[Federal Register Volume 79, Number 129 (Monday, July 7, 2014)]
[Notices]
[Pages 38349-38353]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2014-15719]
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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-72498; File No. SR-NFA-2014-04]
Self-Regulatory Organizations; National Futures Association;
Notice of Filing of Proposed Rule Change to the Interpretive Notice to
NFA Compliance Rules 2-4 and 2-36: Prohibition on the Use of Certain
Electronic Funding Mechanisms
June 30, 2014.
Pursuant to Section 19(b)(7) of the Securities Exchange Act of 1934
(``Exchange Act''),\1\ and Rule 19b-7 under the Exchange Act,\2\ notice
is hereby given that on June 18, 2014, National Futures Association
(``NFA'') filed with the Securities and Exchange Commission (``SEC'' or
``Commission'') the proposed rule change described in Items I and II
below, which Items have been substantially prepared by the NFA. The
Commission is publishing this notice to solicit comments on the
proposed rule from interested persons.
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\1\ 15 U.S.C. 78s(b)(7).
\2\ 17 CFR 240.19b-7.
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On June 18, 2014, NFA submitted the proposed rule change to the
CFTC for approval. The CFTC has not yet approved the proposed rule
change.
I. Self-Regulatory Organization's Description and Text of the Proposed
Rule Change
Under the proposed Interpretive Notice to NFA Compliance Rules 2-4
and 2-36: Prohibition on the Use of Certain Electronic Funding
Mechanisms (``Interpretive Notice''), NFA Members (``Members'') are
prohibited from allowing customers to fund futures or forex accounts
with a credit card or other electronic funding methods tied to a credit
card. The proposed Interpretive Notice does not prohibit Members from
allowing customers to fund futures or forex accounts with electronic
funding mechanisms that are tied to a customer's bank account at a
financial institution provided the funds deposited are drawn directly
from the customer's bank account. The Interpretive Notice requires,
however, that the Member be able to distinguish, prior to accepting
funds, between an electronic funding method that draws money from the
customer's account at a financial institution and a traditional credit
card, and be able to reject the credit card transaction before
accepting funds. The Interpretive Notice also requires Members offering
this type of electronic funding mechanism to provide adequate risk
disclosure in light of the customer's financial circumstances.
The text of the Interpretive Notice is available on NFA's Web site
at www.nfa.futures.org, the Commission's Web site at www.sec.gov, NFA's
office, and at the Commission's Public Reference Room.
II. Self-Regulatory Organization's Statement of the Purpose of, and
Statutory Basis for the Proposed Rule Change
In its filing with the Commission, NFA included statements
concerning the purpose of and basis for the proposed rule change and
discussed any comments it received on the proposed rule change. The
text of these statements may be examined at the places specified in
Item IV below. NFA has prepared summaries, set forth in sections A, B,
and C below, of the most significant aspects of such statements.
A. Self-Regulatory Organization's Statement of the Purpose of, and
Statutory Basis for the Proposed Rule Change
1. Purpose
Section 15A(k) of the Exchange Act \3\ makes NFA a national
securities association for the limited purpose of regulating the
activities of NFA Members who are registered as brokers or dealers
under Section 15(b)(11) of the Exchange Act.\4\ The proposed
Interpretive Notice applies to all NFA Members, including those that
are registered as security futures brokers or dealers under Section
15(b)(11) of the Exchange Act.
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\3\ 15 U.S.C. 78o-3(k).
\4\ 15 U.S.C. 78o(b)(11).
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NFA adopted the Interpretive Notice to NFA Compliance Rules 2-4 and
2-36 prohibiting Members from allowing customers to fund futures or
forex accounts with a credit card or other electronic payment methods
tied to a credit card after an extensive study and analysis done at the
direction of NFA's Compliance and Risk Committee (``CRC''). The CRC's
study and analysis found significant customer protection concerns with
credit card funding in the retail forex area, and therefore NFA's Board
of Directors, upon the recommendation of the CRC, determined the only
appropriate action was to adopt this prohibition. The prohibition is
entirely consistent with NFA's longstanding position that it is a
violation of NFA Compliance Rule 2-4, and inconsistent with just and
equitable principles of trade, for Members to
[[Page 38350]]
encourage customers to borrow money to invest.\5\
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\5\ See In the Matter of First Investors Group of Pal Beaches,
Inc., et.al., NFA Case No. 95-BCC-011 (November 12, 1999).
