Proposed Rule

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Last November NFA's Board adopted a new Interpretive Notice setting supervisory standards for any electronic trading system ("ETS") operated or used by Forex Dealer Members ("FDMs"). The Notice, which became effective on July 1, 2007, includes provisions regarding recordkeeping and trade integrity. NFA is amending the Interpretive Notice to require additional uniform formatting of data the Notice already requires firms to collect. In particular, the Interpretive Notice would require an FDM's system to generate two new types of reports: exception reports for trades meeting certain parameters and transaction reports to aid the firm and NFA auditors in calculating the new FDM assessment fee.

Exception Reports

The Interpretive Notice requires the ETS to keep order information and time and price records. Therefore, a system that complies with the Notice will have all the data needed to generate exception reports for fills outside of the price range displayed by the system when the customer places an order and for price adjustments. The current Interpretive Notice does not, however, require FDMs to generate these reports or to review them for improprieties. Certain inequitable conduct by firm personnel could go unnoticed by upper management. Daily exception reports would also make it easier for NFA auditors to review trade data and discover any wrongdoing. The following real-life examples illustrate the value of exception reports and related procedures in each of those two situations.

In the first situation, an FDM discovered that an AP who worked at the firm's dealing desk had defrauded the firm by placing bogus trades on its trading platform. The AP opened a number of customer accounts and then manufactured profits for those accounts. If a trade was losing money, he would create a profit by closing it out at a price outside of the range on the trading platform at that time. (The AP's position on the dealing desk allowed him to enter trades at prices that were not reflected on the platform.) In this case, the firm uncovered the problem. But not all FDMs have the information and procedures to do so.

In the other situation, an FDM adjusted prices on previously-executed trades that had resulted in sizeable profits for customers and losses for the firm. On the day in question, the Department of Labor released a report with numbers that were significantly lower than traders had projected. As soon as the news came out, a number of customers placed trades on the firm's platform. The platform was designed to change prices automatically by taking the average price from four bank feeds and adding a predetermined spread. Because of the volume and volatility, however, the bank feeds were slower than usual. The FDM eventually changed its price quoting practices for that day, but by that time many of its customers had made money and, as the counterparty, the firm had lost money. It then went back and adjusted the prices on those already-confirmed trades, claiming that the price quotes on the platform at the time did not represent the market.

The amended Interpretive Notice requires management approval of all adjustments except those made according to objective criteria spelled out in the firm's procedures, and the firm would be required to document the reason for each price adjustment (including those that do not require management approval). The amended Interpretive Notice also states that an unreasonable price adjustment violates NFA rules.

The Interpretive Notice states that the system should generate exception reports for all orders filled outside the price range displayed by the system "when the order was placed." NFA's Advisory Committee suggested replacing this with "when the order was executed." While its suggested language may work for limit orders, NFA is concerned that there are at least two situations where it would not be adequate for market orders. First, if an FDM-or an FDM's platform-held a market order until the execution price was reached, it would not show up on an exception report. Second, some FDMs routinely fill orders outside the range showing at the time the order is placed, and we believe the exception report should highlight this situation.1 While the suggested language is not included in the Interpretive Notice, NFA added a footnote stating that the requirement does not apply to limit orders that are not executable when entered but reminding FDMs that they should have procedures for reviewing limit orders that are executed at prices inconsistent with their terms.

Assessment Fees

On May 17, 2007, the Board voted to revise the revenue structure for FDMs. The new structure includes an assessment fee based on the notional value of each transaction (equating to 1 cent on every $10,000). A system that complies with the Interpretive Notice will capture both the number of transactions and their notional value. The amended the Interpretive Notice requires FDMs to generate and maintain reports containing that information. This will help the FDM calculate the amount it owes to NFA and will make it easier for NFA to confirm that amount during an audit.

Finally, NFA made a technical amendment to Footnote 4 to conform it to the recent rule changes expanding NFA's jurisdiction to include Zelener-type contracts.

1 The existing Notice makes it clear that the order is "placed" when it reaches the FDM's platform. Therefore, an FDM is not penalized for transmission delays beyond its control.

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