## _cr10125 ## Source details **Canonical URL:** [_cr10125](https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2010/_cr10125.pdf) ## Other formats - [Markdown version](/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2010/_cr10125.pdf.md) - [Structured JSON version](/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2010/_cr10125.pdf.json) --- ### I. Summary implementation, scope, and methodology - Assessment conducted by Susanne Bergsträsser, Richard Britton, and Tanis MacLaren from October 7 to November 3, 2009 as part of the Financial Sector Assessment Program (FSAP). - Based on the IOSCO Objectives and Principles of Securities Regulation and associated methodology adopted in 2003, updated in 2008; Principle 30 assessed separately. - Conclusions based on information and findings as of November of 2009. - Sources used include legislation and regulatory documentation; self-assessment questionnaires by the CFTC and the SEC; discussions with CFTC and SEC staff, SROs, exchanges, law enforcement, industry, law/accounting professions; Joint Report (October 16, 2009); Department of the Treasury White Paper. - Context and caveats: - Assessment carried out post-crisis; notes reforms introduced recently but requires consistent track record to judge efficacy. - Did not significantly address state-level securities regulatory regimes. ### II. Institutional and market structure — overview - Federal split of responsibilities: - CFTC: supervision of commodity futures market under the CEA as modified by the CFMA. - SEC: regulation of securities markets and participants under Securities Act of 1933; Securities Exchange Act of 1934; Trust Indenture Act of 1939; Investment Company Act of 1940 (ICA); Investment Advisers Act of 1940 (Advisers Act); Sarbanes-Oxley Act of 2002 (SOX). - Complementary elements: regulations, rules, guidance, court decisions, no-action letters; state regulators and DOJ participate in enforcement. - Reliance on SROs: FINRA (broker-dealers), NFA (commodity futures intermediaries and commodity pool operators). - Specialized intermediary categories: BDs, FCMs, IBs, IAs, CTAs, CPOs. ### III. Market developments and key statistics - Futures market: - Increase since CFMA (2000) in number of futures and options contracts by 570 percent and in volume of trading by 594 percent. - Client funds held by FCMs rose by 354 percent over the same period. - Four exchanges in the CME group now account for over 90 percent of total volume. - CFTC full time equivalent staff declined by 18 percent during this period. - Equity market: - Between 2000 and 2007, daily volumes increased by 62 percent. - During 2008, volumes increased by 52 percent over 2007, taking the 10-year growth to 255 percent. - The 10-year growth in equity market volume was 44 percent of the growth rate of on-exchange futures markets. - Increase in pink sheet OTC stocks: 780 percent increase in number of shares traded daily between 2001 and 2008 (from US$200 million in 2001 to US$540 million in 2008). - As of March 2010: 11 registered national securities exchanges, 79 registered alternative trading systems (ATS), and 4 electronic communications networks (ECNs). - Futures statistics (volume of contracts traded, millions): 2000: 580; 2001: 723; 2002: 1,004; 2003: 1,225; 2004: 1,518; 2005: 1,920; 2006: 2,421; 2007: 3,085; 2008: 3,446. - Futures statistics (number of contracts): 2000: 266; 2001: 250; 2002: 278; 2003: 538; 2004: 662; 2005: 906; 2006: 1,135; 2007: 1,365; 2008: 1,521. - Client funds held by FCMs (US$ billions): 2000: 56.7; 2001: 59.7; 2002: 64.3; 2003: 75.6; 2004: 94.5; 2005: 116.7; 2006: 138.0; 2007: 155.4; 2008: 201. - CFTC full time equivalent staff: 2000: 546; 2001: 514; 2002: 521; 2003: 497; 2004: 517; 2005: 491; 2006: 493; 2007: 437; 2008: 448. - Daily average volume of shares traded (millions): 2000: 2,851; 2001: 3,206; 2002: 3,257; 2003: 3,217; 2004: 3,323; 2005: 3,458; 2006: 4,004; 2007: 4,769; 2008: 7,282. - SEC full time equivalent staff: 2000: 2,840; 2001: 2,936; 2002: 3,009; 2003: 3,060; 2004: 3,550; 2005: 3,851; 2006: 3,695; 2007: 3,465; 2008: 3,511; 2009: 3,656. - Overall SEC staff numbers 24 percent up in the period noted, peaking in 2005 and falling back subsequently; increased somewhat in 2008/9. - Registered intermediaries and assets: - Number of BDs declined 6 percent over the 5-year period, while total net capital of these firms increased nearly 80 percent. - Number of IAs up 32 percent and assets under management up 79 percent. - U.S. CIS market: nearly US$10 trillion in assets under management in funds registered with the SEC. - 2008 saw a sharp drop in assets under management (-20 percent); by end-September 2008 total assets had recovered somewhat. - 2008 asset shift from long-term funds to money market funds; since beginning of 2009 trend reversed. - Mutual fund assets (US$ billions): - 2004: Equity 4,384.0; Hybrid 519.3; Bond 1,290.4; Money Market 1,913.2; Total Assets 8,106.9 - 2005: Equity 4,940.0; Hybrid 567.3; Bond 1,357.4; Money Market 2,040.5; Total Assets 8,905.2 - 2006: Equity 5,911.4; Hybrid 653.1; Bond 1,494.3; Money Market 2,354.8; Total Assets 10,413.6 - 2007: Equity 6,521.4; Hybrid 713.4; Bond 1,678.9; Money Market 3,085.8; Total Assets 11,999.5 - 2008: Equity 3,708.1; Hybrid 494.2; Bond 1,567.2; Money Market 3,832.3; Total Assets 9,601.8 - Sept '09: Equity 4,511.2; Hybrid 576.6; Bond 1,973.1; Money Market 3,551.8; Total Assets 10,612.7 - %Change Sept ’08 – Sept ‘09: Equity -20.0%; Hybrid -13.1%; Bond 12.7%; Money Market 1.8%; Total Assets -8. 4% (format as presented in source) - Mutual fund net new cash flow (US$ billions): - 2004: Equity 177.9; Hybrid 42.7; Bond -10.8; Money Market -156.6; Total 53.2; Total Long-Term Funds 209.8 - 2005: Equity 135.5; Hybrid 25.2; Bond 31.3; Money Market 63.1; Total 255.2; Total Long-Term Funds 192.0 - 2006: Equity 160.1; Hybrid 7.1; Bond 60.6; Money Market 247.5; Total 475.2; Total Long-Term Funds 227.8 - 2007: Equity 95.6; Hybrid 22.2; Bond 108.6; Money Market 661.5; Total 887.9; Total Long-Term Funds 226.4 - 2008: Equity -237.7; Hybrid -21.7; Bond 33.0; Money Market 631.7; Total 405.2; Total Long-Term Funds -226.4 - Sept '09: Equity 12.4; Hybrid 3.1; Bond 220.1; Money Market -291.3; Total -55.7; Total Long-Term Funds 235.6 - %Change Sept ’08 – Sept ‘09: Equity 118.1%; Hybrid -49.24%; Bond 128.6%; Money Market -184.7%; Total -114.7%; Total Long-Term Funds 595.0% - Commodity pools (CFTC): number of pools (to nearest hundred) and aggregate NAV (US$ billions): 2004: 3,100; $1,348; 2005: 2,600; $564; 2006: 2,100; $513; 2007: 1,700; $573; 2008: 1,500; $316. ### IV. Commodity pools and intermediary counts (detailed) - Commodity pools: number of commodity pools reporting to the CFTC down 52 percent over the 5-year period; aggregate assets under management down 77 percent over the 5-year period. - Drivers: trading losses, decreased new contributions, ceasing business, conversions to funds exempt from CFTC reporting. - Futures and securities intermediaries (as at September 30) — exact figures: - FCMs: 2004 211, 2005 211, 2006 210, 2007 197, 2008 179 - IBs: 2004 1,664, 2005 1,711, 2006 1,740, 2007 1,699, 2008 1,647 - CTAs: 2004 2,640, 2005 2,635, 2006 2,589, 2007 2,601, 2008 2,534 - CPOs: 2004 1,810, 2005 1,782, 2006 1,570, 2007 1,416, 2008 1,353 - BDs: 2004 5,219, 2005 5,134, 2006 5,052, 2007 4,969, 2008 4,923 - IAs: 2004 8,535, 2005 9,017, 2006 10,662, 2007 10,817, 2008 11,292 - Total Net Capital of BDs (US$ millions): 2004 87,127, 2005 101,334, 2006 102,969, 2007 128,244, 2008 155,468 - Total AUM by Reg’d IAs (US$ trillions): 2004 242, 2005 732, 2006 238, 2007 43 - Median AUM of Reg’d IAs (US$ millions): 2004 99, 2005 108, 2006 116, 2007 123, 2008 125 - Notes: counts include firms registered with one of the two agencies only; firms registered in more than one category counted in each category. ### V. Preconditions for effective securities regulation - General preconditions present: no significant barriers to entry/exit; competition encouraged; foreign participation welcomed. - Legal/accounting systems support implementation; commercial law supports cross-border trade and corporate governance. - Bankruptcy/insolvency frameworks and professionals are sophisticated. - Regulators have legally enforceable powers frequently tested by courts. - Taxation framework supportive of industry operations. ### VI. Main findings, systemic complexity and institutional issues - Complexity: U.S. securities and futures markets and regulatory framework are very complex; division of responsibility and specialization can hinder cross-cutting assessments. - Recommendation: greater focus on systemic issues across securities and futures markets. - Institutional culture: Chairmen of CFTC and SEC recognize need for change; institutional culture difficult to transform due to industry pressure. - Priority actions: simplify internal/institutional structures; establish better internal management and communication to foster learning and response. - Manifestations: enforcement and OTC derivatives regulation are key problem areas affecting the entire system. ### VII. Assessment highlights by principle groups (selected) - Principles relating to regulator (1–5): - Responsibilities of CFTC and SEC clearly stated, but gaps in market coverage and scope of authority exist. - Funding insufficient; no funding method assuring continuing funding for long-term capital projects. - Activities/processes transparent; staff subject to codes of ethics/conduct. - Self-regulation (6–7): - SROs play significant supervision role; authorization regimes differ between securities and futures. - CFTC has insufficient authority post-CFMA in some exchange areas; Joint Report legislative recommendations seek to address deficiencies. - Enforcement (8–10): - Anti-fraud Rule 10b–5 and courts effective; private litigation powerful for compliance. - CFTC and SEC have broad investigative/surveillance powers. - Shortcomings in SEC enforcement program identified; resources for SEC-registered IA examinations insufficient (recommend increase to match BD exam frequency where responsibility shared). - Resources for criminal prosecution of securities fraud too limited. - Cooperation (11–13): - CFTC and SEC can share information broadly; both signatories to IOSCO MOU. - Issuers (14–16): - Extensive disclosure for initial and continuing obligations; limited authority over municipal issuers. - CIS (17–20): - Operators/marketers of public CIS subject to registration; initial eligibility criteria should be more extensive and demonstrated prior to registration. - Valuation under U.S. GAAP, independent auditor verification at least annually; custodian not required to be arm’s length. - Market intermediaries (21–24): - Minimum entry standards include integrity criteria; capital/internal control requirements apply to FCMs, IBs not fully guaranteed by FCM, and BDs. - Advisers not subject to capital requirements or operational capacity assessments prior to licensing. - Prudential requirements need improvement to address funding, liquidity, reputational, and affiliate risks. ### VIII. Principles for the secondary market (25–30) — summary findings and grading - Secondary market structure and oversight: - Exchanges and ATSs authorized and overseen; ECMs exempt from authorization under CEA but legislative changes enable strengthened oversight where appropriate. - Post-trade transparency comprehensive; pre-trade transparency comprehensive but 25 percent of liquidity not publicly displayed. - SEC concern that a two-tier market may be emerging is justified. - Market surveillance by exchanges, futures exchanges, and FINRA effective; comprehensive securities surveillance system (comparable to futures) would be beneficial. - OTC derivatives market opaque compared with OTC equities/bonds markets. - Principle-by-principle grading (25–30) key points: - Principle 25 — BI: authorization exists but ECM/EBOT exemptions and Regulation ATS dark-pool pre-trade transparency concerns noted. - Principle 26 — FI: supervision ongoing, though CFTC oversight of ECMs was light-touch until recent changes. - Principle 27 — FI: transparency largely implemented; 25 percent of liquidity not publicly displayed. - Principle 28 — BI: manipulation policed well; insider dealing law too narrow in derivatives markets. - Principle 29 — FI: futures markets provide timely comprehensive information; securities markets tracking of large exposures should be improved. - Principle 30 — N/A: separate CPSS-IOSCO assessment conducted. - Aggregate grading tally preserved from assessment: - Fully implemented (FI) – 16; Broadly implemented (BI) – 8; Partly implemented (PI) – 5; Not implemented (NI) – 0; Not applicable (N/A) – 1. ### IX. Recommended action items (selected, secondary market focus) - CFTC should consider authorization power over entities seeking to set up ECMs and EBOTs; legislative initiatives consider abolition of ECM and EBOT categories. - SEC’s review of equity market structure should be prioritized to encourage broad public debate and reach actionable conclusions promptly. - SEC should join CFTC in considering explicit and comprehensive financial resource requirements for exchanges; adopt a holistic approach to capital adequacy. - Develop a comprehensive securities trading surveillance system comparable to futures markets for use by exchanges, ATSs, and SEC. - Implement Joint Report recommendations to expand insider trading provisions of the CEA; study whether further expansion warranted. - Ensure SEC rule changes on market structure and advanced trading technologies are supported by independent factual evidence. ### X. Recommendations, authorities’ response, and actions taken - Recommendations in Report (selected): - Comprehensive independent review to establish investor needs across classes. - Implement Joint Report recommendations on insider dealing and Chinese Walls in derivatives. - CFTC to study whether expansion of insider trading prohibition in futures markets beyond Joint Report recommendation is warranted. - Prioritize consolidated surveillance structure discussions among securities exchanges and FINRA. - Amend regulations to provide SEC and exchanges with accurate timely information on large holders/traders similar to CFTC. - Authorities’ response (paragraphs 31–43): - Authorities appreciate FSAP effort; agree on need for comprehensive regulatory reform of OTC derivatives marketplace and increased resources for CFTC and SEC if missions expand. - CFTC and SEC need greater resources and enhanced cooperation; steps underway. - Under existing authority, regulators have adopted measures: SEC proposed municipal market disclosure rule-making; SEC adopted new custody control rules including surprise inspections; SEC launched equity market structure review; CFTC improving large trader reporting in cleared OTC markets. - Areas of disagreement: - Commissions disagree with many Report ratings, arguing Report understates regulatory successes and misunderstands U.S. system. - Criticisms include methodology on intermediaries, capital requirements, fit-and-proper one-time reviews for CIS operators, and applicability of IOSCO CIS Principles to privately-offered commodity pools. - Enforcement metrics and observations: - SEC FY2009 enforcement measures: orders requiring disgorgement of approximately US$2.09 billion; orders imposing money penalties approximately US$345 million (35 percent increase over previous fiscal year); filing of 664 cases against 1,787 persons; SEC distributed approximately US$2.1 billion to harmed investors from disgorgement and Fair Funds during FY2009. - Authorities note restructuring and improvements at SEC: Enforcement Division restructured; inspection program improved; technology modernization underway. ### XI. Detailed assessment — Principles Relating to the Regulator (Principles 1–5) and selected principles (highlights) - Principle 1 — Partly implemented: - Separate federal regimes; identified multi-authority gaps (aiding-and-abetting civil enforcement gap; municipal securities disclosure gap; differing treatment of economically-similar products/services). - Joint Report recommends Joint Agency Enforcement Task Force; cross-agency training; staff sharing; Joint IT Task Force. - Principle 2 — Broadly implemented: - CFTC: five commissioners, five-year terms; required report to Congress within 120 days after fiscal year end; independent OIG with four staff. - SEC: five-member commission, staggered five-year terms; OIG with 19 staff; budget part of federal budget. - Comment: annual appropriations limit assurance of longer-term funding; self-funding suggested as alternative; SEC routine fee revenues exceed budgets of both agencies. - Principle 3 — Partly implemented: - CFTC: powers within CEA but gaps for OTC derivatives; CFTC employs approximately 580 career staff (also noted as about 500 elsewhere). - SEC: extensive powers; gaps include OTC derivatives largely unregulated; hedge funds estimated US$1.5 trillion assets (SEC self-assessment). - Both agencies need more human, informational, technological resources. - Principle 4 — Fully implemented (SEC assessed fully implemented). - Principle 5 — Fully implemented: codes of ethics, confidentiality rules; CFTC felony penalties up to US$500,000 fine or imprisonment up to five years or both; SEC penalties up to US$1 million and/or imprisonment up to ten years. ### XIII. Principles for Issuers (14–16) and CIS (17–20) — selected details - Principle 14 — Broadly implemented: EDGAR filings; audited financial statements due within 60–90 days; material change reports within four days; municipal securities disclosure gap noted. - Principle 15 — Fully implemented: shareholder rights via state corporate law and securities laws; disclosures for >5 percent holders. - Principle 16 — Fully implemented: U.S. GAAP; PCAOB oversight; auditor independence. - Principle 17 — Partly implemented: as of December 31, 2008 approximately 1,350 CPOs filed annual reports for about 1,500 pools with aggregate NAV about US$316.3 billion; ~20 CPOs offered ~50 public pools with aggregate NAV about US$16.6 billion; public pools ~3.3 percent of pools and ~5.2 percent of aggregate NAV. - Principle 18 — Broadly implemented: entity forms, segregation, independent audits; comment that participant notice timing of 21 days after material change should be shortened; consider arm’s-length custodian requirement. - Principle 19 — Fully implemented: CPO disclosure documents, annual audited financial statements, periodic account statements monthly for pools with assets > US$500,000, otherwise quarterly within 30 calendar days. - Principle 20 — Fully implemented: NAV under U.S. GAAP, FAS 157 fair value guidance; auditor verification; redemption suspension rules specified. ### XIV. Market intermediaries, custody, capital and prudential regimes (Principles 21–24, 22 details) - Principle 21 — Minimum entry standards: - CFTC/NFA registration for FCM, IB, CPO, CTA; published minimum standards to detect statutory disqualifications (≥10 percent ownership checks). - SEC/FINRA: BDs must register and join an SRO; FINRA membership checks include controls, compliance, supervisory systems and business continuity; IAs register via Form ADV (SEC registration threshold AUM US$25 million or more). - Part II of Form “ADV” — required disclosures to clients: - Adviser’s educational qualifications, relevant industry experience, disciplinary history (if any), investment strategies, fee structure and other client charges, potential conflicts of interest, and past investment performance. - Guarantee of future investment performance generally unlawful as fraudulent, deceptive, or manipulative. - Misuse of client assets violates anti-fraud provisions. - SEC IA exam program and resource constraints: - IAs on a risk-based model: higher risk profile on a three-year exam cycle; otherwise random/cause/sweep/special purpose exams. - Over 11,000 IAs registered with the SEC and only about 300 examiners available. - Custody rules (pre- and post-March 2010 changes): - If IA holds or has authority to obtain client funds/securities, assets must be held at a qualified custodian; custodian not required to be independent. - March 2010 rules: additional safeguards if custodian not independent — annual report from independent public accountant on custodian's internal controls (Type II SAS–70); surprise examination by independent public accountant if custodian not operationally independent; auditor must certify exam completion to SEC and notify SEC within one business day if discrepancies found; independent auditor must be registered with PCAOB. - Principle 22 — CFTC capital/prudential: - Only FCMs and IBs must meet CFTC-prescribed minimum financial requirements; no capital requirements for CPOs or CTAs. - FCM minimum capital is the greatest of: US$250,000; NFA minimum US$500,000; 8 percent of customer plus 4 percent of non-customer maintenance margin requirements; or SEC-required amount if also registered as BD. - IB minimum is the greatest of: US$30,000; NFA minimum US$45,000; SEC-required amount if also a BD. - Early warning thresholds are 10 to 50 percent above minimum amounts. - Capital calculations require positions marked to market with haircuts for liquidity, funding, affiliate and unsecured receivable risks. - Reporting: FCMs monthly detailed reports to CFTC and SROs; IBs semi-annual reports. - Independent audits required for FCMs and IBs; on-site NFA/JAC inspections every 9 to 18 months. - Principle 22 — SEC capital/prudential (BD focus): - Net Capital Rule: minimum dollar amount varies by business; standard or alternative method. - Standard method minimum varies from US$5,000 to US$250,000. - Aggregate indebtedness limits: must not exceed 800 percent (first year) or 1500 percent (thereafter) of liquid net capital under standard method. - Alternative method: net capital at least greater of US$250,000 or 2 percent of aggregate customer debit items. - Alternative method primarily for firms that hold customer assets. - OTC derivatives dealers and certain BDs may use Value at Risk models subject to conditions. - Holding company program: CSEs electing group-wide SEC supervision must compute group-wide capital monthly in accordance with Basel; no such firms as of February 2010. - FINRA may prohibit expansion when net capital < 150 percent of minimum for > 15 consecutive business days. - Customer protection: Reserve account to contain net dollar amount of cash BD owes to customers. - Monitoring and reporting: monthly/quarterly capital filings with FINRA within 17 days after period end; prompt notice if net capital below 120 percent of minimum or below 5 percent of aggregate debit items. - Assessment: Partly implemented overall; capital rules focus on customer protection but not explicitly on reputational, funding and liquidity risks; treatment of affiliate risk should be reexamined. ### XV. Internal organization, failure procedures, and secondary market operational points (Principles 23–30) - Principle 23 — Internal organization and operational conduct: - CFTC: FCMs/IBs must provide certified financial statements; segregation rules require separate accounting for customer funds; NFA KYC; no statutory requirement for a CCO at futures intermediaries. - SEC: BDs required to have appropriate controls; FINRA requires appointment of CCO for BDs; IAs must appoint a CCO and have CP&P; AML requirements apply to BDs and some CIS but not to IAs. - Assessment: Broadly implemented; recommendations include reexamining BD/FCM risk management expectations, requiring futures intermediaries to mitigate conflicts of interest, and reassessing disclosures for structured products. - Principle 24 — Failure procedures: - CFTC: contingency plan under CEA and Part 190; notification requirements; DCO default rules; frequent regulator/exchange coordination. - SEC: contingency plan for BD failures; SIPA for insolvent BD liquidations; SIPC available to compensate investors; no general statutory power for SEC to act when an IA is in financial difficulty unless securities law violation. - Assessment: Fully implemented. - Secondary market (25–30) — key operational points reiterated: - Authorization, ongoing supervision, transparency, manipulation detection, large exposures/default risk management and clearing/settlement oversight described in detail above. - Dark pools increased from approximately 10 in 2002 to approximately 32 in September 2009; SEC estimated dark-pool trading volume approximately 7.9 percent of total share volume in NMS stocks (one consulting firm estimated 12 percent). - Futures market concentration: in practice 90 percent of all futures contracts clear through the DCO which is part of the CME group. ### XVI. Concluding summary and authorities’ views - U.S. authorities believe overall ratings are not reflective of the U.S. regulated marketplace. - CFTC and SEC will continue to evaluate and enhance regulatory programs and maintain dialogue with the IMF. - Authorities acknowledge areas identified for improvement and note substantial work already underway; authorities contest some methodological assumptions and conclusions of the Report. *Source: IMF staff report (content unit: _cr10125 - 17. In contrast, commodity pools operated by registered CPOs have experienced; includes sections 1 Summary Implementation of the IOSCO Principles—Detailed Assessments through Part II of Form “ADV” disclosures).