Tag Archives: cftc

What is Forex? Information on Retail Off Exchange Foreign Currency Transactions

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(www.hedgefundlawblog.com in conjunction with www.forexregistration.com)

Forex Overview

Forex or FX or retail off-exchange foreign currency transactions all refer to the same thing – trading foreign currencies for gain, usually in the spot market.  The Forex markets have grown tremendously over the last few years and both individual investors and money managers are trading foreign currencies to make money.  Unfortunately, many fraudsters have used the lure of the Forex markets to perpetuate scams and for some Forex has a negative connotation. Continue reading →

CFTC and NFA and Hedge Fund Regulation: Report by the GAO

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This article is part of a series examining the statements in a report issued by the Government Accountability Office (GAO) in February 2008.  The items in this report are important because they provide insight into how the government views the hedge fund industry and how that might influence the future regulatory environment for hedge funds.  The excerpt below is part of a larger report issued by the GAO; a PDF of the entire report can be found here.

The following expert provides a good summary of the roles and duties of both the U.S. Commodity Futures Trading Commission (CFTC) and the National Futures Association (NFA) with regard to hedge funds and their commodities trading activities. Specifically, the report describes the central ways that these groups regulate hedge funds, including the following:

Once registered, CPOs and CTAs become subject to detailed disclosure, periodic reporting and record-keeping requirements, and periodic on-site risk-based examinations. However, regardless of registration status, all CPOs and CTAs (including those affiliated with hedge funds) remain subject to CFTC’s anti-fraud and anti-manipulation authority.

One item to note is that this report was prepared in early 2008 so it does not include the subsequent jurisdictional grant to the CFTC to regulate spot forex.  This grant was provided by the Farm Bill, passed by Congress in June of 2008 (please see CFTC announces retail forex fraud task force).  Subsequent to passing the Farm Bill the CFTC began drafting regulations (yet to be formally proposed) to require the registration of forex managers.  When the CFTC and the NFA eventually regulate the spot forex markets and require forex managers to be registered, it is likely that their duties will increase with regard to forex hedge fund managers, who are currently unregulated at the federal level.

With regard to future regulatory oversight of hedge funds by the CFTC and the NFA, there will probably not be greater mandates for registration.  One thing that could be done is to take away the CPO exemptions, but this seems unlikely.

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CFTC Can Monitor Hedge Fund Activities through Its Market Surveillance, Regulatory Compliance Surveillance, and Delegated Examination Programs:

Although CFTC does not specifically target hedge funds, through its general market and financial supervisory activities, it can provide oversight of persons registered as CPOs and CTAs that operate or advise hedge funds that trade in the futures markets. As part of its market surveillance program, CFTC collects information on market participants, regardless of their registration status, to monitor their activities and trading practices. In particular, traders are required to report their futures and options positions when a CFTC-specified level is reached in a certain contract market and CFTC electronically collects these data through its Large Trader Reporting System (LTRS).[1] CFTC also uses the futures and options positions information reported by traders through the LTRS as part of its monitoring of the potential financial exposure of traders to clearing firms, and of clearing firms to derivatives clearing organizations. CFTC collects position information from exchanges, clearing members, futures commission merchants (FCM), and foreign brokers and other traders– including hedge funds–about firm and customer accounts in an attempt to detect and deter manipulation.[2] Customers, including hedge funds, are required to maintain margin on deposit with their FCMs to cover losses that might be incurred due to price changes. FCMs also are required to maintain CFTC-imposed minimum capital requirements in order to meet their financial obligations. Such financial safeguards are put in place to mitigate the potential spillover effect to the broader market resulting from the failure of a customer or of an FCM.

According to CFTC officials, the demise (due to trading losses related to natural gas derivatives) in the fall of 2006 of Amaranth Advisors, LLC (Amaranth), a $9 billion multistrategy hedge fund, had no impact on the integrity of the clearing system for CFTC-regulated futures and option contracts. The officials said that at all times Amaranth’s account at its clearing FCM was fully margined and the clearing FCM met all of its settlement obligations to its clearinghouse. They also said that the approximate $6 billion of losses suffered by Amaranth on regulated and unregulated exchanges did not affect its clearing FCM, the other customers of the clearing FCM, or the clearinghouse.[3]

CFTC investigates and, as necessary, prosecutes alleged violators of the Commodity Exchange Act (CEA) and CFTC regulations and may conduct such investigations in cooperation with federal, state, and foreign authorities. Enforcement referrals can come from several sources, including CFTC’s market surveillance group or tips. Remedies sought in enforcement actions generally include permanent injunctions, asset freezes, prohibitions on trading on CFTC-registered entities, disgorgement of ill-gotten gains, restitution to victims, revocation or suspension of registration, and civil monetary penalties. On the basis of CFTC enforcement data, from the beginning of fiscal year 2001 through May 1, 2007, CFTC brought 58 enforcement actions against CPOs and CTAs, including those affiliated with hedge funds, for various violations.[4] A summary of the violations cited in the actions includes misrepresentation with respect to assets under management or profitability; failure to register with CFTC; failure to make required disclosures, statement, or reports; misappropriation of participants’ funds; and violation of prior prohibitions (i.e., prior civil injunction or CFTC cease and desist order).

