Federal Register / Vol. 65, No. 240 / Wednesday, December 13, 2000 / Rules and Regulations 77993

1See Mercatus letter, Aug. 21, 2000, p. 4 (‘‘While

it may be appropriate for the CFTC to avoid such

a determination in granting an exemption from

regulation, it is not clear that the CFTC can exercise

its antifraud authority in relation to a particular

transaction without determining that the CFTC is

authorized to exercise jurisdiction in the first

instance.’’) The drafters of the Mercatus letter

further note that the ‘‘broad definition of MTEF’’ in

the proposed rules could even be read ‘‘to cover

auction markets such as eBay and all other forms

of B2B trading facilities, whether electronic or not.’’

Id. at 5. The Commission attempts to deflect this

criticism in the final rules, stating that ‘‘so long as

a facility auctions instruments outside of the

Commission’s regulatory jurisdiction under the Act,

[the] exemptions therefrom and this framework

would have no application to its business.’’ See

Final Rules for a New Regulatory Framework for

Multilateral Transaction Execution Facilities,

Intermediaries and Clearing Organizations, pp. 13–

14. The Commission’s response misses the

rudimentary point that it will be anyone’s guess

whether some instruments possibly traded on DTFs

are within or outside the Commission’s jurisdiction.

2See Lehman Brothers letter, Sept. 5, 2000, p. 2

(‘‘[T]he Commission’s jurisdiction extends solely to

futures and commodity options, such that reserving

anti-fraud and anti-manipulation authority over

futures and commodity options merely restates the

current state of law. Such a reservation of authority

cannot, legally, extend to transactions other than

futures and commodity options and repeating the

nature of the agency’s statutory jurisdiction carries

no legal baggage.’’)

3The only apparent penalty for refusing to

comply with Commission rules is the market’s loss

of recognition as a DTF. I am not comfortable with

this after-the-fallout remedy, and I cannot imagine

potential market participants or domestic or

international regulators being any more pleased.

4See A New Regulatory Framework for

Multilateral Transaction Execution Facilities,

Intermediaries and Clearing Organizations, p. 11,

citing H.R. Rep. No. 978, 102d Cong., 2d Sess. 82–

83 (1992).

5See Department of Treasury letter, Aug. 16,

2000, p. 4.

proposal,1 others took comfort in it.2 Despite

this ‘‘don’t ask, don’t tell’’ approach, DTFs all

will be ‘‘recognized’’ by the Commission as

regulated markets.3 In turn, these DTF

markets will hold themselves out to the

public as markets regulated by the CFTC.

The Commission and certain commenters

within the industry find the possible mix of

futures and non-futures products on DTFs

acceptable. They rely on Congressional report

language from the 1992 legislation that, in

effect, allows the Commission to exempt

transactions without first determining that

they are in the agency’s jurisdiction.4

In the context of bilateral, privately

negotiated transactions—such as those swaps

the Commission was directed by Congress to

‘‘promptly exempt—such an exemption

makes a certain amount of sense. The

consequence of any performance failure or

fraud is borne solely by the parties to the

transaction.

However, today the Commission extends

this rationale to entities that are, in fact,

exchange markets. Global participants and

international regulators rely on our

representations that these markets are

regulated. I will not be comfortable making

such representations with regard to DTFs

where the Commission’s jurisdiction is so

questionable.

As a secondary matter, I am concerned

with the level of oversight that will be

applied to all DTF markets. Under the new

framework, DTFs generally will not be

required to maintain or provide the

Commission with reports of futures positions

held by their customers that exceed certain

thresholds. In what appears to be a nod to the

need for these reports, known as ‘‘large trader

reports,’’ the Commission contemplates

collecting this information only in a select,

few markets. But the vast majority of markets

trading at the DTF level—generally those

without retail participants—will have no

obligation or duty to the Commission or the

public with regard to this important

information.

Large trader reports are an essential tool in

the Commission’s effort to detect and deter

market manipulations. Deterrence is

important because the effects of market

manipulations reach far beyond the market’s

participants. Consumers ultimately pay for

manipulations in commodity markets: Home

buyers pay higher interest rates; commuters

pay higher prices for gasoline; and we all pay

higher prices for heating oil and food. For

these reasons, I would require large trader

reports in all DTF markets, regardless of the

type of commodity product or participant

involved.

The Department of the Treasury identified

this issue in its comment letter, stating that

‘‘large trader reporting requirements have

worked well in the market for treasury

futures, both for the information they reveal

to regulators and their deterrent effect.’’ 5 I

could not agree more strongly with the

Treasury Department on this point. While it

appears that large trader reporting will attach

to government securities markets, I do not

understand why the Treasury’s views have

not provided just as compelling a rationale

for other markets which are not nearly as

deep or liquid.

I believe that DTF markets may prove to be

very successful, commercially. They may

well grow to be the commercial markets

where pricing and price-basing of

commodities occurs. The Commission would

be wise to retain its ability to detect and deter

manipulations at their incipience.

Dated: November 20, 2000.

Thomas J. Erickson,

Commissioner.

[FR Doc. 00–30267 Filed 12–12–00; 8:45 am]

BILLING CODE 6351–01–P

COMMODITY FUTURES TRADING

COMMISSION

17 CFR Parts 1, 3, 4, 140, 155 and 166

RIN 3038–AB56

Rules Relating to Intermediaries of

Commodity Interest Transactions

AGENCY: Commodity Futures Trading

Commission.

ACTION: Final rules.

SUMMARY: As part of a comprehensive

regulatory reform process, the

Commodity Futures Trading

Commission (CFTC or Commission) has

revised its rules relating to

intermediation of commodity futures

and commodity options (commodity

interest) transactions. These new rules

and rule amendments will provide

greater flexibility in several areas. For

example, to ease barriers to entry for

persons seeking registration as futures

commission merchants (FCMs) or

introducing brokers (IBs), the

Commission has established a

simplified registration procedure for

those persons who are regulated by

other federal financial regulatory

agencies and who limit their customer

base to institutional customers only,

regardless of the type of market

involved.

With respect to trading on recognized

derivatives transaction facilities (DTFs),

the Commission has determined to

permit non-institutional customers to

enter into transactions thereon,

provided that such non-institutional

customer business is transacted either

through a registered FCM that is a

clearing member of at least one

designated contract market or

recognized futures exchange (RFE), and

that has adjusted net capital of at least

$20 million or by a registered

commodity trading advisor (CTA) who

has discretionary authority over the

non-institutional customer’s account,

and who has assets under management

of not less than $25 million. The latter

circumstance is an expansion of the

proposal.

As proposed, the Commission is

expanding the range of instruments in

which FCMs may invest customer

funds. In response to various comments

concerning the expansion of permissible

investments, the Commission is making

certain adjustments to the proposals

relating to, among other things,

concentration limits as applied to

securities held in connection with

repurchase transactions, permissible

investments in FCMs and their affiliates

by money market mutual funds meeting

the requirements of Rule 2a–7 under the

Investment Company Act of 1940

(Investment Company Act), and

investment in foreign sovereign debt.

Separately, the Commission also is

considering proposing risk-based capital

rules for FCMs. Further, the

Commission recently adopted a revised

interpretation concerning the treatment

of customer funds on deposit with

77994 Federal Register / Vol. 65, No. 240 / Wednesday, December 13, 2000 / Rules and Regulations

1 65 FR 60558 (Oct. 11, 2000). Unless otherwise

noted, Commission rules referred to herein are

found at 17 CFR Ch. I (2000).

2See A New Regulatory Framework for

Multilateral Transaction Execution Facilities,

Intermediaries and Clearing Organizations, 65 FR

38986; Rules Relating to Intermediaries of

Commodity Interest Transactions, 65 FR 39008; A

New Regulatory Framework for Clearing

Organizations, 65 FR 39027; Exemption for Bilateral

Transactions, 65 FR 39033.

3 65 FR 39008.

4See id. at 39009 nn.1–3.

5See id. A more complete description of the

various new market structures can be found in ‘‘A

New Regulatory Framework for Multilateral

Transaction Execution Facilities, Intermediaries

and Clearing Organizations,’’ published elsewhere

in today’s edition of the Federal Register.

FCMs for the purpose of trading on

foreign markets under Rule 30.7.1

In addition, the Commission is

announcing herein the adoption of other

new rules and rule amendments,

concerning the definition of the term

‘‘principal,’’ certified financial reports,

ethics training, disclosure, account

opening procedures, trading standards,

reporting requirements, and offsetting

positions, as proposed. The Commission

has made additional changes to allow a

registrant to notify the Commission

when a new natural person is added as

a principal ‘‘promptly’’ after the change

occurs. With respect to pre-dispute

arbitration agreements between an

institutional customer and a

Commission registrant, the Commission

has determined to allow such parties to

negotiate any or all terms of the

agreement, provided that the signing of

such agreement by the institutional

customer cannot be made a condition of

doing business with the registrant. The

Commission has also determined to

allow any counterclaim to be heard as

part of an arbitration proceeding

between a non-institutional customer

and a registrant where the parties have

agreed in advance that all such claims

must be included in the proceeding,

provided that the aggregate value of the

counterclaim is capable of calculation

and that the counterclaim arises out of

a transaction subject to Commission

jurisdiction.

EFFECTIVE DATE: February 12, 2001.

FOR FURTHER INFORMATION CONTACT:

Lawrence B. Patent, Associate Chief

Counsel, Paul H. Bjarnason, Jr., Special

Advisor for Accounting Policy (with

respect to Rule 1.25 concerning

investment of customer funds), or Ky

Tran-Trong, Attorney-Advisor, Division

of Trading and Markets, Commodity

Futures Trading Commission, Three

Lafayette Centre, 1155 21st Street, N.W.,

Washington, D.C. 20581. Telephone:

(202) 418–5450.

SUPPLEMENTARY INFORMATION:

Table of Contents

I. Introduction

A. Background

B. The Comments Received

II. Responses to the Comments Received

A. General

B. Core Principle One: Registration

1. Definition of the Term ‘‘Principal’’

2. Special Procedures Available to Firms

Subject to Securities or Banking

Regulation

3. Standard Application Procedures for

FCMs and IBs

C. Core Principles Two and Six: Fitness

and Supervision

D. Core Principle Three: Financial

Requirements

1. Trading by Non-Institutional Customers

on DTFs

2. Segregation of Funds

3. Investment of Customer Funds

E. Core Principle Four: Risk Disclosure and

Account Statements

F. Core Principle Five: Trading Standards

G. Core Principle Seven: Reporting

Requirements

H. Core Principle Eight: Recordkeeping

1. General

2. Customer Account Statements; CloseOut of Offsetting Positions

III. Section 4(c) Findings

IV. Related Matters

A. Regulatory Flexibility Act

B. Paperwork Reduction Act

I. Introduction

A. Background

In accordance with the

recommendations made in a staff task

force report submitted to the

Commission’s Congressional oversight

committees on February 22, 2000, the

Commission on June 22, 2000 published

a proposed new regulatory structure

intended to adapt to the changing needs

of the modern marketplace (New

Regulatory Framework).2 In reviewing

its regulatory structure for

intermediaries, the Commission in its

proposal (Proposing Release) identified

eight Core Principles that it believes are

fundamental to assuring proper conduct

by intermediaries of commodity interest

transactions.3 Although the Commission

did not propose these Core Principles as

rules, they guided the Commission in its

regulatory reform efforts, as the

Commission reviewed all of its rules

related to intermediaries in light of the

Core Principles. The Commission

proposed reforms contemplating greater

flexibility for intermediaries and their

customers via a regulatory structure that

acknowledges the different levels of

safeguards appropriate to the types of

instruments, customers, and markets

involved.

To the extent that an existing rule was

not addressed in the Proposing Release,

and no amendment thereto has been

adopted, the rule will apply to

intermediaries transacting business on

behalf of customers on contract markets,

RFEs and DTFs. When an intermediary

transacts business on an exempt

multilateral transaction execution

facility (exempt MTEF), these

transactions are subject only to the

Commission’s antifraud and

antimanipulation authority to the extent

applicable.4 Similarly, where a DTF

permits trading only on a principal-toprincipal basis, CFTC rules related only

to intermediaries will not be applicable

to such a market structure.5

The Core Principles that guided the

Commission in its review of rules

applicable to intermediaries, which

relate to registration, fitness of

registrants, financial requirements, risk

disclosure, trading standards,

supervision of personnel, large position

reporting requirements, and

recordkeeping, are as follows:

1. Registration Required

Any person or entity intermediating a

transaction on an RFE, or on a DTF that

permits intermediation of trading, must

be registered in the appropriate capacity

with the Commission as an FCM, IB,

CTA, commodity pool operator (CPO),

associated person (AP) of any of the

foregoing, or floor broker (FB). In

addition, a person trading solely for his

or her own account on an RFE or DTF

with a trading floor must register as a

floor trader (FT).

2. Fitness of Registrants

Intermediaries and FTs in all markets

recognized by the CFTC must be and

remain fit.

3. Financial

FCMs must keep and safeguard

customer money and FCMs and IBs

must have sufficient capital to ensure

their capacity to meet their obligations

to customers.

4. Risk Disclosure

Intermediaries must provide to

customers risk disclosure appropriate to

the particular instrument or transaction

and the customer.

5. Trading Standards

Intermediaries and their affiliated

persons are prohibited from misusing

knowledge of their customers’ orders.

6. Supervision

All intermediaries, including APs

having supervisory responsibilities,

must diligently supervise all commodity

interest accounts that they carry,

Federal Register / Vol. 65, No. 240 / Wednesday, December 13, 2000 / Rules and Regulations 77995

6As discussed in a companion release in today’s

edition of the Federal Register, large trader reports

will not be required from participants trading on a

DTF restricted to commercial participants, except

where the Commission specifically orders

otherwise. 7The Commission wishes to make clear that its

regulatory reform efforts are an ongoing process.

Thus, for example, as a part of the regulatory reform

process, the Division of Trading and Markets

recently permitted designated self-regulatory

organizations (DSROs) to conduct ‘‘risk-based’’

auditing and thereby take into account a firm’s

business practices in establishing the scope and

timing of audits. See Financial and Segregation

Interpretation No. 4–2, CFTC Staff Letter 99–32,

[1998–1999 Transfer Binder] Comm. Fut. L. Rep.

(CCH) ¶ 27,745 (Aug. 20, 1999). Similarly, the

Commission is considering amendments to the

minimum capital requirements for FCMs. Those

proposed amendments would contain an approach,

generally referred to as ‘‘risk-based’’ capital

requirements, that is based more upon position risk

than is the case under the current rules.

8Commenters are generally identified by name

below when their comments are discussed.

Citations to comment letters are denoted as ‘‘CL 22–

x.’’ The number 22 represents the comment file for

the Proposing Release and ‘‘x’’ is the number

assigned to a particular comment letter as set forth

on the Commission’s website, www.cftc.gov.

9As explained in the separate release on ‘‘A New

Regulatory Framework for Multilateral Transaction

Execution Facilities, Intermediaries and Clearing

Organizations’’ in today’s edition of the Federal

Register, however, the Commission is amending its

proposal to permit a non-institutional customer to

enter an order directly to a DTF’s electronic trading

platform where the customer’s account is carried by

a registered FCM with at least $20 million in

adjusted net capital that is also a clearing member

of at least one designated contract market or RFE,

provided that such FCM’s credit filter is maintained

as part of the DTF’s electronic trading platform. See

§ 37.2(a)(2)(ii)(A).

In addition, FTs and FBs will be permitted to

trade for their own account on a DTF, even if they

would not otherwise come within the definition of

an institutional customer, provided that their

obligations in connection with their trading on the

DTF are guaranteed by an FCM. See § 37.1(b)(1), (2).

Generally, an FT or an FB must have total assets

exceeding $10,000,000 to be considered an

institutional customer. See §§ 1.3(g), 35.2(b)(10),

(11).

operate, advise, introduce, handle, or

trade, as well as all of the other

activities that arise in their business as

intermediaries. All intermediaries must

establish, maintain, and enforce

supervisory procedures.

7. Reporting of Positions

All intermediaries must report to the

Commission, RFE or DTF information

that permits the Commission, RFE, or

DTF to identify concentrations of

positions and market composition.

Reports of transactions on RFEs are

required on a routine and non-routine

basis, as is the case for transactions on

contract markets. Reports of transactions

on an institutional-participant DTF are

required only on a non-routine basis.6

8. Recordkeeping

All intermediaries (and FTs) must

keep full books and records of all

activities related to their business as an

FCM, IB, CPO, CTA, FB, or FT, in a form

and manner acceptable to the

Commission for a period of five years.

Such information must be readily

available during the first two years and

be produced to the Commission at the

expense of the person required to keep

the books or records. All such books and

records shall be open to inspection by

any representative of the Commission or

the U.S. Department of Justice.

Certain of the Commission’s rule

amendments, such as those concerning

ethics training and the definition of the

term ‘‘principal,’’ will affect all

registered firms. The other new rules

and rule amendments will affect mainly

FCMs and IBs, and are not applicable to

CPOs and CTAs. The Commission

intends to consider further rulemaking

proposals at a subsequent date that will

focus more directly upon Part 4 of the

Commission’s rules, which governs the

operations and activities of CPOs and

CTAs.7

B. The Comments Received

The Commission received 81

comment letters on the New Regulatory

Framework, 51 of which were posted to

the comment file on intermediaries on

the Commission’s web site. Of those 51

comment letters, 31 letters addressed

specific provisions of the Proposing

Release: five from U.S. commodity

exchanges; two from the National

Futures Association (NFA); one from the

Futures Industry Association (FIA); six

from other futures industry professional

associations; one from the Federal

Reserve Bank of Chicago (FRBC); one

from the Department of the Treasury

(Treasury); one from a provider of ethics

training programs for the futures

industry; five from firms registered as

FCMs; one from a margin settlement

bank for various U.S. exchanges and

clearing corporations; three from trade

associations representing the grain

industry; one from a group of trade

associations representing various

producer groups; two from public policy

centers; one from a single firm

registered as an FCM, CPO and CTA;

and one from a certified public

accounting firm. These commenters, as

well as those that addressed the concept

of regulatory reform in a more general

fashion, expressed strong support for

the Proposing Release, but some

suggested that the relief did not go far

enough towards replacing the

Commission’s regulatory framework

concerning intermediaries with core

principles.8

The Commission has carefully

reviewed all of the comments received.

Based upon this review, the

Commission generally has determined

to adopt the new rules and amendments

as proposed in the Proposing Release. In

response to the comments, the

Commission has also decided, however,

to modify the proposal in several

respects. First, the Commission has

determined to expand the ‘‘passport’’

provisions with respect to those FCMs

and IBs that are already registered with

the Securities and Exchange

Commission (SEC) in a similar

registration capacity, or that are

authorized to perform these functions

by a federal banking authority. As

adopted, these rules will allow those

FCMs and IBs to follow a simplified

registration procedure in order to

conduct business solely for institutional

customers on designated contract

markets and RFEs, in addition to DTFs.

Second, the Commission has

determined to permit certain CTAs to

place trades on a DTF on behalf of noninstitutional customers, provided that

the non-institutional customer’s

investment decisions are directed by the

CTA and that total assets over which the

CTA has discretionary authority are not

less than $25 million. The proposal

would have required non-institutional

customers wishing to trade on DTFs to

transact their business only through an

FCM with at least $20 million in

adjusted net capital that is also a

clearing member of at least one

designated contract market or RFE.9

Third, the Commission has made

adjustments to its rules governing

permissible investments for customer

funds in response to the comments

received. Fourth, the Commission has

adopted additional changes to allow a

registrant to notify the Commission

‘‘promptly’’ after a new principal is

added, rather than prior to the change

as was the case previously. Fifth, with

respect to pre-dispute arbitration

agreements between an institutional

customer and a Commission registrant,

the Commission has determined to

allow such parties to negotiate any or all

terms of such agreements, provided that

the signing of the agreement may not be

made a condition of doing business with

the registrant. Sixth, the Commission

has decided to permit any counterclaim

arising out of a transaction subject to the

Commodity Exchange Act (Act) or

regulations thereunder to be heard as

part of an arbitration proceeding

between a non-institutional customer

and a registrant where the parties have

agreed in advance that all such claims

must be included in the proceeding.

In the Proposing Release, the

Commission gave a detailed explanation

for each revision that it proposed to

77996 Federal Register / Vol. 65, No. 240 / Wednesday, December 13, 2000 / Rules and Regulations

10 65 FR at 39012.

11 Id. at 39014–15.

12Should the Commission in the future adopt

core principles in the place of some of its existing

regulations as they pertain to intermediaries, NFA

urged the Commission to look to NFA and the

industry to develop the acceptable practices for

satisfying many of these core principles, subject to

Commission approval. (CL 22–24 at 2) The

Commission notes that it has already taken such an

approach in certain areas, e.g., disclosure to noninstitutional customers trading on DTFs, and looks

forward to continuing to work with NFA and the

industry in developing acceptable practices in

additional areas.

13 65 FR at 39009.

14 64 FR 28735 (May 27, 1999).

15 64 FR 36568 (July 7, 1999).

make to the rules relating to

intermediation of commodity interest

transactions. The scope of this Federal

Register release generally is restricted to

the comments received on the Proposing

Release and changes to the proposed

new rules and rule amendments that the

Commission has made in response

thereto. Accordingly, the Commission

encourages interested persons to read

the Proposing Release for a discussion

of the background and purpose of each

of the rule amendments that is not

described in detail in this Federal

Register release.

The Proposing Release also presented

several sets of questions intended to

elicit public comments on various

issues. For instance, the Commission

requested comment concerning the need

to update and to make more flexible its

minimum net capital requirements for

FCMs by permitting the application of

risk-based net capital requirements.10 In

response to the comments received, the

Commission plans to separately propose

various rules and amendments

addressing risk-based capital

requirements. The Commission also

posed certain questions related to the

treatment of customer funds.11

Reactions were mixed regarding these

additional issues. Consequently, the

Commission will continue to study

these issues.

II. Responses to the Comments

Received

A. General

As noted above, several commenters

urged the Commission to revoke many

of the rules that govern the relationship

between futures and options customers

and intermediaries, and to adopt in their

place a set of core principles and

statements of acceptable practices that

reflect the ‘‘largely institutional nature

of derivatives market participants.’’ (CL

22–31 at 2–3; see also CL 22–22 at 9; CL

22–24 at 1; CL 22–39 at 8; CL 22–35 at

11) In particular, FIA commented that:

[We have] identified the following core

principles that we believe should govern

intermediaries in the conduct of their

business, without regard to the market on

which a transaction is executed: (1)

Registration of intermediaries and their

associated persons; (2) minimum financial

requirements; (3) protection of customer

funds appropriate to the type of customer; (4)

prohibition against fraud and manipulation;

(5) large trader reporting requirements; and

(6) recordkeeping. These core principles,

combined with an effective self-regulatory

organization audit program to assure that

intermediaries have developed and are

enforcing adequate internal controls[,] should

achieve the Commission’s regulatory

purpose. (CL 22–31 at 3 (footnotes omitted))

In general, the Commission believes

that it is more expeditious at this time

to adopt the specific regulatory reforms

contemplated in the original release.

