Category Archives: Forex

Dodd-Frank Establishes New Laws Regarding Spot Commodities and Spot Forex

The Dodd-Frank Wall Street Reform and Consumer Protection Act (“Act”) has changed a number of laws in all of the securities acts including the Commodity Exchange Act.  Two specific changes deal with certain transactions in commodities on the spot market.  Specifically, Section 742 of the Act deals with retail commodity transactions.  In this section, the text of the Commodity Exchange Act is amended to include new Section 2(c)(2)(D) (dealing with retail commodity transactions) and new Section 2(c)(2)(E) (prohibiting trading in spot forex with retail investors unless the trader is subject to regulations by a Federal regulatory agency, i.e. CFTC, SEC, etc.).  According to a congressional rulemaking spreadsheet, these are effective 180 days from the date of enactment.

We provide an overview of the new sections and have reprinted them in full below.

New CEA Section 2(c)(2)(D) – Concerning Spot Commodities (Metals)

The central import of new CEA Section 2(c)(2)(D) is to broaden the CFTC’s power with respect to retail commodity transactions.  Essentially any spot commodities transaction (i.e. spot metals) will be subject to CFTC jurisdiction and rulemaking authority.  There is an exemption for commodities which are actually delivered within 28 days.  While the CFTC wanted an exemption in which commodities would need to be delivered within 2 days, various coin collectors were able to lobby congress for a longer delivery period (see here).

It is likely we will see the CFTC propose regulations under this new section and we will keep you updated on any regulatory pronouncements with respect to this new section.

New CEA Section 2(c)(2)(E) – Concerning Spot Forex

The central import of new CEA Section 2(c)(2)(E) is to regulate the spot forex markets.  While the section requires the CFTC to finalize regulations with respect to spot forex (which were proposed earlier in January), it also, interestingly, provides  oversight of the markets to other federal regulatory agencies such as the CFTC.  This means that in the future, different market participants may be subject to different regulatory regimes with respect to trading in same underlying instruments.  A Wall Street Journal article discusses the impact of this with respect to firms which engage in other activities in addition to retail forex transactions.  The CFTC’s proposed rules establish certain compliance parameters for retail forex transactions, requires registration of retail forex managers and requires such managers to pass a new regulatory exam called the Series 34 exam.  We do not yet know whether the other regulatory agencies will adopt rules similar to the CFTC or if they will write rules from scratch.

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CEA Section 2(c)(2)(D)

‘‘(D) RETAIL COMMODITY TRANSACTIONS.—

‘‘(i) APPLICABILITY.—Except as provided in clause (ii), this subparagraph shall apply to any agreement, contract, or transaction in any commodity that is—

‘‘(I) entered into with, or offered to (even if not entered into with), a person that is not an eligible contract participant or eligible commercial entity; and

‘‘(II) entered into, or offered (even if not entered into), on a leveraged or margined basis, or financed by the offeror, the counterparty, or a person acting in concert with the offeror or counterparty on a similar basis.

‘‘(ii) EXCEPTIONS.—This subparagraph shall not apply to—

‘‘(I) an agreement, contract, or transaction described in paragraph (1) or subparagraphs (A), (B), or (C), including any agreement, contract, or transaction specifically excluded from subparagraph (A), (B), or (C);

‘‘(II) any security;

‘‘(III) a contract of sale that—

‘‘(aa) results in actual delivery within 28 days or such other longer period as the Commission may determine by rule or regulation based upon the typical commercial practice in cash or spot markets for the commodity involved; or

‘‘(bb) creates an enforceable obligation to deliver between a seller and a buyer that have the ability to deliver and accept delivery, respectively, in connection with the line of business of the seller and buyer; or

‘‘(IV) an agreement, contract, or transaction that is listed on a national securities exchange registered under section 6(a) of the Securities Exchange Act of 1934 (15 U.S.C. 78f(a)); or

‘‘(V) an identified banking product, as defined in section 402(b) of the Legal Certainty for Bank Products Act of 2000 (7 U.S.C.27(b)).

‘‘(iii) ENFORCEMENT.—Sections 4(a), 4(b), and 4b apply to any agreement, contract, or transaction described in clause (i), as if the agreement, contract, or transaction was a contract of sale of a commodity for future delivery.

