[Federal Register Volume 76, Number 1 (Monday, January 3, 2011)]
[Notices]
[Pages 202-205]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2010-33097]



[[Page 202]]

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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-63602; File No. SR-NFA-2010-04]


Self-Regulatory Organizations; National Futures Association; 
Notice of Filing and Immediate Effectiveness of Proposed Amendments, as 
Modified by Amendment No. 1 Thereto, to the Interpretive Notice 
Regarding NFA Compliance Rule 2-9: Enhanced Supervisory Requirements

December 22, 2010.
    Pursuant to Section 19(b)(7) of the Securities Exchange Act of 1934 
(``Exchange Act''),\1\ and Rule 19b-7 under the Exchange Act,\2\ notice 
is hereby given that on October 7, 2010, National Futures Association 
(``NFA'') filed with the Securities and Exchange Commission (``SEC'' or 
``Commission'') the proposed rule change described in Items I, II, and 
III below, which Items have been substantially prepared by the NFA. On 
December 7, 2010, NFA filed Amendment No. 1 to the proposed rule 
change. The Commission is publishing this notice to solicit comments on 
the proposed rule change from interested persons. NFA also has filed 
this proposed rule change with the Commodity Futures Trading Commission 
(``CFTC'').
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    \1\ 15 U.S.C. 78s(b)(7).
    \2\ 17 CFR 240.19b-7.
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    On October 6, 2010, NFA requested that the CFTC make a 
determination that review of the proposed rule change of NFA is not 
necessary.\3\ On October 20, 2010, the CFTC notified NFA that it had 
determined not to review the proposed rule change.\4\
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    \3\ See Letter from Thomas W. Sexton III, Senior Vice President/
General Counsel, NFA, to William Penner, Deputy Directory, CFTC 
(Oct. 6, 2010).
    \4\ See Letter from William Penner, Deputy Director, CFTC, to 
Thomas W. Sexton III, General Counsel, NFA (Oct. 20, 2010).
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I. Self-Regulatory Organization's Description and Text of the Proposed 
Rule Change

    The proposed amendments to NFA Compliance Rule 2-9's Interpretive 
Notice entitled ``Enhanced Supervisory Requirements'' (``Notice'') 
would provide limited relief for some Members that currently would 
qualify for the enhanced supervisory requirements (``Requirements'') 
based on a firm principal's previous affiliation with another Member 
firm that was subject to the Requirements; makes changes to the 
enhanced capital requirements in light of a recent increase in the 
futures commission merchant (``FCM'') minimum capital requirement; 
makes changes to deal with the enhanced capital requirements for 
commodity pool operators (``CPOs'') and commodity trading advisors 
(``CTAs'') in a manner more consistent with the nature of their 
business; requires specific items to be included in a firm's written 
supervisory procedures; requires quarterly rather than monthly reports 
on a firm's compliance with the Requirements; and includes clarifying 
language in three areas: (1) Charging abnormally high commissions and 
fees; (2) the effect that receiving a waiver has on determining whether 
a Member is a firm that has met the criteria for future situations 
involving the Requirements; and (3) the status of a ``five year'' 
Disciplined Firm after it has been dropped from the ``five year'' list.
    The text of the Interpretive Notice is available on NFA's Web site 
at http://www.nfa.futures.org, the Commission's Web site at http://www.sec.gov, the self-regulatory organization's office, and at the 
Commission's Public Reference Room.

II. Self-Regulatory Organization's Statement of the Purpose of, and 
Statutory Basis for the Proposed Rule Change

    In its filing with the Commission, NFA included statements 
concerning the purpose of and basis for the proposed rule change and 
discussed any comments it received on the proposed rule change. The 
text of these statements may be examined at the places specified in 
Item IV below. NFA has prepared summaries, set forth in sections A, B, 
and C below, of the most significant aspects of such statements.

