Division of Trading and Markets
The Commission's Division of Trading and Markets (T&M) oversees the compliance activities of the futures industry's self-regulatory organizations (SROs), which include the U.S. commodity exchanges and the National Futures Association (NFA). T&M develops, implements, interprets and oversees enforcement of regulations which protect customer funds, prevent trading and sales practice abuses, and assure the financial integrity of firms holding customer funds.
Review and Approval of Exchange Rules
The staff of T&M promotes and enhances self regulation by reviewing proposed exchange rules for consistency with the Commodity Exchange Act (CEA) and Commission Regulations. During FY 1997, T&M reviewed, and the Commission approved, 233 new rules or rule amendments submitted by exchanges. T&M also reviewed and permitted 365 exchange rules to become effective. Significant exchange rules approved by the Commission or permitted to go into effect by T&M in FY 1997 include the following:
- CBOT rules implementing linkage with the London International Financial Futures and Options Exchange (LIFFE). Based on analysis by the Division, the Commission approved the link, which is the first international linkage permitting the contracts of a U.S. exchange and a foreign exchange to be traded on each other's floor. T&M also prepared procedures to facilitate placement of orders to trade on the link, and to ensure that customer funds would continue to receive equivalent protections under the linkage arrangement.
- A proposed NYMEX arrangement with the Hong Kong Futures Exchange (HKFE), which provides for the placement of NYMEX ACCESS electronic trading terminals in Hong Kong. The arrangement permits bona fide members of HKFE, NYMEX members and their affiliates with offices in Hong Kong, and other persons who lease electronic trading privileges from NYMEX or Comex members to trade NYMEX or Comex products on NYMEX ACCESS. The NYMEX-HKFE arrangement will permit trading of HKFE products by NYMEX and Comex members through NYMEX ACCESS terminals at a later date.
- A CBOT rule permitting member firms and brokers to bunch and allocate non-discretionary customer orders off the trading floor. Staff worked with CBOT to ensure that CBOT would implement internal controls to detect, deter and prosecute those engaging in the misallocation of customer orders and provide clear guidance to firms allocating orders.
- CME rules implementing the operation of the Globex Foreign Exchange Facility (GFX), a wholly-owned subsidiary of CME, as a market maker for certain CME foreign currency futures contracts traded through the Globex electronic trade execution system. Subsequently, CME sought to expand GFX market making activities to include pit trading as well as Globex trading. In approving CME's proposal by issuance of an order, the Commission ensured the presence of suitable provisions governing audit trail and related recordkeeping standards.
- A CME proposal to establish a small-order electronic order routing and entry system for the E-Mini S&P 500 futures and option contracts. Under the system, orders of up to 30 contracts are executed exclusively via the CME's electronic trading system, Globex. Orders for more than 30 contracts must be executed as All-Or-None transactions via open outcry. This is the first time that a U.S. futures exchange has conducted simultaneous trading in both electronic and pit environments during regular trading hours.
- CME rules allowing customer orders to be transmitted through the Internet to CME member firms for entry into Globex.
Rule Enforcement Oversight and Trade Practice Surveillance
The CEA requires each exchange, through a program of continuing rule enforcement, to ensure that its members adhere to exchange rules. Before T&M recommends approval of an application to trade a futures or option contract, it considers whether the exchange maintains an adequate rule enforcement program. T&M periodically reviews each exchange's rule enforcement program and conducts follow-up reviews if it finds a need for improvement in an exchange's programs. When appropriate, the reviews include recommendations for improvements and schedules for implementing those recommendations. In addition, T&M reviews particular practices or program areas across exchanges in ''horizontal'' reviews which facilitate the adoption by exchanges of ''best practices.'' During FY 1997, T&M completed the following reviews.
Audit Trail and Dual Trading. T&M staff followed-up on SRO compliance with audit trail and dual trading requirements. The CEA requires each exchange to have trade monitoring systems that enable effective detection, deterrence, and prosecution of trading abuses. The staff tested and evaluated exchange audit trail systems and other trade monitoring system components. Based on this work, the Commission granted three exchanges (CSCE, Comex, and NYCE) unconditional exemptions from the statutory dual trading prohibition. The Commission will consider the exemption petitions of two other exchanges (CME and CBOT) early in FY 1998.
