Self-Regulatory Organizations; National Futures Association; Notice of Filing and Immediate Effectiveness of Proposed Amendments to the Interpretive Notice to NFA Compliance Rule 2-9: Enhanced Supervisory Requirements., 71347-71352 [E5-6558]

Agencies

• SECURITIES AND EXCHANGE COMMISSION

[Federal Register Volume 70, Number 227 (Monday, November 28, 2005)]
[Notices]
[Pages 71347-71352]
From the Federal Register Online via the Government Printing Office [www.gpo.gov]
[FR Doc No: E5-6558]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-52808; File No. SR-NFA-2005-01]


Self-Regulatory Organizations; National Futures Association; 
Notice of Filing and Immediate Effectiveness of Proposed Amendments to 
the Interpretive Notice to NFA Compliance Rule 2-9: Enhanced 
Supervisory Requirements.

November 18, 2005.
    Pursuant to Section 19(b)(7) of the Securities Exchange Act of 1934 
(``Exchange Act''),\1\ and Rule 19b-7 under the Exchange Act,\2\ notice 
is hereby given that on September 19, 2005, National Futures 
Association (``NFA'') filed with the Securities and Exchange Commission 
(``SEC'' or ``Commission'') the proposed rule change described in Items 
I, II, and III below, which Items have been prepared by NFA. The 
Commission is publishing this notice to solicit comments on the 
proposed rule change from interested persons.
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    \1\ 15 U.S.C. 78s(b)(7).
    \2\ 17 CFR 240.19b-7.
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    NFA also submitted the proposed rule change to the Commodity 
Futures Trading Commission (``CFTC'') on September 19, 2005 for 
approval. The CFTC has not yet given such approval.

I. Self-Regulatory Organization's Description of the Proposed Rule 
Change

    Section 15A(k) of the Exchange Act \3\ makes NFA a national 
securities association for the limited purpose of regulating the 
activities of Members who are registered as brokers or dealers in 
security futures products under Section 15(b)(11) of the Exchange 
Act.\4\ NFA's Interpretive Notice entitled ``Compliance Rule 2-9: 
Enhanced Supervisory Requirements'' (``Notice'') applies to all Members 
who meet the criteria and could apply to Members registered under 
Section 15(b)(11).
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    \3\ 15 U.S.C. 78o-3(k).
    \4\ 15 U.S.C. 78o(b)(11).
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    The Notice requires a Member to adopt certain enhanced supervisory 
procedures (``Requirements'') if its sales force includes a specified 
number of associated persons (``APs'') who have worked at Disciplined 
Firms. NFA's Special Committee to Study Customer Protection Issues 
recently recommended changes to the Notice to resolve some emergent 
loopholes in the Requirements and further prevent abusive sales 
practices. The Board's changes:
     Automatically reimpose the Requirements on any firm that, 
having already completed a term under the Requirements, becomes subject 
to an NFA or CFTC enforcement action alleging sales practice abuses;
     Change the current obligation under the Requirements so 
that a firm may petition to have the Requirements lifted or modified 
after two years rather than automatically terminating;
     Add a provision designed to address issues related to 
firms avoiding the Requirements by making sham changes to entities and 
personnel when they become subject to the Requirements;
     Include listed principals who have previously worked for 
Disciplined Firms in the population used to calculate whether a Member 
firm has triggered an obligation to operate under the Requirements; and
     Exclude APs who worked at Disciplined Firms for less than 
sixty days more than five years ago from having to be counted for 
purposes of calculating whether a Member who hires such an individual 
is required to adopt the Requirements.
    Below is the text of the proposed amendments to the Notice. 
Proposed new language is in italics; proposed deletions are in 
[brackets].
* * * * *

Interpretive Notice

Compliance Rule 2-9: Enhanced Supervisory Requirements
    Over the years, NFA's Board of Directors has adopted strict and 
effective rules to prohibit deceptive sales practices, and those rules 
have been vigorously enforced by NFA's Business Conduct Committees. The 
Board notes, however, that by their very nature, enforcement actions 
occur after the customer abuse has taken place. The Board recognizes 
that NFA's goal must be not only to punish such deception of customers 
through enforcement actions