* ### 1. Summary Implementation of the IOSCO Principles—Detailed Assessments ....................16 ### 1. Summary Implementation of the IOSCO Principles—Detailed Assessments ### I. Introduction, scope, and methodology - Assessment conducted by Susanne Bergsträsser, Richard Britton, and Tanis MacLaren from October 7 to November 3, 2009 as part of the Financial Sector Assessment Program (FSAP). - Assessment based on the International Organization of Securities Commissions (IOSCO) Objectives and Principles of Securities Regulation and the associated methodology adopted in 2003, as updated in 2008. - Principle 30 (securities settlement systems under the CPSS/IOSCO Recommendations) was assessed separately and thus not included here. - Conclusions based on information and findings as of November of 2009. - Sources used: - Relevant legislation and regulatory documentation. - Self-assessment questionnaires prepared by the Commodity Futures Trading Commission (CFTC) and the Securities and Exchange Commission (SEC). - Detailed discussions with CFTC and SEC staff, SROs, exchanges, law enforcement agencies, industry representatives, and law and accounting professions. - Joint Report of the SEC and CFTC on Harmonization of Regulation issued October 16, 2009 (Joint Report). - Department of the Treasury Blueprint for a Modernized Financial Regulatory Structure (White Paper). - Assessment context and caveats: - Carried out in a post-crisis environment; the financial crisis of 2008 exposed weaknesses (e.g., inability of U.S. investment banks to withstand liquidity shocks; secondary effects such as exposure of large frauds). - Important reforms introduced in the past year (some implemented and beginning to take effect); a consistent track record is needed to judge efficacy. - Uncommon level of transparency in the jurisdiction provided access to internal evaluations and official reports; this self-criticism informed findings. - Assessment did not significantly address state-level securities regulatory regimes, which play a more minor, mostly consumer protection role. ### II. Institutional and market structure — overview - Federal regulatory split: - CFTC: supervision of commodity futures market under the Commodity Exchange Act (CEA) as modified by the Commodity Futures Modernization Act (CFMA). - SEC: regulation of securities markets, issuers, and participants under statutes including Securities Act of 1933, Securities Exchange Act of 1934, Trust Indenture Act of 1939, Investment Company Act of 1940 (ICA), Investment Advisers Act of 1940 (Advisers Act), and Sarbanes-Oxley Act of 2002 (SOX). - Complementary elements: - Extensive body of regulations, rules, guidance, court decisions, and regulatory no-action letters. - State securities regulators involved in licensing and enforcement activities in parallel in some areas. - Other law enforcement agencies (e.g., Department of Justice (DOJ), state Attorneys General) participate in enforcement. - Reliance on self-regulatory organizations (SROs): - Exchanges, clearing organizations, and securities or futures associations exercise authority over member activities. - FINRA is the registered securities association with authority over broker-dealers (BDs). - NFA is the registered futures association for commodity futures intermediaries and commodity pool operators. - Specialized intermediary categories across futures and securities regimes: - BDs under the Exchange Act; FCMs and introducing brokers (IBs) under the CEA. - Advisers as IAs or commodity trading advisers (CTAs). - Operators of Collective Investment Schemes (CIS) as IAs under the Advisers Act or commodity pool operators (CPOs) under the CEA. ### III. Market developments and key statistics - Futures market growth and concentration: - Increase since CFMA (2000) in number of futures and options contracts by 570 percent and in volume of trading by 594 percent. - Client funds held by futures commission merchants (FCMs) rose by 354 percent over the same period. - Number of exchanges roughly stable; consolidation and creation of new exchanges. - The four exchanges in the Chicago Mercantile Exchange (CME) group now account for over 90 percent of total volume. - Substantial growth in exempt marketplaces subject to more limited ongoing regulation once operational. - CFTC full time equivalent staff declined by 18 percent during this period. - Equity market growth: - Between 2000 and 2007, daily volumes increased by 62 percent. - During 2008, volumes increased by 52 percent over 2007, taking the 10-year growth to 255 percent. - The 10-year growth in equity market volume was 44 percent of the growth rate of on-exchange futures markets. - Increase in pink sheet OTC stocks: 780 percent increase in number of shares traded daily between 2001 and 2008 (from US$200 million in 2001 to US$540 million in 2008); pink sheet stocks are noted as a major source of securities fraud. - As of March 2010, there were 11 registered national securities exchanges, 79 registered alternative trading systems (ATS), and 4 electronic communications networks (ECNs). - Futures statistics (as presented) - Volume of contracts traded (millions): 2000: 580; 2001: 723; 2002: 1,004; 2003: 1,225; 2004: 1,518; 2005: 1,920; 2006: 2,421; 2007: 3,085; 2008: 3,446. - Number of contracts: 2000: 266; 2001: 250; 2002: 278; 2003: 538; 2004: 662; 2005: 906; 2006: 1,135; 2007: 1,365; 2008: 1,521. - Client funds held by FCMs (in US$ billions): 2000: 56.7; 2001: 59.7; 2002: 64.3; 2003: 75.6; 2004: 94.5; 2005: 116.7; 2006: 138.0; 2007: 155.4; 2008: 201. - Commodity exchanges (counts shown for a sub-period): 15, 18, 13, 12, 12, 13 (as presented). - Exempt markets (ECMs, EBOTs counts for sub-periods): ECMs: 11, 11, 12, 17, 19, 19; EBOTs: 2, 3, 5, 8, 8, 10. - CFTC full time equivalent staff: 2000: 546; 2001: 514; 2002: 521; 2003: 497; 2004: 517; 2005: 491; 2006: 493; 2007: 437; 2008: 448. (Source: CTFC.) - Daily average volume of shares traded (in millions of shares): - 2000: 2,851; 2001: 3,206; 2002: 3,257; 2003: 3,217; 2004: 3,323; 2005: 3,458; 2006: 4,004; 2007: 4,769; 2008: 7,282. (Source: SIFMA.) - SEC staffing: - SEC full time equivalent staff: 2000: 2,840; 2001: 2,936; 2002: 3,009; 2003: 3,060; 2004: 3,550; 2005: 3,851; 2006: 3,695; 2007: 3,465; 2008: 3,511; 2009: 3,656. (Source: SEC.) - Overall SEC staff numbers were 24 percent up in the period noted, peaking in 2005 and falling back subsequently; they increased somewhat in 2008/9. - Registered intermediaries and assets: - Number of registered commodity futures firms and broker-dealers (BDs) declined over the past five years, with more marked drops in CFTC registrants. - Number of BDs declined 6 percent over the 5-year period, while the total net capital of these firms increased nearly 80 percent. - Total number of registered persons at FINRA member firms remained relatively constant. - Substantial growth in the number of registered investment advisers (IAs) and assets under management: number of IAs up 32 percent and assets under management up 79 percent. - U.S. CIS market: nearly US$10 trillion in assets under management in funds registered with the SEC. - 2008 saw a sharp drop in assets under management (-20 percent) reflecting declines in equity markets; by end-September of that year total assets had recovered somewhat. - During 2008 assets shifted from long-term funds (equity and bond funds) to money market funds; since beginning of 2009 the trend reversed with growth in equity and bond funds. ### IV. Assessment implications and context for recommendations - Higher quality of supervisory and regulatory oversight is needed in a jurisdiction with financial systems that are large and complex; the IOSCO methodology was applied with this consideration. - The assessment reflects lessons of the recent financial crisis and acknowledges both causal and secondary issues revealed by the crisis. - Important reforms introduced recently may address many identified issues, but a consistent track record is required to evaluate their efficacy. *Source: 1. Summary Implementation of the IOSCO Principles—Detailed Assessments* ### 17. In contrast, commodity pools operated by registered CPOs have experienced ### _cr10125 - 17. In contrast, commodity pools operated by registered CPOs have experienced ### Commodity pools: recent trends and drivers - The number of commodity pools reporting to the CFTC is down 52 percent over the 5-year period. - Aggregate assets under management for those pools are down 77 percent over the 5-year period. - Drivers cited: - Responses to adverse market conditions (trading losses, decreased new contributions, and ceasing business). - Conversions of funds to ones exempt from reporting to the CFTC. ### Futures and Securities Intermediaries (as at September 30) - Intermediary counts by year and category (exact figures as presented): - FCMs: 2004 211, 2005 211, 2006 210, 2007 197, 2008 179 - IBs: 2004 1,664, 2005 1,711, 2006 1,740, 2007 1,699, 2008 1,647 - CTAs: 2004 2,640, 2005 2,635, 2006 2,589, 2007 2,601, 2008 2,534 - CPOs: 2004 1,810, 2005 1,782, 2006 1,570, 2007 1,416, 2008 1,353 - SEC-registered intermediaries and capital / AUM figures: - BDs: 2004 5,219, 2005 5,134, 2006 5,052, 2007 4,969, 2008 4,923 - IAs: 2004 8,535, 2005 9,017, 2006 10,662, 2007 10,817, 2008 11,292 - Total Net Capital of BDs (in US$ millions): 2004 87,127, 2005 101,334, 2006 102,969, 2007 128,244, 2008 155,468 - Total AUM by Reg’d IAs (in US$ trillions): 2004 242, 2005 732, 2006 238, 2007 43 - Median AUM of Reg’d IAs (in US$ millions): 2004 99, 2005 108, 2006 116, 2007 123, 2008 125 - Notes provided: - "Only includes firms registered with one of the two agencies, not firms exempt from registration or only registered at a state level." - "A firm registered in more than one category is counted in each category." - Sources: CTFC, SEC, and SIFMA. ### Mutual fund assets (US$ billions) and changes - Mutual Fund Assets by category and year (exact figures): - 2004: Equity 4,384.0; Hybrid 519.3; Bond 1,290.4; Money Market 1,913.2; Total Assets 8,106.9 - 2005: Equity 4,940.0; Hybrid 567.3; Bond 1,357.4; Money Market 2,040.5; Total Assets 8,905.2 - 2006: Equity 5,911.4; Hybrid 653.1; Bond 1,494.3; Money Market 2,354.8; Total Assets 10,413.6 - 2007: Equity 6,521.4; Hybrid 713.4; Bond 1,678.9; Money Market 3,085.8; Total Assets 11,999.5 - 2008: Equity 3,708.1; Hybrid 494.2; Bond 1,567.2; Money Market 3,832.3; Total Assets 9,601.8 - Sept '09: Equity 4,511.2; Hybrid 576.6; Bond 1,973.1; Money Market 3,551.8; Total Assets 10,612.7 - %Change Sept ’08 – Sept ‘09 (as presented): - Equity -20.0% - Hybrid -13.1% - Bond 12.7% - Money Market 1.8% - Total Assets -8. 