CFTC Forex Rules In Effect October 18, 2010

Obama Threatens Forex; Says Goodbye to OTC Gold Trading

On July 21, 2010, President Obama signed into law the “Dodd-Frank Wall Street Reform Act” (the “Dodd-Frank Act” or “Act”).  The Dodd-Frank Act most likely will bring about sweeping regulatory changes within the financial services industry.  However, at over 2,300 pages in length, few people have read this legislation in its entirety.  Of those individuals who have read the Act, few can comprehend the implications of such sweeping reform.  As a result, the President of Turnkey Trading Partners (“TTP”), James Bibbings, has teamed up with attorney Nicole Kuchera, from Chicago’s Henderson & Lyman, to review the content of the Dodd-Frank Act.  Through this process we were able to identify some areas of the Act that are most likely to affect Commodity Futures Trading Commission (“CFTC”) regulated entities and National Futures Association (“NFA”) member firms.

The impact of the Act on commodity futures, over-the-counter retail foreign currency (“OTC forex”), and over-the-counter retail precious metals (“OTC metals”) transactions has been largely ignored by the media to date.  Although the Dodd-Frank Act has been championed as a victory for consumer protection and rigid Wall Street reform, there is little actual clarity with respect to its practical implications.  Since being signed into law, FCMs, IBs, CPOs, and CTAs have reached out to us regarding the vast amount of regulatory uncertainty now present in the financial industry.  To assist commodities firms in complying with and understanding the Dodd-Frank Act, we have attempted to identify several of its most sweeping provisions. Our thoughts do not constitute legal advice and should not be relied upon in particular circumstances. We recommend that you contact competent counsel or a legal professional before taking any action in this complex area.

That being said, based on the current language of the Act, the following four areas are likely to have the most significant implications for commodity futures, OTC forex, and OTC precious metals market participants:

Elimination of OTC Forex

Effective 90 days from its inception, the Dodd-Frank Act bans most retail OTC forex transactions.  Section 742(c) of the Act states as follows:

“…A person [which includes companies] shall not offer to, or enter into with, a person that is not an eligible contract participant, any agreement, contract, or transaction in foreign currency except pursuant to a rule or regulation of a Federal regulatory agency allowing the agreement, contract, or transaction under such terms and conditions as the Federal regulatory agency shall prescribe…”

This provision will not come into effect, however, if the CFTC or another eligible federal body issues guidelines relating to the regulation of foreign currency within 90 days of its enactment.  Registrants and the public are currently being encouraged by the CFTC to provide insight into how the Act should be enforced.  See CFTC Rulemakings regarding OTC Derivatives located at the following website address, under Section XX – Foreign Currency (Retail Off Exchange).  As this provision is potentially devastating to the forex industry, affected readers are encouraged to voice their opinions to the CFTC directly.  To do so commentary should be forwarded to via email to:

It is essential that OTC forex participants seek professional help to discuss possible operational and regulatory contingency plans.

Elimination of OTC Metals

As for OTC precious metals such as gold or silver, Section 742(a) of the Act prohibits any person [which again includes companies] from entering into, or offering to enter into, a transaction in any commodity with a person that is not an eligible contract participant or an eligible commercial entity, on a leveraged or margined basis.  This provision intends to expand the narrow so called “Zelener fix” in the Farm Bill previously ratified by congress in 2008.  The Farm Bill empowered the CFTC to pursue anti-fraud actions involving rolling spot transactions and/or other leveraged forex transactions without the need to prove that they are futures contracts.  The Dodd-Frank Act now expands this authority to include virtually all retail cash commodity market products that involve leverage or margin – in other words OTC precious metals.

The prohibition of Section 742(a) does not apply, however, if such a  transaction results in actual delivery within 28 days, or creates an enforceable obligation to deliver between a seller and a buyer that have the ability to deliver, and accept delivery of, the commodity in connection with their lines of business.  This may be problematic as in most spot metals trading virtually all contracts fail to meet these requirements.  As a result, although the courts’ interpretation of Section 742(a) is unknown, Section 742(a) is likely to have a significantly negative impact on the OTC cash precious metals industry.  Here too, it is essential that those who offer to be a counterparty to OTC metals transactions seek professional help to discuss possible operational and regulatory contingency plans.

Small Pool Exemption Eliminated

Pursuant to Section 403 of Act, the “private adviser” exemption, namely Section 203(b)(3) of the Investment Advisers Act of 1940 (“Advisers Act”), will be eliminated within one year of the Act’s effective date (July 21, 2011).  Historically, many unregistered U.S. fund managers had relied on this exemption to avoid registration where they:

At present, advisers can treat the unregistered funds that they advise, rather than the investors in those funds, as their clients for purposes of this exemption.  A common practice has thus evolved whereby certain advisers manage up to 14 unregistered funds without having to register under the Advisers Act.  Accordingly, the removal of this exemption represents a significant shift in the regulatory landscape, as this practice will no longer be allowable in approximately one year.

Also an important consideration, the Dodd-Frank Act mandates new federal registration and regulation thresholds based on the amount of assets a manager has under management (“AUM”).  Although not yet underway, it is possible that various states may enact legislation designed to create a similar registration framework for managers whose AUM fall beneath the new federal levels.

Accredited Investor Qualifications

Section 413(a) of the Act alters the financial qualifications of who can be considered an accredited investor, and thus a qualified as eligible participant (“QEP”).  Specifically, the revised accredited investor standard includes only the following types of individuals:

Based on this language, it is important to note that the revised accredited investor standard only applies to new investors and does not cover existing investors.  However, additional subscriptions from existing investors are generally treated as requiring confirmation of continuing investor eligibility.

