Customer Protection Regulation
|FINAL RULE: CFTC Final Rule: Enhancing Protections Afforded Customers and Customer Funds Held by Futures Commission Merchants and Derivatives Clearing Organizations Appeared in the Federal Register November 15, 2013; Effective Date January 14, 2014|
|FINAL RULE: Investment of Customer Funds by Futures Commission Merchants and Derivatives Clearing Organizations Approved at CFTC Open Meeting, December 5, 2011|
|FINAL RULE: CFTC Final Rule: Customer Clearing Documentation, Timing of Acceptance for Clearing, and Clearing Member Risk Management Approved at CFTC Open Meeting, March 20, 2012|
|FINAL RULE: SEC Final Rule: Broker-Dealer Reports Entered Federal Register August 21, 2013.|
|FINAL RULE: SEC Final Rule: Financial Responsibilities for Broker-Dealers Entered Federal Register August 21, 2013. Effective date October 21, 2013|
|Proposal Date||Comment Deadline||Final Rule Approved||Effective Date|
|November 14, 2012||February 15, 2012||October 30, 2013||January 13, 2014|
|Final Rule Issue||Effective Date||Compliance Deadline|
|December 19, 2011||February 17, 2012||June 18, 2012|
|Final Rule Issue||Effective Date||Compliance Date, FCMs, DCMs, DCOs||Compliance Date, SEFs|
|April 9, 2012||October 1, 2012||October 1, 2012||TBA|
|Final Rule Issue||Effective Date||Compliance Date, Rule 1.73||Compliance Extension, Bunched Orders|
|April 9, 2012||October 1, 2012||June 1, 2013||September 1, 2013|
|Re-proposal Date||Final Rule Issue||Effective Date|
|May 9, 2012||August 21, 2013||October 21, 2013|
|Proposal Date||Final Rule Issue||Effective Date, SIPC Reports||Effective Date, SEC Reports|
|June 27, 2011||August 21, 2013||December 31, 2013||June 1, 2014|
After the financial crisis of 2008 and the passage of the Dodd-Frank Act in 2010, enhancing customer protection has emerged as a major issue. Dodd-Frank contains several provisions intended to restore confidence in the financial markets, including:
- Corporate governance issues such as Business Conduct Standards and Executive compensation;
- Anti-manipulation rules;
- Whistleblower rules;
- Changes to the way broker-dealers handle customer funds; and
- Investment of Customer Funds.
Subsequently, after failures at two futures commission merchants within one year - MF Global and Peregrine Financial - the safety of customer segregated funds has come into question by market participants. The CFTC approved a set of final customer protection rules on October 30, 2013.
On October 30, 2013, the CFTC approved a final set of rules on customer protection. The rules cover FCM risk management, record keeping and disclosure, and the treatment of customer segregated funds secured funds in foreign futures and options accounts. Of particular note is the requirement that FCMs hold a "residual interest" in customer accounts in an amount least equal to its customers’ aggregate undermargined amounts for the prior trade date, in order to protect the funds of customers with excess margin.
- 1 Subsequent Actions
- 2 MF Global
- 3 Peregrine Financial
- 4 Futures Industry Study on Asset Protection Insurance, November 2013
- 5 High Frequency Trading
- 6 MarketsWiki Questions: Restoring Customer Confidence Series, 2012-2013
- 7 References
- On November 13, 2014, the CFTC Division of Swap Dealer and Intermediary Oversight issued a no-action letter regarding the holding by futures commission merchants of funds in foreign-based banks ("30.7 funds"). The relief allows an FCM to exclude certain foreign-held customer funds from the requirement that it hold 120 percent of the required margin on the customers’ foreign futures and foreign options positions. The relief also allows FCMs to net transactions between the FCM and the foreign depository, and to substitute U.S. dollars for foreign currency in 30.7 accounts. VIEW NO-ACTION LETTER
- On November 14, 2014, the commission proposed a change to the phased-in compliance of the residual interest rule. For more information, click HERE.
On October 31, 2011, commodities broker MF Global filed for bankruptcy amid steep losses in its trading book related to European sovereign debt. In the aftermath, it was discovered that the firm had commingled its own money with customer segregated funds. At one point, over $1.2 billion of customer money was reported missing. 
Although the CFTC issued a final rule in December 2011 that amended Regulation 1.25, the investment of customer funds and protection of collateral, the commission had indicated that additional customer protections would be forthcoming. A proposed rule on enhanced customer protections was passed and sent out for public comment on October 22, 2012.
For more information, see these related pages:
- A Layman's Guide to Regulation 1.25
- CFTC Final Rule: Investment of Customer Funds by Futures Commission Merchants and Derivatives Clearing Organizations
On July 9, 2012, non-clearing FCM PFGBest, formerly Peregrine Financial Group, revealed that it had frozen client accounts after its founder, Russell Wasendorf, Sr., had attempted suicide. It was later revealed that the firm had been submitting falsified bank statements to auditors from the National Futures Association (NFA), and that approximately $220 million in customer segregated funds had not been accounted for.
