arned. Also,if you ever have problems with the firm, you can use its disregardof NFA rules in your formal complaint. The specific NFA rule governing promotion is Rule 2-29. Its broad definition of promotionalmaterial includes the following:“1. Any text of a standardized oral presentation, such as asales script, or any communication for publication in anynewspaper, magazine, or similar medium, or anybroadcast over television, radio, or other electronicmedium, which is disseminated or directed to the publicconcerning a futures account, agreement, or transaction2. Any standardized form of report, letter, circular,memorandum, or publication, such as a newsletter, whichis disseminated or directed to the public3. Any other written material disseminated or directed to thepublic for the purpose of soliciting a futures account,agreement, or transaction, such as a seminar or class.”In general, you can consider just about all communications withyou, the public, as promotional activities or promotional material.NFA PROHIBITIONS ON PUBLIC COMMUNICATIONS
The NFA has three general prohibitions that apply to all communications with the public. They are (1) fraudulent or deceitful communications, (2) high-pressure communications, and (3) the statement that futures trading is appropriate for everyone.Rule 2-29 requires anyone selling futures trading to providea balanced discussion of the profit potential and the risk of loss.Whenever the possibility of profit is mentioned, an equally prominent statement of the risk of loss must accompany it.To make this determination, the NFA analyzes the overall impact of the promotional material. The NFA takes into considerationthe number of times each word is used, the size of the type, and the
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amount of time or space devoted to each. But these are not the onlyconsiderations.Remember that the mention of profit can take many forms andis not limited to the word profit. Charts and graphs showing thegrowth of an account, for example, are considered statements aboutprofits.There are two separate cautionary statements that are requiredto be disclosed if actual results or hypothetical results are used inthe promotional material. These are separate and distinct requirements.The question of balance is particularly important in video andother oral presentations. For example, a 60-second commercial withonly 5 seconds discussing loss or superimposing a disclaimer at thebottom of the screen is not acceptable to the NFA.This holds true for telephone sales as well. The AP can’t talkabout profits for 10 minutes and then say, “Past performance is notindicative of future results,” and let it go at that. That AP would bein clear violation of Rule 2-29.High-pressure sales tactics are a serious breach of the NFA’scustomer protection program. The NFA considers the following asthe principal characteristics of high-pressure selling:1. Exaggerating profit potential2. Exaggerating past results3. Exaggerating the qualifications of an AP4. Exaggerating the need for urgency in making the investment decision5. Constantly badgering the prospect6. Belittling the prospect for not investing7. Emphasizing profits that have been missed8. Using courier services to deliver and pick up account papers9. Downplaying the importance of the paperwork as mereregulatory red tape10. Providing poor service to the customer after the sale“Hypothetical results” are records of the results of trading thatactually did not take place. They were constructed from computersimulations or some other mechanical method. When presentedwith a trading track record of a broker, CTA, or system, the first
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thing to do is to check to see if the results are labeled as hypothetical. It must be done in a manner that any reader would be able toimmediately and clearly understand.NFA Rule 2-29(b)(4) requires any hypothetical results (including graphs) to be accompanied by a cautionary statement fromCFTC Regulation 4.41(b)(1), which describes the limitation of hypothetical results.Hypothetical or simulated performance results have certaininherent limitations. Unlike an actual performance record,simulated results do not represent actual trading. Also, sincethe trades have not actually been executed, the results mayhave under- or over-compensated for the impact, if any, ofcertain market factors, such as lack of liquidity. Simulatedtrading programs in general are also subject to the factthat they are designed with the benefit of hindsight. Norepresentation is being made that any account will or is likelyto achieve profits or losses similar to those shown.The creator of the track record must be able to demonstrate tothe NFA the basis for the hypothetical results and keep records toprove how the record was calculated. Real and hypothetical resultsshould never be mixed on the same track record. The NFA believesthis is confusing and misleading.Are the rules any easier if actual, rather than hypothetical, results are used? The person promoting the track record must be ableto prove the results using actual account statements. The accountsselected must be representative of all the accounts the person controls. The CTA can’t just show you the best account. The NFA willcheck equity runs and do all the detail work needed to compare theaccounts used with all other accounts, if and when it audits the CTA.If different types and sizes of accounts are traded, using a representative account becomes more difficult because the NFA willwant an explanation of the selection and how it compares with a“typical” account. Some of the differences taken into considerationare size, margin rates, trading strategies, markets, and commissions.Also, beware of advertising that uses a lot of high-powered adjectives, such as largest or best or fastest. If superlatives are used, theuser may have problems with the NFA. The NFA’s position is thatsuch claims may be regularly used in other industries, but they cannot be used by NFA members without detailed substantiation.