On July 27^th, 2010, the SEC provided additional clarity regarding the valuation of an individual’s primary residence when calculating net worth.  In particular, the SEC has interpreted this provision as follows:

“Section 413(a) of the Dodd-Frank Act does not define the term “value,” nor does it address the treatment of mortgage and other indebtedness secured by the residence for purposes of the net worth calculation…Pending implementation of the changes to the Commission’s rules required by the Act, the related amount of indebtedness secured by the primary residence up to its fair market value may also be excluded. Indebtedness secured by the residence in excess of the value of the home should be considered a liability and deducted from the investor’s net worth.”

Seek Guidance Now

As is evident from reading the provisions detailed above, President Obama’s sweeping reform is far from simple.  At the present date, the Dodd-Frank Act offers up more questions than it provides answers.  One thing is certain though; in time there will be significant implications for the financial industry as a whole.  In order to properly evaluate how the Dodd-Frank Act may affect your CFTC and/or NFA regulated business, it would be prudent to contact a regulatory professional like Turnkey Trading Partners immediately.  Likewise, savvy derivatives industry business owners would be well served to consider operational contingency plans and alternatives sooner rather than later.  To assist in determining if your firm might be affected by the Dodd-Frank Act, TTP has put together a free evaluation worksheet which is available upon request.  To receive this worksheet simply complete the web form available here.

James Bibbings and Nicole Kuchera

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James Bibbings is the President and CEO of Turnkey Trading Partners (“TTP”), a firm that supports all commodity and forex specific regulatory and business needs. Prior to founding TTP, Bibbings worked with the National Futures Association (“NFA”) as a supervising auditor. During his time with NFA he was involved in approximately 100 investigative audits and was able to gain a deep working knowledge of FDM, FCM, IB, CTA, and CPO operations.  Since departing from NFA, Bibbings has owned and operated an independent introducing brokerage and participated in international forums on proposed CFTC regulatory requirements.  He has also provided financial markets content for MSN, Yahoo, Financial Times, FinAlternatives, Wiki-Investments, Safe Haven, Financial Sense, The Wall Street Journal’s Market Watch, Forex Journal, FX Street, Forex Factory, Commodity News Center and many other highly acclaimed investment publications.  Two highly sought after informational pamphlets regarding futures and forex registration authored by Bibbings are currently available for free upon request through his company website.  If you have any questions or comments for Bibbings he can be reached directly by email at james@turnkeytradingpartners.com and would love to hear from you.

Nicole Kuchera is an associate in Henderson & Lyman’s Financial Services Practice Group. She concentrates her practice on transactional and litigation support for securities, futures, and derivatives industry clients.  Presently Ms. Kuchera counsels clients regarding a wide range of compliance and regulatory matters involving rules and regulations of SEC and CFTC, as well as self-regulatory organizations and exchanges.  She also represents financial services industry clients in a wide range of litigation matters in various forums, including state and federal courts and in industry arbitrations and mediations.  Ms. Kuchera is also a member of the Chicago Bar Association’s Securities, Financial and Investment Services, and Futures and Derivatives Law Committees. 

Where to Start; Managed Accounts or a Fund?

I am routinely asked about the advantages and disadvantages of starting a Commodity Trading Advisor (“CTA”) as opposed to a Commodity Pool Operator (“CPO”).  This is a great question and one that all money managers interested in handling forex or commodity managed accounts should consider.  If answered incorrectly this question could literally ruin the chances for success as a CFTC registrant and NFA member.  If that statement wasn’t strong enough to peak interest how about this one; a wrong decision in this space will likely cost thousands of dollars and countless hours of valuable time.

Certainly there are many considerations that must be accounted for when determining how to begin any trading operation.  Among these factors simple decisions such as how to raise assets, what products to trade, and where to locate the business will need to be considered.  However, it may come as a surprise that sifting through a laundry list of business decisions is actually not the most challenging part of establishing a lasting CTA or CPO business.  In my experience the biggest challenge facing new and emerging money managers comes after many of the so-called “easy decisions” are made.  Specifically, what I have found is that the overall direction and success of the business will likely result from the intricate way that each of the company’s individual decisions piece together.

The complexity and sheer number of variables associated with professionally managing commodity and or forex accounts is nearly incomprehensible.  Although this is true, I have put together the following short list of important considerations that should be discussed by the business from its inception.  Keep in mind however that this list is not intended to be inclusive of all necessary factors needed to make an informed decision.  A regulatory professional should be consulted with any questions that may arise prior to moving forward with any long term decisions.

1.  How large an investment is required to trade the strategy?

The first and perhaps most obvious consideration should be determining the minimum investment required to participate in the trading program.  Will clients be able to access the model with a $10,000, $50,000, $250,000, $5 Million Dollar or more deposit?  It will be important to determine the minimum amount of funds needed under management to effectively trade the program.  Here are a few basic things that should be immediately considered while trying to arrive at this answer:

A)  How large will anticipated draw downs be?  Can client accounts survive a hypothetical worst case scenario with the funding level selected?

B)  Based on the products being traded will the accounts have enough funds to cover margin?  Meet security deposit requirements?  Have the resources to invest across several markets with differing margin requirements simultaneously?

C) How much leverage does the program require?  What will account margin to equity be under normal trading conditions?  Under extreme trading conditions?  Will notional funding be used or considered – what implications will this have on program volatility?

D)  How much in assets under management will the company require to remain viable?  With standard industry management fees at 2% and incentive fees at 20% a pro-forma estimation of profitability should be performed and taken into consideration.

2.  How will the company gain access to investment capital?

After determining the minimum account size needed for the program to function properly, figuring out who will invest should come next.  Based on the figures from above how many investors (realistically) does the company likely have access to?  1, 5, 20, 1,000 or more?  Of these people how many of them are likely to invest within the program?  How many of them will be institutional or high net worth investors?  What will the average deposit size likely be?

