As always, the following information is not intended to be all-inclusive or constitute legal advice.  If your firm would like assistance in drafting its performance or promotional materials, we recommend that you contact a competent industry professional or legal advisor to discuss your requirements in light of your unique circumstances.

Hypothetical Trading Results

If you’re a CTA or CPO, then your hypothetical performance cannot be presented for any trading program that has conducted at least three months of actual client or proprietary trading.  In addition, if shown, it must be accompanied by NFA’s prescribed statements regarding hypothetical or simulated performance results.  Hypothetical performance must also include comparable information regarding the past performance of all customer accounts directed by the Member (CTA, CPO, Associated Person, Trader etc.) pursuant to a power of attorney or letter of direction over the past five years.  Furthermore, if the Member has less than one year of experience directing customer accounts, the past performance of the Member’s proprietary trading for the past five years must be included in the materials.

NFA has created the following two-part disclosure standard:

1)      If a CTA or CPO intends to include hypothetical trading results, and if they have other programs’ performance to also show, the CTA does not need to list any proprietary trading performance; or

2)      If a CTA or CPO intends to include hypothetical trading results, but does not have any other programs’ performance to also show, the CTA must include all proprietary performance for the last five years.

In short, it can be very challenging to properly display hypothetical returns as a CTA and/or CPO.

Relevant Regulations?

Do the rules above seem unfamiliar?  Can’t find them in the CFTC’s regulations?  For those of you that were ambitious enough to look into the rulebooks – but were unable to find the above-listed regulations – don’t fret.  The reason you were unable to find these regulations is simple – To be blunt, NFA made up the “5 year rule.”  When we raised this issue with NFA, we were informed by the self-regulatory agency that it would be issuing an interpretative notice explaining its reasoning “very shortly.”

For our benefit, NFA explained its “5 year rule” as follows: Pursuant to CFTC Reg. 4.34(o), “Nothing … shall relieve a CTA from any obligation under the Commodity Exchange Act [“CEA”] or the regulations thereunder, including the obligation to disclose all material information to existing or prospective clients even if the information is not specifically required by such sections.”  Based on this language, NFA has interpreted the phrase “all material information” to include situations in which a CTA is attempting to show hypothetical trading results without also showing its actual trading results.  Hence, the aforementioned requirements discussed above.

Based on this NFA restriction, in addition to other reasons, we generally do not recommend the use of hypothetical results in promotional materials for any reason.  This extends to the inclusion of such results within disclosure documents as well.  The proper use of hypothetical returns can be very difficult to substantiate and properly represent since their very presentation is subjective.  Furthermore, such results become obsolete shortly after trading begins (90 days).  As a result, in the vast majority of cases, the presentation of hypothetical performance simply isn’t worth the effort or the risk.

Proprietary Trading Results

Similar to the discussion above pertaining to hypothetical trading results, NFA likewise applies CFTC Reg. 4.34(o) with respect to intended disclosures concerning proprietary trading results.  For instance, it is NFA’s position that if you choose to include any proprietary trading results (regardless of whether you intend to include hypothetical results) then you must include all proprietary trading results.  Understandably, NFA does not want any cherry-picking of trading results shown to investors – hence the requirement to show all prop results.  However, NFA takes this position to the extreme and has even required our clients to include hedge trading accounts in their performance presentations!  Regardless of how little sense this may make from a materiality point of view, NFA has held firm to this position on a number of occasions.

The moral of the story is that if you want to show some proprietary trading results, then you must show all proprietary trading results.  We have found this to be the case even when the proprietary trading results are for programs entirely different from – and even potentially contrary to – the trading program being offered.  Although we strongly disagree with NFA’s position on this, unless NFA further clarifies what must be included in a subsequent notice, many disclosure documents containing proprietary trading results will continue to be misleading to clients.  This, in our opinion, is especially true for CTAs and CPOs that test systems in live trading environments with proprietary money before offering them publicly.

Further Guidance

Understanding and complying with these trading performance disclosure rules is crucial to your firm’s ability to effectively market its trading results while also complying with applicable rules and regulations.  As a result, it would be prudent to contact a regulatory professional like Turnkey Trading Partners (TTP) to assist you in this effort.  TTP has the business acumen, as well as important relationships with legal professionals, such as Henderson & Lyman of Chicago, to provide you with the guidance you need to tackle these, as well as other, performance disclosure restrictions.

-James Bibbings and Nicole Kuchera

________________________________________

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, spoken at a variety of alternative investment conferences, and participated in international forums on proposed CFTC regulatory requirements.  He has also provided content for Bloomberg, MSN, The Wall Street Journal’s Market Watch Yahoo, Financial Times, FX Street, FinAlternatives, Safe Haven, Financial Sense, Forex Journal, 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, JD, LLM is an Associate in Henderson & Lyman’s Financial Services Practice Group.  She concentrates her legal practice on transactional and litigation support for securities, futures and derivatives industry clients, such as Introducing Brokers, Commodity Trading Advisors, Commodity Pool Operators, Broker-Dealers, Investment Advisers, Futures Commission Merchants, and Forex Dealer Members.  Ms. Kuchera counsels clients regarding a wide range of compliance and regulatory matters involving the rules and regulations of the SEC and the 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 also represents clients in general corporate matters, such as business formation, licensing and industry registration.

“Most futures and commodity-trading advisers, who counsel clients on futures and options contracts, require at least a 50 percent deposit, says James Bibbings, president of Chicago-based Turnkey Trading Partners, a consultant to commodity and currency traders. A fraction of that 50 percent will be invested in actual contracts, with the remainder parked in cash or cash-like securities that can easily be sold if the firm needs to post additional margin on the customer position.”

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As of August 25, 2011 the Commodity Futures Trading Commission (“CFTC”) adopted its final rules on “Commodity Whistleblower Incentives and Protection.”  According to the Dodd-Frank Wall Street Reform and Consumer Protection Act (“Dodd-Frank”), the CFTC must pay an award, subject to certain limitations, to eligible whistleblowers that voluntarily provide the CFTC with original information about a violation of the Commodity Exchange Act (“CEA”) that leads to a successful enforcement action.  In other words, the CFTC is now required to reward certain persons that expose fraud within the industry that it regulates.  Dodd-Frank also prohibits retaliation by employers against persons who provide the CFTC with information about possible CEA violations.  CFTC regulated employers should make themselves aware of the existence and possible implications of these new final whistleblower rules which become effective on October 24, 2011.

A brief summary of the new rules follows.  The final regulations are substantially similar to those that were proposed.  We encourage you to seek assistance if you have any questions regarding these new rules or how they may potentially affect your current or intended business.  The information contained in this summary is not intended to be all-inclusive and does not constitute legal advice.

Key Points of CFTC Whistleblower Rules

• The CFTC must pay awards to whistleblowers that provide original information to the CFTC that leads to the successful prosecution of a CFTC enforcement action resulting in monetary sanctions exceeding $1,000,000. The amount of the award, as determined by the CFTC, will be between 10 to 30 percent of sanctions collected in either the CFTC’s action or a related proceeding that is based upon the original information provided by the whistleblower.

