[Federal Register Volume 65, Number 78 (Friday, April 21, 2000)]
[Rules and Regulations]
[Pages 21309-21311]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 00-9647]


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COMMODITY FUTURES TRADING COMMISSION

17 CFR Part 1

RIN 3038-AB51


Minimum Financial Requirements for Futures Commission Merchants 
and Introducing Brokers

AGENCY: Commodity Futures Trading Commission.

ACTION: Final rules.

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SUMMARY: The Commodity Futures Trading Commission (``Commission'') is 
amending Regulation 1.17, which governs the minimum financial 
requirements imposed upon futures commission merchants (``FCMs'') and 
introducing brokers (``IBs''). The amendments will ease the 
restrictions imposed upon the withdrawal of equity capital from an FCM. 
The amendments also increase the percentage deduction (i.e., 
``haircut'') applied to the value of equity securities pledged as 
collateral for secured demand notes that are included in the adjusted 
net capital of an FCM or IB and delete a reference to a section of the 
Securities and Exchange Commission's (``SEC'') capital rule that has 
been repealed.

EFFECTIVE DATE: May 22, 2000.

FOR FURTHER INFORMATION CONTACT: Henry J. Matecki, Financial Audit and 
Review Branch, Commodity Futures Trading Commission, 300 S. Riverside 
Plaza, Room 1600-N, Chicago, IL 60606; telephone (312) 886-3217; 
electronic mail <a href="/cdn-cgi/l/email-protection#4f27222e3b2a2c24260f2c293b2c61282039"><span class="__cf_email__" data-cfemail="d6bebbb7a2b3b5bdbf96b5b0a2b5f8b1b9a0">[email protected]</span></a>: or Thomas J. Smith, Special Counsel, 
Division of Trading and Markets, Commodity Futures Trading Commission, 
Three Lafayette Centre, 1155 21st Street, NW., Washington, DC 20581; 
telephone (202) 418-5495; electronic mail <a href="/cdn-cgi/l/email-protection#f084839d998498b093968493de979f86"><span class="__cf_email__" data-cfemail="97e3e4fafee3ffd7f4f1e3f4b9f0f8e1">[email protected]</span></a>.

SUPPLEMENTARY INFORMATION

I. Background

    On February 10, 2000, the Commission published in the Federal 
Register \1\ for public comment proposed amendments to Regulation 1.17, 
which governs the minimum financial requirements imposed upon FCMs and 
IBs (the ``Proposal'').\2\ The Proposal was to: (1) Ease the 
restrictions imposed upon the withdrawal of equity capital from an FCM; 
(2) increase the percentage deduction (i.e., ``haircut'') applied to 
the value of equity securities pledged as collateral for secured demand 
notes that are included in the adjusted net capital of an FCM or IB; 
and (3) delete a reference to a section of the SEC's capital rules that 
has been repealed. The comment period expired on March 13, 2000. No 
comments were received.
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    \1\ 65 FR 6569 (February 10, 2000).
    \2\ Commission rules cited herein can be found at 17 CFR Ch. I 
(1999).
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    After considering the issues, the Commission has determined to 
adopt the amendments as proposed. A discussion of the final rule 
amendments is provided below.

