[Federal Register Volume 72, Number 91 (Friday, May 11, 2007)]
[Notices]
[Pages 26858-26861]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: E7-9071]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-55710; File No. SR-NFA-2007-03]


Self-Regulatory Organization; National Futures Association; 
Notice of Filing and Immediate Effectiveness of Proposed Amendments to 
Compliance Rule 2-9 (Supervision) and the Interpretive Notice Regarding 
Compliance Rule 2-9 (Enhanced Supervisory Requirements)

May 4, 2007.
    Pursuant to Section 19(b)(7) of the Securities Exchange Act of 1934 
(``Act'') \1\ and Rule 19b-7 thereunder,\2\ notice is hereby given that 
on February 28, 2007, National Futures Association (``NFA'') filed with 
the Securities and Exchange Commission (``Commission'') the proposed 
rule change described in Items I, II, and III below, which Items have 
been substantially prepared by NFA. The Commission is publishing this 
notice to solicit comments on the proposed rule change from interested 
persons. NFA, on February 27, 2007, submitted the proposed rule change 
to the Commodity Futures Trading Commission (``CFTC'') for approval. 
The CFTC approved the proposed rule change on March 28, 2007.
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    \1\ 15 U.S.C. 78s(b)(7).
    \2\ 17 CFR 240.19b-7.
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I. Self-Regulatory Organization's Description of the Proposed Rules

    Section 15A(k) of the Act \3\ 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 in 
security futures products under Section 15(b)(11) of the Exchange 
Act.\4\ NFA's Interpretive Notice entitled ``Compliance Rule 2-9: 
Enhanced Supervisory Requirements'' (``Interpretive Notice'') applies 
to all Members who meet the criteria in the Interpretive Notice and 
could apply to Members registered under Section 15(b)(11).
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    \3\ 15 U.S.C. 78o-3(k).
    \4\ 15 U.S.C. 78o(b)(11).
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    The amendments to the Interpretive Notice:
    <bullet> Expand the definition of a Disciplined Firm to include 
firms that have been sanctioned by the CFTC or NFA during the preceding 
five years for using deceptive telemarketing practices or promotional 
material, even if the firm was not barred from the industry; and
    <bullet> Impose the enhanced supervisory requirements on firms that 
charge 50% or more of their customers round-turn commissions, fees, and 
other charges that total $100 or more per futures, forex, or option 
contract.
    The amendment to Compliance Rule 2-9(b) adds language specifically 
authorizing NFA's Board to establish criteria related to the employment 
history of a Member's principals and/or to the amount of commissions, 
fees, and other charges assessed by a Member when imposing the enhanced 
supervisory requirements on a Member.

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

    NFA has prepared statements concerning the purpose of, and basis 
for, the proposed rule change, burdens on competition, and comments 
received from members, participants, and others. The text of these 
statements may be examined at the places specified in Item IV below. 
These statements are set forth in Sections A, B, and C below.

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

1. Purpose
    NFA's Board of Directors adopted the original Interpretive Notice 
in January 1993. The Interpretive Notice requires a Member to undertake 
specific enhanced supervisory requirements if its sales force includes 
a specified number of individuals who have worked at Disciplined Firms 
or, in certain situations, when a Member becomes subject to a 
disciplinary action.\5\ The

[[Page 26859]]

