[Federal Register Volume 62, Number 213 (Tuesday, November 4, 1997)]
[Proposed Rules]
[Pages 59624-59639]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 97-29037]


========================================================================
Proposed Rules
                                                Federal Register
________________________________________________________________________

This section of the FEDERAL REGISTER contains notices to the public of 
the proposed issuance of rules and regulations. The purpose of these 
notices is to give interested persons an opportunity to participate in 
the rule making prior to the adoption of the final rules.

========================================================================


Federal Register / Vol. 62, No. 213 / Tuesday, November 4, 1997 / 
Proposed Rules

[[Page 59624]]


-----------------------------------------------------------------------

COMMODITY FUTURES TRADING COMMISSION

17 CFR Parts 3, 32, and 33


Trade Options on the Enumerated Agricultural Commodities

AGENCY: Commodity Futures Trading Commission.

ACTION: Notice of proposed rulemaking.

-----------------------------------------------------------------------

SUMMARY: Generally, the offer or sale of commodity options is 
prohibited except on designated contract markets. One of several 
specified exceptions to the general prohibition on off-exchange options 
is for ``trade options.'' Trade options are defined as off-exchange 
options ``offered by a person having a reasonable basis to believe that 
the option is offered to'' a person or entity within the categories of 
commercial users specified in the rule, where such commercial user ``is 
offered or enters into the transaction solely for purposes related to 
its business as such.'' Trade options, however, are not permitted on 
the agricultural commodities which are enumerated in the Commodity 
Exchange Act (Act).
    The Commodity Futures Trading Commission (Commission or CFTC) is 
proposing to remove the prohibition on off-exchange trade options on 
the enumerated agricultural commodities pursuant to a three-year pilot 
program. The Commission is proposing initially to permit agricultural 
trade options which, if exercised, will result in delivery of the 
commodity and which may not be resold, repurchased, or otherwise 
cancelled other than through the exercise or natural expiration of the 
contract. The Commission is also proposing to permit only those 
entities which handle the commodity in normal cash market channels to 
offer to buy or sell such options. Such entities, in order to sell 
agricultural trade options (puts and calls), would be required to 
become registered as agricultural trade option merchants, to report to 
the Commission on their transactions, to provide their customers with 
disclosure statements, and to safeguard their customers' premiums. The 
Commission is also proposing to exempt from the prohibition and these 
proposed rules individuals or entities which meet a substantial 
financial requirement. Finally, the Commission is proposing to remove 
the prohibition on the offer or sale of exchange-traded options on 
physicals on these commodities.

DATES: Comments must be received by December 4, 1997.

ADDRESSES: Comments should be mailed to the Commodity Futures Trading 
Commission, Three Lafayette Centre, 1155 21st Street, N.W., Washington, 
D.C. 20581, attention: Office of the Secretariat; transmitted by 
facsimile at (202) 418-5521; or transmitted electronically at 
[<a href="/cdn-cgi/l/email-protection#d4a7b1b7a6b1a0b5a6ad94b7b2a0b7fab3bba2"><span class="__cf_email__" data-cfemail="1261777160776673606b52717466713c757d64">[email protected]</span></a>]. Reference should be made to ``Agricultural Trade 
Options.''

FOR FURTHER INFORMATION CONTACT: Paul M. Architzel, Chief Counsel, 
Division of Economic Analysis, Commodity Futures Trading Commission, 
Three Lafayette Centre, 1155 21st Street, N.W., Washington, D.C. 20581, 
(202) 418-5260, or transmitted electronically at [PA<a href="/cdn-cgi/l/email-protection#d4a6b7bcbda0aeb1b894b7b2a0b7fab3bba2"><span class="__cf_email__" data-cfemail="5b293833322f213e371b383d2f38753c342d">[email protected]</span></a>].

SUPPLEMENTARY INFORMATION:

I. Background

A. The Prohibition of Agricultural Trade Options

    In 1936, responding to a history of large price movements and 
disruptions in the futures markets attributed to speculative trading in 
options, Congress completely prohibited the offer or sale of option 
contracts both on and off exchange in all commodities then under 
regulation.<SUP>1</SUP> Over the years, this statutory bar continued to 
apply only to the commodities originally regulated under the 1936 Act. 
The specific agricultural commodities originally regulated under the 
1936 Act included, among others, grains, cotton, butter, eggs, and 
potatoes. Later, fats and oils, soybeans and livestock, as well as 
others, were added to the list of enumerated agricultural commodities. 
Any commodity not so enumerated, whether agricultural or not, was not 
subject to regulation. Thus, options on such nonenumerated commodities 
were unaffected by the prohibition.<SUP>2</SUP>
---------------------------------------------------------------------------

    \1\ Commodity Exchange Act of 1936, Pub. L. No. 74-675, 49 Stat. 
1491 (1936). See, H. Rep. No. 421, 74th Cong., 1st Sess. 1, 2 
(1934); H. Rep. No. 1551, 72d Cong., 1st Sess. 3 (1932).
    \2\ Examples of nonenumerated commodities would include coffee, 
sugar, gold, and foreign currencies. Before 1974, the Act covered 
only those commodities enumerated by name. The 1936 Act regulated 
transactions in wheat, cotton, rice, corn, oats, barley, rye, 
flaxseed, grain sorghum, mill feeds, butter, eggs, and Solanum 
tuberosum (Irish potatoes). Act of June 15, 1936, Pub. L. 74-675, 49 
Stat. 1491 (1936). Subsequent amendments to the Act added additional 
agricultural commodities to the list of enumerated commodities. Wool 
tops were added in 1938. Commodity Exchange Act Amendment of 1938, 
Pub. L. 471, 52 Stat. 205 (1938). Fats and oils, cottonseed meal, 
cottonseed, peanuts, soybeans, and soybean meal were added in 1940. 
Commodity Exchange Act Amendment of 1940, Pub. L. 818, 54 Stat. 1059 
(1940). Livestock, livestock products, and frozen concentrated 
orange juice were added in 1968. Commodity Exchange Act Amendment of 
1968, Pub. L. 90-258, 82 Stat. 26 (1968) (livestock and livestock 
products); Act of July 23, 1968, Pub. L. 90-418, 82 Stat. 413 (1968) 
(frozen concentrated orange juice). Trading in onion futures on 
United States exchanges was prohibited in 1958. Commodity Exchange 
Act Amendment of 1958, Pub. L. 85-839, 72 Stat. 1013 (1958).
---------------------------------------------------------------------------

    A history of abusive practices and fraud in the offer and sale of 
off-exchange options in the nonenumerated commodities was one of the 
catalysts leading to enactment of the Commodity Futures Trading 
Commission Act of 1974 (1974 Act), which substantially strengthened the 
Commodity Exchange Act and broadened its scope by bringing all 
commodities under regulation for the first time.<SUP>3</SUP> Under the 
1974 amendments, the newly-created CFTC was vested with plenary 
authority to regulate the offer and sale of commodity options on the 
previously unregulated, nonenumerated commodities.<SUP>4</SUP> The 
Act's statutory prohibition on the offer and sale of options on the 
enumerated agricultural commodities was retained.
---------------------------------------------------------------------------

    \3\ Congress accomplished this by adding to the list of 
enumerated commodities an expansive catch-all definition of 
``commodity'' which included all ``services, rights, or interests in 
which contracts for future delivery are presently or in the future 
dealt in.'' The definition of commodity is currently codified in 
section 1a(3) of the Act.
    \4\ Section 4c(b) of the Act provides that no person ``shall 
offer to enter into, or confirm the execution of, any transaction 
involving any commodity regulated under this Act'' which is in the 
nature of an option ``contrary to any rule, regulation, or order of 
the Commission prohibiting any such transaction or allowing any such 
transaction under such terms and conditions as the Commission shall 
prescribe.'' 7 U.S.C. 6c(b).
---------------------------------------------------------------------------

    Shortly after its creation, the Commission promulgated a 
comprehensive regulatory framework applicable to off-exchange commodity 
option transactions in the

[[Page 59625]]

nonenumerated commodities.<SUP>5</SUP> This comprehensive framework 
exempted ``trade options'' from most of its provisions except for a 
rule prohibiting fraud (rule 32.9).<SUP>6</SUP> In contrast, commodity 
options on the enumerated commodities--the domestic agricultural 
commodities listed in the Act--were prohibited both as a consequence of 
the continuing statutory bar as well as Commission rule 32.2, 17 CFR 
32.2. This prohibition made no exceptions and applied equally to trade 
options.
---------------------------------------------------------------------------

    \5\ 17 CFR part 32. See, 41 FR 51808 (Nov. 24, 1976) (Adoption 
of Rules Concerning Regulation and Fraud in Connection with 
Commodity Option Transactions). See also, 41 FR 7774 (February 20, 
1976) (Notice of Proposed Rules on Regulation of Commodity Option 
Transactions); 41 FR 44560 (October 8, 1976) (Notice of Proposed 
Regulation of Commodity Options).
    \6\ As noted above, trade options are defined as off-exchange 
options ``offered by a person having a reasonable basis to believe 
that the option is offered to the categories of commercial users 
specified in the rule, where such commercial user is offered or 
enters into the transaction solely for purposes related to its 
business as such.'' Id. at 51815; rule 32.4(a) (1976). This 
exemption was promulgated based upon an understanding that 
commercial users of the underlying commodity had sufficient 
information concerning commodity markets insofar as transactions 
related to their business as such, so that application of the full 
range of regulatory requirements was unnecessary for business-
related transactions in options on the nonenumerated commodities. 
See, 41 FR 44563, ``Report of the Advisory Committee on Definition 
and Regulation of Market Instruments,'' appendix A-4, p. 7 (January 
22, 1976).
---------------------------------------------------------------------------

    The attempt to create a regulatory framework to govern the offer 
and sale of off-exchange commodity options was unsuccessful. Because of 
continuing, persistent, and widespread abuse and fraud in their offer 
and sale, the Commission in 1978 suspended all trading in commodity 
options, except for trade options.<SUP>7</SUP> Congress later codified 
the Commission's options ban, establishing a general prohibition 
against commodity option transactions other than trade and dealer 
options.<SUP>8</SUP>
---------------------------------------------------------------------------

    \7\ 43 FR 16153 (April 17, 1978). Subsequently, the Commission 
also exempted dealer options from the general suspension of 
transactions in commodity options. 43 FR 23704 (June 1, 1978).
    \8\ Pub. L. No. 95-405, 92 Stat. 865 (1978). Pursuant to the 
1978 statutory amendments, option transactions prohibited by new 
section 4c(c) could not be lawfully effected until the Commission 
transmitted to its congressional oversight committees documentation 
of its ability to regulate successfully such transactions, including 
its proposed regulations, and 30 calendar days of continuous session 
of Congress after such transmittal had passed.
---------------------------------------------------------------------------

    The Commission subsequently permitted the introduction of exchange-
traded options on the nonenumerated commodities by means of a three-
year pilot program. <SUP>9</SUP> Based on that successful experience, 
Congress, in the Futures Trading Act of 1982, eliminated the statutory 
bar to transactions in options on the enumerated commodities, 
permitting the Commission to establish a similar pilot program to 
reintroduce exchange-traded options on those agricultural commodities. 
<SUP>10</SUP> When establishing the pilot program, the Commission 
declined to relax the prohibition on off-exchange trade options on 
these commodities. <SUP>11</SUP>
---------------------------------------------------------------------------

    \9\ 46 FR 54500 (November 3, 1981).
    \10\ Pub.L. No. 97-444, 96 Stat. 2294, 2301 (1983).
    \11\ Although the Commission noted that ``there may be possible 
benefits to commercials and to producers from the trading of these 
`trade' options in domestic agricultural commodities,'' it 
determined that ``in light of the lack of recent experience with 
agricultural options and because the trading of exchange-traded 
options is subject to more comprehensive oversight,'' ``proceeding 
in a gradual fashion by initially permitting only exchange-traded 
agricultural options'' was the prudent course. 48 FR 46797, 46800 
(October 14, 1983).
---------------------------------------------------------------------------

    The Commission has reconsidered the issue of whether to remove the 
prohibition on the offer and sale of trade options on the enumerated 
commodities several times. <SUP>12</SUP> On December 19, 1995, the 
Commission hosted a public roundtable (December Roundtable) to consider 
this issue once again and to provide a forum for members of the public 
to provide their views. Subsequently, the Commission instructed the 
staff to study this issue and to forward its analysis to the 
Commission.
---------------------------------------------------------------------------

    \12\ For example, in 1991 the Commission proposed deleting the 
prohibition on trade options on the enumerated commodities and 
including them under the same exemption applicable to all other 
commodities. 56 FR 43560 (September 3, 1991). The Commission never 
promulgated the proposed deletion as a final rule.
---------------------------------------------------------------------------