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In the eyes of the NFA, the use of qualifiers, such as “one of thefastest” or “one of the largest,” does little to alter the need to document the claim. Whatever is said in sales and advertising must beproved if questioned by the NFA.When it comes to promoting exchange-traded options; thereare additional considerations. The NFA takes exception to the useof the term limited risk when referring to options. The broker mustmake it clear that the risk is limited to the entire amount of the premium plus transaction costs. The term transaction costs means thecommission and fees; and the term fees means NFA, exchange, andFCM fees.If a broker is promoting a third-party controller (a CTA), somepromotional material prepared by the CTA may be used. This doesnot reduce the broker’s accountability in any way.The NFA looks at the responsibility to police the industry as atwo-way road. In other words, if a broker is promoting a CTA andthe sales literature is misleading, the broker will be held responsible along with the CTA if the NFA gets involved in a complaint.Every party that prepares or uses promotional materials is responsible for compliance with NFA Rule 2-29, including the supervisory organization.Live TV or radio interviews done by APs or CTAs do not fallwithin the strict definition of promotional material, but the registered person doing the interview is always subject to the three general prohibitions: fraud, high pressure, and inappropriateness of futures trading for all investors. In addition, if the show is paid for bythe NFA member and this fact is not disclosed, the NFA will call itfraud. The NFA strongly discourages shows that “pretend” to benews.The newsletter Commodity Traders Consumer Reports and otherindependent sources that rate CTAs are often used as promotionalmaterials. The person using the material still has a lot of responsibility and must be sure that the report is accurate and that proper disclosure is made regarding the limitations of the results and rating.This means that rates of return must be calculated in a mannerconsistent with CFTC regulations [Rule 4.21(a)(4)(ii)(F)]. The usermust be able to show to the NFA that the calculations comply withthe rules. Lastly, all the information available to support any numerical data must be available to the NFA if it requests it.
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The overall position of the NFA is very clear. From time to time,interpretation of borderline cases can cause consternation betweenbroker and customer. By and large, however, there is little room forconfusion with the NFA.If you are solicited by a broker who is using some type of advertising that delivers an unbalanced presentation of the enormousprofits to be made from the futures market with little or no mentionof risk, this should send up at least two red flags: The material is inviolation of NFA Rule 2-29, and you should beware of whoever ispresenting the materials. If this initial overture is so out of tune, therest of the song will probably be as well. The next refrain will be ahigh-pressure sales presentation most likely.Advertising that is balanced and informative can be very helpful to you in deciding if you are suited for futures trading and if youwant to learn more. As you absorb these types of messages, you’lllearn how much risk you’ll be accepting and have a more completepicture of profit opportunity.INVESTING IS SERIOUS BUSINESS
