Trading and Execution Issues

1. Trading and Execution Issues

2. Suitability of Recommendations • NFA Compliance Rule 2-30 • “Know Your Customer” Rule • NFA Members have never had a “Suitability” Rule • Must deal with suitability if planning to offer security futures

3. Suitability of Recommendations • Compliance Rule 2-30(j)(3): • Cannot recommend a transaction/strategy to a non-institutional customer without making reasonable efforts to obtain current information regarding the customer’s financial status and investment objectives (does not apply to discretionary accounts)

4. Suitability of Recommendations • An institutional customer is defined as: • A bank, savings and loan association, insurance company, registered investment company, a registered CPO, or a pool operated by a registered CTA; • An investment advisor registered with the SEC or with a state securities commission, or a registered CTA;

5. Suitability of Recommendations • An institutional customer is defined as: • An investment company, CPO or CTA exempt from registration, a pool operated by an exempt CPO, an investment advisor exempt from both federal and state registration; • A registered Broker-Dealer or FCM; or • Any other entity with total assets of at least $50 million.

6. Suitability of Recommendations • Compliance Rule 2-30(j)(4) • Members cannot make a recommendation without reasonable grounds for believing it is suitable for customer • Based on customer’s current investment objectives, financial situation and needs, and any other information known by the Member

7. Suitability of Recommendations • Compliance Rule 2-30(j)(5) • Members cannot make a recommendation unless he/she has a reasonable basis for believing customer has: • Knowledge and experience to be capable of evaluating the risks of the transaction, and • Is financially able to bear the risks

8. Case Study

9. Fair Commissions • NFA Compliance Rule 2-37(g) • The SEC required NFA to adopt a fair commission rule comparable to NASD Rule 2440

10. Fair Commissions • Most Members will not be required to make any changes to their commission practices with regards to security futures • Almost identical to the provisions of NASD Rule 2440 that relate to agency transactions

11. Fair Commissions • Rule states that Members cannot charge customers more than a fair commission, taking into consideration: • The expense of executing the order • The value of any service the Member may give based on its experience in and knowledge of the security futures • The market in that product (i.e., What’s the going rate?)

12. Fair Commissions • Members who deal with institutional-based customers can continue to negotiate commissions based on volume • The Interpretive Notice is consistent with NFA’s traditional approach • Requires full disclosure of fees and commissions

13. Best Execution • The SEC required NFA to adopt a Best Execution rule comparable to NASD Rule 2320 • SEC believes that best execution is a common law requirement • Even though there is no fungibility or national market system

14. Best Execution • NFA’s Draft Interpretive Notice addresses Best Execution • Interpretation of NFA Compliance Rule 2-4 • Only applies to security futures • Sets forth the Member’s best execution obligation and provides the Member with flexibility in meeting this obligation • Members have an obligation to assure that customer orders receive the most favorable terms under the circumstances

15. Best Execution • Where a security futures is listed on more than one market and not materially different, the Member has an obligation to use reasonable diligence to ascertain where the order will receive the most favorable execution available

16. Best Execution • Best Execution does not apply when a customer instructs the Member to direct an order to a particular market

17. Best Execution • Guidance for complying with Best Execution obligation: • Member should consider the relevant facts and circumstances in determining which market to route an order. Such as:

18. Best Execution • The character of the market including, but not limited to, price, volatility, liquidity, depth, speed of execution, and pressure on available communications • The size and type of transaction • The location and accessibility to the customer’s intermediary of primary markets and quotation sources

19. Best Execution • Members and Associates must also consider differences in the fees and costs associated with executing the transaction in each market

20. Best Execution • Other issues: • Members cannot channel an order through a third party unless they can show that by doing so, they obtained the most favorable execution available for the customer unless: • Specifically instructed by the customer or account controller, or • It is necessary in order to obtain the execution of an order

21. Best Execution • Other issues: Member firms not fulfilling best execution obligation will be deemed to have violated NFA Compliance Rule 2-4

22. Best Execution • Requirement to review execution quality: • Members are not expected to evaluate execution quality on an order-by-order basis, however, the Member • Should consider the quality of execution when establishing order-routing practices, and

23. Best Execution • Must perform a regular and rigorous review of those practices to ensure that order flow is directed to markets providing the most advantageous terms for execution of customer orders (e.g., must consider how technology changes impact order-routing practices)

24. Best Execution • Not simply a matter of best price • All factors are important in determining whether a customer order received the most favorable terms available under the circumstances

25. Best Execution • NFA will provide further guidance if necessary as the markets for security futures products evolve

26. Margins • Final rules have not been issued • Currently it is anticipated that the margin requirement will be 20% of the current market value of such position

27. Margins • The current market value will mean: • The product of the daily settlement of such security future as shown by any regularly published reporting or quotation service

28. Margins • FCM Notice Registered Broker-Dealer • Customer will follow the existing rules for margining (futures account) • A stand alone rule will most likely be issued for margin purposes • Fully Registered Broker-Dealer FCM • Will follow the account (futures or securities)

29. Margins • For both, the collection, collateral, etc., will follow the account (securities or futures)

30. QUESTIONS?