B. The Advance Notice of Proposed Rulemaking

    On June 9, 1997, the Commission published an advance notice of 
proposed rulemaking (advance notice) in the Federal Register seeking 
comment on whether it should propose rules to lift the prohibition on 
trade options on the enumerated agricultural options subject to 
conditions and, if so, what conditions would be appropriate (62 FR 
31375). The Commission based the advance notice on a study by the 
Commission's Division of Economic Analysis (Division). <SUP>13</SUP>
---------------------------------------------------------------------------

    \13\ The complete text of that study, entitled ``Policy 
Alternatives Relating to Agricultural Trade Options and Other 
Agricultural Risk-Shifting Contracts,'' was forwarded to the 
Commission by the Division on May 14, 1997. It is available through 
the Commission's Internet site at http://www.cftc.gov/ag8.htm.
---------------------------------------------------------------------------

    The advance notice discussed the potential benefits and risks that 
may result from lifting the prohibition on agricultural trade options. 
The benefits include greater customization, a known cost of the 
instrument at the outset, and an increase in possible types of vendors, 
permitting greater convenience and more flexible financing 
arrangements. The risks identified in the study include fraud, credit 
risk, liquidity risk, operational risk, systemic risk, and legal risk.
    In addition, the advance notice offered a variety of regulatory 
protections or conditions which could be used to address many of the 
risks identified in the study. Those conditions included possible 
restrictions on the parties permitted to enter into these transactions, 
restrictions on the instruments or their use, and/or regulation of 
their marketing. The advance notice noted that several of the risks 
could be reduced by imposing eligibility limitations, such as to 
restrict the availability of agricultural trade options to 
sophisticated individuals or entities; to require that those marketing 
these instruments be registered with, or identify themselves to, the 
Commission or be commercial users themselves; and/or to impose an 
education requirement on either buyers or agricultural trade option 
vendors or both.
    The advance notice also discussed possible restrictions on the 
types of options permitted as a possible means of ensuring that 
commercials enter into such transactions ``solely for purposes related 
to (their) business as such.'' Moreover, the possible regulation of 
marketing, including disclosure requirements and account confirmation 
requirements, was considered. Additional issues addressed by the 
advance notice included possible requirements for cover or other 
methods for limiting the risk of possible default and requirements 
regarding the establishment of appropriate internal controls. In order 
to focus comment on these issues, the advance notice invited commenters 
to respond to 30 specific questions relating to the above topics.

II. Comments Received

    In response to its request for public comment, the Commission 
received a total of 76 comment letters from 82 commenters. The 
commenters were almost evenly divided with 35 commenters in favor and 
36 opposed to lifting the ban.<SUP>14</SUP> Those favoring lifting the 
prohibition on agricultural trade options included a futures exchange 
(with qualifications); a futures industry association; a derivatives 
industry association; five risk management firms; a commodity trading 
advisor; a bank; six agriculture-related businesses; 15 trade and farm 
associations, including both

[[Page 59626]]

national organizations and state-level affiliates; three individuals; 
and an accounting firm. Those opposed included two futures exchanges; a 
futures industry trade association; ten futures professionals; two 
producer associations; a grower-owned marketing cooperative; a country 
elevator; an academician; and 18 individuals, eight of whom were 
producers.
---------------------------------------------------------------------------

    \14\ Five letters offered commentary on the issue without taking 
a position on the overall wisdom of lifting the prohibition.
---------------------------------------------------------------------------

    Commenters opposed to lifting the ban generally expressed the view 
that existing exchange-traded products are adequate to manage 
agricultural risk and that agricultural trade options are likely merely 
to replicate those existing products but in a less safe environment. In 
this regard, the commenters stressed the higher likelihood of fraud 
occasioned by the unsophisticated nature of the possible counterparties 
to agricultural trade option transactions, the decentralized nature of 
the market, and the lack of regulatory oversight of possible 
agricultural trade option vendors. Several commenters also opined that, 
as a result of operating in a less regulated environment, agricultural 
trade options would enjoy an unfair competitive advantage over 
exchange-traded instruments, thereby adversely affecting exchange 
liquidity. Others expressed the concern that problems arising as a 
consequence of the less regulated environment for the trading of 
agricultural trade options could damage public confidence in all risk 
management products, including exchange-traded instruments. A final 
concern expressed by several commenters was that lifting the 
prohibition on agricultural trade options will advantage larger, more 
sophisticated agricultural companies over smaller, independent 
businesses, hastening a trend toward greater consolidation and 
concentration in agricultural markets.
    Those commenters favoring lifting the prohibition on agricultural 
trade options generally expressed the view that recent developments in 
domestic and foreign agricultural markets have increased the need for 
agricultural trade options. In particular, several commenters noted 
that agricultural trade options already are being offered outside of 
the United States to the competitive advantage of foreign producers and 
agricultural businesses.
    Other commenters noted that the recent removal of many of the long-
standing government support programs may result in increased price 
uncertainty and volatility, thereby increasing the need for a variety 
of risk-management and marketing tools. In this regard, the Division 
staff in its study noted that the overall impact of the Federal 
Agricultural Improvement and Reform Act of 1996 likely will be to leave 
farm incomes more exposed to changes in market prices and that in 
response to these changes ``new risk management tools are being 
developed, a trend which is likely to continue.'' <SUP>15</SUP>
---------------------------------------------------------------------------

    \15\ See the Division's study at pp. 23-24, 28.
---------------------------------------------------------------------------

    The greater interest by some segments of the agricultural sector in 
managing risks that was noted in the Division's study is also reflected 
in many of the comments. Several commenters who favor lifting the ban 
generally noted that the increasing size and complexity of producers' 
operations also have given rise to the need for more innovative and 
flexible risk management products. For example, one commenter noted 
that:

    All facets of agricultural production whether grain, cotton, 
fruits, vegetables or livestock are becoming more specialized and 
targeted toward niche markets. Producing for these markets often 
requires a greater degree of coordination and long-term commitment 
between the producer and processor. Having the flexibility to write 
marketing contracts that are now banned would be of great benefit in 
facilitating the coordination required.

These rapid and profound changes taking place in these markets are a 
key factor in the Commission's determination to propose these 
rules.<SUP>16</SUP>
---------------------------------------------------------------------------

    \16\ Id. at p. 31.
---------------------------------------------------------------------------

    In addition to the written comments, the Commission received oral 
comments during two public field meetings at which members of the 
public had an opportunity to address the Commission and to answer its 
questions regarding these issues. One of the meetings was held in 
Bloomington, IL, and the other was held in Memphis, TN. A third 
informational meeting was held in conjunction with a general membership 
meeting of the National Cattlemen's Beef Association. Transcripts of 
the proceedings at all three events were included in the Commission's 
comment file and are available through the Commission's internet web 
site. Generally, the participants in these meetings reflected the range 
of views expressed in the written comments and were likewise equally 
divided in their support or opposition to lifting the prohibition on 
agricultural trade options.

III. The Proposed Rules

A. Three-Year Pilot Program

    Based upon the analysis in the Division's study and the comments 
filed in response to the advance notice, including the comments 
presented to the Commission during its field meetings, the Commission 
is proposing to promulgate rules establishing a pilot program to permit 
the offer and sale of trade options subject to a number of strict 
regulatory conditions. Many commenters expressed the view that the 
potential risk of permitting trade options clearly outweighed any 
benefit which they might provide. These commenters, however, typically 
assumed that agricultural trade options would be offered under the same 
level of regulation currently applicable to other trade 
options.<SUP>17</SUP> An approximately equal number of commenters 
expressed the view that the prohibition on trade options should be 
lifted, particularly in response to the new challenges agriculture 
faces as a result of changes in government programs. Nevertheless, the 
vast majority of commenters, both those favoring and opposing lifting 
the prohibition of agricultural trade options, urged caution.
---------------------------------------------------------------------------

    \17\ Currently, trade options and those offering them are 
subject only to regulations regarding fraud. See, 17 CFR 32.4.
---------------------------------------------------------------------------

    The Commission successfully permitted the reintroduction of 
exchange-traded options under a three-year pilot program after their 
nearly half-century ban. See, 46 FR 54500 (November 13, 1981). Many at 
that time expressed concerns similar to those expressed in connection 
with the Commission's consideration of lifting the prohibition on 
agricultural trade options. The Commission determined that a pilot 
program best addressed those concerns, permitting the introduction of 
exchange-traded options subject to strict regulatory controls. By 
structuring its action as a pilot program, the Commission was able to 
test the efficacy of its regulations and to adjust them as experience 
warranted. The use of a pilot program proved to be a highly successful 
means of reintroducing exchange-traded options. Today, those markets 
constitute an important part of the futures industry.<SUP>18</SUP>
---------------------------------------------------------------------------

    \18\ Overall year-to-date volume through July 1997 for exchange-
traded futures and option contracts is 314,068,673 contracts. Of the 
total number of contracts traded, approximately 20 percent are 
option contracts.
---------------------------------------------------------------------------

    Based upon that successful experience, the Commission is proposing 
to lift the ban on agricultural trade options under a similarly 
structured pilot program. As under the previous pilot options program, 
the program being proposed for agricultural trade options will run for 
three years. During that time the Commission will closely monitor the 
efficacy of its rules and their implementation by the industry. 
Although the Commission currently intends that the rules promulgated by 
the Commission under

[[Page 59627]]

the pilot program will remain in effect at the termination of the pilot 
program, it will amend them as experience warrants.<SUP>19</SUP>
---------------------------------------------------------------------------

    \19\ In this regard, the Commission anticipates that, if it 
promulgates final rules, it will promulgate them as ``interim final 
rules,'' denoting its intention to revisit them three years after 
implementation. It is not proposing to limit the time during which 
the rules will remain effective in order to avoid issues of 
contracts extending beyond the three-year period. Instead, it will 
evaluate the efficacy of the interim final rules at the conclusion 
of the pilot program and reissue them if amendments are needed. Any 
such amendments would not affect the validity of contracts entered 
into prior to the issuance of such amendments.
---------------------------------------------------------------------------

    During the course of the pilot program, the Commission anticipates 
that it will direct the Division to conduct at least two reviews of 
trading experience. The conduct of such reviews may require the 
issuance by the Division of industry-wide special calls for information 
from agricultural trade option vendors. Such information requests, 
although used sparingly, were an integral part of the Commission's 
successful monitoring of the prior pilot program and can be expected in 
connection with the Commission's evaluation of the relative success of 
this pilot program as well.

B. Overall Structure of Proposed Rules

    The advance notice identified a number of risks associated with 
lifting the prohibition on options on the enumerated agricultural 
commodities and the possible regulatory responses to those risks, 
ranging from little or few regulatory protections to the full panoply 
of protections mirroring those that are applicable to exchange-traded 
options. It also identified likely immediate uses for trade options on 
these commodities and a number of more theoretical possible uses. In 
proposing the structure for this pilot program, the Commission 
determined to include within the pilot program initially those forms of 
trade options the terms of which are likely to be most widely 
understood and which are closest to current cash market practices. 
Accordingly, the Commission is proposing to lift the trade option ban 
on enumerated agricultural commodities for physically-settled contracts 
between commercial parties in the normal merchandising chain for the 
underlying commodity. Exercise of an option between these parties would 
involve the delivery of the underlying commodity from one party to the 
other either by immediate transfer of title to the commodity or by 
transfer of a forward contract commitment.
    Since at least 1985, when the Commission's General Counsel issued 
an interpretative statement entitled, ``Characteristics Distinguishing 
Cash and Forward Contracts and `Trade' Options,'' 50 FR 39656 
(September 30, 1985) (1985 OGC Interpretation), there has been wide 
understanding that one form of trade option prohibited by the ban 
involved a transaction whereby a producer, in return for payment of a 
premium, would have the right but not the obligation to deliver his 
crop to an elevator at the specified price. The producer would have the 
choice to deliver the commodity elsewhere or at the original elevator 
for a higher price.<SUP>20</SUP> In addition to being commonly 
understood, this form of trade option is a logical extension of other, 
permitted cash market practices.<SUP>21</SUP>
---------------------------------------------------------------------------

    \20\ The 1985 OGC Interpretation described this form of trade 
option as a contract that ``establishes a minimum contract price 
determined when the contract is written, and [for which] a premium 
is collected, either at the initiation of the contract, during the 
life of the contract or, together with interest accumulated over the 
life of the contract, at the time of settlement. In return for the 
premium, the producer has the right to require the merchant to 
accept delivery of and pay a minimum contract price for the crop. 
However, the producer may forfeit the premium and seek a higher 
price for, and deliver, the crop elsewhere.'' 50 FR 39656, 39660.
    \21\ For example, the same 1985 OGC interpretation discussed two 
other examples of delivery contracts having minimum price 
characteristics, finding them to be within the forward contract 
exclusion of the Act. Section 1a(11) of the Act, the forward 
contract exclusion, provides that futures contracts which are 
regulated under the Act do ``not include any sale of any cash 
commodity for deferred shipment or delivery.'' These two contracts, 
although having some option pricing characteristics, were determined 
to be forward contracts because, unlike option contracts, they were 
intended to be a means of merchandizing the commodity, obligating 
the parties to the contract to make or take delivery. 50 FR 39660.
---------------------------------------------------------------------------