[[Page 71348]]

but to prevent it, or minimize its likelihood, through fair and 
effective regulation.
    One NFA rule designed to prevent abusive sales practices is NFA 
Compliance Rule 2-9. Subsection (a) of this rule places a continuing 
responsibility on every Member to supervise diligently its employees 
and agents in all aspects of their futures activities, including sales 
practices. Although NFA has not attempted to prescribe a set of 
supervisory procedures to be followed by all NFA Members, NFA's Board 
of Directors believes that Member firms which are identified as having 
a sales force that has received questionable training in sales 
practices should be required to adopt specific supervisory procedures 
designed to prevent sales practice abuse. Subsection (b) authorizes the 
Board of Directors to require Members, which meet certain criteria 
established by the Board, to adopt specific supervisory procedures 
designed to prevent abusive sales practices. Subsection (b) covers all 
activities regulated by NFA, including the off-exchange retail forex 
activities of Members subject to NFA Compliance Rule 2-36.
    The Board believes that in order for the criteria used to identify 
firms subject to the enhanced supervisory requirements to be useful, 
those criteria must be specific, objective and readily measurable. The 
Board also believes that any supervisory requirements imposed on a 
Member must be designed to quickly identify potential problem areas so 
that the Member will be able to take corrective action before any 
customer abuse occurs. The purpose of this Interpretive Notice is to 
set forth the criteria established by the Board and the enhanced 
supervisory procedures which are required of firms meeting these 
criteria.
    In developing the criteria, the Board concluded that it would be 
helpful to review Member firms which had been closed through 
enforcement actions taken by the CFTC or NFA for deceptive sales 
practices. The Board's purpose was to identify factors common to these 
Member firms and probative of their sales practice problems, which 
could be used to identify other Member firms with potential sales 
practice problems.
    One factor identified by the Board as common to these firms and 
directly related to their sales practice problems is the employment 
history and training of their sales forces. For many of these Members, 
a significant portion of their sales force was previously employed and 
trained by one or more of the other Member firms closed for fraud. The 
Board believes that the employment history of a Member's sales force 
and principals is a relevant factor to consider in identifying firms 
with potential sales practice problems. If a Member firm is closed by 
NFA or the CFTC for fraud related to widespread telemarketing or 
promotional material problems or a firm is closed by NASD or the SEC 
for fraud related to its sales practices regarding security futures 
products as defined in Section 1a(32) of the Commodity Exchange Act 
(``Act''), it is reasonable to conclude that the training and 
supervision of its sales force was wholly inadequate or inappropriate. 
It is also reasonable to conclude that an AP who received inadequate or 
inappropriate training and supervision may have learned improper sales 
tactics, which he will carry with him to his next job. Therefore, the 
Board believes that a Member firm employing such a sales force must 
have stringent supervision procedures in place in order to ensure that 
the improper training its APs have previously received does not taint 
their sales efforts on behalf of the Member.
    The Board has determined that a Member will be required to adopt 
the specific supervisory procedures over its sales practice activities 
if:
