Category Archives: compliance

NFA CPO/CTA Regulatory Seminar Recap

by Bart Mallon, Esq. of Cole-Frieman & Mallon LLP

On March 2, 2010 the NFA held an all-day seminar at the UBS Conference Center in Chicago for the futures and commodities communities. With limited exceptions, the seminar provided useful information and allowed the audience to interact with the regulators directly through Q&A opportunities or by networking during the break periods. This overview will provide a quick summary of the major items discussed and the notes I took during the day. Full supporting materials for each session have been posted on the NFA’s website and the NFA will provide an audio CD of the seminar upon request.

Session One: The Current State of CPO/CTA Regulation

This session may have been mis-named as it focused solely on the potential changes with respect to the broader financial system. Accordingly, much attention was (needlessly) focused on some of the proposed bills pending in the House and Senate (which may or may not ever become law). After discussing the proposed bills in general, the panel moved to the proposed legislation with respect to the OTC derivatives markets (see CFTC thoughts on OTC derivatives regulation and Chairman Gensler’s Recent OTC regulation remarks). Brief mention was also made regarding the CFTC proposal to limit energy positions. A large part of the session was also devoted to issues dealing with harmonization between the CFTC and the SEC, which naturally included a discussion of the OTC derivites markets.

What did any of this have to do with CPO/CTA regulation as the title of the seminar indicates?

Not a lot, but the session did give the NFA a chance to frame some of the issues for the day and show that the mandate of the CFTC and NFA is broad. Surprisingly, the panel did not even mention one of the major proposed regulations which would affect a large number of CPOs/CTAs (and bring many more firms under the CFTC’s jurisdiction) – that issue was the proposed retail forex regulations.

When the panel was asked about the proposed forex regulations the NFA’s Dan Driscol mentioned a couple of interesting things. First, the NFA has been proceeding under the assumption that the forex registration rules will pass and that a large number of forex managers will need to be registered with the CFTC. Accorindingly, the NFA has been building out its systems and apparently there is some sort of way for the NFA to earmark which firms are forex firms (perhaps for greater oversight). The NFA also believes that during the registration process there is going to be a lot of hand holding, but also a lot of enforecment actions.

With respect other parts of the proposal, especially with respect to the increased margin requirements (100:1 leverage will move to 10:1 leverage under the proposed regulations), the NFA indicated that it will be providing the CFTC with a comment letter addressing its thoughts (see NFA Indicates Support for Greater Leverage). Specifically the NFA indicated that they believe margin requirements should be based on the volatility of the underlying instrument (here, the major currencies). While the NFA is not going to take a hard stance, the NFA is expected to provide the CFTC with more information on its experiences with respect to the margin requirements. The comment period for the retail forex proposal ends on March 22 so we will report on the NFA’s comments when they are available. [Note: Cole-Frieman & Mallon LLP will be providing comments on the proposed rules.]

Session Two: Disclosure Document and Performance Reporting

As all CTAs and CPOs probably have experienced, having a disclosure document reviewed and approved by the NFA can be an aggravating experience. Notwithstanding my own opinions on this issue, the panel started by discusing the 4.13 exemptions. The panel noted that the CFTC’s Part 4 regulations require very specific items from disclosure documents. Generally most CTAs and CPOs are familiar with the more important parts – risk disclosures and risk factors, conflict of interests and fee information.

The lawyer on the panel made the case for overdisclosure – the framework which managers should use when thinking about the disclosure documents is that of an opposing counsel in the future. In the event that something would go wrong in the future, what in your disclosure documents would opposing counsel point to? Is there anything which you would be embarrassed about if it was brought before the jury? Is there anything that is simply misstated or omitted? These are the types of things that opposing lawyers would point to during a lawsuit and therefor all managers (whether registered or not) should always make sure anything they give to investors is accurate and discloses all material information.

The panel began in earnest by talking about common comments on disclosure documents.

Common comments

Forex. Under principal risk factors many forex managers have risk factors which have been modified from futures disclosure documents. However, the futures and forex industries operate different therefore there is not the issue with clearing. Also forex transactions are structured different than for futures transactions and therefore the cost structure is different. [New NFA Rule 2-41. Forex risk disclosure statement needs to be exactly as stated in the rule.]
Litigation statement. The litigiation needs to be up to date. Many FCMs will continually update their litigation disclosure statement and if the most recent statement is not in the disclosure documents the NFA will check and will let you know in the deficiency letter that it needs to be updated.
Bios/manager background. It is a requirement for the managers bios to be included and the manager must include the dates of all employment (including unemployment or schooling) for the preceeding five years. This means both month and date needs to be included. Managers need to make sure the dates in the bio match with the dates in the Form 8R.

Litigation Statements

CTAs and CPOs are required to provide the litigation history for the firm and, more importantly, for the FCM and IB. These litigation disclosures are dense paragraphs of legalese which is designed to inform the investor of the potential legal issues with the FCM or IB. In practice these disclosures end up being pages long and, in my experience, are practically unreadable which brings up the question of their utility and if such disclosures really protect investors.

Notwithstanding the above, it is a requirement and CTAs and CPOs need to make sure that the ligitation statement is complete, accurate and up to date. Firms should also realize that the litigation statement may change during the review process which is what happened recently to one of my clients. The disclosure document received no comments from NFA staff except that the litigation statement for the firm’s FCM had just changed days earlier and would need to be updated. This needlessly added weeks to client’s start date.

CTA and CPO Documents “Not Boilerplate”

The attorney on the panel stressed that disclosure documents are not boilerplate, no matter how similar they may appear. He went on to note that there is a lot of detail in the documents and that it is essentially a manager’s contract with the investors. He stressed that managers should know and understand every detail of their documents. I completely agree.

One of the employees of a large CFTC registered firm noted that the manager needs to make sure that the disclosure document accurately reflects the way that business is conducted in the firm. Managers should ask operational personnel to review the document to make sure the language captures the manner in which the firm operates – if there are discrepencies between the document and operational procedures, the document should be amended or revised.

