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Compliance Issues for Forex IBs, CPOs and CTAs

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.

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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:

Listing All Principals – Criteria for being listed as a Principal of the firm generally are (1) job title, (2) ownership (direct or indirect), and (3) job duties and ability to control business activities.  More detail is available in NFA Rule 101.  Tips for ensuring the proper individuals are listed, include:

  • 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).

Recordkeeping

Information in Customer File – This information is normally initially obtained upon account opening, but the firm must also maintain up-to-date and readily accessible information.   The firm shouldn’t rely on the FCM for this information unless it has been agreed upon before account opening.  The following information must be in the firm’s file for each customer and must be obtained before account opening:

  • 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

Policies & Procedures – The firm must develop written procedures for how it creates and reviews promotional materials, as well as how the firm supervises employees on these matters.  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.
Social Media – Any communications with the public is considered promotional materials (e.g. emails, LinkedIn, Twitter, Facebook, etc.).  All information on social media must be in accordance with the NFA’s promotional materials rules.

  • 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 .

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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.

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NFA Forex Registration/Compliance Workshop | Las Vegas September 25, 2010

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Overview of Forex Registration & Compliance Issues

By Bart Mallon, Esq.

In preparation for the implementation of the new retail forex regulations, the NFA recently conducted a retail forex registration and compliance workshop in Las Vegas at the Trader’s Expo.  The workshop covered a number of topics which the NFA views as especially important for forex managers.  I attended the workshop and the following discussion is based on my notes of the conference as well as collateral material provided by the NFA.

This overview will cover the various sessions throughout the day including:

  • Registration
  • General Compliance
  • Net Capital, Recordkeeping & Reporting Requirements
  • Discussion/ Individual Consultations

[Note: this article currently only has the summary of the registration session.  I will be adding the additional summaries directly to this page over the next few days.]

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Registration Session

Firm Registration & Exemption Requirements

This first part discusses the various registration categories and the potential exemptions and other pertinent information.

RFED & FCMs

  • These are entities which execute forex trades for managers.  We will not go into the registration and compliance requirements for these groups in this overview and will instead focus on forex managers and introducing brokers.

Commodity Trading Adviser (CTA)

  • Definition: a firm which is compensated for providing advice with respect to forex transactions, usually by having power of attorney (POA) to trade a client’s account held at an FCM or RFED.  Groups that provide individualized advice without a POA may also be considered to be a CTA.
  • Exemptions: a firm is exempt from CTA registration if the firm (i) provides advice to less than 15 people over the past 12 months and (ii) does not generally hold itself out to the public as a CTA. Managers should note that this exemption is narrowly construed by the CFTC and that very few forex managers will  fit within the exemption.  This exemption is self-executing and so the firm will not need to make a filing with the CFTC or NFA if they are claiming this exemption.  There are additional exemptions which are available but not often used by most forex managers.
  • Costs:
    • Firm – $200 non-refundable registration fee
    • APs/Principals – $85 registration fee (for each individual)
    • NFA Membership Fee – $750 (yearly)
    • Exam Fess – varies with respect to exam
  • Principal/AP Requirement: each firm must have at least one Principal listed and at least one Associated Person registered with the firm (see discussion below).  Each Principal and AP will need to have (i) fulfilled the proficiency (exam) requirements and (ii) provided the NFA with fingerprint cards for the FBI background check.
  • Disclosure Documents: CFTC regulations require each forex CTA disclosure document to include the following information:
    • Basic Background Information on the CTA
    • Information on the Trading Program
    • Discussion of the Risk Factors
    • Discussion of Conflicts of Interest
    • Litigation Information (see NFA Litigation Statement Requirement)
    • Certain Performance Reports
    • Supplemental information
  • Timing: with respect to the actual registration of the entity and the Principals/APs, this can usually be done quickly.  In most cases, after all fees have been paid and a Principal has submitted fingerprint cards and has completed all necessary exam requirements, the registration will be complete in about two days.  While the registration is done quickly, the disclosure document acceptance process can be lengthy.  For a normal CTA it will usually take about 5-10 weeks to get the document accepted, however this will depend on a number of items including the NFA examiner you are assigned and the work load of the NFA.