After these points have been considered it should be relatively easy to determine how much capital may be available to the strategy at its inception.  This exercise will also help to more readily identify the path that should be pursued – CTA or CPO.  In this instance remember that 1,000 accounts depositing $10,000 each are not equivalent to one account investing $10 million independently.  Keep in mind that the administrative costs and operational requirements to manage 1,000 accounts will be substantially higher than those of trading only one.

3. What is the company’s overall experience level?

A large majority of the people I speak with have aspirations to start the next big commodity or forex hedge fund.  That may turn out to be true, but it’s not likely if the members of a company have no prior experience in the financial markets.  Entering into any highly regulated industry exposes people to an incredibly sharp learning curve.  As with any best in class operation it probably won’t be realistic to assume that the “next big fund” will be run by a group of individuals with no prior experience managing client money.  This of course is not to say it’s impossible, however it is highly unlikely.  In making a decision to start a CPO or a CTA it’s very important to assess the company’s skill set and determine what might be missing for success to be obtained.  Consider who will run operations?  Handle potentially complex accounting issues?  Knows the company’s commodity and/or forex compliance obligations?  Can trade with consistent results?  Will solicit on behalf of the program and how will they do it?

Making a Decision CTA vs. CPO

Once the strategy’s capital requirements have been thought out, after determining how much money may be available, and evaluating the company’s experience level it’s time to start deciding on whether a CTA or a CPO is the right choice.  To make this decision all of the company’s intentions and goals must be considered in aggregate.  It simply will not be enough to look at one particular factor and make a final directional decision.  At this time it is in the company’s best interest to contact a regulatory professional such as Turnkey Trading Partners (“TTP”) – a firm that specializes in only commodity and forex matters.  As noted above firms like TTP will be able to provide invaluable insight, should reduce overall costs, and will undoubtedly save everyone involved a great deal of time.

If the company is not yet ready to contact a regulatory professional today, then take a moment to carefully think through the questions presented in this article.  After doing so I have put together some general thoughts on the most common advantages and disadvantages of both CTA and CPO businesses for consideration below:

Commodity Trading Advisor

Individually managed client accounts have the following advantages:

• - Administration, start-up, and maintenance costs are very low

• - Regulatory requirements and overall learning curve is relatively low

• - In general overall costs to the investor should be less

• - Accounting and financial requirements are significantly less complex

• - Client funds must be held with an FCM or FDM rather than with the advisor.  In a post “Madoff” world this  eases client concerns

Individually managed client accounts have the following disadvantages:

• - May require a higher minimum investment as assets will not be pooled

• - Challenging if not impossible to diversify into multiple strategies or investment opportunities

• - Client accounts will have to adhere to strict individual margin requirements

• - Trading may become tedious as the number of accounts and clearing firms utilized by the strategy rise

• - CTA clients will utilize FCM/FDM documents to open an individual account; client identities will not remain anonymous

Commodity Pool Operator

Pooling client assets as a registered fund has the following advantages:

• - Can allow for greater strategy diversification and investment opportunity

• - Minimum investment levels may be lower as accounts are pooled

• - May provide investors with a more focused investment advisor

• - Individual investors will not have margin calls made to them

• - May allow for the operator to collect additional fees – profit margins may be higher

Pooling client assets as a registered fund has the following disadvantages:

• - Administration, start-up, and maintenance costs are very high

• - Regulatory requirements and learning curve is significantly steeper; SEC/FINRA, CFTC/NFA, and State Security registration may be required.

• - In a post “Madoff” world investors may be wary of depositing funds with new managers

• - Hurdles for clients to profit and/or break even within the strategy are relatively high

• - May require a funding threshold to be hit in order to begin trading

It is important to remember that making the decision to begin managing client funds is a difficult one, but with proper preparation can be incredibly rewarding.  Over the coming years I am anticipating and looking forward to seeing more money managers come into the market place; however few will become the “next big thing.”  The financial markets are uncertain, but one thing is for sure those who fail to plan will likely never get off the ground.

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James Bibbings is the President and CEO of Turnkey Trading Partners (“TTP”), a firm that supports all commodity and forex specific regulatory and business needs. Prior to founding TTP, Bibbings worked with the National Futures Association (“NFA”) as a supervising auditor. During his time with NFA he was involved in approximately 100 investigative audits and was able to gain a deep working knowledge of FDM, FCM, IB, CTA, and CPO operations.  Since departing from NFA, Bibbings has owned and operated an independent introducing brokerage and participated in international forums on proposed CFTC regulatory requirements.  He has also provided financial markets content for MSN, Yahoo, Financial Times, FinAlternatives, Wiki-Investments, Safe Haven, Financial Sense, The Wall Street Journal’s Market Watch, Forex Journal, FX Street, Forex Factory, Commodity News Center and many other highly acclaimed investment publications.  Two highly sought after informational pamphlets regarding futures and forex registration authored by Bibbings are currently available for free upon request through his company website.  If you have any questions or comments for Bibbings he can be reached directly by email at james@turnkeytradingpartners.com and would love to hear from you.

NFA Auditors Are Coming; What Now?

If there is one thing that all traders have in common it’s that their hearts skip a beat when they receive a phone call from a financial regulator:

“Hello?” “Is John Trader available?  We’d like to conduct an examination of your firm on… [insert audit date, hard gulp, and stomach hitting floor here] Will you be available?”

Anyone in the financial markets who has received this call before understands the stress that comes with the situation.  Those who haven’t had this experience yet are in luck because there is still time to prepare.

During a Commodity Futures Trading Commission (“CFTC”) or National Futures Association (“NFA”) examination auditors will review company operations in a wide array of regulatory areas.  The scope of this review will be determined independently for every firm but will always be based upon the unique operational circumstances at the business.  Depending on a firm’s respective registration category (FCM, FDM, IB, CTA, CPO) the following areas represent those which are most likely to be reviewed:  Anti-Money Laundering (“AML”), Supervision and Solicitation, Promotional Material, Financial Record Keeping, Performance, General Accounting, Net Capital Computations, Disclosure Documents, Registration, Bylaw 1101 Compliance, Ethics Compliance, Privacy Compliance, Order Handling/Processing, as well as overall General Record Keeping.

