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9001 - RESERVED
9002 - REGISTRATION REQUIREMENTS; BRANCH OFFICES
(Staff, September 6, 1985; revised July 1, 2000; December 9, 2005; and September 30, 2010)
Form 7-R, Branch Offices
Any location, other than the main business address at which an FCM, RFED, IB, CPO or CTA employs persons engaged in activities requiring registration as an AP, is a branch office. This is true even if there is only one person at the location. If the firm has one or more branch offices, NFA's registration records on the firm must include the names of all persons who are branch office managers. Each location must have a branch office manager, and that person's status as a branch office manager should be listed in the Registration Categories section of the person's Form 8-R even if previously listed as a principal in the Registration Categories section of the person's Form 8-R. Each branch office must have a different manager.
The address must also be given for each branch office. A P.O. Box is not sufficient. Anyone with a status as branch office manager must also be currently registered as an AP or have applied for such registration. Whenever a new branch office is established it must be reported, with all the required information, to NFA by filing an update electronically to the firm's Form 7-R. The closing of an existing branch office should also be reported by filing an update electronically to the firm's Form 7-R.
IF YOUR FIRM CURRENTLY HAS PERSONS OPERATING OUT OF LOCATIONS OTHER THAN ITS MAIN BUSINESS ADDRESS, THOSE LOCATIONS MUST IMMEDIATELY BE REPORTED TO NFA BY FILING AN UPDATE ELECTRONICALLY TO THE FIRM'S FORM 7-R AND BY ADDING BRANCH OFFICE MANAGER STATUS ON EACH BRANCH OFFICE MANAGER'S FORM 8-R.
NFA may take disciplinary action against any Member which fails to properly list all of its offices.
An important point to recognize is that a branch office may not itself be a separate corporation or partnership. CFTC Regulation 166.4 requires each branch office to use the name of the firm of which it is a branch for all purposes and to hold itself out to the public under such name. Also, in CFTC Interpretive Letter No. 84-10 (May 29, 1984) it was concluded that a branch office could not maintain a separate identity from the Member. One obvious conclusion to be drawn from this information is that each AP in a branch office must be paid directly by the Member. Payment through any intermediary would lead to the assumption that the intermediary would be required to register as an IB.
The requirement that a branch office hold itself out to the public under the name of the Member is intended to ensure that customers are always aware of the Member with which they are doing business. It is necessary that any branch office AP, even one operating out of a residence or an unrelated place of business, make sure that customers understand who they are doing business with.
9003 - NFA COMPLIANCE RULE 2-29: COMMUNICATIONS WITH THE PUBLIC AND PROMOTIONAL MATERIAL
(Board of Directors, effective November 19, 1985; revised July 24, 2000)
Section 17(p)(3) of the Commodity Exchange Act (7 U.S.C. §21(p)(3)) requires that the rules of a registered futures association such as NFA "establish minimum standards governing the sales practices of its members and persons associated therewith. . . ." NFA has established such minimum standards in the form of its Compliance Rules which, among other things, generally prohibit fraud and deceit and require Members and Associates to "observe high standards of commercial honor and just and equitable principles of trade in the conduct of their commodity futures business." Although these rules supply the required minimum standard, they are general in nature and may not always provide specific guidance as to what particular conduct may be prohibited. It is expected that more detailed content will be given to those general rules through the work of NFA's Business Conduct Committees, which will issue decisions in disciplinary cases applying the rules to specific conduct. It is also expected that NFA's Advisory Committees, through study and recommendation of rule changes, will further the development of uniform industrywide sales practice standards.
NFA's Board of Directors has adopted and the CFTC has approved a new Compliance Rule, 2-29, which was proposed to the Board by the FCM Advisory Committee ("The Committee"). The Committee published a notice for public comment on its proposed rule on February 21, 1985, and considered the comments received in drafting the final rule.
II. The Contemplated Relationship of Rule 2-29 With Other NFA Rules
Rule 2-29 deals specifically with communication with the public and promotional material prepared and used in the conduct of a Member's or Associate's futures business. However, Member and Associate conduct in that area, as in all others related to futures, is, and under the new rule continues to be, subject to all other NFA requirements. For example, certain other NFA Rules deal specifically with communications with the public and promotional materials in a narrower context. Compliance Rule 2-13, which incorporates CFTC Rule 4.41, regulates the advertising of Commodity Pool Operators ("CPOs") and Commodity Trading Advisors ("CTAs"). In addition, all Member and Associate conduct, including communications with the public, is subject to the requirements of Compliance Rule 2-2 (Fraud and Related Matters) and Compliance Rule 2-4 (Just and Equitable Principles of Trade).
The new Rule is not intended to supplant those or any other NFA Requirements but rather to augment them. Hence, literal compliance with Rule 2-29 will not be a "safe harbor" from NFA disciplinary action if the Member or Associate violates any other NFA Requirement.
III. The Scope of Rule 2-29
Rule 2-29 is intended to apply to all forms of communication with the public by a Member or Associate without exception if the communication relates in any way to solicitation of an account, agreement or transaction in the conduct of the Member's or Associate's business in futures as the term "futures" is now or may be defined.1
However, in drafting the Rule the Committee recognized that some specific standards which would be appropriate for communications prepared in advance of delivery to the public might be unenforceable and even inappropriate in the context of routine day-to-day contact with customers. The Committee was concerned that the free flow of information and advice to customers might be impeded to their detriment if spontaneous communication were subjected to rigorous and detailed content standards.
To address this problem, the final Rule distinguishes routine day-to-day communications with customers and applies a different regulatory standard to such communications. This is accomplished by providing a definition of "promotional material" to identify the kinds of communications with the public which will be subject to specific content standards and other requirements beyond those provided in Section (a) General Prohibition. Therefore, the definition of promotional material (which is a broadened version of the definition of that term in the CFTC's option pilot program rules) is intended to include all kinds of promotional communications with the public, other than routine day-to-day contact with customers. It includes, for example, any kind of written, electronic or mechanically reproduced message or presentation which is directed to any member of the public, whether broadcast over the media, delivered through the mail or presented personally. It also includes any oral presentations or statements to customers or prospective customers, whether delivered over the telephone or in person, the substance of which is outlined or scripted in advance for delivery to such persons.