    Option contracts can be used for a variety of purposes depending on 
the structure and settlement characteristics of a particular contract 
and the nature of the option customer's cash market commitments or 
position. Upon exercise, options can settle either by physical delivery 
of the underlying commodity or by cash payment. Cash-settled options 
upon exercise result only in the exchange of cash; a separate marketing 
arrangement is necessary to merchandize the underlying commodity. In 
this respect, because they are distinct from marketing contracts, cash-
settled options bear a resemblance to exchange-traded contracts. In 
contrast, upon exercise of a physical delivery option, the purchaser of 
a put or the seller of a call actually delivers the underlying 
commodity to the counterparty. Thus, like a forward contract, a 
physical delivery trade option can be used as a means of merchandizing 
the commodity.<SUP>22</SUP>
---------------------------------------------------------------------------

    \22\ This is not to suggest that the pay-out characteristics of 
forwards and futures resemble those of physically-delivered or cash-
settled options, respectively. To the contrary, futures and forwards 
share a similar risk/return profile which differs markedly from the 
risk/return profile shared by all options. Rather, the resemblance 
between forwards and physical-delivery options is the ease of their 
use as a form of marketing arrangement that can also be used to 
hedge price risk.
    For those not wishing to combine a merchandizing arrangement 
with a risk-management function, cash-settled options offer greater 
settlement ease. This is true whether settlement is a result of the 
option's offset or its exercise.
---------------------------------------------------------------------------

    Commenters suggested a number of additional reasons for inclusion 
of physical delivery options within the pilot program. Several 
commenters opined that one of the primary benefits of agricultural 
trade options will be to permit producers to enter into such agreements 
directly with those with whom they share trusted cash market business 
relationships. A second often suggested benefit of agricultural trade 
options is the producer's ability to enter into enhanced forms of 
merchandizing agreements. Several commenters, for example, expressed 
the desirability of being able to enter into option contracts that 
would give them the right but not the obligation to deliver on the 
contract. Such individual could ``walk away'' from delivery to avoid 
the purchase or sale of the commodity at too high or low a price during 
a production shortfall or for any other reason. The ability to avoid 
delivery in the case of a production shortfall, in the view of these 
commenters, would allow producers to contract (through options) for a 
higher percentage of their expected production. Including first 
handlers of the commodity underlying agricultural trade options within 
the pilot program and including all physical delivery agricultural 
trade options as eligible for the pilot program would allow producers 
to achieve these benefits.
    Several commenters registered their concern that, if permitted, 
trade options would merely replicate exchange-traded options in all 
respects, but in a less-regulated environment. They argued that on that 
basis the risks associated with trade options do not outweigh their 
potential benefits. Physical delivery trade options, however, will not 
simply replicate exchange-traded instruments. As noted above, 
physically-settled trade options offer the opportunity to combine a 
marketing and risk management tool. In this respect, physical delivery 
trade options on the enumerated commodities would be similar in 
character to forward contracts in that each would be an individually

[[Page 59628]]

negotiated contract involving, if exercised, the merchandising of the 
commodity through normal marketing channels. This potential additional 
cash market function <SUP>23</SUP> of physical delivery trade options 
argues in favor of their inclusion under the pilot program.
---------------------------------------------------------------------------

    \23\ Although, as discussed below, the Commission also is 
proposing to permit exchanges greater flexibility in offering 
agricultural options, physical-delivery trade options entered into 
between those who have a cash-market relationship are apt to be 
different in nature than exchange-traded contracts--that is, they 
are more likely to be more highly customized, including calling for 
delivery at widely scattered facilities.
---------------------------------------------------------------------------

    After having determined, for the above reasons, that trade options 
between counterparties in normal cash market channels requiring 
physical delivery are appropriate for inclusion within the pilot option 
program, the Commission has matched the level of regulation being 
proposed to the risks associated with those instruments. Not only is 
this approach intended to strike the appropriate balance of regulation 
of the instruments included within the pilot program, but it provides a 
solid foundation for analyzing and comparing the regulatory approaches 
which should be applied in the future when considering other possible 
uses of trade options. Accordingly, were the Commission to propose to 
permit additional forms of trade options, it would re-examine the 
adequacy of the proposed regulatory provisions of the pilot program. 
The major components of the proposed regulations governing the pilot 
option program are as follows: regulation of agricultural trade option 
vendors, including net capital, recordkeeping and streamlined 
registration, and proficiency testing requirements; required risk 
disclosure to option customers; and several restrictions on the market 
strategies or contract structure. These proposed components of the 
pilot regulations are discussed below.

C. Regulation of Agricultural Trade Option Merchants

    A primary regulatory protection of the pilot program is its 
restriction of option counterparties to agricultural commercial 
participants. Thus, agricultural trade option vendors--those persons or 
entities engaged in the business of the offer or sale of agricultural 
trade options--as a matter of course, will be businesses active in 
agricultural cash markets. Agricultural trade option vendors, by virtue 
of their cash market operations, should have achieved some level of 
financial soundness and proficiency with respect to risk management 
strategies. In addition, the Commission is proposing streamlined or 
targeted requirements relating to agricultural trade option vendors' 
financial soundness, competency, and probity, including the requirement 
that such vendors be registered with the Commission under the new 
registration category of ``agricultural trade option merchant.''
1. Net Asset and Other Financial Requirements
    By their nature, agricultural trade options, like all commodity 
futures or option instruments, involve risk, particularly the risk 
arising from the need for performance at a future date by the 
counterparty to the contract. Typically, the greatest financial risk 
assumed by an option purchaser is credit risk. Credit risk is the risk 
that the seller of the option may fail to perform on the obligation if 
the purchaser chooses to exercise the option contract. In the event of 
such nonperformance, the option purchaser stands to lose the option 
premium if it has already been paid plus any opportunity gain that 
would have been achieved if the option were exercised.<SUP>24</SUP>
---------------------------------------------------------------------------

    \24\ For example, consider the case of a producer who had paid a 
premium of $.10 per bushel for a put option giving him the right to 
sell corn at a price of $2.80 per bushel. At harvest the price of 
corn is $2.70 per bushel, and the producer decides to exercise the 
option. If the option seller defaults on the contract, the producer 
stands to lose the $.10 per bushel paid for the option. In addition 
the producer loses the opportunity to sell corn at $2.80 per bushel, 
instead having to accept the market price of corn at $2.70 per 
bushel.
---------------------------------------------------------------------------

    In an exchange environment, the clearinghouse and regulations 
requiring minimum net capital for market intermediaries reduce 
counterparty credit risk. Off-exchange transactions do not have the 
safety of the clearinghouse to reduce credit risk. In an off-exchange 
environment, counterparties can take a variety of steps to help assure 
that a counterparty is able to perform and performs on its obligation. 
Sophisticated counterparties may have the means formally to evaluate 
the creditworthiness of their counterparties. They also may require the 
posting of collateral or a third party guarantee. Less sophisticated 
counterparties may simply rely on trust, choosing to deal only with 
known counterparties with whom they have ongoing business 
relationships. Another approach to enhancing an agricultural trade 
option merchant's ability to perform on a trade option is to require 
the merchant to manage the market risk of trade options through 
exchange-traded options.
    Because many agricultural trade option customers will not have the 
resources to conduct formal creditworthiness evaluations of their 
counterparties, some degree of regulatory financial protections are 
desirable. Accordingly, the Commission is proposing a requirement that 
agricultural trade option merchants maintain a minimum level of net 
worth. In addition, the Commission is proposing that agricultural trade 
option merchants segregate from their own funds premiums paid by 
customers at initiation of an option contract. The Commission, however, 
is not proposing specific forms of covering the agricultural trade 
option merchant's market exposure.
    a. Net Worth. Minimum financial requirements have been used by 
government regulators to establish a base level for entry or access to 
a market by individuals and companies. Such requirements are intended 
to assure that companies or entities conducting business offer some 
assurance of having the financial wherewithal to perform on their 
obligations. The Commission places minimum financial requirements on 
futures commission merchants (FCMs) and introducing brokers (IBs) as a 
condition of registration with the Commission. The United States 
Department of Agriculture (USDA) and various states impose minimum 
financial requirements in the cash grain markets on federally-licensed 
grain warehouses.<SUP>25</SUP>
---------------------------------------------------------------------------

    \25\ A number of states require entities to meet a specified net 
worth requirement as a condition of obtaining a state grain 
warehouse's or grain dealer's license. The minimum net worth 
requirements range up to a minimum of $50,000 in Illinois. Some 
states also require that grain warehouses obtain a surety bond and 
have established indemnity funds to offset producer losses on grain 
stored in warehouses. Such indemnity funds, depending upon the 
state, are funded either by the producers or the elevators. For 
example, the indemnity fund in Illinois is funded by grain elevator 
contributions, while in Indiana producers contribute to the fund.
---------------------------------------------------------------------------

    Although many commenters favored minimum financial 
requirements,<SUP>26</SUP> others opposed them on the grounds that such 
minimum financial requirements would exclude smaller entities from the 
agricultural trade option business, possibly accelerating a trend to 
greater concentration in cash grain markets. Some commenters argued 
that the financial requirements currently imposed by the various states 
would be sufficient to foster financial integrity in the trade option 
markets. However, not all states have minimum financial requirements 
for those involved in the cash trade, and the requirements of those 
that do vary widely. Accordingly,

[[Page 59629]]

the Commission believes that a common federal minimum standard should 
apply to all those involved in the business of offering agricultural 
trade options, regardless of geographic location or the agricultural 
commodity.
---------------------------------------------------------------------------

    \26\ Of those favoring minimum financial requirements, some 
specifically suggested that trade option vendors be required to meet 
the same financial requirements currently applicable to FCMs and 
IBs.
---------------------------------------------------------------------------

    Accordingly, the Commission is proposing that agricultural trade 
option merchants, as a condition for offering such contracts, have and 
maintain a minimum of $50,000 of net worth.<SUP>27</SUP> This 
requirement corresponds to the overall minimum financial requirement 
established by USDA as a condition of obtaining a federal grain 
warehouse license. The Commission is proposing this minimum net asset 
level based upon the observation that these warehouses already enter 
into forward contracts as part of their cash business and that the USDA 
requirement appears to have been adequate. As noted above, the physical 
delivery agricultural trade options being included under the pilot 
program are similar in nature to forward contracts, including the 
financial risk to the warehouse or other first handler.<SUP>28</SUP>
---------------------------------------------------------------------------

    \27\ The minimum net worth requirement, as proposed, is a 
continuing requirement. If an agricultural trade option merchant's 
net worth falls below this amount, the merchant would not be 
permitted to offer to buy or to sell additional trade options until 
coming into compliance with the requirement. Moreover, in such a 
situation the agricultural trade option merchant must immediately 
cease offering or entering into new option transactions and must 
notify customers having premiums which the agricultural trade option 
merchant is holding under Sec. 32.13(a)(4) of the proposed rules 
that such customers can obtain an immediate refund of that premium 
amount, thereby closing the option position.
    \28\ That is not to suggest that the risks to the first handler 
are precisely the same between trade options and forward contracts. 
In the case of options, the first handler is not assured of actually 
receiving delivery of the commodity in contrast to a forward 
contract. However, the means available to the first handler to cover 
the financial risk of the transactions are similar.
---------------------------------------------------------------------------

    As noted above, the proposed net asset requirement is ongoing in 
nature. Accordingly, agricultural trade option merchants would be 
required to maintain the specified level of net worth in order to enter 
into new trade option contracts and to notify the Commission at any 
time if they have fallen below prescribed levels. The Commission is 
also proposing that agricultural trade option merchants be required to 
perform a reconciliation of their financial position at least monthly 
to determine compliance with this requirement.\29\ Because agricultural 
trade option merchants are primarily engaged in a cash market business, 
this proposed rule does not require them to change accounting 
procedures to conform to specific Commission accounting requirements, 
provided they use ``fair value'' accounting under generally-accepted 
accounting principles.\30\ It is the Commission's understanding that 
this accounting method is used by most firms in the cash market 
business.
---------------------------------------------------------------------------