     For firms with less than five APs, 2 or more of its APs 
have been employed by one or more Member firms which have been 
disciplined by NFA or the CFTC (or one or more firms disciplined by any 
securities industry self-regulatory organization or the SEC in matters 
involving security futures products) for sales practice fraud 
(``Disciplined Firms'');
     For firms with at least 5 but less than 10 APs, 40 percent 
or more of its APs have been employed by one or more Disciplined Firms;
     For firms with at least 10 but less than 20 APs, four or 
more of its APs have been employed by one or more Disciplined Firms; or
     For firms with at least 20 APs, 20 percent or more of its 
APs have been employed by one or more Disciplined Firms.
    The Board also takes note that there have been instances in which 
Members and Associates have subverted the Board's purpose in imposing 
the enhanced supervisory procedures by closing a firm once it qualifies 
for those procedures and opening another firm or firms that have a mix 
of APs that does not meet the criteria for adopting the procedures. The 
new firms typically have APs who have worked for Disciplined Firms and 
who worked at the original firm, but they are redistributed so as to 
keep the AP mix below the threshold for becoming subject to the 
enhanced supervisory procedures. This strategy deprives the very APs 
whose questionable training backgrounds gave rise to the creation of 
the enhanced supervisory procedures of the benefits of those 
procedures. Therefore, the Board has determined to further ensure that 
the benefits of the enhanced supervisory procedures are applied where 
they are of the greatest effect. Once a Member firm triggers the 
aforementioned criteria and becomes obligated to adopt the enhanced 
supervisory procedures, any other Members of which the principals of 
that Member firm are, or become, principals must also adopt the 
enhanced supervisory procedures or seek a waiver therefrom. In 
addition, for purposes of determining whether a Member will be required 
to adopt the enhanced supervisory procedures, principals of a firm, who 
are not also APs of that firm and who have been previously employed as 
an AP by one or more Disciplined Firms, shall be counted with the 
firm's APs in determining whether the firm meets the aforementioned 
criteria.
    Additionally, for purposes of determining whether a futures 
commission merchant (``FCM'') Member firm meets this requirement, an 
FCM and its guaranteed introducing brokers (``GIBs'') will be 
considered a single firm. Therefore, for FCMs with GIBs, the APs of its 
GIBs will be treated as APs of the FCM for determining whether the FCM 
meets the requirements. If the FCM Member firm meets the requirements, 
then the FCM and all its GIBs shall be required to adopt the 
supervisory procedures specified herein. Of course, individual FCMs or 
GIBs will be required to adopt the enhanced supervisory procedures 
provided the FCM or GIB meets the requirements on its own.
    The Board recognizes that there is a group of APs who worked at 
Disciplined Firms for only a short period of time many years ago and 
who have not worked at any Disciplined Firm since. The Board's review 
of the employment and disciplinary histories of such individuals 
suggests that APs who served a very brief tenure with Disciplined Firms 
more than [10] five years in the past do not raise the same concerns 
regarding their previous supervision and training that are raised by 
APs who have worked at Disciplined Firms for longer periods or at a 
more recent point in time. Therefore, the Board has determined that APs 
who have been previously employed by Disciplined Firms for a cumulative 
total of less than 60 days and who, in addition, have not been employed 
by