IV. Section-by-Section Analysis
Section (a) General Prohibition
This Section provides the general rule governing all communications with the public and is the only portion of the Rule applicable to routine day-to-day communication with customers. That means that routine customer contact would not run afoul of Rule 2-29 as long as it is not fraudulent or deceitful, is not high-pressure in nature and does not contain any statement that futures trading is appropriate for all persons. NFA believes that the general prohibition should not hamper free and open communication with individual customers on a day-to-day basis. In that regard, it is expected that Business Conduct Committees would not find such communications to operate as a fraud or deceit in the absence of evidence of such intent or recklessness on the part of the Member or Associate.2
Section (b) Content of Promotional Material
This Section sets out the specific prohibitions and requirements applicable to promotional material, as defined. Subsection (1) bans material likely to deceive the public. Proof of violation of this provision does not require proof of a specific intent to deceive. This Subsection instead places the burden on the Member to determine whether the material is likely to be deceptive in effect. Of course, to find a violation of this Subsection a Business Conduct Committee would have to find that the Member or Associate reasonably should have been able to determine that the material was likely to deceive. The fact that someone was actually deceived would not by itself be enough.
Subsection (2) deals with facts only. It requires that the facts which a Member or Associate chooses to include must be true and that no facts knowingly be left out which are necessary to make the facts stated not misleading. With that exception, this Subsection does not require the disclosure of facts. As with Subsection (1), a negligence standard would be applied in finding violations of Subsection (2) for making material misstatements of fact in promotional material. However, because evaluating omissions is a much more difficult task, this Subsection applies only to knowing omissions (i.e., instances where the person preparing or reviewing the promotional material knew the omitted fact and failed to include it). This knowledge requirement may complicate the proof necessary to establish a violation of this Subsection. However, knowledge can be inferred from a pattern of failures to include a material fact, the omission of which makes the promotional material misleading. Once knowledge is established, the decision whether the failure to include a fact makes the promotional material misleading in violation of Rule 2-29 will be made by a Business Conduct Committee under a standard of reasonableness.
Subsection (3) requires a statement of risk to "balance" any discussion of the possibility of profit. The requirement that the statement of risk have equal prominence is not intended to mean that the reference to risk must be as long as the discussion of the possibility of profit or indeed to impose any unbending measure of prominence. It is intended to mean only that in the context of the particular promotional material the reference to risk of loss must not be downplayed or hidden.
Subsection (4) requires the Member or Associate to make a statement in the promotional material concerning the predictive value of past results if reference is made in the material to past trading results.
Subsection (5) does not require disclosure of past performance of managed accounts.3 It does require that if performance information is given, it must be representative of the actual performance for the same time period of all reasonably comparable accounts. Hence, under Subsection (5) a Member could not advertise the performance of a "model" account unless that performance is representative of all reasonably comparable accounts.4 Subsection (5) also makes explicit in this context the Members' existing responsibility to be able to demonstrate that performance information is accurate and representative.
The use of performance information in promotional material is, of course, subject to all of the content standards of Rule 2-29, and compliance with Subsection (b)(5) will not excuse violations of other Subsections. If in presenting performance information for an account or group of accounts, a Member omits facts about those accounts or the differences between those accounts and the account being promoted, and the omission makes the material misleading, the use of the material violates Subsection (b)(2) even though the performance information given is accurate and is representative of all reasonably comparable accounts in compliance with (b)(5). This interaction of the requirements of Subsections (b)(2) and (b)(5) will come into play whenever a Member chooses to present performance information about an account or program which differs materially from the account or program being promoted; for example, where performance information about a house account is used, or where trading control or strategies, commission rates or account sizes which applied in the account or program for which performance is being shown differ from those which will apply in the account or program for which the customer is being solicited. Under the Rule, a Member is free to use a sales tool performance information about accounts which differ from the accounts being promoted, but must take care to ensure first, that the performance information complies with Subsection (b)(5), and second, that the differences are explained to the extent necessary to make the promotional material not misleading.
Finally, Subsection (5) requires that the rate of return must not be calculated in a manner inconsistent with that required under the CFTC's Part 4 Rules, which define rate of return as the ratio between net performance and beginning net asset value for the period. This is not intended to require that the precise Part 4 formula be used in all cases but rather to prohibit the use of methods which lead to rates of return which are materially higher than those produced by the Part 4 method.
Section (e) Written Supervisory Procedures
In recognition of the fact that promotional material may be prepared by many individuals within a Member's organization, this Section requires that promotional material be reviewed and approved by someone in a supervisory position before it is used. It should be emphasized, however, that even communications with the public which do not fall within the definition of promotional material must be diligently supervised under other existing NFA and CFTC rules.
Section (f) Recordkeeping
This Section is intended to provide a way in which NFA can conduct meaningful sales practice audits which will reveal both the content of promotional material and whether the supervisory procedures required under Section (e) are being carried out. In addition, this Section contains a requirement that Members who use hypothetical performance results be prepared to demonstrate to NFA's satisfaction the basis for such results. This means that Members must maintain the records necessary to document how the hypothetical results were calculated.
[NOTE: This requirement was extended to all performance results effective July 24, 2000.]
Section (g) Filing with NFA
This Section is intended to allow NFA to maintain close review of promotional material in circumstances where special scrutiny is warranted.
[NOTE: This interpretive notice was amended effective July 24, 2000 to conform it to subsequent changes in NFA rules. In particular, the amendments eliminate the discussion of hypothetical results and update section references within Compliance Rule 2-29 based on changes to Compliance Rule 2-29's treatment of hypothetical results; eliminate references to options rules that are no longer in effect; and make other technical amendments to correspond to subsequent changes to other NFA rules. Furthermore, adjudicated disciplinary decisions are now issued by NFA Hearing Panels rather than Business Conduct Committees. Therefore, all references to Business Conduct Committees, while not changed in the notice, now refer to Hearing Panels. In all other respects, this interpretive notice remains an interpretation adopted by the Board of Directors contemporaneously with the adoption of NFA Compliance Rule 2-29.]
