Source: http://www.thefederalregister.com/d.p/2010-01-20-2010-456
Timestamp: 2014-08-21 02:20:28
Document Index: 329636470

Matched Legal Cases: ['art 7114', 'art 3944', 'art 6726', 'art 140', 'art 5250', 'art 1739', 'art 30206', 'art 514', 'art 9740', 'art 180', 'arts 1', 'art 35']

14 CFR Part 7114 CFR Part 3944 CFR Part 6726 CFR Part 140 CFR Part 5250 CFR Part 1739 CFR Part 30206 CFR Part 514 CFR Part 9740 CFR Part 180	Federal Register: January 20, 2010 (Volume 75, Number 12)
DOCID: fr20ja10-26
FR Doc 2010-456
CFR Citation: 17 CFR Parts 1, 3, 4, et al.
RIN ID: RIN 3038-AC61
SUBJECT CATEGORY: Regulation of Off-Exchange Retail Foreign Exchange Transactions and Intermediaries DATES: Comments must be received on or before March 22, 2010.
DOCUMENT SUMMARY: The Commodity Futures Trading Commission (``Commission'' or ``CFTC'') is proposing to adopt a comprehensive regulatory scheme (``Proposal'') to implement the CFTC Reauthorization Act of 2008 (``CRA'') \1\ with respect to offexchange transactions in foreign currency with members of the retail public (i.e., ``retail forex transactions''). The Commodity Exchange Act, as amended by the CRA, generally provides that the Commission's jurisdiction extends to contracts of sale of a commodity for future delivery (or an option on such a contract) or an option (other than an option executed or traded on a national securities exchange), and to certain leveraged or margined contracts in foreign currency that are offered to or entered into with retail customers. The Commission is proposing a scheme that would put in place requirements for, among other things, registration, disclosure, recordkeeping, financial reporting, minimum capital, and other operational standards, based on both the CFTC's existing regulations for commodity interest transactions and commodity interest intermediaries, as well as rules of the National Futures Association (``NFA'') that are already existing with respect to retail forex transactions offered by NFA's members. Additionally, the Proposal would amend existing regulations as needed to clarify their application to, and inclusion in, the new regulatory scheme for retail forex.
\1\ Food, Conservation, and Energy Act of 2008, Pub. L. 110246, 122 Stat. 1651, 21892204 (2008).
SUMMARY: Commodity Futures Trading Commission
The CRA provides the Commission with broad authority to ``make, promulgate and enforce such rules and regulations as, in the judgment of the Commission, are reasonably necessary to effectuate any of the provisions of [the Commodity Exchange] Act'' in connection with offexchange foreign currency futures, options, and options on futures, as well as leveraged offexchange contracts offered to or entered into with retail customers.\2\ The Commission is given similarly broad authority to promulgate and enforce rules regarding registration of persons who solicit, exercise discretionary trading authority or operate or solicit funds in connection with any of these types of transactions.\3\ \2\ See, 7 U.S.C. 2(c)(2)(B)(v) and 7 U.S.C. 2(c)(2)(C)(ii)(III). \3\ See, 7 U.S.C. 2(c)(2)(B)(iv)(III) and 7 U.S.C. 2(c)(2)(C)(iii)(III).