II. Rule Amendments

A. Restriction on the Withdrawal of Equity Capital From an FCM

    Commission Regulation 1.17(e) prohibits the withdrawal of equity 
capital from an FCM \3\ to redeem or to repurchase shares of stock of 
the FCM, to pay dividends, or to make an unsecured advance or loan to a 
stockholder, partner, sole proprietor or employee of the FCM if, after 
giving effect to the withdrawal and to certain other specified 
withdrawals and payments, the FCM's adjusted net capital would be less 
than the greatest of:
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    \3\ The prohibition against withdrawal of equity capital set 
forth in Regulation 1.17(e) applies to both FCMs and IBs. The 
restriction requires consideration of both the minimum dollar amount 
of net capital required for both types of registrants ($250,000 for 
FCMs and $30,000 for IBs) and, just for FCMs, the amount of funds 
required to be segregated and set aside for FCMs' customers. For 
purposes of this final rulemaking, only the restriction on FCMs need 
be addressed since the amendments relate only to the percentage 
applied to the amount of funds required to be segregated and set 
aside for customers.
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    (1) $300,000 (120 percent of the $250,000 minimum adjusted net 
capital requirement);
    (2) Seven percent of the customer funds required to be segregated 
or set aside pursuant to the Commodity Exchange Act (``Act'') and 
Commission regulations, \4\ (hereinafter collectively referred to as 
the ``customer segregated and secured amount'');
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    \4\ Before applying the percentage capital factor, the amount 
required to be segregated or set aside is reduced by the market 
value of commodity options purchased by customers on or subject to 
the rules of a contract market or a foreign board of trade for which 
the full premiums have been paid: provided, however, that the option 
premium deduction for each customer is limited to the amount of 
customer funds and the foreign futures and foreign options secured 
amounts in such customer's account(s).
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    (3) 120 percent of the amount of adjusted net capital required by a 
registered futures association of which the FCM is a member; or
    (4) For an FCM that is also a securities broker or dealer 
registered with the SEC, the amount of net capital specified in SEC 
Rule 15c3-1(e).\5\
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    \5\ SEC rules cited herein can be found at 17 CFR Part 240 
(1999).

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[[Page 21310]]

    The Commission is amending the restriction in (2) above to permit 
the withdrawal of equity capital from an FCM provided that, after 
giving effect to the withdrawal, the FCM's adjusted net capital is in 
excess of six percent of the customer segregated and secured amount. 
The Commission believes that easing this restriction is appropriate in 
light of other provisions of the Commission's regulations that provide 
adequate assurances against the excessive withdrawal of equity capital.
    Generally, FCMs that carry customer positions are required to 
maintain minimum adjusted net capital of at least four percent of the 
customer segregated and secured amount.\6\ FCMs that are members of 
self-regulatory organizations (``SROs''--that is, commodity exchanges 
and NFA) also must comply with the minimum net capital requirements of 
those exchanges, which are required to be at least as stringent as the 
Commission's.\7\
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    \6\ Regulation 1.17(a)(1)(i). FCMs that are also registered with 
the SEC as securities brokers or dealers are required to comply with 
the Commission's minimum adjusted net capital requirement or the 
minimum adjusted net capital requirement established by SEC Rule 
15c3-1(e), whichever is greater.
    \7\ Regulations 1.17(a)(2)(i) and 1.52.
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    An FCM that fails to comply with the minimum net capital 
requirement must transfer all customer accounts and immediately cease 
doing business as an FCM.\8\ Therefore, each FCM must ensure that a 
capital withdrawal does not cause the FCM's adjusted net capital to 
fall below four percent of the customer segregated and secured amount.
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    \8\ Regulation 1.17(a)(4).
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    In addition, as stated in the Proposal, the Commission's ``early 
warning'' notice and financial reporting requirements deter excessive 
equity withdrawals. Regulation 1.12(b)(2) requires an FCM to notify in 
writing the Commission and its designated self-regulatory organization 
(``DSRO'') if its adjusted net capital does not equal or exceed six 
percent of the customer segregated and secured amount. The early 
warning notices must be filed within five business days of the FCM's 
adjusted net capital falling below the early warning level. Moreover, 
Regulation 1.12(g)(2) requires an FCM to give the Commission written 
notice at least two business days prior to a planned withdrawal of 
equity capital if such withdrawal would reduce excess net capital by 30 
percent or more from that most recently reported in a financial report 
filed with the Commission.
    An FCM that hits the early warning trigger is also required to file 
a financial report on Form 1-FR-FCM with the Commission and its DSRO as 
of the close of the month during which its adjusted net capital does 
not exceed the early warning level and for each month thereafter until 
three successive months have elapsed during which its adjusted net 
capital is at all times equal to or in excess of the early warning 
level.\9\ The early warning notices bring to the Commission's and 
DSRO's attention firms that should be subjected to closer monitoring 
because of their minimal regulatory capital.
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    \9\ Regulation 1.12(b)(4).
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    Furthermore, the Commission's ``debt-equity ratio'' requirement 
also provides a limit on the amount of capital that may be withdrawn 
from an FCM. Regulation 1.17(d) prohibits the withdrawal of capital 
from an FCM if, after giving effect to the withdrawal, the FCM's equity 
capital would be less than 30 percent of its debt-equity total.\10\ 
Finally, as noted in the Proposal, setting the capital withdrawal limit 
at the Commission's early warning level is consistent with the capital 
withdrawal rules adopted by the SEC for securities brokers or dealers 
that compute their minimum net capital requirement in accordance with 
the ``alternative'' method.\11\
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    \10\ Equity capital is defined by Regulation 1.17(d)(1) to 
include certain loans subject to qualifying satisfactory 
subordination agreements and the following: (1) In the case of a 
corporation, the sum of its par or stated value of capital stock, 
paid in capital in excess of par, retained earnings, unrealized 
profit and loss, and other capital accounts;
    (2) In the case of a partnership, the sum of its capital 
accounts of partners (inclusive of such partners' commodity interest 
and securities accounts subject to the provisions of Rule 1.17(e) 
concerning restrictions on withdrawals of equity capital), and 
unrealized profit and loss; and
    (3) In the case of a sole proprietorship, the sum of its capital 
accounts and unrealized profit and loss.
    ``Debt-equity total'' is defined by Regulation 1.17(d)(2) and 
encompasses equity capital as defined above plus loans subject to 
satisfactory subordination agreements that do not qualify as equity 
capital under Regulation 1.17(d)(1).
    \11\ See SEC Rule 15c3-1(a)(1)(ii).
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B. Equity Securities Pledged as Collateral for Secured Demand Notes

