Federal Register, Volume 77 Issue 246 (Friday, December 21, 2012)[Federal Register Volume 77, Number 246 (Friday, December 21, 2012)]
[Rules and Regulations]
[Pages 75523-75543]
From the Federal Register Online via the Government Printing Office [www.gpo.gov]
[FR Doc No: 2012-30691]
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COMMODITY FUTURES TRADING COMMISSION
17 CFR Part 1
RIN 3038-AD53
Adaptation of Regulations To Incorporate Swaps--Records of
Transactions
AGENCY: Commodity Futures Trading Commission.
ACTION: Final rules.
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SUMMARY: The Dodd-Frank Wall Street Reform and Consumer Protection Act
(``Dodd-Frank Act'' or ``DFA'') established a comprehensive new
statutory framework for swaps and security-based swaps. The Dodd-Frank
Act repeals some sections of the Commodity Exchange Act (``CEA'' or
``Act''), amends others, and adds a number of new provisions. The DFA
also requires the Commodity Futures Trading Commission (``CFTC'' or
``Commission'') to promulgate a number of rules to implement the new
framework. The Commission has proposed and finalized numerous rules to
satisfy its obligations under the DFA. This final rulemaking makes
certain conforming amendments to recordkeeping provisions of
regulations 1.31 and 1.35(a) to integrate these regulations more fully
with the new framework created by the Dodd-Frank Act.\1\ This final
rulemaking requires futures commission merchants (``FCMs''), certain
introducing brokers (``IBs''), retail foreign exchange dealers
(``RFEDs'') and certain other registrants
[[Page 75524]]
that are members of designated contract markets (``DCMs'') or swap
execution facilities (``SEFs'') to record all oral communications
provided or received concerning quotes, solicitations, bids, offers,
instructions, trading, and prices, that lead to the execution of a
transaction in a commodity interest, whether communicated by telephone,
voicemail, mobile device, or other digital or electronic media, and to
keep those records for one year. This final rule also requires FCMs,
IBs, RFEDs, and all members of a DCM or SEF to record and keep all
written communications provided or received concerning quotes,
solicitations, bids, offers, instructions, trading, and prices, that
lead to the execution of a transaction in a commodity interest or
related cash or forward transactions, whether communicated by
telephone, voicemail, facsimile, instant messaging, chat rooms,
electronic mail, mobile device, or other digital or electronic media,
and to keep those written records for five years.
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\1\ All Commission regulations are in Chapter I of Title 17 of
the CFR.
DATES: Effective date: This final rule will become effective on
February 19, 2013. Compliance date: Each affected entity must comply
with the oral communications recordkeeping requirement in regulation
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1.35(a)(1) (17 CFR 1.35(a)(1)) no later than December 21, 2013.
FOR FURTHER INFORMATION CONTACT: Katherine Driscoll, Associate
Director, 202-418-5544, [email protected], Elizabeth Miller, Attorney-
Advisor, 202-418-5450, [email protected], Division of Swap Dealer and
Intermediary Oversight; Peter A. Kals, Special Counsel, 202-418-5466,
[email protected], Division of Clearing and Risk; David E. Aron, Counsel,
202-418-6621, [email protected], Office of General Counsel; Alexis Hall-
Bugg, Attorney-Advisor, 202-418-6711, [email protected], Division of
Market Oversight, Commodity Futures Trading Commission, Three Lafayette
Centre, 1151 21st Street NW., Washington, DC 20581.
SUPPLEMENTARY INFORMATION:
I. Introduction
A. The Dodd-Frank Act
On July 21, 2010, President Obama signed the Dodd-Frank Act into
law.\2\ Title VII of the Dodd-Frank Act \3\ (``Title VII'') amended the
CEA \4\ to establish a comprehensive new regulatory framework for swaps
and security-based swaps. The legislation was enacted, among other
reasons, to reduce risk, increase transparency, and promote market
integrity within the financial system by, among other things: (1)
Providing for the registration and comprehensive regulation of swap
dealers (``SDs''), security-based swap dealers, major swap participants
(``MSPs''), and major security-based swap participants; (2) imposing
clearing and trade execution requirements on swaps and security-based
swaps, subject to certain exceptions; (3) creating rigorous
recordkeeping and real-time reporting regimes; and (4) enhancing the
rulemaking and enforcement authorities of the Commission with respect
to, among others, all registered entities and intermediaries subject to
the Commission's oversight.
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\2\ See Dodd-Frank Wall Street Reform and Consumer Protection
Act, Public Law 111-203, 124 Stat. 1376 (2010). The text of the
Dodd-Frank Act is available at http://www.cftc.gov/LawRegulation/OTCDERIVATIVES/index.htm.
\3\ Pursuant to section 701 of the Dodd-Frank Act, Title VII may
be cited as the ``Wall Street Transparency and Accountability Act of
2010.''
\4\ 7 U.S.C. 1 et seq. (2006).
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B. Proposed Changes to Regulation 1.35(a)--Records of Transactions
On June 7, 2011, the Commission published in the Federal Register a
notice of proposed rulemaking (the ``Proposal'') to apply its
regulations, regarding the activities of intermediaries and other DCM
members to the swaps activities of those persons, in conformance with
the Dodd-Frank Act.\5\ The Proposal provided for a 60-day public
comment period, which ended on August 8, 2011. The Proposal proposed to
conform the existing recordkeeping requirements of regulation 1.35(a)
to the recordkeeping requirements for SDs and MSPs, under what was then
proposed regulation 23.202(a)(1) and (b)(1),\6\ so that FCMs, IBs,
RFEDs, and DCM and SEF members would be required to record all oral and
written communications provided or received concerning quotes,
solicitations, bids, offers, instructions, trading, and prices, that
lead to the execution of transactions in a commodity interest \7\ or
cash commodity, whether communicated by telephone, voicemail,
facsimile, instant messaging, chat rooms, electronic mail, mobile
device, or other digital or electronic media. To be consistent with
what was then proposed regulation 23.202(a) and (b), the Proposal would
have amended regulation 1.35(a) by requiring that each record be
maintained in a separate electronic file identifiable by transaction
and counterparty. On November 2, 2012, the Commission published in the
Federal Register the Final Adaptation Rule.\8\ The Final Adaptation
Rule promulgated the vast majority of the amendments that the Proposal
had introduced. In the Final Adaptation Rule, the Commission stated
that it would address in a separate release certain of the proposed
changes to regulation 1.35 (i.e., those enumerated above) and related
amendments to regulation 1.31.\9\
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\5\ Adaptation of Regulations to Incorporate Swaps, 76 FR 33066
(June 7, 2011) (``the Proposal'').
\6\ See the Proposal, 76 FR at 33067; Reporting, Recordkeeping,
and Daily Trading Records Requirements for Swap Dealers and Major
Swap Participants, 76 FR 76666, 76675 (Dec. 9, 2010) (Proposed
regulation 23.202(a)(1) would have required ``[e]ach swap dealer and
major swap participant [to] make and keep pre-execution trade
information, including, at a minimum, records of all oral and
written communications provided or received concerning quotes,
solicitations, bids, offers, instructions, trading, and prices, that
lead to the execution of a swap, whether communicated by telephone,
voicemail, facsimile, instant messaging, chat rooms, electronic
mail, mobile device or other digital or electronic media'').
\7\ The term ``commodity interest'' means: (1) any contract for
the purchase or sale of a commodity for future delivery; (2) any
contract, agreement or transaction subject to Commission regulation
under section 4c or 19 of the Act; (3) any contract, agreement or
transaction subject to Commission jurisdiction under section 2(c)(2)
of the Act; and (4) any swap as defined in the Act, by the
Commission, or jointly by the Commission and the Securities and
Exchange Commission. See Adaptation of Regulations to Incorporate
Swaps, 77 FR 66288, 66319 (Nov. 2, 2012) (``Final Adaptation Rule'')
(to be codified at 17 CFR 1.3(yy)).
\8\ Final Adaptation Rule, 77 FR 66288.
\9\ See id., 77 FR at 66288, 66296 n. 59, 66297 n. 63, and 66299
n. 72.
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In response to the amendments to regulation 1.35(a) in the
Proposal, the Commission received 35 comment letters from a variety of
institutions, including DCMs, agricultural trade associations, and
agricultural cooperatives.\10\ The Commission has
[[Page 75525]]
determined to adopt the Proposal's amendments to regulation 1.35(a),
with certain modifications, discussed below, which address the comments
the Commission received. In addition, as part of this final rulemaking,
the Commission is making certain related modifications to the record
retention periods set forth in regulation 1.31. Finally, the final
amendments to regulations 1.31 and 1.35(a) are consistent with the
Commission's final rules concerning recordkeeping requirements for SDs
and MSPs (regulations 23.202(a) and (b) and 23.203(b)(2)).\11\
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\10\ Commenters included: Agribusiness Council of Indiana;
American Cotton Shippers Association (``ACSA''); Amcot; American
Feed Industry Association (``AFIA''); American Gas Association;
American Petroleum Institute; Barclays Capital (``Barclays''); Mr.
Chris Barnard; Commodity Markets Council (``CMC''); Compliant Phones
(``Compliant''); Electric Power Supply Association (``EPSA'');
Electric Utility Trade Associations (National Rural Electric
Cooperative Association, American Public Power Association, Large
Public Power Council, and Edison Electric Institute) (``ETA'');
Encana; Falmouth Farm Supply; The Fertilizer Institute; Futures
Industry Association(``FIA''); Grain and Feed Association of
Illinois; Kansas City Board of Trade (``KCBT''); CME Group
(``CME''); Henderson & Lyman; IntercontinentalExchange, Inc.
(``ICE''); Land O'Lakes, Inc.; Minneapolis Grain Exchange
(``MGEX''); Minnesota Grain and Feed Association; National Grain and
Feed Association (``NGFA''); National Introducing Brokers
Association (``NIBA''); National Council of Farmer Cooperatives
(``NCFC''); National Futures Association (``NFA''); Natural Gas
Supply Association; Ohio Agribusiness Association; Oklahoma Grain
and Feed Association; Rocky Mountain Agribusiness Association
(``RMAA''); South Dakota Grain & Feed Association; and Working Group
of Commercial Energy Firms (``Commercial Energy Working Group'').
Comments are available in the comment file on www.cftc.gov. In the
Final Adaptation Rule, the Commission addressed those comments
unrelated to the proposed changes to regulation 1.35(a) concerning
records of oral and written communications. See Final Adaptation
Rule, 77 FR 66288.
\11\ See Swap Dealer and Major Swap Participant Recordkeeping,
Reporting, and Duties Rules; Futures Commission Merchant and
Introducing Broker Conflicts of Interest Rules; and Chief Compliance
Officer Rules for Swap Dealers, Major Swap Participants, and Futures
Commission Merchants, 77 FR 20128 (Apr. 3, 2012) (``SD and MSP
Recordkeeping Final Rule'') (adopting for SDs and MSPs reporting and
recordkeeping standards now found in 17 CFR 23.201-23.203).
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II. Oral Communications and Other Recordkeeping Changes in the
Proposal; Comments Received
Under the Proposal, FCMs, IBs, RFEDs, and DCM and SEF members \12\
would be required to record all oral and written communications
provided or received concerning quotes, solicitations, bids, offers,
instructions, trading, and prices that lead to the execution of a
transaction in a commodity interest or cash commodity, whether
communicated by telephone, voicemail, facsimile, instant messaging,
chat rooms, electronic mail, mobile device, or other digital or
electronic media. Comments to these proposed amendments to regulation
1.35(a) primarily focused on: oral recordkeeping generally; the portion
of the proposed provisions that would have required all DCM and SEF
members, including commercial end-users and non-intermediaries, to keep
records of their cash commodity transactions; and the proposed
requirement that each record be maintained in a separately identifiable
electronic file identifiable by transaction and counterparty
(``tagging'').
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\12\ A ``member'' is an individual, association, partnership,
corporation, or trust--(i) owning or holding membership in, or
admitted to membership representation on, a registered entity; or
(ii) having trading privileges on a registered entity. See Final
Adaptation Rule, 77 FR at 66316 (to be codified at 17 CFR 1.3(q)).
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A. Proposed Requirements To Record Oral Communications and Keep Them in
Separate Electronic Files Identifiable by Transaction and Counterparty
1. Comments on Oral Recordkeeping Generally
Commenters asserted that the proposed requirement for FCMs, IBs,
RFEDs, and DCM and SEF members to record oral communications that lead
to the execution of a commodity interest or cash commodity transaction
was too costly, impossible to satisfy, overly broad, and/or
unnecessary. ACSA, AFIA, Amcot, EPSA, ICE, and Land O'Lakes commented
that these proposed amendments were broad and ambiguous.\13\ AFIA, CME,
EPSA, MGEX, and the Commercial Energy Working Group argued that the
phrases ``concerning quotes, solicitations, bids'' and ``lead to the
execution of'' were vague and could encompass a great number of
communications. Amcot asserted that the overbreadth of the proposed
amendment would be burdensome for agricultural DCM members given that
there are a variety of settings, including grower meetings and on-site
visits, where a DCM member could have a discussion with an agricultural
producer that leads to a cash commodity or commodity interest
transaction. Land O'Lakes was unsure whether face-to-face conversations
would have to be recorded under the proposed requirement. ICE inquired
as to whether a general conversation about markets would be subject to
the proposed recording requirement if a transaction occurred later in
the day. AFIA stated that the risk of an incorrect interpretation would
fall on local grain producers.
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\13\ FIA made a similar argument regarding the application of
the amendment to FCMs.
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Regarding application of the proposed requirement to telephone
conversations, Land O'Lakes and MGEX each argued that a DCM member
might not know in advance of a telephone call whether that call would
lead to a transaction. MGEX believed that this fact would require a DCM
member to record all conversations, which they argued would be
impossible. Land O'Lakes asserted that complying with the proposed
requirement could involve massive amounts of recording, thereby
deterring open communication between a DCM member and one of its
agricultural producers. The Commercial Energy Working Group commented
that proposed regulation 1.35(a) was too broad in that it could require
DCM members to record communications of attorneys and other ``middle
office'' personnel, and not just the communications of traders who are
directly involved in executing a transaction. CMC argued that the
Commission has substantially underestimated the considerable costs and
limited benefits associated with the recordkeeping requirements for DCM
and SEF members. CME does not believe firms can comply with the
proposed oral recordkeeping requirements with respect to mobile
telephones because, they stated, mobile telephone recording technology
is not well developed in the United States.
Regarding whether an oral communications recordkeeping requirement
is necessary, NCFC stated that the proposed requirement to record oral
communications is not necessary to achieve the Commission's stated goal
of protecting customers from abusive sales practices. CMC asserted that
current regulation 1.35(a)'s requirement to maintain written records of
commodity interest and cash commodity transactions suffices to prevent
market abuses. Amcot stated that the Commission failed to demonstrate
the inadequacy of its existing regulations. Henderson & Lyman, NFA, and
NIBA stated that the oral recordkeeping requirement is unnecessary
because NFA already requires certain FCMs and IBs with a history of
sales practice abuses to record calls made by their associated persons.
Henderson & Lyman stated that the NFA rule and NFA's related guidance
concerning communications are sufficient and cost-effective.
NIBA commented that all IBs, or at the very least small IBs, should
be exempt from the proposed amendments to regulation 1.35(a) because
the burden on such small entities would be too great. Henderson & Lyman
similarly commented that the proposed regulation would favor large IBs
over small IBs. Neither NIBA nor Henderson & Lyman, however, offered a
definition of ``small IB'' or provided any quantitative or qualitative
thresholds. Henderson & Lyman stated that it is unnecessary to have an
oral recording requirement for IBs because most IBs solicit customers
electronically rather than over the telephone. Henderson & Lyman also
stated that the focus on IBs was misplaced since misleading
communications come from marketing firms rather than from IBs. NIBA
further stated that the proposed amendment would be ineffective in
compelling IBs to record their calls since those who refuse to do so
will find a way to circumvent the regulation.