Pursuant to this authority, the Commission is proposing a scheme that would put in place requirements for, among other things, registration, disclosure, recordkeeping, financial reporting, minimum capital, and other operational standards, based on both the CFTC's existing regulations for commodity interest transactions and commodity interest intermediaries, as well as rules of the National Futures Association (``NFA'') that are already existing with respect to retail forex transactions offered by NFA's members. Subject to certain exceptions (e.g., for certain regulated financial intermediaries not under the Commission's jurisdiction as established in the CRA), the Proposal would require persons offering to be or acting as counterparties to retail forex transactions but not primarily or substantially engaged in the exchange traded futures business, to register as retail foreign exchange dealers (``RFEDs'') with the CFTC. Registered futures commission merchants (``FCMs'') that are ``primarily or substantially'' (as defined in the Proposal) engaged in the activities set forth in the Act's definition of an FCM would be permitted to engage in retail forex transactions without also registering as RFEDs. The Proposal would further require certain entities other than RFEDs and FCMs that intermediate retail forex transactions to register with the Commission as introducing brokers (``IBs''), commodity trading advisors (``CTAs''), commodity pool operators (``CPOs''), or associated persons (``APs'') of such entities, as appropriate, and to be subject to the Act and regulations applicable to that registrant category. In addition, the Proposal would require any IB that introduces retail forex transactions to an RFED or FCM to be guaranteed by that RFED or FCM. The Proposal would also implement the $20 million minimum net capital standard established in the CRA for registering as an RFED or offering retail forex transactions as an FCM; propose an additional volumebased minimum capital threshold calculated on the amount an FCM or RFED owes as counterparty to retail forex transactions; and require RFEDs or FCMs engaging in retail forex transactions to collect security deposits in a minimum amount in order to prudentially limit the leverage available to their retail [[Page 3283]] customers on such transactions at 10 to 1. I. Background
A. The Commodity Futures Trading Commission Act of 1974
Congress created the Commission in 1974 as an independent agency with the mandate to regulate commodity futures and option markets in the United States by the enactment of the Commodity Futures Trading Commission Act of 1974.\4\ While the bill was being considered, the Department of the Treasury (``Treasury'') sent a letter to the Senate Committee with jurisdiction over the bill, expressing concerns that Treasury had regarding the effect that passage would have on the off
exchange foreign currency (``forex'') market that existed at the time between large, institutional customers.\5\ The letter contained proposed language for the bill which would have maintained the status quo for institutional offexchange forex trading, leaving jurisdiction over onexchange trading in futures and options contracts on forex with the newlycreated Commission. The bill was subsequently amended to add the suggested language contained in Treasury's letter, which was intended to give the Commission jurisdiction over retail forex transactions and to exclude from the Commission's jurisdiction the off
exchange, institutional ``interbank'' market in foreign currencies. This language, which has come to be known as the ``Treasury Amendment,'' provided that: \4\ Public Law 93643, 88 Stat. 1389 (1974).
\5\ See, Letter from Donald L.E. Ritger, Acting General Counsel, Department of the Treasury, to the Hon. Herman E. Talmadge (July 30, 1974), reprinted at 1974 U.S.C.C.A.N. 5843, 588789. Nothing in this Act shall be deemed to govern or in any way be applicable to transactions in foreign currency * * * unless such transactions involve the sale thereof for future delivery conducted on a board of trade.\6\ \6\ Id. at 51.
As is discussed below, over time, and on numerous occasions, the Commission and the courts have opined on the proper boundaries of this exclusion. The Commission first addressed the possible scope of the Treasury Amendment with regard to offexchange transactions in securities issued by the Government National Mortgage Association (``GNMA''). In an interpretive letter issued by the Commission's Office of General Counsel, Commission staff stated that the remarks by the Senate Committee were an expression that regulation by the Commission is unnecessary where there exists an informal market among institutional participants in transactions for future delivery in the specified financial instruments only so long as it is supervised by those agencies having regulatory responsibility over those participants. However, where that market is not supervised and where those transactions are conducted with participation by members of the general public, we do not understand the Committee to have intended that a regulatory gap should exist. In these circumstances, we believe the Commodity Exchange Act should be construed broadly to assure that the public interest will be protected by Commission regulation of those transactions.\7\
\7\ Dealers in GNMA Certificates as a Board of Trade, CFTC Staff Interpretive Letter No. 7712, [19771980 Transfer Binder] Comm. Fut. L. Rep. (CCH) ] 20,467 (Aug. 17, 1977). The scope of the exclusion, again with regard to offexchange transactions in GNMA securities, was addressed by the U.S. Court of Appeals for the Seventh Circuit (``Seventh Circuit'') when it determined that the Treasury Amendment did not exclude options on government securities from the Commission's authority.\8\ Specifically, the court determined that although trading in GNMA securities was excluded from the Commission's jurisdiction, trading in options on such instruments was within the Commission's authority. As the court stated:
\8\ Board of Trade of Chicago v. SEC, 677 F. 2d 1137, 1154 (7th Cir. 1982), vacated as moot, 459 U.S. 1026 (1982). From the legislative history, it is quite clear that the Treasury Amendment was adopted by Congress only to prevent dual regulation by the CFTC and bank regulatory agencies of the banks and other sophisticated institutions that ordinarily trade in financial instruments.\9\
\9\ Id. at 1154.
