Document ID: SEC-2014-1110-0001
Agency: sec
Document Type: Notice
Title: Self-Regulatory Organizations; Proposed Rule Changes: National Futures Association
Posted Date: 2014-07-07T04:00Z

[Federal Register Volume 79, Number 129 (Monday, July 7, 2014)]
[Notices]
[Pages 38349-38353]
From the Federal Register Online via the Government Printing Office [www.gpo.gov]
[FR Doc No: 2014-15719]

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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-72498; File No. SR-NFA-2014-04]

Self-Regulatory Organizations; National Futures Association; 
Notice of Filing of Proposed Rule Change to the Interpretive Notice to 
NFA Compliance Rules 2-4 and 2-36: Prohibition on the Use of Certain 
Electronic Funding Mechanisms

June 30, 2014.
    Pursuant to Section 19(b)(7) of the Securities Exchange Act of 1934 
(``Exchange Act''),\1\ and Rule 19b-7 under the Exchange Act,\2\ notice 
is hereby given that on June 18, 2014, National Futures Association 
(``NFA'') filed with the Securities and Exchange Commission (``SEC'' or 
``Commission'') the proposed rule change described in Items I and II 
below, which Items have been substantially prepared by the NFA. The 
Commission is publishing this notice to solicit comments on the 
proposed rule from interested persons.
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    \1\ 15 U.S.C. 78s(b)(7).
    \2\ 17 CFR 240.19b-7.
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    On June 18, 2014, NFA submitted the proposed rule change to the 
CFTC for approval. The CFTC has not yet approved the proposed rule 
change.

I. Self-Regulatory Organization's Description and Text of the Proposed 
Rule Change

    Under the proposed Interpretive Notice to NFA Compliance Rules 2-4 
and 2-36: Prohibition on the Use of Certain Electronic Funding 
Mechanisms (``Interpretive Notice''), NFA Members (``Members'') are 
prohibited from allowing customers to fund futures or forex accounts 
with a credit card or other electronic funding methods tied to a credit 
card. The proposed Interpretive Notice does not prohibit Members from 
allowing customers to fund futures or forex accounts with electronic 
funding mechanisms that are tied to a customer's bank account at a 
financial institution provided the funds deposited are drawn directly 
from the customer's bank account. The Interpretive Notice requires, 
however, that the Member be able to distinguish, prior to accepting 
funds, between an electronic funding method that draws money from the 
customer's account at a financial institution and a traditional credit 
card, and be able to reject the credit card transaction before 
accepting funds. The Interpretive Notice also requires Members offering 
this type of electronic funding mechanism to provide adequate risk 
disclosure in light of the customer's financial circumstances.
    The text of the Interpretive Notice is available on NFA's Web site 
at www.nfa.futures.org, the Commission's Web site at www.sec.gov, NFA's 
office, and at the Commission's Public Reference Room.

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

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

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

1. Purpose
    Section 15A(k) of the Exchange Act \3\ makes NFA a national 
securities association for the limited purpose of regulating the 
activities of NFA Members who are registered as brokers or dealers 
under Section 15(b)(11) of the Exchange Act.\4\ The proposed 
Interpretive Notice applies to all NFA Members, including those that 
are registered as security futures brokers or dealers under Section 
15(b)(11) of the Exchange Act.
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    \3\ 15 U.S.C. 78o-3(k).
    \4\ 15 U.S.C. 78o(b)(11).
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    NFA adopted the Interpretive Notice to NFA Compliance Rules 2-4 and 
2-36 prohibiting Members from allowing customers to fund futures or 
forex accounts with a credit card or other electronic payment methods 
tied to a credit card after an extensive study and analysis done at the 
direction of NFA's Compliance and Risk Committee (``CRC''). The CRC's 
study and analysis found significant customer protection concerns with 
credit card funding in the retail forex area, and therefore NFA's Board 
of Directors, upon the recommendation of the CRC, determined the only 
appropriate action was to adopt this prohibition. The prohibition is 
entirely consistent with NFA's longstanding position that it is a 
violation of NFA Compliance Rule 2-4, and inconsistent with just and 
equitable principles of trade, for Members to

