[Federal Register: June 22, 2000 (Volume 65, Number 121)]
[Proposed Rules]
[Page 39008-39027]
From the Federal Register Online via GPO Access [wais.access.gpo.gov]
[DOCID:fr22jn00-32]
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COMMODITY FUTURES TRADING COMMISSION
17 CFR Parts 1, 3, 4, 140, 155 and 166
RIN 3038-AB56
Rules Relating to Intermediaries of Commodity Interest
Transactions
AGENCY: Commodity Futures Trading Commission.
ACTION: Proposed rules.
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SUMMARY: On February 22, 2000, a staff task force of the Commodity
Futures Trading Commission (``CFTC'' or ``Commission'') submitted a
report to the CFTC's Congressional oversight committees entitled A New
Regulatory Framework. To further the regulatory reform process, the
Commission is proposing to revise its rules relating to intermediation
of commodity futures and commodity options (``commodity interest'')
transactions.
The proposed new rules would provide greater flexibility in several
areas. To ease barriers to entry for persons seeking registration as
futures commission merchants (``FCMs'') or introducing brokers
(``IBs''), the Commission would: Provide a simplified registration
procedure for those persons wishing to operate as FCMs or IBs only on
recognized derivatives transaction facilities ``DTFs'' for
institutional customers, and who are regulated by other federal
financial regulatory agencies; and eliminate the requirement to submit
a certified financial report as part of the standard registration
application for FCMs and IBs. For all registrants, the Commission would
eliminate its rule requiring ethics training, replacing it with a
Statement of Acceptable Practices. In addition, the Commission would
respond favorably to a rule change of the National Futures Association
(``NFA'') that would relieve sales personnel dealing only with
institutional customers of the requirement to pass a proficiency test.
The Commission is also proposing to amend the definition of the term
``principal'' in Rule 3.1(a), mainly to eliminate inclusion of certain
types of officers of a firm, and to make conforming amendments to other
rules.
Account opening procedures would be simplified to allow for all
required disclosures (with the exception of arbitration agreements) to
be acknowledged with a single signature, which may be an electronic
signature. The obligation for FCMs and IBs to provide a specific
disclosure statement would also be eliminated for a greater number of
spohisticated customers. Electronic transmission of account statements
would also be permitted, and the Commission's rules as to close-out of
offsetting positions would be streamlined to allow for customer choice.
Further, the Commission proposes to expand the range of instruments
in which FCMs may invest customer funds. The Commission also requests
comment concerning whether customers should be allowed to ``opt out''
of the rules requiring segregation of customer funds, and whether FCMs
should be allowed to maintain, in the same customer segregated account,
funds used for the purpose of securing or margining instruments other
than those currently permitted. Finally, the Commission is considering
the issuance of a separate order revising its previous pronouncements
regarding the treatment of customer funds on deposit with FCMs for the
purpose of trading on foreign markets.
DATES: Comments must be received on or before August 7, 2000.
ADDRESSES: Comments on the proposed rules should be sent to Jean A.
Webb, Secretary, Commodity Futures Trading Commission, Three Lafayette
Centre, 1155 21st Street, NW., Washington, DC 20581. Comments may be
sent by facsimile transmission to (202) 418-5521, or by e-mail to
[email protected]. Reference should be made to ``Proposed Rules
Concerning Intermediaries.''
FOR FURTHER INFORMATION CONTACT: Lawrence B. Patent, Associate Chief
Counsel, Paul H. Bjarnason, Jr., Special Advisor for Accounting Policy
(with respect to Rule 1.25 concerning investment of customer funds), or
Andrew J. Shipe, Attorney-Advisor, Division of Trading and Markets,
Commodity Futures Trading Commission, Three Lafayette Centre, 1155 21st
Street, N.W., Washington, D.C. 20581. Telephone: (202) 418-5450.
SUPPLEMENTARY INFORMATION:
Table of Contents
I. Introduction
II. Proposed Rules
A. Core Principle One: Registration
1. Definition of the Term ``Principal''
2. Special Procedures Available to Firms Subject to Securities
or Banking Regulation
3. Standard Application Procedures for FCMs and IBs
B. Core Principles Two and Six: Fitness and Supervision
1. Proficiency Testing and Ethics Training for Individual
Registrants
2. Reforms Relating to Statutory Disqualification From
Registration
C. Core Principle Three: Financial Requirements
1. Trading by Non-Institutional Customers on DTFs
[[Page 39009]]
2. Segregation of Funds
3. Investment of Customer Funds
D. Core Principle Four: Risk Disclosure and Account Statements
E. Core Principle Five: Trading Standards
F. Core Principle Seven: Reporting Requirements
G. Core Principle Eight: Recordkeeping
1. General
2. Customer Account Statements; Close-Out of Offsetting
Positions
III. Related Matters
A. Regulatory Flexibility Act
B. Paperwork Reduction Act
I. Introduction
As announced elsewhere in this edition of the Federal Register, the
Commission has proposed a new regulatory structure that is intended to
adapt to the changing needs of the modern marketplace. In reviewing its
regulatory structure, the Commission has identified eight Core
Principles that it believes are fundamental to assuring proper conduct
by intermediaries of commodity interest transactions. While the
Commission is not proposing to adopt these Core Principles as rules,
they have guided the Commission in its regulatory reform efforts. The
Commission has reviewed all of its rules related to intermediaries in
light of the Core Principles. To the extent that an existing rule is
not discussed herein, and no amendment thereto is being proposed, the
rule would apply to intermediaries transacting business on behalf of
customers on contract markets, recognized futures exchanges (``RFEs'')
and DTFs.
In accordance with these Core Principles, the Commission now
proposes reforms contemplating greater flexibility for intermediaries
and their customers via a regulatory structure that acknowledges the
different levels of safeguards appropriate to the types of instruments,
customers and markets involved.1-3 While the Commission, in
this release, is announcing certain proposed changes in its regulatory
structure that would be applicable to all categories of Commission
registrants (e.g., the principal definition and ethics training
requirements discussed below), the Commission is aware that certain
proposals would mainly affect FCMs and IBs, and would not be applicable
to commodity pool operators (``CPOs'') and commodity trading advisors
(``CTAs''). Nevertheless, the Commission seeks comment on these
proposals from all categories of Commission registrant.
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\1-3\ As noted elsewhere in this edition of the Federal
Register, the Commission is proposing a new market structure, an
exempt multilateral transaction execution facility (``MTEF''),
wholly exempt from Commission regulation, except for the antifraud
and antimanipulation provisions of the Commodity Exchange Act
(``Act''). Intermediaries would generally not be subject to
regulation as to their activities on such an exempt MTEF.
Accordingly, the proposals discussed in this release are applicable
generally only to intermediaries on RFEs, DTFs and contract markets.
It should also be noted that some DTFs may permit trading only on a
principal-to-principal basis. Since the rule amendments proposed
herein relate only to intermediaries, they would not be applicable
to such a market structure.
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The Commission also wishes to make clear that its regulatory reform
efforts are an ongoing process. Thus, for example, as a part of the
regulatory reform process, the Division of Trading and Markets recently
permitted designated self-regulatory organizations (``DSROs'') to
conduct ``risk-based'' auditing and thereby take into account a firm's
business practices in establishing the scope and timing of audits.\4\
Similarly, the Commission is considering various changes to the capital
requirements for FCMs, including a risk-based approach.
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\4\ See Interpretative No. 4-2, CFTC Staff Letter 99-32, [1998-
1999 Transfer Binder] Comm. Fut. L. Rep. (CCH) para.27,745 (August
20, 1999).
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The Commission also intends to consider further rulemaking
proposals at a subsequent date that may focus more directly upon Part 4
of the Commission's rules, which govern the activities of CPOs and
CTAs. As examples of its reform efforts with regard to such persons,
the Commission has recently proposed to bring more persons within the
definition of a ``qualified eligible client'' of a CTA or a ``qualified
eligible participant'' of a commodity pool, see 65 FR 11253 (March 2,
2000), which would lessen the disclosure, recordkeeping and reporting
requirements for CTAs and CPOs, and to permit CTAs to compute the rate
of return for partially funded accounts (also known as ``notionally
funded accounts'') by dividing net performance by the agreed-upon
nominal account size, see 64 FR 41843 (Aug. 2, 1999).
Industry representatives have indicated that they would prefer
uniform standards for intermediaries dealing with institutional
customers without regard to the type of facility on which a trade is
executed. Many of the proposals contained herein would have that
effect. The Commission requests comment on whether there are other
specific requirements that should be modified toward that end.
The Core Principles applicable to intermediaries, which relate to
registration, fitness of registrants, financial requirements, risk
disclosure, trading standards, supervision of personnel, large position
reporting requirements, and recordkeeping, are as follows:
1. Registration Required.
Any person or entity intermediating a transaction on an RFE, or on
a DTF that permits intermediation of trading, must be registered in the
appropriate capacity with the Commission as an FCM, IB, CTA, CPO, AP of
any of the foregoing, or floor broker (``FB''). In addition, a person
trading solely for his or her own account on an RFE or DTF with a
trading floor must register as a floor trader (``FT'').
2. Fitness of Registrants
Intermediaries and FTs in all MTEF markets recognized by the CFTC
must be and remain fit.
3. Financial
FCMs must keep and safeguard customer money and FCMs and IBs must
have sufficient capital to ensure their capacity to meet their
obligations to customers.
4. Risk Disclosure
Intermediaries must provide to customers risk disclosure
appropriate to the particular instrument and the customer.
5. Trading Standards
Intermediaries and their affiliated persons are prohibited from
misusing knowledge of their customers' orders.
6. Supervision
All intermediaries, including APs having supervisory
responsibilities, must diligently supervise all commodity interest
accounts that they carry, operate, advise, introduce, handle or trade,
as well as all of the other activities that arise in their business as
intermediaries. All intermediaries must establish and maintain
supervisory procedures.
7. Reporting of Positions
All intermediaries must report to the Commission, RFE or DTF
information that permits the Commission, RFE or DTF to identify
concentrations of positions and market composition. Reports of
transactions on RFEs would be required on a routine and nonroutine
basis as is the case for transactions on contract markets. Reports of
transactions on DTFs would be required only on a non-routine basis.
8. Recordkeeping
All intermediaries (and FTs) must keep full books and records of
all activities related to their business as an FCM, IB, CPO, CTA, FB or
FT, in a form
[[Page 39010]]
and manner acceptable to the Commission for a period of five years.
Such information must be readily available during the first two years
and be produced to the Commission at the expense of the person required
to keep the books or records. All such books and records shall be open
to inspection by any representative of the Commission or the U.S.
Department of Justice.
II. Proposed Rules
A. Core Principle One: Registration
1. Definition of the Term ``Principal''
The second proviso to Section 8a(2) of the Act states that a
principal shall mean a general partner of a partnership, any officer,
director or beneficial owner of at least ten percent of the voting
shares of a corporation, ``and any other person that the Commission by
rule, regulation or order determines has the power, directly or
indirectly, through agreement or otherwise, to exercise a controlling
influence over the activities of [a firm] which are subject to
regulation by the Commission.''
The Commission has implemented this statutory provision by adopting
a definition of ``principal'' in its registration rules that includes
certain specified persons, such as corporate officers and directors, as
well as persons who have the power ``directly or indirectly, through
agreement or otherwise, to exercise a controlling influence'' over the
activities of a firm.\5\ The identification of an applicant's or
registrant's principals is crucial to enabling the Commission or the
National Futures Association (``NFA''), which performs various
registration functions for the Commission pursuant to delegations of
authority, to perform a fitness assessment under the Act. It also
provides information about individuals and firms who provide commodity
interest services to market participants. Because of the important role
principals play in the Commission's regulatory structure, CFTC rules
impose various listing, disclosure, and recordkeeping requirements on a
registrant with regard to its principals.\6\
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\5\ Rule 3.1(a) defines ``principal'' for purposes of the
Commission's Part 3 rules, which govern registration. Rule 4.10(e)
defines ``principal'' for purposes of the Commission's Part 4 rules,
which apply to the activities of commodity pool operators (``CPOs'')
and commodity trading advisors (``CTAs''). The rules are
substantially equivalent, although Rule 3.1(a)(1) contains the final
clause ``to exercise a controlling influence over its activities
which are subject to regulation by the Commission'' while Rule
4.10(e)(1)(i) concludes ``to exercise a controlling influence over
the activities of the entity.'' This distinction has not been
significant in the Commission's analysis of whether a given person
is a principal. The Commission nevertheless proposes to conform
these definitions, as detailed herein, to remove any possible
ambiguity.
\6\ See, e.g., CFTC Rule 3.10(a)(2) (principals must complete a
Form 8-R and submit a fingerprint card); Rules 4.24(e)(1),
4.24(f)(1)(v) and 4.24(j)(1)(v), applicable to CPOs, and 4.34(e)(1),
4.34(f)(1)(ii), and 4.34(j)(1)(iv), applicable to CTAs (identity of
principals, business background of those principals who participate
in making trading or operational decisions or supervise persons so
engaged, and information about any conflicts of interest regarding
principals must be disclosed in the Disclosure Document); Rules
4.23(b)(2)(ii) and 4.33(b)(2)(ii), applicable to CPOs and CTAs,
respectively (recordkeeping requirements for transactions of
principals); Rules 4.25(a)(8)(ii)(A), 4.25(b)(2), 4.25(c)(2)(i)(B),
4.25(c)(2)(ii), applicable to CPOs, and Rules 4.35(a)(7)(ii)(A) and
4.35(b), applicable to CTAs (disclosure requirements for performance
of accounts or pools owned or controlled by principals).
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The Commission staff's current interpretation of Rules 3.1(a)(1)
and 4.10(e)(1)(i) is to treat all officers and directors of a
registrant as principals, pursuant to the language of the second
proviso to Section 8a(2) of the Act.\7\ The Commission recognizes,
however, that there have been changes in management structures over the
last 20 years. The Commission further notes that it has received
requests from registrants that certain employees, such as some vice
presidents, not be considered principals because they do not exercise a
controlling influence over the registrant or any of its activities
subject to Commission regulation. While the Commission believes that,
under its rules, certain officers should continue to be listed as
principals, it also recognizes that listing may be unnecessary for some
mid-level officers. The Commission therefore believes it appropriate to
amend its rules so that not all of a registrant's officers will be
considered to be principals, while ensuring that appropriate personnel
remain listed as such.
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\7\ See, e.g., CFTC Staff Letter No. 76-15, [1975-1977 Transfer
Binder] Comm. Fut. L. Rep. (CCH) para. 20,194 (Office of General
Counsel, Aug. 2, 1976) (the term ``individual principals'' includes
officers, directors, principal shareholders and any other person
who, directly or indirectly, controls the CTA); CFTC Staff Letter
No. 95-19, [1994-1996 Transfer Binder] Comm. Fut. L. Rep. (CCH)
para. 26,346 (Division of Trading and Markets, Feb. 24, 1995) (CTA
required to list corporate secretary as a principal despite
contention that her duties were clerical); CFTC Staff Letter No. 98-
29, [1996-1998 Transfer Binder] Comm. Fut. L. Rep. (CCH) para.