Falmouth Farm Supply had several concerns with the proposed
[[Page 75526]]
amendment, asserting that a grain business-DCM member recording its
telephone conversations with a farmer-supplier would amount to an
invasion of privacy and that grain producers do not need the
Commission's protection. CMC and ICE stated that it would be redundant
for a DCM or SEF member to comply with proposed regulation 1.35(a)
because the DCM or SEF member will have to engage an FCM clearing agent
for each transaction, and the FCM would have to comply with the
regulation.
2. Comments on the Proposed ``Tagging'' Requirement
CME, Barclays, Henderson & Lyman, NGFA, and NIBA stated that it
would be burdensome to comply with the proposed requirement to maintain
records as separate electronic files identifiable by counterparty and
transaction.\14\ FIA commented that the ``separate electronic file
requirement'' is open-ended and, on its face, impossible to
achieve.\15\ CME stated that potentially relevant conversations could
span several days and that it would be difficult to link conversations
to transactions. Therefore, CME commented, FCMs and IBs should only be
required to record and identify conversations immediately preceding an
order. FIA stated that a customer may decide to enter an order with an
FCM at any time, even if that was not the original purpose of the call.
According to FIA, this aspect of the futures business means that an FCM
would have to record all of its telephone calls to comply with proposed
regulation 1.35(a) and this would be difficult if not impossible.
Moreover, FIA stated that compliance would be impossible because one
could argue that any conversation pertains to a particular transaction.
Like CME, Barclays stated that the tagging requirement is vague,
potentially requiring an FCM to tag every communication that could ever
lead to a transaction. Barclays stated that it would be particularly
challenging to tag a telephone call when the firm is telephoned by a
counterparty; when parties discuss a transaction that the firm did not
originally anticipate; or when multiple transactions are discussed
during a particular call. According to Barclays, there is no technology
to automatically tag communications, so the firm would have to manually
tag over 2.4 billion electronic communications it sends and receives
every year. Barclays also stated that it is not aware of any
commercially available technology that would allow entities to tag
their telephone recordings by transactions and counterparty. Other
commenters expressed similar concern regarding the reliability and
availability of technological solutions for the proposed tagging
requirement. The Commercial Energy Working Group stated that, in lieu
of an accurate and commercially available software solution, manual
identification and retrieval of oral records would require as many as
three to five analysts and one to two additional technical support
personnel to support transactions for a small or modest-sized end-user
commodity business and that the total cost to a commodity business is
likely to be in excess of $1 million annually.
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\14\ NGFA's letter was supported by the other Grain and Feed
Associations, the Agribusiness Associations, Land O' Lakes, and
NCFC.
\15\ ACSA generally supported FIA's comment letter.
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According to Barclays, an FCM should be permitted to maintain
records in any manner so long as it is able to respond to Commission
inquiries in a timely and comprehensive fashion. The Commercial Energy
Working Group commented that a firm should only have to identify
communications as pertaining to a particular transaction if the
Commission requests that information. Moreover, the Commercial Energy
Working Group stated that it is unlikely that the Commission will
request such information, so DCM members should not have a general
obligation to tag conversations.\16\ The Commercial Energy Working
Group urged the Commission to allow market participants to make their
records searchable by transaction at the time the Commission requests
the records rather than require that all records be maintained on a
transaction-by-transaction basis in real-time.
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\16\ API generally supported the Commercial Energy Working
Group's comment letter.
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MGEX sought clarification as to whether the requirement in proposed
regulation 1.35(a) to maintain ``each transaction record in a separate
electronic file identifiable by transaction and counterparty'' requires
a file to be kept for each counterparty and for each transaction or
whether it suffices to keep one transaction file that is indexed by
counterparty and transaction. MGEX also stated that it would be
duplicative for a firm to keep records of both written and oral
communications if they contained substantially the same content.
3. Commenters' Suggested Revisions to the Oral Communications
Requirement
Commenters made suggestions about how the Commission should revise
the Proposal to limit the burden. NGFA suggested that if the Commission
adopts the proposed oral recordkeeping requirement, it should give FCMs
and IBs a generous compliance timetable and flexible implementation
options, particularly for smaller firms. CME, FIA, and MGEX asserted
that firms should only be required ``reasonably'' to comply with oral
recordkeeping requirements. MGEX suggested that a DCM member should
only be required reasonably to link a conversation to an executed
transaction. Barclays highlighted that the United Kingdom Financial
Services Authority (``FSA'') adopted a reasonableness standard for
compliance with its mobile telephone conversation recording
requirement.\17\ CME stated that a reasonableness standard is necessary
because of limited technology, particularly a lack of reliable search
mechanisms. According to CME, one way a firm should be able to comply
would be by having a policy prohibiting the use of mobile telephones to
solicit or accept orders. CME commented that the Commission fails to
provide evidence that the Proposal would be less effective with such a
``reasonableness'' standard than without it. CME stated that only firm-
provided landline and mobile telephones should be covered by the rule
as that would make the proposal consistent with foreign regulatory
regimes. ETA stated that the Commission fails to justify aligning its
recordkeeping requirements with those of other countries. CMC commented
that the Proposal's reference to the fact that 80% of large U.K.
financial services firms were already recording their traders'
telephone calls prior to the FSA's enactment of its voice recordkeeping
requirement is irrelevant to the burden that the Proposal would impose
on agricultural enterprises who are DCM members trading for their own
accounts and not on behalf of customers. FIA sought confirmation that
an FCM, IB, or other DCM or SEF member can satisfy the recordkeeping
requirements under regulation 1.35(a) by relying on record retention
performed by a DCM or SEF.
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\17\ In November 2011, the FSA rule requiring taping of mobile
telephones became effective. Under the rule, a firm is required,
``to take reasonable steps to record relevant conversations, and
keep a copy of relevant electronic communications, made with, sent
from or received on equipment: (1) Provided by the firm to an
employee or contractor; or (2) the use of which by an employee or
contractor has been sanctioned or permitted by the firm.'' See
Financial Services Authority, Conduct of Business Sourcebook,
Section 11.8 Recording telephone conversations and electronic
communications (June 2012, Release 126, 11.8.2).
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[[Page 75527]]
NFA recognized that audio recordings have been very useful to the
Commission in enforcement proceedings and stated that only those firms
that choose to record calls should have to maintain their recordings.
Acknowledging that some FCMs currently record their telephone calls,
FIA commented that, to the extent they do, recording is limited to
dedicated order desks and only required to be stored for no more than a
few days or weeks. FIA and MGEX asserted that the technology available
to comply with the Proposal was ``uncertain at best'' and, therefore,
the Proposal should be considered further in the context of available
technology and then re-proposed in a separate release.
EPSA suggested that a separate rulemaking should be published to
address changes to regulation 1.35(a) to give affected parties
reasonable notice. Amcot, Henderson & Lyman, and ICE asserted that the
Commission has not considered existing state and federal wiretapping
law and privacy laws in proposing these new requirements.
B. Proposed Requirement for All Members of a DCM or SEF To Record Oral
and Written Communications Leading to the Execution of Cash Commodity
Transactions
Three DCMs joined various agricultural and energy sector trade
organizations in opposing the Commission's proposed requirement to keep
oral communications, and existing requirement to keep written
communications, regarding cash market transactions on members of a DCM
or SEF who are non-financial entities and commercial end-users, and who
do not have customers.\18\ These commenters pointed out that including
a DCM member's cash transactions would require compliance by hundreds,
if not thousands, of agricultural and energy firms, including many who
do not have customers and do not themselves enter into futures or
swaps.\19\ EPSA and the Commercial Energy Working Group stated that
many of the affected entities in the energy sector would be small
entities that likely are unaware of the Proposal. Commenters asserted
that the requirement amounted to unauthorized regulation of the cash
market, which they asserted has always been carved out of the
Commission's jurisdiction.\20\ Commenters also stated that the Dodd-
Frank Act did not intend for the Commission to subject cash commodity
transactions to new recordkeeping requirements.\21\
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\18\ Commenters included ACSA, the Agribusiness Associations,
Amcot, CMC, Falmouth Farm Supply, the Grain and Feed Associations,
Land O'Lakes, NCFC, AGA, API, EPSA, ETA, the Commercial Energy
Working Group, ICE, KCBT, TFI, and MGEX.
\19\ In related commentary, the Commercial Energy Working Group
asked the Commission to clarify that the definition of ``member'' in
the final rule covers only those people holding equity interests in
a DCM that permit such holder to submit orders directly on the DCM's
floor (or an electronic equivalent).
\20\ Commenters included Agribusiness Council of Indiana;
Agribusiness Association of Ohio; EPSA; Grain and Feed Association
of Illinois; KCBT; Land `O Lakes; Minnesota Grain and Feed
Association; NCFC; NGFA; Oklahoma Grain and Feed Association; RMAA;
and the Commercial Energy Working Group.
\21\ Commenters included Amcot; CME; EPSA; FIA; and NCFC.
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The Grain and Feed Association of Illinois, the Oklahoma Grain and
Feed Association, NCFC, and NGFA opposed the proposed revisions on the
grounds that the employees of a grain elevator that is a DCM member
would have to record calls and preserve emails with farmer producers
from whom they buy grain for cash and, thus, hundreds of employees of
grain storage and processing facilities would be significantly
burdened. As a result, these commenters stated, a grain elevator that
is a DCM member would be disadvantaged as compared to a grain elevator
that is not a DCM member as the non-member would not be burdened by the
compliance costs associated with proposed regulation 1.35(a). KCBT
asserted that this creates a discriminatory regulatory structure.
According to ICE, this outcome would deter firms from hedging
commercial risk on a DCM or SEF, thereby defeating the Dodd-Frank Act's
transparency objectives. NGFA and its affiliates argued that burdening
facilities owned by companies that are DCM members with the new rules
would create a bifurcation of the cash grain marketplace into
facilities required to comply with new recordkeeping requirements and
facilities owned and operated by companies who are not DCM members and,
therefore, not required to comply. KCBT stated that their rules (and
the rules of other DCMs) require that operators of registered delivery
warehouses be members, further stating that the regulatory
disincentives created by the application of proposed regulation 1.35(a)
to all DCM member cash transactions could affect not only DCM
expertise, but deliverable supplies and convergence. According to KCBT,
should DCM commercial members operating delivery warehouses decide to
withdraw from membership because of proposed regulation 1.35(a),
deliverable supplies would be negatively impacted and there would be
fewer deliverable supplies to foster convergence at delivery.
Amcot stated that neither it nor its members should be subject to
the proposed amendments because they do not transact with the public.
Similarly, the Commercial Energy Working Group commented that end-users
(i.e., DCM or SEF members trading for themselves) should not have to
comply with proposed regulation 1.35(a) because they do not trade for
customers and, therefore, pose minimal systemic risk. EPSA stated that
regulation 1.35(a) was never intended to burden end-users.
Several commenters objected to the Commission's regulation of
records of cash commodity transactions. KCBT stated that it did not
believe the Commission ever intended for regulation 1.35(a) to apply to
cash and cash forward transactions outside of those directly relating
to a regulated futures or swaps transaction. KCBT further stated that
it has always interpreted regulation 1.35(a) to cover only those
transactions for which a DCM member is acting as an agent for a
customer. Thus, according to KCBT, the only DCM members (who were not
otherwise FCMs or IBs) who would be required to comply would be floor
brokers (``FBs''); DCM members who trade for themselves would not be
covered. KCBT stated that it has also understood the ``related cash
transactions'' referenced by regulation 1.35(a) to refer only to those
transactions involving an exchange of a futures transaction for a
physical commodity.
The Commercial Energy Working Group asserted that, under the
proposed amendments to regulation 1.35(a), many of the entities that
transact on ICE, for example, would now be required to maintain records
pursuant to Commission rules without consideration of whether the
market users handle customer orders, which would be a departure from
the past for members of contract markets that are not FCMs, IBs, or
present on a trading floor. As a general matter, FIA argued that these
proposed amendments to regulation 1.35(a) are not necessary to
implement the Dodd-Frank Act and, therefore, they run counter to the
guiding principles set out in President Obama's January 2011 Executive
Order 13563, Improving Rulemaking and Regulatory Review.
ACSA, CMC, FIA, Henderson & Lyman, ICE, NFA, and NIBA stated that
the proposed amendments were inconsistent with the Commission's
proposed recordkeeping requirements for SDs and MSPs because they would
require FCMs, RFEDs, IBs, and members
[[Page 75528]]
of a DCM or SEF to record voice communications regardless of any other
recordkeeping requirement that captures the same information.
C. Relationship Between Regulations 1.31 and 1.35(a)
Amcot stated that it would be burdensome for its farmer-owned
cotton marketing cooperative members to retain recordings of telephone
calls for five years as the Commission proposed. CME commented that
conversations should only be retained for six months after the
execution of a transaction. FIA commented that the Commission failed to
provide a justification for requiring that a swap record be maintained
for the life of the swap plus five years. In contrast to other
commenters, Mr. Chris Barnard asserted that all records should be kept
indefinitely and scanned after two years, arguing that there is no
technological or practical reason to limit the record retention period.
Mr. Barnard specifically commented that records of voice communications
also should be kept indefinitely. To support the asserted usefulness of
such records, Mr. Barnard cited a 2009 IOSCO report stating that
telephone records could benefit enforcement investigations.\22\
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\22\ http://www.iosco.org/news/pdf/IOSCONEWS137.pdf.
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III. Final Rules
The markets subject to the jurisdiction of the Commission have
undergone a significant transformation over the last few decades, and
particularly in the last few years. Technological advances have
contributed to a tremendous growth in trading volume as well as the
number and type of market participants, including significant numbers
of retail customers that invest in the commodity markets through a
variety of means. Markets are also more interconnected than ever
before, with order flow distributed across multiple trading centers.
These changes require the Commission to adapt, and these final rules
are part of that adaptation.
The overarching purpose of the Commission's final rules is to
promote market integrity and protect customers. Requiring the recording
and retention of oral communications will serve as a disincentive for
covered entities to make fraudulent or misleading communications to
their customers over the telephone and could serve as a meaningful
deterrent against violations such as trading ahead of customer orders
by providing a record of the time that a customer's telephone order is
received. When the perspectives of the commenters are combined with the
Commission's own experiences regulating the markets subject to its
jurisdiction, a common theme emerges: The collection of and access to
searchable records, both oral and written, are indispensable tools the
Commission needs to ensure market integrity and protect customers.
Currently, many of the market participants that will be subject to the
final rules have such records by way of their business needs or other
regulatory requirements. Some commenters have urged the Commission to
rely on currently available information and not require more. While
existing information aids the Commission in discharging its regulatory
responsibility, the Commission believes current recordkeeping,
particularly in the area of oral recordkeeping, is limited, to varying
degrees, in availability, scope and effectiveness.
The final rules will significantly advance the Commission's efforts
to detect and deter abusive, disruptive, fraudulent and manipulative
acts and practices that seriously harm market integrity and customers.
In addition, the information that will be required as a result of this
rulemaking will benefit the Commission in its market analysis efforts,
such as investigating and preparing market reconstructions and
understanding causes of unusual market activity. Further, the
requirement that records be kept current and readily available
facilitates the timely pursuit of potential violations, which can be
important in seeking to freeze and recover any profits received from
illegal activity.