[[Page 71349]]

any Disciplined Firm during the [10] 5 years preceding the 
determination of whether a Member firm is required to employ the 
enhanced supervisory procedures established in this Interpretive Notice 
shall not be counted for purposes of calculating whether the 
composition of a firm's sales force triggers enhanced supervisory 
requirements.
    For purposes of this requirement, a Disciplined Firm is defined 
very narrowly to include those firms that meet the following three 
criteria:
    1. the firm has been formally charged by either the CFTC or NFA 
with deceptive telemarketing practices or promotional material;
    2. those charges have been resolved; and
    3. the firm has been permanently barred from the industry as a 
result of those charges.
    In addition, a Disciplined Firm shall be defined to include any 
broker-dealer that, in connection with sales practices involving the 
offer, purchase, or sale of any security futures product as defined in 
Section 1a (32) of the Act has been expelled from membership or 
participation in any securities industry self-regulatory organization 
or is subject to an order of the SEC revoking its registration as a 
broker-dealer.
    Attached is a list of firms currently meeting the definition of a 
Disciplined Firm. Although this list is current as of the date of this 
Interpretive Notice, NFA [will provide] provides Members with an 
updated [lists] list [as necessary] on its website at 
www.nfa.futures.org.
    Any Member firm meeting these criteria will be required either to 
operate pursuant to a guarantee agreement or maintain an adjusted net 
capital of at least $250,000 for the entire period during which the 
Member is required to tape record its sales solicitations. Any Member 
opting to maintain the higher level of adjusted net capital would also 
be subject to the financial record-keeping and reporting requirements 
applicable to FCMs. Eligible guarantor futures commission merchants are 
those that meet the eligibility requirements for executing a 
Supplemental Guarantor Certification Statement pursuant to NFA 
Registration Rule 504(a)(2)(B). The Board believes that requiring these 
Members to operate pursuant to a guarantee agreement will likely 
improve the overall level of supervision at these firms.
    Those Member firms meeting the criteria will be required to tape 
record all telephone conversations that occur between their APs and 
both existing and potential customers, including existing and potential 
retail forex customers of Members subject to NFA Compliance Rule 2-36. 
The Board believes that tape recording these conversations provides 
these Members with the best opportunity to monitor closely the 
activities of their APs and also provides these Members with complete 
and immediate feedback on each AP's method of soliciting customers. 
Members that are required to tape their conversations [meeting the 
criteria must tape record these conversations for a period of two years 
and] must retain such tapes for a period of five years from the date 
each tape is created and the tapes shall be readily accessible during 
the first two years of the five-year period. In retaining the tape 
recorded conversations, Member firms must catalog the tapes by AP and 
date. Additionally, any Member firm meeting the criteria must require 
all its APs to maintain a daily log for sales solicitations which 
reflects at a minimum the identity of each customer or prospective 
customer the AP spoke with on each day. A Member firm must be able to 
promptly produce, upon request from NFA or the CFTC, all conversations 
relating to a specific AP, and only that AP, for a given date.
    In addition, [for a period of two years,] those Member firms 
meeting the criteria will be required to file all promotional material, 
as defined in NFA Compliance Rule 2-29(i), with NFA at least 10 days 
prior to its first use.
    Those Members meeting the criteria shall have written supervisory 
procedures that include the titles, registration status and locations 
of the firm's supervisory personnel as these relate to the firm's 
commodity futures business, retail forex business, and applicable 
securities laws and regulations for the trading of security futures 
products. Member firms shall also maintain on an internal record the 
names of all persons who are designated as supervisory personnel and 
the dates for which the designation is or was effective. Additionally, 
a Member meeting the criteria shall by the 30th day of the month 
following the end of each calendar quarter file with NFA's Compliance 
Department a report relating to the Member firm's compliance with the 
supervisory requirements contained herein. Member firms shall retain 
the internal record and report(s) for a period of five years, the first 
two years in an easily accessible place.
    If an NFA Business Conduct Committee disciplinary proceeding or 
Commodity Futures Trading Commission enforcement proceeding has been 
filed against a Member firm required to adopt these enhanced 
supervisory procedures, then the enhanced supervisory procedures will 
remain in effect for the applicable time period specified or until 
after the disciplinary or enforcement proceeding is closed and all 
appeals are completed or the time for appeal has passed without an 
appeal being filed or perfected, whichever occurs latest. In addition, 
any Member that: has previously been required to adopt the enhanced 
supervisory procedures; has, in fact, fulfilled that requirement either 
by adopting the enhanced supervisory procedures for a prescribed period 
or by receiving a full or partial waiver from the enhanced supervisory 
procedures from the Telemarketing Procedures Waiver Committee; and 
subsequently becomes subject to a Commodity Futures Trading Commission 
or NFA enforcement or disciplinary proceeding alleging deceptive sales 
practices, shall, within 30 days of being served with notice of the 
action, initiate all of the enhanced supervisory procedures and may not 
seek a waiver therefrom. This obligation shall continue until after the 
disciplinary or enforcement proceeding is closed and all appeals are 
completed or the time for appeal has passed without an appeal being 
filed or perfected. Member firms shall be required to retain tapes for 
the five-year period as specified above.
    Any Member required to adopt these enhanced procedures may seek a 
waiver of the enhanced supervisory requirements by filing a petition 
with the Telemarketing Procedures Waiver Committee within 30 days of 
the date of being notified by NFA that it is required to adopt the 
enhanced procedures. NFA may grant such a waiver upon a satisfactory 
showing that the Member's current supervisory procedures provide 
effective supervision over its employees, including enabling the Member 
to identify potential problem areas before customer abuse occurs. 
Additionally, if a Member meets the criteria and trades security 
futures products, then the Member firm must also make a satisfactory 
showing that the Member's supervisory procedures ensure compliance with 
all applicable securities laws and regulations. Should a Member fail to 
file a petition seeking a waiver within 30 days or should it file a 
petition that is denied by the Telemarketing Procedures Waiver 
Committee, either in whole or in part, the Member may not petition for 
a full or partial waiver again until at least two years have elapsed 
since the Member adopted the required enhanced procedures.
    Some of the factors that the three-member Waiver Committee may