27,312 (Division of Trading and Markets, Apr. 1, 1998) (CTA required
to list sixteen employees who were either vice presidents, senior
vice presidents or executive vice presidents as principals).
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The Commission proposes to amend Rule 3.1(a)(1) by defining as
principals persons within a given organizational structure who hold
specific offices. Thus, the principal definition would include, if the
entity is organized as a sole proprietorship, the proprietor; if a
partnership, any general partner (including individuals and entities,
such as corporations); if a corporation, any director, the president,
chief executive officer, chief operating officer, chief financial
officer.\8\ and any person in charge of a principal business unit,
division or function subject to regulation by the Commission; and, if a
limited liability company or limited liability partnership, any
director, the president, chief executive officer, chief operating
officer, chief financial officer, the manager, managing member or those
members vested with management authority for the entity, and any person
in charge of a principal business unit, division or function subject to
regulation by the Commission. Thus, a registrant would no longer
automatically be required to treat every officer as a principal, but
only those who met the criteria of the rule.
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\8\ As an indication of the importance of the chief financial
officer, the Commission notes that for purposes of filing a Notice
of Claim of Exemption (``Notice'') under Rules 4.7, 4.12 or 4.13, if
the registrant is organized as a corporation, the rules provide that
the chief financial officer may sign the Notice. The Commission also
notes that the attestation to the truth and correctness of
information contained in a financial report can be made by a chief
financial officer. Rule 1.10(d)(4) (applicable to FCMs and IBs).
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The principal definition would also include an individual who
directly or indirectly, through agreement, holding company, nominee,
trust or otherwise: (1) Is the owner of ten percent or more of any
class of a firm's securities; (2) is entitled to vote ten percent or
more of any class of a firm's voting securities; (3) has the power to
sell or direct the sale of ten percent or more of any class of a firm's
voting securities; (4) has contributed ten percent or more of a firm's
capital (excluding unaffiliated banks and insurance companies); or (5)
is entitled to receive ten percent or more of a firm's profits.
Further, the principal definition would include an entity that is the
direct owner of ten percent or more of any class of a firm's securities
or that has directly contributed ten percent or more of a firm's
capital.\9\ These proposed amendments would permit the deletion of Rule
3.10(a)(2)(ii), which has proved somewhat unwieldy in practice.\10\
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\9\ The portion of the principal definition concerning
contribution of capital retains the current provisions of Rule
3.1(a)(3), which does not appear in this release because it is not
being amended.
\10\ The proposed amendments would also result in the
redesignation of Rule 3.10(a)(2)(i) as Rule 3.10(a)(2) and
conforming modifications to Rule 3.32(a)(2).
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Finally, the principal definition would continue to include the
general provision that defines as a principal any person occupying a
similar status or performing similar functions, having the
[[Page 39011]]
power, directly or indirectly, through agreement or otherwise, to
exercise a controlling influence over a firm's activities that are
subject to regulation by the Commission.\11\
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\11\ While the Commission recognizes that what constitutes ``a
controlling influence'' is best left for determination on a case-by-
case basis, such influence would be ascribed to, among others, those
persons who have policymaking or managerial authority over the
activities of an applicant or registrant that are subject to
Commission regulation.
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The Commission also proposes to amend Rule 3.1(a) to conform it
with certain provisions of Rule 3.32, which governs re-registration and
specifies certain events or changes within a firm's management that
require a new registration. Absent this proposed amendment, the
interplay of Rule 3.32 and Rule 3.1 could create an anomaly when, for
example, under Rule 3.1, a firm would not be required to list a person
as a principal, but under Rule 3.32 would be required, because of that
person, to obtain a new registration.
Thus, to conform to Rule 3.1(a)(1), paragraph (a)(1)(v) of Rule
3.32, addressing corporate registrants, would be amended to include any
person who becomes ``the president, chief executive officer, chief
operating officer or chief financial officer of a corporate registrant,
or becomes in charge of a principal business unit, division or function
subject to regulation by the Commission, or comes to occupy a position
of similar status or perform a similar function.'' Similarly, with
respect to limited liability companies and limited liability
partnerships, a new paragraph (a)(1)(vi) would be added so that re-
registration would also be required when there is a new person who
becomes ``a director, president, chief executive officer, chief
operating officer, chief financial officer, manager, managing member or
member vested with management authority for the registrant, or * * * in
charge of a principal business unit, division or function subject to
regulation by the Commission, or comes to occupy a position of similar
status or perform a similar function.'' \12\ In line with new paragraph
(a)(1)(vi) of Rule 3.32, which brings within the ambit of the rule
changes affecting the management of a limited liability company or
limited liability partnership, Rule 3.32(a)(1)(i) would be amended to
delete the word ``corporate'' before ``registrant's voting securities''
so as to permit a broader application of that paragraph to registrants
other than corporate registrants. To conform Rule 3.32(a)(1)(v) and
(a)(1)(vi) to Rule 3.32(e)(1), the latter would be amended by adding a
reference to the former.\13\
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\12\ The existing paragraphs (a)(1)(vi) and (a)(1)(vii) of Rule
3.32 would be redesignated as paragraphs (a)(1)(vii) and
(a)(1)(viii), respectively.
\13\ Re-registration can be avoided by following the procedures
in paragraph (e)(1) of Rule 3.32, which require a registrant to file
a Form 3-R to amend its Form 7-R, and to include a Form 8-R and
fingerprint card for the new officer, manager or member, unless a
current Form 8-R is already on file for that person. These documents
must be submitted to the NFA prior to the date of the change in
personnel, which is not considered effective until the NFA provides
the registrant with written approval. Therefore, some advance
planning by registrants should make this a relatively
straightforward process.
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In addition, the Commission proposes to amend Rule 4.10(e)(1) to
incorporate by reference the definition of ``principal'' in amended
Rule 3.1(a). \14\ Finally, the Commission proposes to amend Rules
4.24(f)(1)(v), 4.25(a)(8)(ii)(A) and 4.25(c)(2)(i)(B), applicable to
CPOs and 4.34(f)(1)(ii) and 4.35(a)(7)(ii)(A), applicable to CTAs, to
conform these rules to proposed Rule 3.1(a)(1), as incorporated by
reference in amended Rule 4.10(e)(1). Thus, a registrant would only be
required to provide business backgrounds and proprietary trading
results for those principals who participate in making trading or
operational decisions, or supervise persons so engaged, and not all
officers.
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\14\ Although Rule 4.10(e) was amended in 1981 to conform more
closely to the wording of Rule 3.1(a)(1)-(a)(3), the terminology in
the Rules remained slightly different. When Rule 4.10(e)(1) was
adopted, the Commission explained that ``[b]ecause the term
`principal' is employed in both Part 3 and Part 4 to obtain similar
critical information about certain persons associated with a CPO or
a CTA, the Commission has determined to use the same term in both
parts. To serve the objectives of Part 4, however, the term
`principal' does not need to be defined as broadly as it is in
Sec. 3.1(a).'' 46 FR 26004, 26005 (May 8, 1981). Because the
amendments to Rule 3.1(a) proposed herein will restrict the
definition of principal so that, for example, not all officers of a
corporate registrant will be included, the Commission believes it is
no longer appropriate to have different definitions of the term
``principal'' in Parts 3 and 4.
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The Commission's intent in proposing these amendments is to provide
a uniform definition and treatment of principals under its rules. The
amendments would require the filing of fewer individual registration
forms (Forms 8-R) and fingerprint cards, and would also require less
disclosure by CPOs and CTAs. The Commission does not intend to alter
the application of any other CFTC rule that provides relief from
registration requirements. For example, the exemption from registration
as an associated person (``AP'') that is available to the chief
operating officer, general partner or other person in the supervisory
chain-of-command of a registrant under Rule 3.12(h)(1)(iii) would
remain intact.\15\
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\15\ That rule provides an exemption from AP registration for
certain principals provided that, among other requirements, the
sponsoring firm's revenue from commodity interest related activity
for customers is no more than ten percent of its total revenue on an
annual basis.
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2. Special Procedures Available to Firms Subject to Securities or
Banking Regulation
As reflected in the Core Principles, intermediaries and FTs in all
CFTC recognized markets, absent an exemption, are and will be required
to be registered with the CFTC under the Act. Registration
requirements, however, could be eased in several ways, depending on the
particular markets on which the intermediary transacts business.
Under the proposed rules, persons who intermediate transactions on
or subject to the rules of an RFE must be registered under the Act as
FCMs, IBs, CPOs, CTAs, APs of any of the foregoing, or FBs, or qualify
for an existing statutory or regulatory exemption from
registration.\16\ If such persons are required to register as FCMs,
they must also become and remain a member of a registered futures
association.\17\ In addition, persons who trade for their own account
on the floor of an exchange must register as FTs.
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\16\ See, e.g., Section 4m(1) of the Act, Commission Rules
3.10(c), 4.13 and 4.14.
\17\ Commission Rule 170.15. NFA is currently the only
registered futures association. NFA Bylaw 1101 essentially provides
that no NFA member may deal with another person with respect to an
account, order or transaction where the other person is acting in a
capacity that requires registration, unless that other person is
also a member of a registered futures association. The combination
of Commission Rule 170.15 and NFA Bylaw 1101 therefore requires most
registrants to become members of NFA.
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Persons whose business is limited exclusively to transactions
conducted on or subject to the rules of a DTF also would be required to
register as FCMs, IBs, CPOs, CTAs, FBs or FTs, if they perform those
functions. Registration as an FCM or IB, however, would be simplified
for persons that conduct business solely for institutional customers
\18\ on a DTF, if they were already registered with the Securities and
Exchange Commission (``SEC'') in a similar registration category or
they were authorized to perform these functions by a federal banking
authority. Under the proposed changes to Rule 3.10, such applicants
would be
[[Page 39012]]
registered in the corresponding CFTC registration category (FCM or IB)
upon filing notice with the NFA of their intent to undertake such
limited activities, together with a certification that they are
registered or authorized to engage in a similar function by, and are in
good standing with, the SEC or a federal banking authority.\19\ This
would avoid the need to file CFTC registration forms and fingerprints.
A firm acting in the capacity of an FCM would, however, be required to
become a member of a registered futures association.\20\ Because it
would be difficult to track individual sales personnel of these firms
without registration forms, individuals acting in the capacity of APs
for such FCMs or IBs would not be required to be registered or listed,
and would not be subject to proficiency testing or ethics training
requirements. Finally, such firms and their salespersons would, of
course, remain subject to antifraud provisions.
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\18\ The Commission proposes a definition of the term
``institutional customer'' in Rule 1.3(g), which would be the same
as the definition of ``eligible participant'' in Rule 35.1(b) that
is set forth in one of the Commission's other Federal Register
notices published today.
\19\ The Commission will, naturally, consult with other agencies
to solicit their views and determine the most appropriate method of
effecting this proposal.
\20\ See Rule 170.15. The Commission may consider not requiring
NFA membership in the future if reciprocal arrangements were made by
the primary regulators of other financial industry segments to
recognize CFTC registration without requiring corresponding SRO
membership.
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The Commission believes that this proposed structure is appropriate
because (i) firms and individuals involved would be permitted to deal
only with institutional customers, (ii) they would be subject to
oversight by other federal regulatory authorities, and (iii) the
Commission anticipates that they will conduct most of their business in
the securities or banking fields, with only a minor portion of their
activities involving commodity interests. Nevertheless, the Commission
wishes to stress that its reform efforts are an ongoing process, and
that it seeks comment on all facets of the proposal.
In order to implement these changes, the text of Rule 3.10 would be
revised by redesignating paragraph (a)(1)(i) as (a)(1)(i)(A), and a new
paragraph (a)(1)(i)(B) would be added. The new paragraph would provide
that an applicant for registration as an FCM or IB that will conduct
transactions exclusively on or subject to the rules of a DTF for
institutional customers, and who is registered with the SEC as a
securities broker or dealer or is a bank or any other financial
depository institution subject to regulation by the United States, may
apply for registration by filing with NFA notice of its intention to
undertake transactions exclusively on or subject to the rules of a DTF
for institutional customers, together with a certification of
registration and good standing with the appropriate authority or of
authorization to engage in such transactions by said authority.
Further, paragraph (d) of Rule 3.10 is proposed to be amended by
replacing the existing cross-reference to ``paragraph (a)'' with a
conforming cross-reference to ``paragraph (a)(1)(i)(A)'' so that those
registrants who choose to follow these newly proposed registration
procedures will not be required to file an annual update of the basic
registration form for firms, Form 7-R.
The Commission also proposes not to require such ``passported''
registrants to meet the Commission's minimum financial requirements if
(i) they meet the appropriate net capital requirements of their primary
regulator, (ii) their activities are limited to serving institutional
customers trading exclusively on DTFs that do not require compliance
with CFTC minimum financial requirements, and (iii) they conform to
minimum financial standards and related reporting requirements set by
such DTF in its bylaws, rules, regulations or resolutions.\21\ In this
regard the Commission seeks comment on the propriety of such reforms.
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\21\ Intermediaries engaged in transactions on DTFs that are not
registered or licensed by another regulator would be subject to the
CFTC's minimum financial requirements, even if all of the
transactions they are involved in occur on or subject to the rules
of a DTF. It should also be noted that these rule amendments relate
only to intermediaries, and are thus inapplicable to persons who
participate in transactions on DTFs solely on a principal-to-
principal basis in accordance with DTF rules.
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The Commission is therefore proposing to add a new paragraph (iii)
to Rule 1.17(a)(2), which currently contains two exemptions from the
Rule's adjusted net capital requirements. The new paragraph would
provide that the basic minimum financial requirements would not apply
to an FCM registered under the new ``passporting'' procedures in
proposed Rule 3.10(a)(1)(i)(B) whose business is limited to transacting
business on behalf of institutional customers on a DTF, and who
conforms to minimum financial standards and related reporting
requirements set by such DTF in its bylaws, rules, regulations or
resolutions. A conforming amendment would be added to Rule 1.52 by
adding a new paragraph (m) to relieve a DTF from the requirement that
it adopt minimum adjusted net capital standards that are modeled on
those of the Commission with respect to these ``passported'' firms.
The Commission notes that as it proposes to simplify the
registration process for SEC registrants that may wish to conduct the
limited activities in futures markets described above, it encourages
the SEC to consider reciprocal amendments to its rules to accommodate
FCMs and IBs that are not now dually registered as securities brokers
or dealers, but that may wish to act as intermediaries in the
securities markets.
Finally, the Commission is considering updating and making more
flexible its standard minimum net capital requirements with respect to
FCMs by permitting the application of risk-based net capital
requirements. At this time, the Commission is not proposing changes to
its requirements in this area. Rather, the Commission wishes to solicit
input from commenters regarding the most effective approach to
developing changes to these rules.
