[Federal Register: June 2, 2000 (Volume 65, Number 107)]
[Proposed Rules]
[Page 35304-35307]
From the Federal Register Online via GPO Access [wais.access.gpo.gov]
[DOCID:fr02jn00-20]
=======================================================================
-----------------------------------------------------------------------
COMMODITY FUTURES TRADING COMMISSION
17 CFR Part 1
RIN 3038-AB54
Minimum Financial Requirements for Futures Commission Merchants
and Introducing Brokers; Amendments to the Provisions Governing
Subordination Agreements Included in the Net Capital of a Futures
Commission Merchant or Independent Introducing Broker
AGENCY: Commodity Futures Trading Commission.
ACTION: Proposed rules.
-----------------------------------------------------------------------
SUMMARY: The Commodity Futures Trading Commission (``Commission'' or
``CFTC'') is proposing to amend certain provisions of Regulation
1.17(h) which governs the net capital treatment of subordination
agreements. Currently, futures commission merchants (``FCMs'') and
independent introducing brokers (``IBIs'') that are members of a self-
regulatory organization (``SRO''--i.e., a contract market or the
National Futures Association) and that are securities brokers or
dealers registered with the Securities and Exchange Commission
(''SEC'') are required to obtain the approval of both a futures SRO and
a securities designated examining authority (``DEA'') for any proposed
subordination agreement, proposed prepayment of a subordinated loan, or
proposed reduction in the outstanding principal balance of a secured
demand note. The proposed amendments would ease the regulatory burden
imposed upon SROs, FCMs, and IBIs by allowing SROs, subject to the
conditions set forth below, to rely on a DEA's review and approval of a
proposed subordination agreement, a proposed prepayment of a
subordinated loan, or a proposed reduction in the outstanding principal
balance of a secured demand note submitted to the DEA by an FCM or IBI.
DATES: Comments must be received on or before July 3, 2000.
ADDRESSES: Comments should be mailed to Jean A. Webb, Secretary,
Commodity Futures Trading Commission, Three Lafayette Centre, 1155 21st
Street, NW, Washington, DC 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--
Subordination Agreements.''
FOR FURTHER INFORMATION CONTACT: Thomas J. Smith, Special Counsel,
Division of Trading and Markets, Commodity Futures Trading Commission,
Three Lafayette Centre, 1155 21st Street, NW, Washington, DC 20581;
telephone (202) 418-5495; electronic mail [email protected]; or 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].
SUPPLEMENTARY INFORMATION:
I. Subordination Agreements Included in the Net Capital of a
Futures Commission Merchant or Independent Introducing Broker
A. Background
Commission Regulation 1.17 \1\ requires FCMs and IBIs to maintain
minimum levels of adjusted net capital. \2\ In computing adjusted net
capital, FCMs and IBIs are permitted to
[[Page 35305]]
exclude from liabilities funds received which are subordinated to the
claims of all general creditors of the FCM or IBI pursuant to a
``satisfactory subordination agreement,'' as defined in Regulation
1.17(h).\3\
---------------------------------------------------------------------------
\1\ Commission regulations cited herein may be found at 17 CFR
Ch. I (1999).
\2\ Adjusted net capital is generally defined as current assets
less liabilities. See Regulation 1.17(c)(5).
Regulation 1.17(a)(1)(i) requires FCMs to maintain minimum
adjusted net capital of the greatest of: (1) $250,000; (2) four
percent of the customer funds required to be segregated and set
aside pursuant to the Act and the regulations, 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 that the deduction for each
customer is limited to the amount of customer funds in such
customer's account(s); (3) the amount of adjusted net capital
required by a registered futures association of which the FCM is a
member; or (4) for securities brokers and dealers, the amount of net
capital required by SEC Rule 15c3-1(a) (17 CFR 240.15c3-1(a)).
Regulation 1.17(a)(1)(ii) requires IBIs to maintain minimum
adjusted net capital of the greatest of: (A) $30,000; (B) the amount
of adjusted net capital required by a registered futures association
of which the IBI is a member; or (C) for securities brokers and
dealers, the amount of net capital required by SEC Rule 15c3-1(a).
\3\ Regulation 1.17(c)(4)(i).
---------------------------------------------------------------------------
Subordination agreements may take the form of either subordinated
loan agreements or secured demand notes. Subordinated loan agreements
are agreements evidencing a subordinated borrowing of cash by the FCM
or IBI. Secured demand notes are agreements evidencing or governing the
contribution of a secured demand note to an FCM or IBI and the pledge
of securities and/or cash as collateral to secure payment of such note.