[[Page 71350]]

consider in evaluating a waiver request include:
     The total number of APs sponsored by the Member;
     Number of branch offices and GIBs operated by the Member;
     The experience and background of the Member's supervisory 
personnel;
     The number of the Member's APs who had received training 
from firms which have been closed for fraud, the length of time those 
APs worked for those firms and the amount of time which has elapsed 
since those APs worked for the disciplined firms;
     The results of any previous NFA examinations; and
     The cost effectiveness of the taping requirement in light 
of the firm's net worth, operating income and related telemarketing 
expenses.
    Conditions that the Telemarketing Procedures Waiver Committee shall 
impose on any Member to which it grants a full or partial waiver 
include requirements that the firm: Notify NFA of any action charging 
the firm with a violation of Commodity Futures Trading Commission or 
Self Regulatory Organization (``SRO'') regulations or rules; notify NFA 
of any customer complaint involving sales practices or promotional 
material; not change ownership; not have any material deficiencies 
noted during any SRO examination; not hire additional APs from 
Disciplined Firms; execute a written acknowledgement that the firm 
understands the conditions of the waiver; and may include any other 
conditions deemed by the Committee to be appropriate in furtherance of 
the effectiveness of the enhanced supervisory procedures. Violation of 
any of those conditions may serve as cause for the Telemarketing 
Procedures Waiver Committee to review and amend or revoke the waiver.
    A Member firm that does not comply with this Interpretive Notice 
will violate NFA Compliance Rule 2-9(b) and will be subject to 
disciplinary action.
* * * * *

II. Self-Regulatory Organization's Statement of the Purpose of, and 
Statutory Basis for, the Proposed Rule Change

    In its filing with the Commission, NFA has prepared statements 
concerning the purpose of, and basis for, the proposed rule change, 
burdens on competition, and comments received from Members, 
participants, and others. The text of these statements may be examined 
at the places specified in Item IV below. NFA has prepared summaries, 
set forth in Sections A, B, and C below, of the most significant 
aspects of such statements.

A. Self-Regulatory Organization's Statement of the Purpose of, and 
Statutory Basis for, the Proposed Rule Change

1. Purpose
a. Reimposing the Requirements on Members That Have Previously 
Satisfied an Obligation to Abide by Those Requirements and are 
Subsequently Charged in a CFTC or NFA Enforcement Action
    In 1996, NFA's Board amended the Notice to provide that, if a 
Member that is currently subject to the Requirements becomes subject to 
a CFTC or NFA enforcement proceeding, the Requirements will remain in 
place for two years or until after the disciplinary or enforcement 
proceeding is concluded, whichever is longer. This provision does not, 
however, apply to Members that have already served full two-year 
tenures under the Requirements when one of those firms is subsequently 
charged in an enforcement action by the CFTC or NFA.
    The practical effect of the current system is that some Members, 
with a number of APs from Disciplined Firms, that are charged by the 
CFTC or NFA in actions alleging fraudulent sales practices have a 
significant window of time during the pendency of the action to 
continue soliciting the public without any requirement to adopt 
additional prophylactic measures such as taping. Of course, in 
appropriate cases, prophylactic measures may be imposed as part of the 
ultimate resolution of the CFTC's or NFA's action, but it can take many 
months, or even years in cases that go through multiple layers of 
appeals, to resolve such actions.
    There are at least three current NFA Members that served full terms 
under the Requirements and were subsequently charged in enforcement 
proceedings. It is worth noting that each of those firms still retains 
a sales force with histories at Disciplined Firms such that they would 
require the adoption of the Requirements but for the fact that they 
have already served the term of their obligation under the Notice. In 
fact, at one time, one of these firms actually featured its purported 
immunity from further taping requirements as an inducement in a 
recruitment advertisement contained in a South Florida newspaper.
    A review of one firm's history illustrates the differences in the 
operations of the present system and the system being proposed. This 
firm has been an introducing broker (``IB'') NFA Member since August 
1994. The NFA required the Member to adopt the Requirements from 
February 1995 through February 1997, when it was automatically 
discharged of the Requirements.
    NFA then issued a Complaint alleging deceptive sales practices 
against the firm in April 1998. A settled Decision was issued at that 
same time which, among other penalties, required the firm to tape all 
solicitations from April 1998 through April 2000. NFA issued a second 
deceptive sales practice Complaint against the firm in January 2002, 
which was resolved in March 2003.
    Because the firm had already fulfilled its obligation under the 
Notice from 1995 to 1997, it was not required under the current system 
to tape conversations with customers during the pendency of NFA's 2002 
Complaint. This gave the firm a 14-month window to solicit the public 
without any obligation under the Notice to adopt the enhanced 
supervisory procedures--including taping. Incidentally, during this 
time, the firm continued to have a mix of APs that otherwise would have 
triggered the Requirements. The proposed amendments to the Notice would 
have required the firm to observe all of the Telemarketing 
Requirements, including taping all customer solicitations, from the 
time that the 2002 Complaint was initiated until that Complaint was 
completely resolved in March 2003.
    The guiding principle in creating and refining the Requirements has 
always been to improve the overall level of supervision at those few 
Member firms which are likely to cause sales practice problems. When a 
firm that has already operated under the Requirements for two years 
because of the questionable backgrounds of its APs subsequently becomes 
subject to an NFA or CFTC enforcement action for sales practice abuses, 
there is a clear indication that the firm is, indeed, part of the group 
that is likely to cause sales practice problems and that it is prudent 
to require the firm to improve its level of supervision.
    The proposed amendments to the Notice provide that any firm that 
has previously been required to abide by the Requirements but has 
fulfilled its obligation--either by abiding by the Requirements under 
the Notice as it currently stands or by successfully petitioning the 
Telemarketing Procedures Waiver Committee (``Waiver Committee'') to 
have the Requirements lifted or modified--would again become subject to 
the Requirements during the