• Whistleblowers may receive an award based upon violations that occurred prior to the enactment of Dodd-Frank.

• A whistleblower who submits information after July 16, 2011 may have a private cause of action for any employer retaliation against whistleblower activities.

• Ineligibility to receive a whistleblower award from the CFTC does not preclude application of the anti-retaliation protections.

• To receive a whistleblower award, the CFTC will not require internal reporting within the company prior to bringing the case to the CFTC.

• Similar to the SEC whistleblower rules, internal reporting can be considered when determining the amount of the award.  In such cases, whistleblowers who report internally can still qualify for an award as long as they provide information to the CFTC within 120 days of the internal reporting.

• CFTC staff is authorized to communicate directly with whistleblowers without seeking consent from the firm or its counsel, so long as the whistleblower initiates the communication.

• The rights and remedies afforded to whistleblowers cannot be waived by any agreement, policy, form, or condition of employment, including any pre-dispute arbitration agreement.

• Unlike the SEC’S whistleblower rules, the CFTC’s rules do not include a reward for persons who through their own research of public sources provide the CFTC with an independent analysis revealing a likely violation of the CEA.

• Similar to the SEC’s whistleblower rules, the CFTC’s rules generally will not award the following persons:

-          Attorneys who obtain their information through a communication subject to the attorney-client privilege or in connection with the representation of a client;

-          Individuals who obtain their information through a violation of federal or state criminal law;

-          Most officers, directors, trustees, partners, or other individuals at a firm who learn about the misconduct through the firm’s internal channels for identifying and addressing possible violations; and

-          Most employees whose principal duties involve compliance or internal audit functions.

• The above- excluded employees can still qualify for an award, however, if one of the following conditions exists:

-          The person believes that disclosure to the CFTC is necessary to prevent misconduct that is likely to cause substantial financial harm;

-          The firm is impeding an investigation of the alleged misconduct; or

-          At least 120 days have passed since the whistleblower reported information to their supervisor or to the firm’s audit committee, chief legal officer, or chief compliance officer.

• Unlike the SEC’S whistleblower rules, the CFTC’s rules do not exclude employees of public accounting firms from eligibility or protection against retaliation.

Further Guidance

Understanding and complying with these new rules is critical for virtually all firms subject to CFTC jurisdiction.  As a result, you may wish to consider contacting a regulatory professional like Turnkey Trading Partners (TTP) to assist you in this effort.  TTP has the business acumen, as well as relationships with experienced legal professionals, to provide you with the guidance you need to address the new rules affecting your business.

-James Bibbings and Nicole Kuchera

_____________________________

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, Bloomberg, the Wall Street Journal’s Market Watch, FinAlternatives, Safe Haven, Financial Sense, Forex Journal, FX Street, Forex Factory, and many other highly acclaimed investment publications.  Two 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, JD, LLM is an Associate in Henderson & Lyman’s Financial Services Practice Group. She concentrates her legal practice on transactional and litigation support for securities, futures, forex and derivatives industry clients, such as Introducing Brokers, Commodity Trading Advisors, Commodity Pool Operators, Broker-Dealers, Investment Advisers, Futures Commission Merchants, Hedge Funds and Forex Dealer Members.  Ms. Kuchera counsels clients regarding a wide range of compliance and regulatory matters involving the rules and regulations of the SEC and the 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 also represents clients in general corporate matters, such as business formation, licensing and industry registration.

Private Fund Adviser Registration Required

Title IV of Dodd-Frank eliminated the private adviser exemption.  The private adviser exemption had previously allowed advisers to private funds to avoid registering where they had fewer than 15 clients.  For purposes of this exemption, each fund counted as one client regardless of the number of investors in the fund.  As a result, advisers to hedge funds and other private funds had previously remained outside registration requirements despite their management in some cases of large sums of money.  Absent a relevant exemption, such advisers (including CPOs of funds that trade both commodity futures and securities and that previously relied on the private advisor exemption) must now register by March 30, 2012 as a result of the elimination of this exemption. Unless state investment adviser laws and regulations are also amended to eliminate this exemption, however, advisers not subject to the Adviser Act may still be able to claim the state equivalent of the private adviser exemption after March 30, 2012.

Although Dodd-Frank eliminated the private adviser exemption under the Adviser Act, it did not amend the corresponding exemption from registration for commodity trading advisors under the Commodity Exchange Act.  As a result, firms previously relying on the SEC’s private adviser exemption may want to consider whether they could operate in the commodities realm instead. While there are obviously significant differences between trading securities and commodities, the “regulatory arbitrage” presented by Dodd-Frank may be a reason for managers to consider changing their investment universe.

Amended Form ADV for Private Fund Advisers

Under the amended adviser registration form (“Form ADV”), advisers to private funds will have to provide the following additional information to the SEC:

• Organizational Info – Basic organizational and operational information about each fund managed, such as the type of private fund (e.g. hedge fund, private equity fund, or liquidity fund), size, ownership, general fund data, and the adviser’s services to the fund.
• Gatekeepers – Identification of five categories of “gatekeepers” that perform critical roles for advisers and the private funds they manage (i.e., auditors, prime brokers, custodians, administrators and marketers).

• Relationships - The types of clients they advise, their employees, and their advisory activities.
• Conflicts of Interest – Business practices that may present significant conflicts of interest, such as the use of affiliated brokers, soft dollar arrangements, and compensation for client referrals.
• Non-Advisory Activities – Information about their non-advisory activities and their financial industry affiliations.

Exempt Advisers and Reporting Requirements

Although many private fund advisers will be required to register, some may not need to register if they are able to rely on one of the following exemptions from registration under Dodd-Frank:

• Venture Capital Funds – Advisers solely to venture capital funds will be exempt advisers.  Under a grandfathering provision, funds that began raising capital by the end of 2010 and represented themselves as pursuing a venture capital strategy would generally be considered venture capital funds.  Going forward, under the new rules, a venture capital fund is defined as a private fund that:
  • Invests primarily in “qualifying investments” (i.e. private operating companies that do not distribute proceeds from debt financings in exchange for the fund’s investment in the company); the fund may invest in a “basket” of non-qualifying investments of up to 20 % of its committed capital and may hold certain short-term investments;
  • Is not leveraged except for a minimal amount on a short-term basis;
  • Does not offer redemption rights to its investors; and
  • Represents itself to investors as pursuing a venture capital strategy.
  • Under the new rule, foreign advisers: (1) cannot have a place of business in the U.S., (2) must have less than $25 million in aggregate assets under management from U.S. clients and private fund investors, and (3) must have fewer than 15 U.S. clients and private fund investors.
  • Moreover, the SEC is adopting rules to define certain terms included in the statutory definition of “foreign private adviser” in order to clarify the application of the foreign private adviser exemption and reduce the potential burdens for advisers that seek to rely on it.  The rule incorporates definitions set forth in other SEC rules, all of which are likely to be familiar to foreign advisers active in the U.S. capital markets.

• Under $150M – Advisers solely to private funds with less than $150 million in assets under management in the U.S. will be exempt advisers.
• Foreign Advisers – Certain foreign advisers without a place of business in the U.S. will be exempt advisers.