4% (format as presented in source) ### Mutual fund net new cash flow (US$ billions) - Net new cash flow by category and year (exact figures): - 2004: Equity 177.9; Hybrid 42.7; Bond -10.8; Money Market -156.6; Total 53.2; Total Long-Term Funds 209.8 - 2005: Equity 135.5; Hybrid 25.2; Bond 31.3; Money Market 63.1; Total 255.2; Total Long-Term Funds 192.0 - 2006: Equity 160.1; Hybrid 7.1; Bond 60.6; Money Market 247.5; Total 475.2; Total Long-Term Funds 227.8 - 2007: Equity 95.6; Hybrid 22.2; Bond 108.6; Money Market 661.5; Total 887.9; Total Long-Term Funds 226.4 - 2008: Equity -237.7; Hybrid -21.7; Bond 33.0; Money Market 631.7; Total 405.2; Total Long-Term Funds -226.4 - Sept '09: Equity 12.4; Hybrid 3.1; Bond 220.1; Money Market -291.3; Total -55.7; Total Long-Term Funds 235.6 - %Change Sept ’08 – Sept ‘09 (as presented): - Equity 118.1% - Hybrid -49.24% - Bond 128.6% - Money Market -184.7% - Total -114.7% - Total Long-Term Funds 595.0% - Source: Investment Company Institute. - Note: "New sales (excluding reinvested dividends) minus redemptions, combined with net exchanges." ### Commodity pools: counts and aggregate NAV (CFTC) - Number of pools (to nearest hundred) and aggregate net asset value reported for all pools (US$ billions): - 2004: 3,100; $1,348 - 2005: 2,600; $564 - 2006: 2,100; $513 - 2007: 1,700; $573 - 2008: 1,500; $316 - Source: CFTC. ### Preconditions for effective securities regulation - General assessment: - The general preconditions for effective securities regulation in the United States are present. - No significant barriers to entry and exit for market participants. - Competition is encouraged and foreign participation is welcomed. - The legal and accounting system supports implementation of requirements and effective regulation. - Commercial law is up-to-date and capable of supporting cross-border trade, modern financial instruments, and current corporate governance standards. - Legislation regarding bankruptcy, insolvency, and winding up and associated professionals are sophisticated. - Regulators have legally enforceable powers of decision and action, frequently tested by the courts. - The taxation framework is supportive to the operations of the industry. ### Main findings: systemic complexity and institutional issues - Complexity is a key challenge: - U.S. securities and futures markets are very complex; the regulatory framework is equally complex. - Division of responsibility and high specialization within and across agencies can hinder assessment of cross-cutting issues. - Recommendation: greater focus on systemic issues relating to both securities and futures markets to strengthen overall regulatory robustness. - Institutional culture and reform: - Chairmen of the CFTC and SEC have recognized the need for change and have taken steps toward strengthening their institutions. - Institutional culture is difficult to transform; agencies face strong and continuous pressure including from industry. - The challenge: respond to market developments and develop a reform agenda independently. - Manifestation of issues: - Problems appear in key areas such as enforcement and regulation of over-the-counter derivatives markets, and affect the entire system. - Priority actions: - Simplify internal and institutional structures. - Establish better internal management structures and improved communication between departments to foster continuous learning and response. ### Assessment against regulatory principles (selected highlights) - Principles relating to the regulator (Principles 1–5): - Responsibilities of the CFTC and SEC are clearly stated in law. - Gaps exist in coverage of market activity and in scope of authority for both agencies. - Differences exist between futures and securities regimes in how similar instruments are regulated. - Gaps between SEC and the Federal Reserve regarding regulation/oversight of investment bank holding companies contributed to system fragility during the crisis; these gaps should be reduced. - Legal protections for agency independence are sufficient; strong accountability to Congress exists. - Neither agency has sufficient funding nor a funding method assuring continuing funding for long-term capital projects. - Activities and processes are transparent; public consultation occurs; agencies are active in investor education. - Staff and commissioners are subject to codes of ethics and conduct requirements. - Principles relating to self-regulation (Principles 6–7): - SROs play a significant role in supervision; exchanges and clearing organizations perform important self-regulatory functions. - Authorization regimes for SROs address integrity, financial viability, capacity, governance, and fair access; regimes differ for securities vs futures exchanges. - The CFTC has insufficient authority regarding exchanges following the coming into force of the CFMA, with limited ability to intervene in new product introductions or rule changes. - There is no formal opportunity for stakeholders negatively affected to have views taken into account in advance of new product listings or rule changes; deficiencies are being addressed via Joint Report legislative recommendations. - Some demutualized futures exchanges have retained full member regulation powers; concerns exist this may be used to restrain member dissent in pursuit of shareholder interests. - The CFTC publicly examined exchange conflicts of interest from 2003 through 2009, resulting in adoption of acceptable practices for exchanges. - Principles relating to enforcement (Principles 8–10): - Anti-fraud provisions (Rule 10b–5) and court support are effective tools for prosecuting securities law offences. - Private litigation is a powerful tool for compliance and redress. - CFTC and SEC have broad investigative and surveillance powers, can conduct on-site inspections without prior notice, and can obtain information without a court order. - Enforcement powers include seeking injunctions, civil proceedings, compelling information/testimony, imposing administrative sanctions, and referring to criminal authorities. - Shortcomings identified in the SEC enforcement program; SEC is implementing IG recommendations and other changes that are beginning to generate improvements. - Resources dedicated to examination of SEC-registered IAs are insufficient; recommendation to increase resources to at least match frequency and scope of BD examinations where responsibility is shared between the SEC and FINRA. - Resources for criminal prosecution of securities fraud are too limited. - Principles for cooperation (Principles 11–13): - CFTC and SEC have broad authority to share information with domestic and foreign regulators even without MOUs. - Both agencies are signatories of the IOSCO MOU and have many bilateral MOUs. - Agencies have authority to assist foreign regulators in obtaining information not in their files using powers available for their own investigations. - Principles for issuers (Principles 14–16): - Issuers must provide extensive financial and other disclosure on initial offerings and are subject to detailed continuing disclosure obligations in line with IOSCO standards. - Liability provisions ensure issuers are responsible for disclosures; enforcement by SEC, exchanges, and civil suits. - Limited authority exists over municipal government issuers. - Holders of voting securities of a public issuer are generally treated fairly. - Principles for collective investment schemes (Principles 17–20): - Operators and marketers of CIS offered to the public are subject to registration requirements. - Initial eligibility criteria for CIS and operators should be more extensive and demonstrated prior to registration. - Initial and ongoing disclosure requirements for CIS are extensive; update requirements under the CEA are not timely. - Assets of CIS are valued in accordance with U.S. GAAP and verified by an independent auditor at least annually. - The custodian of CIS assets is not required to be an arm’s length party. - Principles for market intermediaries (Principles 21–24): - Minimum entry standards for intermediaries include criteria relating to integrity. - Capital and internal control requirements apply to FCMs, IBs not fully guaranteed by an FCM, and BDs; these are assessed prior to licensing by SROs. - Advisers are not subject to capital requirements or operational capacity assessments prior to licensing. - Capital requirements vary by chief risks undertaken (largely market and credit risk). - Prudential requirements (capital formulae and risk management) appear to need improvement to address full range of risks (funding, liquidity, reputational, and affiliate risks). - Regulators should ensure capital and risk management requirements adequately address risks under stress. - Crisis exposed weaknesses in framework governing investment bank holding companies; conversion of remaining entities into bank holding companies eliminated practical need for securities regulators to address these immediately. - Procedures exist at both agencies to address failures of intermediaries; these have been tested in practice. *Source: IMF staff report (content unit: _cr10125 - 17. In contrast, commodity pools operated by registered CPOs have experienced).* ### 30. Principles for the secondary market (Principles 25–30): Securities and futures ### _cr10125 - 30. Principles for the secondary market (Principles 25–30): Securities and futures ### Summary findings on secondary market structure and oversight - Securities and futures exchanges are subject to authorization and oversight. ATSs are authorized and regulated as BDs. - Under the CEA, there are categories of futures trading systems which are exempt from authorization (exempt commercial markets or ECMs), although recent legislative amendments have enabled the CFTC to strengthen oversight of operational ECMs where appropriate. - The SEC should join the CFTC in considering the introduction of explicit and comprehensive financial resources requirements for exchanges. - In the securities markets: - Post trade transparency (details of completed transactions) is comprehensive. - Publicly displayed liquidity or pre-trade transparency (best bids and offers) is comprehensive, but 25 percent of liquidity is not publicly displayed (i.e., dark pool ATSs and broker dealer internalization of trading on behalf of clients). - The SEC’s concern that a two-tier market may be emerging—that provides valuable order information on the best prices for NMS stocks only to selected market participants—is justified. - Market surveillance by the securities and futures exchanges and FINRA is effective and has kept pace with technological developments in markets. - A comprehensive surveillance system for securities trading to be used by the exchanges, ATS, and the SEC (such as exists in the futures markets) would be beneficial for the detection of market abuse and for identifying indicators of developing stress points. The CFTC and the futures exchanges have been able to construct such a system despite the CFTC’s serious budget constraints. - Market manipulation is generally well policed in both markets. For insider trading: - The legislation should be more comprehensive in futures markets. - The approach to insider trading for securities and futures should be different given the differences in the nature of the markets. - Implementing the recommendations in the Joint Report for expanding the insider trading provisions of the CEA will be an important step. Whether additional expansion of coverage is warranted should be studied. - The opacity of the OTC derivatives market contrasts with the relative transparency of OTC securities markets for equities and bonds. ### Principle-by-principle grading (Principles 25–30) - Principle 25. The establishment of trading systems including securities exchanges should be subject to regulatory authorization and oversight. — BI - Securities and futures exchanges and trading system operators are subject to authorization and oversight. Under the CEA, ECMs and EBOTs are exempt from authorization. Operators of securities market trading systems can elect to be regulated as exchanges or as ATSs (which must register as BDs). The authorization of “dark pool” ATSs under Regulation ATS, which permits them not to publicly display their best-priced orders in NMS stocks, does not provide for adequate pre-trade transparency. - Principle 26. Ongoing regulatory supervision of exchanges and trading systems. — FI - Ongoing supervision of ECMs was an excessively light-touch regime, although the CFTC has recently sought and obtained regulatory change enabling strengthened oversight where appropriate. - CFTC staff is working with Congress to get explicit statutory authority to impose financial resource requirements on designated contract markets (DCMs). - The SEC’s focus on IT and self-regulatory functions is necessary but risks missing other exposures such as affiliate risk. A more holistic approach to capital adequacy would be preferable. - Principle 27. Regulation should promote transparency of trading. — FI - The CEA and CFTC regulations have not been updated to reflect modern concepts of transparency, but futures market