Replacing the current rules with core

principles might have delayed these

changes, and in some instances, resulted

in no practical benefit to the regulated

community. To use Rule 1.55 as an

example, the development of a core

principle approach in this area would

have required the Commission to

propose the repeal of Rule 1.55 and the

adoption of a core principle for

disclosure together with a Statement of

Acceptable Practices. The Statement of

Acceptable Practices would likely

provide, as the rule does now, no

standard disclosure requirement for

institutional customers and the basic

single-page statement now applicable to

non-institutional customers. At the end

of this process, there would be no

discernible change in FCM or IB

operations. Firms might theoretically be

freer to develop their own statements,

but to clear them through counsel and

self-regulatory organization (SRO) staff

would likely be costly and timeconsuming. Accordingly, the

Commission did not believe that it

would be an effective use of the

Commission’s or the industry’s

resources at this time to replace Rule

1.55 solely for the purpose of

establishing a core principle concerning

disclosure. The Commission reaches

similar conclusions with respect to the

repeal of other rules.

Second, the Commission believes that

certain issues, such as the computation

of capital for a financial intermediary,

do not lend themselves easily to a core

principle approach. As one commenter

observed: ‘‘Capital and segregation

requirements * * *‘‘ must be spelled

out in detail to ensure the integrity of

customer funds.’’ (CL 22–24 at 1)

Third, as the New York Mercantile

Exchange (NYMEX) noted, a reexamination of the Commission’s rules

applicable to intermediaries with a goal

towards replacing them with a set of

Core Principles and statements of

acceptable practices ‘‘would require an

intensive review of the applicable rules

in this area,’’ and accordingly,

‘‘undertaking such an examination as

part of the current Reform Proposal

could so greatly lengthen the process as

to undermine the entire reform effort.’’

(CL 22–32 at 16–17)

Nevertheless, the Commission’s

decision at this time not to use a core

principles approach with respect to

intermediaries will not affect its

commitment to the continued review of

the rules affecting intermediaries to

determine where core principles are

appropriate.12 In this regard, the

Commission notes the request it made

in the Proposing Release for specific

comments concerning existing rules and

suggested modifications thereto.13 The

Commission further notes that under

Rule 140.99, there remains a procedure

in place whereby the Commission’s staff

may consider specific individual

circumstances and, where warranted,

the Commission’s staff may grant

interpretative, exemptive, or no-action

relief from requirements under the Act

or Commission rules to individuals or

entities requesting such relief.

Certain commenters specifically

addressed the need for further

regulatory relief with respect to CPOs

and CTAs. (CL 22–22 at 9; CL 22–43 at

5–6; CL 22–47 at 2) The Commission

recognizes that CPOs and CTAs

represent ‘‘important sectors of the

futures industry.’’ (CL 22–22 at 2) As

stated above, the regulatory reform

process is an ongoing one. The

Commission continues to explore

additional areas in which relief for

CPOs and CTAs may be warranted, e.g.,

Part 4 of the Commission’s rules, and

will be making further rulemaking

proposals.

With specific regard to recordkeeping,

the Commission in 1999 adopted

amendments to the recordkeeping

requirements of Rule 1.31 in order to

allow recordkeepers to store most

records on either micrographic or

electronic storage media for the full fiveyear period, thereby harmonizing

procedures for those firms regulated by

both the Commission and the SEC.14 In

order to avoid undue hardship, the

Commission later extended the effective

date of the requirement that

recordkeepers using only electronic

storage media enter into arrangements

with third-party technical consultants.15

The Commission’s staff is continuing to

work with industry representatives to

implement this procedure.

Federal Register / Vol. 65, No. 240 / Wednesday, December 13, 2000 / Rules and Regulations 77997

16Rule 3.1(a) defines ‘‘principal’’ for purposes of

the Commission’s Part 3 rules, which govern

registration. Rule 4.10(e) defines ‘‘principal’’ for

purposes of the Commission’s Part 4 rules, which

apply to the activities of CPOs and CTAs.

17 65 FR at 39010.

18As amended, the ‘‘principal’’ definition will

continue to include all directors of a corporate

registrant. In addition, the definition will include

the general provision that defines as a principal any

person occupying a similar status as or performing

similar functions to those persons specifically

listed, having the power, directly or indirectly,

through agreement or otherwise, to exercise a

controlling influence over a firm’s activities that are

subject to regulation by the Commission. As noted

in the Proposing Release, what constitutes ‘‘a

controlling influence’’ will be left for determination

on ‘‘a case-by-case basis.’’ Id. at 39011 n.11.

19 Id. at 39010. 20 Id. at 39011. 21An additional conforming change was made to

§ 3.21(c) to reflect the deletion of § 3.32, and the

addition of new paragraph (a)(2) to § 3.31. 22 65 FR at 39011–12.

23 Id. at 39012. 24 In this regard, the CME stated that given the

restrictions of the DTF market structure:

The proposed rulemaking provides no relief

whatsoever to a securities broker-dealer (not also

registered as a FCM) that wishes to execute

transactions in both stock index futures and the

underlying stocks in order to implement an asset

allocation strategy for its institutional customers. So

long as the customers are sophisticated institutions,

we can see no regulatory reason not to allow them

to use the federally-regulated intermediary of their

choice in effecting transactions in a futures market,

regardless of whether the market is regulated as a

designated contract market, an RFE, a DTF or an

exempt MTEF. (CL 22–35 at 12)

B. Core Principle One: Registration

1. Definition of the Term ‘‘Principal’’

Under Commission staff’s prior

interpretation of the definition of the

term ‘‘principal’’ in Rules 3.1(a)(1) and

4.10(e)(1),16 all officers of a registrant

were treated as principals and required

to register as such. In response to

changes in management structures over

the last 20 years and requests from

registrants that certain employees, such

as some vice presidents, not be

considered principals because they do

not exercise a controlling influence over

the registrant or any of its activities

subject to Commission regulation, the

Commission proposed to amend Rules

3.1(a)(1) and 4.10(e)(1) by defining as

principals persons within a given

organizational structure who hold

specific offices.17 A registrant would,

therefore, no longer be required to treat

every officer as a principal, but only

those who met the criteria of the rule as

revised.

Commenters were strongly in support

of the proposal to amend the definition

of ‘‘principal’’ to reduce the number of

persons required to be registered, and

the Commission is adopting the

amendments as proposed.18 (CL 22–22

at 11; CL 22–24 at 3; CL 22–25 at 2; CL

22–31 at 13; CL 22–32 at 16) The

Managed Funds Association (MFA)

asked the Commission to confirm that

the reference in the proposed

amendment to the ‘‘principal’’

definition to ‘‘any person in charge of a

business unit subject to regulation by

the Commission’’ applied solely to ‘‘the

aggregate business unit acting in a

registered capacity and not subsidiary

divisions or units such as marketing,

human resources, audit, and other

departments within an operating

entity.’’ (CL 22–22 at 11) The

Commission agrees with this

interpretation, and reiterates that the

intent of the amended ‘‘principal’’

definition is to reduce the number of

officers that will be considered

principals, while ensuring that

appropriate personnel, e.g., those that

exercise, or are in a position to exercise,

‘‘a controlling influence over the

registrant or any of its activities subject

to Commission regulation,’’ 19 remain

listed as such.

The Commission also has determined

to adopt, as proposed, conforming

changes to Rules 4.24(f)(1)(v),

4.25(a)(8)(ii)(A) and 4.25(c)(2)(i)(B),

applicable to CPOs, and 4.34(f)(1)(ii)

and 4.35(a)(7)(ii)(A), applicable to

CTAs, as incorporated by reference in

amended Rule 4.10(e)(1). Accordingly,

CPOs and CTAs will only be required to

provide business backgrounds and

proprietary trading results for those

principals who participate in making

trading or operational decisions, or

supervise persons so engaged, and not

all officers.20

In response to suggestions by FIA, the

Commission has determined to delete

Rule 3.32, which specifies certain

events or changes within a firm’s

management structure that require the

firm to file a new registration form. (CL

22–31 at 13–14) The Commission is

adding a new paragraph (a)(2) to Rule

3.31 to require the registrant to file a

Form 8–R on behalf of each new natural

person principal who was not listed on

the registrant’s Form 7–R ‘‘promptly’’

after the change occurs. Rule 3.31(a)(2)

was drafted to closely parallel Rule

3.10(a)(2)(i), and provides that, if the

change that renders the application for

registration deficient or inaccurate

results from the addition of a new

principal without a current Form 8–R

on file with NFA, a Form 8–R for that

principal must accompany the Form 3–

R amending the registrant’s application

for registration.21

2. Special Procedures Available to Firms

Subject to Securities or Banking

Regulation

The Commission proposed to amend

Rule 3.10 to simplify the registration

process for FCMs or IBs who conduct

business solely for institutional

customers on a DTF, and who are

already registered with the SEC in a

similar registration category or who are

authorized to perform these functions

by a federal banking authority.22 The

Commission stated in the Proposing

Release that such applicants would be

registered as an FCM or IB upon filing

notice with NFA of their intent to

undertake such limited activities,

together with a certification that they

are registered or authorized to engage in

a similar function by, and are in good

standing with, the SEC or a federal

banking authority. In addition,

individuals acting in the capacity of APs

for such FCMs or IBs need not be

registered or listed, and would not be

subject to proficiency testing or ethics

training requirements. These firms and

their salespersons would remain subject

to antifraud provisions, however.23

The Chicago Mercantile Exchange

(CME), along with other commenters,

stated that the ‘‘passporting’’ provisions

did not go far enough and urged the

Commission to extend the provisions to

allow those persons who are regulated

by the SEC or a federal banking agency,

and who opt to register as an FCM or IB

under the simplified registration

procedure, to conduct business for

institutional customers on all trading

platforms, rather than limit their access

to DTFs.24 (CL 22–35 at 12; see also CL

22–24 at 3–4; CL 22–25 at 2–3) In

support of this recommendation, the

Chicago Board of Trade (CBT) stated,

‘‘[i]f the nature of the entity or

individual intermediating the

transaction and the nature of the

customer determines the need for any

particular requirement, whether the

transaction facility is a DTF or an RFE

is irrelevant.’’ (CL 22–25 at 3; see also

CL 22–35 at 15)

In contrast, however, the National

Introducing Brokers Association (NIBA)

urged that any person or organization

conducting any commodity interest

business should be subject to full

registration requirements (CL 22–17 at

4), while MFA stated that firms making

use of the ‘‘passport’’ procedure should

be subject to a limitation upon their

commodity interest business, such as a

requirement that their commodity

interest activities be incidental to their

primary business as a broker-dealer or

bank. (CL 22–22 at 11–12)

Upon consideration of the comments

received, the Commission agrees that

given the nature of the customers (i.e.,

solely institutional customers) for whom

a securities broker-dealer or bank would

77998 Federal Register / Vol. 65, No. 240 / Wednesday, December 13, 2000 / Rules and Regulations

25As noted in the Proposing Release, a firm acting

in the capacity of an FCM would be required to

become a member of a registered futures

association. See § 170.15. NFA is currently the only

registered futures association. NFA Bylaw 1101

essentially provides that no NFA member may deal

with another person with respect to an account,

order or transaction where the other person is

acting in a capacity that requires registration, unless

that other person is also a member of a registered

futures association. The combination of

Commission Rule 170.15 and NFA Bylaw 1101

therefore requires most registrants to become

members of NFA.

The Commission may consider not requiring NFA

membership in the future if reciprocal arrangements

were made by the primary regulators of other

financial industry segments to recognize CFTC

registration without requiring corresponding SRO

membership.

26Because an intermediary that conducts

business on an exempt MTEF will not be subject to

Commission regulation for activity on the exempt

MTEF, except for the antifraud and

antimanipulation provisions of the Act to the extent

applicable, it is unnecessary to extend the

‘‘passporting’’ procedure to firms trading on these

markets.

27 65 FR at 39012.

28 Id.

29 Id.

30Although the Proposing Release did not

generally address registration procedures for firms

that are dually registered with the National

Association of Securities Dealers (NASD) and NFA,

the Association of Registration Management (ARM)

made several suggestions in that area. Among its

comments, ARM recommended that: (1) Firms that

are dually registered with NASD and NFA should

be permitted to maintain internal records about

branch office location and supervision of those

locations; (2) NFA should be permitted to rely on

the fingerprint information available through the

NASD’s Internet-based Central Registration

Depository (Web CRD) database for dual registrants;

and (3) NFA also should be permitted to rely on

disciplinary and disclosure information filed

through amendments to Web CRD. (CL 22–23 at 2–

3) ARM also recommended that the Commission

eliminate its Form 7–R annual update requirement

by allowing NFA to rely upon, and to record

changes in a registrant’s application through use of,

the amendments filed via Form 3–R throughout the

year. (CL 22–23 at 1–2)

The Commission’s Registration Working Group

(RWG) will consider ARM’s suggestions in the near

future. In this regard, Commission staff indicated in

a letter dated July 13, 2000 to NFA that: (1) NFA

could rely upon reporting by the futures industry

SROs and the Commission with respect to SRO

disciplinary actions and Commission enforcement

actions; (2) certain requirements related to the

collection of employment, residential and

educational data could be reduced; and (3) as part

of the annual update process, firms would only be

required to report any new criminal or civil matters

that had arisen since the previous update.

31 Id. However, as stated in the Proposing Release,

those IB applicants who do not raise their own

capital continue to be required to file a guarantee

agreement entered into with an FCM with their

registration application. IBs and FCMs should refer

to Commission Rules 1.10(j) and 1.57(a)(1)

concerning the procedures applicable to guarantee

be acting as an FCM or IB, the securities

broker-dealer or bank should be eligible

for the simplified FCM or IB registration

procedures, irrespective of the type of

exchange on which the customer seeks

to conduct its transactions. Accordingly,

the Commission has adopted Rule

3.10(a)(1)(i)(B) to permit an individual

or entity who is registered with the SEC

as a broker-dealer, or has been

authorized by the appropriate banking

authority, to register as an FCM or IB

simply by filing notice with NFA,

together with a certification of

registration with the appropriate

financial regulator.25 Such FCMs and

IBs who are otherwise regulated by

another federal financial regulator will

be permitted to conduct business solely

for institutional customers on any

designated contract market, RFE or

DTF.26 The Commission notes,

however, in accordance with FIA’s

comments, that the simplified

registration procedure is limited to

banks themselves, and not to their

affiliates, and further, that once

registered, securities broker-dealers and

banks would be subject to the same

rules that govern all FCMs and IBs. (CL

22–34 at 13)

Although ‘‘passported’’ firms will be

eligible for the simplified FCM or IB

registration procedures without regard

to the type of exchange on which their

institutional customers seek to conduct

business, the Commission has

determined to adopt Rules 1.17(a)(2)(iii)

and 1.52(m), as proposed, without

making further changes. Under Rule

1.17(a)(2)(iii), the Commission would

not require an FCM or IB registered

under the ‘‘passporting’’ procedures in

Rule 3.10(a)(1)(i)(B) to meet the

Commission’s minimum financial

requirements if (i) it meets the

appropriate net capital requirements of

its primary regulator, (ii) its activities

are limited to serving institutional

customers trading on DTFs that do not

require compliance with CFTC

minimum financial requirements for

such ‘‘passported’’ firms, and (iii) it

conforms to minimum financial

standards and related reporting

requirements set by such DTF in its

bylaws, rules, regulations or

resolutions.27

If, however, the ‘‘passported’’ FCM or

IB chooses to conduct transactions on

behalf of its institutional customers on

a contract market or RFE in addition to

its DTF activities, the firm would then

be required to satisfy the Commission’s

minimum financial requirements. The

Commission believes that this

requirement is important to protect the

financial integrity of these markets

because a customer default may have

ancillary impacts not just on other

customers of the affected firm, but also

on other firms and their customers

transacting business on such markets.

Moreover, because the Commission

anticipates that ‘‘passported’’ firms will

conduct most of their business in the

securities or banking fields, with only a

minor portion of their activities

involving commodity interests, the

requirement that such firms meet the

Commission’s minimum financial

requirements if they conduct business

for their institutional customers on a

contract market or RFE should not

impose a significant burden. Rules

1.17(a)(1)(i) and (ii) already require the

dually registered FCM or IB to meet the

greater of either the Commission’s or

SEC’s minimum financial requirements,

and in most cases, those entities that

conduct most of their business in the

securities or banking fields will have

satisfied the Commission’s minimum

financial requirements by meeting the

SEC capital requirements. Similarly, the

Commission allows a dually registered

FCM or IB to satisfy the basic financial

reporting requirements of Rule 1.10 by

filing a copy of its FOCUS report in lieu

of a Form 1–FR. In addition, Rule

1.52(m) is adopted as proposed to

relieve a DTF from the requirement that

it adopt for ‘‘passported’’ firms, the

Commission’s minimum adjusted net

capital standards.28

The Commission continues to

encourage the SEC to consider

reciprocal amendments to its rules to

accommodate FCMs and IBs that are not

now dually registered as securities

brokers or dealers, but that may wish to

act as intermediaries in the securities

markets.

The Commission also noted in the

Proposing Release that it was

considering updating and making more

flexible its minimum net capital

requirements with respect to FCMs,

specifically with respect to adopting

risk-based net capital requirements.29

Commenters were overwhelmingly in

favor of this proposal, and the CBT

further noted that it had, along with the

Board of Trade Clearing Corporation

(BOTCC) and the CME, already adopted

risk-based capital requirements at the

clearing organization level. (CL 22–25 at

3) The Commission is separately

considering proposing rules related to

risk-based net capital requirements.30

3. Standard Application Procedures for

FCMs and IBs

The Commission proposed that

applicants for registration as FCMs or

IBs who raise their own capital to satisfy

minimum financial requirements would

be permitted to file an unaudited

financial report indicating satisfaction

of the minimum requirements, rather

than be required to provide certified

financial statements with their

registration application.31 A firm taking

Federal Register / Vol. 65, No. 240 / Wednesday, December 13, 2000 / Rules and Regulations 77999

agreements. See also First American Discount Corp.

v. CFTC, 222 F.3d 1008 (D.C. Cir. Aug. 18, 2000). 32 65 FR at 39013. 33Rules 1.10(a)(2)(i)(C) and (a)(2)(ii)(C) have been

further revised to make clear that the Form 1–FR–

FCM or Form 1–FR–IB that must be submitted by

new applicants for registration as FCMs and IBs

with their application must be dated not more than

17 business days prior to the date on which such

report is filed. This is consistent with Rules

1.10(a)(2)(i)(B) and (a)(2)(ii)(B).

34See, e.g., In re Premex, [1982–1984 Transfer

Binder] Comm. Fut. L. Rep. (CCH) ¶ 21,992 (Feb. 1,

1984), aff’d in relevant part, rev’d in part, 785 F.2d

1403 (9th Cir. 1986).

35 65 FR at 39013.

36 Id.

37 In the Proposing Release, the Commission

indicated that these letters would be published as

an accompanying statement to this Federal Register

release. The Commission has determined to add

these letters to Appendix A to Part 3 because they

relate to the issue of ‘‘other good cause,’’ which is

discussed at the end of Appendix A, and to provide

an easier way to access the texts of these letters.

38 58 FR 19575, 19576 (Apr. 15, 1993).

advantage of the new procedure would

be subject to an on-site review within

six months of registration by the firm’s

DSRO or, at the DSRO’s discretion, a

conference between appropriate staff of

the firm and the DSRO at the DSRO’s

offices. An applicant that did not wish

to be subject to the six-month review

could continue to follow the existing

rules and file a certified financial

statement with its application.32

In general, commenters supported the

proposed elimination of the certified

financial statement requirement for IB

applicants. (CL 22–17 at 3; CL 22–24 at

4; CL 22–25 at 4) Both NFA and the

CBT, however, expressed reservations

about eliminating the requirement for

FCM applicants. (CL 22–24 at 4; CL 22–

25 at 4) In addition, NFA recommended

that the Commission consider allowing

the DSRO to conduct the six-month

review of independent IBs

telephonically where the DSRO has no

reason to be concerned about the IB’s

capital. (CL 22–24 at 4) The CBT

expressed the view that the six-month

time period for the on-site review of the

FCM by the DSRO should be calculated

from the date the FCM begins customer

business, rather than six months from

the date of registration. (CL 22–25 at 4).

The Commission has determined to

eliminate the requirement to file

certified financial statements with FCM

or IB registration applications by

adopting Rules 1.10 (a)(2)(i)(C) and

(a)(2)(ii)(C), generally as proposed.33

This alternative procedure is modeled

on similar procedures in the securities

industry. Although the Commission is

not requiring FCMs to file a certified

financial statement with their

application for registration, this does

not preclude any SRO from imposing

this requirement before accepting an

FCM for membership. With respect to

the six-month review that must be

conducted should an FCM or IB choose

not to file a certified financial statement

with its registration application, the

Commission does not object, in the case

of an IB, to allowing the DSRO to

conduct the review telephonically

where the DSRO does not have reason

to question the IB’s capital. However,

the Commission believes that the sixmonth time period for the review of

both FCMs and IBs should begin from

the date the applicant is registered. The

Commission has held consistently that

once a registrant becomes registered in

a certain capacity, the registrant is

immediately assumed to be engaging in

the activities permitted by such

registration.34

C. Core Principles Two and Six: Fitness

and Supervision

The Commission proposed to delete

Rule 3.34 and instead to implement

Congressional intent regarding ethics

training through a Statement of

Acceptable Practices.35 Rule 3.34

specified frequency and duration of

ethics training, the suggested

curriculum, qualifications of instructors,

and the necessary proof of attendance at

such classes. In proposing to replace the

rule with a Statement of Acceptable

Practices that would leave the format,

frequency, and providers of ethics

training up to the registrants

themselves, the Commission expressed

its belief that greater flexibility

regarding ethics training and

proficiency testing could be afforded to

registrants than was permitted under

Rule 3.34. For registrants seeking

guidance as to the maintenance of

proper ethics training procedures

consistent with the purposes of the Core

Principle that intermediaries must be

and remain fit, the Commission stated

that the Statement of Acceptable

Practices could function as a ‘‘safe

harbor.’’ 36

In general, commenters expressed

strong support for the Commission’s

proposal, stating, for example, that Rule

3.34 had become ‘‘far too detailed and

administratively cumbersome,’’ (CL 22–

24 at 5) and that ‘‘each registrant should

be responsible for implementing an

ethics training program that addresses

the registrant’s business activities.’’ (CL

22–31 at 14) Other commenters,

however, expressed their beliefs that

Rule 3.34 already provided sufficient

flexibility to registrants, and that by

eliminating the rule, the Commission

risks sending the wrong message to the

industry regarding the importance the

Commission assigns to the ethics

requirement. (CL 22–7 at 3; CL 22–43 at

6).

Upon consideration of the comments

received, the Commission is deleting

Rule 3.34 and issuing the Statement of

Acceptable Practices as a new Appendix

B to Part 3 of its Rules as proposed.

