Document ID: SEC-2009-1722-0001
Agency: sec
Document Type: Notice
Title: Self-Regulatory Organizations; Proposed Rule Changes: Financial Industry Regulatory Authority, Inc.
Posted Date: 2009-12-08T05:00Z

[Federal Register: December 8, 2009 (Volume 74, Number 234)]
[Notices]               
[Page 64776-64778]
From the Federal Register Online via GPO Access [wais.access.gpo.gov]
[DOCID:fr08de09-110]                         

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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-61090; File No. SR-FINRA-2009-040]

 
Self-Regulatory Organizations; Financial Industry Regulatory 
Authority, Inc.; Notice of Filing of Proposed Rule Change as Modified 
by Amendment No. 2 To Adopt FINRA Rule 2380 To Limit the Leverage Ratio 
Offered by Broker-Dealers for Certain Forex Transactions

December 1, 2009.
    Pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934 
(``Act'' or ``Exchange Act'') \1\ and Rule 19b-4 thereunder,\2\ notice 
is hereby given that on June 4, 2009, Financial Industry Regulatory 
Authority, Inc. (``FINRA'') (f/k/a National Association of Securities 
Dealers, Inc. (``NASD'')) filed with the Securities and Exchange 
Commission (``SEC'' or ``Commission'') the proposed rule change as 
described in Items I, II, and III below, which Items have been 
substantially prepared by FINRA. The proposal was published for comment 
in the Federal Register on July 6, 2009.\3\ The Commission received 12 
comments on the proposal.\4\ FINRA responded to the comment letters \5\ 
and filed Amendment No. 1 to the proposed rule change on August 27, 
2009. On November 12, 2009, FINRA filed Amendment No. 2 to the proposed 
rule change.\6\ The Commission is publishing this notice to solicit 
comments on the proposed rule change as modified by Amendment No. 2 
from interested persons.
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    \10\ 17 CFR 200.30-3(a)(12).
    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
    \3\ Exchange Act Release No. 60172 (June 25, 2009), 74 FR 32022 
(July 6, 2009).
    \4\ See infra note 21.
    \5\ Letter from Gary L. Goldsholle, Vice President and Associate 
General Counsel, FINRA, to Elizabeth M. Murphy, Secretary, 
Commission, dated August 27, 2009 (``FINRA Response'').
    \6\ Amendment No. 2 replaced and superseded Amendment No. 1 in 
its entirety.
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I. Self-Regulatory Organization's Statement of the Terms of Substance 
of the Proposed Rule Change

    FINRA is proposing to adopt FINRA Rule 2380 to prohibit any member 
firm from permitting a customer to: (1) Initiate any forex position 
with a leverage ratio of greater than 4 to 1; and (2) withdraw money 
from an open forex position that would cause the leverage ratio for 
such position to be greater than 4 to 1. In addition, FINRA proposes to 
exempt from the proposed leverage limitation any security as defined in 
Section 3(a)(10) of the Securities Exchange Act of 1934.
    The text of the proposed rule change is available on FINRA's Web 
site at http://www.finra.org, at the principal office of FINRA and at 
the Commission's Public Reference Room.

II. Self-Regulatory Organization's Statement of the Purpose of, and 
Statutory Basis for, the Proposed Rule Change

    In its filing with the Commission, FINRA included statements 
concerning the purpose of and basis for the proposed rule change and 
discussed any comments it received on the proposed rule change. The 
text of these statements may be examined at the places specified in 
Item IV below. FINRA has prepared summaries, set forth in sections A, 
B, and C below, of the most significant aspects of such statements.