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Many Forex Dealer Members (``FDMs'') offer their retail forex
customers the ability to fund their accounts directly using a credit
card or via an online payment facilitator (e.g., PayPal) that is
commonly tied to a credit card (Payment Facilitator(s)--Credit). The
CRC had several concerns with this practice, including that retail
customers may be using credit cards to open accounts with funds that
are borrowed and, therefore, not risk capital. The CRC's concern had
significant merit since a 2012 review of several FDM Web sites showed
that those FDMs promoted credit funding as the ``quickest,''
``easiest,'' and ``fastest'' method of investing.
Given its concern, the CRC began considering whether it would be
appropriate for NFA to prohibit its Members from allowing customers to
fund their accounts (both forex and futures) via a credit card or a
Payment Facilitator--Credit. As part of its consideration, the CRC
directed NFA staff to conduct a detailed analysis of FDM account
funding practices, customer income levels, and customer account funding
origins. The analysis covered approximately 15,500 accounts held at
seven FDMs--all of which were registered as retail foreign exchange
dealers (``RFED'')--during 2012. The results of this analysis revealed:
Credit card funding restrictions varied among the FDMs.
Several permitted the use of a credit card up to $10,000 per
transaction. One firm based its restriction on a customer's income
level and a permitted customer with a net income between $0-$19,000 to
fund an account with as much as $1,000 through a credit card;
The average life of a retail forex trading account at an
RFED was 4 months regardless of the amount of the initial deposit;
For the 4th quarter 2013, 72% of the accounts analyzed
were unprofitable;
78% of all accounts were initially funded via credit card/
debit card/online payment facilitator;
Almost 50% of all account holders reported a net income of
$50,000 or less; and
Deposits made by credit card/debit card/online payment
facilitator were markedly lower than deposits made by wires or checks.
For example, for customers with a net income less than $50,000, the
average deposit via credit card/debit card/online payment facilitator
was approximately $1,050 whereas for checks or wires it was
approximately $6,650. This difference was also prevalent at other net
income levels, including above $100,000 where the average deposit via
credit card/debit card/online payment facilitator was approximately
$2,450 whereas for checks or wires it was approximately $28,000.
Given the prevalence of credit card usage by customers to initially
fund retail forex accounts and the fact that such a large percentage of
those customers had a relatively low income level ($50,000 or less),
the CRC reviewed whether the FDMs provide specific risk disclosures
regarding the implications of funding via a credit card or a Payment
Facilitator--Credit and learned that none of the FDMs warned customers
that they should not use a credit card or Payment Facilitator--Credit
to borrow money to invest in retail forex.
The CRC found the data very disturbing from a customer protection
perspective because it reveals that lower income individuals
predominantly use credit cards or Payment Facilitators--Credit to fund
their accounts and the vast majority of these individuals lose their
funds trading forex. Although the CRC recognized that it is possible
that all lower income individuals pay off their credit card balances
each month and are not borrowing funds to invest beyond the payment due
date, the CRC concluded that this possibility is simply implausible
given the low income levels.
NFA Compliance Rule 2-4 requires Members and their Associates to
observe high standards of commercial honor and just and equitable
principles of trade in the conduct of their commodity futures business.
Similarly, NFA Compliance Rule 2-36(c) requires Members and their
Associates to observe high standards of commercial honor and just and
equitable principles of trade in the conduct of their forex business.
The CRC concluded that permitting customers to utilize funding
mechanisms that by their very nature allow retail customers to borrow
funds to invest in markets where the risk of loss can be substantial
and a total loss may occur simply is not consistent with a Member's
obligation to observe high standards of commercial honor and just and
equitable principles of trade. Given NFA's analysis of the FDMs'
customers' usage of credit cards and Payment Facilitators--Credit, and
the fact that credit cards and Payment Facilitators--Credit readily
allow individuals to borrow funds to purchase goods and services, the
CRC concluded that without adequate mechanisms in place to ensure that
customers are not borrowing funds to invest in the highly volatile
futures and forex markets, Members should not be permitted to allow
their customers to invest via electronic funding mechanisms.
