[Federal Register: January 7, 1998 (Volume 63, Number 4)]
[Proposed Rules]
[Page 695-707]
From the Federal Register Online via GPO Access [wais.access.gpo.gov]
[DOCID:fr07ja98-24]
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Proposed Rules
Federal Register
________________________________________________________________________
This section of the FEDERAL REGISTER contains notices to the public of
the proposed issuance of rules and regulations. The purpose of these
notices is to give interested persons an opportunity to participate in
the rule making prior to the adoption of the final rules.
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[[Page 695]]
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COMMODITY FUTURES TRADING COMMISSION
17 CFR Part 1
Account Identification for Eligible Bunched Orders
AGENCY: Commodity Futures Trading Commission.
ACTION: Proposed rules.
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SUMMARY: The Commodity Futures Trading Commission ("Commission") is
reproposing to amend Commission Regulation 1.35(a-1) to allow eligible
customer orders to be placed on a contract market without specific
customer account identification either at the time of order placement
or at the time of report of execution.<SUP>1</SUP> Specifically, the
amendment would exempt from the customer account identification
requirements of Regulation 1.35(a-1) (1), (2)(i), and (4) bunched
futures and/or futures option orders placed by an eligible account
manager on behalf of consenting eligible customer accounts as part of
its management of a portfolio also containing instruments which are
either exempt from regulation pursuant to the Commission's regulations
or excluded from regulation under the Commodity Exchange Act ("Act").
The proposed rule would permit orders entered on behalf of these
accounts to be allocated no later than the end of the day on which the
order is executed.
\1\ The Commission published a proposed amendment to Regulation
1.35(a-1) on May 3, 1993. 58 FR 26270 (May 3, 1993).
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DATES: Comments must be received on or before March 9, 1998.
ADDRESSES: Interested persons should submit their views and comments to
Jean A. Webb, Secretary, Commodity Futures Trading Commission, Three
Lafayette Centre, 1155 21st Street, N.W., Washington, D.C. 20581. In
addition, comments may be sent by facsimile transmission to facsimile
number (202) 418-5521, or by electronic mail to [email protected].
Reference should be made to "Eligible orders."
FOR FURTHER INFORMATION CONTACT: Duane C. Andresen, Special Counsel,
Division of Trading and Markets, Commodity Futures Trading Commission,
Three Lafayette Centre, 1155 21st Street, N.W., Washington, D.C. 20581.
Telephone: (202) 418-5490.
SUPPLEMENTARY INFORMATION:
Table of Contents
I. Background
A. Current Regulatory Requirements
B. Proposed Amendment to CME Rule 536
C. Proposed Amendment to Regulation 1.35(a-1)
1. Predetermined Allocation Formulas
2. End-of-Day Allocation to Eligible Customers
II. Reproposed Amendment to Commission Regulation 1.35(a-1)
A. Eligible Orders
1. Proposed Regulation 1.35(a-1)(6)(i)
2. Comments Received
3. Reproposed Regulation 1.35(a-1)(5)(i)
B. Eligible Account Managers
1. Proposed Regulation 1.35(a-1)(6)(ii)
2. Comments Received
3. Reproposed Regulation 1.35(a-1)(5)(ii)
C. Eligible Customers
1. Proposed Regulation 1.35(a-1)(6)(iii)
(a). 1.35(a-1)(6)(iii)(A)--Types of Customers
(b). 1.35(a-1)(6)(iii)(B)--Proprietary Interest
2. Comments Received
(a). 1.35(a-1)(6)(iii)(A)--Types of Customers
(b). 1.35(a-1)(6)(iii)(B)--Proprietary Interest
3. Reproposed Regulation 1.35(a-1)(5)(iii)
(a). 1.35(a-1)(5)(iii)(A)--Types of Customers
(b). 1.35(a-1)(5)(iii)(B)--Proprietary Interest
D. Account Certification
1. Proposed Regulation 1.35(a-1)(6)(iv)
2. Comments Received
3. Reproposed Regulation 1.35(a-1)(5)(iv)
E. Allocation
1. Proposed Regulation 1.35(a-1)(6)(v)
2. Comments Received
3. Reproposed Regulation 1.35(a-1)(5)(v)
F. Recordkeeping
1. Proposed Regulation 1.35(a-1)(6)(vi)
2. Comments Received
3. Reproposed Regulation 1.35(a-1)(5)(vi)
G. Contract Market Rule Enforcement Programs
1. Proposed Regulation 1.35(a-1)(6)(vii)
2. Comments Received
3. Reproposed Regulation 1.35(a-1)(5)(vii)
III. Conclusion
IV. Other Matters
A. Regulatory Flexibility Act
B. Paperwork Reduction Act
I. Background
A. Current Regulatory Requirements
Commission regulations specify that customer orders must be
recorded promptly and include customer account identification at the
time of entry and the time of report of execution. These recordkeeping
requirements, in effect since March 24, 1972, permit a specific
customer's order to be traced at each stage of the order processing
system and help to prevent the improper allocation of trades and other
abuses. Specifically, Commission Regulation 1.35(a-1)(1) requires that
each futures commission merchant ("FCM") and each introducing broker
("IB") receiving a customer's order immediately prepare a written
record of that order, which includes an account identifier for that
customer. Regulation 1.35(a-1)(2)(i) requires that each member of a
contract market who receives a customer's order on the floor of a
contract market that is not in writing immediately prepare a written
record of that order, including the appropriate customer account
identification. Regulation 1.35(a-1)(4) requires, among other things,
that each member of a contract market reporting the time of execution
of a customer's order from the floor of a contract market include the
account identification on a written record of that order.
B. Proposed Amendment to CME Rule 536
By letters dated February 24, 1992, CME submitted both a proposed
amendment to CME Rule 536 pursuant to Section 5a(12) of the
Act,<SUP>2</SUP> 7 U.S.C. 1 et seq., and a petition for rulemaking to
amend Commission Regulation 1.35(a-1) pursuant to Commission Regulation
13.2.<SUP>3</SUP> As discussed below, the Commission published requests
for comments on both submissions.
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\2\ Now redesignated as Section 5a(a)(12)(A).
\3\ The Exchange submitted additional information regarding the
proposed rule amendment in letters dated May 7, 1992, and August 12,
1992. By letter dated August 20, 1992, the Division of Trading and
Markets posed a series of questions to the Exchange. The CME
responded in a letter dated September 25, 1992.
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The proposed CME rule amendment would have exempted from the
customer account designation requirement certain orders entered by
investment advisers registered with the Securities and Exchange
Commission ("SEC") pursuant to the Investment
[[Page 696]]
Advisers Act of 1940, 15 U.S.C. 80b et seq. [1988], and banks,
insurance companies, trust companies, and savings and loan institutions
subject to federal or state regulation ("account
managers").<SUP>4</SUP> These orders could have been placed only for
certain specified institutional accounts whose owners had been notified
in writing that their orders were being placed without customer account
designations. The orders would have been required to be allocated among
participating accounts prior to the end of the day. Finally, the
individual or firm directing the allocation of the orders could not
have a proprietary interest in any account that received any part of
the order, and no related-party account could receive any part of the
order.
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\4\ The term account manager hereinafter is used to include
investment advisers and other persons identified in the proposed
regulation, and their principals, if any, who would place orders and
direct the allocation thereof in accordance with the procedures set
forth in the reproposed amendment.
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On June 8, 1992, the Commission published the proposed amendment to
CME Rule 536 for public comment. <SUP>5</SUP> The Commission received
31 comments in response to the CME's proposal. Twenty-six of the
comments evidenced support for the proposed rule amendment, four were
opposed to the amendment,<SUP>6</SUP> and one recommended
caution.<SUP>7</SUP> Those comments were addressed in the Commission's
subsequent proposed amendment to Regulation 1.35 and are not addressed
herein.
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\5\ 57 FR 24251.
\6\ Commenters opposed to approval of the proposed rule
amendment included a Commission Administrative Law Judge; his law
clerk; the Director, Office of Financial Enforcement, Department of
the Treasury; and the Chief, White-Collar Crimes Section, Criminal
Investigative Division, Federal Bureau of Investigation. These
commenters expressed concern that, by weakening the audit trail, the
proposal could facilitate misallocation, money laundering and tax
evasion.
\7\ The United States Attorney for the Northern District of
Illinois urged that the Commission "exercise great care before
taking any action that could provide any opportunity for fraud,
self-dealing, or other criminal activity."
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C. Proposed Amendment to Regulation 1.35(a-1)
On May 3, 1993, the Commission published proposed amendments to
Regulation 1.35(a-1) for public comment.<SUP>8</SUP> In addition to
amending Regulations 1.35(a-1)(1), (2), and (4), the Commission
proposed to add paragraphs 1.35(a-1)(5) and (6). Paragraph (5)
addressed the placement and allocation of bunched orders generally and
the use of predetermined allocation formulas. Paragraph (6) was the
Commission's followup to CME's proposal to permit the allocation of
certain bunched orders at the end of the day.
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\8\ 58 FR 26274 (May 3, 1993).
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1. Predetermined Allocation Formulas
Proposed Regulation 1.35(a-1)(5) would have permitted the placement
of a bunched order for multiple customer accounts without individual
customer account identification at the time of entry and the time of
report of execution, subject to certain requirements.<SUP>9</SUP>
Proposed Regulation 1.35(a-1)(5) is being withdrawn because it has been
superseded. On May 9, 1997, the Commission published a Notice of
Interpretation and Approval Order approving the National Futures
Association ("NFA") Interpretative Notice to NFA Compliance Rule 2-10
Relating to the Allocation of Block Orders for Multiple Accounts and
providing additional Commission guidance regarding bunched orders and
allocation procedures.<SUP>10</SUP> The guidance provided therein has
been published as Appendix C to Part One of the Commission's
regulations.
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\9\ Those requirements included providing an allocation formula
for allocating the fills fairly among the participating accounts.
