Response to NFA Request for Comment: CTA/CPO Capital Requirements

Since the collapse of MF Global, we have been stedfastly committed to strengthening investor protections. We are working with various groups on initiatives to shore up customer protections via legislative action, regulatory reform and market innovation. We believe the NFA should focus first on the protection of customer property held by its members and second on the prevention of all manner of fraud through the enforcement of its rules.

It is because of our commitment to enhance customer protections that we do not favor enacting capital requirements on CTA or CPO members of NFA. Enacting capital requirements for CTAs and CPOs would impose a costly compliance burden on emerging managers, stifling competition, innovation and growth in managed futures as an asset class. In exchange for that burden, customers would incur higher trading costs and receive little in the way of an effective deterrent to fraud. pola gates of olympus 2023

There is no evidence that capital requirements are an effective means to prevent or deter nonfeasance, misfeasance or malfeasance. In fact, capital requirements may actually provide an inducement for members to raise assets through fraud. Capital requirements did not prevent or help detect the loss of customer property from malfeasance at Peregrine Financial Group. Nor did capital requirements stop losses to customer property incurred by Griffin Trading, MF Global or Sentinel Management Group--especially considering the fact that Sentinel was able to opt out of net capital requirements (and change the way they calculated their net capital) by way of a no-action letter from the CFTC.

What ultimately uncovered the fraud at Peregrine, and what may prevent future theft of customer property, is NFA’s new electronic balance confirmation system for FCMs. NFA should focus its efforts on successfully implementing regulatory measures like this one, utilizing technology to enhance customer protections and minimize the cost of compliance. To this end, and as an alternative to a net capital rule for CTAs and CPOs, we recommend that NFA staff and the CTA/CPO Advisory Committee consider the following:

For CTA Members, a surety or fiduciary bond requirement. A surety bond provides a source of recourse for investors in the case of malfeasance, while not imposing an undue compliance burden on CTAs who pose little theft risk to customer property. This recourse comes from an independent third-party, rather than through the CTA itself, making it much harder for a rogue CTA to impinge on the source of recovery for aggrieved customers.

For CPO Members, a choice between using an independent third-party administrator for disbursements or electronic confirmation of bank, FCM account balances and transparent assets with monthly reporting of NAV to NFA. The use of a third party administrator and custodian provides a layer of separation and control between the CPO and customer property. It introduces a measure of checks and balances over the disbursement of that property and would be less costly for firms to implement than net capital rules. Large pools who cannot implement this kind of system could be permitted to opt out of they agree to enhanced reporting requirements, including: daily confirmation of FCM and bank account balances, daily or periodic confirmation of transparent assets (securities, OTC products, etc) and monthly reporting of NAV to NFA.

We encourage the NFA, its committees and advisors, as well as the industry to consider these proposals in lieu of capital requirements.

Our Analysis of MRAs

In the request for comment, NFA staff noted that the last three years have seen the issuance of 26 Member Responsibility Actions (“MRAs”), 92% of which involved firms which maintained a registration as a CTA or a CPO. We thought it would be instructive to broaden this analysis and look at as much of the history of MRAs as is available.

We analyzed all publicly searchable Member Responsibility Actions (“MRAs”), which includes all MRAs issued from 1998 to 2013 and all those available between 1996 and 1998. In the data available for this 18 year period, there were a total of 87 cases which resulted in the issuance of an MRA.