    The Commission is amending Regulation 1.17(h)(1)(iii) to increase 
from 15 percent to 30 percent the haircut that is applied to equity 
securities collateralizing secured demand notes that are included in an 
FCM's or IB's adjusted net capital computation. The amendment will 
provide greater uniformity between the Commission's and SEC's capital 
rules.
    As stated in the Proposal, SEC capital rules currently require 
brokers and dealers to apply a 30 percent haircut to equity securities 
collateralizing secured demand notes included in the brokers' or 
dealers' adjusted net capital.\12\ Uniform capital rules reduce the 
regulatory burden imposed upon dually-registered FCMs (i.e., FCMs that 
are also SEC registered securities brokers or dealers) by more readily 
permitting such FCMs to comply with both the Commission's and SEC's 
capital rules.
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    \12\ See Rule 15c3-1d(a)(2)(iii).
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    Furthermore, as more fully discussed in the Proposal, the 
Commission's capital rules incorporate by reference the securities 
haircuts set forth in the SEC's capital rules. In 1992, the SEC adopted 
several amendments to its capital rules. One of the amendments had the 
unintended consequence of reducing from 30 percent to 15 percent the 
haircut that an FCM was required to apply to equity securities 
collateralizing a secured demand note. \13\ Brokers and dealers, 
however, were still required to apply a 30 percent haircut to such 
equity securities. The amendments would restore the haircut to the 30 
percent level.
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    \13\ See 57FR 56984 (December 2, 1992).
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C. Technical Amendment

    The Commission is amending Regulation 1.17(c)(5)(v) to delete a 
reference to SEC Rule 15c3-1(f) which has been repealed.\14\ The 
technical amendment has no impact on the Commission's capital rule and 
will not affect FCMs or IBs.
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    \14\ See 57 FR 56973 (December 2, 1992).
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III. Related Matters

A. Regulatory Flexibility Act

    The Regulatory Flexibility Act (``RFA''), 5 U.S.C. 601-611, 
requires that agencies, in proposing rules, consider the impact of 
those rules on small businesses. The rule amendments discussed herein 
would affect FCMs and IBs. The Commission has previously determined 
that, based upon the fiduciary nature of FCM/customer relationships, as 
well as the requirement that FCMs meet minimum financial requirements, 
FCMs should be excluded from the definition of small entity.
    With respect to IBs, the Commission stated that it is appropriate 
to evaluate within the context of a particular rule whether some or all 
IBs should be

