© 2015 International Monetary Fund 

IMF Country Report No. 15/91 

UNITED STATES 

FINANCIAL SECTOR ASSESSMENT PROGRAM 

DETAILED ASSESSMENT OF IMPLEMENTATION ON THE 

IOSCO OBJECTIVES AND PRINCIPLES OF SECURITIES 

REGULATION

This Detailed Assessment of Implementation on the IOSCO Objectives and Principles of 

Securities Regulation on the United States was prepared by a staff team of the International 

Monetary Fund. It is based on the information available at the time it was completed in March 

2015. 

Copies of this report are available to the public from 

International Monetary Fund  Publication Services 

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Price: $18.00 a copy 

International Monetary Fund 

Washington, D.C. 

April 2015 
UNITED STATES 

DETAILED ASSESSMENT OF 

IMPLEMENTATION 

IOSCO OBJECTIVES AND PRINCIPLES OF SECURITIES 

REGULATION 

Prepared By 

Monetary and Capital 

Markets Department 

This Detailed Assessment Report was prepared in the 

context of an IMF Financial Sector Assessment 

Program (FSAP) mission in the United States during 

October-November 2014, led by Aditya Narain, IMF 

and overseen by the Monetary and Capital Markets 

Department, IMF. Further information on the FSAP 

program can be found at 

http://www.imf.org/external/np/fsap/fssa.aspx. 

March 2015 
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CONTENTS 

GLOSSARY _________________________________________________________________________________________ 3

EXECUTIVE SUMMARY ___________________________________________________________________________ 8

INTRODUCTION ________________________________________________________________________________ 10

INFORMATION AND METHODOLOGY USED FOR ASSESSMENT _____________________________ 10

INSTITUTIONAL AND MARKET STRUCTURE—OVERVIEW ___________________________________ 11

A. Regulatory Structure __________________________________________________________________________ 11

B. Market Structure ______________________________________________________________________________ 12

PRECONDITIONS FOR EFFECTIVE SECURITIES REGULATION _________________________________ 17

MAIN FINDINGS ________________________________________________________________________________ 18

SUMMARY IMPLEMENTATION OF THE IOSCO PRINCIPLES __________________________________ 21

RECOMMENDED ACTION PLAN AND AUTHORITIES' RESPONSE ____________________________ 31

C. Authorities’ Response to the Assessment _____________________________________________________ 33

DETAILED ASSESSMENT ________________________________________________________________________ 34

TABLES 

1. Key Equity Market Information ________________________________________________________________ 12

2. Investment Company Total Net Assets by Type _______________________________________________ 14

3. Institutional and Retail Ownership of Mutual Funds ___________________________________________ 15

4. Number of Commodity Pool Operators and their AUM _______________________________________ 15

5. Registered Broker-Dealers _____________________________________________________________________ 16

6. SEC Registered Investment Advisers ___________________________________________________________ 16

7. Derivatives Market Intermediaries Registered with the CFTC __________________________________ 17

8. Summary Implementation of the IOSCO Principles—Detailed Assessments __________________ 21

9. Recommended Action Plan to Improve Implementation of the IOSCO 

Principles _________________________________________________________________________________________ 31

10. Detailed Assessment of Implementation of the IOSCO Principles ____________________________ 35
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INTERNATIONAL MONETARY FUND 3

Glossary

ABS Asset-Backed Security 

AICPA American Institute of Certified Public Accountants 

ALJ Administrative Law Judge 

AML Anti-Money Laundering 

ANC Alternative Net Capital 

AP Associated Person 

APA Administrative Procedure Act 

ARP Automation Review Policy 

ASB Auditing Standards Board 

ATS Alternative Trading System 

AUM Assets under Management 

BCP Business Continuity Plan 

BD Broker-Dealer 

CAT Consolidated Audit Trail 

CBOE Chicago Board Options Exchange 

CCO Chief Compliance Officer 

CCP Central Counterparty 

CD&A Compensation Disclosure and Analysis 

CDO Collateralized Debt Obligation 

CDS Credit Default Swap 

CEA Commodity Exchange Act 

CF SEC’s Corporation Finance Division 

CFMA Commodity Futures Modernization Act of 2000 

CFTC Commodity Futures Trading Commission 

CHX Chicago Stock Exchange 

CIP Customer Identification Program 

CIS Collective Investment Scheme 

CMBS Commercial Mortgage-Backed Security 

CME Chicago Mercantile Exchange 

CP Commodity Pool 

CPA Certified Public Accountant 

CP&P Compliance Policies and Procedures 

CPO Commodity Pool Operator 

CRA Credit Rating Agency 

CRARA Congressional Review of Agency Rulemaking Act 

CSD Central Securities Depository 

CTA Commodity Trading Advisor 

DCM Designated Contract Market 

DCO Derivatives Clearing Organization 
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DCR Division of Clearing and Risk 

DEA Designated Examining Authority 

DERA SEC’s Division of Economic and Risk Analysis 

DFMU Designated Financial Market Utility 

DGCL Delaware General Corporation Law 

DMO Division of Market Oversight 

DOE Division of Enforcement 

DOJ Department of Justice 

DSIO Division of Swap Dealer and Intermediary Oversight 

DSRO Designated Self-regulatory Organization 

DTC The Depository Trust Company 

ECN Electronic Communications Network 

ECP Eligible Contract Participant 

EDGAR Electronic Data Gathering, Analysis, and Retrieval System 

ERA Exempt Reporting Adviser 

ETF Exchange Traded Fund 

FAF Financial Accounting Foundation 

FASB Financial Accounting Standards Board 

FATF Financial Action Task Force 

FBI Federal Bureau of Investigation 

FBOT Foreign Board of Trade 

FCM Futures Commission Merchant 

FDIC Federal Deposit Insurance Corporation 

FERC Federal Energy Regulatory Commission 

FESC Front End Systemic Capture 

FHFA Federal Housing Finance Agency 

FHFOB Federal Housing Finance Oversight Board 

FICC Fixed Income Clearing Corporation 

FinCEN Financial Crimes Enforcement Network 

FINRA Financial Industry Regulatory Authority 

FMU Financial Market Utility 

FOIA Freedom of Information Act 

FSB Financial Stability Board 

FSOC Financial Stability Oversight Council 

FTC Federal Trade Commission 

FTCA Federal Employees Liability Reform and Tort Compensation 

Act of 1988 

GAAP Generally Accepted Accounting Principles 

GAAS Generally Acceptable Auditing Standards 

GAO Government Accountability Office 

GLBA Gramm-Leach-Bliley Act of 1999 

HF Hedge Fund 
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IA Investment Adviser 

IAC Investor Advisory Committee 

IASB International Accounting Standards Board 

IB Introducing Broker 

ICA Investment Company Act of 1940 

ICE Intercontinental Exchange 

ICEEU ICE Clear Europe 

IFRS International Financial Reporting Standards 

IM SEC’s Division of investment Management 

IOPA (Office of) Independent Oversight and Performance 

Assurance 

IOSCO International Organization of Securities Commissions 

IPO Initial Public Offering 

IRS Internal Revenue Service 

ISG Intermarket Surveillance Group 

ISV Independent Software Vendor 

JAC Joint Advisory Committee 

JOBS Act Jumpstart Our Business Startups Act 

LLC Limited Liability Company 

LULD Limit-Up Limit-Down 

MD&A Management’s Discussion and Analysis 

MIDAS Market Information Data and Analytics System 

MLWG Money Laundering Working Group 

MMF Money Market Fund 

MMOU Multilateral Memorandum of Understanding 

MOU Memorandum of Understanding 

MRAC Market Risk Advisory Committee 

MSBSP Major Security-Based Swap Participants 

MSP Major Swap Participant 

MSPPU Municipal Securities and Public Pensions Unit 

MSRB Municipal Securities Rulemaking Board 

NASD National Association of Securities Dealers 

NAV Net Asset Value 

NBB National Best Bid 

NBBO National Best Bid and Offer 

NEP National Examination Program 

NFA National Futures Association 

NMS National Market System 

NRSRO Nationally Recognized Statistical Rating Organization 

NSCC National Securities Clearing Corporation 

NSMIA National Securities Markets Improvement Act of 1996 

NYSE New York Stock Exchange 

OATS Order Audit Trail System 
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OCA SEC’s Office of the Chief Accountant 

OCC Office of the Comptroller of the Currency 

OCE Office of the Chief Economist 

OCIE SEC’s Office of Compliance Inspections and Examinations 

OCR SEC’s Office of Credit Ratings 

OEC SEC’s Office of the Ethics Counsel 

OFR Office of Financial Research 

OGC Office of the General Counsel 

OGE Office of Government Ethics 

OIA Office of International Affairs 

OIG Office of the Inspector General 

OMB Office of Management and Budget 

OTC Over-the-counter 

PCAOB Public Company Accounting Oversight Board 

PRA Paperwork Reduction Act 

RAUM Regulatory Assets Under Management 

RER Rule Enforcement Review 

RFA Registered Futures Association 

RFPA Right to Financial Privacy Act 

RMBS Residential Mortgage-Backed Security 

ROOR Risk Oversight and Operational Regulation 

RSA Regulatory Service Agreement 

RSD Regulatory Services Division 

RSG CFTC’s Risk Surveillance Group 

SAI Statement of Additional Information 

SAR Suspicious Activity Report 

SB SEF Security-Based Swap Execution Facility 

SBS Security-Based Swap 

SBSD Security-Based Swap Dealer 

SCI Systems Compliance and Integrity 

SD Swap Dealer 

SDR Swap Data Repository 

SEC Securities and Exchange Commission 

SEF Swap Execution Facility 

SFP Securities Futures Product 

SIDCO Systemically Important Derivatives Clearing Organization 

SIP Securities Information Processor 

SIPA Securities Investor Protection Act 

SIPC Securities Investor Protection Corporation 

SRO Self-Regulatory Organization 

SOX Sarbanes-Oxley Act of 2002 

TCP Technology Control Program 

TCR Tip, Complaint, or Referral 
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TFCE Trading and Financial Compliance Examinations 

TM SEC’s Division of Trading and Markets 

TRO Temporary Restraining Order 

UIT Unit Investment Trust 

UNTOC U.N. Convention Against Transnational Organized Crime 

VAR Value at Risk 

XBRL eXtensible Business Reporting Language 
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EXECUTIVE SUMMARY 

1. The United States has large, well-developed and complex securities and derivatives 

markets. These provide widespread benefits not only to the U.S. economy, but globally. The crisis 

and recent high profile failures have provided important lessons that have significantly impacted the 

regulation and supervision of these markets. 

2. Post crisis, the legal mandates of the Securities and Exchange Commission (SEC) and 

the Commodity Futures Trading Commission (CFTC) have significantly expanded. The agencies 

now share the responsibility for swaps markets, while hedge fund (HF) managers and municipal 

advisors are now under the SEC’s jurisdiction. The CFTC has already adopted the large majority of 

rules needed for swaps markets, and final registration of swap dealers is underway. The same applies 

to the SEC in connection with HF managers and municipal advisors, while its rulemaking related to 

swaps is less advanced. Enhancements have been made to prudential requirements applicable to 

some key regulated entities, in particular in connection with internal controls, risk management, and 

protection of client assets. The agencies are taking an increasingly forward looking risk-based 

approach to supervision and enhancing their risk identification processes. This includes improving 

data collection, developing automated tools for data analysis, and recruiting staff with diverse skill 

sets. The agencies have also worked on improving the use of the enforcement function. Many of 

these improvements can also be observed at the SROs. All are welcome changes and efforts in all 

these areas should continue as appropriate. 

3. The level of funding of both the SEC and CFTC is a key challenge affecting their ability 

to deliver on their mandates in a way that provides confidence to markets and investors.

Funding limitations have impacted the timely delivery of new rules and the implementation of 

registration programs for the new categories of participants. These are transitory challenges. 

However, the markets under the agencies’ supervision have become larger and more complex. In 

this context, the number of expert staff in the SEC and CFTC does not appear to be sufficient to 

ensure a robust level of hands-on supervision, which has become clear in the case of investment 

advisers (IAs). Leveraging on technology can mitigate but not replace the need for additional human 

resources. Therefore consideration should be given to making both agencies self-funded and 

allowing for multiyear budgeting. 

4. The fragmented structure of equity markets remains a key challenge for the SEC. The 

framework developed by the SEC has served its purpose of enhancing competition and providing a 

framework for best execution. However, the markets have evolved and the framework needs to be 

updated accordingly to ensure sufficient operational transparency for all types of trading venues as 

well as fair and objective access. At the same time, the SEC needs to remain vigilant about the 

impact dark trading may have on overall price formation. The recently announced Equity Market 

Structure Advisory Committee is an important step. 

5. It is important that both agencies continue to strengthen their ability to identify 

emerging and systemic risks. This is critical for the effective discharge of their respective 
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mandates, but also to enhance their contributions to the mandate of the Financial Stability 

Oversight Council (FSOC). Enhancing mechanisms to ensure a holistic view of risks is recommended, 

in particular by the respective Commission (as a whole) of each agency becoming more involved in 

the process of assessing and monitoring responses to risks. 

6. The regulatory and supervisory arrangements remain quite complex, involving two 

agencies and a number of important self-regulatory organizations (SROs). Effective supervision 

of the SROs and, given its gatekeeping role, the Public Company Accounting Oversight Board 

(PCAOB), remains a priority. The SEC and CFTC have made efforts to ensure effective communication 

and, where possible, coordination on rulemaking and supervision. Those efforts should continue, in 

particular because a significant portion of regulated entities conduct activities in both the securities 

and derivatives markets. More generally, effective coordination needs to extend to all regulatory 

authorities—including banking regulators and SROs—with mandates that impact securities and 

derivatives markets. 
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INTRODUCTION 

7. An assessment of the level of implementation of the IOSCO Objectives and Principles 

of Securities Regulation (IOSCO Principles) was conducted in the United States from October 

27 to November 19, 2014. The assessment was made as part of the IMF FSAP by Ana Carvajal, IMF 

(currently seconded to the World Bank Group), Eija Holttinen, IMF, and Malcolm Rodgers, external 

expert working for the IMF. The previous IOSCO assessment of the United States was conducted 

in 2009. 

INFORMATION AND METHODOLOGY USED FOR 

ASSESSMENT 

8. The assessment was made on the basis of the IOSCO Principles approved in 2010 and 

the Assessment Methodology adopted in 2011. As has been the standard practice, 

Principle 38 was not assessed due to the existence of separate standards for securities settlement 

systems and central counterparties. A review of the regulatory and supervisory framework in place at 

the state level was outside of the scope of this assessment. Given the relatively limited role played 

by state regulation and supervision (as described below), the assessors do not consider that this 

limitation in the scope of the assessment has materially affected the overall judgment of the U.S 

regime. 

9. The IOSCO Assessment Methodology requires that assessors not only look at the legal 

and regulatory framework in place, but also at how it has been implemented in practice. The 

ongoing global financial crisis has reinforced the need for assessors to make a judgment about 

supervisory and other operational practices and to determine whether they are sufficiently effective. 

Among other things, such a judgment involves a review of the inspection programs for different 

types of supervised entities, the cycle, scope and quality of inspections, as well as how the relevant 

authorities follow up on findings, including by using enforcement actions. Given that the IOSCO 

Principles and Methodology do not specifically address OTC derivatives, the adoption and 

implementation status of the U.S. OTC derivatives framework has not impacted the grades given. 

10. The assessment was based on several sources. These comprise (i) self-assessments and 

additional written responses prepared by the CFTC and SEC; (ii) reviews of the relevant legislation 

and regulations; (iii) meetings with the management and staff of the CFTC, SEC, PCAOB, and the 

criminal authorities; and (iv) meetings with industry associations and market participants, including 

exchanges, broker-dealers (BDs), IAs, futures commission merchants (FCMs), commodity pool 

operators (CPOs), audit firms, and credit rating agencies (CRAs). 

11. The assessors want to thank the U.S. authorities and market participants for their 

cooperation and willingness to share information. The views of authorities and market 

participants on the current status and the best way forward for the regulation and supervision of the 

U.S. securities and derivatives markets provided an essential input to the conclusions of the mission. 
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INSTITUTIONAL AND MARKET STRUCTURE—

OVERVIEW 

A. Regulatory Structure 

12. Two federal agencies, the SEC and the CFTC, share the primary responsibility for the 

regulation and supervision of the U.S. securities and derivatives markets. Broadly speaking, the 

SEC is in charge of the regulation and supervision of securities markets and single security based 

options, futures and swaps markets. Its functions and powers are based on several Federal Acts, 

most importantly the Securities Exchange Act of 1934 (Exchange Act), the Securities Act of 1933 

(Securities Act), the Investment Company Act of 1940 (ICA), and the Investment Advisers Act of 1940 

(Advisers Act). The CFTC is responsible for the regulation and supervision of futures, options and 

swaps markets (except for narrow-based security indices), exercising its authority primarily under the 

Commodity Exchange Act (CEA). 

13. The SEC’s and CFTC’s mandates were significantly expanded as a result of the 

enactment of the Wall Street Reform and Consumer Protection Act (Dodd-Frank Act). The Act 

provided the SEC and CFTC with shared responsibility over the swaps markets and brought HF 

managers and municipal advisors under the jurisdiction of the SEC. The CFTC has already adopted 

the large majority of rules needed for swaps markets, and final registration of swap dealers is 

underway. The mandatory clearing and trade execution requirements already apply to certain swaps, 

and several swap execution facilities (SEFs) have been temporarily registered. Swaps have to be 

reported to swap data repositories (SDRs). Rulemaking by the SEC in relation to HF managers and 

municipal advisors has been completed, while the SEC’s securities-based swaps rulemaking is less 

advanced. The authorities’ progress in proposing and adopting their respective regulations is further 

described throughout this assessment, but as noted above, has not impacted the grades. 

14. State securities regulators coexist with the federal regulators; however their role is 

limited. The registration of securities for issuance to the public and of intermediaries, along with the 

monitoring and supervision of these activities, are mainly carried out by the federal regulators. State 

regulators maintain responsibility for issuances that are conducted at the state level only. Both state 

and federal legislation provide a regulatory framework for BDs and IAs, but not for futures and 

derivatives intermediaries. The role of state regulators has recently increased for smaller IAs. 

Pursuant to the thresholds established in the Dodd-Frank Act, the registration and supervision of IAs 

with portfolios of $100 million or less (increased from $25 million) is generally now the responsibility 

of the state regulators. 

15. The CFTC and SEC rely to a significant degree on SROs for the regulation of the 

markets and their participants. The SROs include exchanges, clearing organizations, and securities 

and futures associations. Given the focus of the IOSCO assessment, the emphasis has been on the 

exchanges and associations. In general exchanges have a role in market surveillance and some of 

them also in member supervision. There are two registered associations with SRO functions: the 
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Financial Industry Regulatory Authority (FINRA) and the National Futures Association (NFA). FINRA 

has authority over BDs, while the NFA has authority over all intermediaries in the futures and swaps 

markets. Membership in an SRO is mandatory for the corresponding intermediaries.1

 In addition to 

member registration and supervision, FINRA also has a role in market surveillance due to 

agreements with different exchanges and for OTC trading. The NFA is developing a similar role for 

some SEFs. 

16. Criminal enforcement is the responsibility of federal, state and local authorities. The 

SEC and CFTC have significant administrative and civil enforcement powers. In addition, criminal 

prosecution is available by other U.S. authorities to pursue securities and derivatives market 

violations. Federal, state and local prosecutorial authorities play an active role in criminal (and in 

some cases civil) enforcement of securities laws, working both with the regulators and on their own 

initiative. 

B. Market Structure 

Issuers 

17. The U.S. equity markets continue to be the largest in the world. As of end 2013 there 

were 5,655 issuers listed on the three largest exchanges (the majority of them either on the New 

York Stock Exchange (NYSE) or NASDAQ) with a total market capitalization of approximately 

150 percent of GDP. The number of new listings remained high, with 614 new issues listed in 2013. 

(Table 1). 

Table 1. Key Equity Market Information 

 2011 2012 2013 

 NYSE NASDAQ BATS NYSE NASDAQ BATS NYSE NASDAQ BATS 

Number of issuers 2,995 2,680 - 2,989 2,577 2 3,016 2,637 2 

Market 

capitalization 

(billion USD) 

11,796 4,421 - 14,086 5,149 0.5 17,950 6,974 1.4 

Market 

capitalization as 

percent of GDP 

70 28 - 87 32 0.0 107 42 0.0 

Market 

capitalization of 

top 10 issuers 

(billion USD) 

2,210 1,544 - 2,338 1,750 36 2,683 2,151 54 

Number of new 

listings 

497 151 - 376 158 17 369 239 6 

Annual turnover 

(trillion USD) 

19.3 NA - 14.7 NA 1 15.3 NA 3.5 

Average daily 

turnover (billion 

USD) 

75.9 NA - 59 NA 5.6 60.7 NA 17.4 

Source: NYSE, NASDAQ, BATS

 

1

 Only IAs are not required to be members of any SRO and are therefore exclusively supervised by the SEC. Municipal 

advisors must be registered with both the MRSB and the SEC. 
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18. Municipal securities are an important component of the U.S. securities markets. The 

outstanding amount of municipal securities as of end-2014 was approximately $ 3.7 trillion (around 

one third of the size of the corporate and foreign bonds market). There are roughly 45,000 different 

municipalities issuing debt, and some 12,000 bond issues on an annual basis. Average issue size is 

$25 million. Retail investors account for a significant portion of this market. Direct retail holdings are 

estimated at roughly 45–50 percent of total outstanding debt, and indirect holdings (through 

mutual funds) at about 25 percent. Historical rates of default have been low (less than 1 percent 

compared to 11–13 percent for issuers of corporate debt, although the rate of default for nonmunicipal conduit borrowers has been higher). 

19. Almost all asset-backed securities (ABS) markets experienced historic downturns 

following the crisis, and the recovery of these markets has not been uniform.2 Private label 

(non-U.S. agency) ABS issuers held $2.6 trillion in assets in 2004, which grew to $4.5 trillion in 2007, 

and declined to $1.6 trillion in 2013. This distinction is most stark in the case of private-label 

residential mortgage-backed securities (RMBS), including home equity lines of credit. Prior to the 

crisis the overwhelming majority of these securities were registered issuances. In 2004 new issuances 

of registered private-label RMBS totaled $746 billion. This dropped to $12 billion in 2008 and 

$4 billion in 2013, 0.5 percent of the 2004 issuance level. As of the time of the assessment the 

private-label RMBS market remained weak and consisted almost exclusively of unregistered RMBS 

offerings. Registered commercial mortgage-backed securities (CMBS) experienced a similar drop. In 

2004 new issuances totaled $74 billion, declining to $11 billion in 2008, and $53 billion in 2013. The 

consumer finance ABS market, including credit card and auto securitizations, also declined 

drastically both in terms of number of deals and issuance volume after the financial crisis. For 

example, $85 billion of Auto ABS were issued in 2005, but after the crisis issuance dropped to 

$32 billion in 2008. However, unlike RMBS, issuance of consumer finance ABS, especially Auto ABS, 

has since 2008 steadily increased to $62 billion in 2013. 

Trading venues 

20. Trading in the U.S. equity markets is divided between national securities exchanges, 

alternative trading systems (ATS), and over-the-counter (OTC). At the end of December 2014,

there were 11 national securities exchanges and 39 ATS operating equity trading systems. There are 

no official statistics on the distribution of trading between exchanges, ATS, and OTC. Some market 

sources estimate the latter two to amount up to approximately 40 percent of the total value of 

equity trading in the U.S.3

 According to a paper published by SEC staff,4 ATSs executed 11.3 percent 

of the total value of trading in National Market System (NMS) stocks during a one week period in 

 

2

 See Securities and Exchange Commission. 17 CFR Parts 229, 230, 232, 239, 240, 243, and 249. Release Nos. 33-9638; 

34-72982; File No. S7-08-10. 

3

 See, for example, http://www.bloombergview.com/quicktake/dark-pools. 

4

 Tuttle, Laura, Alternative Trading Systems: Description of ATS Trading in National Market System Stocks, October 

2013. 
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May 2012. Another SEC staff paper5 estimates that 17 percent of the total value of trading in NMS 

stocks was executed OTC (excluding ATS trading) during one week in May 2012. During May 2014–

September 2014, ATSs accounted for 15 percent of the trading volume for NMS stocks (by number 

of shares). 

21. While futures and options trading volumes continue to increase, the majority of 

derivatives are traded in the OTC derivatives (swaps) markets. 15 Designated Contract Markets 

(DCMs) currently organize trading in futures and options, with the number of contracts traded 

estimated to amount to 3.7 billion at the end of 2014. At the same time, swap trading volumes were 

estimated to amount to 13.5 billion contracts. The majority of swap trading still takes place OTC 

rather than on the 24 SEFs. 

Collective Investment Schemes 

22. The U.S. securities CIS market is the largest in the world. At the end of 2013, there were 

4,168 registered collective investment scheme (CIS) funds with more than $17 trillion assets under 

management (AUM). The market for securities CIS is dominated by mutual funds, which at end 2013 

accounted for 88 percent of all securities CIS assets. ETFs’ share of overall AUM has grown 

significantly over the last five years, while closed end funds and unit investment trusts (UITs) account 

for only a small proportion of total assets. At the end of 2013, retail investors held over 65 percent 

of assets in mutual funds. 

Table 2. Investment Company Total Net Assets by Type 

$ billions 

 Mutual 

Funds 

Closed-end 

funds ETFs UITs Total 

2009 11,113 223 777 38 12,152

2010 11,831 238 992 51 13,112

2011 11,626 243 1,048 60 12,978

2012 13,044 264 1,337 72 14,717

2013 15,018 279 1,675 87 17,058

Source: 2014 Investment Company Fact Book 

 

5

 Tuttle, Laura, OTC Trading: Description of Non-ATS OTC Trading in National Market System Stocks, March 2014. 
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Table 3. Institutional and Retail Ownership of Mutual Funds 

$ billions Retail Investors Institutional Investors Total 

End-year 2011 2012 2013 2011 2012 2013 2011 2012 2013

Mutual 

Funds 

 Equity 4,713 5,351 6,988 501 589 776 5,214 5,940 7,764 

 Bond 2,513 2,981 2,875 326 398 391 2,838 3,379 3,265 

 Hybrid 851 996 1,220 32 35 50 883 1,031 1,270 

 Money 

Market 1,805 1,795 1,775 886 899 944 2,691 2,694 2,718 

Total 9,882 11,123 12,857 1,745 1,921 2,161 11,627 13,044 15,018 

Source: ICI 

23. As of September 2014, 2,691 IAs registered with the SEC advised at least one HF. 

Registered IAs to HFs manage approximately $5.4 trillion in cumulative reported regulatory assets 

under management (RAUM). As of May 7, 2014 there were 544 IAs classified as large HF managers 

(i.e., with 1.5 billion HF AUM), with a total of 3,835 HFs under management. In addition to IAs 

registered with the SEC, there are also exempted reporting advisers (ERAs), which are exempted 

from registration with the SEC, but are subject to limited reporting on their business and their 

private fund clients. There are approximately 2,693 ERAs with 875 advisers or 32 percent of them 

managing HFs that account for approximately $846 billion in RAUM. 

24. Both the number of commodity pool operators (CPOs) and their total AUM has grown 

dramatically over the past four years. This resulted from the inclusion of swaps in the definition of 

commodity under the Dodd-Frank Act. Many CIS investing in swaps are therefore now regulated as 

commodity pools (CPs) for the first time. Retail participation in swaps-based CIS is small and largely 

confined to traditional CPs, with the CFTC estimating that retail investors hold approximately 10 to 

15 percent of total AUM in those pools. 

Table 4. Number of Commodity Pool Operators and their AUM 

$ billions Total Number of 

NFA Member 

CPOs 

Number of 

Foreign CPOs 

Number of 

U.S. CPOs 

Total AUM 

reported 

end-2011 1,078 83 995 348

end-2012 1,105 76 1,029 493

end-2013 1,686 255 1,431 2,809

Aug. 6, 2014 1,658 267 1,391 2,928

Source: CFTC 
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Market intermediaries 

25. There are separate regimes for securities and derivatives market intermediaries. BDs 

registered under the Exchange Act and FCMs and introducing brokers (IBs) registered under the CEA 

trade as principals or agents. Advisers are registered as IAs or commodity trading advisers (CTAs) 

under the securities or futures legislation. Operators of CIS are registered as IAs under the Advisers 

Act or CPOs under the CEA. The number of registered BDs has fallen over the last five years. As a 

result of changes introduced by the Dodd-Frank Act, IAs that previously were not subject to 

registration (such as IAs to HFs) are now required to register with the SEC, while smaller IAs are now 

subject to registration by the state regulators only. Overall, these changes resulted in a small decline 

in the number of IAs registered with the SEC, while the total AUM for SEC registered IAs has 

increased (the SEC estimates total AUM for IAs, including mutual funds, is approximately 

$63 trillion). The number of FCMs is relatively small and many of the larger FCMs are also registered 

as BDs. 

   Table 5. Registered Broker-Dealers         

   (by SRO membership)   

 ARCA CBOE CHX FINRA NYSE 

NYSE 

MKT* PHLX SEC UNA** Total 

January 1, 2010 28 237 26 4,775 46 46 33 5 57 5,253

January 1, 2011 21 190 27 4,664 0 28 28 5 66 5,029

January 1, 2012 18 155 26 4,515 0 21 20 5 42 4,802

January 1, 2013 14 132 22 4,351 1 21 18 5 48 4,612

January 1, 2014 14 104 16 4,196 0 18 18 5 39 4,410

July 1, 2014 15 92 17 4,097 0 15 18 5 48 4,307

Source: SEC 

* Formerly AMEX 

** UNA - unassigned (not a member of any self-regulatory organization) 

Table 6. SEC Registered Investment Advisers 

At January 2 2012 2013 2014 

SEC-registered investment advisers 11,658 10,754 10,920 

SEC exempt reporting advisers 0 2,331 2,594 

Source: SEC 
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Table 7. Derivatives Market Intermediaries 

Registered with the CFTC 

Type of Person 

Number of Registered 

Persons 

as of July 31, 2014 

Futures Commission Merchant 78 

Introducing Broker 1,354 

Commodity Pool Operator 1,770 

Commodity Trading Advisor 2,539 

Retail Foreign Exchange Dealer 7 

Swap Dealer 102 

Major Swap Participant 2 

Floor Broker 4,495 

Floor Trader 827 

Notice-Registered IB 46 

Notice-Registered FCM 14 

Source: CFTC 

PRECONDITIONS FOR EFFECTIVE SECURITIES 

REGULATION 

26. All the preconditions for effective securities markets regulation appear to be in place 

in the United States. 

 No barriers to entry: Registration requirements for all categories of regulated activities are 

based on objective criteria, which are clearly set up by laws and regulations. Foreign 

investors can invest in the securities and derivatives markets under the same conditions as 

domestic investors. 

 Taxation: There do not appear to be distortions in market structure created by the tax 

regime. 

 Company law: Companies are free to determine the state where they want to be 

incorporated. The majority of companies choose Delaware, as it is considered to provide 

significant freedom for companies to organize their business. As many aspects of corporate 

governance rely on state company law, the Delaware company law and the jurisprudence of 

the Delaware courts are key components of securities markets framework. 
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 Insolvency law: The Bankruptcy Code provides two primary routes for business bankruptcy: 

(i) Chapter 11, where the company usually attempts to reorganize its business and become 

profitable again; management usually continues to run day-to-day business operations, but 

all significant business decisions must be approved by a bankruptcy court; and (ii) Chapter 7, 

where the company stops all operations and goes out of business; a trustee is appointed to 

liquidate the company’s assets and the money is used to pay off creditors and investors in 

accordance with the federal bankruptcy rules. Public companies generally file under Chapter 

11 rather than Chapter 7 because they can continue to run their business and control the 

bankruptcy process. 

 Competition law: The U.S. has strong and vigorously enforced anti-trust legislation, which 

applies to all economic sectors, including the financial sector. 

 Accounting and auditing standards: Accounting and auditing standards are globally 

recognized as of high international quality. 

 Protection of investors’ rights: The judiciary is acknowledged to be independent from 

political influence. There are private rights of action under company, securities and 

derivatives laws, which are actively exercised by investors, including through class action 

suits. The SROs have mechanisms, obligatory for all members, for alternative resolution of 

disputes between intermediaries and their clients. 

MAIN FINDINGS 

27. Principles for the regulator. The SEC and the CFTC are independent agencies, with clear 

mandates stemming from the law. Both have sufficient powers to fulfill their mandates, including 

rulemaking, registration, examination and enforcement powers. They operate under a high level of 

accountability, which is supported by public transparency of a wide range of regulatory actions and 

decisions. Strong ethics rules apply to Commissioners and staff of both the SEC and CFTC. The 

current level of resources poses challenges for the SEC and CFTC to effectively discharge their 

functions, particularly in light of their expanded mandates. The agencies are taking an increasingly 

forward looking risk-based approach to supervision and enhancing their risk identification 

processes, which in turn is helping them to contribute more effectively to the FSOC. Both have 

processes to review the perimeter of regulation. 

28. Principles for self-regulation. The U.S. system relies strongly on SROs, such as FINRA and 

the NFA, for supervision of markets and intermediaries. SROs are subject to oversight, including 

approval or notification of rules, and ongoing monitoring of their self-regulatory activities via 

reporting and examinations.

29. Principles for enforcement. The SEC and CFTC have broad inspection powers over 

regulatees and investigative and enforcement powers over regulated entities, regulated individuals, 

and third parties. Overall, the agencies, along with the SROs, have put in place robust supervisory 

programs to monitor ongoing compliance by regulated entities and individuals and to monitor 
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market activity. The programs for regulated entities are risk-based. In most cases, the coverage of 

the examination program is such that no entity goes without inspection for a long period of time, 

even if it is low risk. The situation is different for IAs, as the coverage of their examination program is 

more limited. Market surveillance relies primarily on SROs’ automated tools. Both agencies make 

extensive use of their enforcement powers. The SEC, the CFTC and criminal authorities are active in 

pursuing securities and derivatives violations. 

30. Principles for cooperation. The SEC and CFTC have the ability and capacity to share 

information and cooperate with other authorities domestically and internationally. They are 

signatories to many Memoranda of Understanding (MOU), including the IOSCO Multilateral MOU 

(MMOU) and a number of bilateral MOUs with domestic and foreign authorities, and have records 

of active cooperation. The SEC and CFTC do not need the permission of any outside authority or an 

independent interest to share or obtain information. Access to the financial records of individuals 

and small partnerships requires notifying the customer; delaying such notice is also possible in 

certain circumstances. 

31. Principles for issuers. Generally issuers of public offerings, including ABS, are subject to 

strong disclosure requirements both at the moment of registration and on a periodic basis, except 

for municipal securities which are exempt from those registration and reporting requirements. The 

current framework provides reporting companies with significant freedom to decide on their 

structure, and the classes of shares to be offered to the public. However, they are subject to strong 

disclosure obligations, and any limitations to the rights of shareholders must be clearly disclosed in 

the prospectus. Federal laws allow the acquisition of control without triggering an obligation to 

make a tender offer. However, a number of features in the legal system, mainly state corporate laws, 

create disincentives from doing so. The current regime requires reporting of insiders’ holdings and 

substantial holdings, as well as reporting of beneficial ownership. The SEC has developed an active 

program to monitor and enforce issuers’ compliance with their disclosure obligations. High quality 

accounting standards, the U.S. Generally Accepted Accounting Principles (GAAP), are set through an 

open and transparent process. 

32. Principles for auditors, credit rating agencies, and other information service providers.

Auditors of reporting companies must be registered with the PCAOB. The PCAOB has developed a 

credible examination program for audit firms. Audit standards are considered of high quality. The 

PCAOB is responsible for the enforcement of compliance with audit standards, and the SEC can also 

exercise its enforcement powers over auditors and has done so in an active manner. CRAs that wish 

their credit ratings to be used for regulatory purposes must elect to register with the SEC as 

Nationally Recognized Statistical Rating Organizations (NRSROs). In practice, ratings are currently 

used for regulatory purposes by the SEC in very limited cases, mainly in connection with money 

market funds (MMFs). The registration process subjects NRSROs to appropriate requirements. The 

SEC conducts NRSRO examinations on an annual basis. BDs on the securities side and FCMs, IBs, 

swap dealers (SDs) and major swap participants (MSPs) on the derivatives side are subject to 

obligations in connection with the provision of research analysis that aim at managing potential 

conflicts of interest.
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33. Principles for collective investment schemes. IAs to mutual funds (MFs) and commodity 

pool operators (CPOs) are subject to registration with the SEC and CFTC, which focuses mainly on 

their integrity and disclosure to investors. MFs and CPs are subject to disclosure obligations both at 

the moment of registration and on a periodic basis. Self-custody and related party custody of MF 

and CP assets is allowed, however additional safeguards apply in the case of MFs. MF and CP assets 

must be valued according to the U.S. GAAP. MF and CP shares and units must be valued at net asset 

value (NAV), except MMFs. IAs to HFs are subject to registration requirements that are based on 

disclosure. Standards of organizational and operational conduct apply to them. The SEC conducts 

only limited examinations of IAs to MFs, although it has implemented a presence examination 

program for newly registered IAs, including those that manage HFs. 

34. Principles for market intermediaries. The registration regime combined with the relevant 

SRO’s membership regime subjects all categories of participants except IAs and CTAs to 

comprehensive eligibility criteria that include integrity, capital requirements, and adequacy of 

internal controls. All categories of intermediaries except IAs and CTAs are subject to capital 

requirements and periodic reporting of their financial position and capital adequacy. IAs and CTAs’ 

registration regime is based on integrity criteria and disclosure. However, they are not permitted to 

hold clients assets nor deal on behalf of customers, though they may have discretion to make 

investment decisions. Early warning systems are in place. There are well-developed processes to deal 

with the failure of intermediaries that have been applied in practice. 

35. Principles for secondary markets. Exchanges and DCMs are subject to detailed registration 

requirements. ATSs are subject to the SEC broker-dealer registration and FINRA membership 

processes along with SEC disclosure obligations. Limited public information is available on ATS 

operations, subscribers and market models. The exchanges and FINRA share the responsibility for 

market surveillance and member supervision in securities markets, and the DCMs and NFA in 

commodity futures and options markets. The exchanges and DCMs are subject to active SEC and 

CFTC supervision. Pre-and post-trade transparency requirements apply in both securities and 

derivatives markets, subject to certain derogations that may lead to less than optimal pre-trade 

transparency. Market abuse is addressed by the Exchange Act and CEA and subject to 

administrative, civil and criminal sanctions. Open positions in commodity futures and options 

markets are closely monitored by the SROs and CFTC, while position information is available in 

securities markets through a DTCC service. Default procedures apply in both clearing agencies and 

Derivatives Clearing Organizations (DCOs) and are disclosed through their rules. Short selling is 

subject to disclosure and “locate” requirements, and the SEC and SROs monitor compliance. 
UNITED STATES 

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SUMMARY IMPLEMENTATION OF THE IOSCO 

PRINCIPLES 

Table 8. Summary Implementation of the IOSCO Principles—Detailed Assessments 

Principle Grade Findings 

Principle 1. The responsibilities 

of the Regulator should be clear 

and objectively stated. 

BI The mandates of the SEC and CFTC are stated by law. The 

agencies can and do interpret the laws under their jurisdiction. 

There is a high level of public transparency on interpretations, 

guidance and no action letters. In general, like products and 

entities are treated in a consistent manner. However, the CPO 

and CTA regimes may lead to different investor protection 

consequences than that applied to IAs. The legal framework 

requires the agencies to consult and coordinate in specific 

areas. In addition, the agencies communicate on a regular 

basis. In a few areas the SEC and CFTC have been able to 

streamline obligations of dually registered entities by 

establishing single reporting or substituted compliance 

mechanisms. In a few cases, joint inspections in areas of 

common interest have taken place. 

Principle 2. The Regulator 

should be operationally 

independent and accountable in 

the exercise of its functions and 

powers. 

BI The SEC and CFTC have been established as independent 

agencies separate from any office of the Government. Rules 

governing the appointment of Commissioners seek to balance 

political affiliations. As per judicial precedents, Commissioners 

can be removed only for cause. The Congressional budget 

approval process has the potential to materially affect the 

agencies’ ability to decide on their priorities, and the annual 

nature of the budget can affect long term planning. In general, 

on a day to day basis the agencies do not require approval of 

or consultation with other authorities to exercise their 

functions. There is a strong accountability regime to Congress 

and the public, supported by a high level of transparency of a 

wide range of regulatory actions and decisions, as well as 

judicial review of rules and regulatory decisions. 

Principle 3. The Regulator 

should have adequate powers, 

proper resources and the 

capacity to perform its functions 

and exercise its powers. 

PI The SEC and CFTC have sufficient powers to fulfill their 

respective mandates, including rulemaking, registration, 

examination, investigation and enforcement powers. The 

agencies have been recruiting staff with diverse skill-sets. 

However, the current level of funding poses challenges for the 

proper discharge of their functions, in particular given their 

expanded mandates. 

Principle 4. The Regulator 

should adopt clear and 

consistent regulatory processes. 

FI Requirements for the provision of regulated activities are 

available on the agencies’ websites. The legal framework 

requires the rulemaking process to include public consultation 

and an analysis of costs. In practice the agencies have also 

used other mechanisms, such as roundtables, to gather views 

from stakeholders on complex topics. Regulatory decisions are 
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subject to due process, including generally a need for notice of 

proposed decisions, opportunity for affected parties to be 

heard, and judicial review. 

Principle 5. The staff of the 

Regulator should observe the 

highest professional standards, 

including appropriate standards 

of confidentiality. 

FI The SEC and CFTC are bound by general rules on ethics 

applicable to government officials. In addition, both agencies 

have established specific ethics rules that include additional 

restrictions for staff, in particular in the area of holding and 

trading securities and commodities. Both agencies are subject 

to strict rules of confidentiality. There are appropriate 

mechanisms to monitor potential breaches of ethics and 

confidentiality obligations. 

Principle 6. The Regulator 

should have or contribute to a 

process to monitor, mitigate 

and manage systemic risk, 

appropriate to its mandate. 

BI The supervisory programs of the different divisions of both 

agencies to monitor entities, products and markets are the 

main mechanisms to identify emerging and systemic risks. At 

the SEC, regular meetings take place between division staff 

and the SEC Chair, between division staff and individual 

Commissioners, and between the SEC Chair and individual 

Commissioners. Through these meetings, the SEC Chair 

obtains the views of the other Commissioners and informs 

them on issues of concern, including on emerging and 

systemic risks. Additionally, through these meetings the Chair 

and the other Commissioners are informed by the staff, and 

they share their views with the staff, on these same issues. 

CFTC staff has informal meetings to discuss risk issues. Weekly 

closed door surveillance meetings of staff with the Commission 

are also scheduled; these are used to discuss emerging risks, 

take decisions on how to tackle them, and follow up. Both 

agencies have made significant improvements to data 

collection and analysis, but enhancements are needed, 

particularly on asset management and swaps data. Through 

the participation of their chairs as voting members at the FSOC 

and of staff members in the subcommittees, the SEC and CFTC 

contribute to the process of identifying emerging and systemic 

risks in the financial sector. 

Principle 7. The Regulator 

should have or contribute to a 

process to review the perimeter 

of regulation regularly. 

FI Various processes allow the SEC and CFTC to review the 

perimeter of regulation, both in regard to a specific sector, 

entity or product, and in a more holistic manner. Examples of 

the former are reviews prompted by concerns identified 

through their supervisory programs, market events, or law. 

Examples of the latter are the strategic plans the agencies 

develop on a five year cycle, which require them to take a view 

on priorities. Types of action taken to address the regulatory 

perimeter include taking supervisory actions, issuing guidance 

or new rules, and proposing changes to the legal frameworks. 

Principle 8. The Regulator 

should seek to ensure that 

conflicts of interest and 

misalignment of incentives are 

avoided, eliminated, disclosed 

FI The regulatory framework to address issuers’ conflicts of 

interest is based on strong disclosure obligations, including on 

related party transactions. Extensive disclosure obligations 

apply to the underlying assets of ABS. New disclosure 

requirements for asset level data and retention requirements 
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INTERNATIONAL MONETARY FUND 23

or otherwise managed. will become effective over the next two years. The regime for 

regulated entities relies on a combination of prohibitions and 

management and disclosure of conflicts of interest. The SEC 

and CFTC monitor compliance primarily through their 

supervisory programs. 

Principle 9. Where the 

regulatory system makes use of 

Self-Regulatory Organizations 

(SROs) that exercise some direct 

oversight responsibility for their 

respective areas of competence, 

such SROs should be subject to 

the oversight of the Regulator 

and should observe standards 

of fairness and confidentiality 

when exercising powers and 

delegated responsibilities. 

FI The current regime relies extensively on the use of SROs for 

the supervision of the majority of the categories of 

intermediaries (FCMs, IBs, BDs), as well as for market 

surveillance. There are two main categories of SROs: the 

exchanges and DCMs and associations (FINRA and NFA). All 

SROs are subject to SEC or CFTC ongoing oversight. This 

includes approval or notification of rules, with appropriate 

tools to prevent rule implementation in case of noncompliance with the statutes; reporting requirements; and riskbased on-site examinations. 

Principle 10. The Regulator 

should have comprehensive 

inspection, investigation and 

surveillance powers. 

FI The SEC and CFTC have broad powers to inspect all categories 

of regulated entities and individuals, require information from 

them, and conduct investigations into their activities for 

potential breaches of their statutory and regulatory 

obligations. They also have the power to conduct market 

surveillance. The CFTC and NFA conduct front line surveillance 

for markets under their jurisdiction. For the securities markets, 

the SEC and the SROs work cooperatively to conduct 

surveillance of those markets. 

Principle 11. The Regulator 

should have comprehensive 

enforcement powers. 

FI The SEC and CFTC have robust powers to access information 

from any person, including subpoena powers over records and 

testimony, where a breach of law is suspected. Both agencies 

have a wide variety of enforcement tools at their disposal, 

including the use of administrative and civil proceedings and 

the ability to refer matters to the criminal authorities. A wide 

range of sanctions can be sought in administrative and civil 

proceedings, including monetary penalties and disgorgement 

and, for the CFTC, restitution. 

Principle 12. The regulatory 

system should ensure an 

effective and credible use of 

inspection, investigation, 

surveillance and enforcement 

powers and implementation of 

an effective compliance 

program. 

BI The agencies and the SROs have put in place robust 

supervisory programs to monitor markets and the ongoing 

compliance of registered entities and individuals. The program 

for regulated entities is risk-based. In most cases, the 

examination program covers all entities so that none goes 

without inspection for a long period of time, even if it is low 

risk. However, the coverage of the IA examination program is 

limited in spite of the importance of the sector. Market 

surveillance for derivatives markets is carried out by the DCMs 

and directly by the CFTC; for securities markets, front line 

surveillance is largely the responsibility of the exchanges and 

FINRA. Both agencies make extensive use of their enforcement 

powers. In recent years, the SEC has made important 

improvements to its enforcement program, including case 
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management, the use of settlements that include an admission 

of breaches, and the constitution of specialized units and task 

forces. The agencies and criminal authorities are active in 

pursuing securities and derivatives violations. 

Principle 13. The Regulator 

should have authority to share 

both public and non-public 

information with domestic and 

foreign counterparts. 

FI Subject to compliance with relevant legal requirements, the 

SEC and CFTC can share information with other domestic and 

foreign authorities without the need for external approval. 

Access to the financial records of individuals and small 

partnerships covered by the Right to Financial Privacy Act 

(RFPA) requires notifying the customer; delaying such notice is 

also possible in certain circumstances. The IOSCO MMOU 

requirement on prior consultation of the requesting foreign 

authority before notifying the customer is followed. 

Principle 14. Regulators should 

establish information sharing 

mechanisms that set out when 

and how they will share both 

public and nonpublic 

information with their domestic 

and foreign counterparts. 

FI The SEC and CFTC have concluded some domestic MOUs and 

are signatories to the IOSCO MMOU. Ad hoc information 

sharing arrangements and access request letters are used in 

the absence of an MOU with sufficient coverage. The agencies 

also have several bilateral MOUs with foreign authorities. Both 

have responded to a significant number of information 

requests from foreign authorities. 

Principle 15. The regulatory 

system should allow for 

assistance to be provided to 

foreign Regulators who need to 

make inquiries in the discharge 

of their functions and exercise 

of their powers. 

FI The SEC and CFTC have assisted foreign authorities on 

numerous occasions through their ability to use their extensive 

powers to obtain and compel documents and testimony. 

Principle 16. There should be 

full, accurate and timely 

disclosure of financial results, 

risk and other information that 

is material to investors’ 

decisions. 

BI The regulatory regime generally subjects issuers to strong 

initial and periodic disclosure obligations, including the 

submission of annual reports that must contain audited 

financial statements, quarterly reports, and disclosure of 

material events. However, municipal securities are exempted 

from the registration and reporting requirements. Through 

indirect mechanisms, the SEC has established disclosure 

obligations applicable to municipal securities. The SEC 

currently lacks direct authority to ensure issuers’ compliance 

with these obligations, except for enforcement authority based 

on antifraud provisions. The current statutory thresholds for 

the suspension of periodic reporting obligations on issuers of 

publicly offered securities are high. The SEC has an active 

program to monitor issuers’ compliance with their disclosure 

obligations. 

Principle 17. Holders of 

securities in a company should 

be treated in a fair and 

equitable manner. 

FI The current legal and regulatory framework generally allows 

companies significant freedom to decide on their structure, the 

classes of shares to be offered to the public and the rights 

associated with the shares. Reporting issuers are subject to 

strong disclosure obligations, including requiring disclosure of 

shareholder rights in the prospectus. This is complemented by 
UNITED STATES 

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strong fiduciary duties, and shareholders can (and do) exercise 

actively their private rights in the courts. Federal laws allow the 

acquisition of control of a reporting company without 

triggering tender offer obligations. There are a number of 

features of the legal system, principally state corporate laws, 

that create disincentives for parties seeking to acquire control 

from doing so other than by negotiating with the board of 

directors or making a tender offer for all shares. The current 

regime requires reporting of insiders’ holdings, substantial 

holdings (over 10 percent), and holdings of most beneficial 

owners within stipulated deadlines. 

Principle 18. Accounting 

standards used by issuers to 

prepare financial statements 

should be of a high and 

internationally acceptable 

quality. 

FI Reporting issuers must prepare their financial statements in 

accordance with the U.S. GAAP, which are considered of high 

quality. Foreign issuers can use International Financial 

Reporting Standards (IFRS), and other accounting standards, 

the latter with reconciliation. The U.S. GAAP are set by the 

Financial Accounting Standards Board (FASB), which is 

overseen by the Financial Accounting Foundation (FAF), an 

independent, non-profit organization run by a Board of 

Trustees. The FASB is funded by fees assessed against issuers. 

The standard setting process is open, provides for consultation 

of stakeholders, and is actively monitored by the SEC. As part 

of its program to monitor issuers’ compliance with their 

disclosure obligations, the SEC examines financial statements 

and their compliance with the U.S. GAAP. The SEC enforcement 

program has renewed its focus on accounting and financial 

fraud through the creation of a specialized task force. 

Principle 19. Auditors should be 

subject to adequate levels of 

oversight. 

FI Auditors of reporting companies must register with the 

PCAOB, which was created by law as a non-profit corporation 

under the oversight of the SEC. The PCAOB is composed of five 

members selected by the SEC, including two certified public 

accountants (CPAs). All members serve on a full time basis and 

must be independent from the audit profession. The PCAOB is 

funded by fees assessed to issuers, BDs, and other entities that 

are required to register with it. The PCAOB has established an 

inspection program for audit firms, where the inspection 

frequency depends on the number of issuers the audit firm 

audits. In addition to remediation of deficiencies, the PCAOB 

can impose enforcement actions on audit firms and individual 

auditors for breaches of their obligations and has done so in 

practice. SEC’s own enforcement actions have complemented 

PCAOB efforts. 

Principle 20. Auditors should be 

independent of the issuing 

entity that they audit. 

FI There are specific SEC rules on auditor independence that 

impose restrictions on financial relations, and address issues 

such as self-interest, advocacy, familiarity, intimidation, 

provision of non-audit services, and rotation of the lead 

auditor every five years. The PCAOB requires audit firms to 

have a system of quality controls that provides reasonable 

assurance that personnel maintain independence in fact and 
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appearance. Audit committees of listed companies are 

required to oversee the selection and work of audit firms. The 

PCAOB inspection program, along with its enforcement 

actions, is the key external mechanism to monitor compliance 

with the independence obligations. SEC enforcement actions 

over auditors have complemented PCAOB efforts. 

Principle 21. Audit standards 

should be of a high and 

internationally acceptable 

quality. 

FI Audit standards are set by the PCAOB and are considered of 

high quality. The standard setting process involves public 

consultation with stakeholders. The PCAOB inspection 

program, along with its enforcement actions, is the main 

mechanism to monitor audit firms’ compliance with the audit 

standards. SEC enforcement actions have complemented 

PCAOB efforts. 

Principle 22. Credit rating 

agencies should be subject to 

adequate levels of oversight. 

The regulatory system should 

ensure that credit rating 

agencies whose ratings are used 

for regulatory purposes are 

subject to registration and 

ongoing supervision. 

FI A U.S. or foreign CRA that wishes its credit ratings to be used 

for regulatory purposes in the U.S. must elect to register with 

the SEC. In practice, credit ratings are currently used for limited 

regulatory purposes by the SEC, most notably in connection 

with MMFs. The registration process and the ongoing 

examinations of NRSROs address the relevant integrity, 

transparency, timeliness, confidentiality and conflict of interest 

management aspects. The SEC conducts examinations of each 

NRSRO at least annually. If needed, it can recommend 

remedial action or bring enforcement actions against an 

NRSRO. Sanctions may range from fines to suspension or 

revocation of registration as an NRSRO. In practice the SEC has 

sanctioned at least one CRA. 

Principle 23. Other entities that 

offer investors analytical or 

evaluative services should be 

subject to oversight and 

regulation appropriate to the 

impact their activities have on 

the market or the degree to 

which the regulatory system 

relies on them. 

FI The provision of equity research by BDs is subject to 

comprehensive SRO rules designed to increase an analyst’s 

independence and manage conflicts of interest. The large BDs 

were subject to a settlement in 2003-2004 that required them 

to strengthen the independence of their research analysis, 

including by establishing information barriers. The settlement 

covers BDs accounting for approximately 80 to 90 percent of 

the U.S. equity underwriting business and is still in effect. Both 

equity and debt research are subject to SEC rules that require 

analysts to certify that their reports accurately reflect their 

views and disclose certain conflicts; in addition antifraud 

provisions apply. On the commodities side, CFTC rules impose 

information barriers and disclosure requirements in connection 

with research analysis conducted by FCMs, IBs, SDs and MSPs. 

Principle 24. The regulatory 

system should set standards for 

the eligibility, governance, 

organization and operational 

conduct of those who wish to 

market or operate a CIS. 

PI IAs to MFs and CPOs are subject to registration by the SEC and 

the CFTC respectively; the latter has delegated this function to 

the NFA. Both registration requirements focus on statutory 

disqualifications and extensive disclosure requirements to the 

regulator and investors. On an ongoing basis, IAs to MFs and 

CPOs are subject to certain organizational and operational 

conduct obligations, in particular the implementation of a 

compliance program. Monitoring of CPOs’ ongoing 

compliance is conducted by the NFA on the basis of a risk-
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INTERNATIONAL MONETARY FUND 27

based supervisory program. MF boards have the responsibility 

of selecting and overseeing the IAs and in practice exercise this 

role in a proactive manner both at the moment of the initial 

selection and on an on-going basis through reporting and 

meetings. The SEC has in place a risk-based supervisory 

program for ongoing monitoring of IAs to MFs. However, its 

coverage is limited despite the importance of the sector. 

Principle 25. The regulatory 

system should provide for rules 

governing the legal form and 

structure of collective 

investment schemes and the 

segregation and protection of 

client assets. 

BI MFs and CPs can adopt different legal structures; these 

structures and the rights of investors must be disclosed in the 

prospectus. MF assets must be segregated. Custody by an IA 

or related entity is allowed, but in both cases additional 

safeguards apply, in particular the requirement for additional 

inspections by an auditor (two unannounced). In practice few 

MFs have self-custody by the IA or its related entity. The 

CFTC’s current regime requires CP assets to be segregated, but 

does not require the use of a custodian or depository. There 

are no additional safeguards in place when assets are held by 

the CPO or a related custodian. In practice most CPs do have 

separate custodians, which however are often related entities. 

Principle 26. Regulation should 

require disclosure, as set forth 

under the principles for issuers, 

which is necessary to evaluate 

the suitability of a CIS for a 

particular investor and the value 

of the investor’s interest in the 

scheme. 

FI MFs and CPs that are offered to the public are subject to the 

Securities Act prospectus obligations (MFs are also subject to 

the ICA). MFs and CPs that issue prospectuses are required to 

provide periodic information to investors including both 

annual and semiannual reports. The CEA framework requires 

CPOs to provide a detailed disclosure document to prospective 

participants. In addition, the CPOs must provide annual 

audited financial statements and an annual report to their 

participants and the regulator. Quarterly or monthly reporting 

is also required. Delegation of activities by IAs and CPOs is 

permitted, but must be entrusted to entities that are also 

registered with the SEC and/or CFTC. 

Principle 27. Regulation should 

ensure that there is a proper 

and disclosed basis for asset 

valuation and the pricing and 

the redemption of units in a CIS. 

BI MFs and CPs are required to value their portfolios according to 

the U.S. GAAP. The MF prospectus and the CP disclosure 

document require disclosure of the frequency, timing and 

manner in which a participant may redeem its units. Sales and 

redemptions must be effected at the current net asset value 

(NAV). MMFs are not required to price their units at market 

value and may use fixed prices; however strict rules apply on 

eligible assets and duration of the portfolio. Federal laws do 

not require disclosure of NAV to investors on a periodic basis, 

but the price of MFs and CPs offered to the public is generally 

available through financial publications and websites There are 

no specific requirements that govern pricing errors, but market 

practices on the securities side address compensation of losses 

to investors in certain circumstances. Suspensions and 

deferrals of redemptions are dealt with via disclosure (and 

pursuant to specific rules under the ICA with respect to MFs 

and MMFs); however, the SEC and CFTC have the authority to 

take action if necessary. 
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28 INTERNATIONAL MONETARY FUND

Principle 28. Regulation should 

ensure that hedge funds and/or 

hedge funds managers/advisers 

are subject to appropriate 

oversight. 

FI Federal laws do not define HFs, but HF managers that operate 

HFs are required to register with the SEC and/or the CFTC as 

IAs or CPOs depending on the type of assets that the HF 

invests in. Similar to any other IA or CPO, current registration 

requirements focus on statutory disqualifications and 

disclosure to investors of extensive information about the 

manager, which must be kept up-to-date. Standards of 

organization and operational conduct apply to both IAs and 

CPOs of HFs on an ongoing basis. HF managers with RAUM 

above a certain threshold are subject to additional periodic 

reporting obligations to the SEC and CFTC on the funds they 

manage, including their assets, exposures and leverage. These 

reports can be shared with domestic authorities, including the 

FSOC, as well as with foreign regulators under the frameworks 

described in Principles 13-15. Capital requirements and other 

prudential requirements could be established on IAs and CPOs 

that manage HFs, if FSOC designated any such entity as 

systemically important. 

Principle 29. Regulation should 

provide for minimum entry 

standards for market 

intermediaries. 

FI The statutory registration regime combined with the SRO 

membership regime subjects all categories of participants 

except IAs and CTAs to a comprehensive set of eligibility 

criteria that includes integrity, capital requirements, and 

adequacy of internal controls. IAs and CTAs are not permitted 

to hold customer assets or deal for customers, though they 

may have discretion to make investment decisions. As a result, 

the registration regime focuses on statutory disqualifications 

and disclosure to the regulators and investors of extensive 

information about the IAs or CTAs. Organizational and conduct 

obligations, including the obligation to implement a 

compliance program, apply on an ongoing basis to IAs and 

CTAs. 

Principle 30. There should be 

initial and ongoing capital and 

other prudential requirements 

for market intermediaries that 

reflect the risks that the 

intermediaries undertake. 

FI All categories of intermediaries except IAs and CTAs are 

subject to capital requirements based on a net capital formula. 

Assets are subject to deductions for liquidity and market risks, 

and additional charges apply to concentration risk. Some large 

BDs apply an alternative net capital (ANC) framework that 

allows them to use models to calculate their haircuts, but ANC 

firms have higher minimum capital requirements, and their use 

of models is approved by the SEC. The ANC framework does 

not include separate concentration charges, but uses value-atrisk to measure concentration risk. Intermediaries must report 

their financial position including net capital on a periodic basis, 

with frequency varying depending on the activities of the 

intermediary. They are also required to notify the authorities, if 

their capital falls below certain thresholds established in the 

regulatory framework. The SEC, CFTC and the SROs have 

mechanisms in place for ongoing monitoring of the financial 

position of firms. 

Principle 31. Market BI With the exception of IAs and CTAs, intermediaries are 
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intermediaries should be 

required to establish an internal 

function that delivers 

compliance with standards for 

internal organization and 

operational conduct, with the 

aim of protecting the interests 

of clients and their assets and 

ensuring proper management 

of risk, through which 

management of the 

intermediary accepts primary 

responsibility for these matters. 

explicitly required to have adequate internal controls and risk 

management systems. Segregation obligations apply to all 

types of intermediaries. Both in the securities and commodity 

futures side, intermediaries are required to know their 

customers. Intermediaries are required to manage conflicts of 

interest, although in the commodity futures side the 

framework relies more extensively on disclosure. The coverage 

of the examination program for IAs is limited, in spite of the 

importance of the sector. 

Principle 32. There should be a 

procedure for dealing with the 

failure of a market intermediary 

in order to minimize damage 

and loss to investors and to 

contain systemic risk. 

FI The CFTC has a plan to deal with market disruption events, 

including the failure of a firm. The SEC has a clearly defined 

process to deal with failures of regulated entities. In both cases 

there are early warning systems for intermediaries with a 

minimum capital requirement, which includes reporting 

requirements when their capital falls below certain thresholds. 

Active monitoring of the firms’ financial positions is conducted 

by both agencies and the SROs. To the extent a BD is in or 

approaching financial difficulty, SEC staff informs the Securities 

Investor Protection Corporation (SIPC), so that the SIPC can 

assess whether it should initiate a Securities Investor Protection 

Act (SIPA) proceeding. If a SIPA proceeding is initiated, a SIPA 

trustee is appointed with power to transfer clients’ accounts. If 

the BD’s assets are not sufficient to cover customers’ claims, 

the SIPC Fund compensates up to a limit. If a failed FCM’s 

assets are not sufficient to cover all losses, customers are 

compensated on a pro rata basis. There is no equivalent to a 

SIPC fund. Under the Dodd-Frank Act, systemically important 

intermediaries may be placed into a Title II receivership with 

the Federal Deposit Insurance Corporation (FDIC) as receiver. 

Principle 33. The establishment 

of trading systems including 

securities exchanges should be 

subject to regulatory 

authorization and oversight. 

BI Exchanges and boards of trade are required to be registered, 

and the registration criteria and processes are set out in the 

Exchange Act, CEA, and related rules and regulations. Before 

commencing operations, an ATS must register as a brokerdealer, become a member of an SRO (in practice FINRA), and 

file an initial Form ATS with the SEC. Form ATS provides the 

SEC with information on the ATS’ subscribers, access to its 

services, and operations. Fair access requirements apply after 

an ATS’s market share exceeds a five percent threshold; 

currently there are no such ATS. Limited public information is 

available on ATSs’ order execution rules and procedures, 

subscribers, and market models on the basis of voluntary 

disclosures. 

Principle 34. There should be 

ongoing regulatory supervision 

of exchanges and trading 

FI The national securities exchanges and FINRA share the 

responsibility for market surveillance and member supervision 

in securities markets, while the DCMs and NFA carry out these 
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systems which should aim to 

ensure that the integrity of 

trading is maintained through 

fair and equitable rules that 

strike an appropriate balance 

between the demands of 

different market participants. 

functions for commodity futures and options markets. Most 

SEFs have outsourced their market surveillance to the NFA. The 

SEC and CFTC can investigate improper market conduct 

referred by the SROs or at their own initiative. They supervise 

exchanges primarily through rule approval/review and on-site 

examinations of exchanges’ self-regulatory functions. 

Examining the exchanges’ technological systems and system 

safeguards has become an increased focus of both the SEC 

and CFTC. 

Principle 35. Regulation should 

promote transparency of 

trading. 

BI The statutory pre- and post-trade transparency requirements 

in equity markets are based on Regulation National Market 

System (NMS). In practice, exchanges’ proprietary feeds are 

also available to subscribers. Pre-trade transparency is not 

available in case of exchanges’ dark order types and trading on 

dark pool ATS. Post-trade transparency information has to be 

disclosed as soon as practicable, but within a maximum delay 

of 10/90 seconds; in practice information is disclosed within 

milliseconds of trades. In commodity futures and options 

markets, block trades and bona fide exchanges of futures for 

related positions are exempted from pre-trade transparency 

through DCM rules. The block trade thresholds set by DCM 

rules have decreased over the past years. The CFTC regulation 

on harmonized block trade requirements has not been 

finalized. 

Principle 36. Regulation should 

be designed to detect and deter 

manipulation and other unfair 

trading practices. 

FI Fraudulent and manipulative practices are prohibited in the 

Exchange Act, CEA and SRO rules. Insider trading prohibition 

applies on securities markets. Trading in commodity futures 

and options on the basis of material nonpublic information in 

breach of a pre-existing duty to disclose may be a violation of 

the CEA. Market abuse is subject to administrative, civil and 

criminal sanctions. The potential for market abuse is monitored 

by the SROs that may take action under their rules or refer 

cases to the SEC, CFTC and criminal authorities. A range of 

administrative, civil and criminal sanctions has been imposed. 

Principle 37. Regulation should 

aim to ensure the proper 

management of large 

exposures, default risk and 

market disruption. 

FI DCMs and DCOs closely monitor open positions in commodity 

futures and options markets. This is complemented by CFTC 

monitoring. Action can be taken, if a clearing member is not 

able to meet its obligations or post required margin. Individual 

clearing agencies monitor member exposures in securities 

markets. Cross-market post-trade monitoring is facilitated 

through the DTCC Limit Monitoring system. Default 

procedures are in place in both clearing agencies and DCOs 

and disclosed through their rules. Short selling is subject to 

disclosure and locate requirements. Both the SEC and SROs 

monitor compliance with the regulatory requirements on short 

selling. 

Principle 38. Securities 

settlement systems and central 

counterparties should be 

 Not assessed. 
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subject to regulatory and 

supervisory requirements that 

are designed to ensure that 

they are fair, effective and 

efficient and that they reduce 

systemic risk. 

Fully Implemented (FI), Broadly Implemented (BI), Partly Implemented (PI), Not Implemented (NI), Not 

Applicable (NA) 

RECOMMENDED ACTION PLAN AND AUTHORITIES' 

RESPONSE 

Table 9. Recommended Action Plan to Improve Implementation of the IOSCO Principles 

Principle Recommended Action 

Principle 1  The SEC and CFTC should continue their efforts to coordinate via joint regulations, 

unified reporting and/or use of substituted compliance as appropriate. 

 All regulatory authorities with mandates impacting securities and derivatives 

markets should continue to enhance coordination. 

 The CFTC is encouraged to review whether legal changes should be pursued in 

order to subject CPOs and CTAs to a similar standard of care as IAs and to a more 

comprehensive framework to address conflicts of interest.

Principle 2  Consideration should be given to mechanisms to make both the SEC and CFTC’s 

funding more stable, for example by the agencies’ becoming self-funded and/or 

providing for multiyear budgeting. 

Principle 3  Additional resources should be provided for the SEC and CFTC commensurate to 

their expanded mandates. 

Principle 6  The SEC should continue to work on improving data availability and automated 

tools to identify risks, in particular in connection with asset managers. 

 The SEC should consider enhancing mechanisms to ensure a holistic view of 

emerging and systemic risk, for example by making more formal arrangements for 

discussions on risk, ensuring participation of the Commission as a whole, and 

establishing a more formal accountability framework. 

 The CFTC should continue to work on improving the quality of swaps data and 

expanding current mechanisms to monitor the swaps markets. 

Principle 8  The SEC is encouraged to review conflicts of interest arising from the participation 

of BD affiliates in an ATS managed by the BD. 

 The SEC is encouraged to review the impact of order types, order routing, and 

related fee structures in equity markets on conflicts of interest. 

 The SEC is encouraged to continue its review of the BD and IA models to 

determine whether harmonization of the standards of care is needed, and whether 
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additional actions are needed in connection with conflicts of interest, including 

those arising from compensation arrangements for different types of accounts, 

products or services. 

Principles 12, 24 

and 31 

 The SEC should increase the intensity of its examination coverage of IAs. 

Principle 16  Consideration should be given to making amendments to the federal securities 

laws to grant the SEC direct authority to impose disclosure requirements on 

issuers of municipal securities and to remove the exemption available to nonmunicipal conduit borrowers. 

 Consideration should be given to reviewing the thresholds that trigger a 

suspension in reporting obligations, in particular for banks and bank holding 

companies. 

Principle 17  The SEC is encouraged to consider reducing the deadline for beneficial ownership 

disclosure as well as for the first report that insiders need to file. 

Principle 19  The PCAOB should take forward the implementation of actions to ensure the 

timeliness of its enforcement proceedings. 

 The SEC and PCAOB are encouraged to further analyze whether PCAOB 

proceedings should be made public. 

Principle 21  The PCAOB should work on ensuring timely advancement of its standard setting 

agenda. 

Principle 23  FINRA is encouraged to finalize its rules for research analysis in debt securities, as 

well as rules for research analysis in equity securities to eliminate, where 

appropriate, potential asymmetries between the regime applicable to the firms 

covered by the Global Settlement and the regime applicable to the rest of the 

industry. 

Principle 24  The authorities should consider to explicitly require IAs to MFs and CPOs to 

implement internal controls and risk management. 

Principle 25  Consideration should be given to amending the CEA to enable the CFTC to require 

additional safeguards where a CPO or a related entity has possession of pool 

assets. 

Principle 27  The CFTC or the NFA should adopt a rule providing for the way investors are to be 

treated, if adversely affected by errors in the pricing of interests in a CP. 

Principle 28  As the authorities continue to analyze the risks posed by HFs, they are encouraged 

to review whether a comprehensive risk management framework is warranted. 

Principle 29  The authorities are encouraged to consider whether to explicitly require internal 

controls and risk management for IAs and CTAs that conduct portfolio 

management. 

Principle 30  The SEC is encouraged to continue its review of the capital and liquidity 

framework for ANC firms. More broadly, the SEC is encouraged to continue 

reviewing the adequacy of liquidity requirements for the larger BDs. 

Principle 33  The SEC should continue to follow the development of bilateral trading systems 

and, if needed, adjust the regulatory framework as appropriate. 
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 The SEC should require the ATSs to disclose their order execution rules and 

procedures. 

 The SEC should ensure that the regulatory framework enhances the requirement 

for fair access to ATS, including by removing or at least lowering the current five 

percent threshold. 

 The SEC and FINRA are encouraged to further ensure that their respective 

processes provide a sufficiently in-depth analysis of the order execution 

procedures of a new ATS, in particular for fairness, and provide specific evidence 

of a BD’s operational and other competence to operate an ATS. 

 The SEC is encouraged to consider whether additional requirements could be 

applied to exchanges themselves to further enhance their ability to manage the 

risks arising from direct electronic access. 

Principle 35  The SEC is encouraged to continue to deepen its analysis of the pre-trade 

transparency impact of various order types and the reference prices dark order 

types are permitted to use to ensure that current derogations do not adversely 

impact the price discovery process. 

 The CFTC should promptly finalize its block trade rules to provide a regulatory 

basis for assessing pre-trade transparency waivers for block trades. 

Principle 37  The authorities are encouraged to review whether the current mechanisms are 

sufficient to provide them with a comprehensive view of the total exposures of 

market participants that are active across various markets (equity, fixed income, 

commodity futures and options). 

C. Authorities’ Response to the Assessment 

36. The Chairs of the SEC and the CFTC appreciate the IMF’s commitment of time and resources 

to the Financial Sector Assessment Program. We would like to express our gratitude to the IMF for 

fielding such a highly professional, hard working, and knowledgeable team of assessors to prepare 

the Detailed Assessment Report. 

37. As the United States has the largest and most complex financial markets in the world, we 

recognize and welcome the fact that the United States is held to the highest and most stringent 

grading standard. We value the objective assessment conducted of our Commissions’ regulatory 

regimes. 

38. In the aftermath of the financial crisis, our agencies were given new powers and broad new 

responsibilities to make our financial regulatory system stronger, more resilient and more effective. 

We are pleased to see that the Report reflects a recognition that over the past five years the SEC and 

CFTC have harnessed these new powers and seized upon these new responsibilities to implement 

more robust and comprehensive rulemaking, supervision and enforcement programs. As just one 

example, the Report noted that our agencies have introduced comprehensive regulatory reform of 

the OTC derivatives marketplace, improved supervisory programs to monitor compliance by 

registered entities, and made extensive use of our enforcement powers. 
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39. The overall ratings in the Report reflect the SEC’s and CFTC’s regulatory successes, while at 

the same time noting that there is room for improvement. Although staff disagrees with certain of 

the conclusions, recommendations, ratings and interpretations of the IOSCO Principles, we found 

the assessment process to be comprehensive and fair. SEC and CFTC staffs will continue to evaluate 

the Report as a tool for our respective Commissions to enhance their regulatory programs and to 

improve cooperation and coordination in rulemaking and regulatory oversight. 

40. We look forward to a continuing dialogue with the IMF to advance our shared goal of 

strengthening the U.S. financial regulatory system. 

DETAILED ASSESSMENT 

41. The purpose of the assessment is primarily to ascertain whether the legal and 

regulatory securities markets requirements of the country and the operations of the securities 

regulatory authorities in implementing and enforcing these requirements in practice meet the 

standards set out in the IOSCO Principles. The assessment is to be a means of identifying 

potential gaps, inconsistencies, weaknesses and areas where further powers and/or better 

implementation of the existing framework may be necessary and used as a basis for establishing 

priorities for improvements to the current regulatory scheme. 

42. The assessment of the country’s observance of each individual Principle is made by 

assigning to it one of the following assessment categories: fully implemented, broadly 

implemented, partly implemented, not implemented and not applicable. The IOSCO 

assessment methodology provides a set of assessment criteria to be met in respect of each Principle 

to achieve the designated benchmarks. The methodology recognizes that the means of 

implementation may vary depending on the domestic context, structure, and stage of development 

of the country’s capital market and acknowledges that regulatory authorities may implement the 

Principles in many different ways. 

 A Principle is considered fully implemented when all assessment criteria specified for that 

Principle are generally met without any significant deficiencies. 

 A Principle is considered broadly implemented when the exceptions to meeting the 

assessment criteria specified for that Principle are limited to those specified under the 

broadly implemented benchmark for that Principle and do not substantially affect the overall 

adequacy of the regulation that the Principle is intended to address. 

 A Principle is considered partly implemented when the assessment criteria specified under 

the partly implemented benchmark for that Principle are generally met without any 

significant deficiencies. 

 A Principle is considered not implemented when major shortcomings (as specified in the 

not implemented benchmark for that Principle) are found in adhering to the assessment 

criteria specified for that Principle. 
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 A Principle is considered not applicable when it does not apply because of the nature of the 

country’s securities market and relevant structural, legal and institutional considerations. 

Table 10. Detailed Assessment of Implementation of the IOSCO Principles 

Principles for the Regulator 

Principle 1. The responsibilities of the regulator should be clear and objectively stated. 

Description Regulatory structure 

Federal regulation 

At the federal level, regulation of securities and derivatives markets is divided between the 

SEC and the CFTC. In broad terms, the SEC is responsible for the securities markets and 

related derivatives markets (such as options on securities), and the CFTC for futures and other 

derivatives markets. 

The Dodd-Frank Act expanded the coverage of the federal legislation, notably by: 

Bringing swaps within the federal legislation, and allocating responsibility for swaps markets 

between the CFTC and the SEC;

Requiring the registration of municipal advisors with the SEC and providing for their 

regulation. The offering of municipal securities continues to be exempted from the 

registration and reporting requirements of the federal securities laws; 

Requiring the registration with the SEC of previously exempt advisers to HFs and private 

equity funds; 

Expanding the authority of the CFTC over off-exchange transactions in foreign currency with 

members of the retail public; and 

Removing exemptions from regulation provided for under the Commodity Futures 

Modernization Act of 2000 (CFMA) for foreign and other exempt boards of trade 

State-based securities regulation 

State authorities continue to play some role in the regulation of the securities markets. For 

example, smaller IAs (those with less than US$100 million in assets under management) are 

generally not required to register with the SEC as IAs, but are subject to state regulation. 

Some offerings of securities must be registered under both the Securities Act and applicable 

state securities laws, unless an exemption from registration is available. The National 

Securities Markets Improvement Act of 1996 (NSMIA) provided that the offer and sale of 

certain "covered securities" (such as securities listed on NYSE or NASDAQ) are no longer 

subject to state securities law registration requirements. NSMIA preserves the right of the 

states to investigate and prosecute fraud. Certain other securities offerings (such as those made 

solely within a single state) are not required to be registered under the Securities Act, but are 

subject to state regulation. Securities market intermediaries are typically required to register at 

the state as well as the federal level. 

SROs 

The U.S. regulatory system makes extensive use of SROs, including exchanges that have SRO 

roles and specialist SROs such as FINRA and the NFA. These SROs are subject to the 

authorization and oversight of the relevant regulator (see further under Principle 9). 
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36 INTERNATIONAL MONETARY FUND

CFTC

Responsibilities, powers and authority 

The CFTC is an operationally independent federal agency established under the CEA. Its 

responsibilities, powers and authority are set out in the CEA and related CFTC Regulations. 

(For example, see Section 2(a) of the CEA for the CFTC’s jurisdiction and Section 8a for its 

powers). The CFTC’s mission is to protect market users and the public from fraud, 

manipulation, other abusive practices, and systemic risk related to derivatives that are subject 

to the CEA and to foster open, transparent, competitive and financially sound markets 

(Section 3(b) CEA). 

Discretion to interpret authority 

The CFTC can interpret the authority granted to it by the CEA. It largely interprets the CEA 

based on the plain meaning of the statute and available legislative history. Interpretation is 

done mainly via guidance as well as more informal means such as frequently ask questions. 

In addition, the CEA gives the CFTC broad exemptive authority (Section 4(c)) and broad 

rulemaking authority (Section 8a(5)). Exemptive authority has been used to exempt classes of 

participants from particular provisions of a regulation, but also to allow a particular firm or 

product (or type of firm or product) not to comply with a specific provision in a law or 

regulation. The latter is usually done via no action letters. 

The rulemaking process is governed by Section 553 of the Administrative Procedure Act (APA) 

and other statutes that prescribe the manner in which the CFTC may adopt rules and 

regulations (see Principle 4). In general, rules are subject to consultation and cost-benefit 

analysis. This process is fully transparent with CFTC rule proposals, adoptions, and concept 

releases published in the Federal Register and on the CFTC’s website. 

Concerns have been expressed about the degree to which the CFTC has relied on guidance 

and no action letter relief to implement some provisions of the Dodd-Frank Act. The former 

because guidance is not subject to the formal consultation and cost-benefit analysis that is 

required for the adoption of rules under the APA. The latter mainly because it has added 

uncertainty to the regulatory framework, in particular since many no action letters have been 

time limited and some of them have been extended only shortly before their original expiry 

date. 

SEC

Responsibilities, powers and authority 

The SEC is an operationally independent federal agency established under the Exchange Act. 

Its responsibilities, powers and authority are set out in the legislation it administers, including 

the Securities Act, the Exchange Act, the Trust Indenture Act, the ICA, the Advisers Act, the 

Sarbanes-Oxley Act (SOX), the Dodd-Frank Act and the Jumpstart Our Business Startups Act 

(JOBS Act). The SEC’s mission is to protect investors; maintain fair, orderly, and efficient 

markets; and facilitate capital formation. 

Discretion to interpret authority 

The SEC can interpret its authority and the process for interpretation is clear and transparent. 

The SEC provides guidance by issuing interpretive releases, interpretive letters, legal or 

accounting bulletins, or less formal guidance such as frequently asked questions. These 

interpretations are posted on the SEC website and published in the Federal Register. 

Similar to the CFTC, the SEC has broad exemptive authority and rulemaking authority pursuant 
UNITED STATES 

INTERNATIONAL MONETARY FUND 37

to the federal securities laws. 

As in the case of the CFTC, the SEC’s rulemaking is governed by the APA and by other statutes 

that prescribe the manner in which the SEC may undertake to consider or adopt rules of 

general applicability (see Principle 4). In general, rules are subject to consultation and costbenefit analysis. This process is also fully transparent with SEC rule proposals, adoptions and 

concept releases published in the Federal Register and on the SEC’s website. 

Multi-authority issues (gaps and overlaps)

As a general rule, the SEC and the CFTC have exclusive jurisdiction for the regulation of 

activities and products within the scope of their statutory mandates. There are, however, a 

number of exceptions. In addition to the authority state authorities have in relation to certain 

securities market activities (see above), there are some areas of the market where the CFTC’s 

and SEC’s authority overlaps, or is shared with one another or with other authorities. 

Swaps 

Title VII of the Dodd-Frank Act provides for a comprehensive new regulatory framework for 

the OTC derivatives market (referred to as swaps in the U.S.). Under this framework, the CFTC 

regulates “swaps”; the SEC regulates security-based swaps (SBS); and the SEC and CFTC jointly

regulate “mixed swaps.” The new framework covers the registration and regulation of dealers 

and major participants, as well as requirements related to clearing, trade execution, regulatory 

reporting, and public dissemination of trade data. While the CFTC has primary regulatory 

responsibility for certain security based swap agreements (e.g., a swap over a broad based 

index such as the S&P 500), the SEC has authority in relation to the anti-fraud provisions of 

federal securities legislation. The prudential authorities also play a part in aspects of the 

regulation of the swaps market, especially in relation to clearing. 

Municipal brokers, dealers and advisors

Banks transacting business in municipal securities are not required to register as BDs, but they 

are included in the definition of municipal securities dealer and must register with the SEC 

and the Municipal Securities Rulemaking Board (MSRB) in that capacity. In the municipal 

market, responsibility for ensuring compliance with MSRB rules is divided between the SEC, 

FINRA and federal bank regulators. The SEC has broad inspection and enforcement authority 

over broker-dealers and non-bank municipal securities dealers with respect to MSRB rules, 

SEC rules, and the federal securities laws. FINRA has inspection and enforcement 

responsibility over its BD members. Federal bank regulators have inspection and enforcement 

authority for municipal securities dealers that are banks. In addition to the SEC and FINRA, the 

FDIC, the Federal Reserve, and the Office of the Comptroller of the Currency (OCC) all play a 

role in the enforcement of MSRB rules. 