Performance Capsules

There are a number of issues which arise in the context of performance capsules and therefore a firm must take care to make sure that the capsule mirrors the NFA requirements exactly.

Break-Even Analysis

Every CTA or CPO disclosure document needs to include a break-even analysis. Generally this analysis will show a prospective investor or client the amount of gains necessary in order to break-even on the investment. Naturally the break-even analysis is an inexact science and, therefore, it is arguably of little value. For instance, the numbers in the table (at least for a newly registered CTA or CPO) are based on assumptions with respect to both level of assets as well as expected trading volume.

While there was no single or common issue discussed with regard to the break-even analysis, the NFA noted that for those managers which allocate or invest in underlying CTAs or CPOs, then the break-even analysis would also need to include the incentive fees payable at the underlying level. The NFA went through the calculations involved with determining such expense.

Timing and Section 4.8

During the question and answer period, I asked the panel whether they often times see groups using the CFTC Regulation 4.8 exemption during the approval process. I think that literally two or three of the representatives from the NFA said that they did not know what Regulation 4.8 was – I noticed that the attorney on the panel might have something to say and so I asked him if his clients had used it. He explained Regulation 4.8 and noted that he did not recommend clients use it because it is awkward to go back to pool investors and explain the issue.

The NFA took the opportunity to say that managers should allow plenty of time to go through the registration process.

Session Three: Pool Financial Reporting

There were essentially two parts to this presentation: a discussion of the new reporting requirements for the NFA and a discussion on fair value and derivatives.

For the first part, Tracey Hunt of the NFA provided information on some of the new reporting changes for CFTC registered firms. These include issues devoted to series funds, relaxed rules regarding liquidation statements, an extension for fund of fund filers.

Perhaps more importantly for many of the groups at the conference was the discussion of new NFA Rule 2-46 and a presentation of the reporting systems for the rule. Rule 2-46 essentially requires certain operators who have reporting requirements under CFTC Regulation 4.22 to make a quarterly filing through the NFA’s EasyFile system. CPOs will need to provide the NFA with the following information within 45 days of the end of the calendar quarter:

Key Relationships – pool administrators, carrying brokers, trading managers, custodians
Statement of Changes in NAV
Monthly Rates of Return
Schedule of Investments – all pool investments greater than 10% of fund NAV need to be disclosed (even if the positions are not futures/commodities)

We were provided with screen shots of the new filing system and it seemed both robust and complicated. The NFA has noted that they have spent a lot of time to update their EasyFile system to accomodate the filers. Even so, we believe their are likely to be bugs in the system and so we recommend that groups begin the EasyFile system as soon as possible to avoid missing the deadline because of technical issues. The system will have functionality to allow for many of the fields to populate automatically based on previous submissions. There are also some specialized issues with respect to master-feeder and fund of fund structures – generally the system will require you to keep drilling down until you reach the actual investments, no matter how many organizational layers are in the structure.

The second part of the discussion included a powerpoint slide from Deloitte discussing new issues with financial reporting. Essentially differences between level 2 and level 3 assets.

Keynote Speech from CFTC Commissioner Dunn

During lunch, which was actually quite nice, CFTC Commissioner Dunn delivered the keynote speech. As all speakers from government agencies do, he noted that his comments were his own and not of the CFTC. He spoke generally about the challenges facing the CFTC and that the issues are more complex than the issues the CFTC had to deal with in the past. Additionally, with greater financial regulation looming, the CFTC’s job (in conjunction with the SEC in certain circumstances) has become even more important.

He also talked to varying degrees on the following issues:

The historic two day meeting between the SEC and the CFTC regarding harmonization
A potential uniform fiduciary duty for all investment advisers (or other groups under SEC and CFTC jurisdiction)
Potential future regulation of the OTC derivitatives markets – he noted his support of OTC derivitatives regulation and Chairman Gensler. He did note, however, that there are many issues that would need to be worked out with any proposed legislation or regulation. He also discussed the proposed position limits on certain energy contracts.
Retail forex and the large amount of comments which have been received.

Session Four: Sales Practices

Perhaps the most entertaining of the panel discussions was on sales practices. The discussion was led by John J. Lothian who is well-known in the futures industry and created MarketsWiki. John did a fantastic job of including all of the panelists which included Natalie Peters of DigiLog Capital LLC, and Dorothy Bobak and Alexandra Shipovskikh, both from the NFA.

Common Deficiencies

The NFA discussed the following common deficiencies:

websites often have many deficiencies including with the general disclaimer and ommissions – it was stressed that the Member must be able to support all material statements of fact on the webiste
opinions should be clearly labeled as such
past trading performance will generllay have a lot of issues
general issue with stuff on third party websites – if you see something that is not correct, even if you did not place it there, you should ask the webmaster to revise or take it down. a member may have some oversight responsibilities

Links from a Member’s Website

Generally a firm should have superviosry procedures in place for linking from a proprietary website to another unaffiliated website (note: Cole-Frieman & Mallon LLP generally recommends to clients that they do not link out to unrelated websites)

Members should make sure that outbound links adhere to requirements of NFA Rule 2-9 and NFA Rule 2-29
Member need to monitor outbound links through periodic review
With respect to reporting sites (i.e. AutumGold, Barclays) you need to make sure all of the information is accurate and all descriptions of the pool or trading program are complete.

Social Media

The NFA just recently amended Rule 2-29(h) and released a social media interpretive notice. The new notice solidifies many of the principles of 2-9 and 2-29 but also deals with specific issues with sites like YouTube, Twitter, LinkedIn, Facebook, blogs, etc. Interestingly, the NFA announced that it has a Facebook page which is used for recruiting new staff members.

