What to Do When the CFTC Gets Into Your Phone Calls

A new requirement from the Commodity Futures Trading Commission (CFTC) that all oral communications on some over-the-counter transactions be recorded, could end up being technologically and economically unfeasible.

In its role as overseer of the burgeoning US$650 billion swaps market — a designation assigned by the US Dodd-Frank Wall Street Reform Act — the CFTC wants to catch any illegal activity conducted either in writing or over-the-phone. Requiring firms to record phone calls should deter them from making fraudulent claims or trading ahead of customers, the regulatory agency reasons.

In addition to storing written communications, firms have to start recording conversations on landlines, voice mail, cell phones and other media, if they trade in a commodity interest– a financial instrument the US regulatory agency defines as a commodity futures contract, commodity option, swap or foreign exchange contract.

Although the CFTC’s rule was effective on December 21, it is likely financial firms will have a few months of breathing room before an examiner swoops into their offices. Even so, if they don’t have a gameplan in place by now, they will likely face some serious reputational and financial risk — aka stiff fines. Just about everyone handling a commodity interest transaction will be affected, including futures commission merchants, larger introducing brokers, and retail forex traders.

There are no official estimates of what percentage of commodity interest transactions are conducted over landline or mobile phone calls, but several New York-based swap traders tell FinOps they plan to eliminate or at least limit deals done over mobile phones to reduce the compliance burden. Doing business on personal cell phones has been banned and in some cases, so have chat rooms.

Relying on an app-based recording solution, say critics, won’t be enough. Apps can either delay the time a mobile phone call can be made, degrade the quality of the call, or even be bypassed by the caller. What’s more, they don’t automatically link the call made over a mobile phone with information leading up to the trade execution.

“The CFTC is requiring a reconstruction of the entire trade. So data must be pieced together from a multitude of applications,” says Mark Miller, US general manager of TeleWare, a London-headquartered firm specializing in mobile phone recordings.

The cost depends in part on just how many traders are monitored and which technology provider is selected. Estimates vary from as little as US$100 a month for each trader to over US$1,000. The Washington, DC-based Futures Industry Association says its members have spent as much as US$600,000 to upgrade and upkeep landline phones. Plus, it can cost as much as US$2.5 million to record mobile phone calls, not including storage and retrieval costs. Naturally, smaller firms will be harder hit than larger ones with deeper pockets. So might firms with numerous branch offices.

“As written, the rule says that all conversations must be recorded, because one never knows when a conversation will lead to a trade,” explains Kevin Foley, a partner with the Chicago-based law firm of Katten Muchin Rosenman. “In addition, specific trades must be identified. The CFTC’s presumption is that there is some type of tagging of the trade which can occur.”

The CFTC apparently wants oral records to be readily accessible — or before the start of the next business day — which comes to as few as fourteen hours. Piecing together all the necessary information on a particular trade amounts to finding a needle in a haystack. A similar rule adopted by the UK’s former Financial Services Authority in 2011 appears far more comprehensive in covering all asset classes, but it is easier to implement as the securities watchdog will likely accept a transcript of all oral communications, say UK compliance experts. Even so, TeleWare estimates that half of the UK’s two thousand financial firms are still not fully compliant.

Although a discussion of the economic details of a trade may well be conducted over a mobile phone that’s not likely where the transaction started, based on the CFTC’s definition of “all information” leading to the execution of the trade such as quotes, bids, instructions, prices, solicitations and offers. “Order management systems, emails, text messages or conversations on landlines also play a role, which could bring the total number of locations to at least ten,” one compliance executive at a New York swap dealer tells FinOps.

So what’s a firm to do? Relying on a manual method of trade reconstruction piecing together data from written and oral communications is certainly achievable, but not all that practical. “The broker-dealer will need to consider that to make such a manual approach work, it will need to have a central catalogue of data required for trade reconstruction,” says Miller. “This central catalogue will identify data, location, established retrievability and the resource responsible for retrieval.”

To ensure this manual approach continues to function over time it is necessary to perform occasional reviews and “fire drills.” Bottom line: such an approach has a high margin of error and will take a helluva lot of staffers.

A more ideal answer: Relying on voice analytics technology to transcribe the voice content along with the text communications and text data. Voice analytic solutions correlate all disparate data and search capability to accurately find all the interactions needed to create a single or multiple trades.

Miller insists that an SIM-based recording which uses a SIM card inside a handset is a critical part of the voice analytics equation. The mobile device redirects the call to a service, such as Teleware’s, which records both the voice and data by effectively roaming the existing mobile national operator networks such as AT&T in the US. The calls and data are stored in the cloud and compliance personnel can access a secure and encrypted web portal to search and replay the recorded information.

“To make any of this work, all fixed or cellular calls need to be captured, along with other communication that is text-based such as email, instant messaging and chat rooms. Teleware, he says is working with a voice analytics vendor to enhance the accuracy of the speech-to-text transcription by recording the call “in stereo.” Each leg of the call is recorded separately and presented to the voice analytics engine, which improves the engine’s ability to decipher and produce accurate content.

But throwing money into even the most sophisticated technology is just one part of the answer. Just as difficult is deciding whose mobile phone conversations should be monitored is another. While it might seem obvious that the mobile phones of dedicated swap traders should be tracked, identifying just who those traders are is a matter of interpretation. “There is plenty of debate as to the number of traders in each firm whose calls should be monitored- is it just the ones who execute swap orders only or does it also include those which do swap deals as hedges in multi-armed fixed-income transactions?” questions Miller.

Erring on the side of caution might sound like an ideal solution, but it isn’t always feasible. “Cost is cost and some firms might opt to monitor far fewer employees,” warns Miller. “In today’s globalized environment not all work is done between office hours at your desk.”

Regardless of how a financial firm decides comply with the CFTC’s requirements technologically, proving the validity of its procedures to the CFTC will be critical. Once a firm has made all of its decisions, all applicable company policies and procedures will need to be updated, including those affecting disaster recovery, supervision and order handling.

“We’re going through an extensive process of documenting our procedures with legal and compliance departments,” says a compliance manager of a Chicago-based financial firm. “It is proving to be quite an administrative burden.”

For US firms annoyed about just how they will meet the CFTC’s requirements, there could well be a silver-lining to being prepared. Global regulators will likely try to ensure equivalent swap regulations. “Large global institutions could end up playing by the US’ more stringent policies so it’s better to prepare for the more stringent standards,” says Miller.

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