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Interpretive Notices

9001 - RESERVED

9002 - REGISTRATION REQUIREMENTS; BRANCH OFFICES

(Staff, September 6, 1985; revised July 1, 2000; December 9, 2005; September 30, 2010 and September 23, 2021)

INTERPRETIVE NOTICE

Form 7-R, Branch Offices

Each FCM, RFED, IB, CPO and CTA is required to list on Form 7-R each of its branch offices. A branch office is defined as follows:

Any location, other than the main business address at which an FCM, RFED, IB, CPO or CTA employs one or more persons engaged in activities requiring registration as an AP, excluding any location where one or more APs from the same household live or rent/lease provided the location is not held out to the public as an office of the Member; the AP(s) does not meet in-person with customers or physically handle customer funds at the location; and any CFTC or NFA required records created at the non-branch office location are accessible for inspection at the Member firm's main or applicable listed branch office as required under CFTC Regulation 1.31 and NFA Compliance Rule 2-10.

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.

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; January 1, 2020 and April 22, 2020)

I. Introduction

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 interest business. Although these rules supply the required minimum standards, they are general in nature and may not always provide specific guidance as to what particular conduct may be prohibited. Additional information related to how NFA rules apply to specific conduct may be found by reviewing disciplinary decisions issued by NFA's Business Conduct Committee and Interpretive Notices issued by NFA.

II. The Relationship of Compliance Rule 2-29 With Other NFA Rules

NFA Compliance Rule 2-29 implements specific requirements for communication with the public and promotional material related to the commodity interest business of an FCM, IB, CPO or CTA Member. However, all Members and Associates are subject to all other applicable NFA requirements, including NFA's rules related to fraudulent and deceptive practices (Compliance Rule 2-2) and just and equitable principles of trade (Compliance Rule 2-4) with respect to their communications with the public and promotional materials.

Compliance Rule 2-29 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 preclude NFA from raising compliance issues with the content of promotional material or taking a disciplinary action if the Member or Associate violates any other NFA Requirement.

III. The Scope of Compliance Rule 2-29

The definition of "promotional material" set forth in Compliance Rule 2-29 is broad and is intended to apply to all forms of communication with the public by an FCM, IB, CPO or CTA 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 commodity interest business.

NFA recognizes certain specific standards that 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. Compliance Rule 2-29 is not intended to impede the free flow of information and advice to customers by subjecting spontaneous communication to rigorous and detailed content standards.

To address this problem, Compliance Rule 2-29 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 that will be subject to specific content standards and other requirements beyond those provided in Section (a) General Prohibition. Therefore, the definition of promotional material 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 that is directed to any member of the public. It also includes any oral presentations or statements to customers or prospective customers the substance of which is standardized, 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 applies to routine communication with customers. That means that routine customer contact will not violate Compliance Rule 2-29 as long as it is not fraudulent or deceptive, does not involve a high-pressure approach and does not contain any statement indicating that commodity interest 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 general, a communication will not be considered fraudulent or deceptive in the absence of evidence of intentional or reckless conduct on the part of the FCM, IB, CPO or CTA Member or Associate. In certain circumstances intentional or reckless conduct may be presumed (e.g., if a Member or Associate specifically contradicts or downplays any disclosure statement required to be made by CFTC regulations or NFA rules).

Section (b) Content of Promotional Material

Deceptive or Misleading 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 subsection 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) also prohibits FCM, IB, CPO and CTA Members from making material misstatements or knowingly omitting any fact that makes promotional material misleading. This subsection 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 deceptive materials a Member must determine whether promotional material is likely to be misleading in effect and specific intent need not be shown to find that a Member violated these provisions by making material misstatements of fact in promotional material. However, because evaluating omissions is a much more difficult task, NFA has implemented a knowledge requirement for omissions (i.e., 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.

Additional information related to deceptive advertising is set forth in Interpretive Notice 9033 - NFA Compliance Rule 2-29: Deceptive Advertising.

Other Content Requirements for Promotional Material Used By FCM, IB, CPO or CTA Members and Associates

Subsection (3) requires FCM, IB, CPO and CTA Members and Associates to include a discussion of risk to balance any discussion of the possibility of profit in promotional material. The requirement that the discussion 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 discussion of the risk of loss is clearly displayed and is not downplayed or hidden.

Subsection (4) provides that any FCM, IB, CPO or CTA Member or Associate using promotional material that refers to actual past trading profits must state that past results are not necessarily indicative of future results.

If performance information is included in promotional material used by an FCM, IB, CPO or CTA Member or Associate, Compliance Rule 2-29(b)(5) provides that the Member or Associate must be able to demonstrate that the performance information is representative of the actual performance for the same time period of all reasonably comparable accounts. An FCM, IB, CPO or CTA Member or Associate could not, for example, advertise the performance of a "model" account unless that performance is representative of all reasonably comparable accounts. An FCM, IB, CPO or CTA Member or Associate may be able to exclude from "reasonably comparable accounts" those accounts that were actually traded pursuant to a different trading strategy or accounts that were traded independently of the accounts in the program for which performance is presented.

The use of performance information in promotional material is, of course, subject to all of the content standards of Compliance 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.

Subsection (b)(5) also provides that the rate of return must be presented net of all fees and expenses1 and must be calculated in a manner that is consistent with the applicable requirements of Part 4 of the CFTC's Regulations and NFA Compliance Rule 2-34, 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.

A CTA Member that is also an SEC Registered Investment Adviser and/or its Associate may present past performance results, including the rate of return, to an eligible contract participant (ECP) on a gross basis in a non-public, one-on-one presentation, if the CTA Member provides the ECP client with a written disclosure that the performance results are presented on a gross basis and do not reflect the deduction of fees and expenses, which will reduce the client's returns, and offers to provide the client with the performance results net of any fees and expenses agreed upon by the CTA Member and the ECP client at or prior to exercising discretion over the client's account.

Compliance Rule 2-29(b)(6) provides that any testimonial used in promotional material must be representative of all reasonably comparable accounts, prominently state that the testimonial is not indicative of future performance, and, if applicable, state that it is a paid testimonial.

Section (c) Hypothetical Results

Compliance Rule 2-29(c) establishes requirements for FCM, IB, CPO or CTA Members and Associates that utilize hypothetical performance results. Additional information related to these requirements is set forth in Interpretive Notice 9025 - Compliance Rule 2-29: Use of Promotional Material Containing Hypothetical Performance Results.

Although promotional material directed exclusively to persons who meet the standards of a Qualified Eligible Person (QEP) under CFTC Regulation 4.7 are not specifically required to comply with Compliance Rule 2-29(c)(3), the presentation of hypothetical performance results in promotional material is subject to all other NFA rules, including Compliance Rule 2-29(b)(1), which prohibits the use of misleading or deceptive promotional material. Therefore, even for promotional material directed exclusively to QEPs, if not including the past performance information required under Compliance Rule 2-29(c)(3) would make the promotional material misleading, then a Member may be subject to discipline under Compliance Rule 2-29(b)(1).

Section (d) Statements of Opinion

Under Compliance Rule 2-29(d), FCM, IB, CPO and CTA Members and Associates must clearly identify statements of opinion used in promotional material as opinions. In addition, any statement of opinion must have a reasonable basis in fact.

Section (e) Written Supervisory Procedures

Pursuant to Compliance Rule 2-29(e), FCM, IB, CPO and CTA Members must implement and enforce written supervisory procedures that are designed to achieve compliance with NFA's requirements for promotional material. In addition, all promotional material must be reviewed and approved in writing by an appropriate supervisory employee prior to first use. 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

Compliance Rule 2-29(f) is intended to provide a way in which NFA can conduct meaningful examinations of both the content of and supervisory procedures for promotional material. In addition, this Section contains a requirement that FCM, IB, CPO and CTA Members who use hypothetical performance results be prepared to demonstrate to NFA's satisfaction the basis for such results. This means that these Members must maintain the records necessary to document how the hypothetical results were calculated.

Section (g) Filing with NFA

Compliance Rule 2-29(g) allows the Compliance Department to implement filing requirements for any FCM, IB, CPO and CTA Member. This provision is intended to allow NFA to maintain close review of promotional material in circumstances where special scrutiny is warranted.

1 Fees and expenses that are not required to participate in a trading program (e.g., non-mandatory custodial or administrative fees) need not be reflected in the performance presentation.


9004 - NFA COMPLIANCE RULE 2-30: CUSTOMER INFORMATION AND RISK DISCLOSURE

(Board of Directors, effective June 1, 1986 and revised January 3, 2011 and March 1, 2020)

INTERPRETIVE NOTICE

I. Introduction

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 commodity futures and swaps business. NFA's Advisory Committees ("the Committees") have considered 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 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 an 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 futures industry differs from the securities industry in several crucial ways. Most importantly, futures contracts are generally 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 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 its Business Conduct Committee ("BCC") and Hearing Panels, which are composed of informed 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 Rule 2-30 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 Member or Associate who "knows the customer." NFA believes that the approach taken in Rule 2-30 is preferable to one which would erect an inflexible "suitability" standard that would bar some persons from using the futures markets.

NFA believes that the principles set forth above also apply when individuals and non-ECP entities trade cleared swaps, and therefore has determined that Members must comply with the requirements of Compliance Rule 2-30 with respect to cleared swaps accounts of individual and other non-ECP customers. Like futures contracts, cleared swaps are generally recognized as highly volatile instruments and the risk associated with these products should be disclosed and understood at the time a customer first opens a cleared swaps customer account.

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 or cleared swaps customers at the time they become customers.2 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 trading futures or cleared swaps on suitability grounds.

NFA's enactment of 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 1a(18) 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 futures 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 an account with the Member for trading futures or cleared swaps. 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 year 3 . 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 previous 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 or swaps 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 and/or cleared swaps 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 Regulation 190.10(c)'s disclosure statement for non-cash margin, which may apply to particular accounts.)5 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 trading futures or cleared swaps as too risky for that customer. In these instances, the only adequate risk disclosure by the Member and Associate is that trading futures or cleared swaps 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 or cleared swaps 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 trading futures or cleared swaps 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 risk disclosure that satisfies Regulation 1.55 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 examine 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 basic 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 applies to all new accounts. This is consistent with the Member's responsibility to supervise the futures and swaps 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 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 no later than the time the trading advisor delivers to the prospective client an advisory agreement to direct or guide the client's account. 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 options. See Compliance Rule 1-1.

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.

5 NFA acknowledges that many FCMs and IBs use the FIA Combined Risk Disclosure Statement to comply with the disclosure statement requirements of CFTC Regulations 1.55(a), 1.55(b), 30.6(a), 33.7(a) and 190.10(c) and NFA Compliance Rule 2-30.

9005 - NFA COMPLIANCE RULE 2-4: GUIDELINES FOR THE DISCLOSURE BY FCMS AND IBS OF COSTS ASSOCIATED WITH FUTURES AND CLEARED SWAP TRANSACTIONS

(Board of Directors, effective June 1, 1986; revised July 24, 2000 and July 1, 2019)

INTERPRETIVE NOTICE

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 and swaps 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 futures1 and cleared swap transactions.

If fees and charges associated with futures and cleared swap transactions are not determined on a per trade or round-turn trade basis, the FCM or IB 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 customers fees and charges associated with futures or cleared swap transactions. 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 and Rules define "futures" to include exchange-traded options. See NFA Bylaw 1507 and NFA Compliance Rule 1-1(q).

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 and June 30, 2020.)

INTERPRETIVE NOTICE

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. §709, 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)

INTERPRETIVE NOTICE

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 and January 1, 2020)

INTERPRETIVE NOTICE

NFA offers a program to review the promotional material of an FCM, IB, CPO or CTA Member prior to its first use. This program is voluntary and no Member is required to file promotional material with NFA prior to using the material unless otherwise required to do so by an NFA rule or directive. In addition, the use of this program in no way lessens the requirement that Members review, approve and supervise the use of all of their promotional material. A Member may not rely on or attempt to use NFA staff's review to meet its promotional material supervisory obligations under NFA Compliance Rule 2-29.

Any FCM, IB, CPO or CTA Member wishing to use the pre-review program must submit promotional material to the Compliance Department through NFA's electronic Promotional Material Filing System at least 14 calendar days prior to its first intended use.1

Promotional material must be submitted to NFA for review by a firm representative who has been designated to file promotional material on behalf of the Member by its security manager. The filing must also include the following information:

  • The name of the supervisor(s) who reviewed and approved the promotional material;
  • A description of how the promotional material will be used and disseminated to prospective client(s);
  • The type(s) of investment products being offered in the promotional material; and
  • The date the Member intends to begin using the promotional material.

NFA staff will review submissions as expeditiously as possible. The Member will be notified if additional information is needed or the review cannot be completed within the 14-day period. The firm representative may communicate with the reviewer regarding a particular submission at any time during the review process by sending an electronic message through the system.

NFA will notify the Member by email when the review is complete and instruct the firm to access the Promotional Material Filing System to view any review comments or obtain notification that staff has no further comments and the material may be used.

The Member is responsible for ensuring the accuracy of all information in the promotional material. 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 14-day review period, and submitting promotional material to NFA will not preclude NFA from raising compliance issues with the content of the promotional material or taking a disciplinary action for misstatements, omissions of material facts or other violations of NFA rules that are subsequently identified. NFA staff's review is designed to provide guidance to Members, particularly with regard to whether the material presents the appropriate balance regarding the possibility of profit and the risk of loss and the proper use of disclaimers.

Members may also ask general questions about promotional material or Compliance Rule 2-29 by contacting NFA's Information Center at (312) 781-1410 or (800) 621-3570 or through the "contact" feature of NFA's web site at www.nfa.futures.org. Inquiries will be forwarded to the appropriate personnel for response.

1 See A Guide to NFA Compliance Rules 2-29 and 2-36 for additional information on NFA's Promotional Material Filing System.

9010 - INFORMATION AVAILABLE FROM NFA REGARDING BACKGROUND OF PROSPECTIVE EMPLOYEES

(Staff, August 21, 1989; effective July 1, 2000 and September 30, 2019.)

INTERPRETIVE NOTICE

The purpose of this Notice is to remind Members of their obligations with respect to prospective employees and the information available from NFA to help Members achieve compliance with these obligations.

I. Obligations of FCMs, FDMs, IBs, CPOs and CTAs

NFA Compliance Rule 2-9 requires each FCM, IB, CPO and CTA Member to supervise diligently the commodity interest activities of their employees and agents. Likewise, NFA Compliance Rule 2-36 imposes an obligation for each FDM to diligently supervise the forex activities of its employees and agents. Obviously, all FCM, IB, CPO and CTA Members and all FDMs should carefully screen prospective APs, both to ensure their qualifications and to determine the extent of supervision the prospective AP would require if hired.

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.

II. Obligations of SDs and MSPs

Pursuant to CFTC Regulation 23.22 and NFA Compliance Rule 2-49, SDs and MSPs are prohibited from permitting an individual who is subject to a statutory disqualification to effect or be involved in effecting swaps on behalf of the SD or MSP if the SD or MSP knows or in the exercise of reasonable care should know of such statutory disqualification. All SD and MSP Members should carefully screen individuals who will effect or be involved in effecting swaps for statutory disqualifications, including by reviewing any applicable information available from NFA.

III. Information Available from NFA

If you have any questions regarding 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, 2022)

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.

1. Bylaws:

    Bylaws 301(a)(d), 513 through 516, 703, 704, 706 through 708, and 1101.

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, 2-35, 2-36, 2-37(a)-(c) and (g), 2-38(a), 2-39, 2-40, 2-43, 2-45 and 2-49.

3. Financial Requirements:

    Sections 4, 14, 15, 16 and 17.

4. Registration Rules:

    Rules 208, 210(a)-(b), 211, 301(c) and (d)(2), and 302(c) and (d)(2).

[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 and March 1, 2020)

INTERPRETIVE NOTICE

NFA's Know-Your-Customer Rule, which deals with customer information and risk disclosure, has been in effect since June 1, 1986. The Rule is 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 Interpretive Notice 9004 – NFA Compliance Rule 2-30: Customer Information and Risk Disclosure, and the decisions NFA's Business Conduct Committee (BCC) and Hearing Panels have made in specific disciplinary cases alleging 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 alleging 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 Interpretive Notice 9004 – NFA Compliance Rule 2-30: Customer Information and Risk Disclosure, some customers may require risk disclosure in addition to that specifically prescribed by Rule 2-30(d). For example, there may be instances where, for some customers, the only adequate risk disclosure is that trading futures or cleared swaps is too risky for that customer. Once adequate disclosure is given, however, the customers are free to decide whether to trade in futures or cleared swaps 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 BCC.

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 medical expenses. Rather than providing the customer with risk disclosure in addition to that contained in the risk disclosure statements, the AP informed the customer that the risk of loss involved in futures trading was slight. Another of the firm's APs instructed a customer not to put down "unemployed actor" for his occupation but rather "self-employed." This AP also advised the customer to include a net worth figure on his account forms which was sufficiently high to insure the opening of the account, and for the income figure, to put down his income prior to becoming unemployed.

Again, the cases summarized above illustrate some of the more egregious violations of the Rule involving either inadequate risk disclosure or inducing customers to provide false information on their account opening forms. However, because the determination of whether additional risk disclosure is required for a given customer can be made only on a case-by-case basis, the above scenarios should not be interpreted to limit the circumstances under which additional risk disclosure may be required.

Recordkeeping and Supervisory Requirements

Though risk disclosure is the heart of the Rule, Compliance Rule 2-30 also imposes certain recordkeeping and supervisory requirements. Violations of these requirements typically involve a failure to obtain all of the information required under the Rule (i.e., occupation, current estimated annual income and net worth, approximate age and previous investment and futures or swaps trading experience) or a failure to retain the appropriate records. Although the Rule 2-30 recordkeeping violations have rarely if ever formed the sole basis of disciplinary actions, they generally are indicative of a widespread recordkeeping problem within the firm.

Rule 2-30(h) requires each Member to "establish and enforce adequate procedures to. . . supervise the activities of its Associates in obtaining customer information and providing risk disclosure." One case alleging a violation of Rule 2-30(h) involved the failure of a firm's account opening procedures to require that the firm's APs obtain the necessary information from the customer. Another case involved a firm whose APs failed to follow guidelines provided to the firm by its guarantor in order to determine whether a prospective customer needed additional risk disclosure. Rule 2-30(h) does not require Members to provide their APs with any sort of grid-like formula to identify those customers who require additional risk disclosure; however, the Rule, as applied by the BCC and Hearing Panels, does require that a firm be able to articulate the general factors its APs are instructed to consider in determining whether additional risk disclosure is required.

In conclusion, NFA recognizes that certain provisions of Compliance Rule 2-30 are stated in general terms. Since the law in this area is developed on a case-by-case basis by NFA's Hearing Panels, no precise formula is available to Members to aid them in their interpretation of the Rule. However, in addition to Interpretive Notice 9004 – NFA Compliance Rule 2-30: Customer Information and Risk Disclosure, Members may obtain guidance regarding the Rule's application by reviewing the case summaries described above.

9014 - NFA COMPLIANCE RULE 2-4: CONFIDENTIALITY LANGUAGE IN RELEASE AGREEMENTS

(Staff, February 7, 1991; revised December 17, 2007)

INTERPRETIVE NOTICE

NFA has become aware of a practice utilized in the settlement of customer complaints and arbitration proceedings whereby, as a condition of settlement, a customer is required to sign a release which limits their ability to cooperate with regulatory authorities. The language being utilized goes beyond the general confidentiality language requiring that no public statement be released with respect to the terms of the settlement. Although the scope of the language in each release differs, it is apparent that the language being incorporated by some firms requires the customer to refrain from releasing or disclosing any information to regulatory bodies except as required by court order or as otherwise required by law.

The plain meaning of such language would bar the customer from cooperating with NFA. NFA has encountered this situation in the course of conducting investigations into apparent violations by Members. Customers have been reluctant to provide information and testimony because of this type of confidentiality provision in their agreements, therefore frustrating the effectiveness of the NFA enforcement process.

While the practice of including language prohibiting the disclosure of settlement terms is acceptable, the use of language which clearly bars customer cooperation with NFA is not. Including such language in settlement agreements is viewed by NFA as an unethical practice and a failure to observe high standards of commercial honor and just and equitable principles of trade.

Therefore, NFA staff has recommended and an NFA Regional Business Conduct Committee has charged a violation of NFA Compliance Rule 2-4 when language which prohibits the customer from cooperating with NFA is used as a term of settlement. NFA staff will continue to recommend that a violation of NFA Compliance Rule 2-4 be charged when this language is used.

The Financial Industry Regulatory Authority ("FINRA") has also encountered the use of this language by some of its members. In response, the FINRA issued a notice informing its members that this practice may be viewed as unethical and would constitute a violation of FINRA rules.

An agreement containing language restricting the release of information to regulatory or law enforcement agencies may also be found to be void as against public policy by state courts. The public policy concern is implicated because the scope of this language goes beyond the private rights of the individuals involved by discouraging the release of information and potential evidence and interfering with the process of justice.

While general confidentiality language in release agreements is certainly permissible, NFA staff cautions Members against the use of settlement agreements which include language limiting or prohibiting a customer from providing information and cooperating with NFA. This is not intended to impose an affirmative duty on Members to include language explicitly permitting such cooperation, but merely to avoid explicit language barring it.

9015 - RESERVED

9016 - NFA BYLAW 1301: NFA ASSESSMENT FEE QUESTIONS AND ANSWERS FOR FCMS

(Staff, revised January 1, 2002; April 1, 2002; July 1, 2002; September 17, 2002; January 1, 2003; January 1, 2005; August 1, 2005; January 1, 2008; January 1, 2011; June 20, 2011; October 25, 2011; October 27, 2011; June 5, 2012; September 1, 2012; January 3, 2013; July 18, 2013; October 1, 2014; November 5, 2014; January 16, 2015 and January 24, 2024.)

INTERPRETIVE NOTICE

From time to time NFA receives questions from Members regarding NFA's assessment fees. Areas of frequent inquiry include the manner and frequency of payment, the proper form of invoicing the assessment fee and the applicability of the assessment fee in different situations. Following is a compilation of the most frequently asked questions and their answers. Members may wish to refer to this compilation when a question regarding assessment fees arises.

I. Definitions

    1. Q: What is a futures contract "round-turn"?

    A: The term "round-turn" as used in NFA Bylaw 1301(b) is intended to include all transactions where an actual futures position is closed out or offset. This would include futures positions closed out by delivery, cash settlement, through an exchange for physicals, and as a result of the transfer to the carrying FCM from another FCM of offsetting futures contracts.

    [Note: Although the NFA assessment fee for futures is calculated on a round-turn basis, NFA Bylaws leave Member FCMs free to invoice and accrue the fee at any point in a round-turn or to split the fee among transactions which make up a round-turn.]

    2. Q: What is meant by "per trade" for the options assessment fee?

    A: The term "per trade" as used in NFA Bylaw 1301(b) means a purchase or sale of an option but does not include the exercise or expiration of an option. However, if an option is exercised, NFA's assessment fee will be assessed on the underlying futures transaction on a round-turn basis.

II. Payments

    1. Q: How much is the NFA assessment fee?

    A: As of January 1, 2018, the NFA assessment fee, payable by FCMs with respect to futures contracts, is $.02 per side, invoiced to customers. The assessment fee on exchange-traded options is $.02 per side.

    2. Q: Is there a different NFA assessment fee for futures contracts that have a very small notional value?

    A: No. The NFA assessment fee for all futures contracts no matter the size is $.02 per side, invoiced to customers.

    3. Q: What is the amount of the NFA assessment fee for security futures contracts and to which accounts is it applied?

    A: The NFA assessment fee for security futures contracts is $.02 per side, invoiced to customers. NFA's assessment fee applies to security futures contracts held in a commodity futures account only.

    4. Q: When is the NFA assessment fee payable?

    A: The assessment fee is payable 30 days following the end of the month for all transactions effected during that month.

    5. Q: How is the NFA assessment fee form submitted every month?

    A: FCMs will receive an automated e-mail on the first day of the month with a link to access EasyFile. The NFA assessment fee form will only be accepted via EasyFile submission.

III. Invoicing

    1. Q: Can an FCM combine the NFA assessment fee with commissions in its statement to customers?
    A: No. Assessment fee amounts must be shown or included in a line item on the customer statement separate from the line item which is used to designate commissions. Such an item may be devoted exclusively to the NFA assessment fee or may include other fees (i.e., a miscellaneous fees category). If, however, the amount indicated in the line is higher than the applicable NFA assessment fee, the customer must receive notice either on the statement or in a separate document of the actual amount of the NFA assessment fee.
    2. Q: Must an FCM invoice to the customer the NFA assessment fee?
    A: Yes. Bylaw 1301(b)(i) requires that the assessment fee be invoiced to customers.
    3. Q: May the assessment fee be invoiced on a monthly statement?
    A: Yes. Although Bylaw 1301(b)(i) requires that an FCM Member invoice assessments to its customers and remit the amount due to NFA, the FCM is given some discretion as to how the customer is invoiced. Invoicing through monthly statements or purchase and sale statements are both acceptable methods.
    4. Q: May the NFA assessment fee on futures transactions be invoiced to customers at the opening of a futures position?
    A: Yes. The invoicing requirement of Bylaw 1301(b) does not restrict or prescribe the timing of the invoicing.

IV. Applicability of NFA Assessment Fee

    1. Q: Does the assessment fee apply to accounts of persons having "privileges of membership" on a contract market?

    A: No. NFA Bylaw 1301(b)(i) makes the NFA assessment fee inapplicable to trades of customers who have "privileges of membership on a contract market where such contract is entered (except that this exemption does not apply to transactions by commodity pools operated by NFA Member CPOs)." If the exchange formally recognizes the customer as a member, the NFA assessment fee does not apply.

    2. Q: Does the assessment fee apply to commodity pools operated by NFA Members?

    A: Yes. If a commodity pool (exempt or non-exempt) is operated by an NFA Member and has privileges of membership on a contract market where such contract is entered, then the commodity pool is still required to pay assessment fees. The assessment fee also applies to an exempt commodity pool operated by a non-Member unless the pool has privileges of membership on a contract market.

    3. Q: Does the assessment fee apply to proprietary accounts?

    A: Generally, accounts belonging to affiliated firms which wholly own, are wholly owned by, or share 100 percent ownership with the FCM are exempt from paying the NFA assessment fee if the transactions are executed on an exchange where the FCM is a member. There are two exceptions to this general rule.

    First, any account that is in the name of a commodity pool operated by an NFA Member CPO is subject to the NFA assessment fee, regardless of affiliations or exchange memberships. Second, any account where someone other than the exchange member FCM or affiliate makes deposits in the account or bears the risk of loss is subject to the assessment fee.

    4. Q: If an FCM carries an omnibus account for another FCM which is an NFA Member, which FCM is liable to NFA for the assessment fee on trades in the omnibus account?

    A: The originating FCM is liable to NFA.

    5. Q: Would an FCM carrying an omnibus account ever be liable to NFA for the assessment fee on trades in the omnibus account?

    A: Yes. If the originating broker is not an FCM Member, the carrying FCM pays the fee. This situation would arise where the originating broker is a foreign broker.

    6. Q: Does an FCM pay an assessment fee on trades on a non-U.S. customer on a domestic exchange?

    A: Yes. The assessment fee applies to trades on domestic exchanges without regard to the nationality or residence of the customer.

    7. Q: Does the assessment fee apply to trades of U.S. customers on foreign exchanges?

    A: Generally, yes. Foreign futures and options are assessed the assessment fee at the same rates applicable to domestic futures and options. There are two exceptions: 1) The "omnibus account" exemption, discussed under Part IV, question 5, applies to foreign futures and options. (A "U.S. customer" includes any customer who resides in the United States, its territories or possessions); and 2) The exemption referenced in Bylaw 1301 (b) (i) (D) (2) regarding proprietary trades of a person who has privileges of membership on certain NFA Member contract markets (irrespective of whether that person is a member of the foreign exchange; in addition, this does not apply to commodity pools operated by an NFA Member). Currently, those contract markets are CME Group, ICE Futures, and Minneapolis Grain Exchange.

    8. Q: Does the assessment fee apply to trades of non-U.S. customers on foreign exchanges?

    A: No. Trades by non-U.S. customers on foreign exchanges are excluded from the definition of "foreign futures and options" and therefore are not subject to the assessment fee.

    9. Q: Does an FCM pay an assessment fee on transactions which are merely bookkeeping entries such as those made to correct errors or to transfer a position from the books of one FCM to the books of another?

    A: No. The term "round-turn" excludes offsets which do not represent an actual transaction but which are merely bookkeeping entries such as those made to correct errors or to transfer a position from the books of one FCM to the books of another.

    10. Q: Concerning linked-market transactions, how do NFA assessment fees apply to futures positions executed on a foreign exchange (e.g., the Singapore Exchange (SGX)) to be offset against positions executed on a domestic exchange (e.g., the Chicago Mercantile Exchange ("CME")) and vice versa?

    A: Any futures transaction that is carried as a CME trade by an FCM Member for the account of a customer (except trades which under Bylaw 1301(b) are not assessable) will be subject to an NFA assessment fee upon completion of the round-turn even though one or both sides of the round-turn may have been actually executed on SGX. Any transaction that is carried as a SGX trade by an FCM Member for the account of a U.S. customer (except trades which under Bylaw 1301(b) are not assessable) will be subject to an NFA assessment fee. Any trade that is executed on the CME but is transferred to a SGX member and the SGX clearing house through the Mutual Offset System will not be subject to an NFA assessment fee.

9017 - NFA BYLAW 1301: FORMS AND PROCEDURES FOR ASSESSMENT FEE COMPUTATION

(Staff, revised July 1, 2002 and January 24, 2024)

INTERPRETIVE NOTICE

Following are examples of forms and instructions to which Members may wish to refer when calculating NF A assessment fees. All FCM members will be required to submit the monthly assessment fee worksheet via EasyFile. Members may also wish to refer to Schedules I and II when developing systems to determine the appropriate fee.

If you will not be remitting an assessment fee to NFA, for example because your firm clears on a fully disclosed basis through another FCM which is remitting fees on your behalf, please complete the monthly assessment fee worksheet in EasyFile showing zero volume and fees and submit to NFA by the due date.

Bylaw 1302 provides that assessments based upon futures transactions shall be payable to NFA within 30 days after the end of each month for the transactions effected during that month.

NFA BYLAW 1301: FORMS AND PROCEDURES FOR ASSESSMENT FEE COMPUTATION
(Staff, revised November 26, 2001 and July 1, 2018)

INTERPRETIVE NOTICE

SCHEDULE I

FCM ASSESSMENT FEE SUMMARY REPORT
MONTH ENDED_______________

NFA ID Number _______________ VOLUME OF
TRANSACTIONS
NON-ASSESSED**		 VOLUME OF
TRANSACTIONS
ASSESSED ONLY		 FEES ($)
DOMESTIC TRADES
A. FUTURES CONTRACTS TRADED ON
U.S. EXCHANGES (ROUND-TURNS) 		________ ________ ________
B. SECURITY FUTURES CONTRACTS
TRADED ON U.S. EXCHANGES
(ROUND-TURNS)		 ________ ________ ________
C. OPTIONS TRADED ON
U.S. EXCHANGES (NUMBER OF TRADES)		 ________ ________ ________
FOREIGN TRADES
D. FUTURES CONTRACTS TRADED ON
FOREIGN EXCHANGES FOR U.S. CUSTOMERS (ROUND-TURNS) 		________ ________
E. OPTIONS CONTRACTS TRADED ON
FOREIGN EXCHANGES FOR U.S. CUSTOMERS (NUMBER OF TRADES)		 ________ ________
F. TOTAL FCM ASSESSMENT FEE DUE MM/DD/YY ________ ________
G. LIST FCM REMITTING FEES ON BEHALF OF THIS ENTITY ______________________________________

IF YOUR FIRM HAS NO ASSESSMENT FEES TO SUBMIT FOR THE MONTH, PLEASE INDICATE ZERO VOLUME AND FEES ABOVE. THEN SIMPLY SIGN AND RETURN THIS FORM BY THE DUE DATE.

I CERTIFY THE ABOVE INFORMATION IS TRUE AND CORRECT.

  ________________________
Authorized Signature

________________________
Name

SEND A COPY OF THIS REPORT ALONG WITH YOUR REMITTANCE TO: NFA
P.O. BOX 98383
CHICAGO, ILLINOIS 60693-0001
ATTN: TREASURER’S OFFICE

** FCM NON-ASSESSED VOLUME WOULD INCLUDE ALL VOLUME THAT IS NOT SUBJECT TO THE NFA ASSESSMENT FEE. IT WOULD INCLUDE TRANSACTIONS OF CUSTOMERS EXEMPT FROM THE NFA ASSESSMENT FEE AS WELL AS NON-CUSTOMER AND PROPRIETARY TRADING ACTIVITY.

 
NFA BYLAW 1301: FORMS AND PROCEDURES FOR ASSESSMENT FEE COMPUTATION
(Staff, revised January 1, 2002; April 1, 2002; July 1, 2002; January 1, 2003; January 1, 2008 and January 1, 2011)

INTERPRETIVE NOTICE

SCHEDULE II

NATIONAL FUTURES ASSOCIATION
Box 98383
Chicago, Illinois 60693-0001

FCM ASSESSMENT FEE WORKSHEET
MONTH ENDED __ / __ / __

_________________
FCM Member

The information concerning transactions provided on this form will be utilized solely for purposes of computing the applicable NFA Assessment Fee and will be treated as confidential by NFA. This information may be supplied to the CFTC upon its request. However, it is the opinion of NFA that such information my be withheld by the CFTC from public disclosure under applicable provisions of the Freedom of Information Act, 5 U.S.C. § 552.

  Futures Contracts Traded On U.S. Exchanges Total
1. Total U.S. futures contracts round-turns _____
2. Less: Round-turns of customers having "privileges of membership" on exchange where contract is executed (_____)
3. Less: Round-turns in an omnibus account carried for another FCM Member for which assessments are payable to NFA by the other FCM (_____)
4. Less: Round-turns in an omnibus account cleared by another FCM Member for which the clearing FCM Member has agreed to pay the NFA assessment fee on your behalf (_____)
5. Less: Round-turns carried in an account owned by a business affiliate of an FCM executed on an exchange of which the FCM is a member (_____)
6. Total assessment fees due on futures contracts traded on U.S. Exchanges (Line 1 less Lines 2-5)

_____x$.04=
$_____
  Futures Contracts Traded On Foreign Exchanges for U.S. Customers  
7. Total foreign futures contract round-turns _____
8. Less: Round-turns in an omnibus account carried for another FCM Member for which assessments are payable to NFA by the other FCM (_____)
9. Less: Round-turns in an omnibus account cleared by another FCM Member for which the clearing FCM Member has agreed to pay the NFA assessment fee on your behalf (_____)
10. Assessable volume (Line 7 less Lines 8-9)

_____x$.04=
$_____
  Options Traded On U.S. Exchanges  
11. Total U.S. exchange-traded option trades _____
12. Less: Trades of customers having "privileges of membership" on exchange where contract is executed (_____)
13. Less: Trades in an omnibus account carried for another FCM Member for which assessments are payable to NFA by the other FCM (_____)
14. Less: Trades in an omnibus account cleared by another FCM Member for which the clearing FCM Member has agreed to pay the NFA assessment fee on your behalf (_____)
15. Less: Trades carried in an account owned by a business affiliate of an FCM executed on an exchange of which the FCM is a member (_____)
16. Total assessment fees due on options contracts traded on U.S. Exchanges (Line 11 less Lines 12-15)

$_____
  Options Traded On Foreign Exchanges For U.S. Customers  
17. Total foreign exchange-traded option trades _____
18. Less: Trades in an omnibus account carried for another FCM Member for which assessments are payable to NFA by the other FCM (_____)
19. Less: Trades in an omnibus account cleared by another FCM Member for which the clearing FCM Member has agreed to pay the NFA assessment fee on your behalf (_____)
20. Assessable volume (Line 17 less Lines 18-19) _____x$.02=
$_____
21. Total NFA assessment fee (Lines 6, 10, 16, and 20) $_____

Transfer the information on Lines 6, 10, 16, 20, and 21 to the FCM Assessment Fee Summary Report.

 
NFA BYLAW 1301: FORMS AND PROCEDURES FOR ASSESSMENT FEE COMPUTATION
(Staff, revised July 1, 2002; January 1, 2003 and January 1, 2011)

INTERPRETIVE NOTICE

NATIONAL FUTURES ASSOCIATION
FCM ASSESSMENT FEE WORKSHEET INSTRUCTIONS

The NFA assessment fee is a transaction fee payable on round-turns in commodity futures contracts and trades in exchange-traded options. The attached worksheet is intended to assist the FCM Member and NFA in calculating the required payment. The following are instructions for completion of the worksheet.

Line 1: Total U.S. futures contract round-turns-Provide total round-turn futures transactions  closed during the month for all accounts. You must include all transactions on a domestic exchange. You should exclude all transactions placed through another FCM on a fully disclosed basis for which the clearing FCM has collected and remitted the assessment fee to NFA.

Line 2: Round-turns of customers having "privileges of membership" on exchange where contract is executed-List the number of round-turn transactions for which the account holder was recognized as a member by the domestic exchange.

Line 3: Round-turns in an omnibus account carried for another FCM Member for which assessments are payable to NFA by the other FCM-List the number of round-turn transactions in an omnibus account carried for another FCM Member of NFA for which the other FCM is paying the assessment.

Line 4: Round-turns in an omnibus account cleared by another FCM Member for which the clearing FCM Member has agreed to pay the NFA assessment fee on your behalf-Indicate the number of round-turn transactions in an omnibus account cleared by another FCM which has agreed to remit the NFA Fee.

Line 5: Round-turns carried in an account owned by a business affiliate of an FCM executed on an exchange of which the FCM is a member-List the number of round-turn transactions (not included on Line 2) carried for a business affiliate that directly or indirectly owns 100 percent of or is owned 100 percent by or has 100 percent ownership in common with the FCM.

Line 7: Total foreign futures contract round-turns-Provide total round-turn futures transactions closed during the month for U.S. customers. (A U.S. customer includes any customer who resides in the United States, its territories or possessions.) You should exclude all transactions placed through another FCM on a fully disclosed basis for which the clearing FCM has collected and remitted the assessment fee to NFA.

Line 8: Round-turns in an omnibus account carried for another FCM Member for which assessments are payable to NFA by the other FCM-List the number of round-turn transactions in an omnibus account carried for another FCM Member of NFA for which the other FCM is paying the assessment.

Line 9: Round-turns in an omnibus account cleared by another FCM Member for which the clearing FCM Member has agreed to pay the NFA assessment fee on your behalf-Indicate the number of round-turn transactions in an omnibus account cleared by another FCM which has agreed to remit the NFA Fee. Attach a list of such clearing brokers to the FCM Assessment Fee Summary Report.

Line 10: Assessable volume-This amount is total foreign futures round-turns less exclusions. The $.04 per round-turn assessment fee is multiplied by this number to arrive at the basic foreign futures contract assessment.

Line 11: Total U.S. exchange-traded option trades-Provide total trades (purchases or sales, not exercises or expirations) in the month for all accounts. You must include all transactions on a domestic exchange. You should exclude all trades placed through another FCM on a fully disclosed basis for which the clearing FCM has collected and remitted the assessment fee to NFA.

Line 12: Trades of customers having "privileges of membership" on exchange where contract is executed-List the number of trades for which the account holder was recognized as a member by the domestic exchange.

Line 13: Trades in an omnibus account carried for another FCM Member for which assessments are payable to NFA by the other FCM-List the number of trades in an omnibus account carried for another FCM Member of NFA for which the other FCM is paying the assessment.

Line 14: Trades in an omnibus account cleared by another FCM Member for which the clearing FCM Member has agreed to pay the NFA assessment fee on your behalf-Indicate the number of option trades in an omnibus account cleared by another FCM which has agreed to remit the NFA fee on your behalf. Attach a list of such clearing brokers to the FCM Assessment Fee Summary Report.

Line 15: Option trades carried in an account owned by a business affiliate of an FCM executed on an exchange of which the FCM is a member-Include all options trades (not included on Line 11) for a business affiliate that directly or indirectly owns 100 percent of or is owned 100 percent by or has 100 percent ownership in common with the FCM.

Line 17: Total foreign exchange-traded option trades-Provide total trades (purchases or sales, not exercises or expirations) in the month for U.S. customers. (A U.S. customer includes any customer who resides in the United States, its territories or possessions.) You should exclude all trades placed through another FCM on a fully disclosed basis for which the clearing FCM has collected and remitted the assessment fee to NFA.

Line 18: Trades in an omnibus account carried for another FCM Member for which assessments are payable to NFA by the other FCM-List the number of trades in an omnibus account carried for another FCM Member of NFA for which the other FCM is paying assessment.

Line 19: Trades in an omnibus account cleared by another FCM Member for which the clearing FCM Member has agreed to pay the NFA assessment fee on your behalf-Indicate the number of option trades in an omnibus account cleared by another FCM which has agreed to remit the NFA fee on your behalf. Attach a list of such clearing brokers to the FCM Assessment Fee Summary Report.

Line 20: Assessable volume-This amount is total foreign exchange-traded option trades less exclusions. The $.02 per trade assessment fee is multiplied by this figure to arrive at the assessment for foreign exchange-traded options.

Line 21: Total NFA assessment fee-This is the sum of the futures and exchange-traded option Assessment Fees as listed in Lines 6, 10, 16 and 20.

9018 - REGISTRATION RULE 402: CPOS OF POOLS TRADING PRIMARILY IN SECURITIES

(Board of Directors, August 1, 1992; revised December 10, 2007)

INTERPRETIVE NOTICE

The Board of Directors has granted the Director of Compliance the authority to waive the Series 3 examination for certain individuals who are associated with CPOs who are required to register solely because they operate commodity pools which are principally engaged in securities transactions. The individual or firm requesting the waiver must provide a written description of the facts which qualify the individual for a waiver. The Director of Compliance's decision will be final.

The Director of Compliance is authorized to waive the Series 3 examination in either of the following situations:

1. The CPO or the commodity pool is subject to regulation by a federal or state regulator (e.g., the Securities and Exchange Commission, federal bank regulators or state insurance agencies) or the pool is privately offered pursuant to an exemption from the registration requirements of the Securities Act of 1933 and the CPO limits its activities for which registration is required to operating a commodity pool which:

    a. engages principally in securities transactions;
    b. commits only a small percentage of its assets as initial margin deposits and premiums for futures and options on futures; and
    c. uses futures transactions and options on futures only for hedging or risk management purposes.

2. The individual requesting the waiver is a general partner of a CPO or of a commodity pool which is primarily involved with securities investments; there is at least one registered general partner of the CPO or pool who has taken and passed the Series 3 examination; and the individual requesting the waiver is not involved in soliciting or accepting pool participations, trading futures or options on futures, handling customer funds, supervising any of the above activities or engaging in any other activity that is integral to the operation of the fund as a pool.

Waiver requests should be directed to:

Director of Compliance
National Futures Association
320 South Canal, Suite 2400
Chicago, Illinois 60606

9019 - COMPLIANCE RULE 2-9: SUPERVISION OF BRANCH OFFICES AND GUARANTEED IBS

(Board of Directors, October 6, 1992; revised July 24, 2000 and January 1, 2020)

NFA Compliance Rule 2-9(a) places a continuing responsibility on every FCM, IB, CPO and CTA Member to diligently supervise its employees and agents in all aspects of their commodity interest activities. Similarly, NFA Compliance Rule 2-36(e) places a continuing responsibility on every FDM to diligently supervise its employees and agents in all aspects of their forex activities. Additionally, NFA Compliance Rule 2-23 provides that a guarantor FCM or RFED (i.e., FDM) is jointly and severally subject to discipline by NFA for violations of NFA Requirements committed by an IB guaranteed by the FCM or FDM, and NFA's Business Conduct Committee has initiated disciplinary action under Rule 2-23 in instances where it appears a guarantor FCM or FDM has failed to supervise its guaranteed IBs.

In order to comply with NFA Compliance Rules 2-9, 2-36 and 2-23, as applicable, each FCM, IB, CPO and CTA Member and FDM must diligently supervise the commodity interest activities at its branch offices and/or guaranteed IBs. NFA recognizes that given the differences in the size and complexity of Member firm operations, Members must be given some degree of flexibility in determining what constitutes diligent supervision. As in all areas of supervision, NFA expects that Member firm supervisory programs over branch offices and guaranteed IBs will vary and it is NFA's policy to provide firms with flexibility to develop and implement policies and procedures for supervising branch offices and guaranteed IBs that are tailored to the operations of the particular Member firm. Nevertheless, NFA's Board of Directors previously determined and continues to believe that NFA should provide Member firms with specific guidance and minimum standards related to the supervision of branch offices and guaranteed IBs.

As described more fully below, effective supervisory oversight of branch offices and guaranteed IBs begins with a due diligence review of each branch office, guaranteed IB and their personnel. An effective oversight program of branch offices and guaranteed IBs also includes written supervisory policies and procedures describing a Member's process for performing routine surveillance and supervision, as well as annual inspections that are documented through a written report. Finally, Members are responsible for ensuring that branch office and guaranteed IB personnel are properly trained to perform their duties.

I. Due Diligence Review

A Member firm should adopt written policies and procedures designed to ensure that a robust due diligence review is performed before it establishes or modifies a branch office or guaranteed IB relationship. At a minimum, the Member firm's due diligence process should include reviewing the business that will be conducted by the potential branch office or guaranteed IB and the background and employment history of its personnel to ensure that they are qualified. A Member firm should also review the disciplinary history of prospective APs, their prior employers and, to the extent applicable, the disciplinary history of the potential branch office or guaranteed IB and its principals. In addition, a Member firm should ensure that one or more individuals at the branch office or guaranteed IB are knowledgeable about and will track developments related to the applicable requirements of the Commodity Exchange Act, CFTC Regulations and NFA Requirements. A Member firm should carefully consider information obtained through the due diligence process to evaluate whether it should establish a branch office or guaranteed IB relationship and to determine the scope of the supervisory oversight it needs to perform with respect to a particular branch office or guaranteed IB.

II. Written Supervisory Policies and Procedures

The starting point for diligently supervising a branch office or guaranteed IB is to adopt and implement written policies and procedures describing the manner in which a Member firm provides supervisory oversight for the commodity interest business of its branches and guaranteed IBs. NFA recognizes that Members need some degree of flexibility to implement supervisory policies and procedures that are tailored to the unique needs of their business. On the other hand, to be effective, written supervisory policies and procedures for branch offices and guaranteed IBs must be designed to address applicable regulatory requirements, identify the areas that will be supervised and describe the specific procedures that the Member firm will implement to provide adequate supervisory oversight. To assist firms in developing appropriate supervisory policies and procedures, Section II.A of this Interpretive Notice provides a detailed description of several areas that, to the extent applicable, must be addressed in a Member's written supervisory policies and procedures for branch offices and guaranteed IBs.

Effective supervision of branch offices and guaranteed IBs requires both routine supervision and surveillance designed to identify and address potential issues as they arise and annual inspections designed to perform a more comprehensive and detailed review of a branch office or guaranteed IB's activities. NFA recognizes that Member firms may use different routine supervision and surveillance processes. For example, some Member firms may implement automated surveillance tools to help review and analyze account activity while others may utilize a periodic manual review process. Likewise, Members may elect to perform routine surveillance and supervision at different intervals (e.g., on a real-time, daily, weekly, monthly, quarterly or an as needed basis). A Member firm's policies and procedures should also address when it will escalate to NFA and/or other appropriate regulators, identified significant findings (e.g., findings related to fraud or customer harm) during its routine supervision and surveillance or annual inspection. As described more fully in Section II.B, Members are also required to perform an annual inspection of each branch office or guaranteed IB.

The personnel who perform routine surveillance and supervision and inspections must be appropriately qualified and knowledgeable of the industry and the nature of the firm's business, and should be able to perform their work with an independent and objective perspective. Written supervisory procedures should provide sufficient detail to ensure that the inspection process is performed in a consistent manner and will not vary due to the involvement of different personnel in the inspection process. Third-party vendors may be used to assist in performing routine supervision and surveillance and/or inspections; however, Member firms must perform due diligence to confirm that a vendor is qualified to perform the services they will be providing. Likewise, supervisory personnel at the branch office or guaranteed IB may perform certain supervisory procedures. Member firms remain responsible for all applicable regulatory requirements including any supervisory functions performed by a third-party vendor or supervisory personnel at a branch office or guaranteed IB.

The Member firm should ensure that the appropriate personnel at each branch office and/or guaranteed IB have a copy of and understand the policies and procedures related to their duties. The Member firm should also ensure that all supervisory personnel are knowledgeable of the firm's supervisory requirements. Each branch office and guaranteed IB should have a readily available copy of the Member firm's policies and procedures that govern the operation of their business.

A. Supervisory Procedures for Branch Offices and Guaranteed IBs

Members that supervise a branch office or guaranteed IB should implement written supervisory policies and procedures that are reasonably designed to achieve compliance with all NFA and CFTC requirements applicable to the commodity interest business of its branch offices and guaranteed IBs. Such policies and procedures should specify the manner and frequency of specific supervisory procedures that have been implemented to address each of the following areas, to the extent applicable to the business conducted by the Member and its branch offices or guaranteed IBs.

Registration. A Member firm's branch offices and guaranteed IBs should hold themselves out to the public in their registered names only, and branch offices should not be separately incorporated entities. Only individuals who are registered as APs and are NFA Associates may conduct sales activities at a branch office or guaranteed IB. Members should implement supervisory procedures that are reasonably designed to ensure that any individual performing AP activities is registered as an AP and that AP activities are only performed from a main or branch office of a Member firm. For example, a Member could adopt procedures to monitor or review commission payments to confirm that commissions are only paid to registered individuals located at the main or branch office of a Member firm.

Hiring. Members should implement supervisory procedures designed to ensure that all prospective employees at a branch office or guaranteed IB are screened and qualified. Such procedures should include inquiring about prior or pending disciplinary matters, reviewing the prospective employee's educational background and contacting prior employers to confirm previous work experience. If a prospective employee is required to complete CFTC Form 8-R (i.e., a new AP), the form should be carefully reviewed with the prospective employee to ensure that he/she provided all required information. Additionally, documentation to support any "yes" answers to the Form 8-R Disciplinary Information questions must be obtained and reviewed for potential disqualifying conduct. Policies and procedures should also require APs to notify the branch office, guaranteed IB and/or Member firm if any new circumstances arise that may require an additional disclosure. If a prospective employee was previously registered as an AP, information related to the prospective employee's disciplinary and registration history must be obtained from NFA. The registration and disciplinary history (if any) of the prospective employee's prior employers should also be reviewed. Information obtained through this screening process should be considered by the Member firm, branch office and/or guaranteed IB in determining the scope of supervision necessary to adequately supervise the prospective employee.

Promotional Material. Members should adopt supervisory procedures reasonably designed to ensure that any promotional material used by a branch office or guaranteed IB has been reviewed and approved by the appropriate supervisory personnel prior to its first use. In some circumstances, or as a matter of policy, a Member firm may require that all promotional material used by a branch office or guaranteed IB be approved by the main office or guarantor prior to its first use. Member firms should also verify that documentation of supervisory reviews and approvals is created and retained and that a branch office or guaranteed IB is not using any promotional material that has not received prior approval.

Sales Practices. A Member's supervisory procedures for branch offices and guaranteed IBs should provide for the review of sales solicitation practices. The individuals at the branch office or guaranteed IB responsible for supervising sales solicitations should be identified, and the method by which sales solicitations are supervised should be reviewed for adequacy. Members should ensure that, when appropriate, enhanced supervisory procedures are implemented for APs that have a disciplinary history. Adequate procedures will also incorporate a review of sales solicitations through in-person monitoring or technological means (e.g., listening to phone calls or reviewing electronic communications). When appropriate (e.g., a potential pattern of wrongdoing or observation of unusual account activity), a Member firm should consider interviewing selected customer(s) about the solicitation process and the handling of their account(s).

Customer Information and Risk Disclosure. All Members are required to implement policies and procedures for collecting specific customer information and providing required risk disclosures. A branch office or guaranteed IB's procedures for opening new accounts should specify that appropriate account documentation must be forwarded to the main office of the Member firm or the firm's guarantor. The main office or guarantor should implement policies and procedures for reviewing account documentation to ensure that required risk disclosures were made and acknowledged and that the appropriate supervisory personnel approved the account. Such procedures could include requiring main office or guarantor approval before opening an account and/or contacting customers to verify that they received and understood the risk disclosure document.

Anti-Money Laundering Program. Member firms that are required to develop and implement anti-money laundering programs should ensure that their branch offices and/or guaranteed IBs have adopted and implemented a program that satisfies NFA's anti-money laundering program requirements, which could include adopting and implementing the program of the main office or guarantor.

Handling of Customer Funds. Supervisory policies and procedures for branch offices and guaranteed IBs should be designed to ensure that all records related to customer funds, including copies of checks, are created, retained and reviewed for compliance with applicable regulatory requirements, including as applicable to guaranteed IBs CFTC Regulation 1.57(c). Such policies and procedures should be designed to confirm that any funds accepted from customers are received in the name of the FCM or FDM and that proper procedures for depositing the funds into a qualifying bank account have been established and are followed. In general, third-party payments should not be accepted. If a third-party payment is accepted, it must be scrutinized to ensure that no customers are acting as unregistered FCMs, FDMs or CPOs.

Customer Order Procedures. Members should adopt supervisory procedures that are reasonably designed to achieve compliance with regulatory requirements for handling and recording customer orders. As part of these procedures, the individuals responsible for accepting customer orders should be identified and a sample of order tickets and/or electronic orders should be reviewed. NFA recommends that order tickets be pre-numbered and that the review test to ensure that all order tickets within the chosen samples have been retained. Order tickets may be reviewed through electronic records (e.g., scanned copies of order tickets), provided that such records are sufficient to confirm that all order tickets are properly time stamped and that all information required by CFTC Regulation 1.35 has been captured and retained. Likewise, Members should implement policies and procedures designed to ensure that all required records related to electronic orders are captured and retained.

Account Activity. A Member firm should also conduct regular reviews of the trading activity in customer accounts, and, if applicable, the trading activity in personal accounts of APs and principals. A number of procedures can be performed to identify problematic activity and accounts that should be flagged for additional scrutiny. For example:

  • Accounts with significant losses, commission charges or a large number of trades should be reviewed to determine if trading strategies that are not appropriate for the customers have been recommended or implemented;
  • Unusual or patterns of position transfers or error trades should be investigated to ensure these transactions were legitimate and properly effected;
  • Commission to equity ratios should be calculated regularly for discretionary accounts to identify potential excessive trading or churning;
  • Trading in the personal trading accounts of APs and principals should be regularly reviewed and compared with the trading in customer accounts to identify potential improper trade allocations or frontrunning; and
  • Trading results among a particular AP's customers should be compared to identify potential preferential treatment.

Written supervisory policies and procedures should be designed to ensure that any potentially problematic account activity is thoroughly reviewed and, when appropriate, escalated to appropriate supervisory personnel.

Discretionary Accounts. NFA Members and Associates are subject to detailed requirements regarding discretionary customer accounts. If a Member firm's branch office or guaranteed IB handles discretionary customer accounts, the Member firm must adopt supervisory policies and procedures reasonably designed to ensure that the branch office or guaranteed IB achieves compliance with these requirements. Trading authorizations granting discretionary authority and all related records should be forwarded to the main office or guarantor. The main office or guarantor should implement policies and procedures to identify discretionary accounts and perform a documented review of the trading activity in those accounts. Member firms should also confirm that all APs exercising discretionary authority have been continually registered for at least two years.

Proprietary Trading. To the extent feasible, a Member's written supervisory policies and procedures should provide for a separation of duties between persons handling customer orders and firm employees or principals trading for the firm's proprietary accounts or their own accounts to prevent the misuse of non-public information or the occurrence of other trading abuses.

Bunched Orders. NFA has adopted specific requirements related to the execution and allocation of bunched orders. Main offices and guarantors should implement supervisory procedures that are reasonably designed to ensure that bunched orders executed by or through a branch office or guaranteed IB achieve compliance with these requirements. For example, a Member firm should review a branch office or guaranteed IB's allocations for bunched orders to confirm that fills are allocated based on a permitted methodology that is applied in an appropriate and consistent manner.

Customer Complaints. A Member firm should require that its branch offices and guaranteed IBs create and maintain a record of all verbal and written complaints in the form and manner and for the period set forth in CFTC Regulation 1.31. Written supervisory procedures should also require that any customer complaints that meet pre-defined criteria established by the Member (e.g., criteria based on the seriousness of the allegations, monetary amount involved, APs or principals involved, or number of complaints against a certain AP or principal) be sent to the main office or guarantor. In some circumstances, or as a matter of policy, a Member firm may require that all customer complaints be forwarded to the main office or guarantor. A Member firm should also contact any customer that files a written or verbal complaint that alleges serious wrongdoing. In addition, written supervisory procedures should provide that the main office or guarantor will review the status of unresolved complaints and the resolution of each complaint to identify possible rule violations or patterns indicative of problematic behavior.

Information System Security Programs. All NFA Members are required to implement an information systems security program (ISSP). A Member firm must ensure that its branch offices comply with its ISSP and its guaranteed IBs adopt and implement an ISSP that satisfies NFA's requirements.

B. Annual Inspection Requirement

A Member firm that supervises one or more branch offices and/or guaranteed IBs must perform an on-site inspection of every branch office and guaranteed IB on at least an annual (i.e., calendar year) basis. Member firms may implement risk-based procedures to tailor the scope (e.g., areas covered), depth (e.g., number of documents reviewed) and nature (e.g., announced or unannounced) of the inspection based on the specific risks of the Member and/or a particular branch office or guaranteed IB. There are two exceptions to the annual on-site inspection requirement.

First, Members must promptly perform an on-site inspection of a branch office or guaranteed IB if the Member becomes aware of any indicia of irregularities or misconduct involving the branch office or guaranteed IB, including but not limited to: disciplinary actions, customer complaints that upon inquiry appear bona fide, significant operational issues or irregularities or misconduct identified through routine surveillance or supervision.

Second, Member firms may use a risk-based approach to identify branch offices or guaranteed IBs for which the Member determines it may be appropriate to examine through an on-site inspection every other calendar year. In making this determination, a Member firm should consider a number of factors including, but not limited to the following:

  • The amount of revenue generated by the branch office or guaranteed IB;
  • The type of business conducted (e.g., hedging v. speculative; discretionary v. non-discretionary);
  • Whether the branch office or guaranteed IB solicits new clients or only services existing clients and if it solicits new clients the number of new accounts opened;
  • The number of APs;
  • The number and nature of customer complaints received;
  • The previous training, experience and disciplinary history of the branch office or guaranteed IB and its personnel;
  • Whether there has been a change in either ownership or supervisory personnel at the branch office or guaranteed IB;
  • Whether a guaranteed IB has one or more branch offices;
  • The frequency and nature of problems or concerns that arise from routine surveillance or supervision of the branch office or guaranteed IB's activities; and
  • If the branch office or guaranteed IB directly accepts customer funds.

A Member firm must document and retain its rationale if it determines that it is appropriate to examine a branch office or guaranteed IB via an on-site inspection every other calendar year. The Member firm must also inspect remotely the branch office or guaranteed IB during the calendar year in which an on-site inspection is not performed. The Member firm must ensure that it has access to books, records and technology (e.g., video conferencing systems, electronic communications and information related to order and/or trading activity) that will enable it to perform a robust inspection from a remote location.

Inspection Report

Promptly after completing either an on-site or remote inspection, the Member firm should prepare a written report fully describing the inspection, including the scope of the inspection, a summary of the testing performed and any findings or deficiencies identified during the inspection. Any findings or deficiencies should also be discussed with the branch office or guaranteed IB's managers, principals and/or supervisory personnel. The Member firm should also conduct follow-up procedures to ensure that any deficiencies identified during an inspection are promptly corrected. Repeated problems in any particular area should heighten the level of scrutiny and follow-up by the main office or guarantor.

III. Ongoing Training

A Member's supervisory responsibilities include the obligation to ensure that its employees are properly trained to perform their duties. Policies and procedures must be in place to ensure that branch office and guaranteed IB personnel receive adequate training to abide by industry rules and regulations and to properly handle customer accounts and that APs have satisfied ethics training requirements. Employees must be educated on developments and changes in the markets, commodity interest products, rules and regulations, technology and firm policies and procedures applicable to their activities. The formality of a training program will depend on the size of the firm and the nature of its business. The individuals responsible for providing the training must be qualified to do so.

Certain APs may require training for soliciting and handling customer accounts. If an AP has previously worked at one or more firms disciplined by NFA or the CFTC for sales practice fraud and has therefore received his or her training from one or more such firms, then the Member firm may have to provide the AP with specialized training in proper sales practices.

This Interpretive Notice is intended to specify minimum supervisory standards for branch offices and guaranteed IBs. A failure to adhere to the requirements specified in this Interpretive Notice will be deemed a violation of NFA Compliance Rule 2-9.

9020 - NFA COMPLIANCE RULES 2-9 and 2-36: SELF-EXAMINATION QUESTIONNAIRES

(Board of Directors, October 6, 1992; revised July 24, 2000; April 8, 2011 and September 30, 2019)

INTERPRETIVE NOTICE

NFA Compliance Rule 2-9 places a continuing responsibility on each FCM, IB, CPO and CTA Member to diligently supervise its employees and agents in all aspects of commodity interest activities, while Compliance Rule 2-36 imposes the same requirements on each FDM with respect to its their forex related activities. NFA recognizes that, given the differences in the size and complexity of the operations of NFA Members, there must be some degree of flexibility in determining what constitutes "diligent supervision" for each firm. It is NFA's policy to leave the exact form of supervision to the Member, thereby providing the Member with flexibility to design procedures that are tailored to the Member's own situation. The Board of Directors adheres to this principle but feels that all Members should regularly review the adequacy of their supervisory procedures.

The Board of Directors has determined that in order to satisfy their continuing supervisory responsibilities, each FCM, IB, CPO and CTA Members and each FDM must review on a yearly basis self-examination questionnaires that can be downloaded from NFA's web site at www.nfa.futures.org. Each FCM, IB, CPO and CTA Member and each FDM must review the general questionnaire and one or more of the applicable supplemental questionnaires (e.g., FCM, FDM, IB, CPO or CTA). The questionnaires must be reviewed by the appropriate supervisory personnel in the home and branch office, if applicable. After reviewing the questionnaire, an appropriate supervisory person must sign the questionnaire stating that the Member's operations have been evaluated based on the questionnaire and attesting that the Member's procedures comply with all applicable NFA requirements.

FCM, IB, CPO and CTA Members and FDMs are required to retain the signed questionnaire in their files for a period of five years from the date of review, with the questionnaires being readily accessible during the first two years. In addition, guaranteed IBs must provide and FCMs and FDMs that guarantee any IBs must obtain copies of the signed questionnaires. Members must also provide the signed questionnaires for inspection upon request by NFA.

Review of the questionnaires should aid Members in recognizing potential problem areas and alert them to procedures which need to be revised or strengthened. The questionnaires focus on a Member's regulatory responsibilities and require a review of the adequacy of the Member's internal procedures. For example, the FCM questionnaire requires review of a Member's procedures relating to customer order flow, customer account documentation, risk disclosure, margin policies, option accounts and transactions, customer complaints, advertising, and compliance with other NFA requirements. Similarly, the CPO/CTA questionnaires contain questions that will assist CPOs and CTAs in their review of disclosure documents.

Any FCM, IB, CPO or CTA Member or FDM that does not comply with this Interpretive Notice will violate NFA Compliance Rule 2-9 or 2-36, as applicable.

Questions regarding this Interpretation or the questionnaires should be directed to the Compliance Department at (800) 621-3570 or through the "contact" feature of NFA's web site.

9021 - NFA COMPLIANCE RULES 2-9 and 2-36: ENHANCED SUPERVISORY REQUIREMENTS FOR FCMs, IBs, FDMs, CPOs AND CTAs

(Board of Directors, January 19, 1993; revised August 14, 1996, December 16, 1996; March 10, 1998; July 1, 2000; January 1, 2001; June 1, 2001; August 21, 2001; March 18, 2003; November 9, 2004; February 15, 2006; April 15, 2006; November 1, 2007; December 17, 2007; September 18, 2008; January 3, 2011; October 1, 2014; June 13, 2016; September 19, 2016; January 31, 2018; and September 30, 2019.)

INTERPRETIVE NOTICE

I. INTRODUCTION

Over the years, NFA's Board of Directors has adopted strict and effective rules to prohibit deceptive sales practices, and those rules have been vigorously enforced by NFA's Business Conduct Committee. The Board notes, however, that by their very nature, enforcement actions occur after the customer abuse has taken place. The Board recognizes that NFA's goal must be not only to punish such deception of customers through enforcement actions but to prevent it, or minimize its likelihood, through fair and effective regulation.

One NFA rule designed to prevent abusive sales practices is NFA Compliance Rule 2-9. Subsection (a) of this rule places a continuing responsibility on every FCM, IB, CPO and CTA Member to diligently supervise its employees and agents in all aspects of their commodity interest activities, including sales practices. Although NFA has not attempted to prescribe a set of supervisory requirements to be followed by such Members, NFA's Board of Directors believes that Member firms that are identified as having a sales force and/or principals that have been affected by questionable sales practice training and firms that charge commissions, mark-ups, fees and other charges well above the industry norm should be required to adopt enhanced supervisory requirements designed to prevent sales practice abuse. NFA Compliance Rule 2-36(e) imposes similar supervisory requirements on forex activities of FDMs. NFA Compliance Rules 2-9(b) and 2-36(e)(2) authorize the Board of Directors to require FCM, IB, CPO and CTA Members and FDMs, which meet certain criteria established by the Board, to adopt specific supervisory procedures designed to prevent abusive sales practices.

The Board believes that in order for the criteria used to identify firms subject to the enhanced supervisory requirements to be useful, those criteria must be specific, objective and readily measurable. The Board also believes that any supervisory requirements imposed on an FCM, IB, CPO or CTA Member or an FDM must be designed to quickly identify potential problem areas so that the Member will be able to take corrective action before any customer abuse occurs. The purpose of this Interpretive Notice is to set forth the criteria established by the Board that obligate a Member to adopt the enhanced supervisory requirements and to specify the enhanced supervisory requirements that are required of firms meeting these criteria.

In developing the criteria, the Board concluded that it would be helpful to review Member firms that had been disciplined through enforcement actions taken by the CFTC or NFA for deceptive sales practices. The Board's purpose was to identify factors common to these Member firms and probative of their sales practice problems, which could be used to identify other Member firms with potential sales practice problems.

One factor identified by the Board as common to these firms and directly related to their sales practice problems is the employment history and training of their APs and principals. For many of these Members, a significant portion of these individuals were previously employed and trained by one or more Member firms which had been disciplined for fraud. The Board believes that the employment history of a Member's APs and principals is a relevant factor to consider in identifying firms with potential sales practice problems. If a Member firm is disciplined by NFA or the CFTC for fraud related to widespread sales practice or promotional material problems or by the Financial Industry Regulatory Authority or the SEC for fraud related to its sales practices regarding security futures products as defined in Section 1a(45) of the Commodity Exchange Act ("Act"), it is reasonable to conclude that the training and supervision of its sales force was wholly inadequate or inappropriate. It is also reasonable to conclude that an AP or principal who received inadequate or inappropriate training and supervision may have learned improper sales tactics, which he will carry with him to his next job. Therefore, the Board believes that a Member firm employing such a sales force must have stringent supervisory procedures in place in order to ensure that the improper training its APs and principals have previously received does not taint their sales efforts on behalf of the Member.