‘‘(iv) ELIGIBLE COMMERCIAL ENTITY.—For purposes of this subparagraph, an agricultural producer, packer, or handler shall be considered to be an eligible commercial entity for any agreement, contract, or transaction for a commodity in connection with the line of business of the agricultural producer, packer, or handler.’’.

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CEA Section 2(c)(2)(E)

‘‘(E) PROHIBITION.—

‘‘(i) DEFINITION OF FEDERAL REGULATORY AGENCY.—In this subparagraph, the term ‘Federal regulatory agency’ means—

‘‘(I) the Commission;

‘‘(II) the Securities and Exchange Commission;

‘‘(III) an appropriate Federal banking agency;

‘‘(IV) the National Credit Union Association; and

‘‘(V) the Farm Credit Administration.

‘‘(ii) PROHIBITION.—

‘‘(I) IN GENERAL.—Except as provided in subclause (II), a person described in subparagraph (B)(i)(II) for which there is a Federal regulatory agency shall not offer to, or enter into with, a person that is not an eligible contract participant, any agreement, contract, or transaction in foreign currency described in subparagraph (B)(i)(I) except pursuant to a rule or regulation of a Federal regulatory agency allowing the agreement, contract, or transaction under such terms and conditions as the Federal regulatory agency shall prescribe.

‘‘(II) EFFECTIVE DATE.—With regard to persons described in subparagraph (B)(i)(II) for which a Federal regulatory agency has issued a proposed rule concerning agreements, contracts, or transactions in foreign currency described in subparagraph (B)(i)(I) prior to the date of enactment of this subclause, subclause (I) shall take effect 90 days after the date of enactment of this subclause.

‘‘(iii) REQUIREMENTS OF RULES AND REGULATIONS.—

‘‘(I) IN GENERAL.—The rules and regulations described in clause (ii) shall prescribe appropriate requirements with respect to—

‘‘(aa) disclosure;

‘‘(bb) recordkeeping;

‘‘(cc) capital and margin;

‘‘(dd) reporting;

‘‘(ee) business conduct;

‘‘(ff) documentation; and

‘‘(gg) such other standards or requirements as the Federal regulatory agency shall determine to be necessary.

‘‘(II) TREATMENT.—The rules or regulations described in clause (ii) shall treat all agreements, contracts, and transactions in foreign currency described in subparagraph (B)(i)(I), and all agreements, contracts, and transactions in foreign currency that are functionally or economically similar to agreements, contracts, or transactions described in subparagraph (B)(i)(I), similarly.’’.

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Other related hedge fund law articles:

Cole-Frieman & Mallon LLP provides legal support and forex registration services to forex managers.  Bart Mallon, Esq. can be reached directly at 415-868-5345.

Forex Registration Workshop Announced

NFA to Discuss Forex Registration in Vegas

The NFA announced a workshop to inform forex managers about the various registration and compliance matters that managers will need to be especially aware of during the registration process.  While we do not yet know what the final rules will look like, we do know a few things and believe that managers will need to focus on the following issues:

  • Series 34 exam – this is an exam specifically for forex managers.  In addition to the Series 34, the managers will most likely need to have passed the Series 3 exam as well.
  • Forex Compliance – all NFA registrants will need to make sure they are compliant with all CFTC laws and regulations in addition to NFA rules.
  • Forex Disclosure Documents – all forex CTAs and CPOs will need disclosure documents.  While these disclosure documents will be similar to traditional futures/commodities disclosure documents, there are some specific forex disclosures managers will also need to include in the documents.  As always, managers should remember that the disclosure documents and the managed account agreement are legal documents and should be drafted by an attorney.

The full NFA announcement is reprinted below.

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NFA’s Registration/Compliance Workshops for Currently Unregistered Forex IBs, CPOs and CTAs in Conjunction with the Upcoming Futures and Forex Expo

Caesars Palace in Las Vegas
Saturday, September 25, 2010

In early 2010, the Commodity Futures Trading Commission (CFTC) published its proposed rules regarding the regulation of retail off-exchange foreign currency (forex) products. One component of the proposed rules requires all forex introducing brokers, account managers and pool operators to register with the CFTC as forex IBs, CTAs and CPOs and to become Members of National Futures Association (NFA).

In anticipation of the publication of the CFTC’s final rules, NFA will be offering registration/compliance workshops in conjunction with the upcoming Futures and Forex Expo to be held on September 23-25 at Caesars Palace in Las Vegas. These workshops will outline the registration process and discuss regulatory requirements for each registration category.