Pursuant to CFTC-delegated authority, NFA, a registered futures association under the CEA and a self-regulatory organization, oversees the activities, and conducts examinations, of registered CPOs and CTAs.[5] As such, hedge fund advisers registered as CPOs or CTAs are subject to direct oversight in connection with their trading in futures markets.[6] More specifically, to the extent that hedge fund operators or advisers trade futures or options on futures on behalf of hedge funds, the funds are commodity pools and the operators of, and advisers to, such funds are required to register as CPOs and CTAs, respectively, with CFTC and become members of NFA if they are not exempted from registration. Once registered, CPOs and CTAs become subject to detailed disclosure, periodic reporting and record-keeping requirements, and periodic on-site risk-based examinations. However, regardless of registration status, all CPOs and CTAs (including those affiliated with hedge funds) remain subject to CFTC’s anti-fraud and anti-manipulation authority.

Our review of NFA documentation found that 29 advisers of the largest 78 U.S. hedge funds (previously mentioned) are registered with CFTC as CPOs or CTAs. In addition, 20 of the 29 also are registered with SEC as investment advisers or broker-dealers. According to NFA officials, because there is no legal definition of hedge funds, it does not require CPOs or CTAs to identify themselves as hedge fund operators or advisers. NFA, therefore, considers all CPOs and CTAs as potential hedge fund operators or advisers. According to NFA, in fiscal year 2006 NFA examined 212 CPOs, including 6 of the 29 largest hedge fund advisers registered with NFA. During the examinations, NFA staff performed tests of books and records and other auditing procedures to provide reasonable assurance that the firm was complying with NFA rules and all account balances of a certain date were properly stated and classified. Our review of four of the examinations found that 3 of the CPOs examined generally were in compliance with NFA regulations and the remaining 1 was found to have certain employees that were not properly registered with CFTC. According to examination documentation, subsequent to the examination, the hedge fund provided a satisfactory written response to NFA noting that it would soon properly register the employees.

According to an NFA official, since 2003 NFA has taken 23 enforcement actions against CPOs and CTAs, many of which involved hedge funds. Some of the violations found included filing fraudulent financial statements with NFA, not providing timely financial statements to investors, failure to register with CFTC as a CPO, failure to maintain required books and records, use of misleading promotional materials, and failure to supervise staff. The penalties included barring CPOs and CTAs from NFA membership temporarily or permanently or imposing monetary fines ranging from $5,000 to $45,000.

[1] According to CFTC officials, the LTRS captures 70 to 90 percent of the daily activity on registered futures exchanges.

[2] FCMs are individuals, associations, partnerships, corporations, or trusts that solicit or accept orders for the purchase or sale of any commodity for future delivery on or subject to the rules of any contract market or derivatives transaction execution facility; and in connection with such solicitation or acceptance of orders, accept money, securities, or property (or extend credit in lieu thereof) to margin, guarantee, or secure any trades or contracts that result or may result therefrom.

[3] In the CFTC complaint filed against Amaranth Advisors, LLC; Amaranth Advisors (Calgary), ULC, and Brian Hunter, CFTC alleged that the defendants attempted to manipulate the price of natural gas contracts on the New York Mercantile Exchange, Inc., in 2006. Complaint for Injunctive and Other Equitable Relief and Civil Monetary Penalties under the Commodity Exchange Act, CFTC v. Amaranth Advisors, LLC, No. 07-6682 (S.D.N.Y., July 25, 2007).

[4] Because “hedge fund” is not a defined term under the CEA or any other federal statute, CFTC and NFA records do not identify whether a commodity pool is a hedge fund. Thus, CFTC cannot report on the exact
number of examinations that involve hedge funds. In the event the CPO or CTA self-designates itself as a hedge fund, the Division of Enforcement typically incorporates that designation in the enforcement action, and that designation is often used in the press release notifying the public of the enforcement action.

[5] A registered CPO or CTA seeking to engage in futures business with the public or with any member of NFA must itself be a member of NFA.

[6] For the purpose of this report the term “hedge fund advisers” includes, as the context requires, CPOs, CTAs, or securities investment advisers.

Other HFLB articles include:

GAO Report Provides Insight into Potential Future Hedge Fund Regulation

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As we have discussed previously, hedge funds, and the investment management industry, are likely to face increasing regulations in the future.  As we look toward Congressional testimony by hedge funds (see Congress to talk with Hedge Funds on November 12) and by other government officials, we have decided to look back at previous GAO reports to see what issues the GAO identified as important.

The U.S. Government Accountability Office has released two reports this year on hedge funds.  The first report (released in February of 2008) described the current hedge fund regulatory regime and some of the risks the current system posed.  The second report (released in September of 2008) focused on some of the issues which pension plans must consider when investing in hedge funds.  I’ve provided a brief overview of the objectives of the two studies below.

Additionally, this week we are going to examine the February report as it includes many of the issues which have surfaced because of the recent market events, especially with regard to counterparty risk.  A list of the topics we will discuss this week include (links activated as soon as articles are published):

The GAO Hedge Fund Reports

Hedge Funds: Regulators and Market Participants Are Taking Steps to Strengthen Market Discipline, but Continued Attention Is Needed

GAO-08-200 Released February 25, 2008  (for full report, please see PDF)

According to the preamble, “This report (1) describes how federal financial regulators oversee hedge fund-related activities under their existing authorities; (2) examines what measures investors, creditors, and counterparties have taken to impose market discipline on hedge funds; and (3) explores the potential for systemic risk from hedge fund-related activities and describes actions regulators have taken to address this risk.”