A. Self-Regulatory Organization's Statement of the Purpose of, and 
Statutory Basis for the Proposed Rule Change

1. Purpose
    Section 15A(k) of the Exchange Act \5\ makes NFA a national 
securities association for the limited purpose of regulating the 
activities of NFA Members (``Members'') who are registered as brokers 
or dealers under Section 15(b)(11) of the Exchange Act.\6\ The 
Interpretive Notice entitled: ``NFA Compliance Rule 2-9: Enhanced 
Supervisory Requirements'' applies to all Members, including those who 
are registered as security futures brokers or dealers under Section 
15(b)(11) of the Exchange Act.
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    \5\ 15 U.S.C. 78o-3(k).
    \6\ 15 U.S.C. 78o(b)(11).
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    Member firms trigger the Requirements based upon the regulatory 
background of either their associated persons (``APs'') or principals. 
Member firms triggering the Requirements must record all telephone 
conversations with customers and prospects, pre-submit promotional 
material, adopt written supervisory procedures and either operate under 
a guarantee agreement or maintain an enhanced capital level. The 
proposed amendments to the Notice include:
    <bullet> Limited relief for some Members that would currently 
qualify for the Requirements based on a firm principal's previous 
affiliation with another Member firm that was subject to the 
Requirements;
    <bullet> Changes to the enhanced capital requirements in light of a 
recent increase in the FCM minimum capital requirement;
    <bullet> Changes to deal with the enhanced capital requirements for 
CPOs and CTAs in a manner more consistent with the nature of their 
business;
    <bullet> Requiring specific items to be included in a firm's 
written supervisory procedures;
    <bullet> Requiring quarterly rather than monthly reports on a 
firm's compliance with the Requirements; and
    <bullet> Clarifying language regarding: (1) Charging abnormally 
high commissions and fees; (2) the effect that receiving a waiver has 
on future situations involving the Requirements; and (3) the status of 
a ``five year'' Disciplined Firm after it has been dropped from the 
``five year'' list.
    Historically, a Member would trigger the Requirements only if it 
had a defined percentage of APs who had previously worked for a 
Disciplined Firm.
    In 2005, NFA's Board made revisions to the Notice after recognizing 
that the principals of several firms that had triggered the 
Requirements had avoided them by simply closing their firms and opening 
other firms that had a mix of APs that did not trigger the 
Requirements. NFA noted that the new firms typically had APs from the 
closed firm who had worked at Disciplined Firms, but their percentage 
ratios to the overall AP population of the new firms were below the 
triggering point for imposing the Requirements. NFA's Board addressed 
this issue by amending the Notice to provide that once a firm had 
triggered the Requirements, then any other firms of which the 
principals of the qualifying firm are also principals would become 
subject to the Requirements.
    NFA believes that the 2005 revision has been generally effective in 
discouraging the practice of sham reorganizations to avoid the 
Requirements. However, NFA has found

[[Page 203]]