Banks’ broker activity 

Some activities conducted by banks that would be regulated by the SEC if conducted by 

another type of market participant are either excluded or exempt from SEC regulation and 

subject only to regulation by the banking regulators. The Gramm-Leach-Bliley Act of 1999 

(GLBA) provided certain exceptions from SEC oversight for specified securities activities. The 

Exchange Act provides conditional exceptions from the definition of “broker” for banks that 

engage in specified securities activities in connection with: third-party brokerage 

arrangements; trust and fiduciary activities; permissible securities transactions; certain stock 

purchase plans; sweep accounts; affiliate transactions; private securities offerings; 

safekeeping and custody activities; identified banking products; municipal securities; and a de 

minimis number of other securities transactions. 
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38 INTERNATIONAL MONETARY FUND

The federal banking statutes generally do not limit the SEC's authority over affiliates of banks 

such as their securities subsidiaries. 

Commodity pools

The solicitation of funds for investment in a CP constitutes the offer of a security and is 

subject to obligations under the Securities Act and the Exchange Act. As a practical matter, 

public offers for CPs are generally made by one prospectus that complies with both the 

securities laws and the CFTC’s CP regulations. The majority of CPs are private placements, and 

therefore subject primarily to CFTC substantive regulation, but exchange traded products 

traded on national securities exchanges are subject to dual regulation by both the CFTC and 

SEC consisting of CP registration and regulation and disclosure requirements under both the 

CEA and federal securities laws. The SEC’s anti-fraud authority applies. 

Broker margin rules 

The Federal Reserve has legislative responsibility for setting margin requirements for both 

securities and futures intermediaries. It delegated this power to the CFTC in 1993, subject to 

annual reporting requirements, in relation to the futures industry but the Federal Reserve’s 

Regulation T applies directly to securities market intermediaries. 

Clearing houses and systemically important financial institutions

Title VIII of the Dodd-Frank Act created a new framework for assessing the systemic risk 

associated with financial institutions and financial market utilities involved in clearing financial 

transactions. The Title grants authority to the Federal Reserve, the CFTC, the SEC, and the FDIC 

to work together to promulgate rules and standards of operation, enforce those rules, and 

generally manage the systemic risk of clearing houses and other financial market utilities. 

FSOC is responsible for designating financial institutions that are, or are likely to become, 

systemically important. 

Dual registration 

BDs registered with the SEC may also dually register with the CFTC, and many of the largest 

FCMs are also registered with the SEC as BDs. The SEC and CFTC have harmonized regulations 

where possible, for example in relation to uniform capital and financial reporting 

requirements. Because swaps are now included in the definition of commodity, HF managers 

that use them may be required to register as CPOs under the CEA as well as IAs under the 

Advisers Act. 

Consistent regulation of like services and products

Insurance products 

Insurance products whose performance is based on underlying investments that are securities 

(such as unit linked products) are regulated as securities and issuers must comply with 

securities legislation disclosure obligations.

Other activities 

CIS are regulated either as MFs under the securities laws or CPs under the CEA. There are 

some differences in the obligations that apply to their operators depending on the applicable 

regime (whether securities or derivatives). For example, IAs are subject to a strict fiduciary 

obligation, but such a duty does not apply to CPOs under the CEA—although this type of 

duty may stem from state law. Similarly, BDs that provide advice to clients incidental to their 

broker-dealer business are not bound by the same fiduciary standard as IAs. 
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Coordination and cooperation between regulators

The chairs of both the CFTC and SEC are members of FSOC, which is responsible for 

facilitating coordination among financial regulators to monitor systemic risk and promote 

financial stability across the U.S. financial system. For further details on the composition and 

operation of FSOC, see Principle 6. 

Both organizations also participate in a variety of cross government forums, such as the 

Financial Fraud Enforcement Taskforce, and in regular meetings between the SEC, the CFTC, 

the Federal Reserve, the FDIC and the OCC to discuss implementation of the Volcker rule. 

Because of the intersections between the securities regime and the regime in the CEA, the 

SEC and the CFTC have worked together over many years on matters of joint interest. The 

chairs of the SEC and CFTC are in regular contact. In some cases, coordination between the 

SEC and CFTC (and in some cases with other agencies) is required by statutes such as the 

Dodd-Frank Act. There are a number of MOUs in place to support these collaborative efforts, 

including MOUs dealing with: 

Ongoing regulatory liaison between the two agencies, including information sharing and key 

principles for dealing with novel derivatives products that may reflect elements of both 

securities and commodity futures and options; 

The oversight of and sharing of information about securities futures products, including 

provisions for example that the agencies will notify each other of planned examinations and 

share examination information; and 

A framework for consultation and information sharing on issues related to CDS central 

counterparties (the Federal Reserve is also a party to this MOU). 

According to market participants, the level of communication between the two agencies has 

increased over time. However, participants expressed concern that this enhanced 

communication has had a more limited impact on ensuring consistency of regulations, and 

reducing duplicative reporting and inspections. 

Other MOUs are in place with other government agencies, such as an MOU between the SEC 

and the Federal Reserve which deals with information sharing and cooperation including on 

AML, bank brokerage activities under the GLBA, clearing and settlement in the banking and 

securities industries, and the regulation of transfer agents. 

Both agencies have a close working relationship with federal law enforcement authorities. 

Assessment Broadly Implemented 

Comments The SEC and CFTC have clear mandates set out in the legislation they administer. Both have 

considerable discretion to interpret the legislation, especially in their rulemaking functions. 

The process for making formal rules is governed by legislation and is fully transparent and 

well understood by market participants and others. In less formal areas, especially guidance, 

there are concerns that in some cases the processes used are less rigorous. This is particularly 

the case in areas subject to recent rulemaking, such as the new swaps jurisdiction, where 

there has been extensive use of no action letters. While they have often been necessary to 

address unanticipated effects of the rules, some market participants considered that in some 

cases they should have been issued at an earlier stage. 

The sweeping changes made by the Dodd-Frank Act have eliminated many gaps in coverage 

in the regulatory system, notably in relation to swaps activity, municipal advisors, advisers to 

HFs and private equity funds, and retail foreign exchange activity. The legislation also 

removed exemptions previously applying to futures trading on exempt markets. Virtually all 
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market activity is now covered by the regulatory regime. One exception is that offerings of 

municipal securities remain exempt from the registration and reporting requirements of the 

Securities Act and Exchange Act, although the anti-fraud provisions of both Acts apply to such 

offerings and the SEC has taken enforcement action against municipal issuers and other 

municipal market participants by using those provisions. This potential gap in the regime has 

not affected the grade under the Principle and is dealt with under Principle 16. 

Two issues contribute to the grade for this Principle: 

Consistent treatment of like conduct and products (Key Question 2(b) of the IOSCO 

Assessment Methodology); 

Arrangements for cooperation between responsible regulators (Key Question 2(d)). 

Consistent treatment of like conduct and products 

For the most part, like regulation is applied to like products and services. In some areas, 

however, there are differences between the regulatory regimes for what is, in essence, the 

same activity, especially from the perspective of retail investors. For example, in the securities 

area, IAs are subject to a fiduciary obligation to their customers and, at least in the case of IAs

to mutual funds, conflicts of interest regulation contains an extensive list of prohibitions. In 

the derivatives area, CPOs and CTAs do not have fiduciary obligations stemming from the 

CEA, and the relationship between them and CP participants and CTA customers is governed 

largely by disclosure obligations and by some specified rules of conduct. 

The assessors recognize that in some cases an obligation akin to a fiduciary duty may arise 

under state law. They also acknowledge that there are differences between securities and 

derivatives products (including futures) that can justify differences in the way these products 

are regulated. Nonetheless, conduct in the form of the provision of advice to retail investors is 

substantially the same type of conduct, regardless of whether the products that are the 

subject of the advice are securities or derivatives. Yet, current differences in the areas 

identified could have a significant impact on the degree of protection afforded to retail 

investors in CPs and customers of CTAs. The CFTC may wish to look more closely to 

determine whether legal changes should be pursued to subject CPOs and CTAs to a similar 

standard of care as IAs and to a more comprehensive framework to address conflicts of 

interest. 

Cooperation between regulators 

In a system as large and complex as the U.S. one, with multiple authorities having sometimes 

overlapping jurisdiction, effective coordination between authorities is critical. This applies to 

coordination in both the rulemaking and the supervision processes and in the latter case also 

applies to coordination between the statutory regulators (the SEC and the CFTC) and the 

SROs (notably FINRA and NFA). The authorities, in particular the SEC and the CFTC, have 

made efforts to ensure effective communication and where possible coordination on 

rulemaking and supervision. For example, there has been extensive communication and 

coordination between the CFTC and the SEC in rulemaking under the Dodd-Frank Act and in 

the development of common standards for data collection from CPOs and private funds. The 

Chairs of the SEC and CFTC have regular discussions. Nonetheless, market participants 

pointed to examples where in both rulemaking and supervision there appears on occasion to 

be less coordination than may be optimal. 

Many market participants are subject to supervision by both the SEC and the CFTC, by the 

SROs, and also in some cases by the banking regulators. For example, many of the largest 

FCMs are also BDs, and potentially subject to examinations by the CFTC, SEC, FINRA and NFA. 
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Market participants recognized the different mandates and areas of focus of the regulators, 

but expressed a need for increased coordination, cooperation and mutual reliance between 

the regulators and SROs in relation to reporting, examinations and other supervisory 

activities. Effective coordination of supervision efforts on the part of all regulators is especially 

important where, as is increasingly the case, supervision and examinations are focusing more 

on areas that are common across regulatory regimes, such as the adequacy of governance 

arrangements, internal control and risk management. These are areas where market 

participants suggest the need for enhanced communication and coordination between the 

regulators, especially in the planning and carrying out of examinations, and in the sharing of 

information both ex ante and post. The assessors agree there would seem to be opportunities 

for further coordination in the planning, implementation and sharing of information about 

these areas of activity. 

Principle 2. The regulator should be operationally independent and accountable in the exercise of its 

functions and powers. 

Description CFTC

Independence 

The CFTC is an independent regulatory commission of the U.S. government and does not 

operate as a division of any Executive Branch department or other agency. It is accountable 

directly to Congress rather than to the Executive Branch of government. 

Governance 

The CFTC is governed by a Commission consisting of five Commissioners appointed by the 

President with the advice and consent of the Senate. Each Commissioner holds office for five 

years, with appointments staggered so that one Commissioner’s term expires each year. No 

more than three Commissioners may be members of the same political party. 

The President appoints, with the advice and consent of the Senate, a member of the CFTC as 

Chairman. The Chairman serves at the pleasure of the President and the President may at any 

time appoint a different Chairman subject to the advice and consent of the Senate. The CFTC 

Chairman replaced through this process may complete his or her term as a Commissioner. 

There are no statutory criteria for the removal from office of a Commissioner, but case law has 

established that the President can exercise the power to remove a Commissioner only for 

cause such as neglect of duty or malfeasance in office. The CEA prohibits CFTC 

Commissioners from accepting employment or compensation from any entity regulated by 

the CFTC and from participating, directly or indirectly, in any transactions subject to CFTC 

regulation. 

Interaction with government and other agencies 

In general, the CFTC can discharge its functions without the need for approval from or 

consultation with any other governmental authority. 

Various pieces of legislation require the CFTC to consult with and coordinate with other 

regulatory authorities in specific cases. For example, Section 712(a)(1) of the Dodd-Frank Act 

requires the CFTC to consult and coordinate with the SEC and the prudential regulators on 

rule making relating to the swaps market. The CFTC must also consult on a number of other 

matters with other authorities such as the Treasury Department and Federal Reserve before 

the registration of a DCM planning to trade futures based on any security issued or 

guaranteed by the U.S. government or any U.S. agency. The CFTC also has obligations to 

coordinate with other federal regulators (such as the Federal Trade Commission (FTC) and the 
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Federal Energy Regulatory Commission (FERC)) on matters relating to the cash markets 

underlying derivatives products. 

The Congressional Review of Agency Rulemaking Act (CRARA) requires agencies to submit 

proposed rules to Congress with specified details about the rules. A non-major rule becomes 

effective as proposed by an agency, if Congress receives the required report. A major rule 

generally becomes effective 60 days after Congressional receipt of an agency’s report. This 

process is an information channel rather than an approval channel (and there may be a 

constitutional question as to Congress’s power to overturn a rule without legislative action). In 

practice, Congress has not sought to exercise a power of disapproval. 

Interaction with commercial and other sectoral interests 

There are explicit conflict of interest provisions that seek to address potential conflicts of 

interest of Commissioners and CFTC staff arising from previous relationships as well as from 

their holdings of financial products. These provisions are further described in Principle 4. 

The CFTC interacts with industry in particular in connection with the rulemaking process. Such 

interactions are conducted under an open process prescribed by the APA. In addition, the 

CFTC has adopted the practice of making a public record of a summary of any ex parte

communications made to Commission members or staff in the course of rulemaking, and 

written submissions on proposed rules are placed on the public record. 

Funding stability

The CFTC is funded through an annual appropriations process. It submits a budget request to 

the President or the Office of Management and Budget (OMB), which provides advice to the 

President on budget matters. The request must also be copied to relevant Congressional 

Committees. Authorization of the CFTC’s budget is through the adoption by the Congress of a 

specific bill authorizing and funding the CFTC’s operations (as part of the President’s budget). 

The appropriate House and Senate committees may hold hearings, request additional 

testimony by CFTC Commissioners or staff, or request additional documentation. 

On many occasions, the budget approved by Congress has been lower than the one 

requested by the CFTC. For example, for fiscal year 2015 the President recommended $280 

million for the CFTC (an increase of $65 million and 253 staff persons over the 2014 levels), 

but the 2015 Agriculture Appropriations Bill provides the CFTC with a budget of $218 million. 

This budget represents an increase of $3 million over the 2014 enacted level, but is $62 

million below the President’s request. The Bill allocates over $52 million for the purchase of 

information technology until September 30, 2016. 

The budget of the CFTC has been subject to sequestration three times during the last five 

years. However, CFTC staff indicated that in practice it has not had material consequences for 

the budget of the agency, although the furlough had to be applied on one occasion. 

Reauthorization process 

In common with a number of other federal agencies, the CFTC is subject to periodic 

reauthorization, typically at five year intervals. But even if a reauthorization decision is not 

made within the specified period (as is currently the case), as long as Congress continues to 

make budget appropriations to the agency, it is taken to have continuing authorization. For 

this reason CFTC senior officials did not consider that the requirement for reauthorization 

hinders the agency’s ability to discharge its functions effectively; rather they consider that it 

provides a point of accountability. 
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Legal protection 

Principles of sovereign immunity apply to the CFTC as an agency of the federal government. 

The Federal Employees Liability Reform and Tort Compensation Act of 1988 (FTCA) provides 

federal employees with immunity from individual liability for torts committed in the scope of 

their employment. The CFTC has also adopted indemnification rules, covering Commissioners 

and staff, to provide protection for individual liability for possible violation of constitutional or 

statutory duties that are not covered by the FTCA. 

Accountability

The CFTC is accountable to Congress. The House Committee on Agriculture and its 

Subcommittee on Risk Management and Specialty Crops, and the Senate Agriculture, 

Nutrition and Forestry Committee and its Subcommittee on Research, Nutrition and General 

Legislation have the principal responsibility for oversight of the CFTC. These Committees 

handle, in the first instance, the reauthorization, budget and funding decisions for the CFTC, 

as well as bills affecting the CEA. 

Transparency 

Section 8(h) of the CEA requires the CFTC to submit to Congress a written report within 120 

days after the end of each fiscal year detailing the operations of the CFTC during that fiscal 

year. The CFTC is required to include in this annual report any information, data and 

legislative recommendations it deems advisable with respect to the administration of the CEA 

and its powers and functions under the CEA. Section 18(b) of the CEA requires that the annual 

report contain plans and findings regarding implementation of Section 18(a) of the CEA, 

which mandates certain research and information programs.

The APA governs CFTC rulemaking and requires interested persons be given an opportunity to

comment on proposed rulemaking. The Sunshine Act generally provides that meetings of the 

Commission must be open to the public and requires the CFTC to provide advance notice of 

such meetings (see Principle 4).

Use of funds 

Section 8(i) of the CEA requires the Comptroller General (Government Accountability Office, 

GAO) to conduct reviews and audits of the CFTC and make reports on them. The CFTC must 

make available to the GAO any required information about its powers, duties, organization, 

transactions, operations and activities, as well as access to any books and records (subject to 

confidentiality requirements). 

In addition, the operations of the CFTC are subject to ongoing review by the CFTC’s 

independent Office of the Inspector General (OIG). OIG conducts and supervises audits and 

investigations of CFTC programs and operations and reviews existing and proposed 

legislation and regulations. OIG recommends policies to promote economy, efficiency and 

effectiveness in CFTC programs and operations, and to prevent and detect fraud and abuse. 

OIG keeps the Chairman of the CFTC and Congress informed about any problems, 

deficiencies, and progress of corrective action in programs and operations. OIG reports may 

be made public. 

Review of decisions 

Under the APA, a person aggrieved by a decision or action of the CFTC can challenge that 

decision in a U.S. Federal District Court. This applies to decisions to adopt rules, and decisions 

such as the denial of applications for registration or sanctions decisions. 
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Confidentiality 

Section 8(a)(1) of the CEA provides that, except as otherwise specified in the CEA, the CFTC 

must not publish data and information that would separately disclose market positions, 

business transactions, trade secrets or names of customers, and the CFTC must not make 

public any data or information concerning or obtained in connection with any pending 

investigation of any person. Confidentiality of information is preserved through the 

accountability process by the code of ethics that applies to members of Congress and their 

staff, and by negotiation between the CFTC and Congress and its members. 

SEC

Independence 

The SEC is an independent federal agency of the U.S. government and operates 

independently of the Executive Branch of government. It is accountable directly to Congress 

rather than to the Executive Branch of government. 

Governance 

The SEC is governed by a Commission consisting of five Commissioners appointed by the 

President with the advice and consent of the Senate. Their terms last five years and are 

staggered so that one Commissioner's term ends on June 5 of each year. No more than three 

Commissioners may belong to the same political party. The President also designates one of 

the Commissioners as Chairman. Some chairs of the SEC have not been affiliated with a 

political party. 

The laws governing the SEC do not provide express criteria for removal of Commissioners, but 

as noted above, judicial precedent establishes that they can only be removed for cause. 

Commissioners must be full time and not engage in any other form of employment other 

than as Commissioner. The SEC’s Supplemental Standards of Ethical Conduct include 

prohibitions for Commissioners and staff on transactions involving an issuer directly regulated 

by the SEC or under investigation by it. These Standards also require Commissioners and staff 

to clear in advance any securities transactions or holdings. 

Interaction with government and other authorities 

As a general matter, the SEC is not required to consult with or obtain approval from a 

government minister or other authority with respect to the discharge of its statutory 

responsibilities under the federal securities laws. 

Various provisions of the securities laws require consultation or cooperation with other 

agencies in specific cases. For example, under the Exchange Act, the SEC consults and 

cooperates with the OCC, the Federal Reserve and the FDIC on bank transfer agents and 

clearing agencies; Title VII of the Dodd-Frank Act requires the SEC to engage in joint 

rulemaking with the CFTC on aspects of the swaps market; and Title VIII of the Dodd-Frank 

Act authorizes the SEC, in consultation with the Federal Reserve and the FSOC, to prescribe 

new risk management standards for example for clearing agencies. The situations in which 

consultation or cooperation is required are set out in legislation and transparent. 

The SEC is also subject to general administrative statutes that require it to undertake 

consultations with respect to its rulemaking or other operations (see Principle 4). As with the 

CFTC, all final SEC rules must be submitted to Congress before they can take effect. 

Interaction with commercial and other sectoral interests 

Similar to the CFTC, there are explicit conflict of interest provisions that seek to address 
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potential conflicts of interest of Commissioners and SEC staff arising from previous 

relationships as well as from their holdings of financial products. These provisions are further 

described in Principle 5. 

As with the CFTC, the SEC interacts with industry particularly in connection with its rulemaking 

function. It does so through a transparent process further described in Principle 4. It also has 

adopted the practice of making a public record of a summary of any ex parte communications 

made to Commission members or staff in the course of rulemaking 

Funding stability

The SEC’s budget is part of the federal budget that is prepared by the President and submitted 

to Congress. Each year, the SEC prepares a budget estimate, which it forwards to OMB. This 

budget request outlines the major program areas of the SEC and estimates the resources 

(including staff and expenses such as salary, facilities and supplies) needed to operate them. 

Funding for the SEC is made through an annual appropriation from Congress. This 

appropriation is deficit-neutral, because it is offset by securities transaction fees assessed on 

SROs in accordance with Section 31 of the Exchange Act. The current fee rate is approximately 

$0.02 per every $1,000 transacted. 

The SEC also has a reserve fund, which can, under certain circumstances, be used for the 

agency’s expenses, and the SEC has dedicated this to technology. The SEC can use up to $100 

million from this fund each year. The funding is provided by deposits of $50 million per year 

in securities registration fees (with the remainder of registration fees being remitted to 

Treasury). 

The level of funding approved by Congress has been significantly lower than that requested 

by the SEC. Similar to the CFTC, SEC budget has been affected by the sequestration process in 

three occasions during the last five years. SEC staff indicated that in one occasion the 

sequestration process had a material effect in the final budget of the agency. 

Legal protection 

Similar to the CFTC, the principle of sovereign immunity provides protection to the SEC as a 

whole and to individuals (the Chair, Commissioners, and staff). While there are exceptions to 

the principle of sovereign immunity, the SEC and its members and staff are generally protected

from frivolous or unwarranted litigation or claims. 

Staff acting in a prosecutorial fashion are entitled to absolute immunity from constitutional 

torts (civil rights actions), so long as the actions are taken within the scope of their authority. 

The FTCA provides immunity for torts committed by employees of the federal government 

within the scope of their employment. 

Accountability

The SEC is subject to Congressional oversight. The two Congressional committees with primary 

authorizing and oversight responsibilities over the SEC are the Senate Committee on Banking, 

Housing and Urban Affairs (Senate Banking Committee) and the House of Representatives 

Committee on Financial Services (House Financial Services Committee). Each of those 

committees contains a subcommittee with jurisdiction specific to securities issues. Various 

other Congressional committees also have oversight or other responsibilities related to the SEC.

Section 961 of the Dodd-Frank Act requires the SEC to report to Congress on the supervisory 

controls over the conduct of the SEC over its examinations of registered entities, enforcement 

investigations, and review of corporate financial securities filings. The Act also mandates a 

number of other periodic reports from the GAO on aspects of the SEC’s performance. 
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The SEC is also accountable to Congress through its relationship with the GAO. The GAO’s work

is done at the request of congressional committees or subcommittees, or is mandated by 

public laws or committee reports. The GAO supports congressional oversight by: 

Auditing agency operations to determine whether federal funds are being spent efficiently 

and effectively; 

Investigating allegations of illegal and improper activities; 

Reporting on how government programs and policies are meeting their objectives; 

Performing policy analyses and outlining options for congressional consideration; and 

Issuing legal decisions and opinions. 

During the last 5 years GAO has delivered reports to Congress on topics such as municipal 

securities, credit rating agencies, the definition of accredited investors and regulation of 

research analysts. 

Transparency 

The SEC’s operations and use of resources are transparent. For example, the SEC publishes 

annually an Agency Financial Report, which describes the SEC’s activities and financial 

operations for a given fiscal year. The SEC also makes publicly available a copy of its current 

Rules of Practice and Rules on Fair Fund and Disgorgement Plans; and the Staff’s Enforcement 

Manual. 

The SEC is required to report to the Senate Banking Committee and the House Financial 

Services Committee not later than 90 days after the end of each fiscal year on the supervisory 

controls over the conduct by the SEC of examinations of registered entities, enforcement 

investigations, and review of corporate financial securities filings. 

The APA governs SEC rulemaking and generally requires that interested persons are given an 

opportunity to comment on proposed rulemaking. The SEC posts its rulemaking releases, 

public comment letters filed with the SEC, as well as other data or information that is 

important to the SEC’s consideration of the rulemaking on the SEC’s website. The Sunshine 

Act generally provides that meetings of the Commission must be open to the public and 

requires the SEC to provide advance notice of such meetings. The SEC videocasts all open SEC

meetings on the Internet.

Use of funds 

The SEC’s receipt and use of funds are subject to regular audit by the GAO and the SEC’s 

Office of Inspector General (OIG). The GAO conducts annual audit of the SEC’s financial 

statements and internal controls over financial reporting. The GAO and OIG also conduct 

regular audits of SEC programs and operations. The results of these audits are reported to 

agency management, made available to Congress and OMB, and are generally made public 

on the Internet. 

Review of decisions 

A person aggrieved by a final order of the Commission may seek judicial review in a federal court. 

Judicial review can be sought by those adversely affected by agency rulemaking, by registration 

decisions and sanctions decisions. 

The APA requires the SEC to prepare a written decision setting out the SEC’s findings of fact and 

conclusions of law and the underlying reasons. The federal securities laws also require the SEC to 

issue orders in its administrative proceedings. The SEC has extensive published rules of 
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procedure aimed at ensuring fairness in the conduct of hearings and other administrative 

activities. 

Confidentiality 

The Exchange Act and Advisers Act contain statutory provisions designed to safeguard the 

confidentiality of information obtained in the course of examinations or investigations. Rule 

24c-1 under the Exchange Act provides that the SEC may provide nonpublic information in its 

possession to certain entities, including other domestic and foreign governmental entities, but 

only if it receives appropriate assurances of confidentiality. 

The Freedom of Information Act (FOIA) governs public access to certain types of documents. 

FOIA requires that the SEC make certain information available to the public, but also provides

certain exceptions for, among other things, commercially sensitive material. 

The confidentiality of information provided through the accountability process is preserved, 

as with the CFTC, through a combination of the ethical obligations of members of Congress 

and their staff, and by negotiation between the SEC and Congress. 

Assessment Broadly Implemented 

Comments Both the SEC and the CFTC are operationally independent on a day-to-day basis and fully 

accountable to the legislature. 

The reason for the grade in this Principle is that the annual budget process to which both 

agencies are subject makes planning for medium and long term priorities subject to 

considerable uncertainties. In addition, in recent years there have been significant gaps 

between both agencies’ budget requests (which have been supported by the President) and 

the funding they have received. This means that new responsibilities, especially those 

resulting from the Dodd-Frank Act, have largely been met by reallocating resources internally, 

including away from other regulatory and supervision areas. This has, notably, impacted the 

frequency of examinations. The sequestration process has added uncertainty about budgets. 

Congress, through legislation, creates mandates that affect both aspects of supervisory 

activity and the structure of the agencies, for example by mandating that the SEC conduct 

annual examinations of CRAs (see Principle 22), and create a separate Office of Credit Ratings. 

While some types of legislative mandate given to the SEC and the CFTC can potentially limit 

their ability to manage resources effectively to meet emerging needs as market circumstances 

change, the assessors consider that the current legislative mandates have been fairly well 

aligned with the SEC’s and CFTC’s own priorities. In the same vein, while in the case of the SEC 

certain structures have been mandated, the impact of those on the agencies’ organizational 

structure has so far been relatively limited. 

The assessors recognize that there is a delicate balance between independence and 

accountability, and that the funding process does not appear to have had any impact on the 

independence of the SEC’s and CFTC’s regulatory and supervisory decision making processes. 

Nonetheless, in recent years the Congressional budget process, on which funding decisions 

for the CFTC and the SEC depends, has been politically complex and subject to considerable 

uncertainties; there have been significant delays in the approval of proposed budgets; and, as 

noted above, there are major gaps between budget requests and final allocations. This adds 

to the uncertainties inherent in an annual budget process, and potentially limits the ability of 

the agencies to make forward plans for multi-year investments (such as in technology) and 

supervisory activities spanning more than the current budget cycle. 

The assessors believe that, within the existing accountability framework, consideration should 

be given to mechanisms that would allow the agencies to make longer term plans for the use 
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of resources than is possible under an annual budget process. Examples of such mechanisms 

include multi-year budgets, or a move toward some or all of the agencies’ budgets being selffunded. 

Composition of both Commissions is subject to a requirement as to the political affiliation of 

Commissioners, and legislation requires that no more than three commissioners may belong 

to the same political party. This is an unusual requirement by international standards and 

reflects particular U.S. traditions. In practice it protects the agencies from a perception that 

agency thinking is dominated by the views of one political party; but it also risks creating a 

perception that decision making at Commission level is in some sense a political process. This 

potentially may lead to a further perception that the agency is not fully independent from 

political influence. The Sunshine Act provisions, which mandate an unusually high level of 

transparency in Commission decision making, are intended to mitigate this risk. 

Principle 3. The regulator should have adequate powers, proper resources and the capacity to perform its 

functions and exercise its powers. 

Description CFTC

The CFTC has four Divisions (Clearing and Risk (DCR); Enforcement (DOE); Market Oversight 

(DMO) and Swap Dealer and Intermediary Oversight (DSIO)) and eight Offices (including an 

Office of the Chief Economist, an Office of Data and Technology, an Office of international 

Affairs) and an Office of the Inspector General). It also has 3 regional offices. 

Power and authorities 

The CEA gives the CFTC extensive powers to supervise the markets, financial institutions, 

market participants and SROs within its jurisdiction. These powers include the power to seek 

information from regulated persons and others, to conduct surveillance of markets, to monitor 

compliance by regulated entities, to investigate suspected breaches of the legislation it 

administers, to impose sanctions and to refer matters to the criminal authorities. See further 

under Principles 10 and 11. 

The Dodd-Frank Act significantly enhanced the CFTC’s regulatory authority including by: 

Giving it new authorities over SDs, major swap participants (MSPs), DCMs, DCOs, SEFs and 

SDRs; 

Significantly enhancing the CFTC’s enforcement anti-manipulation authority (see DEA Section 

753); 

Expanding the CFTC's authority to bring new types of enforcement actions alleging false 

statements to the CFTC (see CEA Section 6(c)(2)); 

Expressly prohibiting certain trading practices that are disruptive of fair and equitable trading 

(see Section 747 of the Dodd-Frank Act and Section 4c(a) of the CEA); 

Removing a number of previous exemptions from regulation; and 

Including detailed Core Principles for DCOs to enhance the CEA regulatory regime for central 

counterparties. 

The CFTC has undertaken extensive rulemaking to implement the requirements of the DoddFrank Act. Most mandated rulemaking is now complete. 

Allocation of resources and sufficiency of funding 

The CFTC’s ability to affect the operational allocation of resources is impacted by the way the 

budget is approved. The budget submitted to Congress must include an allocation request that
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contains a specific breakdown of the proposed resource allocation within the CFTC. This 

allocation may be revised as part of discussions between the Congress and the CFTC. The final 

allocation is established when the Congress adopts the bill funding the CFTC’s operations. 

Significant changes in allocation of funds once appropriated require a reprogramming request 

to the relevant Committee of Congress. 

Senior officials from the CFTC acknowledge that the current level of funding poses challenges 

particularly in light of the expansion of the CFTC mandate brought by the Dodd-Frank Act, but 

that they will continue to use resources as effectively as possible. However, market participants 

expressed concerns about the impact that Congress’ approved budget has on the CFTC’s ability 

to deliver timely high quality regulations as well as effective supervision of the new population 

under the CFTC’s jurisdiction. 

Staff resources 

As of May 31, 2014, the CFTC had 646 employees that comprised 435 regulatory and 

supervision staff (attorneys, economists, auditors, risk and trade analysts, and other financial 

specialists); 163 management and support staff; and 48 executives. 

Section 2(a)(7) of the CEA permits the CFTC to maintain comparative compensation and 

benefits in relation to other federal financial regulators for the purpose of retaining and 

attracting employees. Current salaries are comparable to those paid by other federal financial 

regulators –although some of them can offer better benefits given their self-funded nature. 

Staff turnover has ranged from 8 to 12 percent, and has remained in this range for the last five 

years. 

Training

The CFTC’s Human Resources Branch provides a series of educational/training seminars keyed 

to the primary mission of the CFTC through its Talent Management and Leadership 

Development Section. The Section employs a full-time Chief Learning Officer to ensure that the 

training needs of all employees are met. Training seminars are focused on the financial and 

legal aspects of the futures, options and swaps markets. The Commission recently announced 

that it has entered into a multi-year contract to allow all CFTC employees to take technical 

training related to financial management, financial marketplaces and business skill 

enhancement. 

Technological resources 

CFTC senior staff highlighted the investments that the agency has made to develop robust 

automated mechanisms for market surveillance. Current efforts focus on extending such tools 

to the swaps market as described in Principle 6. 

Investor education

The CFTC has an Office of Consumer Outreach which creates and distributes financial education 

messages to help consumers avoid fraud and deception in the commodities markets. It has a 

section on its website devoted to consumer protection. The consumer protection section of the 

website educates consumers about the U.S. futures markets; notifies the public about the types 

of fraud in the marketplace; offers guidance on how to file complaints or send in tips regarding 

suspicious activities; and provides updates on disciplinary actions. 

SEC

The SEC has five Divisions (Corporation Finance (CF); Enforcement, Investment Management 

(IM); Trading and Markets (TM); and Economic and Risk Analysis (DERA)); and 22 Offices, 

including the Office of Compliance Inspections and Examinations (OCIE), the Office of the Chief 
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Accountant (OCA), the Office of Credit Ratings (OCR), the Office of Municipal Securities, and 

the Office of the Inspector General (OIG). It also has 11 regional offices. 

Power and authorities 

The legislation administered by the SEC (outlined under Principle 1) gives it extensive powers to

supervise the markets, financial institutions, market participants and SROs within its jurisdiction. 

These powers include the power to seek information from regulated persons and others, to 

conduct surveillance of markets, to monitor compliance by regulated entities, to investigate 

suspected breaches of the legislation it administers, to impose sanctions and to refer matters to

the criminal authorities. See further under Principles 10 and 11. 

The Dodd-Frank Act expanded the authority of the SEC in a number of areas, giving it new 

authority over: 

Previously exempt IAs to HFs and private equity funds with over US$100 million assets under 

management; 

Municipal advisors; and 

Security based swaps. 

Allocation of resources and sufficiency of funding 

As is the case for the CFTC, the SEC’s ability to make operational changes to the budget 

approved by Congress is affected by the way the budget is approved. When the agency 

submits its budget proposal to Congress, the proposal must be accompanied by an allocation 

request which establishes the way resources will be spent. In this regard the budget allocates the 

funds for categories of spending called “object classes”. The SEC’s largest budget object class, 

for instance, is for personnel compensation and benefits, which was approximately $927 million 

for fiscal year 2014. The budget approval bill usually includes provisions that authorize the SEC to 

transfer funds among object classes or programs within certain limits (in recent years, for 

instance, the SEC has been allowed to reallocate the lesser of $5 million or 10 percent of a 

category). Outside these limits, the SEC needs to seek the permission of the House and Senate 

Appropriations Committees to reallocate funds from one category to another by submitting a 

formal reprogramming request. 

The SEC budget has not increased in line with the expansion of its mandate as a result of the 

Dodd-Frank Act. According to SEC senior staff, this has among other challenges affected the 

SEC’s ability to implement a robust examination program for IAs. 

Staff resources 

The SEC has a staff of more than 4,000 people. While the majority of the SEC staff is composed 

of lawyers and accountants, the agency has increased the number of economists and 

quantitative analysts as part of its effort to enhance its risk-based supervisory approach. Like 

the CFTC, the SEC is exempted from the general salary scale applicable to government 

employees. Current salaries are comparable to those paid by other financial regulators –

although some of them can offer better benefits given their self-funded nature. The SEC 

continues to implement enhanced employee benefits, market-based pay structure, multiple day 

telework, flexible work schedules, and pay-for-performance, all of which are designed to 

encourage skilled staff members to remain. 

The SEC aims to keep its turnover rate relatively low, below 8 percent per year. During fiscal 

years 2010 through 2013, the SEC experienced a turnover rate that averaged less than 6 percent,

which was consistent with the overall federal sector turnover rate. 
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Training

The SEC has created SEC University to provide training and development opportunities to all 

staff. The mission of SEC University is to develop SEC employees and managers to ensure high 

performance and productivity and a collaborative, effective, and engaged workplace. SEC 

University plans and delivers internally held in-person courses, assists employees who need to 

take a class offered by an outside organization, and provides a variety of web based training. 

Every new employee and Commissioner receives ethics education and training. Regulatory 

requirements regarding ethics training are set forth in the Government-wide ethics regulations. 

OEC has an internal website on the SEC’s intranet that provides additional guidance on all of 

these topics and links to the Office of Government Ethics (OGE) regulations and disclosure forms.

Technological resources 

The SEC is increasingly making more use of quantitative data to support both its rulemaking as 

well as its supervisory activities. Technology is a key component of this effort and sophisticated 

tools have been developed by the agency as described in Principle 6. 

Investor education

The SEC’s Office of Investor Education and Advocacy leads the SEC’s investor education 

initiatives by communicating with investors, responding to complaints and inquiries, and 

providing educational programs and materials. It does so by: 

Handling investment-related complaints; 

Providing responses to investor requests for information and assistance; 

Raising awareness about the SEC’s online educational resources, including the SEC’s 

investor.gov website; 

Implementing investor education programs; and 

Participating in in-person events for investors. 

Assessment Partly Implemented 

Comments Both the CFTC and the SEC have stated in testimonies on their budgets that their levels of 

funding need to be increased to enable them to effectively fulfill their mandates. The SEC in 

particular has stated that its supervision of IAs, including the new population of advisers to HFs 

and private equity funds, is affected by budget constraints. For the CFTC, rulemaking for swaps 

has meant more limited resources are available for areas within its established jurisdiction. The 

CFTC has stated that this has affected its ability to carry out examinations of intermediaries; to 

make full use of swaps data; to conduct effective daily surveillance of market activity; and to 

investigate and prosecute violations. This resource constraint will likely become increasingly 

important with the implementation of new rules. 

The CFTC has also been subject to specific requirements to allocate part of its budget to IT 

investments and activities, which, while important, face implementation challenges due to lack 

of sufficient funding for staff resources. 

In practice, in recent years the budget appropriations of both agencies have not kept pace with 

the expanded mandates and increasingly complex markets. 
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 Source: CFTC and SEC. 

CFTC and SEC appropriations 

Fiscal years 2010-2014 

($ million)

FY 2010 FY 2011 FY 2012 FY 2013 FY 2014 

CFTC 169 203 205 205 215 

SEC 1,111 1,185 1,346 1,302 1,372 

Principle 4. The regulator should adopt clear and consistent regulatory processes. 

Description Clear and equitable procedures 

Procedural rules and regulations 

Both the CFTC and the SEC operate in a highly transparent way. Registration requirements are 

transparent and published on the CFTC and SEC’s websites, and so are interpretations, guidance 

and (subject to requests for confidentiality for a specified time) no action letters. In particular in 

the enforcement area, manuals and guidance available on the agencies’ websites set out the 

agencies’ approach to investigations and the imposition of sanctions. For critical processes the 

agencies require staff to work under the four eye principle, which helps to ensure consistency of 

decisions. 

As a general matter, the U.S. Constitution requires administrative agencies to conduct their 

proceedings with due process. Legislation that applies to most federal agencies applies to the 

CFTC and the SEC. The most important of these statutes are: 

The APA: there are detailed provisions in the APA dealing with processes for agency decision 

making, including rulemaking (for example requirements for notice and an opportunity to 

participate in rulemaking through submission of written data, views or argument) and other 

decisions such as registration and sanctions decisions. It generally requires that affected parties 

be given notice of reasons for decisions and an opportunity to be heard before final decisions 

are made. The APA also provides for judicial review of final agency decisions. 

The Sunshine Act: this Act requires transparent procedures in the discharge of agency business. 

Among other things, it provides that meetings of the Commissions must be open to the public 

unless an exemption applies, and requires advance notice of meetings. 

The Paperwork Reduction Act (PRA): this Act requires review and analysis of reporting and 

record-keeping issues and burdens in agency rulemaking; 

The Regulatory Flexibility Act (RFA): this Act requires the agencies to consider the needs of 

small entities in evaluating proposed rules and rule changes; 

The Freedom of Information Act (FOIA): this Act requires agencies to make publicly available 

information that is not subject to specified restrictions on disclosure; 

The Privacy Act: this Act sets out procedures for agencies when they obtain, maintain and 

disseminate information about members of the public; and 

The Right to Financial Privacy Act (RFPA): this Act requires agencies to follow specified 

procedures when they seek to subpoena certain financial records from financial institutions or 

transfer these records to other government agencies. 

Both the CFTC and the SEC are also bound by procedural rules in the legislation they 

administer. For example, Section 23(a)(2) of the Exchange Act requires the SEC to consider the 
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impact proposed rules would have on competition; and Section 15(a) of the CEA requires the 

CFTC to consider the costs and benefits of its actions before issuing a new regulation. 

The CFTC and the SEC have also promulgated extensive rules and regulations that establish 

procedural and transparency standards for agency actions. For example, both agencies have 

specific regulations setting out rules of procedure for specific aspects of their operations, such 

as adjudicatory proceedings and investigatory proceedings. 

Consultation and transparency 

Both agencies’ rulemaking processes are governed by the APA. The APA generally requires the 

agencies to publish a notice of proposed and final rulemaking in the Federal Register and to 

provide interested persons an opportunity to participate in the rulemaking through submission 

of written data, views or arguments with or without an opportunity for oral presentations. The 

SEC and the CFTC also from time to time use public forums to enable discussion of proposed 

rules. 

The SEC has created a number of advisory committees pursuant to the Federal Advisory 

Committee Act (FACA), which regulates the formation and operation of advisory committees by 

federal agencies. These consultative committees include an Investor Advisory Committee (which 

has been made permanent by the Dodd-Frank Act) and an Advisory Committee on Small and 

Emerging Companies. 

The CFTC also has a number of advisory committees, including an Agricultural Advisory 

Committee, a Global Markets Advisory Committee, a Technology Advisory Committee and an 

Energy and Environmental Markets Advisory Committee. 

The SEC and CFTC websites provide access to all rules, regulations and policies adopted by the 

agencies, as well as other material such as staff interpretive letters and no action letters. 

Cost of compliance 

The consultation processes used by the CFTC and the SEC in their rulemaking enable them to 

consider the costs and benefits of proposed rules. Specific legislation, such as the PRA and RFA, 

also require consideration of regulatory burdens imposed by proposed rules. 

Section 15(a) of the CEA requires the CFTC to consider the costs and benefits of its action from 

five perspectives: protection of market participants and the public; efficiency, competitiveness 

and financial integrity of futures markets; price discovery; sound risk management practices; 

and other public interest considerations. 

Procedural fairness 

As described above, the SEC and the CFTC are bound by statutory provisions and their own 

rules to provide procedural fairness. As a general rule, these provisions require the agency to 

provide a statement of reasons for decisions, and an opportunity for an affected party to be 

heard before a final decision is made. 

Section 557 of the APA requires that the agency decisions (including initial, recommended, and 

tentative decisions) must include a statement of findings and conclusions, and the reasons or 

basis for such, on all material issues of fact, law, or discretion that are presented on the record. 

Such decisions must all include a statement of the appropriate rule, order, sanction, relief or 

denial. In this context decisions include decisions to deny or revoke a license. 

Review of decisions 

Chapter 7 of the APA creates the right of judicial review over agency actions. Under Section 702, 

a person suffering legal wrong because of agency action, or adversely affected or aggrieved by 
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agency action is entitled to judicial review. 

Decisions of an Administrative Law Judge can be appealed to each Commission, and the 

Commissions’ decisions can be appealed to a court. 

Confidentiality 

Section 8(a)(1) of the CEA provides that, except as otherwise specified in the CEA, the CFTC may 

not publish data and information that would separately disclose market positions, business 

transactions, trade secrets or names of customers, and the CFTC may withhold from public 

disclosure any data or information concerning or obtained in connection with any pending 

investigation of any person. 

The Exchange Act and Advisers Act both contain statutory provisions that are designed to

safeguard the confidentiality of information obtained in the course of examinations or

investigations. The SEC also has adopted rules under the Exchange Act to permit confidential 

treatment of requests for certain information. Rule 24c-1 under the Exchange Act provides that 

the SEC may provide nonpublic information in its possession to certain entities, including other 

domestic and foreign governmental entities, but only if it receives appropriate assurances of 

confidentiality. 

Both agencies have a policy of not commenting publicly on ongoing investigations. 

Assessment Fully Implemented 

Comments Both the CFTC and the SEC are subject to transparent and comprehensive procedural rules and 

regulations, imposed by government-wide legislation and by their own rules. The issue of the 

use of guidance and no action letters, rather than rulemaking, to adjust the parameters of the 

regulatory regime is dealt with in the comments under Principle 1. 

Principle 5. The staff of the regulator should observe the highest professional standards, including 

appropriate standards of confidentiality. 

Description The Commissioners and staff of the CFTC and SEC are subject to codes of ethics and 

professional conduct standards that cover integrity, procedural fairness, prevention of conflict 

and confidentiality. 

Regulations issued by the U.S. Office of Government Ethics (OGE) apply to the SEC and the 

CFTC and cover: basic obligations of public trust; gifts from outside sources; gifts between 

employees; conflicting financial interests; impartiality in performing official duties; seeking other 

employment; misuse of position; and outside activities. In addition both agencies have 

supplemented these government-wide rules by adopting detailed rules and regulations 

governing the conduct of Commissioners and staff. 

CFTC

Conflicts of interest 

Subpart C of Part 140 of the CFTC Regulations establishes general ethical standards of conduct 

for CFTC employees and CFTC Commissioners. CFTC Regulations restrict business and financial 

transactions and interests; non-governmental employment and outside activities; and the 

receipt and disposition of foreign gifts and decorations. Other Regulations prohibit the 

disclosure of non-public commercial, economic or official information to any unauthorized 

person; and require reporting by and an ethics review of all former employees who intend to 

practice or otherwise represent a party before the CFTC for two years after terminating 

employment with the CFTC. 
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Trading 

CFTC Regulations prohibit, subject to some narrow exceptions, CFTC Commissioners and staff 

from trading in products regulated by the CFTC. 

Use of information 

Section 9(d) of the CEA makes it a punishable felony for a CFTC employee or CFTC 

Commissioner to share or otherwise benefit from information the employee or Commissioner 

receives in the course of employment which may affect or tend to affect the price of 

commodities. Section 9(c) of the CEA makes it a felony for a CFTC employee or CFTC 

Commissioner to trade commodity futures and options or to participate directly or indirectly in 

any investment transaction in an actual commodity, if nonpublic information is used in the 

transaction or if prohibited by CFTC regulations. 

Confidentiality and secrecy 

Except as otherwise provided in the CEA, Section 8(a) of the CEA prohibits the CFTC from 

disclosing publicly data and information that would separately disclose the business 

transactions, or market positions of any person and trade secrets or names of customers. 

Section 9(a)(5) makes it a felony punishable by a fine of up to $500,000 and/or imprisonment 

up to five years if any person willfully violates any other provision of the CEA. 

Procedural fairness 

CFTC Commissioners and staff are bound by the procedural fairness rules described under 

Principle 4. 

Monitoring compliance 

Most CFTC staff are required to complete annual financial declarations, with more 

comprehensive information mandated for senior staff. Approximately 170 staff members must 

also report financial transactions. 

Compliance is monitored by the Office of General Counsel, which reviews disclosures. If noncompliance is detected, the OIG is asked if it wishes to investigate. If not, the matter is handled 

through management. Serious violations potentially involving criminal breaches are referred to 

the Office of Public Integrity within the DOJ, which makes a decision on whether to commence 

a criminal action. 

SEC

Conflicts of interest 

SEC Commissioners and staff are bound by the government wide rules described above that 

prohibit them from participating personally in particular matters that would have a direct and 

predictable effect on their own or imputed financial interests. 

These standards also regulate non-financial conflicts that could create the appearance that the 

individual would lack impartiality. Commissioners and staff cannot participate in a matter 

involving a person with whom they have a “covered relationship” or if the circumstances would 

cause a reasonable person with knowledge of the relevant facts to question their impartiality in 

the matter unless an SEC ethics official issues an authorization to participate. 

The SEC has adopted Supplemental Standards of Ethical Conduct for its Commissioners and 

employees. Among other things, these standards include comprehensive rules in connection 

with securities holdings and transactions in securities. They also include more strict provisions in 

connection with post-employment restrictions. As per the general framework (supplemented by 
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SEC standards) positions at certain salary levels are subject to a one year cooling off period. 

Securities trading and financial interests 

The SEC’s Conduct Regulation includes comprehensive rules regarding the securities holdings 

and transactions of all staff, including Commissioners, as well as any employee’s spouse, minor 

children, or any person the employee serves as legal guardian. The SEC’s regulations require the

reporting of securities transactions, with certain exceptions, within five days of the receipt of 

confirmation. The SEC’s Supplemental Standards of Ethical Conduct include prohibitions for 

Commissioners and staff on transactions involving an issuer directly regulated by the SEC or 

under investigation by it. These Standards also require SEC staff to clear in advance any 

securities transactions or holdings. 

Commissioners and some senior officers must file a public financial disclosure report when they 

assume office, on an annual basis thereafter, and upon termination. Employees who have the 

greatest risk of creating harm by misusing information or having conflicts of interest must file 

confidential financial disclosure forms. 

Use of information 

The OGE Standards of Conduct prohibit the misuse of one’s official position, including the use of 

(or allowing others to use) confidential or nonpublic information. The SEC’s own regulation also 

prohibits the misuse of confidential and nonpublic information. 

Confidentiality and secrecy 

SEC Commissioners and staff are bound by confidentiality provisions imposed by the statutes 

they administer (see for example Section 24(b) of the Exchange Act). 

Procedural fairness 

SEC Commissioners and staff are bound by the procedural fairness rules described under 

Principle 4. Statutory provisions are supplemented by detailed procedural rules such as those 

governing administrative hearings and enforcement and rulemaking activities. 

Monitoring compliance 

The SEC’s OEC was established in 2011 as an independent office reporting directly to the SEC’s 

Chair. The OEC is responsible for administering the Commission’s ethics program and for 

interpreting the SEC’s supplemental ethics rules as well as federal government-wide ethics laws, 

rules, and regulations. The OEC does not have investigative or disciplinary powers. If it finds a 

potential breach, it refers it to management. If the conduct were criminal, it would be referred 

to OIG. 

OIG has investigative powers. It is responsible for notification to the DOJ and OGE for referrals of 

potential violations of the federal government-wide criminal conflict of interest statutes. If the 

OIG finds evidence of non-criminal misconduct under either government-wide or SEC 

regulations, it forwards a report of investigation to the appropriate management officials for 

consideration of disciplinary or remedial action. 

According to the SEC staff, one staff member has been criminally prosecuted for false 

disclosure. 

Sanctions 

Violations of the federal government-wide conflict of interest statutes may be enforced either 

civilly or criminally. Violations of the SEC’s administrative rules can result in disciplinary action. 

Willful disclosure of nonpublic information under the Exchange Act is also a criminal offense. 

Depending on the circumstances and the legal authority at issue, an SEC employee may be 
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imprisoned, fined, demoted, or terminated for violating an ethics provision. 

Assessment Fully Implemented 

Comments 

Principle 6. The Regulator should have or contribute to a process to monitor, mitigate and manage 

systemic risk, appropriate to its mandate. 

Descriptions SEC 

Process to identify risks 

The statutory mandate of the SEC does not explicitly refer to financial stability or systemic risk. 

Nevertheless, SEC staff commented that contributing to the identification of emerging and 

systemic risk is seen by the agency as an important function which is inextricably linked to its 

statutory objectives of protecting investors, maintaining fair markets and facilitating capital 

formation. 

Current supervisory programs developed to fulfill its core mandate are the main channels 

through which the agency identifies emerging and systemic risks in the U.S. securities markets. 

Those supervisory programs are developed by the divisions in charge of monitoring the 

corresponding entities/sector. Senior staff indicated that in setting up their priorities each 

division has interaction with other relevant parts of the organization including, as appropriate, 

with the Commission to ensure that such priorities take into consideration relevant 

information. 

The supervisory program for monitoring of issuers is described in detail in Principle 16; for 

mutual funds it appears mainly in Principle 24; for securities intermediaries mainly in Principles 

30 and 31; and for market supervision and surveillance mainly in Principles 34 and 37. 

In recent years such programs have been strengthened to more effectively contribute to risk 

identification, in three different ways: 

Data availability 

As part of its ongoing supervision of issuers, mutual funds, and intermediaries, the SEC already 

receives periodic reports (as described in the respective principles) that allow it to identify 

issues of concern in specific firms as well as potential areas of concern across an industry. This 

information is received electronically, and in the case of domestic corporate issuers already in a 

mark-up language that facilitates its use. Mark-up language is also being implemented for 

certain data that securitization issuers and NRSROs will have to provide. 

Through legal and regulatory reforms implemented in recent years the information available to 

the SEC has been expanded. Key examples of data that the SEC already receives and uses as a 

result of these reforms are (i) MMFs’ holdings; and (ii) private funds (including HFs). 

Addition of staff with different skill profiles and corresponding organizational changes 

In recent years the SEC has increased staff with different skill profiles (economists, quantitative 

analysts) and made organizational changes to strengthen its ability to identify risks, including 

for policy-making purposes. For example, organizational changes include: 

The creation of several offices in OCIE, such as the (i) Office of Risk Analysis and Surveillance 

(ORAS) to enhance OCIE’s ability to perform more sophisticated data analytics, (ii) the Risk 

Analysis Examination (RAE) team to develop a more consistent, risk-based approach to the 

selection of firms for examination; and (iii) the Quantitative Analytics Unit (QAU) which provides 

support in the field to the SEC’s examination teams by creating and deploying customized data 
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analytic tools. 

The creation of the Risk and Examinations Office (REO) in the Investment Management Division 

to coordinate with OCIE and contribute to the SEC’s efforts to monitor risk in the asset 

management industry including through ongoing monitoring of a select number of the largest 

asset managers selected for monitoring based on certain risk characteristics. 

The creation of the Office of Risk Supervision in TM, which participates in a variety of ongoing 

monitoring reviews focused on clearing agency risk frameworks and processes. 

Development of sophisticated tools to allow for increased use of data 

In tandem, the SEC has developed more sophisticated tools that allow different divisions to 

have more robust processes of risk identification. For example: 

In connection with issuers’ monitoring: ENF has developed a tool for corporate issuer risk 

assessment that creates a consistent methodology for quantifying earnings management and 

other abnormal behaviors through the use of regression models and statistical analysis. 

In connection with BDs and IAs: ORAS has constructed risk models that attempt to identify 

potential areas of risk at all of these intermediaries based on information contained in 

regulatory filings. 

In connection with private funds: DERA has developed HF performance models (Aberrational 

Performance Inquiry or API models). 

In connection with markets: the SEC launched a new analytical tool called MIDAS that enables 

the SEC to analyze, almost instantaneously, large amounts of trading data across markets. 

Currently MIDAS comprises only data of exchanges. Through another initiative (CAT described 

in Principle 36) the SEC would have available a consolidated audit trail. 

In addition, a risk analytics committee was created in 2013 to facilitate cross departmental 

discussions on risk analytics tools used by different divisions, to avoid duplication and ensure 

cross-fertilization. The committee is coordinated by DERA. 

Internal coordination 

SEC staff indicated that discussions between departments where issues of concern, including 

emerging risks, are discussed take place on a regular basis. Feedback from these discussions 

feeds into SEC’s broader risk assessment process. In addition, the directors hold weekly 

meetings with the SEC Chair. These meetings can deal with a variety of issues, including 

discussions on emerging risk brought by the directors. The meetings do not have a predefined 

agenda. Staff from the Chair’s office attends these meetings and helps to ensure follow up. 

The SEC Chair in turn has weekly (one on one) meetings with each Commissioner, discussing a 

variety of issues, including emerging risks and potential follow up actions, and receiving 

feedback from Commissioners. In addition, staff from the divisions meets with Commissioners, 

both on an ad-hoc and on a routine basis, to discuss topics of interest including emerging risks. 

More informally Commissioners may ask staff for further briefings and responses to their 

questions regarding risks. Based on all this input, the Chair directs staff to undertake specific 

actions to address identified risks; i.e. whether by rule-making, study or change in supervisory 

approach. For each identified risk, particular staff is selected, who remains accountable to 

formulate, if necessary, a recommendation for an agency response to address the risk 

consistent with the Chair’s direction. In the case of rulemaking, counsels to each Commissioner 

are briefed on an ad-hoc and routine basis by the staff and the Chair’s office on rulemaking. 

Finally OCIE coordinates an inter-disciplinary and cross divisional task force called the Market 

Event Response Team, a mechanism through which OCIE, Enforcement, Trading and Markets, 
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other SEC divisions and offices, and self-regulatory organizations work collaboratively to 

respond real-time to rapidly evolving market events. 

CFTC 

Process to identify risks 

The CEA includes CFTC objectives “to deter and prevent price manipulation or any other 

disruptions to market integrity; to ensure the financial integrity of all transactions ... and the 

avoidance of systemic risk; to protect all market participants from fraudulent or other abusive 

sales practices and misuses of customer assets; and to promote responsible innovation and fair 

competition among boards of trade, other markets and market participants.” Similar to the 

SEC, the supervisory processes developed by the CFTC to fulfill its core mandate are the main 

channels through which the agency identifies emerging and systemic risks in commodities 

markets. Those supervisory processes include (i) market surveillance (described mainly in 

Principles 34, 36 and 37); and (ii) monitoring of financial risk posed by regulated entities 

(described mainly in Principles 30 and 37). 

CFTC staff indicated that such processes are well developed and rely on robust access to data 

based on reporting obligations (such as the large traders report submitted by the FCMs and 

information on margins submitted by the DCOs) and automated tools for market surveillance. 

Each day, for all active futures and options contract markets, the CFTC's market surveillance 

staff monitors the activities of large traders, and examines all price spikes, scheduled news 

release periods of market-sensitive data, all daily settlements in the major commodities and all 

option and final settlements in all major futures and options contracts. Staff also tracks key 

price relationships, and relevant supply and demand factors in a review for potential market 

problems. With the addition of swaps, staff now monitors credit events for effects on credit 

default indices and evaluates if the CDS settlement, after a credit event, was potentially 

manipulated. 

 The CFTC risk surveillance staff monitors the financial risk posed to and by DCOs, clearing 

members, and market participants, including market risk, liquidity risk, credit risk, and 

concentration risk. Relevant margin and financial resources are included within this monitoring 

program. CFTC staff regularly conducts back-testing to review margin coverage at the product 

level and follows up with the relevant clearing house regarding exceptional results. Independent 

stress testing of portfolios is conducted regularly. The independent stress tests may lead to 

individual trader reviews and/or FCM risk reviews. Traders and FCMs that have a higher risk 

profile are then reviewed during the CFTC’s on-site review of a clearing house’s risk 

management procedures. In addition, examinations of DCOs involve an analysis of a broad 

range of topics including, but not limited to, the adequacy of a DCO’s financial, operational and 

managerial resources; the DCO’s ability to manage all risks associated with clearing and 

settlement, including whether the DCO uses appropriate tools and procedures to monitor such 

risks; whether the DCO’s risk analysis and oversight program is able to accurately identify and 

minimize sources of operational risk; and a DCO’s ability to resist, and to minimize, any 

potential damage from cyber security threats. 

CFTC staff indicated that the current focus lies in expanding these processes to monitor swaps 

markets. This requires enhancing the expertise of the agency, the technology available to it, and 

a significant effort to improve the quality of swaps data. On the latter, CFTC staff indicated that 

since the passage of the Dodd-Frank Act it has actively engaged its new authority, and has 

registered four SDRs, implemented regulations requiring real time public reporting of swaps 

transaction data by the SDRs on their websites and began publishing a weekly swaps report on 

the CFTC website. CFTC staff continues to evaluate and engage in dialogue regarding the 
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policies and procedures employed by registered SDRs to ensure accuracy of swap data 

received. In addition, the Division of Market Oversight recently created a new Data and 

Reporting Branch. The CFTC is also pursuing data quality metrics. Additionally in January 2014 

the CFTC constituted an interdivisional staff working group to complement ongoing efforts to 

improve swap transaction data quality and the CFTC ability to use the data for analysis and 

regulatory purposes. Finally the CFTC signed an MOU with the OFR in 2014 which establishes a 

framework for assessing the quality of the data. This framework will form the basis of the 

subsequent development of a project plan for understanding swaps and OTC derivatives 

transactions and their impact on financial stability 

Internal coordination 

CFTC staff indicated that a significant amount of coordination among the different divisions 

takes place on a regular basis, under informal mechanisms. In addition, there are meetings of 

staff with the Chair on a weekly basis where concerns on potential risks can be raised. There are 

also informal meetings between staff and individual Commissioners on issues of their interest. 

Through meetings with market participants, the staff and individual Commissioners also 

maintain direct contact with the market which allows them to have a better understanding of 

risks. 

Finally closed door surveillance meetings are held at Commission level every Friday, which are 

permitted under an exception in the Sunshine Act. The meetings have three parts: surveillance, 

examination and enforcement. An agenda is set up seven days in advance of a meeting. Briefs 

are prepared and presented by staff as necessary. In general, the surveillance part of the 

meeting is used by staff to discuss with the Commission emerging issues, take decisions on how 

to tackle them, as well as decide on the need for any follow up. Meetings are recorded: the 

record includes a list of participants, a brief outline of the topics discussed and a statement that 

the General Counsel certified that the meeting was properly closed. 

In addition, staff indicated that the CFTC has formed a Market Risk Advisory Committee (MRAC) 

with a mandate to conduct public meetings and submit reports and recommendations to the 

CFTC regarding systemic risk issues that could potentially threaten the stability of the 

derivatives and other financial markets. The membership of MRAC will consist of 20-25 

members from a variety of different type of industry members and its charter will indicate that 

the MRAC “will make recommendations to the Commission’s mission of ensuring integrity of 

the derivatives markets and monitoring and managing system risk”. 

Coordination among the agencies 

SEC and CFTC staff meet on a frequent basis, in regard to specific firms or issues of common 

interest. The Chairs also meet on a regular basis to discuss issues of common interest. 

Participation of SEC and CFTC in the FSOC 

The FSOC is a key channel by which the SEC and CFTC contribute to a process of emerging and 

systemic risk identification across the financial sector. As per the Dodd-Frank Act, the FSOC is in 

charge of the identification of risks to the financial stability of the U.S. that could arise from the 

material financial distress or failure, or ongoing activities, of large, interconnected bank holding 

companies or nonbank financial companies, or that could arise outside the financial services 

marketplace; and responding to threats to financial stability. 

Pursuant to the Dodd-Frank Act, the FSOC consists of ten voting members and five non-voting 

members. The Chairs of the SEC and CFTC are voting members of the FSOC. Under the current 

framework there is no requirement that the Commission vote ahead of the Chair expressing 

opinions in the FSOC. This enables more expeditious contribution and voting. However, at the 
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same time it means that the positions the heads take in the FSOC meetings do not have to 

reflect the views of the Commission as a whole. 

The FSOC works under a committee structure. The FSOC’s systemic risk committee is the key 

structure for FSOC’s analysis of emerging threats to financial stability. The systemic risk 

committee includes senior staff of all the relevant agencies comprising the FSOC and reports to 

a Deputies Committee. The Deputies Committee coordinates and oversees the work of the 

interagency staff committees. The members of the Deputies Committee include a senior official 

from each member agency. The Deputies Committee convenes approximately every two weeks 

to discuss the Council’s agenda and to direct the work of the Systemic Risk Committee and the 

five other functional committees. 

The systemic risk committee plays a key role in prioritizing the review of sources of systemic risk 

and guiding the work of staff and the systemic risk subcommittees. If there is agreement at the 

systemic risk committee that an issue warrants further examination, the issue is usually assigned 

for its further development to the agency with the most expertise in the area, whereby such 

agency would further explore risks and vulnerabilities and potential responses/actions to 

address vulnerabilities identified and present them to the committee. When the committee 

determines that the issue is sufficiently developed, it presents the issue to the Deputies 

Committee. Examples of issues discussed by FSOC under the jurisdictions of the SEC or the 

CFTC include MMFs and asset managers. In both cases the SEC has taken a lead role in the 

analysis of risks as well as in developing a regulatory response, as appropriate. The FSOC has 

also used its designation powers and designated eight financial market utilities and three nonbank financial companies as systemically important. 

Staff of both the SEC and CFTC concurred that the creation of the FSOC has strengthened 

coordination between all the agencies and provided a structured forum for discussions on risks. 

They agreed that FSOC structure and tools are still evolving. Pursuant to the Dodd-Frank Act 

the GAO has made a number of recommendations to the FSOC, including on the development 

of a more robust framework for identification of emerging and systemic risks. Senior officials 

from the agencies highlighted also the importance that the FSOC develops robust frameworks 

for designation of non-bank SIFIs. Market participants highlighted that there would be benefits 

in increased transparency vis-à-vis the industry. 

International cooperation and coordination 

In addition, SEC and CFTC staff also participate in supervisory arrangements for certain complex 

global financial institutions These arrangements create a framework for ongoing dialogue and 

cooperation among multiple financial authorities with a view to enhancing the risk assessment 

of internationally active entities and to supporting effective supervision of such entities. For 

example, the SEC participates in colleges for CRAs and the CFTC in arrangements of CCPs. The 

SEC and CFTC also cooperate with counterparts on supervisory matters on an ad hoc basis and 

engage in bilateral and multilateral consultations with counterpart regulators to discuss issues 

of general regulatory concern that exist at a higher, more market-wide level. 

Assessment Broadly Implemented 

Comments The main reason for the grade relates to the robustness of current processes to identify 

emerging and systemic risks in connection with Key Question 1 of the Assessment 

Methodology. 

The first assessments of Principle 6 conducted by the IMF after the introduction of the new 

Assessment Methodology focused on three high level issues in assessing the existence of a 

process to identify systemic risk, which is required pursuant to Key Question 1: (i) whether the 

arrangements in place allow for a holistic (across products, entities, and markets) view of risk; 
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(ii) whether they allow for a periodic reassessment of risk; and (iii) whether they allow for proper 

follow-up actions. The experience gained has enabled an enhancement of the assessment 

criteria for Key Question 1, to include the following two additional criteria: (iv) a review of the 

type of data and analysis that the authorities use as part of the process to identify such risks; 

and (v) the degree to which the process implemented allows for proper accountability. This is in 

line with the recommendations included in the recent report of the Assessment Committee of 

IOSCO. These enhanced assessment criteria have been applied since the assessments conducted 

from summer 2013 onwards. 

The assessors note the increased attention that both the SEC and CFTC are giving to proper risk 

identification and its impact on the identification of systemic risk. 

As described above, the SEC has been working on improving data availability, tools to leverage 

such data and, ensuring that the agency has staff with the right set of skills. While these 

improvements are still work in progress, they have already led to significant enhancements in 

the risk identification processes of the different divisions through which the SEC discharges its 

functions. However, in the assessors’ opinion there is room to enhance mechanisms that allow 

the agency to ensure a holistic view of risks (across markets/products/entities), such as via more 

formal/structured and regular discussions/meetings on emerging and systemic risks. The 

assessors acknowledge that there are avenues that are currently being used for risk discussions. 

However, they seem to require enhancements to ensure that discussions on emerging and 

systemic risks are conducted in a systematic way, under a framework that formalizes 

accountability. Further, a stronger involvement of the Commission as a whole appears 

necessary. The SEC cited the Sunshine Act as inhibiting the ability of the Commission (as a 

whole) to hold periodic meetings on risk. Instead the Chair does hold regular meetings with 

individual Commissioners. However, this limitation has the potential of detracting from the 

quality of discussions, and may also have an impact on the accountability of the Commission as 

a whole. 

In addition, efforts to enhance data availability should continue, in particular in connection with 

the asset management industry. As the SEC Chair has stated, “while funds and advisers currently 

report significant information about their portfolios and operations to the Commission, these 

reporting obligations have not adequately kept pace with emerging products and strategies 

being used in the asset management industry”. For example, SEC rules do not require 

standardized reporting for many types of derivatives used by funds today. Similarly, the SEC 

does not currently receive complete information about securities lending by funds. Collecting 

more data on separately managed accounts is also needed. In this regard, the assessors note 

that the SEC staff is currently developing recommendations for the Commission to modernize 

and enhance data reporting for both funds and advisers. 

In the case of the CFTC, the assessors agree that the processes for risk identification in the 

futures markets are at a mature stage, and on an ongoing basis the CFTC has made necessary 

enhancements, such as in the case of the large traders report. The challenges it now faces relate 

to ensuring that it can develop similarly robust mechanisms to monitor the swaps markets. 

Work on the latter is at an early stage. The assessors acknowledge that this is a global 

challenge, given that in most markets swaps have just recently become regulated. They also 

acknowledge initiatives in place that seek to improve the quality of data reporting for swaps. 

Finally, the assessors take note of the fact that the agency has developed mechanisms for the 

Commission as a whole to hold periodic discussions on emerging and systemic risks via its 

closed door surveillance meetings. Given the more focused mandate of the CFTC and the size of 

the organization, current mechanisms can be an effective channel for the agency to have broad 

discussions on risk. 
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Finally, the creation of the FSOC and the participation of the chairs of the SEC and CFTC in the 

FSOC have contributed to enhancing the agencies’ role in systemic risk identification. However, 

the positions the heads take in the FSOC meetings do not have to reflect the views of the 

Commission as a whole (i.e., there is no requirement that the Commission vote ahead of the 

Chair expressing opinions in the FSOC). 

The operation of the FSOC itself is outside of the scope of this assessment (as the requirement 

of the methodology is to assess the agencies’ own process to identify risk and/or contribute to 

a process to identify systemic risk of other agencies). 

Principle 7. The Regulator should have or contribute to a process to review the perimeter of regulation 

regularly. 

Description Different processes lead to reviews of the perimeter of regulation by both agencies. Such 

reviews in turn can prompt changes in (i) regulations which the agencies themselves can 

undertake as they both have rulemaking authority; (ii) proposals for legislative changes; or (iii) 

the adoption of other types of measures to address risks identified in products, entities or 

markets –whether regulated or unregulated. 

Supervisory processes of both agencies 

The supervisory processes established by both agencies to fulfill their mandates (as described in 

Principle 6) are key channels that allow the agencies to identify risks posed by products, entities 

and markets–whether regulated or unregulated. 

In turn, the identification of areas of risks is a key factor that shapes the examination programs 

of both agencies. For example, 

The SEC has instituted a “presence examination program”, for new categories of registrants 

brought under its jurisdiction by the Dodd-Frank Act, such as IAs of private and HFs, whereby 

staff holds meetings with senior staff of the firms to better understand the business model and 

risk associated to these new categories of registrants. 

The CFTC has increased its presence in the FCM community and pays particular attention to 

liquidity risks via horizontal examinations. 

The identification of risks also impacts regulatory proposals and may lead to changes in 

regulations or the issuance of guidance. In both agencies their economic analysis units (DERA 

and OCE) play an important role in rule-making by conducting research as well as cost/benefit 

analysis in connection with rule proposals. For example, the findings from the examination 

program of BDs have led the SEC to issue guidance in connection with liquidity management. 

Further, its program for large BDs has resulted in proposals to review the capital and liquidity 

framework for ANC firms. 

The agencies have also made requests to Congress for reviews of their legal authority as a 

result of risks identified through their supervisory programs. 

For example, in the 2000s the CFTC requested Congress expand the CFTC’s authority over retail 

foreign exchange products. This issue was largely addressed in the reauthorization of the CFTC 

in 2008, and its authority further expanded in the Dodd-Frank Act. 

During the summer of 2009, the Director of IM testified on behalf of the SEC that the 

incomplete information that the SEC had regarding advisers to private funds was a “significant 

regulatory gap in need of closing.” Also that summer, the SEC Chair sent Congress a list of other 

suggested ideas identified by the SEC staff as possible provisions for securities law 

improvements to help the SEC better protect investors, and many of these proposals became 
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part of the Dodd-Frank Act. 

Other types of measures adopted by both agencies to address risks identified through their 

supervisory processes include investor education and the use of alerts, such as alerts on fraud 

and risks stemming from unregulated products. In fiscal year 2013, the SEC OIEA published 26 

investor alerts and bulletins. OIEA’s alerts and bulletins have covered a range of topics including 

Bitcoin and Other Virtual Currency-Related Investments and Advertising for Unregistered 

Securities Offerings. Staff also works with other regulators to issue joint alerts and bulletins. 

Recent examples include: an SEC-CFTC investor alert on binary options, an SEC-FINRA alert on 

pump-and-dump stock schemes, and an SEC-FINRA bulletin on pension and settlement income 

streams. 

FSOC 

Reviews of the perimeter of regulation can also be prompted by discussions at FSOC level. For 

example, internal concerns, as well as discussions at FSOC led the SEC to make significant 

reforms to the MMF regulatory framework, including the removal of an exemptive relief for a 

subset of such funds that will after a transitional period be required to value their portfolios at 

fair value. The SEC is currently conducting a review of specific aspects of the asset management 

industry also as a result of internal concerns as well as discussions at FSOC in connection with 

asset managers and systemic risk. 

Review of past events 

Both agencies have made changes to the perimeter of regulation as a result of lessons from 

market events, and have sought legislative changes as necessary. For example, 

The SEC implemented a series of reforms to its regulatory framework to strengthen the 

reliability of the equity markets, following the 2010 flash crash. Such measures (along with 

others that are currently at a proposal stage) were part of the recommendations of the Joint 

CFTC-SEC Advisory Committee on Emerging Regulatory Issues established on May 11, 2010 to 

analyze the flash crash. 

The CFTC significantly strengthened the financial responsibility rules for FCMs as a result of the 

failures of Peregrine and MF Global in 2011 and 2012. 

Specific reviews required by law or decree 

The Dodd-Frank Act required the GAO to conduct a review of the municipal securities markets. 

This review coincided with a series of recommendations by the SEC to enhance disclosure and 

transparency in the municipal markets, as further described in Principle 16. Those disclosure 

recommendations include legislative changes (to provide the SEC with additional authority to 

impose requirements in connection with the disclosure that municipal issuers must make to 

investors) as well as actions within the authority of the SEC (including issuing updated 

interpretative guidance regarding disclosure obligations of municipal securities issuers or 

amending Exchange Act Rule 15c2-12 to further improve disclosure); 

The JOBS Act mandated the SEC staff to undertake a review of Regulation S-K to determine 

how SEC requirements could be updated and modernized to simplify the securities registration 

process. The SEC staff completed this mandated review and is currently developing specific 

recommendations for updating disclosure requirements. 

Executive Order 13563, Improving Regulation and Regulatory Review (issued January 18, 2011), 

included calls on agencies to undertake an annual retrospective review of agency regulations. 

This Order does not apply to independent agencies; however the CFTC has voluntarily abided 

by it. In determining the extent to which these existing regulations needed to be modified to 
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conform to the Dodd-Frank Act’s new requirements, the CFTC has subjected many of its rules to 

scrutiny in accordance with the Executive Order. The CFTC staff intends to begin the process of 

the periodic, retrospective examination of the remainder of its regulations after completion of 

rules required by Dodd Frank. A Regulatory Review Group consisting of senior agency staff will 

be formed to implement this review. 

Advisory committees 

Both agencies have also made use of advisory committees to identify areas of risk where a 

regulatory response might be needed. 

The SEC’s Investor Advisory Committee (IAC) was established by the Dodd-Frank Act as a 

permanent committee to advise the SEC on regulatory priorities, regulation of securities 

products, trading strategies, fee structures, effectiveness of disclosure, and initiatives that 

protect investor interests and promote investor confidence and the integrity of the securities 

marketplace. The Dodd-Frank Act authorizes the committee to submit findings and 

recommendations for review and consideration by the SEC. In fiscal year 2013, the IAC 

submitted its initial recommendations for review and consideration by the SEC. Among the 

emerging issues the IAC addressed were recommendations for the SEC to review universal 

proxy ballots, data tagging, target date mutual funds, and implementation of the JOBS Act 

rulemaking mandate to remove the ban on general solicitation in private offerings. The SEC also 

utilizes an Advisory Committee on Small and Emerging Companies; and more recently, it 

formed a new Equity Market Structure Advisory Committee. 

The CFTC's Advisory Committees provide input and make recommendations on a variety of 

regulatory and market issues that affect the integrity and competitiveness of U.S. markets. The 

committees, governed by the provisions of the FACA, currently include: Agricultural Advisory 

Committee, Global Markets Advisory Committee, Energy and Environmental Markets Advisory 

Committee, and Technology Advisory Committee. These committees provide recommendations 

as well as guidance to regulated entities in the specific issues under their jurisdictions, thus 

contributing to ensuring that the regulatory perimeter and framework remains up-to-date (see 

for example the recommendations of the Technology Committee on pre-trade practices issued 

in 2011). 

Internal reviews as part of the Strategic Plans 

Both agencies develop strategic plans, which identify the strategic priorities for the agencies as 

well as specific regulatory and supervisory actions to meet such priorities. Such identification is 

supported by formal structured discussions within the organizations. The approved Strategic 

Plan forms the basis for each fiscal year’s operating plan and associated activities. At the end of 

each fiscal year or the conclusion of individual activities, staff evaluates performance and 

resource utilization against performance measures that have been identified in the Strategic 

Plan and in the SEC and CFTC’s budget submissions to Congress. 

For example the SEC Strategic Plan for 2014-2018 identifies the review of the structure of the 

equity markets as an area for review. As part of the implementation of this priority the current 

Chair has announced the creation of a committee, with both internal and external membership, 

that will assess the current market structure and come up with recommendations. 

In the case of the CFTC, the Strategic Plan 2011-2015 identified the review and update of the 

content requirements of the large traders report as a key priority for the agency as it would 

enable it to better monitor the markets. These improvements were implemented this year.

International 

SEC and CFTC staff also participates in a number of international and multilateral processes to 
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review various types of risks associated with market products and participants. For example, SEC 

DERA staff participates in IOSCO’s Committee on Emerging Risks (CER). A key objective of the 

CER is to develop and maintain a detailed research methodology for the identification, 

monitoring and mitigation of systemic risk that can be used by securities regulators around the 

globe. DERA staff is also engaged in the Financial Innovation Network of the Financial Stability 

Board’s Analytical Group on Vulnerabilities, which examines new financial products and services 

with a view towards spotting emerging risks and regulatory gaps. 

Assessment Fully Implemented 

Comments Several different processes contribute to the review of perimeter of regulation by the SEC and 

CFTC both on a sectoral/issue specific basis as well as on a more holistic basis. Examples of the 

former are reviews as a result of the supervisory programs for each type of entities, specific 

events, recommendations from advisory committees, or reviews required by Congress on 

specific provisions of a law. An example of the latter is the strategic planning process, which 

requires the agencies to set priorities and to define areas where changes to regulations (or 

supervisory practices) are needed. In the case of the CFTC, voluntary adherence to the Executive

Order on Improving Regulation is another example of a broader process, as it requires the 

agency to conduct retrospective reviews of its rules on an annual basis to ensure that they 

remain relevant. 

The assessors note however that the robustness of the reviews of the perimeter of regulation is 

dependent of the agencies’ processes for risk identification. In this regard, the assessors refer to 

the comments made on Principle 6. 

Principle 8. The Regulator should seek to ensure that conflicts of interest and misalignment of incentives 

are avoided, eliminated, disclosed or otherwise managed. 

Description Regulation of conflict of interest 

The SEC and CFTC administer a regulatory framework that is designed to address conflicts of 

interest and misalignment of incentives through requirements that prohibit conflicts, mandate 

disclosure, or require appropriate steps to manage or mitigate conflicts of interest and 

misalignment of incentives. 

Issuers 

The framework for issuers mainly relies on disclosure of conflicts of interest in the prospectus 

and subsequent filings (as further explained in Principle 16). This obligation is complemented by 

fiduciary duties owed by company directors to the company and its shareholders (see Principle 

17). 

In particular, the SEC recently adopted rules that will increase the transparency of ABS 

(Regulation AB II). Among others, these rules will require disclosure of asset-level data (ALD) 

that will need to be provided for several types of securitizations at the time of the offering and 

on an ongoing basis; enhanced disclosure about transaction parties and loss mitigation 

practices; and for shelf offerings of ABS, certification by the CEO of the depositor about the 

disclosure contained in the prospectus and the structure of the securitization. Compliance with 

the new rules is required by November 23, 2015 except for compliance with new ALD 

requirements which is, required by November 23, 2016. 

In addition, the final rule recently jointly adopted by six federal agencies, including the SEC, 

implemented risk retention requirements included in the Dodd-Frank Act. The rule requires 

sponsors of ABS to retain no less than five percent of the credit risk of the assets collateralizing 

the ABS issuance. The rule prohibits hedging or transferring of the credit risk that the sponsor is 

required to retain. As required by the Dodd-Frank Act the final rule defines qualified residential 
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mortgages (QRM) and exempt securitizations of QRMs from the retention requirements. In 

defining QRM, the agencies refer to the definition of qualified mortgage developed by the 

Consumer Financial Protection Bureau the key features of which exclude interest-only loans, 

negative amortization loans, loans beyond 30 years, balloon loans, and loans with excessive up 

front points and fees, and require limits on debt to income ratio (not higher than 43 percent). 

The final rule requires the agencies to review the QRM definition not later than 4 years after the 

effective date of the rule (and every five years after that date). The rule also exempts from the 

retention requirements commercial loans, commercial mortgages or automobile loans if they 

meet specific standards of high quality underwriting. The rule is effective one year after 

publication in the Federal Register for RMBS and 2 years after publication for all other 

securitizations. 

Finally the Dodd-Frank Act requires the SEC to implement rules to address potential conflicts of 

interest in the SBS markets. Two sets of rules are currently under consultation, one would limit 

certain concentrations in the ownership of, and exercise of voting rights with respect to SBS 

clearing agencies, security-based SEFs and national securities exchanges that post or make 

available for trading SBS. The other would require SBSDs and MSBSPs to disclose to the 

relevant counterparty material information about the SBS, including material incentives and 

conflicts of interest. 

Securities Intermediaries 

Intermediaries registered with the SEC and CFTC are also subject to conflict of interest 

provisions. Depending on the type of registrant the specific regime applicable to conflicts relies 

on disclosures, prohibitions and/or information barriers. These frameworks are described in 

more detail in other Principles: CIS operators (Principle 24); and other securities intermediaries 

(Principle 31). 

In general, the U.S. regime relies heavily on disclosure to the party affected by the conflict via a 

document made available to that party as a key mechanism to deal with conflict of interest. This 

reliance on disclosure (as opposed to management or prohibition) is much more predominant 

in the commodities side. 

Other entities 

Frameworks for addressing conflicts of interest exist also for SROs (Principle 9), auditors 

(Principle 20) and NRSRO (Principle 22). 

Monitoring of conflicts of interest 

The SEC monitors issuers’ compliance of disclosure obligations through the CF program of file 

review described in Principle 16. 