Defined Benefit Pension Plans: Guidance Needed to Better Inform Plans of the Challenges and Risks of Investing in Hedge Funds and Private Equity

GAO-08-692 Released September 10, 2008 (for full report, please see PDF please also see an earlier article we released on this report entitled Hedge Fund and Pension Report Issued by GAO)

GAO was asked to examine (1) the extent to which plans invest in hedge funds and private equity; (2) the potential benefits and challenges of hedge fund investments; (3) the potential benefits and challenges of private equity investments; and (4) what mechanisms regulate and monitor pension plan investments in hedge funds and private equity.

Other Related HFLB articles include:

Discussion of New Forex Registration Requirements

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Forex hedge funds have escaped registration requirements so far, but that is expected to change very shortly. Yesterday the NFA released a report which provided some detail on the proposed new Forex registration requirements.  While the NFA notes that the CFTC has not yet published its proposed forex rules, the NFA is still getting prepared for the Forex registrations.  The NFA specifically stated that managers of forex account (including hedge fund managers) will need to register with the CFTC and be a member of the NFA.  From the report:

The legislation also requires firms that solicit retail forex customers, manage retail forex accounts or operate pools for retail customers to register with the CFTC and be Members of NFA. FCMs, IBs, CPOs and CTAs whose activities involve retail forex will be designated Forex FCMs, Forex IBs, Forex CPOs and Forex CTAs, while APs of those firms will be designated as Forex Associated Persons.

New Series 34 Exam

The NFA also announced that there will be a new exam which forex managers will need to pass in order to be a Forex CPO and a Forex AP.  According to the release, the NFA’s Vice President of Registration Greg Prusik said “We have developed a new proficiency examination specific to retail forex activity, called the Series 34 exam, and have recommended to the CFTC that its forex rules require any individual applying for registration as a Forex AP to take and pass both the Series 3 exam and the Series 34.”

For information on the likely Series 34 exam topics, please see Series 34 exam topics.

Other HFLB articles:

** Please note that this release is different from the NFA release of last week (see NFA Begins Regulating Forex above).  The release from last week alerted managers who are already registered with the CFTC as CPOs or CTAs that, if they also provide advice to clients regarding off-exchange forex, they will need provide such clients with a disclosure document.   Previously the registered CPOs and CTAs did not need provide clients with a disclosure document if the trading program focused only on spot forex.

Do Commodity Pool Operators also need to be registered as Commodity Trading Advisors?

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A common question for hedge fund managers which are registered as commodity pool operators is whether they also need to be registered as commodity trading advisors (CTA) with the NFA.  The answer is generally no.

There is no need for a commodity-based hedge fund manager (i.e., CPO) to register as a CTA so long as the manager’s commodity trading advice is restricted solely to advising the pool it is running.  This applies to BOTH CFTC/NFA Registered AND unregistered pool operators.  However, if the CPO has clients outside of the pool which the CPO provides advice to regarding commodities, then the manager may need to be registered as a CTA.

Rule 4.14(a)(4) applies to those managers which are registered as CPOs with the NFA.  Rule 4.14(a)(5) applies to those managers which are not registered (exempt) as CPOs.  The full rules are below.

Rule 4.14(a)(4)

A person is not required to register under the Act as a commodity trading advisor if it is registered under the Act as a commodity pool operator and the person’s commodity trading advice is directed solely to, and for the sole use of, the pool or pools for which it is so registered.

Rule 4.14(a)(5)

A person is not required to register under the Act as a commodity trading advisor if it is exempt from registration as a commodity pool operator and the person’s commodity trading advice is directed solely to, and for the sole use of, the pool or pools for which it is so exempt.
Please contact us if you have any questions.  Other HFLB articles related to this topic include:

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NFA Increases Required Capital for Forex Dealers

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Yesterday the NFA announced that Forex Dealer Members, those brokers who engage in Forex transactions with retail customers, will need to have a minimum net capital of $10 million by October 31, 2008.  This doubles the current minimum net capital of $5 million.

The NFA has been very aggressively moving to regulate the retail forex market.  Congress has helped through passing the Farm Bill, but separately from the Farm Bill, the NFA, in conjunction with the CFTC, has been moving towards regulating not only the managers of Forex hedge funds, but also the Forex dealers.

Earlier this year the NFA changed the minimum net capital for Forex Dealers from $1 million to the current $5 million; there are two more hikes scheduled to be implemented in the first half of next year.  While this will undoubtedly serve to protect investors, it also cast a huge burden on current and future Forex Dealer Members.  The NFA notice is posted below and can be found here.

Notice I-08-27
October 24, 2008

Net Capital Requirements for Forex Dealer Members

On October 22, 2008, the Commodity Futures Trading Commission approved increases to NFA’s capital requirements for Forex Dealer Members (FDMs). As stated in a July 23, 2008 Notice to Members, the minimum requirement will be $10 million as of October 31, 2008, $15 million as of January 17, 2009, and $20 million as of May 16, 2009.