With so many areas to be reviewed what is the best way to prepare for an impending NFA examination?  For starters member firms can (and are required to) utilize the NFA’s self examination check list at least once annually to evaluate their compliance.  Although this document is intended to serve as a guide to an internal review it can be challenging to follow and vague about what should be done when changes are required.  To cut through some of the complexity the following is a listing of several common mistakes which are often uncovered during routine examinations.

Registration and Bylaw 1101

During my career I have worked as an NFA auditor, owned and operated an introducing brokerage, and for the last three years run a private consulting business serving commodity and forex brokerages.  Throughout my experiences if there is one regulatory area that is most often overlooked it is registration compliance.  Specifically, all NFA member firms are required to conduct business with only other NFA member firms.  The only exception to this rule comes when a company or person working with the business is exempt from registration for a particular reason.  What many people don’t realize is that it is mandatory for all NFA member firms to inquire about the regulatory status of any company they transact business with – period.  Any partnership or business accounts trading with the firm must also be investigated to ensure they are not operating as unregistered investment pools.  A record of these inquiries should be kept on file and responses should preferably be kept in writing.  As a general rule no payment or business activity should be authorized with any entity prior to knowing their regulatory obligations.

Another frequent registration mistake that is routinely made relates to who is, and who is not considered a firm principal.  To summarize a principal is any individual or entity who directly or indirectly through agreement, holding company, nominees, trusts, or otherwise has contributed 10% or more of the company’s outstanding equity in any class or type.  A principal is also a person who has substantial control or authority over core business functions.  In the event a principal is purely a capital investor it is likely they will not be required to pass any licensing exams.  They will however be required to register with NFA as a principal and go through the entire registration process.  Any business with multiple owners and/or managers would be wise to verify who its true company principals are prior to an examination.

Financial Record Keeping/Accounting (All firms)

CFTC and NFA member firms must adhere to incredibly high standards when it comes to their books and records keeping.  Often times any lack of clarity or conciseness within the company general ledger (“GL”) can lead to additional questions and stress.  Without an accurate understanding and/or presentation of the GL, any subsequent financial statements will also be difficult to decipher.  Since the financials are the heart of any brokerage business, it is critical for firm principals to be aware of all transactions occurring within the company.  Financial principals should at the very least familiarize themselves with all material transactions to gain a full understanding of company operations.

Firms with a capital or financial filing requirement must also ensure that all mandatory monthly reports and computations have been completed.  Here it is important to remember that although many introducing brokers file reports with NFA bi-annually, they must also maintain net capital computations on file internally each month.  Likewise funds with a reporting requirement must also keep accurate monthly financial records regardless of their CFTC and NFA reporting obligations.  This methodology also holds true for firms (CTAs) with only performance reporting requirements.  These firms must ensure that they have adequate supporting documentation to verify their 13 column spreadsheet presentations are accurate.  All sub ledgers must also clearly illustrate the nature of any additions, withdrawals, fees, profit, loss, and other required information to accurately compile monthly performance records.

Ongoing Compliance Reviews and Education

All NFA member firms are required to meet certain ongoing educational, review, and audit requirements.  As noted above at least once annually NFA members must complete and document a review using the self-exam checklist.  Similarly, many company employees will be required to take Ethics and AML training on an ongoing basis.  Depending on a company’s unique policies they may also require periodic account reviews, general account documentation reviews, promotional reviews, supervisory reviews, general correspondence monitoring, AML reviews, financial reviews, annual procedural audits, annual systems audits, and any other ongoing monitoring as may be necessary to maintain regulatory compliance.  Each company will have its own unique set of ongoing obligations, therefore it is imperative to evaluate them prior to an exam.  Ensuring that ongoing reviews and educational standards are upheld is yet another widely mismanaged business function.

As the last several paragraphs have illustrated preparing for a regulatory examination can be challenging.  So what can be done to make life easier for firms anticipating an NFA exam?  Prior to receiving the universally dreaded audit phone call it would be wise for most CFTC registered NFA member firms to contact a regulatory consulting like Turnkey Trading Partners (“TTP”).  We specialize primarily in commodity and forex compliance so we’ll be best suited to help you.  TTP offers a standard mock audit, pre-exam, and general compliance review program.  Prior to beginning work we’ll also provide you with an adequate summary of the areas to be evaluated during our review.  Once a review has been conducted TTP will be readily able to identify areas of high risk within company operations.  We can then also prepare key personnel for the inevitable and assist with any adjustments that may be needed.   An audit of your company will be coming at some point in the future.  Whatever you choose to do, don’t make the biggest mistake of all by waiting until the last minute to prepare and call us today!

-James Bibbings

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James Bibbings is the President and CEO of Turnkey Trading Partners (“TTP”), a firm that supports all commodity and forex specific regulatory and business needs. Prior to founding TTP, Bibbings worked with the National Futures Association (“NFA”) as a supervising auditor. During his time with NFA he was involved in over 100 investigative audits and was able to gain a deep working knowledge of FDM, FCM, IB, CTA, and CPO operations.  Bibbings has provided financial markets content for MSN, Yahoo, Financial Times, FinAlternatives, Wiki-Investments, Safe Haven, Financial Sense, WSJ’s Market Watch, Forex Journal, Commodity News Center and many other highly acclaimed investment publications.  He has also authored two highly sought after informational pamphlets regarding futures and forex registration which are available for free upon request through his company website.  If you have any questions or comments for Bibbings he can be reached directly at: james@turnkeytradingpartners.com and would love to hear from you.