While these advisers are exempt from registration, the SEC can still impose certain reporting requirements upon advisers relying upon either the venture capital or under $150 million exemption (“Exempt Reporting Advisers”).  These Exempt Reporting Advisers must file their first reports in the first quarter of 2012.  Rather than completing all of the items on the Form ADV, Exempt Reporting Advisers will fill out a limited subset of items, including:

• Organizational Info – Basic identifying information for the adviser, the identity of its owners and affiliates, and information about the private funds managed.
• Conflicts of Interest - Other business activities that the adviser and its affiliates are engaged in that present conflicts of interest that may suggest significant risk to clients.
• Discipline – If relevant, any disciplinary history of the adviser and its employees that may reflect on the integrity of the firm.

Changing Investment Adviser Thresholds

As you are likely aware, regulatory responsibility for investment advisers is divided between the SEC and the states based primarily on the amount of money an adviser manages for its clients.  Under existing law, advisers generally may not register with the SEC unless they manage at least $25 million in client assets.  Dodd-Frank raises this threshold to $100 million by creating a new category of advisers called “Mid-Sized Advisers.”  In general, Mid-Sized Advisers will not be allowed to register with the SEC and will instead be subject to state regulation.  A Mid-Sized Adviser is defined as an adviser that:

• Manages between $25 million and $100 million in client assets.
• Must register in the state where it maintains its principal office and place of business.
• Would be subject to examination by that state, if required to register.

As a result of Dodd-Frank’s amendment to the Advisers Act, approximately 3,200 of the 11,500 advisers currently registered with the SEC will be required to deregister and convert to state registration.  These advisers will continue, however, to be subject to the Adviser Act’s general anti-fraud provisions.  Note that the SEC has adopted a buffer range between $90 million and $110 million which will permit advisers with assets in this range to register either with the SEC or the states.  Advisers currently registered with the SEC must declare that they are permitted to remain registered with the SEC in a filing in the first quarter of 2012.  Advisers no longer eligible for SEC registration will have until June 28, 2012 to deregister with the SEC and convert to state registration.

Further Guidance

Understanding and complying with these investment adviser rule changes is going to be critical for fund management firms and certain CPOs going forward.  As a result, it would be prudent to contact a regulatory professional like Turnkey Trading Partners (TTP) to assist you in this effort.  TTP has the business acumen, as well as important relationships with legal professionals, such as Henderson & Lyman of Chicago, to provide you with the guidance you need to tackle the new investment adviser rules affecting your business operations.

-James Bibbings and Nicole Kuchera

_____________________________

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, JD, LLM is an Associate in Henderson & Lyman’s Financial Services Practice Group. She concentrates her legal practice on transactional and litigation support for securities, futures and derivatives industry clients, such as Introducing Brokers, Commodity Trading Advisors, Commodity Pool Operators, Broker-Dealers, Investment Advisers, Futures Commission Merchants, and Forex Dealer Members.  Ms. Kuchera counsels clients regarding a wide range of compliance and regulatory matters involving the rules and regulations of the SEC and the 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 also represents clients in general corporate matters, such as business formation, licensing and industry registration.

As of July 15, 2011, Dodd Frank will be implemented with respect to retail OTC precious metals contracts, thereby affecting both brokers and traders of this contract type. Dodd-Frank has already become effective with respect to retail OTC forex, except for certain delayed provisions regarding broker-dealers. As a result, the requirements of Dodd-Frank should not be a surprise to the forex industry, as preparations for these changes have largely been completed. The Commodity Futures Trading Commission (“CFTC”), and the self regulatory organization National Futures Association (“NFA”), took the lead on this issue and published guidance for forex firms many months ago. Forex traders and brokers within the U.S. should therefore see little difference in their respective trading experiences beginning on July 15th. On the other hand, foreign brokers not registered in the U.S. will now be forced to terminate any and all relationships they may have with U.S. persons. This has already begun to happen in many instances – in some cases forcing U.S. customers to exit trades at times they may not otherwise have chosen. Likewise, traders working with brokers and clearing firms in jurisdictions outside the U.S., and who are not registered, may see substantial changes in their trading arrangements and in many cases a total cessation of their trading activity.

As of July 15, 2011, Dodd Frank will effectively ban the trading of most retail OTC contracts for gold, silver, and all other metals. In particular, Section 742(a) of Dodd Frank prohibits any person [which 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. The intent of this provision was to expand the narrow so called “Zelener fix” in the Farm Bill enacted by Congress during 2008. [Previously the Farm Bill enabled 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 expansion of authority given by Dodd-Frank to the CFTC now allows them to regulate virtually all retail cash commodity market products that involve leverage or margin – in other words OTC precious metals.

The prohibition in Section 742(a) does not apply, however, to metals transactions that result in actual, physical delivery of the metal traded within 28 days, or if such a transaction creates an enforceable obligation to deliver the metals product between a seller and a buyer that have the ability to deliver, and accept delivery of, respectively, the commodity in connection with their lines of business. This may be problematic for many brokers and traders, since in most spot metals trading virtually all contracts fail to satisfy these requirements. As a result, although courts have yet to interpret Section 742(a), this Section is likely to have a significantly restrictive impact on the OTC cash precious metals industry. This in turn may affect forex traders and brokers working with dealers that offer precious metal-currency pair trading within their trading platforms. Those who offer such transactions or intend to be a counterparty to OTC metals transactions should seek professional help to discuss possible operational and regulatory contingency plans. Retail traders also should be aware of this provision, as they too will be ineligible to enter into such contracts.

As noted above, implementation of these new provisions on July 15, 2011 will likely have a mixed impact on the financial industry. Changes to the OTC forex market in the U.S. should be somewhat muted since most firms have been preparing for this day and thus are already registered with the CFTC or have made other business plans. Unfortunately, for many OTC precious metals brokers and traders, July 15th will mark the end of an era. For those of you in these categories, it could be said that some of your financial freedoms have been taken away. Few – if any – would argue that OTC metals trading contributed to the global financial collapse. It is unfortunate that activity which was not attributed to the events which produced Dodd-Frank is nevertheless being prohibited. As a small consolation to those of you affected, the next time someone says “In this economy,” you can stop them and offer back: “Trust me, I know.”

-James Bibbings and Nicole Kuchera

———
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 insight for MSN, Yahoo, Financial Times Bloomberg, 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.

Nicole Kuchera, JD, LLM is an Associate in Henderson & Lyman’s Financial Services Practice Group. She concentrates her legal practice on transactional and litigation support for securities, futures and derivatives industry clients, such as Introducing Brokers, Commodity Trading Advisors, Commodity Pool Operators, Broker-Dealers, Investment Advisers, Futures Commission Merchants, and Forex Dealer Members. Ms. Kuchera counsels clients regarding a wide range of compliance and regulatory matters involving the rules and regulations of the SEC and the 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 also represents clients in general corporate matters, such as business formation, licensing and industry registration.

