DIVISION OF TRADING AND MARKETS

FINANCIAL AND SEGREGATION INTERPRETATION NO. 4-1

Advisory Interpretation For Self-Regulatory Organization Surveillance Over Members' Compliance With Minimum Financial, Segregation, Reporting, and Related Recordkeeping Requirements

PURPOSE

1.  On May 17, 1979, the Division of Trading and Markets ("Division") issued Financial and Segregation Interpretation 4 which provided the self-regulatory organizations ("SROs") with standards for carrying out their surveillance of compliance by futures commission merchants ("FCMs") with the SROs' financial rules. The Interpretation identified the minimum elements which the Division believed should be included in an SRO's in-field examination and ongoing financial surveillance program ("program") for such a Program to meet the SRO's self-regulatory responsibilities under the Commodity Exchange Act ("Act") and the regulations promulgated thereunder.

2.  The Division has made several reviews of the SROs' Programs since it issued that Interpretation and has found that, for the most part, SROs have designed their Programs to conform with the Interpretation. However, those reviews have also made apparent to the Division that Interpretation 4 needs to be revised in certain respects, and therefore, the Division is issuing this new Interpretation 4-1 which supersedes the prior interpretation:

Interpretation 4 did not clearly distinguish between the extent of surveillance to be carried out over registrants that carry customer funds and those that do not. Since the Commission's greatest concern is with those registrants that handle the public's funds, Interpretation 4-1 allows SROs the flexibility needed to direct greater efforts towards monitoring such registrants.

Interpretation 4 did not address SROs' responsibilities with regard to members which, while not Commission registrants, could affect the financial stability of contract market clearing organizations and, in turn, the viability of other member-registrants that do carry customer funds. Interpretation 4-1 discusses the need for adequate surveillance by SROs over such non-registrant clearing members.

Interpretation 4 did not recognize that the primary business of many registrants is securities brokerage (with that segment of their business overseen by securities regulatory organizations). Interpretation 4-1 allows commodity SROs to limit the scope of their examinations of such registrants under certain conditions.

Since publication of Interpretation 4, the first registered futures association ("RFA") has commenced operations and has begun carrying out audits and surveillance activities over those Commission registrants that are not members of any contract market. This includes FCMs as well as introducing brokers ("IBs") and commodity pool operators ("CPOs"). This Interpretation 4-1 specifies the minimum elements of a satisfactory financial surveillance Program for RFAs and clarifies existing guidelines for all SROs.

3.  This Interpretation 4-1 allows SROs greater latitude in determining the scope of their examinations and surveillance activities since they are best situated to assess the relative risks encountered by their own members.

4.  This Interpretation 4-1 only addresses SROs' responsibilities with respect to in-field examinations and ongoing surveillance over members' compliance with the SRO/Commission's financial, segregation and related recordkeeping rules. It does not address the SROs' responsibilities with regard to option sales practice examinations of branch offices, guaranteed IBs, and commodity trading advisors ("CTAs").

STATUTORY REQUIREMENTS

5.  Section 5a(9) of the Act requires each contract market to enforce all bylaws, rules, regulations, and resolutions made or issued by it or by the governing board thereof or by any of its committees, which provide minimum financial standards and related reporting requirements for FCMs that are members of such contract market, and which have been approved by the Commission. Section 1.52(a) of the Commission's regulations requires each SRO to adopt, and submit for Commission approval, rules prescribing minimum financial and related reporting requirements for all of their member-FCMs. Such rules must also be established by any SRO that is not a contract market for member-IBs (a contract market must adopt such rules for IBs, if it elects to establish a membership category for IBs). Section 1.52(b) requires each SRO to have in effect and enforce those rules which have been submitted to and approved by the Commission. Regulation 1.52(c) allows an SRO to delegate examination and financial surveillance responsibility to a designated self-regulatory organization ("DSRO") for any member-FCM or -IB which is a member of more than one SRO.

6.  The general (non-financial) rule enforcement program of a contract market is covered by Commission Guideline No. 2 (1 COMM. FUT. L. REP. (CCH) section 6430 (May 13, 1975)) and Section 1.51 of the Commission's regulations. Section 1.51(a)(3) of the Commission's regulations requires a contract market's program for enforcement of its own rules and the Act to include:

Examination of the books and records kept by contract market members relating to their business of dealing in commodity futures, commodity options and cash commodities, insofar as such business relates to their dealing on such contract market.