Once attention is aroused, most buyers begin the next stage of thesales process, the search for more information. Investing is seriousbusiness. Therefore, as interest in a product or service grows, youwill want to learn as much as you can about it.At this stage, you often see a big difference between the ethicalbroker and one who plays fast and loose. The former will spend timewith you, send you information, such as newsletters, and be sincerely interested in learning about your investment needs. Thewheeler-dealer’s objective is to raise a prospect’s greed level to sucha fever pitch that money is sent immediately. This is high-pressuresales. There’s no time for thought and reflection. You’ll hear lineslike this:“An opportunity this good only comes by once in a bluemoon!”◆ “If you don’t get $2,000 to me by noon tomorrow, you’llmiss your chance to turn it into $10,000 in the next twoweeks!”◆ “Gold is going sky-high tomorrow!”◆
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From ethical brokers, you’ll hear descriptions of opportunities won and opportunities lost. The legitimate AP will tell youthat sooner or later another good, solid trading opportunity willappear. You’ll also be provided with a balanced presentation of therisk, something you won’t hear from “deal peddlers.” A futurestrade that sounds too good to be true probably is, as the sayinggoes.In its booklet Before You Say Yes, the NFA lists 15 questions thatcan help you distinguish qualified investment salespeople fromswindlers. The following is a paraphrased version of those questions:1. What is the commission rate? Other costs?2. What are the risks?3. Can you send me a written explanation of the risk involved?4. Can you send me copies of your sales literature?5. Are you selling futures contracts sold on the regulatedexchanges?6. Which governmental or industry regulator supervisesyour firm?7. Specifically, where would my money be held?8. When and where can we meet in person?9. How and when can I liquidate my investment if I so desire?10. Will you send me your entire proposal in the mail?11. If a dispute arises, what are the means available to resolve it?12. Where did you get my name?13. Would you mind explaining your proposal to my lawyer?14. Would you give me the names of your principals and officers?15. Can you provide references?Experience has shown that the dishonest salespeople usuallyresist or are not prepared for this type of interrogation. Their“marks” are impulsive buyers who make entirely emotional decisions. The answers you get are vague and evasive. For example,
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question: How much are commissions?response: They’re never a problem.question: If I have a complaint, what can I do?response: Don’t even worry about that. I’ll take care of youpersonally.By gathering a lot of information and taking some time making your decision, you can protect yourself from the majority ofswindlers, but not all. The clever ones mimic legitimate sales operations, but their tactics can be uncovered if you do your homeworkand control your emotions.The next step of the typical sales process is the evaluation of alternatives. Only the most experienced investors take the time to dothis. Most people, if they decide to trade, go with the person or company in pursuit of them. Be selective. You need someone who willprovide synergism to your trading effort and who will help youovercome your limitations. Use due diligence. As far as checking ona specific broker, call the NFA on its toll-free number. Explain thatyou want to check the status of an AP and ask the following questions:1. Is the broker currently registered?2. With which firm?3. How long has the broker been registered?4. Has the NFA taken any public disciplinary action againstthe broker?5. Has the broker been registered with any firm that has beencited for compliance problems?6. Is there anything else you can tell me about the broker I’mconsidering?This toll-free call takes about 5 minutes and tells you if the APin question has ever had problems with the NFA. You’ll also getsome facts about the broker’s experience which you can comparewith what you’ve been told.You can also check the website of the Commodity FuturesTrading Commission to see if a broker is under administrative sanctions. The telephone number is 202-418-5508. The address of thewebsite page is www.cftc.gov/proc/admsanclst.htm.