Although the Commission notes the

concern that eliminating Rule 3.34 may

lead firms to place an inadequate

priority on ethics training, the

Commission does not believe that the

replacement of the rule with a

Statement of Acceptable Practices will

diminish a registrant’s obligations to

remain fit and to adequately supervise

the handling of customer accounts.

Instead, the Commission hopes that the

Statement of Acceptable Practices,

which allows registrants to adopt ethics

training programs that are better tailored

to their needs, will help to imbue firms

with a ‘‘culture of ethics’’ that is

ongoing rather than episodic. The

Commission believes that the essence of

the ethics training or continuing

education requirement is to remain

current as to the legal requirements

applicable to a person’s role in the

futures industry, which a registrant

ignores at his or her peril.

The Commission also proposed to

publish its recent ‘‘guidance letters’’

issued to NFA concerning the treatment

of SRO disciplinary actions in assessing

the fitness of FBs and FTs. The guidance

letters were issued to provide greater

clarity in interpreting the ‘‘other good

cause’’ ground for statutory

disqualification from registration under

Section 8a(3)(M) of the Act. Support

was expressed for this proposal and,

accordingly, the Commission is hereby

publishing both letters as an addition to

Appendix A to Part 3 of its Rules.37 (CL

22–25 at 4–5)

The Commission also requested

comment regarding additional changes

that should be considered in this area.

In response, NFA urged the Commission

to consider prohibiting exchange

‘‘subscribers’’ from accessing electronic

exchanges where they have been barred

by another exchange. (CL 22–22 at 5) As

explained by NFA, the term

‘‘subscriber’’ describes the type of

person that is equivalent to an FT. The

Commission previously stated, when it

adopted rules to govern FT registration,

that it would defer consideration of the

application of such requirements to

persons using electronic trading systems

to a later date.38 To date, the

Commission has not revisited the issue,

and accordingly does not believe that it

is appropriate to adopt NFA’s request at

this time. Nevertheless, the exchanges

remain free to ban such ‘‘subscribers’’

78000 Federal Register / Vol. 65, No. 240 / Wednesday, December 13, 2000 / Rules and Regulations

39 65 FR at 38990.

40 Id.

41 65 FR at 39013.

42 Id.

43 Id. 44 65 FR at 47277.

45The term ‘‘direct,’’ as defined in Rule 4.10(f),

refers to, in the context of trading commodity

interest accounts, ‘‘agreements whereby a person is

authorized to cause transactions to be effected for

a client’s commodity interest account without the

client’s specific authorization.’’

from access pursuant to their own rules

and policies. As with the case of

certified financial statements for FCM

applicants discussed above, SROs may

determine to impose requirements that

are stricter than the minimum standards

set forth in Commission rules.

D. Core Principal Three: Financial

Requirements

1. Trading by Non-Institutional

Customers on DTFs

Under the New Regulatory

Framework, trading on DTFs would be

limited to futures and options on

specified commodities or those

commodities deemed eligible under a

case-by-case Commission

determination.39 In addition, DTFs

could permit trading in any

commodities if trading is limited to

qualifying commercial participants.40

The Commission proposed, however,

that under certain conditions a DTF

might permit non-institutional

customers to enter into transactions

thereon.41 To address the higher degree

of risk associated with the lower

regulatory protections offered to DTF

participants, such non-institutional

customer business could be transacted

only through a registered FCM that (1)

Is a clearing member of at least one

designated contract market or RFE, and

(2) has a minimum adjusted net capital

of at least $20 million.42 Such an FCM

is considered to be more capable of

properly handling these transactions

and the associated risk. The

Commission further noted that, in order

to provide guidance to such customers

and their FCMs, NFA would issue a

Statement of Acceptable Practices

regarding additional disclosures to be

made to non-institutional customers

trading on DTFs and related issues

involving price dissemination.43

Several commenters objected to the

$20 million adjusted net capital

requirement for FCMs set forth in Rule

1.17(a)(1)(ii) as proposed, stating that

the amount was arbitrary, and urging

that it be eliminated or reduced. (CL 22–

35 at 8; CL 22–46 at 3–4; CL 22–48 at

3) The CBT observed that the $20

million minimum adjusted net capital

requirement would prevent more than

half of all registered FCMs from

intermediating on DTFs for retail

customers. (CL 22–25 at 5) Instead, the

CBT suggested that the Commission

focus on the FCM’s record of customer

protection, and permit any registered

FCM to transact retail customer business

on a DTF if the firm: (1) Has been

registered as an FCM for at least three

years; and (2) has not been found by a

governmental or SRO authority to have

committed any sales practice violations

against retail customers during the past

three years. (CL 22–25 at 5) Goldenberg,

Hehmeyer & Co. (GHC) recommended

that the Commission apply risk-based

capital requirements in lieu of the $20

million minimum net capital

requirement to assess the FCM’s

financial soundness. (CL 22–19 at 1–2)

In a somewhat related vein, Treasury

commented that a more appropriate

measure of an intermediary’s soundness

is the amount of adjusted net capital in

excess of the minimum required by

regulation. (CL 22–34 at 3–4) Treasury

further observed, however, that because

the Commission’s adjusted net capital

requirements are based on the amount

of segregated funds, whether excess

adjusted net capital is an appropriate

measure of an FCM’s soundness in

addition to total adjusted net capital

depended on what the Commission

ultimately decided on the segregation of

funds issue. Accordingly, Treasury

recommended that the Commission

consider the segregation of funds issue

in conjunction with its review of net

capital rules. (CL 22–34 at 3–4)

Although MFA supported the

Commission’s proposal to allow noninstitutional customers access to DTFs

through qualifying FCMs (i.e., those that

are clearing members of at least one

designated contract market or RFE and

that have at least $20 million in

adjusted net capital), it urged that

customers who opted to trade through

certain registered CTAs should also

have such access. (CL 22–22 at 5)

Specifically, MFA recommended that

CTAs with at least $25 million in assets

under management be permitted to

access both exempt MTEFs and DTFs

and engage in transactions on behalf of

their customers in those markets. In

support, MFA pointed out that in

adopting Rule 30.12, which included in

the definition of ‘‘authorized customer’’

any person whose investment decisions

with respect to foreign futures and

foreign option transactions are made by

a CTA with total assets under

management exceeding $50 million,44

the Commission recognized that where

a professional asset manager such as a

CTA acts for a customer, it is

appropriate to rely on the financial

sophistication of the person managing

the assets rather than on the

sophistication of the individual CTA

client. (CL 22–22 at 5) MFA further

stated that because customers select

their CTAs precisely on the basis of

their determination that those CTAs are

best qualified to make trading decisions

on their behalf, precluding a CTA from

being able to access DTF markets

‘‘would * * * deprive customers of

their ability to elect and receive the full

benefits of the professional management

for which the customer has retained the

CTA.’’ (CL 22–22 at 6) MFA estimated

that less than 10 percent of all registered

CTAs would qualify under a $25 million

assets under management threshold,

and expressed the view that this ‘‘small

but sophisticated’’ class of CTAs would

be an appropriate group for the

Commission to permit access to all

types of futures markets. (CL 22–22 at 8)

The Commission has reviewed these

comments carefully. The Commission

has determined to adopt, as proposed,

the $20 million minimum adjusted net

capital requirement for FCMs wishing to

transact business on behalf of noninstitutional customers on a DTF. The

Core Principle addressing financial

standards encourages intermediaries to

maintain adequate capital to ensure they

are able to meet their obligations to

customers, and the Commission believes

that the $20 million adjusted net capital

requirement is a sufficient proxy for

ensuring that FCMs will be financially

capable of properly maintaining and

servicing customer accounts. The

Commission will monitor the effects of

this requirement and make adjustments

if appropriate.

The Commission has determined to

add a new Rule 4.32 to permit registered

CTAs to enter trades on or subject to the

rules of a DTF on behalf of a noninstitutional client, provided that the

CTA: (1) Directs the client’s commodity

interest account; 45 (2) directs accounts

containing total assets of not less than

$25 million at the time the trade is

entered; and (3) discloses to the client

that it may enter trades on a DTF on the

client’s behalf. Paragraph (b) of Rule

4.32 further requires that the client’s

commodity interest account be carried

by a registered FCM. An FCM who

receives orders on behalf of a noninstitutional customer from a CTA

acting in accordance with Rule 4.32

need not maintain $20 million in

minimum adjusted net capital, however.

See Rule 1.17(a)(1)(ii)(B). In addition, a

CTA placing trades on a DTF on behalf

of a non-institutional client will be

required to make any necessary

Federal Register / Vol. 65, No. 240 / Wednesday, December 13, 2000 / Rules and Regulations 78001

46 65 FR at 39014.

47The Commission notes, however, that crossmargining arrangements are already in place with

respect to trading of stock index options and stock

index futures.

48 65 FR at 39014.

49 Id.

50 Id. at 39014–15.

51 Id. at 39015.

52 Id. This codifies a staff no-action letter issued

three years ago. See CFTC Staff Letter No. 97–45,

[1996–1998 Transfer Binder] Comm. Fut. L. Rep.

(CCH) ¶27,085 (May 5, 1997).

53Because the Commission has determined to

include MMMFs in the list of permissible

investments for customer funds, subject to the

limitations adopted in Rule 1.25, it is hereby

rescinding Division of Trading and Markets

Financial and Segregation Interpretation No. 9,

which previously prohibited such investment. See

Financial and Segregation Interpretation No. 9, 1

Comm. Fut. L. Rep. (CCH) ¶7,119 (Nov. 23, 1983).

disclosures pursuant to Rule 4.34(h),

which requires a CTA to disclose to the

client if, pursuant to Rule 1.46, the CTA

has instructed the FCM carrying the

client account either not to close out all

offsetting positions or to close out

offsetting positions on other than a firstin, first-out basis. This issue is

discussed in greater detail below.

2. Segregation of Funds

The Proposing Release raised two sets

of questions seeking comments about

whether, and under what

circumstances, the Commission should

permit (1) customers to opt out of

segregation and (2) FCMs to maintain, in

the same customer segregated account,

various instruments, such as over-thecounter (OTC) derivatives, equity

securities, and other cash market

positions, as well as the funds used for

the purpose of securing or margining

such products and positions.46 Differing

views were presented on both issues,

and the Commission has determined to

defer action in these areas. With respect

to customer opt-out of segregation, most

parties commenting on the issue urged

the Commission to consider thoroughly

the potential implications with respect

to the bankruptcy rules, e.g., priority of

distribution, before proceeding on the

issue. (CL 22–18 at 1; CL 22–22 at 6; CL

22–25 at 7; CL 22–31 at 7–8; CL 22–32

at 14–15; CL 22–34 at 3) NFA further

expressed the view that there was no

current need for, or interest in, allowing

institutional customers to opt out of

segregation, as the FCM community is

more interested in being able to provide

customers with a unified account

statement reflecting their holdings

across all products, not just futures

contracts. (CL 22–24 at 5)

In response to the Commission’s

query on whether the types of

permissible instruments held in the

same customer account should be

expanded, FIA expressed the view that

Section 4d(2) of the Act permits the

Commission to authorize any FCM that

wishes to carry a customer’s cash, OTC

derivatives, securities and futures

positions in a single account to maintain

that account as a customer segregated

account. The CBT cautioned the

Commission to give further

consideration to bankruptcy

implications before proceeding in this

area. The Commission agrees that action

on this issue should be deferred to allow

for additional study and consultation

with other regulators, including

members of the President’s Working

Group (PWG), and in addition, that any

ultimate determination must be made in

conjunction with deciding the customer

opt-out of segregation issue.47

3. Investment of Customer Funds

The Commission proposed to amend

Rule 1.25, which sets forth the types of

instruments in which FCMs and

clearing organizations are permitted to

invest customer funds pursuant to

Section 4d(2) of the Act (permitted

investments), by expanding the list of

permitted investments.48 Previously, an

FCM or clearing organization was

permitted to invest segregated funds

only in obligations of the U.S., in

general obligations of any State or of any

political subdivision thereof, or in

obligations fully guaranteed as to

principal and interest by the U.S.

The Commission proposed, subject to

specific risk-limiting features, to permit

FCMs to invest customer segregated

funds in the following additional

instruments: (1) Obligations issued by

any agency sponsored by the U.S.; (2)

certificates of deposit issued by a bank,

as defined in Section 3(a)(6) of the

Securities Exchange Act of 1934, or a

domestic branch of a foreign bank

insured by the Federal Deposit

Insurance Corporation; (3) commercial

paper; (4) corporate notes; and (5)

interests in money market mutual funds

(MMMFs). In addition, an FCM or a

clearing organization would also be

permitted to both buy and sell the

permitted investments pursuant to

agreements for resale or repurchase of

the instruments (repurchase

transactions).49

The Proposing Release contained

several provisions intended to minimize

credit risk, market risk, and liquidity

risk, including: (i) A requirement that

the investments be highly-rated by a

nationally-recognized statistical rating

agency (NRSRO), except for U.S.

government securities and those

MMMFs that are not required to be

rated; (ii) a requirement that the dollarweighted average of the time remaining

to maturity of the debt securities held in

the segregated portfolio not exceed 24

months, excluding investment in

MMMFs because MMMFs have no

maturity date; (iii) concentration limits

on the percentage of the portfolio that

may be comprised of the securities of

individual issuers; (iv) specific

prohibitions against leverage, embedded

derivatives, and options; and (v) a

requirement that the daily value and

gains and losses on each investment be

included in the records of the FCM or

clearing organization.50

In connection with the proposed

revisions to Rule 1.25, the Commission

also proposed to amend Rules 1.20(a)

and 1.26(a) to eliminate the requirement

that an FCM obtain a written

acknowledgment, from each clearing

organization where the FCM has

deposited customer funds or

instruments purchased with customer

funds, that the clearing organization was

informed that the customer funds or

instruments purchased with customer

funds and deposited therein belong to

customers and are being held in

accordance with the provisions of the

Act and the rules and orders

promulgated thereunder.51 The

elimination of the written

acknowledgment requirement would be

conditioned upon the clearing

organization’s adoption and submission

to the Commission of rules that provide

for the segregation as customer funds, in

accordance with the Act and the

Commission’s rules and orders, of all

funds held on behalf of customers and

all instruments purchased with

customer funds.52

In general, commenters responded

favorably to the Commission’s proposals

to expand the permissible investments,

and the Commission has determined to

adopt the amendments generally as

proposed.53 Notwithstanding their

overall support, however, commenters

addressed several areas in which they

sought additional adjustments or

clarifications concerning the rule

amendments. Commenters also

responded to specific questions raised

by the Commission in the Proposing

Release.

The CBT suggested that the

Commission set guidelines with regard

to the marketability of the permitted

investments. The CBT recommended

that the guidelines limit permitted

investments to those instruments for

which there are available quotes or

valuations and, further, that the

guidelines provide that there be a

likelihood that any permitted

investments can be liquidated within a

78002 Federal Register / Vol. 65, No. 240 / Wednesday, December 13, 2000 / Rules and Regulations

54 17 CFR 240.15c3–1. As a result of the addition

of new Rule 1.25(b)(1), proposed paragraph (b)(6) of

Rule 1.25 concerning recordkeeping is being

adopted unchanged as paragraph (b)(7).

55 15 U.S.C. 80a–17.

56 17 CFR 270.2a–7.

reasonable time period. (CL 22–25 at 7)

The final rule has been modified so that

paragraph (b)(1) of Rule 1.25 requires

that the permitted securities held in

segregation be ‘‘readily marketable’’

consistent with SEC Rule 15c3–1 under

the Securities Exchange Act of 1934.54

The CBT also recommended that the

Commission use a simpler approach for

the valuation of downgraded

investments than the proposed 20

percent per day reduction. The CBT

suggested instead that a set number of

days be permitted for disposal of the

investment and that, during that

permitted time period, the firm be

allowed to use the full market value of

the instrument towards meeting its

segregated liability. The CBT also

indicated that it thought the 20 percent

per day reduction in value for a

downgraded instrument could lead to

errors in calculation. (CL 22–25 at 7–8)

The Commission has determined not to

change this provision because it

believes that the 20 percent per day

write-down will provide an appropriate

valuation under the circumstances and

that it will serve as an incentive for the

firm to take action to dispose of a

downgraded investment sooner. See

Rule 1.25(b)(2)(ii).

Rosenthal Collins Group, LLC (RCG)

stated that the proposed credit rating

requirements were too restrictive. (CL

22–18 at 2) The Commission notes that

these requirements are intended to

result in the holding of ‘‘investment

grade’’ securities only. After the new

rule takes effect, the Commission plans

to monitor the effectiveness of the rule

on an ongoing basis. If experience

shows that the required ratings are too

stringent, adjustments to the rule will be

considered.

RCG also stated that the Commission

should not impose rating requirements

on investments in municipal securities

because some of these securities are not

rated due to the costs associated with

obtaining a rating. RCG stated further

that if the rule were adopted as

proposed, investments that comply with

the present rules but that do not comply

with the new requirements should be

‘‘grandfathered’’ as part of an existing

portfolio. (CL 22–18 at 2) In response to

this comment, the Commission will not

require the disposal of investments held

as of December 13, 2000, i.e., such

investments may be held until they

mature or are liquidated in the ordinary

course of business, although no new

acquisitions of non-compliant

investments will be permitted.

Brown Brothers Harriman (BBH)

stated that the prohibition against an

FCM investing in an MMMF that has

investments in securities issued by a

parent or affiliate of the FCM should be

dropped. (CL 22–20 at 5) This

recommendation was made because

MMMFs are often operated

independently of the sponsoring

affiliated entity and, in any event, are

subject to a five percent concentration

limit in the securities of any single

issuer. BBH also noted that many FCMs

are affiliated with world-class financial

enterprises and that a prohibition

against MMMFs investing in securities

of the FCMs’ affiliates would eliminate

a large and important group of

instruments. The Commission finds

merit in this suggestion and has

modified Rule 1.25(b)(6)(ii) accordingly.

The Commission also notes that Section

17 of the Investment Company Act 55

restricts investments made by MMMFs

in securities issued by any entity

affiliated with the MMMF or its

sponsors, and that the concentration

limit set forth in SEC Rule 2a–7 under

the Investment Company Act 56 is

similar to the concentration provision of

CFTC Rule 1.25.

BBH also requested that the

requirement that a fund be ‘‘SEC

registered’’ be defined to mean

registration under the Investment

Company Act only and not require

registration under the Securities Act of

1933. (CL 22–20 at 6) This clarification

has been made to paragraph (c)(1) of

Rule 1.25.

Sentinel Management Group, Inc.

(Sentinel) requested clarification as to

whether the concentration limits

provided for in the proposed rule would

apply to securities held in connection

with repurchase agreements. (CL 22–41

at 1) Sentinel stated that the

concentration limits should not apply

because of: (1) The burden that would

be imposed upon the FCMs; (2) the fact

that complete information on such

securities is sometimes not known until

the day following entry into the

repurchase transaction; (3) the fact that

the duration of repurchase transactions

is only one day; and (4) the fact that the

obligation created pursuant to a

repurchase transaction is that of the

counterparty and not the issuer of the

securities. Therefore, it argued, the

creditworthiness of the counterparty

augments the value of the securities

held pursuant to the repurchase

agreement. (CL 22–41 at 1–2) This same

point was raised by BBH in follow-up

conversations.

Taking into consideration these

comments, as well as the requirement

contained in the Proposing Release that

counterparties for repurchase

transactions must be regulated financial

institutions (generally large banks or

brokerage firms), the Commission has

concluded that the focus of

concentration should be primarily upon

the counterparties and secondarily upon

the securities held in connection with

the repurchase agreement. Therefore,

the final rule contains several clarifying

or enhancing changes.

First, paragraph (b)(4)(ii) provides that

securities that are held by a

counterparty, i.e., securities that have

been ‘‘repoed out,’’ are subject to the

concentration limitations along with

currently-owned direct investment

securities. This clarification was made

because a security that has been sold

subject to repurchase at a later date

presents the FCM or clearing

organization with the same price risk as

a security that is currently held in the

portfolio. Second, paragraph (b)(4)(iii)

provides concentration limit

percentages for securities that are held

by the FCM or clearing organization

pursuant to a reverse repurchase

agreement that are double those

required for direct investments,

provided that the counterparty has a

credit rating of single A or higher from

two or more NRSROs. In addition, the

rule was changed to provide that the

concentration percentages for such

securities shall be computed using only

the securities contained in the portfolio

of securities supplied by each

counterparty of the FCM or clearing

organization. This change was made

because the counterparty has the direct

control over what specific securities

will be supplied in a repurchase

transaction. Thus, the Commission

expects that an FCM or clearing

organization will inform its

counterparties as to the per-issuer

concentration limits that must be

observed, as set forth in the rule.

Finally, paragraph (b)(4)(v) makes

explicit that the concentration limits do

not apply to securities owned by

customers that have been posted by

customers as collateral with the FCM.

This clarification was made primarily

because changes in the value of

customer-owned securities accrue to the

customers who posted the securities

and, therefore, in a properly margined

account such securities pose no direct

price risk to the FCM. The Commission

believes that these changes and

clarifications will provide additional

flexibility to FCMs and clearing

Federal Register / Vol. 65, No. 240 / Wednesday, December 13, 2000 / Rules and Regulations 78003

57As is the case for U.S. government securities

and those MMMFs that are not required to be rated,

permitted foreign sovereign debt will not be subject

to a credit rating requirement. See § 1.25(b)(2)(i)(A).

organizations without unduly increasing

associated risk.

The Investment Company Institute

(ICI) suggested that MMMFs sponsored

by investment advisers registered under

the Investment Advisers Act of 1940 be

included in the list of permitted

investments. (CL 22–27 at 6) The

Commission has made this suggested

change. See Rule 1.25(c)(2).

ICI noted that the proposed rule

appeared to require valuation of the

investment portfolio by 9 a.m. each day

and suggested, instead, that valuation

not be required until after the close of

the markets each day, i.e., not until after

4 p.m. (CL 22–27 at 7) The

Commission’s intention was to require

valuation by 9 a.m. the business day

following the investment, so that the

valuation would be available in time for

the segregation calculation, which is

required to be completed on a daily

basis by noon the following business

day. The final rule (paragraph (c)(4) of

Rule 1.25) has been changed to correctly

state the Commission’s intention more

precisely.

ICI also suggested that the proposed

rule should be changed to permit

MMMFs that are not rated by an NRSRO

to invest in unrated securities. The

proposed rule provided that only

MMMFs that are rated may invest in

unrated securities. ICI cited the

comprehensive approach to risk control

and preservation of capital contained in

SEC Rule 2a–7 and noted that that rule

permits an MMMF to invest in unrated

securities if the MMMF determines that

the securities are of comparable quality

to otherwise eligible securities. (CL 22–

27 at 4) The Commission has changed

the final rule (Rule 1.25(b)(2)(i)(D)) to

permit unrated MMMFs to invest in

unrated securities because of the risklimiting features of SEC Rule 2a–7.

ICI also recommended two revisions

to paragraph (c)(3) of Rule 1.25

concerning MMMFs. First, because fund

shares are usually uncertificated, ICI

recommended that the first sentence be

revised to provide that the ownership of

fund shares must be noted (by bookentry or otherwise) in a custody account

of the FCM or clearing organization.