On August 21, 2012, the NFA submitted to the CFTC a list of proposed amendments to its financial requirements of FCMs. The proposed amendments would require FCMs to provide their designated self-regulatory organization ("DSRO") with on-line view-only access to FCM customer segregated/secured amount bank account information. The amendments would also add CFTC Regulation 1.49 to the list of CFTC Regulations, that if violated, constitute a violation of NFA rules.
NFA Audit Procedure Study, January 2013
On January 29, 2013, the NFA released the findings of an investigation conducted by the Berkeley Research Group that audited the NFA's audit procedures on Peregrine from 1995-2012. The independent report includes 21 recommendations covering auditor training, hiring practices, policies and procedures, as well as testing of internal controls at member firms and better identifying of potential risk factors in futures commission merchant operations. BRG reviewed more than 190,000 NFA documents containing over 3 million pages, including 166,000 emails and related attachments.
Futures Industry Study on Asset Protection Insurance, November 2013
On November 15, 2013, CME Group, Futures Industry Association, the Institute for Financial Markets and National Futures Association today announced the release of a study on the economic feasibility of adopting an insurance regime for the U.S. futures industry. The study was commissioned by the four sponsoring organizations in November 2012 and was conducted by Compass Lexecon, a consulting firm that specializes in the application of economics to legal, regulatory, and policy issues. Christopher L. Culp, an expert on risk management with extensive consulting experience in both insurance and derivatives, led the team that conducted the study.
High Frequency Trading
On May 6, 2010, the Dow Jones Industrial Average plunged nearly 1,000 points in a short period of time, only to recover most of the losses within the hour. This became known in the financial sector as the "Flash Crash." Afterward, the SEC and CFTC formed a joint committee to study emerging regulatory issues. Its conclusions and recommendations were released on February 18, 2011.
On Aug. 1, 2012, the market-making unit of Knight Capital Group suffered “a technology issue” that affected the routing of trades on around 150 stocks on the New York Stock Exchange.  The firm's losses, estimated at $440 million, were attributed to an algorithmic glitch that resulted in millions of erroneous trades in under an hour. The Knight glitch has led to renewed calls for regulation of high frequency trading. For more information, see these related pages:
- High Frequency Trading Regulation
- AT 9000
- Fair and Efficient: A Q&A with Michael Aitken, October 2012
MarketsWiki Questions: Restoring Customer Confidence Series, 2012-2013
Restoring Customer Confidence Video Series Launch
In the aftermath of the MF Global collapse, fraud at Peregrine Financial Group and high profile high-frequency trading shocks, John Lothian News asks – how do you restore customer confidence and bring traders back?
John Lothian News interviewed more than a dozen professionals in the industry to get their ideas and solutions. As these ideas become practice, or as new concepts are adopted by the industry, we will continue to add them to the site.
This video series addresses solutions by category: Protection Fund, Confirmations, Daily Reports, Third-Party Custodians, Ratings, Customer Segregation, Regulatory Changes, HFT Rules. Visit the Restoring Customer Confidence video series page >
On May 22, 2013, the National Futures Association (NFA) published and submitted to the CFTC an interpretive notice regarding new Compliance Rule 2.9: FCM Internal Control Systems. The NFA board approved the proposal on May 16, 2013, and requests review and approval by the commission. Compliance RUle 2.9 places the obligation on all members to "diligently supervise its employees and agents in all aspects of their futures activities for or on behalf of the member." This includes providing "reasonable assurance" that the member's books and records are accurate so that financial reports are reliable, and that the member is in compliance with regulators.
NFA Request for Comments: CPO/CTA Capital Requirement and Customer Protection Measures, January 2014
On January 23, 2014, the National Futures Association (NFA) issued a request for comment from its members on the possibility of adding capital requirements and other customer protection measures. The deadline for comment is April 15, 2014.
NFA regularly reviews the continued effectiveness of its regulatory requirements. Over the past three years, NFA has issued 26 Member Responsibility Actions (MRAs), and 92% of those MRAs were against CPO and/or CTA Members. Most of these matters involved misuse of customer funds (including one CPO that improperly used pool funds because it had insufficient assets to operate as a going concern) and/or misstating net asset values and/or performance information. In light of these actions, NFA is reviewing the current regulatory structure applicable to CPO and CTA operations. In particular, NFA is looking at ways to strengthen the regulatory structure governing CPO operations to provide greater protection for customer funds. Additionally, NFA is exploring ways to ensure that CPOs and CTAs have sufficient assets to operate as a going concern. NFA's Executive Committee approved the issuance of this request for comments to solicit CPO and CTA Member input on the concept of imposing a capital requirement on CPO/CTA Members and other customer protection measures. For more information, click HERE.
- MF Global files for bankruptcy after European debt bets. The Telegraph. Retrieved on October 31, 2011.
- Peregrine Financial Group brokerage said to be $220 million short in customer funds. CBS. Retrieved on July 10, 2012.
- Peregrine fraud investigation finds shortcomings at futures regulator. Crain's Chicago Business. Retrieved on February 1, 2013.
- Futures Industry Releases Insurance Study. NFA Press Release. Retrieved on December 5, 2013.
- Glitches send Dow on wild ride. CNN.Money. Retrieved on May 8, 2010.
- Knight Capital shares sink after algorithm glitch. MarketWatch. Retrieved on August 1, 2012.