Interpretive Notice and an enabling provision of NFA Compliance Rule 2-
9(b) provide that affected Members may petition the Telemarketing 
Procedures Waiver Committee for relief from these obligations.
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    \5\ The Interpretive Notice currently provides that Member firms 
triggering the enhanced supervisory procedures must record all 
telephone conversations between the Member's APs and both existing 
and potential customers, submit all promotional material at least 
ten days prior to first use, adopt written supervisory procedures, 
and either operate under a guarantee agreement or maintain at least 
$250,000 in adjusted net capital (``ANC'').
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    NFA's Board has amended the Interpretive Notice on eleven different 
occasions since it was first issued. The amendments have been based on 
various changes affecting the membership and on practical lessons 
learned from administering the Interpretive Notice over the years. The 
various amendments have at times expanded the scope of the Interpretive 
Notice and, at other times, have granted relief to the membership in 
situations when conditions indicated that it was warranted. For 
example, amendments were made due to the emergence of security futures 
products; in response to Members that reorganize their business to 
avoid the enhanced supervisory requirements; and in recognition that 
some associated persons (``APs'') who worked at Disciplined Firms long 
ago and/or for a short time who do not appear to pose an extraordinary 
risk to the public.
a. Expansion of the Definition of Disciplined Firm
    Members currently qualify for the enhanced supervisory requirements 
if they hire a prescribed percentage of APs and principals who 
previously worked at Disciplined Firms. Disciplined Firms are defined 
in the Interpretive Notice as firms that have been formally charged by 
either the CFTC or NFA with using deceptive telemarketing practices or 
promotional material and have been permanently barred from the industry 
as a result of those charges. Disciplined Firms also include firms that 
have been barred by the NASD or the SEC for fraud-related sales 
practices involving security futures products.
    The amendments to the Interpretive Notice expand the definition of 
a Disciplined Firm beyond firms that have been permanently barred from 
the industry for sales practice or promotional material violations by 
adding firms that have been sanctioned in any way for those types of 
violations during the preceding five years. These amendments are 
consistent with the considerations cited by NFA's Board when it 
originally issued the Interpretive Notice in 1993 and are supported by 
information NFA gleaned in reviewing the firms that would be affected 
by the change.
    When NFA's Board first established the enhanced supervisory 
requirements, it noted in the Interpretive Notice that when a firm is 
closed for fraudulent sales tactics, it is reasonable to believe that 
the training and supervision that it gave its APs was ``wholly 
inadequate or inappropriate.'' The Board stated further that:

    It is also reasonable to conclude that an AP who received 
inadequate or inappropriate training and supervision may have 
learned improper sales tactics, which he will carry with him to his 
next job. Therefore, the Board believes that a Member firm employing 
such a sales force must have stringent supervision procedures in 
place in order to ensure that the improper training its APs have 
previously received does not taint their sales efforts on behalf of 
the Member.

    More than 140 former NFA Members are currently classified as 
Disciplined Firms. The amendments to the Interpretive Notice would add 
approximately 180 firms to the list of Disciplined Firms because they 
have received sanctions short of a permanent bar from the CFTC or NFA 
for sales practice and/or promotional material violations during the 
last five years.
    Members that would be added as Disciplined Firms would not 
themselves become subject to the enhanced supervisory requirements 
merely because they are now categorized as Disciplined Firms. Rather, 
the effect of the proposal would be that their APs and principals would 
have to be counted by present and future sponsors as having worked at a 
Disciplined Firm for purposes of determining whether the sponsor's 
employee mix triggered an obligation to adopt the enhanced supervisory 
requirements. The overall effect of the reclassification of the 
individuals who worked for the firms that would be added to the 
Disciplined Firm list under the proposal would be to obligate 
approximately forty-five additional active Members to adopt the 
enhanced supervisory requirements. By comparison, ten Members became 
subject to the enhanced supervisory requirements during 2005 and 
thirty-nine Members became subject to the requirements in 2006.\6\
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    \6\ The increase in 2006 is largely attributable to the impact 
of revisions made to the Interpretive Notice in early 2006 and to 
adding a number of Members to the list of Disciplined Firms when 
charges against them were resolved with permanent bars.
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    NFA's review of the disciplinary histories of the additional 
Members that would become subject to the enhanced supervisory 
requirements indicates that they have an incidence of disciplinary 
actions that far outstrips the industry average for sales practice and 
promotional material violations. In fact, eleven of these firms have 
already been subject to NFA or the CFTC actions alleging abusive sales 
practices and/or misleading promotional material. Based on the 
disciplinary history of these firms and the employment histories of 
their principals and APs, it is reasonable to conclude that they would 
benefit from the enhanced supervisory requirements ``to ensure that the 
improper training [the firm's] APs have previously received does not 
taint their sales efforts on behalf of the Member.''
b. Imposition of Enhanced Supervisory Requirements Based on Commissions 
and Fees
    NFA has also recently reviewed whether it is appropriate to impose 
the enhanced supervisory requirements on the few Members that charge 
commissions and fees that are substantially in excess of the normal 
range assessed by the general membership. NFA staff has reviewed the 
commission and fee structures of a number of Member firms which have 
been subject to disciplinary action and arbitration claims during 
recent years and has found that a significant correlation exists 
between firms that are cited as respondents in actions for misleading 
sales practices and firms that charge abnormally high commissions and 
fees.
    NFA reviewed the commission rates charged by Member firms that have 
been cited by the Business Conduct Committee for misleading sales 
practices over the last three years. All but one of the approximately 
twenty firms included in the group charged total round-turn 
commissions, mark-ups, fees, and other charges of between $95 and $250 
per futures, forex, or option contract--with the strong majority of the 
firms skewing toward the high end of that range.
    In addition, NFA reviewed arbitration claims to determine if there 
was any correlation between claims and high commission rates. Five of 
the twelve firms that have been subject to the highest number of claims 
are small-to-medium-sized firms that charge commissions that compare to 
the high rates described above. Many of the claims against those firms 
included allegations of misleading sales practices.\7\
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    \7\ Six large firms that charge commissions that are in line 
with industry norms are among the twelve Members that have been 
subject to the most arbitration claims made over the past three 
years. This is not surprising based on their size.
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    The correlation between charging abnormally high commissions and 
fees