practice is real time publication. - In securities markets, post trade transparency is comprehensive and pre-trade transparency is publicly displayed for best bids and offers; however, 25 percent of liquidity is not publicly displayed. The Principle was assessed as fully implemented but the judgment was finely balanced. - The SEC’s public consultation on equity market structure and “dark pools” is timely; analysis requires better SEC information and independent factual evidence to support any proposed rule changes. - Principle 28. Regulation should detect and deter manipulation and other unfair trading practices. — BI - Insider dealing law is too narrowly focused in the derivatives markets. Acceptance of Joint Report recommendations would be an important advance; additional study is recommended to consider whether further restrictions would be appropriate. - Market surveillance is carried out to a high standard by the exchanges and FINRA and is particularly comprehensive in the futures markets. The SEC and CFTC are constrained by technology limitations. - Principle 29. Regulation should ensure proper management of large exposures, default risk and market disruption. — FI - Timely and comprehensive information flows available in futures markets provide effective early warnings. In securities markets, tracking large exposures and other potential sources of market disruption is more difficult and should be improved. - Principle 30. Systems for clearing and settlement of securities transactions should be subject to regulatory oversight and designed to ensure that they are fair, effective, and efficient and that they reduce systemic risk. — N/A - A separate CPSS-IOSCO assessment was conducted for the securities markets. Arrangements in the futures markets were not assessed. ### Key numeric and aggregate metrics preserved from the assessment - 25 percent of liquidity is not publicly displayed. - Aggregate grading tally: Fully implemented (FI) – 16, Broadly implemented (BI) – 8, Partly implemented (PI) – 5, Not implemented (NI) – 0, Not applicable (N/A) – 1. ### Recommended action items specific to the secondary market (extracted from recommended action plan) - The CFTC should consider seeking an authorization power over entities seeking to set up ECMs and Exempt Boards of Trade (EBOTs). Ongoing legislative initiatives are also considering the abolition of the ECM and EBOT market categories. - The SEC’s current broad review of equity market structure to determine whether the rules have kept pace with changes in trading technology and practices should be prioritized with a view to encouraging the broadest public debate while reaching actionable conclusions promptly. - The SEC should join the CFTC in considering explicit and comprehensive financial resources requirements for exchanges; a more holistic approach to capital adequacy is preferable to focusing solely on IT and SRO functions. - A comprehensive surveillance system for securities trading, comparable to that in the futures markets, should be developed for use by the exchanges, ATSs, and the SEC to improve detection of market abuse and identification of developing stress points. - Implement the Joint Report recommendations to expand insider trading provisions of the CEA; study whether additional expansion of coverage is warranted. - Any SEC rule changes concerning market structure and advanced trading technologies should be supported by independent factual evidence and the SEC should be better informed in analyzing these issues. *Source: _cr10125 - 30. Principles for the secondary market (Principles 25–30): Securities and futures* ### conclusions promptly. It will be essential that the review be conducted ### _cr10125 - conclusions promptly. It will be essential that the review be conducted ### Recommendations and regulatory actions proposed in the Report - Conduct a comprehensive and independent review to establish accurately the needs of investors of all classes. - Implement the Joint Report recommendations regarding insider dealing and Chinese Walls in derivatives markets. - The CFTC should undertake a study to consider whether expansion of the insider trading prohibition in the futures markets beyond the recommendation in the Joint Report is warranted given the current state of the markets, contracts and investors. - Consideration of an expanded insider trading review would complement the current debate in Europe as to the appropriate coverage of insider trading laws in derivatives markets. - The SEC should review the extent to which the absence of additional offences of insider trading is a limiting factor in the SEC’s enforcement effort in this area. - Give greater priority to current discussions among the securities exchanges and FINRA on creating a consolidated surveillance structure to oversee the consolidated market with a view to reaching a positive conclusion in a timely manner. - Consider amending regulations to provide the SEC and the securities exchanges with accurate and timely information on large holders of and traders in securities, similar to the CFTC and the futures exchanges, to support surveillance and identify emerging market stress points in a timely fashion. - The SEC should join the CFTC in considering the introduction of an explicit and comprehensive financial resource requirement for exchanges. ### Authorities’ response to the assessment (paragraphs 31–43) - The U.S. authorities appreciate the effort and resources committed by the IMF to prepare the FSAP and recognize the FSAP’s role in promoting soundness of financial systems and supervisory practices. - The U.S. assessment was conducted at a critical and extraordinary time given the financial crisis; U.S. regulatory leadership remains critical to global market stability. - The authorities agree with the Report’s strong recommendation for comprehensive regulatory reform of the OTC derivatives marketplace and for increased resources for the CFTC and the SEC should Congress expand the agencies’ missions to include OTC derivatives regulation. - The CFTC and SEC need greater resources to keep up with the growth of securities and futures markets in the United States and should enhance cooperation and coordination; steps have already been taken to do so. - The U.S. regulatory system helped ensure that the world’s largest and most complex exchange-listed equity, commodity futures, and options markets continued to function properly and withstood stress during the financial crisis. - Some proposed OTC derivatives reforms (e.g., requiring standardized products to trade on regulated trading platforms and to be cleared by central counterparties) reflect long-standing elements of the U.S. regulatory approach. - Under existing authority, U.S. regulators have taken actions to remedy problems and improve: - SEC proposed new rules to improve the quality and timeliness of disclosure in municipal markets. - SEC adopted new custody control rules for investment management that include surprise inspections to verify assets held by money managers. - SEC launched a robust review of equity market structure, including issues such as dark pools. - CFTC is improving and extending risk surveillance by requiring large trader reporting in the cleared OTC markets to allow financial surveillance consistent with existing risk programs for on-exchange trading. ### Areas of disagreement with the Report’s ratings and methodology - The Commissions strongly disagree with many Report ratings, arguing the Report does not reflect regulatory successes and, in some cases, misunderstands the U.S. regulatory system. - The Report’s rating on market intermediaries is criticized for assuming every intermediary must be regulated the same way (including an extensive review prior to registration), a requirement the authorities state cannot be found in the IOSCO Principles or the assessment Methodology. - The Report is said to reject a legitimate risk-based approach to registration and oversight of futures and securities intermediaries without evidence that the approach is ineffective. - The Report’s assertion that capital requirements for futures and securities firms do not fully address risk is criticized for providing no evidence that U.S. requirements do not already exceed recognized international best practice as reflected in the Principles. - The Report’s apparent insistence on one-time “fit and proper” reviews for CIS operators is challenged: - The U.S. system mandates disclosure by CIS operators and relies on oversight by a separate CIS board, generally a majority of independent directors, which serves as an ongoing check on fitness, resources, and internal controls. - CIS operators and CIS boards are subject to fiduciary duties enforced by the SEC and private litigants. - The report’s ratings are described as disregarding these important features and their effects on regulated entities. - The IOSCO Principles’ applicability to futures markets “where the context permits” is noted; CIS Principles were written for publicly offered funds and were not intended to cover privately-offered funds, such as the vast majority of CFTC-regulated commodity pools. Publicly offered pools represent a small percentage of total pools regulated by the CFTC; ratings in this area are characterized as misplaced given the de minimis number of publicly offered funds. ### Observations on enforcement findings and metrics - The Report’s adverse conclusions about U.S. enforcement (e.g., Principle 10) are criticized for relying on a single SEC Office of Inspector General (OIG) Report issued in August 2009 and extrapolating failings from a specific investigation to all SEC enforcement activities. - SEC enforcement performance measures cited for fiscal year 2009: - Orders requiring wrongdoers to disgorge ill-gotten gains in the amount of approximately US$2.09 billion. - Orders imposing money penalties on wrongdoers in the amount of approximately US$345 million, a 35 percent increase over the previous fiscal year. - The filing of 664 cases against 1,787 persons. - The SEC distributed approximately US$2.1 billion to harmed investors from both disgorgement funds and Fair Funds during fiscal year 2009. - These measures are presented as evidence of the credibility and effectiveness of the SEC enforcement program and as inconsistent with a conclusion that the SEC enforcement program broadly fails to satisfy Principle 10. - The Report is criticized for failing to articulate objective metrics on which to base the ratings. ### Actions taken in response to identified failings - The SEC restructured the Enforcement Division and streamlined procedures. - The SEC took steps to improve its inspection program and place greater reliance on risk assessment. - The SEC is actively working to improve technology and modernize handling of the massive number of tips and complaints received each year. - The authorities argue the Report’s rating fails to give full credit for these improvements and that enforcement effectiveness should not be judged by zero tolerance for failure. ### Concluding views from the authorities - The SEC and CFTC recognize a number of the areas the IMF identified for improvement and report that much is already underway to address these concerns; such suggestions are described as the exception rather than the rule. - The SEC contends that global investors’ behavior—large-scale investment in the U.S. market and the cost of capital in the United States—indicates that investors view the U.S. regulatory system more positively than some Report conclusions imply, even accounting for recent regulatory failings. *IMF staff report: U.S. FSAP — Authorities’ response (paragraphs 31–43)* ### 44. In sum, the U.S. authorities firmly believe that the overall ratings are not reflective of ### _cr10125 - 44. In sum, the U.S. authorities firmly believe that the overall ratings are not reflective of ### Summary conclusion - U.S. authorities believe the overall ratings are not reflective of the U.S. system for the regulated marketplace. - The CFTC and SEC will continue to evaluate and, as appropriate, enhance regulatory programs and maintain dialogue with the IMF to strengthen financial regulation and enhance supervision of the global financial services sector. ### Detailed assessment — Principles Relating to the Regulator (Principles 1–5) - Principle 1 (Responsibilities clear; Assessment: Partly implemented) - Securities and futures have separate federal regimes: CFTC (exclusive jurisdiction over futures and commodity option transactions) and SEC (oversight of the securities market). - CFTC: operationally independent federal agency under the CEA; about 500 staff; headquarters Washington, D.C.; regional offices Chicago, Kansas City, New York. - SEC: responsibilities set out in multiple federal statutes (Securities Act; Exchange Act; Trust Indenture Act of 1939; ICA, Advisers Act, and SOX); approximately 3,500 staff across Washington, DC and 11 regional offices. - Multi-authority gaps identified: aiding and abetting civil enforcement gap (Joint Report recommends SEC statutory authority to pursue aiding and abetting in civil actions); municipal securities regulatory gap (MSRB lacks authority to apply rules to some professionals and “Tower Amendment” limits SEC/MSRB ability to require issuer disclosure prior to initial sale); differing treatment of economically-similar products/services (forex, GLBA bank “broker” exceptions, derivatives/securities classification). - Joint Report recommendations (no new legislation needed for some items): Joint Agency Enforcement Task Force; cross-agency training; regular sharing of staff; Joint Information Technology Task Force. - Principle 2 (Operational independence and accountability; Assessment: Broadly implemented) - CFTC: five commissioners appointed for five-year terms; budget part of federal budget; required report to Congress within 120 days after end of each fiscal year; independent OIG with four staff. - SEC: five-member commission, staggered five-year terms; approximately 3,500 staff; OIG with 19 staff; budget part of federal budget; pay-parity measures noted; both agencies report funding has not kept pace with market growth. - Comment: annual appropriations process limits assurance of longer-term funding; self-funding (direct) identified as alternative; SEC routine fee revenues exceed budgets of both agencies. - Principle 3 (Adequate powers, resources, capacity; Assessment: Partly implemented) - CFTC powers within CEA but gaps for OTC derivatives jurisdiction (excluded commodities and ECP trades); pursuing stronger DCO core principles; initiatives on transparency, position limits, FBOT rules, retail off-exchange commodity transaction regulation; CFTC employs approximately 580 career staff (noted elsewhere as approximately 580; earlier “about 500” for CFTC headquarters staffing). - SEC: extensive powers under federal securities statutes; identified gaps: OTC derivatives largely unregulated; hedge funds estimated US$1.5 trillion assets (SEC self-assessment); municipal securities disclosure gap; differing regimes for BDs vs IAs; SEC staffing improved by 2002 “pay parity” but still cannot match industry salaries. - Comment: both agencies need more human, informational, technological resources; concerns about “silos” of expertise at SEC; SEC should use authority to request raw data for empirical analysis. - Principle 4 (Clear and consistent regulatory processes; Assessment: Fully implemented for SEC; CFTC processes described) - Both agencies operate with a high degree of transparency and APA-based rulemaking processes; public consultations, advisory committees, roundtables; FOIA obligations for SEC; CFTC publishes regulations and educational materials. - SEC Assessment: Fully implemented; comment about risk of publishing enforcement manual possibly compromising enforcement effectiveness. - Principle 5 (Professional standards and confidentiality; Assessment: Fully implemented) - Both agencies: codes of ethics; subject to U.S. Office of Government Ethics rules; CFTC prohibits participation in commodity transactions by staff; felony penalties for misuse of non-public information at CFTC (up to US$500,000 fine or imprisonment up to five years, or both); SEC rules prohibit unauthorized disclosure with penalties up to US$1 million and/or imprisonment up to ten years. ### Principles of Self-Regulation (Principles 6–7) - Principle 6 (Appropriate use of SROs; Assessment: Fully implemented) - CFTC: DCMs, DCOs, NFA as RFA; 15 DCMs (number growing); one DCO clears ~90 percent of derivatives through CME affiliate; NFA handles registration of commodity futures intermediaries. - SEC: SROs required by Exchange Act; FINRA is only RSA; 20 other SROs including 3 clearing agencies and MSRB. - Principle 7 (SRO oversight and standards; Assessment: Broadly implemented) - CFTC: DCMs must meet 8 Designation Criteria and 18 Core Principles; NFA delegated registration functions; periodic Core Principle oversight reviews and Rule Enforcement Reviews (RERs) every two to three years; public reporting of reviews. - SEC: registration and rule-review of exchanges, associations, clearing agencies; SRO rule filings published for public comment; FINRA administers registration exams and maintains central databases. - Key difference: SEC has prior-approval power for novel securities-exchange products; CFTC relies on self-certification for new products (one-day notice possible); Joint Report recommends amending CEA to provide CFTC powers closer to SEC’s (extend advance notice from 1 day to 10 or possibly to 90 days; grant explicit enforcement against exchanges/clearing orgs for Core Principle breaches) while balancing speed/innovation. ### Principles for Enforcement of Securities Regulation (Principles 8–10) - Principle 8 (Inspection, investigation, surveillance powers; Assessment: Fully implemented) - CFTC: broad inspection powers without judicial action; large-trader reporting system; books and records retention five years (readily accessible first two years); delegated inspections to SROs with CFTC oversight. - SEC: on-site inspections of registrants without prior notice; authority to obtain books/records without judicial action; SRO primary surveillance with SEC oversight; Bank Secrecy Act/CIP interactions noted (SEC-registered IAs not subject to CIP but maintain client identity records). - Principle 9 (Comprehensive enforcement powers; Assessment: Fully implemented) - CFTC civil administrative sanctions: suspension/revocation of registration, civil monetary penalties up to US$140,000 per violation (US$1 million for manipulation), restitution, disgorgement; civil/criminal referrals to DOJ; private rights of action authorized under certain circumstances. - SEC: civil injunctive actions, disgorgement, civil monetary penalties; administrative proceedings before ALJs with appeal to SEC and U.S. Courts of Appeals; can refer for criminal prosecution to DOJ; FY2008 SEC disgorgement US$774 million, civil penalties US$256 million; FY2008 SEC barred 132 defendants from officer/director roles. - Private litigation: Securities Act/Exchange Act private rights; courts have implied private rights (e.g., Exchange Act fraud) with detailed elements listed. - Principle 10 (Effective and credible use of powers; Assessment: Partly implemented) - CFTC: front-line regulation by SROs; NFA exam cycles (new CPOs examined within first two years then every three to four years); CFTC Enforcement Division ~95 attorneys and 18 investigators (additional 14 professional staff scheduled); 40–50 enforcement actions initiated annually historically; FY2008 CFTC brought 40 enforcement cases; FY2008 CFTC CMPs imposed US$234 million (collected US$141 million, 60 percent). - SEC: Division of Enforcement improvements in response to SEC OIG report on Madoff investigation; OIG identified systemic shortcomings with 21 recommendations (SEC concurred); Enforcement had just over 1,200 full time employees in FY2009, 782 attorneys; FY2009 had over 4,300 active investigations; FY2009 brought 664 enforcement actions; FY2008 market manipulation cases 52, insider trading cases 61. - Comments: assessors found SEC enforcement program had significant shortcomings but noted corrective measures underway; resource constraints for CFTC/SEC examination programs, especially SEC oversight of IAs (only 14 percent of IAs examined in 2008 vs 57 percent of BDs). ### Principles for Cooperation in Regulation (Principles 11–13) - Principle 11 (Authority to share public and non-public information; Assessment: Fully implemented) - CFTC/SEC may share public and non-public information with domestic and foreign regulators; MOUs not precondition; no domestic laws impeding cooperation; confidentiality assurances required for non-public info; ECPA and RFPA considerations for electronic communications and bank records with notice/delay mechanisms described. - Principle 12 (Information sharing mechanisms/MOUs; Assessment: Fully implemented) - CFTC: entered into more than 30 bilateral information sharing arrangements; signatory to IOSCO MMOU; FY2008: CFTC made 120 requests to 38 foreign authorities and received 47 requests from 18 jurisdictions. - SEC: entered into over 30 bilateral MOUs; signatory to IOSCO MMOU; FY2008: SEC handled 414 enforcement assistance requests from foreign authorities and made 594 requests to foreign authorities; answered 374 technical assistance requests. - Principle 13 (Assistance to foreign regulators via compulsory powers; Assessment: Fully implemented) - CFTC and SEC can use compulsory powers (subpoena, compel testimony, production of documents including bank/broker/beneficial ownership) to assist foreign regulators; no independent interest required; RFPA procedures for U.S. customer bank records noted (delayed notice possible via court). ### Principles for Issuers and Disclosure (Principles 14–16) - Principle 14 (Full, accurate, timely disclosure; Assessment: Broadly implemented) - Extensive disclosure for public offerings, prospectuses, registration statements, annual/interim reporting; EDGAR electronic filing; annual audited financial statements due within 60–90 days of year-end; material change reports filed within four days (stock exchanges require immediate public disclosure). - Gaps: municipal securities disclosure (SEC lacks authority to require issuer disclosures prior to initial sale); not all publicly offered securities are subject to ongoing Exchange Act disclosure (thresholds such as holdings by fewer than 300 persons). - Principle 15 (Fair and equitable treatment of security holders; Assessment: Fully implemented) - Rights derived from state corporate law, securities laws, exchange rules; proxy/voting disclosure obligations; tender offer rules ensure equal treatment where applicable; disclosure of >5 percent holders and timely filings (most holders within 10 days; passive institutional investors within 45 days after December 31). - Principle 16 (High-quality accounting and auditing standards; Assessment: Fully implemented) - U.S. GAAP for U.S. issuers; SEC selective reviews of accounting; FASB and PCAOB roles; auditors of public companies subject to PCAOB registration and inspection; auditor independence and audit-committee oversight required. ### Principles for Collective Investment Schemes (CIS) (Principles 17–20) - Principle 17 (Standards for eligibility and regulation of CIS operators; Assessment: Partly implemented) - CFTC/NFA: CPO registration delegated to NFA; as of December 31, 2008, approximately 1,350 CPOs filed annual reports for about 1,500 pools with aggregate NAV about US$316.3 billion; ~20 CPOs offered ~50 public pools with aggregate NAV about US$16.6 billion; public pools ~3.3 percent of pools and ~5.2 percent of aggregate NAV. - SEC: CIS operators register as IAs; registration disclosure-based (Form ADV); minimum net worth to issue securities to public US$100,000; board oversight and shareholder approvals required for advisory contracts; written compliance policies and CP&P, designation of a chief compliance officer. - Gaps: regulators do not impose pre-approval assessment of operator competence, human/technical resources, financial capacity or internal controls prior to registration; examination resources insufficient; CEA conflict-of-interest rules rely mainly on disclosure rather than required mitigation. - Principle 18 (Legal form, structure, segregation and protection of client assets; Assessment: Broadly implemented) - Commodity pools: typically LLC or limited partnership; separate entity from CPO; assets received in name of pool; no commingling permitted; financial statements under