[Federal Register: February 10, 2000 (Volume 65, Number 28)]
[Proposed Rules]
[Page 6569-6573]
From the Federal Register Online via GPO Access [wais.access.gpo.gov]
[DOCID:fr10fe00-25]
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COMMODITY FUTURES TRADING COMMISSION
17 CFR Part 1
RIN 3038-AB51
Minimum Financial Requirements for Futures Commission Merchants
and Introducing Brokers; Amendments to the Restrictions on the
Withdrawal of Equity Capital from a Futures Commission Merchant and to
the Percentage Deduction (i.e., Haircut) Applied to the Value of Equity
Securities Collateralizing Secured Demand Notes Included in Adjusted
Net Capital by a Futures Commission Merchant or Introducing Broker
AGENCY: Commodity Futures Trading Commission.
ACTION: Proposed rules.
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SUMMARY: The Commodity Futures Trading Commission (``Commission'' or
``CFTC'') is proposing to amend several provisions of its Regulation
1.17, which governs the minimum financial requirements imposed upon
futures commission merchants (``FCMs'') and introducing brokers
(``IBs''). The proposal would: ease the restrictions
[[Page 6570]]
imposed upon the withdrawal of equity capital from an FCM; increase the
percentage deduction (i.e., ``haircut'') applied to the value of equity
securities pledged as collateral for secured demand notes that are
included in the adjusted net capital of an FCM or IB; and delete a
reference to a section of the Securities and Exchange Commission's
(``SEC'') capital rule that has been repealed.
The Commission believes that the current restriction on the
withdrawal of equity capital that is based on a percentage of the
amount of funds an FCM is required to segregate or set aside for
customers may be unnecessary in light of other early warning capital
standards and the degree of surveillance carried out by SROs over their
member FCMs. The proposed amendment increasing the haircut applied to
equity securities pledged as collateral for secured demand notes would
provide greater conformity between the Commission's capital rules and
the capital rules of the SEC.
DATES: Comments must be received on or before March 13, 2000.
ADDRESSES: Comments should be mailed to Jean A. Webb, Secretary,
Commodity Futures Trading Commission, Three Lafayette Centre, 1155 21st
Street, N.W., Washington, D.C. 20581. In addition, comments may be sent
by facsimile to (202) 418-5521, or by electronic mail to
[email protected]. Reference should be made to ``Minimum Financial
Requirements for Futures Commission Merchants and Introducing Brokers--
Equity Capital.''
FOR FURTHER INFORMATION CONTACT: Henry J. Matecki, Financial Audit and
Review Branch, Commodity Futures Trading Commission, 300 S. Riverside
Plaza, Room 1600-N, Chicago, IL 60606; telephone (312) 886-3217;
electronic mail [email protected]: or Gary C. Miller, Associate Chief
Accountant, Division of Trading and Markets, Commodity Futures Trading
Commission, Three Lafayette Centre, 1155 21st Street, N.W., Washington,
D.C. 20581; telephone (202) 418-5461; electronic mail [email protected].
SUPPLEMENTARY INFORMATION:
I. Restrictions on the Withdrawal of Equity Capital From a Futures
Commission Merchant
A. Background
Commission Regulation 1.17(e) \1\ prohibits the withdrawal of
equity capital from an FCM \2\ to redeem or to repurchase shares of
stock of the FCM, to pay dividends, or to make an unsecured advance or
loan to a stockholder, partner, sole proprietor or employee of the FCM
if, after giving effect to the withdrawal and to certain other
specified withdrawals and payments, the FCM's adjusted net capital
would be less than the greatest of:
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\1\ Commission rules cited herein can be found at 17 CFR Ch. I
(1999).
\2\ The prohibition against withdrawal of equity capital set
forth in Regulation 1.17(e) applies to both FCMs and IBs. The
restriction requires consideration of both the minimum dollar amount
of net capital required for both types of registrants ($250,000 for
FCMs and $30,000 for IBs) and, just for FCMs, the amount of funds
required to be segregated and set aside for FCMs' customers. For
purposes of this proposal, only the restriction on FCMs need be
addressed since the change relates only to the percentage applied to
the amount of funds required to be segregated and set aside for
customers.