1 Article XVIII(k) of NFA's Articles of Incorporation defines futures to include "options contracts traded on a contract market, and such other commodity-related instruments as the Board may from time to time declare by Bylaw to be properly the subject of NFA regulation and oversight." Currently, the only NFA Bylaw expanding that definition is Bylaw 1507, which states that " 'futures' as used in these Bylaws shall include option contracts granted by a person that has registered with the Commission under Section 4c(d) of the Act as a grantor of such option contracts or has notified the Commission under the Commission's rules that it is qualified to grant such option contracts." [Bylaw 1507 has since been amended to include foreign futures and options contracts and leverage transactions.]
2 However, it must be noted that much, if not all, of the benefits to customers of the disclosures and cautionary statements required to be included in promotional material by other sections of Rule 2-29 and other disclosure statements required by CFTC and NFA Rules (e.g., the risk disclosure statements required by CFTC Rule 1.55 and NFA Compliance Rule 2-27) can be intentionally diminished in the course of oral communications with customers. To avoid that result it is expected that Business Conduct Committees will presume intentional or reckless deceit in instances where a Member or Associate specifically contradicts or downplays any disclosure statement required to be made by CFTC or NFA rules.
3 CPOs and CTAs are, however, subject to such a requirement through the CFTC's Part 4 Rules.
4 The Committee expects that a Member or Associate could exclude from "reasonably comparable accounts" those that were actually traded pursuant to a different trading strategy or those that were traded independently of the accounts in the program for which performance is cited. With respect to the question of independence the indicia of independence listed in the CFTC's statement of policy concerning when accounts should be aggregated for position limit purposes would be useful guides for Members, Associates and Business Conduct Committees. Statement of Aggregation Policy (1977-80 Transfer Binder) Comm. Fut. L. Rep. (CCH) 20.837 (June 13, 1979); 44 Fed. Reg. 33839.
9004 - NFA COMPLIANCE RULE 2-30: CUSTOMER INFORMATION AND RISK DISCLOSURE
(Board of Directors, effective June 1, 1986; revised January 3, 2011)
NFA Compliance Rule 2-4 requires Members to observe high standards of commercial honor and just and equitable principles of trade in the conduct of their futures business. NFA's Advisory Committees ("the Committees") have been considering ways in which the general standard of Rule 2-4 can be further defined in order to develop uniform industrywide standards which will offer guidance to the Members. In the course of their work, the Committees noted the increasing level of commentary, in public and regulatory forums, regarding the comparability between the futures industry's "know your customer" requirements and the "suitability" rules in the securities industry. The Committees noted that suitability has a tendency to act as a recurrent red herring to criticize customer protection in the futures industry. NFA's Executive Committee also became aware of these comments and asked the Committees to study the matter and make appropriate recommendations. Based on their knowledge and experience in the industry, the Committees believe that any careful consideration of this issue should continue to take into account the important role that risk disclosure plays whenever a customer opens a futures account or selects a commodity trading advisor.
In addressing this issue, the Committees reviewed research on the evolution of the suitability and "know your customer" doctrines in the securities industry and noted that although there are several different formulations of the rule, all are based on the same premise: that different types of securities can have widely varying degrees of risk potential and serve very different investment objectives. For that reason, the securities suitability rules are cast in terms of the suitability of a particular transaction.
The Committees noted that the futures industry differs from the securities industry in several crucial ways. Most importantly, futures contracts in general are recognized as highly volatile instruments. It therefore makes little sense to presume that a certain futures trade may be appropriate for a customer while others are not. An appreciation of the risks of futures trading must be gained and a determination of its appropriateness made at the time each customer makes a decision to trade futures in the first place. This is true regardless of whether the customer will rely on recommendations by futures professionals or the customer will make his or her own trading decisions.
The futures industry has traditionally met this need through risk disclosure designed to encourage the customer to make an informed decision as to whether futures trading is suitable for that customer. The Risk Disclosure Statement and the Options Disclosure Statement mandated by CFTC Regulations 1.55 and 33.7, respectively, and the Disclosure Document required by the CFTC Part 4 Regulations each are designed to bring the suitability issue to the customer's attention.1
In the specific area of exchange-traded options, the CFTC has previously noted the importance of risk disclosure and the need for the futures professional to learn enough about the customer in order to provide risk disclosure. When the Options Disclosure Statement requirement was enacted in 1981 as part of the options pilot program, the CFTC stated in its Federal Register release [46 Fed. Reg. 54500 (1980-82 Transfer Binder) Comm. Fut. L. Rep. (CCH) 21,263] that:
". . . the FCM must acquaint itself sufficiently with the personal circumstances of each option customer to determine what further facts, explanations and disclosures are needed in order for that particular option customer to make an informed decision whether to trade options . . . . While this requirement is not a "suitability" rule as such rules have been composed in the securities industry, before the opening of an option account the FCM has a duty to acquaint itself with the personal circumstances of an option customer."
The CFTC went on to state that "the extent of the inquiry should be left to the prudent judgment of the FCM."
NFA has always been concerned that allowing suitability or know your customer standards to develop outside of the self-regulatory framework carries with it the possibility that a poorly defined or inappropriate duty would be fashioned on a case-by-case basis, perhaps by an ill-considered analogy to the securities industry rules. Because NFA construes its rules on a case-by-case basis through the decisions of the Business Conduct Committee ("BCC") which is composed of informed futures professionals and non-Members, NFA is uniquely positioned to set an ethical business standard to evaluate the conduct of other Members.
The Committees determined that the exchange of information between a new customer and a futures professional -- the customer providing personal data and the Member providing disclosure about the risks of futures trading -- was the focal point around which to structure a sound customer protection rule. On August 9, 1985, the FCM Advisory Committee released for public comment a Proposed Rule on Customer Information and Risk Disclosure. The comments received were considered in the drafting of the Rule in final form, and Rule 2-30 was adopted by NFA's Board on November 21, 1985. In 2010, in an effort to tighten the Rule's requirements in light of the changes in the futures industry, NFA adopted modifications to NFA Compliance Rule 2-30 that: (1) expand the customers covered by the rule to reach all non-ECPs rather than just individuals; (2) require Members to at least annually refresh customer information and reassess appropriate risk disclosure, including a determination of whether futures trading is too risky for the customer, based on any materially changed information; and (3) prohibit Members and Associates from making individualized recommendations to those customers whom the Member or Associate has or should have advised that futures trading is too risky for them.
