Financial Regulation and Compliance. Kotz H. David

information for corporate and Agency bonds.22 FINRA also has a dispute resolution forum, which is the largest in the country for the securities industry, handling nearly 100 percent of securities-related arbitrations and mediations from more than 70 hearing locations – including at least one in all 50 states, London, and Puerto Rico.23

      1.4 THE COMMODITY FUTURES TRADING COMMISSION (CFTC)

      The SEC's counterpart for futures exchanges and brokers is the CFTC. The CFTC is an independent Agency of the United States government that regulates futures and options markets. The stated mission of the CFTC is “to protect market participants and the public from fraud, manipulation, abusive practices, and systemic risk related to derivatives – both futures and swaps – and to foster transparent, open, competitive and financially sound markets.”24 The CFTC states that it carries out this mission by “polic[ing] the derivatives markets for various abuses and works to ensure the protection of customer funds.”25

      In carrying out this mission, the CFTC polices the derivatives markets for various abuses and works to ensure the protection of customer funds. The CFTC also oversees designated contract markets, swap execution facilities, derivatives clearing organizations, swap data repositories, swap dealers, futures commission merchants, commodity pool operators, and other intermediaries.

      The CFTC is composed of three major divisions: Market Oversight, Clearing and Intermediary Oversight, and Enforcement. The CFTC's Division of Market Oversight ensures that the futures markets are operating efficiently without manipulation and fraud. These tasks are executed first by reviewing and analyzing the very diverse group of instruments and products to ensure that they are not susceptible to manipulation. Market Oversight also conducts active market and trade practice surveillance of trading activity on designated contract markets (known as “DCMs”), like the New York Mercantile Exchange. Traders establishing positions on DCMs are subject to reporting requirements so the CFTC can evaluate position sizes to detect and deter manipulation. Market Oversight monitors the activities of large traders, key price relationships, and relevant supply and demand factors for the estimated 1,400 active futures and option contracts in the country to ensure market integrity. In addition, CFTC surveillance economists prepare weekly summary reports for futures and option contracts approaching their expiration periods.

      The CFTC's Division of Clearing and Intermediary Oversight ensures the financial integrity of transactions on the markets regulated by the CFTC. This division attempts to establish that the intermediaries managing these funds are properly registered, perform appropriate recordkeeping, have adequate capital, employ fair sales practices, and protect the funds their customers invest. Intermediaries overseen by the CFTC include futures commission merchants (“FCMS”), including banks and broker-dealers with specialized futures operations, as well as stand-alone futures trading houses.26

      The CFTC's Division of Enforcement investigates and prosecutes violations of the federal laws governing commodity trading by individuals and firms who are engaged in activities that directly or indirectly affect commodity futures and option trading on domestic exchanges. These federal laws prohibit fraud and abusive practices in solicitations of futures or options, such as falsely guaranteeing profits, minimizing risk, and misrepresenting performance history. In addition, the CFTC is authorized to bring enforcement actions for misappropriating customer funds, and often refers matters to criminal authorities.27

      The CFTC administers the Commodity Exchange Act (“CEA”), 7 U.S.C. section 1 et seq., which prohibits fraudulent conduct in the trading of futures contracts. The CEA also establishes a comprehensive regulatory structure to oversee the volatile futures trading markets. The CEA requires all FCMs to register with the CFTC, unless they qualify for a particular exemption.28 CFTC regulations promulgated pursuant to the CEA also require all registered FCMs to be a member of a Futures Association.29

      1.5 THE NATIONAL FUTURES ASSOCIATION (NFA)

      The National Futures Association (“NFA”) is the industry-wide, self-regulatory organization for the U.S. futures industry and the “designated” regulatory organization for non-clearing FCMs.30 The NFA screens all firms and individuals wishing to register with the CFTC and become members of the NFA. Applicants must meet fitness requirements to determine if they have ever been disciplined or subject to regulatory proceedings in the past, and must provide fingerprint cards for Federal Bureau of Investigation (“FBI”) background checks. In addition, individual registrants must pass proficiency testing requirements. The NFA has the authority to deny, revoke, suspend, restrict, or condition the registration of any firm or individual.

      The NFA has adopted a comprehensive set of rules covering the business conduct of its members, including sales practices, recordkeeping, reporting, risk disclosure, discretionary trading, disclosure of fees, and minimum capital requirements.

      Pursuant to its examination or audit program, the NFA is required to examine FCMs on an annual basis if they hold customer funds.31 As part of these examinations or audits, the NFA examination may include all the FCM's procedures, books, and records associated with its commodities business, including, but not limited to:32

      ■ Corporate records.

      ■ Anti-money laundering policies and practices.

      ■ Sales practices.

      ■ Supervisory procedures.

      ■ Account opening documents.

      ■ Order tickets.

      ■ Bunched order allocations.

      ■ Margin policies.

      ■ Promotional material.

      ■ Disclosure documents.

      ■ Performance capsule support.

      ■ Bank records.

      ■ Trading records.

      ■ Financial statement records.

      In addition, the NFA has the authority to take disciplinary actions against any firm or individual that violates its rules. These actions range from Warning Letters for minor rule infractions to formal complaints in cases where rule violations warrant prosecution. Penalties resulting from complaints include expulsion, suspension for a fixed period, prohibition from future association with any NFA Member, censure, reprimand, and a fine of up to $250,000 per violation. The NFA often collaborates with the CFTC, and other law enforcement Agencies to ensure full, comprehensive prosecutions.33

      The NFA has also worked closely with the CFTC and other SROs to adopt a number of initiatives to further safeguard customer funds. The NFA, in conjunction with other SROs, developed and implemented a system in 2013 that requires all depositories holding customer segregated funds on behalf of an FCM to directly report balances daily to SROs. The SROs then perform an automated comparison to the daily reports filed by the FCMs to identify any suspicious discrepancies. In addition, each FCM is required to provide regulators with immediate notification if it draws down its excess segregated funds (funds deposited by the firm into customer segregated accounts to guard against customer defaults) by 25 percent in any given day. Such withdrawals must be approved by the Chief Executive Officer (“CEO”), Chief Financial Officer (“CFO”) or a financial principal of the firm, and the principal must certify that the firm remains in compliance with segregation requirements.34

      All FCMs also must regularly file certain financial information about the firm with the NFA. This information is posted on the NFA's website. The information includes each FCM's capital requirement, excess capital, segregated funds requirement, excess segregated funds, and how the firm invests

22

For further information on FINRA's TRACE system, see http://www.finra.org/Industry/Compliance/MarketTransparency/TRACE/.

23

For further information on FINRA's Dispute Resolution programs, see http://www.finra.org/ArbitrationAndMediation/FINRADisputeResolution/.

24

See http://www.cftc.gov/About/MissionResponsibilities/index.htm.

25

See ibid.

26

For further background on the CFTC's Division of Clearing and Intermediary Oversight, see http://www.cftc.gov/About/CFTCOrganization/index.htm.

27

For further background on the CFTC's Division of Enforcement, see http://www.cftc.gov/LawRegulation/Enforcement/index.htm.

28

See 7 U.S.C. section 6d(a).

29

See CFTC Regulation 170.15.

30

For further background on FINRA, see www.nfa.futures.org/.

31

See http://www.nfa.futures.org/NFA-faqs/compliance-faqs/examinations/index.HTML.

32

See ibid.

33

See http://www.nfa.futures.org/NFA-about-nfa/who-we-are/how-NFA-fights-fraud-and-abuse.HTML.

34

See http://www.nfa.futures.org/NFA-about-nfa/who-we-are/customer-protection-initiatives.HTML.