CPO and CTA Information on Branch Offices
Many commodity pool operators and commodity trading advisors are large enough that they have more than one central office. Even small CPOs and CTAs may have more than one central office. In these situations the CPO or CTA is deemed to have both a main office as well as one or more branch offices. A branch office will need to have a branch office manager who has taken the Series 30 exam.
What is a “branch office” for CFTC / NFA Purposes?
The term “branch office” is not really defined in any meaningful way in the Commodities Exchange Act but the CFTC Regulation 166.4 specifically discusses branch offices. The NFA too has promulgated rules on branch offices (see below) and has also published an Interpretive Release on Branch Offices (see below). The Interpretive Release gives the best definition of what exactly a branch office is:
Any location, other than the main business address at which an FCM, IB, CPO or CTA employs persons engaged in activities requiring registration as an AP, is a branch office. This is true even if there is only one person at the location.
Series 30 Exam for Branch Office Managers
Each branch office must have an Associated Person who is licensed as a branch office manager. According to the NFA Interpretive Release:
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.
Each branch office manager must pass a proficiency exam called the Series 30 exam unless the branch office manager is sponsored by a registered broker-dealer and is qualified to act as a branch office manager under the rules of either the New York Stock Exchange or the Financial Industry Regulatory Authority. The NFA has provided the following overview of the Series 30 exam requirement:
NFA must receive evidence that individuals applying to be a branch office manager have passed the Series 30. However, NFA will not require evidence that they have passed the Series 30 if, since the date they last ceased acting as a branch office manager, there has not been a period of two consecutive years during which they have not been registered as an AP. Additionally, individuals whose sponsor is a registered broker-dealer may, in lieu of the Series 30, provide proof that they are qualified to act as a branch office manager or designated supervisor under the rules of FINRA.
The Series 30 exam is called the Branch Manager Exam – Futures. The exam is 50 questions long (multiple choice and true/false) and applicants must answer at least 70% correct in order to pass. It is broken up into eleven main parts and the applicants will have 1 hour to complete the exam. For more information, please see our detailed discussion about the Series 30 exam.
Other Branch Office Issues
The CPO or CTA, as well as the branch office manager, must be aware of a couple very important issues with regard to the branch office:
1. Branch office cannot be a separate corporation.
2. Branch office APs must be paid directly by the Member firm.
A typical question we receive involves whether certain activity (even activity out of a home office) rises to the level of a branch office. Generally the answer is going to be, if you have to ask then it will probably be considered a branch office. Please note that the NFA has taken a very hard stance on this issue – I have had conversations with NFA examiners when they specifically questioned me regarding the activities of a firm. Additionally, the following bold text is part of the NFA Interpretive Release:
IF YOUR FIRM CURRENTLY HAS PERSONS OPERATING OUT OF LOCATIONS OTHER THAN ITS MAIN BUSINESS ADDRESS, THOSE LOCATIONS MUST IMMEDIATELY BE REPORTED TO NFA BY FILING AN UPDATE ELECTRONICALLY TO THE FIRM’S FORM 7-R AND BY ADDING BRANCH OFFICE MANAGER STATUS ON EACH BRANCH OFFICE MANAGER’S FORM 8-R.
Application to Forex Managers
Managers who trade in the off-exchange spot forex markets may be subject to reqistration requirements in the near future. If this is the case then it is likely that those firms which register and become NFA Members will need to adhere to the branch office rules as well. This means that a forex branch office manager would likely need to have Series 3, Series 30 and Series 34 exam licenses.
CPO and CTA managers should be very aware of this potential issue. If there are questions regarding a branch office, the manager should immediately speak with an attorney.
Various laws and rules which are applicable are provided below. Please contact us if you have a question on this issue or if you would like to start a hedge fund, CPO or CTA. If you would like more information, please see our articles on starting a hedge fund. Other related hedge fund law articles include:
- How to register as a CPO or CTA
- CPO Exemptions
- CTA Exemptions
- Hedge Fund Licenses
- Forex Hedge Fund Articles
Below are some various primary sources on branch offices.
CFTC Regulation § 166.4
Each branch office of each Commission registrant must use the name of the firm of which it is a branch for all purposes, and must hold itself out to the public under such name. The act, omission or failure of any person acting for the branch office, within the scope of his employment or office, shall be deemed the act, omission or failure of the Commission registrant as well as of such person.