7.  Since the minimum financial and related requirements of a contract market are part of a contract market's rules, Guideline No. 2 will apply in general to a financial compliance program. In the financial rules area, Guideline No. 2 will be supplemented by this Interpretation.

8.  Under the Act an RFA is charged with the responsibility of protecting the public interest by preventing fraudulent and manipulative acts and practices, and promoting just and equitable principles of trade. In this regard, section 17(p)(2) of the Act requires an RFA to establish minimum capital, segregation and other financial requirements which are not less stringent than those imposed by the Commission, and to implement a program to examine and enforce compliance with the financial and segregation rules.

9.  Although Section 1.51 and Guideline No. 2 apply to contract markets and Section 1.52 applies to SROs, the Division believes the standards established for contract markets under Section 1.51 and Guideline No. 2 should also apply to any self-regulatory organization, including an RFA.

GENERAL REQUIREMENTS FOR A SATISFACTORY PROGRAM

10.  The standards set forth in this Interpretation are minimum standards and, as such, are not meant to preclude a particular SRO from including as part of its Program any other procedures it believes necessary to satisfy itself that its members comply with the rules of the SRO and the Commission.

Review of Compliance with Commission and SRO Rules

11.  In general, each DSRO's Program must meet the standards of the CEAct and must include such procedures as it believes necessary to satisfy itself that each member-FCM, -CPO, and -IB for which it has supervisory responsibility under the Act and regulations meets the DSRO's and the Commission's financial, segregation, and related reporting and recordkeeping rules as may be applicable to the registrant. Each DSRO's Program must take into account the characteristics of the particular contract markets on which the member engages in business as well as the nature of the business handled by the member (for example: speculative vs. hedging; retail vs. commercial; floor trader vs. public; securities/commodities vs. commodities-only). Such program must include a combination of ongoing surveillance as well as on-site examination of members' records. The Program of ongoing surveillance should include procedures for assessing adverse trends in the financial condition of members and assessment of the markets which could affect the condition of and pose potential financial risks to its members. Also, the Program should provide for intensified procedures for closely monitoring the condition of members which it knows or suspects are failing to meet an SRO's or CFTC's segregation or net capital requirements or in an early warning net capital position (reg. 1.12(b)); are not maintaining current books and records (reg. 1.12(c)); or are experiencing material inadequacies in internal controls (reg. 1.12(d) and (e) and 1.16(d)(2)).

12.  Most SROs do not have segregation and recordkeeping rules that parallel those of the Commission in all cases. However, the Division believes that the concept of self-regulation through designated self-regulatory organizations contemplates that each DSRO's Program will include procedures for monitoring compliance with the Commission's segregation and recordkeeping rules by its members and for notifying the Commission when material violations are found. (NFA's financial rules do parallel the Commission's and NFA is a member of the Joint Audit Committee.)

Protection of Customer Funds

13.  The primary focus of a DSRO's Program should be on those members that handle regulated commodity customer funds. In this connection, the DSRO should have in place procedures to ensure prompt implementation of its regular surveillance and examination procedures, as soon as such firms begin handling customer funds. In addition, an SRO which is a contract market should establish procedures for monitoring those clearing members of theirs which are not Commission registrants to satisfy itself that they have adequate financial resources to meet their obligations to the SRO's clearing organization.

DSRO Staffing

14.  The DSRO must provide a staff of adequate size and appropriate training and experience to carry out its Program; it must provide such supervision over the execution of the Program as will ensure the Program is carried out efficiently and effectively.

Independence

15.  In all matters relating to its Program, the DSRO's Directors, supervising committee members, officers and staff must maintain an independent mental attitude and their actions must not impair their independence nor appear to impair independence. Each DSRO should establish a policy, concerning its compliance staff's participation in commodity transactions and use of information that comes into its staff's possession by virtue of their employment, which is consistent with the Commission's rules and the Division's interpretation published in the Federal Register on February 18, 1982, 47 FR 7300.

Documentation of Activities

16.  A DSRO must ensure that work done by its staff within the Program is thorough and is clearly and completely documented. Sufficient evidence must be obtained to support conclusions drawn and material questionable items must be investigated completely and resolved.

17.  The DSRO must maintain and make readily available to Commission staff full, complete, systematic and accurate records of all significant activities carried out as part of its Program. The DSRO must also prepare and furnish to Commission staff, within a reasonable time period, analyses and summaries of such records as Commission staff may request.