Notwithstanding the important policy and practical reasons for the
final rules, the Commission shares many of the commenters' concerns
regarding costs and the availability of relevant technology. Therefore,
as discussed below, the Commission is adopting alternatives to the
Proposal where doing so would achieve the Commission's objectives and
the benefits of promoting market integrity and protecting customers
albeit at lower cost. The Commission is also significantly extending
the amount of time entities have to come into compliance with the final
rule requiring the recording of oral communications. In so doing, the
entities subject to this rulemaking are afforded the same amount of
time as SDs and MSPs to come into compliance with analogous
requirements in regulations 23.202(a)(1) and (b)(1).
Regarding oral communications, in response to commenters' concerns
that the scope of the new requirement was too broad, the new
requirement to record oral communications will be limited to those oral
communications that lead to a transaction in a commodity interest. As
proposed, the oral communications recordkeeping requirement would have
applied to commodity interest and cash commodity transactions. In
response to comments asserting that the cost of implementing and
maintaining an oral communication recording system would be overly
burdensome for small entities and the commercial end-user, non-
intermediary members of a DCM or SEF, the Commission has determined to
exclude from the new requirement to record oral communications: Small
IBs\23\; the oral communications of an FB who is a member of a DCM or
SEF that do not lead to the purchase or sale for any person other than
the FB of any commodity for future delivery, security futures product,
swap, or commodity option authorized under section 4c of the Act; and
certain members of a DCM or SEF, including floor traders (``FTs''),\24\
commodity pool operators
[[Page 75529]]
(``CPOs''), SDs, MSPs,\25\ and members that are not registered or
required to be registered with the Commission in any capacity. As
proposed, the oral communications recording requirement would have
applied to FCMs, RFEDs, all IBs and all members of a DCM or SEF. These
exclusions are based on the Commission's experience that such entities
are either unlikely to or prohibited from having a customer interface
or an effect on market integrity. For example, while a Small IB takes
customer orders, they generally do not execute those orders, meaning
that they lack a direct market interface that could affect market
integrity. Further, as defined herein, a Small IB is unlikely to
generate the volume of market activity that the Commission would expect
could affect the integrity of the markets. Conversely, where an FT
could affect market integrity, they are prohibited from accepting
customer funds and are therefore excluded by the limiting principle of
customer protection.
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\23\ Final regulation 1.35(a) excludes from the oral
communications recordkeeping requirement any IB that has generated,
over the preceding three years, $5 million or less in aggregate
gross revenues from its activities as an IB (``Small IB''). All
other IBs with aggregate gross revenue exceeding $5 million will be
referred to as ``non-Small IBs.'' The Commission has previously
determined this to be an appropriate definition of a small IB. In
connection with regulation 1.71 (Conflicts of Interest Policies and
Procedures by Futures Commission Merchants and Introducing Brokers),
the Commission provided a separate regulatory standard for small
IBs, based on this definition, to lessen the compliance burden
imposed by the conflicts of interest requirements on such firms. See
SD and MSP Recordkeeping Final Rule, 77 FR at 20148. In that rule,
the Commission found that ``Section 4d(c) of the Act mandates the
establishment of `appropriate informational partitions' within FCMs
and IBs, and all such firms are bound by that statutory
requirement,'' and. It concluded that ``the size of an IB plays a
significant role in determining the appropriateness of such
partitions.'' Id. at 70149. Applying this new standard for IBs to
the instant final rulemaking, the Commission estimates that with
respect to IBs, limiting the scope of final regulation 1.35(a) to
IBs that are not small excludes more than 95% of IBs from the
regulation 1.35 oral communications recordkeeping requirement
adopted in this release. Thus, at present, the Commission expects
that no more than approximately 75 IBs will be subject to the final
oral recordkeeping requirements of regulation 1.35.
\24\ The Commission notes that certain FTs, although excluded
from the oral communications requirement in regulation 1.35(a), will
be required to record their oral communications concerning swap
transactions and their related cash and forward transactions,
pursuant to regulation 23.202(a)(1) and (b)(1). Pursuant to
regulation 23.200(i), a related cash or forward transaction means a
purchase or sale for immediate or deferred physical shipment or
delivery of an asset related to a swap where the swap and the
related cash or forward transaction are used to hedge, mitigate the
risk of, or offset one another. See SD and MSP Recordkeeping Final
Rule, 77 FR at 20202. The recently finalized definition of SD
(regulation 1.3(ggg)(iv)(H)) requires certain FTs who deal in swaps
to comply with regulation 23.202, as well as certain other
regulations in part 23, notwithstanding the fact that such FTs are
not required to register as SDs. See 17 CFR 1.3(ggg)(iv)(H), as
finalized by the Commission in Further Definition of ``Swap
Dealer,'' ``Security-Based Swap Dealer,'' ``Major Swap
Participant,'' ``Major Security-Based Swap Participant'' and
``Eligible Contract Participant,'' 77 FR 30596 (May 23, 2012).
\25\ As noted above, SDs and MSPs are subject to the oral
communications recording requirement in Part 23. See SD and MSP
Recordkeeping Final Rule, 77 FR at 20148 (to be codified at 17 CFR
23.202(a)(1) and (b)(1)). SDs and MSPs that are also registered in a
capacity covered by the oral communications recording requirement in
regulation 1.35(a) would be subject to the recording requirements in
both rules.
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While seeking to mitigate the costs of compliance for smaller
entities without compromising the Commission's objectives, the
Commission is not exempting Small IBs and other excluded participants
from the requirement to keep written records of covered information,
for example, given or received by telephone. For example, if a Small IB
receives a customer's order over the telephone, then the Small IB would
not be required to record the telephone call under the new provision in
regulation 1.35(a), but the Small IB would be required to keep a
written record of the order under both the existing requirement in
regulation 1.35(a) to keep and maintain records of ``all orders
(filled, unfilled, or cancelled)'' and the new requirement in
regulation 1.35(a) to keep records of ``instructions'' to place orders.
Therefore, although this rulemaking's definition of Small IB will
exclude most IBs from the requirement to record oral communications,
the Commission believes it can continue to promote market integrity and
protect customers because the same IBs will continue to be required to
keep written records under regulation 1.35(a). In addition, because
many of an IB's oral communications leading to a commodity interest
transaction are conducted with FCMs, those oral communications would be
recorded by the FCM.
The Commission has also considered whether FBs should be treated
similarly to IBs in drawing a distinction between large and small
entities.\26\ The Commission does not believe any similar distinction
is warranted. As Congress recognized by creating separate categories of
registrants, FBs and IBs perform different functions. While both
receive orders, an FB executes orders,\27\ and an IB transmits orders
for execution.\28\ Because FBs execute orders and can direct the manner
of the same without an intermediary, they can have a significant impact
on the integrity of the market.\29\ When an IB solicits or receives
order information from a customer through an oral communication, it
then will often communicate that information either to an FCM or FB.
Under the regulation as adopted, the FCM or FB would have to record the
oral communication with the IB. By contrast, an FB may have covered
communications with a customer who is not itself subject to a recording
requirement. The need for recording oral communications with FBs has
been independently recognized by several DCMs.\30\ DCM rules requiring
FBs to record oral communications do not make distinctions based on an
FB's size.
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\26\ Regarding FBs, KCBT stated that, ``it has always understood
1.35(a) to apply to members of DCMs * * * in order to capture and
monitor the activities of DCM members * * * dealing with customers
as agent for such transactions, namely registered FBs.''
\27\ An FB generally is defined in section 1a(22)(A) of the CEA,
7 U.S.C. 1a(22)(A), as: Any person--(--(i) who, in or surrounding
any pit, ring, post, or other place provided by a contract market
for the meeting of persons similarly engaged, shall purchase or sell
for any other person--(I) any commodity for future delivery,
security futures product, or swap; or (II) any commodity option
authorized under section 4c of the CEA; or (ii) who is registered
with the Commission as an FB.
\28\ An IB generally is defined in section 1a(31)(A) of the CEA,
7 U.S.C. 1a(31)(A), as: Any person (except an individual who elects
to be and is registered as an associated person of a futures
commission merchant) (i) who--(I) is engaged in soliciting or in
accepting orders for--(aa) the purchase or sale of any commodity for
future delivery, security futures product, or swap; (bb) any
agreement, contract, or transaction described in section
2(c)(2)(C)(i) or section 2(c)(2)(D)(i); (cc) any commodity option
authorized under section 4c; or (dd) any leverage transaction
authorized under section 19; and (II) does not accept any money,
securities, or property (or extend credit in lieu thereof) to
margin, guarantee, or secure any trades or contracts that result or
may result therefrom; or (ii) who is registered with the Commission
as an IB. See 7 U.S.C. 1a(31)(B).
\29\ See, e.g., In re DiPlacido, [2007-2009 Transfer Binder]
Comm. Fut. L. Rep. (CCH) ] 30,970 at 62,484 (CFTC Nov. 5, 2008),
summary affirmance, 364 Fed. Appx. 657 (2d Cir. 2009), cert. denied,
130 S.Ct. 1883 (2010) (records of FB's oral communications with
customer admitted as evidence in case concerning manipulation of
price of NYMEX electricity futures contracts).
\30\ For instance, CME Rule 536.G, Telephone Recordings, states:
Unless specifically exempted by the Market Regulation Department
or designated Exchange staff, all headset communications must be
voice recorded by the member or member firm authorized to use the
headset and all such recordings must be maintained for a minimum of
10 business days following the day on which the recording is made.
Members and member firms are permitted to utilize their own
recording devices, provided that the devices meet reasonable
standards with respect to quality and reliability. Alternatively,
members and member firms may utilize an Exchange administered voice
recording system for a fee.
CME Rulebook, Chapter 5 Trading Qualifications and Practices,
Rule 536 Recordkeeping Requirements for Pit, Globex, and Negotiated
Trades.
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To address commenter concerns that the proposed rule would capture
the oral communications of certain members of DCMs who currently are
registered as FBs, but are solely trading for their own accounts, i.e.,
acting as FTs.,\31\ the Commission has determined to limit an FB's
obligation to record its oral communications under regulation 1.35(a)
to those oral communications that lead to the purchase or sale for any
person other than the FB of any commodity for future delivery, security
futures product, swap, or commodity option authorized under section 4c
of the CEA. In this way, a registered FB operating as an FT (i.e., not
handling customer orders) will be treated the same as an FT under the
final rules.\32\
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\31\ An FT generally is defined in section 1a(23)(A) of the CEA,
7 U.S.C. 1a(23)(A), as: Any person--(i) who, in or surrounding any
pit, ring, post, or other place provided by a contract market for
the meeting of persons similarly engaged, purchases or sells solely
for such person's own account--(I) any commodity for future
delivery, security futures product, or swap; or (II) any commodity
option authorized under section 4c of the CEA; or (ii) who is
registered with the Commission as an FT.
\32\ See 17 CFR 3.4(a).
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In determining the applicability of the final rules to another
group of market participants that are DCM members, commodity trading
advisors (``CTAs''), the Commission has considered measures to again
tailor the oral communications recordkeeping requirements for CTAs to
mitigate the costs of compliance while achieving the twin objectives of
promoting market integrity and protecting customers. The Commission has
reduced the impact on CTAs by: Limiting the oral communications
recordkeeping requirement to commodity interest transactions (i.e., not
adopting the
[[Page 75530]]
proposal to include cash commodity transactions); reducing the record
retention period for all records of oral communications from 5 years to
1 year; permitting covered persons to contract with other Commission
registrants to retain the required records (provided that the records
retained by the contractor registrant are the same records, thus
allowing covered persons to avoid retaining the same records as other
Commission registrants); and removing the tagging requirement.\33\
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\33\ The Commission considered drawing a revenues-based
threshold for CTAs. However, given that CTAs do not have a capital
requirement it is not possible for the Commission to readily
determine the sizes of all registered CTAs and, therefore, the
Commission would not be able measure the impact that such a
threshold would have on CTAs. The Commission also considered, as an
alternative, limiting the types of oral communications that a CTA
must record in a similar manner to the way in which it has limited
the types of oral communications that an FB must record to brokering
communications. However, the Commission has determined that such a
limitation is a not a reasonable alternative to having all CTAs who
are members of a DCM or SEF record all oral communications that lead
to the execution of a commodity interest transaction. Indeed, the
limitation for FBs is appropriate for FBs, and not for other
registration categories, given the current regulatory regime for FBs
and FTs discussed above.
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The Commission understands that currently available technology for
recording oral communications may not be immediately accessible or may
involve a material cost outlay for an affected entity. However, the
Commission also anticipates that as the availability of this technology
increases over time, the costs to use such technology will decline
accordingly. Accordingly, to further conform regulation 1.35(a) with
the final recordkeeping rule for SDs and MSPs,\34\ and in response to
commenter request for a flexible compliance timetable, the Commission
is adopting a [November 28, 2013] compliance date and regulation
1.35(a)(4)(i) pursuant to which the Commission may, in its discretion,
establish an alternative compliance schedule for the requirement to
record oral communications under regulation 1.35(a)(1). Under new
regulation 1.35(a)(4)(i), compliance with the requirement to record
oral communications must be found to be technologically or economically
impracticable for an affected entity that seeks, in good faith, to
comply with the requirement. Pursuant to new regulation
1.35(a)(4)(iii), the Commission delegates to the Director of the
Division of Swap Dealer and Intermediary Oversight the authority to
exercise the Commission's discretion under regulation 1.35(a)(4)(i).
The purpose of new regulation 1.35(a)(4) is to facilitate the ability
of the Commission to provide a technologically practicable compliance
schedule for an affected entity that seeks to comply in good faith with
the oral communications recordkeeping requirements of regulation
1.35(a)(1). In order to obtain relief under new regulation 1.35(a)(4),
an affected entity must submit a request to the Commission. An affected
entity submitting a request for relief must specify the basis in fact
supporting its claim that compliance with the oral communications
recordkeeping requirement under regulation 1.35(a)(1) would be
technologically or economically impracticable. Such a request may
include a recitation of the specific costs and technical obstacles
particular to the entity seeking relief and the efforts the entity
intends to make in order to ensure compliance according to an
alternative compliance schedule. Relief granted under regulation
1.35(a)(4) shall not cause an affected entity to be out of compliance
or deemed in violation of any recordkeeping requirements. Such requests
for an alternative compliance schedule shall be acted upon within 30
days from the time such a request is received. If not acted upon within
the 30-day period, such request will be deemed approved.
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\34\ See 17 CFR 23.206, as adopted by the Commission in SD and
MSP Recordkeeping Final Rule.
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Regarding comments that the proposed amendments to regulation
1.35(a) were inconsistent with the Commission's proposed recordkeeping
requirements for SDs and MSPs because they would require FCMs, RFEDs,
IBs, and members of a DCM or SEF to record voice communications
regardless of any other recordkeeping requirement that captures the
same information, the Commission addressed these comments in the final
recordkeeping rules for SDs and MSPs, clarifying that, to the extent
pre-execution trade information does not include information
communicated by telephone, an SD or MSP is under no obligation to
create recordings of its telephone conversations. If, however, any of
this pre-execution trade information is communicated by telephone, the
SD or MSP must record such communications.\35\ This clarification is
consistent with the requirements under the revision to regulation 1.35
requiring that all oral communications be recorded regardless of
whether an audit trail can be established with other types of records.
In response to commenter inquiry about whether face-to-face
communications would have to be recorded under the final rule, the
Commission does not intend for the final rule to require the recording
of face-to-face conversations that do not occur over electronic,
digital or other media.
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\35\ See SD and MSP Recordkeeping Final Rule, 77 FR at 20130.