The information set forth in this guide in not intended to be all-inclusive or to constitute legal advice.  If your firm would like assistance in drafting its promotional materials, we recommend that you contact a competent industry professional or legal advisor to discuss particular drafting requirements in light of your unique circumstances.  It is important to note that more stringent requirements are imposed on those Members previously named in disciplinary actions and individuals associated with such Members.  For more information regarding NFA’s enhanced supervisory policies stick with us as we will be writing on this topic in the future.

General Considerations for Promotional Materials

NFA Compliance Rules 2-29 (Rule 2-29) and 2-36 (Rule 2-36) cover all forms of communications with the public by NFA Members.  Rule 2-29 covers communications with the public by Members who solicit customers to trade on-exchange futures and options on futures.  Rule 2-36 covers communications with the public by Members who solicit retail customers to trade forex.  These rules were developed to ensure that all Members observe the highest ethical standards when communicating with the public.

Definition of Promotional Material

NFA has determined that following materials constitute promotional material.

• Sales or educational literature distributed to the public, whether prepared by the Member, its employees, other NFA Members, or non-Members;
• Seminar presentations and any advertising designed to encourage attendance at such seminars;
• All advertising in newspapers, magazines, radio, television, and direct or electronic mail;
• Standardized phone solicitations, including “cold calls”;
• Newsletters, reports, circulars, etc.;
• A prepared sales script, whether actually followed in making sales presentations or developed solely for training purposes;
• Material used on the Internet; and
• Hotlines.

General Prohibitions – All Member Firms

In general, the following prohibitions apply to all Member firms’ promotional materials.  The promotional materials:

• May not be deceptive or misleading;

• May not use high-pressure sales tactics;
• May not be part of a high-pressure approach; and
• May not say or imply that futures or forex trading is appropriate for everyone.

General Requirements – All Member Firms

In general, the following requirements apply to all Member firms’ promotional materials. 

Factual Statements. Probably the most important consideration regarding a Member’s promotional materials is that all statements made in these materials must be true.  In this regard, NFA requires that Members must be able to support the accuracy of each statement made in their promotional materials, including performance figures.

Opinions. When an opinion is provided in a Member’s promotional materials, this statement must be clearly labeled as an opinion.  The opinion must also have a reasonable basis in fact.

Testimonials. All testimonials must be representative of all reasonably comparable accounts.  In addition, all testimonials must prominently state that the testimonial is not indicative of future performance or success.  A testimonial also must prominently state that it is a paid testimonial (if applicable).  We’d highly recommend staying away from testimonials as they are challenging to support and to make representative of all customer experiences.

Possibility of Profit. All statements regarding the possibility of profit must be accompanied by an equally prominent statement regarding the risk of loss.

Actual Performance Results. Actual performance results must always include the following disclosure: “Past results are not necessarily indicative of future results.” In addition, actual performance must be must be representative of the actual performance of all reasonably comparable accounts.  The rate of return figures provided must also be calculated in a manner consistent with CFTC rules.  To learn more about how performance results are calculated it may be wise to contact a commodity or forex based consulting firm with a background in performance calculations.

Hypothetical Performance Results. Hypothetical performance cannot be presented for any trading program that has at least three months of actual client or proprietary trading results.  In addition, it must be accompanied by prescribed statements by NFA regarding hypothetical or simulated performance results.  Hypothetical performance must also include comparable information regarding the past performance of all customer accounts directed by the Member pursuant to a power of attorney or letter of direction over the past five years.  In addition, if the Member has less than one year of experience directing customer accounts, past performance of the Member’s proprietary trading for the past five years must be included in the materials.  Finally, it should be noted that Members tend to get themselves into hot water with NFA when seeking to display hypothetical performance in their promotional materials.  The reason for this is that hypothetical performance is often deemed to be misleading to investors because it is often cherry-picked and/or prepared with the benefit of hindsight.  Once again we do not recommend the use of hypothetical results in promotional materials as they can be very difficult to substantiate and properly represent.  In addition these results become obsolete shortly after trading begins; most of the time their presentation isn’t worth the effort or risk.

Additional Requirements for Forex Firms

The following additional requirements apply with respect to forex Members’ promotional materials.

No Special Bankruptcy Protection. No forex Member, or associate thereof, may represent that forex funds deposited with a Forex Dealer Member (FDM) or Retail Foreign Exchange Dealer (RFED)  are given special protection under bankruptcy laws or represent or imply that any assets necessary to satisfy its obligations to customers are more secure because that Member keeps some of all of those assets at a regulated entity in the US or a money center country (think G6).

Commissions. No forex Member, or associate thereof, may represent that its services are commission free without prominently disclosing how it is compensated in near proximity to that representation.

No-Slippage Representations. No forex Member, or an associate thereof, may represent that it offers trading with “no-slippage” or that it guarantees the price at which a transaction will be executed or filled, unless:

• It can demonstrate that all orders for all customers have been executed and fulfilled at the price initially quoted on the trading platform when the order was placed; and
• No authority exists, pursuant to the contract, agreement, or otherwise, to adjust customer accounts in a manner that would have the direct or indirect effect of changing the price at which an order was executed.

It almost never makes sense, however, to assert a no-slippage claim in your promotional materials.  In general, stating or claiming anything that could (no matter how remote) occur is not wise.  In doing so, you may open your firm up to liability if a “one in a million” incident should occur.

Leverage Representations. Forex Members, and associates thereof, may not solicit customers based on the leverage available unless they balance any discussion regarding the advantages of leverage with an equally prominent contemporaneous disclosure that increasing leverage increases risk.  Since leverage in the US has been standardized, firms may want to consider taking a marketing angle based on this feature of trading.

No Guarantees Against Loss. Forex Members, and associates thereof, may not represent that they can either guarantee against any customer losses or that they can guarantee only limited customer losses.  This also applies to promoting trading platforms that do not allow the client to “lose more than they invest.”  Although in certain instances this may be true, as noted above, if there is any possibility what-so-ever that a client could lose more than their initial investment, the firm may be held liable.

Third Party Marketing Firms
Many NFA Members use third party marketing firms to solicit customers.  This tactic, however, is embedded with unanticipated consequences.  Third party marketing firms that are not NFA Members oftentimes are not subject to the same rules and regulations that Members are subject to.  As a result, some of these marketing firms may engage in somewhat unscrupulous marketing techniques to attract customers.  Members that engage these third party affiliates can be liable for any and all misrepresentations made by the marketing firm.  This may include violations of NFA and CFTC rules concerning misleading statements, high-pressure sales tactics, and inadequate risk disclosures.  If a third party marketing firm is engaged, it is up to the Member to ensure that it uses a highly stringent process to review and monitor all marketing materials generated and disseminated by the third party.

Review and Approval of Promotional Material

NFA Member firms must have written supervisory procedures regarding the promotional materials produced and used by their associated persons (APs) and employees.  In addition, supervisory personnel must document the review and approval of all promotional material before it is used.  One component of these review procedures may be the use of some form of third party pre-review.

