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Changes to NFA Compliance Rules: A Year in Review

Complex industry issues such as anti-money laundering and retail off-exchange foreign currency trading presented many regulatory challenges in 2003. NFA met these challenges-as it has done for the past two decades-with a rule-making process that focuses on customer protection, solicits Member participation and looks for flexible solutions to industry problems. As 2004 begins-and promises even more challenging issues-we thought we would take this opportunity to highlight the regulatory changes that occurred during this past year and provide you with an overview of the ways in which you can ensure compliance with these rules.

Anti-Money Laundering
Although the USA Patriot Act and related NFA Rules became effective in April 2002, additional requirements were issued in 2003. Futures commission merchants (FCM) and introducing brokers (IB) must have programs in place to detect and prevent money laundering activities in customer accounts. Two critical components of these programs are training employees who work in anti-money laundering (AML) areas at the firm and conducting testing of the firm's AML program on an annual basis.

The AML training must also be done annually and may be done on a formal or informal basis. Regardless of the type of training provided, the firm should keep records to identify the training materials that were used, as well as specify the date of training and the names of those employees who participated.

The annual testing of the firm's AML program must be done by an independent party. While the party may be from inside or outside the firm, if the party is employed by the firm, they must be independent of the firm's AML activities. For example, if the firm's Compliance Officer is responsible for reviewing customer trading for suspicious activity, this individual may not be considered suitable to conduct the testing. The firm must also keep records relating to the testing. The records should include a detailed description of the testing that was conducted, as well as the results of the testing.

For NFA's Rule and Interpretive Notice relating to AML, you may access the following links:

www.nfa.futures.org/nfaManual/entireManual.asp#2-9

www.nfa.futures.org/nfaManual/entireManual.asp#45

This past October, the Treasury Department passed rules relating to Customer Identification Programs (CIP). These rules supercede the customer identification requirements in NFA's Interpretive Notice. NFA has drafted revisions to its Notice that include guidelines relating to CIPs. These revisions have not yet been approved by Treasury and the Commodity Futures Trading Commission (CFTC), but NFA sent a notice to our FCM and IB Members informing them of the new CIP requirements. For a copy of this notice, please access the following link:

www.nfa.futures.org/compliance/091803.asp

Suspicious Activity Reports (SAR) allow Treasury to investigative possible cases of money laundering once a firm informs them of suspicious activity. The Treasury Department recently approved a rule outlining the responsibilities for FCMs and IBs with respect to filing these reports, and this rule applies to transactions that occur after May 18, 2004. For a copy of Treasury's final rule on SARs, please go to www.fincen.gov/fedregister_fcmfinalrule.pdf.

With respect to AML programs for commodity pool operators (CPO) and commodity trading advisors (CTA), Treasury has not yet passed rules in this area. NFA anticipates making changes to our rules once the Treasury Department decides on a course of action.

Ethics Training
When the CFTC repealed its specific ethics training rule in October 2001, many Members believed that this relieved them of any ethics training requirements. This, however, is not the case. The Commission's Statement of Acceptable Practices details the requirements for ethics training, although the Statement does allow some flexibility regarding the frequency and method of training. This flexibility allows a firm to tailor its ethics training program to best fit the firm's operations.

In order to help our Members understand the requirements of the Statement, NFA passed an Interpretive Notice to Compliance Rule 2-9, which became effective July 2003. This notice makes it clear that ethics training is an important part of the supervision of the firm. As part of an ethics training program, a firm must develop written procedures that specify the content, frequency and method of training. The Interpretive Notice also details the requirements for individuals who conduct ethics training. Finally, a firm must keep records which demonstrate that ethics training was provided. A copy of NFA's Interpretive Notice may be found at www.nfa.futures.org/nfaManual/entireManual.asp#51.

Disaster Recovery
Disaster recovery and business continuity are important aspects of a firm's business plan. The need for a firm to provide service to its customers in the event of a business disruption is vital, as is the importance of ensuring that NFA can contact firm personnel in the event of an emergency. Towards this end, NFA implemented Compliance Rule 2-38 and a corresponding Interpretive Notice on disaster recovery, both of which became effective in July 2003.

The rule specifies that firms must develop a disaster recovery program which best fits the operations of the particular firm. In addition, as part of a firm's annual on-line questionnaire, firms are required to provide NFA with contact information for at least one individual to reach in the event of an emergency. To access the disaster recovery rule and interpretive notice, you may use the following links:

www.nfa.futures.org/nfaManual/entireManual.asp#2-38

www.nfa.futures.org/nfaManual/entireManual.asp#52

Changes to CFTC Regulation Part 4
On August 8, 2003, the CFTC amended its Part 4 regulations, which deal with CPO and CTA issues. One of the biggest changes was the expansion of the types of firms which may be exempt from CFTC registration, as well as new exemptions from various disclosure and reporting requirements for certain types of commodity pools. NFA is processing these exemptions on behalf of the CFTC, and we are entering this information into NFA's database, so that Members may contact NFA to learn if certain firms and/or pools with which they do business are exempt from registration.