The Interpretive Notice does not ban forms of electronic funding
mechanisms that are tied to a customer's bank account at a financial
institution, such as a debit card or a PayPal account tied to a bank
account. The CRC found that these funding mechanism are acceptable and
appear consistent with a Member's obligation to observe high standards
of commercial honor and just and equitable principles of trade because
when a customer uses an electronic funding mechanism directly tied to
an account at a financial institution, the customer has funds on hand
that are immediately transferred from the customer's bank account to
the Member, which significantly reduces the likelihood that funds are
being borrowed to invest. However, in order for a Member to allow
customers to use electronic funding mechanisms, the Member must be able
to distinguish between those electronic funding mechanisms tied to a
credit card and those tied to a bank account and reject the ones tied
to a credit card.\6\
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\6\ One FDM indicated that it currently uses a third-party
provider to process credit and debit card transactions when they are
initiated by the customer. Accordingly, the third-party provider
uses a programming code, which allows its front-end processer to
identify whether a card is a credit or debit card based on the
digits listed on the card. This front-end processing system has the
ability to identify the card as a debit card even if the customer
elected to process the card as a credit transaction. In other words,
the system programming can distinguish between a debit card issued
by a bank with monies drawn from a checking or savings account, or a
traditional credit card. The third party provider is able to
automatically reject transactions that are credit card transactions.
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Under the Interpretive Notice, if a Member offers customers the
ability to use an electronic funding mechanism, then the Member must
utilize a processing system or some other electronic mechanism that can
ensure the funding device is a debit card or some other payment
facilitator that is tied directly to the customer's bank account at a
financial institution. Moreover, any Member offering this type of
funding mechanism, must also ensure that adequate risk disclosure is
provided to customers in light of the customers' financial
circumstances.
2. Statutory Basis
NFA believes that the proposed rule change is authorized by, and
consistent with, Section 15A(k)(2)(B) of the
[[Page 38351]]
Exchange Act.\7\ That section sets out requirements for rules of a
futures association, registered under Section 17 of the Commodity
Exchange Act, that are a registered national securities association for
the limited purpose of regulating the activities of members who are
registered as brokers or dealers in security futures products pursuant
to Section 15(b)(11) of the Exchange Act. Under Section 15A(k)(2)(B),
the rules of such a limited purpose national securities association
must be designed to prevent fraudulent and manipulative acts and
practices, to promote just and equitable principles of trade, and, in
general, to protect investors and the public interest in connection
with security futures products in a manner reasonably comparable to the
rules of a registered national securities association registered
pursuant to Section 15A(a) that are applicable to securities futures
products. NFA believes the proposed rule change meets these
requirements because NFA determined that permitting customers to use
credit cards to fund futures and forex accounts was inconsistent with
just and equitable principles of trade and the proposed Interpretive
Notice prohibits Members from permitting customers to use credit cards
to fund accounts.
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\7\ 15 U.S.C. 78o-3(k)(2)(B).
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B. Self-Regulatory Organization's Statement on Burden on Competition
NFA recognizes that the proposed rule change may impose a minor
burden on competition with respect to foreign customers that might be
able to use credit cards to fund accounts with foreign intermediaries
that are not Members of NFA. NFA concluded, however, that any burden
was outweighed by the need to adopt appropriate customer protection
measures. NFA also concluded that the burden was minimized by the fact
that the Interpretive Notice permits Members to offer customers the
ability to use an electronic funding mechanism that draws funds
directly from the customer's account at a financial institution,
provided the Member is able to distinguish between those electronic
funding mechanisms drawing funds directly from the customer's account
at a financial institution and those tied to a credit card and reject
those transactions tied to a credit card.
C. Self-Regulatory Organization's Statement on Comments on the Proposed
Rule Change Received From Members, Participants, or Others
The CRC requested feedback on the concept of prohibiting Members
from allowing customers to fund their forex or futures accounts with a
credit card or Payment Facilitator--Credit from NFA's Futures
Commission Merchant (``FCM''), Introducing Broker (``IB''), Commodity
Pool Operator (``CPO'') and Commodity Trading Advisor (``CTA'')
Advisory Committees. Each of these Committees fully supported a ban of
this practice for both futures and forex accounts. Given the importance
of this issue, the CRC did not obtain the views of NFA's FDM Advisory
Committee--which had recently lost most of its representatives due to
FDM withdrawals and consolidations--but rather obtained the FDMs' views
by issuing a Notice to all FDMs requesting their comments. The CRC also
met with affected members of the FDM community to further discuss their
comments.
Specifically, NFA received comments from five of NFA's 17 FDMs (one
of which was filed by a law firm on behalf of the FDM), the Financial
Services Roundtable (``FSR'') and a retail forex customer. All but one
FDM strongly opposed a ban against FDMs accepting credit cards from
customers to fund forex trading accounts. Despite the fact that credit
card funding was not ``an insignificant portion'' of its business, this
FDM did not object to the proposed ban but requested a 60-day
implementation period in order to make operational changes to reject
credit card transactions while permitting debit card transactions and
to educate clients about the ban.