Directing profitable fills to favored accounts and unprofitable
fills to unfavored accounts (preferential allocation) is a violation
of Section 4b of the Act. In the Matter of GNP Commodities, Inc., et
al., [1990-1992 Transfer Binder] Comm. Fut. L. Rep. (CCH) para.
25,360 at 39,214 (CFTC August 11, 1992); In the Matter of
Lincolnwood Commodities, Inc., of California, et al., [1982-1984
Transfer Binder] Comm. Fut. L. Rep. (CCH) para. 21,986 at 28,246
(CFTC January 31, 1984).
\10\ 62 FR 25470 (May 9, 1997).
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2. End-of-Day Allocation to Eligible Customers
Under proposed Regulation 1.35(a-1)(6), contract markets could have
submitted rules for Commission approval that would have exempted
certain orders from the requirement that a specific customer account be
identified at the time of entry and the time of report of execution if
specified requirements were met. These orders could have been allocated
at the end of the day. The specific requirements of the proposal
addressed: (a) Eligible orders, (b) eligible account managers, (c)
eligible customers, (d) account certification, (e) allocation
requirements, (f) account manager recordkeeping, and (g) contract
market rule enforcement programs. The Commission stated that the
proposed regulation would encourage and facilitate institutional
participation in the futures markets subject to customer protection
requirements that were consistent with the sophistication of the
institutional customers.
The Commission received 34 comments in response to the proposed
amendments to Regulation 1.35(a-1).<SUP>11</SUP> Commenters included
eleven FCMs; <SUP>12</SUP> one investment adviser registered with the
SEC; <SUP>13</SUP> seven firms registered with both the Commission and
the SEC; <SUP>14</SUP> four commodity trading advisors ("CTA");
<SUP>15</SUP> three industry associations; <SUP>16</SUP> the CME, the
Chicago Board of Trade ("CBT"), and the NFA.<SUP>17</SUP>
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\11\ Only those comments addressing proposed paragraph 1.35(a-
1)(6) are addressed herein.
\12\ BA Futures, Inc. ("BA"); Cargill Investor Services
("Cargill"); Credit Agricole Futures, Inc. ("Credit Agricole"),
which is also registered as a CTA; Dean Witter Reynolds, Inc.,
Futures Division ("Dean Witter"); First Boston Corporation
("First Boston"); Lind-Waldock & Company ("Lind-Waldock");
PaineWebber Incorporated ("PaineWebber"); Refco, Inc. ("Refco");
Rodman & Renshaw, Inc. ("Rodman"); Sanwa-BGK Futures, Inc.
("Sanwa-BGK"); and Saul Stone and Company ("Saul Stone").
\13\ Pacific Investment Management Company ("Pacific").
\14\ Bear, Stearns & Co., Inc. ("Bear Stearns"); Flaherty &
Crumrine Inc. ("Flaherty"); Goldman, Sachs & Co. ("Goldman
Sachs"); Indosuez Carr Futures, Inc. ("Carr"); Merrill Lynch;
Morgan Stanley & Co. ("Morgan Stanley"); and TSA Capital
Management ("TSA").
\15\ Campbell Company ("Campbell"); John W. Henry & Co., Inc.
("John Henry"); Leland O'Brien Rubinstein Associates Inc.
("Leland"); and Sunrise Commodities, Inc. ("Sunrise").
\16\ Futures Industry Association ("FIA"), Managed Futures
Association ("MFA"), and Investment Company Institute ("ICI").
\17\ The Commission also received comments from the New York
City Bar Association ("N.Y. Bar") and a law firm, Abramson and
Fox.
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Most commenters found the proposed rule burdensome and too
restrictive to be of value. In particular, these commenters objected to
the proposed requirement for an intermarket trading strategy involving
securities and to the recordkeeping and certification requirements. Two
comments from the same commenter opposed the proposal,<SUP>18</SUP> and
one raised concerns about money laundering.<SUP>19</SUP> The Commission
has carefully reviewed the comments received and, as a result, has
modified and clarified the proposed amendments to Regulation 1.35(a-1).
Comments addressing specific areas and an explanation of the
Commission's revisions are discussed below.
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\18\ The commenter, who submitted two comments, was a Commission
Administrative Law Judge. He opposed the proposal because of the
potential for fraud, money laundering and tax evasion. He further
commented that the industry has failed to articulate a compelling
need and that the real reason to do so, the desire to increase
account managers' flexibility and conform commodity regulation to
security regulation, does not justify adoption of a system so open
to abuse.
\19\ The Chief, Money Laundering Section, Criminal Division,
Department of Justice, asked that the Commission consider the
proposal's impact on future money laundering and other law
enforcement investigations.
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[[Page 697]]
II. Reproposed Amendment to Commission Regulation 1.35(a-1)
The Commission is reproposing to amend Regulation 1.35(a-1). Under
reproposed Regulation 1.35(a-1)(5) (formerly 1.35(a-1)(6)), a specific
customer's account identifier need not be recorded at the time an
eligible bunched order ("eligible order") is placed or upon report of
execution, and the order may be allocated by the end of the day on
which it is executed, provided that certain requirements are met. In
addition, the order must be handled in accordance with contract market
rules that have been submitted to the Commission and approved or
permitted into effect pursuant to Section 5a(a)(12)(A) of the Act and
Regulation 1.41. The Commission intends that this reproposal include
certain core regulatory protections while providing meaningful
regulatory relief in a manner which is responsive to the comments
previously received. In the discussion below, the Commission sets forth
each of the components of its 1993 proposal, a summary of the comments
then received, and the manner in which the reproposal addresses the
same issue.
A. Eligible Orders
1. Proposed Regulation 1.35(6)(a-1)(i)
Proposed Regulation 1.35(6)(a-1)(i) would have required that orders
entered and allocated pursuant to the proposed regulation must be
intermarket orders. The term intermarket order was defined as a futures
or futures option order entered on behalf of an eligible customer as
part of a bona fide intermarket trading strategy also involving
securities. The term "securities" was defined to mean equity or debt
securities within the meaning of Section 2(1) of the Securities Act of
1933.
This requirement was based on the stated rationale for allowing
post-trade allocation, which was to permit account managers to provide
equivalent treatment to customers' accounts traded pursuant to
strategies involving activity in both futures markets and securities
markets. For example, if a securities trade is allocable at the end of
the day and the account manager follows a strategy of buying securities
and selling futures, with the futures order to be executed throughout
the day, the account manager may need to await the results of all
transactions before allocating to the accounts so as to provide
equivalent treatment. Similarly, for strategies such as duration
management, where futures transactions are executed on the basis of a
change in interest rates that affects the price of the bonds in an
underlying portfolio, the procedure could be used to maintain positions
of a specified duration under circumstances when this result could not
be achieved through the use of a predetermined allocation formula.
2. Comments Received
With regard to the proposal's description of eligible orders, most
commenters focussed on two issues: the definition of "intermarket"
and the definition of "securities." Numerous commenters suggested
that the proposal should not be limited to intermarket strategies based
on a securities requirement and suggested expanding the definition of
"intermarket" to include trading strategies that did not involve
securities directly.\20\ In addition to concerns about the definition
of intermarket, several commenters voiced the opinion that the
definition of "securities" was too restrictive.\21\ Several
commenters indicated that the proposal appeared to require a
transaction test, i.e., that the securities and futures executions
would be required to occur simultaneously.\22\
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\20\ Bear Stearns, Dean Witter, Goldman Sachs, Carr, Morgan
Stanley, Lind-Waldock, TSA, NFA, ICI, N.Y. Bar, CME and CBT.
CME stated that many other instruments, such as forex and
commodity and interest rate swaps, are used as part of investment
strategies and should not be excluded from the proposed amendments.
CBT commented that the exemption should cover strategies that
include foreign products and off-exchange products such as swaps.
The ICI stated that the "intermarket" requirement should be
deleted and that all orders entered on behalf of investment
companies that are registered with the SEC under the Investment
Company Act of 1940 should be presumed to be eligible orders.
\21\ Bear Stearns, Dean Witter, Lind-Waldock, Merrill Lynch, and
Pacific.
\22\ The CME noted that a requirement that the futures and
securities executions must occur simultaneously would inhibit the
use of duration adjustments, overlay, and other strategies. Goldman
Sachs commented that the Commission should make clear that the
proposed rule did not require that the futures transaction be
related to specific securities transactions, provided that it is
related to the management of a securities portfolio. Morgan Stanley
voiced similar concerns.
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3. Reproposed Regulation 1.35(a-1)(5)(i)
After consideration of the comments, the Commission believes that
it would be appropriate to delete the term "intermarket" as the
descriptive term used to identify eligible orders. The Commission also
agrees with the commenters in recognizing that appropriate multi-market
investment management strategies can involve futures and/or futures
options and financial instruments other than securities. Thus, the
Commission is proposing to eliminate the requirement that the trading
strategy also involve securities. The Commission also wants to make
clear that eligible orders would be subject to a portfolio test and not
a transaction test.
As previously noted, the overriding rationale for allowing post-
trade allocation is to permit equivalent treatment of customers'
accounts traded pursuant to strategies involving trading activity or
changes in valuation in more than one market. The Commission believes
that the account manager, in his or her role as a fiduciary, should be
permitted to determine that the portfolio management strategy requires
the placement of this type of order. Generally, this situation exists
when accounts are being traded in more than one market and the account
manager must review the results of trading activity in all markets
prior to directing order allocation in order to assure fairness. Of
course, it would not be permissible for a purported portfolio to be
established solely to obtain the relief being proposed. Rather, the
other financial instruments included in the portfolio must have a
legitimate financial relationship to the futures or futures option
orders for post-trade allocation to be appropriate.