Horizontal Broker Association Review. T&M assessed the adequacy of exchange rules designed to prevent trading violations attributable to members of broker associations. T&M reviewed exchange programs for enforcing broker association rules. In particular, T&M reviewed programs for monitoring the trading activity of broker association members at the five largest exchanges. T&M evaluated each exchange's procedures for the registration of, and collection of data on, broker associations and their members. T&M found the exchanges' programs consistent with the Commission's regulations for the registration of broker associations. T&M also found that each exchange employs its surveillance systems to varying degrees to monitor broker association trading activity. The report includes several recommendations to improve the exchanges' programs for the registration, collection of data, and oversight of broker associations and their members.
CBOT March Wheat. T&M reviewed the adequacy of disciplinary actions taken by CBOT with respect to the expiration of the March 1996 wheat futures contract. T&M made recommendations to the Commission for modification of those sanctions and of CBOT rules relating to settlement prices for post-close trading sessions. T&M also filed a brief with the Commission in the disciplinary action.
Chicago Board of Trade. T&M reviewed CBOT's market surveillance, trade practice surveillance, and disciplinary programs and the order ticket and trading card components of its audit trail system. T&M found adequate surveillance and disciplinary programs and found general compliance of CBOT members with the audit trail requirements for the preparation of order tickets and trading cards. The Division recommended that CBOT take steps to improve the timeliness of both its market surveillance and trade practice investigations and to improve compliance with Commission requirements concerning trading card collection.
New York Futures Exchange. T&M found generally adequate audit trail, trade practice surveillance, and disciplinary programs at NYFE. The Division recommended that NYFE implement procedures to hasten the completion of all order ticket reviews. In addition, T&M recommended that NYFE take disciplinary action against members that have unusually low compliance with recordkeeping requirements, regardless of NYFE's practice of warning first time offenders.
New York Cotton Exchange -- T&M issued a report on NYCE's financial and sales practice program and concluded that NYCE's program generally meets the Commission's regulatory requirements. The report recommended that NYCE: (1) broaden the criteria in its written program for monitoring high risk firms to provide for heightened surveillance in certain circumstances; (2) amend its written program to include notification to the Commission if a firm fails to maintain current books and records; (3) revise pay/collect reports to state separately options premium data and futures data; and (4) revise financial report analysis forms to include the date on which the review of each financial report was started.
Exchange Clearing Organizations (BOTCC and CME Clearing House) -- T&M's reviews of BOTCC and CME Clearing House cover their compliance with the Commission's segregation and related recordkeeping rules. T&M found both clearing organizations in compliance with all applicable Commission segregation-related requirements. In addition to routine segregation matters, the Division also reviewed new program developments at both clearing organizations, including common settlement and banking arrangements. Also, with respect to BOTCC, the review included ''sub-custodial'' bank account arrangements for the safekeeping of securities and the LIFFE/Link.
Oversight of the National Futures Association (NFA)
The Commission promotes self regulation through delegation of authority to the NFA and oversight of NFA activities. The staff coordinates regulatory efforts with the NFA. For example, the T&M staff participates in and chairs the Registration Working Group, which brings together the NFA and Commission staff members to discuss registration issues of mutual concern.
The staff periodically evaluates how the NFA and CFTC can best use their resources to oversee the industry. During FY 1997, the T&M staff prepared and the Commission issued an Order delegating to the NFA several functions related to activities under Part 30 of the Commission's rules concerning foreign futures and options. In addition, the Commission issued an Order, developed by T&M, authorizing the NFA to take adverse registration action involving floor brokers, floor traders or applicants for registration in either category. The staff also determined that certain functions, including review of disclosure documents, could be delegated to the NFA. The Division drafted a Notice and Order delegating these functions. Staff will work with the NFA in the next fiscal year to ensure the successful transfer of these functions.
Pursuant to a Commission order effective July 3, 1997, the NFA will no longer forward statutory disqualification matters to the Commission for review. Under authority delegated by the Commission, the NFA processes applications and conducts background checks for applicants in all registration categories. The NFA may take adverse action against applicants and registrants. However, with respect to the floor broker and floor trader registration categories, the NFA, prior to the Commission's order, forwarded to the Commission for review any case where there is a potential statutory disqualification for which the NFA did not propose to deny or revoke registration. During FY 1997, T&M reviewed the files of 57 floor broker or floor trader applicants or registrants forwarded by the NFA. In addition, during FY 1997, T&M processed approximately 1,300 requests for withdrawal from registration.
