FINANCIAL SECTOR ASSESSMENT PROGRAM

UNITED STATES OF AMERICA 

THE IOSCO OBJECTIVES AND PRINCIPLES OF 

SECURITIES REGULATION

DETAILED ASSESSMENT OF 

IMPLEMENTATION

MAY 2010 

INTERNATIONAL MONETARY FUND

MONETARY AND CAPITAL MARKETS DEPARTMENT
4046053
 Contents Page 

Glossary .....................................................................................................................................3

I. Summary, Key Findings, and Recommendations 5

Preconditions for Effective Securities Regulation ...........................................11

Recommended Action Plan and Authorities’ Response ..................................22

II. Detailed Assessment ...........................................................................................................29

Tables 

1. Summary Implementation of the IOSCO Principles—Detailed Assessments ....................16

2. Recommended Action Plan to Improve Implementation of the IOSCO Principles ............22

3. Detailed Assessment of Implementation of the IOSCO Principles .....................................29

 
3 

GLOSSARY

Advisers Act Investment Advisers Act of 1940 

ALJ Administrative Law Judge 

AML Anti-Money Laundering 

APA Administrative Procedures Act 

ATS Alternative Trading System 

AUM Assets under Management 

BD Broker Dealer 

BSA Bank Secrecy Act 

CBOE Chicago Board Options Exchange 

CCO Chief Compliance Officer 

CCP Central Counterparty 

CDS Credit Default Swaps 

CEA Commodity Exchange Act 

CFMA Commodity Futures Modernization Act of 2000 

CFTC Commodity Futures Trading Commission 

CIS Collective Investment Schemes 

CPSS Committee on Payment and Settlement Systems 

CME Chicago Mercantile Exchange 

CPO Commodity Pool Operator 

CP&P Compliance Policies and Procedures 

CTA Commodity Trading Advisor 

CTR Complaints, Tips and Referrals 

COT Report Commitment of Traders Report 

CSE Consolidated Supervised Entities 

DCM Designated Contract Market 

DCO Derivatives Clearing Organization 

DOJ Department of Justice 

DSRO Designated Self-regulatory Organization 

DTEF Derivatives Transaction Execution Facility 

EBOT Exempt Board of Trade 

ECM Exempt Commercial Market 

ECN Electronic Communications Network 

ECP Eligible Contract Participant 

EDGAR Electronic Data Gathering, Analysis and Retrieval System 

Exchange Act Securities Exchange Act of 1934 

FASB Financial Accounting Standards Board 

FCM Futures Commission Merchant 

FDIC Federal Deposit Insurance Corporation 

Federal Reserve Board of Governors of the Federal Reserve System 

FINRA Financial Industry Regulatory Authority 

FOIA Freedom of Information Act 

GAAP Generally Accepted Accounting Principles 
4 

GAAS Generally Accepted Auditing Standards 

GLBA Gramm-Leach-Bliley Act 

IA Investment Adviser 

IASB International Accounting Standards Board 

IB Introducing Broker 

ICA Investment Company Act of 1940 

ICE Intercontinental Exchange 

IG Inspector General 

IFRS International Financial Reporting Standards 

IOSCO International Organization of Securities Commissions 

IOSCO MMOU IOSCO Multilateral Memorandum of Understanding 

ISG Inter-market Surveillance Group 

Joint Report Joint Report of the SEC and CFTC on Harmonization of 

Regulation issued October 16, 2009 

LLC Limited Liability Company 

MSRB Municipal Securities Rulemaking Board 

MOU Memorandum of Understanding 

NASD National Association of Securities Dealers 

NASDAQ National Association of Securities Dealers Automated 

Quotations 

NAV Net Asset Value 

NFA National Futures Association 

NMS National Market System 

NYSE New York Stock Exchange 

OCIE Office of Compliance, Inspections, and Examinations (SEC) 

OTC Over-the-Counter 

PCAOB Public Company Accounting Oversight Board 

RFA Registered Futures Association 

RSA Registered Securities Association 

PWG President’s Working Group 

RER Rule Enforcement Review 

RFPA Right to Financial Privacy Act 

SEC Securities and Exchange Commission 

Securities Act Securities Act of 1933 

SFP Securities Futures Product 

SIPA Securities Investor Protection Act of 1970 

SIPC Securities Investor Protection Corporation 

SOX Sarbanes-Oxley Act of 2002 

SPDC Significant Price Discovery Contracts 

SRO Self-regulatory Organization

Treasury Department of the Treasury 

UIT Unit Investment Trust 

White Paper Department of the Treasury Blueprint for a Modernized 

Financial Regulatory Structure 
5 

I. SUMMARY, KEY FINDINGS, AND RECOMMENDATIONS

Introduction 

1. An assessment of the United States securities and futures market regulatory 

system was conducted by Susanne Bergsträsser, Richard Britton, and Tanis MacLaren 

from October 7 to November 3, 2009 as part of the Financial Sector Assessment 

Program (FSAP). 

Information and methodology used for assessment 

2. The assessment was conducted based on the International Organization of 

Securities Commissions (IOSCO) Objectives and Principles of Securities Regulation 

and the associated methodology adopted in 2003, as updated in 2008.1 An assessment of 

the securities settlement systems under the Committee on Payment and Settlement Systems 

(CPSS)/IOSCO Recommendations was conducted separately; thus Principle 30 was not 

assessed here.

3. The conclusions below are based on information and findings as of November of 

2009. As noted below, important reforms have been introduced in the past year, some of 

which have already been implemented and are beginning to take effect. However, while these 

promise to address many of the issues identified in this assessment, it would still be 

important to establish a consistent track record before their efficacy could be judged. 

4. The assessment team relied on number of sources in carrying out this 

assessment. The assessment was based on a review of the relevant legislation, selfassessment questionnaires prepared by the Commodity Futures Trading Commission (CFTC) 

and the Securities and Exchange Commission (SEC) prior to the mission, detailed 

discussions with CFTC and SEC staff, with staff of the various self-regulatory organizations, 

securities and futures exchanges, law enforcement agencies and representatives of industry, 

and the law and accounting professions. We also reviewed the Joint Report of the SEC and 

CFTC on Harmonization of Regulation issued October 16, 2009 (Joint Report) and the 

Department of the Treasury Blueprint for a Modernized Financial Regulatory Structure 

(White Paper). Staff of the regulators was generous in making themselves available for 

discussions which were helpful, frank, and forthcoming. Assistance from market 

representatives was also extremely helpful. 

5. The assessment did not address the securities regulatory regime that is imposed 

at the state level to any significant degree. State regulation plays a more minor role, mostly 

aimed at consumer protection. In certain areas, such as new issues of securities, state blue sky 

 

1 The IOSCO methodology was amended in 2008 to update footnotes to reflect recent IOSCO 

publications. Currently IOSCO is undergoing a substantive review of the Principles, which will be 

followed by a review of the methodology. 
6 

laws have largely been preempted by legislative amendments at the federal level. In others, 

the state regulatory activities run parallel to federal ones, such as in the area of enforcement 

and registration of intermediaries and their representatives. 

6. The assessment has been challenging given the complexity of the U.S. system and 

the task of the regulators in this jurisdiction. The methodology notes that “markets with a 

single or a few issuers, that are totally domestic in nature, or that are predominantly 

institutional, will pose different questions and issues as to the sufficiency of application of 

the Principles and as to the potential vulnerabilities likely to arise from their non-application, 

than jurisdictions where there are substantial numbers of retail participants, intermediaries 

frequently are part of complex groups, issuers are established in other jurisdictions, or the 

markets have other international or cross-border components.” The methodology was 

therefore applied taking into account that a higher quality of supervisory and regulatory 

oversight is needed where financial systems are large and complex, as is the case in this 

jurisdiction. While the assessment has been done against internationally agreed standards, 

care is needed in comparing the results with those for other countries because of this level of 

complexity. Further, the methodology has undergone changes (in 2003 and in 2008) and 

finally the application of the standards in this and other recent cases has necessarily also 

taken into account the lessons of the recent financial crisis. 

7. The assessment was carried out in a post-crisis environment, which had a clear 

impact on the findings. The financial crisis of 2008 exposed a number of underlying issues 

in the U.S. financial markets, some of which were causally related to the crisis—such as the 

lack of ability of U.S. investment banks to withstand shocks to liquidity—while others arose 

as a result of secondary effects of the crisis—such as the exposure of a giant fraud because of 

the precipitous contraction of investment in-flow during the crisis. The system was tested in a 

way that most systems are not and this testing has revealed weaknesses that might otherwise 

have gone undetected. The authorities have been under extraordinary pressure; first to 

respond to the crisis and then to undertake reforms. An assessment is rarely carried out in 

such circumstances—a reading of the findings must give this due consideration. 

8. The uncommon level of transparency in the jurisdiction has also affected the 

assessment findings. The mission had access to a range of official reports, internal 

evaluations of the regulatory framework, and regulatory practice. Given the size and 

importance of the markets, there are many sources of analysis available from the private 

sphere as well. The information made available through this unusual level of transparency 

and ‘self-criticism’ was taken into consideration by mission, and this context is also 

important to understanding the findings. 

Institutional and market structure—overview 

9. The legislative framework in place in the jurisdiction provides a comprehensive, 

but complex, framework for the types of activities undertaken in the public markets. 

The responsibility for regulation of the markets at a federal level is split between two 

agencies created under separate statutes. The CFTC is responsible for the supervision of 
7 

commodity futures market—the commodity exchanges, the intermediaries and the futures 

products offered in the public markets—under the Commodity Exchange Act (CEA) as 

modified by the Commodity Futures Modernization Act (CFMA). The SEC regulates 

securities markets, issuers, and participants. Its authority flows from several statutes 

including the Securities Act of 1933 (Securities Act), Securities Exchange Act of 1934 

(Exchange Act), Trust Indenture Act of 1939, Investment Company Act of 1940 (ICA), 

Investment Advisers Act of 1940 (Advisers Act), and Sarbanes-Oxley Act of 2002 (SOX). 

All of these federal statutes are supplemented by an extensive body of regulations, rules, 

guidance, court decisions, and regulatory no-action letters. In addition, there are state 

securities regulators involved in both licensing and enforcement activities. Further, other law 

enforcement agencies, such as the Department of Justice (DOJ) and state Attorneys General, 

participate in enforcement activities. 

10. The CFTC and SEC rely to a significant degree on self-regulatory organizations 

(SROs) for the regulation of the markets and their participants. These entities include 

exchanges, clearing organizations, and securities or futures associations, each of which has 

authority over their members’ activities. The Financial Industry Regulatory Authority 

(FINRA) is the registered securities association with authority over broker-dealers (BDs), 

and the National Futures Association (NFA) is the registered futures association for 

commodity futures intermediaries and commodity pool operators. 

Market data 

11. The number of futures and options contracts, and the volume of trading in these 

contracts have increased dramatically since the CFMA was passed in 2000 (by 

570 percent and 594 percent respectively). Over the same time period, client funds held by 

futures commission merchants (FCMs)—one measure of risk in the system—rose by 

354 percent. The number of exchanges has been roughly stable which reflects both 

consolidations among existing exchanges and the creation of new exchanges. The four 

exchanges in the Chicago Mercantile Exchange (CME) group now account for over 

90 percent of total volume. There has been substantial growth in exempt marketplaces that 

are not subject to formal designation or licensing and are subject to more limited ongoing 

regulation once operational. During this period, the number of full time equivalent staff at the 

CFTC has declined by 18 percent. 

12. In comparison, the equity market showed more modest growth until 2008. 

Between 2000 and 2007, daily volumes increased by only 62 percent. During the market 

crisis of 2008, volumes increased by 52 percent over 2007, taking the 10-year growth to 

255 percent. This was still only 44 percent of the growth rate of the volume of trading of 

on-exchange futures markets. Not included in these statistics was the 780 percent increase in 

the number of shares of “pink sheet” OTC stocks traded on a daily basis between 2001 and 

2008. Although compared to the main markets the values are small (US$200 million in 2001 

and US$540 million in 2008), pink sheet stocks are a major source of securities fraud. In the 

securities markets, as of March 2010, there were 11 registered national securities exchanges, 
8 

79 registered alternative trading systems (ATS), and 4 electronic communications networks 

(ECNs).2

Futures Statistics 

2000 2001 2002 2003 2004 2005 2006 2007 2008 

Volume of 

contracts traded 

(millions) 

580 723 1,004 1,225 1,518 1,920 2,421 3,085 3,446 

Number of 

contracts 266 250 278 538 662 906 1,135 1,365 1,521 

Client funds held 

by FCMs 

(in US$ billions) 

56.7 59.7 64.3 75.6 94.5 116.7 138.0 155.4 201 

Commodity 

exchanges 15 18 13 12 12 13 

Exempt markets 

ECMs 11 11 12 17 19 19 

EBOTs 2 3 5 8 8 10 

CFTC full time 

equivalent staff 546 514 521 497 517 491 493 437 448 

 Source: CTFC. 

Daily Average Volume of Shares Traded 

(In millions of shares) 

Year 2000 2001 2002 2003 2004 2005 2006 2007 2008

Vol. 2,851 3,206 3,257 3,217 3,323 3,458 4,004 4,769 7,282

 Source: SIFMA. 

13. SEC staff numbers, although 24 percent up in this period peaked in 2005 and fell 

back subsequently; they increased somewhat in 2008/9. 

SEC Staffing 

2000 2001 2002 2003 2004 2005 2006 2007 2008 2009

SEC full time 

equivalent staff 2,840 

 

2,936 

 

3,009 

 

3,060 

 

3,550 

 

3,851 

 

3,695 

 

3,465 

 

3,511 3,656 

Source: SEC. 

 

2

 One ECN (Direct Edge) is in the process of converting from an ECN into two separate registered 

exchanges. The SEC has granted exchange status to those two exchanges, though they are not yet 

operational. The SEC has recently approved the registration of a third new exchange (C2) which 

also is not yet operational. This will bring the total number of exchanges from 11 to 14. 
9 

14. The United States has a system of specialized intermediaries with separate 

categories across the futures and securities regimes. Intermediaries trading as principals or 

agents are registered as BDs under the Exchange Act or FCMs and introducing brokers (IBs) 

under the CEA. Advisers are registered as IAs or commodity trading advisers (CTAs) under 

the securities or futures legislation, respectively. The operators of Collective Investment 

Schemes (CIS) are registered as IAs under the Advisers Act or commodity pool operators 

(CPOs) under the CEA.

15. The number of registered intermediaries participating in the market has grown 

only slightly over the past five years. The number of registered commodity futures firms 

and BDs has declined, with more marked drops in the number of CFTC registrants. This 

reflects both consolidation in and departures from the industry. The data for CFTC 

registrations also reflects a migration of CPOs to providing services that do not require 

registration. The number of BDs has declined 6 percent over the 5-year period, while the 

total net capital of these firms has increased nearly 80 percent and the total number of 

registered persons at FINRA member firms has remained relatively constant. Substantial 

growth has been seen in the number of registered IAs and the assets these firms have under 

management (32 percent and 79 percent). If unregistered firms—such as hedge fund and ones 

that are only registered at the state level—are added in, the growth rate in assets under 

management over the period likely would be much higher. 

16. The U.S. CIS market is the largest in the world with nearly US$10 trillion in 

assets under management in the funds that are registered with the SEC. There was a 

sharp drop in assets under management in 2008 (-20 percent) reflecting substantial declines 

in equity markets. However, by the end of September of this year, the total assets under 

management had recovered somewhat. During 2008, assets in funds moved from long-term 

funds (equity and bond funds) to money market funds with portfolios consisting only of 

short-term government paper and cash. Since the beginning of 2009, that trend has reversed 

and the growth is in equity and bond funds. 

17. In contrast, commodity pools operated by registered CPOs have experienced 

steady declines over the past five years. The number of commodity pools reporting to the 

CFTC is down 52 percent with their aggregate assets under management down 77 percent 

over the 5-year period. This reflects both responses to adverse market conditions (trading 

losses, decreased new contributions, and ceasing business) and conversions of funds to ones 

exempt from reporting to the CFTC. 
10 

Futures and Securities Intermediaries 

Year (As at September 30) 

Intermediary Category1

 2004 2005 2006 2007 2008

CFTC2

FCMs 211 211 210 197 179

IBs 1,664 1,711 1,740 1,699 1,647

CTAs 2,640 2,635 2,589 2,601 2,534

CPOs 1,810 1,782 1,570 1,416 1,353

SEC 

BDs 5,219 5,134 5,052 4,969 4,923

IAs 8,535 9,017 10,662 10,817 11,292

Total Net Capital of BDs 

(in US$ millions) 87,127 101,334 102,969 128,244 155,468

Total AUM by Reg’d IAs 

(in US$ trillions) 24 27 32 38 43

Median AUM of Reg’d 

IAs 

(in US$ millions) 

99 108 116 123 125

 Sources: CTFC, SEC, and SIFMA.

 1 Only includes firms registered with one of the two agencies, not firms exempt from registration or only registered at a 

state level. 

 2 A firm registered in more than one category is counted in each category. 

Mutual Fund Assets 

(US$ billions) 

 Equity Hybrid Bond Money 

Market

Total 

Assets 

2004 4,384.0 519.3 1,290.4 1,913.2 8,106.9 

2005 4,940.0 567.3 1,357.4 2,040.5 8,905.2 

2006 5,911.4 653.1 1,494.3 2,354.8 10,413.6 

2007 6,521.4 713.4 1,678.9 3,085.8 11,999.5 

2008 3,708.1 494.2 1,567.2 3,832.3 9,601.8 

Sept '09 4,511.2 576.6 1,973.1 3,551.8 10,612.7 

%Change Sept 

’08 –Sept‘09 -20.0% -13.1% 12.7% 1.8% -8. 4% 

Mutual Fund Net New Cash Flow1

(US$ billions)

Equity Hybrid Bond Money 

Market Total Total LongTerm Funds

2004 177.9 42.7 -10.8 -156.6 53.2 209.8

2005 135.5 25.2 31.3 63.1 255.2 192.0

2006 160.1 7.1 60.6 247.5 475.2 227.8

2007 95.6 22.2 108.6 661.5 887.9 226.4

2008 -237.7 -21.7 33.0 631.7 405.2 -226.4

Sept '09 12.4 3.1 220.1 -291.3 -55.7 235.6

%Change Sept 

’08 –Sept‘09 118.1% -49.24% 128.6% -184.7% -114.7% 595.0%

 Source: Investment Company Institute. 

 1 New sales (excluding reinvested dividends) minus redemptions, combined with net exchanges. 
11 

Commodity Pools 

Number of pools

(to nearest hundred)

Aggregate net asset 

value reported for all 

pools (US$ billions)

2004 3,100 $1,348

2005 2,600 $564

2006 2,100 $513

2007 1,700 $573

2008 1,500 $316

 Source: CFTC. 

Preconditions for effective securities regulation 

18. The general preconditions for effective securities regulation in the United 

States are present. There are no significant barriers to entry and exit for market participants. 

Competition is encouraged and foreign participation is welcomed. The legal and accounting 

system supports the implementation of requirements and effective regulation of market 

participants. The commercial law is up-to-date and is capable of supporting the demands 

posed by cross-border trade, modern financial instruments, and current corporate governance 

standards. The legislation regarding bankruptcy, insolvency, and winding up in the 

jurisdiction and the professionals associated with those matters are sophisticated. The 

regulators have legally enforceable powers of decision and action, the limits of which have 

been tested frequently by the courts. The taxation framework is supportive to the operations 

of the industry in the jurisdiction. 

Main findings 

19. Complexity is a key challenge. The U.S. securities and futures markets are very 

complex. The regulatory framework and system that has developed equally complex. This is 

evident in the division of responsibility between the agencies and in the way that each is 

structured. There is a high degree of specialization evident at each agency. Although 

specialization may have benefits in a complex environment, regulators may be challenged to 

appropriately assess overall issues that cross specialization lines—both within an agency and 

between agencies. A greater focus on systemic issues relating to both securities and futures 

markets would make the overall regulatory system more robust.

20. The chairmen of the CFTC and SEC have both recognized the need for change 

and have taken steps toward strengthening their institutions. However, institutional 

culture is not easy to transform. Moreover, the agencies are under strong and continuous 

pressure, including from industry, and the agencies’ challenge will be to respond to market 

developments and develop a reform agenda in an independent manner. 
12 

21. These issues manifest themselves in some key areas (such as in the enforcement 

function or in regulation of over-the-counter derivatives markets) but the problems affect the 

entire system. 

22. As a matter of priority, the system should work toward simplification of internal 

and institutional structures. Within the agencies, better internal management structures and 

improved communication between departments should be established to facilitate a 

regulatory culture of continuous learning and response. 

23. Principles relating to the regulator (Principles 1–5): The responsibilities of the 

CFTC and SEC are clearly stated in law. There are gaps in coverage of the wide range of 

activity in the U.S. markets and in the scope of authority of both agencies. There are also 

differences between the futures and securities regimes in how similar instruments are 

regulated. There are also gaps between the authority of the SEC and the Federal Reserve with 

respect to the regulation and oversight of investment bank holding companies which added to 

the fragility of the overall system in the recent crisis. These gaps should be reduced as much 

as possible. The legal system grants the CFTC and SEC sufficient protection for their 

independence and the agencies operate independently on a day to day basis. There is a strong 

system of accountability to Congress. Neither agency has sufficient funding nor does the 

method of funding provide sufficient assurance of continuing funding levels to be able to 

commit to long-term capital projects, such as building new market surveillance systems, 

which are necessary to keep pace with changes in the industry. The CFTC and SEC activities 

and processes are transparent and there is public consultation regarding their regulations. 

They are active in investor education. CFTC and SEC staff and commissioners are subject to 

codes of ethics and other requirements to ensure a high standard of conduct. 

24. Principles relating to self-regulation (Principles 6–7): SROs play a very significant 

role in the supervision of markets and their participants. Exchanges and clearing 

organizations perform important self-regulatory functions, as do registered associations. 

SROs are subject to an authorization regime based on eligibility criteria that address issues of 

integrity, financial viability, capacity, governance, and fair access—although the regimes are 

different for exchanges in the securities and futures markets. The CFTC has insufficient 

authority regarding exchanges following the coming into force of the CFMA. The CFTC has 

limited ability to intervene in the introductions of a new product or changes in rules, such as 

those governing trading. There is also no opportunity for stakeholders whose interests may be 

negatively affected to have their views taken into account in advance of a new product listing 

or rule change. These deficiencies have been recognized and are now being addressed via 

recommendations for legislative change set out in the Joint Report. Unlike securities 

exchanges, some demutualized futures exchanges have retained full member regulation 

powers. Some in the industry are concerned this may be used to restrain member dissent in 

the pursuit of shareholder interests. The CFTC publicly examined this issue from 2003 

through 2009, which resulted in the adoption of acceptable practices for exchanges to follow 

in addressing conflicts of interest. 
13 

25. Principles relating to enforcement of securities regulation (Principles 8–10): The 

anti-fraud provisions under the U.S. federal securities laws, as enforced by the SEC via Rule 

10b–53 and supported by the courts, have proved to be a very effective tool for prosecuting 

offences under the securities laws. Private litigation is also an unusually powerful tool for 

securing compliance and obtaining redress in case of breach. The CFTC and SEC have broad 

investigative and surveillance powers over regulated entities, exchanges, and regulated 

trading systems. They can conduct on-site inspections without prior notice and can obtain 

information of all types without the need for a court order. The CFTC and SEC have broad 

enforcement powers, including the power to seek injunctions, bring an application for civil 

proceedings, and compel information and testimony from third parties. They also can impose 

administrative sanctions and refer matters to criminal authorities. The CFTC and SEC have 

implemented a system of supervision of markets and market participants including 

conducting on-site examinations. Significant shortcomings were identified in the SEC 

enforcement program. However, the SEC’s extensive and wide-ranging program to 

implement the IG’s recommendations and other changes is beginning to generate 

improvements and such efforts should be brought to a conclusion as a matter of high priority. 

Resources dedicated to the examination of SEC-registered IAs (a program currently 

conducted solely by the SEC) are insufficient, thus reducing the effectiveness of the program. 

Therefore, resources should be increased to at least enable the SEC to match the frequency 

and scope of the periodic examination of BDs where the responsibility is shared between the 

SEC and FINRA. Resources for criminal prosecution of securities fraud are too limited. 

26. Principles for cooperation in regulation (Principles 11–13): The CFTC and SEC 

have broad authority to share information with both domestic and foreign regulators, even 

without having memoranda of understanding (MOUs) in place. Both agencies are signatories 

of the IOSCO MOU and also have many bilateral MOUs in place with other regulators. The 

CFTC and SEC have the authority to assist foreign regulators in obtaining information that is 

not in their files, using the powers that are available for their own investigative activities. 

27. Principles for issuers (Principles 14–16): Companies that issue securities in the 

public market must provide extensive financial and other disclosure on initial offerings and 

most are subject to detailed continuing disclosure obligations in line with IOSCO standards. 

Liability provisions are in place to ensure that issuers are held responsible for all disclosure 

provided. This responsibility is enforced by the SEC, the exchanges and by civil suits by 

investors. However, there is limited authority over municipal government issuers. Holders of 

voting securities of a public issuer are generally treated fairly. 

 

3

 Rule 10b–5 under the Exchange Act 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. 
14 

28. Principles for collective investment schemes (Principles 17–20): Operators and 

marketers of CIS offered to the public are subject to registration requirements. Initial 

eligibility criteria for CIS and their operators should be more extensive, and should be 

demonstrated prior to registration. The initial and ongoing disclosure requirements for CIS 

are extensive, however, the update requirements under the CEA are not timely. Assets of CIS 

are valued in accordance with U.S. generally acceptable accounting principles (GAAP) and 

verified by an independent auditor at least annually. The custodian of CIS assets is not 

required to be an arm’s length party. 

29. Principles for market intermediaries (Principles 21–24): There are minimum entry 

standards for all market intermediaries that include criteria relating to integrity. Capital and 

internal control requirements apply to FCMs, IBs that are not fully guaranteed by an FCM, 

and BDs; these are assessed prior to licensing by the SROs. Advisers are not subject to 

capital requirements or to operational capacity assessments prior to licensing. The applicable 

capital requirements vary by the chief risks undertaken by the FCMs, IBs, and BDs (largely 

market and credit risk). The ability of the prudential requirements (capital formulae and risk 

management requirements) to address the full range of risks (funding, liquidity, reputational, 

and affiliate risks) appears to need improvement. The regulators should strive to ensure that 

both capital and risk management requirements adequately address risks under stress. The 

crisis brought to light weaknesses in the framework governing investment bank holding 

companies, but the conversion of the remaining entities into bank holding companies has 

eliminated the practical need for the securities regulators to address these problems 

immediately. There are procedures in place at both agencies to address failures of 

intermediaries, and these have been tested in practice. 

30. Principles for the secondary market (Principles 25–30): Securities and futures 

exchanges are subject to authorization and oversight. ATSs are authorized and regulated as 

BDs. Under the CEA, there are categories of futures trading systems which are exempt from 

authorization (exempt commercial markets or ECMs), although recent legislative 

amendments have enabled the CFTC to strengthen oversight of operational ECMs where 

appropriate. The SEC should join the CFTC in considering the introduction of explicit and 

comprehensive financial resources requirements for exchanges. In the securities markets, post 

trade transparency (details of completed transactions) is comprehensive as is publicly 

displayed liquidity or pre-trade transparency (best bids and offers). However, 

25 percent of liquidity is not publicly displayed (i.e., dark pool ATSs and broker dealer 

internalization of trading on behalf of clients). The SEC’s concern that a two-tier market may 

be emerging—that provides valuable order information on the best prices for NMS stocks 

only to selected market participants—is justified. Its current broad review of and public 

consultation on equity market structure is therefore timely. It should accurately establish the 

needs of investors of all classes. It also needs to reach actionable conclusions promptly. 

Analysing these issues and those related to advanced trading technologies requires the SEC 

to be better informed. Any proposed rule changes should be supported by independent factual 

evidence. Market surveillance by the securities and futures exchanges and FINRA is 

effective and has kept pace with technological developments in markets. A comprehensive 

surveillance system for securities trading to be used by the exchanges, ATS, and the SEC 
15 

(such as exists in the futures markets) would be beneficial for the detection of market abuse 

and also for identifying indicators of developing stress points. The CFTC and the futures 

exchanges have been able to construct such a system despite the CFTC’s serious budget 

constraints. Market manipulation is generally well policed in both markets. For insider 

trading, the legislation should be more comprehensive in futures markets. The approach to 

insider trading for securities and futures should be different given the differences in the 

nature of the markets. Implementing the recommendations in the Joint Report for expanding 

the insider trading provisions of the CEA will be an important step. Whether additional 

expansion of coverage is warranted, should be studied. While the IOSCO Principles do not 

require all markets in financial products to be transparent, the opacity of the OTC derivatives 

market contrasts with the relative transparency of OTC securities markets for equities and 

bonds. 
16 

Table 1. Summary Implementation of the IOSCO Principles—Detailed 

Assessments

Principle Grading Findings 

Principle 1. The responsibilities of the regulator 

should be clearly and objectively stated. 

PI The responsibilities of the CFTC and SEC are 

clearly stated in the laws. However, there are 

gaps in coverage of products and services in 

the market, differences in treatment of similar 

products, and gaps in the scope of each 

agency’s authority. They should be reduced 

as much and as soon as possible. 

Principle 2. The regulator should be 

operationally independent and accountable in the 

exercise of its functions and powers. 

BI The CFTC and SEC are operationally 

independent. There is a strong system of 

accountability to Congress. The funding 

method for the authorities does not provide 

funding sufficient to meet their regulatory and 

operational needs on a long-term basis. 

Principle 3. The regulator should have adequate 

powers, proper resources, and the capacity to 

perform its functions and exercise its powers. 

PI Both authorities have extensive powers over 

their areas of responsibility, but there are 

gaps. The CFTC and SEC need additional 

resources in order supervise the very large 

and complex U.S. securities and futures 

markets. For example, neither agency has the 

resources to make full use of electronic 

systems to oversee the market or upgrade 

their market surveillance systems. 

Principle 4. The regulator should adopt clear and 

consistent regulatory processes. 

FI The CFTC and SEC are subject to a high 

degree of transparency including public 

consultation regarding their regulations. They 

are active on investor education. 

Principle 5. The staff of the regulator should 

observe the highest professional standards. 

FI The CFTC and SEC have developed codes of 

ethics. These include investment limitations 

on staff and, in the case of the SEC, reporting 

obligations. There are mechanisms to monitor 

compliance. 

Principle 6 The regulatory regime should make 

appropriate use of SROs that exercise some 

direct oversight responsibility for their 

respective areas of competence and to the extent 

appropriate to the size and complexity of the 

markets. 

FI The effectiveness of the regulatory regime is 

to a large degree dependent on the skills and 

resources of the SROs. They play a very 

significant role in the supervision of markets 

and their participants. Exchanges and clearing 

agencies perform important self-regulatory 

functions as do registered associations. 

Principle 7. SROs should be subject to the 

oversight of the regulator and should observe 

standards of fairness and confidentiality when 

exercising powers and delegated responsibilities. 

BI SROs are subject to an authorization regime 

based on eligibility criteria that address issues 

of integrity, financial viability, capacity, 

governance, and fair access—although the 
17 

Principle Grading Findings 

regimes are different for exchanges in the 

securities and futures markets. Following the 

coming into force of the CFMA, the CFTC 

has had insufficient authority over exchanges. 

This deficiency is now being addressed via 

recommendations for legislative change set 

out in the Joint Report. However, corrective 

measures should balance prior product or rule 

approval with the exchanges’ ability to 

quickly bring innovative products and rules to 

the marketplace. 

Unlike demutualized securities exchanges, the 

dominant futures exchange group (also 

demutualized) has retained member 

regulation responsibility. The CFTC should 

remain aware of industry concerns that this 

power may be used to restrain member 

dissent in the pursuit of shareholder interests. 

Principle 8. The regulator should have 

comprehensive inspection, investigation, and 

surveillance powers. 

FI The CFTC and SEC have broad investigative 

and surveillance powers over regulated 

entities, exchanges, and regulated trading 

systems. They can conduct on-site inspections 

without prior notice. They can obtain books 

and records and request data or information 

without a court order. 

Principle 9. The regulator should have 

comprehensive enforcement powers. 

FI The CFTC and SEC have broad enforcement 

powers. These include the power to seek 

injunctions, bring an application for civil 

proceedings, and compel information, 

documents, records, and testimony from third 

parties in the course of their investigations. 

They can impose administrative sanctions and 

refer matters to criminal authorities. 

Principle 10. The regulatory system should 

ensure an effective and credible use of 

inspection, investigation, surveillance, and 

enforcement powers and implementation of an 

effective compliance program. 

PI Significant shortcomings were identified in 

the SEC enforcement program. However the 

current extensive and wide-ranging program 

of change—including measures to implement 

the recommendations made in the report by 

the SEC’s Office of Inspector General 

(OIG)—is beginning to generate 

improvements. Important elements, such as 

the restructuring of complaints handling 

processes remain “work in progress.” The 

CFTC and SEC have implemented a system 

of supervision of markets and market 

participants including conducting on-site 

inspections/examinations. However, 

resources for the examination of registered 
18 

Principle Grading Findings 

IAs by the SEC are insufficient, thus reducing 

the effectiveness of these efforts. Resources 

for criminal prosecution of securities fraud 

are too limited. 

Principle 11. The regulator should have the 

authority to share both public and non-public 

information with domestic and foreign 

counterparts. 

FI The CFTC and SEC have broad authority to 

share information with both domestic and 

foreign regulators. They can do so without 

having MOUs in place. Both agencies have 

shared information extensively with 

international counterparties. 

Principle 12. 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. 

FI The CFTC and SEC are signatories of the 

IOSCO MMOU. They also have bilateral 

MOUs with other regulators. 

Principle 13. 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 CFTC and SEC have authority to assist 

foreign regulators in obtaining information 

that is not in their files. 

Principle 14. There should be full, timely, and 

accurate disclosure of financial results and other 

information that is material to investors' 

decisions. 

BI There is extensive initial and ongoing 

disclosure for most public issuers. However, 

there is limited direct authority over 

municipal government. On-going disclosure 

requirements do not apply to all public 

issuers. 

Principle 15. Holders of securities in a company 

should be treated in a fair and equitable manner. 

FI Holders of voting securities of a public issuer 

generally are treated fairly. 

Principle 16. Accounting and auditing standards 

should be of a high and internationally 

acceptable quality. 

FI U.S. GAAP is widely recognized as an 

acceptable accounting standard for use by 

public issuers and the generally accepted 

auditing standards (GAAS) of the U.S. Public 

Company Accounting Oversight Board 

(PCAOB) also are widely accepted globally. 

Principle 17. The regulatory system should set 

standards for the eligibility and the regulation of 

those who wish to market or operate a collective 

investment scheme. 

PI Operators and marketers of CIS are subject to 

registration requirements. Eligibility criteria 

are not comprehensive. In addition, at present 

the resources and internal controls of a CIS 

would be subject to an examination by the 

regulator only sometime after the fund began 

operation, but are not preconditions to the 

original approval. Resources at the SEC, 

CFTC, and NFA do not allow routine 

examination of the operators to take place 

with sufficient frequency. 
19 

Principle Grading Findings 

Principle 18. 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 There are requirements governing the legal 

form of CIS and addressing protection of 

client assets. Notice of changes that affect 

investor rights should be given prior to the 

effective date of the change, whether or not 

investor approval is required. The material 

change requirements set out in CEA are not 

timely. The custodian of a CIS’s assets is not 

required to be an arm’s length party. 

Principle 19. Regulation should require 

disclosure, as set out 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. 

FI The disclosure required for public commodity 

pools and securities CIS is extensive and is 

updated throughout the period when the CIS 

is offering its securities to the public. 

However, the CEA requirements regarding 

updating the Disclosure Documents are not 

timely. The information disclosed is sufficient 

for investors to assess suitability and the 

value of their investments in the CIS. 

Principle 20. Regulation should ensure that there 

is a proper and disclosed basis for assets 

valuation and the pricing and the redemption of 

units in a collective investment scheme. 

FI Assets of CIS are valued in accordance with 

U.S. GAAP and verified by an independent 

auditor at least annually. The prices of the 

instruments are made available to the 

investors periodically. No guidance is 

provided on how pricing errors in commodity 

pools should be addressed. 

Principle 21. Regulation should provide for 

minimum entry standards for market 

intermediaries. 

BI There are minimum entry standards for 

market intermediaries but only some types of 

intermediaries are subject to standards 

relating to financial capacity or assessed with 

respect to their internal controls, risk 

management, and supervisory systems in 

place before licensing. 

Principle 22. There should be initial and ongoing 

capital and other prudential requirements for 

market intermediaries that reflect the risks that 

the intermediaries undertake. 

PI Capital requirements apply to FCMs, nonguaranteed IBs, and BDs that vary by certain 

of the risks undertaken by the firm. The 

capital formulae and other prudential 

requirements do not address fully the 

complete range of risks to which a firm may 

be exposed. The regulators should strive to 

ensure that both capital and risk management 

requirements adequately address risks posed 

when firms are under stress. 

Principle 23. Market intermediaries should be 

required to comply with standards for internal 

organization and operational conduct that aim to 

protect the interests of clients, ensure proper 

BI There are standards of conduct and internal 

control requirements for the protection of 

clients of intermediaries. Management must 

supervise the business of the intermediary 
20 

Principle Grading Findings 

management of risk, and under which 

management of the intermediary accepts primary 

responsibility for these matters. 

appropriately. The risk management 

expectations for BDs and FCMs should be 

reexamined, particularly with regard to 

management of liquidity, funding and 

reputational risks under stress. 