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(1) $300,000 (120 percent of the $250,000 minimum adjusted net
capital requirement);
(2) Seven percent of the customer funds required to be segregated
or set aside pursuant to the Commodity Exchange Act (``Act'') and
Commission regulations, \3\ (hereinafter collectively referred to as
the ``customer segregated and secured amount'');
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\3\ Before applying the percentage capital factor, the amount
required to be segregated or set aside is reduced by the market
value of commodity options purchased by customers on or subject to
the rules of a contract market or a foreign board of trade for which
the full premiums have been paid: provided, however, that the option
premium deduction for each customer is limited to the amount of
customer funds and the foreign futures and foreign options secured
amounts in such customer's account(s).
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(3) 120 percent of the amount of adjusted net capital required by a
registered futures association of which the FCM is a member; or
(4) For an FCM that is also a securities broker or dealer
registered with the Securities and Exchange Commission (``SEC''), the
amount of net capital specified in SEC Rule 15c3-1(e) (17 CFR 240.15c3-
1(e)).
The Joint Audit Committee (``JAC'') has petitioned the Commission
to amend the restriction in (2) above to permit the withdrawal of
equity capital from an FCM provided that, after giving effect to the
withdrawal, the FCM's adjusted net capital is in excess of six percent
of the customer segregated and secured amount. \4\ The JAC's petition
did not address the other withdrawal restrictions listed above.
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\4\ The JAC is comprised of representatives of the audit and
compliance departments of the self-regulatory organizations
(``SROs'') and National Futures Association. The JAC coordinates the
industry's audit and ongoing surveillance activities to promote a
uniform framework of self-regulation.
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In its petition, the JAC stated that prohibiting capital
withdrawals that result in an FCM having adjusted net capital that is
less than seven percent of the customer segregated and secured amount
is an unnecessary regulatory burden. In support of its position, the
JAC claimed that other provisions of the Commission's regulations also
impose effective restraints on the excessive withdrawal of capital from
an FCM by an equity holder. Specifically, the JAC noted that: (1) FCMs
are required to maintain minimum adjusted net capital of at least four
percent of the customer segregated and secured amount funds
requirements in order to operate and to handle customer positions and
funds; (2) the Commission's ``early warning'' notice and financial
reporting requirements provide the Commission and the FCMs' designated
self-regulatory organizations (``DSRO'') with the ability to monitor
the financial condition and operations, including capital withdrawals,
of an FCM that fails to maintain adjusted net capital at a level that
exceeds six percent of the customer segregated and secured amount; and
(3) the Commission's debt-equity ratio requirement imposes an effective
restraint on the excessive withdrawal of equity capital.
Furthermore, the JAC stated that the changes it requested would
provide greater harmony between the Commission's capital rules and the
capital rules of the SEC. In this regard, the JAC noted that the SEC's
capital rules permit withdrawals of capital from a broker or dealer
provided that, after giving effect to the withdrawal, the broker's or
dealer's net capital equals or exceeds the SEC's early warning level.
Each of the reasons set forth by the JAC is discussed below.
B. Proposed Rule Amendments
After careful consideration of the JAC's petition and the issues
that the petition presents, the Commission is proposing to amend
Regulation 1.17(e) to permit equity capital withdrawals provided that,
after giving effect to the withdrawals, the FCM's adjusted net capital
is in excess of six percent of the customer segregated and secured
amount. The Commission is not proposing to amend any of the other
capital withdrawal restrictions set forth in the regulation.
An FCM is required to maintain minimum adjusted net capital of the
greatest of: (A) $250,000; (B) four percent of the customer segregated
and secured amount; (C) the amount of adjusted net capital required by
a registered futures association of which it is a member; or (D) for
securities brokers and dealers, the amount of net capital required by
SEC Rule 15c3-1(a) (17 CFR
[[Page 6571]]
240.15c3-1(a)). FCMs that are members of commodity exchanges must
comply with the net capital requirements of those exchanges, which are
required to be at least as stringent as the Commission's. \5\
Generally, FCMs that handle customer accounts are required to maintain
adjusted net capital in excess of four percent of the customer
segregated and secured amount.
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\5\ See Regulations 1.17(a)(2)(i) and 1.52.
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An FCM that is not in compliance with the minimum net capital
requirement must transfer all customer accounts and immediately cease
doing business as an FCM. \6\ Therefore, each FCM must ensure that a
capital withdrawal does not cause the FCM's adjusted net capital to
fall below four percent of the customer segregated and secured amount.
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\6\ See Regulation 1.17(a)(4).
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In addition, the Commission's ``early warning'' notice and
financial reporting requirements deter excessive equity withdrawals.