    \29\ At least three commenters urged that daily mark-to-market 
of all positions should be required. The Commission is not proposing 
this requirement at the current time, although that is certainly the 
best practice and should be encouraged.
    Under the proposed rules, agricultural trade option contracts 
can be exercised only by delivery and cannot be purchased back, 
resold or otherwise offset before the expiration of the contracts. 
While the net value of an agricultural trade option merchant's 
option position will fluctuate on a daily basis, the option 
contracts themselves will tend to be long term commitments similar 
to forward contracts. In this respect, an agricultural trade option 
merchant will not be faced with the daily potential of large shifts 
in its option position due to rapid changes in market prices. 
Moreover, the price risk to the agricultural trade option merchant 
of an unhedged option position will be similar to that of an 
unhedged forward contract position. For example, elevators selling 
unhedged put options to producers face the risk that prices fall, 
thereby resulting in the elevator purchasing a commodity at a 
relatively high price when producers exercise their options. This is 
the same risk faced by an elevator entering into unhedged forward 
contracts.
    Because of the similarities in long-term price risk between the 
options which can be offered under the proposed rule and forward 
contracts, the availability of hedging tools and the expectation 
that agricultural trade option merchants will hedge their option 
positions in a manner similar to their forward contract positions 
and because of varying levels of sophistication among those who may 
be involved in offering agricultural trade options, the Commission 
is not now proposing a daily net worth calculation. Nonetheless, the 
Commission seeks comments on this issue, asking commenters to focus 
in particular on the needed sophistication of potential agricultural 
trade option merchants to mark assets and liabilities to market on a 
daily basis, whether daily marking-to-market is desirable or 
necessary in light of the long-term nature of the option positions 
and whether current standards used by these entities in operating in 
forward markets are sufficient for operating in the market for 
physical options given the similarity in the risks faced by the 
merchants.
    \30\ The Commission believes that the guidance provided in the 
American Institute of Certified Public Accountant's Audit and 
Accounting Guide, entitled, ``Brokers and Dealers in Securities,'' 
provides the relevant guidance which should be followed in 
connection with assigning a fair value to agricultural trade 
options. It states: ``Under generally accepted accounting 
principles, fair value is measured in a variety of ways depending on 
the nature of the instrument and the manner in which it is traded. 
Many financial instruments are publicly traded, and end-of-day 
market quotations are readily available. Quoted market prices, if 
available, are the best evidence of the fair value of a financial 
instrument. If quoted market prices are not available, management's 
best estimate of fair value should be based on the consistent 
application of a variety of factors available to management.'' A 
complete discussion of the factors is provided in the audit guide.
---------------------------------------------------------------------------

    b. Segregation of Customer Premiums. The Commission is proposing an 
additional financial protection--requiring that agricultural trade 
option merchants segregate customer premiums from their own capital. 
The advance notice noted the potential financial and regulatory 
concerns which arise from the asymmetric credit risk of option 
contracts. That asymmetry exists when the party purchasing the option 
pays the cost of the option--the option premium--in advance of the 
counterparty's having to perform on its obligation.\31\ The purchaser 
then faces the risk that the seller of the option might fail to perform 
on the contract, if exercised. Under such circumstances, not only does 
the option purchaser lose the opportunity gain that would have been 
realized through the exercise of the option, but also would be subject 
to the out-of-pocket loss of the option premium. This is in contrast to 
forward contracts, where both parties have reciprocal obligations and 
neither makes a payment in advance of performance. The ability to 
collect an up-front payment of premiums may also give merchants an 
incentive to sell options in order to generate option premiums for 
immediate use as operating funds.
---------------------------------------------------------------------------

    \31\ Generally producers have used forward contracts as a means 
of hedging price risk (in addition to merchandizing the commodity), 
obviating the need for the producer to maintain a futures position 
or incur out-of-pocket expenses. Under this arrangement, the 
elevator generally covers the price risk of the forward contract by 
entering into a futures position and paying the required margin 
obligations on the position. The elevator may then recoup this cost 
implicitly. To the extent first handlers structure agricultural 
trade options in this manner as well, there will be no up-front 
payment, and no funds will be segregated. Of course, because under a 
trade option a producer may elect not to deliver the commodity, the 
elevator would be expected to establish some other means of 
recovering the cost of the option premium if it is not paid up 
front.
---------------------------------------------------------------------------

    In order better to safeguard customers' up-front premium payments 
and to discourage the writing of trade options in order to generate 
immediate operating funds by a firm experiencing financial 
difficulties, the Commission is proposing that option premiums be held 
in segregation while an option contract is open, and that option 
premiums not be available to the agricultural trade option merchant for 
use in its business during the period an option is open. The Commission 
is proposing that the premium associated with an option must be 
separately accounted for and segregated in an account held for the 
benefit of option customers. Such funds, when deposited in a bank, 
trust company, or other financial institution, must be deposited under 
an account name which clearly identifies them as segregated customer 
funds and shows that they are segregated as required by Commission 
regulations.
    c. Cover of Market Risk. The advance notice posed several specific 
questions relating to whether the Commission should require that 
agricultural trade option merchants cover the market risk of the 
agricultural trade options which

[[Page 59630]]

they write. One commenter, a futures exchange, suggested that the 
Commission require that agricultural trade option merchants be required 
to cover the market risk of their trade options one-for-one with 
exchange-traded options. Other commenters, however, disagreed, pointing 
out that agricultural trade options may be offered for commodities in 
which there is no actively-traded exchange market or may be written for 
a form, grade, expiration, or delivery location not provided under 
exchange-traded instruments. In such instances, a one-to-one cover 
requirement using exchange-traded instruments may be economically 
inefficient or impossible.
    In general, it is the Commission's view that the market risks faced 
by entities offering trade option contracts will be similar to those 
currently associated with the offer of forward contracts. For example, 
an elevator entering into a forward contract to purchase grain from a 
producer faces the risk that the price of grain at the time of delivery 
will be lower than the contract price, requiring the elevator to pay 
the producer a higher price than the elevator can obtain when it 
resells that grain. Balancing this risk is the possibility that prices 
will rise making the contract price relatively cheap. Elevators may 
choose to bear this risk, chancing the fall in cash prices against the 
opportunity to profit if cash prices rise, or they may offset the 
market exposure of rising prices by selling a futures contract on one 
of the futures exchanges.
    An elevator selling a put option to a producer faces similar market 
risk as one entering a forward contract; that is, that spot market 
prices will be lower than the price at which the option is exercised. 
As with forward contracts, the elevator may choose to bear the market 
risk or to cover the market risk by purchasing an exchange-traded put 
option. Whether or not the elevator chooses to bear the market risk 
associated with the trade option, however, it always receives the 
premium from the producer regardless of whether prices rise or fall.
    The Commission assumes that current cover practices common to 
forward contracting will be applied to agricultural trade options. The 
Commission is aware of no reason why those offering trade option 
contracts would be any less likely to cover market exposure on trade 
option contracts than is currently the case with those offering forward 
contracts. In light of the similarities of such option contracts to 
forward contracts as discussed above, the Commission is of the view 
that elevators can determine individually the manner in which they will 
cover their exposure to market risk, if at all.
2. Probity and Competency Requirements for Agricultural Trade Option 
Merchants
    a. Registration. Registration of commodity professionals is an 
important means by which the Commission polices the futures and option 
industry and is the primary mechanism for reassuring the public of the 
futures professional's probity and proficiency.<SUP>32</SUP> 
Registration is an indisputably important safeguard to the public and 
will be critically important in the decentralized market permitted 
under the pilot program. However, the offer and sale of trade options 
will be a complement to the first-handler's existing cash market 
businesses, to some extent offsetting the need for extensive 
registration requirements. Accordingly, the Commission is proposing 
that those engaged in the business of the offer and sale of 
agricultural trade options must register under the new registration 
category of ``agricultural trade option merchant.'' The Commission is 
proposing a streamlined form of registration covering both the 
agricultural trade option merchant as an entity and its authorized 
sales force.<SUP>33</SUP>
---------------------------------------------------------------------------

    \32\ In this regard, by virtue of the required registration of 
their counterparty as agricultural trade option merchants, customers 
will have available to them under section 14 of the Act the 
Commission's reparations program for the resolution of disputes 
arising under agricultural trade option contracts. As proposed, 
customers will be apprised of this right in the disclosure document.
    \33\ The Commission has not proposed to permit FCMs to 
substitute FCM registration for registration as an agricultural 
trade option merchant based on the assumption that few, if any, FCMs 
would qualify to be an agricultural trade option merchant by virtue 
of the requirement that such entities also be a commercial user of 
the underlying commodity. The Commission requests comment on whether 
this assumption is not correct and, if so, whether registration as 
an FCM should be permitted in lieu of registration as an 
agricultural trade option merchant. The Commission also requests 
comment on whether Commission rule 1.19 should be amended to permit 
FCMs to conduct such a business.
---------------------------------------------------------------------------

    The streamlined registration requirement being proposed consists of 
the single filing of a form identifying the agricultural trade option 
merchant, its principals (if the agricultural trade option merchant is 
an entity), and on separate pages, information identifying its sales 
agents, a certification that none of the individuals is statutorily 
disqualified from engaging in a commodity-related business under the 
statutory disqualification provisions of section 8a(2) or 8a(3) of the 
Act, a set of fingerprints for each individual, a copy of the entity's 
certified financial statements completed within the prior 12 months, 
and evidence that individuals have completed successfully a proficiency 
test specifically geared toward agricultural trade options. Amendments 
of such registration applications for new associated persons can be 
filed as necessary.
    The Commission is seeking comment on whether this registration 
function should be delegated to the National Futures Association (NFA). 
NFA has been delegated responsibility by the Commission to administer 
the registration procedures for all futures industry professionals. The 
possible delegation to NFA of responsibility for processing the 
registration applications of agricultural trade option merchants would 
be consistent with this practice and, should NFA agree to accept this 
responsibility, this delegation would conserve Commission resources, as 
well.
    b. Competency Testing. A second important customer protection is 
competency testing of futures professionals. Because agricultural trade 
option merchants will not be engaged in other facets of futures and 
option sales, the series 3 examination which is generally required for 
futures professionals would not be necessary. Accordingly, the 
Commission is proposing that a specialized examination targeted at 
agricultural trade options be developed.<SUP>34</SUP> The Commission, 
as it has with all other similar testing programs, proposes to delegate 
this testing function to the NFA. In light of the proposed competency 
test for agricultural trade option merchants, the Commission is not 
proposing an explicit educational requirement. Successful completion of 
this targeted examination would evidence proficiency in those areas 
relevant to the offer and sale of agricultural trade 
options.<SUP>35</SUP>
---------------------------------------------------------------------------

    \34\ Although agricultural trade option merchants would only be 
required to pass the more specialized agricultural trade option 
examination, passing the series 3 examination would also be 
acceptable as a condition of registration.
    \35\ Many commenters opposed mandatory educational requirements 
for either agricultural trade option merchants or customers. The 
Commission is of the view that customers have the right to expect 
that such merchants and their sales forces will have successfully 
demonstrated mastery of the issues relevant to the offer or sale of 
these instruments. Although the Commission is not proposing an 
educational requirement for customers, it strongly urges private 
sector organizations to provide a variety of means of fulfilling 
this need. The success of the pilot program will depend, in part, on 
the success of various organizations in educating potential trade 
option customers. In this regard, a participant at the Commission's 
open meeting in Memphis, Tennessee, representing the National Grain 
and Feed Association stressed her organization's commitment to these 
efforts.