With respect to the new rule and different media, the following was discussed:

Twitter. How do you comply with 2-29 (disclaimer rule) within 140 characters? The media is necessarily different than a trditional website with a disclaimer. One way might be to format your Twitter page with a prominent disclaimer. You will need to make sure that all of the material you tweet is balanced pursuant to the promotional materials rule. There is always a potential problem with re-tweets. With respect to re-tweets, a Member may have an affirmative duty to ask another person to take down the re-tweet (which request itself, presumably, would be subject to record keeping requirements). Suggestion: use software to complie an archive of tweets. If you remove a tweet, you still need to keep a record of that tweet. The software should be able to provide a record of this. A firm should have a policy regard re-tweets (both by the Member or of the Member’s content).
Facebook. Many groups have a Facebook page. The question was whether a simple Facebook page with basic information would constitute “promotional material” – the NFA said maybe. The next question would be whether the firm was “soliciting” by having a Facebook page. Suggestion: a firm should institute the same oversight policies and procedures for a Facebook page as they would for other promotional materials.
YouTube. As both an audio and a video platform, a YouTube video will generally be subject to NFA Rule 2-29(h). Generally this will require that any audio or video advertisement be submitted to the NFA prior to use. If a member has something that was on YouTube prior to Febuary 1 then the member should take it down immediately and submit the media to the NFA for review – this material is not grandfathered into the amended rule. It sounded like the NFA will be looking at YouTube in the future to catch violations.
Other Mediums. Podcasts, blogs, forums, public wikis, and other forms of media all have medium specific issues which managers should discuss with counsel prior to displaying material which might be considered promotional material.

A firm which uses any of the mediums described above should have policies regarding education of employees on rules and responsibilities and appropriate oversight of the employees. If you firm needs to implement such policies and procedures, Cole-Frieman & Mallon LLP can provide guidance.

How to submit materials

In the event that a firm is subject to Rule 2-29(h) and therefore required to pre-file advertising materials, those materials can be submitted to the NFA in any format including CD, email, zip files, etc. In the context of live feeds, webinars, and seminars – the Member firm should submit an outline of what will be discussed prior to the live performance then submit an recording of the performance after it has happened. Such procedures are generally what you would do if an associated person or principal appeared on live television like CNBC or Bloomberg TV.

Session Five: The NFA Audit Process

Maybe one of the most important things that a firm should be ready for is an NFA audit. For many firms this is a painful process which causes anxiety, but for other firms, it might be an opportunity to get an outside review of back end business operations for “free.” Regardless of how a group views an audit, the discussion was helpful in identifying areas where managers can focus their attention in order to make the audit go as quickly as possible.

Who gets audited by the NFA?

There are no good answer with respect to when a member firm may expect to be audited by the NFA. In general FCMs and very large managers are likely to face NFA audits on a more regular basis. Forex firms can also expect to be audited more regularly than traditional futures only firms. Traditional CTAs and CPOs are under no timeline requirement so these groups might not see an audit for up to three years or longer.

Audit Process

Generally the NFA will alert a member firm 2-3 weeks prior to the exam. This gives the firm plenty of time to gether the inital records and other items requested by the NFA prior to their arrival. While the amount of information requested might seem to be enormous, a firm should attempt to comply with each item as this will decrease the amount of time the NFA will spend at your place of business.

The actual audit may take place over a day or be 2-3 days long. Larger firms can expect the NFA to be on site for a week or longer. The amount of time obviously depends on a number of factors including the size of the member firm and complexity of operations. During the audit there will likely be a lot of interaction between the compliance officer and the auditor. At the end of the audit they will provide the firm with a request list.

One of the most important items to keep in mind during the process is to keep open communication with the auditor. If you believe that the NFA findings are incorrect, you should discuss the issue with the auditor – at times they may see your point of view and side with you.

NFA Self-Exam Checklist

The most import item for Member firms to complete on yearly basis is their annual self-exam. Cole-Frieman & Mallon LLP has provided easy to use NFA self-examination checklists. Generally firms will need to take time to complete these lists on an annual basis and will need to keep a record of these actions pursuant to the firm’s recordkeeping policies.

Focus Areas

General. General issues which often are reviewed include proper registration, review of promotional material, performance reporting, trading (make sure recommendations appropriate), supervision, etc.
Valuation. If there are level 2 or level 3 assets there is likely to be greater review; principals need to make sure they sign off on level 2 or level 3 valuations.
Side Letters. This is a new focus area and the focus here will be to make sure the manager is doing what he says he will do in the side letter
Side pockets. Valuation of assets is going to be a focus area.

Common Audit Deficiencies

Promotional material. Issues include ridiculous performance numbers, withholding information from previous accounts, inaccurate numbers, etc.
Bylaw 1101. Requires that, as a NFA Member Firm, you only do business with other NFA Member Firms or firms that do not need to be registered; firms should have procedures in place to make sure other firms are either registered or not required to be registered (especially in the fund of funds context).
Inconsistencies. Your disclosure documents and compliance manual/ policies and procedures should be an accurate reflection of your firm’s actual operations.
Bunched orders. If a CTA firm bunches client orders, the CTA must conduct a quarterly review to make sure allocations to client accounts are done in a non-preferential manner.
NFA Rule 2-45. No loans from the pool to the manager for own personal use (ex. manager taking money out of pool to pay off mortgage)

Other items

Firms should remember that they need to distribute a privacy policy to customers on a yearly basis (perhaps send it out with December statement).
Disaster recovery plan (DRP) should be reviewed at least annually. The DRP should be resonable based on operations. This is an area where the auditors do not pay as much attention to.
Firm need to have ethics training procedures. Many of these procedures are boilerplate. Firms should make sure they follow their internal procedures.
Creating folders, filing and other systems on the front end will help the firm to remain organized and will help to keep the audit moving as quickly as possible.

Future Seminars

If you are interested in other seminars and conferences, I recommend the New York CTA Expo on April 21 which Cole-Frieman & Mallon LLP is sponsoring. Also, the NFA is having another CPO/CTA conference in New York on April 22. If you are in the San Francisco Bay area, we would also like to extend an invitation to the San Francisco Futures Professionals group which meets every couple of months to discuss issues relevant to members.

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Other related hedge fund law blog posts include:

Cole-Frieman & Mallon LLP (www.colefrieman.com) provides comprehensive legal and compliance services to commodity trading advisors and pool operators. You can reach Bart Mallon, Esq. directly at 415-868-5345.