Commission Regulation 1.12(b)(2) requires an FCM to notify its DSRO and
the Commission in writing if its adjusted net capital does not equal or
exceed six percent of the customer segregated and secured amount. These
early warning notices must be filed within five business days of the
FCM's adjusted net capital falling below the early warning level.
Moreover, Commission Regulation 1.12(g)(2) requires an FCM to give the
Commission written notice at least two business days prior to a planned
withdrawal of equity capital if the withdrawal would reduce excess net
capital by 30 percent or more from that most recently reported in a
financial report filed with the Commission.
An FCM that hits the early warning trigger is also required to file
a financial report on Form 1-FR-FCM with the Commission and its DSRO as
of the close of the month during which its adjusted net capital does
not exceed the early warning level and for each month thereafter until
three successive months have elapsed during which its adjusted net
capital is at all times equal to or in excess of the early warning
level. \7\ This early warning notice is intended to bring to the
Commission's and DSRO's attention firms that should be subjected to
closer monitoring because of their minimal regulatory capital.
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\7\ See Regulation 1.12(b)(4).
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Furthermore, the Commission's ``debt-equity ratio'' requirement
also limits the amount of capital that may be withdrawn from an FCM.
Commission Regulation 1.17(d) prohibits the withdrawal of capital from
an FCM if, after giving effect to the withdrawal, the FCM's equity
capital would be less than 30 percent of its debt-equity total. \8\
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\8\ Equity capital is defined by Regulation 1.17(d)(1) to
include certain loans subject to qualifying satisfactory
subordination agreements and the following:
(1) In the case of a corporation, the sum of its par or stated
value of capital stock, paid in capital in excess of par, retained
earnings, unrealized profit and loss, and other capital accounts;
(2) In the case of a partnership, the sum of its capital
accounts of partners (inclusive of such partners' commodity interest
and securities accounts subject to the provisions of Rule 1.17(e)
concerning restrictions on withdrawals of equity capital), and
unrealized profit and loss; and
(3) In the case of a sole proprietorship, the sum of its capital
accounts and unrealized profit and loss.
``Debt-equity total'' is defined by Regulation 1.17(d)(2) and
encompasses equity capital as defined above plus loans subject to
satisfactory subordination agreements that do not qualify as equity
capital under Regulation 1.17(d)(1).
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Finally, setting the capital withdrawal limit at the Commission's
early warning level is supported by the capital withdrawal rules
adopted by the SEC for securities brokers or dealers that compute their
minimum net capital requirement in accordance with the SEC's
``alternative'' method. \9\ SEC Rule 15c3-1(e)(2)(vi) (17 CFR 240.15c3-
1(e)(2)(vi)) prohibits a capital withdrawal from a broker or dealer
that computes its minimum net capital requirement under the alternative
method if, after giving effect to the withdrawal, the broker's or
dealer's minimum net capital would be less than five percent of the
aggregate debit items as determined by the Reserve Formula. The SEC's
early warning requirement for such brokers and dealers is also set at
five percent of aggregate debit items. \10\
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\9\ SEC Rule 15c3-1(a)(1)(ii) (17 CFR 240.15c3-1(a)(1)(ii))
requires a securities broker or dealer computing its minimum net
capital requirement under the alternative method to maintain minimum
net capital of not less than the greater of $250,000 or 2 percent of
aggregate debit items computed in accordance with the Formula for
Determination of Reserve Requirement for Brokers and Dealers
(Exhibit A to Rule 15c3-3).
\10\ 17 CFR 240.17a-11(c)(2).
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II. Equity Securities Pledged as Collateral for Secured Demand
Notes
A. Background
Commission Regulation 1.17(h) sets forth the minimum requirements
for satisfactory subordination agreements. An FCM or IB may enhance its
regulatory capital by borrowing cash pursuant to subordinated loan
agreements or by accepting secured demand notes. A secured demand note
must be collateralized by cash or readily marketable securities. \11\
The securities collateralizing a secured demand note are subject to
percentage deductions (i.e., haircuts) to provide protection against a
potential decrease in the market values of the securities. Commission
regulations, however, do not specify the specific haircuts to be
applied. Instead, the Commission's regulations provide that an FCM or
IB must apply the haircuts that are set forth in SEC Rule 15c3-
1(c)(2)(vi) (17 CFR 240. 15c3-1(c)(2)(vi)), which are the haircuts that
a broker or dealer must apply to securities that it includes in its
capital computation.
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\11\ The value of the collateral, after applicable haircuts,
must exceed the full outstanding face amount of the secured demand
note.