The outstanding principal balances of a subordinated loan and a secured
demand note are recorded as liabilities of an FCM or IBI.\4\
---------------------------------------------------------------------------
\4\ See Regulation 1.17(h)(1).
---------------------------------------------------------------------------
Regulation 1.17(h) sets forth several minimum requirements for the
subordination agreements and other conditions that must be met in order
for the agreements to qualify as ``satisfactory'' subordination
agreements.\5\ One condition, set forth in Regulation 1.17(h)(3)(vi),
provides that an FCM or IBI may not treat any subordination agreement
as a ``satisfactory'' subordination agreement for net capital purposes
until the FCM's or the IBI's designated-self regulatory organization
(``DSRO''), or the Commission if the FCM or the IBI is not a member of
a DSRO, has reviewed the agreement and determined that it satisfies the
minimum requirements set forth in Regulation 1.17(h).
---------------------------------------------------------------------------
\5\ A contract market may impose, or an FCM or IBI may require,
conditions or restrictions in addition to those established by the
Commission provided that such conditions or restrictions do not
cause the subordination agreement to fail to meet the minimum
requirements of Regulation 1.17(h).
---------------------------------------------------------------------------
Commission regulations also impose restrictions on an FCM's or
IBI's ability to make a payment on a subordinated loan prior to the
scheduled maturity date of such loan or to effect a full or partial
reduction in the outstanding principal balance of a secured demand
note. In this regard, Regulation 1.17(h)(2)(vii)(C) requires an FCM or
IBI to obtain the written approval of its DSRO, or the Commission if
the FCM or IBI is not a member of a SRO, prior to making a prepayment
on a subordinated loan or prior to effecting a full or partial
reduction in the outstanding principal balance of a secured demand
note.
The Joint Audit Committee (``JAC'') has requested that the
Commission amend Regulations 1.17(h)(3)(vi) and 1.17(h)(2)(vii)(C).\6\
The JAC states that the Commission's regulations governing
subordination agreements, including the provisions cited above, are
consistent with requirements imposed by the SEC on registered
securities brokers or dealers. Therefore, registered FCMs and IBIs that
are also registered as securities brokers or dealers with the SEC
(hereinafter referred to as ``dually-registered'' FCMs or IBIs) are
required to obtain the approvals of a futures market SRO and a
securities market DEA prior to excluding subordination agreements from
liabilities in computing net capital or prior to making a prepayment on
a subordinated loan or effecting a reduction in the outstanding
principal balance of a secured demand note.\7\
---------------------------------------------------------------------------
\6\ 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.
\7\ Rule 15c3-1(c)(12) of the SEC, 17 CFR 240.15c3-1(c)(12),
defines DEA as the national securities exchange or the national
securities association of which the broker or dealer is a member, or
if the broker or dealer is member of more than one such exchange or
association, the exchange or association designated by the SEC as
the examining authority of the broker or dealer.
---------------------------------------------------------------------------
The JAC requests that the Commission amend Regulations
1.17(h)(3)(vi) and 1.17(h)(2)(vii)(C) to allow DSROs to adopt
procedures that would permit a DSRO to rely on a DEA's review and
approval of a proposed subordination agreement, a proposed prepayment
of a subordinated loan, or a proposed reduction in the outstanding
principal balance of a secured demand note submitted by a dually-
registered FCM or IBI. In support of its position, the JAC states that
since the Commission's and SEC's regulations are consistent with
respect to subordination agreements, permitting the DSRO to rely on the
review performed by a DEA will reduce the regulatory burden imposed
upon dually-registered FCMs and IBIs without increasing the risk of
noncompliance with Commission regulations. The JAC also states that the
amendments would allow a DSRO to more efficiently use its financial
surveillance resources.