Review of registrants’ compliance with their obligations in relation to conflicts of interest is a 

key component of the examination program instituted by both the SEC and CFTC as well as by 

FINRA and the NFA. These programs are described in more detail in other Principles: SROs 

(Principle 9), NRSRO (Principle 22); CIS operators (Principle 24); and securities intermediaries 

(Principle 31). Monitoring compliance by auditors with their independence obligations is a key 

component of the inspection program developed by the PCAOB. 

When breaches are found, both agencies (and the SROs) require remediation actions and, when 

appropriate, take enforcement actions. For example, in a recent action the SEC instituted 

proceedings against an IA, its chief executive officer, chief compliance officer (CCO), and 

another employee for allegedly misleading investors and breaching their fiduciary duties to 

clients. More specifically, Enforcement alleged, among other things, that the firm and its CEO 

entered into revenue sharing arrangements in which they paid themselves kickbacks and failed 
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to disclose the conflicts of interest created by these agreements as they recommended 

investments to clients. The CCO and an IA representative are also alleged to have breached 

their fiduciary duties and defrauded clients by failing to disclose conflicts of interest and 

concealing the kickbacks they received from the investments that they recommended.

Assessment Fully Implemented 

Comments Overall, discussions with market participants led to conclude that conflicts of interest have been 

an important component of the examination programs of the agencies and SROs. However, 

there are a few important areas where participants expressed concerns about the existence of 

conflicts of interest that require further action by the SEC. Those include: (i) the participation of 

affiliates of brokers that operate ATS in their platforms; (ii) the impact of order types, order 

routing and related fee structures in equity markets; and (iii) the degree of flexibility in the 

choice of registration either as a BD or IA, and in that context, the different standard of care 

that legally applies to each type of intermediary, different compensation arrangements for the 

sale of products, and how they impact customer protection, including in connection with the 

types of accounts, products and/or transactions that are recommended to customers. 

The recently announced recommendation to establish an advisory committee to analyze the 

current equity market structure is an important step. Short term changes are intended to be 

considered, together with a more holistic review of the market. In addition, the SEC has put out 

a request for data to allow the agency to gain deeper understanding on the different regimes 

applicable to BDs and IAs. 

Principles for Self-Regulation 

Principle 9. Where the regulatory system makes use of Self-Regulatory Organizations (SROs) that exercise 

some direct oversight responsibility for their respective areas of competence, such SROs should 

be subject to the oversight of the Regulator and should observe standards of fairness and 

confidentiality when exercising powers and delegated responsibilities. 

Description The U.S. system makes extensive use of SROs in both securities and derivatives markets. The 

overall regulatory effectiveness depends on effective supervision by SROs, and on effective 

supervision by the CFTC and the SEC of SROs within their jurisdiction. SROs have two broad 

areas of responsibility: supervision of markets and supervision of market intermediaries. SRO 

functions are recognized by the CEA and CFTC regulations, and by the Exchange Act and 

related SEC rules. 

CEA SROs 

Several categories of organizations authorized by the CEA have self-regulatory responsibilities: 

futures exchanges (DCMs), SEFs, DCOs, and RFAs. CFTC Regulations define the term SRO as a 

contract market, SEF or RFA. DCOs are not formally recognized as SROs in the CFTC 

Regulations but they do have some self-regulatory obligations. 

There are currently 16 registered DCMs of which 15 are active; 24 SEFs temporarily registered 

or with pending temporary registration; 14 DCOs; and one RFA (NFA). 

Since many FCMs are members of more than one DCM, the CFTC has allowed the SROs to 

agree among themselves which of the SROs will be the designated self-regulatory organization 

(DSRO) for the purpose of maintaining ongoing financial and sales practice surveillance over 

member FCMs. The SROs have entered into agreements among themselves and have 

established the Joint Advisory Committee (JAC) to coordinate their oversight activities. All 

current DCM SROs and the NFA participate in these arrangements. In practice, there are two 

DSROs: CME is the DSRO for all FCMs that are clearing firms; and NFA is the DSRO for a 
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number of non-clearing FCMs, for swap dealers, independent IBs, CTAs and CPOs. 

In addition, some smaller DCMs have contracted with NFA to conduct market surveillance and 

trade practice surveillance on their behalf, and most SEFs have contracted with NFA to conduct 

market surveillance on their behalf. 

SROs that participate in these arrangements remain responsible for their SRO obligations under 

the CEA. 

NFA

The NFA is the only RFA. All firms and individuals that wish to act as futures market 

intermediaries must apply for NFA membership or associate status. 

NFA has incorporated into its rules, by reference, the CFTC’s segregation, recordkeeping, and 

related reporting requirements for SDs, MSPs, FCMs, IBs, CPOs, and CTAs. 

The CFTC has delegated to NFA registration processing functions and the authority to take 

adverse action, such as to revoke or to deny registration, against registrants and applicants for 

registration based upon disqualifying conduct set out in Sections 8a(2) and (3) of the CEA. The 

CFTC retains authority to take actions of this kind. 

The CFTC has also delegated other functions to NFA, including the responsibility to review CPO 

and CTA disclosure documents. 

The CFTC has general oversight responsibility for all NFA functions and has full access to the 

information NFA obtains in the course of its regulatory activities. The CFTC also monitors NFA 

for enforcement of NFA’s own rules and by-laws. 

Market operators and clearing organizations

The CEA contains sets of “core principles” for DCMs (23 Core Principles), SEFs (15) and DCOs 

(18). These core principles recognize the SRO functions performed, and set out requirements to 

be met in carrying out these functions. CFTC Regulations elaborate on these requirements. 

Admission of participants 

Core Principle 2 requires a DCM to establish, monitor and enforce compliance with access 

requirement rules. CFTC regulations require access criteria that are impartial, transparent and 

applied in a non-discriminatory way. Rules to the same effect apply to SEFs (SEF Core Principle 

2 and related CFTC Regulations). DCO Core Principle C requires a DCO to have objective, 

publicly disclosed, fair and open access requirements. 

Section 17(b)(2) of the CEA requires an RFA’s rules to provide that any person or entity 

registered under the CEA, a registered entity, or any other person designated under CFTC 

Regulations as eligible for membership may become a member of the RFA. 

Rules of conduct 

DCM Core Principle 12 requires DCMs to establish and enforce rules to: 

Protect market participants from abusive practices committed by any party, including abusive 

practices committed by a party acting as an agent for a participant; and 

Promote fair and equitable trading on the contract market. 

Section 17(p) of the CEA requires an RFA to establish rules that require the RFA, among other 

things, to establish training standards and proficiency testing for persons involved in futures 

industry, and to establish minimum standards governing sales practices of its members and 

Associated Persons (APs). 
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Disciplinary rules and proceedings 

The CEA and CFTC Regulations require SROs to monitor and enforce compliance with rules and 

standards. In addition, NFA and DCMs must monitor and enforce compliance with CFTC 

Regulations establishing standards for intermediaries, such as CFTC minimum financial and 

reporting requirements, requirements for the protection of customer funds and 

communications with customers. 

Division of responsibilities between the CFTC and SROs 

Although much of the day-to-day supervision of markets and industry participants is carried 

out by the SROs, the CFTC retains authority to inquire into any matters covered by SRO 

supervision. 

Where an SRO does not have the ability to obtain necessary information (for example, where 

the investigation requires subpoenaing third party records) or impose sanctions (for example, 

in the case of a recidivist), CFTC enforcement staff can support the SRO responsibilities. 

Authorization 

Capacity 

To become registered, each DCM, SEF and DCO applicant must show compliance with the Core 

Principles and maintain compliance with them to retain registration. An applicant for RFA status 

must show that it complies with the requirements for an RFA to be registered under Section 17 of 

the CEA. 

Rules 

Section 5c(c) of the CEA requires DCMs, SEFs, and DCOs to file with the CFTC new products, 

new rules, and rule amendments. These entities can choose either to self-certify that the rule 

complies with the CEA or request the CFTC’s approval of the rule. A rule subject to self-certification 

can be implemented 10 days after it has been filed. In practice, almost all rules and rule 

amendments come through the self-certification process. The CFTC can make a decision to stay 

the certification of a rule for up to 90 days if the rule raises novel or complex issues, inadequate 

explanation was provided, or the rule is potentially inconsistent with the CEA. For rules where the 

CFTC’s approval is sought, the CFTC has 45 days to consider the rule (this may be extended if the 

rule raises novel or complex issues). 

Special provisions apply to new products (see Principle 33). Section 8a(7) of the CEA authorizes the 

CFTC to alter or supplement the rules of a registered entity (such as a DCM, SEF or DCO) under 

certain circumstances and provided it follows specified procedural steps. 

Section 17 of the CEA requires an applicant for RFA status to provide the CFTC with copies of its 

constitution, charter or articles of incorporation or association, and all bylaws. An RFA must file 

with the CFTC copies of any changes or additions to its rules. The RFA may make any proposed 

change or addition effective 10 days after the receipt of a filing by the CFTC, unless it requests that 

the CFTC review and approve the submission or the CFTC informs the RFA of its intention to do so.

The CFTC has power to abrogate, alter or supplement the rules of an RFA if it appears necessary or 

appropriate to assure fair dealing by the members of the association, to assure a fair 

representation of its members in the administration of its affairs, or to effectuate the purposes of 

the CEA. 

To deny certification of a rule made by an SRO, the CFTC must make a determination that the rule 

would be inconsistent with the CEA or regulations made under it. 

Co-operation with the CFTC 
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The CEA and CFTC Regulations directly oblige SROs to cooperate with the CFTC and with other 

SROs to investigate and enforce applicable laws and regulations. In view of the statutory 

obligations, MOUs between the CFTC and SROs are not used. 

Governance 

Acceptable Practices under DCM rules state that a board be composed of least 35 percent 

public (independent) directors, and executive committees must also have 35 percent public 

membership. In addition, the Acceptable Practices state that DCM boards must have a Regulatory 

Oversight Committee, consisting of only public directors, which monitors and oversees the DCM’s 

regulatory program and a DCM’s disciplinary panel be composed to minimize conflicts of interest. 

Section 17 of the CEA requires that an RFA’s rules assure a fair representation of its members in the 

adoption of any rule of the association, the selection of its officers and directors, and in all other 

phases of the administration of its affairs. An RFA must provide for meaningful representation on 

the governing board of a diversity of membership interests and that no less than 20 percent of the 

regular voting members of the board are comprised of qualified non-members who are not 

regulated by the RFA. An RFA must provide on all major disciplinary committees for a diversity of 

membership sufficient to ensure fairness and to prevent special treatment or preference for any 

person in the conduct of disciplinary proceedings and the assessment of penalties. 

Avoiding anti-competitive situations and misuse of oversight role

Section 15 of the CEA requires the CFTC to take into consideration the public interest to be 

protected by the antitrust laws and endeavor to take the least anticompetitive means of 

achieving the objectives of the CEA in issuing any order or in approving any rule of a DCM or 

an RFA. CFTC Regulation 170.9 requires that an applicant to become an RFA must demonstrate 

that it will promote fair and open competition among its members and will conduct its affairs 

consistent with the public interest to be protected by the antitrust laws. DCM Core Principle 19 

provides that, unless necessary or appropriate to achieve the purposes of the CEA, the DCM 

must not adopt any rule or take any action that results in any unreasonable restraint of trade, 

or impose any material anticompetitive burden on trading on the contract market. SEFs (Core 

Principle 11) and DCOs (Core Principle N) must not adopt any rule or take any action that 

results in any unreasonable restraint of trade, or impose any material anticompetitive burden. 

Supervision 

All current SROs (DCMs and NFA) participate in a joint audit program under the auspices of the 

JAC, which must meet the requirements of CFTC Regulation 1.52. This audit program focuses 

on the SROs’ supervision of FCMs’ financial and reporting requirements. Recent amendments 

require that the program be separately evaluated by an “examination expert” at least once 

every three years, and that a report containing the content and any related responses to the 

findings of the examination be provided to the CFTC. The first evaluation has not yet taken 

place. 

The CFTC requires that DSROs to ensure that each FCM is subject to an on-site examination 

within nine to 18 months of the date of the previous examination by the DSRO. 

DCMs 

The CFTC's rule enforcement program for DCMs covers review of market surveillance, audit 

trail, trade practice surveillance, disciplinary and dispute resolution programs. DMO’s 

Compliance Branch conducts rule enforcement reviews (RERs) of each DCM’s ongoing 

compliance with the Core Principles through their self-regulatory programs. For the largest 

DCMs, the CFTC aims to conduct an RER each year focusing on at least one of the above topics, 

and generally cover market surveillance and trade practice surveillance at least every two years. 
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For smaller DCMs, RERs are carried out less frequently (in practice every 3 to 4 years) and often 

look at a number of these topics. 

Typically, the DMO’s Compliance Branch selects a 12 month target period and examines a 

DCM’s audit trail reviews, trade practice and market surveillance investigations, investigation 

logs, hedge exemptions, surveillance systems, compliance manuals, summary fine schedules, 

disciplinary files, settlement agreements, and arbitration files. CFTC staff also conduct on-therecord interviews with a DCM’s compliance officials. The Compliance Branch’s findings, any 

deficiencies identified, or recommendations for improvement are included in a report 

presented to the Commission, which votes on whether to accept the report. The report is 

published on the CFTC’s website. 

Other periodic RERs usually examine a DCM’s market surveillance program for compliance with 

DCM Core Principle 4 (Prevention of Market Disruption), and DCM Core Principle 5 (Position 

Limitations or Accountability). The Compliance Branch also from time to time conducts 

horizontal RERs of the compliance of multiple exchanges in regard to particular Core Principles.

DMO also carries out systems safeguards examinations of DCMs, reviewing one or more of 

seven topics, including enterprise risk management and governance, systems operations, 

business continuity planning and disaster recovery. For the critical exchanges such as CME and 

ICE, these are carried out every 12 to 18 months; for others, these reviews take place every 3 to 

4 years. 

The CFTC also has a market surveillance program designed to prevent market manipulation in 

futures and options markets and monitor compliance with the CFTC rules and regulations (see 

Principle 34). 

SEFs

It is anticipated that the DMO’s Compliance Branch will conduct RERs for a SEF after it obtains 

permanent registration. 

NFA

In addition to the FCMs for which it is responsible under the joint audit program, NFA is 

responsible for regulatory compliance matters with respect to its member IBs, except for IBs 

guaranteed by an FCM that does not have NFA as its DSRO. NFA is also responsible for sales 

practice surveillance over all member CPOs and CTAs. NFA’s oversight of CPOs and CTAs 

includes review of annual reports and disclosure documents, and the conduct of examinations 

of these firms on a periodic basis. 

The CFTC monitors compliance by NFA with its self-regulatory obligations by conducting periodic 

reviews of NFA’s compliance programs. NFA oversight reviews focus on the NFA 

responsibilities, including review of the financial and sales practice compliance programs for 

registered intermediaries, as well as review of NFA’s programs for arbitration, registration and 

fitness, and disciplinary actions. 

CFTC staff members meet with NFA and review program materials and databases, evaluate 

procedures, and perform reviews of samples of NFA’s files to determine whether its procedures 

are consistent with its regulatory obligations, whether it has properly executed its program, and 

that the files contain sufficient documentation. The results of these reviews are presented to 

the CFTC and reported back to NFA. Consecutive reviews of the same program may focus on a 

particular aspect of the program in question, including following up on recommendations 

made in prior reviews. 

The CFTC conducted a review of NFA’s registration program in 2010, and within the past ten 
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years has conducted reviews of NFA’s programs for CPO and CTA compliance, telemarketing 

supervision, FCM and IB financial reports, disciplinary actions, and arbitration. In the past year, 

the CFTC has conducted 3 different reviews, with a focus on disclosure document processes, 

the financial disclosure process, and NFA examinations of registrants. 

Professional standards 

The CEA and CFTC Regulations impose conduct standards on SROs and their employees. These 

include: 

Obligations to keep confidential material non-public information (CFTC Regulation 1.59(d)(ii)) 

and information supplied to an SRO by the CFTC); and 

Prohibitions on the misuse of information acquired as a result of carrying out SRO duties 

(Section 9(e)(1) CEA and CFTC Regulation 1.59(d)(ii)). 

Conflicts of interest 

As well as the governance arrangements described above, Core Principles applying to DCMs, 

SEFs and DCOs all contain provisions (elaborated on in the CFTC rules) expressly requiring them 

to minimize and resolve conflicts of interest. The Core Principles are supplemented by more 

detailed rules such as CFTC Regulation 1.69, which requires that a member of an SRO’s 

governing board, disciplinary committee or oversight panel must abstain from voting on any 

matter and from deliberating on the same where that member is a named party or otherwise 

has an interest. 

Exchange Act SROs 

Background 

Two main SRO functions are performed by registered exchanges and FINRA: supervision of 

market activity (market surveillance) and supervision of market intermediaries. All exchanges 

have SRO responsibilities under the Exchange Act but they can “outsource” some or all of their 

market surveillance responsibilities by contracting with another SRO through a regulatory 

service agreement (RSA). The outsourcing exchange remains liable for its market surveillance 

obligations under the legislation. In practice, many exchanges have entered into market 

surveillance RSAs with FINRA (see Principle 34 for further details). 

BDs generally must register with the SEC and become members of at least one SRO, such as a 

national securities exchange or a registered securities association. To deal with the situation 

where BDs are members of more than one SRO, the Exchange Act (Section 17(d)) and SEC 

Rules) permit SROs to enter into a plan (which must be approved by the SEC) for one SRO to 

become the designated examining authority (DEA) for common members. SEC approval of a 

plan filed pursuant to Rule 17d-2 relieves an SRO of the regulatory responsibilities allocated by 

the plan to another SRO. 

FINRA

FINRA is currently the only SRO that is a registered securities association. BDs that have a public 

customer business must be members of a registered securities association and therefore FINRA 

unless they limit their transactions to securities traded on an exchange of which they are a 

member. BDs that limit their activity to government securities or municipal securities are subject 

to special registration. 

Natural persons “associated with” a registered BD do not have to register themselves as BDs, 

but, unless their activities are strictly clerical and ministerial, they must register with the 

appropriate SRO (generally, FINRA), and take the appropriate qualifying examinations. There 
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are about 630,000 individuals registered in this way. All BD staff with client facing 

responsibilities must be registered. 

Exchanges 

To trade directly on a particular exchange, a BD must become a member of that exchange. 

MSRB

Firms that engage in transactions in municipal securities must also comply with the rules of the 

MSRB, an SRO that, subject to SEC review, makes rules governing transactions in municipal 

securities. Unlike other SROs, the MSRB generally does not enforce compliance with its rules. 

Compliance with MSRB rules is monitored and enforced by FINRA and/or the SEC (in the case of 

BDs and municipal advisors), and the federal bank regulators and the SEC (in the case of banks). 

Admission of participants 

Under the Exchange Act, a national securities exchange, registered securities association, or 

clearing agency must have rules that permit any registered BD or natural person associated with 

a BD to become a member of the exchange or association. Under the Exchange Act, the rules of 

an SRO must not be designed to permit unfair discrimination between customers, issuers, 

brokers or dealers regulated by virtue of the Exchange Act on the basis of matters not related to 

the purposes of the Exchange Act or the administration of the SRO. 

If an exchange or FINRA denies membership or participation to an applicant, it must notify the 

SEC.. A denial of membership or participation by an exchange or FINRA is reviewable by the SEC.

Rules of conduct

Exchange and FINRA members are required to comply with trading and business conduct rules. 

The Exchange Act provides that an exchange and FINRA must be able to enforce members’ 

compliance with their rules. The Exchange Act sets out the requirements for rules, which include 

rules designed to prevent fraudulent and manipulative acts and practices and to protect investors

and the public interest. 

Disciplinary rules and proceedings

The exchanges and FINRA must have rules that provide that their members will be appropriately

disciplined for violation of the provisions of the Exchange Act and SEC rules and regulations, and 

their own rules. Sanctions must include expulsion, suspension, limitation of activities, functions 

and operations, fines, censure, and being suspended or barred from being associated with a 

member of any other fitting sanction. Parallel provisions apply to clearing agencies. 

Once an SRO has imposed a final disciplinary sanction against a member or person associated 

with a member, it must promptly file notice with the SEC of its action. A final disciplinary sanction

imposed by a SRO is reviewable by the SEC. 

Division of responsibilities between the SEC and SROs 

Under Sections 21(d) and (e) of the Exchange Act, the SEC has the authority to enforce an SRO’s 

rules and to compel an SRO to enforce its rules with regard to its members by filing an action in 

federal court; relief available includes, among other things, monetary penalties, injunctive action, 

and any form of equitable relief. Section 21(f) of the Exchange Act allows the SEC to bring such 

actions when it appears that an SRO is unable or unwilling to take appropriate action against a 

person in the public interest and for the protection of investors, or when such action is 

otherwise necessary or appropriate in the public interest for the protection of investors. 

The SEC has authority to take disciplinary actions directly against a BD and associated persons. 
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Registration 

Capacity 

Sections 6(b)(1) and 15A(b)(2) of the Exchange Act provide that an exchange or association shall 

not be registered unless it is so organized and has the capacity to carry out the purposes of the 

Exchange Act. The exchange or association must also be able to enforce compliance by its 

members and persons associated with its members with the Exchange Act, the rules and

regulations thereunder, and its own rules. Further details on exchange registration are included 

in Principle 33. 

Rules 

As part of the registration process for SROs, the SEC reviews their proposed rules to ensure 

they comply with the standards required by the Exchange Act. 

Under Section 19(b)(1) of the Exchange Act, an SRO must file any proposed change in, addition 

to, or deletion from its rules. Once filed, the SEC must publish a notice of the filing in the 

Federal Register, which must include specified details and give the public an opportunity to 

submit comments. Thereafter, within 45 days after the publication date, the SEC must approve, 

disapprove, or institute proceedings to determine whether to approve or disapprove the rule 

change, subject to an extension of time from the SRO or on the SEC’s own motion up to a 

maximum of 90 days from the publication date. 

The SEC must approve a proposed rule change, if it finds it consistent with the requirements of 

the Exchange Act and the rules and regulations thereunder. Otherwise it must disapprove it. In 

making this determination, the SEC must consider whether the proposed rule change will 

promote efficiency, competition and capital formation. The SEC has disapproved exchanges’ 

rule changes in the past. 

Rules generally do not take effect until approved by the SEC, but some proposed rule changes 

filed under Section 19(b)(3)(A) of the Exchange Act take effect upon filing, without need for SEC 

approval. The proposed rule changes that may take effect upon filing include rules that: 

constitute a stated, policy, practice or interpretation with respect to the enforcement of an 

existing rule; establish or change a due, fee, or other charge imposed by the exchange; or are 

concerned solely with the administration of the exchange. The SEC has by rule extended the 

categories of rules that become effective on filing to include rules that do not significantly 

affect the protection of investors or the public interest or rules that do not impose a significant 

burden on competition (see SEC Rule 19b-4(f)). 

Section 19(c) of the Exchange Act gives the SEC authority to abrogate, add to, and delete from 

the rules of an SRO (other than a registered clearing agency). 

Co-operation with the SEC and other SROs 

All SROs are defined as SROs under the Exchange Act and have obligations imposed directly on 

them by the legislation and are subject to oversight by the SEC. MOUs are therefore not used. 

Some SROs have entered into agreements under Exchange Act Section 17(d) and SEC Rule 17d2 to coordinate among themselves the allocation of regulatory responsibility regarding the 

receipt of regulatory reports from participants, the examination of participants for compliance, 

and the enforcement of compliance. All agreements must be filed with the SEC and, after public 

notice and comment, may be declared effective by the SEC. 

Governance 

The Exchange Act requires that the rules of an SRO must assure a fair representation of its 

members in the selection of its directors and the administration of the affairs of the SRO. 
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Sections 6(b)(3) and 15A(b)(4) also require that the rules of an exchange provide that one or 

more directors be representative of issuers and investors and not associated with a member of 

the exchange, broker or dealer. 

The SEC has generally approved for SROs other than clearing agencies up to 20 percent 

member representation on SRO boards of directors and on SRO committees dealing with 

trading rules and member discipline. For clearing agencies, the SEC evaluates the procedures of 

each clearing agency for meeting the fair representation requirement on a case-by-case basis. 

Section 15B(b)(2)(B) of the Exchange Act was amended by the Dodd-Frank Act to require that 

the number of public representatives on the MSRB at all times exceed the number of regulated

representatives.

Avoiding anti-competitive situations and misuse of oversight role

The Exchange Act requires that the rules of SROs (including MSRB) must not impose any burden 

on competition that is not necessary or appropriate in furtherance of the purposes of the 

Exchange Act. When reviewing an SRO’s proposed rule, the SEC analyzes, among other things,

the rule’s burden on competition. 

Oversight 

Supervision programs 

The SEC has an examination and enforcement program to oversee the activities of the SROs, 

including exchanges, FINRA, and clearing agencies. 

Section 19(g)(1) mandates that every SRO comply with and enforce compliance with the 

provisions of the Exchange Act and the SEC rules and regulations and the SRO’s own rules, 

“absent reasonable justification or excuse.” The SEC assesses an SRO’s continuing compliance 

with these obligations by carrying out examinations of SROs as part of OCIE’s examination and 

inspection program. 

During these inspections, OCIE can review, among other things, the SROs’ examination and 

surveillance programs for member financial responsibility and operational compliance, 

regulatory programs for monitoring trading activity, disciplinary and enforcement programs, 

exchange listing programs, membership programs and arbitration programs. 

In the past three fiscal years, OCIE has conducted a total of 140 examinations of SROs. 

SEC examinations of the national securities exchanges and FINRA are not done on a fixed cycle, 

and generally a risk based approach is used. In 2012 and 2013, the SEC did an assessment of all 

national securities exchanges and FINRA to establish a baseline for governance, internal 

controls, and enterprise risk management programs at each SRO. Other inputs into the risk 

assessment process include TCRs and information from DERA and Trading and Markets. Among

recent risk areas identified for examination of exchange SROs are: the internal controls and 

governance around their rule making process; their supervision of RSAs; order types used by the

options exchanges and the related governance; systems outages, errors and integrity; and, 

exchanges’ business continuity planning. 

In the past year, OCIE conducted examinations across most of the national securities exchanges 

(and FINRA, SIPC, MSRB and 2 clearing organizations) focusing on, among other areas, the 

listings processes, order types and governance and the collection of securities transaction fees. 

The SEC also has a program for review of the SROs’ information technology systems to evaluate 

whether the systems have sufficient capacity and resiliency to accommodate conditions of 

increased volume and disruptions to normal operations. This program is now carried out by 

OCIE and is staffed by information technology experts who regularly confer and meet with 
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members of the SROs’ information technology staff (for exchanges, see also Principle 34). 

FINRA 

Dodd-Frank Act Section 964 requires that, on a regular basis, the GAO submit a report to 

Congress on the SEC’s oversight of FINRA with respect to ten specified areas. The areas include 

governance (including management of conflicts of interest), examinations, arbitration services, 

and funding of FINRA’s operations. In 2013, OCIE completed an inspection of FINRA focusing 

on these ten areas to assist in its risk scoping efforts. For future risk scoping purposes, OCIE has 

developed a process to evaluate risks and prioritize areas of focus in inspections of FINRA. 

FINRA is subject to periodic reviews and at any time a number of reviews may be taking place. 

A technology review (see above) is generally done annually. Reviews of FINRA’s supervision of 

the sales practices of its BD members are also carried out annually. These involve a review of 

the sales practice supervision programs conducted by three district offices of FINRA. In 2013, 

the SEC reviewed FINRA’s enforcement program. Other reviews include examination of the 

market surveillance activities carried out by FINRA under RSAs. 

Professional standards 

SROs generally have internal policies or rules regarding ethical conduct on the part of their

staff, including the preservation of the confidentiality of material accessible by them and not

publicly available, and prohibit the use thereof for personal benefit. In addition, SROs are 

required to comply with Section 10(b) of the Exchange Act and the rules thereunder, 

particularly Rules 10b-5 and 10b5-1, which prohibit any person that receives material, 

nonpublic information in a duty of trust or confidence from breaching that duty, causing the 

trading of securities on the basis on nonpublic information (insider trading). 

Sections 6(b)(7), 15A(b)(8), and 17A(b)(3)(H) of the Exchange Act require that the rules of an 

exchange, association, and clearing agency must provide for a fair procedure for disciplining 

members and persons associated with members, denying membership, and prohibiting or 

limiting access to services, and for exchange and associations barring persons from being 

associated with members. SROs are required, for example, to notify members of the specific 

charge against them, give them an opportunity to defend themselves and to keep a record of 

the proceeding. 

Conflicts of interest 

The SEC reviews SRO proposals and examines SRO operations to evaluate any potential impact 

conflicts of interest may have on the effective oversight of the securities markets. In particular, 

the SEC reviews proposed changes to an SRO’s ownership and regulatory structure, and has a 

focus in that review of addressing conflicts of interest at the SRO. 

Assessment Fully Implemented 

Comments In the U.S. regulatory system, SROs, including FINRA, NFA, and the exchanges and clearing 

organizations, play a critical role as front line supervisors of markets and intermediaries. SRO 

responsibilities are set out in the legislation. This results in a complex set of arrangements, but 

the legislation gives the regulators full authority to oversee the conduct of SROs, for example 

though the rule approval process, the power to intervene and require changes to rules or 

supervision practices, and by their powers to conduct examinations that test whether SROs are 

complying with their regulatory and supervision obligations. 

Both the CFTC and the SEC have robust programs to monitor compliance by SROs, and carry 

out regular examinations. In addition, there are regular interactions with the SROs, often on a 

daily basis. For the SROs’ market surveillance obligations, these examinations cover, among 
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other things, the exchanges’ governance, compliance with record keeping and audit trail 

obligations, and the functioning of trade practice and market surveillance processes including 

the investigation of suspected misconduct. For member supervision, examinations cover the 

membership application processes used by the SROs, and their ongoing supervision of issues 

such as sales practices, discipline and arbitration. 

The timeframe for the regulators’ review of SRO rule amendments is limited, especially for the 

CFTC. The self-certification process allows the CFTC limited time to review rules, especially for 

new products, and relies on the accuracy of the certification of the SROs. In this regard, 

however, the assessors note: 

The practice of SROs to consult informally with the CFTC prior to formal lodgment of rules, 

including rules relating to new products, where the rule is potentially controversial. This gives 

the CFTC opportunity to influence the final content of the rule prior to formal registration; 

The fact that the regulators can extend the time to enable more scrutiny, including public 

consultation. 

The fact that, although most rules use the self- certification process, the CFTC has used the stay 

procedure on a number of occasions in the past year, in rules relating to SEFs; 

The fact that the CFTC (and the SEC) have the power to mandate or impose changes to SRO 

rules. 

Taking into account these factors, the assessors conclude that the requirements of Key 

Question 2(d) are met. 

Principles for the Enforcement of Securities Regulation 

Principle 10. The regulator should have comprehensive inspection, investigation and surveillance powers. 

Description CFTC

Information gathering and inspection powers 

General powers 

The CFTC’s power to examine documents and inspect regulated entities and individuals is based 

on the entities’ record-keeping obligations and the requirement that all books and records be 

retained for five years and be “readily accessible” to the CFTC and the DOJ during the first two 

years of that period (Regulation 1.31(a)). The CFTC can require records of regulated persons to 

be produced without judicial process or notice. 

Surveillance powers

DCMs and SEFs have responsibility for the conduct of surveillance for trading activity. In 

addition, CFTC staff conducts front line surveillance on a broader base of information than 

individual DCMs and SEFs possess. CFTC has direct access to participant information. In addition 

to information submitted to the CFTC regularly, CFTC staff has authority to request data directly 

from market participants and from DCMs and other regulated entities.(see Principle 34). CFTC 

staff carry out periodic routine inspections and audits of DCMs to ensure that they are carrying 

out their obligations. Staff will conduct these routine audits and inspections on SEFs once they 

have obtained permanent registration status. 

Record keeping requirements 

Customer identity 
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FCMs, IBs and members of a contract market (such as floor brokers) must keep a record which 

shows for each commodity futures or options account the identity of the person for whom such 

account is carried or introduced and their principal occupation or business. They also must keep 

a record showing the identity of any other person guaranteeing such an account or exercising 

any trading control over the account (CFTC Regulation 1.37(a)). Know-your-client and AML 

record keeping requirements also apply (see under Principle 31). SDs and MSPs are subject to 

similar requirements with respect to counterparties whose identity is known to the SD or MSP 

prior to the execution of a swap transaction. 

A Customer Identification Program (CIP) Regulation issued jointly by the CFTC and FinCEN 

pursuant to the Bank Secrecy Act (BSA) requires that certain registrants obtain identification 

and verification information on their customers. An FCM’s or IB’s CIP procedures must enable it 

to form a reasonable belief that it knows the true identity of each customer. 

Bank and brokerage accounts 

CFTC Regulations require that there be a complete record, or audit trail, of the entry and 

execution of all orders for transactions in commodity interest and related cash or forward 

transactions. Comprehensive record creation, retention and reporting requirements ensure that 

all transactions in futures and options can be documented and reconstructed. These obligations 

are supplemented by BSA requirements, under which the CFTC has authority to obtain the 

identification and verification information collected under the CIP Regulation. 

Record retention 

CFTC Regulation 1.31 requires all books and records required by the CEA and CFTC regulations 

to be kept for a period of five years and to be readily accessible during the first 2 years of the 5-

year period. All books and records must be open to inspection by any representative of the 

CFTC or DOJ. 

Outsourcing to SROs and third parties 

As described under Principle 9, the U.S. system makes extensive use of SROs (notably DCMs and 

the NFA) to supervise the conduct of SRO members. SROs performing these roles have member 

inspection programs. SROs’ compliance with their supervision obligations is supervised by the 

CFTC through RERs for DCMs and through its program for the supervision of the NFA. The CFTC 

has access to information about the SRO and can cause improvements to be made in SRO 

processes. SROs themselves may only delegate supervision functions to the NFA or another SRO. 

CFTC Regulation 38.154(a) permits a DCM to use a NFA or another registered entity to provide 

services to assist in complying with the Core Principles. A DCM that uses a regulatory service 

provider must ensure that its regulatory service provider has the capacity and resources 

necessary to provide timely and effective regulatory services, including adequate staff and 

automated surveillance systems. A DCM remains responsible for the performance of any 

regulatory services received from a third party, and for the regulatory service provider's 

performance on its behalf. A DCM must also conduct periodic reviews of the adequacy and 

effectiveness of the services provided. 

Under Commission Regulation 37.204(a), analogous provisions apply to SEFs that delegate 

supervision responsibilities to the NFA, another registered entity, or FINRA. 

SEC

Information gathering and inspection powers 

General powers 

The SEC has the power under the Exchange Act, the Advisers Act, and the ICA to inspect all 
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regulated entities’ business operations, including books and records, at any time without giving 

notice and without judicial action, even in the absence of suspected misconduct. The SEC has 

the power to supervise registered exchanges and ATS pursuant to its authority to conduct SRO 

inspections and broker-dealer examinations. It has access to all books and records of registered 

exchanges and other trading venues. 

Trading activity

Subject to the SEC’s oversight, SROs have legislatively mandated market surveillance 

responsibilities and have the frontline responsibility for overseeing daily trading activities and 

regulatory compliance on the exchanges. 

Record-keeping requirements 

Statutory record-keeping and record retention requirements applying to entities regulated by 

the SEC are contained in the Exchange Act, the ICA and the Advisers Act. 

Exchange Act Rules set out record-keeping rules for securities exchanges, registered securities 

associations (i.e., FINRA), clearing agencies and the MSRB, and for brokers and dealers. Rule 

17a-4 governs the retention of these records, which vary by record type, as well as other 

records such as information supporting a firm’s financial reports and communications sent or 

received by the firm that relate to the firm’s business. 

ICA Rules set out record keeping and retention rules for investment companies. The required 

retention periods vary according to the record type. Advisers Act Rules set out record keeping 

and retention rules for advisers and, in general, records must be maintained and preserved in an

easily accessible place for at least five years (the first two years in an appropriate office of the 

investment adviser). 

The SEC is in the process of developing record keeping and retention rules for regulated 

entities in the swap industry for which it has jurisdiction.

Customer identity 

Registrants are required to maintain specified records concerning client identity under regulations 

promulgated under the Exchange Act, the Advisers Act, the BSA, and the PATRIOT Act. Mutual 

funds are treated as “financial institutions” for certain purposes and thus specific BSA rules apply 

to mutual funds, including client identification obligations. Under this legislative scheme, 

broker-dealers and mutual funds must maintain a CIP appropriate to their size and type of 

business. 

Through use of its powers to require access to books and records and to compel information, 

the SEC has access to the identity of all customers of registrants, including those of brokerdealers, investment companies and IAs. 

IAs cannot be compelled to disclose the identity of clients (Section 210(c) of the Advisers Act) 

except when disclosure may be necessary or appropriate in an enforcement investigation or 

proceeding. In practice, this provision has not posed difficulties for the SEC in obtaining 

information about clients of IAs. 

Bank and brokerage accounts 

Under Exchange Act Rule 17a-3, brokers and dealers are required to keep and maintain records 

showing cash positions and securities purchased, sold, received or transferred to or from 

customer accounts. Additionally, BSA rules require BDs, mutual funds and IAs to obtain and 

keep certain records relating to the transfer of funds to or from the entity. 

Outsourcing to SROs and third parties 
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The SEC does not outsource any of its own inspection or other regulatory enforcement 

authority to SROs or third parties. But as noted under Principle 9 and above, the system 

administered by the SEC makes extensive use of SROs, notably national securities exchanges 

and FINRA. 

An SRO may enter into a regulatory service agreement (RSA) with a registered third-party SRO 

under which the third-party SRO agrees to perform certain regulatory obligations of the 

procuring SRO. The procuring SRO remains responsible for meeting its regulatory obligations 

under the Exchange Act. Under Exchange Act Rule 17d-2, any two or more SROs may file with 

the SEC a plan to allocate regulatory responsibilities among themselves. If the SEC declares the 

plan effective, any SRO that is a party to the plan is relieved of its regulatory responsibility to the 

extent that its responsibility is allocated under the plan to another SRO. 

The SEC has full access to information maintained or obtained by SROs. It can bring an 

enforcement action against an SRO for failure to act or adequately perform required functions. It 

can also cause changes and improvements to be made to an SRO’s processes, for example by 

requiring changes to its rules (including by directly imposing rule changes); or taking 

administrative or court action to impose remedies that result in changes or improvements. 

Assessment Fully Implemented 

Comments 

Principle 11. The regulator should have comprehensive enforcement powers. 

Description CFTC

Powers of investigation 

Section 8(a)(1) of the CEA gives the CFTC comprehensive power to conduct investigations to 

ensure compliance with laws and regulations. Section 6(c) gives the CFTC power to administer 

oaths and affirmations, subpoena witnesses, compel their attendance, take evidence, and 

require the production of any books, papers, correspondence, memoranda, or other records 

that the CFTC deems material to the inquiry. These powers can be used to seek information 

from any person, whether regulated or not. If an individual or firm named in a subpoena refuses 

to comply with its terms, the CFTC may apply to a federal district court to enforce the 

subpoena. 

Enforcement powers 

The CFTC has the authority under the CEA to file a civil enforcement action in federal district 

court or an administrative enforcement proceeding in an administrative tribunal to ensure 

compliance with the CEA. It has extensive rules relating to enforcement activity such as Part 11 

of its rules (Investigations). 

The Dodd-Frank Act strengthened the CFTC’s enforcement powers by adding or amending 

certain provisions, including: 

Section 6(c) (and CFTC Regulation 180.1) to prohibit any manipulative device, scheme or artifice 

in the swaps, futures and cash markets and explicitly prohibit false or misleading statements; 

Section 4c(a) to prohibit disruptive trading practices, including violations of bids and offers, 

intentional or reckless disregard for the orderly execution of transactions during the close, and 

spoofing; 

Section 4s (and CFTC Regulations 23.400-451), setting out business conduct standards for SDs 

and MSPs; 
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Sections 2(c)(2)(B) and 2(c)(2)(D), strengthening the CFTC’s enforcement authority over retail 

Forex and retail commodity transactions (e.g., precious metals); and 

Section 23 (and Regulation 165), creating whistleblower incentives and protection; and Section 

4c(a)(4), prohibiting trading on confidential information emanating from government 

departments or agencies that may affect or tend to affect the price of any commodity in 

interstate commerce or swap. 

Civil proceedings 

Remedies available in a federal district court include injunctions, ex parte orders to preserve 

records and freeze assets, civil monetary penalties, disgorgement, restitution, and contract 

rescission, and any other equitable relief needed. Civil monetary penalties of up to the greater 

of $140,000 or triple the monetary gain to the person can be imposed for each violation other 

than manipulation (plus post-judgment interest). In the case of manipulation or attempted 

manipulation, a civil monetary penalty of up to the greater of $1 million or triple the monetary 

gain to the person can be imposed for each violation (plus post-judgment interest). 

Administrative proceedings

Complaints initiating an administrative action under Sections 6(c) and 6(d) of the CEA are 

conducted under the CFTC's Rules of Practice in Part 10 of the CFTC Regulations. Sanctions that 

can be imposed by administrative action include orders: 

Prohibiting a respondent from trading on or subject to the rules of any contract market and 

requiring all contract markets to refuse such person all trading privileges for any period 

specified in the order; 

Suspending (for a period of not more than six months), revoking or restricting a respondent's 

registration with the CFTC; 

Assessing civil monetary penalties against a respondent, up to $140,000 or triple the monetary 

gain to the person for each violation; not more than the greater of $1 million or triple the 

monetary gain to the person for each violation for manipulation; plus post-judgment interest; 

Directing that a respondent make restitution to customers of damages proximately caused by 

the respondent's violations; and 

Directing a respondent to cease and desist from violating the CEA or CFTC Regulations in an 

administrative action brought pursuant to Section 6(d). 

Criminal prosecutions 

The CFTC has the power to refer matters for criminal prosecution to DOJ and state criminal 

authorities, but it cannot independently initiate criminal actions. The CFTC routinely works in 

parallel with criminal law enforcement authorities to investigate potential violations of the CEA. 

Alleged criminal violations of the CEA pursuant to Section 9 of the CEA or violations of other 

federal laws that involve commodity futures trading are referred to DOJ for prosecution. 

Likewise, conduct that may violate state laws is referred to the appropriate state authority. A 

criminal prosecution does not preclude the CFTC from taking civil action for the same conduct, 

and similarly, CFTC action does not preclude a subsequent criminal prosecution. 

Power to require information 

Power to compel a person to provide information

The CFTC has broad subpoena powers and may obtain information from any individual or 

entity, whether registered or not, in connection with possible violations of the CEA and 
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Commission regulations. Section 6(c) of the CEA authorizes the CFTC to subpoena the 

production of documentary and testimonial evidence from any place in the United States, any 

State, or any foreign country or jurisdiction. 

Telecommunications data 

The CFTC has power to access electronic communications from regulated entities, but a judicial 

decision based on internet privacy legislation has ruled that it cannot require access to the 

content of communications from an internet service provider without seeking judicial approval. 

Bank records 

The RFPA creates a procedure that must be followed in an investigation before the CFTC can 

access bank records relating to individuals or partnerships of less than six people. The Act 

generally requires prior notice to be given to the account holder, but it also permits delayed 

notice in specified circumstances, such as where there is a risk of the destruction of evidence, or 

where notice would seriously jeopardize an investigation. These provisions do not apply to civil 

proceedings, where discovery rules apply. In practice, the CFTC has not had difficulty in using 

the delayed notice provisions where circumstances warrant. (See also Principle 13). 

Private rights of action 

Section 22 of the CEA permits private rights of action under certain circumstances. Section 22(a) 

permits private damage actions against anyone other than a SRO who violates, or willfully aids 

and abets a violation, of the CEA. Section 22(b) establishes a private damage remedy against 

SROs and their officials, which in bad faith refuse to enforce their own rules, or enforce their 

own rules in violation of the CEA, and cause monetary loss to the plaintiff. The CFTC’s 

enforcement powers do not compromise a private person’s right of action to seek remedies 

under the CEA. 

Section 14 of the CEA permits anyone complaining of a violation of the CEA or the CFTC’s rules 

to apply to the CFTC for an order awarding damages caused by the violation. These reparations 

procedures provide a variety of methods to resolve claims, including a voluntary procedure 

based on the submission of written documents, a summary procedure for claims of less than 

$30,000 and a formal procedure before an Administrative Law Judge. 

Information sharing

If information is available from another federal or state agency, such as a state securities 

regulator or the SEC, the CFTC can obtain this information by seeking access to the public and 

non-public information in that agency’s files. The CFTC cooperates with other domestic 

enforcement authorities through explicit statutory authorization, formal MOUs and informal 

arrangements. 

SEC

Powers of investigation 

General investigation power 

The Securities Act, the Exchange Act, the Advisers Act, and the ICA give the SEC broad authority 

to investigate actual or potential violations of the federal securities laws, including the SEC’s 

rules and regulations and the rules of SROs, and give it broad powers to gather evidence from 

any person, whether regulated or not.. For example, Section 21(b) of the Exchange Act gives the 

SEC authority to subpoena witnesses to compel their testimony, and require the production of 

books and records. It also permits the SEC to administer oaths and affirmations, which require 

witnesses to be truthful in their testimony. 
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Enforcement powers 

Civil proceedings 

The SEC can bring civil proceedings in a federal district court seeking remedies that include 

injunctions, temporary restraining orders to halt ongoing fraud and freeze assets, 

disgorgement, civil money penalties and any other equitable relief deemed necessary. The 

range of civil money penalties varies in accordance with the application of the facts of the case 

to the structure for penalties available under the federal securities laws. Statutory amounts are 

adjusted periodically for inflation. Under the Exchange Act for example, the current maximum 

amount of civil penalty per violation in a civil action for fraud is the greater of $160,000 for a 

natural person, $775,000 for an entity or, as to a natural person or entity, the gross amount of 

pecuniary gain (Section 21(d)(3) of the Exchange Act). 

In insider trading cases, for example, the Exchange Act provides that a person who committed 

the violation may be subject to a penalty amount as much as three times the amount of profit 

gained or losses avoided by the unlawful trading or communication of information (Section 21A 

of the Exchange Act). 

Administrative proceedings

The SEC has the authority to institute administrative actions against a person or an entity 

alleged to have violated the law. Administrative actions are instituted by the SEC and litigated 

by Enforcement before an SEC ALJ. The ALJ’s decision is subject to review by the SEC, and the 

SEC’s decision is in turn subject to appeal before a U.S. Court of Appeals. 

Sanctions and remedies available through administrative proceedings include: 

 Securities industry suspensions of up to twelve months; 

 Bars as to regulated individuals; 

 Limitations on activities; 

 Civil penalties; 

 Disgorgement; 

 Revocation of the registration of an entity; and 

 For professionals, such as attorneys and accountants, an order that the professional be 

suspended from or denied the privilege of practicing before the SEC. 

Criminal prosecutions 

The SEC has the authority to refer cases to federal and state criminal law enforcement 

authorities. It routinely works in parallel with criminal law enforcement authorities to

investigate potential violations of the securities laws. A criminal prosecution does not preclude 

the SEC from taking civil action for the same conduct, and similarly, SEC action does not 

preclude a subsequent criminal prosecution. 

Suspension of trading 

The SEC can summarily suspend trading in a security for up to ten business days under Exchange

Act Section 12(k), if it determines that the public interest and protection of investors require 

such a suspension. Also, pursuant to Section 8(d) of the Securities Act, the SEC can issue a stop 

order suspending the effectiveness of a registration statement that contains incomplete, 

inaccurate, false or misleading information. Under Section 12(j) of the Exchange Act, the SEC can 

also deny, suspend for up to twelve months, or revoke the registration of a security if the issuer is
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found to have failed to comply with the Exchange Act and rules made under it. 

Dodd-Frank Act 

 The Dodd-Frank Act gave the SEC additional enforcement powers in a number of areas, 

including by, for example: 

 Authorizing the SEC to impose civil money penalties in cease-and-desist proceedings; 

 Authorizing the SEC to impose industry wide collateral bars on individuals found to have 

violated the securities laws; 

 Providing authority for charging aiding and abetting liability under the Securities Act and 

the ICA (this liability already existed under the Exchange Act and the Advisers Act); 

 Authorizing the SEC to obtain penalties against aiders and abettors in civil actions under 

the Advisers Act; and 

 Specifying that manipulative short sales are unlawful. 

Power to require information 

The SEC can use the supervisory powers described under Principle 10 to access information and 

records held by regulated entities. In addition, under its subpoena authority, the SEC can compel

the production of documents or testimony from any person or entity (whether regulated or not) 

anywhere within the U.S., including from banking entities. 

Electronics data 

As is the case with the CFTC, U.S. federal law imposes restrictions on the SEC’s ability to obtain 

certain information regarding electronic communications. 

Bank records 

The SEC must follow the procedures set out in the RFPA when it seeks financial records of an 

individual customer or small partnership from a financial institution. The process is the same as 

that applied to the CFTC (see also Principle 13). 

Private rights of action 

Private persons can seek their own remedies for misconduct relating to the securities laws. The 

SEC’s enforcement powers do not compromise private rights of action seeking remedies under 

the federal securities laws. In addition, the federal securities laws provide for express remedies 

in favor of private parties who claim damages as a result of specific violations of the federal 

securities laws. For example, Section 11 of the Securities Act imposes liability for misstatements 

or omissions in registration statements; and Section 9 of the Exchange Act imposes liability for 

specified manipulations of exchange-traded securities. 

Federal courts have implied private rights of action under some statutory provisions, notably 

under Exchange Act Section 10(b) for securities fraud. 

Information sharing

The SEC is authorized by law to share information with certain other authorities. Under Section 

24(c) of the Exchange Act, the SEC can make nonpublic information and records in its 

possession available to persons the SEC deems appropriate, including domestic and foreign 

counterparts, if they have a need for the information and make appropriate assurances of 

confidentiality. Generally, the SEC is not reliant on other authorities to obtain evidence necessary 

for its investigations. 
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Assessment Fully Implemented 

Comments 

Principle 12. The regulatory system should ensure an effective and credible use of inspection, investigation, 

surveillance and enforcement powers and implementation of an effective compliance program.

Description CFTC

Inspection, surveillance and compliance monitoring

In 2014, the CFTC has 95 staff positions dedicated to examinations of registrants. 

DCM and DCO supervision 

The CFTC has a direct examination program for DCMs and DCOs, and will commence direct 

examinations of SEFs and SDRs in the near future. This work is undertaken by DMO and DCR, 

which in fiscal year 2014 have a total of 47 examination positions to carry out this function. 

The operational integrity of exchanges is addressed through the CFTC’s periodic RERs that 

broadly address audit trail, market surveillance, trade practice surveillance, and disciplinary 

programs. RERs are typically carried out every year for the larger exchanges and about every 

three to four years for the smaller exchanges. These reviews test each DCM’s ongoing 

compliance with the Core Principles through the self-regulatory programs operated by the 

exchange to enforce its rules, prevent market manipulation and customer and market abuses, 

and ensure the recording and safe storage of trade information. The Compliance Section of 

DMO also carries out horizontal RERs, testing across a number of exchanges compliance with 

particular Core Principles. See also Principles 9 and 34. 

Licensed intermediaries

For intermediaries generally, the CFTC itself does not conduct routine on-site direct inspections 

of intermediaries. The CFTC’s regulatory scheme relies on the supervision activities of the SROs 

(DCMs and NFA) and continuing oversight by the CFTC of the exercise of those responsibilities. 

To test the work performed by DSROs, CFTC staff conduct risk-based reviews that focus on five 

areas of an SRO’s supervisory program: financial stability, customer protection, risk 

management, market moves and operational capabilities. The CFTC conducts examinations of 

intermediaries for cause or to test the quality of the DSROs’ work. In FY 2014, DSIO carried out 

11 limited scope examinations of FCMs and one for cause examination of a swap dealer. 

For detail on the intermediary inspection programs carried out by the SROs, see further under 

Principle 24 (for CPOs) and Principle 31 (for other intermediaries). 

The CFTC requires DSROs to ensure that each FCM is subject to an on-site examination within 

nine to 18 months of the date of the previous examination by the DSRO. 

Unusual market transactions

On a daily basis, DMO’s Surveillance staff reviews details of transactions at each exchange by 

using the CFTC’s surveillance system. Analysts identify potential abuses from data analysis 

conducted using tools developed by the staff. The CFTC is currently in the process of upgrading 

this system to enhance its ability to detect trade practice violations, including wash trading and 

trading ahead. DMO staff also periodically observe trading activity on the floor of each 

exchange for the exchanges that still have open outcry trading and discuss potential issues of 

concern with compliance staff at the exchange. 

Compliance systems

The Core Principles applying to DCMs and SEFs oblige them to have in place arrangements to 
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monitor and enforce compliance with the legislation and with their rules. CFTC Regulations 

require them to have adequate staff to fulfil their obligations as SROs. 

All categories of intermediaries, including FCM, IBs, CPOs and CTAs are required to develop and 

maintain compliance policies and procedures. CFTC Regulation 166.3 requires all CFTC 

registrants to diligently supervise the handling of all commodity interest accounts by partners, 

officers, employees and agents. Any violation of the CEA by a supervised person creates a 

liability on the supervisor for failure to supervise. Section 2(a)(1)(B) of the CEA imposes 

respondeat superior liability on the principal for the acts of its agents. 

Mechanisms to detect and investigate insider trading and other forms of market abuse 

DCM Core Principles require a DCM to monitor and enforce compliance with rules of the 

contract market, including rules relating to abusive trading practices. CFTC Regulation 38.156 

requires DCMs to have an automated trade surveillance system capable of detecting potential 

trade practices violations. The automated system must, among other things, process daily 

orders and trades no later than 24 hours after the completion of the trading day; and be 

capable of detecting and flagging specific trade execution patterns and trade anomalies. 

Regulation 38.157 requires a DCM to conduct real-time market monitoring of all trading activity 

on its electronic trading platform(s) to identify disorderly trading and any market or system 

anomalies. SEFs are subject to analogous requirements. The CFTC conducts oversight of the 

exchanges’ programs to ensure effectiveness. In addition to the exchange surveillance program, 

the CFTC independently conducts an extensive market surveillance program, utilizing large 

trader reports and analysis of trading data, which it receives on a daily basis. 

Intelligence and investor complaints 

CFTC investigations often come from customer tips, complaints, or referrals (TCRs). Over 200 

TCRs were received from whistleblowers in the fiscal year 2014. The Dodd-Frank Act amended 

the CEA by adding a new Section 23 (Commodity Whistleblower Incentives and Protection) 

under which the CFTC established a whistleblower program. The CFTC can pay awards, based 

on collected monetary sanctions, to eligible whistleblowers who voluntarily provide the CFTC 

with original information about violations of the CEA that lead either to a judicial or 

administrative action. The CFTC made its first payment to a whistleblower in May 2014. 

Other CFTC enforcement cases come from a variety of sources, including internal referrals from 

the supervisory areas of the CFTC and referrals from SROs, state and federal authorities or 

foreign regulators. CFTC enforcement staff also monitors press reports and websites the 

information from which may form the basis of enforcement cases. 

Reconstruction of execution and trading 

CFTC Regulation 38.551 requires a DCM to capture and retain all audit trail data necessary to 

detect, investigate, and prevent customer and market abuses. This data must be able to be used 

to reconstruct all transactions within a reasonable period of time. Regulation 37.205 makes 

analogous provisions in relation to SEFs. 

Enforcement 

The CFTC’s Division of Enforcement (DOE) has a total staff of just over 150 people, the majority 

of whom are attorneys, but also include over 20 investigators and 3 economists. 

At the time of the assessment mission, the CFTC had approximately 99 litigation matters 

pending in United States District Courts throughout the U.S., approximately 433 pending 

investigations, and 77 preliminary inquiries. These matters target specific program areas 

including: 
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 Allegations of manipulation, attempted manipulation, and false reporting; 

 Trade practice violations; 

 Fraud and other misconduct involving CPs, HFs, CPOs, and CTAs; and 

 Financial, supervision, recordkeeping and other violations committed by registered 

entities and individuals. 

In addition, the DOE program focuses on pervasive fraud involving retail forex futures, forex 

options, and off-exchange precious metal and retail forex transactions. 

The CFTC has tended to bring cases in the federal courts rather than through administrative 

proceedings before an ALJ. There are no permanent ALJs attached to the CFTC and where used 

they are sourced from outside the agency. Some matters, such as revocation of registration or 

statutory disqualification, must be done administratively. 

DOE works actively with federal and state criminal and civil law enforcement authorities. Over 

90 percent of the CFTC’s major fraud cases (those with customer losses over $1 million) filed 

during fiscal year 2013 involved a parallel criminal proceeding. During fiscal years 2010 to 2013, 

the CFTC referred an average of approximately 50 matters to domestic criminal and civil 

authorities annually, of which an average of 40 matters were referred to criminal authorities. As 

a result of these criminal referrals, an average of 45 indictments were filed annually alleging a 

range of criminal misconduct arising out of activity in the futures and swaps markets. Criminal 

sanctions in those cases included prison sentences, fines, and restitution. Defendants received 

prison sentences of up to 50 years, others received fines of over $100 million, and still others 

were ordered to pay restitution of more than $250 million. 

The CFTC has obtained the following monetary relief in its civil and administrative enforcement 

actions over the last 3 fiscal years: 
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CFTC Enforcement Actions 

Type of Violation and Actions Filed 

(by Fiscal Year)1

Type of Violation FY 

2011 

FY 

2012 

FY 

2013 

FY 

2014 

Fraud 55 57 29 26 

Illegal Offering of Off-Exchange Transactions 1 0 8 13 

Trade Practice 6 15 72 6 

Financial Integrity and Controls 3 12 23 7 

Recordkeeping and Reporting 1 2 0 2 

Manipulation, Attempted Manipulation and 

False Reporting of Market Information 

3 2 4 6 

Disclosure of Non-Public Material Information 0 0 1 0 

Statutory Disqualification 1 9 5 4 

False Statements and Omissions of Material 

Facts to the Commission/NFA/Exchanges 

2 2 13 2 

Violation of a Commission Order 0 0 1 1 

Registration Violations 25 3 1 0 

Audit Failures 2 0 2 0 

 Source: CFTC 

1

 Many of these cases involved multiple, significant charges including various combinations of fraud, illegal offexchange transactions, registration violations, false statements to the CFTC/NFA/exchanges, recordkeeping 

violations, etc. Placement of a case with a particular category was where it was deemed the best fit. 

2

 In Fiscal Year 2013, the CFTC brought its first action using its anti-spoofing/disruptive trading authority enacted 

under the Dodd-Frank Act. 

3

 In Fiscal Year 2013, the CFTC brought its first case for false statements to the CFTC using its new Dodd-Frank Act 

authority. In fiscal year 2014, the CFTC brought two other actions for false statements. 

CFTC Monetary Relief 

Fiscal Year Civil Monetary 

Penalties 

Restitution and 

Disgorgement 

FY11 $316,682,679 $181,844,807 

FY12 $475,360,925 $456,581,900 

FY13 $1,570,700,568 $201,409,408 

FY14 (to Apr 30) $961,072,836 $1,330,365,570 

Total $4,831,648,447 $3,686,210,358 

 Source: CFTC 
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SEC

Inspection, surveillance and compliance monitoring

Intermediaries supervision 

OCIE carries out the SEC’s examination authority through its National Examination Program 

(NEP). OCIE: 

Examines or inspects securities firms registered with the SEC, including BDs, municipal securities 

dealers, clearing agencies, transfer agents, IAs, investment companies, and municipal advisors; 

and: 

Examines and oversees the SROs, which monitor trading activity on the exchanges for which the 

SROs provide additional regulatory oversight. 

In carrying out these responsibilities, OCIE uses a risk-based approach for selecting which 

firms, areas, and issues to examine, and draws on a variety of resources, including its staff’s 

specialized knowledge, risk analytics, and advanced technology, to target its resources on the 

areas that pose the highest risk. 

As of early 2014, OCIE had approximately 805 examiners, many of whom are accountants, 

attorneys, and former industry professionals, devoted to examinations of registrants. A number 

of specialist units and programs within OCIE provide support to the examinations process, as 

discussed under Principle 6. 

In 2013, OCIE began publishing its annual examination priorities to educate and inform 

registrants of particular areas of examination focus and to provide entities an opportunity to 

evaluate their compliance systems and remediate any issues identified before they might be 

selected for examination. 

OCIE conducts inspections in all categories of securities intermediaries. However, FINRA is 

considered the front line supervisor for BDs. Details of the examination programs are included 

in Principle 24 for mutual funds and their operators and Principle 31 for securities 

intermediaries. In addition, the Risk and Examinations Office in IM has a risk monitoring 

program that includes targeted, risk-based examinations to obtain information and evaluate 

potential financial or operational risks in the asset management industry. See further under 

Principle 24. 

SRO supervision 

OCIE conducts comprehensive risk-based examinations of SROs’ regulatory programs, including 

reviews of SROs’ examination and surveillance programs and their disciplinary and enforcement 

programs. See further under Principle 9 and Principle 34. 

NRSROs 

Office of Credit Ratings (OCR) conducts examinations of NRSROs. The Office had 44 staff for 

fiscal year 2014. Pursuant to the Dodd-Frank Act examinations must be conducted on an annual 

basis. (See Principle 22). 
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OCIE and OCR Examinations and Monitoring 

Type/firm FY 2011 FY 2012 FY 2013 

Broker-dealers 390 443 438 

Large firm monitoring 11 11 

Investment advisers 1,004 974 964 

Investment companies 

(including administrators) 112 104 99 

Transfer agents 46 42 42 

Clearing agencies 2 5 17 

Municipal advisors 5 

NRSROs 10 9 10 

SROs 52 38 50 

Technology control program 

11 13 13 

 Source: SEC 

Compliance systems

SEC and SRO rules specifically require regulated entities to have in place supervisory and 

compliance procedures reasonably designed to prevent securities laws violations. For example, 

Rule 206(4)-7 of the Advisers Act requires registered advisers to adopt and implement written 

policies and procedures reasonably designed to prevent violations of the legislation and rules 

made under it; similar provisions apply to investment companies (ICA Rule 38a-1); and FINRA 

rules, NASD Rules and NYSE rules require written compliance policies and supervisory 

procedures reasonably designed to achieve compliance with their rules and federal securities 

laws. FINRA Rules require annual CEO certification of BDs’ compliance and supervisory 

procedures. 

OCIE examination staff and the SROs conduct reviews of the adequacy of firms’ written 

supervisory procedures and test whether the procedures are being implemented, including 

whether employees are given the written supervisory procedures. 

As well as taking action against individual employees of regulated entities, the SEC can sanction 

broker-dealers and IAs and their associated persons for failure reasonably to supervise individuals

subject to their supervision who commit violations of the federal securities laws. A BD or IA can 

be charged with failure to supervise when it fails to have or to implement supervisory and 

compliance policies reasonably designed to detect and prevent violations of the federal securities

laws by subordinate personnel. 

Mechanisms to detect and investigate insider trading and other forms of market abuse 

The mechanisms to detect market abuse are described in Principles 34 and 36. 

When inspecting an SRO’s surveillance program, the SEC staff’s objectives are to determine 
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whether: 

The parameters of SRO automated surveillance systems are appropriately designed to generate 

alerts that identify potential instances of noncompliance with SRO rules and federal securities 

laws; and 

The systems are effectively detecting such activity. 

Intelligence and investor complaints 

OCIE reviews and evaluates TCRs from a variety of external sources in accordance with the SECwide TCR system and related policies. Particular attention is given to TCRs alleging or indicating 

fraud. This process helps inform the selection of registrants for examination and the scope of 

examinations. 

The Office of the Whistleblower (OWB), established in response to the new whistleblower 

provisions in the Dodd-Frank Act, administers the SEC’s whistleblower program. It gathers 

intelligence from whistleblowers, and refers matter to other Enforcement staff for further 

investigation where appropriate. The SEC has made a number of payments under this program. 

The SEC also has direct electronic access to suspicious activity reports (SARs) and other reports 

financial institutions are required to file under the BSA. 

Reconstruction of execution and trading 

Section 19(g) of the Exchange Act requires each SRO to enforce compliance with the SRO’s rules 

by its members, including by having mechanisms for conducting surveillance of the markets and 

establishing an audit trail. FINRA has taken over the Order Audit Trail System (OATS) established 

by NASD and later expanded to include OTC equity securities. Several options exchanges use the 

Consolidated Options Audit Trail System (COATS). 

The SEC in 2012 adopted Rule 613 to require the national securities exchanges and FINRA to 

submit a national market system (NMS) plan to create, implement, and maintain a consolidated 

order tracking system, or consolidated audit trail, with respect to the trading of NMS securities. 

This plan was recently submitted to the SEC (see Principle 36). 

Enforcement 

Background

The SEC has approximately 1,300 employees in Enforcement, including attorneys, accountants, 

and other professionals, who investigate and prosecute violations of the federal securities laws. 

Enforcement staff are located in each of the regional offices and in Washington D.C. The SEC has 

devoted increasing resources to its enforcement program and in fiscal year 2013, Enforcement 

had a budget of $449.35 million. 

The SEC in recent years has enhanced its enforcement activities, including by: 

Establishing a cooperation program to provide incentives for individuals and entities to 

cooperate and assist with SEC investigations and enforcement actions; 

Adopting a new settlement protocol to require admission of wrongdoing in cases where there 

is a need for public accountability, such as in cases involving egregious conduct, significant 

investor harm, significant market risk and obstruction of an SEC investigation (14 cases have so 

far been settled in this way); 

Establishing five new national specialized units to target Enforcement staff and other resources 

to areas of significant concern: an Asset Management Unit; a Municipal Securities and Public 

Pensions Unit; a Foreign Corrupt Practices Act Unit; a Complex Financial Instruments Unit; and a 
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Market Abuse Unit. Each of these units have taken significant enforcement actions since their 

establishment in 2010; and 

Establishing a number of task forces to focus on high priority areas, including task forces on: 

financial reporting and audit; microcap fraud; broker-dealers; and the JOBS Act. 

Enforcement activities

SEC enforcement cases come from a number of sources. These include: 

Referrals from the supervisory areas. Each Regional Office has a referral Committee which 

brings together Enforcement and supervisory staff to discuss possible enforcement cases. 

Around 10-15 percent of OCIE examinations result in referrals to Enforcement; 

Review by Enforcement’s Office of Market Intelligence of TCRs (around 16,000 TCRS are 

reviewed each year): 

Tips from whistleblowers to the Office of the Whistleblower (in fiscal year 2013, there were 

about 3,200 tips); and 

Referrals from the SROs and other external sources. 

Enforcement also commences investigations on its own initiative. For example, the specialized 

units and task forces carry out monitoring and surveillance of the market and either initiate 

their own cases or refer them to other parts of Enforcement. 

Administrative and civil cases 

Enforcement brings cases as administrative proceedings before an ALJ and/or as civil cases in a 

District Court. The decision as to which route to take depends on the facts and circumstances of 

each case. Some remedies, such as the freezing of assets, are available only through a court 

process; and some remedies such as barring individuals from securities industry activity are 

expressly provided for only in administrative proceedings. Enforcement has about 130 litigation 

lawyers who, along with staff attorneys, handle these cases. 

At the end of fiscal year 2013, Enforcement had over 1,444 ongoing investigations, excluding 

litigation and other post investigative activities. In that year, the SEC brought 676 enforcement 

actions, 15 percent of which were high impact cases or reflected a national priority. The SEC 

obtained some form of relief in 93 percent of actions brought in 2013. 

The majority of cases are settled, but an increase in the number of cases against individuals is 

one factor in the increase in cases that go through the full litigation process. 

Total SEC Enforcement Actions 

Fiscal Year Enforcement Actions 

2014 755 

2013 676 

2012 734 

2011 735 

2010 681 

2009 664 

 Source: SEC 
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SEC Enforcement Cases—Selected Types Of Action 

Type of action FY 2010 FY 2011 FY 2012 FY 2013 

Market manipulation 34 35 46 50 

Insider trading 53 57 58 44 

Securities offerings 144 123 89 103 

Issuer reporting and 

disclosure 

126 89 79 68 

 Source: SEC 

Sanctions Ordered in SEC Enforcement Actions 

Fiscal 

Year

Disgorgement 

Ordered

Penalties 

Ordered

Officer and 

Director 

Bars

Trading 

Suspensions

2013 $2.257 billion $1.167 billion 81 371 

2012 $2.083 billion $1.021 billion 120 651 

2011 $1.878 billion $928 million 82 276 

2010 $1.82 billion $1.03 billion 71 254 

2009 $2.09 billion $345 million 90 192 

 Source: SEC 

Criminal cases 

Criminal actions for violations of the securities laws and for fraud involving securities market 

activity are taken by the criminal authorities at federal, state and local level. At the federal level, 

the U.S. Attorney’s Office has 93 offices nationally and some 5,500 assistant U.S. attorneys. 

Economic crime is a significant priority. In addition, the Fraud Section of the Criminal Division of 

the U.S. Department of Justice in Washington, DC has a specialized group of prosecutors who 

bring criminal securities fraud cases throughout the United States. State and local prosecutor’s 

offices also investigate and prosecute securities market cases, especially in the large market 

centers. Large, high profile cases are undertaken at all levels but smaller cases tend to be 

undertaken at state and local level. 

The SEC works closely with criminal authorities, referring cases and providing assistance in 

investigations. Typically, the SEC refers cases to the U.S. Attorney’s Offices and to the Fraud Section 

of the Criminal Division of the U.S. Department of Justice, but it also makes referrals to the other 

authorities. Cases requiring the additional powers available to criminal authorities (such as wiretapping and search warrants) are referred at an early stage. Often, cases are investigated in parallel, 

with the SEC investigating at the same time as the criminal authorities. Frequently, these cases are 

filed simultaneously. Criminal action was taken in 126 cases in 2013 as a result of SEC referrals. 

The criminal authorities receive cases from other sources, such as complaints, referrals from 

SROs, or media reports. Some state authorities also proactively monitor data such as suspicious 
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activity reports to identify possible actionable misconduct. This means that securities fraud 

cases, including smaller ones, are investigated and prosecuted. 

SEC Enforcement also works closely with other regulators on enforcement issues. In 2013, SEC 

staff provided assistance and access to files to domestic regulators in 504 investigations and to 

foreign regulators in 508 investigations. 

In addition, the U.S. Department of Justice (through both U.S. Attorney’s Offices and the Civil 

Division of the Department of Justice in Washington, DC) brings civil actions for securities fraud 

and other financial fraud; this includes circumstances when the higher standard of proof in 

criminal cases is not met. 

The U.S. Department of Justice has a Financial Fraud Enforcement Task Force based in 

Washington, DC, which coordinates certain criminal and civil actions in complex financial crimes 

cases. 

Assessment Broadly Implemented 

Comments The supervision and examination programs of the SROs, and of the SEC and the CFTC, for 

intermediaries and CIS are described in more detail under the relevant sectoral Principles 

(especially Principles 24 and 31). Overall, these programs provide for regular cycle examinations 

of most intermediaries so that even lower risk firms are examined on a regular basis. For cause 

examinations are also undertaken, in response to particular information such as tips or 

complaints. For intermediaries other than IAs, the NFA and FINRA carry out most of these 

examinations, and based on files reviewed by the assessors the examinations are well focused 

and thorough, with appropriate follow up actions taken where problems are identified. The SEC, 

and to a lesser extent the CFTC, also carry out direct risk-based examinations, which are also 

used to test the effectiveness of the supervision carried out by the SROs. 

For reasons described under Principles 24 and 31, the SEC’s supervision of IAs, including those 

that operate mutual funds, is less intensive and examinations cover a relatively small percentage 

of the population each year. This is the reason for the grade under this Principle. The SEC uses 

sophisticated systems to profile risk and to identify higher risk IAs for examination, but given 

the importance of the mutual fund and asset management sectors, more frequent examinations 

of IAs are warranted. 

Both the SEC and the CFTC make robust use of their enforcement powers, and devote 

considerable resources to their enforcement activities. Enforcement actions by the agencies 

cover all areas within their jurisdictions. In particular, the SEC has significantly enhanced many 

aspects of its enforcement program. These enhancements enable it to better detect and act on 

problematic behavior reported to it through tips and complaints. Its new specialized 

enforcement units and taskforces actively monitor priority areas where misconduct may have an 

impact on the markets or investors. 

The criminal authorities act on referrals from the regulators and from other sources, and on 

their own initiative. There are strong incentives for them to act on high profile cases, but 

attention is also given to smaller cases especially at the state and district level. 

Principles for Cooperation in Regulation 

Principle 13. The regulator should have authority to share both public and non-public information with 

domestic and foreign counterparts. 

Description Authority to share information 

Section 24(c) of the Exchange Act and Rule 24c-1 provide that the SEC may, in its discretion and 

upon showing that the information is needed, provide any records and information in its 
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possession6 to a range of domestic and foreign regulators and other authorities,7 subject to 

appropriate assurances of confidentiality. Rule 24c-1 specifically includes foreign financial 

regulatory authorities8

 among the persons to whom the SEC may provide information. The SEC 

staff generally relies on the information provided by the requestor as to the need for the 

information. 

Upon request, the CFTC may share information with any domestic9

 or foreign10 regulator (or 

other authority) acting within the scope of its jurisdiction, provided that the requirements in 

Section 8(e) of the CEA are satisfied. The CFTC staff informed that it generally relies on the 

information provided by the requesting regulator or authority as to the matter falling within the 

scope of the requestor’s jurisdiction. 

The information sharing right of both the SEC and CFTC covers that required under Key 

Questions 13.1(a)-(g) and 13.3(a)-(g). It can also include information concerning the beneficial 

ownership or control of a bank or brokerage account as well as information necessary to 

reconstruct a transaction, including bank records. No external approval is needed for the SEC or 

CFTC to share information. 

The SEC and CFTC have procedures in place for sharing non-public information designed to 

ensure that the required assurances of confidentiality and use are obtained either through an 

MOU or less formal arrangements, such as access request letters. 

Specific information sharing powers under the Dodd-Frank Act 

Sections 112(d)(1)-(2) of the Dodd-Frank Act authorize the FSOC to request and receive, and 

member agencies to provide, any data or information as necessary to monitor the financial 

services marketplace to identify potential risks to the financial stability of the United States or to 

otherwise carry out any of the relevant Dodd-Frank Act provisions. Section 809(e) of the DoddFrank Act includes specific information sharing powers on designated financial market utilities 

(DFMUs) or financial institutions engaged in designated activities (DFMIs) with both domestic 

and foreign authorities. 

No requirement for the breach of U.S. law 

Section 21(a)(2) of the Exchange Act explicitly authorizes the SEC to provide assistance to a 

foreign securities authority without regard to whether the facts as stated in the foreign securities 

authority’s request would also constitute a violation under U.S. laws. Similarly, Section 12(f)(1) of 

the CEA expressly states that the CFTC may provide investigative assistance to a foreign futures 

authority, including collecting and sharing information, without regard to whether the facts 

 

6

 This also covers information that the SEC gathers as a result of a request for information. 

7 This includes federal, state, local and foreign governmental authorities; SROs; foreign financial regulatory 

authorities; SIPC and its trustees; trustees in bankruptcy; court-appointed persons charged with performing functions 

arising from securities litigation, such as receivers; and professional licensing or oversight authorities that are 

government-sponsored, such as bar associations that are part of a state court system. 

8

 The term foreign financial regulatory authority includes foreign securities authorities, other foreign governmental 

bodies, or foreign equivalents of an SRO empowered by a foreign government to administer or enforce its laws 

related to financial activities. 

9

 A domestic regulator or authority refers to a federal department or agency or any department or agency of any 

state or any political subdivision thereof. 

10 A foreign regulator or authority refers to any foreign futures authority or any department, central bank, ministry or 

agency of any foreign government or any political subdivision thereof. 
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stated in the request would also constitute a violation of the laws of the United States. 

Customer financial records 

If the SEC or CFTC is seeking financial records of a customer (defined in the Right to Financial 

Privacy Act (RFPA) as an individual or a partnership of five or fewer individuals) from a covered 

financial institution (including a bank), it must follow specific procedures. According to these 

procedures, a government authority may have access to or obtain copies of such customer’s 

financial records, if the customer has either authorized such disclosure or, after notice to the 

customer, the disclosure takes place in response to an investigative subpoena (Section 3402 

RFPA). An SEC or CFTC subpoena has to indicate that it is from the respective agency, and that 

the records are relevant to a legitimate law enforcement inquiry. A copy of the subpoena must 

be served on the customer or mailed to the customer’s last known address. (Section 3405 RFPA). 

Requests from foreign authorities under the IOSCO MMOU for financial records covered by the 

RFPA require consulting the requesting authority before disclosing the request to the customer 

(Section 11.a of the MMOU). According to the SEC and CFTC, when the SEC or CFTC is making 

the request on behalf of a foreign authority, the subpoena would identify the SEC or CFTC as the 

requester and typically would not reveal the name of the requesting foreign authority, nor 

detailed information about the investigation. Access to records can be gained, if 10 days have 

expired from the date of service or 14 days have expired from the time of mailing and the 

customer has not challenged the inquiry. The customer can try to challenge the disclosure of 

his/her records only on the basis of very limited grounds, including that the records are not 

relevant for the law enforcement inquiry in question. 

The SEC and CFTC could also in certain circumstances obtain the financial records through a 

delayed notice provision without first notifying the customer. In the case of the SEC, this 

approach would involve seeking approval from an appropriate court to delay notice to the 

customer if (Section 21(h) Exchange Act): 

A delay in obtaining access to bank records or providing notice would result in a flight from 

prosecution, destruction of or tampering with evidence, transfer of assets or records outside the 

United States, improper conversion of investor assets, or impeding the ability to identify or trace 

the source or disposition of funds; 

A delay is necessary to identify or trace the record or beneficial ownership interest in any 

security; 

The acts or practices under investigation involve the dissemination of materially false or 

misleading information concerning any security, issuer or market or failure to make disclosures 

required under the securities laws, or a financial loss to investors or other persons which remains 

substantially uncompensated; or 

The acts or practices under investigation involve significant financial speculation in securities or 

endanger the stability of any financial or investment intermediary. 

The CFTC is subject to the general RFPA conditions for delaying notice to the customer that 

enable such delay by order of an appropriate court subject to certain conditions, including that 

there is reason to believe that a notice would result in endangering life or physical safety of any 

person; flight from prosecution; destruction of or tampering with evidence; intimidation of 

potential witnesses; or otherwise seriously jeopardizing an investigation or official proceeding or 

unduly delaying a trial or ongoing official proceeding. 

When the agencies receive requests from foreign authorities that require complying with the 

RFPA, staff explains the RFPA’s requirements and notice provisions, on the basis of which the 

foreign authority can decide on its preferred course of action. The CFTC has been subject to 
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fewer information requests from foreign authorities than the SEC. In the most recent case, the 

foreign authority requested the use of the delayed notification procedure. 

Similarly, U.S. government agencies are subject to restrictions on obtaining certain information 

from internet service providers under the Electronic Communications Privacy Act (ECPA). 

Unsolicited information 

The SEC may share nonpublic information with appropriate authorities on the basis of Section 

24(c) of the Exchange Act upon showing that it is needed and that the authority receiving the 

information provides assurances of confidentiality as the SEC deems appropriate. In some 

instances, both of these requirements can be satisfied without a request for assistance, as is the 

case under various MOUs. For example, Section 13 of the IOSCO MMOU authorizes a signatory 

to proactively share information without prior request under the conditions specified. 

Section 8(g) of the CEA provides that the CFTC may provide, on its own initiative, registration 

information to certain authorities. In other cases, the CFTC can share information subject to the 

conditions set forth in Section 8(e) of the CEA described above. In practice, if the CFTC knows 

that the information in its possession may be important to another regulator or authority, it 

encourages the other regulator or authority to make a request for information (if contemplated 

by the supervisory arrangements) to comply with the relevant Section 8(e) requirement. 

Assessment Fully Implemented 

Comments The RFPA requirements to give notice to customers on requests for records require consulting 

the requesting authority. This is consistent with the IOSCO MMOU. The customer is provided 

with very limited information on the reasons for the request and the process is relatively 

streamlined. 

Principle 14. Regulators should establish information sharing mechanisms that set out when and how they 

will share both public and non-public information with their domestic and foreign counterparts.

Description Power to enter into information sharing arrangements 

Both the SEC and CFTC have the power to enter into information-sharing arrangements with 

other domestic and foreign authorities under Section 24(c) of the Exchange Act and Section 8(e) 

of the CEA, respectively. Both the SEC and CFTC MOUs are approved by the respective 

Commissions and signed by the Chair or his/her designee. Both agencies can also use less 

formal arrangements, such as ad hoc requests for information, to facilitate information sharing. 

This applies regardless of whether a foreign authority has signed the IOSCO MMOU or a 

bilateral MOU. No written, confidential information can be shared either with a domestic or 

foreign regulator or authority without an MOU or another type of arrangement, such as an 

access request letter which provides the necessary assurances of confidentiality and limitations 

on the use of the information. 

The Dodd-Frank Act includes two provisions that explicitly relate to information sharing 

arrangements with foreign regulatory authorities. Under Section 752(a) of the Dodd-Frank Act, 

the CFTC, SEC and prudential regulators may agree to any necessary or appropriate information 

sharing arrangements to promote effective and consistent global regulation of swaps and 

security-based swaps. Specific reference is also made to the right of the CFTC to agree on 

information sharing arrangements for the regulation of commodity futures and options on such 

futures (Section 752(b) Dodd-Frank Act). 

Existing arrangements 
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Domestic 

The SEC and/or the CFTC have entered into MOUs to facilitate supervisory cooperation with 

other domestic regulators, including the following: 

The SEC and the Federal Reserve MOU (July 2008); 

The SEC, the Federal Reserve and the CFTC MOU on CDS CCPs (November 2008); and 

The SEC and CFTC MOU establishing a permanent regulatory liaison between the agencies and 

providing for enhanced information sharing, including an addendum relating to novel financial 

products that may reflect elements of both securities and commodity futures or options (March 

2008). 

Foreign 

Both the CFTC and the SEC have been signatories to the IOSCO MMOU since 2002. The primary 

MOU used by the CFTC for enforcement purposes is the IOSCO MMOU. Before the 

establishment of the IOSCO MMOU, the SEC had signed bilateral information sharing MOUs for 

enforcement cooperation with the securities authorities of 20 different countries. In light of the 

IOSCO MMOU, the SEC staff now strongly recommends the negotiation of bilateral MOUs for 

enforcement cooperation only if a foreign securities authority is empowered to provide 

assistance beyond that required by the IOSCO MMOU. 

The SEC has also entered into supervisory MOUs regarding cross-border regulated entities with 

its counterparts in several jurisdictions. The scope of these MOUs varies depending on the level 

and type of cross-border activity. In addition, the SEC has entered into protocols that cover the 

sharing of nonpublic issuer specific information relating to the application of IFRS and U.S. GAAP 

by dually listed issuers. A list of the SEC’s MOUs, including MOUs for supervisory cooperation, is 

available on the SEC’s website. 