San Francisco Futures Professionals March Meeting | March 16, 2010

CPO Annual Financial Report Filing

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Information on Filing Annual Report with NFA

Commodity Pool Operators (“CPOs”) are required to distribute an Annual Report, certified by an independent public accountant, to each participant in each pool it operates (i.e. the investors in the commodity/futures hedge fund) within 90 days after the pool’s fiscal year-end (normally December 31). CPOs are also required under the Commodity Exchange Act and commission regulations to file this report electronically with the National Futures Association (“NFA”) through the NFA’s EasyFile system. Alternate due dates exist for pools that are operated as a “fund of funds“. CPOs can monitor their filings and review their due dates for each pool in the EasyFile system. We have included an overview of the requirements and process below and Cole-Frieman & Mallon LLP would be able to help CPOs to make this filing as well.

Filing Overview

Who – all CPOs must file the annual financial report unless they are exempt under the CFTC Regulation 4.13.
What – a certified financial statement (PDF of the exact statement distributed to the pools limited partners) from an auditor needs to be filed with the NFA. (Please note that CPOs who are exempt under the CFTC Regulation 4.7 does not need to have their statements audited.)
When – commodity pool annual reports must be distributed to pool participants and filed with the NFA within 90 calendar days of the pool’s fiscal year end. (Mallon P.C. can also check the due date by logging into the EasyFile system on the Filing Index page.)
How – CPOs must submit annual reports to NFA electronically in accordance with NFA’s EasyFile electronic filing system and procedures.

NFA EasyFile System

Pool operators should have their NFA login and password to access the EasyFile system. Submitting pool financial statements using EasyFile involves a three step process:

The CPO (or compliance group) will upload a PDF of the identical pool financial statement provided to the pool’s limited partners, including the balance sheet, income statement, schedule of investments, footnotes, and the Independent Auditor’s Opinion, if applicable.
The CPO (or compliance group) will then enter approximately 30 key financial balances into an electronic schedule. These balances will be pulled directly from the balance sheet, income statement and statement of changes in net asset value included in the pool’s PDF filing.
The CPO (or compliance group) will finally submit the electronic filing, the system will run some basic edit checks. It will also prompt the CPO to read and agree to an electronic oath or affirmation. This oath or affirmation will apply to the information included in the PDF, as well as, the information entered into the schedule of key financial balances.

A common pitfall with this process include miscalculations with the key financial balances. In order to prevent this from occurring, the CPO should make sure the values/balances input into the system correspond with the PDF certified financial statement. After submission, the CPO should ensure the updated status of the filing becomes “Received” by logging into Pool Index page the in the EasyFile system. This status should show up within a few days after the filing has been submitted.

Conclusion

In addition to the various yearly compliance measures, such as the NFA Self-Examination Checklist, CPOs should be aware that they need to file their audited reports with the NFA. This is especially important because the NFA has fined large firms for failing to file on time (see previous NFA Action). If you need help with filing your annual financials, please contact Cole-Frieman & Mallon LLP for further information on our commodities and futures compliance services.

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Other related NFA compliance articles include:

Bart Mallon, Esq. runs the Hedge Fund Law Blog and provides hedge fund information and manager registration services through Cole-Frieman & Mallon LLP. He can be reached directly at 415-868-5345.

California Investment Advisor Annual Compliance Reminder | 2010

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(www.hedgefundlawblog.com)

State registered investment advisory firms usually have annual compliance requirements. The following discusses the major issues for investment advisors (both hedge fund and separately managed account managers) who are registered in California. In general, there is (i) an annual updating requirement and (ii) an annual financial filing requirement.

Annual ADV Updating Amendment

Registered investment advisers will need to update Form ADV (including Part II and Schedule F) on an annual basis. For California registered investment advisers the annual update is due within 90 days after the end of the firm’s fiscal year end (which will normally end on December 31). In general the advisor should review the entire ADV, Part II and Schedule F to make sure everything is accurate as of the date of filing. The advisor may want to make this filing itself (usually the chief compliance officer of the firm will complete) or the advisor may want to have its law firm or compliance firm complete the update for them.

Note: in additional to annual update, each advisor will need to make sure that certain information is updated on a continuous basis. If the information contained in Part I, Items 1, 2, 3, 4, 5, 8, 11, 13A, 13B, 14A and 14B of Form ADV, Form U-4 or any representation or undertaking contained in any affidavit filed with the state securities division, changes in any respect, or if the information contained in Part I, Items 9 and 10 and all items of Part II of Form ADV changes in any material respect, an amendment shall be filed promptly with the state securities division. Such amendment must be filed in writing no more than ten business days after the registrant has knowledge of the circumstances requiring such notification.

Annual Financial Filing Requirement

California registered advisors will also need to submit annual financial reports to the California Securities Regulation Division. Such advisors must submit the following to the division:

a balance sheet prepared in accordance with generally accepted accounting principles
an income statement prepared in accordance with generally accepted accounting principles
CA Minimum Financial Requirements Worksheet
CA Financial Verification Form

The above items should be sent directly to the California Securities Regulation Division at:

California Financial Services Division
1515 K Street
Suite 200
Sacramento, CA 95814

Note: in general both hedge fund managers and separately managed account advisors (who directly debit fees from client brokerage accounts) will be deemed to have “custody” of client assets and would need to make sure that, among other requirements, the balance sheet above is audited. Most advisors, however, will institute certain procedures (including a gatekeeper arrangement) which will allow them to submit unaudited financials. If you have questions, please contact your lawyer or compliance professional.

Other Compliance Issues

In California, like most of the states, there are a number of items that advisors will need to do a continuous basis. The most important is probably to properly maintain their books and records. California has also provided an overview of important issues for California investment advisor and has also provided an overview of the post-effective requirements.

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Please contact us if you have any questions or would like to start an investment advisory business. Other related hedge fund law articles include:

Bart Mallon, Esq. of Cole-Frieman & Mallon LLP runs Hedge Fund Law Blog and has written most all of the articles which appear on this website. Mr. Mallon’s legal practice is devoted to helping emerging and start up hedge fund managers successfully launch a hedge fund. Cole-Frieman & Mallon LLP will also help state based Investment Advisors to register with their state securities division. If you are a hedge fund manager who is looking to start a hedge fund or an investment advisor looking to register, please call Mr. Mallon directly at 415-868-5345.