U.S. GAAP; disclosure document acceptance by NFA required; NFA exams and 2010 expanded quarterly reporting rule on service providers. - CIS (SEC): open-end (redeemable) vs closed-end; at least 40 percent independent directors on board; eligible custodians list provided (no requirement for arm’s-length custodian but additional safeguards if self-custody); annual PCAOB-audited financial statements required. - Comment: timing of participant notice under CEA is 21 days after material change — considered not timely and should be shortened; consider requiring custodians be arm’s-length parties. - Principle 19 (Disclosure necessary to evaluate suitability and value; Assessment: Fully implemented) - CPOs must provide detailed Disclosure Documents (NFA acceptance required); disclosure requirements address Assessment Methodology topics; frequency: annual audited financial statements and annual report within 90 days of year-end; periodic account statements monthly for pools with assets > US$500,000, otherwise quarterly, within 30 calendar days. - SEC CIS: prospectus summary and full prospectus access; registration statements include comprehensive disclosures; advertising/sales literature subject to filing and review; annual/semi-annual reports and quarterly portfolio statements required with specific timing (e.g., transmit to shareholders and file with SEC within 60 days after period end). - Principle 20 (Asset valuation, pricing, redemption basis; Assessment: Fully implemented) - NAV calculations under U.S. GAAP; FAS 157 applies for fair value measurements; independent auditor verification of valuations; Disclosure Document must describe redemption frequency/timing and valuation method; CFTC/NFA and SEC have authority to enforce valuation/pricing rules. - Redemption suspension: CIS may suspend redemptions during NYSE closures or SEC-determined emergency; otherwise CIS cannot postpone payment more than seven days after tender; SEC can order suspension when necessary for investor protection. ### Principles for Market Intermediaries (Principle 21) - Principle 21 (Minimum entry standards for market intermediaries) - CFTC/NFA: registration required for FCM, IB, CPO, CTA; NFA delegated registration and public records on NFA website; published minimum standards to detect statutory disqualifications (principals owning ≥10 percent subject to checks); only FCMs and non-guaranteed IBs have minimum capital requirements; applicants’ internal controls/back office assessment not mandatory prior to registration (off-site review practice exists). - SEC/FINRA: BDs must register with SEC and join at least one SRO (FINRA if doing business with the public); FINRA membership checks include financial controls, compliance, supervisory systems, business continuity plan, designated chief compliance officer; IAs register via Form ADV (assets under management US$25 million or more required for SEC registration); no SEC authority to impose capital requirements on IAs; custody rules require qualified custodian for IAs with custody. - Comments: BD capital/net capital and FINRA pre-membership assessments are more prescriptive; IA entry standards are disclosure-focused and lack pre-registration competence/capacity assessment; registration updates: BD must promptly amend registration on changes; IA must annually update Form ADV within 90 days of fiscal year end. *Source: IMF staff detailed assessment text provided in the content unit.* ### Part II of Form “ADV” that must be given to clients of the IA must contain detailed disclosure on: ### Part II of Form “ADV” that must be given to clients of the IA must contain detailed disclosure on: ### Required disclosures for registered investment advisers (IAs) - Part II of Form “ADV” must contain detailed disclosure on: - the adviser’s educational qualifications, relevant industry experience, disciplinary history (if any), investment strategies, fee structure and other client charges, potential conflicts of interest, and past investment performance. - Guarantees of future investment performance: - A guarantee of future investment performance would generally be unlawful as a fraudulent, deceptive, or manipulative act. - Misuse of client assets: - Misuse of client assets would violate the anti-fraud provisions of the law. ### SEC examination program and resource constraints - IAs are subject to examinations by the SEC using a risk-based assessment model. - Those with a higher risk profile are placed on a three-year examination cycle. - Other IAs are chosen randomly for routine examinations and may also be examined as part of cause, sweep or special purpose examinations. - Resource constraints: - There are over 11,000 IAs registered with the SEC and only about 300 examiners available. - These resource constraints limit the frequency of routine reviews of operations, particularly for IAs. ### Entry requirements, verification, and control thresholds - Assessment summary: - Broadly implemented for registered BDs and FCMs via SRO membership; gaps exist for other futures intermediaries and IAs. - Pre-registration verification: - No general requirement that on-site or off-site examinations of back-office capabilities and internal control of applicants under the CEA be performed prior to registration (exceptions exist at DCOs, NFA, and DCMs for FCM applicants). - FINRA performs such reviews for all BD applicants; no analogous routine review is performed for IA applicants. - Ownership/control thresholds: - CFTC requires detailed information on persons who own 10 percent or more of the voting securities of a firm. - BD registration form requires listing of persons who own more than 5 percent and presumes control where a person owns 25 percent or more of voting securities. - Comment: Adoption by the SEC of the CFTC’s lower 10 percent threshold would enhance common standards. ### Custody rules for IAs (pre- and post-March 2010 changes) - If an IA holds or has authority to obtain client funds or securities, assets must be held at a qualified custodian; the custodian is not required to be independent of the IA. - Under new rules implemented in March of 2010 (at time of assessment): - Additional safeguards required if assets are not held at an independent custodian. - If the custodian is not independent, the IA must receive an annual report from an independent public accountant on the custodian's internal controls on its custody functions such as Type II SAS–70. - If the custodian is not independent of the IA and not 'operationally independent' from the IA, the IA must engage an independent public accountant to perform a surprise examination of client assets during the year. - The auditor must certify to the SEC that the examination has been completed and describe the nature and extent of the examination. - If discrepancies are found, the auditor must give notice to the SEC within one business day. - The independent auditor must be registered with the PCAOB and subject to PCAOB quality standards and oversight. ### Principle 22 — Capital and prudential requirements (CFTC side) - Scope: - Only FCMs and IBs must meet CFTC-prescribed minimum financial requirements; no initial or ongoing capital requirements for CPOs or CTAs. - IBs do not require capital if obligations are guaranteed by an FCM and they deal only through that FCM. - FCM minimum capital requirement is the greatest of: - US$250,000; - the minimum amount of net capital required by the NFA (US$500,000); - 8 percent of customer plus 4 percent of non-customer maintenance margin requirements; - or, if an FCM is also registered as a BD by the SEC, the amount of capital required by the SEC. - IB minimum is the greatest of: - US$30,000; - the minimum amount required by the NFA (US$45,000); - and for IBs also registered as BDs, the amount of capital required by the SEC. - Notes and practices: - CFTC has proposed substantial increases to these minimums (original amounts adopted in 1996). - Early warning thresholds are 10 to 50 percent above these minimum amounts. - Definition of capital: net liquid capital—current liquid assets (discounted by required haircuts) less all liabilities. - Capital calculations require all positions to be marked to market and include haircuts for liquidity, funding, affiliate and unsecured receivable risks (often 100 percent haircut). - Funding risk: haircut on proprietary futures and options positions equal to 100 percent or more of the margin requirement. - Haircut for margin calls not satisfied within no more than three business days. - Unsecured receivables (including from affiliates) generally subject to a 100 percent haircut. - Capital and segregation requirements calculated daily; any deficiency must be rectified and reported immediately. - Reporting: FCMs provide detailed monthly reports to CFTC and SROs; IBs provide semi-annual reports. - Independent audits required for FCMs and IBs, including tests of accounting systems and internal controls; auditors must notify firm and regulators if deficiencies found. - On-site exams: every member firm inspected every 9 to 18 months via NFA/JAC program; CFTC has no routine exam program. ### Principle 22 — Capital and prudential requirements (SEC side) - Capital requirements apply to BDs, not to firms that are just IAs (even if IA has custody of client assets). - Net Capital Rule (NCR) provisions: - Minimum dollar amount of net capital varies by business; standard or alternative method. - Standard method minimum amount varies from US$5,000 to US$250,000. - Aggregate indebtedness to other persons must not exceed 800 percent (first year) or 1500 percent (thereafter) of liquid net capital under the standard method. - Alternative method: net capital at least the greater of US$250,000 or 2 percent of aggregate customer debit items. - Alternative method primarily for firms that hold customer assets. - OTC derivatives dealers and certain BDs may use Value at Risk models subject to conditions. - Holding company program: - Consolidated supervised entities (CSEs) that elect group-wide SEC supervision must compute group-wide capital monthly in accordance with the Basel standards; no such firms as of February 2010. - SROs can set higher capital requirements and restrict business expansion if net capital falls below certain levels: - Example: FINRA prohibits expansion when net capital is less than 150 percent of minimum requirement for more than 15 consecutive business days. - Customer protection: - Reserve account must contain at least the net dollar amount of cash the BD owes to its customers; may be held in cash, U.S. government securities or guaranteed securities. - Monitoring and reporting: - Capital levels monitored via periodic filings and on-site inspections. - Monthly or quarterly reports on capital must be filed with FINRA within 17 days after period end. - Prompt notice required to SEC and FINRA if breach of early warning tests: net capital below 120 percent of minimum or below 5 percent of aggregate debit items. - Equity capital withdrawals: generally require written notice to SEC, SRO and, if applicable, the CFTC; equity withdrawals of less than 30 percent of excess capital only require notice after the fact (CFTC example noted elsewhere). - Audit and auditor requirements: - Annual audited report filed with the SEC and SRO within 60 days of year end; auditor must be independent and review accounting systems and controls. - Assessment summary: - Partly implemented overall; capital rules focus on customer protection and certain risk types but not explicitly on reputational, funding and liquidity risks; re-evaluation recommended. - Treatment of affiliate risk should be reexamined and strengthened; SEC temporary rules on reporting of affiliate exposures (Rules 17h-1T and s17h-2T) should be finalized. - CFTC/SEC divergence: firms registered with both may only be required to meet the higher of the two agencies’ capital amounts rather than combined amounts. ### Principle 23 — Internal organization and operational conduct - CFTC regime: - FCMs and IBs (not guaranteed by an FCM) must provide certified financial statements prior to registration and on an ongoing basis. - FCMs may be required to provide organizational charts, written policies and procedures, systems for monitoring and controlling financial and operational risk, and fiscal year-end consolidated