Monthly Archives: August 2014

NFA Action Against Firm for Inadequate 1101 Investigation

Doing Business with Non-Members – NFA Action Raises Compliance Questions

Under NFA Bylaw 1101, NFA members are restricted from doing business with individuals or entities that should be, but are not, registered with the CFTC and members of the NFA. In a recent action against a forex firm, the NFA shed some light on its enforcement approach to this rule (among other issues).

Note that this action deals with the NFA rule on doing business with non-members as it applies specifically to Forex Dealer Members (under NFA Compliance Rule 2-36(d)). However, the NFA’s enforcement approach here is analogous to the way it views the rule for all NFA members.

The Complaint

The alleged fact pattern: a firm registered as a Forex Dealer Member, Forex Capital Markets LLC (“FXCM”), was approached by the general partner of Revelation Forex Fund LP (“Revelation”) to open an account. FXCM initially declined to open the account after determining that Revelation’s general partner was not registered as a CPO. FXCM instructed Revelation to contact the NFA regarding its registration requirements. Following this, Revelation’s general partner filed with the NFA a CPO registration exemption – the de minimis exemption under CFTC Rule 4.13(a)(3). FXCM then agreed to open an account for Revelation.

Describing these facts, the NFA stated “It is apparent that FXCM did not take adequate steps” to evaluate the registration status of Revelation’s CPO. The NFA also stated “FXCM should have questioned whether [Revelation] qualified for the de minimis exemption. Had FXCM done this, it would have been apparent to FXCM that [Revelation] did not meet the de minimis requirement of 4.13(a)(3) as it exclusively traded forex – and not in a de minimis amount – and was marketed to the public.”

Analysis – Compliance Implications

The facts of the action as alleged by the NFA certainly make Revelation’s eligibility for 4.13(a)(3) sound suspect. Assuming that FXCM knew Revelation’s business was primarily (or exclusively) trading forex, it does not seem reasonable that FXCM took Revelation at its word that it qualified under 4.13(a)(3). More broadly, though, this action raises important questions for what constitutes “adequate” compliance steps to evaluate a business associate’s reliance on a registration exemption.

Specifically, what did the NFA mean when it said an NFA member should “question” whether a business counterparty qualifies for its claimed exemption? One thing is clear: it is not sufficient to merely request proof that an exemption has been filed. But how far must one go? For example, assume an NFA member does business with a registered CPO that relies on the exemptive relief under CFTC Rule 4.7, which requires all investors to be Qualified Eligible Persons (“QEPs”). How does an NFA member “question” this exemption? Must it request a representation – or even some kind of evidence – that the CPO’s pool investors are QEPs?

Another scenario: assume an NFA member wants to do business with a CTA that relies on the exemption under CFTC Rule 4.14(a)(10), which limits the number of clients to 15 in a rolling 12-month period and forbids holding oneself out to the public as a CTA. Would the NFA member have to ask this CTA for representations and/or information on its number of clients? Should it review the CTA’s website and other public-facing materials? It is unclear what degree of diligence the NFA would deem “adequate” here.

Practical Take-Aways

 In terms of interpreting NFA rules, this NFA action probably raises more questions than it answers. However, one practical consequence that is likely is that NFA member firms – especially FCMs and Introducing Brokers with a high volume of new account openings – will implement increasingly stringent account opening procedures for customers that rely on registration exemptions.


Cole-Frieman & Mallon LLP acts as legal counsel to the investment management industry.  If you have questions on the above please contact us or call Bart Mallon directly at 415-868-5345.

Hedge Fund Events August 2014

The following are various hedge fund events happening this month. Please email us if you would like us to add your event to this list.


August 4-5, 2014

August 5, 2014

August 5-6, 2014

August 6, 2014

August 6-9, 2014

August 7, 2014

August 12, 2014

August 12, 2014

August 12, 2014

August 13, 2014

August 14, 2014

August 14, 2014


Cole-Frieman & Mallon provides legal services for hedge fund managers and other groups within the investment management industry.  Bart Mallon can be reached directly at 415-868-5345.