The schedule for the workshops is as follows:

  • 8:30 – 10:30 a.m. Registration workshop for all registration categories. This session will cover who has to register and will present a walkthrough of the registration process.
  • 10:30 a.m. – 12:00 p.m. General compliance workshop for all registration categories. This session will include discussion of NFA rules regarding promotional material/sales practices, supervisory procedures (including ethics training requirements, supervision of branch offices and disaster recovery/business continuity planning) and anti-money laundering requirements.
  • 1:30 – 3:00 p.m. Disclosure documents/financial requirements workshop for CPOs and CTAs, including performance reporting.
  • 3:00 – 5:00 p.m. NFA staff available for one-on-one consultations.

All workshops will be held in the Tribune Room in the Convention Center at Caesar’s Palace.

Although there is no fee to attend the workshops, advanced registration is recommended.

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Other related forex law articles:

Cole-Frieman & Mallon LLP provides legal support, registration and compliance services to all types of forex managers.  Bart Mallon, Esq. can be reached directly at 415-868-5345.

New Forex Regulations: Overview of Public Comments

Leverage, Inaccessibility for Smaller Traders, and Offshore Threat are Focus of Public Comments

As we’ve discussed in related posts, the CFTC has proposed rules regulating the off-exchange spot forex industry (see Retail FOREX Registration Regulations Proposed).  The CFTC has requested comments from the public and there are currently about 100 public comments on CFTC’s website written in response to the new rule. The comments mainly focus on:

  • Leverage reduction rule (approx. 75/100 comments)
  • Forex industry becoming inaccessible to smaller traders (approx. 35/100 comments)
  • Threat of investors moving their money to offshore firms (approx. 25/100 comments)
  • Opposition to government interference/regulation (approx. 20/100 comments)

[Note: over the weekend the CFTC published some of the backlog of comments it received.  Much of this article was written prior to review of these extra comments (which total approximately 3,663).  We will provide an update on such comments in the future.]

To view all of the comments, click here.

The following is our summary of the comments which have been made thus far.

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Leverage Reduction

Approximately 75 of the 100 comments mention a strong or very strong opposition to the new leverage proposal of 10:1. The issue with a reduction of leverage to 10:1 is that investors will have to invest much more money in order to trade what they can currently trade with less capital. Comments regarding leverage include phrases like “strongly object”, “terrible idea”, “unintelligent”, and “strongly oppose”.  The majority opinion is that people should have the freedom and the choice to trade with a higher amount of leverage, and that the federal government’s attempts to lower leverage to 10:1 are “unnecessary” and “intrusive”. John Yeatman Jr. writes,

Please DO NOT reduce leverage in US Forex trading to 10:1…THIS WOULD HAVE A MAJOR IMPACT ON TENS OF THOUSANDS OF TRADERS AND THEIR FAMILIES WHO RELY ON 100:1 LEVERAGE AVAILABILITY TO SUPPORT THEIR FAMILY AND THIS ECONOMY. Please do your part in helping to keep this country great and it’s [sic] freedoms true BY NOT ALLOWING ANYTHING LESS THAN 100:1.

Other comments regarding the leverage proposal include:

  • … strongly objects to new leverage of 10:1
  • … proposed reduction not consistent with futures, which allow a significantly higher leverage
  • … virtually no flexibility trading at 10:1 leverage unless trader has gigantic account balance
  • …reduction in leverage not fair to public…bad for America
  • … new leverage line “out of line with general idea of protecting consumers”
  • …limiting leverage to 10:1 is “a bad idea”
  • …current leverage limit is “more than enough”
  • … CFTC is “unintelligent” to change leverage to 10:1
  • … terrible idea to lower leverage
  • … leverage change is “perversion of the free markets”
  • …leverage restriction “grave injustice” for many who work to secure the American dream of prosperity for themselves and families
  • …leverage limits would delay achievement of financial independence
  • …leverage not dangerous; misuse is
  • …leverage decrease will kill forex business and worsen economic situation in states and worldwide
  • …amount of leverage needs to be at discretion of investors

Smaller Traders

Another argument is that lower leverage will making trading inaccessible for smaller traders but leave the door wide open for larger institutions, since lower leverage requires higher margin (meaning that more money needed to be invested in order to trade). Comments regarding this proposed rules potential affect on smaller traders include:

  • …will stamp out small-time investor
  • …drive smaller guys out of market or offshore
  • …anything lower would be insane for small-time traders
  • …gets rid of investors with small capital so rich can stay rich and poor can stay poor
  • …pushes out small-time investor
  • …denies small trader opportunity
  • …disparate and unintended impact on small traders with lower capital
  • …leave the small, independent traders alone
  • …small businesses are heart of US economy
  • …all small-scale actors will be stifled
  • …10:1 leverage will have unintended consequence of locking out hundreds or thousands of small traders
  • …quit treating the small guy like an idiot
  • …are you trying to allow only rich to trade forex?

Government Interference/Regulation

Many of the comments suggest anger with the government for interfering too much with the forex industry. Michael Thomas writes,

I do not live here in this “free” society to have someone from the government babysitting me. The message that your proposed rules send is that 1) we are not free to make our own choices. 2) The federal government believes that we the general public are too stupid to make decisions for ourselves….I don’t need you, or do I want you getting in the way of my being able to trade as I wish in the United States of America.

Other comments regarding an opposition to increased government interference include:

  • …don’t add more government
  • …not intention of our ancestors to create government which controlled/regulated all aspects of citizens’ lives
  • …the government has no right to control my ability to make profit
  • …unnecessary for Federal government to regulate against individual’s ability to take risks
  • …don’t need government protection; we’re adult traders
  • …not responsibility of government to take away choice from consumers
  • …”big brother” attempt to protect people from “evil” traders and forex hedge funds
  • …stay out of trying to run my personal life

Offshore Threat

In at least 25 of the comments, the public is arguing that the new rules, specifically lower leverage, will drive traders offshore to overseas brokers who may or may not be regulated. Further, a major argument is that the forex industry in the United States will essentially cease altogether as a result of traders moving their forex activities offshore. Comments regarding this offshore threat include:

  • …will send business to London and unregulated offshore markets
  • …consumers will take accounts offshore
  • …will drive smaller guys out of markets entirely or to offshore, unregulated brokers
  • …when traders move accounts offshore, CFTC and NFA will have no control of clients’ trading
  • …I’ve already moved my account offshore
  • …people will do business with offshore brokers

Government Regulation

In terms of the new regulation proposal as a whole, some people support more industry regulation while others are against the idea entirely. Bradford Smith writes,

I feel that regulation of firms is needed…regulation is needed to help people understand the risks such as risk disclosure. [Regulating] the  retail forex market in a similar fashion to how commodities and futures are regulated is a good idea. Stopping companies from trading against their clients is a high priority issue that needs to be stopped.

John M. Bland, on the other hand, who views the proposal as “unfair”,  writes,

…the CFTC has done a lot in recent years to correct many of the problems in the industry…this decision is unfair and anti-competitive.

Other comments regarding opposition to the proposal and/or government interference include:

  • …new rules will destroy US financial firms business and lead to loss of thousands of jobs during the worst economy in decades
  • …regulation should be aimed at encouraging economic growth and innovation vs. restricting it
  • …against proposal
  • …how did forex regulation get in the Farm Bill?
  • …whoever initiated proposal has no knowledge of forex…this rule is utter nonsense…rules for forex in the USA are already quite strict
  • …you are busybody bureaucrats with intrusive minds…you are interested in only one thing: bureaucratic power and complete control of every microscopic aspect of life…you are monsters
  • …rules will harm people who make an honest living trading currency
  • …important to educate and inform, not regulate and ban
  • …proposal is a disaster-in-warning for traders
  • …if it ain’t broke, don’t fix it
  • …proposal is lunacy-communist-legislation
  • …I do not support the proposal…proposal closes doors for forex investors and will make forex market accessible to financial institutions only
  • …vehemently against new, narrow-sighted legislation

Agreement/Disagreement with Proposal

Many of the comments discuss that education about forex and trading risk is the best solution. On a similar note, many traders expressed the fact that anyone who trades in the forex market is aware of the inherent risks, so people who decide to trade are willing to take these risks. There is a general consensus that it is the individual’s, and not the government’s, responsibility to evaluate the level of risk that s/he is willing to take. Remember, higher leverage will be reflected in both your profits and your losses. Thus, if you have high leverage and profit, you will profit a lot more than if your trading had not been leveraged. But the same goes for losses; if you lose, you will lose a lot more based on the higher leverage.

