U.S. COMMODITY FUTURES TRADING COMMISSION 

Three Lafayette Centre
 

1155 21st Street, NW, Washington, DC 20581
 

Telephone: (202) 418-5110
 

Facsimile: (202) 418-5522
 

TO: Vincent McGonagle 

Director, Division of Market Oversight 

FROM: Miguel A. Castillo, CPA, CRMA 

Assistant Inspector General for Audits 

DATE: August 5, 2015 

SUBJECT: Performance Audit of the Division of Market Oversight’s Rule Enforcement 

Reviews 

The Commodity Futures Trading Commission (CFTC, Commission or Agency) Office of 

Inspector General (OIG) contracted with Castro & Company, LLC (Castro & Co) to conduct a 

Performance Audit of CFTC’s Rule Enforcement Reviews (RERs). 

What We Learned 

Castro & Company, LLC (“Castro & Co”) identified the following issues based on procedures 

performed during the examination of CFTC’s Market Compliance Branch. A summary of these 

areas for improvement are identified below with a further explanation included within the 

Notification of Findings and Recommendations section of this report. 

The audit noted the following issues: 

Finding No. 1: The Division of Market Oversight (DMO) is not conducting rule enforcement 

reviews of all core principles. When 16 of 23 core principles are not reviewed, it may hamper 

DMO’s ability to meet CFTC’s strategic goal of promoting market integrity and transparency; 

Finding No. 2: Procedures for selecting designated contract markets (DCM) for a RER needs to 

be improved. When 9 of 20 DCMs are not reviewed, there is a risk of noncompliance with the 

Commodity Exchange Act; 
 

 

 

Finding No. 3: Follow-up procedures on concerns and recommendations made in prior RER 

reports needs to be enhanced. Without robust follow-up, there is the risk that DCMs will not 

address reported concerns and recommendations timely; and 

Finding No. 4: Inadequate staffing leads to lengthy RER completion time. When completion 

time averages 591 days due to inadequate staffing, DMO risks that it will not effectively fulfill 

its business objective of market oversight. 

Recommendations 

Castro & Company recommends the DMO Market Compliance Branch: 

1.	 Implement operating procedures that ensure DCMs comply with all Core Principles. A 

standardized checklist will enable the review team to document exceptions. 

2.	 Enhance documentation of its procedures for selecting DCMs to be reviewed. 

3.	 Strengthen procedures for following up promptly on all concerns and recommendations 

issued to a DCM. 

4.	 Take steps to reduce average time between rule enforcement reviews. 

Management Comments 

Management generally concurred with the findings and recommendations. In reference to 

recommendation 1, management stated that RERs are not optimal for all core principles and that 

certain core principles are better addressed outside the RER process. In addition, for certain core 

principles it is more effective and efficient for other CFTC divisions to lead oversight. While 

acknowledging additional resources allows more principles to be evaluated, in the interim it will 

develop an annual process to evaluate and recommend additional core principles for review. 

In reference to recommendation 2, management agrees that RER selection can be better 

documented but disagrees that Compliance has not established a policy and criteria for DCM 

selection. The DMO will draft a recommendation for desired frequency of RERs for each tier of 

DCM and consider trading volume changes in selections. 

In regards to recommendation 3, management will enhance its transmittal letters to include a 

timeline for corrective action and follow-up. 

For recommendation 4, management appreciates the auditor’s willingness to elevate inadequate 

staffing that limits the ability to review DCMs. While citing staffing limitations and a focus on 

rule-making as the major causes of extended RER cycle times, staff will continue to promote 

market integrity and customer protection under these circumstances. 

Management did not provide action completion dates for the four recommendations. Their 

comments in its entirety can be found in Appendix B. 

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Evaluation of Management Comments 

While acknowledging staffing constraints, Castro and Co reiterated the need to enhance 

procedures for monitoring RERs and following-up with DCMs. Their evaluation of each finding 

and recommendation can be found on pages 4, 8, 10 and 14, respectively. Castro and Co also 

suggested that OIG follow-up on management actions, and we intend to do so. 

With regard to staffing constraints, we would stress that Castro and Co. recommended that CFTC 

“determine whether more staff is needed to timely complete RERs or establish the frequency for 

conducting RERs with existing staff so as to provide timely results to DCMs.” We note with 

approval that recent CFTC investments in data analytical tools may provide an opportunity to 

migrate the RER process from a FTE intensive checklist approach to a data-driven alert-based 

approach. Based on DCM risk profiles and anomaly alerts, subject matter experts across CFTC 

could collaborate on selections, review procedures, and timeframes for completion. 

Since management did not provide action completion dates, the Office of the Inspector General 

will assess the status of actions in the next semiannual reporting period. If management 

implements corrective actions prior to six months after the report date, please submit a formal 

closeout request to us so that we may close the recommendation(s). The request should be 

accompanied by evidence of completion of corrective actions. Please email a signed PDF copy 

of all responses and closeout requests to lwilliams@cftc.gov. Consistent with our responsibility 

under the Inspector General Act, we will provide copies of our report to appropriate 

Congressional committees. The report will be published on the OIG webpage and a synopsis will 

be presented in the October 2015 Semiannual Report to Congress. If you have any questions, 

please contact me at (202) 418-5084. 

Objective, Scope, & Methodology 

The objective of the audit was to review DMO Market Compliance Section’s performance in 

conducting RERs finalized during Fiscal Years 2011 through 2014. Castro & Co reviewed DMO 

responsibility for conducting RERs under the Commodity Exchange Act and the Dodd-Frank 

Act; evaluated frequency of the RERs; length of time to complete RERs; and remediation of 

CFTC identified RER findings and recommendations for improving the operations at DCMs. 

Further the audit team examined the current size of the Market Compliance Branch staff 

responsible for conducting RERs and commented on their ability to deliver a timely and quality 

product that achieves the CFTC’s stated goals for this oversight function of DCMs -- in light of 

expanded CFTC jurisdiction over the swaps markets. 

In order to meet the objectives of the performance audit, Castro & Co: 

 Obtained a business overview and understanding of internal controls associated with 

Market Compliance Branch responsibilities; 

 Documented practices and procedures for conducting RERs of DCMs; 

 Assessed the effectiveness in the design of relevant internal controls; 

 Reviewed RERs conducted during the audit period and assessed implementation and 

operating effectiveness of existing internal controls; 

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 Reviewed documentation to support the timing of the RERs and amount of time to 

conduct a RER and assessed the reasonableness of the timing aspect of the RERs; and 

 Reviewed documentation on number of individuals and experience levels of team 

members conducting RERs. 

To ensure that the audit was conducted in accordance with Generally Accepted Government 

Auditing Standards (GAGAS), the Office of the Inspector General: 

 Validated the contractor’s independence; 

 Assessed their audit plans and methodology; 

 Monitored audit performance; and 

 Reviewed the report finding, conclusions, and recommendations 

Our review disclosed no instances in which Castro & Co. did not comply with GAGAS 

standards. 

Cc: 

Chairman Timothy G. Massad, 

Commissioner Mark P. Wetjen, 

Commissioner Sharon Y. Bowen 

Commissioner J. Christopher Giancarlo 

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Performance Audit of the Division of Market
 

Oversight’s Rule Enforcement Reviews
 

JULY 31, 2015 

Prepared by: 

Castro & Company, LLC 

1711 King Street, Suite C 

Alexandria, VA 22314 
 

 

 

 

 

 

 

 

 

Table of Contents 

NOTIFICATION OF FINDINGS AND RECOMMENDATIONS 

Finding No. 1: The Division of Market Oversight Is Not Conducting Rule
 

Enforcement Reviews of All Core Principles ............................................................................... 1
 

Finding No. 2: Procedures for Selecting Designated Contract Market for a Rule 

Enforcement Review Needs to be Improved............................................................................... 4
 

Finding No. 3: Follow-Up Procedures on Concerns and Recommendations 

Made in Prior Rule Enforcement Review Reports Needs to be Enhanced ................................ 7
 

Finding No. 4: Inadequate Staffing Leads to Lengthy Rule Enforcement 

Review Completion Time............................................................................................................ 10
 

APPENDIX A: 

Background Including Description of Rule Review Process .....................................................14
 

APPENDIX B:
 

Division of Market Oversight Market Compliance Branch Response To Draft Report ...............22
 
 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

NOTIFICATION OF FINDINGS AND RECOMMENDATIONS
 

Finding No. 1: The Division of Market Oversight Is Not Conducting Rule 

Enforcement Reviews of All Core Principles 

I. Condition 

The Division of Market Oversight (DMO) Market Compliance Branch is responsible for 

monitoring each Designated Contract Market (DCM) to ensure its compliance with the twentythree (23) Core Principles established within the Commodity Exchange Act. One of the tools 

used by the Market Compliance Branch to monitor DCMs is regular reviews known as Rule 

Enforcement Reviews (RERs). 