Following that discussion, in 1985, the Commission issued a Statutory Interpretation concerning the Treasury Amendment that specifically dealt with forex.\10\ Responding to reports that forex futures contracts were being offered to retail customers on an off
exchange basis, under the assumption that such transactions were excluded from the Commission's jurisdiction, the Commission reaffirmed and republished its views, as follows:
\10\ Trading in Foreign Currencies for Future Delivery, 50 FR 42983 (Oct. 23, 1985).
[T]he Commission wishes to make very clear that any marketing to the general public of futures transactions in foreign currencies conducted outside the facilities of a contract market is strictly outside the scope of the [Treasury] Amendment. As a result, such an offexchange offer or sale of futures contracts involving foreign currencies is unlawful under section 4(a) of the Act, 7 U.S.C. 6(a) (1982).\11\
\11\ Id. at 42985.
The boundaries of the Treasury Amendment were again tested in Salomon Forex v. Tauber,\12\ where a sophisticated investor sought to invalidate a multimillion dollar trading debt by claiming that the Treasury Amendment only excluded spot or forward forex transactions from the Commission's jurisdiction, and that trading in offexchange futures and options were within the Commission's regulatory authority. If such transactions were deemed to be within the Commission's authority, then the transactions could only occur legally on an approved exchange. The Court determined that the Treasury Amendment excluded offexchange trading in futures and options as well as ``spot'' and ``forward'' transactions from the Commission's authority, if it involved ``sophisticated, largescale foreign currency traders.'' \13\ Although this holding has sometimes been misinterpreted to imply that offexchange forex transactions with the general public were outside the Commission's jurisdiction, this holding concerned only largescale traders and banks that made up the informal network of the foreign currency ``interbank'' market. Indeed, the Court itself noted that: ``[t]his case does not involve mass marketing to small investors, which would appear to require trading through an exchange and our holding in no way implies that such marketing is exempt from the CEA.'' \14\
\12\ 795 F. Supp. 768 (E.D. Va. 1992), aff'd, 8 F.3d 966 (4th Cir. 1993). \13\ Id. at 978. \14\ Id.
B. The Futures Trading Practices Act of 1992
The Futures Trading Practices Act of 1992 reorganized certain sections of the Commodity Exchange Act, 7 U.S.C. 1, et seq. (2000) (the ``Act'') and gave the Commission significant exemptive authority over the activities of a wide variety of persons, including FCMs, CTAs, and CPOs. It was pursuant to this exemptive authority that the Commission addressed some aspects of the overthecounter (``OTC'') markets by adopting Part 35 of its regulations, which provides an exemption from regulation for certain swap agreements.\15\ However, the Commission did not use its newly [[Page 3284]]
granted exemptive authority in the context of retail forex.\16\
\15\ See, Exemption for Certain Swap Agreements, 58 FR 5587 (Jan. 22, 1993).