Conclusions Thus Far

The biggest concern thus far is the proposed reduction in leverage to 10:1. Almost every comment mentioned a strong opposition to this rule. Furthermore, most people seem to be concerned that the new regulations will significantly decrease forex activity in the US—if not kill it off—and drive most investors overseas to offshore firms. We will continue to monitor comments received until the March 22 due date. Please leave us a comment below with your feedback. Should you feel inclined, you may submit your own comment to the CFTC through the methods listed above.

To view CFTC’s proposed rules, click here.

How to Comment

Comments must be received by March 22, 2010 and can be submitted the following ways:

  • Through the Federal eRulemaking Portal: http://www.regulations.gov/search/index.jsp. Follow the instructions for submitting comments.
  • By e-mail: [email protected] Include “Regulation of Retail Forex” in the subject line of the message.
  • By fax: (202) 418-5521.
  • By mail: Send to David Stawick, Secretary, Commodity Futures Trading Commission, 1155 21st Street, NW., Washington, DC 20581.
  • Courier: Same as Mail above.

(Note that all comments received will be posted without change to http://www.cftc.gov, including any personal information provided.)

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Other related CFTC articles include:

Bart Mallon, Esq. of Cole-Frieman & Mallon LLP runs the Hedge Fund Law Blog and provides forex registration services to forex managers. Mr. Mallon also runs the Forex Law Blog.  He can be reached directly at 415-868-5345.

Recent Issues with NFA Annual Questionnaire

As we discussed in an earlier post on NFA Annual Questionnaire, NFA Member Firms are required to complete the questionnaire on an annual basis.  The information helps the NFA in a variety of ways and the NFA encourages members to update their questionnaire on a regular basis, although firms are only required to complete it, at a minimum, on the anniversary of their NFA Membership date.

Number of Half-turn Trades Issue

One issue that we are seeing clients deal with is the last question which applies to commodity trading advisors (CTAs) and commodity pool operators (CPOs).   The question is as follows:

For CTAs and CPOs only: Provide the following information for accounts held by CTAs and/or CPOs:

How many total domestic futures and options trades (half-turns) did your firm place directly with an FCM in the last 12 months? Please include trades for customer, commodity pool (both regulated pools and pools exempt pursuant to CFTC Part 4 Regulations) and proprietary accounts, but do not include trades that were actually placed by another money manager on behalf of any of these accounts.

The issue is that the question asks for the total amount of half-turn trades were completed over the last 12 months.  This could be an absolutely huge number and it would be onerous for a CTA or a CPO to go back and actually count each trade (unless the broker/clearing firm was keeping track for the CTA or CPO).  Accordingly, I have now talked with the NFA twice about this issue and they have confirmed that an approximate or estimated number is sufficient for the purposes of the questionnaire.  While such informal guidance is not binding, it seems like the NFA wants to have a general idea of the trading volumes and is not going to “ding” a manager if the exact number is not determined.

Issues for Forex CTAs and Forex CPOs

Even before the forex registration regulations were proposed, many forex-only managers registered with the CFTC as either forex CTAs or CPOs.  I asked the NFA compliance department how such managers should answer the above question as would not make sense in the spot forex context.  The NFA said that such managers should answer the above question by placing a 0 (zero) in the appropriate box (assuming there was only spot forex trading).

If you have other questions or issues when you are completing the annual questionnaire, you can either call the NFA or your compliance professional.  Also, please let us know what your issues are so we can update this article accordingly.

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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.

Eligible Contract Participant (ECP) Definition

The term “eligible contract participant” is important with regard to managers who provide advice on futures and commodities investments (including off-exchange spot foreign currency or “forex”).  In general there are exemptions from various CTA, CPO and IB registration provisions for those managers who only provide advisory services to those clients who fall within the definition of eligible contract participant (ECP).  The definition is also important for those managers who may be subject to the proposed CFTC forex registration regulations.

This post provides a short general description of the definition and also the full definition.