[[Page 71351]]

pendency and through appeals of a new CFTC or NFA enforcement action.
b. Requiring Telemarketing Firms To Abide by the Telemarketing 
Requirements Until They are Granted a Complete or Partial Waiver by the 
Telemarketing Procedures Waiver Committee
    Currently, the obligation to abide by the enhanced procedures runs 
for two years, at which time it terminates automatically in most 
circumstances. The proposed amendments make it more likely that firms 
that continue to pose problems would remain subject to the Requirements 
for longer than the current two-year tenure provided for in the Notice. 
The modification puts the burden on Member Firms triggering the 
criteria to demonstrate that a waiver from the Requirements is 
warranted after two years rather than automatically discharging the 
obligation to abide by the Requirements once the two years has passed.
    The amendments also provide that a Member firm has 30 days to seek 
a waiver from the Waiver Committee after it first employs an AP mix 
that would trigger the Requirements.\5\ If the Waiver Committee denies 
the initial petition or no petition is filed, the firm would not be 
eligible to petition for a waiver again until it had served a full two 
years under the Requirements. Any waiver would be subject to conditions 
that, if violated, could subject the firm to revocation of the waiver 
by the Waiver Committee.\6\ This additional component gives the Waiver 
Committee the flexibility to revisit the issue of whether a waiver is 
still warranted when there is a material change in the firm's 
organization or regulatory status.
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    \5\ The Notice provides that some of the factors that the Waiver 
Committee may consider in evaluating a Member's waiver request 
include: The number of APs; the number of branch offices and GIBs; 
the experience and background of supervisory personnel; the number 
of APs who received training at Disciplined Firms, the time those 
APs worked for those firms and the amount of time which has passed 
since they worked for Disciplined Firms; The results of previous NFA 
examinations; and the cost effectiveness of taping.
    \6\ The conditions include requirements that the firm: Notify 
NFA of any action charging the firm with a violation of CFTC or SRO 
regulations or rules; Notify NFA of any customer complaint involving 
sales practices or promotional material; not change ownership; not 
have any material deficiencies noted during any SRO examination; not 
hire additional APs from Disciplined Firms; and execute a written 
acknowledgement that the firm understands the conditions of the 
waiver, and may include any other conditions deemed by the Waiver 
Committee to be appropriate in furtherance of the effectiveness of 
the enhanced supervisory procedures.
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c. Combating Sham Transactions and Including Principals Who Have Worked 
at Disciplined Firms in Calculating Whether a Member Firm has Qualified 
Under the Requirements
    The principals of several firms that have triggered the 
Requirements have avoided them by simply closing their firms and 
opening other firms that have a mix of APs that do not trigger an 
obligation to abide by the Requirements. The new firms typically have 
APs from the closed firm who have worked at Disciplined Firms, but 
their ratios to the overall AP population of the new firms are below 
the triggering point for imposing the Requirements.
    For example, one firm, which had been an NFA Member IB since 1987, 
met the Requirements in March 2004. One particular individual had been 
the firm's principal and an AP of the firm since May 1987. The firm 
petitioned the Waiver Committee for a complete waiver from any 
obligation to abide by the Requirements. Although that Waiver Committee 
gave the firm a partial waiver by reducing the firm's required minimum 