Where trades are executed only on domestic futures exchanges, the
account manager should be able to achieve equivalent treatment of
customers' accounts while complying with either the existing customer
account identifier requirements of Regulation 1.35(a-1)(1) and (2)(i)
or the predetermined allocation formula exceptions thereto as described
in Appendix C to Part One of the Commission's regulations. In
particular, for futures-only orders executed on one domestic futures
exchange, average pricing would be available to provide fair treatment
among customers. Accordingly, the Commission is proposing that to be
eligible, orders must be placed as part of the management of a
portfolio also containing instruments which are either exempt from
regulation pursuant to the Commission's regulations or excluded from
Commission regulation under the Act.
The Commission has been advised that there may be instances where a
CTA placing exchange traded futures-only orders on more than one
futures exchange may need post-trade allocation in order to achieve
equivalent treatment of customers' accounts. The Commission requests
comments with regard to whether that relief is necessary. Any comments
should provide specific examples illustrating why the use of
predetermined allocation formulas or average pricing is insufficient to
provide fair treatment.
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B. Eligible Account Managers
1. Proposed Regulation 1.35(a-1)(6)(ii)
Proposed Regulation 1.35(a-1)(6)(ii) would have required that the
person placing and/or directing the allocation of an eligible order and
its principal, if any, ("account manager") must be one of the
following which had been granted investment discretion with regard to
the eligible customer accounts:
(i) an investment adviser registered with the SEC pursuant to the
Investment Advisers Act of 1940, or
(ii) a bank, insurance company, trust company, or savings and loan
association subject to federal or state regulation.
As proposed, the class of persons eligible to place intermarket
orders and direct the end-of-day allocation thereof would have been
identical to that suggested by CME. The Commission believed that, when
managing multiple accounts, these entities might be better able to
achieve similar results for institutional accounts being traded
pursuant to a program which involved multi-market trading strategies.
Under the proposed regulation, account managers for these types of
accounts would have been able to allocate futures and futures option
trades in the same manner as they allocated trades on securities
exchanges and over-the-counter markets.\23\ Additionally, these
entities' fiduciary activities were subject to oversight by various
state or federal regulatory agencies.
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\23\ See, e.g., Interpretation 88-3 of New York Stock Exchange
Rule 410(a)(3): "Member organizations may accept block orders and
permit investment advisors to make allocations on such orders to
customers and remain in compliance with Rule 410(a)(3) provided that
the organizations receive specific account designations or customer
names by the end of the business day." See also Securities and
Futures Authority Rule Book. Rule 5-41 allows a firm to aggregate
customers' orders when it is unlikely to disadvantage the customer
and the firm has disclosed that orders may be aggregated. Rule 5-
34(13), averaging of prices, allows a firm to execute a series of
transactions within a 24-hour period to meet orders it has
aggregated. When a firm has aggregated orders, Rule 5-42 specifies
that the firm must not give unfair preference and if all the orders
cannot be satisfied, the firm generally must give priority to
satisfying customer orders.
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2. Comments Received
Numerous commenters suggested that the list of eligible account
managers be expanded to include other entities. The suggested
additional entities include CTAs,<SUP>24</SUP> foreign investment
advisers subject to regulation in their home jurisdiction,<SUP>25</SUP>
non-U.S. investment advisers registered with the Commission or
otherwise exempt from registration pursuant to Regulation
30.10,<SUP>26</SUP> and investment advisers exempt from SEC
registration under Section 203(b)(3) of the Investment Advisers Act of
1940.<SUP>27</SUP> Finally, CBT proposed that the proposal should be
modified to afford sufficient flexibility to allow exchanges to include
any account manager that is regulated and subject to fiduciary
liability.
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\24\ Campbell, First Boston, John Henry, Merrill Lynch, Morgan
Stanley, PaineWebber, FIA, and NFA. The N.Y. Bar recommended that
CTAs be considered after the rule had been evaluated.
\25\ First Boston, Goldman Sachs, Merrill Lynch, and Morgan
Stanley.
\26\ Carr and N.Y. Bar.
\27\ First Boston and N.Y. Bar.
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3. Reproposed Regulation 1.35(a-1)(5)(ii)
After consideration of the comments, the Commission believes that
it is appropriate to expand the list of eligible account managers to
include CTAs registered with the Commission pursuant to the
Act.<SUP>28</SUP> Because CTAs also attempt to achieve equivalent
treatment of customers' accounts traded pursuant to strategies
involving trading activity in more than one market, the Commission
believes that the relief afforded by this provision should be extended
to these account managers. In addition, CTAs are subject to Commission
and NFA regulatory requirements and oversight, including periodic
audits by the NFA.
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\28\ Where applicable, the employing firm of an account manager
should have appropriate internal controls in place to address the
added discretion that the account manager will be able to exercise
pursuant to this proposal.
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The Commission is not including as eligible account managers non-
U.S. investment advisers registered with the Commission or otherwise
exempt from registration pursuant to Regulation 30.10 and foreign
investment advisers subject to regulation in their home jurisdiction.
The Commission is concerned about potential difficulty in auditing
these entities and in obtaining documentation required to be made
available pursuant to the recordkeeping requirements discussed below.
The Commission specifically requests comments concerning this
determination. The Commission also requests comments with regard to its
determination not to include, at present, investment advisers exempt
from SEC registration under Section 203(b)(3) of the Investment
Advisers Act of 1940.
C. Eligible Customers
1. Proposed Regulation 1.35(a-1)(6)(iii)
(a). 1.35(a-1)(6)(iii)(A)--Types of Customers
Proposed Regulation 1.35(a-1)(6)(iii)(A) provided that intermarket
orders could be allocated to accounts maintained by any of the
following institutional customers:
(i) An Investment Company registered as such under the Investment
Company Act of 1940, 15 U.S.C. 80a et seq. [1988].
(ii) A bank, trust company, insurance company or savings and loan
association subject to federal or state regulation.
(iii) An account for which a bank, trust company, insurance
company or savings and loan association subject to federal or state
regulation is a fiduciary vested with investment discretion.
(iv) A corporate qualified pension, profit sharing, or stock bonus
plan subject to Title 1 of the Employee Retirement Income Security Act
of 1974 ("ERISA"), or any plan defined as a governmental plan in
Section 3(32) of Title 1 of such Act, but not including a self-directed
plan.
(v) An educational endowment, foundation, charitable institution or
trust which is organized or qualifies under Section 501(c)(3) of the
Internal Revenue Code with net assets of more than $100 million.
This group of proposed eligible customers was substantially the
same as that included in the proposed amendment to CME Rule 536. The
CME and certain institutional customers represented that professional
managers of multi-market portfolios needed the flexibility afforded by
CME's proposed rule amendment to treat similarly managed accounts
fairly. Further, the Commission believed that those customers were
institutional investors whose accounts were subject to other regulatory
regimes or a portfolio size requirement and who participated in multi-
market investment strategies. Therefore, these customers could benefit
from use of the proposed regulation. The Commission further believed
the proposed eligible customer accounts were owned by entities with the
capacity to review and evaluate the accounts' trading activity and
results.
(b). 1.35(a-1)(6)(iii)(B)--Proprietary Interest
Proposed Regulation 1.35(a-1)(6)(iii)(B) provided that the
following persons may have no interest in any account that receives any
part of such order or in any related securities account:
(i) The account manager;
(ii) The futures commission merchant allocating the order;
(iii) Any general partner, officer, director, or owner of ten
percent or more of the equity interest in the account manager or the
futures commission merchant allocating the order;
[[Page 699]]
(iv) Any employee or associated person or limited partner of the
account manager or the futures commission merchant allocating the order
who affects or supervises the handling of the order;
(v) Any business affiliate that, directly or indirectly, controls,
is controlled by, or is under common control with, the account manager
or the futures commission merchant allocating the order;
(vi) An employee benefit plan of the account manager, the futures
commission merchant allocating the order, or an affiliate, as defined
in subparagraph (v) above; or
(vii) Any spouse, parent, sibling, or child of the foregoing
persons.
The Commission believed, based on its experience with misallocation
of trades, that the ability to allocate fills between customer and
proprietary accounts subsequent to execution would have created an
unacceptably high potential for favoring the proprietary
accounts.<SUP>29</SUP> The Commission further believed that the ability
to allocate fills subsequent to execution while maintaining a
proprietary interest in a related securities account also would have
created an unacceptably high potential for abuse.<SUP>30</SUP> The
Commission, therefore, believed that prohibiting the account manager,
the allocating FCM, and their related or affiliated persons, from
having any interest in either the futures or a related securities
account was a preventive approach that effectively eliminated the
possibility of preferential allocation for personal gain.
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\29\ See, e.g., In the Matter of GNP Commodities, Inc., et al.,
[1990-1992 Transfer Binder] Comm. Fut. L. Rep. (CCH) para.25,360
(CFTC August 11, 1992); In the Matter of Lincolnwood Commodities,
Inc., of California, et al., [1982-1984 Transfer Binder] Comm. Fut.
L. Rep. (CCH) para.21,986 (CFTC January 31, 1984); Parciasepe v.
Shearson Hayden Stone, Inc., et al., [1980-1982 Transfer Binder]
Comm. Fut. L. Rep. (CCH) para.21,461 (CFTC August 18, 1982); Wilke,
et al., v. Winchester-Hardin Oppenheimer Trading Co., et al., [1977-
1980 Transfer Binder] Comm. Fut. L. Rep. (CCH) para.20,605 (CFTC
December 29, 1977).
\30\ The CME's proposed rule amendment would have prohibited the
individual or firm directing the allocation of the order from having
a proprietary interest in any account that received any part of such
order. Commission Regulation 1.3(y) defines a proprietary account to
include the ownership of ten percent or more of a futures or option
trading account. Therefore, the proposed CME amendment would have
permitted the person or firm directing the allocation to have an
interest of less than ten percent of one or more of the accounts
receiving part of the allocated order.