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Short Definition

An Eligible Contract Participant generally  means:

  1. Financial Institutions
  2. Insurance Companies
  3. Mutual Funds
  4. Certain commodity pools with $5 million or more of assets
  5. Certain organizations with, generally, $10 million or more of assets
  6. ERISA plans with $5 million or more of assets
  7. Certain governmental entities
  8. Certain broker-dealers and investment banks
  9. FCMs
  10. Floor brokers
  11. An individual with generally $10 million or more of assets
  12. Certain brokers or investment advisers

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Full Definition

The following definition is found in the Section 1a(12) of the Commodity Exchange Act.

Eligible contract participant

The term “eligible contract participant” means—

(A) acting for its own account—

(i) a financial institution;

(ii) an insurance company that is regulated by a State, or that is regulated by a foreign government and is subject to comparable regulation as determined by the Commission, including a regulated subsidiary or affiliate of such an insurance company;

(iii) an investment company subject to regulation under the Investment Company Act of 1940 (15 U.S.C. 80a–1 et seq.) or a foreign person performing a similar role or function subject as such to foreign regulation (regardless of whether each investor in the investment company or the foreign person is itself an eligible contract participant);

(iv) a commodity pool that—

(I) has total assets exceeding $5,000,000; and

(II) is formed and operated by a person subject to regulation under this chapter or a foreign person performing a similar role or function subject as such to foreign regulation (regardless of whether each investor in the commodity pool or the foreign person is itself an eligible contract participant);

(v) a corporation, partnership, proprietorship, organization, trust, or other entity—

(I) that has total assets exceeding $10,000,000;

(II) the obligations of which under an agreement, contract, or transaction are guaranteed or otherwise supported by a letter of credit or keepwell, support, or other agreement by an entity described in subclause (I), in clause (i), (ii), (iii), (iv), or (vii), or in subparagraph (C); or

(III) that—

(aa) has a net worth exceeding $1,000,000; and

(bb) enters into an agreement, contract, or transaction in connection with the conduct of the entity’s business or to manage the risk associated with an asset or liability owned or incurred or reasonably likely to be owned or incurred by the entity in the conduct of the entity’s business;

(vi) an employee benefit plan subject to the Employee Retirement Income Security Act of 1974 (29 U.S.C. 1001 et seq.), a governmental employee benefit plan, or a foreign person performing a similar role or function subject as such to foreign regulation—

(I) that has total assets exceeding $5,000,000; or

(II) the investment decisions of which are made by—

(aa) an investment adviser or commodity trading advisor subject to regulation under the Investment Advisers Act of 1940 (15U.S.C. 80b–1 et seq.) or this chapter;

(bb) a foreign person performing a similar role or function subject as such to foreign regulation;

(cc) a financial institution; or

(dd) an insurance company described in clause (ii), or a regulated subsidiary or affiliate of such an insurance company;

(vii)

(I) a governmental entity (including the United States, a State, or a foreign government) or political subdivision of a governmental entity;

(II) a multinational or supranational government entity; or

(III) an instrumentality, agency, or department of an entity described in subclause (I) or (II);

except that such term does not include an entity, instrumentality, agency, or department referred to in subclause (I) or (III) of this clause unless (aa) the entity, instrumentality, agency, or department is a person described in clause (i), (ii), or (iii) of paragraph (11)(A) of this section; (bb) the entity, instrumentality, agency, or department owns and invests on a discretionary basis $25,000,000 or more in investments; or (cc) the agreement, contract, or transaction is offered by, and entered into with, an entity that is listed in any of subclauses (I) through (VI) of section 2(c)(2)(B)(ii) of this title;

(viii)

(I) a broker or dealer subject to regulation under the Securities Exchange Act of 1934 (15 U.S.C. 78a et seq.) or a foreign person performing a similar role or function subject as such to foreign regulation, except that, if the broker or dealer or foreign person is a natural person or proprietorship, the broker or dealer or foreign person shall not be considered to be an eligible contract participant unless the broker or dealer or foreign person also meets the requirements of clause (v) or (xi);

(II) an associated person of a registered broker or dealer concerning the financial or securities activities of which the registered person makes and keeps records under section 15C(b) or 17(h) of the Securities Exchange Act of 1934 (15 U.S.C. 78o–5 (b), 78q (h));

(III) an investment bank holding company (as defined in section 17(i) of the Securities Exchange Act of 1934 (15 U.S.C. 78q (i)); [1]