Notices to the Commission

18.  When material apparent violations of the Commission and other SROs' rules are discovered, the DSRO must promptly notify the Commission and such other SROs. The following situations will call for immediate notification: a member is not in compliance with the net capital rule; a member's net capital falls below early warning levels; a member has failed to segregate or has misused customers' funds; a member has denied the SRO access to its records; or a member has failed to maintain current books and records. However, these notification standards are not in lieu of any other notification requirements imposed on SROs by existing regulations.

19.  An SRO must promptly file appropriate notices with the Commission and with other SROs when required to do so by regulation, the SROs' rules, or this Interpretation. If an SRO becomes aware that a member has not filed a required notice, it should promptly advise the member of its filing responsibility and ascertain whether the member has then made such filing. If the member fails to file, the SRO shall immediately notify the Commission and such other SROs as may be appropriate.

Remedial/Punitive Action by DSRO

20.  The DSRO must take prompt and appropriate remedial and punitive action when the DSRO discovers material violations of its own rules by its members. A DSRO must promptly complete, review and, if appropriate, refer to the proper supervising committee, the results of all examinations and reviews it carries out of its members. What the Division considers to be prompt action will depend on the circumstances surrounding the examination or review. For example, the Division believes a DSRO would be remiss in holding an examination open in an attempt to reconcile control accounts that have been out of balance for an extended period of time. Such a situation could call for immediate referral to the supervising committee -- even before other examination work is completed.

Use of Uniform Audit and Examination Guides

21.  In carrying out their routine audits and examinations of member-registrants, DSROs must, where applicable, use uniform examination guides which have been prepared by the Joint Audit Committee, copies of which have been supplied to the Division. (See paragraph No. 11 for requirement that such guides include procedures sufficient under the CEAct to satisfy the DSRO that the FCM meets the DSRO's and the Commission's financial, segregation, and related reporting and recordkeeping rules.) The DSRO or the Joint Audit Committee must keep current copies of such guides and make them available to the Division. The use of uniform examination guides by DSRO staff is only for convenience and does not lessen the responsibility of the in-charge auditor to design and execute examination procedures appropriate to the immediate situation. If a DSRO contracts out to a non-SRO its routine audits and examinations of member-registrants, such non-SRO may use its own audit/examination guides, provided that such guides include procedures to verify compliance with the Commission's segregation and recordkeeping rules. The DSRO which has contracted out such audit/examination work is responsible for keeping current copies of such non-uniform guides on file with the Division and must satisfy itself through appropriate periodic reviews that the non-SRO is carrying out such audits/examinations in accordance with their guides.

Close Monitoring of FCMs and IBs with Financial or Operational Problems

22.  A DSRO must monitor closely each member-FCM and -IB for which it is responsible and which it knows or suspects is experiencing financial or operational difficulties. It must take prompt and effective action to satisfy itself that the member remedies such difficulties. Where a member has failed to remedy such difficulties promptly, or where the member has recurring financial or operational difficulties, the DSRO must take action to limit the activities of such member until it can affirmatively demonstrate its ability to remain in compliance, or take such other remedial action appropriate to the seriousness of the difficulty. A member-FCM generally will be considered to have recurring financial or operational difficulties when it fails to meet minimum SRO/Commission net capital or segregation requirements, or fails to maintain current books and records, on more than one occasion during any one year period. The Division wishes to make it clear that a DSRO must not automatically and repetitively allow an FCM or IB to continue operating without the registrant's taking substantive action to remedy the cause of the financial or operational difficulty.

NARRATIVE SUMMARY OF PROGRAM

23.  Following the adoption of this Interpretation, each SRO should promptly make available to the Division a written narrative summary of its overall Program and a copy of current examination guides and detailed surveillance procedures. The summary statement should include each major element contained in the SRO's Program and identify those elements within the overall Program which are designed to satisfy the requirements of this Interpretation. Thereafter, whenever a DSRO materially changes any part of its Program, whether relating to the minimum requirements of this Interpretation or the overall Program, it should promptly notify the Division, clearly describing all deletions or additions and the reasons for the changes. In addition, any material changes made to detailed procedures or guides supporting the required elements of the Program should also be made available to the Division. Each January each SRO should file with the Division a then-current summary of its Program, all examination guides, and detailed surveillance procedures.