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Another source to check is the NFA Manual. It includes a section, which is well cross-referenced by broker name, detailing thedisciplinary hearings conducted by the NFA. It is published byPrentice-Hall Information Services (800-562-0245). Your public library may have it or might order it for you. It costs about $78 peryear and is updated periodically throughout the year.Once you make your broker choice, you formally make yourselection by completing the account papers. Your broker should askyou to read them carefully and fill them out in your own handwriting. The reason for you to do it in your own hand is so the broker isassured that you saw them and had the opportunity to read them.The broker will ask you if you understand them and have any questions. Remember, even account papers should describe the risks youare assuming.If the broker offers to fill them out for you (“I’ll just get themtyped up for you”), consider this a warning signal. The easier thebroker makes it for you to fill out the account papers, the less likelyyou are to study them. They are worth the time and effort it takes tounderstand what you are signing because they define the risk youface in great detail.The last phase of the sales process is called the postpurchase period. What happens after your account is opened and funded?Most accounts begin trading at this point. To place a trade, youcall your broker or your broker calls you. The broker has your orderrelayed to the order desk of the proper exchange, which passes it onto the pits. Once filled, it moves back through the chain, culminating with your broker calling you with your “fill.”A written confirmation is mailed to you the next day from theFCM’s back office. On a monthly basis, you receive a summary report of your trading.At this stage of your relationship with your broker, whatshould you be protecting yourself against? The first thing is simple,clerical errors on the part of the back room (accounting) of the FCM.Many rifts occur because customers paid no attention to these documents. The broker has very little or nothing to do with the preparation of trade confirmations or monthly statements. They are generated at the headquarters of the FCM, and depending on its policy,the FCM may or may not send a copy to the broker. Carefully examine all paperwork at the time you receive it. Verify that:
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1. The commissions charged to your account are those towhich you and your broker agreed.2. The fill price is the same as the one your broker gave you.3. Any money you deposited in your account has been properly credited.4. The trade you made is the same as the one on the statement, particularly that you are on the side (long or short)that you want to be.5. The mathematics is correct, and all debits and credits havebeen properly applied.The broker does get a preliminary run of all the trades madeeach day. It is the broker’s responsibility to check it and to make theFCM aware of any discrepancies. The corrections may or may notget made before the trade confirmation is mailed to you. If a correction was not made before the confirmation was mailed, the correction is mailed separately, which you would receive the followingday. In these cases, your broker would normally alert you, but youmust double-check to see the error is corrected. If it doesn’t get corrected, contact your broker to see that the correction is made.COMMUNICATIONS ARE THE KEY
The glue that holds the customer-broker relationship together isgood communication. The most professional brokers set up guidelines early on so you are aware of what to expect and what is expected from you. They want to know:1. Time of day you are most easily accessible.2. Whether you are to call in or whether your broker willcall you.3. What steps will be taken if you can’t be contacted (e.g.,should your broker put stops in the market, close out positions after 4, 8, 12, or 24 hours of not being in contact,etc.).4. What steps will be taken if the account goes into debit?(Do you plan to wire money into the account? Transferfrom another account? Overnight a check?)5. How trading emergencies will be handled.
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6. What hours you are available and whom to contact whenyou are not available.7. Normal office hours and any evening hours your brokeris available.8. Your home phone number, if that’s the only way to stayin touch with you.9. A contact person who can reach you quickly if you arenot always near a phone.10. Provisions for unusual situations, such as when you aretraveling or taking a vacation.Don’t get out of touch with your broker no matter what. If a situation arises where you are not going to be available, either putstops in the market or close out the positions or even the account.Do not risk trading when you cannot be reached. If your brokerdoesn’t mention this, be sure you do.THE THREE CARDINAL SINS