Pre-Review

Members may seek pre-review of promotional material via NFA or third party counsel prior to distribution to the public.  It is imperative that this type of review occurs BEFORE the promotional piece is offered to the public.  In other words, when a firm will utilize pre-review it is imperative that promotional materials are available ONLY to relevant employees within your organization or hired consultants prior to completion of the review.

Moreover, if promotional material has already been used publically to solicit accounts, it almost never makes sense to submit this material to NFA for a belayed pre-review.  Specifically, any materials already in use found to have rule violations will be considered actual rule violations against the firm.  In these instances, NFA generally will not offer an opportunity for corrections without noting that either CFTC or NFA requirements have been broken.

The primary downfall to the pre-review process is that it can take a great deal of time and throw water on any immediate marketing plans.  Furthermore, pre-review (even by NFA) does not guarantee that NFA or the CFTC will not find fault with your firm’s promotional materials in the future.

Suggestion for Pre-Review

Even after considering the points above, in our experience it is almost always useful for firms to have their promotional materials pre-reviewed by NFA.  This may not be true, however, if the firm’s marketing plan success is hinged upon its speed to market.  In this case, third party counsel review may be a better option rather than going to NFA with the firm’s materials immediately.  A decision to pursue this route will also largely be based on a risk vs. return consideration.  Perhaps the best blend of pre-review would be one in which promotional materials are submitted to NFA for consideration.  After NFA responds with a comment letter, seeking third party support in developing your pre-review responses to that letter could be beneficial.

While any type of pre-review does not ensure that a Member’s promotional materials are in compliance with all of NFA rules and CFTC regulations, a pre-review often catches possible rule violations regarding a Member’s promotional materials before distribution.  This provides firms an opportunity to make changes to the material without consequence, leads to less discussion during subsequent NFA audits, and may occasionally provide a defense for Members in the case of subsequent lawsuits by customers.  Specifically, such a pre-review may provide protection against claims that certain misrepresentations were made in the firm’s promotional materials.

Seek Guidance Now

Preparing, reviewing and monitoring the distribution of your firm’s promotional materials is a serious undertaking.  As a result, it would be prudent to contact a regulatory professional like Turnkey Trading Partners (TTP) to assist you in this effort.  TTP has the business acumen, as well as important relationships with legal professionals, such as Henderson & Lyman of Chicago, to provide you with the guidance you need to tackle the myriad of issues that surround the preparation and review of promotional materials.

-James Bibbings and Nicole Kuchera

———————————————-

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 testified in Federal Court as an expert witness, 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 among other highly acclaimed investment publications, and has appeared as a speaker at a variety of commodity futures and forex related conferences.

Nicole Kuchera, JD, LLM is an Associate in Henderson & Lyman’s Financial Services Practice Group. She concentrates her legal practice on transactional and litigation support for securities, futures and derivatives industry clients, such as Introducing Brokers, Commodity Trading Advisors, Commodity Pool Operators, Broker-Dealers, Investment Advisers, Futures Commission Merchants, and Forex Dealer Members.  Ms. Kuchera counsels clients regarding a wide range of compliance and regulatory matters involving the rules and regulations of the SEC and the 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 also represents clients in general corporate matters, such as business formation, licensing and industry registration.

I. § 4.5:  Reinstating Trading Criteria for Exclusion from CPO Definition

CFTC Regulation 4.5 was intended to allow registered investment companies (RICs), i.e. mutual funds, to trade futures and options using a portion of their assets without requiring the RIC to become registered as a CPO or comply with CFTC disclosure obligations.  In the past year, certain RICs have marketed and promoted what amount to traditional commodity pools under this exclusion.  In the NFA and CFTC’s opinion, this should no longer be permitted.

Reg. 4.5 currently requires any person desiring to claim the exclusion to file a notice of eligibility with NFA, which must simply identify the qualifying entity to be operated pursuant to the exclusion.  Under the proposed amendment, such notice of eligibility must also include a representation that, in part, the RIC’s qualifying entity:

1.      Will use commodity futures or commodity options contracts solely for bona fide hedging purposes; and

2.      Will not be marketed to the public as a commodity pool or as a vehicle for investment in commodity futures or commodity options.

Essentially, this amendment would restore the rule’s operating restrictions that applied to RICs prior to 2003, when the CFTC amended the rule to its current form.

II. §§ 4.13(a)(3) and (a)(4): Rescission of CPO Exemptions from Registration

The CFTC proposes to rescind certain exemptions from registration provided in §§ 4.13(a)(3) and (a)(4) of the CFTC regulations.  Section 4.13(a)(3) currently provides that a person is exempt from registration as a CPO if the interests in the pool are exempt from registration under the 1933 Act and offered only to qualified eligible persons (QEPs), accredited investors, or knowledgeable employees, and the pool’s aggregate initial margin and premiums attributable to commodity interests do not exceed 5% of the liquidation value of the pool’s portfolio.  Section 4.13(a)(4) provides that a person is exempt from registration as a CPO if the interests in the pool are exempt from registration under the 1933 Act and the operator reasonably believes that the participants are all QEPs.

According to the CFTC, as a result of the creation of these two exemptions from registration, a large group of market participants have fallen outside of the oversight of the regulators (i.e. there is very little, if any, transparency or accountability over the activities of these participants).  Therefore, the CFTC has concluded that continuing to grant an exemption from registration and reporting obligations for these market participants is outweighed by the CFTC’s concerns of regulatory arbitrage.  In connection with its proposed elimination of the §§ 4.13(a)(3) and (a)(4) exemptions, the CFTC has requested comments from industry participants concerning the following questions:

1.       How much time will be necessary for entities that have previously claimed an exemption under these sections to comply with the proposed changes?

2.       How should the CFTC address entities whose activities do not require registration (i.e. should such entities be required to file notice with the CFTC to avoid registration)?

3.       Should any entities that have previously claimed an exemption under these sections be exempted from compliance with the proposed revisions to these sections?

4.       Should the CFTC consider an alternative de minimis exemption under § 4.13, and if so, what criteria should be required to claim such exemption?

III. §§ 4.5, 4.13 and 4.14:  Annual Filings of Notices of Claims of Exemption

The CFTC proposes to require all persons claiming exemptive or exclusionary relief under §§ 4.5, 4.13 and 4.14 to confirm their notice of claim of exemption or exclusion on an annual basis.  Failure to comply with the annual notice requirement would result in a withdrawal of the exemption or exclusion and, under the circumstances, could result in the initiation of an enforcement action.  The CFTC requests detailed comments on the proposed annual filing requirement and asks for input on the following questions:

1. Is 30 days adequate time to affirm the initial claim for relief?
2. Does it make sense to require a filing within 30 days of the anniversary date of the initial filing, or within 30 days of the end of the calendar year?

Comments Information

Comments must be in writing and received by the CFTC on or before April 12, 2011.  You may submit comments, identified by RIN number 3033-AD30, by any of the following methods:

• CFTC’s Website: http://comments.cftc.gov
• Mail: David A. Stawick, Secretary of the Commission, Three Lafayette Centre, 1155 21^st Street, NW., Washington, DC 20581
• Hand Delivery/Courier: Same as mail above
• Federal eRulemaking Portal: http://www.regulations.gov

Seek Guidance Now

As you can see from the descriptions above, determining whether you may be unreasonably affected or otherwise by the CFTC proposed amendments and crafting an appropriate response can be complex.  In order to properly evaluate your options, it would be prudent to contact a regulatory professional like Turnkey Trading Partners (“TTP”) as soon as possible.  TTP has the business acumen, as well as important relationships with legal professionals, such as Henderson & Lyman of Chicago, to assist you in presenting your views in the most effective manner.