Where a foreign authority is not a signatory to the IOSCO MMOU, the CFTC may use bilateral 

cooperative arrangements entered into primarily for enforcement purposes or informal letter 

arrangements. Copies of MOUs and other information sharing arrangements are available on 

the CFTC website. 

The CFTC has also entered into a range of cooperative arrangements for supervisory, prudential 

and risk assessment purposes, financial information sharing, and supervision of CIS and the 

alternative investment fund industry. The CFTC is also a signatory to the Boca Declaration on 

Cooperation and Supervision of International Futures Exchanges and Clearing Organizations. 

The CFTC has also entered into supervisory MOUs with respect to regulated entities operating 

on a cross-border basis. 

Confidentiality 

The confidentiality requirements described in Principle 5 apply to the SEC and CFTC and their 

staff. In addition, there are specific requirements that relate to confidentiality of information 

exchanged with other authorities. 

SEC 

The SEC can generally maintain the confidentiality of a request for information received from a 

foreign regulator. This is ensured primarily through the following: 

Section 24(d) of the Exchange Act provides a basis for denying a third-party request made under 

the FOIA for records provided by a foreign securities authority that has informed the SEC that 

disclosure of such information would violate the domestic laws applicable it; 
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Section 24(f) of the Exchange Act provides that the SEC cannot be compelled to disclose 

privileged information obtained from any foreign securities or law enforcement authority, if the 

latter has informed the SEC that the information is privileged. 

Section 24(g) of the Exchange Act provides that the SEC is not authorized to withhold 

information from the Congress or prevented from complying with a court order in an action 

commenced by the United States or the SEC. As a result, the Congress is entitled to obtain 

certain information from the SEC. However, it is the practice of the SEC to undertake to keep 

information provided by a foreign securities authority non-public with the understanding that 

disclosure could harm the SEC’s relationship with the foreign securities authority and adversely 

affect the SEC’s ability to obtain information from the foreign securities authority in the future. 

According to the SEC staff, requests for this type of information are infrequent and the Congress 

has been made aware of the need to preserve confidentiality of non-public information held by 

the SEC. 

CFTC 

Pursuant to CFTC Regulation 11.3, information and documents obtained by the CFTC in the 

course of any investigation (including investigations initiated to assist a foreign futures 

authority) are deemed non-public and confidential, unless made a matter of public record (e.g., 

as part of a civil or administrative proceeding). 

The CFTC has additional authority to protect from disclosure information regarding requests 

made by foreign futures authorities and information received from them: 

The CFTC can refuse to make public under the FOIA documents, where their disclosure could 

interfere with the CFTC’s or any other authority’s enforcement activities or disclose the identity 

of a confidential source, including a foreign agency or authority (CFTC Regulations 145.5(g)(1) 

and (4)); 

With the exception of legally enforceable demands, the CFTC cannot be compelled to disclose 

any information obtained from a foreign futures authority, if the latter has stated that public 

disclosure of the information would violate its laws and the CFTC has obtained the information 

pursuant to an MOU or other relevant procedure (Section 8(a)(1) CEA); and 

The CFTC’s DOE may withhold from producing in an administrative enforcement proceeding 

information obtained from a domestic or foreign governmental entity or from a foreign futures 

authority that either is not relevant to the resolution of the proceeding or was provided on 

condition that the information not be disclosed or that it only be disclosed as evidence in an 

enforcement or other proceeding (CFTC Regulation 10.42(b)(2)(v)).

The CFTC follows a similar approach to that of the SEC with regards to information requests 

from Congress (Section 8(a)(1) CEA). 

Practice 

Domestic information sharing 

The SEC’s and CFTC’s practice in sharing information with other domestic authorities is 

described in Principles 1 (other federal authorities and state authorities), 11 (criminal authorities) 

and 13. 

Foreign information sharing 

At the SEC, requests for assistance from foreign authorities (or to foreign authorities) are 

handled centrally by the Office of International Affairs (OIA), in close coordination with 

Enforcement and the other Divisions and Offices, including OCIE and OCR. In fiscal years 2012, 
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2013 and 2014, the SEC responded to, respectively, 450,508, and 548 requests for enforcement 

assistance from foreign authorities. In addition, the SEC provided assistance and received 

assistance in cross-border examinations and other supervisory matters. 

Within the CFTC, the responsibility for foreign information sharing relating to the investigation 

and prosecution of derivatives laws lies within the DOE’s International unit. During fiscal year 

2013, the CFTC received 69 requests for assistance from 23 foreign regulators and authorities 

and provided completed responses to 65 of them by the end of the fiscal year. Over the past 

three fiscal years, the CFTC responded to 173 requests, with an average response time of 39.6 

days. In addition, the CFTC shared information in connection with cross-border examinations 

and other supervisory matters. 

Assessment Fully Implemented 

Comments 

Principle 15. The regulatory system should allow for assistance to be provided to foreign regulators who 

need to make inquiries in the discharge of their functions and exercise of their powers. 

Description Obtaining records, documents, statements and testimonies 

SEC 

Under Section 21(a)(2) of the Exchange Act, the SEC has the authority to open a formal 

investigation to provide assistance to a foreign securities authority to determine whether any 

person has violated, is violating or is about to violate any laws or rules relating to securities 

matters that the requesting authority administers or enforces. The SEC may provide such 

assistance without regard to whether the facts stated in the request would constitute a violation 

of U.S. laws. In exercising this authority, the SEC has to consider whether the requesting 

authority has agreed to provide reciprocal assistance to the SEC, and whether compliance with 

the request would prejudice the public interest of the U.S. While not a prerequisite for sharing 

information with a foreign counterpart, requests made pursuant to an MOU between the SEC 

and a foreign authority, including the IOSCO MMOU, generally would be deemed to satisfy the 

reciprocity requirement. 

As part of providing assistance to a foreign securities authority, the SEC may use its powers 

under Section 21(b) of the Exchange Act as it would in its own investigations. This includes 

requiring the production of documents held by regulated entities as well as the ability to use the 

SEC’s subpoena powers to compel the production of documents or testimony from any person 

or entity anywhere within the U.S. This power is very broad in scope, authorizing any member of 

the SEC or any officer designated by it to administer oaths and affirmations, subpoena 

witnesses, compel their attendance, take evidence, and require the production of any books, 

papers, correspondence, memoranda, or other records that the SEC deems relevant or material 

to the inquiry. Such attendance of witnesses and the production of any such records may be 

required from any place in the U.S. at any designated place of hearing. 

CFTC 

The CFTC’s ability to provide assistance to foreign authorities is practically identical to that of the 

SEC. Section 12(f)(1) of the CEA states that, upon request from a foreign futures authority, the 

CFTC may, in its discretion, provide assistance in conducting an investigation that the foreign 

futures authority deems necessary to determine whether any person has violated, is violating, or 

is about to violate any laws, rules or regulations relating to futures or options matters that the 

requesting authority administers or enforces. The CFTC may conduct such investigation as it 

deems necessary to collect information and evidence pertinent to the request for assistance. 

Section 12(f)(2) of the CEA requires the CFTC, in deciding whether to provide assistance, to 
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consider whether the requesting authority has agreed to provide reciprocal assistance to the 

CFTC in futures and options matters and whether compliance with the request would prejudice 

the U.S. public interest.11 Assistance may be provided without regard to whether the facts stated 

in the request would also constitute a violation of the laws of the United States. 

As in the case of the SEC, the CFTC may compel on behalf of a foreign futures authority the 

production of documents and the taking of statements. 

Independent interest 

The SEC and CFTC are not restricted from sharing information or obtaining information even if 

they do not have an independent interest in a matter. 

Providing other assistance 

Both the SEC and CFTC are able to offer assistance to foreign regulators in securing compliance 

with the laws and regulations identified in Key Question 2. They can also provide information on 

the relevant regulatory processes in the U.S. They do not have the power to use their statutory 

authority to seek urgent injunctions and asset freezes on behalf of foreign regulators. However, 

they can assist in advising foreign regulators on how to initiate a proceeding in civil court or 

request the assistance of the DOJ. 

Foreign regulators may also pursue assistance in obtaining court orders through a mutual legal 

assistance treaty or a multilateral instrument such as the U.N. Convention against Transnational 

Organized Crime (UNTOC). DOJ has the ability to assist foreign regulators and foreign criminal 

authorities in obtaining court orders to issue search warrants, obtain asset freezes, summon 

witnesses, and compel the production of documents and other evidence. The ability to assist a 

foreign regulator depends on the specific language of the mutual legal assistance treaty 

between the U.S. and the foreign country or the terms of UNTOC; typically the remedies offered 

are only available to prosecutors for criminal violations. 

Providing information on financial conglomerates 

The SEC can provide supervisory assistance under Section 24(c) of the Exchange Act. Similarly, 

the CFTC can share supervisory information under Section 8(e) of the CEA and obtain 

information under Section 12(f)(1) of the CEA. Such supervisory information sharing is based on 

information that the SEC and CFTC already have in their possession or that they can receive from 

the books and records of supervised entities. This can include information covered by Key 

Question 7. 

Supervisory MOUs provide a mechanism by which the SEC, CFTC and their counterparts can 

consult, cooperate, and share information on a confidential basis about regulated entities that 

operate across borders. These supervisory MOUs facilitate the easier sharing of supervisory 

information, including on financial conglomerates. 

Assessment Fully Implemented 

Comments 

Principles for Issuers 

 

11 This provision also applies to swaps (Section 723(a)(2) of the Dodd-Frank Act added Section 2(d) to the CEA to 

provide that several enumerated provisions, including Section 12(f), apply to swaps). 
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Principle 16. There should be full, accurate and timely disclosure of financial results, risk and other 

information that is material to investors’ decisions. 

Description Background 

Disclosure obligations associated with the public offering of securities stem from federal 

securities laws. Monitoring issuers’ compliance with such obligations is a function entrusted to 

the SEC. In addition, each exchange’s listing requirements impose a set of disclosure obligations 

on issuers, which in general replicate federal requirements, although in a few areas they 

supplement them. Therefore this assessment focuses on the federal framework—although where 

appropriate complementary requirements of the exchanges are mentioned. Monitoring 

compliance with such listing requirements is the exchanges’ responsibility. 

Public offering of securities 

Under the Securities Act (Sections 3-5), every offer or sale of a security must be registered with 

the SEC unless an exemption is available. The Securities Act provides exemptions from 

registration for (i) specific types of securities (such as any security issued or guaranteed by the 

government (other than foreign governments) or a bank but not a bank holding company, 

offerings of short-term commercial paper and municipal securities) or (ii) certain types of 

transactions (in general such exemptions include limitations on the amount that can be raised 

and/or the type of investors to which the offer can be addressed). The JOBS Act expanded some 

of the transactional exemptions currently available by (i) allowing general solicitation of certain 

offers provided that the securities are only sold to accredited investors or qualified institutional 

buyers depending on the exemption; (ii) exempting from registration offerings up to $50 million,

subject to certain conditions including SEC review and the SEC qualifying the offering statement; 

and (iii) permitting offerings through crowdfunding up to $1 million annually without 

registration. The SEC has already approved regulations for (i) and issued proposals for 

consultation for (ii) and (iii). 

Registration statement and prospectus 

To register a securities offering under the Securities Act, an issuer must file a registration 

statement with the SEC. The registration statement includes a prospectus. 

SEC regulations require a prospectus to include disclosure in specific items: (i) information with 

respect to the issuer, including financial statements (3 years), subject to scaling for smaller 

reporting companies and emerging growth companies, and selected financial data; the 

management’s discussion and analysis of financial condition and results of operations; 

description of the issuer and its business; material legal proceedings; description of properties; 

identification of directors and executive officers; executive compensation and corporate 

governance; security ownership of certain beneficial owners and management; and transactions 

with related persons, promoters, and certain control persons; (ii) description of the securities to 

be registered; (iii) risk factors relating to the issuer and the offering; (iv) dilution; (v) use of 

proceeds; (vi) a plan of distribution; (vii) the manner of determining the offering price; and 

(vii) the interests of named experts and counsel. In addition to the specific line items, the 

prospectus and registration statement must include “such further material information, if any, as 

may be necessary to make the required statements, in the light of the circumstances under 

which they are made, not misleading.” 

A registration statement must also include certain information that is not required to be 

contained in a prospectus, such as detailed expenses of the offering and information about the 

issuer’s indemnification policies and disclosure regarding recent sales of unregistered securities. 

In addition, the exhibits must include various documents such as the underwriting agreement, 
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the issuer’s certificate of incorporation and bylaws, legal opinions, and material contracts. 

Presentation of information 

The SEC’s rules under the Securities Act allow for different methods to present information in the 

prospectus, depending on the characteristics of the issuer and the offering transaction. In most 

IPOs, all information must be directly presented in the prospectus. For other types of 

transactions, an issuer may be permitted to use “incorporation by reference,” under which a 

prospectus refers to past or future reports that are filed under the Exchange Act. 

Shelf registration 

Shelf registration is available to eligible issuers, whereby they can register their securities up to 

three years in advance of the offering. They initially file a short registration statement that may 

be reviewed by the SEC staff unless the issuer files an automatically effective shelf registration 

statement which is available to certain larger issuers. Once it becomes effective, the issuer files a

prospectus supplement for each offering with no additional action required by the SEC for the 

offering to become effective. 

Distribution of prospectus 

The Securities Act requires delivery of a prospectus meeting specified requirements under the 

Securities Act, known as a “final prospectus,” to each investor in a registered offering. Under 

current rules (updated in 2005) which are based on an “access equals delivery” model, investors 

are presumed to have access to the Internet, and issuers and intermediaries can satisfy their 

delivery requirements if the documents are posted to a website. In an IPO, Rule 15c2-8 under 

the Exchange Act requires a broker or dealer to deliver a preliminary prospectus to investors at 

least 48 hours before the confirmation of the sale of the securities is sent. 

Periodic requirements 

The following issuers are subject to the periodic reporting requirements of the Exchange Act: 

Issuers that want to list on a national securities exchange (Section 12(b) of the Exchange Act). 

Issuers with registered offerings unless they satisfy one of the following "thresholds," in which 

case their filing obligations are suspended after the initial filing year: (i) the company has fewer 

than 300 shareholders of record of the class of shares offered (1,200 shareholders of record if the 

company is a bank or bank holding company). SEC staff indicated that in the case of banks and 

bank holding companies, 96 bank holding companies elected to suspend obligations. Currently 

there are roughly 500 reporting banks, but approximately 150 meet the criteria to suspend 

reporting. 

Non-Listed Companies: U.S. issuers which, on the last day of their fiscal year, have more than $10 

million in total assets and a class of equity securities held by either (i) 2,000 or more record 

holders; or (ii) 500 or more record holders who are not accredited investors must register that 

class of securities. For banks or bank holding companies, the requirement applies if the company 

has more than $10 million in total assets and a class of equity securities held by 2,000 or more 

record holders (Section 12(g) Exchange Act). These are generally smaller issuers that trade in the 

OTC markets. According to market participants, the majority of trading is from retail investors. 

Annual reports 

Reporting issuers must file annual reports on Form 10-K. The annual report requires disclosure 

about the company in all of the same areas, and addresses the same topics, as is required in a 

prospectus for an IPO under the Securities Act, other than offering-related information. 

The financial statements required to be included in the annual report include three years of 
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statements of income, cash flow, and changes in shareholders’ equity, two years of balance 

sheets, and a discussion of subsequent events. The issuer must present the information on a 

consolidated basis and provide comprehensive footnote disclosure. The financial statements 

must be audited by an independent public accountant registered with the PCAOB. In addition, 

pursuant to SOX 404 the annual audited financial statements for issuers with a public float of 

$75 million or more must be accompanied by an attestation of the auditor regarding the 

effectiveness of the internal controls for financial reporting. 

The MD&A must accompany the financial statements. The MD&A addresses the financial 

condition, results of operations, liquidity and capital resources as well as events and 

uncertainties known to the issuer’s management that may cause the reported results not to be 

indicative of future financial performance. This disclosure also includes off-balance sheet 

disclosures and contractual obligations. 

Large accelerated filers must file annual reports within 60 days, accelerated filers within 75 days 

and all other U.S. filers within 90 days of the fiscal year-end covered by the report. 

Quarterly reports 

Issuers must also file quarterly reports for the first three fiscal quarters on Form 10-Q. They must 

describe their financial condition and results of operations for the preceding fiscal quarter and 

the corresponding period from the prior fiscal year and also include condensed financial 

statements. 

The financial statements in quarterly reports include balance sheets as of the close of the quarter 

and the comparable quarter of the preceding year, comparative statements of operations for the 

quarter and for the beginning of the year through quarter-end and comparative statements of 

cash flow from the beginning of the year through quarter-end. These financial statements are 

not required to be audited; however, they are required to be reviewed by an independent public 

accountant. Financial statements in quarterly reports also are required to be accompanied by an 

MD&A. 

The requirements for quarterly reports with respect to non-financial statement and related 

information are not as extensive and do not require updating of all information required in the 

annual report. 

Large accelerated filers and accelerated filers must file a quarterly report within 40 days and all 

other domestic filers within 45 days after the end of the fiscal quarter covered by the report. 

SOX reports 

Section 302 of the Sarbanes-Oxley Act (SOX) and corresponding SEC Rules 13a-14(a) and 15d14(a) require issuers’ principal executive officer(s) and principal financial officer(s) to certify in 

each quarterly and annual report that the reports fairly represent the financial condition and 

results of operation of the issuer, as well as certify on the effectiveness of financial reporting 

controls. Section 906 of SOX requires that each periodic report be also accompanied by a 

certification by the same officers that the report fairly presents, in all material respects, the 

financial condition and results of operations of the issuer. A person who certifies any statement 

knowing that the report does not comply with the requirements set forth in SOX is subject to 

criminal sanctions ranging from fines to imprisonment. 

Material events 

Domestic issuers must file current reports on Form 8-K upon the occurrence of a set of 

enumerated events. This is an “exhaustive” list of events (expanded by the SEC in 2004 as a result 

of SOX). These reports must be filed within 4 business days. In addition, each registered 
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securities exchange generally requires its listed companies to (i) timely disclose information that 

may affect security values or influence investment decisions; and (ii) timely provide the exchange 

with other information in order to maintain an orderly market in the company’s securities. (See 

for example 202.05 of the Listed Company Manual of the NYSE and Nasdaq Rule 5250(b)(1)). As 

a result of these obligations, in practice the communication of material events by listed issuers 

usually takes place on shorter deadlines than the 4 business days required under the SEC 

framework. 

Selective disclosure 

Regulation FD requires a reporting issuer to make simultaneous or prompt public disclosure, 

depending on whether the disclosure was intentional, when it discloses material nonpublic 

information to certain individuals or entities (generally, securities market professionals, such as 

stock analysts or holders of the issuer’s securities who may trade on the basis of the 

information). Regulation FD defines public disclosure as furnishing or filing a Form 8-K, or 

disseminating the information through another method that is reasonably designed to provide 

broad, non-exclusionary distribution of information to the public. 

Shareholder’s voting decisions 

Any solicitation of a proxy with respect to an equity security registered under Section 12 of the 

Exchange Act must comply with the proxy rules under Regulation 14A of the Exchange Act. 

These rules require that a proxy statement contain specific disclosures, including material 

information about the matters that will be voted on, and that the proxy statement be delivered 

to shareholders that are being asked to vote on those matters. 

Scaled disclosure 

The SEC rules allow certain type of companies to “scale” their disclosure. These companies fall 

under two categories: 

Smaller reporting companies, which are companies with public equity float of less than $75 

million or less than $50 million in annual revenue, and 

Emerging growth companies (created under the JOBS Act), which are companies with gross 

revenues of less than $1 billion during their most recently completed fiscal year. 

Overall, under the current framework such companies are allowed to include less extensive 

narrative in their disclosure documents, in particular in connection with compensation, include 

financial statements for two years only, and are not subject to the auditor attestation of internal 

control over financial reporting required by SOX. 

Asset-backed securities 

Disclosure requirements for ABS, both arising from the Securities Act and the Exchange Act, are 

contained in Regulation AB, which the SEC initially adopted in 2004. In August 2014, the SEC 

adopted significant revisions to Regulation AB and other rules regarding the offering process, 

disclosure, and reporting for ABS as described in Principle 8. In addition, in 2011, the SEC 

adopted several rules to implement provisions of the Dodd-Frank Act governing the disclosure 

for ABS, including requiring disclosure of fulfilled and unfulfilled repurchase requests, requiring 

issuers to review the assets underlying the ABS, and providing for the suspension of the duty to 

file reports under Section 15(d) of the Exchange Act. 

Prospectus requirements 

The prospectus for ABS must include information on the following areas: (i) disclosure about the 

transaction parties; (ii) static pool information (to the extent material); (iii) pool assets; (iv) review 
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of assets (the review must be designed and effected to provide reasonable assurance that the 

prospectus disclosure about the assets is accurate in all material respects. Disclosure about the 

nature of the review and the findings and conclusions of the review is required to be provided in 

the prospectus. ABS issuers must also provide disclosure in the prospectus about any assets in 

the pool that deviate from the disclosed underwriting criteria, including data on the amount and 

characteristics of those assets that did not meet the disclosed underwriting criteria); (v) 

information on significant obligors; (vi) description of the securities and structure of the 

transaction; (vii) credit enhancements; (viii) use of derivative instruments; (ix) reports and 

additional information; and (x) other disclosure items. In addition to the disclosure items 

discussed above, the SEC’s rules also require disclosure of, among other things, the most 

significant risk factors that make the ABS offering speculative and risky and how those risks 

affect investors, including tailored disclosure if certain risks affect only certain classes of 

investors. 

Periodic reporting 

ABS are subject to periodic reporting under the Exchange Act in two circumstances: 

If ABS are to be listed on a national securities exchange (registered under Section 12 of the 

Exchange Act); and 

If ABS are not going to be listed on a national securities exchange, an offering of ABS that has 

been registered under the Securities Act triggers a reporting obligation until the securities 

registered are no longer held by non-affiliates of the depositor (i.e. the issuer is subject to 

ongoing periodic obligations as long as the securities are held by non-affiliates) (pursuant to 

Section 15(d) of the Exchange Act). 

Annual reports 

ABS issuers must file an annual report on Form 10-K with modified requirements. In lieu of 

audited financial statements, the issuing entity must file as exhibits to the Form 10-K: (i) a report 

on assessment of compliance with the required servicing criteria from each party participating in 

the servicing function; and (ii) an attestation report from a registered public accounting firm 

about the servicer’s assessment of compliance with the required servicing criteria. A servicer 

compliance statement must also be filed as an exhibit to the Form 10-K, which addresses the 

servicer’s compliance with its obligations under the servicing agreement for that particular ABS 

transaction. Similar to operating companies, ABS issuers must include a certification pursuant to 

Section 302 of SOX with their annual report on Form 10-K. The annual report for asset-backed 

transactions must be filed within 90 days after the end of the fiscal year covered by the report. 

Quarterly reports 

In lieu of quarterly reports, an ABS issuer is required to file reports on Form 10-D containing 

periodic distribution and pool performance information for each distribution period. 

Additionally, certain non-financial disclosures, such as legal proceedings and matters submitted 

to a vote of security holders that occurred during the period are also required to be included in 

the Form 10-D. The Form 10-D must be filed within 15 days after each required distribution date 

of the ABS. 

Material events 

ABS issuers must file current reports on Form 8-K upon the occurrence of enumerated events as 

set forth for other reporting issuers. 
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Foreign issuers 

There are approximately 940 foreign private issuers that have registered a class of securities or a 

transaction and file reports with the SEC under the Exchange Act. 

The SEC has in place a separate disclosure regime specifically tailored to foreign private issuers 

which differ from those for U.S. issuers in the following ways: 

Foreign private issuers may present their financial statements in accordance with (i) U.S. GAAP; 

(ii) another comprehensive body of accounting standards reconciled to U.S. GAAP; or (iii) IFRS as 

issued by the IASB without reconciliation to U.S. GAAP. 

Foreign private issuers are permitted to follow home country requirements for disclosure of 

executive compensation. 

Foreign private issuers are required to file annual reports within four months of the fiscal year 

end 

Foreign private issuers are not subject to the quarterly reporting requirements of the Exchange 

Act 

Foreign private issuers are not subject to Regulation FD; 

Foreign private issuers are exempt from the requirements to file proxy or information statements 

under the Exchange Act; and 

Foreign private issuers’ securities are exempt from Section 16 of the Exchange Act, which 

requires insiders and substantial holdings disclosure. 

SEC staff indicated that the majority of foreign registered issuers are also listed on a national 

securities exchange. As a result they are subject to additional disclosure requirements as 

imposed by the listing requirements of the respective exchange. For example, the exchanges 

require at least semiannual reporting. An interim balance sheet and income statement must be 

provided as of the end of the company's second quarter not later than six months following the 

end of the second quarter, in English, but they do not have to be reconciled to U.S. GAAP. 

Further, as the U.S. market practice dictates quarterly statements, foreign issuers also routinely 

provide them. 

Advertisements 

Since 2005 when the corresponding rules were amended, SEC rules allow issuers to 

communicate more openly and freely with investors and the marketplace. Under SEC rules: 

The largest publicly traded companies (e.g., those with a public float in excess of $700 million, 

among other criteria) are permitted to engage at any time in oral and written offering 

communications, subject to enumerated conditions (including, in specified cases, filing the 

communications with the SEC); 

All reporting issuers are permitted, at any time, to continue to publish regularly released factual 

business information and forward-looking information; 

Communications by issuers more than 30 days before filing a registration statement are 

permitted so long as they do not reference a securities offering that is or will be the subject of a 

registration statement; 

All eligible issuers and offering participants in eligible issuer offerings are permitted to use “free 

writing prospectuses” (written offering materials that may not contain all of the information 

contained or required in a statutory prospectus) generally after the filing of the registration 
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statement, subject to enumerated conditions (including, in specified cases, filing with the SEC); 

A broader category of routine communications regarding issuers, offerings, and procedural 

matters, such as communications about the schedule for an offering or about account-opening 

procedures, are excluded from the definition of prospectus; and 

Exemptions for research reports were expanded. 

Most of these rules are not available to blank check companies, penny stock issuers, or shell 

companies. 

Sufficiency of information 

There are several measures available to the SEC that support and promote robust issuers’ 

disclosure, including: 

Staff’s filing review process: The Securities Act does not specifically provide for the SEC staff to 

review or clear prospectuses in connection with public offerings of securities. However, the staff 

has assumed a selective review function for registration statements and prospectuses under the 

Securities Act as a result of the statutory framework under the Securities Act; in particular due to 

provisions that require that the registration statement be in effect (Section 5); that state that a 

registration statement becomes effective 20 days after filing but allows the SEC to accelerate the 

effectiveness date (Section 8), and stop order suspending the effectiveness (Section 8); 

Required certifications relating to the content of disclosure (such as the SOX certifications 

explained above) or to the eligibility to use scaled disclosure; 

Loss of certain benefits if disclosure obligations are not met in a consistent and timely manner: 

Certain rules and benefits only apply to specific categories of issuers (such as scaled disclosure 

or use of shelf registration). Breach of obligations would prompt the loss of such benefits; 

A registration statement stop order, investigation, or enforcement action concerning violations 

of the disclosure requirements. Pursuant to Section 8 of the Securities Act, the SEC may at any 

time issue an order preventing or suspending the effectiveness of a registration statement if it 

has reason to believe that such registration statement includes any untrue statement of a 

material fact or omits to state any material fact required to be stated therein or necessary to 

make the statements therein, in the light of the circumstances under which such prospectus is or 

is to be used, not misleading. Pursuant to Section 12(j) of the Exchange Act, the SEC is 

authorized to deny, to suspend the effective date of, to suspend for a period not exceeding 12 

months, or to revoke the registration of a security, if the SEC finds that the issuer has failed to 

comply with any provision of the Exchange Act or the rules and regulations thereunder. As a 

result, no member of a national securities exchange, broker, or dealer may effect any transaction 

in, or induce the purchase or sale of, any security where the registration of that security has been 

and is suspended or revoked. 

Liability 

The Securities Act provides for rights of action against persons who sold or are involved in the 

sale of securities in an offering. 

Section 11 of the Securities Act: a private action in connection with material misstatements or 

omissions in a registration statement against (i) the issuer; (ii) each of its directors; (iii) each 

underwriter; (iv) each person signing the registration statement, which includes the issuer’s 

principal executive officer, its principal financial officer, and its principal accounting officer; (v) 

the independent accountant with respect to audited financial statements; and (vi) each expert 

with respect to information included in the registration statement in reliance upon the expert. All 
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persons other than the issuer are entitled to certain due diligence defenses; 

Section 12 of the Securities Act: private action against any person who offers or sells a security 

by means of a prospectus or oral communication in connection with material misstatements or 

omissions. An ordinary negligence standard applies and the seller is also entitled to assert a due 

diligence defense in order to demonstrate that, after reasonable investigation, it had reasonable 

grounds to believe that the matters in question were true; 

Section 17(a) of the Securities Act: general anti-fraud provision, enforceable by the SEC that 

imposes liability upon any person who commits fraud in connection with the offer or sale of 

securities; and 

Since Exchange Act filings are often incorporated by reference into Securities Act filings, issuers 

may also be liable under Section 10(b), Rule 10b-5, and Section 18 of the Exchange Act. 

Market participants commented that there is an active exercise of private rights of action and 

the resulting market discipline effects are significant. 

Derogations from full disclosure 

The SEC may grant an issuer’s request for confidential treatment of information included in a 

document file as an exhibit provided the subject information is filed with the SEC for review on a 

nonpublic basis and the information meets the legal test for exclusion under the FOIA. Often, 

issuers applying for confidential treatment in connection with filings rely on the FOIA exemption 

that covers “trade secrets and commercial or financial information obtained from a person and 

that is privileged or confidential”. In practice, these requests usually relate to limited information 

in the material contracts that the issuer must file. Similar to the selective review process for 

registration statements, the SEC staff will undertake a preliminary review of a confidential 

treatment application to determine whether it will receive a full review, a targeted issue review, 

or a no review. Following the resolution of any comments and the completion of the staff’s 

review, the staff will publicly grant an order for the confidential treatment of the redacted 

information, if appropriate. 

The SEC has authority to issue an order under Section 12(k) of the Exchange Act temporarily 

suspending trading in an issuer’s security for a period of up to ten business days. The exchanges 

have adopted rules relating to the temporary suspension of trading of listed securities in certain 

circumstances relating to the pending announcement of material information (See for example 

Rules 202.06(B) and 202.07 of the NYSE Listed Company Manual). 

Availability of information 

The SEC’s website provides public access to the EDGAR system. EDGAR provides free electronic 

access to the information that companies that have offerings or securities registered with the 

SEC file in disclosure documents. 

Practice 

Monitoring program 

Monitoring of issuers’ disclosure obligations under the Securities Act and the Exchange Act is a 

responsibility of SEC’s CF, which is comprised of roughly 500 staff. CF performs its review 

responsibilities through 12 offices organized by industry. These offices comprise approximately 

80 percent of CF’s employees. Each office is staffed with 25 to 35 professionals, primarily 

accountants and lawyers. These offices are complemented by three specialized offices (created 

in 2010) that focus on large financial institutions, asset-backed securities and other structured 

products, and securities offering trends (mainly innovative products). CF assigns filings by 
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companies to the review office responsible for the company’s particular industry. 

As required by Section 408 of SOX, CF undertakes some level of review of the periodic reports 

made under Section 13(a) of the Exchange Act of each reporting company at least once every 

three years. In addition, CF selectively reviews transactional filings – documents companies file 

when they engage in public offerings, business combination transactions, and proxy 

solicitations. CF staff indicated that in its filing reviews, CF concentrates its review resources on 

critical disclosures that appear to conflict with the SEC’s rules or the applicable accounting 

standards and on disclosure that appears to be materially deficient in explanation or clarity. 

The level of review varies from (i) a full cover-to-cover review to review compliance; (ii) a 

financial statement review in which the staff will examine the financial statements and related 

disclosure, such as the MD&A of Financial Condition and Results of Operations, for compliance 

with the applicable accounting standards and the disclosure requirements of the U.S. federal 

securities laws and regulations; or (iii) a targeted issue review in which the staff will examine the 

filing for one or more specific items of disclosure for compliance with the applicable accounting 

standards and/or the disclosure requirements of the U.S. federal securities laws and regulations. 

CF establishes review goals for each year. In general, the CF review focuses on the companies 

that comprise the majority of market capitalization (roughly 2,500 companies account for 98 

percent of market capitalization), but other criteria might also trigger a review. In the past fiscal 

years, CF reviewed the following percentage of companies: (i) FY 2013 52 percent; (ii) FY 2012 48 

percent; (iii) FY 2011 48 percent; (iv) FY 2010 44 percent; and (v) FY 2009 40 percent. 

In general, reviews require that four people review the filing. In issuing comments to an issuer, 

the staff may request that a company provide additional supplemental information so the staff 

can better understand the company’s disclosure. The staff may also request that the issuer revise 

disclosure in a document on file with the SEC, provide additional disclosure in a document on 

file with the SEC, or provide additional or different disclosure in a future filing with the SEC. 

When a company has resolved all comments from CF on an Exchange Act registration statement, 

a periodic or current report, or a preliminary proxy statement, CF provides the company with a 

“no further comment” letter to confirm that its review of the filing is complete. 

Comment letters and company responses to those comment letters are published on the SEC’s 

EDGAR system no earlier than 20 business days after CF has completed its review of a periodic 

or current report or declared a registration statement effective. CF includes the “no further 

comment” letter in this public posting of correspondence. CF staff indicated that accounting and 

law firms prepare summaries of SEC comment letters. 

For Securities Act transactional filings, the staff seeks to provide initial comments on filings 

selected for review within 30 days of the filing date. The target of 30 days or less has become a 

de facto industry expectation for the maximum time to receive initial comments from CF on 

Securities Act transactional filings. There is no comparable target for Exchange Act filings. 

The Office of Disclosure Standards was created in 2013 to evaluate the outcomes of CF’s filing 

review program and create a self-assessment structure. This office has roughly 15 staff. The 

office provides comments and recommendations to CF in connection with its reviews (for 

example highlighting inconsistencies). 

CF staff also indicated that the SEC is currently engaged in a comprehensive review of disclosure 

requirements with a view to assessing the effectiveness of current requirements, and eliminating 

potential duplications. 

Enforcement 

The SEC has instituted a Delinquent Filings Program, whereby the SEC’s Division of Enforcement 
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conducts investigations into possible violations of the U.S. federal securities laws for failing to 

make required filings with the SEC, as well as corporate insiders who fail to file the appropriate 

forms with the SEC regarding their personal securities trades, and prosecutes civil actions and 

administrative proceedings in this area. 

In addition, several initiatives within the enforcement division contribute to SEC’s program to 

monitor issuers’ compliance with their disclosure obligations. In particular, the Enforcement 

Division has recently created the Financial Reporting and Audit Task Force, which focuses on 

financial reporting and accounting fraud (further explained in Principle 18). 

The SEC has also constituted a Microcap Fraud Task Force which closely monitors and pursues 

misconduct related to microcap securities. Abuses in this area frequently involve entities that use 

false or misleading marketing campaigns and manipulative trading strategies, largely at the 

expense of less sophisticated, retail investors. The Task Force engages in initiatives that target 

executives, gatekeepers, and other repeat players who help facilitate these schemes. The Task 

Force also aims to identify and shut down schemes in their early stages in order to halt 

misconduct and mitigate investor harm. 

Finally the Cross-Border Working Group continues to focus on companies with substantial 

foreign operations that are publicly traded in the U.S. To date, the SEC has filed fraud cases 

against more than 65 foreign issuers or executives and deregistered the securities of more than 

50 companies. 

Municipal securities 

Municipal securities are an important component of the U.S. securities markets. The outstanding 

amount of municipal securities as of 2014 was roughly US$ 3.7 trillion, with roughly 45,000 

different municipalities issuing debt, and approximately 12,000 bond issues on an annual basis 

with an issue size of an average of US$25 million. Retail investors account for a significant 

portion of this market. Direct retail holdings are estimated at roughly 45-50 percent of total 

outstanding debt, and indirect holdings (through CIS) at about 25 percent. Historical rates of 

default have been low (less than 1 percent compared to 11-13 percent for issuers of corporate 

debt, although the rate of default for non-municipal conduit issuers has been higher). 

Municipal securities (which definition includes obligations of non-municipal conduit borrowers) 

are exempted from the registration and reporting requirements established by the Securities Act 

and the Exchange Act. In addition, the “Tower Amendment” to the Exchange Act prohibits the 

SEC and the MSRB from requiring state and local government issuers of municipal securities, 

either directly or indirectly through their underwriters, to make any specific disclosure filing with 

the SEC or MSRB prior to the sale of these securities. However, the antifraud provisions of 

Section 17(a) of the Securities Act, Section 10(b) of the Exchange Act, and Rule 10b-5 

promulgated thereunder apply to transactions in municipal securities. 

While federal regulators are prohibited from directly requiring issuers to file presale information 

on municipal securities, the SEC has adopted rules—applicable to BDs acting as underwriters—

that relate to primary market and continuing disclosures. Using its authority over BDs and its 

broad authority to prevent fraud in connection with the offer, purchase, or sale of securities, the 

SEC adopted Rule 15c2-12 in 1989. This rule and its accompanying guidance require 

underwriters of municipal securities to obtain and review issuers’ official statements and provide 

them to investors. In addition, the rule was amended in 1995 to require underwriters to 

reasonably determine that issuers have entered into a written continuing disclosure agreement 

for the benefit of municipal securities holders to provide (i) annual financial information and 

operating data of the type included in the official statement and, if available, audited financial 

statements; and (ii) notices of certain material events. Beginning in 2009, issuers have been 
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required by the agreements to provide the continuing disclosure information and data to the 

Electronic Municipal Market Access (EMMA) database held by the MSRB (either directly or by 

engaging a third-party dissemination agent to submit such information and data on their 

behalf). 

The GAO issued reports on the municipal market in 2011 and 2012 and the SEC issued a report 

on the municipal market in 2012. These reports found significant challenges in the quality, 

consistency and timeliness of disclosure by municipal issuers as well as with the mechanisms 

available to participants to enforce compliance with contractual obligations related to disclosure. 

The SEC report provided a number of recommendations for consideration. Such 

recommendations included legislative proposals to provide the SEC with additional authority to 

impose disclosure requirements on municipal issuers, as well as proposals for actions within the 

current scope of the authority of the SEC. 

The SEC recently created the Office of Municipal Securities to coordinate its municipal securities 

activities. The Office works closely with the municipal securities industry to educate state and 

local officials and conduit borrowers about risk management issues and foster a thorough 

understanding of the SEC’s policies. It also reviews and processes MSRB rule filings and acts as 

the Commission's liaison with the MSRB, FINRA, and a variety of industry groups on municipal 

securities issues. 

On the enforcement side, the Division of Enforcement created the Municipal Securities and 

Public Pensions Unit (MSPPU) in 2010 to focus on the SEC’s enforcement efforts to police 

misconduct in the municipal securities market and in connection with pension funds for state 

and local government employees. The MSPPU has brought several high profile enforcement 

actions including the following recent examples. The SEC brought the first case charging a 

municipal issuer with falsely stating to bond investors that it had been providing the required 

annual financial information and notices in its prior bond offerings. The SEC also brought the 

first case against an underwriter charging it with violations of the MSRB’s pay-to-play rule for 

“in-kind” political donations. 

Additionally, the MSPPU recently launched a novel cooperation initiative - the Municipalities 

Continuing Disclosure Cooperation Initiative - to encourage issuers and underwriters who have 

conducted offerings that have included false representations as to prior compliance with Rule 

15c2-12 filing requirements to self-report those violations in exchange for favorable settlement 

terms. 

Assessment Broadly Implemented 

Comments The main reason for the grade relates to the disclosure regime applicable to the offerings of 

municipal securities. 

In general, the U.S. legal and regulatory framework subject issuers of securities that are offered 

to the public to robust disclosure requirements at the moment of the offering and on an 

ongoing basis. However, the current framework exempts municipal securities from the 

registration and reporting requirements of the Securities Act and the Exchange Act. Through 

indirect mechanisms, municipal issuers that want to offer their securities to the public have been 

subject to disclosure obligations at the moment of the offering as well as on an ongoing basis. 

However, on the basis of the GAO and SEC reports and conversations with market participants 

and SEC senior staff, the assessors concluded that these indirect mechanisms have been 

insufficient to ensure the consistency and quality of the information provided (including the 

accounting principles used) or consistency in the timeliness with which such information is 

provided to investors. 

The assessors acknowledge that the SEC has made municipal securities a key area of focus of its 
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enforcement program through the creation of the MSPPU. However, the MSPPU is of recent 

creation and it is therefore too early to assess whether an increased focus on enforcement by 

itself, without any other direct authority of the SEC, can bring the disclosure by issuers of 

municipal securities to a satisfactory level. The municipal securities market has a significant level 

of retail participation. Although historical rates of default have been low, these securities are 

exposed to default risk. This legal gap in statutory authority has therefore affected the grade. 

In addition, the assessors considered the current thresholds for suspension of reporting 

obligations. The assessors consider that an approach that links periodic reporting obligations to 

a minimum level of dispersion of a company's securities seems reasonable; however the current 

thresholds –established by law—appear high, therefore leaving shareholders of companies with 

an already high level of dispersion without the benefit of periodic information. This applies 

especially to banks and bank holding companies. 

Two more issues deserve comment, although they were not taken into consideration for the 

grade. 

First, the assessors note that the obligations to disclose material events imposed by the SEC 

rules are limited to a list of predefined events. In practice this means that there could potentially 

be material events that would not be communicated to the market until in the quarterly reports. 

In addition, the deadline to communicate material events included in the list appears long 

compared with international best practices. However, the exchanges do impose on listed 

companies a general obligation to disclose events that can affect the price of securities on a 

prompt basis, which is understood to mean immediate release. Given that the majority of issuers 

of registered securities are listed, this issue has not been considered for the grade. 

Second, foreign issuers are not subject to periodic reporting other than an annual report, and 

thus the regime does not appear to provide a similar level of disclosure as provided by domestic 

issuers. Nevertheless, the assessors note that these issuers are generally listed and thus through 

their listing they are subject to stronger disclosure obligations. 

Principle 17. Holders of securities in a company should be treated in a fair and equitable manner. 

Description Background 

Shareholders rights and corporate governance are governed by 

State corporate law: formation and incorporation of companies, and the terms of governance 

among shareholders, the board of directors, and management; 

Corporate chartering documents: State corporate law allows the basic chartering documents of a 

corporation to provide for different rights than may be set out under the statutory provisions 

(the Delaware Corporate Law is the most relevant from the securities markets perspective as it is 

a preferred place of incorporation for the majority of corporations); 

Federal securities laws: The Securities Act and the Exchange Act regulate offerings and sales of 

securities and on-going disclosure by public company issuers. The Exchange Act also regulates 

the process by which public companies solicit proxies in connection with shareholder meetings; 

and 

Exchange rules: The corporate governance listing requirements of several stock exchanges, 

including the NYSE and NASDAQ, the principal markets in the United States, are broadly similar, 

but they do vary in some respects. 

Voting 

State corporate laws cover basic provisions in connection with shareholders’ voting rights 
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including: 

The right of shareholders to vote under the principle of one share one vote unless otherwise 

provided in the certificate of incorporation (DGCL 212(a)); 

The right of the corporation to provide for different voting rights to be conferred on 

stockholders by issuing more than one class or series of stock with voting powers as stated in 

the certificate of incorporation (DGCL Section 151); 

The right of shareholders entitled to vote at a meeting of stockholders or to express consent or 

dissent to corporate actions in writing without a meeting to authorize another person to act for 

such stockholder by proxy (DGCL Section 212(b)); 

The need for written notice not less than 10 and not more than 60 days before the day of the 

meeting (DGCL Section 222); and 

The way to fix the record date for determining stockholders (Section 213). Further, the record 

date must not be more than 60 or less than ten days before the date of the meeting. If the 

meeting is adjourned, the board may fix a new record date as long as the same 60 day/ten day 

notice provisions required for an initial meeting date are observed. 

Federal securities laws complement the above framework, in particular in connection with proxy 

voting. Federal securities laws require disclosure of matters to be voted upon in the form of a 

proxy statement for a stockholders’ meeting pursuant to Schedule 14A under the Exchange Act 

or an information statement relating to action taken in connection with or in lieu of a 

stockholders’ meeting pursuant to Schedule 14C under the Exchange Act. 

Pursuant to Schedule 14A, a proxy statement must set forth the date, time, and place of the 

stockholders meeting as well as the record date for determining eligibility to vote. Schedule 14A 

requires disclosure of the manner by which stockholders may exercise their votes, the voting 

powers designated to each class or series of stock, and the availability and effect of cumulative 

voting (if any). In the case of Schedule 14C, if matters are to be acted upon in lieu of a 

stockholders’ meeting or without a vote at a meeting, information must be furnished with 

respect to all of the items contained in Schedule 14A that would be applicable to any matter to 

be acted upon at the meeting if proxies were to be solicited in connection with the meeting. 

Federal securities laws also contain other requirements relating to the efficient distribution of 

proxies and information statements to beneficial owners. Domestic issuers have an obligation 

under the proxy rules to distribute proxy and other soliciting material to banks and brokers on a 

timely basis to be forwarded to beneficial owners. 

Exchange rules complement these obligations in several areas, such as: 

Notice of meetings: Section 401.01 of the Listed Company Manual of the NYSE requires a 

company to provide immediate publicity for a shareholders’ meeting where any matter affecting 

the rights or privileges of shareholders or any other matter not of a routine nature is to be 

considered; 

Notice to exchanges: Section 401.02 of the NYSE Listed Company Manual requires a company to 

notify the exchange a minimum of ten days prior to the record date of any stockholders meeting 

called. Nasdaq does not require the notice if a proxy statement is filed via EDGAR; 

Time of meetings: Although there is no exchange rule addressing the interval between record 

and meeting dates, the NYSE recommends that a minimum of 30 days be allowed so as to 

provide ample time for the solicitation of proxies, as explicitly stated in Section 401.03 of its 

Listed Company Manual; 
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Proxy voting: Section 402.04 of the Listed Company Manual of the NYSE and Section 5620 of the 

NASDAQ Listing Rules require companies to solicit proxies for all meetings from all stockholders 

whether registered or beneficial owners; and 

Rights of shareholders: Section 313.00 of the Listed Company Manual of the NYSE and Section 

5640 of the NASDAQ Listing Rules provide that the voting rights of existing shareholders cannot 

be disparately reduced or restricted through any corporate action or issuance. Examples of such 

corporate action or issuance include, but are not limited to, the adoption of time-phased voting 

plans, the adoption of capped voting rights plans, the issuance of super-voting stock, or the 

issuance of stock with voting rights less than the per share voting rights of the existing common 

stock through an exchange offer. The restriction against the issuance of super voting stock is 

primarily intended to apply to the issuance of a new class of stock, and companies with existing 

dual class capital structures would generally be permitted to issue additional shares of the 

existing super voting stock without conflict with this policy. 

Election of directors 

State corporate laws require an annual meeting of stockholders for the election of directors 

(DGCL Section 211(b)). Pursuant to DGCL Section 214, cumulative voting is possible if provided 

for in a company’s certificate of incorporation. 

Corporate changes affecting the terms and conditions of securities 

There are specific state law requirements concerning changes in the certificate of incorporation 

that would (i) increase or decrease the authorized capital or reclassify it; (ii) cancel or affect 

rights of shareholders; or (iii) create new classes of stocks (DGCL Section 242(a)). In general, such 

changes require the company’s board to adopt a resolution setting forth the amendment 

proposed, declaring its advisability, and either calling a special meeting or directing that the 

amendment proposed be considered at the next annual meeting. The proposed amendment(s) 

become effective only if a majority of the outstanding stock entitled to vote and a majority of 

the outstanding stock of each class entitled to vote thereon as a class, vote in favor of the 

amendment(s). 

Exchange rules also impose requirements relating to voting decisions affecting the terms and 

conditions of securities. For example, Section 204.13 of the Listed Company Manual of the NYSE 

requires a company to give at least 20 days’ advance notice with respect to any proposed 

changes in the form or nature of listed securities or in the rights or privileges attached to such 

securities. These changes will require the filing of a listing application. Section 312.03 of the 

Listed Company Manual of the NYSE requires shareholder approval of (i) issuances that will 

result in common stock with voting power equal to or in excess of 20 percent; (ii) issuances in a 

change of control of the issuer; (iii) issuance of securities in an equity compensation plan; or 

(iv) the issuance of common stock in transaction(s) with related parties if the number of shares 

to be issued or converted exceeds either 1 percent of the number of shares of common stock or 

1 percent of the voting power outstanding before the issuance. Likewise, Section 5635 of the 

NASDAQ Listing Rules requires shareholder approval under similar circumstances. 

Other fundamental corporate changes 

Mergers and consolidations 

Under DGCL Section 251, the company’s board of directors must adopt a resolution stating their 

advice regarding the proposed merger or consolidation, and then either call a special meeting of

the stockholders entitled to vote on such amendment or directing that the amendment 

proposed be considered at the next annual meeting of the stockholders at least 20 days prior to 

the date of the meeting. The notice must contain a copy of the agreement or a brief summary 
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INTERNATIONAL MONETARY FUND 117

thereof. Adoption of the merger or consolidation generally requires the approval of 

shareholders holding a majority of the outstanding stock of the corporation entitled to vote 

upon such matters. There are limited exceptions to the requirement of a vote. 

Transfer of assets 

Pursuant to DGCL Section 271(a), a corporation may sell, lease or exchange all or substantially all 

of its property and assets. Such action may be taken only if its board of directors deems it to be 

expedient and for the best interests of the corporation, shareholders holding a majority of the 

outstanding stock of the corporation entitled to vote thereon adopt a resolution to such effect 

at a meeting called upon at least 20 days’ notice, and the notice of such meeting states that 

such a resolution will be considered. 

Appraisal rights 

Pursuant to DGCL Section 262(c), any corporation may provide in its certificate of incorporation 

for appraisal rights 12 for any class or series of its stock as a result of an amendment to its 

certificate of incorporation, any merger or consolidation, or the sale of all or substantially all of 

the assets of the corporation. Even in the absence of such a provision, DGCL Section 262(b) also 

confers appraisal rights upon stockholders if they are required in the merger to accept cash or 

certain other consideration for their shares. 

Dissolution 

Pursuant to DGCL Section 275(a), a corporation may dissolve if it is deemed advisable in the 

judgment of the board and shareholders holding a majority of the outstanding stock of the 

corporation entitled to vote thereon adopt a resolution to such effect at a meeting called for 

that purpose. 

Transactions involving a tender offer

Federal securities laws or the SEC’s rules do not contain a specific definition of tender offer. The 

determination of whether a particular course of conduct is a tender offer is important because 

transactions that constitute tender offers are subject to the federal securities laws and the SEC’s 

rules, which provide specific protections to investors as described below under the Section on 

third party tender offers. Judicial decisions have enumerated eight factors to be taken into 

consideration to determine whether a transaction constitutes a tender offer. The eight tender 

offer factors, each of which is relevant but not individually determinative, are as follows: (i) The 

bidder makes an active and widespread solicitation of public shareholders; (ii) The solicitation is 

for a substantial percentage of the target’s stock; (iii) The offer is at a premium above the 

prevailing market price; (iv) The terms are firm rather than negotiable; (v) The offer is contingent 

on the tender of a fixed minimum number of shares; (vi) The offer is open for a limited period of 

time; (vii) Shareholders are subject to pressure from the bidder to sell their stock and (viii) The 

bidder publicly announces an intention to gain control of the target, and then rapidly 

accumulates stock. In practice this means for example that an acquisition of control via open 

market transactions or via a private agreement generally would not trigger the requirements set 

forth in federal laws and SEC rules for tender offers. 

There are a number of features of the legal system, principally state corporate laws, that create 

disincentives for parties seeking to acquire control from doing so other than by negotiating with 

the board of directors (in cases of statutory mergers) or making a tender offer for all shares. 

 

12 An appraisal right is the right to receive fair value for a shareholder’s securities. Fair value is determined by a court 

or independent valuer. 
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First, directors owe a fiduciary duty to shareholders and that principle guides any negotiations 

between the company and an acquirer. In change of control transactions, the state courts have 

applied enhanced scrutiny to the actions of a board of directors. Second, most states have 

adopted some form of business combination statute which prohibits certain transactions—such 

as mergers, acquisitions of assets, purchases of securities—between the company and an 

interested stockholder. For example, in Delaware an acquirer of 15 percent or more of a 

company’s outstanding stock is prohibited from engaging in certain transactions with the 

company unless either its acquisition of stock has been approved in advance by the board of 

directors or it owned at least 85 percent of the company’s outstanding stock after the 

transaction in which it became an interested stockholder. To reach that 85 percent level, as a 

practical matter, an acquiring person would need to make a tender offer to all stockholders. 

Finally, transactions with a controlling stockholder are subject to strict “entire fairness” review by 

the courts, unless various procedural safeguards (e.g., independent committee, majority of the 

minority approval) have been put in place to protect the interest of minority stockholders. 

Third party (non-issuer) tender offers 

Section 14(d) and corresponding Regulation 14D apply to all tender offers for Exchange Act 

registered equity securities made by parties other than the issuer provided that upon 

consummation of the tender offer the offeror would beneficially own more than 5 percent of the 

class of equity securities subject to the offer. An offeror must include any shares it owns before 

the commencement of the tender offer in calculating the 5 percent amount. Such offers are 

subject to a set of disclosure and procedural safeguards summarized below. 

Disclosure: Section 14(d) of the Exchange Act requires any person or group intending to make a 

tender offer to file with the SEC a disclosure document on Schedule TO outlining the terms of 

the offer. A copy must also be delivered to the target issuer and any competing offerors. This 

document is immediately available to the public via the EDGAR system. In addition, Rules 14d4(c) and 14d-6(d) require an offeror to disclose promptly any material change in information 

previously disseminated. This requirement necessarily includes a requirement that security 

holders be given adequate time to consider the new information. 

Time to consider the offer: Rule 14e-1(a) of Regulation 14E requires that an offer remain open 

for a minimum offering period of 20 business days from the date the offer commences. Rule 

14e-1(b) of Regulation 14E requires that the offer remain open for ten business days following a 

change in the offering price or the percentage of the class of securities being sought. If an 

offeror voluntarily or involuntarily extends the offering period, it must provide notice of such an 

extension pursuant to Rule 14e-1(d) of Regulation 14E. Such notice must be given by press 

release or other public announcement prior to 9:00 a.m. Eastern time and identify the number of 

securities tendered. 

Withdrawal rights: Under Rule 14d-7(a), an offeror may not purchase securities during a time in 

which a security holder maintains the right to withdraw the securities. Accordingly, an offeror is 

effectively prohibited from purchasing any securities that have been tendered until the offering 

period has expired. This rule-based withdrawal right supplements the statutory right of 

withdrawal under Section 14(d)(5). 

Proration: Rule 14d-8 provides that where more shares are tendered in a partial tender offer 

within the first ten calendar days of an offer than the offeror is bound or willing to take up, the 

securities must be taken up pro-rata, disregarding fractions, according to the number of 

securities deposited by each tendering security holder. 

Best price protections: Rule 14d-10 require that each tendering security holder must receive the 

highest consideration paid to any security holder during the period of the tender offer. 
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Prompt payment: Rule 14e-1(c) of Regulation 14E requires that the offeror promptly pay for or 

return securities when the tender offer expires. 

Antifraud: Antifraud provisions apply in connection with a tender offer (mainly through Section 

14(e) of the Exchange Act). 

Obligations for the target company: Rule 14d-9 requires the target of the tender offer to send to 

security holders specific disclosure about its recommendation, file a Schedule 14D-9 containing 

that disclosure, and send the Schedule 14D-9 to the offeror. 

Tender offers featuring an offer to exchange securities are further subject to having the 

securities offering aspect of the transaction registered under the Securities Act. 

Issuer tender offers 

Rule 13e-4 regulates cash tender offers and exchange offers by issuers for their equity securities. 

Rule 13e-4 also applies to a tender offer by an affiliate of the issuer for the issuer’s securities 

where the tender offer is not subject to Section 14(d). Rule 13e-4 is different from Regulation 

14D because it applies even if the class of securities sought in the offer is not registered under 

Section 12. Rule 13e-4 also applies regardless of the amount of securities sought in the offer. 

Rule 13e-4 provides for disclosure, filing and procedural safeguards that generally mirror those 

provided under Section 14(d) and Regulation 14D. The rule defines certain fraudulent, deceptive, 

or manipulative acts or practices in connection with issuer cash tender or exchange offers, and 

prescribes the disclosure and dissemination of certain information, among other requirements, 

as measures reasonably designed to prevent such acts or practices. The rule also requires that an 

issuer making a cash tender offer or exchange offer for its equity securities allow tendering 

security holders be given the opportunity to withdraw their tendered securities. Also, Rule 13e4(f)(8), commonly viewed as the “equal treatment provision,” provides that the offer must be 

open to all security holders in the class of equity that is the subject of the offer and that each 

tendering security holder must receive the highest consideration paid to any security holder 

during the period of the tender offer. 

Other changes of control transactions 

State corporate law generally would not apply to a change of control transaction if the 

transaction does not involve a business combination or shareholders’ vote on a matter. The 

federal securities laws would not apply to a change of control transaction if the transaction does 

not involve a tender offer, an offer of securities, or a shareholders’ vote. However, depending on 

the circumstances, disclosure obligations might apply. For example, in change of control 

transactions in which an ownership or management transition may be carried out without a 

security holder vote, the issuer may be required to disseminate an information statement 

complying with Schedule 14C of the Exchange Act. Instances in which Section 14(c) may require 

the dissemination of an information statement are those where management may control 

sufficient shares to constitute a quorum and produce a favorable vote (e.g., a majority owned 

subsidiary), or where a solicitation of proxies is made only to certain security holders or certain 

security holders act unilaterally by written consent. 

Ownership registration and transfer of shares 

Under the DGCL, the officer who has charge of the stock ledger of a corporation is required to 

prepare and make, at least ten days before every meeting of stockholders, a complete list of the 

stockholders entitled to vote at the meeting. The stockholder list is required to remain accessible 

to any stockholder during the time of the meeting. Exchange rules may require the use of a 

qualified registrar (most often a transfer agent) to perform a registrar function. 
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Receipt of dividends and other distributions 

State corporate laws are the primary source of substantive regulation on payment of dividends. 

As a general matter, state corporate laws require that a corporation that declares a cash 

dividend on common stock pay that dividend to stockholders of record on the declared record 

date. The federal securities laws (Regulation S-K) require disclosure relating to dividends in an 

issuer’s registration statements and annual reports. Exchanges also have provisions relating to 

the payment of dividends as part of their listing requirements. (See for example Section 204.12 

of the Listed Company Manual of the NYSE and Section 5250(e)(6) of the Nasdaq Listing Rules 

which both require an issuer to provide notice to the exchange). 

Responsibility of directors 

Responsibility of directors is addressed mainly under state corporate law. DGCL 141(a) provides 

that the business and affairs of a corporation are to be managed or under the control of its 

board of directors. Delaware common law provides that directors owe fiduciary duties to the 

corporation and its stockholders. Most states possess similar judicial precedents. Two general 

fiduciary duties imposed on directors are the duty of care and the duty of loyalty. Delaware 

courts have also developed jurisprudence relating to subsets of the duty of loyalty, reflecting the 

related concepts of good faith and candor. 

Certain state corporate law remedies are available to shareholders to hold the company, its 

directors and senior management accountable for their involvement in connection with 

violations of law. For example, pursuant to DGCL Section 102(b), a company’s certificate of 

incorporation may not contain any provision eliminating or limiting the personal liability of a 

director under certain circumstances. Under the DGCL, shareholder derivative lawsuits provide 

additional means for holding directors and senior managers accountable for their oversight of a 

company’s affairs. In addition, a stockholder who is directly injured retains the right to bring an 

individual action for injuries affecting his or her legal rights as a stockholder. 

Bankruptcy or insolvency of the company 

The Bankruptcy Code provides two primary routes through business bankruptcy: (i) Chapter 11, 

whereby the company usually attempts to reorganize its business and become profitable again. 

Management usually continues to run day-to-day business operations, but all significant 

business decisions must be approved by a bankruptcy court; and (ii) Chapter 7, whereby the 

company stops all operations and goes out of business. A trustee is appointed to liquidate the 

company’s assets and the money is used to pay off creditors and investors in accordance with 

the federal bankruptcy rules. 

Public companies generally file under Chapter 11 rather than Chapter 7 because they can 

continue to run their business and control the bankruptcy process. A company’s securities may 

continue to trade even after the company has filed for reorganization under Chapter 11. Since its 

securities are still trading, a company must continue to file SEC reports and disclose material 

information to shareholders. 

The SEC has statutory authority to participate in all Chapter 11 cases, but generally limits its 

activity to large public company cases. The SEC focuses its activity on four principal areas: 

(i) ensuring that plans and disclosure statements contain adequate information; (ii) ensuring that 

public investors are adequately represented by an official committee, if appropriate; (iii) ensuring 

that Bankruptcy Code exemptions from Securities Act registration are not misused; and 

(iv) participating in legal issues that affect the rights of public investors (such as improper efforts 

by debtors to shield officers and directors from lawsuits for securities fraud). Although the SEC 

reviews disclosure of reorganization plans, it does not get involved in the economic terms of 
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plans. 

Beneficial ownership reporting 

The beneficial ownership reporting system provides investors and the issuer information about 

accumulation of voting classes that may have the potential to change or influence control of the 

issuer. This framework is established under Sections 13(d) and 13(g) of the Exchange Act. 

The rules require a person who beneficially owns, following an acquisition, more than 5 percent 

of a voting class of equity security registered under the Exchange Act to file a Schedule 13D 

filing within ten days after the acquisition, which must contain among other things the 

percentage owned and the reasons surrounding the acquisition (including whether the shares 

were acquired with the intention to acquire control). Section 929R of the Dodd-Frank Act 

authorizes the SEC to shorten the initial filing deadline for Schedules 13D. The SEC has not 

initiated any formal regulatory action to shorten the current ten-day initial reporting period. 

Material changes to the information must be disclosed in an amended filing, which must be filed 

promptly. Under the rules, the acquisition or disposition of beneficial ownership of securities in 

an amount equal to 1 percent or more of the class of securities is deemed material, although 

acquisitions or dispositions of less than those amounts may be material, depending on the facts 

and circumstances. Other material changes in the facts disclosed –including any change in the 

plans and proposals originally disclosed with respect to acquiring control-must likewise be 

disclosed. 

The rules allow certain investors to file a Schedule 13G, “short-form” disclosure document, to 

disclose their ownership interest in equity securities. These filers include specified institutional 

investors holding securities in the ordinary course of business and not with a control purpose. 

Schedule 13G must be filed by these investors within 45 days after December 31 of the year in 

which the 5 percent threshold was exceeded. Amendments to Schedule 13G filings must be filed 

on an annual basis and no later than 45 days following the end of the calendar year in which the 

information previously reported changes regardless of the materiality of such change. In 

addition, the rules permit other classes of investors who are not the beneficial owners of 20 

percent or more of a class of registered voting securities to file a Schedule 13G, provided the 

acquisition is not for the purpose of acquiring control. For these investors, the due date for the 

initial filing is ten days after the acquisition that caused the five percent threshold to be 

exceeded. 

When two or more individuals or entities come together for the purpose of acquiring, holding or 

disposing of a company’s securities, the group is deemed to be a single “person” for purposes of 

the filing requirement under Sections 13(d) and 13(g). As a result, a Schedule 13D or Schedule 

13G must be filed by the members of the “group” when they collectively beneficially own more 

than 5 percent of the class of company securities. Application of this “group” notion is based on 

the facts and circumstances of any particular situation. 

Beneficial ownership of directors and executive officers of the issuer as a group and any person 

who is known to the issuer to be the beneficial owner of more than 5 percent of any class of the 

issuer’s voting securities must be disclosed in annual reports pursuant to Item 403 of Regulation 

S-K. 

All these reports are immediately available to the public via EDGAR. 

Insiders and substantial holdings 

Disclosure about the beneficial ownership interest of directors and executive officers in a 

company, and material changes in those interests, is required pursuant to two distinct reporting 

regimes under the federal securities laws: one regime relates to disclosure provided by the 
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122 INTERNATIONAL MONETARY FUND

issuer on a periodic basis under the issuer’s disclosure obligations under the federal securities 

laws; and the second regime relates to disclosure provided by “insiders” under Section 16 of the 

Exchange Act. 

Issuer disclosure 

In various disclosure documents issuers are required to disclose, as of the most recent 

practicable date, in a specified tabular format, as to each class of equity securities of the issuer 

or any of its subsidiaries or parent companies, the beneficial ownership of securities of all 

directors and nominees (naming them), each of the five mostly highly compensated executive 

officers (naming them), and all directors and executive officers as a group (without naming 

them). The information disclosed must include the title of the class of securities, the name of the 

beneficial owner, the amount and nature of beneficial ownership, and the percent of the class. 

This disclosure must specify the amount of shares that are pledged as security and the amount 

of shares with respect to which the named persons have the right to acquire beneficial 

ownership. 

This disclosure must be made in a prospectus relating to an offering of the issuer’s shares under 

the Securities Act and in a registration statement under the Exchange Act. In addition, the 

disclosure must be updated at least yearly, either in the issuer’s annual report filed under the 

Exchange Act or in the issuer’s proxy or information statement delivered to shareholders in 

connection with the election of directors. 

Section 16 reporting regime 

Section 16 of the Exchange Act provides for a stand-alone reporting regime with respect to 

ownership of an issuer’s securities. Section 16 applies to every officer and director of an issuer 

with a class of equity securities registered under Section 12 of the Exchange Act as well as any 

person who beneficially owns more than 10 percent of the class of equity securities registered 

under Section 12. 

Upon becoming a reporting person or upon the Section 12 registration of that security, Section 

16(a) requires a reporting person to file an initial ownership report with the SEC disclosing his or 

her beneficial ownership of all equity securities of the issuer within 10 days of becoming a 

reporting person or on or before the effective date of the Section 12 registration statement. The 

insider must report the number of securities in which he or she has a direct or indirect 

opportunity to profit. To keep this information current, Section 16(a) also requires reporting 

persons to report changes in such ownership, or the purchase or sale of an SBS or SBS 

agreement involving such equity security, before the end of the second business day following 

the day on which the subject transaction was executed. The SEC has adopted rules that exempt 

insiders from reporting some changes in security ownership, such as routine acquisitions 

pursuant to broad-based, non-discriminatory employee benefit plans. Insiders who are 

delinquent in their current transaction reporting, or who engage in transactions for which 

deferred reporting is permitted (e.g., bona fide gifts) must file an annual statement to report 

those previously unreported transactions. 

All filings under Section 16 (i.e., the initial statement of ownership, the statement of changes in 

ownership, and the annual statement, if required) must be filed electronically through the SEC’s 

EDGAR system. These filings are immediately publicly available on filing. 

The SEC’s Delinquent Filings Program applies similarly to filings under Section 16. The SEC has 

brought enforcement actions against insiders who have not complied with their Section 16 filing 

obligations. 
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Foreign issuers 

In prospectuses under the Securities Act and annual reports under the Exchange Act, all issuers, 

including foreign private issuers, are required to disclose material “risk factors”. In practice, in 

providing “risk factor” disclosure, a foreign private issuer may frequently disclose differences in 

shareholder rights between the foreign jurisdiction and the United States, or note the existence 

of provisions of foreign corporate law or of the issuer’s chartering document that have a 

material effect on shareholders’ ability to pursue certain remedies or other matters affecting 

shareholder rights. 

In September 2008, the SEC adopted a disclosure requirement applicable to the annual reports 

of foreign private issuers. Under this new requirement, all foreign private issuers that are listed 

on a U.S. exchange must provide a concise summary of the significant ways in which the issuer’s 

corporate governance practices differ from the corporate governance practices followed by U.S. 

companies under the relevant exchange’s listing standards. 

Review of transaction files 

As stated in Principle 16, CF is the main SEC division responsible for monitoring issuers’ 

compliance with their obligations vis-à-vis the federal securities laws. In practice this means that 

CF would review transactional filings, for example those submitted in connection with a tender 

offer. In addition, CF is also responsible for monitoring compliance with notifications of holdings 

obligations. 

Violations of shareholders’ rights (when they do not involve obligations imposed by the federal 

securities laws) would need to be taken by shareholders to the judiciary. In practice shareholders 

exercise actively their rights and there is abundance of precedent from the Delaware courts in 

connection with the fiduciary duties of board members. 

Assessment Fully Implemented 

Comments The U.S. legal regime allows companies that offer securities to the public a significant degree of 

freedom in connection with their structure and rights of shareholders. As a result, structures that 

impact the rights of shareholders, such as companies with dual class shares, are allowed in the 

United States. At the same time the current framework imposes robust disclosure in the 

prospectus and related filings of the actual rights provided to shareholders in such structures. 

Further, directors are subject to strong fiduciary duties which shareholders can (and do) make 

effective through the judiciary. Therefore the assessors consider that the current framework 

complies with Principle 17 in respect to the treatment of shareholders. 

Under the current legal and regulatory regime certain mechanisms to acquire control of a 

company do not constitute a tender offer and, as a result, do not trigger the obligations set 

forth in the federal laws and SEC rules, including in particular the equal treatment of all 

shareholders. The assessors acknowledge however that there are a number of features of the 

legal system, mainly state corporate laws, that , create disincentives for parties seeking to 

acquire control from doing so other than by negotiating with the board of directors in the case 

of statutory mergers or making a tender offer for all shares. 

The current framework allows foreign issuers to follow their domestic frameworks relating to 

shareholders’ rights. However, the assessors note the existence of robust disclosure obligations, 

including a description of the differences between shareholders rights, in the prospectus. 

Finally, the deadline for submission of the first “insider” report appears long when compared to 

other jurisdictions. However, the assessors do acknowledge that once this first report has been 

filed, any changes in “holdings” must be reported within 2 days. 
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124 INTERNATIONAL MONETARY FUND

Principle 18. Accounting standards used by issuers to prepare financial statements should be of a high and 

internationally acceptable quality. 

Description Audited financial statements 

Pursuant to SEC Regulation S-X the issuers’ registration statements must include audited 

financial statements, including the balance sheet and profit and loss statement as well as a 

statement of comprehensive income, a statement of cash flows and a statement of changes in 

equity. Regulation S-X also requires that the financial statements for each year presented be 

audited by an independent public accountant. The auditor must be registered with the PCAOB. 

Pursuant to the Exchange Act, annual reports and quarterly reports must also include financial 

statements as described in Principle 16. Unaudited interim financial statements are required to 

be reviewed by an independent public accountant registered with the PCAOB. 

Accounting standards 

Pursuant to Section 108 of SOX the SEC has the authority to recognize the standards of a 

standard setting body as “generally accepted” for the purposes of the U.S. federal securities 

laws. Section 108 of SOX establishes criteria that must be met which encompass provisions 

related to (i) the nature, governance, and funding of the standard setting body, and its capacity 

to ensure prompt consideration of changes to accounting principles necessary to reflect 

emerging accounting issues and changing business practices; as well as (ii) its capacity to assist 

the SEC in fulfilling the requirements of securities laws, in particular by improving the accuracy 

and effectiveness of financial reporting and the protection of investors under the securities laws. 

Section 108, however, ratified the SEC’s authority to establish accounting principles or standards 

for purposes of enforcement of the securities laws. 

Pursuant to Section 108 authority the SEC has recognized the standards of the FASB as 

“generally accepted”. Accordingly, the financial statements of U.S. public companies whether in 

the annual or interim reports are required to be prepared and presented in accordance with U.S. 

GAAP. Pursuant to SEC rules, and as indicated under Principle 16, the financial statements of 

foreign private issuers may be presented in accordance with (i) U.S. GAAP; (ii) another 

comprehensive body of accounting standards reconciled to U.S. GAAP; or (iii) IFRS as issued by 

the IASB without reconciliation to U.S. GAAP. Each company may elect the basis of presentation.

U.S. GAAP comprises standards and interpretations established by the FASB and its 

predecessors, as modified or supplemented by rules and guidance from the SEC and its staff. 

SEC staff indicated that the SEC has rarely used its authority to supplement the standards (the 

last substantive time was roughly 35 years ago in connection with oil and gas companies). What 

is more common is the issuance of guidance on how to interpret them. 

FASB 

The FASB’s mission is to establish and improve standards of financial accounting and reporting 

that foster financial reporting by non-governmental entities that provides decision-useful 

information to investors and other users of financial reports. 

The FASB follows certain guiding principles in conducting its activities. These principles include: 

to be objective in its decision making; to actively solicit and carefully weigh the views of 

stakeholders; to issue standards only when the expected benefits exceed the perceived costs; to 

issue high-quality standards; to manage the process of improving standards in ways that 

balance the desire to minimize disruption of accounting and financial reporting processes with 

the need to improve the decision-usefulness of information in financial reports; to provide clear 

and timely communications; and to review the effects of past decisions and interpret, amend or 
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replace standards in a timely fashion if such action is indicated. 

The FASB is overseen by the Financial Accounting Foundation (FAF) which is responsible for 

selecting the seven full-time FASB members, selecting members of its advisory council and 

ensuring adequate funding of its activities. The FAF is an independent, non-profit organization 

that is run by a Board of Trustees of between 14 and 18 members. The FASB is supported by the 

Financial Accounting Standards Advisory Council, which is responsible for consulting with the 

FASB as to technical issues on the FASB’s agenda and project priorities. 

Funding is received through an annual accounting support fee assessed against issuers as 

provided for under Section 109 of the Sarbanes-Oxley Act. 

Standard setting 

The FASB describes itself as “committed to following an open, orderly process for setting 

standards”. The FASB’s standard setting meetings (including those of the Emerging Issues Task 

Force) are open to the public and information about the status of all projects is available on its 

website. Proposed standards may be developed with input from task forces, working groups and 

public roundtables. The FASB exposes its proposed standards and interpretations for public 

comment. The comments received are discussed in public meetings and the proposed standard 

is re-deliberated by the Board in light of the public input received. Market participants expressed 

positive views about the standard setting process, in particular its transparency and the 

thoroughness of the consultation. 

FASB standards do not require formal approval from the SEC. In practice the SEC staff closely 

monitors the standards development work of the FASB, so that any input necessary is given as 

part of the standard setting process. 

Enforcement of accounting standards 

As indicated in Principle 16, SEC staff selectively reviews the financial information contained in 

prospectuses, listing documents, registration statements, periodic reports and ongoing material 

disclosure reports. In addition to these documents, SEC staff also selectively reviews the financial 

information contained in proxy statements that are filed by companies. The financial information 

contained in prospectuses, registration statements and listing documents is reviewed for 

compliance with accounting standards and reporting requirements, compliance with auditing 

standards and reporting requirements, accuracy and completeness of disclosure, timeliness and 

other qualities. If staff notes a perceived accounting or disclosure deficiency during the review of 

a company’s filing, the staff will send a comment letter to the company that sets forth the 

specific concerns the staff has with the filing. The company has an opportunity to address the 

staff’s comments in a response letter to the staff. 

In addition, as indicated in Principle 16, in July of 2013 the SEC created the Financial Reporting 

and Audit Task Force, to renew its focus on financial reporting and accounting fraud. SEC staff 

indicated that in the wake of the financial crisis the SEC devoted a significant amount of 

resources to financial crisis cases while fewer accounting fraud investigations were undertaken. 

For example, in FY2012, the SEC opened 124 financial fraud/issuer disclosure investigations 

compared to 304 in FY2006 and 228 in FY2007. As for accounting fraud cases, there was a 

reduction as well: the SEC filed 79 financial fraud/issuer disclosure actions in FY2012 compared 

to 219 in FY2007. Post-crisis the SEC has renewed its focus on financial reporting and accounting 

by establishing this task force. The task force has about 12 staff, both lawyers and accountants. 

Its objective is to improve the SEC’s ability to detect and prevent financial statement and other 

accounting fraud. The SEC anticipates that the task force will continue to cover a wide variety of 

issues, for example: (i) the manner in which management and auditors make decisions with 

respect to reserves; (ii) revenue recognition; (iii) independence violations by auditors; and 
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(iv) audit committees. 

In the meantime, the SEC has recently brought several financial reporting cases. For example, the 

SEC charged three top executives at a publicly-traded fund with overstating the company’s 

assets during the financial crisis by failing to fairly value its debt securities and certain 

collateralized loan obligations. And it charged a Fortune 200 company for various accounting 

deficiencies that distorted their financial reporting to investors in the midst of the financial crisis. 

Assessment Fully Implemented 

Comments 

Principles for Auditors, Credit Ratings Agencies, and Other Information Service Providers 

Principle 19. Auditors should be subject to adequate levels of oversight. 

Description PCAOB 

Section 101 of the SOX established the PCAOB to oversee the audits of public companies. The 

Dodd-Frank Act expanded PCAOB jurisdiction to also cover BDs’ audits. 

SOX created the PCAOB as a non-profit corporation, under the oversight of the SEC. Its board is 

composed of five members, including two CPAs. All members serve on a full time basis and must 

be independent from the audit profession. The SEC selects the board members. 

Similar to the FASB, the PCAOB receives funding through an annual accounting support fee, as 

provided for under Section 109 of SOX. The issuer accounting support fee is allocated between 

equity issuers and investment company issuers in relation to their market capitalization. As of 

2014, 8,217 issuers were subject to fees. The largest 100 issuers pay 42 percent of issuer fees. 

At the time of the assessment PCAOB had 809 staff, the majority in its Division of Registration 

and Inspections. According to the PCAOB Chair, a key challenge for the Board is its ability to 

compete with large firms for talent. However, he indicated that overall the PCAOB is able to offer 

competitive salaries given its private sector status and funding model. 

Registration requirement 

Pursuant to Section 102 and 106 of SOX and PCAOB Rule 2100, each public accounting firm 

(including foreign firms) must register with the PCAOB if the firm (i) prepares or issues any 

report with respect to any issuer, broker or dealer or (ii) plays a substantial role in the 

preparation or furnishing of an audit report with respect to any issuer, broker or dealer. The 

term issuer is defined as an issuer the securities of which are registered under Section 12 of the 

Exchange Act (listed issuer) or that is required to file reports under Section 15(d) of the 

Exchange Act (issuer with a registration statement filed with the SEC or that files or has filed a 

registration statement that has not yet become effective under the Securities Act and that it has 

not withdrawn). The term substantial role has been defined as performing material services or 

performing the majority of the audit with respect to a subsidiary or component that constitutes 

20 percent or more of the assets or revenues of the issuer. 

Under PCAOB rules, the PCAOB will not register a firm unless it finds that registration is 

consistent with the Board's responsibilities under the SOX to protect the interests of investors 

and to further the public interest in the preparation of informative, accurate, and independent 

audit reports. In practice registration requirements are limited. PCAOB staff indicated that the 

reason for this is not to create barriers to competition. Registration includes the need for the 

audit firm to be duly licensed in the respective state (or even another country); ; a clean 

disciplinary record; an adequate description of the firm’s systems of quality control; and the 
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ability to cooperate with the PCAOB. The last consideration was incorporated in 2010 as a result 

of challenges that the PCAOB had faced in connection with the auditing of firms located in 

certain foreign jurisdictions; whereby access to working papers has been prevented by host 

confidentiality rules. 

Licensing requirements for individual auditors vary by state but PCAOB staff indicated that in 

general they include the need for an accounting degree and continuing education. 

There are currently six staff in charge of firm registration. PCAOB staff indicated that it 

infrequently denies an application for registration. There are currently about 800 firms that 

conduct audits of issuers –the majority of them audit fewer than five issuers. 

Oversight of audit firms 

Section 104 of SOX requires the PCAOB to conduct a continuing program of inspections to 

assess registered firms with regard to the performance of audits and related matters. Inspections 

are to be performed annually for firms that provide audit reports for more than 100 issuers and 

at least once every three years for most other registered firms. The PCAOB is required to provide 

a written report for each inspection to the SEC, and to make portions of the reports publicly 

available. 

The PCAOB currently has 504 staff dedicated to the inspection programs. This staff is generally 

comprised of auditors with a minimum of 6 years of experience; inspection team leaders for the 

large annually inspected firms have an average of 30 years of relevant experience and inspection 

team members assigned to the global network firms have an average of 16 years of relevant 

experience. 

The inspection program for audit firms is divided into two programs: 

The Global Network firms program: this program includes U.S. firms subject to annual 

examination along with their non U.S. affiliates. Currently 6 global network firms are subject to 

annual examination. Approximately 170 non U.S. firms affiliated with such firms are subject to 

triennial examination. 

Non affiliate firms program: Three of these firms audit more than 100 issuers and are therefore 

subject to annual inspections. The remaining firms are inspected on a triennial basis. On average 

the PCAOB inspects 175 firms per year. However, risk assessments may motivate more frequent 

inspections for triennially inspected firms. 

As indicated above, the PCAOB has inspected non-U.S. registered firms as part of this program 

since 2005. These inspections have generally been carried out in two ways: (i) PCAOB-only 

inspections, where the PCAOB conducts the inspection on its own in coordination with the home 

country regulator; and (ii) inspections conducted jointly with the home country regulator. The 

PCAOB has entered into formal cooperative arrangements with several countries. Under a 

cooperative framework for non-U.S. inspections adopted by the Board, the PCAOB may rely on 

inspection work performed by the home country regulator. The Dodd-Frank Act provided the 

PCAOB with the authority to share confidential information with foreign audit oversight 

authorities. 

PCAOB staff highlighted that it faces challenges to access the working papers of audit firms 

located in a number of jurisdictions, including China and some European countries; due to the 

local confidentiality provisions. PCAOB Chair considers this as a challenge for PCAOB 

effectiveness. The PCAOB publishes and regularly updates a list identifying each issuer whose 

PCAOB-registered auditor is located in a jurisdiction where obstacles to PCAOB inspections exist. 

The PCAOB Chair highlighted, however, that progress has been made with China in connection 

with the development of a framework for cooperation. The SEC has also taken enforcement 
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actions against affiliates of the big four for allegedly failing to produce audit work. 

PCAOB staff noted that the inspection program is designed to promote improvement in audit 

quality. The process includes fieldwork review of firms’ systems of quality control and audit 

engagements. Audit engagements for review are generally selected based on an assessment of 

risk factors (including the size of the issuer, the sector that it belongs to, etc.). Preliminary draft 

reports go through multiple levels of internal PCAOB review and evaluation including by 

inspection staff, staff in the office of the Chief Auditor and in the Office of the General Counsel. 

Following that process, staff provides the draft report to the firm. The firm has an opportunity to 

provide a written response. The inspection staff can make changes to the report based on such 

response. The final report is sent to the Board for issuance. When the Board is satisfied with the 

content, it issues a final report and transmits it to the firm. 

All PCAOB inspection reports have a public portion and most also have a non-public portion. 