The Board notes further that there have been instances in which Members and Associates have subverted the Board's purpose in imposing the enhanced supervisory requirements by closing a firm once it qualifies for those requirements and opening another firm or firms that have a mix of employees that does not meet the criteria for adopting the requirements. The new firms typically have individuals who have worked for firms that have been disciplined for fraud related to sales practices or promotional material and who worked at the original qualifying firm, but they are redistributed so as to keep the employee mix below the threshold for becoming subject to the enhanced supervisory requirements. The Board has determined to apply the enhanced supervisory requirements to firms that use this strategy.

The Board also notes that Members that assess commissions, mark-ups, fees and other charges that total well above the industry norm comprise a disproportionately high share of firms that have been subject to disciplinary action for sales practice abuses. Some of the abuses that have been cited relate to the creation of a misleading impression of the likelihood of achieving profits by investing with a Member through misstatements or material omissions concerning the impact of commissions, mark-ups, fees and other charges.

The Board believes that when an FCM, IB, CPO or CTA Member or an FDM charges its customers commissions, mark-ups, fees and other charges that total well above the industry norm it is incumbent on that Member to exercise a very high degree of supervision of solicitations made by its APs so as to ensure that customers are given accurate information regarding the impact of those expenses on the likelihood of achieving profit. Consistent with its approach in other situations involving an increased likelihood of misleading solicitations, the Board believes that the enhanced supervisory requirements provide a practical opportunity for a Member that charges commissions, mark-ups, fees and other charges that are well above the industry norm to monitor solicitations and correct problems with those solicitations in an expeditious manner.

II. OBLIGATIONS OF MEMBERS SUBJECT TO THE ENHANCED SUPERVISORY REQUIREMENTS

A. Recording of all conversations and maintaining electronic written communications with existing and potential customers

Those FCM, IB, CPO and CTA Members and FDMs meeting the criteria requiring them to adopt the enhanced supervisory requirements will be required to make complete audio recordings of all telephone conversations that occur between their APs and both existing and potential customers, including existing and potential retail forex customers of Members subject to NFA Compliance Rule 2-36. Additionally, those FCM, IB, CPO and CTA Members and FDMs will be required to maintain a record of all electronic written communications that occur between their APs and customers or potential customers. Electronic written communications include, but are not limited to, email, text messages, instant messages conducted via any web-based messaging system (including instant messages sent via a social media application), and any other communication that occurs in a chat room or on any social media platform. The Board believes that recording these conversations and requiring FCM, IB, CPO and CTA Members and FDMs to maintain records of electronic written communications provides these Members with the best opportunity to monitor closely the activities of their APs and also provides these Members with complete and immediate feedback on each AP's method of soliciting customers. Members subject to the enhanced supervisory requirements must retain such audio recordings and records of electronic written communications for a period of five years from the date each recording is created or written electronic communication occurs and the recordings and/or records of electronic written communications shall be readily accessible during the first two years of the five-year period. In retaining the recorded conversations or records of electronic written communications, Member firms must catalog the recordings and electronic written communications by AP and date. Additionally, any Member firm meeting the criteria must require all its APs to maintain a daily log for sales solicitations which reflects at a minimum the identity of each customer or prospective customer the AP spoke with or transmitted electronic written communications to on each day and the method of communication. A Member firm must be able to promptly produce, upon request from NFA or the CFTC, all conversations or records of electronic written communications relating to a specific AP, and only that AP, for a given date. Members that are required to record or maintain records of electronic communications under this Interpretive Notice are further required to promptly provide NFA or the CFTC with appropriate resources for listening to their recordings or viewing the records of electronic communications upon request.

B. Enhanced capital requirement

Any Member introducing broker ("IB") meeting the criteria is required to either operate pursuant to a guarantee agreement or maintain adjusted net capital of at least $250,000 during the entire period for which the Member is required to adopt the enhanced supervisory requirements. Eligible guarantor futures commission merchants ("FCM"s) are those that meet the eligibility requirements for executing a Supplemental Guarantor Certification Statement pursuant to NFA Registration Rule 509(b)(5). Any IB Member opting to maintain the higher level of adjusted net capital shall also be subject to the financial record-keeping and reporting requirements applicable to FCMs.

Any Member commodity trading advisor ("CTA") or commodity pool operator ("CPO") meeting the criteria is required to maintain adjusted net capital of at least $100,000 during the entire period for which the Member is required to adopt the enhanced supervisory requirements. Member CTAs and CPOs meeting the criteria are required to demonstrate compliance with this adjusted net capital requirement to NFA upon request.

Any Forex Dealer Member ("FDM") or FCM meeting the criteria is required to maintain adjusted net capital of at least the early warning requirement under CFTC rules.

C. Filing promotional material with NFA

Those Member firms meeting the criteria will be required to file all promotional material, as defined in NFA Compliance Rule 2-29(i), with NFA at least 10 days prior to its first use.

D. Written supervisory procedures

Those FCM, IB, CPO and CTA Members and FDMs meeting the criteria shall have written supervisory procedures that include the titles, registration status and locations of the firm's supervisory personnel as these relate to the firm's commodity interest business and applicable securities laws and regulations for the trading of security futures products. The written procedures must include at a minimum:

  • a description of the steps taken to supervise and monitor calls which identify how often monitoring of recordings will take place; who will conduct the monitoring; and how the results of monitoring will be documented;
  • specific information identifying the recording equipment being used;
  • a description of the steps taken to supervise and monitor APs' electronic written communications with customers which identify how the Member will monitor them, how often the Member will monitor them, who will conduct the monitoring and how the results of that monitoring will be documented;
  • a description of the method for cataloging and maintaining recordings and written electronic communications; and
  • a description and sample format of the daily logs prepared by APs that includes, at a minimum, the identity of each customer or prospective customer the AP spoke or transmitted an electronic written communication with on each day and the method of communication.

Member firms shall also maintain on an internal record the names of all persons who are designated as supervisory personnel and the dates for which the designation is or was effective. Additionally, a Member meeting the criteria shall file with NFA's Compliance Department a report relating to the Member firm's compliance with the supervisory requirements contained herein within 15 days after the end of each calendar quarter. Member firms shall retain the internal record and report(s) for a period of five years, the first two years in an easily accessible place.

III. QUALIFICATION FOR THE ENHANCED SUPERVISORY REQUIREMENTS

A. Definitions, treatment of individuals and firms and exemptions

1. Definition of Disciplined Firm

A current list of the firms that meet the definition of a Disciplined Firm is maintained on NFA's Web site at https://www.nfa.futures.org/ereg. For purposes of this Interpretive Notice, a Disciplined Firm is defined very narrowly to include those firms that fall into one of the following two groups:

    a. Firms that have been disciplined by NFA or the CFTC

    Members that qualify as Disciplined Firms based on their disciplinary histories with the CFTC or NFA include those firms for which:

      1. the firm has been formally charged by either the CFTC or NFA with deceptive sales practices or promotional material;

      2. those charges have been resolved; and

      3. the firm has either been permanently barred from the industry at any time as a result of those charges or has been sanctioned in any way within the preceding five years as a result of those charges.

    b. Firms that have been disciplined in connection with sales practices involving security futures products

Members that qualify as Disciplined Firms based on their disciplinary histories related to sales practices involving security futures products include any broker-dealer that, in connection with sales practices involving the offer, purchase, or sale of any security futures product as defined in Section 1a (45) of the Act has at any time been expelled from membership or participation in any securities industry self-regulatory organization ("Securities SRO") or is subject to an order of the SEC revoking its registration as a broker-dealer or has been sanctioned in any way within the preceding five years in connection with sales practices involving the offer, purchase, or sale of any security futures product as defined in Section 1a (45) of the Act.

2. Treatment of principals who previously worked at a Disciplined Firm

For purposes of determining whether a Member will be required to adopt the enhanced supervisory requirements based on the employment histories of its APs and principals, principals of a firm, who are not also APs of that firm and who have been previously employed as an AP by one or more Disciplined Firms, shall be counted as if they were APs of the firm.

3. Treatment of FCMs and FDMs that guarantee introducing brokers

For purposes of determining whether an FCM Member or an FDM will be required to adopt the enhanced supervisory requirements, an FCM or FDM and its guaranteed introducing brokers ("GIBs") will be considered a single firm. Therefore, for FCMs and FDMs with GIBs, the APs of its GIBs will be treated as APs of the FCM or FDM for determining whether the FCM or FDM meets the requirements. If the FCM or FDM meets the requirements, then the FCM or FDM and all its GIBs shall be required to adopt the supervisory procedures specified herein. Of course, individual FCMs, FDMs or GIBs will be required to adopt the enhanced supervisory requirements provided the FCM, FDM or GIB meets the requirements on its own.

4. Exemptions from being counted as an AP who worked at a Disciplined Firm

The Board recognizes that there are identifiable populations of APs who are included in the general population of APs who have worked at Disciplined Firms in the past who, further analysis suggests, do not raise the same concerns regarding their previous supervision and training that are raised by the majority of APs who have worked at Disciplined Firms. Generally, these APs worked at Disciplined Firms fairly long ago and are free of additional factors of concern in their employment histories.

A number of the APs in this group worked at Disciplined Firms for only a short period of time many years ago and have not worked at a Disciplined Firm since or been personally subject to disciplinary action. Others worked at a single Disciplined Firm for a somewhat lengthier period and have subsequently been employed for a substantial length of time by Members that have not shown a propensity for customer abuse and the AP has not been personally subject to disciplinary action.

The Board has determined that APs who have not been personally subject to a disciplinary action by NFA or the CFTC and who meet the following criteria shall not be counted by a Member that hires them as having been employed by a Disciplined Firm for purposes of calculating whether the composition of the Member's sales force triggers the enhanced supervisory requirements:

    a. they have been previously employed by Disciplined Firms for a cumulative total of less than 60 days and have not been employed by any Disciplined Firm during the 5 years preceding the determination of whether a Member firm is required to employ the enhanced supervisory requirements established in this Interpretive Notice. In addition, the AP may not have been employed by a Member that has been subject to any sales practice action by NFA or the CFTC, or by any Securities SRO or the SEC in connection with sales practices involving the offer, purchase or sale of any security futures product as defined in Section 1a (45) of the Act since leaving the last Disciplined Firm by which they were employed; or

    b. they worked at only one Disciplined Firm more than 10 years preceding the determination of whether a Member firm is required to employ the enhanced supervisory requirements and they have not been employed by a Member that has been subject to any sales practice action by NFA or the CFTC, or by any Securities SRO or the SEC in connection with sales practices involving the offer, purchase or sale of any security futures product as defined in Section 1a (45) of the Act within the 10 years preceding the determination, and they have been an NFA Member or Associate Member for at least eight of the ten years preceding the determination.

B. Criteria that obligate an FCM, IB, CPO or CTA Member or an FDM to adopt the enhanced supervisory requirements

FCM, IB, CPO and CTA Members and FDMs will be required to adopt the enhanced supervisory requirements if they fall into any of the categories described below.

1. Obligation based on employment histories of APs and principals

FCM, IB, CPO and CTA Members and FDMs that meet any of the following numerical criteria are required to adopt the enhanced supervisory requirements:

  • For firms with less than five APs, 2 or more of its APs have been employed by one or more current Disciplined Firms;
  • For firms with at least 5 but less than 10 APs, 40 percent or more of its APs have been employed by one or more current Disciplined Firms;
  • For firms with at least 10 but less than 20 APs, four or more of its APs have been employed by one or more current Disciplined Firms; or
  • For firms with at least 20 APs, 20 percent or more of its APs have been employed by one or more current Disciplined Firms.1

2. Obligation based on affiliations of principals

Once an FCM, IB, CPO or CTA Member or an FDM meets the criteria to adopt the enhanced supervisory requirements, any other Members of which the principals of that Member firm are, or become, principals must also adopt the enhanced supervisory requirements or seek a waiver therefrom subject to the following exception.

As is the case with some APs, the Board recognizes that there is a limited group of individuals who have been principals of firms that have qualified for the enhanced supervisory requirements who are otherwise free of additional factors that raise concern about their ability to effectively supervise their firms. Therefore, an FCM, IB, CPO or CTA Member or an FDM will not qualify for the enhanced supervisory requirements under this section if the principal whose history would cause the qualification meets the following criteria:

  • the principal has not been personally subject to a disciplinary action by NFA or the CFTC;
  • the principal has never been a principal or an AP of a current Disciplined Firm;
  • the most recent firm in the principal's history that qualified for the enhanced supervisory requirements either received a full waiver from abiding by those requirements or abided by those requirements for at least two years and is no longer subject to the enhanced supervisory requirements; and
  • no firm in the principal's history that qualified for the enhanced supervisory requirements has become subject to a sales practice or promotional material based disciplinary action by NFA or the CFTC since qualifying for the enhanced supervisory requirements.

3. Obligation based on assessing commissions, mark-ups, fees and other charges well above the industry norm

Any FCM, IB, CPO and CTA Member or FDM that charges 50% or more of its active customers round-turn commissions, mark-ups, fees and other charges that total $100 or more per futures, forex or option contract or cleared swap is required to adopt the enhanced supervisory requirements. Any FCM, IB, CPO or CTA Member or FDM that charges 50% or more of its active customers round-turn commissions, mark-ups, fees and other charges in the amount specified above must promptly inform NFA of that fact. In addition, upon request by NFA, Members shall have the burden of demonstrating to NFA that they charge more than 50% of their active customers round-turn commissions, mark-ups, fees and other charges that are less than the specified amounts. The term "active customers" as used in this section means any customers who are entitled to a monthly statement under the provisions of CFTC Regulations Section 1.33(a). For purposes of this section, any Member whose customer initiates an options contract that would result in total commissions, mark-ups, fees and other charges of $100 or more if the trade was liquidated will be deemed to have charged total commissions, mark-ups, fees and other charges of $100 even if the contract is not ultimately liquidated.

4. Obligation based on the initiation of disciplinary action

    a. Members that have fulfilled the enhanced supervisory requirements that become subject to subsequent disciplinary action

Any Member that has previously been required to adopt the enhanced supervisory requirements; has, in fact, fulfilled that requirement either by adopting the enhanced supervisory requirements for a prescribed period or by receiving a full or partial waiver from the enhanced supervisory requirements from the Waiver Committee; and subsequently becomes subject to a CFTC or NFA enforcement or disciplinary proceeding alleging deceptive sales practices, shall, within 30 days of being served with notice of the action, adopt all of the enhanced supervisory requirements and may not seek a waiver therefrom. This obligation shall continue until after the disciplinary or enforcement proceeding is closed and all appeals are completed or the time for appeal has passed without an appeal being filed or perfected.

    b. Members already subject to the enhanced supervisory requirements
If an NFA Business Conduct Committee disciplinary proceeding or CFTC enforcement proceeding has been filed against a Member firm required to adopt the enhanced supervisory requirements, then the enhanced supervisory requirements will remain in effect for the applicable time period specified or until after the disciplinary or enforcement proceeding is closed and all appeals are completed or the time for appeal has passed without an appeal being filed or perfected, whichever occurs latest.

IV. WAIVER PROCEDURE

Any Member required to adopt the enhanced supervisory requirements may seek a waiver by filing a petition with the Waiver Committee within 30 days of the date of being notified by NFA that it is required to adopt the enhanced supervisory requirements. NFA may grant such a waiver upon a satisfactory showing that the Member's current supervisory procedures provide effective supervision over its employees, including enabling the Member to identify potential problem areas before customer abuse occurs. Additionally, if a Member meets the criteria and trades security futures products, then the Member firm must also make a satisfactory showing that the Member's supervisory procedures ensure compliance with all applicable securities laws and regulations. Should a Member fail to file a petition seeking a waiver within 30 days or should it file a petition that is denied by the Waiver Committee, either in whole or in part, the Member may not petition for a full or partial waiver again until at least two years have elapsed since the Member adopted the required enhanced procedures. Members that meet the criteria to adopt the enhanced supervisory requirements and receive either a full or partial waiver of their obligation to adopt those requirements are, nevertheless, deemed to be a Member that qualified for the requirements for the purposes of this Interpretive Notice.

Some of the factors that the three-member Waiver Committee may consider in evaluating a waiver request include:

  • the total number and the backgrounds of APs sponsored by the Member;
  • number of branch offices and GIBs operated by the Member;
  • the experience and background of the Member's supervisory personnel;
  • the number of the Member's APs who had received training from firms which have been closed for fraud, the length of time those APs worked for those firms and the amount of time which has elapsed since those APs worked for the disciplined firms;
  • the results of any previous NFA examinations;
  • the cost effectiveness of the taping requirement in light of the firm's net worth, operating income and related expenses;
  • whether the Member assesses commissions, mark-ups, fees and other charges that are based on all of the relevant circumstances, including the expense of executing orders and the value of services the Member renders based on its experience and knowledge; and
  • whether the Member adequately discloses the amount of commissions, mark-ups, fees and other charges before transactions occur in light of a retail customer's trading experience and the impact that the commissions, mark-ups, fees and other charges may have on the likelihood of profit.

Conditions that the Waiver Committee shall impose on any Member to which it grants a full or partial waiver include requirements that the firm: notify NFA of any action charging the firm with a violation of CFTC, SEC or Self Regulatory Organization ("SRO") regulations or rules; notify NFA of any customer complaint involving sales practices or promotional material; not change ownership; not have any material deficiencies noted during any SRO examination; not hire additional APs from Disciplined Firms; execute a written acknowledgement that the firm understands the conditions of the waiver; and may include any other conditions deemed by the Committee to be appropriate in consideration of a total or partial waiver from the enhanced supervisory requirements. Violation of any of those conditions may serve as cause for the Waiver Committee to review and amend or revoke the waiver.

Any FCM, IB, CPO and CTA Member or FDM that does not comply with this Interpretive Notice will violate NFA Compliance Rule 2-9(b) or 2-36(e) and will be subject to disciplinary action.

1 The Board notes that NFA Registration Rule 214(a) requires sponsors to file a Form 8-T with NFA reporting the termination of an AP within 30 days of their termination. Members should be aware that, notwithstanding that Rule, a Member's obligation to adopt the enhanced supervisory requirements is conclusively established on any day on which its sales force meets one of the listed numerical criteria and that the obligation shall not be extinguished by the effect of the subsequent filing of a Form 8-T for a terminated AP even if the form is filed within 30 days of an AP's termination.

9022 - REGISTRATION RULE 402: CTAS TRADING PRIMARILY IN SECURITIES

(Board of Directors, September 21, 1993; revised December 10, 2007 and July 9, 2013.)

INTERPRETIVE NOTICE

The Board of Directors has granted the Vice-President of Registration and Membership the authority to waive the Series 3 examination for certain individuals associated with CTAs who are required to register solely because their securities advisory services include advice on the use of futures and options for risk management purposes. The individual or firm requesting the waiver must provide a written description of the facts which qualify the individual or firm for a waiver. The Vice-President of Registration and Membership's decision will be final.

The Vice-President of Registration and Membership is authorized to waive the Series 3 examination for a CTA and its APs if: (1) the CTA is subject to regulation by a federal or state regulator; (2) for each customer for whom the CTA provides futures trading advice such advice is incidental to the securities advisory services provided by the CTA to such customer; and (3) the futures trading advice offered by the CTA is for hedging or risk management purposes.

Waiver requests should be directed to:

Vice-President of Registration and Membership 
National Futures Association
320 South Canal, Suite 2400
Chicago, Illinois 60606

9023 - COMPLIANCE RULE 2-13: BREAK-EVEN ANALYSIS

(Board of Directors, August 24, 1995; revised July 24, 2000 and February 1, 2020)

INTERPRETIVE NOTICE

NFA Compliance Rule 2-13 requires, in pertinent part, that each Member CPO which delivers a disclosure document under CFTC Regulation 4.21 must include in the disclosure document a break-even analysis which includes a tabular presentation of fees and expenses. The break-even analysis must be presented in the manner prescribed by NFA's Board of Directors. The purpose of this requirement is to ensure not only that participants will be clearly informed as to the nature and amount of fees and expenses that will be incurred, but that participants will also be made aware of the impact of those fees and expenses on the potential profitability of their investments. NFA's Board of Directors has adopted the following guidelines which must be adhered to by NFA Member CPOs when preparing the break-even analysis required by Compliance Rule 2-13:

  • The break-even analysis must include the applicable fees and expenses required to be described in the CPO's disclosure document by CFTC Regulation 4.24(i).
  • The break-even analysis must be based on the minimum initial investment amount for a participant and the minimum total subscription amount required for the pool to commence trading. Additionally, if the CPO anticipates a higher amount of total funds raised that will affect the fees and expenses per participant, then the CPO may also provide a break-even analysis using the higher amount of anticipated total funds raised.
  • If a redemption fee is charged at the end of the first year of investment, it must be clearly shown, considered part of the total cost and reflected in the break-even analysis. Any other redemption fee(s) (e.g., early withdrawal fees) on the redemption of the initial investment must be disclosed in the explanatory notes to the break-even analysis.
  • If the pool incurs fees and expenses in connection with the pool's participation in other investments, such fees or expenses must be clearly shown, considered part of the total cost and reflected in the break-even analysis.
  • Incentive fees must be stated as a percentage of profits, and the method by which profits are calculated must be described.
  • All management, brokerage and other fees must reflect actual experience or contractual charges, if known. If not known, they must be based on good faith estimates.
  • For purposes of the break-even analysis, CPOs may only offset expenses with interest income generated through the pool's investment in high credit quality short-duration1 instruments or deposits associated with the pool's buy-and-hold cash management strategies. Examples of such instruments or investments include, but are not limited to, Treasury Bills, cash on deposit at a bank or in a money market account, funds on deposit with brokerage firms and interest in a money market mutual fund. The estimate of this interest income must include the assumed interest rate, and that rate must reflect current cash market information. If any interest income is to be paid to the pool operator, or to anyone other than the pool participants, that fact and an estimate of the amount must also be clearly disclosed.

The CPO must calculate the additional trading profit necessary to overcome any incentive fees that would be incurred by a participant prior to the participant recovering the amount of their initial investment. This situation will arise whenever the pool expects to incur expenses which would not be deducted from the net performance that is the basis of in the incentive fee calculation. The incentive fee amount can be computed by first summing all of the pool fees, expenses and interest income that will be excluded from the computation of the incentive fee, then dividing that amount by (1- incentive fee rate) and then multiplying this amount by the incentive fee rate. For example, if the incentive fee is 25%, the denominator would be (1- .25) multiplied by the incentive fee rate of 25%.

As discussed above, the break-even presentation should be based on the minimum initial  investment amount and the minimum total subscription amount required for the pool to commence trading. A sample break-even presentation is shown below:

Minimum Initial Investment (1) $100,000
Upfront Syndication and Selling Expense (2) 1,500
Initial Organizational Expenses (3) 200
General Partner's Management Fee (4) 985
Fund Operating Expenses (5) 1,034
Trading Advisor's
Management Fees (6)		 1,773
Trading Advisor's
Incentive Fees on Trading Profits (7)		 439
The General Partner's Incentive Fees on Trading Profits (8) 0
Brokerage Commissions and Trading Fees (9) 1,724
Less Interest Income (10) (1,231)
Amount of Trading Profits Required for
a Participant's Capital Account
(Redemption Value) at the End of
One Year to Equal Its Initial Investment		 $6,424
Percentage of Minimum Initial Investment 6.42%

Explanatory Notes:

    (1) Investors will initially make an investment of $100,000. The break-even presentation is based on the $100,000 minimum initial investment and the minimum total subscriptions of $5,000,000 for the Fund to commence trading.
    (2) A 1.5% upfront syndication and selling charge will be deducted from each subscription to reimburse the Fund, the General Partner and/or the Clearing Broker for the syndication and selling expenses incurred on behalf of the Fund.
    (3) The initial organizational costs for the Fund are $10,000. Therefore, each participant's allocation of those costs based on a minimum initial investment of $100,000 and minimum total subscriptions of $5,000,000 will be $200.
    (4) The Fund's General Partner will be paid a monthly management fee of 1/12 of 1% of Net Asset Value.
    (5) The Fund's actual accounting, auditing, legal and other operating expenses will be borne by the Fund. These expenses are expected to amount to approximately 1.05% of the Fund's Net Asset Value.
    (6) The Fund's Trading Advisor will be paid a monthly management fee of 1/12 of 2% of Allocated Net Assets, which is anticipated to be 90% of the Net Asset Value.
    (7) The Trading Advisor will receive an incentive fee of 15% of Trading Profits exclusive of interest income. The $439 of incentive fees shown above is equal to 15% of the net of total trading income of $6,424, minus $1,724 of brokerage commissions and trading fees and $1,773 of Trading Advisor management fees.
    (8) In the above example, no incentive fee for the General Partner is included in the calculation. The General Partner charges a 20% quarterly incentive fee based upon New Net High Profits. New Net High Profits is the net of all management fees, brokerage commissions and operating expenses and as such, the General Partner does not receive an incentive fee until the Fund generates trading income sufficient to offset such expenses. Based on the above analysis, the General Partner would need to earn more than $6,424 of gross trading income per unit before it would be entitled to an incentive fee.
    (9) Brokerage commissions (including any spread on forex transactions) and trading fees are estimated at 1.75% of Net Asset Value.
    (10) The Fund will earn interest on margin deposits with its Clearing Broker. Based on a current assumed interest rate of 2%, interest income is estimated at 1.25% of Net Asset Value.

The above break-even analysis is a sample and the fees and expenses included in it may vary from those charged by other commodity pools. The analysis included in an actual disclosure document must include all of the fees and expenses of any type which affect the break-even point of that investment.

1 For the purpose of this Interpretive Notice, short-duration generally means instruments with a term of one year or less.

9024 - RESERVED

9025 - COMPLIANCE RULE 2-29: USE OF PROMOTIONAL MATERIAL CONTAINING HYPOTHETICAL PERFORMANCE RESULTS

(Board of Directors, February 1, 1996; revised August 29, 1996, January 1, 2020 and March 20, 2020)

INTERPRETIVE NOTICE

Over the years the use of hypothetical performance results has repeatedly produced misleading promotional material. By their very nature, such performance results have certain limitations. For example, hypothetical performance results do not represent actual trading and are generally designed with the benefit of hindsight, which may under- or over-compensate for the impact of certain market factors, including lack of liquidity and price slippage. Furthermore, since hypothetical trading does not involve financial risk, no hypothetical performance results can completely account for the impact of certain factors associated with risk, including the ability of the customer or the advisor to withstand losses or to adhere to a particular trading program in the face of trading losses. Despite these limitations, there have been numerous instances in which Members have attempted to induce customers to place undue reliance on hypothetical results. NFA's Business Conduct Committee has not hesitated to issue charges against Members engaging in such practices and will continue to pay close attention to promotional materials that display hypothetical results.

The use of hypothetical results has been the subject of regulatory scrutiny. In 1981, the Commodity Futures Trading Commission ("CFTC" or "Commission") considered a total ban on the use of such results. Ultimately, the Commission required CPOs and CTAs displaying hypothetical results to display the disclaimer set forth in CFTC Regulation 4.41. The Commission noted at the time that it might well impose sterner measures if the disclaimer proved ineffective at preventing abuses. NFA subsequently required all FCM, IB, CPO or CTA Members and Associates to display Regulation 4.41's disclaimer in any promotional material that contains such results.

In NFA's experience, however, the use of the mandated disclaimer has not prevented recurring abuses in the presentation of hypothetical results. In some instances, Members have touted dramatic hypothetical profits without revealing that their actual performance is much worse. This situation was addressed by an amendment to NFA Compliance Rule 2-29(c)(3) that requires FCM, IB, CPO and CTA Members advertising hypothetical results to disclose their actual results as well, except as provided in NFA Compliance Rule 2-29(c)(6). In other cases, Members have effectively diminished the impact of the disclaimer by over-emphasizing the significance of hypothetical profits. For example, some Members have utilized promotional material that presents hypothetical rates of return in large, bold-face print while the disclaimer can be read only with a magnifying glass. In other advertising pieces the disclaimer is so far removed from the touted hypothetical profits that customers may never find it. There have also been instances in which Members or Associates have attempted to disguise hypothetical performance results by referring to the performance with terms such as "live" or "real-time" results. In many cases, the intention of these ambiguous references are intended to give the appearance that hypothetical performance is actual performance.

Due to the nature and the frequency of the issues noted in the use of hypothetical performance, NFA's Board of Directors previously considered a complete ban on the presentation of hypothetical results in promotional material. However, in considering such a ban, the Board also recognized that the presentation of hypothetical performance results in promotional material may have some limited utility in certain circumstances, for example, where a Member has developed a new trading program for which there are no actual trading results. As a result, the Board decided to continue to allow FCM, IB, CPO and CTA Members and Associates to utilize promotional material containing hypothetical performance results under very stringent restrictions. Hypothetical results will not be allowed, however, for any trading program for which the Member has three months of actual trading results except as provided in Compliance Rule 2-29(c)(6). Any FCM, IB, CPO and CTA Member or Associate utilizing promotional material that includes hypothetical results shall, at a minimum, adhere to the requirements set forth in NFA Compliance Rule 2-29(c), which are described more fully below.

First, any FCM, IB, CPO or CTA Member or Associate utilizing promotional material that presents hypothetical performance results must provide to customers the disclaimer contained in NFA Compliance Rule 2-29(c)(1). This disclaimer addresses the limitations of hypothetical results and of the dangers in placing undue reliance upon them. To prevent the over-emphasis of hypothetical performance results, the disclaimer must be displayed as prominently as the hypothetical results themselves. Generally, this would require that the disclaimer be printed in a type size at least as large as that used for the hypothetical results. Similarly, to avoid circumstances where hypothetical performance results are presented in one section of the promotional material with the disclaimer buried in another, the disclaimer should immediately precede, or follow the hypothetical performance results. Whenever the FCM, IB, CPO or CTA Member or Associate has less than 12 months of actual results, the disclaimer must immediately precede the hypothetical performance results.1 Furthermore, if the promotional material contains several pages of hypothetical performance results, then the Member or Associate may need to include this disclaimer more than once in the material.

Second, any FCM, IB, CPO or CTA Member or Associate utilizing promotional material that presents hypothetical performance results must also describe in the promotional material all of the material assumptions that were made in preparing the hypothetical results.2 At a minimum, the description of material assumptions must cover points such as initial investment amount, reinvestment or distribution of profits, commission charges, management and incentive fees, and a general discussion of how performance was calculated (e.g., based on settlement prices, real time pricing). FCM, IB, CPO or CTA Members must also make all material disclosures necessary to place the hypothetical results in their proper context, which in most instances may go well beyond the prescribed disclaimer. Furthermore, FCM, IB, CPO or CTA Members and Associates must calculate hypothetical performance results in a manner consistent with that required under Part 4 of the CFTC's Regulations.

Third, when any FCM, IB, CPO or CTA Member or Associate utilizes promotional material that contains both hypothetical and actual performance results, the actual results must be presented with at least the same prominence devoted to the hypothetical results. Hypothetical and actual performance results must be appropriately identified, presented separately3, discussed in an equally balanced manner and calculated pursuant to the same rate of return method. Furthermore, the promotional material must not contain any statement that places undue emphasis on the hypothetical performance results, for example, by discounting or downplaying the significance of any actual performance results.

NFA's Board of Directors further notes that the preceding requirements also apply to an FCM, IB, CPO or CTA Member or Associate's use of promotional material containing a composite performance record showing what a multi-advisor managed account or pool could have achieved if the account's or pool's assets had been allocated among particular trading advisors. In the past, Members have referred to these composite performance records as pro forma results; however, NFA's Board of Directors believes the pro forma label is misleading. Although the performance for each individual trading advisor is based upon actual results, the selection of and allocation among trading advisors has been done with the benefit of hindsight and, thus, the composite performance record is hypothetical in nature.

Therefore, in addition to the preceding requirements, FCM, IB, CPO or CTA Members and Associates must appropriately label any composite performance record for a multi-advisor managed account or pool as hypothetical and not pro forma. Additionally, because the composite performance record is hypothetical in nature, FCM, IB, CPO or CTA Members must include a description of all the material assumptions noted above and, in this context, also describe the method used to select and allocate assets among particular trading advisors. Furthermore, any hypothetical composite performance results for multi-advisor accounts must be calculated based on the nominal funding level required to trade with each of the advisor's in the composite as required by NFA Compliance Rule 2-34. The performance should be presented based on the trading level that is the basis for the CTA's trading decisions rather than its customer's cash management practices. Presenting the hypothetical performance of a multi-advisor composite based on the cash investment of a partially funded account is not appropriate. Presenting the effects of partial funding at varying cash investment levels creates a potential to manipulate the hypothetical rates of returns by simply increasing or decreasing the cash funding level. If an FCM, IB, CPO or CTA Member or Associate previously used promotional material containing hypothetical composite performance records for multi-advisor managed accounts or pools and the hypothetical results were substantially higher than the actual results subsequently obtained by the Member or Associate in allocating assets among the multi-advisors, then this fact must be disclosed in the promotional material.

The presentation of hypothetical performance results in promotional material is, of course, subject to all other NFA Requirements. Pursuant to NFA Compliance Rule 2-29 (b)(1) and (2), the ultimate test of any promotional material is whether the overall impact of the material is misleading or is likely to be deceptive. Although NFA has issued this Interpretive Notice, the Board recognizes that it cannot describe every manner in which promotional material containing hypothetical performance results may be misleading. The fact that an NFA Member or Associate has printed the disclaimer required pursuant to NFA Compliance Rule 2-29 and that the promotional material is in facial compliance with this Interpretive Notice does not ensure that the material is not misleading.

Promotional material that contains hypothetical performance results will continue to be carefully scrutinized by NFA staff. Pursuant to NFA Compliance Rule 2-29(f), FCM, IB, CPO or CTA Members and Associates presenting hypothetical results in their promotional material must be able to demonstrate to NFA's satisfaction the validity of the presentation of the results. The greater the emphasis on dramatic hypothetical profits, the greater the Member's burden in demonstrating the validity of the presentation.

Addressing a different concern, the Board of Directors also believes that hindsight analysis may be misleading as applied to the presentation of extracted performance in which an FCM, IB, CPO or CTA Member or Associate selects one component of its overall past trading results to highlight to customers. In order to prevent the misleading use of such results, except in the case of promotional material directed exclusively to QEPs, the use of extracted performance is permitted only when a CPO's or CTA's previous disclosure documents designated the percentage of assets that would be committed toward that particular component of the overall trading program. For example, if the previous disclosure document stated that 25 percent of a fund's assets would be dedicated to trading financial futures contracts, and if 25 percent of the fund's assets were in fact dedicated to trading financial futures contracts, the CPO would be allowed to present the extracted performance of its financial futures trading based on net asset values equal to 25 percent of the fund's total net asset value. Performance may also be extracted from a managed account program run by an FCM or IB if these same requirements are met. In other words, the FCM or IB must have previously prepared and distributed to all customers participating in the trading program a written report or similar document which designated the percentage of assets that would be committed toward a particular component of the overall trading program. Oral representations, or written documents that were not distributed to the customers, are not sufficient. Furthermore, any promotional material referring to extracted results must clearly label those results as such and must disclose in an equally prominent fashion the overall actual trading results from which the extracted results were drawn. Members presenting extracted performance in promotional material directed exclusively to QEPs are not required to satisfy the requirements of this paragraph, provided that such performance information is clearly identified and accompanied by disclosure of material assumptions that were made in preparing the extracted performance that differ from the disclosed features of the offered trading program.

Lastly, the Board of Directors believes that the use of pro forma performance histories can present useful information to customers, particularly when used to show how the past performance of a given FCM, IB, CPO or CTA Member or Associate would have been affected by the commission or fee structure that applies to the commodity interest contracts, commodity pool, or trading program offered, recommended or described by the Member or Associate. Therefore, an FCM, IB, CPO or CTA Member or Associate may use pro forma results to adjust for differences in commissions and fees as long as the pro forma results are not calculated in a misleading manner and the assumptions used to arrive at the pro forma results are clearly disclosed.

1 This requirement does not apply to promotional material directed exclusively to QEPs.

2 For promotional material directed exclusively to QEPs, the Member is required to provide the material assumptions only in those instances where the material assumptions differ from the disclosed features of the offered trading program.

3 For promotional material directed exclusively to QEPs, hypothetical and actual performance may be presented together provided that each is clearly identified as hypothetical or actual performance.

9026 - RESERVED

9027 - RESERVED

9028 - NFA FINANCIAL REQUIREMENTS: THE ELECTRONIC FILING OF FINANCIAL REPORTS

(Board of Directors, March 24, 1997; revised July 1, 2000; July 24, 2000; December 31, 2001; October 18, 2010, and January 14, 2016.)

INTERPRETIVE NOTICE

NFA Financial Requirements require each FCM for which NFA is DSRO, each RFED and each IB which is not operating pursuant to a guarantee agreement to file financial reports with NFA. FCMs and RFEDs must file reports monthly while IBs file on a semi-annual basis. FCMs and RFEDs file reports on CFTC Form 1-FR-FCM while IBs use Form 1-FR-IB. FCMs or IBs which are also registered as securities brokers or dealers may use the SEC FOCUS Report in lieu of the Form 1-FR for their financial reports.

NFA, in partnership with the Chicago Mercantile Exchange and the Chicago Board of Trade, has developed computer software which allows FCMs, RFEDs and IBs to electronically file financial reports with NFA, the CME, CBOT and the CFTC. This software is being used industry-wide. The software accommodates filing of the Form 1-FR-FCM, Form 1-FR-IB, FOCUS II and FOCUS IIA Reports, including those required to be certified by a Certified Public Accountant. All FCMs and IBs for which NFA is the DSRO and RFEDs must file their financial reports electronically using this software.

NFA's filing software also includes procedures for the appropriate representative of the NFA Member FCM, RFED or IB to attest to the completeness and accuracy of the financial report in order to comply with NFA and CFTC certification and attestation requirements. Each authorized signer must apply to NFA for a Personal Identification Number using an application form approved by NFA.

Full details about the software and electronic filing procedures and the application form for obtaining a PIN number are available by accessing the Compliance Section, Issues for FCMs, RFEDs and IBs, of NFA's web site at www.nfa.futures.org or by contacting the Information Center at (312) 781-1410. Information is also available on the Joint Audit Committee's web site at www.jacfutures.com/jac/

9029 - NFA COMPLIANCE RULE 2-10: THE ALLOCATION OF BUNCHED ORDERS FOR MULTIPLE ACCOUNTS

(Board of Directors, June 9, 1997; revised September 15, 2003, March 21, 2014 and March 1, 2020)

INTERPRETIVE NOTICE

NFA Compliance Rule 2-10 adopts by reference CFTC Regulation 1.35, which, among other things, imposes on futures commission merchants (FCMs) and introducing brokers (IBs) recordkeeping requirements for customer orders in commodity interests. The purpose of the regulation is to prevent various forms of customer abuse, such as the fraudulent allocation of trades, by providing an adequate audit trail that allows customer orders to be tracked at every step of the order processing system. In general, Regulation 1.35 provides that FCMs and IBs receiving a customer order that cannot immediately be entered into a trade matching engine must prepare a written record of the order immediately upon receipt, including an appropriate account identifier.

With respect to bunched orders placed by an account manager on behalf of multiple clients, the CFTC has interpreted Regulation 1.35 to require that, at or before the time the order is placed, the account manager must provide the FCM with information that identified the accounts included in the bunched order and specified the number of contracts to be allotted to each account.1 CFTC Regulation 1.35(b)(5) provides an exception to this requirement that allows certain account managers, including registered commodity trading advisors (CTAs), FCMs and IBs that have been granted discretionary trading authority in writing (collectively, "Eligible Account Managers"), to enter bunched orders for a limited class of eligible clients and to allocate them to individual accounts no later than the end of the day ("post-execution allocation procedures").

Both the Eligible Account Managers that take advantage of post-execution allocation procedures2 and the IBs that execute or the FCMs that execute or clear these transactions must satisfy several requirements set forth in CFTC Regulation 1.35(b)(5). Among other things, this regulation requires that bunched orders be allocated in a fair and equitable manner so that no account or group of accounts consistently receives favorable or unfavorable treatment over time. The rule further provides that Eligible Account Managers bear the responsibility for the fair and equitable allocation of bunched orders. Eligible Account Managers are also required to receive written investment discretion, adhere to record retention requirements and make certain information regarding the allocation method available to customers upon request. FCMs that execute or clear orders eligible for post execution allocation and IBs that execute orders eligible for post execution allocation must maintain records that identify each order subject to post execution allocation and the accounts to which contracts executed for such order are allocated. Additionally, FCMs and IBs are prohibited by CFTC Regulation 155.3 and 155.4 from including proprietary trades in a bunched order with customer trades.

This Notice sets out certain core principles that govern all allocation methodologies and the respective responsibilities of Eligible Account Managers, as well as the FCMs or IBs that execute or carry the accounts of the Eligible Account Managers' clients. The Notice also describes certain methodologies that generally meet these core principles. Although these methodologies were developed to assure compliance with the requirement that allocation instructions be provided at or before the time a bunched order is placed, they also apply to post-execution allocation procedures.

Core Principles and Responsibilities

Allocation instructions for trades made through bunched orders for multiple accounts must deal with two separate issues. The first, which arises in all such orders, involves the question of how the total number of contracts should be allocated to the various accounts included in the bunched order. For some Eligible Account Managers, this allocation may remain relatively constant. For others, although their basic allocation methodology does not change, the specific allocation instructions produced by the methodology may change on a daily basis.

The second issue involves the allocation of split or partial fills. For example, an Eligible Account Manager may place a bunched order of 100 contracts for multiple accounts. In many instances, however, a market order for 100 contracts may be filled at a number of different prices. Similarly, if an order is to be filled at a particular price, the FCM that executes the trade may be able to execute some but not all of the 100 lot order. In either example, the question arises of how the different prices or the contracts in the partial fill should be allocated among the accounts included in the block order.

The same set of core principles govern the procedures to be used in handling both of these issues. Any procedure for the general allocation of trades or the allocation of split and partial fills must be:

  • designed to meet the overriding regulatory objective that allocations are non-preferential and are fair and equitable over time, such that no account or group of accounts receive consistently favorable or unfavorable treatment;3
  • sufficiently objective and specific to permit independent verification of the fairness of the allocations over time and that the allocation methodology was followed for any particular bunched order; and
  • timely, in that the Eligible Account Manager must provide the allocation information to FCMs that execute or clear the trade as soon as practicable after the order is filled and, in any event, sufficiently before the end of the trading day to ensure that clearing records identify the ultimate customer for each trade.

As noted above, the responsibility for allocating contracts executed through a bunched order rests solely with the Eligible Account Manager.4 The Eligible Account Manager must confirm, on a daily basis, that all its accounts have the correct allocation of contracts. An Eligible Account Manager must also analyze each trading program at least once a quarter to ensure that the allocation method has been fair and equitable (i.e., customers in the same trading program achieve similar allocation results over time). This quarterly review is also required for Eligible Account Managers that do not offer trading programs but routinely execute bunched orders on behalf of the same group of accounts (for example, an IB that maintains discretion over a group of customers who routinely trade in the same contracts and the IB bunches these orders together upon execution). Allocation fairness over time, rather than trade-by-trade, is the critical element in this evaluation. If materially divergent performance results exist over time among accounts in the same trading program, such results must be shown to be attributable to factors other than the Eligible Account Manager's trade allocation procedures. Applicable CFTC and NFA interpretations have addressed permitted reasons for divergent performance results among accounts in the same trading program. If those results indicate that the allocation method has not been fair and equitable over time, however, then the Eligible Account Manager must revise its allocation methodology or adopt a different allocation method for application on a prospective basis only. An Eligible Account Manager must document its internal audit procedures and results in writing and maintain these audit procedures and results as firm records subject to review during an NFA examination.

Examples of Allocation Methodologies

The following are examples of procedures for the allocation of split and partial fills that generally satisfy the core principles described above. These methodologies are the most common that NFA has observed in performing examinations. However, they are not the exclusive means of achieving compliance with Regulation 1.35(b)(5). The appropriateness of any particular method, of course, will depend on the Eligible Account Manager's trading strategy.5

Example #1 - Rotation of Accounts
One basic allocation procedure involves a rotation of accounts on a regular cycle, usually daily or weekly, which receive the most favorable fills. For example, if a firm has 100 accounts trading a particular trading program, in the first phase of the cycle, Account #1 receives the best fill, Account #2 the second best, etc. In phase 2 of the cycle, Account #2 receives the best fill and Account #1 moves to the end of the line and receives the least favorable fill.

Example #2 - Random Allocation
Some firms prepare on a daily basis a computer generated random order of accounts and allocate the best price to the first account on the list and the worst to the last. This method would satisfy the standards stated above.

Example #3 - Highest Prices to the Highest Account Numbers
Some firms rank accounts in order of their account numbers and then allocate the highest fill prices to the accounts with the highest account numbers. Any advantage the higher numbered accounts enjoy on the sell order are theoretically offset by the disadvantage on the buy orders. Although under certain market conditions this may not always be true, the method generally complies with the standards.

Example #4 - Average Price
With regard to split fills, firms may have internal programs which calculate the average price for each bunched order. The program will then assign the average price to each allocated contract. In the alternative, the program will allocate the actual fill prices among the accounts included in the order to approximate, as closely as possible, the average fill price. Either average price allocation method offers a consistent non-preferential method for allocating trades.

Cash Residuals

In certain instances, a bunched order may be filled at multiple prices and allocated to participating accounts at an average price. The average price of a bunched order allocation may be rounded up for a buy order (or down for a sell order) to the next price increment supported by the relevant clearing and accounting systems, provided that the residual created by the rounding process is paid to the customer. For example, if a buy order with an average price of $1.98 in a market with a tick increment of $.05 is rounded up to the nearest tick (e.g., $2.00) and a sell order with an average price of $1.98 is rounded down to the nearest tick (i.e., $1.95), a cash residual of $.02 for the buy orders and $.03 for the sell orders must be distributed to the participating customers. An average pricing system may produce prices that do not conform to whole cent increments. In such cases, any amounts less than one cent need not be distributed to the customer. NFA's Business Conduct Committee and Hearing Panels have found that failing to properly allocate cash residuals to customers can constitute a violation of NFA Rules.

FCM and IB Responsibilities

Although the Eligible Account Manager is responsible for the allocation of each bunched order, the IB that executes or FCM that executes or clears the trade has certain obligations as well. In particular, each IB that executes or FCM that executes or clears the trade must receive from an Eligible Account Manager sufficient information to allow it to perform its functions. For executing FCMs or IBs in a give-up arrangement, this includes, at a minimum, information that identifies the Eligible Account Manager at the time the order is placed and instructions, which the FCM or IB may receive following execution of the order, for the contracts to be given up to each clearing FCM. Information concerning the number of contracts to be allocated to each account included in the bunched order along with instructions for the allocation of split and partial fills among accounts must be provided to the clearing FCM.6

Regulation 1.35(b)(5) requires each IB that executes or each FCM that executes or carries accounts eligible for post-execution allocation to maintain records that, as applicable, identify each order subject to post-execution allocation and the accounts to which the contracts were allocated. One means by which an FCM or IB can meet this recordkeeping requirement is to maintain a copy of the allocation instructions provided by the Eligible Account Manager by facsimile, e-mail, or other form of electronic transmission. If the allocation is provided orally, however, the FCM or IB must create and maintain a written record.

Also, if the FCM or IB has actual or constructive notice that allocations for its customers may be fraudulent, the FCM or IB must take appropriate action. For example, if an FCM or IB has notice of unusual allocation activity, the FCM or IB must make a reasonable inquiry into the matter and, if appropriate, refer the matter to the proper regulatory authorities (e.g., the CFTC, NFA or the FCM's DSRO). Whether an FCM or IB has such notice depends upon the particular facts involved.

Obviously, one of the most significant factors is the amount of information available to the FCM or IB. An FCM that both executes and clears an entire bunched order will possess more information than an IB that executes or an FCM that executes or clears only a portion of an order. Where there are multiple FCMs executing and clearing the bunched order or IBs involved in execution, some FCMs or IBs may have more information available than others, and it is likely that no single FCM or IB would have enough information to determine if there is unusual allocation activity. Likewise, in situations where an investment adviser uses bunched orders for hedging purposes, the FCM or IB may not possess adequate information to evaluate the allocation activity. However, if the FCM or IB has actual or constructive notice that the allocations may be fraudulent, the FCM or IB must take appropriate action.

If any Member has questions concerning how this Interpretive Notice would apply to its operations, please contact NFA's Compliance Department.

1Consistent with the provisions of CFTC Regulation 1.35(b)(5), Eligible Account Managers that place orders for a single account must still provide account identification information at the time of order entry.

2Although this Interpretive Notice addresses the allocation of bunched futures or cleared swaps orders, an Eligible Account Manager that executes a bilateral swap transaction for post-execution allocation to individual clients must comply with the applicable sections of CFTC Regulation 1.35(b)(5) and is subject to discipline under NFA Compliance Rule 2-10 for failure to do so.

3Because customers must have access to information that allows them to assess the fairness of the allocation process, Eligible Account Managersare required to make the following information available to customers upon request: (1) the general nature of the Eligible Account Manager's allocation methodology; (2) whether accounts in which the CTA may have an interest may be included with customer accounts in bunched orders; and (3) summary or composite data sufficient for that customer to compare its allocation results with the allocation results of other comparable customers and, if applicable, any account in which the Eligible Account Manager has an interest.

4However, NFA rules do not preclude an FCM from agreeing to undertake this responsibility, whether it clears or executes the trades, pursuant to either its own procedures or to those supplied by the Eligible Account Manager. For example, the Eligible Account Manager and FCM that executes or clears the trade may agree that the FCM that executes or clears the trade will allocate a bunched order in accordance with instructions that the Eligible Account Manager files with the FCM that executes or clears the trade either prior to or concurrently with placing the bunched order. Any division of responsibilities agreed to by the FCM that executes or clears the trade and Eligible Account Manager should be clearly documented.

5For example, certain allocation methodologies may satisfy the general standards for Eligible Account Managers who trade on a daily basis but be inappropriate for Eligible Account Managers who trade less frequently.

6As noted, an Eligible Account Manager must provide all of this information to the appropriate FCM as soon as practicable after the order is filled and sufficiently before the end of the trading day during which the order is executed to ensure that clearing records identify the ultimate customer for each trade.

9030 - RESERVED

9031 - STANDARD LIST OF DOCUMENTS TO BE EXCHANGED UNDER SECTION 8 OF NFA'S CODE OF ARBITRATION

(Board of Directors, December 1, 1997; revised April 15, 2011)

INTERPRETIVE NOTICE

Section 8 of NFA's Code of Arbitration requires the parties to automatically exchange certain documents early in the discovery process. Under this procedure, NFA will identify the standard documents that are routinely relevant for the causes of action alleged in a particular case from this list of documents approved by NFA's Board of Directors. NFA will then notify the parties that they must automatically exchange the standard documents with each other no later than 15 days after the last pleading is due. Except for the list showing the customer's investment experience, a party is not required to obtain or exchange any documents that do not exist or that are not in the party's possession or control.

The parties may ask for other documents and information within 30 days after the last pleading is due. The parties may ask for documents on the list which have not been identified for automatic exchange if they believe those documents are also relevant to the claim or defense.

A Customer May be Asked to Provide Any or All of the Following:

  • Account opening documents and forms for the customer's account including, but not limited to, account applications, account agreements, acknowledgment forms, margin agreements, option agreements, option disclosure statements, and other risk disclosure statements.

  • Records (including billing records), tapes, notes, and transcriptions of tapes of telephone or in-person conversations between the customer and any party named in the arbitration or any employee of a party named in the arbitration.

  • Any notes made by the customer concerning the customer's account or any transactions in the account.

  • All contracts or written agreements between the customer and any party named in the arbitration.

  • Any correspondence or agreements concerning the strategy to be used in trading the account.

  • All powers-of-attorney giving someone other than the customer the right to trade the account.

  • Daily confirmation statements for the customer's account.

  • Monthly activity statements for the customer's account.

  • A list, to be prepared by the customer, showing the customer's investment experience. For each type of investment the customer has made, the list must contain the type of investment, the names of the firms the customer has done or is doing business with, the account numbers for accounts at each firm, the dates the accounts were opened and, if applicable, the dates the accounts were closed.

  • Research or marketing materials concerning any trading recommendations made to the customer or concerning any transaction made in the customer's account.

  • The disclosure document(s) for any trading advisor trading the account.

  • All notifications the customer received from any party (or employee thereof) named in the arbitration proceeding regarding any price adjustments or system operational difficulties that allegedly occurred on the dates in question.

A Member and/or Associate May be Asked to Provide Any or All of the Following:

  • Account opening documents and forms for the customer's account including, but not limited to, account applications, account agreements, acknowledgment forms, margin agreements, option agreements, option disclosure statements, and other risk disclosure statements.

  • Any correspondence or agreements concerning the strategy to be used in trading the customer's account.

  • Daily confirmation statements for the customer's account.

  • Monthly activity statements for the customer's account.

  • Margin calls for the customer's account.

  • All powers-of-attorney giving someone other than the customer the right to trade the account.

  • Records (including billing records), tapes, notes, and transcriptions of tapes of telephone or in-person conversations between the customer and the broker1, other firm personnel, or the trading advisor.

  • Any notes made by the broker concerning the customer's account or any transactions in the account.

  • Registration applications, biographies, resumes or similar documents showing employment history and educational background of the broker and any trading advisor.

  • Floor and office order tickets and any other documents submitted at the time of the transactions for transactions made in the customer's account.

  • Research and marketing materials prepared or distributed by the firm, the broker, or the trading advisor concerning any trading recommendation made to the customer or any transaction made in the customer's account.

  • The index to the firm's compliance manual.

  • Agreements, contracts or other documents, including guarantee agreements, governing the relationship between the firm introducing the account and the FCM or FDM carrying the account, or between the trading advisor and either the firm introducing the account or the FCM or FDM carrying the account.

  • Commission runs for the broker who serviced the customer's account.

  • The disclosure document(s) for any trading advisor trading the account.

  • All notifications provided to the customer regarding any price adjustments or system operational difficulties that allegedly occurred on the dates in question. This includes notifications the firm received from the applicable counterparty or liquidity provider as well as the notes or internal correspondence regarding the disputed transactions.

  • The firm’s electronic Trading System Procedures required by NFA Interpretive Notice 9060 – NFA Compliance Rule 2-36(e): Supervision of the Use of Electronic Trading Systems for the period the customer’s account was open.

1 In this context, "broker" refers to the individual AP (or APs) who serviced the account.

9032 - STANDARD LIST OF DOCUMENTS TO BE EXCHANGED UNDER SECTION 7 OF NFA'S MEMBER ARBITRATION RULES

(Board of Directors, December 1, 1997)

INTERPRETIVE NOTICE

Section 7 of NFA's Member Arbitration Rules requires the parties to automatically exchange certain documents early in the discovery process. Under this procedure, NFA will identify the standard documents that are routinely relevant for the causes of action alleged in a particular case from this list of documents approved by NFA's Board of Directors. NFA will then notify the parties that they must automatically exchange the standard documents with each other no later than 15 days after the last pleading is due. A party is not required to obtain or exchange any documents that do not exist or that are not within the party's possession or control.

The parties may ask for other documents and information within 30 days after the last pleading is due. The parties may ask for documents on the list which have not been identified for automatic exchange if they believe those documents are also relevant to the claim or defense.

  • Records (including billing records), tapes, notes and transcriptions of tapes of telephone or in-person conversations between the parties relating to the matters involved in the dispute.

  • Any memoranda, notes or other correspondence between the parties relating to the matters involved in the dispute.

  • Contracts or written agreements between the parties.

  • Partnership or joint venture agreements.

  • Corporate documents (i.e., articles of incorporation, by-laws, resolutions, minutes of Board meetings).

  • Annual reports and financial statements.

  • Disclosure documents.

  • Authorizations for transferring accounts or positions from one FCM to another.

  • Records of security or guarantee deposits made by one party with or for the benefit of another party.

  • Commission runs.

  • Customer equity runs.

  • Registration applications, biographies, resumes or similar documents showing employment history and educational background of the parties.

  • Employee personnel files, including performance evaluations.

  • Employee handbooks, including amendments.

  • Forms 8-T or U-5 for the parties.

  • Documents showing salary history (including bonuses, commissions and commission pay-outs).

  • The index to a party's procedures manual.

  • If the dispute involves a customer account, copies of the customer's account opening documents and forms, monthly activity statements, and daily confirmation statements.

9033 - NFA COMPLIANCE RULE 2-29: DECEPTIVE ADVERTISING

(Board of Directors, June 4, 1996; revised January 1, 2020)

INTERPRETIVE NOTICE

NFA Compliance Rule 2-29 governs the use of promotional material and communications between FCM, IB, CPO and CTA Members and the public. The rule prohibits the use of misleading, deceptive or high-pressure promotional material. The purpose of this rule is to protect the public from fraudulent advertising and sales solicitations and to provide Members with specific guidance on the standards by which their promotional material and sales solicitations will be judged.

This Interpretive Notice provides guidance that will help FCM, IB, CPO and CTA Members identify and refrain from using practices that violate the letter or the spirit of NFA Compliance Rule 2-29. One common theme of deceptive or misleading promotional material is the suggestion of a strong likelihood of reaping dramatic profits by investing with the Member firm when, in fact, nothing in the Member's past experience provides any basis for those claims. Below are examples of conduct that may be deemed deceptive or misleading:

  • Claims Regarding Seasonal Trades and Historical Price Moves – Members have suggested almost certain profits from so-called seasonal trades in, among other things, heating oil and unleaded gas. These promotional materials cite historical data supposedly showing that certain trades produce dramatic profits year in and year out. Another theme is the reference to historic price moves in particular commodities with a suggestion that the same record setting move is likely to occur once again. For example, promotional material may refer to a time when a particular commodity traded at a high price, suggest that a similar movement is imminent and project that a customer can expect to double, triple or quadruple their investments in a short period of time. Promotional material can also be deceptive or misleading if the "historical data" involves different products, different time frames or different fee structures. One telling point is that the types of profits touted have not been achieved by the Member or its customers.
  • Cherry Picked Trades – Members have sought to entice prospective investors by claiming that their customers have made dramatic profits. However, when asked to support these claims, the Members rely on a few isolated trades. What these Members fail to disclose is that those profitable trades are not at all representative of the overall performance of either that customer's account or its other customers. In some cases, the customer referred to in the promotional material has actually lost money overall.
  • Profit Projections – Members have claimed that, based on current market conditions, customers can "turn $10,000 into $40,000," or profits of a similar magnitude. Again, however, the Member has not achieved the projected profits for its customers in the past. A variation of this technique involves highlighting the tremendous profits that will result from projected price movements that are characterized, directly or indirectly, as conservative estimates when, in fact, such price movements would be dramatic.
  • Use of Mathematical Leverage Examples – Members have improperly used leverage examples as a means of suggesting that prospective customers are likely to earn large profits trading in commodity interests despite the fact that the past performance of the Members' customers does not support their claims.
  • Use of Price Moves in One Product to Solicit Investment for a Different Product – Members have referred to historical price data for different products than those that are being offered, sold or traded by the Members. For example, Members soliciting for options may present price data relating to the cash or futures market instead of pricing data related to the options.
  • Use of Arbitrary Leverage Level – Members have presented performance results for a trading program that have been adjusted using an arbitrary leverage factor (e.g., depicting returns that are based on a partially funded investment). Some Members have claimed that the presentation is being made to illustrate the effects that partial funding could have on a trading program's performance; however, the particular trading program is not available to customers using the leverage or partial funding level depicted in the promotional material. In some examples, the promotional material also fails to provide the customer with the performance of the Member's actual trading program, which would typically show a materially different rate of return. In addition, the presentation does not adequately, if at all, explain the manner in which the rates of returns were calculated.
  • Use of Third-Party Index Performance – Members have used the performance of a third-party index as a way to promote the benefits of managed futures. In some cases, Members have referenced or highlighted the performance of a third-party index even though it is not representative of the Member's trading program or performance results. In other cases, Members have drawn inappropriate or misleading comparisons between their trading program and a third-party index. Members have also failed to adequately disclose the basis and limitations associated with the index and/or a statement that the customer is unable to invest directly in the index.

Each of the practices described above presents a distorted and misleading view of the likelihood of customers earning dramatic profits by investing with the Member firm, and each of these practices represents a clear violation of NFA sales practice rules. FCM, IB, CPO and CTA Members may not use any promotional material or make any solicitation referencing dramatic profits that could be achieved in the future or could have been achieved in the past by trading in commodity interest contracts for a particular commodity market unless the Member can demonstrate to NFA that, based on the past performance of its customers, those claims are not misleading.

Any FCM, IB, CPO or CTA Member making the types of claims referred to above must be able to demonstrate to NFA upon request that the actual performance of its customers supports those claims. Failure to provide adequate documentation will constitute prima facie evidence that the promotional material is misleading.

9034 - RESERVED

9035 - RULE 2-35. CPO/CTA DISCLOSURE DOCUMENTS

(Board of Directors, April 30, 1999. Effective date of amendments: June 30, 2020.)

INTERPRETIVE NOTICE

A Disclosure Document should provide essential information about the fundamental characteristics of a pool, and it should provide the information in a way that will assist investors in making informed decisions about whether to invest in the pool. Because investors who rely on the Disclosure Document may not be sophisticated in legal or financial matters, the information in the Disclosure Document should be written in clear, concise, and understandable language using plain English principles. If a Disclosure Document uses frequent technical or legal terminology, complex language, excessive detail, and extended discussions of legal requirements, the Disclosure Document becomes difficult for many investors to understand and may, therefore, defeat its purpose.

Compliance Rule 2-35 requires the Disclosure Document to be as clear and concise as possible and to use plain English principles. In particular, Disclosure Documents should be written:

  • In the active voice;
  • Using short sentences and paragraphs;
  • Breaking up the document into short sections, using titles and sub-titles that specifically describe the contents of each section;
  • Using words that are definite, concrete, and part of everyday language;
  • Avoiding legal jargon and highly technical terms;
  • Using glossaries to define technical terms that cannot be avoided;
  • Avoiding multiple negatives;
  • Saying something once where it is most important rather than repeating information;
  • Using tables and bullet lists, where appropriate.

Obviously, these are not hard and fast rules. For example, there may be times when something is so important that it should be said more than once. However, the Disclosure Document should substantially comply with the plain English principles described here.

Compliance Rule 2-35 also limits the information the CPO can include in the Disclosure Document. The Disclosure Document must include most of the information required by the CFTC's Part 4 Rules. It must also include any other information necessary to understand the fundamental characteristics of the pool or keep the Disclosure Document from being misleading. The Disclosure Document may also include information required by the Securities and Exchange Commission and state securities administrators. Such information currently includes items such as:

    (i) Any cautionary statement required by the Securities and Exchange Commission or a state securities administrator for a state where the pool is required to be registered;
    (ii) A concise description of the investment objectives, policies, and principal strategies of the pool, including a brief discussion of the circumstances under which these objectives or policies can be changed;
    (iii) For a pool that has been in operation for a full fiscal year, the compensation paid to all major CTAs for the most recent fiscal year as a percentage of average net assets. For a pool that has not been in operation for a full fiscal year, a general statement of what the major CTAs' fees will be as a percentage of average net assets. (Major CTAs are defined in CFTC Regulation 4.10(i));
    (iv) A brief description of any services provided by the major CTAs beyond those customarily provided by a CTA;
    (v) The identity of any person who provides significant administrative or business affairs management services to the pool with a brief description of the services provided and the compensation paid for these services;
    (vi) The name and principal address of the selling agent;
    (vii) If the pool has more than one class or series of securities offered or outstanding, a description of the characteristics of each class or series of securities, including dividend rights, liquidation rights, conversion rights, and redemption provisions;
    (viii) A description of how participant inquiries should be made;
    (ix) A description of how an investment in the pool is made, including the identity of the principal underwriter, if applicable;
    (x) The minimum initial or subsequent investment amount;
    (xi) A description of how the price of pool units is determined (if the purchase price of a unit is based on the net asset value at a specified date, it is sufficient to state this); and
    (xii) If applicable, a statement that information about the pool, including the Statement of Additional Information, can be reviewed and copied at the Securities and Exchange Commission's Public Reference Room in Washington, D.C.; that information on the operation of the public reference room may be obtained by calling the Securities and Exchange Commission at 1-800-SEC-0330; that reports and other information about the pool are available on the Securities and Exchange Commission's Internet site at http://www.sec.gov; and that copies of this information may be obtained, upon payment of a duplicating fee, by writing the Public Reference Section of the Securities and Exchange Commission, Washington, D.C. 20549-6009.

The Disclosure Document may not include any additional information. The CPO can, however, provide additional information in a Statement of Additional Information.

Disclosure Documents for single-advisor pools should usually be 30 pages or less. Disclosure Documents for more complex pools, such as multi-advisor pools or principal-protected pools, should not usually exceed 40 pages. However, longer Disclosure Documents will still comply with Compliance Rule 2-35 if they use the principles listed above and contain only the information allowed by Compliance Rule 2-35(b). And shorter Disclosure Documents will still violate Compliance Rule 2-35 if they are unnecessarily hard to read and understand.

9036 - RESERVED

9037 - NFA COMPLIANCE RULES 2-9, 2-10, 2-29, 2-36 and 2-39: GUIDANCE ON THE USE AND SUPERVISION OF WEBSITES, SOCIAL MEDIA AND OTHER ELECTRONIC COMMUNICATIONS

(Board of Directors, August 19, 1999; revised January 1, 2020)

INTERPRETIVE NOTICE

Technology has impacted nearly every aspect of how Members conduct their commodity interest business, including how they communicate with customers and other market participants. Many Members use websites, social media and other internet-based forums (e.g., blogs, chat rooms, etc.) to promote and conduct their business with customers. E-mail and other electronic communications (e.g., instant messaging, text messaging, messaging services provided by a social networking site, etc.) have enabled Members and their Associates to engage in frequent and instantaneous communications with customers. While these platforms have many benefits, they also provide opportunities to spread unsubstantiated rumors, intentional misrepresentations and engage in other conduct that is inconsistent with NFA rules. Members and Associates are reminded that many NFA requirements, including Compliance Rules 2-9, 2-10, 2-29, 2-36 and 2-39 apply to all forms of communication related to their commodity interest business.

NFA Compliance Rule 2-9 requires Members and Associates with supervisory duties to diligently supervise employees and agents in the conduct of their commodity interest activities for or on behalf of the Member. The rule is broadly written to provide Members with flexibility in developing procedures tailored to meet their particular needs. This Interpretive Notice is intended to provide guidance to help FCM, IB, CPO and CTA Members establish appropriate content standards and supervisory oversight of websites, social media and other electronic communications used to conduct commodity interest business.

Websites, Social Media and other Internet-Based Forums

Both Members and their employees and agents have used websites, social media and other internet-based forums (e.g., blogs, chat rooms, etc.) to promote and conduct their business with customers. Any communication related to a commodity interest account, agreement or transaction that is posted by or on behalf of an FCM, IB, CPO or CTA Member on a website, social media page or another internet-based forum that can be viewed by the general public or a closed community that includes current and potential customers, falls within the definition of promotional material and is subject to the requirements of NFA rules. For example, a website, social media page or blog discussing commodity interests that is used, maintained or administered by or on behalf of a Member is considered promotional material. The same is true for any commodity interest-related content written by an FCM, IB, CPO or CTA Member or Associate that is posted on a website, social media page or other communication platform maintained by a third party.

FCM, IB, CPO and CTA Members must implement written supervisory procedures governing the use of websites, social media and other internet-based forums that are designed to achieve compliance with the requirements of NFA rules, including Compliance Rules 2-10 and 2-29. These supervisory procedures: must require prior review and approval of a website, social media page or forum used in connection with the commodity interest business of a Member by an appropriate supervisor and must ensure that each substantive change to or new version of such a website, social media page or other internet-based forum is reviewed and approved prior to its first use. Supervisory procedures should also prohibit or describe how the Member will supervise any features that cannot be reviewed in advance (e.g., a streaming script containing real-time market news). Finally, Members must periodically evaluate and, when necessary, modify their review procedures for website, social media and internet-based forums to ensure that they remain effective and must retain all required records, including records of prior versions and supervisory reviews and approvals.