During our audit, we noted that the Market Compliance Branch staff utilized a checklist for each 

RER conducted. This checklist is structured into five (5) sections and includes a listing of 

standard questions and procedures that must be asked and/or performed by the Market 

Compliance Branch staff. When conducting a RER, the Deputy Director of the Market 

Compliance Branch, through discussion with the Associate Director, will determine which 

section of the checklist should be completed. Below are the five (5) sections of the checklist 

with the corresponding seven (7) Core Principles to be reviewed: 

I. Staffing and Organization 

 2 – Compliance with Rules (Focus on DCM’s employees’ ability to perform 

program compliance activities) 

II. Audit Trail 

 10 – Trade Information 

 18 – Recordkeeping 

III. Trade Practice Surveillance 

 2 – Compliance with Rules (Focus on the authority, resources, and adequate 

staffing to enforce rules and verify effective trade practices) 

 12- Protection of Markets and Market Participant 

IV. Market Surveillance 

 4 – Prevention of Market Disruption 

 5 – Position Limitations or Accountability 

V. Disciplinary 

 13 – Disciplinary Procedures 

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Castro & Co noted that the following Core Principles are not being reviewed by the Market 

Compliance Branch through the RERs: 

 1 – Designation as Contract Market  15 – Governance Fitness Standard 

 3 – Contract Not Readily Subject to  16 – Conflicts of Interest 

Manipulation  17 – Composition of Governing 

 6 – Emergency Authority Board of Contracts Markets 

 7 – Availability of General  19 – Antitrust Considerations
 

Information  20 – Systems Safeguards
 

 8 – Daily Publication of Trading  21 – Financial Resources 

Information  22 – Diversity of Boards of Directors 

 9 – Execution of Transactions  23 – Securities and Exchange 

 11 – Financial Integrity of Commission (Availability of
 

Transactions Records for Inspection and 

 14 – Dispute Resolution Evaluation by the SEC) 

Though compliance with these Core Principles may be monitored by another branch within 

DMO, using other tools besides the RER, we did not review any evidence, outside of RERs, that 

the sixteen (16) above stated, Core Principles are being reviewed and documented by the Market 

Compliance Branch. 

II. Criteria 

The Commodity Exchange Act, 7 USC § 7(d)(1) states: 

Core Principles for Contract Markets 

(1)	 Designated as contract market 

(A)	 In general 

To be designated, and maintained a designation, as a contract market, a board of 

trade shall comply with – 

i. any core principle described in this subsection; and 

ii.	 any requirement that the Commission may impose by rule or 

regulation pursuant to Branch 12a (5) of this title. 

The Commodity Exchange Act, 7 USC § 12a (5) states: 

The Commission is authorized – 

(5) to make and promulgate such rules and regulations as, in the judgment of the 

Commission, are reasonably necessary to effectuate any of the provisions or to 

accomplish any of the purposes of this chapter. 

The CFTC’s process for conducting RERs is documented in Appendix A. 

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III. Effect 

A partial review of DCM compliance with all Core Principles may hamper DMO’s ability to 

meets CFTC’s strategic #1 goal of promoting Market Integrity and Transparency1 

. 

IV. Cause 

Management in DMO’s Market Compliance Branch stated that RERs are only one tool they 

utilize to monitor DCMs compliance with the Core Principles. Other tools are utilized by the 

Market Compliance Branch and other DMO branches to determine whether DCMs have 

complied with all the core principles. 

V. Recommendation 

We recommend that DMO Market Compliance Branch leadership should implement operating 

procedures that address all the Core Principles DCMs are required to comply with in order to be 

categorized as a DCM. A standardized checklist will enable the review team to document why a 

certain Core Principle will not be reviewed. This additional procedure should provide 

justification supporting the Core Principles selected for review as well as the ones not selected 

for review so that each RER procedure is formally considered, approved, and documented. 

VI. Auditee’s Response 

DMO stated that the RER program was designed to focus closely on exchanges as the “front-line 

self-regulatory” organizations in U.S. futures markets and the selection of core principles and 

regulations for review reflects a conscious decision to focus resources on the areas of greatest 

risk and maximum reward for market integrity, customer protection, and effective selfregulation. One reason for this approach is due to the limited resources available to DMO. 

In addition, DMO stated they utilize several available tools to determine compliance, including 

lead responsibilities by other Division Branches, the self-regulatory function of the exchanges, 

and other procedural processes available to the DMO including requiring the exchanges to 

confirm compliance with core principles upon request. For example, Core Principle 20 – System 

Safeguards is monitored through System Safeguard Examinations and Core Principle 21 – 

Financial Resources is monitored by the Market Review Branch. 

Finally, DMO stated they will develop an annual process to evaluate and recommend which core 

principles should be added to the RER program or are more efficiently handled outside of the 

RER process. 

VII. Auditor’s Response 

Castro & Co agrees with DMO’s response and acknowledges, as we did in the finding, that 

DMO utilizes tools other than RERs and other CFTC units to monitor DCM’s compliance with 

the core principles. We agree with their development of an annual process to evaluate inclusion 

of additional core principles in the RER program. 

1 See CFTC 2014-2018 Strategic Plan page 10 available at: 

http://www.cftc.gov/ucm/groups/public/@aboutcftc/documents/file/2018strategicplan.pdf 

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Castro & Co recommends that CFTC’s Office of Inspector General (OIG) consider following up 

on DMO’s evaluation of the inclusion of additional core principles within the RERs. For core 

principles that are not included within the RER process, Castro & Co. recommends that the OIG 

consider following up on the other tools utilized by DMO to ensure DCM’s compliance with 

core principles. 

Finding No. 2: Procedures for Selecting Designated Contract Market for a 

Rule Enforcement Review Needs to be Improved 

I. Condition 

The Market Compliance Branch evaluates multiple factors when selecting and prioritizing 

DCMs to conduct RERs. The factors currently in place for selecting a DCM include the 

following: 

 Trading volume (significant, moderate, de minimis/zero volume); 

 Date when last RER was conducted; 

 Date Market Compliance Branch reviewed the DCM in any other capacity (other than 

RERs); 

 Significant issues identified in the last RER or other evaluations that required follow-up; 

 Identification of any regulatory issues brought to the attention of the Market Compliance 

Branch; and 

 Identification of any significant changes in the DCM’s compliance program since the last 

RER or since designated as a DCM. 

Based on our review of the factors utilized by the Market Compliance Branch, Castro & Co 

noted the following issues related to the procedures for selecting a DCM for a RER: 

 The Market Compliance Branch has not established and documented any formalized 

policies or procedures manual for selecting a DCM for a RER. 

 Selection procedures need to provide specific criteria for choosing DCMs including how 

the above factors are reviewed and considered in the selection of a DCM. 

 The Market Compliance Branch should specifically define the Tier trading volume levels 

for Tier 1 - significant, Tier 2 - moderate, and Tier 3 - de minimis/zero volume in its 

policy and procedures to ensure consistency with implementation of the procedures. 

In addition, we noted that 20 DCMs were eligible to be reviewed at some point during Fiscal 

Years 2011 through 2014. The Market Compliance Branch provided a list of these 20 DCMs to 

the auditors. Castro & Co cross referenced the list of DCMs to information posted on the CFTC 

website2 . From the website, we considered all DCMs with the “Designated” status as of a date 

within Fiscal Years 2011 through 2014 to be an eligible DCM. Also, if a DCM had a status of 

“Vacated,” “Dormant,” or “Withdrawn,” we reviewed the effective date for such a change in 

status. If based on its effective date, the DCMs were still active for a portion of the period under 

2 See 

http://sirt.cftc.gov/SIRT/SIRT.aspx?Topic=TradingOrganizations&implicit=true&type=DCM&status=Vacated&Cu 

stomColumnDisplay=TTTTTTTT. 

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our review (Fiscal Years 2011 through 2014), then we determined if they were still eligible for a 

RER. 

Based on the above stated factors, we found the Market Compliance Branch reviewed the 

following DCMs during FY 2011 through 2014: 

Tier Level # of DCMs 

# of DCMs 

Reviewed 

# of DCMs 

Not 

Reviewed 

1 5 6* -

2 5 4 1 

3 10 2 8 

Totals 20 12 9 

*Note: During Fiscal Years 2011 through 2014, one of the DCMs was reviewed twice. 

Though most of the DCMs not reviewed are Tier 3, de minimis/zero trading volume, some of 

these entities have been DCMs since 2010; therefore, we believe that all registered DCMs should 

be reviewed over a reasonable time period in order to identify potential deficiencies that should 

be corrected or the reason the DCM will not be reviewed should be documented. A review 

might ensure that minimal systems and procedures are in place to address a sudden increase in a 

DCM’s business activity. Furthermore, market forces change and newly developed best 

practices may aid an exchange when it elects to activate its marketplace. 

