Source: https://www.federalregister.gov/documents/2007/01/10/E7-173/limitations-on-withdrawals-of-equity-capital
Timestamp: 2018-04-26 02:23:15
Document Index: 37702800

Matched Legal Cases: ['art 1', 'art 30', 'art 30', '§\u2009240', '§\u20091', '§\u20091', '§\u20091', '§\u20091']

A Rule by the Commodity Futures Trading Commission on 01/10/2007
72 FR 1148
https://www.federalregister.gov/d/E7-173 https://www.federalregister.gov/d/E7-173
The Commodity Futures Trading Commission (“Commission”) is amending its regulations to provide that the Commission may, by written order, temporarily prohibit a futures commission merchant (“FCM”) from carrying out equity withdrawal transactions that would reduce excess adjusted net capital by 30 percent or more. The proposed orders would be based on the Commission's determination that such withdrawal Start Printed Page 1149transactions could be detrimental to the financial integrity of FCMs or could adversely affect their ability to meet customer obligations. The proposed amendments also would provide that an FCM may file with the Commission a petition for rescission of an order temporarily prohibiting equity withdrawals from the FCM.
Thomas J. Smith, Deputy Director and Chief Accountant, at (202) 418-5430, or Thelma Diaz, Special Counsel, at (202) 418-5137, Division of Clearing and Intermediary Oversight, Commodity Futures Trading Commission, Three Lafayette Centre, 1155 21st Street, NW., Washington, DC 20581. Electronic mail: tsmith@cftc.gov or tdiaz@cftc.gov.
The Commission issued a release with proposed amendments to Part 1 of the Commission's regulations in September of 2006, as published for notice and comment in the Federal Register (the “Proposing Release”).[1] The Commission received comment letters from the Joint Audit Committee (“JAC”) [2] and two designated contracts markets, the Chicago Mercantile Exchange, Inc. and the Minneapolis Grain Exchange.[3] All of the commenters endorsed the proposed amendments to Regulation 1.17(g), which would provide for Commission orders that temporarily restrict equity capital withdrawals from FCMs if the Commission finds that such withdrawals may be detrimental to the financial integrity of the FCM or may unduly jeopardize its ability to meet customer obligations or other liabilities that may cause a significant impact on the markets. The Proposing Release also included other proposed amendments to Regulations 1.12 and 1.17, which would update these regulations by adding references to “limited liability companies” and “limited liability company members.” [4] For the reasons discussed below, the Commission is adopting each of these amendments as proposed in the Proposing Release.
Commission Regulation 1.17(e) prohibits all equity withdrawal transactions that would reduce the adjusted net capital of FCMs or introducing brokers (“IBs”) beyond the amounts permitted by the regulation.[5] The transactions affected by the regulation include any withdrawals made by the action of a stockholder or partner or by redemption or repurchase of shares of stock by “consolidated entities”,[6] dividend payments or similar distributions, or through unsecured advances or loans made to stockholders, partners, sole proprietors, or employees. When determining the effect of the proposed equity withdrawal transaction on the firm's capital, the firm also must take into account other pending equity withdrawal transactions and scheduled liability payments that will reduce its capital within six months after the subject equity withdrawal transaction.[7] The proposed equity withdrawal transaction is prohibited if, when added together with such other planned capital reductions, it would result in capital levels that are less than required by Regulation 1.17(e).
The purpose of these equity withdrawal restrictions is to help preserve and enhance the required compliance by FCMs and IBs with the minimum financial requirements set forth in the Commission's regulations.[8] As the Commission has explained elsewhere, the Commission's minimum financial requirements protect customers and other market participants by requiring FCMs and IBs to maintain minimum levels of liquid assets in excess of their liabilities to finance their business activities.[9] Moreover, pursuant to Section 4d of the Act,[10] FCMs are required to segregate from their own assets all money, securities, and other property held for customers as margin for their commodity futures and option contracts, as well as any gains accruing to customers from their open futures and option positions. Part 30 of the Commission's regulations also calls for FCMs to set aside funds, called the “foreign futures and foreign options secured amount”, to help protect the funds of U.S. customers trading on non-U.S. futures markets.[11] In the event of a shortfall in the Section 4d segregated funds or the Part 30 secured funds that an FCM must hold, the Commission's minimum net capital requirements provide protection to customers by requiring each FCM to maintain a minimum level of assets that are readily available to be contributed in the event of a shortfall in the customer funds. The minimum capital requirements also protect customers and market participants by ensuring that an FCM remains solvent while waiting for margin calls to be met.
