Supervision of the Futures Industry Flashcards
Internal Supervision
NFA regulations require member firms to diligently supervise their employees and agents in regard to the duties performed for the member. Supervisory personnel are responsible for overseeing the activities of the member and its employees. An important concern for supervisory personnel is the
diligent and proper overseeing of all commercial and promotional material disseminated to the public.
Communications With the Public and Promotional Material
Promotional material is any communication directed to the public for the purpose of soliciting any futures account, agreement, or transaction. (Routine day-to-day communications with customer are not included.) Examples of promotional material include:
P the text of a standardized oral presentation;
P a publication in a newspaper or magazine;
P a communication for broadcast over television, radio, or other electronic medium; and
P a standardized form for a report, letter, circular, memorandum, or other publication.
Prior Approval Clause
NFA rules require prior approval of all promotional material by a partner, officer, or supervisor. Advertising and sales practices must be honest and straightforward. Employment advertising for professionals, newspaper advertising, and other forms of advertising are routinely monitored by the NFA. Statements of opinion that are included in the promotional material must be clearly identifiable as such and must have a reasonable basis.
Maintenance of Approval Documentation
Copies of all promotional material, along with a record
of the approval, must be maintained by each member for five years from the date of last use. These records are subject to NFA inspection. Members may also be required to file copies of promotional materials at the request of the NFA.
Prohibited Activities
The CFTC and the NFA prohibit fraud, misrepresentation, and deceit by member firm personnel in the solicitation of customers. An NFA member or associate may not state anything to the public that operates as a fraud or deceit, or is part of a high-pressure sales approach.
An NFA member or associate may not claim that futures trading is appropriate for all persons.
No Commodity Pool Operator, Commodity Trading Advisor, Introducing Broker, or Futures Commission Merchant, or their associates, may represent or imply that they or their principals have been sponsored, recommended, or approved, or that their abilities or qualifications have been approved by the CFTC or NFA.
Content of Promotional Material
The NFA has established specific prohibitions relating to the content of promotional material furnished to the public. The NFA prohibits:
P fraudulent, misleading, and deceptive statements, and communications that fail to state material facts;
P emphasizing profits without giving equal emphasis to the risks of trading;
P citing past trading profits without also disclosing that such profits may not indicate future profits;
P citing past trading performance statistics that cannot be substantiated; and
P referring to hypothetical trading results, unless the following warning is also displayed:
If a member firm uses promotional material prepared by another party, the member is still responsible
for its content. This includes material prepared by advertising firms or reprints of articles from
industry publications. To the extent that material prepared by others does not meet NFA guidelines, members must present supplementary information to insure it is brought up to standards.
Handling of Customer Complaints
Records must be kept of all customer complaints. Written complaints must be maintained and
written records must be made of all oral complaints. Customer complaints that a firm receives are not public information.
In the case of a complaint by an options customer, an FCM or IB must:
P make and retain a record of the date the complaint was received, the person who serviced the account, a general description of the complaint, and the action that was taken in regard to the complaint; and
P immediately send a copy of the complaint to the member’s designated self- regulatory organization (DSRO) and, upon its disposition, immediately send a copy of the disposition to the member’s DSRO.
Position Reporting Requirements
The CFTC requires persons who own or control one or more accounts to report their gross long or short position, in each commodity, once it reaches a specified threshold level. For example, persons
who own or control 200 or more Crude Oil futures contracts on either the long or short side of the
market must report their holdings to the CFTC in a report. The reporting level applies to both speculators and hedgers.
The FCMs that carry these accounts must also report their positions to the CFTC. On the first day that the account drops below the reporting level, a report must be filed with the CFTC.
A trader who is at the reporting level must report all trades, all deliveries of the cash commodity taken or made, and the number of open contracts currently being maintained. Reports must be made daily and begin on the first day that the reporting level is reached. Reports are filed on each day that any trade is made, or if the trader makes or takes delivery of the cash commodity. The trader may cease reporting only after the position drops below the reporting level.
Speculative Position Limits
Speculative position limits set the maximum number in a particular futures contract that may be held by one account or a group of accounts under common control. The purpose of position limits is to prevent price manipulation and distortion of futures prices.
Position limits apply to the gross long or gross short positions in an account. They apply to all transactions, regardless of the exchange on which the transaction takes place.
Position limits can be set by the exchange on which the contract trades or by the Commodity Futures Trading Commission (CFTC). The CFTC is the government agency that regulates the futures industry and will be discussed in detail in the next chapter. The position limits on a given commodity are typically found in the contract specifications.
Compliance
The NFA compliance rules and regulations that apply to members and associated members are designed to ensure the integrity of customer relationships. These rules and regulations focus on the antifraud provisions covered in the Commodity Exchange Act and the CFTC regulations. The NFA compliance director can require statements under oath from any member or Associated Person of a member and has the ability to subpoena documents. If an applicant has been found guilty of conduct that is inconsistent with just and equitable principles of trade, that applicant’s membership
can be denied.
Surveillance
FCMs are subject to regular surveillance of their financial status to make certain that they are
adequately capitalized. Additionally, member firms who are required to maintain segregated customer accounts must do a daily financial analysis.
Audits
At least once every 24 months, a “full scope” audit is conducted by the NFA, covering every facet of the firm’s business activities. The NFA also conducts “limited scope” unannounced audits.
If violations are found, an indepth investigation may follow. The NFA president, with concurrence from the board of directors, can initiate a member responsibility action which can require the firm to immediately cease doing business. This is the most extreme action that can be taken, and this can be done with or without a hearing.
Disciplinary Proceedings
The NFA has an office of compliance that employs a variety of techniques designed to provide an early warning of potential problems. If an audit or investigation reveals a potential violation of NFA
rules, the infraction is reported to the Regional Committee for the region in which the respondent member or associate resides. If the Regional Committee decides that the facts justify the issuance of a formal complaint, the respondent must answer and is entitled to a hearing before the Committee.
While the NFA member is involved in the proceedings, there is no trading restriction until the matter is resolved. A decision can be appealed to the Appeals Committee, which is a subcommittee of the Board of Directors. The decisions of the Appeals Committee are final, subject to review only by the CFTC.
Disciplinary Actions
Upon conclusion of a disciplinary proceeding, the Regional Committee or the Appeals Committee
(on appeal or review) may impose one or more of the following penalties:
P expulsion or suspension from NFA membership for a specified period (2/3 vote of the committee members that are present is required);
P prohibition or suspension for a specified period from association with an NFA member;
P censure or reprimand;
P a monetary fine not to exceed $250,000 per violation;
P issuance of a cease and desist order; or
P any other reasonable penalty or remedial action that is not inconsistent with NFA rules.
Note: The Appeals Committee may increase, decrease, or set aside the penalties that were imposed
by the Regional Committee.
The CFTC maintains exclusive disciplinary jurisdiction over Floor Brokers and exchanges. The CFTC is empowered to bring administrative or federal court actions against any registered person or
entity, for any violation of the Commodity Exchange Act or CFTC regulations, regardless of whether
the NFA also has jurisdiction. Penalties that may be imposed by the CFTC a maximum fine of the
greater of $140,000 or three times the monetary gain for violation, a suspension or revocation of
registration, a suspension or revocation of trading privileges, and a cease and desist order.
Settlement of Disciplinary Actions
A respondent (party charged with a violation) may settle all charges brought by the NFA, CFTC or the exchange, on mutually agreeable terms, without admitting or denying the allegations. Such settlements avoid a hearing, but may carry penalties as could be applied following a hearing. When a complaint by a regulatory agency is issued against a member, it becomes a matter of public record.