Principle 24. 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 There are procedures in place at both the 

CFTC and SEC to address failures and these 

have been put to the test. 

Principle 25. The establishment of trading 

systems including securities exchanges should 

be subject to regulatory authorization and 

oversight. 

BI Securities and futures exchanges and trading 

system operators are subject to authorization 

and oversight. However, under the CEA, 

there are categories of trading systems, 

ECMs, and EBOTs, which are exempt from 

authorization. Exempt markets are not 

registered with, or designated, recognized, 

licensed, or approved by the CFTC. 

Under the Exchange Act, operators of 

securities market trading systems can elect to 

be regulated as exchanges or as ATSs (which 

must, among other things, register as BDs). 

The authorization of so called “dark pool” 

ATSs under Regulation ATS whereby they 

are not required to publicly display their bestpriced orders in NMS stocks, does not 

provide for adequate pre-trade transparency 

of trading interests. Thus, the consultation 

currently being conducted by the SEC on 

equity market structure, including issues 

related to “dark pools,” is timely. 

See also Principle 27.

Principle 26. 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. 

FI The ongoing supervision of ECMs was an 

excessively light-touch regime, although the 

CFTC has recently sought and obtained 

regulatory change which has enabled it to 

strengthen oversight where appropriate. 

As to futures exchanges, CFTC staff is 

working with Congress to get explicit 

statutory authority to impose financial 

resource requirements on designated contract 

markets (DCMs). 

The SEC’s focus on two elements of an 

exchange’s financial resources risk, namely 

information technology (IT) and the selfregulatory functions, while necessary risks 

missing evaluating other exposures such as 

affiliate risk. A more holistic approach to 
21 

Principle Grading Findings 

capital adequacy would be preferable. 

Principle 27. Regulation should promote 

transparency of trading. 

FI The CEA and CFTC regulations have not 

been updated to reflect modern concepts of 

transparency. However, the practice in futures 

markets, consistent with the Principle, is real 

time publication. 

In the securities markets, post trade 

transparency (details of completed 

transactions) is comprehensive as is publicly 

displayed liquidity or pre-trade transparency 

(best bids and offers). However, 25 percent of 

liquidity is not publicly displayed (i.e., dark 

pool ATSs and broker dealer internalization 

of trading on behalf of clients). The Principle 

has been assessed as fully implemented but 

the judgment was finely balanced. 

The SEC’s concern that a two-tier market 

may be emerging (that provides valuable 

order information on the best prices for NMS 

stocks only to selected market participants) is 

justified. Its current public consultation on 

these issues is therefore timely. Analyzing 

these issues and those related to advanced 

trading technologies requires the SEC to be 

better informed. Any proposed rule changes 

should be supported by independent factual 

evidence. 

 See also Principle 25. 

Principle 28. Regulation should be designed to 

detect and deter manipulation and other unfair 

trading practices. 

BI Insider dealing law is too narrowly focused in 

the derivatives markets. If accepted, the 

recommendations in the Joint Report will be 

an important advance. Additional study is 

recommended to consider whether further 

restrictions would be appropriate. Market 

surveillance is carried out to a high standard 

by the exchanges and FINRA, and is 

particularly comprehensive in the futures 

markets. The SEC and CFTC are constrained 

by technology limitations. 

Principle 29. Regulation should aim to ensure 

the proper management of large exposures, 

default risk and market disruption. 

FI The timely and comprehensive information 

flows available in futures markets provide for 

effective early warnings. In securities 

markets, tracking large exposures and other 

potential sources of market disruption is more 

difficult and should be improved. 
22 

Principle Grading Findings 

Principle 30. Systems for clearing and settlement 

of securities transactions should be subject to 

regulatory oversight and designed to ensure that 

they are fair, effective, and efficient and that 

they reduce systemic risk. 

N/A A separate CPSS-IOSCO assessment was 

conducted for the securities markets. 

Arrangements in the futures markets were not 

assessed. 

Aggregate: 

Fully implemented (FI) – 16, Broadly implemented (BI) –8, Partly implemented (PI) – 5, Not implemented 

(NI) – 0, Not applicable (N/A) – 1 

Recommended action plan and authorities’ response 

Recommended action plan 

Table 2. Recommended Action Plan to Improve Implementation of the IOSCO 

Principles 

Principle Recommended Action 

Principles relating to the regulator 

(Principles 1–5) 

Decisions should be taken promptly on the recommendations of the 

Joint Report to enhance investor protection and improve cooperation 

between the CFTC and SEC. Legislative and regulatory gaps 

identified in the Joint Report should be closed. 

Funding of both authorities needs to be increased and the method of 

funding should be reviewed. The annual appropriations process seems 

inadequate to meet the needs for funding necessary long term projects.

Annual funding makes it difficult to commit to major investments in 

software development which takes place over several years. 

Consideration should be given to moving to direct self-funding (i.e., 

ability to capture fee income for own funding rather than remitting it 

to general government revenue and relying on a government budget). 

The total fee income at the SEC presently generated from its activities 

far exceeds the combined budgets of the SEC and the CFTC. 

Taking into account the size and complexity of the markets and the 

number of registrants they oversee, both agencies need more 

resources—human, informational and technological—to fulfill their 

regulatory functions efficiently and effectively. 

Principles relating to self-regulation 

(Principles 6–7)

As recommended in the Joint Report, the CEA should be amended to 

provide the CFTC with greater powers over product and rules 

approval of the futures exchanges and to provide greater scope for 

public consultation prior to their introduction. Corrective measures 

should recognize the need to balance prior product or rule approval 

with the exchanges’ ability to benefit from their innovative endeavors 

in a competitive market. 

The CFTC should remain aware of industry concerns regarding the 

retention of member regulation by demutualized DCMs. 
23 

Principle Recommended Action 

The SEC should consider delegating sole registration authority for 

BDs to FINRA. 

Principles relating to enforcement of 

securities regulation (Principles 8–10)

Although many improvements have been made or are under way 

within the SEC, the current program in the Enforcement Division and 

Office of Compliance, Inspections and Examinations (OCIE) to 

implement the 21 recommendations set out in the 2009 report of the 

OIG and other improvements should be completed as a matter of high 

priority. The SEC also may want to consider adding enforcement staff 

with more accounting and economics backgrounds. Mixed teams with 

different skill sets and experience in the Enforcement Division could 

enhance its performance. 

The number of staff dedicated to the periodic examination of 

registered IAs (whether at the SEC alone, or in combination with 

FINRA and/or state regulators) should be increased at least to a level 

where the percentage of IAs examined annually matches 

the percentage of BDs examined by the SEC and FINRA. 

The enforcement division of the CFTC would benefit from more 

resources. Given the current limited scope of its remit and the 

integrated market surveillance systems it operates in close cooperation 

with the DCMs this is not a pressing problem though it will become 

one if its remit is expanded (e.g., to include OTC derivatives). 

The securities unit of the fraud section in the criminal division of the 

DOJ should be given additional resources to prosecute securities fraud.

Principles for issuers (Principles 14–16) Continuous disclosure requirements should apply to all public issuers. 

The SEC should have the power to mandate both initial disclosure 

requirements and on-going obligations directly on municipal 

government issuers. 

Principles for collective investment 

schemes (Principles 17–20)

The eligibility criteria for CIS and their operators should include the 

human and technical resources to carry out the required functions, the 

appropriate financial capacity and adequate internal management and 

controls. These should be assessed before a CIS or its operator is 

permitted to begin operations. 

The resources at the relevant regulators (statutory or SRO) for routine 

examinations of operators and CIS should be increased. 

CPOs should be required to have policies in place to avoid or mitigate 

conflicts. 

Notice of changes that affects investor or participant rights should be 

given prior to the effective date of that change, whether or not prior 

approval is required. Prompt changes to commodity pool disclosure 

documents should be required when material changes occur. 

Consideration should be given to requiring the custodian of a CIS’s 

assets to be an arm’s length party. Requiring an auditor of a CIS to 

have relevant prior experience might also be considered. 

The CFTC should provide guidance to the industry on how to address 

pricing errors in the valuation of commodity pools. 
24 

Principle Recommended Action 

Principles for market intermediaries 

(Principles 21–24) 

The threshold for review of the fitness of control persons of an 

intermediary should be the same under the CEA and Exchange Act; 

the lower 10 percent threshold should be adopted. 

There should be an assessment of the back-office capabilities, internal 

controls and policies and procedures of all futures intermediaries and 

IAs prior to the grant of registration. 

FINRA should have clear authority to examine and address all 

securities-related activities of members, including their registered IA 

activities. 

Consideration should be given to requiring that custodian be at arm’s 

length to the IA. 

The proposed changes to the futures capital rules to address gaps 

relating to cleared OTC derivatives and improve the sensitivity of the 

formula to the actual risks undertaken by the firm should be 

implemented promptly. 

The capital rules and other prudential requirements, such as risk 

management standards, should be reexamined to ensure all risks, 

including funding, reputational, liquidity and affiliate risks are 

addressed fully. The regulators should strive to ensure that both capital 

and risk management requirements adequately address risks posed 

when firms are under stress. Consideration should be given to 

reviewing the rules governing BD custody of client assets. 

The CFTC should have authority to review and approve/disapprove 

margin requirements set by the DCMs. 

Principles for the secondary market 

(Principles 25–30)

In addition to pursuing legislative change to secure the enhanced 

powers as set out in the Joint Report the CFTC should consider 

seeking an authorization power over entities seeking to set up ECMs 

and Exempt Boards of Trade (EBOTs). However ongoing legislative 

initiatives are considering the abolition of the ECM and EBOT market 

categories. 

The SEC’s current broad review of equity market structure to 

determine whether the rules have kept pace with changes in trading 

technology and practices should be prioritized with a view to 

encouraging the broadest public debate while reaching actionable 

conclusions promptly. It will be essential that the review be conducted 

on the basis of comprehensive and independent evidence in order to 

establish accurately the needs of investors of all classes. 

The recommendations in the Joint Report regarding insider dealing 

and Chinese Walls in derivatives markets should be implemented. The 

CFTC should undertake a study to consider whether expansion of the 

insider trading prohibition in the futures markets beyond the 

recommendation in the Joint Report is warranted given the current 

state of the markets, contracts and investors. Such a study would 

complement the current debate in Europe as to the appropriate 

coverage of insider trading laws in derivatives markets. The SEC 

should review the extent to which the absence of additional offences 

of insider trading is a limiting factor in the SEC’s enforcement effort 
25 

Principle Recommended Action 

in this area. 

Current discussions among the securities exchanges and FINRA on 

creating a consolidated surveillance structure to oversee the 

consolidated market should be given greater priority with a view to 

reaching a positive conclusion in a timely manner. 

Consideration should be given to amending the regulations to provide 

the SEC and the securities exchanges with accurate and timely 

information on large holders of and traders in securities as the CFTC 

and the futures exchanges have in their markets. This would support 

surveillance and identify emerging market stress points in a timely 

fashion. 

The SEC should join the CFTC in considering the introduction of an 

explicit and comprehensive financial resource requirement for 

exchanges. 

Authorities’ response to the assessment 

31. The U.S. authorities appreciate the effort, time, and resources committed by the IMF 

to prepare the FSAP. The FSAP is intended to promote the soundness of financial systems in 

member countries and to contribute to improving supervisory practices around the world. 

The U.S. assessment has presented a challenging and complex task. In light of the financial 

crisis as well as the maturity, complexity and significance of the U.S. financial system, we 

understand that the U.S. regulatory system was subject to a more stringent standard than in 

previous IMF assessments. Nevertheless, it is essential that regulators hear from third parties 

to gauge their effectiveness. We are grateful for the opportunity to provide the following 

comments regarding the IMF’s Report, although as discussed below we take exception to a 

number of the findings. 

32. As recognized in this Report, the U.S. FSAP is occurring at a critical and 

extraordinary time. According to the G20 leaders in April 2009, major failures in the 

financial system, including in regulation and supervision, were fundamental causes of the 

crisis. The last 18 months have taught regulators around the world much about the new 

realities of our financial markets. We have learned the limits of foresight and the need for 

candor about the risks we face. We were reminded that transparency and accountability are 

essential. Only through strong, intelligent regulation—coupled with aggressive enforcement 

mechanisms—can we fully protect the American public and keep our economy strong. Given 

the global nature of markets, we recognize that U.S. leadership remains critical to the 

stability of markets worldwide. 

33. The financial crisis left regulators with enormous challenges and a heightened interest 

in strengthening regulation. Perhaps most importantly, as the Report recommends, 

comprehensive regulatory reform of the OTC derivatives marketplace is essential. The 

financial crisis highlighted how opaque markets can threaten the financial system and the 
26 

broader public. The U.S. authorities agree with the Report’s strong recommendation for 

increased resources for the CFTC and the SEC should the U.S. Congress expand the 

agencies’ missions to include the regulation of OTC derivatives. The CFTC and SEC 

additionally need greater resources to keep up with the growth of securities and futures 

markets in the United States. The U.S. authorities also agree with the assessment that the 

CFTC and SEC should enhance cooperation and coordination and already have taken steps to 

do so. 

34. While change is needed, the U.S. regulatory system nevertheless helped ensure that 

the world’s largest and most complex exchange-listed equity, commodity futures, and 

options markets continued to function properly and withstood the ultimate stress test during 

the financial crisis. The system has served as a model for regulatory authorities worldwide. 

Moreover, some of the proposed reforms to address risk in OTC derivatives—for example, 

requiring standardized products to trade on regulated trading platforms and to be cleared by 

central counterparties—reflect long-standing elements in the U.S. approach to regulating 

financial markets. 

35. In addition to supporting reform, U.S. regulators have taken action under existing 

authority to remedy problems and to make improvements. For example, in the area of 

disclosure, the SEC proposed new rules that would improve the quality and timeliness of 

disclosure in municipal markets. In the area of investment management, the SEC sought to 

provide greater protections to investors by adopting new custody control rules that include 

surprise inspections to verify assets held by money managers. Finally, in the past year, the 

SEC launched a robust and vigorous review of equity market structure, including issues such 

as dark pools. The CFTC is continuing to improve and extend its world-class system of risk 

surveillance by requiring large trader reporting in the cleared OTC markets. This effort will 

allow the CFTC to conduct financial surveillance in this area consistent with its existing risk 

program for on-exchange trading. 

36. The overall ratings in the Report, however, do not reflect the CFTC’s and SEC’s 

regulatory successes and, in some cases, suggest a misunderstanding of the U.S. regulatory 

system. Thus, the Commissions strongly disagree with many of the ratings in the Report. By 

way of example, while the IOSCO Principles recognize that regulators may use different 

approaches to accomplish the same objectives, the Report’s rating on market intermediaries 

is based on the assumption that every intermediary must be regulated the same way. That is, 

they must undergo an extensive review prior to registration. This requirement, however, 

cannot be found in the Principles or the assessment Methodology. The Report rejects a 

legitimate risk-based approach to a registration requirement and oversight of futures and 

securities intermediaries without evidence that the approach is ineffective. The Report also 

states that capital requirements for futures and securities firms do not fully address risk, yet 

provides no evidence that the CFTC’s and SEC’s current requirements do not already exceed 

recognized international best practice as reflected in the Principles. 
27 

37. In particular, the Report suggests that only systems that call for review of the “fitness 

and properness” of CIS operators are acceptable. The Report finds that the regulatory 

framework in the United States does not address the adequacy of the CIS operators’ human 

and technical resources, financial capacity and internal management and controls. However, 

this finding does not take into account key and unique features of the U.S. system. The U.S. 

system mandates disclosure by CIS operators and also relies on oversight by a separate 

entity, a CIS board, which generally consists of a majority of independent directors. The CIS 

board serves as an initial check on the fitness, resources, and internal controls of the CIS 

operator. Moreover, both the CIS operators and CIS boards are subject to fiduciary duties, 

which are enforced by the SEC and by private litigants. This system offers an ongoing review 

of the fitness, resources, and internal controls of a CIS operator instead of a one-time “fit and 

proper” check. The Report disregards these important features of U.S. market regulation, and 

the effects they have on how regulated entities operate. 

38. As a related matter, the IOSCO Principles make clear that they apply to futures 

markets “where the context permits.” For instance, the Principles relating to CIS were written 

for publicly offered funds, such as mutual funds. The CIS Principles were not intended to 

cover privately-offered funds, such as the vast majority of CFTC-regulated commodity pools. 

The pools that are publicly offered represent a small percentage of total pools regulated by 

the CFTC. The ratings in this area are misplaced given the de minimis number of publicly 

offered funds. 

39. In addition, some of the Report’s adverse conclusions about the U.S. regulatory 

system are not based on objective criteria. For example, the Report finds that per Principle 10 

the U.S. system fails to “ensure an effective and credible use of inspection, investigation, 

surveillance and enforcement powers.” This conclusion appears to be based solely on an SEC 

Office of Inspector General (OIG) Report issued in August 2009 that reviewed the failings of 

a specific high-profile investigation, and then extrapolates those failings to all SEC 

enforcement activities. In so doing, the Report overlooks the SEC’s overall success in the 

area of enforcement. In fiscal year 2009, SEC enforcement actions yielded: (1) orders that 

required wrongdoers to disgorge ill-gotten gains in the amount of approximately 

US$2.09 billion; (2) orders that imposed money penalties on wrongdoers in the amount of 

approximately US$345 million, a 35 percent increase over the previous fiscal year; and 

(3) the filing of 664 cases against 1,787 persons. SEC enforcement actions also have resulted 

in the return of billions of dollars to injured investors since the agency received “Fair Fund” 

authority in 2002. During fiscal year 2009 alone, the SEC distributed approximately 

US$2.1 billion to harmed investors from both disgorgement funds and Fair Funds. 

40. These performance measures are a testament to the credibility and effectiveness of the 

SEC enforcement program in relation to the U.S. securities markets—a level of enforcement 

activity and investigative aggressiveness that far exceeds that of any other securities regulator 

in the world. These facts are inconsistent with a conclusion that the SEC enforcement 

program broadly fails to satisfy Principle 10. Granted, the metrics set forth above may not be 

the only objective measures by which to judge the effectiveness of the SEC’s enforcement 

program. But, the Report fails to articulate any objective metrics on which to base the rating. 
28 

41. To be sure, the OIG Report highlights a major failure. The SEC, however, has taken 

action in response. In the past year, the SEC, among other things, restructured the 

Enforcement Division and streamlined its procedures. The SEC also took steps to improve its 

inspection program and place greater reliance on risk assessment. The SEC is actively 

working to improve its technology and modernize the way it handles the massive number of 

tips and complaints it receives each year. The Report’s rating fails to give full credit for these 

improvements. In short, the effectiveness of an enforcement program should not be measured 

by zero tolerance for failure. There are many effective criminal justice systems around the 

world that are held in high esteem, not because of an absence of crime or a perfect record, but 

because, among other things, they apply considerable resources and visible effort to prevent, 

investigate, and prosecute crime. 

42. In conclusion, the SEC and CFTC recognize a number of the areas that the IMF 

identified for improvement. Much is already underway to address these concerns. However, 

these types of suggestions in the Report are the exception rather than the rule. 

43. Further, the SEC believes that the Report’s conclusions are seemingly at odds with 

those of investors from around the world, both large and small. Capital markets essentially 

function to allocate capital. In making decisions about capital allocation and the premiums 

charged for such investments, investors make judgments about the quality of the regulator, 

the breadth and depth of disclosure, the efficacy of the enforcement regime and the fairness 

of the marketplace, among other things. Judging by the degree of global investment in the 

U.S. market and taking into account the cost of capital in the United States, it would appear 

that those whose money is at stake view the U.S. regulatory system in a different, more 

positive light—even in light of recent regulatory failings. 

44. In sum, the U.S. authorities firmly believe that the overall ratings are not reflective of 

the U.S. system for the regulated marketplace. Nonetheless, the U.S authorities will continue 

to evaluate and, as appropriate, enhance their regulatory programs. The CFTC and SEC look 

forward to a continuing dialogue with the IMF to advance our shared goal of strengthening 

financial regulation and enhancing supervision of the global financial services sector. 
29 

II. DETAILED ASSESSMENT

Table 3. Detailed Assessment of Implementation of the IOSCO Principles 

Principles Relating to the Regulator 

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

Description Since the 1930s, securities and futures have been subject to separate federal regulatory regimes in 

the United States; the U.S. CFTC has exclusive jurisdiction over futures and commodity option 

transactions, whereas the U.S. SEC has oversight of the securities market. Both authorities make 

use of SROs for supervision of trading systems (including exchanges) and intermediaries. 

There also is regulation at the state level for securities, primarily with a consumer protection focus. 

CFTC 

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

responsibilities, powers, and authority assigned by law to the CFTC are clearly defined and 

transparently set out in the CEA and CFTC regulations. It is the mission of the CFTC to protect the 

public interest by providing a means for managing and assuming price risks, discovering prices, 

and/or disseminating pricing information through trading in liquid, fair, and financially secure 

trading facilities for commodities. In order to foster the public interest, the CFTC endeavours to 

detect and prevent price manipulation or any other disruptions to market integrity; to protect all 

commodity market participants from fraudulent or abusive sales practices and misuses of customer 

assets; and to promote responsible innovation. The CFTC, which has about 500 staff members, is 

divided into three divisions and across several offices. The CFTC ́s headquarters is in Washington, 

D.C., with three regional offices in Chicago, Kansas City, and New York. 

The CFTC can interpret how to apply the authority granted to it by the CEA and is engaged in 

rulemaking. The criteria for interpreting the CFTC’s authority are clear and transparent. The CFTC 

largely interprets the CEA based on the plain meaning of the statute and available legislative 

history as it relates to relevant markets and market participants. CFTC staff may also provide 

guidance to market participants and practitioners on a variety of legal and regulatory matters. 

Although not legally binding on the CFTC, these staff interpretations provide useful direction to 

market participants on the CEA and related issues. 

Domestically, the CFTC participates in a variety of committees, working groups, and 

intergovernmental partnerships with other regulators, governmental agencies, and federal law 

enforcement entities on matters of common interest. The CFTC is, for example, a member in the 

President’s Working Group (PWG)—a key forum for the coordination of regulation across 

financial markets with participants from the Secretary of the Treasury, Federal Reserve, SEC, 

National Economic Council, Council of Economic Advisors, Office of the Comptroller of the 

Currency, Federal Deposit Insurance Corporation, and Federal Reserve Bank of New York. The 

CFTC has established several MOUs with national authorities (see Principle 12). 

SEC 

The responsibilities, powers, and authority assigned by law to the SEC are clearly defined and 

transparently set out in several federal securities statutes (Securities Act; Exchange Act; Trust 

Indenture Act of 1939; ICA, Advisers Act, and SOX), and in the rules and regulations that the SEC 

has adopted under these statutes. Generally, these statutes are broadly drafted, establishing basic 

principles and objectives. To ensure that the intent of Congress is carried out in specific 

circumstances and to address technological, market, product, and service developments, the SEC 

engages in rulemaking. The mission of the SEC is to protect investors; maintain fair, orderly and 
30 

efficient markets; and facilitate capital formation. The agency’s functional responsibilities are 

organized into four divisions and 19 offices, each of which is headquartered in Washington, DC. 

The SEC’s approximately 3,500 staff is located in Washington, DC and across 11 regional offices 

located in New York, Boston, Philadelphia, Atlanta, Chicago, Miami, Fort Worth, Denver, Salt 

Lake City, Los Angeles, and San Francisco. 

The SEC participates in a variety of committees, working groups, intergovernmental partnerships 

with other regulators, governmental agencies, and federal law enforcement entities on matters of 

common interest. The SEC is also a member, for example, in the PWG, as described above. The 

SEC has entered into several MOUs with national authorities (see also Principle 12). 

Multi-authority issues 

There are many aspect of securities market regulation for which more than one regulator has 

responsibility. 

In some cases, the responsibilities are clearly defined and there do not appear to be cooperation 

deficits, for example in the division of responsibility between federal and state regulation of 

securities activities. In particular, investment advisers with less than US$25 million in assets under 

management are prohibited from registering with the SEC as investment advisers and must register 

under state law. Securities offerings made solely within a single state, where the issuer of such 

security is a person resident in (or, if a corporation, incorporated in) and doing business within that 

state are not required to be registered under the Securities Act. 

However, in some areas, where more than one regulator is assigned responsibility, gaps and 

cooperation deficits exist. The CFTC and the SEC self-assessments as well as the Joint Report, 

identified several differences with respect to powers and disparate regulation of similar types of 

financial instruments. These differences exist, not only between the futures and securities 

regulators, but between the securities regulators and the Federal Reserve, as detailed below. 

Aiding and Abetting: The Joint Report identified a gap between the enforcement powers of the 

CFTC and SEC in the context of civil actions, and recommended legislation to close the gap. 

Specifically, it recommends that the SEC should be granted specific statutory authority to pursue 

persons for aiding and abetting offences in civil actions under the Securities Act and the ICA. This 

would match the specific statutory enforcement authority for civil actions of the CFTC regarding 

aiding and abetting all violations of the CEA and CFTC rules and regulations. 

Municipal Securities: There is a regulatory gap with respect to the regulation of municipal 

securities. Currently, the Municipal Securities Rulemaking Board (MSRB), an SRO, writes the 

rules regulating securities firms and banks involved in underwriting, trading, and selling municipal 

securities, but does not have the authority to apply these rules to other professionals and 

intermediaries in the municipal finance market. Moreover, under a provision of the federal 

securities laws known as the “Tower Amendment,” the SEC and the MSRB are prohibited from 

directly requiring state and local government issuers of municipal securities to comply with 

disclosure requirements or file any document prior to the initial sale of securities. 

Economically-Similar Products and Services: Under the current regulatory structure, the rights and 

remedies applicable to the sale of the same or economically-similar products depend on, among 

other things, the type of intermediary selling the product. In a few instances, this has resulted in the 

imposition of different regulatory regimes on similar products. For example: 

Foreign Currency (forex) Transactions: The regulation of off-exchange retail forex transactions 

depends upon the entity offering the product. The CFTC has jurisdiction over such transactions 

where the entity is an FCM or retail foreign exchange dealer, but transactions with “otherwise 

regulated” entities such as banks, BDs, and insurance companies are overseen by their respective 

regulators. The CFTC is currently consulting on measures intended to increase the level of client 

protection when these products are offered by entities subject to CFTC registration. There are no 

unifying standards for forex trading activities across regulators, leading to possible inconsistencies 
31 

in the regulation of the participants and different levels of protection afforded to clients. 

Gramm-Leach-Bliley Act (GLBA) and Bank “Broker” Activity: The GLBA amended several 

federal statutes governing the activities and supervision of banks, bank holding companies, and 

their affiliates. Among other things, it lowered barriers between the banking and securities 

industries erected by the Glass-Steagall Act. With respect to the definition of “broker,” the GLBA 

amended the Exchange Act to provide 11 specific exceptions for banks. Each of these exceptions 

permits a bank to act as a broker or agent in securities transactions that meet specific statutory 

conditions. In particular, there are conditional exceptions from the definition of broker for banks 

that engage in certain securities activities such as 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. The same activity carried on by a bank and the BD may be subject to very different 

regimes, such as consumer protection requirements and compensation schemes in the event of the 

failure of the intermediary. 

Regulation of Derivatives and Securities: Certain economically-identical investment products are 

regulated differently depending on their classification as securities (SEC-regulated) or 

commodities derivatives (CFTC-regulated). As trading in commodity futures has evolved to 

include derivatives on financial instruments and as the SEC has maintained jurisdiction over 

security options (which can be economically equivalent to certain commodity derivative products), 

the lines between securities and commodities regulation have blurred. This has also led to 

jurisdictional disagreements between the SEC and CFTC. 

SEC – Federal Reserve: The GLBA divided responsibility for the supervision of financial holding 

companies that were primarily investment banks between the Federal Reserve and the SEC. The 

recent crisis and the evident lack of financial resilience of the investment bank holding companies 

highlighted gaps in the efficacy of both the regulatory regime and resolution framework for these 

entities. 

Additionally, other products resembling securities and commodities derivatives are generally 

unregulated. For example, certain qualifying transactions among “eligible contract participants” or 

“eligible commercial entities” for contracts subject to individual negotiation fall within a broad 

definition of “swaps” and are traded in the OTC market. These swaps, as defined in the CEA and 

the securities laws, are largely excluded or exempted from regulation by the SEC or CFTC. The 

anti-fraud and anti-manipulation provisions of the federal securities laws only apply to a subset of 

swap agreements, known as security-based swaps. The CFTC also has anti-fraud and antimanipulation authority over some markets. 

Inter-agency cooperation 

Joint Advisory Committee

The CFTC and SEC have, for many years, attempted to work together on a cooperative basis to the 

extent permitted by the evolving formulations of the CEA and Exchange Act. This has not always 

been an easy task to carry out in practice. The CFTC and the SEC have entered into several MOUs 

and initiatives to enhance coordination and cooperation between the two authorities. The most 

recent initiative took place in November 2008, when the SEC, Federal Reserve, and CFTC entered 

into an MOU related to credit default swaps (CDS) and central counterparties (CCPs). There is an 

MOU between the CFTC and SEC, dated March 11, 2008, addressing “novel” derivative products 

to enhance legal certainty, share information permit the trading of these products—in either or both 

a CFTC- or SEC-regulated environment—and to provide for regular meetings of staffs to discuss 

particular issues and products. 

There also is an MOU in place between the two agencies regarding the oversight of security futures 

product (“SFP”) trading and the sharing of SFP information. The MOU provides for notice of any 
32 

planned examinations and the reasons for that examination, sharing of examination-related 

information, and the conduct of joint examinations, if feasible. The MOU also provides for notice 

of significant issues arising from these markets and the sharing of trading data and related 

information for SFP activity. 

The Joint Report recommends legislation to authorize the SEC and the CFTC to jointly form, fund,

and operate a Joint Advisory Committee. According to the Joint Report, this committee would 

identify emerging regulatory risks and assess and quantify their implications for investors and 

other market participants, and provide recommendations for solutions. The committee would serve 

as a vehicle for discussion and communication on regulatory issues of mutual concern affecting 

CFTC- and SEC-regulated markets; the industry generally; and their effect on the SEC’s and 

CFTC’s statutory responsibilities. The SEC and CFTC already have requested and received 

statutory authority to jointly form, fund, and operate a Joint Advisory Committee as recommended 

by the Joint Report. 

(See also the discussion of cooperation with other domestic regulators under Principles 11 and 12.)

Assessment Partly implemented. 

Comments No single issue was determinative of the grade under this Principle; rather, when considered 

together, the totality of the matters identified raised significant concerns. 

The regulatory infrastructure described briefly above is highly complex. In many areas, this 

complexity does not produce gaps or inequity. However, in some of the instances of legislative and 

institutional divisions of responsibility set out above, that is not the case. As detailed above, there 

are gaps in the authority of agencies to cooperate, such as on aiding and abetting, and on the 

supervision of financial holding companies operating primarily as investment banks. There are also 

differences in the regulation of economically similar products and services such as foreign 

exchange transactions, the treatment of banks vis-à-vis brokers when carrying out the same 

activity, and the regulation of securities and derivatives. The gaps and differences in treatment 

should be reduced as much as and as soon as possible. In addition, the rapid development of the 

market in complex derivatives, such as CDS, large parts of which neither agency has had the 

authority to regulate, has created significant regulatory gaps as discussed at length in the Treasury 

White Paper and noted in the Joint Report. This issue is currently the subject of deliberation in 

Congress. 

Regarding effective management of the division of responsibilities between CFTC and SEC, the 

Joint Report has laid out a way forward and both agencies' staff appears to be fully supportive of 

change. In addition to seeking legislative authority to establish a Joint Advisory Committee, the 

Joint Report makes recommendations on how to improve coordination and cooperation between 

the agencies, in ways which do not require new legislation and could therefore be achieved 

quickly. They include establishing: 

 A Joint Agency Enforcement Task Force to harness synergies from shared market 

surveillance data to improves market oversight, enhance enforcement, and relieve 

duplicative regulatory burdens. 

 Cross-agency training programs for enforcement personnel. 

 A program for regular sharing of staff. 

 A Joint Information Technology Task Force to pursue linking information on CFTC and 

SEC regulated persons and entities. 

Historically, legislation lacked clarity as to the scope of the powers of the SEC and CFTC over 

particular types of derivative instruments and markets. Consequently, the commissions found it 

difficult to work in a cooperative and coordinated fashion. The recommendations in the Joint 

Report mark a strong commitment to establish a new, more effective way of working together. 

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

and powers. 
33 

Description CFTC 

The CFTC is an operationally independent regulatory commission of the U.S. government, 

accountable to, and subject to the oversight of, U.S. Congress. 

By law, the five commissioners are appointed by the President with the consent of the Senate. Each 

CFTC Commissioner holds office for a term of five years. Not more than three commissioners may 

be members of the same political party. The President also appoints one of the commissioners as 

chairman, with the consent of the Senate. The President may replace the chairman at any time and 

the former chairman may complete his or her term as a CFTC Commissioner should he/she choose 

to do so—which seems unlikely. The criteria for removal of a commissioner are not set out in 

statute. However, case law regarding independent regulatory agencies suggests that the President 

has the power to remove a commissioner for “cause” such as neglect of duty or malfeasance in 

office. The CEA prohibits any CFTC Commissioner or employee from accepting employment or 

compensation from any person, exchange, or clearinghouse subject to regulation by the CFTC and 

from participating, directly or indirectly, in any contract market operations or transactions subject 

to CFTC regulation. 

The CFTC may consult with any department or agency of the government. In specific instances, 

the consultation process is established by law. For example, the CFTC may not designate a board 

of trade as a DCM or register a derivatives transaction execution facility (DTEF) in 

U.S. government-issued or guaranteed securities until the shorter of 45 days after the CFTC 

provides a copy of the application to Treasury, and the Federal Reserve or the CFTC receives 

comments from those agencies.

The CFTC’s budget is part of the federal budget that is prepared by the President and submitted to 

Congress. The budget is subject to review and recommendation at several levels, including House 

and Senate committees, and must be adopted by Congress annually. The budget has not kept pace 

with the growth in the futures market. The CFTC Chairman has testified about the commission’s 

need for more resources and the Administration and U.S. Congress are considering the agency’s 

need for more resources.

Federal law provides federal employees with immunity from individual liability for torts 

committed in the scope of their employment. In order to insulate CFTC staff from individual 

liability for possible violation of constitutional or statutory duties that are not shielded by statute, 

the CFTC has adopted indemnification rules.

The CFTC is accountable for its conduct to U.S. Congress primarily through reporting to House 

and Senate committees. In general, these committees handle, in the first instance, the 

reauthorization, budget, and funding decisions for the CFTC, as well as bills affecting the CEA. By 

law, the CFTC is subject to reviews and audits by the government. The CFTC is also required to 

deliver a written report to Congress within 120 days after the end of each fiscal year detailing 

CFTC operations of that fiscal year. 

In addition, CFTC operations are subject to ongoing review by an independent OIG with offices in 

the CFTC headquarters. It has four staff members. OIG conducts and supervises audits and 

investigations of programs and operations of the CFTC 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 the 

progress of corrective action in programs and operations. 

The CFTC must comply with the Administrative Procedures Act (APA), which requires 

administrative agencies to give affected parties notice of proposed actions, and an opportunity to 

make submissions prior to a decision being made and provide written decisions setting out its 

findings of fact, conclusions of law, and the reasons for its decisions. Additionally, the APA 

creates the right of judicial review over agency actions. A person suffering legal wrong because of 
34 

an administrative agency’s action, or adversely affected by its decision, is entitled to a judicial 

review of the action. The CFTC also has extensive rules of procedure to ensure fairness in the 

conduct of hearings and other administrative activities. 

SEC 

The SEC is an operationally independent federal agency headed by a bipartisan five-member 

commission, comprised of the chairman and four commissioners, who are appointed by the 

President and confirmed by the Senate for staggered five-year terms. By law, no more than three of 

the commissioners may belong to the same political party. All SEC Commissioners and staff are 

subject to the federal criminal law conflict of interest statutes including a specific prohibition from 

participating personally and substantially in particular matters that would have a direct and 

predictable effect on their financial interests or one that is imputed to them. The Exchange Act also 

expressly prohibits any commissioner from engaging in any other business, vocation, or 

employment than that of a commissioner. 

There are matters of regulatory policy which require consultation with or approval by other 

authorities, such as the requirement for joint rule-making with the Federal Reserve in connection 

with the implementation of the GLBA. Where consultation is required, the process is clear and the 

criteria are transparent. Despite these requirements to consult, the SEC has the authority to make 

day-to-day decisions on technical matters without the need to consult with other government 

authorities. 

The SEC’s budget is part of the federal budget that is prepared by the President and submitted to 

Congress annually. The budget estimate is subject to review and approval by OMB before it is 

forwarded to Congress as part of the overall budget request of the President. The budget is subject 

to review and recommendation at several levels, including House and Senate committees and must 

be adopted by Congress annually. The budget has not kept pace with the growth in the securities 

market. Presently, in light of the events in the financial markets over the past year, the SEC, the 

Administration, and U.S. Congress are reexamining the SEC’s need for more resources. The SEC 

chairman, in her recent appropriations testimony, presented the SEC’s fiscal 2010 budget request 

with specific reference to the need for additional resources to match significant growth in the size 

and complexity of the securities industry, including the BD and IA industries. 

Statute law and various principles of sovereign and qualified immunity provide significant 

protection to the SEC, commissioners, and staff. 

All commissioners, including the chairman are appointed by the President and confirmed by the 

Senate. The chairman is designated by the President and can be replaced as chairman at any time, 

but would then complete the remainder of his/her term as a commissioner should he/she choose to 

do —which seems unlikely. There are no statutory provisions governing removal of a 

commissioner. However, there is case law regarding independent regulatory agencies that says a 

commissioner may only be removed for cause.