To date, NFA has received over 1,000 exemptions, and the vast majority of these firms are new to the futures industry. The CFTC's changes did not diminish customer protection and have resulted in easier entry into the futures markets, which is beneficial to the entire industry. To see the revisions to the CFTC's Part 4 regulations, you may access the Federal Register release at www.cftc.gov/files/foia/fedreg03/foi030808a.pdf.

CTA Performance
When the CFTC revised its Part 4 regulations, it also invited NFA to determine acceptable methods for CTAs to report the performance of their managed accounts. Towards that end, NFA recently drafted NFA Compliance Rule 2-34, which will go into effect in May 2004. This rule, which can be accessed at www.nfa.futures.org/news/newsRuleSubLetter.asp?ArticleID=1214, indicates that firms will no longer be permitted to use the fully-funded subset method. Instead, CTAs will be required to use the nominal value of their managed accounts when calculating performance. Nominal value includes both actual and notional funds for the CTA's managed accounts, and this method of calculating performance should be easier for firms to utilize.

Bunched Order Allocation
Another change to NFA's rules that was based on changes to CFTC regulations relates to the post execution allocation of bunched orders. Prior to the CFTC's changes, only certain types of account managers could allocate fill prices after the order was executed, and this could only be done for certain types of customers. This rule was further complicated by requiring FCMs to be responsible for ensuring that the allocation was fair and non-preferential, which could be difficult if the account manager was using several FCMs to execute its trades. Due to the complexity of the CFTC's rule, many firms did not utilize post-execution allocation for their trades.

The CFTC's changes allow all customers to have their trades allocated after execution, which means that retail customers now have the same advantage as institutional customers. It also expands the definition of eligible account managers. All CTAs and firms that are exempt from CTA registration are now eligible account managers. However, the CFTC's new regulations in this area continue to prohibit FCMs and IBs from using post execution allocation for their discretionary accounts.

In addition to changes in the types of customers and account managers that are now eligible to use post execution allocation, the amendments more clearly define the responsibilities of FCMs and account managers. Account managers, and not firms, are responsible for the allocation of bunched orders. Account managers are required to keep records showing that the allocation of trades is fair and non-preferential, and that it follows the allocation method decided upon by the account manager. FCMs are now only required to review accounts on a periodic basis to ensure that there is no unusual allocation activity.

In response to the CFTC's changes to its regulations in this area, NFA made changes in its Interpretive Notice relating to bunched orders. You may review the revised notice at www.nfa.futures.org/nfaManual/entireManual.asp#29.

Forex
NFA's rules regarding over-the-counter foreign currency futures and options for retail customers (forex) became effective on December 1, 2003. The new rules and interpretive notice are designed to promote customer protection, and include, among other areas, disclosure, financial reporting, supervision, just and equitable principles of trade, and an anti-fraud provision.

For NFA Members that introduce customers or manage accounts that trade through forex dealer members, the rules ensure that these Members are also subject to anti-fraud, just and equitable principles of trade, and supervision requirements. If the individual who introduces the customer account to a forex dealer member is not a registered entity, the forex dealer member is responsible for supervising that individual's activities. NFA's revised forex rule and Interpretive Notice can be accessed through the following links:

www.nfa.futures.org/compliance/forexRuleAmendments.asp

www.nfa.futures.org/compliance/forexInterpNotice.asp

NFA has also published a resource guide to aid our forex dealer Members and Members who do business with them in complying with the new rules. This guide can be accessed at www.nfa.futures.org/compliance/publications/forexRegGuide.pdf.

NFA's Commitment to You
NFA is committed to providing you with the information you need to meet your regulatory responsibilities. This newsletter, Notices to Members and our Web site are just three of the communication methods we use to give you the most current regulatory information. We especially encourage you to visit our Web site (www.nfa.futures.org) on a regular basis because we are constantly adding new information, such as rule proposals, enforcement actions and news releases.

We also invite you to attend one of our "Issues and Answers 2004" Member meetings scheduled throughout the coming year. These meetings are a great opportunity for you to discuss current issues with NFA staff. The first two meetings are scheduled on February 24 and 25 in San Francisco and Los Angeles, respectively. We will post additional cities and dates on our Web site in the near future.

Of course, if you need additional guidance, please call NFA's Information Center at 800-621-3570. Our experienced and knowledgeable Information Center Representatives will be happy to answer your questions.

NFA is the premier independent provider of efficient and innovative regulatory programs that safeguard the integrity of the futures markets.
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