In addition, during the audit, Castro & Co became aware of CFTC filing and settling charges 

against ICE Futures U.S., a DCM, for submitting inaccurate and incomplete reports and data to 

the CFTC over the period of October 2012 through May 2014.3 We believe more frequent 

reviews of all DCMs are necessary to ensure significant issues are identified and either corrected 

or sanctions being imposed on the DCMs more timely, such as this CFTC action taken against 

ICE Futures U.S. 

II. Criteria 

The Commodity Exchange Act, 7 USC § 7(d)(1) states: 

Core Principles for Contract Markets 

(1) Designated as contract market 

(A) In general 

To be designated, and maintain a designation, as a contract market, a board of 

trade shall comply with – 

i. any core principle described in this subsection; and 

3 CFTC, CFTC Orders ICE Futures U.S., Inc. to Pay a $3 Million Civil Monetary Penalty for Recurring Data 

Reporting Violations, Release: PR7136-15 (http://www.cftc.gov/PressRoom/PressReleases/pr7136-15). 

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ii.	 any requirement that the Commission may impose by rule or 

regulation pursuant to Section 8a (5) [7 USC § 12a(5)]. 

The Commodity Exchange Act, 7 USC § 12a (5) states: 

The Commission is authorized – 

(5) to make and promulgate such rules and regulations as, in the judgment of the 

Commission, are reasonably necessary to effectuate any of the provisions or to 

accomplish any of the purposes of this chapter. 

The CFTC’s process for conducting RERs is documented in Appendix A. 

III. Effect 

Without sound and specific procedures for selecting DCMs for review, there is a risk that not all 

DCMs will be reviewed and monitored for compliance with the Commodity Exchange Act. 

IV. Cause 

The Market Compliance Branch has identified factors that should be evaluated in selecting 

DCMs for a RER and the Core Principles to be reviewed during the RER. Although we were not 

provided guidelines on how the factors are weighted in selecting DCMs, the Market Compliance 

Branch utilizes them as procedures. 

V. Recommendation 

We recommend that DMO Market Compliance Branch leadership should enhance its procedures 

for selecting DCMs to be reviewed to include the following: 

 Establish, identify and document selection factors into a formalized policies and 

procedures manual. 

 Specify in a policies and procedure manual how the factors gathered for each DCM 

(trading volume, date of last RER or other evaluations, etc.) should be analyzed and 

weighted to determine which DCM will be selected. 

 Establish specific trading volumes associated with each Tier classification. 

 Specify a period of time (i.e., two (2) to three (3) years) in which a DCM should be 

reviewed at least once. In addition, the policy could be different for each Tier 

classification. 

 Working papers should clearly identify the analysis and conclusions reached by the 

Market Compliance Branch associated with the DCMs selected for review. 

VI. Auditee’s Response 

DMO agrees that procedures for selecting DCMs for RERs should be better documented; 

however, they believe that factors associated with the selection process has already been 

identified and established. The DMO will establish a RER procedures folder and all factors used 

in conducting a review will be formally documented in that folder, including selection analysis 

for each RER initiated. 

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Furthermore, DMO stated that the Commission strives for DMO to examine DCMs deemed most 

significant on an annual basis (i.e., Tier 1s) and the other DCMs every two to three years. The 

DMO expects to draft a recommendation within the next 30 days specifying desired frequency of 

RERs for each tier of DCM; however, this will be a goal due to the limited resources available to 

the DCM and this goal will not be met without significant additional resources. 

VII. Auditor’s Response 

Castro & Co agrees with the corrective action plan by DMO to establish a RER procedures 

folder and to utilize this folder to document evaluation of each of the factors when assessing the 

DCMs for a RER and to document the overall selection analysis for each RER initiated. Castro 

& Co suggest that a follow-on review should be conducted to ensure that the RER procedures 

folder is established and is being effectively utilized. 

Since DMO believes that the recommended frequency of RERs by the Commission is only a 

goal and a goal that cannot be obtained without significant additional resources, we recommend 

that this policy document the recommended goal as well as a more realistic goal considering the 

current resources of the Market Compliance Branch. This more realistic goal will provide a 

benchmark for measuring the current Market Compliance Branch. Castro & Co. recommends 

that the OIG consider evaluating Market Compliance Branch adherence to the enhanced policy. 

Finding No. 3: Follow-Up Procedures on Concerns and Recommendations 

Made in Prior Rule Enforcement Review Reports Needs to be Enhanced 

I. Condition 

After each RER, the Market Compliance Branch sends a transmittal letter to the DCM with a 

summary of the concerns and recommendations that emerged from the review. The DCM is 

required to respond to the DMO within 30 days of the date of the transmittal letter on how they 

will address the stated concerns and recommendations. During our audit, we were not provided 

evidence to document any follow-up with the DCMs on their corrective action plan but we noted 

that the corrective action plan to address these concerns and recommendations are only reviewed 

during subsequent RERs. Based on our audit, Castro & Co believes the procedures for following 

up on the concerns and recommendations noted within RERs need to be strengthened to verify 

that all DCMs’ corrective action plans are timely reviewed and addressed prior to a subsequent 

RER. We were not provided documentation to support ongoing dialogue with DCMs for 

addressing Market Compliance Branch’s recommendations. 

II. Criteria 

The Commodity Exchange Act, 7 USC § 7(d)(1) states: 

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Core Principles for Contract Markets 

(1) Designated as contract market 

(A)	 In general 

To be designated, and maintain a designation, as a contract market, a board of 

trade shall comply with – 

i. any core principle described in this subsection; and 

ii.	 any requirement that the Commission may impose by rule or 

regulation pursuant to Section 8a (5) [7 USC § 12a(5)]. 

The Commodity Exchange Act, 7 USC § 12a (5) states: 

The Commission is authorized – 

(5) to make and promulgate such rules and regulations as, in the judgment of the 

Commission, are reasonably necessary to effectuate any of the provisions or to 

accomplish any of the purposes of this chapter. 

The CFTC’s process for conducting RERs is documented in Appendix A. 

In the case of a DCM that may delegate self-regulatory organizations (SRO) functions to the 

National Futures Association (NFA) and become aware that a delegated function is not being 

performed as required under the regulations, the DCMs must take the appropriate actions to 

address noncompliance, as required by the Commodity Exchange Act. The Commodity 

Exchange Act, 7 USC § 7a-2(b)(3), states: 

COMMON PROVISIONS APPLICABLE TO REGISTERED ENTITIES 

(b) Delegation of functions under core principles 

(3) Noncompliance 

If a contract market, derivatives transaction execution facility, or electronic trading 

facility that delegates a function under paragraph (1) becomes aware that a delegated 

function is not being performed as required under this Act, the contract market, 

derivatives transaction execution facility, or electronic trading facility shall promptly 

take steps to address the noncompliance. 

III. Effect 

The Market Compliance Branch practice of only reviewing corrective action plans of previously 

reported concerns and recommendations during a subsequent RER increases the risk that initially 

reported concerns and recommendations will not be implemented timely by DCMs due to the 

following issues: 

 For the FY 2011 through 2014 period, not all of the DCMs received a RER. 

 Infrequent follow-up review will lead to delays in DCMs implementing corrective 

actions. 

 For the FY 2011 through 2014 period, only one of the DCMs was reviewed more than 

once. 

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IV. Cause 

The Market Compliance Branch believes the issues discussed within the transmittal letters are 

not findings that need follow-up on prior to subsequent RERs or the Market Compliance Branch 

has not maintained and provided support to evidence its follow-up calls to the DCMs to address 

matters reported within the transmittal letter. 

V. Recommendation 

We recommend that Market Compliance Branch leadership strengthen procedures for following 

up promptly on all concerns and recommendations issued to a DCM. These procedures should 

consider, at a minimum, the following: 

 In consultation with a DCM, establish a time period for the corrective action plans to be 

implemented. 

 Establish scheduling guidelines based on the severity of the concerns and 

recommendations for Market Compliance Branch follow-up on corrective action plans to 

determine whether a reviewed DCM has promptly addressed matters identified during the 

RER. 

VI. Auditee’s Response 

Though DMO agrees with the value associated with following up with a DCM to address 

recommendations and concerns identified in the DMO’s RER transmittal letter prior to a 

subsequent RER, it disagrees with the assertion that a DCM’s corrective action plan is only 

reviewed during the subsequent RER. DMO further states while they do not have a fixed 

timetable for RER follow-up, the staff verbally provided several examples of the follow-up 

conducted with DCMs following their response letters and prior to any subsequent RER. DMO 

stated they will better document its follow-up process and will maintain the documentation in the 

appropriate electronic RER folder. 

Finally, the DMO stated its current practice includes direction within the transmittal letters 

requiring a DCM to respond within 30 days regarding how it will address recommendations or 

deficiencies. Moving forward, DMO stated, they will include language in the transmittal letters 

requiring a DCM’s response to include specific timeline in which the DCM plans to address each 

recommendation and/or correct any deficiency. Upon review of the DCM’s corrective action 

plan, DMO will communicate any concerns to the DCM. The transmittal letter will also require 

the corrective action plan to be implemented as soon as practical and for DCMs to provide DMO 

with information sufficient to demonstrate that the action plan has been implemented. 