(ix) a futures commission merchant subject to regulation under this chapter or a foreign person performing a similar role or function subject as such to foreign regulation, except that, if the futures commission merchant or foreign person is a natural person or proprietorship, the futures commission merchant or foreign person shall not be considered to be an eligible contract participant unless the futures commission merchant or foreign person also meets the requirements of clause (v) or (xi);

(x) a floor broker or floor trader subject to regulation under this chapter in connection with any transaction that takes place on or through the facilities of a registered entity (other than an electronic trading facility with respect to a significant price discovery contract) or an exempt board of trade, or any affiliate thereof, on which such person regularly trades; or

(xi) an individual who has total assets in an amount in excess of—

(I) $10,000,000; or

(II) $5,000,000 and who enters into the agreement, contract, or transaction in order to manage the risk associated with an asset owned or liability incurred, or reasonably likely to be owned or incurred, by the individual;

(B)

(i) a person described in clause (i), (ii), (iv), (v), (viii), (ix), or (x) of subparagraph (A) or in subparagraph (C), acting as broker or performing an equivalent agency function on behalf of another person described in subparagraph (A) or (C); or

(ii) an investment adviser subject to regulation under the Investment Advisers Act of 1940 [15 U.S.C. 80b–1 et seq.], a commodity trading advisor subject to regulation under this chapter, a foreign person performing a similar role or function subject as such to foreign regulation, or a person described in clause (i), (ii), (iv), (v), (viii), (ix), or (x) of subparagraph (A) or in subparagraph (C), in any such case acting as investment manager or fiduciary (but excluding a person acting as broker or performing an equivalent agency function) for another person described in subparagraph (A) or (C) and who is authorized by such person to commit such person to the transaction; or

(C) any other person that the Commission determines to be eligible in light of the financial or other qualifications of the person.

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Other related FOREX law articles include:

Bart Mallon, Esq. of runs the Hedge Fund Law Blog and provides forex registration service through Cole-Frieman & Mallon LLP. Mr. Mallon also runs the Forex Law Blog.  He can be reached directly at 415-868-5345.

Retail FOREX Registration Regulations Proposed

Forex Managers Required to be Registered Under New Regulations

The much anticipated off-exchange retail foreign currency regulations were proposed today by the CFTC.  The release announcing the publication in the Federal Register is reprinted below and can be found here.  We will be providing an overview of the major provisions shortly.

The full proposed rules are posted here: Proposed Retail Forex Registration Rules

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Release: 5772-10

For Release: January 13, 2010

CFTC Seeks Public Comment on Proposed Regulations Regarding Retail FOREX Transactions

Washington, DC – The U.S. Commodity Futures Trading Commission (CFTC) today announced the publication in the Federal Register of proposed regulations concerning off-exchange retail foreign currency transactions. The proposed rules follow the passage of the Food, Conservation, and Energy Act of 2008, Pub. L. No. 110-246, 122 Stat. 1651, 2189-2204 (2008), also known as the “Farm Bill,” which amended the Commodity Exchange Act in several significant ways. In particular, the Farm Bill:

  • clarified the scope of the CFTC’s anti-fraud authority with respect to retail off-exchange foreign currency transactions;
  • provided the CFTC with the authority to register entities wishing to serve as counterparties to retail forex transactions as well as those who solicit orders, exercise discretionary trading authority and operate pools with respect to retail off-exchange foreign currency transactions; and
  • mandated minimum capital requirements for entities serving as counterparties to such transactions.

“These proposed rules for retail foreign exchange trading are important steps in implementing the additional consumer protections authorized in the 2008 Farm Bill,” CFTC Chairman Gary Gensler said. “The Commission looks forward to receiving and considering the public’s comments on this important issue.”

Pursuant to this authority, the Commission is proposing a comprehensive scheme that would put in place requirements for, among other things, registration, disclosure, recordkeeping, financial reporting, minimum capital, and other operational standards. Specifically, the proposed regulations would require the registration of counterparties offering retail foreign currency contracts as either futures commission merchants (FCMs) or retail foreign exchange dealers (RFEDs), a new category of registrant created by the Farm Bill. Persons who solicit orders, exercise discretionary trading authority and operate pools with respect to retail forex would also be required to register, either as introducing brokers, commodity trading advisors, commodity pool operators, or as associated persons of such entities. As was the case prior to the passage of the Farm Bill, “otherwise regulated” entities such as financial institutions and SEC-registered brokers or dealers remain able to serve as counterparties in such transactions under the oversight of their primary regulators.