Questions concerning these requirements should be directed to Sharon Pendleton, Director, Compliance ([email protected] or 312-781-1401) or Valerie Kretschmer, Manager, Compliance ([email protected] or 312-781-1290).

Other relate HFLB articles:

NFA to Begin Regulating FOREX

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The last unregulated space within the hedge fund industry was the retail foreign exchange (“Forex”) market.  As of November 30 of this year, many hedge fund managers which invest in the spot forex markets will need to be registered with the NFA.  More analysis on this to follow.

The press release and the new NFA rules follow below.

Notice I-08-26

October 16, 2008

Effective Date of NFA Compliance Rules 2-41 and 2-42: Disclosure by Forex Pool Operators and Trading Advisors

NFA has received notice that the Commodity Futures Trading Commission has approved NFA Compliance Rules 2-41 and 2-42. The new rules will become effective on November 30, 2008. Accordingly, after November 30th Members that manage forex accounts on behalf of customers or offer pools trading forex must provide prospective clients and pool participants with a disclosure document that has been filed with NFA prior to use. The new rules only apply if the forex pool or the person for whom the forex account is being managed is not an eligible contract participant as defined in Section 1a(12) of the Commodity Exchange Act. A forex pool, however, may not claim to be an eligible contract participant by virtue of Section 1a(12)(A)(v)(II) or (III) of the Commodity Exchange Act.

The disclosure document must provide disclosures similar to those currently required under CFTC Part 4 regulations. Finally, a Member operating a pool subject to the new rules must provide periodic (monthly or quarterly) account statements and an annual report to the pool participants.

Copies of the new rules are attached for your convenience. Additionally, NFA’s February 29, 2008, 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/newsRuleSubLetter.asp?ArticleID=2101.

Questions concerning these changes should be directed to Mary McHenry, Senior Manager, Compliance ([email protected] or 312-781-1420) or Susan Koprowski, Manager, Compliance ([email protected] or 312-781-1288).

COMPLIANCE RULES

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Part 2 – RULES GOVERNING THE BUSINESS CONDUCT OF MEMBERS REGISTERED WITH THE COMMISSION

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RULE 2-41. FOREX POOL OPERATORS AND TRADING ADVISORS

(a) Pool Operators. Except for Members who meet the criteria in Bylaw 306(b) and Associates acting on their behalf, any Member or Associate operating or soliciting funds, securities, or property for a pooled investment vehicle that is not an eligible contract participant as defined in Section 1a(12) of the Act must comply with this section (a) if it enters into or intends to enter into any transaction described in NFA Bylaw 1507(b)(1) except as described in NFA Bylaw 1507(b)(3). For purposes of this section, a pooled investment vehicle may not claim to be an eligible contract participant by virtue of Section 1(a)(12)(A)(v)(II) or (III) of the Act.

(1) For each such pooled investment vehicle, the Member or Associate must prepare a Disclosure Document and must file it with NFA at least 21 days before soliciting the first potential pool participant that is not an eligible contract participant.

(2) The Member or Associate must deliver the Disclosure Document to a prospective pool participant who is not an eligible contract participant no later than the time it delivers the subscription agreement for the pool. Any information delivered before the Disclosure Document must be consistent with the information in the Disclosure Document.

(3) The Disclosure Document must comply with the requirements in CFTC Regulations 4.24, 4.25, and 4.26 as if operating a pool trading on-exchange futures contracts. The term “commodity interest” in those regulations should be read to include forex transactions, and the Risk Disclosure Statement required by CFTC Regulation 4.24(b)(1) must be replaced by the following if the pool does not trade on-exchange contracts and must be added as a separate statement if the pool trades both on-exchange contracts and forex.

RISK DISCLOSURE STATEMENT

YOU SHOULD CAREFULLY CONSIDER WHETHER YOUR FINANCIAL CONDITION PERMITS YOU TO PARTICIPATE IN A POOLED INVESTMENT VEHICLE. IN SO DOING, YOU SHOULD BE AWARE THAT THIS POOL ENTERS INTO TRANSACTIONS THAT ARE NOT TRADED ON AN EXCHANGE, AND THE FUNDS THE POOL INVESTS IN THOSE TRANSACTIONS MAY NOT RECEIVE THE SAME PROTECTIONS AS FUNDS USED TO MARGIN OR GUARANTEE EXCHANGE-TRADED FUTURES AND OPTIONS CONTRACTS. IF THE COUNTERPARTY BECOMES INSOLVENT AND THE POOL HAS A CLAIM FOR AMOUNTS DEPOSITED OR PROFITS EARNED ON TRANSACTIONS WITH THE COUNTERPARTY, THE POOL’S CLAIM MAY NOT RECEIVE A PRIORITY. WITHOUT A PRIORITY, THE POOL IS A GENERAL CREDITOR AND ITS CLAIM WILL BE PAID, ALONG WITH THE CLAIMS OF OTHER GENERAL CREDITORS, FROM ANY MONIES STILL AVAILABLE AFTER PRIORITY CLAIMS ARE PAID. EVEN POOL FUNDS THAT THE COUNTERPARTY KEEPS SEPARATE FROM ITS OWN OPERATING FUNDS MAY NOT BE SAFE FROM THE CLAIMS OF OTHER GENERAL AND PRIORITY CREDITORS.