[[Page 26860]]

and allegations of sales practice fraud suggests that firms that charge 
commissions that are significantly in excess of industry norms would 
benefit from the enhanced supervisory requirements. In particular, 
recording conversations with the public would give affected Members the 
opportunity to ensure that misrepresentations and failure to disclose 
costs would be detected and, hopefully, corrected.
    Based on this information, the Board amended the Interpretive 
Notice to impose the enhanced supervisory requirements on any Member 
firm that charges 50% or more of its active customers round-turn 
commissions, fees, and other charges that total $100 or more per 
futures, forex, or option contract.\8\ In setting the amount of 
commissions at this level, NFA relied upon feedback from NFA's Advisory 
Committees and Joint Audit Committee representatives, and used data 
obtained in NFA's examinations of Member firms. This feedback suggests 
that Members that charge commissions and fees below this level are less 
likely to engage in fraudulent sales practices.
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    \8\ The term ``active customers'' means any customers who are 
entitled to a monthly statement under the provisions of CFTC 
Regulations Sec.  1.33(a).
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    The amended Interpretive Notice imposes a duty on Members to notify 
NFA if they charge round-turn commissions, fees, and other charges that 
reach the triggering levels specified in the Interpretive Notice. In 
addition, upon inquiry by NFA, Members have the burden of demonstrating 
that they do not meet the triggering levels. The amendments to the 
Interpretive Notice add the reasonableness of commissions and the 
effectiveness of any disclosure to customers regarding them to the list 
of factors that the Telemarketing Procedures Waiver Committee may 
consider in evaluating a waiver request.
c. Exemptions for Certain Associated Persons
    The Interpretive Notice exempts two groups of APs who have 
previously worked at Disciplined Firms from being counted for purposes 
of calculating whether their current employer's sales force triggers 
the enhanced supervisory requirements. NFA's analysis shows that, in 
general, the APs covered by the exemptions do not pose a greater threat 
to the public than the overall population of APs.
    The first exempt group was created in 2003 and includes APs who 
worked for Disciplined Firms for less than 60 days and who have not 
been employed by any Disciplined Firm during the preceding five years. 
The second exempt group was created in April of 2006 and includes APs 
who worked at a single Disciplined Firm more than ten years ago and who 
have not worked for a Member that has been subject to any sales 
practice action by NFA or the CFTC since leaving the Disciplined Firm. 
The Interpretive Notice provides that those APs must not have been 
personally subject to disciplinary action by NFA or the CFTC. The 
amendments to the Interpretive Notice require APs who fall into the 
first exempt group to be treated consistently with those in the second 
group by also requiring them to be free from personal disciplinary 
action by NFA or the CFTC.
d. Enhanced Adjusted Net Capital Requirement
    The Interpretive Notice currently requires all Members that are 
subject to the enhanced supervisory requirements to either operate 
pursuant to a guarantee agreement or to maintain ANC of at least 
$250,000, which has historically been the benchmark amount for FCMs 
required under NFA Financial Requirements. Revisions to NFA's Financial 
Requirements that raised the ANC requirements for Forex Dealer Members 
(``FDMs'') to $1,000,000 and for other FCMs to $500,000 became 
effective on July 31, 2006--thus rendering the current Interpretive 
Notice outdated as it applies to the ANC requirements for those 
Members. The ANC requirement for IBs was raised from $30,000 to $45,000 
at the same time, but the new IB levels are still much less than the 
$250,000 required under the Interpretive Notice.
    The revised Interpretive Notice imposes an ANC requirement of 
$2,000,000 on FDMs and $1,000,000 on other FCMs that are subject to the 
enhanced supervisory requirements. The Interpretive Notice also makes 
it clear that the $250,000 increased ANC requirement applies to CTAs 
and CPOs as well as IBs.
e. Miscellaneous Amendments
    In giving the option to Members that qualify for the enhanced 
supervisory procedures to either operate under a guarantee agreement or 
maintain at least $250,000 in ANC, the current language of the 
Interpretive Notice limits the pool of potential guarantors to FCMs 
that meet the eligibility requirements for executing a Supplemental 
Guarantor Certification Statement (``SGCS'') pursuant to NFA 
Registration Rule 504(a)(2)(B). Changes have been made to NFA's 
Registration Rules since the inclusion of the reference to NFA 
Registration Rule 504(a)(2)(B) in the Interpretive Notice and, in fact, 
the Registration Rule provision cited in the Interpretive Notice no 
longer exists. A technical amendment to the Interpretive Notice deletes 
the reference to defunct NFA Registration Rule 504(a)(2)(B) and 
replaces it with a reference to NFA Registration Rule 509(b)(5), which 
contains comparable provisions for eligibility to execute an SGCS.
    Most Members that are required to record conversations with 
customers use standard format audio cassette recordings or commonly 
used digital recording programs. However, there have been several 
instances in which Members have provided recordings to NFA that are in 
outdated or exotic media formats. NFA has occasionally had to go to 
extraordinary lengths in order to hear and understand the contents of 
some of those recordings. In one case, NFA Compliance staff auditors 
had to travel to the FBI facility at Quantico, Virginia to listen to 
tapes because the FBI had one of the few machines capable of playing 
back recordings produced by a Member and the firm had represented that 
its outdated machinery was irreparably damaged. The amended 
Interpretive Notice requires Members subject to enhanced supervisory 
requirements to promptly provide NFA or the CFTC with the appropriate 
resources for listening to the recording upon request. Obviously, such 
a request would be rare but the addition would be of great benefit in 
certain circumstances and would likely encourage affected Members to 
use standard media formats in the first place.
    NFA Compliance Rule 2-9(b) authorizes NFA's Board to establish 
criteria for becoming subject to the enhanced supervisory requirements. 
The existing rule explicitly authorizes the Board to establish those 
criteria based on the employment history of a firm's APs but does not 
mention either the employment history of a Member's principals or the 
amount of commissions, fees and other charges assessed by a Member. The 
amendments to the rule add this language.
2. Statutory Basis
    NFA has filed these proposed regulations pursuant to Section 
19(b)(7) of the Act.\9\ The rule change is authorized by, and 
consistent with, Section 15A(k) of the Act.
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    \9\ 15 U.S.C. 78s(b)(7).
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B. Self-Regulatory Organization's Statement on Burden on Competition