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2. Comments Received
(a). 1.35(a-1)(6)(iii)(A)--Types of Customers
Numerous commenters suggested that the list of eligible customers
be expanded to include other entities. Several commenters suggested
that the list be expanded to include "appropriate persons" as
described in Section 4(c)(3) of the Act <SUP>31</SUP> or eligible swap
participants.<SUP>32</SUP> One commenter suggested expanding the list
to include either "appropriate persons" or "accredited investor" as
set forth in Rule 501 (Regulation D) of the Securities Act of
1993.<SUP>33</SUP> Four commenters stated that domestic and foreign
corporations should be eligible customers.<SUP>34</SUP> Commenters also
suggested including large, sophisticated corporate investors
<SUP>35</SUP> and individuals or entities with assets in excess of $100
million.<SUP>36</SUP> One commenter suggested including a CTA acting
for its proprietary account.<SUP>37</SUP> Finally, one exchange
recommended expanding the list to include "appropriate persons" and
all those who qualify for exemptive relief under Commission Regulation
4.7.<SUP>38</SUP>
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\31\ Carr, Pacific, FIA, and CME. CME also proposed expanding
the list to include foreign corporations.
\32\ Dean Witter, First Boston, Lind-Waldock, and Morgan
Stanley. Goldman Sachs suggested that the eligible customer
restriction be eliminated because it would require account managers
to treat their customers in a disparate manner and to disadvantage
those customers who were not permitted to be included in a bunched
order. In the alternative, Goldman Sachs recommended that the list
be expanded to include eligible swap participants.
\33\ Bear Stearns.
\34\ Bear Stearns, Dean Witter, Lind-Waldock, and TSA.
\35\ Flaherty.
\36\ N.Y. Bar.
\37\ First Boston. The N.Y. Bar suggested including FCMs, IBs,
CTAs, and CPOs trading for their own accounts as eligible customers.
\38\ CBT.
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(b). 1.35(a-1)(6)(iii)(B)--Proprietary Interest
Many commenters believed the provision limiting proprietary
interests was overly restrictive. Commenters stated that it would
inhibit access to U.S. markets <SUP>39</SUP> and would result in unfair
customer treatment.<SUP>40</SUP> Two commenters pointed out that the
provision would exclude certain publicly owned organizations from
becoming eligible customers.<SUP>41</SUP> Most commenters stated that
the limit on proprietary interest should be less than 10 percent, which
is consistent with the definition of proprietary interest contained in
Commission Regulation 1.3(y).<SUP>42</SUP> One commenter, however,
stated that a de minimis provision exempting interests of less than one
percent in participating accounts would be adequate.<SUP>43</SUP>
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\39\ Credit Agricole and Refco.
\40\ Bear Stearns asserted that it would be unfair to exclude
otherwise eligible types of funds because the account manager was
required to have a small interest in a partnership or contributed
seed money at the start up of a mutual fund or was paid a management
fee by the fund.
\41\ Flaherty stated that a registered investment company would
not be an eligible customer, for instance, if the investment adviser
made a seed money investment in the initial shares issued by the
fund or if officers of the account manager served on the Board of
Directors of the fund and, held shares of the fund. In addition, it
would be impossible for the account manager or the FCM allocating
the order to know with certainty that no relative of any of the
listed persons held any shares in a publicly owned corporation for
whose account the transaction was executed.
The ICI commented that the practical effect of the provision
would be to disqualify most, if not all, investment advisers to
investment companies from relying on the proposal. Additionally, it
would be almost impossible for such investment advisers to assure
compliance on an ongoing basis and it would impede the investment
adviser's ability to act in the best interests of investment
companies that were clients.
\42\ Dean Witter, First Boston, Lind-Waldock, Pacific, FIA, N.Y.
Bar, CBT, and CME. CME also suggested removing from the list of
entities subject to the no interest provision "[a]ny business
affiliate that, directly or indirectly, controls, is controlled by,
or is under common control with, the account manager or the futures
commission merchant allocating the order." The CME posited that
removing this provision would prevent managed accounts from being
unnecessarily excluded from eligibility.
\43\ Flaherty stated that while an FCM who is also an
underwriter and a market maker for securities might want a higher
percentage interest, permitting an owner of up to 10 percent of the
interest in the account manager to hold an unlimited interest in a
participating account would seem to invite possible abuse.
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3. Reproposed Regulation 1.35(a-1)(5)(iii)
(a). 1.35(a-1)(5)(iii)(A)--Types of Customers
After consideration of the comments, the Commission believes that
it is appropriate to expand the list of eligible customers. As
reproposed, the group of eligible customers would be substantially
similar to those entities defined as "eligible participants" for
purposes of Part 36--Exemption of Section 4(c) Contract Market
Transactions, of the Commission's regulations, except that sole
proprietorships, floor brokers, floor traders, and natural persons, as
well as self-directed employee benefit plans, would not be included as
eligible customers.
As the Commission stated in promulgating the final rules for Part
36, the list of "eligible participants" was modeled on the list of
"appropriate persons" set forth in Section 4(c)(3)(A) through (J) of
the Act and on the definition of "eligible swap participant" under
Part 35 of the Commission's regulations.<SUP>44</SUP> Having previously
considered this group of entities and
[[Page 700]]
determined that they are eligible to participate both in exempt
transactions and in swaps, the Commission believes that they are
sufficiently sophisticated to monitor the results of post-trade
allocations in their accounts. The Commission is incorporating into
this paragraph the requirement that these entities, in order to be
considered eligible customers, must have consented in writing that
eligible orders may be placed, executed, and allocated for their
accounts. The issue of consent is discussed below.
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\44\ 60 FR 51328 (October 2, 1995).
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The Commission does not believe, however, that accounts owned by
sole proprietorships, floor brokers, floor traders, natural persons, or
self-directed employee benefit plans should be included as eligible
customers. The Commission believes that the eligible customers should
be institutional or other comparatively large entities whose accounts
are subject to other regulatory or management regimes and who may
participate in multi-market investment strategies. Although the
Commission recognizes that natural persons meeting certain asset or net
worth standards may be sufficiently sophisticated to participate, the
Commission believes that preferential allocations would be more likely
to occur if accounts owned by individuals were included in eligible
orders.<SUP>45</SUP> The Commission requests comments regarding the
proposed exclusion of natural persons as eligible customers.
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\45\ A review of preferential allocation cases reveals that
misallocations, when they occur, often are made to personal or
proprietary accounts or to accounts owned by family members.
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(b). 1.35(a-1)(5)(iii)(B)--Proprietary Interest
After consideration of the comments, the Commission has determined
to modify the proposed provisions regarding ownership interest in any
account that receives any part of an eligible order or in any related
securities account. The Commission is deleting from the reproposal the
interest requirement as it applies to any related securities account.
As reproposed, the regulation requires that there be a portfolio
containing instruments which are either exempt from regulation pursuant
to the Commission's regulations or excluded from regulation under the
Act rather than a related securities account.
The Commission also is proposing to increase the acceptable level
of ownership interest in any account that receives any part of an
eligible order from no interest to an interest of less than ten
percent, which is similar to the Commission's definition of proprietary
interest as set forth in Regulation 1.3(y). The Commission is aware
that the account manager may have "seed" money invested in the
eligible account or, in fact, may invest in the account in order to
attract other investors. In any event, the Commission believes that
application of the less than ten percent restriction to the listed
participants is an appropriate provision that would neither unduly
restrict the placement of eligible orders nor increase the incentive to
misallocate.
Finally, the Commission is proposing to delete the following as one
of the entities subject to the interest restriction: an employee
benefit plan of the account manager, the futures commission merchant
allocating the order, or an affiliate. These plans are subject to
strict ERISA regulations.
D. Account Certification
1. Proposed Regulation 1.35(a-1)(6)(iv)
Proposed Regulation 1.35(a-1)(6)(iv)(A) required that the account
manager, before placing the initial order pursuant to this paragraph,
certify the following, in writing, to the FCM allocating the order:
(i) The account manager had no interest in any account to which any
part of the order may be allocated or in any related securities
account.
(ii) The account was owned by an eligible customer.
(iii) The customer had consented in writing that orders may be
executed and allocated in accordance with this regulation.
(iv) Orders for such account would be intermarket orders for which
it would be impracticable to pre-file a predetermined allocation
formula.
(v) Records required by paragraph (a-1)(6)(vi)(A) of the regulation
would be made available to the Commission or Department of Justice upon
request of any representative thereof.
In addition, proposed Regulation 1.35(a-1)(6)(iv)(B) required that
the account manager, before placing the initial order pursuant to this
paragraph, must provide the FCM allocating the order with a list of
eligible accounts and their related securities accounts.
The Commission believed that these safeguards addressed several
purposes of the proposed regulation and were intended to reduce the
likelihood of misallocation. In order to encourage compliance with the
proposal's requirements, the account manager placing intermarket orders
would have been required to certify to the FCM allocating the order
that he or she had no interest in any account to which any part of an
intermarket order may have been allocated or in any related securities
account. The account manager also would have been required to certify
that the accounts to which intermarket orders would be allocated were
owned by eligible customers. These one-time certification requirements
would have helped to assure that personal or proprietary accounts were
not included among the accounts to which intermarket order allocations
were made.
With regard to customer consent, the Commission believed that
notification was insufficient and that these institutional accounts
should have the opportunity to consent affirmatively to participate in
the intermarket allocation procedure.\46\ The Commission believed that
customer consent was an important tool in assuring adequate customer
oversight of trading activity. Drawing upon comments that the account
controller had the relevant relationship with the customer for purposes
of obtaining consent, the Commission believed that the account manager
would be the appropriate party to obtain that consent and so certify to
the FCM so that the FCM could assure that intermarket allocations were
made only to the eligible accounts. The consent could have been
contained in account opening documents or obtained separately.
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\46\ The CME's proposed amendment to Rule 536 would have
required that the FCM notify the identified eligible account owners
that orders for those accounts could be bunched and entered without
individual customer account identification and allocated at the end
of the day.
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The proposed amendment was designed for the benefit of
institutional accounts that were being traded pursuant to a strategy
that involved related positions in both the futures and securities
markets. The Commission believed that, whenever possible, the account
manager should place and allocate the order by use of a predetermined
allocation formula. The intermarket order allocation procedure was
available where use of the predetermined allocation formula would not
permit the account manager to attain equitable results. Thus, the
Commission believed that a one-time certification that orders placed
would be intermarket orders for which it would be impracticable to pre-
file a predetermined allocation formula was appropriate.