adjusted net capital from $250,000 to $100,000, it did not waive the 
taping or other obligations.
    Rather than having the firm abide by the Requirements, the 
individual simply withdrew the firm from NFA membership and created two 
new firms. Neither of those firms triggered the Requirements because 
the individual kept their AP populations below the triggering points by 
judiciously splitting APs from Disciplined Firms between the two firms. 
In addition, while the individual is a principal of both firms, he did 
not register as an AP of either of them. By so doing, he was able to 
avoid being personally counted as an AP from a Disciplined Firm for 
purposes of determining whether either firm had an AP population that 
triggered the Requirements.
    The firm's use of a sham reorganization to avoid triggering the 
Requirements is not unique. NFA is aware of several other firms that 
have used similar tactics to avoid the Requirements.
    NFA has developed a twofold approach to combat sham reorganizations 
and transfers designed to avoid the Requirements. First, once a firm 
has triggered the Requirements, then any other firms of which the 
principals of the qualifying firm are also principals would become 
subject to the Requirements.
    Second, individuals who are listed principals, but who are not APs 
of the firm, will be included in the calculation for purposes of 
determining whether a firm has triggered the Requirements if such 
individuals have previously worked as an AP at a Disciplined Firm. 
Principals who have not previously worked at a Disciplined Firm will 
not be included in the calculation. Otherwise, a firm could name 
``straw man'' principals, thereby increasing the firm's overall 
calculation population and diluting the impact of the number of 
individuals who have worked at Disciplined Firms.
    Counting non-AP principals who have been APs at Disciplined Firms 
in the past will cause eight current Member firms to trigger the 
Requirements. Collectively those firms have 12 individuals who are 
listed as principals but are not currently registered as APs of their 
respective firms. Those non-AP principals have worked as APs at 14 
different Disciplined Firms in the past, and several of them have been 
personally named in CFTC and NFA actions. At least three other former 
Members would have been added during the past few years under the 
proposed amendments to the Notice, except that the CFTC took injunctive 
actions against them for sales practice violations and their NFA 
memberships were withdrawn.
    Both of the successor firms resulting from the sham reorganization 
described above would trigger the Requirements under either of NFA's 
proposed amendments to the Notice. Since the principal of the original 
firm is also a principal of the two successor firms, that fact would 
automatically trigger the Requirements for those two firms. In 
addition, since the individual previously worked at a Disciplined Firm 
and is a non-AP principal of both successor firms, he would be included 
in the calculation of whether the AP mix at these two firms triggered 
the Requirements, which would result in a ratio that would trigger the 
Requirements for both successor firms.
d. Individuals Who Had Brief Tenures at a Disciplined Firm a Number of 
Years Ago
    In 2003, the Board amended the calculation of APs that would 
trigger the Requirements to exclude APs who had worked at Disciplined 
Firms for less than 60 days more than 10 years ago. The proposed 
amendments to the Notice decrease the required time away from 
Disciplined Firms to five years while retaining the requirement that 
the individual must have worked a total of less than 60 days at 
Disciplined Firms.
    Although their impact has been limited in terms of numbers, the 
2003 modifications have had the desired effect of allowing a few firms 
that hire

[[Page 71352]]