VII. Auditor’s Response 

Castro & Co agrees with DMO’s corrective action plan to better document the follow-up process 

and to maintain proper documentation within the RER folder. In addition, Castro & Co. agrees 

with the language to be included within the transmittal letter requiring DCM to provide a specific 

timeline for addressing recommendations and/or deficiencies, as well as providing information to 

DMO to demonstrate that the action plan has been implemented. Castro & Co further 

recommends that the OIG consider conducting follow-up procedures to ensure that the 

procedures have been properly implemented. 

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Finding No. 4: Inadequate Staffing Leads to Lengthy Rule Enforcement 

Review Completion Time 

I. Condition 

DMO’s goal is to foster derivatives markets that accurately reflect the forces of supply and 

demand and are free of disruptive activity. It oversees trade execution facilities and data 

repositories, conducts surveillance, reviews new exchange applications and examines existing 

exchanges to ensure compliance with applicable core principles. DMO also evaluates new 

products to examine susceptibility to manipulation as well as rule filings by exchanges to ensure 

compliance with core principles. These responsibilities are addressed by employees in various 

DMO branches. 

Castro & Co noted that the limited number of full-time employees within the Market Compliance 

Branch might have an effect in the following areas: 

 Number of RERs conducted – new RERs are assigned to Market Compliance Branch 

staff as determined by the Deputy Director. 

 RERs are not being concluded in a timely manner –Market Compliance Branch sets a 

goal of one (1) year to complete each selected RER. Of the 12 (twelve) RERs conducted 

during the period FY 2011 through FY 2014, only one of the RERs was completed within 

one year. On average, twelve (12) were completed within one year and eight months 

with the longest being completed in two years and ten months. Castro & Co performed 

an analysis of the period of time to complete RERs using the Initiation letter date as the 

start date of the RER and the date of the RER report as the end date. See the table below: 

9 

# 

1 

2 

3 

4 

5 

6 

7 

8 

New York Mercantile 

Exchange, Inc. 

Designated Contract Market 

CBOE Futures Exchange 

Chicago Board of Trade 

Chicago Mercantile Exchange 

Commodity Exchange 

ELX Futures 

ICE Futures U.S. 

ICE Futures U.S. 

Minneapolis Grain Exchange 

1 

Tier 

Level Start Date 

2 11/15/2010 

1 11/21/2011 

1 11/21/2011 

1 12/11/2009 

3 06/21/2012 

1 06/21/2012 

1 11/10/2011 

2 06/13/2012 

12/11/2009 08/30/2011 

End Date 

09/06/2013 

07/29/2013 

07/29/2013 

08/30/2011 

09/06/2013 

07/22/2014 

12/17/2012 

09/06/2013 

627 1 year 9 months 

Period of Time to Complete RER 

Days Years/Month 

1,026 2 years 10 months 

616 1 year 8 months 

616 1 year 8 months 

627 1 year 9 months 

442 2 years 3 months 

761 2 years 1 month 

403 1 year 1 month 

450 1 year 3 months 

10 North American Derivatives 

Exchange 

2 12/18/2012 11/19/2013 336 11 months 

11 

12 

NYSE LIFFE, U.S. 

One Chicago, LLC 

3 

2 

Totals 

Average 

11/05/2010 

6/28/2012 

04/23/2012 

04/07/2014 

535 

648 

7,087 

591 

1 year 5 months 

1 year 10 months 

19 years 5 months 

1 year 8 months 

Management informed the audit team that factors which can affect RER completion time 

include delays in the exchange of information between Market Compliance Branch 

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employees and the DCM, and workload constraints on Market Compliance Branch 

employees. 

During our review, Castro & Co requested a report of the total hours charged to tasks by 

employees in the Market Compliance Branch for FY 2011 through FY 2014, which 

included employees that no longer work in the Market Compliance Branch. For each 

fiscal year, hours were provided and we identified the different hours billed to the DCMs 

by each employee as “class 1” associated with conducting the RERs and the total hours 

charged by the Market Compliance Branch. In addition, for FY 2013 and 2014, we were 

provided the hours charged, but not billed to the DCMs, by each employee as “class 2” 

associated with conducting the RERs.

4 The table below shows the hours charged to “class 

1”, “class 2”, total hours, and the number of RERs completed during the fiscal year: 

Description FY 2011 FY 2012 FY 2013 FY 2014 

Class 1 Hours 1,022 3,686 6,796 1,926 

Class 2 Hours - - 13,730 8,492 

Total Hours Charged 20,691 24,620 38,254 29,169 

Total RERs Completed 2 1 6 3 

II. Criteria 

The Commodity Exchange Act, 7 USC § 7(d)(1) states: 

Core Principles for Contract Markets 

(1) Designated as contract market 

(A) In general 

To be designated, and maintained a designation, as a contract market, a board of 

trade shall comply with – 

i. any core principle described in this subsection; and 

ii. any requirement that the Commission may impose by rule or 

regulation pursuant to Branch 12a (5) of this title. 

The Commodity Exchange Act, 7 USC § 12a (5) states: 

The Commission is authorized – 

(5) to make and promulgate such rules and regulations as, in the judgment of the 

Commission, are reasonably necessary to effectuate any of the provisions or to 

accomplish any of the purposes of this chapter. 

We did not document a standard completion cycle for RERs. 

4 The hours reported by employees are self-reported and we were unable to confirm with each employee the 

accuracy of the hours entered into the payroll system. Nonetheless, this was the best available information for 

ascertaining staff hours charged to an RER and does take into consideration annual leave and training hours. 

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III. Effect 

Inadequate staffing increases the risk that the DMO will not meet an overall objective of market 

oversight. In addition, if the RERs can be completed within a year, the issues noted within the 

RERs can be addressed sooner by the DCMs or referred to the Division of Enforcement (for 

more significant issues) to minimize subsequent impact of the open issues. 

IV. Cause 

Due to delays in the exchange of information between the Market Compliance Branch and 

DCMs and other tasks required of the individuals completing the RER, employees may have 

developed a reduced sense of urgency to finalize the open RER. 

V. Recommendation 

We recommend that DMO Market Compliance Branch leadership: 

 Determine whether more staff is needed to timely complete RERs or establish the 

frequency for conducting RERs with existing staff so as to provide timely results to 

DCMs. 

Or 

 Enhance procedures on how RERs are monitored by the Deputy and Associate Directors 

of Market Compliance Branch by establishing the use of budgets for each RER and/or 

implementation of strict timeline for the completion of the RER. 

 Procedures should be enhanced to require DCMs to be more responsive to the Market 

Compliance Branch’s request for information. These and other procedures should be 

implemented with the purpose of ensuring RERs are completed on a timelier basis. 

Strengthen the procedures for selecting DCMs and the specific core principles to be reviewed 

during the RER, as discussed in Findings 1 and 2, to ensure the DCMs and core principles 

which pose the most operational risk are timely reviewed. 

VI. Auditee’s Response 

DMO stated that they agree with the finding that inadequate staffing within the Market 

Compliance Branch leads to lengthy completion times for RERs. In addition to inadequate 

staffing, DMO points out that the RER program has been impacted in fiscal years 2011 through 

2014 by extensive rulemaking and other responsibilities arising from implementation of the 

Dodd-Frank Wall Street Reform and Consumer Protection Act by requiring a significant portion 

of time from compliance attorneys who otherwise would have been leading RERs. These 

rulemaking projects have continued into fiscal year 2015 and DMO anticipates it will continue 

into fiscal year 2016. Given the above constraints, DMO stated they are committed to fulfilling 

their oversight responsibilities. 

12
 
 

 

 

 

VII. Auditor’s Response 

Castro & Co agrees that the Market Compliance Branch is inadequately staffed and 

acknowledges that rulemaking projects significantly reduced the amount of resources available 

for conducting and completing RERs; however, Castro & Co. reiterates our recommendations to 

enhance procedures for monitoring RERs and for following up with DCMs. 

13
 
 

 

APPENDIX A:
 

BACKGROUND INCLUDING DESCRIPTION OF RULE REVIEW PROCESS
 

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Background 

The CFTC was created by Congress in 1974 as an independent agency with the mandate to 

regulate the commodity futures and options market in the United States. The Agency protects 

market participants against manipulation, abusive trade practices and fraud. Through effective 

oversight and regulation, the CFTC enables the markets to serve better their important functions 

in the nation’s economy – providing a mechanism for price discovery and a means of offsetting 

price risk. 

To assist the financial and market integrity of the nation’s futures markets, the CFTC reviews the 

terms and conditions of proposed futures and option contracts. All futures and options 

transactions must be conducted on or subject to the rules of a CFTC designated board of trade. 