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2. Written Communications
Regarding written communications, the Commission has decided to
adopt the proposed amendment to regulation 1.35(a) to clarify that the
existing requirement to keep written records applies to electronic
written communications such as emails and instant messages, as
proposed. The Commission considered comments asserting that: The
requirement to keep ``electronic communications'' should not extend to
members of a DCM or SEF that do not handle customer orders; regulation
1.35(a) has never required DCM members to keep records of their
electronic communications relating to their cash commodity
transactions; and storing records of electronic communications would be
overly burdensome for these members. In response, the Commission notes
that the record retention requirements of existing regulation 1.35, as
confirmed by the Commission's Division of Market Oversight in 2009,
include all electronic forms of communication (emails, instant
messages, and any other form of communication created or transmitted
electronically).\36\ Thus, contrary to commenter assertions, the
recordkeeping obligations of regulation 1.35 currently require that all
DCM members keep electronic
[[Page 75531]]
communications. Therefore, the relevant portion of the proposed new
language (now being adopted by the Commission) ``all * * * written
communications * * * whether communicated by * * * instant messaging,
chat rooms, electronic email, mobile device, or other digital or
electronic media'' does not impose any new requirements on DCM members.
Instead, the new language clarifies the existing requirement for DCM
members to maintain electronic communications by enumerating the forms
of communications that the Commission intends to be covered by the
rule. In addition, as explained above, the final language relating to
written communications is consistent with the final recordkeeping rule
for SDs and MSPs.\37\
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\36\ See U.S. Commodity Futures Trading Commission, Division of
Market Oversight, Advisory for Futures Commission Merchants,
Introducing Brokers, and Members of a Contract Market over
Compliance with Recordkeeping Requirements, Feb. 5, 2009, (http://www.cftc.gov/idc/groups/public/@industryoversight/documents/file/recordkeepingdmoadvisory0209.pdf) (footnotes omitted):
The Division of Market Oversight (``Division'') has become aware
that there is an industry misunderstanding of the record retention
requirements of Regulations 1.35 and 1.31 as it relates to
electronically conveyed records. The Division is issuing this
Advisory to address any industry misunderstanding of the
Commission's recordkeeping requirements applicable to futures
commission merchants (``FCMs''), introducing brokers (``IBs''), and
members of a designated contract market (``members''). With the
increased reliance in the futures industry on electronic media and
the use of personal electronic devices and communications technology
to facilitate the execution of transactions for both open outcry and
electronic trading, the Division is issuing this Advisory to correct
any misunderstandings and to make certain that the individuals and
entities subject to the Commission's recordkeeping requirements
maintain all electronic forms of communications, including email,
instant messages, and any other form of communication created or
transmitted electronically for all trading.
\37\ See SD and MSP Recordkeeping Final Rule, 77 FR at 20202-03
(17 CFR 23.202(a)(1) and (b)(1)).
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The Commission also has decided to change the proposed language in
regulation 1.35(a) which would have required an entity to keep records
of ``all transactions related to its business of dealing in commodity
interests and cash commodities'' to ``all transactions related to its
business of dealing in commodity interests \38\ and related cash and
forward transactions.'' This is different than existing regulation
1.35, which states ``commodity futures, retail forex transactions,
commodity options and cash commodities (including currencies).'' \39\
The final rule defines ``related cash or forward transaction'' as a
purchase or sale for immediate or deferred physical shipment or
delivery of an asset related to a commodity interest where the
commodity interest transaction and the related cash or forward
transaction are used to hedge, mitigate the risk of, or offset one
another.\40\ Because a forward is a type of cash transaction already
covered by existing regulation 1.35, amending regulation 1.35 to apply
to related forward transactions does not constitute an expansion of the
scope of existing regulation 1.35.\41\
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\38\ ``Commodity interest'' includes commodity futures, retail
forex, commodity options, and swaps. See Final Adaptation Rule, 77
FR at 66319 (to be codified at 17 CFR 1.3(yy)).
\39\ 17 CFR 1.35(a). Regulation 1.35(a) has included
transactions in ``cash commodities'' since as early as 1964:
Each futures commission merchant and each member of a contract
market shall keep full, complete, and systematic records, together
with all pertinent data and memoranda, of all transactions relating
to his business of dealing in commodity futures and cash commodities
* * *
17 CFR 1.35(a) (1964).
\40\ This definition of ``related cash or forward transaction''
mirrors the definition of the same term as it applies to swap
transactions for purposes of certain of an SD's or MSP's
recordkeeping obligations under Part 23 of the Commission's
regulations. See SD and MSP Recordkeeping Final Rule, 77 FR at
20202.
\41\ The Commission's glossary includes this definition of
``forward contract'':
A cash transaction common in many industries, including
commodity merchandising, in which a commercial buyer and seller
agree upon delivery of a specified quality and quantity of goods at
a specified future date. Terms may be more ``personalized'' than is
the case with standardized futures contracts (i.e., delivery time
and amount are as determined between seller and buyer). A price may
be agreed upon in advance, or there may be agreement that the price
will be determined at the time of delivery.
See CFTC Glossary, A Guide to the Language of the Futures
Industry, at http://www.cftc.gov/ConsumerProtection/EducationCenter/CFTCGlossary/glossary_f.html.
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To reflect these changes, the Commission also is changing the
proposed revision to the title of regulation 1.35 from ``Records of
Commodity Interest and Cash Commodity Transactions'' to ``Records of
Commodity Interest and Related Cash or Forward Transactions.''
In response to comments that the requirement to keep transaction
records in separate files identifiable by transaction and counterparty
is overbroad, overly burdensome, costly, and/or impossible to achieve,
the Commission is modifying the Proposal to remove the requirement that
each transaction be maintained as a separate electronic file. Instead,
the final rule will require that such records be kept in a form and
manner identifiable and searchable by transaction. This should be less
burdensome than the Proposal because it will allow those required to
comply to maintain searchable databases of the required records without
the added cost and time needed to compile the required records into
individual electronic files. It also is consistent with the final
recordkeeping rule for SDs and MSPs under regulation 23.202.\42\ As the
Commission noted in the final release for that rulemaking, regulation
23.202 does not require the raw data to be tagged with transaction and
counterparty identifiers so long as the recordkeeper can readily access
and identify records pertaining to a transaction or counterparty by
running a search of the raw data.\43\ Covered entities will be able to
comply with this obligation by using any of a number of different
solutions available, including commercially available products capable
of conducting speech analytics on recordings from both landlines and
mobile calls.
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\42\ See SD and MSP Recordkeeping Final Rule, 77 FR at 20130.
\43\ Id.
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FIA requested guidance on whether an FCM, IB, or other DCM or SEF
member can satisfy the recordkeeping requirements under regulation
1.35(a) by relying on record retention performed by a DCM or SEF,\44\
and other commenters similarly requested guidance on whether a covered
participant can rely on another Commission registrant's records to
satisfy its recordkeeping obligations. While complying with the final
rule is the responsibility of the covered participant and the covered
participant will be liable for failure to comply, depending on the type
of record and arrangements made for access, covered persons may
reasonably rely on a DCM, SEF or other Commission registrant to
maintain certain records on their behalf. For example, a member of a
DCM or SEF can rely on electronic order routing or order execution
systems of FCMs, DCMs, or SEFs to record the audit trail information it
enters into the system in accordance with Commission requirements, if
the covered person arranges to get access to such records in order to
satisfy requirements under the regulation. Reliance on another person,
however, will not relieve a covered person of responsibility for
compliance with the regulation. Reliance on a third party is only
appropriate where the records maintained by the third party duplicate
the information required to be kept by the regulation. For example, if
an FCM records its telephone calls with a covered IB, the IB need not
separately record the same calls if the IB and FCM agree that the FCM
will maintain the record and provide access to the IB. By contrast, if
a covered IB receives a customer order by telephone and then calls it
into the FCM, the covered IB must record its telephone call with the
customer, while the FCM records the call between the IB and FCM. For
other types of records, like instant messages and emails, it is
unlikely that covered persons will be able to rely on recordkeeping by
a third party because the third party recipient will not have a
complete record of the distribution of the message by the sender.
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\44\ FIA stated:
We interpret the Commission's statement to mean that, to the
extent a DCM or SEF records the relevant conversations of orders
transmitted for execution by telephone, a Commission registrant that
transmits such orders may rely on the DCM or SEF and is not required
to record such conversations and maintain such records separately.
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The Commission has considered commenter requests to adopt best
efforts approach to compliance, and require only the recording of
conversations on firm-provided mobile telephones, not personal devices.
The Commission declines these requests and reiterates that any
conversation the content of
[[Page 75532]]
which is described under the regulation must be recorded, regardless of
whether it occurs on a firm-provided or personal phone.\45\ It would be
contrary to the objectives of ensuring market integrity and customer
protection to allow circumvention of the rule simply by communicating
on a personal device lacking recording capability. To be clear, covered
persons must ensure that covered communications do not occur on
personal phones that lack recording capability. And while the
Commission is not adopting any explicit safe harbors, as a matter of
course, the Commission considers good faith compliance with policies
and procedures reasonably designed to comply with the oral
communications recording rule as a mitigating factor when exercising
its discretion in enforcement actions for violation of the rule.
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\45\ Significant technological advancements in recent years,
particularly with respect to the cost of capturing and retaining
copies of electronic material, including telephone communications,
have made the prospect of establishing recordkeeping requirements
for digital and electronic communications more economically feasible
and systemically prudent. Evidence of these trends was examined in
March 2008 by the FSA, which studied the issue of mandating the
recording and retention of voice conversations and electronic
communications. The FSA issued a Policy Statement detailing its
findings and ultimately implemented rules relating to the recording
and retention of such communications, including a recent
determination that all financial service firms will be required to
record any relevant communication by employees on their work cell
phones. Similar rules that mandate recording of certain voice and/or
telephone conversations have been promulgated by the Hong Kong
Securities and Futures Commission and by the Autorit[eacute] des
March[eacute]s Financiers in France and have been recommended by the
International Organization of Securities Commissions (IOSCO). FSA,
``Policy Statement: Telephone Recording: recording of voice
conversations and electronic communications'' (March 2008).
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Regarding comments about the existing NFA requirement that NFA
member firms with more than a certain percentage of disciplined
associated persons must record all conversations that they have with
existing and potential customers for two years, the Commission believes
that the NFA rule has been effective at protecting the markets and the
public. However, as discussed throughout, the Commission does not view
its final recording requirement solely as a customer protection rule.
The amendments adopted by this release are also a means to protect the
integrity of the markets by aiding the Commission in detecting and
deterring market abuse, including manipulation and false reporting.\46\
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\46\ Recorded telephone conversations have been used in a number
of the Commission's enforcement cases as evidence of market abuse.
See, e.g., DiPlacido v. CFTC, 364 Fed.Appx. 657 (2d Cir. 2009); In
re Barclays PLC, CFTC Docket No. 12-25 (June 27, 2012); CFTC v.
Optiver US LLC, 2012 WL 1632613 (S.D.N.Y. Apr. 19, 2012).
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The Commission disagrees with commenters who stated that compliance
with the new recording requirement would be illegal in certain
jurisdictions.\47\ Federal law does not prohibit a person from
recording a telephone call where the person recording the call is a
party to the call or one of the parties to the call has given prior
consent to being recorded.\48\ While state laws differ regarding the
ability to record customer telephone conversations, the difference
exists in the type of consent required to be given before recording can
occur. For example, some states require the consent of one party to the
call and others require the consent of all parties to the call.\49\
Consent can be explicit or implied. A customer will have provided
consent if, after being notified that the call is being recorded, he or
she continues with the call.\50\ Therefore, a covered participant will
in all circumstances be able to comply with this final recording rule
without violating any other state or federal laws by informing the
other parties to the call that the call is being recorded.\51\
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\47\ Commenters included Henderson & Lyman; Amcot; and ICE.
\48\ See 18 U.S.C. 2511(2)(d) (Interception and disclosure of
wire, oral, or electronic communications prohibited) (``It shall not
be unlawful under this chapter for a person not acting under color
of law to intercept a wire, oral, or electronic communication where
such person is a party to the communication or where one of the
parties to the communication has given prior consent to such
interception unless such communication is intercepted for the
purpose of committing any criminal or tortious act in violation of
the Constitution or laws of the United States or of any State.'')
\49\ For example, under New York state law, only one of the
parties to the conversation must consent. See NY CLS Penal Sec.
250.00. Under California and Illinois state laws, all parties to the
conversation must consent to the recording. See Cal. Pen. Code Sec.
632; 720 ILCS 5/14-1.
\50\ See, e.g., Griggs-Ryan v. Smith, 904 F.2d 112,118 (1st Cir.
1990) (call recipient, previously warned that all incoming calls
were being recorded, impliedly consented to interception); Kearney
v. Salomon Smith Barney, Inc., 45 Cal.Rptr.3d 730, 749 (Cal. 2006)
(business that adequately advises all parties to a telephone call,
at the outset of the conversation, of its intent to record the call
would not violate the statute prohibiting the recording of telephone
conversations without the consent of all parties).
\51\ Moreover, if a state law were to conflict with the
recording requirement in regulation 1.35(a), such a law would be
preempted by regulation 1.35(a).
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Commenters also focused on the relationship between the proposed
changes to regulation 1.35(a) and the existing record retention
obligations of regulation 1.31 (Books and records; keeping and
inspection). Under regulation 1.31, all books and records required to
be kept under the Act or by the Commission's regulations must be kept
for five years from the date thereof and be readily accessible during
the first two years of the five-year period. Given the proposed
amendment to regulation 1.35(a) to include a requirement to record all
oral communications leading to the execution of a commodity interest or
cash commodity transaction and that all such recordings be retained
pursuant to regulation 1.31, records of oral communications kept
pursuant to proposed regulation 1.35(a) would have had to be kept for
five years.\52\ Concerning the relationship between regulations 1.31
and 1.35(a), the Commission has determined to adopt a retention period
of one year for all records of oral communications that lead to the
execution of a transaction in a commodity interest. This modification
responds to comments stating that the proposed retention period of five
years for records of oral communications was too long. This also is
consistent with the final provision for SD and MSP oral communications
under new regulation 23.203(b)(2).\53\ In addition, the Commission
believes that the one-year retention period for records of oral
communications will enable it to adequately execute its enforcement
responsibilities under the Act and these regulations, while minimizing
the storage costs imposed on affected entities.
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\52\ See 17 CFR 1.31
\53\ See SD and MSP Recordkeeping Final Rule, 77 FR at 20204
(Apr. 3, 2012) (``Provided, however, that records of oral
communications communicated by telephone, voicemail, mobile device,
or other digital or electronic media pursuant to Sec. 23.202(a)(1)
and (b)(1) shall be kept for a period of one year.'').
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In specific response to Amcot's concern that the five-year
retention period for oral communications would have been too burdensome
to its farming cooperative members, the Commission notes that, due to
the adopted revisions to regulation 1.35(a), discussed above, the
requirement to record oral communications likely will not apply to a
significant portion, if any, of Amcot's members.\54\ With respect to
Encana's request for clarification concerning the applicability of
regulation 1.31 to
[[Page 75533]]
commercial end-users, regulation 1.31 applies to all records required
to be kept by the Act or the Commission's regulations, such as records
required to be kept under regulations 1.35, 18.05 and 23.202.
Therefore, Encana's request is better addressed in particular response
to those other recordkeeping requirements than in a discussion of how
those records should be kept. In response to CME's comment that
although the Commission suggests that the retention period for swaps
applies only to SDs and MSPs, as addressed in proposed regulation
23.203(b), the proposed amendment to regulation 1.31 is ambiguous in
that it could be read to apply to all entities, the Commission
clarifies that the final provision in regulation 1.31 regarding the
retention period for records of swap transactions is triggered by the
type of record and not the entity that is required to keep the record.