Second, to ensure that confirmations for

transactions in fund shares are retained,

ICI recommended that the confirmation

relating to the purchase be retained in

the FCM’s or clearing organization’s

records. (CL 22–27 at 6) The

Commission has made these suggested

changes.

ICI further recommended that the oneday liquidity requirement applicable to

MMMFs be extended to seven days, to

be consistent with SEC requirements

and the longer settlement time-frames

associated with direct investments. (CL

22–27 at 7)

The Commission believes the one-day

liquidity requirement for investments in

MMMFs is necessary to ensure that the

funding requirements of FCMs will not

be impeded by a long liquidity time

frame. Since a material portion of an

FCM’s customer funds could well be

invested in a single MMMF, this is an

important provision of the rule. The

Commission notes that, although sales

of directly-owned securities settle in

longer than one-day time-frames, an

FCM or clearing organization could

obtain liquidity by entering into a

repurchase transaction. Therefore, the

Commission has retained the one-day

liquidity requirement imposed on

investments in MMMFs and, in view of

the importance of this provision, has

clarified that demonstration that this

requirement has been met may include

either an appropriate provision in the

offering memorandum of the fund or a

separate side agreement between the

fund and an FCM or clearing

organization. See Rule 1.25(c)(5).

The FRBC commented that permitted

investments should have either a CUSIP

or ISIN number, and that permitted

investments should be required to have

a reasonably transparent secondary

market enabling accurate and efficient

valuation of the investments. (CL 22–30

at 6) The Commission has changed the

final rule to include securities with ISIN

numbers as permitted investments.

The FRBC also recommended that

permitted investments have a

reasonably transparent secondary

market. As noted above, the

Commission strengthened the rule in

this respect by adding a requirement

that all permitted securities, except for

MMMFs, meet the SEC’s ‘‘readily

marketable’’ standard. The Commission

intends to monitor closely for any

problems concerning valuation of

permitted investments, and will

consider proposing further rule

amendments if appropriate.

The FRBC also recommended that

permitted investments should settle on

a same-day or next-day basis, to ensure

adequate liquidity. It pointed out that,

currently in the U.S., virtually all

corporate and municipal debt securities

settle on a T+3 basis, which is not

sufficient for futures clearing

organization demands, and that this

delay could deprive the FCM or clearing

organization of the liquidity that is so

important in times of market stress or

emergency. (CL 22–30 at 5) The

Commission has elected to permit

investment of customer funds in

investment grade corporate notes and

municipal securities because FCMs have

methods of obtaining liquidity other

than by selling the securities, such as by

entering into repurchase transactions

and by establishing backup bank lines of

credit using the securities as collateral.

The FRBC further recommended that

CFTC rules should permit the

investment of customer funds held in a

foreign currency in identicallydenominated sovereign debt securities.

(CL 22–30 at 4–5; see also CL 22–31 at

9; CL 22–42 at 2) The Commission notes

that, under the rule as proposed, an

FCM that decided to invest deposits of

foreign currencies was required to

convert the foreign currencies received

to a U.S. dollar-denominated asset. This

would increase its exposure to foreign

currency fluctuation risk, unless it

incurred the additional expense of

hedging. Therefore, the Commission has

determined that the FRBC’s suggestion

should be adopted. The Commission has

changed the proposed rule to permit

investment in the general obligations of

any country whose sovereign debt is

rated in the highest category by at least

one NRSRO, but limited as follows: an

FCM may invest in the sovereign debt

of a country to the extent it has balances

owed to its customers denominated in

that currency; a clearing organization

may invest in the sovereign debt of a

country to the extent it has balances

owed to its clearing member FCMs

denominated in that currency.57 The

Commission notes that foreign sovereign

debt that is denominated in the Euro

will qualify as a permitted investment

under this rule, provided the country

that issued the debt qualifies as a

permitted country under the rule, the

obligation is a general obligation of the

country, and the balances owed to the

customers or the FCMs are Eurodenominated. As with other aspects of

Rule 1.25, the Commission will monitor

the effect of this provision and stands

ready to make additional adjustments as

experience dictates.

In addition, the FRBC suggested that

the CFTC expressly approve the use of

certain ‘‘sweep’’ accounts in connection

with the investment of customer funds

in MMMFs or other permissible forms of

investment. (CL 22–30 at 6) The

Commission notes that Rule 1.25 will

not preclude the use of sweep accounts

and encourages this practice to enhance

the efficiency of liquidity management.

The FRBC also suggested that, with

respect to the concentration provision,

the rule should be clarified that it

applies only to the portfolio of securities

78004 Federal Register / Vol. 65, No. 240 / Wednesday, December 13, 2000 / Rules and Regulations

58 65 FR at 39015. There would continue to be no

specific disclosure requirements for institutional

customers. Id. at 39016.

59 Id. at 39015–16.

60See infra.

61 65 FR 12466 (Mar. 9, 2000).

62 65 FR at 39016. This is discussed further

below.

63 Id.

64 Id.

purchased with customer funds, i.e., the

provision does not apply to customerowned securities posted as margin. (CL

22–30 at 6) As noted previously, the

Commission has made this clarification

in paragraph (b)(4)(v) of Rule 1.25.

FIA suggested that the Commission

clarify what is meant by the required

ratings in the rule, where the ‘‘two

highest ratings of an NRSRO’’ are

specified, i.e., AAA and AA. In

particular, it recommended that the

Commission clarify whether ‘‘AA’’

includes all variations included within

the AA rating. (CL 22–31 at 8) The

Commission confirms that this

interpretation is correct.

FIA also suggested that the

Commission clarify whether a security

would be a permitted investment if one

NRSRO gave it an acceptable rating,

even though another NRSRO gave it an

unacceptable rating. (CL 22–31 at 9) The

Commission hereby confirms that if one

NRSRO gave an acceptable rating and

another did not, investment in the

security would be permitted. The

Commission believes that it would be

rare for such differences to occur at the

investment grade ratings level and,

further, that any differences would

probably be temporary.

FIA also suggested providing a grace

period for FCMs or clearing

organizations that find themselves in

violation of the concentration limits.

(CL 22–31 at 9) The Commission has

decided against adopting this suggestion

because the Commission would not

expect FCMs to violate the

concentration limits, except perhaps

under unusual circumstances. Further,

the Commission is concerned that were

a formal grace period provided in the

rule, it might be subject to abuse.

In addition, FIA suggested that the

Commission plan to review the list of

permitted investments every six months

to determine whether revisions should

be made. (CL 22–31 at 9) The

Commission plans to review all aspects

of the new rule on an ongoing basis and

further changes will be proposed, if

appropriate.

Two exchanges, the NYMEX and the

CME, pointed out that each clearing

organization would need to make its

own determination as to the types of

assets that would be accepted by that

clearing organization. (CL 22–32 at 16;

CL 22–35 at 13) The Commission

recognizes that an SRO may adopt more

restrictive requirements than those set

forth in Rule 1.25 for its member FCMs.

E. Core Principle Four: Risk Disclosure

and Account Statements

Although the Commission stated in

the Proposing Release that noninstitutional customers should continue

to receive the risk disclosures regarding

futures and options trading that are

currently required,58 it proposed to

streamline the account opening process

by amending Rules 1.55(d)(1) and (2) to

expand the list of disclosures and

consents that could be provided in a

single document and acknowledged

with a single signature.59 This list

includes: (1) The disclosures required

by new Rule 1.33(g) (relating to

electronic transmission of

statements); 60 (2) the consent

referenced in Rule 155.3(b)(2) (relating

to customer permission for FCMs to take

the opposite side of an order); and (3)

a provision for preauthorization of

transfers of funds from a customer’s

segregated account to another account of

that customer. The single signature

could be made electronically as

provided for in recently-adopted

Commission Rules 1.3(tt) and 1.4. 61

Disclosure concerning arbitration of

disputes, however, would continue to

require a separate signed

acknowledgement by non-institutional

customers, pursuant to proposed Rule

166.5 (which was modeled on, and

would replace, prior Rule 180.3).62

All of the commenters who addressed

the proposed amendments to Rule

1.55(d) responded favorably to the

expansion of disclosures and consents

that could be acknowledged and made

by a single signature, and the

Commission is adopting the

amendments as proposed. (CL 22–17 at

3; CL 22–24 at 6; CL 22–25 at 8; CL 22–

31 at 14; CL 22–32 at 16; CL 22–35 at

11; CL 22–44 at 2) FIA requested that

the Commission confirm that an FCM

may obtain an acknowledgement of

receipt and understanding of the risk

disclosure statement

contemporaneously with opening an

account. The Commission agrees that

the FCM may open the customer

account simultaneously with receiving

the acknowledgment of receipt and

understanding of the risk disclosure

statement, along with margin funds and

any other required account opening

documents, from the customer. The

FCM will remain responsible for

ensuring that the risk disclosure

document is furnished to the customer

in such a way that the customer can

review and understand the document

before committing funds to the FCM.

NFA commented generally that the

Commission should not dictate the

specifics of how disclosures and

consents are delivered and

acknowledged, and that it would be

willing to develop best practice

guidance in this area. (CL 22–24 at 6)

The Commission believes that its rules

requiring risk disclosure and customer

acknowledgments do not impose a

significant burden in light of their

important customer protections. The

Commission is providing additional

flexibility to the industry in this area.

As the Commission noted in the

Proposing Release, there would

continue to be no specific disclosure

requirements for institutional customers

and, in addition, as provided in Rule

35.1(b), governmental entities would be

included in the definition of

‘‘institutional customer,’’ and

consequently would not be required to

receive and to acknowledge a disclosure

statement.63 Further, the single

signature acknowledgment could be

made electronically as provided for in

Rules 1.3(tt) and 1.4. The Commission

looks forward to working with NFA and

the industry both in developing a

Statement of Acceptable Practices for

disclosure to non-institutional

customers trading on DTFs, and in

developing more streamlined disclosure

requirements for domestic exchangetraded options under Rule 33.7.

As noted above, the Commission

proposed to continue to require a

separate signed acknowledgement by

non-institutional customers with respect

to disclosure concerning arbitration of

disputes. Nevertheless, the Commission

also solicited comment on whether to

maintain this requirement.64 FIA

opposed continuing to require a

separate signature from noninstitutional customers if their account

agreement contains a pre-dispute

arbitration provision. (CL 22–31 at 14)

In general, FIA expressed the opinion

that the Commission should eliminate

all of its rules pertaining to the use of

pre-dispute arbitration agreements, as

well as the Commission’s reparations

program. For example, FIA commented

that the Commission’s rule that an FCM

may not require a customer to sign a

pre-dispute arbitration agreement as a

condition to opening an account with

the FCM inhibits the ability of FCMs

that are also securities broker-dealers to

enter into a single agreement with their

customers, because the SEC does not

prohibit the use of such mandatory

agreements. (CL 22–31 at 10) At the very

least, FIA stated that the Commission

Federal Register / Vol. 65, No. 240 / Wednesday, December 13, 2000 / Rules and Regulations 78005

65As a result of these changes, proposed

paragraphs (c)(2) (ii) and (iii) of Rule 166.5 are

adopted as paragraphs (c)(2) (i) and (ii),

respectively. In addition, to reflect the recent

amendments to Rule 4.7, paragraph (c)(2)(ii) of Rule

166.5 (formerly paragraph (c)(2)(iii)) has been

modified to apply to a person who is a ‘‘qualified

eligible person’’ as defined by Rule 4.7. See 65 FR

47848 (Aug. 4, 2000).

66NFA referred to several recent lower court

cases where registrants who brought debit balance

claims against their customers in state court

successfully argued, in response to the customers’

attempts to force the claims to arbitration, that a

pre-dispute arbitration agreement did not apply to

their claims against customers. NFA questioned the

logic of these decisions, stating that there is no

consideration for a customer to sign a pre-dispute

arbitration agreement if it does not apply to the

intermediary’s claims as well. (CL 22–24 at 9)

67 65 FR at 39016.

68 Id.

should permit institutional customers

contractually to waive their right to file

a complaint under the Commission’s

reparations program. (CL 22–31 at 10) In

this regard, NFA maintained that

intermediaries and institutional

customers should be allowed to

negotiate all terms in pre-dispute

arbitration agreements. (CL 22–24 at 8).

The Commission is adopting Rule

166.5 as it pertains to non-institutional

customers as proposed. Further, the

Commission believes that no customer,

regardless of their level of

sophistication, should be required to

sign a pre-dispute arbitration agreement

as a condition for doing business in the

futures industry. The Commission has

determined, however, to allow

institutional customers and

intermediaries to negotiate any terms of

a pre-dispute arbitration agreement as

they deem appropriate, including a

waiver of the customer’s right to file a

complaint under the Commission’s

reparations program. Accordingly, the

definition of the term ‘‘customer’’ in

Rule 166.5(a)(2) has been changed to

exclude institutional customers from

general application of the rule. In

addition, new paragraph (g) has been

added to make clear that an institutional

customer and a registrant may negotiate

any terms of a pre-dispute arbitration

agreement, except that the institutional

customer may not be required to sign a

pre-dispute arbitration agreement as a

condition of opening an account with

the registrant.65

NFA specifically requested that the

Commission clarify the reach of predispute arbitration agreements and

confirm that such agreements are

binding on both the intermediary as

well as the customer, unless the

agreement states specifically that the

registrant is not required to arbitrate its

claims.66 (CL 22–24 at 9) Former Part

180, which is to be replaced by Rule

166.5, was mainly intended to provide

for fair and equitable SRO arbitration

forums and to prevent firms from

requiring customers to agree to

arbitration in order to do business. Part

180 did not require registrants to submit

their claims against customers to

arbitration, and the Commission did not

propose to require that registrants do so

in the Proposing Release. Thus,

provided that a registrant pursues a

dispute in accordance with the terms of

the customer agreement, and the

procedures followed do not violate Rule

166.5, Commission rules would not

prohibit the registrant’s actions.

NFA also objected to proposed Rule

166.5(f), which would permit

counterclaims that do not arise out of

the same transaction or occurrence that

is the subject of the original claim only

if (1) The customer agreed to the

counterclaim being heard after it has

arisen, and (2) the aggregate monetary

value of the counterclaim is capable of

calculation. NFA believes that, for both

retail and institutional customers, the

parties should be allowed to agree in

advance that any counterclaim would be

required to be included in the

arbitration proceeding. (CL 22–24 at 9)

The Commission has determined to

adopt NFA’s suggestion, and has revised

Rule 166.5(f) to permit any counterclaim

arising out of a transaction subject to the

Act and Commission regulations

promulgated thereunder for which a

non-institutional customer has utilized

the services of a registrant, to be made

part of an arbitration proceeding

between the non-institutional customer

and the registrant where the parties

have agreed in advance to require that

any such claim be included in the

arbitration proceeding, provided that

the aggregate monetary value of the

counterclaim is capable of calculation.

As noted above, under Rule 166.5(g),

institutional customers remain free to

negotiate any terms of their pre-dispute

arbitration agreement, including the

type of counterclaims that may be

included in an arbitration proceeding.

F. Core Principle Five: Trading

Standards

The Commission proposed that Rules

155.1, 155.3 and 155.4, which

collectively require FCMs and IBs to

establish and to maintain supervisory

procedures to assure that neither they

nor any affiliated persons use their

knowledge of customer orders to the

customer’s disadvantage, would

continue to apply to intermediation of

trades on contract markets. These

requirements would be extended to

trading on RFEs, and to trading by noninstitutional customers on DTFs under

new Rule 155.6(a).67 These rules over

the years have helped the Commission

deter such practices as ‘‘front-running,’’

‘‘trading ahead,’’ ‘‘bucketing,’’ taking the

opposite side of customer orders, and

improper disclosure of customer orders.

However, for intermediation of trades by

institutional customers at DTFs, the

Commission proposed a new Rule

155.6(b), which set forth a general

standard of practice in this area that

parallels the language of the core

principle concerning trading standards.

The Commission stated that ‘‘it is

nevertheless intended to proscribe the

same trade practice abuses as Rules

155.1–155.5.’’ 68

The commenters who addressed this

section were critical of the

Commission’s approach. The CBT

expressed its belief that all prescriptive

rules regarding trading practices should

be replaced with core principles, not

just the rules governing trades for

institutional customers on DTFs. (CL

22–25 at 8) MFA stated that it was

inconsistent to add a general prohibition

against ‘‘misuse’’ of knowledge as

contained in Proposed Rule 155.6(b) if

the rule was intended to proscribe the

same trade practice abuses referred to in

Rules 155.1–155.5. (CL 22–22 at 13–14)

NFA commented that RFEs and DTFs

should not be treated differently with

respect to trading standards rules,

because otherwise operators of DTFs

would have a competitive advantage

over operators of RFEs. (CL 22–24 at 6)

The Commission has determined to

leave unchanged Rules 155.1–155.5 at

this time, and to adopt Rule 155.6 as

proposed. The Commission believes that

the existing rules should continue to

apply in connection with noninstitutional customer trades no matter

where they occur because of such

customers’ greater susceptibility to

trading abuses by intermediaries, as

compared to institutional customers.

The Commission recognizes that, with

respect to institutional customers

trading on a DTF, a general standard of

practice is more appropriate. However,

the Commission remains open to

specific suggestions regarding how

individual provisions in Rules 155.3

and 155.4 might be streamlined.

The Commission notes that because

the core principle concerning trading

standards states that intermediaries

must not misuse their knowledge of

their customers’ orders without making

any distinctions regarding the nature of

the customer, the same trade practice

abuses that are proscribed by Rules

155.1–155.5 should also be considered

78006 Federal Register / Vol. 65, No. 240 / Wednesday, December 13, 2000 / Rules and Regulations

69As explained in a companion release in today’s

edition of the Federal Register, large trader reports

may be required upon special call depending upon

the nature of the commodity interest traded on a

commercial-participant DTF.

70Large trader reports may be required upon

special call on the DTF itself, however. See

§ 37.6(a).

71 65 FR at 39017.

72 64 FR 28735.

73 65 FR at 39017; see also 62 FR 31507 (June 10,

1997).

as being in violation of Rule 155.6(b).

The Commission believes that its overall

approach with respect to trading

standards strikes a reasonable balance in

preserving rules that have worked

successfully over the years in curbing

abusive trading practices, while relaxing

certain of the specific provisions of the

existing rules in connection with the

trading on DTFs by more sophisticated

customers.

G. Core Principle Seven: Reporting

Requirements

The Commission proposed to apply

its existing large trader reporting

requirements to intermediaries on RFEs,

but would reduce reporting

requirements with respect to

intermediaries transacting business on

DTFs, because of the nature of the

instruments traded or the limited access

granted to non-institutional traders.

Intermediaries trading on DTFs would

be subject to large trader reporting

requirements only by special call.

The Commission received varying

comments in response to its large trader

reporting proposal. NFA agreed with

both aspects of the Commission’s

proposal, asserting that large trader

reporting requirements should remain

in place for intermediaries on RFEs,

while a more flexible approach would

be appropriate for gathering information

from intermediaries trading on DTFs.

(CL 22–24 at 7) FC Stone suggested that

reduced large trader reporting should be

available to all FCMs with institutional

customers only, not just to those trading

on DTFs. (CL 22–44 at 4) The CBT

stated that the Commission should

permit individual markets to require

large trader reporting, as they deem

necessary, and that any large trader

reporting to the Commission should be

done pursuant to special call, without

drawing a distinction between DTFs and

RFEs. (CL 22–25 at 8–9) NIBA also

commented that the Commission should

not make a distinction between DTFs

and RFEs; NIBA stated, however, that

regular large trader reports should be

required on both types of exchanges,

and that otherwise customers who trade

on RFEs would lose the benefit of price

transparency. (CL 22–17 at 4) Treasury

expressed concern about the mechanics

of large trader reporting on a DTF,

stating that because eligible participants

would not be required to use FCMs to

execute trades on a DTF, it was unclear

how large trader positions could be

reported. In addition, Treasury noted

that large trader reporting requirements

have worked well in the market for

Treasury bond futures, both for the

information they reveal to regulators

and their deterrent effect, and

consequently, urged the Commission to

establish a mechanism for large trader

reporting for government securities

futures trading on DTFs. (CL 22–34 at 4)

The Economic Strategy Institute agreed

with Treasury that the elimination of

large trader reports would reduce the

Commission’s ability to effectively

detect and deter manipulation. (CL 22–

45 at 2) Finally, the American Farm

Bureau Federation, the American

Soybean Association, the National

Association of Wheat Growers, the

National Cattlemen’s Beef Association,

the National Corn Growers Association,

the National Farmers Union, the

National Grain Sorghum Producers and

the National Pork Producers Council

collectively commented that if the

Commission determined to permit

agricultural products to be traded on a

DTF, large trader reports relating thereto

should be filed with the Commission.

(CL 22–51 at 1)

The Commission has determined to

adopt the large trader reporting

requirements for RFEs and DTFs as

proposed, except that large trader

reports will not be required from

participants trading on a commercialparticipant DTF. The reporting system is

critical to the Commission’s ability to

oversee markets and provides a valuable

bulwark against illegitimate trade

practices. RFEs in particular permit

unconditioned access to any type of

trader, including both institutional and

non-institutional customers or

participants, and may list contracts on

any type of commodity, including those

based on commodities that have finite

deliverable supplies or cash markets

with limited liquidity. Such markets

potentially have a greater susceptibility

to price manipulation and raise greater

customer protection concerns than do

DTFs. Consequently, regular large trader

reports are necessary to enable the

Commission to carry out its oversight

responsibilities for RFE markets.

With respect to intermediaries

transacting business on DTFs, however,

because of the nature of the instruments

traded and the limited access granted to

non-institutional traders, large trader

reporting on a less routine basis, i.e.,

upon special call by the Commission, is

more appropriate. Where trading access

on a DTF is restricted to eligible

commercial participants only, however,

large trader reports generally will not be

required from such participants.69 The

Commission will rely instead on its

investigative authority, which also

applies to a person’s cash market

activities.70

H. Core Principle Eight: Recordkeeping

1. General

The Core Principles state that all

registrants must keep full books and

records of their activities related to their

business. Thus, the Commission did not

propose to amend any of its

recordkeeping requirements in the

Proposing Release.71 NFA asked the

Commission to consider replacing Rule

1.31 with a core principle and

acceptable practice guidance that

follows NFA’s December 1997 proposal.

NFA’s proposal recommended that Rule

1.31 be rewritten to require only that

registrant recordkeeping systems meet

general reliability and accessibility

standards. (CL 22–24 at 7) The

Commission revised Rule 1.31 in 1999

to provide additional flexibility to

recordkeepers, allowing them to store

most required records on either

micrographic or electronic storage

media for the full five-year required

retention period.72 The Commission

intends to revisit NFA’s proposal in the

future and, where appropriate, will

undertake to work with the SEC to make

additional changes in this area.