Recent Issues with NFA Annual Questionnaire

NFA Self-Examination Checklist 2010 | FCMs, IBs, CPOs and CTAs

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Easy Step by Step Guide for NFA Member Firms

NFA Member Firms are all required to complete a yearly self-examination checklist to ensure that the Member Firm is complying with all the NFA Rules (as well as the CFTC Regulations and other applicable laws). The NFA has provided some resources on their website. We believe that the resources are good, but they are not easy to use for NFA Member Firms. Accordingly, Mallon P.C. has reworked the forms into a more easy-to-use format. Below is a description on how you should proceed with this process along with the various checklists that each Member Firm should print off and complete.

All of the checklists below are based on, and contain the same information, as the NFA checklists which can be found here.

Overview of Process

The whole process should take anywhere from 1 to 3 hours (or more) depending on the exact structure of the NFA Member Firm. Firm authorized personnel should complete the following steps:

Print off the General Checklist
Print off the Registration Specific Checklist
Print off the Attestation Sheet
Go through the checklists step by step and write notes and initial the appropriate areas. If a certain area is not applicable, write N/A.
Sign the Attestation Sheet
File the Checklists according to the Firm’s internal compliance procedures

If there are compliance issues which arise during the course of the self-examination process, please record the issue and how the issue has been or will be addressed. Do not try to cover up the issue – the NFA is more interested in the fact that a firm identifies and appropriately deals with compliance issues than a firm that has a perfect self-exam checklist (through a cover-up). Do not be afraid to take ample notes in the appropiate places on the checklist – this will show the NFA examiners that the Firm is committed to thinking about the relevant compliance issues.

* Note: there are other yearly compliance procedures that a firm will need to complete in addition to the self-examination checklist. For more information, please see the Mallon P.C. NFA Compliance Guide or contact your compliance consultant. Please note that the compliance guide may not cover all compliance requirements.

Checklists

Each Member Firm will need to complete at least two checklists – (1) a general NFA Member Firm checklist and (2) a specific registration category checklist (i.e. FCM, IB, CPO, CPA).

General Checklist

NFA Self-Exam Checklist (General – All Firms)

Registration Specific Checklist

Attestation

Each Member Firm will need to complete an attestation sheet which acknowledges that the Firm has completed the annual self-examination checklists.

NFA 2010 Checklist Attestation

Appendices

Each of the checklists makes reference to certain appendices. Below we have created links to those appendices.

Appendix A – General, FCM, IB
Appendix B – General
Appendix C – General
Appendix D – General

Acronyms

Each of the checklists include acronyms. We have listed them below for your convenience.

AML – Anti-Money Laundering
AP – Associated Person
BASIC – Background Affiliation Status Information Center
BSA – Bank Secrecy Act
CIP – Customer Identification Program
CRD – Central Registration Depository
DSRO – Designated Self-Regulatory Organization
FATF – Financial Action Task Force
FIFO – First-in, First-out
FinCEN – Financial Crimes Enforcement Network
NAV – Net Asset Value
NCCT – Non-Cooperative Countries and Territories
OFAC – Office of Foreign Assets Control
SAR – Suspicious Activity Report
SDN – Specially Designated Nationals
SPAN – Standard Portfolio Analysis

Rules & Regulations

Some of the checklists have references to certain CFTC Regulations and NFA Rules. We have listed them below for your convenience.

CFTC Part 4 Regulations
CFTC Regulation 160
CFTC Interpretation #10
NFA Compliance Rule 2-7
NFA Compliance Rule 2-29
NFA Compliance Rule 2-30
NFA Bylaw 1301
Securities Exchange Act of 1933 – Sections 9(a), 9(b), 10(b)

Forms

Some of the checklists have references to forms and these are included below.

CFTC Form 40
CFTC Form 8-T
Form U5

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Other related NFA compliance articles include:

Bart Mallon, Esq. of Cole-Frieman & Mallon LLP runs the Hedge Fund Law Blog. He can be reached directly at 415-868-5345

CFTC Provides Annual Guidance to CPOs

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Annual Report Guidance for Commodity Pool Operators

In a recent release, which we have reprinted in full below, the CFTC reminds CPOs of their annual reporting requirements under Regulation 4.22. The release includes a link to the 2010 CPO Annual Guidance Letter. In general the letter provides another reminder to CPOs to file their annual reports with the NFA and provide a copy to the investors in the pool. I have outlined below the major parts of the letter.

General Issues to consider

Commodity pool annual reports must be distributed to pool participants within 90 calendar days of the pool’s fiscal year end. For most funds this means by March 31, 2010.
Commodity pool annual reports must be filed with the NFA within 90 clendar days of the pool’s fiscal year end. For most funds this means by March 31, 2010.
All documents must be filed electronically through the NFA’s filing system.
Extensions are available in certain circumstances.

Other Issues

For groups which have different or more complex structures, additional considerations need to be addressed. Such groups include:

Master/feeder commodity pool structures
Commodity pool fund of funds
Offshore commodity pools
CPOs claiming an exemption under Regulation 4.13
Reports of commodity pools which are liquidating
Commodity pools established as a series structure (such as a series LLC)
Commodity pools which invest in non-exchange traded instruments may have additional issues

Moreover, the letter includes references to the recently amended CPO relations.

If a CPO will not be able to file on time, the CPO should file for an extension. “Automatic” extensions can be granted to CPOs to fund of fund structures. If you have questions with making a filing, please feel free to contact Cole-Frieman & Mallon LLP. The following press release can be found here.

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CFTC’s Division of Clearing and Intermediary Oversight Provides Annual Report Guidance to Commodity Pool Operators

Washington, DC — The Commodity Futures Trading Commission’s Division of Clearing and Intermediary Oversight has issued its annual guidance letter to registered commodity pool operators (CPOs). The letter is intended to assist CPOs and their public accountants in complying with the Commission’s regulations on the preparation and filing of commodity pool annual financial reports.

