CFTC rule 1.35: Are you kidding!

December 24, 2013 06:33 AM
Blog first appeared in DanCollinsReport on Sept. 18, 2013

I ran into an old friend while I was downtown this week and she made me aware of some new recordkeeping compliance rules that will come into effect before the end of the year that may cause some big problems for smaller introducing brokers and those that have branch offices.

I took a look at the National Futures Association (NFA) notice on the new rules and I understood her concerns. Looking at the language in CFTC Regulation 1.35 and it seems to indicate that IBs would need to record preliminary conversations that may occur over cell phones if it relates to trading or if it starts a conversation that may lead to an order being placed.

The rules, which go into effect on Dec. 21,  seem overly broad and problematic. Check out the language: “The recent amendment specifies that FCMs, certain IBs and RFEDs are required to keep a record of (and therefore tape record) all oral 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 related cash or forward transaction, whether communicated by telephone, voicemail, mobile device, or other digital or electronic media for a period of one year.2

The CFTC’s rulemaking made clear that any conversation must be recorded if it meets the content described in Regulation 1.35(a), regardless of whether it occurred on a firm provided or personal phone. The amendment also requires that the records be kept in a form and manner identifiable and searchable by transaction.”

I talk to commodity trading advisors and brokers all of the time. When calling their general phone number after hours, or if they are busy, you will often hear a message that states something like the following: “Do not place an order over this line. If you want to place an order or check on an existing order, please call our order desk at…”

There are reasons for this. First off those lines (order desk) are recorded, which protects the trader and the broker in case there is an error or miscommunication. Obviously you don’t want to place an order on voice mail as you don’t know when it will be received and there is no one to confirm if or when it was received.

Another important distinction is that brokers and customers talk markets all of the time. What looks good, what is moving, what reports are coming out, what are the expectations for a report etc. Any of which could be said to “lead to the execution of a transaction.” How do IBs build a convention to record cell phone conversations and keep those records in a form and manner identifiable and searchable by transaction.”

This is an overly proscriptive rule initiated by a regulatory regime out of touch with the industry it is regulating and a bit out of control. What is the purpose of all of this data? It is important to have a record of all orders placed but not every conversation leading up to it. A broker and customer can have 10 conversations formal an informal leading up to an order being placed.

I understand that over-the-counter swaps trading was extremely informal and needed to become more structured but a simple rule mandating orders be placed over recorded order desk lines would serve that purpose. Frankly, I don’t think this rule could pass a constitutional challenge. It doesn’t pass the logic test and there doesn’t seem to be anyone at the CFTC asking, ‘what burden will this place on the broker and why do we need a recording of secondary conversations that may lead up to an order being placed?’

My friend’s concern was regarding the cost of expensive recording equipment for IB branch offices. I have no problem with a rule that all lines on an order desk must be recorded. That is a simple common sense regulation. But there is no common sense behind the overly broad rule that actually requires hindsight to know if a certain personal conversation led to a trade further down the road. And then have it searchable by transaction.

The CFTC does offer the following: “Regulation 1.35(a)(4)(i) provides that the CFTC’s Director of the Division of Swap Dealer and Intermediary Oversight (DSIO) may establish an alternative compliance schedule if the requirement to record oral communications is found to be technologically or economically impracticable for an affected entity that seeks, in good faith, to comply with the requirement.”

The specifics of the rule itself are technologically and economically impracticable.

About the Author

Editor-in-Chief of Modern Trader, Daniel Collins is a 25-year veteran of the futures industry having worked on the trading floors of both the Chicago Board of Trade and Chicago Mercantile Exchange.