2. Customer Account Statements; CloseOut of Offsetting Positions

The Commission proposed to codify

its June 1997 advisory relating to the

electronic transmission of account

statements in a new Rule 1.33(g).73

Thus, an FCM would be permitted, with

customer consent, to deliver required

confirmation, purchase-and-sale, and

monthly account statements

electronically in lieu of mailing a paper

copy. FCMs would need only to retain

the daily confirmation statement as of

the end of the trading session, provided

that it reflects all trades made during

that session. Before transmitting any

statement electronically to a customer,

however, the FCM would be required to

make certain disclosures regarding the

practice, and in the case of noninstitutional customers, the FCM would

be required to obtain the customer’s

signed consent acknowledging the

disclosures. The acknowledgement

could be made through a single

signature in accordance with Rule 1.55

as discussed above. NIBA and FC Stone

responded favorably to the

Federal Register / Vol. 65, No. 240 / Wednesday, December 13, 2000 / Rules and Regulations 78007

74 65 FR at 39017.

75 Id.

76Pub. L. No. 102–546 (1992), 106 Stat. 3590.

77H.R. Rep. No. 978, 102d Cong., 2d Sess. 78

(1992). The Conference Report also states that the

reference in Section 4(c) to the ‘‘purposes of the

Act’’ is intended to ‘‘underscore [the Conferees’]

expectation that the Commission will assess the

Continued

Commission’s proposal (CL 22–17 at 3;

CL 22–44 at 2), while NFA commented

that the 1997 Advisory should be

treated as acceptable practices guidance

rather than codified in a new rule. (CL

22–24 at 7) The Commission has

determined to adopt the rule as

proposed, believing that, as noted

previously, a certain level of uniformity

and standardization is essential in an

area such as reporting to customers to

facilitate the processing of massive

quantities of data, which is often

accomplished by third-party, ‘‘back

office’’ firms.

The Commission also proposed to

revise Rule 1.46 to allow customers or

account controllers to instruct the FCM

if they wished to deviate from the

default rule that the FCM close out

offsetting positions on a first-in, first-out

basis, looking across all accounts it

carries for the same customer.74 CPOs

and CTAs would be required to

disclose, under proposed amendments

to Rules 4.24(h)(2) and 4.34(h),

respectively, if they instruct an FCM to

deviate from the default rule for closing

out offsetting positions.75

After considering the comments

received, the Commission is adopting

the revisions as proposed. Nevertheless,

the Commission agrees with NFA that

FCMs should closely monitor the

activity in those customer accounts that

depart from the default close-out

method set forth in Rule 1.46 to ensure

that their customers are not offsetting

their positions other than by a first-in,

first-out method solely to avoid taxes, to

launder money, or to improve their

delivery position. (CL 22–24 at 7)

In addition, the Commission believes

that customers may transmit their offset

instructions to their FCMs orally, as

requested by FIA. (CL 22–31 at 8) In the

case of CPOs and CTAs, the

Commission agrees with MFA that

responsibility for transmitting

instructions regarding offset should

normally lie with the registrant

directing trading. Generally, where a

pool’s trading is directed by a CTA, this

should be the CTA, not the CPO. (CL

22–22 at 14) The Commission does not

agree, however, that it is unnecessary to

require CPOs and CTAs to disclose

whether they instructed their FCM to

offset positions in a manner other than

by a first-in, first-out method. The

Commission does not believe that this

requirement would impose a significant

burden on CPOs and CTAs, particularly

in light of the fact that these entities

would no longer be prevented from

offsetting their positions in a manner

other than on a first-in, first-out basis,

as was previously the case. The

Commission believes that it is

appropriate in this area to provide

greater choice balanced with disclosure

as to the method of operation.

III. Section 4(c) Findings

Certain of these final rules and rule

amendments are being promulgated

under Section 4(c) of the Act, which

grants the Commission broad exemptive

authority. Section 4(c) of the Act

provides that, in order to promote

responsible economic or financial

innovation and fair competition, the

Commission may, by rule, regulation or

order, exempt any class of agreements,

contracts or transactions, including any

person or class of persons offering,

entering into, rendering advice or

rendering other services with respect to,

the agreement, contract, or transaction,

from the contract market designation

requirement of Section 4(a) of the Act,

or any other provision of the Act other

than Section 2(a)(1)(B), if the

Commission determines that the

exemption would be consistent with the

public interest. Furthermore, Section

4(c)(2) of the Act provides that the

Commission may not grant an

exemption from the contract market

designation requirement of Section 4(a)

of the Act unless the Commission also

finds that: (i) The contract market

designation requirement should not be

applied to the agreement, contract, or

transaction for which the exemption is

requested and the exemption would be

consistent with the public interest and

the purposes of the Act; (ii) the

exempted transaction will be entered

into solely between ‘‘appropriate

persons’’; and (iii) the agreement,

contract or transaction in question will

not have a material adverse effect on the

ability of the Commission or any

contract market to discharge its

regulatory or self-regulatory duties

under the Act. For the reasons stated

below, the Commission believes that

issuing the exemptive relief as set forth

in these final rules and rule

amendments is consistent with those

determinations.

As explained above, certain of the

final rules and rule amendments would

provide greater flexibility for

intermediaries and their customers in

several areas. Specifically, the

Commission is adopting final rule

amendments concerning the definition

of the term ‘‘principal’’ that recognize

the evolution of management structures

by reducing the number of officers that

will be considered principals, while

ensuring that appropriate personnel that

perform significant roles within the firm

remain listed as such. In addition, the

Commission is expanding the range of

instruments in which FCMs may invest

customer funds beyond those listed in

Section 4d(2) of the Act to enhance the

yield available to FCMs, clearing

organizations and their customers,

without compromising the safety of

customer funds. These final rule

amendments acknowledge the

development of new financial

instruments over the last 60 years, and

should both enable FCMs to remain

competitive globally and domestically

and maintain safeguards against

systemic risk. In light of the foregoing,

the Commission has determined that the

adoption of the final rules and rule

amendments relating to the definition of

the term ‘‘principal’’ and the expansion

of permitted instruments for the

investment of customer funds will be

consistent with the public interest.

Further, the final rules and rule

amendments adopted herein, as well as

the existing rules as they also relate to

the transaction of business by

intermediaries, will be applied, or

extended, to agreements, contracts and

transactions carried out on new markets,

i.e., RFEs and DTFs. As more fully

discussed in a companion release

published in this edition of the Federal

Register, the rules pertaining to the new

markets establish a new regulatory

framework that is intended to promote

innovation and competition in the

trading of derivatives and to permit the

markets the flexibility to respond to

technological and structural changes in

the markets. The new framework

establishes three regulatory tiers with

regulations tailored to the nature of the

commodities traded and the nature of

the market participant, and access to

each of the tiers is dependent upon the

appropriateness of the participant. In

this respect, the Commission believes

that the actions taken herein are

consistent with the ‘‘public interest’’ as

that term is used in Section 4(c) of the

Act. When that provision was enacted,

the Conference Report accompanying

the Futures Trading Practices Act of

1992 76 stated that the ‘‘public interest’’

in this context would ‘‘include the

national public interests noted in the

Act, the prevention of fraud and the

preservation of the financial integrity of

the markets, as well as the promotion of

responsible economic or financial

innovation and fair competition.’’ 77

78008 Federal Register / Vol. 65, No. 240 / Wednesday, December 13, 2000 / Rules and Regulations

impact of a proposed exemption on the

maintenance of the integrity and soundness of

markets and market participants.’’ Id.

78See Section 4(c)(3)(K) of the Act, 7 U.S.C.

6(c)(3)(K).

79 47 FR 18618–21 (Apr. 30, 1982).

80 Id. at 18619–20 (discussing FCMs and CPOs);

54 FR 19556, 19557 (May 8, 1989) (discussing

LTMs); and 63 FR 18821, 18830 (Apr. 16, 1998)

(discussing ATOMs).

The Commission has retained or

adopted safeguards to ensure that

transactions will be carried out between

appropriate persons. Appropriate

persons can include, beyond those

specified in Section 4(c)(3)(A)–(J) of the

Act, ‘‘[s]uch other persons that the

Commission determines to be

appropriate in light of their financial or

other qualifications, or the applicability

of appropriate regulatory

protections.’’ 78 The Commission has

determined that it is appropriate to

permit any person to trade on an RFE

because the rules pertaining to RFEs

will be closest to those currently

pertaining to contract markets and the

bulk of the existing regulatory

framework pertaining to intermediaries

will apply in connection with their

intermediation of transactions on RFEs.

On the other hand, customers on DTFs,

which will be subject to looser

regulation than RFEs, are generally

restricted to the types of persons

specified in Section 4(c)(3)(A)–(J) of the

Act. The Commission has determined,

however, that it is appropriate to allow

access to retail, or non-institutional,

customers on DTFs, subject to stated

limits and conditions. For example, if a

non-institutional customer seeks to

enter into transactions on a DTF

permitting such access, such customer

may only do so through either: a) a

registered FCM that is a clearing

member of at least one designated

contract market or RFE, and that has

adjusted net capital of at least $20

million; or b) a registered CTA who has

discretionary authority over the noninstitutional customer’s account, and

who has assets under management of

not less than $25 million. The

Commission further believes that, in

light of these conditions and safeguards,

the exemptive relief would have no

adverse effect on any of the regulatory

or self-regulatory responsibilities

imposed by the Act.

IV. Related Matters

A. Regulatory Flexibility Act

The Regulatory Flexibility Act (RFA),

5 U.S.C. 601 et seq. (1994 & Supp. II

1996), requires federal agencies, in

proposing rules, to consider the impact

of those rules on small businesses. The

rules adopted herein would affect

FCMs, IBs, CPOs, CTAs, FBs, FTs,

leverage transaction merchants (LTMs)

and agricultural trade option merchants

(ATOMs), as well as principals thereof.

The Commission has previously

established certain definitions of ‘‘small

entities’’ to be used by the Commission

in evaluating the impact of its rules on

small entities in accordance with the

RFA.79 The Commission has previously

determined that registered FCMs, CPOs,

LTMs and ATOMs are not small entities

for the purpose of the RFA.80 With

respect to IBs, CTAs, FBs and FTs, the

Commission has stated that it is

appropriate to evaluate within the

context of a particular rule proposal

whether some or all of the affected

entities should be considered small

entities and, if so, to analyze the

economic impact on them of any rule.

In this regard, the rules being adopted

herein would not require any registrant

to change its current method of doing

business. For many registrants, the

revisions should decrease the number of

persons within the registrant’s

organization who would be considered

principals under the CFTC rules.

Further, the revisions should reduce,

rather than increase, the regulatory

requirements that apply to registrants

and applicants for registration,

regardless of size. Accordingly,

pursuant to 5 U.S.C. 605(b), the

Chairman, on behalf of the Commission,

certifies that the action taken herein will

not have a significant economic impact

on a substantial number of small

entities. In this regard, the Commission

notes that it did not receive any

comments concerning the RFA

implications of the rules and rule

amendments discussed herein.

B. Paperwork Reduction Act

As required by the Paperwork

Reduction Act of 1995 [44 U.S.C.

3507(d)], the Commission submitted a

copy of the proposed amendments to its

rules to the Office of Management and

Budget for its review. The Commission

did not receive any comments on any

potential paperwork burden associated

with the Proposing Release.

List of Subjects

17 CFR Part 1

Brokers, Commodity futures,

Consumer protection, Reporting and

recordkeeping requirements.

17 CFR Part 3

Administrative practice and

procedure, Brokers, Commodity futures,

Principals, Registration, Reporting and

recordkeeping requirements.

17 CFR Part 4

Advertising, Commodity futures,

Commodity pool operators, Commodity

trading advisors, Consumer protection,

Disclosure, Principals, Reporting and

recordkeeping requirements.

17 CFR Part 140

Authority delegations (Government

agencies), Conflict of interests,

Organization and functions

(Government agencies).

17 CFR Part 155

Brokers, Commodity futures,

Reporting and recordkeeping

requirements.

17 CFR Part 166

Brokers, Commodity futures,

Consumer protection, Reporting and

recordkeeping requirements.

In consideration of the foregoing, and

pursuant to the authority contained in

the Commodity Exchange Act, and in

particular, Sections 2, 4(c), 4b, 4d, 4f,

4m, 4n, 8a, and 19 thereof, 7 U.S.C. 2,

6(c), 6b, 6d, 6f, 6m, 6n, 12a and 23, the

Commission hereby amends Parts 1, 3,

4, 140, 155 and 166 of Chapter I of Title

17 of the Code of Federal Regulations as

follows:

PART 1—GENERAL REGULATIONS

UNDER THE COMMODITY EXCHANGE

ACT

1. The authority citation for Part 1

continues to read as follows:

Authority: 7 U.S.C. 1a, 2, 2a, 4, 4a, 6, 6a,

6b, 6c, 6d, 6e, 6f, 6g, 6h, 6i, 6j, 6k, 6l, 6m,

6n, 6o, 6p, 7, 7a, 7b, 8, 9, 12, 12a, 12c, 13a,

13a–1, 16, 16a, 19, 21, 23 and 24.

2. Section 1.3 is amended by adding

new paragraphs (g), (m) and (v) to read

as follows:

§ 1.3 Definitions.

* * * * *

(g) Institutional customer. This term

has the same meaning as ‘‘eligible

participant’’ as defined in § 35.1(b) of

this chapter.

* * * * *

(m) Derivatives transaction facility.

This term has the same meaning as a

‘‘derivatives transaction facility’’ under

part 37 of this chapter.

* * * * *

(v) Recognized futures exchange. This

term has the same meaning as a

‘‘recognized futures exchange’’ under

part 38 of this chapter.

* * * * *

3. Section 1.10 is amended as follows:

a. Revising paragraph (a)(2)(i)(B);

b. Adding paragraph (a)(2)(i)(C);

c. Designating the undesignated

paragraph following paragraph

Federal Register / Vol. 65, No. 240 / Wednesday, December 13, 2000 / Rules and Regulations 78009

(a)(2)(i)(B) as paragraph (a)(2)(i)(D) and

revising it;

d. Designating the undesignated

paragraph following paragraph

(a)(2)(ii)(C) as paragraph (a)(2)(ii)(E) and

revising it;

e. Redesignating paragraph

(a)(2)(ii)(C) as (a)(2)(ii)(D) and revising

it; and

f. Adding a new paragraph

(a)(2)(ii)(C).

The revisions and additions read as

follows:

§ 1.10 Financial reports of futures

commission merchants and introducing

brokers.

(a) * * *

(2) * * *

(i) * * *

(B) A Form 1–FR–FCM as of a date

not more than 17 business days prior to

the date on which such report is filed

and a Form 1–FR–FCM certified by an

independent public accountant in

accordance with § 1.16 as of a date not

more than one year prior to the date on

which such report is filed; or

(C) A Form 1–FR–FCM as of a date

not more than 17 business days prior to

the date on which such report is filed,

Provided, however, that such applicant

shall be subject to a review by the

applicant’s designated self-regulatory

organization within six months of being

granted registration.

(D) Each such person must include

with such financial report a statement

describing the source of his current

assets and representing that his capital

has been contributed for the purpose of

operating his business and will continue

to be used for such purpose.

(ii) * * *

(C) A Form 1–FR–IB as of a date not

more than 17 business days prior to the

date on which such report is filed,

Provided, however, that such applicant

shall be subject to a review by the

applicant’s designated self-regulatory

organization within six months of

registration; or

(D) A guarantee agreement.

(E) Each person filing in accordance

with paragraphs (a)(2)(ii) (A), (B) or (C)

of this section must include with such

financial report a statement describing

the source of his current assets and

representing that his capital has been

contributed for the purpose of operating

his business and will continue to be

used for such purpose.

* * * * *

4. Section 1.17 is amended by

redesignating paragraph (a)(1)(ii) as

(a)(1)(iii) and by adding new paragraphs

(a)(1)(ii) and (a)(2)(iii) to read as follows:

§ 1.17 Minimum financial requirements for

futures commission merchants and

introducing brokers.

(a) * * *

(1) * * *

(ii) Each person registered as a futures

commission merchant engaged in

soliciting or accepting orders and

customer funds related thereto for the

purchase or sale of any commodity for

future delivery on or subject to the rules

of a derivatives transaction facility from

any customer who does not qualify as

an ‘‘institutional customer’’ as defined

in § 1.3(g):

(A) Must be a clearing member of a

designated contract market or

recognized futures exchange, and must

maintain adjusted net capital in the

amount of the greater of $20,000,000 or

the amounts otherwise specified in

paragraph (a)(1)(i) of this section; or

(B) Receive orders on behalf of the

customer from a commodity trading

advisor acting in accordance with § 4.32

of this chapter.

* * * * *

(2) * * *

(iii) The requirements of paragraph

(a)(1) of this section shall not be

applicable if the registrant is a futures

commission merchant or introducing

broker registered in accordance with

§ 3.10(a)(1)(i)(B) of this chapter, whose

business is limited to transacting

business on behalf of institutional

customers on a derivatives transaction

facility, and who conforms to minimum

financial standards and related

reporting requirements set by such

derivatives transaction facility in its

rules.

* * * * *

5. Section 1.20 is amended by revising

paragraphs (a) and (c) to read as follows:

§ 1.20 Customer funds to be segregated

and separately accounted for.

(a) All customer funds shall be

separately accounted for and segregated

as belonging to commodity or option

customers. Such customer funds when

deposited with any bank, trust

company, clearing organization or

another futures commission merchant

shall be deposited under an account

name which clearly identifies them as

such and shows that they are segregated

as required by the Act and this part.

Each registrant shall obtain and retain in

its files for the period provided in § 1.31

a written acknowledgment from such

bank, trust company, clearing

organization, or futures commission

merchant, that it was informed that the

customer funds deposited therein are

those of commodity or option customers

and are being held in accordance with

the provisions of the Act and this part:

Provided, however, that an

acknowledgment need not be obtained

from a clearing organization that has

adopted and submitted to the

Commission rules that provide for the

segregation as customer funds, in

accordance with all relevant provisions

of the Act and the rules and orders

promulgated thereunder, of all funds

held on behalf of customers. Under no

circumstances shall any portion of

customer funds be obligated to a

clearing organization, any member of a

contract market, a futures commission

merchant, or any depository except to

purchase, margin, guarantee, secure,

transfer, adjust or settle trades, contracts

or commodity option transactions of

commodity or option customers. No

person, including any clearing

organization or any depository, that has

received customer funds for deposit in

a segregated account, as provided in this

section, may hold, dispose of, or use any

such funds as belonging to any person

other than the option or commodity

customers of the futures commission

merchant which deposited such funds.

* * * * *

(c) Each futures commission merchant

shall treat and deal with the customer

funds of a commodity customer or of an

option customer as belonging to such

commodity or option customer. All

customer funds shall be separately

accounted for, and shall not be

commingled with the money, securities

or property of a futures commission

merchant or of any other person, or be

used to secure or guarantee the trades,

contracts or commodity options, or to

secure or extend the credit, of any

person other than the one for whom the

same are held: Provided, however, That

customer funds treated as belonging to

the commodity or option customers of a

futures commission merchant may for

convenience be commingled and

deposited in the same account or

accounts with any bank or trust

company, with another person

registered as a futures commission

merchant, or with a clearing

organization, and that such share

thereof as in the normal course of

business is necessary to purchase,

margin, guarantee, secure, transfer,

adjust, or settle the trades, contracts or

commodity options of such commodity

or option customers or resulting market

positions, with the clearing organization

or with any other person registered as a

futures commission merchant, may be

withdrawn and applied to such

purposes, including the payment of

premiums to option grantors,

commissions, brokerage, interest, taxes,

78010 Federal Register / Vol. 65, No. 240 / Wednesday, December 13, 2000 / Rules and Regulations

storage and other fees and charges,

lawfully accruing in connection with

such trades, contracts or commodity

options: Provided, further, That

customer funds may be invested in

instruments described in § 1.25.

6. Section 1.25 is revised to read as

follows:

§ 1.25 Investment of customer funds.

(a) Permitted investments. (1) Subject

to the terms and conditions set forth in

this section, a futures commission

merchant or a clearing organization may

invest customer funds in the following

instruments (permitted investments):

(i) Obligations of the United States

and obligations fully guaranteed as to

principal and interest by the United

States (U.S. government securities);

(ii) General obligations of any State or

of any political subdivision thereof

(municipal securities);

(iii) General obligations issued by any

agency sponsored by the United States

(government sponsored agency

securities);

(iv) Certificates of deposit issued by a

bank (certificates of deposit) as defined

in section 3(a)(6) of the Securities

Exchange Act of 1934, or a domestic

branch of a foreign bank that carries

deposits insured by the Federal Deposit

Insurance Corporation;

(v) Commercial paper;

(vi) Corporate notes;

(vii) General obligations of any

country whose sovereign debt is rated in

the highest category by at least one

nationally recognized statistical rating

organization (NRSRO), as that term is

defined in § 270.2a–7 of this title

(permitted foreign sovereign debt),

subject to the following limits: a futures

commission merchant may invest in the

sovereign debt of a country to the extent

it has balances in segregated accounts

owed to its customers denominated in

that country’s currency; a clearing

organization may invest in the sovereign

debt of a country to the extent it has

balances in segregated accounts owed to

its clearing member futures commission

merchants denominated in that

country’s currency; and

(viii) Interests in money market

mutual funds.

(2) In addition, a futures commission

merchant or a clearing organization may

buy and sell the permitted investments

listed in paragraphs (a)(1)(i) through

(viii) of this section pursuant to

agreements for resale or repurchase of

the instruments, in accordance with the

provisions of paragraph (d) of this

section.

(b) General terms and conditions. A

futures commission merchant or a

clearing organization is required to

manage the permitted investments

consistent with the objectives of

preserving principal and maintaining

liquidity and according to the following

specific requirements.

(1) Marketability. Except for interests

in money market mutual funds,

investments must be ‘‘readily

marketable’’ as defined in § 240.15c3–1

of this title.

(2) Ratings. (i) Initial requirement.

Instruments that are required to be rated

by this section must be rated by an

NRSRO. For an investment to qualify as

a permitted investment, ratings are

required as follows:

(A) U.S. government securities and

the permitted sovereign debt of the

countries listed in paragraph (a)(1)(vii)

of this section, need not be rated;

(B) Municipal securities, government

sponsored agency securities, certificates

of deposit, commercial paper, and

corporate notes, except notes that are

asset-backed, must have the highest

short-term rating of an NRSRO or one of

the two highest long-term ratings of an

NRSRO;

(C) Corporate notes that are assetbacked must have the highest rating of

an NRSRO; and

(D) Money market mutual funds that

are rated by an NRSRO must be rated at

the highest rating of the NRSRO.

(ii) Effect of downgrade. If an NRSRO

lowers the rating of an instrument that

was previously a permitted investment

on the basis of that rating to below the

minimum rating required under this

section, the value of the instrument

recognized for segregation purposes will

be the lesser of:

(A) The current market value of the

instrument; or

(B) The market value of the

instrument on the business day

preceding the downgrade, reduced by

20 percent of that value for each

business day that has elapsed since the

downgrade.

(3) Restrictions on instrument

features. (i) With the exception of

money market mutual funds, no

permitted investment may contain an

embedded derivative of any kind,

including but not limited to a call

option, put option, or collar, cap, or

floor on interest paid.