[¶ 9002] REGISTRATION REQUIREMENTS; BRANCH OFFICES
(Staff, September 6, 1985; revised July 1, 2000 and December 9, 2005)
Form 7-R, Branch Offices
Any location, other than the main business address at which an FCM, IB, CPO or CTA employs persons engaged in activities requiring registration as an AP, is a branch office. This is true even if there is only one person at the location. If the firm has one or more branch offices, NFA’s registration records on the firm must include the names of all persons who are branch office managers. Each location must have a branch office manager, and that person’s status as a branch office manager should be listed in the Registration Categories section of the person’s Form 8-R even if previously listed as a principal in the Registration Categories section of the person’s Form 8-R. Each branch office must have a different manager.
The address must also be given for each branch office. A P.O. Box is not sufficient. Anyone with a status as branch office manager must also be currently registered as an AP or have applied for such registration. Whenever a new branch office is established it must be reported, with all the required information, to NFA by filing an update electronically to the firm’s Form 7-R. The closing of an existing branch office should also be reported by filing an update electronically to the firm’s Form 7-R.
IF YOUR FIRM CURRENTLY HAS PERSONS OPERATING OUT OF LOCATIONS OTHER THAN ITS MAIN BUSINESS ADDRESS, THOSE LOCATIONS MUST IMMEDIATELY BE REPORTED TO NFA BY FILING AN UPDATE ELECTRONICALLY TO THE FIRM’S FORM 7-R AND BY ADDING BRANCH OFFICE MANAGER STATUS ON EACH BRANCH OFFICE MANAGER’S FORM 8-R.
NFA may take disciplinary action against any Member which fails to properly list all of its offices.
An important point to recognize is that a branch office may not itself be a separate corporation or partnership. CFTC Regulation 166.4 requires each branch office to use the name of the firm of which it is a branch for all purposes and to hold itself out to the public under such name. Also, in CFTC Interpretive Letter No. 84-10 (May 29, 1984) it was concluded that a branch office could not maintain a separate identity from the Member. One obvious conclusion to be drawn from this information is that each AP in a branch office must be paid directly by the Member. Payment through any intermediary would lead to the assumption that the intermediary would be required to register as an IB.
The requirement that a branch office hold itself out to the public under the name of the Member is intended to ensure that customers are always aware of the Member with which they are doing business. It is necessary that any branch office AP, even one operating out of a residence or an unrelated place of business, make sure that customers understand who they are doing business with.
[¶ 5053] RULE 2-7. BRANCH OFFICE MANAGERS AND DESIGNATED SECURITY FUTURES PRINCIPALS.
[Adopted effective September 30, 1992. Effective date of amendments: January 28, 1994; August 21, 2001; December 9, 2005; and December 17, 2007.]
(a) No Member shall allow an Associate to be a branch office manager unless:
(1) The Associate has taken and passed the “Branch Manager Exam-Futures”: Provided, however, that any Associate who subsequently ceases acting as a branch manager will not be required to retake and pass the examination in order to resume acting as a branch manager unless after acting as a branch manager the Associate was not registered in any capacity for a period of more than two years; or
(2) The Associate is sponsored by a registered broker-dealer and is qualified to act as a branch office manager under the rules of either the New York Stock Exchange or the Financial Industry Regulatory Authority.
(b) Each Member registered as a broker-dealer under Section 15(b)(11) of the Exchange Act must have at least one designated security futures principal. No such Member shall designate a person as a security futures principal unless:
(1) The person is a partner, officer, director, branch office manager or supervisory employee of the Member;
(2) The person is a Member or an Associate of the Member as defined in Bylaw 301(b); and
(3) The person has taken and passed the “Branch Manager Exam-Futures.”
[¶ 9019] COMPLIANCE RULE 2-9: SUPERVISION OF BRANCH OFFICES AND GUARANTEED IBS
(Board of Directors, October 6, 1992; revised July 24, 2000)
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. Rule 2-9 applies not only to the supervision of branch office operations, but also imposes a direct duty on guarantor FCMs to supervise the activities of their guaranteed IBs. NFA Compliance Rule 2-23 provides that a guarantor FCM may be held jointly and severally subject to discipline by NFA for violations of NFA rules committed by the FCM’s guaranteed IBs. In practice, NFA’s Business Conduct Committee has charged FCMs under Rule 2-23 only where it appears that the guarantor failed to diligently supervise its guaranteed IBs.