When the CFTC declined in 1978 to adopt a "suitability" rule, after releasing a proposed rule for comment, it stated that it was unable "to formulate meaningful standards of universal application." [43 Fed. Reg. 31886 (1977-1979 Transfer Binder) Comm. Fut. L. Rep. (CCH) 20,642] NFA found the same difficulty, and for that reason the Rule is premised on NFA's conclusion that the customer is in the best position to determine the suitability of futures trading if the customer receives an understandable disclosure of risks from a futures professional who "knows the customer." NFA believes that the approach taken in Rule 2-30 is preferable to one which would erect an inflexible standard that would bar some persons from using the futures markets.
II. Section-by-Section Analysis
Section (a): General Rule
Rule 2-30 is intended to define "high standards of commercial honor and just and equitable principles of trade" as applied to a Member's procedures for exchanging information with new futures customers at the time they become customers2. Section (a) sets forth the basic requirement: obtain information and provide risk disclosure, which includes the disclosures required by the Rule plus, in some cases, additional disclosure. Rule 2-30 is a "know your customer" rule; however, it does not require the Member or Associate to make the final determination that a customer should be barred from futures trading on suitability grounds.
NFA's enactment of the Rule 2-30 should not be construed to expose Members to increased potential liability for damages in customer litigation or reparation proceedings, for several reasons. First, a business conduct standard promulgated by a self-regulatory organization does not create a private cause of action. Furthermore, Rule 2-30 is not an antifraud rule. In order to prove a violation, there is no requirement to prove any intent to deceive on the part of the Member. Therefore, evidence of a violation of Rule 2-30 would not in and of itself constitute evidence of a violation of any antifraud rule or statute. Finally, to the extent that personal information about a customer is germane to the issues in a reparations or arbitration case, it is undoubtedly already being considered even in the absence of a formal rule requiring Members to obtain it.
Section (a) provides that the Rule applies to all individual customers and any other customers who are not eligible contract participants (as defined in Section 1(a)(12) of the Act), including all parties to a joint account. Members should be aware that regardless of whether they collect information from certain non-individual customers pursuant to Rule 2-30, accounts opened by business entities such as corporations and partnerships may also present other concerns (such as compliance with NFA Bylaw 1101, which prohibits Members from transacting customer business with non-Members who are required to be registered).
Section (b): Customer Information - Frequency
For customers who are individuals, the Member's obligation to obtain information and provide risk disclosure under the Rule is not limited to the first time the customer establishes a futures account with the Member. At least annually, the FCM Member that carries the customer account is also required to request updated information from any active customer who is an individual. The term active customer means any customer who was entitled to a monthly account statement under the provisions of CFTC Regulation 1.33(a) at any time during the preceding year3. Members may satisfy this requirement by contacting the customer in writing (by electronic or any other means reasonably designed to reach the customer) and requesting that the customer notify the Member of any material changes to the information provided under Section (c) of Rule 2-30.4 Absent advice to the contrary from the customer, the information previously provided is deemed verified. Whenever the customer notifies the FCM Member carrying the customer's account of any material changes to the information (whether through the update process or through the customer's own initiative), a determination must be made as to whether additional risk disclosure is required to be provided to the customer based on the changed information. If another FCM or IB introduces the customer's account on a fully disclosed basis or a CTA directs trading in the account, then the carrying FCM must notify that Member of the changes to the customer's information. Consistent with Section (e) of this Rule, the Member or Associate who currently solicits and communicates with the customer is responsible for determining if additional risk disclosure is required to be provided based on the changed information. In some cases, this may be the Member introducing or controlling the account; in other cases, it may be the carrying FCM.
Section (c): Information To Be Obtained
Item (1) is essentially the information required by CFTC Regulation 1.37(a), which applies to FCMs and IBs. Item (2) includes estimated annual income and net worth or net assets. For individuals, Members must obtain both estimated annual income and net worth. For all other customers, Members must obtain estimated annual income and net worth or net assets, however, if the customer is unable to provide a current estimated annual income figure, the Member may satisfy the Rule by obtaining the customer's pervious year's annual income. Item (3), the customer's age or date of birth (for individuals), helps the Member put the customer's financial condition, ability to understand and level of sophistication into perspective. Information about previous futures trading experience and securities or options trading experience may also be relevant and, therefore, have been included. The information set forth in items (6) through (10) must be obtained if a customer who is an individual trades security futures products.
Information on age, estimated annual income and net worth may be obtained through the use of brackets or "in excess of" descriptions so long as these are reasonably designed to elicit the required information in a meaningful manner.
The information specified in Section (c) is a minimum requirement, intended to serve as a core of basic information that should always be obtained. Some Members routinely elicit additional items, such as liquid net worth, risk capital, or number of dependents, which may be quite useful, and NFA received comments on the Rule when it was drafted in 1985 suggesting that these items be required by the Rule. NFA concluded, however, that the better approach was to adopt a Rule that would specify the minimum required information and allow Members to obtain other information as they deemed appropriate. Therefore, item (5) specifies that the Member or Associate should obtain any other information used or considered to be reasonable in providing the customer with adequate disclosure of the risks of futures trading.
Section (d): Risk Disclosure
The risk disclosures incorporated into this Section are required by CFTC Regulations. (There are other disclosures required by CFTC Regulations, such as the Regulation 32.5 dealer options disclosure statement and the Regulation 190.10(c) disclosure statement for non-cash margin, which may apply to particular accounts.) These disclosures are only the minimum required. NFA believes that the decision with respect to what additional disclosure, if any, should be given to the customer is best left to the Member or Associate, whose conduct is subject to review by the BCC. There may be some customers for whom the additional disclosure will portray futures trading as too risky for that customer. In these instances, the only adequate risk disclosure by the Member and Associate is that futures trading is too risky for that customer. However, NFA believes that a determination of who those customers are cannot be made except on a case-by-case basis, because no objective criteria can be established that will apply to all customers. The essential feature of the Rule is the link between "knowing the customer" and providing risk disclosure. Once that has been done and the customer has been given adequate disclosure, the customer is free to make the decision whether to trade futures and the Member is permitted to accept the account. Members and Associates, however, are prohibited from making individualized recommendations to any customer for which the Member or Associate has or should have advised that futures trading is too risky for that customer.