-James Bibbings and Nicole Kuchera

_____________________________

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, JD, LLM is an Associate in Henderson & Lyman’s Financial Services Practice Group. She concentrates her legal practice on transactional and litigation support for securities, futures and derivatives industry clients, such as Introducing Brokers, Commodity Trading Advisors, Commodity Pool Operators, Broker-Dealers, Investment Advisers, Futures Commission Merchants, and Forex Dealer Members.  Ms. Kuchera counsels clients regarding a wide range of compliance and regulatory matters involving the 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 also represents clients in general corporate matters, such as business formation, licensing and industry registration.

CTA Exemptions

The following exemptions are self executing, meaning that they absolve persons/entities from CFTC registration all together.  In particular, persons meeting the following requirements are exempt from the registration requirements of the CEA and need not apply for exemption relief.

• Less than 15 Persons –  A person who, in the preceding twelve months, has not furnished commodity trading advice to more than 15 persons and who does not hold himself out generally to the public as a CTA.  “Holding oneself out” briefly means that a person is not advertising to obtain clients or actively trying to get new accounts.  See CEA § 4(m)(1).
• Investment Advisers – A person who is: (1) registered with the Securities and Exchange Commission (SEC) as an investment adviser; (2) whose business does not consist primarily of acting as a CTA; and (3) who does not act as a CTA to any investment trust, syndicate, or similar form of enterprise that is engaged primarily in trading in any commodity for future delivery on or subject to the rules of any contract market or registered derivatives transaction execution facility.  See CEA § 4(m)(3).
• Solely in Connection – Under CFTC Regulation 4.14, an exemption applies if the commodity trading advice being provided is solely incidental to the company’s main business activity or the person’s commodity trading advice is issued solely in connection with its employment or business with a firm otherwise registered or exempt from registration.

The following exemption is NOT self executing and thus requires a notice of exemption to be filed with the CFTC through the National Futures Association (NFA).  Firms claiming this exemption must still register with the CFTC and become members of the NFA.

• Qualified Eligible Persons – CFTC Reg. 4.7 makes available an exemption from certain CEA Part 4 requirements when investments are only made by qualified eligible persons (QEPs).  Perhaps the most significant of these requirements is the need to provide program participants with a disclosure document. Briefly, QEPs include certain investment professionals, knowledgeable employees, qualified purchasers or participants (the very wealthy), non-United States persons, and other high net worth individuals or entities.

CPO Exemptions

4.13 Exemptions – CFTC Reg. 4.13 makes available certain exemptions which allow CPOs to forgo the formal CFTC registration process. These exemptions, however, are NOT self-executing.  Rather, notice of relief under these exemptions must be filed with the CFTC through the NFA if they are to be relied upon.

• Closely Held Pools - CFTC Reg. 4.13(a)(1) makes available an exemption for operators of pools where no compensation is received for operating the pool.  Operators under this exemption may only operate one pool at a time, may not advertise, and the operator must not otherwise be required to register for any other reason.
• Small Pools - CFTC Reg. 4.13(a)(2) makes available an exemption for operators of pools where none of the pools operated by such person have more than 15 non-excluded participants at any time.  Total gross capital contributions in all pools operated or intended to be operated cannot in the aggregate exceed $400,000.
• De Minimus Rule - CFTC Reg. 4.13(a)(3) makes available an exemption for private placement pools exempt under the Securities Act of 1933 where the pool trades minimal amounts of futures and/or forex.  The operator must also reasonably believe that its pool participants meet certain net worth qualifications.
• All QPs - CFTC Regulation 4.13(a)(4) makes available an exemption for private placement pools exempt under the Securities Act of 1933 where all individual participants in the pool are qualified persons (QPs), as defined in the Investment Company Act.  Here, operators must be diligent to determine the suitability of all pool participants.

Note: On February 11, 2011, the CFTC published for comment a proposal to eliminate the “De Minimus Rule” and the “All QP” exemption.  All comments with respect to this proposal must be received by the CFTC in writing on or before 60 days after publication in the Federal Register.

The following exemptions from certain CEA requirements are also NOT self executing and require a notice of exemption to be filed with the CFTC through the NFA.  In addition, firms claiming these exemptions must still register with the CFTC and become members of the NFA.

• Qualified Eligible Persons – CFTC Reg. 4.7 makes available an exemption from certain CEA Part 4 requirements when investments are only made by qualified eligible persons (QEPs).  Perhaps the most significant of these requirements is the need to provide program participants with a disclosure document. Briefly, QEPs include certain investment professionals, knowledgeable employees, qualified purchasers or participants (the very wealthy), non-United States persons, and other high net worth individuals or entities.
• Pool Meets Certain Trading Criteria – CFTC Reg. 4.12(b) provides an exemption from certain CEA Part 4 requirements for the operators of certain commodity pools.  Among other things, the pools these CPOs operate cannot commit more than 10% of the fair market value of their assets to establish commodity interest trading positions and must trade commodity interests in a manner solely incidental to their securities trading activities.
• Offshore Commodity Pools – CFTC Advisory No. 18.96 also provides an exemption from certain CEA Part 4 requirements for certain registered CPOs from disclosure, reporting and certain record-keeping requirements in connection with the operation of offshore commodity pools.

Seek Guidance Now

As you can see from the descriptions above, determining whether your intended CTA or CPO may qualify for an exemption from CFTC registration or an exemption from certain Part 4 requirements can be complex.  In order to properly evaluate your options, it would be prudent to contact a regulatory professional like Turnkey Trading Partners (“TTP”) as soon as possible.  TTP has the business acumen, as well as important relationships with legal professionals, such as Henderson & Lyman of Chicago, to provide you with the tools you need to get your fund or trading advisory business up and running.

-James Bibbings and Nicole Kuchera

________________________________

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, JD, LLM is an Associate in Henderson & Lyman’s Financial Services Practice Group. She concentrates her legal practice on transactional and litigation support for securities, futures and derivatives industry clients, such as Introducing Brokers, Commodity Trading Advisors, Commodity Pool Operators, Broker-Dealers, Investment Advisers, Futures Commission Merchants, and Forex Dealer Members.  Ms. Kuchera counsels clients regarding a wide range of compliance and regulatory matters involving the 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 also represents clients in general corporate matters, such as business formation, licensing and industry registration.

Within the following paragraphs several of the most commonly missed annual requirements are discussed.  Every FCM, IB, CTA, or CPO will have similar obligations; however that does not mean all review policies will be uniform.  Each commodity or forex firm registered in the United States is required to maintain custom procedures which are tailored to their specific operations.  Thus each of the following discussions is based on a generalization of what most firms should be doing at year end.  This presentation is not inclusive or exhaustive of all firm requirements and thus should not be relied upon independently.  For further details in this area interested persons should contact a competent consulting professional for assistance.