The staff reviews and recommends approval of NFA oversight activities. During FY 1997, T&M recommended, and the Commission approved, several National Futures Association (NFA) initiatives and programs which enhance customer information and protection, including:
- Two NFA interpretive notices regarding ethics training providers. One notice related to a delegation which permits the NFA to maintain the list of persons eligible to provide required ethics training to registrants. The Commission also approved NFA rules assessing fees for late compliance, intended to ensure that the NFA's database remains accurate.
- An interpretive notice that revised the NFA's requirements regarding the supervision of telemarketing activity. Under the interpretive notice, member firms that have a significant number of associated persons (APs) who were previously employed by disciplined member firms would be required to tape record all AP-customer telephone conversations for a two-year period, to catalogue each tape, and to retain them for a two-year period. The interpretive notice also subjects these firms to increased financial requirements.
To ensure effective oversight by the NFA, T&M periodically undertakes reviews of the NFA's activities. During FY 1997, the staff conducted a review and advised the NFA of inaccuracies of data in its MRRS (Membership, Registration, Receivables System) due to firms' failure timely to report their AP terminations and required ethics training. The NFA corrected the problems by improving enforcement of ethics training and by requiring registrants timely to report previously terminated APs. T&M also reviewed the NFA's compliance program covering members who are registered as CPOs and CTAs. T&M found that the NFA's compliance program generally meets the Commission's regulatory requirements. The Division made recommendations in the following areas: (1) enhancement of the audit priority system for improved selection of members to be audited; (2) expansion of the NFA's promotional material review program; (3) modification of the FACTS system with respect to reporting funds under management; (4) establishment of procedures to identify members requesting withdrawal of their NFA membership prior to audit; (5) development of criteria to assist in implementing the NFA's amendment to Compliance Rule 2-29 with respect to hypothetical performance; (6) amendment of the self-examination checklist to improve monitoring of members' internal control procedures; (7) updating the checklist for desk review of disclosure documents; (8) follow up concerning filing of annual reports required for Rule 4.7 and offshore pools; and (9) measures to address failures to respond to annual questionnaires. In addition, T&M reviewed the NFA's registration program to assess actions taken in response to recommendations for action in prior year's reviews.
Oversight of Financial Practices
The Commission conducts direct audits of clearing organizations and firms handling customer money to ensure compliance with capitalization and segregation rules. In FY 1997, Division of Trading and Markets' activities to ensure sound financial practices by clearing organizations and firms holding customer funds included:
- Review of 4,218 financial reports filed by registrants in FY 1997.
- Fifty-four direct audits of FCMs, CPOs, CTAs and other registrants to test industry self-regulatory programs and to address special issues, including review of compliance in support of investigations and proceedings by the Division of Enforcement.
- Processing of more than 200 risk assessments filings.
- Issuance of 279 warning and non-compliance letters based upon audit and review of financial reports.
- Follow-up investigation of 223 notices of reportable items by registrants.
- Preparation of a review of clearing house and exchange risk management programs in conjunction with the annual report to the Board of Governors of the Federal Reserve System on stock index futures margin, pursuant to the Board's delegation of authority to the CFTC in this area.
- Review of self-regulatory financial compliance programs.
Rulemakings and Guidance
The Commission develops regulations to ensure sound financial practices of clearing organizations and firms and to promote and enhance self-regulation by the industry. The agency also facilitates the continued development of an effective, flexible regulatory environment, responsive to evolving market conditions, by providing exemptive, interpretive or other relief, as appropriate. This guidance fosters the development of innovative transactions, trading systems and similar arrangements.
SRO Rules and Guidance
During FY 1997, T&M undertook a number of initiatives to increase the efficacy of SRO programs and Commission oversight of self-regulatory organization (SRO) programs. Staff recommended and the Commission adopted the following final rules, advisories, or interpretations.
