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Tuesday, August 31, 2021 - Amended Financial Requirement Section 18 - Swap Dealer and Major Swap Participant Financial Requirements. An explanation of the amended financial requirement can be found in the August 31, 2021 rule submission letter.
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.
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.