Commodity & Forex Pools to File Quarterly Reports

On March 17^th of 2010 the self regulatory organization for commodities trading and retail foreign currency transactions in the United States, National Futures Association (“NFA”), announced a major change to the way Hedge, Commodity, and Forex funds operate.  The change, titled “Compliance Rule 2-46” is NFA’s latest effort to work towards detecting and eliminating Madoff Style investment frauds within the industries they regulate.   In order to comply with any set of new regulatory standards one has to first understand the intentions and implications of the adjusted policy.  So what then does this adjustment mean for the commodity and forex industries?

Understanding 2-46

Beginning March 31, 2010 NFA Compliance Rule 2-46 will go into effect and be applicable to all NFA CPO members who currently have reporting obligations under the CFTC’s existing section 4.22 regulations.   Since it is reasonable to assume that most people are not familiar with regulation 4.22, let’s recap.  Briefly section 4.22 requires that all commodity pool operators (unless they have been granted specific exemption status by the CFTC) distribute an annual report.  This report is required to be certified by an independent public accountant and provided to participants, as well as the NFA within 90 days of the funds fiscal year end.  Regulation 4.22 further requires that funds deliver client account statements to participants within 30 calendar days after the last date of a specified reporting period (monthly or quarterly).  These statements must reflect specific customer and fund investment information, however I won’t go into detail on that here.

If an NFA member CPO manages a fund or funds which have a reporting obligation under section 4.22, as of the quarter beginning April 1st, 2010, they will have to adhere to new quarterly reporting guidelines.  For managers who may be wondering this new rule affects funds which are designated 4.7 exempt as well.

New Reporting Requirements

During the second quarter of 2010 NFA member CPO’s of all types will have much more stringent reporting requirements; No longer will one financial filing per year be satisfactory for affected firms.  On Monday, May 17th of 2010 the first of many quarterly financial reports will be due to NFA via an extension to the regulators “Easy File” system.  From that date forward NFA will require that CPO members submit to them the following financial information for all applicable funds 45 days after the close of each subsequent quarter they operate:

(a) The identity of the pool’s administrator, carry broker(s), trading manager(s) and custodian(s);

(b) A statement of changes in net asset value for the quarterly reporting period;

(c) The monthly performance for the three months comprising the quarterly reporting period; and

(d) A schedule of investments identifying any investment that exceeds 10% of the pool’s net asset value at the end of the quarterly reporting period.

How to Comply

The introduction of compliance rule 2-46 greatly increases the reporting obligations for most NFA member CPO’s.  Firms now more than ever will have to ensure that meticulous books and records are kept to properly support the information they will be filing with NFA.  The very nature of this rule change also suggests that after May 17^th of this year NFA will begin to include additional financial testing requirements within its audits of pool operators.  Moreover, the requirement for CPO’s to file financial information quarterly in many ways goes beyond what is currently required of independent introducing brokerages (“IIB’s”) who file only semi annually.  This puts CPO’s behind only Futures Commission Merchant’s (“FCM’s”) for the greatest number of financial filings in the industry.  Based on that fact alone, one thing is certain, NFA will be taking a much closer look at the activity of its member CPO’s.  This also seems to suggest that NFA now potentially views funds as the second greatest financial risk to the industry. 

Developing proper procedures and internal policies to accurately and efficiently produce financial records has never been more important for NFA’s CPO membership.  Simply knowing that the quarterly figures submitted to NFA will be subject to further audit scrutiny validates this fact.  In order to best comply with these new requirements, fund managers should begin looking for additional assistance in preparing their monthly performance and quarterly NFA filings ahead of the March 31st effective date.  Those managers who are looking for outside assistance should also be mindful to select a firm that is well versed in commodity regulation and has a strong understanding of the CFTC’s financial reporting requirements.  It is important when looking for outside help to remember that many public accountants and attorneys have never worked in the commodities industry and as a result can be unfamiliar with its standards.  Funds seeking to bring on third party help should consider hiring a commodity specific consulting and compliance firm with the same qualities as Turnkey Trading Partners (“TTP”).  TTP offers a great deal of depth in both its regulatory and financial offerings which will benefit funds falling under the new obligations on multiple levels.  Regardless of what you believe your firm requires to meet NFA’s new standards, a full inventory of your existing policies and procedures must be taken.  Fund managers would be wise to start this self assessment process ahead of March 31st to ensure their continued compliance with CFTC and NFA requirements.

-James Bibbings

____________

James Bibbings is the President and CEO of Turnkey Trading Partners (“TTP”), a firm that supports all commodity and forex specific regulatory and business needs. Prior to founding TTP, Bibbings worked with the National Futures Association (“NFA”) as a supervising auditor. During his time with NFA he was involved in over 100 investigative audits and was able to gain a deep working knowledge of FDM, FCM, IB, CTA, and CPO operations.  Bibbings has provided financial markets content for MSN, Yahoo, Financial Times, FinAlternatives, Wiki-Investments, Safe Haven, Financial Sense, WSJ’s Market Watch, Forex Journal, Commodity News Center and many other highly acclaimed investment publications.  He has also authored two highly sought after informational pamphlets regarding futures and forex registration which are available for free upon request through his company website.  If you have any questions or comments for Bibbings he can be reached directly by email at james@turnkeytradingpartners.com and would love to hear from you.

Forex Dealers Coalition Launches Website

The Forex Dealers Coalition (“FXDC”) launched its first ever website this evening at www.fxdc.org to combat the Commodity Futures Trading Commission’s “Proposal to Regulate Retail Over-the-Counter Foreign Currency Transactions”.  To learn more about the proposal please read TTP President James Bibbings’s article “CFTC Forex Proposal; US Retail Market to Disappear?” now to determine how these rule changes may affect you.   

Haven’t heard of the FXDC yet?  Here’s some more information about them taken from their site:

“The Foreign Exchange Dealers Coalition is an alliance of the largest U.S. foreign exchange dealers. It was created to pool together industry resources to create awareness and recognition that forex dealers are a powerful choice for individuals who choose to speculate in financial markets.