Commodity Pool Operator (CPO)

  • Definition: a firm which is compensated for providing advice to a pooled investment vehicle.  The investment vehicle (colloquially known as a “hedge fund”) is deemed to be a “commodity pool” and the firm providing advice is the operator or CPO.
  • Exemptions: there are a number of CPO exemptions which are potentially available for forex managers.  We have detailed these requirements before in our list of CPO exemptions.
  • Costs:
    • Firm – $200 non-refundable registration fee
    • APs/Principals – $85 registration fee
    • NFA Membership Fee – $750 (yearly)
    • Exam Fess – varies with respect to exam
  • Principal/AP Requirement: same as above.
  • Disclosure Documents: the requirement is generally the same as for CTAs.  However, CPO disclosure documents are usually much longer and deal with a number of other federal laws.  CPO disclosure documents must be drafted by an attorney.
  • Timing: generally timing will be similar to the above.

Guaranteed Introducing Broker

  • Definition: generally a firm which introduces client accounts to an FCM or RFED.  These brokers might include groups that license EA software and receive per trade compensation from a broker.  A guaranteed IB is a firm which only introduces to one FCM or RFED and who enters into a guarantee agreement with the FCM or RFED.
  • Exemptions: generally there are no exemptions.  Firms should note that the exact manner in which the firm is compensated (e.g. for use of the EA software) may make a difference in whether the firm will need to be registered wellbutrin buy as an introducing broker with the NFA.
  • Costs:
    • Firm – $200 non-refundable registration fee
    • APs/Principals – $85 registration fee
    • NFA Membership Fee – $750 (yearly)
    • Exam Fess – varies on exams (see below)
    • Other – written guarantee agreement with the FCM or RFED must be executed prior to registration
  • Principal/AP Requirement: same as above.

Independent Introducing Broker

  • Definition: definition is same as above, except an independant IB may introduce to any number of FCMs or RFEDs and does not need to enter into a guarantee agreement.  The independent IB will need to maintain a certain net capital.
  • Exemptions: generally there are no exemptions.  As above, the manner of compensation will determine whether the firm is an IB.
  • Costs:
    • Firm – $200 non-refundable registration fee
    • APs/Principals – $85 registration fee
    • NFA Membership Fee – $750 (yearly)
    • Exam Fess – varies on exams (see below)
  • Other: must maintain net capital of $45,000 subject to CFTC regulations.  NFA rules require an extra $5,000 buffer.
  • Principal/AP Requirement: same as above.

Discussion of Principals and Associated Persons

Principals

Principals generally mean persons who meet any of the following:

  • Certain title: Director, President, usually any “Chief” role
  • Ownership: generally owners with 10% or more interest, including owners which are entities and owners of those entities (there are also look-through rules for entities)
  • Other: Individuals with management and supervisory authority

Associated Person

Generally any partner, officer, employee, consultant, or agent (or any natural person occupying a similar status or performing similar functions), in any capacity which involves:

  • the solicitation of funds, securities, or property for participation in a commodity pool or
  • the supervision of any person or persons so engaged.

Firms should note that while the definition of AP does not include a person who acts solely as a trader, the NFA highly recommends that such persons become registered as APs.  If a firm decides that such person does not need to register with the NFA, the firm must be extra careful that the trader does not perform any functions of an AP.  This will likely be an issue which the NFA will examine closely during any audit.

Other Important Discussion Items

Soliciting Clients after October 18, 2010

Forex managers who currently are managing client accounts but are not registered with the NFA, will need to be registered by the October 18th deadline and continue to manage accounts for current clients.  However, these managers will not be able to accept new money from existing clients or new clients until the disclosure document is accepted by the NFA.