The public portion describes the inspection process and any identified audit deficiencies that the 

PCAOB’s inspection staff judged to have resulted in an audit opinion that was insufficiently 

supported when issued. The non-public portion of a report may provide additional discussion of 

those deficiencies; criticisms, if any, of the firms’ system of quality control; and potentially other 

process issues related to the firm, such as the possibility of Board disciplinary actions. If the 

PCAOB issues a final inspection report that contains criticisms of, or potential defects in, a firm’s 

quality control systems, the firm may avoid having that portion of the report become public by 

addressing that criticism to the Board’s satisfaction within 12 months of the date of the PCAOB 

report. For the largest firms there is a team assigned to follow up on remediation actions and 

there is communication throughout the year on the plan for remediation and the status of 

actions taken. For smaller firms, the PCAOB assigns a staff in charge of follow up, but in those 

cases the level of contact varies. 

The PCAOB cannot disclose to an audit committee the non-public portion of an inspection 

report or other non-public inspection information—including whether the inspection identified 

deficiencies in the audit that the audit committee oversees—and the PCAOB Board cannot 

compel an audit firm to disclose such information to an audit committee. The audit committee 

can request such information to the audit firm and potentially if it refuses to share it, the audit 

committee could recommend that the firm be fired. The PCAOB has issued guidance in 

connection with its inspection reports that provides information about the inspection process, 

and the meaning of reported results, to better equip audit committees to engage in meaningful 

discussion with audit firms about the results of its inspections (PCAOB Release No. 2012-003). 

If the PCAOB determines that the remediation of a quality control criticism is satisfactory, it 

notifies the SEC and any applicable state regulatory authorities. If no evidence of remediation is 

submitted or if the PCAOB determines the remediation is not sufficient, the PCAOB will make 

those findings public. 

PCAOB staff highlighted that deficiencies have been found in roughly 40 percent of the 

inspections. Common findings relate to weaknesses in auditing (i) internal control over financial 

reporting; (ii) fair value measurement and disclosures; (iii) revenue recognition; and 

(iv) management estimates. PCAOB staff noted that in general the majority of the firms have 

managed to satisfactorily address deficiencies during the 12 month remediation period 

established. PCAOB staff commented that while improvements have been observed, concerns 

remain as to the quality of the audits. However, as the engagements for inspections are 

generally selected based on risk, staff considers difficult to make generalizations. As a result, 

staff indicated that the PCAOB is currently analyzing the possibility to expand the review of 

engagements beyond those triggered by the risk-based approach. 
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Enforcement 

The PCAOB has authority to investigate and discipline registered public accounting firms and 

persons associated with those firms for noncompliance with the SOX, the rules of the PCAOB 

and the SEC, and other laws, rules, and professional standards governing the audits of public 

companies. If the PCAOB finds evidence of a violation the PCAOB may report it to the SEC or 

state regulatory body or open an enforcement investigation pursuant to Section 105 of the SOX. 

Investigations are conducted by the Division of Enforcement, which is comprised of 28 attorneys, 

22 accountants and support staff totaling over 60 staff. Cases are litigated before a hearing 

officer, who is a PCAOB employee insulated from the investigative function. Decisions of the 

hearing officer can be appealed to the Board and those in turn to the SEC. Pursuant to the SOX, 

PCAOB investigations are confidential and nonpublic. The SOX also requires that disciplinary 

proceedings are confidential and nonpublic, unless both the auditor and the PCAOB consent to 

public proceedings, or until there is a final decision imposing sanctions. 

Pursuant to SOX ,the PCAOB can impose appropriate sanctions, including: temporary suspension 

or permanent revocation of registration; temporary suspension or permanent bar of a person 

from association with a registered public accounting firm; temporary or permanent limitation on 

the activities of a firm or person; civil monetary penalties; censure; requiring additional 

education or training; requiring an independent monitor or consultant; implementation of 

additional or remedial policies and procedures; and requiring an independent review and report 

on an engagement. PCAOB staff noted that common types of investigations have referred to 

(i) violations of professional standards (audit failures not limited to matters involving GAAP 

departures); (ii) independence violations; and (iii) failure to cooperate with an inspection or 

investigation. 

A total of 69 settled disciplinary orders have been issued since the establishment on the PCAOB 

in 2002, and another 12 disciplinary orders have been issued in proceedings that were 

adjudicated to conclusion. In addition, a number of other proceedings are currently in litigation, 

but they are non-public as required by the SOX. 

The key enforcement actions used have been revocation of registration and bars, which the 

PCAOB considers to be more effective than monetary penalties given the impact that they have 

in the actual business of the firm and the individuals. In practice the PCAOB has imposed 

sanctions on 61 registered firms including 42 revocations of firm registrations and sanctions on 

79 individuals including 69 suspensions or bars. 

A significant portion of the enforcement orders and the corresponding sanctions have been 

imposed during the last 3-5 years. SEC staff indicated that the number of sanctions and its 

concentration on the last years is a natural reflection of the fact that the PCAOB is still a 

relatively new organization and that some time has been necessary for the PCAOB to become a 

fully functioning supervisory body. In this regard SEC staff also indicated that the quality of the 

cases brought by the PCAOB has improved overtime. 

A recent review of the enforcement division by the Office of Independent Oversight and 

Performance Assurance (IOPA) (the internal audit function of the PCAOB) concluded that overall 

the PCAOB has been able to establish a comprehensive enforcement program. However, the 

review highlighted a number of opportunities to improve internal processes and, potentially, 

case timeliness. This is an issue that has also been raised by SEC staff. PCAOB staff highlighted 

that they are currently looking at ways to improve the enforcement process and make it more 

efficient. 

Finally, PCAOB staff considers the confidentiality provisions of the SOX in connection with 

disciplinary proceedings to be a challenge for effective enforcement. Further the fact that 
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confidentiality remains through the appeal process (unless the SEC lifts the stay) adds more 

incentive for firms to litigate as long as possible regardless of whether they believe they will 

ultimately prevail. SEC staff indicated, however, that the differences in the treatment of PCAOB 

disciplinary proceedings versus SEC proceedings needs to be analyzed in the context of the 

different nature of the PCAOB versus the SEC, and the different due process that accompanies 

SEC proceedings. 

Enforcement by the SEC 

Pursuant to its selective review of filings, the SEC staff considers the appropriateness of the form 

of the auditor’s report on the financial statements. The staff may issue comments with respect to 

the auditor’s report similar to the process for issuing comments on the content of the financial 

statements and associated disclosures. The SEC can also use its enforcement powers. 

During the last 5 years the SEC has taken 99 actions against audit firms: 28 in 2014; 18 in 2013; 

17 in 2012; 18 in 2011 and 18 in 2010. Actions taken in 2014 involved both small and large audit 

firms. The types of sanctions imposed varied depending on the gravity of the cases; but have 

involved suspensions as well as the imposition of monetary penalties. SEC staff indicated that 

the number of actions taken in the last year reflects the renewed attention that the SEC is giving 

to financial reporting and accounting fraud, through the recently created Task Force described in 

Principles 16 and 18. Staff also highlighted increased effectiveness in coordination of 

enforcement actions with the PCAOB. 

Oversight of the PCAOB 

As indicated above the PCAOB is under the oversight of the SEC. Technical oversight is 

conducted through the Office of the Chief Accountant. 

The SEC has a wide range of tools to oversee the PCAOB. In particular, it approves the PCAOB 

budget and accounting support fees. The budget approval process provides an opportunity for 

the SEC to provide input in connection with the PCAOB strategic priorities and work program. In 

addition, through the budget order approval the SEC establishes reporting obligations for the 

PCAOB. For example, the order approval for the 2014 budget directs the PCAOB during the 2014 

budget cycle to continue to include in its quarterly reports to the SEC information about the 

PCAOB’s inspection program. Such information is to include: (i) statistics relative to the numbers 

and types of firms budgeted and expected to be inspected in 2014, including by location and by 

year the inspections that are required to be conducted in accordance with SOX and PCAOB 

rules; (ii) information about the timing of the issuance of inspection reports for domestic and 

non-U.S. inspections; and (iii) updates on the PCAOB’s efforts to establish cooperative 

arrangements with respective non-U.S. authorities for inspections required in those countries. 

The SEC also approves PCAOB auditing standards and rules. The SEC has made use of onsite 

inspections of the PCAOB.. The last inspections were conducted around 2009, when the 

registration and inspection programs were formally reviewed. In addition, as indicated above the 

SEC receives a copy of all examination reports and is informed of all investigations opened by 

the PCAOB. 

SEC and PCAOB staff highlighted that in addition to all these more formal oversight mechanisms 

in practice there is very close contact between the PCAOB and SEC staff. 

Assessment Fully Implemented 

Comments The assessment of the effectiveness of the enforcement of audit standards has taken into 

consideration the fact that both the PCAOB and the SEC can file enforcement cases against audit 

firms. The information provided shows that PCAOB enforcement actions have increased over 

time. Further, the SEC has made gatekeepers a focus of its enforcement program, and important 
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cases have been filed during the last five years, thus complementing PCAOB efforts. 

The assessors note, however, recommendations issued by the IOPA in particular on the 

timeliness of PCAOB cases. Timeliness of procedures can be a challenge for credible deterrence, 

and thus it is important that the PCAOB works in improving its procedures (as it is currently 

doing). Finally, the assessors also note the fact that PCAOB proceedings are subject to 

confidentiality, which could also potentially undermine the deterrent effect of PCAOB 

enforcement efforts. 

The assessors note efforts by the PCAOB to address existing challenges in connection with 

access to audit work in certain foreign jurisdictions. Such efforts have been complemented with 

disclosure to investors (via the PCAOB website) of the countries where such limitations remain. 

In addition, the assessors also note recent enforcement actions by the SEC in this area. For new 

audit firms this access limitation has been addressed via the inclusion of a registration 

requirement that relates to their ability to cooperate with the PCAOB. 

Finally, the assessors note the limited use of inspections by the SEC for the oversight of the 

PCAOB, at least in recent years. However, this appears to be largely offset by the work 

conducted by IOPA, and other regular interactions between the SEC and the PCAOB. 

Principle 20. Auditors should be independent of the issuing entity that they audit. 

Description Auditors’ independence 

Independence of the external auditor both in fact and in appearance is required under the U.S. 

system. It is addressed by the SEC’s auditor independence rules adopted in 2000 and 

subsequently strengthened in 2003 after the passage of SOX. 

Rule 2-01 of Regulation S-X sets forth the general standard of auditor independence which 

considers whether a relationship or the provision of a service: (i) creates a mutual or conflicting 

interest between the accountant and the audit client; (ii) places the accountant in the position of 

auditing his or her own work; (iii) results in the accountant acting as management or an 

employee of the audit client; or (iv) places the accountant in a position of being an advocate for 

the audit client. In addition, some of the specific major areas covered include financial interests, 

employment relationships, business relationships, non-audit services, contingent fees, partner 

rotation, audit committee administration of the audit engagement, quality controls, definitions 

and other matters. The PCAOB also has adopted certain auditor independence requirements. 

Restrictions on financial relations 

In particular, Rule 2-01(c) of Regulation S-X prohibits financial, business, employment and other 

relationships with an entity that the firm audits that would threaten an auditor’s independence. 

Threats to independence 

The Rule covers also the areas addressed by IOSCO: 

Self-interest: Rule 2-01(c) sets forth a non-exclusive list of circumstances that are considered 

inconsistent with the general standard of independence in Rule 2-01(b). Rule 2-01(c) specifies 

circumstances related to financial relationships, employment relationships, business 

relationships and non-audit services, as well as prohibitions on contingent fees and 

compensation paid to an audit partner for procuring engagements for non-audit work, that 

could result in an auditor’s self-interest being in conflict with the performance of an 

independent audit. 

Advocacy: The general standard of independence is intended to prevent the auditor from being 

an advocate for the client. Additionally, Rule 2-01(c)(4)(x) prohibits an auditor from providing an 
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expert opinion or other service for the purpose of advocating a client’s interests in litigation or 

in a regulatory or administrative proceeding or investigation. Also, Rule 2-01(c)(4)(ix) prohibits 

the auditor from providing legal services to its client. Legal service is defined as any service that 

“under circumstances in which the service is provided, could be provided only by someone 

licensed, admitted, or otherwise qualified to practice law in the jurisdiction in which the service is 

provided.” 

Familiarity: Rule 2-01(c) addresses the threat of familiarity by requiring the rotation of an audit 

partner who has performed the services of a lead or concurring partner for an issuer for more 

than five consecutive years and certain other members of the audit team who have worked on 

the audits of an issuer for more than seven consecutive years. In addition, Rule 2-01(c)(2) 

provides restrictions on certain employment relationships and provides for a cooling off period 

for certain participants in the audit. Rule 2-01(c)(4) also prohibits an auditor from providing 

management or human resource functions for an audit client. 

Intimidation: SEC rules require that the audit committee (and not management) be responsible 

for the hiring and retention of the auditor. In addition, the auditor is required under Rule 2-07 of 

Regulation S-X and PCAOB auditing standards to communicate certain audit-related matters to 

the audit committee. Administering the relationship with the auditor through the audit 

committee reduces the possibility of intimidation because the auditor has regular, direct 

communications with the audit committee, which for listed companies is required to be 

composed of independent directors. Pursuant to SEC rules, an auditor will not be viewed to be 

independent when an adversarial relationship has been created between the client and its 

auditor due to litigation or the possibility of litigation that substantially alters the normal 

relationship between an auditor and its client. Further, Rule 13b2-2 under the Exchange Act 

prohibits certain persons from taking any action to coerce, manipulate, mislead or fraudulently 

influence an auditor engaged in an audit or review of financial statements of an issuer that are 

required to be filed with the SEC. 

Non-audit services 

The general standard of independence is intended to prevent the provision of any non-audit 

services that would impair the independence of the auditor. In addition, Rule 2-01(c)(4) sets 

forth a non-exclusive list of non-audit services that would impair the independence of the 

auditor, including bookkeeping services, financial information systems design and 

implementation, appraisal or valuation services, actuarial services, internal audit outsourcing 

services, management functions, human resources, broker-dealer, investment adviser or 

investment banking services, legal services or expert services unrelated to the audit. Rule 2-

01(c)(3) prohibits the auditor from having, directly or indirectly, any business relationship with 

the client or certain persons associated with the client. The PCAOB also has rules governing the 

provision of certain tax services to audit clients. Both the SEC and PCAOB also have rules 

requiring pre-approval by the audit committee of any non-audit service provided by the auditor.

Internal systems, governance arrangements and processes for monitoring, identifying and 

addressing threats to independence 

The PCAOB requires auditors to have a system of quality controls that provides, among other 

things, reasonable assurance that personnel maintain independence in fact and appearance in 

all required circumstances (QC 20.09). 

Rule 2-01(d) under Regulation S-X provides a safe harbor from certain independence violations 

so long as the auditor had in place a quality control system that provides reasonable assurance 

that the accounting firm and its employees do not lack independence. For accounting firms that 

annually provide audit, review or attest services to more than 500 issuers, their quality control 
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system must include written independence policies and procedures, an automated system that 

identifies investments of partners and managerial employees, a system that provides timely 

information about entities requiring independence, an annual or on-going training program, an 

annual internal inspection and testing program, notification of the member of senior 

management responsible for compliance with independence requirements, written policies and 

procedures requiring notice when professionals are engaged in employment negotiations and a 

disciplinary mechanism. 

In addition, Rule 2-01(c)(6) provides that an accountant will not be independent if an audit 

partner performs the services of a lead partner on an audit engagement for more than five 

consecutive years or the services of a concurring partner for more than seven consecutive years.

Appointment of auditors by issuers 

SOX and Regulation S-X (Article 2, Rule 2-01) contain rigorous independence requirements. The 

Preliminary Note to Rule 2-01 expressly provides that the rule is designed to ensure that 

auditors are independent in both fact and appearance. 

Listing standards mandated by SOX require that the audit committee of the board of directors 

oversee the process of selection and appointment of the external auditor of a public company. 

Each national securities exchange has requirements that issuers have audit committees 

composed of independent directors. These requirements also include certain composition, 

charter and responsibility requirements for audit committees. 

Pursuant to Rule 10A-3 under the Exchange Act, national securities exchanges are prohibited 

from listing any security of an issuer that is not in compliance with the following standards: 

 Each member of the audit committee of the issuer must be independent according to 

specified criteria in addition to the general director independence requirement in the 

listing standards; 

 The audit committee of each issuer must be directly responsible for the appointment, 

compensation, retention and oversight of the work of any registered public accounting 

firm engaged for the purpose of preparing or issuing an audit report or performing other 

audit, review or attest services for the issuer, and each such registered public accounting 

firm must report directly to the audit committee; 

 Each audit committee must establish procedures for the receipt, retention and treatment 

of complaints regarding accounting, internal accounting controls, or auditing matters, 

including procedures for the confidential, anonymous submission by employees of the 

issuer of concerns regarding questionable accounting or auditing matters; 

 Each audit committee must have the authority to engage independent counsel and other 

advisors, as it determines necessary to carry out its duties; and 

 Each issuer must provide appropriate funding for the audit committee. 

Also, the U.S. regulatory framework has a number of specific audit committee requirements for 

listed issuers. The SEC’s rules implementing Sections 10A(h) and 10A(i) of the Exchange Act, as 

added by Sections 201 and 202 of the SOX require that all audit and non-audit services to be 

provided by the independent accountant must be pre-approved by the issuer’s audit committee, 

subject to a de minimis exception. Information regarding the audit committee’s pre-approval 

responsibilities is required to be disclosed in the issuer’s annual report. The auditor is also 

required by the PCAOB standards to communicate information to the audit committee 

regarding the auditor’s independence. 

Market participants believe that audit committees are increasingly taking an active role in the 
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oversight of the accounting firms’ work, although more progress is still necessary Actions by the 

PCAOB and the SEC are contributing to this outcome. The former has issued guidance including 

for example in connection with PCAOB audit reports (as explained in Principle 19). The SEC has 

recently pursued enforcement actions against members of audit committees of two issuers for 

alleged failures in their oversight role. 

Disclosure of information about the resignation, removal or replacement of an external 

auditor 

When the auditor has resigned during a current audit, declined to stand for re-election after the 

completion of the audit, or was dismissed by the company being audited, prompt public 

disclosure of these facts is required. For U.S. companies this occurs by the issuer filing a Form 8-

K within four business days of the termination date. Item 304 of Regulation S-K specifies the 

information required to be disclosed in the Form 8-K and encompasses such matters as whether 

there were any disagreements with the former auditor on accounting matters, whether the 

former auditor’s report for the last two years involved an adverse opinion or disclaimer of 

opinion or other qualifications to the opinion, whether the change was recommended or 

approved by the board of directors or the audit committee, and other matters relating to the 

change in auditors. 

Supervision and enforcement of independence requirements 

The PCAOB assesses a firm’s independence as part of its regular inspection program. In addition, 

the PCAOB can require remedial action by firms that are not appropriately maintaining 

independence from their clients; and impose enforcement actions. The SEC can also bring 

enforcement actions against firms that have violated its independence rules. More information 

on the inspection program of auditors by the PCAOB, and on enforcement efforts by the PCAOB 

and the SEC are provided in Principle 19. 

Assessment Fully Implemented 

Comments As indicated under Principle 19, the assessors note current legal limitations that prevent the 

PCAOB from sharing the confidential portion of its inspection reports with the audit committees. 

However, the PCAOB has taken steps to encourage audit committees to take a proactive 

approach and ask relevant questions from the audit firms themselves. 

Principle 21. Audit standards should be of a high and internationally acceptable quality. 

Description Auditing standards 

Before the enactment of SOX and the establishment of the PCAOB in 2002, auditing standards 

for registered public companies were established by the AICPA. The AICPA’s Auditing Standards 

Board (ASB) had developed a number of Statements of Auditing Standards (SAS) through a 

process that included deliberations in public meetings and public exposure of draft statements. 

Section 103 of SOX gave the PCAOB authority to establish auditing, ethics, independence and 

quality control standards for registered public accounting firms and specified that the PCAOB 

may establish standards through its own development and/or through the adoption of 

standards proposed by other professional groups of accountants, all pursuant to SEC oversight. 

The PCAOB adopted the auditing and related professional practice standards of the ASB as they 

existed in April 2003 as interim professional standards. Subsequently, the PCAOB has been 

reviewing these standards to determine whether they need to be modified, superseded or 

adopted as permanent standards. For example, the PCAOB has proposed and adopted auditing 

standards that address audit documentation (AS No. 3), an audit of internal control over 

financial reporting that is integrated with an audit of financial statements (AS No. 5), 

engagement quality review (AS No. 7), risk assessment (AS Nos. 8-15), and communications with 
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audit committees (AS No. 16). 

The PCAOB standard setting agenda includes projects on the auditor’s reporting model, related 

parties, the auditors' responsibilities with respect to other accounting firms and specialists, and 

auditing accounting estimates, including fair value measurements. Both senior staff from the SEC 

and market participants noted that while these proposals are important, current standards are 

already of high quality. 

Standard setting 

The PCAOB recognizes that the development of standards should be an open, public process in 

which investors, the accounting profession, the preparers of financial statements and others 

have the opportunity to participate. In addition, Section 103(a)(4) of the Sarbanes-Oxley Act 

authorizes the PCAOB to convene expert advisory groups as may be appropriate to aid in 

standard-setting. The PCAOB has convened a Standing Advisory Group to advise it on the 

establishment of auditing and related professional practice standards. 

PCAOB staff is actively involved in drafting proposed standards. After completing the 

development process, which ordinarily includes consultation with the Standing Advisory Group 

and may include other public fora such as roundtable discussions, the PCAOB’s staff 

recommends a proposed standard to the PCAOB. . Proposed standards approved by the PCAOB 

are published for public consideration and comment. After the PCAOB and its staff evaluate the 

comments received, the PCAOB staff recommends to the PCAOB a final standard, revised as 

necessary based on the evaluation of the comments received. PCAOB meetings at which 

standards –proposed or final—are considered are open meetings. Final standards adopted by 

the PCAOB are submitted to the SEC for approval and do not become effective unless approved 

by the SEC. The SEC reviews the rules, issues them for public comments, considers the 

comments received and then determines whether to approve the standards. 

Enforcement of auditing standards 

The PCAOB is the main body responsible for enforcing compliance with auditing standards 

through its inspection program and enforcement proceedings described in Principle 19. In 

addition, the SEC can use both formal and informal mechanisms to enforce compliance with 

auditing standards, as described in Principle 19. Through the Financial Reporting and Audit Task 

Force recently constituted the SEC has increased its enforcement efforts in accounting and 

auditing. 

Assessment Fully Implemented 

Comments The assessors note the existence of an important agenda of revision to audit standards that are 

yet to be approved. While both SEC staff and market participants were of the view that the 

current standards remain of high quality, they did emphasize the importance of many of the 

proposals on the table as a mechanism to enhance the quality of auditors’ work, particularly in 

the context where the PCAOB still finds important deficiencies in auditors’ reports. 

Principle 22. Credit rating agencies should be subject to adequate levels of oversight. The regulatory system 

should ensure that credit rating agencies whose ratings are used for regulatory purposes are 

subject to registration and ongoing supervision. 

Description Definition of credit rating 

The Exchange Act defines “[c]redit [r]ating” as “an assessment of creditworthiness of an obligor 

as an entity or with respect to specific securities or money market instruments.” The Exchange 

Act defines “[c]redit [r]ating [a]gency as “any person (i) engaged in the business of issuing credit 

ratings on the Internet or through another readily accessible means, for free or for a reasonable 
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fee, but does not include a commercial credit reporting company; (ii) employing either a 

quantitative or qualitative model, or both, to determine credit ratings; and (iii) receiving fees 

from either issuers, investors, or other market participants, or a combination thereof.” 

Use for regulatory purposes 

A CRA, whether located in the U.S. or elsewhere, that wishes its credit ratings to be used for 

regulatory purposes in the U.S. must elect to register with the SEC. If credit ratings issued by 

affiliates (including affiliates located outside the United States) are to be used for regulatory 

purposes in the United States, they would need to be properly identified by the NRSRO in its 

registration form. 

The credit ratings of these affiliates are treated as credit ratings issued by the NRSRO, and the 

affiliates are thus subject to the laws and rules applicable to NRSROs (collectively, the NRSRO 

Regulations) and to direct oversight by the SEC. 

Currently credit ratings are used for limited purposes in SEC regulations, most notably in MMF 

regulation (and reporting forms). CFTC regulations do not make reference to ratings. 

Registration requirements 

In 2007, the SEC adopted rules which established the framework for voluntary registration of 

CRAs as NRSROs. A number of these rules were amended in 2014; the effective dates of these 

amendments vary but they will generally be effective mid-2015. Pursuant to these rules, a CRA 

applying to be registered with the SEC as an NRSRO must submit an initial application on Form 

NRSRO. An application is not eligible for approval unless Form NRSRO has been completed 

properly, following all applicable instructions. 

Form NRSRO requires an applicant to provide information about itself and its policies and 

procedures related to its credit rating business, including the following: 

The class or classes of credit ratings for which the applicant is applying, specifying for each class: 

the approximate number of credit ratings currently outstanding; the approximate date the 

applicant began issuing credit ratings for the class; and performance measurement statistics; 

A description of the procedures and methodologies used in determining credit ratings; 

Identification of conflicts of interest relating to the issuance of credit ratings; 

Policies and procedures to address and manage conflicts of interest and to prevent the misuse 

of material, non-public information; 

The corporate organizational and managerial structure of the applicant and information about 

its credit rating analysts, credit rating analyst supervisors, and designated compliance officer; 

Audited financial statements of the applicant or its parent for each of the three prior fiscal years, 

unaudited revenue information, including the amount of revenue generated from determining 

and maintaining credit ratings for the most recently concluded fiscal year, and information 

regarding the total and median annual compensation of credit analysts; and 

Information regarding any violations of law or other regulations by the applicant or persons 

associated with the applicant. 

An applicant is required to notify the SEC if any information submitted in its application is found 

to be or becomes materially inaccurate prior to the grant or denial of registration. If such 

circumstances were to occur, the applicant is also required to submit a supplement to its Form 

NRSRO application identifying the information. 

The SEC is required to deny an application for registration if it finds that the applicant does not 
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have adequate financial and managerial resources to: consistently produce credit ratings with 

integrity; materially comply with the procedures and methodologies that it uses in determining 

credit ratings; and materially comply with the NRSRO Regulations that are in place to prevent 

the misuse of non-public information, to manage conflicts of interest, to prohibit certain unfair, 

coercive or abusive practices, and to require designation of a compliance officer responsible, 

among other things, for ensuring compliance with the NRSRO Regulations. 

The SEC must also deny an application for registration if a condition exists that would subject 

the applicant, if so registered, to suspension or revocation of its registration. The SEC has the 

authority to suspend or revoke the registration of an NRSRO, entirely or with respect to one or 

more classes of credit ratings for which the NRSRO is registered, for any of the following 

reasons: 

Willful misstatements or omissions on Form NRSRO or any other report required to be filed with 

the SEC; 

Willful violation of or inability to comply with federal securities laws, willful assistance of a 

violation of federal securities laws or a failure to reasonably supervise, with a view to preventing 

such violations, a person who violates federal securities laws; 

Convictions by the NRSRO or associated persons of certain crimes; 

The finding by a foreign financial regulatory authority of a violation of foreign securities law and 

certain related actions; 

A final order of certain state or federal authorities finding a violation of law meant to prevent 

fraudulent, manipulative or deceptive conduct; 

Injunction by any court of competent jurisdiction from acting as or being associated with an 

NRSRO; 

Failure to file the annual amendment and certification of Form NRSRO; 

Failure to “maintain adequate financial and managerial resources to consistently produce credit 

ratings with integrity; or 

Effective June 15, 2015 a violation of the SEC’s conflicts of interest rules that affected a credit 

rating. 

Quality and integrity 

Procedures and methodologies designed to ensure the issuance of initial credit ratings based on a 

fair and thorough analysis of all information 

Pursuant to Section 15E(c)(3)(A) of the Exchange Act, NRSROs are required to “establish, 

maintain, enforce and document an effective internal control structure governing the 

implementation of and adherence to policies, procedures, and methodologies for determining 

credit ratings taking into consideration such factors as the Commission may prescribe by rule.” 

In issuing credit ratings, an NRSRO is required to consider information in its possession that it 

finds “credible and potentially significant to a rating decision,” including information it “receives 

from a source other than the issuer or underwriter.” Each NRSRO must also publicly disclose on 

Form NRSRO a description of the procedures and methodologies that it uses to determine its 

credit ratings. 

Internal records 

NRSROs are required to keep certain records. The records required to be retained, to the extent 

made or received, include internal records, including non-public information and work papers, 
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used to form the basis of a credit rating, credit analysis reports, credit assessment reports, and 

private credit rating reports of the NRSRO and internal records, including non-public 

information and work papers, forming a basis for the opinions in these reports; and both 

internal and external communications that relate to initiating, determining, maintaining, 

monitoring, changing or withdrawing a credit rating. In addition, the NRSRO Regulations require 

NRSROs to make and retain certain records, including “a record documenting the established 

procedures and methodologies used by the NRSRO to determine credit ratings”. Each NRSRO 

must make and retain records with respect to each of its current credit ratings showing the 

identity of the credit analysts who participated in determining the credit rating and any other 

person that approved the credit rating prior to its issuance. 

Any written communication received from third parties containing complaints about the 

performance of a credit rating analyst must be retained by the NRSRO. 

Finally, the NRSRO Regulations require an NRSRO to retain external and internal 

communications received and sent by the NRSRO concerning the initiating, determining, 

maintaining, monitoring, changing, or withdrawing of a credit rating. Additionally, for those 

structured finance securities where a quantitative model plays a substantial role in the 

determination of the credit rating, the NRSRO must make and retain a record of the rationale for 

any material difference between the credit rating implied by the model and the final credit 

rating issued. 

Sufficiency of resources to carry out high-quality credit ratings 

Form NRSRO requires applicants to provide relevant information about their resources including 

managerial resources. An NRSRO must also disclose the employment history and educational 

background of its designated compliance officer on Form NRSRO. 

In addition, an NRSRO must disclose annually the number of credit analysts and credit analyst 

supervisors and the required qualifications for each such role. 

Each NRSRO is required to provide audited financial statements for itself or its parent (and, if 

applicable, unaudited consolidating financial statements) with its initial application for 

registration and, on an ongoing basis, within 90 days of its fiscal year end. Together with such 

financial statements, an NRSRO must provide unaudited revenue information that specifies the 

amount of revenue generated from determining and maintaining credit ratings and the total 

aggregate and mean annual compensation of the NRSRO’s credit analysts. 

Conflict of interests 

Prohibition and management of conflicts 

The Exchange Act required the SEC to adopt rules to prohibit or require the management of 

conflicts of interest related to the issuance of credit ratings. Pursuant to that mandate, the SEC 

has adopted two categories of rules, one of which prohibits certain conflicts of interest and the 

other of which requires other conflicts of interest to be identified and managed. 

Prohibitions: the NRSRO Regulations prohibit NRSROs from having the following conflicts of 

interest: 

Issuing or maintaining a credit rating solicited by a person that provided the NRSRO with 10 

percent or more of its total net revenue in its most recently ended fiscal year; 

Issuing or maintaining a credit rating with respect to which the related fee was negotiated, 

discussed or arranged by a person within the NRSRO who has responsibility for participating in 

determining credit ratings or developing or approving the related procedures and 
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methodologies; 

Issuing or maintaining a credit rating for an affiliate of the NRSRO; 

Issuing or maintaining a credit rating with respect to a security where the NRSRO or its affiliate 

made recommendations about the corporate or legal structure, assets, liabilities, or activities of 

the obligor or issuer of the security; 

Issuing or maintaining a credit rating for a person where the NRSRO directly owns securities of 

the person that would be subject to the credit rating; 

Issuing or maintaining a credit rating for a person where an employee of the NRSRO that 

participated in determining, or is responsible for approving, the credit rating directly owns 

securities of the person that would be subject to the credit rating; 

Issuing or maintaining a credit rating for a person where an employee of the NRSRO that 

participated in determining, or is responsible for approving, the credit rating is an officer or 

director of the person that would be subject to the credit rating; 

Issuing or maintaining a credit rating where an employee of the NRSRO that participated in 

determining or monitoring the credit rating or is responsible for approving the credit rating 

received gifts valued over $25 from the person being rated; and 

Effective June 15, 2015, issuing or maintaining a credit rating where a person within the NRSRO 

who participates in determining or monitoring the credit rating, or developing or approving 

procedures or methodologies used for determining the credit rating, including qualitative and 

quantitative models, also (i) participates in sales or marketing of a product or service of the 

NRSRO or a product or service of an affiliate of the NRSRO or (ii) is influenced by sales or 

marketing considerations. 

Management of conflicts: The following conflicts of interest are permissible only if the NRSRO 

has identified and implemented procedures for managing their impact: 

Being paid by obligors, issuers, sponsors of asset-backed securities, or underwriters to 

determine credit ratings for such entity or the securities they issue, sponsor, or underwrite or for 

other services offered by the NRSRO; 

Being paid for services in addition to determining credit ratings by issuers, underwriters, or 

obligors that have paid the NRSRO to determine a credit rating; 

Being paid by subscribers to receive access to credit ratings or other services if such subscribers 

may use the NRSRO’s credit ratings to comply with, and obtain benefits or relief under, statutes 

or regulations using the term “nationally recognized statistical rating organization” or if such 

subscribers may own investments or have entered into transactions that could be impacted by a 

credit rating issued by the NRSRO; 

Allowing persons within the NRSRO to have an ownership interest in rated obligors or securities 

or to have business relationships that are other than arm’s length, ordinary course relationships 

with such obligors or the issuers of such securities; 

 Having an affiliate that is a broker or dealer engaged in underwriting activities; and 

Any other type of conflict of interest relating to the issuance of credit ratings by the NRSRO that 

is material to its organization and identified in its Form NRSRO disclosures. 

Each NRSRO is required to disclose on Form NRSRO the written policies and procedures 

maintained and enforced by the NRSRO to manage the conflicts of interest that apply to it. 

Finally, the NRSRO Regulations also require each NRSRO to have policies and procedures in 
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place to provide for an internal review process in order to determine whether a conflict of 

interest of a former employee influenced a credit rating action in certain instances. A review is 

required if a former employee is subsequently employed by an entity rated by the NRSRO (or by 

an issuer, underwriter or sponsor of a security rated by the NRSRO) and the former employee 

participated in the determination of a credit rating action during the one-year period preceding 

the date of such credit rating action. 

NRSROs are required to retain a record of each person who has paid for a credit rating and who 

has subscribed for a credit rating or credit rating analysis. The twenty largest issuers, subscribers, 

obligors, and underwriters by revenue must be identified to the SEC annually. 

An NRSRO is also required to keep records of the general types of products and services it 

offers, which can be useful in identifying any potential conflicts of interest that can arise from 

activities ancillary to an NRSRO’s credit rating business. 

Both internal and external communications related to the rating process, which could potentially 

identify any influence exerted by clients or otherwise by internal sources (e.g., with respect to 

sales or marketing considerations) are required to be retained. 

Compensation 

NRSROs are required to disclose actual and potential conflicts of interest on Form NRSRO, 

including those arising from the nature of compensation arrangements for producing credit 

ratings. The SEC has identified specific conflicts of interest that generally arise from 

compensation issues in the business of issuing credit ratings, including conflicts relating to 

credit ratings paid by the entities being rated (i.e., issuer-paid ratings) or by subscribers who 

stand to benefit by certain rating actions (i.e., subscriber-paid ratings). In particular, the SEC has 

specified in the NRSRO Regulations that a conflict of interest exists if an NRSRO is paid by 

obligors, issuers, sponsors of ABS, or underwriters to determine credit ratings for such entities or 

the securities they issue, sponsor, or underwrite or for other services offered by the NRSRO, or if 

an NRSRO is paid by subscribers to receive access to credit ratings or other services if such 

subscribers obtain benefits from the regulatory use of credit ratings or have entered into 

transactions that could be impacted by a credit rating issued by the NRSRO. 

The instructions for Form NRSRO list these potential conflicts of interest and require the NRSRO 

to disclose such conflicts to the extent they apply to its business. Each NRSRO is also required to 

disclose on Form NRSRO the written policies and procedures maintained and enforced by the 

NRSRO to manage the conflicts of interest that apply to it. Each NRSRO must update its Form 

NRSRO annually and certify that the information therein, as updated, continues to be accurate 

and must also promptly file an amendment to its Form NRSRO if any information therein 

becomes materially inaccurate. 

A NRSRO has to make its Form NRSRO publicly available on its website. 

Effective June 15, 2015, each NRSRO will also be required to disclose information relating to 

conflicts of interest of the NRSRO when taking certain credit rating actions. In particular, an 

NRSRO will be required to disclose the source of payment for its fees, if applicable, with respect 

to the credit rating and whether the NRSRO was paid for any other services provided during the 

most recently ended fiscal year to the person paying for the credit rating. 

Transparency and timeliness 

Dissemination of ratings in a timely manner 

Oversight of NRSROs addresses whether NRSROs disseminate their credit ratings in a timely 

manner. 
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The Exchange Act requires each NRSRO to maintain and enforce written policies and procedures 

reasonably designed to prevent the inappropriate dissemination of a pending credit rating 

action before issuing the credit rating on the Internet or through another readily accessible 

means. As applicable to the business model of the NRSRO, these policies may include 

procedures designed to ensure that a credit rating action is issued in a way that makes it readily 

accessible to the market place, such as posting the credit rating or an announcement of the 

credit rating action on the NRSRO’s website or through a news or information service used by 

market participants or by making it available to all subscribers simultaneously. 

The NRSRO Regulations also require each NRSRO to establish, maintain, enforce, and document 

an effective internal control structure governing the implementation of and adherence to 

policies, procedures, and methodologies for determining credit ratings. 

Information on methodologies 

NRSROs are required to publish a description of their procedures and methodologies so that 

outside parties can understand how a credit rating was determined and the attributes and 

limitations of each NRSRO’s credit ratings. 

Each NRSRO must publicly disclose on Form NRSRO a description of the procedures and 

methodologies that it uses to determine its credit ratings. The instructions for Form NRSRO state 

that this description must be sufficiently detailed to provide users of credit ratings with an 

understanding of the processes employed by the NRSRO in determining credit ratings. 

Specifically, the disclosure must include, among other things: 

 A description of the sources of information used in determining credit ratings; 

 How information about the verification performed with respect to the collateral backing a 

structured finance product is relied upon in determining credit ratings; 

 How the quality of the originators of assets underlying structured finance products factor 

into the determination of credit ratings; 

 The quantitative and qualitative models and metrics used to determine credit ratings; 

 The procedures for interacting with the management of the rated entity; 

 The structure and voting process of the NRSRO’s credit rating committees; 

 The procedures for monitoring, reviewing, and updating credit ratings, including how 

frequently credit ratings are reviewed; and 

 The procedures to withdraw a credit rating or suspend maintenance of a credit rating. 

These specific items are designed to provide users of credit ratings with useful information to 

understand how an NRSRO produces credit ratings and to provide a basis for comparing 

NRSROs. Certain of the required items allow users of credit ratings to understand any limitations 

of a given credit rating. For instance, the extent to which an NRSRO verifies information (e.g., 

value of the property or income of the borrower) about the assets underlying a structured 

finance product will be useful to users of credit ratings in assessing the potential for an NRSRO’s 

credit ratings to be adversely impacted by inaccurate information about the underlying assets. 

Additionally, information regarding the process for monitoring and maintaining credit ratings 

after they are issued allows users of credit ratings to assess any limitations on the accuracy of 

the credit ratings over time. 

As noted above, the instructions to Form NRSRO identify specific items that an NRSRO may 

address in its procedures, and these must be disclosed to the extent applicable. However, the list 

of items identified in the instructions is not exhaustive, and each NRSRO is required to disclose a 
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description that is “sufficiently detailed to provide users of credit ratings with an understanding 

of the processes employed by the NRSRO in determining credit ratings”. The NRSRO 

Regulations also require NRSROs to retain certain records supporting various credit rating 

actions and with respect to the development of its methodologies to ensure that OCR 

examination staff has adequate information to review whether an NRSRO has sufficiently 

described its methodologies and procedures on Form NRSRO. 

Each NRSRO is also required to make additional disclosures regarding the general attributes of 

its credit ratings, by defining the credit rating categories, notches, grades and rankings it uses. 

This information is designed to allow users of credit ratings to understand what an NRSRO’s 

ratings symbols represent. 

Effective June 15, 2015, each NRSRO will be required to disclose certain information about its 

procedures, methodologies, and assumptions when taking certain credit rating actions. Such 

information includes, among other things, the version of the procedure or methodology used to 

determine the credit rating; the main assumptions and principles used in constructing the 

procedures and methodologies used to determine credit ratings, including qualitative 

methodologies and quantitative inputs; the potential limitations of the credit rating, including 

the types of risks excluded from the credit rating; information regarding the uncertainty of the 

credit rating, including information on the reliability of the data relied on in determining the 

credit rating; an explanation or measure of the potential volatility of the credit rating, including 

any factors that are reasonably likely to lead to a change in the credit rating; and information on 

the sensitivity of the credit rating to assumptions made by the NRSRO. 

Information on historical default rates 

NRSROs are required to publish on their Forms NRSRO information about the historical default 

rates of their credit ratings so that interested parties can understand the historical performance 

of their credit ratings. 

The NRSRO Regulations require each NRSRO to publicly disclose performance measurement 

statistics with respect to its credit ratings. These performance measurement statistics must 

include historical credit ratings transition and default rates, showing the changes in the credit 

ratings assigned to obligors and securities over 1-, 3-, and 10-year periods through the most 

recent calendar year end. The data are required to be provided separately for each class and 

certain subclasses of credit ratings for which the NRSRO is registered so that interested parties 

can focus on the information relevant to them. 

Amendments to the instructions for Exhibit 1 to Form NRSRO, effective January 1, 2015, 

standardize the production and presentation of the performance measurement statistics, in 

order to allow users of credit ratings to compare the performance of credit ratings across 

NRSROs and provide a standardized definition of default for purposes of calculating the default 

statistics. The amendments also require statistics to be produced for subclasses of structured 

finance products and for credit ratings where the obligation was paid off or the credit rating was 

withdrawn for reasons other than a default or the obligation being paid off. 

In addition, under the enhanced credit rating history disclosure requirements effective June 15, 

2015, an NRSRO, among other things, will be required to publicly disclose historical information 

concerning each credit rating, such as information that could be used to generate statistics, 

including default statistics, about the performance of the NRSRO’s credit ratings. 

Confidential Information 

Use of private information 

The NRSRO Regulations require NRSROs to take steps to address the protection of nonpublic 
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information provided by issuers and others so that such information is only used for credit 

rating activity purposes. The NRSRO Regulations require each NRSRO to maintain and enforce 

written policies and procedures reasonably designed to prevent the “inappropriate 

dissemination within or outside the NRSRO of material non-public information obtained in 

connection with the performance of credit rating services” and to prevent NRSRO personnel 

from trading securities when they are aware of material non-public information obtained in 

connection with the performance of credit rating services. The NRSRO Regulations also require 

that each NRSRO publicly disclose those policies and procedures on Form NRSRO. 

Pending ratings 

The NRSRO Regulations require each NRSRO to maintain and enforce written policies and 

procedures reasonably designed to prevent the inappropriate dissemination of a pending credit 

rating action before issuing the credit rating on the Internet or through another readily 

accessible means. The NRSRO Regulations also require that each NRSRO publicly disclose those 

policies and procedures on Form NRSRO. 

Oversight of the NRSRO 

Once a CRA is registered with the SEC as an NRSRO, it is subject to continuing oversight by the 

SEC to monitor compliance with the federal securities laws, including Section 15E of the 

Exchange Act and the SEC’s related rules (collectively, the NRSRO Regulations). 

SEC authority to require information 

The Exchange Act requires all NRSROs to make and keep for prescribed periods such records, 

furnish such copies thereof, and make and disseminate such reports as the Commission, by rule, 

prescribes as necessary or appropriate in the public interest, for the protection of investors, or 

otherwise in furtherance of the Exchange Act. Pursuant to the NRSRO Regulations all records 

maintained by an NRSRO are subject to examination by the SEC. 

The NRSRO Regulations also require each NRSRO to provide certain information to the SEC on 

an ongoing basis. Each NRSRO must update its Form NRSRO annually and certify that the 

information therein, as updated, continues to be accurate. The NRSRO Regulations also require 

that material changes be communicated to the SEC as they occur; an NRSRO must promptly file 

an amendment to its Form NRSRO if any information therein becomes materially inaccurate. 

In addition to requiring periodic updates to Form NRSRO, the NRSRO Regulations require each 

NRSRO to deliver annually certain financial reports and other information to the SEC. Further, 

the designated compliance officer at each NRSRO is required to file an annual report with the 

SEC discussing the NRSRO’s compliance with federal securities laws and its own policies and 

procedures, including a description of any material changes to the code of ethics and conflict of 

interest policies of the NRSRO and a certification that the report is accurate and complete. 

Commencing January 1, 2015, each NRSRO must also deliver a report to the SEC containing an 

assessment by management of the effectiveness during the fiscal year of the internal control 

structure governing the implementation of and adherence to policies, procedures, and 

methodologies for determining credit ratings. 

Examinations 

All NRSROs, whether located in the U.S. or elsewhere, are subject to an annual examination 

process and to further examination and enforcement by the SEC when appropriate. 

Section 15E(p)(3) of the Exchange Act requires the SEC to conduct examinations of each NRSRO 

at least annually. Each examination must include, but is not limited to, a review of the following 

specified areas: 
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 Whether the NRSRO conducts business in accordance with its policies, procedures, and 

rating methodologies ; 

 The management of conflicts of interest by the NRSRO; 

 Implementation of ethics policies by the NRSRO; 

 The internal supervisory controls of the NRSRO; 

 The governance of the NRSRO; 

 The activities of the designated compliance officer; 

 The processing of complaints by the NRSRO; and 

 The NRSRO’s policies governing the post-employment activities of former staff of the 

NRSRO. 

In addition to the required annual examinations, the SEC has broad discretion to conduct 

examinations of NRSROs whenever it considers an examination to be necessary or appropriate 

in the public interest, for the protection of investors, or otherwise in furtherance of the Exchange 

Act. 

Enforcement 

The SEC has authority to bring enforcement actions against NRSROs for possible violations of 

the federal securities laws, rules and regulations. This includes the ability to censure, place 

limitations on the activities, functions, or operations of, suspend, or revoke the registration of 

any NRSRO upon the occurrence of certain events, including the failure to maintain adequate 

financial and managerial resources to consistently produce credit ratings with integrity or the 

failure reasonably to supervise, with a view to preventing a violation of the securities laws, an 

individual who commits such violation. More broadly, the SEC is authorized to seek an 

injunction, civil penalty and/or equitable relief if it appears to the SEC that there has been a 

violation of the Exchange Act or any of the rules or regulations thereunder. 

Practice 

Establishment of OCR 

The Dodd-Frank Act required the SEC to establish an Office of Credit Ratings and provide it with 

sufficient staff. This Office was formally established in June 2012. OCR had 44 staff for fiscal year 

2014 (and 6 more staff were requested in the budget for fiscal year 2015). In fiscal year 2014, 

approximately half of the staff focused on examinations, and the remaining half focused on 

policy and monitoring work. Staff recruited by OCR include former supervisors and CRA 

employees as well as attorneys. In addition, a quantitative analyst has been added to OCR’s staff 

in fiscal year 2015. 

Registration 

Currently 10 CRAs are registered as NRSROs, of which two are foreign and are subject to the 

same process as the domestic NRSROs. With one exception, all the registrations took place in 

2007. However an application to rate new asset classes is treated as a “mini registration”.

Examinations 

As indicated above, the Dodd-Frank Act requires the OCR to include eight areas for review in its 

examinations. Within such review areas, the OCR conducts a risk- assessment for each NRSRO to 

identify specific issues to focus on for each exam, and also identifies issues or risks that are 

present at multiple NRSROs. To this end, the OCR initially reviews information such as: each 
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NRSRO’s response to deficiencies identified in previous exams; Form NRSRO submissions and 

NRSROs’ public disclosures; any tips, complaints, and referrals concerning NRSROs submitted to 

the SEC; and news articles and other sources. For large CRAs the examination team would 

consist of approximately 3-6 examiners; while for the smaller CRAs the examination team would 

consist of approximately 2-3 examiners. Certain examiners of the big 3 CRAs are exclusively 

dedicated to that exam. The OCR has generally implemented a practice of rotation of the exam 

team lead to avoid the risk of regulatory capture and provide fresh perspectives. 

During an examination, OCR staff gathers information from the NRSRO and then typically visits 

one or more of the NRSRO’s offices and interviews the NRSRO’s analytical personnel, senior 

management, compliance personnel, board of directors, business development/marketing 

personnel, and other personnel. The OCR examination staff also reviews, among other things, 

documents received from the NRSRO including internal and nonpublic documents and other 

sources of information used to conduct its risk assessment, such as the Form NRSRO 

submissions, and tips, complaints, and referrals sent to the SEC. 

Upon completion of the annual examination, OCR examination staff discusses the results of the 

examination with the corresponding NRSRO and issues a letter identifying any deficiencies and 

recommending remedial measures. An NRSRO is typically requested to submit a written 

response within 30 days of the final recommendations of the examination staff. Examples of 

remedial actions included that one or more of the examined NRSROs evaluate whether they 

have sufficient staff and resources to manage their volume of business and that they review their

current disclosures relating to process and methodologies for rating certain asset classes to 

assess whether they are fully disclosing their ratings methodologies in compliance with the law. 

In addition to the individual letters, the examination staff also prepares an annual public report 

summarizing the essential findings of the examinations, the responses of each NRSRO to any 

material regulatory deficiencies identified by the examinations, and whether the 

recommendations contained in previous public reports have been appropriately addressed. The 

public report for 2013 highlighted that NRSROs responded to the 2012 recommendations with 

remedial measures such as adopting new or revising existing procedures, enhancing or 

implementing new internal controls, implementing new software systems, and conducting 

compliance and analytical training. Further, NRSROs have added, or have begun to add, 

compliance resources, both in the form of experienced compliance personnel and in software 

systems and information technology infrastructure. NRSROs have also improved oversight by 

boards of directors or governing committees to which oversight duties have been assigned. In 

the report SEC staff noted five general areas of improvement among NRSROs: 

 Enhanced documentation, disclosure, and Board oversight of criteria and methodologies; 

 Investment in software or computer systems; 

 Increased prominence of the role of the DCO within NRSROs; 

 Implementation or enhancement of internal controls; and 

 Adherence to internal policies and procedures. 

The public report concluded that there has been a noticeable positive shift in the compliance 

culture of NRSROs. 

OCR staff indicated that during 2014 they conducted the first examination abroad of affiliates of 

domestic CRAs. In addition, they have started to conduct thematic reviews. 

Consistent with the IOSCO Final Report on Supervisory Colleges for Credit Rating Agencies, 

supervisory core and general colleges for CRAs were established for the three largest globally 
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active CRAs (Fitch, Moody’s and S&P). Two of the colleges are chaired by the SEC and the third 

one by ESMA. The first meeting of the core colleges took place in November 2013. It was a two 

day meeting where the regulators had meetings with each of the CRAs and meetings restricted 

to regulators. The second meeting of the core colleges for CRAs took place in December 2014; 

the core colleges met for three days (one day for each of the CRAs). The first meeting of the 

general colleges for CRAs took also place in December 2014 where the regulators met for one 

day. 

Enforcement 

In 2012 the SEC brought an enforcement action against an NRSRO and its president charging 

them with willful and material misrepresentations and omissions in the NRSRO’s application, 

pursuant to Form NRSRO, to the SEC to register as an NRSRO for issuers of ABS and issuers of 

government, municipal and foreign government securities. The NRSRO consented to the SEC’s 

order revoking its NRSRO registration with respect to issuers of asset-backed securities and 

issuers of government, municipal and foreign government securities, but providing for the right 

to re-apply for registration in these classes after 18 months. The president of the NRSRO was 

barred from association with any NRSRO registered in these two classes of credit ratings, with 

the right to apply to the SEC for re-entry after 18 months. The SEC’s order required the NRSRO 

to complete a comprehensive review of its policies, procedures, practices, and internal controls 

that related to the findings set forth in the SEC’s order and the findings of the 2012 examination 

by OCR staff. In addition, the settlement required the NRSRO to adopt, implement, and maintain 

policies, procedures, practices, and internal controls that correct the issues identified in the SEC’s 

order, the 2012 examination, and any deficiency identified in the NRSRO’s comprehensive review 

and to submit a report to OCR detailing the steps it took to address these issues. The settlement 

further required the NRSRO and its president to cease and desist from committing or causing 

future violations. 

Assessment Fully Implemented 

Comments 

Principle 23. Other entities that offer investors analytical or evaluative services should be subject to oversight 

and regulation appropriate to the impact their activities have on the market or the degree to 

which the regulatory system relies on them. 

Description Sell side analysts 

SEC 

In 2003 and 2004, the SEC and the SROs which it oversees (collectively “U.S. Broker-Dealer 

Regulatory Agencies”) as well as other regulatory agencies settled charges against twelve of the 

leading U.S. BDs (the Global Settlement) in connection with their research analysis. The Global 

Settlement required a number of structural changes at the settling firms, such as information 

barriers between research analysts and investment bankers. The Global Settlement applies to 

BDs who account for roughly 80 to 90 percent of the equity underwriting activity in the U.S. The 

Global Settlement has been amended over time to remove aspects that are covered by U.S. 

Broker-Dealer Regulatory Agencies regulations. However, Global Settlement firms continue to 

be subject to more requirements than those that apply to the rest of the industry based on U.S. 

Broker Dealer Regulatory Agencies rules described below. 

SEC Regulation AC adopted in 2003 seeks to address conflicts of interest related to research 

analysis at an industry level. Regulation AC covers research on equity and debt securities. It 

requires that BDs include in research reports a statement by the analyst certifying that the views 

expressed in the report accurately reflect his or her personal views and disclosing whether his or 
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her compensation was, or will be, directly or indirectly, related to the specific recommendations 

or views in the research report. In addition, Regulation AC requires BDs to obtain periodic 

certifications by analysts in connection with the analyst's public appearances. 

Equity 

In addition to this general rule, pursuant to SOX provisions, the U.S. Broker-Dealer Regulatory 

Agencies adopted rules to address equity analyst conflicts of interests (NASD Rule 2711 and 

NYSE Rule 472).13 These rules address conflicts of interest that can arise when analysts work at 

firms that have investment banking or other business relationships with issuers. These rules also 

address conflicts of interest that can arise when the analyst or the firm owns securities of the 

issuer that an analyst covers. In particular, the SRO rules contain provisions concerning trading 

activities, financial interests, business relationships, reporting lines, and compensation, as well as 

other items, in a manner designed to increase an analyst’s independence and manage conflicts. 

Restriction on trading by the analysts 

The rules place various restrictions on an analyst’s personal trading. For example, the rules 

restrict the analyst, and his or her household members, from purchasing or receiving any 

securities before an issuer’s initial public offering, if the issuer is principally engaged in the same 

type of business as companies that the analyst follows. In addition, the rules contain provisions 

that generally restrict an analyst, and his or her household members, from trading in any 

securities of an issuer that the analyst follows during certain periods before and after the 

publication of a research report, and from trading in a manner inconsistent with the analyst’s 

most recent published recommendation regarding that security. The rules require prior approval 

by legal or compliance personnel of certain transactions by persons who oversee research 

analysts. 

Disclosure obligations 

In addition to trading restrictions, the rules place substantial disclosure obligations on member 

firms and analysts. The first category of disclosure is in relation to conflicts of interest arising out 

of ownership interests, including: 

If the analyst or a member of the analyst’s household has a financial interest in the subject 

company, the existence and nature of such interest (including any option, right, warrant, future, 

long or short position; and 

Ownership by the member firm or one of its affiliates of 1 percent or more of the subject 

company’s equity securities. 

The rules also require disclosure if an analyst, or his or her household member, serves as an 

officer, director or advisory board member of the subject company. 

The rules further require disclosure in research reports if the firm was making a market in the 

subject company’s securities at the time a research report was published. 

In addition, the rules generally require various disclosures in research reports regarding 

investment banking business and compensation as well as other activities. For example, the rules 

require that a firm disclose in a research report if: 

The analyst received compensation based upon the firm’s investment banking business or from 

 

13 These Rules were adopted prior to the creation of FINRA. They remain in place and are part of the framework 

under the supervision of FINRA. 
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the subject company in the past 12 months; 

The firm, or its affiliates, (i) managed or co-managed a public offering of securities for the 

subject company in the past 12 months; (ii) received compensation for investment banking 

services from the subject company in the past 12 months; or (iii) expects to receive or intends to 

seek compensation for investment banking services from the subject company in the next 3 

months; 

The firm received compensation for products or services other than investment banking services 

in the past 12 months; 

The analyst or an employee who has the ability to influence the substance of a report knows that 

an affiliate has received compensation for products or services other than investment banking in 

the past 12 months; 

The firm or the analyst has reason to know that an affiliate received such compensation in the 

past 12 months; and 

A subject company is, or during the prior 12-month period was, a client of the firm and types of 

service provided to the subject company. 

In addition, the rules mandate certain compensation disclosures in public appearances. 

Reporting lines and independence of the analysts 

The rules generally provide that no analyst may be subject to the supervision or control of any 

investment banking department employee. 

In addition, the rules generally provide that no personnel engaged in investment banking 

activities may have influence or control over the compensatory evaluation of an analyst. The 

rules also require that analyst compensation be reviewed and approved by a committee that 

reports to a firm’s board of directors or to a senior executive officer of the firm. The committee 

cannot have representation from the firm’s investment banking department. Further, the rules 

delineate specific factors that the committee must consider in its review. 

Influence by issuers 

In addition, the rules address potential undue influence of issuers by placing restrictions on 

communications with the issuer. For example, these rules restrict a firm from sharing draft 

research reports with the subject company issuer other than as necessary to verify the factual 

accuracy of information in the draft report. Further, the draft report cannot contain certain 

information, such as the research rating or the price target. In addition, the rules require that the 

firm’s legal or compliance department be involved in this company review. A complete draft of 

the report must be submitted to legal or compliance personnel before a section of the report is 

sent to the subject company. 

Similar restrictions on internal review by non-research department personnel may reduce the 

possibility of an indirect conflict from the firm’s business relationships (e.g., a sales trader 

representing an institutional investor attempting to influence the outcome).The rules restrict 

when a firm may notify a subject company of a ratings change and prohibit a firm from offering 

favorable research, a specific rating, or price target to an issuer as consideration or inducement 

for the receipt of business or compensation. 

Also, the rules require disclosure of any other actual, material conflict of interest of the research 

analyst or member of which the research analysts knows or has reason to know at the time of 

publication of the research report or at the time of the public appearance. In regard to the 

manner of disclosure, the rules require prominence of disclosures. In particular, the rules provide 
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that the required disclosures must be presented on the front page of a research report or the 

front page must refer to the page on which disclosures are found. In addition, these provisions 

require that the disclosures and references to disclosures be clear, comprehensive, and 

prominent. 

Ethical behavior 

The U.S. Broker Dealer Regulatory Agency rules require that any written or oral communication 

by an analyst with a current or prospective customer or internal personnel related to an 

investment banking services transaction be fair, balanced and not misleading, taking into 

consideration the overall context in which the communication is made. 

Additional rule provisions promote the integrity of research by helping to insulate analysts from 

investment banking pressures. Investment banking personnel are prohibited from directing an 

analyst to engage in sales or marketing efforts related to an investment banking transaction, or 

communicating with a current or prospective customer about an investment banking 

transaction. These rules specifically mandate that no firm or firm employee involved in 

investment banking activities may retaliate against, or threaten to retaliate against, an analyst for 

issuing negative research that may adversely affect the firm’s investment banking business. 

Senior management responsibility 

The U.S. Broker-Dealer Regulatory Agency rules require that firms adopt and implement written 

supervisory procedures reasonably designed to ensure that the firm and its employees comply 

with these rules regarding analyst conflicts. A senior officer of the firm must annually attest that 

the firm has adopted and implemented those procedures. The rules further require specific 

written policies and procedures reasonably designed to restrict or limit information flow 

between research department personnel and trading department personnel. The purpose of this 

rule is to prevent the firm trading ahead of information to be released in a research report. 

Debt research 

Neither the Global Settlement nor most U.S. Broker Dealer Regulatory Agency rules apply to 

fixed income research, though Regulation AC does. In the absence of specific U.S. Broker Dealer 

Agency research analyst rules beyond Regulation AC covering fixed income research conflicts, 

NASD (now FINRA) and NYSE generally rely on antifraud statutes and other SRO rules 

prohibiting fraud and requiring ethical conduct and a comprehensive supervisory scheme to 

oversee a firm’s securities business. 

Also, NASD (now FINRA) and NYSE encouraged firms to consider adopting industry-developed 

principles to address such conflicts. In 2004 the Bond Market Association (BMA), an industry 

association, issued voluntary, principle-based guidelines designed to help firms manage 

potential conflicts faced by fixed income analysts. 

Pending proposals 

A recent GAO report recommended a review of current requirements vis-à-vis the Global 

Settlement with a view to determine whether all firms should be subject to the same 

requirements; and reviewed potential expansion of current rules, beyond Regulation AC, 

regarding research on debt securities. FINRA has been working on both topics (see Regulatory 

Notice 11-11, March 2011 for debt research). 

Monitoring 

The SEC has conducted examinations of select firms not covered by the Global Settlement to 

analyze both voluntary compliance with the Global Settlement and compliance with the U.S. 

Broker Dealer Regulatory Agency rules. The firms reviewed were selected to represent larger, 
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mid-sized and smaller broker-dealers. SEC staff found that these firms had voluntarily adopted 

at least some of the Global Settlement requirements, but such controls were not as formal as for 

the firms covered by the Global Settlement. The SEC staff identified instances of non-compliance 

with the U.S. Broker Dealer Regulatory Agency rules, mainly related to disclosure of conflicts. 

CFTC 

FCMS and IBs

Section 732 of the Dodd-Frank Act (amending section 4d of the CEA) directed FCMs and IBs to 

implement informational partitions between those researching or analyzing prices or markets for 

commodities and those involved in trading or clearing activities. 

CFTC Regulation 1.71 implements the conflict of interest provisions for FCMs and IBs set forth in 

the CEA and contains, among other things, provisions prohibiting improper interference with 

clearing decisions and undue influence on customers, as well as the disclosure of any financial 

interest that a research analyst maintains in any derivative of a type that the research analyst 

follows and the general nature of the financial interest. 

Under CFTC Regulation 1.71, FCMs and IBs are required to adopt written policies and 

procedures that are reasonably designed to ensure that the firm and its employees are in 

compliance with Regulation 1.71. Subsections 1.71(b) and (c) set forth most of the substantive 

requirements as follows: 

Restrictions on relationships with the research department including: 

Non-research personnel may not direct a research analyst's decision to publish a research report 

or direct the views and opinions in the report; 

Research analysts may not be under the supervision, control (including with respect to 

performance evaluation and compensation) of employees of the firm's business trading unit or 

clearing unit; and 

Non-research personnel may not review or approve a research report prior to publication except 

for certain specified reasons; and reviews must be done by authorized legal and compliance 

personnel. 

Restrictions on communications that provide that a research analyst's written or oral 

communication to customers relating to a derivative may not omit any material fact or 

qualification that would make the communication misleading to a reasonable person. 

Restrictions on research analyst compensation that prohibit FCMs and IBs from considering a 

research analyst's contribution to the firm's trading or clearing business in determining 

compensation. 

FCMs and IBs are prohibited from offering favorable research or threatening to change research 

to a customer as consideration or inducement for business or compensation. 

FCMs, IBs and their research analysts must comply with specific disclosure requirements relating 

to a research analyst's financial interest in any derivative that the research analyst follows. 

FCMs, IBs and their employees who are involved in the firm's trading or clearing activities are 

prohibited from retaliating against a research analyst employed by the firm or its affiliate as a 

result of a research report (made in good faith by the analyst) that may adversely affect the 

FCM's or IB's trading or clearing activities. 

The Regulation provides an exemption from the above requirements for smaller IBs that, over 

the preceding 3 years, have generated $5 million or less in aggregate gross revenues from their 
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IB activities. IBs qualifying for this exemption, however, must establish structural and institutional 

safeguards reasonably designed to ensure that the activities of persons who research or analyze 

the price or market for any commodity or derivative are separated by appropriate informational 

partitions from the review, pressure or oversight of persons involved in trading or clearing 

activities. 

Regulation 1.71(e) also requires FCMs and IBs, regardless of size, to adopt and implement 

written policies and procedures that require them to disclose to their customers any material 

incentives and any material conflicts of interest regarding a customer's decision as to trade 

execution and/or clearing of a derivatives transaction. 

Finally, subsection 1.71(d) sets forth specific requirements for FCMs related to clearing activities. 

Those provisions do not become effective until the date on which swap dealers and major swap 

participants are required to apply for registration under CFTC Regulation 3.10. 

SDs and MSPs 

The Dodd-Frank Act (amending Section 4 of the CEA) requires SDs and MSPs to implement 

conflict of interest systems and procedures that establish structural and institutional safeguards 

to ensure that the activities of any person within the firm relating to research or analysis of the 

price or market for any commodity or swap, or acting in a role of providing clearing services, are 

separated by appropriate informational partitions from persons whose involvement in pricing, 

trading, or clearing activities might potentially bias their judgment and contravene open access 

requirements or business conduct standards set forth in the Act. 

Commission Regulation 23.605 implements the conflict of interest provisions set forth in the 

CEA for SDs and MSPs and requires, among other things, the disclosure of any financial interest 

in any derivative of a type that a research analyst follows, the general nature of the financial 

interest, and appropriate informational partitions between business trading units of a SD or MSP 

and clearing units of any affiliated clearing member of a DCO. 

NFA framework 

Research reports that are disseminated to the public would be considered promotional material 

under NFA rules. Therefore, research reports are subject to all of NFA's promotional material 

requirements, including the requirement of Compliance Rule 2-29 that the report not be 

misleading or omit facts that make it misleading. In addition, NFA Compliance Rule 2-4 requires 

Members and Associates to observe high standards of commercial honor and just and equitable 

principles of trade in the conduct of their commodity futures business. If a Member or Associate 

gave preferable treatment to certain customers or used information obtained in a research 

report to their advantage over customers, this conduct would violate NFA Compliance Rule 2-4. 

NFA's Interpretive Notice entitled: Obligations to Customers and Other Market Participants 

prohibits these Members and their Associates from purposefully establishing, increasing, 

decreasing or liquidating a position in any SFP in anticipation of the issuance of a research 

report regarding the underlying security or a derivative based upon the underlying security. The 

Interpretive Notice recommends that Members develop and implement firewalls to isolate 

specific information within research and relevant departments to prevent the trading 

department from using the advance knowledge of the issuance of the research report. The 

Interpretive Notice also recognizes that supervisory procedures need to be adaptable to a firm's 

size and business practices and, therefore, it gives Members the flexibility to develop firewalls 

that are appropriate for their business models. Although NFA acknowledges that SFPs have 

traded on a limited basis, our regulatory oversight of these products has not found any issues 

with the use of research reports. 
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Monitoring 

Compliance with CFTC regulations in connection with conflicts of interest is conducted by the 

NFA through its regular examination program. NFA staff has indicated that their inspections 

have not found significant problems in connection with research analysis 

Other information service providers 

As indicated under Principle 7, the SEC and CFTC review the perimeter of regulation on a regular 

basis via different mechanisms. These reviews have not triggered concerns related to the need 

to regulate any other category of information service provider different from CRAs and sell side 

analysts. Neither did inquiries with market participants reveal concerns on the need to regulate 

any other category of information service provider. 

Assessment Fully Implemented 

Comments The assessors note the lack of more comprehensive rules applicable to research for debt 

securities. However, Regulation AC does cover it and the antifraud provisions do apply to BDs in 

connection with such research. The assessors also note the existence of different requirements 

between the firms covered by the Global Settlement and those that are not covered by it. Work 

on both areas by FINRA is therefore welcome. 

Principles for Collective Investment Schemes 

Principle 24. The regulatory system should set standards for the eligibility, governance, organization and 

operational conduct of those who wish to market or operate a collective investment scheme. 

Description CFTC

Marketing and operating a CIS 

Under section 4m of the CEA, all individuals and firms (with limited exceptions) that intend to 

do business as a CPO (including marketing CPs) must register with the CFTC. Section 1a(11) of 

the CEA defines a CPO as any person who conducts a business of soliciting, accepting or 

receiving from others funds, securities or other property for the purpose of trading in 

commodity interests. The CFTC has delegated registration of CPOs to the NFA. NFA decisions 

on registration are subject to appeal to the CFTC and the courts. Natural person principals 

(which includes beneficial owners of more than ten percent of the firm’s capital) and APs must 

also register. Firms must submit form 7R. 

Eligibility criteria 

Integrity and competence

The CEA (Sections 8a(2) and (3)) specifies factors that disqualify an applicant from registering 

with the CFTC. These include prior disciplinary and criminal offences. To register as an AP, a 

person must disclose background information including on employment and education, and 

pass proficiency tests before soliciting customers. 

Financial capacity

CPOs are not required to meet any minimum financial requirements. 

Organizational requirements 

There are no specific requirements in the CEA or CFTC Regulations mandating specific human 

and technical resources, nor the obligation for the CPOs to have adequate internal controls 

and compliance or risk management as part of the registration process. These issues would 

arise after registration in relation to a firm’s ability to comply with its ongoing obligations. In 
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this regard, NFA Rule 2-9 imposes an obligation on CPOs to supervise their personnel. Based 

on this obligation, CPOs are required to implement compliance programs, which include the 

development of appropriate policies and procedures on day-to-day operations. They are also 

obliged to review their compliance program on an annual basis. There are no explicit 

requirements for CPOs to implement appropriate internal controls and risk management 

systems. However, the NFA has considered that these obligations are implicitly required by 

Rule 2-9, and therefore its supervision modules include the corresponding reviews of such 

arrangements. 

Primacy of investor interests 

CEA and CFTC Regulations create a regulatory system that is primarily disclosure based and 

CFTC Regulations create a range of disclosure obligations. CFTC Regulation 4.24 requires CPOs 

to disclose to pool participants, among other things, fees and expenses, potential conflicts, 

and any material transactions between the CPO and persons affiliated with it. The relationship 

between the CPO and pool participants depends on the form the pool takes (for example 

whether the pool is a limited partnership or an LLC) and the relevant general law relating to 

that relationship. Depending on the structure of the CPO, state corporate law may impose 

some form of fiduciary obligation on the CPO and some aspects of this may apply to the 

CPO’s obligations to pool participants. 

International cooperation 

All pools offered to U.S. investors, including pools managed by foreign entities are required 

(with limited, de minimis, exceptions) to be registered under the CEA. In practice foreign 

operators prefer to constitute a separate domestic pool for U.S. investors. 

For foreign based applicants, NFA also where appropriate performs additional background 

checks such as checks with foreign regulatory and self-regulatory bodies and Interpol. In some 

cases, NFA consults with foreign regulatory authorities to assess the fitness of applicants for 

registration whose applications disclose prior employment with a non-U.S. firm, or where the 

U.S. registrant has foreign principals. 

Sanctions for non–compliance 

If a registered CPO fails to comply with its regulatory obligations, NFA’s Business Conduct 

Committee (BCC) is empowered to take action against the entity and impose sanctions, 

including expulsion, suspension, fine, censure, or any other fitting penalty, for any violation of 

its rules. The CFTC, through its DOE, can impose civil penalties for violations of CFTC 

Regulations ranging from a ban from registration to a monetary penalty. It can also seek 

criminal penalties and does so, especially in relation to breaches of the obligation to register 

(such as by illegal schemes). 

Supervision and ongoing monitoring 

Responsibility and powers of regulator 

The CFTC and NFA are responsible for oversight of CPOs. 

Under Section 17 of the CEA, as a RFA, NFA must: 

Establish training standards and proficiency testing for persons involved in the solicitation of 

transactions, supervisors of such persons and all persons for which it has registration 

responsibilities, and a program to audit and enforce compliance with these standards; and 

Establish minimum standards governing sales practices of its members and associated persons 

for transactions subject to the provisions of the CEA. 
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Registration 

The CFTC has delegated the registration function to NFA, which is responsible for 

authorization of CPOs. When an entity seeks to be registered as a CPO, it must submit a Form 

7R and its Disclosure Document to NFA for review to determine compliance with CFTC 

Regulations as well as NFA membership rules. Form 7R provides details of the applicant 

including prior criminal and disciplinary history. At the time of registration, the NFA does not 

routinely make enquiries about an applicant’s procedures, internal controls and risk 

management, and more generally its compliance arrangements, unless it has adverse 

information about the applicant’s principals or advisers. In that case it makes more detailed 

enquiries. 

A CPO’s principals and APs must complete a From 8R and demonstrate that they have met the 

relevant competence standards (Series 3 examinations). 

Ongoing monitoring and examinations 

NFA, as an RFA, has oversight responsibility for CPOs and has instituted a program that 

monitors compliance by CPOs with all applicable CFTC Regulations and NFA rules, subject to 

oversight of its activities undertaken by the CFTC. Although the CFTC retains authority to 

conduct examinations, NFA has primary responsibility for examinations of CPOs and performs 

periodic examinations. The CFTC does not conduct direct examinations of CPOs. 

NFA conducts examinations of registered CPOs generally within the first year after them 

becoming active and then every 3 to 4 years to monitor compliance with the CFTC’s 

Regulations and NFA’s rules, with higher risk firms subject to more frequent examinations. 

NFA conducts a risk-based analysis to determine the frequency with which it conducts 

examinations and has a separate NFA risk assessment team that contributes to this process. A 

points system is used to score risks. Risk analysis takes into account information filed with the 

NFA, specific business factors and other information such as customer complaints or concerns 

that arise during NFA's review of a firm's Disclosure Document, financial statements or 

promotional material. NFA carried out 186 examinations of CPOs in calendar year 2012; 155 in 

2013; and 100 up to November 2014. Common areas of focus include disclosure and 

performance reporting; review of promotional material; handling of pool funds; financial 

records; and financial reporting requirements; and valuation of assets. 

In its examinations, NFA reviews the compliance program developed by the CPOs, which must 

include review of policies and procedures, internal controls and risk management. To this end, 

the NFA has separate examination modules dealing with these topics. It has also taken 

enforcement actions for deficiencies in processes and procedures. 

NFA also reviews disclosure documents, pool quarterly reports (PQRs), pool certified annual 

financial statements, promotional material and investigative matters (customer complaints and 

referrals from other agencies). CFTC conducts ongoing oversight of NFA with respect to these 

responsibilities. 

Record-keeping and reporting 

Record-keeping

CFTC Regulation 4.23 requires a CPO to make and keep books and records relating to the 

pool as well as to its operation as a CPO in an accurate, current and orderly manner in its main 

business office and in accordance with CFTC Regulation 1.31. 

Reporting 

CFTC Regulation 4.22(c) requires the distribution to pool participants of an annual report 
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within 90 days of the period end. The report must include among other things financial 

statements of pool investments, and CFTC Regulation 4.22(d)(1) requires that these statements 

are prepared in accordance with GAAP, and that the financial statements be audited by an 

independent public accountant. 

NFA requires CPOs to provide annual updates regarding their registration information and 

business operations. In addition, as any other category of registrants, CPOs must submit a selfassessment questionnaire on an annual basis. 

Changes in management and operations

CFTC Regulation 4.26 requires each CPO to correct any defect in its Disclosure Document that 

it knows to be materially inaccurate or incomplete in any respect. Amendments to the 

Disclosure Document must be filed electronically with the NFA, which must accept them 

before they become operative. Changes must be made available to all existing participants 

within 21 days of the date on which the CPO first becomes aware of the need for the change. 

NFA review takes place within this 21 day period. 

Conduct of business 

NFA Rule 2-4 requires a CPO, like other registrants, to observe high standards of commercial 

honor and just and equitable principles of trade in the conduct of its commodity futures 

business. The regime is largely disclosure based, and CPOs are responsible for adhering to 

trading strategies and other information set out in the Disclosure Document and other 

documents governing the operation of the pool, and are required under CFTC Regulation 

4.24(h)(2) to disclose any material restrictions or limitations on trading. 

The relationship between a CPO and pool participants is not a fiduciary one, but anti-fraud 

provisions of the CEA are available to deal with misconduct such as churning and to enforce 

compliance with best execution requirements. 

Allocation of trades

CFTC Regulation 1.35(b)(5) provides detailed rules for the post-trade allocation of transactions, 

including requirements that allocation be made in a fair and equitable manner, and that the 

general nature of the allocation methodology be disclosed to customers. 

Due diligence in investments 

There are no requirements in the CEA or CFTC Regulations regarding the CPO’s due diligence 

in the selection of investments for its CP. This is a disclosure issue and CFTC Regulation 4.24(h) 

requires CPOs to provide a detailed description of the CP’s investment program, including the 

types of commodity interests and other investments the pool will trade, the trading programs 

of any commodity trading advisors the CPO will employ, and the trading programs of funds or 

CPs in which the CPO plans to invest pool assets. CFTC Regulation 4.25 also requires detailed 

past performance statistics and information to be included in a CPO’s Disclosure Document. 

Fees and commissions 

CFTC Regulation 4.24(i) requires CPOs’ Disclosure Documents to include a complete 

description of all fees, commissions and other expense which the CPO knows or should know 

has been incurred by the CP for its preceding fiscal year and is expected to be incurred by the 

pool in its current fiscal year, including fees or other expenses incurred in connection with the 

pool’s participation in investee CPs and funds. 

Conflicts of interest 

The CEA and CFTC Regulations do not mandate that a CPO take action to minimize conflicts of 
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interest, and the regime is disclosure based. CFTC Regulation 4.24(j) requires a CPO to include 

in its Disclosure Document a full description of any actual or potential conflicts of interest 

regarding any aspect of the pool on the part of the CPO, the trading manager (if any), any 

major CTA, the CPO of any major investee pool, any principal of these entities, and any other 

persons providing services to the CP. The CPO must also describe any other material conflict 

of interest with respect to the pool. 

Delegation 

Neither the CEA nor CFTC Regulations prohibit a CPO from delegating functions to another 

person or entity. If a CPO delegates its functions to another person or entity, the CPO remains 

legally responsible for its obligations under the CEA and CFTC Regulations. The delegating 

CPO is jointly and severally liable with the entity to which the CPO delegates its functions 

where the delegate is a related party. 

Through CFTC staff letters allowing for delegation of this kind, the person or entity to which 

the CPO delegates its functions is itself required to register with the CFTC as a CPO and be a 

member of NFA. Regulatory oversight is maintained through periodic audits of CPOs by NFA. 

Both the NFA and CFTC have access to records and information about the delegated 

functions. 

Generally, delegation by a CPO is performed through a contractual arrangement, and the 

CPO’s ability to terminate that arrangement depends on the terms of the contract. 

A CPO is required under CFTC Regulation 4.24 to disclose information about entities and 

individuals who provide services to the CP, any conflicts of interest that may arise, and any 

related party transactions 

SEC

Under the federal securities legislation, a CIS vehicle is either an open-end fund (mutual fund), 

closed-end fund or a unit investment trust (UIT) registered under the ICA. Mutual fund and 

closed-end fund operators are IAs registered under the Advisers Act. 

Exchange traded funds (ETFs) are commonly structured as investment companies, and thus 

subject to the requirements of the ICA as well as the Securities Act disclosure and reporting 

regime. The SEC has provided exemptive relief that takes into account the specific features of 

ETFs and their differences from mutual funds, for example by permitting them to be bought 

and sold at market prices rather than redeemed at NAV.UITs are a small part of the overall CIS 

market. They are fixed period, fixed size and fixed portfolio vehicles, and involve no ongoing 

active management by the trustee. 

REITs are not covered by the ICA framework as they invest in assets different from securities. 

Instead they are governed by the framework applicable to issuers. As a result their offering to 

the public is subject to disclosure requirements as set forth in Principle 16. There is a separate 

disclosure form S-11 where additional disclosures about the investment policies and 

properties of the REIT must be made. Most REITs are exchange listed and as a result the 

corporate governance requirements of the exchanges’ listing requirements would apply to 

them. Many REITS are internally managed (i.e., they do not have a, IA). When externally 

managed (for example mortgage REITs), the officers of the management company are 

deemed to be officers of the REITs. 

Mutual funds account for the vast majority of AUM. As at 31 December 2013, mutual funds 

accounted for 78 percent of total ICA regulated AUM; ETFs for 18 percent; closed-end funds 

for 3 percent; and UITs for less than 1 percent. Because of their importance, the following 
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description deals mainly with mutual funds. 

Marketing and operating a mutual fund 

To become the operator of a mutual fund, a person must register as an IA under Section 203 

of the Advisers Act. The shares of a mutual fund can be marketed by the fund itself, its 

operator or a broker-dealer. Each of these entities is required to be registered with the SEC. 

Eligibility criteria 

A person may not be registered if he/she is subject to a statutory disqualification, which 

relates largely to a previous history of criminal and disciplinary sanctions. Similar to CPOs, 

there are no provisions under the ICA and the Advisers Act that mandate specific human and 

technical resources, nor the obligation for the IAs to MFs to have adequate internal controls 

and compliance or risk management as part of the registration process. States may impose 

educational and professional training requirements on the representatives of SEC-registered IAs 

who have a place of business in that state. 

However, similar to CPOs a series of obligations apply on an ongoing basis, in particular the 

need for IAs to implement a compliance program. Under Advisers Act Rule 206(4)-7 IAs must 

have written compliance policies and procedures that are reasonably designed to prevent 

violations of the Advisers Act; review annually the adequacy of those policies and procedures; 

and designate a Chief Compliance Officer. In adopting this Rule, the SEC articulated its 

expectations about the minimum content of compliance policies and procedures. These include 

portfolio management processes; trading practices; proprietary trading; disclosure to clients; 

safeguarding of client assets; record keeping; marketing; and valuation. There is no explicit 

requirement for IAs to implement adequate internal controls and risk management; however, 

SEC staff indicated that in practice many of the elements that such a requirement would entail 

are covered by the IA’s obligation to implement the compliance rule as well as other relevant 

rules such as the custody and recordkeeping rules. 

For registered funds, a mutual fund’s board of directors, particularly the independent directors,

and the fund’s shareholders bear primary responsibility for assessing the fitness and 

competence of the IA not only initially but on an on-going basis. A fund board must be 

composed of at least 40 percent independent directors; however SEC staff and market 

participants indicated that the practice is generally to have a majority of such directors. This 

practice has been triggered in part by exemptive relief for related party transactions given to 

investment companies provided that their board is composed of a majority of independent 

directors and the requirement for investment companies that pension plans invest in to have a 

majority of independent directors. 