---------------------------------------------------------------------------

[[Page 59631]]

    c. Ethics Training Requirement. The final protection relating to 
both probity and competency is the ethics training requirement 
applicable to all Commission registrants. A few commenters expressed 
concern that without this requirement, if the prohibition on 
agricultural trade options were lifted, regulatory oversight of 
agricultural trade option merchants could be inadequate. The Commission 
carefully considered what degree of ethical instruction would be 
necessary and appropriate for registered agricultural trade option 
merchants and is proposing to apply to agricultural trade option 
merchants the same mandatory ethical training requirements currently 
required by the Act for all other registrants. See, 17 CFR 
3.34.<SUP>36</SUP>
---------------------------------------------------------------------------

    \36\ In 1992, section 210 of the Futures Trading Practice Act of 
1992 (FTPA) amended section 4p of the Act to mandate ethics training 
for persons required to be registered under the Act. On April 15, 
1993, the Commission adopted regulation 3.34 to implement the 
requirements of FTPA section 210. 58 FR 19575. Commission regulation 
3.34 requires natural persons registered under the Act to attend 
ethics training to ensure that they understand their 
responsibilities to the public under the Act.
---------------------------------------------------------------------------

    Under this requirement, Commission registrants are required to 
attend ethics training within six months of being granted registration 
and, thereafter, every three years. This ethics training must be at 
least four hours in duration for the initial session and one hour in 
duration for subsequent periodic sessions. Training is available from a 
variety of sources and can be undertaken through videotape, computer 
programs, or other similar means, in addition to attendance in person. 
See, 17 CFR 3.34(b)(3)(iii). These requirements apply equally to all 
Commission registrants and are being proposed to apply to agricultural 
trade option merchants as well.<SUP>37</SUP>
---------------------------------------------------------------------------

    \37\ Those functions relating to ethics training delegated to 
NFA for all Commission registrants will also be proposed to be 
delegated to NFA for agricultural trade option merchants.
---------------------------------------------------------------------------

D. Restrictions on the Instruments or Market Strategies

    The Commission posed a series of questions in the advance notice 
related to restrictions on the use of option contracts by various 
parties. In particular, the Commission asked whether it would be 
appropriate under a trade option exemption for producers to write 
covered calls and whether agricultural trade options should be 
permitted to be bundled to create risk-return payouts different from a 
simple put or call.
    Several commenters expressed the opinion that option customers 
should have unfettered freedom over the types of options available and 
the manner of their use, ceding only the restriction that trade options 
should be related to a business purpose. Others, however, expressed 
concern that more complex instruments or trading strategies might lead 
to high levels of fraud and abuse. Although many of these commenters 
favored a continuance of the prohibition as the remedy, their concern 
over fraud and abuse was shared by many commenters who favored lifting 
the prohibition. These commenters accepted the wisdom of some 
limitations or conditions on the types of options and trading 
strategies that might be used, particularly in connection with a pilot 
program.
    The Commission remains concerned that, in lifting the prohibition 
on agricultural trade options, it not also open the door to fraudulent 
dealing. Although additional risk management instruments may assist the 
agricultural sector in meeting the new challenges which it faces, 
opening up this long-restricted market to all types of options may 
unnecessarily expose participants to abuse. In order to balance these 
concerns, the Commission is proposing several limitations on the 
structure of option contracts and on permitted trading strategies or 
uses. First, the Commission is proposing a prohibition on the writing 
of covered call options by producers. Covered call options are short 
call positions written by an individual who has a long position in the 
underlying commodity. The option is covered in the sense that, if the 
option is exercised, the writer of the option has the commodity in his 
or her possession to deliver on the contract. While an individual 
writing a covered call has limited risk in the sense that he or she 
possesses a commodity which can be delivered against the option 
contract, the call does not provide downside price risk protection on 
the long commodity position except to the extent that a premium has 
been paid by the purchaser. Moreover, the short call caps any gains 
that the producer might earn on the long commodity position. Although 
such a strategy may be appropriate in certain instances, it is 
susceptible to abuse to the extent that producers do not appreciate the 
extent to which downside price protection and upside pricing potential 
is surrendered for a premium payment and is not appropriate for 
inclusion in the pilot program. It is also the Commission's opinion 
that the writing of put options by agricultural producers is not an 
appropriate business-related use of options. The Commission, therefore, 
is proposing a prohibition on the writing of such options.
    However, trade option customers would be permitted to enter into 
options that simultaneously combine long put and short call option 
positions only to the extent that the size of the delivery quantity 
associated with the short call option position does not exceed the size 
of the delivery quantity associated with the long put option position. 
Thus, for example, an agricultural trade option could give the producer 
the right to deliver 5,000 bushels of corn at harvest time at a price 
of $2.50 per bushel and the elevator the right to call for the delivery 
of 5,000 bushels at $3.00 per bushel. Under such an option, if at 
harvest time the price of corn was below $2.50, the producer would 
exercise the option to deliver the 5,000 bushels of corn at $2.50 per 
bushel. If, however, the price of corn was above $3.00 per bushel, the 
elevator would exercise its option to call for the delivery of 5,000 
bushels of corn at $3.00 per bushel. If the price of corn was between 
$2.50 and $3.00, it would not be economically rational for either party 
to call for or to make delivery of corn. In this example, the producer 
has purchased a put option from the elevator for 5,000 bushels of corn 
with a strike price of $2.50 per bushel. The producer has also sold a 
call option to the elevator for 5,000 bushels of corn at a strike price 
of $3.00. This transaction would be permissible under the proposed 
restriction that the delivery amount of the short call option portion 
of the contract cannot exceed the delivery amount of the long put 
option. However, the elevator could not obtain the right to call for 
the delivery of more than 5,000 bushels of corn. Moreover, the 
Commission is proposing that under no circumstances would a producer be 
permitted to write a put option, even if such option was combined with 
a long call option.
    In addition, the Commission is proposing to limit the termination 
and reestablishment of agricultural trade option positions. Some 
commenters expressed the view that agricultural trade options should 
not be used as a means to speculate in commodities. One manner in which 
speculation might be possible would be to move into and out of trade 
option positions based on updated predictions of expected price moves. 
Although some commenters argued that such strategies could enhance the 
price of the commodity being merchandised, the ultimate success of such 
a strategy would depend upon one's ability accurately to foresee

[[Page 59632]]

future price movements. Limiting the ability to enter and exit trade 
option contracts is consistent with the Commission's desire to include 
within the pilot program those trade options which are closest in 
nature to forward contracts, contracts for which offset is not 
permitted. Thus, the Commission is proposing that, once a trade option 
contract is purchased or sold, that position cannot be offset prior to 
expiration.

E. Risk Disclosure, Required Contract Terms and Required Account 
Information

1. Risk Disclosure Statements
    The Commission in its advance notice noted that required risk 
disclosures are a customer protection generally used in the regulation 
of futures and option trading and requested comment on whether, and in 
what form, risk disclosure should be required if the prohibition on 
agricultural trade options were lifted. The majority of the commenters 
responding to these questions agreed that mandated written risk 
disclosure would be appropriate, but varied in their view of the degree 
of detail which should be required. Some commenters suggested that the 
mandated risk disclosure statement should disclose all financial risks, 
including a description of worst possible scenarios. Others were of the 
view that a more general statement of risk would be sufficient.
    The Commission is of the view that a mandatory written risk 
disclosure statement for agricultural trade options is necessary and 
appropriate. Such a written statement is essential to ensuring that 
trade option customers receive knowledge of and understand the risks 
involved in entering into such transactions. Because of the current ban 
on agricultural trade options, customers initially will have had no 
experience using such instruments. Moreover, agricultural trade options 
may attract customers with little or no experience trading on 
designated futures or option markets. In light of this, the risk 
disclosure statement being proposed by the Commission addresses the 
full range of risks that were identified in the Division's study. This 
disclosure statement has two parts. The general disclosure is brief and 
is intended to cause a customer to ask additional questions of the 
agricultural trade option merchant or to seek additional information 
from other sources, as necessary. For example, the Commission is 
proposing that the disclosure statement include mandatory language 
regarding the requirement that trade options must be entered into in 
connection with the conduct of the business of the agricultural trade 
option merchant and its customers. This discussion would also provide 
producers in particular with guidance regarding prudent, business-
related uses of trade options.
    In addition, a transaction-specific portion of the disclosure is 
designed to provide specific information relating to the terms of a 
particular transaction. In this portion of the disclosure statement, 
the Commission is proposing to require that, where the full option 
premium or purchase price of the option is not collected up front or 
where through amendments to the option contract it is possible to lose 
more than the amount of the initial premium, the agricultural trade 
option merchant must disclose the worst possible financial outcome that 
could be suffered by the customer. In this regard, the provision of the 
mandatory risk disclosure statement will not relieve the agricultural 
trade option merchant of the responsibility to avoid material 
misstatements or omissions or any other form of fraudulent misconduct. 
This Commission and the courts have repeatedly stated that provision of 
a mandatory risk disclosure statement will not necessarily cure what is 
otherwise fraud. See, e.g., Clayton Brokerage Co. v. Commodity Futures 
Trading Commission, 794 F.2d 573, 580-581 (11th Cir. 1986). In 
particular, agricultural trade option merchants may need to make such 
additional disclosures as necessary in light of all the particular 
circumstances, including the nature of the instrument and the customer.
    The Commission is proposing that the full disclosure statement must 
be delivered to the customer prior to the customer's first transaction 
with the particular agricultural trade option merchant, as is customary 
with respect to current practice in futures and option trading. In 
subsequent transactions, only the transaction-specific portion need be 
provided. The Commission is requesting comment on whether this 
requirement should allow its fulfillment through electronic media. 
Moreover, the agricultural trade option merchant must retain a written 
acknowledgment which has been signed and dated by the customer 
evidencing receipt of the disclosure statement by the customer.
2. Required Contract Terms
    In addition to delivery of the required disclosure statement, the 
Commission is also proposing to require that the option contract itself 
(a) be written and (b) contain certain specified provisions. Generally, 
the terms of designated futures and option contracts are contained in 
the rules of an exchange, which under the Act are required to be 
approved by the Commission. In the case of trade options, like forward 
contracts, the particular terms are left to individual negotiation 
between the counterparties. However, in connection with its issuance of 
guidance relating to ``hedge-to-arrive'' contracts, CFTC Interpretative 
Letter No. 96-41, Comm. Fut. L. Rep. para. 26,091 (May 15, 1996), the 
Division observed that such contracts often contained few or 
insufficiently expressed terms and conditions. The lack of written 
terms and conditions in these contracts led to widespread disagreement 
among parties over the terms of the instruments, complicating the 
resolution of various issues. To reduce the chance for disputes over 
vaguely defined contract terms in connection with agricultural trade 
options, the Commission is proposing to require that the trade option 
contracts be written and include a number of specified terms. In 
particular, the Commission is proposing that such contracts must 
include terms specifying the procedure for exercise of the option 
contract, including the expiration date and latest time on that date 
for exercise; total quantity and grade of commodity to be delivered if 
the contract is exercised and any adjustments to price for deviations 
from stated quality or grade; listing of elements comprising the 
purchase price to be charged, including the premium, mark-ups on the 
premium, costs, fees, and other charges; the strike price(s) of the 
option contract; additional costs, if any, which may be incurred if the 
commodity option is exercised; and delivery location, if the contract 
is exercised.
    An important means of safeguarding the public from abusive 
transactions is the requirement that transactions be confirmed in 
writing at the time of contract initiation. This provides the customer 
effective notice of the terms of the agreement, permitting the customer 
to object to transactions. Moreover, such a requirement likely would be 
beneficial to the merchant as well by providing an effective means of 
avoiding disputes over the terms initiating the transaction. The 
Commission, therefore, is proposing that agricultural trade option 
merchants provide trade confirmation and verification of information 
relating to specified contract terms within 24 hours of executing a 
contract. See, proposed Sec. 32.13(a)(6).

[[Page 59633]]

3. Report of Account Information to Customers
    The Commission is proposing that agricultural trade option 
merchants be required to furnish a monthly account statement to all 
customers with open option positions. This statement would include a 
complete listing of all individual agricultural trade option 
transactions entered into by the customer, all outstanding requests to 
enter into an agricultural trade option at the time of issuance of the 
statement, a current commodity price related to all open option 
positions or open orders held by the customer and the amounts of any 
funds owed by or to the customer related to the purchase or sale of 
option contracts or to the delivery of physical commodity related to 
the exercise of an option.
    Agricultural trade option merchants will also be required to 
indicate clearly expiration dates of options and to highlight those 
options which will expire within the next month. This may be done by 
highlighting the expiration information on such account statements, by 
using boldface type for such information, by separating these contracts 
from other contracts on the account statement, or by listing contracts 
chronologically by expiration date or by some similar method. The 
Commission is proposing this requirement as a means to assist 
agricultural trade option customers in managing their option accounts. 
Even though agricultural trade options cannot be offset, it is 
important for customers to know the current status of their option 
contracts with respect to which options may be approaching expiration 
and whether options are in or out of the money.
    In addition, the Commission is proposing to require that 
agricultural trade option merchants supply current commodity price 
quotes or other information relevant to an option customer's positions 
within 24 hours of a request. In the case of options that may be 
exercised at any time, it is important that customers obtain timely 
commodity price quotes in order to be able to make decisions regarding 
exercise of the options. Although the Commission anticipates that price 
information typically would be available immediately, other information 
might require the agricultural trade option merchant to search its 
records to obtain the requested information. The Commission believes 
that a 24-hour period should be sufficient to enable agricultural trade 
option merchants to retrieve the information and to respond to the 
customer.