The use of the post-trade order allocation procedure would have
been limited to eligible accounts participating in regulated multi-
market trading and both the futures and the related securities accounts
would have to have
[[Page 701]]
been identified to the FCM allocating the order.\47\ Additionally, the
proposed regulation contained a requirement that the account manager
agree that the records discussed in paragraph (vi)(A) of the proposed
regulation would be made available to specified government agencies
upon request.\48\
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\47\ The identification of both the futures and securities
accounts was believed to be necessary to assure that (1) use of the
allocation procedure was restricted to eligible accounts
participating in multi-market trading and (2) the related securities
account was known in the event it became necessary to review the
trading in both markets for possible violative activity.
\48\ The Commission, although not the primary regulator of the
account manager, recognized that it might require records of
transactions in other markets which would not otherwise have been
readily available in order to review allegations of preferential
allocation.
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2. Comments Received
Two commenters stated that all five certifications were unnecessary
and duplicative.\49\ Numerous commenters opposed the requirement that
the account manager certify that the customer had consented in writing
that intermarket orders may be executed and allocated, stating that
notification would be sufficient.\50\ Commenters also stated that the
requirement to obtain consent would deter account managers from
utilizing the markets in this manner \51\ and that it is inconsistent
with practices in other markets \52\ and with the ability of account
managers to monitor client activity and to perform in the client's best
interest.\53\ One commenter agreed that customer consent should be in
writing.\54\ Several commenters opposed the requirement that the
account manager certify that the orders would be intermarket orders
\55\ for which it would be impracticable to pre-file a predetermined
allocation formula.\56\
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\49\ CBT and CME. In addition, Morgan Stanley commented that,
since it was the account manager's obligation to obtain the written
consent, it seemed redundant to require that the FCM obtain such a
certification.
\50\ Dean Witter, Lind-Waldock, Pacific, PaineWebber, TSA, and
FIA. Bear Stearns stated that the proposal should be clarified so
that customer consent could be given when the customer signs the
investment manager contract with the account manager and further
stated that, for those customers with existing contracts,
notification with the right of the customer to affirmatively opt out
should be sufficient.
\51\ Credit Agricole and PaineWebber.
\52\ Credit Agricole, Pacific, and CME.
\53\ Leland. Carr asserted that requiring the expert (account
manager) to get written permission from the account owner to manage
the assets in the best possible manner seemed a bit pointless.
\54\ Flaherty.
\55\ Leland, Lind-Waldock, TSA, and ICI. Carr commented that the
requirement to identify the orders as part of an intermarket
strategy undermined the proprietary nature and confidentiality of a
trader's strategy. Morgan Stanley stated that the FCM would not be
in a position to determine whether orders were in fact intermarket
orders.
\56\ ICI expressed concern regarding the standards by which
impracticability would be judged. It recommended elimination of this
component of the certification requirement.
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Numerous commenters stated that the requirement that the account
manager must provide the FCM with a list of eligible accounts and their
related securities accounts should be eliminated. Commenters felt that
this requirement would result in the disclosure of proprietary
information,<SUP>57</SUP> would serve no useful purpose,<SUP>58</SUP>
and would be overly burdensome because of the potentially large number
of accounts at issue.<SUP>59</SUP>
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\57\ Dean Witter, Lind-Waldock, TSA, FIA, ICI, CBT, and CME.
Bear Sterns also stated that providing such information to the FCM
might be a breach of the account manager's fiduciary duty. Pacific
stated that it would breach customer confidence to share such
information with FCMs. Goldman Sachs stated that, for reasons of
confidentiality, account managers may not be willing to provide FCMs
with the identification of securities accounts under their
management. NFA commented that the burden imposed and the privacy
concerns which may be raised outweighed the minimal benefit to be
derived from requiring the account manager to provide the FCM with a
list of related securities accounts.
\58\ Credit Agricole, Dean Witter, Refco, and FIA. Goldman Sachs
also stated that, even with the information, the FCM would be unable
to make any meaningful assessment regarding the nature of the order.
In addition, in some instances, such as overlay programs, the
account manager might not have the ability to provide information
because he or she may not control the accounts.
\59\ Bear Sterns, Merrill Lynch, Pacific, PaineWebber, FIA, CBT,
and CME.
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3. Reproposed Regulation 1.35(a-1)(5)(iv)
After consideration of the comments received, the Commission has
determined to reduce the required account manager certifications to
one: any account manager placing eligible orders must certify, in
writing, to each FCM executing and/or allocating any part of an
eligible order, that he or she is aware of the provisions of this
paragraph and is, and will remain, in compliance with the requirements
therein. The Commission intends that this certification would encourage
compliance by account managers and need be made only once to each
applicable FCM, not on an order-by-order basis.<SUP>60</SUP>
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\60\ Where the account manager places orders directly with a
floor broker rather than an executing FCM, the certification need
only be filed with each FCM allocating any part of an eligible order
and not with the floor broker.
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The Commission believes that the responsibility for compliance with
the eligible order provisions should generally fall on the account
manager and his or her principal, if applicable.<SUP>61</SUP> The
Commission has become convinced that little regulatory benefit or
additional customer protection would accrue from requiring the FCM to
obtain other account manager certifications. The extent of the account
manager's compliance with these requirements would be determined during
audits and on a for-cause basis.
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\61\ Pursuant to Regulation 166.3, an account manager's
employer, if registered with the Commission, has a duty diligently
to supervise his or her activities. Regardless of registration
status, a principal could be held liable for an account manager's
wrongdoing under Section 2(a)(1)(A) of the Act.
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On the topic of customer consent, the Commission continues to
believe that notification alone is insufficient and that these eligible
accounts should have to consent affirmatively prior to participating in
the post-trade allocation of eligible orders. This is particularly true
in the context of the reproposal, which has streamlined and deleted
many previously proposed requirements. As the Commission stated in the
proposed rule, the account manager is the appropriate party to obtain
that consent, either in account opening documents or
separately.<SUP>62</SUP>
---------------------------------------------------------------------------
\62\ Where applicable, the account manager's employing firm
should be aware that an account manager has the client's consent to
place eligible orders.
---------------------------------------------------------------------------
The Commission has eliminated the requirement that the account
manager must provide the FCM allocating the order with a list of
related securities accounts. However, the reproposal continues to
require that the account manager must provide a list of eligible
futures accounts to the FCM allocating the order. This requirement
should enable the FCM to assure that allocations are made only to
eligible accounts.
E. Allocation
1. Proposed Regulation 1.35(a-1)(6)(v)
Proposed Regulation 1.35(a-1)(6)(v) required the following:
(1) Intermarket orders allocated pursuant to the regulation must be
designated as such on the order at the time of entry.
(2) Intermarket orders must be identified on contract market trade
registers and other computerized trade practice surveillance records.
(3) The account manager and the FCM allocating the order must
allocate fills from intermarket orders to eligible participating
customer accounts prior to the deadline for final submission of trade
data to clearing on the day the intermarket order is executed.
(4) The FCM allocating the order must assure that all intermarket
orders are allocated to eligible customer accounts.
[[Page 702]]
The Commission believed that these allocation requirements, in
combination with the requirement that the account manager, the FCM, and
their affiliates and related parties not have any interest in any
participating account or related securities account, would limit the
potential for self-dealing by the account manager and the FCM. It would
also provide an audit trail reflecting the ultimate disposition of the
order. Further, these requirements would be consistent with good
business practice.
When the order was placed, it would have to be identified as an
intermarket order. The exchange would have to assure that the order was
specially identified on the trade register and other computerized trade
practice surveillance records. The account manager would have to
provide allocation instructions for the entire order to the FCM prior
to the deadline for final submission of trade data to clearing on the
day the intermarket order was executed. Finally, the FCM would have to
assure that the entire order was allocated to eligible customer
accounts previously identified by the account manager.
2. Comments Received
The CME and CBT stated that the proposed requirement that
intermarket orders must be so designated at the time of entry was
inappropriate because it could reveal proprietary information and would
impose a costly regulatory burden.<SUP>63</SUP> One commenter opposed
the proposed requirement that these orders be identified on contract
market trade registers and other records.<SUP>64</SUP> Three
commenters, while agreeing that allocations should occur by the end of
the day, stated that the exchange, and not the Commission, should
decide the trade submission deadlines.<SUP>65</SUP> Finally, several
commenters expressed concern about holding the FCM responsible for
assuring that orders are allocated to eligible customer
accounts.<SUP>66</SUP>
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\63\ CBT also stated that no such requirement existed for
securities transactions and that the requirement ignored the fact
that the account manager was already under an existing regulatory
scheme that imposed fiduciary duties. As previously noted, Carr
commented that requiring that such orders be designated as part of
an intermarket strategy undermines the proprietary nature and
confidentiality of a trader's strategy.
\64\ CBT stated that the requirement would lead to a costly
regulatory burden and should be eliminated.
\65\ FIA, CBT, and CME.
\66\ Merrill Lynch. First Boston stated that imposing this
requirement on the FCM failed to recognize that the FCM acts for the
account manager and that it should be the account manager's
responsibility to document and to use a fair and equitable
allocation system. CBT stated that the FCM's allocation
responsibilities should be limited to making allocations in
accordance with the account manager's instructions and in a timely
manner. Commenting on the proposed regulation generally, FIA stated
that its focus should be to enable account managers the maximum
latitude in placing trades subject to a fair, equitable and
demonstrable allocation scheme, while recognizing that FCMs have no
practical ability to supervise independent account controllers.
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3. Reproposed Regulation 1.35(a-1)(5)(v)
After consideration of the comments received, the Commission has
determined to modify certain of the allocation requirements and to add
one requirement. In addition, the Commission has reorganized this
paragraph to include some of the originally proposed allocation
requirements as recordkeeping requirements.