that there were some principals whose firms triggered the Requirements 
with backgrounds that suggested they were not part of the population to 
which the amendment was designed to apply. NFA undertook the task of 
identifying objective criteria that were met by individuals who did not 
appear to be part of the target group but were, nevertheless, affected 
by the 2005 amendment. In doing so, NFA focused on criteria similar to 
those that have been adopted to provide exemptions to some APs who 
previously worked at Disciplined Firms. These criteria include a clean 
personal regulatory record and limited affiliation with potentially 
problematic Members.
    NFA has identified a set of five criteria that apply to 
approximately 60 individuals and approximately five entities that do 
not appear to raise undue concerns regarding their ability to 
effectively supervise their firms. Those criteria include the 
following:
    <bullet> The principal has not been personally subject to a 
disciplinary action by NFA or the CFTC;
    <bullet> The principal has been a principal of only one firm that 
has qualified for the Requirements;
    <bullet> The principal has never been a principal or an AP of a 
current Disciplined Firm;
    <bullet> The firm in the principal's history that triggered the 
Requirements either received a full waiver from the Requirements or 
abided by the Requirements for at least two years and is no longer 
subject to the Requirements; and
    <bullet> The firm in the principal's history that triggered the 
Requirements has not become subject to a sales practice action since 
triggering the Requirements.
    NFA believes that exempting Members from adopting the Requirements 
when those Requirements are triggered by a principal who meets the 
aforementioned five criteria would eliminate the need for some waiver 
petitions (which are typically granted), saving time and undue 
complications for the affected Members, the Telemarketing Procedures 
Waiver Committee (``Waiver Committee'') and NFA staff. NFA believes 
that this exemption could provide relief to certain principals whose 
profiles indicate that they are unlikely to pose any supervisory 
issues. In addition, NFA does not believe that this change will 
diminish customer protection because the principals that will be 
exempted are those principals who would almost always have been granted 
a waiver based on meeting the aforementioned criteria.
    The Notice currently provides that FCMs affected by the Notice are 
required to maintain adjusted net capital (``ANC'') of at least 
$1,000,000. When this provision was adopted the minimum ANC level was 
$500,000. However, the minimum ANC for all FCMs was raised to 
$1,000,000 in March 2010, rendering the current provision moot.
    NFA proposes to revise the language in the Notice regarding the 
enhanced level of ANC required to be maintained by affected FCMs to tie 
the required enhanced ANC to the minimum ANC for FCMs. The proposed 
amendments would track the approach taken by the Board in 2008 to deal 
with changes to the enhanced ANC provision for Forex Dealer Members 
(``FDMs''). Specifically, rather than set a defined number, it would 
tie the enhanced ANC level for FCMs to the early warning requirement 
under CFTC rules, which is currently 150% of required ANC. NFA believes 
that this revision would not only bring the current enhanced ANC 
obligation into harmony with that required of FDMs, but would also 
provide flexibility in light of any future changes to the level of the 
minimum ANC required of FCMs.
    The Notice currently requires CPOs and CTAs that trigger the 
Requirements to maintain ANC of at least $250,000. In addition, 
affected CPOs and CTAs are currently subject to the financial 
recordkeeping and reporting requirements applicable to FCMs.
    According to NFA, it is relatively uncommon for CPOs and CTAs to 
qualify for the Requirements, and if CPOs and CTAs do qualify, they 
often request relief from the $250,000 capital requirement even if they 
are required to tape. The Waiver Committee has dealt with ten waiver 
petitions from CPO or CTA Members and completely denied five of those 
petitions. Four of those firms are no longer NFA Members. The other 
five received partial waivers that reduced the enhanced ANC 
requirement. Two waivers set the required ANC level at $100,000, two 
set it at $75,000, and one eliminated the obligation altogether. Three 
of the five firms that received waivers remain NFA Members. In granting 
these petitions, the Waiver Committee recognized that because CPOs and 
CTAs do not have a minimum net capital requirement, imposing the 
reduced $100,000 requirement was sufficient to meet the purpose of the 
requirement.
    In light of the Waiver Committee's past decisions regarding this 
issue, NFA proposes to amend the Notice to reduce the ANC required of 
CPOs and CTAs that trigger the Requirements from the current $250,000 
to $100,000. In addition, the proposed amendments to the Notice would 
provide that the financial recordkeeping and reporting obligations of 
affected CPOs and CTAs be simplified by merely requiring them to 
demonstrate compliance with their enhanced ANC obligation to NFA upon 
request.
    The proposed amendments to the Notice identify specific areas that 
would need to be addressed by an affected Member in the written 
supervisory procedures they are required to prepare. NFA believes that 
this addition will give clear guidance as to the minimum standards to 
be met in preparing written supervisory procedures. Generally, the 
proposed language requires procedures for monitoring, cataloging and 
logging taped conversations in an affected Member's written supervisory 
procedures.
    The Notice currently requires affected Members to file monthly 
reports regarding their compliance with the Requirements. It has been 
NFA's experience in reviewing these reports that most of them tend to 
be repetitious in nature. Nevertheless, NFA feels that the reports are 
useful in that they periodically bring the Member's focus to bear on 
the Requirements, create a written historical record and, on occasion, 
may provide the impetus for corrective action by the Member. NFA 
proposes to change the frequency of the obligation to file such reports 
from monthly to quarterly. NFA believes that lengthening the frequency 
for filing the reports will not in any way diminish customer protection 
because the reports alone do not typically form the basis of an NFA 
investigation or disciplinary action. Moreover, NFA uses other methods 
to monitor Member compliance with the Requirements.
    Members that charge 50% or more of their active customers round-
turn commissions, fees and other charges that total $100 or more per 
futures, forex or option contract are required to adopt the 
Requirements. NFA represents that it has recently encountered 
situations in which Members purchase out-of-the-money options and 
charge a commission just short of $100. In these situations there are 
additional charges if the option is liquidated that would bring total 
charges above $100; however, NFA believes that it is often the case 
that the out-of-the-money options expire worthless and no additional 
costs are assessed. The result is that some Members are able to avoid 
the Requirements by encouraging their customers to take on riskier out-
of-the-money positions that are less likely to

