NFA Interpretive Notice 9021
CPOs and CTAs generally must be members of the National Futures Association (“NFA”) and all NFA Member firms have certain compliance obligations. An important compliance obligation of any firm is to know whether it will be subject to enhanced supervisory requirements. In general, if a certain percentage of a firm’s APs or Principals has worked at other firms which have been disciplined in the past, then the NFA may require that the firm adopt enhanced supervisory requirements (“ESRs”). In addition to having a robust NFA compliance program, firms should actively monitor the employment history of any new hire to make sure that either ESRs are not required or, if required, that appropriate compliance procedures have been implemented.
Background
Authority Under NFA Rule 2-9 & Adopting Supervisory Procedures
NFA Rule 2-9 prohibits deceptive sales practices and authorizes the NFA's Board of Directors to require Member firms which meet certain criteria established by the Board, to adopt specific supervisory procedures to prevent abusive sales practices. [Note: for more on NFA Rule 2-9, please see NFA Social Media Compliance.]
The Board believes that the employment history of the firm’s APs and Principals is relevant to identifying firms that may have problematic sales practices and, accordingly, have instituted more strict supervisory procedures to ensure that APs and Principals that may have received improper training in the past (from their employment with disciplined firms, discussed below), do not commit the same problematic sales practices at their new firm.
In addition, the Board believes that Member firms that charge commissions or fees above the industry norm also should be required to adopt more strict supervisory procedures.
Interpretive Notice 9021
Pursuant to NFA Compliance Rule 2-9(b), the Board issued
Interpretive Notice 9021 which sets forth the criteria used to determine whether a Member firm must adopt ESRs. In general, a firm must adopt ESRs if:
- its APs and Principals were previously employed with a “Disciplined Firm,” or
- its Principals are affiliated with other firms that must adopt ESRs, or
- it charges 50% or more of its active customers round-turn commissions, fees and other charges that total $100 or more per futures, forex or option contract, or
- it becomes subject to NFA or CFTC enforcement or disciplinary proceedings.
The NFA defines a “Disciplined Firm” as one that has been sanctioned by the NFA or the CFTC during the last 5 years or permanently barred by the NFA or the CFTC based on a formal charge of sales practice or promotional material violations. The definition also includes a firm that has been sanctioned for sales practices involving the offer, purchase or sale of security futures products. The NFA maintains a list of Disciplined Firms that can be found through the Report Center on the NFA’s Online Registration System (ORS). A firm’s disciplinary history can also be found on BASIC.
Requirements for Adopting ESRs
Effective January 3, 2011, NFA Member firms that meet the following criteria are required to adopt ESRs.
Obligations based on employment histories of APs and Principals. A firm will need to adopt ESRs if:
- it has less than 5 APs and 2 or more APs have been employed by one or more current Disciplined Firms;
- it has between 5 and 10 APs and 40% or more of the APs have been employed by one or more current Disciplined Firms;
- it has between 10 and 20 APs and 4 or more of the APs have been employed by one or more current Disciplined Firms; or
- it has at least 20 APs and 20% or more of the APs have been employed by one or more current Disciplined Firms.
Obligations based on affiliation of Principals. A firm will generally need to adopt ESRs or obtain a waiver (discussed [here]) if any of its Principals are also Principals of any other firm that is required to adopt ESRs However, the Board has identified and carved out certain situations in which a Member firm will not be required to adopt ESRs based on specific Principal's affiliations, including:
- the Principal has not personally been subject to a disciplinary action by the NFA or the CFTC;
- the Principal has been a Principal of only one other firm that is required to adopt ESRs;
- the Principal has never been a Principal or an AP of a current Disciplined Firm;
- the Principal is affiliated with only one other firm that has been required to adopt ESRs and that firm has received a full waiver from the ESRs or abided by the ESRs for at least 2 years and is no longer required to have them; and
- the Principal is affiliated with only one other firm has been required to adopt ESRs and that firm has not become subject to a sales practice or promotional material based disciplinary action by the NFA or the CFTC since it was required to adopt the ESRs.
Obligation based on assessing commissions, fees and other charges well above the industry norm. A firm will need to adopt ESRs if it charges 50% or more of its active customers round-turn commissions, fees and other charges that total $100 or more per futures, forex or option contract.
Obligation based on the initiation of disciplinary action. A firm will need to adopt ESRs if:
- the firm has fulfilled previously required ESRs (or received a full or partial waiver from the ESRs) and becomes subject to a subsequent NFA or CFTC enforcement or disciplinary proceeding alleging deceptive sales practices. The firm must adopt all of the ESRs until after the proceeding is closed and all appeals (if any) are completed and the firm may not seek a waiver.
- the firm, which is required to adopt ESRs, becomes subject to an NFA or CFTC enforcement or disciplinary proceeding. The adopted ESRs will remain in effect.
Enhanced Supervisory Requirements
Firms that are subject to ESRs because they fall into one of the categories above, must adopt additional requirements in order to comply with their supervisory duties. Such additional requirements can include:
- tape-recording sales solicitations,
- increased capital requirements,
- filing all promotional material with the NFA, and
- filing reports with the NFA.
It is also important to note that once a firm meets these criteria, changing the composition of the firm’s personnel (e.g. terminating an AP who was previously employed with a disciplined firm) will not remove the requirement to adopt ESRs.
Conclusion
It is important that firms review their compliance programs to make sure they have adequately addressed this issue. The issue will also need to be reviewed, on at least an annual basis, through the NFA Self-Exam Checklist (for 2010). In the event that a firm is subject to an NFA audit, the firm will need to show it has complied with the ESRs or that it is not subject to ESRs.
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Cole-Frieman & Mallon LLP provide NFA registration and compliance support to CTAs, CPOs, IBs (guaranteed & introducing) and FCMs. Cole-Frieman & Mallon LLP is also able to help firms draft and implement enhanced supervisory procedures. Please contact Bart Mallon directly at 415-868-5345.
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