F. Recordkeeping and Reporting Requirements

1. Required Books and Recordkeeping
    The maintenance of full, complete, and systematic books and records 
by agricultural trade option merchants is crucial to the Commission's 
ability to respond to complaints of customer abuse arising from such 
transactions and is necessary to the agricultural trade option 
merchant's establishment of appropriate internal controls of their 
financial operations. Although most merchants will already have 
recordkeeping systems in place, the proposed pilot program for 
agricultural trade options involves a number of regulatory protections, 
such as furnishing customers with disclosure statements, which may 
require records which have not been customary for first handlers as 
part of their cash market businesses. Accordingly, the Commission is 
proposing to require that records relating to agricultural trade 
options including covering transactions must be kept and maintained for 
a period of five years and must be readily accessible during the first 
two years of that five-year period. See, 17 CFR 1.31.
    Specifically, the Commission is proposing that trade option 
merchants be required to maintain full, complete, and systematic 
records of all agricultural trade option transactions. Such books and 
records should include all orders (filled, unfilled, or cancelled), 
books of record, journals, ledgers, cancelled checks, copies of all 
statements of purchase, exercise or lapse, and reports, letters, 
disclosure statements required by proposed Sec. 32.13(a)(7), 
solicitation or advertising material or other such communications with 
agricultural trade option customers or potential customers. All such 
books and records must be kept for a period of five years from the date 
of their creation and must be readily accessible during the first two 
years of the five-year period. All such books and records must be open 
to inspection by any representative of the Commission or the U.S. 
Department of Justice or the NFA in connection with functions delegated 
to it.
2. Routine Reports
    In addition to the maintenance of books and records, the Commission 
is proposing to require quarterly reporting by all agricultural trade 
option merchants of information relating to their agricultural trade 
option transactions. These reports are intended to enable the 
Commission to evaluate the success of the pilot program on an ongoing 
basis. The information required to be reported will enable the 
Commission to determine the overall size of the market, the types of 
contracts being offered, the costs to customers, the amount of 
commodity being merchandized through options, and the number of 
customers using trade options. Routine quarterly reporting from all 
agricultural trade option merchants also will permit the Commission to 
construct a more complete picture of the market and will better allow 
the Commission to evaluate the impact of activity in the trade option 
market on that in the cash and exchange-traded markets.
    Specifically, the Commission is proposing that reports shall be 
filed quarterly by any registered agricultural trade option merchant 
having an open trade option contract during the reporting period. The 
Commission is proposing to delegate to the NFA responsibility for 
receiving and maintaining these reports. NFA will make the information 
in this data base available to the Commission upon request. Initially, 
the Commission anticipates that such reports may be filed manually, 
including by facsimile or electronically, by dial-up transmission or 
via the Internet. Commenters are requested specifically to address 
issues relating to the means of filing reports and their capability to 
file electronically.
3. Special Calls for Information
    During the course of the pilot program, in addition to routine 
quarterly reports, the Commission anticipates that it will direct the 
Division to conduct two special calls for information from agricultural 
trade option merchants during the course of the pilot program. The 
Commission will use the information it gathers through these special 
calls to conduct a study to evaluate the success of the pilot program.
    Under a special call, every agricultural trade option merchant will 
be required to provide the Commission with the information specified in 
the special call. Such information may include: (a) Positions and 
transactions in agricultural trade options; (b) positions and 
transactions in commodity options and/or futures on all contract 
markets entered to cover agricultural trade options; (c) positions and 
transactions in cash commodities, their products, and by-products and; 
(d) customer identification information. Such information may include 
the name, address, and position of each

[[Page 59634]]

customer of the agricultural trade option merchant. All agricultural 
trade option merchants should maintain a current listing of such 
customer identification information.<SUP>38</SUP>
---------------------------------------------------------------------------

    \38\ Of course, such information is a routine business record 
and is required to be maintained as such by the agricultural trade 
option merchant. This information would be available to the 
Commission by special call for information or through inspection on 
an as needed basis. The separate listing would be encouraged as a 
means of responding to a request for a total enumeration of this 
information relating to an in-depth analysis in connection with 
evaluating the pilot program.
---------------------------------------------------------------------------

G. Internal Controls

    The Commission noted in the advance notice that generally 
requirements regarding internal controls are a condition of 
registration. These include the requirement that FCMs provide audited 
financial statements, have in place a system of internal controls, and 
supervise the conduct of all employees. The Commission also noted that 
many country elevators and others at the first-handler level of the 
marketing chain do not now have in place adequate internal controls to 
engage in a variety of off-exchange transactions nor are they subject 
to a regulatory scheme requiring such controls.<SUP>39</SUP>
---------------------------------------------------------------------------

    \39\ 62 FR 31381.
---------------------------------------------------------------------------

    The Commission posed a series of questions on this issue in the 
advance notice, asking specifically for comment on the minimum types of 
internal controls that an agricultural trade option merchant should 
have in place; the regulatory oversight mechanisms that would be 
necessary to assure implementation of such minimum levels of internal 
controls; and the most cost-effective means by which such internal 
controls could be implemented. Of the 13 commenters responding to these 
questions, the majority were of the opinion that, although prudent 
business practice necessitates use of internal controls, the Commission 
should not require them. Several commenters, however, supported 
Commission-mandated audits of agricultural trade option merchants. In 
this regard, one commenter, noting that state grain warehousing 
agencies may already require annual audits and that state and Federal 
warehouse regulators already visit every licensed grain dealer, 
suggested that the Commission consider developing audit procedures 
which existing agencies can implement on the Commission's behalf.
    The Commission is proposing to mandate an internal controls 
requirement for agricultural trade option merchants similar to that 
applicable to FCMs. In mandating such a requirement, the Commission 
believes that agricultural trade option merchants will be made aware of 
the importance of maintaining internal controls without being subjected 
to regulations that are unduly burdensome. As proposed, agricultural 
trade option merchants will be required to be audited on a yearly basis 
in accordance with generally-accepted accounting principles and to 
inform the Commission within three business days of the discovery by a 
certified public accountant of any material inadequacies in the 
agricultural trade option merchant's internal controls. As proposed, 
the agricultural trade option merchant must file a written report with 
the Commission stating what steps have been taken or are being taken to 
correct the material inadequacy within five days of such a 
notification.
    In addition, the Commission is proposing to require that the 
agricultural trade option merchant must maintain and preserve a written 
record of internal trading and supervisory controls. Such internal 
controls must include any systems and policies that the agricultural 
trade option merchant has for supervising, monitoring, reporting and 
reviewing trading activities in agricultural trade options, any 
policies it has for covering, hedging or managing risk created by 
trading activities, including a description of the reviews it conducts 
to monitor positions, and policies that relate to restrictions or 
limitations on trading activities.

H. Regulatory Oversight

    Several commenters expressed the concern that the Commission would 
not be able to provide adequate regulatory oversight of trading in 
agricultural trade options. Specifically, commenters questioned whether 
the Commission's existing staff and financial resources would be 
sufficient to monitor trading activity effectively in such a 
decentralized market.
    The Commission is proposing this three-year pilot program based, in 
part, on its belief that it will be joined in its efforts to promote a 
safe and responsible trading environment by many sectors of 
agriculture. During the Commission's public hearings, several producer 
associations and other agriculture industry associations pledged their 
assistance in promoting sound practices by both merchants and 
producers. The Commission has also determined to seek the assistance of 
NFA in undertaking responsibility for performing certain specified 
functions. These delegations should do much to aid the Commission in 
maintaining adequate levels of oversight, given its resource 
limitations. In addition, the various states and USDA conduct oversight 
of warehouses, and the Commission will cooperate with them in those 
efforts. The Commission will also devote an appropriate level of its 
resources to the conduct of sales practice audits and other forms of 
oversight.
    In this regard, the Commission is seeking comment on the number of 
entities which may offer such contracts under the rules as proposed. 
Should this potentially create too large a burden on Commission 
resources, the Commission will explore additional delegations of 
oversight or other means of conserving its resources while providing 
adequate oversight coverage. The Commission is optimistic that, with 
these cooperative efforts, it will be able to foster the growth of 
responsible trading of agricultural trade options using its available 
resources and without harming existing programs or compromising its 
ability to achieve its overall regulatory mission. It would not proceed 
with the pilot program if it thought otherwise.

I. Exemption for Sophisticated Entities

    Some commenters expressed the opinion that the prohibition on 
agricultural trade options should be lifted with few or no constraints. 
These commenters maintained that participants in these markets possess 
sufficient sophistication with respect to contracting so as not to 
require regulatory oversight. The agricultural sector, however, 
includes a diverse group of entities with different levels of 
sophistication, ranging from the small family farmer to highly 
sophisticated multinational corporations. Although any one of these 
individuals or entities might be entirely capable of understanding and 
managing the risks associated with entering into a trade option 
contract, only the larger and better financed entities will 
consistently have available the legal and financial resources needed to 
protect their interests in an unregulated environment. The Commission 
is of the view that an exemption from regulatory conditions similar to 
that available for trade options on other commodities may be 
appropriate for those entities having a very high net 
worth.<SUP>40</SUP> However, a greater level of regulatory protection 
is appropriate for transactions involving less well-financed entities. 
Congress adopted a similar approach for Commission determinations of 
the

[[Page 59635]]

availability of exemptive relief under section 4(c) of the Act.
---------------------------------------------------------------------------

    \40\ Such an exemption would be from the requirements relating 
to agricultural trade options being proposed. Any such transaction, 
however, would not be exempt from the prohibition of fraud contained 
in 17 CFR 32.9.
---------------------------------------------------------------------------

    In setting the eligibility requirements for exemption from these 
rules, the Commission considered the current levels of net worth or 
total worth required of eligible participants under parts 35 and 36 of 
its rules. Under parts 35 and 36, corporations or partnerships having 
total assets exceeding $10 million or net worth of $1 million in cases 
where the transaction was entered into in connection with the conduct 
of its business or to manage the risk of an asset or liability, are 
considered eligible for the exemption. Some have observed, however, 
that these qualifying amounts when applied to entities in agriculture 
are too low given the relatively large investment in land and equipment 
needed to operate a farm. The concern is that a relatively large number 
of individuals engaged in agriculture might meet these financial 
criteria based not so much on their investment sophistication and 
ability to gather and manage a sizable asset portfolio, but rather 
simply reflecting the need to acquire a threshold level of land and 
machinery to operate successfully a farm or agricultural enterprise. 
Accordingly, the Commission is proposing that, to qualify for this 
exemption, individuals or entities should have a net worth of at least 
$10 million.
    In order to qualify for this proposed exemption, both 
counterparties must meet the eligibility requirements. If any one 
counterparty is not eligible for this exemptive relief, the 
counterparties must comply with all of the regulatory requirements.

J. Relief for Exchange-Traded Instruments

    Representatives of several futures and option exchanges have 
expressed the concern that lifting the ban on agricultural trade 
options would put the exchanges at a competitive disadvantage. They 
note that exchanges are currently prohibited from offering options on 
physicals for these same commodities.<SUP>41</SUP> They further 
maintain that the current prohibition on exchange trading of options on 
physicals for the enumerated commodities restricts their ability to 
offer more flexible exchange-traded instruments that would be 
competitive with agricultural trade options.<SUP>42</SUP>
---------------------------------------------------------------------------

    \41\ Commission rule 33.4 provides in part that ``The Commission 
may designate any board of trade located in the United States as a 
contract market for the trading of * * * options on physicals in any 
commodity regulated under the Act other than those commodities which 
are specifically enumerated in section 1a(3) of the Act * * * ''.
    \42\ Flex options on futures on the enumerated agriculture 
commodities have recently been proposed by exchanges and approved by 
the Commission under current rules. These options are flexible in 
terms of strike prices, last trading days, the underlying futures 
months, and the style of exercise--American or European. Additional 
types of flexible terms involving physical delivery would be 
permitted if the Commission's rule is amended.
---------------------------------------------------------------------------

    The Commission agrees that the restriction on options on physicals 
in these commodities can be removed. At the time of the pilot program 
for exchange-traded options on agricultural commodities, based on 
comments received from industry participants and the U.S. Department of 
Justice and taking into consideration the history of abuse in option 
markets, the Commission followed a cautious approach by not allowing 
options on physicals for agricultural commodities.<SUP>43</SUP> The 
Commission, however, did express its willingness to revisit the 
possibility of allowing exchange-traded options on physicals for 
agricultural commodities after gaining experience in the trading of 
options on agricultural futures. Given the success of exchange-traded 
options on futures, the lack of widespread abuse in these markets, the 
permissible flexibility of many option terms under current rules, and 
the exchanges' desire to experiment with offering new forms of more 
flexible, physical delivery option contracts, the Commission is 
proposing to amend Sec. 33.4 to permit exchanges to trade options on 
physicals on the enumerated agricultural commodities.
---------------------------------------------------------------------------

    \43\ See, 49 FR 2752 (January 23, 1984).
---------------------------------------------------------------------------

IV. Other Matters

A. Paperwork Reduction Act (PRA)

    When publishing proposed rules, the PRA of 1995 (Pub. L. 104-13 
(May 13, 1996)) imposes certain requirements on federal agencies 
(including the Commission) in connection with their conducting or 
sponsoring any collection of information as defined by the PRA. In 
compliance with the Act, the Commission, through this rule proposal, 
solicits comments to:
    1. Evaluate whether the proposed collection of information is 
necessary for the proper performance of the functions of the agency, 
including the validity of the methodology and assumptions used.
    2. Evaluate the accuracy of the agency's estimate of the burden of 
the proposed collection of information including the validity of the 
methodology and assumptions used.
    3. Enhance the quality, utility, and clarity of the information to 
be collected.
    4. Minimize the burden of the collection of the information on 
those who are to respond, including through the use of appropriate 
automated, electronic, mechanical, or other technological collection 
techniques or other forms of information technology; e.g., permitting 
electronic submission of responses.
    The Commission has submitted the proposed rule and its associated 
information collection requirements to the Office of Management and 
Budget. The burden associated with this new collection, including these 
proposed rules, is as follows:

Average burden hours per response--5.359
Number of respondents--5105
Frequency of response--Daily

    Persons wishing to comment on the information which would be 
required by this proposed/amended rule should contact the Desk Officer, 
CFTC, Office of Management and Budget, Room 10202, NEOB, Washington, DC 
20503, (202) 395-7340. Copies of the information collection submission 
to OMB are available from the CFTC Clearance Officer, 1155 21st Street, 
NW, Washington, DC 20581, (202) 418-5160.