 The FXDC partnership was formed in the fall of 2007 to demonstrate the viability of the forex industry and to ensure fair regulation and oversight that does not hamper freedom of choice, innovation or job creation.

 The global forex industry has boosted the national economy by training and employing a domestic workforce of thousands. In a global marketplace where Americans struggle to compete for high-tech jobs, American forex dealers lead the world in this fast-growing industry, outpacing other firms based in Europe, Japan and Australia.

 The American firms are regarded as the leaders in the industry, hiring highly-coveted, knowledge-based workers who contribute to the economy’s bottom line.”

 If you have further questions about the FXDC, the CFTC’s current proposal, or about any of TTP’s compliance solutions contact us today!  You can fill out our contact form here, or may call us at any time by dialing (312) 324-0040.

Live Coverage: Open Discussion about the CFTC 10:1 Leverage Proposal

Thursday 21st, at 14:00 GMT – 09:00 EST, FX Street.com
Valeria Bednarik, FXstreet.com Chief Analyst

Speakers:

James Bibbings President and CEO of Turnkey Trading Partners

Joseph Trevisani, Chief Market Analyst at FX Solutions and representative of the Forex Dealers Commission

Jason Rogers Ambassador for Online Communities at FXCM and representative of the Forex Dealers Commission

Join us in a  debate about the future of the Forex Retail Trading on US after the proposal of the CFTC about leverage.

James Bibbings, expert in the regulatory environment of the markets, will give his explanation and point of view about the proposal; you will also be able to ask

Joseph Trevisani and Jason Rogers what you want to know about how the new regulation may affect your trading.

Sign Up Now Here: Live Coverage: Open Discussion about the CFTC 10:1 Leverage Proposal

CFTC Forex Proposal; US Retail Market to Disappear?

On January 13^th, 2010 the Commodity Futures Trading Commission (“CFTC”) issued a press release regarding its highly anticipated rule proposal for the regulation of retail forex transactions.  The proposal seeks to adopt a new regulatory scheme to implement the CFTC Reauthorization Act of 2008.  In particular it strives to address the way the federal agency will deal with off-exchange transactions in foreign currency with the retail public.  Currently the CFTC’s proposal is open for public comment for sixty days (60) and was published in the Federal Register on January 7^th, 2010.  Before anyone can comment though, they’ll have to fully understand what the proposal says. 

What the Proposal Attempts to Establish

The following is a summary listing of the major provisions included in the CFTC’s proposal.  While reading through these items please note that they are not the only changes to the law which have been proposed.  Rather, these items represent what will be the most significant changes to the industry through the eyes of a former regulator and industry professional; they are presented in order of most important to least.

1)  The CFTC has revised its definition of “commodity interest” (i.e. futures) to include off-exchange retail forex transactions (“forex”).  This change grants the CFTC jurisdiction over the United States retail forex market.

2)  With the authority found in item one above; the CFTC will create new registration categories for retail foreign currency firms as follows: 

A) Dealers (Currently FDM’s) in retail forex transactions will be required to register as retail foreign exchange dealers or (“RFEDs”). 

B) Persons or entities that solicit or accept orders for an RFED, a Futures Clearing Merchant (“FCM”), or an affiliate of an FCM will be required to register as Introducing Brokers (“IBs”). 

C)  Persons or entities exercising discretionary authority over accounts will be required to register as Commodity Trading Advisors (“CTAs”).

D)  Persons or entities which operate or solicit funds or property for a pooled investment vehicle would be required to register as Commodity Pool Operators (“CPOs”).

E)  All persons who qualify as being “associated” with the foregoing registration categories will be required to become registered as associated persons (“AP’s).

3)  All Introducing Brokers (“IBs”) and all applicants working towards registration as IBs in connection with retail forex transactions will be required to enter into a guarantee agreement with an RFED.

4)  RFEDs and FCMs which engage in retail forex transactions will be required to collect from their customers a security deposit equal to no less than ten percent of the notional value of the retail forex transaction to be conducted; thus imposing a strict 10:1 leverage ratio.

The Implications  

Items 1 and 2: Revised Definition of “Commodity Interest”:  The definitional change of “Commodity interest” to include off-exchange retail forex transactions gives full authority of the US retail foreign currency market to the CFTC.  Based on this definitional adjustment the CFTC will now have the legal ability to require forex professionals to register with the agency.  It also means these professionals will be required to become members of a self regulatory organization (“SRO”) which in most instances will be the National Futures Association (“NFA”).  Firms will be required to register by law as RFEDs, FCMs, IBs, CTAs, and/or CPOs to solicit for or accept retail customer orders.  Many of these firm’s employees will then also be required to become APs and/or business principals.

Item 3:  All IB’s Must Be Guaranteed by an RFED:  This provision of the proposal is likely to be more devastating to the United States forex industry than any other.  The reason?  Requiring RFED’s to be entirely liable for the solicitation activity and performance of all their introducing brokers will prove to be impossible.  Since there will be no such thing as an independent forex IB, it does not seem reasonable to think that the handful of RFEDs in the United States will be willing to take on the risk of guaranteeing all of the nation’s introducing agents.  If they were to do so, the level of liability as well as the capital required to stand behind the performance of such entities would be staggering.  Further this requirement completely eliminates the role of an independent IB as it calls for each guaranteed IB to introduce client accounts to only its guarantor RFED.  This will greatly reduce consumer and IB strategy options and may also cause clients to open relationships with multiple brokerage houses.  For these two reasons, and the requirement discussed below in item 4, third party forex brokerage as it currently exists will be under tremendous stress.

