Tag Archives: nfa regulations

Social Media Regulation & Managed Futures Industry

Futures Magazine Publishes Article on Social Media by Bart Mallon

In this month’s issue of Futures Magazine I wrote a featured article about the legal and regulatory issues that managers in the futures industry face with respect to the use of social media. The article, Social Media Considerations for Financial Firms, provides a broad overview of the many issues which managers should be aware of when utilizing social media in any sort of marketing campaign. Specifically the article discusses the NFA rules which member firms must follow and also discusses some best practices and common deficiencies.

I believe that the article comes at an important time – managers

are using social media more often to communicate with clients. These managers are also using various platforms to communicate and market to potential clients. The necessity of creating compliance programs with respect to these activities has been clearly communicated to the managed futures community by the NFA and we have written a number of posts on the use of social media. Many of these posts are informed by information provided to the NFA either through more formal discussions or informally at

various conferences. The posts include:

We recommend that NFA member firms implement robust compliance policies with respect to the use of such media. Additionally, these programs should be reviewed and revised, as appropriate, on a periodic basis to respond to new marketing and communication practices and any guidance promulgated by the NFA or CFTC.

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Bart Mallon’s is a managing partner at Cole-Frieman & Mallon LLP and his practice focuses on the hedge fund industry. He routinely works with managers who trade commodities and futures on corporate and regulatory matters. He can be reached through our contact form or by phone at 415-868-5345.

Disclosure Document Guidance for CTAs and CPOs

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NFA Provides Overview of Manager Background (Bio) Disclosure Requirements

CFTC registered CTAs and CPOs need to have their disclosure documents reviewed by the NFA prior to using those documents to solicit clients or investors. As any manager who has gone through this NFA review process understands, the NFA will take their time to scrutinize the documents. One issue which comes up again and again is the background information that must be disclosed for any principals or managers disclosed in the disclosure document. Managers should take note of the following points:

Each bio must include a complete and detailed business background for the last 5 years (any gaps must be explained);
Business background further back than 5 years does not need to be disclosed; and
If a manager chooses to mention anything that happened in the manager’s business background further back than 5 years, the manager must disclose all subsequent employment.

The third point is really the most important for this discussion. Let’s say a manager makes a general reference that he has been in the investment management business for 16 years – that means that the manager will need to provide a description of each job, including dates of employment (month and year) over the last 16 years. Because in practice this would lead to ridiculously long bios (for some managers), it is generally recommended to leave the bio to the last 5 years so that the bio is manageable.

The NFA recently released a member notice, reprinted below, discussing this issue and the various questions that arise. The following NFA Notice can be found here.

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Notice I-10-12

May 11, 2010

NFA provides guidance for disclosure of business background information by commodity pool operators and commodity trading advisors

In 1997, the Commodity Futures Trading Commission (CFTC) delegated the review of disclosure documents submitted by commodity pool operators (CPO) and commodity trading advisors (CTA) to NFA. The Division of Clearing and Intermediary Oversight (DCIO) performs periodic oversight of NFA’s implementation of its delegated authority. As part of these reviews, DCIO staff has communicated to NFA its expectations as to the type and breadth of information that must be disclosed regarding the background of CTAs, CPOs, and relevant individuals. NFA is providing the following guidance to clarify the requirements of the applicable regulations regarding the disclosure of business background.

CFTC Regulations 4.24 and 4.34 require that disclosure documents include, for the previous five years from the date of the document, the business backgrounds of the CTA, the CPO, the major CTAs, the CPOs of major investee pools, the pool’s trading manager, and each principal of the foregoing who participates in making trading or operational decisions, or supervises persons so engaged. For each of the persons listed above, the document must include employers, business associations, or ventures (including the starting and ending month and year) for the same five year period, as well as a discussion of the duties performed by the person for each. When disclosing business background information, the discussion must be complete for the entire five year period. Any gaps in time must be explained.

Examples of disclosures within the most recent five year period:

Ms. Smith attended ABC University and graduated in June 2005 with a degree in Economics. In August 2008, she joined XYZ LP as an associated person.

The business background must disclose what Ms. Smith was doing during the period between June 2005 and August 2008. Additionally, if XYZ LP is not the entity for which the disclosure document has been prepared, a description of its main business must be included.

Mr. Jones has been a listed principal of XYZ Company, a commodity trading advisor, since January 2005. In 2007 Mr. Jones began publishing a monthly newsletter entitled “The Trading Corner,” which outlines Jones’ trading research in the energy markets.

The business background must disclose Mr. Jones’ duties at XYZ Company. The month in which Mr. Jones began publishing his newsletter and the name and main business of the employer, if any, for whom the newsletter is being published must also be disclosed.