The requirement that eligible orders must be so identified on the
order at time of entry has been redesignated as a recordkeeping
requirement. The Commission currently is proposing that each eligible
order, as well as the account manager placing that order, be identified
on the office order ticket, if applicable, and on the floor order
ticket at the time of order placement. The Commission believes that the
maintenance of a complete audit trail requires that eligible orders be
properly identified from order placement through order allocation. The
office and/or floor order ticket is the first step in this process.
Identification of this kind would not appear to reveal any
proprietary or trading strategy information. The executing and/or
allocating FCM would not need to know the specifics of the other
instruments in the portfolio. Moreover, the only accounts identified to
an FCM would be those to which that FCM would be allocating fills
either directly or through give-ups. Rather than identifying a trading
strategy, the designator would only identify an eligible order that
would be allocated pursuant to these procedures. The requirement that
each transaction resulting from the execution of an eligible order be
identified on contract market trade registers and other computerized
trade practice surveillance records remains substantially unchanged. It
is simply redesignated as a recordkeeping requirement.
The reproposal would require that allocation of an eligible order
must take place prior to the end of the day the order is executed, as
specified by exchange rules for this purpose. Because this paragraph
would also require that the account manager and the FCM allocating the
order allocate fills to eligible participating customer accounts, the
Commission is deleting as redundant the proposed separate paragraph
that required that the FCM do so.<SUP>67</SUP>
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\67\ When a trade is allocated to a specific eligible account,
it belongs to that account and cannot be reallocated to any other
eligible account. In re Collins, CFTC Docket No. 94-13, Slip op. at
11-15 (CFTC Dec. 10, 1997).
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The Commission agrees that the account manager has the
responsibility for employing a system that results in fair, equitable,
and non-preferential allocations. As noted below, the account manager
must, upon request, provide to the Commission or the Department of
Justice records that, among other things, identify the trading strategy
and demonstrate the fairness of the allocations. The FCM's allocation
responsibilities generally should be limited to complying with
instructions from the account manager. However, as previously noted,
the account manager is required to provide the FCM allocating the order
with a list of eligible accounts. If the FCM were directed to allocate
eligible orders to accounts not included on the list, or if the FCM
should become aware of what appear to be preferential allocations, the
FCM is required to make a reasonable inquiry and, if appropriate, to
refer the matter to a regulatory authority (i.e., the Commission, the
NFA, or its designated self regulatory organization). In addition, the
FCM must act consistently with its obligations under Regulation 166.3
diligently to supervise the handling of its customer accounts.
Finally, the Commission is proposing to add a new paragraph to the
allocation requirements. Specifically, the Commission is proposing a
requirement that allocations made pursuant to these procedures must be
fair and non-preferential, taking into account the effect on each
relevant portfolio in the bunched order.
F. Recordkeeping
1. Proposed Regulation 1.35(a-1)(6)(vi)
Proposed Regulation 1.35(a-1)(6)(vi) required the following:
(1) Each account manager must make available, upon request of the
Commission or the United States Department of Justice, the records
referred to in paragraph (iv) of the regulation and other records,
including records of securities transactions, reflecting order
placement and allocation to the participating customer accounts. These
records must demonstrate the relationship between the futures and the
other transactions, the allocations made, the basis for allocation, and
the nature of the
[[Page 703]]
intermarket strategy. They should also permit reviewers to compare
results obtained for different customers.
(2) Each account manager shall make available for review, upon
request of an eligible customer, documentation sufficient for the
customer to compare its results with those of other customers. The
other accounts for which intermarket orders are entered may be
designated by symbols so that the identity of account holders is not
disclosed.
(3) Upon request, each FCM allocating intermarket orders at the
direction of an account manager will exercise its best efforts to
obtain from the account manager and to provide to the Commission or the
Department of Justice records reflecting the related transactions in
the securities accounts.
In order that any allegation of misallocation or unfavorable
treatment could be properly investigated, the Commission believed that
the account manager should have been required to retain and to make
available for review, upon request of the Commission or the Department
of Justice, the investment management rationale for intermarket orders
and allocations. In order to enhance customer protection and to
simplify customer account review, the Commission believed that the
account manager should have been required to make available for review,
upon request of a customer, documentation sufficient for that customer
to compare its results with those of other customers. The identity of
other account holders for which intermarket orders were entered need
not, however, have been disclosed to another customer.
Finally, the Commission believed that the FCM allocating
intermarket orders at the direction of an account manager should have
been required, upon request of certain government agencies, to exercise
its best efforts to obtain records reflecting the related transactions
in the securities accounts. The determination that preferential
allocation occurred could be accomplished only when all related
transactions were examined and allocations in all markets were
compared.\68\
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\68\ Based upon discussions with participants in the industry,
the Commission believed that the documents, worksheets and computer
programs that determined the allocation formula already were created
and retained by account managers responsible for allocation
decisions.
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2. Comments Received
Numerous commenters described the proposed recordkeeping
requirements as burdensome,\69\ unnecessary,\70\ or unreasonable.\71\
Commenters addressing the proposed requirement to make documentation
available to the customer to allow that customer to compare its results
with those of other customers focussed both on the possible disclosure
of proprietary or confidential information \72\ and on the limited
value of such information to the customer.\73\ All commenters who
addressed the issue opposed the proposed requirement that the FCM
exercise its best efforts to obtain records reflecting securities
transactions from the account manager.\74\
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\69\ Credit Agricole, Goldman Sachs, Pacific, Refco, Saul Stone,
and NFA.
\70\ Goldman Sachs, Morgan Stanley, TSA, MFA, and NFA. CBT
commented that the value of the recordkeeping requirements appeared
to be minimal.
\71\ Dean Witter and Lind-Waldock. CME commented that it was
overreaching for the Commission to impose recordkeeping requirements
on investment advisers that are otherwise regulated.
\72\ Flaherty, First Boston, Carr, N.Y. Bar, and CBT. Carr
commented that it doubted customers would authorize their account
manager to release details of their trading activity in order for
another managed account to verify the fairness of its allocations.
The N.Y. Bar stated that it believed that many customers would
object to such disclosure, even in the absence of the customer's
identity. According to the N.Y. Bar, activity in a particular
account could provide information which would serve to identify a
particular customer, and even if the identity were shielded,
customers and advisers may object to the release of information
which would reveal market strategies.
\73\ Pacific, CBT, and CME. Flaherty commented that the proposed
requirement should be modified to data, rather than documentation,
sufficient for the customer to compare its overall results with
those of other customers. Flaherty also suggested that eligible
customers be required to acknowledge in writing that they have been
informed of their right to request information on comparative
results.
\74\ First Boston, Goldman Sachs, Carr, Merrill Lynch, Morgan
Stanley, Pacific, FIA, NFA, N.Y. Bar, CBT, and CME. According to
Flaherty, such a requirement would give FCMs substantial leverage
for obtaining proprietary data of the account manager and its
clients, would result in account managers switching to FCMs without
securities operations, and would be unnecessary because the same
data could be obtained directly from the account manager by the
Commission or the Department of Justice.
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3. Reproposed Regulation 1.35 (a-1)(5)(vi)
After consideration of the comments, the Commission has determined
to modify the recordkeeping requirements originally proposed. As noted
above, two items formerly identified as allocation requirements have
been redesignated as recordkeeping requirements. Additionally, the
Commission is proposing to add the requirement that the FCM carrying an
eligible account to which an eligible order has been allocated must
identify each trade resulting from the execution of an eligible order
on confirmation statements provided to the affected account owner and/
or trustee. The Commission believes that the account owner should be
informed of all aspects of transactions executed for his or her account
in order to make informed decisions about the continued use of the
eligible order procedures. The Commission is deleting the requirement
that, upon request, the FCM allocating eligible orders exercise its
best efforts to obtain documentation from the account manager. This
requirement is unnecessary since the account manager already is
required to provide such documentation directly to the Commission or
the Department of Justice if requested.
The Commission proposes to streamline the documentation that would
be required to be made available to the Commission or the Department of
Justice by the account manager. In addition to documentation reflecting
customer consent to the placement and allocation of eligible orders,
the account manager would be required to make available records
reflecting (i) futures and option transactions,\75\ (ii) other
transactions executed pursuant to the portfolio management strategy,
and (iii) any other records that identify the strategy and relate to,
or reflect upon, the fairness of the allocations. Thus, the reproposal
does not identify with the same specificity the records required to be
provided. Nonetheless, the account manager would have the
responsibility to demonstrate, when records are requested or during
regulatory authority audits, that allocations were made fairly.
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\75\ The account manager must create and retain a record
reflecting the participation of all accounts in each eligible order,
including the allocation of all fills.
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The Commission continues to believe that eligible customers should
be able to compare results to other customers with similar accounts and
investment strategies. Thus, the reproposal would require that the
account manager make available, upon request of an eligible customer,
data sufficient for that customer to compare its results with those of
other relevant customers. In addition, the account manager must
indicate in which of the other relevant customers it or the FCM has an
interest. The Commission believes that describing the requirement in
these terms permits the use of established methods used by
sophisticated institutional investors in securities to measure and to
compare performance. Data enabling the customer to perform such a
comparison may be prepared so
[[Page 704]]
as not to disclose the identity of individual account holders.
G. Contract Market Rule Enforcement Programs
1. Proposed Regulation 1.35(a-1)(6)(vii)
Proposed Regulation 1.35(a-1)(6)(vii) required that, as part of its
rule enforcement program, each contract market that adopted rules
allowing the placement of intermarket orders would have to assure that
all fills resulting from these orders were identified on contract
market trade registers and other computerized trade practice
surveillance records. Each contract market, or the designated self-
regulatory organization ("DSRO") of a member firm, would have to
adopt an audit procedure to determine compliance with the following
components of the regulation: recordkeeping requirements in paragraph
(iv), account certification in paragraph (v), and allocation
requirements in paragraph (vi).