The proposed regulations also include financial requirements designed to ensure the financial integrity of firms engaging in retail forex transactions and robust customer protections. For example, FCMs and RFEDs would be required to maintain net capital of $20 million plus 5% of the amount, if any, by which liabilities to retail forex customers exceed $10 million. Leverage in retail forex customer accounts would be subject to a 10-to-1 limitation. All retail forex counterparties and intermediaries would be required to distribute forex-specific risk disclosure statements to customers, and comply with comprehensive recordkeeping and reporting requirements.

Comments regarding the proposed regulations may be submitted by any of the means listed in the Federal Register release and should be received by the Commission within 60 days of the date of publication.

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Other related FOREX law articles include:

Bart Mallon, Esq. of runs the Hedge Fund Law Blog and provides forex registration service through Cole-Frieman & Mallon LLP. Mr. Mallon also runs the Forex Law Blog.  He can be reached directly at 415-868-5345.

NFA Provides Social Networking Compliance Guidance

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

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.

CTA and CPO Registration and Compliance Guide

Practical guidance for CTA and CPO firms

Commodity Trading Advisors (CTAs) and Commodity Pool Operators (CPOs) have been contacting me with greater regularity and we have decided to provide those firms with more detailed information on their registration and compliance requirements. Over the course of the next few weeks we will be continually updating this page with more legal and business guidance for CTAs and CPOs. Specifically, we will be providing information on the following topics:

CTA and CPO Registration – this article discusses the how-to’s of registration with the CFTC. The article details the general requirements for firms, principals, and associated persons. Included in this discussion is information on CTA/CPO exam requirements and an overview of the registration process through the NFA’s electronic registration system.

CTA and CPO Registration Exemptions – while the Commodities Exchange Act will generally require CTA and CPO firms to register with the CFTC, there are some important exemptions from the registration provisions. Review this article to see if your firm might be able to claim an exemption from the registration provisions.

CTA and CPO Compliance Overview – CTAs and CPOs are subject to a number of laws, regulations and rules. Not only must CTAs and CPOs follow CFTC laws and regulations, but as Members of the NFA, these groups must also follow all of the rules developed by the NFA. We will be discussing compliance best practices, major examination issues, major deadlines and the CTA/CPO compliance manual. Being prepared for an NFA examination is of great importance.

Recent NFA Actions against CTA and CPO Managers – the NFA and the CFTC have been quite active lately. In this article we will be discussing some of the most recent actions against NFA member firms. This article will also provide common-sense advice on what managers can do the protect themselves from examination deficiencies.

Important NFA Rules for CTA and CPO Firms – there are a number of rules which the NFA has regarding the conduct of CTAs and CPOs. In general CTAs and CPOs must hold themselves out with the utmost professionalism. This article will detail this and other important NFA rules.

CTA and CPO advertising – there are a number of important rules regarding advertising for CTAs and CPOs. CPOs, especially, must be careful about advertising because of the restrictions under Rule 506 of Regulation D, an exemption that many CPOs utilize in offering their fund interests. Websites will be touched upon in this post and will also be discussed in greater depth in a subsequent posting.

CTA and CPO websites – many CTA firms utilize the internet to advertise their services. CPO firms will also sometimes have a (minimal) internet presence. This article will detail the considerations that both CTA and CPO firms face when creating and maintaining an internet presence and how to deal with internet based inquiries from potential investors.

NFA Exam Requirements for CTAs and CPOs – individuals of NFA member firms will generally need to have a Series 3 exam license and potentially a Series 30 exam. Some individuals may need to have a Series 31 exam license and, potentially in the future, forex CTAs and CPOs will need to have a Series 34 exam license. This article will discuss these exams and the process an individual will go through in order to register to take the exams.

CTA Expo Blog – the unofficial blog of the CTA Expo most recently held in October of 2009.  Information for CTA managers on business, legal and compliance issues.  Included is a directory of CTA firms and service providers.

Forex CTAs and CPOs – the regulatory light has been focused on retail spot forex managers recently. Read this article to get up to speed on recent CFTC and NFA pronouncements regarding this area of the industry. We will also provide information on Forex IBs and Forex FCMs.

In addition to the above topics we are hoping to add others over time. We welcome all feedback and encourage you to leave comments below. We will also attempt to answer CTA and CPO frequently asked questions.

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.