Mrs. Green was registered as an associated person of LMN LLC, a commodity pool operator from March 2008 until May 2008. In June 2008, she formed PQR Limited Partnership (PQR), a commodity pool operator which became registered on November 1, 2008. Mrs. Green became a registered AP and listed principal of PQR on November 1, 2008.

The business background must be complete for the last five years. Specifically, it must disclose what Mrs. Green was doing prior to March 2008. Mrs. Green’s and PQR’s activities between June 2008 (when she formed PQR) and November 2008 (when she and the firm became registered) must also be disclosed.

As noted above, CFTC Regulations mandate disclosure of business background information for only the last five years from the date of the disclosure document. DCIO has advised NFA, however, that if a CTA or CPO elects to provide business background information beyond the previous five year period it must provide this information in the same level of detail as that required for the last five years. DCIO has further directed that a general reference regarding the length of an entity’s or individual’s experience or involvement in an industry serves to extend the time period for which disclosures must be made.

The following is an example of a disclosure recently submitted to NFA and an explanation as to why it would not comply with the above stated policy:

Example of disclosure beyond the most recent five year period:

Mr. Brown has been in the futures industry since October 1982 or Mr. Brown has over twenty eight years of management experience.

Mr. Brown’s business background must be disclosed from October 1982 to the present. The disclosure must be complete for the entire period including the name and main business of each employer, the nature of the duties performed for each employer, and the starting and ending dates (month and year) of employment, including an explanation of any gaps in employment.

CPOs and CTAs are encouraged to review their existing disclosure documents in light of DCIO’s guidance and make any necessary changes prior to submitting subsequent filings of the document. If you have any questions concerning this notice or disclosure documents generally, please contact Mary McHenry, Senior Manager, Compliance ([email protected] or 312-781-1420) or Kaitlan Chi, Manager, Compliance ([email protected] or 312-781-1219).

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Other related hedge fund law blog posts include:

Cole-Frieman & Mallon LLP is a hedge fund law firm which provides CTAs and CPOs with comprehensive formation and regulatory support. Bart Mallon, Esq. can be reached directly at 415-868-5345.

CTA Regulatory and Compliance Discussion

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By Bart Mallon, Esq. (www.colefrieman.com)

“Compliance in a Changing Environment”

As we are all well aware both the investing and the regulatory environments have experienced a dramatic refocusing on compliance and related issues in the wake of the 2008 meltdown and the Bernie Madoff affair. This overview is for the CTA Expo 2009 program entitled Compliance in a Changing Environment. The program was sponsored by Woodfield Fund Administration and featured Kate Dressel of Strategic Compliance Solutions as well as Patty Cushing of the National Futures Association.

Ms. Dressel announced that compliance and processes and procedures have become increasingly important, especially since investors are now concerned about fraud. The best defense with regard to fraud, and an theme that pervaded this and other discussions, is that a CTA needs to have a reputable accountant and auditor. Having reputable service providers (including administrators, auditors and legal firms) will help potential investors/clients to feel more comfortable with the CTA and the investment program.

Ms. Cushing, who is the associate director for Risk Management and Member Education at the NFA, began by emphasizing that CTA performance information needs to be accurate. She also mentioned that CTAs really need to be focused on trading and the other business issues, especially accounting and legal, should be done by experienced people or service providers. Ms. Cushing made reference to the NFA’s spreadsheet (although I could not find this on the NFA’s website) as well as an informative webscast by the NFA discussing CTA Performance Reporting webcast. Basically she said that if you don’t want to spend the time making sure that all of the numbers are perfect, then you are going to need to use a consulting firm.

If you self administrer you are going to need to think about an outside administrator so that there will be increased oversight.

Ms. Dressel talked about the current industry buzzword – transparency. Transparency is important, she went on, not just in trading but in all aspects of the CTA business. Compliance and operations, especially, need well ordered and solid procedures in place. Oversight is the key and it is very important that the principals are aware of everything that is going on in the firm.

[Note: Ms. Cushing talked about forex managers and noted that forex managers needed to make sure they were submitting their forex disclosure documents to the NFA for review. I spoke with Ms. Cushing after the session was over to gain clarification over her statement and also discuss the forex registration rules which were supposed to be proposed by the CFTC some time ago. For clarification, I want to point out that forex managers only need to have the NFA review their forex disclosure documents if they are already a member of the NFA – that is, if they are already registered as a CTA or CPO. Forex only managers who are currently not registered with the NFA (and who trade only in the off-exchange spot markets) currently do not need to register with the NFA. I discussed this with Ms. Cushing and asked if she had seen a draft of the registration rules or if she had heard anything from the CFTC as to when the rules might be proposed – she said that the CFTC has been working on the rules but that she has no idea when or if the rules will be proposed. She seemed to be parroting the CFTC on this issue – the agency has told me a number of times that they are working on the rules and that they will be proposed shortly.]