Therefore, although regulation 23.203(b) only applies to SDs and MSPs
with regard to their swap transactions, the final corresponding
provision in regulation 1.31 applies to anyone who is required by the
Act or by Commission regulations to keep records of swap or related
cash or forward transactions.
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\54\ The obligation to record oral communications under final
regulation 1.35(a)(1) will not apply to (i) oral communications that
lead solely to the execution of a related cash or forward
transaction; (ii) oral communications by an FB that do not lead to
the purchase or sale for any other person of any commodity for
future delivery, security futures product, swap, or commodity option
authorized under section 4c of the Commodity Exchange Act; (iii) an
IB that has generated over the preceding three years $5 million or
less in aggregate gross revenues from its activities as an IB; (iv)
an FT; (v) a CPO; (vi) an SD; (vii) an MSP; or (viii) a DCM or SEF
member that is not registered or required to be registered with the
Commission in any capacity.
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IV. Administrative Compliance
A. Paperwork Reduction Act
Regulation 1.35(a) is being amended to provide that certain
Commission registrants be required to record and keep records of their
oral communications that lead to the execution of a commodity interest
transaction and their written communications that lead to the execution
of a commodity interest or related cash or forward transaction, similar
to the requirement that SDs and MSPs keep records of their oral and
written communications that lead to the execution of swaps and related
cash or forward transactions. Only the oral communications
recordkeeping amendments impose new information recordkeeping
requirements. These new requirements constitute a collection of
information within the meaning of the Paperwork Reduction Act of 1995
(``PRA'').\55\ Under the PRA, an agency may not conduct or sponsor, and
a person is not required to respond to, a collection of information
unless it has been approved by the Office of Management and Budget
(``OMB'') and displays a currently valid control number.\56\ This
rulemaking contains new collections of information, which amend the
existing collection of information set forth in the ``Adaptation of
Regulations to Incorporate Swaps'' final rule,\57\ OMB Control Number
3038-0090, to add a new oral communication recordkeeping requirement
that was not made part of the earlier Final Adaptation Rule. The
Commission has submitted the Proposal containing the oral communication
recordkeeping requirements that have been separately addressed in this
release,\58\ this final rule release, and supporting documentation to
OMB for review in accordance with 44 U.S.C. 3507(d) and 5 CFR 1320.11.
Responses to these information collections will be mandatory.
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\55\ 44 U.S.C. 3501 et seq.
\56\ Id.
\57\ On November 2, 2012, the Commission published in the
Federal Register the Final Adaptation Rule. The Final Adaptation
Rule promulgated the vast majority of the amendments that the
Proposal had introduced. However, in the Final Adaptation Rule, the
Commission stated that it would address in a separate release
certain of the proposed changes to regulation 1.35 (i.e., the oral
communication recordkeeping requirements).
\58\ See 76 FR 33066, June 7, 2011.
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With respect to all of the Commission's collections, the Commission
will protect proprietary information according to the Freedom of
Information Act and 17 CFR part 145, ``Commission Records and
Information.'' In addition, section 8(a)(1) of the Act strictly
prohibits the Commission, unless specifically authorized by the Act,
from making public ``data and information that would separately
disclose the business transactions or market positions of any person
and trade secrets or names of customers.'' The Commission also is
required to protect certain information contained in a government
system of records according to the Privacy Act of 1974, 5 U.S.C. 552a.
1. Information To Be Provided by Reporting Entities/Persons
a. Amendments to Regulation 1.35 (Records of Commodity Interest and
Related Cash or Forward Transactions)
i. Obligation To Develop and Maintain Recordkeeping Policies and
Controls
The final amendments to regulation 1.35(a) that require
recordkeeping related to oral communications will require that each
FCM, non-Small IB, RFED, and DCM or SEF member that is registered or
required to be registered with the Commission in any capacity, except
if registered as an FT, CPO, SD, or MSP, retain all oral communications
provided or received concerning quotes, solicitations, bids, offers,
instructions, trading, and prices, that lead to the execution of a
commodity interest transaction, whether communicated by telephone,
voicemail, facsimile, instant messaging, chat rooms, electronic mail,
mobile device or other digital or electronic media. The final
amendments to regulation 1.35(a) will also apply to FBs who are members
of a DCM or SEF. However, FBs will only be required to record oral
communications that lead to the purchase or sale for any person other
than the FB of any commodity for future delivery, security futures
product, swap, or commodity option authorized under section 4c of the
Act.
In the Proposal, the Commission anticipated that the aforementioned
registrants may incur certain one-time start-up costs in connection
with establishing a system to record oral communications. The
Commission estimated that the cost of procuring systems to record these
oral communications would be $55,000 for an average large entity that
does not already have such systems in place, and estimated procurement
costs of $10,000 for each small firm that does not already have such
systems in place. Following publication of the Proposal, the Commission
researched these costs further. As discussed below in the Cost-Benefit
Considerations, the Commission now estimates that the cost for
establishing a system to record oral communications on mobile phones
using a cloud-based solution would be $90 per phone line and that the
cost for establishing a system to record oral communications on a
landline using a cloud-based solution would be $50 per phone line. The
Commission estimates further that a small entity required to comply
will have 10 phone lines and that a large entity required to comply
will have 1,000 phone lines. Thus, to figure out the initial cost of
establishing a system for recording oral communications, an entity will
have to multiply the number of phone lines by the cost per line ($50
per landline and $90 per mobile phone). The Commission estimates each
entity to have 50% landlines and 50% mobile phone lines. Therefore, the
initial cost for a small firm (10 phone lines) to establish a system
for recording oral communications would be (5 x $50) + (5 x $90) or
$700, and the initial cost for a large firm (1,000 phone lines) would
be (500 x $50) + (500 x $90) or $70,000. For purposes of the PRA, the
Commission has chosen to use an average initial cost of $35,000.
Also in the Proposal, the Commission estimated the burden hours
associated with these start-up costs to be 135 hours for any entity
that does not already have a system in place. According to research
referenced in the previous paragraph, the Commission now estimates that
an entity will not have to spend any time
[[Page 75534]]
setting up a cloud-based solution for recording oral communications on
a mobile phone or landline because the entity will merely have to
contract for services from an outside vendor. However, an entity will
spend an estimated range of 1 to 10 hours arranging the services of an
outside vendor. If the entity chooses to negotiate the vendor's
contract, the burden hours will be towards the higher end of the range.
The Commission also estimated in the Proposal that one employee
from each affected entity would have to devote one hour per trading day
to ensure the operation of the system to record oral communications.
Pursuant to the research referred to above, the Commission estimates
that employees of those entities who will be required to record oral
communications will not have to spend any time each day to ensure the
operation of the system because the Commission expects that outside
vendors would maintain the system.
ii. Comments Received
As indicated earlier in this rule, in the Final Adaptation Rule,
the Commission stated that it would address in a separate release
certain of the proposed changes to regulation 1.35 and related
amendments to regulation 1.31.\59\ In response to the amendments to
regulation 1.35(a) in the Proposal, the Commission received 35 comment
letters from a variety of institutions, including DCMs, agricultural
trade associations, and agricultural cooperatives.\60\ The Commission
has determined to adopt the Proposal's amendments to regulation
1.35(a), with certain modifications, discussed above, in order to
address the comments the Commission received. In addition, as part of
this final rulemaking, the Commission is making certain related
modifications to the record retention periods set forth in regulation
1.31. The final rules provide for a retention period of one year for
all records of oral communications that lead to the execution of a
transaction in a commodity interest. This modification responds to
comments stating that the proposed retention period of five years for
records of oral communications was too long. This also is consistent
with the final provision for SD and MSP oral communications under new
regulation 23.203(b)(2).\61\ Moreover, in light of comments stating,
among other things, that it would be overly burdensome for Small IBs
and DCM members that do not have customers to comply with the oral
communications recordkeeping requirement, the Commission decided to
exclude these market participants from the oral recordkeeping
amendments to regulation 1.35(a).
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\59\ See supra section I.B.
\60\ Comments are available in the comment file on www.cftc.gov.
\61\ See SD and MSP Recordkeeping Final Rule, 77 FR at 20204
(``Provided, however, that records of oral communications
communicated by telephone, voicemail, mobile device, or other
digital or electronic media pursuant to Sec. 23.202(a)(1) and
(b)(1) shall be kept for a period of one year.'').
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B. Regulatory Flexibility Act
The Regulatory Flexibility Act (``RFA'') requires that agencies
consider whether the rules they propose will have a significant
economic impact on a substantial number of small entities \62\ and, if
so, provide a regulatory flexibility analysis respecting the
impact.\63\ The Commission is adopting a substantive rule change to
regulation 1.35(a). This substantive change would affect FCMs, certain
IBs,\64\ RFEDs, and any member of a DCM or SEF who is registered or
required to be registered with the Commission in any capacity other
than as an FT, CPO, SD, or MSP by requiring them to keep records of all
oral communications leading to the execution of a commodity interest
transaction.
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\62\ The Small Business Administration (SBA) identifies (by
North American Industry Classification System codes) a small
business size standard of $7 million or less in annual receipts for
Subsector 523--Securities, Commodity Contracts, and Other Financial
Investments and Related Activities. 13 CFR Ch. 1, Sec. 121.201.
\63\ 5 U.S.C. 601 et seq.
\64\ See note 2323, supra, for discussion of definition of Small
IB.
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1. FCMs and RFEDs
The Commission has previously determined that registered FCMs and
RFEDs are not small entities for purposes of the RFA.\65\ Accordingly,
the Chairman, on behalf of the Commission, hereby certifies pursuant to
5 U.S.C. 605(b) that the final rules will not have a significant
economic impact on a substantial number of small entities with respect
to these entities.
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\65\ See Policy Statement and Establishment of Definitions of
``Small Entities'' for Purposes of the Regulatory Flexibility Act,
47 FR 18618, 18619 (Apr. 30, 1982) (DCMs, FCMs, and large traders)
(``RFA Small Entities Definitions''); Opting Out of Segregation, 66
FR 20740, 20743 (Apr. 25, 2001) (ECPs); Regulation of Off-Exchange
Retail Foreign Exchange Transactions and Intermediaries, 75 FR
55410, 55416 (Sept. 19, 2010) (RFEDs) (``Retail Forex Final
Rules''); and Position Limits for Futures and Swaps; Final Rule and
Interim Final Rule, 76 FR 71626, 71680 (Nov. 18, 2011) (SEFs).
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2. IBs
Regulation 1.35(a) may have a significant economic impact on IBs
with annual receipts between $5 million and $7 million. The Commission
provided an initial regulatory flexibility analysis in its proposed
rulemaking for all IBs, regardless of their size, as the proposed
rulemaking did not exclude any IBs from the application of the
requirement to keep records of all oral communications.\66\
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\66\ See the Proposal, 76 FR at 33079. To the extent that small
IBs were affected by the proposed rules, the Commission conducted an
initial regulatory flexibility analysis. These final rules exclude
Small IBs, as defined above. The final rules have therefore
significantly reduced the number of IBs affected by regulation
1.35(a). However, to the extent that certain small IBs, for purposes
of RFA, may be affected by these rules, the Commission is conducting
a final regulatory flexibility analysis.
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As discussed above, this final rule will involve substantive
changes to regulation 1.35(a), by requiring, among others, non-Small
IBs to record all oral communications that lead to the execution of a
commodity interest transaction. As indicated above, the Commission
provided an initial regulatory flexibility analysis for IBs in the
Proposal, as required by 5 U.S.C. 603, because the oral recordkeeping
requirement under regulation 1.35(a), as proposed, may have had a
significant economic impact on a significant number of small IBs.\67\
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\67\ See the Proposal, 76 FR at 33079-80.
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The Commission has never previously determined that IBs, as a
registrant category, are not ``small entities'' for the purposes of the
RFA. Instead, historically, the Commission has evaluated within the
context of a particular regulatory proposal whether all or some
affected IBs would be considered to be small entities and, if they are
considered small entities, the economic impact on them of the
particular regulation. Accordingly, the Commission offers, pursuant to
5 U.S.C. 604, the following final regulatory flexibility analysis.
a. A Statement of the Need for, and Objectives of, the Rule
The primary objective of final regulation 1.35(a) is to increase
market integrity by requiring IBs with greater than $5 million in total
aggregate gross revenues over the preceding three years to keep records
of all oral communications leading to the execution of a commodity
interest transaction. This rule is necessary for several reasons.
First, it will protect the integrity of the market as a whole by aiding
the Commission in detecting and deterring market abuse, including
manipulation and false reporting. Additionally, it will make
enforcement investigations more efficient by preserving critical
evidence that otherwise may be lost to memory lapses
[[Page 75535]]
and inconsistent recollections. This, in turn, is expected to increase
the success of enforcement actions, which will benefit customers,
regulated entities, and the markets as a whole.\68\ Moreover, it also
will protect customers from abusive sales practices, protect
registrants from the risks associated with transactional disputes, and
allow registrants to follow-up more effectively on customer complaints
of abuses by their associated persons. Finally, final regulation
1.35(a) provides regulatory parity of futures and swaps markets because
the requirements of final regulation 1.35(a) are consistent with
recently finalized regulations requiring SDs and MSPs to keep records
of all oral communications leading to the execution of a swap
transaction or a related cash or forward transaction.\69\
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\68\ In promulgating its own telephone recording rule, the
Financial Services Authority issued guidance stating the following
benefits: ``(i) Recorded communication may increase the probability
of successful enforcement; (ii) this reduces the expected value to
be gained from committing market abuse; and (iii) this, in
principle, leads to increased market confidence and greater price
efficiency.'' See Financial Services Authority, ``Policy Statement:
Telephone Recording: Recording of voice conversations and electronic
communications'' (Mar. 2008).
\69\ See SD and MSP Recordkeeping Final Rule, 77 FR at 20203-04
(to be codified at 17 CFR 23.202(a)(1) and (b)(1)).
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b. A Statement of the Significant Issues Raised by the Public Comments
in Response to the Initial Regulatory Flexibility Analysis, a Statement
of the Assessment of the Agency of Such Issues, and a Statement of Any
Changes Made in the Proposed Rule as a Result of Such Comments
i. Significant Issues Raised by the Public Comments in Response to the
Initial Regulatory Flexibility Analysis
Comments on the proposed amendments to regulation 1.35(a) primarily
focused on the implications of the proposed oral recordkeeping and
tagging requirements and, in particular, on the portion of the Proposal
requiring all DCM and SEF members, including commercial end-users and
non-intermediaries, to keep records of their cash commodity
transactions. One theme of the comments was that the proposed oral
communications recordkeeping and tagging requirements were overly
burdensome.\70\ Commenters were also concerned that the proposed
separate electronic file requirement was open-ended, seemingly
impossible to achieve,\71\ and overly burdensome. Commenters also
explained that it could be difficult to link conversations occurring
over several days,\72\ and could require the recording of all
conversations \73\ because a call might begin unrelated to a covered
transaction but eventually lead to a covered transaction. Commenters
sought a reasonableness standard regarding oral recordkeeping and a
limitation to exclude oral communications on mobile telephones and
argued that the new oral communications recordkeeping requirement would
be illegal in certain jurisdictions. Commenters also requested that the
proposal to record and store oral communications should be reviewed in
the context of available technology.
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\70\ See, e.g., comments from Amcot (overbreadthover breadth
would be burdensome for agricultural DCM members) and NIBA (at the
very least, small IBs should be exempt from the proposed amendments
to 1.35(a) because the burden on such small entities would be too
great).
\71\ See comment from FIA.
\72\ See comment from CME.
\73\ See id.