Managers with a Disciplinary History

Individuals who have certain criminal or regulatory issues in their background will need to make sure that they are able to produce records of the issue.  For persons with these issues, the NFA will require full records and will review those records prior to deciding whether to allow the person to register as an AP.  For more information, please see our discussion of registration issues for managers with disciplinary history.

Heightened Supervisory Procedures

Many forex managers and introducing brokers will need to implement heightened supervisory procedures because they will have Principals/APs which were either subject to prior NFA disciplinary actions or worked for firms subject to NFA disciplinary actions.  Almost every single forex broker has been subject to NFA disciplinary actions so persons who come from these firms will need to be aware of this fact and firms may need to augment their employee base to fit within certain guidelines.  This issue will most likely be identified by NFA staff during the registration process and may delay a registration.

Branch Office

Firms which have more than one office must designate a main office.  All of the other offices will be deemed to be banch offices and each of these branch offices will need to have a branch office manager (who has passed the Series 30 exam).

Firms often wonder whether a home office will count as a branch office.  Generally, it will depend on the exact facts of the situation, but if any person is acting as an AP at the home office, then it will be deemed to be a branch office.

While it does not cost extra to have a branch office, firms must make sure that they institute certain oversight procedures with respect to the branch office.  This means that compliance policies and procedures must be implemented.  This is likely to be another issue which the NFA will examine closely during an audit.

For more information, please see our article on the NFA Branch Office Designation.

Forex Exams

Overview – we have discussed the various exam requirements for forex managers a number of times.  For full information, please see our overview of the forex exams.  We also have specific information on the Series 3 exam, Series 30 exam, and how to pass the Series 34 exam.

Grandfather Provisions – For persons who were registered on May 22, 2008 as an AP (and have remained continuously registered as an AP with the CFTC), such persons will not be required to pass the Series 34 exam prior to providing advice to customers with respect to forex transactions.

Discretionary Waiver – some persons who would normally be required to complete the proficieny requirements may be able to apply for a waiver of the requirements from the NFA.  Such waiver is rarely granted.  For more information, please see NFA Rule 402.

Overview of Registration Process

At this point during the presentation the NFA staff took us completely through the registration process on the NFA’s online registration system.  In general the process is fairly straightforward and the NFA has provided a number of resources on their website which are designed to help managers navigate the process.  In general the process includes the following steps:

  • Obtain Security Manager Access
  • Pay Registration Fees
  • Complete Form 7-R for Firm Application
  • Complete Form 8-R for all Principals and APs

General Compliance Session

[To be forthcoming…]

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Other related hedge fund law articles:

Bart Mallon, Esq. runs the hedge fund law blog and provides forex registration and compliance services to forex managers through Cole-Frieman & Mallon.  He can be reached directly at 415-868-5345.

Forex Registration Workshop Announced

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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.

San Francisco Futures Professionals March Meeting | March 16, 2010

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NFA Regulations and Capital Raising on Agenda

The San Francisco Futures Professionals Group (LinkedIn Group) will be meeting next week to discuss the most recent NFA Regulatory Seminar.  Bart Mallon of Cole-Frieman & Mallon LLP will be providing an overview of the major regulatory items discussed at the seminar including the new NFA rule on social media, issues with disclosure documents and performance reporting, and perhaps most, importantly, how to prepare for and deal with an NFA audit.

In addition to Mr. Mallon’s discussion, Bill Grayson has offered to join the group to discuss strategy and capital raising for emerging managers.

The meeting will take place at Mr. Mallon’s office suite (1 Ferry Building, Suite 255) on March 16th at 4pm.  After the discussion the futures professionals group will move to the Slanted Door for continued discussion, drinks and networking.

All bay area futures professionals are invited to attend (please RSVP).  Additionally, Cole-Frieman & Mallon LLP would like to welcome any bay area forex professionals to attend.  Many forex professionals will need to become NFA members after the CFTC’s proposed forex registration rules are adopted and we recommend that such forex professionals begin preparing for registration.  All bay area forex professionals are encouraged to join the San Francisco Forex Professionals LinkedIn group as well.

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Other related hedge fund law blog posts 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.