24.  As part of its Program each DSRO should establish criteria whereby member-FCMs which appear to be "high-risk" can be identified and targeted for more intense surveillance and auditing. The high-risk members are those that pose the greatest risk to customer funds, contract market clearing houses, or other FCMS.

DSRO REPORTS

25.  Each DSRO shall report monthly to the Regional Office of the Commission nearest to it: (a) all financial reports due to be filed by its members which are other than those specifically required by Commission regulation or SRO rule (quarterly, semi-annual, early warning reports); (b) any acceleration of report filing due dates; and (c) all actions taken with respect to subordinated loan agreements. An SRO shall also immediately notify the Commission's Regional Office of any special calls it or its clearing organization makes to members for additional margin or capital (whether in the form of permanent capital, subordinated debt or otherwise). Special calls for margin which must be reported are those which are made as a result of a known or perceived financial problem.

IN-FIELD EXAMINATIONS--FCMs

26.  At least once every other year a DSRO must make a full scope financial/compliance audit of each member-FCM that carries customers' accounts. The audit should be made in accordance with the uniform audit guide developed by the Joint Audit Committee (see paragraph 21). In those years in which a full scope audit is not made, a DSRO must make an examination of each such FCM which will satisfy itself that the FCM is complying with Commission/SRO's segregation, recordkeeping, and reporting rules. The latter off-year examination should be made using the limited scope segregation examination guide developed by the Joint Audit Committee. In any event, the segregation examination must be of sufficient scope to satisfy the DSRO that the member-FCM is complying with the Commission/SRO's segregation, recordkeeping and reporting requirements. Complete documentation of the scope setting process must be included in the segregation examination work papers.

27.  The scope of the biennial full scope audit shall be determined after taking into consideration all information available on the firm, including its compliance history, and through on-site evaluation and testing of the firm's internal controls. The assessment of internal controls should include a review and evaluation of such procedures as may be followed by an FCM in evaluating and minimizing the financial risk to the FCM and its customers which may be present by virtue of the types, size and concentration of customer, non-customer, and proprietary futures and options positions it carries. It is the responsibility of the DSRO's in-charge auditor and management to set the scope of the audit after considering all such relevant factors and review of internal controls. However, the biennial audit must be of sufficient scope to satisfy the DSRO that the member-FCM is complying with the Commission/SRO's net capital, segregation, recordkeeping and reporting requirements. Complete documentation of the scope setting process must be included in the audit workpapers.

28.  In the first phase of the full scope audit and as a part of the review and evaluation of internal control, sufficient testing should be carried out to conclude whether the records are current with regard to: daily segregation calculations; monthly net capital computations; daily reconciliations of open commodity trades and the settlement account; monthly reconciliations of other control accounts; and posting of transactions and adjustments to account balances. The latter tests must normally be performed on a surprise basis, since advance notice of these tests may impair the effectiveness of the examination in determining the currency of the records maintained throughout the year.

29.  Field work for each audit or examination must commence within two months of the "as of" date. For purposes of computing whether a DSRO is up-to-date on the audit and examination cycles, the "as of" dates will be used to determine the interval between audit and examination dates. The Division must be notified whenever an audit or examination is not completed within five months of the inception of field work.

30.  The Division believes it is desirable for DSROs, rather than the Commission's staff, to maintain ongoing routine surveillance over the activities of a DSRO's members. It recognizes that many SROs that are contract markets do not have rules requiring member-FCMs to segregate customer funds, yet their ongoing surveillance and in-field examination procedures are such that, either directly or indirectly, the SRO/contract markets are able to ascertain their member-FCMs' compliance with the Commission's segregation rules. All DSROs must determine an FCM's segregation requirement in order to determine the FCM's net capital requirement and must determine an FCM's segregated position in order to satisfy itself that the FCM is correctly classifying its assets. Consequently, where a DSRO has incorporated the Commission's segregation rules into its own rules (either directly or by reference) and it discovers a serious apparent violation of those rules, the DSRO should itself take appropriate remedial and/or punitive action against the member and notify the Commission of such rule violations; where an SRO that does not have its own segregation rules discovers an apparent violation of the Commission's segregation rules, it should promptly bring them to the attention of the member and to the attention of the Commission.

31.  The Division expects the DSRO to carry out in-field examinations of FCMs as of the most recent month-end for which a net capital computation is available (or should have been completed) at the time field work commences. The DSRO should schedule its examinations so that they are not all as of the dates for which the quarterly (or semi-annual as the case may be) financial reports are filed. At least one-half of the examinations must be carried out as of dates other than the required quarterly financial reporting dates. Examinations should not be made as of the FCM's fiscal year end except in unusual circumstances or where the objective of the examination is to ascertain the quality of the certified public accountant's examination.