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When the Commission adopted its current capital rules in September
1978, the haircut for an equity security under SEC Rule 15c3-
1(c)(2)(vi) was 30 percent. Therefore, an FCM or IB was required to
apply a 30 percent haircut to an equity security collateralizing a
secured demand note. \12\
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\12\ 43 FR 39956 (September 8, 1978).
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In December 1992, the SEC amended its capital rules. As part of
these amendments, the SEC amended Rule 15c3-1(c)(2)(vi) by reducing the
haircut on equity securities from 30 percent to 15 percent. \13\ Since
the Commission's capital rules incorporated the haircuts in SEC Rule
15c3-1(c)(2)(vi), the Commission's capital rules were effectively
amended and the haircut applied to equity securities collateralizing a
secured demand note was reduced from 30 percent to 15 percent. In the
December 1992 amendments, however, the SEC also explicitly retained the
30 percent haircut on equity securities collateralizing secured demand
notes included in adjusted net capital by brokers or dealers. Thus, an
unintended difference developed between the Commission's capital rules
and the capital rules of the SEC. The difference stems from the
Commission incorporating the SEC's regulation imposing haircuts on
securities that a broker or dealer includes in its capital computation
(Rule 15c3-1(c)(2)(vi)) as opposed to the regulation imposing haircuts
on securities that a broker or dealer receives as collateral for a
secured demand note that was contributed as capital (Rule 15c3-1d) (17
CFR 240.15c3-1(d)).
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\13\ 57 FR 56984 (December 2, 1992).
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B. Proposed Rule Amendment
The Commission attempts to maintain, to the extent practicable,
uniformity between its capital rules and those of the SEC. Uniform
capital rules more readily permit dually-registered FCMs (i.e., FCMs
that are also SEC-registered securities brokers or dealers) that comply
with the Commission's
[[Page 6572]]
capital rules to comply with the SEC's capital rules. As set forth
above, the Commission's capital rules were originally consistent with
the SEC's capital rules with respect to the haircuts to be applied to
equity securities collateralizing secured demand notes and the current
difference is unintended. Accordingly, in order to provide greater
uniformity between the Commission and SEC capital rules, the Commission
proposes increasing to 30 percent from 15 percent the haircut on the
market value of equity securities pledged as collateral for a secured
demand note.
III. Technical Amendment
Commission Regulation 1.17(c)(5)(v) requires an FCM or IB, in
computing its adjusted net capital, to apply haircuts to securities
positions carried in the FCM's or IB's proprietary accounts and to
securities purchased with customer funds that are required to be
segregated or set aside in separate accounts. The regulation directs
the FCM or IB to apply the specific haircut percentages that are set
forth in SEC Rule 15c3-1(c)(2)(vi) for equity securities and Rule 15c3-
1(c)(2)(vii) (17 CFR 240.15c3-1(c)(2)(vii)) for non-marketable
securities, or Rule 15c3-1(f) (17 CFR 240. 15c3-1(f)) for dually
registered securities brokers or dealers and FCMs that compute their
minimum net capital requirements in accordance with the SEC's
``alternative, or aggregate debit items,'' method.
In December 1992, the SEC amended its capital rules by, among other
things, revising the securities haircuts that a broker or dealer
subject to the alternative capital method had to apply to securities
positions in the broker's or dealer's proprietary accounts.
Specifically, the amendments made the haircuts consistent regardless of
the method that a broker or dealer used in computing its minimum net
capital. The SEC effected the revisions by consolidating the haircuts
in Rule 15c3-1(f) into Rules 15c3-1(c)(2)(vi) and 15c3-1(c)(2)(vii) and
repealing15c3-1(f). Accordingly, the Commission proposes deleting the
reference to Rule 15c3-1(f) in its Rule 1.17(c)(5)(v).
IV. Related Matters
A. Regulatory Flexibility Act
The Regulatory Flexibility Act (``RFA''), 5 U.S.C. 601-611,
requires that agencies, in proposing rules, consider the impact of
those rules on small businesses. The proposed rule amendments discussed
herein would affect FCMs and IBs. The Commission has previously
determined that, based upon the fiduciary nature of FCM/customer
relationships, as well as the requirement that FCMs meet minimum
financial requirements, FCMs should be excluded from the definition of
small entity.\14\
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\14\ 47 FR 18618, 18619-18620 (April 30, 1982).
