May 26, 2021 By: Greg Baracy At any given time, Turnkey Trading Partners (“Turnkey”) is engaged in supporting many of our customers that are undergoing an NFA, CFTC, or CME related examination. This is a tremendous benefit to anyone that chooses to work with our firm as a compliance and operational consultant. Turnkey’s exposure to ongoing regulatory examination allows for our staff to have its proverbial finger on the pulse of which areas regulators are placing a new testing emphasis on. One of the trends we have identified during recent audits of Introducing Brokers (“IBs”) is that National Futures Association, Commodity Futures Trading Commission, and CME Group examiners are becoming increasingly granular about their testing of trade execution record keeping. In particular, we are seeing attempts to evaluate how brokerage firms are able to “recreate the trade”. More specifically, the degree to which NFA is now testing these processes is more focused than Turnkey staff has seen in years past. This makes it imperative that each and every IB has a robust documentation process for how all trades are handled and recorded. Record Keeping Requirements Perhaps the best place to consider what NFA, CFTC, and CME expectations are with respect to recreating the trade is CFTC Regulation 1.35(a). While not all brokers fall under this regulation, examiners are increasingly playing the “supervision” card to attempt to enforce the regulation’s record keeping obligations and methods. It seems that during recent exams, regulators want all firms, not just those obligated to CFTC 1.35(a) to be able to adhere to the “spirit” this regulation with respect to their order execution record keeping practices. For those who are not familiar with CFTC Regulation 1.35(a), the regulation requires that brokers of commodity interest and related cash or forward transactions, who have generated $5m or more in aggregate gross revenues over the preceding three years: “Keep all oral and written communications provided or received concerning quotes, solicitations, bids, offers, instructions, trading, and prices that lead to the execution of a transaction in a commodity interest and any related cash or forward transactions, whether transmitted by telephone, voicemail, facsimile, instant messaging, chat rooms, electronic mail, mobile device, or other digital or electronic media.” It is Turnkey’s opinion that every firm, regardless of their obligation to CFTC 1.35(a), deeply reconsider its current record keeping practices. Based on our observations during recent examinations, firms of all sizes are being asked to reconstruct selected trades to do this they are being asked to demonstrate that each step of the trade execution process has be adequately documented and recorded. So, what can registrants do to be able to fully satisfy this new and increasing audit standard? The Trade Process Every trade process begins in one of two ways, either the client will engage the broker or the broker will engage the client. Let’s use a simple example to discuss the first scenario: A broker receives a text message from a client. The client wants to know what is going on in the wheat market. Texts are exchanged regarding market conditions. The client requests a phone call for follow up. During the subsequent phone call the broker states that other clients have been selling wheat at a premium. Based on this information the client requests to sell wheat on a market order. The broker accepts the order, calls in or places a trade electronically, and the order is executed. The customer then receives a confirmation, and the trade process has been completed While the preceding example is basic, and it seems as if the broker has acted according to expectations, what could be missing from the above process if anything? In many instances, the firm accepting an order such as the one in the example above, never considered its record keeping obligations. First, were the text messages between the broker and the client captured and recorded? Was the phone call recorded? Should it have been? If the texts were recorded, what if they had been made via personal cell phone? Are personal cell phone texts archived? What if the broker had used an instant message platform? How is that communication stored? These are some critical components that must be considered; especially if your firm is asked to “recreate the trade” during its next regulatory examination. The Testing Process Auditors will attempt to recreate selected transactions from trade statements. Listed below are some of the materials that examiners will likely request which will allow them to engage in their testing process: ALL phone records of a pre-determined time frame ALL text or instant messages of a pre-determined time frame ALL social media correspondence (if firm permits use of social media) ALL order tickers of a pre-determined time frame ANY other client communications in the time frame selected Examiners will then engage in the testing process is as follows: Select, at random, order tickets to review Identify the dates the orders were placed and tie those back to phone call/text messages, or other forms of communication. Listen to the phone call/review the text message or other forms of communication which correspond to the selected order. Identify if there are any high-pressure sales tactics, presentations of misleading information, inappropriate suggestions, etc. Confirm that the order was accepted, placed, executed and handled in accordance with both regulatory and market best practice expectations. Consider if CFTC 1.35(a) was followed OR if not applicable supervisory and record keeping obligations are properly being upheld. Recommended Best Practices So, what are some so called “Best Practices” in this area? Particularly what should brokers do if they do not fall under CFTC 1.35(a) but are still being asked to “recreate the trade” during an examination? All firms should consider mandating the use of only company issued phones. These phones should be connected to an archiving platform or software service. Many brokers utilize RingCentral, Cell Trust, Smarsh or other similar vendors to capture phone recordings, text messages, and other client communications. If it is not possible to issue company phones to all brokers, firms should then consider banning the use of personal phones and/or text messages for conducting company related business. If a broker is talking on a personal phone with a client, and they want to discuss brokerage business, your policy should be that the broker must hang up and continue the call on a dedicated company line. This line should be set up for proper record keeping. If personal phones are permitted, firms should consider installing applications on these devices to ensure regulated activity is properly captured and archived. Firm’s that allow brokers to use social media for business purposes must have in place a mechanism for capturing ALL correspondence between the broker and the public. Additionally, if a broker uses their personal social media account(s) for business purposes, these must also be reviewed and captured to adequately monitor solicitation and/or trade practices Robust documentation of the time the order is 1) Accepted 2) Placed 3) Executed and 4) Confirmed is required. Even when utilizing electronic platforms, ensure offices on different time zones have harmonized timing devices. In this area UTC is often utilized. Lastly, firms should ensure that an internal trade process review is in place and utilized on a regular basis. One of the worst things a firm can do is put in place a record keeping policy and then not abide by it. The only way to ensure a process is followed and works is to test it before an examiner does. Conclusion As a firm, even if you do not fall under CFTC 1.35(a) you should consider implementing some, if not all, of the above best practices. Doing so will allow you to more easily “recreate the trade” when asked to do so during a regulatory exam. If the trends Turnkey has been seeing continue, this area is something that may be evaluated during your next examination. Beyond this, having an accurate record of pre and post trade activities can protect your firm from untoward broker behavior. It can also help to resolve potential costly errors and miscommunications with clients. Each year compliance obligations grow. Keeping up with these obligations can be very difficult and time consuming. Let Turnkey Trading Partners help you to stay compliant in 2021! To further discuss your firm’s operations regarding CFTC/NFA regulatory obligations, please contact us today via (312) 324-0040 or by clicking here. About the Author: Greg Baracy has over 15 years of experience in the financial services industry. His expertise spans across many verticals such as investment banking, financial advisory, quantitative and qualitative analysis. His area of focus at Turnkey is in new business origination, customer on-boarding and relationship management. Greg also regularly conducts reviews of customer outside office locations for Turnkey clients. Before joining Turnkey, he managed the Mid-Atlantic, Midwest and Northeast portfolio of municipal issuers for one of the big three Wall Street Bond Rating Agencies. During his tenure, he grew the agencies portfolio to its largest size since its inception. He holds a degree in Economics and Applied Policies from Michigan State University.