32.  With respect to those FCMs that are also registered securities broker-dealers, the annual in-field examination must at a minimum satisfy the SRO that the FCM is in compliance with the SRO/Commission's segregation rules and the related recordkeeping and reporting requirements. The Division will permit the commodity-side DSRO to rely on the securities-side SRO's work in verifying net capital compliance and, therefore, the commodity-side DSRO need not make a full examination, if the DSRO confers at least annually with the broker-dealer's securities-side SRO concerning the member's compliance with the net capital rules and receives a copy of all review/examination reports prepared by the securities-side SRO. However, at a minimum, as part of its required examination, the commodity-side DSRO must review the FCM's compliance with the requirement that the FCM prepare monthly a net capital computation, and must also satisfy itself that each such monthly computation prepared since the last examination by the DSRO shows that the FCM met the net capital requirements. It should be noted that certain securities broker-dealers clear their securities customers' transactions on a disclosed basis through another broker-dealer, but handle commodity customers' funds and accounts themselves. In such cases, the commodity-side DSRO is responsible for monitoring the financial condition of such FCMs.

33.  With respect to newly-registered member-FCMs, the DSRO should make an in-field examination of the FCM no later than three months after the FCM has begun handling customers' accounts. During this examination the DSRO should determine whether the FCM is properly segregating such customers' funds, whether recordkeeping rules are being complied with, and whether adequate internal controls are in place.

34.  In the case of member-FCMs for which DSRO responsibility has been transferred from another DSRO, the case history of that FCM should also be transferred and the examination cycle previously established at the former DSRO and examinations actually made may be considered in setting up the new examination schedule.

INTRODUCING BROKERS

35.  The DSRO should conduct an in-field review program for non-guaranteed member-IBs, which will provide satisfaction to the DSRO that there is compliance with the capital, recordkeeping, and reporting rules and to verify that IBs are not handling customer funds. Given the large number of IBs and their geographic dispersion, the Division will permit wide latitude as to the selection of IBs for review, provided that the criteria for selecting IBs results in the selection of IBs that generate a significant amount of commodities trading transactions and those with a history of significant non-compliance with the Commission/SRO's rules. (If an IB is a member of a contract market which does not have a membership category for IBs, that contract market is not subject to this requirement-see Regulation 1.52(a).)

36.  The IB's DSRO should secure copies of all guarantee agreements and related documents required by Commission regulation 1.10(f) for member-IBs that are guaranteed by FCMs. It should ensure such agreements conform to the requirements of that regulation.

IN-FIELD EXAMINATIONS - CPO

37.  The DSRO should plan audits of CPOs in accordance with established priority guidelines. Such guidelines should be in writing and be submitted as part of the periodic submission of Program summaries, guides and procedures called for in paragraph No. 24 above. In order to establish appropriate priorities for auditing CPOs, the DSRO must maintain a continuing profile of each member-CPO. In general, the highest priority should include CPOs which are the subject of investor complaints or reports of questionable conduct, or whose principals or associated persons have had questionable prior affiliations. Secondary priorities should include: CPOs that have had no apparent previous commodity experience; CPOs that are not affiliated with any FCM; and CPOs which handle pools which hold significant amounts of the public's funds, but solicitation for which does not require registration of shares therein as securities with securities regulatory bodies and such registration has actually been made. The lowest priority should include those CPOs that do not handle any pool funds and those CPOs that handle only pools whose shares are publicly registered.

38.  A DSRO must establish procedures which will result in the DSRO's being promptly apprised of member-CPOs which begin operating commodity pools that had not previously operated any pools.

FINANCIAL REPORTS - FCMs and IBs

39.  A DSRO's ongoing surveillance should include thorough reviews of all financial reports filed by member-FCMs and member-IBs and any follow-up work required as a result of the review should be carried out promptly. Financial reports should be preliminarily reviewed within two days after receipt to identify any reported undersegregation or undercapitalization. A DSRO should prioritize its review of reports with those firms that carry customer accounts being accorded a higher priority than those that do not. A detailed review of reports of such higher priority FCMs should normally commence within two weeks of the receipt of the financial report and should be completed no later than four weeks following receipt of the report. Final resolution of all discrepancies disclosed by the detailed review should normally be completed within six weeks of original receipt of the report. With respect to certified financial reports prepared as of the end of the calendar year and reports from firms that do not carry customer accounts, an additional two weeks will generally be allowed to complete the detailed review and resolution of all discrepancies.