As an additional measure to ensure capital compliance by FCMs, Commission Regulation 1.12(g)(2) requires each FCM to provide notice to the Commission of certain equity withdrawal transactions.[12] In particular, Regulation 1.12(g)(2) requires each FCM to provide notice at least two business days prior to an action to withdraw equity from the FCM, or a subsidiary or affiliate consolidated pursuant to Regulation 1.17(f), if the equity withdrawal transaction would cause, on a net basis, a reduction in the FCM's excess adjusted net capital of 30 percent or more. In response to the receipt of such a notice, Regulation 1.12(g)(3) provides that the Director of the Commission's Division of Clearing and Intermediary Oversight (“Division”), or the Director's designee, may require that the FCM provide, within three business Start Printed Page 1150days from the date of the request or such shorter period as the Director or designee may specify, such other information as the Director or designee determines to be necessary based upon market conditions, reports provided by the FCM, or other available information.[13]
When first proposing the notification provision eventually adopted as Regulation 1.12(g)(2), the Commission noted that it could serve as “early warning” of impending financial difficulties at an FCM or at its holding company.[14] The only consequence that the regulation expressly contemplates as a result of the warning is that the Commission may require additional information from the FCM, with the response to be provided in a period of three days or less, as directed by the Commission. At the time that Regulation 1.2(g)(2) was adopted, the Commission determined that it was not necessary to adopt additional limitations within the Commission's regulations on equity withdrawal transactions.[15]
In response to these foregoing events, the Securities and Exchange Commission (“SEC”) issued an order to temporarily restrict withdrawals of capital from two other subsidiaries of the holding company, which were registered as securities broker-dealers.[16] In issuing the order, the SEC cited to its regulation, 17 CFR 240.15c3-1(e)(3)(i), which provides that the SEC may by order restrict, for a period up to twenty business days, any withdrawal by the broker or dealer of equity capital or unsecured loan or advance to a stockholder, partner, sole proprietor, employee or affiliate, if (1) such withdrawal, advance or loan when aggregated with all other withdrawals, advances or loans on a net basis during a 30 calendar day period, exceeds 30 percent of the broker or dealer's excess net capital; and (2) the SEC, based on the facts and information available, concludes that the withdrawal, advance or loan may be detrimental to the financial integrity of the broker or dealer, or may unduly jeopardize the broker or dealer's ability to repay its customer claims or other liabilities that may cause a significant impact on the markets or expose the customers or creditors of the broker or dealer to loss without taking into account the application of the Securities Investor Protection Act.[17] As described by the SEC, § 240.15c3-1(e)(3)(i) enables the SEC and its staff to examine further the financial condition of the broker-dealer, so as to determine whether, and under what circumstances, to permit the withdrawal, entirely or partially, or to prohibit the withdrawal for additional periods by issuing subsequent orders, with terms that are no longer than twenty business days.[18]
As proposed in the Proposing Release, the Commission is adding a new paragraph (g) to Regulation 1.17, which will enhance the Commission's ability, in the face of fast-developing events, to impose temporary restrictions on the flow of capital from an FCM to its holding company and other affiliated entities, as appropriate.[19] It is imperative that the Commission have the option to consider requiring such temporary delays of equity withdrawals whenever urgent circumstances so require. Under the amended regulation, the Commission may issue a written order to impose temporary restrictions on equity withdrawals for a period of up to twenty business days, and the Commission may continue to make the restrictions effective against the FCM by issuing subsequent orders, each with a term of no more than twenty business days. The order would restrict any withdrawal by the FCM of equity capital, or any unsecured advance or loan to a stockholder, partner, limited liability company member, sole proprietor, employee or affiliate, if:
During the periods that such orders are effective, Commission staff may evaluate the effect of the proposed withdrawals on the continuing adequacy of customer safeguards at the firm, including the continuing adequacy of the firm's liquid assets, in light of the most current information available from the FCM concerning its operations and those of its holding company and affiliates. These amendments to Regulation 1.17 may therefore serve to further enhance the security of customer funds and the overall financial integrity of the futures markets.[20]
The Regulatory Flexibility Act (“RFA”), 5 U.S.C. 601 et seq., requires that agencies, when amending their rules, consider the impact of those amendments on small businesses. The Commission included in the Proposing Release a certification from the Chairman that these rules would not have a significant economic impact on a substantial number of small entities.[21] The Commission received no comments on the certification.