Under Sections 15(a) and (c) of the ICA, the terms of an IA’s contract, and any renewal, must be 

approved by a vote of a majority of the fund’s independent directors and by a vote of a majority

of the holders of the fund’s outstanding voting securities. The board of the mutual fund has a 

positive obligation to obtain the information necessary to assess the terms of the advisory 

contract agreement. Information about the IA and the contract, including the compensation to 

be paid under it, must be provided in the proxy statement provided to shareholders. To this 

end, mutual fund boards meets frequently with the IA. The current practice is to have at least 

quarterly meetings (aligned with financial reporting) and an annual meeting to review the 

performance of the fund as well as other issues including fees. Market participants emphasized 

the active role that mutual fund boards have in practice. This role is supported by additional 

requirements in the regulatory framework including the fact that the board must have 

independent legal counsel and the fund must have a Chief Compliance Officer. The SEC has 

taken enforcement actions against boards that have failed to meet their duties to oversee the 
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158 INTERNATIONAL MONETARY FUND

IAs. 

Mutual funds are subject to a minimum capital requirement of at least $100,000 in net worth. 

For UITs, section 26(a)(1) of the ICA requires the trustee to be a bank with minimum 

capitalization of $500,000. State trustee laws also apply and impose obligations on UIT 

trustees. 

Primacy of investor interests 

The U.S. Supreme Court has interpreted the Advisers Act as imposing a fiduciary standard that 

governs the conduct of fund operators (IAs). The fiduciary duty is enforceable by the antifraud 

provisions in Section 206 of the Advisers Act. IAs’ fiduciary duty obliges them to act in the best 

interests of their clients, including mutual funds of which they are the operator, and to provide 

investment advice in the clients’ best interests. As fiduciaries, operators owe their clients duties 

of loyalty, good faith, full disclosure of material facts and an obligation to avoid or disclose 

conflicts of interest. 

International cooperation 

Mutual funds, including foreign funds, generally must be registered with the SEC to operate in 

the US. Arrangements for cooperation with foreign regulators are described under Principles 

13 and 14. 

Supervision and ongoing monitoring 

Responsibility and powers of regulator 

The SEC has authority to register and inspect mutual funds and IAs, investigate suspected 

violations and take remedial actions under the ICA and the Advisers Act. Violations of the 

legislation and SEC rules are subject to the full range of administrative, civil and criminal 

sanctions described under Principle 11. 

Registration 

The Advisers Act requires IAs seeking to become registered with the SEC to make detailed 

public disclosures in Form ADV. An IA generally provides the mutual fund’s board of directors 

with a copy of this disclosure form, and it is publicly available. 

Both the mutual fund and the securities it issues must be registered. The fund must be 

registered under the ICA and the securities under the Securities Act. The registration 

document for open-end and closed-end mutual funds consists of three parts: 

A prospectus, containing the most essential information for investors to make an informed 

decision about investing in the fund; 

A statement of additional information (SAI) containing information that, while important, is 

not considered as essential to the investor’s investment decision as the information contained 

in the prospectus; and 

A section containing other information (Part C). Part C contains exhibits to the registration 

statement that include the fund’s articles of incorporation and/or bylaws, as well as all material

contracts, such as the advisory contract and any distribution contracts. 

A UIT’s registration statement consists of nine parts and requires a detailed description of the 

trust. 

Registration statements are public documents. For new funds, the SEC must declare the 

documents “effective” before sales of the fund are made. Where a new series is added to an 

already existing fund, post effective amendments to registration statements must be filed, and 
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become effective 75 days after filing without the need for SEC action. 

The SEC reviews all mutual fund registration statements, including post effective amendments 

to ensure appropriate disclosure. In these reviews, the SEC focuses on compliance with all 

disclosure requirements, including: 

 Disclosure of fees and compensation arrangements; 

 Investment policies and associated risks; and 

 The role of the IA and other service providers. 

Ongoing monitoring and examinations 

OCIE administers an examination program that covers mutual funds and their IA operators. 

This program is part of the examination program of IAs (i.e., there is no separate/differentiated 

program for IAs that operate mutual funds). Examinations are conducted primarily to 

determine whether funds and their operators continue to meet eligibility standards and 

whether their practices and procedures comply with the federal securities laws and regulations, 

and also to keep the SEC and its staff informed of developments in the industry. 

Each year, OCIE prepares (and publishes) National Examination Priorities which includes 

priorities for the asset management industry generally, and more specifically for the mutual 

fund industry. For example, for 2014 national priorities included alternative investment 

companies (with a focus on leverage, liquidity and valuation and governance practices) and 

MMFs (with a focus on how MMFs manage stress events). National priorities are developed by 

consultation across the SEC and by using a number of sources of information, including 

information in regulatory filings, information gathered through examinations, comments and 

tips received directly from investors and registrants, data maintained in third party databases, 

and interactions with registrants. 

Selection of firms for examination is based on a variety of quantitative and qualitative factors. 

One input into the overall process is the review of registrant-wide data elements and metrics 

that speak to certain risks at firms. OCIE’s ORAS group and examination staff in Regional 

Offices and the Home Office leverage data analytics and other available information to 

identify firms that may pose higher risk (for example because of potential compliance stress, 

previous examinations, or complaints).This process feeds into the overall planning of firms to 

be examined, which is also governed by Examination Priorities put out each year by the 

National Examination Program.. 

IM’s REO performs ongoing monitoring of a select number of the largest asset managers 

selected for monitoring based on certain risk characteristics. REO engages senior management 

of these firms and fund boards in direct, ongoing discourse about market risks and events, as 

well as operational risks. 

In addition to examinations identified through its risk assessment process, OCIE also conducts 

cause examinations, based on complaints, tips, press reports or other information that 

suggests violations may have occurred, and focuses on the transactions or events giving rise to

its concerns. OCIE also conducts risk-targeted sweep examinations, which typically focus on a 

particular practice (such as soft dollar practices) among a number of mutual fund operators. 

Examinations of individual investment companies are also undertaken, often in conjunction 

with examination of the fund’s IA. 

Examination teams typically consist of a senior manager, an examination manager and 2 to 3 

examiners. SEC systems require a supervisor’s approval be given in at least three points in the 

process to ensure quality standards are met. An examination report that includes any 
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deficiencies identified is provided to the firm, typically with a request for the firm to respond 

and provide details of remediation steps it has taken or intends to take. 

In fiscal year2014, OCIE carried out approximately 170 examinations of IAs that operate 

mutual funds, out of a total population of over 1,600 firms in this category. Typically, the SEC 

also carries out examinations of around 100 investment companies each year out of a total of 

approximately 840 fund complexes. 

Record-keeping and reporting 

Record-keeping 

The ICA, the Advisers Act and related SEC rules require mutual funds and IAs to maintain and 

preserve detailed books and records. All books and records are subject to examination by the 

SEC at any time. 

Reporting 

Section 30(e) of the ICA requires a mutual fund to provide shareholders with annual and semiannual reports and, under SEC rules, these reports must be provided within 60 days of period 

end. These reports must contain detailed information about the financial position of the fund; 

changes in net assets; and the amount and value of each security held. 

Changes in management and operations 

Information about management and organization must be described in an IA’s Form ADV, and 

the IA must keep the information in its Form ADV current by promptly amending it to correct 

any responses that become materially inaccurate. A mutual fund is required to keep current its 

prospectus which contains information about its management and organization. 

Conduct of business 

As a fiduciary, an IA has an obligation to seek to obtain best execution for its clients, including 

mutual funds. The way trades are allocated across accounts managed by an IA must be fair 

and reasonable and consistently applied on a timely basis. The antifraud provisions apply to 

churning, and SROs, including FINRA, prohibit churning and excessive trading by BDs 

executing trades for clients, including a mutual fund. 

Conflicts of interest 

There are detailed provisions in the legislation and SEC rules dealing with conflicts of interest. 

Some conflicts are prohibited (for example, some transactions between the mutual fund and 

its affiliates or IA); some require shareholder approval (for example amendments to a 

distribution plan to increase materially the amount spent on marketing or distribution); some 

require independent review or approval by the fund’s board, especially the independent 

directors. Conflicts must be disclosed. SEC rules require mutual funds and their IAs and 

principal underwriters to adopt codes of ethics governing the personal securities transactions 

of employees. 

Delegation 

There is no statutory prohibition on delegation of operator functions to other persons, if the 

advisory contract between the IA and the mutual fund permits the delegation. There is no 

statutory prohibition against the systematic and complete delegation of core functions (the 

advisory responsibilities) of the IA. If advisory responsibilities are delegated, the delegate is 

considered an IA and may perform services for the fund only under a written contract approved

by a majority of the fund’s shareholders and a majority of the fund’s independent directors. 

The delegate must be also registered with the SEC as an IA. As an IA, the delegate owes a 
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fiduciary duty to the fund. 

Whether the IA is responsible for the actions of the delegate depends on the advisory and subadvisory contracts. Both the IA and the delegate may be responsible for the actions of the 

delegate under some contracts; in other cases only the delegate is responsible. The SEC can 

bring an enforcement action against an IA for failure to supervise a delegate if the delegate 

violates the law and is subject to the IA’s supervision. If the delegate is a sub-adviser, the ICA 

does not permit the IA to terminate the contract without approval by either a majority of the 

fund’s directors or its shareholders. If the delegate is another kind of service provider, the 

ability to terminate the contract depends on the terms of the contract. 

Disclosure to investors of the delegation arrangements and the identity of the delegates is 

made as part of the shareholder vote approving the sub-advisory contract. In addition, a fund 

generally must disclose the same information about the delegate in its registration statement. 

The conflict of interest provisions described above apply equally to delegates. 

Assessment Partly Implemented 

Comments The main reason for the grade has been the limited examination coverage of IAs and 

investment companies (Key Question 8 of the Assessment Methodology). In addition, the 

assessors have also taken into account the absence of express eligibility requirements for CPO 

and IAs in particular in relation to internal controls and risk management (Key Question 2 of 

the Assessment Methodology). 

Examination coverage of IAs 

The SEC has an increasingly sophisticated system for carrying out risk assessments of IAs to 

MFs and identifying higher risk firms for examination. The initial assessment is conducted 

through automated tools, but staff from the regions conducts additional evaluations of firms 

to further refine the selection process. The examinations that do take place appear intensive 

and thorough. However, resource constraints mean that only a little over 10 percent of IAs are 

examined each year. Given that mutual funds are an important investment venue for retail 

investors, and that total mutual fund AUM is approximately $17 trillion, the current rate of 

examinations is less than the importance the sector warrants. 

The assessors recognize that the number of examinations does not reflect other monitoring 

work the SEC carries out in this area, or other contact it has with the industry and individual 

firms. For example, all disclosures and reports filed by mutual funds and their IAs are 

examined by IM staff, and the SEC actively engages with the largest asset management firms. 

Nonetheless, as the IOSCO Assessment Methodology recognizes, on-site inspections are an 

essential tool in monitoring compliance for CIS. 

Eligibility requirements: internal controls and risk management 

The IOSCO Assessment Methodology requires that the regulatory framework for CIS set 

standards for eligibility that include human and technical resources and financial capacity (Key 

Question 2(e)) and internal controls and compliance arrangements (Key Question 2(f)). The 

IOSCO Assessment Methodology states explicitly that, to comply with Key Question 2, it is not 

necessary that a regulator assesses compliance with these eligibility criteria at the time of the 

initial approval of a CIS. Thus, while the requirements need to exist, the methodology allows 

their verification to take place at a moment different from registration. 

The assessors note that the current regime for IAs and CPOs is based on integrity and 

disclosure; and thus from a strictly technical perspective the standard of the methodology is 

not met, as no other requirement is needed for registration (irrespective of the moment of 
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verification). 

However, IAs and CPOs are subject to certain organizational and operational conduct 

obligations on an ongoing basis. In particular, they are required to implement compliance 

programs. Adherence to this obligation is monitored by the examinations undertaken by the 

relevant regulators (including the NFA’s examination of new registrants within their first year 

of operation). In the case of IAs, the role played by MF boards provides some further 

assurance on the adequacy of internal controls and compliance arrangements. 

Neither the rules of the SEC nor those of the NFA expressly require the implementation of 

adequate internal controls or risk management; however, the assessors agree that many of the 

elements that a risk management framework would entail are covered by the existing 

obligations. These include the compliance rule, custody and record-keeping rule for the SEC 

and the obligation to supervise, segregation and record-keeping requirements for the NFA. 

Thus, the assessors consider that the current framework broadly achieves the objectives that 

the Principles and Assessment Methodology seek to achieve. 

However, the authorities should consider the need for an explicit rule, not only to comply with 

the IOSCO Principles, but to ensure that their expectations in this area are well understood by 

the market. In this regard, the assessors note that the SEC is currently considering whether 

broad risk management programs should be required for mutual funds and ETFs to address 

the risks related to their liquidity and derivatives use, as well as measures to ensure the SEC’s 

comprehensive oversight of those programs. These developments are welcome. 

Principle 25. The regulatory system should provide for rules governing the legal form and structure of 

collective investment schemes and the segregation and protection of client assets. 

Description CFTC

Legal form and investors’ rights 

CFTC Regulation 4.20(a) generally requires that a CPO operate its pool as a legal entity 

separate from the CPO. In practice, typically pools have been limited partnerships or LLCs, with 

the CPO acting as the general partner or the managing member. There has been an increase 

in the number of pools structured as investment companies, registered under the securities 

legislation as well as the CEA. 

Disclosure 

CFTC Regulation 4.24(d) requires a CPO to disclose the pool’s form of organization in the 

pool’s Disclosure Document distributed to prospective participants. The offering of an interest 

in the pool generally involves the provision of the organizational documents for the pool in 

conjunction with the Disclosure Document. 

Responsibility for monitoring compliance with form and structure requirements 

When an entity seeks to be registered as a CPO, it must submit a Disclosure Document to NFA 

for review to determine compliance with the CFTC Regulations and NFA rules prior to 

soliciting participants. CFTC Regulations require the Disclosure Document to be up to date 

and materially correct. NFA reviews all Disclosure Documents. The CFTC reviews NFA’s review 

of Disclosure Documents as part of the CFTC’s oversight of NFA. 

Investment and borrowing restrictions

CFTC Regulation 4.24(h)(2) requires a CPO to disclose in its Disclosure Document any material 

restrictions or limitations on trading required by the pool’s organizational documents or 

otherwise. 
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Changes to investor rights 

CFTC Regulation 4.26 requires all information in the Disclosure Document to be current, 

including information relating to rights of participants. It also requires a CPO to provide 

participants with notice of changes to the information in the Disclosure Document within 21 

days of the date on which the CPO becomes aware of the changes (see also Principle 24). 

CFTC staff indicated that this deadline allows for NFA review of the changes. CFTC Regulation 

4.24(w) requires a CPO to disclose all material information to existing or prospective pool 

participants even if the information is not specifically required by CFTC Regulations. 

Separation of assets/safekeeping 

The CEA does not contain provisions that require a separate custodian for CPs. CFTC 

Regulations require that all funds, securities and property received by a CPO must be received 

in the name of the CP. A CPO is not permitted to commingle the property of any CP with the 

property of any other person. In addition, CFTC Regulations require a CPO to disclose in its 

Disclosure Document the name of the entity (such as a bank, broker-dealer or custodian) that 

will hold the pool’s assets. A CPO must disclose the manner in which the pool’s assets will be 

held in segregation. If assets are held by an entity affiliated with the CPO, that fact would need 

to be disclosed. 

In practice, most CP assets are held by parties other than the CPO. Of the approximately 6,000 

pools for which CPOs had filed information with the CFTC on June 30, 2014, only 374 did not 

list a separate custodian or broker. Of that 374, 268 only invest in other funds or pools, per 

their schedule of investments, and 89 had a NAV of $0. Of the remaining 17 pools without 

custodians, 13 have added a broker or custodian since the filing date. The authorities advised 

that, where a custodian is used, it may be a related party of the CPO, and this is likely to occur 

for larger CPOs that are members of financial services groups. 

Winding up

CFTC Regulations require the filing of a final annual report containing financial statements 

within 90 days of a pool’s permanent cessation of trading or the return of funds to 

participants. If necessary, Section 6c of the CEA provides the CFTC with the ability to obtain 

court orders to freeze pool and/or CPO assets and have receivers appointed to operate the CP

for the benefit of participants. 

SEC

Legal form and investors’ rights 

There are no specific requirements as to the legal form of open-end or closed-end funds in the 

ICA. Under the Act, a fund must be organized or created either under the laws of the U.S. or a 

state or under the laws of a foreign country. An open-end or closed-end fund generally may 

be organized as a corporation, a partnership, an association, a joint-stock company, a trust, or 

any organized group of persons, and most open-end and closed-end funds are structured as 

business trusts or as corporations. A UIT must be organized under a trust indenture, contract of

custodianship or agency, or similar instrument. 

The ICA imposes some capital structure requirements on mutual funds. For example, Section 18

of the ICA requires that all common stock issued by a fund be voting stock and have equal 

voting rights. The Act provides that closed-end funds are permitted to have only one class of 

debt and one class of preferred stock in addition to one class of common stock. 

Open-end funds must offer redeemable securities that entitle a fund investor to redeem shares 

at the fund’s NAV. Closed-end funds do not issue redeemable securities. 
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Disclosure 

A fund must disclose in its registration statement whether it is an open-end or closed-end 

fund or a UIT, information about the redeemability of shares and the jurisdiction in which it is 

organized. The registration statement exhibits include copies of its organizational documents 

(such as articles of incorporation). 

Responsibility for monitoring compliance with form and structure requirements 

Responsibility for ensuring that requirements are observed rests primarily with the mutual fund

board and with those who signed its registration statement.The SEC reviews fund registration 

statements to determine whether the fund has made the disclosures required by the 

registration form, including disclosure about the form and structure of the mutual fund. OCIE 

examinations would detect any material non-compliance by a mutual fund with its disclosed form 

and structure, and where appropriate enforcement action could be initiated. 

Investment and borrowing restrictions—fund liquidity rules 

Under SEC rules, open-end funds must have 85 percent of assets as liquid assets. In this 

context “liquid” means assets that can be sold within 7 days at their carrying value, which is 

understood to mean in normal market conditions. 

For MMFs, the SEC introduced new liquidity rules in 2010. These include: 

Daily Requirement: all taxable money market funds must hold at least 10 percent of assets in 

cash, U.S. Treasury securities, or securities that convert into cash (e.g., mature) within one day; 

Weekly Requirement: all money market funds must hold at least 30 percent of assets in cash, 

U.S. Treasury securities, certain other government securities with remaining maturities of 

60 days or less, or securities that convert into cash within one week; 

Rules restricting money market funds from purchasing illiquid securities if, after the purchase, 

more than 5 percent of the fund's portfolio will be illiquid securities (defining as "illiquid" any 

security that cannot be sold or disposed of within seven days at carrying value). 

Changes to investor rights 

Under the ICA, some material changes (such as the approval of an advisory contract) require 

the approval of shareholders. Material changes that do not require shareholder approval (for 

example, changes in a fund’s investment objectives or strategy) require a fund to update its 

registration statement, including its prospectus, so that new shareholders or existing 

shareholders making a new investment are informed of the change. All registration statements 

are available through the SEC website. In practice, open-end funds generally provide updated 

prospectuses annually to shareholders. A closed-end fund discloses material changes in its 

annual reports to shareholders. 

A fund must provide shareholders with at least 60 days’ notice prior to changing a fundamental 

investment policy of investing at least 80 percent of the fund’s assets in the type of investments 

suggested by the fund’s name (SEC Rule 35d-1). 

Separation of assets/safekeeping 

Pursuant to Section 17(f) of the ICA and related rules, a mutual fund must place securities and 

similar investments in the custody of certain eligible custodians. For open-end and closed-end 

investment companies, eligible custodians include: 

Banks subject to federal or state regulation that have capital of at least $500,000; 

Members of a national securities exchange (i.e., certain broker-dealers); 
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Securities depositories; 

FCMs and commodity clearing organizations; and 

Certain foreign entities subject to certain conditions. 

Because a UIT has no board to monitor custody arrangements, Section 26(a) of the ICA 

provides that a UIT may not maintain custody of its own assets, but must designate one or 

more banks (that have an aggregate capital of not less than $500,000) as trustees or

custodians. 

Related party trustee-custodian 

There is no requirement that a fund’s custodian be legally or functionally independent from the

IA operator. If an operator or its affiliate acts as a fund’s custodian, however, the fund is 

deemed to have “self-custody”. A fund deemed to have self-custody is subject to additional 

obligations under ICA Rule 17f-2, which requires, among other things, that: 

The fund must deposit the securities and similar investments in the safekeeping of, or in a 

vault or other depository maintained by a bank or other company whose functions and 

physical facilities are supervised by federal or state authorities; 

The securities and similar investments must be physically segregated from those of any other 

person; 

The board of directors of the fund must designate which employees (not more than five 

persons) are authorized to have access to the assets; and 

Written notations must document each deposit or withdrawal of securities. 

In addition, the fund must employ an independent public accountant to verify, by actual 

examination, the fund’s assets at least three times each year (twice without prior notice). A 

certificate of this accountant, stating that the examination has been made, and describing its 

nature and extent, must be sent to the SEC after each examination. 

In practice, the use of the self-custody is rare, with less than 200 out of the 4,200 registered 

funds using it, and most custodians are independent. 

Winding up

A mutual fund remains subject to all provisions of the ICA until it is deregistered. To 

deregister, the fund must obtain an order from the SEC declaring that it has ceased to be a 

fund and that its registration is no longer in effect. The SEC has authority to impose conditions

on deregistration that are necessary for the protection of investors. The SEC in practice has 

generally required that, to deregister, a fund must have distributed all assets to shareholders, 

sold its assets to another fund or merged with another fund. 

Assessment Broadly Implemented 

Comments The grade of this Principle is caused by the current regime applicable to CPs in connection 

with Key Question 8(b) of the IOSCO Assessment Methodology that requires special legal or 

regulatory safeguards in cases where the functions of custodian and/or depositary are 

performed by the same legal entity responsible for the investment functions or its related 

entities. 

The assessors recognize that CFTC Regulations require a segregation regime rather than a 

“custody” regime and that such an arrangement is contemplated by the Assessment 

Methodology. Thus, in the assessors’ opinion the regime required by the CFTC meets the 

requirements of Key Questions 8(a) and 8(c). However, the current legal and regulatory 
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166 INTERNATIONAL MONETARY FUND

framework does not require additional safeguards to deal with the risks arising where the CPO

(or a related entity) performs the custodian or depositary function. In this respect, while there 

is a widespread industry practice regarding the use of separate custodians, such custodians 

can be a related party (and this seems to be the case for larger groups) and thus, the 

additional safeguards required by the Assessment Methodology would still be necessary. 

Therefore the assessors recommend that consideration be given to amending the legislation 

to require additional safeguards where a CPO or a related entity has possession of pool assets.

For mutual funds, additional safeguards are provided by the requirement that, where assets 

are held by the IA itself or its affiliate, an independent public accountant must examine the 

fund’s assets at least three times during the year (twice in a surprise examination). 

Principle 26. Regulation should require disclosure, as set forth under the principles for issuers, which is 

necessary to evaluate the suitability of a collective investment scheme for a particular investor 

and the value of the investor’s interest in the scheme. 

Description CFTC

In practice, most CPs are institutional funds only available to sophisticated investors, and only 

10-15 percent have retail investors. Non-retail pools are distributed by private placement and 

do not need to comply with the disclosure rules described below. Retail pools are subject to 

both CEA Disclosure Document rules and, since they constitute a security under the securities 

legislation, Securities Act prospectus obligations. Compliance with both CEA and Securities Act 

disclosure obligations can generally be met in a single set of disclosure documents. The antifraud provisions apply to all disclosures made in connection with CPs, including non-retail 

pools. 

Disclosure to investors 

Offering documents 

CFTC Regulations require that a CPO provide a detailed Disclosure Document to prospective 

pool participants before accepting their subscriptions. Regulation 4.24 sets out detailed 

requirements for the Disclosure Document, including information about the pool and its 

operator; fees and expenses; conflicts of interest relating to the operation of the pool; risks of 

futures trading and specific risks of the pool; information on the pool’s investment program 

and use of proceeds; and provisions relating to redemption. Regulation 4.25 regulates 

performance information, including by requiring it to be in a prescribed format. NFA Rule 

2.35(a)(1) requires Disclosure Documents to be written using plain English principles. 

If a CPO knows or should know that the Disclosure Document is materially inaccurate or 

incomplete, it must correct that defect and distribute the correction within 21 calendar days. 

Periodic reports

A CPO must provide a report to each participant at least monthly (quarterly for pools with less 

than $500,000 in assets), which contains detailed financial information about the pool, 

including the realized and unrealized gains and losses for the pool, all management and 

advisory fees and brokerage commissions paid by the pool, and the net asset value of the 

pool. 

A CPO must also provide an annual report to each participant. This must contain all of the 

items of the monthly report, plus additional financial disclosures by way of a statement of 

financial condition of the pool for both the current and preceding fiscal year. 
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Regulator’s powers

The NFA is responsible for reviewing all Disclosure Documents. Before using a Document, a 

CPO must receive an acceptance letter from the NFA. The CFTC conducts quarterly reviews of 

the NFA’s review of Disclosure Documents by analyzing a sample of Disclosure Documents 

that have been accepted by the NFA. 

Advertising 

CFTC Regulation 4.41 prohibits fraudulent and misleading advertising in relation to CPs. NFA 

receives and reviews all promotional material used in the marketing of pools, and also 

proactively monitors advertising in broadcast media. 

Accounting standards 

CFTC Regulation 4.22 requires that the financial statements in the periodic and annual reports 

must be presented and computed in accordance with U.S. GAAP consistently applied. The 

pool’s annual report must be certified by an independent public accountant. 

Ensuring compliance with investment policies

All offering materials and account statements provided by a CPO to its participants must also 

be filed with NFA under CFTC Regulations. NFA reviews these documents, and conducts 

periodic on-site examinations of the CPO as a means of monitoring and assuring compliance 

with CFTC Regulations. Changes in the investment policy of a fund would require an updated 

Disclosure Document, which must be accepted by the NFA before it can be used. 

SEC

Disclosure to investors 

Offering documents 

Prospectuses for mutual funds must comply with detailed disclosure obligations set out in 

forms required for each type of fund, open-end (Form N-1A), closed-end (Form N-2) and UIT 

(Form N-8B-2). Prospectuses must contain all the information required by Key Question 5 of 

the IOSCO Methodology. They include requirements to disclose all information that is material 

to an investor’s decision to invest. There are detailed requirements for disclosure of fees 

including the use of mandated fee tables. More detailed fee information is also available 

through the SAI that must be made available to investors. 

In practice, most investors in closed-end funds acquire their shares in the secondary market 

and may not receive a prospectus because the prospectus delivery requirement applies only 

to the primary offer. For these investors, the main source of information on, for example, fees 

is the annual and semi-annual reports. 

SEC rules require a summary of key information at the front of a fund’s prospectus. This key 

information must be in plain English in a standardized order. Delivery of the summary 

prospectus to clients is optional, but if the fund chooses to deliver one, itsr content must be 

the same as the summary in the full prospectus, and investors must have access to the full 

prospectus on an Internet website. 

Periodic reports

Section 30(e) of the ICA requires that funds provide annual and semi-annual reports to 

shareholders. The reports must include financial statements, a statement of operations, a 

statement of changes in net assets, a schedule of portfolio holdings that shows the amount 

and value of each security owned by the fund on that date, and a financial highlights schedule.

The financial highlights information shows financial results for a single share of a fund. Only 
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168 INTERNATIONAL MONETARY FUND

the annual reports must include audited financial statements accompanied by a certificate of 

an independent public accountant registered with the PCAOB. Reports must be transmitted to 

shareholders within sixty days of the close of the relevant period. 

Sections 30(a) and (b) of the ICA and SEC Rule 30a-1 require a fund to file with the SEC a semiannual report on Form N-SAR within 60 days of the close of the relevant period. Form N-SAR 

contains information designed to aid in the SEC’s monitoring of a fund’s operations. 

Material event reporting

An open-end fund that continuously offers its shares to the public must have at all times a 

current, effective registration statement. As a result, an open-end fund amends its registration 

statement at least annually to include updated financial information, or more frequently, if 

necessary, to reflect material changes in its operations. 

The Securities Act requires a fund that is making a continuous offering of its securities to maintain 

a current statutory prospectus. A fund making a continuous offering of its securities can update its 

prospectus by filing a post-effective amendment to its registration statement that contains updated

financial statements and other information. 

Regulator’s powers

To sell its shares to the public, a mutual fund must register itself under the ICA, and register the 

offering of its securities under the Securities Act. The Securities Act gives the SEC power to 

hold back or intervene in an offering if an offering document is found to contain incomplete, 

inaccurate, or false and misleading information,, for example through the use of stop orders 

(Section 8) and cease and desist orders (Sections 8A and 10(b)). As noted under Principle 24, 

the SEC reviews all registration documents and material amendments to them, including 

prospectuses. 

Advertising 

Like offering documents, all marketing materials are subject to the antifraud provisions of the 

federal securities laws and are prohibited from containing material misstatements or omissions. 

Different disclosure requirements apply depending on the type of advertisement. 

Section 24(b) of the Investment Company Act requires open-end investment companies and 

UITs and their underwriters, in connection with a public offering, to file copies of all of their 

advertisements and sales literature with the SEC or with FINRA (if the shares are sold by a 

FINRA member). Typically a fund’s shares are sold through BDs, and FINRA rules require a BD to

file with FINRA any advertisement or sales literature that it uses to market the company. FINRA 

reviews these. Advertisements and sales literature filed with the SEC may be reviewed by the 

SEC staff as part of an inspection to ensure that the material is not false or misleading. 

Accounting standards 

The financial statements in a fund’s annual and semi-annual reports must be prepared in 

accordance with the U.S. GAAP. Regulation S-X requires that an independent public accountant

registered with the PCAOB perform an audit of the fund’s financial statements in accordance 

with PCAOB standards and state that the financial statements are prepared in accordance with 

the U.S. GAAP. 

Ensuring compliance with investment policies

OCIE examinations of funds and their IAs (described under Principle 24) include checking 

compliance with a fund’s stated investment policy or trading strategy. 

Assessment Fully Implemented 
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Comments 

Principle 27. Regulation should ensure that there is a proper and disclosed basis for asset valuation and the 

pricing and the redemption of units in a collective investment scheme. 

Description CFTC

Under the CEA, issues relating to asset valuation and the redemption of interests in CPs are 

primarily dealt with through disclosure requirements. The disclosure regime is supplemented 

in some areas by CFTC Regulations. 

Asset valuation 

Principles for valuation 

CFTC Regulations require CPOs to use U.S. generally accepted accounting principles (GAAP) in 

calculating the net asset value of a pool. These principles include FAS 157 (now FASB ASC 

820), Fair Value Measurements, which establishes a framework for measuring fair value and 

requires disclosure about fair value measurements. 

Timing 

There are no rules in the CEA or CFTC Regulations that deal with the timing of asset valuations 

other than those that require valuation at least monthly (quarterly for small pools) for the 

purposes of the account statement that is sent to all pool participants. Investors in exchangetraded products have access to daily market price information. 

Independent audit 

Annual financial reports of CPs must be audited by an independent public accountant. 

Pricing and redemption of interests 

CFTC Regulation 4.24(p) requires a pool’s Disclosure Document to contain a complete 

description of any restrictions upon the transferability of a participant’s interest in the pool, 

and a complete description of the frequency, timing, and manner in which a participant may 

redeem interests in the pool. The description about redemption must specify how the 

redemption value of a participant’s interest will be calculated, the conditions under which 

redemption will be made (including the time between request for redemption and payment) 

and any restrictions on redemptions. 

CFTC Regulation 4.22 requires CPOs to distribute Account Statements to participants monthly 

(quarterly if the pool has AUM less than $500,000). These reports include all material 

information relevant to the net asset value per participation of the pool. Similar information 

must be included in the Disclosure Document provided to any prospective participant. 

Pricing errors 

The regulatory regime (including NFA rules) does not contain specific provisions dealing with 

errors in the pricing of interests and the authorities are not aware of any industry standards or 

similar protocols that provide for the way in which investors who have been adversely affected 

by pricing errors are to be treated. 

Suspension/deferral of redemptions 

A pool’s Disclosure Document must disclose the circumstances under which redemptions can 

be suspended. If a CPO were to suspend or defer redemptions in a manner inconsistent with 

its Disclosure Document it would need to update the Disclosure Document and provide a 

copy of the amended document to the NFA. In appropriate circumstances, such an action may 

also trigger an enforcement action by NFA or the CFTC. A CPO’s quarterly report on Form 
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170 INTERNATIONAL MONETARY FUND

CPO-PQR is required to disclose any halt or any other material limitation on redemptions 

during the reporting period. 

Regulatory authority to monitor compliance 

The CFTC and NFA have the power to take action where a CPO has violated either CFTC or 

NFA rules with respect to valuation and redemption. 

SEC

Asset valuation 

Principles for valuation 

Valuation of investment companies’ portfolio securities is governed by the ICA and related SEC 

rules. These regulations require a fund to value securities for which market quotations are 

readily available at their current market value, and other securities and assets at fair value as 

determined in good faith by the fund’s board of directors. The SEC has also addressed many 

issues relating to fund valuation and pricing in its Accounting Series Releases. 

Financial statements filed with the SEC generally must be prepared in accordance with U.S. 

GAAP. The FASB Accounting Standards Codification, which is the source of GAAP, requires 

investment companies to report investments at fair value. 

Where market prices not available

Section 2(a)(41) of the ICA provides that the board of directors of a fund must determine, in 

good faith, the fair value of portfolio securities (and other assets) for which market quotations 

are not readily available. The methodology approved by the board must be consistent with 

U.S. GAAP. 

Timing 

ICA Rule 22c-1 generally requires that an open-end fund compute its NAV at least once daily, 

Monday through Friday. 

Independent audit 

The board of directors of the fund is responsible for overseeing the valuation of the fund’s 

portfolio securities. Fund boards must approve the valuation criteria and are responsible for 

continuously reviewing valuation methods to assure that the valuations of portfolio securities 

are fair and accurate. ICA Rule 38a-1 requires a fund to adopt written policies and procedures 

to, among other things, regularly review the appropriateness and accuracy of the method 

used to value securities. 

As part of the annual audit, PCAOB registered independent auditors review and evaluate the 

processes used by funds to value their portfolio securities. This includes processes for the 

valuation of securities for which market quotations are readily available, and also the 

processes used by the board in arriving at fair value for other securities. 

Pricing and redemption of interests 

Requirement 

SEC Rule 22c-1 requires that sales and redemptions must be effected at the current net asset 

value next computed after receipt of an order to redeem, purchase or sell. Closed-end funds do 

not redeem their shares but they can repurchase them. Section 23 of the ICA generally 

prohibits a closed-end fund from selling its common stock at a price below current NAV. MMFs 

are subject to different rules and currently permitted to apply constant NAV for sales and 

redemptions. Recent rules which will become effective in 2016 would require institutional 
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INTERNATIONAL MONETARY FUND 171

prime MMFs and institutional municipal MMFs to use variable NAV. 

Disclosure 

Disclosure of the procedures for subscription and redemption of shares is required in the 

prospectus of an open-end fund and a UIT. 

The federal securities laws do not require that the prices of a fund be disclosed or published on

a regular basis to investors other than in semi-annual reports. However, the price of a fund is 

generally available in financial publications and web sites and may also be available on the 

fund’s or IA’s website. 

Pricing errors 

The SEC indicated that it may bring an enforcement action against a fund or its IA if a pricing 

error violates, or results in violation of, the U.S. federal securities laws. 

There are voluntary industry rules of practice, adopted by many funds, to address pricing 

errors. These include rules on the circumstances in which compensation should be made to 

shareholders for losses resulting from pricing errors. 

The valuation procedures of a fund generally provide for the reporting of any material pricing 

errors to the board of directors, and may call for the board to review or approve any corrective

action that was taken. Pricing errors that are not considered material would be corrected on a 

going-forward basis. A fund typically would not report pricing errors to the SEC unless the 

error is required to be reflected in its financial statements filed with the SEC. 

Suspension/deferral of valuations and redemptions 

Under the ICA, funds may, but are not required to, suspend redemptions and postpone 

payment for redemptions already tendered for any period during which the NYSE is closed. A 

fund also may suspend redemptions: 

For any period during which trading on the NYSE is restricted, as determined by the SEC; or 

For any period during which an emergency exists, as determined by the SEC, as a result of 

which it is not practicable for a fund to either liquidate its portfolio securities or fairly 

determine its NAV. 

Under rules made in 2010 and recently amended, MMFs are permitted to permanently suspend 

redemptions in certain circumstances in order to facilitate an orderly liquidation of the fund, if 

the board including a majority of independent directors approves the liquidation. Other 

amendments to come into effect in 2016 will allow the board of an MMF that holds other than 

government securities to temporarily suspend redemptions (impose redemption gates) in 

specified circumstances for a limited amount of time and will allow (and in some circumstances 

require) a non-government MMF’s board to impose a liquidity fee on shareholder redemptions

in certain circumstances. 

Generally a fund (other than an MMF in specified circumstances) cannot suspend the right of 

redemption or postpone the date of payment more than seven days after the tender of the 

security to the fund or its redemption agent. The fund must amend its prospectus to discuss 

any suspension or deferral of redemption rights, and the amended prospectus must be filed 

with the SEC. Suspension of redemptions for other reasons requires an order from the SEC. 

The SEC can grant such an order only if it determines the order is necessary for the protection 

of the fund’s shareholders. 

Regulatory authority to monitor compliance 

The SEC has the power to ensure compliance with the rules applicable to asset valuation and 
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172 INTERNATIONAL MONETARY FUND

pricing through its examinations of registrants and through enforcement actions. OCIE reviews 

fund asset valuation and pricing during its examinations of funds, fund operators, and thirdparty administrators that perform operational and administrative functions. The SEC has taken 

enforcement actions for inappropriate valuation practices. 

Assessment Broadly Implemented 

Comments The issue that impacted the grade for this Principle is the absence of any regulatory 

requirements, rules of practice and/or rules addressing pricing errors in CPs, as contemplated 

by Key Question 8 of the Methodology. In the assessors’ view, what the Methodology 

envisages is rules that provide for the way investors are to be treated, if errors in the pricing of 

CIS interests occur, and goes further than merely accounting adjustments when errors are 

discovered. Express provisions, including where appropriate compensation arrangements, are 

a feature of many other jurisdictions, in some cases contained in industry rather than 

regulatory standards. The assessors acknowledge the authorities’ observation that in practice 

there appear to be few examples of pricing errors in CPOs, and the issue does not appear to 

arise in customer complaints or NFA arbitration cases. 

In addition, the assessors note that there is a voluntary industry code of practice dealing with 

pricing errors for MFs, which deals with compensation to investors for losses arising from 

pricing errors. However, the code is voluntary and the SEC does not have explicit authority to 

enforce it, although in some cases it may be able to take action on pricing errors, if they 

resulted in a violation of the federal laws. 

Principle 28. Regulation should ensure that hedge funds and/or hedge funds managers/advisers are 

subject to appropriate oversight. 

Description Definition of HFs 

U.S. federal securities and commodities laws do not specifically define HFs. 

CIS in the U.S. are regulated by the ICA when the CIS invests primarily in securities and the 

CEA when the CIS invests primarily in commodities. 

A HF (as defined in the IOSCO Assessment Methodology) may be regulated by the ICA if it 

meets the definition of “investment company” and is ineligible for an exemption or exclusion. 

HFs and other private pools of capital that are not offered to the public typically rely on one of 

two statutory exclusions: (i) Section 3(c)(1) of the ICA excludes any issuer whose outstanding 

securities (other than short-term paper) are beneficially owned by not more than 100 investors 

and that does not make a public offering of such securities. (ii) Section 3(c)(7) of the ICA 

excludes any issuer whose outstanding securities are owned exclusively by persons who, at the 

time of acquisition of such securities, are “qualified purchasers” (as defined by Section 2(a)(51) 

of the ICA) and that does not make a public offering of such securities. Qualified purchasers 

are generally individuals with $5 million in investments or entities with $25 million in 

investments. 

A HF (as defined in the IOSCO Assessment Methodology) may be regulated under the CEA, if 

it meets the definition of a “CP” described in Principle 24 and is ineligible for an exclusion or 

an exemption. In practice most HFs that invest in commodities are as a product exempted 

from registration. 

Registration of HF managers 

HFs that invest in securities 

Title IV of the Dodd-Frank Act expanded the categories of IAs that are subject to registration 

with the SEC. Pursuant to this Act each IA with AUM over S$100 million must be registered 
UNITED STATES 

INTERNATIONAL MONETARY FUND 173

with the SEC, regardless of the number of clients, unless that adviser can fit within several 

exemptions that include the following three: (i) adviser to a “venture capital fund”; (ii) adviser 

solely to “private funds” with total U.S. assets under management (AUM) of less than $150 

million; or (iii) a foreign private adviser. Managers relying on exemptions (i) and (ii) above 

(known as “exempt reporting advisers,” or “ERAs”) are subject to examination by the SEC, and 

all advisers, even if exempt from registration continue to be subject to the antifraud provisions 

of the U.S. federal securities laws. As a result, the majority of advisers to HFs offered in the U.S.

are subject to registration with the SEC. 

Registration requirements for IAs to HFs 

IAs to HFs registered with the SEC are subject to the same entry requirements as all other 

registered IAs. IAs, including IAs to HFs, register with the SEC by filing Form ADV. ERAs report 

certain information on Form ADV. Form ADV requires an IA to provide specific information 

upon registration that provides transparency into the business of the HF manager and on the 

HFs that it manages. The information provided by IAs that manage HFs upon registration 

includes: (i) background of organization and ownership; (ii) assets under management; 

(iii) services offered; (iv) types of clients, (v) fees charged; (vi) investment related affiliates; 

(vii) investment strategies utilized; (viii) identification of key service providers; and (ix) conflicts 

of interest. Forms ADV are public from the moment of filing and can be accessed via the SEC 

website. 

Ongoing reporting requirements 

Rule 204-1 under the Advisers Act requires registered advisers to complete and file an annual 

update of Part 1A and 2A of the Form ADV registration form through Investment Advisers 

Registration Depository (IARD). Advisers must file an annual updating amendment to Form 

ADV within 90 days after the end of the firm’s fiscal year. In addition to annual filings, 

amendments must be filed promptly whenever certain information contained in the Form ADV 

becomes inaccurate. Therefore, all information required at registration is required to be 

updated on an ongoing basis. 

Pursuant to Section 204 of the Advisers Act and Rule 204(b)-1 IAs with at least $150 million in 

private fund RAUM are subject to additional ongoing regulatory requirements through the 

filing of Form PF, to assist the FSOC in identification of systemic risk. Forms PF are filed on a 

confidential basis. Both the amount of information to be reported and the frequency with 

which Form PF must be filed depend on the amount of the adviser’s private fund RAUM and 

the types of private funds managed. Most advisers are required to file Form PF once a year, 

and report only basic information regarding the private funds they advise. This annual filing 

requirement includes general data such as the types of private funds that an adviser advises 

(e.g., private equity or HFs, and information relating to such funds’ size, leverage, types of 

investors, liquidity and performance). IAs to HFs must also report information about fund 

strategy, counterparty credit risk, and the use of trading and clearing mechanisms. Large 

private fund advisers must also provide more detailed information. The content and frequency 

of this more detailed reporting is different depending on the type of private fund the large 

adviser manages: 

Advisers with at least $1.5 billion in HF RAUM must file Form PF quarterly with respect to their 

HFs. Information required to be reported generally includes aggregate information on such 

funds’ exposures, geographical concentration, and turnover by asset class (not position-level 

information). For each Qualifying HF (i.e., $500 million or more in net assets), additional 

information relating to each fund’s exposures, leverage, risk profile, and liquidity is required. 

These reports must be filed within 60 days. 
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174 INTERNATIONAL MONETARY FUND

Advisers with at least $1 billion in combined liquidity fund and registered money market fund 

RAUM must file Form PF quarterly with respect to their liquidity funds. Information required to 

be reported generally includes each such fund’s exposures, geographical concentration, and 

turnover by asset class (not position-level information), and direct and indirect forms of 

leverage and liquidity. These reports must be filed within 15 calendar days. 

Advisers with at least $2 billion in private equity fund RAUM must file Form PF annually with 

respect to their private equity funds. Information required to be reported generally relates to 

each such fund’s use of direct and indirect leverage (e.g., use of financing) and investments in 

financial institutions. These reports must be filed within 120 calendar days. 

Form PF requires the reporting of information on counterparty credit exposure in relation to 

OTC derivatives positions, loans, and loan commitments. 

Disclosure requirements towards clients 

As indicated above ADV Forms are public. In addition, registered IAs including those that 

manage HFs must provide clients and prospective clients with a brochure containing narrative 

disclosure of certain information about the firm. Any additional duty to provide documents to 

investors will depend upon the IA’s contractual relationship with each client (i.e., the IA’s 

duties as described in the private offering memorandum or advisory contract). 

Other ongoing requirements 

IAs to HFs are subject to the same ongoing obligations as other registered IAs, including: 

The “Books and Records Rule” (see Principle 24) which requires registered advisers, to make 

and keep true, accurate and current certain books and records relating to the firm’s 

investment advisory business. Generally, most books and records must be kept for five years 

from the end of the year created, in an easily accessible location. 

Segregation of client assets rule, which generally makes it fraudulent for IAs to have custody 

of client funds or securities, unless certain conditions are met (as discussed under Principle 

29). If an adviser has custody of client assets, an independent public accountant must verify all 

of those client assets by actual examination at least once during each calendar year. 

The “Code of Ethics Rule” which requires registered advisers to adopt a code of ethics which 

sets forth the standards of business conduct expected of the adviser’s supervised persons and 

must address the personal trading of their securities. 

The “Advertising Rule” which prohibits advertisements by registered advisers that are false or 

misleading or contain any untrue statements of material fact. 

The “Compliance Rule” which, as described in Principle 24, requires registered advisers to 

(a) adopt and implement written policies and procedures reasonably designed to prevent 

violation of the Advisers Act and rules that the Commission has adopted under the Advisers 

Act; (b) conduct a review, no less than annually, of the adequacy of the policies and 

procedures; and, (c) designate a chief compliance officer who is responsible for administering 

the policies and procedures. 

As any other IAs, IAs to hedge funds are subject to fiduciary duties. 

HFs that invest in commodities 

Prior to Dodd-Frank Act, CPOs of HFs were usually not subject to registration with the CFTC as 

most of them fell under an exemption from registration in cases where the pool operated by 

the CPO met certain requirements, including investor qualifications. The CFTC reviewed 

exemptions and exclusions in light of the expansion of the definition of commodities interest 
UNITED STATES 

INTERNATIONAL MONETARY FUND 175

and eliminated the exemption listed above. As a result, CPOs that manage HFs must now 

register with the CFTC under the same terms of any other CPO. In practice the registration is 

conducted by the NFA pursuant to delegation. 

Registration requirements 

As any other CPOs, CPOs for HFs must submit to the NFA a Form 7R which provides details of 

the applicant including prior criminal and disciplinary history. The review that the NFA 

conducts is similar to any other CPO, and thus it primarily focuses on the integrity of the 

applicant. In addition, as any other CPO, CPOs of HFs must also provide information about 

their principals and APs. 

Ongoing reporting requirements 

As any other CPO, CPOs of HFs are required to provide an annual registration update 

regarding their own registration and the registration filings to their APs and principals, and 

complete the Annual Questionnaire. 

In addition, CFTC Regulation 4.27 requires all CPOs registered with the CFTC to file a Form 

CPO-PQR with the NFA under the following rules: 

Schedule A: All registered CPOs irrespective of their AUM must provide basic information 

about the CPO, AUM, pools managed by the CPO, certain service providers to those pools, 

monthly returns, and subscription and redemption activity. 

Schedule B: CPOs with AUM in the amount of $500 million or greater are required to provide 

the CFTC with the following information: pool borrowings, counterparty credit exposure, fund 

strategy, derivatives exposure, and a full schedule of investments. 

Schedule C: CPOs with AUM greater than $1.5 billion must also provide the following 

information to the CFTC: their operated pools’ geographical exposure, liquidity, and risk 

testing based upon several specific scenarios. 

Smaller CPOs and mid-size CPOs must file annually, within 90 days of the end of each calendar 

year; while large CPOs must file quarterly within 60 days of the end of the calendar year. 

Disclosure requirements vis-à-vis investors 

CPs that would classify as HFs under the IOSCO definition could (and generally) request 

regulatory relief from disclosure obligations based on Rule 4.7 (which overall allows regulatory 

relief for CPs whose participants are accredited investors). If regulatory relief is granted, the 

CPOs are subject to more streamlined obligations, as summarized below: 

There is no obligation to file a disclosure document with the NFA; although the market practice 

is that the CPOs provide an offering memorandum to investors. Pursuant to CFTC rules if such 

memorandum is provided, a disclaimer must be made to the fact that it has not been reviewed 

by the NFA. 

Account statements need to be provided only on a quarterly basis and the degree of 

information required is more streamlined. In practice, most CPOs continue to provide monthly 

statements. 

The information required to be included in the Annual Report is also more streamlined. 

Other ongoing requirements 

CPOs that manage HFs are subject to the same ongoing requirements as any other CPOs, 

including: 
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Recordkeeping obligations: As described under Principle 24, CFTC Rule 4.23 imposes very 

detailed recordkeeping obligations on registered CPOs, both with respect to their funds and 

the CPO itself. CPOs that manage HFs could seek regulatory relief as Rule 4.7 pools. In that 

case, CPOs are still required to maintain at their main business address copies of the account 

statements and annual reports that they are required to distribute to investors, and all other 

books and records prepared in connection with their activities as the CPO of a Rule 4.7 pool. 

CPOs of Rule 4.7 pools must preserve such books and records for the same time periods as any 

other CPO. 

Asset protection: As described under Principle 25, CFTC Regulations require proper segregation 

by the CPO of all funds, securities and property of the pools it operates. 

General supervisory obligations: As described under Principle 24, NFA Compliance Rule 2-9 

requires each NFA member to diligently supervise its employees and agents in the conduct of 

their commodity futures activities for or on behalf of the Member. Pursuant to this Rule, a CPO 

must establish and implement written supervisory policies and procedures with respect to 

various day-to-day operations. 

As any other CPO, CPOs to HFs do not have fiduciary duties stemming from the federal laws. 

However they are subject to antifraud provisions. 

Oversight authority 

Under Section 204(a) of the Advisers Act, the SEC has the authority to require IAs to maintain 

records and provide reports. Additionally, Section 204(b)(2) of the Advisers Act, added by 

Dodd-Frank Act, deems the records of a private fund to be the records of its IA, thereby giving 

SEC staff access to private fund records for examination or inspection. 

Similar powers over CPOs are provided to the CFTC by the CEA. 

The FSOC may subject certain nonbank financial companies to oversight by the Federal 

Reserve and additional prudential standards, if it determines that they could pose a threat to 

the financial stability of the United States. IAs and CPOs to HFs like all other financial 

companies, are subject to this regime. The evaluation of any nonbank financial company under 

the framework is company-specific. At the time of the assessment the FSOC had not 

considered necessary to designate any IA or CPO to HFs as systemically important. 

Enforcement authority 

As explained under Principle 10, the SEC and the CFTC have broad authority to enforce 

securities and commodities laws and their respective regulations against an IA or CPO that 

manages HFs. 

Sharing of information 

Pursuant to the federal securities and commodities laws as described in Principles 13-15, the 

SEC and CFTC can share information related to HFs advisers/operators with foreign 

supervisors. In addition, pursuant to the Dodd-Frank Act, the SEC has shared Form PF filings 

with the OFR, subject to the confidentiality provisions of the Act. 

Supervision of HF managers: practice 

HFs that invest in securities 

As indicated above a key mechanism for the ongoing supervision of HFs and the risks they 

pose are the periodic reports that IAs are required to submit to the SEC. Such reports are 

shared with the FSOC. 

In addition, the SEC launched the “Presence Exam Initiative” at the start of fiscal year 2013 to 
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examine a significant percentage of the advisers registered since the effective date of Title IV 

of the Dodd-Frank Act. These examinations have focused on the following areas: marketing, 

portfolio management, conflicts of interest, safety of client assets, and valuation. 

Finally, through the annual CEO certification requirement and the IA annual review 

requirements discussed in Principle 12, firms are required to do annual monitoring of the 

adequacy of their written supervisory procedures as well as how the procedures are being 

carried out. OCIE staff review IAs’ annual compliance reviews as part of the examinations of 

those entities. The SEC may also use the information provided in Form PF for the purpose of 

examining SEC registered IAs. 

HFs that invest in commodities 

The analysis of the reports that CPOs are required to submit is a key mechanism for ongoing 

monitoring of the risks posed by the funds managed by the CPOs. 

As explained under Principle 24, the NFA follows a risk-based approach for the supervision of 

CPOs. In addition to the quarterly reporting, NFA uses other data available (including 

complaints, as well as information from the SEC) to “score” the firms and determine whether 

they should be subject to on-site examinations. Notwithstanding the risk based approach, the 

NFA aims to conduct on-site examinations of non-FCM entities at least every 3-4 years. The 

scope of the examinations is determined based on the identification of areas of concern done 

by the risk analysis team. As indicated under Principle 24 the supervision modules include a 

review of the compliance program developed by the CPO. 

Assessment Fully Implemented 

Comments The current registration regime for IAs and CPOs that manage HFs is based on integrity 

criteria and disclosure requirements. In addition, both IAs and CPOs of HFs are subject to a set 

of ongoing organizational and operational conduct standards. The explanatory notes to Key 

Question 3 of the Assessment Methodology explicitly clarify that “there may be differences in 

how the jurisdictions handle this Question. Jurisdictions will determine what, and under what 

circumstances, standards for internal organization and operational conduct will be imposed on 

the HF managers/advisers”. 

The assessors note that most of the elements that the Assessment Methodology provides as a 

reference are already part of the ongoing obligations of HF managers. While there is no 

explicit obligation to implement risk management arrangements, the assessors agree with the 

authorities that many of the elements required under such an obligation are currently covered

by other obligations, such as the obligation to implement a compliance program, the 

custody/segregation rule, and the record-keeping requirements. Finally, the provision of 

audited financial statements is a market practice. In this context, the assessors consider that 

the current framework satisfies the requirements of the Assessment Methodology. However, 

as the authorities continue to analyze the risks posed by the HFs, the assessors encourage 

them to review whether an explicit obligation to implement a comprehensive risk 

management framework is required. 

Finally, the current regime does not impose capital requirements on IAs or CPOs that manage 

HFs. The footnotes to Key Question 7 of the Assessment Methodology explain that “prudential 

regulation may vary from one jurisdiction to the other. Each jurisdiction may decide what form 

of prudential regulation is appropriate to the risks posed by hedge funds”. In this context, the 

assessors note that the current framework subjects both IAs and CPOs to certain ongoing 

requirements that can be considered prudential in nature, in particular certain reporting 

obligations (PF and CPO-PQR Forms), rules in connection with the segregation of clients’ 

assets, and obligations related to the implementation of a compliance program (inasmuch as 
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this has required the establishment of appropriate policies and procedures). Further, the 

assessors note the powers afforded to the FSOC to impose additional prudential requirements 

on non-bank financial entities that it designates as systemically important. Thus, the assessors 

consider that the current framework meets the minimum requirements of Key Question 7 of 

the Assessment Methodology. 

Principles for Market Intermediaries 

Principle 29. Regulation should provide for minimum entry standards for market intermediaries. 

Description CFTC

Authorization of licensees 

Basic requirement 

Section 8a of the CEA requires intermediaries that intend to do business in the markets 

regulated by the CFTC to be registered with the CFTC, subject to limited exceptions. Sections 

4s(a) and (b) of the CEA prohibit a person from acting as an SD or MSP unless they are 

registered with the CFTC. Firms that act as market intermediaries must apply for NFA 

membership. The same applies to their APs, with the exception of those associated with SDs 

and MSPs. 

Registration categories include: 

SDs and MSPs; 

Futures industry participants: 

FCMs, who deal on exchange and hold customer assets and positions; 

IBs, who solicit or accept orders, but do not hold client assets or positions 

CTAs, who advise on dealing in futures and manage individual discretionary accounts, but who 

are not permitted to deal on behalf of customers or hold client assets. 

Floor brokers and floor traders, who trade on exchange floors; 

RFEDs, who deal in foreign exchange contracts with retail clients. 

(CPOs are dealt with under the Principles for CIS) 

Registration is performed by the NFA under authority delegated by the CFTC. The CFTC’s 

rules on registration are set out in Parts 3 and 23 of its regulations, and NFA’s requirements 

and procedures for registration are set out in Part 200 of its Manual/Rules. 

Integrity and competence 

NFA’s registration process includes an examination of an applicant’s past conduct and 

proficiency requirements. Form 7-R, used for applicants for registration, requires disclosure of 

the prior criminal or regulatory actions. Form 8-R, used for principals and APs of applicants, 

requires disclosure of criminal, civil, regulatory, financial, professional, educational and 

residential background, and evidence of the satisfaction of proficiency examination 

requirements. Applicants must submit fingerprint cards to enable criminal background checks 

to be carried out. 

Capital requirement 

CFTC Regulation 1.17 prescribes the minimum levels of adjusted net capital that FCMs and 

non-guaranteed IBs must have. CFTC Regulation 5.7 prescribes the minimum level of adjusted 

net capital for RFEDs. For SDs and MSPs, Section 4s(e) of the CEA requires the adoption of 
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rules establishing capital and margin requirements. If an SD or MSP applicant has a prudential 

regulator, that regulator’s capital and margin rules apply; if there is no prudential regulator, 

CFTC rules apply. The CFTC is in the process of finalizing the SD and MSP capital and margin 

rules. No capital requirements exist for CTAs or floor brokers and traders. 

Internal controls and risk management 

Registration requirements for FCMs and IBs under the CEA focus on integrity and proficiency 

issues and do not explicitly require a specific assessment of the sufficiency of an applicant’s 

internal controls and risk management prior to granting an FCM or IB registration. However, 

CFTC Regulation 1.11 requires each FCM to establish, enforce and monitor a system of risk 

management policies and procedures designed to monitor and manage the risk associated 

with the activities of an FCM; and to provide its risk management policies and procedures to 

the CFTC and to the firm’s DSRO upon its application for registration or upon request by the 

CFTC. In addition, membership requirements established by the NFA include adequacy of 

internal controls and risk management. As a result, as part of its review of applications for 

membership the NFA requests firms to provide a copy of their procedures and processes and 

conducts a review of them. The NFA can also require an applicant to submit details about 

specific procedures, for example order routing systems, promotional materials and the 

supervision of APs. Applicants for registration must also provide certified financial statements. 

If there are material inadequacies in the accounting system, internal accounting control, or 

procedures for safeguarding customer funds or assets, the certified accountant must notify 

the applicant, who in turn must notify NFA, the DSRO, and the CFTC. 

For SDs, registration requirements prescribed under the CEA require participants to 

demonstrate compliance with all CEA requirements, which include having in place appropriate 

policies, procedures and risk management. 

In practice, the NFA initially conducted a provisional registration for which SDs were required 

to submit the information required by Form N-R. The NFA conducted a top line review to 

confirm that the applicant had submitted documentation covering all requirements (i.e., it was 

a review of completeness of documentation). If all information was submitted the applicant 

was granted temporary registration. The NFA is currently in the process of conducting a 

thorough review of applications with a view towards final registration. NFA reports its findings 

on these issues to the CFTC to seek comments and feedback. 

Authority of regulator 

The CEA and CFTC regulations give the CFTC (and the NFA as the CFTC’s delegate) authority 

to refuse to register an intermediary if a statutory bar to registration exists. NFA decisions can 

be appealed to the CFTC, and CFTC decisions to the courts. 

Section 8a(4) of the CEA allows the CFTC to suspend, revoke or place restrictions on the 

registration of any persons registered under the CEA in specified circumstances, which include

violations of the CEA or CFTC Regulations. NFA Rule 501 allows the NFA to suspend, revoke 

or impose conditions on the registration of any registrant. 

Ongoing requirements 

CFTC Regulation 3.31 requires each registrant or applicant for registration to promptly correct 

any deficiency or inaccuracy in its registration information including information about its 

principals and APs. 

Public disclosure of licensed intermediaries 

NFA’s Background Affiliation Status Information Center (BASIC), accessible through the NFA 
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website, contains information on each registrant, the category of license held by the firm or 

individual, the main office, its listed principals, and membership/registration history. 

Disciplinary actions against the firm or individual are also included. 

Investment advisers 

CTAs can manage discretionary accounts on behalf of clients and typically have authority to 

trade individual or pool accounts, but they are not permitted to deal on behalf of customers 

or to have custody of client assets. There is a limited exclusion from the definition of a CTA 

for FCMs with respect to advising which occurs and is solely incidental to their other business 

as an FCM. In this case, all the FCM requirements regarding record-keeping, protection of 

client assets, including segregation and periodic risk-based inspections, capital, and 

organizational requirements (see Principle 31) would apply fully. 

CTAs’ registration is disclosure based. CTAs are required to disclose specific information, 

including the business background of the CTA and its principals that will make trading or 

operational decisions, any material actions against the CTA and its principals, a description of 

the trading program and related risk factors, fees, any actual or potential conflicts of interest, 

and past performance of its client accounts (Regulations 2.34 and 4.35). Conflict of interest 

rules are based on a requirement to disclose and include material conflicts relating to the 

trading program offered by the CTA. CTAs are required to keep accurate, current and orderly 

books and records (CFTC Regulation 4.33). 

SEC

Authorization of licensees 

Basic requirement

Broker dealers

A person engaged in the business of effecting transactions in securities for the account of 

others, or buying and selling securities for their own account, through a broker or otherwise, 

must generally register as a broker-dealer (BD) with the SEC. Foreign broker-dealers who 

engage in such activities in the U.S. are required to register with the SEC except in connection 

with non-solicited transactions by U.S. investors and in certain other circumstances. As 

indicated in Principle 1, banks also enjoy certain targeted exceptions and exemptions from BD 

registration in connection with a limited set of activities, such as networking arrangements, 

trust activities, custody activities and sweep accounts. 

BBDs must generally be members of FINRA unless they do not do business with the public. 

BDs may also need to register with the securities authority of one or more states, in 

accordance with the applicable laws of each state. 

A BD registers with the SEC by filing an application for registration on Form BD. Form BD 

requests extensive background information about the applicant, including its principals, 

control persons (having 25 percent or more of the shareholdings of the company), and 

whether the applicant has been subject to criminal, regulatory or civil actions in connection 

with any investment-related activity. 

The BD registration process is coordinated through the Central Registration Depository (CRD) 

system operated by FINRA. In practice, for a BD to be eligible to carry on business it generally 

must register with the SEC and be a member of an SRO, typically FINRA. 

OTC derivatives dealers

OTC derivatives dealers are a special class of BDs that are exempt from certain broker-dealer 

requirements, including membership of an SRO, regular broker-dealer margin rules, and 
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membership of SIPC. They are registered directly by the SEC, and are subject to special 

requirements, including limitations on the scope of their securities activities as well as 

specified internal risk management control system, record-keeping, and reporting 

responsibilities. Very few participants are currently registered in this category; however, due 

to the new regulatory framework for swaps, several market participants have inquired about 

registering as an OTC derivatives dealer. 

Security-based swap dealers (SBSD)

The Exchange Act definition of “dealer” does not include certain security-based swap dealers, 

but Section 15F of the Exchange Act prohibits any person from acting as an SBSD without 

being registered with the SEC, and requires that the SEC issue rules to provide for registration 

of these entities. The SEC is in the process of finalizing rules for their registration. 

Investment advisers

The SEC registers IAs that have $100 million or more of assets under management or that 

provide advice to an investment company (CIS). Foreign IAs who provide services in the U.S. 

must also be registered unless that adviser can fit within an exemption (e.g., a foreign private 

adviser). An IA that has between $25 million and $100 million of assets under management 

must also register with the SEC, if it is not required to be registered as an adviser with, and is 

not subject to examination by, the state securities authority where it maintains its principal 

office and place of business. IAs that are not registered with the SEC generally must register 

with the state securities authorities of the state in which they are organized and in each of the 

states in which they do business as an IA. 

An IA registers with the SEC by filing an application for registration on Form ADV under the 

Advisers Act. Form ADV requests extensive information regarding the adviser’s background 

and business practices. 

Municipal advisors

Section 975 of the Dodd-Frank Act amended Section 15B of the Exchange Act to create a new 

class of regulated persons, municipal advisors, and require these advisors to register with the 

SEC and comply with MSRB rules. As of October 1, 2010, it became unlawful for municipal 

advisors to provide certain advice to or on behalf of, or to solicit municipal entities or 

obligated persons without registering with the SEC. The SEC adopted an interim final 

temporary rule providing a temporary means for municipal advisors to satisfy the registration 

requirement. The SEC adopted a final rule providing for municipal advisor registration in 

September 2013. The SEC provided for a four month phased-in compliance period that began 

on July 1, 2014 and ended on October 31, 2014 for existing municipal advisors to comply with 

the requirement to register with the SEC on Form MA. All municipal advisors must register 

with the SEC by filing Form MA. The disclosures requested by Form MA are based generally 

on the disclosures required by Form BD for BDs and Form ADV for IAs and require extensive 

information on the applicant’s background, business and associated persons. A municipal 

advisor applicant must also provide information regarding natural persons associated with 

their municipal advisory firm and engaged in municipal advisory activities on the municipal 

advisory firm’s behalf by filing a Form MA-I for each such natural person. 

Integrity 

Registration may be denied for all classes of applicants on the basis of past criminal, 

administrative or civil action against the applicant or, in some instances, persons associated 

with the applicant, subject only to administrative or judicial review. 
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Capital requirement 

BDs must meet minimum net capital requirements. During the pre-membership process the 

BD must demonstrate that it has sufficient net capital to fulfill the requirements of the SEC’s 

net capital and early warning rules. See further under Principle 30. OTC derivative dealers are 

also subject to special capital requirements. 

The Exchange Act does not impose any ongoing capital requirements on IAs and municipal 

advisors unless they are also registered as BDs. 

Competence 

For BDs, FINRA membership rules require that most persons associated with a BD register 

with FINRA using Form U4, and impose qualification requirements on those individuals based 

on their activities. To fulfill SRO requirements, all registered representatives, general sales 

personnel, principals, general officers of the firm and other management personnel involved 

in the day-to-day operation of the firm’s investment banking or securities business must 

prove themselves to be qualified in the areas in which they will work by passing qualification 

examinations. 

For IAs and municipal advisors, only the firm but not the persons associated with it must 

register. The statutory framework is based on a disclosure regime rather than a review by the 

SEC of competence or proficiency requirements. According to the SEC staff, with respect to 

IAs this approach is based on the type of risks IAs have that are for the most part limited to 

investment risk; other safeguards are in place for other key risks such as custody. Part 2 of 

Form ADV, which must be provided to prospective clients, is designed to enable clients and 

prospective clients to evaluate the risks associated with a particular adviser. Many states also 

require the registration of the individual persons who are associated with state-registered IAs. 

The states may also impose certain educational and professional training requirements upon 

the representatives of SEC-registered IAs who have a place of business in that state. Although 

individuals are not required to separately register with the SEC, a municipal advisor must 

provide a Form MA-I with respect to each natural person associated with it and engaged in 

municipal advisory activities on its behalf. The Form MA-Is, along with the Form MAs, are 

publicly available on the SEC’s website where prospective clients can access and review them.

Internal controls

FINRA membership rules require BDs, among other things, to have: 

 Financial controls to ensure compliance with federal securities laws, rules and 

regulations; 

 Compliance, supervisory, operational and internal control practices including written 

supervisory procedures; 

 An appropriate supervisory structure; 

 Appropriate systems of customer protection, risk management and internal controls; 

and 

 A designated chief compliance officer. 

Exchange Act Rule 15c3-4, which applies to OTC derivatives dealers and ANC BDs, requires 

that a firm establish, document, and maintain a system of internal risk management controls 

to assist it in managing the risks associated with its business activities, including market, 

credit, leverage, liquidity, legal, and operational risks. Registration of BDs whose only business 

is OTC derivatives dealing is with the SEC rather than FINRA. 
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Under Rule 206(4)-7 of the Advisers Act, registered IAs must adopt and implement written 

compliance and control procedures (CP&P) reasonably designed to prevent the violation of 

the Advisers Act by the IA or any of its supervised persons. The SEC has issued detailed 

guidelines setting out minimum standards for advisers’ CP&P. SEC Rules also require an IA to 

designate a single chief compliance officer (CCO) to administer the CP&P. 

For municipal advisors, MSRB rulemaking to establish the full regulatory regime for municipal 

advisors is not yet complete. The Exchange Act requires that the rules of the MSRB with 

respect to municipal advisors, at a minimum, prescribe means reasonably designed to prevent

acts, practices, and courses of business that are not consistent with a municipal advisor’s 

fiduciary duty to its client, provide continuing education requirements for municipal advisors, 

and provide professional standards. 

Authority of regulator 

Assessment of applications for authorization

The SEC registration process for BDs focuses on assessing whether the applicant has 

submitted all the information required on Form BD and whether any statutory disqualification 

exists. An SEC order granting registration generally will not become effective until the BD 

becomes a member of an SRO, typically FINRA. FINRA’s membership process in turn involves 

a more comprehensive review of the applicant. 

For BDs, when a firm applies for membership, the applicant is subject to FINRA’s premembership process, which requires it to file a new member application form (Form NMA) 

with detailed evidence of its ability to comply with the standards set in FINRA rules. This 

includes basic information about the applicant, written supervisory and record-keeping 

procedures, and bank statements. As well as reviewing this information, FINRA also conducts 

a membership interview with the applicant. During these interviews FINRA staff raise 

substantive questions that could lead the applicant to change the initial application (for 

example narrowing the type of products the firm would deal in). FINRA staff indicated that it 

is rare to deny applications. However, as a matter of policy FINRA conducts an examination of 

a new firm within six months to one year, depending on whether the firm has conducted any 

activity, in order to ensure that policies and controls as described in the application have in 

fact been implemented, and more generally that the firm is complying with applicable SEC 

and FINRA regulations. The SEC oversees FINRA’s membership and licensing processes and 

procedures through its SRO registration and examinations program. 

For IAs and municipal advisors, the SEC has responsibility for registration. When a prospective 

IA submits its initial completed Form ADV, the application is made available to the SEC and 

many state securities agencies through IARD. The SEC staff reviews the application to ensure 

(i) that the applicant meets the conditions for registration (for example, that the applicant has 

AUM of $100 million or more); (ii) that all the information required in Form ADV has been 

submitted; and (iii) that no statutory disqualification exists as a result of previous criminal or 

disciplinary action. For the latter background checks are conducted. SEC staff also contacts 

the IA’s CCO by phone to obtain information about how the IA developed its plans and 

procedures and what compliance plans are in place. 

When a prospective municipal advisor submits its initial completed Form MA, the SEC staff 

reviews the application to ensure that the applicant has submitted all the information 

required in Form MA and all the required Form MA-I(s); and that no statutory disqualification 

exists as a result of previous criminal or disciplinary action. The SEC staff may perform cross 

checks of applicants through the use of the applicant’s other registration numbers, such as 

other SEC registration numbers, to the extent available. The staff may contact the applicant to 
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ask questions as needed. 

Refusal of application

The SEC can refuse licensing of a BD, subject to administrative or judicial review, if 

authorization requirements have not been met. Subject to an opportunity for a hearing, 

FINRA can condition or deny membership based on similar findings. It can also deny or 

condition membership, subject to an opportunity for a hearing, based on, among other 

things, failure to meet standards of financial responsibility or operational capability. 

Similarly, the SEC may refuse to register an IA or a municipal advisor if authorization 

requirements are not met, including in the case of IAs, that the adviser is prohibited from 

registering with the SEC (for example, because they do not meet the minimum AUM 

threshold). 

Generally the SEC has 45 days from receipt of an application to grant a registration or 

commence denial proceedings. 

Revocation/suspension of registration 

The SEC and FINRA generally have authority to withdraw, suspend or condition a BD’s 

registration, and impose sanctions on BDs and their associated persons for violations of 

applicable law and related rules. The SEC has these powers in relation to IAs and municipal 

advisors. 

The SEC has a wide range of other sanctions it can impose on registrants (BDs, IAs and 

municipal advisors) for failure to comply with the securities laws. Sanctions available to the 

SEC are described under Principle 11. 

Generally the SEC and/or SROs have authority to prevent the employment of persons with a 

market intermediary where they find it is not in the public interest to allow such persons to 

associate with the market intermediary. If individuals associated with registrants commit 

certain willful misconduct, the SEC and/or SROs can bar them from future association with 

registrants. The SEC and/or SROs have this authority with respect to persons seeking to 

associate with a broker-dealer, investment adviser or municipal advisor. 

Ongoing requirements 

A BD must promptly file an amendment to its Form BD if the information on the form is or 

becomes inaccurate for any reason. In addition, SROs generally require that registered 

individuals promptly update their Forms U-4 if the information on that form is or becomes 

inaccurate. 

An IA’s Form ADV must be updated each year by filing an annual updating amendment within 

90 days of the adviser’s fiscal year end. In addition, an investment adviser must amend its 

Form ADV to keep it current. If material information in an investment adviser’s Form ADV 

becomes inaccurate, it must be amended promptly. Similar provisions apply to municipal 

advisors. 

Public disclosure of licensed intermediaries 

Completed Forms BD and the non-confidential portion of BDs’ annual audited financial 

statements are publicly available through the SEC's public reference office. Form BD indicates 

the types of business conducted by a BD, as well as the states and SROs with which the BD is 

registered. 

In addition, FINRA compiles regulatory information from BDs and their registered associated 

persons, as well as from states and other sources. It maintains this information in its CRD 
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system, including the status of the BD’s registration. Certain information derived from CRD is 

made available free of charge to the public through FINRA’s BrokerCheck system. 

IAs and municipal advisors registration Forms (Forms ADV and MA) are publicly available on 

the SEC’s website. Part 2B of Form ADV requires an IA to prepare a “brochure supplement” 

that contains information about each advisory employee that provides investment advice to 

clients. This supplement is not required to be filed with the SEC but must be made available 

to clients. Although individuals are not required to separately register with the SEC, a 

municipal advisor must provide a Form MA-I with respect to each natural person associated 

with it and engaged in municipal advisory activities on its behalf. Form MA-Is also are publicly 

available on the SEC’s website where prospective clients can access and review them. 

Investment advisers 

To buy or sell securities on behalf of customers, an IA would also be required to be registered 

as a BD. 

By Advisers Act Rule 206(4)-2, an IA cannot hold client assets as a “qualified custodian” unless 

it is separately regulated to hold assets (e.g., it is also registered and regulated as a BD, or it is 

chartered and regulated as a bank). Absent this qualification, an adviser must hold client 

assets with a qualified custodian such as a bank, BD, FCM or foreign custodian. At the 

custodian level, there are detailed safeguards regarding segregation and reporting to clients. 

Regardless of who acts as the custodian, the Advisers Act layers additional protections onto 

the custodian’s safeguards, such as having and an independent public accountant conduct a 

surprise audit at least once a year. If the adviser or a related person of the adviser acts as a 

qualified custodian, the Advisers Act requires additional safeguards to apply, including: 

the annual surprise audit must performed by a PCAOB registered auditor, unless the related 

person is “operationally independent” of the IA (as defined in the custody rule) ; and 

The auditor must report to the IA annually on internal controls relating to the custody of 

client assets. 

In practice, as of January 2015 88 out of more than 11,500 registered IAs act as qualified 

custodians. In addition, there are 400 SEC-registered IAs for which a related person acts as 

qualified custodian in connection with advisory services the IA provides to its clients. 

In addition, the Advisers Act deems an adviser to “have custody” in some circumstances 

where client assets are held by a qualified custodian but the IA can access client assets, for 

example where the IA has a power of attorney that permits it to access client funds to pay 

bills or transfer funds between accounts. In these circumstances the additional safeguards 

mentioned above apply. This definition of “custody” is broader than the concept of custody in 

the IOSCO Methodology which refers to physical holding of the assets. 

For pooled investment vehicles (other than CIS), slightly different rules can apply. The pool’s 

financial statements must be audited by a PCAOB registered auditor; the statements must be 

sent to investors annually; the custodian must send quarterly statements of account to each 

investor; and the pool’s assets must be subject to a surprise audit. 

Under Rule 204-2 of the Advisers Act, an IA is subject to detailed record keeping 

requirements. Under Advisers Act Rule 206(4)-7, IAs must also have written compliance 

policies and procedures that are reasonably designed to prevent violations of the Advisers 

Act; review annually the adequacy of those policies and procedures; and designate a Chief 

Compliance Officer. 

An IA’s fiduciary duty requires it to disclose to its clients and prospective clients any material 
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facts that might cause the adviser to render advice that is not disinterested. An IA must 

disclose all material potential conflicts of interest between the adviser and its clients, even if 

the adviser believes that a conflict has not affected and will not affect the adviser’s 

recommendations to its clients. 

Extensive disclosures are also required in an IA’s Form ADV about business, ownership, 

clients, employees, business practices (especially those involving potential conflicts with 

clients), and any disciplinary events of the adviser or its employees. The SEC recently 

amended Part 1A and Part 2 of Form ADV to expand the amount of information collected and 

the way it is presented to clients. 

The Advisers Act contains requirements to mitigate conflicts, for example by requiring an IA 

to disclose to and obtain the consent of a client when it is acting as principal for its own 

account (Section 206(3)). Rule 204A-1 under the Advisers Act requires registered IAs to adopt 

codes of ethics setting out standards of conduct and requiring compliance with applicable 

federal securities laws. Codes of ethics must address personal trading and must require 

personnel to report personal securities holdings and transactions. 

Assessment Fully Implemented 

Comments For most intermediaries, registration requires membership of an SRO and the registration 

process in practice consists of a combination of the process required by the legislation and 

the membership process of the relevant SRO. The process required by the legislation, and 

related rules and forms, focuses largely on the integrity of an applicant, and its control 

persons and associated persons, and whether any statutory disqualifications are present. The 

membership processes conducted by FINRA and by the NFA (other than for CTAs) involve an 

assessment of the internal organization, risk management and supervisory systems of 

applicant firms, and competence requirements for individuals. The checks they make appear 

robust, and both carry out an examination of new registrant members within the first year 

after registration. 

For IAs, the situation is somewhat different. IAs are registered directly by the SEC and are 

subject only to the integrity checks required by the legislation and the conversation with the 

CCO. They are subject to comprehensive disclosure obligations which permit a customer to 

make an informed decision about the competence of the IA, its personnel, and its business. 

They are also subject to certain ongoing obligations including the need to implement a 

compliance program. 

The IOSCO Assessment Methodology expressly contemplates a disclosure-based regime for 

IAs as an alternative to more substantive licensing criteria. The assessors note that the 

Methodology requires advisers permitted to have custody of client assets to be subject to the 

requirements that apply to other intermediaries, including an assessment of internal 

organization, risk management and supervisory systems and, as applicable, capital 

requirements. In this context it is important to recognize that the Assessment Methodology 

defines custody as meaning “physically” holding client assets; and that, for an IA itself to hold 

assets in this way, it would need separate authorization as a qualified custodian by seeking 

authorization as a BD. 

The Advisers Act and related rules in some circumstances deem an adviser to have custody of 

client assets if it can access client assets, but this is not “custody” in the sense it is used in the 

Assessment Methodology. Because of these differences in the notion of custody, the 

assessors conclude that the disclosure-based approach to the registration of IAs complies 

with the requirements of Key Question 7 of the Assessment Methodology. 

The situation is similar for futures industry CTAs, as they are not permitted either to deal on 
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behalf of clients or hold client assets. Full disclosure, as required by the CEA and CFTC 

requirements is therefore consistent with the Methodology. 

However, the assessors understand that in the U.S. context, IAs are typically portfolio 

managers with substantial assets under management (total AUM is about $63 trillion, of 

which about $17 million is in mutual funds). CTAs may also and in practice do operate 

discretionary accounts. From that perspective, the assessors encourage the authorities to 

consider whether there is a need to implement more comprehensive internal control and risk 

management requirements relating to portfolio management. 

Principle 30. There should be initial and ongoing capital and other prudential requirements for market 

intermediaries that reflect the risks that the intermediaries undertake. 

Description CFTC

Capital requirement 

Capital requirements apply to SDs, MSPs, FCMs, RFEDs and IBs, but not to CTAs, floor brokers 

and floor traders. IBs do not require capital if their obligations are guaranteed by an FCM and 

they deal only through that FCM. 

For FCMs, the minimum adjusted net capital requirement under the current Regulation 

1.17(a) is the greatest of: 

 $1,000,000; 

 The FCM's risk-based capital requirement, computed as eight percent of the total risk 

margin requirement for positions carried by the FCM in customer accounts and noncustomer accounts; 

 The amount of adjusted net capital required by the NFA; or 

 For securities brokers and dealers, the amount of net capital required by SEC Rule 15c3-

1(a). 

“Adjusted net capital’’ is defined as an FCM’s “current assets’’- in this context meaning liquid 

assets - less all liabilities (except certain qualifying subordinated debt), and further reduced by 

certain capital charges (haircuts) to reflect potential market and credit risk of the firm’s 

current assets. 

When determining current assets, Regulation 1.17(c)(2) specifically excludes certain items 

such as unsecured receivables, and also requires unrealized losses to be deducted, and 

unrealized profits added to the extent that they are secured or are on exchange-traded 

positions and thus take account of some off-balance sheet items. Other assets must be 

marked to market, including all long and all short positions in commodity options traded on a 

contract market; all listed security options; and all long and short securities and commodities 

positions. Further, the rule sets out values to be attributed to any commodity option that is 

not traded on a contract market and to any unlisted security option. 

Haircuts apply to an FCM’s futures and futures options; its inventory; fixed price commitments 

and forward contracts; and to its securities and security options. The CFTC has harmonized 

the haircuts applied to securities and securities options with the haircuts required under the 

SEC’s net capital rule. 

Regulation 1.12(b) requires FCMs to provide immediate notification to the CFTC and their 

DSROs if the FCM’s capital falls below: 

 110 percent of the risk-based capital requirement; 
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 150 percent of the minimum dollar requirement, or of the requirement for minimum 

capital under NFA rules; or 

 If the FCM is a securities BD, the early warning level established under SEC rules. 

For IBs subject to minimum capital requirements, the minimum adjusted net capital 

requirement is the greatest of: 

 $45,000; 

 The amount of adjusted net capital required by the NFA; or 

 For securities brokers and dealers, the amount of net capital required by SEC rules. 

For SDs and MSPs capital and margin requirements are in the process of being finalized. The 

CEA provides that SDs and MSPs that have a prudential regulator must meet the capital and 

margin requirements established by that regulator; where there is no prudential regulator, the 

SD or MSP must meet requirements set out in CFTC Regulations. CFTC proposed regulations 

provide that SDs and MSPs that are also FCMs are required to meet existing FCM 

requirements to hold minimum levels of adjusted net capital, with a higher minimum fixed 

dollar net capital requirement of $20 million. SDs and MSPs that are not FCMs and are 

nonbank subsidiaries of U.S. bank holding companies would be required to meet a minimum 

capital requirement of $20 million Tier 1 capital as defined in bank regulations, the minimum 

risk-based ratio requirement that would apply as if the SD itself were a bank holding 

company, or any higher amount required by a registered futures association of which such SD 

or MSP is a member. SDs and MSPs that are neither FCMs nor bank holding company 

subsidiaries would be required to maintain tangible net equity equal to $20 million, plus 

additional amounts for market risk and OTC derivatives credit risk. The proposed capital 

requirements for SDs and MSPs do not have the same liquid assets requirements as the FCM 

capital requirements. 

