NFA Proposes Guidance on Diligent Supervision of Associated Persons
UPDATE: On 1 May 2025, NFA withdrew Interpretive Notice 9083. The guidance remains available on NFA’s website for industry participants’ review.
On 21 April 2025, the National Futures Association (NFA) submitted to the US Commodity Futures Trading Commission (CFTC) a proposed interpretive notice entitled Compliance Rules 2-9(a) and (d), 2-36(e) and 2-51(d): Member Supervisory Obligations for Associated Persons (the Notice), which provides specific guidance and minimum standards related to NFA members’ duty to diligently supervise their Associated Persons (APs).1 The Notice, which affects NFA Compliance Rules 2-9(a) and (d), 2-36(e), and 2-51(d), provides NFA members with the necessary elements of an effective supervision program to oversee APs.2 The Notice serves as a reminder of the importance of diligent supervision throughout the derivatives industry. The Notice could become effective as early as 1 May 2025. Generally, NFA issues a subsequent notice with a specific effective date. NFA members should monitor for this announcement.
In this client alert, we describe the Notice and also describe guidance from the CFTC and from CFTC-registered designated contract markets (DCMs or exchanges) concerning their duty to diligently supervise.
NFA’s Requirement of Diligent Supervision
Background: Overview of NFA Members’ Supervision Obligations Under Rule 2-9
Pursuant to NFA Compliance Rule 2-9, NFA members (i.e., futures commission merchants (FCMs), introducing brokers (IBs), commodity trading advisors (CTAs), commodity pool operators (CPOs), swap dealers, major swap participants, and their APs) must diligently supervise all aspects of their employees’ and agents’ commodity interest or swap activities.3 Generally, supervision is the oversight of persons who trade in futures or other commodity interests to ensure that their trading activities are compliant with applicable rules and regulations.4
The failure to maintain a sufficient supervisory program may have severe consequences. Settlements between the NFA and NFA members charged with violating NFA Compliance Rule 2-9 have included fines ranging from US$10,000 to US$1 million, depending on the severity of the supervisory failures and the nature of the other charged violations.5 Other settlements arising from alleged violations of NFA Compliance Rules, including NFA Compliance Rule 2-9, have included bans from NFA registration that range from two years to permanent.
The Notice’s New Minimum Standards for Supervisory Frameworks
The Notice sets forth in detail NFA’s expectations for the minimum standards of NFA members’ written policies and procedures governing supervision (Supervisory Framework). The Notice explains that NFA will continue to provide flexibility to NFA members since no program is one-size-fits-all.7 Although an NFA member has flexibility to develop and implement supervisory policies and procedures tailored to its particular business and risks, the minimum components detailed in the Notice are requirements for an NFA member’s Supervisory Framework.8 Failure to implement the minimum standards set forth in the Notice may be deemed a violation of NFA Compliance Rules.9
The Notice requires NFA members to have a written Supervisory Framework and to assess the Supervisory Framework to confirm that it is tailored to mitigate risks on an ongoing basis. The Supervisory Framework applies to an NFA member’s activities related to commodity interests and digital asset commodities (i.e., Bitcoin and Ether), regardless of where an AP is located. That said, different measures may be needed for APs that work remotely. The Supervisory Framework should address whether a third-party service provider assists in the NFA member’s supervisory obligations. In addition, the Supervisory Framework should identify areas within the firm that are responsible for each AP supervisory function, along with the person (by title or role) that is responsible for performing each such function. In the Notice, NFA goes on to provide that the Supervisory Framework must incorporate due diligence procedures to ensure that APs are qualified and address the NFA member’s training obligations.
For each AP activity, the Supervisory Framework must identify:
- The specific procedures used to identify potential areas of noncompliance;
- Procedures for escalation and resolution of noncompliance matters;
- The frequency with which tasks in the Supervisory Framework are performed; and
- Recordkeeping policies that evidence that the Supervisory Framework was implemented, assessed, and appropriately tailored to the risks of the firm.