[[Page 38350]]

encourage customers to borrow money to invest.\5\
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    \5\ See In the Matter of First Investors Group of Pal Beaches, 
Inc., et.al., NFA Case No. 95-BCC-011 (November 12, 1999).
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    Many Forex Dealer Members (``FDMs'') offer their retail forex 
customers the ability to fund their accounts directly using a credit 
card or via an online payment facilitator (e.g., PayPal) that is 
commonly tied to a credit card (Payment Facilitator(s)--Credit). The 
CRC had several concerns with this practice, including that retail 
customers may be using credit cards to open accounts with funds that 
are borrowed and, therefore, not risk capital. The CRC's concern had 
significant merit since a 2012 review of several FDM Web sites showed 
that those FDMs promoted credit funding as the ``quickest,'' 
``easiest,'' and ``fastest'' method of investing.
    Given its concern, the CRC began considering whether it would be 
appropriate for NFA to prohibit its Members from allowing customers to 
fund their accounts (both forex and futures) via a credit card or a 
Payment Facilitator--Credit. As part of its consideration, the CRC 
directed NFA staff to conduct a detailed analysis of FDM account 
funding practices, customer income levels, and customer account funding 
origins. The analysis covered approximately 15,500 accounts held at 
seven FDMs--all of which were registered as retail foreign exchange 
dealers (``RFED'')--during 2012. The results of this analysis revealed:
     Credit card funding restrictions varied among the FDMs. 
Several permitted the use of a credit card up to $10,000 per 
transaction. One firm based its restriction on a customer's income 
level and a permitted customer with a net income between $0-$19,000 to 
fund an account with as much as $1,000 through a credit card;
     The average life of a retail forex trading account at an 
RFED was 4 months regardless of the amount of the initial deposit;
     For the 4th quarter 2013, 72% of the accounts analyzed 
were unprofitable;
     78% of all accounts were initially funded via credit card/
debit card/online payment facilitator;
     Almost 50% of all account holders reported a net income of 
$50,000 or less; and
     Deposits made by credit card/debit card/online payment 
facilitator were markedly lower than deposits made by wires or checks. 
For example, for customers with a net income less than $50,000, the 
average deposit via credit card/debit card/online payment facilitator 
was approximately $1,050 whereas for checks or wires it was 
approximately $6,650. This difference was also prevalent at other net 
income levels, including above $100,000 where the average deposit via 
credit card/debit card/online payment facilitator was approximately 
$2,450 whereas for checks or wires it was approximately $28,000.
    Given the prevalence of credit card usage by customers to initially 
fund retail forex accounts and the fact that such a large percentage of 
those customers had a relatively low income level ($50,000 or less), 
the CRC reviewed whether the FDMs provide specific risk disclosures 
regarding the implications of funding via a credit card or a Payment 
Facilitator--Credit and learned that none of the FDMs warned customers 
that they should not use a credit card or Payment Facilitator--Credit 
to borrow money to invest in retail forex.
    The CRC found the data very disturbing from a customer protection 
perspective because it reveals that lower income individuals 
predominantly use credit cards or Payment Facilitators--Credit to fund 
their accounts and the vast majority of these individuals lose their 
funds trading forex. Although the CRC recognized that it is possible 
that all lower income individuals pay off their credit card balances 
each month and are not borrowing funds to invest beyond the payment due 
date, the CRC concluded that this possibility is simply implausible 
given the low income levels.
    NFA Compliance Rule 2-4 requires Members and their Associates to 
observe high standards of commercial honor and just and equitable 
principles of trade in the conduct of their commodity futures business. 
Similarly, NFA Compliance Rule 2-36(c) requires Members and their 
Associates to observe high standards of commercial honor and just and 
equitable principles of trade in the conduct of their forex business. 
The CRC concluded that permitting customers to utilize funding 
mechanisms that by their very nature allow retail customers to borrow 
funds to invest in markets where the risk of loss can be substantial 
and a total loss may occur simply is not consistent with a Member's 
obligation to observe high standards of commercial honor and just and 
equitable principles of trade. Given NFA's analysis of the FDMs' 
customers' usage of credit cards and Payment Facilitators--Credit, and 
the fact that credit cards and Payment Facilitators--Credit readily 
allow individuals to borrow funds to purchase goods and services, the 
CRC concluded that without adequate mechanisms in place to ensure that 
customers are not borrowing funds to invest in the highly volatile 
futures and forex markets, Members should not be permitted to allow 
their customers to invest via electronic funding mechanisms.
    The Interpretive Notice does not ban forms of electronic funding 
mechanisms that are tied to a customer's bank account at a financial 
institution, such as a debit card or a PayPal account tied to a bank 
account. The CRC found that these funding mechanism are acceptable and 
appear consistent with a Member's obligation to observe high standards 
of commercial honor and just and equitable principles of trade because 
when a customer uses an electronic funding mechanism directly tied to 
an account at a financial institution, the customer has funds on hand 
that are immediately transferred from the customer's bank account to 
the Member, which significantly reduces the likelihood that funds are 
being borrowed to invest. However, in order for a Member to allow 
customers to use electronic funding mechanisms, the Member must be able 
to distinguish between those electronic funding mechanisms tied to a 
credit card and those tied to a bank account and reject the ones tied 
to a credit card.\6\
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    \6\ One FDM indicated that it currently uses a third-party 
provider to process credit and debit card transactions when they are 
initiated by the customer. Accordingly, the third-party provider 
uses a programming code, which allows its front-end processer to 
identify whether a card is a credit or debit card based on the 
digits listed on the card. This front-end processing system has the 
ability to identify the card as a debit card even if the customer 
elected to process the card as a credit transaction. In other words, 
the system programming can distinguish between a debit card issued 
by a bank with monies drawn from a checking or savings account, or a 
traditional credit card. The third party provider is able to 
automatically reject transactions that are credit card transactions.
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    Under the Interpretive Notice, if a Member offers customers the 
ability to use an electronic funding mechanism, then the Member must 
utilize a processing system or some other electronic mechanism that can 
ensure the funding device is a debit card or some other payment 
facilitator that is tied directly to the customer's bank account at a 
financial institution. Moreover, any Member offering this type of 
funding mechanism, must also ensure that adequate risk disclosure is 
provided to customers in light of the customers' financial 
circumstances.
2. Statutory Basis
    NFA believes that the proposed rule change is authorized by, and 
consistent with, Section 15A(k)(2)(B) of the