Unless the website, social media page or internet-based forum limits access to a particular target audience, through a login mechanism or other means, the Member's review procedures should take into consideration the fact that the content is available to the public. Personal websites, social media pages or other internet-based forums of Associates, employees or agents that are used in connection with their commodity interest activities constitute promotional material of the Member and must be covered by the Member's supervisory program. Consequently, the Member's procedures must be adequate to enable it to properly review its Associates', employees' and agents' websites, social media pages and other internet-based forums, including all substantive modifications, according to its procedures. Additionally, to ensure compliance with the recordkeeping requirements, the firm's procedures should provide the means to identify the time frame in which particular versions of the website, social media page or other internet-based forum are in use. Finally, Members must periodically evaluate and modify as necessary their review procedures to ensure their effectiveness.

If a Member or Associate maintains a website, a presence on social media sites or hosts a blog, a chat room or other forum where commodity interests are discussed, the Member firm must supervise the use of that site, page or forum, including supervising comments or posts made by participants that are not affiliated with the Member. At a minimum, the Member or Associate must regularly monitor the content of the sites, pages or forums it hosts, promptly take down any post that violates NFA rules (e.g., a deceptive, misleading or fraudulent post) and ban users for egregious or repeat violations. Not only are these actions required by NFA’s supervision rules, they are both common sense and standard practice.

If a Member solicits leads through another party's website, social media or other forum, the Member will be responsible for supervising the content of such platforms and will be subject to an NFA disciplinary action for any content that violates NFA rules. Likewise, a Member may be subject to an NFA disciplinary action if it knows or should know that a non-Member or Member firm maintains a website, social media page or other internet-based forum with deceptive or misleading information related to commodity interests that links to the Member's website, social media page or other internet-based forum and the Member fails to take corrective action.

The fact that a Member creates a hyperlink from its website, social media page or internet-based forum to another website, social media page or internet-based forum does not, in and of itself, make the Member firm accountable for the content of the other site, page or forum. Member firms should bear in mind, though, that their supervisory obligations under Rule 2-9 and Rule 2-29 require them to diligently supervise their employees and agents who are responsible for creating and maintaining the web sites, social media pages or internet-based forums including hyperlinks. Members' supervisory procedures should include periodic inquiries as to whether their employees and agents are monitoring the general content of the website, social media page or internet-based forum to which the Member links. NFA is not suggesting that firms are necessarily responsible for a virtually infinite chain of links. At the same time, Members who seek to circumvent NFA promotional material and supervision rules by using a chain of hyperlinks to a "remote" website, social media page or internet-based forum may be held accountable for the content of that site, page or forum.

Electronic Communications

An FCM, IB, CPO or CTA Member's duty to supervise the use of commodity interest-related electronic communications, including e-mails, instant messages, text messages and messages sent through social media, by its employees and agents is basically the same as its duty to supervise other forms of correspondence. NFA expects each Member to adopt review procedures that are appropriate in light of its business activities, including the structure, size and nature of its business operations. Like other supervisory procedures, a Member's supervisory procedures with respect to electronic communications must:

  • be in writing;
  • identify by title or position the person responsible for conducting the review;
  • specify how and with what frequency electronic communications will be reviewed and how that review will be documented;
  • categorize the type of electronic communications that will be pre-reviewed or post-reviewed; and
  • specify how electronic communications will be maintained and made available upon request by NFA and the CFTC.

Each Member is free to adopt the specific procedures that it will use to conduct its review. However, those procedures must take into consideration the nature of the communication, the relative sophistication of the recipient and the training and background of the employees and agents. In some instances, spot-checking, sampling, or using automated tools or key word searches to identify potentially problematic electronic communications between Associates, employees or agents and customers, may be appropriate and in others it may not. For example, a firm dealing with sophisticated or institutional customers might choose to implement an automated review, key word search or sample a relatively small but representative amount of the routine electronic communications. On the other hand, firms dealing with individual, retail customers might choose to use an automated review, key word search and review a larger sample of or even all electronic communications. Similarly, a firm may wish to conduct a comprehensive review of employees' and agents' electronic communications if they have a disciplinary history involving problems with customers or were employed by or associated with a firm that has been disciplined for fraud or sales practice violations.

Members' procedures should also address whether employees and agents are permitted to use electronic communication systems other than the firm's system. If a firm permits them to use other systems for business purposes, whether on their work or home computer, the firm's procedures must treat these off-system electronic communications as its own records and must ensure that the firm is capable of adequately retaining, reviewing and supervising these records. Given the supervisory problems that could arise, some firms may choose not to permit their employees and agents to communicate with the public outside of work through an electronic communication system that is not linked to the firm's network. A Member should implement supervisory procedures that are reasonably designed to ensure that its personnel are not using unauthorized electronic communications systems to conduct business on behalf of the Member.

In many instances electronic communications may constitute promotional material. Electronic communications directed to the public soliciting business constitutes advertising and is subject to the same rules as any other form of promotional material. For example, an e-mail message sent to targeted individuals or groups would be considered promotional material if its ultimate purpose was to solicit funds or orders. A Member's electronic communication review procedures must be designed to ensure compliance with NFA's promotional material content and review requirements. These requirements, found in NFA Compliance Rule 2-29, provide, among other things, for prior review of this type of electronic communication by appropriate supervisory personnel. Additionally, this type of electronic communication is subject to the specific recordkeeping requirements of Compliance Rule 2-29.

Members should properly educate and train their employees and agents on the firm's policies regarding electronic communications - particularly on those communications that are not reviewed by supervisory personnel prior to use. Special attention should be given to those employees and agents with previous compliance or disciplinary problems. Finally, Members must periodically evaluate the effectiveness of their electronic communications review procedures and modify them as necessary.

Recordkeeping

Pursuant to NFA Compliance Rule 2-10, FCM, IB, CPO and CTA Members must maintain certain books and records related to the conduct of their commodity interest business. Members are reminded that the content of electronic communication, and not the type of device or technology used to transmit the communication, determines whether the communication is subject to recordkeeping requirements. Furthermore, Members must train their Associates, employees and agents to ensure that they understand and comply with applicable record retention requirements.

9038 - NFA COMPLIANCE RULES 2-29: HIGH PRESSURE SALES TACTICS

(Staff, June 19, 1996; revised January 1, 2020)

INTERPRETIVE NOTICE

NFA Compliance Rule 2-29 governs FCM, IB, CPO and CTA Members' communications with the public and is one of the most important NFA rules in ensuring that Members observe high ethical standards in their dealings with customers. NFA Compliance Rule 2-29(a)(2) prohibits the use of high-pressure sales practices. The rule itself does not define "high-pressure sales practices." However, NFA has taken a number of disciplinary actions related to high-pressure sales practices, and those cases provide guidance to Members on the types of practices that have been found to constitute high-pressure sales practices.

A common thread in many of the disciplinary actions involving high-pressure sales practices is a sense of undue urgency conveyed to the customer by an AP. In essence, the AP is asking the customer to act now and think later. The purpose of NFA's rule is to ensure that the customer makes a fully informed and carefully considered investment decision. Any tactic, such as those outlined below, that pressures a customer for a hasty decision will be considered a violation of NFA Compliance Rule 2-29(a)(2).

Over the years, NFA has observed an undue sense of urgency conveyed through many different high-pressure tactics. In some cases, the AP rushes the customer through the account opening forms, glossing over the risk disclosure in his or her haste to open the account. In other cases, APs have inundated a customer with multiple communications designed to provide a sense of urgency to open an account to avoid missing out on predicted market movements. APs have also used electronic communications with bolded, capitalized or highlighted text or subject lines in an attempt to convey false urgency to a customer.

These high-pressure sales practices have been enhanced by rapidly changing technology, including smartphones with multiple communication applications, easily accessible online account forms, the use of electronic signatures and the electronic transfer of funds. Members must be aware of the changes to technology and new technology that could be used by APs to pressure customers into investing or entering into trades in violation of NFA rules.

High-pressure sales practices could also involve a pattern of telephone calls, emails, instant messages and/or text messages, which are unusual in their timing or frequency. For example, an AP may barrage a customer with calls, emails, instant messages and/or text messages at all hours of the day, including late at night, early in the morning and during weekends. Alternatively, an AP's solicitations to open an account may occur several times a day, several days a week for weeks on end. Any solicitation designed to abuse, annoy or harass a customer into opening an account, including soliciting customers at unusual hours and with unusual frequency may constitute a high-pressure approach in violation of NFA Compliance Rule 2-29.

Perhaps the most obvious indicator of a high-pressure sales practice is simply the tone used by the AP to address the customer. In a handful of cases, APs have shouted at customers, used profane language or otherwise berated the customer in an attempt to bully the customer into opening an account. Such conduct clearly violates NFA rules.

This notice cannot and is not intended to alert Members to all of the factors that may constitute a high-pressure approach. Each of the factors highlighted above, however, has frequently been present in the high-pressure sales cases brought by NFA, and Members should certainly be vigilant in preventing and detecting such practices in their own operations.

9039 - NFA COMPLIANCE RULES 2-29 AND 2-9: NFA'S REVIEW AND APPROVAL OF CERTAIN AUDIO AND VIDEO ADVERTISEMENTS

(Board of Directors, March 28, 2000; revised January 1, 2020)

INTERPRETIVE NOTICE

NFA Compliance Rule 2-29 governs communications between FCM, IB, CPO and CTA Members and the public. Among other things, the rule prohibits the use of promotional material that is misleading or deceptive. The purpose of this rule is to protect the public from fraudulent advertising and sales solicitations and to provide guidance to Members on the standards by which their promotional material will be evaluated.

NFA's Board of Directors ("Board") previously issued guidance establishing specific requirements for certain radio and television advertisements. Emerging technologies and innovations, including internet broadcasts, various forms of social media and downloadable audio or video content, have led to a wide range of audio and video forums beyond traditional radio and television that allow Members to reach a broad and, in some cases, targeted audience. Since these technologies may also be used to disseminate deceptive or misleading content, the Board has, as described below, amended Compliance Rule 2-29(h) to apply to all promotional materials and public advertisements that use audio or video content.

Although the content and method of delivery may vary, many problematic audio and video advertisements have a consistent theme, which is that customers are likely to make substantial profits by following the sponsoring firm's recommendations. These advertisements hurt both customers naïve enough to believe the claims and the reputation of the industry. The Board is especially concerned where FCM, IB, CPO or CTA Members are making trade recommendations or touting the profitability of past or future trading performance. Some FCM, IB, CPO or CTA Members have taken advantage of audio and video forums to distribute advertisements that are misleading or deceptive. For example, FCM, IB, CPO or CTA Members have used audio or video advertisements that have intentionally omitted required risk disclosures and material information required to put the content of the advertisement in the proper context.

NFA Compliance Rule 2-29(h) requires any FCM, IB, CPO or CTA Member firm using or directly benefiting from any promotional material or public advertisement that uses audio or video content to make any specific trading recommendation or refer to or describe the extent of any profit obtained in the past or that can be achieved in the future to submit the advertisement to NFA's Promotional Material Review Team for its review and approval at least 10 days prior to first use. If additional information is needed, or the review cannot be completed within the 10-day period, the Member will be so notified. Obviously, NFA staff will not be able to independently verify the accuracy of every statement made in an advertisement within the 10-day review period; that responsibility remains with the Member. Therefore, submitting promotional material to NFA will not preclude NFA from raising compliance issues with the content of the promotional material or instituting a disciplinary action if misstatements, omissions of material fact or other violations of NFA rules are subsequently identified.

The Board has directed staff to be particularly vigilant in reviewing audio and video advertisements containing specific trading recommendations and/or a description of past or future profits. In fact, the Board finds the content of certain advertisements to be inherently misleading and has further directed staff to disapprove of their usage. Typically, these advertisements include one or more of the practices outlined in Interpretive Notice 9033 – NFA Compliance Rule 2-29: Deceptive Advertising, which describes a variety of problematic practices.

It is important to note that the list of deceptive advertising techniques described in NFA's Interpretive Notice 9033 – NFA Compliance Rule 2-29: Deceptive Advertising, is not all inclusive. Any practice that presents a distorted and misleading view of the likelihood of customers earning dramatic profits by investing with the Member, represents a clear violation of NFA's sales practice rules.

Finally, one additional issue relating to advertising occurs when a Member benefits from the use of a "blind ad." Specifically, some Members attempt to evade NFA's advertising requirements by purchasing leads from non-Members that run misleading audio and video advertisements basically identical to those prosecuted by NFA's BCC. These ads do not identify any particular Member firm and invite the viewer to call a toll-free number or subscribe online to obtain more information. The non-Member then sells the resulting leads to a Member firm, which then claims that it has no responsibility for the content of the advertisement. Members cannot evade their supervisory responsibilities by buying leads from such firms.

NFA Compliance Rule 2-9 requires each Member to diligently supervise its employees and agents in the conduct of their commodity interest activities. The CFTC has brought cases against companies that run "blind ads" and has alleged that they are, in fact, soliciting orders and are required to be registered as IBs. In addition to a Member's responsibilities under NFA Bylaw 1101, the Board believes that Member firms have a supervisory duty to ensure, to the extent possible, that their employees and agents are not purchasing leads from non-Members required to be registered and/or using fraudulent advertising practices.

In many instances, a Member firm will have direct knowledge of the source of leads that the Member purchases. For example, the Member firm purchases leads from a provider that generates leads solely incidental to some other business purpose (e.g., a subscription list). However, in the event a Member firm does not have direct knowledge, then the Member firm has a duty to inquire as to the source of leads. Specifically, under those circumstances, a Member firm has an affirmative duty to determine if the leads were generated from a provider using any type of advertisement soliciting investments in commodity interests, one of whose business purposes is the generation and sale of the leads. If a Member firm purchases leads from such a provider, then the Member must ensure, prior to soliciting any customer with the leads that the advertisement utilized by the lead provider complies with NFA Compliance Rule 2-29. If the advertisement does not comply with the requirement outlined by this rule, then the Member is not permitted to solicit any customer with the leads purchased from that provider.

9040 - RESERVED

9041 - OBLIGATIONS TO CUSTOMERS AND OTHER MARKET PARTICIPANTS

Board of Directors, August 21, 2001; revised September 10, 2001)
 
INTERPRETIVE NOTICE

The Commodity Futures Modernization Act of 2000 (CFMA), which was signed into law on December 21, 2000, lifts the 18-year ban on single-stock futures and narrow-based security indices ("security futures products"). Unlike other futures contracts, however, the CFMA provides that security futures products are securities as well as futures. Therefore, under Section 15A(k) of the Securities Exchange Act of 1934 (Exchange Act), NFA is a national securities association (NSA) for the limited purpose of regulating the activities of Members who are registered as brokers or dealers in security futures products under Section 15(b)(11) of the Exchange Act (i.e., FCMs and IBs who "passport" in to broker-dealer registration because they limit their securities activities to security futures products).

Since NFA is a registered futures association, the Commodity Exchange Act requires it to have rules designed to promote fair dealing with customers and other market participants for all futures contracts, including security futures.1 Since NFA is a limited purpose NSA, the Exchange Act also requires it to have rules that are designed to promote fair dealing for security futures products.2 All of NFA's rules apply to activities involving security futures products. However, certain additional requirements apply to activities in security futures products by Members registered as broker-dealers under Section 15(b)(11) of the Exchange Act and their Associates.

NFA Compliance Rule 2-4 requires all 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. This includes a requirement to deal fairly with customers and other market participants at all times. This interpretive notice reminds all Members and Associates of their obligation not to trade ahead of customer orders in any commodity. It also discusses those fair dealing obligations that are unique to security futures products.

Trading Ahead of Customer Orders

CFTC Regulations 155.3 and 155.4 — which are incorporated into NFA rules through Compliance Rule 2-26 — require FCMs and IBs to establish and enforce internal rules, procedures, and controls to insure, to the extent possible, that those firms and their employees do not trade ahead of customer orders that are executable at or near the market price. Literally read, those regulations require procedures but do not contain an outright prohibition on trading ahead. However, knowingly trading ahead of customer orders in any commodity violates NFA Compliance Rule 2-4, which requires Members and Associates to observe high standards and just and equitable principles of trade.

Further, Compliance Rule 2-4 also requires Members and Associates to exercise due care to avoid trading ahead of customer orders. Members and Associates will be considered to be exercising due care if they do not know or should not reasonably have known of the customer order. For example, absent knowledge, a Member will not be held accountable for trading ahead of customer orders that originate in a different branch office or for proprietary orders that originate in a trading department that does not have access to information regarding customer orders.

Trading Based on Material, Non-Public Information

Other than trading ahead, the Commodity Exchange Act, CFTC regulations, and NFA and exchange rules do not generally prohibit trading futures based on material, non-public information.3 The securities laws, on the other hand, generally do prohibit this conduct. As required by the CFMA, NFA Compliance Rule 2-37(a) prohibits Members registered as broker-dealers under Section 15(b)(11) of the Exchange Act and their Associates from violating Sections 9(a), 9(b) and 10(b) of the Exchange Act and the regulations thereunder in connection with security futures products. Insider trading and other forms of trading based on material, non-public information that are violations of SEC Rule 10b-5 would also be violations of NFA Compliance Rule 2-37(a).4

Members registered as broker-dealers under Section 15(b)(11) of the Exchange Act and their Associates may not purposefully establish, increase, decrease, or liquidate a position in any security futures product in anticipation of the issuance of a research report regarding the underlying security or a derivative based primarily upon the underlying security (including the security futures product itself). Members should consider developing and implementing firewalls to isolate specific information within research and other relevant departments of the firm so as to prevent the trading department from utilizing the advance knowledge of the issuance of the research report. Firms that choose not to develop these firewalls bear the burden of demonstrating that the change in position was not done in anticipation of the issuance of the report.

Block Orders

It shall be considered conduct inconsistent with just and equitable principles of trade for a Member registered as a broker-dealer under Section 15(b)(11) of the Exchange Act or an AP of such a Member, acting for an account in which such Member or AP has an interest, for an account with respect to which such Member or AP exercises investment discretion, or for certain customer accounts, to cause to be executed:

    (a) an order to buy or sell a security futures product when such Member or AP causing such order to be executed has material, non-public market information concerning an imminent block transaction in the underlying security, or when the customer has been provided such material non-public market information by the Member or AP; or
    (b) an order to buy or sell an underlying security when such Member or AP causing such order to be executed has material, non-public market information concerning an imminent block transaction in a security futures product overlying that security, or when the customer has been provided such material, non-public market information by the Member or AP;

prior to the time information concerning the block transaction has been reported to the exchange.5

The violative practice noted above may include transactions which are executed based upon knowledge of less than all of the terms of the block transaction, so long as there is knowledge that all of the material terms of the transaction have been or will be agreed upon imminently. A Member will not, however, violate this requirement if it has exercised due care to avoid trading on that information and the individual or individuals causing the order to be executed do not know and should not reasonably have known about the imminent block transaction.

The general prohibitions stated above shall not apply to transactions executed by member participants in automatic execution systems in those instances where participants must accept automatic executions. These prohibitions also do not include situations in which a Member or AP receives a customer's order of block size relating to both security futures product and the underlying security. In such cases, the Member and AP may position the other side of one or both components of the order. However, in these instances, the Member and AP would not be able to cover any resulting proprietary position(s) by entering an offsetting order until information concerning the block transaction involved has been reported to the exchange.

Additionally, a contract market or derivatives transaction execution facility may have a specific rule that permits block transactions that are privately negotiated. Pursuant to these rules, a block transaction must be reported to a designated exchange official and/or the exchange's clearing house within a specified time period after execution of the block transaction. During this time period after execution but prior to reporting, Member firms that are a party to the block transaction have a legitimate need to hedge their own risk exposure. Therefore, the general prohibitions stated above shall not apply to transactions executed by Member firms if done in conjunction with hedging the Member firm's own risk in a block transaction executed under the applicable rules of a contract market or derivatives transaction execution facility.

A transaction involving 10,000 shares or more of an underlying security or security futures product covering such number of shares is generally deemed to be a block transaction, although a transaction of less than 10,000 shares could be considered a block transaction in appropriate cases. A block transaction that has been agreed upon does not lose its identity as such by arranging for partial executions of the full transaction in portions which themselves are not of block size if the execution of the full transaction may have a material impact on the market. In this situation, the requirement that information concerning the block transaction be reported to the exchange will not be satisfied until the entire block transaction has been completed and reported to the exchange.

Communications with the Public

Under NFA Compliance Rules 2-4 and 2-29(a)(1), all communications with the public regarding security futures products must be based on principles of fair dealing and good faith and no material fact or qualification may be omitted if the omission, in the light of the context of the material presented, would cause the communication to be misleading. Furthermore, Members registered under Section 15(b)(11) of the Exchange Act and their Associates should provide a sound basis for evaluating the facts regarding any particular security futures product, including facts regarding the underlying security, industry, or group of securities.

1See Section 17(b)(7) of the Commodity Exchange Act (7 U.S.C. 21(b)(7)).

2See Section 15A(k)(2)(B) of the Securities Exchange Act of 1934 (15 U.S.C. 78o-3(k)(2)(B)).

3CFTC Regulation 1.59 prohibits self-regulatory organization board and committee members from using or disclosing material, non-public information obtained as part of their service on the board or committee. Depending on the circumstances, Members and Associates may also violate a fiduciary obligation by trading on material, non-public information obtained from their customers or employer or making use of information that the Member or Associate knows was wrongfully disclosed.

4Although Compliance Rule 2-37(a) applies only to Members registered as broker-dealers under Section 15(b)(11) of the Exchange Act and their Associates, all Members and Associates are subject to the securities laws in connection with their security futures activities. Violating any law that applies to a Member or Associate's futures business — including securities laws that apply to security futures activities — is conduct inconsistent with just and equitable principles of trade under NFA Compliance Rule 2-4.

5Commodity pool operators and commodity trading advisors who engage in similar conduct would violate NFA Compliance Rule 2-4 if they abuse their fiduciary relationship with pool participants or clients.

9042 - COMPLIANCE RULE 2-9: SPECIAL SUPERVISORY REQUIREMENTS FOR MEMBERS REGISTERED AS BROKER-DEALERS UNDER SECTION 15(b)(11) OF THE SECURITIES EXCHANGE ACT OF 1934

(Board of Directors, August 21, 2001; revised December 17, 2007; September 15, 2017 and January 1, 2020)

INTERPRETIVE NOTICE

The Commodity Futures Modernization Act of 2000 (CFMA), which was signed into law on December 21, 2000, lifts the 18-year ban on single-stock futures and narrow-based security indices ("security futures products"). Unlike other futures contracts, however, the CFMA provides that security futures products are securities as well as futures. Therefore, under Section 15A(k) of the Securities Exchange Act of 1934 (Exchange Act), NFA is a national securities association (NSA) for the limited purpose of regulating the activities of Members who are registered as brokers or dealers in security futures products under Section 15(b)(11) of the Exchange Act (i.e., FCMs and IBs who "passport" in to broker-dealer registration because they limit their securities activities to security futures products).

NFA Compliance Rule 2-9 places a continuing responsibility on every Member to diligently supervise its employees and agents in all aspects of their futures business. Compliance Rule 2-9 and the interpretive notices issued under Compliance Rule 2-9 apply to activities involving security futures products just as they do to all other futures-related activities. When regulating the securities futures activities of Members registered as broker-dealers under Section 15(b)(11) of the Exchange Act, however, Section 15A(k)(2)(B) of the Exchange Act requires NFA to impose requirements reasonably comparable to those of national securities associations registered under Section 15A(a) of the Exchange Act. This notice describes special supervisory requirements for those Members.1

A Member's security futures activities must be supervised by a designated security futures principal who meets the requirements of NFA Compliance Rule 2-7. A Member must also have one or more designated security futures principals at each main or branch office that solicits or accepts accounts or orders for or recommends or engages in transactions in security futures products on behalf of customers. The Member must have clear lines of supervision that assign each registered individual engaged in security futures activities to a particular designated security futures principal.

Members must develop and implement specific written procedures concerning the manner of supervision of customer accounts that trade security futures products and specifically providing for frequent supervisory review of those accounts. Within a reasonable time, Members must amend their procedures to incorporate applicable changes in the futures and securities laws and regulations and NFA requirements as well as changes in their supervisory systems. Each designated security futures principal shall be responsible for reviewing and enforcing the procedures and taking or recommending to senior management appropriate action reasonably designed to achieve the Member's compliance with the applicable futures and securities laws and regulations and with NFA requirements.

Each main or branch office that solicits or accepts accounts or orders or recommends or engages in transactions in security futures products - and each office that supervises these activities - must keep and maintain a current copy of the Member's written supervisory procedures governing these activities. Members must communicate all changes in the procedures to the appropriate offices.

Discretionary Accounts

Under Compliance Rule 2-8(b), a security futures principal must regularly review discretionary security futures trading activity and must make a written record of that review. A security futures principal must also consider the discretionary nature of the account when approving the account to trade security futures and must comply with the requirements of the interpretive notice entitled "Compliance Rule 2-9: Supervision of Branch Offices and Guaranteed IBs" (9019) regarding account activity and discretionary accounts.

Promotional Material and Correspondence

FCM, IB, CPO and CTA Members must comply with Interpretive Notice 9037 – NFA Compliance Rules: 2-9, 2-10, 2-29, 2-36 and 2-39: Guidance on the Use and Supervision of Websites, Social Media and Other Electronic Communications for security futures products. E-mails are not the only type of security futures correspondence that must be reviewed, however. Both incoming and outgoing correspondence must be reviewed, and the designated security futures principal must make a record of the review, including noting who conducted the review. The review must include steps to ensure that all correspondence is retained and that the names of the persons who prepared outgoing correspondence are ascertainable from the retained record.

Members must adopt review procedures that are appropriate in light of their business activities, including the structure, size, and nature of their business operations. In establishing criteria for review of correspondence, the procedures must take into consideration the nature of the communication, the relative sophistication of the customer and the training and background of the Member's employees or the employees of its guaranteed IBs. In some instances, spot-checking or sampling correspondence may be appropriate and in others it may not. For example, a firm dealing with sophisticated or institutional customers might choose to sample a relatively small but representative amount of correspondence, while firms dealing with individual, relatively unsophisticated retail customers must use a larger sample or even review all outgoing correspondence. Similarly, if any employee or employee of a guaranteed IB has a disciplinary history involving problems with customers or was previously employed at a firm that has been disciplined for fraud, then the firm must have a heightened level of scrutiny regarding that employee's correspondence.

In many instances outgoing correspondence may constitute promotional material. Correspondence directed to the public soliciting business constitutes promotional material and is subject to the same rules as any other form of promotional material. For example, a letter or e-mail message sent to targeted individuals or groups is promotional material if its ultimate purpose is to solicit funds or orders. Therefore, a Member's correspondence review procedures must also be designed to ensure compliance with NFA's promotional material content and review requirements.

Where the firm's procedures for the review of correspondence do not require review of all outgoing correspondence prior to its use or distribution, Members must educate and train their employees on the firm's policies regarding correspondence with the public. Special attention should be given to those employees with previous compliance or disciplinary problems.

Account Approval

Under NFA Compliance Rule 2-30(j)(1), accounts that trade security futures products must be approved in writing for that activity by the designated security futures principal. The Member must adopt and enforce specific written procedures regarding the approval process that include at least the following:

  • Specific criteria and standards to be used in evaluating the suitability of a customer to engage in security futures transactions;
  • Specific procedures for approving accounts to engage in security futures transactions, including requiring written approval by a designated security futures principal;
  • A requirement that the designated security futures principal explain, in writing, why he or she has approved an account that does not meet the specific criteria and standards set forth in the procedures; and
  • Specific financial requirements for initial approval and maintenance of customer accounts that engage in security futures transactions.

Compliance with Securities Laws

Compliance Rule 2-37(b) provides that Members must establish, maintain, and enforce written procedures reasonably designed to achieve compliance with applicable securities laws, including Sections 9(a), 9(b), and 10(b) of the Exchange Act and any applicable regulation thereunder. Again, these procedures must be approved, in writing, by a designated security futures principal.

Use and Disclosure of the Member's Name

Members must have supervisory procedures reasonably designed to ensure that the public understands who they are doing business with. It is conduct inconsistent with just and equitable principles of trade, and therefore a violation of NFA Compliance Rule 2-4, for Members and Associates to use misleading names or to fail to disclose their affiliation when dealing with the public. Similarly, Members and their Associates may not refer to another entity or individual in any manner that implies an affiliation that does not exist. Furthermore, CFTC Regulation 166.4 requires branch offices to use the name of the firm for all purposes and to hold itself out to the public under that name, and Appendix A to Part 3 of the CFTC's rules states that a person's registration can be denied, revoked, or conditioned under Section 8a(3)(M) of the Commodity Exchange Act if the person uses a misleading name. Members are, however, allowed to use non-misleading "doing business as" names if those names are reported to NFA on Form 7-R or an update to Form 7-R.

The use of misleading names, affiliations, and qualifications is a violation of Compliance Rule 2-29(a)(1) and (b)(1). For example, if reference is made to membership in any organization (e.g., NFA, SIPC, an exchange), it should be clear which entity belongs to that organization. Similarly, Members and Associates may not state or imply that any individual has any degree or designation that does not exist or is self-conferred, nor may they use bona fide degrees or designations in a misleading manner. Therefore, the Member's supervisory procedures should be reasonably designed to ensure that neither the Member nor its employees use misleading names, affiliations, or qualifications in connection with their security futures activities.

Supervision of Branch Offices and Guaranteed IBs

As with other futures activities, Members must supervise each branch office and guaranteed IB that solicits or accepts accounts or orders for or recommends or engages in transactions in security futures products. A designated security futures principal must approve, in writing, and enforce written procedures that include all of the review steps discussed in the interpretive notice entitled "Compliance Rule 2-9: Supervision of Branch Offices and Guaranteed IBs" (9019). The review must be conducted under the supervision of a designated security futures principal and must include annual (or more frequent) on-site reviews of each branch office and guaranteed IB that solicits or accepts accounts or orders for or recommends or engages in transactions in security futures products.

Hiring Employees and Entering Into Guarantee Agreements

An adequate program for supervision must include thorough screening procedures for prospective employees who will be involved in commodity futures activities. In regard to prospective employees who may be involved in activities regarding security futures products and who have been registered in the securities industry, this screening process must include a check of the Central Registration Depository (CRD) for any derogatory information on the employee and his or her employer.2 The screening does not have to be done by a designated security futures principal. The designated security futures principal must, however, regularly review hiring practices to ensure that the screening process is taking place and to otherwise ensure that qualified personnel are investigating the good character, business repute, qualifications, and experience of employees who may be involved in security futures activities. Furthermore, all relevant information must be considered in making the hiring decision and determining how much supervision the employee will require.

A Member must obtain and review a copy of the most recent Form 8-T or U-5 (including any amendments) filed by a new employee's most recent security or futures employer if the employee will be involved in registered activities regarding security futures products. The Member shall obtain the Form 8-T or U-5 (including any amendments) no later than sixty days after the individual files an application for registration as an associated person (AP) of the Member under the Commodity Exchange Act. A Member that does not obtain the information within 60 days has the burden of demonstrating that it has made a reasonable effort by attempting to obtain the information both from NFA and FINRA (through the CRD), as applicable, and from the employee. If the Form 8-T or U-5 includes any derogatory information, the employer shall take such action as it deems appropriate.

The procedures must also require the employee to provide a copy of the Form 8-T or U-5 (and any amendments) to the Member within two business days after the Member requests it or, if the former employer did not provide a copy of the Form 8-T or U-5 to the employee, the employee shall promptly request a copy from the former employer (or from NFA or FINRA if the former employer cannot or will not provide it), and must provide the Form 8-T or U-5 to the Member within two business days after receiving it. The procedures must also require the employee to promptly provide the Member with any subsequent amendments to the Form 8-T or U-5.3

Guarantor FCMs must also do a due diligence inquiry before entering into a guarantee agreement. If the IB may be involved in activities regarding security futures products, the prospective guarantor must check the CRD for any derogatory information on the IB, its principals, and its employees. Again, all relevant information must be considered when deciding whether to guarantee an IB and determining how much supervision a guaranteed IB will require.

Meetings with Associated Persons

Each employee registered as an associated person under the Commodity Exchange Act and engaging in security futures activities must participate, no less than once a year, in an individual interview or group meeting, conducted by persons designated by the Member, at which compliance matters relevant to the associated person's security futures activities are discussed. The interview or meeting may include other matters and may occur at a central or regional location or at the associated person's place of business.

1 This notice does not change the general supervisory responsibilities that Compliance Rule 2-9 imposes on other NFA Members.

2If the prospective employer does not have direct access to the CRD, it can obtain the information from the Financial Industry Regulatory Authority (FINRA) using FINRA's public disclosure program. FINRA's public disclosure program can be accessed through its web site at www.finra.org.

3It is conduct inconsistent with just and equitable principles of trade, and therefore a violation of Compliance Rule 2-4, for an Associate to violate written procedures that are required by NFA, the CFTC, or the SEC.

9043 - NFA COMPLIANCE RULE 2-29: USE OF PAST OR PROJECTED PERFORMANCE; DISCLOSING CONFLICTS OF INTEREST FOR SECURITY FUTURES PRODUCTS

(Board of Directors, August 21, 2001 and January 1, 2020)

INTERPRETIVE NOTICE

The Commodity Futures Modernization Act of 2000 (CFMA), which was signed into law on December 21, 2000, lifts the 18-year ban on single-stock futures and narrow-based security indices ("security futures products"). Unlike other futures contracts, however, the CFMA provides that security futures products are securities as well as futures. Therefore, under Section 15A(k) of the Securities Exchange Act of 1934 (Exchange Act), NFA is a national securities association (NSA) for the limited purpose of regulating the activities of Members who are registered as brokers or dealers in security futures products under Section 15(b)(11) of the Exchange Act (i.e., FCMs and IBs who "passport" in to broker-dealer registration because they limit their securities activities to security futures products).

NFA Compliance Rule 2-29 imposes high standards on Members' and Associates' communications with the public in connection with any of their futures activities. When regulating the securities futures activities of Members registered as broker-dealers under Section 15(b)(11) of the Exchange Act, however, Section 15A(k)(2)(B) of the Exchange Act requires NFA to impose sales practice and promotional material requirements reasonably comparable to those of national securities associations registered under Section 15A(a) of the Exchange Act. In light of those requirements, this notice reiterates some of the requirements that apply to all products and describes some of the additional requirements imposed by new section (j) of Compliance Rule 2-29. Section (j) applies to the security futures activities of those Members who are registered as broker-dealers under Section 15(b)(11) of the Exchange Act and their Associates. Sections (a)-(i) apply to all Members.

The requirements described in this interpretation are in addition to — and do not in any way limit or amend — any other requirements imposed by NFA rules, including those discussed in other interpretations issued by the Board of Directors.

Use of Misleading Statements

NFA Compliance Rule 2-29(b)(1) prohibits FCM, IB, CPO and CTA Members from using promotional material that is likely to deceive the public. Additionally, NFA Compliance Rule 2-29(b)(2) prohibits FCM, IB, CPO and CTA Members from using promotional material which contains any material misstatement of fact or which the Member or Associate knows omits a fact which causes the material to be misleading. NFA has always considered the following items to be violations of these Rules:

  • Promotional material that uses outdated information to support current claims;1
  • Promotional material that makes claims regarding research or other facilities beyond those which the Member or Associate actually possesses or has reasonable capacity to provide.2
  • Promotional material that makes any statement to the effect that any report, analysis, or other service will be furnished free or without any charge unless such report, analysis or other service actually is or will be furnished entirely free and without condition or obligation.3

Use of Past or Projected Performance

NFA Compliance Rule 2-29 places certain limitations on the use of past or projected performance in communications with the public. Some of those limitations — most of which apply to all futures contracts regardless of the underlying commodity — are discussed in this section.

Provided that the performance is representative of all reasonably comparable accounts, most promotional material may discuss past performance of actual or recommended transactions if it meets a number of standards.

  • Performance must be presented in a balanced manner. (See NFA Compliance Rule 2-29(b)(2) and (b)(5).
  • The promotional material must disclose all relevant costs, including commissions and fees. (See NFA Compliance Rule 2-29(b)(2).)
  • Any discussion of the performance of recommended transactions must comply with NFA Compliance Rule 2-29(b) and (c).
  • For security futures products, the promotional material must indicate the general market conditions during the period covered. (See NFA Compliance Rule 2-29(b)(1) and (2).
  • Performance information used by FCMs, IBs, and their Associates must include the date of each initial recommendation or transaction; the price at that date; and the date and price at the end of the period or when liquidation was suggested or effected, whichever was earlier. If a summary is used, it must be calculated in a manner consistent with CFTC Regulation 4.25 and NFA Compliance Rule 2-34. (See NFA Compliance Rule 2-29(b)(2) and (5).
  • Performance information used by FCMs, IBs, and their Associates must also be current, meaning that it must cover at least the most recent 12-month period or must include the performance in its entirety if less than 12 months. The Member or Associate must disclose more than the last 12 months of performance if the last 12 months is not representative, and the Member or Associate may not include gaps or otherwise cherry-pick the periods for which it discloses performance. (See NFA Compliance Rule 2-29(b)(1) and (2).
  • The Member or Associate must keep records showing how it calculated the performance numbers used in the promotional material. These records must identify the trades and accounts that were used in calculating performance, describe how and why those transactions and accounts were selected, and demonstrate how the results are representative of all reasonably comparable accounts. (See NFA Compliance Rule 2-29(f).
  • A person who is authorized to approve the promotional material must determine that the performance information is accurate and is presented in a manner that is not misleading. (See NFA Compliance Rules 2-9(a) and 2-29(e).)

Promotional material that discusses projected performance must also meet a number of standards.

  • The promotional material must disclose, and the projected performance must be adjusted for, all relevant costs, including commissions and fees. (See NFA Compliance Rule 2-29(b)(2).
  • The projected performance must have a reasonable basis in fact. (See NFA Compliance Rule 2-29(d).)
  • All material assumptions made in projecting performance must be clearly identified. (See NFA Compliance Rule 2-29(b)(2).
  • The risks must be discussed and balanced with the discussion of projected profits. (See NFA Compliance Rule 2-29(b)(3).)

Annual rates of return may not be used in any promotional material unless they are based on 12 consecutive months of actual performance, and they must be calculated in a manner consistent with CFTC Regulation 4.25. (See NFA Compliance Rule 2-29(b)(5).) Furthermore, the promotional material must state that past results are not necessarily indicative of future results. (See NFA Compliance Rule 2-29(b)(4).)

NFA Compliance Rule 2-29(j) imposes additional restrictions on promotional material of Members registered as broker-dealers under Section 15(b)(11) of the Exchange Act and their Associates if the promotional material specifically refers to security futures products. Where the promotional material is accompanied or preceded by the disclosure statement for security futures products, references to past recommendations must include all of the information described in Compliance Rule 2-29(j)(9), and references to current recommendations must include instructions on how to obtain that information. However, promotional material for these products may not contain any discussion of past or projected performance unless accompanied or preceded by the disclosure statement for security futures products. This means that most forms of mass media advertising cannot discuss past or projected performance.

Research reports for underlying securities are not promotional material under NFA Compliance Rule 2-29 merely because the customers who receive the reports may trade security futures products in those securities. Compliance Rule 2-29 does, however, cover any research report that mentions security futures products or discusses any strategy that includes using security futures products.

Disclosing Conflicts of Interest in Security Futures Products by Members Registered as Broker-Dealers Under Section 15(b)(11) of the Exchange Act

Due to the nature of the securities markets, Members may have special conflicts of interest that may not necessarily be known to their customers. NFA Compliance Rule 2-29(j)(11) - which applies to Members registered as broker-dealers under Section 15(b)(11) of the Exchange Act - provides that promotional material that makes a recommendation regarding security futures products must disclose material conflicts of interest that the Member may have due to its activities in the underlying security. In particular, the promotional material must disclose any of the following conflicts, if applicable:

  • The Member and/or its officers or partners own options, rights, or warrants to purchase any of the securities of the issuer whose securities underlie the security futures product being recommended, unless the ownership is nominal; and
  • Within the last three years, the Member was manager or co-manager of a public offering of any securities of the issuer whose securities underlie the security futures product being recommended.

1 See, In the Matter of MBH Commodity Advisors, Inc., NFA Case No. 96-BCC-015 (Hearing Panel, May 5, 1998), aff'd, NFA Case No. 98-APP-001 (App. Comm., Feb. 19, 1999); aff'd, CFTC Docket No. CRAA 99-3 (CFTC, Mar. 31, 2000), aff'd, MBH Commodity Advisors, Inc. v. Commodity Futures Trading Commission, No. 00-1957, 7th Cir., May 7, 2001.

2See, In re Universal Commodity Corporation, NFA Case No. 95-BCC-20 (Hearing Panel, Feb. 3, 1998), aff'd, In re Parks, NFA Case Nos. 98-APP-1, 98-APP-2, and 98-APP-3 (App. Comm., Mar. 14, 2000); In re JCC, Inc., NFA Case No. 90-BCC-30 (Aug. 25, 1992); aff'd, NFA Case Nos. 92-APP-2 through 92-APP-8 (App. Comm., July 19, 1993); aff'd, CFTC Docket No. CRAA 93-6 (CFTC, June 29, 1994).

3 See, In re Filler Zaner & Associates, NFA Case No. 89-BCC-32 (BCC, Nov. 30, 1989).

9044 - NFA COMPLIANCE RULE 2-4: BROKER-DEALER REGISTRATION REQUIREMENTS FOR SECURITY FUTURES PRODUCTS

(Board of Directors, April 16, 2002)

INTERPRETIVE NOTICE

The Commodity Futures Modernization Act of 2000 (CFMA), which was signed into law on December 21, 2000, amended the Commodity Exchange Act (CEA) to lift the ban on single-stock futures and narrow-based security indices ("security futures products"). Under the CFMA, security futures products are securities as well as futures and, therefore, trading in these products is subject to regulatory schemes in both the futures and securities industries, including registration requirements. As a result, NFA Member FCMs and IBs that solicit or accept orders or carry accounts for security futures products are also required to be registered as broker-dealers under the Securities Exchange Act of 1934 (Exchange Act). NFA Member FCMs and IBs that are not fully registered broker-dealers may fulfill the broker-dealer registration requirement through notice registration by filing Form BD-N with NFA.

NFA Compliance Rule 2-4 requires all 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. This includes the requirement that Members abide by all applicable state and federal laws and regulations governing their commodity futures business, including security futures products. It is a violation of NFA Compliance Rule 2-4 for an NFA Member FCM or IB to solicit or accept orders, carry accounts, or otherwise act as a broker-dealer for security futures products unless the Member is properly registered either as a full broker-dealer under Section 15(b)(1) or as a notice registered broker-dealer under Section 15(b)(11) of the Exchange Act.

9045 - NFA COMPLIANCE RULE 2-9: FCM AND IB ANTI-MONEY LAUNDERING PROGRAM

(Board of Directors, April 23, 2002; revised November 16, 2006; January 15, 2008; March 28, 2008; January 3, 2012; August 27, 2013; July 30, 2018; June 16, 2020 and October 19, 2022)

INTERPRETIVE NOTICE

The International Money Laundering Abatement and Anti-Terrorist Financing Act of 2001 ("Title III"),1 which was signed into law on October 26, 2001, imposed significant new anti-money laundering requirements on all "financial institutions," as so defined under the Bank Secrecy Act (BSA),2 including FCMs.3 In particular, Section 352 of Title III and NFA Compliance Rule 2-9(c) requires all financial institutions to establish anti-money laundering (AML) programs which, at a minimum, must include internal policies, procedures and controls; a designated compliance officer to oversee day-to-day operations of the program; an ongoing training program for employees; and an independent audit function to test the program. Additionally, regulations adopted by FinCEN under the BSA require an FCM's and IB's AML program to have appropriate risk-based procedures for conducting ongoing customer due diligence (May 11, 2016 regulation), including, but not limited to: i) understanding the nature and purpose of customer relationships for the purpose of developing a customer risk profile; and ii) conducting ongoing monitoring to identify and report suspicious transactions and, on a risk basis, to maintain and update customer information. For purposes of the May 11, 2016 regulation, customer information includes information regarding the beneficial owners of legal entity customers. 4

NFA's Board of Directors adopted NFA Compliance Rule 2-9(c) to impose these requirements on NFA Member FCMs and IBs.5 NFA recognizes, of course, that the exact form of program adopted by a Member will vary based on a Member's type of business, the size and complexity of its operations, the breadth and scope of its customer base, the number of firm employees, its risks and vulnerabilities to money-laundering and the firm's resources. Nevertheless, the Board believes that certain minimum standards must be a part of any adequate program. The purpose of this interpretive notice (Notice) is to highlight those minimum standards and provide Members with additional guidance on satisfying the requirements of Compliance Rule 2-9(c). Members must be aware, however, that the laws in this area are changing rapidly and that they need to conduct a regular review of their anti-money laundering program to ensure that the program is in compliance with any subsequent changes to the federal law or NFA Rules.

Many of the procedures discussed in the Notice are practices that firms may already employ in their businesses. FCMs should also have procedures in place related to deposits of cash or cash-like instruments and procedures to obtain identifying information on customers. FCMs and IBs should use their existing programs and procedures as the building blocks for their anti-money laundering compliance programs. Moreover, FCMs and IBs that are registered as broker-dealers under the federal securities laws are subject to similar anti-money laundering requirements. In most cases, programs that comply with requirements applicable to the securities industry will comply with the requirements of this Notice.

Money laundering occurs when funds from an unlawful activity are moved through the financial system in such a way as to make it appear that the funds have come from legitimate sources. Money laundering usually follows three stages. First, cash or cash equivalents are placed into the financial system. Second, the money is transferred or moved to other accounts (e.g. futures accounts) through a series of financial transactions designed to obscure the origin of the money (e.g. executing trades with little or no financial risk or transferring account balances to other accounts). Finally, the funds are reintroduced into the economy so that the funds appear to have come from legitimate sources (e.g. closing a futures account and transferring the funds to a bank account). Trading accounts that are carried by FCMs are one vehicle that can be used to launder illicit funds. In particular, a trading account could be used to execute financial transactions that help obscure the origin of the funds. FCMs and IBs need to be aware of potential money laundering abuses that could occur in a customer account and implement a compliance program to, among other things, deter, detect and report potentially suspicious activity.

DEVELOPING POLICIES, PROCEDURES AND INTERNAL CONTROLS

The starting point for an FCM and IB is to adopt a policy statement that clearly outlines the firm's policy against money laundering and its commitment to follow all applicable laws and regulations to ensure that its business is not used to facilitate money laundering or the financing of terrorist activities. The policy statement should also make clear that all employees of the firm have a responsibility to follow the firm's written anti-money laundering procedures and controls, and to abide by all applicable laws and regulations involving anti-money laundering programs and terrorist financing. The policy statement also should discuss the consequences of not following these procedures. The firm's procedures and controls should enable appropriate personnel to form a reasonable belief that they know the true identity of each customer; recognize suspicious customers and transactions; and require personnel to report suspicious or unusual activity to appropriate supervisory personnel, including senior management, and to FinCEN when appropriate. The firm's procedures and controls should also ensure that the firm maintains an adequate audit trail to assist law enforcement agencies in any investigation. The key components of these policies, procedures and controls are discussed below.

A. Customer Identification Program

As part of its AML program, each FCM and IB Member must adopt a written customer identification program (CIP)6 that meets the requirements of the BSA.7 For purposes of the CIP requirements, a customer includes individuals or entities opening new accounts8 as of October 1, 2003. FCMs and IBs do not have to apply the CIP requirements to existing customers9 opening additional accounts provided the FCM or IB has a reasonable belief that it knows the true identity of the customer.10 FCMs and IBs should consider the following guidelines when determining whether it is required to apply its CIP requirements:

  • For an omnibus account where an intermediary is the account holder, the FCM should treat the intermediary as the customer and the FCM does not have to apply its CIP requirements to the underlying beneficiaries.  See FIN-2006-G004, Frequently Asked Question Regarding Customer Identification Programs for Futures Commission Merchants and Introducing Brokers (31 CFR 103.123), February 14, 2006.

  • If an intermediary opens an account in the name of a collective investment vehicle such as a commodity pool, the FCM or IB is not required to identify and verify the pool's underlying participants.

  • In a give-up arrangement, the clearing FCM, not an FCM acting solely as an executing broker, is required to apply its CIP to the customer. See FIN-2007-G001, Application of the Customer Identification Program Rule to Futures Commission Merchants Operating as Executing and Clearing Brokers in Give-Up Arrangements, April 20, 2007.

As discussed more fully below, the CIP must include the following elements:

  • Required Identifying Information and Identity Verification Procedures

  • Recordkeeping Procedures

  • Comparison with Government List Procedures

  • Customer Notice Procedures

  • Reliance on Other Financial Institutions Procedures (if applicable)

Required Identifying Information and Identity Verification Procedures - These procedures should be designed to enable the FCM or IB to form a reasonable belief that it knows the true identity of each customer. In designing the procedures, the FCM or IB should consider the various types of accounts it maintains, the various account opening methods it uses, the various types of identifying information available and the firm's size, location and customer base.

Each CIP must specify the identifying information the FCM or IB will require from each customer. Although the type of identifying information a firm may require will vary based on, among other things, the nature of the firm's business and the type of customer, all firms must obtain certain minimum information prior to opening an account. For all customers, a firm must obtain the customer's name. For an individual, the firm must obtain the customer's date of birth and a residential or business address11 and for non-natural persons, the customer's principal place of business, local office or other physical location. For a U.S. person, a firm must obtain the customer's social security number or taxpayer identification number (TIN). For a non-U.S. person, the firm must obtain one or more of the following: a TIN, a passport number and country of issuance, an alien identification card number, or the number and country of issuance of any other government-issued document evidencing nationality or residence and bearing a photograph or similar safeguard. For a non-U.S., non-natural person, the firm must obtain a government issued identification number.12 A firm may also choose to include procedures that provide for an exception for a person who has applied for a TIN. The CIP must include procedures to confirm that the application was filed before the customer opens the account and to obtain the TIN within a reasonable period of time after the account is opened.

The CIP must also include risk-based procedures to verify the identity of each customer to the extent reasonable and practicable. Verification may occur within a reasonable time before or after the customer's account is opened.13 Accounts may be verified using documentary methods, non-documentary methods or a combination of both. The CIP, however, must describe under what circumstances the firm will use each of these methods. In addition, the CIP must identify situations where the firm will require additional verification based on the FCM's or IB's risk assessment of the new account.

Each firm's CIP should identify the documents that will be used for documentary verification. These documents may vary from firm to firm based on the firm's own risk-based analysis of the types of documents that it believes will enable it to verify customer identity. A firm is encouraged, however, to obtain more than one type of documentary verification to ensure that it has a reasonable belief that it knows its customer's true identity. Documents that would be appropriate for verification include, for an individual, an unexpired government-issued identification that evidences nationality or residence and bears a photograph or similar safeguard (e. g. driver's license or passport); and for a non-individual (e.g. corporation, partnership or trust), documents that show the existence of the entity, such as certified articles of incorporation, a government issued business license, a partnership agreement or a trust instrument. In most instances, once an FCM or IB verifies the identity of a customer through documentary evidence, the FCM or IB does not have to determine whether the document is valid. However, if the document shows an obvious indication of fraud, then the FCM or IB must determine whether the document is sufficient for the firm to form a reasonable belief that it knows the customer's true identity.

In some situations, it may be appropriate to use non-documentary methods in addition to or in lieu of documentary methods. For example, a firm may want to use non-documentary methods in addition to documentary methods when a firm is not familiar with the documentary evidence provided. Non-documentary methods in lieu of documentary methods may be appropriate when the account is opened over the Internet or telephone. If a firm will rely on non-documentary methods, the firm's CIP must describe the non-documentary methods that will be used. These procedures must address situations where an individual is unable to present an unexpired government issued identification document that bears a photograph or similar safeguard; the FCM or IB is not familiar with the documents presented; the account is opened without obtaining documents; the customer opens the account without appearing in person; or where the FCM or IB is otherwise presented with circumstances that increase the risk that the FCM or IB will be unable to verify the identity of a customer through documents. Appropriate non-documentary methods include contacting a customer; independently verifying the customer's identity through the comparison of information provided by the customer with information obtained from a consumer reporting agency, public database or other source; checking references with other financial institutions; or obtaining a financial statement. A firm may also want to examine whether there is a logical consistency between the customer's name, street address, ZIP code, telephone number, date of birth and social security number.

A firm's procedures should also include a mechanism to identify potentially high-risk accounts in the account opening process. Although attempts to launder money or finance terrorism can come from numerous sources, FCMs and IBs should be aware that certain types of entities or entities or individuals from certain geographic locations may pose a greater risk. FCMs and IBs should consult the Financial Action Task Force's (FATF) public statements of jurisdictions with strategic anti-money laundering and combating the financing of terrorism deficiencies (AML/CFT)14 to determine whether a customer is from one of those jurisdictions. If the customer is from one of the jurisdictions identified as having AML/CFT deficiencies, the FCM or IB should determine what, if any additional due diligence is necessary in deciding whether to open the account, and if the account is accepted, what if any additional monitoring of the account activity is appropriate.

Accounts opened in the name of a corporation, partnership or trust that is created or conducts substantial business in a jurisdiction that has been designated by Treasury as a primary money laundering concern or has been designated as having AML/CFT deficiencies by FATF may pose additional risks. An FCM's and IB's CIP must also include additional procedures that address under what circumstances the firm will require, for a customer that is not an individual, information about individuals with authority or control over the account in order to verify the customer's identity. These procedures would be used only in situations where the FCM or IB is unable to adequately verify the customer's identity after using documentary and non-documentary methods.

Finally, there may be situations where an FCM or IB cannot form a reasonable belief that it knows the true identity of the customer. The firm's CIP must include procedures for handling this situation. At a minimum, these procedures should address: (1) when an account should not be opened; (2) the terms under which a customer may conduct transactions while the FCM or IB attempts to verify the customer's identity; (3) when an account should be closed after attempts to verify a customer's identity have failed; and (4) when the FCM or IB should file a Suspicious Activity Report (SAR) in accordance with applicable law and regulation.15

Recordkeeping Procedures - The firm's CIP must also describe the firm's recordkeeping policies regarding information and documents obtained during the identification and verification process. At a minimum, the CIP must require that a record be kept for: (1) all identifying information obtained from a customer; (2) either a copy or a description of any document that was relied on to verify identity, noting the type of document, any identification number contained in the document, the place of issuance, and if any, the date of issuance and expiration date; (3) a description of the non-documentary verification methods or additional verification methods used and the results; and (4) a description of the resolution of each substantive discrepancy discovered when verifying the identifying information obtained. Although firms are required to keep a record of the identifying information, they do not have to maintain copies of the documents used to verify identity. However, if a firm elects to maintain copies of documents, then the copies themselves may serve as records of the identifying information that was relied upon to verify a customer's identity.

The CIP should also outline the firm's procedure for retaining records. FCMs and IBs must maintain a record of the identifying information collected from a customer for five years after the account is closed, and records of the description of the documents used to verify identity, description of the non-documentary methods or additional verification methods used and the results, and the resolution of any discrepancies for five years after the record is made.

Comparison with Government Lists Procedures - The firm's CIP must also include procedures for determining whether a customer appears on any list of known or suspected terrorists or terrorist organizations issued by any Federal government agency and designated as such by Treasury in consultation with the Federal functional regulators. The firm's procedures must require the FCM or IB to make this determination within a reasonable period of time after the account is opened or earlier if required by another Federal law or regulation or Federal directive issued in connection with the applicable list. The CIP must also require the FCM or IB to follow all Federal directives issued in connection with such lists. No lists have yet been designated under the CIP rules.16

Customer Notice Procedures - An FCM's and IB's CIP must also include procedures that require the firm to provide customers with adequate notice that the firm is requesting information to verify their identity. An adequate notice describes the identification requirements of the final rule and provides notice in a manner reasonably designed to ensure that a customer is able to view the notice, or is otherwise given notice, before opening the account. For example, depending on how an account is opened, notice could be provided by the firm posting notice in its office lobby or on its website, including the notice on its account application or using other forms of oral or written notice.17

Reliance on Other Financial Institutions' Procedures - An FCM or IB may share a customer relationship with one or more financial institutions. For example, in the FCM/IB relationship, although the customer is a customer of both the FCM and IB, the IB often has primary contact with the customer. This type of relationship may give rise to circumstances where it would be appropriate for an FCM or IB to reasonably rely on the customer identification and verification procedures of another financial institution that has an account or similar relationship with the customer. If an FCM or IB intends to reasonably rely on another financial institution, it must specify in its CIP when the firm will satisfy its obligations by relying upon another financial institution (including an affiliate).

An FCM or IB may rely on another financial institution if: (1) the reliance is reasonable under the circumstances; (2) the other financial institution is subject to an AML compliance program requirement under the BSA and is regulated by a Federal functional regulator;18 and (3) the other financial institution enters into a contract requiring it to certify annually to the FCM or IB that it has implemented an AML program and that it will perform (or its agent will perform) the specified requirements of the FCM's or IB's own CIP. If the FCM or IB meets these requirements, it will not be held responsible for the failure of the other financial institution to adequately fulfill the FCM's or IB's CIP obligations.

An FCM or IB may also delegate some or all CIP implementation to a third party service provider or an agent. In those instances, the FCM or IB should have a written agreement with the other entity outlining the other entity's responsibilities. Under these circumstances, however, the FCM or IB remains solely responsible for assuring compliance with the CIP requirements. As a result, if an FCM or IB delegates any of its CIP responsibilities, it should actively monitor the delegation, assure that the procedures are being conducted in an effective manner and ensure that NFA and other appropriate regulatory bodies are able to obtain information and records relating to the CIP.

B. Identifying and Verifying Beneficial Owners

Each FCM's and IB's AML Program must include written procedures that are reasonably designed to identify and verify beneficial owners of legal entity customers19 for which a new account20 is opened on or after May 11, 2018. A beneficial owner means:  (1) each individual, if any, who directly or indirectly, through any contract, arrangement, understanding, relationship, or otherwise, owns 25% or more of the equity interests of a legal entity customer; and (2) a single individual with significant responsibility to control, manage or direct a legal entity customer, including an executive officer or senior manager or any other individual who regulary performs similar functions.21 Although the number of beneficial owners for each legal entity customer may vary, each FCM and IB is required to identify at least one beneficial owner under the control prong. An FCM or IB is not precluded from identifying additional individuals as part of its customer due diligence.

Required Identification and Verification Procedures – Each FCM's and IB's written procedures must require the firm to identify the beneficial owner(s) by obtaining certain required information from the natural person opening the account on behalf of the legal entity customer, along with the natural person's certification regarding the accuracy of the information provided.22 The information required includes the name and title of the person opening the account and the name and address of the legal entity for which the account is being opened. Additionally, for each beneficial owner, the FCM or IB must obtain the person's name (and title for beneficial owners under the control prong), date of birth, address and social security number (for U.S. persons) or passport number and country of issuance or other similar identification (for foreign persons).

An FCM or IB must also develop written risk-based procedures that allow it to verify the identity of the beneficial owner that, at a minimum, contain the same elements as it employs for verifying the identity of customers under its CIP procedures, including procedures that address situations in which the FCM or IB cannot form a reasonable belief that it knows the true identity of the beneficial owner. Unlike the CIP requirements, however, in the case of documentary verification, the firm may use photocopies or other reproductions of documents. An FCM and IB may rely on the information provided by the legal entity customer regarding its beneficial owners, provided the firm has no knowledge of facts that would reasonably call into question the reliability of that information.

Recordkeeping Procedures – FCMs and IBs must establish procedures for making and maintaining a record of all information obtained during the identification and verification of beneficial owners. At a minimum, these procedures must require that a record be kept for: (1) for identification, all identifying information obtained from a customer, including without limitation the certification (if obtained); (2) for verification, (i) a description of any document relied on (noting the type, any identification number, place of issuance and expiration); (ii) a description of any non-documentary verification methods or additional verification methods used and the results of any measures undertaken; and (iii) a description of the resolution of each substantive discrepancy discovered when verifying the identifying information obtained. All records used for identification purposes must be maintained for five years after the date the account is closed and all records made for verification purposes must be maintained for five years after the record is made.

Reliance on Other Financial Institutions' Procedures – An FCM or IB may share a customer relationship with one or more financial institutions. For example, in the FCM/IB relationship, although the customer is a customer of both the FCM or IB, the IB often has primary contact with the customer. This type of relationship may give rise to circumstances where it would be appropriate for an FCM or IB to reasonably rely on the beneficial ownership procedures of another financial institution that has an account or similar relationship with the customer. If an FCM or IB intends to reasonably rely on another financial institution, it must specify in its beneficial ownership procedures when the firm will satisfy its obligations by relying upon another financial institution (including an affiliate).

An FCM or IB may rely on another financial institution to carry out its obligation to identify and verify beneficial owners of legal entity customers if: (1) the reliance is reasonable under the circumstances; (2) the other financial institution is subject to an AML compliance program requirement under the BSA and is regulated by a Federal functional regulator;23 (3) the other financial institution enters into a contract requiring it to certify annually to the FCM or IB that it has implemented an AML program and that it will perform (or its agent will perform) the specified requirements of its obligation to identify and verify the beneficial owner of legal entity customers. If the FCM or IB meets these requirements, it will not be held responsible for failure of the other financial institution to adequately fulfill the FCM's or IB's obligations.

C. Ongoing CDD and Detection and Reporting of Suspicious Activity

Another essential component of an effective anti-money laundering compliance program is a set of systems and procedures designed to detect and report suspicious activity. As with most components of a firm's compliance program, the manner in which a firm monitors for suspicious activity will vary based on the firm's size and the nature of its business.

For some firms, appropriate manual monitoring of transactions in excess of a certain dollar amount may constitute acceptable review for suspicious transactions, while other firms may need to implement an automated monitoring process. Although in some instances the carrying FCM may be in the best position to monitor accounts for suspicious transactions, an FCM or IB that is involved in the account opening process or the order flow process should be alert to suspicious transactions and, where appropriate, refuse to open an account or accept a suspicious order and report such suspicious activity to the carrying FCM and FinCEN where required.

Examples of suspicious transactions are those that have no business or apparent lawful purpose, are unusual for the customer, or lack any reasonable explanation. As discussed above, recognizing suspicious transactions requires familiarity with the firm's customers, including the customer's business practices, trading activity and patterns. What constitutes a suspicious transaction will vary depending on factors such as the identity of the customer and the nature of the particular transaction.

Since suspicious transactions may occur at the time an account is opened or at any time throughout the life of an account, FCMs and IBs must train appropriate staff to identify suspicious behavior during the account opening process and monitor cash activity and trading activity in order to detect unusual transactions. Identifying suspicious activity may prove difficult and often requires subjective evaluation because the activity may be consistent with lawful transactions.

One area that firms should give heightened scrutiny is wire transfer activity. Monitoring of this area should include review of unusual wire transfers, including those that involve an unexpected or extensive number of transfers by a particular customer during a particular period and transfers involving certain countries identified as high risk or having AML/CFT deficiencies.24

Firms should provide employees with examples of behavior or activity that should raise a "red flag" and cause further inquiry. These "red flags" may alert employees to possible suspicious activity. Some examples of "red flags" that could cause further investigation include:25

  • A customer exhibits an unusual level of concern for secrecy, particularly with regard to the customer's identity, type of business or source of assets;

  • A corporate customer lacks general knowledge of its own industry;

  • A customer is unconcerned with risks, commissions or other costs associated with trading;

  • A customer appears to be acting as an agent for another entity or individual but is evasive about the identity of the other entity or individual (except situations involving the identity of ownership interests in a collective investment vehicle);

  • A customer is from, or has accounts in a country identified as, a haven for bank secrecy, money laundering or narcotics production;

  • A customer engages in extensive, sudden or unexplained wire activity (especially wire transfers involving countries with bank secrecy laws);26

  • A customer engages in transactions involving more than $5,000 in currency or cash equivalents (in one transaction or a series of transactions in one or more days and in any number of accounts); and27

  • A customer makes a funds deposit followed by a request that the money be wired out or transferred to a third party, or to another firm, without any apparent business purpose.

Monitoring accounts for suspicious activities is a fruitless activity without timely and effective follow-up and investigative procedures. Although the internal structure for reporting suspicious activities will vary from firm to firm, each firm's compliance program must require employees to promptly notify identified firm personnel of any potential suspicious activity. Appropriate supervisory personnel must evaluate the activity and decide whether the activity warrants reporting to FinCEN. In making this determination, an IB should consult with its carrying FCM.28

For transactions occurring after May 18, 2004, FCMs and IBs29 are required30 to file form SAR31 with FinCEN to report suspicious transactions that are conducted, or attempted by, at, or through an FCM or IB, involve an aggregate of at least $5,000 in funds or other assets (not limited to currency), and the FCM or IB knows, suspects or has reason to suspect that the transaction or pattern of transactions:

  • Involves funds that come from illegal activity or is intended or conducted in order to hide or disguise funds or assets derived from illegal activity (including, without limitation, the ownership, nature, source, location, or control of such funds or assets) as part of a plan to violate or evade any Federal law or regulation or to avoid any transaction reporting requirement under Federal law or regulation;

  • Is designed, whether through structuring or any other means, to evade any requirements of 31 CFR Chapter X or any other regulations under the BSA;

  • Has no business or apparent lawful purpose or is not the sort in which the particular customer would normally be expected to engage, and the FCM or IB knows of no reasonable explanation for the transaction after examining the available facts, including the background and possible purpose of the transaction; or

  • Involves the use of the FCM or IB to facilitate a criminal activity.32

FCMs and IBs must file a SAR within 30 days after the date of the initial detection by the firm of facts that may constitute the basis for reporting the suspicious transaction. However, if the identity of the suspect involved is unknown on the date the firm first becomes aware of the initial detection, the firm may delay filing up to an additional 30 days in order to identify the suspect. A copy of the SAR and all supporting documentation must be maintained for five years from the date the SAR was filed.

FCMs and IBs must develop appropriate risk-based CDD procedures for conducting ongoing CDD to include, but not limited to: (1) understanding the nature and purpose of customer relationships for purposes of developing a customer risk profile;33 and (2) conducting ongoing monitoring to identify and report suspicious transactions, and on a risk basis, to maintain and update customer information, including information regarding the beneficial owner of a legal entity customer. An FCM or IB is not expected to update customer information on a continuous basis. Rather a firm should update customer information when it detects information relevant to assessing the risk of a customer relationship during the course of the firm's normal monitoring.

FCMs and IBs are prohibited from disclosing that a SAR was filed, or any information that would reveal the existence of a SAR to the person involved in the transaction, as well as any other persons except as specifically authorized by 31 CFR 1026.32. Firms should develop additional risk based measures to help ensure the confidentiality of SARs, including limiting access to a "need-to-know" basis, establishing restricted areas for reviewing SARs, maintaining a log of access to SARs, using cover sheets for SARS or supporting documentation that indicates the filing of a SAR, or using electronic notices that highlight confidentiality concerns before a person may access or disseminate the information. Firms should also consider including information on SAR confidentiality and the penalties associated with unauthorized disclosure in its ongoing training of employees.