FOREX TRADING CAN QUICKLY LEAD TO LARGE LOSSES AS WELL AS GAINS. SUCH TRADING LOSSES CAN SHARPLY REDUCE THE NET ASSET VALUE OF THE POOL AND CONSEQUENTLY THE VALUE OF YOUR INTEREST IN THE POOL. IN ADDITION, RESTRICTIONS ON REDEMPTIONS MAY AFFECT YOUR ABILITY TO WITHDRAW YOUR PARTICIPATION IN THE POOL.

INVESTMENTS IN THE POOL MAY BE SUBJECT TO SUBSTANTIAL CHARGES FOR MANAGEMENT, ADVISORY, AND BROKERAGE FEES, AND THE POOL MAY NEED TO MAKE SUBSTANTIAL TRADING PROFITS TO AVOID DEPLETING OR EXHAUSTING ITS ASSETS. THIS DISCLOSURE DOCUMENT CONTAINS A COMPLETE DESCRIPTION OF EACH EXPENSE (SEE PAGE [insert page number]) AND A STATEMENT OF THE PERCENTAGE RETURN NECESSARY TO BREAK EVEN, THAT IS, TO RECOVER THE AMOUNT OF YOUR INITIAL INVESTMENT (SEE PAGE [insert page number]).

THIS BRIEF STATEMENT CANNOT DISCLOSE ALL THE RISKS AND OTHER FACTORS NECESSARY TO EVALUATE YOUR PARTICIPATION IN THIS POOL. THEREFORE, BEFORE YOU DECIDE TO PARTICIPATE YOU SHOULD CAREFULLY REVIEW THIS DISCLOSURE DOCUMENT, INCLUDING A DESCRIPTION OF THE PRINCIPAL RISK FACTORS OF THIS INVESTMENT (SEE PAGE [insert page number]).

NATIONAL FUTURES ASSOCIATION HAS NEITHER PASSED UPON THE MERITS OF PARTICIPATING IN THIS POOL NOR THE ADEQUACY OR ACCURACY OF THIS DISCLOSURE DOCUMENT.

(b) Trading Advisors. Except for Members who meet the criteria in Bylaw 306(b) and Associates acting on their behalf, any Member or Associate managing, directing or guiding, or soliciting to manage, direct, or guide, accounts or trading on behalf of a client that is not an eligible contract participant as defined in Section 1a(12) of the Act by means of a systematic program must comply with this section (b) if it intends to manage, direct, or guide the client’s account or trade in transactions described in NFA Bylaw 1507(b).

(1) The Member or Associate must prepare a Disclosure Document and must file it with NFA at least 21 days before soliciting the first potential client that is not an eligible contract participant.

(2) The Member or Associate must deliver the Disclosure Document to a prospective client who is not an eligible contract participant no later than the time it delivers the agreement to manage, direct, or guide the client’s account or trading. Any information delivered before the Disclosure Document must be consistent with the information in the Disclosure Document.

(3) The Disclosure Document must comply with the requirements in CFTC Regulations 4.34, 4.35, and 4.36 as if managing, directing, or guiding accounts or trading in on-exchange futures contracts. The term “commodity interest” in those regulations should be read to include forex transactions, and the Risk Disclosure Statement required by CFTC Regulation 4.34(b)(1) must be replaced by the following if the managed, directed, or guided account or trading will not include transactions in on-exchange contracts and must be added as a separate statement if it will include transactions in both on-exchange contracts and forex.

RISK DISCLOSURE STATEMENT

THE RISK OF LOSS IN FOREX TRADING CAN BE SUBSTANTIAL. YOU SHOULD THEREFORE CAREFULLY CONSIDER WHETHER SUCH TRADING IS SUITABLE FOR YOU IN LIGHT OF YOUR FINANCIAL CONDITION. IN CONSIDERING WHETHER TO TRADE OR TO AUTHORIZE SOMEONE ELSE TO TRADE FOR YOU, YOU SHOULD ALSO BE AWARE OF THE FOLLOWING:

FOREX TRANSACTIONS ARE NOT TRADED ON AN EXCHANGE, AND THOSE FUNDS DEPOSITED WITH THE COUNTERPARTY FOR FOREX TRANSACTIONS MAY NOT RECEIVE THE SAME PROTECTIONS AS FUNDS USED TO MARGIN OR GUARANTEE EXCHANGE-TRADED FUTURES AND OPTIONS CONTRACTS. IF THE COUNTERPARTY BECOMES INSOLVENT AND YOU HAVE A CLAIM FOR AMOUNTS DEPOSITED OR PROFITS EARNED ON TRANSACTIONS WITH THE COUNTERPARTY, YOUR CLAIM MAY NOT RECEIVE A PRIORITY. WITHOUT A PRIORITY, YOU ARE A GENERAL CREDITOR AND YOUR CLAIM WILL BE PAID, ALONG WITH THE CLAIMS OF OTHER GENERAL CREDITORS, FROM ANY MONIES STILL AVAILABLE AFTER PRIORITY CLAIMS ARE PAID. EVEN CUSTOMER FUNDS THAT THE COUNTERPARTY KEEPS SEPARATE FROM ITS OWN OPERATING FUNDS MAY NOT BE SAFE FROM THE CLAIMS OF OTHER GENERAL AND PRIORITY CREDITORS.

