[Federal Register: August 28, 2001 (Volume 66, Number 167)]
[Proposed Rules]
[Page 45221-45235]
From the Federal Register Online via GPO Access [wais.access.gpo.gov]
[DOCID:fr28au01-25]
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COMMODITY FUTURES TRADING COMMISSION
17 CFR Parts 1, 3, 4, 140 and 155
RIN 3038-AB56
Rules Relating to Intermediaries of Commodity Interest
Transactions
AGENCY: Commodity Futures Trading Commission.
ACTION: Proposed rulemaking.
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SUMMARY: Following the enactment of the Commodity Futures Modernization
Act of 2000 (CFMA) and the resulting revisions to the Commodity
Exchange Act (CEA or Act), the Commodity Futures Trading Commission
(CFTC or Commission) is proposing rules relating to intermediation of
commodity futures and commodity options (commodity interest)
transactions. These proposed new rules and rule amendments would
provide greater flexibility in several areas, and address, among other
things, the definition of the term "principal," certified financial
reports, ethics training, disclosure, account opening procedures,
trading standards, reporting requirements, and offsetting positions.
The Commission would also make additional changes to allow a registrant
to notify the Commission when a new natural person is added as a
principal promptly after the change occurs.
The proposed rules are consistent with the mandate of the CFMA to
streamline regulation of entities registered under the Act. Most of the
proposed new rules and rule amendments were part of the Commission's
final rules relating to intermediaries that were adopted in December
2000, and subsequently withdrawn following the CFMA's enactment in
order to determine their consistency with the CFMA (December Release).
Upon reviewing the proposed rules in light of the CFMA, as described in
greater detail below, the Commission has determined that the rules
proposed herein are consistent with the CFMA. The Commission encourages
interested persons to read the December Release and the proposals
published in June 2000 for a discussion of the background and purpose
of each of the rules and
[[Page 45222]]
rule amendments that is not described in detail in this Federal
Register release.
DATES: Comments must be received by September 12, 2001.
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, or Michael A. Piracci, Attorney-Advisor, Division of Trading
and Markets, Commodity Futures Trading Commission, Three Lafayette
Centre, 1155 21st Street, NW, Washington, DC 20581. Telephone: (202)
418-5450.
SUPPLEMENTARY INFORMATION:
Table of Contents
I. Background
II. Proposed Rules
A. Registration
1. Definition of the Term "Principal"
2. Application Procedures for IBs and FCMs
3. Special Procedures Available to Firms Subject to Securities
or Banking Regulation
B. Fitness and Supervision
C. Financial Requirements
1. Trading by Non-Institutional Customers on DTFs
2. Segregation of Funds
3. Investment of Customer Funds
D. Risk Disclosure and Account Statements
E. Trading Standards
F. Recordkeeping
1. Customer Account Statements
2. Close-Out of Offsetting Positions
III. Section 4(c) Findings
IV. Cost-Benefit Analysis
V. Related Matters
A. Regulatory Flexibility Act
B. Paperwork Reduction Act
I. Background
Section 2 of the CFMA sets forth the purposes of the CFMA, which
include streamlining and eliminating unnecessary regulation for the
commodity futures exchanges and other entities regulated under the Act.
Section 125 of the CFMA directs the Commission to complete a study of
its rules, regulations and interpretations governing the conduct of
persons registered under the Act by December 21, 2001. The proposed
rules are designed to be an initial step in fulfilling the mandates of
section 2 and section 125.
Most of the proposed new rules and rule amendments were part of the
Commission's final rules relating to intermediaries that were adopted
in December 2000, and subsequently withdrawn following the CFMA's
enactment in order to determine their consistency with the CFMA
(December Release).\1\ Upon reviewing the proposed rules in light of
the CFMA, as described in greater detail below, the Commission has
determined that the rules proposed herein are consistent with the CFMA.
The Commission encourages interested persons to read the December
Release and the proposals published in June 2000 for a discussion of
the background and purpose of each of the rules and rule amendments
that is not described in detail in this Federal Register release.
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\1\ See Rules Relating to Intermediaries of Commodity Interest
Transactions, 65 FR 39008 (June 22, 2000) (proposed rules); "Rules
Relating to Intermediaries of Commodity Interest Transactions," 65
FR 77993 (Dec. 13, 2000) (final rules); 65 FR 82272 (Dec. 28, 2000)
(final rules; partial withdrawal).
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As further discussed below, certain rules have been modified to
conform to specific provisions of the CFMA. Thus, for example, section
111 of the CFMA permits a registered derivatives transaction execution
facility (DTF) to allow by rule certain persons who are regulated by
other federal financial regulatory agencies to act as intermediaries
thereon in limited instances without first registering with the
Commission. Accordingly, the Commission will not repropose the
"passporting" registration procedure for certain otherwise regulated
entities as previously contemplated.\2\ The Commission may revisit this
issue in the context of the study mandated by section 125 of the CFMA,
which requires a review of the Act and Commission rules thereunder
pertaining to registrants.
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\2\ In addition, Section 252(b)(2) of the CFMA adds a new
section 4f(a)(2) to the Act to permit "notice" registration as a
futures commission merchant (FCM) or an introducing broker (IB) by
securities brokers or dealers that will limit their futures-related
activities to security futures products. See also "Notice
Registration as a Futures Commission Merchant or Introducing Broker
for Certain Securities Brokers or Dealers," 66 FR 27476 (May 17,
2001) (proposed rules); 66 FR 43080 (Aug. 17, 2001) (final rules).
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The proposals discussed in this release are applicable generally to
intermediaries transacting business on behalf of customers on
designated contract markets and registered DTFs. To the extent that an
existing rule is not addressed in this release, the Commission intends
that the rule continues to apply to intermediaries transacting business
on behalf of customers on designated contract markets and registered
DTFs pending completion of the study mandated by Section 125,
regardless of whether the contract market or DTF itself, or its
operators, have been exempted from applicable provisions of the
rule.\3\ Thus, for example, under Rule 1.35, intermediaries would still
be required to keep full and complete records, together with pertinent
data and memoranda, of all transactions relating to their business of
dealing in commodity interests,\4\ notwithstanding the fact that the
contract market or DTF on which the intermediaries transacted business
would be exempt from the provisions of the rule that relate
specifically to the exchange. When an intermediary transacts business
on an exempt board of trade,\5\ these transactions are generally
subject only to the Commission's antifraud and antimanipulation
authority to the extent applicable. Similarly, where a DTF permits
trading only on a principal-to-principal basis, CFTC rules related only
to intermediaries will not generally be applicable to such a market
structure.\6\
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\3\ See 66 FR at 14263, 14264 (stating in the proposed
rulemaking to implement the new statutory framework that contract
markets and DTFs, respectively, would be exempt from all Commission
regulations applicable to a trading facility that are not reserved
in the relevant Part). Unless otherwise noted, Commission rules
referred to herein are found at 17 CFR Ch. I (2001).
\4\ These required records include order tickets, a daily
transaction record, a record of transactions by customer account, a
financial ledger record and documentation concerning exchanges of
futures for physicals.
\5\ While the Act as amended provides that exempt commercial
markets be restricted to transactions entered on a principal-to-
principal basis (Section 2(h)(3)(A) of the Act), exempt boards of
trade are not so restricted (Section 5d of the Act).
\6\ A more complete description of the various new market
structures can be found in "A New Regulatory Framework for Trading
Facilities, Intermediaries and Clearing Organizations," 66 FR at
14264-66 (Mar. 9, 2001) (proposed rules).
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Certain of the Commission's proposed rule amendments, such as those
concerning ethics training and the definition of the term
"principal," would affect all registered firms. The other new
proposed rules and rule amendments would affect mainly FCMs and IBs,
and are not applicable to commodity pool operators (CPOs) and commodity
trading advisors (CTAs). The Commission intends to consider further
rulemaking proposals at a subsequent date that will focus more directly
upon Part 4 of the Commission's rules, which governs the operations and
activities of CPOs and CTAs.
As examples of its ongoing reform efforts with regard to such
persons, the Commission has adopted changes that simplify the
regulatory framework for CPOs and CTAs dealing with certain highly
accredited pool participants or clients, or "qualified eligible
persons,"
[[Page 45223]]
and made this relief under CFTC Rule 4.7 available to more CPOs and
CTAs by adding more persons to the definition of a "qualified eligible
person." \7\ The Commission has also adopted Rule 4.14(a)(9) to create
an additional exemption from registration for CTAs that provide
standardized advice by means of media such as newsletters, Internet web
sites, and non-customized computer software.\8\ Further, the Commission
amended Part 30 of its rules by adding Rule 30.12 to allow CTAs with
total assets under management exceeding $50 million to place, directly
with unregistered foreign futures and options brokers, orders for
foreign futures or foreign options contracts for customers that do not
otherwise qualify as "eligible swap participants."\9\ In adopting
Rule 30.12, the Commission incorporated industry requests to focus on
the financial sophistication of the person managing the assets, rather
than on the sophistication of the individual client advised by the
CTA.\10\ In addition, the CFTC adopted rule amendments to permit CPOs
to deliver to prospective participants a summary "profile" document
containing only key information about a pool prior to providing them
with the pool's complete disclosure document.\11\
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\7\ See 65 FR 47848 (Aug. 4, 2000).
\8\ See 65 FR 12938 (Mar. 10, 2000).
\9\ See 65 FR 47275 (Aug. 2, 2000).
\10\ Id. at 47277.
\11\ 65 FR 58648 (Oct. 2, 2000).
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II. The Proposed Rules
A. Registration
1. Definition of the Term "Principal"
Under Commission staff's prior interpretation of the definition of
the term "principal" in Rules 3.1(a)(1) and 4.10(e)(1),\12\ all
officers of a registrant were treated as principals and required to
register as such.\13\ In response to changes in management structures
over the last 20 years and 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,
the Commission is proposing to amend Rules 3.1(a)(1) and 4.10(e)(1) by
defining as principals persons within a given organizational structure
who hold specific offices.\14\ A registrant would, therefore, no longer
be required to treat every officer as a principal, but only those who
meet the criteria of the rule as revised.\15\ The proposed amendment to
the definition of principal thus reduces the number of officers that
will be considered principals, while ensuring that appropriate
personnel, e.g., those that exercise, or are in a position to exercise
a controlling influence over the registrant or any of its activities
subject to Commission regulation, remain listed as such.
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\12\ 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 CPOs and CTAs.
\13\ This interpretation was consistent with the language of the
second proviso to Section 8a(2) of the Act, which 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 [firms] which are
subject to regulation by the Commission."
\14\ 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, 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.
See proposed Rule 3.1(a)(1).
The reference in the proposed amendment to the "principal"
definition to "any person in charge of a principal business unit
subject to regulation by the Commission" would not include
departments such as human resources or administration.
\15\ As proposed, the "principal" definition will continue to
include all directors of a corporate registrant. In addition, the
definition will include the general provision that defines as a
principal any person occupying a similar status as or performing
similar functions to those persons specifically listed, having the
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. What constitutes "a
controlling influence" will generally be left for determination on
a case-by-case basis; however, 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 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; 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. These proposed amendments would permit the deletion of
Rule 3.10(a)(2)(ii), which has proved somewhat unwieldy in
practice.\16\
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\16\ The proposed amendments would also result in the
redesignation of Rule 3.10(a)(2)(i) as Rule 3.10(a)(2).
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The Commission is also proposing conforming changes to 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, as
incorporated by reference in amended Rule 4.10(e)(1). Accordingly, CPOs
and CTAs 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 for all officers.
Finally, in response to industry suggestions, the Commission is
proposing to delete Rule 3.32, which specifies certain events or
changes within a firm's management structure that require the firm to
file a new registration form. In its place, a new paragraph (a)(2)
would be added to Rule 3.31 to require the registrant to file a Form 8-
R on behalf of each new natural person principal who was not listed on
the registrant's Form 7-R promptly after the change occurs. Proposed
Rule 3.31(a)(2) was drafted to closely parallel Rule 3.10(a)(2)(i),\17\
and provides that, if the change that renders the application for
registration deficient or inaccurate results from the addition of a new
principal without a current Form 8-R on file with the National Futures
Association (NFA), a Form 8-R for that principal must accompany the
Form 3-R amending the registrant's application for registration.\18\
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\17\ As noted in the preceding footnote, this provision is
proposed to be redesignated as Rule 3.10(a)(2).
\18\ An additional conforming amendment is proposed to Rule
3.21(c) that would reflect the deletion of Rule 3.32, and the
addition of new paragraph (a)(2) to Rule 3.31.
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2. Application Procedures for IBs and FCMs
The Commission is proposing that applicants for registration as IBs
who raise their own capital to satisfy minimum financial requirements
would be permitted to file an unaudited financial report indicating
satisfaction of the minimum requirements, rather
[[Page 45224]]
than be required to provide certified financial statements with their
registration application.\19\ A firm taking advantage of the 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.\20\ This alternative procedure is modeled on similar
procedures in the securities industry.\21\
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\19\ See Proposed Rule 1.10(a)(2)(ii)(A)(3). However, 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. IBs and FCMs should refer to
Commission Rules 1.10(j) and 1.57(a)(1) concerning the procedures
applicable to guarantee agreements. See also First American Discount
Corp. v. CFTC, 222 F.3d 1008 (D.C. Cir. Aug. 18, 2000).
Filing of financial statements or guarantee agreements would be
unnecessary for any FCM or IB registered in accordance with Proposed
Rule 3.10(a)(3), which applies to those securities brokers or
dealers registering as FCMs or IBs because their only futures-
related activities involve security futures products. See 66 FR
27476.
\20\ Although the proposed rule would not require IBs to file a
certified financial statement with their application for
registration, this does not preclude any SRO from imposing this
requirement before accepting an IB for membership.
\21\ Certain technical amendments are also proposed to be made
to paragraph (j)(8), which addresses guaranteed IBs' compliance with
the financial reporting requirements in the event that their
guarantee agreement has been terminated. Such IBs will be deemed to
have satisfied the Commission's minimum financial requirements if
they enter into another guarantee agreement or file a certified 1-
FR-IB statement.
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With respect to the six-month review that must be conducted should
an IB choose not to file a certified financial statement with its
registration application, the Commission believes that the six-month
time period for the review of IBs should begin from the date the
applicant is registered. The Commission has held consistently that once
a registrant becomes registered in a certain capacity, the registrant
is immediately assumed to be engaging in the activities permitted by
such registration.\22\ However, the Commission notes that the DSRO
would be able to conduct the review telephonically where the DSRO does
not have reason to question the IB's capital. In addition, an applicant
that does not wish to be subject to the six-month review could continue
to follow the existing rules and file a certified financial statement
with its application.
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\22\ See, e.g., In re Premex, [1982-1984 Transfer Binder] Comm.
Fut. L. Rep. (CCH) para. 21,992 (Feb. 1, 1984), aff'd in relevant
part, rev'd in part, 785 F.2d 1403 (9th Cir. 1986).
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The Commission notes that the December Release contained a similar
provision for FCM applicants. NFA commented that "[t]here is a
significant difference in the role of FCMs and IBs in terms of safety
of customer funds. The one-time filing requirement for FCMs is not
unduly burdensome, especially in light of the potential exposure if the
initial financial statement is incorrect." \23\ Upon further
consideration in light of the comment filed by NFA opposing the
elimination of the certified financial report for an FCM applicant, the
Commission has determined not to repropose the rule change for FCM
applicants.
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\23\ NFA Comment Letter at 4 (Aug. 7, 2000), which can be found
on the Commission's website at http://www.cftc.gov/files/foia/comment00/foicf0022c024.pdf.
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3. Special Procedures Available to Firms Subject to Securities or
Banking Regulation
The December Release contained a "passporting" registration
process for certain otherwise federally regulated FCMs or IBs who
conduct business on futures exchanges solely for institutional
customers.\24\ The CFMA includes a passporting provision that is
broader than the CFTC's proposal in certain respects and narrower in
others. The CFMA provision allows entities subject to regulation by an
appropriate financial regulator to act as intermediaries on a DTF
subject to the DTF's election, provided that the entity meets certain
conditions. Specifically, section 111(e) of the CFMA authorizes a DTF
to allow by rule a broker-dealer, depository institution, or
institution of the Farm Credit System to act as an intermediary in
transactions executed on the facility for any customer of the broker-
dealer, depository institution or Farm Credit institution, provided
that the firm is in good standing with its appropriate regulator. These
passporting intermediaries would not be required to register with the
Commission as an FCM or IB (or even to file a notice registration) or
to become a member of a registered futures association, unless they
carry or hold customer accounts or funds for transactions on the DTF
for more than one business day.\25\ In light of the CFMA provisions,
the Commission will not be separately reproposing its earlier
passporting proposal, or the related amendments to Rules 1.17(a)(2) or
1.52(m).\26\ As noted above, however, the Commission recently adopted
rules that would permit securities brokers or dealers who limit their
futures-related activities to security futures products to register as
FCMs or IBs upon the submission of notice to the Commission.\27\
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\24\ The term "institutional customer" is defined in proposed
Rule 1.3(g) as an "eligible contract participant" within the
meaning of section 1a(12) of the Act as amended, and generally
refers to a non-retail customer.
\25\ These firms and their salespersons would remain subject to
antifraud provisions of the Act and rules thereunder, however.
\26\ In the December Release, the Commission would have extended
its passporting provision to allow broker-dealers and firms
regulated by appropriate banking regulators to conduct transactions
for institutional customers on designated contract markets and
recognized futures exchanges in addition to DTFs. In light of the
provisions contained in the CFMA, however, a broker-dealer,
depository institution or Farm Credit institution seeking to act as
an intermediary on a designated contract market will be required to
register as an FCM or IB and become a member of a registered futures
association, even if the firm carries or holds accounts or funds for
less than one business day.
Section 5a of the Act as amended further directs the Commission,
in coordination with the SEC, the Secretary of the Treasury, and
Federal banking regulatory agencies, to adopt rules and take any
other appropriate action to facilitate the implementation of the
passporting procedure by these otherwise federally regulated
entities.
\27\ See note 2 supra; see also "Exemption for Certain Brokers
or Dealers from Provisions of the Commodity Exchange Act and CFTC
Regulations," 66 FR __ (Aug. 17, 2001) (adopting new rule to govern
the granting of orders exempting notice-registered broker-dealers
from provisions of the Act and Commission regulations where the
Commission determines that the exemption is necessary or appropriate
in the public interest and consistent with the protection of
investors).
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The Commission is separately considering updating and making more
flexible its minimum net capital requirements for FCMs by adopting
risk-based net capital requirements.
B. Fitness and Supervision
An essential component of maintaining fitness is continuing
education concerning obligations under the Act and rules thereunder. In
order to provide flexibility and ease compliance for all registrants,
the Commission is proposing to delete Rule 3.34 and instead to
implement Congressional intent regarding ethics training through a
Statement of Acceptable Practices. Rule 3.34 currently specifies
frequency and duration of ethics training, the suggested curriculum,
qualifications of instructors, and the necessary proof of attendance at
such classes. In proposing to replace the rule with a Statement of
Acceptable Practices that would leave the format, frequency, and
providers of ethics training up to the registrants themselves, the
Commission believes that greater flexibility regarding ethics training
and proficiency testing could be afforded to registrants than is now
permitted under Rule 3.34. For registrants seeking guidance as to the
maintenance of proper ethics training procedures, the Statement of
Acceptable
[[Page 45225]]
Practices would serve as a "safe harbor." \28\
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\28\ 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
registrants and DSROs deem appropriate. Thus, the Commission would
not specify any particular programs or procedures that must be
followed.
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Although the Commission notes the possibility that eliminating Rule
3.34 may lead firms to place an inadequate priority on ethics training,
the Commission does not believe that the replacement of the rule with a
Statement of Acceptable Practices would diminish a registrant's
obligations to remain fit and to adequately supervise the handling of
customer accounts. Instead, the Commission hopes that the Statement of
Acceptable Practices, which would allow registrants to adopt ethics
training programs that are better tailored to their individual needs,
will help to imbue firms with a culture of ethics that is ongoing
rather than episodic. The Commission believes that the essence of the
ethics training or continuing education requirement is to remain
current as to the legal requirements applicable to a person's role in
the futures industry, which a registrant ignores at his or her peril.
The Commission is also proposing to publish its recent "guidance
letters" issued to NFA concerning the treatment of SRO disciplinary
actions in assessing the fitness of floor brokers (FBs) and floor
traders (FTs). The guidance letters were issued to provide greater
clarity in interpreting the "other good cause" ground for statutory
disqualification from registration under section 8a(3)(M) of the Act.
These letters would be added to the end of Appendix A to Part 3 as they
relate to the issue of "other good cause," which is discussed at the
end of Appendix A.
C. Financial Requirements
1. Trading by Non-Institutional Customers on DTFs
Although access to DTFs is generally limited to institutional
customers,\29\ under certain conditions a DTF may permit non-
institutional customers to enter into transactions thereon. To address
the higher degree of risk associated with the lower regulatory
protections offered to DTF participants, such non-institutional
customer business may be transacted through a registered FCM that (1)
is a clearing member of a derivatives clearing organization, and (2)
has a minimum net capital of at least $20 million.\30\ Such an FCM is
considered to be more capable of properly handling these transactions
and the associated risk. In order to provide guidance to non-
institutional customers trading through a highly-capitalized FCM, NFA
will issue a Statement of Acceptable Practices regarding additional
disclosures to be made to such customers trading on DTFs and on related
issues involving price dissemination.
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\29\ See new Part 37 of the Commission rules, 66 FR 42256 at
42271 (Aug. 10, 2001).
\30\ Section 5a of the Act, 7 U.S.C. 7a, as amended by Pub. L.
No. 106-554, 114 Stat. 2763.
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In the December Release, the Commission had determined to add a new
Rule 4.32 that would also permit non-institutional customers to trade
on a DTF through certain registered CTAs. The Commission is again
proposing to adopt this rule to permit registered CTAs to enter trades
on or subject to the rules of a DTF on behalf of a non-institutional
customer, provided that the CTA: (1) Directs the client's commodity
interest account; \31\ (2) directs accounts containing total assets of
not less than $25 million at the time the trade is entered; and (3)
discloses to the client that it may enter trades on a DTF on the
client's behalf. Paragraph (b) of Rule 4.32 further requires that the
client's commodity interest account be carried by a registered FCM.
However, an FCM who receives orders on behalf of a non-institutional
customer from a CTA acting in accordance with Rule 4.32 need not
maintain $20 million in minimum adjusted net capital. See Rule
1.17(a)(1)(ii)(B).
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\31\ The term "direct" as defined in Rule 4.10(f), refers to,
in the context of trading commodity interest accounts, "agreements
whereby a person is authorized to cause transactions to be effected
for a client's commodity interest account without the client's
specific authorization."
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As with a highly-capitalized FCM, a CTA meeting this asset test, in
its capacity as a professional asset manager, would have the
appropriate financial sophistication to handle the risk associated with
trading for non-institutional customers on a DTF.\32\ Additionally,
focusing on the financial sophistication of the person managing the
assets, rather than on the sophistication of the individual client
advised by the CTA, is consistent with the approach taken by the
Commission in adopting Rule 30.12.\33\
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\32\ See Section 1a(12)(C) of the Act.
\33\ See 65 FR at 47277.
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2. Segregation of Funds
The June 2000 Release raised two sets of questions seeking comments
about whether, and under what circumstances, the Commission should
permit (1) customers to opt out of segregation, and (2) 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.\34\
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\34\ 65 FR at 39014.
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With respect to the opt-out issue, most parties commenting on the
issue urged the Commission to consider thoroughly the potential
implications with respect to the bankruptcy rules, e.g., priority of
distribution, before proceeding on the issue. Consequently, in the
Adopting Release the Commission determined to continue to study the
issue and defer action in this area.\35\ Under Section 5a(f) of the
Act, as amended by the CFMA, however, the Commission was required to
adopt rules within 180 days after the date of enactment of the CFMA to
permit a registered DTF to authorize an FCM to offer its customers that
are eligible contract participants the right not to have their funds
that are carried by the FCM for purposes of trading on the registered
DTF, separately accounted for and segregated. Accordingly, on April 19,
2001, the Commission adopted new rules that, effective June 19, 2001,
allow FCMs to offer eligible contract participants to opt out of
segregation.\36\ The Commission also amended existing rules concerning,
among other things, the bankruptcy treatment of a customer that opts
out of segregation.
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\35\ See 65 FR at 78001.
\36\ 66 FR 20740 (April 25, 2001).
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3. Investment of Customer Funds
The Commission did not withdraw its final rules and rule amendments
concerning the investment of customer funds, and those rules and rule
amendments became effective on December 28, 2000. To facilitate the
implementation of Rule 1.25 and its related amendments, new paragraph
(a)(7) to Rule 140.91 is proposed to be added to delegate to the
Director of the Division of Trading and Markets any functions reserved
to the Commission in Rule 1.25 regarding permitted investments for
customer funds. The Commission also wishes to note that it has
determined not to rescind Division of Trading and Markets Financial and
Segregation Interpretation No. 9 (Interp.
[[Page 45226]]
9).\37\ The Commission had previously indicated that it would do so in
light of the fact that amendments to Rule 1.25 would now permit
investment of customer funds in money market mutual funds (MMMFs).\38\
Because Interp. 9 addresses the use of money market deposit accounts
rather than MMMFs, however, the Commission has decided not to rescind
Interp. 9.
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\37\ Comm. Fut. L. Rep. (CCH) para. 7119 (Nov. 23, 1983).
\38\ See 65 FR at 78001 n.53.
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D. Risk Disclosure and Account Statements
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 of their customers' receipt of the basic risk
disclosure statements relating to futures and options in accordance
with Rules 1.55 and 33.7. For institutional customers, as provided in
proposed Rule 1.55(f), there would continue to be no general disclosure
requirements.\39\ The Commission also may consider issuing a Statement
of Acceptable Practices on disclosure to institutional customers, with
industry input, at a later date. As noted above, the Commission also
anticipates that NFA will develop appropriate disclosure for qualifying
FCMs to provide to retail customers permitted to trade on DTFs.
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\39\ In contrast to the December Release, which did not restrict
the type of governmental entities that would be considered to be
institutional customers, the Act as amended imposes certain
limitations on the governmental entities that will be considered to
be eligible contract participants. Compare 65 FR at 78035 with
section 1a(12)(A)(vii) of the Act as amended.
---------------------------------------------------------------------------
The Commission recognizes that there are certain areas of the
account opening process that may be streamlined. Accordingly, in
proposed amendments to Rules 1.55(d)(1) and (2), the Commission would
permit certain required disclosures, such as those concerning consent
to (1) allow electronic transmission of statements under proposed new
Rule 1.33(g),\40\ or (2) 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 signature,"
rather than the multiple signatures that are currently required.\41\
The single signature could be made electronically as provided for in
recently-adopted Rules 1.3(tt) and 1.4.\42\
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\40\ See infra.
\41\ Contemporaneously with opening an account, an FCM may
obtain the acknowledgment of receipt and understanding of the risk
disclosure statement, along with margin funds and any other required
account opening documents, from the customer. However, the FCM
remains responsible for ensuring that the risk disclosure document
is furnished to the customer in such a way that the customer can
review and understand the document before committing funds to the
FCM.
\42\ 65 FR 12466 (Mar. 9, 2000).
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E. Trading Standards
The Commission is proposing that Rules 155.1, 155.3 and 155.4,
which collectively require FCMs and IBs to establish and to maintain
supervisory procedures to assure that neither they nor any affiliated
persons use their knowledge of customer orders to the customer's
disadvantage, would continue to apply to intermediation of trades on
contract markets, with certain conforming changes to reflect the recent
statutory changes to the Act. These requirements would be extended to
trading by non-institutional customers on DTFs under proposed Rule
155.6(a). These rules over the years have helped the Commission deter
such practices as "front-running," "trading ahead," "bucketing,"
and improper disclosure of customer orders. However, for intermediation
of trades by institutional customers at DTFs, the Commission is
proposing a new Rule 155.6(b), which sets forth a general standard of
practice in this area. The Commission believes that this overall
approach with respect to trading standards strikes a reasonable balance
in preserving rules that have worked successfully over the years in
curbing abusive trading practices, while relaxing certain of the
specific provisions of the existing rules in connection with the
trading on DTFs by more sophisticated customers.
Although proposed new Rule 155.6 is intended to proscribe the same
trade practice abuses as Rules 155.1, 155.3 and 155.4 the Commission
encourages specific suggestions regarding how these rules might be
streamlined.\43\ The Commission also 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.\44\
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\43\ The Commission recently proposed to prohibit dual trading
in security futures products on designated contract markets and
registered DTFs, as required by Section 251(c) of the CFMA, which
amended Section 4j of the Act. See 66 FR 36218 (July 11, 2001).
\44\ Because the DTF is a new institution, and it is not known
how such an institution would choose to operate (e.g., a DTF may
choose to sponsor trading in a traditional open-outcry pit trading
system, in a purely automated, electronic trading format, or in a
combination of the two formats), the Commission is not at this time
issuing a Statement of Acceptable Practices in this area.
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F. Recordkeeping
1. Customer Account Statements
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 in a new Rule
1.33(g).\45\ 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. 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. Before transmitting any statement electronically to a
customer, however, the FCM would be required to make certain
disclosures regarding the practice, including: (1) The electronic
medium or source through which statements would be delivered, (2) the
duration, whether indefinite or not, of the period during which consent
would be effective, (3) any charges for such service, (4) the
information that would be delivered electronically, and (5) a statement
that consent to electronic delivery may be revoked at any time. For
non-institutional customers, the FCM would be required to obtain the
customer's signed consent acknowledging the disclosures, prior to the
transmission of any statement by means of electronic media. The
acknowledgement could be made through a single signature in accordance
with Rule 1.55 as discussed above. 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. Any statement required to be furnished to a person
other than a customer in accordance with paragraph (d) of Rule
[[Page 45227]]
1.33 would also be permitted to be furnished by electronic media.
---------------------------------------------------------------------------
\45\ 65 FR at 39017; see also 62 FR 31507 (June 10, 1997).
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2. Close-Out of Offsetting Positions
The Commission also proposes to revise Rule 1.46 to allow customers
or account controllers to instruct the FCM (in writing or orally) if
they wish to deviate from the current default rule that the FCM close
out offsetting positions on a first-in, first-out basis, looking across
all accounts it carries for the same customer.\46\ CPOs and CTAs would
be required to disclose, under proposed amendments to Rules 4.24(h)(2)
and 4.34(h), respectively, if they instruct an FCM to deviate from the
default rule for closing out offsetting positions.\47\
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\46\ An FCM must take into consideration positions in separate
accounts of the same customer that it is carrying in applying Rule
1.46. See 57 FR 55082, 55083 n.2 (Nov. 24, 1992), citing U.S.
Department of Agriculture, Commodity Exchange Authority
Administrative Determination No. 134 (May 25, 1948).
\47\ Generally, responsibility for transmitting instructions
regarding offset would lie with the registrant directing trading.
Thus, where a pool's trading is directed by a CTA, it would be the
CTA who would be responsible for transmitting offset instructions,
not the CPO.
---------------------------------------------------------------------------
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 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. Section 4(c) Findings
Certain of the rules and rule amendments discussed herein are being
proposed under section 4(c) of the Act, which grants the Commission
broad exemptive authority. Section 4(c) of the Act provides that, in
order to promote responsible economic or financial innovation and fair
competition, the Commission may, by rule, regulation or order, exempt
any class of agreements, contracts or transactions, including any
person or class of persons offering, entering into, rendering advice or
rendering other services with respect to the agreement, contract, or
transaction, from any of the provisions of the Act (except certain
provisions governing a group or index of securities and security
futures products). As relevant here, when granting an exemption
pursuant to section 4(c), the Commission must find that the exemption
would be consistent with the public interest.
As explained above, the proposed rules and rule amendments would
provide greater flexibility for intermediaries and their customers in
several areas. Specifically, the Commission is proposing rule
amendments concerning the definition of the term "principal" that are
narrower than the language of the second proviso of Section 8a(2) of
the Act. These amendments recognize the evolution of management
structures by reducing the number of officers that will be considered
principals, while ensuring that appropriate personnel that perform
significant roles within the firm remain listed as such. The Commission
believes that, in light of the conditions and safeguards provided for
under the rules and rule amendments, the exemptive relief will have no
adverse effect on any of the regulatory or self-regulatory
responsibilities imposed by the Act. Moreover, the Commission believes
that the additional flexibility for intermediaries and their customers
provided for by the rules and rule amendments proposed herein would be
consistent with the public interest. The Commission invites public
comment on this finding.
IV. Cost-Benefit Analysis
Section 15 of the Act, as amended by section 119 of the CFMA,
requires the Commission to consider the costs and benefits of its
action before issuing a new regulation under the Act. By its terms,
section 15 as amended does not require the Commission to quantify the
costs and benefits of a new regulation or to determine whether the
benefits of the proposed regulation outweigh its costs. Rather, section
15 simply requires the Commission to "consider the costs and
benefits" of its action.
The amended section 15 further specifies that costs and benefits
shall be evaluated in light of five broad areas of market and public
concern: protection of market participants and the public; efficiency,
competitiveness, and financial integrity of futures markets; price
discovery; sound risk management practices; and other public interest
considerations. Accordingly, the Commission could in its discretion
give greater weight to any one of the five enumerated areas and could
in its discretion determine that, notwithstanding its costs, a
particular rule was necessary or appropriate to protect the public
interest or to effectuate any of the provisions or to accomplish any of
the purposes of the Act.
The proposed rulemaking constitutes a package of related rule
provisions affecting market intermediaries. The proposed rules and rule
amendments are intended to provide greater flexibility for
intermediaries and their customers in their methods of doing business.
The Commission is considering the costs and benefits of these rules in
light of the specific provisions of section 15 of the Act:
1. Protection of market participants and the public. In general,
the proposed rules would be expected to cost little in terms of
diminishing the protection of market participants and the public.
2. Efficiency and competition. The proposed rules are expected to
benefit competition and market efficiency broadly by providing
increased flexibility for intermediaries. For instance, the Commission
is proposing new rule amendments concerning the definition of the term
"principal" that recognize the evolution of management structures by
reducing the number of officers that will be considered principals,
while ensuring that personnel that exercise or are in a position to
exercise a controlling influence over the activities of the registrant
will remain listed as such. In addition, FCMs will be permitted to
obtain several consents from consumers with a single signature. The
rules do not impose a cost on market efficiency or competition.
3. Financial integrity of futures markets and price discovery. The
proposed rules should have no effect, from the standpoint of imposing
costs or creating benefits, on the financial integrity or price
discovery function of the futures and options markets or on the risk
management practices of FCMs, CTAs, CPOs or IBs.
4. Sound risk management practices. The Commission has previously
adopted amendments to its rules regarding the investment of customer
funds that were originally part of the December Release. These
amendments expanded the list of permissible investments in which FCMs
and clearing organizations are permitted to invest cash segregated for
the benefit of commodity customers, thereby enhancing the yield
available to FCMs, clearing organizations and their customers, and
contained specific risk-limiting features intended to minimize credit
risk, market risk, and liquidity risk.
5. Other public interest considerations. The Commission's rules
[[Page 45228]]
implementing the new regulatory structure would open up new markets for
the benefit of market participants and the public, thus making
available more customized products for risk management purposes. The
proposed new rules and rule amendments contained herein would establish
appropriate safeguards for those customers seeking to trade on the new
DTF and security futures product markets.
After considering these factors, the Commission has determined to
propose the revisions to its rules discussed above. The Commission
invites public comment on its application of the new cost-benefit
provision. Commenters also are invited to submit any data that they may
have quantifying the costs and benefits of the proposed rules with
their comment letters.
V. 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 rules
proposed 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.\48\ The Commission has previously determined
that registered FCMs, CPOs, LTMs and ATOMs are not small entities for
the purpose of the RFA.\49\ 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. In this regard, the
rules being 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's 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 Acting Chairman, on behalf of the
Commission, certifies that the proposed amendments will not have a
significant economic impact on a substantial number of small entities.
The Commission invites the public to comment on this finding.
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\48\ 47 FR 18618-21 (Apr. 30, 1982).
\49\ Id. at 18619-20 (discussing FCMs and CPOs); 54 FR 19556,
19557 (May 8, 1989) (discussing LTMs); and 63 FR 18821, 18830 (Apr.
16, 1998) (discussing ATOMs).
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B. Paperwork Reduction Act
This proposed rulemaking contains information collection
requirements. As required by the Paperwork Reduction Act of 1995, 44
U.S.C. Sec. 3507(d), the Commission has submitted a copy of these
proposed amendments to its rules to the Office of Management and Budget
(OMB) 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 Commission Merchants, OMB Control Number 3038-0005.
Rules Pertaining to Contract Markets and Their Members, OMB Control
Number 3038-0022.
Regulations and Forms Pertaining to the Financial Integrity of the
Marketplace, OMB Control Number 3038-0024.
The proposed amendments would not affect the paperwork burdens
associated with the above collections of information, which have
previously been approved by OMB in connection with the Commission's
previous submission of the proposed rules.
Rules, Regulations and Forms for Domestic and Foreign Futures and
Options Relating to Registration with the Commission, OMB Control
Number 3038-0023.
The proposed rules will reduce the collection of information burden
previously approved by OMB by 2 hours because of the elimination of
Rule 3.32:
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.
The annual reporting burden of 7,337 hours represents a reduction
of 2 hours as a result of the proposed new rules.
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,
Principals, Registration, Reporting and recordkeeping requirements.
17 CFR Part 4
Advertising, Commodity futures, Commodity pool operators, Commodity
trading advisors, Consumer protection, Disclosure, Principals,
Reporting and recordkeeping requirements.
[[Page 45229]]
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.
For the reasons discussed in the preamble, the Commission hereby
proposes to amend Chapter I of Title 17 of the Code of Federal
Regulations as follows:
PART 1--GENERAL REGULATIONS UNDER THE COMMODITY EXCHANGE ACT
1. The authority citation for Part 1 is revised to read as follows:
Authority: 7 U.S.C. 1a, 2, 5, 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, as amended by Appendix E of Pub.
L. No. 106-554, 114 Stat. 2763 (2000).
2. Section 1.3 is amended by adding new paragraph (g) to read as
follows:
Sec. 1.3 Definitions.
* * * * *
(g) Institutional customer. This term has the same meaning as
"eligible contract participant" as defined in section 1a(12) of the
Act.
* * * * *
3. Section 1.10 is amended by revising paragraphs (a)(2) and (j)(8)
to read as follows:
Sec. 1.10 Financial reports of futures commission merchants and
introducing brokers.
(a) * * *
(2)(i)(A) Except as provided in paragraphs (a)(3) and (h) of this
section, each person who files an application for registration as a
futures commission merchant and who is not so registered at the time of
such filing, must, concurrently with the filing of such application
file either:
(1) A Form 1-FR-FCM certified by an independent public accountant
in accordance with Sec. 1.16 as of a date not more than 45 days prior
to the date on which such report is filed; or
(2) 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.
(B) 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)(A) Except as provided in paragraphs (a)(3) and (h) of this
section, each person who files an application for registration as an
introducing broker and who is not so registered at the time of such
filing, must, concurrently with the filing of such application file
either:
(1) A Form 1-FR-IB certified by an independent public accountant in
accordance with Sec. 1.16 as of a date not more than 45 days prior to
the date on which such report is filed;
(2) A Form 1-FR-IB 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-IB
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;
(3) A Form 1-FR-IB as of a date not more than 17 business days
prior to the date on which such report is filed, 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
(4) A guarantee agreement.
(B) Each person filing in accordance with paragraphs (a)(2)(ii)(A)
(1), (2) or (3) 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.
* * * * *
(j) * * *
(8)(i)(A) An introducing broker which is a party to a guarantee
agreement which has been terminated in accordance with the provisions
of paragraph (j)(5) of this section, or which is due to expire in
accordance with the provisions of paragraph (j)(4)(ii) of this section,
must cease doing business as an introducing broker on or before the
effective date of such termination or expiration unless, on or before
10 days prior to the effective date of such termination or expiration
or such other period of time as the Commission or the designated self-
regulatory organization may allow for good cause shown, the introducing
broker files with its designated self-regulatory organization either a
new guarantee agreement effective as of the day following the date of
termination of the existing agreement, or, in the case of a guarantee
agreement which is due to expire in accordance with the provisions of
paragraph (j)(4)(ii) of this section, a new guarantee agreement
effective on or before such expiration, or either:
(1) A Form 1-FR-IB certified by an independent public accountant in
accordance with Sec. 1.16 as of a date not more than 45 days prior to
the date on which the report is filed; or
(2) A Form 1-FR-IB as of a date not more than 17 business days
prior to the date on which the report is filed and a Form 1-FR-IB
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 the report is filed.
(B) Each person filing a Form 1-FR-IB in accordance with this
section must include with the 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)(A) Notwithstanding the provisions of paragraph (j)(8)(i) of
this section or of Sec. 1.17(a), an introducing broker that is a party
to a guarantee agreement that has been terminated in accordance with
the provisions of paragraph (j)(5)(ii) of this section shall not be
deemed to be in violation of the minimum adjusted net capital
requirement of Sec. 1.17(a)(1)(ii) or (a)(2) for 30 days following such
termination. Such an introducing broker must cease doing business as an
introducing broker on or after the effective date of such termination,
and may not resume doing business as an introducing broker unless and
until it files a new agreement or either:
(1) A Form 1-FR-IB certified by an independent public accountant in
accordance with Sec. 1.16 of this part as of a date not more than 45
days prior to the date on which the report is filed; or
(2) A Form 1-FR-IB as of a date not more than 17 business days
prior to the date on which the report is filed and a Form 1-FR-IB
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 the report is filed.
(B) Each person filing a Form 1-FR-IB in accordance with this
section must include with the 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 amended by redesignating paragraph (a)(1)(ii) as
[[Page 45230]]
(a)(1)(iii) and by adding new paragraph (a)(1)(ii) 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
or any commodity option on or subject to the rules of a registered
derivatives transaction execution facility from any customer who does
not qualify as an "institutional customer" as defined in Sec. 1.3(g)
must:
(A) Be a clearing member of a derivatives clearing organization and
maintain 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; or
(B) Receive orders on behalf of the customer from a commodity
trading advisor acting in accordance with Sec. 4.32 of this chapter.
* * * * *
5. Section 1.33 is 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 any
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 customer who does not qualify as an
"institutional customer" as defined in Sec. 1.3(g), a futures
commission merchant must obtain the 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.
* * * * *
6. Section 1.46 is 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 designated contract market or
registered derivatives transaction execution facility:
* * * * *
(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).
* * * * *
7. Section 1.55 is 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 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
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 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" as defined in Sec. 1.3(g) 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) and
190.10(c) of this chapter.
* * * * *
PART 3--REGISTRATION
8. 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, 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.
9. Section 3.1 is 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
[[Page 45231]]
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
* * * * *
Sec. 3.10 [Amended]
10. Section 3.10 is amended by removing paragraph (a)(2)(ii) and by
redesignating paragraph (a)(2)(i) as paragraph (a)(2).
11. Section 3.21 is amended by revising paragraph (c) introductory
text to read as follows:
Sec. 3.21 Exemption from fingerprinting requirement in certain cases.
* * * * *
(c) Outside directors. Any futures commission merchant, introducing
broker, commodity trading advisor, commodity pool operator or leverage
transaction merchant that has a principal who is a director but is not
also an officer or employee of the firm may, in lieu of submitting a
fingerprint card in accordance with the provisions of Secs. 3.10(a)(2)
and 3.31(a)(2), file a "Notice Pursuant to Rule 3.21(c)" with the
National Futures Association. Such notice shall state, if true, that
such outside director:
* * * * *
12. Section 3.31 is amended by redesignating paragraph (a) as
paragraph (a)(1), and by adding new paragraph (a)(2) to read as
follows:
Sec. 3.31 Deficiencies, inaccuracies, and changes, to be reported.
(a)(1) * * *
(2) Where the deficiency or inaccuracy is created by the addition
of a new principal not listed on the registrant's application for
registration (or amendment of such application prior to the granting of
registration), each Form 3-R filed in accordance with the requirements
of paragraph (a)(1) of this section must be accompanied by a Form 8-R,
completed in accordance with the instructions thereto and executed by
each natural person who is a principal of the registrant and who was
not listed on the registrant's initial application for registration or
any amendment thereto. The Form 8-R for each such principal must be
accompanied by the fingerprints of that principal on a fingerprint card
provided by the National Futures Association for that purpose, unless
such principal is a director who qualifies for the exemption from the
fingerprint requirement pursuant to Sec. 3.21(c). The provisions of
this paragraph do not apply to any principal who has a current Form 8-R
on file with the Commission or the National Futures Association.
* * * * *
Sec. 3.32 [Removed]
13. Section 3.32 is removed.
Sec. 3.34 [Removed]
14. Section 3.34 is removed.
15. Appendix A to Part 3 is amended by adding to the end thereto
the following:
Appendix A to Part 3--Interpretative Statement With Respect to
Section 8a(2)(C) and (E) and Section 8a(3)(J) and (M) of the
Commodity Exchange Act
* * * * *
The Commission has further addressed "other good cause" under
section 8a(3)(M) of the Act in issuing guidance letters on assessing
the fitness of floor brokers, floor traders or applicants in either
category:
First Guidance Letter
December 4, 1997.
Robert K. Wilmouth, President,
National Futures Association, 200 West Madison Street, Chicago, IL
60606-3447
Re: Adverse Registration Actions With Respect to Floor Brokers,
Floor Traders and Applicants for Registration in Either Category
Dear Mr. Wilmouth:
As you know, the Commission on June 26, 1997, approved for
publication in the Federal Register a Notice and Order concerning
adverse registration actions by the National Futures Association
("NFA") with respect to registered floor brokers ("FBs"),
registered floor traders ("FTs") and applicants for registration
in either category. 62 FR 36050 (July 3, 1997). The Notice and Order
authorized NFA to grant or to maintain, either with or without
conditions or restrictions, FB or FT registration where NFA
previously would have forwarded the case to the Commission for
review of disciplinary history. The Commission has worked with its
staff to determine which of the pending matters could efficiently be
returned to NFA for handling, and such matters have been forwarded
to NFA. The Commission will continue to accept or to act upon
requests for exemption, and the Commission staff will consider
requests for "no-action" opinions with respect to applicable
registration requirements.
By this correspondence, the Commission is issuing guidance that
provides NFA further direction on how it expects NFA to exercise its
delegated power, based upon the experience of the Commission and the
staff with the registration review process during the past three
years. This guidance will help ensure that NFA exercises its
delegated power in a manner consistent with Commission precedent.
In exercising its delegated authority, NFA, of course, needs to
apply all of the provisions of Sections 8a(2) and (3) of the
Commodity Exchange Act ("Act").\1\ In that regard, NFA should
consider the matters in which the Commission has taken action in the
past and endeavor to seek similar registration restrictions,
conditions, suspensions, denials, or revocations under similar
circumstances.
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\1\ 7 U.S.C. 12a(2) and (3) (1994). The letter is intended to
supplement, not to supersede, other guidance provided in the past to
NFA. In this regard, the NFA should continue to follow other
guidance provided by the Commission or its staff.
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One of the areas in which NFA appears to have had the most
uncertainty is with regard to previous self-regulatory organization
("SRO") disciplinary actions. Commission Rule 1.63 \2\ provides
clear guidelines for determining whether a person's history of
"disciplinary offenses" should preclude service on SRO governing
boards or committees.\3\ In determining whether to grant or to
maintain, either with or without conditions or restrictions, FB or
FT registration, NFA should, as an initial matter, apply the Rule
1.63(a)(6) criteria to those registered FBs, registered FTs and
applicants for registration in either category. However, NFA should
be acting based upon any such offenses that occurred within the
previous five years, rather than the three years provided for in
Rule 1.63(c). NFA should consider disciplinary actions taken by an
SRO as that term is defined in Section 3(a)(26) of the Securities
Exchange Act of 1934 no differently from disciplinary actions taken
by an SRO in the futures industry as
[[Page 45232]]
defined in Rule 1.3(ee).\4\ Application of the Rule 1.63 criteria,
as modified, to these matters will aid NFA in making registration
determinations that are reasonably consonant with Commission
views.\5\ NFA should focus on the nature of the underlying conduct
rather than the sanction imposed by an SRO. Thus, if a disciplinary
action would not come within the coverage of Rule 1.63 but for the
imposition of a short suspension of trading privileges (such as for
a matter involving fighting, use of profane language or minor
recordkeeping violations), NFA could exercise discretion, as has the
Commission, not to institute a statutory disqualification case. On
the other hand, conduct that falls clearly within the terms of Rule
1.63, such as violations of rules involving potential harm to
customers of the exchange, should not be exempt from review simply
because the exchange imposed a relatively minor sanction.
---------------------------------------------------------------------------
\2\ Commission rules referred to herein are found at 17 CFR Ch.
I.
\3\ Rule 1.63(c) provides that a person is ineligible from
serving on an SRO's disciplinary committees, arbitration panels,
oversight panels or governing board if, as provided in Rule 1.63(b),
the person, inter alia: (1) within the past three years has been
found by a final decision of an SRO, an administrative law judge, a
court of competent jurisdiction or the Commission to have committed
a disciplinary offense; or (2) within the past three years has
entered into a settlement agreement in which any of the findings or,
in the absence of such findings, any of the acts charged included a
disciplinary offense.
Rule 1.63(a)(6) provides that a "disciplinary offense"
includes: (i) any violation of the rules of an SRO except those
rules related to (A) decorum or attire, (B) financial requirements,
or (C) reporting or record-keeping unless resulting in fines
aggregating more than $5,000 within any calendar year; (ii) any rule
violation described in subparagraphs (A) through (C) above that
involves fraud, deceit or conversion or results in a suspension or
expulsion; (iii) any violation of the Act or the regulations
promulgated thereunder; or (iv) any failure to exercise supervisory
responsibility with respect to an act described in paragraphs (i)
through (iii) above when such failure is itself a violation of
either the rules of an SRO, the Act or the regulations promulgated
thereunder.
\4\ Thus, for example, a disciplinary action taken by the
Chicago Board Options Exchange or the National Association of
Securities Dealers, Inc. should be considered in a manner similar to
a disciplinary action of the Chicago Board of Trade or NFA.
\5\ In reviewing these matters, the NFA should bear in mind
recent Commission precedent which allows for reliance on settled
disciplinary proceedings in some circumstances. See In the Matter of
Michael J. Clark, [1996-1998 Transfer Binder] Comm. Fut. L. Rep.
(CCH) para. 27,032 (Apr. 22, 1997) ("other good cause" under
Section 8a(3)(M) of the Act exists based upon a pattern of exchange
disciplinary actions resulting in significant sanctions for serious
rule violations--whether settlements or adjudications), aff'd sub
nom., Clark v. Commodity Futures Trading Commission, No. 97-4228 (2d
Cir. June 4, 1999) (unpublished).
---------------------------------------------------------------------------
The Commission has treated the registration process and the SRO
disciplinary process as separate matters involving separate
considerations. The fact that the Commission has not pursued its own
enforcement case in a particular situation does not necessarily mean
that the Commission considers the situation to be a minor matter for
which no registration sanctions are appropriate. Further, the
Commission believes that it and NFA, entities with industry-wide
perspective and responsibilities, are the appropriate bodies, rather
than any individual exchange, to decide issues relating to
registration status, which can affect a person's ability to function
in the industry well beyond the jurisdiction of a particular
exchange. Thus, NFA's role is in no way related to review of
exchange sanctions for particular conduct, but rather it is the
entirely separate task of determining whether an FB's or FT's
conduct should impact his or her registration.
NFA also should look to Commission precedent in selecting
conditions or restrictions to be imposed, such as a dual trading ban
where a person has been involved in disciplinary offenses involving
customer abuse. Where conditions or restrictions are imposed, or
agreed upon, NFA also should follow Commission precedent, under
which such conditions or restrictions generally have been imposed
for a two-year period.
The Commission has required sponsorship for conditioned FBs and
FTs when their disciplinary offenses have involved noncompetitive
trading and fraud irrespective of the level of sanctions imposed by
an SRO. Indeed, but for a sponsorship requirement there would be no
one routinely watching and responsible for the activities of these
registrants. Absent sponsorship, such FBs and FTs would only be
subject to routine Commission and exchange surveillance. The
Commission's rules are premised upon the judgment that requiring FTs
and FBs to have sponsors to ensure their compliance with conditions
is both appropriate and useful. See Rule 3.60(b)(2)(i).
A question has arisen whether, if NFA is required to prove up
the underlying facts of an SRO disciplinary action, the exchanges
can provide information on exchange disciplinary proceedings
directly to NFA. Although Section 8c(a)(2) of the Act states that an
exchange shall not disclose the evidence for a disciplinary action
except to the person disciplined and to the Commission, Section
8a(10) of the Act allows the Commission to authorize any person to
perform any portion of the registration functions under the Act,
notwithstanding any other provision of law. The effective discharge
of the delegated registration function requires NFA to have access
to the exchange evidence. Thus, the Commission believes that Section
8a(10) may reasonably be interpreted to allow the disclosure of
information from exchange disciplinary proceedings directly to NFA
despite the provisions of Section 8c(a)(2).
Nothing in the Notice and Order affects the Commission's
authority to review the granting of a registration application by
NFA in the performance of Commission registration functions,
including review of the sufficiency of conditions or restrictions
imposed by NFA, to review the determination by NFA not to take
action to affect an existing registration, or to take its own action
to address a statutory disqualification. Moreover, the Commission
Order contemplates that to allow for appropriate Commission
oversight of NFA's exercise of this delegated authority, NFA will
provide for the Commission's review quarterly schedules of all
applicants cleared for registration and all registrants whose
registrations are maintained without adverse action by NFA's
Registration, Compliance, Legal Committee despite potential
statutory disqualifications.
The Commission will continue to monitor NFA activities through
periodic rule enforcement reviews, and NFA remains subject to the
present requirement that it monitor compliance with the conditions
and restrictions imposed on conditioned and restricted registrants.
Sincerely,
Jean A. Webb,
Secretary of the Commission.
Second Guidance Letter
April 13, 2000.
Robert K. Wilmouth, President
National Futures Association, 200 West Madison Street, Chicago, IL
60606-3447
Re: Use of Exchange Disciplinary Actions as "Other Good Cause" to
Affect Floor Broker/Floor Trader Registration
Dear Mr. Wilmouth:
I. Introduction and Background
In July 1997, the Commission issued a Notice and Order
authorizing the National Futures Association ("NFA") to grant or
to maintain, either with or without conditions or restrictions,
floor broker ("FB") or floor trader ("FT") registration where
NFA previously would have forwarded the case to the Commission for
review of disciplinary history.\1\ By letter dated December 4, 1997
("Guidance Letter"), the Commission provided further direction on
how the Commission expected NFA to exercise its delegated power and
to ensure that NFA exercised its delegated power in a manner
consistent with Commission precedent.
---------------------------------------------------------------------------
\1\ Registration Actions by National Futures Association With
Respect to Floor Brokers, Floor Traders and Applicants for
Registration in Either Category, 62 FR 36050 (July 3, 1997).
---------------------------------------------------------------------------
The Commission has determined to revise the Guidance Letter.
Specifically, the Commission is revising the portion of the Guidance
Letter that addresses the use of exchange disciplinary actions as
"other good cause" to affect FB and FT registrations. The
Commission has made this determination following its own
reconsideration of the issue and at the urging of industry
members.\2\
---------------------------------------------------------------------------
\2\ See letters submitted by James Bowe, former president of the
New York Board of Trade ("NYBOT"), dated October 13, 1999,
Christopher Bowen, general counsel of the New York Mercantile
Exchange ("NYMEX"), dated October 18, 1999, and the Joint
Compliance Committee ("JCC"), dated February 2, 2000. The JCC
consists of senior compliance officials from all domestic futures
exchanges and the NFA (i.e., the domestic self-regulatory
organizations ("SROs")). In addition, staff from the Contract
Markets Section of the Commission's Division of Trading and Markets
attend the JCC meetings as observers. The JCC was established to aid
in the development of improved compliance systems through joint
efforts and information-sharing among the SROs. Commission staff
have also discussed this issue with SRO staff.
---------------------------------------------------------------------------
The Guidance Letter pointed out that, in exercising its
delegated authority, NFA must apply all of the provisions of
Sections 8a(2) and (3) of the Commodity Exchange Act ("Act").\3\
In particular, Section 8a(3)(M) of the Act authorizes the Commission
to refuse to register or to register conditionally any person if it
is found, after opportunity for hearing, that there is other good
cause for statutory disqualification from registration beyond the
specifically listed grounds in Sections 8a(2) and 8a(3) of the Act.
The Commission held in In the Matter of Clark that statutory
disqualification under the "other good cause" provision of Section
8a(3)(M) may arise on the basis of, among other things, a pattern of
exchange disciplinary actions alleging serious rule violations that
result in significant sanctions, and that it is immaterial whether
the sanctions imposed resulted from a fully-adjudicated disciplinary
action or an action that was taken following a settlement.\4\
---------------------------------------------------------------------------
\3\ 7 U.S.C. 12a(2) and (3) (1994).
\4\ In the Matter of Clark, [1996-1998 Transfer Binder] Comm.
Fut. L. Rep. (CCH) para. 27,032 (Apr. 22, 1997), aff'd sub nom.,
Clark v. Commodity Futures Trading Commission, No. 97-4228 (2d Cir.
June 4, 1999) (unpublished).
---------------------------------------------------------------------------
The Guidance Letter recommended the application of the
provisions of Commission
[[Page 45233]]
Rule 1.63 \5\ as criteria to aid in assessing the impact of an FB or
FT applicant's or registrant's previous disciplinary history on the
person's fitness to be registered, with the exception that NFA
should be acting based on disciplinary history from the previous
five years, rather than the three years provided for in Rule
1.63.\6\ The Guidance Letter also noted that NFA should consider
disciplinary actions taken not only by futures industry SROs but
also those taken by SROs as defined in Section 3(a)(26) of the
Securities Exchange Act of 1934 ("1934 Act"), including settled
disciplinary actions.
---------------------------------------------------------------------------
\5\ Commission rules referred to in this letter are found at 17
CFR Ch. 1.
\6\ Rule 1.63 provides, among other things, that a person is
ineligible from serving on SRO disciplinary committees, arbitration
panels, oversight panels or governing boards if that person, inter
alia, entered into a settlement agreement within the past three
years in which any of the findings or, in the absence of such
findings, any of the acts charged included a disciplinary offense.
Rule 1.63(a)(6) defines a "disciplinary offense" to include:
(i) any violation of the rules of an SRO except those rules
related to (A) decorum or attire, (B) financial requirements, or (C)
reporting or record-keeping unless resulting in fines aggregating
more than $5,000 within any calendar year; (ii) any rule violation
described in subparagraphs (A) through (C) above that involves
fraud, deceit or conversion or results in a suspension or expulsion;
(iii) any violation of the Act or the regulations promulgated
thereunder; or (iv) any failure to exercise supervisory
responsibility with respect to an act described in paragraphs (i)
through (iii) above when such failure is itself a violation of
either the rules of an SRO, the Act or the regulations promulgated
thereunder.
---------------------------------------------------------------------------
II. REVISED GUIDANCE
As stated above, the Commission has determined to revise the
Guidance Letter. From this point forward, NFA should cease using
Rule 1.63 as the basis to evaluate the impact of an FB or FT
applicant's or registrant's disciplinary history on his or her
fitness to be registered. Instead, as Clark stated, when reviewing
disciplinary history to assess the fitness to be registered of an
FB, FT, or applicant in either category, a pattern of exchange
disciplinary actions alleging serious rule violations that result in
significant sanctions will trigger the "other good cause"
provision of Section 8a(3)(M). The "pattern" should consist of at
least two final exchange disciplinary actions, whether settled or
adjudicated.
NFA also should consider initiating proceedings to affect the
registration of the FB or FT, even if there is only a single
exchange action against the FB or FT, if the exchange action was
based on allegations of particularly egregious misconduct or
involved numerous instances of misconduct occurring over a long
period of time. If, however, a proceeding is initiated based on a
single exchange action that was disposed of by settlement, NFA may
have to prove up the underlying misconduct. Furthermore, traditional
principles of collateral estoppel apply to adjudicated actions,
whether they are being considered individually or as part of a
pattern.\7\
---------------------------------------------------------------------------
\7\ Clark at 44,929.
---------------------------------------------------------------------------
As provided by the Guidance Letter, "exchange disciplinary
actions" would continue to include disciplinary actions taken by
both futures industry SROs and SROs as defined in Section 3(a)(26)
of the 1934 Exchange Act. Furthermore, NFA should review an
applicant's or registrant's disciplinary history for the past five
years.\8\ At least one of the actions forming the pattern, however,
must have become final after Clark was decided by the Commission on
April 22, 1997. Finally, "serious rule violations" consist of, or
are substantially related to, charges of fraud, customer abuse,
other illicit trading practices, or the obstruction of an exchange
investigation.
---------------------------------------------------------------------------
\8\ The Commission generally looked at a five-year period of
disciplinary history. On occasion, however, the Commission examined
a longer period of an applicant's or registrant's disciplinary
history. For example, the Commission revoked the registration of one
FB on the basis of exchange disciplinary cases that extended back
six years, see Clark, 2 Comm. Fut. L. Rep. (CCH) para. 27,032, and
denied an application for registration as an FT on the basis of
exchange disciplinary cases that extended back seven years, see In
the Matter of Castellano, [1987-1990 Transfer Binder] Comm. Fut. L.
Rep. (CCH) para. 24,360 (Nov. 23, 1988), summarily aff'd (May 29,
1990), reh. denied [1990-1992 Transfer Binder] Comm. Fut. L. Rep.
para. 24,870 (June 26, 1990), aff'd sub nom. Castellano v. CFTC,
Docket No. 90-2298 (7th Cir. Nov. 20, 1991).
---------------------------------------------------------------------------
Congress, the courts and the Commission have indicated the
importance of considering an applicant's history of exchange
disciplinary actions in assessing that person's fitness to
register.\9\ Furthermore, NFA's review of exchange disciplinary
actions within the context of the registration process should not
simply mirror the disciplinary actions undertaken by the exchanges.
The two processes are separate matters that involve separate
considerations. As part of their ongoing self-regulatory
obligations, exchanges must take disciplinary action \10\ and such
disciplinary matters necessarily focus on the specific misconduct
that forms the allegation. In a statutory disqualification action,
however, NFA must determine whether the disciplinary history of an
FB, FT or applicant over the preceding five years should impact his
or her registration. Additionally, NFA possesses industry-wide
perspective and responsibilities. As such, NFA, rather than an
individual exchange, should decide registration status issues, since
those issues affect an individual's status within the industry as a
whole, well beyond the jurisdiction of a particular exchange.
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\9\ Letter dated July 14, 1995, from Mary L. Schapiro to R.
Patrick Thompson, President, New York Mercantile Exchange
(unpublished). See also Castellano, supra note 8.
\10\ See Rule 1.51(a)(7).
---------------------------------------------------------------------------
The Commission also wants to clarify to the fullest extent
possible that its power to delegate the authority to deny or
condition the registration of an FB, FT, or an applicant for
registration in either category permits exchanges to disclose to NFA
all evidence underlying exchange disciplinary actions,
notwithstanding the language of Section 8c(a)(2) of the Act.\11\ The
Commission's power to delegate stems from Section 8a(10) of the Act,
which permits delegation of registration functions, including
statutory disqualification actions, to any person in accordance with
rules adopted by such person and submitted to the Commission for
approval or for review under Section 17(j) of the Act,
"notwithstanding any other provision of law." Certainly, Section
8c(a)(2) qualifies as "any other provision of law." Furthermore,
the effective discharge of the delegated function requires NFA to
have access to the exchange evidence. Thus, the exercise of the
delegated authority pursuant to Section 8a(10) permits the exchanges
to disclose all evidence underlying disciplinary actions to NFA.\12\
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\11\ Section 8c(a)(2) states, in relevant part, that "[A]n
exchange * * * shall not disclose the evidence therefor, except to
the person who is suspended, expelled, disciplined, or denied
access, and to the Commission."
\12\ Of course, the Commission could request records from the
exchange and forward them to NFA. The Commission believes that this
is an unnecessary administrative process and that NFA should obtain
the records it needs to carry out the delegated function of
conducting disciplinary history reviews directly from the exchanges.
In this context and pursuant to Commission orders authorizing NFA to
institute adverse registration actions, NFA should be viewed as
standing in the shoes of the Commission.
---------------------------------------------------------------------------
This letter supersedes the Guidance Letter to the extent
discussed above. In all other aspects, the Guidance Letter and other
guidance provided by the Commission or its staff remain in effect.
Therefore, NFA should continue to follow Commission precedent when
selecting conditions or restrictions to be imposed. For example, NFA
should impose a dual trading ban where customer abuse is involved
and any conditions or restrictions imposed should be for a two-year
period. Furthermore, NFA should require sponsorship for conditioned
FBs or FTs when their disciplinary offenses involve noncompetitive
trading and fraud.
Nothing in the Notice and Order or this letter affects the
Commission's authority to review the granting of a registration
application by NFA in the performance of Commission registration
functions, including review of the sufficiency of conditions or
restrictions imposed by NFA, to review the determination by NFA not
to take action to affect an existing registration, or to take its
own action to address a statutory disqualification. Moreover, the
Commission Order contemplates that to allow for appropriate
Commission oversight of NFA's exercise of this delegated authority,
NFA will provide for the Commission's review quarterly schedules of
all applicants cleared for registration and all registrants whose
registrations are maintained without adverse action by NFA's
Registration, Compliance, Legal Committee despite potential
statutory disqualifications.
The Commission will continue to monitor NFA activities through
periodic rule enforcement reviews, and NFA remains subject to the
present requirement that it monitor compliance with the conditions
and restrictions imposed on conditioned and restricted registrants.
Sincerely,
Jean A. Webb,
Secretary of the Commission.
16. Part 3 is amended by adding Appendix B to read as follows:
[[Page 45234]]
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. 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, 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
registered derivatives transaction execution 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 and
registered derivatives transaction execution 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;
(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 or registered derivatives transaction
execution 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 or
registered derivatives transaction execution 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
17. The authority citation for Part 4 continues to read as follows:
Authority: 7 U.S.C. 1a, 2, 6b, 6c, 6l, 6m, 6n, 6o, 12a, and 23.
18. Section 4.10 is 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.
* * * * *
19. Section 4.24 is amended by revising paragraphs (f)(1)(v) and
(h)(2) to read as follows:
Sec. 4.24 General disclosures required.
* * * * *
(f) * * *
(1) * * *
[[Page 45235]]
(v) Each principal of the persons referred to in this paragraph
(f)(1) 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;
* * * * *
20. Section 4.32 is added to read as follows:
Sec. 4.32 Trading on a Registered Derivatives Transaction Execution
Facility for Non-Institutional Customers.
(a) A registered commodity trading advisor may enter trades on or
subject to the rules of a registered derivatives transaction execution
facility on behalf of a client who does not qualify as an
"institutional customer" as defined in Sec. 1.3(g) of this chapter,
provided that the trading advisor:
(1) Directs the client's commodity interest account;
(2) Directs accounts containing total assets of not less than
$25,000,000 at the time the trade is entered; and
(3) Discloses to the client that the trading advisor may enter
trades on or subject to the rules of a registered derivatives
transaction execution facility on the client's behalf.
(b) The commodity interest account of a client described in
paragraph (a) of this section must be carried by a registered futures
commission merchant.
21. Section 4.34 is 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
22. The authority citation for Part 140 continues to read as
follows:
Authority: 7 U.S.C. 2, 12a.
23. Section 140.91 is amended by adding 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.
* * * * *
PART 155--TRADING STANDARDS
24. 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.
25. Section 155.6 is added to read as follows:
Sec. 155.6 Trading standards for the transaction of business on
registered derivatives transaction execution facilities.
(a) A futures commission merchant, or affiliated person thereof,
transacting business on behalf of a customer who does not qualify as an
"institutional customer" as defined in Sec. 1.3(g) on a registered
derivatives transaction execution 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 registered derivatives transaction
execution facility.
Issued in Washington, D.C. on August 20, 2001 by the Commission.
Catherine D. Dixon,
Assistant Secretary of the Commission.
[FR Doc. 01-21451 Filed 8-27-01; 8:45 am]
BILLING CODE 6351-01-P