B. Proposed Rule Amendments
The Commission is proposing to amend Regulations 1.17(h)(2)(vii)(C)
and 1.17(h)(3)(vi) to allow a DSRO to rely on a review performed by a
DEA with respect to a proposed subordination agreement, a proposed
prepayment of a subordinated loan, or a proposed reduction of the
outstanding principal balance of a secured demand note submitted by a
dually-registered FCM or IBI. As noted above, the Commission's
regulations regarding subordination agreements are consistent in all
material respects with the rules of the SEC for brokers or dealers. In
this regard, SEC Rule 15c3-1d(c)(6)(i) (17 CFR 240.15c3-1d(c)(6)(i)) is
consistent with CFTC Regulation 1.17(h)(3)(vi) in that it requires a
registered securities broker or dealer to file copies of any proposed
subordination agreement with its DEA prior to the effective date of the
agreement. The rule further provides that no subordination agreement
shall be deemed a ``satisfactory'' subordination agreement for capital
purposes until the DEA has determined that the agreement satisfies the
minimum requirements for a satisfactory subordination agreement as set
forth in the SEC's rules.\8\
---------------------------------------------------------------------------
\8\ The SEC's minimum requirements for a satisfactory
subordination agreement are set forth in Rule 15c3-1d(2) (17 CFR
240.15c3-1d(2)) and are comparable to the minimum requirements
established by the Commission in Regulation 1.17(h)(2).
---------------------------------------------------------------------------
Furthermore, SEC Rule 15c3-1d(b)(7) (17 CFR 240.15c3-1d(b)(7)) is
consistent with CFTC Regulation 1.17(h)(2)(vii)(C) in that it requires
a broker or dealer to obtain the written approval of its DEA prior to
making a prepayment of a subordinated loan before the scheduled
maturity date of the payment and prior to effecting a reduction in the
outstanding principal balance of a secured demand note. Therefore, as
noted above, subordination agreements of dually-registered FCMs and
IBIs are currently subject to review and approval by two separate
regulatory authorities applying consistent standards.
The proposed amendments would provide that a DSRO may rely on a
DEA's review of a proposed subordination agreement or a request to make
a prepayment on a subordinated loan or to reduce the outstanding
principal balance of a secured demand note, provided that the dually-
registered FCM or IBI files signed copies of the proposals with its
applicable DEA, in the manner and form provided by the DEA, prior to
the proposed effective dates. The proposal would also direct the FCM or
IBI to file copies of the proposals with its DSRO prior to the
respective effective dates and to file copies of the DEA's approval of
the transactions with the DSRO immediately upon receipt of such
approval.
The requirement that the FCM or IBI file copies of the proposals
with its DSRO provides the DSRO with an opportunity to review the
transactions to ensure compliance with Commission regulations prior to
the effective dates. The proposed amendments would
[[Page 35306]]
further provide that the DEA's review and approval of the proposals
would be deemed, absent objection by the DSRO, a finding by the DSRO
that the proposals meet the minimum requirements and conditions set
forth in Commission Regulation 1.17(h). The final responsibility for
ensuring that the proposals satisfy the minimum Commission
requirements, however, would remain with the DSROs.
II. 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 IBIs. 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.\9\
---------------------------------------------------------------------------
\9\ 47 FR 18618, 18619-18620 (April 30, 1982).
---------------------------------------------------------------------------
With respect to IBIs, the Commission stated that it is appropriate
to evaluate within the context of a particular rule whether some or all
introducing brokers should be considered to be small entities and, if
so, to analyze the economic impact on such entities at that time.\10\
The proposed amendments to Regulations 1.17(h)(2)(vii)(C) and
1.17(h)(3)(vi) do not impose additional requirements on an IBI. 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.
---------------------------------------------------------------------------
\10\ 48 FR 35248, 35275-78 (August 3, 1983).
---------------------------------------------------------------------------
B. Paperwork Reduction Act
The Paperwork Reduction Act of 1995, 44 U.S.C. 3501 et seq. (Supp.
I 1995), imposes certain requirements on 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 the proposed amendments to Regulation 1.17(h)
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 proposed to be amended by revising paragraphs
(h)(2)(vii)(C) and (h)(3)(vi) to read as follows:
Sec. 1.17 Minimum financial requirements for futures commission
merchants and introducing brokers.
* * * * *
(h) * * *
(2) * * *
(vii) * * *
(C)(1) Notwithstanding the provisions of paragraphs (h)(2)(vii)(A)
and (h)(2)(vii)(B) of this section, in the case of an applicant, no
prepayment or special prepayment shall occur without the prior written
approval of the National Futures Association; in the case of a
registrant, no prepayment or special prepayment shall occur without the
prior written approval of the designated self-regulatory organization,
if any, or of the Commission if the registrant is not a member of a
self-regulatory organization.