Expedited Review of Contract Market Proposals -- These rules shorten the Commission's timeframe for reviewing complex contract market rules and streamline the rule review process. Under the new rules, the Commission deems approved or permitted to be put into effect all proposed rule changes that do not affect the terms or conditions of a futures contract. The exchange may implement such rule change ten days after Commission receipt, unless the Commission elects to review the proposal further for either a 45- or 75-day period.
Potential Conflicts of Interest by Exchange Governing Board Members -- These rules require SROs to adopt rules prohibiting governing board, disciplinary committee, and oversight panel members from deliberating and voting on any matter in which the member has a personal or business relationship with the named party in interest or in which the member has a substantial financial interest in the outcome.
Guidance Concerning Automated Systems -- The Automated Systems Advisory explains that each contract market and clearing organization must use due diligence to ensure that its automated systems function in a way which reduces risks from system failure and assures equitable access to the markets. SROs must also conduct oversight and risk analysis addressing the areas specified by the International Organization of Securities Commissions in its Principles for the Oversight of Screen-Based Trading Systems.
Guidance on Commission Rules Preventing Fabrication or Destruction of Trading Records -- These final rules concern preparation, submission, and correction of trading cards. The rules, which are applicable to all trading records, require that the correction of errors on trading records not render illegible the original information. The rules also require that a ply of any trading card that is rewritten in order to correct errors be submitted in accordance with contract market rules for the regular collection of trading cards.
Guidance to Facilitate Use of Markets by Managed Funds Advisors -- This interpretation makes the account identification requirement applicable to bunched orders. The Commission simultaneously issued an order approving an NFA interpretive notice concerning the placement, execution, and allocation of bunched orders by CTAs and FCMs. The NFA notice generally provides that bunched orders may be placed so long as the appropriate account identifier information and the allocation responsibilities of all participants are provided before or with placement of the order.
Guidance on Financial Matters -- During FY 1997, T&M staff provided the following guidance on financial regulatory matters:
- Worked with SROs to permit FCMs to file required financial reports via electronic means.
- Compiled and published for public use selected FCM financial data every six months, including amounts of net capital and customer funds carried.
- Continued operation and refinement of the Commission's Risk Assessment System, working with reporting firms to clarify descriptions of internal controls and risk management systems and to identify Material Affiliated Persons.
- Commented to the Financial Accounting Standards Board and assisted the American Institute of Certified Public Accountants in the development of accounting and auditing standards and guides relevant to the commodities industry.
- Briefed the Commission as warranted on major market moves. No matters occurred which required emergency intervention by the Commission or which jeopardized the financial or operational viability of specific firms. Related to this activity, the staff also directed the largest exchange markets to conduct specific stress tests and to compare resulting clearing firm positions with capital and liquidity facilities on two occasions during large market moves.
- Recommended final rule amendments, adopted by the Commission, and an interpretation permitting FCMs to change the amount of segregated customer funds by making direct transfers of permitted securities into and out of customer segregated safekeeping accounts. Previously, such transfers were required to be made in cash.
- Recommended final rule amendments adopted by the Commission concerning the financial reporting cycle and debt-equity ratio requirement for FCMs and introducing brokers (IBs), which conform the Commission's rules more closely to those of the SEC.
CPO and CTA Rules and Guidance
The T&M staff develops and interprets Commission regulations relating to registration, disclosure, managed funds, segregation of funds, ethics training, and other requirements applicable to commodity professionals and commodity pools. The staff responds to requests for exemptions and other relief from regulations and prepares advisories and guidelines on the application of Commission regulations. The staff also develops regulatory approaches to off-exchange derivative instruments, prepares Congressional testimony, and drafts reports and proposed legislation. Staff comment on regulations and interpretations prepared by other divisions and offices. During FY 1997, activities included the following:
Electronic Media -- T&M staff drafted the following documents which were adopted by the Commission:
- Final rule amendments which allow voluntary electronic filing of disclosure documents by CPOs and CTAs. Filers may also electronically receive staff comments on such documents.
- An interpretative release on the use of electronic media to comply with the requirements of Part 4 of the Commission's regulations. Part 4 contains requirements for the delivery of disclosure documents by CPOs and CTAs to potential customers, for distribution of monthly or quarterly statements and annual reports by CPOs, and for maintaining required books and records. Related final rule amendments were also adopted.