[[Page 204]]

incur liquidation charges that would raise costs to $100 or more.
    Members that engage in the practice described above are, in NFA's 
view, clearly within the group of Members that the Board believed 
should be subject to the Requirements when it chose to use high 
commissions and fees as a trigger for imposing the Requirements. 
Therefore, the proposed amendments to the Notice provide that trading 
an options contract that would result in total commissions, fees and 
other charges of $100 or more if the trade was liquidated will be 
deemed to have been charged $100 even if the contract is not ultimately 
liquidated.
    The proposed amendments to the Notice would add language that NFA 
believes would clarify that a Member that receives a full or partial 
waiver is still deemed to be a Member that has met the criteria for 
purposes of the Notice.
    From 1993 until 2007, the term ``Disciplined Firm'' included only 
Members that had been permanently barred from the industry as the 
result of a sales practice or promotional material action. In 2007, the 
amendments to the Notice added Members that had been sanctioned in any 
way in a sales practice or promotional material action within the 
preceding five years to the definition of a Disciplined Firm. This 
resulted in the creation of a list of ``five year'' Disciplined Firms 
that is separate from the list of permanent Disciplined Firms. The 
electronic reporting system that monitors Disciplined Firms 
automatically removes these firms from the Disciplined Firm list once 
five years have passed.
    According to NFA, there has been some confusion expressed as to 
whether a ``five year'' Disciplined Firm is still considered to be a 
Disciplined Firm for purposes of triggering the Requirements once the 
firm is dropped from the ``five year'' list. NFA believes that the 
proposed amendments to the Notice would eliminate this confusion by 
simply adding the word ``current'' before the term ``Disciplined Firm'' 
in four relevant places in Section III (B)(1) of the Notice.
    Amendments to the Interpretive Notice regarding NFA Compliance Rule 
2-9: Enhanced Supervisory Requirements were previously filed with the 
SEC in SR-NFA-2003-01, Exchange Act Release No. 34-47533 (Mar. 19, 
2003), 68 FR 14733 (Mar. 26, 2003); SR-NFA-2005-01, Exchange Act 
Release No. 34-52808 (Nov. 18, 2005), 70 FR 71347 (Nov. 28, 2005); SR-
NFA-2006-01, Exchange Act Release No. 34-53568 (Mar. 29, 2006), 71 FR 
16850 (Apr. 4, 2006); SR-NFA-2007-03, Exchange Act Release No. 34-55710 
(May 4, 2007), 72 FR 26858 (May 11, 2007); SR-NFA-2007-07, Exchange Act 
Release No. 34-57142 (Jan. 14, 2008), 73 FR 3502 (Jan. 18, 2008); and 
SR-NFA-2008-01, Exchange Act Release No. 34-57640 (Apr. 9, 2008), 73 FR 
20341 (Apr. 15, 2008).
2. Statutory Basis
    NFA believes that the proposed rule change is authorized by, and 
consistent with, Section 15A(k)(2)(B) of the Exchange Act.\7\ That 
section sets out requirements for rules of futures associations, 
registered under Section 17 of the Commodity Exchange Act,\8\ that are 
a registered national securities association for the limited purpose of 
regulating the activities of members who are registered as brokers or 
dealers in security futures products pursuant to Section 15(b)(11) of 
the Exchange Act. Under Section 15A(k)(2)(B), the rules of such a 
limited purpose national securities association must be designed to 
prevent fraudulent and manipulative acts and practices, to promote just 
and equitable principles of trade, and, in general, to protect 
investors and the public interest, including rules governing sales 
practices and the advertising of security futures products reasonably 
comparable to the rules of a registered national securities association 
applicable to security futures products. NFA believes the proposed rule 
change would meet these requirements by: Providing limited relief for 
some Members that would currently qualify for the Requirements based on 
a principal's previous affiliation with another Member firm that was 
subject to the Requirements; changing the enhanced capital requirements 
in light of a recent increase in the FCM minimum capital requirement; 
changing the enhanced capital requirements for CPOs and CTAs in a 
manner more consistent with the nature of their business; requiring 
specific items to be included in a firm's written supervisory 
procedures; requiring quarterly rather than monthly reports on a firm's 
compliance with the Requirements; and clarifying language regarding--
charging abnormally high commissions and fees; the effect that 
receiving a waiver has on determining whether a Member is a firm that 
has met the criteria for futures situation involving the Requirements; 
and the status of a ``five year'' Disciplined Firm after it has been 
dropped from the ``five year'' list.
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    \7\ 15 U.S.C. 78o-3(k)(2)(D).
    \8\ 7 U.S.C. 21.
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B. Self-Regulatory Organization's Statement on Burden on Competition