The SEC is subject to the oversight by committees of Congress and the Senate. It also provides 

information to Congress and the President, including information on pending enforcement matters 

of interest to Congress or the Executive. The SEC’s receipt and use of funds are subject to regular 

audit by the Government Accountability Office (GAO) and the SEC’s OIG. The OIG is an 

independent office inside the SEC; the Inspector General is appointed by the SEC chair, but can 

only be removed by Congress. There are 19 staff members. The OIG has investigative powers and 

staff members are required to cooperate with investigations. The results of these audits are reported 

to agency management, made available to Congress and the Office of Management and Budget 

(OMB) and generally are made public on the Internet. 

The SEC must comply with the APA (see the description above under the CFTC). The securities 

laws themselves also require the SEC to issue orders in its administrative proceedings. Final orders 

of the SEC may be appealed to the courts. The agency also has extensive rules of procedure to 
35 

ensure fairness in the conduct of hearings and other administrative activities. 

Assessment Broadly implemented. 

Comments Both agencies are subject to an annual appropriations process at the legislature. The experience has 

been that the funding provided to the CFTC and SEC by this process has not been subject to wide 

fluctuations year to year. However, the funding has not kept pace with the growth in the markets, 

let alone their increasing complexity. The annual process and resulting lack of assurance of 

continuing funding prevent the agencies from committing to necessary long-term capital projects, 

such as building new market surveillance systems to replace the existing outdated systems at the 

agencies. Both chairmen are on record saying their agencies are underfunded and need more 

resources to increase staff levels. 

Each agency is tasked with regulating markets where the technology used by market participants is 

cutting edge; and products, markets, and trading techniques are changing at an accelerating rate. In 

this environment, regulators need to have sufficient resources in order to develop and maintain 

highly sophisticated electronic tools to support their supervisory tasks. 

One alternative to provide more assurance of longer-term funding would be to consider moving to 

direct self-funding. It is clear that the revenue generated by SEC routine activities would be 

sufficient to meet its funding needs. The total fees presently generated from activities such as 

filings, registrations, etc., at the SEC far exceed the budgets of both agencies. 

Principle 3. The regulator should have adequate powers, proper resources, the capacity to perform its functions,

and exercise its powers. 

Description CFTC

The legal framework for the CFTC provides it with sufficient powers to regulate and supervise the 

futures market and its participants within the parameters of the CEA as presently written. The 

CFTC has the power to obtain information regarding regulated markets, institutions, financial 

products, customers, and parties to transactions. In addition, it has the power to conduct 

investigations and to sanction violations of the CEA. Administrative sanctions may include orders 

suspending, denying, revoking, or restricting registration and exchange trading privileges, and 

imposing civil monetary penalties and orders of restitution. The CFTC has the power to conduct 

direct surveillance of those markets and financial institutions that fall within its regulatory 

jurisdiction. The CFTC also can obtain certain information on the affiliates of FCMs, whether 

those entities are unregulated or subject to regulation by other authorities such as the SEC, the 

banking regulators, or foreign authorities. 

The CFTC has the power to direct “registered entities“ such as DCMs to alter or supplement their 

rules and to take such action as it deems to be necessary to maintain or restore orderly trading. The 

CEA authorizes the CFTC to suspend or revoke the designation of a DCM, DTEF, or derivatives 

clearing organization (DCO) based on non-compliance with any of the provisions of the CEA, 

CFTC regulations, or CFTC orders. 

The CFTC states in its self-assessment that the recent financial crisis has illustrated the need to 

modernize consumer and investor protection requirements; to expand those requirements to 

previously unregulated areas; and establish structural mechanisms to ensure that gaps are addressed 

as soon as new products are developed. Recent draft legislation, such as the “Over the Counter 

Derivatives Markets Act of 2009” that is based on the White Paper, seeks to close some of those 

gaps. 

OTC Derivatives. Under the CEA as presently drafted, the CFTC has no jurisdiction over contracts 

or transactions in an “excluded commodity” entered into by ECPs (“OTC derivatives”). Excluded 

commodities consist of interest rates, exchange rates, currencies, securities, security indices, credit 

risks or measures, and other indices based solely on commodities that have no cash market or on 

prices, rates, values, or levels that are not within the control of any party to the relevant transaction. 
36 

In addition, the CEA provides an exclusion from CFTC jurisdiction for electronic trading facilities 

that execute OTC Derivatives traded on a principal-to-principal basis between ECPs. OTC 

derivatives based on exempt commodities (e.g., energy, metals, chemicals) are subject to basic 

anti-fraud and anti-manipulation prohibitions when executed off organized trading facilities, but 

are not otherwise subject to regulatory oversight. OTC derivatives in exempt commodities that are 

executed on trading facilities are subject to various CFTC filing and reporting requirements and, 

when they become significant price discovery contracts (SPDC) as determined by the CFTC 

following public consultation, are subject to both CFTC regulatory oversight and self-regulatory 

responsibilities. 

Strengthening Requirements for Clearing Organizations. The CFTC is pursuing the adoption of 

stronger and more detailed core principles for DCOs to enhance the CEA regulatory regime for 

CCPs, and to ensure that U.S. law is consistent with international standards for CCPs. 

Ensuring Greater Transparency of the Marketplace. The CFTC recently announced several 

initiatives designed to bring greater transparency to the market regarding participation by noncommercial participants (such as commodity index funds, swaps dealers, and others); positions of 

traders of contracts determined to perform a significant price discovery function; and positions for 

contracts listed by foreign boards of trade (FBOTs) that are linked to the settlement price of 

domestic contracts. 

Applying Consistent Position Limits. The CFTC recently held public hearings on whether federal 

speculative limits should be set by the CFTC for commodities of finite supply, particularly energy 

commodities. The CFTC also recently requested public comment on whether a “bona fide hedge 

exemption” should continue to apply to persons using the futures markets to hedge risks other than 

risks arising from the actual use of a commodity and CFTC staff is considering the extent to which 

swap dealers should continue to be granted exemptions from position limits. 

Enhancing Conditions for FBOT Trading Linked Energy Contracts. To enhance its ability to 

conduct market surveillance and to maintain market integrity, the CFTC recently announced 

additional amendments to the terms under which an FBOT is permitted to make its electronic 

trading and order matching system available to exchange members in the United States. 

Strengthening Regulation of Retail Off-exchange Commodity Transactions. The CFTC is working 

on legislative amendments to extend the commission’s anti-fraud authority for off-exchange retail 

foreign exchange transactions to transactions in other commodities. 

The CFTC currently employs approximately 580 career staff. This is just under the commission’s 

peak levels in the early 1990s. In the period 1998 to 2008, the agency shrank by approximately 

20 percent in head count, while the markets grew five-fold and the number of contracts grew sixfold. Further, the complexity of the market has increased markedly over this period. The budget for 

this year and next should allow for staff numbers to increase, but additional funds are needed. (See 

also the discussion of funding under Principle 2.) 

The complexity of the market imposes significant demands on the regulator to hire, train, and 

retain staff with a high degree of expertise. The CEA permits the CFTC to provide additional 

compensation and benefits to employees if the same types of compensation or benefits are 

provided by another comparable agency; this enables the CFTC to maintain compensation and 

benefits that are comparable to that paid by other federal financial regulators. Even at the best paid 

federal regulators, salary levels are far below industry salaries, which make it challenging to attract 

staff with market experience and to retain skilled staff. 

There are regular in-house educational/training seminars keyed to the primary mission of the 

CFTC. Technical and computer skills are also provided to employees as needed. In addition, 

employees may also use various on-line, web-based, and in-house educational materials to 

maintain and increase proficiency. 
37 

SEC

The SEC’s extensive powers and authorities are delineated in various federal securities statutes and 

in the rules and regulations that the SEC has adopted under these statutes.

As the SEC staff stated in its self-assessment, the recent financial crisis has illustrated the need to 

modernize consumer and investor protection requirements, expand those requirements to 

previously unregulated areas and establish structural mechanisms to ensure that gaps are addressed 

as soon as new products are developed. Areas identified that need to be addressed include: 

OTC Derivatives. The issue and trading of OTC derivatives, such as swap agreements, are largely 

unregulated in the United States. While this is true in some other developed jurisdictions, the U.S. 

market for these instruments is significantly larger than elsewhere. 

Hedge Funds. Hedge funds are significant participants in the securities markets, both as managers 

of an estimated US$1.5 trillion in assets and as traders of securities. However, their activities, and 

the activities of other private investment pools, are largely “below the radar” (as in many other 

jurisdictions). Under the current regulatory structure, hedge funds usually operate using 

exemptions from the registration and disclosure requirements of the statutes. As noted in the White

Paper, requiring registration with the SEC would allow data to be collected that would permit an 

informed assessment of how such funds are changing over time and whether any funds have 

become so large, leveraged or interconnected that they require regulation for financial stability 

purposes. This registration would promote greater transparency in the markets, improve the ability 

to deter and detect fraud, and provide better oversight of the hedge fund industry by regulators and 

the markets. 

Municipal Securities. As noted above under Principle 1 and discussed in more detail under 

Principle 14, there is a gap in the SEC’s powers with respect to the direct regulation of disclosure 

requirements applicable to issues of municipal securities. 

BDs vs. IAs. IAs and BDs are regulated by the SEC under different statutory and regulatory 

frameworks, even though the services they provide may be virtually identical from a retail 

investor’s perspective. Retail investors are confused about the differences between IAs and BDs 

and the varying legal duties that financial professionals owe investors. The White Paper noted that 

a consistent standard should apply to any CTA, FCM, IB, BD, or IA that provides similar 

investment advisory services. 

While the SEC’s funding has increased in late years, the chair has indicated a need for additional 

resources to match significant growth in the BD and IA industries. The SEC has some degree of 

autonomy on reallocating its budget among activities. For major changes consent of the relevant 

legislative committees is required. Permission to reallocate funds has been granted on request in 

the past. (See also the discussion of funding under Principle 2.) 

The complexity of the market imposes significant demands on the regulator to hire, train, and 

retain staff with a high degree of expertise. The SEC’s ability to attract and retain experienced and 

skilled staff was significantly improved by the 2002 enactment by Congress of “pay parity” 

legislation that authorizes the SEC to create a compensation system similar to the systems of other 

federal financial regulators. As a result of the SEC’s new pay system, the staff turnover rate has 

diminished significantly. At the same time, pay parity has placed pressure on the funding process 

to obtain the necessary budget increases to match the personnel compensation levels at other 

federal financial regulators, such as the Federal Reserve. It should be noted that the Federal 

Reserve is self-funded and not subject to the annual appropriations process. Salary levels even at 

the best paid federal regulators are far below industry salaries, hampering the ability of the agency 

to hire personnel with significant industry experience and retain skilled staff. 

The SEC training program provides significant training opportunities to all staffs. Several divisions 

inside the SEC organize their own comprehensive training programs for new and existing staff 

which are especially designed for their individual needs. Every new employee and commissioner 
38 

receives education and training on ethics. 

Assessment Partly implemented 

Comments The funding of the CFTC and SEC does not provide sufficient resources to meet the needs of the 

regulators in supervising markets of the size and complexity of the U.S. markets. Both agencies 

need more resources—human, informational, and technological—in order to fulfill their present 

regulatory functions more effectively. Each agency is tasked with regulating markets where the 

technology used by market participants is cutting edge; and products, markets, and trading 

techniques are changing at an accelerating rate. In this environment, regulators need to have 

sufficient resources in order to develop and maintain highly sophisticated electronic tools to 

support their supervisory tasks. The expansion of responsibilities contemplated in the White Paper 

and reform legislation will result in even greater funding needs. (See also the comments under 

Principle 2 regarding the need for assured longer term funding and the discussion under Principles 

10, 17, and 21 regarding the resource needs of the examination programs.) 

While pay parity with other federal financial institution regulators has improved the ability of the 

CFTC and SEC to hire and keep skilled staff, the agencies still cannot compete with industry 

compensation levels. Consideration should be given to ensuring the agencies have sufficient 

compensation flexibility to attract and retain employees with the specialized skills and experience 

needed. 

The CFTC and SEC have extensive powers within the scope of authority currently granted to the 

agencies by the statutes under which they operate. However, as noted in Principles 1, 2, 14, and 

elsewhere in this assessment, there are gaps in that authority that is of concern—both between the 

agencies and within the ambit of responsibility of each. Both agencies identified several areas of 

concern in their self-assessments and the Joint Report and made recommendations in the latter to 

address the issues. The White Paper and the proposed regulatory reform legislation also will 

provide additional authority to the agencies. Given the size, complexity, and importance of the 

U.S. capital markets, it is important that these gaps be addressed promptly. 

The complexity of the market demands expertise and drives a tendency for specialization. This was 

particularly evident among SEC staff, which showed a very high degree of specialization. 

However, care needs to be exercised to ensure the resulting “silos” of expertise do not limit the 

ability to see the bigger picture when analyzing problems and developing policy responses. It also 

demands strong management controls to overcome fragmented organizational structures to ensure 

the public interest is served. It was not clear that the required level of controls were in place at the 

SEC to manage these issues effectively. 

The SEC’s ability to make policy determinations would be enhanced by a greater use of its 

authority to request raw data and to develop empirical analysis based on this data rather than 

relying on data generated and processed by exchanges, SROs, and others. 

Principle 4. The regulator should adopt clear and consistent regulatory processes. 

Description Overall, the CFTC and the SEC work under a high degree of transparency. 

CFTC

The law provides various procedural rules for disciplinary proceedings and the reparations 

program, among other matters. The CFTC has implemented the laws that require open meetings of 

the commission. The CFTC also has adopted regulations to provide objective due process 

procedures to ensure that its programs are conducted with fairness and impartiality. The general 

criteria for granting, denying or revoking a license are contained in the CEA and the CFTC 

regulations and so are public. Those affected by the licensing process are entitled to a hearing with 

respect to the regulator’s decision to grant, deny, or revoke a license and the decision may be 
39 

appealed to the courts. 

CFTC rulemaking must comply with the procedural requirements of the APA, which generally 

require the CFTC to publish a notice of Proposed Rulemaking and provide interested persons with 

an opportunity to participate in the rulemaking through submission of written data, views or 

arguments. The CFTC sometimes holds an open forum to permit the public to give its views on 

proposed rules of particular significance. The APA requires an agency to give its rationale and 

policy purpose in proposing or adopting a rule. In addition, the CFTC generally articulates the 

rationale for all interpretations, exemptions, orders or policy changes. 

Before an agency rule can take effect, federal agencies must submit to each House of Congress and 

to the Comptroller General a report containing a copy of the rule, a concise statement relating to 

the rule (including a cost-benefit analysis and whether it is a major rule) and the proposed effective 

date. 

The CFTC has created various advisory committees as a mechanism for public consultation with 

interested members of the commodities industry and users of the futures markets. The CFTC also 

holds informal roundtables and formal public hearings on issues from time to time. 

All CFTC regulations are published in the U.S. Code of Federal Regulations and are available at 

the CFTC’s website.

CFTC regulations provide that the CFTC may decline to publish or make available to the public 

any “non-public” record. In general, this type of information concerns trade secrets, national 

defence or foreign policy concerns, personal privacy, various financial statement forms and 

pending investigations. In addition, CFTC regulations outline the procedures by which a person 

submitting information to the CFTC may request confidential treatment of that information. CFTC 

rules implement the Privacy Act, which provides protections for information concerning an 

individual. 

The CFTC website provides information about the regulatory mandate of the CFTC, the economic 

role of the futures markets, new market instruments, market regulation, international regulatory 

developments and cooperative initiatives, enforcement actions, customer protection issues and the 

diverse functions of the CFTC. In addition to issuing press releases and advisories covering the 

CFTC’s regulatory and enforcement activities, the CFTC’s web site provides an Education Center 

that highlights and explains important policy issues and initiatives and salient aspects of the 

CFTC’s regulatory mandate. 

The CFTC publishes brochures and educational materials about the CFTC, the futures industry and

the futures and commodity option markets. The CFTC conducts research and publishes reports 

from time to time on major policy issues facing the futures markets. 

SEC 

Under the Freedom of Information Act (FOIA) all agencies, including the SEC, are required to: 

(1) publish certain types of information in the Federal Register, such as procedural rules and 

substantive rules of general applicability; (2) make available for public inspection and copying 

other types of information such as adjudicative opinions and staff manuals; and (3) make available 

to the public other types of information upon specific request for that information. 

The U.S. Constitution requires administrative agencies like the SEC to conduct their proceedings 

with due process. All final SEC rules are accompanied by a release that is published in the Federal 

Register, with an explanation of the reasons for adoption and responses to the more salient issues 

raised in the comment letters. 

The SEC also occasionally provides guidance on topics of general interest to the business and 

investment communities by issuing “interpretive” releases, in which the SEC publishes its views 

and interprets the federal securities laws and SEC regulations. These interpretations are disclosed 

to the public via the SEC website and the Federal Register and, in some instances, may include a 
40 

request for comment. 

As is required for the CFTC, the law provides that most meetings of the SEC must be open to the 

public and requires the SEC to provide advance notices of such meetings. The SEC videocasts all 

open SEC meetings on the Internet. 

The SEC is subject to similar requirements under the APA as is the CFTC regarding rule-making. 

The SEC hosts public roundtables to which experts are invited to share their views with the SEC 

and the public about approaches to certain issues affecting the securities markets. Finally, the SEC 

has created and utilized various federal advisory committees. The SEC considers the costs of 

compliance of all rules it adopts, both when the rule is proposed and when the rule is adopted. 

The SEC is subject to both statutory provisions and its own rules that are intended to ensure the 

fairness of its processes. For example, the SEC is subject to restrictions relating to ex parte contacts 

and is required to maintain a separation of certain functions under both the APA and its own rules. 

The SEC is required to give written reasons for its decisions that affect the rights and interests of 

others. These 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. 

The SEC’s criteria and application processes for registration of various entities and products are 

made public under SEC rules and regulations. Affected persons are entitled to hearings. 

Both the Exchange Act and Advisers Act 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. 

The Privacy Act provides procedures for agencies when they obtain, maintain and disseminate 

personal information concerning members of the public. It requires that the SEC make certain 

disclosures to any individual from whom the SEC requests or seeks to compel information and that 

the SEC maintain a record of information released to persons outside the SEC. The Privacy Act 

generally forbids disclosure of information concerning an individual, subject to several important 

exceptions. 

The SEC plays an active role in investor education. Its investor education programs includes 

producing and distributing educational materials; participating in educational seminars and 

investor-oriented events; and partnering with federal agencies, state regulators, consumer groups, 

industry associations and others on financial literacy initiatives. 

Assessment Fully implemented. 

Comments While publishing its enforcement manual on the SEC website may enhance the transparency of the 

agency and its procedures, there is some risk that it might compromise the effective 

implementation of the enforcement program. 

Principle 5. The staff of the regulator should observe the highest professional standards including appropriate 

standards of confidentiality. 

Description CFTC members and staff of the CFTC and the SEC are subject to a code of ethics and professional 

conduct requirements which deal with issues of integrity, procedural fairness, and prevention of 

conflict and confidentiality. 

CFTC 

CFTC Commissioners and employees fall under the jurisdiction of several sets of ethical standards. 

Each of these establish that public service is a public trust and that all government employees must 

avoid both explicit conflicts of interests as well as even the appearance of impropriety in the 

conduct of their official business. 

Regulations issued by the U.S. Office of Government Ethics apply to CFTC employees and set 
41 

basic obligations concerning 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, an Executive Order of the President mandates high 

principles of ethical conduct for government employees. 

Additionally, the CFTC has adopted specific standards of conduct for commissioners and 

employees, including restrictions on business and financial transactions and interests; restrictions 

concerning the receipt and disposition of foreign gifts and decorations; prohibitions on the 

disclosure of non-public commercial, economic, or official information to any unauthorized 

person; and restrictions of the ability of former CFTC employees to practice or otherwise represent 

a person before the CFTC. 

CFTC regulations generally provide that no member or employee of the CFTC may participate 

directly or indirectly in any transaction involving commodity futures and commodity options. It is 

a felony for a CFTC employee or commissioner to pass on or benefit from information received in 

the course of employment which may affect or tend to affect the price of commodities. 

The CEA prohibits the CFTC from publicly disclosing information that would separately disclose 

the business transactions or market positions of any person and trade secrets, or names of 

customers. CFTC rules contain recordkeeping and access requirements, including requirements 

governing the handling and protection of non-public information. The CEA makes it a felony 

punishable by a fine of up to US$500,000 or imprisonment for up to five years, or both, for a 

CFTC employee or commissioner to trade commodity futures and options, or to participate directly 

or indirectly in any investment transaction in an actual commodity if non-public information is 

used in the transaction or if prohibited by CFTC regulations. 

The CFTC has adopted rules of procedure addressing many aspects of the CFTC’s program, as for 

example, procedural regulations relating to the review of exchange disciplinary, access denial or 

other adverse actions; regulations of practice that are generally applicable to adjudicatory 

proceedings before the CFTC under the CEA; regulations specifying the conditions for conduct of 

CFTC business, with a presumption of open CFTC meetings; and procedures applicable to the 

review of NFA decisions etc. 

SEC

All staff, including commissioners, is subject to the criminal law conflict of interest statutes which 

prohibit them from participating personally and substantially in particular matters that would have 

a direct and predictable effect on their financial interests or one that is imputed to them. This 

statute has been implemented and supplemented by regulations issued by the U.S. Office of 

Government Ethics. 

In addition the rules applying to all governmental agencies, all SEC employees and commissioners 

must follow the SEC’s Standards of Ethical Conduct, which is enforced by the SEC’s Ethics 

Office. Various divisions have implemented ethics guidelines specific to the special nature of their 

programs (e.g., enforcement and examinations). 

Unlike the CFTC, SEC staff is allowed to trade in securities subject to the agency’s jurisdiction but 

they have to comply with comprehensive rules regarding their securities holdings and transactions 

which were recently—after some irregularities—enhanced. These rules apply to staff, 

commissioners, and any of their spouses, dependent children, or other persons residing in the same 

household who are related to the employee by blood or marriage. The regulation also prohibits the 

misuse of non-public information and the purchase of a security of an issuer that the employee 

knows to be involved in SEC litigation or investigation. To bolster these requirements, the SEC 

now requires employees to certify in writing before any trade that they do not possess any nonpublic information about the company being traded. The SEC’s regulation requires the reporting of 

securities transactions within five days of the receipt of the confirmation of the trade. In addition to 

this regulation, certain other employees are subject to government-wide financial disclosure rules. 
42 

Employees who have the greatest risk of creating harm by misusing information or having conflicts 

of interest must file a confidential financial disclosure form annually. 

The SEC’s Conduct Regulation prohibits the unauthorized disclosure of confidential and nonpublic information. Violations of the conflict of interest restrictions may be enforced either civilly 

or criminally. Violations of administrative rules can result in disciplinary action including 

discharge. Officers and employees of the SEC are prohibited from making confidential information 

or documents or any other non-public record of the SEC available to anyone outside the SEC. This 

includes information received from foreign regulators. SEC officers or employees who fail to 

comply with SEC regulations may, upon conviction, be fined up to US$1 million and/or 

imprisoned for a period not exceeding ten years. 

The government ethical standards require impartiality in the performance of official duties. In 

addition, the SEC’s Rules of Practice establish standards of procedural fairness. An additional 

protection of procedural fairness may be found in other SEC codes. The Congressional review 

process for final SEC rules is set out in legislation and has safeguards designed to protect the 

integrity of the process. 

Assessment Fully implemented. 

Comments 

Principles of Self-Regulation 

Principle 6. The regulatory regime should make appropriate use of SROs that exercise some direct oversight 

responsibility for their respective areas of competence and to the extent appropriate to the size and 

complexity of the markets. 

Description The effectiveness of the regulatory regime is to a large degree dependent on the skills and 

resources of the SROs. 

CFTC 

There are several categories of organizations authorized by the CFTC which have self-regulatory 

responsibilities: futures exchanges or DCMs, DCOs, and the NFA as a Registered Futures 

Association (RFA). 

In order to trade futures contracts (the regulated activity), a market must be designated as a 

“contract market” under the CEA. A DCM designs the terms and conditions of futures contracts 

(consistent with CFTC Guideline 1) and determines the mechanism and terms of trading and 

execution, as well as which DCO would provide clearing and settlement services. It must also 

carry out surveillance of the operation of its market. There are currently 15 DCMs though the 

number is growing as new DCMs are being set up. With one exception, DCOs are owned by or are 

affiliates of DCMs. Ninety percent of derivatives contracts are cleared though one DCO, which is 

part of the CME. 

The NFA is the only existing RFA. The CEA provides that the CFTC may approve rules that 

require persons eligible for membership to become members of at least one registered futures 

association. Under CFTC regulations, all FCMs which are the type of financial intermediary for 

U.S. commodity futures transactions that are permitted to hold customer funds, are required to be 

members of the NFA. The CFTC has delegated the registration functions for all commodity futures 

intermediaries to the NFA on behalf of the CFTC. Under CFTC regulations, examination and 

monitoring of members’ compliance with financial and reporting requirements may be performed 

under agreement between SROs to reduce multiple monitoring and auditing for compliance. The 

CEA provides Designation Criteria for DCMs, including that such a contract market establish 

trading rules, discipline violators, and ensure the financial integrity of transactions and member 

intermediaries. Through the Joint Audit Agreement, DCMs and the NFA divide up primary SRO 

responsibility for monitoring the financial condition and rule compliance of joint members. 
43 

SEC 

The regulatory system makes extensive use of SROs as required by the Exchange Act. By law, 

national securities exchanges (exchange) and registered securities associations (RSA) are selfregulatory organizations. The principal function of an association is regulating its members 

through a continuous program of rulemaking and interpretation, surveillance and enforcement of 

the applicable federal securities laws, and its own ethical standards through its disciplinary process. 

In a process similar to that applied to national securities exchanges, the SEC evaluates the selfregulatory authority of an association in determining whether the association and through the 

association its members, are fulfilling their statutory and regulatory obligations. FINRA is 

currently the only RSA. There are 20 other SROs, including 3 clearing agencies and the MSRB. 

The number is growing because of the creation of new national securities exchanges. Some are also 

coming together in groups to organize their regulatory functions collectively. Generally, a BD 

generally must register with the SEC and become a member of at least one SRO which can be a 

national securities exchange or FINRA. 

FINRA is the result of the consolidation of the member firm regulatory functions of the New York 

Stock Exchange (NYSE) and National Association of Securities Dealers (NASD). With limited 

exceptions, FINRA is responsible for regulating all securities firms that do business with the 

public, including with respect to professional training, testing and licensing of registered persons, 

arbitration, and mediation. BDs that do business with the public must be members of FINRA 

unless they limit their transactions to securities traded on an exchange of which they are a member 

or unless they limit their business to one state. BD registrations with the SEC, states, and FINRA 

are maintained on a central data base operated by FINRA. 

Assessment Fully implemented. 

Comments IOSCO has indicated that there are no criteria for this Principle. Assessment is subsumed within 

the assessment of Principle 7. 

Principle 7. 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 SEC and CFTC employ structurally different regimes to register and oversee exchanges. The 

SEC uses a traditional “rules-based” approach; the CFTC uses a “principles-based” approach. 

CFTC 

An applicant for registration as an exchange (DCM) must demonstrate that it complies with 8 

Designation Criteria and 18 Core Principles set out in the CEA. DCM Designation Criterion 1 

requires a DCM to demonstrate to the CFTC that the DCM meets initially and on an on-going basis 

the Designation Criteria and the Core Principles. A DCM must establish and enforce rules defining 

the manner of operations of the trade execution facility maintained by the DCM and demonstrate 

that the trade execution facility operates in accordance with the rules of the DCM. 

The eight Designation Criteria cover the range of standards required of an SRO by the IOSCO 

Principles, including prohibiting market manipulation; promoting fair and equitable trading; 

enforcement of its rules and the law; ensuring the financial integrity of transactions; and 

establishing appropriate disciplinary mechanism including fairness. 

The 18 Core Principles, with which a DCM must comply on a continuing basis, cover similar 

ground and also deal with other matters such as conflicts of interest; the governance of mutually 

owned exchanges and dispute resolution; and other futures exchange specific matters as discussed 

under Principles 25 and 26. The CFTC has provided additional information and guidance to 

applicants on how DCMs can remain in compliance with the Core Principles and Designation 

Criteria. 

An RFA application is processed in a traditional rules-based approach. The requirements largely 

replicate those applied to DCMs, with the exception of the exchange specific requirements. The 
44 

CEA provides for less flexibility as to how an RFA meets the requirements. The CEA requires that 

the prospective RFA demonstrate that the rules of the association provide that its members and 

persons associated with its members shall be appropriately disciplined, by expulsion, suspension, 

fine, censure, being suspended, or barred from being associated with all members, or any other 

fitting penalty, for any violation of its rules. Following review, the CFTC may by order grant the 

registration if the requirements are satisfied or, after appropriate notice and opportunity to be 

heard, deny such registration if the application is deficient. 

The designation process for a DCO is described in Principle 29. 

Unlike the SEC, the CFTC has delegated to the registered association, in this case NFA, 

responsibility for processing and granting applications for registration of various categories of 

registrants under the CEA. The NFA has adopted the CFTC’s standards defining the scope of 

evidence that may be presented by the applicant or registrant to challenge allegations of statutory 

disqualification, as well as the standards to be followed by the party reviewing the matter and 

making determinations. Wherever NFA has modified those procedures, the CFTC’s review 

concluded that the modifications would not adversely affect the rights of applicants and registrants.

The CFTC requires RFAs to demonstrate a capability to promulgate rules and conduct proceedings 

which provide a fair, equitable, and expeditious procedure, through arbitration or otherwise, for the 

voluntary settlement of customers’ claims or grievances brought against any member of the 

association or any of their employees. 

A prospective RFA must demonstrate that its rules assure a fair representation of its members in 

the adoption of any rule of the association or amendment thereto, the selection of its officers and 

directors, and in all other phases of the administration of its affairs. 

In addition, various CFTC regulations impose standards of procedural fairness on SRO programs. 

DCMs are required to monitor and enforce compliance with the rules of the contract market, 

including the terms and conditions of any contracts to be traded and any limitations on access to 

the contract market. A DCM must have arrangements, resources, and authority for effective rule 

enforcement. 

DCMs are required to establish and enforce rules to protect market participants from abusive 

practices committed by any party acting as an agent for the participants. DCMs should have rules 

prohibiting conduct by intermediaries that is fraudulent, non-competitive, unfair, or an abusive 

practice in connection with the execution of trades; and a program to detect and discipline such 

behavior. DCMs should have methods and resources appropriate to the nature of the trading system 

and the structure of the market to detect trade practice abuses. 

SROs are required to maintain the confidentiality of material non-public information and 

information obtained from the CFTC in connection with the exercise of their self-regulatory 

responsibilities. They must provide for appropriate limitations on the use or disclosure of material 

non-public information gained through the performance of official duties by board members, 

committee members, and contract market employees; or gained through an ownership interest in 

the contract market. Criminal sanctions can apply for certain breaches of the confidentiality 

requirements set out in the CEA. 

A DCM is required to establish and enforce rules to minimize conflicts of interest in the decision 

making process of the contract market and establish a process for resolving such conflicts of 

interest. The CFTC has provided guidance on how to comply. 

The CFTC ensures compliance by NFA with its self-regulatory obligations and DCMs with Core 

Principles, by conducting periodic reviews of NFA’s compliance programs and Core Principle 

oversight reviews of DCMs. NFA oversight reviews focus on the specific program responsibilities 

of NFA, including review of the financial and sales practice compliance programs for FCMs, IBs, 

CPOs, and CTAs, as well as review of NFA’s programs for arbitration, registration and fitness, and
45 

disciplinary actions. The CFTC’s audit and review of DCMs also encompass the market 

surveillance, audit trail, and trade practice surveillance functions. The CFTC provides the SROs 

with minimum standards for carrying out their surveillance of compliance by FCMs with 

applicable financial and related reporting requirements. 

CFTC staff conducts on-site inspections, meets with NFA or DCM staff, and reviews program 

materials and databases, evaluates procedures and performs reviews of samples of NFA’s or the 

DCM’s files to determine whether the SRO’s procedures are consistent with its regulatory 

obligations; whether the SRO 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 or the DCM. Every two to three years, the CFTC’s Division of Market Oversight 

(DMO) conducts a review of a DCM’s ongoing compliance with Core Principles through the selfregulatory programs operated by the exchange in order to enforce its rules, prevent market 

manipulation, customer and market abuses, and ensure the recording and safe storage of trade 

information. Upon completion of a review, a report is issued and submitted to the CFTC for 

approval for issuance to the SRO. These reports also are made available to the public, which 

provides an opportunity for external comment on the findings, critical or otherwise. 

The CFTC examines FCMs to ensure that DSROs are carrying out their member regulation 

responsibilities and also examines FCMs for its own purposes and not necessarily just “for cause.” 

The CFTC is authorized to abrogate any rule of the NFA if it appears to the CFTC that such 

abrogation is 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. The CFTC also may alter or supplement NFA rules after notice and hearing. 

The CEA provides that the CFTC may suspend the registration of the NFA if it finds that the rules 

thereof do not conform to the requirements of the CFTC. 

SEC 

A national securities exchange, national securities association, and clearing agency must be 

registered with and have its rules reviewed by the SEC for compliance with the Exchange Act. The 

test is whether the entity is organized and has the capacity to carry out the purposes of the act. An 

SRO also must be able to enforce compliance with the act, the rules and regulations thereunder, 

and the SRO’s own rules by its members and their associated persons. The SEC evaluates whether 

applicants for registration as a national securities exchange or an association which operates a 

market have adequate computer system capacity, integrity, and security to support the operation of 

the exchange. 

An SRO may deny membership to a BD or bar from association with a member a natural person 

who is subject to a “statutory disqualification.” The rules must not permit unfair discrimination 

between customers, issuers, and BDs or impose any burden on competition that is not necessary or 

appropriate in furtherance of the purposes of the act. Clearing agencies also may not permit unfair 

discrimination in the admission of participants or among participants in the use of the clearing 

agency. 

Further, an exchange or association may deny membership to a BD that does not meet financial 

responsibility or operational capability standards, or that does not have the minimum level of 

training, experience, or competence prescribed by the exchange’s rules. In addition, an exchange or 

association 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. 

The act requires 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 to have implemented measures to ensure that information obtained during the 
46 

course of carrying out SRO regulatory functions is not misused. These measures include internal 

policies or rules regarding ethical conduct on the part of staff, the preservation of the 

confidentiality of information that is not public, and prohibitions on the use of such information for 

personal benefit. 

The SEC reviews SRO rules and other proposals and examines SRO operations to evaluate any 

potential harmful impact that conflicts of interest may have on the effective oversight of the 

securities markets. In particular, the SEC reviews an SRO’s ownership and regulatory structure and

any proposed changes, with the objective of identifying conflicts of interest that the SRO may have 

between regulating its members and operating its business. The SEC has also taken steps to ensure 

that the SEC has effective tools to oversee an exchange that is controlled by an entity not fully 

subject to its jurisdiction. 

The designation process for a clearing agency is described in Principle 29. 

The SEC reviews all prospective exchange, association, MSRB, and clearing agency rules to 

evaluate whether the mandated standards have been met. Under the act, an SRO must file any 

proposed rule changes, additions, or deletions with the SEC. Once filed, the SEC must publish a 

notice of the filing in the Federal Register and give the public an opportunity to submit comments 

on the proposal. The SEC must approve a proposed rule change if it finds that the proposed rule 

change is consistent with the requirements of the Exchange Act. 

As part of the registration process, securities professionals who work for BDs (including 

prospective officers of the firm and other management and supervisory personnel involved in the 

day-to-day operation of the firm’s investment banking or securities business) must pass an 

examination administered by FINRA to demonstrate competence in the areas in which they will 

work. These mandatory qualification examinations cover a broad range of subjects on the markets. 

The rules of an exchange, association, or clearing agency must provide for a fair procedure for 

disciplining members and persons associated with members, denying membership, barring persons 

from being associated with members, and prohibiting or limiting access to services offered by the 

exchange or its members. 

If the SEC finds that an exchange, association, or clearing agency has failed, without reasonable 

justification or excuse, to enforce compliance with any such provision by a member or person 

associated with a member, it may impose sanctions against the SRO including suspension, 

revocation, censure, and limitation of activities. If an SRO fails to take appropriate disciplinary 

action against a member, the SEC has its own authority to take action against such member under 

the Exchange Act, Advisers Act, and the ICA. 

As regards the governance of SROs, the Exchange Act requires that the rules of an SRO must 

ensure fair representation of members in the selection of the SRO’s directors and the 

administration of its affairs. One or more directors of an exchange must be representative of issuers 

and investors and not associated with a member of the exchange. 

In order to satisfy itself that an SRO is in compliance with the obligations and responsibilities set 

out above, the SEC has a surveillance, examination, and enforcement program to oversee the 

activities of the SROs, including exchanges, associations, and clearing agencies. SEC staff 

conducts periodic inspections of the SROs to evaluate whether they and their members comply 

with applicable federal securities laws and SRO rules. These inspections focus on the SRO’s 

regulatory programs, including: market surveillance, investigative and disciplinary programs, 

member examination programs, and listing and arbitration programs, among others. In practice, at 

least one themed inspection generally is underway at any point in time. Staff also examines an 

SRO’s disciplinary actions against members and denials of membership in, or access to, the SRO. 

The SEC examines BDs to ensure that SROs are carrying out their member regulation 

responsibilities and also examines BDs for its own purposes and not necessarily just “for cause.” 