\16\ See, e.g., Sections 4(c) and 4(d) of the Act, 7 U.S.C. 6(c) and 6(d). Rather, the Commission's efforts were directed to combating forex fraud activities through increased enforcement and public awareness. In response to increased fraud activity in the forex markets, the CFTC issued a fraud advisory to the public on March 30, 1998.\17\ Notwithstanding the Commission's guidance and the legislative history, the ambiguity of the Treasury Amendment continued to present opportunities for defendants to challenge the Commission's jurisdiction in the courts, which consumed much of the Commission staff's time and resources.\18\ Unfortunately, these challenges would persist until the adoption of the Commodity Futures Modernization Act of 2000 (``CFMA'').\19\
\17\ Fraud Advisory from the CFTC: Foreign Currency Trading (Forex) Fraud, available at: http://www.cftc.gov/customerprotection/
fraudawarenessandprevention/fraudadvisories/fraudadv_forex.html. The Commission also issued brochures to alert customers to the possible scams involving forex fraud. See CFTC Brochure on Forex Fraud, available at: http://www.cftc.gov/enf/enfforex.htm and http://www.cftc.gov/stellent/groups/public/
@cpfraudawarenessandprotection/documents/file/enfforexbrochure.pdf (last visited Oct. 15, 2009).
\18\ For instance, in Dunn & Delta Consultants, Inc. v. CFTC, 519 U.S. 465, 469 (1997), the U.S. Supreme Court held that foreign currency options were ``transactions in foreign currency'' within the meaning of the Treasury Amendment.
\19\ Consolidated Appropriations Act of 2001, Public Law 106
554, App. E, 114 Stat. 2763 (2000), available at Commodity Futures Modernization Act of 2000, [20002002 Transfer Binder] Comm. Fut. L. Rep. (CCH) ] 28,433 (Dec. 21, 2000). Under the Treasury Amendment, retail forex transactions were excluded from the Commission's jurisdiction unless they were conducted on a ``board of trade.'' This broad phrase caused further confusion when courts tried to interpret its meaning in order to delineate where the Commission's jurisdiction ended. The U.S. Court of Appeals for the Ninth Circuit (``Ninth Circuit'') relied on the language in the Senate Committee report to interpret the clause and believed that a proper reading of the Treasury Amendment excluded all offexchange forex transactionseven with retail customersfrom the Commission's jurisdiction and that the Commission only had jurisdiction over forex transactions traded on organized exchanges.\20\ Other courts interpreting the same clause came to the conclusion that retail off
exchange forex transactions were within the Commission's jurisdiction and that the legislative history indicates that only large institutional trades were intended to be excluded from the Commission's oversight.\21\
\20\ CFTC v. Frankwell Bullion Ltd., 99 F. 3d 299 (9th Cir. 1996).
\21\ See, CFTC v. Baragosh, 278 F.3d 319 (4th Cir. 2002), which relied on the Conference Committee Report, not mentioned in Frankwell Bullion, to arrive at the opposite conclusion from the Ninth Circuit; See also, CFTC v. Standard Forex, No. CV930088 (CPS). 1993 WL 809966 (E.D.N.Y. Aug. 9, 1993).
C. The Commodity Futures Modernization Act of 2000
The CFMA amended the Act to clarify the jurisdiction of the Commission in the area of forex futures and options trading. For the first time, offexchange retail forex transactions were expressly permitted, provided the counterparty was one of certain enumerated, regulated entities listed in the Acte.g., a registered FCM.\22\ Transactions between certain institutional entities (eligible contract participants, or ``ECPs'' \23\) remained outside the Commission's jurisdiction altogether, based on several provisions of the Act and the Commission's regulations.\24\ Shortly after the adoption of the CFMA, however, the Commission and the National Futures Association (``NFA'') \25\ noted that firms were registering as FCMs but not engaging in any exchangetraded activities. Rather, they were limiting their activities solely to retail forex. Additionally, the Commission noted that firms were registering as FCMs but conducting retail forex transactions through unregistered affiliates. Nothing in the Act or CFMA's amendments to the Act prohibited these ``shell FCMs'' from conducting business through their unregistered affiliates.
\22\ See, 7 U.S.C. 2(c)(2)(B). Broadly stated, these entities included: (1) A financial institution; (2) a registered broker/
dealer (``BD'') or FCM; (3) an insurance company; (4) a financial holding company; and (5) an investment bank holding company.
\23\ Section 1(c)(12) of the Act defines the term ``eligible contract participant.'' Entities classified as ECPs include financial institutions, insurance companies, certain commodity pools and individuals who meet certain asset thresholds. NonECPs, generally speaking, are retail custome