    NFA believes that the portion of the proposed rule change that 
exempts Members from adopting the Requirements when those Requirements 
are triggered by a principal who meets the specified five criteria 
should lessen the burden on competition by eliminating the need for 
waiver requests that are typically granted and decreasing the number of 
firms that are subject to the requirement by automatically exempting 
firms that qualify based on principals whose profiles indicate that 
they are unlikely to pose supervisory problems.
    NFA does not believe that the proposed changes to CPO and CTA 
capital requirements and reporting requirements for firms that trigger 
the Requirements would impose any burden on competition.
    Although the proposed rule change would require FCMs subject to the 
Requirements to maintain additional capital, NFA believes that the 
increase is necessary in order to maintain the purpose behind the 
Requirements, and is also consistent with the approach NFA adopted with 
respect to FDMs. The minimum capital level for all FCMs was recently 
increased to $1,000,000, which is the same amount currently required of 
FCMs subject to the enhanced requirement. In order for the enhanced 
Requirements to maintain their original purpose, NFA believes that the 
capital requirement must be increased. Rather than setting another 
fixed dollar amount, the proposed amendment would tie the required 
enhanced ANC to the early warning requirement under CFTC rules (150% of 
minimum ANC). This revision would impose the same standard on FCM and 
FDM Members and take into consideration any future changes to ANC 
levels.
    The proposed rule change identifies specific areas that need to be 
addressed by an affected Member in the written supervisory procedures 
it is currently required to prepare. NFA represents that the changes 
would not impose additional substantive requirements on Members. 
Rather, NFA believes this language would address requests for Members 
for specific guidance on how to comply with their obligation to 
monitor, catalog and log taped conversations. Therefore, NFA does not 
believe this change imposes any burden on competition.
    The current rule requires Members that charge 50% or more of their 
active customers round-turn commissions, fees and other charges that 
total $100 or more per futures, forex or option

[[Page 205]]