Before an exchange lists a new futures or options contract for trading, it must certify that the 

contract complies with the requirements of the Commodity Exchange Act (CEA) and the 

Commission’s regulations, including the requirement that the contract terms reflect commercial 

trading practices and that the contract not be readily susceptible to manipulation. The CFTC 

conducts daily market surveillance and can, in an emergency, order an exchange to take specific 

action or to restore orderliness in any futures contract that is being traded. 

Companies and individuals who handle customer funds or give certain trading advice must apply 

for registration through the NFA, a self-regulatory organization approved by the Commission. 

The CFTC also seeks to protect customers by requiring registrants to disclose market risks and 

past performance information to prospective customers, by requiring customer funds be kept in 

accounts separate from those maintained by the firm for its own use, and by requiring customer 

accounts to be adjusted to reflect the current market value at the close of trading each day. In 

addition, the CFTC monitors registrant supervision systems, and internal controls and sales 

practice compliance programs. 

Commodity exchanges complement Federal regulation with rules of their own, rules covering 

clearance of trades, trade orders and records, position limits, price limits, disciplinary actions, 

floor trading practices, and standards of business conduct. A new or amended exchange rule may 

be implemented upon certification by the exchange that the new or amended rule complies with 

the CEA and Commission regulations. The CFTC may also direct an exchange to change its 

rules or practices if found to be in violation. The NFA, a self-regulatory organization for the U.S. 

futures industry, performs similar functions for member firms. The CFTC also regularly reviews 

each exchange’s and the NFA’s compliance program. 

The Commission consists of five Commissioners, appointed by the President with the advice and 

consent of the Senate to serve staggered five-year terms. The Commission develops and 

implements agency policy and direction. One of the Commissioners is designated by the 

President to serve as Chair. The Chair’s staff has direct responsibility for providing information 

about the Commission to the public and interacting with other governmental agencies and the 

Congress, and for the preparation and dissemination of Commission documents. The Chair’s 

staff also ensures that the Commission is responsive to requests filed under the Freedom of 

Information Act and Privacy Act. 

The CFTC monitors markets and market participants by maintaining, in addition to its 

headquarters office in Washington, DC, offices in Chicago, New York, and Kansas City. In 

15
 
 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

addition, the CFTC operates through four different divisions listed below and are supported by a 

number of offices not listed in this abridged chart: 

Figure 1 

CFTC 

Division of Market 

Oversight 

Division of Clearing 

and Risk 

Division of 

Enforcement 

Division of Swap 

Dealer and 

Intermediary 

Oversight 

 Division of Market Oversight (DMO) – fosters derivatives markets that reflect the 

forces of supply and demand and are free of disruptive activity. The DMO is also 

responsible for performing RERs on DCMs. 

 Division of Clearing and Risk – oversees derivatives clearing organizations and other 

market participants in the clearing process, including futures commission merchants, 

swap dealers, major swap participants, and large traders. 

 Division of Enforcement – investigates and prosecutes alleged violations of the CEA 

and CFTC regulations. Potential violations include fraud, manipulation and other abuses 

concerning commodity derivatives and swaps that threaten market integrity, market 

participants, and the general public. Successful prosecution by the Division of 

Enforcement can result in a court imposed financial sanction -- known as a civil monetary 

penalty. 

 Division of Swap Dealer and Intermediary Oversight – oversees the registration and 

compliance of intermediaries and futures industry self-regulatory organizations, including 

U.S. derivatives exchanges and the National Futures Association. 

On July 21, 2010, the “Dodd-Frank Wall Street Reform and Consumer Protection Act” (the 

Dodd-Frank Act, or the Act) was signed into law, significantly expanding the powers and 

responsibilities of the CFTC to also include oversight of the swaps markets. 

Designated Contract Markets 

DCMs are boards of trade, i.e. exchanges, which may list for trading futures or option contracts 

based on all types of commodities and grant access to their facilities by all types of traders. To 

obtain and maintain its designation, a DCM must comply, on an initial and ongoing basis with 

twenty-three (23) Core Principles established in Section 5(d) of the CEA, 7 USC 7(d) and Part 

38 of the CFTC’s regulations and with the implementing regulations under Part 38 of the 

CFTC’s regulations. 

16
 
 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

The Dodd-Frank amendments of the CEA included the following: 

 Section 735 of the Dodd-Frank Act amended CEA by eliminating the eight criteria for 

designation as a contract market under Section 5(b); 

 Amended a majority of the core principles, including incorporating into the Core 

Principles most of the former designation criteria; and, added five new core principles: 

Core Principle 13 (Disciplinary Procedures), Core Principle 20 (System Safeguards), 

Core Principle 21 (Financial Resources), Core Principle 22 (Diversity of Boards of 

Directors), and Core Principle 23 (Securities and Exchange Commission). 

 Section 723 of the Dodd-Frank Act added Section 2(h)(8) of the CEA to require that the 

execution of swaps, those that are subject to the mandatory clearing requirement of CEA 

Section 2(h), occur on DCMs or Swap Execution Facilities (SEF), except where no DCM 

or SEF makes the Swap available for trading. 

The CFTC approved new rules for DCMs that became effective on August 20, 2012.5 All of 

these requirements (e.g., CFTC’s regulations, application guidance, acceptable practices, and the 

new approved rules) implement the twenty-three (23) core principles, and incorporate the trading 

and execution of swaps on DCMs. 

Rule Enforcement Reviews of Designated Contract Market Process 

DMO’s Market Compliance Branch is headed by a Deputy Director who oversees four 

organizational units which are: Regional Section, Section One, Section Two, and Section Three. 

Below is an overview of the Market Compliance Branch: 

Figure 2 

Deputy Director 

Regional 

Section Section One Section Two Section Three 

Associate 

Director 

Associate 

Director 

Associate 

Director 

Associate 

Director 

4 Trade Practice 

Analysts 

2 System Risk 

Analyst 

4 Attorney 

Advisors 

2 Attorney 

Advisors 

5 77 FR 36611 (June 19,, 2012). 

17
 
 

 

 

 

 

 

 

 

- 

 

-

'

 

 

 

 

 

 

 

 

 

 

 

 

Market Compliance Branch is responsible for conducting regular reviews of each DCM’s 

ongoing compliance with core principles through the self-regulatory programs operated by the 

exchange in order to enforce its rules, prevent market manipulation and customer and market 

abuses, and ensure the recording and safe storage of trade information. These reviews are known 

as RERs. Each RER will include the examination of trading and compliance activities over a 

twelve (12) month period immediately preceding the start of the review. The process for 

conducting a RER is summarized below: 

Figure 3 

DCM Selection 

Process 

Determining 

Sections of the RER 

Checklist that must 

be completed. 

Performance of the 

RER 

Prepare and Finalize 

the RER Report 

Follow Up on the 

Corrective Action 

Plan(s) 

Designated Contract Markets RER Selection Process 

Figure 4 

Trading 

Volume Last RER 

Last Review 

of Core 

Principles 

(non RER) 

Regulatory 

Issues 

Significa nt 

Changes in 

DCM s 

Complia nce 

Program 

DCM 

When it is determined that an RER needs to be conducted, the Deputy Director will meet with 

the Associate Directors of the Regional Section, Section Two and Section Three. These 

individuals will analyze several factors before selecting a DCM for a RER. These factors 

include the following: 

 Trading Volume on the DCM, which are identified as: 

o	 Tier 1 - significant volume transactions; 

o	 Tier 2 - moderate volume transactions; and 

o	 Tier 3 - zero or de minimis volume transactions). 

 Last time a review was conducted on the DCM in any capacity. These reviews may 

include reviews completed by other divisions of the DMO related to product; market; 

data and reporting; business management; and market and contract analysis reviews. 

Additionally, they may discuss reviews related to Core Principle 20 (System Safeguards), 

which is performed by Section One of the DMO Market Compliance Branch. 

18
 
 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 Last time a particular Core Principle was reviewed at the DCM through an audit trail, 

trade practice surveillance, market surveillance, and disciplinary procedures. Any issues 

identified in a previous RER performed on a DCM that require follow up to evaluate 

implementation of recommendations or areas that require corrective action due to a 

deficiency with a CFTC regulation. 

 Any regulatory issues brought to the attention of the Market Compliance Branch. 

 Any significant changes in the DCMs Compliance program since the last RER or DCM 

registration. DCMs are required to notify the CFTC of any significant changes in their 

compliance program. 

The Deputy Director and the Associate Director will also consult with other CFTC divisions to 

ensure there are not any duplication of efforts before the final determination is made on selection 

of a DCM for conducting an RER. 

Process for Selecting Sub-Section of the RER Checklist to Review 

Figure 5 

RER Checklist 

Staffing and 

Organization 

Audit Trail 

Trade 

Practice 

Surveillance 

Market 

Surveillance Disciplinary 

The Market Compliance Branch utilizes a checklist for completing RER on a selected DCM. 