The CRC carefully considered all of the comments received. Below is
a summary of the material comments and the CRC's response.
Forex customers must react to market changes during non-
banking hours and credit cards are the only funding method to do so,
while checks or wire transfers often take too long to be credited to
prevent a margin close-out.
Credit cards are more economical since FDMs do not charge
a fee to use them while banks charge fees for wire transfers and use of
Automated Clearing House (``ACH'').
Credit card funding is one of the fastest, most
convenient, and lowest cost funding vehicles.
Many FDMs represented to NFA that customers need to use
credit cards in order to quickly add funds in order to avoid forced
liquidation of their positions.
The CRC recognized that credit cards may provide an efficient and,
in some instances, economical method for depositing funds into a
trading account. The CRC believed, however, that this benefit is vastly
outweighed by the risk associated with a customer borrowing funds to
invest in futures or forex. Moreover, the CRC believed that the
efficient and economical benefits of credit card funding can be
retained by permitting Members to offer customers the ability to use an
electronic funding mechanism that draws funds directly from the
customer's account at a financial institution, provided the Member is
able to distinguish between those electronic funding mechanisms drawing
funds directly from the customer's account at a financial institution
and those tied to a credit card and reject those transactions tied to a
credit card.
Additionally, NFA's analysis revealed that very few forex positions
overall are auto-liquidated, customers generally add funds to their
account using the same method as their initial funding method, and
positions in accounts funded through a credit card are not less likely
to be auto-liquidated. In fact, NFA's analysis showed that those
accounts funded through a credit card actually had positions auto-
liquidated more frequently than those accounts funded through
traditional methods, although the percentage of auto-liquidations
remained relatively low.
Funds deposited by traditional methods may ultimately be
drawn from credit sources.
The CRC acknowledged that the prohibition could be circumvented
because accounts funded with deposits using traditional methods may
ultimately be drawn from credit sources. The CRC, however, concluded
that banning the direct use of credit cards would lessen the likelihood
of this occurrence because a customer can make an instantaneous
decision to use a credit card, whereas other forms of credit generally
take longer to obtain and provide the customer with more time to
consider the consequences of borrowing funds to invest. Moreover, the
CRC felt that credit cards are funding mechanism that lend themselves
to borrowing funds and permitting this type of funding mechanism is
directly contrary to NFA's longstanding position that it is a violation
of NFA Compliance Rule 2-4, and inconsistent with just and equitable
principles of trade, for Members and Associates to encourage customers
to borrow money to invest.
The ban is overly broad since alternative payment
facilitators (e.g., PayPal, MoneyBookers and Google Checkout) may be
funded through a bank account or other debit sources.
The CRC addressed this comment by providing that the ban did not
apply to electronic payment methods that are
[[Page 38352]]
tied to a bank account at a financial institution provided that the
Member is able to distinguish between electronic payment mechanisms
that are tied to a bank account and traditional credit card
transactions and reject the credit card transactions before accepting
funds.
FDMs have other procedures in place to ensure that
customers only use risk capital even if the source is a credit card.
NFA has other rules that ensure that customers do not
invest funds in excess of risk capital (Rule 2-36 ``know your
customer,'' risk disclosure requirements, and guidance requiring FCMs
to prominently disclose that customers should only fund with risk
capital).
The CRC acknowledged that NFA had other rules in place to guard
against customers investing in excess of risk capital and that FDMs
should have other procedures in place to ensure customers only use risk
capital even if the source was a credit card. The CRC concluded,
however, that based on the analysis conducted and the fact that credit
cards by their nature permit easy access to borrowed funds any
disclosure alone is an insufficient customer protection measure to
address the issue.
Banks that issue credit cards consider a customer's credit
worthiness in determining the customer's credit limit, which is a built
in risk safeguard.
The CRC did not believe this provided a credible rationale to
permit credit card funding. Retail customers should not be borrowing
funds to invest in futures or forex. Regardless of the credit limit
determined by a bank, a customer should not be using borrowed funds to
invest in the volatile futures or forex markets where the risk of loss
may be substantial.
Certain foreign jurisdictions permit credit card funding.
Credit cards are permitted in numerous industries in which
``customer funds are put at risk with far fewer safeguards than retail
forex trading,'' including the New York State Lottery, which provides
customers the option of signing up for subscriptions to certain lottery
games using credit cards, and the Nassau County New York OTB permits
individuals to make deposits via credit card to their permanent
wagering account.