(ii) No instrument may contain

interest-only payment features.

(iii) No instrument may provide

payments linked to a commodity,

currency, reference instrument, index,

or benchmark except as provided in

paragraph (b)(3)(iv) of this section.

(iv) Variable-rate securities are

permitted, provided the interest rates

paid correlate closely and on an

unleveraged basis to a benchmark of

either the Federal Funds target or

effective rate, the prime rate, the threemonth Treasury Bill rate, or the onemonth or three-month LIBOR rate.

(v) Certificates of deposit, if

negotiable, must be able to be liquidated

within one business day or, if not

negotiable, must be redeemable at the

issuing bank within one business day,

with any penalty for early withdrawal

limited to any accrued interest earned

according to its written terms.

(4) Concentration. (i) Direct

investments. (A) U.S. government

securities, money market mutual funds,

and permitted foreign sovereign debt

securities shall not be subject to a

concentration limit.

(B) Securities of any single issuer of

government sponsored agency securities

held by a futures commission merchant

or clearing organization may not exceed

25 percent of total assets held in

segregation by the futures commission

merchant or clearing organization.

(C) Securities of any single issuer of

municipal securities, certificates of

deposit, commercial paper, or corporate

notes held by a futures commission

merchant or clearing organization may

not exceed 5 percent of total assets held

in segregation by the futures

commission merchant or clearing

organization.

(ii) Repurchase agreements. For

purposes of determining compliance

with the concentration limits set forth in

this section, securities sold by a futures

commission merchant or clearing

organization subject to agreements to

repurchase shall be combined with

securities held by the futures

commission merchant or clearing

organization as direct investments.

(iii) Reverse repurchase agreements.

The concentration limit applicable to

securities of each issuer that are held by

a futures commission merchant or

clearing organization subject to

agreements to resell to a particular

counterparty shall be as follows:

(A) For a portfolio of securities held

that are subject to resale to a

counterparty that has been rated single

A or higher by two or more NRSROs, or

whose obligation under an agreement is

guaranteed by a parent or affiliate

company that has been rated single A or

higher by two or more NRSROs:

(1) Government sponsored agency

debt, issued by the same issuer and

supplied by the counterparty, may not

exceed 50 percent of the total amount of

securities supplied by such

counterparty; and

(2) Municipal securities, certificates of

deposit, commercial paper, and

corporate notes, issued by the same

issuer and supplied by the counterparty,

Federal Register / Vol. 65, No. 240 / Wednesday, December 13, 2000 / Rules and Regulations 78011

may not exceed 10 percent of the total

amount of securities supplied by such

counterparty; and

(B) For a portfolio of securities held

that are subject to resale to a

counterparty that does not have a rating

or guarantee as specified in paragraph

(b)(4)(iii)(A) of this section:

(1) Government sponsored agency

debt, issued by the same issuer and

supplied by the counterparty, may not

exceed 25 percent of the total amount of

securities supplied by such

counterparty; and

(2) Municipal securities, certificates of

deposit, commercial paper, and

corporate notes, issued by the same

issuer and supplied by the counterparty,

may not exceed 5 percent of the total

amount of securities supplied by such

counterparty.

(iv) Treatment of securities issued by

affiliates. For purposes of determining

compliance with the concentration

limits set forth in this section, securities

issued by entities that are affiliated, as

defined in paragraph (b)(6) of this

section, shall be aggregated and deemed

the securities of a single issuer. An

interest in a permitted money market

mutual fund is not deemed to be a

security issued by its sponsoring entity.

(v) Treatment of customer-owned

securities. For purposes of determining

compliance with the concentration

limits set forth in this section, securities

owned by the customers of a futures

commission merchant and posted as

margin collateral are not included in

total assets held in segregation by the

futures commission merchant, and

securities posted by a futures

commission merchant with a clearing

organization are not included in total

assets held in segregation by the

clearing organization.

(5) Time-to-maturity. Except for

investments in money market mutual

funds, the dollar-weighted average of

the time-to-maturity of the portfolio, as

that average is computed pursuant to

§ 270.2a–7 of this title, may not exceed

24 months.

(6) Investments in instruments issued

by affiliates. (i) A futures commission

merchant shall not invest customer

funds in obligations of an entity

affiliated with the futures commission

merchant, and a clearing organization

shall not invest customer funds in

obligations of an entity affiliated with

the clearing organization. An affiliate

includes parent companies, including

all entities through the ultimate holding

company, subsidiaries to the lowest

level, and companies under common

ownership of such parent company or

affiliates.

(ii) A futures commission merchant or

clearing organization may invest

customer funds in a fund affiliated with

that futures commission merchant or

clearing organization.

(7) Recordkeeping. A futures

commission merchant and a clearing

organization shall prepare and maintain

a record that will show for each

business day with respect to each type

of investment made pursuant to this

section, the following information:

(i) The type of instruments in which

customer funds have been invested;

(ii) The original cost of the

instruments; and

(iii) The current market value of the

instruments.

(c) Money market mutual funds. The

following provisions will apply to the

investment of customer funds in money

market mutual funds (the fund).

(1) Generally, the fund must be an

investment company that is registered

under the Investment Company Act of

1940 with the Securities and Exchange

Commission and that holds itself out to

investors as a money market fund, in

accordance with § 270.2a–7 of this title.

A fund sponsor, however, may petition

the Commission for an exemption from

this requirement. The Commission may

grant such an exemption provided that

the fund can demonstrate that it will

operate in a manner designed to

preserve principal and to maintain

liquidity. The application for exemption

must describe how the fund’s structure,

operations and financial reporting are

expected to differ from the requirements

contained in § 270.2a–7 of this title and

the risk-limiting provisions for direct

investments contained in this section.

The fund must also specify the

information that the fund would make

available to the Commission on an

ongoing basis.

(2) The fund must be sponsored by a

federally-regulated financial institution,

a bank as defined in section 3(a)(6) of

the Securities Exchange Act of 1934, an

investment adviser registered under the

Investment Advisers Act of 1940, or a

domestic branch of a foreign bank

insured by the Federal Deposit

Insurance Corporation, except for a fund

exempted in accordance with paragraph

(c)(1) of this section.

(3) A futures commission merchant or

clearing organization shall maintain the

confirmation relating to the purchase in

its records in accordance with § 1.31

and note the ownership of fund shares

(by book-entry or otherwise) in a

custody account of the FCM or clearing

organization in accordance with

§ 1.26(a). If the futures commission

merchant or the clearing organization

holds its shares of the fund with the

fund’s shareholder servicing agent, the

sponsor of the fund and the fund itself

are required to provide the

acknowledgment letter required by

§ 1.26.

(4) The net asset value of the fund

must be computed by 9 a.m. of the

business day following each business

day and made available to the futures

commission merchant or clearing

organization by that time.

(5) A fund must be able to redeem an

interest by the business day following a

redemption request by the futures

commission merchant or clearing

organization. Demonstration that this

requirement has been met may include

either an appropriate provision in the

offering memorandum of the fund or a

separate side agreement between the

fund and a futures commission

merchant or clearing organization.

(6) The agreement pursuant to which

the futures commission merchant or

clearing organization has acquired and

is holding its interest in a fund must

contain no provision that would prevent

the pledging or transferring of shares.

(d) Repurchase and reverse

repurchase agreements. A futures

commission merchant or clearing

organization may buy and sell the

permitted investments listed in

paragraphs (a)(1)(i) through (viii) of this

section pursuant to agreements for

resale or repurchase of the securities

(agreements to repurchase or resell),

provided the agreements to repurchase

or resell conform to the following

requirements:

(1) The securities are specifically

identified by coupon rate, par amount,

market value, maturity date, and CUSIP

or ISIN number.

(2) Counterparties are limited to a

bank as defined in section 3(a)(6) of the

Securities Exchange Act of 1934, a

domestic branch of a foreign bank

insured by the Federal Deposit

Insurance Corporation, a securities

broker or dealer, or a government

securities broker or government

securities dealer registered with the

Securities and Exchange Commission or

which has filed notice pursuant to

section 15C(a) of the Government

Securities Act of 1986.

(3) The transaction is executed in

compliance with the concentration limit

requirements applicable to the securities

held in connection with the agreements

to repurchase referred to in paragraphs

(b)(4)(ii) and (iii) of this section.

(4) The transaction is made pursuant

to a written agreement signed by the

parties to the agreement, which is

consistent with the conditions set forth

in paragraphs (d)(1) through (d)(12) of

this section and which states that the

78012 Federal Register / Vol. 65, No. 240 / Wednesday, December 13, 2000 / Rules and Regulations

parties thereto intend the transaction to

be treated as a purchase and sale of

securities.

(5) The term of the agreement is no

more than one business day, or reversal

of the transaction is possible on

demand.

(6) The securities transferred under

the agreement are held in a safekeeping

account with a bank as referred to in

paragraph (d)(2) of this section, a

clearing organization, or the Depository

Trust Company in an account that

complies with the requirements of

§ 1.26.

(7) The futures commission merchant

or the clearing organization may not use

securities received under the agreement

in another similar transaction and may

not otherwise hypothecate or pledge

such securities, except securities may be

pledged on behalf of customers at

another futures commission merchant or

clearing organization. Substitution of

securities is allowed, provided,

however, that:

(i) The qualifying securities being

substituted and original securities are

specifically identified by date of

substitution, market values substituted,

coupon rates, par amounts, maturity

dates and CUSIP or ISIN numbers;

(ii) Substitution is made on a

‘‘delivery versus delivery’’ basis; and

(iii) The market value of the

substituted securities is at least equal to

that of the original securities.

(8) The transfer of securities is made

on a delivery versus payment basis in

immediately available funds. The

transfer is not recognized as

accomplished until the funds and/or

securities are actually received by the

custodian of the futures commission

merchant’s or clearing organization’s

customer funds or securities purchased

on behalf of customers. The transfer or

credit of securities covered by the

agreement to the futures commission

merchant’s or clearing organization’s

customer segregated custodial account

is made simultaneously with the

disbursement of funds from the futures

commission merchant’s or clearing

organization’s customer segregated cash

account at the custodian bank. On the

sale or resale of securities, the futures

commission merchant’s or clearing

organization’s customer segregated cash

account at the custodian bank must

receive same-day funds credited to such

segregated account simultaneously with

the delivery or transfer of securities

from the customer segregated custodial

account.

(9) A written confirmation to the

futures commission merchant or

clearing organization specifying the

terms of the agreement and a

safekeeping receipt are issued

immediately upon entering into the

transaction and a confirmation to the

futures commission merchant or

clearing organization is issued once the

transaction is reversed.

(10) The transactions effecting the

agreement are recorded in the record

required to be maintained under § 1.27

of investments of customer funds, and

the securities subject to such

transactions are specifically identified

in such record as described in paragraph

(d)(1) of this section and further

identified in such record as being

subject to repurchase and reverse

repurchase agreements.

(11) An actual transfer of securities by

book entry is made consistent with

Federal or State commercial law, as

applicable. At all times, securities

received subject to an agreement are

reflected as ‘‘customer property.’’

(12) The agreement makes clear that,

in the event of the bankruptcy of the

futures commission merchant or

clearing organization, any securities

purchased with customer funds that are

subject to an agreement may be

immediately transferred. The agreement

also makes clear that, in the event of a

futures commission merchant or

clearing organization bankruptcy, the

counterparty has no right to compel

liquidation of securities subject to an

agreement or to make a priority claim

for the difference between current

market value of the securities and the

price agreed upon for resale of the

securities to the counterparty, if the

former exceeds the latter.

(e) Deposit of firm-owned securities

into segregation. A futures commission

merchant shall not be prohibited from

directly depositing unencumbered

securities of the type specified in this

section, which it owns for its own

account, into a segregated safekeeping

account or from transferring any such

securities from a segregated account to

its own account, up to the extent of its

residual financial interest in customers’

segregated funds; provided, however,

that such investments, transfers of

securities, and disposition of proceeds

from the sale or maturity of such

securities are recorded in the record of

investments required to be maintained

by § 1.27. All such securities may be

segregated in safekeeping only with a

bank, trust company, clearing

organization, or other registered futures

commission merchant. Furthermore, for

purposes of §§ 1.25, 1.26, 1.27, 1.28 and

1.29, investments permitted by § 1.25

that are owned by the futures

commission merchant and deposited

into such a segregated account shall be

considered customer funds until such

investments are withdrawn from

segregation.

7. Section 1.26 is revised to read as

follows:

§ 1.26 Deposit of instruments purchased

with customer funds.

(a) Each futures commission merchant

who invests customer funds in

instruments described in § 1.25 shall

separately account for such instruments

and segregate such instruments as

belonging to such commodity or option

customers. Such instruments, when

deposited with a bank, trust company,

clearing organization or another futures

commission merchant, shall be

deposited under an account name

which clearly shows that they belong to

commodity or option customers and are

segregated as required by the Act and

this part. Each futures commission

merchant upon opening such an

account shall obtain and retain in its

files an acknowledgment from such

bank, trust company, clearing

organization or other futures

commission merchant that it was

informed that the instruments belong to

commodity or option customers and are

being held in accordance with the

provisions of the Act and this part.

Provided, however, that an

acknowledgment need not be obtained

from a clearing organization that has

adopted and submitted to the

Commission rules that provide for the

segregation as customer funds, in

accordance with all relevant provisions

of the Act and the rules and orders

promulgated thereunder, of all funds

held on behalf of customers and all

instruments purchased with customer

funds. Such acknowledgment shall be

retained in accordance with § 1.31. Such

bank, trust company, clearing

organization or other futures

commission merchant shall allow

inspection of such obligations at any

reasonable time by representatives of

the Commission.

(b) Each clearing organization which

invests money belonging or accruing to

commodity or option customers of its

clearing members in instruments

described in § 1.25 shall separately

account for such instruments and

segregate such instruments as belonging

to such commodity or option customers.

Such instruments, when deposited with

a bank or trust company, shall be

deposited under an account name

which will clearly show that they

belong to commodity or option

customers and are segregated as

required by the Act and this part. Each

clearing organization upon opening

such an account shall obtain and retain

in its files a written acknowledgment

Federal Register / Vol. 65, No. 240 / Wednesday, December 13, 2000 / Rules and Regulations 78013

from such bank or trust company that it

was informed that the instruments

belong to commodity or option

customers of clearing members and are

being held in accordance with the

provisions of the Act and this part. Such

acknowledgment shall be retained in

accordance with § 1.31. Such bank or

trust company shall allow inspection of

such instruments at any reasonable time

by representatives of the Commission.

§ 1.27 [Amended]

8. Section 1.27 is amended by:

a. Revising the word ‘‘obligations’’ to

read ‘‘instruments’’ each time it appears;

and

b. Adding the phrase ‘‘or ISIN’’

following the word ‘‘CUSIP’’ each time

it appears.

§§ 1.28 and 1.29 [Amended]

9. Sections 1.28 and 1.29 are amended

by revising the word ‘‘obligations’’ to

read ‘‘instruments’’ each time it appears.

10. Section 1.33 is amended by

adding a new paragraph (g) to read as

follows:

§ 1.33 Monthly and confirmation

statements.

* * * * *

(g) Electronic transmission of

statements. (1) The statements required

by this section, and by § 1.46, may be

furnished to any customer by means of

electronic media if the customer so

requests, Provided, however, that a

futures commission merchant must,

prior to the transmission of any

statement by means of electronic media,

disclose the electronic medium or

source through which statements will be

delivered, the duration, whether

indefinite or not, of the period during

which consent will be effective, any

charges for such service, the information

that will be delivered by such means,

and that consent to electronic delivery

may be revoked at any time.

(2) In the case of a customer who does

not qualify as an ‘‘institutional

customer’’ as defined in § 1.3(g), a

futures commission merchant must

obtain the customer’s signed consent

acknowledging disclosure of the

information set forth in paragraph (g)(1)

of this section prior to the transmission

of any statement by means of electronic

media.

(3) Any statement required to be

furnished to a person other than a

customer in accordance with paragraph

(d) of this section may be furnished by

electronic media.

(4) A futures commission merchant

who furnishes statements to any

customer by means of electronic media

must retain a daily confirmation

statement for such customer as of the

end of the trading session, reflecting all

transactions made during that session

for the customer, in accordance with

§ 1.31.

* * * * *

11. Section 1.46 is amended as

follows:

a. By revising paragraph (a),

introductory text,

b. By removing and reserving

paragraphs (d)(4) through (d)(7),

c. By removing paragraph (d)(9) and

d. By revising paragraph (e) to read as

follows:

§ 1.46 Application and closing out of

offsetting long and short positions.

(a) Application of purchases and

sales. Except with respect to purchases

or sales which are for omnibus

accounts, or where the customer has

instructed otherwise, any futures

commission merchant who, on or

subject to the rules of a contract market,

recognized futures exchange or

derivatives transaction facility:

* * * * *

(e) The statements required by

paragraph (a) of this section may be

furnished to the customer or the person

described in § 1.33(d) by means of

electronic transmission, in accordance

with § 1.33(g).

* * * * *

12. Section 1.52 is amended by

adding a new paragraph (m) to read as

follows:

§ 1.52 Self-regulatory organization

adoption and surveillance of minimum

financial requirements.

* * * * *

(m) Nothing in this section shall

apply to the activities of a derivatives

transaction facility or the minimum

adjusted net capital requirements it may

require of persons operating thereon

pursuant to § 1.17(a)(2)(iii).

* * * * *

13. Section 1.55 is amended by

revising paragraphs (d) and (f) to read as

follows:

§ 1.55 Distribution of ‘‘Risk Disclosure

Statement’’ by futures commission

merchants and introducing brokers.

* * * * *

(d) Any futures commission

merchant, or in the case of an

introduced account any introducing

broker, may open a commodity futures

account for a customer without

obtaining the separate acknowledgments

of disclosure and elections required by

this section and by § 1.33(g), and by

§§ 33.7, 155.3(b)(2), and 190.06 of this

chapter, provided that:

(1) Prior to the opening of such

account, the futures commission

merchant or introducing broker obtains

an acknowledgment from the customer,

which may consist of a single signature

at the end of the futures commission

merchant’s or introducing broker’s

customer account agreement, or on a

separate page, of the disclosure

statements and elections specified in

this section and § 1.33(g), and in §§ 33.7,

155.3(b)(2), and 190.06 of this chapter,

and which may include authorization

for the transfer of funds from a

segregated customer account to another

account of such customer, as listed

directly above the signature line,

provided the customer has

acknowledged by check or other

indication next to a description of each

specified disclosure statement or

election that the customer has received

and understood such disclosure

statement or made such election;

(2) The acknowledgment referred to in

paragraph (d)(1) of this section must be

accompanied by and executed

contemporaneously with delivery of the

disclosures and elective provisions

required by this section and § 1.33(g),

and by §§ 33.7, 155.3(b)(2), and 190.06

of this chapter.

* * * * *

(f) A futures commission merchant or,

in the case of an introduced account an

introducing broker, may open a

commodity futures account for an

institutional customer without

furnishing such institutional customer

the disclosure statements or obtaining

the acknowledgements required under

paragraph (a) of this section, §§ 1.33(g)

and 1.65(a)(3), and §§ 30.6(a), 33.7(a),

155.3(b)(2), and 190.10(c) of this

chapter.

* * * * *

PART 3—REGISTRATION

14. The authority citation for Part 3 is

revised to read as follows:

Authority: 5 U.S.C. 522, 522b; 7 U.S.C. 1a,

2, 4, 4a, 6, 6a, 6b, 6c, 6d, 6e, 6f, 6g, 6h, 6i,

6k, 6m, 6n, 6o, 6p, 8, 9, 9a, 12, 12a, 13b, 13c,

16a, 18, 19, 21, 23.

15. Section 3.1 is amended by revising

paragraphs (a)(1) and (a)(2) to read as

follows:

§ 3.1 Definitions.

(a) * * *

(1) If the entity is organized as a sole

proprietorship, the proprietor; if a

partnership, any general partner; if a

corporation, any director, the president,

chief executive officer, chief operating

officer, chief financial officer, and any

person in charge of a principal business

78014 Federal Register / Vol. 65, No. 240 / Wednesday, December 13, 2000 / Rules and Regulations

unit, division or function subject to

regulation by the Commission; if a

limited liability company or limited

liability partnership, any director, the

president, chief executive officer, chief

operating officer, chief financial officer,

the manager, managing member or those

members vested with the management

authority for the entity, and any person

in charge of a principal business unit,

division or function subject to

regulation by the Commission; and, in

addition, any person occupying a

similar status or performing similar

functions, having the power, directly or

indirectly, through agreement or

otherwise, to exercise a controlling

influence over the entity’s activities that

are subject to regulation by the

Commission;

(2)(i) Any individual who directly or

indirectly, through agreement, holding

company, nominee, trust or otherwise,

is the owner of ten percent or more of

the outstanding shares of any class of

stock, is entitled to vote or has the

power to sell or direct the sale of ten

percent or more of any class of voting

securities, or is entitled to receive ten

percent or more of the profits; or

(ii) Any person other than an

individual that is the direct owner of ten

percent or more of any class of

securities; or

* * * * *

16. Section 3.10 is amended by

revising paragraph (a)(1)(i), by

redesignating paragraph (a)(2)(i) as

paragraph (a)(2), by removing paragraph

(a)(2)(ii), and by revising paragraph (d)

to read as follows:

§ 3.10 Registration of futures commission

merchants, introducing brokers, commodity

trading advisors, commodity pool operators

and leverage transaction merchants.

(a) Application for registration.

(1)(i)(A) Except as provided in

paragraph (a)(1)(i)(B) of this section,

application for registration as a futures

commission merchant, introducing

broker, commodity trading advisor,

commodity pool operator or leverage

transaction merchant must be on Form

7–R, completed and filed with the

National Futures Association in

accordance with the instructions

thereto.

(B) An applicant for registration as a

futures commission merchant or

introducing broker that will conduct

transactions on or subject to the rules of

a contract market, recognized futures

exchange or derivatives transaction

facility for institutional customers, and

which is registered with the Securities

and Exchange Commission as a

securities broker or dealer, or is a bank

or any other financial depository

institution subject to regulation by the

United States, may apply for registration

by filing with the National Futures

Association notice of its intention to

undertake transactions on or subject to

the rules of a contract market,

recognized futures exchange, or

derivatives transaction facility for

institutional customers, together with a

certification of registration and good

standing with the appropriate authority

or of authorization to engage in such

transactions by said authority.

* * * * *

(d) Annual filing. Any person

registered as a futures commission

merchant, introducing broker,

commodity trading advisor, commodity

pool operator or leverage transaction

merchant in accordance with paragraph

(a)(1)(i)(A) of this section must file with

the National Futures Association a Form

7–R, completed in accordance with the

instructions thereto, annually on a date

specified by the National Futures

Association. The failure to file the Form

7–R within thirty days following such

date shall be deemed to be a request for

withdrawal from registration. On at least

thirty days written notice, and following

such action, if any, deemed to be

necessary by the Commission or the

National Futures Association, the

National Futures Association may grant

the request for withdrawal from

registration.