This checklist is structured into five (5) sections and includes a listing of questions and/or 

procedures that must be asked and/or performed in order to complete the specified RER checklist 

section. The separate sections of the checklist are: 1) Staffing and Organization, 2) Audit Trail, 

3) Trade Practice Surveillance, 4) Market Surveillance, and 5) Disciplinary. Each of the separate 

sections of the RER checklist is designed to address one or more core principles. 

Before conducting a RER, the Market Compliance Branch will determine which sections of the 

checklist must be completed. Some guidelines utilized by the Market Compliance Branch 

include sections of the checklist that are not usually reviewed in consecutive years for a specific 

Tier 1 DCM, unless significant findings or deficiencies were identified. In addition, for Tiers 2 

and 3 DCMs, a RER for a specific section of the checklist will not be repeated for review until 

the other sections of the checklist have been reviewed also. 

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Conducting a RER 

Figure 6 

Assemble the 

RER Team 

Set Target 

Dates 

Send Initiation 

Letter 

Complete the 

RER Checklist 

The Market Compliance Branch will assign staff to conduct RERs based on availability and 

skillset required. The team is generally made up of a lead attorney either from Section Two or 

Three and a trade practice analyst from the Regional Section. All RERs are supervised by the 

Deputy Director and the Associate Director. Also, if a market surveillance review is being 

performed, the Market Compliance Branch will request assistance and support from the DMO 

Market Surveillance Section. 

The Associate Director and the RER team will set target dates for completing the various stages 

of the RER, including completing the applicable checklist sections and the written transmittal 

letter. Once the target dates are set, the RER team will send an initiation letter to the DCM to 

notify them about the RER, the sections of the checklist to be performed, and the applicable 

target dates for starting the RER. 

The RER team completes the applicable sections of the RER checklist by examining trading and 

compliance activities for the DCM over the twelve (12) months preceding the date of the 

initiation letter. The review period can be expanded to subsequent periods if issues are identified 

which would require further evaluation and analysis. More specifically, the RER team conducts 

an extensive review of documents and systems used by the DCM, including but not limited to the 

following: 

 Organizational charts 

 Qualifications of compliance staff 

 Compliance manuals 

 Reports and other documents used routinely for surveillance 

 Investigation files and logs 

 Disciplinary files and logs 

 Committee meeting minutes involving compliance functions. 

On site, the lead attorney performs interviews with the DCM personnel, who are recorded and 

transcripts of the interviews are documented by a court reporter. DCMs have the ability to 

review the transcripts and correct any inaccuracies, if any. The lead attorney and trade practice 

analyst will complete the applicable sections of the RER checklist to support the information 

obtained from the DCM. The RER checklist represents the main source for writing the report. 

20
 
 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Prepare and Finalize the RER Report 

Figure 7 

Draft RER 

Report 

Associate 

Director and 

Deputy Director 

Review 

Division of 

Enforcement 

Review 

Send to DCM Exit Conference 

Conducted 

CFTC 

Commissioners 

Accept 

Press Release 

Issued and 

Posted on CFTC 

Website 

Once the checklist has been completed by the RER team, a comprehensive RER report is drafted 

by the lead attorney. The RER report describes the DCM’s compliance program and includes an 

analysis of the DCM’s compliance with the relevant core principles and CFTC regulations. In 

addition, the RER report includes findings as a result of the review with recommendations for 

areas of improvement. A draft of the RER report is reviewed and edited by an Associate 

Director and Deputy Director. A draft is also sent to the Division of Enforcement for its review 

and comments. 

Once reviewed and approved, the final draft is sent to the DCM and an exit conference is 

conducted to discuss the RER report. Then the RER report is submitted to the CFTC 

Commissioners for acceptance. After the Commission accepts the report, the report, along with 

a press release is issued and made public through the CFTC website (www.cftc.gov). 

Follow-Up on the Corrective Action Plan(s) 

Figure 8 

DCM Response to Transmittal 

Letter 

Market Compliance 

Branch 

Communicates with 

DCM 

Follow_up on 

Subsequent RERs 

A response to the transmittal letter is required from the DCM within 30 days of issuance and the 

DCM’s response should address how the DCM plans to correct any deficiencies and/or 

implement recommendations. The Market Compliance Branch will communicate with the DCM 

frequently to ensure all corrective action plans are being implemented and will conduct follow up 

procedures for deficiencies reported on subsequent RERs. 

21
 
APPENDIX B:
 

DIVISION OF MARKET OVERSIGHT MARKET COMPLIANCE BRANCH
 

RESPONSE TO DRAFT REPORT
 

22
 
U.S. COMMODITY FUTURES TRADING COMMISSION 

Three Lafayette Centre 

1155 21st Street, NW, Washington, DC 20581 

Telephone: (202) 418-5260 

Facsimile: (202) 418-5527 

www.cflc.gov 

Division of 

Market Oversight 

To: Tony Baptiste, Senior Program Analyst 

Office ofthe Inspector General 

From: Vincent McGonagle, Director ~ Rachel Berdansky, Deputy Direct~ Division of Market Oversight 

Re : Performance Audit of the Division of Market Oversight's Rule Enforcement Review 

Program 

Date: July 2, 2015 

The Division of Market Oversight ("Division") appreciates the opportunity to respond to the 

Performance Audit conducted by Castro & Company, LLC on behalf of the Office of the 

Inspector General of the Division's Rule Enforcement Review Program ("Castro Report"). The 

Division effectively uses its rule enforcement review ("RER") program as an oversight tool and 

welcomes suggestions for further enhancement. The Division is pleased that the Castro Report 

agrees with the Division's approach of reviewing those designated contract markets ("DCMs") 

and core principles w hich pose the most risk. The Castro Report made four specif ic findings 

w ith related recommendations. The Division intends to implement those recommendations. 

All of the Castro Report's findings and the Division's adoption of the Castro Report's 

recommendations are discussed below. 

Finding 1: The Division Is Not Conducting Rule Enforcement Reviews of All Core Principles 

The Castro Report found t hat the Division's RER program is designed to focus on those core 

principles and Commission regulations related to four areas: audit trail, trade practice 

surveillance, market surveillance, and exchange disciplinary programs. In addition, all RERs, 

regardless of subject area being examined, review the exchange's staffing and organization in 

that subject area to determine whether the exchange has adequate staff and resources to 

perform its self-regulatory functions. The Division agrees with these findings. The RER program 

was designed from its inception to focus closely on exchanges as the front-line self-regulatory 

organizations in U.S. futures markets. The Division's selection of core principles and regulations 

for review in RERs reflects a conscious decision to focus resources on the areas of greatest risk 

and maximum reward for market integrity, customer protection, and effective self-regulation. 

23
 
The Castro Report also states that the Division's Market Compliance Branch ("Compliance") is 

responsible for reviewing exchange compliance "with the twenty-three (23) Core Principles 

established within the Commodity Exchange Act." However, the Division utilizes several 

available tools to determine compliance, including lead responsibilities by other Division 

Branches, the self-regulatory function of the exchanges, and other procedural processes 

available to the Division requiring the exchanges to confirm compliance with core principles 

upon request. Notwithstanding, the Division will evaluate whether and which additional core 

principle reviews may be effectively subject to a rule enforcement review. 

A. RERs Are Not Optimal for all Core Principles 

As a general matter, the Castro report does not independently evaluate whether and how each 

of the core principles is suitable for a rule enforcement review. The Division has determined 

that given resource limitations, the Compliance Branch's RER program will focus on DCMs 

compliance with those core principles related to subject areas that are likely to pose the most 

risk to the general public. At this time, this includes audit trail (Core Principle 2- Compliance 

w ith Rules and Core Principle 10- Trade Information); trade practice surveillance (Core Principle 

2 and Core Principle 12- Protection of Market Participants); market survei llance (Core Principle 

2, Core Principle 4- Monitoring of Trading, and Core Principle 5- Position Limitation or 

Accountability); and exchange disciplinary programs (Core Principle 13- Disciplinary 

Procedures). 

Presently, the Division has determined that oversight of some core principles is better 

addressed outside of the RER process. The Castro Report lists specific core principles for which 

Compliance does not conduct RERs. Included in that list is Core Principle 20- System 

Safeguards. The Division notes, however, that the Compliance Branch includes a dedicated 

Market Continuity Program that conducts System Safeguard Examinations ("SSEs") specifically 

to review DCMs' compliance with Core Principle 20. The Division also has determined that DCM 

compliance with Core Principle 18- Recordkeeping, which in the past was addressed in audit 

trail RERs, is better addressed in SSEs. 