Section (e): Introduced and Third-Party Controller Accounts
The purpose of this Section is to place the obligation to obtain information and provide risk disclosure on the Member who deals directly with the customer when an account is introduced to a carrying FCM by an IB or another FCM doing business on a fully disclosed basis, or when a CTA controls the trading in a customer's account pursuant to written authorization. NFA believes that the Member or Associate who solicits the customer and communicates with the customer in the process of the account opening is the appropriate party to comply with the Rule. In some cases, this may be the Member introducing or controlling the account; in other cases, it may be the carrying FCM.
Of course, each Member remains responsible for compliance with all applicable CFTC Regulations and NFA Requirements. For example, an FCM (or, in the case of an introduced account, the IB) must furnish a Regulation 1.55 Risk Disclosure Statement to each customer, including those whose accounts were solicited by and will be traded by CTAs. Similarly, a CTA must deliver a Disclosure Document to each customer, including those who were solicited by the FCM. Section (i), which is discussed below, clarifies each Member's obligation to comply with other requirements.
Section (f): Reliance on the Customer as the Source of the Information
Some Members confirm financial data because of concern about the creditworthiness of the customer. NFA believes, however, that the decision whether to confirm customer data is best left to the Member's sound business judgment and is irrelevant to a customer protection rule aimed at providing information to a customer.
Rule 2-30 contemplates a good faith exchange of information between the customer and the Member or Associate. A customer who gives incorrect information would still receive all the required risk disclosure statements but would have impaired the Member's ability to consider fully the customer's ability to understand the risk disclosures or whether additional disclosure was necessary. However, Section (f) will not operate as a "safe harbor" for a Member or Associate who falsifies information or who induces or suggests falsification by the customer. Information invented by the Member or Associate does not constitute "information about the customer" as required by the general rule. Members and Associates engaging in such conduct will be subject to appropriate disciplinary action.
Section (g): Recordkeeping: Customers Who Decline to Provide Information
In order to allow NFA to audit for compliance with the Rule, Section (g) requires that a timely record be made or obtained which contains the information obtained from the customer. Customers who decline to provide information (beyond that required by CFTC Regulation 1.37(a), which must always be obtained) may still open accounts, but NFA would expect Members to take appropriate action upon learning that an inordinate number of a particular Associate's customers apparently "decline" to provide basis information. Because Section (a) imposes an affirmative duty on Members to obtain information, a Member who engages in (or allows Associates to engage in) a course of conduct which is designed to or has the effect of eliciting or prompting refusals by customers to provide that information would not have discharged that duty and could not use Section (g) as a shield from disciplinary action.
The approval requirement has been broadened to apply to all new accounts. This is consistent with the Member's responsibility to supervise the futures activities of its employees diligently pursuant to NFA Compliance Rule 2-9.
In the case of non-U.S. customers (those who neither reside in nor are citizens of the United States) a record that the customer declined to provide the information need not be made.
Section (h): Review Procedures
The requirement that a Member establish adequate review and compliance procedures provides Members with the flexibility to design procedures that are tailored to the way the Member does business. NFA's audit staff will, in the routine course of an examination, check these procedures for adequacy, taking into account the facts and circumstances of the particular Member.
Section (i): Relationship to Other Requirements
Rule 2-30 incorporates certain CFTC Regulations, but its requirements are in addition to any imposed by those Regulations or other NFA Requirements. For example, the Rule requires a CTA to provide a Disclosure Document, if required to do so by CFTC Regulation 4.31, at the time a customer first authorizes the Member to direct trading in a futures account for the customer.
This is because Rule 2-30 is intended initially to apply to "account opening" or its equivalent. However, CFTC Regulation 4.31 requires that the Disclosure Document be delivered at the time of solicitation. Other examples of CFTC Regulations which affect the process covered by the Rule have been cited in the discussion of Sections (b), (d), (e) and (g) above. Section (i) serves to clarify the ongoing obligation of Members to comply with all CFTC Regulations and NFA Requirements.
1 The risk disclosure statements required by CFTC Regulations 1.55 and 4.31 direct the customer to "carefully consider whether [futures] trading is suitable for you in light of your financial condition": the one required by CFTC Regulation 33.7 informs the customer that "commodity option transactions are not suitable for many members of the public."
2 NFA Bylaws define "futures" to include domestic exchange-traded options and dealer options. See Compliance Rule 1-1(g).
3 For any customer who was not considered active at the time of the annual update of information, the Member who currently solicits and communicates with the customer must refresh the customer information prior to accepting any new funds or orders from the customer.
4 If the customer informs the FCM that he/she cannot verify the information because the information previously provided to the carrying FCM is not currently available to the customer, then the carrying FCM shall promptly provide any necessary information to the customer.
9005 - NFA COMPLIANCE RULE 2-4: GUIDELINES FOR THE DISCLOSURE BY FCMS AND IBS OF COSTS ASSOCIATED WITH FUTURES TRANSACTIONS
(Board of Directors, effective June 1, 1986; revised July 24, 2000)
National Futures Association ("NFA") Compliance Rule 2-4 provides that "Members and Associates shall observe high standards of commercial honor and just and equitable principles of trade in the conduct of their commodity futures business." NFA Compliance Rule 2-4 requires that each FCM Member, or in the case of introduced accounts, the Member introducing the account make available to its customers, prior to the commencement of trading, information concerning the costs associated with futures transactions.1
If fees and charges associated with futures transactions are not determined on a per trade or round-turn trade basis, the Member must provide the customer with a complete written explanation of such fees and charges.
NFA recognizes that FCM and IB Members may employ various arrangements in assessing fees and charges associated with futures transactions to customers. Any such arrangement which is intended to or is likely to deceive customers is a violation of NFA Requirements and will subject the Member to disciplinary action.
1 NFA Bylaws define "futures" to include exchange-traded options. See NFA Compliance Rule 1-1(l).
9006 - NFA COMPLIANCE RULE 2-13: GUIDELINE FOR THE DISCLOSURE BY CPOS AND CTAS OF "UP FRONT" FEES AND ORGANIZATIONAL AND OFFERING EXPENSES
(Board of Directors, effective July 1, 1986; revised November 26, 1996.)