The Paperwork Reduction Act of 1995 (“PRA”) [22] imposes certain requirements on federal agencies (including the Commission) in connection with their conducting or sponsoring any collection of information as defined by the PRA. As noted in the Proposing Release,[23] these amended regulations do not require a new collection of information on the part of the entities that are subject to the amended regulations.
The Commission invited, but did not receive, public comment on its application of the cost-benefit provision.[24] After considering these factors, the Commission has determined to issue this final rule.
(2) If equity capital of the futures commission merchant or a subsidiary or affiliate of the futures commission merchant consolidated pursuant to § 1.17(f) (or 17 CFR 240.15c3-1e) would be withdrawn by action of a stockholder or a partner or a limited liability company member or by redemption or repurchase of shares of stock by any of Start Printed Page 1152the consolidated entities or through the payment of dividends or any similar distribution, or an unsecured advance or loan would be made to a stockholder, partner, sole proprietor, limited liability company member, employee or affiliate, such that the withdrawal, advance or loan would cause, on a net basis, a reduction in excess adjusted net capital (or, if the futures commission merchant is qualified to use the filing option available under § 1.10(h), excess net capital as defined in the rules of the Securities and Exchange Commission) of 30 percent or more, notice must be provided at least two business days prior to the withdrawal, advance or loan that would cause the reduction: Provided, however, That the provisions of paragraphs (g)(1) and (g)(2) of this section do not apply to any futures or securities transaction in the ordinary course of business between a futures commission merchant and any affiliate where the futures commission merchant makes payment to or on behalf of such affiliate for such transaction and then receives payment from such affiliate for such transaction within two business days from the date of the transaction.
(i) Such withdrawal, advance or loan would cause, when aggregated with all other withdrawals, advances or loans during a 30 calendar day period from the futures commission merchant or a subsidiary or affiliate of the futures commission merchant consolidated pursuant to § 1.17(f) (or 17 CFR 240.15c3-1e), a net reduction in excess adjusted net capital (or, if the futures commission merchant is qualified to use the filing option available under § 1.10(h), excess net capital as defined in the rules of the Securities and Exchange Commission) of 30 percent or more, and
1. See 71 FR 57451 (September 29, 2006).
2. The JAC is a committee formed by U.S. commodity futures and options exchanges and the National Futures Association to coordinate audit and financial surveillance activities of FCMs.
3. The comment letters are available for inspection and copying at the Commission's Washington office in its public reading room, Room 4072, Three Lafayette Centre, 1155 21st Street, NW., Washington, DC 20581. The telephone number for the public reading room is (202) 418-5025. The comment letters are also available on the Commission's public Web site, at http://www.cftc.gov/​foia/​comment06/​foi06-007_​1.htm.
4. The Commission has revised other regulations to reflect the development of limited liability companies (“LLCs”). See, e.g. 69 FR 49784, 49793-4 (August 12, 2004). The amendments adopted in 2004 related to the management of LLCs, in order to determine persons with appropriate signature authority to file financial reports for the FCM or IB.