For certain core principles, the Division believes it is a more effective and efficient use of 

resources for other Division Branches to have lead responsibility to conduct oversight. For 

example, Core Principle 21- Financial Resources, is a core principle that the Division has 

determined is more efficiently handled by the Market Review Branch outside of the RER 

process, rather than by Compliance. Market Review oversees the designation of DCMs (an 

applicant must demonstrate compliance with all of the core principles to be designated as a 

contract market), and thereafter, the market activities and functions of DCMs by reviewing rule 

filings and submissions.1 With respect to Core Principle 21, Commission regulation § 38.1101(f) 

1 Part 40 of the Commission's regulations requires that before implementing any new rule, a DCM must either 

submit the rule for approval or self-certify that the rule complies with the Act and Commission regulations. The 

term "rule" is defined broadly and pursuant to§ 40.l(i) includes "any constitutional provision, article of 

incorporation, bylaw, rule, regulation, resolution, interpretation, stated policy, advisory, terms and conditions, 

trading protocol, agreement or instrument corresponding thereto, including those that au tho rile a response or 

24
 
requires that DCMs file detailed quarterly reports regarding financial resources. 2 Market 

Review assesses each DCM's quarterly report to determine wheth er the DCM is in compliance 

with the core principle and its associated rules. Given that this assessment is made four times a 

year, the Division believes that conducting a Core Principle 21 RER is redundant and not a 

prudent use of limited resources. For some core principles, such as Core Principle 19- Antitrust 

Considerations, the Division has det ermined that at present, oversight is best accomplished 

through the rule submission process that is handled by the Market Review Branch. 

Core Principle 3- Contracts Not Readily Subject to Manipulation, is a program area to which the 

Division has devoted an entire (separat e) Branch: the Product Review Branch. Under Part 40 of 

the Commission's regulations, a DCM cannot list a product for trading that has not been either 

self-certified by the DCM that the product complies with the Commodity Exchange Act ("Act") 

and Commission regulations, or approved by the Commission pursuant to a request by the 

DCM. The vast majority of new products are self-certified.3 In reviewing new product 

establish standards for responding to a specific emergency, and any amendment or addition thereto or repeal 

thereof, made or issued by a registered entity or by the governing board thereof or any committ ee thereof, in 

whatever form adopted." Accordingly, rules are submitted in connection with all core principles, including core 

principles that may not be reviewed in an RER. Market Review's evaluation of rule filings thus serves as another 

Division tool to evaluate DCM's core principle compliance. Commission regulation§ 40.6(a)(7)(v) requires that rule 

certifications include an explanation of the operation, purpose, and effect of the proposed rule or rule 

amendment, and its compliance with the Act and Commission regulations. 2 Commission regulation§ 38.1101(f) provides as follows: 

(f) Reporting Requirements. (1) Each fiscal quarter, or at any time upon Commission request, a designated contract 

market must: 

(i) Report to the Commission: 

(A) The amount of financial resources necessary to meet the requirements of paragraph (a} of this section; 

and 

(B) The value of each financial resource available, computed in accordance with the requirements of 

paragraph (d) of this section; and 

(ii) Provide the Commission with a financial statement, including the balance sheet, income statement, and 

statement of cash flows of the designated contract market or of its parent company. 

(2) The calculations required by this paragraph shall be made as of the last business day of the designated contract 

market's fiscal quarter. 

(3) The designated contract market must provide the Commission with: 

(i) Sufficient documentation explaining the methodology used to compute its financial requirements under 

paragraph (a) of this section; 

(ii} Sufficient documentation explaining the basis for its determinations regarding the valuation and liquidity 

requirements set forth in paragraphs (d) and (e) of this section; and 

(iii) Copies of any agreements establishing or amending a credit facility, insurance coverage, or other 

arrangement evidencing or otherwise supporting the designated contract market's conclusions. 

(4) The reports shall be filed not later than 40 calendar days after the end of the designated contract market's first 

three fiscal quarters, and not later than 60 calendar days after the end of the designated contract market's fourth 

fiscal quarter, or at such later time as the Commission may permit, in its discretion, upon request by the 

designated contract market. 

3 Commission regulation§ 40.2(a)(3)(v} requires that the certification include an explanation and analysis of the 

product and its compliance with the Act and Commission regulations. The explanation and analysis must be 

25
 
submissions, Product Review is particularly focused on Core Principle 3. Given that over 2,400 

different products traded in each of the past three yea rs (2012, 2013, and 2014), the Division 

believes it is impractical to determine compliance with Core Principle 3 th rough the RER 

process. 

The Division notes that Commission regulation§ 38.5(b) is another mechanism used by the 

Division, outside of the RER process, to determine whether a DCM is in compliance with core 

principles. Pursuant t o delegated authority, that regulation permits the Division to request that 

a DCM file a writt en demonstration, containing supporting data and documents, that 

demonstrat e the DCM is in compliance with one or more core principles. Several of the 

Division's Branches, including Compliance, have utilized this process upon learning of 

potentially problematic exchange practices or procedures through the Branches' routine work. 

Moreover, if a DCM rule on its face appears to comply with the Act and Commission regulations 

but Division staff is concerned regarding its actual operation and market impact , the Division 

wi ll utilize§ 38.5(b) and request that the DCM demonstrate its compliance w ith the potentially 

impacted core principles and/or Commission regulations. 

B. Resource Limitations 

The Division acknowledges that with more staff, additional core principles, such as those 

related to governance, would be included in the RER program. As recognized by the Castro 

Report in Finding 4 (addressed more fully below), Compliance is constrained by limited 

resources- most specifically the number of staff. Given that limited staffing is a chronic issue 

(not only for Compliance, but for the entire Division), the Division has made a strategic decision 

to structure its RER program to focus on those core principles that it believes are likely to pose 

t he most risk to the general public and areas t hat are the most fluid, e.g., the effectiveness of 

exchange trade practice and market surveillance programs, the adequacy of exchange 

investigations, and the sufficiency of exchange-imposed sanctions for violations of rules or law. 

While the Division is responsible for oversight of all of the core principles, RERs are only one of 

the many t ools available to the Division to perform its oversight responsibilities. 

Castro Report Recommendation: Compliance Branch leadership should implement operating 

procedures that address off of the DCM Core Principles. A standardized checklist wiff enable 

the review team to document why a certain Core Principle wiff not be reviewed. This 

additional procedure should provide justification supporting the Core Principles selected for 

review as weff as the ones not selected for review so that each RER procedure is forma fly 

considered, approved, and documented. 

The Division has determined that DCM compliance with certain core principles is more 

effectively analyzed and reviewed by other Branches and th at further review by Compliance 

RERs wi ll likely be duplicative and unnecessarily divert scarce resources from the core areas for 

accompanied by the documentation relied upon to establish the basis for compliance, or incorporate information 

contained in such documentation with appropriate citations to data sources. 

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which RERs have been deemed to be the most effective oversight tool. However, the Division 

agrees that it will develop an annual process to evaluate and recommend which DCM core 

principles not routinely included in the RER program should be added to the program in that 

year, if any. This recommendation process will include senior Compliance staff consultation 

with the Division Director and Division Deputy Directors to discuss: market changes that 

warrant adding a particular core principle to the RER program; consideration of Commission 

rules recently adopted in connection with a particular core principle; the risk to market 

participants if the core principle is not included in the program; resources; and other Division 

priorities and considerations. A determination also will be made if DCM compliance with the 

core principle is more efficiently handled outside of the RER process. This process will be 

implemented by the Division prior to the initiation of any new RERs and documented in a 

checklist as recommended. The documentation, however, will recognize that what the Division 

believes poses the most risk could change at any time, depending on circumstances. 

Documenting the selection of those core principles selected for a specific DCM review will be 

addressed in the Division's response to the Castro Report's recommendation made in 

connection with Finding 2. 

Finding 2: Procedures for Selecting DCMs for an RER Need to be Improved 

The Compliance Branch provided Castro with a list of the factors Complian\=e considers in 

selecting a particular DCM for an RER. The Castro Report cites these factors but nevertheless 

concludes that Compliance has not "established and documented any formalized policy or 

procedures manual for selecting a DCM for a RER." The Castro Report further concludes that 

Compliance's selection procedures need to provide specific criteria for choosing DCMs and how 

those factors are reviewed and considered in the selection process. The Division agrees that 

documentation of the selection for a DCM RER can be better documented. The Division, 

however, disagrees with any implication that Compliance has not established a formalized 

policy for DCM selection and that Compliance does not have specific criteria that it considers 

for DCM RER selection. 

The Castro Report explains how Compliance divides DCMs into different tiers depending upon 

trading volume. A DCM's tier level is one factor considered when selecting a DCM for an RER. 

DCMs with significant trading volume are considered Tier 1, DCMs with moderate trading 

volume are considered Tier 2, and DCMs with de minimis or zero trading volume are considered 

Tier 3. The Castro Report concludes that Compliance should define the trading volume levels 

for each tier. 

The Castro Report also discusses the number of DCMs subject to an RER during the relevant 

review period (FY 2011-FY 2014). The report notes that most of the DCMs not examined during 

the review period had de minimis or zero trading volume and that some of these Tier 3 

exchanges had not been examined since designation dating back to 2010. The report explains 

that an RER "might ensure that minimal systems and procedures are in place to address a 

sudden increase in a DCM's business activity." While it is the Division's goal to perform RERs of 

all DCMs on a regular basis, as recognized by the Castro Report, the Division is constrained by 

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• Work papers should clearly identify the analysis and conclusions reached by 

Compliance associated with the DCMs selected for review. 