A. Self-Regulatory Organization's Statement of the Purpose of, and 
Statutory Basis for, the Proposed Rule Change

1. Purpose
    FINRA is proposing to limit the leverage ratio offered by broker-
dealers for certain forex transactions to no more than 4 to 1. 
Amendment No. 2 modifies the proposed leverage limitation from the 
original proposed rule change of 1.5 to 1 to 4 to 1, and makes 
conforming changes to Supplementary Material .01.\7\ In addition, FINRA 
proposes in Amendment No. 2 to exempt from the leverage limitation any 
security as defined in Section 3(a)(10) of the Securities Exchange Act 
of 1934, by adding paragraph (b) to the proposed rule change. Finally, 
Amendment No. 2 to the proposed rule change redesignates original 
paragraph (b) as paragraph (c) with no other modifications to the 
definitions contained in proposed paragraph (c).
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    \7\ See supra note 3.
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    FINRA is proposing to limit the leverage ratio offered by broker-
dealers for certain forex transactions to no more than 4 to 1. The 
proposed rule change addresses forex transactions in the off-exchange 
spot contract market. This market has grown in recent years following 
the passage of the Commodity Futures Modernization Act of 2000 
(``CFMA''), which permits certain enumerated entities, including 
broker-dealers, to act as counterparties to a retail forex contract.\8\ 
While most of the growth in this area has been concentrated in the 
futures commission merchant (``FCM'') channel, recent changes in 
legislation have brought greater interest to forex by broker-
dealers.\9\ The proposed rule change seeks to limit investor losses 
resulting from small changes in the exchange rate of a foreign currency 
and is intended to reduce the risks of excessive speculation.
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    \8\ Commodity Futures Modernization Act of 2000, Pub. L. 106-
554, 114 Stat. 2763, 2763A-378 (2001).
    \9\ See CFTC Reauthorization Act of 2008, Pub. L. 110-246, 122 
Stat. 1651 (2008).
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    Paragraph (a) of the proposed rule change states that no member 
shall permit a customer to initiate a forex position (as defined below) 
with a leverage ratio greater than 4 to 1. Thus, at the time a customer 
initiates a forex position, the customer must deposit at least \1/4\ of 
the notional value of the contract. Using the example in supplementary 
material .01, a customer entering into a forex contract representing 
$500,000 of a foreign currency must have an initial deposit of at least 
$125,000. The proposed rule change differs from the leverage limits in 
the FCM channel, where depending on the foreign currency selected, a 
customer at 400 to 1 leverage would need only an initial deposit of 
$1,875.
    In addition, paragraph (a) also states that ``no member shall 
permit a customer to withdraw money from an open forex position that 
would cause the leverage ratio for such position to be greater than 4 
to 1.'' This provision is intended to prevent a customer from 
depositing funds at the initiation of the forex position and then 
immediately withdrawing them once the position is established. If a 
customer were permitted to withdraw the funds once a position is 
established, the leverage limitation could easily be circumvented as 
the same deposit could be used to establish multiple forex positions.

[[Page 64777]]

    The limitation on a customer's ability to withdraw funds that would 
cause the leverage ratio to exceed 4 to 1 differs from a maintenance 
margin requirement in that an adverse movement in a customer's forex 
contract will not necessitate the deposit of additional funds. The 
intra-day and day-to-day pricing changes of a forex contract may cause 
a customer to have a leverage ratio greater than 4 to 1. So long as a 
customer does not withdraw funds from those initially used to establish 
the position, a leverage ratio may exceed 4 to 1. FINRA considered 
imposing a maintenance margin requirement but determined that the level 
of initial deposit was sufficiently high that a maintenance margin 
requirement was not necessary.
    The proposed rule change does not impact existing rules addressing 
the necessary customer funds to enter into and maintain a forex 
position. For example, Regulation T does not have margin requirements 
for forex and allows a customer to obtain nonpurpose credit in a good 
faith account to effect and carry transactions in forex.\10\ However, 
it should be noted that any funds deposited in a margin account to 
maintain a forex position or any account equity derived from a forex 
position may not be used to purchase securities in that account.
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    \10\ 12 CFR 220.6.
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    Paragraph (b) of the proposed rule change exempts from the leverage 
limitation any security as defined in Section 3(a)(10) of the 
Securities Exchange Act of 1934.
    Paragraph (c) of the proposed rule change establishes the key 
definitions. The term ``forex'' is defined to mean a foreign currency 
spot, forward, future, option or any other agreement, contract, or 
transaction in foreign currency that: (1) Is offered or entered into on 
a leveraged basis, or financed by the offeror, the counter party, or a 
person acting in concert with such person, (2) offered to or entered 
into with persons that are not eligible contract participants; \11\ and 
(3) not executed on or subject to the rules of a contract market,\12\ 
derivatives transaction execution facility,\13\ national securities 
exchange,\14\ or foreign board of trade.\15\ FINRA's definition of 
forex is similar to the National Futures Association's (``NFA'') 
definition of forex \16\ and to amended Section 2(c)(2) of the 
Commodity Exchange Act which sets forth the scope of the Commodity 
Futures Trading Commission's (``CFTC'') rulemaking jurisdiction.\17\ 
The FINRA definition, however, does not contain an exclusion for 
certain spot and forward contracts found in the NFA and CFTC 
definitions, which were included due to CFTC jurisdictional 
limitations.\18\
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    \11\ ``Eligible Contract Participants'' (``ECPs'') include 
regulated entities such as financial institutions, insurance 
companies, investment companies and broker-dealers. Certain 
corporations and individuals qualify as ECPs by meeting the 
requirements under the statute. See 7 U.S.C. 1a(12).
    \12\ ``Contract markets'' are markets that are designated by the 
CFTC that meet the criteria in Section 5 of the Commodity Exchange 
Act. See 7 U.S.C. 7.
    \13\ ``Derivatives transaction execution facilities'' 
(``DTEFs'') are CFTC-registered trading facilities that limit access 
primarily to institutional or otherwise eligible traders and/or 
limit the products traded. See 7 U.S.C. 7a.
    \14\ A ``national securities exchange'' is a securities exchange 
that has registered with the SEC under Section 6 of the Exchange 
Act. See 15 U.S.C. 78f.
    \15\ A ``foreign board of trade'' means any organized exchange 
or trading facility located outside of the United States.
    \16\ NFA By-Law 1507(b).
    \17\ See CFTC Reauthorization Act of 2008, 13101 (to be codified 
at 7 U.S.C. 2(c)(2)(C)(i)(I)).
    \18\ NFA By-Law 1507(b) and CFTC Reauthorization Act of 2008, 
13101 (to be codified at 7 U.S.C. 2(c)(2)(C)(i)(II)).
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    Paragraph (c) also defines the term ``leverage ratio'' to mean the 
fraction represented by the numerator which is the notional value of a 
forex transaction, and the denominator, which is the amount of good 
faith deposit or account equity required from the customer for a forex 
position. For example, if the notional value of a forex contract is 
$250,000, and the customer deposits $200,000, the leverage ratio would 
be 1.25 to 1.
    FINRA will announce the effective date of the proposed rule change 
in a Regulatory Notice to be published no later than 60 days following 
Commission approval. The effective date will be 30 days following 
publication of the Regulatory Notice announcing Commission approval.
2. Statutory Basis
    FINRA believes that the proposed rule change is consistent with the 
provisions of Section 15A(b)(6) of the Act,\19\ which requires, among 
other things, that FINRA rules must be designed to prevent fraudulent 
and manipulative acts and practices, to promote just and equitable 
principles of trade, and, in general, to protect investors and the 
public interest. FINRA believes that the proposed rule change is 
consistent with the provisions of the Act noted above in that it will 
limit leverage ratios, requiring greater initial deposits that will 
substantially reduce the likelihood that any small adverse percentage 
change in the exchange rate of a foreign currency will cause an 
investor's funds to be wiped out. Moreover, limiting the leverage 
ratios is intended to reduce the risks of excessive speculation.
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    \19\ 15 U.S.C. 78o-3(b)(6).
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B. Self-Regulatory Organization's Statement on Burden on Competition