FCMs and IBs are not required to file form SAR for activity related to a robbery or burglary, provided the activity is reported to the appropriate law enforcement agency. FCMs and IBs are also relieved of the filing requirement for a violation of the Commodity Exchange Act, CFTC Regulations, Exchange or NFA rules that is otherwise required to be reported under the Commodity Exchange Act, CFTC regulations, Exchange or NFA rules committed by the FCM/IB or any of its officers, directors, employees or associated persons, provided that the activity is properly reported to the appropriate regulatory authority. If this activity also involves a violation of the BSA, a firm must file the form SAR with FinCEN regardless of whether it has reported the activity to the CFTC or other appropriate regulator. If more than one FCM and/or IB is involved in a particular situation, firms may satisfy the filing requirement by filing one form, provided that the form contains all relevant information. The two firms involved in the transaction may consult with each other and share information, including the SAR itself, to enable the firms to file a single report.34

Although the BSA and the implementing regulations prohibit an FCM or IB from sharing both the SAR itself or any information which would reveal the existence of a SAR,35 firms may share a SAR with parent entities, both domestic and foreign, for the purpose of the parent entity fulfilling its oversight responsibilities with respect to enterprise-wide risk management and compliance with applicable laws and regulations. FCMs and IBs, however, must have written confidentiality agreements or other arrangements in place specifying that the parent entity (or entities) must protect the confidentiality of the SARs through appropriate internal controls. In addition, FCMs and IBs may also share a SAR, or any information that might reveal the existence of a SAR, with an affiliate, provided the affiliate is subject to a SAR regulation issued by FinCEN or another regulatory agency.36 However, the affiliate may not share the existence of that SAR, or any information that would reveal the existence of that SAR, with another affiliate, even if that affiliate is subject to a SAR rule. Futhermore, the FCM or IB, as part of its internal controls, must have policies and procedures in place which ensure that its affiliates protect the confidentiality of the SAR.

In the event an FCM or IB receives a request from an authorized law enforcement agency to keep an open account that has suspicious activity, FinCEN recommends that the firm ask for a written request from the law enforcement agency. This request should be issued by a supervisory agent or by an attorney within a United States Attorney's Office or another office of the Department of Justice. If the request is made by a state or local law enforcement agency, the request should be from a supervisor of the state or local law enforcement or from an attorney within a state or local prosecutor's office. The request should indicate that the agency requested that the financial institution maintain the account and the purpose of the request. The request should also indicate the duration of the request, not to exceed six months (law enforcement may issue a subsequent request for a longer duration). FinCEN also recommends that the FCM or IB maintain the request for five years after the request has expired.

In guidance issued in this area, note that, ultimately, the decision to maintain or close an account should be made by a financial institution in accordance with its own standards and guidelines. Although there is no requirement that a financial institution maintain a particular account relationship, financial institutions should be mindful that complying with such a request may further law enforcement efforts to combat money laundering, terrorist financing, and other crimes.

D. Section 314(a) Information Requests37

FCM Members are also required to develop procedures to access and respond to FinCEN's 314(a) subject lists that are published bi-weekly on FinCEN's Secure Information Sharing System website.38 These lists identify individuals, entities or organizations that are suspected by various law enforcement agencies of engaging in money laundering or terrorist financing. FCMs are required to access FinCEN's Secure Information Sharing System to obtain the most recent lists and search their records for any current accounts and accounts maintained by a named subject during the preceding 12 months and for transactions not linked to an account conducted by a named subject during the preceding 6 months. FinCEN sends notification to designated contacts within financial institutions across the country once every 2 weeks informing them new information has been made available. FCMs must report any matches to FinCEN through the web based system within the required time-frames (generally within 14 days of the lists being posted on the secure web-site). For matches involving an introduced account, FCMs should inform FinCEN or the appropriate law enforcement agency that the match involves an introduced account (and identify the IB) during any follow up conducted by FinCEN or the law enforcement agency. FCMs are not required to respond to FinCEN if no matches are found. FCMs must ensure that FinCEN's requests are kept confidential. FCMs and IBs are not expected to search beneficial ownership information when responding to a 3.14(a) information request.

FCMs should maintain the following records to verify that they are complying with 314(a) request requirements: a record of the date of the request, the tracking numbers within the request, and the date the request was searched; and for positive matches, the date the match was reported to FinCEN. FCMs should also maintain information concerning the identified accounts and transactions in a positive match in a manner that can be easily accessed when requested by law enforcement.

FCMs are required to designate a point of contact (POC) person(s) for matters involving 314(a) and provide NFA with that information. Any changes to POC information must be immediately reported to NFA.

E. Section 312 Private Banking and Foreign Correspondent Accounts

FCMs and IBs are also required to establish due diligence programs for correspondent accounts established or maintained for foreign financial institutions (correspondent account rule) and private banking accounts established or maintained for non-U.S. persons (private banking rule).38

Correspondent Account Rule - As part of its anti-money laundering program, FCMs and IBs must establish a due diligence program that includes appropriate, specific, risk based, and where necessary, enhanced policies, procedures and controls that are reasonably designed to enable the FCM/IB to detect and report, on an ongoing basis, any known or suspected money laundering activity conducted through or involving any correspondent account39 established, maintained, administered or managed by the FCM or IB in the United States for a foreign financial institution. However, an IB that only solicits or accepts orders for the purchase or sale of commodity futures contracts does not establish, maintain or administer a correspondent account for the foreign financial institution and therefore is not subject to the requirements of Section 312 (including the enhanced due diligence requirements for certain foreign banks described below) with respect to correspondent accounts. To the extent an IB performs additional services for the account, the IB may be administering or managing the correspondent account and would be subject to Section 312. Similarly, for give-up transactions involving correspondent accounts, the carrying FCM, and not the executing FCM, is subject to compliance with the due diligence provisions of the correspondent account rule.40

In assessing the risk presented by a correspondent account, FCM and IBs should consider a number of factors, as appropriate. These factors include: (1) the nature of the foreign financial institution's business and the markets it serves; (2) the type, purpose and anticipated activity of the correspondent account; (3) the nature and duration of the FCM's or IB's relationship with the foreign financial institution (and any of its affiliates); (4) the anti-money laundering and supervisory regime of the jurisdiction in which the foreign financial institution is chartered or licensed and, to the extent reasonably available, of the jurisdiction in which any company that is an owner of the foreign financial institution is incorporated or chartered; and (5) information known or reasonably available to the FCM or IB about the foreign financial institution's anti-money laundering record.41 The due diligence program should also require the FCM or IB to conduct a periodic review of the activity in the correspondent account.

FCMs and IBs42 are required to apply enhanced due diligence measures to correspondent accounts maintained for a foreign bank operating under an offshore banking license, under a license issued by a country designated as being non-cooperative with international money laundering principles by FATF (and the U.S. concurs with the designation),43 or under a license issued by a country that has been designated by the Secretary of Treasury as a primary money laundering concern and as warranting special measures under Section 311. At a minimum, these measures must include taking reasonable steps to (1) conduct risk-based enhanced scrutiny of correspondent accounts established or maintained for this type of foreign bank to guard against money laundering and to identify and report suspicious activity, (2) determine whether any such foreign bank maintains correspondent accounts for other foreign banks that enable those other foreign banks to gain access to the foreign bank's correspondent account with the FCM or IB, and if so, to take reasonable steps to obtain information to assess and mitigate the money laundering risks associated with such accounts, and (3) identify the owners of the foreign bank if the bank's shares are not publicly traded, and the nature and extent of each owner's ownership interest.

Enhanced scrutiny should require the FCM or IB, (1) to obtain and consider information related to the anti-money laundering program of the foreign bank to assess the risk of money laundering presented by the bank's correspondent account in appropriate circumstances; (2) to monitor transactions to, from or through the correspondent account in a manner reasonably designed to detect money laundering and suspicious activity; and (3) to obtain information from the foreign bank about the identity of any person with authority to direct transactions through any correspondent account that is a payable-through account, and the sources and beneficial owner of the funds and other assets in the payable-through account.

An FCM/IB's due diligence program should include procedures for situations where the FCM/IB cannot perform the enhanced due diligence, including when the FCM/IB should refuse to open an account, suspend transaction activity, file a suspicious activity report or close the account.

Private Banking Rule - FCMs and IBs must also include in their AML program a due diligence program that includes policies, procedures and controls that are reasonably designed to detect and report any known or suspected money laundering or suspicious activity conducted through or involving any private banking account44 that is established, maintained, administered, or managed in the United States by the financial institution for one or more non-U.S. persons. The due diligence program should ensure that FCMs and IBs take reasonable steps to (1) ascertain the identity of all nominal and beneficial owners of a private banking account; (2) ascertain whether any owner of the account is a senior foreign political figure; (3) ascertain the source(s) of funds deposited into a private banking account and the purpose and expected use of the account; and (4) review the activity of the account to ensure that it is consistent with the information obtained about the client's source of funds and with the stated purpose and expected use of the account.45

An FCM's/IB's due diligence program must include procedures for enhanced scrutiny of a private banking account where a senior foreign political figure is a nominal or beneficial owner. This scrutiny must be reasonably designed to detect and report transactions that may involve the proceeds of foreign corruption.

An FCM's/IB's due diligence program should also include procedures for situations where the FCM/IB cannot perform appropriate due diligence with respect to a private banking account, including when the FCM/IB should refuse to open the account, suspend transaction activity, file a SAR or close the account.

F. Ongoing Compliance Responsibilities

Office of Foreign Assets Control – FCMs and IBs, like other financial institutions, also have obligations under regulations issued by the Office of Foreign Assets Control (OFAC). FCMs and IBs are currently restricted from engaging in certain transactions with individuals or entities located in countries that are under a sanction program administered by OFAC. If the customer is located in one of these countries, the FCM or IB needs to review the sanctioning document or contact OFAC to determine the breadth of the restrictions.46 FCMs and IBs are also required to block funds from individuals or entities identified on OFAC's list of Specially Designated Nationals and Blocked Persons (SDN list).47 If the customer's name appears on this list, the firm should immediately notify OFAC.48 To avoid violating the economic sanctions laws administered by OFAC, FCMs and IBs need to check the OFAC lists for new customers and also recheck their existing customer base against the lists when the lists are updated and new countries or Specially Designated Nationals and Blocked Persons are added to the lists. Otherwise FCMs and IBs risk violating the laws by engaging in prohibited transactions with persons who were not subject to sanction when they became customers, but became subject to sanctions later. FCMs and IBs should use beneficial ownership information to help ensure that they do not open or maintain an account, or otherwise engage in prohibited transactions or dealings, involving individuals or entities subject to OFAC-administered sanctions.

Section 311 Special Measures - Section 311 of the USA Patriot Act gives the Secretary of the Treasury the authority to designate a foreign jurisdiction, institution(s), class(es) of transactions, or type(s) of account(s) as a "primary money laundering concern" and to impose certain "special measures" with respect to such jurisdiction, institution(s), class(es) of transaction, or type(s) of account(s). FCMs and IBs should monitor FinCEN's website (www.fincen.gov) for information on foreign jurisdiction(s), institution(s), class(es) of transactions, or type(s) of account(s) that have been designated as a primary money laundering concern and any special measures that have been imposed.

Foreign Bank and Financial Accounts – FCMs and IBs are required to file a Report of Foreign Bank and Financial Accounts (FBAR) if they have a financial interest in, or signature authority over any financial accounts which exceed $10,000 in a foreign country at any time during the calendar year. This report must be filed with the Department of Treasury on or before June 30th of the following year.

International Transportation of Currency or Monetary Instruments – An FCM is required to file a Report of International Transportation of Currency or Monetary Instruments (CMIR) if the firm physically transports, mails or ships or causes to be physically transported, mailed or shipped an aggregate amount exceeding $10,000 at any one time from the United States to any place outside of the United States or any place into the United States from outside the United States. A CMIR must also be filed if the firm receives in the United States any currency or other monetary instrument in aggregate exceeding $10,000 at one time which has been transported, mailed or shipped from outside the United States. A CMIR does not need to be filed, however, if the FCM is a bank or broker-dealer, and the currency or other monetary instrument is mailed or shipped through the postal service or by a common carrier. CMIRs must be filed on or before the date of the shipment and must be filed within 15 days of the receipt of the currency/monetary instruments.

G. Hiring Qualified Staff

It is also important for the firm to ensure that the individuals that staff areas that are susceptible to money-laundering schemes are trained to work in these areas. A firm may also want to conduct background checks on key employees to screen employees for criminal or disciplinary histories.

H. Recordkeeping

An adequate compliance program for money laundering must also include written requirements on the types of records that should be maintained. The program also must specify where the records should be maintained and that, unless the BSA rules otherwise require, the records must be maintained in accordance with CFTC recordkeeping and record retention requirements under Regulation 1.31 (e.g., maintained for five years and be readily accessible for the first two years). The ultimate goal of the recordkeeping requirements is to provide an adequate audit trail for law enforcement officials investigating potential money laundering schemes.

DESIGNATION OF A COMPLIANCE OFFICER

NFA Compliance Rule 2-9(c) also requires that FCMs and IBs designate an individual or individuals to oversee the anti-money laundering program, including the firm's CIP. This person may be the compliance officer that is responsible for other compliance areas of the firm. Although the compliance officer need not be a designated principal or Associate Member, the person should ultimately report to the firm's senior management.

The firm must provide this compliance officer with sufficient authority and resources to effectively implement the firm's anti-money laundering program. Among other duties with respect to the firm's CIP and suspicious activity reporting, this person should

  • Receive reports of suspicious activity from firm personnel;

  • Gather all relevant business information to evaluate and investigate suspicious activity; and

  • Determine whether the activity warrants reporting to senior management, and, if authorized to do so, the firm's DSRO or FinCEN.

Obviously, the person responsible for overseeing the anti-money laundering procedures should not be the same employee responsible for the functional areas where money-laundering activity may occur.

EMPLOYEE TRAINING PROGRAM

Another important component of NFA Compliance Rule 2-9(c) is the requirement that FCM and IB Members provide ongoing education and training for all appropriate personnel. This training program should be conducted at least every 12 months and include training on the firm's policies and procedures, the relevant federal laws and NFA guidance issued in this area. Firms should also maintain records to evidence their compliance with this requirement.

INDEPENDENT AUDIT FUNCTION

NFA Compliance Rule 2-9(c) also requires that FCM and IB Members49 provide for independent testing of the adequacy of their anti-money laundering compliance programs. Most FCMs and IBs must conduct this independent testing at least every 12 months. FCMs and IBs that engage solely in proprietary trading or are inactive, however, may satisfy this requirement by conducting the independent test every two years. All firms, however, are required to test the adequacy of their AML program more frequently than the minimum requirements if circumstances warrant.

A firm may satisfy the independent testing requirement with its own personnel (such as an internal audit staff) or others who do not perform or oversee AML functions.50 In either circumstance, the audit function should test all affected areas to ensure that personnel understand and are complying with the anti-money laundering policies and procedures and that these policies and procedures are adequate. The results of any audit should be documented and reported to the firm's senior management or an internal audit committee or department, and follow up should be done to ensure that any deficiencies in the firm's anti-money laundering program are addressed and corrected.

ALLOCATION OF COMPLIANCE PROGRAM RESPONSIBILITIES51

NFA Compliance Rule 2-9(c) requires all FCMs and IBs to establish and implement anti-money laundering compliance programs. NFA recognizes, however, that given the inter-business relationships between and among some Members, the interests of business efficiency and anti-money laundering effectiveness may be best served if Members cooperate with each other in order to meet their respective obligations. Members may allocate between themselves elements of their anti-money laundering compliance programs. Any allocation agreement, however, must be clearly set forth in writing and any Member allocating anti-money laundering responsibilities to another Member must have a reasonable basis for believing that the other party is properly performing the required functions. Members should keep in mind, however, that Treasury takes the position that these allocation arrangements do not relieve an FCM or IB Member from its independent obligation to comply with anti-money laundering requirements.

CONCLUSION

Money-laundering and terrorist financing schemes in the financial services industry lessen the public's faith in the integrity of the system. Therefore, NFA Members must ensure that they take adequate steps to identify and verify the identity of their customers (and the beneficial owners of legal entity customers) and to detect, deter and report suspicious transactions that could be part of a money-laundering scheme. The guidelines set forth in this Notice should provide FCMs and IBs with the tools needed to develop an effective anti-money laundering program. Member firms should keep in mind, however, that this is an evolving area and NFA expects to provide further guidance as additional requirements in this area are imposed.

1 Pub. L. 107-56, 115 Stat. 296, 324 (2001). This Act is Title III of the Uniting and Strengthening America by Providing Appropriate Tools Required to Intercept and Obstruct Terrorism (USA PATRIOT) Act of 2001.

2 31 U.S.C. 5311 et seq. (2000). Title III amended the BSA, adding certain entities to the definition of financial institution. Regulations implementing the BSA can be found in Part 103 of Title 31 of the Code of Federal Regulations.

3 Title III also defines CPOs and CTAs as "financial institutions" under the BSA; however, the Secretary of the Treasury (Treasury) temporarily deferred application of these requirements to certain financial institutions, including CTAs and CPOs, pending further review and analysis of the money laundering risks posed by these entities. On September 26, 2002, Treasury issued a proposed regulation that would require certain unregistered investment companies to develop and implement a written anti-money laundering program. Commodity pools are included in the definition of unregistered investment companies. See 67 FR 60617 (September 26, 2002). A final rule has not been issued. In addition, on May 5, 2003, Treasury issued a proposed regulation concerning anti-money laundering programs for certain CTAs. See 68 FR 23640 (May 5, 2003). A final rule has not yet been issued. NFA will issue separate anti-money laundering program guidance for CPOs and CTAs, at such time as they become subject to the requirements of section 352.

4 See 31 CFR 1010.230 for definitions legal entity customer and beneficial owner.

5 Although IBs are not explicitly defined as "financial institutions" under the BSA, Treasury has clarified that IBs fall within the BSA's "financial institution" definition, which includes "a broker or dealer in securities or commodities." See 68 FR 25149 n.3 (May 9, 2003).

6 CFTC Interpretive Letter No. 19-18 entitled Interpretive Guidance Regarding Voice Broker Customer Identification Program and Beneficial Ownership Rule Requirements provides that voice broker IBs that negotiate/facilitate block futures and cleared swap transactions do not have customers or accounts for purposes of the CIP Rule. Accordingly, while these IBs are still required to adopt and implement an AML program, they are not required to establish and implement a CIP program or apply beneficial ownership requirements with respect to their voice broker business. These IBs are required to conduct suspicious activity reviews and comply with all other applicable NFA requirements using the information available to them.

7 See 31 U.S.C. 5318(l) and the implementing regulation jointly promulgated by Treasury and the CFTC at 31 CFR 1026.00.

8 See 31 CFR 1026.100(a) for a definition of what does and does not constitute an account.

9 For purposes of these requirements, a customer with an existing securities account with a dually registered securities broker-dealer and FCM who elects to open a futures account with the dually registered firm may be treated as an existing customer of the firm.

10 See 31 CFR 1026.100(d) for the complete definition of who is and who is not a customer. The rule specifically excludes (1) financial institutions regulated by a Federal functional regulator; (2) banks regulated by a state bank regulator; and (3) persons described in 31 CFR 1026.220 (entities such as governmental agencies and instrumentalities and the domestic operations of a publicly traded company).

11 For an individual that does not have a residential or business street address, an Army Post Office or Fleet Post Office box number, or the residential or business street address of a next of kin or another contact individual should be obtained.

12 In situations where a foreign business or enterprise does not have an identification number, an FCM or IB must request alternative government issued documentation certifying the existence of the business or enterprise.

13 A reasonable amount of time may depend on various factors such as the type of account opened, whether the customer opens the account in person, and the type of identifying information that is available. A firm may choose to place limits on an account, such as restricting the number of transactions or the dollar value of transactions, until a customer's identity is verified. See Customer Identification Program for Futures Commission Merchants and Introducing Brokers, 67 FR 48328, 48333 (July 23, 2002). A firm should also keep in mind the regulations of Treasury's Office of Foreign Assets Control (OFAC) (see 31 CFR Part 500 et.seq.) prohibiting transactions involving designated foreign countries, their nationals, and other specially designated persons. See Customer Identification Programs for Futures Commission Merchants and Introducing Brokers, 68 FR 25149, 25154 (May 9, 2003).

14 FATF is an inter-governmental body whose purpose is the development and promotion of policies, both at national and international levels, to combat money laundering, terrorist financing, and proliferation financing. Since 2007, FATF's International Co-operation Review Group analyzes high risk jurisdictions and recommends specific action to address these jurisdictions' money laundering and financial terrorism risks. These public statements can be found at http://www.fatf- gafi.org. This process replaces FATF's previous procedure of publishing a list of non- cooperative countries/territories in the fight against money laundering.

15 See Section C of this Notice for details regarding SARs.

16 Firms are required to comply with OFAC's list of blocked persons, restricted countries and specially designated nationals, for example, which can be found at www.treasury.gov/ofac. Firms should also establish policies and procedures for consulting such lists and other publicly available information as part of their anti-money laundering programs. See, e.g., In the Matter of the Federal Branch of Arab Bank PLC, No. 2005-2 at 5,7, available at https://www.fincen.gov/sites/default/files/enforcement_action/arab081705.pdf.

17 If appropriate, an FCM or IB may use the following sample language to provide notice to its customers:

    Important Information About Procedures For Opening a New Account

    To help the government fight the funding of terrorism and money laundering activities, Federal law requires all financial institutions to obtain, verify and record information that identifies each person who opens an account.

    What this means for you: When you open an account, we will ask you for your name, address, date of birth and other information that will allow us to identify you. We may also ask to see your driver's license or other identifying documents.

18 Currently, these financial institutions include banks, broker-dealers, FCMs and IBs. FCMs and IBs may rely upon these financial institutions to carry out the CIP provided that the other reliance requirements noted above are satisfied. (See CFTC No Action Letter 05-05 (March 14, 2005)).

19 See 31 CFR 1010.230(e) which defines a legal entity customer and provides the list of all entities excluded from the definition of a legal entity customer. Among others, the definition excludes registered FCMs, IBs, CPOs, CTAs, retail foreign exchange dealers, swap dealers, major swap participants and pooled investment vehicles operated or advised by these entities Therefore, FCMs and IBs are not required to obtain beneficial ownership information from accounts opened for commodity pools advised or operated by registered CPOs or CTAs.

20 Account is defined under 31 CFR 1026.100(a) and has the same meaning as it does for CIP purposes. New Account, however, means each account opened at an FCM or IB by a legal entity customer on or after May 11, 2018. Therefore, if an existing legal entity customer opens a new account, the FCM or IB must identify and verify the beneficial owners.

21 Examples of the types of positions that could qualify as controlling include chief executive officer, chief financial officer, chief operating officer, managing member, general partner, president, vice president, treasurer, or any person who regularly performs similar functions.

22 Firms may comply with this requirement by obtaining a completed FinCEN certification form (See 31 CFR 1010.230 Appendix A ) from the natural person opening the account on behalf of the legal entity customer or by obtaining the information required by FinCEN's certification form, along with the required certification as to the accuracy of the information.

23 Currently, these financial institutions include banks, broker-dealers, FCMs and IBs. FCMs and IBs may rely upon these financial institutions to carry out beneficial ownership obligations provided that the other reliance requirements noted above are satisfied.

24 See supra note 14.

25 Each firm should determine whether it needs to develop additional "red flags" based on the nature of its customers and its business.

26 Although alternative means of funding an account, such as credit cards and non-bank online remittance systems, e.g. PayPal, are not common in the futures industry, firms that accept such forms of payment should determine if their use by a customer, like suspicious wire activity, raises a "red flag" that should cause further inquiry.

27 FinCEN has added FCMs and IBs to the "financial institution" definition in the rules under the BSA, thereby making them subject to the requirement to file currency transaction reports in lieu of Form 8300, See 68 FR 65392 (November 20, 2003). FCMs and IBs are also required to comply with BSA recordkeeping and reporting requirements set forth in 31 CFR 1010.410, including the requirements regarding requests by customers for transfers and transmittals of funds in the amount of $3,000 or more.

28 FCMs and IBs that comply with 31 CFR 1010.540, which includes an annual notice filing and verification requirement, are immune from civil liability for sharing information for the purpose of detecting, identifying, or reporting activities involving possible money laundering or terrorist activities. This notice can be accessed at www.fincen.gov/resources/advisories/fincen-advisory-issue-5.

29 Broker dealers that are notice registered for purposes of offering security futures products are required to comply with the broker-dealer reporting requirements in the securities industry. Dually registered broker- dealers may comply with the SAR requirements in the futures industry or the securities industry's requirements. See 68 FR 65392 (November 20, 2003).

30 Firms are encouraged to file form SAR for suspicious activity that is not required to be reported (e.g. a transaction falling below the $5,000 threshold). 31 U.S.C. 5318(g)(3) provides a safe harbor from liability in situations where a firm makes a voluntary SAR filing.

31 A copy of form SAR and the filing instructions are available at www.fincen.gov.

32 See 31 CFR 1026.320 for a copy of the final regulation.

33 A customer risk profile for purposes of suspicious activity monitoring refers to information gathered about a customer to develop the baseline against which customer activity is assessed for suspicious activity reporting. Depending on the facts and circumstances, relevant information could include basic information such as a customer's annual income, net worth, domicile, or principal occupation or business, as well as, in the case of longstanding customers, the customer's history of trading activity.

34 Firms jointly filing a single SAR are immune from liability with respect to such filing as provided at 31 CFR 1026.320(f).

35 As noted earlier, FCMs and IBs are not prohibited from sharing or disclosing the existence of a SAR to appropriate law enforcement agencies or regulatory agencies, including the CFTC, that examine them for compliance with the BSA; or to NFA and other self-regulatory organizations that examine them for compliance with SAR requirements, upon the request of the CFTC. In addition, when requested by one of these agencies, FCMs and IBs are required to provide these agencies with any supporting documentation to a SAR. (See FIN-2007-G003, Suspicious Activity Report Supporting Documentation, June 13, 2007.) Firms should create procedures to verify that any requests for SARs or supporting documentation comes from a representative of FinCEN or an appropriate law enforcement or supervisory agency.

36 Other regulatory agencies include the Board of Governors of the Federal Reserve System, the Federal Deposit Insurance Corporation, the National Credit Union Administration, the Office of the Comptroller of the Currency, the Office of Thrift Supervision and the Securities and Exchange Commission.

37 FCMs are directed to follow the detailed instructions and frequently asked questions concerning these information requests that have been issued directly to them by FinCEN.

38 See 71 Fed. Reg. 496 (January 4, 2006). See also FIN-2006-G009 - Application of the Regulations Requiring Special Due Diligence Programs for Certain Foreign Accounts to Securities and Futures Industries, May 10, 2006.

39 Correspondent accounts include accounts for foreign financial institutions to engage in futures or commodity options transactions, funds transfers, or other financial transactions, whether for the financial institution or principal or for its customers. An account includes any formal relationship established by an FCM to provide regular services, including but not limited to, those established to effect transactions in contracts of sale of a commodity for future delivery, options on a commodity or options on futures. 31 CFR 1010.605(c).

40 See FIN-2206-G011, Application of the Regulations Requiring Special Due Diligence Programs for Certain Foreign Accounts to Certain Introduced Accounts and Give-Up Arrangements in the Futures Industries, June 7, 2006.

41 See 31 CFR 1010.610(a).

42 As previously noted, as a general rule, the FCM establishing and maintaining the account is subject to the enhanced due diligence requirements of Section 312. An IB that only solicits or accepts orders for the purchase or sale of commodity futures contracts is not subject to the enhanced due diligence requirements of Section 312.

43 The final rule refers to being designated by an intergovernmental group or organization of which the United States is a member. Currently, FATF is the only such group.

44 A private banking account is an account (or any combination of accounts) that (1) requires a minimum aggregate deposit of funds or other assets of not less than $1,000,000; (2) is established on behalf of one or more non-U.S. persons who have a direct or beneficial ownership interest in the account; and (3) is assigned to, or is administered or managed by, in whole or in part, an officer, employee, or agent of a financial institution acting as a liaison between the financial institution and the direct or beneficial owner of the account.

45 See 31 CFR 1010.620(b).

46 OFAC administers sanction programs against a number of foreign countries. Further information is available at https://www.treasury.gov/resource- center/sanctions/Pages/default.aspx.

47 As part of its enforcement efforts, OFAC publishes a SDN list of individuals and companies owned or controlled by, or acting for or on behalf of targeted countries. It also lists individuals, groups, and entities, such as terrorists and narcotics traffickers designated under programs that are not country-specific.
Collectively, such individuals and companies are called "Specially Designated Nationals" or "SDNs." Their assets are blocked and U.S. persons are generally prohibited from dealing with them. View more information at: https://home.treasury.gov/policy-issues/office-of-foreign-assets-control-sanctions-programs-and-information.

48 In addition, if a customer attempts to wire transfer money to or receive money from a country under a sanction program or an entity or individual on the SDN list, the firm should file the reports as required by 31 CFR 501.603 and 501.604.

49 Although guarantor FCMs may conduct this audit for any of their guaranteed IBs, the IB's senior management must review the scope of the audit and its findings and take corrective action where necessary.

50 For small firms with limited staff, the audit function can be accomplished by a staff person who is not involved in the anti-money laundering program.

51 This discussion does not apply to reliance arrangements that meet the requirements discussed under the customer identification program section of this interpretive notice.

9046 - COMPLIANCE RULE 2-9: SUPERVISION OF THE USE OF AUTOMATED ORDER-ROUTING SYSTEMS

(Board of Directors, June 21, 2002; revised December 12, 2006)

INTERPRETIVE NOTICE

NFA Compliance Rule 2-9 places a continuing responsibility on every Member to diligently supervise its employees and agents in all aspects of their futures activities. The rule is broadly written to provide Members with flexibility in developing procedures tailored to meet their particular needs. On certain issues, however, NFA has issued Interpretive Notices to provide more specific guidance on acceptable standards for supervisory procedures.

Currently, information technology is changing nearly every aspect of how Members conduct business, including how customer orders are transmitted. The Board of Directors firmly believes that supervisory standards do not change with the medium used. How those standards are applied, however, may be affected by technology. Therefore, in order to fulfill their supervisory responsibilities, Members must adopt and enforce written procedures to examine the security, capacity, and credit and risk-management controls provided by the firm's automated order-routing systems (AORSs).1

NFA recognizes that, given the differences in the size, complexity of operations, and make-up of the customers serviced by NFA Members, there must be some degree of flexibility in determining what constitutes "diligent supervision" for each firm. It is NFA's policy to leave the exact form of supervision up to the Member, thereby providing the member with flexibility to design procedures that are tailored to the Member's own situation. It is also NFA's policy to set general standards rather than to require specific technology. Therefore, other procedures besides the ones described in this Interpretive Notice may comply with the general standards for supervisory responsibilities imposed by Compliance Rule 2-9.

The procedures discussed in this Interpretive Notice assume that customers have access to the AORS without human intervention. Systems used by Members to transmit customer orders from the firm to the exchange vary significantly, and certain of the procedures discussed in this Notice may not be needed when only firm personnel can enter orders into the system.

This Interpretive Notice applies to AORSs that are within a Member's control, including AORSs that are provided to the Member by an application service provider or an independent software vendor. While a Member is not, of course, responsible for an AORS chosen by the customer and outside of the Member's control - such as direct access systems provided by exchanges - the Member is nevertheless responsible for adopting procedures reasonably expected to address the trading, clearing, and other risks attendant to its customer relationship.2

Security
General Standard. Members who accept orders must adopt and enforce written procedures reasonably designed to protect the reliability and confidentiality of customer orders and account information at all points during the order-routing process. The procedures must also assign responsibility for overseeing the process to one or more individuals who understand how it works and who are capable of evaluating whether the process complies with the firm's procedures.

Authentication. The AORS, or other systems the customer must go through to access the AORS, should authenticate the user. Authentication can be accomplished through a number of methods, including, but not limited to, the following:

  • Passwords;
  • Authentication tokens, such as SecurID cards; or
  • Digital certificates.

Encryption. The system should use encryption or equivalent protections for all authentication and for any order or account information that is transmitted over a public network, a semi-private network, or a virtual private network.3 Encryption is less important for a private network that uses dedicated lines and is controlled by the Member (although it can still be a valuable protection). If more appropriate and effective security procedures are developed or identified, the use of those procedures would comply with this standard.

Firewalls. Firewalls or equivalent protections should be used with public networks, semi-private networks, and virtual private networks. The system should log the activities that pass through a firewall, and the log should be reviewed regularly for abnormal activity. If more appropriate and effective security procedures are developed or identified, the use of those procedures would comply with this standard.

Authorization. Although it is the customer's responsibility to ensure that only authorized individuals access the AORS using the customer's facilities and authentication devices (e.g., passwords), the Member's procedures should, as appropriate, provide customers with a means to notify the Member that particular individuals are no longer authorized or to request that authentication devices be disabled. Customers should be informed about the notification process.4

Periodic Testing. The Member should conduct and evidence periodic,reasonable reviews designed to assess the security of the AORS using an independent internal audit department, a qualified outside party, or other appropriate means.

Administration. The Member should adopt and enforce written procedures assigning the responsibility for overseeing the security of the AORS to appropriate supervisory personnel. The procedures should also provide that appropriate personnel keep up with new developments, monitor the effectiveness of the system's security, and respond to any breaches, and that the firm update the system as needed so that the AORS maintains the appropriate level of security.

Capacity
General Standard. Members who accept orders must adopt and enforce written procedures reasonably designed to maintain adequate personnel and facilities for the timely and efficient delivery of customer orders and reporting of executions. The procedures must also be reasonably designed to handle customer complaints about order delivery and reporting in a timely manner.

Members may not misrepresent the services they provide or the quality of those services. If a Member represents that it maintains a particular capacity or performance level, it must take the measures necessary to achieve that level.5

Capacity Reviews.

The Member should adopt and enforce written procedures to regularly evaluate the capacity of the AORS and to increase capacity when needed. The procedures should also provide that the system will be subjected to an initial stress test. Such test may be conducted through simulation or other available means. Thereafter, the system should be subject to periodic reviews by using an independent internal audit department, or a qualified outside party, or using other appropriate means.

The Member should monitor both capacity (how much volume the system can handle before it is adversely impacted or shuts down) and performance (how much volume the system can handle before response time materially increases), and should assess the AORS’s capacity and performance levels based on the major strains imposed on the system. The Member should establish acceptable capacity and performance levels for its AORS. The Member’s procedures should be reasonably designed to provide adequate capacity to meet estimated peak volume needs based on past experience, present demands, and projected demands.

The procedures should also provide for the Member to follow-up on customer complaints about access problems, system slowdowns, or system outages. This follow-up should include identifying the cause of the problem, if any, and taking action to correct it, and/or evaluating ways to prevent it from re-occurring.

Disaster Recovery and Redundancies. The Member should have contingency plans reasonably designed to service customers if either the system goes down or activity exceeds reasonably expected peak volume needs. The Member should use redundant systems or be able to quickly convert to other systems if the need arises. These backup systems can include facilities for accepting orders by telephone or reliance on third-party brokers or clearing firms.

When operational difficulties occur, the Member should provide prompt and effective notification to customers affected by the operational difficulties. Notification can be made by a number of methods, including, but not limited to, the following:

  • a message on the Member's web site;
  • e-mails or instant messages;
  • a recorded telephone message for customers on hold; and/or
  • a recorded telephone message on a line dedicated to providing information to AORS customers.

Advance Disclosure. The Member should disclose, in advance, the factors that could reasonably be expected to affect materially the system's performance (e.g., periods of stress). The Member should also educate customers on alternative ways to enter orders when the system goes down or reaches an unacceptable performance level. This disclosure may be made in the account agreement, on the Member's web site, or in any other manner designed to provide this information to current customers before problems occur.

Credit and Risk-Management Controls
General Standard. Members who accept orders must adopt and enforce written procedures reasonably designed to prevent customers from entering into trades that create undue financial risks for the Member or the Member's other customers.6

Pre-Execution Controls.7 An AORS should allow the Member to set limits for each customer based on commodity, quantity, and type of order or based on margin requirements. It should allow the Member to impose limits pre-execution and to automatically block any orders that exceed those limits.8

The Member does not have to impose pre-execution controls on all customers, however. The Member should review the customer's sophistication, credit-worthiness, objectives, and trading practices and strategies when determining whether to impose controls pre-execution or post-execution and deciding what levels to use when setting limits.

Post-Execution Controls. For customers subject to post-execution controls, the Member should have the ability to monitor trading promptly.9 This ability can be provided by the AORS or through other risk-management systems. The AORS should generate alerts when limits are exceeded through that system. The system should also allow the Member to block subsequent orders, either in their entirety or by kind (e.g., to block orders that create a new position or increase an existing position but not orders that liquidate some or all of an existing position).

Direct Access Systems. When authorizing (qualifying a customer for) use of a direct access system that does not allow the Member to monitor trading promptly, the Member should utilize pre-execution controls, if available, to set pre-execution limits for each customer, regardless of the nature of the customer.10 Where the limits are set should be based on the customer's sophistication, credit-worthiness, objectives, and trading practices. Members should also consider any other relevant information when deciding whether to authorize a customer to use a direct access system.

Review. Members should use AORSs in conjunction with their credit-review/risk-management systems and should evaluate the controls imposed on each customer as part of their regular credit and risk-control procedures.

* * *

NFA Compliance Rule 2-9 requires NFA Members to meet the standards for security, capacity, and credit and risk-management controls that are set out in this Interpretive Notice. It is NFA's policy to leave the exact form of supervision up to the Member, thereby providing the Member with flexibility to design procedures that are tailored to the Member's own situation.

1The written procedures do not, however, have to contain technical specifications or duplicate procedures that are documented elsewhere.

2An AORS may also be outside an IB Member's control if it is provided by the FCM.

3 This notice only applies to AORSs. It does not, for example, require Members to encrypt account information provided to customers electronically under CFTC Rule 1.33(g).

4For purposes of this notice, the term "customer" includes CTAs except when referring to credit-worthiness and ability to accept risk. In those instances, the term "customer" is limited to the owner of the account.

5Misrepresenting capacity or performance levels or other material information regarding a Member's order-routing system is a violation of NFA Compliance Rule 2-29.

6NFA Compliance Rule 2-30 also requires Members to consider an individual customer's ability to accept risk.

7Pre-execution controls include both credit and "fat-finger" protections.

8The ability to impose pre-execution controls does not, however, have to be built into a system that will only be used by customers subject to post-execution controls.

9"Promptly" means as soon as practical under the circumstances. Obviously, Members can review trades of customers who engage in simple strategies on only one market much more quickly than they can review trades of customers who execute complex strategies on multiple markets. In the latter case, a Member may not have all of the relevant information until the end of the day.

10 Customers may have a choice of direct access systems, some of which are better suited to their trading needs than others. While this interpretation does not dictate which system the customer uses, the Member should have the ability to either set pre-execution controls or monitor trading promptly.

9047 - NFA COMPLIANCE RULE 2-37: FAIR COMMISSIONS

(Board of Directors, April 16, 2002; revised December 17, 2007 and June 30, 2020.)

INTERPRETIVE NOTICE

Under Section 15A(k) of the Securities and Exchange Act of 1934 (Exchange Act), NFA is a national securities association for the limited purpose of regulating the activities of Members who are registered as brokers and dealers in security futures products under Section 15(b)(11) of the Exchange Act (i.e., FCMs and IBs who "passport" in to broker-dealer registration because they limit their securities activities to security futures products). Section 15A(k) also requires NFA to impose customer protection requirements reasonably comparable to those of national securities associations registered under Section 15A(a) of the Exchange Act. One of these requirements relates to the amount of commissions these Members may charge for security futures transactions.

NFA Compliance Rule 2-37(g) prohibits Members registered as broker-dealers under Section 15(b)(11) of the Exchange Act from charging more than a fair commission for security futures transactions. That rule also provides that what is a fair commission depends on all of the relevant circumstances, including the expense of executing the order and the value of any service the Member may have rendered based on its experience and knowledge.

The vast majority of NFA Members charge fair commissions, and Compliance Rule 2-37(g) will not require them to make any changes to their commission practices for security futures products. Commissions for futures transactions have been set competitively since the 1970s. They are usually based on the Member's costs plus a reasonable profit. Commission rates also vary based on the services provided by the Member. Additionally, Members who deal with institutional customers often negotiate commissions based on volume or similar measures. All of these practices continue to be acceptable for security futures products.1

NFA has occasionally encountered retail firms that have charged fees significantly out-of-line with the Member's costs and services and the industry norm. In most of these cases, customers have been misled as to either the amount of the commission, the effect of the commission on profitability, or how the commission rate compares with other firms in light of the services offered. High commissions also have a significant effect on commission-to-equity ratios and increase the likelihood that the Member will churn accounts over which they or their Associates have discretionary authority or de facto control. As a result, NFA has consistently responded to unreasonably high commission rates by charging the firms and their Associates with violating NFA Compliance Rule 2-2(a) and/or NFA Compliance Rule 2-29, and NFA will continue to do so.2

NFA Compliance Rule 2-37(g) and this interpretive notice do not relieve Members of their obligation to make the applicable per trade or round-term commission charges available to customers prior to the commencement of trading and to fully explain any fees and charges that are not determined on a per trade or round-turn basis.3

1 NFA does not believe it is appropriate to apply a guideline similar to the Financial Industry Regulatory Authority's 5% guideline for securities mark-ups. The cost of executing orders in the futures markets tends to have little correlation with either the notional value of the contract or the amount of margin. Although nothing prohibits NFA Members from setting commissions for security futures contracts based on the notional value of the contract or the amount of margin, those commissions must be reasonable in light of all of the circumstances, including the Member's expenses and the value of the Member's services.

2 See, e.g., In re Bachus & Stratton Commodities, Inc., NFA Case No. 92-BCC-15 (Hearing Panel, Feb. 18, 1993), aff'd, NFA Case No. 93-APP-2 (App. Comm., Nov. 11, 1993); In re Churchill Group, Inc., NFA Case No. 90-BCC-12 (BCC, Sep. 5, 1990) (settlement); In re The Siegel Trading Co., Inc., NFA Case No. 97-BCC-7 (Hearing Panel, Jan. 4, 1999) (settlement).

3 See Interpretive Notice 9005 – Interpretation of NFA Compliance Rule 2-4: Guideline for the Disclosure by FCMs and IBs of Costs Associated With Futures Transactions.

9048 - NFA COMPLIANCE RULE 2-4: THE BEST EXECUTION OBLIGATION OF NFA MEMBERS REGISTERED AS BROKER-DEALERS UNDER SECTION 15(b)(11) OF THE SECURITIES EXCHANGE ACT OF 1934

(Board of Directors, July 31, 2002)

INTERPRETIVE NOTICE

Under Section 15A(k) of the Securities Exchange Act of 1934 ("Exchange Act"), NFA is a national securities association for the limited purpose of regulating the activities of NFA Members who are registered as brokers or dealers in security futures products under Section 15(b)(11) of the Exchange Act (i.e. FCMs and IBs that passport in to broker-dealer registration because they limit their securities activities to security futures products). NFA Compliance Rule 2-4 requires Members and Associates to observe high standards of commercial honor and just and equitable principles of trade. This rule imposes an obligation on all Members and Associates to put their customers' interests before their own when soliciting and executing futures transactions. To this end, in executing security futures transactions, Members and Associates have an obligation to use reasonable diligence to ensure that customer orders receive the most favorable terms under the circumstances.

When a customer's order may be executed on only one exchange, Members do not have to decide where to route the order and, consequently, satisfying their best execution obligation is simpler than when Members must consider the relative merits of routing an orders to two or more markets. In those cases where a customer's order may be executed on two or more markets trading security futures contracts that are not materially different, Members and Associates have an obligation to use reasonable diligence to ascertain the market in which the customer's security futures order will receive the most favorable terms and, in particular, the best price available under prevailing market conditions. This notice provides guidance on how to fulfill that obligation.

First, it should be clear that if a customer or customer's designee1 requests that a security futures order be directed to a particular market, or specifies the purchase or sale of a particular security futures product that trades on only one market, then the Member or Associate is required to follow the customer's or designee's instructions. In this particular case, a Member does not have an obligation to ascertain the best market for a customer's security futures order.

A Member or Associate must consider the relevant facts and circumstances including, at a minimum, the following factors in discharging its obligation to use reasonable diligence in ascertaining where a customer's security futures order will receive the most favorable execution available:

  • The character of the market including, but not limited to, price, volatility, liquidity, depth, speed of execution, and pressure on available communications;

  • The size and type of transaction, including the type of order; and

  • The location, reliability and accessibility to the customer's intermediary of primary markets and quotation sources.

Members and Associates must also consider differences in the fees and costs to customers ( e.g. transaction fees, clearing costs and expenses) associated with executing transactions in each market. Unless specifically instructed by a customer or customer's designee or necessary to obtain the execution of an order, a Member shall not channel an order through a third party unless the Member can show that by doing so the total cost or proceeds of the transaction were better than if the Member decided not to channel the order through the third party. Moreover, a Member through whom a retail order is channeled and who knowingly is a party to an arrangement whereby the initiating Member firm has not fulfilled its best execution obligation will also be deemed to have violated NFA Compliance Rule 2-4. Members should be aware that channeling orders through a third party to receive reciprocation for service or business will not relieve a Member of its best execution obligation. Likewise, Members should not allow an order routing inducement, such as payment for order flow, to interfere with a Member's duty of best execution.

Failure of Member firms to maintain or adequately staff an order room or other department assigned to execute customer orders cannot be considered justification for executing away from the best available market. NFA recognizes that it may be impracticable for Members and Associates to make order routing decisions for retail orders on an order-by-order basis. Members and Associates that do not make order routing decisions for retail orders on an order-by-order basis should, at a minimum, consider the above factors and the materiality of any differences among contracts traded on different markets when establishing their retail order-routing practices and perform a regular and rigorous review of those practices to ensure that their best execution obligation is fulfilled.

This notice describes the best execution obligation of Members that are registered as brokers or dealers in security futures products under Section 15(b)(11) of the Exchange Act for transactions in security futures products only and does not impose such an obligation upon Members for transactions in other products. By necessity, this notice is general in nature since it is issued before security futures products have begun trading. NFA will provide further guidance if necessary as the markets for security futures products evolve.

1A person that exercises discretion over a customer's account.

9049 - NFA COMPLIANCE RULES 2-7 AND 2-24 AND REGISTRATION RULE 401: PROFICIENCY REQUIREMENTS FOR SECURITY FUTURES PRODUCTS

(Effective Dates of Amendments: May 5, 2003; revised December 4, 2006; December 17, 2007; December 28, 2009; February 21, 2013; and December 14, 2015.)

INTERPRETIVE NOTICE

The Commodity Futures Modernization Act of 2000 amended the Securities Exchange Act of 1934 to require NFA to "have rules that ensure that members and natural persons associated with members meet such standards of training, experience, and competence necessary to effect transactions in security futures products and are tested for their knowledge of securities and security futures products."1 NFA has determined that Members and Associates may meet the proficiency requirements by taking an appropriate training course before they engage in activities involving security futures products. This notice describes training programs that would satisfy NFA's proficiency requirements.

NFA Members and Associates will be able to satisfy their proficiency requirements for security futures by taking any training program that covers the subject matter included in a content outline that has been jointly developed by NFA, the Financial Industry Regulatory Authority, and a number of securities and futures exchanges. A copy of that outline can be found on NFA's website at www.nfa.futures.org. Additionally, NFA, in partnership with the Financial Industry Regulatory Authority and the Institute for Financial Markets, has developed a web-based training program that will satisfy the training requirement. That program can be accessed at www.nfa.futures.org. There is no charge for completing this training program. THE TRAINING MUST BE COMPLETED BEFORE ANY INDIVIDUAL REGISTRANT ENGAGES IN ACTIVITIES INVOLVING SECURITY FUTURES PRODUCTS.

In order to meet the proficiency requirements to qualify as a designated security futures principal through training, supervisors must complete a training program that also includes a section devoted to supervisory issues as well as the portions intended for all Associates.

NFA Members and Associates are not required to notify NFA that they have completed a training program. However, Members must be able to demonstrate to NFA during an audit that those registered individuals who are engaging in security futures activities have completed the necessary training. For example, Members could keep records of Associates who attend internal training programs or require Associates to provide certificates of completion for outside training programs.

1 Section 15A(k)(2)(D) of the Securities Exchange Act of 1934.

9050 - NFA COMPLIANCE RULE 2-30(b): RISK DISCLOSURE STATEMENT FOR SECURITY FUTURES CONTRACTS

(Board of Directors, October 7, 2002; revised December 12, 2002; December 17, 2007;
October 7, 2010; April 7, 2014; October 12, 2018 and August 14, 2020)

INTERPRETIVE NOTICE

NFA Compliance Rule 2-30(b) requires Members and Associates who are registered as brokers or dealers under Section 15(b)(11) of the Securities Exchange Act of 1934 to provide a disclosure statement for security futures products to a customer at or before the time the Member approves the account to trade security futures products.1

NFA Compliance Rule 2-30(j)(1) requires these Members and Associates to make a record of when the disclosure statement was provided, and Compliance Rule 2-29(j)(12) prohibits them from including anything other than basic information in promotional material unless the promotional material is preceded or accompanied by the disclosure statement.2 The disclosure statement for security futures products referred to in these Rules is a uniform statement that has been jointly developed by NFA, the Financial Industry Regulatory Authority, and a number of securities and futures exchanges.

The uniform disclosure statement, which is titled "Risk Disclosure Statement for Security Futures Contracts," can be downloaded from NFA's web site at https://www.nfa.futures.org/investors/investor-resources/files/security-futures-disclosure.pdf. Copies are also available by calling NFA's Information Center at 800-621-3570.3

Members must be able to demonstrate to NFA, during an audit, that they provided the disclosure statement as required. Members are not, however, required to obtain a written acknowledgment from the customer regarding the disclosure statement.

* * *

RISK DISCLOSURE STATEMENT FOR SECURITY FUTURES CONTRACTS

This disclosure statement discusses the characteristics and risks of standardized security futures contracts traded on regulated U.S. exchanges. At present, regulated exchanges are authorized to list futures contracts on individual equity securities registered under the Securities Exchange Act of 1934 (including common stock and certain exchange-traded funds and American Depositary Receipts), futures on certain debt instruments as well as narrow-based security indices. Futures on other types of securities and options on security futures contracts may be authorized in the future. The glossary of terms appears at the end of the document.

Customers should be aware that the examples in this document are exclusive of fees and commissions that may decrease their net gains or increase their net losses. The examples also do not include tax consequences, which may differ for each customer.

Section 1 – Risks of Security Futures

1.1. Risks of Security Futures Transactions
Trading security futures contracts may not be suitable for all investors. You may lose a substantial amount of money in a very short period of time. The amount you may lose is potentially unlimited and can exceed the amount you originally deposit with your broker. This is because futures trading is highly leveraged, with a relatively small amount of money used to establish a position in assets having a much greater value. If you are uncomfortable with this level of risk, you should not trade security futures contracts.

1.2. General Risks

  • Trading security futures contracts involves risk and may result in potentially unlimited losses that are greater than the amount you deposited with your broker. As with any high risk financial product, you should not risk any funds that you cannot afford to lose, such as your retirement savings, medical and other emergency funds, funds set aside for purposes such as education or home ownership, proceeds from student loans or mortgages, or funds required to meet your living expenses.

  • Be cautious of claims that you can make large profits from trading security futures contracts. Although the high degree of leverage in security futures contracts can result in large and immediate gains, it can also result in large and immediate losses. As with any financial product, there is no such thing as a "sure winner."

  • Because of the leverage involved and the nature of security futures contract transactions, you may feel the effects of your losses immediately. Gains and losses in security futures contracts are credited or debited to your account, at a minimum, on a daily basis. If movements in the markets for security futures contracts or the underlying security decrease the value of your positions in security futures contracts, you may be required to have or make additional funds available to your carrying firm as margin. If your account is under the minimum margin requirements set by the exchange or the brokerage firm, your position may be liquidated at a loss, and you will be liable for the deficit, if any, in your account. Margin requirements are addressed in Section 4.

  • Under certain market conditions, it may be difficult or impossible to liquidate a position. Generally, you must enter into an offsetting transaction in order to liquidate a position in a security futures contract. If you cannot liquidate your position in security futures contracts, you may not be able to realize a gain in the value of your position or prevent losses from mounting. This inability to liquidate could occur, for example, if trading is halted due to unusual trading activity in either the security futures contract or the underlying security; if trading is halted due to recent news events involving the issuer of the underlying security; if systems failures occur on an exchange or at the firm carrying your position; or if the position is on an illiquid market. Even if you can liquidate your position, you may be forced to do so at a price that involves a large loss.

  • Under certain market conditions, it may also be difficult or impossible to manage your risk from open security futures positions by entering into an equivalent but opposite position in another contract month, on another market, or in the underlying security. This inability to take positions to limit your risk could occur, for example, if trading is halted across markets due to unusual trading activity in the security futures contract or the underlying security or due to recent news events involving the issuer of the underlying security.

  • Under certain market conditions, the prices of security futures contracts may not maintain their customary or anticipated relationships to the prices of the underlying security or index. These pricing disparities could occur, for example, when the market for the security futures contract is illiquid, when the primary market for the underlying security is closed, or when the reporting of transactions in the underlying security has been delayed. For index products, it could also occur when trading is delayed or halted in some or all of the securities that make up the index.

  • You may be required to settle certain security futures contracts with physical delivery of the underlying security. If you hold your position in a physically settled security futures contract until the end of the last trading day prior to expiration, you will be obligated to make or take delivery of the underlying securities, which could involve additional costs. The actual settlement terms may vary from contract to contract and exchange to exchange. You should carefully review the settlement and delivery conditions before entering into a security futures contract. Settlement and delivery are discussed in Section 5.

  • You may experience losses due to systems failures. As with any financial transaction, you may experience losses if your orders for security futures contracts cannot be executed normally due to systems failures on a regulated exchange or at the brokerage firm carrying your position. Your losses may be greater if the brokerage firm carrying your position does not have adequate back-up systems or procedures.

  • All security futures contracts involve risk, and there is no trading strategy that can eliminate it. Strategies using combinations of positions, such as spreads, may be as risky as outright long or short positions. Trading in security futures contracts requires knowledge of both the securities and the futures markets.

  • Day trading strategies involving security futures contracts and other products pose special risks. As with any financial product, persons who seek to purchase and sell the same security future in the course of a day to profit from intra-day price movements ("day traders") face a number of special risks, including substantial commissions, exposure to leverage, and competition with professional traders. You should thoroughly understand these risks and have appropriate experience before engaging in day trading. The special risks for day traders are discussed more fully in Section 7.

  • Placing contingent orders, if permitted, such as "stop-loss" or "stop-limit" orders, will not necessarily limit your losses to the intended amount. Some regulated exchanges may permit you to enter into stop-loss or stop-limit orders for security futures contracts, which are intended to limit your exposure to losses due to market fluctuations. However, market conditions may make it impossible to execute the order or to get the stop price.

  • You should thoroughly read and understand the customer account agreement with your brokerage firm before entering into any transactions in security futures contracts.

  • You should thoroughly understand the regulatory protections available to your funds and positions in the event of the failure of your brokerage firm. The regulatory protections available to your funds and positions in the event of the failure of your brokerage firm may vary depending on, among other factors, the contract you are trading and whether you are trading through a securities account or a futures account. Firms that allow customers to trade security futures in either securities accounts or futures accounts, or both, are required to disclose to customers the differences in regulatory protections between such accounts, and, where appropriate, how customers may elect to trade in either type of account.

Section 2 – Description of a Security Futures Contract

2.1. What is a Security Futures Contract?
A security futures contract is a legally binding agreement between two parties to purchase or sell in the future a specific quantity of shares of a security or of the component securities of a narrow-based security index, at a certain price. A person who buys a security futures contract enters into a contract to purchase an underlying security and is said to be "long" the contract. A person who sells a security futures contract enters into a contract to sell the underlying security and is said to be "short" the contract. The price at which the contract trades (the "contract price") is determined by relative buying and selling interest on a regulated exchange.

In order to enter into a security futures contract, you must deposit funds with your brokerage firm equal to a specified percentage (usually at least 20 percent) of the current market value of the contract as a performance bond. Moreover, all security futures contracts are marked-to-market at least daily, usually after the close of trading, as described in Section 3 of this document. At that time, the account of each buyer and seller reflects the amount of any gain or loss on the security futures contract based on the contract price established at the end of the day for settlement purposes (the "daily settlement price").

An open position, either a long or short position, is closed or liquidated by entering into an offsetting transaction (i.e., an equal and opposite transaction to the one that opened the position) prior to the contract expiration. Traditionally, most futures contracts are liquidated prior to expiration through an offsetting transaction and, thus, holders do not incur a settlement obligation.

Examples:

    Investor A is long one September XYZ Corp. futures contract. To liquidate the long position in the September XYZ Corp. futures contract, Investor A would sell an identical September XYZ Corp. contract.
    Investor B is short one December XYZ Corp. futures contract. To liquidate the short position in the December XYZ Corp. futures contract, Investor B would buy an identical December XYZ Corp. contract.

Security futures contracts that are not liquidated prior to expiration must be settled in accordance with the terms of the contract. Some security futures contracts are settled by physical delivery of the underlying security. At the expiration of a security futures contract that is settled through physical delivery, a person who is long the contract must pay the final settlement price set by the regulated exchange or the clearing organization and take delivery of the underlying shares. Conversely, a person who is short the contract must make delivery of the underlying shares in exchange for the final settlement price.

Other security futures contracts are settled through cash settlement. In this case, the underlying security is not delivered. Instead, any positions in such security futures contracts that are open at the end of the last trading day are settled through a final cash payment based on a final settlement price determined by the exchange or clearing organization. Once this payment is made, neither party has any further obligations on the contract.

Physical delivery and cash settlement are discussed more fully in Section 5.

2.2. Purposes of Security Futures
Security futures contracts can be used for speculation, hedging, and risk management. Security futures contracts do not provide capital growth or income.

Speculation

Speculators are individuals or firms who seek to profit from anticipated increases or decreases in futures prices. A speculator who expects the price of the underlying instrument to increase will buy the security futures contract. A speculator who expects the price of the underlying instrument to decrease will sell the security futures contract. Speculation involves substantial risk and can lead to large losses as well as profits.

The most common trading strategies involving security futures contracts are buying with the hope of profiting from an anticipated price increase and selling with the hope of profiting from an anticipated price decrease. For example, a person who expects the price of XYZ stock to increase by March can buy a March XYZ security futures contract, and a person who expects the price of XYZ stock to decrease by March can sell a March XYZ security futures contract. The following illustrates potential profits and losses if Customer A purchases the security futures contract at $50 a share and Customer B sells the same contract at $50 a share (assuming 100 shares per contract).

Price of XYZ at Liquidation Customer A Profit/Loss Customer B Profit/Loss
$55 $500 - $500
$50 0 0
$45 - $500 $500

Speculators may also enter into spreads with the hope of profiting from an expected change in price relationships. Spreaders may purchase a contract expiring in one contract month and sell another contract on the same underlying security expiring in a different month (e.g., buy June and sell September XYZ single stock futures). This is commonly referred to as a "calendar spread."

Spreaders may also purchase and sell the same contract month in two different but economically correlated security futures contracts. For example, if ABC and XYZ are both pharmaceutical companies and an individual believes that ABC will have stronger growth than XYZ between now and June, he could buy June ABC futures contracts and sell June XYZ futures contracts. Assuming that each contract is 100 shares, the following illustrates how this works.

Opening Position Price at Liquidation Gain or Loss Price at Liquidation Gain or Loss
Buy ABC at 50 $50 $300 53 $300
Sell XYZ at 45 $46 - $100 $50 - $500
Net Gain or Loss $200   - $200

Speculators can also engage in arbitrage, which is similar to a spread except that the long and short positions occur on two different markets. An arbitrage position can be established by taking an economically opposite position in a security futures contract on another exchange, in an options contract, or in the underlying security.

Hedging

Generally speaking, hedging involves the purchase or sale of a security future to reduce or offset the risk of a position in the underlying security or group of securities (or a close economic equivalent). A hedger gives up the potential to profit from a favorable price change in the position being hedged in order to minimize the risk of loss from an adverse price change.

An investor who wants to lock in a price now for an anticipated sale of the underlying security at a later date can do so by hedging with security futures. For example, assume an investor owns 1,000 shares of ABC that have appreciated since he bought them. The investor would like to sell them at the current price of $50 per share, but there are tax or other reasons for holding them until September. The investor could sell ten 100-share ABC futures contracts and then buy back those contracts in September when he sells the stock. Assuming the stock price and the futures price change by the same amount, the gain or loss in the stock will be offset by the loss or gain in the futures contracts.

Price in
September		 Value of 1,000
Shares of ABC		 Gain or Loss
on Futures		 Effective
Selling Price
$40 $40,000 $10,000 $50,000
$50 $50,000 $ 0 $50,000
$60 $60,000 -$10,000 $50,000

Hedging can also be used to lock in a price now for an anticipated purchase of the stock at a later date. For example, assume that in May a mutual fund expects to buy stocks in a particular industry with the proceeds of bonds that will mature in August. The mutual fund can hedge its risk that the stocks will increase in value between May and August by purchasing security futures contracts on a narrow-based index of stocks from that industry. When the mutual fund buys the stocks in August, it also will liquidate the security futures position in the index. If the relationship between the security futures contract and the stocks in the index is constant, the profit or loss from the futures contract will offset the price change in the stocks, and the mutual fund will have locked in the price that the stocks were selling at in May.

Although hedging mitigates risk, it does not eliminate all risk. For example, the relationship between the price of the security futures contract and the price of the underlying security traditionally tends to remain constant over time, but it can and does vary somewhat. Furthermore, the expiration or liquidation of the security futures contract may not coincide with the exact time the hedger buys or sells the underlying stock. Therefore, hedging may not be a perfect protection against price risk.

Risk Management
Some institutions also use futures contracts to manage portfolio risks without necessarily intending to change the composition of their portfolio by buying or selling the underlying securities. The institution does so by taking a security futures position that is opposite to some or all of its position in the underlying securities. This strategy involves more risk than a traditional hedge because it is not meant to be a substitute for an anticipated purchase or sale.

2.3. Where Security Futures Trade
By law, security futures contracts must trade on a regulated U.S. exchange. Each regulated U.S. exchange that trades security futures contracts is subject to joint regulation by the Securities and Exchange Commission (SEC) and the Commodity Futures Trading Commission (CFTC).

A person holding a position in a security futures contract who seeks to liquidate the position must do so either on the regulated exchange where the original trade took place or on another regulated exchange, if any, where a fungible security futures contract trades. (A person may also seek to manage the risk in that position by taking an opposite position in a comparable contract traded on another regulated exchange.)

Security futures contracts traded on one regulated exchange might not be fungible with security futures contracts traded on another regulated exchange for a variety of reasons. Security futures traded on different regulated exchanges may be non-fungible because they have different contract terms (e.g., size, settlement method), or because they are cleared through different clearing organizations. Moreover, a regulated exchange might not permit its security futures contracts to be offset or liquidated by an identical contract traded on another regulated exchange, even though they have the same contract terms and are cleared through the same clearing organization. You should consult your broker about the fungibility of the contract you are considering purchasing or selling, including which exchange(s), if any, on which it may be offset.

Regulated exchanges that trade security futures contracts are required by law to establish certain listing standards. Changes in the underlying security of a security futures contract may, in some cases, cause such contract to no longer meet the regulated exchange's listing standards. Each regulated exchange will have rules governing the continued trading of security futures contracts that no longer meet the exchange's listing standards. These rules may, for example, permit only liquidating trades in security futures contracts that no longer satisfy the listing standards.

2.4. How Security Futures Differ from the Underlying Security
Shares of common stock represent a fractional ownership interest in the issuer of that security. Ownership of securities confers various rights that are not present with positions in security futures contracts. For example, persons owning a share of common stock may be entitled to vote in matters affecting corporate governance. They also may be entitled to receive dividends and corporate disclosure, such as annual and quarterly reports.

The purchaser of a security futures contract, by contrast, has only a contract for future delivery of the underlying security. The purchaser of the security futures contract is not entitled to exercise any voting rights over the underlying security and is not entitled to any dividends that may be paid by the issuer. Moreover, the purchaser of a security futures contract does not receive the corporate disclosures that are received by shareholders of the underlying security, although such corporate disclosures must be made publicly available through the SEC’s EDGAR system, which can be accessed at www.sec.gov. You should review such disclosures before entering into a security futures contract. See Section 8.1 for further discussion of the impact of corporate events on a security futures contract.

All security futures contracts are marked-to-market at least daily, usually after the close of trading, as described in Section 3 of this document. At that time, the account of each buyer and seller is credited with the amount of any gain, or debited by the amount of any loss, on the security futures contract, based on the contract price established at the end of the day for settlement purposes (the "daily settlement price"). By contrast, the purchaser or seller of the underlying instrument does not have the profit and loss from his or her investment credited or debited until the position in that instrument is closed out.

Naturally, as with any financial product, the value of the security futures contract and of the underlying security may fluctuate. However, owning the underlying security does not require an investor to settle his or her profits and losses daily. By contrast, as a result of the mark-to-market requirements discussed above, a person who is long a security futures contract often will be required to deposit additional funds into his or her account as the price of the security futures contract decreases. Similarly, a person who is short a security futures contract often will be required to deposit additional funds into his or her account as the price of the security futures contract increases.

Another significant difference is that security futures contracts expire on a specific date. Unlike an owner of the underlying security, a person cannot hold a long position in a security futures contract for an extended period of time in the hope that the price will go up. If you do not liquidate your security futures contract, you will be required to settle the contract when it expires, either through physical delivery or cash settlement. For cash-settled contracts in particular, upon expiration, an individual will no longer have an economic interest in the securities underlying the security futures contract.

2.5. Comparison to Options
Although security futures contracts share some characteristics with options on securities (options contracts), these products are also different in a number of ways. Below are some of the important distinctions between equity options contracts and security futures contracts.

If you purchase an options contract, you have the right, but not the obligation, to buy or sell a security prior to the expiration date. If you sell an options contract, you have the obligation to buy or sell a security prior to the expiration date. By contrast, if you have a position in a security futures contract (either long or short), you have both the right and the obligation to buy or sell a security at a future date. The only way that you can avoid the obligation incurred by the security futures contract is to liquidate the position with an offsetting contract.

A person purchasing an options contract runs the risk of losing the purchase price (premium) for the option contract. Because it is a wasting asset, the purchaser of an options contract who neither liquidates the options contract in the secondary market nor exercises it at or prior to expiration will necessarily lose his or her entire investment in the options contract. However, a purchaser of an options contract cannot lose more than the amount of the premium. Conversely, the seller of an options contract receives the premium and assumes the risk that he or she will be required to buy or sell the underlying security on or prior to the expiration date, in which event his or her losses may exceed the amount of the premium received. Although the seller of an options contract is required to deposit margin to reflect the risk of its obligation, he or she may lose many times his or her initial margin deposit.

By contrast, the purchaser and seller of a security futures contract each enter into an agreement to buy or sell a specific quantity of shares in the underlying security. Based upon the movement in prices of the underlying security, a person who holds a position in a security futures contract can gain or lose many times his or her initial margin deposit. In this respect, the benefits of a security futures contract are similar to the benefits of purchasing an option, while the risks of entering into a security futures contract are similar to the risks of selling an option.

Both the purchaser and the seller of a security futures contract have daily margin obligations. At least once each day, security futures contracts are marked-to-market and the increase or decrease in the value of the contract is credited or debited to the buyer and the seller. As a result, any person who has an open position in a security futures contract may be called upon to meet additional margin requirements or may receive a credit of available funds.

Example:

    Assume that Customers A and B each anticipate an increase in the market price of XYZ stock, which is currently $50 a share. Customer A purchases an XYZ 50 call (covering 100 shares of XYZ at a premium of $5 per share). The option premium is $500 ($5 per share X 100 shares). Customer B purchases an XYZ security futures contract (covering 100 shares of XYZ). The total value of the contract is $5000 ($50 share value X 100 shares). The required margin is $1000 (or 20% of the contract value).