B. Regulatory Flexibility Act (RFA)

    The RFA, 5 U.S.C. 601 et seq., requires that agencies, in proposing 
rules, consider the impact of those rules on small businesses. The 
Commission has not previously determined whether all or some 
agricultural trade option merchants should be considered ``small 
entities'' for purposes of the RFA and, if so, to analyze the economic 
impact on such entities. However, the Commission is proposing that one 
of the conditions for registration as an agricultural trade option 
merchant is maintenance of a minimum level of net worth. The Commission 
previously found that other entities which were required to maintain 
minimum levels of net capital were not small entities for purposes of 
the RFA. See, 47 FR 18618, 18619 (April 30, 1982).<SUP>44</SUP> The 
Commission has also found, however, that one category of Commission 
registrant--introducing brokers (IBs)--which is required to maintain a 
minimum level of net capital may include small entities for purposes of 
the RFA.<SUP>45</SUP> Nevertheless, in addition

[[Page 59636]]

to the $50,000 minimum net worth required for registration as an 
agricultural trade option merchant, such registrants must be in 
business in the underlying cash commodity so that they are able to take 
physical delivery on those option contracts. This will require that 
they have additional resources invested in order to qualify as an 
agricultural trade option merchant, in contrast to an IB whose 
additional investment beyond the minimum net capital may be relatively 
small. For this reason, the Commission believes that agricultural trade 
option merchants are more appropriately treated as not being small 
entities under the RFA. The Chairperson, on behalf of the Commission, 
hereby certifies, pursuant to 5 U.S.C. 605(b), that the action taken 
herein will not have a significant economic impact on a substantial 
number of small entities. This certification is based on the fact that 
the proposed rules will remove a complete ban on the offer or sale of 
trade options on the agricultural commodities enumerated under the Act. 
The proposed rules permitting such transactions subject to the 
specified conditions therefore remove a burden for all entities, 
regardless of size.
---------------------------------------------------------------------------

    \44\ Specifically, in April 1982 the Commission found that FCMs 
were required to have a minimum net capital of $50,000.
    \45\ IBs are required to maintain minimum levels of net capital 
in the amount of $30,000. See, 61 FR 19177 (May 1, 1996).
---------------------------------------------------------------------------

List of Subjects

17 CFR Part 3

    Administrative practice and procedure, Brokers, Commodity futures.

17 CFR Part 32

    Commodity futures, Commodity options, Prohibited transactions and 
trade options.

17 CFR Part 33

    Commodity futures, Consumer protection, Fraud.

    In consideration of the foregoing, and pursuant to the authority 
contained in the Act, and in particular sections 2(a)(1)(A), 4c, and 
8a, 7 U.S.C. 2, 6c, and 12a, as amended, the Commission hereby proposes 
to amend parts 3, 32, and 33 of chapter I of title 17 of the Code of 
Federal Regulations as follows:

PART 3--REGISTRATION

    1. The authority citation for part 3 continues to read as follows:

    Authority: 7 U.S.C. 1a, 2, 4, 4a, 6, 6b, 6c, 6e, 6f, 6g, 6h, 6i, 
6k, 6m, 6n, 60, 6p, 8, 9, 9a, 12, 12a, 13b, 13c, 16a, 18, 19, 21, 
23; 5 U.S.C. 552, 552b.

    2. New Sec. 3.13 is proposed to be added to read as follows:


Sec. 3.13  Registration of agricultural trade option merchants and 
their associated persons.

    (a) Registration required. It shall be unlawful for any person in 
the business of offering or selling the instruments listed in Sec. 32.2 
of this chapter to offer or to enter into transactions in such 
instruments except if registered as an agricultural trade option 
merchant or a person associated with such a registered agricultural 
trade option merchant under this section.
    (b) Duration of registration. A person registered in accordance 
with the provisions of this section shall continue to be registered 
until the revocation or withdrawal of registration.
    (c) Conditions for registration. Applicants for registration as an 
agricultural trade option merchant and its associated persons must meet 
the following conditions:
    (1) The agricultural trade option merchant must have and maintain 
at all times net worth of at least $50,000 computed in accordance with 
generally accepted accounting principles.
    (2) The agricultural trade option merchant must certify:
    (i) That none of the natural persons who are principals of the 
agricultural trade option merchant, directly or indirectly through the 
beneficial ownership of ten percent or more of a principal which is a 
non-natural person, nor any of the natural persons who are associated 
persons is disqualified for the reasons listed in section 8a(2) and (3) 
of the Act; and
    (ii) That such natural persons successfully complete the series 3 
examination or another proficiency test administered by the National 
Futures Association.
    (3) Provide access to any representative of the Commission, the 
U.S. Department of Justice, or the National Futures Association for the 
purpose of inspecting books and records.
    (d) Application for registration. Application for registration as 
an agricultural trade option merchant and its associated persons must 
be made on the appropriate form specified by the NFA, in accordance 
with the instructions thereto. Such application:
    (1) Must include the agricultural trade option merchant's most 
recent annual financial statements certified by an independent 
certified public accountant in accordance with generally accepted 
auditing standards prepared within the prior 12 months.
    (2) Must include the fingerprints, on a fingerprint card obtained 
from the National Futures Association, of all natural persons who are 
principals, or the beneficial owners of ten percent or more of a 
principal which is a non-natural person, of the applicant, and of all 
natural persons who are to be associated persons of the agricultural 
trade option merchant and such other identifying background information 
as specified.
    (3) Must include separate certification from each natural person 
that the person is not disqualified for any of the reasons listed in 
section 8a(2) and 8a(3) of the Act.
    (4) Must include such other information as may be specified on the 
application form.
    (5) This application must be supplemented to include changes in 
associated persons, a principal, or other required information or 
conditions.
    (e) Temporary licensing. Notwithstanding any other provision of 
this part, the National Futures Association may grant a temporary 
license to any applicant for registration under this section upon 
filing of a complete application meeting all of the requirements of 
paragraph (d) of this section, subject to termination provisions of 
section 3.60 of this part, Provided however, that such temporary 
license shall terminate:
    (1) Immediately upon failure by an applicant to respond to a 
written request by the Commission or the National Futures Association 
for clarification or supplementation of any information set forth in 
the application or for the resubmission of fingerprints.
    (2) Immediately upon failure to comply with an order to pay a civil 
monetary penalty within the time permitted under sections 6(e), 6b, or 
6c(d) of the Act.
    (3) Immediately upon failure to pay the full amount of a reparation 
order within the time permitted under section 14(f) of the Act.
    (4) Five days after service upon the applicant of a notice by the 
Commission or the National Futures Association that the applicant may 
be found subject to a statutory disqualification from registration.
    3. Section 3.34 is proposed to be amended by revising paragraphs 
(a), (d)(1), and (e)(1) to read as follows:


Sec. 3.34  Mandatory ethics training for registrants.

    (a) Any individual registered as a futures commission merchant, 
introducing broker, commodity trading advisor, commodity pool operator, 
leverage trading merchant, associated person, floor broker, floor 
trader, or agricultural trade option merchant under the Act must attend 
ethics training to ensure that he or she

[[Page 59637]]

understands his or her responsibilities to the public under the Act, 
including responsibilities to observe just and equitable principles of 
trade, rules, or regulations of the Commission, rules of any 
appropriate contract market, registered futures association, or other 
self-regulatory organization, or any other applicable federal or state 
law, rule or regulation.
* * * * *
    (d) * * *
    (1) Any individual granted registration under the Act as a futures 
commission merchant, introducing broker, commodity trading advisory, 
commodity pool operator, leverage transaction merchant, associated 
person, floor broker, floor trader or agricultural trade option 
merchant after April 26, 1993, who has not been duly registered under 
the Act at any time during the two year period immediately preceding 
the date such individual's application for registration was received by 
the National Futures Association, must attend training referred to in 
this section within six months after being granted registration, and 
thereafter every three years.
* * * * *
    (e) Evidence of attendance at ethics training, including evidence 
of completion of videotape or electronic training, must be maintained 
in accordance with Sec. 1.31 of this chapter by:
    (1) An individual registered as a futures commission merchant, 
introducing broker, commodity trading advisor, commodity pool operator, 
leverage transaction merchant, or agricultural trade option merchant;
* * * * *

PART 32--REGULATION OF COMMODITY OPTION TRANSACTIONS

    4. The authority citation for part 32 continues to read as follows:

    Authority: 7 U.S.C. 2, 6c and 12a.

    5. Section 32.2 is proposed to be revised to read as follows:


Sec. 32.2  Prohibited transactions.

    Notwithstanding the provisions of Sec. 32.11, no person may offer 
to enter into, confirm the execution of, or maintain a position in, any 
transaction in interstate commerce involving wheat, cotton, rice, corn, 
oats, barley, rye, flaxseed, grain sorghums, mill feeds, butter, eggs, 
solanum tuberosum (Irish potatoes), wool, wool tops, fats and oils 
(including lard, tallow, cottonseed oil, peanut oil, soybean oil and 
all other fats and oils), cottonseed meal, cottonseed, peanuts, 
soybeans, soybean meal, livestock, livestock products, and frozen 
concentrated orange juice if the transaction is or is held out to be of 
the character of, or is commonly known to the trade as an ``option,'' 
``privilege,'' ``indemnity,'' ``bid,'' ``offer,'' ``put,'' ``call,'' 
``advance guarantee,'' or ``decline guarantee,'' except as provided 
under Sec. 32.13 of this part.

    6. New Sec. 32.13 is proposed to be added to part 32 to read as 
follows:


Sec. 32.13  Exemption from prohibition of commodity option transactions 
for trade options on certain agricultural commodities.

    (a) The provisions of Sec. 32.11 shall not apply to the 
solicitation or acceptance of orders for, or the acceptance of money, 
securities or property in connection with the purchase or sale of any 
commodity option on a physical commodity listed in Sec. 32.2 by a 
person who is a producer, processor, or commercial user of, or a 
merchant handling, the commodity which is the subject of the commodity 
option transaction, or the products or byproducts thereof, if all of 
the following conditions are met at the time of the solicitation or 
acceptance:
    (1) That person is registered with the Commission under Sec. 3.13 
of this chapter as an agricultural trade option merchant.
    (2) The option offered by the agricultural trade option merchant is 
offered to a producer, processor, or commercial user of, or a merchant 
handling, the commodity which is the subject of the commodity option 
transaction, or the products or byproducts thereof, and such producer, 
processor, or commercial user of, or merchant is offered or enters into 
the commodity option transaction solely for purposes related to its 
business as such.
    (3) The option can only be settled through physical delivery of the 
underlying commodity.
    (4) To the extent that payment by the customer of the purchase 
price is made to the agricultural trade option merchant prior to option 
expiration or exercise, that amount shall be treated as belonging to 
the customer until option expiration or exercise as provided under 
Sec. 32.6, provided however, that notwithstanding the last sentence of 
Sec. 32.6(a), the full amount of such payment shall be treated as 
belonging to the option customer.
    (5) Producers may not:
    (i) Grant or sell a put option; or
    (ii) Grant or sell a call option, except to the extent that such a 
call option is purchased or combined with a purchased or long put 
option position, and only to the extent that the customer's call option 
position does not exceed the customer's put option position in the 
amount of delivery quantity. Provided, however, that the options must 
be entered into simultaneously and expire simultaneously or at any time 
that one or the other option is exercised.
    (6) All option contracts, including all terms and conditions, 
offered or sold pursuant to this section shall be in writing and shall 
contain terms relating to the following:
    (i) The procedure for exercise of the option contract, including 
the expiration date and latest time on that date for exercise;
    (ii) The strike price(s) of the option contract;
    (iii) The total quantity of commodity underlying the option 
contract;
    (iv) The quality or grade of commodity to be delivered if the 
contract is exercised and any adjustments to price for deviations from 
stated quality or grade;
    (v) The delivery location if the contract is exercised;
    (vi) The separate elements comprising the purchase price to be 
charged, including the premium, markups on the premium, costs, fees and 
other charges; and
    (vii) The additional costs, if any, in addition to the purchase 
price which may be incurred by an option customer if the commodity 
option is exercised, including, but not limited to, the amount of 
storage, interest, commissions (whether denominated as sales 
commissions or otherwise) and all similar fees and charges which may be 
incurred.
    (7) Prior to the entry by a customer into the first option 
transaction with an agricultural trade option merchant, the 
agricultural trade option merchant shall furnish a summary disclosure 
statement to the option customer. The summary disclosure statement 
shall include:
    (i) The following statements in boldface type on the first page(s) 
of the disclosure statement:

    This brief statement does not disclose all of the risks and 
other significant aspects of trading in commodity trade options. You 
are encouraged to seek out as much information as possible from 
sources other than the person selling you this option about the use 
and risks of using option contracts before entering into this 
contract. The issuer of your option should be willing and able to 
answer clearly any of your questions. If this is not the case, 
contact someone else to find answers to your questions before 
entering into a contract. Sources of information include the 
Commodity Futures Trading Commission (a U.S. Government agency), the 
U.S. Department of Agriculture, the National Futures Association (a 
self-regulatory

[[Page 59638]]

association in the commodity futures industry), your state extension 
service, and various agricultural associations.