The highlights contained in this year’s letter include:

Recent amendments to Commission regulations pertaining to various reporting issues;
Annual report filing procedures and due dates;
Special considerations that apply to filings made for Master/Feeder and Fund of Funds structures;
Use of International Financial Reporting Standards in lieu of U.S. generally accepted accounting principles;
Reporting requirements for pools in liquidation;
Reporting requirements for series funds with limitation of liability among the different series; and
Various accounting developments that may impact report preparation.

For more information on CPO Annual Guidance Letter 2009, please see the Related Documents link.

Copies of the letter also may be obtained by contacting the Commission’s Office of the Secretariat, Three Lafayette Centre, 1155 21st Street, N.W., Washington, D.C. 20581, (202) 418-5100.

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Other related compliance articles for CPOs and CTAs include:

Bart Mallon, Esq. runs the Hedge Fund Law Blog. He can be reached directly at 415-868-5345.

CTA and CPO Foreign Language Disclosure Documents

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Translating a Disclosure Document to Another Language is Fine

NFA Member Firms are required to have their disclosure documents reviewed by the NFA generally before such firms can distribute the documents to potential investors. One issue which sometimes arises is when the firm (generally either a CTA or CPO) has potential clients/investors who are non-U.S. citizens and do not speak English. In these cases the question arises as to whether the CTA or CPO can translate their disclosure documents into another language.

I just recently spoke with a compliance representative at the NFA and the answer I received is: Yes, the CTA or CPO can have the document translated into another language. The big issue obviously is that the NFA Member Firm must be able to represent to the NFA that the translation is exact and the firm must generally make the translated copy available to the NFA during examination. Also, there are two central ways which firms will typically approch this situation:

Disclose to NFA – some firms will proactively disclose to the NFA that they have translated a disclosure document into another language. This can be done in a number of ways including: (i) providing a note to the NFA during the document submission or (ii) calling the NFA directly and talking with a representative or compliance manager.

Do not disclose to the NFA – some firms will not disclose to the NFA that a document has been translated. According to my phone conversation, this is fine, but the Member Firm will need to have a copy of the translated document and verify to the NFA that the translated version is exactly the same as the English language based version.

NFA Compliance Issues

Compliance. CTAs and CPOs must remember that, as Member Firms, there are ongoing recordkeeping responsibilities. Accordingly, the firm should have policies and procedures in place that address the issue of having translated disclosure documents. Additionally, firms should remember that disclosure documents are usually good for nine (9) months and must be updated thereafter (or if there are any material changes to the document which must be disclosed) – this means that the translated copy should also be appropriately updated.

Forex. These same rules will also apply to Forex CTAs and Forex CPOs. The CFTC just recently announced that forex managers will need to register with the CFTC and become NFA member firms. When forex managers register then, this will apply to them and they will need to follow these rules as well.

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Other articles applicable to NFA member firms include:

Bart Mallon, Esq. of Cole-Frieman & Mallon LLP runs the Hedge Fund Law Blog. He can be reached directly at 415-868-5345.

NFA Provides Social Networking Compliance Guidance

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Member Firms Subject to Increased Oversight & Compliance Responsibilities

In early December the National Futures Association (“NFA”) submitted two proposed amendments proposed amendments to the Commodity Futures Trading Commission (“CFTC”) regarding NFA Member Firms and their use of the internet and social media networks. The amendments focus on communications by firms over the internet in various capacities including blogs, chat rooms, forums, and various social media websites (i.e. Facebook, Twitter, etc). While these amendments will increase the oversight responsibilities for Member Firms, it makes sense for the NFA to alert members to their responsibilities with regard to these growing forms of communication. This post describes the two amendments, application to forex managers, the NFA social media podcast and the impact these amendments are likely to have on all NFA Member firms. The NFA’s Notice to Members on this issue is also reprinted at the end of this post.

Overview of Amendments

Amendment to Rule 2-29

Rule 2-29 was broadened by the following changes (underline and strikethrough):

(h) Radio and Television Advertisements.

No Member shall use or directly benefit from any radio or television advertisement or any other audio or video advertisement distributed through media accessible by the public if the advertisement that makes any specific trading recommendation or refers to or describes the extent of any profit obtained in the past that can be achieved in the future unless the Member submits the advertisement to NFA’s Promotional Material Review Team for its review and approval at least 10 days prior to first use or such shorter period as NFA may allow in particular circumstances.

By broadening the rule the NFA effectively is requiring Member Firms to make sure all audio and video internet advertising (i.e. podcasts, youtube, voiceover presentations, etc) be reviewed prior to use. Effectively groups who have used these channels to market their services will need to (i) have all such media reviewed by the NFA or (ii) take all media off of the internet.

Interpretive Notice: Internet Communication & Social Media

This interpretive notice is not so much an amendment of an existing Interpretive Notice as it is simply the creation of a new notice. The full Interpretive Notice can be found in the proposed amendments link above, but I have also reprinted some of the more interesting parts of the notice:

The form of communication does not change the obligations of Members and Associates who host or participate in these groups, and electronic communications must comply with Compliance Rules 2-9, 2-29, 2-36, and 2-39.

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Therefore, content generated by the Member or Associate is subject to the requirements of NFA Compliance Rules 2-29, 2-36, or 2-39. The same is true for futures, options, or forex content written by a Member or Associate and posted on a third party’s site.

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Members should have policies regarding employee conduct. These policies could require employees to notify the employer if they participate in any on-line trading or financial communities and provide screen names so that the employer can monitor employees’ posts periodically. Alternatively, the policy could simply prohibit participation in such communities. The Member must, of course, take reasonable steps to enforce whatever policies it adopts.

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The issue becomes more complicated for user-generated comments responding to a Member or Associate’s blog and for Members and Associates who host chat rooms or forums. What is their responsibility for posts from customers or others over whom the Member or Associate has no direct control? When inadequately monitored, social networking sites may contain misleading information, lure customers into trades that they would not normally make, or be used in an attempt to manipulate prices.