[[Page 38351]]

Exchange Act.\7\ That section sets out requirements for rules of a 
futures association, registered under Section 17 of the Commodity 
Exchange Act, that are a registered national securities association for 
the limited purpose of regulating the activities of members who are 
registered as brokers or dealers in security futures products pursuant 
to Section 15(b)(11) of the Exchange Act. Under Section 15A(k)(2)(B), 
the rules of such a limited purpose national securities association 
must be designed to prevent fraudulent and manipulative acts and 
practices, to promote just and equitable principles of trade, and, in 
general, to protect investors and the public interest in connection 
with security futures products in a manner reasonably comparable to the 
rules of a registered national securities association registered 
pursuant to Section 15A(a) that are applicable to securities futures 
products. NFA believes the proposed rule change meets these 
requirements because NFA determined that permitting customers to use 
credit cards to fund futures and forex accounts was inconsistent with 
just and equitable principles of trade and the proposed Interpretive 
Notice prohibits Members from permitting customers to use credit cards 
to fund accounts.
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    \7\ 15 U.S.C. 78o-3(k)(2)(B).
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B. Self-Regulatory Organization's Statement on Burden on Competition

    NFA recognizes that the proposed rule change may impose a minor 
burden on competition with respect to foreign customers that might be 
able to use credit cards to fund accounts with foreign intermediaries 
that are not Members of NFA. NFA concluded, however, that any burden 
was outweighed by the need to adopt appropriate customer protection 
measures. NFA also concluded that the burden was minimized by the fact 
that the Interpretive Notice permits Members to offer customers the 
ability to use an electronic funding mechanism that draws funds 
directly from the customer's account at a financial institution, 
provided the Member is able to distinguish between those electronic 
funding mechanisms drawing funds directly from the customer's account 
at a financial institution and those tied to a credit card and reject 
those transactions tied to a credit card.