    Price of
    XYZ at
    expiration    		 Customer A
    Profit/Loss    		 Customer B
    Profit/Loss
    65 1000 1500
    60 500 1000
    55 0 500
    50 -500 0
    45 -500 -500
    40 -500 -1000
    35 -500 -1500

    The most that Customer A can lose is $500, the option premium. Customer A breaks even at $55 per share, and makes money at higher prices. Customer B may lose more than his initial margin deposit. Unlike the options premium, the margin on a futures contract is not a cost but a performance bond. The losses for Customer B are not limited by this performance bond. Rather, the losses or gains are determined by the settlement price of the contract, as provided in the example above. Note that if the price of XYZ falls to $35 per share, Customer A loses only $500, whereas Customer B loses $1500.

2.6. Components of a Security Futures Contract
Each regulated exchange can choose the terms of the security futures contracts it lists, and those terms may differ from exchange to exchange or contract to contract. Some of those contract terms are discussed below. However, you should ask your broker for a copy of the contract specifications before trading a particular contract.

2.6.1. Each security futures contract has a set size. The size of a security futures contract is determined by the regulated exchange on which the contract trades. For example, a security futures contract for a single stock may be based on 100 shares of that stock. If prices are reported per share, the value of the contract would be the price times 100. For narrow-based security indices, the value of the contract is the price of the component securities times the multiplier set by the exchange as part of the contract terms.

2.6.2. Security futures contracts expire at set times determined by the listing exchange. For example, a particular contract may expire on a particular day, e.g., the third Friday of the expiration month. Up until expiration, you may liquidate an open position by offsetting your contract with a fungible opposite contract that expires in the same month. If you do not liquidate an open position before it expires, you will be required to make or take delivery of the underlying security or to settle the contract in cash after expiration.

2.6.3. Although security futures contracts on a particular security or a narrow-based security index may be listed and traded on more than one regulated exchange, the contract specifications may not be the same. Also, prices for contracts on the same security or index may vary on different regulated exchanges because of different contract specifications.

2.6.4. Prices of security futures contracts are usually quoted the same way prices are quoted in the underlying instrument. For example, a contract for an individual security would be quoted in dollars and cents per share. Contracts for indices would be quoted by an index number, usually stated to two decimal places.

2.6.5. Each security futures contract has a minimum price fluctuation (called a tick), which may differ from product to product or exchange to exchange. For example, if a particular security futures contract has a tick size of 1¢, you can buy the contract at $23.21 or $23.22 but not at $23.215.

2.7. Trading Halts
The value of your positions in security futures contracts could be affected if trading is halted in either the security futures contract or the underlying security. In certain circumstances, regulated exchanges are required by law to halt trading in security futures contracts. For example, trading on a particular security futures contract must be halted if trading is halted on the listed market for the underlying security as a result of pending news, regulatory concerns, or market volatility. Similarly, trading of a security futures contract on a narrow-based security index must be halted under such circumstances if trading is halted on securities accounting for at least 50 percent of the market capitalization of the index. In addition, regulated exchanges are required to halt trading in all security futures contracts for a specified period of time when the S&P 500 Index experiences one-day declines of seven-, 13- and 20-percent. The regulated exchanges may also have discretion under their rules to halt trading in other circumstances – such as when the exchange determines that the halt would be advisable in maintaining a fair and orderly market.

A trading halt, either by a regulated exchange that trades security futures or an exchange trading the underlying security or instrument, could prevent you from liquidating a position in security futures contracts in a timely manner, which could prevent you from liquidating a position in security futures contracts at that time.

2.8. Trading Hours
Each regulated exchange trading a security futures contract may open and close for trading at different times than other regulated exchanges trading security futures contracts or markets trading the underlying security or securities. Trading in security futures contracts prior to the opening or after the close of the primary market for the underlying security may be less liquid than trading during regular market hours.

Section 3 – Clearing Organizations and Mark-to-Market Requirements

Every regulated U.S. exchange that trades security futures contracts is required to have a relationship with a clearing organization that serves as the guarantor of each security futures contract traded on that exchange. A clearing organization performs the following functions: matching trades; effecting settlement and payments; guaranteeing performance; and facilitating deliveries.

Throughout each trading day, the clearing organization matches trade data submitted by clearing members on behalf of their customers or for the clearing member's proprietary accounts. If an account is with a brokerage firm that is not a member of the clearing organization, then the brokerage firm will carry the security futures position with another brokerage firm that is a member of the clearing organization. Trade records that do not match, either because of a discrepancy in the details or because one side of the transaction is missing, are returned to the submitting clearing members for resolution. The members are required to resolve such "out trades" before or on the open of trading the next morning.

When the required details of a reported transaction have been verified, the clearing organization assumes the legal and financial obligations of the parties to the transaction. One way to think of the role of the clearing organization is that it is the "buyer to every seller and the seller to every buyer." The insertion or substitution of the clearing organization as the counterparty to every transaction enables a customer to liquidate a security futures position without regard to what the other party to the original security futures contract decides to do.

The clearing organization also effects the settlement of gains and losses from security futures contracts between clearing members. At least once each day, clearing member brokerage firms must either pay to, or receive from, the clearing organization the difference between the current price and the trade price earlier in the day, or for a position carried over from the previous day, the difference between the current price and the previous day's settlement price. Whether a clearing organization effects settlement of gains and losses on a daily basis or more frequently will depend on the conventions of the clearing organization and market conditions. Because the clearing organization assumes the legal and financial obligations for each security futures contract, you should expect it to ensure that payments are made promptly to protect its obligations.

Gains and losses in security futures contracts are also reflected in each customer's account on at least a daily basis. Each day's gains and losses are determined based on a daily settlement price disseminated by the regulated exchange trading the security futures contract or its clearing organization. If the daily settlement price of a particular security futures contract rises, the buyer has a gain and the seller a loss. If the daily settlement price declines, the buyer has a loss and the seller a gain. This process is known as "marking-to-market" or daily settlement. As a result, individual customers normally will be called on to settle daily.

The one-day gain or loss on a security futures contract is determined by calculating the difference between the current day's settlement price and the previous day's settlement price.

    For example, assume a security futures contract is purchased at a price of $120. If the daily settlement price is either $125 (higher) or $117 (lower), the effects would be as follows:

    (1 contract representing 100 shares)
    Daily
    Settlement
    Value    		 Buyer's
    Account    		 Seller's
    Account
    $125 $500 gain
    (credit)    		 $500 loss
    (debit)
    $117 $300 loss
    (debit)    		 $300 gain
    (credit)

The cumulative gain or loss on a customer's open security futures positions is generally referred to as "open trade equity" and is listed as a separate component of account equity on your customer account statement.

A discussion of the role of the clearing organization in effecting delivery is discussed in Section 5.

Section 4 – Margin and Leverage

When a broker-dealer lends a customer part of the funds needed to purchase a security such as common stock, the term "margin" refers to the amount of cash, or down payment, the customer is required to deposit. By contrast, a security futures contract is an obligation and not an asset. A security futures contract has no value as collateral for a loan. Because of the potential for a loss as a result of the daily marked-to-market process, however, a margin deposit is required of each party to a security futures contract. This required margin deposit also is referred to as a "performance bond."

In the first instance, margin requirements for security futures contracts are set by the exchange on which the contract is traded, subject to certain minimums set by law. The basic margin requirement is 20% of the current value of the security futures contract, although some strategies may have lower margin requirements. Requests for additional margin are known as "margin calls." Both buyer and seller must individually deposit the required margin to their respective accounts.

It is important to understand that individual brokerage firms can, and in many cases do, require margin that is higher than the exchange requirements. Additionally, margin requirements may vary from brokerage firm to brokerage firm. Furthermore, a brokerage firm can increase its "house" margin requirements at any time without providing advance notice, and such increases could result in a margin call.

For example, some firms may require margin to be deposited the business day following the day of a deficiency, or some firms may even require deposit on the same day. Some firms may require margin to be on deposit in the account before they will accept an order for a security futures contract. Additionally, brokerage firms may have special requirements as to how margin calls are to be met, such as requiring a wire transfer from a bank, or deposit of a certified or cashier's check. You should thoroughly read and understand the customer agreement with your brokerage firm before entering into any transactions in security futures contracts.

If through the daily cash settlement process, losses in the account of a security futures contract participant reduce the funds on deposit (or equity) below the maintenance margin level (or the firm's higher "house" requirement), the brokerage firm will require that additional funds be deposited.

If additional margin is not deposited in accordance with the firm's policies, the firm can liquidate your position in security futures contracts or sell assets in any of your accounts at the firm to cover the margin deficiency. You remain responsible for any shortfall in the account after such liquidations or sales. Unless provided otherwise in your customer agreement or by applicable law, you are not entitled to choose which futures contracts, other securities or other assets are liquidated or sold to meet a margin call or to obtain an extension of time to meet a margin call.

Brokerage firms generally reserve the right to liquidate a customer's security futures contract positions or sell customer assets to meet a margin call at any time without contacting the customer. Brokerage firms may also enter into equivalent but opposite positions for your account in order to manage the risk created by a margin call. Some customers mistakenly believe that a firm is required to contact them for a margin call to be valid, and that the firm is not allowed to liquidate securities or other assets in their accounts to meet a margin call unless the firm has contacted them first. This is not the case. While most firms notify their customers of margin calls and allow some time for deposit of additional margin, they are not required to do so. Even if a firm has notified a customer of a margin call and set a specific due date for a margin deposit, the firm can still take action as necessary to protect its financial interests, including the immediate liquidation of positions without advance notification to the customer.

Here is an example of the margin requirements for a long security futures position.

A customer buys 3 July EJG security futures at 71.50. Assuming each contract represents 100 shares, the nominal value of the position is $21,450 (71.50 x 3 contracts x 100 shares). If the initial margin rate is 20% of the nominal value, then the customer's initial margin requirement would be $4,290. The customer deposits the initial margin, bringing the equity in the account to $4,290.

First, assume that the next day the settlement price of EJG security futures falls to 69.25. The marked-to-market loss in the customer's equity is $675 (71.50 - 69.25 x 3 contacts x 100 shares). The customer's equity decreases to $3,615 ($4,290 - $675). The new nominal value of the contract is $20,775 (69.25 x 3 contracts x 100 shares). If the maintenance margin rate is 20% of the nominal value, then the customer's maintenance margin requirement would be $4,155. Because the customer's equity had decreased to $3,615 (see above), the customer would be required to have an additional $540 in margin ($4,155 - $3,615).

Alternatively, assume that the next day the settlement price of EJG security futures rises to 75.00. The mark-to-market gain in the customer's equity is $1,050 (75.00 - 71.50 x 3 contacts x 100 shares). The customer's equity increases to $5,340 ($4,290 + $1,050). The new nominal value of the contract is $22,500 (75.00 x 3 contracts x 100 shares). If the maintenance margin rate is 20% of the nominal value, then the customer's maintenance margin requirement would be $4,500. Because the customer's equity had increased to $5,340 (see above), the customer's excess equity would be $840.

The process is exactly the same for a short position, except that margin calls are generated as the settlement price rises rather than as it falls. This is because the customer's equity decreases as the settlement price rises and increases as the settlement price falls.

Because the margin deposit required to open a security futures position is a fraction of the nominal value of the contracts being purchased or sold, security futures contracts are said to be highly leveraged. The smaller the margin requirement in relation to the underlying value of the security futures contract, the greater the leverage. Leverage allows exposure to a given quantity of an underlying asset for a fraction of the investment needed to purchase that quantity outright. In sum, buying (or selling) a security futures contract provides the same dollar and cents profit and loss outcomes as owning (or shorting) the underlying security. However, as a percentage of the margin deposit, the potential immediate exposure to profit or loss is much higher with a security futures contract than with the underlying security.

For example, if a security futures contract is established at a price of $50, the contract has a nominal value of $5,000 (assuming the contract is for 100 shares of stock). The margin requirement may be as low as 20%. In the example just used, assume the contract price rises from $50 to $52 (a $200 increase in the nominal value). This represents a $200 profit to the buyer of the security futures contract, and a 20% return on the $1,000 deposited as margin. The reverse would be true if the contract price decreased from $50 to $48. This represents a $200 loss to the buyer, or 20% of the $1,000 deposited as margin. Thus, leverage can either benefit or harm an investor.

Note that a 4% decrease in the value of the contract resulted in a loss of 20% of the margin deposited. A 20% decrease would wipe out 100% of the margin deposited on the security futures contract.

Section 5 – Settlement

If you do not liquidate your position prior to the end of trading on the last day before the expiration of the security futures contract, you are obligated to either 1) make or accept a cash payment ("cash settlement") or 2) deliver or accept delivery of the underlying securities in exchange for final payment of the final settlement price ("physical delivery"). The terms of the contract dictate whether it is settled through cash settlement or by physical delivery.

The expiration of a security futures contract is established by the exchange on which the contract is listed. On the expiration day, security futures contracts cease to exist. Typically, the last trading day of a security futures contract will be the third Friday of the expiring contract month, and the expiration day will be the following Saturday. This follows the expiration conventions for stock options and broad-based stock indexes. Please keep in mind that the expiration day is set by the listing exchange and may deviate from these norms.

5.1. Cash settlement
In the case of cash settlement, no actual securities are delivered at the expiration of the security futures contract. Instead, you must settle any open positions in security futures by making or receiving a cash payment based on the difference between the final settlement price and the previous day's settlement price. Under normal circumstances, the final settlement price for a cash-settled contract will reflect the opening price for the underlying security. Once this payment is made, neither the buyer nor the seller of the security futures contract has any further obligations on the contract.

5.2. Settlement by physical delivery
Settlement by physical delivery is carried out by clearing brokers or their agents with National Securities Clearing Corporation (NSCC), an SEC-regulated securities clearing agency. Such settlements are made in much the same way as they are for purchases and sales of the underlying security. Promptly after the last day of trading, the regulated exchange's clearing organization will report a purchase and sale of the underlying stock at the previous day's settlement price (also referred to as the "invoice price") to NSCC. In general, if NSCC does not reject the transaction by a time specified in its rules, settlement is effected pursuant to the rules of the exchange and NSCC's Rules and Procedures within the normal clearance and settlement cycle for securities transactions, which currently is two business days. However, settlement may be effected on a shorter timeframe based on the rules of the exchange and subject to NSCC's Rules and Procedures.

If you hold a short position in a physically settled security futures contract to expiration, you will be required to make delivery of the underlying securities. If you already own the securities, you may tender them to your brokerage firm. If you do not own the securities, you will be obligated to purchase them. Some brokerage firms may not be able to purchase the securities for you. If your brokerage firm cannot purchase the underlying securities on your behalf to fulfill a settlement obligation, you will have to purchase the securities through a different firm.

Section 6 – Customer Account Protections

Positions in security futures contracts may be held either in a securities account or in a futures account. Your brokerage firm may or may not permit you to choose the types of account in which your positions in security futures contracts will be held. The protections for funds deposited or earned by customers in connection with trading in security futures contracts differ depending on whether the positions are carried in a securities account or a futures account. If your positions are carried in a securities account, you will not receive the protections available for futures accounts. Similarly, if your positions are carried in a futures account, you will not receive the protections available for securities accounts. You should ask your broker which of these protections will apply to your funds.

You should be aware that the regulatory protections applicable to your account are not intended to insure you against losses you may incur as a result of a decline or increase in the price of a security futures contract. As with all financial products, you are solely responsible for any market losses in your account.

Your brokerage firm must tell you whether your security futures positions will be held in a securities account or a futures account. If your brokerage firm gives you a choice, it must tell you what you have to do to make the choice and which type of account will be used if you fail to do so. You should understand that certain regulatory protections for your account will depend on whether it is a securities account or a futures account.

6.1. Protections for Securities Accounts
If your positions in security futures contracts are carried in a securities account, they are covered by SEC rules governing the safeguarding of customer funds and securities. These rules prohibit a broker-dealer from using customer funds and securities to finance its business. As a result, the broker-dealer is required to set aside funds equal to the net of all its excess payables to customers over receivables from customers. The rules also require a broker-dealer to segregate all customer fully paid and excess margin securities carried by the broker-dealer for customers.

The Securities Investor Protection Corporation (SIPC) also covers positions held in securities accounts. SIPC was created in 1970 as a non-profit, non-government, membership corporation, funded by member broker-dealers. Its primary role is to return funds and securities to customers if the broker-dealer holding these assets becomes insolvent. SIPC coverage applies to customers of current (and in some cases former) SIPC members. Most broker-dealers registered with the SEC are SIPC members; those few that are not must disclose this fact to their customers. SIPC members must display an official sign showing their membership. To check whether a firm is a SIPC member, go to www.sipc.org, call the SIPC Membership Department at (202) 371-8300, or write to SIPC Membership Department, Securities Investor Protection Corporation, 1667 K Street NW, Suite 1000, Washington, DC 20006-1620.

SIPC coverage is limited to $500,000 per customer, including up to $250,000 for cash. For example, if a customer has 1,000 shares of XYZ stock valued at $200,000 and $10,000 cash in the account, both the security and the cash balance would be protected. However, if the customer has shares of stock valued at $500,000 and $250,000 in cash, only a total of $500,000 of those assets will be protected.

For purposes of SIPC coverage, customers are persons who have securities or cash on deposit with a SIPC member for the purpose of, or as a result of, securities transactions. SIPC does not protect customer funds placed with a broker-dealer just to earn interest. Insiders of the broker-dealer, such as its owners, officers, and partners, are not customers for purposes of SIPC coverage.

6.2. Protections for Futures Accounts
If your security futures positions are carried in a futures account, they must be segregated from the brokerage firm's own funds and cannot be borrowed or otherwise used for the firm's own purposes. If the funds are deposited with another entity (e.g., a bank, clearing broker, or clearing organization), that entity must acknowledge that the funds belong to customers and cannot be used to satisfy the firm's debts. Moreover, although a brokerage firm may carry funds belonging to different customers in the same bank or clearing account, it may not use the funds of one customer to margin or guarantee the transactions of another customer. As a result, the brokerage firm must add its own funds to its customers' segregated funds to cover customer debits and deficits. Brokerage firms must calculate their segregation requirements daily.

You may not be able to recover the full amount of any funds in your account if the brokerage firm becomes insolvent and has insufficient funds to cover its obligations to all of its customers. However, customers with funds in segregation receive priority in bankruptcy proceedings. Furthermore, all customers whose funds are required to be segregated have the same priority in bankruptcy, and there is no ceiling on the amount of funds that must be segregated for or can be recovered by a particular customer.

Your brokerage firm is also required to separately maintain funds invested in security futures contracts traded on a foreign exchange. However, these funds may not receive the same protections once they are transferred to a foreign entity (e.g., a foreign broker, exchange or clearing organization) to satisfy margin requirements for those products. You should ask your broker about the bankruptcy protections available in the country where the foreign exchange (or other entity holding the funds) is located.

Section 7 – Special Risks for Day Traders

Certain traders who pursue a day trading strategy may seek to use security futures contracts as part of their trading activity. Whether day trading in security futures contracts or other securities, investors engaging in a day trading strategy face a number of risks.

  • Day trading in security futures contracts requires in-depth knowledge of the securities and futures markets and of trading techniques and strategies. In attempting to profit through day trading, you will compete with professional traders who are knowledgeable and sophisticated in these markets. You should have appropriate experience before engaging in day trading.

  • Day trading in security futures contracts can result in substantial commission charges, even if the per trade cost is low. The more trades you make, the higher your total commissions will be. The total commissions you pay will add to your losses and reduce your profits. For instance, assuming that a round-turn trade costs $16 and you execute an average of 29 round-turn transactions per day each trading day, you would need to generate an annual profit of $111,360 just to cover your commission expenses.

  • Day trading can be extremely risky. Day trading generally is not appropriate for someone of limited resources and limited investment or trading experience and low risk tolerance. You should be prepared to lose all of the funds that you use for day trading. In particular, you should not fund day trading activities with funds that you cannot afford to lose.

Section 8 – Other

8.1. Corporate Events
As noted in Section 2.4, an equity security represents a fractional ownership interest in the issuer of that security. By contrast, the purchaser of a security futures contract has only a contract for future delivery of the underlying security. Treatment of dividends and other corporate events affecting the underlying security may be reflected in the security futures contract depending on the applicable clearing organization rules. Consequently, individuals should consider how dividends and other developments affecting security futures in which they transact will be handled by the relevant exchange and clearing organization. The specific adjustments to the terms of a security futures contract are governed by the rules of the applicable clearing organization. Below is a discussion of some of the more common types of adjustments that you may need to consider.

Corporate issuers occasionally announce stock splits. As a result of these splits, owners of the issuer's common stock may own more shares of the stock, or fewer shares in the case of a reverse stock split. The treatment of stock splits for persons owning a security futures contract may vary according to the terms of the security futures contract and the rules of the clearing organization. For example, the terms of the contract may provide for an adjustment in the number of contracts held by each party with a long or short position in a security future, or for an adjustment in the number of shares or units of the instrument underlying each contract, or both.

Corporate issuers also occasionally issue special dividends. A special dividend is an announced cash dividend payment outside the normal and customary practice of a corporation. The terms of a security futures contract may be adjusted for special dividends. The adjustments, if any, will be based upon the rules of the exchange and clearing organization. In general, there will be no adjustments for ordinary dividends as they are recognized as a normal and customary practice of an issuer and are already accounted for in the pricing of security futures. However, adjustments for ordinary dividends may be made for a specified class of security futures contracts based on the rules of the exchange and the clearing organization.

Corporate issuers occasionally may be involved in mergers and acquisitions. Such events may cause the underlying security of a security futures contact to change over the contract duration. The terms of security futures contracts may also be adjusted to reflect other corporate events affecting the underlying security.

8.2. Position Limits and Large Trader Reporting
All security futures contracts trading on regulated exchanges in the United States are subject to position limits or position accountability limits. Position limits restrict the number of security futures contracts that any one person or group of related persons may hold or control in a particular security futures contract. In contrast, position accountability limits permit the accumulation of positions in excess of the limit without a prior exemption. In general, position limits and position accountability limits are beyond the thresholds of most retail investors. Whether a security futures contract is subject to position limits, and the level for such limits, depends upon the trading activity and market capitalization of the underlying security of the security futures contract.

Position limits are required for security futures contracts on a security. Position limits also apply only to an expiring security futures contract during its last three trading days. A regulated exchange must establish a default position limit on a security futures contract that is no greater than 25,000 100-share contracts (or the equivalent if the contract size is different than 100 shares), either net or on the same side of the market, unless the underlying security exceeds 20 million shares of estimated deliverable supply, in which case the limit may be set at a level no greater than 12.5 percent of the estimated deliverable supply of the underlying security, either net or on the same side of the market.

For a security futures contract on a security with a six-month total trading volume of more than 2.5 billion shares and there are more than 40 million shares of estimated deliverable supply, a regulated exchange may adopt a position accountability rule in lieu of a position limit, either net or on the same side of the market. Under position accountability rules, a trader holding a position in a security futures contract that exceeds 25,000 100-share contracts (or the equivalent if the contract size is different than 100 shares) or such lower level specified under the rules of the exchange, must agree to provide information regarding the position and consent to halt increasing that position if requested by the exchange.

Brokerage firms must also report large open positions held by one person (or by several persons acting together) to the CFTC as well as to the exchange on which the positions are held. The CFTC’s reporting requirements are 1,000 contracts for security futures positions on individual equity securities and 200 contracts for positions on a narrow-based index. However, individual exchanges may require the reporting of large open positions at levels less than the levels required by the CFTC. In addition, brokerage firms must submit identifying information on the account holding the reportable position (on a form referred to as either an “Identification of Special Accounts Form” or a “Form 102”) to the CFTC and to the exchange on which the reportable position exists no later than the following business day when a reportable position is first established.

8.3. Transactions on Foreign Exchanges
U.S. customers may not trade security futures on foreign exchanges until authorized by U.S. regulatory authorities. U.S. regulatory authorities do not regulate the activities of foreign exchanges and may not, on their own, compel enforcement of the rules of a foreign exchange or the laws of a foreign country. While U.S. law governs transactions in security futures contracts that are effected in the U.S., regardless of the exchange on which the contracts are listed, the laws and rules governing transactions on foreign exchanges vary depending on the country in which the exchange is located.

8.4. Tax Consequences
For most taxpayers, security futures contracts are not treated like other futures contracts. Instead, the tax consequences of a security futures transaction depend on the status of the taxpayer and the type of position (e.g., long or short, covered or uncovered). Because of the importance of tax considerations to transactions in security futures, readers should consult their tax advisors as to the tax consequences of these transactions.

Section 9 – Glossary of Terms

This glossary is intended to assist customers in understanding specialized terms used in the futures and securities industries. It is not inclusive and is not intended to state or suggest the legal significance or meaning of any word or term.

Arbitrage – taking an economically opposite position in a security futures contract on another exchange, in an options contract, or in the underlying security.

Broad-based security index – a security index that does not fall within the statutory definition of a narrow-based security index (see Narrow-based security index). A future on a broad-based security index is not a security future. This risk disclosure statement applies solely to security futures and generally does not pertain to futures on a broad-based security index. Futures on a broad-based security index are under exclusive jurisdiction of the CFTC.

Cash settlement – a method of settling certain futures contracts by having the buyer (or long) pay the seller (or short) the cash value of the contract according to a procedure set by the exchange.

Clearing broker – a member of the clearing organization for the contract being traded. All trades, and the daily profits or losses from those trades, must go through a clearing broker.

Clearing organization – a regulated entity that is responsible for settling trades, collecting losses and distributing profits, and handling deliveries.

Contract – 1) the unit of trading for a particular futures contract (e.g., one contract may be 100 shares of the underlying security), 2) the type of future being traded (e.g., futures on ABC stock).

Contract month – the last month in which delivery is made against the futures contract or the contract is cash-settled. Sometimes referred to as the delivery month.

Day trading strategy – an overall trading strategy characterized by the regular transmission by a customer of intra-day orders to effect both purchase and sale transactions in the same security or securities.

EDGAR – the SEC's Electronic Data Gathering, Analysis, and Retrieval system maintains electronic copies of corporate information filed with the agency. EDGAR submissions may be accessed through the SEC's Web site, www.sec.gov.

Futures contract – a futures contract is (1) an agreement to purchase or sell a commodity for delivery in the future; (2) at a price determined at initiation of the contract; (3) that obligates each party to the contract to fulfill it at the specified price; (4) that is used to assume or shift risk; and (5) that may be satisfied by delivery or offset.

Hedging – the purchase or sale of a security future to reduce or offset the risk of a position in the underlying security or group of securities (or a close economic equivalent).

Illiquid market – a market (or contract) with few buyers and/or sellers. Illiquid markets have little trading activity and those trades that do occur may be done at large price increments.

Liquidation – entering into an offsetting transaction. Selling a contract that was previously purchased liquidates a futures position in exactly the same way that selling 100 shares of a particular stock liquidates an earlier purchase of the same stock. Similarly, a futures contract that was initially sold can be liquidated by an offsetting purchase.

Liquid market – a market (or contract) with numerous buyers and sellers trading at small price increments.

Long – 1) the buying side of an open futures contact, 2) a person who has bought futures contracts that are still open.

Margin – the amount of money that must be deposited by both buyers and sellers to ensure performance of the person's obligations under a futures contract. Margin on security futures contracts is a performance bond rather than a down payment for the underlying securities.

Mark-to-market – to debit or credit accounts daily to reflect that day's profits and losses.

Narrow-based security index – in general, and subject to certain exclusions, an index that has any one of the following four characteristics: (1) it has nine or fewer component securities; (2) any one of its component securities comprises more than 30% of its weighting; (3) the five highest weighted component securities together comprise more than 60% of its weighting; or (4) the lowest weighted component securities comprising, in the aggregate, 25% of the index's weighting have an aggregate dollar value of average daily trading volume of less than $50 million (or in the case of an index with 15 or more component securities, $30 million). A security index that is not narrow-based is a "broad based security index." (See Broad-based security index).

Nominal value – the face value of the futures contract, obtained by multiplying the contract price by the number of shares or units per contract. If XYZ stock index futures are trading at $50.25 and the contract is for 100 shares of XYZ stock, the nominal value of the futures contract would be $5025.00.

Offsetting – liquidating open positions by either selling fungible contracts in the same contract month as an open long position or buying fungible contracts in the same contract month as an open short position.

Open interest – the total number of open long (or short) contracts in a particular contract month.

Open position – a futures contract position that has neither been offset nor closed by cash settlement or physical delivery.

Performance bond – another way to describe margin payments for futures contracts, which are good faith deposits to ensure performance of a person's obligations under a futures contract rather than down payments for the underlying securities.

Physical delivery – the tender and receipt of the actual security underlying the security futures contract in exchange for payment of the final settlement price.

Position – a person's net long or short open contracts.

Regulated exchange – a registered national securities exchange, a national securities association registered under Section 15A(a) of the Securities Exchange Act of 1934, a designated contract market, a registered derivatives transaction execution facility, or an alternative trading system registered as a broker or dealer.

Security futures contract – a legally binding agreement between two parties to purchase or sell in the future a specific quantify of shares of a security (such as common stock, an exchange-traded fund, or ADR) or a narrow-based security index, at a specified price.

Settlement price – 1) the daily price that the clearing organization uses to mark open positions to market for determining profit and loss and margin calls, 2) the price at which open cash settlement contracts are settled on the last trading day and open physical delivery contracts are invoiced for delivery.

Short – 1) the selling side of an open futures contract, 2) a person who has sold futures contracts that are still open.

Speculating – buying and selling futures contracts with the hope of profiting from anticipated price movements.

Spread – 1) holding a long position in one futures contract and a short position in a related futures contract or contract month in order to profit from an anticipated change in the price relationship between the two, 2) the price difference between two contracts or contract months.

Stop limit order – an order that becomes a limit order when the market trades at a specified price. The order can only be filled at the stop limit price or better.

Stop loss order – an order that becomes a market order when the market trades at a specified price. The order will be filled at whatever price the market is trading at. Also called a stop order.

Tick – the smallest price change allowed in a particular contract.

Trader – a professional speculator who trades for his or her own account.

Underlying security – the instrument on which the security futures contract is based. This instrument can be an individual equity security (including common stock and certain exchange-traded funds and American Depositary Receipts) or a narrow-based index.

Volume – the number of contracts bought or sold during a specified period of time. This figure includes liquidating transactions.

1Since CTAs are not required to provide the disclosure statement for security futures products, the Member carrying the account must provide that statement to customers whose accounts are solicited by CTAs.

2 Financial Industry Regulatory Authority ("FINRA") members are subject to equivalent FINRA requirements.

3 There is a small charge for bulk orders.

9051 - NFA COMPLIANCE RULES 2-9 and 2-36: ETHICS TRAINING REQUIREMENTS

(Board of Directors, July 1, 2003; effective September 30, 2019.)

INTERPRETIVE NOTICE

In October 2001, the CFTC issued a Statement of Acceptable Practices ("Statement") for ethics training. This Statement replaces the Commission's prescriptive ethics training rule and allows flexibility in the format, frequency and providers of ethics training, permitting each firm to tailor its training program to better suit its own operations. By the same token, this shifted the responsibility to each firm to adopt and implement an appropriate ethics training scheme. The Commission intended that the compliance with the Statement's principles would serve as a "safe harbor" concerning acceptable procedures for ethics training programs and topics that ethics training programs should address. Because the Statement is fairly general in nature, however, Members have requested that NFA provide additional information to assist them to comply with their ethics training requirement.

Ethics training is one of a Member's supervisory obligations under NFA's Compliance Rules 2-9 and 2-36. The repeal of the specific regulations relating to ethics training does not diminish Members' and Associates' obligation to diligently supervise its employees. Professional ethical standards remain an essential element of each Member's business model. The use of well-designed ethics training programs supports each Member's supervision of its employees and business activities. Like any other business process, remaining aware of changing industry standards and ensuring high ethical standards is an on-going effort. Developments in technology, commercial practices and regulations and other changes will have ethical ramifications associated with them. Good business practice dictates that employees receive periodic training to keep them cognizant of these developments and their ethical implications.

PROCEDURES
The first thing that all firms should have is written procedures that outline their ethics training program. Acceptable procedures will address:

  1. the topics that will be included in the training program;
  2. by whom the training will be provided;
  3. the format of the training, e.g., classroom instructions, software, etc.;
  4. the frequency with which the Member expects its employees to obtain ethics training; and
  5. how the firm will document that it has followed its written procedures.

CONTENT
The Statement lists the following as topics that an ethics training program should address:

  1. An explanation of the applicable laws and regulations and rules of self-regulatory organizations or contract markets and registered derivatives transaction execution facilities; 1
  2. The registrant's obligation to the public to observe just and equitable principles of trade;
  3. How to act honestly and fairly and with due skill, care and diligence in the best interest of customers and the integrity of the markets;
  4. How to establish effective supervisory systems and internal controls;
  5. Obtaining and assessing the financial situation and investment experience of customers;
  6. Disclosure of material information to customers; and
  7. Avoidance, proper disclosure and handling of conflicts of interest.

The Statement provides that ethics training should be focused to some extent on a person's registration category. Likewise, NFA believes it is appropriate for Members to tailor their ethics training programs to the specific obligations of their membership category and the roles of their personnel.

TRAINING PROVIDERS
It is still acceptable to obtain ethics training sponsored by independent persons, firms, or industry associations. Each Member should ensure that its selected provider is qualified and obtain proof that the provider has completed relevant proficiency testing and has three years of relevant industry experience, or similar experience. NFA's Vice President of Registration may waive the testing requirement where the provider demonstrates competency comparable to satisfying proficiency testing requirements. Firms should only use providers that they reasonably in good faith believe are not subject to any investigations or bars from registration. In-house training is also acceptable; however, firms should apply these same criteria to any in-house training personnel. NFA's BASIC system, which can be found on our website, is an excellent resource to check registration and disciplinary history of providers.

TRAINING FORMAT

Ethics training may be provided through a variety of media, including the Internet, audiotapes, computer software, and videotapes, as well as in-person courses. Less formal methods of training are also permitted, including distribution of periodicals, legal cases and advisories. Each Member should choose a format or formats that best suit its business operations and the nature of its workforce. For example, firms that have a high percentage of APs with disciplinary histories or who come from firms with disciplinary histories may well decide that more structured, formal training is appropriate.

FREQUENCY

Like format, Members should decide how frequently ethics training is required based on the business model, the composition of their sales force and the format of the training. For example, firms that opt for less formal training such as distribution of pertinent written materials should consider keeping the training on a more on-going basis. More formal training, such as classroom instruction, could appropriately be offered less frequently but on a periodic basis.

DOCUMENTATION

Maintaining documentation that the Member has complied with its procedures is a critical element of an acceptable ethics training program because it enables the Member to be certain that it is actually implementing the policies it has deemed necessary and appropriate for its business. The appropriate documentation will vary depending on the firm's overall ethics training program. Firms that distribute written materials should maintain documentation showing what materials were distributed, who selected them and when and to whom they were circulated. Firms that utilize more formal training programs should keep records showing who obtained the training, the date of training, and any materials used.

REQUIREMENTS OF OTHER SELF-REGULATORY ORGANIZATIONS

Other self-regulatory organizations have taken a variety of approaches to ethics training. Members are urged to review the ethics training requirements of the other self-regulatory organizations of which they are members.

CONCLUSION

Members that establish a corporate culture of high ethical behavior will provide the best service for their customers. Remaining aware of changing industry standards and adopting an appropriate ethics training program will help ensure that Members and their Associates continually adhere to the high ethical standards that the Members set for themselves.

1 The regulatory category for derivatives transaction execution facilities was removed by the Dodd-Frank Wall Street Reform and Consumer Protection Act. NFA believes it is appropriate for an ethics training program to explain the rules of swap execution facilities applicable to a Member's business.

9052 - NFA COMPLIANCE RULE 2-38: BUSINESS CONTINUITY AND DISASTER RECOVERY PLAN

Board of Directors, July 1, 2003)

INTERPRETIVE NOTICE

Since the events of September 11, 2001, the financial services industry has devoted increased attention to issues relating to disaster recovery plans. NFA's Board of Directors (Board) believes that disaster recovery and business continuity issues are of utmost importance and that NFA should be proactive in ensuring that its Members have adequate disaster recovery plans in place. As a result, NFA's Board recently adopted NFA Compliance Rule 2-38 to require all Members to adopt a business continuity and disaster recovery plan (Plan).

Compliance Rule 2-38 is broadly written to provide Members with the flexibility to adopt a Plan tailored to their individual needs. NFA recognizes that the exact form of the Plan adopted by a Member will vary based on a number of factors, including the size and complexity of the Member's business and the firm's resources. Nevertheless, the Board believes Members need additional guidance on the essential components of a Plan and what is required to maintain a Plan. This interpretive notice provides that guidance.

Essential Components
Compliance Rule 2-38 requires Members to have a Plan reasonably designed to enable them to continue operating, to reestablish operations, or to transfer their business to other Members with minimal disruption to their customers, other Members, and the commodity futures markets. A Plan should address the following, as applicable:

  • Establishing back-up facilities, systems, and personnel that are located in one or more reasonably separate geographic areas from the Member's primary facilities, systems, and personnel (e.g. primary and back-up facilities should be located in different power grids and different telecommunication vendors should be used), which may include arrangements for the temporary use of facilities, systems, and personnel provided by third parties;

  • Backing up or copying essential documents and data (e.g. general ledger) on a periodic basis and storing the information off-site in either hard-copy or electronic format;

  • Considering the impact of business interruptions encountered by third parties and identifying ways to minimize that impact; and

  • Developing a communication plan to contact essential parties such as employees, customers, carrying brokers, vendors and disaster recovery specialists.

These components are minimum areas that should be addressed in Members' Plans. A Member's Plan should also address any other areas that are essential to its business operations. An effective Plan will be designed to meet the Member's individual situation and needs.

Maintaining the Plan
In order for a Member's Plan to remain effective, the Member must update its Plan as necessary to respond to material changes in the Member's operations. Each Member must also periodically conduct and evidence reasonable reviews designed to assess the Plan's effectiveness.

Even the best Plan is useless if it is not available when needed. Therefore, each Member should distribute and explain the Plan to its key employees and communicate the essential components of the Plan to all employees. Each Member should also maintain copies of the Plan at one or more off-site locations that are readily accessible to key employees.

NFA Compliance Rule 2-38 requires NFA Members to establish and maintain business continuity and disaster recovery plans that are consistent with this interpretive notice. The Rule provides Members with flexibility in developing those Plans, and each Member should adopt a Plan that meets its individual situation and needs.

9053 - FOREX TRANSACTIONS

(Board of Directors, December 1, 2003; revised November 9, 2004; June 13, 2005; September 15, 2005; November 30, 2005; April 30, 2006; July 31, 2006; October 1, 2006; February 13, 2007; March 7, 2007; March 9, 2007; March 31, 2007; May 7, 2007; June 5, 2007; July 1, 2007; September 21, 2007; October 1, 2007; October 25, 2007; December 17, 2007; December 21, 2007; June 1, 2008; July 1, 2008; October 31, 2008; April 1, 2009; June 1, 2009; November 30, 2009; December 17, 2009; October 1, 2010; October 18, 2010; February 1, 2011; October 1, 2011; January 2, 2012; February 1, 2012; July 26, 2012; July 1, 2016; September 19, 2016; March 15, 2019; September 30,2019; January 1, 2020; March 20, 2020; September 10, 2020 and July 1, 2021.)

INTERPRETIVE NOTICE

The Commodity Exchange Act (CEA or Act) gives the Commodity Futures Trading Commission (CFTC or Commission) jurisdiction over certain off-exchange foreign currency transactions offered to or entered into with retail customers.

As described below, NFA Bylaw 306 creates a Forex Dealer Member category for NFA Members who act as counterparties to forex transactions with retail customers. This category allows NFA to exercise appropriate regulatory jurisdiction over the retail forex activities of these Members.

NFA Bylaw 1507(b) defines forex as foreign currency futures and options and any other agreement, contract, or transaction in foreign currency that is offered or entered into on a leveraged or margined basis, or financed by the offeror, the counterparty, or a person acting in concert with the offeror or counterparty on a similar basis that are:

  • offered to or entered into with persons that are not eligible contract participants as defined in Section 1a(18) of the Act (retail customers); and
  • not executed on or subject to the rules of a contract market, a derivatives transaction execution facility, a national securities exchange registered pursuant to Section 6(a) of the Securities Exchange Act of 1934, or a foreign board of trade.1

Bylaw 1507(b) also excludes the following from the forex definition if the transaction is not a futures or options contract:

  • securities (other than security futures products);
  • any contract of sale that results in actual delivery within two days; and
  • any contract of sale that creates an enforceable obligation to deliver between a seller and buyer that have the ability to deliver and accept delivery, respectively, in connection with their line of business.

Given the differences between off-exchange forex transactions and traditional exchange-traded futures and options, NFA's Board of Directors has adopted Compliance Rule 2-36 and this Interpretive Notice to establish specific requirements for forex transactions, Forex Dealer Members and their Associates.

In developing its forex requirements, NFA's primary concern was to ensure that they provide adequate protection for retail customers without imposing undue burdens on NFA Members. NFA also believes that its requirements should, where consistent with customer protection, promote innovation and competition. In order to provide Members with as much flexibility as possible, NFA has chosen to deal with a number of issues by providing guidance under NFA Compliance Rule 2-36 instead of by adopting additional rules.

NFA Compliance Rule 2-36 sets out the general standards that apply to Forex Dealer Members and their Associates in connection with forex transactions. Subsection (b) prohibits Forex Dealer Members and their Associates from engaging in fraudulent activities, subsection (c) requires Forex Dealer Members and their Associates to observe high standards of commercial honor and just and equitable principles of trade in connection with their forex business, subsection (d) prohibits Members from accepting forex orders or accounts from, handling a forex transaction for or on behalf of, receiving compensation for forex transactions from, or paying compensation for forex transactions to any non-Member of NFA that is required to be registered with the Commission as a FCM, RFED, IB, CPO, or CTA in connection with its forex activities, subsection (e) requires Forex Dealer Members and their Associates with supervisory duties to supervise their employees and agents, subsection (f) requires Forex Dealer Members to provide customers (at account opening and annually thereafter) with written information regarding NFA’s BASIC, subsection (g) provides that communication with the public and promotional material used by a Forex Dealer Member or its Associate must comply with all of the requirements of  NFA Compliance Rule 2-29 and the Interpretive Notices related to this rule, subsection (i) requires Forex Dealer Members to notify NFA prior to commencing customer business, subsection (j) requires Forex Dealer Members to designate a Chief Compliance Officer and subsection (l) requires Members and Associates to obtain specific customer information and provide required risk disclosure at the time of account opening. Compliance Rule 2-39 extends these provisions to other Members and their Associates who solicit, introduce or manage forex accounts.

This notice has three sections. The first section explains who qualifies as a Forex Dealer Member under NFA Bylaw 306, the second section provides additional guidance about the requirements in Compliance Rule 2-36, and the third section covers other miscellaneous requirements.

A. BYLAW 306

Forex Dealer Members are NFA Members who act as counterparties to forex transactions. This is a self-executing requirement, which means that any Member who qualifies is automatically a Forex Dealer Member. There is no application form and no approval requirement.

Members who do not act as counterparties are not Forex Dealer Members, even if they introduce or manage forex accounts. Under NFA Compliance Rule 2-39, however, Members who introduce or manage forex accounts are required to comply with subsections (a), (b), (c), (d), (e), (g), (h) and (l) of NFA Compliance Rule 2-36.

B. COMPLIANCE RULE 2-36

As noted above, this section provides additional guidance on what Compliance Rule 2-36 requires. Certain sections specifically refer to Forex Dealer Members. All other provisions of this notice also apply to Members and their Associates who solicit, introduce or manage forex accounts.

1. Disclosure - Members must provide forex customers with understandable and timely disclosure on essential features of forex trading.

At or before the time a customer first engages in a forex transaction, a Forex Dealer Member and its Associates should provide the customer sufficient information concerning the characteristics and particular risks of entering into forex transactions. Members and Associates introducing or managing accounts should know what information has been provided and should supplement it when necessary. At or before the time a customer first engages in a forex transaction, a Member and its Associates should also disclose how the Member will be compensated for the services it will provide to the customer. Forex Dealer Members should provide both the bid and the offer when the customer enters an order. Members should update any material information that has changed prior to entering into new transactions with current customers if failing to update the information would make it misleading.

2. Supervision - Members and their Associates having supervisory responsibilities must diligently supervise the Member's forex business, including the activities of the Member's Associates and agents. Members must establish, maintain, and enforce written supervisory procedures.

NFA has provided Members with guidance on minimum standards of supervision through interpretive notices issued under NFA Compliance Rule 2-9.2 In these interpretive notices NFA recognized that, given the differences in the size of and complexity of the operations of NFA Members, there must be some degree of flexibility in determining what constitutes "diligent supervision" for each firm. This principle also applies to the supervision of a Member's forex business.

Although Members have the flexibility to design procedures that are tailored to their own situation, an adequate program for supervision would include procedures for performing day-to-day monitoring. These procedures would include:

  • screening prospective Associates to ensure that they are qualified and to determine the extent of supervision the person would require if hired;
  • screening persons with whom the Member intends to do forex business to determine if they are required to be registered with the Commission and, if so, to ensure that they are Members of NFA;
  • monitoring communications with the public, including sales solicitations and web sites, and approving promotional material;
  • reviewing the information obtained from and the information provided to customers solicited by the firm and its employees to ensure that the necessary account information has been obtained and the appropriate information provided; and
  • handling and resolving customer complaints;
  • reviewing disclosures given to customers to ensure they are understandable, timely, and provide sufficient information;
  • reviewing and analyzing the forex activity in customer accounts, including discretionary customer accounts; and
  • handling customer funds, including accepting security deposits, if applicable.

A Forex Dealer Member and a listed principal that is also a registered associated person (see Financial Requirements 15(c)) must supervise the preparation of a Forex Dealer Member's financial books and records. Diligent supervision includes hiring and retaining qualified staff. In determining whether an individual responsible for preparing the Member's financial books and records is qualified, the firm and its financial principal should consider the following:

  • Is the individual qualified for the position by experience or training?
  • Does the individual exercise independent judgment?
  • Has the individual ever been sanctioned or refused membership or licensing by NFA, the CFTC, the SEC, NASD or FINRA, the Public Company Accounting Oversight Board, or any other financial regulator?
  • Has the individual ever been sanctioned or refused membership by the American Institute of Certified Public Accountants or any other accounting organization?
  • Has any firm for which the individual performed auditing, accounting, or bookkeeping been subject to an emergency action or sanctioned by NFA, the CFTC, the SEC, NASD or FINRA, the Public Company Accounting Oversight Board, or any other financial regulator for failure to comply with financial requirements or for having inadequate books and records while the individual was engaged in those activities?
  • Are there any pending actions against the individual or a firm for which the individual performed auditing, accounting, or bookkeeping?

This is not an exclusive list. If the individual or a firm for which the individual worked (either as an independent contractor or an employee) was subject to an emergency action, sanctioned by a financial regulator, or is subject to a pending action, the FDM and the listed principal/registered AP responsible for the FDM's financial books and records should consider the nature and seriousness of the conduct (or alleged conduct) and the individual's role in it. An NFA Member Responsibility Action or an emergency action by another financial regulator is always an extremely serious matter.

The Forex Dealer Member and its financial principal must also conduct due diligence and consider analogous information when selecting an independent public accountant to certify the firm's annual financial statements.

An adequate supervisory program should include on-site visits to branch offices and guaranteed introducing brokers that conduct forex business on behalf of the Member. The Member needs to determine the frequency and nature of these visits. Members should refer to NFA Interpretive Notice 9019 - Compliance Rule 2-9: Supervision of Branch Offices and Guaranteed IBs for the minimum standards for a supervisory program for branch offices and guaranteed IBs, including the inspection requirement.

Finally, a Member's supervisory responsibilities include the obligation to ensure that its employees are properly trained to perform their duties. The formality of a training program will depend on the size of the firm and the nature of its business. Procedures should be in place to ensure that supervisory personnel know and understand the firm's supervisory procedures and that employees receive adequate training to abide by NFA requirements and to properly handle customer accounts.

3. Communications with the Public and Promotional Material - No Member or Associate shall make any communication with potential or current customers that is not in accordance with the requirements set forth under NFA Compliance Rule 2-29 and the Interpretative Notices related to this rule.

Further, the Forex Dealer Member and its Associates must also comply with the following requirements, which are exclusive to communications relating to forex transactions:

No Member or Associate may represent that forex funds deposited with a Forex Dealer Member are given special protection under the bankruptcy laws. No Member or Associate may represent or imply that any assets necessary to satisfy its obligations to customers are more secure because the Member keeps some or all of those assets at a regulated entity in the United States or a money center country.

No Member or Associate may represent that its services are commission free without prominently disclosing how it is compensated in near proximity to that representation.

No Member or Associate may represent that a customer will have direct access to the interbank-market because the Member is actually the counterparty to every customers' forex transactions. Similarly, no Member or Associate that is straight through processing orders can suggest that they are not the counterparty to the customers' trade (i.e., the FDM is simply acting as a middleman between the customer and the Prime Broker in the interbank market).

No Member or Associate may represent that it offers trading with "no-slippage" or that it guarantees the price at which a transaction will be executed or filled, unless:

  • It can demonstrate that all orders for all customers have been executed and fulfilled at the price initially quoted on the trading platform when the order was placed3; and
  • No authority exists, pursuant to a contract, agreement, or otherwise, to adjust customer accounts in a manner that would have the direct or indirect effect of changing the price at which an order was executed.4

Members and Associates may not solicit customers based on the leverage available unless they balance any discussion regarding the advantages of leverage with an equally prominent contemporaneous disclosure that increasing leverage increases risk.

Members may also be subject to discipline for promotional material promoting forex trading systems developed by third parties. For example, a Member has direct responsibility for misleading promotional material if the Member prepares or distributes it; has agency responsibility if the trading system developer is an agent of the Member under established principles of agency law; and has supervisory responsibility if the Member fails to supervise its own employees when linking to a third-party trading system developer's website, recommending a third-party's trading system, or entering into a referral agreement with a third-party system developer.

4. Customer Information and Risk Disclosure- Members and Associates are required to acquaint themselves sufficiently with the personal and financial circumstances of each forex customer and provide the customer with certain required risk disclosures as well as other facts, explanations and disclosures needed in order for the customer to make an informed decision on whether to enter into forex transactions.

Every Member should determine what information it will obtain from a prospective forex customer. At a minimum, the Member soliciting the customer to engage in forex transactions must obtain the information and provide the disclosures required by Compliance Rule 2-36(l). Members and their Associates need to ensure that each customer they solicit has received adequate information concerning the risks of forex transactions so that the customer can make an informed decision as to whether forex transactions are appropriate for the customer. There may be some customers for whom the additional disclosure will portray forex trading as too risky for that customer. In these instances, the only adequate risk disclosure by the Member and Associate is that forex 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 forex 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 forex trading is too risky for that customer. Finally, although it is the responsibility of the Member soliciting the account to comply with these requirements, Members may agree in writing that the Member acting as the counterparty to the transaction will be responsible for fulfilling the requirements of Compliance Rule 2-36(l). Members should refer to NFA Interpretive Notice 9004 – NFA Compliance Rule 2-30: Customer Information and Risk Disclosure for additional guidance on the requirements of this section.

5. BASIC Disclosure - Members must provide forex customers with information on NFA's BASIC system.

NFA Compliance Rule 2-36(g) requires Forex Dealer Members to provide customers with written information regarding NFA's Background Affiliation Status Information Center (BASIC), including the website address. Forex Dealer Members may comply with this requirement by providing customers with a copy of NFA's publication entitled "BASIC: A Due Diligence Resource for the Investing Public" which is available in print and on NFA's website at www.nfa.futures.org. This information must be provided when the customer first opens an account and at least once a year thereafter.

Forex Dealer Members may provide the information electronically but must do it in a way that ensures each customer is aware of it. For example, merely having the information on the Member's web site is not adequate, but sending customers an e-mail including a link to that information and explaining what the link is would be sufficient in most circumstances.

C. OTHER REQUIREMENTS

This section of the notice provides guidance on dues, capital requirements, and security deposits. These requirements apply only to Forex Dealer Members.

1. Bylaw 1301

NFA Bylaw 1301(e) requires Forex Dealer Members to pay annual dues that are graduated according to the firm's gross annual revenue from customers (e.g., commissions, mark-ups, mark-downs) for its forex activities. Profits and losses from proprietary trades are not to be included.

The following table shows the dues to be assessed for Forex Dealer Members:

Amount of Annual Gross Revenue From Forex Transactions Dues if NFA is the DSRO Dues if NFA is not the DSRO
$5 million or less $125,000 $25,000
More than $5 million, but not more than $10 million $250,000 $25,000
More than $10 million, but not more than $25 million $500,000 $25,000
More than $25 million, but not more than $50 million $750,000 $25,000
More than $50 million $1,000,000 $25,000

These dues apply when a firm first becomes approved as a Forex Dealer Member or accepts a forex trade (whichever is earlier). New Members' initial dues will be the minimum dues ($125,000), payable quarterly. If an existing Member becomes approved as a Forex Dealer Member, NFA will send the Member an invoice for the minimum dues ($125,000) minus any amount already paid for that membership year. Thereafter, the dues will be assessed on the firm's membership renewal date, will be invoiced and paid quarterly, and will be based on the Forex Dealer Member's latest certified financial statement.

The only exception to the dues set forth above is a situation in which NFA does not serve as the DSRO for a Forex Dealer Member and the DSRO has agreed to examine the Forex Dealer Member's forex activities. In this case, the membership dues paid by the Forex Dealer Member, regardless of gross annual revenue, is $25,000. Accordingly, for such a Forex Dealer Member the dues to be assessed at the time it offers to be a counterparty to a forex transaction or accepts a forex trade (whichever is earlier), and on its membership renewal date thereafter, will be $25,000.

Each Forex Dealer Member is also required to pay an assessment of $.001 on each order segment submitted by the Forex Dealer Member to NFA's Forex Transaction Reporting Execution Surveillance System. For purposes of this requirement, an order segment is a record of any line of data associated with an order, and includes when an order is added, modified, cancelled or filled. In addition, unfilled open orders that are carried over by the system are considered a new order segment the next day.

NFA will invoice the Member monthly for the Forex Transaction Reporting Execution Surveillance System assessment amount and the Member must remit the assessment to NFA within 30 days after the date of the invoice.

2. Financial Requirements Section 11(a)

Forex Dealer Members must maintain adjusted net capital equal to or in excess of the greatest amount specified in subsections (a)(i), (a)(ii), and (a)(iii) (if applicable). Subsection (a)(ii) applies to Forex Dealer Members that execute any customer transactions and that also have liabilities to customers of more than $10 million. Where it applies, the Member’s capital requirement is the minimum capital required by subsection (a)(i) plus 5% of the liabilities over $10 million. The formula is:

    Amount required by (a)(i) + .05(customer liabilities - $10,000,000)

For example, if the minimum capital requirement is $20 million, a Forex Dealer Member that operates a dealing desk and has $208 million in liabilities to customers would be required to maintain adjusted net capital equal to or in excess of $29.9 million.

3. Financial Requirements Section 11(b)

Section 11(b) prohibits a Forex Dealer Member from including assets held by an affiliate or an unregulated person in the firm's current assets for purposes of determining its adjusted net capital under CFTC Regulation 5.7(b)(2)(v)(A). This means an FDM may not count any part of those assets for capital purposes.5

An unregulated person is any person that is not:

    (i) a bank or trust company regulated by a U.S. banking regulator;

    (ii) a broker-dealer registered with the U.S. Securities and Exchange Commission and a member of FINRA;

    (iii) a futures commission merchant registered with the U.S. Commodity Futures Trading Commission and a Member of NFA;

    (iv)a retail foreign exchange dealer registered with the U.S. Commodity Futures Trading Commission and a Member of NFA; or

    (v) a bank or trust company regulated in a money center country which has in excess of $1 billion in regulatory capital.

NFA will not accept requests to approve an affiliate or unregulated person under NFA Financial Requirements Sections 11(b) or 11(c) or CFTC Regulation 5.7.

4. Financial Requirements Section 11(c)

Section 11(c) prohibits Forex Dealer Members from considering offsetting currency transactions or positions executed with or held by or through an affiliate or unregulated person for purposes of determining net currency positions and the required capital deductions under CFTC Regulations 1.17(c)(5) and 5.7(b)(2)(v)(A).

The rule does not prohibit Forex Dealer Members from entering into positions with an affiliate or unregulated counterparty. They may not, however, count positions with those counterparty when calculating their net positions or covered positions for purposes of CFTC Regulations 1.17(c)(5) and 5.7(b)(2)(v)(A).

5. Financial Requirements Section 13

Section 13 obligates FDMs to file daily reports regarding an FDM's capital position and its ability to meet its obligation to retail Forex customers. Among other daily reporting obligations, FDMs must indicate the net aggregate notional value for all open futures and options Forex positions.

In addition, NFA requires FDMs to provide operational information on a monthly basis. These monthly reports must specify the number of retail and ECP Forex customers as well as how many customers are active, US domiciled or foreign domiciled. Also, FDMs must file monthly reports with respect to the FDM's risk management of its market exposure. NFA may require an FDM to file additional information on a monthly basis as needed. These monthly operational reports must be filed within seventeen business days of the month for which the report is prepared.

FDMs must also file quarterly reports containing the most updated performance disclosures required by CFTC Regulation 5.5(e)(1)(i) – (iii). This report must include the total number of non-discretionary retail forex customer accounts maintained by the FDM for the prior quarter, the percentage of such accounts that were profitable during the quarter and the percentage of accounts that were not profitable during the quarter. These quarterly reports must be filed within seventeen business days of the quarter for which the report is prepared.

NFA may also require FDMs to file other reports regarding the FDM's capital position, its operations or any other information which NFA deems relevant in assessing the FDM's overall compliance with NFA requirements.

1 The Board of Directors has declared that these transactions are a proper subject of NFA regulation and oversight under Article XVIII, paragraph (k).

2 See, for example, Interpretive Notice 9019 - Compliance Rule 2-9: Supervision of Branch Offices and Guaranteed IBs; Interpretive Notice 9037 - NFA Compliance Rules 2-9, 2-10, 2-29, 2-36 and 2-39: Guidance on the Use and Supervision of Websites, Social Media and Other Electronic Communications; Interpretive Notice 9046 - Compliance Rule 2-9: Supervision of the Use of Automated Order-Routing Systems (the principles included in this Interpretive Notice apply to forex activities.)

3 The Forex Dealer Member is not required to give the customer a price that is no longer reflected on the platform at the time the order reaches it. The Forex Dealer Member is not responsible for transmission delays outside its control. If a Forex Dealer Member, however, advertises "no-slippage" or that it guarantees fill prices, it must prominently disclose that transmission delays might result in customer orders being executed at a price other than that seen by the customer.

4 This includes force majeure provisions.

5 Where the CFTC's requirements for holding current assets are more stringent, those requirements apply.

9054 - COMPLIANCE RULE 2-34: CTA PERFORMANCE REPORTING AND DISCLOSURES

(Board of Directors, November 20, 2003; effective May 1, 2004. Revised February 1, 2020 and June 30, 2020.)

INTERPRETIVE NOTICE

I. Introduction

NFA's Board of Directors (Board) believes that Member CTAs should use a uniform calculation to make it easier for clients to compare the performance of different CTAs. The Board also believes that rate of return (ROR) should be based on the amount that is the basis for the CTA's trading decisions so that ROR measures the CTA's true performance regardless of its clients' various cash management practices. Therefore, NFA's Board has adopted NFA Compliance Rule 2-34 to provide performance standards for Member CTAs and to require certain disclosures to clients that explain the effect of partially funding their accounts. The Board has also adopted this Interpretive Notice to provide guidance to CTA Members regarding performance reporting and disclosure requirements for accounts with actual funds that differ from nominal account size, as well as to provide additional performance presentation guidance.

II. Accounts with Actual Funds that Differ from the Nominal Account Size Written Confirmation for Accounts with Actual Funds that Differ from the Nominal Account Size

The Board recognizes a client may elect to partially fund its account by depositing less funds with the FCM carrying its account than the client has directed the CTA trading the account to use as the basis for trading decisions. A client may also choose to fund or maintain its account with an amount in excess of the amount the client has directed the CTA to use as the basis for trading decisions. The amount of equity in the client's commodity trading account plus any funds that can be transferred to that account without the client's consent to each transfer is known as actual funds (see NFA Compliance Rule 1-1(b)). The amount of funds agreed to by the client that establishes the level of trading engaged in by the CTA is known as the nominal account size (see NFA Compliance Rule 1-1(x)).1 The Board believes that the nominal account size should be documented to provide "discipline in the denominator" by ensuring that the client and the CTA have agreed on the account size before the account begins trading. This documentation will also provide an objective audit trail to verify past performance records.

Compliance Rule 2-34(b) requires the CTA to document the trading program nominal account size and the effect of cash additions, cash withdrawals and net performance on nominal account size for each client with actual funds that differ from the nominal account size by either receiving a written confirmation from or providing a written confirmation to the client with this information prior to the time the CTA places the first trade for the client.2 If the CTA is providing the written confirmation, the information may be included in the advisory agreement or delivered to the client as a separate document as long as the written confirmation is provided to the client before the CTA places the first trade for that client. If any changes are made to the client's trading program, nominal account size or the way in which cash additions, cash withdrawals or net performance affect nominal account size, a written confirmation describing these changes must be provided to or received from the client prior to the CTA placing any new trades for the client. In the absence of a written confirmation designating a nominal account size, performance returns must be based upon the amount of actual funds.

The Rule does not require the CTA to get the client's written acknowledgement to a confirmation provided by the CTA, although the CTA may choose to do so. If the CTA does not require a written acknowledgement, the confirmation should inform the client that the client must notify the CTA, within a reasonable period specified in the confirmation, if the client does not agree with the terms included in the confirmation. The confirmation may be delivered in any manner consistent with CFTC requirements for delivery of account statements by commodity pool operators under CFTC Regulation 4.22(i).

Additional Disclosure for Partially-Funded Accounts

Compliance Rule 2-34(c) requires CTAs to provide certain information to clients with partially-funded accounts if those clients are not QEPs. These additional disclosures are designed to provide information to clients on the effects of partial funding on net performance, fees, margin and leverage so that they can make informed decisions when funding their accounts

Subsection (c)(4) requires CTAs to provide a description, by example or formula, of the effect of partial funding on ROR and draw-down percentages. A CTA may provide this information by example using a simple matrix showing the effect of partial funding at different funding levels as illustrated by the following matrix:

Rates of Return Based On Various Funding Levels

Actual Rate of Return Level of Funding
100.00% 75.00% 66.67% 50.00%
-40.00% -40.00% -53.33% -60.00% -80.00%
-30.00% -30.00% -40.00% -45.00% -60.00%
-20.00% -20.00% -26.67% -30.00% -40.00%
-10.00% -10.00% -13.33% -15.00% -20.00%
00.00% 00.00% 00.00% 00.00% 00.00%
10.00% 10.00% 13.33% 15.00% 20.00%
20.00% 20.00% 26.67% 30.00% 40.00%
30.00% 30.00% 40.00% 45.00% 60.00%
40.00% 40.00% 53.33% 60.00% 80.00%

In the alternative, a CTA may provide the client with the following formula, which converts ROR percentages based on the nominal account size to ROR percentages based on the partial funding level:

    (nominal account size / actual funds) * n = a

    where n is the ROR percentage based on the nominal account size and a is the ROR percentage based on actual funds

The disclosures required by Compliance Rule 2-34(c) can be included in the CTA's disclosure document or the advisory agreement. They can also be provided in a separate document delivered to the client before the CTA places the first trade for the client.

II. Other Performance Reporting Guidance

Actual Funds

Rule 2-34(a)(3) provides that CTAs may include earned interest on actual funds in calculating net performance but may not impute interest on other funds. Compliance Rule 1-1(b) defines actual funds as the equity in a commodity trading account over which a CTA has trading authority and funds that can be transferred to that account without the client's consent to each transfer. Funds that are not in the trading account, often referred to as committed funds, qualify as actual funds if they meet the following four tests:

1. The ownership of the trading account and any other accounts holding funds available to the CTA for trading must be identical;

2. The funds must be available for transfer to the client's trading account (e.g., free credit balances that are not committed to another CTA's trading program);

3. The client must agree in writing that the FCM may transfer the funds to the client's managed account at the CTA's request; and

4. The CTA must be able to verify the amount of these funds.3

Composite Performance Reporting

Compliance Rule 2-34(a) requires RORs to be calculated on nominal account size. As a general rule, accounts in the same trading program should have materially the same ROR and should be included in the same composite performance capsule.4 Accounts that have similar RORs but are traded differently are not considered to be in the same trading program and may not be included in the same composite performance capsule.

Whether RORs are materially the same may vary depending on the circumstances. However, accounts that are part of the same trading program that meet the requirements of the following test generally will be considered to have materially the same ROR:5

  • If the composite ROR including the account and the composite ROR excluding the account average 10% or more, they are materially the same if the difference between the two RORs is less than 10% of their average.

  • If the composite ROR including the account and the composite ROR excluding the account average less than 10% and greater than 5% they are materially the same if the absolute difference between the two RORs is no more than 1.5%.

  • If the composite ROR including the account and the composite ROR excluding the account average 5% or less, they are materially the same if the absolute difference between the two RORs is no more than 1%.

The primary reason for this materiality test is to objectively demonstrate that each account included in the performance capsule is part of the same trading program. For that reason, the materiality test should use gross trading profits and losses rather than net performance. If a particular account in the capsule has a material effect on the capsule's net performance due to account-specific factors (e.g., commissions or interest), the CTA may continue to include that account in the capsule if it meets the materiality test using gross trading profits and losses. However, the CTA should disclose the difference in net performance and identify the factors that are responsible for that difference.

There may be instances in which a population of the accounts included in a CTA's composite performance capsule appear on their face to meet one of the materiality tests described above on an account by account basis, but due to material differences in the nominal size of these accounts they serve to distort the overall performance of the composite. As a result, the ROR of the composite performance is not representative of the actual ROR experienced by a majority of the other accounts. In such instances, the population of accounts with nominal sizes that materially differ from the nominal size of the majority of the accounts should be composited separately.

Additions and Withdrawals

Large additions and withdrawals during the reporting period may distort ROR. If they do have a material effect, however, the CTA must use an approved method to minimize the distortion. Appendix B to Part 4 of the CFTC's Regulations describes two methods that CTAs may use to adjust for additions and withdrawals when calculating ROR: the compounded rate of return method and the time-weighted method. These methods are available to all CTAs under the terms described in Appendix B of Part 4 of the CFTC's Regulations.

CTAs may also use a third method - the only accounts traded (OAT) method - that adjusts for additions and withdrawals by temporarily excluding certain accounts when calculating ROR.6 This method can be used if the following conditions are met:

1. As with any performance information, all of the accounts are part of the same trading program;

2. Excluding the accounts does not result in the systematic exclusion of any material costs (e.g., accounts with withdrawals or that are closed during the reporting period must be included in ROR if there is a significant fee that is only charged when funds are withdrawn or accounts are closed);

3. Only accounts that meet one of the following requirements are excluded:

  • The account was opened during the reporting period,

  • The account was closed during the reporting period,

  • The account had no open positions and did not trade during the reporting period because it has not yet been approved for trading or because during the reporting period the client intended to close the account and then closed the account shortly after the reporting period ended,7 or

  • The net additions and withdrawals in the account exceeded 10% of the beginning net nominal account value for the period for that individual account;

4. Use of this method does not produce an ROR that is materially different from the ROR expected to be produced by either the compounded rate of return method or the time-weighted method over time; and

5. The method does not exclude a significant percentage of the accounts in the trading program.

In general, the CTA should use one method consistently provided that it results in an ROR calculation that accurately and reasonably represents the ROR. The CTA should use this method except where the method would produce results that are materially different from the actual experience of accounts in the trading program,8 in which case the CTA should use one of the other methods described above that better reflects the actual experience of accounts in the trading program. The CTA must disclose the method that is consistently used and, if the CTA uses a different method for a particular reporting period, the CTA must disclose the method actually used for that reporting period and describe why that method was used.9

CTAs may use any of these three methods without obtaining prior approval from NFA or the CFTC. Pursuant to Appendix B to Part 4 of the CFTC's Regulations, a CTA may use another method of addressing the effect of additions and withdrawals on the ROR calculation if the CTA submits a proposal to the CFTC, prior to use, that demonstrates that the alternate method provides an accurate picture of the CTA's ROR and is more appropriate for that CTA.