Commodity Futures Trading Commission ("CFTC") Regulation 4.24(i) states that the disclosure document of a CPO must contain a description of each expense which has been or is expected to be incurred by the pool. CFTC Regulation 4.34(i) applies to CTAs and requires that the disclosure document of a CTA describe each fee which the CTA will charge the client. In addition, CFTC Regulations 4.24(w) and 4.34(o), respectively, require CPOs and CTAs to disclose all "material" information. These requirements have been incorporated into NFA Compliance Rule 2-13. Because "up front" fees and charges can have a significant impact on the net opening equity of pools and managed accounts, the above NFA rule requires not only disclosure of the existence and the amount of the up front charges but also disclosure of how the up front charges affect the return which must be achieved to break even at the end of an investor's first year or the initial amount of capital available for trading. Furthermore, the impact of the up front charges on net performance must be included in the rate of return figures reflected on a CPO's or CTA's required past performance presentation.
A. Disclosure of Prospective Up Front Fees and Charges
The disclosure document must disclose up front fees and expenses, if any, to participants in a pool or clients in a managed account. NFA's Board of Directors believes that investors should be fully aware of not only the amount of such fees and expenses but also their impact on the return which must be achieved to break even at the end of the investor's first year or the net proceeds that will be available at the outset for futures trading. For a CPO, NFA Compliance Rule 2-13(b) provides that a CPO's disclosure document must include break-even analysis presented in the manner prescribed by NFA's Board of Directors, which is described in a separate interpretive notice. (See Interpretive Notice Compliance Rule 2-13: Break-Even Analysis.) CTAs may provide similar information either through the use of break-even analysis which complies with the requirements of Compliance Rule 2-13(b) and the accompanying interpretive notice or through the use of a dilution table.
If a CTA chooses to use a dilution table, the dilution table should be highlighted in a tabular format on the cover page of the disclosure document. The suggested format for the table would detail a standardized amount of initial investment, all up front fees and charges, including all sales and administrative fees, and the net proceeds that would be available for trading after deducting the up front expenses. If a CTA does not use standardized amounts, minimums or units for initial investments, the required table should be presented showing dilution of an investment of $1,000. Moreover, if the results in the dilution table, without further explanation, could be materially misleading as to the impact of the up front fees and charges on the amount of initial capital available for trading (for example, because the fees as a percentage of the initial investment vary depending on the amount of the investment), then explanatory footnotes should be used.
The extent to which a CTA breaks down the up front expenses into categories, including, but not limited to, fees, sales and administrative fees, is solely within the discretion of the CTA as long as the net proceeds for trading and the portion that is deducted from the initial investment are clearly delineated as such. All fees that are charged up front must be disclosed except that a CTA that charges periodic management fees on the first day of each period, including the initial period, need not describe such fees for the first period in the dilution table.
B. Treatment of Up Front Fees in the Required Past Performance Presentation
In preparing rate of return information, the beginning net asset value of a pool or managed account must be calculated before any up front fees and expenses, including organizational and offering expenses, are deducted. However, a CTA acting as an independent advisor to a commodity pool is not required to include the up front fees or expenses charged by the CPO in beginning net asset value for the purposes of calculating rate of return information for the CTA's own disclosure document. In general, a CTA is acting as an independent advisor if it is not an affiliate of the CPO and does not receive any portion of the up front fee. For these purposes, "affiliate" means any advisor which owns or controls, is owned or controlled by, or is under common ownership or control with the CPO.
All up front fees and organizational expenses must be reflected as a reduction of net performance in the period in which the contribution was made to the pool or client's managed account, unless such fees and expenses can be amortized pursuant to Generally Accepted Accounting Principles.1 If organization or syndication expenses can be, and are, amortized, then net performance shall be reduced each month by the monthly amortizable amount. The monthly amortizable amount shall be calculated by dividing the total amount of amortizable expenses by the total number of months over which such expenses shall be amortized.
1 Section 709 of the Internal Revenue Code, 26 U.S.C. §700, governs whether or not organization or syndication expenses incurred to organize and to promote the sale of interests in a partnership can be amortized.
9007 - COMPLIANCE WITH NFA BYLAW 1101
(Staff, March 19, 1987; revised July 1, 2000)
Mandatory membership in NFA is the cornerstone of NFA's regulatory structure. From the earliest stages of its formation, NFA's founders recognized that the creation of a meaningful and effective industrywide self-regulatory organization would be completely impossible unless all persons required to be registered as FCMs, IBs, CPOs or CTAs were required to be Members. The founders of NFA considered the issue to be of such critical importance that they not only prohibited the conduct of customer business with non-Members through NFA Bylaw 1101, but included that prohibition as one of NFA's fundamental purposes in Article III, Section 1(f) of NFA's Articles of Incorporation.
Given the importance of the mandatory membership concept, NFA Bylaw 1101, which tracks the language of Article III, Section 1(f), states the prohibition in the strongest possible terms. [See Bylaw 1101.]
The rule by its terms imposes strict liability on any Member conducting customer business with a non-Member that is required to be registered. The rule does not require proof that the Member firm was at fault or failed to exercise due diligence, simply that it transacted customer business with a non-Member that is required to be registered. NFA Bylaw 1101 requires Members to make two determinations: whether it is doing business with an entity which is required to be registered, and if so, whether that person is a Member of NFA. The second of these determinations is relatively simple. Any Member can check the BASIC system on NFA's web site at www.nfa.futures.org, send a request to NFA through the "contact" feature of the web site, or call NFA's Information Center at a toll-free number (800) 621-3570 to receive current and accurate information concerning the membership status of any person. The determination of whether a particular person is required to be registered can obviously be much more difficult. Any Member could, despite its best efforts, be transacting customer business with a person who is actually required to be registered as an FCM, IB, CPO or CTA. In such a case, the Member is in technical violation of the strict liability terms of NFA Bylaw 1101.
A review of NFA policy, procedures and past disciplinary actions, however, clearly indicates that NFA Bylaw 1101 has not been enforced unreasonably. In making its recommendations in cases involving apparent Bylaw 1101 violations, staff has consistently not relied on the strict liability standard set by the rule itself. Staff has recommended the issuance of complaints in Bylaw 1101 cases in which the evidence indicates that the Member knew or should have known of the violation. Of course, under NFA Compliance Rules, the ultimate decision of whether a particular violation of NFA Rules warrants prosecution rests with the Members of NFA's Business Conduct Committee ("BCC"). BCC Members exercise their informed business judgment in making these decisions, and are certainly aware that some violations of Bylaw 1101 may occur in spite of reasonably diligent efforts to comply with the rule.