    FINRA does not believe that the proposed rule change will result in 
any burden on competition that is not necessary or appropriate in 
furtherance of the purposes of the Act.

C. Self-Regulatory Organization's Statement on Comments on the Proposed 
Rule Change Received From Members, Participants, or Others

1. Proposed Rule Change as Modified by Amendment No. 2
    No written comments were either solicited or received on the 
proposed rule change as modified by Amendment No. 2.
2. Comments Received in Response to Original Proposed Rule Change with 
1.5 to 1 Leverage Ratio
    The Commission, however, solicited comment on the original proposed 
rule change which proposed a leverage ratio of 1.5 to 1.\20\ The 
comment period ended on July 29, 2009. The Commission received 12 
comments.\21\ Commenters generally opposed the original proposed rule 
change.\22\ Retail investors generally opposed the original proposed 
rule change stating that the original proposed leverage ratio of 1.5 to 
1 would effectively ban participation in the forex market for most 
average retail traders.\23\ One commenter stated that it is up to the 
Federal Reserve to set margin requirements.\24\ Three commenters stated 
that the original proposed leverage limitation of 1.5 to 1 was 
arbitrary and is unfair to dually-registered FCM/broker-dealers.\25\ 
One commenter suggested that dually-registered FCM/broker-dealers be 
exempted from the original proposed leverage limitation.\26\ FINRA 
responded to the comments and filed Amendment

[[Page 64778]]