3. Standard Application Procedures for FCMs and IBs
In order to lower a potential barrier to entry for new firms and to
conform CFTC practice more closely with that of the SEC, the Commission
proposes to streamline further its current application requirements for
the registration of FCMs and IBs. Current Commission Rules
3.10(a)(1)(ii) and 1.10(a)(2) require new applicants for registration
as FCMs and IBs to file Form 1-FR-FCM or 1-FR-IB, respectively, with
their applications. Pursuant to Rule 1.10(a)(2), these forms must be
certified by an independent public accountant.
The Commission is proposing that applicants for registration as
FCMs or IBs who raise their own capital to satisfy minimum financial
requirements would not be required to provide these certified financial
statements with their registration applications.\22\ Rather, such
applicants would be permitted to file an unaudited financial report
indicating satisfaction of the minimum requirements. A firm taking
advantage of this new procedure would be subject to an on-site review
within six months of registration by the firm's DSRO or, at the DSRO's
discretion, a conference between appropriate staff of the firm and the
DSRO at the DSRO's offices. This alternative procedure is modeled on
similar procedures in the securities industry. An applicant would
remain
[[Page 39013]]
free to follow the existing rules concerning the filing of a certified
financial statement with its application and thereby delay the initial
DSRO review.\23\ Appropriate rule changes would be made by adding new
paragraphs (a)(2)(i)(C) and (a)(2)(ii)(D) to Rule 1.10.
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\22\ Those IB applicants who do not raise their own capital
would continue to be required to file a guarantee agreement entered
into with an FCM with their registration application.
\23\ Of course, a DSRO retains the authority to inspect its
member firms at any time.
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B. Core Principles Two and Six: Fitness and Supervision
1. Proficiency Testing and Ethics Training for Individual Registrants
The second of the Core Principles for intermediaries identified by
the Commission is that intermediaries in commodity interest markets
must be and remain fit. This requirement is reflected by various
provisions of the Act. Section 4p(a) of the Act permits the Commission
to require written proficiency examinations for individual applicants
for registration. Section 17(p) of the Act further requires that any
futures association registered under the Act must submit to the
Commission for approval rules to establish training standards and
proficiency testing for persons involved in solicitations of
transactions, their supervisors and all persons for whom the
association has registration responsibilities. The NFA administers this
testing program through the facilities of the National Association of
Securities Dealers, Inc. NFA rules that the Commission has approved
generally require that all applicants for AP registration present
evidence of passage of a proficiency test, the basic test being the
National Commodity Futures Examination (commonly known as the ``Series
3 Test''). In keeping with the recommendations of A New Regulatory
Framework, the Commission believes that those APs dealing only with
institutional customers need not pass a specific proficiency
examination, and it would consider an NFA rule change to this effect.
The Commission notes that under Sections 4p(a) and 17(p) of the Act and
Rule 170.10, NFA is currently allowed to adopt such rules as it may
deem appropriate, subject to Commission approval. Therefore, no changes
to the Commission's rules are deemed necessary to effect these changes.
Section 4p(b) of the Act requires the Commission to issue
regulations requiring new registrants to attend ethics training
sessions within six months of registration, and requiring all
registrants to attend such training on a periodic basis. The Commission
has issued Rule 3.34 to fulfill this statutory mandate. Rule 3.34
specifies the frequency and duration of such training, the suggested
curriculum, qualifications of instructors, and the necessary proof of
attendance at such classes.
In order to provide flexibility and ease compliance for all
registrants, the Commission proposes to delete Rule 3.34. In place of
that rule, the Commission proposes to implement Congressional intent
through a Statement of Acceptable Practices consistent with its second
Core Principle, which requires intermediaries to be and remain fit. The
Commission believes that the maintenance of professional ethical
standards is a key element of a registrant's fitness. Further, training
standards in the field of ethics are relevant to adherence to the sixth
Core Principle, requiring adequate supervision of handling accounts by
a firm and its personnel. The Commission therefore proposes to issue
this Statement of Acceptable Practices as an Appendix to Part 3 of its
Rules. The Commission believes that Section 4p(b) of the Act expresses
Congressional intent that futures industry professionals remain abreast
of their responsibilities to the public under the Act and rules
thereunder. The Commission further believes that there can be greater
flexibility concerning acceptable practices to achieve this objective
than is permitted under the existing rule. For registrants seeking
guidance as to the maintenance of proper ethics training procedures in
keeping with the purposes of the Core Principles, the Statement of
Acceptable Practices would function as a ``safe harbor.''
For instance, under the Statement of Acceptable Practices,
registrants may engage in ethics training programs sponsored by the
registrants themselves, their DSROs, trade associations or others. The
format of such training, whether by personal or recorded instruction,
or by circulation of written materials such as legal cases,
interpretative letters or advisories, would also be left to the
discretion of registrants and DSROs. It would also be permissible to
require training on whatever periodic basis the registrant and DSROs
deem appropriate. Thus, the Commission would not specify any particular
programs or procedures that must be followed.
2. Reforms Relating to Statutory Disqualification From Registration
The grounds for statutory disqualification from registration, which
establish fitness standards based upon disciplinary history, are set
forth in Sections 8a(2) and (3) of the Act. One of those provisions
states that registration can be denied or conditioned based upon, in
addition to specific matters such as revocation of a previous
registration or a felony conviction, ``other good cause'' (see Section
8a(3)(M) of the Act). In an effort to provide greater clarity in this
area, the Commission recently revised the ``Guidance Letter'' issued to
NFA concerning the treatment of self-regulatory organization (``SRO'')
disciplinary actions in assessing the fitness of FBs, FTs or applicants
in either category. See CFTC Letter No. 00-56 (April 13, 2000); CFTC
Guidance to NFA Concerning Floor Broker and Floor Trader Registration
Actions, [1996-1998 Transfer Binder] Comm. Fut. L. Rep. para. 27,202
(Dec. 4, 1997). The Commission considers these letters to be part of
its overall regulatory reform efforts and intends to publish both as an
accompanying statement when it publishes final rules. The Commission
requests comment as to any further changes that should be considered in
this area.
C. Core Principal Three: Financial Requirements
1. Trading by Non-Institutional Customers on DTFs
As noted above, the Commission's proposed new regulatory framework
contemplates the recognition of a new form of trading facility that is
subject to an intermediate degree of regulatory oversight, the DTF.
Under the proposed rules, trading on DTFs generally would be limited to
futures and options on specified commodities. In addition, DTFs could
permit trading on any commodities if trading is limited to qualifying
commercial participants.
Thus, although trading on DTFs would generally be limited to
institutional or commercial customers, under certain conditions a DTF
might permit non-institutional customers to enter into transactions
thereon. Because of the lower regulatory protections offered to
participants in these markets, and the higher degree of risk associated
therewith, the Commission is proposing that such non-institutional
customers' business be transacted through FCMs that are more capable of
properly maintaining such accounts and handling the associated risk.
This is in accordance with the third Core Principle, which requires
intermediaries to maintain adequate capital to ensure they are able to
meet their obligations to customers. Thus, non-institutional customers
who desire to conduct transactions on or subject to the rules of
[[Page 39014]]
a DTF would be required to do so through a registered FCM that (1) is a
clearing member of at least one designated contract market or RFE, and
(2) has a minimum adjusted net capital of at least $20 million (the
basic minimum requirement for FCMs is $250,000). The Commission notes
that this would not prevent a DTF from including any similar or greater
restrictions in its own rules or bylaws. Further, in order to provide
guidance to such customers and their FCMs, NFA will issue a Statement
of Acceptable Practices regarding additional disclosures to be made to
non-institutional customers trading on DTFs and on related issues
involving price dissemination. The Commission presumes that this would
be forthcoming as DTFs come into existence. Since DTFs do not yet
exist, and it is not known how such institutions would choose to
operate, the Commission believes that it is premature at this time to
propose a Statement of Acceptable Practices in this area.
Therefore, the Commission proposes to amend Rule 1.17, to add a new
paragraph (a)(1)(ii) and to redesignate current paragraph (a)(1)(ii) as
(a)(1)(iii). The new paragraph (a)(1)(ii) would provide that an FCM
engaged in soliciting or accepting orders and customer funds related
thereto from a non-institutional customer for the purchase or sale of
any commodity for future delivery on or subject to the rules of a DTF
must be a clearing member of a contract market or an RFE and must
maintain adjusted net capital at least equal to the greater of $20
million or the other amounts specified in Rule 1.17.
2. Segregation of Funds
The futures industry has a long history of keeping customer funds
safe. The Commission believes that segregation of customer funds has
worked well and should continue to be required for the funds of all
customers trading on an RFE and the funds of all non-institutional
customers trading on a DTF that permits such customers. Nevertheless,
the Commission is considering whether, and under what circumstances, to
permit other customers to ``opt out'' of segregation. Before proposing
any rule changes in this area, however, the Commission seeks comment as
to how, if at all, this change should be implemented. Commenters may
wish to address several issues in this area, including:
� Whether opting out of segregation should be permitted;
� If so, whether it should be limited to the accounts of
institutional customers;
� Where such non-segregated funds should be held;
� How such funds would be accounted for, especially for
purposes of establishing minimum capital requirements, and computing
a firm's adjusted net capital;
� How accounts that have opted out of segregation would
be treated under Part 190 of the Commission's rules, and under the
Bankruptcy Code;
� What the effects of similar practices have been in
other jurisdictions; and
� What an FCM's disclosure obligations should be in this
area.
The Commission notes that certain industry participants have also
suggested that the Commission revise its regulations to permit FCMs to
maintain, in the same customer segregated account, various instruments,
such as over-the-counter (``OTC'') derivatives, equity securities, and
other cash market positions, as well as the funds used for the purpose
of securing or margining such products and positions. The Commission
notes that, pursuant to its authority under the second proviso of
Section 4d(2) of the Act,\24\ it has previously permitted futures and
securities options to be held in the same customer segregated account
pursuant to cross-margining arrangements.\25\ The Commission believes
that, under Section 4d(2) of the Act, the segregation requirements
could be modified to permit such additional instruments and funds to be
held in a single segregated account at both the FCM and the clearing
organization level. As with the concept of ``opting out'' of
segregation, the Commission believes, however, that further
consideration is necessary in this area before a formal proposal can be
made. Therefore, the Commission seeks comment as to how such changes
might be implemented. Commenters may wish to address several issues in
this area, including:
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\24\ 7 U.S.C. 6d(2) (1994).
\25\ See, e.g., Commission Order, In the Matter of the Chicago
Mercantile Exchange Proposal to Expand its Cross-Margining Program
with the Options Clearing Corporation to Include the Cross-Exchange
Net Margining of the Positions of Market Professionals, (November
26, 1991), reprinted in 56 FR 61404 (December 3, 1991); Commission
Order, In the Matter of The Intermarket Clearing Corporation
Proposal to Expand its Cross-Margining Program with the Options
Clearing Corporation to Include the Cross-Exchange Net Margining of
the Positions of Market Professionals (November 26, 1991), reprinted
in 56 FR 61406 (December 3, 1991). For each of these programs, the
SEC approved parallel rules of the Options Clearing Corporation.
� What protections would be necessary in order to permit
FCMs and clearing organizations to maintain, in the same customer
segregated account, additional instruments and products and the
funds used for the purpose of securing or margining such instruments
and products;
� Whether such practices should be limited to the
accounts of institutional customers;
� Whether, if this is permitted, it would be desirable to
permit ``opting out'' of segregation;
� How such funds would be accounted for, especially for
purposes of establishing minimum capital requirements and computing
a firm's adjusted net capital;
� How such accounts would be treated under Part 190 of
the Commission's Rules, and under the Bankruptcy Code;
� What the effects of similar practices have been in
other jurisdictions; and
� What an FCM's disclosure obligations should be in this
area.
3. Investment of Customer Funds
The Commission also is proposing to amend Rule 1.25, which sets
forth the types of instruments in which FCMs and clearing organizations
are permitted to invest (the permitted investments) cash segregated for
the benefit of regulated commodity customers pursuant to Section 4d(2)
of the Act. Currently, Rule 1.25 permits an FCM or clearing
organization to invest segregated funds only in obligations of the
U.S., in general obligations of any State or of any political
subdivison thereof, or in obligations fully guaranteed as to principal
and interest by the U.S. The Commission believes that an expanded list
of permitted investments could enhance the yield available to FCMs,
clearing organizations and their customers, without compromising the
safety of customer funds.
Subject to specific risk-limiting features contained in the
proposal, the following additional investments would be permitted: (1)
Obligations issued by any agency sponsored by the United States; (2)
certificates of deposit issued by a bank, as defined in Section 3(a)(6)
of the Securities Exchange Act of 1934, or a domestic branch of a
foreign bank insured by the Federal Deposit Insurance Corporation; (3)
commercial paper; (4) corporate notes; and (5) interests in money
market mutual funds. In addition, it is proposed than an FCM or a
clearing organization may both buy and sell the permitted investments
pursuant to agreements for resale or repurchase of the instruments.
The proposal includes several provisions intended to minimize
credit risk, volatility risk and liquidity risk. These features
include: (i) A requirement that the investments be highly-rated by a
nationally-recognized statistical rating agency (NRSRO), except for
U.S. government securities and those money market mutual funds that are
not required to be rated; (ii) a requirement that the dollar-weighted
[[Page 39015]]
average of the time remaining to maturity of the debt securities held
in the segregated portfolio not exceed 24 months, excluding investment
in money market mutual funds; (iii) concentration limits on the
percentage of the portfolio that may be comprised of the securities of
individual issuers; (iv) specific prohibitions against leverage,
embedded derivatives, and options; and (v) a requirement that the daily
value and gains and losses on each investment be recorded in the
records of the FCM or clearing organization. The Commission recognizes
that events beyond the control of an FCM or clearing organization could
cause a portfolio to exceed the time-to-maturity and concentration
requirements. Accordingly, the Commission would permit portfolios to be
adjusted within a reasonable period of time to meet these requirements.
The Commission plans to modify the segregation computation schedule,
which is prepared by FCMs every day, to reflect changes in value of the
investments.
As noted above, in addition to expanding the list of permitted
investments, the proposal would allow investments to be bought and sold
pursuant to agreements for repurchase or resale of the instruments.
These transactions are usually simply referred to as ``repurchase
transactions.'' This part of the proposal essentially incorporates
Division of Trading and Markets Financial and Segregation
Interpretation No. 2-1 (Interp. 2-1) \26\ with three significant
modifications. First, in order to increase the liquidity of the
segregated portfolio, repurchase transactions will be permitted for the
first time. (Interp. 2-1 currently only permits reverse repurchase
transactions.) Second, the 180-day cap on the time-to-maturity of
collateral subject to reverse repurchase agreements, contained in
footnote No. 13 of Interp. 2-1, has been deleted. The Commission has
been persuaded by comment received regarding Interp. 2-1 that
collateral of any maturity would serve adequately, subject to other
regulatory protections in place such as capital charges. Third, the
Depository Trust Corporation has been added as a permitted depository
for securities. If this rule proposal is adopted by the Commission, it
will take the place of Interp. 2-1, which will be rescinded.