The Supervisory Framework must address recordkeeping of oral and written communications. For example, along with the requirement that NFA members capture and retain pre-trade communications, the Notice specifies that the written policies and procedures should specify what communication methods are approved for an AP’s use, how the firm will retain the communications, and how the firm will prohibit communication methods that are not captured and retained.10
The Notice also highlights certain ongoing practices that NFA members should undertake to ensure compliance with the minimum standards. With regard to monitoring AP’s trading activities, for instance, an NFA member’s supervisory framework should include measures to review daily trade reports, monitor post-trade activities, and compare trading results among an AP’s customers, along with other measures, to identify potential trading misconduct and market abuses.11
Other Interpretive Notices Affected by the Notice
The Notice also affects other interpretive notices. NFA has proposed to update Interpretive Notice 9019, Supervision of Branch Offices and Guaranteed IBs, to align those supervisory requirements with those included in the Notice and extend these requirements to members’ digital asset commodity activities.12 The changes to Interpretive Notice 9037, Guidance on the Use and Supervision of Websites and Social Media, streamline supervisory requirements related to websites and social media.13 Finally, the NFA made changes to Interpretive Notice 9053, Forex Transactions, by referring to the Notice and specifying that an adequate supervision program includes day-to-day monitoring of the firm’s operations.14
Duty of Diligent Supervision in the Derivatives Industry
The concept of “diligent supervision”—a cornerstone of customer protection—requires the creation and implementation of a compliance program that is reasonably appropriate for the business of the registrant, member, or trader.15 In addition to the NFA, the CFTC and DCMs impose a duty to diligently supervise on CFTC registrants and all other market participants, respectively.16 In light of the Notice, a refresher on market participants’ supervisory obligations may be instructive.
CFTC Registrants’ Duty to Diligently Supervise
The CFTC requires its registrants—which generally are also NFA members—to diligently supervise the handling of commodity interest accounts “carried, operated, advised or introduced by the registrant” and all activities relating to the registrant’s business by its partners, officers, employees, and agents.17
A violation of CFTC Regulation 166.3, which applies to all CFTC registrants except APs with no supervisory duties, is demonstrated by showing either that (1) the registrant’s supervisory system was generally inadequate, or (2) the registrant failed to perform its supervisory duties diligently.18 A supervisory system’s adequacy depends on the facts and circumstances of the registrant’s activities.19 The CFTC generally alleges that that supervisory systems are inadequate when there is a lack of written policies and procedures, a failure to provide adequate training on a registrant’s trading activities, or a failure to ensure that agents and employees follow the established procedures (or all of the above).20
It is important to note that, according to the CFTC, a violation of Regulation 166.3 may be found even in the absence of an underlying violation of the Commodity Exchange Act (CEA) or CFTC regulations. Based on past CFTC enforcement actions, orders, and settlements, supervisory failures could be found if a registrant does not adhere to its internally developed policies and procedures.21 For example, the CFTC filed and simultaneously settled a case where the CFTC alleged that an FCM did not ensure that its employees and agents followed written procedures in its compliance manual.22 The FCM, without admitting or denying the charge, settled the stand-alone failure-to-supervise claim for US$200,000.23
Futures Exchange Approaches to the Duty to Diligently Supervise
As CFTC-registered DCMs, ICE Futures U.S., Inc. (ICE) and the four CME Group exchanges (CBOT, CME, COMEX, and NYMEX) (collectively, CME) are required by the CEA to establish, monitor, and enforce compliance with rules designed to prohibit abusive trading practices.24 Parties that trade on ICE or CME, and those that benefit from such trading, are deemed to agree to being bound by exchange rules, including those requiring diligent supervision of employees and agents.25 Put simply, any person who executes a trade, or even places a bid or offer, on the exchanges is deemed to consent to exchange jurisdiction.