Three very serious offenses sometimes committed by brokers aremisrepresentation, unauthorized trading, and churning.Misrepresentation usually revolves around the broker nottelling the prospective client enough about the risk of futures trading. As mentioned earlier, the NFA is very stringent about this, butit can happen anyway. One day a customer opens the mail to find a$2,000, or $5,000, or $10,000 margin call. The broker had told the customer this would never happen because stop-loss orders were to beused religiously. Unfortunately, the futures market being tradedmade limit moves against the client’s position for a day or two andno trading took place. As a result, the stop orders could not be activated. When the smoke cleared, the customer was seriously in debt.The customer had not been warned about the possibility of limitmoves.Another common misrepresentation is representing a hypothetical track record of a trading system or showing a track recordwithout noting that commissions have not been deducted. Whenthey are, the track record is negative or substantially less attractive.Unauthorized trading occurs when a broker places trades fora customer’s account without the customer’s authority, knowledge,or consent. Usually, this is a breakdown of communications. The
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broker makes assumptions about what the client wants to do, or“thinks” it was discussed and approval implied. Worse yet, the broker deliberately placed trades without talking to the customer, solely to generate commissions. For these reasons, you must carefullyreview the trade confirmation and monthly statements. Do you remember discussing and approving each trade?The professional broker guards against this eventuality by taperecording all orders placed by customers. Some firms have tapeequipment that records every conversation. The order desks of theexchanges record all conversations. Check with your broker in thebeginning to learn if taping equipment is used. When there is aquestion, ask your broker to play back the conversation. You mayalso want to tape your conversations with your broker. If you do, besure to inform the broker you are doing so.Churning or overtrading an account is another serious violation by brokers. This is measured by calculating the commission-toequity ratio over a specific period of time, usually a month. If $1,000in commissions is generated in an account with $10,000 in equityduring a particular month, the commission-to-equity ratio would be1:10, or 10 percent. How high is too high? When has your broker violated NFA rules?First, if you are calling all the trades, there are no grounds forcomplaints. You can trade as much as you want as long as you maintain the proper level of equity. If, on the other hand, you have turnedover trading discretion in your account to your broker by signing alimited power of attorney, your broker’s supervisor, the FCM, andthe NFA should be checking the trade volume. There is no set ratiofigure that automatically triggers a churning violation, but once themonthly commission-to-equity ratio gets into the 15 to 25 percentrange, regulators and supervisors take notice. They may require anexplanation of why the ratio is so high.Sometimes there are legitimate reasons for the high ratio. Youmay have agreed to have your broker trade a certain day tradingsystem. These are very short-term positions that are opened andclosed during the same trading session. No positions are carriedovernight. Day trading systems, because they are so short term, often generate a lot of commissions. If they are making money, customers like them because the customers do not assume the risk ofholding a position overnight.However, if there are no obvious explanations and the broker
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is churning an account just to bolster personal income, regulatorscan step in and take disciplinary action. The customer can file a complaint as well in hopes of recovering commissions and equity.ONLINE BROKERS
Futures trading online only heightens all trading concerns. Thereare no instructor-brokers to direct you and keep you out of trouble.The ride may be exhilarating, but it is fraught with peril.In preparation, you need to question the prospective brokerabout how the firm’s system works. Is it fast enough to give you fillsduring fast markets? Or will it overload and leave you out in thecold? How quickly are trades confirmed? What are the commissionfees for online? Will trading online save you money? This is only thebeginning of what you need to know. Many of the more establishedbrokerage firms offer online trading now, but as one analyst hassaid, “It’s a brand-new paradigm.”MANAGING YOUR COMPLAINT
Futures trading is a very complex and fast-moving investment.Thousands of things can go wrong. Most are accidental, but a fewmay be intentional. There are procedures to deal with them all.Naturally, the simple complaints involving obvious errors onstatements can be resolved with a call to your broker. What do youdo though if you feel you have suffered some serious loss or damage at the hands of your broker? What recourse do you have? Thepossible eventuality of this ever occurring is one of the strongest arguments for only investing in federally regulated investments, suchas futures. With these types of investment vehicles, a wide array ofoptions are open to you.The first step, as always, is discussing the problem with thebroker and the broker’s supervisor. If you get no satisfaction, youcan turn to the regulators for help.The first level in the futures industry is the NFA. Call the NFAon its toll-free number 800-621-3570, or 800-572-9400 if you live inIllinois. Explain your situation and the NFA will outline your options. One of the questions it will ask is whether you signed the PreDispute Arbitration Agreement, included in your account papers.