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\26\ 1 Comm. Fut. L. Rep. para. 7112A (December 15, 1993).
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The Commission notes that the specific safeguards applicable to the
permitted investments set forth in Rule 1.25 will not be the only
protections in place. The Commission's proposed Rule 1.25 would take
its place as part of a broad set of protections built into the system
intended to guard against financial risk at FCMs. First, FCMs generally
must meet the Commission's net capital and segregation requirements, as
well as SRO requirements. An FCM that is a contract market clearing
member also will likely have capital requirements that are higher than
those set by the Commission. Second, Commission regulations require
firms to keep current books and records, prepare a daily segregation
computation and a formal, monthly capital calculation, among other
things. Further, an early-warning system requires FCMs to report
certain events to the Commission and the SROs. These requirements serve
as elements of the overall system of controls to protect segregated
funds.
The Commission recognizes that some adjustments may be desirable
before the proposal is adopted in final form. Accordingly, the
Commission seeks industry and public comment on a number of issues:
� Whether the proposed list of investments is appropriate
for segregated funds investments, considering the primary objective
of safety of principal;
� Whether the proposed list of investments would create
any risks that are not properly contained by the risk-limiting
features of the proposed rule and, if so, what additional features
should be provided for in the rule;
� The proposed rule contains credit-rating standards and
a cap on the dollar-weighted average for the time-to-maturity of
investments held in the portfolio. The Commission notes that certain
types of structured notes may have significant prepayment and other
risks, because they offer a large variety of payment obligations
and, therefore, present substantial market and liquidity risks in
addition to credit risk. Does the rule sufficiently address this
type of exposure?;
� Whether the proposed standards for money market funds
are appropriate;
� Whether there are other categories of funds that could
be included, and, if so, pursuant to what standards; and
� As is currently the case under Interp. 2-1, the
proposed rule limits the permitted counterparties in purchases or
sales of securities subject to a repurchase agreement. The
Commission requests comment on whether the class of permitted
counterparties should be expanded and, if so, to what extent.
The Commission is also proposing to amend Rules 1.20(a) and 1.26(a)
to eliminate the requirement that an FCM obtain a written
acknowledgment, from each clearing organization where the FCM has
deposited customer funds or instruments purchased with customer funds,
that the clearing organization was informed that the customer funds or
instruments purchased with customer funds and deposited therein belong
to customers and are being held in accordance with the provisions of
the Act and rules thereunder. The proposed elimination of the
requirement that an FCM obtain a clearing organization acknowledgment
is conditioned upon the clearing organization's adoption and submission
to the Commission of rules that provide for the segregation as customer
funds, in accordance with all relevant provisions of the Act and the
rules and orders promulgated thereunder, of all funds held on behalf of
customers and all instruments purchased with customer funds. These
proposed rule amendments would codify a staff no-action letter issued
three years ago.\27\ An FCM's obligation to obtain written
acknowledgments from banks, trust companies and other FCMs, and a
clearing organization's obligation to obtain written acknowledgments
from banks and trust companies, concerning the treatment of customer
funds would be unaffected.
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\27\ CFTC Staff Letter No. 97-45, [1996-1998 Transfer Binder]
Comm. Fut. L. Rep. (CCH) para. 27,085 (May 5, 1997).
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D. Core Principle Four: Risk Disclosure and Account Statements
As reflected in the fourth Core Principle, the disclosure of risks
by intermediaries is an important customer protection. Over the years,
however, certain persons have suggested that customers would be better
protected by receiving risk disclosures more attuned to their relative
level of sophistication and to the particular instruments they trade.
Other commenters have suggested that disclosure obligations could be
simplified and streamlined.
In keeping with these observations, the Commission proposes that
non-institutional customers continue to receive the risk disclosures
regarding futures and options trading that are currently required.
Thus, intermediaries will continue to be required to obtain prior
acknowledgement by non-institutional customers of their receipt of the
basic risk disclosure statements relating to futures and options in
accordance with Rules 1.55 and 33.7.
The Commission is proposing that the account opening process be
streamlined, however, in certain areas. The Commission would permit
certain required disclosures, such as those concerning consent to allow
cross-trades or to transfer funds out of segregated accounts to another
account (such as a money market account), to be included in a customer
agreement and acknowledged through a ``single
[[Page 39016]]
signature'' (which could include an electronic signature as provided
for in recently-adopted Commission Rules 1.3(tt) and 1.4),\28\ rather
than the multiple signatures that are currently required.\29\ In order
to enhance the ``single-signature'' format for account opening
agreements, the Commission would amend Rules 1.55(d)(1) and (2) by
expanding the list of disclosures and consents that may be provided in
a single document and acknowledged with a single signature to include:
(1) The disclosures required by new Rule 1.33(g) (relating to
electronic transmission of statements); \30\ (2) the consent referenced
in Rule 155.3(b)(2) (relating to customer permission for FCMs to take
the opposite side of an order); and (3) a provision for
preauthorization of transfers of funds from a customer's segregated
account to another account of that customer. Disclosure concerning
arbitration of disputes, however, would continue to require a separate
signed acknowledgment by non-institutional customers, pursuant to
proposed new Rule 166.5 (this proposed new rule would replace and is
modeled on current Rule 180.3).\31\ The Commission specifically
requests comment on whether to continue to require a separate signed
acknowledgment by non-institutional customers of a pre-dispute
arbitration agreement.
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\28\ 65 FR 12466 (March 9, 2000).
\29\ This would reverse existing Commission policy. See 58 FR
17495, 17499 (April 5, 1993).
\30\ See proposed changes to Rule 1.33, below.
\31\ Part 180 is proposed to be deleted in its entirety, as
detailed elsewhere in today's Federal Register. The Commission is
also proposing to add a new Rule 166.5 to govern the use of pre-
dispute arbitration agreements for customer claims and grievances
arising out of transactions executed on or subject to the rules of a
contract market, an RFE or a DTF. Proposed Rule 166.5 restates
current Rule 180.3, while taking into account the additional trading
facilities that may be available to customers. Proposed Rule 166.5
also expands the use of the ``single-signature'' format for account
opening agreements to include, in addition to entities that are
excluded from the definition of a commodity pool operator under Rule
4.5 and ``qualified eligible participants'' as defined in Rule 4.7,
institutional customers as defined in proposed Rule 1.3(g) and
``qualified eligible clients'' as defined in Rule 4.7. Since certain
of the persons currently eligible to use the single signature format
are included within the proposed definition of institutional
customer, the provisions of proposed Rule 166.5(c)(2) contain
modifications of rule 180.3(b)(2) so as to avoid duplication. The
Commission is also proposing to include within the group of persons
who need not separately endorse the provisions of a pre-dispute
arbitration agreement persons other than those who would be defined
as institutional customers. The Commission is making this proposal
because the institutional customer definition would not include all
of those now eligible for the single signature treatment under Rule
180.3(b)(2) (e.g., a foreign insurance company or a qualified
eligible participant) and the Commission does not intend to
restrict, but rather intends to expand, this aspect of the rule. The
proposed rule further recognizes that a registered futures
association may be authorized to act as a decision-maker in customer
dispute resolution proceedings involving floor brokers that are not
members of the registered futures association and makes additional
stylistic changes designed to make the rule more readable.
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In contrast, for institutional customers, as provided in Rule
1.55(f), there would continue to be no specific disclosure
requirements.\32\ Because the definition of institutional customer
referred to above would include governmental entities, these entities
would not be required to receive and to acknowledge a disclosure
statement. This reverses the position that the Commission took when it
last amended its risk disclosure rules two years ago.\33\
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\32\ In this regard, the Commission would, with industry input,
issue a Statement of Acceptable Practices on disclosure to
institutional customers at a later date.
\33\ 63 FR 8566, 8568 (February 20, 1998). Particular
governmental entities and trade associations for such entities are,
of course, free to establish their own restrictions concerning
futures trading through statute, regulation or Statements of
Acceptable Practices.
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Finally, the Commission is considering developing more streamlined
disclosure requirements for domestic exchange-traded options under Rule
33.7. The Commission therefore seeks comments regarding how such
disclosure may be more effectively presented to customers while
reducing the associated burdens on registrants.
E. Core Principle Five: Trading Standards
Under the Core Principles, intermediaries and their affiliated
persons are prohibited from misusing knowledge of their customers'
orders. Currently, FCMs and IBs are required to establish and to
maintain supervisory procedures to assure that neither they nor any
affiliated persons (as defined in Rule 155.1) abuse their knowledge of
customer orders to the customer's disadvantage. These rules have proven
effective in the Commission's efforts to curb such practices as
``front-running,'' ``trading ahead,'' ``bucketing,'' taking the
opposite side of customer orders, or improper disclosure of customer
orders to third parties. Indeed, the Commission has found that these
rules have generated few comments from industry professionals. The
Commission therefore proposes that Rules 155.1, 155.3 and 155.4 will
continue to apply to intermediation of trades at contract markets,
RFEs, and for non-institutional customers' trades at DTFs. See proposed
new Rule 155.6(a).
For intermediation of trades by institutional customers at DTFs,
the Commission is proposing a new Rule 155.6(b) setting forth a general
standard of practice in this area. The rule would simply parallel the
language of the Core Principle prohibiting the misuse of knowledge of
customer orders. Although the proposed new Rule 155.6(b) would not
include as much detail as the current trading standards rules, it is
nevertheless intended to proscribe the same trade practice abuses as
Rules 155.1-155.5. Such practices as ``front-running,'' ``trading
ahead,'' ``bucketing,'' taking the opposite side of customer orders, or
disclosure of customer orders to third parties, would thus be deemed to
be misuse of knowledge of customer orders and violations of Rule 155.6.
The Commission will consider the development of a Statement of
Acceptable Practices to be issued at a later date, with the
consultation of DTFs, regarding appropriate procedures that should be
employed in order to ensure compliance with the general standard.\34\
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\34\ As noted above, the DTF is at this point a proposed new
institution, and it is not known how such institutions would choose
to operate. Such institutions may choose to sponsor trading in a
traditional open-outcry pit trading system with natural persons
acting as FBs or FTs. On the other hand, some DTFs may choose a
purely automated, electronic trading format, or a combination of
open outcry and electronic trading. Because it cannot be known at
this time how such entities will choose to organize themselves, and
what policies they will wish to pursue, the Commission is not at
this time issuing a Statement of Acceptable Practices in this area.
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F. Core Principle Seven: Reporting Requirements
The Commission has found that its reporting system provides a
valuable bulwark against illegitimate trade practices. Accordingly, the
Commission would continue, and apply to intermediaries on RFEs, its
large trader reporting requirements. Thus, FCMs would be required to
report to the Commission and RFEs information that permits the
identification of concentrations of positions and market composition on
a routine and nonroutine basis, and information to detect manipulation,
price distortion and disruptions of the delivery or cash settlement
process.
With respect to intermediaries transacting business on DTFs,
however, because of the nature of the instruments traded or the limited
access granted thereto for non-institutional traders, the Commission
would reduce its reporting requirements. Such intermediaries would only
be subject to large trader reporting requirements by special call.
These proposed reforms are detailed elsewhere in today's Federal
Register.
[[Page 39017]]
G. Core Principal Eight: Recordkeeping
1. General
The Core Principles maintain that all registrants must keep full
books and records of their activities related to their business. Thus,
the Commission would maintain recordkeeping requirements as they relate
to intermediaries, while considering whether greater use may be made of
information technology in this regard. The Commission notes that Rule
1.31 was recently revised to provide for enhanced electronic
recordkeeping similar to SEC recordkeeping requirements. See 64 FR
36568 (July 7, 1999); 64 FR 28735 (May 27, 1999). The Commission seeks
comments regarding Rule 1.31 and on how greater use of information
technology may be made in the future for recordkeeping purposes.
2. Customer Account Statements; Close-Out of Offsetting Positions
In keeping with changes in technology and commercial practices, the
Commission is proposing to codify its previous Advisory relating to the
electronic transmission of account statements, 62 FR 31507 (June 10,
1997), in a new Rule 1.33(g). Thus, an FCM would be permitted, with
customer consent, to deliver required confirmation, purchase-and-sale,
and monthly account statements electronically in lieu of mailing a
paper copy. In keeping with the above-referenced Advisory, FCMs would
need only to retain the daily confirmation statement as of the end of
the trading session, provided that it reflects all trades made during
that session, to satisfy recordkeeping obligations.
Proposed Rule 1.33(g) also provides, as did the above-referenced
Advisory, that an FCM must, prior to the transmission of any statement
by means of electronic media, disclose (1) The electronic medium or
source through which statements will be delivered, (2) the duration,
whether indefinite or not, of the period during which consent will be
effective, (3) any charges for such service, (4) the information that
will be delivered electronically, and (5) that consent to electronic
delivery may be revoked at any time. In the case of a non-institutional
customer, an FCM must obtain the non-institutional customer's signed
consent acknowledging disclosure of this information prior to the
transmission of any statement by means of electronic media. This
acknowledgment can be included in a customer account agreement and
acknowledged through a single signature in accordance with Rule 1.55.
Institutional customers would not need to provide written consent, and
the Commission recommends that FCMs confirm procedures relating to
electronic transmission of statements to institutional customers as
described in the above-referenced Advisory. The Commission specifically
requests comment, however, as to whether FCMs may treat non-
institutional customers in the same manner as institutional customers
are proposed to be treated in this area. Any statement required to be
furnished to a person other than a customer in accordance with
paragraph (d) of Rule 1.33 would also be permitted to be furnished by
electronic media.
The Commission also proposes to revise Rule 1.46 so that its
general standard would function as a default rule in the absence of
instruction by a customer or account controller. The Rule currently
requires, absent one of several exceptions, that an FCM close out
offsetting positions on a first-in, first-out basis, looking across all
accounts it carries for the same customer.\35\ Under the proposed rule,
any customer or account controller could instruct the FCM otherwise, so
that offsetting positions could be held open or closed out on other
than a first-in, first-out basis. CPOs and CTAs would be required to
disclose if they operate in this fashion, by amending Rules 4.24(h)(2)
(which applies to CPOs) and 4.34(h) (which applies to CTAs) to include
reference to the CPO's or CTA's instructions to FCMs concerning
application of offsetting positions pursuant to Rule 1.46.
---------------------------------------------------------------------------
\35\ An FCM must take into consideration positions in separate
accounts of the same customer that it is carrying in applying Rule
1.46. 57 FR 55082, 55083 n. 2 (November 24, 1992), citing U.S.
Department of Agriculture, Commodity Exchange Authority
Administrative Determination No. 134 (May 25, 1948).
---------------------------------------------------------------------------
In order to implement this revision of Rule 1.46, the Commission
proposes to amend the rule by inserting, after the words ``omnibus
accounts'' in paragraph (a), the phrase ``or where the customer or
account controller has instructed otherwise.'' Rule 1.46 also would be
amended by revising paragraph (e) to correspond to proposed new Rule
1.33(g) (the substance of the current paragraph (e) of Rule 1.46 would
be deleted because it currently relates back to paragraph (d)(6), which
is being removed and reserved) to read: ``The statements required by
paragraph (a) of this section may be furnished to the customer or the
person described in Sec. 1.33(d) by means of electronic transmission,
in accordance with Sec. 1.33(g).''