ICE and CME have similar expectations for traders’ supervision programs.26 The disciplinary actions described below provide details and context about traders’ conduct that led to alleged violations of the exchanges’ rules related to diligent supervision.
Trading firms’ supervisory systems, policies, and procedures need to suit the trading activities of the trading firm.27 For example, if a firm engages in block trading subject to ICE’s rules, the firm must implement policies designed to address block trading or risk a disciplinary action related to a violation of ICE Rule 4.01(b).28 Failure to supervise charges may be brought against individuals and, thus, not only against firms. CME brought a disciplinary action against a trader who failed to diligently supervise his employee, because appropriate policies and procedures were not in place prohibiting frontrunning.29
ICE and CME require that traders regularly monitor their employees and agents for compliance with their rules.30 Both exchanges consider fully and semi-automated trading systems (each, an ATS) to be agents of firms trading on their exchanges and, thus, subject to such firms’ supervisory obligations.31 For example, ICE charged a trading firm with violating ICE Rule 4.01 after it allegedly deployed an ATS on ICE without adequately testing the ATS, resulting in the ATS entering orders at prices far from the prevailing bid or offer and without intent to execute bona fide transactions.32 Similarly, when a trader on CME used an ATS without monitoring it (which resulted in disruptive price movements in certain futures markets), CME charged him with a violation of CME Rule 432.W (i.e., making it an offense to fail to supervise).33
The duty of diligent supervision on these exchanges includes the duty to take corrective action to address noncompliance and deficiencies in its supervision program.34 In one disciplinary action, a trading firm allegedly violated ICE Rule 4.01 when it redeployed a malfunctioning ATS that previously disrupted crude oil markets, even though the firm had knowledge that the ATS was not updated to prevent future disruptions.35 As another example, a trading firm allegedly violated CME Rule 432.W when its employees failed to detect account changes and trade transfers between customer accounts—despite customer complaints putting the trading firm on notice of these changes and transfers—thus allowing brokers to allocate gains to accounts they controlled and avoid losses in those same accounts for years.36
Each exchange has also exercised its disciplinary authority in idiosyncratic ways that traders should be aware of. The disciplinary actions described below show circumstances that led to alleged violations of supervisory duties.
ICE has brought a disciplinary action on a stand-alone failure-to-supervise claim, similar to how the CFTC has brought claims based on stand-alone violations of CFTC Regulation 166.3.37 ICE may pursue failure-to-supervise charges even if it may believe that it cannot prove that other violations occurred.38 CME Rule 433 establishes strict liability for employers and individuals, making them liable for the acts of their employees, even if the employers themselves are not negligent.39 In one disciplinary action, CME charged a trader with a violation of CME Rule 433, and not CME Rule 432.W (i.e., CME’s supervisory obligation), because his employee, on multiple occasions, used credentials assigned to the employer to engage in allegedly disruptive trading.40 This CME case is unusual because it charged an individual instead of a firm with failing to diligently supervise an employee.
Conclusion
Robust compliance is good for business. It helps protect the firm, its employees, and its customers. It minimizes the risk of enforcement actions and private litigation. NFA members should review the guidance and minimum standards contained in the Notice and the revisions to Interpretive Notices 9019, 9037, and 9053 to ensure their supervisory program satisfies the minimum standards. NFA members should also remember that their duty to diligently supervise is ongoing: An adequate supervisory program requires routine assessment of the supervision framework to ensure it is appropriate to mitigate risks specific to the firm’s business.
The publication of the Notice is also a good opportunity for all derivatives market participants—not just NFA members—to review their policies and procedures and consider whether their supervisory programs align with their trading activities and satisfy regulatory requirements.
This publication/newsletter is for informational purposes and does not contain or convey legal advice. The information herein should not be used or relied upon in regard to any particular facts or circumstances without first consulting a lawyer. Any views expressed herein are those of the author(s) and not necessarily those of the law firm's clients.