The SEC has recently introduced more rigorous processes to prevent examinations remaining open 
47 

for excessive periods without good cause and to provide BDs with better and timelier feedback. 

Outsourcing 

Under the CEA, a DCM may comply with any applicable Core Principle through delegation of any 

relevant function to the NFA or another DCM or DCO. The CFTC also permits DCMs to meet 

their self-regulatory obligations by using persons under contract to perform specified duties subject 

to the DCM “maintaining a sufficient degree of control over the persons under contract” and the 

“person under contract having no conflict of interest.” In both cases, the DCM remains responsible 

for the performance of its obligations under the CEA and is overseen by the CFTC accordingly. 

The SEC oversees arrangements between SROs whereby responsibilities are allocated between 

them. These arrangements may take two forms. In the first, the delegating SRO remains 

responsible for meeting its regulatory obligations under the Exchange Act. In the second and 

subject to SEC approval, the obligations can be transferred to the second SRO. Currently, there are 

no third parties other than SROs performing regulatory services. 

Assessment Broadly implemented. 

Comments There are marked differences in the powers that the SEC and CFTC can exercise over SROs that 

are exchanges. The Joint Report published on October 16, 2009 highlighted differing authority 

regarding new product approval and the procedures for reviewing and approving the rules of 

exchange SROs. 

 New derivatives products listed on a securities exchange that are novel and therefore do 

not fit within existing listing standards must be approved in advance by the SEC. Trading 

rules must be pre-approved. The SEC reviews the proposal against the Exchange Act and 

the regulations and must take account of the views of respondents to the mandatory public 

consultation process. Absent a positive finding, a rule is not approved. 

 The CFTC has more limited authority. The CEA generally allows for the introduction of 

new products or changes in trading rules by a self certification process whereby the DCM 

files a notice with the CFTC containing an assertion that the product or change does not 

violate the CEA or CFTC regulation. Notification to the CFTC can be as short as the day 

before the product is introduced or the rule is changed. Although the CFTC reviews all 

new products and rules after the fact, its power to delist or require a rule to be amended is 

dependent on the CFTC determining that the implemented rule or newly introduced 

product violates the CEA. 

The Joint Report has identified this as one area of deficiency in the CFTC’s powers and has 

recommended that the CEA be amended to provide the CFTC with a power equivalent to that of 

the SEC for rule changes; extend (from 1 day to 10, or possibly to 90 days) the advance notice 

requirement for new or amended rules and products; and provide the CFTC with clear authority to 

bring an enforcement action against an exchange (or clearing organization) for violation of a Core 

Principle. Self certification was introduced by Congress in the CFMA in recognition of the need to 

enable the futures exchanges to act quickly to benefit from their innovative endeavors in a 

competitive market. In the view of the assessors, implementation of the Joint Report’s 

recommendations, while necessary, will need careful delineation to preserve this ability. There 

were some comments from industry participants that inflexible prior approval of rules can 

sometimes be used to avoid taking a decision on a politically or commercially sensitive issue or 

one on which the staff of the regulator are unwilling to admit that that they do not have the 

expertise to analyze properly. 

IOSCO Principle 7 accommodates a broad spectrum in the balance of power between a statutory 

regulator and an SRO. For example, prior approval of rules and rule changes is not mandatory, 

subject to the regulator determining that it is not necessary. The CFTC lacks this power as regards 

new products and associated rule changes. In addition, the CFTC is unable to require public 

comment in advance of an exchange’s introduction of new products and trading rules unless the 

Commission stays a rule’s effectiveness. IOSCO’s Principles Methodology also notes that in the 
48 

case of for-profit demutualized exchanges (as is typical in the United States for both securities and 

futures markets), there may be increased concern regarding conflicts of interest and inappropriate 

use of self-regulatory resources which call for enhanced powers of oversight by the regulator. 

Futures exchanges (including the exchange with a 90 percent plus market share) have retained 

regulatory responsibility for all aspects of their members’ conduct. There are industry concerns that 

a demutualized exchange will abuse its powers over members to restrain dissent over important 

structural or other changes, which will have a negative effect on the interests of a particular 

member or a group of members. However, the CFTC thoroughly examined and reviewed this issue 

as part of a study that commenced in 2003 and culminated in 2009 with the adoption of acceptable 

practices for Core Principle 15 (which requires that exchanges adopt and enforce rules to minimize 

conflicts of interest in the decision-making process). The review included extensive public 

consultation. The adopted acceptable practices recognize exchanges’ unique public interest 

responsibilities as SROs and remind all exchanges that they bear special responsibility to regulate 

effectively, impartially and with due consideration of the public interest. The acceptable practices 

include instituting boards of directors composed of at least 35 percent public directors and 

establishing oversight of all regulatory functions through regulatory oversight committees 

consisting exclusively of public directors. The acceptable practices also set forth minimum 

disciplinary panel composition standards to include at least one public person and define the term 

“public director.” 

 In the equity markets in contrast, the association (FINRA) has taken over the work of supervising 

BDs almost entirely, with the merger of NASD Regulation and NYSE member regulation activities

(with NYSE Euronext retaining only market regulation and the listing function), which provides 

for full independence of the self regulatory function. 

Differences also exist in the licensing of BDs and FCMs. BDs must register with the SEC and then 

must join an SRO, which must be FINRA if they do business with the public. In the case of FCMs 

and others in the futures business, the CFTC has delegated the registration function in its entirety 

to NFA and then monitors NFA to satisfy itself that the NFA is meeting its responsibilities under 

the CEA. This would appear to be a more efficient approach which the SEC might wish to 

consider. 

Principles for the Enforcement of Securities Regulation 

Principle 8. The regulator should have comprehensive inspection, investigation, and surveillance powers. 

Description The CFTC and the SEC have comprehensive inspection, investigation, and surveillance powers. 

CFTC

The CFTC has access to records, including non-public and public information, held by individuals 

and entities regulated by the CFTC (FCMs, floor brokers, floor traders, IBs, CTAs, CPOs, 

associated persons, and exchanges) including information about customers and persons that do 

business with regulated individuals and entities. The CFTC has access to these records using its 

inspection powers. No judicial action or suspected misconduct is required. 

The CFTC conducts a market surveillance program to detect and prevent price manipulation in 

futures and commodity option markets. The principal goals of market surveillance are to spot 

adverse situations in these markets and to pursue appropriate remedial actions, in coordination with 

the exchange, to avoid market disruption. The heart of the CFTC’s market surveillance system (and 

also as an important component of its financial surveillance system) is the large-trader reporting 

system. In order to identify potentially disruptive futures positions, staff uses the reporting system 

to collect and analyze data on large trader positions in all commodities. Reportable positions—

daily reports of futures positions above specified reporting levels—are obtained from FCMs, 

clearing members, and foreign brokers. 

CFTC regulations and NFA rules also impose comprehensive record creation, retention, and 
49 

reporting requirements to ensure that all transactions in futures and options can be reliably 

documented and reconstructed and are readily available to investigating authorities without prior 

notice. All books and records required to be kept must be retained for five years and must be 

“readily accessible” during the first two years of that period. In addition, the CFTC can obtain 

information from certain ECMs. 

Registrants must keep a record of the identity of the owners, controllers, and principals of accounts 

carried by or introduced to or by them. Principals of registered intermediaries, defined as each 

person who is a holder or beneficial owner of 10 percent or more of the outstanding shares of any 

class of stock, or has contributed 10 percent or more of the capital of the entity, must provide the 

CFTC with identifying information. Moreover, CTAs and CPOs must provide the CFTC with 

names and addresses of all partners, officers, directors, and persons performing similar functions. 

The CFTC has delegated both inspections and enforcement functions to the SROs. (See the 

descriptions of these SROs in Principle 7.) However, the CFTC has full access to information 

concerning the SROs, and the SROs are subject to confidentiality provisions. 

SEC

The SEC has sufficient legal powers to conduct surveillance, undertake examinations, inspections 

and investigations, obtain information, and take enforcement actions. In particular, the SEC can: 

a. conduct on-site inspections of all entities registered with the SEC (“registrants”), 

including books and records, without prior notice; 

b. obtain books and records and request data for information without the need for a 

judicial action even in the absence of suspected misconduct; and 

c. supervise exchanges and regulated trading systems, even if the frontline responsibility 

for overseeing daily trading activities and regulatory compliance on the exchanges 

lies with SROs. 

SROs have market surveillance responsibilities and have primary surveillance authority over their 

marketplaces. Under the Exchange Act, SROs are obliged to comply with the act and the rules and 

regulations thereunder, as well as the SRO’s own rules. 

All entities regulated by the SEC are subject to books and recordkeeping obligations, both by 

statute (Exchange Act, ICA, and Advisers Act), the SEC’s and SRO’s rules. In general, the books 

and recordkeeping obligations require these entities to keep the documents for the period specified 

by applicable SEC rules. The maintained documents permit tracing of funds and securities in and 

out of brokerage and bank accounts related to securities transactions. The SEC has authority to 

pursue violations of the record keeping and record retention requirements via enforcement action. 

All registrants are required to maintain certain records concerning client identity under the Bank 

Secrecy Act (BSA). The U.S.A. Patriot Act requires financial institutions to establish written 

customer identification programs (CIP). SEC-registered IAs are not subject to the CIP obligation. 

However, under the Advisers Act, an IA must maintain certain records that, as a practical matter, 

include the identities of its clients. The Advisers Act permits IAs to maintain the confidentiality of 

the identity of their clients: even during examinations by SEC staff, the IA does not have to reveal 

client identities. However, the SEC has the authority under various statutes and rules to determine 

or access the identity of all customers of registrants, such as those rules requiring registered entities 

to maintain specified books and records and the SEC’s statutory authority to examine such books 

and records. The SEC may bring enforcement actions for violations of certain reporting, record 

keeping and record retention requirements promulgated under the BSA, including those that relate 

to a BD’s CIP. 

The SEC conducts inspections of SROs to assess their compliance with federal securities laws, 

rules and regulations and to evaluate the SRO’s programs for overseeing, enforcing and 

disciplining its members for compliance with federal requirements and the SRO’s own rules. The 

Exchange Act requires that SROs, upon request of any representative of the SEC, promptly furnish 
50 

to such representative copies of any documents the SRO makes or receives in the course of its selfregulatory activity. The SEC can issue an inspection report to the SRO noting the deficiencies and 

recommending that the SRO take corrective action. The SRO must submit a written response 

describing the corrective measures it plans to implement with respect to each deficiency noted in 

the inspection report. In some cases, an SRO may enter into a Regulatory Services Agreement with 

a registered third-party SRO whereby the third-party SRO agrees to perform certain regulatory 

obligations of the procuring SRO. In such cases, the procuring SRO remains responsible for 

meeting its regulatory obligations under the Exchange Act. As such, the SEC conducts inspections 

that focus on the procuring SRO to ensure that it is appropriately overseeing compliance for all 

activities on its exchange, including those activities directly monitored by the third-party SRO 

under the Regulatory Services Agreement, as well as inspections that focus on the third-party SRO 

to ensure that it is appropriately administering its contracted regulatory obligations. 

The SEC can also cause changes/improvements to be made in SRO processes by using its authority 

to review SRO rule-change filings under the Exchange Act and SEC rules. The SEC may bring an 

enforcement action against an SRO for failure to act or adequately perform required functions. 

Assessment Fully implemented. 

Comments 

Principle 9. The regulator should have comprehensive enforcement powers. 

Description The CFTC and the SEC have comprehensive enforcement powers. Both have quasi-criminal 

authority. 

CFTC

Under the CEA, the CFTC has comprehensive power to conduct investigations to ensure 

compliance with laws and regulations. The CFTC can 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 relevant or material to the 

inquiry. 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. 

The CFTC has the authority 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. The CFTC has the power to seek: 

a. preliminary and permanent injunctions barring future violations of the CEA and 

CFTC regulations; 

b. an ex parte order (i) prohibiting any person from destroying, altering or disposing of, 

or refusing to permit authorized representatives of the CFTC to inspect any books and 

records or other documents; (ii) prohibiting any person from withdrawing, 

transferring, removing, dissipating or disposing of any funds, assets or other property;

or (iii) appointing a temporary receiver to administer such restraining order; 

c. the imposition of civil penalties; 

d. the appointment of a permanent receiver to administer a person’s estate; 

e. an order directing that a person disgorges ill-gotten gains; 

f. an order directing that a person makes restitution to customers; 

g. an order rescinding contracts entered into by a person with a customer; 

h. an order directing that the person makes an accounting of the person’s estate; and 

i. an award of pre-judgment interest on any sums to be disgorged or paid in restitution. 

Sanctions: All administrative complaints contain notice of the possible sanctions that may be 

imposed if liability is found. The following sanctions are available in administrative actions: 

a. an order prohibiting a person 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 a period specified in the order; 
51 

b. an order suspending (for a period of not more than six months), revoking or restricting 

a person’s registration with the CFTC; 

c. an order assessing civil monetary penalties against a person, not to exceed 

US$140,000 per violation (US$1 million for manipulation); 

d. an order directing that a person makes restitution to customers of damages 

proximately caused by the person’s violations; and 

e. an order directing a person to cease and desist from violating the CEA or a CFTC 

regulation. 

The CFTC has the power to refer matters for criminal prosecution to the Department of Justice 

(DOJ). 

Private persons can seek their own remedies for any misconduct relating to the CEA, including 

exercising a right of action for damages. The CEA: 

a. 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; 

b. permits private rights of action under certain circumstances; 

c. permits private damage actions against anyone other than a SRO who violates, or 

wilfully aids and abets a violation, of the CEA; and 

d. 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 extent relevant information is available from another federal or state agency, such as a state 

securities regulator, the SEC or the CFTC may obtain this information by seeking access to the 

public and non public information in that agency’s files. 

SEC

The SEC has broad authority to investigate actual or potential violations of the federal securities 

laws and to determine the scope of its investigations and the persons subject to investigation. The 

SEC can rely on voluntary cooperation to obtain documents or testimony. If the SEC relies on 

voluntary cooperation, it generally does not issue subpoenas or require or administer oaths or 

affirmations, although it may do so in some circumstances. Alternatively, the SEC can authorize a 

formal order of investigation, which grants the SEC staff the power to issue subpoenas and 

administer oaths, take testimony and compel the production of documents. 

The SEC is responsible for civil (non-criminal) enforcement of the federal securities laws and 

prosecutes cases in U.S. federal courts and in administrative proceedings. If the SEC decides to 

institute enforcement proceedings, it has several options. 

A. Civil Action: The SEC may bring a civil injunctive action against a person or an entity that the 

SEC believes has violated or is violating the federal securities laws. In its civil actions, the SEC 

can obtain disgorgement by which a wrongdoer is required to give up any illegal profits gained as a 

result of violations of the laws. The SEC also has the authority to seek civil monetary penalties. In 

fiscal year 2008, the SEC obtained orders in judicial and administrative proceedings requiring 

securities laws violators to disgorge illegal profits of US$774 million and to pay civil penalties of 

US$256 million. The SEC may bar individuals from serving as officers or directors of public 

companies under the Exchange Act. In fiscal year 2008, the SEC sought orders barring 132 

defendants and respondents from serving as officers or directors of public companies. 

B. Administrative Action: The SEC has the ability to institute various types of administrative 

proceedings against a person or an entity that it believes has violated the law. This type of 

enforcement action is brought by the Enforcement Division and is litigated before an SEC 

administrative law judge (ALJ). The ALJ’s decision is subject to appeal directly to the SEC and 

the SEC’s decision is in turn subject to review by a U.S. Court of Appeals. Administrative 

proceedings provide for a variety of relief. For regulated persons and entities, such as BDs, IAs, 
52 

and persons associated with them, sanctions include censure, limitation on activities, suspension 

of up to 12 months, and bar or revocation of registration. For professionals such as attorneys and 

accountants, the SEC can order that the professional be censured, suspended or barred from 

practicing before the SEC. Against any person who violates or is a cause of a violation of a 

provision of the federal securities laws, the SEC may impose a cease and desist order. The SEC 

can obtain disgorgement and civil money penalties in administrative proceedings. 

C. Criminal Action: The SEC can refer the matter to DOJ and the individual U.S. Attorney’s 

offices for criminal prosecution. 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. 

The SEC’s enforcement powers do not compromise private rights of action seeking remedies under 

the federal securities laws. The laws provide for express remedies in favor of private parties who 

claim damages as result of specific violations of these laws. The Securities Act imposes liability: 

 for misstatements or omissions in registration statements; 

 for the sale of unregistered securities and for fraud in the sale of securities; and 

 on controlling persons. 

Additionally, private persons can seek remedies under the Exchange Act, which imposes liability: 

 for specified manipulations of exchange-traded securities; 

 for “short-swing” profits; and 

 for misleading statements in periodic reports filed with the commission. 

Private persons also can seek remedies under the Exchange Act, which: 

 imposes liability on controlling persons; and 

 imposes insider trading liability on contemporaneous traders. 

Federal courts have “read in” private rights of action under certain statutory provisions that, on 

their face, do not provide actions for monetary damages. The most significant of these is the 

implied private right of action under Exchange Act for securities fraud. To state a claim for 

securities fraud a plaintiff must prove: (1) a material misrepresentation or omission by the 

defendant; (2) intent; (3) a connection between the misrepresentation or omission and the purchase 

or sale of a security; (4) reliance upon the misrepresentation or omission; (5) economic loss; and 

(6) loss causation. 

Assessment Fully implemented. 

Comments 

Principle 10. 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

The front line regulation (inspections, enforcement actions) of FCMs, IBs, CTAs, and CPOs is 

done by the SROs subject to oversight by CFTC. The NFA has oversight responsibility for CPOs 

and CTAs and has a program in place to monitor compliance by CPOs with all applicable CFTC 

regulations and NFA rules—both through on-site inspections and off-site reviews. Most new CPOs 

are examined in their first two years of operation and then every three to four years, based on an 

assessment of their risk.

For FCMs and IBs, the NFA and other SROs conduct regular on-site exams of their member firms. 

Every member firm is to be inspected every 9 to 18 months. The CFTC does not have a routine 

examination program, but might conduct an on-site exam in response to an early warning notice or 

for other causes. Ongoing financial and other supervision of FCMs and IBs that are members of 

more than one SRO are shared by the relevant DCMs and NFA, with the NFA primarily 

responsible for FCMs that are not members of a DCM. The CFTC also conducts its own 
53 

investigations and takes action where breaches are found. 

The operational integrity of exchanges is addressed through the CFTC’s periodic Rule 

Enforcement Reviews (RER) that address market surveillance, trade practice surveillance, and 

disciplinary programs. There are regular reviews of each DCM’s ongoing compliance with the 

Core Principles set out in the CEA through the self-regulatory programs operated by the DCM in 

order to enforce its rules, prevent market manipulation and customer and market abuses and ensure 

the recording and safe storage of trade information. Periodic RERs normally examine a DCM’s 

audit trail, trade practice surveillance, disciplinary and dispute resolution programs for compliance 

with the relevant Core Principles. 

Other periodic RERs normally examine a DCM’s market surveillance program for compliance 

with principles on monitoring of trading and position limits or accountability levels. On some 

occasions, these two types of RERs may be combined in a single RER. The CFTC also conducts 

horizontal RERs of the compliance of multiple exchanges in regard to particular Core Principles. 

In conducting an RER, staff examine trading and compliance activities at the exchange in question 

over an extended time period, typically the twelve months immediately preceding the start of the 

review. Staff conducts extensive review and analysis of documents and systems used by the 

exchange in carrying out its self- regulatory responsibilities; interview compliance officials and 

staff of the exchange and prepare a detailed written report of their findings. In nearly all cases, the 

RER report is made available to the public and posted on the CFTC website. 

In an emergency, the CFTC may direct a DCM or ECM to take such action as in the CFTC’s 

judgment is necessary to maintain or restore orderly trading in or liquidation of any futures 

contract. The CFTC may alter or supplement the rules of a DCM under certain (limited) 

circumstances. In order for the CFTC to take such action, the CFTC must first make a written 

request to a contract market. If the CFTC determines that a DCM is violating Core Principles, it 

will provide notice to the entity in writing of such determination and afford the entity an 

opportunity to make appropriate changes to come into compliance, after which the CFTC may take 

further steps, including suspension or revocation of certification.

The CFTC has over 95 attorneys and 18 investigators in the Enforcement Division who are 

charged with investigating and prosecuting violations of the CEA. As part of the commission’s 

efforts to bolster staffing levels, an additional 14 professional staff are scheduled to join the 

division. Currently, there are more than 200 pending investigations. Taking into account the size 

and the growth of the market, the division does not appear to have adequate resources. Considering 

the CFTC recommendation in the Joint Report to expand the insider dealing scope and to enhance 

its authority with respect to disruptive trading practices, the need for an increased staff level is 

even more pressing. 

When an investigation indicates that there is reason to believe that violation has occurred, the 

CFTC files either an administrative or civil injunctive enforcement action against the alleged 

wrongdoers. In an administrative action, wrongdoers who are found to have violated the CEA or 

CFTC regulations or orders can be prohibited from trading on U.S. futures markets and, if 

registered, have their registrations suspended or revoked. Violators also can be ordered to cease 

and desist from further violations, to pay civil monetary penalties of US$140,000 per violation 

(US$1 million for manipulation) or triple their monetary gain and to pay restitution to those 

persons harmed by the misconduct. In civil injunctive actions, defendants can be enjoined from 

further violations, their assets can be frozen, and their books and records impounded. Defendants 

also can be ordered to disgorge all illegally obtained funds, make full restitution to customers and 

pay civil monetary penalties. 

As the CEA does not generally prohibit insider trading in the commodity futures and options 

markets, there have been no enforcement cases charging insider trading. The premise has been that 

insider trading has limited applicability to futures trading because it would defeat the market’s 

basic economic function of allowing traders to hedge the risks of their commercial enterprises. 
54 

Nevertheless, the CEA does recognize certain duties in connection with trading relationships. 

Thus, trading ahead or front running has been charged by the CFTC under the CEA’s general antifraud provisions when persons traded for their own account (or through an associated account) 

ahead of a customer or an employer for whom the person was trading. 

Each year, the CFTC initiates between 40 and 50 enforcement actions. In fiscal year 2008, the 

CFTC brought 40 enforcement cases. These cases target certain program areas, for example: 

(1) allegations of manipulation, attempted manipulation, trade practice violations, and false 

reporting; (2) misconduct by commodity pools, hedge funds, CPOs, and CTAs; and (3) financial, 

supervision, recordkeeping, and other violations committed by registered entities. 

Overall Civil Monetary Penalties: During FY2008, a total of US$234 million in civil monetary 

penalties (CMPs) was imposed in the CFTC’s enforcement actions, which included both 

administrative and federal district court cases. Of that amount, the CFTC collected 

US$141 million, or 60 percent of the amount imposed. 

Commodity Pools and Hedge Funds: From October 2000 through September 2008, the CFTC filed 

a total of 73 enforcement actions alleging misconduct in connection with commodity pools and 

hedge funds and the CFTC has obtained penalties of US$564 million in these actions. The majority 

of the commission’s commodity pool/hedge fund fraud cases are brought against unregistered 

CPOs and/or CTAs (40 of 73 cases filed). 

Cooperative Enforcement: During FY2008, cooperative efforts resulted in 31 cases being filed by 

other domestic criminal and civil law enforcement authorities that included cooperative assistance 

from the CFTC. 

From December 2001 through December 2008, the CFTC filed a total of 98 enforcement actions 

against 181 firms and 193 individuals selling illegal forex futures and option contracts. To date, the 

CFTC has obtained approximately US$562 million in civil monetary penalties and US$453 million

in restitution in these enforcement actions. 

Energy Market Manipulation: From December 2002 to September 2009, the CFTC filed a total of 

43 enforcement actions charging a total of 73 respondents/defendants (42 companies and 31 

individuals) with misconduct in the energy markets. The CFTC has obtained US$446 million in 

civil monetary penalties in settlement of these enforcement actions. 

SEC

The SEC conducts five types of inspections/examinations of intermediaries, CIS, and their 

operators: 

 routine examinations designed to test a registrant’s overall compliance; 

 “cause examinations” based upon complaints, tips, press reports or other information 

suggesting the registrant might be violating securities laws, rules or regulations; 

 risk-targeted sweep examinations, in which multiple firms are reviewed for a particular 

compliance risk; 

 special purpose examinations, in which examination staff review a firm for a potential 

issue or risk; and 

 SRO oversight examinations of registered BDs, during which SEC examiners analyze and 

sample a BD’s records from the same time period and focus areas that the SRO reviewed 

during its examination of the BD. SEC examiners may also review the firm’s activities 

following the SRO examination to identify new problematic behaviour or additional risks. 

In addition, SEC examiners may review the firm’s current activities to determine whether 

it implements any corrective measures recommended by the SRO. 

The SEC communicates with the Federal Reserve when the SEC conducts examinations of certain 

large entities and coordinates some examinations with state regulators. The SEC has an 

examination program that covers both CIS and their operators. Examinations are conducted 

primarily to determine whether CIS and their operators continue to meet eligibility standards and 
55 

conduct their activities in compliance with the law. 

The SROs examine their own members; the SEC examines the SROs to determine whether they 

are meeting their responsibilities. By rule, SROs are permitted to file with the SEC a plan to 

allocate the responsibilities among the SROs to: receive regulatory reports from persons who are 

common members of the SROs, examine such persons or enforce compliance of such persons with 

the federal securities laws. Where a firm is a member of FINRA, FINRA is generally the 

responsible SRO. FINRA inspects its BD members cyclically; the frequency of examination 

depends on the types of business the BD engages in and the perceived risk of those businesses. For 

instance, FINRA generally inspects BDs that hold customer funds and securities at least once every 

year. Other BDs are subject to less frequent on-site examinations. In addition, the FINRA reviews 

a BD’s capital levels when periodic reports are filed. 

The SEC is the sole regulator for SEC registered IAs. There is no SRO to share the work as is the 

case with SEC registered BDs. The SEC uses a scoring process to risk-rate IAs. The SEC attempts 

to risk-rate IAs based on filing information, including whether the IA has custody of client assets, 

charges performance-based fees, its disciplinary history, the results of previous exams, and other 

information available to the staff. In recent years, those IAs with a higher risk profile are placed on 

a three-year examination cycle. However, their Office of Compliance, Inspections, and 

Examinations (OCIE) is currently working to create a more flexible risk management process. 

Once fully implemented, the frequency of examinations of “higher risk” IAs may change. Other 

IAs are chosen randomly for routine examinations on a less frequent basis and may also be 

examined as part of cause, sweep, or special purpose examinations. 

In order to satisfy itself that an SRO is in compliance with the obligations and responsibilities 

imposed upon it, the SEC has a surveillance, examination, and enforcement program to oversee the 

activities of the SROs, including exchanges, associations, and clearing agencies. The standard is 

set in the Exchange Act which mandates that each SRO complies with and enforce compliance 

with law and the SRO’s own rules, “absent reasonable justification or excuse.” SEC staff conducts 

inspections of the SROs to assess the adequacy of the SRO’s regulatory programs. These 

inspections focus on the SRO’s regulatory programs, including: market surveillance, investigative 

and disciplinary programs, member examination programs, and listing and arbitration programs, 

among others. Staff may also examine an SRO’s disciplinary actions against members and denials 

of membership in, or access to, the SRO. 

Oversight of SROs is carried out by SEC staff which conducts several types of examinations and 

inspections as for intermediaries above. 

The SEC has the authority to inspect both the SROs and market participants to determine whether 

the various anti-fraud, anti-manipulation, and reporting regulations are being complied with. The 

SEC can also obtain surveillance and/or trading data from the SROs. 

An SRO must have procedures to survey its market and its members for securities laws violations, 

including violations to the SRO’s own rules. On a continuing basis, the SEC will consider whether 

an applicant has adequate surveillance measures, as well as sufficient resources, including staff 

expertise and capital, to monitor its markets. Surveillance mechanisms are not standardized among 

the markets and the SEC recognizes that surveillance procedures may vary depending on the nature 

and structure of the market and the securities traded on a particular exchange. At a minimum, the 

SEC has said that an applicant should demonstrate that the officers that manage the day-to-day 

surveillance function must be familiar with federal securities laws and the role of the SRO. In 

addition, as part of its surveillance responsibilities, an SRO must have the capability to maintain an 

order audit trail for all transactions in its system. 

In addition to national securities exchanges, the SEC and SROs regulate ATSs for compliance with 

Regulation ATS and other applicable federal securities laws. Regulation ATS includes rules and 

obligations that provide the SEC with information necessary to monitor trading activity on these 

systems. Clearing agencies are SROs under the Act. See Principle 29 for a detailed description of 
56 

the SEC’s oversight of these entities. 

If the SEC finds that an exchange, association, or clearing agency has failed, without reasonable 

justification or excuse, to enforce compliance with any of its rules by a member or person 

associated with a member, it may impose sanctions against the SRO. The SEC has the authority to 

suspend an SRO for a period of up to twelve months, revoke a SRO’s registration, or censure or 

impose limitations upon its activities, functions and operations if the SEC finds that the SRO has 

violated or is unable to comply with the provisions of the law or its own rules. 

Among other remedies and sanctions, SEC enforcement actions may seek censures, suspensions, or 

bars from the securities industry for violations of federal securities laws. SEC suspensions are up to 

12 months, while bars are permanent with a right to reapply. In addition, an adverse adjudication in 

an SEC enforcement action results in an automatic disqualification from association with any SRO 

member. Independent of SEC actions, but in a complementary fashion, SRO enforcement actions 

may seek suspensions or expulsions of its member firms or individuals for violations of 

membership rules. The overall structure and dynamic for regulating the securities markets is 

dependent on vigorous SRO enforcement programs. 

The investigation by the OIG of the SEC into the SEC’s conduct concerning the huge Ponzi 

scheme which came to light in 2008 identified several areas in the SEC Division of Enforcement 

that were problematic. These have been documented in public reports which had to be considered 

by the assessors. According to the OIG’s report, the SEC failed to detect the scheme despite 

6 substantive complaints over 16 years that raised significant red flags. One missed enforcement 

case, no matter how large, can happen anywhere and does not necessarily mean an enforcement 

program is ineffective. However, if the findings show deeper flaws, there will be concerns about 

the effectiveness of the whole program. The OIG report found such systemic problems. It stated 

that enforcement staff: 

 lacked adequate guidance on how to analyze complaints; 

 did not always exercise due diligence in their handling of critical information; 

 assigned to investigate the complaint were inexperienced in investigating Ponzi schemes; 

 did not always seek assistance from other offices and divisions as needed; 

 lacked supervision; 

 failed to verify information provided by the suspect with independent sources; 

 did not adequately evaluate additional information received by the SEC; and 

 did not complete administrative tasks associated with opening and closing the 

investigation promptly. 

Furthermore, the investigation of this case revealed that the complaint handling system to detect 

fraud via handling of complaints, tips, and referrals (CTRs) needs improvement. The SEC 

receives hundreds of thousands of investor complaints each year, including letters, calls, and 

emails. In the fiscal year 2008, the Enforcement Division received approximately 618,000 CTRs. 

Enhancements are in the process of being implemented. 

The OIG made 21 recommendations, with which the SEC concurred. The SEC is taking actions to 

strengthen its enforcement program. Based on a self-assessment and the recommendations from the 

OIG, the Division of Enforcement has implemented a number of important improvements. These 

improvements include: (1) the establishment of specialized enforcement units targeting complex 

products, transactions and markets, including asset management, large-scale insider trading and 

other market abuses, structured products and derivatives, municipal securities and violations of the 

Foreign Corrupt Practices Act; (2) flattening management to dedicate more resources to the core 

mission of enforcement investigations; and (3) offering cooperation agreements and other tools to 

encourage persons with knowledge of wrongdoing to cooperate in enforcement investigations. 

Further improvements are under way in other areas. Currently, the SEC is implementing systems to 

add certain qualitative measures to the current quantitative measures for assessing the enforcement 

program’s effectiveness in enforcing regulatory requirements and in meeting program objectives. 
57 

Specifically, systems are being implemented to track whether enforcement cases of the utmost 

importance are bring brought, whether enforcement cases are being brought in a timely manner and

whether enforcement resources are being used efficiently to meet its objectives. The SEC is also 

seeking to develop more sophisticated metrics to measure the deterrent impact of the enforcement 

cases brought. Finally, the SEC is starting to develop systems that would measure changes in 

industry behavior as a result of the SEC’s enforcement actions. 

In FY2009 the Division of Enforcement had just over 1,200 full time employees, of which 782 

were attorneys. Enforcement attorneys investigate and prosecute violations of the federal securities 

laws. On September 30, 2009, the last day of FY2009, enforcement had over 4,300 active 

investigations. Each year the SEC brings between 500 and 675 enforcement actions. The SEC 

brought 664 enforcement actions in FY2009. In FY2008, the SEC brought 671 enforcement 

actions, the second highest number in its history. 

Market and/or Price Manipulation 

In the 2008 fiscal year, the SEC brought 52 market manipulation cases (in 2007: 36, in 2006: 27). 

Insider Trading 

In fiscal year 2008, the SEC brought 61 insider trading cases (in 2007: 47 insider trading cases, 

in 2006: 46 ) The distribution of the 664 enforcement cases filed in FY2009 across core 

enforcement areas are as follows: 

Type of Case Number % of Total 

Cases

Issuer Reporting 143 22 

Securities Offering 141 21 

Market Manipulation 39 6 

Broker-Dealer 109 16 

Investment Adviser/ Investment 

Company 

81 12 

Insider Trading 37 6 

Delinquent Filings 92 14 

Contempt/Other 22 3 

Total 664 100 

CFTC and SEC 

Given the size of the market, relatively few cases have been taken for criminal prosecution and 

even fewer have resulted in criminal sanctions. 

In the United States, at state and federal level, many charges concerning securities fraud are settled. 

The defendant in the action neither admits, nor denies the allegations4

 in the complaint, but may 

have sanctions imposed on them, such as disgorgement, monetary penalties and/or restrictions on 

the ability to associate with registered entities. Settlements have the advantage of not requiring the 

regulator to prove that the elements of the offence have been committed, but at the same time, have 

the disadvantage that they produce less case law that would help to develop interpretation of the 

laws and give more certainty about the scope of the laws. However, in matters resolved by 

 

4

 The SEC and CFTC have formal policy established by rule that does not permit a defendant to settle an action 

while denying the allegations. However, settlements are permitted if the defendant states it “neither admits nor 

denies” the allegations. 
58 

settlement, the final orders contain findings of fact and conclusions of law that provide guidance on 

the type of behavior that the regulators consider to be in violation of the law. In administrative 

cases, settlement orders also contain an analysis of how the law applies to the facts. While not 

binding precedent, these orders have been cited in court decisions as evidence of an agency’s 

interpretation of the law. 

The Securities Regulators of All States brought 8,365 enforcement actions (including 

administrative, civil, and criminal cases) in the last three years. They resulted in 

 US$178 million fines and penalties (including civil and criminal). 

 US$1.8 billion ordered to be returned to investors (includes restitution, rescission and 

disgorgement). 

 2,765 years of incarceration sentenced. 

Assessment Partly implemented. 

Comments When assessing a jurisdiction’s implementation of the enforcement principles, assessors do not 

normally have access to such a comprehensive, detailed, and painstaking independent analysis of 

the weaknesses in a regulator’s enforcement and examination programs as that contained in the 

2009 report of the SEC’s IG. Indeed this assessment may be unique in that respect. Nor do 

assessors normally have the time or the resources to probe in depth behind a regulator’s (usually 

positive) self assessment, and its data on enforcement cases etc., beyond some limited discussions 

with capital market participants on their views of the regulator’s effectiveness and credibility. It 

remains the case, however, that assessors have generally found this Principle to be partly 

implemented in a relatively high proportion of jurisdictions. It is also an indication of the high 

level of transparency embedded in the U.S. system that the IG’s detailed report was published and 

extensively discussed. 

The Division of Enforcement of the SEC has taken significant action on all of the 

recommendations contained in the IG’s report. By the end of March 2010, it believes that over 

50 percent of the recommendations will have been completed. The division’s completion or 

“closing” of each recommendation remains subject to the approval of the IG. Implementation of 

the remaining initiatives will, the assessors believe, fully restore the SEC’s standing as an effective 

and credible enforcer of the securities laws and its regulations. 

Enforcement 

SEC: As contemplated by the Principles and the Methodology assessors may make use of a variety 

of sources to assess the effectiveness of an enforcement program. In the case of this assessment, 

the assessors have looked at quantitative indicators such as the number of cases brought by the 

SEC, the number and amount of the fines imposed, relative to the size of the overall market. Such 

indicators have limited value as proxies for performance, and thus the assessors have supplemented 

this analysis with other publicly available information, including the OIG report mentioned earlier, 

and with interviews of SEC staff and market participants. All of these factors led the assessors to 

conclude that the SEC enforcement program has significant shortcomings, which should be 

addressed as a matter of priority. The assessors note that the SEC has given high priority to this 

task and is in the process of implementing a program of improvements. 

The recent SEC OIG report, which examined the failed investigation into Madoff, determined there 

were systemic shortcomings in the program as a whole. The OIG made 21 recommendations to 

improve the SEC enforcement program, the SEC concurred in all of the recommendations. 

Pursuant to the published timeline, all planned improvements should be implemented by mid-2010. 

It is also carrying out a range of internally generated improvements not explicitly recommended by 

the IG. The SEC also may want to consider adding staff with more accounting and economics 

backgrounds; the division of enforcement is largely staffed by lawyers and setting up teams with 

different skill sets and experience could enhance its performance. 

CFTC: Taking into account the size and growth of the market, the enforcement division needs 
59 

more resources. Given the current limited scope of its remit and the integrated market surveillance 

systems it operates in close cooperation with the DCMs, (as described under Principle 28) this is 

not a pressing problem though it will become one if its remit is expanded (e.g., to include OTC 

derivatives). 