* * * * *

17. Section 3.21 is amended by

revising paragraph (c) introductory text

to read as follows:

§ 3.21 Exemption from fingerprinting

requirement in certain cases.

* * * * *

(c) Outside directors. Any futures

commission merchant, introducing

broker, commodity trading advisor,

commodity pool operator or leverage

transaction merchant that has a

principal who is a director but is not

also an officer or employee of the firm

may, in lieu of submitting a fingerprint

card in accordance with the provisions

of §§ 3.10(a)(2)(i) and 3.31(a)(2), file a

‘‘Notice Pursuant to Rule 3.21(c)’’ with

the National Futures Association. Such

notice shall state, if true, that such

outside director:

* * * * *

18. Section 3.31 is amended by

redesignating paragraph (a) as paragraph

(a)(1), and by adding new paragraph

(a)(2) to read as follows:

§ 3.31 Deficiencies, inaccuracies, and

changes, to be reported.

(a) * * *

(1) * * *

(2) Where the deficiency or

inaccuracy is created by the addition of

a new principal not listed on the

registrant’s application for registration

(or amendment of such application prior

to the granting of registration), each

Form 3–R filed in accordance with the

requirements of paragraph (a)(1) of this

section must be accompanied by a Form

8–R, completed in accordance with the

instructions thereto and executed by

each natural person who is a principal

of the registrant and who was not listed

on the registrant’s initial application for

registration or any amendment thereto.

The Form 8–R for each such principal

must be accompanied by the

fingerprints of that principal on a

fingerprint card provided by the

National Futures Association for that

purpose, unless such principal is a

director who qualifies for the exemption

from the fingerprint requirement

pursuant to § 3.21(c). The provisions of

this paragraph do not apply to any

principal who has a current Form 8–R

on file with the Commission or the

National Futures Association.

* * * * *

§ 3.32 [Removed]

19. Section 3.32 is removed.

§ 3.34 [Removed]

20. Section 3.34 is removed.

21. Appendix A to Part 3 is amended

by adding to the end thereto the

following:

Appendix A to Part 3—Interpretive

Statement with Respect to Section

8A(2)(C) and (E) and Section 8A(3)(J)

and (M) of the Commodity Exchange

Act

* * * * *

The Commission has further addressed

‘‘other good cause’’ under Section 8a(3)(M) of

the Act in issuing guidance letters on

assessing the fitness of floor brokers, floor

traders or applicants in either category:

[First guidance letter]

December 4, 1997.

Robert K. Wilmouth,

President, National Futures Association, 200

West Madison Street, Chicago, IL.

Re: Adverse Registration Actions with

Respect to Floor Brokers, Floor Traders

and Applicants for Registration in Either

Category

Dear Mr. Wilmouth:

As you know, the Commission on June 26,

1997, approved for publication in the Federal

Register a Notice and Order concerning

adverse registration actions by the National

Futures Association (‘‘NFA’’) with respect to

registered floor brokers (‘‘FBs’’), registered

floor traders (‘‘FTs’’) and applicants for

registration in either category. 62 Fed. Reg.

36050 (July 3, 1997). The Notice and Order

authorized NFA to grant or to maintain,

Federal Register / Vol. 65, No. 240 / Wednesday, December 13, 2000 / Rules and Regulations 78015

1 7 U.S.C. 12a(2) and (3) (1994). The letter is

intended to supplement, not to supersede, other

guidance provided in the past to NFA. In this

regard, the NFA should continue to follow other

guidance provided by the Commission or its staff.

2Commission rules referred to herein are found

at 17 CFR Ch. I.

3Rule 1.63(c) provides that a person is ineligible

from serving on an SRO’s disciplinary committees,

arbitration panels, oversight panels or governing

board if, as provided in Rule 1.63(b), the person,

inter alia: (1) within the past three years has been

found by a final decision of an SRO, an

administrative law judge, a court of competent

jurisdiction or the Commission to have committed

a disciplinary offense; or (2) within the past three

years has entered into a settlement agreement in

which any of the findings or, in the absence of such

findings, any of the acts charged included a

disciplinary offense.

Rule 1.63(a)(6) provides that a ‘‘disciplinary

offense’’ includes: (i) any violation of the rules of

an SRO except those rules related to (A) decorum

or attire, (B) financial requirements, or (C) reporting

or record-keeping unless resulting in fines

aggregating more than $5,000 within any calendar

year; (ii) any rule violation described in

subparagraphs (A) through (C) above that involves

fraud, deceit or conversion or results in a

suspension or expulsion; (iii) any violation of the

Act or the regulations promulgated thereunder; or

(iv) any failure to exercise supervisory

responsibility with respect to an act described in

paragraphs (i) through (iii) above when such failure

is itself a violation of either the rules of an SRO,

the Act or the regulations promulgated thereunder.

4Thus, for example, a disciplinary action taken

by the Chicago Board Options Exchange or the

National Association of Securities Dealers, Inc.

should be considered in a manner similar to a

disciplinary action of the Chicago Board of Trade

or NFA.

5 In reviewing these matters, the NFA should bear

in mind recent Commission precedent which

allows for reliance on settled disciplinary

proceedings in some circumstances. See In the

Matter of Michael J. Clark, [1996–1998 Transfer

Binder] Comm. Fut. L. Rep. (CCH) ¶ 27,032 (Apr.

22, 1997) (‘‘other good cause’’ under Section

8a(3)(M) of the Act exists based upon a pattern of

exchange disciplinary actions resulting in

significant sanctions for serious rule violations—

whether settlements or adjudications), aff’d sub

nom., Clark v. Commodity Futures Trading

Commission, No. 97–4228 (2d Cir. June 4, 1999)

(unpublished).

either with or without conditions or

restrictions, FB or FT registration where NFA

previously would have forwarded the case to

the Commission for review of disciplinary

history. The Commission has worked with its

staff to determine which of the pending

matters could efficiently be returned to NFA

for handling, and such matters have been

forwarded to NFA. The Commission will

continue to accept or to act upon requests for

exemption, and the Commission staff will

consider requests for ‘‘no-action’’ opinions

with respect to applicable registration

requirements.

By this correspondence, the Commission is

issuing guidance that provides NFA further

direction on how it expects NFA to exercise

its delegated power, based upon the

experience of the Commission and the staff

with the registration review process during

the past three years. This guidance will help

ensure that NFA exercises its delegated

power in a manner consistent with

Commission precedent.

In exercising its delegated authority, NFA,

of course, needs to apply all of the provisions

of Sections 8a(2) and (3) of the Commodity

Exchange Act (‘‘Act’’).1 In that regard, NFA

should consider the matters in which the

Commission has taken action in the past and

endeavor to seek similar registration

restrictions, conditions, suspensions, denials,

or revocations under similar circumstances.

One of the areas in which NFA appears to

have had the most uncertainty is with regard

to previous self-regulatory organization

(‘‘SRO’’) disciplinary actions. Commission

Rule 1.632 provides clear guidelines for

determining whether a person’s history of

‘‘disciplinary offenses’’ should preclude

service on SRO governing boards or

committees.3 In determining whether to grant

or to maintain, either with or without

conditions or restrictions, FB or FT

registration, NFA should, as an initial matter,

apply the Rule 1.63(a)(6) criteria to those

registered FBs, registered FTs and applicants

for registration in either category. However,

NFA should be acting based upon any such

offenses that occurred within the previous

five years, rather than the three years

provided for in Rule 1.63(c). NFA should

consider disciplinary actions taken by an

SRO as that term is defined in Section

3(a)(26) of the Securities Exchange Act of

1934 no differently from disciplinary actions

taken by an SRO in the futures industry as

defined in Rule 1.3(ee).4 Application of the

Rule 1.63 criteria, as modified, to these

matters will aid NFA in making registration

determinations that are reasonably consonant

with Commission views.5 NFA should focus

on the nature of the underlying conduct

rather than the sanction imposed by an SRO.

Thus, if a disciplinary action would not come

within the coverage of Rule 1.63 but for the

imposition of a short suspension of trading

privileges (such as for a matter involving

fighting, use of profane language or minor

recordkeeping violations), NFA could

exercise discretion, as has the Commission,

not to institute a statutory disqualification

case. On the other hand, conduct that falls

clearly within the terms of Rule 1.63, such

as violations of rules involving potential

harm to customers of the exchange, should

not be exempt from review simply because

the exchange imposed a relatively minor

sanction.

The Commission has treated the

registration process and the SRO disciplinary

process as separate matters involving

separate considerations. The fact that the

Commission has not pursued its own

enforcement case in a particular situation

does not necessarily mean that the

Commission considers the situation to be a

minor matter for which no registration

sanctions are appropriate. Further, the

Commission believes that it and NFA,

entities with industry-wide perspective and

responsibilities, are the appropriate bodies,

rather than any individual exchange, to

decide issues relating to registration status,

which can affect a person’s ability to function

in the industry well beyond the jurisdiction

of a particular exchange. Thus, NFA’s role is

in no way related to review of exchange

sanctions for particular conduct, but rather it

is the entirely separate task of determining

whether an FB’s or FT’s conduct should

impact his or her registration.

NFA also should look to Commission

precedent in selecting conditions or

restrictions to be imposed, such as a dual

trading ban where a person has been

involved in disciplinary offenses involving

customer abuse. Where conditions or

restrictions are imposed, or agreed upon,

NFA also should follow Commission

precedent, under which such conditions or

restrictions generally have been imposed for

a two-year period.

The Commission has required sponsorship

for conditioned FBs and FTs when their

disciplinary offenses have involved

noncompetitive trading and fraud

irrespective of the level of sanctions imposed

by an SRO. Indeed, but for a sponsorship

requirement there would be no one routinely

watching and responsible for the activities of

these registrants. Absent sponsorship, such

FBs and FTs would only be subject to routine

Commission and exchange surveillance. The

Commission’s rules are premised upon the

judgment that requiring FTs and FBs to have

sponsors to ensure their compliance with

conditions is both appropriate and useful.

See Rule 3.60(b)(2)(i).

A question has arisen whether, if NFA is

required to prove up the underlying facts of

an SRO disciplinary action, the exchanges

can provide information on exchange

disciplinary proceedings directly to NFA.

Although Section 8c(a)(2) of the Act states

that an exchange shall not disclose the

evidence for a disciplinary action except to

the person disciplined and to the

Commission, Section 8a(10) of the Act allows

the Commission to authorize any person to

perform any portion of the registration

functions under the Act, notwithstanding any

other provision of law. The effective

discharge of the delegated registration

function requires NFA to have access to the

exchange evidence. Thus, the Commission

believes that Section 8a(10) may reasonably

be interpreted to allow the disclosure of

information from exchange disciplinary

proceedings directly to NFA despite the

provisions of Section 8c(a)(2).

Nothing in the Notice and Order affects the

Commission’s authority to review the

granting of a registration application by NFA

in the performance of Commission

registration functions, including review of

the sufficiency of conditions or restrictions

imposed by NFA, to review the

determination by NFA not to take action to

affect an existing registration, or to take its

own action to address a statutory

disqualification. Moreover, the Commission

Order contemplates that to allow for

appropriate Commission oversight of NFA’s

exercise of this delegated authority, NFA will

provide for the Commission’s review

quarterly schedules of all applicants cleared

for registration and all registrants whose

registrations are maintained without adverse

action by NFA’s Registration, Compliance,

Legal Committee despite potential statutory

disqualifications.

The Commission will continue to monitor

NFA activities through periodic rule

enforcement reviews, and NFA remains

subject to the present requirement that it

78016 Federal Register / Vol. 65, No. 240 / Wednesday, December 13, 2000 / Rules and Regulations

1Registration Actions by National Futures

Association With Respect to Floor Brokers, Floor

Traders and Applicants for Registration in Either

Category, 62 FR 36050 (July 3, 1997).

2See letters submitted by James Bowe, former

president of the New York Board of Trade

(‘‘NYBOT’’), dated October 13, 1999, Christopher

Bowen, general counsel of the New York Mercantile

Exchange (‘‘NYMEX’’), dated October 18, 1999, and

the Joint Compliance Committee (‘‘JCC’’), dated

February 2, 2000. The JCC consists of senior

compliance officials from all domestic futures

exchanges and the NFA (i.e., the domestic selfregulatory organizations (‘‘SROs’’)). In addition,

staff from the Contract Markets Section of the

Commission’s Division of Trading and Markets

attend the JCC meetings as observers. The JCC was

established to aid in the development of improved

compliance systems through joint efforts and

information-sharing among the SROs. Commission

staff have also discussed this issue with SRO staff.

3 7 U.S.C. 12a(2) and (3) (1994).

4 In the Matter of Clark, [1996–1998 Transfer

Binder] Comm. Fut. L. Rep. (CCH) ¶ 27,032 (Apr.

22, 1997), aff’d sub nom., Clark v. Commodity

Futures Trading Commission, No. 97–4228 (2d Cir.

June 4, 1999) (unpublished).

5Commission rules referred to in this letter are

found at 17 CFR Ch. 1.

6Rule 1.63 provides, among other things, that a

person is ineligible from serving on SRO

disciplinary committees, arbitration panels,

oversight panels or governing boards if that person,

inter alia, entered into a settlement agreement

within the past three years in which any of the

findings or, in the absence of such findings, any of

the acts charged included a disciplinary offense.

Rule 1.63(a)(6) defines a ‘‘disciplinary offense’’ to

include:

(i) any violation of the rules of an SRO except

those rules related to (A) decorum or attire, (B)

financial requirements, or (C) reporting or recordkeeping unless resulting in fines aggregating more

than $5,000 within any calendar year; (ii) any rule

violation described in subparagraphs (A) through

(C) above that involves fraud, deceit or conversion

or results in a suspension or expulsion; (iii) any

violation of the Act or the regulations promulgated

thereunder; or (iv) any failure to exercise

supervisory responsibility with respect to an act

described in paragraphs (i) through (iii) above when

such failure is itself a violation of either the rules

of an SRO, the Act or the regulations promulgated

thereunder.

7Clark at 44,929.

8The Commission generally looked at a five-year

period of disciplinary history. On occasion,

however, the Commission examined a longer period

of an applicant’s or registrant’s disciplinary history.

For example, the Commission revoked the

registration of one FB on the basis of exchange

disciplinary cases that extended back six years, see

Clark, 2 Comm. Fut. L. Rep. (CCH) ¶ 27,032, and

denied an application for registration as an FT on

the basis of exchange disciplinary cases that

extended back seven years, see In the Matter of

Castellano, [1987–1990 Transfer Binder] Comm.

Fut. L. Rep. (CCH) ¶ 24,360 (Nov. 23, 1988),

summarily aff’d (May 29, 1990), reh. denied [1990–

1992 Transfer Binder] Comm. Fut. L. Rep. ¶ 24,870

(June 26, 1990), aff’d sub nom. Castellano v. CFTC,

Docket No. 90–2298 (7th Cir. Nov. 20, 1991).

9Letter dated July 14, 1995, from Mary L.

Schapiro to R. Patrick Thompson, President, New

York Mercantile Exchange (unpublished). See also

Castellano, supra note 8.

10See Rule 1.51(a)(7).

monitor compliance with the conditions and

restrictions imposed on conditioned and

restricted registrants.

Sincerely,

Jean A. Webb,

Secretary of the Commission.

[Second guidance letter]

April 13, 2000.

Robert K. Wilmouth,

President, National Futures Association, 200

West Madison Street, Chicago, IL.

Re: Use of Exchange Disciplinary Actions

as ‘‘Other Good Cause’’ to Affect Floor

Broker/Floor Trader Registration

Dear Mr. Wilmouth:

I. Introduction and Background

In July 1997, the Commission issued a

Notice and Order authorizing the National

Futures Association (‘‘NFA’’) to grant or to

maintain, either with or without conditions

or restrictions, floor broker (‘‘FB’’) or floor

trader (‘‘FT’’) registration where NFA

previously would have forwarded the case to

the Commission for review of disciplinary

history.1 By letter dated December 4, 1997

(‘‘Guidance Letter’’), the Commission

provided further direction on how the

Commission expected NFA to exercise its

delegated power and to ensure that NFA

exercised its delegated power in a manner

consistent with Commission precedent.

The Commission has determined to revise

the Guidance Letter. Specifically, the

Commission is revising the portion of the

Guidance Letter that addresses the use of

exchange disciplinary actions as ‘‘other good

cause’’ to affect FB and FT registrations. The

Commission has made this determination

following its own reconsideration of the issue

and at the urging of industry members.2

The Guidance Letter pointed out that, in

exercising its delegated authority, NFA must

apply all of the provisions of Sections 8a(2)

and (3) of the Commodity Exchange Act

(‘‘Act’’).3 In particular, Section 8a(3)(M) of

the Act authorizes the Commission to refuse

to register or to register conditionally any

person if it is found, after opportunity for

hearing, that there is other good cause for

statutory disqualification from registration

beyond the specifically listed grounds in

Sections 8a(2) and 8a(3) of the Act. The

Commission held in In the Matter of Clark

that statutory disqualification under the

‘‘other good cause’’ provision of Section

8a(3)(M) may arise on the basis of, among

other things, a pattern of exchange

disciplinary actions alleging serious rule

violations that result in significant sanctions,

and that it is immaterial whether the

sanctions imposed resulted from a fullyadjudicated disciplinary action or an action

that was taken following a settlement.4

The Guidance Letter recommended the

application of the provisions of Commission

Rule 1.63 5 as criteria to aid in assessing the

impact of an FB or FT applicant’s or

registrant’s previous disciplinary history on

the person’s fitness to be registered, with the

exception that NFA should be acting based

on disciplinary history from the previous five

years, rather than the three years provided for

in Rule 1.63.6 The Guidance Letter also noted

that NFA should consider disciplinary

actions taken not only by futures industry

SROs but also those taken by SROs as

defined in Section 3(a)(26) of the Securities

Exchange Act of 1934 (‘‘1934 Act’’),

including settled disciplinary actions.

II. Revised Guidance

As stated above, the Commission has

determined to revise the Guidance Letter.

From this point forward, NFA should cease

using Rule 1.63 as the basis to evaluate the

impact of an FB or FT applicant’s or

registrant’s disciplinary history on his or her

fitness to be registered. Instead, as Clark

stated, when reviewing disciplinary history

to assess the fitness to be registered of an FB,

FT, or applicant in either category, a pattern

of exchange disciplinary actions alleging

serious rule violations that result in

significant sanctions will trigger the ‘‘other

good cause’’ provision of Section 8a(3)(M).

The ‘‘pattern’’ should consist of at least two

final exchange disciplinary actions, whether

settled or adjudicated.

NFA also should consider initiating

proceedings to affect the registration of the

FB or FT, even if there is only a single

exchange action against the FB or FT, if the

exchange action was based on allegations of

particularly egregious misconduct or

involved numerous instances of misconduct

occurring over a long period of time. If,

however, a proceeding is initiated based on

a single exchange action that was disposed of

by settlement, NFA may have to prove up the

underlying misconduct. Furthermore,

traditional principles of collateral estoppel

apply to adjudicated actions, whether they

are being considered individually or as part

of a pattern.7

As provided by the Guidance Letter,

‘‘exchange disciplinary actions’’ would

continue to include disciplinary actions

taken by both futures industry SROs and

SROs as defined in Section 3(a)(26) of the

1934 Exchange Act. Furthermore, NFA

should review an applicant’s or registrant’s

disciplinary history for the past five years.8

At least one of the actions forming the

pattern, however, must have become final

after Clark was decided by the Commission

on April 22, 1997. Finally, ‘‘serious rule

violations’’ consist of, or are substantially

related to, charges of fraud, customer abuse,

other illicit trading practices, or the

obstruction of an exchange investigation.

Congress, the courts and the Commission

have indicated the importance of considering

an applicant’s history of exchange

disciplinary actions in assessing that person’s

fitness to register.9 Furthermore, NFA’s

review of exchange disciplinary actions

within the context of the registration process

should not simply mirror the disciplinary

actions undertaken by the exchanges. The

two processes are separate matters that

involve separate considerations. As part of

their ongoing self-regulatory obligations,

exchanges must take disciplinary action 10

and such disciplinary matters necessarily

focus on the specific misconduct that forms

the allegation. In a statutory disqualification

action, however, NFA must determine

whether the disciplinary history of an FB, FT

or applicant over the preceding five years

should impact his or her registration.

Additionally, NFA possesses industry-wide

perspective and responsibilities. As such,

NFA, rather than an individual exchange,

should decide registration status issues, since

those issues affect an individual’s status

Federal Register / Vol. 65, No. 240 / Wednesday, December 13, 2000 / Rules and Regulations 78017

11Section 8c(a)(2) states, in relevant part, that

‘‘[A]n exchange * * * shall not disclose the

evidence therefor, except to the person who is

suspended, expelled, disciplined, or denied access,

and to the Commission.’’

12Of course, the Commission could request

records from the exchange and forward them to

NFA. The Commission believes that this is an

unnecessary administrative process and that NFA

should obtain the records it needs to carry out the

delegated function of conducting disciplinary

history reviews directly from the exchanges. In this

context and pursuant to Commission orders

authorizing NFA to institute adverse registration

actions, NFA should be viewed as standing in the

shoes of the Commission.

within the industry as a whole, well beyond

the jurisdiction of a particular exchange.

The Commission also wants to clarify to

the fullest extent possible that its power to

delegate the authority to deny or condition

the registration of an FB, FT, or an applicant

for registration in either category permits

exchanges to disclose to NFA all evidence

underlying exchange disciplinary actions,

notwithstanding the language of Section

8c(a)(2) of the Act.11 The Commission’s

power to delegate stems from Section 8a(10)

of the Act, which permits delegation of

registration functions, including statutory

disqualification actions, to any person in

accordance with rules adopted by such

person and submitted to the Commission for

approval or for review under Section 17(j) of

the Act, ‘‘notwithstanding any other

provision of law.’’ Certainly, Section 8c(a)(2)

qualifies as ‘‘any other provision of law.’’

Furthermore, the effective discharge of the

delegated function requires NFA to have

access to the exchange evidence. Thus, the

exercise of the delegated authority pursuant

to Section 8a(10) permits the exchanges to

disclose all evidence underlying disciplinary

actions to NFA.12

This letter supersedes the Guidance Letter

to the extent discussed above. In all other

aspects, the Guidance Letter and other

guidance provided by the Commission or its

staff remain in effect. Therefore, NFA should

continue to follow Commission precedent

when selecting conditions or restrictions to

be imposed. For example, NFA should

impose a dual trading ban where customer

abuse is involved and any conditions or

restrictions imposed should be for a two-year

period. Furthermore, NFA should require

sponsorship for conditioned FBs or FTs

when their disciplinary offenses involve

noncompetitive trading and fraud.

Nothing in the Notice and Order or this

letter affects the Commission’s authority to

review the granting of a registration

application by NFA in the performance of

Commission registration functions, including

review of the sufficiency of conditions or

restrictions imposed by NFA, to review the

determination by NFA not to take action to

affect an existing registration, or to take its

own action to address a statutory

disqualification. Moreover, the Commission

Order contemplates that to allow for

appropriate Commission oversight of NFA’s

exercise of this delegated authority, NFA will

provide for the Commission’s review

quarterly schedules of all applicants cleared

for registration and all registrants whose

registrations are maintained without adverse

action by NFA’s Registration, Compliance,

Legal Committee despite potential statutory

disqualifications.