40.  As a minimum, the review procedures should provide for:

-determining that reports are received by their due dates and that they include all required statements and supporting schedules

-determining that the statements foot and crossfoot and that balances crosscheck between statements within the report

-comparing the report under review with prior reports filed by the member and accounting for material changes in excess net capital

-identifying, questioning and resolving material balances that appear to be improperly classified, unusual balances and unusual changes in balances. The DSRO should establish written guidelines to be followed by its staff in assessing when such follow-up is required; however, this should not preclude staff from following up on items that are not strictly within the guidelines.

-requesting revised financial reports when reports are incomplete or material errors exist in the reports. A material error is defined as a misstatement of any individual financial statement account balance, i.e. line item, where the amount of the individual adjustment, if made to the financial statements, would cause a change of 10 percent or more in excess net capital or excess segregated funds or where the adjustment, if made to the financial statements, would cause the firm to fall into an "early warning" net capital position. Errors within individual line items may be offset, but errors occurring on different line items may not be offset for purposes of this definition. That is, for example, an overstatement of cash is not to be offset by an overstatement of accounts payable, since they are different line items. If corresponding adjustments are made between line items merely because of misreporting a balance on the incorrect line, and such misreporting is not a recurring problem with the specific firm involved, then a revised financial report need not be obtained.

-integrating the review of reports with other aspects of the financial surveillance program (for example, comparison of subordinated debt reflected on the reports to DSRO control records for subordinated debt; comparison of data reflected on the report to data collected through daily telephone collection procedures)

SUBORDINATION AGREEMENTS - FCMs AND IBS

41.  The DSRO must set up a program for reviewing subordinated loan agreements on an ongoing basis to ensure that such agreements conform to the requirements for satisfactory subordination agreements, that secured demand notes are fully collateralized, and that the debt/equity ratio is within required parameters. In addition, the DSRO must have procedures for monitoring maturing subordinated loans, assessing the effect of such maturities on net capital compliance and ensuring appropriate action is taken by the FCM or IB to remain in capital compliance.

DAILY COLLECTION OF FINANCIAL DATA - FCMs

42.  The DSRO should obtain at least daily from each FCM it has identified as a high-risk FCM, the following information:

-the amount required to be segregated for customers' accounts

-total funds in segregated accounts to cover such liability

-total unsecured customer and noncustomer debits and deficits

-proprietary futures and options trading losses since the previous financial report

The Program should call for the FCM confirming such data in writing to the DSRO at least weekly. This information should be used to evaluate the FCM's compliance with the segregation and net capital rules. The accuracy of the data should be assessed against other information obtained by the DSRO during both in-field examinations and other ongoing surveillance activities. For example, the data collected should be tested whenever the DSRO's auditors make an on-site examination at a member's office.

SURVEILLANCE OF RISK AND FINANCIAL DETERIORATION

43.  Each SRO which is a contract market must establish surveillance procedures for monitoring its members' current financial condition and market risk exposure. Such procedures should include: (a) daily review and cumulative daily review of clearing house pay and collect data and, if applicable, original margin call data and comparison of such data to the respective members' last reported net capital; and (b) daily monitoring of all members' open positions on that contract market (whether or not the SRO is the DSRO) and assessing the potential impact upon each member's financial position of possible market moves. If the SRO/contract market has conservative, capital-based position limits for each FCM (with limits imposed on customers' positions), the scope of the latter procedures may be modified. The extent of the latter procedures as applied to particular member-FCMs should also be determined based upon the extent of the risk management procedures in place at the particular memberFCMs and other pertinent factors, such as size of the particular firm, and the size and diversification of its clientele.

SURVEILLANCE OF COMPLIANCE WITH MARGIN RULES

44.  Each DSRO should establish procedures for monitoring compliance by member-FCMs with the DSRO's margin rules through at least annual reviews of the FCM's system for margining accounts, making margin calls, and collection of margins. The review may be made as part of the annual examination of the FCM.

CPO REPORTS AND DISCLOSURE DOCUMENTS

45.  The DSRO should have in place a system whereby CPOs certify to the DSRO at least semi-annually such data as the DSRO believes is relevant to the DSRO's establishment of an in-field review schedule.

