It conducted 32 separate interviews of individuals with knowledge of the factors or circumstances surrounding NFA's audits of PFG, including PFG’s former CEO Russell Wasendorf, Sr., who was in a federal correctional facility at the time of his interview. NFA is lucky to have outstanding public directors and we should all be grateful for their work on this committee.
The Committee and BRG submitted its findings in a report to NFA's Board of Directors in January 2013, which the Board then made available to the public on NFA's website. Although BRG's review found that "NFA audits were conducted in a competent fashion and the auditors dutifully implemented the appropriate modules that were required," it also stated that NFA needed to develop a greater sense of professional skepticism in its examinations, and it put forth a list of 20 recommendations designed to achieve that result. In addition to adopting the report in its entirety and making the report public, NFA's Board appointed an Implementation Special Committee to ensure those recommendations were fully implemented in a timely fashion. Organizational change is uncomfortable so our appreciation goes out to the Implementation Special Committee chaired by independent director Ron Filler, and comprised of Maureen Downs and Gerald Corcoran, as well as to the NFA staff.
At the outset of the implementation process, NFA staff and the Implementation Special Committee categorized BRG's recommendations into four categories: 1) examination process/risk management; 2) professional development; 3) monitoring compliance with segregated funds requirements; and 4) industry interface. We then identified the specific actions needed to implement each of the recommendations and tracked the progress of each action step on a regular basis. In many areas, we implemented improvements that even exceeded the requirements needed to fulfill BRG's recommendations.
The majority of BRG's recommendations focused on NFA’s examination process and risk management, including modifying and strengthening the futures commission merchant (FCM) exam modules. To assist with this effort, the Implementation Special Committee engaged an outside examination expert, PricewaterhouseCoopers LLP (PwC), to review the module enhancements. After a three-month review process, we are happy to report that PwC concluded that NFA's modifications to its exam modules fully implement the relevant BRG recommendations.
The BRG report also made a number of recommendations related to NFA's training and professional development. Prior to receiving the BRG report, in November 2012, NFA formalized a relationship with the Association of Certified Fraud Examiners (ACFE) to ensure its examiners have appropriate training on professional skepticism. Since that time, more than 80 futures compliance staff have completed training and passed a test that covers fraud prevention and deterrence as well as fraud investigations to achieve the certified fraud examiner (CFE) designation. With few exceptions, by December 2013, all NFA staff members involved in the examination function had completed ACFE training and obtained the CFE designation.
Additionally, the BRG report recommended that NFA evaluate its hiring practices to ensure its examiners have diverse skills. Over the past few years, NFA had already begun to modify its hiring philosophy to place greater emphasis on hiring individuals with prior industry and related experience. This effort will continue in the years to come. Nearly one-third of NFA’s recently hired employees had industry related experience.
Going beyond the scope of the BRG recommendations, NFA established an Office of Professional Development (OPD). After benchmarking with other regulators, law firms and accounting firms that have similar departments, NFA created the OPD to oversee the training and professional development of NFA's professional staff in the Futures Compliance, Swaps Compliance, Market Regulation and Registration departments.
With respect to industry interface, NFA staff implemented BRG's recommendation that we improve the flow of information between NFA and other regulators regarding our examinations of FCMs. NFA and the CFTC's Division of Swap Dealer and Intermediary Oversight staff have agreed to meet at least quarterly to discuss NFA's upcoming FCM examinations as well as any concerns the CFTC may have regarding the FCMs subject to those exams. In addition, NFA instituted a regular series of lectures by industry leaders for staff.
After many months of hard work, the Implementation Special Committee reported to the Board at the November meeting that NFA staff had addressed each recommendation, and substantially completed the implementation of all of BRG’s recommendations. We are confident that all of the actions that we have taken will help us to create a stronger regulatory environment and a better industry.
Both of the special committees and NFA staff devoted significant resources and energy to conduct the study of the PFG events and to implement the recommended changes outlined in the BRG report. The Implementation Special Committee has completed its work and turned over the remaining tasks to NFA staff. Again, we should all be grateful for their efforts.
Regulatory Improvements & New Responsibilities
As mentioned above, NFA has also improved the self-regulatory system by adopting a number of significant rulemakings. These rulemakings, which are designed to enhance customer protection, are described in detail in NFA's 2013 Annual Review, which will be available on NFA's website by January 15, 2014.
Additionally, in line with rulemakings to enhance customer protection was the development of a system to perform a daily confirmation of customer segregated funds. In December 2012, NFA and the CME Group began using a daily segregation confirmation system to electronically confirm the balances in customer segregated and secured fund accounts. This past summer, NFA and CME expanded surveillance systems to include obtaining daily confirmations from clearing firms, and expect to receive daily reports from clearinghouses shortly. Upon receipt of the data, NFA performs an automated comparison of the FCMs' reports to the daily confirmations from the depositories to identify any suspicious discrepancies. This process is a vast improvement of the regulatory process.
Beyond traditional futures regulation, NFA has significant new responsibilities under Dodd-Frank with the assignment of regulatory authority over Swap Dealers, Major Swap Participants, and market surveillance for Swap Execution Facilities (SEFs). These developments mean a bigger organization with far greater reach. The Board and senior management were prudent not to overly commit NFA resources until the scope and timing of these regulatory responsibilities were made clear. Now, though, NFA has taken action.
NFA's compliance program for swap dealers is still in its embryonic stage, but much has been accomplished in the past year. We were prepared for the glut of swap dealer applications and the voluminous 4s filings that arrived in December 2012. We performed an initial review of more than 5,000 4s submissions totaling more than 165,000 pages, and granted provisional registration to all applicants by Jan. 1, 2013. NFA staff also began the development of modules designed to implement an exam process for swap participants that will be phased in over time. NFA's Board also was modified to integrate swap participants into the governance structure. Finally, now that the timing and scope of NFA's responsibilities are clearer, NFA is fully committed to building its swaps regulatory staff.
Significant work also was done to develop a regulatory services program for SEFs. Since 2011, NFA has been working to develop the systems required to conduct trade practice and market surveillance for potential SEFs. In June 2013, the CFTC published its final SEF rules. At that time, 16 potential SEFs signed regulatory services agreements with NFA to provide surveillance on their behalf. The CFTC granted temporary registration to all of the SEFs that executed regulatory service agreements with NFA prior to Oct. 2, 2013, thereby allowing them to operate as a SEF on the compliance date.
The events of the past two years have been shocking, traumatic and almost overwhelming ... almost. The failures of MF Global and PFG have eroded trust in both the marketplace and regulators. But as hurtful as these lessons have been, they have helped us to improve over the last two years and we have become a much stronger, more effective regulator. We are painfully aware of Warren Buffet's admonition, "It takes 20 years to build a reputation and five minutes to ruin it. If you think about that, you'll do things differently".
As a new year begins, we will now cast our eyes to the future and toward the challenges that lie ahead while continuing to strive to restore customer confidence in the futures industry. We look forward to working with Congress, the CFTC, other self-regulatory organizations, and the industry to ensure that customers have justified confidence in the integrity of the U.S. derivatives markets. Thank you for your attention and "welcome to next year"!
Daniel J. Roth
Christopher K. Hehmeyer