financial statements. - No general requirement for independent periodic evaluation of internal controls and risk management beyond certified financial reporting; NFA requires members to conduct a formal review of operations yearly. - Segregation rules: FCMs must separately account for customer funds and segregate these funds from firm and related person funds; segregation must equal 100 percent of gross account equity of all customers; under-margined accounts value must be made up from firm funds. - Disclosure documents: only an extensive risk disclosure statement is required to be provided to clients; signed acknowledgements must be kept. - Know-Your-Customer (NFA KYC) rule: extensive information required before opening an account; suitability determination customer-by-customer; FCMs must obtain signed acknowledgements. - Supervision: registrants must “diligently supervise” handling of activities; no statutory requirement that a specific person/group have overall compliance responsibility; no requirement for a CCO at futures intermediaries. - Risk Surveillance Group (RSG) performs daily risk assessments of traders, FCMs, and DCOs. - No general requirement that all intermediaries avoid or mitigate conflicts of interest; CTAs and CPOs have mandatory conflict disclosure; FCMs and IBs required to establish and enforce internal rules to transmit customer orders before proprietary orders. - SEC regime: - All BDs required to have appropriate controls to protect client interests and manage risk. - OTC derivatives dealers must have systems to manage market, credit, leverage, liquidity, legal, and operational risks. - No specific standards that BD risk management procedures must meet; adequacy determined by facilitation of compliance. - FINRA requires supervisory systems and designates one or more persons responsible for reviewing supervisory systems; FINRA requires a BD to appoint a chief compliance officer (CCO). - IAs must disclose management on Form “ADV”, have CP&P and appoint a CCO; IA’s CCO is not independent but must have enough seniority and authority. - Audit coverage: owing to gaps, PCAOB does not have authority to oversee all BD auditors; IA auditors generally not required except where IA holds custody and sends statements directly to clients—then independent public accountant verification required. - Client documentation and statements: - Registered IAs only statutorily required to provide Part II of Form “ADV”; no general statutory requirement to send account statements except for IAs with custody who must send statements at least quarterly. - BDs must provide confirmations and statements (monthly if options held, otherwise quarterly) and keep books and records per SEC/FINRA rules. - Suitability, KYC and AML: - BDs must obtain KYC on account opening, recommend suitable investments, and observe suitability obligations under FINRA. - Registered IAs must make a reasonable determination of suitability for clients. - AML requirements apply to BDs and some CIS, but not to IAs. - Assessment: - Broadly implemented. - Comments and recommendations: - Reexamination of risk management expectations for BDs and FCMs, especially liquidity, funding and reputational risks. - All licensed futures intermediaries should be required to avoid or mitigate conflicts of interest and disclose conflicts to clients. - Reassess disclosures to investors regarding complex structured products. - Note limited audits of IAs and IA custody at non-arm’s length custodians; some IAs operating CIS subject to additional internal control review via CIS governance. ### Principle 24 — Failure procedures for market intermediaries - CFTC framework: - CFTC contingency plan to address failures of FCMs; CEA, CFTC regulations, and Bankruptcy Code (Part 190 of CFTC regulations and Chapter 7, Subchapter IV of the Bankruptcy Code) provide framework. - CFTC may apply to court for appointment of a receiver; customers notified as part of process. - FCM must notify CFTC upon defined events indicating financial distress. - CFTC can restrict activities, require account transfers, freeze assets or seek appointment of receiver/monitor. - DCOs have default rules and processes to manage failing/failed FCMs, including access to guarantee funds. - Practice includes frequent conference calls among regulators and exchanges (domestic and foreign) on failures. - SEC framework: - Contingency plan exists for BD failures; staff may determine if self-liquidation possible. - BD must cease doing securities business immediately if net capital falls below required level and give notice to SEC and SRO. - Insolvent BD liquidations proceed under SIPA if self-liquidation impossible; client accounts transferred quickly where possible. - SIPC available to compensate investors if assets or cash are not available when a BD fails; SIPC does not cover IAs. - No general statutory power for SEC to act if an IA is in financial difficulty unless the difficulty relates to a violation of federal securities laws. - SEC would not provide notice to IA clients or general public about an IA’s financial condition; Form “ADV” disclosures may reveal precarious financial condition. - Assessment: - Fully implemented. - Comment: - Crisis highlighted weaknesses in regime governing investment bank holding companies and need to reconcile differences between futures and securities segregation and margining rules. ### Principles for the Secondary Market (25–30) — key points - Principle 25 (authorization of trading systems and exchanges) - CFTC: - Markets trading futures/options must apply to become a DCM, with CFTC analysis against CEA criteria and Core Principles. - ECMs must notify CFTC when operating under Section 2(h)(3) exemption; ECMs become registered entities subject to greater oversight if a contract is determined to be an SPDC. - EBOTs have limited anti-fraud/anti-manipulation requirements only. - DCM applicants must provide substantial documentation; DCMs must adopt fitness standards and rules for financial and market integrity. - SEC: - Exchanges must register as national securities exchanges or be exempt before operations; registration makes them SROs. - SEC reviews exchange applications for trading system operations, means of access, order entry/display, order routing/execution/reporting, clearing and settlement, recordkeeping, emergency powers. - ATSs can register as exchanges or BDs; ATSs that trade 5 percent or more of volume in a NMS security must be linked to an exchange and disseminate best priced orders and provide equal access; 20 percent threshold triggers capacity/contingency procedures. - Assessment: - Broadly implemented; concerns about ECM/EBOT authorization under CFTC and pre-trade transparency under SEC Regulation ATS (the “5 percent rule”). - Principle 26 (ongoing regulatory supervision of exchanges and trading systems) - CFTC: - Monitors DCMs and ECMs trading SPDCs via compliance reporting and for-cause inquiries; empowered to require ECMs trading SPDCs to comply with 9 Core Principles. - Emergency authority to direct DCM/ECM to maintain or restore orderly trading; power to suspend or revoke DCM designation. - SEC: - Trading rules generally pre-approved; SEC can block immediately effective filings for up to 60 days. - Ongoing supervision via routine/cycle and for-cause inspections; authority to inspect exchanges, associations, ATSs and obtain surveillance/trading data. - Exchanges required to maintain operational capability standards and adequate resources for self-regulatory function. - Assessment: - Fully implemented. - Principle 27 (transparency of trading) - CFTC: - CEA and regulations require transparency; Core Principle 8 requires DCMs to make daily public information on settlement prices, volume, open interest and ranges. - Exchanges publish trade data real-time (generally fee-based) and delayed for free (delay at most ten minutes). - Concern about fair and equitable distribution of data to third-party vendors. - SEC: - Pre- and post-trade transparency for equities and options via national market system plans; exchanges and FINRA submit transaction and quotation information to Plan processors for dissemination; proprietary data products permitted but obligations to contribute real-time data remain. - Derogations: quotes from OTC market-makers with ≤ 1 percent executed volume and ATSs trading < 5 percent not consolidated; one ATS has 20 percent limit (2005 approval). - Dark pools: number increased from approximately 10 in 2002 to approximately 32 in September 2009; SEC estimated trading volume of dark pools approximately 7.9 percent of total share volume in NMS stocks (one consulting firm estimated 12 percent). - Assessment: - Fully implemented overall, with SEC concerns about non-publicly displayed liquidity; SEC proposed reducing the 5 percent limit to 0.25 percent and addressing actionable indications of interest. - Principle 28 (detecting/deterring manipulation and unfair trading) - CFTC: - Section 4b of the CEA prohibits cheating or defrauding in connection with futures contracts; prohibits fictitious trading. - Insider trading provisions are explicit but limited in scope. - CFTC market surveillance program being upgraded; sanctions include trading bans, restitution, disgorgement, fines, injunctions, and criminal penalties (fines up to US$1 million or imprisonment up to ten years or both). - SEC: - Broad anti-fraud provisions across Exchange Act, Securities Act, Advisers Act and ICA; civil and administrative enforcement. - Enforcement targets include price manipulation, insider trading, front running, spoofing practices and many other manipulative schemes. - SROs collect and analyze trading data; FINRA spends more than US$30 million per annum on market surveillance technology; NYSE Regulation estimated market surveillance cost US$62 million in 2009 with further increase scheduled for 2010. - SEC enforcement results (fiscal year 2008): 671 enforcement cases; orders requiring disgorgement of approximately US$774 million and penalties of approximately US$256 million. - Assessment: - Broadly implemented. - Comments: - CFTC insider dealing scope narrow; assessors support expanding insider dealing offence and requiring Chinese walls between research and trading in FCMs/IBs. - Cross-market surveillance differences: futures markets (CFTC) have broader daily visibility of positions compared with fragmented securities surveillance. - Principle 29 (management of large exposures, default risk and market disruption) - CFTC: - Risk Surveillance Group (RSG) receives timely clearing member and large trader data; focuses on concentration and proactive identification of risks. - Emergency powers: suspend/halt trading, set margin/position limits, impose circuit breakers, alter rules, etc. - DCMs must have rules for emergency authority including liquidation/transfer of open positions and special margin requirements. - Transactions on ECMs, if cleared, must be cleared by approved clearing organizations (DCOs or others meeting FDICIA/CFMA criteria). - In practice, 90 percent of all futures contracts clear through the DCO which is part of the CME group. - SEC: - Continuous monitoring of BDs’ open positions and large exposure primarily performed by clearing agencies which receive real-time data and review positions end of day and intraday. - Clearing agency rules pre-approved by SEC; SEC conducts on-site exams of each clearing agency on a two-year cycle and for cause. - Limited explicit large exposure disclosure requirements: BDs with outstanding options positions exceeding aggregate of 200 or more option contracts on same side of market covering same underlying must report. - Clearing agency rules and bankruptcy/SIPA frameworks applicable on BD liquidation. - Assessment: - Fully implemented. - Comment: - SEC faces limitations in obtaining beneficial ownership details of securities positions compared with CFTC large trader information. - Principle 30 (clearing and settlement oversight) - Note: - A separate CPSS-IOSCO assessment was conducted for securities markets; arrangements in futures markets were not assessed in this source. *Italic: Source — _cr10125 - Part II of Form “ADV” that must be given to clients of the IA must contain detailed disclosure on:_* --- _Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2010/_cr10125.pdf_