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NFA has always been aggressive in prosecuting its Members' fraudulent or misleading solicitation practices. Most recently, misleading statements in forex promotional materials have been particularly extensive and problematic. Since October 1, 2006, NFA has brought twenty-two enforcement cases against Members for fraudulent or misleading sales practices. Eighteen of these cases involved Forex Dealer Members' ("FDMs") promotional material, and one was the FDM's second case in just over a year.
NFA's enforcement efforts are more effective when it can hold not just the Member firm but also an individual responsible for misleading promotional material. This has proven difficult, however, because in many situations involving FDMs the only principal that is also an NFA Associate does not approve the promotional materials or supervise the employees who do. Accordingly, the Board amended the Interpretive Notice entitled Forex Transactions ("Forex Interpretive Notice") to require that the supervisory employee responsible for reviewing promotional materials be under the ultimate supervision of a principal who is also an NFA Associate. As a result of this amendment, an individual principal of the FDM may be held responsible for the use of fraudulent or misleading promotional materials.
NFA Compliance Rule 2-36(d) subjects FDMs to discipline for the activities of non-Members that solicit, introduce, or manage customer accounts at the FDM. In spite of this liability, NFA has found through its examinations that FDMs often fail to have in place written procedures to review the activities of these non-Members, or if they do have such procedures fail to adequately follow them. Many FDMs fail to take the simple step of regularly reviewing the promotional materials of these non-Members. This is particularly surprising because the overwhelming majority of promotional activities by these non-Members are conducted on websites, which can be readily reviewed at anytime and from anywhere there is internet access.
The amendments make clear that an FDM must adopt and enforce written supervisory procedures for reviewing the activities of non-Members with which they do business. Among other things, these procedures must include the regular review of trading being conducted in the accounts solicited, introduced, or managed by these non-Members, procedures for following up on any customer complaints regarding the non-Members, and the regular review of promotional materials used by the non-Members. Just as with an FDM's own promotional activities, the review of the non-Member's activities must be conducted by a supervisory employee that is under the ultimate supervision of a listed principal that is also an NFA Associate.
NFA requested comments from FDMs and other interested persons and received four letters in response to this request.1 All four comment letters opposed the proposal.
One FDM indicated that having all changes to promotional material reviewed by a supervisory employee would pose a challenge to a large firm. However, the rule as currently adopted already requires that a supervisory employee review an FDM's promotional materials. This comment only emphasizes the need for the proposed amendments to hold a principal liable. The FDM also raised a concern that the obligation to maintain copies of promotional materials of non-Member firms reviewed by the FDM would have a significant impact on their compliance resources. Specifically, the commenter points to the fact that each non-Member's website may contain dozens and dozens of pages that would have to be retained after the FDM reviews it. However, in light of available technology NFA believes this requirement does not pose a significant burden. Moreover, when an FDM chooses to do business with a non-Member knowing that it may be subject to discipline for violations by that firm, the FDM should be maintaining copies of such materials.
Another FDM stated that a principal should not be held liable except when the violation involves fraud. Compliance Rule 2-36, however, is already an anti-fraud rule. Further, where FDMs have been held liable for promotional materials of non-Members, the materials included fraudulent, deceitful, or misleading statements. This FDM also objected to the fact that the proposed amendments only apply to FDMs and not all futures commission merchants ("FCMs"). As noted above, however, NFA has not seen the same number of sales practice issues with promotional materials used by traditional FCMs that it has with FDMs. The FDM also stated that concerns related to the solicitation materials of non-Member solicitors would be better resolved by requiring these solicitors to become registered. As part of the CFTC reauthorization process, NFA has consistently called for amendments to the Commodity Exchange Act to require registration by such solicitors. Moreover, under NFA's current rules, the FDM may achieve the same result, and avoid liability, by dealing solely with regulated NFA Member entities. Absent amendments to the Commodity Exchange Act, NFA continues to believe that it is appropriate for FDMs to bear responsibility for choosing to do business with unregulated entities.
Another FDM noted that while it supports requiring written procedures for the review of non-Member promotional activities, it opposes the requirement that the FDM review trading conducted in accounts solicited, introduced, or managed by non-Members, and stated that such review would "burden the FDM with an overwhelming task of monitoring extensive activities within a large number of accounts." The commenter also stated that NFA should offer "pre-approval services" for the promotional materials of non-Members. NFA believes, however, that the proposed requirement is appropriate given the nature of the solicitors. Further, if an FDM chooses to benefit from the activities of unregulated non-Members, then it must bear the responsibility for reviewing their promotional materials and their ongoing activities.
This FDM also objected to the fact that Compliance Rule 2-36(d) imposes strict liability on FDMs for the activities of non-Members and suggested that the rule should be amended to provide for "some form of good faith standard" that would apply when "a firm produces well documented evidence of detailed supervisory reviews." NFA believes that such an amendment is unnecessary as the Interpretive Notice currently states that, as a practical matter, NFA will not take disciplinary action unless the FDM knew or should have known of the misconduct or "failed to exercise due diligence when establishing and maintaining the relationship" with the non-Member. Moreover, the enforcement actions brought under NFA Compliance Rule 2-36(d) to date have been consistent with this standard.
FXIA, in its comments, appears to take issue with holding a principal liable for the actions of a non-Member where the principal does not have an active role in the conduct of the non-Member. As NFA noted when it adopted NFA Compliance Rule 2-36(d), the use of unregulated solicitors creates an opportunity for FDMs to disavow any responsibility for the actions of these non-Members. NFA's Board, however, believes that an FDM should not be able to benefit from fraudulent solicitations without also bearing responsibility for those solicitations. While a principal of an FDM might not have control over the non-Member's activities, he or she does exercise control over the activities of the FDM that chose to deal with unregulated entities. FXIA also asked for a definitive "Safe Harbor" whereby FDMs would not be subject to disciplinary action for the actions of non-Members. The amendments include concrete requirements that must be followed by FDMs with regard to the activities of non-Members. Although not a "Safe Harbor," it does offer additional guidance on due diligence steps that FDMs should undertake. Moreover, NFA will continue not to bring enforcement actions against an FDM unless it knew or should have known of the non-Member's conduct or failed to exercise due diligence in its relationship. The only "Safe Harbor," however, is for an FDM to deal only with NFA Member entities.
A principal should be held personally accountable for the solicitation activities his or her firm relies upon to obtain customers. By making an individual principal who is also an NFA Associate subject to discipline for this supervisory obligation, NFA expects that FDMs will take their obligations under NFA rules more seriously than they appear to do presently.
NFA respectfully requests that the Commission review and approve the proposed amendments to the Interpretive Notice regarding Forex Transactions.
1 Letters were received from the Foreign Exchange Industry Association ("FXIA") and three FDMs.