Annual NFA Requirements

Every 365 days (read not necessarily every December 31) NFA member firms must complete a variety of compliance related tasks.  For starters all firms must complete NFA’s annual membership questionnaire.  This document is intended to relay information about firm operations to NFA and is accessed online via NFA’s Online Registration System (“ORS”).  Similarly at least once annually firms are required to update their registration information by filing an electronic annual registration update.  This document again ensures all registration information on file with NFA is accurate.  Lastly, and it probably goes without saying though many firms forget, membership dues must be submitted no later than the anniversary date of your firm’s registration.   In summation at minimum firms must do the following at least one time annually:

- Complete NFA’s Annual Questionnaire

- File an electronic Annual Registration Update

- Pay NFA membership Dues

General Reviews and Tasks

Outside of interacting with NFA, firms of all registration types are required to complete a range of review and/or testing activities.  Various internal policy checks, certain employee training, and several customer notifications must be completed.  In this area one of the most frequently disregarded obligations facing firms is that they must send all of their clients a copy of the company privacy policy at least once annually.  A record that this notice has been sent to all clients must be kept on file and will likely be requested during the firm’s next routine NFA examination.

As for internal training requirements, depending on company operations, certain employees may be required to take various annual training courses.  All FCM’s and IB’s must maintain an adequate Anti-Money Laundering (“AML”) policy which includes a provision for annual AML training.  This training must be provided (at a minimum) to employees who work in areas susceptible to possible money laundering.  Also, depending on internal policies, several other training obligations may exist for employees.  Prudent firms would be wise to review internal procedures or speak with a commodity compliance professional about their specific obligations.  Such testing may include among other things ethics training, operational best practices training, or providing lessons about proper customer solicitations.

Lastly in this area firms are also required to review all company policies to ensure that there procedures are adequate for the then current operations.  An example of such a policy review required annually would be the testing of the company business continuity disaster recovery (“BCDR”) plan.  In this instance, applicable firm personnel are required to work step by step through the BCDR in order to expose potential weaknesses.  This review should be documented in writing, weaknesses should be amended, and if any changes are made employees should be notified in a timely and reasonable manner.  In this area, my firm offers a comprehensive mock examination service that could be used to assist your firm with many of these obligations.  Some common things firms should be considering at year end include:

- Sending privacy notices to clients at least annually

- Notifying customers of any material business changes

- Ensuring applicable employees receive adequate training

- Testing various firm policies for reasonableness

- Visiting branch offices at least once annually

Financial Obligations

For CFTC registrants their financial reporting obligations are arguably the most important area in a complete compliance review.  Here mistakes can lead to costly fines, disciplinary action, and in extreme cases quickly force a company out of business.  Interestingly, even though this aspect of running a commodity or forex brokerage is immensely important, many people simply look past this area of their business.  Instead of taking this position a great deal of time should be spent ensuring year end books and records have been prepared in a proper and accurate manner.  This is especially true at firms who must file reports with the CFTC and NFA on a recurring basis.

FCMs, IBs, CTAs, and CPOs in general all have annual financial reporting obligations which must be adhered to.  Although CTA’s are not required to file financial statements, they are required to maintain accurate books and records as well as a complete record of all client performance.  Similarly, Futures Commission Merchants, Introducing Brokers, and Commodity Pool Operators are required to file specific financial information with the Commodity Futures Trading Commission.  These filings must be submitted through the National Futures Association through the self-regulatory body’s various electronic submission channels.  More specifically certain FCM’s and IB’s must file unaudited form 1-FR FCM or 1-FR IB/FOCUS reports.  In addition to this they must also file audited and certified financial statements produced by a third party accounting firm.  In the case of CPO’s they must file reports for each of their respective pools as appropriate based on their registration type.   In this area competent staff should review the firm’s general ledger to ensure all financial transactions have been recorded properly.  After doing so all supporting information necessary to compile financial reports should be gathered for submission to the company’s third party certified accounting firm.

Conclusion

As a former NFA auditor and consulting veteran I have seen many examples of firms who have failed to comply with their annual requirements.  Whether these firms were unaware of their requirements or simply forgetful matters not.  Violations of CFTC regulations and NFA rules can have serious consequences and put a damper on an otherwise bright start to the new year.  In order to more fully understand your obligations at year end you should contact a competent regulatory and operational consulting firm like Turnkey Trading Partners for assistance.  For a free checklist of the yearend obligations your firm may be required to uphold feel free to contact us by visiting our website at www.turnkeytradingpartners.com and filing out the available contact form.

_______________________

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 testified in Federal Court as an expert witness regarding over the counter commodity transactions.  From time to time Bibbings also provides 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 among other highly acclaimed investment publications.  A variety of resources authored by Bibbings are currently available for free upon request through his company website.  If you have any questions or comments for James he can be reached directly by email at james@turnkeytradingpartners.com and would love to hear from you.

Limited Liability Companies

A limited liability company (“LLC”) is one of the more recent and most flexible business structures available to commodity and forex firms.  An LLC is a separate legal entity having the authority to conduct business, acquire, hold and dispose of property, and sue or be sued in its own name.  Management of an LLC may be controlled by the members (as few as one) or by selected managers who may or may not also be members themselves.  The relationship among members and the management structure are typically set forth in a written operating agreement executed or accepted by each of the members.  An LLC can elect to be taxed as either a partnership, corporation, or as a sole proprietorship depending on the planning decisions made by the company.

Benefits:

• Asset Protection – No member or manager is personally liable for the obligations of an LLC beyond the amount such person has contributed to the LLC (if any)
• Tax Structuring – An LLC can determine its own tax structure (see above)
• Flexible Management – An LLC be member or manager managed

Disadvantages:

• Established History – The primary disadvantage of an LLC is its “newness” as an entity form, because case law pertaining to LLCs is not uniform (or even necessarily consistent) between the various states
• Shared Authority – Depending on whether the company is member or manager managed, a respective member or manager may act on behalf of or bind an LLC; in other words, certain elements of centralized control may be forfeited

Limited Partnerships

A limited partnership (“LP”) is a common form of arrangement between two or more parties to form a business entity.  An LP is a separate legal entity from its partners and it must have both at least one general partner and also at least one limited partner.  The general partner must be different from the limited partner. In an LP, the relationship among partners is governed primarily by a partnership agreement.  While the agreement may be oral, use of a written agreement is almost always advisable.  The principal distinguishing feature of an LP is that the limited partners are not personally liable for the debts and obligations of the partnership. In effect, limited partners are only at risk up to the value of their invested capital.  The general partner, on the other hand, remains fully liable for the overall debts and obligations of the company.  From a tax perspective, LPs are pass-through entities.  This means that any income or expense from the business is passed through to the individual partners and is included on their individual tax returns.