The question of whether a Member should have known of a violation of NFA Bylaw 1101 depends in large part on the adequacy of its procedures to prevent such violations. Though it would be impossible to describe all of the situations which should put a Member on notice that a particular person is required to be a Member or NFA, there are certain minimal steps which should be taken to reduce the possibility of a violation of NFA Bylaw 1101:
1. FCM Members should ensure that all omnibus accounts they carry are held by FCM Members of NFA;
2. Each Member should review the list of CFTC registrants with which it does business to determine if they are NFA Members. A Member can determine whether a particular entity is a CFTC registrant by checking the BASIC system on NFA's web site located at www.nfa.futures.org, sending a request to NFA through the "contact" feature on the web site, or calling NFA's Information Center toll-free at (800) 621-3570.
3. Each Member should review its list of customers. If a customer's name indicates that it may be engaged in the futures business, the Member should inquire as to its registration and membership status;
4. When a FCM or IB Member carries an account controlled by a third party (other than an AP of the FCM or IB or a member of the same family as the account owner), the FCM or IB Member should check to see if the account controller is registered as a CTA and, if not registered, should inquire as to the basis of any exemption and, if applicable, should verify that account controller has made the required filings with the CFTC and NFA;
5. If any customer is operating a commodity pool but claims to be exempt from registration as a CPO, the Member should verify that the customer has made the required filings with the CFTC and NFA;
6. Members should ensure that their branch offices are not separately incorporated entities. The CFTC Division of Trading and Markets has issued an interpretive letter stating that branch offices which are separately incorporated entities are required to be registered as introducing brokers; and
7. FCM Members should determine whether non-Member foreign brokers for whom the Member carries accounts solicit U.S. customers for transactions on U.S. exchanges.
As mentioned above, these suggested steps do not purport to be a dispositive list of internal procedures required to prevent violation of NFA Bylaw 1101. Though under some circumstances a Member following these suggestions could still be found liable for a violation of NFA Bylaw 1101, the suggested procedures should help foster compliance with NFA Bylaw 1101 and greater protection to the investing public.
9008 - RESERVED
9009 - NFA COMPLIANCE RULE 2-29: REVIEW OF PROMOTIONAL MATERIAL PRIOR TO ITS FIRST USE
(Staff, May 1, 1989; revised July 1, 2000)
As a service to its Members and the investing public, NFA offers a program for the review of promotional material prior to its first use. This program is voluntary and no Member must file promotional material with NFA unless otherwise required to do so by rule or directive. In addition, this program in no way lessens the requirement that Members supervise the preparation of and review all promotional material. Members may not attempt to use NFA staff's review as a substitute for its own.
Members wishing to avail themselves of the pre-review program may submit promotional material to the Compliance Department at least 21 calendar days prior to its first intended use. This material should be directed to:
National Futures Association
Advertising Regulation Team
300 S. Riverside Plaza
Chicago, IL 60606
In addition, Members may ask general questions about promotional material or Compliance Rule 2-29 by contacting NFA's Information Center at (312) 781-1410 or (800) 621-370 or through the "contact" feature of NFA's web site at www.nfa.futures.org. Such inquiries will be forwarded to the appropriate personnel for response.
Submitted material must be accompanied by a cover letter signed by a supervisory employee responsible for the review of the Member's promotional material. NFA staff will not pre-review material received directly from APs.
NFA staff will review submissions as expeditiously as possible. If additional information is needed, or the review cannot be completed within the 21 day period, the Member will be so notified. (In our experience, most reviews take far less than 21 days, and reviews take more than 21 days only in highly unusual circumstances.) At the conclusion of the review the comments of NFA staff will be conveyed to the Member, generally by telephone. Obviously NFA staff will not be able to independently verify the accuracy of every statement or numerical claim made in a piece of promotional material within the 21 day review period; that responsibility remains with the Member. Therefore, submitting promotional material to NFA will not provide a "safe harbor" for Members if misstatements or omissions of material facts are discovered subsequently. However, NFA staff review will provide valuable guidance to Members, particularly with regard to such areas as balance and the proper use of disclaimers.
9010 - INFORMATION AVAILABLE FROM NFA REGARDING BACKGROUND OF PROSPECTIVE EMPLOYEES
(Staff, August 21, 1989; revised July 1, 2000)
NFA Compliance Rule 2-9 requires Members to supervise diligently the futures-related activities of their employees and agents. Obviously, all Members should carefully screen prospective APs, both to ensure their qualifications and to determine the extent of supervision the prospective AP would require if hired. The purpose of this Notice is to remind you of the information available from NFA to aid Members in that effort.
All applicants for AP registration are required to fill out the Form 8-R, supplying, among other things, information concerning their recent employment history and any disciplinary proceedings against them. What may not be immediately apparent from the face of the application is whether any of the applicant's previous employers have been the subject to disciplinary proceedings by the Commission or by NFA. This information could be helpful to a prospective employer in determining the extent of supervision a particular applicant would require after he is hired. Certainly, if a recently hired AP has received the bulk of his professional training and experience from, for example, a number of firms which have been closed down as a result of disciplinary proceedings brought by the Commission or by NFA, that individual may well require closer supervision for a period of time than other APs.
If you have any questions whether the Commission or NFA has taken any action against a particular firm or individual, check the BASIC system on NFA's web site at www.nfa.futures.org, send a request to NFA through the "contact" feature of the web site, or call NFA's Information Center at (800) 621-3570. Summary information concerning the proceeding is available through BASIC or can be provided over the phone, and copies of any available documents relating to the proceeding can be provided upon request.
Prospective employers are also entitled to any non-public registration records regarding a prospective employee. For example, each applicant for registration as an AP must complete the disciplinary history portion of the Form 8-R, and must supply a detailed explanation of any "yes" answers to those questions. That detailed explanation is treated as non-public but is available to prospective employers under NFA Registration Rule 701(c). Thus, a prospective employer may obtain the non-public supplementary information which the applicant may have submitted in connection with any past registrations.
The supervision of employees must be an issue of paramount concern to all NFA Members. NFA recognizes that certain employees, by virtue of their past training or experience, may need more supervision than others and will gladly supply our Members with whatever information may be available to help identify those employees.