III. Related Matters
A. Regulatory Flexibility Act
The Regulatory Flexibility Act (``RFA''), 5 U.S.C. 601 et seq.
(1994 & Supp. II 1996), requires federal agencies, in proposing rules,
to consider the impact of those rules on small businesses. The rule
amendments discussed herein would affect FCMs, IBs, CPOs, CTAs, FBs,
FTs, leverage transaction merchants (``LTMs'') and agricultural trade
option merchants (``ATOMs''), as well as principals thereof. The
Commission has previously established certain definitions of ``small
entities'' to be used by the Commission in evaluating the impact of its
rules on small entities in accordance with the RFA.\36\ The Commission
has previously determined that registered FCMs, CPOs, LTMs and ATOMs
are not small entities for the purpose of the RFA.\37\ With respect to
IBs, CTAs, FBs and FTs, the Commission has stated that it is
appropriate to evaluate within the context of a particular rule
proposal whether some or all of the affected entities should be
considered small entities and, if so, to analyze the economic impact on
them of any rule.
---------------------------------------------------------------------------
\36\ 47 FR 18618-18621 (April 30, 1982).
\37\ 47 FR 18619-18620 (discussing FCMs and CPOs); 54 FR 19556,
19557 (May 8, 1989) (discussing LTMs); and 63 FR 18821, 18830 (April
16, 1998) (discussing ATOMs).
---------------------------------------------------------------------------
The amendments proposed herein would not require any registrant to
change its current method of doing business. For many registrants, the
proposed revisions should decrease the number of persons within the
registrant's organization who would be considered principals under the
CFTC rules. Further, the proposed revisions should reduce, rather than
increase, the regulatory requirements that apply to registrants and
applicants for registration, regardless of size. Accordingly, pursuant
to 5 U.S.C. 605(b), the Chairman, on behalf of the Commission,
certifies that these proposed amendments will not have a significant
economic impact on a substantial number of small entities.
B. Paperwork Reduction Act
As required by the Paperwork Reduction Act of 1995 [44 U.S.C.
3507(d)], the Commission has submitted a copy of these proposed
amendments to its rules to the Office of Management and Budget for its
review.
Collection of Information
Rules Relating to the Operations and Activities of Commodity Pool
Operators and Commodity Trading Advisors and to Monthly Reporting by
Futures
[[Page 39018]]
Commission Merchants, OMB Control Number 3038-0005.
The Commission believes that the amendments to Part 4 of its
regulations impose no burden. While these proposed rule amendments have
no burden, the group of rules (3038-0005) of which the rules proposed
to be amended are a part, has the following burden:
Average burden hours per response: 7.25.
Number of respondents: 7,362.
Frequency of response: Monthly, Quarterly, Annually, On Occasion.
Rules Pertaining to Contract Markets and Their Members, OMB Control
Number 3038-0022.
The Commission believes that the amendments to Parts 1 and 155 of
its regulations impose no burden. While these proposed rule amendments
have no burden, the group of rules (3038-0022) of which the rules
proposed to be amended are a part, has the following burden:
Average burden hours per response: 2.
Number of respondents: 15,894.
Frequency of response: On Occasion.
Rules, Regulations and Forms for Domestic and Foreign Futures and
Options Relating to Registration with the Commission, OMB Control
Number 3038-0023.
The expected effect of the proposed amended rule will be to reduce
the burden previously approved by OMB for this collection by 5,521.8
hours.
Specifically: The burden associated with Commission Rule 3.10(a) as
applied to FCMs is expected to be decreased by 2 hours:
Estimated number of respondents (after proposed amendment): 6.
Annual responses by each respondent: 1.
Estimated average hours per response: 0.5.
Annual reporting burden: 3 hours.
The burden associated with Commission Rule 3.10(a) as applied to
IBs is expected to be decreased by 54.8 hours:
Estimated number of respondents (after proposed amendment): 343.
Annual responses by each respondent: 1.
Estimated average hours per response: 0.4.
Annual reporting burden: 137.2 hours.
The burden associated with Form 8-R is expected to be decreased by
132 hours:
Estimated number of respondents (after proposed amendment): 2,400.
Annual responses by each respondent: 1.
Estimated average hours per response: 0.33.
Annual reporting burden: 792 hours.
The burden associated with Commission Rule 3.32 is expected to be
decreased by 1 hour:
Estimated number of respondents (after proposed amendment): 10.
Annual responses by each respondent: 1.
Estimated average hours per response: 0.2.
Annual reporting burden: 2 hours.
The recordkeeping and reporting burdens associated with Commission
Rule 3.34 are expected to be decreased by 5,332 hours:
Estimated number of respondents (after proposed amendment): 0.
Annual responses by each respondent: 0.
Estimated average hours per response: 0.
Annual reporting burden: 0 hours.
Regulations and Forms Pertaining to the Financial Integrity of the
Marketplace, OMB Control Number 3038-0024.
The expected effect of the proposed amended rule will be to reduce
the burden previously approved by OMB for this collection by 7.5 hours.
Specifically: The burden associated with Commission Rule 1.10 is
expected to be decreased by 7.5 hours:
Estimated number of respondents (after proposed amendment): 15.
Annual responses by each respondent: 1.
Estimated average hours per response: 1.
Annual reporting burden: 15 hours.
Copies of the information collection submission to OMB are
available from the CFTC Clearance Officer, 1155 21st Street NW.,
Washington, DC 20581, (202) 418-5160.
Persons wishing to comment on the information collection
requirements that would be required by these proposed rules should
contact the Office of Information and Regulatory Affairs, Office of
Management and Budget, Room 10235, New Executive Office Building,
Washington, DC 20503, Attn: Desk Officer for the Commodity Futures
Trading Commission.
The Commission considers comments by the public on this proposed
collection of information in--
� Evaluating whether the proposed collection of information
is necessary for the proper performance of the functions of the
Commission, including whether the information will have a practical
use;
� Evaluating the accuracy of the Commission's estimate of
the burden of the proposed collection of information including the
validity of the methodology and assumptions used;
� Enhancing the quality, utility, and clarity of the
information to be collected; and
� Minimizing the burden of the collection of the information
on those who are to respond, including through the use of appropriate
automated, electronic, mechanical or other technological collection
techniques or other forms of information technology, e.g. permitting
electronic submissions of responses.
OMB is required to make a decision concerning the collection of
information contained in these proposed regulations between 30 and 60
days after publication of this document in the Federal Register.
Therefore, a comment to OMB is best assured of having its full effect
if OMB receives it within 30 days of publication. This does not affect
the deadline for the public to comment to the Commission on the
proposed regulations.
Copies of the information collection submission to OMB are
available from the CFTC Clearance Officer, 1155 21st Street NW,
Washington, DC 20581 (202) 418-5160.
Lists of Subjects
17 CFR Part 1
Brokers, Commodity futures, Consumer protection, Reporting and
recordkeeping requirements.
17 CFR Part 3
Administrative practice and procedure, Brokers, Commodity futures,
Reporting and recordkeeping requirements, Registration, Principals.
17 CFR Part 4
Advertising, Commodity futures, Consumer protection, Reporting and
recordkeeping requirements, Principals, Commodity pool operators,
Commodity trading advisors, Disclosure.
17 CFR Part 140
Authority delegations (Government agencies), Conflict of interests,
Organization and functions (Government agencies).
17 CFR Part 155
Brokers, Commodity futures, Reporting and recordkeeping
requirements.
17 CFR Part 166
Brokers, Commodity futures, Consumer protection, Reporting and
recordkeeping requirements.
In consideration of the foregoing, and pursuant to the authority
contained in the Commodity Exchange Act, and in particular, Sections 2,
4b, 4d, 4f, 4m, 4n, 8a, and 19 thereof, 7 U.S.C. 2, 6b, 6d,
[[Page 39019]]
6f, 6m, 6n, 12a and 23, the Commission hereby proposes to amend Parts
1, 3, 4, 140, 155 and 166 of Chapter I of Title 17 of the Code of
Federal Regulations as follows:
PART 1--GENERAL REGULATIONS UNDER THE COMMODITY EXCHANGE ACT
1. The authority citation for Part 1 continues to read as follows:
Authority: 7 U.S.C. 1a, 2, 2a, 4, 4a, 6, 6a, 6b, 6c, 6d, 6e, 6f,
6g, 6h, 6i, 6j, 6k, 6l, 6m, 6n, 6o, 6p, 7, 7a, 7b, 8, 9, 12, 12a,
12c, 13a, 13a-1, 16, 16a, 19, 21, 23 and 24.
2. Section 1.3 is proposed to be amended by adding a new paragraph
(g) to read as follows:
Sec. 1.3 Definitions.
* * * * *
(g) Institutional customer. This term has the same meaning as
``eligible participant'' as defined in Sec. 35.1(b) of this chapter.
* * * * *
3. Section 1.10 is proposed to be amended as follows:
a. Revising paragraph (a)(2)(i)(B);
b. Adding paragraph (a)(2)(i)(C);
c. Designating the undesignated paragraph following paragraph
(a)(2)(i)(B) as paragraph (a)(2)(i)(D) and revising it;
d. Designating the undesignated paragraph following paragraph
(a)(2)(ii)(C) as paragraph (a)(2)(ii)(E) and revising it;
e. Redesignating paragraph (a)(2)(ii)(C) as (a)(2)(ii)(D) and
revising it; and
f. Adding a new paragraph (a)(2)(ii)(C).
The revisions and additions read as follows:
Sec. 1.10 Financial reports of futures commission merchants and
introducing brokers.
(a) * * *
(2) * * *
(i) * * *
(B) A Form 1-FR-FCM as of a date not more than 17 business days
prior to the date on which such report is filed and a Form 1-FR-FCM
certified by an independent public accountant in accordance with
Sec. 1.16 as of a date not more than one year prior to the date on
which such report is filed; or
(C) A Form 1-FR-FCM, Provided however, that such applicant shall be
subject to a review by the applicant's designated self-regulatory
organization within six months of being granted registration.
(D) Each such person must include with such financial report a
statement describing the source of his current assets and representing
that his capital has been contributed for the purpose of operating his
business and will continue to be used for such purpose.
(ii) * * *
(C) A Form 1-FR-IB, Provided however, that such applicant shall be
subject to a review by the applicant's designated self-regulatory
organization within six months of registration; or
(D) A guarantee agreement.
(E) Each person filing in accordance with paragraphs (a)(2)(ii)
(A), (B) or (C) of this section must include with such financial report
a statement describing the source of his current assets and
representing that his capital has been contributed for the purpose of
operating his business and will continue to be used for such purpose.
* * * * *
4. Section 1.17 is proposed to be amended by redesignating
paragraph (a)(1)(ii) as (a)(1)(iii) and by adding new paragraphs
(a)(1)(ii) and (a)(2)(iii) to read as follows:
Sec. 1.17 Minimum financial requirements for futures commission
merchants and introducing brokers.
(a) * * *
(1) * * *
(ii) Each person registered as a futures commission merchant
engaged in soliciting or accepting orders and customer funds related
thereto for the purchase or sale of any commodity for future delivery
on or subject to the rules of a derivatives transaction facility from
any non-institutional customer must be a clearing member of a
designated contract market or recognized futures exchange, and must
maintain adjusted net capital in the amount of the greater of
$20,000,000 or the amounts otherwise specified in paragraph (a)(1)(i)
of this section.
* * * * *
(2) * * *
(iii) The requirements of paragraph (a)(1) of this section shall
not be applicable if the registrant is a futures commission merchant or
introducing broker registered in accordance with Sec. 3.10(a)(1)(i)(B)
of this chapter, whose business is limited to transacting business on
behalf of institutional customers on a derivatives transaction
facility, and who conforms to minimum financial standards and related
reporting requirements set by such derivatives transaction facility in
its bylaws, rules, regulations or resolutions.
* * * * *
5. Section 1.20 is proposed to be amended by revising paragraphs
(a) and (c) to read as follows:
Sec. 1.20 Customer funds to be segregated and separately accounted
for.
(a) All customer funds shall be separately accounted for and
segregated as belonging to commodity or option customers. Such customer
funds when deposited with any bank, trust company, clearing
organization or another futures commission merchant shall be deposited
under an account name which clearly identifies them as such and shows
that they are segregated as required by the Act and this part. Each
registrant shall obtain and retain in its files for the period provided
in Sec. 1.31 a written acknowledgment from such bank, trust company,
clearing organization, or futures commission merchant, that it was
informed that the customer funds deposited therein are those of
commodity or option customers and are being held in accordance with the
provisions of the Act and this part: Provided, however, that an
acknowledgment need not be obtained from a clearing organization that
has adopted and submitted to the Commission rules that provide for the
segregation as customer funds, in accordance with all relevant
provisions of the Act and the rules and orders promulgated thereunder,
of all funds held on behalf of customers. Under no circumstances shall
any portion of customer funds be obligated to a clearing organization,
any member of a contract market, a futures commission merchant, or any
depository except to purchase, margin, guarantee, secure, transfer,
adjust or settle trades, contracts or commodity option transactions of
commodity or option customers. No person, including any clearing
organization or any depository, that has received customer funds for
deposit in a segregated account, as provided in this section, may hold,
dispose of, or use any such funds as belonging to any person other than
the option or commodity customers of the futures commission merchant
which deposited such funds.
* * * * *
(c) Each futures commission merchant shall treat and deal with the
customer funds of a commodity customer or of an option customer as
belonging to such commodity or option customer. All customer funds
shall be separately accounted for, and shall not be commingled with the
money, securities or property of a futures commission merchant or of
any other person, or be used to secure or guarantee the trades,
contracts or commodity options, or to secure or extend the credit, of
any person other than the one for whom the same are held: Provided,
however, That customer funds treated as belonging to
[[Page 39020]]
the commodity or option customers of a futures commission merchant may
for convenience be commingled and deposited in the same account or
accounts with any bank or trust company, with another person registered
as a futures commission merchant, or with a clearing organization, and
that such share thereof as in the normal course of business is
necessary to purchase, margin, guarantee, secure, transfer, adjust, or
settle the trades, contracts or commodity options of such commodity or
option customers or resulting market positions, with the clearing
organization or with any other person registered as a futures
commission merchant, may be withdrawn and applied to such purposes,
including the payment of premiums to option grantors, commissions,
brokerage, interest, taxes, storage and other fees and charges,
lawfully accruing in connection with such trades, contracts or
commodity options: Provided, further, That customer funds may be
invested in instruments described in Sec. 1.25.
6. Section 1.25 is proposed to be revised to read as follows:
Sec. 1.25 Investment of customer funds.
(a) Permitted investments. (1) Subject to the terms and conditions
set forth in this section, a futures commission merchant or a clearing
organization may invest customer funds in the following instruments
(permitted investments):
(i) Obligations of the United States and obligations fully
guaranteed as to principal and interest by the United States (U.S.
government securities);
(ii) General obligations of any State or of any political
subdivision thereof (municipal securities);
(iii) Obligations issued by any agency sponsored by the United
States (government sponsored agency securities);
(iv) Certificates of deposit issued by a bank (certificates of
deposit) as defined in section 3(a)(6) of the Securities Exchange Act
of 1934, or a domestic branch of a foreign bank insured by the Federal
Deposit Insurance Corporation;
(v) Commercial paper;
(vi) Corporate notes; and
(vii) Interests in money market mutual funds.
(2) In addition, a futures commission merchant or a clearing
organization may buy and sell the permitted investments listed in
paragraphs (a)(1)(i) through (vii) of this section pursuant to
agreements for resale or repurchase of the instruments, in accordance
with the provisions of paragraph (d) of this section.
(b) General terms and conditions. A futures commission merchant or
a clearing organization is required to manage the permitted investments
consistent with the objectives of preserving principal and maintaining
liquidity and according to the following specific requirements.
(1) Ratings--(i) Initial requirement. Instruments that are required
to be rated by this section must be rated by a nationally recognized
statistical rating organization (NRSRO), as that term is defined in
Sec. 270.2a-7 of this title. Ratings are required for permitted
investments as follows:
(A) U.S. government securities need not be rated;
(B) Municipal securities, government sponsored agency securities,
certificates of deposit, commercial paper, and corporate notes, except
notes that are asset-backed, must have the highest short-term rating of
an NRSRO or one of the two highest long-term ratings of an NRSRO;
(C) Corporate notes that are asset-backed must have the highest
rating of an NRSRO; and
(D) Money market mutual funds that are rated by an NRSRO must be
rated at the highest rating of the NRSRO or, if the fund is not rated,
investments made by the fund must comply with the requirements
applicable to direct investments under this section.
(ii) Effect of downgrade. If an NRSRO lowers the rating of an
instrument that was previously a permitted investment to below the
minimum rating required under this section, the value of the instrument
recognized for segregation purposes will be the lesser of:
(A) The current market value of the instrument; or
(B) The market value of the instrument on the business day
preceding the downgrade, reduced by 20 percent of that value for each
business day that has elapsed since the downgrade.
(2) Restrictions on instrument features. (i) With the exception of
money market mutual funds, no permitted investment may contain an
embedded derivative of any kind, including but not limited to a call
option, put option, or collar, cap or floor on interest paid.
(ii) No instrument may contain interest-only payment features.
(iii) No instrument may provide payments linked to a commodity,
currency, reference instrument, index, or benchmark except as provided
in paragraph (b)(2)(iv) of this section.
(iv) Variable-rate securities are permitted, provided the interest
rates paid correlate closely and on an unleveraged basis to a benchmark
of either the Federal Funds target or effective rate, the prime rate,
the three-month Treasury Bill rate, or the one-month or three-month
LIBOR rate.
(v) Certificates of deposit, if negotiable, must be able to be
liquidated within one business day or, if not negotiable, must be
redeemable at the issuing bank within one business day, with any
penalty for early withdrawal limited to any accrued interest earned.
(3) Concentration. (i) The aggregate investment in U.S. government
securities or in money market mutual funds shall not be subject to a
concentration limit.
(ii) The aggregate investment in the securities of any one issuer,
or related issuers, of government sponsored agency securities shall not
exceed 25 percent of the total assets held in segregation by the
futures commission merchant or the clearing organization. Securities
issued by an entity that directly or indirectly constitute an interest
in securities issued by a government sponsored agency shall be combined
and treated as the securities of a single issuer for the purpose of
determining the concentration limit.
(iii) The aggregate investment in the obligations of any one
issuer, or related issuers, of any permitted investments, other than
U.S. government securities, money market mutual funds, and government
sponsored agency instruments, may not exceed five percent of the total
assets held in segregation by the futures commission merchant or the
clearing organization.
(4) Time-to-maturity. Except for investments in money market mutual
funds, the dollar-weighted average of the time-to-maturity of the
portfolio, as that average is computed pursuant to Sec. 270.2a-7 of
this title, may not exceed 24 months.
(5) Investments in instruments issued by affiliates. (i) Except as
provided in paragraph (b)(5)(ii) of this section, a futures commission
merchant shall not invest customer funds in obligations of an entity
affiliated with the futures commission merchant, and a clearing
organization shall not invest customer funds in obligations of an
entity affiliated with the clearing organization. An affiliate includes
parent companies, including all entities through the ultimate holding
company, subsidiaries to the lowest level, and companies under common
ownership of such parent company or affiliates.
(ii) A futures commission merchant or clearing organization may
invest customer funds in a fund affiliated with that futures commission
merchant or clearing organization provided that the
[[Page 39021]]
fund itself does not invest in any instrument issued by the futures
commission merchant, clearing organization or affiliate thereof.
(6) Recordkeeping. A futures commission merchant and a clearing
organization shall prepare and maintain a record that will show for
each business day with respect to each type of investment made pursuant
to this section, the following information:
(i) The type of instruments in which customer funds have been
invested;
(ii) The original cost of the instruments; and
(iii) The current market value of the instruments.
(c) Money market mutual funds. The following provisions will apply
to the investment of customer funds in money market mutual funds (the
fund).
(1) Generally, the fund must be registered with the Securities and
Exchange Commission as a money market mutual fund, in compliance with
applicable requirements. A fund sponsor, however, may petition the
Commission for an exemption from this requirement. The Commission may
grant such an exemption provided that the fund can demonstrate that it
will operate in a manner designed to preserve principal and to maintain
liquidity. The application for exemption must describe how the fund's
structure, operations and financial reporting are expected to differ
from the requirements contained in Sec. 270.2a-7 of this title and the
risk-limiting provisions for direct investments contained in this
section. The fund must also specify the information that the fund would
make available to the Commission on an ongoing basis.
(2) The fund must be sponsored by a federally-regulated financial
institution, a bank as defined in section 3(a)(6) of the Securities
Exchange Act of 1934, or a domestic branch of a foreign bank insured by
the Federal Deposit Insurance Corporation, except for a fund exempted
in accordance with paragraph (c)(1) of this section.
(3) A futures commission merchant or clearing organization shall
hold its shares of the fund in a custody account in accordance with
Sec. 1.26(a). If the futures commission merchant or the clearing
organization holds its shares of the fund with the fund's shareholder
servicing agent, the sponsor of the fund and the fund itself are
required to provide the acknowledgment letter required by Sec. 1.26.
(4) The net asset value of the fund must be computed daily by 9
a.m. of each business day and made available to the futures commission
merchant or clearing organization by that time.
(5) An interest in a fund must be able to be liquidated by the
business day following a request to liquidate by the futures commission
merchant or clearing organization.
(6) The agreement pursuant to which the futures commission merchant
or clearing organization has acquired and is holding its interest in a
fund must contain no provision that would prevent the pledging or
transferring of shares.
(d) Repurchase and reverse repurchase agreements. A futures
commission merchant or clearing organization may buy and sell the
permitted investments pursuant to agreements for resale or repurchase
of the securities (repurchase transactions), provided the agreements
for resale or repurchase conform to the following requirements:
(1) The securities are specifically identified by coupon rate, par
amount, market value, maturity date, and CUSIP number.
(2) Counterparties are limited to a bank as defined in section
3(a)(6) of the Securities Exchange Act of 1934, a domestic branch of a
foreign bank insured by the Federal Deposit Insurance Corporation, a
securities broker or dealer, or a government securities broker or
government securities dealer registered with the Securities and
Exchange Commission or which has filed notice pursuant to section
15C(a) of the Government Securities Act of 1986.
(3) The transaction is made pursuant to a written agreement signed
by the parties to the agreement, which is consistent with the
conditions set forth in paragraphs (d)(1) through (d)(11) of this
section and which states that the parties thereto intend the
transaction to be treated as a purchase and sale of securities.
(4) The term of the agreement is no more than one business day, or
reversal of the transaction is possible on demand.
(5) The securities transferred under the agreement are held in a
safekeeping account with a bank as referred to in paragraph (d)(2) of
this section, a clearing organization or the Depository Trust
Corporation in an account that complies with the requirements of
Sec. 1.26.
(6) The futures commission merchant or the clearing organization
may not use securities received under the agreement in another similar
transaction and may not otherwise hypothecate or pledge such
securities, except securities may be pledged on behalf of customers at
another futures commission merchant or clearing organization.
Substitution of securities is allowed, provided, however, that:
(i) The qualifying securities being substituted and original
securities are specifically identified by date of substitution, market
values substituted, coupon rates, par amounts, maturity dates and CUSIP
numbers;
(ii) Substitution is made on a ``delivery versus delivery'' basis;
and (iii) The market value of the substituted securities is at least
equal to that of the original securities.
(7) The transfer of securities is made on a delivery versus payment
basis in immediately available funds. The transfer is not recognized as
accomplished until the funds and/or securities are actually received by
the custodian of the futures commission merchant's or clearing
organization's customer funds or securities purchased on behalf of
customers. The transfer or credit of securities covered by the
agreement to the futures commission merchant's or clearing
organization's customer segregated custodial account is made
simultaneously with the disbursement of funds from the futures
commission merchant's or clearing organization's customer segregated
cash account at the custodian bank. On the sale or resale of
securities, the futures commission merchant's or clearing
organization's customer segregated cash account at the custodian bank
must receive same-day funds credited to such segregated account
simultaneously with the delivery or transfer of securities from the
customer segregated custodial account.
(8) A written confirmation to the futures commission merchant or
clearing organization specifying the terms of the agreement and a
safekeeping receipt are issued immediately upon entering into the
transaction and a confirmation to the futures commission merchant or
clearing organization is issued once the transaction is reversed.
(9) The transactions effecting the agreement are recorded in the
record required to be maintained under Sec. 1.27 of investments of
customer funds, and the securities subject to such transactions are
specifically identified in such record as described in paragraph (d)(1)
of this section and further identified in such record as being subject
to repurchase and reverse repurchase agreements.
(10) An actual transfer of securities by book entry is made
consistent with Federal or State commercial law, as applicable. At all
times, securities received subject to an agreement are reflected as
``customer property.''
[[Page 39022]]
(11) The agreement makes clear that, in the event of the bankruptcy
of the futures commission merchant or clearing organization, any
securities purchased with customer funds that are subject to an
agreement may be immediately transferred. The agreement also makes
clear that, in the event of a futures commission merchant or clearing
organization bankruptcy, the counterparty has no right to compel
liquidation of securities subject to an agreement or to make a priority
claim for the difference between current market value of the securities
and the price agreed upon for resale of the securities to the
counterparty, if the former exceeds the latter.
(e) A futures commission merchant shall not be prohibited from
directly depositing unencumbered securities of the type specified in
this section, which it owns for its own account, into a segregated
safekeeping account or from transferring any such securities from a
segregated account to its own account, up to the extent of its residual
financial interest in customers' segregated funds; provided, however,
that such investments, transfers of securities, and disposition of
proceeds from the sale or maturity of such securities are recorded in
the record of investments required to be maintained by Sec. 1.27. All
such securities may be segregated in safekeeping only with a bank,
trust company, clearing organization, or other registered futures
commission merchant. Furthermore, for purposes of Secs. 1.25, 1.26,
1.27, 1.28 and 1.29, investments permitted by Sec. 1.25 that are owned
by the futures commission merchant and deposited into such a segregated
account shall be considered customer funds until such investments are
withdrawn from segregation.
7. Section 1.26 is proposed to be revised to read as follows:
Sec. 1.26 Deposit of instruments purchased with customer funds.
(a) Each futures commission merchant who invests customer funds in
instruments described in Sec. 1.25 shall separately account for such
instruments and segregate such instruments as belonging to such
commodity or option customers. Such instruments, when deposited with a
bank, trust company, clearing organization or another futures
commission merchant, shall be deposited under an account name which
clearly shows that they belong to commodity or option customers and are
segregated as required by the Act and this part. Each futures
commission merchant upon opening such an account shall obtain and
retain in its files an acknowledgment from such bank, trust company,
clearing organization or other futures commission merchant that it was
informed that the instruments belong to commodity or option customers
and are being held in accordance with the provisions of the Act and
this part. Provided, however, that an acknowledgment need not be
obtained from a clearing organization that has adopted and submitted to
the Commission rules that provide for the segregation as customer
funds, in accordance with all relevant provisions of the Act and the
rules and orders promulgated thereunder, of all funds held on behalf of
customers and all instruments purchased with customer funds. Such
acknowledgment shall be retained in accordance with Sec. 1.31. Such
bank, trust company, clearing organization or other futures commission
merchant shall allow inspection of such obligations at any reasonable
time by representatives of the Commission.
(b) Each clearing organization which invests money belonging or
accruing to commodity or option customers of its clearing members in
instruments described in Sec. 1.25 shall separately account for such
instruments and segregate such instruments as belonging to such
commodity or option customers. Such instruments, when deposited with a
bank or trust company, shall be deposited under an account name which
will clearly show that they belong to commodity or option customers and
are segregated as required by the Act and this part. Each clearing
organization upon opening such an account shall obtain and retain in
its files a written acknowledgment from such bank or trust company that
it was informed that the instruments belong to commodity or option
customers of clearing members and are being held in accordance with the
provisions of the Act and this part. Such acknowledgment shall be
retained in accordance with Sec. 1.31. Such bank or trust company shall
allow inspection of such instruments at any reasonable time by
representatives of the Commission.
Secs. 1.27, 1.28 and 1.29 [Amended]
8. Sections 1.27, 1.28 and 1.29 are proposed to be amended by
revising the word ``obligations'' to read ``instruments'' each time it
appears.
9. Section 1.33 is proposed to be amended by adding a new paragraph
(g) to read as follows:
Sec. 1.33 Monthly and confirmation statements.
* * * * *
(g) Electronic transmission of statements. (1) The statements
required by this section, and by Sec. 1.46, may be furnished to anyt
customer by means of electronic media if the customer so requests,
Provided, however, that a futures commission merchant must, prior to
the transmission of any statement by means of electronic media,
disclose the electronic medium or source through which statements will
be delivered, the duration, whether indefinite or not, of the period
during which consent will be effective, any charges for such service,
the information that will be delivered by such means, and that consent
to electronic delivery may be revoked at any time.
(2) In the case of a non-institutional customer, a futures
commission merchant must obtain the non-institutional customer's signed
consent acknowledging disclosure of the information set forth in
paragraph (g)(1) of this section prior to the transmission of any
statement by means of electronic media.
(3) Any statement required to be furnished to a person other than a
customer in accordance with paragraph (d) of this section may be
furnished by electronic media.
(4) A futures commission merchant who furnishes statements to any
customer by means of electronic media must retain a daily confirmation
statement for such customer as of the end of the trading session,
reflecting all transactions made during that session for the customer,
in accordance with Sec. 1.31.
10. Section 1.46 is proposed to be amended as follows:
a. By revising paragraph (a), introductory text,
b. By removing and reserving paragraphs (d)(4) through (d)(7),
c. By removing paragraph (d)(9) and
d. By revising paragraph (e) to read as follows:
Sec. 1.46 Application and closing out of offsetting long and short
positions.
(a) Application of purchases and sales. Except with respect to
purchases or sales which are for omnibus accounts, or where the
customer has instructed otherwise, any futures commission merchant who,
on or subject to the rules of a contract market:
* * * * *
(e) The statements required by paragraph (a) of this section may be
furnished to the customer or the person described in Sec. 1.33(d) by
means of electronic transmission, in accordance with Sec. 1.33(g).
[[Page 39023]]
11. Section 1.52 is proposed to be amended by adding a new
paragraph (m) to read as follows:
Sec. 1.52 Self-regulatory organization adoption and surveillance of
minimum financial requirements.
* * * * *
(m) Nothing in this section shall apply to the activities of a
derivatives transaction facility or the minimum adjusted net capital
requirements it may require of persons operating thereon pursuant to
Sec. 1.17(a)(2)(iii).
12. Section 1.55 is proposed to be amended by revising paragraphs
(d) and (f) to read as follows:
Sec. 1.55 Distribution of ``Risk Disclosure Statement'' by futures
commission merchants and introducing brokers.
* * * * *
(d) Any futures commission merchant, or in the case of an
introduced account any introducing broker, may open a commodity futures
account for a customer without obtaining the separate acknowledgments
of disclosure and elections required by this section and by
Sec. 1.33(g), and by Secs. 33.7, 155.3(b)(2), and 190.06 of this
chapter, provided that:
(1) Prior to the opening of such account, the futures commission
merchant or introducing broker obtains an acknowledgment from the
customer, which may consist of a single signature at the end of the
futures commission merchant's or introducing broker's customer account
agreement, or on a separate page, of the disclosure statements and
elections specified in this section and Sec. 1.33(g), and in
Secs. 33.7, 155.3(b)(2), and 190.06 of this chapter, and which may
include authorization for the transfer of funds from a segregated
customer account to another account of such customer, as listed
directly above the signature line, provided the customer has
acknowledged by check or other indication next to a description of each
specified disclosure statement or election that the customer has
received and understood such disclosure statement or made such
election;
(2) The acknowledgment referred to in paragraph (d)(1) of this
section must be accompanied by and executed contemporaneously with
delivery of the disclosures and elective provisions required by this
section and Sec. 1.33(g), and by Secs. 33.7, 155.3(b)(2), and 190.06 of
this chapter.
* * * * *
(f) A futures commission merchant or, in the case of an introduced
account an introducing broker, may open a commodity futures account for
an institutional customer without furnishing such institutional
customer the disclosure statements or obtaining the acknowledgements
required under paragraph (a) of this section, Secs. 1.33(g) and
1.65(a)(3), and Secs. 30.6(a), 33.7(a), 155.3(b)(2), and 190.10(c) of
this chapter.
* * * * *
PART 3--REGISTRATION
13. The authority citation for Part 3 is revised to read as
follows:
Authority: 5 U.S.C. 522, 522b; 7 U.S.C. 1a, 2, 4, 4a, 6, 6a, 6b,
6c, 6d, 6e, 6f, 6g, 6h, 6i, 6k, 6m, 6n, 6o, 6p, 8, 9, 9a, 12, 12a,
13b, 13c, 16a, 18, 19, 21, 23.
14. Section 3.1 is proposed to be amended by revising paragraphs
(a)(1) and (a)(2) to read as follows:
Sec. 3.1 Definitions.
(a) * * *
(1) If the entity is organized as a sole proprietorship, the
proprietor; if a partnership, any general partner; if a corporation,
any director, the president, chief executive officer, chief operating
officer, chief financial officer, and any person in charge of a
principal business unit, division or function subject to regulation by
the Commission; if a limited liability company or limited liability
partnership, any director, the president, chief executive officer,
chief operating officer, chief financial officer, the manager, managing
member or those members vested with the management authority for the
entity, and any person in charge of a principal business unit, division
or function subject to regulation by the Commission; and, in addition,
any person occupying a similar status or performing similar functions,
having the power, directly or indirectly, through agreement or
otherwise, to exercise a controlling influence over the entity's
activities that are subject to regulation by the Commission;
(2)(i) Any individual who directly or indirectly, through
agreement, holding company, nominee, trust or otherwise, is the owner
of ten percent or more of the outstanding shares of any class of stock,
is entitled to vote or has the power to sell or direct the sale of ten
percent or more of any class of voting securities, or is entitled to
receive ten percent or more of the profits; or
(ii) Any person other than an individual that is the direct owner
of ten percent or more of any class of securities; or
* * * * *
15. Section 3.10 is proposed to be amended by revising paragraph
(a)(1)(i), by redesignating paragraph (a)(2)(i) as paragraph (a)(2), by
removing paragraph (a)(2)(ii), and by revising paragraph (d) to read as
follows:
Sec. 3.10 Registration of futures commission merchants, introducing
brokers, commodity trading advisors, commodity pool operators and
leverage transaction merchants.
(a) Application for Registration. (1)(i)(A) Except as provided in
paragraph (a)(1)(i)(B) of this section, application for registration as
a futures commission merchant, introducing broker, commodity trading
advisor, commodity pool operator or leverage transaction merchant must
be on Form 7-R, completed and filed with the National Futures
Association in accordance with the instructions thereto.
(B) An applicant for registration as a futures commission merchant
or introducing broker that will conduct transactions exclusively on or
subject to the rules of a derivatives transaction facility for
institutional customers, and which is registered with the Securities
and Exchange Commission as a securities broker or dealer, or is a bank
or any other financial depository institution subject to regulation by
the United States, may apply for registration by filing with the
National Futures Association notice of its intention to undertake
transactions exclusively on or subject to the rules of a derivatives
transaction facility for institutional customers, together with a
certification of registration and good standing with the appropriate
authority or of authorization to engage in such transactions by said
authority.
* * * * *
(d) Annual filing. Any person registered as a futures commission
merchant, introducing broker, commodity trading advisor, commodity pool
operator or leverage transaction merchant in accordance with paragraph
(a)(1)(i)(A) of this section must file with the National Futures
Association a Form 7-R, completed in accordance with the instructions
thereto, annually on a date specified by the National Futures
Association. The failure to file the Form 7-R within thirty days
following such date shall be deemed to be a request for withdrawal from
registration. On at least thirty days written notice, and following
such action, if any, deemed to be necessary by the Commission or the
National Futures Association, the National Futures Association may
grant the request for withdrawal from registration.
16. Section 3.32 is proposed to be amended as follows:
a. Adding paragraphs
(a)(1)(i)(A) and (B);
[[Page 39024]]
b. Revising paragraphs (a)(1)(ii) and (a)(1)(v);
c. Redesignating paragraphs (a)(1)(vi)and (a)(1)(vii) as paragraphs
(a)(1)(vii) and (a)(1)(viii), respectively;
d. Adding a new paragraph (a)(1)(vi);
e. Revising paragraph (a)(2)(i); and
f. Revising paragraph (e)(1).
The revisions and additions read as follows:
Sec. 3.32 Changes requiring new registration; addition of principals.
(a)(1) * * *
(i) * * *
(A) As an individual, directly or indirectly, through agreement,
holding company, nominee, trust or otherwise, becomes the owner of ten
percent or more of the outstanding shares of any class of stock or
acquires the right to vote or the power to sell or to direct the sale
of ten percent or more of the registrant's voting securities;
(B) Any person other than an individual that becomes the direct
owner of ten percent or more of any class of a registrant's securities;
(ii) As an individual becomes entitled to receive ten percent or
more of the registrant's profits;
* * * * *
(v) Becomes the president, chief executive officer, chief operating
officer or chief financial officer of the corporate registrant, or
becomes in charge of a principal business unit, division or function
subject to regulation by the Commission, or comes to occupy a position
of similar status or perform a similar function;
(vi) Becomes a director, president, chief executive officer, chief
operating officer, chief financial officer, manager, managing member or
a member vested with the management authority for the registrant or
becomes in charge of a principal business unit, division or function
subject to regulation by the Commission, or comes to occupy a position
of similar status or perform a similar function in the case of a
limited liability company or limited liability partnership;
* * * * *
(2)(i) If a person becomes a principal of the registrant because of
an event described in paragraph (a)(1)(i)(B) of this section, the
registrant's registration shall not be deemed to terminate and a new
Form 7-R need not be filed: Provided, however, that within twenty days
of the occurrence of the event described in paragraph (a)(1)(i)(B) of
this section, the registrant must notify the National Futures
Association of the name of such added principal on Form 3-R and must
file written certifications with the National Futures Association
stating:
(A) The ultimate day-to-day control of the registrant remains the
same,
(B) The addition of the new principal will not affect the conduct
or the day-to-day operations of the registrant, and
(C) The insertion of the new principal into the chain of ownership
is not being done for the purpose, and will not have the effect, of
limiting any liability of the registrant.
* * * * *
(e)(1) Except where a registrant chooses to file an application
pursuant to paragraph (d) of this section, if applicable, in the event
of a change as described in paragraph (a)(1)(v) or (a)(1)(vi) of this
section, a new registration will not be required if the registrant
submits a written notice on Form 3-R to the National Futures
Association prior to the date of such change in control (and such
change does not occur until the registrant receives written approval
from the National Futures Association) and includes with such notice a
Form 8-R, completed in accordance with the instructions thereto and
executed by the person referred to in paragraph (a)(1)(v) or (a)(1)(vi)
of this section. The Form 8-R for such individual must be accompanied
by the fingerprints of that individual on a fingerprint card provided
for that purpose by the National Futures Association: Provided,
however, That a fingerprint card need not be provided under this
paragraph for any individual who has a current Form 8-R on file with
the National Futures Association or the Commission.
* * * * *
Sec. 3.34 [Removed]
17. Section 3.34 is proposed to be removed.
18. Part 3 is proposed to be amended by adding Appendix B to read
as follows:
Appendix B to Part 3--Statement of Acceptable Practices With
Respect to Ethics Training
(a) The provisions of Section 4p(b) of the Act (7 U.S.C. 6p(b)
(1994)) set forth requirements regarding training of registrants as
to their responsibilities to the public. This section requires the
Commission to issue regulations requiring new registrants to attend
ethics training sessions within six months of registration, and all
registrants to attend such training on a periodic basis. Consistent
with the will of Congress, the Commission believes that a Core
Principle for all persons intermediating transactions in recognized
multilateral trade execution facilities is fitness. The awareness
and maintenance of professional ethical standards are essential
elements of a registrant's fitness. Further, the use of ethics
training programs is relevant to a registrant's maintenance of
adequate supervision, itself a Core Principle, and a requirement
under Rule 166.3.
(b)(1) The Commission recognizes that technology has provided
new, faster means of sharing and distributing information. In view
of the foregoing, the Commission has chosen to allow registrants to
develop their own ethics training programs. Nevertheless, futures
industry professionals may want guidance as to the role of ethics
training. Registrants may wish to consider what ethics training
should be retained, its format, and how it might best be
implemented. Therefore, the Commission finds it appropriate to issue
this Statement of Acceptable Practices regarding appropriate
training for registrants, as interpretative guidance for
intermediaries on fitness and supervision. Commission registrants
may look to this Statement of Acceptable Practices as a ``safe
harbor'' concerning acceptable procedures in this area.
(2) The Commission believes that section 4p(b) of the Act
reflects an intent by Congress that industry professionals be aware,
and remain abreast, of their continuing obligations to the public
under the Act and the regulations thereunder. The text of the Act
provides guidance as to the nature of these responsibilities. As
expressed in section 4p(b) of the Act, personnel in the industry
have an obligation to the public to observe the Act, the rules of
the Commission, the rules of any appropriate self-regulatory
organizations or contract markets (which would also include
recognized futures exchanges and recognized derivatives transactions
facilities), or other applicable federal or state laws or
regulations. Further, section 4p(b) acknowledges that registrants
have an obligation to the public to observe ``just and equitable
principles of trade.''
(3) Additionally, section 4p(b) reflects Congress' intent that
registrants and their personnel retain an up-to-date knowledge of
these requirements. The Act requires that registrants receive
training on a periodic basis. Thus, it is the intent of Congress
that Commission registrants remain current with regard to the
ethical ramifications of new technology, commercial practices,
regulations, or other changes.
(c) The Commission believes that training should be focused to
some extent on a person's registration category, although there will
obviously be certain principles and issues common to all registrants
and certain general subjects that should be taught. Topics to be
addressed include:
(1) An explanation of the applicable laws and regulations, and
the rules of self-regulatory organizations or contract markets,
recognized futures exchanges and derivatives transaction facilities;
(2) The registrant's obligation to the public to observe just
and equitable principles of trade;
(3) How to act honestly and fairly and with due skill, care and
diligence in the best interests of customers and the integrity of
the market;
(4) How to establish effective supervisory systems and internal
controls;
[[Page 39025]]
(5) Obtaining and assessing the financial situation and
investment experience of customers;
(6) Disclosure of material information to customers; and
(7) Avoidance, proper disclosure and handling of conflicts of
interest.
(d) An acceptable ethics training program would apply to all of
a firm's associated persons and its principals to the extent they
are required to register as associated persons. Additionally,
personnel of firms that rely on their registration with other
regulators, such as the Securities and Exchange Commission, should
be provided with ethics training to the extent the Act and the
Commission's regulations apply to their business.
(e) As to the providers of such training, the Commission
believes that classes sponsored by independent persons, firms, or
industry associations would be acceptable. It would also be
permissible to conduct in-house training programs. Further,
registrants should ascertain the credentials of any ethics training
providers they retain. Thus, persons who provide ethics training
should be required to provide proof of satisfactory completion of
the proficiency testing requirements applicable to the registrant
and evidence of three years of relevant industry or pedagogical
experience in the field. This industry experience might include the
practice of law in the fields of futures or securities, or
employment as a trader or risk manager at a brokerage or end-user
firm. Likewise, the Commission believes that registrants should
employ as ethics training providers only those persons they
reasonably believe in good faith are not subject to any
investigations or to bars to registration or to service on a self-
regulatory organization governing board or disciplinary panel.
(f)(1) With regard to the frequency and duration of ethics
training, it is permissible for a firm to require training on
whatever periodic basis and duration the registrant (and relevant
self-regulatory organizations) deems appropriate. It may even be
appropriate not to require any such specific requirements as, for
example, where ethics training could be termed ongoing. For
instance, a small entity, sole proprietorship, or even a small
section in an otherwise large firm, might satisfy its obligation to
remain current with regard to ethics obligations by distribution of
periodicals, legal cases, or advisories. Use of the latest
information technology, such as Internet websites, can be useful in
this regard. In such a context, there would be no structured
classes, but the goal should be a continuous awareness of changing
industry standards. A corporate culture to maintain high ethical
standards should be established on a continuing basis.
(2) On the other hand, larger firms which transact business with
a larger segment of the public may wish to implement a training
program that requires periodic classwork. In such a situation, the
Commission believes it appropriate for registrants to maintain such
records as evidence of attendance and of the materials used for
training. In the case of a floor broker or floor trader, the
applicable contract market, recognized futures exchange or
derivatives transaction facility should maintain such evidence on
behalf of its member. This evidence of ethics training could be
offered to demonstrate fitness and overall compliance during audits
by self-regulatory organizations, and during reviews of contract
market, recognized futures exchange or derivatives transaction
facility operations.
(g) The methodology of such training may also be flexible.
Recent innovations in information technology have made possible new,
fast, and cost-efficient ways for registrants to maintain their
awareness of events and changes in the commodity interest markets.
In this regard, the Commission recognizes that the needs of a firm
will vary according to its size, personnel, and activities. No
format of classes will be required. Rather, such training could be
in the form of formal class lectures, video presentation, Internet
transmission, or by simple distribution of written materials. These
options should provide sufficiently flexible means for adherence to
Congressional intent in this area.
(h) Finally, it should be noted that self-regulatory
organizations and industry associations will have a significant role
in this area. Such organizations may have separate ethics and
proficiency standards, including ethics training and testing
programs, for their own members.
PART 4--COMMODITY POOL OPERATORS AND COMMODITY TRADING ADVISORS
19. The authority citation for Part 4 continues to read as follows:
Authority: 7 U.S.C. 1a, 2, 4, 6b, 6c, 6l, 6m, 6n, 6o, 12a, and
23.
20. Section 4.10 is proposed to be amended by revising paragraph
(e)(1) to read as follows:
Sec. 4.10 Definitions.
* * * * *
(e)(1) Principal, when referring to a person that is a principal of
a particular entity, shall have the same meaning as the term principal
under Sec. 3.1(a) of this chapter.
* * * * *
21. Section 4.24 is proposed to be amended by revising paragraphs
(f)(1)(v) and (h)(2) to read as follows:
Sec. 4.24 General Disclosures required.
* * * * *
(f) * * *
(1) * * *
(v) Each principal of the foregoing persons who participates in
making trading or operational decisions for the pool or who supervises
persons so engaged.
* * * * *
(h) * * *
(2) A description of the trading and investment programs and
policies that will be followed by the offered pool, including the
method chosen by the pool operator concerning how futures commission
merchants carrying the pool's accounts shall treat offsetting positions
pursuant to Sec. 1.46 of this chapter, if the method is other than to
close out all offsetting positions or to close out offsetting positions
on other than a first-in, first-out basis, and any material
restrictions or limitations on trading required by the pool's
organizational documents or otherwise. This description must include,
if applicable, an explanation of the systems used to select commodity
trading advisors, investee pools and types of investment activity to
which pool assets will be committed;
* * * * *
22. Section 4.34 is proposed to be amended by revising paragraphs
(f)(1)(ii) and (h) to read as follows:
Sec. 4.34 General Disclosures required.
* * * * *
(f) * * *
(1) * * *
(ii) Each principal of the trading advisor who participates in
making trading or operational decisions for the trading advisor or
supervises persons so engaged.
* * * * *
(h) Trading program. A description of the trading program, which
must include the method chosen by the commodity trading advisor
concerning how futures commission merchants carrying accounts it
manages shall treat offsetting positions pursuant to Sec. 1.46 of this
chapter, if the method is other than to close out all offsetting
positions or to close out offsetting positions on other than a first-
in, first-out basis, and the types of commodity interests and other
interests the commodity trading advisor intends to trade, with a
description of any restrictions or limitations on such trading
established by the trading advisor or otherwise.
* * * * *
PART 140--ORGANIZATION, FUNCTIONS AND PROCEDURES OF THE COMMISSION
23. The authority citation for Part 140 continues to read as
follows:
Authority: 7 U.S.C. 4a, 12a.
24. Section 140.91 is proposed to be amended by adding a new
paragraph (a)(7) to read as follows:
Sec. 140.91 Delegation of authority to the Director of the Division of
Trading and Markets.
(a) * * *
(7) All functions reserved to the Commission in Sec. 1.25 of this
chapter.
* * * * *
[[Page 39026]]
PART 155--TRADING STANDARDS
25. The authority citation for Part 155 continues to read as
follows:
Authority: 7 U.S.C. 6b, 6c, 6g, 6j and 12a unless otherwise
noted.
26. Sections 155.2, 155.3, 155.4 and 155.5 are proposed to be
amended by adding the words ``or recognized futures exchange'' after
the words ``contract market'' each time they appear.
27. Section 155.6 is proposed to be added to read as follows:
Sec. 155.6. Trading Standards for the Transaction of Business on
Derivatives Transaction Facilities.
(a) A futures commission merchant, or affiliated person thereof,
transacting business on behalf of a non-institutional customer on a
derivatives transaction facility shall comply with the provisions of
Sec. 155.3.
(b) No futures commission merchant, introducing broker or
affiliated person thereof shall misuse knowledge of any institutional
customer's order for execution on a derivatives transaction facility.
PART 166--CUSTOMER PROTECTION RULES
28. The authority citation for Part 166 is proposed to be amended
to read as follows:
Authority: 7 U.S.C. 1a, 2, 4, 6b, 6c, 6d, 6g, 6h, 6k, 6l, 6o,
7a, 12a, 21 and 23, unless otherwise noted.
29. Section 166.5 is proposed to be added to read as follows:
Sec. 166.5 Dispute settlement procedures.
(a) Definitions.
(1) The term claim or grievance as used in this section shall mean
any dispute that
(i) Arises out of any transaction executed on or subject to the
rules of a contract market, a recognized futures exchange or a
derivatives transaction facility,
(ii) Is executed or effected through a member of such facility, a
participant transacting on or through such facility or an employee of
such facility, and
(iii) Does not require for adjudication the presence of essential
witnesses or third parties over whom the facility does not have
jurisdiction and who are not otherwise available.
(iv) The term claim or grievance does not include disputes arising
from cash market transactions that are not a part of or directly
connected with any transaction for the purchase or sale of any
commodity for future delivery or commodity option.
(2) The term customer as used in this section includes an option
customer (as defined in Sec. 1.3(jj) of this chapter) and any person
for or on behalf of whom a member of a contract market, a recognized
futures exchange or a derivatives transaction facility or a participant
transacting on or through such market, exchange or facility effects a
transaction on or through such market, exchange or facility, except
another member of or participant in such market, exchange or facility.
(3) The term Commission registrant as used in this section means a
person registered under the Act as a futures commission merchant,
introducing broker, floor broker, commodity pool operator, commodity
trading advisor, or associated person.
(b) Voluntariness. The use by customers of dispute settlement
procedures shall be voluntary as provided in paragraph (c) of this
section.
(c) Pre-Dispute Arbitration Agreements. No Commission registrant
shall enter into any agreement or understanding with a customer in
which the customer agrees, prior to the time a claim or grievance
arises, to submit such claim or grievance to any settlement procedure
except as follows:
(1) Signing the agreement must not be made a condition for the
customer to utilize the services offered by the Commission registrant.
(2) If the agreement is contained as a clause or clauses of a
broader agreement, the customer must separately endorse the clause or
clauses containing the cautionary language and provisions specified in
this section. A futures commission merchant or introducing broker may
obtain such endorsement as provided in Sec. 1.55(d) of this chapter for
the following classes of customers only:
(i) An institutional customer as defined in Sec. 1.3(g) of this
chapter;
(ii) A plan defined as a government plan or church plan in section
3(32) or section 3(33) of title I of the Employee Retirement Income
Security Act of 1974, or a foreign person performing a similar role or
function subject as such to comparable foreign regulation; and
(iii) A person who is a ``qualified eligible participant'' or a
``qualified eligible client'' as defined in Sec. 4.7 of this chapter.
(3) The agreement may not require the customer to waive the right
to seek reparations under section 14 of the Act and part 12 of this
chapter. Accordingly, the customer must be advised in writing that he
or she may seek reparations under section 14 of the Act by an election
made within 45 days after the Commission registrant notifies the
customer that arbitration will be demanded under the agreement. This
notice must be given at the time when the Commission registrant
notifies the customer of an intention to arbitrate. The customer must
also be advised that if he or she seeks reparations under section 14 of
the Act and the Commission declines to institute reparation
proceedings, the claim or grievance will be subject to the pre-existing
arbitration agreement and must also be advised that aspects of the
claim or grievance that are not subject to the reparations procedure
(i.e., do not constitute a violation of the Act or rules thereunder)
may be required to be submitted to the arbitration or other dispute
settlement procedure set forth in the pre-existing arbitration
agreement.
(4) The agreement must advise the customer that, at such time as he
or she may notify the Commission registrant that he or she intends to
submit a claim to arbitration, or at such time as such person notifies
the customer of its intent to submit a claim to arbitration, the
customer will have the opportunity to elect a qualified forum for
conducting the proceeding.
(5) Election of forum. (i) Within ten business days after receipt
of notice from the customer that he or she intends to submit a claim to
arbitration, or at the time a Commission registrant notifies the
customer of its intent to submit a claim to arbitration, the Commission
registrant must provide the customer with a list of organizations whose
procedures meet Acceptable Practices established by the Commission for
customer dispute resolution, together with a copy of the rules of each
forum listed. The list must include:
(A) The contract market, recognized futures exchange or derivatives
transaction facility, if available, upon which the transaction giving
rise to the dispute was executed or could have been executed;
(B) A registered futures association; and
(C) At least one other organization that will provide the customer
with the opportunity to select the location of the arbitration
proceeding from among several major cities in diverse geographic
regions and that will provide the customer with the choice of a panel
or other decision-maker composed of at least one or more persons, of
which at least a majority are not members or associated with a member
of the contract market, recognized futures exchange or derivatives
transaction facility or employee thereof, and that are not otherwise
associated with the contract market, recognized futures exchange or
derivatives transaction
[[Page 39027]]
facility (mixed panel): Provided, however, that the list of qualified
organizations provided by a Commission registrant that is a floor
broker need not include a registered futures association unless a
registered futures association has been authorized to act as a
decision-maker in such matters.
(ii) The customer shall, within forty-five days after receipt of
such list, notify the opposing party of the organization selected. A
customer's failure to provide such notice shall give the opposing party
the right to select an organization from the list.
(6) Fees. The agreement must acknowledge that the Commission
registrant will pay any incremental fees that may be assessed by a
qualified forum for provision of a mixed panel, unless the arbitrators
in a particular proceeding determine that the customer has acted in bad
faith in initiating or conducting that proceeding.
(7) Cautionary Language. The agreement must include the following
language printed in large boldface type:
THREE FORUMS EXIST FOR THE RESOLUTION OF COMMODITY DISPUTES: CIVIL
COURT LITIGATION, REPARATIONS AT THE COMMODITY FUTURES TRADING
COMMISSION (CFTC) AND ARBITRATION CONDUCTED BY A SELF-REGULATORY OR
OTHER PRIVATE ORGANIZATION.
THE CFTC RECOGNIZES THAT THE OPPORTUNITY TO SETTLE DISPUTES BY
ARBITRATION MAY IN SOME CASES PROVIDE MANY BENEFITS TO CUSTOMERS,
INCLUDING THE ABILITY TO OBTAIN AN EXPEDITIOUS AND FINAL RESOLUTION OF
DISPUTES WITHOUT INCURRING SUBSTANTIAL COSTS. THE CFTC REQUIRES,
HOWEVER, THAT EACH CUSTOMER INDIVIDUALLY EXAMINE THE RELATIVE MERITS OF
ARBITRATION AND THAT YOUR CONSENT TO THIS ARBITRATION AGREEMENT BE
VOLUNTARY.
BY SIGNING THIS AGREEMENT, YOU: (1) MAY BE WAIVING YOUR RIGHT TO
SUE IN A COURT OF LAW; AND (2) ARE AGREEING TO BE BOUND BY ARBITRATION
OF ANY CLAIMS OR COUNTERCLAIMS WHICH YOU OR [NAME] MAY SUBMIT TO
ARBITRATION UNDER THIS AGREEMENT. YOU ARE NOT, HOWEVER, WAIVING YOUR
RIGHT TO ELECT INSTEAD TO PETITION THE CFTC TO INSTITUTE REPARATIONS
PROCEEDINGS UNDER SECTION 14 OF THE COMMODITY EXCHANGE ACT WITH RESPECT
TO ANY DISPUTE THAT MAY BE ARBITRATED PURSUANT TO THIS AGREEMENT. IN
THE EVENT A DISPUTE ARISES, YOU WILL BE NOTIFIED IF [NAME] INTENDS TO
SUBMIT THE DISPUTE TO ARBITRATION. IF YOU BELIEVE A VIOLATION OF THE
COMMODITY EXCHANGE ACT IS INVOLVED AND IF YOU PREFER TO REQUEST A
SECTION 14 ``REPARATIONS'' PROCEEDING BEFORE THE CFTC, YOU WILL HAVE 45
DAYS FROM THE DATE OF SUCH NOTICE IN WHICH TO MAKE THAT ELECTION.
YOU NEED NOT SIGN THIS AGREEMENT TO OPEN OR MAINTAIN AN ACCOUNT
WITH [NAME]. SEE 17 CFR 166.5.
(d) Enforceability. A dispute settlement procedure may require
parties utilizing such procedure to agree, under applicable state law,
submission agreement or otherwise, to be bound by an award rendered in
the procedure, provided that the agreement to submit the claim or
grievance to the procedure was made in accordance with paragraph (c) of
this section or that the agreement to submit the claim or grievance was
made after the claim or grievance arose. Any award so rendered shall be
enforceable in accordance with applicable law.
(e) Time limits for submission of claims. The dispute settlement
procedure established by a contract market, recognized futures exchange
or derivatives transaction facility shall not include any unreasonably
short limitation period foreclosing submission of customers' claims or
grievances or counterclaims.
(f) Counterclaims. A procedure established by a contract market,
recognized futures exchanges or derivatives transaction facility under
the Act for the settlement of customers' claims or grievances against a
member or employee thereof may permit the submission of a counterclaim
in the procedure by a person against whom a claim or grievance is
brought. The contract market, recognized futures exchanges or
derivatives transaction facility may permit such a counterclaim where
the counterclaim arises out of the transaction or occurrence that is
the subject of the customer's claim or grievance and does not require
for adjudication the presence of essential witnesses, parties or third
persons over whom the contract market, recognized futures exchanges or
derivatives transaction facility does not have jurisdiction. Other
counterclaims are permissible only if the customer agrees to the
submission after the counterclaim has arisen, and if the aggregate
monetary value of the counterclaim is capable of calculation.
Issued in Washington, DC on June 8, 2000, by the Commission.
Jean A. Webb,
Secretary of the Commission.
[FR Doc. 00-14915 Filed 6-21-00; 8:45 am]
BILLING CODE 6351-01-U
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