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

    The CRC requested feedback on the concept of prohibiting Members 
from allowing customers to fund their forex or futures accounts with a 
credit card or Payment Facilitator--Credit from NFA's Futures 
Commission Merchant (``FCM''), Introducing Broker (``IB''), Commodity 
Pool Operator (``CPO'') and Commodity Trading Advisor (``CTA'') 
Advisory Committees. Each of these Committees fully supported a ban of 
this practice for both futures and forex accounts. Given the importance 
of this issue, the CRC did not obtain the views of NFA's FDM Advisory 
Committee--which had recently lost most of its representatives due to 
FDM withdrawals and consolidations--but rather obtained the FDMs' views 
by issuing a Notice to all FDMs requesting their comments. The CRC also 
met with affected members of the FDM community to further discuss their 
comments.
    Specifically, NFA received comments from five of NFA's 17 FDMs (one 
of which was filed by a law firm on behalf of the FDM), the Financial 
Services Roundtable (``FSR'') and a retail forex customer. All but one 
FDM strongly opposed a ban against FDMs accepting credit cards from 
customers to fund forex trading accounts. Despite the fact that credit 
card funding was not ``an insignificant portion'' of its business, this 
FDM did not object to the proposed ban but requested a 60-day 
implementation period in order to make operational changes to reject 
credit card transactions while permitting debit card transactions and 
to educate clients about the ban.
    The CRC carefully considered all of the comments received. Below is 
a summary of the material comments and the CRC's response.
     Forex customers must react to market changes during non-
banking hours and credit cards are the only funding method to do so, 
while checks or wire transfers often take too long to be credited to 
prevent a margin close-out.
     Credit cards are more economical since FDMs do not charge 
a fee to use them while banks charge fees for wire transfers and use of 
Automated Clearing House (``ACH'').
     Credit card funding is one of the fastest, most 
convenient, and lowest cost funding vehicles.
     Many FDMs represented to NFA that customers need to use 
credit cards in order to quickly add funds in order to avoid forced 
liquidation of their positions.
    The CRC recognized that credit cards may provide an efficient and, 
in some instances, economical method for depositing funds into a 
trading account. The CRC believed, however, that this benefit is vastly 
outweighed by the risk associated with a customer borrowing funds to 
invest in futures or forex. Moreover, the CRC believed that the 
efficient and economical benefits of credit card funding can be 
retained by permitting Members to offer customers the ability to use an 
electronic funding mechanism that draws funds directly from the 
customer's account at a financial institution, provided the Member is 
able to distinguish between those electronic funding mechanisms drawing 
funds directly from the customer's account at a financial institution 
and those tied to a credit card and reject those transactions tied to a 
credit card.
    Additionally, NFA's analysis revealed that very few forex positions 
overall are auto-liquidated, customers generally add funds to their 
account using the same method as their initial funding method, and 
positions in accounts funded through a credit card are not less likely 
to be auto-liquidated. In fact, NFA's analysis showed that those 
accounts funded through a credit card actually had positions auto-
liquidated more frequently than those accounts funded through 
traditional methods, although the percentage of auto-liquidations 
remained relatively low.
     Funds deposited by traditional methods may ultimately be 
drawn from credit sources.
    The CRC acknowledged that the prohibition could be circumvented 
because accounts funded with deposits using traditional methods may 
ultimately be drawn from credit sources. The CRC, however, concluded 
that banning the direct use of credit cards would lessen the likelihood 
of this occurrence because a customer can make an instantaneous 
decision to use a credit card, whereas other forms of credit generally 
take longer to obtain and provide the customer with more time to 
consider the consequences of borrowing funds to invest. Moreover, the 
CRC felt that credit cards are funding mechanism that lend themselves 
to borrowing funds and permitting this type of funding mechanism is 
directly contrary to NFA's longstanding position that it is a violation 
of NFA Compliance Rule 2-4, and inconsistent with just and equitable 
principles of trade, for Members and Associates to encourage customers 
to borrow money to invest.
     The ban is overly broad since alternative payment 
facilitators (e.g., PayPal, MoneyBookers and Google Checkout) may be 
funded through a bank account or other debit sources.
    The CRC addressed this comment by providing that the ban did not 
apply to electronic payment methods that are

[[Page 38352]]