9011 - NFA BYLAWS 515, 708 AND 802: NFA REQUIREMENTS WHICH CONSTITUTE DISCIPLINARY OFFENSES.
(As of January 1, 2010)
NFA Bylaws 515, 708 and 802 set qualification standards for individuals serving on the Board, disciplinary committees, and arbitration panels and incorporate the disqualification standards in CFTC Regulation 1.63. Under those Bylaws and CFTC Regulation 1.63, individuals who violate the following rules are automatically disqualified from serving on the Board, disciplinary committees, and arbitration panels for at least three years.
2. Compliance Rules:
Rules 2-2 through 2-7, 2-8(a)-(c), 2-9, 2-10(b) and (d)(4)-(5), 2-11, 2-13, 2-22 through 2-27, 2-29(a)-(e), (h), and (j), 2-30, 2-31, 2-32, 2-34(a) and (c)-(d), 2-35, 2-36, 2-37(a)-(c) and (g), 2-38(a), 2-39, 2-40, 2-41, 2-42, 2-43, 2-44, and 2-45.
3. Financial Requirements:
4. Registration Rules:
[NOTE: Individuals are also disqualified from serving on the Board, disciplinary committees, and arbitration panels if they violated certain requirements that have since been repealed and the disqualification period is still in effect. These requirements are former Compliance Rules 2-15 through 2-17, 2-19 through 2-20, and 2-28 and former Registration Rule 205.]
9012 - RESERVED
9013 - NFA COMPLIANCE RULE 2-30: CUSTOMER INFORMATION AND RISK DISCLOSURE
(Staff, November 30, 1990; revised July 1, 2000)
NFA's Know-Your-Customer Rule, which deals with customer information and risk disclosure, has been in effect since June 1, 1986. As drafted by NFA's Advisory Committees and approved by the Board of Directors, the Rule was designed to accomplish two primary objectives:
1. to define "high standards of commercial honor and just and equitable principles of trade" as applied to Member procedures for exchanging information with new customers who are individuals; and
2. to provide a useful tool to combat any unscrupulous firms attempting to take advantage of unsophisticated investors.
Given these broad purposes, some of the Rule's provisions are very specific, while others, of necessity, are more general. Since some of the Rule's provisions are stated in general terms, Members may understandably seek more specific guidance on some points. The best sources for such guidance are the Interpretive Notice to Rule 2-30 ("Interpretive Notice")1, and the decisions NFA's Regional Business Conduct Committees ("BCCs") and Hearing Panels have made in specific disciplinary cases which allege violations of the Rule. The purpose of this Notice is to provide Members with additional guidance in complying with Rule 2-30 by summarizing how the BCCs have applied Rule 2-30 since the Rule became effective in 1986.
Since Rule 2-30 became effective, a number of complaints have been filed by NFA which allege violations of the Rule. Typical violations of the Rule generally fall into one of three categories.
1. failing to give additional risk disclosure when required or disguising the fact that additional risk disclosure may be required by inducing customers to provide false information on their account opening papers;
2. violations of recordkeeping requirements; and
3. violations of supervisory requirements.
A description of typical violations in each category is set forth below.
Inadequate Risk Disclosure
The heart of Rule 2-30 is the requirement that Members obtain certain basic information from the customer concerning his financial background, analyze that information and ensure that the customer has received adequate risk disclosure information. As discussed in the Interpretive Notice, some customers may require risk disclosure in addition to that specifically prescribed by Rule 2-30(d)2. For example, there may be instances where, for some customers, the only adequate risk disclosure is that futures trading is too risky for that customer. Once adequate disclosure is given, however, the customers are free to decide whether to trade in futures and the Member is free to accept the account. The Rule recognizes that the identification of customers who require additional risk disclosure can only be done on a case-by-case basis and that the determination of whether additional risk disclosure is required for a given customer is best left to the Member firm, subject to review by the BCCs.
The most serious violations of the Rule have involved either failing to provide additional risk disclosures when necessary or inducing customers to provide false information on their account opening forms. A number of the more egregious cases, which have generally resulted in expulsions from NFA membership, are summarized below. The exact factual circumstances vary from case to case, but one common thread in these cases is that the customer had no previous futures trading experience and little, if any, other investment experience. Obviously, these extreme examples do not in any way limit the circumstances which may trigger a need for additional risk disclosures:
- An AP instructed a customer, who noted on his account opening forms that he had owned his own home for 18 years, to falsify his account application by indicating that he had been involved in real estate development for 18 years.
- An AP solicited a 52-year-old retired Air Force Colonel who had no prior commodity trading experience. The AP did not advise the customer of any specific numbers to put down on his account opening form regarding his net worth, but told him to make the numbers high enough to get the account approved.
- An AP solicited a 32-year-old nurse and her husband, a 39-year-old computer operator, neither of whom had any prior investment experience in commodities or securities. The customers repeatedly informed the AP that they could not afford a minimum required investment of $10,000. The AP told them to take out a loan from their credit union and that the required investment amount would then be reduced to $5,000. The customers subsequently took out a $3,000 loan from their credit union and added $2,000 from their savings account to meet the $5,000 minimum investment requirement. The husband then went to the firm's office and signed the account forms during his 30-minute lunch break; however, he did not read the forms, nor were they explained to him by the firm or its AP.
- An AP instructed a customer to inaccurately complete his account application by stating that he was a foreman rather than a factory laborer, and by indicating that he had liquid assets in the amount of $51,000 instead of $20,000. Another of the firm's APs told a customer that his actual annual income of $12,500 was too low and that if he did not change that figure to read between $20,000 and $40,000, his account would be rejected.
- A customer who had been unemployed for two years, with a net worth of $30,000 derived from an inheritance and sale of property and no futures trading experience, was instructed by an AP to "put down anything" on the account opening form regarding her employment and income. The customer received no risk disclosure other than the Risk Disclosure Statement required by CFTC Regulation 1.55. In addition, the AP neither explained the account documents to the customer, nor gave her sufficient time to review them.
- An AP solicited a 77-year-old retired real estate investor with a net worth of $100,000 and a fixed annual income of $20,000. The customer informed the AP that both he and his wife were in ill health and that one of the reasons for his interest in investing in commodity futures contracts was his limited health insurance coverage and a desire to earn enough money to pay for his