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ii. Agency Assessment of Significant Issues Raised by the Public
Comments in Response to the Initial Regulatory Flexibility Analysis
The Commission carefully considered the comments, determined that a
number of concerns and requested alternatives had merit and, as a
result, made a number of adjustments in response. In response to
commenters' concerns that the proposed amendments were overly
burdensome to non-intermediaries' cash agricultural and energy
transactions, the Commission has limited not only the oral
recordkeeping requirements of regulation 1.35(a) to commodity interest
transactions, but also the existing written recordkeeping requirements
therein to commodity interest and related cash and forward
transactions.
Some commenters expressed concerns that the proposed revisions to
regulation 1.35(a) would be unduly burdensome for small entities and
DCM and SEF members who are commercial end-users and non-
intermediaries. In response, the Commission has excluded Small IBs
(those IBs with less than $5 million in total aggregate gross revenues
over the preceding three years) from the application of the rules and
certain DCM and SEF members from the scope of the new requirement to
record oral communications, namely FTs, CPOs, SDs, and MSPs that would
have been obligated to comply by virtue of their status as a DCM or SEF
member.
Commenters also expressed the view that the requirement to keep
transaction records in separate files identifiable by transaction and
counterparty is overbroad, overly burdensome, costly, and/or impossible
to achieve. In response, the Commission has removed the requirement
that each transaction be maintained as a separate electronic file. In
response to a request that covered persons be able to rely on another
Commission registrant's records to satisfy their recordkeeping
obligations, the Commission provided for such reliance in the final
rules, to be applicable only when the records being kept are identical.
The Commission declined to amend the Proposal in response to
certain comments. Although commenters sought a reasonableness standard
regarding oral recordkeeping and a limitation to exclude oral
communications on mobile telephones, the Commission determined to
retain the provisions of the Proposal that any covered communication
must be recorded, whether it occurs on a firm-provided or personal
device.\74\
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\74\ As discussed in more detail above, significant
technological advancements in recent years, particularly with
respect to the cost of capturing and retaining copies of electronic
material, including telephone communications, have made the prospect
of establishing recordkeeping requirements for digital and
electronic communications more economically feasible and
systemically prudent.
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The Commission also has determined not to amend the Proposal in
response to commenters stating that compliance with the new oral
communications recordkeeping requirement would be illegal in certain
jurisdictions. It is not a violation of federal law to record a
telephone call where the person recording the call is a party to the
call or one of the parties to the call has given prior consent to being
recorded.\75\ While state laws differ regarding the ability to record
customer telephone conversations, the difference is in the type of
consent to recording required. Therefore, the most a covered
participant will have to do to comply with the final oral
communications recording rule without violating any other state or
federal laws is to obtain the prior consent of the other parties to the
call to record the conversation. The Commission also notes that DCM
rules currently require all floor personnel who wear headsets to record
their conversations, so there is only an incremental burden to the
entities already subject to those rules, such as FBs.
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\75\ See 18 U.S.C. 2511(2)(d).
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iii. Changes Made in the Proposed Rule as a Result of Such Comments
In response to comments, the Commission incorporated the
following modifications to the Proposal into final regulation 1.35(a):
Reduced the scope of the obligation to record oral
[[Page 75536]]
communications as proposed by limiting it to commodity interest
transactions; reduced the retention period for records of oral
communications leading to a commodity interest transaction from five
years to one; reduced the scope of persons required to record oral
communications from FCMs, RFEDs, IBs and all members of a DCM or SEF to
FCMs, RFEDs, IBs with total aggregate gross revenues of at least $5
million over the preceding three years, and any member of a DCM or SEF
registered or required to be registered with the Commission in any
capacity, other than FTs, CPOs, SDs, and MSPs (although SDs and MSPs
are required to comply with regulations 23.202(a)(1) and (b)(1) which
require recordkeeping of certain oral communications, among other
requirements); eliminated the tagging requirement; and allowed for
covered persons to rely on the records of another Commission
registrant, where appropriate (since reliance will not be appropriate
in all circumstances as discussed in section III above) in complying
with their recording obligations, while confirming that the covered
person will be liable for any violation of the regulation.
iv. Response to ETA Comment Letter
Among other things, the Proposal stated that, except for the
proposed revision to regulation 1.35(a) requiring IBs to maintain
records of voice communications, the Proposal would not have a
significant economic effect on a substantial number of small entities.
The Proposal included a Regulatory Flexibility Analysis with respect to
the proposed requirement that IBs maintain such records. That analysis
concluded with the determination to treat equally all Commission
registrants transacting on behalf of customers with respect to keeping
records of oral communications.
The ETA commented that the Proposal failed to reflect that the vast
majority of the ETA's constituents, electrical utilities that the ETA
believes would be affected by the Proposal, are ``small entities'' and,
therefore, that an analysis under the RFA was required. The ETA's
comment letter did not specify which proposed provisions in the instant
rulemaking would affect its members or into which affected entity
category or categories its members could fall. Notably, the RFA does
not obligate the Commission to analyze the indirect effects on persons
not subject to the rule itself. As the Commission understands, those
electrical utilities that may be small entities will not be FCMs,
RFEDs, IBs with annual receipts of over $5 million, or members of a DCM
or SEF transacting business with customers. Rather, they most likely
will be end-users of the transactions conducted, the recorded rather
than the recorders. As such, there will be no direct, significant
economic impact on these electric utilities. Rather, the impact will be
imposed on the entities through which they may effect transactions.
c. A Description of and an Estimate of the Number of Small Entities to
Which the Rule Will Apply or an Explanation of Why No Such Estimate Is
Available
An IB generally \76\ is defined in CEA section 1a(31)(A) as
follows:
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\76\ CEA section 1a(31)(B), 7 U.S.C. 1a(31)(B), grants the
Commission the authority to further define the term IB.
Any person (except an individual who elects to be and is
registered as an associated person of a futures commission
merchant)--
(i) Who--
(I) Is engaged in soliciting or in accepting orders for--
(aa) The purchase or sale of any commodity for future delivery,
security futures product, or swap;
(bb) Any agreement, contract, or transaction described in
section 2(c)(2)(C)(i) or section 2(c)(2)(D)(i);
(cc) Any commodity option authorized under section 4c; or
(dd) Any leverage transaction authorized under section 19; and
(II) Does not accept any money, securities, or property (or
extend credit in lieu thereof) to margin, guarantee, or secure any
trades or contracts that result or may result therefrom; or
(ii) Who is registered with the Commission as an introducing
broker.\77\
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\77\ 7 U.S.C. 1a(31)(A).
As the Commission stated in the initial Regulatory Flexibility
Analysis, there are an estimated 1,500 IBs registered with the
Commission at any given time. As of June 30, 2012, there were 1,431
registered IBs.\78\ The Commission stated in the Proposal's Regulatory
Flexibility Analysis that a large percentage of registered IBs are
``guaranteed'' IBs,\79\ many of which may be small entities.\80\
However, the Commission estimates that limiting, with respect to IBs,
the scope of final regulation 1.35(a) to non-Small IBs excludes more
than 95% of registered IBs from regulation 1.35's oral communications
recordkeeping requirement. Thus, the Commission expects that no more
than approximately 75 registered IBs will be subject to the final oral
recordkeeping requirements of regulation 1.35(a) at any one time.
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\78\ Source: NFA.
\79\ A guaranteed IB (``GIB'') is an IB that ``does not have to
maintain a partic[ul]ar level of net capital but, instead, is
guaranteed by a particular FCM/RFED and is generally required to
introduce all its business to that FCM/RFED.'' Independent IBs
``must maintain adjusted net capital of at least $45,000 but may
introduce business to any registered FCM/RFED.'' NFA, What is the
difference between an independent IB and a guaranteed IB?, available
at http://www.nfa.futures.org/nfa-faqs/registration_faqs/requirements-for-FCM-IB-applicants/what-is-difference-between-IIB-and-GIB.html last visited Sept. 28, 2012.
\80\ According to the NFA, as of June 30, 2012, there were 832
registered GIBs.
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d. A Description of the Projected Reporting, Recordkeeping, and Other
Compliance Requirements of the Rule, Including an Estimate of the
Classes of Small Entities Which Will Be Subject to the Requirement and
the Type of Professional Skills Necessary for Preparation of the Report
or Record
Regulation 1.35(a), as amended, will require, among others, non-
Small IBs to record all oral communications that lead to the execution
of a commodity interest transaction.\81\ The regulation is primarily a
recordkeeping requirement, which will obligate covered IBs that do not
already do so to record their oral communications \82\ or the oral
communications of their traders and sales forces. The final rules
provide for a retention period of one year for all records of oral
communications that lead to the execution of a transaction in a
commodity interest. This modification responds to comments stating that
the proposed retention period of five years for records of oral
communications was too long. This also is consistent with the final
provision for SD and MSP oral communications under new regulation
23.203(b)(2).
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\81\ The Proposal had required recording of oral communications
that lead to the execution of a commodity interest and cash
commodity transaction. See the Proposal, 77 FR at 33091.
\82\ Covered market participants will be allowed to arrange with
third parties, including DCMs, SEFs, and FCMs, to have access to the
DCMs', SEFs', or other Commission registrants' records and, to the
extent the records are duplicative of what would be required ofby
the covered entity under the rule, may rely on such records to
satisfy their own recordkeeping obligations. The Commission
notesNote, however, that this does not relieve the covered
participant from liability for compliance failures.
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[[Page 75537]]
e. A Description of the Steps the Agency Has Taken To Minimize the
Significant Economic Impact on Small Entities Consistent With the
Stated Objectives of Applicable Statutes, Including a Statement of the
Factual, Policy, and Legal Reasons for Selecting the Alternative
Adopted in the Final Rule and Why Each One of the Other Significant
Alternatives to the Rule Considered by the Agency Which Affect the
Impact on Small Entities Was Rejected
In connection with adopting the final rules, the Commission
considered, as alternatives, establishing different compliance or
reporting requirements that take into account the resources available
to smaller entities, exempting smaller entities from coverage of the
disclosure requirements, and clarifying, consolidating, or simplifying
disclosure for small entities. In response to comments that the
proposed oral communications recordkeeping requirement would be overly
burdensome for small IBs, the Commission dramatically scaled back the
scope of regulation 1.35(a) as it applies to oral recordkeeping by IBs,
reducing by well more than half the number of IBs expected to be
subject to the requirement. The Commission further reduced the impact
on IBs by limiting the oral communications recordkeeping requirement to
commodity interest transactions from the proposed commodity interest
and cash commodity transactions.
Although commenters sought a reasonableness standard regarding oral
recordkeeping and a limitation to exclude oral communications on mobile
telephones, the Commission has retained the provisions of the Proposal
that any covered communication must be recorded, whether it occurs on a
firm-provided or personal device.\83\ The Commission is, however,
ameliorating the impact thereof by stating that it will consider good
faith compliance with policies and procedures reasonably designed to
comply with the oral communications recording requirement as a
mitigating factor when exercising its discretion for violations of the
requirement.
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\83\ As discussed in more detail above, significant
technological advancements in recent years, particularly with
respect to the cost of capturing and retaining copies of electronic
material, including telephone communications, have made the prospect
of establishing recordkeeping requirements for digital and
electronic communications more economically feasible and
systemically prudent.
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C. Consideration of Costs and Benefits
Section 15(a) of the CEA requires the Commission to consider the
costs and benefits of its actions before promulgating a regulation
under the CEA or issuing certain orders. Section 15(a) further
specifies that the costs and benefits shall be evaluated in light of
the following five broad areas of market and public concern: (1)
Protection of market participants and the public; (2) efficiency,
competitiveness and financial integrity of futures markets; (3) price
discovery; (4) sound risk management practices; and (5) other public
interest considerations. The Commission considers the costs and
benefits resulting from its discretionary determinations with respect
to the section 15(a) factors.
1. Background
The markets subject to the jurisdiction of the Commission have
undergone a significant transformation over the last few decades, and
particularly in the last few years. Technological advances have
contributed to a tremendous growth in trading volume in swaps as well
as other derivatives, including futures, as well as the number and type
of market participants. Among other notable changes, today's derivative
markets include significant numbers of retail customers that invest in
the commodity markets through a variety of means. Markets are also more
interconnected than ever before, with order flow distributed across
multiple trading centers. With this interconnectivity comes not only
positive efficiencies, but also the potential for cross-market
manipulation that can be difficult to detect and prove without ready
access to information evincing the intent of those engaged in market
activity. In addition, the Commission notes that requiring the
recording and retention of oral communications will serve as a
disincentive for covered entities to make fraudulent or misleading
communications to their customers over the telephone and could serve as
a meaningful deterrent against violations such as trading ahead of
customer orders by providing a record of the time that a customer's
telephone order is received.
In July 2010, Congress passed the Dodd-Frank Act which, among other
things, establishes a comprehensive regime for the regulation of swaps.
The Dodd-Frank Act brings swaps under the Commission's jurisdiction and
obligates the Commission to adopt new regulations related to
registration and regulation of SDs and MSPs, trade execution and
clearing requirements, and swap data recordkeeping and real time
reporting. In section 731 of the Dodd-Frank Act, Congress added CEA
section 4s to require the registration and regulation of SDs and MSPs
by the Commission, including the establishment of requirements for SDs
and MSPs to keep records of swap transactions.\84\
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\84\ 76 FR 33066.
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In response to Congress' act of requiring that SDs and MSPs keep
daily trading records of their swaps, including records of
communications made by telephone,\85\ and to be consistent with the
oral communications recordkeeping requirement for SDs and MSPs in
connection with their swap and related cash and forward
transactions,\86\ the Commission is exercising its discretion to amend
its regulations to require FCMs, RFEDs, non-Small IBs (i.e., IBs that
have generated more than $5 million in aggregate gross revenues over
the preceding three years) \87\ and members of a DCM or SEF who are
registered or required to register with the Commission in any capacity
other than FTs, CPOs, SDs, and MSPs to record all oral communications
that lead to the execution of a transaction in a commodity interest.
FBs that are members of a DCM or SEF are required to record all oral
communications that lead to the purchase or sale for any person other
than the FB of any commodity for future delivery, security futures
product, swap, or commodity option authorized under section 4c of the
Act. In this way, the Commission is affording the other markets subject
to its jurisdiction the same market integrity and customer protections
that Congress afforded the swaps markets in the Dodd-Frank Act. The
Commission recognizes that these benefits are not without cost, and has
carefully considered both benefits and costs in light of the
considerations provided in CEA section 15(a) and, where appropriate,
adopted alternatives to the Proposal that would achieve similar
benefits as proposed, but at a lower cost.
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\85\ See 7 U.S.C. 6s(g)(1).
\86\ See SD and MSP Recordkeeping Final Rule, 77 FR at 20203-04
(Regulation 23.202(a)(1) and (b)(1)).
\87\ See note 2323, supra, for discussion of definition of Small
IB.
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2. Summary of the Final Rule
Prior to this amendment, regulation 1.35(a) specified which parties
are required to keep written records related to commodity futures,
commodity options, and cash commodities, and what information they are
required to record. The requirements of regulation 1.35(a) applied to
FCMs, RFEDs, IBs, and DCM members.
[[Page 75538]]
As discussed above, the Commission is adopting a provision
requiring certain entities to record all oral communications leading to
the execution of a transaction in a commodity interest. Unlike existing
regulation 1.35(a), this new provision will apply to FCMs, RFEDs, non-
Small IBs, and DCM and SEF members that are registered or required to
be registered with the Commission in any capacity other than as an FT,
CPO, SD or MSP.
