NFA Produces Compliance Webinar for Retail Forex Firms
Since the CFTC passed its final rules on retail participation in off-exchange foreign currency markets back in October 2010, there has been an influx of newly registered introducing forex brokers (IBs), commodity pool operators (CPOs), and commodity trading advisors (CTAs). On June 8, 2011, the NFA hosted a webinar that focused on common regulatory deficiencies that NFA staff members have found during compliance audits of these IBs, CPOs and CTAs. The following is a brief overview of the common regulatory deficiencies the NFA staff found regarding registration issues, disclosure documents, recordkeeping requirements, promotional materials, and anti-money laundering programs.
Forex Registration Issues
Any entity intermediating retail forex transactions is required to be registered as forex IB, CPO, or CTA. Common deficiencies for these
firms include having unlisted APs, failing to register supervisory APs, failing to withdraw APs, or failing to list branch offices. Additionally, the following are areas emphasized in the webinar:
- After any board of directors’ meetings, ensure any new directors/officers become listed as Principals of firm.
- Periodically review the owners of any holding company of the firm to ensure indirect owners are listed if required.
Associated Person (AP) Registration – Essentially anyone who is a salesperson or supervises salespersons is required to be registered as an AP. It is important to look at the supervisory chain of command–an individual must be registered, no matter how high he/she is on the supervisory chain of command.
- Exam requirements – The APs must pass the Series 3 exam and the Series 34 exam. If a person was registered as an AP, sole proprietor, or floor broker as of May 22, 2008 and there has not been more than a 2-year gap since that registration, the person is not required to pass the Series 34.
- Tips for ensuring the proper individuals are registered:
- Terminate an AP’s registration within 30 days of an AP leaving the firm.
- After any shifts in control, ensure those with controlling influence are listed as Principals, and those that supervise APs are registered as APs themselves.
Branch Office Registration – Common deficiencies include:
- Branch Office Address – Each branch office must be registered. Each branch office must use the name of the firm and hold itself out as a branch of the firm. It cannot be a separate entity.
- Payment of APs – Each AP in the branch office must be paid directly by the firm (payment by an intermediary would lead to the assumption the intermediary needs to be registered with the NFA).
- name, address, date of birth, and principal occupation,
- for individuals – current estimated annual income and net worth,
- notes about the customer’s previous investment and trading experience and any other information that would assist the firm to accurately and fully disclose all the risks of trading,
- signed customer acknowledgment that he/she has received all of the required risk disclosures, which include:
- CFTC Regulation 5.5 risk disclosures (e.g. the FCM is the counterparty to all trades and forex trading is extremely risky and not suitable for all investors),
- performance for the last 4 quarters for all non-discretionary accounts held at customer’s FCM (broken down by profitable/non-profitable accounts in percentage form), and
- some customers need to receive additional risk disclosure statements based on age, trading experience, and net worth.
Business with Member Firms – Firms need to make sure they are not conducting business with any non-NFA member firms that are required to be registered (or are suspended). Make sure counterparties are registered as FCMs or RFEDs, or solicitors are registered IBs. The firm should also review their list of customers–if a customer’s name indicates he/she might be engaged in the trading business, inquire as to the customer’s registration/membership status. The firm can also check on the NFA’s BASIC system to see if the customer is properly registered or operating under an exemption from registration. The firm should document this process to show it did proper due diligence on the account.
Forex Disclosure Documents
All nonexempt CPOs operating a pool and CTAs that manage forex accounts for retail customers must distribute a forex disclosure document to their clients. Three common problems are:
Risk Disclosures – The firm needs to make sure all risks associated with forex trading are disclosed. This can include volatility, leverage, liquidity, counterparty creditworthiness, and others risks relevant to the program.
Fee Description – The fee description must be complete and all defined terms must be fully explained.
Performance Results –
- CTA disclosure documents must include the actual performance of all clients directed by the CTA and each trading principal for the last 5 years to date (any past performance must be calculated net of all fees, including mark ups associated with bid/ask spread, etc.). If the CTA directed accounts prior to be being registered as a CTA, the disclosure document must still disclose those accounts.
- The NFA has a guide on disclosure documents available here.
Forex Promotional Materials
- must present a balanced discussion of the risk of loss (any discussion of profits should also discuss the risk of loss),
- must provide a discussion of fees associated with trading forex,
- must provide appropriate disclaimers for past performance, and
- must not suggest forex trading is appropriate for everyone or guarantee success.
- If the firm hosts a blog, chat room, or other discussion forum that allows the general public to comment, those comments must be reviewed regularly to ensure they are not misleading or one-sided. Such comments must be removed immediately and the firm should also ban those users who repeatedly post comments that violate the rules.
- Keep records of which posts are deleted, which users are blocked, how often a review is conducted, and how employees are supervised.
- If employees have personal blogs, Facebook accounts, etc., the firm should monitor the posts periodically. Any references to the firm can be seen as promotional materials. If after monitoring employees’ personal pages, there are never any references to the firm’s business, then the procedures can change and require less frequent monitoring.
- Special rules apply for the use of audio/visual ads. If the firm provides trade recommendations or discuss past/potential profits through radio or webcasts (such as YouTube), the firm is required to submit them to the NFA for approval at least 10 days prior to use.
Anti-Money Laundering Program
An anti-money laundering program is required for IBs (guaranteed and independent), FCMs and RFEDs (even if they don’t hold customer funds). These procedures are designed to guard against someone using the firm to facilitate money laundering or other terrorist financing. The program should include:
- written policies and procedures,
- the appointment of a chief compliance officer,
- ongoing training, and
- an annual, independent audit.
The NFA has an Anti-Money Laundering webinar available on its website.
The NFA’s “Compliance Issues for Forex IBs, CPOs and CTAs” webinar is archived on the NFA’s website and can be found here .
Bart Mallon is an attorney with a practice focused on hedge funds managed futures and forex regulatory issues. He can be reached directly at 415-868-5345.