THE HIGH DEGREE OF LEVERAGE THAT IS OFTEN OBTAINABLE IN FOREX TRADING CAN WORK AGAINST YOU AS WELL AS FOR YOU. THE USE OF LEVERAGE CAN LEAD TO LARGE LOSSES AS WELL AS GAINS.

MANAGED ACCOUNTS MAY BE SUBJECT TO SUBSTANTIAL CHARGES FOR MANAGEMENT AND ADVISORY FEES AND THE ACCOUNT MAY NEED TO MAKE SUBSTANTIAL TRADING PROFITS TO AVOID DEPLETING OR EXHAUSTING ITS ASSETS. THIS DISCLOSURE DOCUMENT CONTAINS A COMPLETE DESCRIPTION OF EACH FEE TO BE CHARGED TO YOUR ACCOUNT BY THE ACCOUNT MANAGER. (SEE PAGE [insert page number]).

THIS BRIEF STATEMENT CANNOT DISCLOSE ALL THE RISKS AND SIGNIFICANT ASPECTS OF THE FOREX MARKETS. THEREFORE, YOU SHOULD CAREFULLY REVIEW THIS DISCLOSURE DOCUMENT BEFORE YOU TRADE, INCLUDING THE DESCRIPTION OF THE PRINCIPAL RISK FACTORS OF THIS INVESTMENT (SEE PAGE [insert page number]).

NATIONAL FUTURES ASSOCIATION HAS NEITHER PASSED UPON THE MERITS OF PARTICIPATING IN THIS TRADING PROGRAM NOR THE ADEQUACY OR ACCURACY OF THIS DISCLOSURE DOCUMENT.

RULE 2-42. FOREX POOL REPORTING

(a) Except for Members who meet the criteria in Bylaw 306(b), any Member operating a pool that trades forex must comply with the requirements in CFTC Regulation 4.22 in the same manner as would be applicable to the operation of a pool trading on-exchange futures contracts. The term “commodity interest” in that regulation should be read to include forex transactions.

(b) A Member may file with NFA a request for an extension of time in which to file the annual report in the same form as provided for in CFTC Regulation 4.22(f).

CFTC Fines Hedge Funds for Failure to File Annual Report with NFA

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Certain hedge funds which trade futures and/or commodities as part of their investment program are deemed to be commodity pools and the hedge fund management company must register with the NFA as a commodity pool operator (CPO).  Registered CPOs must file annual reports with the NFA and such reports must be sent to investors in the fund.  Generally this will need to be done within either 45 or 90 days after the end of the fund’s fiscal year.  If a CPO needs extra time to file the report, it can request an extension from the CFTC.

In the cases below, each of the CPOs had filed for and were granted extensions.  Even with these extensions, however, they were not able to file their reports.  The NFA evidently takes such an infraction very seriously as the fines were stiff – ranging from $75,000 to $135,000.  Such a potential monetary penalty should make CPOs especially eager to file the appropriate reports on time.

CFTC Rule 4.22 includes the following major provisions.

  • must distribute an Annual Report to each participant in each pool that it operates, and must electronically submit a copy of the Report and key financial balances from the Report to the National Futures Association pursuant to the electronic filing procedures of the National Futures Association
  • Annual Report must be sent to pool participants within 45 calendar days after the end of the fiscal year
  • financial statements in the Annual Report must be presented and computed in accordance with generally accepted accounting principles consistently applied and must be certified by an independent public accountant

If you are a hedge fund manager registered as a CPO you should make sure you understand this and other CFTC rules.  If you have any questions on the rules or other CPO requirements, including possible CPO exemptions, you should have a conversation with your attorney so that you know what needs to be filed and when so that you can avoid harsh fines like the ones below.

The CFTC release below can be found here.

Release: 5555-08
For Release: September 24, 2008

CFTC Sanctions Four Registered Commodity Pool Operators for Failing to File Timely Commodity Pool Reports with the National Futures Association

Mansur Capital Corp., Persistent Edge Management, LLC, Stillwater Capital Partners, Inc., and Stillwater Capital Partners, LLC Ordered to Pay a Total of $330,000 in Civil Monetary Penalties

Washington, DC – The U.S. Commodity Futures Trading Commission (CFTC) today simultaneously filed and settled charges against four registered commodity pool operators (CPOs), charging them with failing to distribute to investors and file with the National Futures Association (NFA) one or more of their respective commodity pools’ annual reports in a timely manner. Mansur Capital Corporation of Chicago, Persistent Edge Management, LLC of San Francisco, California, and Stillwater Capital Partners, Inc. and Stillwater Capital Partners, LLC, both of New York, were charged in the CFTC action.

The CFTC orders require the CPOs to pay civil monetary penalties in the following amounts: Mansur, $75,000; Persistent Edge, $120,000; and Stillwater I and Stillwater II to jointly and severally pay $135,000.