As described above, the Commission considered adopting an exclusion
for certain FBs similar to the exclusion for Small IBs, but determined
to not adopt such an exclusion, in part, because FBs are parties to
oral communications relating to the means or methods by which a trade
will be executed. However, the Commission did determine to limit the
application of the rule to FBs so that an FB will only be required to
record their oral communications that lead to the purchase or sale for
any person other than the FB of any commodity for future delivery,
security futures product, swap, or commodity option authorized under
section 4c of the CEA. This provision of the final rule addressed
commenter concerns that the Proposal inappropriately captured the oral
communications of certain members of DCMs who currently are registered
as FBs, but are solely trading for their own accounts, i.e., acting as
FTs. In addition, in response to comments regarding implementation
challenges associated with oral recordkeeping requirements for SDs and
MSPs, the Commission is extending the implementation deadline to
provide these entities with approximately one year to comply following
the publication of the final rule.\88\ This change provides entities
subject to regulation 1.35(a) with the same amount of implementation
time as was made available to SDs and MSPs.\89\ The Commission believes
that an extended period for implementation is warranted in order to
ensure that entities subject to this rule have adequate time to address
the implementation challenges noted by SIFMA, as discussed below.
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\88\ See letter from SIFMA dated August 10, 2012, Re: Request
for No-Action Relief: Recordkeeping Requirements under the Internal
Business Conduct Rules. Available at: [XXXX].
\89\ See Letter from the Division of Swap Dealer and
Intermediary Oversight of the CFTC to SIFMA, dated Oct. 29, 2012,
CFTC Letter No. 12-29. Available at: http://www.cftc.gov/idc/groups/public/@lrlettergeneral/documents/letter/12-29.pdf.
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3. Benefits
By this action, the Commission improves its ability to ensure the
integrity of all the markets subject to its jurisdiction and that
customers are similarly protected, whether they be engaged in a swap
with an SD, or a futures transaction with an FCM.
As stated above, the markets subject to the jurisdiction of the
Commission have undergone a significant transformation over the last
few decades, and particularly in the last few years. Technological
advances have contributed to a tremendous growth in trading volume as
well as the number and type of market participants, including
significant numbers of retail customers that invest in the commodity
markets through a variety of means. Markets are also more
interconnected than ever before, with order flow distributed across
multiple trading centers. This interconnectivity yields important
benefits but also presents increased risk, including the potential for
cross-market manipulation where an action in one market is purposefully
orchestrated to yield a desired outcome in another market. Therefore,
to ensure that the integrity of the markets and customers are similarly
protected across all markets subject to the Commission's jurisdiction,
the Commission must have similar access to information regardless of
whether the market participant is registered, for example, as an SD or
an FCM.
As the Commission explained when adopting similar
transactional level recordkeeping requirements for SDs and MSPs, the
Commission believes these recordkeeping requirements will protect
market participants and promote the integrity of the markets by
ensuring the existence of an audit trail that includes relevant oral
communications. A strong audit trail, among other things: Provides a
basis for efficiently resolving transactional disputes; acts as a
disincentive to engage in unduly risky, injurious, or illegal conduct
in that the conduct will be traceable; and in the event such conduct
does occur, provides a mechanism for policing such conduct, both
internally as part of a firm's compliance efforts and externally by
regulators enforcing applicable laws and regulations.
With respect to the latter-noted benefit--enforcing applicable laws and
regulations--oral records have proven to be no less, and in some cases
perhaps more, valuable than written records alone.\90\
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\90\ See note 4646, supra.
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By requiring records of all communications leading to a transaction
in a commodity interest, the public benefits and the financial
integrity of the markets is protected because additional documentation
enhances the Commission's ability to detect and enforce rule
violations, including manipulation and fraud. In particular, records of
oral communications related to such transactions provide a record of
the facts and circumstances that give rise to a violation that can be
used in enforcement proceedings to redress the same. Effective
enforcement of the Commission's regulations, particularly those
prohibiting fraud and manipulation, protects market participants and
the public and promotes the integrity of the markets subject to the
Commission's jurisdiction.
Notwithstanding the important, practical benefits of the final
rules, the Commission has considered commenters' concerns regarding
costs and product availability.
4. Costs
The public comments related to changes to regulation 1.35(a) can be
broken down into roughly four general categories: Concerns about the
costs of compliance to firms,\91\ concerns about the feasibility of
complying with the requirements of the regulation,\92\ concerns about
market participants choosing to exit the market or of a market
bifurcation,\93\ and privacy concerns.\94\
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\91\ See, e.g., FIA; NFA; ICE, Inc.; Hunton and Williams, LLP;
National Grain and Feed Association, Land O' Lakes; Minneapolis
Grain Exchange, Inc.; CME Group; Commodity Markets Council;
Barclay's Capital; Amcot; Grain and Feed Association of Illinois;
Agribusiness Council of Indiana; Minnesota Grain and Feed
Association; Agribusiness Association of Iowa; American Petroleum
Institute; Ohio AgriBusiness Association; American Feed Industry
Association; South Dakota Grain and Feed Association; Natural Gas
Supply Association; Commodity Markets Council; Natural Gas Supply
Association; the Fertilizer Institute; Kansas City Board of Trade;
Oklahoma Grain and Feed Association; Electric Power Supply
Association; Henderson & Lyman; Rocky Mountain Agribusiness
Association; American Cotton Shippers Association.
\92\ See, e.g., Land O'Lakes; Minneapolis Grain Exchange, Inc.;
CME Group; Commodity Markets Council.
\93\ See, e.g., National Grain and Feed Association; Grain and
Feed Association of Illinois; Agribusiness Council of Indiana;
Minnesota Grain and Feed Association; Agribusiness Association of
Iowa; Ohio AgriBusiness Association; American Feed Industry
Association; Kansas City Board of Trade.
\94\ See, e.g., Virginia Nobbe; American Feed Industry
Association; Henderson and Lyman.
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Commenters cited a broad range of compliance costs associated with
setting up and maintaining systems to record and tag oral
communications. One commenter that is a recording technology provider
stated that it would cost in the range of $50/month to record a
landline phone or $90/month to record a mobile phone with minimal
[[Page 75539]]
fixed setup costs. They also stated that market participants may be
able to negotiate more favorable rates if they are able to sign longer
contracts, or if they have a large number of phones and/or landlines
that need to be recorded. While other commenters did not provide per
line estimates, they did provide aggregate cost estimates that are
significantly higher than those cited above.\95\
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\95\ For example, FIA cited expenditures on the part of several
of its members of between $300,000-$600,000 to upgrade and maintain
their landline phones in order to record conversations and estimated
expenditures of anywhere from $160,000 to $2.5 million to record
conversations on mobile phones depending on firm size. Further, FIA
cited a fee of $500,000 to purchase licenses for ``word spotting''
software to search and retrieve these oral records. The Commercial
Energy Working Group stated that this compliance with the amended
regulation 1.35 could cause costs to firms to ``increase
exponentially'' (they cited an ``unidentified investment bank'' in
the UK that spent $4.2 million each year to monitor its Blackberry
phones in response to a similar Financial Services Authority
mandate).
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The Commission has considered that the requirement to record and
maintain records of oral communications that lead to the execution of
commodity interest transactions will create additional costs for market
participants subject to the requirements. Those costs include set-up
costs to implement voice recording technology on both landlines and
mobile phones, recurring costs (such as a monthly fee per user or per
phone line to record), and the costs incurred by data storage.
Commenters estimate that for participants using a so-called ``cloud-
based solution,'' the monthly fees would be approximately $90/month/
phone for mobile phones, and approximately $50/month/line for
landlines. The setup costs, in each case, are estimated to be roughly
one month's subscription fees or less.\96\ Commenters estimate that
data storage costs are likely to be approximately $13/month/line.\97\
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\96\ Compliant Phones.
\97\ Id.
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According to commenters, internal recording solutions (i.e., ``non-
cloud-based solutions'') typically entail more significant
implementation costs, though those costs are likely to vary widely
based on existing technology, and particularly on any existing
recording capabilities, that an entity already has. The Commission does
not have adequate data to estimate the number of entities that already
have recording capabilities, or the extent to which such capabilities
are deployed in parts of the organization that would be impacted by the
oral recordkeeping requirements in regulation 1.35.
SIFMA, in response to the final oral recordkeeping requirements for
SDs and MSPs, noted implementation challenges related to recording
calls made on both landlines and cell phones, recording calls outside
the U.S., and the ability to search and retrieve records of calls, and
requested additional time to address those challenges.\98\
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\98\ See SD and MSP Recordkeeping Final Rule, 77 FR 20128. Based
on SIFMA's representations, the Commission determined that relief
from certain oral recordkeeping requirements for SDs and MSPs is
warranted to address the issues presented, and granted no-action
relief to SDs and MSPs until March 31, 2013.
Among other things, SIFMA stated that implementing systems to
record landline conversations will require upgrades to data
retention infrastructure, testing that must occur on nights and
weekends, and overcoming difficulties obtaining products and
services. Further, they stated that mobile phone recording
technology has ``not achieved the levels of stability, performance
and scalability that would be considered for commercial grade
products.'' They stated that shipping delays, testing and
troubleshooting challenges due to different time zones, legal
requirements, and ``an apparent lack of recording capabilities'' in
certain countries and uncertainty about what transactions may be
subject to the requirements would delay efforts to implement
solutions in foreign offices. And last, they asserted that
limitations related to caller identification technology and
associated metadata would prevent SDs and MSPs from rapidly
implementing solutions that would enable them to search and retrieve
calls related to specific counterparties or transactions.
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The Commission, mindful of the fact that the entities subject to
this rule will likely face some of the same implementation challenges,
is providing the same amount of time for entities subject to regulation
1.35(a) to comply as was afforded to SDs and MSPs to comply with
regulations 23.202(a)(1) and (b)(1). In addition, 1.35(a)(4)(i) permits
entities seeking to comply in good faith with the oral communications
recordkeeping requirements of regulation 1.35(a)(1) to submit a request
for relief if compliance is technologically or economically
impracticable for an affected entity prior to the compliance deadline.
The Commission anticipates that the additional time for implementation
will benefit entities subject to this rule by providing more time to
address the challenges noted by SIFMA. Moreover, it will create
opportunities for entities that are subject to this rule to benefit
from solutions developed by vendors serving SDs and MSPs.
The Proposal included an additional requirement that transaction
records be kept in separate electronic files identifiable by
transaction and counterparty.\99\ In response to comments, the
Commission is not adopting that requirement, such that firms are not
required to keep records in separate electronic files. Instead, firms
are only required to identify and retrieve relevant records upon
Commission request. Therefore, the cost associated with ``tagging'' of
oral communication records has been eliminated. Relevant entities,
however, will need to be able to search and select records related to a
particular transaction or counterparty when the Commission requests
them. The Commission expects that this may be done in one of two ways.
Market participants may use an electronic means of scanning records by
key word or they may identify key words and concepts in records
manually by listening to the recordings. In either case, participants
must be able to identify and retrieve records if they are required to
do so by the Commission.
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\99\ With respect to the proposed requirement that entities
proactively identify which communications relate to specific
traders, trades, and counterparties and then ``tag'' them as such,
comments expressed concerns regarding the reliability of
technological solutions. For instance, the FIA writes, ``We
understand that two software providers, NICE Actimize and Nexidia,
offer so-called `word spotting' programs'' but that they believe
that these programs ``are not foolproof and may identify less than
50 percent of potentially relevant conversations.'' The Commercial
Energy Working Group stated that in lieu of an accurate software
solution, manual identification and retrieval of oral records would
require ``as many as 3-5 analysts and 1-2 additional technical
support personnel to support transactions'' for ``a small or modest-
sized end-user commodity business'' and that ``the total cost to a
commodity business is likely to be in excess of $1 million
annually.''
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If, when recordings are requested by the Commission, an entity
chooses to assign or hire personnel to listen to recordings and
identify those being requested, the costs will vary significantly
depending on the number and length of oral communications that must be
reviewed. These variables will, in turn, be influenced by a host of
other factors, including: the number of transactions or counterparties
for which relevant recordings must be identified; the length of time
across which specified traders were active or specified trades were
likely discussed, or the specified counterparties were in contact with
the entity from whom the recordings are requested; the number of oral
communications that specified traders or counterparties made during the
period that may be in question; and the average length of each call.
The Commission estimates that in such cases, an entity might dedicate
personnel to spend as little as 50 hours reviewing recordings, or as
much as 5,000 hours reviewing recordings. The average wage for a
compliance specialist is $155.96 per hour and therefore the cost for
manual review, if an entity chooses that option when the
[[Page 75540]]
Commission requests records, could range from $7,800 to $780,000.\100\
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\100\ The average wage for a compliance specialist is $155.96
[($58,303 per year)/(2,000 hours per year) * 5.35 = $155.96]. For
the purposes of the Cost Benefit Considerations section, the
Commission has used wage estimates that are taken from the SIFMA
``Report on Management and Professional Earnings in the Securities
Industry 2011'' because industry participants are likely to be more
familiar with them. Hourly costs are calculated assuming 2,000 hours
per year and a multiplier of 5.35 to account for overhead and
bonuses. All totals calculated on the basis of cost estimates are
rounded to two significant digits.
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Alternatively, the Commission is aware that vendors that provide
recording services are also capable of providing speech analytic search
capabilities for a set fee. For example, one vendor estimated this cost
at $40 to $80 per user per month.\101\ According to commenters, other
entities may choose to acquire speech analytics services that can be
housed internally rather than on the vendor's servers. Another vendor
stated that the costs would depend on the number of hours sent through
the speech analytics device and that initial deployment costs would
likely range from $160,000 to $1,500,000 for the largest organizations
with ongoing annual fees that are approximately 18% of the initial cost
($29,000--$270,000 per year). Alternatively, small entities can
implement a desktop solution with the same analytics capabilities. The
initial license costs approximately $25,000 per user and 18% ongoing
maintenance fees ($4,500 per year per user).\102\ Another vendor
estimated that setup costs, including relevant licenses, would range
from $450,000 for a small entity to $4,000,000 for a large entity, and
that annual maintenance costs would range from $80,000 to
$800,000.\103\ These numbers assume that entities do not yet have
speech analytics services being used in other parts of the company's
operations that could be expanded to include the oral records required
under this rule. However, the Commission understands that some of the
largest financial entities may already be customers of companies that
provide speech analytics services. As a consequence, the costs for
those entities may be less than if they were implementing speech
analytics services de novo.
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\101\ See Compliant Phones communication.
\102\ See Nexidia communication.
\103\ See NICE communication.
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In response to the Proposal, some commenters expressed concern that
the imposition of more stringent recordkeeping requirements on DCM
members could prompt a bifurcation in the markets for certain services
because of the compliance cost advantage that market participants who
are not DCM members enjoy.\104\ They suggested that entities that are
DCM members might stop offering services that make them subject to the
regulation 1.35 requirements.\105\
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\104\ Several commenters submitted a form letter addressing this
point. Entities submitting this letter, with minor modifications in
some cases, include: National Grain and Feed Association, Grain and
Feed Association of Illinois, Agribusiness Council of Indiana,
Minnesota Grain and Feed Association, Agribusiness Association of
Iowa, Ohio AgriBusiness Association, South Dakota Grain and Feed
Association, Kansas City Board of Trade, and Oklahoma Grain and Feed
Association.
\105\ For instance, the Kansas City Board of Trade writes that
the operators of delivery warehouses are often required to be DCM
members and that the added expense of compliance with regulation
1.35 could cause firms to withdraw from the business of providing
warehousing services, thereby decreasing market competitiveness.