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With respect to IBs, the Commission stated that it is appropriate
to evaluate within the context of a particular rule whether some or all
IBs should be considered to be small entities and, if so, to analyze
the economic impact on such entities at that time.\15\ The proposed
technical amendment to Regulation 1.17(c)(5)(v) and the proposed
amendment to Regulation 1.17(e) easing the restriction on the
withdrawal of equity capital from an FCM do not impose additional
requirements on an IB. The proposed amendment to Regulation
1.17(h)(1)(iii) increasing the haircut on equity securities submitted
as collateral for a secured demand note may impact an IB's financial
operations. The proposal, however, conforms the Commission's rules to
those of the SEC and restores the haircut to its previous level prior
to the SEC amendment of its capital rules in December 1992. Thus, on
behalf of the Commission, the Chairman certifies that the proposed rule
amendments will not have a significant economic impact on a substantial
number of small entities. The Commission, however, invites comments
from registered FCMs or IBs who believe that the proposed amendments
would have a significant impact on their operations.
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\15\ 48 FR 35248, 35275-78 (August 3, 1983).
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B. Paperwork Reduction Act
The Paperwork Reduction Act of 1995 (PRA), 44 U.S.C. 3501 et seq.
(Supp. I 1995), requires federal agencies (including the Commission) to
review rules and rule amendments to evaluate the information collection
burden that they impose on the public. The Commission believes that
paragraphs (c)(5)(v), (e)(1)(ii), and (h)(1)(iii) of Rule 1.17, as
proposed, do not impose an information collection burden on the public.
List of Subjects in 17 CFR Part 1
Brokers, Commodity futures.
In consideration of the foregoing and pursuant to the authority
contained in the Commodity Exchange Act and, in particular, Sections
4f, 4g and 8a(5) thereof, 7 U.S.C. 6d, 6g and 12a(5), the Commission
hereby proposes to amend Chapter I of Title 17 of the Code of Federal
Regulations as follows:
PART 1--GENERAL REGULATIONS UNDER THE COMMODITY EXCHANGE ACT
1. The authority citation for Part 1 continues to read as follows:
Authority: 7 U.S.C. 1a, 2, 2a, 4, 4a, 6, 6a, 6b, 6c, 6d, 6e, 6f,
6g, 6h, 6i, 6j, 6k, 6l, 6m, 6n, 6o, 6p, 7, 7a, 7b, 8, 9, 12, 12a,
12c, 13a, 13a-1, 16, 16a, 19, 21, 23, and 24.
2. Section 1.17 is amended by revising paragraphs (c)(5)(v),
(e)(1)(ii), and (h)(1)(iii) to read as follows:
Sec. 1.17 Minimum financial requirements for futures commission
merchants and introducing brokers.
* * * * *
(c) * * *
(5) * * *
(v) In the case of securities and obligations used by the applicant
or registrant in computing net capital, and in the case of a futures
commission merchant with securities in segregation pursuant to Section
4d(2) of the Act and these regulations which were not deposited by
customers, the percentages specified in Rule 240.15c3-1(c)(2)(vi) of
the Securities and Exchange Commission (17 CFR 240.15c3-1(c)(2)(vi))
(``securities haircuts'') and 100 percent of the value of
``nonmarketable securities'' as specified in Rule 240.15c3-1(c)(2)(vii)
of the Securities and Exchange Commission (17 CFR 240.15c3-
1(c)(2)(vii));
* * * * *
(e) * * *
(1) * * *
(ii) For a futures commission merchant or applicant therefor, 6
percent of the following amount: The customer funds required to be
segregated pursuant to the Act and the regulations in this part and the
foreign futures or foreign options secured amount, less the market
value of commodity options purchased by customers on or subject to the
rules of a contract market or a foreign board of trade for which the
full premiums have been paid: Provided, however, That the deduction for
each customer shall be limited to the amount of customer funds in such
customer's account(s) and foreign futures and foreign options secured
amounts;
* * * * *
(h) * * *
(1) * * *
(iii) The term ``collateral value'' of any securities pledged to
secure a secured demand note means the market value of such securities
after giving effect to the percentage deductions specified in Rule
240.15c3-1d(a)(2)(iii) of the Securities
[[Page 6573]]
and Exchange Commission (17 CFR 240.15c3-1d(a)(2)(iii)).
* * * * *
Issued in Washington D.C. on February 3, 2000 by the Commission.
Catherine D. Dixon,
Assistant Secretary of the Commission.
[FR Doc. 00-2917 Filed 2-9-00; 8:45 am]
BILLING CODE 6351-01-P
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