(2) A registrant may make a prepayment or special prepayment
without the prior written approval of the designated self-regulatory
organization: Provided, That the registrant: is a securities broker or
dealer registered with the Securities and Exchange Commission; files a
request to make a prepayment or special prepayment with its applicable
securities designated examining authority, as defined in Rule 15c3-
1(c)(12) of the Securities and Exchange Commission (17 CFR 240.15c3-
1(c)(12)), in the form and manner prescribed by the designated
examining authority; files a copy of the prepayment request or special
prepayment request with the designated self-regulatory organization at
the time it files such request with the designated examining authority
in the form and manner prescribed by the designated self-regulatory
organization; and files a copy of the designated examining authority's
approval of the prepayment or special prepayment with the designated
self-regulatory organization immediately upon receipt of such approval.
The approval of the prepayment or special prepayment by the designated
examining authority will be deemed approval by the designated self-
regulatory organization, unless the designated self-regulatory
organization notifies the registrant that the designated examining
authority's approval shall not constitute designated self-regulatory
organization approval.
(3) The designated self-regulatory organization shall immediately
provide the Commission with a copy of any notice of approval issued
where the requested prepayment or special prepayment will result in the
reduction of the registrant's net capital by 20 percent or more or the
registrant's excess adjusted net capital by 30 percent or more.
(3) * * *
(vi) Filing. An applicant shall file a signed copy of any proposed
subordination agreement (including nonconforming subordination
agreements) with the National Futures Association at least ten days
prior to the proposed effective date of the agreement or at such other
time as the National Futures Association for good cause shall accept
such filing. A registrant that is not a member of any designated self-
regulatory organization shall file two signed copies of any proposed
subordination agreement (including nonconforming subordination
agreements) with the regional office of the Commission nearest the
principal place of business of the registrant (except that a registrant
under the jurisdiction of the Commission's Western Regional Office
shall file such copies with the Commission's Southwestern Regional
Office) at least ten days prior to the proposed effective date of the
agreement or at such other time as the Commission for good cause shall
accept such filing. A registrant that is a member of a designated self-
regulatory organization shall file signed copies of any proposed
subordination agreement (including nonconforming subordination
agreements) with the designated self-regulatory organization in such
quantities and at such time as the designated self-regulatory
organization may require prior to the effective date. The applicant or
registrant shall also file with said parties a statement setting forth
the name and address of the lender, the business relationship of the
lender to the applicant or registrant and whether the applicant or
registrant carried funds or securities for the lender at or about the
time the proposed agreement was so filed. A proposed agreement filed by
an applicant with the National Futures
[[Page 35307]]
Association shall be reviewed by the National Futures Association, and
no such agreement shall be a satisfactory subordination agreement for
the purposes of this section unless and until the National Futures
Association has found the agreement acceptable and such agreement has
become effective in the form found acceptable. A proposed agreement
filed by a registrant shall be reviewed by the designated self-
regulatory organization with whom such an agreement is required to be
filed prior to its becoming effective or, if the registrant is not a
member of any designated self-regulatory organization, by the regional
office of the Commission where the agreement is required to be filed
prior to its becoming effective. No proposed agreement shall be a
satisfactory subordination agreement for the purposes of this section
unless and until the designated self-regulatory organization or, if a
registrant is not a member of any designated self-regulatory
organization, the Commission, has found the agreement acceptable and
such agreement has become effective in the form found acceptable:
Provided, however, That a proposed agreement shall be a satisfactory
subordination agreement for purpose of this section if the registrant:
is a securities broker or dealer registered with the Securities and
Exchange Commission; files signed copies of the proposed subordination
agreement with the applicable securities designated examining
authority, as defined in Rule 15c3-1(c)(12) of the Securities and
Exchange Commission (17 CFR 240.15c3-1(c)(12)), in the form and manner
prescribed by the designated examining authority; files signed copies
of the proposed subordination agreement with the designated self-
regulatory organization at the time it files such copies with the
designated examining authority in the form and manner prescribed by the
designated self-regulatory organization; and files a copy of the
designated examining authority's approval of the proposed subordination
agreement with the designated self-regulatory organization immediately
upon receipt of such approval. The designated examining authority's
determination that the proposed subordination agreement satisfies the
requirements for a satisfactory subordination agreement will be deemed
a like finding by the designated self-regulatory organization, unless
the designated self-regulatory organization notifies the registrant
that the designated examining authority's determination shall not
constitute a like finding by the designated self-regulatory
organization.
* * * * *
Issued in Washington D.C. on May 25, 2000 by the Commission.
Jean A. Webb,
Secretary of the Commission.
[FR Doc. 00-13606 Filed 6-1-00; 8:45 am]
BILLING CODE 6351-01-U
======== RETURN TO INDEX ========