[[Page 21311]]

considered to be small entities and, if so, to analyze the economic 
impact on such entities at that time. The technical amendment to 
Regulation 1.17(c)(5)(v) and the amendment to Regulation 1.17(e) easing 
the restriction on the withdrawal of equity capital from an FCM do not 
impose additional requirements on an IB. The amendment to Regulation 
1.17(h)(1)(iii) increasing the haircut on equity securities submitted 
as collateral for a secured demand note may have a minimal economic 
impact on an IB's financial operations. The amendment, however, 
conforms the Commission's rules to those of the SEC and restores the 
haircut to its previous level prior to the SEC amendment of its capital 
rules in December 1992. Furthermore, no comments were received in 
response to the Commission's specific request for comments on the 
impact these rules, as proposed, would have on small entities. Thus, on 
behalf of the Commission, the Chairman certifies that the rule 
amendments will not have a significant economic impact on a substantial 
number of small entities.

B. Paperwork Reduction Act

    The Paperwork Reduction Act of 1995 (PRA), 44 U.S.C. 3501 et seq., 
requires federal agencies (including the Commission) to review rules 
and rule amendments to evaluate the information collection burden that 
they impose on the public. The Commission believes that paragraphs 
(c)(5)(v), (e)(1)(ii), and (h)(1)(iii) of Rule 1.17, as amended, do not 
impose an information collection burden on the public.

List of Subjects in 17 CFR Part 1

    Brokers, Commodity futures.

    In consideration of the foregoing and pursuant to the authority 
contained in the Commodity Exchange Act and, in particular, Sections 
4f, 4g and 8a (5) thereof, 7 U.S.C. 6d, 6g and 12a(5), the Commission 
hereby amends Chapter I of Title 17 of the Code of Federal Regulations 
as follows:

PART 1--GENERAL REGULATIONS UNDER THE COMMODITY EXCHANGE ACT

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

    Authority: 7 U.S.C. 1a, 2, 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 1.17 is amended by revising paragraphs (c)(5)(v), 
(e)(1)(ii), and (h)(1)(iii) to read as follows:


Sec. 1.17  Minimum financial requirements for futures commission 
merchants and introducing brokers.

* * * * *
    (c) * * *
    (5) * * *
    (v) In the case of securities and obligations used by the applicant 
or registrant in computing net capital, and in the case of a futures 
commission merchant with securities in segregation pursuant to section 
4d(2) of the Act and the regulations in this chapter which were not 
deposited by customers, the percentages specified in Rule 240.15c3-
1(c)(2)(vi) of the Securities and Exchange Commission (17 CFR 240.15c3-
1(c)(2)(vi)) (``securities haircuts'') and 100 percent of the value of 
``nonmarketable securities'' as specified in Rule 240.15c3-1(c)(2)(vii) 
of the Securities and Exchange Commission (17 CFR 240.15c3-
1(c)(2)(vii));
* * * * *
    (e)* * *
    (1)* * *
    (ii) For a futures commission merchant or applicant therefor, 6 
percent of the following amount: The customer funds required to be 
segregated pursuant to the Act and the regulations in this part and the 
foreign futures or foreign options secured amount, less the market 
value of commodity options purchased by customers on or subject to the 
rules of a contract market or a foreign board of trade for which the 
full premiums have been paid: Provided, however, That the deduction for 
each customer shall be limited to the amount of customer funds in such 
customer's account(s) and foreign futures and foreign options secured 
amounts;
* * * * *
    (h)* * *
    (1)* * *
    (iii) The term ``collateral value'' of any securities pledged to 
secure a secured demand note means the market value of such securities 
after giving effect to the percentage deductions specified in Rule 
240.15c3-1d(a)(2)(iii) of the Securities and Exchange Commission (17 
CFR 240.15c3-1d(a)(2)(iii)).
* * * * *

    Issued in Washington D.C. on April 12, 2000 by the Commission.
Jean A. Webb,
Secretary of the Commission.
[FR Doc. 00-9647 Filed 4-20-00; 8:45 am]
BILLING CODE 6351-01-P


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