The Commission will continue to monitor

NFA activities through periodic rule

enforcement reviews, and NFA remains

subject to the present requirement that it

monitor compliance with the conditions and

restrictions imposed on conditioned and

restricted registrants.

Sincerely,

Jean A. Webb,

Secretary of the Commission.

22. Part 3 is amended by adding

Appendix B to read as follows:

Appendix B to Part 3—Statement of

Acceptable Practices with Respect to

Ethics Training

(a) The provisions of section 4p(b) of the

Act (7 U.S.C. 6p(b) (1994)) set forth

requirements regarding training of registrants

as to their responsibilities to the public. This

section requires the Commission to issue

regulations requiring new registrants to

attend ethics training sessions within six

months of registration, and all registrants to

attend such training on a periodic basis.

Consistent with the will of Congress, the

Commission believes that a Core Principle for

all persons intermediating transactions in

recognized multilateral trade execution

facilities is fitness. The awareness and

maintenance of professional ethical

standards are essential elements of a

registrant’s fitness. Further, the use of ethics

training programs is relevant to a registrant’s

maintenance of adequate supervision, itself a

Core Principle, and a requirement under Rule

166.3.

(b)(1) The Commission recognizes that

technology has provided new, faster means of

sharing and distributing information. In view

of the foregoing, the Commission has chosen

to allow registrants to develop their own

ethics training programs. Nevertheless,

futures industry professionals may want

guidance as to the role of ethics training.

Registrants may wish to consider what ethics

training should be retained, its format, and

how it might best be implemented. Therefore,

the Commission finds it appropriate to issue

this Statement of Acceptable Practices

regarding appropriate training for registrants,

as interpretative guidance for intermediaries

on fitness and supervision. Commission

registrants may look to this Statement of

Acceptable Practices as a ‘‘safe harbor’’

concerning acceptable procedures in this

area.

(2) The Commission believes that section

4p(b) of the Act reflects an intent by Congress

that industry professionals be aware, and

remain abreast, of their continuing

obligations to the public under the Act and

the regulations thereunder. The text of the

Act provides guidance as to the nature of

these responsibilities. As expressed in

section 4p(b) of the Act, personnel in the

industry have an obligation to the public to

observe the Act, the rules of the Commission,

the rules of any appropriate self-regulatory

organizations or contract markets (which

would also include recognized futures

exchanges and recognized derivatives

transactions facilities), or other applicable

federal or state laws or regulations. Further,

section 4p(b) acknowledges that registrants

have an obligation to the public to observe

‘‘just and equitable principles of trade.’’

(3) Additionally, section 4p(b) reflects

Congress’ intent that registrants and their

personnel retain an up-to-date knowledge of

these requirements. The Act requires that

registrants receive training on a periodic

basis. Thus, it is the intent of Congress that

Commission registrants remain current with

regard to the ethical ramifications of new

technology, commercial practices,

regulations, or other changes.

(c) The Commission believes that training

should be focused to some extent on a

person’s registration category, although there

will obviously be certain principles and

issues common to all registrants and certain

general subjects that should be taught. Topics

to be addressed include:

(1) An explanation of the applicable laws

and regulations, and the rules of selfregulatory organizations or contract markets,

recognized futures exchanges and derivatives

transaction facilities;

(2) The registrant’s obligation to the public

to observe just and equitable principles of

trade;

(3) How to act honestly and fairly and with

due skill, care and diligence in the best

interests of customers and the integrity of the

market;

(4) How to establish effective supervisory

systems and internal controls;

(5) Obtaining and assessing the financial

situation and investment experience of

customers;

(6) Disclosure of material information to

customers; and

(7) Avoidance, proper disclosure and

handling of conflicts of interest.

(d) An acceptable ethics training program

would apply to all of a firm’s associated

persons and its principals to the extent they

are required to register as associated persons.

Additionally, personnel of firms that rely on

their registration with other regulators, such

as the Securities and Exchange Commission,

should be provided with ethics training to

the extent the Act and the Commission’s

regulations apply to their business.

(e) As to the providers of such training, the

Commission believes that classes sponsored

by independent persons, firms, or industry

associations would be acceptable. It would

also be permissible to conduct in-house

training programs. Further, registrants should

ascertain the credentials of any ethics

training providers they retain. Thus, persons

who provide ethics training should be

required to provide proof of satisfactory

completion of the proficiency testing

requirements applicable to the registrant and

evidence of three years of relevant industry

or pedagogical experience in the field. This

industry experience might include the

practice of law in the fields of futures or

securities, or employment as a trader or risk

manager at a brokerage or end-user firm.

Likewise, the Commission believes that

registrants should employ as ethics training

providers only those persons they reasonably

believe in good faith are not subject to any

investigations or to bars to registration or to

78018 Federal Register / Vol. 65, No. 240 / Wednesday, December 13, 2000 / Rules and Regulations

service on a self-regulatory organization

governing board or disciplinary panel.

(f)(1) With regard to the frequency and

duration of ethics training, it is permissible

for a firm to require training on whatever

periodic basis and duration the registrant

(and relevant self-regulatory organizations)

deems appropriate. It may even be

appropriate not to require any such specific

requirements as, for example, where ethics

training could be termed ongoing. For

instance, a small entity, sole proprietorship,

or even a small section in an otherwise large

firm, might satisfy its obligation to remain

current with regard to ethics obligations by

distribution of periodicals, legal cases, or

advisories. Use of the latest information

technology, such as Internet websites, can be

useful in this regard. In such a context, there

would be no structured classes, but the goal

should be a continuous awareness of

changing industry standards. A corporate

culture to maintain high ethical standards

should be established on a continuing basis.

(2) On the other hand, larger firms which

transact business with a larger segment of the

public may wish to implement a training

program that requires periodic classwork. In

such a situation, the Commission believes it

appropriate for registrants to maintain such

records as evidence of attendance and of the

materials used for training. In the case of a

floor broker or floor trader, the applicable

contract market, recognized futures exchange

or derivatives transaction facility should

maintain such evidence on behalf of its

member. This evidence of ethics training

could be offered to demonstrate fitness and

overall compliance during audits by selfregulatory organizations, and during reviews

of contract market, recognized futures

exchange or derivatives transaction facility

operations.

(g) The methodology of such training may

also be flexible. Recent innovations in

information technology have made possible

new, fast, and cost-efficient ways for

registrants to maintain their awareness of

events and changes in the commodity

interest markets. In this regard, the

Commission recognizes that the needs of a

firm will vary according to its size,

personnel, and activities. No format of

classes will be required. Rather, such training

could be in the form of formal class lectures,

video presentation, Internet transmission, or

by simple distribution of written materials.

These options should provide sufficiently

flexible means for adherence to

Congressional intent in this area.

(h) Finally, it should be noted that selfregulatory organizations and industry

associations will have a significant role in

this area. Such organizations may have

separate ethics and proficiency standards,

including ethics training and testing

programs, for their own members.

PART 4—COMMODITY POOL

OPERATORS AND COMMODITY

TRADING ADVISORS

23. The authority citation for Part 4

continues to read as follows:

Authority: 7 U.S.C. 1a, 2, 4, 6b, 6c, 6l, 6m,

6n, 6o, 12a, and 23.

24. Section 4.10 is amended by

revising paragraph (e)(1) to read as

follows:

§ 4.10 Definitions.

* * * * *

(e)(1) Principal, when referring to a

person that is a principal of a particular

entity, shall have the same meaning as

the term ‘‘principal’’ under § 3.1(a) of

this chapter.

* * * * *

25. Section 4.24 is amended by

revising paragraphs (f)(1)(v) and (h)(2) to

read as follows:

§ 4.24 General disclosures required.

* * * * *

(f) * * *

(1) * * *

(v) Each principal of the persons

referred to in this paragraph (b)(1) who

participates in making trading or

operational decisions for the pool or

who supervises persons so engaged.

* * * * *

(h) * * *

(2) A description of the trading and

investment programs and policies that

will be followed by the offered pool,

including the method chosen by the

pool operator concerning how futures

commission merchants carrying the

pool’s accounts shall treat offsetting

positions pursuant to § 1.46 of this

chapter, if the method is other than to

close out all offsetting positions or to

close out offsetting positions on other

than a first-in, first-out basis, and any

material restrictions or limitations on

trading required by the pool’s

organizational documents or otherwise.

This description must include, if

applicable, an explanation of the

systems used to select commodity

trading advisors, investee pools and

types of investment activity to which

pool assets will be committed;

* * * * *

26. Section 4.32 is added to read as

follows:

§ 4.32 Trading on a derivatives transaction

facility for non-institutional customers.

(a) A registered commodity trading

advisor may enter trades on or subject

to the rules of a derivatives transaction

facility on behalf of a client who does

not qualify as an ‘‘institutional

customer’’ as defined in § 1.3(g) of this

chapter, provided that the trading

advisor:

(1) Directs the client’s commodity

interest account;

(2) Directs accounts containing total

assets of not less than $25,000,000 at the

time the trade is entered; and

(3) Discloses to the client that the

trading advisor may enter trades on or

subject to the rules of a derivatives

transaction facility on the client’s

behalf.

(b) The commodity interest account of

a client described in paragraph (a) of

this section must be carried by a

registered futures commission

merchant.

27. Section 4.34 is amended by

revising paragraphs (f)(1)(ii) and (h) to

read as follows:

§ 4.34 General disclosures required.

* * * * *

(f) * * *

(1) * * *

(ii) Each principal of the trading

advisor who participates in making

trading or operational decisions for the

trading advisor or supervises persons so

engaged.

* * * * *

(h) Trading program. A description of

the trading program, which must

include the method chosen by the

commodity trading advisor concerning

how futures commission merchants

carrying accounts it manages shall treat

offsetting positions pursuant to § 1.46 of

this chapter, if the method is other than

to close out all offsetting positions or to

close out offsetting positions on other

than a first-in, first-out basis, and the

types of commodity interests and other

interests the commodity trading advisor

intends to trade, with a description of

any restrictions or limitations on such

trading established by the trading

advisor or otherwise.

PART 140—ORGANIZATION,

FUNCTIONS AND PROCEDURES OF

THE COMMISSION

28. The authority citation for Part 140

continues to read as follows:

Authority: 7 U.S.C. 4a, 12a.

29. Section 140.91 is amended by

adding a new paragraph (a)(7) to read as

follows:

§ 140.91 Delegation of authority to the

Director of the Division of Trading and

Markets.

(a) * * *

(7) All functions reserved to the

Commission in § 1.25 of this chapter.

* * * * *

PART 155—TRADING STANDARDS

30. The authority citation for Part 155

continues to read as follows:

Authority: 7 U.S.C. 6b, 6c, 6g, 6j and 12a

unless otherwise noted.

Federal Register / Vol. 65, No. 240 / Wednesday, December 13, 2000 / Rules and Regulations 78019

§§ 155.2, 155.3, 155.4 and 155.5 [Amended]

31. Sections 155.2, 155.3, 155.4 and

155.5 are amended by adding the words

‘‘or recognized futures exchange’’ after

the words ‘‘contract market’’ each time

they appear.

32. Section 155.6 is added to read as

follows:

§ 155.6 Trading standards for the

transaction of business on derivatives

transaction facilities.

(a) A futures commission merchant, or

affiliated person thereof, transacting

business on behalf of a customer who

does not qualify as an ‘‘institutional

customer’’ as defined in § 1.3(g) of this

chapter on a derivatives transaction

facility shall comply with the provisions

of § 155.3.

(b) No futures commission merchant,

introducing broker or affiliated person

thereof shall misuse knowledge of any

institutional customer’s order for

execution on a derivatives transaction

facility.

PART 166—CUSTOMER PROTECTION

RULES

33. The authority citation for Part 166

is amended to read as follows:

Authority: 7 U.S.C. 1a, 2, 4, 6b, 6c, 6d, 6g,

6h, 6k, 6l, 6o, 7a, 12a, 21 and 23, unless

otherwise noted.

34. Section 166.5 is added to read as

follows:

§ 166.5 Dispute settlement procedures.

(a) Definitions. (1) The term claim or

grievance as used in this section shall

mean any dispute that:

(i) Arises out of any transaction

executed on or subject to the rules of a

contract market, a recognized futures

exchange or a derivatives transaction

facility,

(ii) Is executed or effected through a

member of such facility, a participant

transacting on or through such facility

or an employee of such facility, and

(iii) Does not require for adjudication

the presence of essential witnesses or

third parties over whom the facility

does not have jurisdiction and who are

not otherwise available.

(iv) The term claim or grievance does

not include disputes arising from cash

market transactions that are not a part

of or directly connected with any

transaction for the purchase or sale of

any commodity for future delivery or

commodity option.

(2) The term customer as used in this

section includes an option customer (as

defined in § 1.3(jj) of this chapter) and

any person for or on behalf of whom a

member of a contract market, a

recognized futures exchange or a

derivatives transaction facility or a

participant transacting on or through

such market, exchange or facility effects

a transaction on or through such market,

exchange or facility, except another

member of or participant in such

market, exchange or facility. Provided,

however, a person who is an

‘‘institutional customer’’ as defined in

§ 1.3(g) of this chapter shall not be

deemed to be a customer within the

meaning of this section.

(3) The term Commission registrant as

used in this section means a person

registered under the Act as a futures

commission merchant, introducing

broker, floor broker, commodity pool

operator, commodity trading advisor, or

associated person.

(b) Voluntariness. The use by

customers of dispute settlement

procedures shall be voluntary as

provided in paragraph (c) of this

section.

(c) Pre-dispute arbitration agreements.

No Commission registrant shall enter

into any agreement or understanding

with a customer in which the customer

agrees, prior to the time a claim or

grievance arises, to submit such claim or

grievance to any settlement procedure

except as follows:

(1) Signing the agreement must not be

made a condition for the customer to

utilize the services offered by the

Commission registrant.

(2) If the agreement is contained as a

clause or clauses of a broader

agreement, the customer must

separately endorse the clause or clauses

containing the cautionary language and

provisions specified in this section. A

futures commission merchant or

introducing broker may obtain such

endorsement as provided in § 1.55(d) of

this chapter for the following classes of

customers only:

(i) A plan defined as a government

plan or church plan in section 3(32) or

section 3(33) of title I of the Employee

Retirement Income Security Act of 1974,

or a foreign person performing a similar

role or function subject as such to

comparable foreign regulation; and

(ii) A person who is a ‘‘qualified

eligible person’’ as defined in § 4.7 of

this chapter.

(3) The agreement may not require the

customer to waive the right to seek

reparations under section 14 of the Act

and part 12 of this chapter. Accordingly,

the customer must be advised in writing

that he or she may seek reparations

under section 14 of the Act by an

election made within 45 days after the

Commission registrant notifies the

customer that arbitration will be

demanded under the agreement. This

notice must be given at the time when

the Commission registrant notifies the

customer of an intention to arbitrate.

The customer must also be advised that

if he or she seeks reparations under

section 14 of the Act and the

Commission declines to institute

reparation proceedings, the claim or

grievance will be subject to the preexisting arbitration agreement and must

also be advised that aspects of the claim

or grievance that are not subject to the

reparations procedure (i.e., do not

constitute a violation of the Act or rules

thereunder) may be required to be

submitted to the arbitration or other

dispute settlement procedure set forth

in the pre-existing arbitration

agreement.

(4) The agreement must advise the

customer that, at such time as he or she

may notify the Commission registrant

that he or she intends to submit a claim

to arbitration, or at such time as such

person notifies the customer of its intent

to submit a claim to arbitration, the

customer will have the opportunity to

elect a qualified forum for conducting

the proceeding.

(5) Election of forum. (i) Within ten

business days after receipt of notice

from the customer that he or she intends

to submit a claim to arbitration, or at the

time a Commission registrant notifies

the customer of its intent to submit a

claim to arbitration, the Commission

registrant must provide the customer

with a list of organizations whose

procedures meet Acceptable Practices

established by the Commission for

customer dispute resolution, together

with a copy of the rules of each forum

listed. The list must include:

(A) The contract market, recognized

futures exchange or derivatives

transaction facility, if available, upon

which the transaction giving rise to the

dispute was executed or could have

been executed;

(B) A registered futures association;

and

(C) At least one other organization

that will provide the customer with the

opportunity to select the location of the

arbitration proceeding from among

several major cities in diverse

geographic regions and that will provide

the customer with the choice of a panel

or other decision-maker composed of at

least one or more persons, of which at

least a majority are not members or

associated with a member of the

contract market, recognized futures

exchange or derivatives transaction

facility or employee thereof, and that are

not otherwise associated with the

contract market, recognized futures

exchange or derivatives transaction

facility (mixed panel): Provided,

78020 Federal Register / Vol. 65, No. 240 / Wednesday, December 13, 2000 / Rules and Regulations

however, that the list of qualified

organizations provided by a

Commission registrant that is a floor

broker need not include a registered

futures association unless a registered

futures association has been authorized

to act as a decision-maker in such

matters.

(ii) The customer shall, within fortyfive days after receipt of such list, notify

the opposing party of the organization

selected. A customer’s failure to provide

such notice shall give the opposing

party the right to select an organization

from the list.

(6) Fees. The agreement must

acknowledge that the Commission

registrant will pay any incremental fees

that may be assessed by a qualified

forum for provision of a mixed panel,

unless the arbitrators in a particular

proceeding determine that the customer

has acted in bad faith in initiating or

conducting that proceeding.

(7) Cautionary Language. The

agreement must include the following

language printed in large boldface type:

Three Forums Exist for the Resolution of

Commodity Disputes: Civil Court litigation,

reparations at the Commodity Futures

Trading Commission (CFTC) and arbitration

conducted by a self-regulatory or other

private organization.

The CFTC recognizes that the opportunity

to settle disputes by arbitration may in some

cases provide many benefits to customers,

including the ability to obtain an expeditious

and final resolution of disputes without

incurring substantial costs. The CFTC

requires, however, that each customer

individually examine the relative merits of

arbitration and that your consent to this

arbitration agreement be voluntary.

By signing this agreement, you: (1) May be

waiving your right to sue in a court of law;

and (2) are agreeing to be bound by

arbitration of any claims or counterclaims

which you or [name] may submit to

arbitration under this agreement. You are

not, however, waiving your right to elect

instead to petition the CFTC to institute

reparations proceedings under Section 14 of

the Commodity Exchange Act with respect to

any dispute that may be arbitrated pursuant

to this agreement. In the event a dispute

arises, you will be notified if [name] intends

to submit the dispute to arbitration. If you

believe a violation of the Commodity

Exchange Act is involved and if you prefer

to request a section 14 ‘‘Reparations’’

proceeding before the CFTC, you will have

45 days from the date of such notice in

which to make that election.

You need not sign this agreement to open

or maintain an account with [name]. See 17

CFR 166.5.

(d) Enforceability. A dispute

settlement procedure may require

parties utilizing such procedure to

agree, under applicable state law,

submission agreement or otherwise, to

be bound by an award rendered in the

procedure, provided that the agreement

to submit the claim or grievance to the

procedure was made in accordance with

paragraph (c) of this section or that the

agreement to submit the claim or

grievance was made after the claim or

grievance arose. Any award so rendered

shall be enforceable in accordance with

applicable law.

(e) Time limits for submission of

claims. The dispute settlement

procedure established by a contract

market, recognized futures exchange or

derivatives transaction facility shall not

include any unreasonably short

limitation period foreclosing submission

of customers’ claims or grievances or

counterclaims.

(f) Counterclaims. A procedure

established by a contract market,

recognized futures exchange, or

derivatives transaction facility under the

Act for the settlement of customers’

claims or grievances against a member

or employee thereof may permit the

submission of a counterclaim in the

procedure by a person against whom a

claim or grievance is brought. The

contract market, recognized futures

exchange, or derivatives transaction

facility may permit such a counterclaim

where the counterclaim arises out of the

transaction or occurrence that is the

subject of the customer’s claim or

grievance and does not require for

adjudication the presence of essential

witnesses, parties, or third persons over

whom the contract market, recognized

futures exchange, or derivatives

transaction facility does not have

jurisdiction. Other counterclaims arising

out of a transaction subject to the Act

and rules promulgated thereunder for

which the customer utilizes the services

of the registrant may be permissible

where the customer and the registrant

have agreed in advance to require that

all such submissions be included in the

proceeding, and if the aggregate

monetary value of the counterclaim is

capable of calculation.

(g) Institutional customers. (1) A

person who is an ‘‘institutional

customer’’ as defined in § 1.3(g) of this

chapter may negotiate any term of an

agreement or understanding with a

Commission registrant in which the

institutional customer agrees, prior to

the time a claim or grievance arises, to

submit such claim or grievance to any

settlement procedure, except that

signing the agreement must not be made

a condition for the institutional

customer to use the services offered by

the registrant.

(2) If the agreement is contained as a

clause or clauses of a broader

agreement, the institutional customer

must separately endorse the clause or

clauses containing the agreement;

Provided, however, a futures

commission merchant or introducing

broker may obtain such endorsement as

provided in § 1.55(d) of this chapter.

Issued in Washington, D.C. on November

21, 2000 by the Commission.

Jean A. Webb,

Secretary of the Commission.

[FR Doc. 00–30268 Filed 12–12–00; 8:45 am]

BILLING CODE 6351–01–P

COMMODITY FUTURES TRADING

COMMISSION

17 CFR Part 39

RIN 3038–AB57

A New Regulatory Framework for

Clearing Organizations

AGENCY: Commodity Futures Trading

Commission.

ACTION: Final rulemaking.

SUMMARY: The Commodity Futures

Trading Commission (Commission or

CFTC) is promulgating a new regulatory

framework to apply to clearing

organizations. These regulations for

clearing organizations are part of an

initiative that would also establish a

new regulatory framework for

multilateral transaction execution

facilities (MTEF) and market

intermediaries. The final new

framework in its entirety is

simultaneously announced today in

companion releases. The new

framework, including these regulations

are centered on broad, flexible, core

principles and are designed to ‘‘promote

innovation, maintain U.S.

competitiveness, and at the same time

reduce systemic risk and protect

customers.’’ The Commission has

fashioned these regulations so that it

can fairly and efficiently carry out the

important duty of overseeing clearing

organizations in a changing, dynamic

industry pursuant to a transparent

codified framework.

EFFECTIVE DATE: February 12, 2001.

FOR FURTHER INFORMATION CONTACT:

Alan L. Seifert, Deputy Director,

Division of Trading and Markets, or Lois

J. Gregory, Special Counsel, Division of

Trading and Markets, Commodity

Futures Trading Commission, Three

Lafayette Centre, 1155 21st Street, NW.,

Washington, DC 20581. Telephone (202)

418–5260 or e-mail PArchitzel@cftc.gov,

ASeifert@cftc.gov, or LGregory@cftc.gov.

SUPPLEMENTARY INFORMATION: