[Federal Register: October 23, 2001 (Volume 66, Number 205)]
[Rules and Regulations]
[Page 53510-53523]
From the Federal Register Online via GPO Access [wais.access.gpo.gov]
[DOCID:fr23oc01-3]
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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: Final rules.
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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 adopting rules relating to intermediation of
commodity futures and commodity options (commodity interest)
transactions. These new rules and rule amendments provide greater
flexibility in several areas, and addresses, 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 is also adopting changes to allow a registrant to notify the
Commission when a new natural person is added as a principal promptly
after the change occurs.
These rules are consistent with the mandate of the CFMA to
streamline regulation of entities registered under the Act. Most of the
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subsequently withdrawn following the CFMA's enactment in order to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 rules in light of the CFMA, the Commission has determined
that the rules being adopted herein are consistent with the CFMA.
EFFECTIVE DATE: October 23, 2001.
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. Overview of Comments
III. New Rules and Rule Amendments
A. Registration
1. Definition of the Term ``Principal'
2. Application Procedures for IBs and FCMs
B. Fitness and Supervision
C. Financial Requirements
1. Trading by Non-Institutional Customers on DTFs
2. 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
IV. Section 4(c) Findings
V. Cost-Benefit Analysis
VI. Related Matters
A. Regulatory Flexibility Act
B. Paperwork Reduction Act
C. Administrative Procedure 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 rules
adopted herein are designed to be an initial step in fulfilling the
mandates of Section 2 and Section 125.
Most of the 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\ On August 20, 2001, after reviewing the rules in
light of the CFMA and determining that the rules are consistent with
the CFMA, the Commission proposed the new rules and rule amendments
being adopted herein.\2\
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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).
\2\ See 66 FR 45221 (Aug. 28, 2001).
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II. Overview of Comments
The Commission received five comment letters on the proposals. The
commenters included Fimat USA Inc. (Fimat), a registered futures
commission merchant (FCM) and securities broker-dealer (BD); the
Chicago Board of Trade (CBT), a designated contract market; Exchange
Analytics Inc. (EA), an ethics
[[Page 53511]]
training provider; National Futures Association (NFA), a registered
futures association; and the Managed Funds Association (MFA), an
industry trade association. Each commenter indicated that it generally
supported the adoption of the proposed new rules and rule amendments.
The issue that generated the most discussion was ethics training, which
was addressed by four of the five commenters. As discussed more fully
below, the Commission proposed to replace Rule 3.34 governing ethics
training with a Statement of Acceptable Practices.
As noted above, these rules are intended to be a first step with
respect to intermediaries in meeting the purpose of the CFMA to
streamline and eliminate unnecessary regulation. The Commission will
look at possible further regulatory relief related to intermediaries as
part of the study mandated by Section 125 of the CFMA.\3\ Fimat urged
the Commission to consider adopting further relief for intermediaries
prior to the conclusion of this study. The study is just one aspect of
the Commission's ongoing efforts in this regard and the Commission
anticipates that additional reforms may be implemented before the study
is completed.\4\ The Commission urges Fimat and any other persons
interested in intermediaries reform to submit comments regarding
appropriate reforms to the Secretary of the Commission in accordance
with the Federal Register release soliciting such comments.\5\
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\3\ See 66 FR 33531 (June 22, 2001).
\4\ As the Commission stated in the August proposals, to the
extent that an existing rule is not addressed in this release, the
Commission will, pending further relief, continue to apply the rule
to intermediaries transacting business on behalf of customers on
designated contract markets and registered derivatives transaction
execution facilities (DTFs) regardless of whether the contract
market or DTF itself, or its operators, have been exempted from
applicable provisions of the rule. See 66 FR 45221 at 45222.
\5\ See 66 FR at 33532.
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III. New Rules and Rule Amendments
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),\6\ all
officers of a registrant were treated as principals and were required
to register as such.\7\ 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 amending Rules 3.1(a)(1) and 4.10(e)(1) by defining
as principals persons within a given organizational structure who hold
specific offices.\8\ A registrant, therefore, will no longer be
required to treat every officer as a principal, but only those who meet
the criteria of the rule as revised.\9\ The 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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\6\ Rule 3.1(a) defines ``principal'' for purposes of the
Commission's Part 3 rules, which govern registration. Rule 4.10(e)
defines ``principal'' for purposes of the Commission's Part 4 rules,
which apply to the activities of commodity pool operators (CPOs) and
commodity trading advisors (CTAs).
\7\ 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.''
\8\ Thus, the principal definition includes, 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 Rule 3.1(a)(1).
The reference in the amendment to the ``principal'' definition
to ``any person in charge of a principal business unit subject to
regulation by the Commission'' does not include departments such as
human resources or administration.
\9\ The ``principal'' definition continues to include all
directors of a corporate registrant. In addition, the definition
includes 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 also includes 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 includes 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. Adopting these amendments permits the deletion of Rule
3.10(a)(2)(ii), which has proved somewhat unwieldy in practice.\10\ NFA
and CBT supported these amendments to the principal definition.
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\10\ The amendments 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 adopting 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 are only 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, the Commission is deleting 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) is being 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. New Rule 3.31(a)(2) closely parallels Rule 3.10(a)(2)(i),\11\
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 NFA, a Form 8-R for
that principal must accompany the Form 3-R amending the registrant's
application for registration.\12\ NFA supported these rule changes, as
well as the changes to Part 4 referred to above.
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\11\ As noted in the preceding footnote, this provision is being
redesignated as Rule 3.10(a)(2).
\12\ An additional conforming amendment to Rule 3.21(c) reflects
the deletion of Rule 3.32, and the addition of new paragraph (a)(2)
to Rule 3.31.
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[[Page 53512]]
2. Application Procedures for IBs and FCMs
The Commission is also adopting Rule 1.10(a)(2)(ii)(A)(3), which
will permit applicants for registration as IBs who raise their own
capital to satisfy minimum financial requirements, to file an unaudited
financial report indicating satisfaction of the minimum requirements,
rather than requiring them to provide certified financial statements
with their registration application.\13\ A firm taking advantage of the
new procedure will be subject to an on-site review within six months of
registration by the firm's designated self-regulatory organization
(DSRO) or, at the DSRO's discretion, a conference between appropriate
staff of the firm and the DSRO at the DSRO's offices.\14\ This
alternative procedure is modeled on similar procedures in the
securities industry.\15\
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\13\ However, those IB applicants who do not raise their own
capital 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 is
unnecessary for any FCM or IB registered in accordance with
recently-adopted 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 43080 (Aug. 17, 2001).
\14\ Although the rule does 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.
\15\ Certain technical amendments are also being 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 Form
1-FR-IB.
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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.\16\ However, the Commission notes that the DSRO will
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 can continue
to follow the existing rules and file a certified financial statement
with its application.
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\16\ 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's December Release contained relief for FCM
applicants similar to that provided to IB applicants. The Commission
did not repropose these rule changes for FCM applicants in light of
comments filed by NFA and CBT on the June 2000 proposed rules. NFA and
CBT reiterated in their comment letters filed on the August 2001
proposals their strong support for maintaining the requirement of a
certified financial report as part of an FCM registration
application.\17\
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\17\ As noted in the August 2001 proposals, the Commission did
not repropose its ``passporting'' registration procedure in light of
various provisions of the CFMA. See 66 FR 45221 at 45222 & n.2. The
Commission also indicated that it might revisit that issue in the
context of the study mandated by Section 125 of the CFMA. NFA agreed
that the Commission's earlier passporting proposal was generally
rendered moot by the CFMA, but stated that the issue of streamlining
the registration process for dual securities and futures applicants
by eliminating duplicate background checks should be addressed as
part of the mandated study.
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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 proposed deleting Rule 3.34 and instead implementing
Congressional intent regarding ethics training through a Statement of
Acceptable Practices. Rule 3.34 specified the 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 leaves the format, frequency, and providers of ethics training up
to the registrants themselves, the Commission noted that greater
flexibility regarding ethics training would be afforded to registrants
than had been permitted under Rule 3.34 so that registrants could
tailor training to their particular business activities. For
registrants seeking guidance as to the maintenance of proper ethics
training procedures, the Statement of Acceptable Practices would serve
as a ``safe harbor.''\18\
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\18\ 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, is left to the
discretion of registrants and DSROs. It is also permissible to
require training on whatever periodic basis the registrants and
DSROs deem appropriate. Thus, the Commission will not specify any
particular programs or procedures that must be followed.
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Ethics training generated the most discussion among the commenters.
Fimat commented that, while it did not oppose the elimination of
Commission Rule 3.34, it did believe that a Commission rule providing
for ethics training on a specified schedule would help Fimat to
``ensure full cooperation by all [of its] employees.'' EA expressed
opposition to the repeal of Rule 3.34, although it indicated that it
would be amenable to the removal of the minimum time requirements of
that rule (four hours within six months of being granted registration
and an hour every three years thereafter) and to allowing training in
whatever format works best for the industry. EA also expressed concern
about the maintenance of records of completion of ethics training and
stated that NFA should continue to assist firms by maintaining records
of training even if Rule 3.34 is replaced with a Statement of
Acceptable Practices. EA stated that the Commission's proposal
concerning ethics training would create uncertainty, may lead firms to
place an inadequate priority on training, and weaken public confidence
in the industry. CBT applauded the Commission's proposal concerning
ethics training, stating that the result would avoid micromanagement in
this area, consistent with the overall intent of the CFMA. NFA also
strongly supported the Commission's proposal, claiming that the current
rule was far too detailed and administratively cumbersome.
The Commission does not believe that the replacement of the rule
with a Statement of Acceptable Practices diminishes a registrant's
obligations to remain fit and to adequately supervise the handling of
customer accounts. Instead, the Commission, through the Statement of
Acceptable Practices, which provides guidance to registrants to develop
training programs that are suited to their individual needs, is
signaling that ethics should be considered an ongoing responsibility
rather than an episodic one. 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 further believes that, given
[[Page 53513]]
the increasing rapidity of market evolution, it is appropriate for
firms to determine how frequently their employees need to be updated on
their obligations to customers. Thus, the Commission is not adopting
EA's suggestion to maintain the current six-month and three-year
training schedule or Fimat's suggestion that the Commission mandate
that all registrants participate in some kind of program at least
annually or once within some other specified time period. Instead, the
Commission is replacing Rule 3.34 with the Statement of Acceptable
Practices as proposed.
The Commission is also publishing 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 are being 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,\19\ 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.\20\ Such an FCM is
considered to be more capable of properly handling these transactions
and the associated risk.
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\19\ See new Part 37 of the Commission rules, 66 FR 42256 at
42271 (Aug. 10, 2001).
\20\ 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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The Commission is adopting new Rule 4.32 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;\21\ (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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\21\ 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, should have the
appropriate financial sophistication to handle the risk associated with
trading for non-institutional customers on a DTF.\22\ 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.\23\ NFA and MFA supported the new
rule pertaining to CTAs.
In order to provide guidance to non-institutional customers trading
through a highly-capitalized FCM or a CTA meeting the standards of Rule
4.32, 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. NFA stated in its
comment letter that it looked forward to developing appropriate
disclosures for non-institutional customers trading on DTFs.
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\22\ See Section 1a(12)(C) of the Act.
\23\ See 65 FR 47275, at 47277 (Aug. 2, 2000).
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2. Investment of Customer Funds
Final rules and rule amendments concerning the investment of
customer funds by FCMs and clearing organizations became effective on
December 28, 2000.\24\ To facilitate the implementation of Rule 1.25
and its related amendments, new paragraph (a)(7) to Rule 140.91 is
being 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 notes that it
has determined not to rescind Division of Trading and Markets Financial
and Segregation Interpretation No. 9 (Interp. 9).\25\ 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).\26\ 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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\24\ See 65 FR 82270 (Dec. 28, 2000).
\25\ 1 Comm. Fut. L. Rep. (CCH) para. 7119 (Nov. 23, 1983).
\26\ See 65 FR at 78001 n.53.
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D. Risk Disclosure and Account Statements
The Commission recognizes that there are certain areas of the
account opening process that may be streamlined. Accordingly, the
Commission has adopted amendments to Rules 1.55(d)(1) and (2), to
permit certain required disclosures, such as those concerning consent
to (1) allow electronic transmission of statements under new Rule
1.33(g),\27\ 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.\28\
The single signature may be made electronically as provided for in
Rules 1.3(tt) and 1.4.\29\
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\27\ See infra.
\28\ 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.
\29\ 65 FR 12466 (Mar. 9, 2000).
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CBT supported these rule changes. NFA commented that Rule 1.55
should not dictate the specifics of delivering and acknowledging
disclosure. Because the Commission made no proposal on those aspects of
Rule 1.55, it has determined not to adopt NFA's suggestion, but will
revisit the issue in the intermediary study.
E. Trading Standards
The Commission proposed 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, continue to apply to intermediation of trades on contract
markets. The Commission also proposed to extend these requirements to
trading by non-institutional customers on DTFs under new Rule 155.6(a).
Rules 155.1, 155.3 and 155.4 have helped the Commission to deter
[[Page 53514]]
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 proposed
to adopt a new Rule 155.6(b), which would set forth a general standard
of practice in this area. The Commission also indicated in the August
2001 proposals that it would 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.\30\
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\30\ 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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NFA commented that, with respect to trading standards, there should
be no distinctions based upon the type of trading facility or the type
of customer. NFA further commented that it could support either
extending the existing rules to DTFs or a core principle with a
Statement of Acceptable Practices for both designated contract markets
and DTFs. CBT suggested a rule change related to the Commission's
proposal to retain the applicability of Rules 155.3 and 155.4 to FCMs
and IBs with regard to transactions on designated contract markets. CBT
noted that paragraph (b)(2) of each rule prohibits an FCM or IB,
respectively, and their affiliated persons, from knowingly taking the
other side of a customer order ``except with such other person's prior
consent and in conformity with contract market rules approved by the
Commission.'' (Emphasis added.) CBT requested that, in light of the new
rule certification procedures permitted by the CFMA and the Commission,
the emphasized text be amended to read ``approved by or certified to
the Commission.''
The Commission believes that its proposed 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. New Rule 155.6 is intended to proscribe the
same trade practice abuses as Rules 155.1, 155.3, and 155.4.
Accordingly, the Commission is adopting Rule 155.6 as proposed and has
determined not to follow NFA's suggestions in this area. However, the
Commission believes that CBT's comment is valid and has adopted
amendments to Rules 155.3 and 155.4 to encompass rules certified to the
Commission as well as those approved by the Commission concerning
trading standards.
F. Recordkeeping
1. Customer Account Statements
In keeping with changes in technology and commercial practices, the
Commission proposed to codify its previous Advisory relating to the
electronic transmission of account statements in new Rule 1.33(g).\31\
The Advisory permitted an FCM, with customer consent, to deliver
required confirmation, purchase-and-sale, and monthly account
statements electronically in lieu of mailing a paper copy. FCMs 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 is 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 is 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 do 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 1.33 would also be permitted to
be furnished by electronic media.
---------------------------------------------------------------------------
\31\ 65 FR at 39017; see also 62 FR 31507 (June 10, 1997).
---------------------------------------------------------------------------
NFA opposed codification of the Advisory, even though it fully
supports its content. NFA stated that codification would decrease
flexibility and that the Advisory should be treated as acceptable
practices guidance rather than codified in a rule. The Commission
believes that adopting the contents of the Advisory as a rule provides
greater legal certainty and visibility, and has determined to adopt new
Rule 1.33(g) as proposed.
2. Close-Out of Offsetting Positions
The Commission is amending 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.\32\ NFA supported this rule change,
but cautioned that the discretion provided by the rule amendment should
not be misused to permit customers to change offsetting instructions on
every transaction. The Commission appreciates these concerns and will
monitor implementation of the rule amendment to prevent misuse.
---------------------------------------------------------------------------
\32\ 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).
---------------------------------------------------------------------------
The Commission proposed that CPOs and CTAs be required to disclose
to customers, under 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.\33\ NFA objected to these
proposals. NFA commented that disclosure would only be material if a
CPO or CTA is compensated based upon realized gains and, if that is the
case, disclosure about how positions are closed out and the effect on
fees is already required. The Commission believes that, given the
change in the longstanding rule concerning offsetting positions and the
concerns about possible misuse expressed by NFA as noted above,
disclosure by CPOs and CTAs as proposed is appropriate. Accordingly,
the Commission has determined to adopt the amendments to Rules
4.24(h)(2) and 4.34(h) as proposed.
---------------------------------------------------------------------------
\33\ 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 is
amending 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 is also being
[[Page 53515]]
amended by revising paragraph (e) to correspond to new Rule 1.33(g)
(the substance of paragraph (e) of Rule 1.46 is being 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).''
IV. Section 4(c) Findings
Certain of the rules and rule amendments discussed herein are being
adopted 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 rules and rule amendments provide greater
flexibility for intermediaries and their customers in several areas.
Specifically, the Commission is adopting 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 adopted herein are consistent with the public
interest. The Commission, in proposing the rules and rule amendments
adopted herein, specifically invited public comment on this finding.
The Commission received no comments regarding this finding.
V. 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 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.
This rulemaking constitutes a package of related rule provisions
affecting market intermediaries. The 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 rules would be expected to cost little in terms of diminishing the
protection of market participants and the public.
2. Efficiency and competition. The rules are expected to benefit
competition and market efficiency broadly by providing increased
flexibility for intermediaries. For instance, the Commission is
adopting 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
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
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
new rules and rule amendments adopted herein 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
adopt the revisions to its rules discussed above. The Commission
invited public comment on its application of the new cost-benefit
provision. The Commission did not receive any comments regarding the
application of the cost-benefit provision.
VI. 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 promulgating rules, to
consider the impact of those rules on small businesses. The rules
adopted 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
[[Page 53516]]
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.\34\ The Commission has previously determined that registered
FCMs, CPOs, LTMs and ATOMs are not small entities for the purpose of
the RFA.\35\ 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 adopted
herein would not require any registrant to change its current method of
doing business. For many registrants, the revisions should decrease the
number of persons within the registrant's organization who would be
considered principals under the CFTC's rules. Further, the revisions
should reduce, rather than increase, the regulatory requirements that
apply to registrants and applicants for registration, regardless of
size. The Commission notes that no comments were received from the
public on the RFA and its relation to the proposed rules.
---------------------------------------------------------------------------
\34\ 47 FR 18618-21 (Apr. 30, 1982).
\35\ 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).
---------------------------------------------------------------------------
B. Paperwork Reduction Act
This proposed rulemaking contains information collection
requirements. As required by the Paperwork Reduction Act of 1995, 44
U.S.C. 3507(d), the Commission has submitted a copy of these proposed
amendments to its rules to the Office of Management and Budget (OMB)
for its review. No comments were received in response to the
Commission's invitation in the proposed rules to comment on any
potential paperwork burden associated with this regulation.
C. Administrative Procedures Act
The Administrative Procedures Act provides that the required
publication of a substantive rule shall be made not less than 30 days
before its effective date, but provides an exception for ``a
substantive rule which grants or recognizes an exemption or relieves a
restriction.'' \36\ The new rules and rule amendments herein provide
greater flexibility in several areas, including, among other things,
amending the definition of ``principal'' so as to reduce the number of
officers of a registrant that are required to be listed as principals
with the Commission, reducing the burden on a registrant in notifying
the Commission when a new natural person is added as a principal, and
permitting a firm greater freedom in creating its own program for
ethics training. Further, the Commission notes that most of the rules
and rule amendments have now been published twice for public comment
and that this is the second time they have been adopted by the
Commission. Accordingly, the Commission has determined to make the new
rules and rule amendments effective immediately.
---------------------------------------------------------------------------
\36\ 5 U.S.C. 553(d).
---------------------------------------------------------------------------
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.
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 foregoing, the Commission hereby
amends Chapter I of Title 17 of the Code of Federal Regulations as
follows:
PART 1--GENERAL REGULATIONS UNDER THE COMMODITY EXCHANGE ACT
1. The authority citation for Part 1 continues to read as follows:
Authority: 7 U.S.C. 1a, 2, 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 the Commodity
Futures Modernization Act of 2000, 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)
and removing the undesignated paragraphs within and following
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
[[Page 53517]]
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 that is a party to a guarantee
agreement that has been terminated in accordance with the provisions of
paragraph (j)(5) of this section, or that 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 that 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 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
(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 consents,
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
[[Page 53518]]
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; and
(2) The acknowledgment referred to in paragraph (d)(1) of this
section is 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 acknowledgments 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
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
* * * * *
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:
[[Page 53519]]
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 Fed. Reg. 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 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.
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\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).
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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
[[Page 53520]]
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.
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\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).
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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\
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\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.
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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\
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\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).
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The Guidance Letter recommended the application of the
provisions of Commission 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.
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\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.
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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\
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\7\ Clark at 44,929.
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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
[[Page 53521]]
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.
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\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).
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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).
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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.
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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:
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.
[[Page 53522]]
(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) * * *
(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
[[Page 53523]]
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 155.3 is amended by revising paragraph (b)(2) to read
as follows:
Sec. 155.3 Trading standards for futures commission merchants.
* * * * *
(b) * * *
(2) Knowingly take, directly or indirectly, the other side of any
order of another person revealed to the futures commission merchant or
any of its affiliated persons by reason of their relationship to such
other person, except with such other person's prior consent and in
conformity with contract market rules approved by or certified to the
Commission.
* * * * *
26. Section 155.4 is amended by revising paragraph (b)(2) to read
as follows:
Sec. 155.4 Trading standards for introducing brokers.
* * * * *
(b) * * *
(2) Knowingly take, directly or indirectly, the other side of any
order of another person revealed to the introducing broker or any of
its affiliated persons by reason of their relationship to such other
person, except with such other person's prior consent and in conformity
with contract market rules approved by or certified to the Commission.
* * * * *
27. 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) of this chapter 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 October 16, 2001 by the
Commission.
Jean A. Webb,
Secretary of the Commission,
[FR Doc. 01-26523 Filed 10-22-01; 8:45 am]
BILLING CODE 6351-01-P