Item 4:  Forex Transactions Must Adhere to 10:1 leverage:  There has been more written about this portion of the CFTC proposal than any other and perhaps rightfully so.  Currently in the US firms are able to offer clients 100:1 leverage, which is already lower than what is available in other parts of the world.  At this time US customers appear to be satisfied with security deposit levels which currently reside at either 1% or 4% (by pair traded) of a contracts notional value.  Although the CFTC may believe that lowering leverage from 100:1 may be better for clients (which in many cases it will be) I do not believe they have fully considered the ramifications of this action.

It is largely anticipated that in the event leverage in the US is reduced from 100:1 to 10:1 most US accounts will migrate to the United Kingdom.  Individual traders have voiced publically that they are unwilling to post higher levels of margin to trade within the United States.  Specifically many have shared that as long as well regulated, financially similar, trading venues exist internationally; staying in the US will not make sense with a 10% security deposit.  Therefore, if the objective of the CFTC is to protect US investors with their new proposal and this occurs, they may actually be making matters worse.  If US clients are encouraged to move their accounts abroad on to pursue higher leverage, the CFTC will then no longer have jurisdiction over the companies handling those accounts and the point will become moot. 

In addition to potentially losing jurisdiction over US client monies, should a capital exodus occur as a result of reduced leverage, the CFTC will have also made US RFED’s less competitive internationally.  The implications here are far reaching; especially when one considers the size of the global forex market space.  Furthermore, reducing leverage by as much as ten times will also drastically reduce off exchange retail currency trading volumes for RFEDs.  If this were to occur these firms would likely seek out new forms of revenue in order to supplement falling profit margins.  They would likely do so through various fees and/or by additional commissions through wider trading spreads.  This too will not be good for the US retail trader or the RFED’s which directly and indirectly create numerous employment opportunities.  Worst yet, it is conceivable that an adjustment to the security deposit, especially when coupled with the requirement to guarantee IB’s, might move some RFEDs entirely out of the country.

Options and the Long Road Ahead

Share Your Thoughts: Now that the CFTC proposal exists, what’s next for retail forex traders and brokerage firms within the United States?  The first thing that should be done if you’d like to comment on this proposal would be to submit your thoughts to the CFTC and your legislators.  The CFTC will accept comments for at least sixty days (60) starting from January 7th, 2010. 

When sending in a comment it will be important to use the subject “Proposed CFTC Regulation of Retail Forex”; Federal Register – January 7th, 2010.  After this be sure to include the proposals identification number which is RIN3038-AC61 in the body of your message.

To comment on the proposal choose one of the following options:

Emailing: secretary@cftc.gov or using the CFTC’s online form

Fax comments to (202) 418-5521, or mail to:

David Stawick,

Secretary, Commodity Futures Trading Commission

21^st Street, NW

Washington DC 20581

Industry Professionals:  Industry professionals that have not yet registered with the CFTC and elected to become NFA members; now is the time.  It is possible that the CFTC may alter some of its proposed amendments if it deems the comments received from the public are reasonable.  However, it is highly unlikely that the requirement for all forex professionals to become CFTC registrants and members of a DSRO will be omitted.  In just a short period of time every forex firm in the country will be required to register and this will create a massive back log with the NFA.  To learn more about this process it would be advisable to contact a regulatory professional and seek advice immediately.  Due to the time sensitive nature of this requirement it would also be wise to look for a company that is well versed in forex compliance.  Most importantly they should be intimately aware of the CFTC’s current proposal.  To learn more about my company and the registration process you may contact us here.  You may also be interested in reviewing “Forex Registration Almost Here” published previously.

Retail Traders:  Individuals who trade retail forex will need to consider the implications of having to post as much as ten times more capital to hold trades open.  This will materially alter trading strategies and significantly reduce the size of the positions that a person can initiate.  Customers should speak with their respective brokerage houses, the CFTC, NFA, and their legislators to let them know how this rule will impact their trading.

-James Bibbings

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 James Bibbings is the President and CEO of Turnkey Trading Partners (“TTP”), a firm that supports all commodity and forex specific regulatory and business needs. Prior to founding TTP, Bibbings worked with the National Futures Association (“NFA”) as a supervising auditor. During his time with NFA he was involved in over 100 investigative audits and was able to gain a deep working knowledge of FDM, FCM, IB, CTA, and CPO operations.  Bibbings has provided financial markets content for MSN, Yahoo, FinAlternatives, Wiki-Investments, Safe Haven, Financial Sense, Market Watch, FX Street, The Financial Times, Commodity News Center and many other highly acclaimed investment publications.  He has also authored two highly sought after informational pamphlets regarding futures and forex registration which are available for free upon request through his company website.  If you have any questions or comments for Bibbings he can be reached directly by email at james@turnkeytradingpartners.com and would love to hear from you.

CFTC Breaks Silence on Forex

As Turnkey Trading Partners has mentioned over the past several months, the CTFC is getting closer to requiring forex brokerage firms, traders, and some systems providers to register with and become members of the NFA.  In case you missed it, just yesterday, the CFTC issued a press release related to the “Farm Bill” which will amend the Commodity Exchange Act to include retail forex as a financial market for which the CFTC will have jurisdictional authority.  More specifically the CFTC is now soliciting public comments on proposed rule changes to retail forex transactions brought forth by NFA and other financial regulatory authorities.  From a practical stand point what this means for forex traders is that these changes are getting ever closer to becoming hard and fast law.  

If you would like to learn more about this bill, would like to begin the process to comply with this new regulatory requirement, or are unsure on whether you will be required to register, please also consider reviewing our previous article “Forex Registration Almost Here.”  From there if you still have additional questions and would like a free consultation with a Turnkey Trading Partners consultant please feel free to fill out an information request here and some one will be back with you shortly.

To read the latest from the CFTC please read “CFTC Seeks Public Comment on Proposed Regulations Regarding Retail FOREX Transactions.”