NFA recognizes 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. 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. Nevertheless, NFA’s Board of Directors believes that it is appropriate to provide Members with specific minimum standards for a supervisory program for branch offices and guaranteed IBs (“remote locations”) and therefore issues the following Interpretive Notice.
Though Members may tailor their supervisory procedures to meet their particular needs, any adequate program for supervision must include procedures for performing day-to-day monitoring and surveillance activities, conducting on-site visits of remote locations and conducting ongoing training for firm personnel. The firm’s policies and procedures, including those for the supervision of branch offices and guaranteed IBs, should be in written form. Firm personnel and guaranteed IB personnel should be provided a copy of the appropriate policies and procedures relating to their duties, and be aware of the firm’s requirements. A copy of all policies and procedures should be on file with the branch office or guaranteed IB. All supervisory personnel should be knowledgeable of the firm’s requirements for supervision.
I. Day-to-Day Monitoring
On a regular basis a Member should perform a number of supervisory procedures in order to monitor the business being conducted in its remote locations. The extent of the supervision depends on a number of factors, including the volume of trading, the experience of the personnel, the nature of the customers, the trading strategies followed by the office or certain APs, the number of customer complaints and the length of time that the office has conducted business with the firm. Repeated problems in any particular area should heighten the level of scrutiny and follow-up by the main office or guarantor.
The procedures to review the day-to-day activities of an office should include the following areas.
Hiring. An adequate program for supervision must include thorough screening procedures for prospective employees to ensure they are qualified and to determine the extent of supervision the person would require if hired. The appropriate documentation to support any “yes” answers on the Form 8-R should be obtained and reviewed for potential disqualifying information. Derogatory information, which the applicant may have submitted in connection with any past regulations, should be obtained from NFA.1 Prior employers should be contacted to confirm the person’s previous work experience.
In connection with the review of the person’s prior work experience, a prospective employer should check for any futures-related disciplinary proceedings against the person’s prior employer.2 This information should be used by the prospective employer to determine the extent of supervision a particular applicant would require after he or she is hired.
Due Diligence Check of Guaranteed IBs. Guarantor FCMs must do a due diligence inquiry before entering into a guarantee agreement. The due diligence review must include a check to ensure that the IB is properly registered. The FCM’s due diligence review should also include inquiries concerning the disciplinary history of the IB and the disciplinary and employment history of the IB’s principals and APs. This type of information could be helpful to a prospective guarantor in determining the types of difficulties, if any, experienced by an IB, its principals and APs in the past and the extent of supervision which may be required of that IB under a guarantee agreement. For example, if the APs at a certain IB have received their futures training and experience at a firm or firms that have been subject to serious disciplinary actions by NFA or the CFTC, that IB may well require more supervision. Both registration and disciplinary information is readily available from NFA.3
Registration. Records of commissions payable to or generated by the branch office or guaranteed IB should be broken down by sales person and should be frequently reviewed to ensure that no commissions are being paid to unregistered individuals.
Customer Information. NFA Compliance Rules require each Member to adopt and enforce procedures regarding customer information and risk disclosure. The procedures for opening new accounts should require that the appropriate account documentation, including an acknowledgment of receipt of the required risk disclosure statement, be forwarded to the main office or guarantor.4 The documentation should be reviewed to ensure that the appropriate supervisory personnel approved the account. The information obtained from a customer should be reviewed to determine whether additional risk disclosure should have been provided to the customer. For any customer who should have received additional risk disclosure, the main office or guarantor should ensure that additional disclosure has been given and that such disclosure has been documented. It may also be necessary to contact the customer to verify that the disclosure was provided and that the customer understood its meaning. Notwithstanding these procedures, a firm may wish to require that all new account information and documentation be forwarded to the main office or guarantor for approval before trading commences in the account.
Account Activity. The trading activity in customer and AP personal accounts should be reviewed and analyzed on a regular basis in order to highlight those accounts which may require further scrutiny. There are a number of calculations and comparisons which can be performed to flag accounts for follow-up or further monitoring. For example, significant losses, commission charges or number of trades should be reviewed for inappropriate trading strategies. The reason for error and correction entries to trading accounts should be investigated, especially if there appears to be a pattern of errors or corrections made by an office. Commission-to-equity ratios should be calculated for discretionary accounts to detect possible excessive trading. In order to identify improper trade allocations for discretionary accounts or front running, the trading results in an AP’s personal account should be compared to the trading gains and losses in his or her customer accounts. Profitable customer accounts for a given AP should be reviewed for possible preferential treatment.
