FCMs Risk Stiff Penalties for Compliance Lapses

Terry Flanagan

Futures commission merchants and swap dealers could be at risk for civil or legal actions if it’s later found that the firm is not compliant with regulations stemming from the Dodd-Frank Act.

As part of the Act, firms need to designate a chief compliance officer and then, as part of a mandatory CFTC Annual Compliance Review process, the CCO or the chief executive officer must certify that the firm is in compliance with all rules under the Commodity Exchange Act.

“That rule requires the CCO or CEO of any FCM to provide annually a report to the CFTC that certifies, under penalty of law, that you’re in compliance with every rule and regulation,” Rick Schell, founder and managing partner of Automated Compliance Management, a provider of compliance technology. “This is unprecedented.”

Having to certify compliance with every rule can be extremely burdensome. “Finra and other regulators have had certification processes where you had to certify that you had reasonable procedures in place, it just wasn’t this very granular compliance with every rule,” Schell said.

Jamila Piracci, National Futures Association

Jamila Piracci, National Futures Association

CCOs are in a position where they need to certify their firm is in full compliance with every rule, but many of those rules concern specifics on segregated funds that fall under the purview of a chief financial officer, or in areas overseen by a COO or Chief Risk Officer.

“No single person can certify compliance with every rule because they’re not the subject matter expert,” said Schell. “So whether it’s the CCO or the CEO doing the ultimate certification, their subject matter expertise isn’t in the segregation rules. That would typically be the CFO.”

That could ultimately put the CEO on the hook. “One could argue the CEO is ultimately responsible for areas like accounting where the CCO really hasn’t been involved in because they weren’t subject matter experts,” Schell said.

The National Futures Association, the self-regulatory organization of the futures industry, has adopted its own rule (Compliance Rule 2-49), which stipulates that that any violation by a swap dealer of the CFTC’s CCO rule is deemed a violation of an NFA requirement.

The NFA has begun a formal monitoring program with swap dealers and major swap participants.

“What we are doing by initiating and developing a formal monitoring program is to really put a little more structure around that so that we can ask key questions and obtain feedback from firms between onsite exams,” said Jamila Piracci, NFA’s vice president of OTC Derivatives, during a presentation in June.

As an SRO overseen by the CFTC, the NFA has held dialogues with CCOs about coordinating efforts to monitor compliance. “We’ve actually already had meetings with CCOs at some swap dealers and will continue those as the early stages of an effort to keep abreast of significant developments in swap dealer and major swap participant member firms,” Piracci said.

ACM’s software allows the CCO to assign rules to the appropriate people within an organization and tracks the firm’s policy related to the assigned rule and records the certification of compliance by the firm’s subject matter expert.

“We mapped every single CFTC rule to the subject matter experts, or as a default to each department,” Schell said. “So for example, let’s say there are a hundred rules that are related to segregation of funds. Those rules are marked as the finance department or the CFO’s responsibility to certify those rules. So what we’ve done is we’ve categorized all the rules at a default at a hypothetical FCM and our system allows the firm to change those rules around depending on their organization.”

The company has contracted with approximately 15 U.S. based FCMs and expects to continue adding more clients, said Schell.

Featured image via iQoncept/Dollar Photo Club

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