DOJ: Securities fraud cases are prosecuted primarily in the 94 States Attorney Offices located 

across the United States. Those offices are staffed by about 5,500 to 5,600 federal prosecutors. 

They have the authority to prosecute a full range of federal crimes, including securities fraud. In 

practice, other higher profile crimes (murder, drug trafficking, etc.) may take priority over 

securities fraud. The main office of the DOJ in Washington, D.C. has a securities fraud unit with 

only about ten attorneys. 

Complaints Handling

To upgrade the complaint handling systems, the SEC has employed consultants to conduct a 

comprehensive review of the agency’s systems and procedures for evaluating and tracking CTRs 

and to make recommendations as to how the process can be improved to ensure that enforcement 

leads and areas for high risk examinations are identified more effectively. Improvements will 

include implementation of a centralized information technology solution that will provide the 

agency with an automated mechanism for, among other things, tracking and reporting on CTR 

handling activities on an agency-wide basis. However, this remains “work in progress.” 

Examinations

Although the OCIE makes maximum and creative use of the resources at its disposal, lack of 

sufficient resources currently has a major negative impact on the effectiveness and credibility of 

the inspection and examination systems of the SEC with regard to IAs. The legal basis for funding 

this activity may also be an issue; the SEC does not charge IAs for examinations. The SEC is the 

sole examiner of over 11,000 IAs—a responsibility it attempts to meet with approximately 425 

examiners. Only 14 percent of IAs was examined in 2008 compared to 57 percent of BDs (in the 

latter case most examinations are carried out by FINRA). In FY 2008, approximately 38 percent of 

fund/IA exams conducted by the staff resulted in significant findings (e.g., deficiencies that may 

cause harm to customers or clients of a firm, have a high potential to cause harm, or reflect 

recidivist misconduct). Extrapolated to funds/IAs in total there may be substantial undetected risk 

to investors. Furthermore, SIPC protection is not available to these investors when losses arise 

from the failure of an IA. However, SIPC coverage applies to IA client assets that are custodied at 

a broker-dealer.5

Although all IAs file annual statements with the SEC, which provides input for the risk based 

examination system, the information collected is not comprehensive. In addition until recently, IAs 

identified as “higher risk” based on this and other information were placed on only a three-year 

examination cycle. OCIE is currently working to create a more flexible risk management process. 

The impact on frequency of examinations of ‘higher risk’ IAs would need to be examined once 

fully implemented. 

 

5

 As applied to IAs, the term “custody” is defined in Advisers Act Rule 206-4(2) (“Custody of Funds or 

Securities by Investment Advisers”). See also, SEC Release IA-2176 (Sept. 25, 2003); 68 Fed. Reg. 56692–01 

(Oct. 1, 2003). Among other requirements, Rule 206(4)–2 requires that IAs with custody of client funds or 

securities maintain those assets with broker-dealers, banks or other qualified custodians. In addition, on 

December 31, 2009, the SEC adopted amendments to Advisers Act Rule 206(4)–2. The amendments are 

designed to strengthen controls over the custody of client assets by registered investment advisers and to 

encourage the use of independent custodians. The SEC also adopted related amendments to Rule 204–2, Form 

“ADV,” and Form “ADV-E” that will improve the staff’s ability to oversee advisers’ custody practices. For 

additional discussion regarding these amendments, see SEC Final Rule Release No. IA-2968 available at 

http://www.sec.gov/rules/final/2009/ia-2968. 
60 

The assessors understand one of the recent regulatory reform proposals included raising the 

threshold for registration under the Advisers Act, thereby reducing the number of registrants in this 

category subject to oversight by the SEC. This would shift some of the burden to the state 

regulators. The SEC might also want to consider making use of the FINRA examination program 

when the IA is also a BD member of FINRA. 

As regards BDs, which are subject to examination by the SEC and FINRA, the assessors were 

informed by firms that from time to time there are subject matter overlaps and annual reviews 

which begin before the final report from the previous year had been received. Some overlap may 

be necessary, for example where the SEC is conducting an oversight exam of an SRO’s exam 

program, but these overlaps should be minimized. The OCIE has recently introduced enhanced 

examination review processes to minimize unnecessary duplication and to provide BDs and IAs 

with timely feedback where appropriate. It also engages in an active program to inform and 

educate Compliance Officers as to the SEC’s objectives in carrying out examinations and what 

constitutes good compliance practice. 

Principles for Cooperation in Regulation 

Principle 11. The regulator should have authority to share both public and non-public information with domestic 

and foreign counterparts. 

Description CFTC

The CFTC has authority to share public and non-public information with domestic and foreign 

regulators for regulatory, surveillance, technical assistance, or enforcement purposes, in connection 

with matters of authorization, licensing or approvals, market conditions and events, client 

identification, and regulated entities. External approval is not needed. The CFTC can exchange all 

types of information, including information and records identifying the person or persons 

beneficially owning or controlling bank accounts related to derivatives transactions and brokerage 

accounts. There are no domestic laws which impede international cooperation. An independent 

interest in the subject matter of the inquiry is not a precondition for the exchange of information. 

In order to grant access, the CFTC asks that, in the absence of a formal MOU between the CFTC 

and the requesting authority, the domestic authority provide a written access request setting out its 

need for the requested information and providing confidentiality undertakings. When exchanging 

information with foreign authorities, the CFTC takes into account the status of the requesting 

authority, the confidentiality provided, restriction of use of the information for the purposes stated 

within the request and reciprocity. 

The existence of an MOU is not precondition for information sharing. Neither does the CFTC 

impose a dual illegality requirement, which means, the facts stated in the request need not also 

constitute a violation of the laws of the United States. The CFTC can share information on an 

unsolicited basis. 

SEC

Pursuant to the Exchange Act and SEC rules, the SEC may share public and non-public 

information with domestic and foreign counterparts, provided the SEC receives assurances of 

confidentiality from the person receiving non-public information. The SEC does not need external 

approval to share information. There are no limitations on the type of information that the SEC can 

share in connection with authorization, licensing and registration, surveillance, market events, 

regulated entities, listed companies, and companies that go public. This includes information 

concerning the beneficial ownership or control of a bank or brokerage account, provided the 

requesting authority shows that such information is needed and provides the SEC with assurances 

of confidentiality. The act authorizes the SEC to provide assistance to a foreign securities authority 

if reciprocity is provided and compliance with the request is not against public interest, without 

regard to whether the facts as stated in the foreign securities authority’s request constitute a 

violation under U.S. laws. The SEC can share information on an unsolicited basis. The existence of
61 

an MOU is not precondition for information-sharing. There are no domestic laws which impede 

international cooperation. 

Assessment Fully implemented. 

Comments To the extent that non-public information sought by a foreign or domestic authority includes 

electronic communications subject to the Electronic Communications Privacy Act (ECPA) or bank 

records subject to the Right to Financial Privacy Act (RFPA), notice of the subpoena must be given 

to the bank account holder or subscriber, as appropriate. However, a government agency may delay 

notifying the account holder or subscriber of an administrative subpoena to a financial institution 

or service provider for renewable periods of 90 days. It should be noted that documents covered by 

the ECPA are unlikely to include bank, brokerage, or beneficial ownership information within the 

scope of the IOSCO MOU. 

Before sharing the records with foreign or domestic authorities, the commissions must ascertain 

that the material is relevant to a legitimate law enforcement inquiry of the requesting agency and, 

for domestic authorities, ensure that there is a valid access request granted to that agency that 

includes RFPA and/or ECPA material. There is no requirement in the ECPA that a government 

entity gives notice to a subscriber if the information is shared with another government entity 

(either foreign or domestic). The RFPA does require that a government entity gives notice to the 

account holder within 14 days of transferring the information to another domestic government 

agency, but there is no such notice requirement for sharing the information with foreign authorities.

Principle 12. 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 CFTC 

The CFTC can enter into information-sharing arrangements (MOUs) to facilitate consultation and 

cooperation and to establish the conditions for the public or non-public exchange of information 

with domestic and foreign authorities. 

The CFTC has entered into more than 30 bilateral information sharing arrangements that support 

surveillance, enforcement and regulatory cooperation. The MOUs are in writing and publicly 

available on the website of the CFTC. In addition, the CFTC is a signatory to the IOSCO MMOU, 

the first worldwide multilateral enforcement cooperation arrangement among 55 securities and 

derivatives regulators. 

Pursuant to the various confidentiality provisions of the CEA, the CFTC can protect the 

confidentiality of information transmitted consistent with its uses. The CEA only permits the 

CFTC to disclose to foreign authorities information in the CFTC’s possession when it is satisfied 

that the information will not be publicly disclosed except in an adjudicatory action or proceeding to 

which the authority is a party. 

Fiscal year 2008: The CFTC cooperative efforts resulted in 31 cases being filed by other domestic 

criminal and civil law enforcement authorities that included cooperative assistance from the 

agency. 

The CFTC made 120 requests for assistance to 38 different foreign authorities and received and 

responded to 47 requests from 18 different jurisdictions. 

SEC

The SEC can enter into MOUs to facilitate consultation, cooperation and the exchange of public 

and non-public information with domestic and foreign authorities in both enforcement and 

supervisory matters. The SEC requires assurances of confidentiality which do not restrict the 

foreign authority’s ability to use the information for the purposes of its investigation and/or 

proceeding or any resulting proceedings or its ability to transfer the information to criminal law 

enforcement authorities and self-regulatory organizations. 
62 

The SEC has entered into over 30 bilateral information-sharing arrangements with foreign 

regulators. In addition, the SEC is a signatory to the IOSCO MMOU. The SEC enters into the 

negotiation of bilateral MOUs for enforcement cooperation only if a foreign securities authority is 

empowered to provide assistance beyond what is required by the IOSCO MMOU, such as the 

ability to compel testimony or the gathering of Internet service provider, phone and other records 

other than bank, broker, and beneficial owner information on behalf of the requesting authority. 

The SEC entered into four regulatory MOU with other domestic regulatory agencies under the 

terms of which the SEC is actively sharing regulatory and supervisory information. All MOUs are 

public and on the website of the SEC. 

Fiscal Year 2008: The SEC handled 414 requests for enforcement assistance from foreign 

authorities and made 594 requests to foreign authorities. In addition, the SEC answered 374 

requests from foreign regulators for technical assistance. 

Assessment Fully implemented, 

Comments Disclosure to Congress: As the U.S. Congress has oversight responsibility for the CFTC and SEC, 

it is entitled to obtain all information from the CFTC’s and SEC’s files. Should the CFTC and SEC 

staff learn of an impending demand from Congress for production of non-public information 

provided by a foreign authority, the staff would recommend to their respective Commissions that 

the agency informs Congress that: (i) the agency has undertaken to keep the information nonpublic; and (ii) disclosure could harm the agency’s relationship with the foreign authority and 

adversely impact the agency’s ability to obtain information from its counterpart in the future. 

Disclosure Under the FOIA: The CFTC and the SEC are able to protect from public disclosure 

information regarding requests made by foreign securities authorities as well as information 

received from foreign securities authorities. Any records obtained from a foreign securities 

authority are explicitly exempted from disclosure under the FOIA. 

Principle 13. 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 CFTC 

Under the CEA, the CFTC has the authority to conduct an investigation, including the use of 

compulsory powers, on behalf of a foreign futures authority on regulatory matters in its 

jurisdiction. This includes compelling (a) the production of documents (including, but not limited 

to, bank records, trading records, and records identifying beneficial owners that are critical to such 

investigations) and (b) the taking of statements and testimony under oath. 

The CFTC does not need an independent interest in the alleged violations. In exercising its 

statutory authority to provide such assistance, the CFTC is directed by Congress to consider 

whether (1) the requesting authority has agreed to provide reciprocal assistance in futures matters 

to the CFTC and (2) compliance with the request would prejudice the public interest of the United 

States. The CFTC has the authority to assist a foreign authority in obtaining a court order, 

including in urgent circumstances. 

SEC 

The SEC may conduct an investigation and use its compulsory powers under the Exchange Act as 

it would in its own investigations. These powers include 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 United 

States. This information includes records sufficient to reconstruct all securities and derivatives 

transactions, including records of all funds and assets transferred into and out of bank and 

brokerage accounts relating to those transactions, the name of the account holder, the person 

authorized to transact business, the amount purchased or sold, the time of the transaction, the price 

of the transaction, the individual, and the bank, or broker and brokerage house that handled the 
63 

transaction and the beneficial owner. An independent interest is not a precondition for the 

exchange of information. 

The SEC can assist in advising a foreign authority on how to initiate a proceeding in civil court or 

request to the DOJ to pursue assistance in obtaining court orders through a Mutual Legal 

Assistance Treaty. 

Assessment Fully implemented. 

Comments As discussed under Principle 28, the scope of the explicit insider trading prohibitions under the 

CEA is rather narrow and focuses solely on employees and agents of the CFTC, SROs, and 

markets that are regulated by the CFTC. However, this limited scope does not raise concerns 

concerning the ability to cooperate with foreign regulators as the CFTC can provide assistance to a 

foreign authority even if the matter would not constitute a violation of the laws of the United 

States. Moreover, as described under Principle 10, the CFTC can and does bring a wide range of 

actions under the CEA. 

Right to Financial Privacy Act: The CFTC and the SEC can obtain bank records through their 

subpoena authority; however if seeking bank account records of a customer, defined as an 

individual or a small partnership of five or fewer individuals, from a financial institution both 

authorities must follow procedures set out in the RFPA. The RFPA requires the customer 

notification prior to such disclosure. If an investigative subpoena is issued, the customer must 

receive a copy of the subpoena. The CFTC and the SEC may also obtain bank records for a 

customer without first notifying the customer through a delayed notice provision which requires an 

ex parte hearing in front of an appropriate court in order to delay notice to the customer. 

In practice, this statute does not hamper the ability of CFTC and SEC to cooperate. Most foreign 

requests concern trading accounts with a BD to which the RFPA does not apply. Fewer requests 

from foreign authorities relate to bank saving or cash accounts. If such a request is received, the 

requesting authority is asked to decide if the customer can be notified and in most cases they agree 

to that. If the requesting authority does not want to have the customer informed, the CFTC or the 

SEC may file with an appropriate court in order to delay notice to the customer. The process of 

obtaining a court order takes several days. 

Principles for Issuers 

These principles do not apply generally to futures under the jurisdiction of the CFTC. Futures contracts are issued by 

the exchange on which the instrument is traded. The disclosure provided goes to the nature of the contract and the 

underlying commodity, rather than the characteristics of the issuer. 

Principle 14. There should be full, accurate and timely disclosure of financial results and other information that 

is material to investors’ decisions. 

Description There are extensive disclosure requirements in the legislation and regulations that apply to public 

offerings of most securities, including very detailed requirements that apply to prospectuses, 

registration statements, annual and interim financial reporting and proxy disclosure. There are also 

specialized disclosure regimes for particular types of securities, such as asset backed securities. 

Virtually all disclosure documents are filed with the SEC via the internet on an Electronic Data 

Gathering, Analysis, and Retrieval System (EDGAR) maintained by the SEC and are available to 

the public almost immediately after filing. In addition, disclosure documents are available to 

investors in paper form and may be provided through issuer websites. The review of these 

disclosure documents takes place on a selective basis, meaning not all documents are reviewed by 

the SEC. 

Listed securities also must be registered with the SEC under the Exchange Act and are also subject 

to the listing standards—initial and on-going—of the relevant exchange. Both NASDAQ and the 

NYSE have extensive and high quality continuing disclosure standards that apply to the companies 

that are listed on their respective exchanges. The exchanges monitor that disclosure to ensure 
64 

issuers continue to meet their requirements. Only equity securities (as that term is defined in the 

Exchange Act) registered under the Exchange Act are subject to continuing disclosure 

requirements. An issuer that only has sold equity or debt securities to the public that are held by 

fewer than 300 persons would not be subject to the continuing disclosure requirements under this 

statute. Legislation requires public company’s continuing disclosure documents to be reviewed by 

the SEC at least once every three years. 

Annual audited financial statements are due within 60–90 days of the issuer’s year-end; interim 

statements are due within 40–45 days of the end of each of the first three quarters. Most companies 

make public announcement of the fourth quarter results, which triggers a requirement to file a 

report on EDGAR. The shorter time periods apply to larger issuers. 

All disclosure is to be full, fair and contain all material facts. Anti-fraud provisions in securities 

legislation require “prompt” updating of public disclosure to ensure information is not misleading. 

Reports on material changes are required to be filed with the SEC within four days of the event 

being reported, while the NYSE and NASDAQ require such changes to be publicly disclosed 

immediately. These standards are backed up by extensive liability provisions and a very active 

plaintiff’s bar. There are also detailed rules that govern advertising of offerings (other than via the 

prospectus). 

Derivatives are actively traded in the jurisdiction, both over-the-counter and on-exchange. 

Standardized options and futures are exchange traded. Swap agreements (security-based or not) are 

expressly stated not to be securities under the Exchange Act and so not subject to the issuer 

disclosure requirements. Even derivatives that would qualify as securities under legislation often 

are sold using one of the disclosure exemptions and so no prospectus is prepared. 

Options and futures that are traded on securities and futures exchanges are sold using standardized 

disclosure documents that include a description of the terms of the contracts, mechanics of trading 

and risks. In addition, customers proposing to trade in these standardized contracts through a BD 

(for options) or an FCM or IB (for futures) would be given a specified risk disclosure statement 

that provides additional information regarding the risks associated with the instruments. 

The issuer’s most recent financial period statements (annual or interim) generally are required to be 

included in a registration statement once the financials are available. There are slightly different 

requirements that apply to initial public offerings of securities. Other financial information 

contained in the registration statement is to be as of a date that is as close to the date of the 

document as is practicable. Non-financial information is required to be “current.” 

Disclosure by issuers is promoted through: 

 SEC review of filings; 

 stock exchange listing requirements and oversight activities; 

 required certification of the content of disclosure (financial and registration statements) 

and eligibility to use certain specific disclosure regimes; 

 the loss of certain benefits if disclosure obligations are not met consistently and on time; 

and 

 investigation and possible enforcement actions concerning violations of the requirements.

Certification of financial statements and registration statements by officers, directors and other 

persons attracts liability to sanctions by the SEC and civil suits by injured investors. If a 

registration statement contains a material misstatement or omission, purchasers may sue all or any 

of the issuer, its directors, any officer who signed the registration statement, the underwriters, 

auditor and any expert whose opinion is included in the disclosure document, such as a geologist. 

Issuers are subject to strict liability. All others may be able to plead a defense of due diligence. 

Very limited exemptions from full disclosure exist. Information (such as parts of material 

contracts) may be filed on confidential basis if specified conditions are met under the FOIA—such 

as for trade secrets. 
65 

The SEC can issue temporary cease trade orders. Stock exchanges have rules in place to halt 

trading in a company’s securities temporarily while a material announcement is made. 

Trading in securities on insider information is subject to both criminal and civil sanctions. 

Regulation also imposes obligations on issuers to make prompt public disclosure if material 

information has been disclosed selectively. 

There is a separate disclosure regime for “foreign private issuers” (essentially, foreign corporate 

issuers) that produces disclosure that largely is equivalent to that for U.S. public companies for 

public offerings of securities and annual reports. 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. Each company 

may elect the basis of presentation. The statements must be audited by an auditor who is registered 

with the PCAOB and the audit must be in compliance with U.S. GAAS. 

The disclosure regime for municipal securities (those securities issued or guaranteed by U.S. state 

or municipal governments or agencies) is very different from that described above. By law, the 

SEC has no authority to impose disclosure requirements on these issuers. However, the 

information voluntarily made available to the public in connection with these offerings is viewed 

by the SEC as being insufficient for investors to make informed choices. To improve the disclosure 

for these offerings, the SEC imposes obligations on any BD acting as underwriter of an issue to 

ensure the certain information is made available. These “official statements” are not certified by 

the municipal issuer, but are made available, along with the financial statements and other 

continuing disclosure of the issuer, to the public through a website maintained by the MSRB. The 

disclosure guidance for these official statements is principles-based and far less detailed than that 

which would apply to a corporate issuer. However, the anti-fraud provisions of securities laws 

apply if the disclosure contains a misrepresentation or material omission. The issuer may be 

audited by an independent auditor or by the state auditor and the financial statements may or may 

not be prepared in accordance with U.S. GAAP. 

Assessment Broadly implemented. 

Comments While the initial and continuing disclosure regime in the United States is extensive, it is not 

comprehensive. There are certain limitations in the application of both the initial and continuing 

disclosure requirements, the timeliness of material change notices, and the disclosure regime for 

complex structured securities that gave rise to the assessment rating. 

Not all companies that have issued their securities to the public are required to provide ongoing 

disclosure to their investors. A public issue of securities under the Securities Act requires extensive 

initial disclosure and continuing disclosure for the first year thereafter, but only registration of a 

class of equity shares of that issuer under the Exchange Act gives rise to ongoing disclosure 

requirements under securities legislation. Listed securities are required to be so registered, as are 

equity securities that are held by more than 300 investors. Below that threshold, the only applicable 

requirement may be corporate law provisions that mandate delivery of annual and interim financial 

statements. This system creates gaps in disclosure to investors holding publicly offered securities 

and should be re-examined. 

There may be a need to reassess the disclosure regime governing distributions of complex 

structured products, particularly with respect to initial and on-going risk disclosure, to ensure 

investors and the marketplace have sufficient current information to make informed investment 

decisions. 

It would be preferable for the SEC to have authority to regulate directly the disclosure provided to 

investors regarding new issues of municipal securities. The SEC should have the power to mandate 

both initial disclosure requirements and on-going obligations on these issuers to provide the 

necessary financial and other information about the securities and the issuer. (See also the 

discussion of this issue under Principles 1 and 3.) 
66 

Principle 15. Holders of securities in a company should be treated in a fair and equitable manner. 

Description The rights of security holders of public companies are set out in a combination of state corporate 

law, securities laws, stock exchange rules for listed companies, and judicial decisions. Provisions 

of state corporate law may differ, do not apply to issuers that are not corporations, and may not 

provide significant protections to holders of securities other than voting securities. Each of the 

enumerated topics set out in key question 1 of the Assessment Methodology is covered by one or 

more of these requirements and generally results in equitable treatment of voting security holders. 

Generally, security holders have the right to vote on changes that affect the terms of the securities 

they hold and on certain other fundamental changes. The company must provide reasonable notice 

and material information about all matters to be voted on at a security holder meeting. Both 

registered and beneficial owners must receive this proxy related information. 

The term “tender offer” is not defined under the federal securities laws or the SEC’s rules. Judicial 

decisions have defined a tender offer as any direct offer to purchase securities from security 

holders where certain other criteria are present. The purpose of tender offer regulation is to provide 

disclosure and procedural safeguards to equity shareholders who hold securities that are registered 

under the Exchange Act and are subject to an offer. If a transaction meets the tests for a tender 

offer, the offer must be made to all holders and all must get the same (best) price. Special rules 

apply if the offer is made by the issuer and these rules apply even if the securities sought to be 

repurchased are not registered under the act. 

In most cases, change of control transactions would be subject to federal securities laws and/or 

state corporate law. However, a private agreement to acquire securities from a very limited number 

of shareholders may not meet the test to be a “tender offer” or trigger any other legislative 

provisions designed to protect the interest of security holders. For example, a purchaser may 

acquire control of a public company by buying the securities of an existing controlling shareholder 

at whatever price, without triggering an obligation to offer similar terms to other shareholders or 

other requirements under state law. The only statutory requirement that may be triggered by these 

types of transactions would be subsequent insider reporting obligations on the seller and purchaser.

While there is no explicit compulsory bid rule, there are a number of features of the legal system 

that tend to dissuade acquirers from proceeding via private agreement. In particular, provisions of 

various state laws (including that of Delaware and New York) create serious obstacles for such a 

controlling stockholder. In essence these statutes prohibit an “interested stockholder”—an acquirer 

of 15 percent (for Delaware) or 20 percent (for New York) ownership—from engaging in a wide 

variety of transactions with the corporation, including mergers, purchases of assets, issuances of 

additional securities, and “any receipt ... of the benefit, directly or indirectly (except 

proportionately as a stockholder of such corporation), of any loans ... or other financial benefits ... 

provided by or through the corporation or any direct or indirect majority-owned subsidiary,” for 

three years (for Delaware) or five years (for New York) after becoming an interested stockholder. 

Both of these statutes permit the board of directors of the corporation to waive the statutory 

moratorium in advance of the acquirer’s becoming an interested stockholder. In determining 

whether to grant such a waiver, the directors’ fiduciary obligations require them to take into 

account the interests of all stockholders, not just those of the controller. Decisions that favour the 

controller would likely be tested in court and the directors would be required to demonstrate that 

their waiver decision was entirely fair to the minority shareholders. 

All material information relevant to a shareholder’s voting decision must be disclosed for annual 

meetings, special meetings, and in the tender offer scenario. The rules address the time to be given 

to equity shareholders to make their decisions. 

Directors are generally subject to fiduciary duties of loyalty, good faith, and candor that are owed 

to the corporation and its shareholders. If a director fails to act appropriately, whether in the 

takeover context or otherwise, the corporation may take action against that director. Further, 
67 

derivative actions may be brought by shareholders if the corporation fails to take action against a 

director for a breach of his duties. 

The registration statement and the annual report must include information on any shareholder 

holding more than five percent of any class of voting securities of the issuer. “Holding” is defined 

as beneficial ownership or the right to vote or dispose of the shares. There are also timely public 

disclosure requirements that apply to these shareholders—both initial requirement on acquiring 

five percent of the shares and on any change in holdings. Most holders have to disclose within 

10 days, but passive institutional investors only have to disclose within 45 days after 

December 31 of the year the threshold was exceeded. Material changes to holdings are to be 

disclosed; 1 percent of the class of securities is deemed to be material. Persons acting together by 

agreement to buy, sell, or hold securities are deemed to be a single person and their collective 

holdings are subject to the reporting requirements. 

Holdings of voting securities by directors and senior management also are subject to disclosure 

requirements—both individually and collectively. The issuer is subject to requirements to disclose 

officer and director holdings in its registration statement and update this annually. A director or 

executive officer of the issuer has an individual obligation to disclose all equity securities of the 

issuer in which he or she has a direct or indirect opportunity to profit immediately upon becoming 

a director or officer. If the positions change, an amended report must be filed by the end of the 

second business day following the transaction. Directors and officers may also be required to pay 

to the issuer any profit they obtain on short-term trading in the issuer’s securities. 

All of these insider filings are on EDGAR and available to the public promptly. 

If a foreign private issuer has a class of securities registered under the Exchange Act, it is required 

to include in its registration statement (under “risk factors”) information regarding differences in 

shareholder rights between the foreign jurisdiction and the U.S. It must also note the existence of 

provisions of foreign corporate law or in the issuer’s incorporating documents that have a material 

effect on shareholders’ ability to pursue remedies or other matters affecting shareholder rights. 

Other foreign private issuers may, but are not specifically required, to make similar disclosure. 

Assessment Fully implemented. 

Comments 

Principle 16. Accounting and auditing standards should be of a high and internationally acceptable quality. 

Description Issuer registration statements and annual reports must contain audited financial statements. The 

financial statements must include a 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, plus all necessary notes. All financial statements, whether audited or unaudited, interim or 

annual, for U.S. issuers are required to be prepared and presented in accordance with U.S. GAAP. 

See the description in Principle 14 of the rules that apply to foreign private issuers. 

The SEC performs selective reviews of the accounting disclosure included in the financial 

reporting of public companies to ensure necessary information is included and presented in a 

manner that will be understandable by investors. 

To promote consistency and comparability in period to period reporting, specific guidance is 

provided for presentation and disclosure associated with reclassifications and changes in 

accounting policies, changes in estimates, changes in reporting entity and other conditions which 

affect comparability. The auditor is required to comment in the audit report on material changes in 

accounting. 

The SEC has the power to set standards of accounting, auditing and financial reporting for 

companies that file information and reports with the SEC. However, historically it has relied on the 

work of the accounting standard setters. Legislation sets criteria that must be met in order for the 

SEC to recognize the work product of an accounting standard-setting body as “generally accepted.” 
68 

The standards of the U.S. Financial Accounting Standards Board (FASB) have been so recognized 

for the purpose of the U.S. federal securities laws. 

The auditing standards used by auditors of public companies in the U.S. are the standards of the 

PCAOB, as modified or supplemented by the SEC. The PCAOB adopted the auditing and related 

professional practice standards of the Accounting Standards Board as they existed in April 2003 as 

interim professional standards. In addition, unaudited interim financial statements are required to 

be reviewed by an independent public accountant registered with the PCAOB. Independence of the 

external auditor is required under the U.S. system and detailed tests for independence are 

prescribed. 

FASB is part of a structure that is independent of other business and professional organizations. 

However, given the recent actions on fair value accounting after lobbying by companies, 

particularly banks, FASB’s independence might be questioned. Legislation established the PCAOB 

to be an independent overseer of the audit of public companies that are subject to U.S. securities 

laws. The SEC selects the five board members of the PCAOB. SEC staff oversees the operation of 

the PCAOB and also monitors its standard setting work. Both FASB and the PCAOB are funded 

via an annual accounting support fee assessed against issuers. Both boards also provide extensive 

transparency with respect to their activities and standard-setting. 

The audit committee of the board of directors of a public company is required to oversee the 

selection and appointment of its external auditor. All directors on the audit committee must be 

independent and the tests for independence of audit committee members are more stringent than 

those that apply to other independent directors. The company is required to file a notice with the 

SEC within four days if the external 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. 

The SEC can use both formal (enforcement action or obtain court orders) and informal 

mechanisms (seek additional disclosures, agreement to make changes to future filings or 

restatements) to enforce compliance with accounting standards. The SEC has the authority to bar 

accountants from acting as an auditor or as a preparer of financial statements (such as a chief 

financial officer or comptroller) of a public company. These orders are posted on the SEC website. 

In addition, the PCAOB carries out inspections of registered audit firms and takes action where 

deficiencies are found. 

Assessment Fully implemented. 

Comments 

Principles for Collective Investment Schemes 

Principle 17. The regulatory system should set standards for the eligibility and the regulation of those who wish 

to market or operate a collective investment scheme. 

Description CFTC 

The operator of a commodity pool must be registered under the CEA as a CPO and the registration 

function has been delegated to the NFA by the CFTC, subject to appeal to the CFTC and the 

courts. The commodity pool may be marketed by registered persons (the CPO, an IB, FCM or a 

BD registered with the SEC). The CEA sets out certain disqualifications from registration (mostly 

based on prior history of disciplinary/criminal offences)—both at the firm level and the level of 

principals/associated persons, including shareholders holding more than 10 percent of the voting 

shares. The NFA performs an extensive background check to determine whether a disqualification 

exists. No subjective inquiry is performed with respect to the business model or management 

capabilities of the applicant for registration. No on-site inspection is required to be done prior to 

registration. Prior to registration, the NFA does not routinely conduct on-site or off-site reviews of 

the operational capacity of a CPO applicant. 
69 

There are no initial or ongoing minimum capital requirements for CPOs. 

The NFA may consult 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. This is done either directly by the NFA, or where necessary, 

through the CFTC. 

Clear authority is granted to the CFTC and delegated to NFA with respect to registration of CPOs 

and authorization of commodity pools, inspections, investigations and the taking of remedial 

actions in the event of any breach. The CFTC also takes action directly—particularly with respect 

to investigations and remedial action. The CFTC and the NFA have an array of tools available to 

address breaches of the law. They may take administrative proceedings against CPOs, impose civil 

penalties and restitution to customers or cease and desist orders and refer matters for criminal 

prosecution. 

The NFA has oversight responsibility for CPOs and has a program in place to monitor on-going 

compliance by CPOs with all applicable CFTC and NFA rules and regulations—both through onsite inspections and off-site reviews. Most new CPOs are examined in their first two years of 

operation and then every three to four years, based on an assessment of their risk. During fiscal 

years 2007, 2008, and 2009, the NFA conducted examinations of 179, 250, and 211 CPOs 

respectively (about 20 percent per year). Off-site supervision activities include reviews of 

disclosure documents, financial statements, pool performance data services, hiring patterns for 

employees and principals, customer complaints, annual questionnaire data, and website 

monitoring. 

Each registrant firm or applicant for registration must promptly correct any deficiency or 

inaccuracy in its registration information, including information about its principals and associated 

persons. The NFA also requires CPOs to provide annual updates regarding their registration 

information and business operations. 

Very few commodity pools are offered to the retail public, although the practice is not prohibited. 

Most commodity pools are marketed to sophisticated persons and are private offerings under 

federal securities laws. Approximately 3.3 percent of the pools offered by CPOs are publicly 

offered pools, and these pools have reported about 5.2 percent of the total aggregate net asset value 

(“NAV”) of all pools. As of December 31,2008, approximately 1,350 CPOs registered with the 

CFTC and filed annual reports for about 1,500 pools with a reported aggregate NAV of about 

US$316.3 billion. Of the 1,350 registered CPOs, 20 CPOs offered approximately 50 public pools 

with a reported aggregate NAV of about US$16.6 billion. 

CPO regulation is not comparable in scope to requirements under the ICA applicable to SECregulated investment companies (i.e., mutual funds). Pools offered to the public are subject to the 

disclosure requirements imposed under the CEA, those of the NFA and the requirements of the 

Securities Act. The Disclosure Document requirements across all three sets of rules are consistent, 

although if a pool is subject to the Securities Act, some additional information must be provided. 

Most pools are offered by way of private placement and so are exempt from the registration 

statement requirements of the Securities Act. 

Registered CPOs are required to file Disclosure Documents regarding the commodity pool and 

annual financial statements with the NFA for review. NFA reviews 100 percent of the initial and 

renewal/updated Disclosure Documents. During fiscal years 2007, 2008 and 2009, the NFA 

received and reviewed 1,372, 1,365, and 1,512 pool Disclosure Documents respectively. As part of 

the CFTC’s oversight of the NFA, CFTC staff regularly reviews a sample of Disclosure 

Documents to determine the efficacy of the NFA’s review. No Disclosure Document is required if 

the only participants in the pool are Qualified Eligible Persons (largely institutional investors). 

If the CPO is currently soliciting potential pool participants and is not operating under an 

exemption, the pool’s Disclosure Document must be updated within 21 days of a material change. 
70 

There is no general obligation to issue a press release or other public notice of the change. The 

periodic account statement distributed to participants monthly or quarterly must disclose any 

material business dealings involving the CPO and any other person providing services to the pool 

if they have not previously been disclosed to the pool’s participants. The Disclosure Document 

must contain a full description of any actual or potential conflicts of interest regarding any aspect 

of the pool. CFTC regulations do not mandate that a CPO take any actions to minimize conflicts of 

interest; the only requirement is full disclosure. 

The CPO must adhere to any information set out in the Disclosure Document with regard to best 

execution, trade allocations, related party transactions, etc. Bunched trades are to be allocated on 

an objective and fair basis. There also are rules governing closing out positions and offsetting 

trades that require netting of positions. 

Each CPO must keep books and records relating to the pool as well as to its operations as a CPO. 

The CEA and CFTC regulations do not prohibit a CPO from delegating functions to another person 

or entity. If the delegate is carrying on operator functions, it must be registered as a CPO. The 

delegating CPO remains primarily responsible for its obligations. The CPO is required to disclose 

information about entities and individuals who provide services to the commodity pool as well as 

any conflicts of interest that may arise. The NFA has an expanded reporting rule that will go into 

effect in 2010 that will require CPOs to provide some additional information on their service 

providers such as custodians and administrators and to update that information quarterly. 

SEC 

The CIS operator must register with the SEC as an IA under the Advisers Act. The shares of a CIS 

may be marketed by the CIS itself, its operator (if any) or a BD. Each of these entities is required 

to be registered with the SEC. 

A person may not be registered if a statutory disqualification is present—largely related to that 

person’s history of criminal or disciplinary sanctions. Statutory provisions do not address all the 

criteria for eligibility to operate a CIS set out in the Assessment Methodology. There are no 

eligibility criteria that address the competence to carry out the functions and duties of the operator 

(i.e., human and technical resources); financial capacity; and adequacy of internal management 

procedures that are assessed by the regulator prior to licensing. Under the ICA and the Advisers 

Act, the SEC does not assess the qualifications of persons or firms seeking to become CIS 

operators, except as noted. The fact that an entity is registered with the SEC as an operator does not

represent a determination by the SEC as to the fulfilment of criteria for eligibility to operate CIS 

that are listed above. The SEC does not make registration determinations based on those factors, 

except to the extent noted. 

The responsibility for assessing the fitness and competence of a CIS’s operator is placed primarily 

upon the CIS’s board of directors and their fiduciary duties to the CIS and its shareholders. Under 

the ICA, there must be written contract between the CIS and its operator but there is little guidance 

on what must be covered by that contract. The terms of a CIS operator’s contract (and any renewal)

must be approved by a vote of a majority of the CIS’s independent directors. The CIS operator’s 

contract also must be approved by a vote of a majority of the holders of the CIS’s outstanding 

voting securities. The ICA also requires CIS directors to request and evaluate such information as 

may be reasonably necessary to assess the terms of the advisory contract and the operators must 

furnish this information to CIS directors. When shareholder approval of the CIS operator’s contract 

is sought certain information regarding the CIS operator and the contract, including the 

compensation to be paid under the contract, must be provided in the proxy statement provided to 

shareholders. 

The Advisers Act requires operators that seek to become registered with the SEC to make certain 

public disclosures. In the case of a CIS, an operator generally provides the CIS’s board of directors 

with a copy of the operator’s disclosure form. A CIS also must disclose in its registration statement 
71 

certain information regarding the operator, including the operator’s experience as an operator, the 

operator services that it provides to the CIS and a description of the compensation that the operator 

receives. 