The Commission believed that this surveillance was necessary to
deter possible unlawful activity and to ensure that an adequate audit
trail existed for intermarket transactions. As part of its routine
oversight of member firms, the exchange would have been required to
assure that intermarket orders were correctly identified on exchange
trade registers. The exchange or the DSRO would have been required to
audit member firms to assure that (i) the order was allocated prior to
the deadline for final submission of trade data to clearing on the day
the intermarket order was executed; (ii) the order was allocated only
to eligible participating institutional customer accounts whose owners
had consented to the allocation; and (iii) the FCM received and
retained required documents from the account managers.
2. Comments Received
CME and CBT commented adversely on the audit procedures proposed to
be imposed on exchanges. Both exchanges asserted that costs would be
high and the benefit to market users would be minimal.
3. Reproposed Regulation 1.35(a-1)(5)(vii)
The requirement that the contract market assure that all fills
resulting from eligible orders are identified on trade registers and
other computerized trade practice surveillance records is being
retained as a proposed recordkeeping requirement. Therefore, it is
being deleted from this paragraph as redundant. The remainder of this
paragraph is substantially consistent with the paragraph originally
proposed. The contract market must adopt audit procedures to determine
compliance with the identified provisions of the reproposed regulation.
Specifically, these provisions would include (i) the certification
requirements; (ii) the requirement that orders must be allocated to
eligible accounts by the end of the day; and (iii) the requirement that
eligible orders must be so identified on trade registers, other
surveillance records, order tickets, and customer confirmation
statements. The Commission continues to believe that these requirements
are necessary to deter possible unlawful activity and to ensure that an
adequate audit trail is created for eligible transactions.
III. Conclusion
The Commission is proposing, subject to certain core regulatory
protections, to permit a limited number of regulated account managers
to place orders for a defined group of eligible customers without
providing specific customer account identifiers at the time of order
placement.\76\ The Commission previously has identified all of these
customers as eligible to enter swap agreements or execute Section 4(c)
contract market transactions. The account managers would be required to
allocate the order at the end of the day.\77\ As discussed below, in
addition to the customer safeguards being reproposed, significant
existing audit trail and recordkeeping requirements would remain
applicable.
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\76\ The Commission believes that these core regulatory
protections adequately address the issues raised by those who
submitted comments opposed to either the proposed amendment to CME
Rule 536 or the Commission's proposed amendment to Regulation 1.35.
The Commission appreciates the views of the law enforcement
authorities which commented on the previous proposed regulation and
shares their desire that Commission-regulated futures and option
markets not be used as a vehicle to commit serious financial crimes.
It is with those concerns in mind that the Commission has crafted
the protections incorporated into the reproposed regulation. These
protections include specific eligibility requirements for account
managers and customers and recordkeeping provisions intended to
document fair and non-preferential treatment of customers. Coupled
with the strong antifraud provisions of the Act and the Commission's
rigorous supervision rule, these protections should insure that the
proposed allocation procedure will not unduly threaten customer
protection or market integrity. Rather, the rule should enable
portfolio managers acting in a fiduciary capacity to handle customer
interests across markets, without undermining any legitimate
customer or law enforcement interests.
\77\ End-of-day or post-trade allocation of bunched or block
orders is permissible on foreign futures exchanges and in the cash
and securities markets. The New York Stock Exchange ("NYSE"), for
example, has permitted end-of-day allocation of securities block
orders since October 1983. Interpretation 88-3 of NYSE Rule
410(a)(3).
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Under the reproposal, the customer must consent in advance, in
writing, that orders may be placed, executed, and allocated as eligible
orders. Allocations of eligible orders must be fair and non-
preferential, taking into account the effect on the relevant portfolio
of each customer in the bunched order. The account managers would be
required to maintain records that would, among other things, reflect
the portfolio management strategy and demonstrate the fairness of the
allocations. These records would be available, upon request, to the
Commission or the Department of Justice. The account manager would be
required to provide the customer, upon request, with data sufficient to
compare results with those of other relevant customers.
The reproposal prohibits an account manager and his or her
partners, officers, employees, and related parties and affiliates from
having an interest of ten percent or more in any account to which he or
she is allocating orders. This prohibition should diminish the
incentive to make preferential allocations for personal gain. Because,
in some instances, the FCM may be able to influence the fairness of the
allocations, the same restriction would apply to the FCM allocating the
order and its partners, officers, employees, and related parties and
affiliates. In addition, the reproposed recordkeeping requirements
would deter and facilitate detection of misallocations which may
indirectly benefit the account manager.\78\ The reproposal would also
require that an exchange that permits the placement, execution, and
allocation of eligible orders must adopt, as part of its rule
enforcement program, audit procedures to determine compliance with
relevant provisions.
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\78\ As a matter of state law and federal securities,
commodities, or banking law, eligible account managers would have
fiduciary responsibility for their investment management activities.
Additionally, account managers would be subject to Section 4b, the
general antifraud provision of the Act. Account managers who are
also acting as commodity trading advisors or commodity pool
operators, irrespective of registration status, would also be
subject to Section 4o. The securities anti-fraud rules may also
apply.
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Under the reproposal, an eligible order must be identified at time
of placement on the floor order ticket and, if appropriate, on the
office order ticket. The identity of the account manager must also be
included on the order tickets. All trades resulting from the execution
of an eligible order must be identified on exchange trade registers and
computerized trade practice
[[Page 705]]
surveillance records. Finally, these trades must also be identified on
confirmation statements provided to the customer accounts.
Those requirements, in conjunction with existing audit trail
requirements, should enable the Commission and self-regulatory
organizations to track any eligible order from time of placement to
allocation of fills. At time of placement, the order would be
identified on order tickets. These order tickets would be timestamped
upon receipt of the order. The order executions would be identified on
exchange trade registers by, among other things, both time and price.
The order tickets would be timestamped again to identify time of report
of execution. The trading cards and/or order tickets would reflect the
terms of the order executions. The subsequent allocation of the fills
would be maintained on FCM and exchange records. Where it is the
exchange's practice to do so, the allocation of the fills to specific
customer accounts would be reflected on the exchange's final trade
register. The order would be identified on confirmation statements sent
to the owner of the account. Thus, an auditor could determine, among
other things, the size and time of initial order placement, the times
and prices of executions, the identities of accounts to which the fills
were allocated, and the prices and quantities of the fills allocated
thereto.
The Commission encourages commenters to address the appropriateness
of the balance being struck by this reproposal between protection of
sophisticated market participants and regulatory reform. Additionally,
the Commission encourages commenters to address the proposition that
the relief being proposed herein, through an amendment to the
Commission's recordkeeping requirements, might be achievable to some
extent through enhanced customer disclosure and reliance on the account
managers' fiduciary responsibility.
IV. Other Matters
A. Regulatory Flexibility Act
The Regulatory Flexibility Act ("RFA"), 5 U.S.C. 601 et. seq.,
requires that agencies, in proposing rules, consider the impact of
those rules on small businesses. The Commission has previously
determined that contract markets,\79\ futures commission merchants,\80\
registered commodity pool operators,\81\ and large traders \82\ are not
"small entities" for purposes of the Regulatory Flexibility Act. The
Commission has previously determined to evaluate within the context of
a particular rule proposal whether all or some commodity trading
advisors should be considered "small entities" for purposes of the
Regulatory Flexibility Act and, if so, to analyze the economic impact
on commodity trading advisors of any such rule at that time.\83\
Commodity trading advisors who would place eligible orders pursuant to
these procedures would do so for multiple clients and would be
participating as investment managers in more than one financial market.
Accordingly, the Commission does not believe that commodity trading
advisers should be considered "small entities" for purposes of this
regulation.
---------------------------------------------------------------------------
\79\ 47 FR 18618, 18619 (April 30, 1982).
\80\ Id.
\81\ Id. at 18620.
\82\ Id.
\83\ Id.
---------------------------------------------------------------------------
Therefore, the Chairperson, on behalf of the Commission, hereby
certifies, pursuant to 5 U.S.C. 605(b), that the action proposed to be
taken herein will not have a significant economic impact on a
substantial number of small entities.
Proposed Regulation 1.35(a-1)(5) generally would apply to large
users of the market. It would provide relief from individual account
identification requirements, thereby providing those small entities who
elect to use the relief with a less burdensome method for satisfying
Commission Regulation 1.35 requirements.
B. Paperwork Reduction Act
When publishing proposed rules, the Paperwork Reduction Act of 1995
(Pub. L. 104-13 (May 13, 1995)) imposes certain requirements on federal
agencies (including the Commission) in connection with their conducting
or sponsoring any collection of information as defined by the Paperwork
Reduction Act. In compliance with the Act, the Commission, through this
rule proposal, solicits comments to:
(1) evaluate whether the proposed collection of information is
necessary for the proper performance of the functions of the agency,
including the validity of the methodology and assumptions used; (2)
evaluate the accuracy of the agency's estimate of the burden of the
proposed collection of information, including the validity of the
methodology and assumptions used; (3) enhance the quality, utility, and
clarity of the information to be collected; and (4) minimize the burden
of the collection of information on those who are to respond, including
through the use of appropriate automated, electronic, mechanical, or
other technological collection techniques or other forms of information
technology, e.g., permitting electronic submission of responses.
The Commission has submitted this proposed rule and its associated
information collection requirements to the Office of Management and
Budget. The burden associated with this entire collection (3038-0022),
including this proposed rule, is as follows:
Average burden hours per response: 3547.01.
Number of Respondents: 11,011.00.
Frequency of Response: On Occasion.
The burden associated with this specific proposed rule is as
follows:
Average burden hours per response: 0.75.
Number of Respondents: 400.00.
Frequency of Response: On Occasion.
Persons wishing to comment on the information which would be
required by this proposed rule should contact the Desk Officer, CFTC,
Office of Management and Budget, Room 10202, NEOB, Washington, DC
20503, (202) 395-7340. Copies of the information collection submission
to OMB are available from the CFTC Clearance Officer, 1155 21st Street,
NW, Washington, DC 20581, (202) 418-5160.