APPROPRIATENESS OF OPTION CONTRACTS

    Option contracts may subject the user to a high degree of price 
risk including total loss of any funds you pay to the issuer of your 
option. You should carefully consider whether trading in such 
instruments is appropriate for you in light of your experience, 
objectives, financial resources and other relevant circumstances. 
The issuer of your option contract should be willing and able to 
explain the financial outcome of your option contract under all 
market conditions.

COSTS AND FEES ASSOCIATED WITH AN OPTION CONTRACT

    All costs and obligations associated with your option contract 
including the premium, commissions, fees, costs associated with 
delivery if the option is exercised and any other charges which may 
be incurred should be specified in the terms of your option contract 
and are explained in this disclosure statement. Before entering into 
an option contract, you should obtain a clear explanation of all of 
these costs and fees and understand them.

BUSINESS USE OF TRADE OPTIONS

    In order to comply with the law, you must be buying this option 
for business-related purposes. As such, the terms and structure of 
the contracts should relate to your activity or commitments in the 
underlying cash market. If a trade option is exercised, delivery of 
the commodity must occur. Delivery dates, grades, quantities, and 
delivery locations, which are specified in the contract, should 
relate to your ability to make or take delivery of the commodity. 
Any amendments allowed to the option contract must reflect changes 
to your activity or commitments in the underlying cash market or to 
reflect the carrying of inventory. Producers are not permitted to 
sell call options unless the producer is also entering into a put 
option contract at the same time with the same expiration date. In 
those situations, the contracts cannot give the person buying the 
call option the right to call for the delivery of an amount of 
commodity greater than the producer would have the right to deliver 
if he or she exercises the delivery option. Producers are also not 
permitted to sell put options, whether alone or in combination with 
a call option.

RISK OF FRAUD

    You should be aware that trade options are offered in a 
relatively unregulated and decentralized environment, which may 
allow for a higher incidence of fraud than in a more regulated and 
restricted market. You should be aware that you may be able to 
obtain a similar contract or execute a similar strategy using an 
instrument offered on a more highly regulated futures exchange. 
Moreover, exchange products will likely be more transparent and the 
current prices on which are likely to be reported on a more regular 
basis. In addition, exchange options are highly liquid and may be 
offset at any time. In contrast, trade options legally may only be 
satisfied if exercised through physical delivery.

COUNTERPARTY PERFORMANCE RISK

    If you are purchasing an option contract (i.e., acquiring the 
right to sell or purchase the commodity), be aware that you face the 
risk that the other party to the contract may not perform on its 
obligation to purchase or sell the commodity. If this occurs, you 
may lose any price protection the option contract would have offered 
you. You should take this risk into account in selecting an 
agricultural trade option merchant.

DISPUTE RESOLUTION

    If a dispute should arise under the terms of this trade option 
contract, you may be able to use the reparations program run by the 
Commission in addition to any other dispute resolution forums 
provided to you under law or under the terms of your customer 
agreement. For more information on the Commission's Reparations 
Program contact: Office of Proceedings, Commodity Futures Trading 
Commission, Three Lafayette Centre, 1155 21st Street, NW., 
Washington, DC 20581, (202) 418-5250.

ACKNOWLEDGEMENT OF RECEIPT

    The Commodity Futures Trading Commission requires that all 
customers receive and acknowledge receipt of a copy of this 
disclosure statement. The Commodity Futures Trading Commission does 
not intend this statement as a recommendation or endorsement of 
agricultural trade options. These commodity options have not been 
approved or disapproved by the Commodity Futures Trading Commission, 
nor has the Commission passed upon the accuracy or adequacy of this 
disclosure statement. Any representation to the contrary is a 
violation of the Commodity Exchange Act and Federal regulations;

    (ii) The following additional information must be provided prior to 
entry by a customer into every option transaction with an agricultural 
trade option merchant:
    (A) The procedure for exercise of the option contract, including 
the expiration date and latest time on that date for exercise;
    (B) A description of the elements comprising the purchase price to 
be charged, including the premium, mark-ups on the premium, costs, fees 
and other charges, and the services to be provided for the separate 
elements comprising the purchase price;
    (C) A description of any and all costs in addition to the purchase 
price which may be incurred by an option customer if the commodity 
option is exercised, including, but not limited to, the amount of 
storage, interest, commissions (whether denominated as sales 
commissions or otherwise) and all similar fees and charges which may be 
incurred;
    (D) Where the full option premium or purchase price of the option 
is not collected up front or where through amendments to the option 
contract it is possible to lose more than the amount of the initial 
purchase price, a description of the worst possible financial outcome 
that could be suffered by the customer; and
    (E) The following acknowledgment section:

    I hereby acknowledge that I have received and understood this 
risk disclosure statement.

Date-------------------------------------------------------------------

Signature of Customer--------------------------------------------------

    (b) Report of account information. Registered agricultural trade 
option merchants must provide in writing to customers with open 
positions the following information:
    (1) Within 24 hours of execution of an agricultural trade option 
confirmation of the transaction, including a copy of the written 
contract and all information required in paragraph (a)(6) of this 
section;
    (2) Within 24 hours of a request by the customer, current commodity 
price quotes or other information relevant to the customer's position 
and account; and
    (3) Monthly, a current account statement including a complete 
listing of all individual agricultural trade option transactions which 
clearly states the expiration date of each option and clearly 
distinguishes and draws attention to those options which will expire 
within the next month, all orders to enter into such transactions not 
yet filled, a current commodity price related to all open option 
positions or open orders, and the amount of any funds owed by, or to, 
the customer.
    (c) Recordkeeping. Registered agricultural trade option merchants 
shall keep full, complete and systematic books and records together 
with all pertinent data and memoranda of or relating to such 
transactions, including customer solicitation and covering 
transactions, maintain such books and records for the period specified 
in Sec. 1.31 of this chapter, and make such reports to the Commission 
as provided for in paragraphs (c) and (d) of this section and as the 
Commission may otherwise require by rule, regulation, or order. Such 
books and records shall be open at all times to inspection by any 
representative of the Commission, the Department of Justice, or the 
National Futures Association.
    (d) Reports. Registered agricultural trade option merchants must 
file reports quarterly with the National Futures Association, in the 
form and manner specified by the National Futures Association and 
approved by the Commission, which shall contain the following 
information:

[[Page 59639]]

    (1) By commodity and put, call or combined option:
    (i) Total number of new contracts entered into during the reporting 
period;
    (ii) Total quantity of commodity underlying new contracts entered 
into during the reporting period;
    (iii) Total number of contracts outstanding at the end of the 
reporting period;
    (iv) Total quantity of underlying commodity outstanding under 
option contracts at the end of the reporting period;
    (v) Total premiums collected on options during the reporting 
period;
    (vi) The value of all fees, commissions, or other charges other 
than option premiums, collected on trade options during the reporting 
period;
    (vii) Total number of options exercised during the reporting 
period;
    (viii) Total quantity of commodity underlying the exercise of 
options during the reporting period.
    (2) Total number of customers by commodity with open option 
contracts at the end of the reporting period.
    (e) Special calls. Upon special call by the Commission for 
information relating to agricultural trade options offered or sold on 
the dates specified in the call, each agricultural trade option 
merchant shall furnish to the Commission within the time specified the 
following information as specified in the call:
    (1) All positions and transactions in agricultural trade options 
including information on the identity of agricultural trade option 
customers.
    (2) All positions and transactions for future delivery or options 
on contracts for future delivery or on physicals on all contract 
markets.
    (3) All positions and transactions in cash commodities, their 
products, and by-products.
    (f) Internal controls. (1) Each agricultural trade option merchant 
registered with the Commission shall prepare, maintain and preserve 
information relating to its written policies, procedures, or systems 
concerning the agricultural trade option merchant's internal controls 
with respect to market risk, credit risk, and other risks created by 
the agricultural trade option merchant's activities, including systems 
and policies for supervising, monitoring, reporting and reviewing 
trading activities in agricultural trade options; policies for hedging 
or managing risk created by trading activities in agricultural trade 
options, including a description of the types of reviews conducted to 
monitor positions; and policies relating to restrictions or limitations 
on trading activities.
    (2) The financial statements of the agricultural trade option 
merchant must on an annual basis be audited by a certified public 
accountant in accordance with generally accepted auditing standards.
    (3) The agricultural trade option merchant must file with the 
Commission a copy of its certified financial statements within 90 days 
after the close of the agricultural trade option merchant's fiscal 
year.
    (4) The agricultural trade option merchant must perform a 
reconciliation of its books at least monthly.
    (5) The agricultural trade option merchant:
    (i) Must report immediately if its net worth falls below the level 
prescribed in Sec. 3.13 of this chapter, and must report within three 
days discovery of a material inadequacy in its financial statements by 
the independent public accountant or any state or federal agency 
performing an audit of its financial statements promptly to the 
Commission and National Futures Association by facsimile, telegraphic 
or other similar electronic notice; and
    (ii) Within five business days after giving such notice, the 
agricultural trade option merchant must file a written report with the 
Commission stating what steps have been taken or are being taken to 
correct the material inadequacy.
    (6) If the agricultural trade option merchant's net worth falls 
below the level prescribed in Sec. 3.13(c)(1) of this chapter, it must 
immediately cease offering or entering into new option transactions and 
must notify customers having premiums which the agricultural trade 
option merchant is holding under paragraph (a)(4) of this section that 
such customers can obtain an immediate refund of that premium amount, 
thereby closing the option position.
    (g) Exemption. (1) The provisions of this section shall not apply 
to a commodity option offered by a person which has a reasonable basis 
to believe that the option is offered to a producer, processor, or 
commercial user of, or a merchant handling, the commodity which is the 
subject of the commodity option transaction, or the products or by 
products thereof, and that such producer processor, commercial user or 
merchant is offered or enters into the commodity option transaction 
solely for purposes related to its business as such, and that both 
parties to the contract have a net worth of not less than 10 million 
dollars.
    (2) Provided, however, that Sec. 32.9 of this part continues to 
apply to such option transactions.

PART 33--REGULATION OF DOMESTIC EXCHANGE-TRADED COMMODITY OPTION 
TRANSACTIONS

    7. The authority citation for part 33 continues to read as follows:

    Authority: 7 U.S.C. 1a, 2, 4, 6, 6a, 6d, 6e, 6f, 6g, 6h, 6i, 6j, 
6k, 6l, 6m, 6n, 6o, 7, 7a, 7b, 8, 9, 11, 12a, 13a, 13a-1, 13b, 19, 
and 21.

    8. The first sentence of the introductory text of Sec. 33.4 is 
proposed to be revised to read as follows:


Sec. 33.4  Designation as a contract market for the trading of 
commodity options.

    The Commission may designate any board of trade located in the 
United States as a contract market for the trading of options on 
contracts of sale for future delivery or for options on physicals in 
any commodity regulated under the Act, when the applicant complies with 
and carries out the requirements of the Act (as provided in Sec. 33.2), 
these regulations, and the following conditions and requirements with 
respect to the commodity option for which the designation is sought:
* * * * *
    Issued this 29th day of October 1997, in Washington, DC, by the 
Commodity Futures Trading Commission.
Jean A. Webb,
Secretary of the Commission.
[FR Doc. 97-29037 Filed 11-3-97; 8:45 am]
BILLING CODE 6351-01-P


</pre><script data-cfasync="false" src="/cdn-cgi/scripts/5c5dd728/cloudflare-static/email-decode.min.js"></script></body>
</html>