A CIS may not issue its securities to the public unless it has a net worth of at least US$100,000. 

State law may impose proficiency requirements on individual representatives of IAs resident or 

carrying on business in that state. 

CIS and their operators must have written compliance policies and procedures in place that are 

reasonably designed to prevent violations of the law, including policies and procedures designed to 

ensure that the CIS’s board has at least a minimum of 40 percent independent directors. In practice, 

most CIS have a majority of independent directors in order to be able to rely on certain 

exemptions. 

Both the CIS and the securities it issues must be registered; the CIS must be registered under the 

ICA and its securities must be registered under the Securities Act. There is a common disclosure 

form under both acts. The registration statement for a CIS consists of three parts: prospectus, 

statement of additional information and supplementary information (material contracts, 

incorporation documents etc.). Selective reviews of registration statements, post-effective 

amendments, proxy statements and other periodic reports are carried out by the SEC. The reviews 

cover registration statements and other reports to assess, among other things, the continued 

eligibility of the CIS and its operator. No sales of a CIS’s shares may be made before its 

registration statement is effective. 

The SEC has the authority to inspect CIS and their operators, investigate suspected breaches and 

take remedial action under the ICA and Advisers Act via administrative proceedings or civil and/or 

criminal court actions. There are a full range of penalties that may be applied for breach of the 

legal requirements, such as civil fines. (See also the discussion under Principles 8 and 9 above.) 

A CIS operator has a general and continuing obligation to report to the SEC, either prior to or after 

the event, information relating to material changes in its management or organization that are 

described in the operator’s Form “ADV.” The information in that form is required to be kept 

current. 

CIS and CIS operators are required to maintain books and records. All books and records kept are 

subject to examination by the SEC at any time. 

Various methods are used to address conflicts of interest, from direct legal prohibition of particular 

transactions to disclosure by the operator to independent review or approval by the board of 

directors of the CIS or its auditor. Certain transactions with affiliates are not permitted even if 

disclosure is made. Other conflicts between an operator and a CIS that are not specifically 

prohibited must be disclosed to the board of directors and may be disclosed to investors. 

As a fiduciary, an operator has an obligation to seek to obtain “best execution” of a CIS’s 

transactions. The method of allocation of trades across the accounts managed by the operator must 

be fair, reasonable, and consistently applied on a timely basis. CIS operators are subject to the antifraud provisions that would prohibit churning. The major SROs have rules prohibiting churning 

and excessive trading that would apply to BDs executing trades for the CIS. 

There is no statutory prohibition on delegation of CIS operator functions to other persons if the 

advisory contract between the operator and the CIS permits the delegation. Systematic and 

complete delegation of core functions of the CIS operator is not prohibited. There is no specific 

requirement that the operator maintains adequate capacity or monitors the delegate. However, the 

delegate would be an operator of the CIS, and be required to be registered with the SEC and may 

perform services for the CIS only under a written sub-advisory contract that is approved by a 

majority of the CIS’s shareholders and a majority of its independent directors. As an IA, the 

delegate would have a fiduciary duty to the CIS. The directors of the CIS are expected to oversee 

the performance of the operator and any service provider to the fund. By rule, CIS boards must 
72 

approve the policies and procedures of fund service providers, including the investment adviser 

and to review the implementation of the service providers’ policies and procedures on an annual 

basis. 

Whether the CIS operator is responsible for the actions of the delegate depends on the advisory and 

sub-advisory contracts. Both the operator 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 a CIS operator for failure to supervise a delegate if the delegate 

violates the law and is subject to the CIS operator’s supervision. If the delegate is a sub-adviser, 

the statute does not permit the operator to terminate the contract without approval by either a 

majority of the CIS directors or its shareholders. If the delegate is another service provider, the 

ability to terminate the contract depends on the terms of the relevant 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 CIS generally must 

disclose the same information about the delegate in its registration statement as for its operator. 

The same provisions to prohibit, restrict or disclose certain conduct likely to give rise to conflicts 

of interest above apply equally to delegates of a CIS. 

Assessment Partly implemented. 

Comments To meet the standards set out in the Assessment Methodology, regulators should establish specific 

eligibility criteria for CIS and their operators that include the necessary human and technical 

resources to carry out the required functions, the appropriate financial capacity, and adequate 

internal management and controls. In addition, the Methodology requires that the regulator be 

responsible for ensuring compliance with the eligibility standards. 

At present, the resources and internal controls of a CIS would be subject to an examination by the 

regulator only sometime after the fund began operation, but are not preconditions to the original 

approval. Neither regime imposes any initial or ongoing financial capacity requirements on the 

CPO or IA acting as operator. 

The resources at the SEC, CFTC, and NFA do not allow routine examination of the operators to 

take place with sufficient frequency. These weaknesses should be addressed. (See also the 

comments under Principle 10.) 

The requirements under the CEA with regard to conflicts of interest at a commodity pool need to 

go beyond simply requiring disclosure of the conflicts among various parties to require actions to 

be taken to avoid or mitigate conflicts. 

Principle 18. 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 

The commodity pool almost always is a limited liability company or a limited partnership and is 

required to be a separate entity from its CPO. There is no restriction on the legal form that it may 

take. All relevant material facts and risks are to be set out in the Disclosure Document that is 

reviewed by the National Futures Association (NFA) and provided to investors. Any important 

risks associated with the pool’s legal form would be included. As a matter of course, the 

organizational documents for the pool are provided with the Disclosure Document to the regulators 

and investors. The Disclosure Document cannot be used without being accepted by the NFA. 

All information contained in the Disclosure Document must be current as of the date of the 

document, including information relating to rights of participants. If the CPO is currently soliciting 

potential pool participants and is not operating under an exemption, the pool’s Disclosure 

Document must be updated within 21 days of a material change. There is no general obligation to 

issue a press release or other public notice of the change. Also, a CPO must disclose all material 

information to existing or prospective pool participants even if the information is not specifically 
73 

required by CFTC regulations. The CPO must file any amendments to the Disclosure Document, 

including any changes made to the rights of commodity pool participants, with NFA. 

All funds, securities and property received by a CPO must be received in the name of the 

commodity pool. No CPO may commingle the property of any commodity pool with the property 

of any other person. The Disclosure Document must set out the identity of the custodian or other 

entity (e.g., FCM, bank, or BD) which will hold the pool’s assets. Detailed records of the 

operations of the CPO and the pool must be kept. 

The NFA’s periodic examinations of CPOs include testing, on a sample basis, the reporting of 

assets in a pool’s financial statements. The NFA tests all material and unusual assets, liabilities, 

cash inflows and cash outflows, revenues, and expenses included in a pool’s financial statements. 

The testing of a pool’s financial statements also includes confirmation of material balances with 

third parties. The NFA recently adopted a rule to require CPOs to report limited pool performance 

and operational data on a quarterly basis to enhance monitoring capabilities. This rule is designed 

to provide NFA with current information related to commodity pools so that risk trends can be 

identified and appropriate audit priorities assigned. 

The financial statements of the commodity pool that are required to be set out in the periodic and 

annual reports must be presented in accordance with U.S. GAAP and the annual report must be 

certified by an independent public accountant. The auditor of a commodity pool need not be 

registered with the PCAOB because the Sarbanes-Oxley Act established the PCAOB to oversee 

the audits of public companies. 

The CFTC has the power to obtain court orders to freeze pool and/or CPO assets and have 

receivers appointed to operate the commodity pool for the benefit of participants. 

SEC 

Open-end CIS must offer securities that entitle a CIS investor to redeem the shares held at the 

NAV per share upon demand. Closed-end CIS do not issue redeemable securities. There are no 

specific requirements on the legal form of an open-end or closed-end CIS. They usually are 

organized as corporations, business trusts or statutory trusts. All CIS, regardless of their legal form, 

are required to have a board of directors or a functional equivalent of that body. At least 40 percent

of those directors must be independent of the CIS operator and other CIS affiliates. In practice, 

usually a majority of directors are independent. Independent directors are charged with various 

significant oversight responsibilities. 

A CIS must state whether it is an open-end, closed-end or unit investment trust (UIT) fund in its 

registration statement and disclose information about the redeemability of its shares, as well as the 

name of the jurisdiction in which it is organized. The registration statement contains exhibits, 

including copies of its organizational documents that would include information about its legal 

form and structure. 

The responsibility for ensuring that the structure requirements are observed rests primarily with the 

CIS and those who signed its registration statement. CIS registration statements are reviewed by 

the SEC on a selective basis to ensure the requirements are met. The SEC does not approve or 

disapprove a CIS registration statement based upon the merits of an investment in the CIS, the 

qualifications of a CIS operator or the legal structure of the CIS. 

A CIS is not required to give its existing shareholders prior notice of changes that do not require 

shareholder approval. A CIS that is making a continuous offering of its securities must maintain a 

current registration statement, including its prospectus. Open-end CIS and UITs must update their 

registration statements, including prospectuses, immediately to reflect any material changes that 

have been made to investor rights. Material changes include, among other things, changes in the 

CIS’s investment objectives or fundamental policies, suspension of sales or redemption of shares, 

termination of an advisory contract and the resignation of the CIS’s independent auditor. 
74 

All CIS registration statements are available on the SEC’s website. CIS using a summary 

prospectus must provide updated prospectuses on their own websites. In practice, open-end CIS 

generally provide updated prospectuses annually to all existing shareholders. 

The general objective of the rules governing the custody of CIS assets is to separate the assets of a 

CIS from the assets of any other person, including its operator. CIS assets are to be held by an 

eligible custodian, such as (a) a federal or state bank that has capital of at least US$500,000; (b) a 

member of a national securities exchange; (c) a securities depository; (d) a futures commission 

merchant or commodity clearing organization; and (e) a foreign bank or securities depository 

subject to certain conditions. An eligible custodian may deposit CIS assets with another eligible 

custodian, such as a registered clearing agency acting as a securities depository. A UIT may not 

maintain custody of its own assets and must designate one or more banks as trustees or custodians. 

There is no requirement that a CIS’s custodian be legally or functionally independent from the 

CIS’s operator. If a CIS operator or its affiliate acts as a CIS’s custodian, the CIS is deemed to 

have “self custody” of its assets and additional requirements apply including depositing the 

securities in the safekeeping of, or in a vault or other depository maintained by, a federally or state 

supervised financial institution, segregation, limited access by staff and special recordkeeping. In 

addition, the CIS must employ an independent public accountant to verify the CIS’s assets at least 

three times during the year by actual examination. The auditor must send a certificate to the SEC 

stating that the examination has been made and describing the nature and extent of the 

examination. Further, a CIS must maintain a fidelity insurance bond against larceny and 

embezzlement involving CIS assets. 

Current accounts, books, and other documents relating to the CIS’s assets must be kept. The CIS 

must keep records for all securities transactions and ledgers for all of the CIS’s accounts and 

detailed shareholder records. 

Independent accountants registered with PCAOB must conduct an annual audit of a CIS’s financial 

statements. CIS are not required to employ internal auditors. To deregister, the CIS must obtain an 

order from the SEC declaring that it has ceased to be a CIS and that its registration is no longer in 

effect. The SEC has authority to impose conditions on deregistration as necessary for the 

protection of investors. Prior orders have generally been based on a finding that the company has 

distributed substantially all of its assets to shareholders and is winding up its affairs or that the 

company has sold substantially all of its assets to another CIS or merged into or consolidated with 

another such CIS. 

Assessment Broadly implemented. 

Comments There are very few circumstances where securities legislation or the CEA requires investors in 

commodity pools or mutual funds to be given notice of a change that affects their rights prior to the 

effective date of that change, other than where prior approval of the investors is required. Under 

the CEA, where a material change takes place, existing participants must receive notice of the 

change within 21 days of that change. This is not timely disclosure and the notice period should be 

shortened considerably. 

There is no requirement under securities or commodities legislation that the custodian of CIS assets 

and cash be independent of the operator or other service providers to the CIS. Both regimes do 

require the assets to be segregated and held in a manner that makes the CIS’s interests evident, 

which is consistent with the standards set out in the IOSCO Principles. However, strong 

consideration should be given to requiring the custodian be an arm’s length party, which would 

avoid complications if a corporate group containing a CIS operator and its custodian got into 

financial difficulty. 

Under both the securities and futures regimes, any registered entity or registrant may be audited by 

anyone who is qualified to render an audit opinion under state law and is independent of the party 

being audited. Auditors of securities mutual funds must be registered with and subject to inspection 
75 

by the PCAOB. However, the audit of a CIS (or for that matter the audit of a market intermediary) 

may need someone who has specific experience in the area. While U.S. auditing standards require 

an auditor to ensure that the engagement team (which includes the audit partner in charge) has the 

necessary competencies, consideration should be given to requiring the audit partner in charge of 

the audit have some relevant experience. 

Principle 19 Regulation should require disclosure, as set out 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 

Commodity pools, if offered publicly, are subject to both the CEA and the Securities Act, meaning 

the prospectus/Disclosure Document must meet requirements of both acts. However, the majority 

of pools are distributed by private placement and so would only be subject to the CEA/NFA 

requirements outlined here. If the pool is offered only to Qualified Eligible Persons (largely 

institutional investors), the Disclosure Document is not required and there are less onerous periodic 

reporting requirements. The information contained in any Disclosure Document must not be 

misleading. 

CPOs must provide a detailed Disclosure Document to prospective participants before accepting 

their subscriptions for interests in a commodity pool. The disclosure requirements set out specific 

information that must be included and there is a general requirement that all material information 

be provided. NFA rules require the use of plain language. The Disclosure Document requirements 

address the range of topics enumerated in the Assessment Methodology. 

Prior to using a Disclosure Document, a CPO must submit the Document to NFA and receive an 

acceptance letter confirming that the Document can be used to solicit. If the Document does not 

meet regulatory requirements, NFA will provide notice of deficiencies. The Document may not be 

used until all issues are addressed. There are rules regarding advertising and marketing materials 

that include rules that prohibit any false or misleading communications with the public. No 

Disclosure Document may be used that is more than nine months old. See also the material change 

update requirements set out in Principle 18. 

The CPO is required to provide the commodity pool’s annual audited financial statements and 

annual report within 90 days of the pool’s year end to its participants and the regulators. It must 

also provide periodic account statements to its participants, either monthly for pools with assets 

greater than US$500,000, otherwise quarterly, within 30 calendar days of the end of each reporting 

period. These periodic reports and annual financial statements must be prepared in accordance with

U.S. GAAP and annual reports must be audited in accordance with U.S. GAAS. 

SEC 

Key information is required to appear in plain English in a standardized order at the front of a 

CIS’s prospectus. Under a new disclosure regime that is in the process of being implemented, an 

investor may get the key information in the form of a summary prospectus so long as the full 

prospectus is easily accessible on a website. A CIS’s prospectus must include all information that 

would be material to an investment decision by a prospective investor. The specified disclosure 

items include the full range of topics enumerated in the Assessment Methodology. A prospectus 

must be delivered to an investor purchasing a CIS in a primary distribution. 

An open-end CIS may describe the types of investors for whom the CIS is intended or the types of 

investment goals that may be consistent with an investment in the CIS. In addition, FINRA rules 

impose suitability requirements on any BD that recommends to investors that they purchase a 

CIS’s securities. 

The registration statement must include extensive disclosure on all of the disclosure items set out 

in the Assessment Methodology. There are some differences in requirements across the various 
76 

types of CIS, as some items are not applicable to all types of CIS, particularly UITs. 

The SEC may intervene in an offering if it appears that the registration statement includes an 

untrue statement of material fact or omits to state any material fact required to be stated or 

necessary to make the statements not misleading. It may issue stop orders or cease and desist 

orders to stop offerings. It also can institute a proceeding against a person or seek an injunction in 

federal court for violations of the ICA or Securities Act. 

A CIS may use brochures or advertisements and may market through the full range of media. Like 

offering documents, all marketing materials are subject to the anti-fraud provisions of the law and 

may not contain material misstatements or omissions. There are specific, detailed requirements that 

apply to various types of advertising. 

Copies of all advertisements and sales literature must be filed with the SEC. If a CIS’s shares are 

sold by a FINRA member BD, FINRA requires the BD to file any advertisement or sales literature 

that it uses to market the company. These advertisements and sales literature are reviewed by 

FINRA. Advertisements and sales literature filed with the SEC may be reviewed. 

Each open-end CIS always must have a current, effective registration statement. An open-end CIS 

must amend 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 CIS to maintain a “current” statutory prospectus, any prospectus used more than nine 

months after the registration statement’s effective date must contain financial and other 

information as of a date not more than sixteen months prior to such use. 

CIS prepare and send annual and semi-annual reports to their shareholders. The reports must 

include full financial statements for the CIS prepared in accordance with U.S. GAAP, including a 

schedule of portfolio holdings that shows the amount and value of each security owned by the CIS 

on that date. The annual report must include audited financial statements, accompanied by a 

certificate of an independent public accountant that is a member of the PCAOB. There is also a 

semi-annual financial reporting requirement to investors and a requirement that the CIS's portfolio 

statement be sent to the SEC quarterly. CIS must transmit reports to shareholders and file 

information with the SEC within 60 days after the end of the period for which each report is made.

The auditor is required to include procedures designed to detect illegal acts, identify related party 

transactions and evaluate the CIS’s ability to continue as a going concern. If the auditor becomes 

aware that an illegal act has occurred, the accountant has obligations to promptly notify the CIS’s 

operator and ensure that the CIS’s audit committee or directors. In some circumstances, the auditor 

must report the issues directly to the SEC. 

Assessment Fully implemented. 

Comments See comments under Principle 18 regarding the timing of notice of material changes under the 

CEA. 

Principle 20. 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 

The NAV of a commodity pool must be calculated using U.S. GAAP, consistently applied. 

Valuations are to be reported in the Statement of Changes in Net Assets included in the periodic 

and annual reports of the pool. U.S. GAAP requires the use of Statement of Financial Accounting 

Standards (FAS) 157, Fair Value Measurements. This statement includes provisions for fair value 

of commodity pools, establishes a framework for measuring fair value under U.S. GAAP and 

expands disclosure about fair value measurements. 

Information in the CIS’s annual report on the valuation of the assets and calculation of NAV must 

be audited by the independent auditor. The NAV of a pool is disclosed to participants in the 
77 

periodic account statements provided by the CPO. 

The Disclosure Document must contain a complete description of any restrictions on the 

transferability of a participant’s interest in the pool and the frequency, timing and manner in which 

a participant may redeem interests in the pool. This must include how the redemption value of a 

participant’s interest will be calculated, the conditions under which redemption will be made 

(including time between request for redemption and payment) and any restrictions on redemption. 

There are no specific requirements that govern pricing errors, other than what would be covered by 

the general disclosure and audit requirements. The suspension and deferral of routine valuation, 

pricing and redemptions are covered by disclosure requirements and otherwise are not subject to 

review or involvement by the regulators. However, the CFTC and NFA have the power to take 

action where necessary. The CFTC has the authority to take court action under the CEA, and the 

NFA may take a Member Responsibility Action pursuant to NFA Compliance Rules. In 2010, new 

NFA rules on quarterly reporting requirements for CPOs will require CPOs to provide the NFA 

with notice of the suspension or deferral of redemption rights. 

The CFTC and NFA have and exercise the authority to enforce requirements regarding asset 

valuation and pricing. Regular reviews are conducted by NFA of CPO operations that would cover 

the CPO’s valuation and pricing practices and procedures. Actions have been taken where breaches 

have been found. 

SEC 

CIS assets must be marked to market or otherwise valued at fair market value as required by 

U.S. GAAP. As is the case for commodity pools, FAS No. 157, Fair Value Measurements applies. 

There is no specific requirement regarding the frequency of calculation of the NAV of a CIS. 

Open-end CIS may be redeemed only at a price based on the NAV of such security next computed 

after receipt of a redemption request (forward pricing). The ICA generally prohibits a closed-end 

CIS from issuing its common stock at a price below its current NAV. 

A CIS’s independent auditors must verify the CIS’s NAV calculations and test the process by 

which the CIS values its portfolio securities as part of the CIS’s annual audit. The SEC has issued 

detailed guidance on how this audit verification is to be conducted. 

The CIS’ board is responsible for overseeing the valuation of CIS portfolio securities, must 

approve the valuation criteria and are responsible for reviewing the CIS’s valuation methods to 

assure that the valuations of the CIS’s portfolio securities are fair and accurate. 

Federal securities laws do not require that the prices of a CIS be disclosed or published on a regular 

basis to investors other than in the CIS’ annual or semi-annual reports. In practice, the current price 

of a CIS is generally available in financial publications and websites every business day. 

There are industry rules of practice on pricing errors that have been adopted by some CIS boards of

directors. These set out when price adjustments should or do not need to be made (i.e., set de 

minimis standards). The valuation procedures of a CIS generally provide for the reporting of any 

material pricing errors to the board 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 CIS typically would not report pricing errors to the SEC unless the error is 

required to be reflected in its financial statements, i.e., is material. 

CIS 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 CIS also may suspend 

redemptions for any period during which (a) trading on the NYSE is restricted, or (b) an 

emergency exists, as determined by the SEC, as a result of which it is not practicable for the CIS to 

liquidate its portfolio securities, or fairly determine the value of its net assets. Otherwise, a CIS 

cannot suspend the right of redemption or postpone the date of payment more than seven days after 

the tender of the security to the CIS or its redemption agent. The CIS must amend its prospectus to 
78 

discuss any suspension or deferral of redemption rights. Such an update would be filed with the 

SEC. If a CIS wants to suspend redemptions for any reason other than those discussed above, it 

must request an order from the SEC, which will be granted only if the order is necessary for the 

protection of the CIS’s shareholders. 

The SEC has the power to enforce compliance with the rules on asset valuation and pricing through 

its examinations and enforcement actions. The SEC reviews CIS asset valuation and pricing during 

its examinations of CIS, CIS operators and third-party administrators that perform operational and 

administrative functions for CIS. The SEC has taken enforcement actions against entities for 

having inadequate review procedures to identify pricing deviations or where pricing practices 

breach the law—such as for late trading. 

The SEC has the authority to intervene when the suspension of redemptions is in breach of the law 

and in certain other situations. It also has the authority to seek a court order to suspend 

redemptions. 

Assessment Fully implemented. 

Comments The CFTC should consider providing guidance to the industry on how to address pricing errors in 

the valuation of commodity pools. 

Principles for Market Intermediaries 

Principle 21. Regulation should provide for minimum entry standards for market intermediaries. 

Description CFTC 

Legislation requires anyone carrying on business as an FCM, IB, CPO, or CTA to be registered 

with the CFTC. If these firms are dealing with the public they must also be members of the NFA. 

The CFTC has delegated the responsibility to the NFA to receive and review registration 

applications and grant or deny registrations, subject to appeal to the CFTC and the courts. The 

CFTC oversees the operations of the NFA. (See also the discussion under Principle 7.) 

There are published minimum standards that require information be provided to ensure that no 

statutory bar to registration is present (such as a criminal record or certain financial sector 

offences) and other proficiency requirements are met, such as courses and experience etc. for 

individuals. This assessment extends to principals who beneficially own 10 percent or more of the 

equity of the firm. The regulators have authority to refuse licensing if one of the statutory bars is 

present. The NFA also has minimum educational and other requirements that apply to specified 

personnel at all FCMs, IBs, CPOs, and CTAs. 

An assessment of the internal controls, back office capabilities, record keeping systems, etc., of 

applicants is not mandatory before registration is granted. The NFA’s practice is to perform an offsite review of an FCM’s or non-guaranteed IB’s policies and procedures as part of the licensing 

process. DCOs and DCMs generally perform reviews of the internal controls and back office 

capabilities of applicants for clearing membership. Applicants that are required to provide audited 

financial statements must have those statements certified by an independent auditor. This 

certification process involves review of the firm’s accounting system, internal accounting controls 

and procedures for safeguarding customer or firm assets. If material inadequacies come to light, the 

certifying accountant must notify the applicant/registrant, who must notify NFA, the firm’s 

designated self-regulatory organization (DSRO), and the CFTC. 

Each firm registrant or applicant for registration must promptly correct any deficiency or 

inaccuracy in its registration information, including information about its principals and associated 

persons. Only FCMs and non-guaranteed IBs have minimum capital requirements and each of 

these types of firms is required to give immediate notice if it falls below the required on-going 

capital thresholds. Various actions may be taken by the regulators as a result. (See the discussion 

under Principles 22 and 24.) The firm must give notice within 20 days of any new principal of the 

firm. If the principal is not suitable, the regulator may take action against the firm to ensure the 
79 

principal ceases to be associated with the firm. 

Detailed information on firms and individuals is publicly available on the NFA website. 

Information available on the site extends to the disciplinary history of both firms and individuals. 

CTAs may manage client assets on a discretionary basis but they are not permitted to have custody 

of those assets. There are no capital requirements for CTAs. They must keep accurate and current 

records concerning their clients and their activities. They must disclose specific information to 

clients, including the business background of the CTA and its principals who will make trading or 

operational decisions, any material actions against the CTA and 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. The usual warning that past performance does not predict future 

returns must be included if performance information is provided to clients. The disclosure also 

must include a full description of any actual or potential conflicts of interest regarding any aspect 

of the CTA’s trading program and other material conflicts of interest. The general anti-fraud 

standards also apply to disclosures made by these firms. Unlike IAs registered with the SEC, CTAs 

are not automatically fiduciaries, although that standard may apply if the common law tests of trust 

and reliance are met. 

SEC

Any person engaged in the business of effecting transactions in securities for the account of others 

or of buying and selling securities for his own account, through a broker or otherwise, must register

with the SEC as a BD and be a member of at least one SRO. If the BD carries on customer 

business it must be a member of FINRA. State law may require BDs and their personnel to register 

with state securities authorities. 

There are some exceptions from the definition of a BD, including banks engaged in certain limited 

activities, persons trading solely on their own account, and issuers. There are also exemptions from 

the registration requirement for foreign brokers only carrying on limited activities; BDs operating 

only intra-state; or a BD only trading in exempted securities, commercial paper, bankers’ 

acceptances, or commercial bills. 

The application form for a BD requires extensive information about the background of the 

applicant, its principals, controlling persons (defined as having at least 25 percent of the voting 

shares of the company) and employees, the type of business it proposes to engage in and discipline 

history of any of these persons or affiliates. 

To carry on business as an IA (in the business of providing advice, making recommendations, 

issuing reports, or furnishing analyses on securities, either directly or through publications), a 

person must register with the SEC or a state securities authority. There are the usual exceptions for 

banks, lawyers, accountants, journalists, etc. Firms that manage investments on a discretionary 

basis register as IAs. In specified circumstances, an advisor may choose not to register. For 

example there is a de minimis exemption for an adviser that has fewer than 15 clients, does not 

hold itself out generally to the public as an IA and does not act as an IA to a registered investment 

company or certain other persons. 

An adviser is prohibited from registering with the SEC unless the adviser has assets under 

management of US$25 million or more; advises a registered investment company; or is exempt 

from the prohibition by SEC rule or order. Smaller IAs generally must register with the securities 

authorities in the state in which they are organized and in each of the states in which they do 

business as an IA. Note that even if registered with the SEC, IAs are still subject to state laws 

regarding anti-fraud, filing of materials as with the SEC and the payment of fees to states. 

The IA registration process is disclosure based. An IA registers with the SEC by filing an 

application for registration on Form “ADV” under the Advisers Act. The form requires extensive 

information regarding the adviser’s background and business practices. Part II of the Form must be 

provided to the IA’s clients. The SEC may deny registration if a statutory bar is present. (See also 
80 

the discussion under Principle 17.) An assessment of the internal controls, back office capabilities, 

record keeping systems, etc. of applicants for IA registration is not mandatory before registration is 

granted. 

A BD applicant must comply with net capital and other requirements established by SEC rules and 

any SRO requirements that may be higher. FINRA requires most BD employees directly involved 

in investment banking or brokerage sales to register with FINRA and have suitable 

experience/have passed required proficiency exams. 

OTC derivatives dealers are exempt from certain BD requirements such as SRO membership, 

regular BD margin rules and the application of the Securities Investor Protection Act (SIPA). They 

are subject to special requirements including limitations on the scope of their securities activities, 

specified internal risk management and control systems, recordkeeping obligations and reporting 

responsibilities. These dealers may calculate their net capital based on the use of Value at Risk 

models. 

The SEC does not have authority under the Advisers Act to impose initial or on-going capital 

requirements on IAs. Only the IA firm, not the persons who are associated with the adviser, must 

register with the SEC. There are no minimum proficiency standards for individuals acting for an IA 

under the federal regime, although individual states impose requirements as part of their 

registration process. 

FINRA requires applicants to have: 

 financial controls to ensure compliance with the federal securities requirements and the 

SRO’s rules; 

 compliance, supervisory, operational and internal control practices and standards that are 

consistent with those regularly employed in the securities business, for the nature and 

scope of the applicant’s proposed business; 

 appropriate systems of customer protection, risk management and internal controls; 

 a written business continuity plan with procedures that are reasonably designed to enable 

it to meet its existing obligations to customers in the event of an emergency or a 

significant business disruption; 

 a supervisory system, including written supervisory procedures, internal operating 

procedures (including operational and internal controls) and compliance procedures 

designed to detect and prevent violations of the applicable standards; 

 an explicitly delineated supervisory hierarchy, including the designation of a direct 

supervisor for each representative and the assignment of specific supervisory 

responsibilities; and 

 measures to monitor compliance with its policies and procedures under FINRA rules; and 

 a designated chief compliance officer. 

These are checked by FINRA before membership is granted; the SEC does not conduct any 

separate assessment of these matters. The BD is also required to certify annually to FINRA that the 

BD has a process to establish, maintain, test, and modify its supervisory procedures. 

Registered IAs must adopt and implement written compliance policies and procedures (CP&P) 

reasonably designed to prevent the violation of the legislation by the IA or any of its supervised 

persons and address potential conflicts of interest with its clients and other compliance factors 

creating risks for clients. An IA must designate a single chief compliance officer (CCO) to 

administer the CP&P. The CP&P must be reviewed annually by the IA for adequacy and 

effectiveness. These IA requirements apply to registered firms and are not assessed by SEC prior 

to the grant of registration, but may be reviewed on an examination. 

The SEC can refuse an applicant a license as a BD or IA if its application is incomplete, contains 

false information or a statutory bar to registration exists. It may also deny an IA’s registration if the 

firm is prohibited from registering with the SEC. The SEC’s registration decisions are subject to 
81 

judicial review. 

The SEC has the authority to withdraw, suspend or condition a registration if the firm breaches the 

law, has ceased to carry on business or is no longer eligible to be registered. If a new controlling 

shareholder does not qualify for registration, the SEC (and FINRA for BDs) may suspend or 

impose conditions on the firm’s license. 

FINRA is the front line regulator of BDs. The SEC reviews/approves all SRO rules, plus inspects 

its membership and licensing processes. (See the detailed discussion under Principle 7.) Generally, 

IAs are not members of SROs, unless they are also BDs. 

A BD must promptly file an amendment to its registration form if the information changes. An IA 

must file an annual updating amendment to its registration form. Also, the registration form must 

be amended to keep it current. If material information on the form becomes inaccurate, it must be 

amended promptly. There is no specific guidance on what “promptly” means. For IAs, other 

corrections or updates, including a required annual update, must be made within 90 days of the 

IA’s fiscal year end. 

Completed registration forms and annual audited financial statements for BDs are publicly 

available. The form indicates the types of business conducted by a BD, the states and SROs with 

which it is registered and information on its senior managers etc. FINRA maintains regulatory 

information about its BD members and their associated persons and make much of this information 

publicly available on its website. The public may confirm an IA’s registration status with the SEC 

through the SEC’s web site or by consulting the staff. The public may confirm state registration 

status by consulting with the relevant state securities commission. Information on the IA's 

activities, directors, officers and controlling shareholders are set out in its registration form. 

See the discussion of the examination programs that apply to intermediaries set out under 

Principle 10. 

An IA with custody of client funds or securities must hold the client assets at a “qualified 

custodian,” (a similar list of entities as for an eligible custodian for a CIS) and subject to conditions 

regarding segregation of assets, reporting to clients and periodic checks/verifications by an 

independent auditor. The qualified custodian is not required to be at arm’s length to the IA. There 

are also special record keeping requirements that apply to an IA with custody of client assets 

regarding client transactions and positions. 

Part II of Form “ADV” that must be given to clients of the IA must contain detailed disclosure on: 

the adviser’s educational qualifications, relevant industry experience, disciplinary history (if any), 

investment strategies, fee structure and other client charges, potential conflicts of interest, and past 

investment performance. A guarantee of future investment performance would generally be 

unlawful as a fraudulent, deceptive, or manipulative act. Misuse of client assets also would violate 

the anti-fraud provisions of the law. 

IAs are subject to examinations by the SEC using a risk-based assessment model. Those with a 

higher risk profile are placed on a three-year examination cycle. Other IAs are chosen randomly for 

routine examinations and may also be examined as part of cause, sweep or special purpose 

examinations. However, there are over 11,000 IAs registered with the SEC and only about 300 

examiners available. These resource constraints limit the frequency of the reviews of the operations 

of these market participants, particularly for routine reviews. 

Assessment Broadly implemented. 

Comments The standards of this Principle regarding intermediary entry requirements are met for registered 

BDs and FCMs, each of which is required to be a member of an SRO and is thereby subject to 

entry requirements. For other futures intermediaries and IAs there are gaps in the entry 

requirements and/or the process of verification of compliance with those standards prior to 

registration being granted. 
82 

Although the SROs may review certain policies and procedures of an FCM applicant before 

granting registration, there is no general requirement that on-site or off-site examinations of the 

back-office capabilities and internal control of applicants under the CEA be performed, prior to 

registration. The practice at the DCOs, NFA, and DCMs is to conduct such examinations prior to 

granting an FCM membership in the SRO. These reviews are neither required, nor routinely carried 

out for other categories of firms under the CEA prior to registration. Compliance with the required 

standards would be assessed as part of the examination process after the registration was granted. 

FINRA performs these reviews for all BD applicants for membership; no one performs these tasks 

for IA applicants. 

See the comments under Principle 10 above regarding the effectiveness of the examination 

program for firms, particularly for IAs. FINRA should have clear authority to examine and address 

all securities-related activities of members, including their registered IA activities. 

The SEC and the CFTC use differing ownership thresholds to identify those persons who are 

presumed to control an intermediary or applicant. The CFTC requires detailed information be 

provided on all persons who exercise a controlling influence over the firm or, among other things, 

own 10 percent or more of the voting securities of a firm. The BD registration form requires a 

listing of all persons who own more than 5 percent of a firm’s shares and presumes control to exist 

(subjecting the person to detailed scrutiny) where a person owns 25 percent or more of the firm’s 

voting securities. The CFTC’s lower threshold is the one more commonly seen in other 

jurisdictions and adoption of this lower figure by the SEC would enhance the common standards 

across the two agencies. 

If an IA holds or has authority to obtain client funds or securities, those assets are to be held at a 

qualified custodian but the custodian is not required to be independent of the IA. These custody 

rules were under review at the time the assessment was performed. Under the new rules that were 

implemented in March of 2010, additional safeguards are required if the assets are not held at an 

independent custodian. If the custodian is not at independent, the IA must receive an annual report 

from an independent public accountant on the custodian's internal controls on its custody functions 

such as Type II SAS–70. In addition, if the custodian is not independent of the IA and not 

'operationally independent' from the IA, the IA must also engage an independent public accountant 

to perform a surprise examination of client assets during the year. The auditor must certify to the 

SEC that the examination has been completed and describe the nature and extent of the 

examination. If discrepancies are found, the auditor must give notice to the SEC within one 

business day. The independent auditor that prepared the internal control report and performs the 

surprise examination would be required to be registered with the PCAOB and subject to that 

entity’s quality standards and oversight process. The assessors understand that SEC staff is 

reviewing recommendations to enhance the rules governing BD custody of customer assets. 

Principle 22. There should be initial and ongoing capital and other prudential requirements for market 

intermediaries that reflect the risks that the intermediaries undertake. 

Description CFTC 

Only FCMs and IBs must meet the minimum financial requirements that the CFTC prescribes. 

Each FCM and IB must maintain adjusted net capital in an amount that meets or exceeds the 

greatest of several alternative amounts. There are no initial or ongoing capital requirements for 

CPOs or CTAs. IBs do not require capital if their obligations are guaranteed by an FCM and they 

deal only through that FCM. 

For FCMs, the minimum capital requirement is the greatest of: US$250,000; the minimum amount 

of net capital required by the NFA (US$500,000); 8 percent of customer plus 4 percent of noncustomer maintenance margin requirements; or, if an FCM is also registered as a BD by the SEC, 

the amount of capital required by the SEC. For IBs the minimum is the greatest of US$30,000; the 

minimum amount required by the NFA (US$45,000); and for IBs also registered as BDs, the 

amount of capital required by the SEC. The CFTC has proposed substantial increases in these 
83 

minimum capital amounts because as the amounts were adopted in 1996, they do not reflect 

inflation and no longer are consistent with the regulatory objective of requiring registrants to 

maintain a minimum base of liquid capital from which to meet their financial obligations, 

including those to customers. In reality, the capital a firm is required to hold is higher, as there are 

early warning thresholds that must be met that are 10 to 50 percent above these minimum amounts. 

The definition of capital is net liquid capital—current liquid assets (discounted by the required 

haircuts) less all liabilities. The terms and calculations are consistent with those used by the SEC 

for BDs. 

