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Notice I-12-07

June 04, 2012

Compliance Date of CFTC Conflict of Interest Rules for FCMs and IBs Has Been Extended Until August 3, 2012

The Commodity Futures Trading Commission (CFTC) recently adopted CFTC Regulation 1.71 to implement new section 4d(c) of the Commodity Exchange Act, which requires FCMs and IBs to implement a conflict of interest system and procedures with respect to its research function and its trading and clearing activities. Except as for the requirements under Regulation 1.71(d) related to clearing activities, FCMs and IBs must be in compliance with Regulation 1.71 by August 3, 2012. Although the final rulemaking set a June 4, 2012 compliance date, the Commission issued a No-Action letter on June 1, 2012 extending the final compliance date for Regulation 1.71(a)-(c), (e) and (f) to the August 3, 2012 date. A copy of the final regulation is available at http://www.cftc.gov/ucm/groups/public/@lrfederalregister/documents/file/2012-5317a.pdf.

Under CFTC Regulation 1.71, FCMs and IBs are required to adopt written policies and procedures that are reasonably designed to ensure that the firm and its employees are in compliance with Regulation 1.71. Subsection 1.71(a) sets forth a number of definitions that are material to understanding the requirements of the Regulation. Subsections 1.71(b) and (c) set forth most of the substantive requirements as follows:

  • Restrictions on relationship with the research department including:

    • Non-research personnel may not direct a research analyst's decision to publish a research report or direct the views and opinions in the report;
    • Research analysts may not be under the supervision, control (including with respect to performance evaluation and compensation) of employees of the firm's business trading unit or clearing unit; and
    • Non-research personnel may not review or approve a research report prior to publication except for certain specified reasons, which must be done through authorized legal and compliance personnel.

  • Restrictions on communications that provide that a research analyst's written or oral communication to customers relating to a derivative may not omit any material fact or qualification that would make the communication misleading to a reasonable person.

  • Restrictions on research analyst compensation that prohibit FCMs and IBs from considering a research analyst's contribution to the firm's trading or clearing business in determining compensation.

  • FCMs and IBs are prohibited from offering favorable or threatening to change research to a customer as consideration or inducement for business or compensation.

  • FCMs, IBs and their research analysts must comply with specific disclosure requirements relating to a research analyst's financial interest in any derivative that the research analyst follows.

  • FCMs, IBs and their employees who are involved in the firm's trading or clearing activities are prohibited from retaliating against a research analyst employed by the firm or its affiliate as a result of a research report (made in good faith by the analyst) that may adversely affect the FCM's or IB's trading or clearing activities.

The Regulation provides an exemption from the above requirements for smaller IBs that, over the preceding 3 years, have generated $5 million or less in aggregate gross revenues from its IB activities. IBs qualifying for this exemption, however, must establish structural and institutional safeguards reasonably designed to ensure that the activities of persons who research or analyze the price or market for any commodity or derivative are separated by appropriate informational partitions from the review, pressure or oversight of persons involved in trading or clearing activities.

Regulation 1.71(e) also requires FCMs and all IBs regardless of size to adopt and implement written policies and procedures that require it to disclose to its customers any material incentives and any material conflicts of interest regarding a customer's decision as to trade execution and/or clearing of a derivatives transaction.

Finally, subsection 1.71(d) sets forth specific requirements for FCMs related to clearing activities. Those provisions do not become effective until the date on which swap dealers and major swap participants are required to apply for registration under CFTC Regulation 3.10.

FCMs and IBs should review the CFTC's final rulemaking and ensure that they have adopted the appropriate written policies and procedures to comply with the requirements. If you have any questions on these requirements, contact Lauren Brinati, Director, Compliance at lbrinati@nfa.futures.org or Carol Wooding, Associate General Counsel at cwooding@nfa.futures.org.

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