Jun 29, 2015 Bryant Craft, Turnkey Trading Partners – June 25, 2015 Until recently I was working as a field auditor with the National Futures Association (“NFA”). During my time at NFA, the self-regulator was enduring a great deal of criticism. After the failures of MF Global and PFG calls for the heads of NFA’s leadership were coming in at a frenetic pace. While this period was no doubt painful for NFA to endure, the long hard look in the mirror they had to take as an organization became transformative. Today NFA is implementing some of the most sweeping changes to its audit approach since becoming the industry’s lead watch dog. After joining Turnkey Trading Partners (“Turnkey”, a leading compliance service provider) I have frequently been asked by clients what internal changes NFA has made since the collapse of the aforementioned FCMs and final implementation of the Wall Street Reform Act (“Dodd Frank”) regulations. In this article I will provide some of my insights from working at NFA while also offering a glimpse at what you might expect during your next regulatory examination. Internal Controls Testing A key area that NFA has begun focusing on during routine audits is the testing of certain internal controls. Adding internal controls testing is an expansion of NFA’s initial mission, which was and still is, to ensure the integrity of the futures industry. While audits previously focused almost entirely on whether or not member firms were complying with both CFTC and NFA requirements, the assessment of internal controls is intended to provide additional assurances that a registrant is able to meet its ongoing regulatory obligations. More specifically, NFA (rightly) believes that correctly instituted internal controls will help to ensure a company functions properly long after they have left the field. As of the time I had departed from NFA they had determined they would focus on three key areas at member firms: Evaluating any established and existing written procedures related to internal controls processes if they are available. Considering a firm’s day to day processes, specifically their effectiveness and overall implementation. An evaluation of the personnel at the firm relative to their ability to carry out each of the aforementioned processes. One of the most frustrating issues for members when it comes to considering internal controls is the current lack of guidance provided by the CFTC and/or NFA on the topic. Turnkey clients are now being asked by NFA auditors about firm internal controls. Accordingly, registrants should expect to have in-depth conversations with an NFA audit team about internal controls during their next examination. Firms should take a pro-active approach to internal controls and begin considering practices taking place on a day to day basis. The use of check lists, audit programs, or other documentation and forms can be helpful for demonstrating controls and procedures that you may already be implementing but have simply not taken time to write down. Turnkey is presently working with clients to create effective internal controls practices, and providing written policies, so that they are prepared during their next review. It would be wise for all NFA member firms to think through their internal controls processes and be prepared before NFA calls to schedule their next exam. Experienced Auditor Standard NFA’s audit teams will be using what is known as the “Experienced Auditor Standard” when approaching reviews of member firms. The goal of following this standard is to better align NFA’s examination practices with those used within the certified financial audit space. In summary, what this means is that the scope of audit testing must clearly define the work to be performed, detail the purpose of the work being conducted, provide details about the source of the information used to evaluate a process or audit item, and then to provide a detailed discussion of the ultimate conclusion reached through the area of testing. NFA has begun to focus heavily on strengthening the “source of the information” component of this standard. NFA members will now experience audit teams trying to obtain some sort of documented support or evidence for each area of testing conducted. If no such records exist, firms will be asked to provide a written representation regarding the responses they have provided to NFA. Generally, the idea is that NFA will no longer rely upon oral representations or previous audit experiences. They want to ensure that the firms being reviewed are held accountable for their representations, which can only be achieved through the documentation of responses. NFA audits can be very stressful for both member firms and the audit team. It is easy for either the firm or the audit team to be misunderstood, information misremembered, or an erroneous answer provided when people are put on the spot and encouraged to respond immediately. Prior to your next NFA review, it would be prudent to ensure that, as often as possible, company activities are documented in writing and/or supported by your record keeping. NFA will require verification that company practices and day to day activities are being performed in accordance with written policies. It will no longer be good enough to simply state that a daily, weekly, or monthly routine review function is occurring. NFA will request tangible proof a company’s activities are being carried out as described within their policy manuals. Miscellaneous Changes Quality Review – NFA has begun to implement an additional quality review step to finish its audit process. This involves a final review of audits required to be done by someone that is independent from the actual testing. The goal with this measure is to ensure the accuracy of the testing, while also improving upon audit continuity and overall findings documentation. This new step is likely to increase the amount of time it takes NFA to issue a final audit report. It also is likely to increase the amount of time NFA audit teams will be onsite at member firm offices. Be prepared for an increase in requests for additional documents well after NFA auditors have left the field. Document Deadlines – NFA will more frequently be giving firms specific deadlines and time-frames that they expect to be met with respect to document requests. This includes the initial audit request list that is sent ahead of field work, as well as all subsequent requests during and after field work. NFA’s goal in moving to a more formal request approach is two-fold. First, to improve the speed and efficiency of the audit process and second, to prevent or minimize a firm’s time available to falsify requested documents. Our industry was given a black eye when MF Global and PFG failed. Fortunately NFA is responding by sharpening their audit processes in an attempt to ensure such catastrophes never occur again. While NFAs latest audit process changes will no doubt increase the time and cost burden on CFTC Registrants and NFA members, in my opinion, they were necessary. While I may not agree with every change that is being implemented, NFA’s focus on internal controls as well as their requiring of more documentation throughout the audit process is a good thing. It will never be possible for any regulatory agency to stop fraud. Rather the best anyone can hope for is that they are doing the best they can with the tools afforded them to ensure fraud is dealt with quickly. NFA is making steps in the right direction even if those steps do cost additional time and money. Our industry needs a well-respected and competent regulatory framework to continue to grow. Unfortunately, given the futures industry’s past transgressions, many in the public won’t be willing to invest in the commodity markets otherwise. While to some, what NFA is trying to accomplish may be a day late and a dollar short, to me it is a needed step in the right direction for our industry as a whole. ————————– Bryant Craft is a Senior Consultant at Turnkey Trading Partners (“Turnkey”), a consulting firm that specializes in assisting CFTC registrants and NFA members (FCM, IB, CTA, CPO, Futures, Forex, and Swap Firms) with their regulatory and operational needs. Prior to joining Turnkey Bryant worked at the National Futures Association (“NFA”) as field auditor. During his time at NFA he assisted with and conducted numerous reviews of NFA member firms. He also previously worked in the research department for Centennial Group, a registered financial advisor. Bryant has a degree in finance from the Eli Broad School of Business at Michigan State University. While in college he was on the varsity wrestling team for the Spartans and was named to the Big Ten’s all-academic team on several occasions. To reach Bryant for any questions or comments on this article you may contact him directly at (312) 239-8905.