The capital calculation based on maintenance varies with market risks and is directly related to 

increases in margin requirements for the futures and options positions held by the firm. The capital 

calculations require all positions to be marked to market. The CFTC’s net capital regulation 

includes provisions that address certain asset liquidity, funding, and affiliate risks. The capital 

regulation generally addresses these risks by imposing specific deductions (or haircuts) on the 

value of assets for purposes of determining whether the firm meets minimum capital requirements. 

Funding risk is reflected through the application of a haircut on proprietary futures and options on 

futures positions that is equal to 100 percent or more of the margin requirement of the position, and 

a haircut for margin calls made to customers and non-customers (generally affiliates) that are not 

satisfied within a brief period of time (no more than three business days). The regulation also 

includes a calculation that is tied to a percentage of the risk maintenance margin requirements of its 

customers and noncustomers, which results in increased capital requirements as the amount of such 

required risk margin increases. Unsecured receivables, including unsecured receivables from 

affiliates, are also generally subject to a 100 percent haircut. There are no express capital 

requirements to cover other types of risk. However, the early warning threshold requirements and 

the 100 percent margin requirement for proprietary positions do provide an additional capital 

buffer to address these other risks. These capital requirements, coupled with the requirements for 

strict segregation of client assets, have permitted orderly wind-downs of firms without loss to 

customers or disruption to the market attributable to the registered firm. 

Each FCM and IB must be in compliance with applicable capital requirements at all times and 

must be able to demonstrate such compliance at any time. Capital and segregation requirements 

must be calculated daily and any deficiency rectified and reported immediately. There are also 

detailed recordkeeping requirements relating to the financial condition of FCMs and IBs and to the 

customer funds held by FCMs. 

An FCM must provide detailed monthly reports on its financial condition to its regulators (the 

CFTC and its SROs). IBs provide the same reports semi-annually. FCMs that are also BDs with the 

SEC may file the financial reporting form used by the SEC (the FOCUS report) with the CFTC, 

rather than the using the financial reporting form required under the CEA. The SEC does not 

accept the CFTC form for BDs that chiefly are FCMs. 

Ongoing financial and other supervision of FCMs and IBs that are members of more than one SRO 

are shared by the relevant SROs, with the NFA primarily responsible for FCMs that are not 

members of a DCM. 

FCMs and IBs are subject to independent audit requirements. In addition, the audit must include 

tests of the accounting system of the firm, its internal accounting controls, and its procedures for 

safeguarding customer and firm assets. The audit procedures must provide reasonable assurance 

that any material deficiencies will be discovered. If deficiencies are found, the auditor must notify 

the firm, which must then notify the regulators. 

The NFA and other SROs conduct regular on-site exams. All of the futures SROs participate in the 

Joint Audit Committee (JAC). JAC has issued a joint audit program. NFA's audit modules follow 

the objectives established by this program. The JAC program is used for FCMs that are members 

of an exchange (regardless of whether the FCM is a member of multiple exchanges). Every 

member firm is to be inspected every 9 to 18 months. The CFTC does not have a routine 
84 

examination program, but might conduct an on-site exam for cause. 

If material deficiencies in capital are found, the firm’s business may be restricted or other actions 

taken by the firm’s DSRO or the CFTC. They have authority to impose more frequent reporting 

requirements and/or restrictions on the intermediary’s business and/or a requirement to transfer 

accounts to another FCM. For example, Bear Stearns was subject to daily reporting after its capital 

dropped 45 percent. (See the discussion under Principle 24.) Note that equity withdrawals of less 

than 30 percent of excess capital only require notice to the regulators after the fact. Prior notice is 

otherwise required. The CFTC has the authority to deny a request for a withdrawal. 

Affiliate risk generally is addressed through mandatory reporting and filing requirements. Further, 

the capital calculations of FCMs and IBs must exclude from their current assets any deposits at 

affiliates, whether licensed or not. Also, certain off-balance sheet items must be reported as noncurrent assets in the capital computations of FCMs and IBs. There are operational requirements 

that address management of the risks that may be posed by FCM affiliates. The CFTC is 

authorized to obtain information about affiliates of an FCM that might jeopardize the FCM’s 

ability to meet financial requirements or to otherwise remain in business. FCMs are required to 

monitor their affiliates whose activities are reasonably likely to have a material impact on the 

FCM’s financial or operational condition. The FCM’s risk assessment filings identify who its 

affiliates are and the regulators have the authority to ask for additional detailed information from 

the FCM. 

SEC 

There are capital requirements only for BDs, not for firms that are just IAs, even if the IA has 

custody of client assets. The Net Capital Rule (NCR) requires that all BDs maintain certain 

minimum level of liquid net assets at all times. All BDs are subject to the NCR. If a firm’s net 

capital falls below the level required, the firm must cease doing securities business 

The minimum dollar amount of net capital applicable to BDs differ based upon the types of 

business each firm engages in and the perceived relative risk associated with these activities. A 

firm’s net capital requirement may be determined using either the standard or alternative method. 

In both cases, the firm must calculate its liquid assets using the formula set out in the NCR. Among 

other things, the formula applies haircuts (or discounts) to the value of assets on the BD’s books 

based on the nature of those assets (their liquidity, market and credit risks). For example, nonmarketable securities are generally subject to a 100 percent haircut/discount. The standard method 

requires the firm to have liquid net assets greater than the minimum dollar amount specified, which 

varies based on the nature of the business undertaken by the BD. This minimum amount varies 

from US$5,000 to US$250,000. In addition, the BD’s aggregate indebtedness to all other persons 

must not exceed 800 percent (for its first year of operation) or 1500 percent (thereafter) of its liquid 

net capital. 

If the BD elects to use the alternative method, the BD must maintain net capital of at least the 

greater of US$250,000 or 2 percent of aggregate customer debit items. This method was designed 

primarily for firms that hold customer assets and the debit items tend to increase with the amount 

of customer business a firm does. This method is used by many of the larger firms. The aggregate 

indebtedness limit of the standard method does not apply to these firms, 

The NCR also permits OTC derivatives dealers and certain other BDs to calculate their net capital 

using Value at Risk models. The use of this method by BDs that are not OTC derivatives dealers is 

subject to several conditions, including the supervision of the BD's ultimate holding company. The 

holding company supervision focuses on its financial and operational condition and its risk 

management methodologies, with the aim of reducing the likelihood that weakness at the holding 

company will destabilize the BD or the financial system as a whole. Under the SEC rules, a BD’s 

holding company and its affiliates (known as consolidated supervised entities, or CSEs) may elect 

to be subject to group-wide SEC supervision. In electing to operate under this program, the holding 

company must, among other things, compute its group-wide capital monthly in accordance with 
85 

the Basel standards. However, there are no such firms as of February 2010. 

All SROs may set capital requirements for BDs at higher levels than the NCR. SROs also may 

prevent a firm from expanding its business or otherwise limit its business to the extent that the firm

fails to maintain sufficient levels of net capital. For example, FINRA prohibits a member from 

expanding its business when its net capital is less than 150 percent of its minimum requirement and 

that condition has existed for more than 15 consecutive business days. 

Customer assets must be segregated from proprietary assets so that if liquidation were to occur, 

customer assets would not be available to the creditors of the BD. This customer protection rule 

requires BDs to maintain a reserve account that contains at least the net dollar amount of cash the 

BD owes to its customers. This may be held in cash, U.S. government securities or those securities 

guaranteed as to principal and interest by the U.S. government. 

On one recent large failure of a BD and its affiliates, eligible customers of the BD were made 

whole through a combination of these requirements and Securities Investor Protection Corporation 

(SIPC) coverage, but markets were disrupted and counterparties did lose money. The failure of the 

group had a significant impact on global markets. Adjustments may be necessary to address 

funding, liquidity and affiliate risks, particularly under stress, more directly. The assessors 

understand the relevant capital and related rules are under review by the SEC. 

Capital levels are monitored through filing of periodic and annual reports by the BD and through 

on-site inspections. Monthly or quarterly reports on capital calculations must be filed with FINRA 

within 17 days after the period end. The BD must give prompt notice to the SEC and FINRA if it 

breaches one of the early warning threshold tests (net capital below 120 percent of minimum or 

below 5 percent of aggregate debit items). Generally, the equity capital of a BD may not be 

withdrawn without written notice to the SEC, the SRO and, if applicable, the CFTC. 

An audited annual report must be filed with the SEC and SRO within 60 days of year end. 

Financial statements must be audited by an independent public accountant meeting the same 

qualifications and tests for independence as for auditors of securities CIS and issuers. The auditor 

must review the firm’s accounting system, internal accounting controls, and the procedures for 

safeguarding customer funds or firm assets. There is a similar reporting obligation on the auditor, 

as for the auditor of CIS and public issuers, if deficiencies are found. 

FINRA inspects its BD members periodically; the frequency of examination depends on the types 

of business the BD engages in and the perceived risk of those businesses. For instance, FINRA 

inspect BDs that hold customer funds and securities at least once every year. Other BDs are subject 

to less frequent on-site examinations. In addition, the FINRA reviews a BD’s capital levels when 

periodic reports are filed. 

If a BD is in violation of the NCR or the customer protection rule, it must cease to conduct 

securities business and must give its regulators immediate notice. The regulators may restrict the 

ability to withdraw capital from the BD if certain parameters have been broken and the SRO may 

restrict the activities that the BD may carry on or require the BD to reduce the business on its 

books. The SEC may also petition the court to place a freeze on the BD’s assets. More frequent 

reporting may also be ordered.

The NCR requires that a BD consolidate, 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. The NCR also requires 

deductions of affiliate positions. 

In addition, BDs are required to have policies, procedures, or systems for monitoring and 

controlling financial and operational risks to the BD resulting from activities of affiliates whose 

“business activities are reasonably likely to have a material impact on the financial and operational 

condition” of the firm. Included in these requirements are risk management policy information, 

financial data (including consolidating and consolidated financial statements, securities, and other 
86 

financial product position data) and financial instruments with off-balance sheet risk, among other 

things. BDs are required to report quarterly on these matters. 

Assessment Partly implemented. 

Comments The capital rules on both the securities and futures sides are focused on ensuring customers are 

protected on the failure of a firm. The rules address market risk, credit risk, certain operational and 

funding risks and asset liquidity and certain operational risks faced by the firm. The formulae are 

conservative in their treatment of assets and liabilities. This conservatism, coupled with the higher 

early warning thresholds produces capital buffers that provide additional cover for other risks not 

expressly addressed, such as broader operational risks (e.g., reputational and legal risks). However, 

in common with many other jurisdictions, these latter risks are not specifically addressed in the 

capital formula. In particular, the recent crisis highlighted issues relating to the impact that 

reputational, funding and liquidity risks may have on regulated firms, particularly under stress. A 

re-evaluation of the capital rules, risk management expectations and other prudential requirements 

imposed on FCMs and BDs in light of recent circumstances is warranted. 

Further, the treatment of affiliate risk would bear reexamination and strengthening, through some 

combination of changes to the capital rule, enhanced risk management requirements or other 

regulatory or oversight mechanisms. In particular, all aspects of the exposure to risk at the 

regulated firm when a related company is in trouble may not be reflected fully. The SEC’s 

temporary rules on reporting of affiliate exposures (Rules 17h-1T and s17h-2T) should be finalized 

as soon as possible, a project we also understand to be in train, although the assessors understand 

that their temporary status does not affect their enforceability. 

The current CFTC capital formula for firms registered with both the CFTC and SEC may not 

reflect fully the scope of the customer activity by both securities and futures customers as it only 

mandates the higher of the CFTC or SEC capital amounts—not the combined amount of the two 

sets of requirements. 

Because unsecured receivables associated with uncleared OTC positions are excluded as assets 

under regulatory capital rules, while payables are counted as liabilities, uncleared OTC derivatives 

are rarely carried in an entity registered as an FCM or BD (other than an OTC derivatives dealer). 

There are proposed changes to the futures capital rules to address gaps with respect to cleared OTC 

derivatives transactions and improve the sensitivity of the formula to the actual risks undertaken by 

the firm which would be helpful. 

The crisis brought to light weaknesses in the regime governing investment bank holding 

companies. The conversion of the remaining entities into bank holding companies has, in practice, 

eliminated the pressure to address these issues at the SEC level at the present time. The wider 

challenge of the effective supervision of global financial conglomerates is an issue in many 

jurisdictions. 

As noted by the Joint Report, the segregation and margining rules under the futures and securities 

regimes operate differently and serve different purposes. The treatment of the segregated accounts 

also differs on a bankruptcy. The introduction of risk-based portfolio margining where the margin 

requirements take into account offsetting positions in related instruments in one account highlight 

the need for reconciling the two regimes. 

Also, the recent crisis highlighted some concerns that the risks associated with custody of client 

assets may not be addressed fully. There are deductions for assets held at affiliates, but the risk of 

failure of other depositories holding client cash may not be fully reflected in the various applicable 

rules. 

For futures firms, margin requirements for particular contracts are set by the exchanges, not the 

CFTC. At the very least, the CFTC should have authority to review and approve/disapprove these 

requirements. 
87 

The audit of a market intermediary may require someone who has experience in the area. 

Consideration should be given to requiring the audit partner in charge of the audit have some 

relevant experience. Specific information on the auditor used by a market intermediary should be 

obtained as part of the application process and tracked so that problem auditors may be identified 

more easily. 

Principle 23. Market intermediaries should be required to comply with standards for internal organization and 

operational conduct that aim to protect the interests of clients, ensure proper management of risk 

and under which management of the intermediary accepts primary responsibility for these matters.

Description CFTC 

FCMs and IBs that are not guaranteed by an FCM are required to provide certified financial 

statements to the regulators prior to registration and on an ongoing basis. (See the description of 

the scope of the certification process described under Principle 21.) Further, FCMs may be 

required to provide the regulators with current organizational charts that identify affiliated persons; 

written policies, procedures or systems concerning methods for monitoring and controlling 

financial and operational risk, capital adequacy, internal controls with respect to market, credit and 

other risks relating to proprietary and non-customer clearing activities; and fiscal year-end 

consolidated financial statements. The ongoing review of the firms’ internal controls etc. falls 

within the scope of the SRO audit and surveillance obligations. There is no requirement for an 

independent periodic evaluation of internal controls and risk management processes for FCMs and 

IBs other than those associated with the certified financial reporting requirements. 

FCMs must separately account for customer funds in their records and segregate these funds from 

their own funds and those of related persons. The amount in segregation must equal 100 percent of 

the gross account equity of all customers; the value of any under-margined account must be made 

up from the firm’s own funds. FCMs may pool all customer funds in a single account that is clearly 

identified as belonging to customers. Customer funds must be deposited by the FCM with a bank, 

trust company, DCO, or another FCM and the depository must acknowledge that these are 

customer funds. The depository does not have to be at arm’s length to the FCM and the other 

requirements do not address the risk of failure of a depository. Proprietary positions held at an 

affiliated depository may not exceed a specified threshold; assets above the threshold attract a 

100 percent capital requirement. Segregation calculations must be done daily, any deficiencies 

rectified immediately and the FCM must give immediate notice to the CFTC and DSRO if it is not 

in compliance with these requirements. 

The only disclosure document required to be provided to clients is an extensive risk disclosure 

statement and the firm must keep the clients’ signed acknowledgements of receipt of the 

statements. Customers generally may obtain written contracts, although the specific form and 

content of the agreement are not mandated. 

The NFA has a Know-Your-Customer (KYC) rule that is tailored to the requirements of the futures 

markets. Unlike the securities industry where investors can purchase instruments with varying 

degrees of risk and that serve very different investment objectives, all futures contracts are highly 

volatile and risky instruments. In the futures market, the suitability determination has to be made 

on a customer by customer basis rather than on a contract or transaction basis. The KYC rule 

requires extensive information about each customer be obtained before opening an account. Based 

on that information, the FCM has to make a judgment whether the customer requires additional 

risk disclosures beyond the standard information required by CFTC regulations or to refuse the 

account because futures trading are too risky for that customer. This standard applies even if the 

FCM makes no recommendations to the customer. Further, the NFA has a rule that governs both 

oral and written communications. Among other provisions, it prohibits misleading or high-pressure 

communications. 

FCMs must provide each customer with a monthly account statement regarding the details of 

transactions in the account, as well as charges and credits to the account. The FCM also must 
88 

provide confirmation statements of each transaction by the next business day following the 

transaction. For customers of an IB, the carrying FCM provides these statements. 

CFTC regulations and NFA rules require each registrant (except an associated person 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. There is no requirement that 

any specific person or group have overall responsibility for compliance with regulatory and legal 

requirements. There is no requirement for a CCO at any futures intermediary. NFA rules do require

that a principal subject to NFA jurisdiction be in charge of firm activities such as review of 

promotional material, review of financial statements and certification of annual questionnaires. 

There are extensive books and records requirements for FCMs and IBs. More limited requirements 

apply to CPOs and CTAs. Further, there are specific requirements that relate to customer 

protection, risk disclosure, financial and other recordkeeping and net capital compliance. However, 

the CEA and CFTC regulations do not require intermediaries to adopt specific internal and risk 

management controls outside of these requirements, nor do they require the testing of these 

controls, other than through the certification of financial statement requirements. The NFA requires 

its members to conduct a formal review of their operations on a yearly basis. 

With respect to risk management, the CFTC’s Risk Surveillance Group (RSG) conducts extensive 

review and analysis of risks posed by traders, FCMs, and DCOs, including assessment of their risk 

management practices. On a daily basis, the RSG endeavors: (i) to identify significant financial 

risks from positions in products that an FCM clears through a DCO and fall within the jurisdiction 

of the CFTC; and (ii) to confirm that such financial risks are being appropriately managed. The 

RSG undertakes these tasks at the trader level, the firm level and the clearing level. It identifies 

both traders that pose risks to FCMs and FCMs that pose risks to DCOs. It also reviews financial 

resources and risk management practices at traders, FCMs and DCOs. 

FCMs and IBs are required 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. CTAs and CPOs are subject to 

mandatory conflict of interest disclosure requirements. There is no general requirement that would 

require all intermediaries to avoid, or establish procedures to mitigate, conflicts of interests with 

their clients. 

SEC 

There are rules that require all BDs to have appropriate controls in place to protect the interests of 

their clients and to manage risk properly. In addition, a BD that is an OTC derivatives dealer must 

have a system of controls to manage the full range of risks associated with its business activities, 

including market, credit, leverage, liquidity, legal, and operational risks. 

The SEC does not have specific standards that a BD’s risk management procedures and internal 

controls must meet. So long as the relevant systems in place at the BD facilitate its compliance, 

they are considered to be adequate by the SEC. Under FINRA rules, each firm must implement a 

supervisory system reasonably designed to achieve compliance with applicable securities 

requirements and that includes designation of one or more persons responsible for reviewing the 

BD’s supervisory system and taking action to achieve requisite level of compliance. FINRA 

requires a BD to appoint a chief compliance officer. 

IAs must disclose information on its management on Form “ADV.” They also must have in place 

CP&P and are required to appoint a chief compliance officer. All supervisors, including senior 

management, are subject to liability for failure to supervise. 

Every BD is required to periodically inspect all aspects of its business. An examination of the 

accounting system, the internal accounting controls, and the procedures for safeguarding securities 

are included in the scope of the annual audit and must be certified by the auditor, who must be 

registered with the PCAOB. Owing to some gaps in the relevant legislation, the PCAOB does not 
89 

have authority to oversee the activities of a BD auditor. 

An IA’s CCO is not independent, but must have enough seniority and authority to conduct an 

independent compliance review and compel others to comply with the CP&P. Only an IA with 

custody of client assets who chooses to send account statements directly to its clients must have an 

independent public accountant verify all of those funds and securities by actual examination at the 

custodian at least once each year. Other IAs do not to have their controls assessed or to report 

material breakdowns in controls to senior management or to the regulator. 

Generally BD customer agreements require that disputes be arbitrated. FINRA rules require its 

members to arbitrate any eligible dispute submitted by a customer. BDs are required to keep 

records of client complaints. An IA is not required to provide a particular mechanism for the 

resolution of investor complaints. Customers of IAs may have private rights of action under 

securities legislation or otherwise. 

Both the SEC and FINRA have extensive rules governing holding of client assets designed to 

ensure they remain separate from those of the BD—covering recordkeeping, segregation, use of 

free credit balances, and excess securities in margin accounts. See the description in Principle 21 

regarding IA custody requirements. 

BDs must obtain KYC information regarding customers when accounts are opened, including the 

customer’s employment status, net worth, annual income and investment objectives and for each 

cash and margin account, the name and address of the beneficial owner of the account. Also, BDs 

have an obligation to recommend only those specific investments or overall investment strategies 

that are suitable for their customers. The concept of suitability also appears in FINRA rules. 

Registered IAs 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. AML 

requirements apply to BDs and some CIS, but not IAs. 

Written contracts are only required for certain types of BD accounts (e.g., margin, options, and 

discretionary accounts). In practice, many firms have a client agreement to ensure that they are 

able to enforce contractual provisions against the customer, such as arbitration clauses. FINRA 

requires prior written authorization for discretionary trading. The investment advisory contract is 

the basis for the relationship between the IA and its clients. The legal framework specifies items 

required to be or prohibited from being included in an investment advisory contract, but there is no 

prescribed form of contract. 

BDs must provide clients with specific risk disclosure statements for certain types of trading (such 

as options and futures) in the secondary market. They also must make available prospectuses for 

new issues and conflict of interest disclosure statements. A BD is required to send its customers 

written trade confirmations, account statements (monthly if options are held, otherwise quarterly) 

and other reports disclosing activities and transactions it has taken on the customer’s behalf. 

Registered IAs are not required by statute to provide their clients with any specific documents etc. 

other than Part II of Form “ADV.” An IA’s duty to provide other documents to its clients (such as 

confirmations, statements and proxy related materials for securities held in the account) depend on 

the terms of its client contracts. There is no general requirement that IAs send account statements 

to their clients. The BD that is used to carry out trades would be responsible for generating these 

documents. However, many IAs do send monthly or quarterly client account statements. Only IAs 

who hold client assets must send statements at least quarterly setting out specific information about 

the client’s assets and transactions during the period. 

The SEC and FINRA have detailed rules regarding the books and records that a BD must keep. 

BDs are required to maintain these books and records for specific periods of time and to produce 

such records promptly to examiners. There are also simpler recordkeeping requirements imposed 

on IAs to maintain business accounting records as well as those that relate to the fiduciary nature 

of its business. 
90 

A BD has a duty of fair dealing towards its customers and is also required under FINRA rules to 

observe high standards of commercial honor and just and equitable principles of trade, which 

include the suitability obligation, engaging in fair and balanced communications with the public, 

providing timely and adequate confirmation of transactions, providing account statement 

disclosures, receiving fair compensation, disclosing material information, charging prices 

reasonably related to the prevailing market, fully disclosing any conflicts of interest and giving 

customers the opportunity to resolve disputes through arbitration. There also are requirements to 

limit conflicts of interest on investment research. Further, BDs must disclose to their customers if 

they have any control, affiliation or interest in a security they are offering or with the issuer of the 

security. Finally, a BD has a legal duty to seek to obtain best execution of customer orders. 

A BD may have a fiduciary duty to its clients under certain circumstances, either under state 

common law which varies by state, or otherwise. Generally, courts have held that BDs that 

exercise discretion or control over customer assets, or have a relationship of trust and confidence 

with their customers, owe customers a broad fiduciary duty similar to that imposed on IAs. 

An IA is subject to a fiduciary duty to act in the utmost good faith with respect to its clients. An IA 

is required to treat all clients fairly where conflicts of interest arise between several of the firm’s 

clients and have written procedures in place to prevent the misuse of material non-public 

information by the IA or any associated person. 

Assessment Broadly implemented. 

Comments Given the experiences of the recent crisis, a reexamination of the risk management expectations for 

BDs and FCMs, particularly with regard to management of liquidity, funding, and reputational 

risks, is warranted. 

All licensed futures intermediaries (FCMs, IBs, CPOs, and CTAs) should be required to avoid, or 

establish procedures to mitigate, conflicts of interests with their clients. FCMs and IBs should be 

required to disclose conflicts of interest to their clients. 

There may be a need to reassess the disclosure provided to investors regarding complex structured 

products, to ensure they receive sufficient current information to make informed investment 

decisions. (See also Principle 14.) 

See the comment above under Principles 17 and 21 regarding IAs holding client assets at nonarm’s length custodians. Note also, that very few IAs are subject to any sort of audit requirement 

so there is no routine outside confirmation (other than by the SEC through its examination 

program) that they have the appropriate internal controls in place, even to ensure the requirements 

regarding not holding client assets are observed. However, for those IAs that are also operators of 

CIS subject to the ICA, some additional review of the appropriateness of internal controls comes 

from the CIS board (including its independent directors), the CCO, and periodic certification by 

CIS officers with respect to certain internal controls. 

See also the comments above under Principle 22 regarding the general risks associated with where 

the client assets are held and the lack of limitations that apply if the depository is at arm’s length to 

the FCM or BD. 

Principle 24. 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 

The CFTC has a contingency plan in place to address failures of FCMs. The CEA and CFTC 

regulations, in conjunction with the Bankruptcy Code, provide a clear framework for the CFTC to 

follow in managing the failure of an FCM. Part 190 of the CFTC’s regulations and Chapter 7, 

Subchapter IV of the Bankruptcy Code specifically addresses failures of commodity brokers, 

including FCMs. The CFTC may apply to court for the appointment of a receiver. Customers of a 
91 

failed firm are notified as part of the process under the framework. 

The FCM must notify the CFTC upon the occurrence of one of a number of events, any of which 

may indicate financial distress. CFTC has the power to restrict activities of an FCM in financial 

difficulty, require accounts to be transferred or apply to have assets frozen or for the appointment 

of a receiver/monitor etc. 

Derivatives Clearing Organizations (DCOs) also have default rules and processes in place to 

manage the obligations of failing/failed FCMs to minimize the impact of the failure on other 

participants. These rules may permit the DCO to access a guarantee fund held at the DCO. These 

default procedures include notices to other participants. 

As a matter of practice, on a failure there are frequent conference calls among affected regulators 

and exchanges, both domestic and foreign. 

SEC 

There is a contingency plan at the SEC for responding to a BD failure. If the SEC staff have 

concerns about a broker-dealer they will send examiners into the firm to determine if a selfliquidation is possible. If a firm’s net capital falls below the required level, the firm must 

immediately cease doing securities business and must give notice to SEC and its SRO. If a BD fails 

or is in danger of failing to meet its obligations to customers and the firm is insolvent or not in 

compliance with applicable financial responsibility rules, the BD will be liquidated under SIPA if a 

self-liquidation is not possible. As far as possible, client accounts are transferred quickly to another 

firm. 

There is no general disclosure requirement that would apply to all cases of financial difficulty. If 

the firm is a public company, the usual prompt public disclosure of material change standard would 

apply. Also, a BD is required to tell clients if their accounts have been transferred. 

SIPC is available to compensate investors if their assets or cash are not available when a BD fails. 

SIPC does not cover IAs. 

The legislation does not provide expressly for the SEC to take action if an IA is in financial 

difficulty. The SEC only has the power to intervene if an IA’s financial difficulties are related to a 

violation of the federal securities laws. If so, the SEC can request that a federal court appoint a 

monitor, receiver, curator or other administrator.

The SEC would not provide notice to an IA’s clients or the general public about an IA’s financial 

condition. Information about an IA’s financial condition may otherwise be public via Form “ADV”

disclosures as IA may have obligations to disclose it is in ‘precarious financial condition’. 

See the detailed discussions under Principles 11 and 12 regarding cooperation with other 

regulators. For example, on the failure of the Lehman Brothers group, there were daily 

conversations among the regulators involved in winding up the regulated firms. 

Assessment Fully implemented. 

Comments The crisis brought to light weaknesses in the regime governing investment bank holding 

companies. The conversion of the remaining entities into bank holding companies has, in practice, 

eliminated the pressure to address these issues at the SEC level at the present time. 

As noted by the Joint Report, the treatment of segregated accounts under the futures and securities 

regimes differs on a bankruptcy. The introduction of risk-based portfolio margining and greater 

overlap between futures and securities activities highlight the need for reconciling the two regimes.

Principles for the Secondary Market 

Principle 25. The establishment of trading systems including securities exchanges should be subject to 

regulatory authorization and oversight. 
92 

Description See Principle 7 for a description of the legislative and regulatory framework governing 

authorization and oversight of SROs generally, including exchanges. 

CFTC 

Apart for the exceptions described below, 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. The CFTC analyzes the DCM application before deciding to grant or reject the application. 

The CEA establishes the basis for requiring markets to register. Criteria, procedures, and 

requirements for designation as a DCM are set out in the CEA and CFTC regulations. A DCM may 

list for trading futures or option contracts based on any underlying commodity, index, or 

instrument. However, there are special requirements for security futures products, which are 

subject to joint CFTC/SEC oversight under rules promulgated by these agencies in 2001. 

One category of trading system is not subject to regulatory authorisation as required by the 

Principle Methodology—ECM and another category is exempt from both authorisation and 

oversight—EBOT. ECMs are merely required to notify the CFTC that they intend to operate under 

the exemption provided in Section 2(h)(3) of the CEA and they must comply with the requirements 

of the exemption provision. An ECM becomes a registered entity, like a DCM, and is subject to 

greater oversight by the CFTC only after the CFTC makes a formal determination that a contract 

traded on an ECM is an SPDC. This determination has been made for one contract on one ECM. 

For EBOTs, the only requirements that apply are limited anti-fraud and anti-manipulation 

provisions. 

Under the CFTC’s regulations, an applicant for contract market designation must provide 

substantial documentation for the CFTC’s approval. A DCM is required to establish and enforce 

appropriate fitness standards for directors, members of any disciplinary committee, members of the 

contract market and any other persons with direct access to the facility. DCMs are required to 

adopt and enforce rules for ensuring the financial integrity of transactions and the market integrity 

of the trading mechanism. The CFTC provides detailed guidance on all areas of the designation 

criteria as to the standards it expects an applicant for designation to meet. The CFTC has further 

stated that it believes that the guidelines issued by IOSCO in 1990 (“Principles for Screen-Based 

Trading Systems”) and adopted by the CFTC on November 21,1990 as supplemented in 

October, 2000, are appropriate guidelines for an electronic trading facility to apply to electronic 

trading systems. 

As regards new products and new or amended rules, the CFTC is required to be informed of the 

types of products to be traded through the two listing methods—self-certification (as discussed 

under Principle 7) and CFTC prior approval. The latter is only mandatory for certain listed 

agricultural commodities. There are also formal listing requirements that must be satisfied for 

security futures products as part of joint CFTC/SEC oversight. Except for certain enumerated 

agricultural commodities a DCM may also implement most new rules and rule amendments by self 

certification.

Fair access to the exchange is established via Designation Criteria, Core Principles, Acceptable 

Practices, and CFTC-adopted guidance. As regards competition, a DCM must endeavour to avoid, 

unless necessary or appropriate to achieve the purposes of the CEA, adopting any rules or taking 

any actions that result in any unreasonable restraints of trade; or imposing any material 

anticompetitive burden on trading on the contract market. 

The fairness, consistency and transparency of order routing procedures and execution rules are set 

out in the Designation Criteria, Core Principles, and CFTC guidance. A DCM is required to store 

all identifying trade information in a manner that enables the contract market to use the 

information for purposes of assisting in the prevention of customer and market abuses and 

providing evidence of any violations of the rules of the contract market.
93 

SEC 

Exchange Trading Systems 

An exchange must register with the SEC as a national securities exchange, or be exempt from 

registration, before it may begin operations. The Exchange Act sets forth the SEC’s responsibilities 

and obligations upon the filing of an exchange application. Once registered, a national securities 

exchange becomes an SRO. See Principle 7 for a description of the legislative and regulatory 

framework governing authorization and oversight of SROs generally. 

In addition to the rules that applies to SROs generally as set out under Principle 7, the SEC reviews 

exchange applications against criteria specific to the provision of a secondary market, such as 

relevant information about the operators of any electronic trading system that is used to effect 

transactions; the operation of the trading system, including, among other things, the means of 

access; the procedures for entering and displaying quotes; procedures for order routing and 

execution and reporting; and clearing and settling transactions for reliability, resilience, and 

fairness; record keeping; and emergency powers. The SEC seeks to ensure, among other things, 

that an applicant’s rules do not confer unfair trading advantages of members over non-members, or 

investors generally. 

The SEC also requires, among other things, a list of members and a schedule of all securities listed 

on the exchange or association; all securities traded on the exchange or association pursuant to 

unlisted trading privileges; all securities exempt from registration and traded on the exchange or 

association; and other securities traded on the exchange or association. 

In addition to satisfying the requirements of the Exchange Act, a prospective exchange or 

association must demonstrate to the satisfaction of the SEC prior to authorization its ability to 

operate as part of the national market system as set out in Regulation National Market System 

(NMS). Regulation NMS contains rules that, among other things, require trading centers to avoid 

trading through the protected quotations of other trading centers that display automated quotations. 

Non-exchange Trading Systems 

In addition to exchanges and associations, ATSs operate electronic trading markets. An ATS can 

register as an exchange or a BD. If an ATS chooses to register as a BD, it must be a member of an 

SRO and comply with additional reporting and record-keeping requirements set out under 

Regulation ATS. Like any other BD, an ATS must have sufficient clearing capabilities in place by 

either becoming a member of a registered clearing agency, or being affiliated with a member of a 

registered clearing agency through which the ATS can clear and settle trades. ATSs registered as 

BDs are subject to FINRA rules in addition to Regulation ATS and other SEC rules governing 

BDs. 

An ATS that trades 5 percent or more of the volume in a national market system security must: 

 

 be linked to a national securities exchange or registered securities association so that the 

best priced orders in that security that are placed in the ATS and are displayed to more 

than one subscriber are also disseminated into the public quote stream and provide access 

to such orders that is equivalent to that of other orders displayed by the exchange or 

association; and establish objective standards to grant or deny access to the trading system 

(with respect to that security) and apply them in a non-discriminatory manner. 

In addition, an ATS must comply with the rules that govern execution priority and obligations that 

are imposed by the SRO to which the ATS is linked. If an ATS has 20 percent or more of the 

trading volume in any single national market system security, the ATS must follow certain 

procedures to ensure adequate systems capacity, integrity, and contingency planning. Currently, no 

ATS has reached this threshold and in some cases, actively manage their system to avoid 

exceeding the 20 percent limit. 
94 

Cross Trading System Issues 

Continued compliance with the initial registration requirements is a condition for continued 

registration. Registered exchanges and associations are required to maintain rules, policies and 

procedures consistent with their statutory obligations and to have the capacity to carry out their 

obligations and prevent fraudulent and manipulative acts and practices. ATSs that meet the volume

thresholds in the rules must publicly disseminate their best priced orders, limit the fees they charge, 

and satisfy certain system capacity, integrity, and security standards. 

The SEC has an Automation Review Program (ARP). Staff conducts reviews on application and 

subsequently (at least annually) of the information technology systems operated by the exchanges, 

clearing agencies and certain ATSs that publicly display quotations (electronic communications 

networks or “ECNs”) to evaluate whether the systems have sufficient capacity and resiliency to 

accommodate conditions of increased volume and disruptions to normal operations. 

All exchanges and ATSs are required to have rule and procedures governing audit trails to aid in 

the surveillance of their market. In general, an audit trail requires information about the parties to 

the trade, the security, the type of order, the time of the trade, the number of shares to which the 

order applies and the price of the trade. 

Exchanges and ATSs are required to make available to the public monthly electronic reports that 

include uniform statistical measures of execution quality. 

FINRA and the SEC have emergency powers, including trading halts, trading suspensions, and the 

SEC’s emergency authority and market closure decisions. The exchanges can impose trading halts 

and suspensions for a variety of reasons. An exchange also has the authority to suspend trading in 

all securities on that market, adopt abbreviated trading hours or close the exchange if such actions 

would be in the public interest. The listing standards of the exchanges address when a listed 

company is required to notify the exchange of certain material events. 

The listing of new products is normally subject to the rule filing and approval process described in 

Principle 7. However, the SEC allows certain new derivative securities products to be listed 

without a proposed rule change if: 

 the product meets the definition of “new derivative securities product” set out in the rule; 

 the exchange that introduces the product has established generic trading rules, procedures 

and listing standards for the product class that would include the new derivatives 

securities product; and 

 the SEC has approved the SRO’s standards. 

The SEC also has the power to issue rules governing the trading of a product, rather than 

reviewing proposed rules filed by an SRO. It also has broad authority to amend the rules of an 

SRO as it deems necessary or appropriate to insure the fair administration of the SRO and to 

conform its rules to the requirements of the Exchange Act. 

Fair Access 

As discussed under Principle 7, an exchange or association’s ability to deny membership to its 

market is limited. ATSs are required to provide fair access to their systems only if they meet 

certain volume thresholds. For example, an ATS is subject to fair access with respect to a national 

market system stock only if it trades five percent or more of the stock’s average daily volume over 

four of the previous six months. The SEC has provided a broader exemption for one ATS using its 

exemptive authority under the Exchange Act. 

Assessment Broadly implemented. 

Comments CFTC 

The powers of the CFTC over the authorization of DCMs raise no significant issues as regards the 
95 

IOSCO Principles. Issues concerning oversight are dealt with under Principle 7. However, the lack 

of an authorization power over ECMs and Exempt Boards of Trade (EBOTs) is not consistent with 

Principle 25. It should be noted that under the OTC derivatives legislation recently passed by the 

U.S. House of Representatives, and in the discussion draft versions of OTC legislation offered by 

the U.S. Senate Banking Committee, both the ECM and EBOT market categories would be 

abolished. Ongoing oversight, at least of ECMs, is no longer a significant issue, as discussed under 

Principle 26. 

SEC 

Based on data published by the SEC and discussions with market participants, the assessors have 

concluded that the authorization provisions currently applied to some non-exchange trading 

systems do not fully meet the standards of Principle 25 concerning adequate transparency. 