tied to a bank account at a financial institution provided that the 
Member is able to distinguish between electronic payment mechanisms 
that are tied to a bank account and traditional credit card 
transactions and reject the credit card transactions before accepting 
funds.
     FDMs have other procedures in place to ensure that 
customers only use risk capital even if the source is a credit card.
     NFA has other rules that ensure that customers do not 
invest funds in excess of risk capital (Rule 2-36 ``know your 
customer,'' risk disclosure requirements, and guidance requiring FCMs 
to prominently disclose that customers should only fund with risk 
capital).
    The CRC acknowledged that NFA had other rules in place to guard 
against customers investing in excess of risk capital and that FDMs 
should have other procedures in place to ensure customers only use risk 
capital even if the source was a credit card. The CRC concluded, 
however, that based on the analysis conducted and the fact that credit 
cards by their nature permit easy access to borrowed funds any 
disclosure alone is an insufficient customer protection measure to 
address the issue.
     Banks that issue credit cards consider a customer's credit 
worthiness in determining the customer's credit limit, which is a built 
in risk safeguard.
    The CRC did not believe this provided a credible rationale to 
permit credit card funding. Retail customers should not be borrowing 
funds to invest in futures or forex. Regardless of the credit limit 
determined by a bank, a customer should not be using borrowed funds to 
invest in the volatile futures or forex markets where the risk of loss 
may be substantial.
     Certain foreign jurisdictions permit credit card funding.
     Credit cards are permitted in numerous industries in which 
``customer funds are put at risk with far fewer safeguards than retail 
forex trading,'' including the New York State Lottery, which provides 
customers the option of signing up for subscriptions to certain lottery 
games using credit cards, and the Nassau County New York OTB permits 
individuals to make deposits via credit card to their permanent 
wagering account.
    The CRC was not persuaded by the comment that many foreign 
jurisdictions permit customers to use credit cards to fund forex 
accounts. The CRC felt that the customer protection concerns raised by 
this practice were far too disturbing and the fact that foreign 
jurisdictions may permit this practice did not outweigh these concerns. 
The CRC also found entirely unpersuasive the fact that other 
industries, particularly off-track betting parlors or lottery related 
agencies, permitted customers to use credit cards.
     The FDMs opposing a ban on funding via a credit card 
recommended that NFA address this issue short of imposing a 
prohibition. For example, these FDMs believe that NFA should do one or 
more of the following--prohibit heavy promotion of credit card funding, 
require account withdrawals to go back to the original funding credit 
card, establish a monthly deposit cap for credit card funding, enhance 
disclosures regarding risk capital usage, issue prominent warnings 
regarding credit card usage to underscore the risks of using this 
funding means if a customer does not have sufficient bank funds to 
cover the deposit, and recommending that customers pay off credit card 
balances monthly by the due date.
    The CRC considered other alternatives and concluded that given the 
customer protection concerns raised, and the fact that credit cards are 
any easy source of borrowed funds, the only way to address the issues 
was to prohibit Members from allowing customers to use credit cards or 
other electronic methods unless the Member could distinguish between 
electronic payments that are tied to a bank account and traditional 
credit card transactions and reject the credit card transactions.
     The FSR's letter claimed banning credit cards and the use 
of credit cards through payment facilitators (e.g. Paypal) is a 
significant regulatory action that has far reaching implications. The 
FSR urged NFA to consider viable alternatives and seek comments from 
those outside the forex industry.
    The CRC determined that one of NFA's primary responsibilities is 
the protection of customers in the futures and forex industries and 
that the prohibition was necessary to achieve this objective. The CRC 
also observed that NFA's mandate is not to promote the business 
interests of credit card companies.

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

    The proposed rule change is not effective because the CFTC has not 
approved the proposed rule change.
    Section 19(b)(7)(C) of the Act provides, inter alia that ``[a]ny 
proposed rule change of a self-regulatory organization that has taken 
effect pursuant to [Section 19(b)(7)(B) of the Act] may be enforced by 
such self-regulatory organization to the extent such rule is not 
inconsistent with the provisions of the title, the rules and 
regulations thereunder, and applicable Federal law. At any time within 
60 days of the date of effectiveness of the proposed rule change, the 
Commission, after consultation with the CFTC, may summarily abrogate 
the proposed rule change and require that the proposed rule change be 
refiled in accordance with the provisions of Section 19(b)(1) of the 
Exchange Act.

IV. Solicitation of Comments

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

Electronic Comments

     Use the Commission's Internet comment form (http://www.sec.gov/rules/sro.shtml); or
     Send an email to rule-comments@sec.gov. Please include 
File Number SR-NFA-2014-04 on the subject line.

Paper Comments

     Send paper comments in triplicate to Secretary, Securities 
and Exchange Commission, Station Place, 100 F Street NE., Washington, 
DC 20549-1090.

All submissions should refer to File Number SR-NFA-2014-04. This file 
number should be included on the subject line if email is used. To help 
the Commission process and review your comments more efficiently, 
please use only one method. The Commission will post all comments on 
the Commission's Internet Web site (http://www.sec.gov/rules/sro.shtml). Copies of the submission, all subsequent amendments, all 
written statements with respect to the proposed rule change that are 
filed with the Commission, and all written communications relating to 
the proposed rule change between the Commission and any person, other 
than those that may be withheld from the public in accordance with the 
provisions of 5 U.S.C. 552, will be available for Web site viewing and 
printing in the Commission's Public Reference Room, 100 F Street NE., 
Washington, DC 20549, on official business days between the hours of 10 
a.m. and 3 p.m. Copies of such filing also will be available for 
inspection and copying at the principal office of NFA. All comments 
received will be posted without change; the Commission does not edit 
personal identifying information from submissions. You should submit 
only information that you wish to make publicly available. All 
submissions should refer to File

[[Page 38353]]

Number SR-NFA-2014-04 and should be submitted on or before July 28, 
2014.

    For the Commission, by the Division of Trading and Markets, 
pursuant to delegated authority.\8\
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    \8\ 17 CFR 200.30-3(a)(73).
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Jill M. Peterson,
Assistant Secretary.
[FR Doc. 2014-15719 Filed 7-3-14; 8:45 am]
BILLING CODE 8011-01-P