5. Commission regulations cited in this release may be found at 17 CFR Ch. I (2006). Generally speaking, Regulation 1.17(e) prohibits equity withdrawal transactions if such withdrawals would reduce the firm's adjusted net capital to less than 120 percent of its minimum adjusted net capital requirement under Regulation 1.17(a)(1). Such transactions also are prohibited if they would result in less than the minimum amount of equity required under Regulation 1.17(d), which provides that FCMs and IBs must maintain a debt-equity ratio of at least 30 percent equity.
6. Commission Regulation 1.17(f) requires, and in other circumstances permits, FCMs and IBs to consolidate the assets and liabilities of their subsidiaries and/or affiliates in a single computation of adjusted net capital for the FCM or IB and its consolidated entities.
7. Regulation 1.17(e) specifically requires the firm to combine the amount of the subject equity withdrawal transaction with any of the following that are scheduled to occur within six months after the subject withdrawal: any other proposed equity withdrawal; any payments under satisfactory subordination agreements under Regulation 1.17(h); and any payments of the liabilities identified in Regulation 1.17(c)(4)(vi).
8. Section 4f(b) of the Commodity Exchange Act (“Act”) authorizes the Commission, by regulation, to impose minimum financial and related reporting requirements on FCMs and IBs. The Act is codified at 7 U.S.C. 1 et seq. (2000), and Section 4f(b) of the Act is codified at 7 U.S.C. 6f(b).
9. 68 FR 40835, 40836 (July 9, 2003) (Minimum Financial and Related Reporting Requirements for Futures Commission Merchants and Introducing Brokers).
10. Section 4d of the Act is codified at 7 U.S.C. 6d (2000).
11. The term “foreign futures and foreign options secured amount” is defined in Regulation 1.3(rr).
12. Regulation 1.12(g) applies only to FCMs and not IBs.
13. Regulation 1.12(g)(2) also provides that the Commission may require the FCM to cause a Material Affiliated Person, as that term is defined in Commission Regulation 1.14(a)(2), to respond to requests for information from the Division Director.
14. The provisions of this regulation originally were included among several proposals made by the Commission in 1994 in response to the financial difficulties experienced by certain FCMs operating within holding company structures. These proposals were intended to provide the Commission with access to information concerning the activities of FCM affiliates whose activities were reasonably likely to have a material impact on the financial or operational condition of the FCM. The Commission subsequently determined, in response to the recommendations of several commenters, that the notice requirements in Regulation 1.12(g) should be applied broadly to all FCMs, and not just to those subject to reporting requirements with respect to their material affiliates. See, generally, 59 FR 9689, 9690-9691 (March 1, 1994) (Risk Assessment for Holding Company Systems).
15. 61 FR 19177, 19180 (May 1, 1996).
16. A copy of the SEC order, dated October 13, 2005, may be accessed electronically at http://www.sec.gov/​rules/​other/​34-52606.pdf.
17. This SEC regulation also provides that an order temporarily prohibiting the withdrawal of capital shall be rescinded if, sometime after a hearing that is to be held within two business days from the date of the request in writing by the broker or dealer, the SEC determines that the restriction on capital withdrawal should not remain in effect. See 17 CFR 240.15c3-1(e)(3)(ii).
18. 55 FR 34027, 34030 (August 15, 1990) (proposing amendments to SEC Regulation 15c3-1 regarding withdrawals of equity capital).
19. Paragraph (g) of Regulation 1.17 currently is reserved.
20. In the years since the Commission last adopted rule amendments addressing equity withdrawal transactions, the amount of funds that FCMs are required to hold as segregated funds has more than doubled. As of August 31, 1995, FCMs were required to hold approximately $25 billion as segregated funds, and $6 billion as secured funds. As of December 31, 2005, the amount that FCMs were required to hold as segregated funds had increased to over $95 billion, and the amount required to be held as secured funds had grown to almost $25 billion.
21. 71 FR at 57452.
22. 44 U.S.C. 3507(d).
23. 71 FR at 57453.
24. 71 FR at 5745.