Benefits:

• Asset Protection – Limited partners have no liability beyond their initial contribution
• Tax Structuring – An LP is a pass-through entity (see above description)
• Management Control – The general partner maintains control over the company

Disadvantages:

• Liability – The primary disadvantage of an LP is that the general partner has personal liability for obligations of the company.  As a result it is often recommended to make the general partner a company as opposed to an individual
• Shared Authority – Any general partner (if more than one exists) may bind or obligate the company
• Formalities – There are generally more filings, formalities, and state requirements with LPs than with LLCs

General Partnerships

A general partnership is simply an association of two or more persons to own or carry on a business together.  No formalities or legal filings are required to create a general partnership, as opposed to an LP. Thus, a general partnership may arise out of the conduct and actions of the parties, or through a simple oral agreement. It is prudent, however, to use a written agreement that specifies the respective rights and duties of each partner. Where no agreement exists, the Revised Uniform Partnership Act provides some rules for the creation, operation, dissolution and termination of a general partnership, but it is not considered a desirable substitute for a written agreement.  Lastly, general partnerships are taxed as pass-through entities, meaning that each partner is responsible for their personal tax liabilities.

The distinguishing features of a general partnership are that each partner is an agent for the partnership with the power to legally bind (i.e. speak and act on behalf of) the general partnership.  As a result, each partner is personally liable for the debts and obligations of the general partnership as a whole. Most business decisions may be made by a majority of the partners, although some matters, such as admission of a new partner, may require unanimous agreement.

Benefits:

• Easy Set-up – Very easy to form and no legal filing requirements

Disadvantages:

• Liability – The primary disadvantage of a general partnership is that all partners in the general partnership are personally liable for the company’s actions
• Shared Authority – Any partner to a general partnership may bind or obligate all partners in the partnership

Sole Proprietorships

The simplest form of business enterprise is a sole proprietorship. This business is conducted by an individual after obtaining any necessary licenses, permits or other authorizations necessary to commence business.  A sole proprietorship does not involve the creation of a legal entity separate from the proprietor.  Since there are no organizational or operational formalities involved, a sole proprietorship is very simple to start, operate and terminate.  However, if business will be conducted under a trade name, a “fictitious name filing” or “doing business as” may be required.  Sole proprietors are personally liable for all debts and obligations of the business and there is no continuity of business in the event of disability or death. The only way to transfer ownership of the business is through a sale of the assets used in the business.  Sole proprietorships are taxed at the personal income tax rate of its owner, and they might also be subject to additional self-employment taxes.

Benefits:

• Easy Set-up – Very easy to form and no legal filing requirements
• No Shared Authority – One individual is free to make all of the business decisions for the company

Disadvantages:

• Liability – The primary disadvantage of a sole proprietorship is that the individual running the business is personally liable for all debts and obligations of the business
• Possible “double taxation” based on an individual’s unique tax filing status

Corporations

Probably the most common type of business entity, in general, is a corporation.  A corporation is a legal entity that is separate and distinct from its owners, and may acquire, hold, and dispose of property, conduct its business, and sue or be sued in its own name.  The relative rights and duties of the corporation, its owners, and its management are largely defined by statute and by the corporation’s certificate of incorporation and bylaws.

Most corporations are organized as stock corporations and issue one or more classes of stock to evidence ownership. Under certain circumstances, a corporation may be formed as a non-stock, membership corporation. Stockholders in small corporations often choose to enter into a stockholders’ agreement to regulate the voting and transfer of stock in order to better protect their investment.

As a separate legal entity, a corporation is liable for its debts and other obligations.  Except under unusual circumstances, stockholders, directors and officers of a corporation are not personally liable for the corporation’s obligations.

Management of a corporation generally rests with its board of directors, who are elected by the stockholders. Other than the right to elect directors and approve certain transactions, such as mergers, sale of all assets, and dissolution, stockholders generally have no role in managing a corporation.

Benefits:

• Asset Protection – The owners of a corporation cannot be held personally liable for the obligations of the business
• Tax Structuring – C-corporations must file their own separate tax form.  An S-corporation is a pass-through entity, however to be considered an S-Corporation specific IRS filings are required and certain restrictions may apply
• Centralized Ownership – A corporation is owned by its shareholders

Disadvantages:

• Burdensome Formalities – Corporations are legally required to observe a vast array of corporate formalities.  Such formalities include holding and documentation of company meetings, formal approval of major corporate decisions, and the approval of the board of directors and shareholders.  Failure to meet such requirements may jeopardize the Corporation’s tax deductions and the asset protection attributes of a corporation.

Offshore Companies

While the above descriptions generally refer to U.S. based companies, companies can also be formed offshore.  Companies are often set up offshore to allow for different groups of investors.  For instance, a company that anticipates having most of its investors outside of the U.S. and/or have U.S. tax-exempt investors might want to consider forming a company offshore.  Other times an offshore company is selected in an attempt to afford privacy to investors.  In cases where investor confidentiality and privacy are necessary, an offshore company should generally not accept U.S. investors.

Master-Feeder Structure

As an additional entity formation consideration, oftentimes new trading companies are confused by the use of onshore and offshore funds in a master/feeder structure.  A master/feeder structure simply allows a fund manager to manage money for a broad spectrum of investors.  The master fund, structured as an offshore corporation (but treated as a partnership for U.S. tax purposes via a “check-the-box” election), engages in all trading activity.  The fund manager will pool money and “feed” it in to a master fund and allocate trading gains and losses back to the onshore and offshore feeder funds based on the percentage assets under management in each feeder fund.  A master/feeder structure typically includes (in addition to the master fund company) a U.S. limited partnership or limited liability company as the feeder fund for U.S. taxable investors and a foreign corporation as the offshore feeder for foreign investors and U.S. tax-exempt investors, but it is also possible using this arrangement to have multiple domestic and offshore feeder funds flow into the master fund.

Piercing the Veil

Although one of the primary motivations for creating a separate legal entity is to shield personal assets from liabilities associated with the business, there are certain circumstances under which courts will “pierce the veil” and allow creditors of a company to pursue claims against the owners personally. For example, limited liability generally depends among other things on an entity’s adherence to the formalities required by applicable law, e.g. segregation of company funds from personal funds and maintenance of appropriate corporate books and records for the company. Liability may also extend to personal assets if:

• An owner of the company personally and directly injures someone;
• An owner personally guarantees a bank loan or business debt on which the company defaults;
• An owner engages in fraudulent activity in connection with the company’s business activities; or
• An owner treats the company as an extension of his/her personal affairs, rather than a separate legal entity.

Seek Guidance Now

As you can see from the descriptions above, determining how to properly structure your commodity futures or forex business can be complex.  In order to properly evaluate your options, it would be prudent to contact a regulatory professional like Turnkey Trading Partners (“TTP”) as soon as possible.  TTP has the business acumen, as well as important relationships with legal professionals, such as Henderson & Lyman of Chicago, to provide you with the tools you need to get your fund or trading advisory business up and running.

-James Bibbings and Nicole Kuchera

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, JD, LLM is an Associate in Henderson & Lyman’s Financial Services Practice Group. She concentrates her practice on transactional and litigation support for securities, futures, forex, 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 & Investment Services, and Futures & Derivatives Law Committees.