Ms. Cushing mentioned that some CTA firms will actually use a previous NFA audit as a kind of “stamp of approval” by the regulatory agency. Although the NFA audit is only designed for the NFA Member who was subject to the audit, some Members will send these to their clients. Accoring to Ms. Cushing, the NFA is taking no opinion with regard to this practice. She did note, however, that such reports might not be the best source of information regarding a firm’s procedures as it might be out of date.

Ms. Dressel mentioned that mock audits for CTAs are good to pursue – you can contact a number of outside firms like her own that can help a manager through a mock audit. Not only does a mock audit help a firm for an actual NFA audit, but it will also help to identify operational issues which the manager can refocus upon.

One of the most important items that CTAs should be aware of is their marketing materials and disclosure documents. It is imperative that CTA firms make sure that every statement in the disclosure documents and other marketing materials be true. CTA firms should not try to stretch the truth – potential investors are check and there is a whole new paradigm. Any stretched truth will be uncovered during the due diligence process which now includes, for some managers, phorensic accounting to make sure that trading parameters have been consistently adheared to. Investors now need absolute confidence in who you are and what you do.

CTA firms should be vigilant about making sure they stick to the trading parameters in the disclosure documents.

A very good piece of advice is that if there is anything in your disclosure documents which is not true, you need to update your documents. [BM note: and potentially discuss the change with your current investors/clients.]

Ms. Cushing noted that there a number of ways to that your firm can prepare for an NFA audit. The first step is to read and be aware of the NFA’s yearly self-examination checklist. [Note: if you do not know about the self-exam checklist, and if you do not have a compliance program in place, please see a CTA attorney or compliance person immediately to become compliant. The self-exam checklist is a central part of a good compliance program.] Ms. Cushing urged those firms who have questions about the checklist to call the NFA (although, in practice, this is usually an effort in futility as the staff will generally not ask questions and tell firms to consult with an attorney or other compliance professionals).

Questions From Audience

After this we had an opportunity to move onto questions from the attendees. One comment came from Fred Gehm who has worked in due diligence for a fund of funds which allocated to the CTAs through separately managed accounts. He made the statement that if the manager doesn’t have an external administrator the FOF will not allocate to that CTA – even if the CTA has audited returns. He also made the comment that 10-15% of the time CTAs (or other managers) will lie to him and he will catch it. Obviously in these cases the FOF does not allocate to such a group. He said that many times if the manager had been honest about fact in the first place, it would likely have been something that would have been passed over but for the lied.

Ms. Cushing and Ms. Dressel emphasized that the CTA is ultimately responsible for making sure that the books and records are correct – even if there is an outside administrator, the CTA needs to take an active role in this area.

The next questioner noted that family offices and pensions are beginning to get involved in the CTA space and he wondered how smaller CTAs can set up structures to be well positioned for such investors. Ms. Dressel suggested that the CTA manager get as much of the program together as possible – this means the manager should try to get the best administrators, auditors and legal counsel that they can afford. The manager should also be able to completely answer a standard due diligence questionnaire – these questionnaires highlight some of the important structural and governance items that family offices and pensions will be focusing on.

Mr. Gehm mentioned that he is concerned with two central issues when allocating to small CTAs: (1) custody and (2) risk management. With the first, custody, he said he was especially concerned with who signs the checks and where is the dollar control. Fred recommended that CTAs have secondary signer for disbursements. With regard to the second issue, risk management, he said he looked for a structure where someone with independent authority had authority with regard to this issue. The key here is that the risk manager should have no fear of losing his job, that there is contractual safeguards for him doing his risk management.

There were a couple of other brief questions before the session ended. One takeaway with regard to risk management is to think about things throughout the organization – key man provisions and plans for odd eventualities. The more that a CTA manager really thinks about and understands the risk of his business, the better it will be for the investors and the more likely for the CTA manager to have an easier time raising capital.

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This article was first printed on the CTA Expo Blog. This article was contributed by Bart Mallon, Esq. who runs the Hedge Fund Law Blog and is committed to providing useful and easy to understand information for CTAs and CPOs which can be found in our CTA and CPO Registration and Compliance Guide. For more information on CTA registration or compliance services please contact Bart Mallon, Esq. at 415-868-5345.