Exception to Compounded Returns

CFTC Regulation 4.35 requires that the annual ROR, the peak-to-valley draw-down percentage and the net lifetime ROR be computed on a compounded monthly basis. However, for programs where net performance does not affect the nominal account size, and therefore profits are not reinvested, the CTA must sum the monthly performance returns instead of compounding them when calculating the annual return, the peak-to-valley draw-down percentage and the net lifetime ROR.

* * * * *

All performance information must be presented in a manner that is balanced and is not misleading. CTAs have an obligation to disclose all material information even if it is not specifically required by CFTC or NFA rules. Compliance Rule 2-34 and this Interpretive Notice do not relieve CTAs of that obligation.

1 Another term often referred to in discussing partial funding is notional funds. Notional funds represent the difference between nominal account size and actual funds in a client's account.

2 If cash additions, cash withdrawals and net performance will not affect the nominal account size, the CTA must provide in the written confirmation an affirmative statement to this effect.

3 Compliance Rule 2-34(a) provides that Member CTAs may include interest earned on actual funds but may not impute interest on other funds when calculating net performance. The CTA must be able to verify the amount of interest earned on the funds if the CTA includes that interest as part of its net performance.

4Accounts in the same trading program generally have the same pattern of trading.

5 This same materiality test can be used in other contexts. For example, Interpretive Notice 9029 – NFA Compliance Rule 2-10: The Allocation of Bunched Orders for Multiple Accounts requires CTAs to modify their allocation methods if accounts in the same trading program have materially different performance results. This is another instance where materiality would be measured using gross trading profits and losses.

6 The accounts can only be excluded when calculating ROR. They must be included in the CTA's capsule performance for other purposes, including reporting of total assets under management.

7 An account that was open for the entire reporting period and had open positions or trading activity during the reporting period cannot be excluded even if it has not yet caught up to the performance of the other accounts in the program (unless its net additions and withdrawals exceeded 10% of its beginning net nominal account value for the period). An account with a trading pause cannot be excluded solely because of the trading pause, especially if the program dictated the trading pause. If the trading pause results from client-imposed restrictions that cause the account to be idle or traded differently from the other accounts in the trading program the account may belong in a different performance capsule.

8 These instances should be rare. If the CTA's principal method frequently produces results that are materially different from the actual experience of accounts in the trading program, the CTA should change to a more consistent method.

9 This information should be included in a footnote to the performance capsule. If the trading program experienced an unusual change in the number or size of additions, withdrawals, accounts opened, or accounts closed during the reporting period, the CTA should also highlight that change in a footnote and should describe the reason for the change, if known.

9055 - NFA BYLAW 1101, COMPLIANCE RULES 2-9 AND 2-29: GUIDELINES RELATING TO THE REGISTRATION OF THIRD-PARTY TRADING SYSTEM DEVELOPERS AND THE RESPONSIBILITY OF NFA MEMBERS FOR PROMOTIONAL MATERIAL THAT PROMOTES THIRD-PARTY TRADING SYSTEM DEVELOPERS AND THEIR TRADING SYSTEMS

(Board of Directors, August 19, 2004; effective January 10, 2005; September 19, 2016 and January 1, 2020)

INTERPRETIVE NOTICE

In recent years, there has been a significant increase in the number of futures trading systems being marketed to the public. These trading systems typically are computerized programs that generate signals as to when to buy and sell commodity futures and options contracts.

A number of NFA Member firms offer trade execution services to customers who use these computerized trading systems, many of which are developed by third-party trading system developers ("third-party system developers"), who are neither NFA members nor registered with the CFTC. Typically, in these situations, the customer will execute a Letter of Direction that directs the Member to place trades for the customer in strict accordance with the signals generated by the trading system. In some cases, the Letter of Direction is more limited and includes instructions to follow only certain signals (e.g., signals in given contracts or signals that meet particular parameters). In almost all cases in which a Letter of Direction is used, the Member is not permitted to use any judgment when placing orders for the customer.

This notice is designed to provide guidance as to the circumstances which may give rise to liability on the part of the Member, under NFA Bylaw 1101, for providing execution services to users of computerized trading systems developed by non-Member third-party system developers. This notice will also discuss the factors that may cause a Member to be responsible, under NFA Compliance Rule 2-29, for promotional material which promotes these trading systems and the Member's supervisory obligations under NFA Compliance Rule 2-9.

REGISTRATION REQUIREMENTS FOR
THIRD-PARTY SYSTEM DEVELOPERS

Section 1a(12) of the Commodity Exchange Act ("CEA") defines a CTA as any person who for compensation or profit, engages in the business of advising others, directly or through publications, writings, or electronic media, as to the value of or the advisability of trading commodity futures. Generally, Section 4m of the CEA requires individuals who fall within this definition to register with the CFTC. In March 2000, the CFTC adopted CFTC Rule 4.14(a)(9) to create an exemption from the CEA's registration requirements for CTAs that provide standardized advice by means of media such as newsletters, pre-recorded telephone hotlines, Internet web sites, and non-customized computer software.

To qualify for the exemption, under Rule 4.14(a)(9)(i) a CTA may not direct client accounts. As defined by Commission Rule 4.10(f), "Direct, as used in the context of trading commodity interest accounts, refers to agreements whereby a person is authorized to cause transactions to be effected for a client's commodity interest account without the client's specific authorization.'' In a Commission Staff letter issued in May 2003, Commission Staff indicated that an agreement authorizing a person to direct a client's account - and, thus, requiring the person to be registered as a CTA - may be an informal agreement. The fact pattern addressed by the Commission's Staff letter involved a developer of a computerized trading system who was registered as an associated person ("AP") of an introducing broker ("IB"). The AP's activities on behalf of the IB consisted solely of soliciting clients to use his trading program. Such clients executed a "letter of direction" providing that the IB should execute trades for the clients' accounts and "follow [the trading program] signals as close as reasonably possible."

In analyzing the above fact pattern, Commission Staff concluded that, since the clients' contact with the AP/trading system developer included not only the trading program, but also the opening of a trading account that would be traded pursuant to a "letter of direction," there was an "informal arrangement", for which the exemption provided under Rule 4.14(a)(9) was not intended. After specifically noting that the "whole of [the AP/trading system developer's] activities as an AP of the IB consisted of the solicitation of clients for the trading program, CFTC staff determined that registration as a CTA was required of either the IB or the AP. (See CFTC staff letter, No. 03-26, May 30, 2003, re Section 4m - Interpretation with regard to Commodity Trading Advisor Registration.)

Rule 4.14(a)(9)(ii) also provides that, to qualify for the exemption, a CTA may not provide "commodity trading advice based on, or tailored to, the commodity interest or cash market positions or other circumstances or characteristics of particular clients." So long as the CTA's advice is based on or tailored to such information, the CTA is required to register even if it gives the same advice to groups of similarly situated clients.

In determining whether advice is "based on or tailored to" within the meaning of 4.14 (a)(9)(ii), the context of the advice will be taken into account. For example, if the advice is provided in a book or a periodical, that factor may weigh against a finding that the CTA is providing advice "based on or tailored to" the characteristics of particular clients. On the other hand, if the advice is provided to a particular client in a face-to-face communication or over the telephone, that factor may weigh in favor of a finding that the CTA's advice is "based on or tailored to" that particular customer's characteristics, since such a context suggests that the CTA is being responsive to the client's individual needs.1

Whether a third-party system developer is required to be registered as a CTA still depends on the particular facts of each case. In some cases, the third-party system developer - or any third-party, for that matter - may be required to register as an IB, if it refers customers to an NFA Member and receives compensation for the referrals. Members who have questions concerning the application of Rule 4.14 are urged to seek advice from the CFTC.

Regardless of whether a third-party system developer is required to register as a CTA, the question sometimes arises whether the IBs involved must also register as CTAs. If the IB and the third-party system developer are operated as wholly independent entities and the IB has no authority to deviate from the third-party system developer's recommendations, generally the IB need not also register as a CTA. This is clearly the case where a customer independently selects a trading system and the IB does not solicit discretionary trading authority. However, if any of these factors change (e.g., the IB has authority to deviate from the trading system by selecting only some of the trades generated by the system), the IB may be required to register as a CTA, unless the IB is otherwise exempt because its activities related to placing trades based on the recommendations of the trading system are "solely in connection with its business as an IB."

NFA Bylaw 1101 provides, in pertinent part, that no Member may carry an account, accept an order or handle a transaction in commodity futures on behalf of any non-Member that is required to be registered as a CTA or in some other capacity. Therefore, if it appears that a third-party system developer, with whom an NFA Member does business, is required to be registered as a CTA or in some other capacity, the Member should request that the third-party system developer provide a letter from counsel stating the reasons why registration is not required.2 In the absence of such a letter, the Member should request that the third-party system developer apply for registration and NFA membership. If the third-party system developer fails or refuses to register and become an NFA Member, the Member should terminate its relationship with the third-party system developer to avoid liability under NFA Bylaw 1101.

A MEMBER'S RESPONSIBILITY FOR MISLEADING
PROMOTIONAL MATERIAL WHICH PROMOTES A
THIRD-PARTY SYSTEM DEVELOPER'S TRADING PROGRAM

NFA has encountered, with increasing frequency in recent years, misleading promotional material promoting trading systems developed by third-party system developers, who are not NFA Members, and for which an NFA Member provides trade execution services. Often this promotional material uses hypothetical or simulated results - which are trading results not achieved by an actual account - that are not clearly identified as hypothetical and show impressive gains, when customers actually using the trading system have suffered substantial losses. In this and other contexts, both NFA and the Commission have brought numerous enforcement actions charging fraud in the use of such promotional material.

Following are several examples of situations where Members may be held accountable under Compliance Rules 2-29 and 2-9 for misleading promotional material that promotes third-party trading system developers and their trading systems.

Direct Responsibility


If an NFA Member or its Associates prepare or distribute the promotional material, the Member will be responsible for its misleading content under NFA Compliance Rule 2-29, which prohibits a Member from using misleading or deceptive promotional material.

Agency Responsibility

NFA's Business Conduct Committee has always recognized that each Member is responsible for the acts of its agents. This certainly applies to the preparation of advertising material. Thus, an NFA Member may be responsible, under NFA Compliance Rule 2-29, for misleading promotional material prepared and disseminated by a third-party trading system developer, whether or not the third-party trading system developer is an NFA Member or not, if there is an agency relationship between the NFA Member and the third-party trading system developer. (Of course, if the third-party trading system developer is also an NFA Member, it too would be responsible under NFA Compliance Rule 2-29 for the misleading promotional material that it prepared and distributed.)

In determining whether there is an agency relationship between the Member and the third-party system developer, which would trigger liability under NFA Compliance Rule 2-29, the central inquiry focuses on the nature of the business relationship between the parties and whether the parties have expressly or implicitly agreed that one may act for the other. As the CFTC has held, whether an agency relationship exists turns "on an overall assessment of the totality of the circumstances in each case." The more limited the contacts are between the third-party system developer and the NFA Member, the more likely it is that an agency relationship will not be found to exist between the parties.

If there is an agency relationship between the Member and the third-party system developer, then the Member has an affirmative duty, under NFA Compliance Rule 2-9, to supervise the activities of the third-party system developer/agent.

Supervisory Responsibility Under NFA Compliance Rule 2-9

Even where no agency relationship exists, a Member whose web site links to or otherwise refers customers to a third-party system developer or has a referral agreement with a third-party trading system developer should conduct a due diligence inquiry into the system developer's advertising practices with a view towards identifying and avoiding the misleading advertising practices described earlier, i.e., the use of exaggerated profit claims, and hypothetical or simulated results which are not clearly identified as hypothetical, or which show highly profitable performance when actual customers trading the system have sustained significant losses.3

The fact that a Member creates a hyperlink from its web site or otherwise refers customers to a third-party system developer or has a referral agreement with a third-party system developer does not, in and of itself, make the Member firm accountable for the third-party system developer's web site or promotional material. Member firms should bear in mind, though, that their supervisory obligations under Rule 2-9 and Rule 2-29 require them to diligently supervise their employees and agents who are responsible for creating and maintaining hyperlinks to web sites of third-party system developers; or establishing referral agreements with third-party system developers. Members should consider whether appropriate supervisory procedures include periodic inquiries as to whether their employees and agents are conducting due diligence with respect to the third-party system developer's web site or advertising, and taking appropriate steps if deficiencies are found in such web site or advertising. A Member's failure to supervise its employees and agents in this regard will constitute a violation of NFA Compliance Rule 2-9 on the part of the Member. Moreover, in these situations, Member firms should not seek to circumvent NFA's promotional material requirements by relying upon the unregistered status of the third-party trading system developer.

1 The Commission gives a number of examples, which illustrate the application of Rule 4.14(a)(9) in specific situations, in the Rule's publication in the Federal Register. (Federal Register: March 10, 2000 (Volume 65, Number 48, pages 12938-12943.)

2 Member firms may rely in good faith upon a copy of a letter from counsel. However, in some cases, a Member may have to perform additional due diligence to ascertain whether a third-party system developer is required to be registered.

3 See also Interpretive Notice 9037 - NFA Compliance Rules 2-9, 2-10, 2-29, 2-36 and 2-39: Guidance on the Use and Supervision of of Websites, Social Media and Other Electronic Communications.

9056 - NFA COMPLIANCE RULE 2-6: CONDUCTING COMMODITY INTEREST BUSINESS WITH AN EXPELLED OR SUSPENDED MEMBER OR ASSOCIATE

(Board of Directors, May 19, 2005; effective July 20, 2005 and July 1, 2019)

INTERPRETIVE NOTICE

In the last several years, NFA has encountered several instances where brokers, who have been barred from NFA membership or affiliation as a result of an NFA disciplinary action, have continued to work at a Member firm. NFA Compliance Rule 2-6 addresses this situation (as well as situations where the broker has been suspended or subjected to a similar sanction that temporarily prohibits the person from being an NFA Member or Associate) by specifically prohibiting an FCM, IB, CPO or CTA Member, FDM or Associate from maintaining an affiliation with or permitting any such person to perform any activities for, on behalf of or in connection with its commodity interest business. This prohibition applies regardless of whether the person's affiliation or activities require registration or NFA membership and continues throughout the period the sanction is in effect unless an exception is authorized by the Business Conduct Committee, Hearing Committee or the Appeals Committee.

Under Compliance Rule 2-6, FCM, IB, CPO or CTA Members and FDMs are also prohibited from having such persons acting for or on behalf of the firm in connection with its commodity interest business, including as employees, consultants, independent contractors, agents or unpaid volunteers. Moreover, absent extraordinary circumstances, FCM, IB, CPO or CTA Members and FDMs should not have such persons physically present in their offices.

9057 - COMMISSIONS, FEES AND OTHER CHARGES

(Board of Directors, August 17, 2006; effective November 1, 2006. Revised June 30, 2020.)

INTERPRETIVE NOTICE

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 2-36(c) similarly provides that Forex Dealer Members and their Associates shall observe high standards of commercial honor and just and equitable principles of trade in the conduct of their forex business. Over the years, NFA's Board of Directors ("Board") has provided guidance on certain issues to ensure that Members and Associates understand their responsibilities to observe just and equitable principles of trade and to act honestly, fairly and in the best interests of their customers.

For example, in 1986, the Board issued an Interpretive Notice to provide Members with guidelines relating to the disclosure by FCMs and IBs of costs associated with futures transactions. The Board stated that 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 commencement of trading, information concerning the costs associated with futures transactions.

NFA's 1986 Notice also recognized that Members may employ various arrangements in establishing their commissions, fees and other charges associated with futures transactions to customers. Typically, commissions for futures transactions have been set competitively since the 1970s, and Members usually base these charges on their costs plus a reasonable profit, and the services provided by the Member. The vast majority of NFA Members impose commission charges in a manner commensurate with their costs and the services provided by the Member, and adequately disclose and explain to customers commission rates, fees and other charges.

The Board has also previously recognized, however, that any fee arrangement which is intended to or is likely to deceive customers is a violation of NFA Requirements (e.g., NFA Compliance Rules 2-2 and 2-29(a)) and will subject the Member to disciplinary action. Over the years, NFA's Business Conduct Committee ("BCC") has charged several Members and their Associates with violating NFA sales practice requirements because they misled customers as to either the amount of commissions or the significant impact of the commission charges on the likelihood of obtaining any profit. Most of these cases have involved the sale to retail customers of commodity options and forex. 1

The Board believes that it is appropriate at this time to provide guidance on the types of sales practices specifically relating to commissions, fees and other charges that have been found to be deceptive and misleading, and violate commercial honor and just and equitable principles of trade.2 Therefore, the following are relevant factors regarding commissions, fees and other charges in determining whether a Member or Associate has presented retail customers with a distorted and misleading view of the likelihood of earning profits by investing with a Member:

  • Whether the Member or Associate adequately disclosed the amount of commissions, fees and other charges before the transaction occurred. In evaluating the adequacy of disclosure, the Member or Associate should consider whether the retail customer has little or no experience trading futures, options, and forex, the customer's estimated annual income and net worth, and prior investment experience.
  • Whether the Member or Associate downplayed the significance of the commissions, fees and other charges, especially in connection with any suggestion that the retail customer is likely to reap profits.
  • If the Member or Associate solicits retail customers to engage in commodity option transactions and charges commissions and fees well above the industry norm, what, if any, break-even analysis or additional disclosure has been provided about the significant impact that these commissions and fees have on the likelihood of profit.
  • If the Member or Associate solicits retail customers to engage in forex transactions and charges commissions and fees well above the industry norm, what, if any, break-even analysis or additional disclosure has been provided about the significant impact that commissions, fees, mark-ups and other charges have on the likelihood of profit.
  • Whether the Member or Associate engages in trading practices or recommends transactions or strategies to retail customers that are intended to increase the amount of commissions and fees generated, without serving any economic or other purpose for the customers. For example, a few Members have used large spread positions, butterfly spreads or deep out-of-the money options in an apparent scheme to maximize commissions, without regard to the customers' best interests.
In conclusion, this Notice cannot and is not intended to alert Members and Associates to all of the factors regarding commissions, fees and other charges that may be considered in determining whether they have presented retail customers with a distorted and misleading view of the likelihood of earning profits by investing with a Member. Each of the factors noted above regarding commissions, fees and other charges, however, have frequently been present in sales practice cases brought by NFA, and Members and Associates should certainly be vigilant in preventing and detecting such practices.

1 See, e.g., In re Qualified Leverage Providers, Inc., NFA Case No. 05-BCC-003; In re Calvary Financial Group LLC, NFA Case No. 02-BCC-005; In re The Siegel Trading Co., Inc., NFA Case No. 97-BCC-007; In re Bachus & Stratton Commodities, Inc., NFA Case No. 92-BCC-015 aff'd, NFA Case No. 93-APP-002; and In re Churchill Group, Inc., NFA Case No. 90-BCC-012.

2 This Notice does not apply to security futures products, which are governed by NFA Compliance Rule 2-37(g) and Interpretive Notice 9047 – NFA Compliance Rule 2-37: Fair Commissions.

9058 - NFA COMPLIANCE RULE 2-40: PROCEDURES FOR THE BULK ASSIGNMENT OR LIQUIDATION OF FOREX POSITIONS; CESSATION OF CUSTOMER BUSINESS

(Board of Directors, November 16, 2006; effective February 16, 2007. Revised October 18, 2010; October 1, 2011; November 15, 2011; and July 26, 2012.)

INTERPRETIVE NOTICE

In addition to the requirements of CFTC Regulation 5.23, a Forex Dealer Member ("FDM") must follow these procedures when seeking to employ a bulk assignment or liquidation of its customer's positions or a bulk transfer of customer accounts. NFA may waive or modify any of these procedures or impose additional requirements if doing so is in the FDM's customers' best interest or if the circumstances otherwise require.

BULK ASSIGNMENTS AND TRANSFERS

Permitted Assignees

An FDM must notify NFA's Compliance Department ("Compliance") prior to any bulk assignment of customer positions or bulk transfer of customer accounts. An FDM may only assign open positions to an entity that is an authorized counterparty enumerated in Section 2(c)(2)(B)(i)(II) of the Act, provided that entity is not prohibited from acting as a counterparty under 2(c)2(E) of the Act. Prior to the assignment or transfer, the FDM must conduct a reasonable investigation and determine that the assignee intends and is financially able to honor its commitments to the FDM's customers as a result of the assignment or transfer. The FDM must document this investigation and provide this information to NFA.

Written Consent or Prior Notice

An FDM may assign customer positions and transfer customer accounts to an authorized counterparty with the express written consent of its customers. Alternatively, an FDM may assign open positions and transfer accounts by providing its customers with prior notice. The FDM must send NFA's Compliance Department a copy of this notice before the notice is sent to customers.

    Notice to Customers
    The notice should be sent to the customer's independent e-mail address (not a dedicated address provided by the Forex Dealer Member) and by postal mail (at least first class delivery). Generally, the FDM must provide this notice at least seven calendar days before the assignment or transfer. In rare and unusual circumstances, NFA's Compliance Department might determine that a shorter notice period is appropriate. Additionally, there might be circumstances in which the Compliance Department determines that a longer notice period is required.

    The notice should include any information that is material based upon the specific circumstances of the assignment or transfer. At a minimum, the notice must include:

      1. The reason for the assignment/transfer;

      2. A clear and concise statement that as of a particular date (the assignment/transfer date, which should not be less than seven calendar days after the date of the notice) the FDM will no longer be the counterparty to the customer's positions and will not service the customer's account;

      3. The name, NFA ID (if applicable), postal and e-mail addresses, and telephone number of the proposed assignee/transferee as well as the name of an individual at the assignee/transferee the customer can contact about the proposed assignment/transfer;

      4. A statement that the customer is not required to accept the proposed assignment/transfer but may direct the assignor/ transferor FDM to liquidate the customer's positions;

      5. The name, postal and e-mail address, and telephone number of an individual at the assignor/transferor FDM the customer can contact with questions or to liquidate positions; and

      6. A statement that failure to respond to the notice within a specified period of time, not less than seven days from the date of the notice, will result in a default action, which must be either (A) assigning the customer's positions and transferring account balances to the assignee (if authorized by contract) or (B) liquidating the customer's positions and returning the remaining funds, whichever is the case.

    Where the customer positions and accounts are being assigned/transferred to a firm that is not an NFA Member, the notice must include the following disclosure:

      YOUR POSITIONS AND ACCOUNT WILL BE ASSIGNED TO A FIRM THAT IS NOT A MEMBER OF NATIONAL FUTURES ASSOCIATION (NFA), IS NOT REGULATED BY NFA, AND IS NOT REQUIRED TO COMPLY WITH NFA's RULES.

    Obligations of the Assignee/Transferee

    If forex positions or accounts are assigned or transferred to an FDM or an IB, the assignee/transferee FDM or IB may not accept orders initiating new positions until it obtains the personal and financial information pertaining to the retail forex customer that is required under Compliance Rule 2-36 from either the retail forex customer or the assignor/transferor FDM or IB.

    In addition to the disclosures required by CFTC Regulation 5.23, the assignee/transferee FDM or IB must also provide the retail forex customer with the disclosures required under CFTC Regulation 5.5(e)((1)(i)-(iii) with respect to the assignee/transferee FDM (prior to accepting any orders initiating new positions) and must receive the required signed acknowledgement within sixty days of such assignment or transfer. The only exception to this requirement is when the assignee/transferee IB introduces the retail forex customer to the same FDM as the assignor/transferor IB and the assignee/transferee IB has clear written evidence that the assignor/transferor IB provided the retail forex customer with these disclosures with respect to the FDM.

    Finally, the assignee/transferee FDM or IB must provide the disclosure required under 5.5(e)(1)(i)-(iii) with respect to the transferee FDM even in those situations when the assignment or transfer is at the retail forex customer’s request.

    BULK LIQUIDATIONS

    An FDM must notify NFA's Compliance Department prior to any bulk liquidation of customer positions. An FDM may liquidate customer positions with the express written consent of its customers. Alternatively, an FDM may liquidate customer positions by providing its customers with prior notice of the liquidation. The FDM must send NFA's Compliance Department a copy of this notice before the notice is sent to customers.

      Notice to Customers

      The notice should be sent to the customer's independent e-mail address (not a dedicated address provided by the Forex Dealer Member) and by postal mail (at least first class delivery). Generally, the FDM must provide this notice at least seven calendar days before the liquidation. In rare and unusual circumstances, NFA's Compliance Department might determine that a shorter notice period is appropriate. Additionally, there might be circumstances in which the Compliance Department determines that a longer notice period is required.

      The notice should include any information that is material based upon the specific circumstances of the liquidation. At a minimum, the notice must include:

        1. The reason for the liquidation;

        2. A clear and concise statement that as of a particular date (the liquidation date, which should not be less than seven calendar days after the date of the notice) the FDM will liquidate all open positions in the customer's account and close the account; and

        3. The name, postal and e-mail address, and telephone number of an individual at the FDM the customer can contact with questions regarding the liquidation.

    RECORDS

    For a bulk assignment, liquidation, or transfer, the assignor/transferor FDM and the assignee/transferee FDM must provide NFA's Compliance Department with all pertinent records pertaining to the transaction, including at a minimum:

    (A) At the time that the assignor/transferor FDM first contacts NFA's Compliance Department, the assignor/transferor FDM must provide:

      1. representative copies of the customer agreements;
      2. a list of the affected accounts, including:
        a. customer names;
        b. account numbers; and
        c. account values as of the end of the previous day;
      3. if an assignment or transfer, documentation regarding the assignor/transferor FDM's investigation of the assignee/transferee's status as an authorized counterparty and its financial ability to honor its commitments to the customers.

    (B) Immediately after the bulk assignment, liquidation, or transfer, the assignee/transferee FDM must provide a list of the affected accounts and the value of each account as of the date of the transaction.

      9059 - NFA COMPLIANCE RULE 2-4: DISCLOSURE GUIDELINES FOR FCMS OFFERING SWEEP ACCOUNTS

      (Board of Directors, February 15, 2007; effective July 1, 2007 and July 1, 2019.)

      INTERPRETIVE NOTICE

      Due to the increasingly competitive industry environment, Futures Commission Merchants ("FCMs") may seek to develop and offer to customers sweep account programs to manage cash balances. These sweep account programs transfer a customer's excess funds from a regulated commodity account (whether a customer segregated, secured account or cleared swaps customer account) to a non-regulated account for the customer at the FCM, an affiliate of the FCM or another entity so that the customer can obtain a higher investment return than maintaining the funds in the FCM's customer regulated commodity accounts.

      Given disclosure concerns regarding these programs, NFA's Board of Directors believes that FCMs offering sweep account programs should adopt certain disclosure guidelines. The guidelines contained in this Notice apply only to sweep account programs offered by an FCM, including those regularly recommended by the FCM. In other words, if a customer elects on its own to transfer funds to a particular sweep account program that is not offered by the FCM, then the FCM does not have any disclosure obligations pursuant to this Notice. Additionally, this Notice's disclosure guidelines are inapplicable to transfers made pursuant to an FCM's customer agreement's provisions whereby a customer authorizes the transfer of funds from a regulated commodity account to any other account maintained by the customer at the FCM or one of its affiliates as may be necessary to avoid a margin call or to reduce the debit balance in the other account, or to satisfy any other obligation to the FCM or its affiliates.

      Failure to follow the disclosure guidelines contained in this Notice may be deemed conduct inconsistent with a Member's obligation under NFA Compliance Rule 2-4 to observe high standards of commercial honor and just and equitable principles of trade in the conduct of its commodity futures business and cleared swaps business. NFA recognizes, however, that FCMs offering these sweep account programs may have to modify these guidelines to address their particular programs.

      Initially, FCMs should identify the entity maintaining the sweep account and whether that entity is subject to regulation, and should disclose any material terms and conditions, risks and features of their offered programs. In addition, FCMs should advise customers of any conflicts of interest in connection with the offered programs, including whether the FCM receives compensation or other benefits for customer balances maintained in the sweep account, and the FCM should advise the customer which entity to contact to gain access to any swept funds. An FCM should make these disclosures at the time a sweep account program is offered to a customer and, of course, the disclosures should be updated for participants if any material changes are made to an existing sweep program. The Board believes that if a customer elects to participate in a sweep program offered by the FCM, then the FCM must obtain the customer's written consent prior to any funds being transferred pursuant to the program.

      The Board also believes that FCMs should advise customers of the consequences of transferring monies from the FCM's customer regulated accounts. Specifically, the FCM should disclose that by transferring excess funds from an FCM's customer regulated commodity accounts, the customer will not receive the preferential treatment afforded funds held in a customer regulated commodity account pursuant to Part 190 of the CFTC's Regulations and the U.S. Bankruptcy Code. The Board recognizes, however, that an FCM may offer programs that transfer monies to an account whereby customers receive certain protections (e.g. SIPC or FDIC) in the event of a bankruptcy. In this case, the FCM should disclose the nature and extent of the protection available, including any applicable SIPC or FDIC coverage. If the FCM's programs transfer funds to a non-regulated account that does not offer protections comparable to those afforded funds held in a customer regulated commodity account, then the FCM must clearly disclose this fact and describe the impact upon customer funds in the unlikely event that the entity maintaining the sweep account files for bankruptcy.

      9060 - COMPLIANCE RULE 2-36(e): SUPERVISION OF THE USE OF ELECTRONIC TRADING SYSTEMS

      (Board of Directors, November 16, 2006; effective July 1, 2007; revised October 15, 2007; December 17, 2007; June 1, 2009; October 18, 2010; October 1, 2011; November 15, 2011; September 19, 2016 and June 30, 2020.)

      INTERPRETIVE NOTICE

      NFA Compliance Rule 2-36(e) places a continuing responsibility on every Forex Dealer Member (FDM) to diligently supervise its employees and agents in all aspects of its forex activities, and Compliance Rule 2-39 applies this same requirement to Members who solicit, introduce, or manage forex customer accounts. These rules are broadly written to provide Members with flexibility in developing procedures tailored to meet their particular needs, so NFA uses interpretive notices to provide more specific guidance.1

      Although the Board of Directors firmly believes that supervisory standards do not change with the medium used, technology may affect how those standards are applied. The forex markets are highly automated, with virtually all trading done on electronic platforms. Most orders are also placed electronically, usually entered directly with the platform via the Internet. Therefore, in order to fulfill their supervisory responsibilities, Members must adopt and enforce written procedures to address the security, capacity, credit and risk-management controls, and records provided by the firm's electronic trading systems.2 This includes electronic trading platforms, order-routing systems incorporated into electronic trading platforms, and separate order-routing systems (AORSs).3 For an electronic trading platform, the procedures must also address the integrity of the trades placed on it.

      NFA recognizes that Members who solicit or manage accounts may not have control over the electronic platform where the customer places its trades. Nonetheless, if these Members are dealing with a counterparty that is not an FDM, they have a supervisory responsibility to conduct a reasonable investigation regarding security, capacity, credit and risk-management, records, and integrity of trades on the platform prior to entering into a relationship with that counterparty and periodically thereafter. Therefore, while they are not subject to the more specific requirements of this Notice, they should adopt written procedures addressing the steps they will take to investigate the platform and how they will respond if they have reason to believe that the platform does not meet the general standards set out after each major heading.4

      The specific requirements of this Notice do, however, apply to any FDM that uses another entity's trading platform through a "white-labeling" arrangement.5 If the entity providing the platform (the white labeler) is also an FDM, the FDM using the platform (the sponsor) may rely on the white labeler to comply with most of these requirements. The sponsor must, however, adopt and enforce written procedures to:

      • Provide required notifications and disclosures to customers;
      • Maintain records; and
      • Respond to situations where it has reason to believe the white labeler is not complying with the Notice.

      If the white labeler is not an FDM, the sponsor and the white labeler may agree by contract that the white labeler will comply with the Notice, but the sponsor FDM will still be liable if the requirements are not met.6

      Each FDM must notify NFA of the trading platform it uses including the identity of the platform's owner and developer (if different than the owner) and whether the platform is proprietary, used under a white-labeling arrangement, or leased from a third-party under other terms. The FDM must also notify NFA when it changes its trading platform, adds a new trading platform, or drops a trading platform.

      Each FDM must also maintain a copy of the procedures required by this Notice and provide a copy to NFA upon its request. The procedures must assign the responsibility for complying with this Notice to individuals who are under the ultimate supervision of an Associated Person who is also a listed principal.

      Members must also ensure that any promotional or other material they distribute or endorse regarding the electronic trading system, or the services (e.g., capacity) or the quality of services (e.g., performance level) they provide with respect to that system, accurately and completely discuss the system’s functions and operation. Using material that misrepresents the electronic system, or the Member’s services or quality of service, constitutes a violation of NFA Compliance Rules 2-36(b) and 2-39(a).

      Given the differences in NFA Members' size, complexity of operations, and business activities, they must have some flexibility in determining what constitutes "diligent supervision" for their firms. NFA's policy is to leave the exact form of supervision up to each Member, thereby providing the Member with flexibility to design procedures tailored to its own situation. It is also NFA's policy to set general standards rather than to require specific technology. Therefore, other procedures besides the ones described in this Interpretive Notice may comply with the general standards for supervisory responsibilities imposed by Compliance Rules 2-36 and 2-39.

      Security

      General Standard. Members who handle customer orders must adopt and enforce written procedures reasonably designed to protect the reliability and confidentiality of customer orders and account information. The procedures must also assign responsibility for overseeing the process to one or more individuals who understand how it works and who are capable of evaluating whether the process complies with the firm's procedures.

      Authentication. Electronic trading systems, or other systems the customer must go through to access electronic trading systems, should authenticate the user. Authentication can be accomplished through a number of methods, including:

      • Passwords;
      • Authentication tokens, such as SecurID cards; or
      • Digital certificates.

      Encryption. The system should use encryption or equivalent protections for all authentication and for any order or account information that is transmitted over a public network (including the Internet), a semi-private network, or a virtual private network. If more appropriate and effective security procedures are developed or identified, the use of those procedures would comply with this standard.

      Firewalls. Firewalls or equivalent protections should be used with public networks, semi-private networks, and virtual private networks. The system should log the activities that pass through a firewall, and the log should be reviewed regularly for abnormal activity. If more appropriate and effective security procedures are developed or identified, the use of those procedures would comply with this standard.

      Authorization. Although it is the customer's responsibility to ensure that only authorized individuals have access to the electronic trading system using the customer's facilities and authentication devices (e.g., passwords), the Member's procedures should, as appropriate, provide customers with a means to notify the Member that particular individuals are no longer authorized or to request that authentication devices be disabled. Customers should be informed about the notification process.7

      Administration. The Member should adopt and enforce written procedures assigning the responsibility for overseeing the security of the electronic trading system to appropriate supervisory personnel. The procedures should also provide that appropriate personnel keep up with new developments, monitor the effectiveness of the system's security, and respond to any breaches. Additionally, the procedures should provide for updating the system as needed to maintain the appropriate level of security.

      Capacity

      General Standard. Members who handle customer orders must adopt and enforce written procedures reasonably designed to maintain adequate personnel and facilities for the timely and efficient delivery of customer orders and reporting of executions. Members who operate trading platforms must adopt and enforce written procedures reasonably designed to maintain adequate personnel and facilities for the timely and efficient execution of customer orders. The procedures must also be reasonably designed to handle customer complaints about order delivery, execution (if applicable), and reporting and to handle those complaints in a timely manner.

      Capacity Reviews. The Member should adopt and enforce written procedures to regularly evaluate the capacity of each electronic trading system and to increase capacity when needed. The procedures should also provide that each system will be subjected to an initial stress test. Such test may be conducted through simulation or other available means. Capacity reviews should be conducted whenever major changes are made to the system or the Member projects a significant increase in volume and should occur at least annually.

      The Member should monitor both capacity (how much volume the system can handle before it is adversely impacted or shuts down) and performance (how much volume the system can handle before response time materially increases), and should assess the electronic trading system's capacity and performance levels based on the major strains imposed on the system. The Member should establish acceptable capacity and performance levels for each of its electronic trading systems. The Member's procedures should be reasonably designed to provide adequate capacity to meet estimated peak volume needs based on past experience, present demands, and projected demands.

      The procedures should also provide for the Member to follow up on customer complaints about access problems, system slowdowns, system outages, or other problems that may be related to capacity.8 The Member should identify the cause of any problem and take action to prevent it from re-occurring.

      Disaster Recovery and Redundancies. The Member should have contingency plans reasonably designed to service customers if either the system goes down or activity exceeds reasonably expected peak volume needs. The Member should use redundant systems or be able to quickly convert to other systems if the need arises. These backup systems can include facilities for accepting orders by telephone.

      When operational difficulties occur, including but not limited to a system outage or disruption or delay in execution time, the Member should provide prompt and effective notification to any customers affected by the operational difficulties. Notification can be made by a number of methods, including:

      • a message on the Member's web site;
      • e-mails or instant messages;
      • a recorded telephone message for customers on hold; and/or
      • a recorded telephone message on a line dedicated to providing system bulletins to existing customers.

      An FDM must notify NFA as soon as reasonably possible, but no more than 24 hours, after operational difficulties occur. The notice should include the date, time, length, and cause of the outage or disruption; what the FDM did to remedy the situation in the short term; what steps the FDM will take to guard against future occurrences; the number of customers affected; and any actions the FDM took to adjust customer trades or accounts.

      Advance Disclosure. The Member should disclose, in advance, the factors that could reasonably be expected to materially affect the system's performance (e.g., periods of stress) and the means available for contacting the Member during a system outage or slow-down. This disclosure should be provided to each customer at the time the customer opens an account using a method reasonably calculated to ensure that the customer becomes aware of it.9 The disclosure should also be prominently displayed on the Member's web site. The Member should also educate customers on alternative ways to enter orders when the system goes down or reaches an unacceptable performance level. This disclosure must be made in a manner designed to provide this information to current customers before problems occur, such as through the account agreement or a notice on the Member's website.

      Credit and Risk-Management Controls

      General Standard. Members who handle customer orders must adopt and enforce written procedures reasonably designed to prevent customers from entering into trades that create undue financial risks for the Member or the Member's other customers.10 Regardless of its business model - dealer or straight through processor - a Member must also have policies and procedures in place to monitor its own proprietary trading, including open positions, and the impact those positions and any potential market movement or adjustments may have on the Member’s ability to meet its capital requirement.

      Account Controls. An electronic trading system should be designed to allow the Member to set limits for each customer based on the amount of equity in the account or the currency, quantity, and type of order, and the Member should utilize these controls. The system should automatically block any orders that exceed the pre-set limits.11

      If the trading platform automatically liquidates positions, the FDM should set the liquidation levels high enough so that the positions will be closed out at prices that will prevent the account from going into a deficit position under all but the most extraordinary market conditions.12 The FDM's platform must automatically liquidate positions, and it must set its liquidation levels to comply with this requirement, if its customer agreement or promotional material states or implies that customers cannot lose more than they invest.

      An electronic trading platform that does not automatically liquidate positions should generate an immediate alert when an account is in danger of going into a deficit position. Firm personnel should monitor those alerts throughout the day and take action when necessary.

      System Controls. An electronic trading system should also be designed to identify trading anomalies or patterns that indicate a system malfunction, especially a malfunction that could result in undue risk to the FDM.

      Recordkeeping

      General Standard. Members who handle orders must adopt and enforce written procedures reasonably designed to record and maintain essential information regarding customer orders and account activity, including the information required by CFTC Regulation 5.18(b)(4).

      Profit and Loss Reports. Electronic trading platforms should be able to produce, upon request, a report showing monthly and yearly realized and unrealized profits and losses by customer. The report should be sortable by the person soliciting, introducing, or managing the account.

      The system should generate year-end reports for each customer showing the realized profits and losses incurred during the calendar year and the unrealized profits and losses on open positions. The FDM must distribute these reports to customers by January 31st.13

      Reporting to NFA

      General Standard. Each FDM must submit to NFA any reports or information required by NFA.

      Daily Trade Records. Each FDM must file a daily electronic report of trades with NFA in accordance with NFA Compliance Rule 2-48. The report must contain the following data, and any other data required by NFA:

      • All order transaction records on a daily basis;
      • A list of executed trades on a daily basis;
      • A list of all money managers on the first day of reporting, with any changes being reported daily;
      • A list of all price adjustments made by the FDM on a daily basis; and
      • A list of any unusual events, such as a system outage or "fast market" on a daily basis as applicable.

      Management should review this report to ensure that it is providing NFA with full and complete information and review all transactions, exceptions and unusual events for suspicious or unjustifiable activity.

      Assessment Fee Reports. Electronic trading platforms should generate month-end assessment fee reports for each FDM using the platform. The report should summarize the number of forex transactions executed during the month and the size of those transactions.14

      Retention. Members must maintain this information for five years from the date created, and it must be readily accessible during the first two years, in accordance with CFTC Regulation 1.31. These records must be open to inspection by NFA, and copies must be provided to NFA upon request.

      Trade Integrity

      General Standard. FDMs must adopt and enforce written procedures reasonably designed to ensure the integrity of trades placed on their trading platforms.

      Pricing. Trading platforms must be designed to provide bids and offers that are reasonably related to current market prices and conditions. For example, bids and offers should increase as prices increase, and spreads should remain relatively constant unless the market is volatile.15 Furthermore, if an FDM advertises a particular spread (e.g., 1 pip) for certain currency pairs or provides for a particular spread in its customer agreement, the system should be designed to provide that spread.16

      Slippage. An electronic trading platform should be designed to ensure that any slippage is based on real market conditions. For example, slippage should be less frequent in stable currencies than in volatile ones, and prices should move in customers' favor as often as they move against it.

      Settlement. An electronic trading platform should be designed to calculate uniform settlement prices. An FDM must have written procedures describing how settlement prices will be set using objective criteria.

      Rollovers. If an electronic trading platform automatically rolls over open positions, the trading platform should be designed to ensure that the rollover complies with the terms disclosed in the customer agreement, including those provisions dictating how the rollover price is determined. Forex Dealer Members should adopt and enforce a written policy detailing the procedures it follows to calculate rollover or interest charges and payments. The policy must include the factors that are considered as well as the names of any sources for these factors. The Member should document the underlying factors reviewed in completing the calculation, including any related transactions entered into by the Forex Dealer Member, so it can be replicated.

      Periodic Reviews and Annual Certification

      Members should conduct periodic reviews (at least annually, but more frequently if the circumstances warrant a more frequent review) of any electronic trading system it utilizes. This review should be designed to:

      • Assess the security of the electronic trading system;
      • Assess the reliability of the electronic trading system’s credit and risk-management controls;
      • Ensure that the electronic trading system maintains required data and is capable of generating the reports required by this Notice;
      • Ensure that the electronic system protects the integrity of the trades placed on it and executes customer forex orders in a fair manner.

      The Member must prepare a report of the periodic review, noting the scope of the review, any findings and corrective action and maintain a copy of the review in accordance with CFTC Regulation 1.31. The results of this review should be reported to the firm’s senior management, including the FDM’s Chief Compliance Officer, and any follow up should be recorded and signed by senior management.

      An FDM must also have a qualified outside party conduct an independent annual review of any electronic trading platform it uses within twelve months after the FDM begins trading on that platform or within twelve months after the firm becomes an FDM, whichever is later.17 Thereafter, an independent review must be conducted at least annually, and a qualified outside party must conduct the review every other year. The remaining annual reviews and any additional reviews (which should be performed when needed) may be conducted by either an independent internal audit department or a qualified outside party. For pure order-routing systems, the required reviews may be conducted by an independent internal audit department or a qualified outside party and must be done at least annually.

      The reviews should audit the system for compliance with the requirements in this Notice. The results should be documented and reported to the firm's senior management or to an internal audit committee or department. The Member should follow up to ensure that any deficiencies are addressed and corrected. The FDM should document the corrective action taken and a member of the firm's senior management should sign off on that report. The FDM should retain this report in accordance with CFTC Regulation 1.31.

      Each FDM - including each FDM that provides a trading platform to its customers through a white-labeling arrangement - must certify annually that the requirements in this Notice have been met and that the written procedures required by this Notice are up-to-date. The certification must be signed by a principal who is also a registered AP and must be filed with NFA. In completing this certification the AP/principal should review the results of the periodic reviews and any corrective action taken.

      Members who solicit or introduce forex customers or manage forex customer accounts must provide annual certifications if they use an electronic trading platform offered by a counterparty that is not an FDM or if they provide or endorse a separate AORS. The certification must be signed by a principal who is also a registered AP and must be filed with NFA. The certification may, however, be limited to the applicable requirements.

      1 For purposes of this Notice, the term "Forex Dealer Member" has the same meaning as in Bylaw 306, the term "forex" has the same meaning as in Bylaw 1507(b), and the term "customer" has the same meaning as in Compliance Rule 2-36(i).

      2 The written procedures do not, however, have to contain technical specifications or duplicate procedures that are documented elsewhere.

      3 A trading platform executes a customer's trade by assigning the other side of the trade to a counterparty. An order-routing system transmits orders to a trading platform (or to another system or individual). In most instances, the same trading system will perform both functions. NFA understands that separate systems are extremely rare in the forex markets. Nonetheless, since most of the same principles apply, these separate systems are included in this Notice.

      4 If the Member provides or endorses a separate AORS, however, the Member is responsible for meeting all of the applicable requirements in connection with that system.

      5 White labeling refers to the practice of leasing the right to place the lessee's name on and market another firm's trading platform as its own and then passing the trades through to the lessor. In the typical while labeling arrangement, the lessee's customers do not have a contractual relationship with, and in fact may be unaware of, the firm that owns and operates the platform. For regulatory purposes, the lessee is the counterparty to the customer's trades and the corresponding transactions with the lessor are separate transactions between the lessee and the lessor to hedge the lessee's customer obligations.

      6 As a practical matter, NFA will not take disciplinary action unless the sponsor knew or should have known that the white labeler was not meeting its contractual obligation to comply with this Notice or the sponsor failed to exercise due diligence when establishing and maintaining the relationship with the white labeler.

      7 For purposes of this notice, the term "customer" includes CTAs entering orders for forex customers except when referring to credit-worthiness and ability to accept risk. In those instances, the term "customer" is limited to the owner of the account.

      8 For example, lack of capacity might result in excessive slippage or an order not being filled.

      9 A Member could, for example, provide the disclosure in a separate e-mail to an address provided by the customer. Burying the disclosure in the account opening documents is not sufficient.

      10 A Member should assess each individual customer's ability to accept risk as part of the Member's obligation to know its customers. See Interpretive Notice 9053 – Forex Transactions.

      11 An AORS used to access an electronic trading platform need not include pre-execution and post-execution controls if the Member providing or sponsoring the AORS has determined, after a reasonable investigation, that the trading platform complies with those requirements and that the Member who controls the trading platform effectively utilizes its controls.

      12 If the FDM unconditionally guarantees customers against deficits it should, of course, take any loss that occurs beyond the amount of equity in the account even when the deficit occurs because of those extraordinary market conditions. Misrepresenting the potential for customer losses is a violation of NFA Compliance Rule 2-36(b) or 2-39(a).

      13 FDMs can use Form 1099-B to satisfy this requirement.

      14 The report should exclude transactions by eligible contract participants as that term is defined in Section 1a(18) of the CEA.

      15 Management should approve each fill outside the price range displayed by the system when a market order was placed and should document the reason for the fill price.

      16 If the FDM's customer agreement provides for exceptions in volatile or illiquid markets and those exceptions are prominently disclosed, the system may be programmed to be consistent with the agreement's terms.

      17 For purposes of this Notice, "qualified outside party" means an unaffiliated individual or entity that, through experience or training, understands complex IT systems and is able to test the firm's systems for compliance with the requirements in the Notice.

      9061 - NFA COMPLIANCE RULE 2-4: MISUSE OF TRADE SECRETS AND PROPRIETARY INFORMATION

      (Board of Directors, August 17, 2007; effective September 5, 2007; revised December 11, 2007)

      INTERPRETIVE NOTICE

      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. Over the years, NFA's Board of Directors ("Board") has provided guidance on certain issues to ensure that Members and Associates understand their responsibilities to observe just and equitable principles of trade and to act honestly, fairly, and in the best interests of customers.

      Compliance Rule 2-4 prohibits Members and Associates from knowingly obtaining or seeking to obtain another Member's or Associate's confidential information or trade secrets without that person's permission. It also prohibits Members and Associates from knowingly or recklessly misusing confidential information or trade secrets in their possession. Although that rule does not seek to regulate business disputes between Members or to extend beyond commodity futures activities, it does reach conduct that could potentially harm futures customers.

      Conduct that may violate Compliance Rule 2-4 includes:

      • Misusing sensitive personal information, such as a social security number or purposefully or recklessly violating the firm's privacy policy;

      • Disclosing customer orders prior to execution (except as permitted by exchange rules); or

      • Obtaining or attempting to obtain information disclosing a CTA's historical trading positions without the CTA's permission.

      These are merely examples of conduct that could potentially harm customers. Any Member or Associate that knowingly obtains or seeks to obtain confidential information or trade secrets of another Member or Associate without that person's permission or that knowingly or recklessly misuses trade secrets and/or proprietary information in the conduct of its commodity futures business violates Compliance Rule 2-4.

      9062 - COMPLIANCE RULE 2-45: PROHIBITION OF LOANS BY COMMODITY POOLS TO CPOS AND RELATED ENTITIES

      (Board of Directors, August 20, 2009; effective September 11, 2009. Effective date of amendments: September 13, 2013; and February 5, 2015.)

      INTERPRETIVE NOTICE

      NFA has taken a number of Member Responsibility Actions (MRAs) against commodity pool operators (CPOs) and CPO principals who directly or indirectly loaned or advanced pool assets to themselves or an affiliated person or entity. Many of these arrangements were used by these principals to purchase luxury items, while others went to related entities that did not have sufficient assets to repay the loans. In each case, the transaction resulted in significant losses to participants' funds.

      The Board of Directors has determined that direct or indirect loans or advances from pools to their CPOs, the CPO's principal(s), or related entities should be prohibited. Therefore, NFA Compliance Rule 2-45 prohibits CPOs from permitting a commodity pool to use any means to make a direct or indirect loan or advance of pool assets to the CPO or any other affiliated person or entity.

      NFA understands that certain CPOs exempt from registration prior to December 31, 2012 may have caused pools that they operate to make these types of loan or advance arrangements prior to the CPOs becoming NFA Members and subject to NFA Compliance Rule 2-45. A CPO is required to notify NFA of these existing arrangements within thirty (30) days of either (i) the effective date of any amendments to Compliance Rule 2-45 or this Interpretive Notice or (ii) becoming an NFA Member CPO, whichever occurs latest.

      These arrangements violate NFA's existing compliance rules if the arrangements are not consistent with the pool's current disclosure document or offering materials and both the loan(s) or advance(s) and the conflict of interest are not fully disclosed to participants. Existing arrangements also violate NFA's rules if the loan or advance is not secured by marketable, liquid assets (e.g. a CPO participant's pro-rata interest in the pool's liquid assets) and, therefore, the arrangement could have a material effect upon the pool's ability to meet its obligations to participants.

      NFA has received a number of inquiries from CPOs about whether the following transactions, which may be engaged in on a regular basis and as part of the normal course of business, are prohibited by Compliance Rule 2-45:

        (i) those associated with short securities sales, cash financings, guarantee obligations, repurchase or reverse-repurchase agreements, wholly-owned subsidiaries, tax-related distributions engaged in by a CPO operating a pool that is a registered investment company (RIC), business development company (BDC), exempt pursuant to CFTC Regulations 4.7 or 4.13(a)(3), excluded from registration pursuant to Sections 3(c)(1) or 3(c)(7) of the Investment Company Act of 1940 (ICA) or securities registered under the Securities Act of 1933; or

        (ii) those engaged in pursuant to a loan arrangement permitted by the ICA, exemptive rules under the ICA, an exemptive order issued by the Securities and Exchange Commission (SEC) or in accordance with a no-action letter issued by SEC staff under Section 17 or Section 57 of the ICA by a CPO operating a pool that is a RIC or BDC.

      Provided these transactions are engaged in under the circumstances described below, as applicable, they are not considered a prohibited loan or advance under NFA Compliance Rule 2-45. Furthermore, Member CPOs are reminded of their obligation pursuant to NFA Compliance Rule 2-10 and 2-5 to make any books and records available upon request to NFA relating to any of the transactions described below, including the books and records of any wholly-owned subsidiary of a commodity pool.

      Certain Securities Borrowings/Securities Loans

      In order to take a short position in a security, a pool must locate and borrow the security that is being sold short and deliver it to the purchaser in order to settle the short sale. A pool that is selling a security short may locate and borrow the security from a pool operated by the same CPO — from which the security can be easily located — since the CPO of both pools is fully aware of the securities that are available in the lending pool's portfolio. This type of transaction would not violate Compliance Rule 2-45 provided that no later than the close of business on the day of the securities loan, the pool lending the security has received from the pool borrowing the security collateral with a market value at least equal to the market value of the borrowed security.

      Securities Loans for Cash Financing

      A pool may raise cash using otherwise idle securities positions held by it by "loaning" these securities to an affiliate as part of a prime brokerage service, and receiving cash based on the market value of these securities. These transactions are typically documented and effected in accordance with a standard form agreement — Master Securities Loan Agreement (MSLA) — provided to the industry by the Securities Industry and Financial Markets Association. Although the transaction is documented as a securities loan, from the pool's perspective the transaction involves the borrowing of cash from its affiliate secured by the pool's long securities position. This type of transaction does not violate NFA Compliance Rule 2-45, provided that: (i) the transaction is cleared by an affiliated prime broker that is registered with the Securities and Exchange Commission as a broker-dealer, is a member of FINRA, the Depository Trust Company and the National Securities Clearing Corporation; and (ii) the transaction is documented under a MSLA.

      Guarantee Obligations

      One or more pools may make a direct or indirect debt or equity investment in a subsidiary or other affiliated entity for tax, legal, regulatory, or other reasons. Because, among other reasons, the entity will often have a limited amount of capital, the pool(s) will often guarantee or otherwise support (e.g., by pledging collateral) certain of the entity's obligations and a pool will provide such guarantees or support in accordance with the pool's relative investment in the entity from time to time. If the obligee draws upon the guarantee or other credit support, then the amount drawn may become a debt to the pool(s). This type of investment and guarantee or other credit support does not violate NFA Compliance Rule 2-45 provided that a pool is not liable for an amount that is materially above its proportionate share (based on the pool's relative investment in the entity from time to time).

      Wholly-Owned Subsidiaries of a Pool

      A CPO may for tax, legal, regulatory, or other similar reasons, cause a loan to be made from a pool to a wholly-owned subsidiary1, without violating Compliance Rule 2-45 provided that:

        (a) The CPO causes a single pool to make a loan directly or indirectly2 to a single wholly-owned subsidiary that is formed for trading or investment purposes and is operated by a registered CPO provided that: (1) the subsidiary is formed solely to benefit the pool that made the loan; (2) the financial statements of the subsidiary and the pool making the loan are prepared in accordance with U.S. GAAP3; (3) any outside participant in the pool qualifies as a qualified eligible participant4; (4) the loan is not used for a purpose that is otherwise prohibited by NFA rules (e.g., as a conduit for an indirect loan to the CPO or an affiliate of the CPO); or

        (b) The CPO or affiliated CPOs cause pools5 to make loans directly or indirectly to a wholly-owned subsidiary (collectively owned by the pools) that is a registered broker-dealer and/or registered futures commission merchant provided that: (1) the subsidiary is formed solely to provide clearing and other prime brokerage services to the pools that made the loan; (2) the pools make any loans on the same terms; (3) the loan amounts are proportionate in size to each pool's relative equity ownership of the subsidiary; (4) any outside pool participants in the pools making the loans receive a separate complete disclosure of the terms of the loan, including but not limited to, the loan's principal amount, interest rate and repayment schedule, and any other material information regarding the transaction prior the loan(s) being made; (5) any outside pool participants in a pool making a loan(s) is given a right to redeem in full prior to the loan(s) being made; (6) the loans are not used for a purpose that is otherwise prohibited by NFA rules (e.g., as a conduit for an indirect loan to the CPO or an affiliate of the CPO); and (7) the CPO provides NFA's Compliance Department with written notification of the loan(s) and the disclosure provided to outside pool participants prior to the loan(s) being made.

      Repurchase Agreements and Reverse Repurchase Agreements

      Affiliated pools may engage in repurchase agreements/reverse repurchase agreements in which there is a sale of securities combined with a contemporaneous agreement for the seller to buy back the securities at a later date at a higher price. The party that originally buys the securities effectively acts as a lender of cash. The party that originally sells the securities effectively acts as a borrower of cash using its securities as collateral for the cash loan at a fixed rate of interest. For the party selling the securities and agreeing to repurchase them in the future, this transaction is considered a repurchase agreement. For the party buying the securities and agreeing to resell them at a later date, this transaction is considered a reverse repurchase agreement. These types of transactions between affiliated pools do not violate NFA Compliance Rule 2-45 because the buyer's possession of the securities effectively collateralizes the buyer's exposure in respect to the seller's obligation to repurchase the securities.

      Tax-Related Distributions

      Tax rules relating to pools treated as partnerships for tax purposes are complex and give rise to circumstances that are difficult to predict and plan for. In particular, the CPO (or a related party) is often required to pay tax on its share of a pool’s income whether or not it has actually received an income distribution from the pool. Accordingly, many pools have contractual provisions, disclosed to and agreed to by its participants, that expressly permit the CPO (or a related party) to receive distributions from the pool based upon the CPO's (or a related party's) share of the pool's taxable income. In addition, some pools may make loans or advances to the CPO (or a related party) to enable it to meet tax obligations. These tax-related loans, advances, or distributions (collectively, distribution) do not violate NFA Compliance Rule 2-45 provided that (a) they are made in strict accordance with the provisions of the pool’s organizational documents that expressly permit the distribution; (b) they relate solely to the CPO's (or related party's) taxable income arising from the pool (and not to any other income), and (c) if the CPO's (or related party's) taxable income arising from operating the pool is ultimately lower than that on which the distribution was based, thus resulting in an excess distribution amount having been made, the CPO shall ensure that repayment is made to the pool, in a manner determined by the CPO and as promptly as reasonably practicable, of (i) any portion of the excess distribution not already paid to an applicable tax authority and (ii) with respect to any portion of the excess already paid to a tax authority, any refund or credit received with respect to such payment.

      Transactions Permitted by the Investment Company Act of 1940 (ICA) and its Exemptive Rules; and Exemptive Orders Issued by the SEC and No-Action Letters Issued by SEC Staff under Sections 17 and 57 of the ICA

      Sections 17 of the ICA restricts transactions between RICs and their affiliates, and Section 57 of the ICA restricts transactions between BDCs and their affiliates, which in each case may include loans or advances of pool assets prohibited under NFA Compliance Rule 2-45. However, RICs and BDCs are permitted to engage in certain loans or advances of fund assets pursuant to the ICA, exemptive rules under the ICA, exemptive orders issued by the SEC and no-action letters issued by SEC staff subject to specific conditions set forth in the rule, exemptive order or no-action letter, as applicable, that are designed to ensure that the inter-fund loans only occur in circumstances that are favorable to both funds, and not in circumstances when an affiliate might cause a fund to engage in transactions that are detrimental to the interest of one of the funds. Therefore, transactions by a pool that is also a RIC or BDC that are permitted pursuant to the ICA, exemptive rules promulgated under the ICA, and exemptive orders issued by the SEC or no-action letters issued by SEC staff pursuant to Sections 17 or 57 of the ICA, as applicable, do not violate NFA Compliance Rule 2-45.

      1 For purposes of this exclusion only, a subsidiary will be considered to be wholly-owned even though a general partner, managing member, or similar entity (collectively, a "managing entity") controlled by the CPO owns a small equity interest (i.e., less than 5%) in the subsidiary. The managing member's equity interest in the subsidiary should be in proportion to the size of the managing member's relative debt/equity contribution to the subsidiary. Moreover, if a managing entity makes a loan to the subsidiary, then the managing entity's loan should be on terms no more favorable than the pool(s).

      2 For example, a pool may make a loan to a first-tier wholly owned subsidiary that, in turn, makes an equity contribution or loan to a second-tier wholly owned subsidiary.

      3 The financial statements of the subsidiary and the pool making the loan may be prepared, as applicable, in accordance with International Financial Reporting Standards provided it is permitted by the CFTC's rules and requirements.

      4 The provision relating to qualified eligible participants does not apply to pools registered under the Investment Company Act of 1940.

      5 Provided the conditions in this subsection are satisfied, a single CPO may cause a loan to be made from a single pool to a wholly-owned subsidiary of the pool for tax, legal, regulatory, or other similar reasons.

      9063 - RESERVED

      9064 - NFA COMPLIANCE RULE 2-36: REQUIREMENTS FOR FOREX TRANSACTIONS

      (Board of Directors, September 2, 2011; effective March 26, 2012)

      INTERPRETIVE NOTICE

      NFA Compliance Rule 2-36 imposes a number of obligations on a Forex Dealer Member (FDM) regarding the manner in which it handles customer forex transactions. Compliance Rule 2-36(b)(1) prohibits an FDM engaging in a forex transaction from cheating, defrauding, or deceiving or attempting to cheat, defraud or deceive any other person. NFA Compliance Rule 2-36(b)(4) prohibits an FDM from engaging in any manipulative acts or practices regarding the price of any foreign currency or forex transaction. Also, NFA Compliance Rule 2-36(c) requires an FDM to observe high standards of commercial honor and just and equitable principles of trade in the conduct of its forex business. NFA's Board of Directors (Board) adopted these provisions to ensure that an FDM acts honestly, fairly and in the best interests of its customers.

      NFA's Business Conduct Committee (BCC) recently issued several disciplinary Complaints for violations of these rule provisions based on strikingly similar conduct. As described more fully below, in each of these disciplinary matters, the FDM dealt with price changes that occurred from the time the customer entered an order until the time it reached the FDM's system in an asymmetrical manner that benefited the FDM to the detriment of the customer. Given the severity of the conduct at issue in these disciplinary matters, NFA's Board of Directors is issuing this Notice to provide further guidance.

      When a customer's order reaches an FDM's trading system, the price being offered on the system may be different than the price offered at the time the customer first submitted the order.1 The difference between these two prices is commonly referred to as slippage. If the customer's order is executed at the price quoted at the time the customer entered the order, the slippage will result in an immediate unrealized gain or loss to the customer based on the direction of the market's movement. Since the FDM takes the other side of the customer's order, if the market movement is unfavorable to the customer, it will be favorable to the FDM and vice versa.

      When slippage occurs, some FDMs immediately requote the customer the current price and require the customer to confirm that it still wants to place the order at the requoted price. In order to prevent excessive requoting in a fast moving market and to ensure timelier fills, some FDMs have built in and clearly disclosed slippage parameters to customers that permit the execution of the order if the slippage is within the established slippage parameters.2 In each of the recent disciplinary matters, the FDM used asymmetrical slippage settings that benefited the FDM to the detriment of the customer because the slippage settings made it much more likely that a customer order that moved against the customer (and therefore in the FDM's favor) would be filled than one that moved in the customer's favor (and therefore against the FDM). In particular, the FDMs named in the BCC Complaints employed one or more of the following practices:

      • The FDM set the maximum losing slippage (i.e., slippage that was unfavorable to the customer and favorable to the FDM) at a much wider range of pips than the maximum profit slippage (i.e., slippage that was favorable to the customer and unfavorable to the FDM). As a result, a customer was much more likely to have an order filled when the market move was unfavorable to it than when the movement was favorable to the customer.

      • The FDM set the limit on the number of contracts in an order that could be executed that experienced losing slippage for the customer at a much higher number than the limit on the number of contracts in an order that could be executed that experienced profitable slippage for the customer. As a result, a larger sized order that moved against the customer was much more likely to be executed than a smaller sized order that moved in the customer's favor.

      • The FDM only passed negative slippage on to the customer. If the FDM was able to offset the customer's order at a better price than the price at the time the customer submitted its order, the FDM did not give the customer the better price. However, if the FDM offset the customer's order at a price that had negative slippage and was unfavorable to the customer, the FDM would thereby benefit from the slippage and fill the customer's order at the offset price.

      In each of the above instances, the FDM's asymmetrical slippage settings allowed it to manipulate the prices that the forex customer received and allowed the FDM to benefit from the order slippage to the detriment of the customers, which clearly violates Compliance Rule 2-36(b)(1) and (b)(4) and Compliance Rule 2-36(c). The above practices are examples of the type of conduct that would violate these rule provisions, but is not an all encompassing list. Any asymmetrical slippage settings or requoting practices, or any other manipulative practices, that provide an advantage to the FDM to the detriment of the forex customer would violate these rule provisions.3

      The Board is not prohibiting an FDM from setting symmetrical slippage parameters or requoting prices in appropriate circumstances. An FDM should not be held responsible for order transmission delays that are beyond its control that result in the FDM's trading system reflecting a price at the time a customer order reaches the platform that is different from the price at the time the customer placed the order.4 However, in order for an FDM to avoid violating these rule provisions, the FDM must apply the slippage settings uniformly regardless of the direction in which the market has moved. Similarly, if the FDM requotes prices based on slippage parameters when the market has moved against it, then it must also requote prices when the market has moved in its favor. An FDM must also ensure that the customer is aware of how the FDM handles such circumstances prior to trading with the FDM. Accordingly, prior to entering into the first forex transaction with a customer, an FDM must disclose its policy with regard to orders that are received for a price that is no longer reflected on the platform. For example, the FDM must disclose whether the order will automatically be executed or filled at the price reflected on the platform or if the customer will be notified of the price reflected on the platform and provided with an opportunity to accept or reject this new price. Similarly, if the FDM utilizes slippage parameters, it must disclose these parameters. In particular, the FDM must fully disclose how slippage parameters will be used with respect to limit orders. If the FDM applies different slippage settings and requoting practices depending on the customer, the FDM must also disclose this fact, and indicate the guidelines it uses to determine the appropriate settings and practices for a particular customer.

      An FDM must also have written procedures in place regarding its handling of instances where the price at the time a customer's order reaches the FDM's trading system is different from the price that was reflected at the time the customer placed the order. For those FDMs that utilize different slippage parameters and requoting practices depending on the customer, the FDM's procedures should indicate the guidelines it uses to determine the appropriate settings and practices for a particular customer. A listed principal that is also an NFA associate must have reviewed and approved these procedures.

      Finally, an FDM must ensure that any of its promotional material that discusses the mechanics of its trading system does not provide information that misrepresents or is misleading with respect to how it deals with price slippage and requoting. This includes ensuring that if the FDM uses promotional material that discusses the performance in a demo account, that demo account is subject to the same slippage parameters as actual customer accounts and those parameters are disclosed. Moreover, if the FDM advertises that its electronic trading platform ensures "no slippage," the electronic trading platform must be designed to execute a market order at the price displayed to the customer when the order is entered by the customer.

      1 Although this difference could be the result of an FDM manipulating the prices, the difference may also occur for a number of legitimate reasons including a fast moving market and/or delays in transmitting the order.