Appropriate supervisory personnel at the remote location should be notified of questionable account activity. Measures should be taken to follow up, such as reviewing order tickets and trade blotters, discussing the activity with the broker or contacting the customer.
Discretionary Accounts. NFA Compliance Rule 2-8 contains detailed requirements concerning the supervision and review of discretionary accounts. The written customer authorization and customer acknowledgment for third-party account controllers should be forwarded to the main office or guarantor. 5 Confirmation of the registration history of APs of FCMs and IBs exercising discretion should be made to ensure that they have been properly registered for the requisite two-year minimum.
Promotional Material. NFA Members are required by rule to adopt and enforce procedures regarding communications with the public. All promotional material should be submitted by the branch office or guaranteed IB to the home office or guarantor for review and approval prior to its first use. Review and approval of the material should be documented by the appropriate supervisory personnel.
Customer Complaints. An adequate system for handling customer complaints should require that a written record of all complaints be maintained, and that complaints which meet certain criteria be sent to the main office or guarantor. Notification of the main office of customer complaints may be based on factors including the seriousness of the allegations of wrong-doing, the monetary amount involved, and which APs or principals are subjects of the complaints. If the remote location is responsible for resolving customer complaints, the home office or guarantor should also be notified of the outcome of resolved complaints. Notwithstanding these criteria, a firm may wish to consider having all customer complaints received by a remote location submitted to the main office.
The main office or guarantor should review the complaints for possible rule violations. It should also compare the allegations in the complaint for similarity to other complaints received against the same individuals or office. Such a review may detect a pattern of sales practice or other abuses.
The status of unresolved complaints should be periodically reviewed to ensure that the branch office or guaranteed IB has promptly responded to complainants.
II. On-Site Visits
In addition to day-to-day supervisory procedures, adequate supervision of the personnel who do work in the main office must also include periodic on-site inspections. As a general matter, NFA would expect these on-site inspections of guaranteed IBs or branch offices to be performed annually.
Members should develop written procedures for the on-site review process including detailed steps to be followed during the visit. This will help ensure that the review process is performed in a consistent manner and will not vary due to the involvement of different personnel in the review process. A Member’s supervisory procedures should also address the number of visits to be made to a branch office or guaranteed IB. The frequency and nature of the visits, as well as whether the visit will be announced or unannounced, will depend on a number of factors including: the amount of business generated; the number of customer complaints received; the previous training and experience of the branch office personnel; and the frequency and nature of problems or concerns that arise as the result of day-to-day monitoring and surveillance of the office’s activities. The personnel who make the visits should be qualified to perform examinations and knowledgeable of the industry and the nature of the firm’s business. Such personnel should be able to perform their work with an independent, objective perspective.
The length of time between visits to the remote location coupled with the size and scope of its operation also plays a role in determining the procedures for on-site review of records and account documentation.6 In reviewing a smaller operation, it is feasible to conduct a comprehensive review of the remote location’s records and documents over the entire time period between visits, while reviewing a larger scale operation may require the selection of a sample of records and documents for given time intervals. The selection of samples should be accomplished on a random basis, for example, selecting every third account for review for randomly selected time periods.
Promptly after the completion of an on-site visit, a written report should be prepared and its findings discussed with the branch office and regional managers or guaranteed IB’s principals and supervisory personnel. Follow-up procedures should also be performed to ensure that any deficiencies revealed during an on-site visit are promptly corrected. The written procedures for the on-site examination should include steps to review the following areas:
Customer Order Procedures. An on-site visit to a remote location should include a review of procedures for handling and recording customer orders. The individuals responsible for accepting customer orders should be identified and a sample of a order tickets should be selected for review. NFA recommends that order tickets be prenumbered and that the on-site review test to ensure that all order tickets within the chosen samples are accounted for. The order ticket review should also confirm that all order tickets are properly time stamped and that all information required by CFTC Regulation 1.35 is included. If option orders are placed by the branch office or guaranteed IB, those order tickets should be reviewed to ensure that they contain the additional information required by CFTC Regulation 1.35.
Discretionary Accounts. If a branch office or guaranteed IB handles discretionary accounts, the supervisory visit should confirm that the branch office or guaranteed IB identifies discretionary orders as such and that the firm’s procedures regarding the supervision of discretionary trading activity are followed. In the event a branch office or guaranteed IB enters block orders, those orders should be reviewed to confirm that customer orders are not included with proprietary orders and that nondiscretionary customer orders are not included with discretionary customer orders. Split fills should be reviewed to ensure that they have been allocated according to established procedures.