The Division agrees that Compliance should better document its procedures for selecting a 

DCM for an RER. The Division, however, already has identified and established the selection 

factors it considers for choosing a particular DCM for an examination. These factors are cited 

on page 4 of the Castro Report. The Division wi ll establish an RER procedures folder and those 

factors w ill be formally documented in that folder. The Division does not believe that each 

factor should be assigned a specific weight but that senior Compliance staff should have the 

flexibi lity to balance the various factors. The Division will document its selection analysis for 

each RER initiated. 

With respect to RER frequency, as noted on page 30 of the FY 2016 President's Budget, the 

Commission strives for the Division to examine those DCMs deemed most significant on an 

annual basis (this equates with what the Division deems Tier 1) and the other DCMs every two 

to three years.6 The Division wi ll draft a recommendation within the next 30 days stating the 

desired frequency of RER for each tier of DCM (recognizing that that this is a goal that wi ll not 

be met without significant additional resources). This document will be maintained in an RER 

procedures manual folder. The Division also will establish specific trading volume for each DCM 

tier classification. Because exchange trading volume changes year-to year, during the first 

quarter of every calendar year, the Division will define Tier 1, Tier 2, and Tier 3 based on 

exchange reported trading volume for the previous year. Once the tiers are defined, the 

Division wi ll then classify each DCM. This process wi ll be documented and maintained in the 

electronic RER procedures manual folder. 

Finding 3: Follow-Up Procedures on Concerns and Recommendations Made in Prior Rule 

Enforcement Review Reports Needs to be Enhanced 

The Division agrees with the Castro Report's finding that recognizes the value of following-up 

with a DCM to address recommendations and concerns identified in the Division's RER 

transmittal letter prior to a subsequent RER. This has always been the Division's practice. The 

report states, however, that Castro "was not provided any evidence to document any follow-up 

with the DCM on their corrective plan but we noted that the corrective plan to address these 

concerns and recommendations are only reviewed during subsequent RERs." The Division 

disagrees with the assertion that a DCM's corrective action plan is on ly reviewed during the 

subsequent RER. 

The Division's current practice is to transmit the RER report with a transmittal letter t o the DCM 

at the conclusion of the RER and to require the DCM to respond within 30 days regarding how it 

intends to address a recommendation for improvement and/or a deficiency. The Division 

carefully reviews the DCM response and promptly discusses any concerns with the DCM after 

reviewing the response letter. 

6 The Division has been unable to meet this goal due to resource limitations. As discussed below in connection 

with Finding 4, Compliance st aff has several other responsibilities in addition to conducting RERs. 

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While Compliance may not have a fixed timetable for RER follow-up, Compliance staff verbally 

provided Castro with several examples of the follow-up conducted with DCMs following their 

response letters and prior to any subsequent RER. For example, in one RER that completed 

during t he Castro Report's review period, the Division found that the DCM did not have an audit 

trail enforcement program. The DCM provided Compliance with continuous updates (both 

orally and in writing) 7 regarding its progress for implementing an appropriate program. 

Compliance staff worked closely with the DCM to review documents and to provide feedback 

on new audit trail rules governing the DCM's participants and an updated DCM Compliance 

Manual. The Division will better document its follow-up process and wi ll maintain the 

documentation in the appropriate electronic RER folder. 

Castro Report Recommendation: Compliance leadership strengthen procedures for following 

up promptly on all concerns and recommendations issued to a DCM. These procedures should 

consider, at a minimum, the following: 

• In consultation with a DCM, establish a time period for the corrective action plans to 

be implemented. 

• Establish scheduling guidelines based on the severity of the concerns and 

recommendations for Market Compliance Branch follow-up on corrective action plans 

to determine whether a reviewed DCM has promptly addressed matters identified 

during the RER. 

The Division's current practice includes direction in its transmittal letter requiring a DCM to 

respond within 30 days regarding how it will address a recommendation or deficiency. Moving 

forward, the Division will include language in all transmittal letters that wi ll require the DCM to 

file a written response to the Division's letter and include a specific timeline in which the DCM 

plans t o address each recommendation or correct any deficiency. The Division will carefully 

review the DCM's corrective action plan and promptly communicate with the DCM to address 

any concerns (e.g., the timing for implementing the action plan or the manner in w hich the 

DCM intends to address the recommendation or deficiency). The transmittal letter also will 

require that as soon as practicable after the DCM implements the corrective action plan for a 

specific recommendation or deficiency, the DCM provide the Division with information 

sufficient to demonstrate that the action plan has been implemented. 

Finding 4: Inadequate Staffing Leads to Lengthy Rule Enforcement Review Completion Time 

The Division agrees with the Castro Report's finding that inadequate staffing in Compliance 

leads to lengthy RER completion times. The Castro Report also correctly identifies "the limited 

number of full-time employees" within the Compliance Branch as a factor that may impact both 

the number of RERs conducted and the time necessary to complete an RER. The Division 

appreciates the Castro Report's willingness to elevate this important issue which significantly 

1 Compliance can provide Castro with em ails evidencing RER follow-up. 

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limit s Compliance's ability to review more DCMs for compliance with more core principles and 

t o do so more quickly. 

The Castro Report provides st atistics regarding t he total number of hours charged to tasks by 

staff in the Compliance Branch for fiscal years 2011 t hrough 2014. These statist ics illustrat e the 

impact of inadequat e staffing on Compliance and the RER program; t hey are certainly below 

Compliance's potential if it were adequately staffed. As discussed below, Compliance and the 

RER program were also impacted in fiscal years 2011 through 2014 by t he Division's extensive 

rulemaking and ot her responsibilities arising from implementation of the Dodd-Frank Wall 

Street Reform and Consumer Protection Act ("Dodd-Frank Act").8 

Fiscal years 2011 through 2013 coincided with significant rulemaking projects undertaken by 

the Division. Compliance attorneys-who ot herwise would have been leading RERs-were 

primarily devoted in fiscal years 2011 t hrough 2013 to numerous rulemaking projects arising 

from Dodd-Frank. These included: (1) proposed rules for DCMs published in December 2010; 

(2) proposed rules for swap data repositories ("SDRs") published in Decem ber 2010; (3) 

proposed rules for swap execution faci lities ("SEFs") published in January 2011; (4) f inal rules 

for SDRs adopted in Sept ember 2011; (5) final rules for DCMs adopted in June 2012; and (6) 

final rules for DCMs adopted in June 2013. Attorneys in Compliance also contributed t o other 

significant rulemaking projects during this time. 

Upon completion of its rulemakings, the Division turned in fiscal year 2014 to temporary and 

then permanent registration of over two dozen SEFs. Compliance attorneys were heavily 

involved in such work. Today, in fiscal year 2015, Compliance att orneys continue to spend 

significant port ions of their time implementing the Dodd-Frank Act, including complex reviews 

to transit ion SEFs from t emporary to permanent registration. The Division anticipates t hese 

responsibilit ies wi ll continue into fiscal year 2016. 

Castro Report Recommendation: Compliance leadership should: 

• Determine whether more staff is needed to timely complete RERs or establish the 

frequency for conducting RERs with existing staff so as to provide timely results to 

DCMs. 

Or 

• Enhance procedures on how RERs are monitored by the Deputy and Associate 

Directors of Market Compliance Branch by establishing the use of budgets for each 

RER and/or implementation of strict time line for the completion of the RER. 

8 See Dodd-Frank Wall Street Reform and Consumer Protection Act, Public Law 111-203, 124 Stat. 1376 (2010). 

31
 
• Procedures should be enhanced to require DCMs to be more responsive to the Market 

Compliance Branch's request for information. These and other procedures should be 

implemented with the purpose of ensuring RERs are completed on a timelier basis. 

The Castro Report's recommendations in this area provide options, including that the Division 

"determine whether more staff is needed to timely complete RERs .... " The Division has long 

believed that the Compliance Branch does in fact require additional st aff and has requested 

significant additional staff in annual budget request document s. The Dodd-Frank Act, which 

established SEFs as an entirely new category of self-regulatory organization subject to core 

principles and numerous regulations, only adds to the urgency of additional Compliance staff. 

In particular, once all SEFs are permanently registered, there will be more than twice as many 

entities subject to RERs as there are now, and almost twice as many core principles and 

regulations. The Division's need for additional staff in th e RER program for DCMs alone is 

already self-evident. With the addition of SEFs, the Division will be unable to perform effective 

systematic oversight of self-regulatory organizations through RERs. 

The Division and its Compliance Branch are committed to fulfilling their oversight 

responsibilities. Staff will continue its efforts through t he RER program to promot e market 

integrity and customer protection to the greatest extent possible under difficult circumstances. 

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