The problem lies in the rules governing exchanges and alternative trading systems, known as 

Regulation ATS, which were introduced in 1998, and in particular the impact on pre-trade 

transparency, or the publication of best bids and best offers to investors and market participants 

generally, of the 5 percent rule described above. As IOSCO has observed, “The wide availability of

information on bids and offers is a central factor in ensuring price discovery and in strengthening 

users’ confidence that they will be able to trade at fair prices. This confidence should, in turn, 

increase the incentive of buyers and sellers to participate, facilitate liquidity, and stimulate 

competitive pricing.” The number of active ATS authorized by the SEC, operating under the 

5 percent rule (so called “dark pools”) and trading NMS stocks has increased from approximately 

10 in 2002 to approximately 32 in September 2009. At that time, the trading volume of these dark 

pools was estimated by the SEC as approximately 7.9 percent of the total share volume in NMS 

stocks, One consulting firm has put it as high as 12 percent. As the SEC has observed, “Given this 

dispersal of volume among a large number of trading venues, dark pools collectively represent a 

significant source of liquidity in NMS stocks.” 

The SEC has published proposed rule changes to reduce the 5 percent limit to a mere 0.25 percent 

and to extend the definition of an order to cover so called “actionable indications of interest” which 

are currently being used by some dark pool ATSs and others as a way around the 5 percent limit. 

The SEC has also proposed exemptions for large orders to enable institutions which trade in large 

size to execute their orders with other similar sized institutions without causing damaging market 

impact or short term volatility effects. These proposed rule changes, if implemented, would appear 

to meet the Principle 25 benchmark that authorization requirements for exchanges and other 

trading systems provide for adequate transparency. 

See also the comments under Principle 27. 

Principle 26. 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 CFTC 

The CFTC monitors DCMs and ECMs that trade SPDCs (as determined by the CFTC based on 

price linkage, arbitrage, material price reference and material liquidity) on an ongoing basis 

through compliance reporting and “for cause” inquiries. CFTC staff also periodically reviews the 

programs and procedures adopted by each DCM to ensure compliance with the relevant core 

principles and to assess the effectiveness of those rules and procedures. 

A recent amendment to the CEA has given the CFTC powers of ongoing oversight of ECMs in 

certain circumstances. The CFTC is now empowered to require that ECMs which trade SPDCs 

comply with 9 Core Principles concerning transparency, anti-manipulation, position limits or 

accountability levels. The amendment does not apply to EBOTs. 

The CFTC has emergency authority to direct a DCM or ECM to maintain or restore orderly trading 
96 

in or liquidation of any futures contract. The CEA authorizes the CFTC to alter or supplement the 

rules of a DCM under certain circumstances. The CFTC has the power to suspend or revoke a 

DCM’s designation. 

SEC 

In most cases, trading rules must be pre-approved. There are limited exceptions that permit trading 

rules to be filed on an immediately effective basis, such as where they are substantially similar to a 

rule of another exchange. However, the SEC can block a rule from becoming immediately 

effective for up to 60 days after it was filed, which essentially means the proposal is required to go 

through the regular notice and approval process. The SEC reviews a proposed rule against the 

requirements in the Exchange Act and regulations and must take account of the views of 

respondents to the mandatory public consultation process. A proposed rule change is not approved 

unless it is consistent with the Exchange Act. 

Ongoing supervision is carried out by SEC staff which conduct several types of examinations and 

inspections including routine or cycle examinations and inspections, which test an entity’s 

compliance with applicable laws and regulations; “for cause” examinations and inspections and 

risk-targeted examination sweeps, that focus on particular compliance risks. These include the 

staff’s inspections of the exchange’s regulatory programs, including their examination, 

surveillance, investigative and enforcement programs, among others. The SEC has the authority to 

inspect exchanges, associations, ATSs and other market participants to determine whether the 

various anti-fraud, anti-manipulation and reporting regulations are being complied with. The SEC 

can also obtain surveillance and/or trading data from the SROs. 

An exchange or association must have procedures to survey its market and its members for 

securities laws violations, including violations of the exchange’s own rules. The SEC considers on 

an on-going basis whether an exchange has adequate surveillance measures, as well as sufficient 

resources, including staff expertise and capital, to monitor its markets. See Principle 29 for a 

detailed description of the SEC’s oversight of clearing organizations. 

The exchanges are required to maintain certain operational capability standards such that market 

participants can be confident in the exchanges’ ability to handle the foreseeable volume of 

securities transactions directed to them. The SEC requires that exchanges have adequate computer 

system capacity, integrity and security to support the operation of their markets. In addition to 

reviewing the systems capability of an exchange, the SEC will consider whether an exchange has 

sufficient capital to maintain its automated systems and staff with technical expertise. The 

exchanges are also required to have rules that preserve the integrity of the market and that protect 

against risks to market integrity. 

While the Exchange Act does not set out minimum levels of funding for maintaining the 

self-regulatory function, the SEC has considered the funding of the self-regulatory functions of an 

exchange in the context of recent exchange demutualizations. In these filings, the SEC has sought 

to ensure that fees, fines, or dues collected by an exchange are not used for commercial purposes 

and that mechanisms have been established that are designed to ensure a proper level of funding of 

the self regulatory function. 

The SEC has the authority under the Exchange Act to cancel, suspend or revoke the registration of 

an exchange or association. The Exchange Act provides the SEC with the authority to impose 

penalties on exchanges or associations and their members for violations of the federal securities 

laws and/or SRO rules. Specifically, the SEC has the authority to suspend or revoke the 

registration of an SRO; censure or impose limitations on its activities; and remove from office or 

censure officers or directors of an SRO for violations of the Exchange Act or the SRO’s rules. The 

SEC also has the authority to suspend or expel any member or person associated with a member 

from an SRO for violations of the federal securities laws or rules. 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. 
97 

Assessment Fully implemented. 

Comments The CFTC has issued guidance on how DCMs might comply with the Core Principles and has also 

described acceptable practices to achieve the same end. Some have argued that this limits the 

extent to which DCMs are able to diverge significantly from what the CFTC believes to be 

appropriate. The assessors are not persuaded of this. It is also argued that the move to a 

principles-based approach has enabled CFTC staff to focus more on the risk management and 

controls of a DCM rather than engaging in what can become a “tick box” approach of a 

conventional rule-based examination, which can overlook important systemic issues. This 

argument may have more merit. If changes are to be made it will be important to ensure that an 

efficient and effective balance is struck. 

As regards ongoing regulatory supervision of ECMs, the CFTC has been successful in obtaining 

legislative amendments which empower it to ensure that, in markets where the CFTC determines 

that ECMs are significant, they operate in an orderly and transparent manner. 

A separate issue in the authorization and oversight of exchanges and trading systems is that of 

capital. Unlike for BDs or FCMs, there are no explicit capital requirements for exchanges at the 

application or operational stages. The IOSCO Principles are silent on the matter except where an 

exchange takes principal risk. This situation is unusual, although in the case of most DCMs which 

are part of groups with integrated clearing organizations, affiliate risk is an issue. In the absence of 

explicit amounts of required capital, the staffs of the Commissions are required to make judgments 

as to whether the overall financial resources of the exchanges they monitor are adequate to 

maintain all their commercial and regulatory functions, staffing levels and IT expenses. The SEC 

focuses on two aspects, IT capacity and resilience and funding of the self-regulatory functions, 

although there are other demands on financial resources. 

The issue of financial resources has been growing in importance with demutualization of existing 

exchanges and the growing number of new exchanges in futures and derivatives where ownership 

is concentrated and the owners are themselves “for profit” entities that may assume significant 

principal risk in their main businesses. Where they are firms active in capital markets, their profit 

and loss profiles are likely to strongly correlate with the profit and loss profiles of the exchanges 

they are acquiring or establishing, which might expose an exchange to sudden commercially driven 

financial pressures in a crisis. Under the principles-based approach employed by the CFTC, it is 

not clear precisely what the CFTC’s powers are in this area and staff are working with Congress to 

get explicit statutory authority to impose financial resource requirements on DCMs. 

Principle 27. Regulation should promote transparency of trading. 

Description CFTC 

Transparency is mandated by the CEA and CFTC regulations which require transparency and fair 

treatment. Core Principle 8 requires a DCM to make public daily information on settlement prices, 

volume, open interest and open and closing ranges for actively traded contracts. Regulation 16.01 

requires the DCM to report specified information no later than the business day following the day 

to which the information pertains. In practice, exchanges publicly disseminate trade data, including 

last transaction price and size and current bid and offer information, on both a real time (generally 

for a fee) and delayed basis for free (the delay is at most ten minutes). Third-party data providers 

typically aggregate and publish data for all exchanges, not just contracts traded on a single 

exchange. At least one exchange posts quote data on its website on a real-time basis, including the 

bid-ask spread and the size of the bids and asks, for all of its contracts. The CFTC has generally 

found these methods of data dissemination acceptable and the only issue that occasionally raises 

concern is whether exchanges are providing data to third-party vendors on a fair and equitable 

basis. 

As regards ECMs, to date the CFTC has determined that only one contract traded on an ECM is a 

significant price discovery contract. The ECM publishes delayed quotes for this contract for free. 
98 

Real-time quotes for this product are available by subscription.

SEC 

Equity/option markets 

The SEC administers a system for pre- and post-trade transparency for securities traded on 

exchanges (both equities and options). Over-the-counter trades in national market system equity 

securities are also covered by that system. Exchange rules require real-time reporting of 

transactions occurring on the exchanges and FINRA rules require real-time reporting of 

transactions in equity securities occurring in the OTC market. The dissemination of pre- and posttrade information for equities and options is governed by national market system plans (Plans) that 

operate in accordance with the Exchange Act. The text of the Plan or amendment thereto must be 

filed with the SEC. No Plan or amendment is effective unless approved by the SEC, with some 

limited exceptions for routine filings. The exchanges and FINRA submit all transaction 

information to the relevant Plan processor for immediate public dissemination. Similarly, 

exchanges collect order and quotation information from their members and submit their best bids 

and offers and associated sizes to the relevant Plan processor. Information collected by the Plans is 

widely disseminated via subscription. Subscriptions must be on terms that are fair and reasonable 

and not unreasonably discriminatory. Exchanges can offer proprietary market data products via 

subscription, but offering such products does not eliminate their duties to contribute real-time data 

to the Plans. Such subscription products must also be offered on terms that are fair and reasonable 

and not unreasonably discriminatory. 

Quotes from OTC market-makers whose executed volume in a security is one percent or less of the 

aggregate trading volume in such security and quotes on ATS that trade less than five percent of 

the volume in a national market system security are not subject to consolidation and public 

dissemination through the Plans. One “dark pool” ATS operates under a 20 percent limit approved 

by the SEC in 2005. The number of active “dark pools” trading NMS stocks has risen from 

approximately 10 in 2002 to approximately 29 in 2009. For the second quarter of 2009, according 

to the SEC, the trading volume of these dark pools was approximately 7.2 percent of the total 

traded volume in NMS stocks. 

Debt markets. In addition, comprehensive systems for post-trade transparency exist for corporate 

debt securities (through the TRACE system administered by FINRA) and municipal debt securities 

(through the RTRS system administered by the MSRB). In government securities there is limited 

pre-trade transparency but no mandatory trade publication. These markets are OTC dealer markets 

with no central exchange. Their detailed transparency requirements are public and have been 

intensively negotiated and researched over recent years. 

Assessment Fully implemented 

Comments CFTC 

The CEA and CFTC regulations have not been updated to reflect modern concepts of timely 

publication. However, consistent with Principle 27, the practice in futures markets is real time 

publication. A short delay for free publication is the normal practice in many jurisdictions. 

Derogations for block trades and other trades involving the interaction of futures with cash 

commodities and swaps appear reasonable. Since the markets the CFTC supervises are all on 

exchange, as required by the CEA, OTC business, whether carried on by telephone or otherwise, is 

not an issue as it is in securities markets, nor, until recently, have similar contracts been listed on 

more than one DCM/ECM. The current exclusion of swap transactions from oversight by the 

CFTC (or the SEC) and therefore the opacity of this market is a matter of current legislative and 

regulatory debate. 

SEC 

In making a judgment as to whether the regulation of the U.S. equity market fully meets the 
99 

IOSCO benchmark that there be requirements or arrangements for providing pre-trade 

(e.g., posting of bids and offers) and post-trade (e.g., last sale price and volume of transaction) 

information to market participants on a timely basis, the assessors had to balance several issues. In 

their view: 

 As regards post trade transparency the SEC’s requirements fully meet the standard. 

 SEC requirements for pre-trade transparency or publicly displayed liquidity, that is bids 

and offers submitted to and displayed by trading venues such as exchanges, displayed 

ATSs and ECNs, fully meet the standard. This is estimated to amount to 75 percent of 

total liquidity in NMS stocks (September 2009). According to most independent research, 

full implementation of Regulation NMS in October 2007 generated a significant increase 

in publicly displayed pre-trade transparency. 

 A substantial amount of liquidity is not publicly displayed. The SEC believes that this 

amounted to 25 percent of total liquidity in September 2009. Dark pool ATSs authorized 

by the SEC under Regulation ATS are one component of this non-publicly displayed 

liquidity. Internalization of client order flow by BDs is another. The percentage may have 

grown by more than 20 percent between September 2008 and September 2009 according 

to some industry estimates. The reasons for this growth are disputed—indeed some query 

whether there has been an increase at all. 

However, the SEC is concerned about the issue and its impact on investors. In the November 2009 

release proposing rule changes for dark pools (Regulation of Non-Public Trading Interest) referred 

to in Principle 25 the SEC sets out, repeatedly, its fears that a two-tier market may be emerging 

that provides valuable order information on the best prices for NMS stocks only to selected market 

participants. So, for example, the National Best Bid and Offer (NBBO) or publicly displayed best 

quote in 1000 shares may be US$5.25 to 29. A dark pool may have a BBO of US$5.26 to 28 in the 

same size but these better prices are only transparent to, and available for trading by, clients of the 

dark pool operator. As the SEC has stated, its proposed rule changes are intended to “to promote 

the Exchange Act goals of transparency, fairness, and efficiency.” 

In the judgment of the assessors, taking account of the three elements of transparency set out above 

the issue as to whether the Principle has been fully implemented in U.S. equity markets is finely 

balanced. However, on balance the assessors’ view is that the IOSCO benchmark is met. 

In addition to the proposed dark pool rule changes the SEC issued, in February 2010, a Concept 

Paper on Equity Market Structure in which it seeks public comment on a wide range of market 

structure issues that have arisen in recent years, including high frequency trading, order routing, 

market data linkages, and undisplayed or dark liquidity. The commission intends to use the 

public’s comments to help determine whether regulatory initiatives to improve the current equity 

market structure are needed and, if so, the specific nature of such initiatives. This is a timely 

exercise. 

The assessors have observed that well financed lobbying on these issues has begun. Historically, 

market regulation has been viewed by many broker dealers, exchanges ad trading system operators 

as a competitive tool. This phenomenon is not limited to the United States. There is therefore a 

high probability that data provided by various major market participants will support their own 

business models and seek to denigrate their competitors’ as will the rationales they claim their data 

“proves.” Thus, it is vitally important that, in evaluating the responses, the SEC directly obtains 

comprehensive raw data on what is actually happening in the equity market, where and when 

trades are being done, at what prices and with what impact on investors of all classes in order to 

reach correct conclusions. As observed under Principle 3, the SEC’s ability to make policy 

determinations would be enhanced by a greater use of its authority to request raw data and to 

develop empirical analysis based on this data rather than relying on data generated and processed 

by exchanges, SROs and others. 

See also the comments under Principle 25. 
100 

Principle 28. Regulation should be designed to detect and deter manipulation and other unfair trading practices. 

Description CFTC 

In general, Section 4b of the CEA makes it unlawful to cheat or defraud in connection with futures 

contracts.

The CEA also prohibits fictitious trading or trading which would cause the market to reflect a price 

that is not “true and bona fide.” 

As regards insider trading, the CEA provides an explicit but limited scope prohibition against 

insider trading for certain persons and not for persons generally as is the case in the securities 

market 

The CFTC has its own comprehensive market surveillance program to detect and prevent market 

manipulation. The CFTC’s market surveillance program uses many sources of market information 

to accomplish its objectives. Some of this information is publicly available and some of the 

information is highly confidential, which includes data from exchanges, intermediaries and large 

traders. The CFTC is currently in the process of significantly upgrading this system to enhance its 

ability to detect trade practice violations, including wash trading and trading ahead. 

When problems develop, surveillance economists prepare weekly summary reports of futures and 

option contracts for regional surveillance supervisors, who immediately review these reports. 

Surveillance staff informs the CFTC and senior staff of potential problems and significant market 

developments at weekly surveillance meetings so that they will be prepared to take prompt action 

when necessary. Reports and briefings are prepared more often, as needed. 

The market surveillance process is not conducted exclusively at the CFTC. Surveillance issues are 

usually handled jointly by the CFTC and the appropriate exchange. If an exchange fails to take 

actions that the CFTC deems appropriate, the agency has broad emergency powers under which it 

can order the exchange to take actions specified by the CFTC. Such actions could include imposing 

or reducing limits on positions, requiring the liquidation of positions, extending a delivery period, 

or closing a market. As regards domestic cross-market trading issues, there are numerous 

mechanisms and structures by which information can be shared and cooperation achieved. The 

Inter-market Surveillance Group (ISG) provides a framework for the sharing of information and 

the coordination of regulatory efforts among exchanges trading securities and related products to 

address potential inter-market manipulations and trading abuses. 

The CEA provides for robust sanctions in administrative and civil cases of manipulation and 

other unfair trading practices which serve the twin purposes of punishing the wrongdoer and 

deterring misconduct by others, all in an effort to protect the integrity of the futures market. The 

sanctions apply across all markets within the CFTC’s jurisdiction and to registrants and nonregistrants alike. These sanctions include: trading bans, registration sanctions, restitution, 

disgorgement, fines, preliminary and permanent injunctions, and cease and desist orders. 

In addition to the civil remedies and penalties available to the CFTC, manipulation, cornering, 

conversion, false statements to a registered entity or to the CFTC and all other willful violations of 

the CEA and regulations are also felonies that may be prosecuted by the DOJ and are punishable 

by a fine of up to US$1 million or imprisonment for up to ten years or both.

SEC 

The SEC is an operationally independent agency and brings enforcement cases in the civil and 

administrative arenas based on the facts and evidence, as appropriate. The U.S. federal securities 

laws prohibit market participants from engaging in fraud. The Exchange Act prohibits the full 

range of manipulative, fraudulent and deceptive practices such as price manipulation, 

disseminating misleading information, insider trading, front running and other activities. In 

addition to the Exchange Act’s broad anti-fraud provisions, the Securities Act, Advisers Act, and 

ICA all contain anti-fraud provisions which provide a meaningful and useful arsenal for combating 
101 

fraud across sectors of the securities industry. Charges may be brought under any or all of these 

provisions in, for example, a manipulation case depending on the facts and evidence. The antifraud provisions of each of these Acts operate in a complementary, not duplicative, manner. 

The federal securities laws empower the SEC to prescribe rules that it deems necessary and 

appropriate to protect investors and the public interest. These requirements and prohibitions are 

supplemented by rules of the SROs. 

Laws in the United States are developed and established through the judicial system as well as 

through legislation. The broad anti-fraud provisions of the Exchange Act make it unlawful to 

engage in fraud or misrepresentation in connection with the purchase or sale of a security. It is well 

established in case law that illegal insider trading is a violation of the anti-fraud provisions of the 

Exchange Act. Interpretations of the anti-fraud provisions by federal courts provide valuable 

flexibility for the successful prosecution of new schemes for insider trading. The definition of what 

constitutes illegal insider trading can and has evolved through case law. This process provides the 

SEC with the agility to attack novel insider trading schemes head on. The typical theories used in 

insider trading cases, classical and misappropriation theories, are examples of the successful 

evolution of federal case law in this area and are well-accepted theories across the federal courts, 

including the U.S. Supreme Court. 

The SEC regularly brings insider trading enforcement actions against: 

 Corporate officers, directors, and employees who traded the corporation’s securities after 

learning of significant corporate developments. 

 Friends, business associates, family members, and other “tippees” of such officers, 

directors, and employees, who traded the securities after receiving such information. 

 Other persons who misappropriated and took advantage of confidential information from 

their employers. 

Where the SEC identifies a possible gap in judicial interpretation of securities law, it has the ability 

to seek to close that gap through rulemaking. For example, because issuer selective disclosure 

bears a close resemblance to “tipping” and insider trading and their adverse market effects are 

essentially the same, the SEC promulgated Regulation FD. Regulation FD targets the practice of 

issuer selective disclosure by establishing requirements for full and fair disclosure by public 

companies 

 In addition, the Exchange Act imposes liability for short-swing profits in the issuer’s stock upon 

all persons required to file reports under Section 16(a) of the Exchange Act (officers, directors, and 

beneficial owners of more than ten percent of any class of equity security). These statutory insiders 

must disgorge to the issuer any profit realized as a result of a purchase and sale or sale and 

purchase of covered equity securities occurring within a six-month period. 

The SEC investigates and enforces a wide variety of misconduct under the anti-fraud provisions of 

the Exchange Act. Examples of these fraudulent practices and market abuses include: interpositioning, front running, unauthorized trading in customer accounts, undisclosed revenue 

sharing, breach of best execution, excessive mark-ups, suitability violations and a variety of 

colloquially described activities involving “boiler rooms,” “churning,” “scalping,” “pump and 

dump” and other forms of manipulative schemes. Hacking into client accounts at on-line brokerage 

firms and trading in their accounts has emerged as a problem in recent years. The Enforcement 

Division has brought many cases addressing this and other forms of securities fraud stemming 

from on-line activities and new technology. 

With respect to gathering and analyzing information, monitoring market participants, and 

generating alerts, the SROs collect and analyze information relating to trading activities. Exchange 

and FINRA systems capture order details throughout the lifecycle of a trade. Unusual trading 

activity is reviewed to determine whether fraudulent activity is occurring. FINRA spends more 

than US$30 million per annum on market surveillance technology necessary to keep pace with 

market developments. Market surveillance by NYSE Regulation is estimated to cost 
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US$62 million in 2009 with a further increase scheduled for 2010. The SROs may take remedial 

action for violations of such rules or refer violations of federal securities laws to the SEC. The SEC 

also has an office within the Division of Enforcement that monitors the markets for suspicious 

activity. This office serves as a liaison for the SROs, each of which has primary responsibility for 

monitoring their respective markets. The SEC and SROs work closely and collaboratively in 

exchanging information regarding suspicious market activity. The SEC’s surveillance systems 

technology requires significant investment to bring it up to date. 

Cross market issues are dealt with under the auspices of the ISG. See reference above under CFTC. 

As regards other foreign linkages, see the description and comments under Principle 13.

As to whether the sanctions available for violations are effective, proportionate and dissuasive, in 

fiscal year 2008, the SEC brought 671 enforcement cases, which was its second highest number in 

history. Additionally, in fiscal year 2008, the SEC obtained orders in judicial and administrative 

proceedings requiring securities violators to disgorge illegal profits of approximately 

US$774 million and to pay penalties of approximately US$256 million. 

The SEC is responsible for civil enforcement of the federal securities laws. In addition to the 

significant number of civil cases the SEC brought in fiscal year 2009, criminal prosecutors filed 

indictments, informations, or contempt charges in 154 SEC-related criminal cases. In fiscal 

year 2008, criminal prosecutors brought 108 SEC-related cases. 

The SEC files its cases in U.S. federal courts and in administrative proceedings. As in other civil 

cases, the SEC’s burden of proof is that of preponderance of the evidence. The SEC may seek 

either temporary or permanent injunctive relief in a U.S. federal district court. It can seek a broad 

range of sanctions. In civil suits, the SEC seeks injunctions, which are orders that prohibit future 

violations. A person who violates an injunction is subject to fines or imprisonment for contempt. 

The SEC also may ask a federal court for emergency relief, generally in the form of a temporary 

restraining order. The SEC may also request that a court issue an order “freezing” assets to 

preserve the ability to obtain monetary relief at the successful conclusion of the case and return 

money to defrauded investors. 

In a civil action, in addition to injunctive relief, the SEC may and typically does, seek other 

equitable relief to remedy the harm caused by the violation. Such relief may include an accounting 

or disgorgement of ill-gotten gains where a defendant has profited from a violation of law. The 

SEC is also authorized to seek civil money penalties and court orders barring a defendant from 

serving as an officer or director of a public company or from participating in an offer of penny 

stock. 

The SEC may also institute administrative proceedings against a person or an entity regulated by 

the SEC or any person that it believes has violated or is violating the law. Administrative 

proceedings provide for a variety of relief, including a censure, a limitation on activities (in the 

case of a regulated entity or associated person of a regulated entity) such as suspension or 

revocation of registration (in the case of a regulated entity), suspension of up to twelve months or a 

bar from the industry (in the case of an associated person), a cease-and-desist order, accounting or 

disgorgement, or civil money penalties. In both civil injunctive actions and administrative 

proceedings, the SEC has the power to enter into enforceable settlements. In the typical settlement, 

the settling party neither admits nor denies the SEC’s allegations. In a civil action, the SEC 

requests that a court issue an order reflecting the settlement. In administrative proceedings, a 

settlement order is entered by the SEC describing findings of fact tied to the violations of the 

federal securities laws. 

The SEC may suspend trading in a particular security or a group of securities and national 

securities exchanges have the authority to suspend or remove a security from trading. 

 In addition, the Exchange Act empowers the SEC to deregister and de-list securities for the 

protection of investors and to approve or reject voluntary and involuntary deregistration and de-
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listing of shares requests from issuers or exchanges, pursuant to rules of the applicable exchange. 

By rulemaking, the SEC has adopted the policy that in any civil lawsuit brought by it or in any 

administrative proceeding of an accusatory nature pending before it, it is important to avoid 

creating, or permitting to be created, an impression that a decree is being entered or a sanction 

imposed, when the conduct alleged did not, in fact, occur. This rule is designed to address 

situations where the SEC settles a case only to have the defendant or his or her counsel take issue 

with the legal or factual basis for the SEC’s action. Thus, where there is a settlement of an 

enforcement action, the defendant settles “without admitting or denying” the allegations. This 

language safeguards the deterrent effect of the sanctions in that the defendant cannot, without 

breaking the terms of the settlement, denounce publicly the basis for the SEC action. The SEC 

enforces the “neither admit nor deny” provision in its settlements. 

Assessment Broadly implemented. 

Comments CFTC 

The issue which accounts for the assessment is the very narrow scope of the insider dealing 

provisions in the CEA. The statute’s current prohibitions on insider trading generally cover trading 

on the basis of CFTC, exchange, or SRO information by certain persons associated with those 

institutions. However, trading ahead or front running has been charged by the commission under 

the CEA’s general anti-fraud provision when persons traded for their own account (or through a 

associated account) ahead of a customer or an employer for whom the person was trading. 

The assessors strongly support the recommendation in the Joint Report for a further extension of 

the insider dealing offence to misappropriation and trading on the basis of material non-public 

information from any government authority. The assessors recognize that there may be legitimate 

reasons for different approaches to insider dealing for securities and futures given the differences 

in the nature of the markets. However, the assessors also recommend that the CFTC undertake a 

study to examine whether there should be an expansion of insider trading prohibitions beyond what 

is recommended in the Joint Report. Such a study would complement the current debate in Europe 

as to the appropriate coverage of insider trading laws in derivatives markets. 

The assessors also strongly support the recommendation to require FCMs and IBs to erect Chinese 

walls between their research departments and their traders. If implemented, this latter measure 

would replicate the measures the SEC imposed on equity BDs following the misuse of research in 

the dotcom bubble and would be a step towards a harmonised approach in this area. 

SEC

The absence of additional offences of insider trading may be a limiting factor in the SEC’s 

enforcement effort in this area. However, it has not prevented the SEC from prosecuting cases 

under the civil law and existing specific offences of insider trading in connection with a tender 

offer (Rule 14e–3) and under rules that define (i) when a purchase or sale constitutes trading on the 

basis of material, nonpublic information (Rule 10b5–1); and (ii) the circumstances in which a 

person has a duty of trust or confidence for the purposes of the misappropriation theory of insider 

trading (Rule 10b5–2). The courts appear to have been willing to be supportive when interpreting 

the law. But criminal convictions and civil judgments generally depend on proving a breach of a 

duty of care and that the person acted with intent. 

Cross market comparison 

There is a major difference in the efficiency with which overall market surveillance is carried out 

in the securities and futures markets. In the equity markets no one body sees the whole picture. 

FINRA now monitors trading on most exchanges except NYSE and Chicago Board Options 

Exchange (CBOE) and on all the ATSs. Further consolidation is under discussion to create a 

consolidated surveillance structure to oversee the consolidated market. However, with current 

technology it will still be difficult to look through to identify the underlying traders. In contrast, in 
104 

the futures markets the CFTC, working in cooperation with the exchanges, sees almost the total 

picture across all futures as a matter of daily routine and can identify the major traders who are 

clients of the FCMs, if necessary, with ease and in a timely fashion. Its ability to measure the 

financial exposure of all FCMs on a daily basis and changes in the size and ownership of the open 

interest is significantly in advance of what the SEC and the equity exchanges can achieve now or 

in the near future. 

However, in the case of both the SEC and CFTC, their IT resources are limited and outdated due to 

budgetary limitations and the problems of planning long-term IT projects when the commission’s 

budget is determined annually by Congress. However, in 2009 the CFTC has been able to commit 

to spend almost US$26 million on IT, up from US$11 million in 2008. 

Principle 29. Regulation should aim to ensure the proper management of large exposures, default risk and 

market disruption. 

Description CFTC 

As discussed in connection with Principle 23, the CFTC deals with the issues of large exposures, 

default risk and market disruption via its Risk Regulatory Surveillance Group (RSG). The RSG has 

developed or obtained access to a number of automated systems and applications, which 

collectively permit the RSG to receive timely data on clearing members and large traders. The 

RSG attempts to be proactive rather than reactive. Accordingly, RSG staff attempts to identify 

traders and FCMs who might pose risk before a market becomes volatile, not just after the 

volatility appears. Concentration of risk is a key indicator that the RSG focuses on when it 

examines data. 

If there is a problem in a futures market, both the CFTC and DCMs have a number of emergency 

powers such as the power to suspend and halt trading, set margin, position limits, and price limits, 

and impose “circuit breakers” or otherwise intervene in the market. The CFTC can also alter or 

supplement the rules of a registered entity and direct a registered entity to take such action as in the 

CFTC’s judgment is necessary to maintain or restore orderly trading in or liquidation of any 

futures contract. CFTC enforcement powers are comprehensive and authorize civil injunctive 

actions for failing to comply with requests for required information and subpoena enforcement 

actions for failure to comply with subpoena demand for documents or testimony. Failure to comply 

with a court order is punishable as contempt of court. 

DCMs must have rules which provide for the exercise of emergency authority, in consultation or 

cooperation with the commission, where necessary and appropriate, 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. The CFTC has 

provided guidance on these procedures. 

In terms of information sharing, the CFTC and DCMs have executed agreements to share 

information that is prompted by, among other things, large exposures. The CFTC essentially has 

the same information that DCMs have with respect to large exposure information. Wherever the 

exchanges manage position limits, they inform the CFTC of any exemptions granted. The 

exchanges are able to monitor the exposure size within each contract on an intraday basis. Frequent 

conversations occur between exchange and CFTC staff when liquidation or acquisitions of large 

exposures create a heightened concern. The increasing volume traded on an ECM that settles off a 

futures contract has prompted the CFTC to increase oversight of certain “linked contracts.” The 

CFTC has issued rules regarding a category of contract deemed to be SPDCs which encompasses 

linked contracts. Under these rules, ECMs and clearing organizations will have the same reporting 

obligations with respect to SPDCs as DCMs have for futures contracts. In the meantime, a hybrid 

situation exists in which the ECM is reporting a form of large trader positions but not yet meeting 

the quality standards the CFTC requires. 

Internationally, the key documents are the Declaration on Cooperation and Supervision of 
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International Futures Markets and Clearing Organizations and its companion Exchange 

Memorandum of Understanding. (For international information sharing and cooperation more 

broadly see Principle 13.) 

If an FCM is executing transactions on a DCM, then such FCM must clear such transactions 

through a DCO. In general, most DCOs publish their default procedures on their websites. In 

practice, 90 percent of all futures contracts clear through the DCO which is part of the CME group. 

Issues concerning the bankruptcy of an FCM are dealt with in Principle 24. 

CFTC Regulation of DCOs 

The CFTC supervises DCOs in three main ways. First, the CFTC evaluates applications from 

entities seeking to become DCOs. Second, the CFTC conducts periodic reviews of registered 

DCOs. Third, the CFTC surveys, on a daily basis, DCO exposures and compares such exposures to 

DCO financial resources. Additionally, the CFTC may review and approve DCO rules. 

Under the CEA, an entity that wants to register as a DCO must submit an application to the CFTC 

which demonstrates that it complies with the Core Principles applicable to DCOs. The CFTC 

provides guidance to applicants on how to demonstrate compliance with the core principles. 

The Core Principles set out a range of requirements including adequate financial, operational and 

managerial resources; appropriate standards for participant and product eligibility; adequate and 

appropriate risk management capabilities; the ability to complete settlements on a timely basis 

under varying circumstances; standards and procedures to protect member and participant funds; 

efficient and fair default rules and procedures; adequate rule enforcement and dispute resolution 

procedures; and adequate and appropriate systems safeguards, emergency procedures and plans for 

disaster recovery. There are also record keeping requirements, obligations to report to the CFTC, 

public availability of its rules and operating procedures and obligations to share information 

domestically and internationally. 

As regards ECMs, transactions executed on an ECM, if cleared, must be cleared by a clearing 

organization that satisfies the requirements of the Federal Deposit Insurance Corporation 

Improvement Act of 1991 (FDICIA) as amended by the CFMA. This includes DCOs, registered 

securities clearing agencies, various banks and clearing organizations supervised by a foreign 

financial regulator that one of the U.S. federal financial regulators has determined satisfies 

appropriate standards.

SEC 

For a detailed assessment of clearing and settlement in securities markets see the CPSS IOSCO 

reports. 

The only explicit large exposure disclosure requirements imposed by the SEC cover BDs with 

outstanding options positions to the extent that those positions exceed an aggregate position of 200 

or more option contracts on the same side of the market covering the same underlying security or 

index. In addition, to the extent any option position exceeds certain limits; the firm is required to 

decrease the position. These reports generally must be submitted on the day that the position 

parameters are exceeded or change. 

Continuous monitoring of BDs’ open positions and large exposure is primarily the responsibility of

the clearing agencies They receive data on a real time basis and review positions at end of day and 

frequently intraday. Under the Exchange Act, clearing agencies are SROs and have full self 

regulatory powers and responsibilities, including the power to discipline participants for violation 

of any provision of the rules of the clearing agency by expulsion, suspension, limitation of 

activities, functions and operations, fine, censure, or any other fitting sanction. They have authority 

to require increased margin and/or collateral deposits. Clearing agencies generally do not compel 

participants to reduce their exposures, although increased margin calls may cause a participant to 

reduce its exposure. The securities depository registered with the SEC requires that all settlement 
106 

obligations of participants be fully collateralized. 

The rules of a clearing agency must be pre-approved by the SEC. The SEC conducts on-site 

examinations of each clearing agency on a two-year cycle and “for cause” using examiners with 

particular knowledge and expertise in relevant subject matter such as VAR modeling. 

A BD must also comply with the rules of each SRO of which it is a member such as an exchange 

or FINRA. To the extent that a BD fails to furnish information requested by an SRO, the SROs 

have rules as to what action the SRO may take. The margin rules also help SROs control the risk of

open positions. The SEC has entered into MOUs with other domestic regulatory agencies regarding 

the clearance and settlement of financial products which provide, inter alia, for consultation in 

order to minimize the adverse effects of market disruptions. These include the CFTC and the 

Federal Reserve. In addition, the SEC has entered into bilateral agreements with various 

international agencies that allow the SEC to share information on a timely basis. Information 

regarding large options positions is shared on a case by case basis, as appropriate. The SEC 

participates in five of the recently established international colleges of regulators although the 

U.S. BD component of these groups is relatively small. 

When a BD must be liquidated, the United States bankruptcy laws will apply. In addition, if a BD 

holds customer funds or securities, SIPA may also apply. Finally, if the BD is a member of a 

clearing agency, the clearing agency rules may apply to the rights of the clearing agency to close 

out any open exposures to its defaulting clearing members. Clearing agencies are required to 

publish their rules and procedures on their web sites including those relating to participant defaults. 

Apart from the corporate finance rules on disclosure of beneficial ownership of positions by 

insiders (see Principle 15), there is no automatic disclosure of the beneficial ownership of 

securities. The SEC must rely on the rule which requires BDs maintain records regarding all 

securities positions and the accounts to which they belong. This information includes the size of 

every position held in each account and the identity and address of the beneficial owner of each 

account. BDs are required to provide this information to the SEC upon request. 

Assessment Fully implemented. 

Comments The difficulty which the SEC faces in obtaining beneficial ownership details of securities holders is 

typical of securities regulators globally. However, in the United States, it compares poorly with the 

ease and timeliness with which the CFTC can obtain large trader information in futures and related 

markets. This is a limitation which the authorities should consider correcting. 

Principle 30. Systems for clearing and settlement of securities transactions should be subject to regulatory 

oversight and designed to ensure that they are fair, effective and efficient and that they reduce 

systemic risk. 

Description A separate CPSS-IOSCO assessment was conducted for the securities markets. Arrangements in 

the futures markets were not assessed. 

Assessment 

Comments