Under CFTC regulations, CPOs are required to file annual reports with the NFA and distribute them to each pool participant. This must be done within a prescribed period after the close of their pools’ fiscal years. An annual report is designed to “provide [pool] participants with the information necessary to assess the overall trading performance and financial condition of the pool.” (See Commodity Pool Operators and Commodity Trading Advisors, Final Rules, 44 Fed. Reg. 1918 [CFTC Jan. 8, 1979], re the adoption of Rule 4.22.) According to the CFTC orders, without timely reporting, the CFTC’s goal of providing pool participants with complete and necessary data is hampered.

The CFTC orders find that each of the four CPOs operated one or more commodity pools, including pools that operated as funds-of-funds. While each of the CPOs had obtained extensions of the prescribed deadlines for various pools and reporting years, each failed to timely comply with its obligations, in violation of CFTC regulations.

The following CFTC Division of Enforcement staff are responsible for this case: Camille M. Arnold, Alan I. Edelman, Ava M. Gould, Susan J. Gradman, James H. Holl, III, Diane M. Romaniuk, Scott R. Williamson, Rosemary Hollinger, Gretchen Lowe, and Richard B. Wagner.

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SEC files complaint against forex fraud

1 Reply

Summary:

Last Wednesday the SEC filed a complaint against a forex hedge fund manager who was supposedly using a “trading robot” to generate huge returns. It turns out the forex hedge fund manager and the trading robot did not generate the outsized returns, but instead lost investor money. There are two very important items to note here:

1. It is scams like this that has the SEC and CFTC on the offensive to regulate the spot forex market.

2. Again, it is so important for all investors to do proper due diligence on managers and to make sure they know what they are investing in. These fraudsters give a bad name to all hedge fund managers and, sometimes, they can be stopped if the right questions are asked in the beginning.

SEC Release:

U.S. SECURITIES AND EXCHANGE COMMISSION
Litigation Release No. 20688 / August 22, 2008

Securities and Exchange Commission v. Royal Forex Management, LLC and Patrick H. Haxton, (U.S.D.C., Northern District of Texas, Dallas Division, Civil Action No. 3:08-CV-1467-L)

SEC Accuses Carrolton, Texas, Man of Selling Fraudulent Securities Involving Foreign Currency Trading

On August 20, 2008, the Securities and Exchange Commission filed an action in Dallas federal court to halt an alleged unregistered and fraudulent offering of securities by Patrick H. Haxton of Carrollton, Texas, and his company Royal Forex Management, LLC (“Royal”). The securities were investment contracts involving the trading of foreign currencies on the Forex market. On August 21, 2008, United States District Judge Sam A. Lindsay entered a temporary restraining order suspending the offering and orders freezing the defendants’ assets, requiring sworn accountings, prohibiting any alteration or destruction of documents and expediting discovery. The court set a hearing for September 4, 2008 to consider the Commission’s application for preliminary injunctive relief.

The defendants named in the Commission’s Complaint are: Patrick H. Haxton, age 51, of Carrollton, Texas, the owner and sole manager of Royal; and Royal Forex Management, LLC, a Texas limited liability corporation operated out of Haxton’s Carrollton home.

The Commission’s Complaint alleges that from at least June 2007 to the present Haxton, personally and through Royal, raised at least $305,000 from 8 investors in three states. Haxton offers the Forex investments through the Royal web site (www.royalforexmanagement.com), advertising on his work truck and personal contacts. Royal’s promotional materials and Haxton’s oral statements are replete with representations of phenomenal past trading returns, including claims of 400% to 500% annual returns, generated by a complex software program named “The Currency Trading Robot” (“Trading Robot”), purportedly created by Haxton. On the web site, Haxton claims to have a great history and to have been a very successful trader since 2000. Haxton and the web site also represent that there is very little risk of loss.

The Commission alleges, however, that these representations are materially false and misleading. For instance, the Commission contends that Haxton and Royal never generated the claimed phenomenal returns by trading currency. Indeed, according to the Complaint, Haxton lost a significant portion of investor funds trading foreign currencies and misappropriated the remaining funds for his own personal use. In some instances, investor funds were never traded, but were used to pay business and personal expenses.

The defendants are charged with securities fraud under Section 17(a) of the Securities Act of 1933 and Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5 thereunder, and with conducting an unregistered offering under Section 5 of the Securities Act. The Complaint also seeks permanent injunctions, civil penalties and disgorgement of ill-gotten gains, among other relief, against each defendant.

The Commission would like to thank and acknowledge the assistance of the Texas State Securities Board in this matter.

CTA registration requirement and exemption

3 Replies

Question: does my commodity/futures trading firm need to register as a CTA?