- An Advisory for futures commission merchants (FCMs) on delivering confirmation, purchase-and-sale, and monthly statements and maintaining related records in electronic media.
- Final rule amendments permitting registrants to file non-certified reports electronically using a Commission-issued personal identification number (PIN) rather than filing such reports in paper form. In addition, the Commission adopted a final rule amendment allowing the use of a PIN in lieu of a manual signature for purposes of attesting to the completeness and accuracy of financial reports filed electronically.
Streamlining -- Assisted the Commission in exploring areas where regulatory burdens may be reduced, such as proposing rule amendments that would streamline the Commission's existing rules governing risk disclosure statements required to be furnished by FCMs and IBs to customers prior to opening commodity interest accounts. These proposed rule amendments would eliminate the requirement to provide risk disclosure statements to customers with high levels of financial resources.
Civil Monetary Penalties. -- Drafted a new Rule 143.8 to adjust for inflation the maximum civil monetary penalties that may be assessed under the CEA, which was adopted by the Commission on October 21, 1996. This action was taken to comply with the Debt Collection Improvement Act of 1996. The T&M staff has responsibility for the agency's debt collection program. During FY 1997, the staff collected approximately $1,652,000.
Financial Oversight Coordination -- Maintained strong working relationships with other financial oversight organizations and groups, such as the President's Working Group on Financial Markets. In response to a Congressional inquiry, staff assisted in preparing a report concerning recent actions by federal agencies to reduce risks in financial markets.
Banking Issues -- Prepared a draft of a comment letter from the Commission to the Board of Governors of the Federal Reserve System conveying the Commission's support for proposed amendments to Regulation Y designed to remove restrictions on subsidiaries of bank holding companies operating as FCMs and CTAs and to defer to certain Commission requirements relating to such subsidiaries.
Uniform Commercial Code -- Drafted a comment letter from the Commission to the National Conference of Commissioners on Uniform State Laws concerning a proposed amendment to draft Article 2B of the Uniform Commercial Code.
Responses to Public Inquiries -- In FY 1997, T&M staff prepared over 300 responses to requests for exemption, no-action positions and interpretations relating to registration, disclosure and other regulatory requirements.
- CPO/CTA Matters. The T&M staff prepared and the Commission issued an Advisory exempting registered CPOs of certain publicly offered pools from the requirement to provide a copy of the pool's most recent annual report to a prospective pool participant at the same time that the CPO delivers the pool's disclosure document. In order for a CPO to be eligible for the exemption, the CPO must offer and sell units of participation in the pool pursuant to an effective registration statement under the Securities Act. The pool must also be subject to the reporting requirements of the Securities Exchange Act. The staff also issued an Advisory clarifying the Commission's reparations jurisdiction over certain CTAs exempt from registration under the CEA.
- CTA Registration -- T&M confirmed that a news wire service which wished to provide a listing of daily estimated rates of return and net asset values of publicly offered pools would be excluded from the definition of a CTA and would not appear to be otherwise violating the CEA or Commission rules in publishing the listing, provided that it complied with certain conditions. CFTC Letter 97-63, July 15, 1997.
- CPO and CTA Registration -- T&M provided no-action relief concerning CPO and CTA registration to a state-regulated insurance company and two trust companies in connection with an estate planning device consisting of insurance contracts held in trust, the premium payments for which would be invested in an insurance company separate account, a subaccount of which might invest in commodity pools. The subaccount also was permitted to invest more than ten percent of its assets in certain exempt pools. CFTC Letter 97-53, June 24, 1997.
- Investment Advisers -- T&M permitted a registered investment adviser to provide securities advisory services to FCMs in connection with segregated customer funds without having to register in any capacity under the CEA, provided that the investment adviser has a limited power of attorney from each FCM client and that each FCM client maintains appropriate internal controls. CFTC Letter No. 97-38, March 26,1997.
- CTA Registration -- T&M provided no-action relief to allow an IB who exercised no discretionary trading authority over customer accounts to withdraw its CTA registration and still provide commentaries on the cash and futures agricultural markets through various media. Relief was conditioned upon the IB continuing to maintain any applicable records that would be required by Rule 4.33 for a registered CTA. CFTC Letter 97-49, June 20, 1997.