The biggest take-away is that the NFA is expecting NFA Members to integrate a social media awareness into their current compliance program. Accordingly, compliance programs (especially those parts dealing with Compliance Rules 2-9, 2-29, 2-36, and 2-39) will need to be updated appropriately to reflect the requirements of the Interpretive Notice. Member Firms will also need to vigillantly follow their new/revised compliance procedures and monitor their employees – it will be very easy for the NFA to do simple internet searches and potentially “catch” firms who do not adequately comply the Interpretive Release.

Issues for Forex Managers

Forex is specifically discussed throughout the Interpretive Notice so it is clear that the NFA’s intent is to make sure that forex communications, especially, are subject to monitoring and oversight. Currently this rule applies to those firms who are NFA Member Firms (currently registered) and, in the future, after the forex registration rules have been adopted, it will apply to all registered forex firms (CTAs, CPOs, IBs and FDMs/FCMs). The NFA has made it clear before that forex managers/traders are in the NFA’s regulatory cross-hairs and this Interpretive Notice reinforces that impression.

NFA Podcast on Social Media

The NFA has produced a podcast titled “Use and Supervision of Online Social Networking Communication” and can be found with other NFA produced podcasts. This podcast is helpful to provide Member Firms with some helpful guidance on some of the major issues to consider when developing a social media policy to comply with the Interpretive Notice and Rule amendment. There are a number of considerations that firms will need to make and the social media policy must be tailored to the business practices of the firm. There are likely to be a number of hot button issues which will develop regarding Member Firms and this policy, especially concerning oversight of associated persons. The podcast also hints at one of the big compliance issues which managers should be aware of – the reposting of content. Because internet posts are routinely “scraped” from the original website and reposted on other websites, Member Firms should be aware of this issue and create appropriate procedures.

It is recommended that compliance officers listen to this podcast when developing their social media compliance policies and procedures.

Impact on NFA Members

I view these amendments as relatively major – because so many firms use the internet for marketing and because prior NFA rules essentially did not address the issues of social networks there has been a bit of a regulatory gap. However, I do think that the NFA is doing the right thing by publicly notifying Member Firms that this will be a compliance issue going forward – this is much better than a retroactive interpretation of existing NFA compliance rules. One thing I think that member firms should be especially concerned with is potential liability for what 3rd parties do with information which is posted online. On the podcast, the NFA specifically suggested that firms should be policing their content and actively follow how it might be used by 3rd parties which is obviously problematic given the way the internet works.

Because these amendments affect both a current NFA Rule as well as the NFA’s Interpretive Releases, these amendments may make their way (eventually) onto the various exams (Series 3, Series 30, Series 34 especially).

These rules are also likely to create a compliance nightmare for many firms which have utilized the internet previously (and social media specifically).

Compliance Recommendations

The safest approach to social media compliance for all NFA Member Firms is to not allow the use any social media websites or other means of internet communication which would subject the firm to have a robust social media policy (including record retention policy for such media). It will be much less costly to put a blanket prohibition on these types of activities than to develop and monitor such a policy. For those firms who are willing to spend the time and money to implement a policy, such firms should make sure that all major aspects of the amendments are included in the policy. Such items to consider will include: internet and social media content review, recordkeeping and storage, oversight of employees (including spot-checking internet posts and activity), and reposting review procedures, among other issues to consider. It will be absolutely critical to make sure the policy addresses all issues raised in the Interpretive Notice and podcast because the NFA has not minced words – this is going to be a hot-button issue and it will be something the NFA will actively pursue during examinations.

Of course we will be able to provide greater guidance over the next few months as we see how the NFA handles this issue during and outside of examinations.

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Notice to Members I-10-01

January 5, 2010

Effective Dates of NFA Requirements Regarding On-Line Advertising and Social Networking Groups

NFA has received notice from the Commodity Futures Trading Commission (“CFTC”) that NFA may make effective certain proposed amendments regarding the use of internet and on-line social networking groups when communicating with the public. The Interpretive Notice entitled “Use of On-Line Social Networking Groups to Communicate with the Public” makes clear that on-line communications are subject to the same standards as other types of communications with the public and provides guidance to Members to meet their responsibilities in this area. The Interpretive Notice became effective on December 24, 2009.

A related amendment to Compliance Rule 2-29(h) requires that any audio or video distributed through media accessible by the public (e.g., through the internet) that makes any specific trading recommendation or refers to the extent of profit previously obtained or achievable in the future must be submitted to NFA for review and approval at least 10 days prior to first use. In this way the amendment subjects certain on-line advertising to the same requirements as similar television and radio advertising. To allow Members sufficient time to submit these types of advertisements to NFA for approval, the amendment becomes effective as of February 1, 2010. Accordingly, any audio or video advertisements that a Member posts on-line after January 31, 2010, must have been previously reviewed and approved by NFA.

NFA’s December 8, 2009, submission letter to the CFTC contains a more detailed explanation of the changes. You can access an electronic copy of the submission letter at: http://www.nfa.futures.org/news/PDF/CFTC/CR2-29_IntNotc_re_OnLine_Social_Networking_120209.pdf.

Questions concerning these changes should be directed to Sharon Pendleton, Director, Compliance ([email protected] or 312-781-1401) or Michael A. Piracci, Senior Attorney ([email protected] or 312-781-1419).

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Other related hedge fund law blog articles include:

If you are a manager or firm that needs to register as a CTA or CPO, or if you are contemplating registration, please contact Bart Mallon, Esq. of Cole-Frieman & Mallon LLP at 415-868-5345.

NFA Annual Questionnaire

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Reminder to NFA Member Firms

As part of the annual processes and procedures NFA Members will need to make sure that they complete the NFA Annual Questionnaire. As discussed below in the NFA’s most recent notice to members, it is important that NFA Members complete the questionnaire because some of the answers will appear as BASIC entries sometime within the first half of 2010 (for an image of this, please see Notice to Members I-10-02, reprinted in full below). Below we have provided an overview of the major items which are addressed on the questionnaire. NFA Members are urged to complete the NFA’s Self Exam Checklist prior to logging in to complete the questionnaire.