Risk-sensitivity of capital requirements 

The objective of the CFTC’s FCM and IB net capital rule is to require registrants to maintain a 

minimum base of liquid assets in excess of their liabilities to finance their business activity. 

The requirements in CFTC Regulation 1.17 are mostly focused on mitigating market risk, 

credit risk, and liquidity risk. 

The capital requirements of FCMs are directly related to margin requirements for the futures 

and options positions of their customers and non-customers. Also, FCMs with proprietary 

positions in futures or options on futures must deduct from their net capital 100 percent of 

the margin requirements for these positions (or 150 percent if the FCM is not a clearing 

member). FCMs’ and IBs’ capital requirements reflect market moves because their assets are 

required to be marked to market. 

Record-keeping and reporting 

Record-keeping 

CFTC Regulation 1.18 requires FCMs and IBs to prepare and keep current ledgers which show 

each transaction affecting asset, liability, income, expense and capital accounts consistently 

with the Form 1-FR (or the FOCUS Report if a securities BD). 

CFTC Regulation 23.201(b)(2) requires SDs and MSPs to maintain records reflecting all assets 

and liabilities, income and expenses, and capital accounts as required by the CEA and CFTC 

regulations. 
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Reporting 

CFTC Regulation 1.17(a)(3) provides that each FCM and IB must be in compliance with capital 

requirements at all times and must be able to demonstrate such compliance to the 

satisfaction of the CFTC or the designated SRO. CFTC Regulation 1.12 requires immediate 

notification to the CFTC and the designated SRO should an FCM not be in compliance with 

minimum capital requirements. 

FCMs must report their net capital computations to the CFTC and SROs as of month end and 

IBs every six months. The financial reporting requirements are set out in CFTC Regulation 

1.10. Other relevant recordkeeping and reporting requirements deal with the financial 

condition of FCMs and IBs and with the customer funds held by FCMs. 

As well as the obligation to report to the CFTC and the relevant SRO when capital levels fall 

below specified thresholds (see above), CFTC Regulation 1.12(g)(1) requires that, if the net 

capital of an FCM declines by 20 percent or more from the amount last reported, the FCM 

must provide notice within 2 business days of the event or series of events causing the 

reduction in net capital. 

In addition, FCMs must submit quarterly reports on large exposures to the CFTC, which now 

shares them with the corresponding SROs. 

Independent audit 

For FCMs, RFEDs, and IBs, CFTC Regulation 1.10 requires the filing with the CFTC of annual 

financial reports certified by an independent certified public accountant, within 90 days of 

period end. The independent public accountants must be registered and in good standing 

under the laws of the relevant state licensing authorities. In addition, certified public 

accountants that conduct examinations of FCMs must be registered with and subject to 

examinations by the PCAOB. 

An accountant who discovers a material inadequacy in the course of an audit is required 

under CFTC Regulation 1.16 to notify the FCM or IB, who, in turn, must notify the CFTC, NFA 

and the appropriate DSRO. 

Under proposed CFTC Regulations certain SDs and MSPs will be required to file annual 

audited financial statements with the CFTC and with any registered futures association of 

which they are members. This proposed rule applies to SDs and MSPs that are not subject to 

the capital requirements of a prudential regulator, or designated by the FSOC as a SIFI. 

Monitoring by regulator 

Both the CFTC and the SROs receive and review the monthly financial reports that include 

information on the computation of minimum capital requirements. 

Historically the SROs have been responsible for the front line supervision of individual firms. 

However, the CFTC’s DSIO also conducts monitoring of the financial position of FCMs. To this 

end, the CFTC has automated systems to detect anomalies in a firm and trends in the industry 

that could be of concern. If necessary it conducts on-site examinations on firms. In addition, 

the CFTC conducts sweeps with the purpose of gaining a deeper understanding of how a 

specific issue is dealt with in the industry. For example, recent sweeps included a review of 

liquidity across the industry. For other intermediaries (i.e., IBs) the CFTC relies on NFA 

monitoring. 

Regulator’s powers of intervention 

CFTC Regulation 1.17(a)(4) provides that an FCM that fails to demonstrate that it holds 

sufficient capital to meet the required minimum must transfer all customer accounts and 
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immediately cease doing business as an FCM until it is able to demonstrate compliance with 

the capital requirements. The FCM may trade only for liquidation purposes during this period 

unless prohibited from doing so by its DSRO or the CFTC. 

The CFTC and the DSROs can take other steps, such as requiring an FCM in difficulty to do 

daily instead of monthly capital reporting. 

CFTC proposed regulations (Proposed Regulation 23.105) require an SD or MSP to notify the 

CFTC if it knows or ought to know that the firm does not maintain tangible net equity in 

excess of its minimum requirement. An early warning notice is required if net tangible equity 

falls below 110 percent of the required amount. 

Risks from outside the regulated entity 

Affiliate risk generally is addressed through record-keeping and reporting obligations. Under 

CFTC Regulations 1.14 and 1.15, in computing their tangible net equity FCMs are required to 

consolidate the assets and liabilities of any subsidiary or affiliate for which the FCM 

guarantees the obligations or liabilities. Consolidated and consolidating annual financial 

statements must be submitted to the CFTC along with a map of how the affiliates related to 

the FCM. Also, certain off-balance sheet items such as unrealized gains on futures positions 

must be reported as non-current assets in the capital computations of FCMs and IBs. 

CFTC proposed Regulation 23.102 would also require an SD or MSP in computing its tangible 

net equity to consolidate the assets and liabilities of any subsidiary or affiliate for which the 

SD or MSP guarantees the obligations or liabilities. Proposed Regulation 23.103 provides that 

for purposes of computing specific and general market risk charges to capital, off-balance 

sheet positions are included. 

SEC

Capital requirement 

There are capital requirements for BDs, but not for firms that are only IAs (including those 

that are deemed to “have custody” under the Advisers Act) or municipal advisors. Exchange 

Act Rule 15c3-1 (the net capital rule, NCR) requires all BDs to maintain net capital in specified 

amounts that are determined by the type of business conducted by the BD. The NCR is a net 

liquid assets test designed to promote the orderly liquidation of a firm, without disruption for 

customers. If a firm’s net capital falls below the required minimum, it must cease doing 

securities business. In 2013, the SEC amended the NCR to also require a BD to cease 

conducting securities business if certain insolvency events occur. 

The NCR requires that a BD perform two calculations: 

A computation of the minimum amount of net capital the BD must maintain; and 

A computation of the amount of net capital the BD is maintaining. 

The minimum required dollar amount varies from $5,000 for the least risky type of activity 

(such as a business limited to selling mutual funds) to $250,000 for the most risky type of 

activity (such as holding customer funds and assets). The minimum net capital requirement is 

the greater of these fixed-dollar amounts and an amount determined by applying one of two 

financial ratios: 

A 15-to-1 aggregate indebtedness to net capital ratio (basic method), and for firms in their 

first year of operation an 8-to-1 ratio; or 

2 percent of aggregate debit items ratio (alternative method). 
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The alternative method is generally used by firms that hold customer funds and securities, 

and in practice is used by many larger BDs. It ties the minimum capital requirement to the 

amount of aggregate customer receivables. 

For the purpose of calculating net capital, fixed assets and other illiquid assets are excluded, 

as are most unsecured receivables. Discounts (haircuts) are applied to the value of assets held 

on the BD’s books based on the nature of those assets, reflecting their liquidity, market and 

credit risks (for example, non-marketable securities are generally subject to a 100 percent 

haircut). Other charges apply, such as capital charges related to fail-to-deliver contracts that 

are outstanding for more than five days. 

Alternative Net Capital (ANC) BDs and OTC derivative dealers are permitted, with the SEC 

approval, to calculate net capital using internal models as the basis for taking market risk and 

credit risk charges in lieu of the standardized haircuts for classes of positions for which they 

have been approved to use models. The NCR imposes substantially higher minimum capital 

requirements for ANC BDs (currently $500 million in net capital, $1 billion in tentative capital 

and an early warning level of $5 billion) and for OTC derivatives dealers. SEC staff indicated 

that, while very few participants are currently registered as OTC derivatives dealers, as a result 

of the new regulatory framework for swaps, several market participants have inquired about 

registering as one. 

SEC staff emphasized that the Commission has broad authority to approve a BD’s use of the 

ANC computation. SEC staff conduct a thorough review of the firm’s systems, including its 

internal models and the control environment. This review takes about one year. The approval 

must be granted at Commission level. Currently only 6 firms have been approved to use the 

ANC. There is currently a proposal to increase the minimum net capital of ANC BDs to $1 

billion, minimum tentative net capital to $5 billion and the early warning level to $6 billion. 

Concentration risk is addressed via a concentration charge. The charge generally applies if a 

position has a market value of more than 10 percent of the net capital of a BD. If a 

concentrated position exists, before computing haircuts for the position, the BD must deduct 

an amount equal to 50 percent of the standard haircut for the position, on that portion of the 

position that exceeds 10 percent. If the BD uses models to compute haircuts, the charge 

would be expected to increase if a concentrated position exists. It is expected that ANC 

broker-dealers incorporate stress testing into their policies and procedures. 

SROs have the ability to set capital requirements for BDs at levels higher than that required 

pursuant to the SEC’s rule. Many SROs also may prevent a firm from expanding its business or 

otherwise limit its business to the extent that it fails to maintain sufficient levels of net capital 

if the SRO has rules in place that permit them to do so. 

The NCR is in itself a net liquid assets test. All ANC BDs also perform an internal liquidity 

stress test for a minimum of a 30 day stress period. In addition, the SEC has proposed a 

liquidity stress test for ANC BDs and is currently reviewing whether the proposed liquidity 

stress test requirements should be imposed on all carrying brokers. 

The SEC is also considering whether a specific leverage ratio should be imposed on the 

carrying BDs. 

Reserve account

SEC Rule 15c3-3 (the Customer Protection Rule) requires that every BD obtain and maintain 

possession and control of customer fully paid and excess margin securities, and maintain a 

reserve account that contains at least the net dollar amount of cash the BD owes to its 

customers. The customer reserve formula permits the BD to offset customer credit items only 
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with customer debit items. 

Physical possession or control of securities means the BD must hold these securities in one of 

the locations specified in Rule 15c3-3and free of liens or any other interest that could be 

exercised by a third party to secure an obligation of the BD. Permissible control locations 

include a bank and a clearing agency. 

As for cash, pursuant to amendments introduced in 2013 a BD is prohibited from depositing 

cash in its customer reserve account at an affiliated bank and limited in the amount of cash a 

BD can deposit in any one bank to meet its minimum required customer reserve deposit. 

The Dodd-Frank Act amended the Securities Investor Protection Act of 1970 (SIPA) to take 

into account futures and options on futures held in a portfolio margin account carried as a 

securities account pursuant to an SEC-approved portfolio margining program. As a result, 

persons who hold futures positions in a portfolio margining account carried as a securities 

account would be entitled to SIPA protection. 

Record keeping and reporting 

Record-keeping 

BDs are required to make, keep and preserve records regarding their net capital computation 

under the SEC’s record-keeping rules (Rules 17a-3 and 17a-4). BDs are required to monitor 

their capital on a daily basis. 

Reporting 

Exchange Act Rule 17a-5(a) requires all BDs to file unaudited financial reports with the SEC 

either once each month or once each quarter, depending on the types of business in which 

the firm engages and the perceived relative risk. All broker-dealers must include their net 

capital computations in the financial report (commonly called the FOCUS Report). The SEC 

has delegated the responsibility for receiving those reports to each firm’s designated 

examining authority (DEA). The SEC generally is able to access these reports electronically, 

and receives information regarding them in database format from the SROs. 

Under Exchange Act Rule 17a-11 (the early warning rule), a BD must promptly notify the SEC 

and its DEA, when, among other things: 

 Its net capital falls below 120 percent of its required net capital; 

 If the firm computes its net capital using the alternative method, the firm’s net capital 

falls below 5 percent of aggregate debit items; 

 If the firm computes its net capital using the basic method, if the firm’s aggregate 

indebtedness is in excess of 1,200 percent of its net capital; 

 If its net capital falls below the minimum required amount; or 

 If the firm fails to keep current the books and records required by SEC rules. 

SROs also have early warning rules, which in some cases have higher thresholds than the 

SEC’s early warning rule. 

Independent audit 

According to Exchange Act Rule 17a-5(d), each BD must file an audited annual report with the 

SEC, the BD’s DEA, SIPC if the BD is a member, and each SRO of which it is a member unless 

the SRO waives the requirement by rule. The report must be audited by an independent 

public accountant registered with the PCAOB. 
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Monitoring by regulator 

The capital levels of a BD, and its compliance at all times with minimum capital requirements, 

is monitored through filings of periodic and annual reports made by the BD, and through onsite inspections. The BD’s DEA regularly monitors compliance with capital levels. SROs inspect 

BDs that hold customer funds and securities at least once each year. Other BDs are also 

subject to on-site examinations by SROs, although they may be examined less frequently. 

While SROs are the front line supervisors, the SEC also may review a firm’s filings. In 

particular, the SEC has recently constituted a program for Large Firm Monitoring through 

which it conducts ongoing monitoring of the largest, most complex BDs in order to enhance 

OCIE’s ability to identify risks at these firms. 

Regulator’s powers of intervention 

The Exchange Act and the regulations prohibit a BD from continuing to do securities business 

if it does not have sufficient net capital. A BD is restricted from withdrawing capital if certain 

parameters have been broken. The SROs also have rules that restrict the activities of a BD in 

financial difficulty. The SEC and SROs regularly use these authorities. 

Risks from outside the regulated entity 

The NCR requires that a BD consolidate in a single computation, for purposes of calculating 

net capital and aggregate indebtedness, the assets and liabilities of any subsidiary or affiliate 

for which it guarantees, endorses, or assumes directly or indirectly the obligations or 

liabilities. In addition, a BD must take a capital charge to the extent of any obligations it has 

assumed with respect to its affiliates. 

Rule 17h-1T sets out specific record-keeping requirements applicable to BDs and provides 

guidelines to be used in establishing which affiliates are “material” for purposes of the rules, 

and therefore whose information is subject to these record-keeping and reporting 

requirements. Material associated persons can be licensed or unlicensed. Included in these 

requirements are risk management policy information, financial data (including consolidating 

and consolidated financial statements, securities and other financial product position data), 

and financial instruments with off-balance sheet risk, among other things. Current Rule 17h2T requires BDs to file quarterly reports concerning these records. 

ANC BDs must file with the SEC the consolidated and consolidating financial statements for 

the ANC BD’s ultimate holding company, the holding company’s most recent capital 

measurements computed in accordance with Basel standards, as reported to its principal 

regulator; and certain regular risk reports provided to the persons responsible for managing 

group-wide risk as the SEC may request from time to time. 

Assessment Fully Implemented 

Comments Both the SEC and the CFTC use a net capital approach to the setting of capital standards for 

intermediaries such as BDs and FCMs. The IOSCO Assessment Methodology recognizes a net 

capital regime as one of the main alternative approaches to the setting of capital standards 

for intermediaries. The net capital approach is designed to ensure sufficient liquid assets are 

available at all times to meet the claims of customers and creditors, and to allow an orderly 

liquidation in the event of failure. In the SEC’s NCR, liquidity is the focus, market and credit 

risk are explicitly dealt with through the haircut regime, and concentration risk is explicitly 

provided for. Other risks such as operational risk are dealt with implicitly by the inherent 

conservatism of the haircut regime and the conservative treatment of assets and liabilities in 

the calculation of capital requirements. The CFTC’s capital rules are similarly structured. Under 

both SEC and CFTC rules, capital requirements increase as the volume of business and 
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therefore risk increases. 

The early warning thresholds imposed by the SEC, the CFTC, and the SROs, functions as a de 

facto higher minimum capital requirement by creating incentives to ensure intermediaries do 

not become subject to additional scrutiny by breaching reporting trigger points. 

Both the SEC’s and the CFTC’s capital rules apply on a solo basis, and the registered entity is 

required at all times to be in compliance. This is consistent with the Assessment 

Methodology. 

The SEC’s rules for ANC BDs give it the power to impose additional conditions on a regulated 

entity on a case-by-case basis. In practice, it has used these powers to impose a higher 

minimum capital requirement in one case, and to subject some of the firms under this regime 

to more stringent reporting requirements. This framework allows, if necessary, additional 

conditions to be imposed on a firm relating to liquidity or leverage. 

The SEC has proposed changes to its rules for ANC BDs that would, among other things: 

Increase the minimum tentative net capital requirement to $5 billion (the early warning 

threshold under the current rules); and 

Require the liquidity pool to be maintained at all times in the BD, not its holding company. 

The assessors encourage the SEC to continue this review. 

Principle 31. Market intermediaries should be required to establish an internal function that delivers 

compliance with standards for internal organization and operational conduct, with the aim of 

protecting the interests of clients and their assets and ensuring proper management of risk, 

through which management of the intermediary accepts primary responsibility for these 

matters. 

Description CFTC

Management, supervision and organizational requirements 

CFTC Regulation 166.3 requires every registrant (except APs with no supervisory duties), to 

diligently supervise the handling by its partners, officers, employees and agents of all 

activities relating to its business as a CFTC registrant. 

FCMs 

CFTC Regulation 1.11 sets out detailed requirements for FCM’s risk management programs, 

including requirements for review and testing by internal audit independent of the business 

unit, or a third party audit service reporting to staff independent of the business unit. The 

annual review of the risk management program must be reported to the chief compliance 

officer (CCO), senior management and the governing body of the FCM. CFTC staff noted that 

with the mandatory risk management requirements, CCOs have become more involved in 

firms’ compliance with the risk management program. 

CFTC Regulation 1.10 establishes a requirement for review of certain FCM operations by 

outside auditors. The annual audit for FCMs and IBs must use procedures that provide 

reasonable assurance that they will discover any material deficiencies in the accounting 

system, in the internal accounting controls, and in the FCM's or IB's system for safeguarding 

customer and firm assets. Regulations 1.14 and 1.15 impose risk assessment, recordkeeping 

and reporting requirements. 

SDs and MSPs 

CFTC Regulation 23.602 requires SDs and MSPs to establish and maintain a system to 
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diligently supervise all activities relating to the business performed by their partners, 

members, officers, employees, and agents (or persons occupying a similar status or 

performing a similar function). This system must be reasonably designed to achieve 

compliance with the requirements of the CEA and CFTC Regulations. 

CFTC Regulation 23.600 requires SDs and MSPs to have a risk management program and to 

report quarterly to senior management and the governing body on the operation of that 

program. Risk management programs must be reviewed and tested annually, or on any 

material change in the business of the SD or MSP. Annual testing must be performed by 

qualified internal audit staff that are independent of business units, or by a qualified third 

party audit service. 

Direct Electronic Access

CFTC Regulation 38.607 requires a DCM that permits direct electronic access by customers to 

have in place effective systems and controls reasonably designed to facilitate FCMs’ 

management of financial risk, such as automated pre-trade controls that enable member 

FCMs to implement appropriate financial risk limits (see also Principle 33). 

CFTC Regulation 37.202 requires a SEF to provide impartial access to markets and market 

services. The CFTC has interpreted this to mean that a SEF should allow participants to access 

its platform via intermediation or direct access. 

Protection of clients 

Client funds and assets 

CEA Section 4d(a)(2) and CFTC Regulation 1.20 require FCMs to separately account for 

customer funds on their books and records, and segregate customer funds from their own 

funds and funds of other persons. An FCM is permitted to pool all customer funds in a single 

account or in multiple accounts, and these accounts must be clearly identified as containing 

funds belonging to the FCM’s customers. Customer funds must be deposited with a bank, 

trust company, DCO, or another FCM under an account name that clearly identifies the funds 

as belonging to customers of the depositing FCM and held in segregation as required by the 

CEA and CFTC Regulations. 

Regulation 1.20 requires an FCM to obtain a written acknowledgment prior to or 

contemporaneously with the opening of the customer account with the depository holding 

customer funds (except that an acknowledgment letter is not required if the funds are 

deposited by an FCM with a DCO that has rules requiring the segregation of the customer 

funds in accordance with the requirements set out in the CEA and CFTC Regulations). The 

written acknowledgment letter must provide: (i) CFTC staff with read-only electronic access to 

transaction and account balance information in the accounts; (ii) authorization for the 

depository to allow CFTC staff to examine accounts containing futures customer funds; and 

(iii) authorization for the depository to respond promptly and directly to any request from 

CFTC staff or DSRO staff for confirmation of account balances or other information regarding 

the accounts. 

FCMs are required to maintain at all times a sufficient amount of funds in the customer 

segregated accounts to repay each customers’ total account balances, including both funds 

used as margin and funds intended to be used as margin in the future, as well as proceeds. 

FCMs are also required to keep in the omnibus account the full amount of unmet margin calls 

from all customers without netting. The prohibition on using one customer’s funds to margin 

another customer’s position means that the FCM must cover any customer margin shortfalls 

with its own capital, but in practice this is done as of the end of the business day based upon 
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clearing house settlement prices and the FCM may recognize customer margin payments 

received up until 6:00 pm Eastern Time on the next business day in computing the amount of 

the margin deficiency as of the close of business on the previous business day. By contrast, 

customer deficit balances must be covered by firm capital at all times. If the FCM is bankrupt 

and there is a deficiency of funds in the omnibus account, the bankruptcy code provides for 

pro rata distribution. 

CEA Section 4d(f) requires the segregation of cleared swaps pertaining to customers, as well 

as associated collateral. Pursuant to this provision, Part 22 of the CFTC Regulations requires 

cleared swaps customer collateral to be segregated from the FCM’s own property, but 

permits the cleared swaps collateral of all FCM cleared swaps customers to be kept together 

pre-bankruptcy in one account (legally segregated operationally commingled, LSOC). In 

practice this means that in the event of a bankruptcy of the FCM, the margins of each 

customer are protected and cannot be used to meet uncovered margins of other customers. 

Regulations applicable to futures allow hypothecation of collateral in form but not in value 

(i.e., FCMs must have at all times 100 percent of the correct value of customers’ margins in 

segregation). Following MF Global bankruptcy, the CFTC approved new regulations that 

tightened the type of assets in which customer collateral can be invested. The CFTC 

emphasized the existence of additional controls to check on FCMs’ compliance with their 

customer protection rules. For example, each FCM is now required to file formal segregation 

computation on a daily basis with both the CFTC and with the FCM’s DSRO. Prior to the 

revised customer protection rules, an FCM was only required to file a formal segregation 

computation with the CFTC on a monthly basis. The daily segregation computations show the 

total amount of funds held in segregated accounts for customers and the total amount of 

funds due to the customers as of the end of each business day. Any shortfall in segregation is 

therefore immediately identified. In addition, every depository holding customer funds for 

any FCM is required to provide a daily written confirmation of account balances to the FCM’s 

DSRO. The daily confirmations provide the DSROs with a mechanism to independently verify 

that the information reported by the FCMs is accurate and substantiated by the depositories. 

Additional controls and checks on FCMs’ compliance with the CFTC customer protection rules 

include the requirement that each depository must enter into a standard form written 

acknowledgment letter for each account opened by the FCM. Under the acknowledgment 

letter, the FCM and the depository agree to provide CFTC staff with read-only electronic 

access to account balance and transaction information. CFTC staff can access this information 

directly using its own access information. The acknowledgment letter further provides that 

the FCM authorizes the depository to provide CFTC staff with access to examine the accounts 

and authorizes the depository to respond to CFTC staff and DSRO staff inquiries regarding 

account balances and transactions in the accounts. 

Investor complaints 

CFTC Regulation 166.5 sets out requirements that registrants must include in a customer 

account agreement with respect to dispute resolution procedures, including the use of 

arbitration procedures. Three fora exist for the resolution of disputes: civil court litigation, 

CFTC reparations proceedings, and arbitration conducted by an SRO or other private 

organization. 

CFTC Regulation 23.504 requires SDs and MSPs to execute written trading relationship 

documentation with their counterparties, which must cover all terms governing the trading 

relationship, including dispute resolution. CFTC Regulation 23.201(b)(3) requires that SDs and 

MSPs retain records of any complaint received, including the disposition of the complaint and 
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the date the complaint was resolved. 

Section 14 of the CEA permits anyone complaining of a violation of the CEA or the CFTC’s 

rules to apply to the CFTC for an order awarding damages caused by the violation. These 

reparations procedures offer a variety of methods to resolve claims, including a voluntary 

procedure based on the submission of written documents and a summary procedure for 

claims of less than $30,000. 

Client information, know your client and suitability rules 

AML requirements and PATRIOT Act require intermediaries to conduct identity checks of their 

customers. CFTC Regulation 1.37 requires each FCM, RFED, IB and member of a contract 

market to record in permanent form details about customers for whom they operate 

accounts. 

CFTC Regulations 23.402(b) and 23.402(c) require SDs to have systems to record details of 

each counterparty whose identity is known to the SD prior to the execution of a transaction. 

CFTC Regulation 1.55 requires detailed disclosures, including prescribed risk disclosures and 

firm-specific information, to be made before an FCM or IB opens an account with a customer. 

NFA's Know Your Customer rule (2-30) requires each Member to obtain extensive information 

about each customer's experience, income, net worth and age before opening an account. 

Based on that information, the Member has to make a judgment as to the amount of 

disclosure that is adequate and must decide whether the customer requires additional risk 

disclosures beyond the standard disclosures required by CFTC regulations. In some cases, the 

only adequate risk disclosure that the Member can provide is that futures trading is too risky 

for that customer. This is true even if the Member makes no recommendations to the 

customer. 

NFA Compliance Rule 2-4 requires that each FCM, or in the case of introduced accounts, the 

IB, make available to its customers, prior to the commencement of trading, information 

concerning the costs associated with futures transactions. 

CFTC Regulation 23.431 requires an SD or MSP to disclose to non-dealer counterparties 

material information concerning the swap in a manner reasonably designed to allow the 

counterparty to assess the material risks and characteristics of the swap and the incentives 

and conflicts of interest that the SD or MSP may have in connection with the swap. 

NFA Compliance Rule 2-4 provides that Members and Associates must observe high 

standards of commercial honor and just and equitable principles of trade in the conduct of 

their commodity futures business. Part 23 of the CFTC’s Regulations requires that SDs and 

MSPs communicate in a fair and balanced manner based on principles of fair dealing and 

good faith with respect to any communication between the SD or MSP and any counterparty, 

and prohibits fraud, manipulation, and other abusive practices. An SD acting as an advisor to 

a “special entity” (which includes government agencies and employment benefit plans) has a 

duty to make a reasonable determination that any swap or trading strategy involving a swap 

recommended by the SD is in the best interests of the special entity. 

CFTC Regulations contain detailed record-keeping requirements, including transaction 

records, and records about customer funds and accounts. These requirements apply to FCMs 

and where appropriate IBs. SDs and MSPs are also subject to record-keeping requirements. 

CFTC Regulation 1.31 requires all books and records required by the CEA and CFTC 

regulations to be kept for a period of five years and to be readily accessible during the first 2 

years of the 5-year period. All books and records must be open to inspection by any 

representative of the CFTC or DOJ. 
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CFTC Regulation 1.33(a) requires that FCMs provide monthly statements to customers who 

have active accounts. Regulation 1.33(b) requires that each FCM furnish trade confirmations 

no later than the next business day. For customers of an IB, the carrying FCM provides these 

statements.

Conflicts of interest

The regulatory regime for conflicts is primarily disclosure based, and CTAs are subject to 

mandatory conflict disclosure obligations. 

There are explicit rules in Part 155 of the CFTC’s regulations that require FCMs and IBs to 

establish and enforce internal rules, procedures and controls to ensure, to the extent possible, 

that orders received from customers are transmitted before any order in the same commodity 

for the benefit of a proprietary account. 

CFTC Regulation 23.431(a)(3) requires SDs and MSPs to disclose to any counterparty to a 

swap the material incentives and conflicts of interest that the SD or MSP may have in 

connection with a particular swap, including any compensation or other incentive from any 

source that the SD or MSP may receive in connection with the swap. 

Supervision

Supervision of intermediaries takes place at a number of levels. Front line responsibilities are 

with the SROs (exchanges and NFA). The NFA has supervision responsibilities for CTAs. In the 

case of FCMs, the allocation of responsibility for supervision of compliance with financial 

requirements, including a daily review of the segregation calculation, is governed by the JAC 

arrangements, under which the CME is the DSRO for the majority of FCMs, with NFA playing 

this role for around 20 FCMs. CME supervision of FCMs also includes monitoring compliance 

with the sales practices and AML obligations of FCMs for which it is the DSRO. 

NFA has an Examinations group consisting of about 200 people. The CFTC requires the NFA 

to inspect all FCMs for which it is the DSRO on at least once every 15 months. In practice a 

second horizontal examination on compliance with segregation requirements is also carried 

out annually. For non-FCMs and CTAs, the NFA uses a risk scoring system, based on analysis 

of the data it holds on registrants and its knowledge of individual entities, to select registrants 

for examination and the areas of focus of that review. The time since the last examination is a 

factor used in the risk system. The NFA does not use a rigid cycle for examination of these 

registrants but expects to conduct an on-site inspection about every 3 to 4 years. On average, 

the NFA carries out between 550 and 650 examinations each year. In recent years, the NFA 

has been doing a higher number of examinations for cause. The number of disciplinary 

actions (member responsibility actions) resulting from examinations has increased. 

The NFA also reviews all registrants’ disclosure documents and monitors promotional 

material. It has also been active in the supervision of retail foreign exchange activity. 

Examinations of SDs have commenced. 

The exchanges also monitor compliance by their members with obligations under the 

legislation, exchange rules and NFA rules. Monitoring includes member compliance with their 

trade practice obligations in relation to market activity (for example, the prohibitions on wash 

trades and other abusive practices). 

Within the CFTC, the Examinations group is comprised of approximately 40 staff members, 

mostly auditors and accountants. The Examinations group activities in relation to monitoring 

the financial condition of FCMs and related examinations are described in Principle 30.In 

general, the CFTC conducts a limited number of examinations given the frontline 

responsibility of the NFA. In fiscal year 2014, the examinations branch of DSIO performed 11 
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limited scope reviews of FCMs, one for cause examination of a swap dealer, and no 

examinations of IBs. With respect to CPOs and CTAs, CFTC staff does not directly examine 

CPOs and CTAs. According to CFTC senior staff, its examinations are increasingly shifting to 

an approach focusing on the control environment and risk management processes. The work 

of the Examinations group is supplemented by the Registration and Compliance group, which 

reviews annual and quarterly reports for compliance with legislative and rule requirements. 

All SROs have mechanisms for taking disciplinary action against members, and the NFA and 

the large exchanges have significant numbers of investigations and disciplinary proceedings 

in process at any given time. Each SRO meets quarterly with the CFTC and shares information 

about current investigations. The NFA also meets quarterly with law enforcement agencies 

such as the FBI. 

SEC

Management, supervision and organizational requirements 

BDs

To comply with their obligations, including the financial responsibility rules such as the NCR, 

the Customer Protection Rule, the Hypothecation Rules and the Quarterly Count Rule and 

associated reporting obligations, BDs must have in place appropriate systems of control to 

manage risk. 

SRO rules, including those of FINRA, require BDs to implement a supervisory system 

reasonably designed to achieve compliance with applicable securities laws, regulations and 

rules. Under those rules, BDs must appoint a chief compliance officer (CCO), and the chief 

executive must certify annually that the BD has in place policies and procedures to establish, 

review and modify compliance procedures. Under SRO rules, internal examinations of aspects 

of a BD’s business must be carried out at least once each year, and results reported to senior 

management. 

In addition to monthly or quarterly FOCUS reports, BDs must prepare and file with the SEC 

annual reports consisting of a financial report and either a compliance report or an exemption 

report, as well as reports prepared by an independent public accountant covering the 

financial report and the compliance report or the exemption report. SROs also have rules 

requiring members to file an annual report. 

OTC derivatives dealers and ANC broker-dealers are explicitly required to establish, 

document, and maintain a system of internal risk management controls to manage the risks 

associated with their business activities, including market, credit, leverage, liquidity, legal, and 

operational risks. The management of ANC broker-dealers and OTC derivatives dealers is 

required to periodically review, in accordance with written procedures, their business activities 

for consistency with risk management guidelines. 

The Exchange Act authorizes the SEC to sanction a broker-dealer or any associated person 

that fails to reasonably supervise another person subject to the firm’s or the person’s 

supervision that commits a violation of the federal securities laws. The Exchange Act provides 

an affirmative defense against a charge of failure to supervise where reasonable procedures 

and systems for applying the procedures have been established and effectively implemented 

without reason to believe those procedures and systems are not being complied with 

(Exchange Act Sections 15(b)(4)(E) and (b)(6)(A)). The SEC’s policy regarding failure to 

supervise emphasizes that it is the responsibility of broker-dealers and their supervisory 

personnel to supervise their employees. 
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Investment advisers 

An investment adviser is required to disclose information regarding its management and 

organizational structure on its Form ADV. Rule 206(4)-7 under the Advisers Act requires an 

investment adviser to adopt and implement written CP&P reasonably designed to prevent the 

violation of the Advisers Act by the investment adviser or any of its supervised persons; 

review annually the adequacy of those policies and procedures; and to appoint a CCO to 

administer the CP&P. An investment adviser’s CCO must have enough seniority and authority 

within the investment adviser’s organization to conduct an independent compliance review 

and compel others to comply with the CP&P. All supervisors, including senior management, 

are subject to liability for failure to supervise. 

If an adviser is deemed to “have custody” of client assets under the Advisers Act, an 

independent public accountant must verify all those assets by actual examination at least 

once during each calendar year at a time that is chosen by the accountant without prior 

notice or announcement to the adviser and that is irregular from year to year. 

Direct Electronic Access 

SEC Exchange Act Rule 15c3-5 applies to BDs with access to trading in securities by virtue of 

being an exchange member or an ATS subscriber. It also applies to access to trading on an 

ATS that the BD operating the ATS provides to its non-BD subscribers. A BD with market 

access, or that provides a customer or any other person with access to an exchange or ATS 

through the use of its market participant identifier or otherwise, is required to establish, 

document, and maintain a system of risk management controls and supervisory procedures 

that, among other things, are reasonably designed to: 

Systematically limit the financial exposure of the BD that could arise as a result of market 

access; and 

Ensure compliance with all regulatory requirements that are applicable in connection with 

market access. 

The rules establish detailed standards that these systems must meet. The SEC has recently 

conducted a sweep to review how BDs have implemented their obligations under this new 

rule (see below). 

Protection of clients 

Fair treatment of clients 

BDs are subject to comprehensive statutory requirements as well as SEC and SRO rules 

designed to promote business conduct that protects investors from abusive practices. FINRA 

rules require BDs to deal fairly with customers and observe high standards of commercial 

honor and just and equitable principles of trade, and impose more specific obligations such 

as having a reasonable basis of recommending transactions to a client, best execution and 

disclosing conflicts of interest. 

BDs have a duty of fair dealing towards their customers that is derived from the anti-fraud 

provisions of the federal securities laws. Under the “shingle” theory, by virtue of engaging in 

the brokerage profession, a BD impliedly represents to those persons with whom it transacts 

business that it will deal fairly with them, consistent with the standards of the profession. 

SRO rules also require BDs to deal fairly with customers. For example, FINRA rules: 

Require a BD to have a reasonable basis for believing that any recommended transaction or 

investment strategy involving a security or securities is suitable for the customer; 
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Impose a duty of best execution on BDs; 

Require a BD to engage in fair and balanced communications with the public; provide timely 

and adequate confirmation of transactions; and disclose conflicts of interest; and 

Give customers the opportunity for redress of disputes through arbitration. 

IAs have a fiduciary obligation (imposed by Section 206 of the Advisers Act as interpreted by 

the courts) to act in the utmost good faith with respect to their clients. This general obligation 

is supplemented by detailed statutory provisions such as those relating to conflicts and the 

protection of material non-public information. 

Conflicts of interest

BDs are required under relevant circumstances, such as when making a recommendation, to 

disclose material conflicts of interest to their customers. The federal securities laws and SRO 

rules also restrict broker-dealers from participating in certain transactions that may present 

particularly acute potential conflicts of interest. In other instances, the federal securities laws 

require broker-dealers to mitigate conflicts by engaging in specified actions. 

Research analysts are subject to detailed conflict rules (described under Principle 23). 

An IA must disclose all material facts regarding a conflict or potential conflict so that a client 

or prospective client can make an informed decision whether to enter into or continue an 

advisory relationship with the adviser, or take action to protect himself or herself against the 

conflict. As a fiduciary, an adviser owes its clients undivided loyalty and must take steps 

reasonably necessary to fulfill his or her fiduciary obligations. 

Specific provisions in the Advisers Act deal with potential adviser conflicts, such as those 

relating to performance fees, and proprietary dealings by the adviser. 

Client funds and assets 

As indicated above, a number of SEC financial responsibility rules provide for the protection 

of customer funds and assets, including the Customer Protection Rule, the Hypothecation 

Rules, and the Quarterly Count Rule. 

The Customer Protection Rule requires a broker-dealer to segregate customer securities and 

cash from the firm’s proprietary business activities. The Rule requires that every BD obtain 

and maintain possession or control of customer fully paid and excess margin securities, which 

means that it must hold them itself, or as is more common, hold them in a satisfactory 

location. This Rule also requires that a broker-dealer maintain a reserve account that contains 

(at least) the net dollar amount of cash the broker-dealer owes to its customers (in 

accordance with a prescribed formula). 

The Hypothecation Rules prohibit a broker-dealer from hypothecating customers’ fully paid 

and excess margin securities. 

The Quarterly Count Rule requires that broker-dealers count positions owed to customers 

and securities on hand and reconcile those two numbers on a quarterly basis. 

As described in Principle 30, new rules effective in 2014 require the audit report to be 

accompanied by a separate compliance report through which the auditor must evaluate the 

BD’s compliance with its financial responsibility rules (including the net capital and customer 

protection rules). 

The regime for IAs that “have custody” of customer funds and assets is described under 

Principle 29. 
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Investor complaints 

Exchange Act Rule 17a-3(a)(18) requires BDs to maintain: 

A record for each written customer complaint received regarding an associated person, 

including the disposition of the complaint; and 

A record indicating that each customer has been provided with a notice with the address and 

telephone number to which complaints may be directed. 

In addition, SRO rules require BDs to document and respond to all customer complaints. 

Pursuant to SRO rules, BDs must report to the SROs specified events related to customer 

complaints, as well as statistical and summary information on customer complaints. SROs’ 

arbitration rules are designed to effectively facilitate the resolution of disputes involving 

members, associated persons of members, and customers. Today, substantially all disputes 

are heard in arbitration, and the vast majority of brokerage-related arbitration claims are 

handled through the forum of one SRO, FINRA. 

For IAs, dissatisfied clients can sue under state law, and Section 215 of the Advisers Act 

provides a client with a limited private right of action for contracts made in violation of the 

Advisers Act, to void the contract or for restitution. 

Client information, know your client and suitability rules 

Client identity 

Client identity requirements are established for financial institutions by the BSA (administered 

by FinCEN) and elaborated by provisions of the PATRIOT Act. The PATRIOT Act requires BDs 

to establish a written customer identification program (CIP) with procedures for, among other 

things, obtaining and retaining customer identifying information and verifying customer 

identity. 

SROs also have rules dealing with AML compliance and customer account information. 

IAs must conduct financial transactions for their clients through financial institutions that are 

subject to BSA requirements, including customer identification requirements. 

Know your customer and suitability

Under SEC Rules, BDs must obtain and retain certain information regarding customers that 

open accounts (including the beneficial owners of accounts). Information required includes 

the customer’s employment status, net worth, annual income, and investment objectives. 

Firms are required to update this customer account record information at least once every 

three years. 

BDs generally have an obligation to recommend only those specific investments or overall 

investment strategies that are suitable for their customers. The concept of suitability appears 

in specific SRO rules and has been interpreted by the courts as an obligation under the antifraud provisions of the federal securities laws. 

IAs under the Advisers Act owe their clients the duty to provide only suitable investment 

advice. To fulfill this suitability obligation, an investment adviser must make a reasonable 

determination that the investment advice provided is suitable for the client based on the 

client's financial situation and investment objectives. 

Records 

SEC rules make detailed provisions for the creation and retention by BDs of books and 

records, including for example detailed records about all purchases and sales of securities. 
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The length of time a BD must preserve records depends on the type of record (for example, 6 

years for records of securities transactions; 3 years for trade confirmations). 

The Advisers Act imposes extensive recordkeeping obligations on IAs, SEC Advisers Act Rule 

204-2 requires an adviser to maintain business accounting records as well as records that 

relate to the fiduciary nature of its business. Additional records must be maintained in certain 

circumstances (for example if an investment adviser has custody of client assets). Generally, all 

required books and records must be maintained and preserved in an adviser’s office for two 

years after the last entry date and three additional years in an easily accessible place. 

Disclosure to clients

Under the anti-fraud provisions, a BD’s duty to disclose material information to its customer is 

based upon the scope of the relationship with the customer. For transaction only accounts 

the material information the BD is required to disclose to its customer is limited to the details 

of the transaction. When recommending a security, a broker-dealer may be liable if it does 

not give honest and complete information. A broker-dealer also may be liable if it does not 

disclose material adverse facts of which it is aware. 

For certain types of transactions, the legislation and SRO rules require disclosure documents 

to be given to the client, sometimes including mandated forms of disclosure. Examples 

include disclosures relating to penny stocks, credit terms in margin transactions, day trading 

risk disclosures, and disclosure about options and securities futures. A BD participating in a 

securities distribution registered under the Securities Act must deliver a preliminary 

prospectus to the client. 

For BDs, written contracts are required for certain types of accounts (such as margin accounts, 

options accounts and discretionary accounts). In practice, most broker-dealers have a 

customer sign a customer agreement, although they are not required to do so. 

The investment advisory contract forms the basis for the relationship between the investment 

adviser and its clients. Section 205 of the Advisers Act and related rules contain a number of 

provisions relating to items required to be included or prohibited from inclusion in an 

investment advisory contract. 

Registration requirements under the Advisers Act require IAs to provide to their clients (and 

prospective clients) disclosure documents that are written in a plain English standardized 

format and provide meaningful, current disclosure of the business practices, conflicts of 

interest and background of the investment adviser and its advisory personnel. 

Reports to clients 

A BD is required to send its customers written trade confirmations, account statements, and 

other reports disclosing activities and transactions it has taken on the customer’s behalf. SRO 

rules require that a broker-dealer send each customer an account statement at least quarterly 

showing the client’s security positions and account balances. The industry practice is to send 

monthly account statements to customers with activity in their accounts during that month. 

The Advisers Act generally does not require an investment adviser to send account 

statements to its clients. An investment adviser may use a BD to effect trades and the BD 

would be responsible for providing these documents. However, many IAs do send monthly or 

quarterly account statements to their clients. IAs are not required to report performance, but 

it is market practice to do so. This reporting is subject to the antifraud provisions. 

Advisers Act Rule 206(4)-2 requires an investment adviser that has custody of client assets to 

have a reasonable belief, after due inquiry, that the qualified custodian that maintains the 
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client assets sends each client, not less frequently than once every three months, an itemized 

statement showing the client’s funds and securities in the adviser’s custody or possession, 

and all debits, credits, and transactions in the client’s account during the period. 

Information about remuneration 

FINRA rules require BDs to provide customers with adequate notice prior to their 

implementation or change of a service fee. BDs should provide written notice to customers of 

all service charges when accounts are opened, and at least 30 days prior to the 

implementation or change of any service charge. 

Investment adviser compensation arrangements are required to be disclosed extensively in 

Form ADV. Part 1A of Form ADV requires IAs to disclose the nature of their compensation 

arrangements. Part 2A of Form ADV requires additional disclosures about how an adviser is 

compensated for its services. 

Supervision

Broker-dealers 

SROs have front line responsibility for overseeing BDs’ compliance with federal securities laws 

and SRO rules. BDs that are members of multiple exchanges have a single DEA, which is the 

SRO that is primarily responsible for the firms’ financial and operational regulation. In 

practice, many SROs have entered into an agreement with FINRA under Exchange Act Rule 

17d-2 to allocate DEA responsibility to FINRA, and FINRA is the SRO responsible for 

examinations of almost all 4,400 BDs. 

FINRA’s member regulation program is risk-based with regard to both the frequency of 

examinations and their scope. Frequency is dictated by the impact of the firm as measured by 

variables such as employees, branch offices, and revenue as well as the risks presented by the 

firm’s business lines and activities taking into account factors such as the registered 

representatives the firm employs, the products it sells and the customers it does business 

with. There are four levels of impact against which a firm is measured (1-4) and five levels of 

risk (A-E). From a risk perspective, the highest risk firms categorized as A or B risk are 

examined annually; C firms on a 2-year cycle; D firms on a 3-year cycle; and E firms on a 4-

year cycle. Additionally, all impact 1 firms, which are typically the largest carrying and clearing 

firms, are reviewed annually. 

FINRA’s Member Regulation Department conducts routine cycle examinations and for cause 

examinations. The Member Regulation Department consists of approximately 1,100 staff, 

including over 800 staff in the District Offices, over 200 staff in the Risk Oversight and 

Operational Regulation Group (ROOR), and over 80 staff in its Shared Services Department. 

As part of the routine cycle examinations FINRA develops a list of priorities which is shared 

ex-ante with the SEC in order to obtain its feedback. 

Cycle examinations are conducted in the District Office Program and by the Risk Oversight 

and Operational Regulation Group (ROOR). The District Offices examine for business conduct 

risk at all member firms and financial and operational risk at primarily introducing firms. 

ROOR examines for financial and operational risk at the largest carrying and clearing brokerdealers (190 firms) and their affiliates. FINRA carries out about 1,700 cycle examinations each 

year, and about 3,000 for cause examinations. Cause matters are typically triggered by 

customer complaints, terminations for cause, regulatory tips, arbitrations, litigation, referrals 

from other regulators and other sources, and sweep examinations. Some 8 to 10 percent of 

FINRA examinations result in formal investigations and disciplinary action. 

The Market Regulation Department’s Trading and Financial Compliance Examinations (TFCE) 
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group within FINRA’s Market Regulation unit conducts cycle, cause, and sweep examinations 

of broker dealers in FINRA’s capacity as an SRO/DEA. In addition, TFCE conducts cycle, cause, 

and sweep examinations pursuant to various agreements with exchange clients. TFCE is 

composed of four units: Equities, Options, Trading Examinations, and Financial Operations 

(FinOp). TFCE - Equities and Options conduct primarily cycle trading examinations on behalf 

of FINRA’s exchange clients and FINRA. TFCE – FinOp conducts primarily cycle, financial, and 

operational examinations, including FinOp DEA examinations performed under an RSA. As an 

adjunct to the trading exam cycle program, TFCE’s Trading Examinations Unit (TEU) conducts 

primarily equities and options cause and sweep examinations. Cause and sweep examinations 

may by initiated and/or involve a review of: issues identified during a cycle examination or 

surveillance review; issues raised in a complaint or referral; compliance with a new rule or 

regulatory requirement; FINRA management or RSA exchange client input; or the industry’s 

response to an emerging regulatory issue 

In addition, a separate department of FINRA, consisting of 65 people, reviews promotional 

material relating to BDs’ marketing of their services and compliance with SEC rules relating to 

product distribution by BDs. Some 100,000 filings are reviewed each year, 85 percent of which 

are from continuously offered mutual funds. 

As well as having oversight of FINRA’s supervision of BDs, the SEC also conducts direct 

examinations of BDs. The SEC has a dedicated team of 300 staff for BD examinations. 

OCIE has in place a program of examinations that is based on national priorities decided on 

an annual basis. The process of setting up these priorities involves a dialogue between OCIE 

and other divisions of the SEC, as well as feedback from FINRA and the SEC Commissioners. 

Last year the SEC published for the first time its annual priorities for the examination 

program. According to OCIE staff, the SEC is using publication as a way to affect firm behavior 

(as once an issue is highlighted as a priority, firms start analyzing their own compliance with 

these priorities). This list of priorities is used by Regional and Home Office examination staff 

to help plan examinations for the upcoming year. In some cases, examinations are selected 

solely based on a priority and in other cases, a priority is a focus area within an examination. 

Sometimes, in the case of a tip, complaint or referral for example, an examination may focus 

on a high risk investor protection area that is not necessarily addressed in the list of priorities 

for the year however conducting an examination in these cases would be consistent with a 

risk-based approach. Regional budgets also take into account the need to leave room for the 

regions to include also topics that are of concern for the particular region. 

OCIE uses a risk-based approach for selecting which firms to examine and draws on a variety 

of data sources, including registrants’ reports, FINRA’s reports and TCRs, supported by 

technology. For each BD in addition to the national priorities, the examination would focus on 

the specific areas that pose the highest risk. 

Important examination initiatives for 2014 have involved cybersecurity; sales practices and 

fraud; retirement issues, AML and market access rule. 

The SEC carried out 443 direct examinations of BDs in FY 2012; 438 in FY 2013; and 493 in FY 

2014. 

In addition to its examination program, OCIE has recently instituted a large firm monitoring 

program (LFM). As described in Principle 30, this program focuses on large and complex firms 

that could pose significant risk to the markets and to their customers due to their size, 

complexity, and connectivity with other large firms and financial institutions. This group 

includes the largest BDs. LFM conducts its monitoring primarily by meeting periodically with 

firms’ risk and control functions, including: market risk; credit risk; treasury; finance; internal 
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audit; operations; operational risk; legal; compliance (including AML); and new products. 

Using the information gathered at these meetings, LFM provides information to other OCIE 

staff regarding individual firm and cross firm risks and developments for use in examination 

planning. The LFM team also supports OCIE’s enterprise risk management reviews, which 

include meetings between senior regulators and firms’ senior management, board members, 

and heads of control functions. Eleven examinations of large firms were carried out in each of 

2012 and 2013. 

The SEC copies FINRA on all deficiency letters it sends to BDs as a result of its examinations, 

and receives copies of all FINRA examination reports. 

Investment advisers

The SEC is responsible for the supervision of IAs and no SROs are involved. It has a dedicated 

team of 450 staff for the examination of IAs. 

The IA population is large (some 11,500 registered IAs) and diverse. It includes IAs who are 

the operators of mutual funds (see further under Principle 24), IAs who are also BDs, 

managers of private client discretionary accounts and other asset managers. 

OCIE uses a risk based approach to the supervision of IAs. It uses information contained in 

IAs’ Form ADV and other information filed with the SEC, as well as other data sources 

including TCRs to select firms to be inspected. As described under Principle 24, OCIE’s ORAS 

group leverages data analytics and other available information to identify firms that may pose 

higher risk (for example because of potential compliance stress, disclosures, previous 

examinations, or complaints) This information, and on-the-ground information from regional 

offices, is used to identify firms to be examined. As with BDs, there are national priorities for 

IAs. Examinations of IAs focus on the national priorities, but also include firm-specific issues. 

For 2014, focus areas in the national program included: safety of assets and custody; conflicts 

of interest inherent in some IA business models; marketing/performance; wrap fee programs; 

quantitative trading models; and payments for distribution. 

OCIE conducted 1,004 examinations of IAs in FY 2011; 974 in FY 2012; 964 in FY 2013 and 

1,150 in 2014. For FY 2014, these figures include approximately 170 examinations of the over 

1,600 IAs that are mutual fund operators. 

The number of examinations for 2014 represents roughly 10 percent of the IA population and 

30 percent of AUM. The SEC staff acknowledges that this coverage is limited and has meant 

in practice that firms may go without inspection for extended periods of time. On the other 

hand, a new population of IAs is now subject to registration, putting further pressure on its 

resources. To address these challenges the SEC included in its 2014 priorities focused, riskbased examinations of IAs that have been registered for more than three years but have not 

yet been examined. 

The SEC is also continuing an initiative to examine a significant percentage of the advisers 

registered since the effective date of the Dodd-Frank Act. The five key focus areas of these 

examinations are marketing, portfolio management, conflicts of interest, safety of client 

assets, and valuation. The vast majority of these new registrants are advisers to HFs and 

private equity funds that were not registered or regulated by the SEC prior to the Dodd-Frank 

Act, and have never been examined by the SEC. 

Assessment Broadly Implemented 

Comments The issue of concern under this Principle is the supervision of IAs, and in particular their 

coverage by examinations (see also under Principle 24 regarding IAs that operate CIS). 
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Securities and derivatives intermediaries other than IAs are covered by the examination 

programs of the SROs, notably FINRA and the NFA, and also by some direct examinations by 

the SEC and the CFTC. For these intermediaries, especially the larger BDs and FCMs, 

examination coverage is adequate and examinations appear to be well focused and thorough, 

and there is good evidence of appropriate follow up by the SROs and the regulators. The 

SROs appear well resourced (for example, the NFA’s budget and size have doubled in the last 

2-3 years) and have well qualified and experienced staff. 

For IAs, the situation is somewhat different. The population is large, and has changed in 

composition since the Dodd-Frank Act, with a larger proportion of smaller advisers now 

subject to state jurisdiction and HF and private equity advisers being brought under the SEC’s 

jurisdiction. In fiscal year 2014, 11,523 regulated IAs had $63.1 trillion in AUM; this is in 

contrast with, for example, fiscal year 2011 where 11,728 regulated advisers had $43.5 trillion 

in AUM. 

SEC resources to conduct examinations are limited. On average, only a little over 10 percent 

of the population is covered each year. The SEC is actively engaged in ensuring that priority is 

given to the new adviser population and to advisers that have not been previously examined. 

It also employs sophisticated systems to identify firms that are higher risk. Nonetheless, 

senior SEC officials acknowledge that in this area they would like to do more. Given that some 

$63 trillion of assets are managed by this part of the industry (of which about $17 trillion is in 

mutual funds) a more active presence in the market through increased on-site examinations 

is warranted. 

The assessors acknowledge that the definition of what constitutes an examination is narrow 

and applies only where a formal request for documents is made; and that a focus only on the 

number of examinations does not reflect other supervisory interactions with the IA 

population, such as informal requests for information or other forms of monitoring. 

Nevertheless, examinations are a critical component of effective supervision, and the current 

relatively low coverage of the IA population indicates the need for more resources to be 

devoted to this activity. 

Although it has not affected the grade for this Principle, the assessors note the absence of a 

suitability requirement for futures intermediaries, especially for retail customers. This 

contrasts with the positive obligation of securities intermediaries to ensure that advice and 

recommendations are suitable for the client. The NFA points out that its know-your-customer 

rule provides comparable protection to that afforded by the suitability rule of securities 

markets; that in the securities industry, investors can purchase a wide variety of securities with 

varying degrees of risk potential that serve very different investment objectives; and that in 

contrast, all futures and swaps contracts are highly volatile and risky instruments. Therefore 

the NFA has considered that “it makes no sense to say that a customer is suitable to invest in 

heating oil futures but not in Treasury note futures. Instead, the determination has to be 

made on a customer by customer basis rather than a contract by contract or transaction by 

transaction basis”. This appears to meet the requirement of Key Question 12 of the IOSCO 

Assessment Methodology. 

Principle 32. There should be a procedure for dealing with the failure of a market intermediary in order to 

minimize damage and loss to investors and to contain systemic risk. 

Description CFTC

Plans for dealing with failure of regulated firm 

The CFTC has a market disruption contingency plan which sets out a framework to deal with 

specific types of events, from a capital incident, liquidity incident, natural event (such as a 
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hurricane) to the failure of an intermediary. For each type of event, the plan provides 

guidance on the type of information needed, the type of issues that would need to be 

escalated and the divisions that would need to be involved. 

Early warning

A variety of methods are available to the CFTC to enable it to ascertain when an FCM may be 

experiencing financial distress, including the obligations of FCMs to notify the CFTC when 

early warning capital thresholds are met. The CFTC may also receive notification from an 

FCM’s DSRO or a DCO that the FCM is not meeting its financial obligations, or may soon be 

unable to meet them. 

Regulator’s powers to intervene 

If the CFTC determines that an FCM is likely to fail, then it will attempt: 

To cause the transfer of customer accounts. Under CFTC Regulation 1.17(a)(4), if an FCM 

holds less capital than the amount specified in its minimum capital requirement, it generally 

must transfer all customer accounts and immediately cease conducting business as an FCM, 

until the FCM is able to demonstrate compliance with its minimum capital requirement; and 

To determine the effects that such failure would have on the counterparties of the FCM, as 

well as on the futures markets. In most instances, if the FCM is clearing transactions through a 

DCO, the failure would cause minimal disruption to counterparties and the futures markets. 

If a DCO currently cannot collect payments from a member, or if a DCO believes that it will 

shortly be unable to collect such payments, the DCO will declare the member to be in default. 

The rules of the DCO govern the management of such default. Usually, such rules would 

permit the DCO to: 

Liquidate or transfer positions carried by the defaulting member; 

Access all property held in the proprietary accounts of the defaulting member; 

Access all property held in the customer account of the defaulting member, if the default of 

the member to the DCO resulted from the default of a customer to the member; and 

Access any amounts that the defaulting member had contributed to the guarantee fund. 

Bankruptcy

Under section 6(c) of the CEA, the CFTC has the authority to request the appointment of a 

monitor, receiver, curator or other administrator for an FCM that the CFTC has reason to 

believe is violating or has violated any provision in the CEA and the CFTC Regulations. 

The CEA and CFTC regulations, in conjunction with the Bankruptcy Code, provide a clear 

framework for the CFTC and the insolvency officer (trustee) to follow in managing the failure 

of an FCM. Part 190 of the CFTC Regulations and Subchapter IV of Chapter 7 of the 

Bankruptcy Code deal specifically with the bankruptcy of commodity brokers, including FCMs.

If an FCM becomes the subject of bankruptcy proceedings, Subchapter IV of Chapter 7 of the 

Bankruptcy Code and CFTC Regulation Part 190 apply and allow the prompt and effective 

transfer of customer positions and associated collateral to a financially solvent transferee 

FCM, or the prompt return of customer property. 

For FCMs that are members of SIPC because they are also BDs, bankruptcy would be 

conducted under SIPA procedures as described below. 
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Investor compensation 

There is no insurance scheme or guarantee fund for customer recompense in the event of 

intermediary failure when there is a shortfall in customer property, although there are 

significant regulatory requirements to keep customer property segregated, identify a shortfall 

quickly, transfer business, and provide priority claims to customer property under bankruptcy.

SEC

Plans for dealing with failure of regulated firm 

If the SEC staff became aware of a BD approaching financial difficulty, they would assemble all 

available information, contact the BD’s DEA and, if the firm is an introducing firm, its clearing 

firm. In these circumstances, the SEC must also contact SIPC to inform it of the situation so 

that SIPC can assess whether it should initiate a liquidation proceeding. Once SIPC 

determines that a member BD has failed or is in danger of failing to meet its obligations to 

customers and the firm is either insolvent or not in compliance with the SEC’s financial 

responsibility rules, SIPC may file an application in court to initiate a proceeding to liquidate 

the BD. If SIPC’s application is granted, the court appoints a trustee for the BD. If SIPC elects 

not to commit its funds, the SEC may petition a U.S. district court to order SIPC to act. 

SBSDs that are not BDs are subject to the stockholder provisions of the Bankruptcy Code 

instead of SIPA’s liquidation provisions. SIPC is not involved in liquidations under the 

Bankruptcy Code. 

Early warning systems 

BDs are subject to obligations under the early warning rule (described under Principle 30) to 

provide notice promptly (but within 24 hours) to the SEC, and under SRO rules to its DEA, 

when reporting trigger levels are reached. If a BD fails to make a required deposit in its 

reserve bank account, it must immediately notify the SEC and its DEA. 

Regulator’s powers to intervene 

The SEC, SIPC, and a firm’s DEA have the authority to restrict the activities of a BD that is in or 

approaching financial distress. The Exchange Act and related regulations prohibit a BD from 

continuing to conduct a securities business if the firm does not have sufficient net capital. A 

BD’s stockholders and partners are not allowed to withdraw equity capital from the BD if, 

among other things, the BD’s net capital falls below 120 percent of the minimum net capital 

requirement. The SEC has also approved DEA rules that allow the DEA to restrict a brokerdealer’s activities if it is in or approaching financial difficulty, such as limits on business 

expansions; and rules requiring a BD in or nearing financial difficulty to actively reduce its 

business. 

In a SIPC supervised liquidation proceeding, the trustee works to restore securities and cash 

to customers as soon as possible. The trustee and its staff close the BD’s offices and take 

control of its books and records. In a failed BD with accurate records, the trustee and SIPC 

may arrange to have some or all customer accounts transferred to another broker-dealer. 

Customers whose accounts are transferred are notified promptly of the move. 

Use of powers

The SEC has used its power to take action in response to firm failures on numerous occasions, 

including in the case of failures of major BDs during the financial crisis. 

Investor compensation 

Under a SIPA liquidation, customers of a failed broker-dealer receive all securities (such as 
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stocks and bonds) that are already registered in their names or are in the process of being 

registered. After this first step, the firm’s remaining customer assets are divided on a pro rata 

basis with securities and cash shared in proportion to the size of claims. If sufficient assets are 

not available in the firm’s customer accounts to repay customers fully, the SIPC Fund (see 

below) is available to supplement the distribution, up to a ceiling of $500,000 per customer, 

including a maximum of $250,000 for cash claims (increased from $100,000 by the DoddFrank Act). These payments can be made at any time during the liquidation process and in 

practice have been made at an early stage, with SIPC then having a claim on the proceeds of 

the liquidation. 

SIPC maintains the SIPC Fund, which constitutes an insurance program for member BDs’ 

customers. Target for this Fund is $2.5 billion and the current level is around $2.1 billion. The 

Fund is funded by an annual assessment from SIPC’s members, which is deposited in the SIPC 

Fund to reach the fund target. Assessments in 2013 were approximately $418 million. If the 

need arises, the SEC has authority to lend SIPC up to $2.5 billion that the SEC would, in turn, 

borrow from the Treasury. 

Communication and cooperation with other regulators 

The board of SIPC is structured under SIPA to ensure domestic cooperation. SIPA requires 

that one director be a Treasury employee appointed by the Secretary of the Treasury and one 

director be a Federal Reserve Board employee appointed by the Federal Reserve Board. The 

President appoints the remaining five directors, with three members coming from the 

securities industry and two members coming from the general public with no association with 

the securities industry for the previous two years. 

The SEC works closely with SIPC, and is permitted to participate as a party in any SIPC 

proceedings. The SEC also works with domestic and foreign regulators on broker-dealer 

liquidations and has processes in place for quickly contacting other regulators’ key decision 

makers. 

Title II of the Dodd-Frank Act contemplates expanding cooperation between domestic 

regulators by providing an alternative insolvency regime for the orderly liquidation of large 

financial companies, including some large BDs. In the case of a BD determined to be 

systemically important under section 203 of the Dodd-Frank Act, the Federal Reserve Board 

and the SEC, in consultation with the FDIC, are authorized to issue a written orderly 

liquidation recommendation to the Secretary of the Treasury. The determination could be 

made at the point the firm hit difficulties, and is not limited to those the FSOC had previously 

designated as systemically important. The SEC and the FDIC, in consultation with SIPC, are 

working together to propose rules that further define this process. 

Assessment Fully Implemented 

Comments 

Principles for the Secondary Markets 

Principle 33. The establishment of trading systems including securities exchanges should be subject to 

regulatory authorization and oversight. 

Description Trading systems requiring authorization

Exchanges 

The definition of an exchange is in the Exchange Act. An exchange is any organization, 

association, or group of persons, whether incorporated or unincorporated, which constitutes, 

maintains, or provides a market place or facilities for bringing together purchasers and sellers 
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INTERNATIONAL MONETARY FUND 211

of securities or for otherwise performing with respect to securities the functions commonly 

performed by a stock exchange as that term is generally understood, and includes the 

marketplace and the market facilities maintained by such exchange (Section 3(a)(1) Exchange 

Act). 

Rule 3b-16 defines whether a system would qualify as an exchange. A system meets the 

Rule’s criteria, if it brings together the orders for securities of multiple buyers and sellers and 

uses established, non-discretionary methods under which such orders interact with each 

other, and the buyers and sellers entering such orders agree to the terms of a trade. A system 

that meets these criteria must either register with the SEC as a national securities exchange or 

seek an appropriate exemption. One frequently used exemption is for alternative trading 

systems (see below). A system could also or be exempted based on limited volume; no such 

exemptions currently apply. 

Order routing is specifically excluded from the definition of an exchange, as are single-dealer 

systems that incidentally match undisplayed orders. Market makers may also operate systems 

that match customer orders under certain conditions without being considered to be 

exchanges. According to the SEC staff, such crossing of customer orders is however not done 

in a systematic manner. The SEC continuously monitors the broker-to-broker bilateral 

networks to assess whether they may develop towards multilateral systems. 

A DCM may register by notice filing with the SEC as a national securities exchange for the 

purposes of listing and trading security futures products. Such notice registration is effective 

immediately. Currently there is only one exchange that trades both commodity and security 

futures: OneChicago, LLC. 

Alternative trading systems 

Rule 3a1-1(a)(2) under the Exchange Act provides that a system will be exempt from the 

statutory definition of an exchange, if it registers as a broker-dealer and complies with 

Regulation ATS. An ATS trading solely in government securities and certain other related 

instruments is not required to comply with Regulation ATS. Rule 300(a) of Regulation ATS 

defines an ATS as a system that meets the criteria of Rule 3b-16. Similar to an exchange, an 

ATS is required to be a multilateral system. The Regulation ATS definition implies that the BD 

itself would be an ATS. However, in practice a BD operates an ATS that is a system rather than 

a separate legal entity. In many cases, BDs trade on own account in their ATS or their 

affiliated BD conducts such trading. This is permitted under Regulation ATS, subject to 

compliance with the relevant conflicts of interest requirements on BDs (see Principles 8 and 

31). Contrary to a national securities exchange, an ATS is not an SRO and does not set rules 

governing its subscribers’ conduct other than their trading conduct on the ATS itself, or 

discipline its subscribers other than by exclusion from trading. 

As of the end of December 2014, there were 88 ATSs that had an active Form ATS on file with 

the SEC. At the same time, information published by FINRA included 39 equity ATSs. The 

other ATSs organized trading in fixed income instruments. There is no public, consolidated 

information available on the trading models and subscribers of these ATSs and the specific 

instruments they organize trading in. Varying levels of such information is publicly available 

on the ATSs’ websites. The large majority of ATSs are dark pool ATSs that provide no pretrade transparency, with a few equity ATSs operating as lit Electronic Communication 

Networks (ECNs). The assessment of this Principle focuses on the equity ATSs, because they 

operate equity trading systems similar to those of national securities exchanges. In contrast, 

trading in fixed income instruments takes place primarily OTC. 
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Designated contract markets 

Any market that seeks to provide a trading facility to trade futures, options on futures or 

options on commodities must apply to the CFTC to become a DCM, unless an exemption or 

exclusion applies. Currently there are no exemptions; the prior exemptions on exempt 

commercial markets and exempt boards of trade were removed by the Dodd-Frank Act. 

Swap execution facilities and security-based swap execution facilities 

A swap execution facility is a trading system or platform in which multiple participants have 

the ability to execute or trade swaps by accepting bids and offers made by multiple 

participants in the facility or system. Any such multilateral trading facility must register with 

the CFTC as either a DCM or SEF (Section 5h(a)(1) CEA). SEF registration is only available for 

swap trading facilities that limit participation to ECPs. 

The definition of security-based swap execution facility (SB SEF) in Section 3(a)(77) of the 

Exchange Act is the same as the one for a SEF in the CEA. SB SEFs will have to register with 

the SEC (Section 3D Exchange Act) by the date to be specified in the relevant SEC final rules. 

In the interim, SB SEFs are permitted to operate without registering. 

Foreign boards of trade 

CFTC Regulation 48.3 requires a foreign board of trade (FBOT) that provides its members or 

other participants located in the U.S. with direct access to its electronic trading and order 

matching system to register with the CFTC. 

General registration requirements 

National securities exchanges 

Section 6(b) of the Exchange Act includes the criteria that an applicant has to fulfill in order to 

be registered as a national securities exchange. They include(see also Principle 9): 

 Having the organization and capacity to enforce compliance by its members and their 

associated persons with the Exchange Act, the SEC rules and regulations, and the 

exchange rules; 

 Enabling any registered broker or dealer to become an exchange member; 

 Assuring a fair representation of its members in the selection of the exchange’s directors 

and providing that one or more directors is a representative of issuers and investors; 

 Providing for the equitable allocation of reasonable dues, fees, and other charges 

among its members and issuers and other persons using its facilities; and 

 Providing for appropriate and fair procedures for disciplining its members for law or rule 

violations. 

An applicant must also demonstrate its ability to operate as part of the National Market System 

(Section 11A Exchange Act). In particular, it must satisfy the following Regulation NMS 

requirements: 

The Order Protection Rule, which requires exchanges and other trading centers, including 

ATSs,14 to establish policies and procedures reasonably designed to prevent the execution of 

 

14 This requirement also applies to exchange specialists, OTC market makers or any broker-dealer that executes 

orders internally by trading as principal or crossing orders as agent. 
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INTERNATIONAL MONETARY FUND 213

trades at prices inferior to automated quotations that are the best quote of another exchange

or another automated trading center, subject to applicable exceptions; 

The Access Rule, which requires fair and non-discriminatory access to quotations, establishes 

a limit on access fees to harmonize the pricing of quotations across different exchanges and 

other trading centers, and requires rules addressing locked and crossed markets; and 

The Sub-Penny Rule, which prohibits market participants from accepting, ranking, or 

displaying orders for securities priced $1.00 or more in increments smaller than a penny. 

Section 6(a) of the Exchange Act includes the general requirements for the content of an 

application to register as a national securities exchange. The application must include the 

rules of the exchange and the information prescribed in SEC Rule 6a-1 and Form 1. This 

covers, among other issues, the following: 

 Information about the exchange operators; 

 The manner of operation of the trading system, including the means of access; the 

procedures for entering and displaying quotes; procedures of executing, reporting, 

clearing and settling transactions; and fees; 

 Lists of officers, governors and members of all standing committees; 

 For exchanges with one or more owners, shareholders or partners that are not also 

members of the exchange, lists of shareholders that own 5 percent or more of a class of 

voting shares; 

 Criteria for exchange membership and the conditions and process for suspension or 

termination of membership; 

 A list of all members; and 

 A schedule of all securities listed or traded on the exchange. 

The SEC must publish notice of the application for public comment and, generally within 90 

days of publication, by order grant the registration or institute proceedings to determine 

whether the application should be denied. The SEC must grant such registration, if it finds 

that the relevant requirements are satisfied and deny a registration if it cannot make this 

finding. Once registered, a national securities exchange becomes an SRO. (Section 19(a) 

Exchange Act). 

Alternative trading systems 

To comply with Regulation ATS, a firm needs to register as a BD and become a member of an 

SRO (in practice FINRA). A BD wishing to operate an ATS must file a notice (an Initial 

Operation Report) with the SEC on Form ATS at least 20 days prior to commencing operation 

as an ATS. This requires providing certain information on the ATS, including: 

A description of the class of subscribers and of any differences in access to services offered by 

the ATS to different groups or classes of subscribers; 

The name of any entity, other than the BD operating the ATS, that will be involved in the 

operation of the ATS, including the execution, trading, clearing and settling of transactions; 

The manner of operation of the ATS, procedures governing entry of orders, means of access, 

and procedures governing execution, reporting, clearing and settlement of transactions 

effected through the ATS; 

Procedures for ensuring subscriber compliance with system guidelines; 
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214 INTERNATIONAL MONETARY FUND

A copy of the ATS’ subscriber manual and any other materials provided to subscribers; and 

A brief description of the ATS’s procedures for reviewing system capacity, security, and 

contingency planning procedures. 

The responsibility for the review of Forms ATS and the continuous monitoring of ATSs lies 

with the SEC’s Trading and Markets Division’s Office of Market Supervision. While the SEC 

does not approve Forms ATS, Office of Market Supervision attorneys review them for 

compliance with the Form ATS instructions as well as potential inconsistencies with 

Regulation ATS and applicable federal securities laws. A form that complies with the 

requirements for the Form ATS will be considered complete and deemed to be filed with the 

SEC as of the day it was received. If a form does not meet the requirements, it is considered 

incomplete, deemed not filed, and must be resubmitted to the SEC. In such cases, the ATS 

would not be in compliance with Regulation ATS.

Forms ATS are not required to be published; however a few BDs have voluntarily published 

them. In addition, the SEC Chair has asked SEC staff to prepare a recommendation to the 

Commission to expand the information about ATS operations submitted to the SEC and to 

make the information available to the public. 

In addition to the above process with the SEC, a registered BD that is already a FINRA 

member and plans to operate an ATS must file an application for approval of a change it its 

business operations under FINRA Rule 1017. The application is made electronically on the 

Continuing Membership Application Form. The form is reviewed by FINRA’s Department of 

Member Regulation that works closely with FINRA’s Market Regulation Group in case of a 

change related to operating an ATS. In the connection of reviewing such a change, FINRA 

staff consider the ability of the BD to comply with, among other matters, the Regulation ATS 

requirements. They also evaluate the applicant’s business plan, the manner in which orders 

interact in the ATS, and the ATS’ connectivity arrangements. As part of this review, FINRA gets 

a copy of the Form ATS. The Department of Member Regulation generally has to make a 

decision on the application within 45-60 days of receiving the application, depending on 

whether it requires the applicant to attend an interview or provide additional information. A 

member may not implement the change in its business operations until the conclusion of the 

FINRA proceeding. 

Regulation ATS includes additional requirements for certain types of ATS. The order display 

and execution access requirements under Rule 301(b)(3) apply to ATSs that display their 

orders to at least one person other than an employee and whose average daily trading 

volume in a particular NMS stock was at least five percent of the stock’s average daily trading 

volume (measured in shares) during at least four of the preceding six months. The fair access 

requirement under Rule 301(b)(5) of Regulation ATS applies to an ATS, including a dark pool 

ATS, when its trading volume reaches or exceeds the five percent threshold, unless an 

exception stipulated in Rule 301(b)(5)(iii) applies. According to current requirements, an ATS 

with an at least 20 percent market share must also follow certain procedures to ensure the 

capacity, integrity and security of its trading system (Rule 301(b)(6)).15 

 

15 This threshold has been lowered and amended to be calculated on the basis of average daily dollar volume in 

Regulation Systems Compliance and Integrity (Regulation SCI) (see the section on technical system standards and 

procedures below for further details). The new requirements will apply to equity ATSs with at least one percent 

market share of the average daily dollar volume in all NMS stocks, or five percent market share in any single NMS 

stock together with 0.25 percent market share in all NMS stocks. 
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INTERNATIONAL MONETARY FUND 215

DCMs 

To be designated and maintain designation as a contract market, a board of trade must 

comply with the 23 Core Principles set forth in Section 5(d) of the CEA. Applicants for 

designation must submit a Form DCM and follow the application procedures set forth in CFTC 

Regulation 38.3. The application must include information sufficient to demonstrate 

compliance with the CEA Core Principles, including a copy of all rules, technical manuals, 

other guides or instructions for users of, or participants in, the market; a description of the 

trading system, algorithms, security and access limitation procedures; and copies of any 

agreements that enable or empower the applicant to comply with the Core Principles. 

The CFTC reviews new applications pursuant to the 180-day time frame and procedures 

specified in Section 6(a) of the CEA. The CFTC may approve or deny the application or, if 

deemed appropriate, designate the applicant as a contract market subject to conditions. 

SEFs and SB SEFs 

To be registered and maintain registration, a SEF must comply on a continuing basis with the 

15 Core Principles stipulated in Section 5h(f) of the CEA. CFTC Regulation 37.3 sets forth the 

requirements and procedures for registration as a SEF. The application must include 

information sufficient to demonstrate compliance with the CEA Core Principles. The CFTC 

issues an order granting registration upon its determination that the applicant has 

demonstrated compliance with the CEA and regulations applicable to SEFs. If appropriate, the 

registration may be granted subject to conditions. 

Similarly, SB SEFs will have to comply with 14 Core Principles and any other rule that the SEC 

may ultimately adopt. The SEC has proposed rules on the registration process for SB SEFs and 

for compliance with the 14 Core Principles. 

FBOTs 

Criteria, procedures and requirements for registration as an FBOT are set forth in Section 4(b) 

of the CEA and Part 48 of the CFTC’s regulations. In determining whether to register an FBOT, 

the CFTC evaluates whether the FBOT’s home regulatory authority oversees the FBOT in a 

manner that is comparable to the CFTC’s oversight of DCMs. After registration, an FBOT is not 

subject to the CFTC’s oversight, except in relation to trading in so called linked contracts (see 

Principle 36). 

Prudential requirements and clearing and settlement arrangements 

National securities exchanges 

National securities exchanges do not generally assume principal, settlement, guarantee or 

performance risk. Instead, the clearing and settlement of securities transactions occurs 

through registered CCPs and CSDs that operate separately from exchanges and are registered 

with the SEC as clearing agencies. The national securities exchanges’ level of funding may 

differ depending on their business model, trading systems, regulatory responsibilities, and 

types of members. 

ATS 

Similar to any other BD, an ATS operator must have sufficient clearing capabilities in place by 

either becoming a member of a clearing agency, or by being affiliated with a member of a 

clearing agency through which the ATS can clear and settle trades. The BDs’ capital 

requirements are discussed in Principle 30. 
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DCMs 

DCM Core Principle 21, Financial Resources, requires a DCM to have adequate financial, 

operational, and managerial resources to discharge its responsibilities. The financial resources 

are considered to be adequate, if they exceed the DCM’s operating costs for a one year 

period, calculated on a rolling basis. 

DCM Core Principle 11 requires a DCM to establish and enforce rules and procedures for 

ensuring the financial integrity of transactions entered into on or through the facilities of the 

contract market (including the clearing and settlement of transactions with a registered DCO). 

SEFs and SB SEFs 

SEFs are subject to the same financial resources requirements as DCMs (SEF Core Principle 

13). Similarly, transactions executed on or through a SEF that are required to be cleared or 

that are voluntarily cleared have to be cleared through a DCO. 

Market surveillance, member supervision, dispute resolution and appeal procedures 

National securities exchanges 

The Exchange Act requires national securities exchanges to be able to enforce compliance by 

their members and persons associated with their members with the Exchange Act, the SEC 

rules and regulations, and their own rules. To register as an exchange requires submitting to 

the SEC information on all arrangements for monitoring, surveillance and supervision of the 

trading system and its participants. The SEC considers whether the applicant has adequate 

surveillance measures and sufficient resources, including staff expertise and capital, to 

monitor its markets. The SEC evaluates each applicant’s ability to conduct member and 

market surveillance and to address any potential violations of the market’s rules or the U.S. 

federal securities laws. All exchanges must tailor their surveillance functions to their markets’ 

characteristics. If applicable, the SEC determines whether the applicant has made sufficient 

arrangements with reliable and capable third parties to implement systems that will meet the 

applicable statutory standards. 

ATS 

As noted above, ATS are not required to conduct market surveillance. ATSs are not SROs, but 

are required to be members of an SRO. Therefore, as BDs required to meet supervisory 

obligations under the SRO rules, ATSs have responsibility for monitoring trading activity that 

occurs on or through their systems. In addition, as discussed in Principle 9, SROs have an 

obligation to enforce compliance by their members with the federal securities laws and the 

SRO rules. 

DCMs 

DCM Core Principle 2 requires a DCM to establish, monitor and enforce compliance with rules 

prohibiting abusive trading practices and to have the capacity to detect, investigate and apply 

sanctions to any person that violates the rules of the DCM. The applicant must demonstrate 

the means to monitor trading conduct, to supervise the system, and to address disorderly 

trading conditions (CFTC Regulations 38.250 and 38.251). 

DCM Core Principle 12 requires a DCM to establish and enforce rules to protect markets and 

market participants from abusive practices and to promote fair and equitable trading on the 

DCM. CFTC’s regulations require trade practice monitoring systems to monitor trading and 

supervise rule compliance by members; a market surveillance system to deter, detect and 

address manipulation; and a disciplinary process to address violations of exchange rules. A 

DCM must establish and maintain sufficient compliance staff and resources to conduct audit 
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trail reviews, trade practice surveillance, market surveillance, and real-time market monitoring, 

and have the ability to address unusual market or trading events and to complete any 

investigations in a timely manner (CFTC Regulation 38.155(a)). 

DCM Core Principle 4 requires a DCM to have the capacity and responsibility to prevent 

manipulation, price distortion, and disruptions of the delivery or cash settlement process 

through market surveillance, compliance, and enforcement practices and procedures, 

including methods for conducting real-time monitoring of trading; and comprehensive and 

accurate trade reconstructions. 

SEFs and SB SEFs 

SEF Core Principle 2 requires SEFs to establish and enforce trading, trade processing, and 

participation rules that will deter abuses and have the capacity to detect, investigate, and 

enforce those rules, including means to provide market participants with impartial access to 

the market and to capture information that may be used in establishing whether rule 

violations have occurred. SEFs are required to establish a rule enforcement program for the 

monitoring, surveillance and supervision of the SEF and its market participants (CFTC 

Regulation 37.203). They also need to have disciplinary procedures and sanctions in place to 

enforce trading, trade processing, and participation rules that will deter abuses (CFTC 

Regulation 37.206). 

SEF Core Principle 4 requires a SEF to monitor trading in swaps to prevent manipulation, price 

distortion, and disruptions of the delivery or cash settlement process through surveillance, 

compliance, and disciplinary practices and procedures, including methods for conducting 

real-time monitoring of trading and comprehensive and accurate trade reconstructions. A SEF 

must also establish and enforce rules governing trading procedures and trade processing. A 

SEF is also required to have access to sufficient information to assess whether trading in 

swaps listed on its market, in the index or instrument used as a reference price, or in the 

underlying commodity for its listed swaps is being used to affect prices on its market (CFTC 

Regulation 37.404(a)). 

Similar requirements are expected to apply to SB SEFs. 

Technical system standards and procedures 

National securities exchanges and ATS 

The SEC has issued two ARP statements that set forth its view that the SROs should 

voluntarily establish comprehensive planning and assessment programs to determine their 

systems’ capacity and vulnerability. In ARP I, published in 1989, the SEC recommended that 

the SROs’ programs should have three objectives: (i) establishing current and future capacity 

estimates; (ii) conducting periodic capacity stress tests; and (iii) obtaining an annual 

assessment of whether the affected systems can perform adequately in light of estimated 

capacity levels and possible threats to the systems. In ARP II, published in 1991, the SEC set 

forth its views on: (i) the nature of the reviews that the SROs are encouraged to obtain with 

respect to their automated trading and information dissemination systems; (ii) the contents of 

the SROs’ annual reports on major systems changes and a process for provision of 

notifications of material systems changes; and (iii) notifications of significant systems 

problems. 

As noted above, ATSs meeting or exceeding a 20 percent market share become subject to 

certain system related requirements, including the requirement to perform an independent 

review of their system controls according to established audit procedures and standards. 

On November 19, 2014, the SEC adopted Regulation SCI to replace the ARP statements and 
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system related requirements in Regulation ATS applicable to certain equity ATSs. Among 

other things, Regulation SCI requires an SCI entity, which include national securities 

exchanges and ATSs trading certain equity securities above specified dollar volume 

thresholds (see footnote above), to: 

 Establish, maintain, and enforce policies and procedures reasonably designed to ensure 

that its systems have adequate levels of capacity, integrity, resiliency, availability, and 

security; 

 Establish, maintain, and enforce policies and procedures reasonably designed to ensure 

that its systems operate in compliance with the Exchange Act, the SEC ‘s rules and 

regulations under the Exchange Act, and the entity’s rules and governing documents; 

 Take timely corrective action in response to systems disruptions, systems compliance 

issues, and systems intrusions (together, SCI events); 

 Notify the SEC on certain SCI events and material changes to its systems; 

 Disseminate information to applicable members or participants about certain SCI events; 

 Conduct an annual review of its compliance with Regulation SCI, submit a report of the 

annual review to its senior management, and provide the report of the annual review, 

along with any response by senior management, to the board of directors (or its 

equivalent) and the SEC; 

 Designate certain members or participants to participate in the testing of its business 

continuity and disaster recovery plans at least once every 12 months, and coordinate the 

testing with other entities on an industry- or sector-wide basis; and 

 Make, keep, and preserve records relating to its compliance with Regulation SCI. 

Regulation SCI will become effective 60 days after publication in the Federal Register, with 

required compliance generally to begin nine months later, and required compliance with the 

business continuity and disaster recovery plan testing provision to begin an additional 12 

months after that.

DCMs, SEFs and SB SEFs 

DCM Core Principle 20 requires DCMs to establish and maintain a program of risk oversight 

to identify and minimize sources of operational risk through the development of appropriate 

controls and procedures and the development of automated systems that are reliable, secure, 

and have adequate scalable capacity; establish and maintain emergency procedures, backup 

facilities, and a plan for disaster recovery that allow for the timely recovery and resumption of 

operations and the fulfillment of the responsibilities and obligations of the DCM; and 

periodically conduct tests to verify that backup resources are sufficient to ensure continued 

order processing and trade matching, price reporting, market surveillance, and maintenance 

of a comprehensive and accurate audit trail. 

The requirements on SEFs in SEF Core Principle 14 are identical to the above. The 

requirements planned to be applied to SB SEFs are similar. 

Ability to deal with disorderly trading conditions 

Cross-market trading halts for securities 

In May 2012, the SEC approved a NMS Plan to Address Extraordinary Market Volatility (known 

as Limit-Up Limit-Down or LULD) proposed by the SROs that is intended to prevent 

erroneous trades and moderate volatility in the market for individual equity securities. The 
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LULD has been implemented on a pilot basis. It prevents trades in individual securities from 

occurring outside of a specified price band, which varies depending on the security and time 

of day. Trading pauses occur if the price moves to and remains outside of the band for a 

specified period. An individual stock enters a limit state if its price moves a certain 

percentage–generally 5, 10 or 20 percent–over a five minute period. If the market does not 

naturally exit the limit state within 15 seconds, there is a five minute trading pause, at the 

conclusion of which trading resumes under normal reopening procedures. SROs, ATSs, and 

BDs executing internally must establish policies and procedures reasonably designed to 

prevent trades from occurring outside the applicable price band, to honor any trading pause, 

and to otherwise comply with the NMS Plan. 

DCMs 

CFTC Regulation 38.255 requires a DCM to establish and maintain risk control mechanisms to 

prevent and reduce the potential risk of price distortions and market disruptions, including, 

but not limited to, market restrictions that pause or halt trading in market conditions 

prescribed by the DCM. DCM Core Principle 6 requires the DCM, in consultation or 

cooperation with the CFTC, to adopt rules to provide for the exercise of emergency authority, 

as is necessary and appropriate, including the authority to liquidate or transfer open positions 

in any contract; to suspend or curtail trading in any contract; and to require market 

participants in any contract to meet special margin requirements. 

SEFs 

A SEF must have the authority to adjust trade prices or cancel trades when necessary to 

mitigate market disrupting events caused by malfunctions in its system(s) or platform(s) or 

errors in orders submitted by members and market participants (CFTC Regulation 37.203). 

CFTC Regulation 37.405 requires a SEF to establish and maintain risk control mechanisms to 

prevent and reduce the potential risk of market disruptions, including market restrictions that 

pause or halt trading under market conditions prescribed by the SEF. SEF Core Principle 8 also 

provides for the exercise of emergency authority, in consultation or cooperation with the 

CFTC, as is necessary and appropriate, including the authority to liquidate or transfer open 

positions in any swap or to suspend or curtail trading in a swap. 

Record-keeping 

National securities exchanges 

Every exchange is required to make and keep for prescribed periods of time such records, 

furnish such copies thereof, and make and disseminate such reports as prescribed by the SEC 

in Rule 17a-1 (Section 17(a) Exchange Act). 

ATS 

An ATS is subject to certain reporting and record-keeping requirements set forth under 

Regulation ATS (including maintaining an audit trail of all orders and transactions entered 

into the system) as well as the record-keeping requirements of registered broker-dealers (see 

Principle 31). 

DCMs 

DCM Core Principle 10 requires a DCM to maintain rules and procedures to provide for the 

recording and safe storage of all identifying trade information in a manner that enables it to 

use the information to assist in the prevention of customer and market abuses and to provide 

evidence of any violations of its rules. These requirements are further specified in CFTC 

Regulations 38.551, 38.552 and 38.256. 
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SEFs and SB SEFs 

SEF Core Principle 10 requires a SEF to maintain records of all activities relating to its 

business, including a complete audit trail in a form and manner acceptable to the CFTC for a 

period of 5 years. CFTC Regulation 37.406 requires a SEF to have the ability to 

comprehensively and accurately reconstruct all trading on its facility. Similarly, the Exchange 

Act requires SB SEFs to maintain audit trails and records of all activities relating to the 

business of their facilities and comply with any other recordkeeping and reporting 

requirements the SEC may adopt. 

Delegation and outsourcing 

National securities exchanges 

There are no specific requirements on outsourcing by exchanges. However, the SEC would be 

able to supervise outsourced activities on the basis of the general requirement of the 

Exchange Act that national securities exchanges must always be able to fulfill their obligations 

under the Act. 

DCMs and SEFs 

DCMs and SEFs are required to provide the CFTC with copies of any service provider 

agreements as a registration application exhibit. If a CFTC registered entity delegates a 

function to another registered entity, the CFTC has the regulatory authority to access the 

books and records of a registered entity to which the function was delegated. If a registered 

entity outsources a function to a non-registered entity, the CFTC maintains the authority to 

obtain relevant books and records from the registered entity itself. 

Admission of securities and derivatives 

National securities exchanges 

An exchange’s listing criteria are set out in its rules. Pursuant to Section 19(b) of the Exchange 

Act and Rule 19b-4, every SRO has to file with the SEC any proposed rule, or any proposed 

change to a rule. The rules must be designed to prevent fraudulent and manipulative acts and 

practices, to promote just and equitable principles of trade, and to protect the investors and 

the public interest (Section 6(b)(5) of the Exchange Act). 

The listing of certain new derivative products16 does not require prior approval of the rule 

changes by the SEC, if the SEC has approved the SRO’s trading rules, procedures and listing 

standards for the product class that would include the new product (Exchange Act Rule 19-

4(e)). 

DCMs and SEFs 

Under Section 5c of the CEA and Part 40 of the CFTC regulations, DCMs and SEFs must inform 

the CFTC of the types of products to be traded on the DCM or SEF through either of two 

methods: (i) self-certification (CFTC Regulation 40.2); or (ii) voluntary submission of new 

products for the CFTC’s review and approval (CFTC Regulation 40.3). CFTC prior approval is 

required for certain enumerated agricultural commodities.17 

 

16 An option, warrant, hybrid securities product or any other security, other than a single equity option or security 

futures product, whose value is based, in whole or in part, upon the performance of, or interest in, an underlying 

instrument. 

17 This relates to contracts on the commodities enumerated in Section 1a(9) of the CEA with open interest. 
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For contracts filed under the self-certification procedure, DCMs and SEFs are required to 

assume primary responsibility for ensuring that the contracts meet, on a continuous basis, the 

applicable statutory and regulatory requirements. The procedure requires DCMs and SEFs to 

file their submissions no later than the opening of business on the business day preceding 

the initial listing of the product. The submission must include the product’s rules, the 

intended listing date, a certification by the DCM or SEF that the product complies with the 

CEA and CFTC Regulations, a concise explanation and analysis of the product and its 

compliance with applicable provisions, and a certification by the DCM or SEF posted on its 

website that a notice of pending product certification is with the CFTC. If requested by the 

CFTC staff, the DCM or SEF must provide additional information or data that demonstrates 

that the contract meets the relevant requirements. The CFTC may stay the listing of a contract 

while its proceedings are pending for filing a false certification or while a petition to alter or 

amend the contract terms and conditions is pending. 

DCMs and SEFs may voluntarily request the CFTC to approve a new or dormant product prior 

to its listing. A product request for approval must include similar documentation as required 

under the self-certification procedure. All products submitted for CFTC approval are generally 

deemed approved 45 days after receipt by the CFTC or at the conclusion of an extended 

period. However, the CFTC, at any time during its review, may notify the DCM or SEF that it 

will not, or is unable to, approve the product because the submission lacks sufficient 

information for a determination. 

In practice the large majority of contracts is subject to the self-certification procedure. 

DCM Core Principle 3 requires that listed contracts not be readily susceptible to manipulation. 

In order to demonstrate compliance with this requirement, DCMs listing new futures 

contracts must provide the CFTC with certain information, including data and information to 

support the contract’s terms and conditions and a detailed cash market description for 

physical and cash-settled contracts. For futures contracts settled by physical delivery, the 

terms and conditions should be designed to avoid impediments to delivery so as to promote 

convergence between the price of the futures contract and the cash-market value of the 

commodity. Specific requirements are included in CFTC Regulations 38.252 and 38.253. 

Admission of market participants 

National securities exchanges 

A national securities exchange must have rules that permit any registered BD or natural 

person associated with a BD to become its member (Section 6(b)(2) Exchange Act). An 

exchange’s ability to deny membership is limited pursuant to Section 6(c) of the Exchange 

Act. An exchange must deny membership to any non-registered BD and may deny 

membership to any BD that is subject to a statutory disqualification. A denial on the grounds 

of a statutory disqualification must be reported to the SEC. Further, an exchange may deny 

membership to a BD that does not meet the financial responsibility or operational capability 

standards or have the minimum level of training, experience or competence prescribed by the 

exchange’s rules. In addition, an exchange may deny membership to a BD that has engaged 

or is likely to engage in acts or practices that are inconsistent with just and equitable 

principles of trade. 

Further, the exchange’s rules may not be designed to permit unfair discrimination between 

BDs and may not impose any burden on competition that is not necessary or appropriate in 

furtherance of the purposes of the Exchange Act. 

Rule 610(a) of Regulation NMS prohibits an SRO from imposing unfairly discriminatory terms 

that prevent or inhibit any person from obtaining efficient access through a SRO member to 
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the quotations in a NMS stock displayed in the SRO trading facility. This anti-discrimination 

provision provides non-members indirect access to quotes by members. This provision 

prohibits, for example, different fees or order priority rules based on the identity of a 

member’s customer. Rule 610(c) also limits the amount of fees that may be charged by a 

trading facility to access its best bids and offers. 

ATS 

If an ATS accounted for five percent or more of the average daily trading volume during at 

least four of the preceding six calendar months in any equity security, municipal security, or 

corporate debt security, it would need to comply with the fair access requirements of Rule 

301(b)(5)(ii) of the Exchange Act. Specifically, these ATSs would be required to establish 

written standards for granting access to trading on their systems and maintain these 

standards in their records (Rule 301(b)(5)(ii) and Rule 303(a)(2)(ii)). Such ATSs would be 

prohibited from unreasonably prohibiting or limiting any person’s access to their services by 

applying their access standards in an unfair or discriminatory manner. Certain ATSs specified 

in Rule 301(b)(5)(iii) of the Regulation ATS would not need to comply with the fair access 

requirement, even if they exceeded the five percent threshold. 

DCMs 

CFTC Regulation 38.151(b) requires a DCM to provide its members, persons with trading 

privileges, and independent software vendors (ISVs) with impartial access to its markets and 

services, including by having access criteria that are impartial, transparent, and applied in a 

non-discriminatory manner. CFTC Regulation 38.151(b)(2) requires that the DCM provide 

comparable fee structures for members, persons with trading privileges, and ISVs receiving 

equal access to, or services from, the DCM. CFTC Regulation 38.151(c) requires a DCM to 

establish and impartially enforce rules governing any decision by the DCM to deny, suspend, 

or permanently bar a member’s or a person with trading privileges access to the DCM. 

Accordingly, any decision by a DCM to deny, suspend, or permanently bar a member’s or 

person with trading privileges access to the DCM must be impartial and applied in a nondiscriminatory manner. 

SEFs and SB SEFs 

SEF Core Principle 2 requires SEFs to provide market participants with impartial access to the 

SEF. CFTC Regulation 37.202 requires SEFs to provide any eligible contract participant and any 

ISV with impartial access to their markets and market services, including any indicative quote 

screens or any similar pricing data displays. SEFs have to have impartial criteria governing 

access, comparable fee structures and impartial enforcement of rules for limiting access. 

SB SEFs will be required to establish and enforce trading, trade processing, and participation 

rules that include means to provide market participants with impartial access to the market. 

Order routing and order execution procedures 

National securities exchanges 

An exchange’s rules are required to cover its order routing and execution procedures. As part 

of the exchange registration process, the SEC reviews such procedures. They can only be 

approved, if they are consistent with relevant securities laws and regulations, including those 

with respect to precedence, front running and trading ahead of customer orders, and are not 

unfairly discriminatory. 

The SEC analyzes any proposed rule that would give a member a trading advantage against 

the obligations the member has to the market. For example, exchange specialists and market 
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makers are permitted to trade for their own account ahead of public orders in certain 

instances due to their obligations to maintain a fair and orderly market. Section 11(b) of the 

Exchange Act provides for the regulation of specialists and odd-lot dealers, and requires that 

the rules of the SRO reflect the appropriate rules for their registration and activities. 

The terms of any service that impacts access to the exchange and its facilities, such as colocation services, including the fees charged for such services, are required to be filed as 

proposed rule changes. When reviewing such rule changes, the SEC takes into account 

Section 6(b)(4) of the Exchange Act that requires that the rules of the exchange provide for 

the equitable allocation of reasonable dues, fees, and other charges among its members and 

issuers and other persons using its facilities. Further, the rules of the exchange cannot be 

designed to permit unfair discrimination between customers, issuers, brokers, or dealers 

(Section 6(b)(5) Exchange Act) or impose any burden on competition not necessary or 

appropriate in furtherance of the Exchange Act (Section 6(b)(8)). 

ATS 

OCIE and FINRA have examined BDs that operate ATSs. They may review a BD’s algorithmic 

trading system or proprietary trading system to ensure that it fairly allocates and executes 

orders, does not discriminate among certain types of orders, and does not use non-public 

information about order flow obtained through the BD’s other business activities to benefit 

the firm’s own account. The ATS reviews may also focus on the BD’s order handling practices 

and processes. 

DCMs 

DCM Core Principle 7 requires a DCM to make available to market authorities, market 

participants, and the public information on the rules, regulations, and mechanisms for 

executing transactions on or through the DCM. DCM Core Principle 9 requires DCMs to 

provide a competitive, open, and efficient market and a mechanism for executing transactions 

that protects the price discovery process of trading in the centralized market of the DCM. 

CFTC Regulation 1.38, which applies to commodity futures and options, requires competitive 

execution. It permits certain noncompetitive trades that are executed pursuant to rules that 

have been approved by the CFTC. The DCM applicant must attach Exhibit Q to its application 

on Form DCM, which requires a description of the applicant’s trading system and trade 

matching algorithm and examples of how that algorithm works in various trading scenarios 

involving various types of orders. DCM rulebooks are also required to be publicly available. 

SEFs 

Applicants for registration as a SEF must meet statutory requirements that execution rules are 

disclosed to the regulator and to market participants, and are fairly applied to all participants. 

SEF rulebooks are required to be publicly available. A SEF applicant must also explain the 

operation of its trading system or platform and the manner by which the trade functionality 

requirement of CFTC Regulation 37.3(a)(2) is satisfied. Transactions in swaps that are subject 

to the trade execution requirement have to be executed either in an order book or in a 

request for quote system that operates in conjunction with an order book where the requests 

have to be submitted to at least three participants in the system. 

For trading systems or platforms that enable market participants to engage in transactions 

through an order book, the SEF applicant must attach as Exhibit Q to its Form SEF an 

explanation of any trade matching algorithm and examples of how that algorithm works in 

various trading scenarios involving various types of orders. For trading systems or platforms 

that enable market participants to engage in transactions through a request for quote system, 

the SEF applicant must attach as Exhibit Q to Form SEF an explanation of how a requester 
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224 INTERNATIONAL MONETARY FUND

may transact on resting bids or offers along with the responsive orders. 

Direct market access 

National securities exchanges and ATSs 

In November 2010, the SEC adopted Rule 15c3-5—Risk Management Controls for Brokers or 

Dealers with Market Access. This Rule is applicable to BDs with access to trading in securities 

by virtue of being an exchange member or an ATS subscriber. It is also applicable to brokerdealer operators of an ATS that provides market access to non-BD subscribers. A BD with 

market access, or that provides a customer or any other person with access to an exchange or 

ATS through the use of its market participant identifier or otherwise, is required to establish, 

document, and maintain a system of risk management controls and supervisory procedures 

reasonably designed to manage the financial, regulatory, and other risks of this business 

activity. 

Specifically, the risk management controls and supervisory procedures are required to be 

reasonably designed to: 

 Prevent the entry of orders that exceed appropriate pre-set credit or capital thresholds, or 

that appear to be erroneous; 

 Prevent the entry of orders unless there has been compliance with all regulatory 

requirements that must be satisfied on a pre-order entry basis; and 

 Prevent the entry of orders that the BD or customer is restricted from trading, restrict market 

access technology and systems to authorized persons, and assure appropriate surveillance 

personnel receive immediate post-trade execution reports. 

There are no specific regulatory requirements on exchanges themselves to have in place 

automated pre-trade controls that would enable intermediaries to implement appropriate risk 

limits. However, Rule 15c3-5 permits broker-dealers to use third party technology, which may 

be provided by an exchange or other service provider, provided that the broker-dealer 

maintains direct and exclusive control of the risk management system. 

DCMs 

CFTC Regulation 38.607 requires DCMs that permit direct electronic access by customers to 

have in place effective systems and controls reasonably designed to facilitate the FCM’s 

management of financial risk, such as automated pre-trade controls that enable member 

FCMs to implement appropriate financial risk limits. A DCM must implement and enforce 

rules requiring the member FCMs to use the provided systems and controls. 

Access to trading information 

National securities exchanges, ATSs and SB SEFs 

The NMS Plans require participating SROs to collect and promptly report both pre- and posttrade information to NMS plan processors. The processors are then responsible for 

consolidating the information and disseminating it to the public, including all market 

participants. The SROs must report the stock symbol, volume, and price at which transactions 

were executed to the plan processor, in most cases (see Principle 35) within 10 seconds after 

the time of execution. The same requirement applies to trades made on an ATS. In practice 

exchanges and ATSs report transactions on an as real-time basis as technologically possible. 

Last sale and trade data is reported on the consolidated tape, an electronic system that 

reports the latest price and volume data on sales of exchange-listed stocks. If a transaction is 

not reported within the set deadline, the SRO must designate the last sale price as “late” on 
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the report to the NMS plan processor. 

Even though it is not a regulatory requirement, in practice exchanges provide the ability to 

subscribe to direct access to their proprietary trading information. This enables exchange 

members and other market participants to implement more effective risk monitoring and risk 

management controls than those based on the NMS data (see Principle 35). 

SB SEFs will be required to make public timely trade information on the basis of SEC rules 

pending finalization. 

DCMs and SEFs 

DCMs and SEFs are required to provide to market participants, on a fair, equitable and timely 

basis, information regarding prices, bids and offers, as applicable to the market. 

Assessment Broadly Implemented 

Comments ATSs and other off-exchange trading methods 

The preamble to the IOSCO Assessment Methodology notes that the word “markets” should 

be understood in its widest sense, including any facility to trade equity and debt securities, 

options and derivative products. It further notes that in addition to traditional organized 

exchanges, secondary markets should be understood to include various forms of nonexchange trading systems, such as ATSs, multilateral trading facilities (MTFs), and proprietary 

systems developed by market intermediaries. However, the preamble concludes that for 

assessment purposes the Methodology is directed to topics that have been addressed by 

IOSCO reports and names multilateral systems, such as exchanges and other similar regulated 

trading systems, as the main focus of the assessment. 

For the above reason, this assessment has focused on national securities exchanges and ATSs. 

However, the current single dealer/market maker bilateral trading systems may continue to 

converge towards multilateral systems. While these systems are not further discussed in the 

assessment of this Principle (however, see Principle 35), the assessors agree with the SEC that 

there is a need to closely follow the developments in this area and adjust the regulatory 

framework, if needed. 

There are two main shortcomings that have led to the grade for this Principle. Most 

importantly, ATSs are not required to disclose their order execution rules and procedures to 

market participants, although some ATSs have provided additional information on their 

websites or published their Forms ATS. ATS subscribers typically get additional information. 

This voluntary approach is not sufficient to comply with Key Questions 5(a), 5(b) and 6 of the 

IOSCO Assessment Methodology. Therefore, the assessors consider that it is important that 

the SEC pursues the initiative of the SEC Chair to enhance public information about ATS 

operations. 

Secondly, applying the fair access requirements to an ATS only after it would reach or exceed 

a relatively high market share of five percent in a particular NMS security does not comply 

with Key Question 4(c) of the Assessment Methodology. The assessors consider that the 

current five percent threshold should be removed or at a minimum, significantly lowered. 

The current approach to authorizing new ATSs is based on a requirement for the BD to inform 

the SEC of the planned establishment of an ATS on Form ATS, together with the requirement 

for the BD to file an application with FINRA on a change in its business operations. Within the 

limits of their respective processes, the SEC and FINRA seek to assess the ATSs’ order 

execution procedures and the operational and other competence of the BD in relation to 

operating an ATS. This appears to comply with the minimum requirements of the Assessment 
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Methodology. However, the SEC and FINRA are encouraged to further ensure that their 

processes provide a sufficiently in-depth analysis of the order execution procedures of a new 

ATS, in particular for fairness, and focus on ensuring that there is sufficient evidence of a BD’s 

operational and other competence specific for ATS operations. 

Requirements on national securities exchanges 

The obligation to ensure sufficient pre-trade controls applies to BDs. Exchanges are not 

subject to any particular requirements in this regard. The assessors consider that this 

approach is sufficient to comply with the minimum requirement of Principle 33. However, the 

assessors encourage the SEC to consider whether additional requirements could be applied 

to exchanges themselves to further enhance their ability to manage the risks arising from 

direct electronic access. 

Listing of new products on DCMs 

Key Question 4.(c) of the IOSCO Assessment Methodology requires the regulator to approve 

the rules governing the admission of securities (or derivatives) to trading. While the CFTC 

does not approve the DCMs’ rules on the admission of (new classes of) futures or options, the 

assessors consider the current system with the CFTC’s ability to stay the listing of a new 

contract to be sufficient for the purposes of compliance with Principle 33. 

Principle 34. There should be ongoing regulatory supervision of exchanges and trading systems which 

should aim to ensure that the integrity of trading is maintained through fair and equitable 

rules that strike an appropriate balance between the demands of different market 

participants. 

Description Market surveillance 

Securities exchanges 

Subject to SEC oversight, the SROs have the primary responsibility for the daily surveillance of 

trading activities. All securities exchanges conduct their own real-time “market watch” 

surveillance. Certain exchanges also perform their own market specific surveillance activities 

(other than for insider trading) in-house, while some have contracted part of their surveillance 

programs to FINRA through RSAs. For example, NASDAQ OMX Group outsources crossmarket surveillance functions to FINRA, but uses NASDAQ’s own surveillance technology to 

run specific surveillance patterns for NASDAQ’s three markets. NYSE Group announced in 

October 2014 that its subsidiary NYSE Regulation will start directly performing the market 

surveillance functions for NYSE Group’s three equities exchanges and two options exchanges 

on January 1, 2015. 

After the recent integration of the BATS Exchange into FINRA’s program, FINRA conducts 

cross-market surveillance for 99 percent of the U.S. listed equity market. FINRA’s cross-market 

surveillance aims at detecting potentially illegal trading behavior across multiple markets. 

After the January 1, 2015 change, FINRA will also continue to retain the cross-market 

surveillance responsibility for the NYSE Group’s exchanges. FINRA also provides equity market 

insider trading surveillance to all U.S. exchanges pursuant to the Consolidated Insider Trading 

Plan 17d-2 agreement. 

FINRA conducts automated options surveillance in hybrid and electronic options 

marketplaces for approximately 40 percent of U.S. options exchange trading. Through RSAs, 

FINRA conducts varying levels of oversight of trading activity on NYSE Arca; NYSE MKT; 

International Securities Exchange; International Securities Exchange Gemini; BATS Options 

operated by BATS Exchange; BOX Options Exchange; NASDAQ Options Market; NASDAQ 

OMX PHLX; and NASDAQ OMX BX Options. Options insider trading surveillance is conducted 
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by the CBOE as contracted by the Options Regulatory Surveillance Authority operated by all 

the 11 U.S. options exchanges. 

SEC 

The SEC’s Market Surveillance Group in the Enforcement Division’s Office of Market 

Intelligence has oversight over all domestic equity and securities options markets. It can 

obtain surveillance and/or trading data from the SROs and coordinates with them to detect 

any anomalous market activity, including suspicious trading by particular persons and/or 

entities. 

In July 2011, the SEC adopted the new Large Trader Reporting Rule 13h-1 and the new Form 

13H under Section 13(h) of the Exchange Act to enhance its ability to identify large market 

participants, collect information on their trading, and analyze their trading activity. The new 

rule requires large traders18 to register with the SEC by submitting Form 13H through the 

EDGAR system. The SEC assigns each large trader a unique identification number to be 

provided to the trader’s BD, which will be required to maintain transaction records for each 

large trader and report that information to the SEC upon request. Large trader registration 

information is available to EDGAR authorized SEC staff users, including staff from TM, 

Enforcement, and OCIE. 

The large trader reporting requirements provide the SEC with information that supports its 

investigative and enforcement activities. For example, the SEC can obtain enhanced 

transaction data, including the large trader ID number and the execution time of its 

transactions each time it requests data through the Electronic Bluesheets System. In addition, 

the large trader reporting requirements can help the SEC assess the impact of large trader 

activity on the securities markets, to reconstruct trading activity following periods of unusual 

market volatility, and to analyze significant market events for regulatory purposes. 

The SEC launched MIDAS in 2013. MIDAS collects and processes data from the consolidated 

tapes and proprietary feeds of each equity exchange. In addition to data on listed stocks and 

exchange-traded products, MIDAS also collects and processes data on equity options and 

futures contracts. This data includes posted orders and quotes, modifications and 

cancellations, and trade executions. Among other things, the SEC can use MIDAS to identify 

possibly troublesome or illegal behavior and reconstruct market events. 

DCMs 

Under Core Principle 2, a DCM is required to conduct effective trade practice surveillance, 

market surveillance, and real-time market monitoring, maintain an automated trade 

surveillance system capable of detecting and investigating potential trade practice violations, 

and conduct real-time market monitoring of all trading activity on its electronic trading 

platform(s) to identify disorderly trading and any market or system anomalies. The automated 

system must load and process daily orders and trades no later than 24 hours after the 

completion of the trading day. In addition, the automated trade surveillance system must 

have the capability to detect and flag specific trade execution patterns and trade anomalies. 

In practice, some DCMs conduct the above activities in-house, while the NFA provides trade 

practice surveillance and market surveillance services for the rest. 16 SEFs have also 

 

18 A person is considered to be a large trader, when it (directly or indirectly) exercises investment discretion over one 

or more accounts and effects transactions exceeding two million shares or $20 million during a calendar day or 

twenty million shares or $200 million during a calendar month (Rule 13h-1(a)(7)). In fiscal year 2013, 2948 large 

traders had registered with the SEC. 
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outsourced these surveillance activities to the NFA. 

CFTC 

The CFTC monitors trading and positions of market participants on an on-going basis. Each 

day, for all active futures and options contract markets, the CFTC's market surveillance staff 

monitors the activities of large traders, and examines all price spikes, scheduled news release 

periods of market-sensitive data, all daily settlements in the major commodities and futures 

and options contracts. Staff also tracks key price relationships, and relevant supply and 

demand factors in a review for potential market problems. Periodically, CFTC staff conducts 

deep forensic examinations of trading in physical or derivatives products to uncover market 

abuses stemming from cash markets that influence derivatives values. 

SEC supervision of trading systems 

Rule approval 

An exchange must file any proposed change in, addition to, or deletion from its rules with the 

SEC (Section 19(b)(1) Exchange Act). This process is described in more detail in Principle 9. 

Reporting 

A national securities exchange is required to submit to the SEC within 10 days amendments 

to certain exhibits of its Form 1 registration (Rule 6a-2(a)). In addition, each year a national 

securities exchange must file amendments to certain other Form 1 exhibits relating to 

exchange financial information, ownership, membership, and listed securities. Further, every 

three years an exchange must file completely updated information on the exchange’s 

governing documents, managers, and facility operators. In lieu of making periodic filings, an 

exchange may make the required information available through several alternatives, including 

through publications and Internet websites controlled by the exchange. Rule 6a-3 also 

requires exchanges to submit to the SEC certain additional information, including notices, 

circulars, bulletins, and lists or periodicals that the exchange issues or makes generally 

available to members, participants or subscribers. 

ATS are required to file with the SEC quarterly reports on their activities on Form ATS-R within 

30 days of the end of the quarter. Information to be reported includes a list of all subscribers 

and all securities traded, and statistics on trading volume and value. They must also amend 

their Form ATS to correct any inaccurate information within 30 days after the end of the 

relevant quarter and at least 20 calendar days prior to implementing a material change to the 

operation of the ATS. 

The CCO of a SB SEF will be required to submit to the SEC the SB SEF’s annual financial report 

and a report containing a description of the SB SEF’s compliance with the Exchange Act and 

its policies and procedures, including its code of ethics and conflict of interest policies 

(Section 3D(d)(14)(C) Exchange Act). 

Examinations 

The SEC’s examinations of the exchanges’ self-regulatory functions are discussed in 

Principle 9. 

The SEC has also implemented a Technology Control Program (TCP), through which its staff 

conducts reviews of the exchanges’ trading and information technology systems to evaluate 

whether they have sufficient capacity and resiliency to accommodate increased volumes and 

disruptions to normal operations. In addition to reviewing systems capability, the TCP staff 

also considers whether the exchange has sufficient capital to maintain its automated systems, 

and appropriate staff with technical expertise. Besides routine examinations, the TCP staff 
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INTERNATIONAL MONETARY FUND 229

may perform for cause or special focus examinations. 

OCIE’s TCP staff also monitors exchanges and certain high volume ATSs’ planned significant 

system changes and responds to reports of system failures and disruptions. TCP staff also 

regularly meets with the exchanges’ information technology staff. 

CFTC supervision of DCMs and SEFs 

Rule approval 

Section 5c(c) of the CEA requires DCMs and SEFs to file with the CFTC new rules and rule 

amendments. In addition to the self-certification of products discussed under Principle 33, 

DCMs and SEFs may self-certify to the CFTC new rules and rule amendments and implement 

them no earlier than 10 business days following the CFTC’s receipt of the submission (CFTC 

Regulation 40.6). Alternatively, they may voluntarily submit new rules and rule amendments 

for the CFTC review and approval (CFTC Regulation 40.5). See Principle 9 for further details. 

Reporting 

DCMs and SEFs have to report material changes in their operations on an ongoing basis to 

the CFTC. They also have to submit quarterly financial statements to the CFTC within 40 days 

of the end of their first three fiscal quarters and within 60 days of the end of their fiscal year. 

Examinations 

The CFTC’s examinations on the exchanges’ self-regulatory functions are discussed in 

Principle 9. 

In addition, the CFTC conducts systems safeguards examinations, where it reviews one or 

more of the following areas: (i) enterprise risk management and governance; (ii) information 

security; (iii) capacity planning; (iv) systems operations; (v) systems development 

methodology; (vi) business continuity and disaster recovery; and (vii) physical security. Such 

examinations are conducted at the systemically important DCMs every 12-18 months. 

Enforcement 

SEC 

The SEC has the authority under Section 19(a)(3) of the Exchange Act to cancel, suspend, or 

revoke an SRO’s registration. If the SEC finds that an SRO is no longer in existence or has 

ceased to do business in the capacity specified in its application for registration, the SEC, by 

order, must cancel its registration. Section 19(h) of the Exchange Act provides the SEC with 

the authority to impose penalties on SROs for certain violations of the federal securities laws 

and/or exchange rules. Specifically, the SEC has the authority to: (i) suspend or revoke the 

registration of an SRO; (ii) censure or impose limitations on its activities; and (iii) remove from 

office or censure officers or directors of an SRO for violations of the Exchange Act or the 

SRO’s rules. 

The SEC has taken enforcement actions against national securities exchanges. These include 

an action against the NYSE for alleged compliance failures that gave certain customers 

improper early access to trading information, where NYSE and its parent company NYSE 

Euronext agreed to a $5 million penalty and undertakings to settle the SEC's charges. The SEC 

also brought a settled action against NASDAQ for securities laws violations resulting from 

NASDAQ’s poor systems and decision-making during the IPO and secondary market trading 

of Facebook shares. NASDAQ agreed to settle the SEC’s charges by paying a $10 million 

penalty. 

The SEC’s ability to cancel, suspend or revoke the registration of a BD, including an ATS, is 
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230 INTERNATIONAL MONETARY FUND

discussed in Principle 29. The SEC can also apply various penalties discussed in Principle 10. It 

has recently taken enforcement action against two ATS operators for alleged violation of 

confidentiality requirements. 

CFTC 

The CFTC has the power to direct DCMs and SEFs to alter or supplement their rules and to 

take such action as it deems necessary to maintain or restore orderly trading (Sections 8a(7) 

and (9) CEA). It can also suspend or revoke a registrant’s registration based on a failure or 

refusal to comply with any of the provisions of the CEA, CFTC regulations, or CFTC orders 

(Sections 5(d)(1), 5b(c)(2), 5h(a)(1) and 6(b) CEA). 

Assessment Fully Implemented 

Comments 

Principle 35. Regulation should promote transparency of trading. 

Description National market system 

Pre- and post-trade transparency requirements in securities and options markets are built 

around the principles set forth in Regulation NMS. Section 11A(a)(2) of the Exchange Act 

directs the SEC to facilitate the establishment of a national market system (NMS) for 

securities. The NMS is intended to link all markets for qualified securities through 

communication and data processing facilities (Section 11A(a)(1) Exchange Act). There are 

currently several NMS plans that the SEC has approved. The Consolidated Quotation (CQ) 

Plan/Consolidated Tape Association (CTA) Plan (for which the Securities Industry Automation 

Corporation (SIAC) serves as the exclusive processor) and NASDAQ UTP Plan (for which 

NASDAQ serves as the exclusive processor) coordinate the dissemination of real-time quote 

and trade information in equity securities. The Options Price Reporting Authority (OPRA) Plan 

(for which SIAC serves as the exclusive processor) provides, through market data vendors, 

current options quotations and last sale information from participant options exchanges. 

The Exchange Act requires that all securities information processors (SIPs) have equitable 

access to market information from the exclusive processors of that information on terms that 

are fair and reasonable (Section 11A(c)(1)(C) Exchange Act). The SEC must also ensure that all 

persons may obtain market information on terms that are not unreasonably discriminatory 

(Section 11A(c)(1)(D) Exchange Act). Any limitation of access by a registered SIP to its services 

is subject to review by the SEC (Section 11A(b)(5) Exchange Act). 

Pre-trade transparency for securities 

Rule 602 of Regulation NMS requires exchanges and FINRA to establish procedures and 

mechanisms for collecting bid and offer information from responsible brokers and dealers 

and for making it available to vendors. Responsible brokers and dealers must promptly 

submit to an exchange or FINRA their best bids, best offers, and quotation sizes for any NMS 

security. The exchanges and associations must then promptly submit this information to the 

NMS plan processors that use the data to produce the consolidated tape. Fee-based access 

to the consolidated tape is available to anybody. However, most non-professional investors 

do not pay fees, because their brokers provide them with access to the consolidated tape as 

part of the brokerage service. 

Limit order display rule 

Rule 604 of Regulation NMS provides that exchange specialists and OTC market makers must 

display public customer limit orders for NMS stocks that improve the bid or offer of the 

specialist or market maker. In addition, specialists and market makers must include the size of 
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INTERNATIONAL MONETARY FUND 231

public customer limit orders for NMS stocks that are priced equal to the specialist’s or market 

maker’s bid or offer. However, this requirement does not apply to customer limit orders for at 

least 10,000 shares or $200,000 (block size). 

ATS 

As noted in Principle 33, an ATS that displays its orders to at least one person (other than an 

ATS employee) will become subject to the order display and execution access rule, if its 

market share in a particular NMS stock was five percent or more during at least four of the 

preceding six months. Currently there are no such ATSs. Therefore all current equity ATSs can 

operate as dark pools without pre-trade transparency to their subscribers or to the public. 

However, due to the Regulation NMS Order Protection Rule (Rule 611), trading on an ATS can 

only take place at prices that fall at or between the current national best bid and offer 

(NBBO). In practice, this is achieved by, for example, pegging the order prices to the midpoint 

of the NBBO. Both ATSs and national securities exchanges can decide whether the reference 

price they use is derived from an NBBO calculated from the NMS feed or the exchanges’ 

proprietary feeds. 

Market makers 

Real-time reporting of quotes made in the OTC market is also required, if the quote is 

communicated by a registered market-maker or any OTC market maker whose executed 

volume in the security is greater than 1 percent of the aggregate trading volume in such 

security. 

Hidden orders

Some exchanges currently have order types that are completely hidden, i.e. they are not 

displayed in the order book, but can match against displayed orders, subject to the priority 

rules of the relevant exchange. Such order types and priority rules are subject to the SEC’s 

approval as part of the SRO rule approval process. As in the case of dark pool ATSs, trades 

based on hidden orders have to occur at prices that comply with the Regulation NMS Order 

Protection Rule. The exchange order types, including their transparency features, are analyzed 

and approved on a case by case basis. 

The SEC staff has also conducted some analytical work on on-exchange dark trading. This 

includes publishing a data series that measures the percentage of exchange-based trading 

volume that results from executions against hidden (undisplayed) orders.19 In addition, OCIE 

included the review of order types in its National Examination Programs in 2013 and 2014. In 

June 2014, the SEC Chair asked the exchanges to conduct comprehensive reviews of their 

order types and how they operate in practice, and as part of this review, consider appropriate 

rule changes to help clarify the nature of their order types. Since these rule changes were 

published for comments after the end of the assessment mission, the assessors have not 

discussed with the SEC what the potential impact of these changes on pre-trade transparency 

may be. 

Priority for displayed orders 

The exchange rules typically provide that displayed orders receive priority over undisplayed 

orders at the same price (see e.g., BATS Rule 11.2 (Priority of Orders); and NYSE Rule 72 

 

19 Hidden Volume Ratios, October 9, 2013, available at http://www.sec.gov/marketstructure/research/highlight-2013-

02.html. The analysis showed that the hidden volume ratio for stocks was typically between 11 percent and 14 

percent. 
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232 INTERNATIONAL MONETARY FUND

(Priority of Bids and Offers and Allocation of Executions). 

Dissemination 

In practice most NMS quote information is submitted by the exchanges. It is also possible to 

use FINRA’s Alternative Display Facility (ADF), but it is currently used only by one ATS 

(LavaFlow ECN) to display its best quotes. It does this on a voluntary basis, because it 

operates a lit trading system rather than a dark pool. 

Exchanges also make their full order book available to subscribers of their real-time 

proprietary data feeds. Rule 603(a) prohibits an exchange from releasing data related to 

quotes and trades to its customers through proprietary feeds before it sends its quotes and 

trade reports to the SIPs. However, in practice the proprietary feeds are available to 

subscribers in a more expeditious manner than the NMS feed that is prone to additional 

delays due to the extra step of being routed through the NMS plan processors. 

Pre-trade transparency for commodity futures and options 

DCMs 

DCM Core Principle 9 requires a DCM to provide a competitive, open, and efficient market 

and mechanism for executing transactions that protects the price discovery process of trading 

in the centralized market. CFTC Regulation 1.38 requires that the purchase and sale of 

commodity futures and options on or subject to the DCM rules is executed openly and 

competitively by open outcry or posting of bids and offers or by other equally open and 

competitive methods. In practice, all DCMs utilize central limit order books, with some still 

maintaining a trading floor alongside electronic trading. 

Iceberg orders 

DCMs allow for the use of iceberg order types, which are designed to permit the hidden part 

of an order to retain the time priority of the order’s initial visible part. 

Non-competitive trades 

Transactions which are executed non-competitively in accordance with the DCM’s written 

rules are exempted from pre-trade transparency (Regulation 1.38). This includes exchanges of 

derivatives for related positions, office trades and transfer trades for bona fide business 

purposes (Regulation 38.500). 

In addition, an FCM, acting as principal or agent, can enter into or confirm the execution of a 

futures contract if it is reported, recorded, or cleared in accordance with the rules of a DCM or 

DCO. This enables, among other trades, recording off order book block trades under the 

DCMs’ rules. Currently the relevant thresholds are determined in each DCM’s rules. The 

conversion of certain swaps to futures in connection with the removal of the former 

registration exemptions for certain markets thereafter led to a lowering of the block trade 

thresholds. This trend has continued, allegedly also due to competitive pressure. According to 

the CFTC staff, this applies in particular to energy futures, where in some cases the block 

trade threshold is only one trading lot. 

The CFTC proposed in 2012 rules and related guidance on block transactions, including 

relevant size, price and reporting requirements. The initial thinking behind the rules was that 

the thresholds would need to be set in such a manner that a certain, relatively high 

percentage (such as 85 percent) of trading would take place through the central limit order 

book. However, the CFTC ultimately decided not to finalize those rules at that point of time, 

and continues to work on them. Pending the finalization of the rules, the CFTC has had 

limited ability to address any concerns it may have had about the lowering of the block trade 
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INTERNATIONAL MONETARY FUND 233

thresholds. 

Dissemination 

DCMs are required to provide impartial access to their markets to independent software 

vendors, which are free to collect, aggregate and disseminate trade information to the public. 

Pre-trade transparency for swaps and security-based swaps 

One of the statutory objectives of the SEF registration requirement is to promote pre-trade 

transparency in the swaps market (Section 5h(e) CEA). The CFTC has interpreted that pretrade transparency refers to making information about a swap available to the market, 

including bid and offer prices, quantity available at those prices, and other relevant 

information before the execution of a transaction. In practice most SEFs are request for quote 

systems, and therefore do not provide the same type of pre-trade transparency as an order 

book based system. 

Pre-trade transparency is specifically waived for swap transactions that are large in scale and 

qualify as block trades (Part 43 CFTC Regulations). A block trade in a swap occurs away from a 

SEF or DCM trading system or platform, but pursuant to the SEF or DCM rules, and has a 

notional or principle amount at or above the minimum block threshold. A large notional offfacility swap is an off-facility swap that does not meet the definition of a block trade, but is 

for a notional or principle amount in excess of the minimum block threshold. 

Similar requirements are included in the SEC’s proposed pre-trade transparency requirements 

for SBS. 

Post-trade transparency for securities 

Rule 601(a) of Regulation NMS requires exchanges and associations (i.e., FINRA) to file 

transaction reporting plans for approval with the SEC. Rule 601(b) prohibits BDs from 

executing any transaction in any NMS security unless there is an effective transaction 

reporting plan with respect to reporting transactions in such security. Rule 601 also requires 

BDs that are members of an exchange or FINRA to promptly transmit to the SRO all 

information required by the NMS plans. The NMS plans require participating SROs to collect 

and promptly report post-trade information to the NMS plan processors. The processors are 

then responsible for receiving the post-trade information from the participants, consolidating 

it, and disseminating it to the public, including all market participants. 

Pursuant to the applicable NMS plans for equities, the SROs must report the stock symbol, 

volume, and price at which transactions were executed to the NMS plan processor after the 

time of execution. Last sale and trade data is reported on the consolidated tape. If a 

transaction is not reported within the required time periods, the SRO must designate the last 

sale price as “late” on the report to the NMS plan processor. The SROs must also keep a 

transaction record of all trades for audit purposes. 

FINRA Rules 6300A and 6300B require OTC transactions in NMS securities to be reported to 

the FINRA transaction reporting facility (TRF) as soon as practicable but within no later than 

10 seconds. On May 14, 2014, the CTA filed with the SEC an amendment to the CTA Plan, 

which, if approved by the SEC, will also reduce from the current 90 seconds to 10 seconds the 

amount of time within which trades are to be reported to the CTA Plan processor. The 

amendment to the CTA Plan was published for comments on December 31, 2014. The 10-

second reporting requirements would represent the outer limit; in practice post-trade 

transparency information is provided within milliseconds of trades. There is no delay for 

reporting or disseminating block trade information. 
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234 INTERNATIONAL MONETARY FUND

Rule 601(f) provides the SEC with the authority to grant exemptions from post-trade 

transparency. Generally, the only transactions that are excluded from the NMS plans are those 

that are not comparable to regular open-market transactions, such as options exercises, 

purchases pursuant to a tender offer, and primary-market issuance (e.g., an IPO). 

Post-trade transparency for futures and options 

DCM Core Principle 8, Daily Publication of Trading Information, requires that a DCM make 

available to the public accurate information on settlement prices, volume, open interest, and 

opening and closing ranges for actively traded contracts on the contract market (see CFTC 

Regulation 38.450). While this is the only statutory post-trade transparency requirement, 

immediate trade-by-trade post-trade transparency is generally required in DCM rules. These 

typically permit delayed publication of block trade information, with delays ranging from 5 to 

15 minutes. 

Post-trade transparency for swaps and security-based swaps 

SEFs and DCMs must transmit all swap transaction data for publicly reportable swap 

transactions executed on or pursuant to the SEF or DCM rules to an SDR as soon as 

technologically practicable after execution. The SDR must then, as soon as technologically 

practicable after it has received the data, disseminate the swap transaction information to the 

public, unless the swap is a block trade that is subject to a time delay in public dissemination. 

SDRs have to make the transaction information freely available to the public in a nondiscriminatory manner through their websites (CFTC Regulation 43.3). Post-trade public 

dissemination of transaction data is deferred for large transactions that qualify as a block 

trade or large notional off-facility swap transaction under Part 43 of the CFTC Regulations. 

SB SEFs will be required to make public timely information on price, trading volume, and 

other trading data on security-based swaps to the extent to be prescribed by the SEC. 

Information on and monitoring of dark trading 

National securities exchanges are required to describe their order types and order execution 

procedures in their rules. An ATS must disclose such information in its Form ATS, Exhibit F, 

which is submitted to the SEC, but not required to be published. . 

Exchange transactions are currently identifiable from the consolidated tape. While ATSs must 

report their trade information to FINRA for inclusion in the consolidated tape, all ATS 

transactions are currently identified as OTC transactions without identifying the ATS on which 

the transaction was executed. 

Additional data concerning ATS trading activity recently became available as a result of FINRA 

Rule 4552 approved by the SEC. The rule requires ATSs to report to FINRA aggregate weekly 

trading volume and number of trades executed within the ATS on a security-by-security basis. 

The new regime also requires each individual ATS to use a unique market participant 

identifier, which can be used only for reporting orders and trades that occur on the ATS to 

FINRA. FINRA makes the reported volume and trade count information for equity securities 

publicly available on its website. 

The SEC staff continues to evaluate the impact of dark liquidity on the price discovery process 

and market quality, pursuing a data-driven approach. 

Assessment Broadly Implemented 

Comments Commodity futures and options 

Pending the finalization of the CFTC block trade rules, current block trade thresholds for 
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futures and options are based on each DCM’s rules. Without a final CFTC Regulation, it is 

difficult for the CFTC to address any concerns about the lowering of the thresholds over the 

past few years. This lack of appropriately framed pre-trade transparency derogations, as 

required by Key Question 2a of the Assessment Methodology, has been taken into account in 

the grade for this Principle. It is important that the CFTC promptly finalizes its block trade 

rules to provide a regulatory basis for assessing the appropriateness of DMCs’ pre-trade 

transparency waivers for block trades. 

While the design of the DCMs’ iceberg order type is somewhat unconventional, and may not 

be optimal from pre-trade transparency perspective, the assessors have not taken it into 

account in the grade of this Principle, given lack of specific guidance in the Assessment 

Methodology on the interpretation of the requirement for transparent orders to have priority 

over dark orders. 

Equity securities 

As discussed in Principle 33, dark pool ATSs do not currently provide sufficient public 

information on the manner they handle and execute orders, as required by Key Question 2.(e). 

This deficiency has been taken into account in the grade of this Principle. 

In addition, the assessors note that a significant proportion of trading in the U.S. equity 

markets currently takes place without pre-trade transparency.20 Current pre-trade 

transparency level on the U.S. equity markets is impacted by various factors: 

Most of the equity ATSs operate as dark pools, using order types that are executed at or 

within the current NBBO to enable the ATSs to comply with the Order Protection Rule; 

National securities exchanges use order types that may be completely undisplayed (fully 

hidden orders in contrast to iceberg orders); and 

A relatively large proportion of trading takes place outside exchanges and ATSs through 

various OTC trading mechanisms. 

The IOSCO Assessment Methodology focuses on pre-trade transparency requirements 

applied by trading systems (i.e., exchanges and ATSs in the case of the U.S.). Regulation NMS 

frames those requirements, together with exchange rules and ATS market models. The two 

key derogations from pre-trade transparency (as defined in the Assessment Methodology) 

are trading occurring on dark pool ATSs and exchanges’ dark order types. Regulation NMS 

constrains both trading methods by requiring such trading to take place at or within the 

current NBBO. As a result, the requirements of the Assessment Methodology as to having 

conditions for derogations from pre-trade transparency are complied with. Nevertheless, 

there may be benefits in the SEC continuing to deepen its analysis of the pre-trade 

transparency impact of various exchange and ATS order types and the reference prices dark 

order types are permitted to use to ensure that current derogations do not adversely impact 

the price discovery process. This is particularly important given the differences in the 

timeliness of the NMS and proprietary feeds. 

Additional public information on the extent of dark pool trading has recently become 

available through FINRA reporting requirements. The SEC’s MIDAS system provides 

information on the extent of on-exchange dark trading. Therefore the SEC is in a position to 

 

20 As noted in the introduction of this report, estimates on the value of trading on dark pools and OTC have ranged 

between 28 and 40 percent in 2012-2014. As noted above, the proportion of on-exchange dark trading ranged 

between 11 and 14 percent in 2013. 
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236 INTERNATIONAL MONETARY FUND

monitor the development of dark pools and dark orders. 

Principle 36. Regulation should be designed to detect and deter manipulation and other unfair trading 

practices. 

Description Fraud and market manipulation 

Securities 

Fraud and market manipulation are prohibited under the federal securities laws. Section 17(a) 

of the Securities Act prohibits fraud, material misstatements, and omissions of fact in the offer 

or sale of any security. Section 10(b) of the Exchange Act prohibits any person, in connection 

with a purchase or sale of any security, from using or employing any manipulative or 

deceptive device or contrivance in contravention of the SEC’s rules. Rule 10b-5 implements 

Section 10(b) of the Exchange Act and makes it unlawful for any person, directly or indirectly, 

to use any device, scheme or artifice to defraud, to make any untrue statements of material 

fact or to omit to state a material fact necessary in order to make the statements made not 

misleading, and to engage in any act, practice, or course of business which operates or would 

operate as a fraud or deceit upon any person, in connection with the purchase or sale of any 

security. Section 9 of the Exchange Act prohibits manipulative practices in connection with 

the trading of securities. Section 15(c) of the Exchange Act prohibits fraudulent and 

manipulative conduct by BDs. Section 14(e) of the Exchange Act prohibits fraudulent, 

deceptive, and manipulative acts in connection with a tender offer. 

Front running and trading ahead of customer orders are also illegal under the anti-fraud 

provisions of the federal securities laws. SEC Rule 10b-21 includes a specific naked short 

selling anti-fraud rule, according to which it is a manipulative device or contrivance to deceive 

about a seller’s intention or ability to deliver securities in time for settlement. 

Commodity futures and options 

A range of violations can be enforced under the CEA. These include: 

 Price manipulation, cornering a market, squeezing a futures contract, and 

communication of false information that tend to affect commodity prices (Sections 6(c), 

6(d) and 9(a)(2) CEA); 

 Position limit violations (Section 4a(e) CEA); 

 Trade practice violations, such as wash trades, accommodation trades and fictitious sales 

(Section 4c(a) CEA); 

 Disruptive practices, such as violating bids or offers, spoofing, and disregard for the 

orderly execution of transactions during the closing period (Section 4c(a) CEA); and 

 Use or attempted use of any manipulative device, scheme or artifice to defraud, untrue 

or misleading statement, false report or any act that operates or would operate as a 

fraud (Section 4b(a) CEA). 

Insider trading 

Securities 

Under U.S. law, insider trading is generally described as trading on the basis of material 

nonpublic information that has been used or obtained in breach of a fiduciary duty or a duty 

of trust or confidence. The fundamental prohibition against insider trading under the federal 

securities laws is not based on an explicit statutory prohibition. Instead, federal courts have 

interpreted the general anti-fraud provisions of Section 17(a) of the Securities Act, as well as 
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the Exchange Act (primarily Section 10(b) and Rule 10b-5 thereunder) to prohibit trading 

based on material nonpublic information in violation of a duty. It is also unlawful for a tippee 

to trade on material nonpublic information that the tippee knew or should have known was 

communicated by a tipper in breach of a duty owed by the tipper. 

There are also specific provisions relating to the disclosure of insider information and insider 

trading: 

Section 14(e) of the Exchange Act and corresponding Rule 14e-3 prohibit tipping and trading 

while in possession of material, nonpublic information in connection with a tender offer; 

SEC Regulation FD requires a reporting issuer to make simultaneous or prompt public 

disclosure, depending on whether the disclosure was intentional, when it discloses material 

nonpublic information to certain individuals or entities (such as stock analysts or holders of 

the issuer’s securities); and 

Section 16(b) of the Exchange Act imposes liability for short-swing profits in the issuer’s stock 

upon officers, directors, and beneficial owners of more than 10 percent of any class of equity 

security, who may be in a position to obtain material, nonpublic information. These corporate 

insiders must disgorge to the issuer any profit realized as a result of a purchase and sale of 

equity securities occurring within a six-month period. 

Commodity futures and options 

The CEA does not prohibit trading in the commodity futures and options markets on the 

basis of lawfully obtained material nonpublic information. The thinking has been that such 

trading has limited applicability to futures trading, because it would hinder the traders’ ability 

to hedge the risks of their commercial enterprises. Therefore it is not a violation to withhold 

information that a market participant lawfully possesses about market conditions. However, 

the knowing communication of false or misleading information that tends to affect 

commodity prices is a violation of Section 9(a)(2) of the CEA. In addition, depending on the 

facts and circumstances, a person who engages in deceptive or manipulative conduct in 

connection with swaps or commodity futures or options for example by trading on the basis 

of material nonpublic information in breach of a pre-existing duty to disclose (under another 

law, rule, agreement, understanding, or some other source), or by trading on the basis of 

material nonpublic information that was obtained through fraud or deception, may be in 

violation of CFTC Rule 180.1. The CFTC considers that this would enable it to address conduct 

where trading is conducted with knowledge of information that is subject to a specific 

disclosure requirement. 

Further, Section 9(e) of the CEA prohibits insider trading and disclosure of insider information 

by employees and board and board committee members of the NFA, a DCM or a registered 

entity. Insider trading by other persons on the basis of such information is also prohibited. 

Section 746 of the Dodd-Frank Act also added an insider trading prohibition regarding 

information emanating from Federal government departments and agencies that may affect 

or tend to affect the price of any commodity in interstate commerce or swap (Section 4c(a)(4) 

CEA). 

Monitoring 

Securities 

The division of responsibilities between the SROs and the SEC in conducting surveillance of 

the market for market manipulation, insider trading and other market abuse is described in 

Principle 34. 
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The SROs’ electronic monitoring is designed to identify unusual trading activity, which is then 

reviewed by the SROs to determine if market participants have violated any laws or rules. 

SROs monitor trading both on an intra-day basis and after the close of the trading day. 

To detect insider trading, FINRA has established automated surveillance systems that monitor 

trading for aberrant movements in stock prices or volumes of shares traded and generate 

alerts if they move outside of set parameters. If, in reviewing the trading associated with the 

alert, FINRA staff determines that there is a strong likelihood of insider trading, they can 

expand the review to a full investigation. 

In 1996, the SEC ordered FINRA (then NASD) to design and implement an audit trail system 

that would capture a time-sequenced record of orders and transactions from the receipt of an 

order through its execution or cancellation. In response, FINRA developed OATS. BDs 

entering orders into the marketplace are responsible for reporting order details to OATS. In 

1999, the SEC ordered the NYSE to design and implement a similar system. In response, the 

NYSE established its Front End Systemic Capture (FESC) and Order Tracking System (OTS). 

When FINRA added NYSE-listed securities to OATS, and NYSE adopted OATS rules in October 

2011, NYSE discontinued its FESC and OTS systems. 

In 2012, the SEC adopted a new Rule 613 under the Exchange Act to require the national 

securities exchanges and FINRA to create, implement, and maintain a consolidated audit trail 

(CAT) that would collect and identify every order, cancellation, modification, and trade 

execution for all exchange-listed equities and equity options across all U.S. markets. The CAT 

will increase the data available for investigating illegal activities and improve the ability to 

reconstruct broad-based market events. The SROs’ plan was submitted to the SEC on 

September 30, 2014. The transitional period for the new system will last three years from the 

effective date of the plan. 

The SEC’s Market Surveillance Group coordinates with the SROs to detect anomalous market 

activity, including suspicious trading. In addition, the SEC uses technology to review all 

merger and acquisition activity and major market moving events in coordination with the 

relevant SRO so that the SRO can conduct the proper review of the market activity. For 

example, if the SEC finds unusual activity in the equity or options market, it alerts each market 

to the activity to heighten surveillance of that activity. 

Commodity futures and options 

In the case of commodity futures and options markets, a key element in reducing the threat 

of market manipulation or congestion (especially during trading in the delivery month) is 

requiring the DCMs to adopt speculative position limits or position accountability for each 

contract. For any contract that is subject to a position limit established by the CFTC, the DCM 

must set the position limits at a level not higher than the position limitation established by 

the CFTC (DCM Core Principle 5; CFTC Regulation 38.300). CFTC staff contacts large position 

holders to understand the business practices behind positions and the execution of economic 

physical substitution and orderly futures position liquidations. 

As described in Principle 34, the DCMs and NFA conduct market and trade practice 

surveillance in commodity futures and options markets. In swaps markets, the majority of 

SEFs have outsourced the function to the NFA. 

Enforcement 

SEC 

The number of SEC market abuse enforcement actions is presented in the table below. 
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Number of SEC Market Abuse Enforcement Actions 

Fiscal year 2009 2010 2011 2012 2013 Total 

Market 

manipulation 

39 34 35 46 50 204 

Insider 

trading 

37 53 57 58 44 249 

Source: SEC 

CFTC 

Over the past four fiscal years (2011-2014), the CFTC has taken enforcement action in a total 

of 15 cases of manipulation, attempted manipulation and false reporting of market 

information (2011: 3; 2012; 2; 2013: 4; 2014: 6). During the same time period, its enforcement 

actions addressed a total of 34 trade practice violations (2011: 6; 2012; 15; 2013: 7; 2014: 6), 

including first actions taken in 2013 using its anti-spoofing/disruptive trading authority 

enacted under the Dodd-Frank Act. 

Cross-market trading 

Intermarket Surveillance Group 

There are mechanisms for information sharing and surveillance among the markets. Currently, 

all U.S. national securities exchanges and FINRA are members of the Intermarket Surveillance 

Group (ISG), an industry organization created in 1981 to coordinate intermarket surveillance 

among the major U.S. exchanges. It has since grown into an international group of exchanges 

and market regulators that perform frontline market surveillance in their respective 

jurisdictions. Although the ISG Agreement was not established under Section 11A or 17(d) of 

the Exchange Act, the SEC has required new SROs to become ISG members as a condition of 

operation. Membership in the ISG is open to all recognized market centers that have rules 

and regulations designed to detect and deter possible abuses in their marketplaces and meet 

certain other requirements. The ISG is not subject to regulatory oversight, nor does it file rule 

changes with the CFTC or the SEC or seek approval when it considers requests from securities 

or futures exchanges to become a member. 

The goal of the ISG’s information sharing is to coordinate regulatory efforts to address 

potential intermarket manipulations and trading abuses. Participants in the ISG must have the 

ability to share regulatory information and otherwise cooperate with other ISG participants in 

connection with regulatory matters affecting their markets. The ISG focuses on information 

sharing among markets that trade securities, options on securities, security futures products, 

and futures and options on broad-based security indexes. Many DCMs are also members of 

the ISG. 

Membership in the ISG carries with it a commitment to share information required for 

regulatory purposes with other members. ISG agreements provide that information that is 

shared must be kept strictly confidential and used only for regulatory purposes. Such 

information is shared on an as-needed basis and only upon request. In connection with the 

routine sharing of information, the ISG has defined certain types of violations that can occur 

across markets, and has allocated responsibility for surveillance for such activity to the 

appropriate member. In addition, U.S. securities exchanges, via the facilities of the Securities 

Industry Automation Corporation (SIAC), routinely share trading information electronically. 

Generally, the full ISG meets twice a year. Meetings are open only to representatives of 
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members, prospective members, SIAC representatives, and by invitation appropriate 

governmental authorities such as the CFTC, SEC, the UK Financial Conduct Authority, and, on 

occasion, international organizations such as IOSCO. Senior market surveillance or market 

regulation personnel represent member organizations. From time to time, and at the 

discretion of the Chairman of the ISG, subgroups may be formed to address specific issues of 

importance. 

Joint Compliance Committee 

To foster improvements and uniformity in their systems and procedures used for trade 

practice compliance, the futures exchanges have formed the Joint Compliance Committee 

(JCC). The JCC has developed uniform definitions of trade practice offenses and typically 

meets twice a year to share information on automated compliance systems and other 

surveillance matters with a view to improving exchange compliance programs. 

Specific requirements on FBOTs with linked contracts 

An FBOT applying for registration to provide direct access to its trade matching system to 

members and other participants located in the United States is required to identify any 

contract that it will make available in the United States that is linked to a contract listed on a 

DCM or has any other relationship with a DCM listed contract (CFTC Regulation 48.7(c)(3)). 

Once registered, such FBOT must comply with specific conditions for registration, including 

the ongoing obligations regarding linked contracts set forth in CFTC Regulation 48.8(c)(2). 

Specific obligations relating to linked contracts include a requirement to report to the CFTC 

on a quarterly basis any member that had positions in a linked contract above the applicable 

FBOT trade position limit, whether a hedge exemption was granted and, if not, whether 

disciplinary action was taken. The FBOT must also provide to the CFTC trade execution and 

audit trail data for the CFTC’s trade surveillance system on a trade date plus one basis. Finally, 

if the CFTC directs the DCM that lists the contract to which the FBOT’s contract is linked to 

take emergency action with respect to the contract, the FBOT must promptly take similar 

action. 

Assessment Fully Implemented 

Comments 

Principle 37. Regulation should aim to ensure the proper management of large exposures, default risk and 

market disruption. 

Description Clearing and settlement 

Equities 

The clearing of on exchange equities trades takes place at the National Securities Clearing 

Corporation (NSCC). It also clears off exchange equities trades between two brokers, 

including those made on ATSs. Equity trades settle at T+3 at the Depository Trust Company 

(DTC). 

Commodity futures and options trades 

Commodity futures and options trades have to be cleared on a DCO. Many DCMs operate 

also as DCOs (such as the Chicago Mercantile Exchange (CME)). ICE Futures U.S. trades are 

cleared at ICE Clear U.S. 

Large exposure monitoring and management in securities markets 

SEC 
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The SEC’s net capital rule requires that a BD apply haircuts to a securities position to account 

for the risks of the position to the firm. These charges include specific capital charges if the 

BD exceeds certain position limits. If the market value of a securities position exceeds 10 

percent of the tentative net capital of the BD, the BD must apply an additional haircut to the 

amount in excess. (See Principle 30). 

As part of helping to ensure that a BD remains in capital compliance at all times (see 

Principles 30 and 32), the SEC staff and the relevant DEA’s staff monitor and evaluate the risk 

of open positions and credit exposures. The SEC and DEA monitoring and oversight is 

accomplished via the ongoing review of monthly and quarterly FOCUS reports, regular 

meetings and discussions with the firms, and regular examinations. BDs are also required to 

provide to the SEC upon request information on the size and beneficial ownership of 

positions held by direct customers of market intermediaries. 

National securities exchanges 

In case a BD poses a financial risk to the market, its SRO has a range of actions it may invoke 

under appropriate circumstances, acting in coordination with the SEC. Those actions may 

include trading limits, forced liquidation, increased margin requirements, revocation of 

trading privileges, suspension from trading, and imposition of higher capital charges. In 

addition, an SRO may take steps to shut the BD down, either through imposition of a 

suspension or bar, or by revocation of the BD’s membership. 

The margin rules also help SROs control the risk of open positions. Although the Federal 

Reserve’s Regulation T sets minimum initial margin levels, the SROs are responsible for 

setting margin maintenance requirements. In addition, the SROs may set initial margin levels 

higher than those set pursuant to Regulation T. Thus, an SRO could increase the margin level 

for a particular security, forcing an individual or entity to post additional margin or reduce a 

position in order to comply with the new margin level. 

Clearing agencies 

The SEC has adopted rules concerning risk management requirements for CCPs (SEC Rules 

17Ad-22(b)(1)–(4)). Currently the CCPs registered with the SEC have implemented these 

requirements by applying the following procedures: (i) measuring credit exposures at least 

once a day; (ii) setting margin coverage at a 99 percent confidence level over a set period; 

(iii) using risk-based model parameters to set margin requirements; (iv) establishing a fund 

that mutualizes losses of defaults by one or more participants that exceed margin coverage; 

and (v) maintaining sufficient financial resources to withstand the default of at least the 

largest participant family (in the case of SBS transactions, the default of two largest 

participant families). 

To limit its risks, a clearing agency may place a member on a watch list. If a member fails to 

comply with the clearing agency’s operational standards and requirements, its continued 

activities with the clearing agency may be limited, or it may be required to post an additional 

deposit to the clearing fund. A clearing agency may also prohibit a member from taking on 

new positions, if it deems the member to be a financial concern. 

DTCC Limit Monitoring 

In mid-2014 the DTCC launched a risk management tool (DTCC Limit Monitoring) that alerts 

clearing firms to trading activity that is nearing the credit limits they have set for their own 

and their correspondents’ accounts, enabling them to step in and manage potential risk. 

Clearing firms can utilize the information generated by this risk mitigation tool to help 

determine what action is appropriate for their executing firm. Through the NSCC’s role in 
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clearing the majority of securities trades, the DTCC Limit Monitoring combines almost all 

broker-to-broker equity, listed corporate and municipal bond and unit investment trust 

trading in the U.S. to provide aggregated exposure data that can be used to monitor the 

behavior of market participants. 

In near real-time, the NSCC’s Universal Trade Capture service feeds to DTCC Limit Monitoring 

all broker-to-broker trading cleared from all exchanges, ECNs, and a range of dark pools and 

liquidity destinations in the U.S. Users have the ability to set limits on specific trading 

activities for individual clients at the executing broker level, including the ability to modify 

such limits intraday. Users also have the ability to enter start of day exposure information in 

an automated fashion. When the pre-selected “early warning” limit is reached or a breach on 

the established limit has occurred, a standard protocol message is disseminated alerting the 

affected clearing broker. 

Using this system is compulsory for all NSCC member clearing firms that need to monitor 

correspondent firms and NSCC member proprietary trading firms. 

Large exposure monitoring and management in commodity futures and options 

markets 

CFTC reporting requirements 

Every trading day, DCMs must report to the CFTC each clearing member’s open long and 

short positions, purchases and sales, exchanges of futures for cash, and futures delivery 

notices for the previous trading day. This data is reported separately by proprietary and 

customer accounts by futures month, and for options by puts and calls, expiration date and 

strike price. (Part 16 CFTC Regulations). 

In addition, clearing members, FCMs, and foreign brokers (reporting firms) file daily reports 

with the CFTC. The reports show the futures and options positions of traders with positions at 

or above specific reporting levels set by the CFTC. Since traders frequently carry futures 

positions through more than one broker and control or have a financial interest in more than 

one account, the CFTC regularly collects information that enables its surveillance staff to 

aggregate related accounts. Reporting firms must file a form that identifies each new account 

with reportable positions for each futures contract. In addition, if a trader’s position reaches a 

reportable level, the trader may be required to file a more detailed identification report to 

identify accounts and reveal any relationships that may exist with other accounts or traders. 

(Part 17 CFTC Regulations). 

CFTC market surveillance staff may investigate further the positions of large traders by 

instituting a special call. A special call is designed to gain additional information about a 

firm’s traders and/or about a participant’s trading and delivery activity, including information 

on persons who control or have a financial interest in the account. The special call may also 

request information about positions and transactions in the underlying commodity. This 

mechanism may be used when a trader is using too many firms to be easily monitored 

through required reports. (Parts 18 and 21 CFTC Regulations). 

Routine reports are required from DCOs, as well as clearing members and swap dealers with 

reportable positions in certain covered physical commodity swaps. Such large trader 

reporting provides the CFTC with data regarding large positions in swaps that are linked, 

directly or indirectly, to a list of U.S.-listed physical commodity futures contracts. This system 

is intended to enable the CFTC to identify significant traders in the covered physical 

commodity swaps and to collect data on their trading activity in order to reconstruct market 

events. (Part 20 CFTC regulations). 
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In some specific contracts, traders that hold positions are required to disclose their full 

portfolio of related products through a special call. These exposure forms are filed before the 

last day of trading of a specific contract month and are forwarded to the CFTC surveillance 

staff. The need for this special disclosure derives from the existence of a large physical OTC 

market that is linked to the futures contract, and for positions that are not observable by the 

exchange. 

CFTC risk surveillance program 

In addition to the above mentioned reporting requirements, the CFTC also conducts more 

sophisticated analysis. DCR’s Risk Surveillance Group (RSG) defines risk as the potential that a 

market participant may not fulfill its financial obligations on a contract subject to the CFTC’s 

jurisdiction under the CEA. RSG attempts to identify positions in cleared products that pose 

significant financial risk to confirm that these risks are being appropriately managed. The RSG 

undertakes these tasks at the trader level, the clearing member level, and the DCO level. That 

is, it identifies both traders that pose risks to clearing members and clearing members that 

pose risks to the DCO. It then evaluates the financial resources and risk management 

practices of traders, clearing members, and DCOs in relation to those risks. 

The risk surveillance program contains four primary components: i) identifying traders, 

clearing members, and DCOs at risk on the basis of their account characteristics and current 

market conditions; ii) estimating the magnitude of the risk through stress testing and other 

risk estimation techniques; iii) comparing the risk to the available financial resources (initial 

margin, trader assets, clearing member capital, and DCO resources); and iv) assessing the risk 

management practices of the traders, clearing members, and DCOs. RSG uses a number of 

tools to perform the above tasks. Improving and integrating these tools is an ongoing 

process. Currently RSG does not have the same ready access to financial information about 

traders or self-clearing firms that it has about FCMs and DCOs. 

The program for futures and options is well-established. RSG is in the process of developing 

tools and techniques to address interest rate swaps and CDS and to integrate the swaps 

program with the futures and options program. 

DCMs and SEFs 

DCM Core Principle 6 provides that a DCM, in consultation or cooperation with the CFTC, 

must adopt rules to provide for the exercise of necessary and appropriate emergency 

authority, including the authority to liquidate or transfer open positions in any contract; 

suspend or curtail trading in any contract; and require market participants in any contract to 

meet special margin requirements. In situations where a contract is fungible with a contract 

on another platform, emergency action to liquidate or transfer open interest must be 

directed, or agreed to, by the CFTC or CFTC staff. The DCM must promptly notify the CFTC of 

the exercise of its emergency authority. 

Similar requirements apply to SEFs. 

Sharing of information 

SEC 

There are certain arrangements for the sharing of large trader and other concentration risk, 

both domestically and, to some extent, cross-border. The SEC has an MOU for information 

sharing with the Federal Reserve and is in contact with other financial regulators both in the 

U.S. and abroad about observed key developments and the risks they pose to individual firms 

and the broader marketplace. In addition, the SEC has entered into bilateral agreements with 

various agencies that allow it to share information on a timely basis with those agencies. The 
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SEC also participates in supervisory colleges with other U.S. regulators. These include colleges 

of supervisors established by holding company supervisors for each large global financial 

institution and ongoing supervisory meetings to discuss ANC BDs (see Principles 30 and 31). 

CFTC 

The CFTC and DCMs have arrangements to share information, including on large exposures. 

The CFTC essentially has the same large exposure information as the DCMs. When the DCMs 

manage position limits, they inform the CFTC of any exemptions granted. The DCMs are able 

to monitor the exposure size within each contract on an intraday basis. Conversations occur 

between exchange and CFTC staff when liquidations or acquisitions of large exposures create 

a heightened concern. 

The Boca Declaration on Cooperation and Supervision of International Futures Markets and 

Clearing Organizations (Declaration), and its companion Exchange MOU were created in 1995 

to address the challenge of accessing information about large exposures of exchange 

members and market participants trading on multiple exchanges. Under the Declaration, the 

occurrence of agreed triggering events affecting an exchange member’s financial resources, 

positions, price movements or price relationships, or events suggesting manipulation or other 

abusive conduct, prompt the sharing of information. 

The CFTC also has a special arrangement in place with regards to WTI Crude Oil, because ICE 

Europe trades a financially settled futures contract whose settlement price is directly linked to 

a NYMEX contract. Given that these two contracts form effectively a single market, the CFTC 

and the UK FCA entered on November 17, 2006 into a MOU, under which the FCA and CFTC 

share information on a daily basis regarding large exposures. 

Default procedures 

Clearing agency member failure 

Clearing participants that clear customer positions are registered BDs and, as such, are 

subject to the SEC’s customer protection rules in Rule 15c3-3 and the rules on the 

hypothecation of customer securities in Rule 8c-1 (see Principle 31). In addition, the 

insolvency of a BD that has customer accounts is administered by the SIPC pursuant to SIPA’s 

framework (see Principle 32). 

Registered clearing agencies are required to establish, implement, maintain and enforce 

written policies and procedures reasonably designed to make key aspects of their default 

procedures publicly available and establish default procedures that ensure that they can take 

timely action to contain losses and liquidity pressures and to continue meeting their 

obligations in the event of a participant default (SEC Rule 17Ad-22(d)(11)). In practice, 

clearing agency rules typically state what constitutes a default, identify whether the board or 

a committee of the board may make that determination, and describe what steps the clearing 

agency may take to protect itself and its participants. 

The rules of a clearing agency must be designed to assure the prompt and accurate clearing 

and settlement of securities and the safeguarding of securities or funds which are in the 

custody or control of the clearing agency or for which it is responsible (Section 17A(b)(3)(F) 

Exchange Act). Registered clearing agencies have rules granting them authority to take over 

accounts, manage positions, and utilize the defaulting participant’s collateral to meet the 

participant’s settlement obligations. In this regard, clearing agencies typically attempt, among 

other things, to close out, hedge or liquidate a defaulting participant’s positions. 

Articles 8 and 9 of the Uniform Commercial Code provide legal certainty with respect to a 

clearing agency’s lien on participants’ collateral. Provisions in the U.S. Bankruptcy Code, 
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Federal Deposit Insurance Act, Federal Deposit Insurance Corporation Improvement Act, and 

SIPA provide legal certainty regarding a clearing agency’s authority to liquidate or transfer a 

position and to apply margin or draw down liquidity resources in the event of the insolvency 

of a participant. 

Clearing agencies are not required to distinguish between their participants’ customer and 

proprietary positions. Instead, they generally treat their participants as principals. In the event 

of a participant default, the clearing agency will work with the receiver appointed by the SIPC 

to distribute customer cash and securities. 

DCO member failure 

A DCO is required to provide information concerning the rules and operating procedures 

governing the clearing and settlement systems (including default procedures) to market 

participants (Section 5b(c)(2)(L) CEA). Most DCOs make their default procedures accessible to 

the public via their website. 

If the CFTC determines that an FCM is likely to fail, it will attempt to cause the transfer of 

customer accounts. Pursuant to CFTC Regulation 1.17(a)(4), if an FCM holds less capital than 

the amount specified in its minimum capital requirement, it generally must transfer all 

customer accounts and immediately cease conducting business as an FCM, until such time as 

it is able to demonstrate compliance with its minimum capital requirement. The FCM itself or 

its DSRO would actually arrange the transfer of customer accounts. The role of the CFTC 

would be to facilitate such transfer as necessary (e.g., grant relief from certain notice 

requirements applicable to such transfer under CFTC Regulation 1.65). 

If a DCO cannot collect payments from a member, or if it believes that it will shortly be unable 

to collect such payments, it would generally declare the member to be in default. The DCO 

rules govern the management of such default. Usually, such rules permit the DCO: (i) to 

liquidate or transfer positions carried by the defaulting member; (ii) to access all property 

held in the proprietary accounts of the defaulting member; (iii) to access all property held in 

the customer account of the defaulting member, if the default of the DCO member resulted 

from the default of the member’s customer; and (iv) to access any amounts that the 

defaulting member had contributed to the guarantee fund. If the above do not cover all DCO 

losses, the rules of the DCO may permit the DCO: (i) to access the amounts that nondefaulting members had contributed to the guarantee fund; (ii) to look to its own capital; and 

(iii) to levy an assessment on all members. 

Short selling 

Rules

Regulation of Short Sales (Regulation SHO) has four general principles. First, it contains 

detailed provisions regarding when a sell order can be marked long, short, or short exempt. 

An order can be marked long only if the seller is deemed to own the security being sold and 

the security is in the broker or dealer’s possession or control or it is reasonably expected that 

this will be the case no later than the settlement day of the transaction. Second, Regulation 

SHO’s locate requirement directs a broker or dealer, prior to effecting a short sale, to borrow 

or enter into an arrangement to borrow the security. Third, Regulation SHO requires that a 

clearing firm deliver securities by settlement date, or if the clearing firm has not done so, 

immediately purchase or borrow securities to close out a fail to deliver position resulting from 

a short sale by no later than the morning of T+4. Fourth, Regulation SHO includes a price test 

that effectively restricts the price at which short sales can be made. The price test is triggered 

whenever the price of the security drops 10 percent or more from the prior trading day’s 

closing price. Once triggered, the price test prevents short sales from being effected at or 
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below the National Best Bid (NBB). 

Regulation SHO provides certain exceptions. For example, Regulation SHO defines when a 

person, broker or dealer is deemed to own a security for short sale purposes, and provides 

certain exceptions to the deemed-to-own requirements for a broker or dealer that is engaged 

in certain arbitrage or hedging activity. Regulation SHO also provides an exception from the 

locate requirement for market makers engaged in bona fide market making activity. In 

addition, for such market makers, the close out requirement is extended to the morning of 

T+6. 

As noted in Principle 36, SEC Rule 10b-21 includes a specific naked short selling anti-fraud 

rule, according to which it is a manipulative device or contrivance to deceive about a seller’s 

intention or ability to deliver securities in time for settlement. The SEC has taken enforcement 

action in 2014 under these provisions. 

Reporting and monitoring 

Several SROs provide on their websites daily aggregate short selling volume information for 

individual equity securities. The SROs also provide website disclosure on a one-month 

delayed basis of information regarding individual short sale transactions in all exchange-listed 

equity securities. In addition, the SEC discloses on its website twice a month fails to deliver 

data for all equity securities. The SROs’ websites also provide the threshold securities list for 

those securities for which the SRO is the primary market. 

The SEC has an examination and enforcement program to monitor for, and prosecute, 

violations of these rules. Also, the SROs have varying programs in place to monitor short 

selling activity, including, but not limited to, failures to deliver in equity securities. 

Assessment Fully Implemented 

Comments The IOSCO Assessment Methodology assigns the responsibility for monitoring open positions 

or credit exposures on unsettled trades to market authorities. A market authority refers to the 

authority in the jurisdiction that has statutory or regulatory powers over a market. It further 

notes that the relevant market authority, depending on a jurisdiction, may be a regulatory 

body, an SRO, and/or the market itself. 

The complexity of the U.S. market structure and the existence of multiple regulators and 

SROs, national securities exchanges, DCMs, and CCPs makes assessing this Principle 

particularly challenging. Individual market authorities—in particular CCPs—are subject to 

requirements to monitor open positions in the markets that they clear. In the case of 

commodity futures and options, this is complemented by ongoing monitoring by the CFTC. 

Individual market authorities also have sufficient powers to require additional information 

and to take appropriate action. They have also developed various mechanisms to facilitate 

sharing of information both domestically and internationally. 

While the clearing agencies are not required to distinguish between their participants’ 

customer and proprietary positions, the SIPC process can be considered to provide the means 

to protect customer funds and assets as required under Key Question 4 of the Assessment 

Methodology (see Principle 32). The CFTC has wide powers to intervene in the case of a 

potential failure by, for example, requiring the transfer of customer accounts (see 

Principle 32). 

As a result, the minimum requirements of the IOSCO Assessment Methodology appear to be 

complied with, due to which this Principle has been assessed as Fully Implemented. However, 

the authorities are encouraged to review whether the current mechanisms are sufficient to 

provide them with a comprehensive view of the total exposures of market participants that 
UNITED STATES 

INTERNATIONAL MONETARY FUND 247

are active across various markets (equity, fixed income, commodity futures and options). 

Principles Relating to Clearing and Settlement 

Principle 38. Securities settlement systems and central counterparties should be subject to regulatory and 

supervisory requirements that are designed to ensure that they are fair, effective and efficient 

and that they reduce systemic risk. 

Description 

Assessment Not Assessed. 

Comments