contract to adopt the Requirements. NFA has identified a trend where 
some Members encourage their customers to take on riskier out-of-the 
money options at a cost just below $100. Because in NFA's view these 
positions are much less likely to be liquidated and charged a 
liquidation fee, the total cost remains under the $100 threshold. NFA 
states that the proposed rule change may increase the number of Members 
subject to the Requirements because option contracts that would result 
in total commission, fees and other charges of $100 or more if the 
trade was liquidated will be deemed to have been charged $100 even if 
the trade is not liquidated. NFA believes that the additional burden is 
necessary, however, because Members that engage in this practice are 
clearly within the group of Members that NFA's Board believed should be 
subject to the enhanced Requirements when it chose to use high 
commissions and fees as a trigger for imposing the Requirements.
    NFA believes that the proposed provision that changes a Member's 
reporting obligation with respect to its report on compliance with the 
Requirements will also lessen the burden on Members. Under this 
provision, a Member will be permitted to file this report on a 
quarterly rather than monthly basis.
    NFA believes that the final two proposed revisions do not add any 
burden to competition because they are merely clarifying current 
requirements. One proposed rule change would add language that NFA 
believes makes it clear that a Member that receives a full or partial 
waiver is still deemed to be a Member that has met the criteria for 
purposes of the Notice. Another proposed rule change would add the word 
``current'' before the term ``Disciplined Firm'' in four relevant 
places in order to clarify that a ``five year'' Disciplined Firm will 
no longer be a Disciplined Firm for purposes of triggering the 
Requirements once the firm is dropped from the ``five year'' list.

C. Self-Regulatory Organization's Statement on Comments on the Proposed 
Rule Change Received From Members, Participants, or Others

    NFA states that it worked with its Member Advisory Committees in 
developing the rule change. NFA did not, however, publish the rule 
change to its membership for comment. NFA states that it did not 
receive comment letters concerning the rule change.

III. Date of Effectiveness of the Proposed Rule Change and Timing for 
Commission Action

    On October 20, 2010, the CFTC notified NFA that it had approved the 
rule change, and therefore, NFA is permitted to make the amendments 
effective as of this date.
    Within 60 days of the date of effectiveness of the proposed rule 
change, the Commission, after consultation with the CFTC, may summarily 
abrogate the proposed rule change and require that the proposed rule 
change be refiled in accordance with the provisions of Section 19(b)(1) 
of the Act.

IV. Solicitation of Comments

    Interested persons are invited to submit written data, views, and 
arguments concerning the foregoing, including whether the proposed rule 
change is consistent with the Exchange Act. Comments may be submitted 
by any of the following methods:

Electronic Comments

    <bullet> Use the Commission's Internet comment form (http://www.sec.gov/rules/sro.shtml); or
    <bullet> Send an e-mail to <a href="/cdn-cgi/l/email-protection#c1b3b4ada4eca2aeacaca4afb5b281b2a4a2efa6aeb7"><span class="__cf_email__" data-cfemail="1163647d743c727e7c7c747f6562516274723f767e67">[email protected]</span></a>. Please include 
File Number SR-NFA-2010-04.

Paper Comments

    <bullet> Send paper comments in triplicate to Elizabeth M. Murphy, 
Secretary, Securities and Exchange Commission, 100 F Street, NE., 
Washington, DC 20549-1090.

All submissions should refer to File Number SR-NFA-2010-04. This file 
number should be included on the subject line if e-mail is used. To 
help the Commission process and review your comments more efficiently, 
please use only one method. The Commission will post all comments on 
the Commission's Internet Web site (http://www.sec.gov/rules/sro.shtml 
). Copies of the submission, all subsequent amendments, all written 
statements with respect to the proposed rule change that are filed with 
the Commission, and all written communications relating to the proposed 
rule change between the Commission and any person, other than those 
that may be withheld from the public in accordance with the provisions 
of 5 U.S.C. 552, will be available for Web site viewing and printing in 
the Commission's Public Reference Room, 100 F Street, NE., Washington, 
DC 20549, on official business days between the hours of 10 a.m. and 3 
p.m. Copies of such filing also will be available for inspection and 
copying at the principal office of NFA. All comments received will be 
posted without change; the Commission does not edit personal 
identifying information from submissions. You should submit only 
information that you wish to make publicly available.

    For the Commission, by the Division of Trading and Markets, 
pursuant to delegated authority.\9\
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    \9\ 17 CFR 200.30-3(a)(73).
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Florence E. Harmon,
Deputy Secretary.
[FR Doc. 2010-33097 Filed 12-30-10; 8:45 am]
BILLING CODE 8011-01-P


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