The CRC was not persuaded by the comment that many foreign
jurisdictions permit customers to use credit cards to fund forex
accounts. The CRC felt that the customer protection concerns raised by
this practice were far too disturbing and the fact that foreign
jurisdictions may permit this practice did not outweigh these concerns.
The CRC also found entirely unpersuasive the fact that other
industries, particularly off-track betting parlors or lottery related
agencies, permitted customers to use credit cards.
The FDMs opposing a ban on funding via a credit card
recommended that NFA address this issue short of imposing a
prohibition. For example, these FDMs believe that NFA should do one or
more of the following--prohibit heavy promotion of credit card funding,
require account withdrawals to go back to the original funding credit
card, establish a monthly deposit cap for credit card funding, enhance
disclosures regarding risk capital usage, issue prominent warnings
regarding credit card usage to underscore the risks of using this
funding means if a customer does not have sufficient bank funds to
cover the deposit, and recommending that customers pay off credit card
balances monthly by the due date.
The CRC considered other alternatives and concluded that given the
customer protection concerns raised, and the fact that credit cards are
any easy source of borrowed funds, the only way to address the issues
was to prohibit Members from allowing customers to use credit cards or
other electronic methods unless the Member could distinguish between
electronic payments that are tied to a bank account and traditional
credit card transactions and reject the credit card transactions.
The FSR's letter claimed banning credit cards and the use
of credit cards through payment facilitators (e.g. Paypal) is a
significant regulatory action that has far reaching implications. The
FSR urged NFA to consider viable alternatives and seek comments from
those outside the forex industry.
The CRC determined that one of NFA's primary responsibilities is
the protection of customers in the futures and forex industries and
that the prohibition was necessary to achieve this objective. The CRC
also observed that NFA's mandate is not to promote the business
interests of credit card companies.
III. Date of Effectiveness of the Proposed Rule Change and Timing for
Commission Action
The proposed rule change is not effective because the CFTC has not
approved the proposed rule change.
Section 19(b)(7)(C) of the Act provides, inter alia that ``[a]ny
proposed rule change of a self-regulatory organization that has taken
effect pursuant to [Section 19(b)(7)(B) of the Act] may be enforced by
such self-regulatory organization to the extent such rule is not
inconsistent with the provisions of the title, the rules and
regulations thereunder, and applicable Federal law. At any time within
60 days of the date of effectiveness of the proposed rule change, the
Commission, after consultation with the CFTC, may summarily abrogate
the proposed rule change and require that the proposed rule change be
refiled in accordance with the provisions of Section 19(b)(1) of the
Exchange Act.
IV. Solicitation of Comments
Interested persons are invited to submit written data, views, and
arguments concerning the foregoing, including whether the proposed rule
change is consistent with the Exchange Act. Comments may be submitted
by any of the following methods:
Electronic Comments
Use the Commission's Internet comment form (http://www.sec.gov/rules/sro.shtml); or
Send an email to [email protected]. Please include
File Number SR-NFA-2014-04 on the subject line.
Paper Comments
Send paper comments in triplicate to Secretary, Securities
and Exchange Commission, Station Place, 100 F Street NE., Washington,
DC 20549-1090.
All submissions should refer to File Number SR-NFA-2014-04. This file
number should be included on the subject line if email is used. To help
the Commission process and review your comments more efficiently,
please use only one method. The Commission will post all comments on
the Commission's Internet Web site (http://www.sec.gov/rules/sro.shtml). Copies of the submission, all subsequent amendments, all
written statements with respect to the proposed rule change that are
filed with the Commission, and all written communications relating to
the proposed rule change between the Commission and any person, other
than those that may be withheld from the public in accordance with the
provisions of 5 U.S.C. 552, will be available for Web site viewing and
printing in the Commission's Public Reference Room, 100 F Street NE.,
Washington, DC 20549, on official business days between the hours of 10
a.m. and 3 p.m. Copies of such filing also will be available for
inspection and copying at the principal office of NFA. All comments
received will be posted without change; the Commission does not edit
personal identifying information from submissions. You should submit
only information that you wish to make publicly available. All
submissions should refer to File
[[Page 38353]]
Number SR-NFA-2014-04 and should be submitted on or before July 28,
2014.
For the Commission, by the Division of Trading and Markets,
pursuant to delegated authority.\8\
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\8\ 17 CFR 200.30-3(a)(73).
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Jill M. Peterson,
Assistant Secretary.
[FR Doc. 2014-15719 Filed 7-3-14; 8:45 am]
BILLING CODE 8011-01-P