No. 1 on August 27, 2009.\27\ In its response to comments to the 
original proposed rule change, FINRA noted that the original proposed 
rule change received almost no opposition from the retail investor 
community, in contrast to the comments received in response to FINRA 
Regulatory Notice 09-06 because FINRA believes that these investors now 
better understand the nature of the proposal and the scope of FINRA's 
jurisdiction.\28\ In addition, FINRA stated that the thrust of the 
remaining three comment letters is to advance the pecuniary interests 
of dually-registered FCM/broker-dealers at the expense of investor 
protection.\29\ In response to comments and subsequent meetings with 
the Commission, however, FINRA filed Amendment No. 2 to the proposed 
rule change on November 12, 2009 to increase the proposed leverage 
ratio from 1.5 to 1 to 4:1.
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    \20\ See supra note 3.
    \21\ See letters from Mike Andrews (February 8, 2009); Mike 
Andrews (February 8, 2009) (``Andrews 2''); Steve Gallagher et al. 
(February 11, 2009); Steve Gallagher (February 11, 2009); Mary M. 
Jackson (February 17, 2009); Aaron I. Cohn (February 21, 2009); 
George Selinsky (June 13, 2009); Ryan Koester (June 13, 2009); 
Douglas W. Schriner, CEO, Harrison Douglas, Inc. (July 20, 2009); 
Interactive Brokers LLC (July 27, 2009); TD AMERITRADE, Inc and 
thinkorswim Group Inc. (July 27, 2009) (``TD/thinkorswim''); and 
Futures Industry Association (July 27, 2009) (``FIA'').
    \22\ Id.
    \23\ Selinsky; Cohn; Gallagher et al; Gallagher; Jackson; 
Koester; Andrews; Andrews 2.
    \24\ Harrison Douglas.
    \25\ Interactive Brokers; TD/thinkorswim; FIA.
    \26\ Interactive Brokers.
    \27\ See FINRA Response, supra note 5.
    \28\ Id.
    \29\ Id. FIA; Interactive Brokers; and TD/thinkorswim.
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    3. Comments Received in Response to FINRA Regulatory Notice 09-06 
with Original Proposed 1.5 to 1 Leverage Limitation
    In addition, the original proposed rule change was published for 
comment in FINRA Regulatory Notice 09-06 (January 2009). FINRA received 
109 comments in response to the Regulatory Notice. A copy of the 
Regulatory Notice is attached as Exhibit 2a, the index to the comment 
letters is attached as Exhibit 2b and copies of the comment letters 
received in response to the Regulatory Notice are attached as Exhibit 
2c.\30\ FINRA's response to these comment letters is discussed in the 
Exchange Act Release No. 60172, which solicited comment on the original 
proposed rule change.\31\
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    \30\ All references to commenters under this Item are to the 
commenters as listed in Exhibit 2b to the proposed rule change [SR-
FINRA-2009-040].
    \31\ See supra note 3, Section II.C of original proposed rule 
change.
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III. Date of Effectiveness of the Proposed Rule Change and Timing for 
Commission Action

    Within 35 days of the date of publication of this notice in the 
Federal Register or within such longer period (i) as the Commission may 
designate up to 90 days of such date if it finds such longer period to 
be appropriate and publishes its reasons for so finding or (ii) as to 
which the self-regulatory organization consents, the Commission will:
    (A) By order approve such proposed rule change, or
    (B) institute proceedings to determine whether the proposed rule 
change should be disapproved.

IV. Solicitation of Comments

    Interested persons are invited to submit written data, views and 
arguments concerning the proposed rule change as modified by Amendment 
No. 2, including whether the proposed rule change is consistent with 
the Act. Comments may be submitted by any of the following methods:

Electronic Comments

     Use the Commission's Internet comment form (http://
www.sec.gov/rules/sro.shtml); or
     Send an e-mail to rule-comments@sec.gov. Please include 
File Number SR-FINRA-2009-040 on the subject line.

Paper Comments

     Send paper comments in triplicate to Elizabeth M. Murphy, 
Secretary, Securities and Exchange Commission, 100 F Street, NE., 
Washington, DC 20549-1090.

All submissions should refer to File Number SR-FINRA-2009-040. This 
file number should be included on the subject line if e-mail is used. 
To help the Commission process and review your comments more 
efficiently, please use only one method. The Commission will post all 
comments on the Commission's Internet Web site (http://www.sec.gov/
rules/sro.shtml). Copies of the submission, all subsequent amendments, 
all written statements with respect to the proposed rule change that 
are filed with the Commission, and all written communications relating 
to the proposed rule change between the Commission and any person, 
other than those that may be withheld from the public in accordance 
with the provisions of 5 U.S.C. 552, will be available for inspection 
and copying in the Commission's Public Reference Room, 100 F Street, 
NE., Washington, DC 20549, on official business days between the hours 
of 10 a.m. and 3 p.m. Copies of such filing also will be available for 
inspection and copying at the principal office of FINRA. All comments 
received will be posted without change; the Commission does not edit 
personal identifying information from submissions. You should submit 
only information that you wish to make available publicly. All 
submissions should refer to File Number SR-FINRA-2009-040 and should be 
submitted on or before December 29, 2009.

    For the Commission, by the Division of Trading and Markets, 
pursuant to delegated authority.\32\
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    \32\ 17 CFR 200.30-3(a)(12).
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Florence E. Harmon,
Deputy Secretary.
[FR Doc. E9-29131 Filed 12-7-09; 8:45 am]

BILLING CODE 8011-01-P