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In the Proposal, the Commission proposed to include FCMs, RFEDs,
IBs, and all DCM and SEF members under the oral recordkeeping
requirement and also proposed that such recordkeeping requirements
would apply to all transactions in commodity interests and cash
commodities. However, in the final rule, the Commission amended
regulation 1.35(a) such that Small IBs and members of DCMs and SEFs who
are not otherwise registered or required to be registered with the
Commission in any capacity, as well as those members registered as FTs,
CPOs, SDs, and MSPs, are not subject to the oral communication
recordkeeping requirements under regulation 1.35(a). The limiting
principle for the determination of which classes of registrants must
comply with the final rule are, as discussed further above,
transactions by entities that could affect both market integrity and
customer protection.
Finally, some commenters expressed concern that if employees of a
regulated entity use personal phones (either landline or mobile) for
business purposes, calls on those lines must be recorded. Commenters
stated privacy concerns with the same. However, simple solutions to
protect employee privacy do exist. For example, depending on the
policies of the firm, it is possible for certain phone numbers to be
excluded from recording.\106\ Alternatively, the company could
institute a policy that employees are not to conduct personal business
on recorded lines.
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\106\ See Compliant Phones communication.
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In addition, amendments in this final rule will require SEF members
to comply with regulation 1.35, and it is likely that some of those
members will not have been subject to regulation 1.35(a) previously. In
addition to the costs related to oral communications recordkeeping,
mentioned above, the Commission estimates that SEF members that are
newly subject to regulation 1.35(a) will spend additional time each day
compiling and maintaining transaction records. The Commission estimates
that the cost of that additional time is $236,000 to $393,000 per
entity per year.\107\
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\107\ This is estimated to take 6-10 hours per day (assuming 252
days per year) of the time of an office services supervisor. The
average wage for an office services supervisor is $155.96 [($58,303
per year)/(2,000 hours per year) * 5.35 = $155.96]. $155.95*6*252 =
235,812.31. $155.95*10*252 = 393,020.52.
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Also, the amendments in this final rule will require FCMs, RFEDs,
IBs, and members of DCMs to comply with the regulation 1.35(a)
recordkeeping requirements for any swap transactions into which they
enter. The Commission estimates that such entities will spend an
additional 0.5 hours per swap capturing and maintaining the records
required under regulation 1.35(a), and therefore estimates that the
per-swap cost will be $83.00.\108\
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\108\ This estimates 0.5 hours of time from an office services
supervisor. The average salary for an office services supervisor is
$165.25/hour [($61,776 per year)/(2,000 hours per year) * 5.35 =
$165.25 per hour]. $165.25*0.5 = $82.63.
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4. Consideration of Alternatives
As compared to the Proposal, the Commission has limited the range
of entities that are subject to the oral recordkeeping requirement,
narrowing it to entities that could affect market integrity and
customer protection by way of their function as intermediaries for
other parties. The Commission also has limited the range of
transactions that are subject to the requirement from commodity
interest and cash commodity transactions to commodity interest
transactions. Limiting the range of entities that must record and keep
oral communications reduces the number of entities that must bear the
costs of creating and maintaining records required by regulation
1.35(a). In particular, by excluding from the new regulation 1.35(a)
oral communications recordkeeping provisions Small IBs and DCM or SEF
members that are registered as FTs or CPOs, or SDs or MSPs (as SDs and
MSPs are covered by regulations 23.202(a)(1) and (b)(1)), or neither
registered nor required to be registered with the Commission in any
capacity, certain entities such as agricultural cooperatives, energy
end-users and other smaller entities that may transact on DCMs and SEFs
on their own behalf, but not on behalf of customers, avoid mandatory
recordkeeping costs.
[[Page 75541]]
As noted above, new regulation 1.35 will not require entities to
keep records in separate electronic files. Instead, the amendments as
adopted require only that subject entities be able to identify which
records relate to specific parties or transactions when requested to do
so by the Commission. Such requests are infrequent for any one market
participant, and therefore the costs of complying with them will be far
less than what would have been the case under the proposed rule.
As described above, the Commission considered alternatives to
compliance, including various safe harbors, but determined not to adopt
them. For example, the Commission has considered, but declines to
adopt, recommendations that it include a ``reasonableness'' standard
because such a standard could result in market participants documenting
policies and procedures but failing to vigorously monitor for
compliance with the same. The Commission also declines to adopt this
recommendation as inconsistent with the requirements applicable to SDs
and MSPs under Part 23 of the Commission's regulations. Rather, the
Commission determines that it would be more appropriate to consider
good faith compliance with policies and procedures reasonably designed
to comply with the oral communications recording rule as a mitigating
factor when exercising its enforcement discretion with respect to
violations of the rule.
5. Consideration of Section 15(a) Factors
(1) a. Protection of Market Participants and the Public
The oral recordkeeping requirement in regulation 1.35(a) will
protect market participants and the public by ensuring the existence of
an audit trail that includes relevant oral communications. A strong
audit trail, among other things, provides a basis for resolving
transactional disputes; acts as a disincentive to engage in unduly
risky, injurious or illegal conduct in that the conduct will be
traceable; and in the event such conduct does occur, provides a
mechanism for policing such conduct, both internally as part of a
firm's compliance efforts and externally by regulators enforcing
applicable laws and regulations.
(2) b. Efficiency, Competitiveness, and Financial Integrity of Futures
Markets
Requiring records of all oral communications leading to a
transaction in a commodity interest promotes the efficiency,
competitiveness and financial integrity of the markets by increasing
the Commission's ability to detect and prosecute violations of the Act
and the Commission's rules related to fraud, manipulation and other
disruptive trade practices.
(3) c. Price Discovery
Neither the Commission nor commenters have identified consequences
for price discovery that are expected to result from this rule.
(4) d. Sound Risk Management Practices
The Commission believes that proper recordkeeping--though likely to
require initial investment in recordkeeping and other back office
systems--is essential to risk management because it facilitates an
entity's awareness of its transactions, positions, trading activity,
internal operations, and any complaints made against it, among other
things. Such awareness supports sound internal risk management policies
and procedures ensuring that decision-makers within affected entities
are fully informed about the entity's activities and can take steps to
mitigate and address significant risks faced by the firm. When
individual market participants engage in sound risk management
practices the entire market benefits. Accordingly, the Commission
believes that this final rule, notwithstanding the potential costs
identified above, will promote the public interest in sound risk
management.
(5) e. Other Public Interest Considerations
The Commission has not identified any other public interest
considerations that could be impacted by the oral communications
recordkeeping rule under regulation 1.35(a).
List of Subjects in 17 CFR Part 1
Agricultural commodity, Agriculture, Brokers, Committees, Commodity
futures, Conflicts of interest, Consumer protection, Definitions,
Designated contract markets, Directors, Major swap participants,
Minimum financial requirements for intermediaries, Reporting and
recordkeeping requirements, Swap dealers, Swaps.
For the reasons stated in the preamble, under the authority of 7
U.S.C. 1 et seq., the Commodity Futures Trading Commission hereby
amends Chapter I of Title 17 of the Code of Federal Regulations as set
forth below:
PART 1--GENERAL REGULATIONS UNDER THE COMMODITY EXCHANGE ACT
0
1. The authority citation for part 1 continues to read as follows:
Authority: 7 U.S.C. 1a, 2, 2a, 5, 6, 6a, 6b, 6c, 6d, 6e, 6f, 6g,
6h, 6i, 6k, 6l, 6m, 6n, 6o, 6p, 6r, 6s, 7, 7a-1, 7a-2, 7b, 7b-3, 8,
9, 10a, 12, 12a, 12c, 13a, 13a-1, 16, 16a, 19, 21, 23, and 24, as
amended by Title VII of the Dodd-Frank Wall Street Reform and
Consumer Protection Act, Pub. L. 111-203, 124 Stat. 1376 (2010).
0
2. Amend Sec. 1.31 by revising paragraph (a)(1) to read as follows:
Sec. 1.31 Books and records; keeping and inspection.
(a)(1) All books and records required to be kept by the Act or by
these regulations shall be kept in their original form (for paper
records) or native file format (for electronic records) for a period of
five years from the date thereof and shall be readily accessible during
the first 2 years of the 5-year period; Provided, however, That records
of any swap or related cash or forward transaction shall be kept until
the termination, maturity, expiration, transfer, assignment, or
novation date of the transaction and for a period of five years after
such date. Records of oral communications kept pursuant to Sec. Sec.
1.35(a) and 23.202(a)(1) and (b)(1) of this chapter shall be kept for a
period of one year. All such books and records shall be open to
inspection by any representative of the Commission, or the United
States Department of Justice. For purposes of this section, native file
format means an electronic file that exists in the format in which it
was originally created.
* * * * *
0
3. Amend Sec. 1.35 by revising the section heading and paragraph (a)
to read as follows:
Sec. 1.35 Records of commodity interest and related cash or forward
transactions.
(a) Futures commission merchants, retail foreign exchange dealers,
introducing brokers, and members of designated contract markets or swap
execution facilities. (1) Each futures commission merchant, retail
foreign exchange dealer, introducing broker, and member of a designated
contract market or swap execution facility shall keep full, complete,
and systematic records, which include all pertinent data and memoranda,
of all transactions relating to its business of dealing in commodity
interests and related cash or forward transactions. Included among such
records shall be all orders (filled, unfilled, or canceled), trading
cards, signature cards, street books, journals, ledgers, canceled
checks, copies of confirmations, copies of statements of purchase and
sale, and all other records, which have been prepared in the course of
its business of dealing in commodity
[[Page 75542]]
interests and related cash or forward transactions. Among such records
each member of a designated contract market or swap execution facility
must retain and produce for inspection are all documents on which trade
information is originally recorded, whether or not such documents must
be prepared pursuant to the rules or regulations of either the
Commission, the designated contract market or the swap execution
facility. For purposes of this section, such documents are referred to
as ``original source documents.'' Such records shall be kept in a form
and manner identifiable and searchable by transaction. Also included
among the records required to be kept by this paragraph are all oral
and written communications provided or received concerning quotes,
solicitations, bids, offers, instructions, trading, and prices that
lead to the execution of a transaction in a commodity interest and
related cash or forward transactions, whether communicated by
telephone, voicemail, facsimile, instant messaging, chat rooms,
electronic mail, mobile device, or other digital or electronic media;
provided, however, the requirement in this paragraph (a)(1) to record
oral communications shall not apply to:
(i) Oral communications that lead solely to the execution of a
related cash or forward transaction;
(ii) Oral communications provided or received by a floor broker
that do not lead to the purchase or sale for any person other than the
floor broker of any commodity for future delivery, security futures
product, swap, or commodity option authorized under section 4c of the
Commodity Exchange Act;
(iii) An introducing broker that has generated over the preceding
three years $5 million or less in aggregate gross revenues from its
activities as an introducing broker;
(iv) A floor trader;
(v) A commodity pool operator;
(vi) A swap dealer;
(vii) A major swap participant; or
(viii) A member of a designated contract market or swap execution
facility that is not registered or required to be registered with the
Commission in any capacity.
(2) For purposes of paragraph (a)(1) of this section, ``related
cash or forward transaction'' means a purchase or sale for immediate or
deferred physical shipment or delivery of an asset related to a
commodity interest transaction where the commodity interest transaction
and the related cash or forward transaction are used to hedge, mitigate
the risk of, or offset one another.
(3) Each futures commission merchant, retail foreign exchange
dealer, introducing broker, and member of a designated contract market
or swap execution facility shall retain the records required to be kept
by this section in accordance with the requirements of Sec. 1.31, and
produce them for inspection and furnish true and correct information
and reports as to the contents or the meaning thereof, when and as
requested by an authorized representative of the Commission or the
United States Department of Justice.
(4)(i) The Commission may in its discretion establish an
alternative compliance schedule for the requirement to record oral
communications under paragraph (a)(1) of this section that is found to
be technologically or economically impracticable for an affected entity
that seeks, in good faith, to comply with the requirement to record
oral communications under paragraph (a)(1) of this section within a
reasonable time period beyond the date on which compliance by such
affected entity is otherwise required.
(ii) A request for an alternative compliance schedule under
paragraph (a)(4)(i) of this section shall be acted upon within 30 days
from the time such a request is received, or it shall be deemed
approved.
(iii) The Commission hereby delegates to the Director of the
Division of Swap Dealer and Intermediary Oversight or such other
employee or employees as the Director may designate from time to time,
the authority to exercise the discretion. Notwithstanding such
delegation, in any case in which a Commission employee delegated
authority under this paragraph believes it appropriate, he or she may
submit to the Commission for its consideration the question of whether
an alternative compliance schedule should be established. The
delegation of authority in this paragraph shall not prohibit the
Commission, at its election, from exercising the authority set forth in
paragraph (a)(4)(i) of this section.
(iv) Relief granted under paragraph (a)(4)(i) of this section shall
not cause an affected entity to be out of compliance or deemed in
violation of any recordkeeping requirements.
* * * * *
Issued in Washington, DC, on December 17, 2012, by the
Commission.
Sauntia S. Warfield,
Assistant Secretary of the Commission.
Note: The following appendices will not appear in the Code of
Federal Regulations.
Appendices to Adaptation of Regulations To Incorporate Swaps--
Commission Voting Summary and Statements of Commissioners
Appendix 1--Commission Voting Summary
On this matter, Chairman Gensler and Commissioners Sommers,
Chilton, O'Malia and Wetjen voted in the affirmative; no
Commissioner voted in the negative.
Appendix 2--Statement of Chairman Gary Gensler
I support the final rule to amend 1.31 and 1.35(a) of the
Commodity Futures Trading Commission's (CFTC) regulations to conform
them to recordkeeping requirements for swap dealers and major swap
participants. The rule enhances the Commission's enforcement program
for the futures market to promote market integrity and protect
customers.
These conforming amendments integrate the CFTC's regulations
with the Dodd-Frank Wall Street Reform and Consumer Protection Act
(Dodd-Frank Act), which expanded the scope of the Commodity Exchange
Act to include swaps.
As proposed, the rule would have required members of a
designated contract market (DCM) or swap execution facility (SEF) to
record all oral communications that lead to the execution of a
transaction in a cash commodity. The Commission received numerous
comments about the effect of such a requirement on members of the
agricultural community that trade in cash commodities and are not
required to be registered with the Commission other than, in some
cases, as floor traders.
In consideration of comments, the Commission adopted
modifications that preserve the rule's purpose without adversely
affecting the agricultural community. Only those oral communications
that lead to a transaction in a commodity interest (i.e. a commodity
futures contract, commodity option contract, foreign exchange
contract, or swap) will have to be recorded. Furthermore, only FCMs,
certain introducing brokers (IBs), retail foreign exchange dealers
(RFEDs), and those members of a DCM or SEF who are registered or
required to be registered with the Commission (except for floor
traders, commodity pool operators, swap dealers, major swap
participants, and floor brokers who trade for themselves) will have
to record oral communications.
Market participants that must comply will be required to record
communications relating to: Quotes, solicitations, bids, offers,
instructions, trading, and prices that lead to the execution of a
transaction in a commodity interest. Methods of communication that
fall under the rule include telephone, voicemail, facsimile, instant
messaging, electronic mail, mobile device, or other digital or
electronic media. Thus, the rulemaking also clarifies that the
existing requirement under regulation 1.35(a) to keep written
records applies to electronic written communications, such as emails
and instant messages. Records of oral communications must be kept
for one year.
The rule will make enforcement investigations more efficient by
preserving
[[Page 75543]]
critical evidence that otherwise may be lost to memory lapses and
inconsistent recollections. The Commission will have access to
evidence of fraud and market manipulation, which is expected to
increase the success of enforcement actions for the benefit
customers, market participants and the markets. Moreover, it also
will protect customers from abusive sales practices, lower the risk
of transactional disputes and allow registrants to follow-up more
effectively on customer complaints.
[FR Doc. 2012-30691 Filed 12-20-12; 8:45 am]
BILLING CODE 6351-01-P
Last Updated: December 21, 2012