List of Subjects in 17 CFR Part 1
Brokers, Commodity futures, Commodity options, Consumer protection,
Contract markets, Customers, Members of contract markets,
Noncompetitive trading, Reporting and recordkeeping requirements, Rule
enforcement programs.
In consideration of the foregoing, and pursuant to the authority
contained in the Commodity Exchange Act and, in particular, Sections 5,
5a, 5b, 6(a), 6b, 8a(7), 8a(9) and 8c, 7 U.S.C. 7, 7a, 7b, 8(a), 8b,
12a(7), 12a(9), and 12c, the Commission hereby proposes to amend Part 1
of Chapter I of Title 17 of the Code of Federal Regulations as follows:
PART 1--GENERAL REGULATIONS UNDER THE COMMODITY EXCHANGE ACT
1. The authority citation for Part 1 continues to read as follows:
Authority: 7 U.S.C. 1a, 2, 2a, 4, 4a, 6, 6a, 6b, 6c, 6d, 6e, 6f,
6g, 6h, 6i, 6j, 6k, 6l, 6m, 6n, 6o, 6p, 7, 7a, 7b, 8, 9, 12, 12a,
12c, 13a, 13a-1, 16, 16a, 19, 21, 23 and 24.
2. Section 1.35 is proposed to be amended by revising paragraphs
(a-1)(1), (2)(i), and (4) and by adding paragraph (a-1)(5) to read as
follows:
[[Page 706]]
Sec. 1.35 Records of Cash Commodity, Futures, and Option Transactions
* * * * *
(a-1) * * *
(1) Each futures commission merchant and each introducing broker
receiving a customer's or option customer's order shall immediately
upon receipt thereof prepare a written record of the order including
the account identification, except as provided in paragraph (a-1)(5) of
this section, and order number, and shall record thereon, by timestamp
or other timing device, the date and time, to the nearest minute, the
order is received, and in addition, for option customers' orders, the
time, to the nearest minute, the order is transmitted for execution.
(2)(i) Each member of a contract market who on the floor of such
contract market receives a customer's or option customer's order which
is not in the form of a written record including the account
identification, order number, and the date and time, to the nearest
minute, the order was transmitted or received on the floor of such
contract market, shall immediately upon receipt thereof prepare a
written record of the order in nonerasable ink, including the account
identification, except as provided in paragraph (a-1)(5) of this
section or appendix C to this part, and order number and shall record
thereon, by timestamp or other timing device, the date and time, to the
nearest minute, the order is received.
* * * * *
(4) Each member of a contract market reporting the execution from
the floor of the contract market of a customer's or option customer's
order or the order of another member of the contract market received in
accordance with paragraphs (a-1)(2)(i) or (a-1)(2)(ii)(A) of this
section, shall record on a written record of the order, including the
account identification, except as provided in paragraph (a-1)(5) of
this section, and order number, by timestamp or other timing device,
the date and time to the nearest minute such report of execution is
made. Each member of a contract market shall submit the written records
of customer orders or orders from other contract market members to
contract market personnel or to the clearing member responsible for the
collection of orders prepared pursuant to this paragraph as required by
contract market rules adopted in accordance with paragraph (j)(1) of
this section. The execution price and other information reported on
such order tickets must be written in nonerasable ink.
(5) Bunched orders for eligible accounts. A specific customer's
account identifier need not be recorded at the time a bunched order is
placed on a contract market or upon report of execution, provided that
the following requirements are met and that the order is handled in
accordance with contract market rules that have been submitted to the
Commission and approved or permitted into effect pursuant to Section
5a(a)(12)(A) of the Act and Sec. 1.41. The bunched order must be
allocated to the eligible accounts prior to the end of the day on which
the order is executed.
(i) Eligible orders. Bunched orders placed, executed, and allocated
pursuant to this paragraph (a-1)(5) must be placed by an eligible
account manager on behalf of consenting eligible customers as part of
its management of a portfolio also containing instruments which are
either exempt from regulation pursuant to the Commission's regulations
or excluded from Commission regulation under the Act.
(ii) Eligible account managers. The person placing and/or directing
the allocation of an eligible order and its principal, if any,
("account manager") must be one of the following which has been
granted investment discretion with regard to eligible customer
accounts:
(A) A commodity trading advisor registered with the Commission
pursuant to the Act;
(B) An investment adviser registered with the Securities and
Exchange Commission pursuant to the Investment Advisers Act of 1940; or
(C) A bank, insurance company, trust company, or savings and loan
association subject to federal or state regulation.
(iii)Eligible customers.
(A) Eligible orders may be allocated to accounts owned by the
following entities which have consented in advance, in writing, to the
account manager that orders may be placed, executed, and allocated in
accordance with this paragraph:
(1) A bank or trust company;
(2) A savings association or credit union;
(3) An insurance company;
(4) An investment company subject to regulation under the
Investment Company Act of 1940 (15 U.S.C. 80a-1, et seq.) or an
investment company performing a similar role or function subject to
foreign regulation, provided that the investment company or foreign
person is not formed solely for the purpose of constituting an eligible
customer and has total assets exceeding $5,000,000;
(5) A commodity pool formed and operated by a person subject to
regulation under the Act or a foreign person performing a similar role
or function subject to foreign regulation, provided that the commodity
pool or foreign person is not formed solely for the purpose of
constituting an eligible customer and has total assets exceeding
$5,000,000;
(6) A corporation, partnership, proprietorship (but not a sole
proprietorship), organization, trust, or other entity comprised of more
than one person, provided that the entity was not formed solely for the
purpose of constituting an eligible customer and has either a net worth
exceeding $1,000,000 or total assets exceeding $10,000,000;
(7) A corporate qualified pension, profit sharing, or stock bonus
plan subject to Title 1 of the Employee Retirement Income Security Act
of 1974 ("ERISA"), or a foreign person performing a similar role or
function subject to foreign regulation, with total assets exceeding
$5,000,000 or whose investment decisions are made by a bank, trust
company, insurance company, investment adviser subject to regulation
under the Investment Advisers Act of 1940 (15 U.S.C. 80b-1, et seq.),
or a commodity trading advisor subject to regulation under the Act, or
any plan defined as a governmental plan in Section 3(32) of Title 1 of
ERISA, but not including a self-directed plan;
(8) Any governmental entity (including the United States, any
state, or any foreign government) or political subdivision thereof, or
any multinational or supranational entity or any instrumentality,
agency, or department of any of the foregoing;
(9) A broker-dealer subject to regulation under the Securities
Exchange Act of 1934 (15 U.S.C. 78a, et seq.) or a foreign person
performing a similar role or function subject to foreign regulation,
acting on its own behalf; provided, however, that the broker-dealer may
not be a natural person or sole proprietorship; or
(10) A futures commission merchant subject to regulation under the
Act or a foreign person performing a similar role or function subject
to foreign regulation, acting on its own behalf; provided, however,
that the futures commission merchant may not be a natural person or
sole proprietorship.
(B) The following persons, or any combination thereof, may not have
an interest of ten percent or greater in any account that receives any
part of an eligible order:
(1) The account manager;
(2) The futures commission merchant allocating the order;
(3) Any general partner, officer, director, or owner of ten percent
or more of the equity interest in the
[[Page 707]]
account manager or the futures commission merchant allocating the
order;
(4) Any employee, associated person, or limited partner of the
account manager or the futures commission merchant allocating the order
who affects or supervises the handling of the order;
(5) Any business affiliate that, directly or indirectly, controls,
is controlled by, or is under common control with, the account manager
or the futures commission merchant allocating the order; or
(6) Any spouse, parent, sibling, or child of the foregoing persons.
(iv) Account certification.
(A) Before placing the initial eligible order, the account manager
must certify, in writing, to each futures commission merchant executing
and/or allocating any part of the order that the account manager is
aware of the provisions of this paragraph and is, and will remain, in
compliance with the requirements of this paragraph.
(B) Before placing the initial eligible order, the account manager
must provide each futures commission merchant allocating the order with
a list of eligible futures accounts.
(v) Allocation.
(A) The account manager and the futures commission merchant
allocating the order must allocate fills from each eligible order to
eligible participating customer accounts prior to the end of the day
the order is executed, as specified by exchange rules for this purpose.
(B) Allocations of eligible orders must be fair and non-
preferential, taking into account the effect on each relevant portfolio
in the bunched order.
(vi) Recordkeeping.
(A) Each eligible order must be identified on the office and floor
order tickets at the time of placement. These order tickets also must
identify the account manager placing the order.
(B) Each transaction resulting from an eligible order must be
identified on contract market trade registers and other computerized
trade practice surveillance records.
(C) The futures commission merchant carrying the account must
identify each trade resulting from the execution of an eligible order
on confirmation statements provided to eligible customer accounts.
(D) Each account manager must make available, upon request of any
representative of the Commission or the United States Department of
Justice, the following:
(1) The customer consent documents required pursuant to paragraph
(a-1)(5)(iii)(A) of this section; and
(2) Records reflecting futures and option transactions, other
transactions executed pursuant to the portfolio management strategy,
and any other records that would identify the management strategy and
relate to, or reflect upon, the fairness of the allocations.
(E) Each account manager must make available for review, upon
request of an eligible customer, data sufficient for that customer to
compare its results with those of other relevant customers. These data
may be prepared so as not to disclose the identity of individual
account holders.
(vii) Contract market rule enforcement programs. As part of its
rule enforcement program, each contract market that adopts rules that
allow the placement, execution, and allocation of eligible orders must
adopt audit procedures to determine compliance with the certification,
allocation, and recordkeeping requirements identified in paragraphs (a-
1)(5)(iv), (v)(A), and (vi)(A) through (C) of this section.
* * * * *
Issued in Washington, DC on December 31, 1997 by the Commission.
Catherine D. Dixon,
Assistant Secretary of the Commission.
[FR Doc. 98-240 Filed 1-6-98; 8:45 am]
BILLING CODE 6351-01-P
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