If there is one thing that all traders have in common it’s that their hearts skip a beat when they receive a phone call from a financial regulator:
“Hello?” “Is John Trader available? We’d like to conduct an examination of your firm on… [insert audit date, hard gulp, and stomach hitting floor here] Will you be available?”
Anyone in the financial markets who has received this call before understands the stress that comes with the situation. Those who haven’t had this experience yet are in luck because there is still time to prepare.
During a Commodity Futures Trading Commission (“CFTC”) or National Futures Association (“NFA”) examination auditors will review company operations in a wide array of regulatory areas. The scope of this review will be determined independently for every firm but will always be based upon the unique operational circumstances at the business. Depending on a firm’s respective registration category (FCM, FDM, IB, CTA, CPO) the following areas represent those which are most likely to be reviewed: Anti-Money Laundering (“AML”), Supervision and Solicitation, Promotional Material, Financial Record Keeping, Performance, General Accounting, Net Capital Computations, Disclosure Documents, Registration, Bylaw 1101 Compliance, Ethics Compliance, Privacy Compliance, Order Handling/Processing, as well as overall General Record Keeping.
With so many areas to be reviewed what is the best way to prepare for an impending NFA examination? For starters member firms can (and are required to) utilize the NFA’s self examination check list at least once annually to evaluate their compliance. Although this document is intended to serve as a guide to an internal review it can be challenging to follow and vague about what should be done when changes are required. To cut through some of the complexity the following is a listing of several common mistakes which are often uncovered during routine examinations.
Registration and Bylaw 1101
During my career I have worked as an NFA auditor, owned and operated an introducing brokerage, and for the last three years run a private consulting business serving commodity and forex brokerages. Throughout my experiences if there is one regulatory area that is most often overlooked it is registration compliance. Specifically, all NFA member firms are required to conduct business with only other NFA member firms. The only exception to this rule comes when a company or person working with the business is exempt from registration for a particular reason. What many people don’t realize is that it is mandatory for all NFA member firms to inquire about the regulatory status of any company they transact business with – period. Any partnership or business accounts trading with the firm must also be investigated to ensure they are not operating as unregistered investment pools. A record of these inquiries should be kept on file and responses should preferably be kept in writing. As a general rule no payment or business activity should be authorized with any entity prior to knowing their regulatory obligations.
Another frequent registration mistake that is routinely made relates to who is, and who is not considered a firm principal. To summarize a principal is any individual or entity who directly or indirectly through agreement, holding company, nominees, trusts, or otherwise has contributed 10% or more of the company’s outstanding equity in any class or type. A principal is also a person who has substantial control or authority over core business functions. In the event a principal is purely a capital investor it is likely they will not be required to pass any licensing exams. They will however be required to register with NFA as a principal and go through the entire registration process. Any business with multiple owners and/or managers would be wise to verify who its true company principals are prior to an examination.
Financial Record Keeping/Accounting (All firms)
CFTC and NFA member firms must adhere to incredibly high standards when it comes to their books and records keeping. Often times any lack of clarity or conciseness within the company general ledger (“GL”) can lead to additional questions and stress. Without an accurate understanding and/or presentation of the GL, any subsequent financial statements will also be difficult to decipher. Since the financials are the heart of any brokerage business, it is critical for firm principals to be aware of all transactions occurring within the company. Financial principals should at the very least familiarize themselves with all material transactions to gain a full understanding of company operations.
Firms with a capital or financial filing requirement must also ensure that all mandatory monthly reports and computations have been completed. Here it is important to remember that although many introducing brokers file reports with NFA bi-annually, they must also maintain net capital computations on file internally each month. Likewise funds with a reporting requirement must also keep accurate monthly financial records regardless of their CFTC and NFA reporting obligations. This methodology also holds true for firms (CTAs) with only performance reporting requirements. These firms must ensure that they have adequate supporting documentation to verify their 13 column spreadsheet presentations are accurate. All sub ledgers must also clearly illustrate the nature of any additions, withdrawals, fees, profit, loss, and other required information to accurately compile monthly performance records.
Ongoing Compliance Reviews and Education
All NFA member firms are required to meet certain ongoing educational, review, and audit requirements. As noted above at least once annually NFA members must complete and document a review using the self-exam checklist. Similarly, many company employees will be required to take Ethics and AML training on an ongoing basis. Depending on a company’s unique policies they may also require periodic account reviews, general account documentation reviews, promotional reviews, supervisory reviews, general correspondence monitoring, AML reviews, financial reviews, annual procedural audits, annual systems audits, and any other ongoing monitoring as may be necessary to maintain regulatory compliance. Each company will have its own unique set of ongoing obligations, therefore it is imperative to evaluate them prior to an exam. Ensuring that ongoing reviews and educational standards are upheld is yet another widely mismanaged business function.
As the last several paragraphs have illustrated preparing for a regulatory examination can be challenging. So what can be done to make life easier for firms anticipating an NFA exam? Prior to receiving the universally dreaded audit phone call it would be wise for most CFTC registered NFA member firms to contact a regulatory consulting like Turnkey Trading Partners (“TTP”). We specialize primarily in commodity and forex compliance so we’ll be best suited to help you. TTP offers a standard mock audit, pre-exam, and general compliance review program. Prior to beginning work we’ll also provide you with an adequate summary of the areas to be evaluated during our review. Once a review has been conducted TTP will be readily able to identify areas of high risk within company operations. We can then also prepare key personnel for the inevitable and assist with any adjustments that may be needed. An audit of your company will be coming at some point in the future. Whatever you choose to do, don’t make the biggest mistake of all by waiting until the last minute to prepare and call us today!
James Bibbings is the President and CEO of Turnkey Trading Partners (“TTP”), a firm that supports all commodity and forex specific regulatory and business needs. Prior to founding TTP, Bibbings worked with the National Futures Association (“NFA”) as a supervising auditor. During his time with NFA he was involved in over 100 investigative audits and was able to gain a deep working knowledge of FDM, FCM, IB, CTA, and CPO operations. Bibbings has provided financial markets content for MSN, Yahoo, Financial Times, FinAlternatives, Wiki-Investments, Safe Haven, Financial Sense, WSJ’s Market Watch, Forex Journal, Commodity News Center and many other highly acclaimed investment publications. He has also authored two highly sought after informational pamphlets regarding futures and forex registration which are available for free upon request through his company website. If you have any questions or comments for Bibbings he can be reached directly at: firstname.lastname@example.org and would love to hear from you.