-TTP’s Compliance Team

5 Strategies to Raise Capital for Your CTA or Fund in 2010

The recent uncertainty in the markets has changed the game for Commodity Trading Advisors and hedge fund managers.  While performance is still a major factor in attracting capital, in the post-Madoff era, savvy investors grow increasingly concerned with clarity, transparency, and operational integrity when they screen various managers.  Performance catches the eye on the database, but it doesn’t close the deal.

Attracting capital is about offering clients exactly what they’re looking for in a capital management firm.  A recent survey by SEI found that while 90% of institutional investors plan to maintain or increase their allocations to hedge funds, they would be exercising greater due diligence. In other words, just having great returns will not cut it. CTAs and Hedge Fund managers must present an image that builds trust and embodies operational integrity if they are looking to attract interest from both high net worth and institutional investors.

With this in mind, Turnkey Trading Partners offers 5 strategies to help you raise capital for the coming year:

Build a Team That Inspires the Confidence That is Expected of Institutions

Your public image should exude professionalism in every aspect of your firm.  It’s tough to promote your company as a top tier financial institution if there are weaknesses in your operation. Some weaknesses include having a trader wear multiple hats in the organization, or eve lacking the proper operational guidelines in place to pass an onsite due-diligence exam. While costs might be an issue for some managers, there are ways to outsource some of these critical roles. Smaller funds should seek out third party expertise to handle those functions where they may lack the needed competencies.  Ensuring your fund has no weaknesses gives you a stronger product to offer your market.

Maximize Your Exposure

Most Hedge Funds lack a solid public relations component.  While the clients to whom you can market directly are a select group, getting your name out there helps you get them to come looking for you.  Getting listed on the fund databases is a good start, but it’s only a start. You need two separate marketing strategies.  The first is to get the client’s attention.

While regulations prevent you from directly marketing your trading program to the general public, a savvy fund manager can get media exposure, and the interest that comes with it by offering thoughtful commentary on market or economic trends.  Press releases and media appearances can go a long way toward building a positive buzz for you. 

Some fund managers run blogs—that may or may not be about finance—while others write and promote books.  While you should always consult a regulatory professional before speaking directly to the public to ensure your message plays by the rules, the attention is always worth the effort.

Have Your Message Ready To Go

Prepare a presentation ahead of time.  The second part of an effective marketing strategy is to diligently develop marketing materials before making a presentation to potential investors.  When you have the opportunity to pitch to a potential client it is imperative to be well organized; there is only one chance to make a first impression.  In most instances, especially with high net worth customers, the fund’s prospectus or disclosure document alone won’t cut it.  Presenting marketing materials that explain the fund’s investment strategy and philosophy in ways that are easily understood can make all the difference.

Investors are reluctant to invest their money in strategies they don’t understand.  There’s nothing wrong with complex or unorthodox investment strategies as long as they are clearly explained and easily understood.  Your sales materials should carefully describe your investment process in an audience-friendly manner.  If you can’t readily articulate how you do what you do, you will find it all the more challenging to win the confidence of a potential client. 

Your investor relations kit must make it simple to verify your claims because your clients will be studious.  Sales materials should never make claims that are not included in the fund prospectus, and forward-looking statements must be used with great care.  Your materials must be as much about transparency as they are about sales. 

An attractive PowerPoint presentation that gets the right message across should be the centerpiece of the sales package, but you also need sales brochures, due-diligence questionnaires, a corporate introduction and sales aids.

Be Completely Transparent and Honest to Build Trust

In this market, your clients will be clenching their dollars tightly to their chests until they know they can trust you.  While this point seems a bit too obvious, it is essential that you emphasize integrity from the get-go. Don’t embellish your performance, and don’t hide things in fine print. Don’t exaggerate your previous trading experience or tell investors about how much money you are expecting to receive in the next few months.  Being honest and transparent builds trust with your clients.  If the fund performed well, explain exactly why.  Even more important is to clearly explain the reasons if the fund underperforms.  Investors expect forthrightness from their money managers, but they also appreciate it when they get it.  You want long-term relationships with your clients based on trust, so do everything you can to foster that trust and you will win more business.

Another way to build trust with your clients is to emphasize the purpose each member of your investment team plays.  This way the client can put a face with a function that is looking out for their money.

Emphasize What Makes You Different

Of course, your presentation must cover the 4 P’s: People, Process, Pedigree and Performance, but your clients have probably heard the same pitch from dozens of fund managers.  How are you different?  Try to explain your fund’s operation in ways that capture the interest of the audience. What about the trading strategy? Are you able to effectively communicate why it is different from similar programs? Many investors often scan marketing material and look only for programs that are different and unique. That is why it is important to articulate- in both written and verbal terms- what makes your program stand out from the crowd.

If you are a new or emerging manager, don’t get discouraged.  While your track record might not be as long or your pedigree might not be spectacular, there are countless examples of non-professional traders who are now managing large funds. In addition, this could be a way that you emphasize how your trading program is different from the rest.  Over the past decade, there have been several funds and investors that have formed with the focused purpose of allocating only to new or emerging managers.  Positioning yourself to market to these investor groups might prove advantageous.

Using these five strategies will go a long way to building up your capital, and keeping your firm competitive for the long run.  Turnkey Trading Partners is able to help you achieve your goals by helping you develop a marketing plan that gets the kind of attention you seek.  To learn more about what we have to offer please contact us through our webform or give us a call to see how we can assist you with your marketing and PR needs.

 -Kevin Rogers

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Kevin Rogers is a marketing consultant with Turnkey Trading Partners working to create unique and powerful branding and marketing solutions for Commodity Trading Advisors, Hedge Funds, FX and Capital Management firms.  Before teaming up with TTP, Rogers worked as an independent developer of marketing and public relations materials for a wide array of financial companies.  He is a graduate of U.C. Berkeley and holds an M.A. in business communication.  If you like Kevin’s thoughts, have ideas, or want to ask questions we’d love to hear from you.  For specialized assistance send your requests to info@turnkeytradingpartners.com and we’d be more than happy to get back with you.