Answer: Generally Section 6m(1) of the Commodities Exchange Act (“CEA”) requires that any person (or firm) which falls within the definition of a CTA be registered as such. Section 6m(1) of the CEA states:

“It shall be unlawful for any commodity trading advisor or commodity pool operator, unless registered under this chapter, to make use of the mails or any means or instrumentality of interstate commerce in connection with his business as such commodity trading advisor or commodity pool operator”

The Commodities Exchange Act (“CEA”) specifically defines a Commodity Trading Adviser (“CTA”) as:

“any person who– (i) for compensation or profit, engages in the business of advising others, either directly or through publications, writings, or electronic media, as to the value of or the advisability of trading in– (I) any contract of sale of a commodity for future delivery made or to be made on or subject to the rules of a contract market or derivatives transaction execution facility; (II) any commodity option authorized under section 6c of [the CEA]; or (III) any leverage transaction authorized under section 23 of [the CEA]; or (ii) for compensation or profit, and as part of a regular business, issues or promulgates analyses or reports concerning any of the activities referred to in clause (i)”

Because the above definition is quite broad, Congress specifically excluded certain groups from the definition. These groups include:

  • any bank or trust company or any person acting as an employee thereof;
  • any news reporter, news columnist, or news editor of the print or electronic media, or any lawyer, accountant, or teacher;
  • any floor broker or futures commission merchant;
  • the publisher or producer of any print or electronic data of general and regular dissemination, including its employees;
  • the fiduciary of any defined benefit plan that is subject to the Employee Retirement Income Security Act of 1974 (29 U.S.C. 1001 et seq.);
  • any contract market or derivatives transaction execution facility; and
  • such other persons not within the intent of this paragraph as the Commission may specify by rule, regulation, or order.

I have previously discussed how to register as a CTA in the article titled How to register as a CPO or CTA.

Question: are there any exemptions from CTA registration?

Answer: Yes. Section 6m(1) of the CEA states:

That the [registration] provisions of this section shall not apply to any commodity trading advisor who, during the course of the preceding twelve months, has not furnished commodity trading advice to more than fifteen persons and who does not hold himself out generally to the public as a commodity trading advisor. [emphasis added]

To fall within the above exemption, both elements must be met. That is, the CTA must

  • have less than 15 clients over the preceeding 12 months and
  • not hold himself out generally to the public as a CTA

The question then becomes what does “holding out” as a CTA entail?

The CFTC views “holding oneself out as a CTA” to include such conduct as promoting advisory services through mailings, directory listings, and stationery, or otherwise initiating contact with prospective clients. Thus, unless a CTA restricts his clients to family, friends, and existing business associates, a CTA generally will be viewed as holding himself out to the public as a CTA and would not be able to claim the exemption from registration in Section 6m(1).

The CFTC specifically gave such guidance in the following letter.

CFTC Letter No. 97-26
March 26, 1997
Division of Trading & Markets

Re: Section 4m(1): Exemption from CTA Registration

Dear [_______]:

This is in response to your letter dated January 29, 1997 to the Division of Trading and Markets (the “Division”) of the Commodity Futures Trading Commission (the “Commission”), whereby you inquire as to whether you may claim an exemption from registration as a commodity trading advisor (“CTA”) pursuant to Section 4m(1) [now 6m(1)] of the Commodity Exchange Act (the “Act”). *

Based on your letter, we understand the pertinent facts to be as follows. You intend to sell subscriptions to a fax service (the “Service”) entitled “A”, of which you are the sole designer. The Service will provide subscribers with buy and sell recommendations for Eurodollar futures and option contracts traded on “X”.

Section 4m(1) [now 6m(1)] of the Act generally requires that a person who provides commodity interest trading advice to the public must register as a CTA. Section 4m(1) does, however, provide an exemption from registration as a CTA for a person who satisfies two conditions: (1) during the course of the preceding twelve months, he has not furnished commodity trading advice to more than fifteen persons; and (2) he does not hold himself out generally to the public as a CTA. The Division views “holding oneself out as a CTA” to include such conduct as promoting advisory services through mailings, directory listings, and stationery, or otherwise initiating contact with prospective clients.** Thus, unless a CTA restricts his clients to family, friends, and existing business associates, a CTA generally will be viewed as holding himself out to the public as a CTA and would not be able to claim the exemption from registration in Section 4m(1) [now 6m(1)]. This is true whether or not the CTA is advising fifteen or fewer persons, since in order to qualify for the Section 4m(1) exemption, the CTA must satisfy both conditions. [Emphasis added]

Thus, if you plan to solicit clients other than immediate family members, friends, and business associates, you would be holding yourself out as a CTA and would be required to register as such prior to marketing the Service. You would also be required to comply with all other provisions of the Act and Commission’s regulations thereunder applicable to registered CTAs, including Section 4b and Section 4o,*** the antifraud provisions of the Act, Part 4 of the Commission’s regulations applicable to CTAs, and the reporting requirements for traders set forth in Parts 15, 18, and 19 of the Commission’s regulations.

The advice provided herein is based upon the representations that you have made to us. Any different, changed or omitted facts or conditions might require us to reach a different conclusion. In this connection, we request that you notify us immediately in the event your activities change in any way from those as represented to us.

If you have any questions concerning this correspondence, please feel free to contact me or Monica S. Amparo, an attorney on my staff, at (202) 418-5450.

Very truly yours,

Susan C. Ervin

Chief Counsel

* 7 U.S.C. §6m(1) (1994).

** Division of Trading and Markets Interpretative Letter 91-9, [1990-1992 Transfer Binder] Comm. Fut. L. Rep. (CCH) ¶ 25,189 (Dec. 30, 1991). We have enclosed a copy of this letter for your reference.

*** 7 U.S.C. §§ 6b and 6o (1994).