Sales Practices. The on-site visit should include a review of sales solicitation practices as well as any promotional material utilized. A suggested starting point for review of the sales solicitation practices of a branch office or guaranteed IB is to identify the persons involved in sales solicitation and to confirm that they are properly registered. The individuals conducting the on-site review should also monitor sales solicitations while at the branch office or guaranteed IB. Interviews with selected customers should be conducted concerning the solicitation process and the handling of the customer’s account. 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.
The branch office or guaranteed IB’s promotional material, including sales solicitation scripts, must be approved by appropriate supervisory personnel. Therefore, an on-site visit should be designed to ensure that the branch or guaranteed IB is not using any promotional material that has not received prior approval. If the main office or guarantor has not approved the promotional material, it should be reviewed during the on-site visit.
Customer Complaints. The on-site review should include steps to confirm that all complaints requiring notification have been reported to the main office.
Handling of Customer Funds. In order to assure that customer funds are being properly handled by a branch office, the on-site review should determine whether the branch office accepts funds from customers and, if so, whether appropriate bank accounts, including segregated accounts for customer funds, have been established by authorized personnel. In addition, for guaranteed IBs, the on-site review should confirm that if funds are accepted from customers, they are received in the name of the FCM. The branch office or guaranteed IB should make copies of any customer checks that they deposit into a qualifying or branch bank account. The check copies should be reviewed during the visit to ensure that the branch office or guaranteed IB only accepts checks made payable to the FCM. In addition, third-party checks should be scrutinized to ensure that no customers are acting as unregistered FCMs or CPOs. If the guaranteed IB receives customer funds in the FCM’s name, the review should confirm that the proper authorization to do so exists, that appropriate bank accounts are maintained and that proper procedures for forwarding the funds have been established and are followed. For both branch offices and guaranteed IBs, the flow of customer funds in a sample of accounts should be reviewed to determine that all funds have been timely transmitted and properly credited.
Proprietary Trading. To the extent feasible, there should be 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 misuse of non-public information or the occurrence of other trading abuses.
III. Ongoing Training
A Member’s supervisory responsibilities include the obligation to ensure that its employees are properly trained to perform their duties. Procedures must be in place to ensure that employees receive adequate training to abide by industry rules and regulations and to properly handle customer accounts and that APs have completed the ethics training required by CFTC Regulation 3.34. Employees must be educated on developments and changes in the markets, futures products, rules and regulations, technology, and firm policies and procedures. 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 firms closed through an enforcement action for sales fraud and has therefore received his or her training from such firms, that AP may need specialized training in proper sales practices.
This Notice is intended to specify minimum supervisory standards for branch offices and guaranteed IBs. A failure to adhere to the requirements specified in this Notice will be deemed a violation of NFA Compliance Rule 2-9.
1 The detailed explanation of any “yes” answers on an 8-R is treated as nonpublic information; however, it is available to prospective employers under NFA Registration Rule 701(c). See Interpretive Notice at ¶9010.
2 Information concerning futures-related disciplinary proceedings can be obtained by checking the BASIC system on NFA’s web site at www.nfa.futures.org, sending a request to NFA through the “contact” feature of the web site, or calling NFA’s Information Center at (800) 621-3570. See Interpretive Notice at ¶9010.
3Registration Information is also available by checking the BASIC system on NFA’s web site at www.nfa.futures.org, sending a request to NFA through the “contact” feature of the web site, or calling NFA’s Information Center at (800) 621-3570. See Interpretive Notice at ¶9007.
4 NFA Rules require that a guaranteed IB maintain a record of the information obtained from a customer and a copy of the risk disclosure acknowledgment. A branch office may wish to keep copies of this information for its files.
5 NFA Rules require that a guaranteed IB maintain a record of the written customer authorization and customer acknowledgments for third-party account controllers. A branch office may wish to keep copies of this information for its files.
6 If a visit is prompted by awareness of a particular problem at a remote location or if a problem is discovered during a routine visit, the Member must ensure that the scope of the review is adequate to thoroughly examine the problem area.
[¶ 9007] COMPLIANCE WITH NFA BYLAW 1101
(Staff, March 19, 1987; revised July 1, 2000)
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;