      2 These slippage parameters dictate the number of pips the market may move without affecting the execution of the customer's order at the price at the time the customer entered the order. If the order is outside the slippage parameters, the FDM will requote the customer and obtain confirmation of the new price.

      3 These practices apply to FDM proprietary systems where these parameters are internally and inherently programmed into the system as well as for FDM systems that are enhanced by add-ons that are purchased or leased from third parties. An FDM is responsible for ensuring that its trading system, whether proprietary, purchased or leased, is in compliance with this Interpretive Notice.

      4 An FDM is, however, responsible for taking steps to ensure that its trading system has sufficient capacity and integrity to handle the timely and efficient transmission and execution of customer orders.

      9065 - NFA COMPLIANCE RULE 2-10: THE ALLOCATION OF BUNCHED RETAIL FOREX ORDERS FOR MULTIPLE ACCOUNTS

      (Board of Directors, August 18, 2011; effective June 18, 2012; amended March 21, 2014 and March 1, 2020)

      INTERPRETIVE NOTICE

      NFA Compliance Rule 2-10 adopts by reference CFTC Regulation 1.35, which, among other things, imposes on futures commission merchants (FCMs) and retail foreign exchange dealers (RFEDs) certain recordkeeping requirements relating to customer forex1 orders. The purpose of the regulation is to prevent various forms of customer abuse, such as the fraudulent allocation of trades, by providing an adequate audit trail that allows customer orders to be tracked at every step of the order processing system. In general, Regulation 1.35 provides that FCMs and RFEDs receiving a customer order that cannot immediately be entered into a trade matching engine must prepare a written record of the order immediately upon receipt, including an appropriate account identifier.

      With respect to bunched orders placed by a commodity trading advisor (CTA) on behalf of multiple clients, the CFTC has interpreted Regulation 1.35 to require that, at or before the time the order is placed, the CTA must provide the FCM with information that identifies the accounts included in the bunched order and specifies the number of contracts to be allotted to each account,2 (unless the order is done in accordance with the post-execution allocation of bunched order requirements)3. NFA has have found that many CTAs who manage retail forex customer accounts use a percentage allocation management module (PAMM) to allocate bunched orders placed by them on behalf of multiple clients.

      CTAs utilizing PAMM trade an unlimited number of customer accounts under one "Master Account" at an FCM or RFED. Each individual customer then has a sub-account under the Master Account. CTAs utilize the total equity of the Master Account—the aggregate of all individual customers' funds—to place a bunched order for forex lots or contracts and then subsequently allocate a percentage of the lot(s) or contract(s) to each individual customer's sub-account based on each customer's account equity as a percentage of the overall total equity in the Master Account.4

      If PAMM resulted in the fair and non-preferential allocation of regularly offered and tradable sized lot(s) or contract(s)5 to each customer's sub-account—and was not based on the customer's account equity as a percentage of the overall total equity in the Master Account—then this method would be consistent with prior interpretations of Regulation 1.35. However, certain CTAs trading customer accounts and FCMs and RFEDs acting as counterparty to these accounts have not applied PAMM in this manner. Specifically, NFA has found that some CTAs determine the quantity of regularly offered and tradable sized lots or contracts for a bunched order based on the Master Account's equity, rather than on the quantity of regularly offered and tradable sized lots or contracts that would be permitted based on the margin equity in each individual account, which is often too low to place a trade for a regularly offered and tradable sized lot or contract. In such a case, after the FCM or RFED executes the order, PAMM's application does not result in regularly offered and tradable sized lot(s) or contract(s) being allocated to the individual sub-accounts. Rather, pursuant to PAMM, a percentage of the lot(s) or contract(s) are allocated to each customer based upon their percentage of equity in the Master Account. For example, if two customers had equity that equaled 40% and 12.5% of the Master Account's equity, respectively, then the customers would be allocated .4 and .125 of the regularly offered and tradable sized lot or contract, respectively, if the account manager traded one contract.

      The placement of trades based upon the Master Account's total equity and subsequent allocation of a percentage of the lot(s) or contract(s) to individual client accounts pursuant to PAMM, rather than based upon the equity in each individual account causes these individual accounts to be treated similar to a commodity pool's participant units—without the Master Account being legally structured as a commodity pool. Moreover, PAMM leads to certain client accounts not being treated fairly and in a non-preferential manner. Specifically, because FCMs and RFEDs are likely to only act as counterparty with respect to the regularly offered and tradable sized lot(s) or contract(s) margined and traded at the Master Account level, PAMM often restricts the ability of account managers to offset an open position in a smaller percentage lot or contract without affecting the positions of all the sub-accounts underlying the Master Account.

      NFA also noted that each FCM and RFED that utilizes PAMM impose varying restrictions applicable to the process by which customers withdraw and add funds to their accounts. In the extreme situation, individual client withdrawal requests are held up indefinitely because the customer's percentage lot open forex position may not be offset until the regularly offered and tradable sized position is offset for all customers at the Master Account level. In another situation, NFA found that if an individual customer is removed from the PAMM module without their open percentage position being offset, then this customer account may not incur a profit or loss for this position and the original regularly offered and tradable lot sized position is simply reallocated to the remaining sub-accounts, thereby immediately increasing the percentage of equity each individual account has in the regularly offered and tradable sized position established based on the Master Account’s equity. Due to these restrictions, NFA is concerned that customers may not be able to close their accounts and have timely access to their funds, and customers are not being treated fairly as a result of this trade allocation method.

      In summary, CTAs managing retail forex customer accounts may use bunched orders. However, in determining the quantity of lots or contracts for a bunched order, the CTA may not exceed the sum of the quantity of regularly offered and tradable sized contracts that would be permitted based on the equity in each individual account, not the overall equity in the Master Account. In addition, prior to or at the time the CTA places a bunched order with an FCM or RFED, the CTA must inform the FCM or RFED of the number of regularly offered and tradable sized contracts each individual customer account will receive if the order is filled. The CTA must allocate regularly offered and tradable sized lots or contracts to each individual account using a non-preferential predetermined allocation methodology. Further, all customers should be allowed to make additions and withdrawals in a fair and timely manner, and in a manner that does not affect other customers who are managed by the CTA in the same trading program. Given the significant allocation issues with the use of PAMM, NFA at this time is detailing for forex CTAs the longstanding core principles and responsibilities applicable to the allocation of customer bunched orders.

      Core Principles and Responsibilities

      Allocation instructions for retail forex trades made through bunched orders for multiple accounts must deal with two separate issues. The first involves the question of how the total number of contracts should be allocated to the various accounts included in the bunched order. For some CTAs, this allocation may remain relatively constant. For others, although their basic allocation methodology does not change, the specific allocation instructions produced by the methodology may change on a daily basis.

      The second issue involves the allocation of split and partial fills, which may be somewhat less applicable to retail forex transactions given the counterparty nature of these transactions. For example, a CTA may place a bunched order of 100 contracts for multiple accounts. This order may be either filled at a number of different prices or if an order is to be filled at a particular price the FCM or RFED may be willing to act as counterparty for some but not all of the 100 lot order. In either example, the question arises of how the different prices of the contracts in the split or partial fill should be allocated among the accounts included in the bunched order.

      The same set of core principles govern the procedures to be used in handling both of these issues. Any procedure for the general allocation of trades or the allocation of split and partial fills must be:

      • designed to meet the overriding regulatory objective that allocations are non-preferential and are fair and equitable over time, such that no account or group of accounts receive consistently favorable or unfavorable treatment;6
      • sufficiently objective and specific to permit independent verification of the fairness of the allocations over time and that the allocation methodology was followed for any particular bunched order; and
      • timely, in that the CTA must provide the allocation information to FCMs and RFEDs as soon as practicable at the time the order is placed or after the order is filled.7

      The responsibility for allocating contracts executed through a bunched order rests solely with the CTA.8 The CTA must confirm, on a daily basis, that all its accounts have the correct allocation of contracts. A CTA must also analyze each trading program at least once a quarter to ensure that the allocation method has been fair and equitable (i.e., customers in the same trading program achieve similar allocation results over time).9 Allocation fairness over time, rather than trade-by-trade, is the critical element in this evaluation. If materially divergent performance results exist over time among accounts in the same trading program, such results must be shown to be attributable to factors other than the CTA's trade allocation procedures. Applicable CFTC and NFA interpretations have addressed permitted reasons for divergent performance results among accounts in the same trading program. If those results indicate that the allocation method has not been fair and equitable over time, however, then the CTA must revise its allocation methodology or adopt a different allocation method for application on a prospective basis only. A CTA must document its internal audit procedures and results and maintain these audit procedures and results as firm records subject to review during an NFA examination.

      Although the CTA is responsible for the allocation of each bunched order, FCMs and RFEDs have certain obligations as well. In particular, each FCM and RFED must receive from an account manager sufficient information to allow it to perform its functions, including information concerning the number of contracts to be allocated to each account included in the bunched order along with instructions, if applicable, for the allocation of split and partial fills among accounts. One means by which an FCM or RFED can meet this recordkeeping requirement is to maintain a copy of the allocation instructions provided by the account manager by facsimile, e-mail, or other form of electronic transmission. If the allocation is provided orally, however, the FCM or RFED must create a written record and maintain that record.

      Also, if an FCM or RFED has actual or constructive notice that allocations may be fraudulent, the FCM or RFED must take appropriate action. For example, if an FCM or RFED has notice of unusual allocation activity, the FCM or RFED must make a reasonable inquiry into the matter and, if appropriate, refer the matter to the proper regulatory authorities (e.g., the CFTC or NFA or its DSRO). Whether an FCM or RFED has such notice depends upon the particular facts involved.

      1 For purposes of the Notice, the term "forex" has the same meaning as in Bylaw 1507(b).

      2 Consistent with the provisions of CFTC Regulation 1.35(b)(1), account managers that place orders for a single account must still provide account identification information at the time of order entry.

      3 CFTC Regulation 1.35(b)(5)'s language governing the post-execution allocation of bunched orders appears inapplicable to retail forex bunched orders.

      4 FCMs and RFEDs acting as counterparties to retail Forex customer accounts traded as part of a block order have an obligation to ensure that they have collected and maintained for each individual customer the applicable security deposit requirement pursuant to NFA Financial Requirements Section 12 for each lot or contract placed in a customer's account by a CTA.

      5 Forex positions are often regularly traded in the following lot sizes: Standard (100,000 units), Mini (10,000 units) and Micro (1,000 units). CTAs must disclose to their customers the lot size they intend to use.

      6 Because customers must have access to information that allows them to assess the fairness of the allocation process, CTAs are required to make the following information available to customers upon request: (1) the general nature of the CTA's allocation methodology; (2) whether accounts in which the CTA may have an interest may be included with customer accounts in bunched orders; and (3) summary or composite data sufficient for that customer to compare its allocation results with the allocation results of other comparable customers and, if applicable, any account in which the account manager has an interest.

      7 Interpretive Notice 9029-NFA Compliance Rule 2-10: The Allocation of Bunched Orders for Multiple Accounts sets out examples of methodologies for the allocation of bunched orders that generally satisfy the core principles described above. Although these methodologies were set forth with regard to on-exchange futures and options transactions, their application may be equally applicable to retail forex transactions.

      8 However, NFA rules do not preclude an FCM or RFED from agreeing to undertake this responsibility, pursuant to either its own procedures or to those supplied by the CTA. For example, the CTA and FCM or RFED may agree that an FCM or RFED will allocate a bunched order in accordance with instructions that the CTA files with the FCM or RFED either prior to or concurrently with placing the bunched order. Any division of responsibilities agreed to by the FCM and CTA should be clearly documented.

      9 CTAs must review customer performance at the individual client account level and not the master account level. Moreover, CTAs must maintain the necessary records and calculate customer performance for each trading program in conformity with the CFTC's Part 4 Regulations.

      9066 - NFA FINANCIAL REQUIREMENTS SECTION 16: FCM FINANCIAL PRACTICES AND EXCESS SEGREGATED FUNDS/SECURED AMOUNT/CLEARED SWAPS CUSTOMER COLLATERAL DISBURSEMENTS

      (Board of Directors, May 17, 2012; effective September 1, 2012. Revised July 1, 2013; January 14, 2016;  March 29, 2017 and June 30, 2020.)

      INTERPRETIVE NOTICE

      A futures commission merchant's (FCM) segregation of customer funds forms the foundation of the futures industry's customer protection regime. NFA Financial Requirements Section 16 is designed to establish requirements regarding the maintenance of an FCM's residual interest in the customer segregated funds, customer secured amount, and cleared swaps customer collateral account(s). Additionally, to enhance transparency and regulatory risk monitoring relating to each Member FCM's protection of customer funds, Section 16 places requirements upon FCMs relating to certain withdrawals of their residual interest, and requires FCMs to report certain financial and operational information to NFA in the form and manner prescribed by NFA. This Notice provides a subsection-by-subsection analysis of Financial Requirements Section 16 and further describes certain regulatory requirements that FCMs must adopt to implement Section 16's specific requirements.

      Funds that customers deposit with an FCM, or that are otherwise required to be held for the benefit of customers, to margin futures and options on futures contracts traded on futures markets located in the United States must be held in a customer segregated funds account pursuant to Section 4d(a)(2) of the Commodity Exchange Act and Commodity Futures Trading Commission (CFTC) Regulation 1.20. Funds that customers deposit with an FCM, or that are otherwise required to be held for the benefit of customers, to margin futures and options on futures contracts traded on foreign boards of trade must be held in a foreign futures and foreign options secured amount account in accordance with CFTC Regulation 30.7. Funds that customers deposit with an FCM, or that are otherwise required to be held for the benefit of customers, to margin, guarantee or secure a cleared swap, must be segregated and held in accordance with CFTC Regulation 22.2. CFTC Regulation 1.22 prohibits an FCM from using one customer's funds to meet the obligations of another customer. Similarly, CFTC Regulation 22.2(d) prohibits an FCM from using one cleared swaps customer's collateral to meet the obligations of any other person. Therefore, if a customer fails to have sufficient funds on deposit with an FCM to meet the customer's obligation, then the FCM must use its own funds to make up any deficiency in a customer's account. NFA Financial Requirements Section 4 adopts by reference CFTC Regulations 1.20, 1.22, 22.2 and 30.7.

      To comply with Regulation 1.22 and 22.2(d), an FCM is permitted pursuant to Regulation 1.23 to maintain excess funds in the customer segregated and secured amount accounts and is permitted pursuant to Regulation 22.2(e)(3) to maintain excess funds in the cleared swaps customer collateral accounts. The excess funds in these accounts are referred to as the FCM's residual interest and the funds are for the exclusive benefit of the FCM's customers while held in these accounts.

      CFTC Regulation 1.32, Regulation 30.7 and Regulation 22.2(g) require FCMs to complete a segregated funds calculation, secured amount funds calculation, and/or cleared swaps customer collateral calculation respectively for each business day by noon of the following business day. Under Financial Requirements Section 16 and CFTC Regulation 30.7(f)(2), in determining the FCM's secured amount requirement, the FCM must use the method that calculates net liquidating equity plus the market value of any securities held in customers' accounts.

      Subsection 16(a) requires each Member FCM to maintain written policies and procedures regarding the maintenance of the FCM's residual interest in the customer segregated funds account(s) as identified under CFTC Regulation 1.20, in its foreign futures and foreign options customer secured amount funds account(s) as identified in CFTC Regulation 30.7, and in its cleared swaps customer collateral account(s) as identified in CFTC Regulation 22.2. The FCM's policies and procedures must establish a target amount (either by percentage or dollars) that the FCM seeks to maintain as its residual interest in these accounts and that amount must be designed to reasonably ensure that the FCM remains in compliance with the segregation, secured amount and cleared swaps customer collateral requirements. The target amount can be expressed with descriptive terms (e.g., at least "x" dollar amount or percent of segregated/secured amount funds or cleared swaps customer collateral) or as a range (e.g., between "x" dollar amount and "y" dollar amount or percent).1 The FCM's Board of Directors or similar governing body2, must approve, as part of the FCM's Risk Management Program under CFTC Regulation 1.11, in writing the FCM's targeted residual amount and any material change in either the targeted amount or the FCM's policies and procedures regarding the maintenance of the FCM's residual interest in the customer segregated funds account(s), the foreign futures and foreign options customer secured amount funds account(s) or the cleared swaps customer collateral account(s).

      In establishing the target amount of residual interest, the Board of Directors or similar governing body, CEO, CFO, or other officer or officers specifically granted the authority and responsibility to fulfill the responsibilities of senior management by the governing body, must perform a due diligence inquiry and consider various factors, if applicable, relating to the nature of the firm's business, including but not limited to: the firm's type of customers, their general creditworthiness, and trading activity; the type of markets and products traded by the firm's customers and the firm itself; the general volatility and liquidity of those markets and products; the firm's own liquidity and capital needs; and historical trends in customer segregated/secured amount funds or cleared swaps customer collateral balances and undermargined amounts and net deficit balances in customers' accounts. Member FCMs are required to create a written record containing a description of the analysis of the factors used by the FCM to determine its targeted residual amount. The primary purpose of the residual interest is to ensure that sufficient funds are on deposit with an FCM to meet customer obligations and to remain in compliance at all times with the segregation requirements.

      Although, falling below the target amount of residual interest is not, in and of itself, a violation of the segregated/secured amount or cleared swaps customer collateral requirements, any FCM that does not hold sufficient funds to meet its target residual interest amount in segregated/secured account or cleared swaps customer collateral accounts must file immediate notice of this occurrence with the CFTC and the FCM's DSRO. If the FCM sets its target residual as a range, a notice filing is required if the target residual amount falls below the specific dollar or percentage amount specified on Form 1-FR-FCM. Additionally, in those instances where an FCM withdraws a portion of its residual interest via disbursement(s) not for the benefit of customers thereby causing the firm to fall below its target amount of residual interest, then the FCM by the close of business on the next business day should either deposit funds into the segregated, secured amount funds or cleared swaps customer collateral account(s) necessary to restore the respective account'(s) balance to the target amount of residual interest or, if appropriate, revise the FCM's target amount of residual interest and follow the requirements in doing so set forth in subsection 16(a) and this Notice relating to establishing and changing the targeted residual amount. Unless the nature of an FCM's business materially changes, NFA would not expect material and/or frequent modifications to either an FCM's targeted amount or the FCM's policies and procedures regarding the maintenance of the FCM's targeted residual interest.

      An FCM's disbursement(s) of its residual interest in any dollar amount from customer segregated funds, secured amount funds, and cleared swaps customer collateral account(s) not made for the benefit of customers must be done in a manner that ensures that the FCM maintains sufficient funds to remain in continual compliance with the customer segregated funds, customer secured amount and cleared swaps customer collateral requirements. In making a disbursement(s) from customer segregated funds, customer secured amount funds and cleared swaps customer collateral account(s), an FCM's internal procedures must require the FCM to not only consider the daily segregated/secured amount/cleared swaps customer collateral calculation required by CFTC Regulation 1.32, CFTC Regulation 30.7 or CFTC Regulation 22.2(g), computed as of the close of business on the previous business day, but also the impact of any known unsecured debit(s), deficit(s), and previous disbursements that could cause material adjustments to its most current segregated, secured amount funds and cleared swaps customer collateral calculations.

      Subsection 16(b) adopts requirements relating to an FCM's internal approval and notification to NFA of any significant disbursement, as defined, of customer segregated funds that is not made for the benefit of customers. Specifically, this subsection provides that no Member FCM via a single or multiple transaction(s) may withdraw, transfer or otherwise disburse funds from any customer segregated funds account(s) as identified under CFTC Regulation 1.20 exceeding 25% of the FCM's residual interest in customer segregated funds based upon the daily segregated funds calculation required by CFTC Regulation 1.32 computed as of the close of business on the previous business day (hereinafter the "25% threshold") unless the FCM's CEO, CFO or other senior official who holds a position with knowledge of the firm's financial requirements and financial position and is listed as a principal on the firm's Form 7-R (for purposes of Section 16 only, a "Financial Principal") pre-approves in writing the segregated funds disbursement whereby the FCM exceeds or will exceed the 25% threshold.

      In addition to obtaining the CEO's, CFO's or Financial Principal's approval, subsection 16(b)(iii) requires the FCM to file a written notice with NFA immediately after the FCM's CEO, CFO or Financial Principal pre-approves in writing the disbursement whereby the FCM exceeds or will exceed the 25% threshold. The notice to NFA must be signed by the FCM's CEO, CFO or Financial Principal and subsection 16(b)(iii)(1)-(4) provides that the notice must include the following: (1) notification that the FCM has made or intends to make a disbursement(s) from segregated funds that exceeds or will exceed 25% of the FCM's residual interest in customer segregated funds based upon the daily segregated funds calculation required by CFTC Regulation 1.32 computed as of the close of business on the previous business day; (2) a description of the reason(s) for, and the amount provided to each recipient of the single or multiple transaction(s) that results or will result in the disbursement(s) that exceeds the 25% threshold; (3) confirmation that the FCM's CEO, CFO, or Financial Principal (and the identity of that person if different from the person who signed the notice) pre-approved in writing the disbursement whereby the FCM exceeds or will exceed the 25% threshold; and (4) the current estimate of the FCM's remaining total residual interest in the customer segregated funds account(s) after the disbursement, and representation that to the best of the CEO, CFO or Financial Principal's knowledge and reasonable belief, after due diligence, the FCM remains in compliance with the segregation requirements after the disbursement.

      Financial Requirements subsection 16(b)(iv) addresses disbursement(s) made from an FCM's segregated funds account(s) subsequent to an FCM making a disbursement(s) that exceeds the 25% threshold that required the approval and notice described in subsections 16(b)(i) and (b)(ii). In those circumstances, from the time of the original disbursement that exceeds the 25% threshold until the FCM completes its next required daily segregated funds calculation, the firm may not make any subsequent disbursement(s) in any amount from the segregated funds account(s), except to or for the benefit of commodity and options customers, without obtaining for each disbursement the pre-approval of the CEO, CFO or Financial Principal and filing a written notice signed by the CEO, CFO or Financial Principal that discloses the amount to each recipient of the disbursement and the reasons for the disbursement, and which confirms that the CEO, CFO or Financial Principal (and the identity of that person if different from the person who signed the notice) pre-approved the disbursement in writing, indicates the current estimate of the FCM's remaining total residual interest in the customer segregated funds account(s) after the disbursement, and contains a representation that to the best of the CEO, CFO or Financial Principal's knowledge and reasonable belief, after due diligence, the FCM remains in compliance with the segregation requirements after the disbursement.

      Financial Requirements subsection 16(c) replicates subsection 16(b)'s internal approval and notice requirements applicable to customer segregated funds account(s) for foreign futures and foreign options customer secured amount funds account(s) as identified under CFTC Regulation 30.7. Similarly, subsection 16(d) replicates subsections 16(b)'s internal approval and notice requirements applicable to customer segregated funds accounts for cleared swaps customer collateral account(s) as identified under CFTC Regulation 22.2.

      Importantly, Financial Requirements subsections 16(b)(iv), (c)(iv) and (d)(iv) place a key qualification on the disbursements utilized to calculate whether an FCM has or will exceed the 25% threshold. Specifically, these subsections provide that for purposes of calculating the 25% threshold an FCM shall exclude any segregated funds disbursement(s), secured amount funds disbursement(s) or cleared swaps customer collateral disbursement(s) that are made to or for the benefit of customers..

      Therefore, certain disbursements, transactions and/or occurrences for the benefit of customers should not be included in an FCM's calculation of the 25% threshold. Specifically, a reduction in segregated or secured amount funds or cleared swaps customer collateral caused by, for example—a loss in the market value of the segregated or secured amount funds' or cleared swaps customer collateral investments; an increase in customer unsecured debits/deficits from one day to the next; the transfer of a particular futures customer's cash from a segregated funds account for the customer's domestic futures trading to a secured amount account for that customer's trading on foreign markets and/or to a cleared swaps customer collateral account or vice-versa; the transfer of a particular futures customer's cash from a segregated funds account to a delivery account for that customer to take delivery of a commodity; the transfer of a particular futures customer's equity and cash to that customer's securities or foreign exchange account at either the FCM/broker-dealer (BD) or a BD affiliate of the FCM; and the simultaneous exchange of cash for the same dollar value of securities allowable pursuant to Regulation 1.25 or vice-versa—are not the type of disbursements, transactions and/or occurrences to be considered by an FCM in calculating the 25% threshold. The aforementioned examples are not intended to encompass all transactions, disbursements or occurrences that are for the benefit of a customer.

      Additionally, subsections 16(b)(iii)(1), (c)(iii)(1) and (d)(iii)(1) require an FCM to utilize the daily segregated funds, secured amount funds and cleared swaps customer collateral calculations as of the close of business on the previous business day, respectively, to determine whether the FCM has made or intends to make disbursement(s) that exceeds or will exceed 25% of the FCM's residual interest in segregated funds, secured amount funds and cleared swaps customer collateral. Therefore, unless acting pursuant to relief granted by the Commission related to cleared swaps customer accounts in CFTC Letter No. 17-033, an FCM is prohibited from making any disbursement(s) from the account for which the calculation as of the close of business on the previous day has not been completed (i.e., the customer segregated, secured amount funds or cleared swaps customer collateral account(s)), unless the disbursement is to or for the benefit of customers, until the required calculation(s) is completed and submitted to NFA.

      Additionally, subsections 16(b)(iii)(1), (c)(iii)(1) and (d)(iii)(1) require an FCM to utilize the daily segregated funds, secured amount funds and cleared swaps customer collateral calculations as of the close of business on the previous business day, respectively, to determine whether the FCM has made or intends to make disbursement(s) that exceeds or will exceed 25% of the FCM's residual interest in segregated funds, secured amount funds and cleared swaps customer collateral. Therefore, unless acting pursuant to relief granted by the Commission related to cleared swaps customer accounts in CFTC Letter No. 17-033, an FCM is prohibited from making any disbursement(s) from the account for which the calculation as of the close of business on the previous day has not been completed (i.e., the customer segregated, secured amount funds or cleared swaps customer collateral account(s)), unless the disbursement is to or for the benefit of customers, until the required calculation(s) is completed and submitted to NFA.

      Lastly, subsection 16(e) requires Member FCMs to submit certain financial and operational information to NFA on a monthly or semi-monthly basis. NFA's Board of Directors (Board) has recently authorized certain of this financial and operational information (as described below) to be posted to and made publicly available on NFA's website.

      Subsection 16(e)(i) (1)-(2) requires FCMs on a monthly basis, within 17 business days after the end of each month, to submit the following information as of the close of business on the last business day of the month: (1) total adjusted net capital, minimum net capital and excess net capital (listed in dollar figures); and (2) the firm's measure of leverage (i.e., total balance sheet assets, less any instruments guaranteed by the U.S. government and held as an asset or to collateralize an asset (e.g., reverse repo) divided by total capital (the sum of stockholder's equity and subordinated debt) all computed in accordance with U.S. GAAP.

      Subsection 16(e)(ii) requires FCMs by 11:59 P.M. Eastern time on the business day following the 15th (or the business day following the "as of" reporting day if the 15th falls on a weekend) and the last business day of each month to submit the following information as of the close of business on the 15th (or the following business day if the 15th falls on a weekend) and the last business day of each month: (1) The identity and location of each depository holding customer segregated funds and the dollar amount held at each depository; (2) The dollar amount of customer segregated funds held in cash, each type of permitted investment identified in CFTC Regulation 1.25(a), customer owned securities held as margin, and as securities under agreements to resell the securities (reverse repurchase transactions) held at each depository identified in subsection (1); (3) The identity and location of each depository holding foreign futures and foreign options customer secured amount funds and the dollar amount held at each depository; (4) The dollar amount of foreign futures and foreign options customer funds held in cash, each type of permitted investment identified in CFTC Regulation 1.25(a), customer owned securities held as margin, and as securities under agreements to resell the securities (reverse repurchase transactions) held at each depository identified in subsection (3); (5) The identity and location of each depository holding cleared swaps customer collateral and the dollar amount held at each depository; (6) The dollar amount of cleared swaps customer collateral held in cash, each type of permitted investment identified in CFTC Regulation 1.25(a), customer owned securities held as margin, and as securities under agreements to resell the securities (reverse repurchase transactions) held at each depository identified in subsection (5); and (7) The identity of each depository that held customer segregated funds, foreign futures and foreign options customer secured amount funds or cleared swaps customer collateral during the reporting period that is an affiliate of the FCM. Subsection 16(e)(iii) requires FCMs to submit by noon of each business day, the daily segregated funds, secured amount funds and cleared swaps customer collateral computations as of the close of the preceding business day.

      Member FCMs will be held liable for willfully submitting materially false or misleading information to NFA in connection with the information required to be submitted pursuant to Financial Requirements Section 16. Moreover, to the extent that an FCM purposefully manipulates the information submitted pursuant to subsection 16(e) so that the information is not reflective of the firm's general financial condition during the month, then the FCM may be liable for submitting misleading information to NFA and for a violation of just and equitable principles of trade.

      Pursuant to subsection 16(e)(iv), either the FCM's CEO, CFO or other individual designated by the CEO or CFO to file on his/her behalf, or where applicable, a person described in CFTC Regulation 1.10(d)(4)(ii) is required to submit the information required by subsections 16(e)(i)-(iii). For purposes of submitting the information, the FCM's CEO or CFO must complete a User Identification Request Form (Form). If the CEO or CFO designates a person on this Form to submit the information on his/her behalf, the CEO/CFO must identify that person on the Form and acknowledge that he/she remains responsible for the accuracy of the information submitted by the designated submitter. Additionally, the CEO or CFO will have to represent that with respect to the electronic submission of certain financial reports, supplemental information and regulatory notifications the use of his/her User ID or his/her designated submitter's User ID is a representation in accordance with any applicable CFTC or other federal agency requirement that, to best of her/his knowledge and belief, all information contained in the reports and supplemental information is true, correct and complete.

      Subsection 16(e)(v) is designed to ensure that the information required to be submitted pursuant to subsections 16(e)(i)-(iii) is actually submitted in a timely manner. Therefore, any information filed after its due date shall be accompanied by a fee of $1,000 for each business day that it is late. Payment and acceptance of the fee does not preclude NFA from filing a disciplinary action under NFA's Compliance Rules for failure to comply with the required time periods.

      As noted above, NFA Financial Requirements Section 16 is designed to establish requirements regarding the maintenance of an FCM's residual interest in the customer segregated funds, secured amount and cleared swaps customer collateral account(s). Additionally, to enhance transparency and regulatory risk monitoring relating to each Member FCM's protection of customer funds, Section 16 places requirements upon FCMs relating to certain withdrawals of their residual interest, and requires FCMs to report certain financial and operational information to NFA in the form and manner prescribed by NFA. NFA and a Member FCM's designated self-regulatory organization will closely monitor the information submitted pursuant to Financial Requirements Section 16 to ensure that an FCM maintains sufficient funds to remain in continual compliance with the customer segregated funds, customer secured amount and cleared swaps customer collateral requirements. If NFA believes that an FCM's financial condition poses a concern that it may not have sufficient funds to remain in continual compliance with these obligations, then NFA's President, with the concurrence of NFA's Board of Directors or Executive Committee, may issue a Member Responsibility Action against the Member FCM pursuant to NFA Compliance Rule 3-15. This emergency action may suspend or restrict the FCM's operations or otherwise direct the firm to take remedial action, which may include infusing additional residual interest funds into the customer segregated funds, customer secured amount and/or cleared swaps customer collateral accounts or additional capital into the firm's operating accounts.

      1 Although an FCM's policies and procedures may establish a target range for managing its residual interest, the firm is still required to report a specific dollar/percentage amount on its Form 1-FR-FCM Statement of Segregation/Secured Amounts/Cleared Swaps Customer Requirements. FCMs must ensure that the specific amount reported is within the range and is an amount that reasonably ensures that the FCM remains in compliance with its segregation requirements. Any FCM using a target range, should also report the range each reporting day on Daily Segregation – Cover Page and monthly on the Form 1-FR-FCM Exchange Supplementary NFA Financial Requirements Section 16 Information.

      2 Governing Body means proprietor if FCM is a sole proprietorship; general partner if the FCM is a partnership; board of directors if the FCM is a corporation; Member(s) vested with management authority if the FCM is a LLC or LLP.

      3 See CFTC Letter No. 17-03 – No-Action Position Regarding Regulation 22.17(b) Withdrawals of Residual Interest (January 26, 2017).

      9067 - RESERVED

      9068 - NFA COMPLIANCE RULES 2-4 AND 2-36: PROHIBITION ON THE USE OF CERTAIN ELECTRONIC FUNDING MECHANISMS

      (Board of Directors, May 15, 2014; effective January 31, 2015 and July 1, 2019.)

      INTERPRETIVE NOTICE

      NFA Compliance Rule 2-4 requires 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 and swaps business. Similarly, NFA Compliance Rule 2-36(c) requires Forex Dealer Members (FDM) and their Associates to observe high standards of commercial honor and just and equitable principles of trade in the conduct of their forex business.

      NFA's Board of Directors (Board) recently reviewed information regarding the use of credit cards1 by FDM retail customers to fund their forex trading accounts, which indicates that retail forex customers overwhelmingly fund their trading accounts using a credit card. For the reasons described below, the Board believes that permitting customers to invest in commodity interest markets using a credit card is inconsistent with a Member's obligation to observe high standards of commercial honor and just and equitable principles of trade.

      Credit cards, by their very nature, permit easy access to borrowed funds. Given the highly volatile nature of the commodity interest markets, the substantial risk of loss, and the possibility that a total loss may occur in a very short period of time, the Board has concluded that Members should be prohibited from permitting customers to use credit cards to fund commodity interest accounts.

      The Board also recognizes that the retail commodity interest businesses are largely Internet based, electronic payments are the acceptable payment method for most Internet based businesses, and that certain electronic funding methods may provide some convenience to customers. Therefore, the Board is not prohibiting all forms of electronic payment mechanisms.

      Specifically, the Board believes that certain electronic funding mechanisms are acceptable and appear consistent with a Member's obligation to observe high standards of commercial honor and just and equitable principles of trade. Those electronic funding mechanisms, however, must be tied to a customer's bank account at a financial institution. In particular, the Board is aware that with an electronic payment made through a debit card, the funds are drawn directly from the customer's bank account and therefore this payment method functions in a manner very similar to a check drawn on a customer's account. The Board also understands that certain other electronic payment facilitators may draw funds directly from a customer's bank account.

      The key factor differentiating a credit card payment from an electronic funding method that is directly tied to the customer's account at a financial institution is that with the latter method, the customer has funds on hand and those funds are immediately transferred from the customer's bank account to the FDM or FCM, which significantly reduces the likelihood that the customer is borrowing funds to invest. The Board also believes, however, that in order to accept an electronic funding method such as a debit card, the Member must be able to distinguish, prior to accepting funds, between a debit card or other electronic funding method that draws money from the customer's checking or savings account at a financial institution and a traditional credit card, and be able to reject the credit card before accepting funds. For example, in processing electronic payments, Members may utilize a third-party provider that uses technology to differentiate between a credit or debit card transaction.

      As always, any FCM or FDM offering this type of funding mechanism should make sure that adequate risk disclosure is provided to a customer in light of the customer's financial circumstances.

      1 For purposes of this Interpretive Notice, the term credit card also includes other electronic payment facilitators (e.g., Paypal) that commonly draw funds from a customer's credit card.

      9069 - NFA COMPLIANCE RULE 2-36: RISK MANAGEMENT PROGRAM FOR FOREX DEALER MEMBERS

      (Board of Directors, May 21, 2015, effective January 4, 2016.)

      INTERPRETIVE NOTICE

      Each NFA Member Futures Commission Merchant (FCM) is required under NFA Compliance Rule 2-26 (incorporating CFTC Regulation 1.11) to establish, maintain and enforce a system of risk management policies and procedures designed to monitor and manage the risks associated with its activities as an FCM (known as a Risk Management Program). Each NFA Member Swap Dealer (SD) and Major Swap Participant (MSP) is subject to similar requirements under NFA Compliance Rule 2-49 (incorporating CFTC Regulation 23.600) and must have a Risk Management Program with respect to monitoring and managing the risks associated with its swap dealing activities.

      NFA's Board of Directors (Board) believes that each NFA Forex Dealer Member (FDM) should be subject to Risk Management Program requirements with respect to monitoring and managing its forex activities.1 Therefore, the Board is amending NFA Compliance Rule 2-36 to specifically require FDMs to establish, maintain and enforce a Risk Management Program designed to monitor and manage the risks associated with their forex activities.2 The purpose of this interpretive notice is to provide guidance relating to the FDM Risk Management Program requirements.

      Written Risk Management Program

      Each FDM must establish, maintain, and enforce a Risk Management Program designed to monitor and manage the risks associated with its forex activities. Each FDM must adopt written policies and procedures that describe its Risk Management Program, and those policies and procedures along with any material changes thereto must be approved in writing by the firm's governing body.3 The Risk Management Program must also include procedures for the timely distribution of the written Risk Management Program to relevant supervisory personnel. The FDM must maintain records of the persons to whom the Risk Management Program is distributed, along with the date of distribution. The FDM must also submit a copy of the Risk Management Program to NFA and/or the CFTC upon request.

      Risk Management Unit

      Each FDM must establish and maintain a risk management unit. This unit must have sufficient authority; qualified personnel; and financial, operational and other resources to carry out the firm's Risk Management Program. The risk management unit must report directly to the firm's senior management4 and be independent from those employees involved (including in a supervisory capacity) in pricing, trading, sales, marketing, advertising, and solicitation activities of the FDM (collectively business trading unit).

      Elements of the Risk Management Program

      At a minimum, the Risk Management Program must include policies and procedures to monitor and manage the following risks:

        a. Market Risk shall take into account, among other things, for all counterparties (i.e., ECP and Non-ECP) the daily measurement of market exposure, volatility of prices, basis and correlation risks, leverage, sensitivity of option positions (if applicable), and position concentration to comply with market risk tolerance limits; timely and reliable valuation data derived from, or verified by, sources that are independent of the business trading unit; and periodic reconciliation of profits and losses resulting from valuations with the general ledger.

        b. Credit Risk shall take into account, among other things, for all counterparties the daily measurement of overall credit exposure to comply with forex counterparty credit limits; monitoring and reporting violations of counterparty customer credit limits performed by persons independent of the business trading unit; the firm's process for monitoring and adjusting security deposit requirements imposed upon all counterparty customers; and regular valuation of collateral (including appropriate haircuts) used to cover credit exposures and safeguarding of collateral.

        c. Liquidity Risk shall take into account, among other things, the daily measurement of liquidity needs, risks presented by prime brokers and/or liquidity providers, and, if applicable, procedures for liquidating all non-cash collateral in a timely manner and without significant effect on price and application of appropriate collateral haircuts that accurately reflect market and credit risk.

        d. Foreign Currency Risk shall take into account, among other things, the daily measurement of the amount of capital exposed to fluctuations in the value of foreign currency to comply with applicable limits and the establishment of safeguards against adverse currency fluctuations.

        e. Legal Risk shall take into account, among other things, the determination that any transaction and netting arrangements entered into have a sound legal basis, account opening documents are properly completed and adequate risk disclosure provided, and an evaluation of what impact any potential litigation may have upon firm capital.

        f. Operational Risk shall take into account, among other things, secure and reliable operating and information systems with adequate, scalable capacity and independence from the business trading unit; safeguards to detect, identify and promptly correct deficiencies in the operating and information systems; automated financial and risk management controls reasonably designed to prevent the placing of erroneous trades, including those that exceed pre-set capital, credit or volume thresholds; and reconciliation of all data and information in operating and information systems.

        g. Counterparty Risk shall take into account, among other things, all risks including but not limited to, settlement risks, pricing risks associated with offsetting the FDM's forex positions with counterparties, including different prime brokers, banks and other FDMs.

        h. Liabilities to Retail Forex Customers Risk shall take into account, among other things, the process to ensure that the FDM has sufficient assets to cover the amount owed to retail forex customers on a daily basis. This process must include:

        • a separation of duties among individuals responsible for advising customers on trading activities, approving or overseeing customer cash receipts and disbursements and recordkeeping and reporting financial transactions;
        • a method for ensuring the firm is accurately computing its liability to retail forex customers and accurately monitoring and valuing the funds used to cover the liability to retail forex customers;
        • a method for evaluating on a continued basis the depositories used to hold funds used to cover the amount owed to retail forex customers including ensuring that the depositories meet specified criteria relating to the depository's capitalization, creditworthiness, operational reliability and access to liquidity, as well as the requirements of CFTC Regulation 5.8 and NFA Financial Requirements Section 14;
        • a method for assessing the appropriateness of specific investments of funds used to cover the liability to retail forex customers in permitted investments under CFTC Regulation 1.25; and
        • the timely recording of all transactions, including transactions impacting retail forex customers' accounts, in the FDM's books and records.

        i. Technological Risk shall take into account, among other things, the process to identify and guard against all risks relating to technology including but not limited to the risks associated with both proprietary and third party trading platforms, the security of proprietary and third party platforms, technology changes and the firm's business continuity plan.

        j. Capital Risk shall take into account, among other things, that the FDM has sufficient capital to be in compliance with the Commodity Exchange Act and its regulations and NFA Financial Requirements, as well as having sufficient capital and liquidity to meet the reasonably foreseeable needs of the FDM.

        k. Any Other Applicable Risks.

      Risk Tolerance Limits

      The Risk Management Program must also set risk tolerance limits for each of the elements described above and discuss the underlying methodology used in setting these limits, as well as any policies and procedures governing exceptions to these limits and detecting and reporting to appropriate management. These risk tolerance limits must be reviewed and approved quarterly by the firm's senior management and annually by the firm's governing body. The FDM must maintain a copy of these approvals.

      Additionally, the Risk Management Program must include policies and procedures for detecting breaches of risk tolerance limits set by the FDM and alerting supervisors within the risk management unit and senior management, as appropriate.

      Stress Testing

      As part of the Risk Management Program, the FDM must conduct stress tests under extreme but plausible conditions of all positions in the proprietary account and in each counterparty account (both retail customers and ECPs) at least on a semi-monthly basis.

      Affiliate Risk

      The Risk Management Program must also consider all risks posed by the FDM's affiliates, including the risks affiliates pose when the FDM functions as the primary risk manager and/or liquidity provider for affiliates, the FDM's other business lines and any other trading activity engaged in by the FDM.

      Periodic Risk Exposure Reports

      Each FDM's risk management unit must provide to senior management and its governing body quarterly written risk exposure reports, which set forth all applicable risk exposures of the FDM, breaches of any established risk limits, any recommended or completed changes to the Risk Management Program, the recommended time frame for implementing the recommended changes; and the status of any incomplete implementation of previously recommended changes to the Risk Management Program.

      Each FDM must also provide senior management and the governing body with interim risk exposure reports immediately at any time the FDM detects a material change in the risk exposure of the FDM. An FDM must provide to NFA a copy of all quarterly and interim risk exposure reports provided to its senior management and governing body within 5 business days of providing the report to the FDM's senior management and governing body.

      Supervision of the Risk Management Program

      The FDM must have a supervisory system in place to ensure that the Risk Management Program is being diligently followed by all appropriate personnel.

      Review and Testing

      The FDM must ensure that the Risk Management Program is reviewed and tested at least annually or upon any material change in the FDM's business that is reasonably likely to alter the FDM's risk profile by qualified internal audit staff that are independent of the business trading unit, or by a qualified third party audit service, which reports to FDM staff that are independent of the business trading unit. The review must include an analysis of adherence to, and the effectiveness of, the risk management policies and procedures, and any recommendations for modifications to the Risk Management Program. The results of the review must be reported to and reviewed by senior management and the FDM's governing body.

      The FDM must document all internal and external reviews and testing of the Risk Management Program including the date of the review or test; the results; any identified deficiencies; the corrective action taken; and the date the corrective action was taken.

      Recordkeeping

      An FDM shall maintain copies of all written policies and procedures, changes thereto, and approvals required in this notice pursuant to NFA Compliance Rule 2-10 for the period required under CFTC Regulation 1.31.

      1 The FDM Risk Management Program requirements are drawn from similar requirements set forth in CFTC Regulations 1.11 and 23.600. In light of the counterparty nature of forex transactions and the fact that FDMs accept customer funds, the Board believes it appropriate to apply certain requirements set forth in CFTC Regulations 1.11 and 23.600.

      2RFEDs that are also registered as an FCM and/or SD may have one risk management program that addresses all the risks associated with the activities of each registration category.

      3Governing body means (a) board of directors; (b) a body performing a function similar to a board of directors; or (c) any committee of a board or body.

      4Senior management means, any officer or officers specifically granted the authority and responsibility to fulfill the requirements of senior management by the governing body.

      9070 - NFA COMPLIANCE RULES 2-9, 2-36 AND 2-49: INFORMATION SYSTEMS SECURITY PROGRAMS1

      (Board of Directors, August 20, 2015, effective March 1, 2016; April 1, 2019 and September 30, 2019.)

      INTERPRETIVE NOTICE

      NFA Compliance Rule 2-9 places a continuing responsibility on every Member futures commission merchant (FCM), commodity trading advisor (CTA), commodity pool operator (CPO), and introducing broker (IB) to diligently supervise its employees and agents in all aspects of their commodity interest activities. Compliance Rule 2-36 places identical supervisory obligations on retail foreign exchange dealers (RFED) for their forex activities. Additionally, NFA Compliance Rules 2-9(d) and 2-49, which adopts by reference CFTC Regulation 23.602, places a continuing responsibility on every Member swap dealer (SD) and major swap participant (MSP) to diligently supervise their business. These rules are broadly written to provide Members with flexibility in developing procedures tailored to meet their particular needs. On certain issues, however, NFA issues Interpretive Notices to provide more specific guidance on acceptable standards for supervisory procedures.

      Over the years, information technology has changed nearly every aspect of how Members conduct business. For example, Members may use electronic means to collect and maintain customer and counterparty information. This information may include personally identifying information (PII) for individuals such as social security numbers and confidential or sensitive information for institutional customers and counterparties, including corporate records and financial information. Additionally, Members may have websites that are available to customers and counterparties for opening accounts, trading, and accessing account information, and rely upon electronic means to enter customer, counterparty and proprietary orders. Moreover, Members either directly or indirectly connect electronically with other Members, exchanges, clearinghouses, third-party service providers, NFA and the CFTC. NFA's Board of Directors believes that Members should have supervisory practices in place reasonably designed to diligently supervise the risks of unauthorized access to or attack of their information technology systems, and to respond appropriately should unauthorized access or attack occur.

      NFA recognizes that, given the differences in the type, size and complexity of operations of Members' businesses including but not limited to their customers and counterparties, markets and products traded, and the access provided to trading venues and other industry participants, Members must have an appropriate degree of flexibility to determine how best to diligently supervise information security risks. Accordingly, this Interpretive Notice is designed to establish general requirements relating to Members' information systems security programs (ISSPs) but leave the exact form of an ISSP up to each Member thereby allowing the Member flexibility to design and implement security standards, procedures and practices that are appropriate for their circumstances. Given the rapidly changing nature of technology and threats to information systems, NFA's policy is not to establish specific technology requirements.

      We also recognize that practices other than those described in this Interpretive Notice may comply with the general standards for supervisory responsibilities imposed by Compliance Rules 2-9, 2-36 and 2-49. For example, CFTC Regulations 160.30 and 162.21 require all FCMs, RFEDs, CTAs, CPOs, IBs, MSPs and SDs (Registrants) to adopt policies and procedures that address administrative, technical and physical safeguards to protect customer information. CFTC Regulation 162.30(d) requires some Registrants to develop and implement a written Identity Theft Prevention Program designed to detect, prevent and mitigate customer identity theft.2 Moreover, CFTC Regulations 1.11 and 23.600 also require certain FCMs and SDs to adopt risk management policies and procedures addressing operational risks. The CFTC Division of Swap Dealer and Intermediary Oversight (DSIO) also issued guidance on what it considers to be best practices for privacy and security in connection with these rules.3 Finally, almost all states have data protection laws that govern the loss of customers' PII.

      Further, NFA recognizes that Member firms may be part of a larger holding company structure that shares common information systems security personnel, resources, systems and infrastructure. In these circumstances, the top level company in the holding company structure may be in the best position to evaluate the risks associated with the use of information technology systems, as privacy and security safeguards are often adopted and implemented organization-wide. Therefore, to the extent a Member firm is part of a holding company that has adopted and implemented privacy and security safeguards organization-wide, then the Member firm can meet its supervisory responsibilities imposed by Compliance Rules 2-9, 2-36 and 2-49 to address the risks associated with information systems through its participation in a consolidated entity ISSP. If a Member firm is participating in a consolidated entity ISSP, then the Member firm still has an obligation to ensure that the written policies and procedures relating to the program are appropriate to its information security risks, are maintained in a readable and accessible manner and can be produced upon request to NFA4 and the CFTC.

      This Notice provides guidance regarding information systems security practices that Member firms should adopt and tailor to their particular business activities and risks.

      Information Security Program

      • Written Program

      Each Member firm should establish and implement a governance framework that supports informed decision making and escalation within the firm to identify and manage information security risks. In implementing an ISSP, each Member must adopt and enforce a written ISSP reasonably designed to provide safeguards, appropriate to the Member's size, complexity of operations, type of customers and counterparties, the sensitivity of the data accessible within its systems, and its electronic interconnectivity with other entities, to protect against security threats or hazards to their technology systems.5 The Member's ISSP should be approved, in writing, by the Member's Chief Executive Officer or other senior level officer with primary responsibility for information system security (e.g., Chief Technology Officer (CTO) or Chief Information Security Officer (CISO)) or other senior official who is a listed principal and has the authority to supervise the Member's execution of its ISSP. If the Member has a committee that approves the ISSP, then it must include one of these individuals. In those instances where the Member meets its obligations through participation in a consolidated entity ISSP, which has been approved at the parent company level, the Member's CEO, CTO, CISO (or person with equivalent responsibility), or a senior official who is a listed Principal of the Member firm, must approve in writing that the written policies and procedures relating to the program are appropriate for the Member's information security risks. Additionally, if applicable, the Member's senior management should periodically provide sufficient information about the Member's ISSP to the Member's board of directors or similar governing body, the board's or governing body's delegate or a committee of the board or body to enable it to monitor the Member's information security efforts.

      In order to develop and adopt appropriate ISSPs, Members may consider several resources available appropriate to their size, sophistication and role in the financial industry. For example, in developing procedures, NFA suggests that Members review the cybersecurity best practices and standards promulgated by the various professional associations identified in the Frequently Asked Questions on Cybersecurity issued by NFA.

      NFA does not require a Member to utilize any of these resources in developing its ISSP, but each Member must formally adopt an ISSP appropriate for the Member's business.6

      • Security and Risk Analysis

      Each Member firm has a supervisory obligation to assess and prioritize the risks associated with the use of its information technology systems. In appropriate circumstances, personnel from a Member firm's business unit(s), information technology, back-office, risk management and internal audit, if applicable, may be included in performing this assessment.

      Members should maintain an inventory of critical information technology hardware with network connectivity, data transmission or data storage capability and an inventory of critical software with applicable versions. Members should identify the significant internal and external threats and vulnerabilities to at-risk data that is collected, maintained and disseminated, including customer and counterparty PII, corporate records and financial information; assess the threats to and the vulnerability of their electronic infrastructure including any systems used to initiate, authorize, record, process and report transactions relating to customer funds, capital compliance, risk management and trading; assess the threats posed through any applicable third-party service providers or software; and know the devices connected to their network and network structure.

      Generally speaking, threats include loss, destruction or theft of critical hardware containing at-risk data; insertion of viruses, spyware and other malware; and interception and compromising of electronic transmissions (e.g., email and payment processing systems). In assessing security risks, Members should estimate the severity of the potential threats, perform a vulnerability analysis, and decide how to manage the risks of these threats. A Member's assessment should address past internal and external security incidents at the firm and, to the extent applicable and within a reasonable time, consider known threats identified by the firm's critical third-party service providers, the industry or other organizations.

      • Deployment of Protective Measures Against the Identified Threats and Vulnerabilities

      Members should document and describe in their ISSPs the safeguards deployed in light of the identified and prioritized threats and vulnerabilities. Adopted safeguards will be highly dependent upon a Member's size, business, technology, electronic interconnectivity with other entities and the potential threats identified in its risk assessment. Examples of these safeguards may include:

      • protecting the Member's physical facility against unauthorized intrusion by imposing appropriate restrictions on access to the facility and protections against the theft of equipment;
      • establishing appropriate identity and access controls to a Member's systems and data, including media upon which information is stored;
      • using complex passwords and changing them periodically;
      • using and maintaining up-to-date firewall and anti-virus and anti-malware software to protect against threats posed by hackers;
      • using supported and trusted software or, alternatively, implement appropriate controls regarding the use of unsupported software;
      • prevent the use of unauthorized software through the use of application whitelists;
      • using automatic software updating functionality or, alternatively, manually monitoring the availability of available software updates and installing updates, and spot check to ensure that updates are applied when necessary;
      • using supported and current operating systems or, alternatively, implement appropriate controls regarding the use of unsupported operating systems;
      • regularly backing up systems and data as part of a sustainable disaster recovery and business continuity plan;
      • deploying encryption software to protect the data on equipment in the event of theft or loss of the equipment;
      • using network segmentation and network access controls;
      • using secure software development practices if the Member develops its own software;
      • using web filtering technology to block access to inappropriate or malicious websites;
      • encrypting data in motion, (e.g., encrypting email attachments containing customer information or other sensitive information), to reduce the risk of unauthorized interception; and
      • ensuring that mobile devices are subject to similar applicable safeguards.

      Members should also document and implement reasonable procedures to detect potential threats. These steps may include utilizing network monitoring software, watching for the presence on the Member's physical premises of unauthorized users and becoming members of threat/data sharing organizations such as the Financial Services Information Sharing and Analysis Center (FS-ISAC)7 or establishing procedures designed to identify unauthorized connections by employees to the Member's network.

      • Response and Recovery from Events that Threaten the Security of the Electronic Systems

      Members should create an incident response plan to provide a framework to manage detected security events or incidents, analyze their potential impact and take appropriate measures to contain and mitigate their threat. Members should consider in appropriate circumstances forming an incident response team responsible for investigating an incident, assessing its damage and coordinating the internal and external response. A Member should consider including in its incident response plan a description of how the Member will address common types of cybersecurity events or incidents related to its commodity interest business (e.g., data loss, unauthorized access, malicious code, denial of service, ransomware attack and inappropriate usage), including how it will communicate internally with an appropriate escalation procedure and externally with customers/counterparties, financial industry regulators and self-regulatory organizations and law enforcement. The Member should be familiar with notice requirements contained in applicable U.S. and non-U.S. data security and privacy statutes and regulations. Members are encouraged to obtain contact information for applicable regulatory bodies, self-regulatory organizations and law enforcement in advance of an event or incident. In addition, Members should consider providing details of any detected threats to an industry-specific information sharing platform such as the FS-ISAC.

      As part of reporting cyber events to regulators and agencies, NFA Member FCMs and IBs should consider whether it is appropriate to file a suspicious activity report (SAR). A Notice to Members issued on October 31, 2016 (Notice I-16-24) includes further details regarding the Advisory and FAQ issued by FinCEN on cyber-events and cyber-enabled crimes. However, FCMs and IBs should not provide a copy of an actual SAR when providing notice to NFA. Rather, Members should prepare a written summary of the relevant details to the related cybersecurity event for submission to NFA.

      Finally, the ISSP should contain a Member's procedures to restore compromised systems and data, communicate with appropriate stakeholders and regulatory authorities and incorporate lessons learned into the ISSP.

      • Notice to NFA

      The Member should have procedures to promptly notify NFA in the form and manner required of a cybersecurity incident related to the Member's commodity interest business and that results in: 1) any loss of customer or counterparty funds; 2) any loss of a Member's own capital; or 3) in the Member providing notice to customers or counterparties under state or federal law.8 In notifying NFA, the Member must provide a written summary of the incident with the relevant details. If the Member provides a notice to customers or counterparties, however, the Member may provide a copy of the notice to NFA in lieu of a written summary. If substantially identical notices regarding the same incident are provided to multiple parties (e.g. to all affected customers in a breach of personally identifiable information), the Member should only provide a copy of one particular notice as an example.

      • Employee Training

      A Member's ISSP should contain a description of the Member's ongoing education and training relating to information security for all appropriate personnel. The description should identify the topics covered in the training contents. Members should consider including as training topics social engineering tactics and other general threats posed for system compromise and data loss. This training program should be conducted for employees upon hiring and annually during their employment, but more frequently if circumstances warrant additional training. The program should also be appropriate to the security risks the Member faces as well as the composition of its workforce.

      Review of Information Security Programs

      Members should monitor and regularly review the effectiveness of their ISSPs, including the efficacy of the safeguards deployed, and make adjustments as appropriate. A Member should perform a regular review of its ISSP at least once every twelve months using either in-house staff with appropriate knowledge or by engaging an independent third-party information security specialist. Under appropriate circumstances, a Member's review may include penetration testing of the firm's systems, the scope and timing of which is highly dependent upon the Member's size, business, technology, its electronic interconnectivity with other entities and the potential threats identified in its risk assessment.

      Third-Party Service Providers

      A Member's ISSP should address in its security risk assessment the risks posed by critical third-party service providers that have access to a Member's systems, operate outsourced systems for the Member or provide cloud-based services such as data storage or application software to the Member. A Member should consider using a risk based approach to manage the information security risks posed by these providers. NFA recognizes that a Member's ability to manage the security risks posed by third-party service providers may be limited by the information these service providers elect to provide to the Member. Generally, a Member should perform due diligence on a critical service provider's security practices and avoid using third parties whose security standards are not comparable to the Member's standards in a particular area or activity. Members should consider including in their arrangements with critical third-party service providers appropriate measures that are designed to protect customer and firm confidential data. Members should also consider adopting procedures to place appropriate access controls to their information systems and data upon third-party service providers, and procedures to restrict or remove, on a timely basis, a third-party service provider's access to their information systems once the service provider is no longer providing services.9

      Recordkeeping

      All records relating to a Member's adoption and implementation of an ISSP and that document a Member's compliance with this Interpretive Notice must be maintained pursuant to NFA Compliance Rule 2-10.

      NFA Compliance Rules 2-9, 2-36 and 2-49, as applicable, require NFA Members to develop, maintain and implement an appropriate ISSP in light of the importance of protecting the integrity of their technology systems. NFA recognizes that the particulars of a Member's ISSP will vary based on the Member's size, complexity of operations, type of customers and counterparties, and its electronic interconnectivity with other entities. There is no one-size-fits-all ISSP, and resources and processes that differ from those described above can be used to develop an appropriate ISSP.

      1 Nothing in this Interpretive Notice is intended to relieve Members from or reduce the obligations to which Members are subject under other state or federal statutes or regulations related to data security and privacy.

      2 The CFTC's adopted rules are designed to be consistent with the regulations of other financial regulators, including the Office of the Comptroller of the Currency, the Department of Treasury, the Board of Governors of the Federal Reserve System, the Federal Deposit Insurance Corporation, the Office of Thrift Supervision, the National Credit Union Administration and the Federal Trade Commission.

      3 The guidance can currently be found at http://www.cftc.gov/ucm/groups/public/@lrlettergeneral/documents/letter/14-21.pdf

      4 FCMs should be able to provide the ISSP to their DSRO.

      5 The ISSP's policies and procedures may be documented in a single document or in documents maintained throughout a Member's various departmental areas so long as the ISSP can be made available upon appropriate requests by NFA and the CFTC. Additionally, a Member should consider including definitions of the terminology used in its ISSP in order to facilitate reviews of its ISSP.

      6 In developing their ISSPs, Members are permitted to use more than one of these resources and use relevant portions of each as appropriate to their business and risk.

      7 Through contributions from firms across the financial services sector, information sharing organizations like FS-ISAC can help mitigate the effects of cyber attacks by analyzing incoming threat information and promptly notifying participants of potential attacks.

      8 FCM-only Members for which NFA is not the DSRO need not provide copies of notices to NFA.

      9 Additionally, Members whose data resides in third-party service provider systems should consider including procedures to respond to notices from a service provider that it has experienced a data breach as state laws may require the Member to notify its customers of the breach.

      9071 - NFA COMPLIANCE RULE 2-46: REPORTING FINANCIAL INFORMATION ON NFA FORMS PQR AND PR

      (Board of Directors, August 18, 2016, effective June 30, 2017.)

      INTERPRETIVE NOTICE

      NFA Compliance Rule 2-46 requires NFA Member CPOs and CTAs (with reporting requirements under CFTC Regulation 4.27) to file NFA Forms PQR and PR, respectively, on a quarterly basis. These forms collect certain general identifying information regarding the CPO or CTA, as well as specific information on the pools operated by the CPO and the assets directed by the CTA. NFA reviews and analyzes this information as an integral part of NFA's oversight program for CPO and CTA Members.

      Unlike FCM and independent IB Members, which file regular reports with NFA containing specific information on the Members' financial condition, NFA does not collect any financial information on the financial condition of CPO or CTA Members. NFA uses the information reported by FCMs and IBs in determining a firm's risk profile and to identify firms that may be facing financial difficulties.

      NFA's Board of Directors (Board) has determined that this type of information is an important component of NFA's oversight program, and that each CPO and CTA Member should also report information to NFA that provides NFA with the ability to monitor the firm's financial condition and identify firms that may be facing financial difficulties. Therefore, NFA is revising Forms PQR and PR to require each CPO and CTA to report two financial ratios related to the firm's financial health. The purpose of this Interpretive Notice is to provide additional information on the requirements for providing this information.

      Required Ratios

      NFA Forms PQR and PR will contain data fields requiring CPOs and CTAs to report the following two ratios (reported to the nearest two decimal places):

        a. Current Assets/Current Liabilities (CA/CL) Ratio

      This ratio divides a firm's current assets by its current liabilities, providing a measure of a firm's liquidity. This ratio is based on a firm's current asset and current liability balances at the reporting quarter end.

      The following definitions apply for the purpose of computing this ratio:

      Current Assets: Cash or any asset that can be readily converted to cash within one year. Current assets for a CPO or CTA may include, but are not limited to, cash, marketable securities, short-term investments, accounts receivable, and a general partner's investment in its pool.

      Current Liabilities: Obligations that are reasonably expected to be paid within one year. Current liabilities include, but are not limited to, accounts payable, accrued expenses, payroll liabilities, income tax liabilities, and interest payable. A firm's long-term financial obligations that are not due within the present accounting year are considered a noncurrent liability and should not be included in this ratio.

        b. Total Revenue/Total Expenses (TR/TE) Ratio

      This ratio divides a firm's total revenue by its total expenses, measuring a firm's operating margin. Although a firm will report this ratio each quarter, the ratio must reflect the total revenue earned and total expenses incurred during the prior 12 months.

      The following definitions apply for the purpose of computing this ratio:

      Total Revenue: Gross income earned by a firm from its normal business activities before any expenses have been deducted. Income may be received as cash or a cash equivalent and is typically generated by a CPO or CTA through management and/or incentive fees.

      Total Expenses: Costs incurred in a firm's efforts to generate revenue, representing the cost of doing business. Expenses may include, but are not limited to, wages and salaries, rent, utilities, depreciation, and bad debts.

      A CPO or CTA that has a fiscal year end that does not align with the Form PQR or PR reporting quarters may report the ratios as of the firm's most recently ended fiscal quarter. For example, the regular quarterly financial reporting quarters for a firm with a July 31 fiscal year end would be July 31, October 31, January 31 and April 30. The firm may report the ratio information as of July 31 on the September 30 Form PQR or PR, the ratio information as of October 31 on the December 31 PQR, etc.

      The components of current assets, current liabilities, total revenue, and total expenses should be based on the requirements of generally accepted accounting principles or another internationally recognized accounting standard, consistently applied.

      The ratios must be reported using the accrual method of accounting. Accrual accounting requires that the firm record revenue when it is earned rather than when it is received in cash and record an expense when it is incurred rather than when it is actually paid. For example, a CTA charges a monthly management fee of 2%, which equates to a $24,000 fee earned as of March 31. The CTA, however, does not actually receive payment of the fee until April 15. Under the accrual method of accounting, the CTA would record the $24,000 fee as part of its revenue for the month of March and not for the month of April. Similarly, a CTA receives a utility bill in March for services it has already received. The CTA, however, does not pay the bill until April. The CTA should record the amount of the bill as an expense for the month of March and not for the month of April.

      CPOs and CTAs that are part of a holding company/subsidiary structure may elect to report the ratios at the parent level. However, firms will be required to notify NFA that it is part of a holding company structure and indicate its reporting level election (i.e., parent/holding company level or subsidiary Member firm level) on Form PQR or PR.

      The Board is not establishing any minimum ratio percentages that a firm must meet. Rather, NFA will incorporate the financial information collected on Forms PQR and PR into its oversight program and use it to identify trends that indicate that a firm may be facing financial difficulties which could impair its ability to act in the best interests of its customers.

      Recordkeeping

      Each CPO and CTA must be able to demonstrate to NFA how it calculated the ratios reported in Form PQR or PR. Therefore, each CPO and CTA must maintain financial records supporting the calculation of these ratios, which, for those Member firms that are part of a holding company structure, may include relevant financial records of the holding company, in accordance with NFA Compliance Rule 2-10 and make those records available to NFA during an examination or otherwise upon request.

      9072 - NFA COMPLIANCE RULE 2-49: SWAP VALUATION DISPUTE FILING REQUIREMENTS

      (Board of Directors, May 18, 2017, effective January 2, 2018.)

      INTERPRETIVE NOTICE

      Commodity Futures Trading Commission (CFTC or Commission) Regulation 23.502(c) requires Swap Dealers and Major Swap Participants (collectively SDs) to promptly notify the Commission (and other enumerated regulators) of any swap valuation dispute that exceeds $20 million (or equivalent amount in another currency) (the $20 million Reporting Threshold) within certain timeframes depending on counterparty type (the Resolution Period).1 On January 21, 2016, the Commission issued an Order authorizing NFA to, among other things, receive and review notices of reportable swap valuation disputes.2

      NFA Compliance Rule 2-49 authorizes NFA to require SDs to promptly submit relevant information to NFA in the form and manner prescribed by NFA. Beginning March 1, 2016, NFA required SDs to submit notices of reportable swap valuation disputes to NFA. Based on NFA's experience with these notices, NFA has determined that the notices will be more useful for NFA's monitoring and risk profiling of SDs if NFA collects standardized information that can be easily tracked and analyzed across SDs and the industry. Therefore, SDs will be required to electronically notify NFA of a reportable swap valuation dispute by completing an NFA form requiring specified information. NFA will notify SDs of the specified information well in advance of the effective date of the new reporting requirements.

      NFA has determined that swap valuation dispute information is relevant for risk monitoring purposes. SDs will be required to file notices of disputes involving collateral pursuant to an eligible Master Agreement, including any applicable Schedule and Credit Support Annex (Collateralized Eligible Master Netting Agreement)3 that exceed the $20 million Reporting Threshold (after the Resolution Period). This reporting requirement is applicable to disputes involving the exchange of collateral regardless of whether the CFTC margin requirements are applicable to the swaps transactions. For transactions with a counterparty with which the SD does not exchange collateral, the SD will be required to report disputes involving the portfolio valuation when the counterparty notifies the SD that it is disputing any reported valuation by the SD and the disputed amount exceeds the $20 million threshold (after the Resolution Period).

      The purpose of this Interpretive Notice is to provide SDs with more information on the required filings.