APs who worked at Disciplined Firms for less than 60 days more than ten 
years ago to avoid triggering the Requirements. In fact, only two firms 
would have triggered the Requirements under the former method but were 
not so classified because of the 2003 modification, and neither has 
been subject of any regulatory action. In its latest review of the 
Requirements, NFA revisited the question of whether further 
modifications can be prudently made to decrease the potential burden on 
NFA's membership and the Waiver Committee. NFA studied data to examine 
the effect of keeping the less than sixty days at a Disciplined Firm 
requirement while reducing the time away from Disciplined Firms from 
ten to five years.
    NFA's analysis showed that reducing the required period from 10 
years to five years while maintaining the less 60 days cumulative 
tenure at Disciplined Firms requirement yielded a population that is of 
no more cause for concern than the present system. Approximately 1,280 
individuals are exempted from being counted under the current system. 
Reducing the required length of time away from a Disciplined Firm to 
five years would add approximately 275 APs who would not have to be 
counted in determining if a firm triggered the Requirements. As was the 
case with the group that has been exempted under the current ten-year 
test, the number of additional APs who would be exempted under the 
proposed modification who have been subject to any kind of regulatory 
action is small.\7\
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    \7\ Ten individuals who have been subject to actions by NFA or 
the CFTC are exempted from being included in the calculation of 
whether a Member has become a Telemarketing Firm under the Notice's 
current 10-year provision. The proposed modification to reduce the 
required time away from a Disciplined Firm to more than five years 
would exempt six additional individuals who have been subject to 
actions by NFA or the CFTC. All charges against those individuals 
have been resolved. None of the individuals has been permanently 
barred from the industry and none of them are currently registered.
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    Based upon this data, NFA believes that the triggering criteria as 
currently set out in the Notice can be further refined to reduce the 
burden on the membership while still imposing supervisory enhancements 
on firms that pose a concern given the background of their APs and 
principals at Disciplined Firms. Not including APs and principals who 
served less than sixty cumulative days with Disciplined Firms more than 
five years ago in calculating whether a Member is subject to enhanced 
supervision would also serve the efficiency and fairness of the Waiver 
Committee's function by removing a few non-problematic firms from the 
waiver process.
2. Statutory Basis
    The rule change is authorized by, and consistent with, Section 
15A(k) of the Exchange Act.\8\
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    \8\ 15 U.S.C. 78o-3(k).
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B. Self-Regulatory Organization's Statement on Burden on Competition

    The rule change will not impose any burden on competition that is 
not necessary or appropriate in furtherance of the purposes of the 
Exchange Act and the Commodity Exchange Act.\9\
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    \9\ 7 U.S.C. 1.
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C. Self-Regulatory Organization's Statement of Comments on the Proposed 
Rule Change Received From Members, Participants, or Others

    NFA discussed the proposed rule change with its Special Committee 
to Study Customer Protection Issues, which voted to recommend the 
proposed rule change. NFA did not publish the proposed rule change to 
the membership for comment. NFA did not receive comment letters 
concerning the proposed rule change.

III. Date of Effectiveness of the Proposed Rule Change and Timing for 
Commission Action

    The proposed rule change is not effective because the CFTC has not 
approved the proposed rule change. Within 60 days of the date of 
effectiveness of the proposed rule change, the Commission, after 
consultation with the CFTC, may summarily abrogate the proposed rule 
change and require that the proposed rule change be refiled in 
accordance with the provisions of Section 19(b)(1) of the Exchange 
Act.\10\
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    \10\ 15 U.S.C. 78s(b)(1).
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IV. Solicitation of Comments

Electronic Comments

     Use the Commission's Internet comment form (https://
www.sec.gov/rules/sro.shtml); or
     Send an e-mail to rule-comments@sec.gov. Please include 
File No. SR-NFA-2005-01 on the subject line.

Paper Comments

     Send paper comments in triplicate to Jonathan G. Katz, 
Secretary, Securities and Exchange Commission, 100 F Street NE., 
Washington, DC 20549-9303.
    All submissions should refer to File No. SR-NFA-2005-01. This file 
number should be included on the subject line if e-mail is used. To 
help the Commission process and review your comments more efficiently, 
please use only one method. The Commission will post all comments on 
the Commission's Internet Web site (https://www.sec.gov/rules/
sro.shtml). Copies of the submission, all subsequent amendments, all 
written statements with respect to the proposed rule change that are 
filed with the Commission, and all written communications relating to 
the proposed rule change between the Commission and any person, other 
than those that may be withheld from the public in accordance with the 
provisions of 5 U.S.C. 552, will be available for inspection and 
copying in the Commission's Public Reference Room. Copies of such 
filing will also be available for inspection and copying at the 
principal office of the NFA. All comments received will be posted 
without change; the Commission does not edit personal identifying 
information from submissions. You should submit only information that 
you wish to make available publicly. All submissions should refer to 
File No. SR-NFA-2005-01 and should be submitted on or before December 
19, 2005.

    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\11\
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    \11\ 17 CFR 200.30-3(a)(75).
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Jonathan G. Katz,
Secretary.
 [FR Doc. E5-6558 Filed 11-25-05; 8:45 am]
BILLING CODE 8010-01-P