Questionnaire Items

The annual questionnaire actually requires the NFA Member to provide fairly detailed information on the nature of the Member’s business and the extent in which the Member participates in certain aspects of the industry such as trading in the forex markets. Each firm will need to complete a section called “Firm & DR Information” as well as one section (or multiple sections if applicable) devoted to CTA, CPO, IB, or FCM specific questions. Below we’ve outlined the major categories.

CTA Questionnaire

The central part of the CTA questionnaire focuses on information related to the trading program. Such information requested includes: nominal AUM, forex account information, number of accounts trading Securities Futures Products (SFPs)*, most recent disclosure document date, whether any exemptions exist, types of investors, etc.

* A securities futures contract is a legally binding agreement between two parties to purchase or sell in the future a specific quantity of shares of a single equity security or narrow-based securities Index (e.g. products traded on One Chicago or NQLX). It does not include broad-based indices such as the S&P 500 or Dow.

CPO Questionnaire

The central part of the CPO questionnaire focuses on information related to the commodity pool. Such information requested includes: pool trading information, question on restrictions (if any), forex trading information (if applicable), SFP trading (if applicable), most recent disclosure document date, whether any exemptions exist, etc.

Firm & DR Information

In the Firm & DR Information section you will need to include certain information on the preparer (name, title, phone, email) and you will need to complete firm information and disaster recovery information.

Firm Information

For the firm information there are a number of questions regarding the number of accounts to which the firm is currently providing advice, whether the firm is engaged in forex activities, the extent to which the firm utilizes advertising (tv/radio, print, internet), and/or whether the firm is registered in other capacity. Importantly, there is a question regarding whether the firm has completed the self-exam checklist within the last 12 months.

Disaster Recovery Information

All NFA Member firms are required to have addressed disaster recovery. For the purposes of the questionnaire, Members are required to provide primary and secondary contact information. Specifically, the instructions are as follows:

For purposes of business continuity and disaster recovery, members are required to provide NFA with the name and contact information for one or two persons who NFA can contact during an emergency. Since this information will serve as an alternative contact in the event you are unable to continue doing business at your main location, the contact information that you provide should be different from that of your main location.

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Notice to Members I-10-02

January 6, 2010

Reminder to all Members to complete new questions in Annual Questionnaire assessing Member’s futures-related and off-exchange forex business

On November 30, 2009, NFA issued Notice to Members I-09-21 [HFLB Note: reprinted directly below] requesting all Members to complete a series of new questions located in the Annual Questionnaire assessing their futures-related business. Although some NFA Members have complied with this request, many have not. It is critical that Members access and complete questions in the Firm and DR Information section of the Annual Questionnaire as soon as possible. This applies not only to Members trading on-exchange futures products but also Members trading in the off-exchange foreign currency (forex) market.

Beginning in early 2010 NFA’s BASIC system will display information reflecting whether firms are actively engaged in futures-related business activity or not. If the questions are not answered, the answers will default to no activity, which is what will be displayed in BASIC, as illustrated below.

For additional information and instructions on accessing the Annual Questionnaire, click here.

If you have any questions, please contact NFA’s Information Center at 800-621-3570 or 312-781-1410.

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Notice I-09-21

November 30, 2009

NFA adds new questions to Annual Questionnaire to assess Member’s futures-related business

NFA has approximately 500 firms that are NFA Members but have represented to NFA via their Annual Questionnaire that they are not doing any business that requires membership (“Inactive firms”). Almost universally, these Members indicate that they maintain their membership because they may do business in the future.

Since 2006, NFA has taken several Member Responsibility Actions against Member firms that had told NFA they were inactive. These actions were taken after NFA obtained information from reviewing the internet, through contacts with other NFA Members, and by receiving customer complaints suggesting that these firms were in fact active.

Due to these disciplinary actions, NFA’s Board of Directors requested that beginning in early 2010 NFA’s BASIC system display information reflecting whether firms are actively engaged in futures-related business activity or not. Presumably, if a Member is identified in BASIC as not conducting futures-related business, this will raise a “red flag” to potential customers who are being solicited by an Inactive Firm.

Specifically, BASIC will contain information regarding whether or not the Member has on-exchange customer accounts, manages customer accounts, operates pools, is engaged in retail off-exchange foreign currency activities and/or is soliciting customer business. This information will be based solely on information that Member firms provide in their responses to the questions in the Firm and DR Information section of the Annual Questionnaire.

NFA has re-designed this portion of the Annual Questionnaire by adding new questions and moving certain questions from other sections. Firms may update the answers in the Firm and DR Information section of the Annual Questionnaire at any time.

It is critical that Members access and complete questions in the Firm and DR Information section of the Annual Questionnaire as soon as possible. If the questions are not answered, the answers will default to no activity, which is what will be displayed in BASIC.

Please follow these instructions to access the Annual Questionnaire and provide the required information.

1. Open the Questionnaire system using this link: https://www.nfa.futures.org/AppEntry/Redirect.aspx?app=SPECIAL_QUESTION

2. Enter your ORS ID and password to logon.

3. From the “Online Questionnaire Index” screen, select “Firm and DR Information” under “Questionnaire Type.” (In addition, if you have not completed your most recent Questionnaire, you should update the previous version at this time.)

4. Update the Preparer Information on the next screen, if necessary, and then click “Next.”

5. To respond to this special request,

a. Answer the questions listed at the top of the screen under the heading “Please address the following questions regarding you firm’s business operations”.

b. After answering the applicable question(s), scroll to the bottom of the screen and click the “Submit Filing” button.

c. The system will then confirm that you submitted the updated Questionnaire to NFA.

If you have any questions about this Notice, please contact NFA’s Information Center at 800.621.3570 or 312.781.1410.

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Other articles related to CTAs and CPOs include:

If you are a manager or firm that needs to register as a CTA or CPO, or if you are contemplating registration, please contact Bart Mallon, Esq. of Cole-Frieman & Mallon LLP at 415-868-5345.