    The rule change will not impose any burden on competition that is 
not necessary or appropriate in furtherance

[[Page 26861]]

of the purposes of the Act and the Commodity Exchange Act.

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

    NFA did not publish the rule change to the membership for comment 
but did discuss it with NFA's FCM, IB and CPO/CTA Advisory Committees. 
NFA did not receive comment letters concerning the rule change.

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

    On February 27, 2007, NFA submitted the proposed amendments to 
NFA's Compliance Rule 2-9 and the Interpretive Notice to the CFTC for 
approval. The proposed rule change has become effective on March 28, 
2007, the date of approval of the proposed rule change by the CFTC.
    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 Exchange Act.\10\
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    \10\ 15 U.S.C. 78s(b)(1).
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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 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#b8cacdd4dd95dbd7d5d5ddd6cccbf8cbdddb96dfd7ce"><span class="__cf_email__" data-cfemail="3b494e575e16585456565e554f487b485e58155c544d">[email protected]</span></a>. Please include 
File Number SR-NFA-2007-03 on the subject line.

Paper Comments

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

All submissions should refer to File Number SR-NFA-2007-03. 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 inspection and 
copying in the Commission's Public Reference Room. Copies of the filing 
also will be available for inspection and copying at the principal 
office of the Exchange. 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 available publicly. All submissions should refer to File Number 
SR-NFA-2007-03 and should be submitted on or before June 1, 2007.

    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\11\
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    \11\ 17 CFR 200.30-3(a)(12).
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Florence E. Harmon,
Deputy Secretary.
 [FR Doc. E7-9071 Filed 5-10-07; 8:45 am]
BILLING CODE 8010-01-P


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