46.  The DSRO should establish procedures for monitoring the timely receipt of copies of the pool's disclosure documents and certified financial reports. The DSRO should establish procedures for reviewing the financial reports of pools handled by the highest priority CPOs (see paragraph No. 38) promptly upon receipt and all other pools' financial reports within three months of receipt. Such review includes an initial, comprehensive review of the pool's report and communication of deficiencies therein to its CPO. Thereafter, the DSRO will seek prompt resolution of the deficiencies by the CPO. Amended reports should be requested where appropriate and the DSRO should receive certification from the pool operator that pool participants have been provided with corrected reports.

MONITORING OF DISCONTINUING REGISTRANTS

47.  The DSRO should set up procedures whereby it will provide guidance to FCMs and CPOs withdrawing from membership or discontinuing operations. If the FCM or CPO is withdrawing from membership, but not discontinuing operations, the DSRO should: (a) ascertain the member's reason for withdrawal and, if it appears there exist any material apparent violations of the SRO/Commission's rules, investigate such apparent violations and take appropriate action; and (b) ascertain whether the member has filed with the Commission or other SROs any notices that may be required.

48.  If the withdrawing member-FCM/CPO is, at the same time, discontinuing operations, the DSRO should also: (c) satisfy itself the member has established satisfactory procedures for disposing of its obligations to customers (or investors in commodity pools) and, if such is not the case, report such fact to the Commission; (d) where warranted by the circumstances, determine through test checks or by examination that the member has actually satisfied such obligations; and (e) unless waived by the Commission and the DSRO, ensure the member-FCM files a certified financial report covering its operations (or, in the case of a CPO its pool's operations) since the date of the last certified report, if the member was still registered at the date as of which such a report should normally have been filed.

49.  Each DSRO must establish procedures to be followed by the DSRO in the event an FCM must suspend or cease operations as an FCM because of financial or operational difficulties. Such procedures must be submitted to the Division for review and comment promptly upon adoption of this revised Interpretation. The procedures must include steps that require the DSRO staff to: (a) immediately notify and coordinate its activities with the Commission and other affected commodity and securities industry SROs; (b) ascertain the status of customer accounts; (c) determine the amount of funds in segregation and required to be in segregation; (d) determine the firm's net capital position to the extent necessary to ascertain the firm has sufficient funds to satisfy its obligations to customers; (e) monitor the transfer of properly margined custmer accounts to another FCM; or, in the event of undersegregation, if possible and in cooperation and consultation with the Commission and any court appointed official, transfer to another FCM customer positions with a pro-rata transfer of related account equity, including the ledger balance, open trade gain/loss and securities; and (f) ascertain that the FCM has made provision for notifying the customers of its status.

50.  In the SRO's notice to the Commission that an FCM or IB is no longer a member in good standing, which is required to be filed under regulation 1.52(j), the SRO should address the following points: (a) the reason the registrant is no longer a member in good standing; (b) whether the SRO has any knowledge of material apparent violations of Commission/SRO rules and, if so, what action the SRO is taking in that regard; and (c) if the registrant is an FCM that is discontinuing operations, the manner in which the FCM has indicated it is discharging its obligations to customers (that is, whether by direct payment or transfer to other FCMs). With respect to item (b), if the violations of which the SRO has knowledge represent violations of the net capital rule or any other rule surveillance over which has been delegated to a DSRO under a joint audit plan, such SRO shall report such violations to the firm's DSRO; if they represent violations of rules surveillance over which has not been delegated, the SRO shall itself make whatever investigation and take whatever action is appropriate. Also, the Division notes that, so long as an entity is registered with the Commission, regardless of whether customer funds are held, the entity is required to comply with the Commission's regulations.

* * * * * * * *

The statements made in this Interpretation are not rules or interpretations of the Commodity Futures Trading Commission, nor are they published as bearing the Commission's approval; they represent interpretations and practices followed by the Division in administering the Commodity Exchange Act and the regulations thereunder.

FOR FURTHER INFORMATION CONTACT: Paul H. Bjarnason, Jr., Chief Accountant of the Division of Trading and Markets, Commodity Futures Trading Commission.  Telephone (202) 418-5430.

Issued in Washington, D.C. on July 29, 1985, by the Division of Trading and Markets.

ANDREA M. CORCORAN

DIRECTOR