      Required Filings

      With regard to each of the filings described below, if the dispute involves two SD counterparties, then each SD is required to file a separate notice of the dispute.

        a. Initial Margin Disputes

      Counterparties to one or more swap transactions may not agree on the amount of initial margin (IM) that is to be posted or collected by each party pursuant to a Collateralized Eligible Master Netting Agreement. An SD is required to file a notice of any dispute regarding the amount of IM to be posted or collected if the amount in dispute exceeds the $20 million Reporting Threshold (after the Resolution Period).

        b. Variation Margin Disputes

      Counterparties to one or more swap transactions may also disagree on the amount of collateral to be exchanged from one party to the other for variation margin pursuant to a Collateralized Eligible Master Netting Agreement. An SD is required to file a notice of any dispute regarding the amount of variation margin to be exchanged if the amount in dispute exceeds the $20 million Reporting Threshold (after the Resolution Period).

        c. Swaps Transactions Where Collateral Is Not Exchanged

      For those counterparties with which the SD does not exchange collateral, if the counterparty notifies the SD that it is disputing any valuation provided by the SD, the SD must report the dispute if it exceeds the $20 million Reporting Threshold (after the Resolution Period).

        d. Other Filings
        1. Notice Amendments for All Dispute Filing Types

      SDs should not file a daily notice of a previously reported dispute even if the valuation dispute amount changes. SDs are required, however, to notify NFA of certain changes to the dispute amount on the 15th (or the following business day if the 15th is a weekend or holiday) and last business day of each month by amending any previously filed notice where the dispute amount has increased in $20 million incremental bands. For example, if a SD files a notice of a $30 million dispute, an amended notice updating the dispute amount is required if that dispute increases to $40 million or more and each subsequent $20 million increment (i.e., dispute amount increases to $60 million or more, $80 million or more, etc.). SDs are also required to amend a previously filed notice to update the dispute amount if the amount decreases at these $20 million increments. The determination of whether an amended notice is required is based on the dispute amount on the reporting date.

      In the event an SD identifies any errors in the information reported in an open notice, the SD must amend the notice to provide the correct information.

        2. Dispute Termination

      SDs are also required to terminate disputes that are no longer reportable under CFTC Regulation 23.502(c) or this Interpretive Notice. Therefore, any SD that is a party to the originally filed dispute must electronically notify NFA by terminating the notice when the dispute is resolved. Termination notices are also due on the 15th (or the following business day if the 15th is a weekend or holiday) and the last business day of the month based on the dispute amount on the reporting date.

      1"Resolution Period" as defined in CFTC Regulation 23.502(c) (i.e., within three business days where the counterparty is an SD and within five business days for all others).

      2See Performance of Certain Functions by the National Futures Association Related to Notices of Swap Valuation Disputes Filed by Swap Dealers and Major Swap Participants, 81 Fed. Reg. 3390 (Jan. 21, 2016).

      3If no master netting agreement exists, the SD must report at the transaction level.

      9073 - DISCLOSURE REQUIREMENTS FOR NFA MEMBERS ENGAGING IN VIRTUAL CURRENCY ACTIVITIES

      [Board of Directors, May 17, 2018; effective October 31, 2018]

      INTERPRETIVE NOTICE

      The growth of the virtual currency market has attracted a significant amount of investor attention. Virtual currencies and virtual currency derivatives (i.e., futures, options and cleared swaps) have a variety of unique and potentially significant risks. NFA's Board of Directors is concerned that these products may be attracting customers that do not fully understand their nature, the substantial risk of loss that could arise from trading them and the limitations of NFA's oversight role. To address these concerns, NFA is implementing new disclosure requirements for NFA Members engaging in virtual currency products. Section I is applicable to FCMs and IBs and Section II is applicable to CPOs and CTAs.

      NFA also reminds Members that NFA Compliance Rule 2-29 prohibits the use of any promotional material that is misleading or deceptive.

        I. Disclosure Obligations of FCMs and IBs Engaging in Virtual Currency Derivatives and Virtual Currency Transactions

          A. Virtual Currency Derivatives

          FCM or IB Members must provide the NFA Investor Advisory – Futures on Virtual Currencies Including Bitcoin and the CFTC Customer Advisory: Understand the Risk of Virtual Currency Trading to any customer that engages in a virtual currency derivative transaction with or through the FCM or IB Member. For introduced accounts the advisories may be provided by either the FCM or IB Member. If the FCM or IB Member has any customers who traded a virtual currency derivative with or through the FCM or IB Member prior to the issuance of this Interpretive Notice, the FCM and/or IB Member must provide the advisories to the customer within thirty calendar days of the date of this Interpretive Notice.

          B. Underlying or Spot Virtual Currencies

          NFA is also aware that certain FCM and IB Members may seek to solicit or engage in transactions involving underlying or spot virtual currencies with customers or counterparties. NFA's Board of Directors is concerned that market participants may not understand that NFA does not regulate in any manner an FCM or IB Member's activities with customers or counterparties involving underlying or spot virtual currencies. Moreover, NFA Compliance Rule 2-22 prohibits a Member from, among other things, stating or implying that it has been sponsored, recommended or approved by NFA. To provide clear disclosure about the lack of NFA's regulatory oversight, any FCM or IB Member engaging in activities with customers or counterparties involving underlying or spot virtual currencies in any manner must provide the customer or counterparty with the following disclosure language:

            [NAME OF NFA MEMBER] IS A MEMBER OF NFA AND IS SUBJECT TO NFA'S REGULATORY OVERSIGHT AND EXAMINATIONS. HOWEVER, YOU SHOULD BE AWARE THAT NFA DOES NOT HAVE REGULATORY OVERSIGHT AUTHORITY OVER UNDERLYING OR SPOT VIRTUAL CURRENCY PRODUCTS OR TRANSACTIONS OR VIRTUAL CURRENCY EXCHANGES, CUSTODIANS OR MARKETS.

          The advisories and disclosure language described in Sections I.A and I.B may be provided to eligible contract participants through an FCM or IB Member's web site but must be provided to retail customers in writing or electronically in a prominent manner designed to ensure a customer is aware of them. Merely having the advisories and disclosure language on a Member's web site is not adequate for retail customers. Including the advisories and disclosure language in a risk disclosure booklet that is distributed to retail customers or sending retail customers an e-mail including links to the advisories and disclosure language and explaining what the links are would be sufficient provided the communication is reasonably designed to achieve customer awareness and the disclosure language is prominently displayed. The advisories must be provided to a customer at or before the time the customer first engages in a virtual currency derivatives transaction with or through the FCM or IB Member. The disclosure language must be prominently displayed in any promotional materials related to underlying or spot virtual currencies and must be provided to any customer or counterparty at or before the time they engage in any underlying or spot virtual currency activities with or through the FCM or IB Member.

        II. Disclosure Obligations of CPOs and CTAs Engaging in Virtual Currency Derivatives and Virtual Currency Transactions

        A few CPO and CTA Members are offering pools, exempt pools or trading programs that trade virtual currencies or virtual currency derivatives. NFA's Board of Directors is concerned that these pools and trading programs may be attracting pool participants and managed account clients who do not fully understand the nature of these products or the substantial risk of loss that may arise from trading them. Virtual currencies and virtual currency derivatives have unique features and present some potentially significant risks that warrant enhanced disclosures to pool participants and managed account clients.

        CPO and CTA Members should carefully consider the risks arising from their activities in virtual currencies and virtual currency derivatives and customize their disclosure documents, offering documents and promotional material to address the unique risks related to their specific activities. The guidelines set forth below are designed to ensure that CPO and CTA Members provide robust disclosures related to the risks of virtual currencies and virtual currency derivatives. The guidelines are not an exhaustive list of disclosure items, and Members should not necessarily limit their disclosures to those areas discussed in this Interpretive Notice. NFA recognizes that the risks associated with trading virtual currencies or virtual currency derivatives will vary over time, and this Interpretive Notice may be supplemented in the future.

        NFA's Board of Directors is also concerned that investors may not understand NFA's role with respect to Member activities involving underlying or spot virtual currency products. Therefore, as set forth below, NFA is mandating a standardized disclosure that any CPO or CTA Member operating a pool (exempt or non-exempt) or managed account trading program that trades underlying or spot virtual currencies must display in its disclosure document, offering document and promotional material related to virtual currencies. NFA is also requiring a separate standardized disclosure that must be provided to customers and displayed in any promotional materials related to virtual currencies if a CPO or CTA engages in any other virtual currency activities.

          A. Virtual Currency Disclosure Requirements for Pools and Managed Account Programs

          While NFA does not intend to prescribe standardized disclosure language for CPO and CTA Members engaging in underlying or spot virtual currency transactions in a pool or managed account program, CPO and CTA Members that engage in these transactions must address any of the following areas that are applicable to their activities in their disclosure documents, offering documents and promotional material related to virtual currencies:

          • Unique Features of Virtual Currencies. Virtual currencies are not legal tender in the United States and many question whether they have intrinsic value. The price of many virtual currencies is based on the agreement of the parties to a transaction. The risks associated with the unique features of virtual currencies should be explained.

          • Price Volatility. The price of a virtual currency is based on the perceived value of the virtual currency and subject to changes in sentiment, which make these products highly volatile. Certain virtual currencies have experienced daily price volatility of more than 20%. The risks associated with the extreme price volatility of virtual currencies and the possibility of rapid and substantial price movements, which could result in significant losses, should be explained.

          • Valuation and Liquidity. Virtual currencies can be traded through privately negotiated transactions and through numerous virtual currency exchanges and intermediaries around the world. The lack of a centralized pricing source poses a variety of valuation challenges. In addition, the dispersed liquidity may pose challenges for market participants trying to exit a position, particularly during periods of stress. NFA generally expects the policies and procedures for valuing virtual currency products implemented by CPOs and CTAs to take into account their access to liquidity and the volatility of these markets. The valuation and liquidity risks and the procedures used for valuing virtual currencies and the related risks should be explained.

          • Cybersecurity. The cybersecurity risks of virtual currencies and related “wallets” or spot exchanges include hacking vulnerabilities and a risk that publicly distributed ledgers may not be immutable. A cybersecurity event could result in a substantial, immediate and irreversible loss for market participants that trade virtual currencies. Even a minor cybersecurity event in a virtual currency is likely to result in downward price pressure on that product and potentially other virtual currencies. The cybersecurity risks associated with engaging in virtual currency transactions should be explained.

          • Opaque Spot Market. Virtual currency balances are generally maintained as an address on the blockchain and are accessed through private keys, which may be held by a market participant or a custodian. Although virtual currency transactions are typically publicly available on a blockchain or distributed ledger, the public address does not identify the controller, owner or holder of the private key. Unlike bank and brokerage accounts, virtual currency exchanges and custodians that hold virtual currencies do not always identify the owner. The opaque underlying or spot market poses asset verification challenges for market participants, regulators and auditors and gives rise to an increased risk of manipulation and fraud, including the potential for Ponzi schemes, bucket shops and pump and dump schemes. The risks associated with the opaque nature of the underlying or spot virtual currency market should be explained.

          • Virtual Currency Exchanges, Intermediaries and Custodians. Virtual currency exchanges, as well as other intermediaries, custodians and vendors used to facilitate virtual currency transactions, are relatively new and largely unregulated in both the United States and many foreign jurisdictions. Virtual currency exchanges generally purchase virtual currencies for their own account on the public ledger and allocate positions to customers through internal bookkeeping entries while maintaining exclusive control of the private keys. Under this structure, virtual currency exchanges collect large amounts of customer funds for the purpose of buying and holding virtual currencies on behalf of their customers. The opaque underlying spot market and lack of regulatory oversight creates a risk that a virtual currency exchange may not hold sufficient virtual currencies and funds to satisfy its obligations and that such deficiency may not be easily identified or discovered. In addition, many virtual currency exchanges have experienced significant outages, downtime and transaction processing delays and may have a higher level of operational risk than regulated futures or securities exchanges. If virtual currencies are traded or held through an exchange, intermediary or custodian, then the risks associated with engaging in these transactions should be explained.

          • Regulatory Landscape. Virtual currencies currently face an uncertain regulatory landscape in the United States and many foreign jurisdictions. In the United States, virtual currencies are not subject to federal regulatory oversight but may be regulated by one or more state regulatory bodies. In addition, many virtual currency derivatives are regulated by the CFTC, and the SEC has cautioned that many initial coin offerings are likely to fall within the definition of a security and subject to U.S. securities laws. One or more jurisdictions may, in the future, adopt laws, regulations or directives that affect virtual currency networks and their users. Such laws, regulations or directives may impact the price of virtual currencies and their acceptance by users, merchants and service providers. The risks associated with the current regulatory landscape for virtual currencies should be explained.

          • Technology. The relatively new and rapidly evolving technology underlying virtual currencies introduces unique risks. For example, a unique private key is required to access, use or transfer a virtual currency on a blockchain or distributed ledger. The loss, theft or destruction of a private key may result in an irreversible loss. The ability to participate in forks could also have implications for investors. For example, a market participant holding a virtual currency position through a virtual currency exchange may be adversely impacted if the exchange does not allow its customers to participate in a fork that creates a new product. The risks posed by this nascent technology should be explained.

          • Transaction Fees. Many virtual currencies allow market participants to offer miners (i.e., parties that process transactions and record them on a blockchain or distributed ledger) a fee. While not mandatory, a fee is generally necessary to ensure that a transaction is promptly recorded on a blockchain or distributed ledger. The amounts of these fees are subject to market forces and it is possible that the fees could increase substantially during a period of stress. In addition, virtual currency exchanges, wallet providers and other custodians may charge high fees relative to custodians in many other financial markets. The impact of these transaction fees on performance should be explained.

          In addition to the these disclosure items, any CPO or CTA Member engaging in an underlying or spot virtual currency transaction in a commodity pool, exempt pool or managed account program must prominently display the following language in its disclosure document, offering document and promotional material related to the Member's activity in virtual currencies:

            [NAME OF NFA MEMBER] IS A MEMBER OF NFA AND IS SUBJECT TO NFA'S REGULATORY OVERSIGHT AND EXAMINATIONS. [NAME OF NFA MEMBER] HAS ENGAGED OR MAY ENGAGE IN UNDERLYING OR SPOT VIRTUAL CURRENCY TRANSACTIONS IN A [COMMODITY POOL OR MANAGED ACCOUNT PROGRAM]. ALTHOUGH NFA HAS JURISDICTION OVER [NAME OF NFA MEMBER] AND ITS [COMMODITY POOL OR MANAGED ACCOUNT PROGRAM], YOU SHOULD BE AWARE THAT NFA DOES NOT HAVE REGULATORY OVERSIGHT AUTHORITY FOR UNDERLYING OR SPOT MARKET VIRTUAL CURRENCY PRODUCTS OR TRANSACTIONS OR VIRTUAL CURRENCY EXCHANGES, CUSTODIANS OR MARKETS. YOU SHOULD ALSO BE AWARE THAT GIVEN CERTAIN MATERIAL CHARACTERISTICS OF THESE PRODUCTS, INCLUDING LACK OF A CENTRALIZED PRICING SOURCE AND THE OPAQUE NATURE OF THE VIRTUAL CURRENCY MARKET, THERE CURRENTLY IS NO SOUND OR ACCEPTABLE PRACTICE FOR NFA TO ADEQUATELY VERIFY THE OWNERSHIP AND CONTROL OF A VIRTUAL CURRENCY OR THE VALUATION ATTRIBUTED TO A VIRTUAL CURRENCY BY [NAME OF NFA MEMBER].

          B. Virtual Currency Derivatives Disclosure Requirements for Pools and Managed Account Programs

          While NFA does not intend to prescribe standardized disclosure language for CPO and CTA Members engaging in virtual currency derivative transactions in a pool, exempt pool or managed account program, virtual currency derivatives have a number of unique features that CPO and CTA Members that engage in these transactions must address in their disclosure documents, offering documents and promotional material related to the Member's activity in virtual currency derivatives. For example, virtual currency derivatives may experience significant price volatility and the initial margin for virtual currency derivatives may be set as a percentage of the value of a particular contract, which means that margin requirements for long positions can increase if the price of the contract rises. In addition, some futures commission merchants may pose restrictions on customer trading activity in virtual currency derivatives, such as requiring additional margin, imposing position limits, prohibiting naked shorting or prohibiting give-in transactions. The rules of certain designated contract markets impose trading halts that may restrict a market participant's ability to exit a position during a period of high volatility. The risks associated with the unique features of engaging in virtual currency derivatives should be disclosed and the impact these risks may have on a pool's or managed account program's performance should be explained.

          C. Any Other Activities in Underlying or Spot Virtual Currencies

          Moreover, as described above, NFA Compliance Rule 2-22 prohibits a Member from, among other things, stating or implying that it has been sponsored, recommended or approved by NFA. To provide clear disclosure about the lack of NFA's regulatory oversight, any CPO or CTA Member engaging in any manner in activities with customers or counterparties involving underlying or spot virtual currencies other than those described in Sections II.A and II.B above must provide its customer or counterparty with the following disclosure language at or before the time the CPO or CTA Member engages in any underlying spot or virtual currency activities with the customer or counterparty, which must also be prominently displayed in any promotional materials related to the Member's activity in virtual currencies:

            [NAME OF NFA MEMBER] IS A MEMBER OF NFA AND IS SUBJECT TO NFA'S REGULATORY OVERSIGHT AND EXAMINATIONS. HOWEVER, YOU SHOULD BE AWARE THAT NFA DOES NOT HAVE REGULATORY OVERSIGHT AUTHORITY OVER UNDERLYING OR SPOT VIRTUAL CURRENCY PRODUCTS OR TRANSACTIONS OR VIRTUAL CURRENCY EXCHANGES, CUSTODIANS OR MARKETS.

          Failure to follow the disclosure guidelines in this Interpretive Notice may be deemed conduct inconsistent with a Member's obligations under NFA Compliance Rule 2-4 to observe high standards of commercial honor and just and equitable principles of trade as well as violations of NFA Compliance Rule 2-29.1

      1 NFA Compliance Rule 2-29 requires, among other things, that promotional material (including disclosure documents and offering documents) used by Members include all material information necessary to ensure that such material is not misleading.

      9074 - NFA COMPLIANCE RULE 2-9: CPO INTERNAL CONTROLS SYSTEM

      [Effective April 1, 2019.]

       

      INTERPRETIVE NOTICE

      INTRODUCTION

      NFA Compliance Rule 2-9 places a continuing responsibility on every Member to diligently supervise its employees and agents in all aspects of their commodity interest activities. For those Members that have control over customer funds, these supervisory obligations include developing a framework that deters errors and fraudulent activity by employees, management and third parties in order to safeguard customer funds, produces financial reports that are timely, accurate and reliable and maintains full compliance with all regulatory requirements addressing the control of those funds. Since an adequate internal controls system is the foundation for building that framework, NFA's Board of Directors (Board) believes that it is essential for CPO Members, which handle customer funds, to have an adequate system of internal controls in order to meet their supervisory obligations under Compliance Rule 2-9. Therefore, the Board has determined that each CPO Member must implement an internal controls system that is designed to deter fraudulent activity by employees, management, and third parties in order to address the safety of customer funds and provide reasonable assurance that a CPO's commodity pool's financial reports are reliable and that the Member is in compliance with all CFTC and NFA requirements.

      NFA recognizes that, given the differences in the size and complexity of the operations of CPO Members, including the number of persons employed by the CPO, there must be some degree of flexibility in determining what constitutes an adequate internal controls system. NFA also recognizes that some CPO Members are subject to related requirements of other regulators and have designed processes and controls in accordance with those Requirements. Compliance with those requirements by a CPO Member, and in some instances the CPO's pool and/or service provider, may satisfy a CPO Member's supervisory obligations under Compliance Rule 2-9 to have an adequate system of internal controls. The purpose of this Notice is to provide CPO Members with guidance on designing and implementing an adequate internal controls system and the minimum components that must be included. Each CPO Member, however, must conduct its own review to identify any other areas that should be included in the CPO's internal controls system based on the CPO's size, operations and activities.

      INTERNAL CONTROLS SYSTEM

      In order to implement an adequate internal controls system, the CPO must have a strong control environment. As a starting point, the CPO must adopt and implement written policies and procedures reasonably designed to ensure the CPO's operations are in compliance with applicable NFA rules and CFTC regulations. Additionally, management must demonstrate its commitment to integrity and ethical values and emphasize the importance of establishing and following the internal controls.1 The CPO should also have written policies and procedures that fully explain the CPO's internal controls framework, and describe the CPO's supervisory system, which should be reasonably designed to ensure that the policies and procedures are diligently followed by all employees. No employee, including senior management, should inappropriately circumvent the firm's internal controls system. Each firm should have an escalation policy in place for employees to report to the CPO's senior management if they believe individuals have attempted to improperly override the CPO's internal controls system in any respect. The firm's escalation procedures should also address whether and when a matter should be reported to the firm's regulator.

      In developing and implementing the particular controls, the CPO should conduct a risk assessment to see where its most critical risks arise, and then design and implement controls to address those risks. This is not a one-time assessment and should be completed periodically to take into account new risks that may arise especially with any changes in the firm's business or operations. Moreover, the CPO should monitor the effectiveness of implemented controls to ensure that the controls function properly and make adjustments where necessary.

      There is one internal controls procedure that is widely accepted as a key control activity regardless of the risk area—and that is separation of duties.

      Separation of Duties

      A CPO's internal controls system should require, when possible, appropriate segregation of duties designed to ensure that no single employee is in a position to carry out and conceal errors or fraud or have control over any two phases of a transaction or operation that are covered by this Interpretive Notice. To the extent possible, persons who perform the day-to-day functions in areas involving the handling of pool funds, trade execution activities, financial records and risk management should be different from the persons who supervise those functions. In those instances where supervisors also handle day-to-day functions, one of the CPO's principals or other appropriate supervisory person should periodically review the supervisor's work in material areas.

      Generally, in order to ensure proper segregation of duties, whenever possible, the CPO should require that:

      • Duties are assigned to different employees in a manner, or there are appropriate automated controls, that ensure that there is regular cross-checking of the work performed in material areas;

      • Operational functions relating to the custody of pool assets should be separated from financial reporting functions such as recordkeeping/accounting for the assets; and

      • In the pool funds area (e.g., subscriptions, transfers and redemptions), no one person should be responsible for initiating a transaction, approving the transaction, recording the transaction and reconciling the account to third party documentation and information.

      Risk Assessment

      Although each CPO Member should conduct its own risk assessment, there are a number of risk areas that are generally applicable to the business operations of most CPOs. Set forth below is a discussion of those risk areas and control activities that would form the basis of an adequate internal control system.

        A. Pool Subscriptions, Redemptions and Transfers

      A strong internal controls system should be designed to provide reasonable assurance that the CPO is continually in compliance with the requirements related to pool subscriptions, redemptions and pool transfers and has appropriate controls in place to safeguard participant and pool assets. Among other things, these controls should include:

      • Verification that pool investments are held in accounts properly titled with the pool's name and are not commingled with the assets of any other person (this is also an appropriate control for risk management and investment and valuation of pools funds);

      • Reconciliation (on a periodic basis) of transactions between the pool's general ledger, banks and other third party depositories (this is also an appropriate control for risk management and investment and valuation of pools funds);

      • Authorization of redemptions, including verification that the request is made by a participant, adequate funds are available, the proper Net Asset Value has been calculated (e.g., fee calculations and profit and loss allocations) and amount of funds is released, and timely payment is made to a pool participant or authorized third party; and

      • Verification that transactions involving pool funds do not violate NFA Compliance Rule 2-45, Prohibition of Loans by Commodity Pools to CPOs and Affiliated Entities.

        B. Risk Management and Investment and Valuation of Pool Funds

      The investment activity carried out by the firm and the pools it operates is also a high risk area. The CPO should have a risk management program that emphasizes the importance of the firm's business principals or trading principals playing a direct and primary role in assessing and monitoring the risks posed by their particular areas. Important control activities include:

      • Approval of investments to ensure that each type of investment is authorized and is consistent with the pool's strategy;

      • Verification that the CPO values investments in accordance with the CPO's valuation policies;

      • Ongoing due diligence of counterparties and other third party depositories that includes reviewing the depository's or counterparty's reputation, trading strategy, past performance and any actions taken by regulators;

      • Ongoing monitoring of the risks associated with investments held at third parties utilized by the pool(s) including market risk and credit risk; and

      • Ongoing monitoring of pool liquidity to ensure the pool is able to satisfy redemption requests, margin calls and other financial obligations.

        C. Use of Administrators

      CPOs often use a third-party administrator to facilitate the preparation of pool financial records and account statements or assist in certain areas, including subscription and redemption processing, valuation, reconciling and reporting balances, or issuance of pool account statements. In those situations, an adequate internal controls system would include controls designed to ensure that the CPO performs adequate due diligence related to the use of the administrator. Among other things, these controls should include:

      • Initial and ongoing due diligence on the administrator2; and

      • Obtaining evidence of a test of controls and security measures conducted at the administrator by an internal audit department or independent specialist.3

      The CPO should also consider whether its own independent financial records (i.e., shadow books) are necessary as a control to ensure that the CPO's records and financial statements are in agreement with those of the administrator's records and financial statements. If the CPO does not prepare shadow books, it should consider periodic reconciliation of its internal records with the records of banks, carrying brokers and other third parties.

      RECORDKEEPING

      In addition to establishing an internal controls system and developing written policies and procedures that fully describe it4, each CPO must maintain records that support the implementation and effectiveness of its internal controls system in accordance with NFA Compliance Rule 2-10.

      CONCLUSION

      NFA recognizes that the particulars of a CPO's internal controls system will vary based on the Member's size and complexity of operations. There is no one-size-fits-all internal controls system, and processes that differ from those described above can be used to develop an adequate internal controls system. In designing and implementing an internal controls system, however, each CPO should assess its areas of risk and implement controls that deter fraudulent activity by employees, including management, and third parties in order to address the safety of customer funds and provide reasonable assurance that the books and records of a CPO's commodity pool(s) are current and accurate so that the pool's financial reports are reliable and that the Member is in compliance with all CFTC and NFA requirements.

      1 The internal controls system should be supported by strong information technology controls operating within the firm's Information Systems Security Program (ISSP). NFA Interpretive Notice 9070 – NFA Compliance Rules 2-9, 2-36 and 2-49: Information Systems Security Programs requires all NFA Members to establish and implement a governance framework that supports the firm in identifying and managing information security risks and to adopt and enforce a written ISSP, appropriate to its circumstances, to secure customer data and access to the firm's electronic systems.

      2 Initial due diligence of an administrator may include the consideration of several factors including the administrator's costs, reputation, expertise, timeliness of work and attention to detail, responsiveness, work history with the firm or senior members of the firm, technological tools, income tax expertise and cybersecurity system. A CPO's ongoing due diligence may include regular communications with the administrator and other processes and procedures that provide some assurance that the CPO continues to be comfortable with the administrator, its services and personnel.

      3 For example, the administrator may engage an independent third party to conduct a System and Organization Controls examination under the Statement on Standards for Attestation Engagements for service organizations issued by the American Institute of Certified Public Accountants or similar examination under the Assurance Reports on Controls at a Service Organization standard issued by the International Auditing and Assurance Standards Board.

      4 The internal controls policies and procedures may be documented in a single document or in documents maintained throughout a Member's various departmental areas so long as the internal controls policies and procedures can be made available upon appropriate requests by NFA and the CFTC.

      9075 - NFA BYLAW 301 and COMPLIANCE RULE 2-24: PROFICIENCY REQUIREMENTS FOR SWAP APS

      (Board of Directors, February 21, 2019, effective January 31, 2020.)

      Section 17(p) of the Commodity Exchange Act (Act) requires NFA "to establish training standards and proficiency testing for persons involved in the solicitation of transactions subject to the provisions of the Act, supervisors of such persons…" This provision of the Act is not limited to those who are required to be registered as associated persons (AP).

      NFA requires that APs engaging in commodity futures and forex activities take and pass a proficiency examination that tests both their market knowledge and their knowledge of regulatory requirements. NFA's Board of Directors has determined that APs engaging in swaps activities at FCMs, IBs, CPOs and CTAs, as well as individuals acting as APs at SDs and MSPs1, should be required to meet a minimum proficiency standard that tests both their market knowledge and their knowledge of regulatory requirements involving swaps activities. Accordingly, NFA is imposing proficiency requirements on individuals approved as swap APs at FCMs, IBs, CPOs and CTAs in NFA Bylaw 301(l). NFA is also requiring that SD and MSP Members ensure that individuals acting as APs have satisfied these proficiency requirements in NFA Compliance Rule 2-24 (NFA's Swaps Proficiency Requirements).

      Specifically, NFA Bylaw 301(l) requires an individual to satisfy NFA's Swaps Proficiency Requirements in order to be approved as a swap associated person at an FCM, IB, CPO or CTA (intermediary swap AP).2 Additionally, Compliance Rule 2-24 prohibits an SD or MSP from having associated with it any individual who is acting as an associated person as defined in subsection 6 of the Associated Person definition under CFTC Regulation 1.3 who has not satisfied NFA's Swaps Proficiency Requirements.3 NFA's Swaps Proficiency Requirements referenced in Bylaw 301(l) and Compliance Rule 2-24 are detailed in this Interpretive Notice.

      NFA's Swaps Proficiency Requirements

      NFA's Swaps Proficiency Requirements cover the topics included in the content outline developed by NFA, which is available on NFA's website at www.nfa.futures.org. NFA's Swaps Proficiency Requirements will be administered via the internet through a number of individual modules covering specific topic areas, each of which contains both a training and testing component.

      NFA recognizes that there are differences in the type of swaps activity performed by an individual based on whether the individual works for an SD or an intermediary. NFA also recognizes that some individuals acting as APs at SDs perform more limited functions than others. Accordingly, NFA has developed two proficiency tracks—a Long Track and a Short Track.

      • SDs must ensure that individuals designated as APs in the sales and trading areas who negotiate, price and/or execute swaps with counterparties on behalf of the SD and/or manage the SD's swaps related risks satisfy the Long Track. The SD must ensure that designated APs who are responsible for supervising APs acting in this capacity at the SD satisfy the Long Track.

      • An SD that has designated APs who perform functions other than those described above has the option of permitting those individuals to satisfy either the Long Track or the Short Track. SDs also have the option to allow designated APs who are responsible for supervising these APs to satisfy the Long Track or the Short Track. However, if the responsibilities of any AP who has satisfied the Short Track expands to the sales and trading areas as described above, the SD must ensure that the AP satisfies the remaining modules in the Long Track before engaging in these new activities.

      • Intermediary swap APs are required to satisfy the Short Track. Individuals responsible for supervising intermediary swap APs are also required to satisfy the Short Track.

      Additional information regarding the two tracks can be found in the FAQs at www.nfa.futures.org.

      Obligations of SDs

      Individuals acting as APs at SDs are not required to register with the CFTC and are not NFA Associate Members.  Therefore, SDs are responsible for ensuring that any individual acting as an AP as defined in subsection 6 of the Associated Person definition under CFTC Regulation 1.3 has satisfied NFA's Swaps Proficiency Requirements prior to engaging in the defined activities on behalf of the SD. For individuals who satisfied NFA's Swaps Proficiency Requirements prior to joining the SD, the SD will meet its obligation if it ensures:

      • The individual satisfied the track of NFA's Swap Proficiency Requirements (i.e., Long Track or Short Track) required by the functions of the AP within the prior two years; or

      • The individual satisfied the track of NFA's Swaps Proficiency Requirements required by the functions of the AP and since the date of doing so, there has been no period of two consecutive years during which the individual has not been employed by an SD (or its affiliated entity) that is a Member of NFA, approved as a swap AP of an FCM, IB, CPO or CTA or approved as a swap firm that is a Member of NFA.

      SDs are not required to (nor should they) notify NFA when an individual satisfies NFA's Swaps Proficiency Requirements. However, each SD must maintain records that demonstrate that the individuals have satisfied NFA's Swaps Proficiency Requirements applicable to the person's functions as an AP and be able to provide those records to NFA during an examination or otherwise upon request. Examples of adequate documentation include a log identifying individuals and dates of completion or copies of the certificate of completion that an individual will receive upon successfully completing NFA's Swaps Proficiency Requirements.

      Individuals acting as APs at SDs located outside of the U.S. (including non-U.S. branch offices of a U.S. SD) who solely solicit or accept swaps with counterparties that are non-U.S. persons and/or non-U.S. branch offices of U.S. SDs are excluded from NFA's Swaps Proficiency Requirements. The framework for the exclusion of certain Non-U.S. APs is described in more detail in the FAQs at www.nfa.futures.org.

      Implementation

      The Compliance Date to complete NFA's Swaps Proficiency Requirements is January 31, 2021. All individuals who are approved as swap APs at an FCM, IB, CPO or CTA Member firm or are acting as APs at SDs on the Compliance Date are required to satisfy the applicable NFA Swaps Proficiency Requirements (i.e., no grandfathering provision) by that date in order to remain approved as a swap AP or continue acting as an AP at an SD after the Compliance Date. Any individual seeking approval as a swap AP at an FCM, IB, CPO or CTA after January 31, 2021 must satisfy NFA's Swaps Proficiency Requirements prior to being approved as a swap AP and engaging in swaps activities. SDs must ensure that any individual seeking to act as an AP after January 31, 2021 satisfy the applicable track of NFA's Swaps Proficiency Requirements required by the functions of the AP prior to engaging in swaps activity at the SD.

      Additional information on these requirements can be found in the FAQs located on NFA's website at www.nfa.futures.org.

      1 Under Commodity Futures Trading Commission Regulation 1.3, subsection (6) of the Associated Person definition, an individual acts as an AP of an SD or MSP if the person solicits or accepts swaps (other than in a clerical or ministerial capacity) or supervises any person engaged in those activities.

      2 NFA Bylaw 301(l) also requires individuals applying for approval as an FCM, IB, CPO or CTA Member swap firm to satisfy the Swaps Proficiency Requirements.

      3 Although not necessary to impose the Swaps Proficiency Requirements on intermediary swap APs, Compliance Rule 2-24 also prohibits an FCM, IB, CPO or CTA from having a swap AP who has not satisfied the Swaps Proficiency Requirements.

      9076 - NFA COMPLIANCE RULE 2-9(d): SUPERVISION REQUIREMENTS FOR SWAP DEALER AND MAJOR SWAP PARTICIPANT MEMBERS

      (Effective September 30, 2019.)

      NFA Compliance Rule 2-9(d) places a continuing responsibility on each Swap Dealer and Major Swap Participant (collectively SD) Member to diligently supervise its employees and agents in the conduct of their swap activities for or on behalf of the Member. Compliance Rule 2-9(d) is broadly written to provide each firm with some degree of flexibility in determining what constitutes "diligent supervision" and to develop and implement written supervisory procedures tailored to meet the Member's particular needs. Although NFA leaves the exact form of supervision to the SD Member, all SD Members are required to have written policies and procedures designed to achieve ongoing compliance with applicable NFA and CFTC requirements. In discharging their supervisory obligations, SD Members should have written policies and procedures (supervisory program) governing the use of marketing materials if they provide marketing materials to counterparties and potential counterparties (collectively counterparties). NFA is adopting this Notice to provide guidance to SD Members on meeting their regulatory obligations under Compliance Rule 2-9(d) related to their use of marketing materials

      NFA recognizes that the CFTC has issued Interpretive Guidance (Guidance)1 permitting certain non-U.S. SD Members to substitute compliance with the requirements of their home jurisdiction's law and regulation for compliance with certain CFTC entity-level requirements under the Commission's regulations. In particular, under the Guidance, the CFTC permits certain non-U.S. SDs to substitute compliance with a non-U.S. jurisdiction's supervisory requirements for the CFTC's diligent supervision requirement under CFTC Regulation 23.602. Similarly, this Guidance provides that, depending on the status of the counterparty, certain non-U.S. SDs and foreign branches of U.S. banks that are SDs may substitute compliance with their home jurisdiction's law and regulation for compliance with certain CFTC transaction-level requirements under the Commission's regulations. The CFTC's substituted compliance framework for both entity-level and transactional-level requirements is contingent on the CFTC finding that the home jurisdiction's requirements are comparable with and as comprehensive as the corollary area(s) of regulations contained in the applicable CFTC entity-level and/or transaction-level requirements. Importantly, the CFTC has retained examination and enforcement authority over SD Members in areas of substituted compliance, and NFA retains similar authority.

      NFA reminds non-U.S. SD Members that in those instances where NFA finds a violation of applicable CFTC requirements and/or NFA requirements that indicate a non-U.S. SD Member has failed to diligently supervise its employees and agents in the conduct of their swap activities for or on behalf of the Member, NFA may find that the SD Member has also violated NFA's supervision requirement under NFA Compliance Rule 2-9(d). For example, if NFA determines that a non-U.S. SD Member failed to set up the appropriate framework to comply and monitor for compliance with NFA's requirement that the firm file monthly risk data reports under NFA Financial Requirements Section 17, if appropriate, NFA could also charge the firm with failing to meet its supervisory obligations under NFA Compliance Rule 2-9(d).

      NFA's Board of Directors recognizes the importance that all NFA Members, regardless of their geographic location, have an appropriate supervisory framework to oversee the swap related activities of their employees and agents and their ongoing compliance with applicable NFA and CFTC requirements. Therefore, the Board determined to adopt NFA Compliance Rule 2-9(d) to ensure that SD Members are fully aware of their obligation and to provide NFA with clear authority to enforce this requirement.1

      1 See, Commodity Futures Trading Commission – Interpretive Guidance and Policy Statement Regarding Compliance with Certain Swap Regulations, 78 Fed. Reg. 45292 (July 26, 2013).

      9077 - NFA COMPLIANCE RULE 2-9(d): SWAP DEALER AND MAJOR SWAP PARTICIPANT SUPERVISION OF THE USE OF MARKETING MATERIALS

      (Board of Directors, November 19, 2020, effective May 31, 2021.)

      Introduction

      NFA Compliance Rule 2-9(d) places a continuing responsibility on each Swap Dealer and Major Swap Participant (collectively SD) Member to diligently supervise its employees and agents in the conduct of their swap activities for or on behalf of the Member. Compliance Rule 2-9(d) is broadly written to provide each firm with some degree of flexibility in determining what constitutes "diligent supervision" and to develop and implement written supervisory procedures tailored to meet the Member's particular needs. Although NFA leaves the exact form of supervision to the SD Member, all SD Members are required to have written policies and procedures designed to achieve ongoing compliance with applicable NFA and CFTC requirements. In discharging their supervisory obligations, SD Members should have written policies and procedures (supervisory program) governing the use of marketing materials if they provide marketing materials to counterparties and potential counterparties (collectively counterparties). NFA is adopting this Notice to provide guidance to SD Members on meeting their regulatory obligations under Compliance Rule 2-9(d) related to their use of marketing materials.

      NFA has previously adopted guidance that applies to FCM, IB, CPO and CTA Members' (intermediary Members) use and supervision of promotional materials, and many of the principles of this guidance are appropriate for SD Members. NFA recognizes, however, that SD Members conduct business and engage with clients differently than intermediary Members—most notably SD Members generally conduct business with counterparties that qualify as Eligible Contract Participants and negotiate bilateral, bespoke swaps tailored to a counterparty's specific needs. The guidance set forth in this Notice takes into account these fundamental differences.

      Definition of Marketing Material

      For purposes of this Notice's requirements, marketing materials include standardized documents in the form of pitch books, reports, letters, circulars, memoranda, presentations, publications, or brochures or other similar standardized documents (delivered via either hard copy or electronically, e.g., by email, text, or instant message) used for the purpose of soliciting a counterparty to enter into swap transaction(s) with the SD.1 Marketing materials do not include research reports as defined by CFTC Regulation 23.605(a)(9).2

      Supervision of the Use of Marketing Materials

      To satisfy its supervisory responsibilities under NFA Compliance Rule 2-9(d), each SD Member must implement and enforce a written supervisory program that is designed to reasonably ensure that marketing materials comply with all applicable NFA and CFTC requirements including rules related to fraudulent and deceptive practices (Compliance Rules 2-2 and 2-49 incorporating CFTC Regulation 23.410), fair and balanced communications (Compliance Rule 2-49 incorporating CFTC Regulation 23.433), and just and equitable principles of trade (Compliance Rule 2-4). NFA recognizes that, given the differences in the size and complexity of their operations, SD Members must have flexibility to design procedures regarding the use and supervisory review of marketing materials that are tailored to the Member's own situation. However, any adequate supervisory system must include policies and procedures for reviewing and approving marketing materials, training employees on the appropriate content and use of marketing materials, and recordkeeping requirements.

        a. Review and Approval

        All marketing materials used by a SD Member must be reviewed and approved by appropriate SD personnel. The primary purpose of this review is to ensure that the marketing materials comply with the SD Member's requirements, as well as to ensure that the material does not violate any applicable NFA or CFTC requirement.

        NFA recognizes that SD Members may use marketing materials that are general in nature, as well as marketing materials that are tailored to or focused on a particular type or group of counterparties (e.g., counterparties interested in a specific swap product). Although all marketing materials must be reviewed and approved, the timing of the review and approval may vary based on the type of material and/or the SD Member's relationship with the counterparty. For example, an SD Member may use a pitch book that includes general information on the SD Member and its business (i.e., a template). Since this general material may be provided to multiple counterparties, the supervisory program must require that this type of material be reviewed and approved prior to its first use to ensure that the material is not deceptive and misleading on its face, is fair and balanced and that it includes all information necessary to ensure that the material is not misleading. However, once an SD Member reviews and approves this marketing material, then the SD Member is permitted to use the material with other counterparties in the future, unless the SD Member has reason to know that the material may not be appropriate for a particular counterparty or potential counterparty.

        With respect to marketing material that is tailored to or focused on a particular type or group of counterparties, an SD Member's supervisory program may retain some flexibility on the timing of the review and approval of the material based on the nature and extent of the SD Member's relationship with the counterparty. For example, while the supervisory program should generally require review and approval of tailored material before it is provided to a new or potential new counterparty, an SD Member's supervisory program may allow for review and approval of tailored material to occur after the material is provided to an existing counterparty, particularly one that has previously engaged in swaps activity with the SD Member. Moreover, in determining whether a particular piece is fair and balanced and not deceptive or misleading, the SD Member may consider its relationship with a particular counterparty, including past discussions and materials shared about a particular swap transaction, provided it is reasonable for the SD Member to believe that the counterparty is aware of those past discussions or materials. Whatever review and approval process an SD Member adopts, its policies and procedures must adequately set forth the firm's requirements around the timing of its review and approval.

        An SD Member's supervisory program must specify the type of personnel who are authorized to create marketing materials and those that are authorized to review and approve marketing materials. Additionally, the supervisory program must require that an individual other than the creator of the marketing material review and approve the material in accordance with the SD Member's requirements, and that those authorized to review and approve have general knowledge of NFA and CFTC rules and understand the requirements related to communications with counterparties and marketing materials. To that end, SD Members have the flexibility to identify appropriate personnel for the review and approval, including compliance staff, a desk supervisor, a marketing department, or other individuals with sufficient knowledge to ensure that the material is fair and balanced and not misleading and in compliance with applicable NFA and CFTC requirements. If compliance staff is not involved in the review and approval process, the SD Member’s policies and procedures should indicate under what circumstances it will provide appropriate compliance staff with the marketing material within a reasonable time of it being used.

        b. Training

        An SD Member's written supervisory program must require individuals authorized to create or provide marketing materials to counterparties and the individuals authorized to review and approve marketing materials to be appropriately trained. The supervisory program must also include a description of the SD Member's training related to the use of marketing materials. In particular, the training must cover applicable NFA and CFTC rules and include examples of material that are considered fair and balanced communications and not deceptive and misleading, as well as examples that would violate these requirements. The training should also discuss the SD Member's procedures for the review and approval of marketing material. While NFA is not mandating the frequency of this training, the training should be provided to individuals before they are permitted to create, review, and approve materials, and on a periodic basis afterward, with additional training required whenever there is a material change in regulatory requirements, an SD Member materially changes its policies and procedures, or identifies a material area of concern. In any case, an SD Member's policies and procedures should specify the frequency.

        c. Recordkeeping

        An SD Member's supervisory program must also outline an SD's requirements with respect to recordkeeping of marketing material. At a minimum, an SD Member must maintain copies of all marketing materials along with a record of the material's review and approval. These records should be maintained for the periods specified in CFTC Regulations 23.203(b) and 1.31.3

      1 NFA recognizes that the list of items under "Marketing and Sales Materials" under CFTC Regulation 23.201(b)(4) may be broader than the definition of "Marketing Materials" used in this Notice. Certainly, not all communications between an SD Member and its counterparties are covered by the requirements of this Notice nonetheless, an SD Member is required to have policies and procedures reasonably designed to ensure that all communications with counterparties comply with NFA and CFTC requirements, including those highlighted above.

      2 CFTC Regulation 23.605(a)(9) provides that a research report is any written communication (including electronic) that includes an analysis of the price or market for any derivative, and that provides information reasonably sufficient upon which to base a decision to enter into a derivatives transaction, subject to certain exceptions.

      3 NFA Compliance Rule 2-49 adopts by reference CFTC Regulations 23.201(b)(4) and 23.203(b), which govern records retention, including marketing and sales materials.

      9078 - NFA FINANCIAL REQUIREMENTS SECTION 18: NFA PRE-APPROVAL OF THE USE OF SUBORDINATED DEBT

      (Board of Directors, February 18, 2021, effective October 6, 2021).

      NFA Financial Requirements Section 18 sets forth minimum capital requirements for swap dealers (SDs) and major swap participants (MSPs). Subsection (d) requires certain SD Members that elect to comply with the Bank Based (BB) capital requirements under CFTC Regulation 23.101(a)(1)(i) or the Net Liquid Asset (NLA) capital requirements under CFTC Regulation 23.101(a)(1)(ii) to obtain NFA's pre-approval of a subordinated debt loan agreement before using subordinated debt for capital purposes. As described more fully below, NFA adopted this requirement to provide non-SEC registered Member SDs with the ability to use subordinated debt as regulatory capital to meet their capital requirements.

      Both the BB and NLA alternatives permit SD Members to use subordinated debt as capital if the subordinated debt qualifies under SEC Regulation 240.18a-1d. This SEC regulation requires that the SEC approve the subordinated debt loan agreement prior to the agreement's effective date (i.e., before the subordinated debt may be used as capital) and to approve any pre-payments of the subordinated debt. SD Members that are also registered with the SEC as broker-dealers or security-based swap dealers are expected to obtain the requisite approvals under applicable SEC Regulations. Certain SD Members that are not registered with the SEC may also elect one of these alternative methods to calculate their capital requirements and may wish to use subordinate debt for capital purposes. However, since these SD Members are not SEC registered, the firms will not be able to obtain approval by the SEC of the subordinated loan agreement and thus will not be able to use subordinated debt as capital. In order to permit these non-SEC registered SD Members to use subordinated debt in appropriate circumstances, NFA Financial Requirements Section 18 permits a Member SD that is not otherwise registered with the SEC to use subordinated debt for capital provided the SD Member obtains NFA's pre-approval of the subordinated debt loan agreement. Financial Requirements Section 18 also prohibits a Member SD from making any pre-payment of the subordinated debt without prior approval of NFA.

      Proposed subordinated loan agreements must be filed with NFA at least 30 days prior to the proposed execution date of the agreement. NFA will review the agreement for conformity, consistency and applicability with SEC Regulation 240.18a-1d and CFTC Regulations 23.101(a)(i) and 23.101(a)(ii). An SD Member may not use subordinated debt to meet its capital requirement, or make a pre-payment of previously approved subordinated debt, until it receives NFA's approval.

      9079 - NFA COMPLIANCE RULES 2-9 AND 2-36: MEMBERS' USE OF THIRD-PARTY SERVICE PROVIDERS

      (Board of Directors, February 18, 2021, effective September 30, 2021).

      NFA Compliance Rule 2-9(a) places a continuing responsibility on every Member futures commission merchant (FCM), commodity trading advisor (CTA), commodity pool operator (CPO), and introducing broker (IB) to diligently supervise its employees and agents in all aspects of their commodity interest activities. NFA Compliance Rule 2-9(d) places the same supervisory responsibilities on swap dealer and major swap participant Members (collectively, Swap Dealer Members) regarding their swap activities and NFA Compliance Rule 2-36(e) places identical supervisory obligations on NFA forex dealer members (FDMs) for their forex activities. Over the years, NFA has issued Interpretive Notices to provide more specific guidance in certain areas on acceptable standards for supervisory procedures.

      NFA recognizes that a Member may fulfill, in part, its regulatory obligations by having a third-party service provider(s) or vendor(s) (Third-Party Service Provider)1 perform certain functions that would otherwise be undertaken by the Member itself to comply with NFA and CFTC Requirements. NFA understands that outsourcing certain functions may provide benefits to a Member. If a Member outsources a regulatory function, however, it remains responsible for complying with NFA and/or CFTC Requirements and may be subject to discipline if a Third-Party Service Provider's performance causes the Member to fail to comply with those Requirements. To mitigate the risks associated with outsourcing, a Member must have a written supervisory framework over its outsourcing function.2

      NFA recognizes that a Member must have flexibility to adopt a written supervisory framework relating to outsourcing functions to a Third-Party Service Provider that is tailored to a Member's specific needs and business as described below.3 This Interpretive Notice establishes general requirements relating to a Member's written supervisory framework,4 which requires Members to address, at a minimum, the following areas: an initial risk assessment; onboarding due diligence; ongoing monitoring; termination; and recordkeeping relating to Third-Party Service Providers.5

      A Member must comply with the general requirements set forth in this Notice only with respect to a Third-Party Service Provider(s) that performs functions to assist the Member in fulfilling its regulatory obligations that address NFA and/or CFTC Requirements. Further guidance relating to each of these areas is discussed below.6

      Initial Risk Assessment

      At the outset, a Member should determine whether a particular regulatory function is appropriate to outsource and evaluate the risks associated with outsourcing the function.7 For example, a Member may determine that it is appropriate to engage a third party to conduct annual branch office reviews, but based on its circumstances, determine it is not appropriate to engage it to conduct initial due diligence on a potential branch office. Similarly, a Member might conclude that it is appropriate to outsource the collection of long-term outstanding debit balances, but determine that it should monitor outstanding daily margin calls. Moreover, a Member may determine that it is appropriate to outsource certain core regulatory functions that are required to be performed by the Member on a frequent or even daily basis (e.g., issuing swaps confirmations, calculating and issuing margin calls, or reporting swaps data to a swap data repository).8

      Although the potential risks associated with outsourcing a function may vary, a Member should analyze and identify certain primary areas of risk including:

        Information Security — The type of confidential, personally identifying information or other valuable information a Third-Party Service Provider may obtain or have access to and the measures it puts in place to protect the information;

        Regulatory — The impact to the Member, customers, and counterparties if the service provider fails to carry out the function properly; and

        Logistics — The location of the service provider and whether it has the resources to meet its contractual obligations and provide the Member with access to required records.

      In addition to these primary areas of risk, a Member should consider other potential areas of risk applicable to its business and the regulatory function that is being outsourced. Unless a Member determines that it may adequately manage the risks associated with outsourcing a particular function, a Member generally should not move forward with outsourcing the function.

      Onboarding Due Diligence

      Scope of Due Diligence. A Member should perform due diligence on any prospective Third-Party Service Provider prior to entering into a contractual outsourcing arrangement in order to determine whether the service provider is able to successfully carry out the outsourced function in a manner designed to comply with NFA and/or CFTC Requirements. For example, in choosing to utilize a third party to examine a Member's branch offices or to comply with recurring or operationally intensive swaps regulatory requirements, Members should ensure that the service provider is aware of relevant NFA and CFTC rules and regulations, has sufficient regulatory experience, and has the operational capabilities to fully and accurately carry out the outsourced function(s). A Member's level of onboarding due diligence should be commensurate with the risks associated with outsourcing a particular regulatory function, be tailored to a Member's business needs, and provide a Member with an appropriate level of confidence in the Third-Party Service Provider's ability to properly carry out the outsourced function.

      Additionally, a Member's onboarding due diligence process should be heightened for Third-Party Service Providers that obtain or have access to a Member's critical and/or confidential data and those that support a Member's critical regulatory-related systems (e.g., handling customer segregated funds, keeping required records, filing financial reports, etc.). In these instances, a Member should consider assessing the following key areas relating to a Third-Party Service Provider: IT security (e.g., practices regarding data transmission and storage),9 financial stability,10 background of key employees, regulatory history (e.g., regulatory actions or lawsuits), and business continuity and contingency plans, particularly those related to data availability and integrity.

      A Member should also inquire about whether a Third-Party Service Provider subcontracts any of the regulatory functions that the Member outsourced to the service provider. If so, the Member should request the identity of a subcontractor(s) and, if possible, assess the risks associated with the Third-Party Service Provider's subcontracting of the function. A Member should require a Third-Party Service Provider to notify the Member of any change in a subcontractor(s) and retain the ability to terminate the relationship if the service provider makes any material changes involving a subcontractor that would have an adverse effect on the performance of the outsourced function.

      Written Agreement.11 A Member and Third-Party Service Provider should execute a written agreement12 that fully describes the scope of services being performed and addresses any guarantees and indemnifications, limitations of liability, and payment terms. NFA recognizes that in some cases a Member, due to its size or otherwise, may have little or no ability to negotiate and secure the inclusion of specific contractual terms, especially in agreements with industry service providers that support critical infrastructure. Each Member, however, should carefully review its Third-Party Service Provider relationships to ensure to the extent possible that contractual terms are appropriate and reflect the outsourcing relationship(s) as intended.

      When entering into a prospective written agreement, a Member should make a reasonable effort to ensure that the service provider agrees to comply with all applicable regulatory requirements, including the production of records, and to immediately notify the Member of any material failure(s) in performing the outsourced regulatory function(s).13 If applicable, a Member's agreement with a Third-Party Service Provider should address the process for data management at the termination of the relationship.

      Depending on the criticality of, and risk associated with, the function being outsourced, a Member should consider whether it is appropriate for a firm principal to either execute the outsourcing agreement or be notified that the Member has entered into an agreement. For example, a large CPO Member should consider if its CFO should execute or be notified that the CPO has entered into an agreement for a Third-Party Service Provider to provide monthly bookkeeping functions or administrative functions for the CPO's pool(s).

      Ongoing Monitoring

      The Required Risk-Based Review. A Member should conduct ongoing monitoring of a Third-Party Service Provider's ability to properly carry out an outsourced function and meet its contractual obligations. A Member's ongoing monitoring should involve both the ongoing review (e.g., by reviewing any reports generated by a third party for accuracy) of a particular outsourced function(s) to ensure that it is being performed appropriately, and periodic holistic reviews of each Third-Party Service Provider's performance, regulatory compliance and, if appropriate, IT security, financial stability, business continuity and contingency plans, audit or examination results, websites, public filings, insurance coverage, and references. In general, a Member should require a Third-Party Service Provider to notify it of any material changes to the provider's material systems or processes utilized to carry out an outsourced regulatory function. A Member should tailor the frequency and scope of ongoing monitoring reviews to the criticality of, and risk associated with, the outsourced function. For example, a Member may determine to review a Third-Party Service Provider with access to customer or counterparty data more frequently than a service provider that has no access to this type of data.

      Some Third-Party Service Providers perform multiple functions for a Member or otherwise provide an essential or critical service (e.g., collect and maintain customer/counterparty onboarding data). NFA recognizes that there may be only one or few service provider(s) to perform certain functions. However, to the extent applicable, a Member should evaluate the risk associated with becoming overly reliant on a particular Third-Party Service Provider and consider the availability of alternatives, including other service provider(s) or in-house solutions in case a viable "exit strategy" is necessary.

      Senior Management Involvement . Depending on a Member's size, operations, risk tolerance and the criticality of, and risk associated with, the outsourced function, a Member should consider whether the Member has adequate resources and qualified personnel performing ongoing monitoring. Additionally, a Member should have a process of escalation to senior management when a Third-Party Service Provider fails to perform an outsourced function or its risk profile materially changes (e.g., regulatory fine or business failure). Some Members may maintain internal committees (including risk committees) that must be notified about Third-Party Service Provider relationships and any material changes14 to them and may also engage an independent party to review their third-party outsourced relationships.

      Contractual Renewals. Finally, as part of the on-going monitoring process, a Member should consider incorporating best practices relating to contractual renewals. Throughout the length of its relationship with a Third-Party Service Provider, a Member should identify and evaluate the risks associated with any proposed changes to its agreements.

      Termination

      A Member's agreement with a Third-Party Service Provider should require that the Third-Party Service Provider give the Member sufficient notice prior to terminating its relationship with the Member in order to ensure that the Member can maintain operational, regulatory or other capabilities supported by the service provider. In particular, a Member must be able to meet all NFA and CFTC requirements, including recordkeeping requirements, after termination. Members will often need to obtain records from a Third-Party Service Provider at the termination of the outsourcing relationship or enter into an agreement with the service provider to continue acting as a records custodian for an appropriate amount of time.

      Upon termination, a Member should also make a reasonable effort to ensure that a terminated Third-Party Service Provider no longer has access to confidential information and data of the Member and its customers or counterparties.15 Further, a Member should ensure that a terminated service provider does not unnecessarily retain and, in appropriate circumstances, returns confidential information and data of the Member and its customers or counterparties. For example, a Third-Party Service Provider that performs accounting functions may have been granted "read-only" access to certain Member back-office systems and internal reports, and a Member should verify that this provider's access is terminated.

      Recordkeeping

      Any Member that engages a Third-Party Service Provider to perform a function to meet a regulatory obligation pursuant to an NFA and/or CFTC Requirement must maintain records pursuant to NFA Compliance Rules 2-10 and 2-49 to demonstrate that it has addressed the areas described in this Notice.

      1 When outsourcing to a Third-Party Service Provider, a Member should ensure, to the extent applicable, compliance with NFA Bylaw 1101. Further, even if a Member outsources a regulatory obligation to an affiliate, or to a Third-Party Service Provider with an existing contractual relationship with the Member's parent entity, a Member should comply with this Notice's requirements.

      2 NFA has previously issued Interpretive Notices relating to specific regulatory areas that also include guidance regarding Members' supervisory obligations related to Third-Party Service Providers. This Notice's requirements supplement the requirements set forth in those Notices. For example, see: NFA Interpretive Notice (IN) 9037 – NFA Compliance Rule 2-9: Supervisory Procedures for E-Mail and the Use of Web Sites; IN 9045 – NFA Compliance Rule 2-9: FCM and IB Anti-Money Laundering Program; IN 9046 – Compliance Rule 2-9: Supervision of the Use of Automated Order-Routing Systems; IN 9055 – NFA Bylaw 1101, Compliance Rules 2-9 and 2-29: Guidelines Relating to the Registration of Third-Party Trading System Developers and the Responsibility of NFA Members for Promotional Material That Promotes Third-Party Trading System Developers and Their Trading Systems; IN 9060 – Compliance Rule 2-36(e): Supervision of the Use of Electronic Trading Systems; IN 9070 – NFA Compliance Rules 2-9, 2-36 and 2-49: Information Systems Security Programs.

      3 A Member may be part of a larger holding company structure that has a dedicated procurement or vendor management department responsible for onboarding and maintaining Third-Party Service Provider relationships for the Member. A Member may meet its obligations under this Notice through the holding company's procurement or vendor management department as long as it addresses the areas described in the Notice with respect to the Member.

      4 CFTC Regulation 1.11(e)(3)(i)(A)-(B) requires FCMs to conduct onboarding and ongoing due diligence on depositories carrying customer funds. This Notice does not impact an FCM's obligations under this regulation. Moreover, an FCM may want to consider the processes and procedures used to meet this obligation when designing the processes for onboarding and conducting ongoing due diligence for Third-Party Service Providers.

      5 NFA recognizes that the guidance relating to several of these areas may overlap and, therefore, a Member's supervisory framework does not have to address each of these areas in isolation provided that the issues and risks associated with each area are addressed when initiating and managing outsourcing relationships.

      6 As additional guidance, Members may want to consider incorporating relevant standards and guidelines including, but not limited to, those set out in the National Institute of Standards and Technology (NIST) SP-800 series of publications (https://csrc.nist.gov/publications/sp800); the International Organization of Securities Commissions' (IOSCO) 2021 report Principles on Outsourcing (https://www.iosco.org/library/pubdocs/pdf/IOSCOPD187.pdf); and the Federal Financial Institutions Examination Council (FFIEC) IT Examination Handbook sections on outsourcing (https://ithandbook.ffiec.gov/it-booklets/outsourcing-technology-services.aspx).

      7 A Member's size and operations may impact how it onboards and maintains Third-Party Service Provider relationships. Members may have dedicated procurement or vendor management departments responsible for all aspects of these relationships. Other Members may divide the responsibilities of onboarding a vendor to various firm personnel. Members should ensure that all employees involved in this process are aware of this Notice's requirements.

      8 These examples are for illustrative purposes only. The Notice is not outlining functions that a Member is permitted or not permitted to outsource. The determination of whether to outsource a function remains with the Member.

      9 Members should avoid using service providers that are unable to meet NFA and CFTC standards regarding the confidentiality of customer data, which are set out, for example, in NFA Interpretive Notice 9070 – NFA Compliance Rules 2-9, 2-36 and 2-49: Information Systems Security Programs and CFTC Part 160.

      10 In assessing financial stability, a Member may want to consider, as appropriate, reviewing a potential service provider's financial statements, audit or examination (internal or third party) results, websites, public filings, insurance coverage, or references.

      11 NFA understands that Members will have existing agreements in place at the time this Interpretive Notice becomes effective. NFA does not expect a Member to re-negotiate these agreements prior to their termination dates, but NFA does recommend that a Member consider the above guidance when re-negotiating, renewing existing agreements, and engaging new Third-Party Service Providers.

      12 A written agreement mitigates the risks of non-performance or disagreements relating to the scope and nature of the services performed.

      13 As noted in the introduction to this Interpretive Notice, if the Third-Party Service Provider fails to perform in a manner that meets the Member's regulatory requirements, the Member is ultimately responsible for this failure, and based on the facts and circumstances, may be subject to discipline.

      14 The definition of a "material change" may differ depending on a Member's size, business, the functions outsourced, and the type of Third-Party Service Provider(s) utilized (e.g., regulated).

      15 Members should also consider requiring Third-Party Service Providers to notify them if a key employee with access to a Member's information is terminated and provide assurance that the employee's access to this information has been shut-off.

      9080 - NFA COMPLIANCE RULE 2-50: CPO NOTICE FILING REQUIREMENTS

      (Board of Directors, February 18, 2021: effective June 30, 2021.)

      NFA Compliance Rule 2-50 requires CPO Members to file notice with NFA when a market or other event affects the ability of a commodity pool to fulfill its obligations to participants.1 This Rule is designed to ensure that CPO Members timely notify NFA of potential financial issues that may impact a CPO's ability to fulfill its obligations to pool participants or which may result in a pool's unplanned liquidation. In particular, Compliance Rule 2-50 will assist NFA in readily identifying CPO Members with pools that have been adversely impacted by a market or other event. Specifically, NFA Compliance Rule 2-50 requires that CPOs provide prompt notification, in the form and manner prescribed by NFA no later than 5:00 p.m. (CT) of the next business day in the following circumstances:

      • CPO Member operates a commodity pool that is unable to meet a margin call(s);
      • CPO Member operates a commodity pool that is unable to satisfy redemption requests in accordance with its subscription agreements;
      • CPO Member operates a commodity pool that has halted redemptions and the halt on redemptions is not associated with pre-existing gates or lockups, or a pre-planned cessation of operations; or
      • CPO Member receives notice from a swap counterparty that a pool the CPO Member operates is in default.

      NFA recognizes that there may be circumstances that technically fall within one of the above events but is not the type of event that should require a CPO Member to notify NFA. The purpose of this Interpretive Notice is to provide guidance that more fully clarifies the circumstances that require notice under Compliance Rule 2-50.

      A Commodity Pool is Unable to Meet a Margin Call

      A commodity pool may experience a routine margin call that it may not be able to meet on the day of the call, but is able to meet within the time period imposed by its FCM or broker by altering its portfolio or accessing other means to meet the call. A CPO Member is not required to file notification on the day the pool receives a margin call if the CPO Member reasonably expects to meet the margin call within the prescribed time period. However, once a CPO Member determines that one of its commodity pools will be unable to meet a margin call, including in situations where the CPO disputes the amount or appropriateness of the margin call,2 the CPO Member must file the notice required by Compliance Rule 2-50 within the required time period.

      A Commodity Pool is Unable to Satisfy Redemption Requests

      In determining whether it is obligated to file a notice under this provision, a CPO Member should consider the terms of the pool's subscription agreement, including any grace period or other provisions that impact the timing of a redemption payment. The mere fact that a pool is unable to meet the request on the day received is not controlling. For example, a pool may have securities that will mature within the grace period and can be used to satisfy the redemption. In some instances, a CPO Member may also be able to offer a participant a payment-in-kind or provide for the creation of a side pocket when dealing with illiquid investments. Provided a CPO Member is able to meet a redemption request in accordance with the subscription agreement, no notice is required. However, once a CPO Member determines that a pool will not be able to meet a redemption request within the terms of the subscription agreement, the CPO Member must file notice within the required time period, even if the grace period has not expired.

      A Commodity Pool Halts Redemptions

      Pool subscription agreements often identify pre-determined gates or lockups dependent on a base level of funding. When a CPO Member decides to liquidate a pool in the ordinary course of business (i.e., not due to a market or other unexpected event), there may also be a halt on redemptions until a final accounting can occur. A CPO Member is not required to file notice for its pool(s) in these instances. However, a CPO Member is required to file notice within the required time period when one of its pools unexpectedly halts redemptions, either temporarily or permanently, as a result of a market or other event that impacts the pool's ability to meet redemptions.

      A Commodity Pool is Declared in Default by Swap Counterparty

      A Member CPO may receive notification if one of its pools is in default to a swap counterparty on a margin call, resulting in a deficit that the pool will not be able to cover or address by adding additional funds. NFA requires a Member CPO to file notice with NFA within the required time period once notified that a pool is in default to a swap counterparty if the CPO Member does not reasonably believe the pool can cure the default within the previously agreed to cure period regardless of whether the pool is in negotiations with the swap counterparty to liquidate positions or disputes the default notice.

      1 NFA recognizes that CPO Members are currently required to report some of these events to NFA in a PQR filing or pool annual report. However, this reporting does not provide NFA with timely information about critical events that impact NFA Members and their pool participants.

      2 A CPO is not required to file a notice in situations that it disputes the amount and appropriateness of a margin call provided the commodity pool has sufficient assets to meet the greatest of the disputed amount.

      9081 - FINANCIAL REQUIREMENTS SECTION 17: INITIAL MARGIN MODEL ONGOING MONITORING REPORTS

      (Board of Directors, August 19, 2021. Effective October 6, 2021.)

      INTERPRETIVE NOTICE

      Swap Dealer and Major Swap Participant (collectively, SD) Members that are subject to the CFTC's initial margin (IM) requirements under CFTC Regulation 23.154 may calculate IM using a standardized table based method or an internal risk based IM model that has been approved by the CFTC or NFA. In 2016, NFA established an IM model approval program and subsequently established an IM model oversight program to ensure that SD Members using an approved IM model could demonstrate that the model complied with CFTC Regulation 23.154 (incorporated by reference in NFA Compliance Rule 2-49) on an ongoing basis.

      SD Members using NFA approved IM models are required to submit certain information on IM model performance to NFA on a periodic basis. This Interpretive Notice specifically identifies the required filings.

      SD Members using an approved IM model must submit the following information to NFA in the noted time frames:[1]

      Quarterly (due by the last day of the following month):

      • AcadiaSoft IM portfolio reconciliation reports for each of the three month ends in the quarter;
      • A listing of the top five backtesting and benchmarking shortfalls; and
      • An analysis of exceedances that breached the firm's internal thresholds and a description of remedial actions on the IM amount.

      Annually (due by January 31 each year):

      • The annual internal audit report required by CFTC Regulation 23.154(b)(5)(iv); and
      • NFA's IM Model monitoring questionnaire.

      NFA may also request other information from SD Members using approved IM models. SD Members must submit any additional information to NFA in the required time frame.

      1In the instance the due date does not fall on a business day, the information must be filed with NFA the immediate business day prior.