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You were not required to sign it, but if you did, it binds you andyour broker to accepting arbitration of disputes by the NFA. Thiscan be to your advantage, particularly if you are a small investor,because it reduces the expense and time of litigation. You won’thave to hire an attorney and you can request nonindustry arbitrators on your panel. You’ll get a square deal, particularly if you arein the right. The only negative aspect is that you may be waivingfurther rights to sue in a court of law. If you didn’t sign the Pre-Dispute Arbitration Agreement, you can still turn to the NFA for helpand take advantage of its arbitration facility.You can also file a complaint with the CFTC. If you are considering this approach, contact the CFTC for a copy of its free bookletQuestions & Answers about How You Can Resolve a Commodity MarketRelated Dispute. The CFTC has basically three reparation procedures:voluntary, summary and formal.The voluntary procedure is used for claims under $10,000, andCFTC-appointed judgment officers administer it. Both parties havean opportunity to uncover facts (“discovery”) and present their arguments in writing. There is no oral hearing. Decisions are final, andno appeal is permitted. A nonrefundable $25 fee is required.The summary procedure is similar to the voluntary one, but itallows for both a limited oral presentation and a written presentation and takes place in Washington, D.C. Further, you can appeal thedecision beyond the CFTC to a court of law if you are still not satisfied. The CFTC handles complaints of $10,000 or less and requires a$50 nonrefundable filing fee.The formal procedure is designed to handle major complaints,over $10,000. A courtlike hearing is conducted in one of twentylocations throughout the United States before an administrativejudge. An attorney can represent you if you wish. Appeals to theCFTC and the courts are possible. A $200 nonrefundable fee is required to file.Besides the NFA and the CFTC, you can take a complaint to theAmerican Arbitration Association, or you can file a civil suit. In addition, if you think your broker or firm has committed a criminal offense, you can contact the Federal Bureau of Investigation. If the U.S.mail was involved, contact the Chief Postal Inspector of the UnitedStates Postal Service. If you invested in a limited partnership or afund, you may be able to appeal to your local state attorney gener-
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al or the federal Security and Exchange Commission. Other placeswith which you may check are the Better Business Bureau and theFederal Trade Commission.For help deciding your most effective alternative, you shouldprobably sit down and discuss choices with your attorney. It ishoped that you will not get to this stage if you have kept in mindtwo very critical considerations: Your most effective protection results from systematically conducting due diligence research whenselecting a broker. Act rationally. Don’t get caught up in an emotional response to the potential the futures markets may offer. Stickto investments that are federally regulated. This gives you a betterdispute resolution process than unregulated investments.The most beneficial arbitration is usually done between brokers and clients. Once it goes beyond this stage, the costs and complications seem to outweigh the results. Work hard at this level tokeep the lines of communication open. Efforts in this area pay dividends in better trading, fewer errors, and more enjoyable trading.
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I N D E X
Page references in italics indicate additional display materialACCESS system, 209Accounting, single- and multiple-currency,211–212Accounts:account papers, 56– 58opening with broker, 55– 59, 254 –255types of discretionary, 229 –231ACPC (Association of Coffee ProducingCountries), 89Additions, impact of, 242–243After-hours trading (see Online services)Agency portfolio-level trading package, 45Agricultural Marketing Act, 99Agriculture, U.S. Department of [see U.S.Department of Agriculture (USDA)]Alexander the Great, 97America On Line (AOL), 207American Stock Exchange (AMEX), 42AMEX (American Stock Exchange), 42Analysis system, choosing, 196Anticipatory, technical analysis as, 126–127AOL (America On Line), 207APs (associated persons), 254, 256Arabica coffee, 87– 88Arbitrage, 120 –121, 213 –215Arbitrageur, 214Ascending triangle formation, 148–149Associated persons (APs), 254, 256Association of Coffee Producing Countries(ACPC), 89Availability of broker, 52, 53Averaging a loss, 200
Back office procedures in future, 211Bank of Nova Scotia-Scotia Mocatta, 102,105Bank Reserve Position Report, 117Bank reserves and interest rates, 116 –117Barbonel, Jack, 228Barrows, 77Baruch, Bernard, 159
Bear market:anatomy of (defined), 31– 32management, 26option spreads, 182, 184 –185prediction of, 43Beef market overview, 8